48947731 a-project-report-on-microfinance-in-india


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48947731 a-project-report-on-microfinance-in-india

  1. 1. 201 1 MBA RESEARCH PROJECT SABUJ GHOSH The report is submitted as partial fulfillment of the Requirement of MBA Program of PTU. Plot Y8, Block EP, Sector V, Salt Lake, Kolkata - 700091, India.|Page 1
  2. 2. APPROVED BY JOINT COMMITTEE OF UGC-DEC- AICTE, MINISTRY OF HRD, GOVT: OF INDIA. RESEARCH PROJECT STUDENT NAME: SABUJ GHOSH MBA Specialization: FINANCE Registration / Roll No -911170101 Email Id : sabuj1ghosh@gmail.com MOB- 9433241627.A PROJECT REPORT ON:-|Page 2
  4. 4. I am Sabuj Ghosh, hereby declare that the Project entitled Micro-finance Critical Analysis & OperationManagement submitted to the Punjab Technical University in partial fulfillment for the award of theDegree of MASTER IN BUSINESS ADMINISTRATION and that the Project has not previously formed thebasis for the award of any other degree, Diploma, Associate ship, Fellowship or other title.Place:Date: Signature of the Candidates. ACKNOWLEDGEMENT|Page 4
  5. 5. The satisfaction and euphoria that accompanied the successful completion of any task would beincomplete without the mention of the people who made it possible, whose constant guidance andencouragement crowned out effort with success. I take this opportunity to express our deep sense ofgratitude and respect to our Supervisor BARNASREE CHANDRA Faculty Member of FINANCE for thevaluable guidance, BRAINWARE BUSINESS SCHOOL (Plot Y 8,Block EP, Sector – V, Salt Lake, Kolkata-700091) India and Kotalipara Development Society (KDS MFI), Arabida pally, Noapara, Kolkata-124 ,for providing us with essential facilities for completing and presenting this project. I am greatlyindebted to their help, which has been of immense value and has played a major role in bringing this toa successful completion. I would like to thank our family and friends for their constant support andencouragement throughout our project. -----------|Page 5
  6. 6. ABSTRACT OF THE PROJECT Learning from the project * The History of Modern Microfinance. I learnt in detail the process of Micro Finance, from its need at the grass root level. *Functioning of various Govt:, Semi Govt: & various other delivery channels. *Practical learning of how SHGs are formed. *Practical learning of how the MFIs work. *Most important learning, how it can change the life of the Economic disadvantaged people. Learning from the Company * Microfinance Regulation in India. *Micro Finance Model. *Microfinance Management, Critical Analysis. *Practical learning of Equity, Future & Options market by terminal trading. *Various strategies of Market. *Apart from Micro Finance, Nine mine projects, which helped to relate to the Present Market conditions. *Business Model.|Page 6
  7. 7. TABLE OF CONTENTS PAGE*DECLARATION 4*ACKNOWLEDGEMENT 5*ABSTRACT OF THE PROJECT 6 Chapter 1- Introduction 8 2- The History of Modern Microfinance 8 3- Overview Chapter 9 4- Government’s role supporting microfinance 12 5- Microfinance Social Aspects 13 6- The Need in India 14 7- Micro-Financing Regulation in India 14 8- Micro Finance Models 16 9- Coordinating Microfinance Efforts in India 18 10- Microfinance Strategic 19 11- Microfinance Management 22 12- Critical Analysis 27 13- Micro-Finance Accounting and Management Information Systems 34 14- Capital Requirements 41 15- Development Fund 43 16- NABARDs Support to microfinance Institutions (MFIs) 45 17- Business Model of KDS MFI 46 19- Success Factors of Micro-Finance in India 56 20- Future of Micro Finance 57 21- Top 50 Microfinance Institutions in India 59 22- Microfinance India Summit 2010 61 • Recommendations and suggestions 62 • ACRONOMY 62 • Conclusion 63 • References 64|Page 7
  8. 8. 1. Introduction A. About Microfinance: Microfinance is a general term to describe financial services to low-income individuals or to those who do not have access to typical banking services.Microfinance is also the idea that low-income individuals are capable of lifting themselves out of poverty ifgiven access to financial services. While some studies indicate that microfinance can play a role in the battleagainst poverty, it is also recognized that is not always the appropriate method, and that it should never beseen as the only tool for ending poverty.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 poorindividuals which fall below that poverty line, with the goal of creating social value. The creation of social valueincludes poverty alleviation and the broader impact of improving livelihood opportunities through the provisionof capital for micro enterprise, and insurance and savings for risk mitigation and consumption smoothing. Alarge variety of actors provide microfinance in India, using a range of microfinance delivery methods. Since theICICI Bank in India, various actors have endeavored to provide access to financial services to the poor increative ways. Governments also have piloted national programs, NGOs have undertaken the activity of raisingdonor funds for on-lending, and some banks have partnered with public organizations or made small inroadsthemselves in providing such services. This has resulted in a rather broad definition of microfinance as anyactivity that targets poor and low-income individuals for the provision of financial services. The range ofactivities undertaken in microfinance include group lending, individual lending, the provision of savings andinsurance, capacity building, and agricultural business development services. Whatever the form of activityhowever, the overarching goal that unifies all actors in the provision of microfinance is the creation of socialvalue.‘Microfinance refers to small scale financial services for both credits and deposits- that are provided to peoplewho farm or fish or herd; operate small or micro enterprise where goods are produced, recycled, repaired, ortraded; provide services; work for wages or commissions; gain income from renting out small amounts of land,vehicles, draft animals, or machinery and tools; and to other individuals and local groups in developingcountries in both rural and urban areas’.Marguerite S. Robinson. 2. The History of Modern Microfinance A. ABSTRACT: In the late 1970s the concept of microfinance had evolved. Although, microfinance have a long history from the beginning of the 20th century we will concentrate mainly on the period after 1960. Many credit groups have been operating in many countries for several years, for example, the "chit funds" (India), tontines" (West Africa), "susus" (Ghana), "pasanaku" (Bolivia) etc. Besides, many formal saving and credit institutions have been working for a long time throughout the world. During the early and mid 1990s various credit institutions had been formed in Europe by some organized poor people from both the rural and urban areas. These institutions were named Credit Unions, Peoples Bank etc. The main aim of these institutions was to provide easy access to credit to the poor people who were neglected by the big financial institutions and banks.|Page 8
  9. 9. In the early 1970s, few experimental programs had started in Bangladesh, Brazil and some othercountries. The poor people had been given some small loans to invest in micro-business. This kind ofmicro credit was given on the basis of solidarity group lending, that is, each and every member of thatgroup guaranteed the repayment of the loan of all the members.Many banks and financial institutions have been pioneering the microfinance program after 1970.These are listed below. B. ACCION International:This institution had been established by a law student of Latin America to help the poor peopleresiding in the rural and urban areas of the Latin American countries. Today, in 2008, it is one of themost important microfinance institutions of the world. Its network of lending partner comprises not onlyLatin America but also US and Africa. C. SEWA Bank: In 1973, the Self Employed Womens Association (SEWA) of Gujarat (in India) formed a bank,named as Mahila SEWA Cooperative Bank, to access certain financial services easily. Almost 4thousand women contributed their share capital to form the bank. Today the number of the SEWABanks active client is more than 30,000. D. GRAMEEN Bank:Credit unions and lending cooperatives have been around hundreds of years. However, thepioneering of modern microfinance is often credited to Dr. Mohammad Yunus, who beganexperimenting with lending to poor women in the village of Jobra, Bangladesh during his tenure as aprofessor of economics at Chittagong University in the 1970s. He would go on to found GrameenBank in 1983 and win the Nobel Peace Price in 2006.Since then, innovation in microfinance has continued and providers of financial services to the poorcontinue to evolve. Today, the World Bank estimates that about 160 million people in developingcountries are served by microfinance. Grameen Bank (Bangladesh) was formed by the Nobel PeacePrize (2006) winner Dr Muhammad Younus in 1983. This bank is now serving almost 400, 0000 poorpeople of Bangladesh. Not only that, but also the success of Grameen Bank has stimulated theformation of other several microfinance institutions like, ASA, BRAC and PROSHIKA . 3. Overview A. Microfinance Definition:According to International Labor Organization (ILO), “Microfinance is an economic development approach thatinvolves providing financial services through institutions to low income clients”.In India, Microfinance has been defined by “The National Microfinance Taskforce, 1999” as “provision of thrift,credit and other financial services and products of very small amounts to the poor in rural, semi-urban or urbanareas 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."Microfinance is the supply of loans, savings, and other basic financial services to the poor."|Page 9
