Project Report On Analysis of Microfinance Industry in India

PROJECT WORK PAPER NO. XXXVII (OPTION B) TERM PAPER

SUBMITTED BY: Ashish Chopra College Roll No. 5221 B. Com (H) - III Year Academic Year: 2010-11

Hans Raj College University of Delhi

The project has been submitted to the DEPARTMENT OF COMMERCE and has been made under the guidance of MS. REETIKA JAIN
1

Certificate
This is to certify that the project report titled Analysis of Microfinance Industry in India has been carried out by Ashish Chopra, Roll No. 5221, Batch 2010-11 for the partial fulfilment of the Bachelor of Commerce (Honours).

Ashish Chopra B. Com (H) III Year College Roll No. 5221 Hans Raj College

Mr. Rakesh Aggarwal Teacher In charge Department of Commerce Hans Raj College

Ms. Reetika Jain Mentor Department of Commerce Hans Raj College

Declaration
I, Ashish Chopra, hereby declare that the project report titled Analysis of Microfinance Industry in India is my original piece of work and is based on my understanding of the subject. It has not been copied from any published source or website.

Ashish Chopra B. Com (H) III Year College Roll No. 5221 Hans Raj College

Acknowledgement
As a student of commerce, I have gone through a vast amount of literature and material available on the topic Microfinance. I feel indebted to several authors and researchers who helped me a lot in understanding various issues relating to my topic.

I owe many thanks and gratitude to Ms. Reetika Jain, my mentor and guide for the project. The guidelines laid down by her have been very instrumental in the successful completion of the project. I felt motivated and exceedingly encouraged under her supervision. She guided me to a wide range of resources that became a catalyst in the project development.

In addition, I sincerely thank my family and friends who provided me their support.

Ashish Chopra B. Com (H) III Year College Roll No. 5221 Hans Raj College

Index
Certificate.................................................................................................................. 2 Declaration................................................................................................................ 3 Acknowledgement..................................................................................................... 4

Section 1: An overview of the Indian Microfinance Industry

1. Introduction to Microfinance 1.1. Microfinance Definitions............................................... 7 1.2. Functions of Microfinance Institutions.......................... 7 1.3. Structures of Microfinance Institutions......................... 8 1.4. Who are clients of Micro-finance?................................. 8 1.5. Inception of Microfinance.............................................. 9 1.6. Need in India.................................................................. 9 2. Models of Microfinance 2.1 Self Help Group (SHG) Bank Linkage Model.................. 11 2.2 Microfinance Institution (MFI) Model........................... 12 2.3 Legal Forms of MFI........................................................ 14 2.4 Regulation of Interest Rates.......................................... 15 3. Principles of Microfinance......................................................................... 16 4. History of Microfinance in India 4.1 Focus on Financing the Poor......................................... 17 4.2 Rise of Self Help Groups................................................ 17 4.3 SHG Bank Linkage Model in India................................. 18 4.4 Summary of Strategic Policy Initiatives in India............ 20 5. Demand of Micro-credit or Micro-finance in India.................................... 21 6. Scope of Microfinance and its role in India 6.1 Microfinance: A game changer..................................... 22 6.2 Role and Activities of Microfinance.............................. 23 7. Issues related to Microfinance in India 7.1 Problems faced by Borrowers...................................... 24 7.2 Problems faced by Lenders.......................................... 26

Section 2: Major Players particularly SKS Microfinance Ltd.

CRISIL Ratings of Top MFIs........................................................ 29 Profile of Top 4 MFIs................................................................. 31 o Asmitha Microfin Ltd..................................................... 32 o Share Microfin Ltd......................................................... 33 o Spandana Sphoorthy Financial Ltd................................ 34 o SKS Microfinance Ltd..................................................... 35 The SKS Microfinance Ltd. Story............................................... 36 SKS Microfinance and its models of operation......................... 37 o Operations..................................................................... 37 o Awards........................................................................... 38 o Models of Operation...................................................... 38 Conclusion............................................................................................................ 40 References............................................................................................................ 41

Section 1:

An overview of the Indian Microfinance Industry

Introduction
Microfinance is the provision of financial services to low-income clients, including consumers and the self-employed, who traditionally lack access to banking and related services. More broadly, it is a movement whose object is "a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers." Those who promote microfinance generally believe that such access will help poor people out of poverty. Microfinance in India has had a significant shift from the days when microfinance was being discussed as the next big innovation to address the poverty issues in India to being discussed in terms of the next big investment opportunity. The language of microfinance has undergone a fundamental change in the two decades of its evolution. Microfinance started with the recognition that poor people had the capability to lift themselves out of poverty if they had access to affordable loans. High repayment rates in the industry have changed the perception that the poor are not credit worthy. With the right opportunities, the poor have proved themselves to be productive and capable of borrowing, saving and repaying, even without collateral.

Bibi Hanifa is a successful micro entrepreneur from Hubli, Karnataka who has set up an incense-stick unit along with a group of women in her neighbourhood. Earlier they worked as daily wage labor at a nearby factory and earned a meagre income. Today, thanks to the simple system of taking loans and repaying them, these women manage a successful enterprise and dream of a better and more prosperous tomorrow

Microfinance Definitions:
According to International Labor Organization (ILO), Microfinance is an economic development approach that involves 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 urban areas for enabling them to raise their income levels and improve living standards. "The poor stay poor, not because they are lazy but because they have no access to capital." The dictionary meaning of finance is management of money. The management of money denotes acquiring & using money. Micro Finance is buzzing word, used when financing for micro entrepreneurs. Concept of micro finance is emerged in need of meeting special goal to empower under-privileged class of society, women, and poor, downtrodden by natural reasons or men made; caste, creed, religion or otherwise. The principles of Micro Finance are founded on the philosophy of cooperation and its central values of equality, equity and mutual self-help. At the heart of these principles are the concept of human development and the brotherhood of man expressed through people working together to achieve a better life for themselves and their children. Microcredit or Microfinance is the process of granting small loans to poor people, primarily to women, who have no collateral and are marginalised. These women tend to use their income to benefit their households and children. The process is accomplished through a microfinance institution.

