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Project Report on

³A Critical Analysis of Micro Finance in India´

SUBMITTED TO:-

PROF. S MITRA

SUBMITTED BY:-

Batch-Spring Summer SANJAY KUMAR SHAH

Year- 2009-11



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ACKNOWLEDGEMENT

We acknowledge with gratitude and appreciation, our indebtedness to our mentor &

guide, Prof S Mitra for allowing us to work on a very intrinsic part of aviation sector,

³MICROFINACE IN INDIA´ we also thank his for the ideas and basic concepts he delivered

and shared with us, as they helped us a lot in accomplishing this project.

It gave us enormous gratification to articulate our thankfulness and heart full sense of

indebtedness to our dearest friends for the great support in completion of this project



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ABSTRACT

In recent years Microfinance has attracted widespread attention for its

developmental Impact for the poor, but it too has multitude of issues and complications. This

research project has adopted a mix of empirical and theoretical approach with the objective

to identify a comprehensive range of implementation and impact issues of microfinance.

This paper will seek to examine what is the current status of the microfinance in

India and the overall industry analysis and how they are contributing in achieving the financial

inclusion. A comprehensive survey in real-life setting of the donors, the practitioners and the

beneficiaries (the groups) through various means such as formal and informal talks has been

performed.

The deliberations are focused around examining the implementation issues; the

economics behind the issue, the complications involved thereon, the impact- individualistic

and wider context, providing practical solutions for the problems and the case for including

health and education among its domain of services.



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CONTENTS

Page No.

Introduction 4

Microfinance Definition 4

Need in India 6

Role of Microfinance 8

Origin of Microfinance 9

Microfinance Today 11

Status of Microfinance 13

Activities 13

Legal regulations 15

MF industry analysis 18

Success factor of MFIs in India 26

Real life example 29

Issues 30

References 36



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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 factors provide

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

various factors have endeavored to provide access to financial services to the poor in creative ways.

Governments also have piloted national programs, NGOs have undertaken the activity of raising donor

funds for on-lending, and some banks have partnered with public organizations 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 factors 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 ³The National Microfinance Taskforce, 1999´ 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´.

"The poor stay poor, not because they are lazy but because they have no access to capital."



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The dictionary meaning of µfinance¶ is management of money. The management of money

denotes acquiring & using money. Micro Finance is buzzing word, used when financing for micro

entrepreneurs. Concept of micro finance is emerged in need of meeting special goal to empower under-

privileged class of society, women, and poor, downtrodden by natural reasons or men made; caste,

creed, religion or otherwise. The principles of Micro Finance are founded on the philosophy of

cooperation and its central values of equality, equity and mutual self-help. At the heart of these

principles are the concept of human development and the brotherhood of man expressed through

people working together to achieve a better life for themselves and their children.

Traditionally micro finance was focused on providing a very standardized credit product. The

poor, just like anyone else, (in fact need like thirst) need a diverse range of financial instruments to be

able to build assets, stabilize consumption and protect themselves against risks. Thus, we see a

broadening of the concept of micro finance--- our current challenge is to find efficient and reliable

ways of providing a richer menu of micro finance products. Microfinance is not merely extending

credit, but is extending credit to those who require most for their and family¶s survival. It cannot be

measured in term of quantity, but due weightage to quality measurement. How credit availed is used to

survive and grow with limited means.

Who are the clients of micro finance?

The typical micro finance clients are low-income persons that do not have access to formal

financial institutions. Micro finance clients are typically self-employed, often household-based

entrepreneurs. In rural areas, they are usually small farmers and others who are engaged in small

income-generating activities such as food processing and petty trade. In urban areas, micro finance

activities are more diverse and include shopkeepers, service providers, artisans, street vendors, etc.

Micro finance clients are poor and vulnerable non-poor who have a relatively unstable source of

income.



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The Need in India

y India is said to be the home of one third of the world¶s poor; official estimates range from 26 to 50

percent of the more than one billion population.

y About 87 percent of the poorest households do not have access to credit.

y The demand for microcredit has been estimated at up to $30 billion; the supply is less than $2.2

billion combined by all involved in the sector.