  10. 10. As these financial services usually involve small amounts of money - small loans, small savings, etc. - the term"microfinance" helps to differentiate these services from those which formal banks provideIts easy to imagine poor people dont need financial services, but when you think about it they are using theseservices 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 asidecorn from their harvest to sell at a later date. They bury cash in the garden or stash it under the mattress. Theyparticipate in informal savings groups where everyone contributes a small amount of cash each day, week, ormonth, and is successively awarded the pot on a rotating basis. Some of these groups allow members toborrow from the pot as well. The poor also give their money to neighbors to hold or pay local cash collectors tokeep it safe."However widely used, informal savings mechanisms have serious limitations. It is not possible, for example, tocut a leg off a goat when the family suddenly needs a small amount of cash. In-kind savings are subject tofluctuations 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 limited amounts of money. Moreover, these groupsoften require rigid amounts of money at set intervals and do not react to changes in their members ability tosave. Perhaps most importantly, the poor are more likely to lose their money through fraud or mismanagementin informal savings arrangements than are depositors in formal financial institutions.“Poor rarely access services through the formal financial sector. They address their need for financial servicesthrough a variety of financial relationships, mostly informal." B. Role of Microfinance:The micro credit of microfinance prename was first initiated in the year 1976 in Bangladesh with promise ofproviding credit to the poor without collateral , alleviating poverty and unleashing human creativity andendeavor of the poor people. Microfinance impact studies have demonstrated that1. Microfinance helps poor households meet basic needs and protects them against risks.2. The use of financial services by low-income households leads to improvements in household economicwelfare and enterprise stability and growth.3. By supporting women’s economic participation, microfinance empowers women, thereby promoting gender-equity and improving household well being.4. The level of impact relates to the length of time clients have had access to financial services. C. Difference between micro credit and microfinance:Micro credit refers to very small loans for unsalaried borrowers with little or no collateral, provided by legallyregistered institutions. Currently, consumer credit provided to salaried workers based on automated creditscoring is usually not included in the definition of micro credit, although this may change.Microfinance typically refers to micro credit, savings, insurance, money transfers, and other financial productstargeted at poor and low-income people. D. Borrowers:|Page 10
  11. 11. Most micro credit borrowers have micro enterprises—unsalaried, informal income-generating activities.However, micro loans may not predominantly be used to start or finance micro enterprises. Scattered researchsuggests that only half or less of loan proceeds are used for business purposes. The remainder supports awide range of household cash management needs, including stabilizing consumption and spreading out large,lumpy cash needs like education fees, medical expenses, or lifecycle events such as weddings and funerals.Some MFIs provide non-financial products, such as business development or health services. Commercial andgovernment-owned banks that offer microfinance services are frequently referred to as MFIs, even though onlya portion of their assets may be committed to financial services to the poor. E. Activities in Microfinance:Micro credit: It is a small amount of money loaned to a client by a bank or other institution. Micro credit can beoffered, 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 tomeet 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 entrepreneursto concentrate more on developing their businesses while mitigating other risks affecting property, health or theability to work.Remittances: These are transfer of funds from people in one place to people in another, usually acrossborders to family and friends. Compared with other sources of capital that can fluctuate depending on thepolitical or economic climate, remittances are a relatively steady source of funds.Product Design: The starting point is: how do MFIs decide what product s to offer? The actual loan productsneed to be designed according to the demand of the target market. Besides the important question of whatrisks to cover, organizations also have to decide whether they want to bundle many different benefits into onebasket policy, or whether it is more appropriate to keep the product simple. For marketing purposes, MFI‘ssometimes prefer the basket cover, since it can make the policies sound comprehensive, but is that the rightapproach for the low-income market? After picking products, one must also understand how they are priced.What assumptions do the organizations make with regard to operating costs, risk premiums, and reinsurance,and how did they come to those conclusions? Would their clients be willing to pay more for greater benefits?From price, the logical next set of questions involves efficiency. Indeed, given the relative high costs ofdelivering large volumes of small policies, maximizing efficiency is a critical strategy to ensuring that theproducts are affordable to the low-income market. One way is to make the products mandatory, whichincreases volumes, reduces transaction costs and minimizes adverse selection. What does an organizationlose by offering mandatory insurance, and how does it overcome the disadvantages? MFI‘s can combine amandatory product with some voluntary features to make the service more us to mar-oriented while.Techniques of Product Design: To design a loan product to meet borrower needs it is important tounderstand the cash pattern of the borrowers. Cash pattern is important so far as they affect the debt capacityof the borrowers. Lenders must ensure that borrowers have sufficient cash inflow to cover loan payments whenthey are due efficiency depends less on the delivery model than on the simplicity of the product or productmenu. Simple products work best because they are easier to administer and easier for clients to understand.Another efficiency strategy is to use technology to reduce paperwork, manual processing and errors. MFIs need to conduct a costing analysis to determine how much they need to earn in commission to covertheir administrative expenses. F. MFI’s Products and its Management:|Page 11
  12. 12. Product & services of MicrofinanceFinancial Services Other Financial Services Non Financial Services1. Credit Services-i Small Credit, Micro-insurance, Life Insurance , Family Health and SanitationSmall Business Credit. Health Insurance , Loan for Education, Financial Education, Housing, Education, Health. Micro-entrepreneur Training.2. Deposit Services - VoluntariSavings Services, Manda torySavings. G. The micro-credits model:*The model is fairly straightforward and simple.*Focus on jump-starting self-employment, providing the capital for poor women to use their innate "survivalskills" to pull themselves out of poverty.*Lend to women in small groups (credit circles), say of five or seven.* Make loans of small amounts to two out of five.* The three who have not received loans will be eligible only when this first round of loans has been repaid.* Draw up a weekly or bi-weekly repayment schedule.* In case any member defaults the entire circle is denied access to credit.* Banks have been given freedom to formulate their own lending norms keeping in view ground realities. Theyhave been asked to devise appropriate loan and savings products and the related terms and conditionsincluding size of the loan, unit cost, unit size, maturity period, grace period, margins, etc. 4. Government’s role supporting microfinanceGovernment’s most important role is not provision of retail credit services, for reasons mentioned inGovernment can contribute most effectively by:*Setting sound macroeconomic policy that provides stability and low inflation.*Avoiding interest rate ceilings - when governments set interest rate limits, political factors usually result inlimits that are too low to permit sustainable delivery of credit that involves high administrative costs—such astiny loans for poor people. Such ceilings often have the announced intention of protecting the poor, but aremore likely to choke off the supply of credit.*Adjusting bank regulation to facilitate deposit taking by solid MFIs, once the country has experience withsustainable microfinance delivery.*Creating government wholesale funds to support retail MFIs if funds can be insulated from politics, and theycan hire and protect strong technical management and avoid disbursement pressure that force fund to supportunpromising MFIs. *Promote microfinance as a key vehicle in tackling poverty, and as vital part of the financial system.*Create policies, regulations and legal structures that *encourage responsive, sustainable microfinance.*Encourage a range of regulated and unregulated institutions that meet performance standards.|Page 12
  13. 13. *Encourage competition, capacity building and innovation to lower costs and interest rates in microfinance.*Support autonomous, wholesale structures. RBI data shows that informal sources provide a significant part of the total credit needs of the rural population.The magnitude of the dependence of the rural poor on informal sources of credit can be observed from thefindings of the All India Debt and Investment Survey, 1992, which shows that the share of the Non-institutionalagencies (informal sector) in the outstanding cash dues of the rural households were 36 percent. However, thedependence of rural households on such informal sources had reduced of their total outstanding dues steadilyfrom 83.7 percent in 1961 to 36 percent in 1991. 5. Microfinance Social AspectsMicro financing institutions significantly contributed to gender equality and women’s empowerment as well aspoor development and civil society strengthening. Contribution to women’s ability to earn an income led to theireconomic empowerment, increased well being of women and their families and wider social and politicalempowerment.Microfinance programs targeting women became a major plank of poverty alleviation and gender strategies inthe 1990s. Increasing evidence of the centrality of gender equality to poverty reduction and women’s highercredit repayment rates led to a general consensus on the desirability of targeting women.Self Help Groups (SHGs): Self- help groups (SHGs) play today a major role in poverty alleviation in ruralIndia. A growing number of poor people (mostly women) in various parts of India are members of SHGs andactively engage in savings and credit (S/C), as well as in other activities (income generation, natural resourcesmanagement, literacy, child care and nutrition, etc.). The S/C focus in the SHG is the most prominent elementand 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 breakgradually away from exploitation and isolation.Savings services help poor people: Savings has been called the “forgotten half of microfinance.” Most poorpeople now use informal mechanisms to save because they lack access to good formal deposit services,. Theymay tuck cash under the mattress; buy animals or jewelry that can be sold off later, or stockpile inventory orbuilding materials.These savings methods tend to be risky—cash can be stolen, animals can get sick, and neighbors can run off.Often they are illiquid as well – one cannot sell just the cow’s leg when one needs a small amount of cash.Poor people want secure, convenient deposit services that allow for small balances and easy access to funds.MFIs that offer good savings services usually attract far more savers than borrowers.Women’s indicators of empowerment through microfinance:*Ability to save and access loans*Opportunity to undertake an economic activity*Mobility-Opportunity to visit nearby towns*Awareness- local issues, MFI procedures, banking transactions*Skills for income generation |Page 13