Functions of a Microfinance institution:

recruits and trains responsible, appropriate borrowers, each of whom establishes her small business helps them form groups that are accountable for each other's loans distributes funds for loans meets with groups of borrowers to collect loan repayments and to guide their endeavours

Examples of enterprises established include, buying a buffalo to sell its milk; starting a kirana store; manufacturing sweets; selling soft drinks; grinding spices; sewing; candle making; collecting fallen hair for wigs and extensions; repairing watches; tea or petty shops; vegetable stands; bicycle repair; carpentry and welding shop or an auto rickshaw.

Structures of a Microfinance Institution

Microfinance institutions broadly operate under a wide range of legal structures. They could be registered as1. NGO, 2. Trusts, 3. Sec 25 Companies, 4. Cooperative Societies, 5. Cooperative Banks, 6. Regional Rural Banks, 7. Local Area Banks, 8. Public and Private Sector banks, 9. Business Correspondents and 10. Non-Banking Finance Companies. For instance, SKS Microfinance is registered with the RBI as a non-deposit taking NBFC and is regulated by the RBI.

Who are the clients of micro finance?

The typical micro finance clients are low-income persons that do not have access to formal financial institutions. Micro finance clients are typically self-employed, often household-based entrepreneurs. In rural areas, they are usually small farmers and others who are engaged in small income-generating activities such as food processing and petty trade. In urban areas, micro finance activities are more diverse and include shopkeepers, service providers, artisans, street vendors, etc. Micro finance clients are poor and vulnerable non-poor who have a relatively unstable source of income. India has 800 million poor people who live on the brink of subsistence. This is one of the largest populations of poor in the world. The bottom 5% of Indias poor, considered ultra poor, face even deeper levels of chronic hunger, persistent poor health and illiteracy.
9

To cope with their vulnerability, the poor have no choice but to take loan for consumption and income generation from money lenders that charge exploitative rates of interest. This can put the poor in a debt trap. If poor people can access loans with fair interest rates, they could break out of the cycle of poverty. Bureaucracy, corruption, illiteracy and challenging logistics prevent the poor from accessing loans from banks and the government.

Inception of Microfinance
Microfinance in India started in 1974 in Gujarat as Shri Mahila SEWA (Self Employed Womens Association) Sahakari Bank. Registered as an Urban Cooperative Bank, they provided banking services to poor women employed in the unorganised sector. Microfinance later evolved in the early 1980s around the concept of informal SelfHelp Groups (SHGs) that provided deprived poor people with financial services. From modest origins, the microfinance sector has grown at a steady pace. Now in a strong endorsement of microfinance, the National Bank for Agriculture and Rural Development (NABARD) and Small Industries Development Bank of India (SIDBI) have committed themselves to developing microfinance. The microfinance sector has been "witnessing a tremendous growth" during the last few years in India in terms of loan portfolio, geographical area and outreach. With Indias GDP growing at the rate of 7.1 % the countrys socio-economic pyramid is turning around the story with millions of poor people becoming entrepreneurs.

The Need in India

India is said to be the home of one third of the worlds poor; official estimates range from 26 to 50 percent of the more than one billion population. About 87 percent of the poorest households do not have access to credit. The demand for microcredit has been estimated at up to $30 billion; the supply is less than $2.2 billion combined by all involved in the sector. Due to the sheer size of the population living in poverty, India is strategically significant in the global efforts to alleviate poverty and to achieve the Millennium Development Goal of halving the worlds poverty by 2015. Microfinance has been present in India in one form or another since the 1970s and is now widely accepted as an effective poverty alleviation strategy. Over the last five years, the microfinance industry has achieved significant growth in part due to the participation of

10

commercial banks. Despite this growth, the poverty situation in India continues to be challenging. As we broaden the notion of the types of services micro finance encompasses, the potential market of micro finance clients also expands. It depends on local conditions and political climate, activeness of cooperatives, SHG & NGOs and support mechanism. For instance, micro credit might have a far more limited market scope than say a more diversified range of financial services, which includes various types of savings products, payment and remittance services, and various insurance products. For example, many very poor farmers may not really wish to borrow, but rather, would like a safer place to save the proceeds from their harvest as these are consumed over several months by the requirements of daily living. Central government in India has established a strong & extensive link between NABARD (National Bank for Agriculture & Rural Development), State Cooperative Bank, District Cooperative Banks, Primary Agriculture & Marketing Societies at national, state, district and village level.