Due to the sheer size of the population living in poverty, India is strategically significant in the

global efforts to alleviate poverty and to achieve the Millennium Development Goal of halving the

world¶s poverty by 2015. Microfinance has been present in India in one form or another since the

1970s and is now widely accepted as an effective poverty alleviation strategy. Over the last five years,

the microfinance industry has achieved significant growth in part due to the participation of

commercial banks. Despite this growth, the poverty situation in India continues to be challenging.

Some principles that summarize a century and a half of development practice were encapsulated

in 2004 by Consultative Group to Assist the Poor (CGAP) and endorsed by the Group of Eight leaders

at the G8 Summit on June 10, 2004:

y Poor people need not just loans but also savings, insurance and money transfer services.

y Microfinance must be useful to poor households: helping them raise income, build up assets and/or

cushion themselves against external shocks.

y ³Microfinance can pay for itself.´ Subsidies from donors and government are scarce and uncertain,

and so to reach large numbers of poor people, microfinance must pay for itself.

y Microfinance means building permanent local institutions.

y Microfinance also means integrating the financial needs of poor people into a country¶s mainstream

financial system.

y ³The job of government is to enable financial services, not to provide them.´

y ³Donor funds should complement private capital, not compete with it.´

y ³The key bottleneck is the shortage of strong institutions and managers.´ Donors should focus on

capacity building.

y Interest rate ceilings hurt poor people by preventing microfinance institutions from covering their

costs, which chokes off the supply of credit.



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y Microfinance institutions should measure and disclose their performance ± both financially and

socially.

Microfinance can also be distinguished from charity. It is better to provide grants to families who

are destitute, or so poor they are unlikely to be able to generate the cash flow required to repay a loan.This situation can occur for example, in a war zone or after a natural disaster.

Financial needs and financial services

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.

In Stuart Rutherford¶s recent book T he Poor and T heir Money, he cites several types of needs:

y Lifecycle Needs: such as weddings, funerals, childbirth, education, homebuilding, widowhood, old

age.

y P ersonal Emergencies: such as sickness, injury, unemployment, theft, harassment or death.

y Disaster s: such as fires, floods, cyclones and man-made events like war or bulldozing of

dwellings.

y 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 count dry but typically include livestock, grains, jewellery and precious metals.

As Marguerite Robinson describes in The Microfinance Revolution, the 1980s demonstrated

that ³microfinance could provide large-scale outreach profitably,´ and in the 1990s, ³microfinance

began to develop as an industry´. In the 2000s, the microfinance industry¶s objective is to satisfy the

unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has



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been made in developing a viable, commercial microfinance sector in the last few decades, several

issues remain that need to be addressed before the industry will be able to satisfy massive worldwide

demand.

The obstacles or challenges to building a sound commercial microfinance industry include:

� Inappropriate donor subsidies

� Poor regulation and supervision of deposit-taking MFIs

� Few MFIs that mobilize savings

� Limited management capacity in MFIs

� Institutional inefficiencies

� Need for more dissemination and adoption of rural, agricultural microfinance methodologies

Role of Microfinance:

The micro credit of microfinance progamme was first initiated in the year 1976 in Bangladesh

with promise of providing credit to the poor without collateral , alleviating poverty and unleashing

human creativity and endeavor of the poor people. Microfinance impact studies have demonstrated that

Ø Microfinance helps poor households meet basic needs and protects them against risks.

Ø The use of financial services by low-income households leads to improvements in household

economic welfare and enterprise stability and growth.

Ø By supporting women¶s economic participation, microfinance empowers women, thereby promoting

gender-equity and improving household well being.

Ø The level of impact relates to the length of time clients have had access to financial services.

The Origin of Microfinance



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Although neither of the terms microcredit or microfinance were used in the academic literature

nor by development aid practitioners before the 1980s or 1990s, respectively, the concept of providing

financial services to low income people is much older.

