IFMR Mezzanine Finance

Over the years, India’s banking sector has grown steadily with the total deposits increasing at an average annual growth rate of 18%. About 100 commercial banks are in operation currently, with 30 of them being state owned, 30 private sector banks and the remaining 40 being foreign banks . Despite these impressive figures, the rural poor in India still have very little access to formal finance. A recent World Bank-NCAER Survey on rural access to finance indicates that 70 percent of the rural poor do not have a bank account and approximately 87 percent have no access to credit from a formal source. Poor households in general, need access to credit and other financial services and do not possess it. In India, it is estimated that there are approximately 7.5 crore poor households, of which 6 crore are rural and 1.5 crores urban households. Assuming that each family needs about Rs. 2000, the total annual requirement of credit would be Rs. 15,000 crores. This does not include demand estimates for savings, insurance or housing. Bank advances to weaker sections in 1997-98 was about Rs. 9700 crores, while Microfinance Institutions (MFIs) and SHGs together contributed about 137 crores. This indicates a vast unmet gap in the provision of financial services .

One of the ways in which access to finance can be extended to the poor is through MFIs. The last decade has seen a tremendous growth in the area of microfinance, with increasing interest in the sector displayed by banks that are more willing to increase their exposure to this sector and a growing number of commercially oriented microfinance institutions . Specifically in India, there are several factors that act favourably leading to a conducive environment for the growth of MFIs like a vibrant commercial banking sector, the presence of operationally sound MFIs and a regulatory environment that permits multiple models of building access to credit . Keeping in mind the number of people that have to be included in a formal financial system, MFIs need to scale and the one factor that seems to be impeding scale seems to be access to capital and liquidity.

Rationale for mezzanine finance:

There are multiple factors that make mezzanine finance in the microfinance sector a welcome development.

The first factor is the high capital requirements brought on by the impending change in the regulatory framework, particularly for recently formed NBFCs. While there are no regulatory norms that affect the capital requirements of microfinance institutions that are NGOs, trusts or societies, there is a lack of growth capital available to the sector. As a consequence, several of these microfinance institutions that have legal forms that are not considered commercially viable, such as NGOs, trusts, societies or section 25 companies, find it difficult to access capital which in turn severely restricts their growth.

In the absence of easy access to debt capital, most institutions turn to equity infusion early on in their lifestage. Such a development leads to a rapid dilution of the promoter’s stake in the organisation, which can pose a threat to the robustness of the sector as a whole. On the other hand, infusion of capital in the form of subordinated debt allows other lenders to treat it almost at par with equity, thereby delaying the need for equity capital and facilitating the flow of debt capital.

Currently, entities that provide debt capital for a mid to long term horizon are few and far between. Given this scenario, most MFIs have to depend on equity capital for rapid expansion, which poses the danger of diluting the equity at a critical life-stage of the MFI. Also, with the new prudential norms, there is a need to maintain debt to equity in the ratio 6:1, which is difficult to achieve for most MFIs that are starting off or aiming to expand rapidly with the limited access to debt capital. This situation creates a high demand for a product like mezzanine finance.

About IFMR Mezzanine Finance

IFMR Mezzanine Finance operates under the overall vision of IFMR Trust of ensuring that every individual and every enterprise in India has complete access to financial services. One of the key processes that has emerged in the past decade to facilitate access to financial services is microfinance. While the microfinance sector is gaining momentum and the past decade has seen the establishment of several microfinance institutions (MFIs) in the country, not all of these are able to attract funds easily.

IFMR Mezzanine Finance believes that enabling small to medium MFIs to access funds would catalyse growth in the sector and allowing a larger number of individuals to benefit from this growth. Further, IFMR Mezzanine Finance proposes to provide long term loans and partner with the MFIs during the tenure of the loan to assist them in strengthening their internal processes. This strategy has been developed to catalyse growth in the microfinance sector while ensuring that the resultant asset class develops in a robust manner.

IFMR Mezzanine Finance will work with NGOs, Trusts, Societies, Section 25 companies as well as NBFCs, particularly the recently formed NBFCs who have outstanding portfolios of less than Rs. 300 million.

Download IFMR Mezzanine finance presentation at the AmFA business meet, Bhopal, 26 February 2010

Download the list of pre-due diligence criteria

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