  14. 14. *Decision making within the household* Group mobilization in support of individual clients- action on. 6. The Need in IndiaIndia is said to be the home of one third of the world’s poor; official estimates range from 26 to 50 percent ofthe more than one billion population.• About 87 percent of the poorest households do not have access to credit.• The demand for micro credit has been estimated at up to $30 billion; the supply is less than $2.2 billioncombined by all involved in the sector. Due to the sheer size of the population living in poverty, India isstrategically significant in the global efforts to alleviate poverty and to achieve the Millennium DevelopmentGoal of halving the world’s poverty by 2015.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 canoccur for example, in a war zone or after a natural disaster.While India is one of the fastest growing economies in the world, poverty runs deep throughout country.About two thirds of India’s more than 1billion people live in rural areas and almost 170 million of themare poor.For more than 21 percent of them, poverty is a chronic condition. Three out of four of India’s poor live inrural areas of the country. Poverty is deepest among scheduled castes and tribes in the country’s ruralareas.The micro-finance scene in India is dominated by Self Help Groups (SHGs) - Banks linkage program forover a decade now. As the formal banking system already has a vast branch network in rural areas, itwas perhaps wise to find ways and means to improve the access of rural poor to the existing bankingnetwork. This was tried by routing financial.Indian microfinance is poised for continued growth and high valuation but faces pressing challenges andopportunities that—left unaddressed—could negatively impact the long-term future of the industry.The industry needs to move past a single-minded focus on scale, expand the depth and breadth of productsand services offered, and focus on the double bottom line and over indebtedness to effectively address therisks facing the industry. 7. Micro-Financing Regulation in India Advantage of Regulation: Following are the advantages and benefits of regulation and supervision of /MFIs: i. Protects the interest of the depositors;ii. Put in place prudential norms, standards and practices;iii. Provides sufficient information about the true risks faced by the banks/MFIs;iv. Promoters systemic stability and thereby sustains public confidence in the banks/MFIs;v. Prevents a bank’s/MFI’s failure/potential dangers through timely interventions;vi. Penalizes the violations, misconducts, non-compliance to the norms of behavior;vii. Provides invaluable advisory inputs for problem-solving and overall improvement of the banks/MFIs;viii. Promoters safe, strong and sound banking/MF system and effective banking/MF policy and|Page 14
  15. 15. ix. Promotes and enhances orderly economic growth and development. A. Unified Regulation System: 8.18 at present, all the regulatory aspects of microfinance arenot centralized. For example, while the Rural Planning and Credit Department (RPCD) in RBI looksafter Rural lending, MF-NBFCs are under the control of the Department of Non-Banking Supervision(DNBS) and External Commercial Borrowings are looked after by the Foreign Exchange Department.The Committee feels that RBI may consider bringing all regulatory aspects of microfinance under asingle, mechanism. Further, supervision Of MF-NBFCs could be delegated to NABARD by RBI. B. Legal forms of MFIs in India:MFIs and Legal Forms: With the current phase of expansion of the SHG – Bank linkage programmed andother MF initiatives in the country, the informal micro finance sector in India is now beginning to evolve. TheMFIs in India can be broadly sub-divided into three categories of organizational forms as given in Table 1.While there is no published data on private MFIs operating in the country, the number of MFIs is estimated tobe around 800. However, not more than 10 MFIs are reported to have an outreach of 100,000 micro financeclients. An overwhelming majority of MFIs are operating on a smaller scale with clients ranging Between 500 to1500 per MFI. The geographical distribution of MFIs is very much lopsided with concentration in the southernIndia where the rural branch network of formal banks is excellent. It is estimated that the share of MFIs in thetotal micro credit portfolio of formal & informal institutions is about 8 per cent.*Not for profit MFIs governed by societies registration act, 1860 or Indian trusts act 1882*Non profit companies governed by section 25 of the companies act, 1956*For profit MFIs regulated by Indian companies act, 1956*NBFC governed by RBI act, 1934.*Cooperative societies by cooperative societies act enacted by state government. Legal Forms of MFIs in India: Types of MFIs Estimated Legal Acts under which Registered Number*1. Not for Profit MFIs 400 to 500 Societies Registration Act, 1860 or similar Provincial Actsa.) NGO - MFIs Indian Trust Act, 1882b.) Non-profit Companies 10 Section 25 of the Companies Act, 19562. Mutual Benefit MFIs 200 to 250 Mutually Aided Cooperative Societies Acta.) Mutually Aided Cooperative enacted by State GovernmentSocieties (MACS) and similarly setup institutions3. For Profit MFIs 6 Indian Companies Act, 1956a.) Non-Banking Financial Reserve Bank of India Act, 1934Companies (NBFCs)Total 700 - 800* The estimated number includes only those MFIs, which are actually undertaking lending activity. C. Recommendation by RBI Micro Credit Institutions:• Company Law Board to allow SHGs to be members of Section 25 of the companies act. |Page 15
  16. 16. • There will be no ceiling in respect of loan amount extended by Section 25 companies to SHGs;however SHGs, to provide credit not exceeding Rs. 50000/- per member of the SHG. RBI mayconsider issuing revised instructions.• As regards capital, to encourage more flow of donations/ contributions, donors to be exempted fromincome tax under Section 11C of the IT Act.• As regards capital adequacy, since there is no mandatory capital requirement, minimum standardsneed not be considered.• Savings of SHGs promoted by Section 25 companies be maintained with permitted organizations.• Complete income tax exemption for Section 25 companies purveying micro credit (to the donor and tothe receiver).Government to consider complete exemption from IT for income earned, as the main purpose of theorganization is to empower the poor.Indian microfinance is poised for continued growth and high valuation but faces pressing challenges andopportunities that—left unaddressed—could negatively impact the long-term future of the industry.The industry needs to move past a single-minded focus on scale, expand the depth and breadth of productsand services offered, and focus on the double bottom line and over indebtedness to effectively address therisks facing the industry. 8. Micro Finance Models A. Microfinance Providers: a. Microfinance Institutions: A microfinance institution (MFI) is an organization that provides microfinance services. MFIs range from small non-profit organizations to large commercial banks. Most MFIs started as not-for-profit organizations like NGOs (non-governmental organizations), credit unions and other financialcooperatives, and state-owned development and postal savings banks. An increasing number of MFIsare now organized as for-profit entities, often because it is a requirement to obtaining a license frombanking authorities to offer savings services. For-profit MFIs may be organized as Non-BankingFinancial Companies (NBFCs), commercial banks that specialize in microfinance, or microfinancedepartments of full-service banks.The micro finance service providers include apex institutions like National Bank for Agriculture and RuralDevelopment (NABARD), Small Industries Development Bank of India (SIDBI), and, Rashtriya Mahila Kosh(RMK). At the retail level, Commercial Banks, Regional Rural Banks, and, Cooperative banks provide microfinance services. Today, there are about 60,000 retail credit outlets of the formal banking sector in the ruralareas comprising 12,000 branches of district level cooperative banks, over 14,000 branches of the RegionalRural Banks (RRBs) and over 30,000 rural and semi-urban branches of commercial banks besides almost90,000 cooperatives credit societies at the village level. On an average, there is at least one retail credit outletfor about 5,000 rural people. This physical reaching out to the far-flung areas of the country to provide savings,credit and other banking services to the rural society is an unparalleled achievement of the Indian bankingsystem. In the this paper an attempt is made to deal with various aspects relating to emergence of privatemicro finance industry in the context of prevailing legal and regulatory environment for private sector rural andmicro finance operators.MFIs are an extremely heterogeneous group comprising NBFCs, societies, trusts and cooperatives. They areprovided 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.|Page 16