11

Models of Microfinance in India

1. Self Help Group (SHG) Bank Linkage Model: The microfinance movement started in India with the introduction of the SHGBank Linkage Programme in the 1980s by NGOs that was later formalized by the Government of India in the early 1990s. Pursuant to the programme, banks, which are primarily public sector regional rural banks, are encouraged to partner with SHGs to provide them with funding support, which is often subsidized. A self help group, or SHG, is a group of 10 to 20 poor women in a village who come together to contribute regular savings to a common fund to deposit with a bank as collateral for future loans. The group has collective decision making power and obtains loans from the partner bank. The SHG then loans these funds to its members at terms decided by the group. Members of the group meet on a monthly basis to conduct transactions and group leaders are responsible for maintaining their own records, often with the help of NGOs or government agency staff. NABARD is presently operating three models of linkage of banks with SHGs and NGOs: Model 1: In this model, the bank itself acts as a Self Help Group Promoting Institution (SHPI). It takes initiatives in forming the groups, nurtures them over a period of time and then provides credit to them after satisfying itself about their maturity to absorb credit. About 16% of SHGs and 13% of loan amounts are using this model (as of March 2002). Model 2: In this model, groups are formed by NGOs (in most of the cases) or by government agencies. The groups are nurtured and trained by these agencies. The bank then provides credit directly to the SHGs, after observing their operations and maturity to absorb credit. While the bank provides loans to the groups directly, the facilitating agencies continue their interactions with the SHGs. Most linkage experiences begin with this model with NGOs playing a major role. This model has also been popular and more acceptable to banks, as some of the difficult functions of social
12

dynamics are externalized. About 75% of SHGs and 78% of loan amounts are using this model. Model 3: Due to various reasons, banks in some areas are not in a position to even finance SHGs promoted and nurtured by other agencies. In such cases, the NGOs act as both facilitators and micro- finance intermediaries. First, they promote the groups, nurture and train them and then approach banks for bulk loans for on-lending to the SHGs. About 9% of SHGs and 13% of loan amounts are using this model

2. Micro Finance Institution (MFI) Model: The MFI model has gained significant momentum in India in recent years and continues to grow as the viable alternative to SHGs. In contrast to an SHG, an MFI is a separate legal organization that provides financial services directly to borrowers. MFIs have their own employees, record keeping and accounting systems and are often subject to regulatory oversight. MFIs require borrowers from a village to organize themselves in small groups, typically of five women, that have joint decision making responsibility for the approval of member loans. The groups meet weekly to conduct transactions. MFI staff travel to the villages to attend the weekly group meetings to disburse loans and collect repayments. Unlike SHGs, loans are issued by MFIs without collateral or prior savings. MFIs now exist in a variety of legal forms, including trusts, societies, cooperatives, non-profit NBFCs registered under Section 25 of the Companies Act, 1956, or Section 25 Companies, and NBFCs registered with the RBI. Trusts, cooperatives and Section 25 companies are regulated by the specific act under which they are registered and not by the RBI. Attempts have been made by some of the associations of MFIs like Sa-Dhan to capture the business volume of the MFI sector. As per the Bharat Micro Finance Report of Sa-Dhan, in March 2009, the 233 member MFIs of Sa-Dhan

13

had an outreach of 22.6 million clients with an outstanding microfinance portfolio of INR 117 billion (USD 2.5 billion).

Legal Forms of MFIs in India

* The estimated number includes only those MFIs, which are actually undertaking lending activity. Adapted from www.nabard.org

14

Regulation of Interest Rates

The interest rates are deregulated not only for private MFIs but also for formal banking sector. In the context of softening of interest rates in the formal banking sector, the comparatively higher interest rate (12 to 24 per cent per annum) charged by the MFIs has become a contentious issue. The high interest rate collected by the MFIs from their poor clients is perceived as exploitative. It is argued that raising interest rates too high could undermine 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 MFIs would affect their sustainability in the long run. Lending small amounts to the poor is expensive and is the reason so many rural poor have been excluded from the mainstream financial system for so long. In order to operate in hard to reach areas, provisioning such small loans, MFIs must charge higher interest rates, which currently average 28% to 33%, to cover their costs. While higher than mainstream banks loaning to richer customers, these rates are much lower than those levied by local moneylendersoften the rural poors only other option.

15

Principles of Microfinance

Some principles that summarize a century and a half of development practice were encapsulated in 2004 by Consultative Group to Assist the Poor (CGAP): Poor people need not just loans but also savings, insurance and money transfer services. Microfinance must be useful to poor households: helping them raise income, build up assets and/or cushion themselves against external shocks. Microfinance can pay for itself. Subsidies from donors and government are scarce and uncertain, and so to reach large numbers of poor people, microfinance must pay for itself. Microfinance means building permanent local institutions. Microfinance also means integrating the financial needs of poor people into a countrys mainstream financial system. The job of government is to enable financial services, not to provide them. Donor funds should complement private capital, not compete with it. The key bottleneck is the shortage of strong institutions and managers. Donors should focus on capacity building. Interest rate ceilings hurt poor people by preventing microfinance institutions from covering their costs, which chokes off the supply of credit. Microfinance institutions should measure and disclose their performance both financially and socially.

These principles were endorsed by the Group of Eight leaders at the G8 Summit on June 10, 2004.

16

A Brief History of Microfinance

Microfinance has evolved over the past quarter century across India into various operating forms and to a varying degree of success. One such form of microfinance has been the development of the self-help movement. Based on the concept of selfhelp, small groups of women have formed into groups of ten to twenty and operate a savings-first business model whereby the members savings are used to fund loans. The results from these self-help groups (SHGs) are promising and have become a focus of intense examination as it is proving to be an effective method of poverty reduction.

Focus on Financing the Poor

The post-nationalization period in the banking sector, circa 1969, witnessed a substantial amount of resources being earmarked towards meeting the credit needs of the poor. There were several objectives for the bank nationalization strategy including expanding the outreach of financial services to neglected sectors. As a result of this strategy, Credit came to be recognized as a remedy for many of the ills of the poverty. While the objectives were laudable and substantial progress was achieved, credit flow to the poor, and especially to poor women, remained low. This led to initiatives that were institution driven that attempted to converge the existing strengths of rural banking infrastructure and leverage this to better serve the poor. The pioneering efforts at this were made by National Bank for Agriculture and Rural Development (NABARD), which was given the tasks of framing appropriate policy for rural credit, provision of technical assistance backed liquidity support to banks, supervision of rural credit institutions and other development initiatives.

