While you maybe right about the tough aspects and sustainability of the old MFI model, we need to see where this lending segment is going. Ever since DEMON, the old JLG model has shown its weakness in times of widespread stress in the economy, whether the catalyst is exogenous or endogenous, micro or macro doesn’t matter. The group liability breaks down when everyone is under stress.
The JLG model was very similar to the new Credit card (CC) business, the lenders would start newly acquired customers with very low amounts of credit to gauge their repayment ability, motivation and discipline. Once a repayment relationship was established the good customers were graduated to an expanding relationship.
Today the JLG model has just become a funnel for separating the wheat from the chaff, the graduating customer after their 3rd or 4th cycle moves on to bigger individual, business, and home loans. I would hazard a guess that those who graduate from the JLG model are more entrepreneurial and industrious and this helps in growing the relationship. Yes, there may be a loophole here for evergreening by the lenders but it seems highly improbable that a lot of relationships graduate from an 8k credit to an 8 lacs loan amount on just evergreening. If it does, then this would just be a big Ponzi scheme by the lenders in pursuit of valuations.
There is a lot of competition for prime lending, and the middle segment, even for the bottom segment the competition is heating up. There is value to be found/grabbed/created here but it’s just harder. There is also the risk of these bottom-up lending institutions painstakingly growing the relationship to a bigger size and bigger banks just taking the cream away when the time is right with no investment. Access to credit bureau data just levels the playing field for all lenders and the database is only going to get more extensive as the years pass.
For these lenders to become institutions, they need growth, growth is fueled by capital raising, and capital raising requires trust, confidence, and stable ROA to fuel a healthy PB above 1 so that each capital raise is value accretive from the start. Unfortunately, when the sector was initially listed everyone was enamoured by the growth and high ROEs and granted even 5x valuations to MFIs. At one point Bandhan was the most expensive bank in the world. Now these lenders even struggle to a steady state PB of 1.5. The reason is that the market is unsure of what the full cycle ROA/ROE for this business is, and unless the investors get a concrete idea of this they won’t have the confidence to invest in these lenders for the longer term and impart valuations required for institutionalization.
Currently, the sector is indeed a long shot, if things go right, there will be lots of value creation for the believers and if not at current undemanding valuations the risk of capital loss is low and at worse one may get away with low returns. An asymmetric bet if you will.