  17. 17. Since 2000, commercial banks including Regional Rural Banks have been providing funds to MFIs for onlending to poor clients. Though initially, only a handful of NGOs were “into” financial intermediation using avariety of delivery methods, their numbers have increased considerably today. While there is no published dataon private MFIs operating in the country, the number of MFIs is estimated to be around 800.MFIs are an extremely heterogeneous group comprising NBFCs, societies, trusts and cooperatives. They areprovided 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 onlending to poor clients. Though initially, only a handful of NGOs were “into” financial intermediation using avariety of delivery methods, their numbers have increased considerably today. While there is no published dataon private MFIs operating in the country, the number of MFIs is estimated to be around 800. b. For NGOs:1. The field of development itself expands and shifts emphasis with the pull of ideas, andNGOs perhaps more readily adopt new ideas, especially if the resources required are small, entry and exit areeasy, tasks are (perceived to be) simple and people’s acceptance is high – all characteristics (real orpresumed) 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 theInternational Fund for Agricultural Development (IFAD), United Nations Development Programme (UNDP),World Bank and Department for International Development, UK (DFID)], and lately commercial banks, hasgreatly added to the idea pull. Induced by the worldwide focus on microfinance, donor NGOs too have beenfunding 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 resultsand 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 ‘customersatisfaction’ 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. Itis implicitly assumed that no ‘technical skill’ is involved. Besides, external resources are not needed as SHGsbegin with their own savings. Those NGOs that have access to revolving funds from donors do not have toworry about financial performance any way. The chickens will eventually come home to roost but in the firstflush, it seems all so easy.5. For many NGOs the idea of ‘organizing’ – forming a samuha – has inherent appeal. Groups connoteempowerment and organizing women is a double bonus.6. Finally, to many NGOs, microfinance is a way to financial sustainability. Especially for the medium-to-largeNGOs that are able to access bulk funds for on-lending, for example from SIDBI, the interest rate spread couldbe an attractive source of revenue than an uncertain, highly competitive and increasingly difficult-to-raise donorfunding. C. Service Company Model: In this context, the Service Company Model developed by ACCION andused in some of the Latin American Countries is interesting. The model may hold significant interest for stateowned banks and private banks with large branch networks. Under this model, the bank forms its own MFI,|Page 17
  18. 18. perhaps as an NBFC, and then works hand in hand with that MFI to extend loans and other services. Onpaper, the model is similar to the partnership model: the MFI originates. 9. Coordinating Microfinance Efforts in India NABARD coordinates the microfinance activities in India at international/ national/ state / district levels. Theseinclude organizing international/national Workshops, Seminars, etc for experience sharing, Organizing Nationaland State level Meets of Bankers and NGOs etc .Dissemination of best practices in SHG / microfinance. A. Other Initiatives: Micro enterprise Development Programmer (MEDP) for Matured SHGsThe progression of SHG members to take up micro enterprise involves intensive training and hand holding onvarious aspects including understanding market, potential mapping and ultimately fine tuning skills andentrepreneurship to manage the enterprise. Hence, a separate, specific and focused skill-building programme‘Micro Enterprise Development Programmed (MEDP)’ has been formulated.This involves organizing short duration, location specific programmers on skill up gradation / development forsetting up sustainable micro-enterprises by matured SHG members. The duration of training programme canvary between 3 to 13 days, depending upon the objective and nature of training. The training may beconducted by agencies that have background and professional competency in the field of micro enterpriseDevelopment with an expertise in skill development. B. Scheme for Capital/ Equity Support to Micro-Finance Institutions (MFIs) from MFDEF: The scheme attempts to provide capital/equity support to Micro Finance Institutions (MFIs) so as to enable them to leverage capital/equity for accessing commercial and other funds from banks, for providing financial services at an affordable cost to the poor, and to enable MFIs to achieve sustainability in their credit operations over a period of 3-5 years. C. Scheme for financial assistance to banks/ MFIs for rating of Micro Finance Institutions (MFIs): In order to identify MFIs, classify and rate such institutions and empower them to intermediate between the lending banks and the clients, NABARD has decided to extend financial assistance to Commercial Banks and Regional Rural Banks by way of grant. The banks can avail the services of credit rating agencies, M-CRIL, ICRA, CARE and Planet Finance in addition to CRISIL for rating of MFIs. The financial assistance by way of grant for meeting the cost of rating of MFIs would be met by NABARD to the extent of 100% of the total professional fees subject to a maximum of Rs.3,00,000/-/-. The remaining cost would be borne by the concerned MFI.The cost of local hospitality (including boarding and lodging) towards field visit of the team from thecredit rating Agency, as a part of the rating exercise, would also be borne by the MFI. Those MFIswhich have a minimum loan outstanding of more than Rs. 50.00 lakh (Rupees fifty lakh only) andmaximum of Rs 10 crore (Rupees Ten crore only) would be considered for rating and support underthe scheme. Financial assistance by way of grant would be available only for the first rating of theMFI.MFIs availing Capital Support and/or Revolving Fund Assistance from NABARD are also eligible for re-imbursement of 50% of the cost of professional fee charged by Credit Rating Agency for second rating subjectto a maximum of Rs.1.50 lakh (i.e 50% of Rs.3 lakh). This will be in addition to the re-imbursement ofprofessional fee for first rating of the MFI. D. Refinance support to banks for financing MFIs: The scheme is to provide 100% refinance to banks for financing MFIs. Interest rate on refinance to Commercial Banks and Regional Rural Banks on their|Page 18
  19. 19. loans to MFIs for on lending to clients will be at 3% less than that charged by banks subject to minimum interest rate of 7.5% for all regions and all eligible purposes. The revised rate of interest is applicable to refinance disbursed on or after 01 March 2010.Source: NABARD website 10. Microfinance StrategicStrategic Management: Strategic management is a field that deals with the major intended and emergentinitiatives taken by general manager on behalf of owners, involving utilization of resources, to enhance theperformance of rams in their external environments. It entails.Understanding microfinance strategies: This report explores strategic issues shaping the future of the MFIsector in India.The study approached CEOs of select MFIs with a set of issues ranging from concerns to competition andsought their opinions about future strategies. The report draws from their responses, and states that: • Future strategy is about being strong on processes and being overtly client-centric; • Success is a prudential combination of three factors, namely, culture, beliefs and aspirations; • Culture is about the degree of trust rather than the rate of interest; • Risk management systems of economically weaker families are built on their beliefs about dependability and access; • Micro credit stories have revealed ingenious ways that clients have used their loans for purposes that satisfied their aspirations.Finally, the sector, at about Rs. 14,000 crore (approximately US$3 bn) looks large, but is small by any businessscale. Competition and unhealthy practices are overshadowing the good work and reputation earned overmany years. MFIs in India need to overcome these challenges in the future. 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 byPMO), 2002.Microfinance Development and Equity Fund, NABARD, 2005.Working group on Financing NBFCsby Banks- RBI. A. Product-market matrix:A market penetration strategy is a business-as-usual strategy, where the MFI focuses on achieving growth byselling existing products in existing markets. This can be done through more competitive pricing strategies,increased promotional activities, and more liberal terms and conditions.For example, the MFI may develop strategic alliances to begin|Page 19
  20. 20. *Adapted from Ansoff 1957. B. The BCG Growth-Share Matrix:The BCG Growth-Share Matrix is a portfolio planning model developed by Bruce Henderson of the BostonConsulting Group in the early 1970s. It is based on the observation that a companys business units canbe classified into four categories based on combinations of market growth and market share relative tothe largest competitor, hence the name "growth-share". Market growth serves as a proxy for industryattractiveness, and relative market share serves as a proxy for competitive advantage. The growth-sharematrix thus maps the business unit positions within these two important determinants of profitability.BCG Growth-Share MatrixThis framework assumes that an increase in relative market share will result in an increase in thegeneration of cash. This assumption often is true because of the experience curve; increased relativemarket share implies that the firm is moving forward on the experience curve relative to its competitors,thus developing a cost advantage. A second assumption is that a growing market requires investment inassets to increase capacity and therefore results in the consumption of cash. Thus the position of abusiness on the growth-share matrix provides an indication of its cash generation and its cashconsumption.Henderson reasoned that the cash required by rapidly growing business units could be obtained from thefirms other business units that were at a more mature stage and generating significant cash. By investingto become the market share leader in a rapidly growing market, the business unit could move along theexperience curve and develop a cost advantage. From this reasoning, the BCG Growth-Share Matrix was born.The four categories are:|Page 20