Rise of Self Help Groups

This lead to the rise of Self Help Groups and more formal SHG Federations coupled now with SHG Bank Linkage have made this a dominant form of microfinance in addition to microfinance institutions (MFI). The policy environment in India has been extremely supportive for the growth of the microfinance sector in India. Particularly during the International Year of Microcredit 2005, significant policy announcements
17

from the Government of India (GoI) and the Reserve Bank of India (RBI) have served as a shot in the arm for rapid growth. SHGs have spread rapidly due to their ease of replication. SHG Bank Linkage has provided the capacity for SHGs to increase their capital base to fund more members and bigger projects. Today, it is estimated that there are at least over 2 million SHGs in India. In many Indian states, SHGs are networking themselves into federations to achieve institutional and financial sustainability. Cumulatively, 1.6 million SHGs have been bank-linked with cumulative loans of Rs. 69 billion. In 2004-05 alone, almost 800,000 SHGs were bank-linked. While no definitive date has been determined for the actual conception and propagation of SHGs, the practice of small groups of rural and urban people banding together to form a savings and credit organization is well established in India. In the early stages, NGOs played a pivotal role in innovating the SHG model and in implementing the model to develop the process fully. In the 1980s, policy makers took notice and worked with development organizations and bankers to discuss the possibility of promoting these savings and credit groups. Their efforts and the simplicity of SHGs helped to spread the movement across the country. State governments established revolving loan funds which were used to fund SHGs. By the 1990s, SHGs were viewed by state governments and NGOs to be more than just a financial intermediation but as a common interest group, working on other concerns as well. The agenda of SHGs included social and political issues as well. The spread of SHGs led also to the formation of SHG Federations which are a more sophisticated form of organization that involve several SHGs forming into Village Organizations (VO) / Cluster Federations and then ultimately into higher level federations (called as Mandal Samakhya (MS) in AP or SHG Federation generally). SHG Federations are formal institutions while the SHGs are informal. Many of these SHG federations are registered as societies, mutual benefit trusts and mutually aided cooperative societies.

SHG Bank Linkage Model in India

A most notable milestone in the SHG movement was when NABARD launched the pilot phase of the SHG Bank Linkage programme in February 1992. This was the first instance of mature SHGs that were directly financed by a commercial bank. The informal thrift and credit groups of poor were recognised as bankable clients. Soon after, the RBI advised commercial banks to consider lending to SHGs as part of their rural credit operations thus creating SHG Bank Linkage. The linking of SHGs with the
18

financial sector was good for both sides. The banks were able to tap into a large market, namely the low-income households, transactions costs were low and repayment rates were high. The SHGs were able to scale up their operations with more financing and they had access to more credit products. The institutionalisation of self help groups (SHGs) and their recognition by the banking system as a saving and effective credit delivery mechanism in 1990s was an important step in financial inclusion of the relatively less banked or unbanked rural areas. More so, because it was built on a premise that the SHG mechanism would instil credit discipline in the members and one day empower them to become individual clients of banks. What followed was a proliferation of the SHG-Bank Linkage Programme (SHG-BLP) to unprecedented heights (albeit not equitable). After the pilot testing phase from 1992 to 1995, the Reserve Bank of India advised banks that lending to SHGs should be treated as a normal banking activity in 1996. This led to the second phase (mainstreaming) of the programme as banks started financing SHGs on a relatively larger scale. During 1998-99, there was a quantum jump in the number of SHGs that had availed of loans from the banking system to 18,678 from 5,719 during 1997-98.This was the beginning of the growth and expansion phase (see graphic). As on March 31, 2009 42.24 lakh SHGs had loans outstanding with the banking system, which included 9.77 lakh SHGs under Swaranjayanti Gram Swarozgar Yojana (SGSY). The loan outstanding to the banking system, of non SGSY SHGs, was Rs 16,818 crore.

19

Summary of Strategic Policy Initiatives in India

Some of the most noteworthy strategic policy initiatives in the area of Microfinance taken by the government and regulatory bodies in India are: 1. 2. 3. 4. 5. Working group on credit to the poor through SHGs, NGOs, NABARD, 1995 The National Microfinance Taskforce, 1999 Working Group on Financial Flows to the Informal Sector (set up by PMO), 2002 Microfinance Development and Equity Fund, NABARD, 2005 Working group on Financing NBFCs by Banks- RBI

20

Demand for Micro-credit or Microfinance

In terms of demand for micro-credit or micro-finance, there are three segments, which demand funds. They are: 1. At the very bottom in terms of income and assets , are those who are landless and engaged in agricultural activities on a seasonal basis, and manual labourers in forestry, mining, household industries and construction. This segment requires, first and foremost, consumption credit during those months when they do not get labour work, and for contingencies such as illness. They also need credit for acquiring small productive assets, such as livestock, using which they can generate additional income. The next market segment is small and marginal farmers and rural artisans, weavers and those self-employed in the urban informal sector as hawkers, vendors, and workers in household micro-enterprises. This segment mainly needs credit for working capital, a small part of which also serves consumption needs. This segment also needs term credit for acquiring additional productive assets, such as irrigation pumpsets, borewells and livestock in case of farmers, and equipment (looms, machinery) and worksheds in case of non-farm workers. The third market segment is of small and medium farmers who have gone in for commercial crops such as surplus paddy and wheat, cotton, groundnut, and others engaged in dairying, poultry, fishery, etc. Among non-farm activities, this segment includes those in villages and slums, engaged in processing or manufacturing activity, running provision stores, repair workshops, tea shops, and various service enterprises. These persons are not always poor, though they live barely above the poverty line and also suffer from inadequate access to formal credit.

2.

3.

