finance (microfinance) report

8/7/2019 finance (microfinance) report

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REPORT ON MICROFINANCE

ORIGIN OF MICROFINANCE

Over the past centuries practical visionaries the Franciscan monks who founded the community-

oriented pawnshops in the fifteenth century. A pawnbroker is an individual or business entity that

offers monetary loans in exchange for an item of value to the given pawn broker. The pawning

process begins when a customer brings an item into a pawnshop or pawn shop. The pawnbroker then

assesses it for its condition and sale ability, as well as the amount the customer may need for it. If the

pawnbroker is interested in the item, he offers the customer an amount for it. The customer can

either sell the item outright if as in most cases the Pawnbroker is also a licensed Secondhand Dealer,

or offer the item as collateral on a loan.

The European credit union movement in the nineteenth century (such as Friedrich Wilhelm

Raiffeisen). A credit union is a cooperative financial institution that is owned and controlled by its

members, and operated for the purpose of promoting thrift, providing credit at reasonable rates, and

providing other financial services to its members. Many credit unions exist to further community

development or sustainable international development on a local level. Worldwide, credit union

systems vary significantly in terms of total system assets and average institution asset size since

credit unions exist in a wide range of sizes, ranging from volunteer operations with a handful of

members to institutions with several billion dollars in assets and hundreds of thousands of members.

Yet Credit unions are typically smaller than banks; for example, the average U.S. credit union has$93 million in assets, while the average U.S. bank has $1.53 billion, as of 2007.

The founders of the microcredit movement in the 1970s (such as Muhammad Yunus) have tested

practices and built institutions designed to bring the kinds of livelihood opportunities and risk

management tools that financial services provide to the doorsteps of poor people. While the success

of Grameen Bank (which now serves over seven million poor Bangladeshi women) has inspired the

world, it has proved difficult to replicate this success in practice. In nations with lower population

densities, meeting the operating costs of a retail branch by serving nearby customers has proven

considerably more challenging.



INTRODUCTION

Microfinance is defined as any activity that includes the provision of financial services such as

credit, savings, and insurance to low income individuals which fall just above the nationally defined

poverty line, and poor individuals which fall below that poverty line, with the goal of creating social

value. The creation of social value includes poverty alleviation and the broader impact of improving

livelihood opportunities through the provision of capital for micro enterprise, and insurance and

savings for risk mitigation and consumption smoothing. A large variety of actors provide

microfinance in India, using a range of microfinance delivery methods. Since the founding of the

Grameen Bank in Bangladesh, various actors have endeavored to provide access to financial services

to the poor in creative ways. Governments have piloted national programs, NGOs have undertaken

the activity of raising donor funds for on-lending, and some banks have partnered with publicorganizations or made small inroads themselves in providing such services. This has resulted in a

rather broad definition of microfinance as any activity that targets poor and low-income individuals

for the provision of financial services. The range of activities undertaken in microfinance include

group lending, individual lending, the provision of savings and insurance, capacity building, and

agricultural business development services. Whatever the form of activity however, the overarching

goal that unifies all actors in the provision of microfinance is the creation of social value.

Microfinance Definition

According to International Labor Organization (ILO), ³Microfinance is an economic development

approach that involves providing financial services through institutions to low income clients´.

In India, Microfinance has been defined by Reserve Bank of India (R.B.I) as ³provision of thrift,

credit and other financial services and products of very small amounts to the poor in rural, semi-

urban or urban areas for enabling them to raise their income levels and improve living standards´.



Need of Microfinance

In developing economies and particularly in the rural areas, many activities that would be classified

in the developed world as financial are not monetized: that is, money is not used to carry them out.

Almost by definition, poor people have very little money. But circumstances often arise in their lives

in which they need money or the things money can buy.

Types of needs

Lifecycle Needs: such as weddings, funerals, childbirth, education, homebuilding,widowhood, old age.P ersonal Emergencies: such as sickness, injury, unemployment, theft, harassment or death.Disasters: such as fires, floods, cyclones and man-made events like war or bulldozing of dwellings.I nvestment Opportunities: expanding a business, buying land or equipment, improving

housing, securing a job (which often requires paying a large bribe), etc.

Poor people find creative and often collaborative ways to meet these needs, primarily through

creating and exchanging different forms of non-cash value. Common substitutes for cash vary from

country to country but typically include livestock, grains, jewellery and precious metals.

It's easy to imagine poor people don't need financial services, but when you think about it they are

using these services already, although they might look a little different.

"Poor people save all the time, although mostly in informal ways. They invest in assets such as gold,

jewelry, domestic animals, building materials, and things that can be easily exchanged for cash.They may set aside corn from their harvest to sell at a later date. They bury cash in the garden or

stash it under the mattress. They participate in informal savings groups where everyone contributes a

small amount of cash each day, week, or month, and is successively awarded the pot on a rotating

basis. Some of these groups allow members to borrow from the pot as well. The poor also give their

money to neighbors to hold or pay local cash collectors to keep it safe.

However widely used, informal savings mechanisms have serious limitations. It is not possible, for

example, to cut a leg off a goat when the family suddenly needs a small amount of cash. In-kind

savings are subject to fluctuations in commodity prices, destruction by insects, fire, thieves, or

illness (in the case of livestock). Informal rotating savings groups tend to be small and rotate limitedamounts of money. Moreover, these groups often require rigid amounts of money at set intervals and

do not react to changes in their members' ability to save. Perhaps most importantly, the poor are

more likely to lose their money through fraud or mismanagement in informal savings arrangements

than are depositors in formal financial institutions."-



"The poor rarely access services through the formal financial sector. They address their need for

financial services through a variety of financial relationships, mostly informal."

The formal financial sectors rarely provide services to poor people the reason for this give by

banks:

Poor don't have any money to open a savings account with Poor don't have any collateral to secure a loan with Poor don't have a credit record as they never been formally employed and they never taken

out a loan before Poor might even be unable to complete the necessary paperwork as they are illiterate.

"T he great challenge before us is to address the constraints that exclude people from full

participation in the financial sector... T ogether, we can and must build inclusive financial sectorsthat help people improve their lives."

- Kofi Annan, UN Secretary General



Microfinance in India

Microfinance has been in practice for ages (though informally).

Legal framework for establishing the co-operative movement set up in 1904.

Reserve Bank of India Act, 1934 provided for the establishment of the Agricultural Credit

Department.

In the early 1960s, India realized the high welfare costs that resulted from the financial exclusion of

low income segments, then predominantly dwelling in the country's rural areas. For those who had

access to financial services, the cost of doing business with informal credit providers was very high.

Identifying access to credit as an integral component of its development plan, the government

initiated focused initiatives to rectify the imperfections in rural credit markets. Until the late 1960s,

the credit delivery system in rural India was largely dominated by the cooperative segment. The

period between 1960 and 1990, referred to as the ³social banking´ phase, saw a series of measures

nationalization of private commercial banks, expansion of rural branch networks, extension of

subsidized credit, establishment of Regional Rural Banks (RRBs) and the establishment of apex

institutions such as the National Bank for Agriculture and Rural Development (NABARD) and the

Small scale Industries Development Board of India (SIDBI). By the early 1990s, these measures

showed results in terms of impressive rural outreach and credit volumes. However, it was also found

that the Institutional structure was neither profitable nor suitable to the needs of low income

population segments. The decade also saw the creation of many civil society initiatives such as the

SEWA Bank and the Women's Welfare Forum (WWF) extending credit to women workers in the

unorganized economy.