While the emergence of informal financial institutions in Nigeria dates back to the 15 th century,

they were first established in Europe during the 18th century as a response to the enormous increase in

poverty since the end of the extended European wars (1618 ± 1648). In 1720 the first loan fund

targeting poor people was founded in Ireland by the author Jonathan Swift. After a special law was

passed in 1823, which allowed charity institutions to become formal financial intermediaries a loan

fund board was established in 1836 and a big boom was initiated. Their outreach peaked just before the

government introduced a cap on interest rates in 1843. At this time, they provided financial services to

almost 20% of Irish households. The credit cooperatives created in Germany in 1847 by Friedrich

Wilhelm Raiffeisen served 1.4 million people by 1910. He stated that the main objectives of thesecooperatives ³should be to control the use made of money for economic improvements, and to improve

the moral and physical values of people and also, their will to act by themselves.´

In the 1880s the British controlled government of Madras in South India, tried to use the

German experience to address poverty which resulted in more than nine million poor Indians belonging

to credit cooperatives by 1946. During this same time the Dutch colonial administrators constructed a

cooperative rural banking system in Indonesia based on the Raiffeisen model which eventually became

Bank Rakyat Indonesia (BRI), now known as the largest MFI in the world.

Origin of Indian Microfinance:

Microfinance as being practiced today was not always intended to be in this way when it

started. Initially microfinance was not the exclusive activity that the organizations were performing. It

all started with failure of government run poverty alleviation programs which motivated social

entrepreneurs to look outside India when they came across the powerful Grameen Bank model and

which was not dependent on government infrastructure.

Typically these organizations were led by somebody who had a strong visible social

commitment and they mostly wanted to work around the areas which they either have known through

their upbringing or through their professional experiences. That¶s how the entire microfinance sector

started to grow.



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Suddenly private banks woke up to the potential of this sector and started lending to these

institutions. With the credits easily available the organizations started expanding their microfinance

initiatives and realized that their other activities had become quite negligible in comparison to their

microfinance initiatives. In the process financial institutions realized that these organizations were very

highly leveraged and they started becoming anxious about the risk associated with such lending.

At the same time regulatory authorities realized that the NGOs which otherwise are

supposed to be philanthropic in nature were making huge profits and regulatory authorities found it

increasingly difficult to reconcile to these two contradictory features of microfinance organizations.

These two factors started pushing the Indian microfinance organizations towards getting

formalized and that¶s when the trend of getting converted into NBFC started.

Microfinance Today



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The groundbreaking efforts by pioneers in the microfinance industry have already begun to

yield substantial returns. Today, more than 150 million people worldwide have access to microcredit,

the industry¶s flagship product - roughly equivalent to half the population of the United States. From

the perspective of microfinance institutions (MFIs), this growing market has been successful, as well.

Loans are being repaid, and many lenders are generating profits. It¶s clear that the foundation for

microfinance has been established « but there is still plenty of room for growth. After all, 2.6 billion

people ² over 40 percent of the world¶s population ² still live on less than USD2 per day and more

than 2 billion remain ³unbanked´ (i.e., without access to traditional financial systems).

An exceptional rate of growth has brought the microfinance industry to its current size. In 1997

² only 12 years ago ² slightly more than 13 million people had access to microcredit. The market

nearly doubled by 2000 and registered a tenfold increase by 2006. Few markets have grown as quickly

in such a short period of time.

Even considering the industry¶s profound recent rate of growth, there remains plenty of room for

more. If we assume (somewhat conservatively) the total market for microfinance product purchasers

(excluding children and the infirm) consists of about 1.5 billion people, market penetration is only

around 10 percent. While the immediate potential to generate profits from this untapped space is

enormous, the development of financial capabilities amongst customers at the bottom of the

socioeconomic pyramid (BOP) will also create a platform for future wealth generation, which in turn

will create the need for more robust financial services. Put simply, today¶s low-income client will be

tomorrow¶s middle-income client. Companies entering the market now have a unique opportunity to

build brand loyalty and familiarity with BOP customers as they move up the socioeconomic ladder.

This will likely yield substantial long-term opportunities ² especially for early movers ² which will

result in market preeminence as targeted economies develop.



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Gaining access to the target market for microfinance clients, of course, is not easy.