21

Scope of Microfinance and its Role in India

Microfinance Institutions (MFIs) are uniquely positioned to facilitate financial inclusion, and provide financial services to a clientele poorer and more vulnerable than the traditional bank clientele. There is no comprehensive regulatory framework for the microfinance sector in India: MFIs exist in many legal forms. Many mid-sized and large MFIs are, however, acquiring and floating new companies to get registered as non-banking financial institutions (NBFCs), which will help them achieve scale.

Microfinance: A game changer

Microfinance began in India in the 1990s as a way of alleviating poverty, by encouraging income generating activities by poor households. Since then, the outreach of microfinance institutions (MFIs) in India has crossed 30 million poor households as at the end of March 2010. This is very commendable. However, there are two issues need to be addressed how to reduce interest rates and the net impact of microcredit. Let me take the example of BASIX (headquartered in Hyderabad, Andhra Pradesh), which is working with over a million poor households. For the first five years since inception in 1996, BASIX took the approach of primarily delivering micro-credit to its customers. After five years of pursuing this approach, BASIX carried out an impact assessment the year 2001. The results of this were rather disappointing. Only 52% of the customers, who had received at least three rounds of micro-credit from BASIX, showed a significant increase in their income (compared to a control group), 25% reported no change in income levels and 23% reported decline in their income levels. BASIX then carried out a detailed study of those who had had no increase or even a decline in income and found that the reasons for this could be clubbed into three factors: (1) Un-managed risk in their lives and livelihoods (2) Low productivity, in terms of poor yields and higher costs, and (3) Unfavourable terms in input and output market transactions. This showed that there is a need for risk mitigation, yield enhancement, cost reduction, and bringing rural producers together for better bargaining at the market place. Hence in 2002, BASIX revised its strategy, to provide a comprehensive set of
22

livelihood promotion services to rural poor households. BASIX reaffirmed that credit is a necessary but not sufficient condition for livelihood promotion. Its revised Livelihood Triad Strategy included provision of financial services beyond credit such as insurance; provision of agricultural, livestock and non-farm enterprise development services; and institutional development services for producer organisations.

Role and Activities of Microfinance:

Microcredit: It is a small amount of money loaned to a client by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending. Micro savings: These are deposit services that allow one to save small amounts of money for future use. Often without minimum balance requirements, these savings accounts allow households to save in order to meet unexpected expenses and plan for future expenses. Micro insurance: It is a system by which people, businesses and other organizations make a payment to share risk. Access to insurance enables entrepreneurs to concentrate more on developing their businesses while mitigating other risks affecting property, health or the ability to work. Remittances: These are transfer of funds from people in one place to people in another, usually across borders to family and friends. Compared with other sources of capital that can fluctuate depending on the political or economic climate, remittances are a relatively steady source of funds

23

Issues related to Microfinance in India Problems faced by Borrowers

1. Coercion One of the most important moral issues being raised in relation to microfinance is that of coercion. After 54 people killed themselves in the state of Andhra Pradesh in October 2010, Indian authorities placed microfinance institutions (MFI) under a microscope, and drafted new rules the MFI companies must follow. The farmers were reportedly deep in debt to microfinance institutions (MFIs). "Microfinance institutions charge exorbitant interest rates. The poor are driven to take their own lives because of their burden of debt and the brutal methods used to call in the loans", the chief minister of Andhra Pradesh said.

2. Brutal and Aggressive Debt-Collection Tactics "The people calling in the loans are often not aware of the code of conduct of the MFIs. Many of the MFIs have been resort to brutal methods for collection of debt from these borrowers. News items like the one below are quite common in India. Unable to repay Rs. 235, Farmer kills self MFI Loan Suicide, Hyderabad News A farmer committed suicide by consuming pesticides, allegedly after being harassed by the collection agents of a microfinance institution at in Nalgonda district, Andhra Pradesh. 3. Joint Microfinance Joint microloans are granted to a group of people who are jointly responsible for repaying the loan. Individual failures to pay (due to illness or a bad week) are avoided and group pressure serves as a strong incentive in ensuring responsible behavior by making loans to individuals within a lending circle. The individuals meet regularly, ostensibly creating a self-help group. In reality, all the borrowers in the group are responsible for making the loan repayment if a member defaults, so peer pressure is a very strong factor."
24

However, in case of default either due to business failures, unproductive expenditure or greed to consume more, all members are troubled. 4. High Interest Rates Many in the urban centres would commit suicide if the banks start charging us 24 per cent rate of interest. Even at 8.5 per cent rate of interest, those who have drawn housing loans, find it difficult to make monthly EMI payments. Imagine the stress and threat under which the poor in the rural areas are being made to borrow at 24 per cent rate of interest. Whatever the justification for charging 24 per cent rate of interest, how can human beings exploit a hungry stomach in the name of a successful business model? 5. Not aimed at lifting people out of poverty Micro finance serves not to lift people out of poverty but, assist those near or slightly above the poverty line. Money is given to those people who have a possibility of returning the principle amount. This leads to the fact that lending money to these people is feasible and sustainable, while lending to the poorest of the poor is not. 6. Poverty alleviation mission has now been reduced to a Money making tactic of MNCs Micro finance has now, become a weapon for multinational companies to sell their products, by collaborating with such institutions. This in turn, is destroying the spirit of micro credit. For instance: Recently a mobile phone manufacturer offered a micro financing scheme on a pilot basis in Andhra Pradesh and Karnataka, to sell their handset to the poorest. Under this project, the company was offering an easy payment scheme of Rs 100 per week over a period of time. Andhra Pradesh has promulgated an ordinance to check malpractices in microfinance institutions (MFIs). The state should not throw out the baby with the bathwater: it should check malpractices without checking MFI growth. Globally, MFIs have expanded at phenomenal rates largely because they lend without loan scrutiny to groups of women, and peer pressure of the group keeps defaults below 2% despite the absence of any collateral or legal procedures for loan
25