After 1990, India witnessed the second phase of initiatives in rural credit delivery. These mirroredother initiatives across the globe in the 1980s that operated on certain common principles such as the

reliance on peer pressure as opposed to physical collateral, self-sustainability, and self-help. It is

during this period that ³microfinance,´ as it is understood today, first emerged on the Indian

development scene. NABARD initiated the Self Help Group (SHG) - Bank Linkage program, which

links informal women's groups to formal banks. This concept held great appeal for non-government

organizations (NGOs) working with the poor, prompting many of them to collaborate with

NABARD in the program.

Such initiatives then led to the development of a new paradigm for what is now known as

³commercial microfinance´ or the ³financial system approach.´ This period was marked by theextension of credit at market rates, unlike the focus on subsidies during the social banking phase.

This period also witnessed the entry of another set of stakeholders Microfinance Institutions (MFIs),

largely of non-profit origins, with existing development programs. Financial intermediation emerged

as the new development mantra for engaging with the poor. They were supported in this effort by

apex institutions such as SIDBI, Rashtriya Mahila Kosh (RMK) and Friends of Women's World

Banking (FWWB) through extension of on-lending funds. Though initially aided by international



donors and soft loans, many of the NGO-MFIs went on to access commercial loan funds from

domestic banks and achieved extensive client outreach.

In 2000, the third phase in the development of Indian microfinance began, marked by further

changes in policies, operating formats, and stakeholder orientations in the financial services space. In

the current decade, India witnessed a surge in its economic growth, a result of the reforms initiatedin the early 1990s.

Amidst the general economic euphoria, a growing emphasis emerged on ³inclusive growth´ and

³financial inclusion.´ Microfinance and rural markets are seen as key drivers to meet this objective

and informal actors including NGOMFIs and SHGs, pioneers in the space, have gained greater

legitimacy. This period also saw many NGO-MFIs transform into regulated legal formats such as

Non-Banking Finance Companies (NBFCs). Commercial banks such as ICICI Bank adopted

innovative ways of partnering with NGO-MFIs and other rural organizations to extend their reach

into rural markets. MFIs have emerged as strategic partners to individuals and entities interested in

reaching out to India's low income client segments. Consumer finance, primarily driven by auto

finance, housing finance, and consumer durable finance, emerged as high growth area within the

financial system with many players competing for market share. There is increased policy

recognition, the latest measure being a specific microfinance bill proposed to be discussed in the

state parliament in the near future.



Microfinance Social Aspects

Micro financing institutions significantly contributed to gender equality and women¶s empowerment

as well as pro poor development and civil society strengthening. Contribution to women¶s ability to

earn an income led to their economic empowerment, increased well being of women and their

families and wider social and political empowerment.

Microfinance programs targeting women became a major plank of poverty alleviation and gender

strategies in the 1990s. Increasing evidence of the centrality of gender equality to poverty reduction

and women¶s higher credit repayment rates led to a general consensus on the desirability of targeting

women.

Activities in Microfinance

Microcredit: It is a small amount of money loaned to a client by a bank or other institution.

Microcredit can be offered, often without collateral, to an individual or through group

lending.

Micro savings: These are deposit services that allow one to save small amounts of money

for future use. Often without minimum balance requirements, these savings accounts allow

households to save in order to meet unexpected expenses and plan for future expenses.

Micro insurance: It is a system by which people, businesses and other organizations make a

payment to share risk. Access to insurance enables entrepreneurs to concentrate more on

developing their businesses while mitigating other risks affecting property, health or the

ability to work.

R emittances: These are transfer of funds from people in one place to people in another,usually across borders to family and friends. Compared with other sources of capital that can

fluctuate depending on the political or economic climate, remittances are a relatively steady

source of funds.

Estimating Demand for Microcredit

To estimate India's annual microcredit demand and identify the potential users of credit, weanalyzed data along the following variables:

Incidence of Poverty using Census 2001 population data, poverty ratios, and average loans

sizes for potential microfinance clients

Economic Activities of Low Income Segments assessing demand for financial services from

marginal and small operational landholders, landless agricultural laborers, and non-agri

microentrepreneurs

Penetration of formal banking services exploring the current outreach of financial services



I. Incidence of Poverty

Understanding the 'poor,' a segment with credit needs for consumption smoothening and deployment

in productive activities, is important in estimating annual microcredit demand. India's currentpopulation, corrected for 1.6 annual percent population growth since 2001, is estimated at 1.1 billion

people. Further, according to the 2001 census, a poverty ratio of 26 percent of India's population

lives below the national poverty line (NPL), which corresponds to 289.6 million people, while 34.7

percent or 386.5 million people live below the international poverty line (IPL). Assuming one

microfinance client per household and given that the average number of people per household is

five, the potential number of below poverty line (BPL) microfinance clients ranges from 57.9 million

to 77.3 million. To determine the amount of on-lending capital required for these BPL clients, an

annual average loan size of USD 98.8 (INR 4,000) to USD 246.9 (INR 10,000) is used. Applying

these loan amounts to the poor population identified above, the annual credit demand could result in

financing requirements of USD 5.7 billion (INR 231.6 billion) USD 19.08 billion (INR 773 billion).

Annual Microfinance Demand (Using National P overty Line [N PL] Statistics)

Loan size (INR) Potential Client NPL Financial R equirements- National

INR crores

4,000 23,160

5,000 28,950

6,000 34740

7,000 57.9 M 40530

8,000 46,320

9,000 52110

10,000 57900



Annual Microfinance Demand (Using I nternational P overty Line [ IPL] Statistics)

Loan size (INR) Potential Clients IPL Financial R equirements -

International INR crores

4,000 30,920

5,000 38,650

6,000 46,380

7,000 77.3M 54,110

8,000 61,840

9,000 69,570

10,000 77,300

Economic Activities of Low Income Segment

Given that there are many individuals in the low income segment who might not qualify as 'poor'

under the national or international poverty line but need small amounts of credit for economic

activities, understanding such economic segments could prove useful while estimating microcredit

demand. This segment includes landless agricultural workers and laborers, small and marginal

farmers, rural artisans and craftsman, and those who are self-employed in the informal sector. Given

difference in income, albeit incremental, it is important to note that small and marginal farmer andmicroentrepreneurs or the self-employed typically have a slightly higher income than laborers.

Therefore, the first group requires credit for productive purposes, while very poor individuals such

as landless agricultural laborers, typically need credit primarily for household consumption. While a

number of these individuals may not fall below the national or international poverty lines, many still

do not have access to credit and other mainstream financial services. Consequently, these low-

income groups should be included in the potential market that Indian microfinance providers can

serve.

In 2005, the number of operational landholdings in India was 137.6 million. Of these, 80% or 110.5

million were cultivated by marginal and small farmers, who hold less than 1 hectare and between 1-2hectares, respectively. If one landholding per household is taken, then there are 110.5 million

landowners that could be potential microfinance clients. Assuming annual credit demand of USD

250 (INR 10,125) per landholding, the annual on-lending requirements by microfinance providers to

serve this population could be estimated at around USD 27 billion (INR 1.1 trillion).