Significant barriers exist, particularly the absence of an enabling infrastructure. Without the necessary

technology and institutional knowledge in place, it would be quite difficult for most commercial

enterprises to generate an immediate return on microfinance investments since the micro market has

several unique distinguishing characteristics which call for entirely different operational approaches

and business models.

This problem is particularly vexing for insurers and reinsurers looking to get involved in

micro insurance, given the lack of historical data necessary to inform traditional underwriting andcapital management decisions. In general, for commercial enterprises to succeed in the micro

(re)insurance space, some of their fundamental views regarding risk management and underwriting will

need to change.



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Status of Microfinance today

Strategic Policy Initiatives

Some of the most recent strategic policy initiatives in the area of Microfinance taken by the

government and regulatory bodies in India are:

Working group on credit to the poor through SHGs, NGOs, NABARD, 1995

The National Microfinance Taskforce, 1999

Working Group on Financial Flows to the Informal Sector (set up by PMO), 2002

Microfinance Development and Equity Fund, NABARD, 2005 Working group on Financing NBFCs by Banks- RBI

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.



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Remittances: 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.



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Legal Regulations

Banks in India are regulated and supervised by the Reserve Bank of India (RBI) under the RBI

Act of 1934, Banking Regulation Act, Regional Rural Banks Act, and the Cooperative Societies Acts

of the respective state governments for cooperative banks. NBFCs are registered under the CompaniesAct, 1956 and are governed under the RBI Act. There is no specific law catering to NGOs although

they can be registered under the Societies Registration Act, 1860, the Indian Trust Act, 1882, or the

relevant state acts. There has been a strong reliance on self-regulation for NGO MFIs and as this

applies to NGO MFIs mobilizing deposits from clients who also borrow. This tendency is a concern

due to enforcement problems that tend to arise with self-regulatory organizations. In January 2000, the

RBI essentially created a new legal form for providing microfinance services for NBFCs registered

under the Companies Act so that they are not subject to any capital or liquidity requirements if they do

not go into the deposit taking business. Absence of liquidity requirements is concern to the safety of

the sector.

Importance of legal structure

� Clarity of ownership

� Initial capital requirement

� Ability of the MFI to mobilize deposits

� Ability to raise equity

� Ability to raise grants

� Ability to raise funds from banks and FIs

� Regulatory requirements

� Tax implications

Legal Structures

� SHGs and federations

� Societies and Trusts

� Co-operative societies

� Co-operative Banks

� Regional Rural Banks

� Local Area Banks

� Public and private sector banks



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� Companies incorporated under Section 25 of the Companies Act

� Companies registered with the RBI as NBFCs

� Eligible organizations under BC/BF guidelines of RBI SHGs and Federations

� An SHG is an unregistered entity of between10-20 individuals, having own rules and regulations,

office bearers and books of accounts.

� SHGs are recognized by the RBI and government for specific purposes.

� SHGs use savings of their members as well as funds from banks and MFIs for providing credit to

their members.

� SHGs network in clusters and form in to Federations which are usually registered as Societies or

Co-operative Societies.

Transformation� MFIs registered as societies, trusts and Section-25 companies want to transform to a for-profit

NBFC as

± For profit structure allows them to raise commercial equity

± Banks are more comfortable lending to the NBFCs

Issues in Transformation

Capital

� MFI promoters find it difficult to mobilize Rs20mn of minimum capital required for an NBFCs

� Many MFI promoters have µacquired¶ old NBFCs having lesser minimum capital required but have

to pay significant premium to the existing owners. There are also legacy issues.

Transfer of assets and liabilities

� Option 1: Assets from the old entity can be purchased by the new entity

� Option 2: All new disbursement to be made by the new entity and the loan portfolio of the old

entity is allowed to come down gradually

� Option 3: New entity gives loans to the clients who can pre-pay loans in the old entity

Microfinance Bill

� Registered MFOs will be required to submit reports to the regulator

� MFOs will also be subject to inspection by the regulator in case of complaints of harmful practices



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� Bill to promote and regulate the microfinance sector. NABARD to be made the regulatory authority

� Microfinance is defined to include loans, savings, insurance and pension services. Loans cannot

exceed more than Rs50,000 (Rs150,000 for housing purposes)

� The bill defines an MFO as any organization that provides micro-finance services and includes

societies, trusts and cooperative societies.

