CHAPTER 1: AN INTRODUCTION TO MICROFINANCE
1.1 What’s microfinance?
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Chapter 1: An Introduction to Microfinance
1.1 What’s microfinance?
The term microfinance refers to small-scale financial services both credit and savings- that are extended to the poor in rural, semi-urban and urban areas. The poor need microfinance to undertake economic activity, smoothen consumption, mitigate vulnerability to income shocks (in times of illness and natural disasters), increase saving and support self-empowerment.
Microfinance – the provision of loans and other financial services to those who have traditionally been denied access to the formal financial sector has grown from an idea into an industry. Brought to the world‘s attention in 2006, when Muhammad Yunus and the Grameen Bank won the Nobel Peace Prize for ―their efforts to create economic and social development from below‖1, the rapid growth of the microfinance movement across the developing world has spurred both accolades and accusations. Those who promote microfinance, consider it a powerful tool in poverty alleviation and women‘s empowerment.
In 1997, then United Nations (UN) Secretary General, Kofi Annan, declared that,
―Microcredit is a critical anti-poverty tool - a wise investment in human capital. When the poorest, especially women receive credit they become economic actors with power. Power to improve not only their own lives but, in a widening circle of impact, the lives of their families, their communities, and their nations‖2
1 Press Release – Nobel Peace Prize 2006. Available at:
http://nobelprize.org/nobel_prizes/peace/laureates/2006/press.html.
2The Global Development Research Centre website. Available at:
http://www.gdrc.org/icm/iym2005/index.html.
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1.2 Need for microfinance in IndiaThe Reserve Bank of India (RBI) defines microfinance as ―the provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and urban areas for enabling them to raise their income levels and improve their living standards.
It also serves as an umbrella term for the provision of financial access, through focused financial intermediaries, to those parts of the population that are not being served by mainstream financial services providers. The vicious cycle of ―low income → low savings → low investment → low income‖ can be broken with the injection of credit in the cycle. ―Credit intended for more investment → more income → more savings → more investment → more income‖ is the result that is sought through the credit intervention.
1.2.1 Why the Bank Network has failed to deliver?
In order to understand why most Indians are unable to borrow from formal financial institutions, there are combination of factors involving the banks and the clients themselves.
They argue that the banks are wary of the repayment capacity of poor borrowers, their volatile income streams and incapability to provide collateral. The clients also make bad-borrowers as they typically avail of loans for consumption smoothing rather than investment in business and when the loans are for entrepreneurial purposes the poor borrowers often lack the technical/business skills and market information to make their businesses viable. Further, the transaction costs of rural loans are significantly higher since the loan size is usually small, there is widespread illiteracy among poorer clients and they are spread over a large geographical area.
From the perspective of the borrowers, rural banks are unattractive for multiple reasons as well. As noted previously, the services offered by banks are not well suited to the non-uniform income patterns of the poor, compounded with the transaction costs and in some cases bribes to bank officials, banks begin to seem as tedious an option as usurious moneylenders. Borrowers also usually have to travel long distances from their villages to reach the bank, and alongside paying for the transportation cost, lose close to a day‘s wages due to the time spent travelling.
Finally, bank loans take, on average, about 33 weeks to process, and are made out against collateral, making them unviable for poorer rural borrowers.
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1.3 Microfinance market and its participants in India
Microcredit is the most common product offering. Microfinance in India is synonymous with microcredit; this is because savings and micro insurance constitute a miniscule segment of the microfinance space. In India, most microfinance loans are in range of $110 to $450 (the Development Regulation Bill, 20073, defines microfinance loans as loans with amounts not exceeding $1000 in aggregate per individual/small enterprise). Its estimates that around 120 million households in India continue to face financial exclusion: this translates into a credit demand of around $240 billion4.
MFIs are the main players in the microfinance space in India their primary product is microcredit. Other players that extend microfinance services, in addition to their core businesses, include banks and insurance companies, agricultural and dairy co-operatives, corporate organizations such as fertilizer companies and handloom houses, and the postal network.
Additionally, there are specialized lenders, called apex MFIs that both loans and capacity building support to MFIs. National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India, Rashtriya Mahila Kosh and Friends of Women's World Banking are the apex MFIs in India.