While the above segment represents the bottom of the pyramid in terms of landholdings, a large

percentage of the total credit need comes from another portion of the rural economy landless

agricultural laborers. Estimates from the Commerce Ministry indicate that there are 100 million

landless agricultural laborers across the country. With an average USD 150 (INR 6,075) annual

credit demand from a client within this segment, the industry will require approximately USD 15

billion (INR 607.5 billion) in annual on-lending capital to address their credit needs. Looking

beyond agricultural employment, another occupational segment with credit demands are non-agri

enterprises. In India, of the 42.12 million enterprises operating in 2006, 35.7 million constituted such

a segment within which 98.6 percent were microenterprises. The number of non-agri

microenterprises therefore totals 35.2 million. This segment, like small and marginal landholders,

requires an average annual credit amount of USD 250 (INR 10,125). Given this figure, the annual

on-lending requirements to serve this segment amount to USD 8.8 billion (INR 356.4 billion).

Combined, these three population sets amount to 245.7 million people with a total annual credit

demand of approximately USD 51.4 billion (INR 2.08 trillion)



THE SUPPLY SIDE STORY OF MICROFINANCE

Reaching out to India's vast low income population with flexible financial services presents a

formidable challenge. India's financial service providers range from formal banks to informal actors

such as moneylenders and semi-formal players such as microfinance institutions.

I ndia's Financial Service P roviders: Level of Access

The status of the country's banking infrastructure, a formal institutional source, has progressed

significantly since the 1960s when social banking reforms were initiated. As of June 2006, India hadan extensive network of 222 commercial banks with 69,417 branches. The average population

served by a bank branch has come down from 64,000 in 1969 to 16,000 in 2006 . However, there

remain disparities in the geographic distribution of bank branches and credit extension. Many

regions such as the Northeast, East, and Central India still have an average population per branch

much higher than the all India average. The addition of branches is also relatively low in such

regions.

According to the 2001 Census, more than half of India's population does not have access to

the formal banking system.



Bank Coverage by Region 2005-06

While Indian banks' extension of credit continues to grow, many sections of the population remain

excluded from the banking system. According to the 2001 Census, more than half of India's

population does not have access to the formal banking system. Even more alarming, financial

exclusion is much higher in rural areas, home to a large proportion of low income individuals.

As of 2002, an analysis of the sources of credit access to Indian households, the percentage share of

institutional providers of credit was around 57.1 percent in rural India and 75.1 percent in urban

areas. Of the non-institutional credit sources, moneylenders hold an alarmingly high share of 30

percent in the total indebtedness of rural households. This indicates that banks and other institutionalcredit suppliers are unable to meet the needs of many households. It is well known that a large

portion of the above households who continue to access expensive, informal credit belongs to the

low income segments. Most often, such credit is accessed at exorbitant interest rates, sometimes

averaging 48 percent per year. It is in this context that semi-formal interventions such as the SHG-

Bank Linkage Program and fast growing MFIs become relevant in the supply of microcredit.

Semi-Formal Providers of Microcredit

Launched in 1991, the SHG-Bank Linkage Program aims to connect low-income and un-banked

individuals to formal banks. In its most popular form, NGOs facilitate bank linkages through

community mobilization and investments in client capacity building and financial literacy.

In the latter channel, MFIs are localized financial institutions that access social and commercial

funds to further on-lend such capital to clients after covering their costs and margins. Their legal

constitutions include for-profit, non-profit, and mutual benefit forms.

Some of the key characteristics that distinguish these two channels are shown in the table below:



Data shows that SHG-Bank Linkage microcredit supply has grown tremendously since its

implementation in 1991. By March 2003, the SHG channel had reached 11.6 million households

with a cumulative loan disbursement of USD 506 million (INR 20.5 billion). Between 2003 and

2007, the SHG channel continued to maintain high growth

According to NABARD progress reports, as of March 31, 2007, cumulatively, 2.92 million SHGs

have been linked to approximately 500 banks. Ten percent of the total banks linked to SHGs were

commercial banks, while 19.2 percent and 70.6 percent were regional rural and cooperative banks,

respectively. Cumulative loan disbursements to SHGs totaled nearly USD 4.45 billion (INR 180.4

billion) as on March 31, 2007.

Comparing the two Microfinance Channels:SHG-Bank Linkage Program and MFIs

It is evident that both SHG and MFI channels have seen a high level of activity within the last fewyears. As of March 2007, the two channels have collectively disbursed around USD 3.7 billion (INR

149 billion), addressing almost seven percent of our demand estimates of USD 51.4 billion (INR

2.08 trillion). Figure 19 shows the relative increase in disbursements by each channel during the

period 2003 to 2007.



Supply of Microfinance Services in Addition to Credit

While credit has been the primary product offered to microfinance clients since the start of

microfinance, the industry is increasingly finding ways to provide additional services such as

savings, insurance, remittances, and pensions. While the proposed Microfinance Bill 2007 may

determine whether or not savings can be formally collected, an increasing number of partnerships

could advance the industry in terms of other services. Increasing migration within and outside of

India necessitate remittance services for low-income individuals. Insurance and pensions also remain

important in order to address unexpected events and risks as well as the needs of elder low-income

individuals.

SAVINGS:

The Microfinance Bill, if passed in its current form, may have potential implications on savings, as it

facilitates NGO-MFIs in offering savings facilities to clients. Such MFIs should be registered as

non-profits or Section 25 companies, which can also become agents for banks that are offering

savings through the banking correspondent model.

INSUR ANCE:

Insurance supply to low-income segments is difficult to measure in India. However, as a percentage

of GDP in 2006-2007, it is reported that general insurance accounted for three percent while life

insurance accounted for 1.8 percent. Further, at the beginning of 2006, life insurance providers

³underwrote premiums of USD 7.3 billion (INR 296.6 billion)´ while non-life insurers ³underwrote



a premium of USD 3.05 billion (INR 123.7 billion).´ The current insurance penetration scenario is

an improvement over the level of life insurance penetration in 2005 at 2.53 percent and 0.62 percent

for non-life insurance.

With a large number of mainstream life and general insurance providers, there is increasing potential

for MFIs to tie up with such entities to offer insurance services to lower-income clients. The 2005

micro insurance regulation stipulates that NGOs, MFIs, and SHGs can act as agents to distribute

insurance to their clients.

R EMITTANCES:

With approximately USD 25.7 billion (INR 1.04 trillion) in remittances flowing into India in 2006, it

is important to understand the entities that are able to service such inflow. As of June 2006,

approximately ³Eighty seven commercial banks [were] designated as authorized dealers, while there

were 53 Money Transfer agents.´ Remittances are also transferred through a number of informal

agents including ³unregistered entities such as hawala dealers, returning migrants, friends, relatives

and trading companies. Designated post offices can also receive remittances.´ With growing low

income client bases, MFIs can play an important role in providing remittance services to their

clients. An initiative in this direction is the partnership forged between Western Union Money

Transfer and Spandana.

PENSION:

Sufficient data to determine pensions supply to low-income individuals or microfinance clients is

currently unavailable. However, the industry has recently witnessed UTI, a mainstream mutual fund

taking an active role in the provision of micro pensions. Following the launch of the scheme with

SEWA Bank in early 2006, UTI added new partners such as SHEPHERD, a southern MFI, and

Compfed, a Bihar based milk producers' federation.