� All MFOs that accept deposit from µeligible clients¶ need to be registered with NABARD.

Minimum experience of three years and minimum net owned fund of Rs five lakhs has been fixed

as condition for registration.

� Different legal structures reflect diversity within the country and represent various stages of

evolution of the financial sector

� Each legal structure has a purpose, has its pros and cons and is more effective in a particular

situation



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ANALYSIS OF MICROF I NAN C E AS AN I N DUSTRY

Due to the entry of more players in the business of small and medium loan & finance, the

sector turned in to an industry i.e. the microfinance industry. Gradually it is going to grab more marketand people in terms of its capitalization. The policy bound banking system is now-a-days unable to

meet the demand of the needy customer due to RBI¶s norms regarding CRR & SLR. Hence the

revolution starts in terms of small and medium loan financing with the name called microfinance

popularly seen in terms of self help group (SHGs). Now this industry is in lime light of every investor

in terms of its growth and return. Even private equity firms are looking for it eagerly.

For that reason we are going to analyze the industry with the help of famous

PORTER¶S FIVE FORCES MODEL of industry analysis.



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Competition: How strong is the rivalry posed by the present competition?

The number of firms in the industry- the more firms the stronger the competition because

there are more firms competing for the same customers. Here in this case the competitors are



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Despite having competition the sector is growing, which signifies that there is vast market to

tap.

y market growth-as it is a growing sector the growth rate and the growing investment can be known

in the fig. below table:-

In addition to the SHG-Bank linkage model, Small Industries Development Bank of India (SIDBI)

has also supported MFIs. The details for the year 2009-10 are given below:-



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By looking at the figure we can know that the growth of MFI (bank linkage model) is growing at a

faster rate than the SHG (bank linkage model).this indicate the attractiveness of the industry due to the

entry of all large private banks.

y Levels of product differentiation-this is pretty low here. This signifies more competition in the

industry. More competition leads to satisfaction of the customer in terms of lowering the operating

cost which will lead to low interest rate to the end user & capture more investor.

y Economies of scale-firms having low economic scale can survive in the competitive rivalry. I.e.

the fixed component is more than variable one. Here the bank lending rate is fixed but one can

manipulate in the operating rate in order to reduce the interest to attract more customer.

y Switching costs-switching cost here is very much high as someone is taken loan and he/she has to

repay it totally for switching over to another firm. Which signs an entry for new player by looking

at the vast market?

y High exit barriers- increase competition because firms that might otherwise exit the industry are

forced to stay and compete. The common factor is the recovery of debt and the large volume of

asset. This can known by seeing the below table



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1. Barriers to entry: What is the threat posed by new players entering the

market?

As this is capital based industry hence the barrier is basically the cost of capital. The more

factors are

y High capital costs of setting up a business in a particular industry

y Requirement of highly specialized instruments-no such factor is a constraint for microfinance as

an industry.

y Branding of existing competitors-as such for SHGs there no such provision for branding

needed but due to the entrance of new banking players it would be a constraint in future. But as

the market is growing it would take a lot time to happen.

y Government regulations-till now there is no such government intervention is found in this

sector. But due to increase in rate of interest government may interfere in it in near future.Recently there was an article upon appointing NABARD as the regulatory authority for

microfinance. But as such government hindrances may be a negative factor for the growth of

industry like microfinance. Hence as of now there is no barrier for the new entrant.

2. Substitutes: What is the threat posed by substitute products and services?

As it is a service rendering organization hence the substitute are more but due to regulation of

government and the harassment of local lenders the substitute is less. They are

y The small loan of private banks-this is now a day¶s not exactly the substitute of MFI although it¶s

from banking industry. Because the mortgage and guarantee taken by then is not affordable by poor

people. After that they also can¶t recover the money if failure. But MFIs & SHGs as such taken

more interest but help the poor in the time of requirement. And also the recovery is quite good here.

That we can see in fig.



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As regards recovery percentage of SHG loans by banks under SGSY, out of total 165 Banks

reported the recovery data of SHGs under SGSY, 86 banks (52.2%) had more, Than 80%recovery of as

on 31 March 2010 as against 58.9% as on 31 March 2009.