3 This bill, which envisages the regulation of the microfinance sector, is under the Parliament's consideration
4The number of households facing exclusion has been arrived at by adding rural households facing financial exclusion (93 million) and urban below-poverty line (BPL) households (18 million). The average credit demand per household has been estimated at USD 220 per annum.
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9 1.4 Differentiating factors of MFIs
1.5 Lending model
In terms of lending model, MFIs may be classified as lenders to groups or as lenders to individuals. In India, MFIs usually adopt the group-based lending models, which are of two types ― the self-help group (SHG) model and the joint-liability group (JLG)/solidarity group model. Under the SHG model, an MFI lends to a group of 10 to 20 women. Under the SHG-bank linkage model, an NGO promotes a group and gets banks to extend loans to the group. Under the JLG model, loans are extended to, and recovered from, each member of the group (unlike under the SHG model, where the loan is extended to the group as a whole).
The model of lending to individuals is similar to the retail loan financing model of banks.
In India, MFIs adopting the group-lending models extend individual loans to more successful borrowers who have completed a few loan cycles as part of a group (who have relatively large credit requirements and good repayment track record). Corporate and cooperatives, typically dairy farms and sugar mills, are also known to undertake microfinance by extending credit to farmers; this helps companies strengthen their procurement and distribution networks.
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MFIs are also differentiated on the basis of their loan repayment structures. Most MFIs following the JLG model adopt the weekly and fortnightly repayment structure; those under the SHG model have a monthly repayment structure. MFIs lending to traders in market places also offer daily repayment, while MFIs extending agricultural loans have bullet- and cash-flow based repayment structures depending on the crop patterns.
Most MFIs in India are solely engaged in extending microcredit: a few also extend saving/thrift, insurance, pension, and remittance facilities. For providing insurance facilities, MFIs have tied up with insurance companies and mutual networks (funds created by community-owned organizations); some MFIs also do underwriting on their own.
MFIs offer savings services in two ways the savings are either collected by the MFI or the SHG. In the latter method, the MFI or the NGO encourages the SHG to collect savings/thrift from each member of the group on a weekly/monthly basis and rotate the savings/thrift among members. An MFI collecting savings from borrowers may either make it compulsory for borrowers/members to have savings with it, or offer voluntary savings services to both members /non-members. Only MFIs registered as cooperatives or depositing NBFCs can collect savings/deposits; a few MFIs registered as societies and trusts continue to accept savings/deposits, and thus face regulatory risks.
1.6 Legal structure
With respect to legal structure, MFIs may be classified as follows:
Not-for-profit MFIs
o Societies (such as Bandhan, Rashtriya Seva Samithi, and Gram Utthan)
o Public trusts (such as Shri Kshetra Dharmasthala Rural Development Project, and Community Development Centre)
o Non-profit companies, section 25 company (such as Indian Association for Savings and Credit, and Cashpor Micro Credit)
Mutual benefit MFIs
o Co-operatives registered under State or National Acts (such as Pustikar Laghu Vyaparik Pratisthan Bachat and Sakh Sahkari Samiti Limited)
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o Mutually-aided co-operative societies (MACS; such as Sewa Mutually Aided Cooperative Thrift Societies Federation Ltd)
For-profit MFIs
o Non-banking financial companies (NBFCs; such as Bhartiya Samruddhi Finance Ltd, Share Microfin Ltd , SKS Microfinance Ltd and Spandana Sphoorthy Financials Ltd)
o Producer companies (such as Sri Vijaya Visakha Milk Producers Co Ltd) o Local area banks (the only such MFI is Krishna Bhima Samruddhi Local Area
Bank)
Table 1 : Microfinance Legal structure
Type of entity Not-for-profit Mutual benefit For-profit Association Society under Societies
Registration Act 1860
Charitable trust Mutual benefit trust Investment trusts Company under Indian
Companies Act, 1956
Section 25 Company Mutual Benefit (Sec 620A Nidhi Company)
Company which is further either an NBFC or a bank
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Chapter 2: Key Strengths and weaknesses of Indian MFIs
2.1 Strong business growth, improving geographic diversity
The microfinance market in India is expected to grow rapidly, supported by the Government of India's (GoI's) initiatives to achieve greater financial inclusion, and growth in the country's retail sector. MFIs have a grass-root level reach and understanding of the economic needs of the poor. The growing retail market in India provides opportunities for MFIs to act as intermediaries in the retail supply chain. The banking sector will also help the microfinance sector grow - banks are expected to use MFIs to meet their financial inclusion targets by allowing MFIs to open bank accounts, and distribute financial services and other structured products.