While both the MFI and SHG channels are making progress, it has become clear that combined;

their efforts are barely touching the surface. In absolute terms, the SHG channel has spurred greater

outreach. However, with 28 percent disbursement in 2003 to 47 percent in 2007, MFIs are clearly

reaching out to a larger client base within shorter time periods. Further, although poverty appears

highest in the northeast, east, and central regions, it is evident that there is a movement towards

tapping into the market potential and filling the demand supply gap of those regions. Traditional

services combined with the market for insurance, remittances, and pensions, which are currently

small in supply, show good growth, but even more potential for the future industry.



Self Help Groups (SHGs)

Self- help groups (SHGs) play today a major role in poverty alleviation in rural India. A growing

number of poor people (mostly women) in various parts of India are members of SHGs and actively

engage in savings and credit (S/C), as well as in other activities (income generation, natural

resources management, literacy, child care and nutrition, etc.). The S/C focus in the SHG is the most

prominent element and offers a chance to create some control over capital, albeit in very small

amounts. The SHG system has proven to be very relevant and effective in offering women the

possibility to break gradually away from exploitation and isolation.

1 How self-help groups work

NABARD (1997) defines SHGs as "small, economically homogenous affinity groups of rural poor,

voluntarily formed to save and mutually contribute to a common fund to be lent to its members as

per the group members' decision".

Most SHGs in India have 10 to 25 members, who can be either only men, or only women, or only

youth, or a mix of these. As women's SHGs or sangha have been promoted by a wide range of

government and non- governmental agencies, they now make up 90% of all SHGs.

The rules and regulations of SHGs vary according to the preferences of the members and those

facilitating their formation. A common characteristic of the groups is that they meet regularly

(typically once per week or once per fortnight) to collect the savings from members, decide to which

member to give a loan, discuss joint activities (such as training, running of a communal business,

etc.), and to mitigate any conflicts that might arise. Most SHGs have an elected chairperson, a

deputy, a treasurer, and sometimes other office holders.

Most SHGs start without any external financial capital by saving regular contributions by the

members. These contributions can be very small (e.g. 10 Rs per week). After a period of consistent

savings (e.g. 6 months to one year) the SHGs start to give loans from savings in the form of small

internal loans for micro enterprise activities and consumption. Only those SHGs that have utilized

their own funds well are assisted with external funds through linkages with banks and other financial

intermediaries.





The system is very flexible. The group aggregates the small individual saving and borrowing

requirements of its members, and the bank needs only to maintain one account for the group as a

single entity. The banker must assess the competence and integrity of the group as a micro-bank, but

once he has done this he need not concern himself with the individual loans made by the group to its

members, or the uses to which these loans are put. He can treat the group as a single customer,

whose total business and transactions are probably similar in amount to the average for his normal

customers, because they represent the combined banking business of some twenty µmicro-

customers¶. Any bank branch can have a small or a large number of such accounts, without having to

change its methods of operation.

Unlike many customers, demand from SHGs is not price-sensitive. Illiterate village women are

sometimes better bankers than some with more professional qualifications. They know that rapid

access to funds is more important than their cost, and they also know, even though they might not be

able to calculate the figures, that the typical micro-enterprise earns well over 500% return on the

small sum invested in it (Harper, M, 1997, p. 15). The groups thus charge themselves high rates of

interest; they are happy to take advantage of the generous spread that the NABARD subsidized bank

lending rate of 12% allows them, but they are also willing to borrow from NGO/MFIs which on-lend

funds from SIDBI at 15%, or from µnew generation¶ institutions such as Basix Finance at 18.5% or

21%.

4. SHGs-Bank Linkage Model

NABARD is presently operating three models of linkage of banks with SHGs and NGOs:

Model ± 1: In this model, the bank itself acts as a Self Help Group Promoting Institution (SHPI). It

takes initiatives in forming the groups, nurtures them over a period of time and then provides credit

to them after satisfying itself about their maturity to absorb credit. About 16% of SHGs and 13% of

loan amounts are using this model (as of March 2002).

Model ± 2: In this model, groups are formed by NGOs (in most of the cases) or by government

agencies. The groups are nurtured and trained by these agencies. The bank then provides credit

directly to the SHGs, after observing their operations and maturity to absorb credit. While the bank

provides loans to the groups directly, the facilitating agencies continue their interactions with the

SHGs. Most linkage experiences begin with this model with NGOs playing a major role. This model



has also been popular and more acceptable to banks, as some of the difficult functions of social

dynamics are externalized. About 75% of SHGs and 78% of loan amounts are using this model.

Model ± 3: Due to various reasons, banks in some areas are not in a position to even finance SHGs

promoted and nurtured by other agencies. In such cases, the NGOs act as both facilitators and micro-

finance intermediaries. First, they promote the groups, nurture and train them and then approach

banks for bulk loans for on-lending to the SHGs. About 9% of SHGs and 13% of loan amounts are

using this model.

Comparative Analysis of Micro-finance Services offered to the poor

Source: R. Arunachalam - Alternative Technologies in the Indian Micro- finance Industry



5. Life insurances for self-help group members

The United India Insurance Company has designed two PLLIs (personal line life insurances) for

women in rural areas. The company will be targeting self-help groups, of which there are around

200,000 in the country, with 15-20 women in a group. The two policies are

(1) the Mother Teresa Women & Children Policy, with the aim of giving to the woman in the event

of accidental death of her husband and to support her minor children in the event of her death, and

(2) The Unimicro Health Scheme, giving personal accident and hospitalization covers besides cover

for damage to dwelling due to fire and allied perils.

Source: http://www.hinduonnet.com/2002/12/05/stories/2002120501172100.htm



Micro Finance Models

1. Micro Finance Institutions (MFIs):

MFIs are an extremely heterogeneous group comprising NBFCs, societies, trusts and cooperatives.They are provided financial support from external donors and apex institutions including the

Rashtriya Mahila Kosh (RMK), SIDBI Foundation for micro-credit and NABARD and employ a

variety of ways for credit delivery.

Since 2000, commercial banks including Regional Rural Banks have been providing funds to MFIs

for on lending to poor clients. Though initially, only a handful of NGOs were ³into´ financial

intermediation using a variety of delivery methods, their numbers have increased considerably today.

While there is no published data on private MFIs operating in the country, the number of MFIs is

estimated to be around 800.

Legal Forms of MFIs in India

Types of MFIs Estimated

Number* Legal Acts under which R egistered

1. Not for Profit MFIs

a.) NGO - MFIs

400 to 500 Societies Registration Act, 1860 or similar Provincial Acts

Indian Trust Act, 1882

b.) Non-profit Companies 10 Section 25 of the Companies Act, 1956

2. Mutual Benefit MFIs

a.) Mutually Aided CooperativeSocieties (MACS) and similarlyset up institutions

200 to 250 Mutually Aided Cooperative SocietiesAct enacted by State Government

3. For Profit MFIs

a.) Non-Banking FinancialCompanies (NBFCs)

6 Indian Companies Act, 1956

Reserve Bank of India Act, 1934

Total 700 - 800

Source: NABARD website



2. Bank Partnership Model

This model is an innovative way of financing MFIs. The bank is the lender and the MFI acts as an

agent for handling items of work relating to credit monitoring, supervision and recovery. In other

words, the MFI acts as an agent and takes care of all relationships with the client, from first contact

to final repayment. The model has the potential to significantly increase the amount of funding that

MFIs can leverage on a relatively small equity base.