Agency-wise percentage distribution of banks according to recovery performance is Given in

the table below:-

y Local money lender-but it¶s not an organized one. Hence after some days it¶s going to vanish.

Because they quite harsh in terms of their recovery. Due to the more lucrative future of this sector

many big players are including in it.

y There is less substitute of microfinance till now. So this industry is more advantageous than other

to get in.



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y Relative price-performance of substitutes-the relative price ±performance of substitute is not as

good as the substitutes are not good in terms of accessibility and affordability.

3. Supplier bargaining power: How much bargaining power do suppliers have?

While deciding the bargaining power of suppliers we have to look upon to the

y Number of possible suppliers and the strength of competition between suppliers-here the number

is not more as per the market required. But till now the suppliers are playing games in terms of rate

of interest due to more demand of the loner. Hence their power is more till now. Hence good to

enter.

There are also more players newly entered in MFIs. But by having a glance at it we can easily get

to know that the scope here is pretty much.



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y The services of the competitors are nearly similar. But only looking at the demand and their

accessibility they are tapping the marketing.

y Importance of sales volume to the supplier-the supply has less importance then the recovery.

Hence the volume is less effective.

y Cost to the firm of changing suppliers (switching cost)-the switching cost is more. Hence the

suppliers are less concern about the buyers.

y The presence of substitute inputs-due to less substitute services the bargaining power of is more in

comparison to allied services.

y Vertical integration of the supplier or threat to become vertically integrated-here the integration is

more due to the merger between lender MFI and the loner business.

4. Customer bargaining power: How much bargaining power do customers have?

Customers bargaining power here is less because they are having need for finance. The points

under it are

y Volume of goods or services purchased- in this scenario the chunk is taken by the needy people

but they don¶t have any alternative for that. Hence they don¶t have bargaining power here. The

volume of fund has given in the previous table.

y As such maximum people don¶t go for any brand for this matter. Hence here is no brand

recognition. In fact people believe in local funding organization.

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 groupsaround 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



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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 factors, 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 fundingmicrofinance 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



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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, promotionalwork 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, and 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 corporate, business, trade, and now even housing and



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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. Someamount 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.

A real life Examples :

Lakshmi, a 22-year-old school dropout, lived in a remote village of Tamil Nadu. Instead

of getting married and starting a family like any other village girl of her age in India, she wanted to set

up on her own business.

Lakshmi started an Internet kiosk in her village, offering services like e-mail, Internet chat

and tips on health and education. The kiosk was partially financed by ICICI Bank and was set up in

association with n-Logue Communications. Latha, a 29-year-old married woman with three children

borrowed Rs.18,000 to set up a small provision store in Kothaipalli, a small village, in the north o

Andhra Pradesh. Within a year, she started earning Rs.3500 a month from the store. With this money,

she was able to provide her children a good education at a local private school. She was a part of a self

help group in Andhra Pradesh which received financial assistance from ICICI Bank. These are real-life



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examples to illustrate how the micro-lending initiatives of ICICI Bank affected the lives of poor

women in India.

By becoming a part of self-help groups, several rural women were able to move out of

poverty. Apart from financial benefits, the initiatives helped the women to develop self confidence,

improve their communication skills and raise their position in society.

Issues in Microfinance

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.

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 sociallyoriented 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 f or meeting the equity

requirements of MFIs.



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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 startup 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.

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 skillsin 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 e-choupal, has started exploring synergies with financial service providers including

MFIs through pilots with vegetable vendors 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 kegs 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:



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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 women are 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 moreenergy efficient as opposed to fixed format retail outlets.

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 because

candidates 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.

4. Adverse selection and moral hazard



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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.

5. Microfinance Interest rates:

This is perhaps the most contentious issue in this whole debate. It has been reported in the media

that MFIs charge between 26-60% p.a. effective rates. The truth is MFIs do charge higher rates thanbanks and very few, if any, charge more than 36%, all inclusive. Someone who is doing it at more than

40% is probably not the MFIs as we know them. It would be good to check the credentials of these

entities just to be sure if they really qualify to be a part of the industry or just wearing MFI hats to get

away with their exploitative businesses.