  21. 21. Dogs - Dogs have low market share and a low growth rate and thus neither generate nor consume alarge amount of cash. However, dogs are cash traps because of the money tied up in a business that haslittle potential. Such businesses are candidates for divestiture.Question marks - Question marks are growing rapidly and thus consume large amounts of cash, butbecause they have low market shares they do not generate much cash. The result is large net cashconsumption. A question mark (also known as a "problem child") has the potential to gain market shareand become a star, and eventually a cash cow when the market growth slows. If the question mark doesnot succeed in becoming the market leader, then after perhaps years of cash consumption it willdegenerate into a dog when the market growth declines. Question marks must be analyzed carefully inorder to determine whether they are worth the investment required to grow market share.Stars - Stars generate large amounts of cash because of their strong relative market share, but alsoconsume large amounts of cash because of their high growth rate; therefore the cash in each directionapproximately nets out.If a star can maintain its large market share, it will become a cash cow when the market growth ratedeclines. The portfolio of a diversified company always should have stars that will become the next cashcows and ensure future cash generation.Cash cows - As leaders in a mature market, cash cows exhibit a return on assets that is greater than themarket growth rate, and thus generate more cash than they consume. Such business units should be"milked", extracting the profits and investing as little cash as possible. Cash cows provide the cashrequired to turn question marks into market leaders, to cover the administrative costs of the company, tofund research and development, to service the corporate debt, and to pay dividends to shareholders.Because the cash cow generates a relatively stable cash flow, its value can be determined withreasonable accuracy by calculating the present value of its cash stream using a discounted cash flowanalysis.Under the growth-share matrix model, as an industry matures and its growth rate declines, a businessunit will become either a cash cow or a dog, determined solely by whether it had become the marketleader during the period of high growth.While originally developed as a model for resource allocation among the microfinance business units in acorporation, the growth-share matrix also can be used for resource allocation among products within asingle business unit. Its simplicity is its strength - the relative positions of the firms entire businessportfolio can be displayed in a single diagram.LimitationsThe growth-share matrix once was used widely, but has since faded from popularity as morecomprehensive models have been developed. Some of its weaknesses are:Market growth rate is only one factor in industry attractiveness, and relative market share is only onefactor in competitive advantage. The growth-share matrix overlooks many other factors in these twoimportant determinants of profitability. The framework assumes that each business unit is independent ofthe others. In some cases, Microfinance business unit that is a "dog" may be helping other business unitsgain a competitive advantage.The matrix depends heavily upon the breadth of the definition of the market. A business unit maydominate its small niche, but have very low market share in the overall industry. In such a case, thedefinition of the market can make the difference between a dog and a cash cow.While its importance has diminished, the BCG matrix still can serve as a simple tool or viewing acorporations business portfolio at a glance, and may serve as a starting point for discussing resourceallocation among strategic business units.C. Overall Strategy:|Page 21
  22. 22. *Forming and nurturing small, homogeneous and participatory self-help groups (SHGs) of the poor has todayemerged as a potent tool for human development.This process enables the poor, especially the women from the poor households, to collectively identify andanalyses the problems they face in the perspective of their social and economic environment. It helps them topool their meager resources, human and financial, and priorities their use for solving their own problems.*The emphasis on regular thrift collection and its use to solve immediate problems of consumption andproduction not only helps to meet their most urgent needs, but also trains them to handle larger financialresources more skillfully, prudently and with a more lasting impact.*Encourage SHGs to become a forum for many social sector interventions. D. SHG-Bank Linkage Programmer:A Facilitating SHGs to access credit from formal banking channels. SHG-Bank Linkage Programmer hasproved to be the major supplementary credit delivery system with wide acceptance by banks, NGOs andvarious government departments. E. Capacity Building: Capacity building must be tailored to meet the differing needs of the nascent/emerging MFIs and ofthe expanding/mature MFIs. There is a pressing need to develop comprehensive, relevant andintegrated training modules on a wide range of topics to professionalize Indian microfinance – thusbuilding the much sought-after second tier management in MFIs. The industry continues to grow, andso does the demand for competent middle management. Currently, these are typically sourced byMFIs from the rural institutes of management. But these rural institutes are using curricula largelybased on the one developed by SIDBI nearly a decade ago – and it is high time to revisit thiscurriculum, to update it both in terms of content (to reflect the new realities in India microfinance) andin terms of its delivery (to use multi-media/practical examples, and thus bring the courses to life withvideo clips, case studies and field-based exercises that take the students out into the field). 11.Microfinance Management: A. Objectives: The programmer aims at enabling the participants to gain a clear understanding of various policies, conceptual, and operational issues involved in developing effective and successful microfinance interventions. B. Innovative Methodologies: Tiny amount of loan to large number of borrowers at their doorstep is a costly operation compared to revenue income. Cost reduction is also an essential element in microfinance operation. Reducing cost can be possible either offering larger loan size or by innovating no conventional Management which is less costly.The essences of innovative management are as follows:1. Specialized operation.2. Documentation of essential information only.3. Simple product, simple loan application and verification process.4. Absence of grant guarantee.|Page 22
  23. 23. 5. Staff recruitment in no conventional manner.6. On the job training (each one teaches one).7. Simple standard loan register along with ledger and cash book abandoning the bookkeeper/cashier.8. Standard furniture, fixture and collective use of facilities in the office.9. Decentralized branch structure.10. Branch level financial planning.11. Strong monitoring from mid and head office.12. Written Manual.C. Microfinance Working Environment: How can microfinance institutions (MFIs) help improve workingconditions? How can they contribute to job creation? And how can MFIs help reduce child labor? Should MFIshave an interest in addressing these and other decent work issues? These are some of the questions that theILO intends to address through an experimental global action research programmer (2008-2011) in partnershipwith microfinance Institutions interested in promoting decent work. Access to micro credit or other financialservices can help improve the decent work status. Conditional loans, credit with education, incentives likeinterest rate rebates, linkages with social partners and NGOs as well as the provision of micro insurance,conditional cash transfers or health care can be effective ways to reduce child labor, decrease vulnerabilities,raise awareness and create incentives to improve working conditions.Enabling Environment:Favorable environment for microfinance in different manners are prevailing in most developing countries.Favorable environment is not only among Government but also among general public, civil society, media andvarious institutions within the country needed for favorable growth of microfinance for poverty reduction.Though Government is favorable in general to microfinance in many countries but specific modalities of NGOs/MFIs determine the nature of favorable.D. Current Challenging Issues:1. Capacity Building: The long-term future of the micro-finance sector depends on MFIs being able to achieveoperational, financial and institutional sustainability.2. Innovation: Tiny amount of loan to large number of borrowers at their doorstep is a costly operationcompared to revenue income. Cost reduction is also an essential element in microfinance operation.Reducing cost can be possible either offering larger loan size or by innovating no conventional Managementwhich is less costly.3. Funding: A substantial outreach is a guarantee of efficiency that can play a large part in leveraging funds.4. Outreach: A substantial outreach is a guarantee of efficiency that can play a large part in leveraging funds.E. HR Issues: Recruitment and retention is the major challenge faced by MFIs as they strive to reach moreclients and expand their geographical scope. Attracting the right talent proves difficult because candidatesmust have, as a prerequisite, a mindset that fits with the organization’s mission.|Page 23
  24. 24. Many mainstream commercial banks are now entering microfinance, who are poaching staff from MFIs andMFIs are unable to retain them for other job opportunities. 85% of the poorest clients served by microfinanceare women. However, women make up less than half of all microfinance staff members, and fill even fewer ofthe 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 letthem work as front line staff, but as soon as they marry and certainly once they start having children, itbecomes unacceptable. Long distances and long hours away from the family are difficult for women toaccommodate and for their families to understand.F. Microfinance Training & Capacity Building Methods:1. Microfinance Training Methodology and How to Build Efficient Workforce?2. Staff Motivation & Built in Cost effective Training Component.3. Human Resource Planning and Development.4. Good Governance.G. SWOT MATRIX for Microfinance Management:STRENGTHS 1. Experienced senior management Team. 2. Robust IT system. 3. Clear and well defined HR policy. 4. Infusion of own equity - commitment from promoters. 5. Process innovation. 6. Clarity and good understanding of vision. 7. Transparency at all levels. 8. Plans for value added and livelihood support services (LDS). 9. Shared ownership.WEAKNESSES 1. Limited resources. 2. Micro managing. 3. Start up organisation; therefore, yet to institutionalise the standard processes. 4. Attracting/Holding on to the staff till the time we become established players. 5. Refine the processes for growth.OPPORTUNITIES 1. Huge Potential Market. 2. Scope of introducing livelihood related services. 3. Financial crunch is helping organisation to be cost conscious and effective. 4. IT systems.THREATS 1. Financial crisis. 2. Increasing competition. 3. Increasing competition.|Page 24