A sub - variation of this model is where the MFI, as an NBFC, holds the individual loans on its

books for a while before securitizing them and selling them to the bank. Such refinancing through

securitization enables the MFI enlarged funding access. If the MFI fulfils the ³true sale´ criteria, the

exposure of the bank is treated as being to the individual borrower and the prudential exposurenorms do not then inhibit such funding of MFIs by commercial banks through the securitization

structure.

3. Banking Correspondents

The proposal of ³banking correspondents´ could take this model a step further extending it to

savings. It would allow MFIs to collect savings deposits from the poor on behalf of the bank. It

would use the ability of the MFI to get close to poor clients while relying on the financial strength of

the bank to safeguard the deposits. This regulation evolved at a time when there were genuine fears

that fly-by-night agents purporting to act on behalf of banks in which the people have confidence

could mobilize savings of gullible public and then vanish with them. It remains to be seen whether

the mechanics of such relationships can be worked out in a way that minimizes the risk of misuse.

4. Service Company Model

Under this model, the bank forms its own MFI, perhaps as an NBFC, and then works hand in hand

with that MFI to extend loans and other services. On paper, the model is similar to the partnership

model: the MFI originates the loans and the bank books them. But in fact, this model has two very

different and interesting operational features:



(a) The MFI uses the branch network of the bank as its outlets to reach clients. This allows the client

to be reached at lower cost than in the case of a stand±alone MFI. In case of banks which have large

branch networks, it also allows rapid scale up. In the partnership model, MFIs may contract with

many banks in an arms length relationship. In the service company model, the MFI works

specifically for the bank and develops an intensive operational cooperation between them to their

mutual advantage.

(b) The Partnership model uses both the financial and infrastructure strength of the bank to create

lower cost and faster growth. The Service Company Model has the potential to take the burden of

overseeing microfinance operations off the management of the bank and put it in the hands of MFI

managers who are focused on microfinance to introduce additional products, such as individual loans

for SHG graduates, remittances and so on without disrupting bank operations and provide a more

advantageous cost structure for microfinance.



R ole, Functions and Working Mechanism of Financial Institutions

1. ICICI Bank

ICICI¶s microfinance portfolio has been increasing at an impressive speed. From 10,000

microfinance clients in 2001, ICICI Bank is now (2005) lending to 1.2 million clients through its

partner microfinance institutions, and its outstanding portfolio has increased from Rs. 0.20 billion

(US$4.5 million) to Rs. 9.98 billion (US$227 million). A few years ago, these clients had never been

served by a formal lending institution.

There is an increasing shift in the microfinance sector from grant-giving to investment in the form of

debt or equity, and ICICI believes grant money should be limited to the creation of facilitativeinfrastructure. ³We need to stop sending government and funding agencies the signal that

microfinance is not a commercially viable system´, says Nachiket Mor, Executive Director of ICICI

Bank.

As a result of banks entering the game, the sector has changed rapidly. ³There is no dearth of funds

today, as banks are looking into MFIs favorably, unlike a few years ago´, says Padmaja Reddy, the

CEO of one of ICICI Bank¶s major MFI partners, Spandana.

Partnership Models

A model of microfinance has emerged in recent years in which a microfinance institution (MFI)

borrows from banks and on-lends to clients; few MFIs have been able to grow beyond a certain

point. Under this model, MFIs are unable to provide risk capital in large quantities, which limits the

advances from banks. In addition, the risk is being entirely borne by the MFI, which limits its risk-

taking.



The MFI as Collection Agent

To address these constraints, ICICI Bank initiated a partnership model in 2002 in which the MFI acts

as a collection agent instead of a financial intermediary. This model is unique in that it combines

debt as mezzanine finance to the MFI (Mezzanine finance combines debt and equity financing: it is

debt that can be converted by the lender into equity in the event of a default.

This source of financing is advantageous for MFIs because it is treated like equity in the balance-

sheet and enables it to raise money without additional equity, which is an expensive financing

source.).The loans are contracted directly between the bank and the borrower, so that the risk for the

MFI is separated from the risk inherent in the portfolio. This model is therefore likely to have very

high leveraging capacity, as the MFI has an assured source of funds for expanding and deepening

credit. ICICI chose this model because it expands the retail operations of the bank by leveraging

comparative advantages of MFIs, while avoiding costs associated with entering the market directly.

Securitization

Another way to enter into partnership with MFIs is to securitize microfinance portfolios. In 2004, the

largest ever securitization deal in microfinance was signed between ICICI Bank and SHARE

Microfin Ltd, a large MFI operating in rural areas of the state of Andra Pradesh. Technical assistance

and the collateral deposit of US$325,000 (93% of the guarantee required by ICICI) were supplied by

Grameen Foundation USA. Under this agreement, ICICI purchased a part of SHARE¶s microfinance

portfolio against a consideration calculated by computing the Net Present Value of receivables

amounting to Rs. 215 million (US$4.9 million) at an agreed discount rate. The interest paid by

SHARE is almost 4% less than the rate paid in commercial loans. Partial credit provision was

provided by SHARE in the form of a guarantee amounting to 8% of the receivables under the

portfolio, by way of a lien on fixed deposit. This deal frees up equity capital, allowing SHARE to

scale up its lending. On the other hand, it allows ICICI Bank to reach new markets. And by trading

this high quality asset in capital markets, the bank can hedge its own risks.

Beyond Microcredit

Microfinance does not only mean microcredit, and ICICI does not limit itself to lending. ICICI¶s

Social Initiative Group, along with the World Bank and ICICI Lombard, the insurance company set



up by ICICI and Canada Lombard, have developed India¶s first index-based insurance product. This

insurance policy compensates the insured against the likelihood of diminished agricultural

output/yield resulting from a shortfall in the anticipated normal rainfall within the district, subject to

a maximum of the sum insured. The insurance policy is linked to a rainfall index.

Technology

One of the main challenges to the growth of the microfinance sector is accessibility. The Indian

context, in which 70% of the population lives in rural areas, requires new, inventive channels of

delivery. The use of technologies such as kiosks and smart cards will considerably reduce

transaction costs while improving access. The ICICI Bank technology team is developing a series of

innovative products that can help reduce transaction costs considerably. For example, it is piloting

the usage of smart cards with Sewa Bank in Ahmedabad. To maximize the benefits of these

innovations, the development of a high quality shared banking technology platform which can be

used by MFIs as well as by cooperatives banks and regional rural banks is needed. ICICI is strongly

encouraging such an effort to take place. Wipro and Infosys, I-Flex, 3iInfotech, some of the best

Indian information technology companies specialized in financial services, and others, are in the

process of developing exactly such a platform. At a recent technology workshop at the Institute for

Financial Management Research in Chennai, the ICICI Bank Alternate Channels Team presented the

benefits of investing in a common technology platform similar to those used in mainstream banking

to some of the most promising MFIs.

The Centre for Microfinance R esearch

ICICI bank has created the Centre for Microfinance Research (CMFR) at the Institute for

Financial Management Research (IFMR) in Chennai. Through research, research-based advocacy,

high level training and strategy building, it aims to systematically establish the links between

increased access to financial services and the participation of poor people in the larger economy. TheCMFR Research Unit supports initiatives aimed at understanding and analyzing the following issues:

impact of access to financial services; contract and product designs; constraints to household

productivity; combination of microfinance and other development interventions; evidence of credit

constraints; costs and profitability of microfinance organizations; impact of MFI policies and



strategies; people¶s behavior and psychology with respect to financial services; economics of micro-

enterprises; and the effect of regulations.