The microfinance sector has passed its evolutionary phase, when the profit-oriented working model of MFIs was perceived by the market as exceptionable; acceptance for the same has increased gradually. Also, investors now have a wider choice of MFIs with scalable processes. NGO-MFIs have been acquiring dormant NBFCs for regulatory, financial, and operational reasons. Many large players are now focused on urban microfinance, and have begun extending loans to individuals.
The microfinance sector and MFIs in India are estimated to have total loans of Rs.160 to Rs.175 billion ($3.5 to $3.9 billion), and Rs.110 to Rs.120 billion ($2.4 to $2.7 billion), respectively, as on March 31, 2009. The microfinance sector in India is fragmented - there are more than 3,000 MFIs, NGOs, and NGO-MFIs, of which about 400 have active lending programmes. The top 10 MFIs are estimated to account for around 74 per cent of the total loans outstanding for MFIs; around 17 MFIs had outstanding loans of more than Rs.1 billion ($22 million) as on March 31, 2009, with the top three MFIs crossing Rs.10 billion ($220 million) in terms of outstanding loan portfolio on that date.
As on March 31, 2009, its estimates MFIs' outstanding loans to have increased to Rs.114 billion - $ 2.5 billion (refer Chart 1) from Rs.60 billion ($1.3 billion) a year ago. The growth in
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disbursements by MFIs was more than that of the SHG-bank linkage programme during 2007-08 (refers to financial year, April 1 to March 31); MFIs' disbursement have increased aggressively, at a compound annual growth rate (CAGR) of 90 per cent, over the past four years.
CRISIL estimates the overall disbursement during 2008-09 to be around Rs.287 billion ($6.4 billion), of which disbursements of Rs.185 billion ($4.1 billion) were made by MFIs (refer Chart 2). This is reflective of the increased acceptance of MFIs as commercially viable and their resultant ability to attract capital and resources during the past two years.
Chart 1 : MFIs Growth Trend
Chart 2: Trend in disbursements
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A majority of MFIs, including the larger players, operated mainly in South India till 2005-06. Since 2006-07, however, the large MFIs have extended their presence to states such as Maharashtra, Chhattisgarh, Orissa, Jharkhand, and West Bengal; over the past two years, the larger MFIs have established pan-India coverage. The growth of the microfinance sector in eastern India was driven primarily by capacity enhancement initiatives by the apex MFIs, and tapping of growth opportunities in the eastern market by South-India-based MFIs, and banks.
Many of the large MFIs, nevertheless, continue to have a significant exposure to South India.
2.2 Healthy asset quality
MFIs' asset quality, indicated by their current portfolio, and the portfolio at risk (PAR) by more than 30 days, has improved (refer Chart 3), and is healthier than those of other financial service players in India. The ―current portfolio” is the outstanding amount of all loans as on a particular date, with no interest and principal over dues.
MFIs have maintained relatively healthy asset quality mainly because of strong group pressure and efficient collection mechanisms, which have ensured high repayment rates. The 'current portfolio' improved significantly during the first half of 2008-09 over the corresponding period in 2007-08 and was at similar levels before March 2006. Delinquencies increased during 2005-06 and 2006-07 as many leading MFIs were impacted by non-repayment by borrowers in some coastal districts of Andhra Pradesh. This was triggered by the local administration of Krishna District in Andhra Pradesh ordering an enquiry into the high interest rates charged by some MFIs in the district, and closing of a few branches of these MFIs for a brief period. This impacted the loan portfolios of MFIs not only in Krishna District, but also in the neighbouring districts.
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Chart 3: Trend in assets quality
Among MFIs, Section 25 companies and co-operatives tend to have average risk management practices; these entities, therefore, have typically higher delinquency levels.
Societies/trusts have demonstrated good collection efficiency supported by the credit-plus initiatives provided by this segment. Most MFIs are NGO-MFIs, which were set up to promote social development, and subsequently began extending financial intermediation to ensure sustained livelihood for members. These social development activities and long relationships with borrowers enhance the NGO-MFIs' influence over borrowers, and consequently, their repayment efficiency and asset quality.