recovery. MFIs are, in effect, benevolent moneylenders, charging interest rates of around 30% to cover high operational costs. They are a great improvement on moneylenders charging 60% and using force to seize assets. However, the AP media accuse some MFIs of using force too, and claim that some suicides have been caused by such coercion. Proving the connection is difficult: Persons commit suicide for several reasons, ranging from psychological to financial issues. The global suicide rate is 14 per lakh persons, it is even higher in rich countries like Finland and Japan which have no MFIs. No rules or regulations can end suicides. But rules should certainly be framed to stop forcible loan recovery. The top MFIs agree on the need to ensure there is no coercion, and have adopted a code of conduct on this. But while bad apples among MFIs must be dealt with firmly, care must be taken not to create new regulations that encourage corruption or crimp legitimate and desirable MFI lending. Proposals to prevent members of self-help groups from borrowing from MFIs are terribly wrong, and will penalise poor borrowers and hit financial inclusion. People should be free to borrow from all sources, and members of self help groups should not require a no-objection certificate before applying for an MFI loan it will be one more avenue for corruption and harassment. The use of force is an issue that must not be mixed up with the separate question of how the RBI should regulate MFIs. MFIs have reached 20 million people in a few years, a success owing something to light regulation that facilitated much innovation and experimentation. Some MFIs have become large institutions, and large ones need tougher regulation. But care should be taken to give MFIs, especially smaller ones, continued scope for innovation and experimentation.

Problems faced by Lenders

1. Sustainability The first challenge relates to sustainability. MFI model is comparatively costlier in terms of delivery of financial services. An analysis of 36 leading MFIs by Jindal & Sharma shows that 89% MFIs sample were subsidy dependent and only 9 were able to cover more than 80% of their costs. This is partly explained by the fact that while the cost of supervision of credit is high, the loan volumes and
26

loan size is low. It has also been commented that MFIs pass on the higher cost of credit to their clients 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. 2. Lack of Capital The second area of concern for MFIs, which are on the growth path, is that they face a paucity of owned funds. This is a critical constraint in their being able to scale up. Many of the MFIs are socially oriented institutions and do not have adequate access to financial capital. As a result they have high debt equity ratios. Presently, there is no reliable mechanism in the country for meeting the equity requirements of MFIs. The IPO issue by Mexico based Compartamos was not accepted by purists as they thought it defied the mission of an MFI. The IPO also brought forth the issue of valuation of an MFI 3. Financial service delivery Another challenge faced by MFIs is the inability to access supply chain. This challenge can be overcome by exploring synergies between microfinance institutions with expertise in credit delivery and community mobilization and businesses operating with production supply chains such as agriculture. The latter players who bring with them an understanding of similar client segments, ability to create microenterprise opportunities and willingness to nurture them, would be keen on directing microfinance to such opportunities. This enables MFIs to increase their client base at no additional costs. Those businesses that procure from rural India such as agriculture and dairy often identify finance as a constraint to value creation. Such businesses may find complementarities between an MFIs skills in management of credit processes and their own strengths in supply chain management. ITC Limited, with its strong supply chain logistics, rural presence and an innovative transaction platform, the e-choupal, has started exploring synergies with financial service providers including MFIs through pilots with vegetable vendors and farmers. Similarly, large FIs such as Spandana foresee a larger role for themselves in the rural economy ably supported by value creating partnerships with players such as Mahindra and Western Union Money Transfer.
27

ITC has initiated a pilot project called pushcarts scheme along with BASIX (a microfinance organization in Hyderabad). Under this pilot, it works with twenty women head load vendors selling vegetables of around 10- 15 kgs per day. BASIX extends working capital loans of Rs. 10,000/- , capacity building and business development support to the women. ITC provides support through supply chain innovations by: 1. Making the Choupal Fresh stores available to the vendors, this avoids the hassle of bargaining and unreliability at the traditional mandis (local vegetable markets). 2. Continuously experimenting to increase efficiency, augmenting incomes and reducing energy usage across the value chain. For instance, it has forged a partnership with National Institute of Design (NID), a pioneer in the field of design education and research, to design user-friendly pushcarts that can reduce the physical burden. 3. Taking lessons from the pharmaceutical and telecom sector to identify technologies that can save energy and ensure temperature control in push carts in order to maintain quality of the vegetables throughout the day. The model augments the incomes of the vendors from around Rs.30-40 per day to an average of Rs.150 per day. From an environmental point of view, push carts are much more energy efficient as opposed to fixed format retail outlets

28

Section 2:

Major Players particularly SKS Finance

In late 2009, CRISIL which is Indias leading ratings, research and risk advisory company released its list of top 50 microfinance institutions in India. The report titled Indias Top 50 Microfinance Institutions presents an overview of leading players in Indias microfinance institution (MFI) space. This is the first inaugural issue and includes additional commentary analysing the key strengths and challenges of different microfinance players in the sector. The publication is part of CRISILs enabling role in the structured evolution of the MFI sector in India. CRISIL launched MFI grading as early as in 2002 and has since then become the worlds first mainstream rating agency to develop a separate methodology and scale to assess MFIs. Currently CRISIL has assessed more than 140 MFIs, and is currently the most preferred rating agency in the Indian microfinance space. In light of SKS Microfinances proposed IPO in the coming days the CRISIL report is presented below for the benefit of the readers of this blog. Market sources reveal that some of these microfinance institutions which figure in the top 50 are in talks with merchant bankers and investors to tap the primary markets and want to gauge the response to SKS Microfinances IPO before they fast track their own listing plans. The four MFIs chosen for the research based on the CRISIL data are: 1. SKS Microfinance [SKS] 2. Spandana Spoorthy Financials Limited [Spandana], 3. Share Microfin Limited [SML] 4. Asmitha Microfin Limited [AML]