Finally, the CMFR recognizes that while MFIs aim to meet the credit needs of poor households,

there are other missing markets and constraints facing households, such as healthcare, infrastructure,

and gaps in knowledge. These have implications in terms of the scale and profitability of client

enterprises and efficiency of household budget allocation, which in turn impacts household well-

being. The CMFR Microfinance Strategy Unit will address these issues through a series of

workshops which will bring together MFI practitioners and sectoral experts (in energy, water, roads,

health, etc). The latter will bring to the table knowledge of best practices in their specific areas, and

each consultation workshop will result in long-term collaboration between with MFIs for

implementing specific pilots.

2. Bandhan

(R anked 2nd

by Forbes Magazine in December 2007)

Bandhan is working towards the twin objective of poverty alleviation and women empowerment. It

started as a Capacity Building Institution (CBI) in November 2000 under the leadership of Mr.

Chandra Shekhar Ghosh. During such time, it was giving capacity building support to local

microfinance institutions working in West Bengal.

Bandhan opened its first microfinance branch at Bagnan in Howrah district of West Bengal in July

2002. Bandhan started with 2 branches in the year 2002-03 only in the state of West Bengal and

today it has grown as strong as 412 branches across 6 states of the country! The organization had

recorded a growth rate of 500% in the year 2003-04 and 611% in the year 2004-05. Till date, it has

disbursed a total of Rs. 587 crores among almost 7 lakh poor women. Loan outstanding stands at Rs.

221 crores. The repayment rate is recorded at 99.99%. Bandhan has staff strength of more than 2130

employees.



As on July 2008 No. of statesNo. of branchesNo. of membersNo. of staff

Cumulative loan disbursedLoan outstanding

: 8: 528: 1,182,741: 3,191

: Rs.1,249 crores: Rs. 417 crores

Operational Methodology

Bandhan follows a group formation, individual lending approach. A group of 10-25 members are

formed. The clients have to attend the group meetings for 2 successive weeks. 2 weeks hence, they

are entitled to receive loans. The loans are disbursed individually and directly to the members.

Economic and Social Background of Clients

Landless and asset less women

Family of 5 members with monthly income less than Rs. 2,500 in rural and Rs. 3,500

in urban

Those who do not own more than 50 decimal (1/2acre) of land or capital of its

equivalent value

Loan Size

The first loan is between Rs. 1,000 ± Rs. 7,000 for the rural areas and between Rs. 1,000 ± Rs.

10,000 for the urban areas. After the repayment, they are entitled to receive a subsequent loan which

is Rs 1,000 - 5,000 more than the previous loan.

Service Charge

Bandhan charges a service charge of 12.50% flat on loan amount. Bandhan initially charged 17.50%.

However from 1st July 2005, it has slashed down its lending rate to 15.00%. Then it was further

reduced to 12.50% in May 2006. The reason is obvious. As overall productivity increased,



operational costs decreased. Bandhan, being a non profit organization wanted the benefit of low

costs to ultimately trickle down to the poor.

Monitoring System

The various features of the monitoring system are:

A 3 tier monitoring system ± Region, Division and Head Office

Easy reporting system with a prescribed checklist format

Accountability at all levels post monitoring phase

Cross- checking at all the levels

The management team of Bandhan spends 90.00% of time at the field

Liability structure for Loans

When a member wants to join Bandhan, she at first has to get inducted into a group. After she gets

inducted into the group, the entire group proposes her name for a loan in the Resolution Book. Two

members of the group along with the member¶s husband have to sign as guarantors in her loan

application form. If she fails to pay her weekly installment, the group inserts peer pressure on her.

The sole purpose of the above structure is simply to create peer pressure.

3. Grameen Bank

The Grameen Model which was pioneered by Prof Muhammed Yunus of Grameen Bank is perhaps

the most well known, admired and practised model in the world. The model involves the following

elements.

! Homogeneous affinity group of five

! Eight groups form a Centre

! Centre meets every week

! Regular savings by all members

! Loan proposals approved at Centre meeting



! Loan disbursed directly to individuals

! All loans repaid in 50 instalments

The Grameen model follows a fairly regimented routine. It is very cost intensive as it involves

building capacity of the groups and the customers passing a test before the lending could start. The

group members tend to be selected or at least strongly vetted by the bank. One of the reasons for the

high cost is that staff members can conduct only two meetings a day and thus are occupied for only a

few hours, usually early morning or late in the evening. They were used additionally for accounting

work, but that can now be done more cost effectively using computers. The model is also rather

meeting intensive which is fine as long as the members have no alternative use for their time but can

be a problem as members go up the income ladder.

The greatness of the Grameen model is in the simplicity of design of products and delivery. The

process of delivery is scalable and the model could be replicated widely. The focus on the poorest,

which is a value attribute of Grameen, has also made the model a favourite among the donor

community.

However, the Grameen model works only under certain assumptions. As all the loans are only for

enterprise promotion, it assumes that all the poor want to be self-employed. The repayment of loans

starts the week after the loan is disbursed ± the inherent assumption being that the borrowers can

service their loan from the ex-ante income.

4. SKSMicrofinance

Many companies say they protect the interests of their customers. Very few actually sit in dirt with

them, using stones, flowers, sticks, and chalk powder to figure out if they will be able to repay a $20

loan at $1 a month. With this approach, this company has created its own loyal gang of over 2

million customers.

Its borrowers include agricultural laborers, mom-and-pop entrepreneurs, street vendors, home based

artisans, and small scale producers, each living on less than $2 a day. It works on a model that would



allow micro-finance institutions to scale up quickly so that they would never have to turn poor

person away.

Its model is based on 3 principles-

1. Adopt a profit-oriented approach in order to access commercial capital- Starting with

the pitch that there is a high entrepreneurial spirit amongst the poor to raise the funds, SKS

converted itself to for-profit status as soon as it got break even and got philanthropist Ravi

Reddy to be a founding investor. Then it secured money from parties such as Unitus, a

Seattle based NGO that helps promote micro-finance; SIDBI; and technology entrepreneur

Vinod Khosla. Later, it was able to attract multimillion dollar lines of credit from Citibank,

ABN Amro, and others.

2. Standardize products, training, and other processes in order to boost capacity- They

collect standard repayments in round numbers of 25 or 30 rupees. Internally, they have

factory style training models. They enroll about 500 loan officers every month. They

participate in theory classes on Saturdays and practice what they have learned in the field

during the week. They have shortened the training time for a loan officer to 2 months though

the average time taken by other industry players is 4-6 months.

3. Use Technology to reduce costs and limit errors- It could not find the software that suited

its requirements, so it they built their own simple and user friendly applications that a

computer-illiterate loan officer with a 12th grade education can easily understand. The system

is also internet enabled. Given that electricity is unreliable in many areas they have installed

car batteries or gas powered generators as back-ups in many areas.