Table 2 : Movement in current portfolio across different legal structures (in %)
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The MFIs current portfolio has improved on account of several factors. MFIs‘ business volume improved by around 46% during the first half of 2008-09 over 2007-08. Disbursement increased at a CAGR of 90 per cent, and the loan portfolio by 81 per cent, over the past three years. The collection efficiency of MFIs was supported by a loan waiver scheme in 2008-09, unlike in 2007-08, when most microfinance portfolios were transferred by MFIs registered as societies and trusts to NBFCs, with overdue loans retained with the societies and trusts;
consequently, the asset quality appears to have improved. Most delinquent loans in 2006 in Krishna and the adjoining districts were managed by MFIs for a leading private sector bank. The bank did not invoke the loan default guarantee and since 2007-08, the MFIs have stopped tracking these overdue loans.
2.3 Key weaknesses found amongst many MFIs in India
Lack of a business orientation which limits sustainability – most MFIs in the region emerge from NGOs with a social agenda
Perceive microfinance as extension of social development not financial intermediation – affects orientation/systems
Many are leader dominated institutions with centralised decision making, which affects receptivity to ideas, limits response to market opportunities.
Incomplete understanding of client needs/product design
Poor loan tracking and follow up
Lack of incentives for staff
Accounting deficiencies
Failure to take account of income accruals
Rescheduling and refinancing of client loans (minor) cases of fraud undetected on account of poor MIS/internal audit process.
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17 2.4 Matter of concern
2.4.1 Mission Drift
In an environment where the measure for success often-times remains the number of loans disbursed or the number of clients acquired, the poor often become casualties rather than beneficiaries. Poor people have always been prey to unscrupulous and recalcitrant moneylenders or other bogus savings institutions. Therefore, there is a very real risk that in the guise of genuine MFIs, swindlers or worse incompetent people may injure them even further
2.4.2 Use of Loans
There is a latent assumption that micro-loans will lead to entrepreneurial and profit-generating activity, thereby perpetuating a virtuous cycle of poverty reduction. However, the reality is that a large portion of loans are taken for non-productive activities, such as weddings, funerals, dowries, roof-repair, subsistence etc. This is not to say that such activities do no merit loans, in fact, one of the primary merits of microfinance is that it makes the poor less vulnerable to destitution by making available these small loans. It may also be argued that by smoothing over the expenditure on food consumption of a farmer for instance, a micro-loan may allow him/her to work better in the fields, and is therefore eventually remunerative.
The clients of microfinance institutions have always used some of their loans for purposes other than micro-enterprise investment. This may still be known as ‗misuse‘ by some agencies but most providers of microfinance services are coming to realize that money is fungible, and that their customers probably know better than they do how to best use their money.
However, a cautionary note must be added that when micro-loans are made available of for non-remunerative purposes, by an over-zealous loan officer to a financially-uneducated client, they may engender a spiral of further poverty. The State of the Sector (SOS) Report 2009 explicitly warns against such loans and recommends that the ability of the client to repay the loan amount must be established prior to the disbursement of the loan.
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18 2.4.3 Multiple-borrowing
Often when a borrower is unable to repay a micro-loan within the stipulated time, she may be forced to take another loan, from a different MFI in order to meet her commitment. The problem of multiple-lending has permeated most regions in southern India, where there is a high concentration of MFIs, and intense competition to woo the maximum number of clients. In such a scenario, it would be appropriate to cite that ‗micro-credit is also micro-debt‘
As MFIs expand and loan officer incentives are tied to client repayment, there may be a clash between profitability and sensitivity to client needs and circumstances. The most heinous consequence of taking a micro-loan and being unable to repay it was evident in the much publicized Krishna district debacle of 2006 where some farmers committed suicide due to the debt-burden. However, to the credit of the microfinance community, there is a concerted effort towards sensitizing field officers and higher management towards the needs of the microfinance clientele. In fact, Indian NBFC MFIs have come together to initiate the formation of a ‗credit-bureau‘ in order to avoid the cataclysmic consequences being repeated elsewhere. Most MFIs have some sort of procedure in place to re-schedule loan repayments in the face of genuine circumstances.
2.4.4 Quality Issues
There have also been allegations against the quality of MFIs in India, many of which suffer from weak governance and management structures, the absence of internal controls and the lack of financial discipline. This is particularly true of the many opportunistic start-up
There have also been allegations against the quality of MFIs in India, many of which suffer from weak governance and management structures, the absence of internal controls and the lack of financial discipline. This is particularly true of the many opportunistic start-up