Having said that, let us put these interest rates (26-36%) in perspective. In order to do so it is

important to start with a comparison to loans that are available to relatively well off people. Keeping

aside the intended purpose for a moment, a credit card loan can probably be considered the closest

comparative to a microfinance loan.

Average credit card balances are typically smaller than other loans and, most importantly,

unsecured. You pay anywhere between 24-36% effective on these loans. One could still argue that poor

people should have access to this service at a cheaper price compared to the rich. In theory it sounds

good but in practice we are yet to see a viable and scalable model that can achieve this. Several

industry experts touched on this subject and tried to explain why MFIs charge high rates and why

indiscriminate subsidies do not go a long way in serving the needs of the poor. Notwithstanding high

operating costs in delivering loans at clients¶ doorstep which primarily drive the interest rates to the

levels mentioned above, let us try and understand in simple terms what these interest rates really mean

for cash flows of the poor: MFIs in India lend an average of Rs. 10,000 ($200) per borrower and charge

12% ± 15% flat rate + 2-3% upfront fees (translates into 26-36% effective rate). Without bothering



33

about how much is it in terms of effective interest rate, let us understand how these rates translate into

absolute amount and how that could affect the borrowers. 15% flat rate literally means Rs. 1,500 ($30)

interest on a Rs. 10,000 ($200) loan because the interest is computed on disbursed amount and not

declining loan balance. It is perhaps safe to assume that upfront fee of 2-3% i.e., Rs. 200-300 ($4-$6)

is good for covering initial group formation, loan processing and disbursement costs, considering the

number of trips (4 to 6) a loan officer makes to the client location before the loan is issued.

One should also note (and make sure) that the borrower pays nothing else to obtain or repay

the loan, not even a visit to MFI office except on the disbursement day. Most MFIs collect loans in 50

weekly cycles. Rs. 1,500 ($30) interest literally means Rs. 125 ($2.5) per month or Rs. 30 ($0.75) per

week. From MFIs¶ standpoint, Rs. 15 ($0.38) of this weekly interest collected is remitted directly to

banks in the form of interest on borrowed funds, it costs at least Rs. 11-12 ($0.30) to deliver the

services at the clients¶ doorstep, if managed efficiently, and Rs. 2 ($0.05) is set aside to cover for

possible defaults leaving Rs. 1-2 ($0.05) as margin. Not much of a margin really. This does not mean

to say though that there are no greedy players in the industry. They are however exceptions than the

norm.

Profit is good for any business but profiteering is not. If we consider credit as a service

similar to any others such as phone, cable, electricity and so on, it is not unusual for someone of the

profile of an MFI client to be buying a talk time of Rs. 125 ($2.5) or paying for electricity in similar

amount in a month. We know that these services offer great value and intended to improve the quality

of life of clients and their families in addition to making profits for the provider. Similarly a Rs. 10,000

($200) loan goes a long way in meeting working capital needs of a small shop or a dairy unit or a small

farm or treatment of a sick family member or fees for a college student.

Now, let us assume that MFIs reduce the interest rates to 7.5% flat (half of the original rate)

which translates into approx. 15% effective rate, close to commercial bank lending rates. The interest

obligation ends up to be Rs. 62.5 ($1.25) per month or Rs. 15 ($0.38) per week. So, it sounds like the

argument is essentially about the difference of Rs. 62.5 ($1.25) per month or Rs. 15 ($0.38) per week

per average MFI loan. It is hard to believe that someone would end his/her life for less than Rs. 100

($2). Even for someone with 5 loans of similar nature total interest obligation does not seem worth

one¶s life. Based on this logic the real problem seems to lie somewhere else, certainly not in interest

rates per se.





References

- www.ifmr.ac.

: www.google.com

: www.microfinanceinsight.com

: www.investopedia.com

: www.books.google.com

: www.seepnetwork.org

: www.forbes.com

: www.nationmaster.com

: www.thaindian.com

: www.authorstream.com

: www.knowledge.allianz.com

Documents

MFI Report1