Scaling up Customer Loyalty

Instead of asking illiterate villagers to describe their seasonal pattern of cash flows, they

encourage them to use colored chalk powder and flowers to map out the village on the ground

and tell where the poorest people lived, what kind of financial products they needed, which areas

were lorded over by which loan sharks, etc. They set people¶s tiny weekly repayments as low as

$1 per week and health and whole life insurance premiums to be $10 a year and 25 cents per

week respectively. They also offer interest free emergency loans. The salaries of loan officers are



not tied to repayment rates and they journey on mopeds to borrowers¶ villages and schedule loan

meetings as early as 7.00 A.M. Deep customer loyalty ultimately results in a repayment rate of

99.5%.

Leveraging the SKS brand

Its payoff comes from high volumes. They are growing at 200% annually, adding 50 branches

and 1,60,000 new customers a month. They are also using their deep distribution channels for

selling soap, clothes, consumer electronics and other packaged goods.



Marketing of Microfinance Products

1.

Contract Farming and Credit Bundling

Banks and financial institutions have been partners in contract farming schemes, set up to enhance

credit. Basically, this is a doable model. Under such an arrangement, crop loans can be extended

under tie-up arrangements with corporate for production of high quality produce with stable

marketing arrangements provided ± and only, provided ± the price setting mechanism for the farmer

is appropriate and fair.

2. Agri Service Centre ± R abo India

Rabo India Finance Pvt Ltd. has established agri-service centres in rural areas in cooperation with a

number of agri-input and farm services companies. The services provided are similar to those in

contract farming, but with additional flexibility and a wider range of products including inventory

finance. Besides providing storage facilities, each centre rents out farm machinery, provides

agricultural inputs and information to farmers, arranges credit, sells other services and provides a

forum for farmers to market their products.

3. Non Traditional MarketsSimilarly, Mother Dairy Foods Processing, a wholly owned subsidiary of National Dairy

Development Board (NDDB) has established auction markets for horticulture producers in

Bangalore. The operations and maintenance of the market is done by NDDB. The project, with an

outlay of Rs.15 lakh, covers 200 horticultural farmers associations with 50,000 grower members for

wholesale marketing. Their produce is planned with production and supply assurance and provides

both growers and buyers a common platform to negotiate better rates.

4. Apni Mandi

Another innovation is that of The Punjab Mandi Board, which has experimented with a µfarmers¶

market¶ to provide small farmers located in proximity to urban areas, direct access to consumers by

elimination of middlemen. This experiment known as "Apni Mandi" belongs to both farmers and

consumers, who mutually help each other. Under this arrangement a sum of Rs. 5.2 lakh is spent for



providing plastic crates to 1000 farmers. Each farmer gets 5 crates at a subsidized rate. At the mandi

site, the Board provides basic infrastructure facilities. At the farm level, extension services of

different agencies are pooled in. These include inputs subsidies, better quality seeds and loans from

Banks. Apni Mandi scheme provides self-employment to producers and has eliminated social

inhibitions among them regarding the retail sale of their produce.



Success Factors of Micro-Finance in India

Over the last ten years, successful experiences in providing finance to small entrepreneur and

producers demonstrate that poor people, when given access to responsive and timely financial

services at market rates, repay their loans and use the proceeds to increase their income and assets.

This is not surprising since the only realistic alternative for them is to borrow from informal market

at an interest much higher than market rates. Community banks, NGOs and grass root savings and

credit groups around the world have shown that these microenterprise loans can be profitable for

borrowers and for the lenders, making microfinance one of the most effective poverty reducing

strategies.

A. For NGOs

1. The field of development itself expands and shifts emphasis with the pull of ideas, and NGOs

perhaps more readily adopt new ideas, especially if the resources required are small, entry

and exit are easy, tasks are (perceived to be) simple and people¶s acceptance is high ± all

characteristics (real or presumed) of microfinance.

2.

Canvassing by various actors, including the National Bank for Agriculture and Rural

Development (NABARD), Small Industries Development Bank of India (SIDBI), Friends of

Women¶s World Banking (FWWB), Rashtriya Mahila Kosh (RMK), Council for

Advancement of People¶s Action and Rural Technologies (CAPART), Rashtriya Gramin

Vikas Nidhi (RGVN), various donor funded programmes especially by the International

Fund for Agricultural Development (IFAD), United Nations Development Programme

(UNDP), World Bank and Department for International Development, UK (DFID)], and

lately commercial banks, has greatly added to the idea pull. Induced by the worldwide focus

on microfinance, donor NGOs too have been funding microfinance projects. One might call

it the supply push.

3. All kinds of things from khadi spinning to Nadep compost to balwadis do not produce such

concrete results and sustained interest among beneficiaries as microfinance. Most NGO-led



microfinance is with poor women, for whom access to small loans to meet dire emergencies

is a valued outcome. Thus, quick and high µcustomer satisfaction¶ is the USP that has

attracted NGOs to this trade.

4. The idea appears simple to implement. The most common route followed by NGOs is

promotion of SHGs. It is implicitly assumed that no µtechnical skill¶ is involved. Besides,

external resources are not needed as SHGs begin with their own savings. Those NGOs that

have access to revolving funds from donors do not have to worry about financial

performance any way. The chickens will eventually come home to roost but in the first flush,

it seems all so easy.

5. For many NGOs the idea of µorganising¶ ± forming a samuha ± has inherent appeal. Groups

connote empowerment and organising women is a double bonus.

6. Finally, to many NGOs, microfinance is a way to financial sustainability. Especially for the

medium-to-large NGOs that are able to access bulk funds for on-lending, for example from

SIDBI, the interest rate spread could be an attractive source of revenue than an uncertain,

highly competitive and increasingly difficult-to-raise donor funding.

B. For Financial Institutions and banks

Microfinance has been attractive to the lending agencies because of demonstrated sustainability and

of low costs of operation. Institutions like SIDBI and NABARD are hard nosed bankers and would

not work with the idea if they did not see a long term engagement ± which only comes out of

sustainability (that is economic attractiveness).

On the supply side, it is also true that it has all the trappings of a business enterprise, its output is

tangible and it is easily understood by the mainstream. This also seems to sound nice to the



government, which in the post liberalisation era is trying to explain the logic of every rupee spent.

That is the reason why microfinance has attracted mainstream institutions like no other

developmental project.

Perhaps the most important factor that got banks involved is what one might call the policy push.

Given that most of our banks are in the public sector, public policy does have some influence on

what they will or will not do. In this case, policy was followed by diligent, if meandering,

promotional work by NABARD. The policy change about a decade ago by RBI to allow banks to

lend to SHGs was initially followed by a seven-page memo by NABARD to all bank chairmen, and

later by sensitisation and training programmes for bank staff across the country. Several hundred

such programmes were conducted by NGOs alone, each involving 15 to 20 bank staff, all paid for by

NABARD. The policy push was sweetened by the NABARD refinance scheme that offers much

more favourable terms (100% refinance, wider spread) than for other rural lending by banks.

NABARD also did some system setting work and banks lately have been given targets. The

canvassing, training, refinance and close follow up by NABARD has resulted in widespread bank

involvement.

Moreover, for banks the operating cost of microfinance is perhaps much less than for pure MFIs.

The banks already have a vast network of branches. To the extent that an NGO has already promoted

SHGs and the SHG portfolio is performing better than the rest of the rural (if not the entire)

portfolio, microfinance via SHGs in the worst case would represent marginal addition to cost and

would often reduce marginal cost through better capacity utilisation. In the process the bank also

earns brownie points with policy makers and meets its priority sector targets.