  25. 25. 4. Poor banking infrastructure. 5. Political instability.H. Microfinance Operation management: 1. Capacity Building: The long-term future of the micro-finance sector depends on MFIs being able toachieve operational, financial and institutional sustainability. The constraints and challenges vary with thedifferent types and development stage of MFIs. Most MFIs are currently operating below operational viabilityand use grant funds from donors for financing up-front costs of establishing new groups and covering initiallosses incurred until the lending volume builds up to a break-even level. The MFIs are generally constrained inreaching a break-even level and finally achieving sustainability, primarily due to a narrow client and productbase, high operational and administrative costs for delivering credit to the poor, and their inability to mobilizerequisite resources. Moreover, lack of technical manpower, operational systems, infrastructure and MIS areprevalent. In view of the above, to scale up micro-finance initiatives at a faster pace, a special effort is requiredfor capacity building of the Micro Finance Institutions. In this background, SFMC has in the past under theDFID collaboration (which has since come to an end on March 31,2009) provided need based capacity buildingsupport to the partner MFIs, in the initial years, to enable them to expand their operations, cover theirmanagerial, administrative and operational costs besides helping them achieve self-sufficiency in due course.2. Liquidity Management: In view of the fact that liquidity is a major concern of many of the middle level MFIsand a small working capital support can go a long way in their better liquidity management and thus pave wayfor faster growth, SFMC has introduced a special short term loan scheme, Liquidity Management Support(LMS) for the long term partners.3. Equity: Provision of equity capital to the NBFC-MFIs is perceived as an emerging requirement of the microfinance sector in India. SIDBI provides equity capital to eligible institutions not only to enable them to meet thecapital adequacy requirements but also to help them leverage debt funds. Keeping in tune with the sect oralrequirements, the bank has also introduced quasi-equity products viz., optionally convertible Preference sharecapital; optionally convertible debt and optionally convertible Subordinate debt for new generation MFIs whichare generally in the pre-breakeven stage requiring special dispensation for capital support by way of a mix ofTier I and Tier II capital.4. Transformation Loan:The Transformation Loan (TL) product is envisaged as a quasi-equity type support topartner MFIs that are in the process of transforming themselves / their existing structure into a more formal andregulated set-up for exclusively handling micro finance operations in a focused manner.Being quasi-equity in nature, TL helps the MFIs not only in enhancing their equity base but also in leveragingloan funds and expanding their micro credit operations on a sustainable basis. The product has the feature ofconversion into equity after a specified period of time subject to the MFI attaining certain structural, operationaland financial benchmarks. This non-interest bearing support facilitates the young but well performing MFIs tomake long term institutional investments and acts as a constant incentive to transform themselves into formaland regulated entities.5. Micro Enterprise Loans: In order to build and strengthen new set of intermediaries for Micro EnterpriseLoans, the Bank has formulated new scheme for Micro Enterprise Loans. Institutions/ MFIs with minimum fundrequirement of Rs. 25 lakh p.a. and having considerable experience in financial intermediation/ facilitating orsetting up of enterprises/ providing escort services to SSI/ tiny units/ networking or active interface with SSIsetc. and having professional expertise and capability to handle on-lending transactions shall be eligible underthe dispensation. The institutions would be selected based on their relevant experience, potential to expand,|Page 25
  26. 26. professional management, transparency in operations and well laid-out systems besides qualified/ trainedmanpower.Lending to be based strictly on an intensive in-house appraisal supplemented with the credit rating by anindependent professional agency. Relaxed security norms more or less on line with micro credit dispensationto be adopted to reduce procedural bottlenecks as well as to facilitate easy disbursements.6. Loan Syndication: Keeping in view the increased fund requirement of major partner MFIs, the Bank hasalso undertaken fee based syndication arrangement where loan requirement is comparatively higher.7. Microfinance Operations:a. Marketing Strategy and Microfinance Clients Targeting Methodology.b. Microfinance Products, Services and Lending Procedures.c. Microfinance Lending Methodology: Individual and Group Lending.d. Micro finance Indian Lending Methodology.e. Institutional Business Planning for Microfinance Program6. Financial Planning & Analysais.f. Savings and Credit Management.g. Program Operational Policies and Procedures.h. Accounting and Record Keeping.i. Auditing for Microfinance Operation.j. Management Information System.k. Branch Manager Leadership Training: Managing, Controlling, and Reporting Tools.l. Detection of Fraud and Internal Control.m. Monitoring and Supervision System.n. Delinquencies and its Management.I. Clients of micro finance: The typical micro finance clients are low-income persons that do not have access to formal financialinstitutions. Micro finance clients are typically self-employed, often household-based entrepreneurs. Inrural areas, they are usually small farmers and others who are engaged in small income-generatingactivities such as food processing and petty trade. In urban areas, micro finance activities are morediverse and include shopkeepers, service providers, artisans, street vendors, etc. Micro financeclients are poor and vulnerable non-poor who have a relatively unstable source of income. a. The six principles of client protection are:|Page 26
  27. 27. 1. Avoidance of Over-Indebtedness: Providers will take reasonable steps to ensure that credit will be extended only if borrowers have demonstrated an adequate ability to repay and loans will not put the borrowers at significant risk of over-indebtedness. Similarly, providers will take adequate care that non- credit, financial products, such as insurance, provided to low-income clients are appropriate. 2. Transparent and Reasonable Pricing: The pricing, terms and conditions of financial products (including interest charges, insurance premiums, all fees, etc.) are transparent and will be adequately disclosed in a form understandable to clients. 3. Appropriate Collections Practices: Debt collection practices of providers will not be abusive or coercive. 4. Ethical Staff Behavior: Staff of financial service providers will comply with high ethical standards in their interaction with microfinance clients and such providers will ensure that adequate safeguards are in place to detect and correct corruption or mistreatment of clients. 5. Mechanisms for Redress of Grievances: Providers will have in place timely and responsive mechanisms for complaints and problem resolution for their clients. 6. Privacy of Client Data: The privacy of individual client data will be respected, and such data cannot be used for other purposes without the express permission of the client (while recognizing that providers of financial services can play an important role in helping clients achieve the benefits of establishing credit histories).J. Social performance measurement:The Social Performance Task Force defines social performance as: "The effective translation of an institutionssocial mission into practice in line with accepted social values that relate to serving larger numbers of poor andexcluded people; improving the quality and appropriateness of financial services; creating benefits for clients;and improving social responsibility of an MFI.”Most MFIs have a social mission that they see as more basicthan their financial objective, or at least co-equal with it. There is a great deal of truth in the adage thatinstitutions manage what they measure.Social performance measurement helps MFIs and their stakeholders focus on their social goals and judge howwell they are meeting them. Social indicators are often less straightforward to measure, and less commonlyused than financial indicators that have been developed over centuries. Today’s increasing use of socialmeasures reflects an awareness that good financial performance by an MFI does not automatically guaranteeclient interests are being appropriately advanced.12. Critical Analysis A. MFIs Critical Issues: MFIs can play a vital role in bridging the gap between demand & supply of financial services if the critical challenges confronting them are addressed.Sustainability: The first challenge relates to sustainability. It has been reported in literature that the MFI modelis comparatively costlier in terms of delivery of financial services. An analysis of 36 leading MFIs2 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 loanvolumes and loan size is low. It has also been commented that MFIs pass on the higher cost of credit to theirclients who are ‘interest 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.|Page 27
  28. 28. Lack of Capital: The second area of concern for MFIs, which are on the growth path, is that they face apaucity 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 debtequity ratios. Presently, there is no reliable mechanism in the country for meeting the equity requirements ofMFIs. As you know, the Micro Finance Development Fund (MFDF), set up with NABARD, has been augmentedand re-designated as the Micro Finance Development Equity Fund (MFDEF). This fund is expected to play avital role in meeting the equity needs of MFIs.Borrowings: In comparison with earlier years, MFIs are now finding it relatively easier to raise loan funds frombanks. This change came after the year 2000, when RBI allowed banks to lend to MFIs and treat such lendingas part of their priority sector-funding obligations. Private sector banks have since designed innovativeproducts such as the Bank Partnership Model to fund. Source: Issues in Sustainability of MFIs, Jindal & Sharma.Top 14 Microfinance Institutions in India by Growth of Number of active Borrowers.|Page 28