29

Based on the CRISIL data, each of these four institutions serve more than 8,00,000 customers, have a loan portfolio of more than US$ 100 million and an asset size of more than US$ 170 million each by the year end 2009. Of the four institutions listed above, three [except Asmitha] have followed a similar path in terms of the original organizational structure, incorporation into a commercial format and the methodology of moving from a charitable construct to the commercial construct. Unlike the international counterparts of BancoSol and BC the legal framework in India did not permit the NGOs to take an equity position in for-profit finance companies. The promoters of each of these institutions possibly did not have the resources to meet the initial capitalization requirements of Rs. 2 Crore to set up a for-profit finance company at that time. While this is not explicit, the nature of initial capitalization and the later movement gives enough reason to believe that personal resources were indeed a problem. Given the legal framework of non-profit societies which were operating in the microfinance space, it was impossible to shift the portfolio without the new company providing consideration in cash.
30

This posed a significant challenge because residual claims on current income and on liquidation cannot be applied for such purposes; the promoters had to look at innovative mechanisms of utilizing the investments made in the non-profits in a meaningful manner. If we were to look at a legal mechanism to overcome this there could have been only two options: 1. Ensure that the residual claims are so low, by skimming resources above the line. This could be done by paying an exorbitant salary to the promoter and enrich him or her to generate personal wealth in a legal manner to invest in the next wave of the business. It appears that this was not a route that these promoters preferred at that time, because all of the promoters genuinely came from a developmental background. 2. The second option for these entities was to look at ways of distributing the un- distributable the residual claims themselves the excess of income over expenditure as well as the grant funds held in the books of the not-forprofits. When we look at each of the four firms listed above, at least three of them resorted to the second option of using the grant funding sought in the not-for-profit organization to capitalize the for-profit operations of NBFCs. This possibly was done with a fairly benign intention at that time as it was seen as genuinely involving the community members who were also borrowers in the capital structure of the companies that were being promoted. In fact this was honourably called transformation and all these MFIs had no problems in sharing the details of the process with the world at large.

The profiles of these Four Biggest Microfinance Institutions in India have been discussed in the following pages.

31

Position 4:

Asmitha Microfin Ltd.

32

Position 3:

Share Microfin Ltd.

33

Position 2:

Spandana Sphoorthy Financial Ltd.

34

Position 1:

SKS Microfinance Ltd.

35

The SKS MICROFINANCE LTD. Story

It was merely a coincidence that the year after C K Prahalads bestseller, The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits (2004), that Vikram Akula returned to SKS Microfinance, leaving a consultancy job at McKinsey & Company in Chicago that he took a year earlier. Akula, a Fulbright Scholar researching poverty and a student of arts, had founded SKS Microfinance as a non-profit venture in late 1997 with funding close to $52,000 raised from 357 people. He converted it into a for-profit company in 2005 during his second stint. Success came rather swiftly. In 2006, Akula was named by Time magazine as one of the worlds 100 most influential people. In less than a decade, SKS emerged as the largest micro-finance institution (MFI) in the country. Profits after tax (PAT) increased from Rs 2 crore in FY07 to Rs 80 crore in FY09, and Rs 174 crore in FY10. Little wonder, then, that the companys recent initial public offering (IPO) attracted high-profile investors like billionaire George Soros, and was oversubscribed 13.69 times, even with the price fixed at the highest band of Rs 985 a share.

After SKS success, more microfinance public issues are on the horizon
The countrys second-largest MFI, Spandana Sphoorty Financial, which will decide on whether to go for an IPO in the next month, is not far behind SKS. In fact, as an NGO, both SKS and Spandana started in 1998 in Andhra Pradesh. As on July 31, Spandana had loan outstandings of Rs 4,205 crore, against SKSs Rs 4,321 crore as in March. Moreover, Spandana is the most profitable MFI at Rs 203 crore the last financial year. Along the lines of SKS, Spandana was started by NGO worker Padmaja Reddy at Chilakalurpet in Guntur District of Andhra Pradesh. She was working on local development projects funded predominantly by grants, when a woman rag-picker inspired her to strike out on her own. In the first two years (1998-2000), Spandana crossed the Rs 1-crore disbursement mark with around 2,000 clients.

36

SKS Microfinance and its Models of Operation

SKS Microfinance was started in 1998 as non-profit SKS Society. It was funded by individual and institutional donations and focused on markets within its home state of Andhra Pradesh. In 2005 SKS decided to pursue an aggressive growth plan and transformed into a Non-Banking Financial Company (NBFC) named SKS Microfinance and regulated by the Reserve Bank of India (RBI). Since transformation, SKS has been successful in creating a for-profit model of microfinance using commercial funds that is scalable. Delivering services at the doorsteps of its members and following clearcut processes, SKS has been able to ensure a repayment rate of over 99 % on its loans. SKS Microfinance is Indias largest and one of the worlds fastest-growing microfinance organizations. Its mission is to empower the poor by providing them collateral-free loans for income generation. SKS Microfinance has 5.8 million clients (2010) in 1,627 branches in 19 states across India and total assets worth $897.9 million (Sept.'09.) SKS charges an annual effective interest rate ranging from 26.7% to 31.4%

Operations
Its borrowers include agricultural laborers, mom-and-pop entrepreneurs, street vendors, home based artisans, and small scale producers, each living on less than $2 a day. It works on a model that would allow micro-finance institutions to scale up quickly so that they would never have to turn poor person away. Borrowers (mostly women) take loans for a range of income-generating activities, including livestock, agriculture, trade (such as vegetable vending), production (from basket weaving to pottery) and new age business (photography to beauty parlours). SKS also provides members with interest-free loans for emergencies as well as life insurance and loan cover insurance to borrowers. It leverages its equity to raise debt from public sector, private sector and multinational banks operating in India. This capital has helped the organisation scale up operations and reach out to millions of poor households across the length and breadth of India. In addition to rapid expansion, SKS leads the industry in technology innovation and transparency. It is one of the first MFIs in the world to have a fully automated MIS
37

that streamlines operations and helps reduce transaction costs. It is setting up an ERP system that will ensure quick data transfers, data mining, data recovery facilities which will improve operational efficiencies and response times.