It does not take much analysis to figure out that the market for financial services for the 50-60

million poor households of India, coupled with about the same number who are technically above

the poverty line but are severely under-served by the financial sector, is a very large one. Moreover,

as in any emerging market, though the perceived risks are higher, the spreads are much greater. The

traditional commercial markets of corporates, business, trade, and now even housing and consumer

finance are being sought by all the banks, leading to price competition and wafer thin spreads.



Further, bank-groups are motivated by a number of cross-selling opportunities in the market, for

deposits, insurance, remittances and eventually mutual funds. Since the larger banks are offering all

these services now through their group companies, it becomes imperative for them to expand their

distribution channels as far and deep as possible, in the hope of capturing the entire financial

services business of a household.

Finally, both agri-input and processing companies such as EID Parry, fast-moving consumer goods

(FMCG) companies such as Hindustan Levers, and consumer durable companies such as Philips

have realised the potential of this big market and are actively using SHGs as entry points. Some

amount of free-riding is taking place here by companies, for they are using channels which were

built at a significant cost to NGOs, funding agencies and/or the government.

On the whole, the economic attractiveness of microfinance as a business is getting established and

this is a sure step towards mainstreaming. We know that mainstreaming is a mixed blessing, and one

tends to exchange scale at the cost of objectives. So it needs to be watched carefully.



Issues in Microfinance

1. Sustainability

The first challenge relates to sustainability. MFI model is comparatively costlier in terms of

delivery of financial services. An analysis of 36 leading MFIs by Jindal & Sharma shows that

89% MFIs sample were subsidy dependent and only 9 were able to cover more than 80% of their

costs. This is partly explained by the fact that while the cost of supervision of credit is high, the

loan volumes and loan size is low. It has also been commented that MFIs pass on the higher cost

of credit to their clients who are µinterest insensitive¶ for small loans but may not be so as loan

sizes increase. It is, therefore, necessary for MFIs to develop strategies for increasing the range

and volume of their financial services.

2. Lack of Capital

The second area of concern for MFIs, which are on the growth path, is that they face a paucity

of owned funds. This is a critical constraint in their being able to scale up. Many of the MFIs are

socially oriented institutions and do not have adequate access to financial capital. As a result they

have high debt equity ratios. Presently, there is no reliable mechanism in the country for meeting

the equity requirements of MFIs.

The IPO issue by Mexico based µCompartamos¶ was not accepted by purists as they thought it

defied the mission of an MFI. The IPO also brought forth the issue of valuation of an MFI.

The book value multiple is currently the dominant valuation methodology in microfinance

investments. In the case of start up MFIs, using a book value multiple does not do justice to the

underlying value of the business. Typically, start ups are loss making and hence the book value

continually reduces over time until they hit break even point. A book value multiplier to value

start ups would decrease the value as the organization uses up capital to build its business, thus

accentuating the negative rather than the positive.



3. Financial service delivery

Another challenge faced by MFIs is the inability to access supply chain. This challenge can be

overcome by exploring synergies between microfinance institutions with expertise in credit

delivery and community mobilization and businesses operating with production supply chains

such as agriculture. The latter players who bring with them an understanding of similar client

segments, ability to create microenterprise opportunities and willingness to nurture them, would

be keen on directing microfinance to such opportunities. This enables MFIs to increase their

client base at no additional costs.

Those businesses that procure from rural India such as agriculture and dairy often identify

finance as a constraint to value creation. Such businesses may find complementarities between

an MFI¶s skills in management of credit processes and their own strengths in supply chain

management.

ITC Limited, with its strong supply chain logistics, rural presence and an innovative transaction

platform, the echoupal, has started exploring synergies with financial service providers including

MFIs through pilots with vegetable endors and farmers. Similarly, large FIs such as Spandana

foresee a larger role for themselves in the rural economy ably supported by value creating

partnerships with players such as Mahindra and Western Union Money Transfer.

ITC has initiated a pilot project called µpushcarts scheme¶ along with BASIX (a microfinance

organization in Hyderabad). Under this pilot, it works with twenty women head load vendors

selling vegetables of around 10- 15 kgs per day. BASIX extends working capital loans of

Rs.10,000/- , capacity building and business development support to the women. ITC provides

support through supply chain innovations by:

1. Making the Choupal Fresh stores available to the vendors, this avoids the hassle of

bargaining and unreliability at the traditional mandis (local vegetable markets). The womenare able to replenish the stock from the stores as many times in the day as required. This has

positive implications for quality of the produce sold to the end consumer.

2. Continuously experimenting to increase efficiency, augmenting incomes and reducing energy

usage across the value chain. For instance, it has forged a partnership with National Institute



of Design (NID), a pioneer in the field of design education and research, to design user-

friendly pushcarts that can reduce the physical burden.

3. Taking lessons from the pharmaceutical and telecom sector to identify technologies that can

save energy and ensure temperature control in push carts in order to maintain quality of the

vegetables throughout the day. The model augments the incomes of the vendors from around

Rs.30-40 per day to an average of Rs.150 per day. From an environmental point of view,

push carts are much more energy efficient as opposed to fixed format retail outlets.

4. HR Issues

Recruitment and retention is the major challenge faced by MFIs as they strive to reach more

clients and expand their geographical scope. Attracting the right talent proves difficult becausecandidates must have, as a prerequisite, a mindset that fits with the organization¶s mission.

Many mainstream commercial banks are now entering microfinance, who are poaching staff

from MFIs and MFIs are unable to retain them for other job opportunities.

85% of the poorest clients served by microfinance are women. However, women make up less

than half of all microfinance staff members, and fill even fewer of the senior management roles.

The challenge in most countries stems from cultural notions of women¶s roles, for example,

while women are single there might be a greater willingness on the part of women¶s families to

let them work as front line staff, but as soon as they marry and certainly once they start having

children, it becomes unacceptable. Long distances and long hours away from the family are

difficult for women to accommodate and for their families to understand.

5. Microinsurance

First big issue in the microinsurance sector is developing products that really respond to the

needs of clients and in a way that is commercially viable.

Secondly, there is strong need to enhance delivery channels. These delivery channels have been

relatively weak so far. Microinsurance companies offer minimal products and do not want to go

forward and offer complex products that may respond better. Microinsurance needs a delivery

channel that has easy access to the low-income market, and preferably one that has been engaged



in financial transactions so that they have controls for managing cash and the ability to track

different individuals.

Thirdly, there is a need for market education. People either have no information about

microinsurance or they have a negative attitude towards it. We have to counter that. We have to

somehow get people - without having to sit down at a table - to understand what insurance is,

and why it benefits them. That will help to demystify microinsurance so that when agents come,

people are willing to engage with them.

6. Adverse selection and moral hazard

The joint liability mechanism has been relied upon to overcome the twin issues of adverse

selection and moral hazard. The group lending models are contingent on the availability of

skilled resources for group promotion and entail a gestation period of six months to one year.

However, there is not sufficient understanding of the drivers of default and credit risk at the level

of the individual. This has constrained the development of individual models of micro finance.

The group model was an innovation to overcome the specific issue of the quality of the portfolio,

given the inability of the poor to offer collateral. However, from the perspective of scaling up

micro financial services, it is important to proactively discover models that will enable direct

finance to individuals.





Documents

finance (microfinance) report