  29. 29. B. Problems for Alternative Micro-Finance Institutions: The main aim with which the alternative MFIs have come up is to bridge the increasing gap between the demand and supply. A vast majority of them set up as NGOs for getting access to funds as, the existing practices of mainstream financing institutions such as SIDBI and NABARD and even of the institutions specially funding alternatives, such RMK and FWWB, is to fund only NGOs, or NGO promoted SHGs. As a result, the largest incentive to enter such services remains through the nonprofit route. The alternative finance institutions also have not been fully successful in reaching the needy.There are many reasons for this:1. Financial problems leading to setting up of inappropriate legal structures.2. Lack of commercial orientation.3. Lack of proper governance and accountability.4. Isolated and scattered. C. Risk: This looks at the quality of their loan portfolio measured as the percent of the portfolio at riskgreater than 30 days. And return, which is measured as a combination of return on equity and return on assets.From this above table we can notice that the Risk of companies is measured as the percentage ofPortfolio at Risk (PAR) which means and returns is measured as a combination of ROA and ROE. Return on Assets (ROA): A Return on Assets is an indication of how well an MFI is managing its asset baseto maximize its profits. The ratio does not evaluate the source of the asset base – whether through debt orequity, but simply the return of the portfolio and other revenue generated from investments and operations. Areturn on assets should be positive. There is a positive relationship between Return on Assets and the Portfolioto Assets ratio discussed in the next section. MFIs that maintain most of their assets in the loan portfolio tendto break even sooner, and generate higher returns on their assets; provided the loan portfolio performs welland other costs are also controlled.Return on Assets = Net Operating Income – Taxes____ Average AssetsTrend: An increasing Return on Assets is positive. Return on Assets (ROA) indicates how well an MFI is managing its assets to optimize itsprofitability. The ratio includes not only the return on the portfolio, but also all other revenuegenerated from investments and other operating activities.From the above list we can notice that, there are seven companies of India in top 50 companiesin the world. There is a huge potential for India to grow in this sector, because out of total 500million poor people from all over the world, who is getting beneficial from the micro financeinstitutions, 80 to 90 million are from India only. So there is still a huge market andopportunities in this segment.The total loan that the MFI‘s had provided to the poor people in India crosses Rs 24 billion tillOctober 08. And this is only 40% of the total poor. If this turns into 100%, then we will see the new face ofIndia.|Page 29
  30. 30. Return on Equity: A Return on Equity is probably one of the most important profitability indicators forcommercial banks and MFIs, particularly in comparison with other institutions. The return is measured only inrelation to what the MFI has built from operating surpluses, or what it has generated through donations or othercontributed sources. The shareholders of a for-profit MFI or bank, is very interested in this ratio, as it is ameasure of their investment choice, and its ability to pay dividends. Increasing equity also strengthens theMFI’s capital structure and its ability to leverage debt financing. As markets mature and competition increases,Return on Equity may level off and maintain a positive position without increasing dramatically or at all.Return on Equity = Net Operating Income – Taxes____ Average EquityTrend: An increasing Return on Equity is positive. H. Risk Management: Risk management is a discipline for dealing with the possibility that some future event will cause harm. It provides strategies, techniques, and an approach to recognizing and confronting any threat faced by an organization in fulfilling its mission. Risk management may be as uncomplicated as asking and answering three basic questions:Major Risks to Microfinance Institutions:Financial Risks Operational Risks Strategic RiskCredit Risk Transaction Risk Governance RiskTransaction riskPortfolio risk Human resources Risk Ineffective oversightLiquidity Risk Information & technology Poor governanceMarket Risk Risk structureInterest rate risk Fraud (Integrity) Risk Reputation RiskForeign exchange risk Legal & Compliance External BusinessInvestment portfolio risk Risks Risk Event riskSources: - www. Scribd.comThis are the most significant risks (with the most potentially damaging consequences for theMFI), how they interact, and current challenges faced by MFIs. a. Financial Risks: Most MFIs focus on financial risks, including credit, liquidity, Interest rate, and investment risks. Mentioned under are the risks which are very critical for the MFI‘s. 1. Credit risk: Credit risk, the most frequently addressed risk for MFIs, is the risk to earnings or capital due to borrowers’ late and non-payment of loan obligations. Credit risk encompasses both the loss of income resulting from the MFI‘s inability to collect anticipated interest earnings as well as the loss of principle resulting from loan defaults. Credit risk includes both transaction risk and portfolio risk.|Page 30
  31. 31. 2. Transaction risk: Transaction risk refers to the risk within individual loans. MFIs mitigate transaction risk through borrower screening techniques, underwriting criteria, and quality procedure for loan disbursement, monitoring, and collection. 3. Portfolio risk: Portfolio risk refers to the risk inherent in the composition of the overall loan portfolio. Policies on diversification, maximum loan size, types of loans, and loan structures lessen the portfolio risk. 4. Liquidity risk: Liquidity risk is the ―risk that an MFI cannot meet its obligations on a timely basis Liquidity risk usually arises from management‘s inability to adequately anticipate and plan for changes in funding sources and cash needs.Efficient Liquidity Management requires maintaining sufficient cash reserves on hand (to meet clientwithdrawals, disburse loans and fund unexpected cash shortages) while also investing as many funds aspossible to maximizeearnings. Liquidity management is an ongoing effort to strike a balance between having too much cash and toolittle cash. 5. Interest rate risk: Interest rate risk is the risk of financial loss from changes in market interest rates. The greatest interest rate risk occurs when the cost of funds goes up faster than the financial institution can or is willing to adjust its lending rates. Manage interest rate risk: To reduce the mismatch between short-term variable rate liabilities and long-termfixed rate loans, managers may refinance some of the short-term borrowings with long-term fixed rateborrowings. This might include offering one and two-year term deposits as a product and borrowing five to 10year funds from other sources. Such a step reduces interest rate risk and liquidity risk, even if the MFI pays aslightly higher rate on those funding sources.To boost profitability, MFIs may purposely ―mismatch assets and liabilities in anticipation of changes ininterest rates. If the asset liability managers think interest rates will fall in the near future, they may decide tomake more long-term loans at existing fixed rates, and shorten the term of the MFI‘s liabilities. By lending longand borrowing short, the MFI can take advantage of the cheaper funding in the future, while locking in thehigher interest rates on the asset side. In this case, the MFI has increased the interest rate risk in the hope ofimproving the profitability of the bank. b. Operational Risks: Operational risk arises from human or computer error within daily service or product delivery. This risk includes the potential that inadequate technology and information systems, operational problems, insufficient human resources, or breaches of integrity (i.e. fraud) will result in unexpected losses.Two types of operational risk: transaction risk and fraud risk: 1. Transaction risk: Transaction risk is particularly high for MFIs that handle a high volume of small transactions daily. Since MFIs make many small, short-term loans, this same degree of cross-checking is not cost-effective, so there are more opportunities for error and fraud. As more MFIs offer additional financial products, including savings and insurance, the risks multiply and should be carefully analyzed as MFIs expand those activities 2. Fraud risk: Fraud risk is the risk of loss of earnings or capital as a result of intentional deception by an employee or client. The most common type of fraud in an MFI is the direct theft of funds by loan officers or other branch staff. Other forms of fraudulent activities include the creation of misleading financial statements, bribes etc.Minimize fraud risk: To introduced an education campaign to encourage clients to speak out against corruptstaff and group leaders. This standardized all loan policies and procedures so that the staff cannot make anydecision outside the regulations. To Established an inspection unit that performs random operational checks.|Page 31