Awards
SKS was ranked as the Number 1 MFI in India and number 2 in the world by MIX Market. Business Week has rated SKS as one of the most influential companies. SKS has received numerous awards including the CGAP Pro-Poor Innovation Award, the ABN-Ambro/ Planet Finance Process Excellence Award, Citibank Information Integrity Award, the Digital Partners SEL Award, SHG Foundation funding and the Grameen Foundation USA Excellence Award. SKS is the only MFI in India to receive the MIX Transparency Certification.

Models
Its model is based on 3 principles1. Adopt a profit-oriented approach in order to access commercial capitalStarting with the pitch that there is a high entrepreneurial spirit amongst the poor to raise the funds, SKS converted itself to for-profit status as soon as it got break even and got philanthropist Ravi Reddy to be a founding investor. Then it secured money from parties such as Unitus, a Seattle based NGO that helps promote micro-finance; SIDBI; and technology entrepreneur Vinod Khosla. Later, it was able to attract multimillion dollar lines of credit from Citibank, ABN Amro, and others. 2. Standardize products, training, and other processes in order to boost capacity- They collect standard repayments in round numbers of 25 or 30 rupees. Internally, they have factory style training models. They enroll about 500 loan officers every month. They participate in theory classes on Saturdays and practice what they have learned in the field during the week. They have shortened the training time for a loan officer to 2 months though the average time taken by other industry players is 4-6 months. 3. Use Technology to reduce costs and limit errors- It could not find the software that suited its requirements, so it they built their own simple and user friendly applications that a computer-illiterate loan officer with a 12th grade education can easily understand. The system is also internet enabled.

38

Given that electricity is unreliable in many areas they have installed car batteries or gas powered generators as back-ups in many areas.

Scaling up Customer Loyalty

Instead of asking illiterate villagers to describe their seasonal pattern of cash flows, they encourage them to use colored chalk powder and flowers to map out the village on the ground and tell where the poorest people lived, what kind of financial products they needed, which areas were lorded over by which loan sharks, etc. They set peoples tiny weekly repayments as low as $1 per week and health and whole life insurance premiums to be $10 a year and 25 cents per week respectively. They also offer interest free emergency loans. The salaries of loan officers are not tied to repayment rates and they journey on mopeds to borrowers villages and schedule loan meetings as early as 7.00 A.M. Deep customer loyalty ultimately results in a repayment rate of 99.5%.

Leveraging the SKS brand

Its payoff comes from high volumes. They are growing at 200% annually, adding 50 branches and 1,60,000 new customers a month. They are also using their deep distribution channels for selling soap, clothes, consumer electronics and other packaged goods.

39

Conclusion
Microfinance refers to a movement that envisions a world in which many poor and near-poor households, have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance and fund transfers. The microfinance sector in India has developed a successful and sustainable business model which has been able to overcome challenges traditionally faced by the financial services sector in servicing the low income population by catering to its specific needs, capacities and leveraging pre-existing community support networks. The concept has grown over the past two decades. Over the years, major commercial banks and multinational corporations have decided to sponsor it. However, this type of financing has a darker side too. Most of studies are qualitative which tell that more than 90 per cent of the people who receive micro credit are poor and most of them succeed in businesses started with these loans. But the suicides committed by Indian farmers after being harassed by the microfinance institutions (MFIs) for their inability to repay the debt have raised serious moral and ethical issues against the institutions. The aggressive debt-collection tactics of these MFIs have left us wondering if the government has been playing ignorant to the modus operandi of MFIs. Moreover, the interest rates charged by micro financing institutions are usurious. Today, MFIs pay little attention to the core concerns of the poor. For them the critical concern is to sustain services against emerging odds. Weve seen a major mission drift in micro finance, from being a social agency first, to being primarily a lending agency that wants to maximise its profit. Thus, there is a great need to set out rules limiting interest rates and stipulating legal consequences for the MFIs who badger/ harass borrowers for payments.

40

References
Online 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Sksindia.com http://www.editorialjunction.com/opinions/mfis-yes-coercion-no/ http://business-standard.com/india/news/after-sks-success-moremicrofinance-public-issues-arethe-horizon/406417/ http://www.nabard.org/microfinance/mf_institution.asp http://www.microfinanceinsights.com/blog-details.php?bid=223 http://www.scribd.com/doc/1194640/Micro-Finance CRISIL ratings India- top 50 MFIs The Financial Express- Microfinance World: Apr-June 2010 http://www.portalmicrofinanzas.org/p/site/s/template.rc/1.1.8214/?page 1=print http://www.digitaljournal.com/article/299621 http://indiamicrofinance.com/micro-finance-also-leads-to-suicides-inrural-areas.html http://mifin.wordpress.com/ http://www.rnw.nl/english/article/stricter-rules-microfinance-after-indiasuicides

Newspapers 1. 2. 3. 4. Times of India Business Standard Economic Times The Hindu

41