INDIA’S largest microfinance lender, SKS Microfinance, hopes to raise US$250 million in July through an initial public offering (IPO) – the first microfinance institution (MFI) in the country to go for a listing.

Not only does SKS’s impending IPO spotlight India’s rapidly expanding microfinance industry, it also revives the debate about how MFIs should be funded. Traditionally, MFIs finance their lending through donations or deposits from borrowers. A more controversial, though increasingly popular option is private equity funding.

Since its inception in 1997 as a non-governmental organisation, Swayam Krishi Sangam (SKS) has shown phenomenal growth. SKS became a non-banking finance company in 2005 and converted into a public limited company in May 2009.

From March 2006 to September 2009, the number of SKS’s active borrowers jumped from 172,970 to 5.3 million, its branch network expanded from 80 to 1,627 while its gross loan portfolio ballooned from 919 million rupees (RM65.3 million) to 32.1 billion rupees (RM2.3 billion), data compiled by Vikash Kumar and Daniel Rozas in Microfinance Focus shows.

Its return on equity swelled from 5.1% in the financial year (FY) ending March 2007 to 18.3% in FY 2009. On a loan portfolio of US$320 million, SKS earned US$18 million in FY 2009. For first time borrowers, SKS loans range from US$20 to US$260 at annual interest rates of 26.7% to 31.4%.

Prior to its IPO, SKS was the first Indian MFI to obtain private equity funding. Venture investors in SKS include Sequoia Capital India, Silicon Valley Bank and Bajaj Allianz Life Insurance. Another pre-IPO investor was Catamaran Management Services, a fund run by N.R. Narayana Murthy, co-founder of outsourcing giant, Infosys.

For private equity investors, the attraction of MFIs lies in two sets of figures: interest rates ranging from 30% to 60% and repayment rates exceeding 95%. These figures, compiled by Kavaljit Singh in Global Research, suggest MFIs are extraordinarily profitable.

Indeed, Sequoia Capital estimates its investment in SKS will yield a return of eight times. MFIs’ super profits have attracted tremendous criticism. Social activists claim high interest rates charged by MFIs are exploitative and could trap borrowers into a cycle of poverty. Another concern is pressure to boost profits could prompt microlenders to ignore the poor.

Critics should note three salient facts. First, microlending in India grew by an estimated 45% for the year ended March 2010, Micro-Credit Ratings International says. Despite the high interest rates charged, this suggests there is tremendous demand for microfinance.

Second, that repayment rates are five percentage points short of 100% suggests the activities for which the loans are used generate sufficient profit to ensure repayment. This indicates access to loans may be far more critical to the poor than the interest rate.

Third, while pioneer Grameen Bank in Bangladesh took 30 years to expand its client base to six million, SKS achieved the same feat in only six years. This suggests a more commercial orientation will enable an MFI to help a greater number of the poor and expand its reach far more quickly.

SKS’s business model should be studied by Malaysian policymakers because it offers a far more effective means of addressing the loan shark problem. In Malaysia, the most notable MFI is Amanah Ikhtiar Malaysia (AIM) which is funded by the federal government.

Malaysian policymakers should note microfinance can be adapted to Islamic finance. Although no figures were given, an article written by Abdul Aziz V.K. in Arab News says Islamic microfinance has demonstrated huge potential in fighting poverty and suggests zakat appears ideally suited to support microfinance.

Globally, the microfinance industry controls over US$50 billion in assets, Kavaljit Singh adds.

Three news items involving MFIs underscore microlending’s growth, profit potential and viability as a commercial undertaking.

The World Bank’s private investment arm, the International Finance Corp (IFC), this month invested in two MFIs – US$15 million in Lok II, a US$80 million venture capital fund that will invest in microfinance in India and an undisclosed sum in a Delhi-based microfinance outfit, Satin Creditcare Network.

In Mexico, Banco Compartamos, which raised US$467 million in an IPO in 2007, has US$633 million in outstanding loans which average US$450. Its 1.5 million customers appear undeterred by its average annual interest rate of 68%.

Another Indian MFI, Spandana Sphoorty Financial Ltd, is negotiating to raise US$60 million in equity capital from Singapore’s Temasek Holdings. Although the deal may be called off, the sum involved reflects Spandana’s 3.9 million borrowers and a portfolio under management of 31.5 billion rupees (RM2.24 billion).

In short, India’s microfinance sector is close to becoming a megatrend.

Opinions expressed in this article are the personal views of the writer and should not be attributed to any organisation she is connected with. Comments: letters@thesundaily.com