  32. 32. c. Strategic Risks: Strategic risks include internal risks like those from adverse business decisions or improper implementation of those decisions, poor leadership, or ineffective governance and oversight, as well as external risks, such as changes in the business or competitive environment.This section focuses on two critical strategic risks: Governance Risk, Business Environment Risk. 1. Governance risk: Governance risk is the risk of having an inadequate structure or body to make effective decisions. The Financial crisis, described above illustrates the dangers of poor governance that nearly resulted in the failure of that institution. 2. External business environment risk: Business environment risk refers to the inherent risks of the MFI‘s business activity and the external business environment. To minimize business risk, the microfinance institution must react to changes in the external business environment to take advantage of opportunities, to respond to competition, and to maintain a good public reputation.MFI manage their repayment and risk management: Risk is an integral part of financial services. Whenfinancial institutions issue loans, there is a risk of borrower default. When banks collect deposits and on-lendthem to other clients (i.e. conduct financial intermediation), they put clients’ savings at risk. Most MFIS‘sprovides the loans without or with smaller portion of deposit or, so for them repayment of interest or principal isvery risky. All MFI‘s face risks that they must manage efficiently and effectively to be successful. When poorlymanaged risks begin to result in financial losses, donors, investors, lenders, borrowers and savers tend to loseconfidence in the organization and funds begin to dry up. When funds dry up, an MFI is not able to meet itssocial objective of providing services to the poor and quickly goes out of business. d. Benefit of Risk Management: Early warning system for potential problems: A systematic process for evaluating and measuring risk identifies problems early on, before they become larger problems or drain management time and resources. Less time fixing problems means more time for production and growth. Better information on potential consequences, both positive and negative. A proactive and forward-thinking organizational culture will help managers identify and assess new market opportunities, foster continuous improvement of existing operations, and more effectively performance incentives with the organization‘s strategic goals. Encourages cost-effective decision- making and more efficient use of resources. e. Interest Rates: Most MFI’s financially sustainable by charging interest rates that are high enough to cover all their costs. Four key factors determine these rates: •The cost of funds. •The MFIs operating expenses. •Loan losses. •And profits needed to expand their capital base and fund expected future growth. There are three kinds of costs the MFI has to cover when it makes micro loans: •The cost of the money that it lends. •The cost of loan defaults. •Transaction and Operating cost. For instance, MFI lends is 10 percent, and it experiences defaults of 1 percent of the amount lent, then total Rs 11 for a loan of Rs 100, and Rs 55 for a loan of Rs 500. And the third cost i.e. transaction cost.The interest rates are deregulated not only for private MFIs but also for formal baking sector. In the context ofsoftening of interest rates in the formal banking sector, the comparatively higher interest rate (12 to 24 per centper annum) charged by the MFIs has become a contentious issue. The high interest rate collected by the MFIsfrom their poor clients is perceived as exploitative. It is argued that raising interest rates too high couldundermine the social and economic impact on poor clients. Since most MFIs have lower business volumes,their transaction costs are far higher than that of the formal banking channels. The high cost structure of MFIswould affect their sustainability in the long run.|Page 32
  33. 33. MFI being criticized because of high interest rate:Most MFI‘s financially sustainable by charging interestrates that are high enough to cover all their costs. The problem is that the administrative costs are inevitablyhigher for tiny micro lending than for normal bank lending. As a result, interest rates in sustainablemicrofinance institutions (MFIs) are substantially higher than the rates charged on normal bank loans.Four key factors determine these rates:1. The cost of funds,2. the MFIs operating expenses,3. Loan losses,4. And profits needed to expand their capital base and fund expected future growth.Formula to decide the interest rate is:R = AE + LL + CF + K - II1– LLWhere AE is administrative expenses, LL is loan losses, CF is the cost of funds, K is the desired Capitalizationrate and II is investment income.Example:Suppose that the transaction cost is Rs 15 per loan and that the loans are for one year. To break even on theRs 500 loan, the MFI would need to collect interest of Rs 50 + Rs 5 + Rs 15 = Rs 70, which represents anannual interest rate of 13 percent. To break even on the Rs 100 loan, the MFI would need to collect interest ofRs 10 +Rs 1 + Rs 15 = Rs 26, which is an interest rate of 26 percent. f. SWOT Analysis:SWOT stands for Strength, Weakness, Opportunity, and Threat.Strength• Helped in reducing the poverty: The main aim of Micro Finance is to provide the loan to the individualswho are below the poverty line and cannot able to access from the commercial banks. As we know that Indian,more than 350 million people in India are below the poverty and for them the Micro Finance is more than thelife. By providingsmall loans to this people Micro finance helps in reducing the poverty.• Huge networking available: For MFIs and for borrower, both the huge network is there. In India there aremany more than 350 million who are below the poverty line, so for MFIs there is a huge demand and networkof people. And for borrower there are many small and medium size MFIs are available in even remote areas.Weakness• Not properly regulated: In India the Rules and Regulation of Micro Finance Institutions are not regulatedproperly. In the absent of the rules and regulation there would be high case of credit risk and defaults. In theshed of the proper rules and regulation the Micro finance can function properly and efficiently.• High number of people access to informal sources: According to the World Bank report 80% of the Indianpoor can‘t access to formal source and therefore they depend on the informal sources for their borrowing andthat informal charges 40 to 120% p.a.• Concentrating on few people only: India is considered as the second fastest developing country afterChina, with GDP over 8.5% from the past 5 years. But this all interesting figures are just because of fewpeople. India‘s 70% of the population lives in rural area, and that portion is not fully touched.Opportunity• Huge demand and supply gap: There is a huge demand and supply gap among the borrowers andissuers. In India around 350 million of the people are poor and only few MFIs there to serving them.|Page 33
  34. 34. There is huge opportunity for the MFIs to serve the poor people and increase their living standard. The annualdemand of Micro loans is nearly Rs 60,000 crore and only 5456 crore are disbursed to the borrower.( April 09)Employment Opportunity:Micro Finance helps the poor people by not only providing them with loan but also helps them in their business;educate them and their children etc.So in this Micro Finance helping in increase the employment opportunity for them and for the society.• Huge Untapped Market: India‘s total population is more than 1000 million and out of 350 million is livingbelow poverty line. So there is a huge opportunity for the MFIs to meet the demand of that unsaved customersand Micro Finance should not leave any stones unturned to grab the untapped market.• Opportunity for Pvt. Banks: Many Pvt. Banks are shying away from to serve the people are unable toaccess big loans, because of the high intervention of the Govt. but the door open for the Pvt. Players to getentry and with flexible rules Pvt. Banks are attracting towards this segment.Threat• High Competition: This is a serious threat for the Micro Finance industry, because as the more playerswill come in the market, their competition will rise , and we know that the MFIs has the high transaction costand after entrant of the new players there transaction cost will rise further, so this would be serious threat.• Neophyte Industry: Basically Micro Finance is not a new concept in India, but that was all by informalsources. But the formal source of finance through Micro Finance is novice, and the rules are also not properlyplaced for it.• Over involvement of Govt.: This is the biggest that threat that many MFIs are facing. Because the excessof anything is injurious, so in the same way the excess involvement of Govt. is a serious threat for the MFIs.Excess involvement definition is like waive of loans, make new rules for their personal benefit etc.13. Micro-Finance Accounting and Management Information SystemsThe basic components of an accounting system are fairly universal and applicable to all org Source documentsform the basis of all transactions. A Chart of Accounts is a numbered system that is structured to Classify andorganize transactions by account. The journals cash journals, general journals, or bank journals record eachand every transactions or adjustment. They are summarized monthly, cross-totaled and posted to the generalledger. The general ledger holds a record for each account in the Chart of Accounts. It accumulates the totalsposted from the journals to provide monthly and annual revenue and expenses for reporting periods. Itaccumulates all the accounts of the Balance Sheet.These accounting records and processes form the basis of all accounting systems. Most MFIs choosecomputerized. The following diagram illustrates a “generic” financial management information system in amicrofinance institution, whether its clients are individuals, Self Help Groups, Solidarity Groups, or JointLiability Groups, and regardless of its legal structure or registration. The accounting system follows the usualflow from transaction to the parathion of financial statements. One of the most distinctive aspects of theaccounting system for microfinance institutions is that financial and operational activity must be tracked byBranch. Loan information should also be tracked by Credit Officer, by product and by area if needed. This iscritical for internal management & monitoring.Another distinctive aspect of accounting for MFIs is that the loan tracking system for client transactions acts asa subsidiary ledger. Client transactions must be entered into both systems, but can be summarized in theaccounting general ledger. Some loan tracking systems are manual, but it is a huge challenge to handle alarge number of clients, produce reports &age loans with great efficiency in a manual system. Most MFIs preferautomated systems, particularly loan tracking systems that are integrated with, and linked to a general ledger.The following diagram shows the connection between the two systems.|Page 34
  35. 35. Accounting System and Client Portfolio System (MIS) MicrofinanceThe MFI financial management systems illustrated dose not operates in a vacuum. There are fourdistinct areas that guide & govern a well-managed & effective financial system. A. Portfolio Report:Is it a number reflecting a period of time (e.g. the Income Statement, and some numbers from the PortfolioReport)? Is the number reflective of information from a point in time – as from the Balance Sheet? WhenIncome Statement numbers or any number reflecting a period of activity is used to calculate a ratio, the secondcomponent of the ratio must also reflect a period of activity. Therefore, some of the ratio components take theaverage of Balance Sheet numbers. Remember to note these distinctions in the ratio calculations.*14 MFI in India Growth of Gross Loan Portfolio|Page 35