A PROJECT ON:

MICRO-FINANCE IN INDIA

SUBMITTED BY
PRIYA DHARMESH PATANI

TYBMS

ROLL NO-550

SEMESTER V

PROJECT GUIDE
Prof. RAMANATH IYER

SUBMITTED TO
UNIVERSITY OF MUMBAI

NAGINDAS KHANDWALA COLLEGE OF SCIENCE,

COMMERCE, ARTS AND MANAGEMENT STUDIES,
MALAD (W) Mumbai- 400 064

2016-2017

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 MICRO-FINANCE
Aim to make a Difference

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 CERTIFICATE

I Prof. Pravin Akolkar hereby certify that Dhanashree Vilas Gawas a

Student of Shri. Chinai College Of Commerce And Economics, TY-BBI
Sem V has Completed Project on ‘MicroFinance’ in the Academic Year
2014-2015. This information submitted is true and original to the best of
my knowledge.

Project Guide: Principal:

Date:

External Examiner:
Date: College Seal:

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 DECLARATION
I Miss. Dhanashree Vilas Gawas a student of Shri. Chinai College Of
Commerce And Economics. Andheri-(E) TY-BBI, V Sem hereby
Declared I have completed project on ‘Microfinance’ in the Academic
Year 2014-2015. This information Submitted is true and original to
best of knowledge.

Date:

Signature of Student

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 ACKNOWLEDGEMENT

I take this opportunity to thanks the UNIVERSITY OF MUMBAI for giving

me the chance to prepare this project.

I express my sincere gratitude to th e Principal Mrs. KELKAR, Chief Co-

coordinator and project guide Mr. PRAVIN AKOLKAR, teaching faculty and
our librarian for their constant support and help for completing the project.

I am also graceful to my friends for giving me moral support during the course
of my project work. Lastly, I would like to thank each and every person who
helped me in completing the project successfully especially MY PARENTS.

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 INDEX
Sr.No. Cha pter nam e Pa ge. No.

1 I ntro ductio n
 Ab stra ct
 List o f ab br evi ations
 D efinition
 K ey f acilitato r
 Mi cro fin an ce ins titution
 S upp ort
 Oth er institution s
 S ev er al ty p es of ne ed
2 M a in tex t o f the Pro ject
 Mo d els
 Histo ry
 St and a rds a nd pr incipl es
 F e atur es
 Role a nd i mport an ce
 Ba ck gro un d
 Go als
3 Da ta Ana lys is & I nterpretatio n
 P rod uct offe r ed
 P ov erty r ed uctio n
 S co pe
 Ov e rvie w o f s ust ain ability
 S ubsid y an d s ustain ability
4 Recom menda tions & Co nclus ion
 Wa ys
 Be ne fits a nd li mitations
 Ap p endi x
 Bi bliogr ap hy
 Gloss a ry

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 1. INTRODUCTION

 ABSTRACT :
Microfinance has been recognized as an effective tool in helping poor people and
developing rural econom y since its beginning in the late 1970s. Empirical research
provides convincing evidence for its significant contribution to social development in
various economies. However, we see huge variation at their performance level among
different economies. Considering their immense impact on economic development and
povert y reduction, it is important to understand sustainabilit y of the microfinance
institutions (MFIs).

It is believed that the entry of MFIs would adversel y impact informal sector lenders. It is
puzzling that even with enormous growth of MFIs over the last few decades; we still see
coexistence of these two forms of lending. I anal yze how informat ional asymmetry may
explain this coexistence. I develop a simple theoretical model to explore the role of
informational constraint on the optimal contract offered by MFIs. Among other findings,
we see that MFIs objective to screen good projects from the ba d projects may put
additional constraint in removing informal sector lending or in increasing
borrowers‘payoff . In addition, in m y thesis, I provide a review of empirical evidences on
microfinance‘s povert y reduction effect. Finall y, I briefl y discuss the issues related to
sustainabilit y of microfinance.

Key words: microfinance institutions, povert y reduction, informal money lending,

sustainable development, subsidy

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  LIST OF ABBREVIATIONS:

1. MFIs- Microfinance Institutions

2. NGOs - Nongovernmental organizations

3. CIDA- Canadian International Development Agency

4. IRDP- India‘s Integrated Rural Development Program

5. CGAP- Consultation Group to Assist the Poorest

6. MIX- Microfinance Information Exchange

7. SDI- Subsidy Dependence Index

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  INTRODUCTION TO MICROFINANCE

Traditionall y banks and Lending Institutions do not lend money to low income
Individuals.

The reasons being

1. Lack of Information about Individuals.

2. Collateral.
3. High Transaction cost of processing

Microfinance provides a solution for the above problem.

 DEFINITION

Microfinance is defined as “Financial Services (savings, insurance, fund, credit etc.) provided to poor and
low income clients so as to help them raise their income, thereby improving their standard of living”.

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  MICROFINANCE INSTITUTIONS

1. Association for Sarva Seva Farms (ASSEFA)

2. Mitrabharati - The Indian microfinance Information Hub
3. M ysore Resettlement and Development Agency (MYRADA)
4. SADHAN - The Association of Community Development Finance Institutions
5. SEWA: Self-help Women's Association
6. SKS India - Swayam Krishi Sangam
7. Streedhan - Banking with Rural Women
8. Working Women's Forum, Madras, India

 MICROFINANCE SUPPORT INSTITUTIONS

1. National Bank for Agriculture and Rural Development

2. Rashtri ya Mahila Kosh
3. SIDBI - Small Industries Development Bank of India
4. Tamil Nadu Women's' Development Corporation

 OTHER INSTITUTIONS

1. Commercial Banks:
2. State Bank of India
3. ABN-AMRO
4. Andhra Bank
5. IC IC I-Citigroup
6. ING-Vysya
7. HDFC

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  MICROFINANCE

Microfinance is a source of financial services for entrepreneurs and small businesses

lacking access to banking and related services. The two main mechanisms for the deliver y
of financial services to such clients are:

(1) relationship -based banking for individual entrepreneurs and small businesses; and

(2) group -based models, where several entrepreneurs come together to appl y for loans and
other services as a group.

In some regions, for example Southern Africa , microfinance is used to describe the suppl y
of financial services to low -income employees, which is closer to the retail finance model
prevalent in mainstream banking.

For some, microfinance 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 qualit y fina ncial services, including not just credit but also savings, insurance, and
fund transfers."[1] Many of those who promote microfinance generall y believe that such
access will help poor people out of povert y, including participants in the Microcredit
Summit Campaign. For others, microfinance is a way to promote economic development,
employment and growth through the support of micro -entrepreneurs and small businesses.

Microfinance is a broad category of services, which includes microcredit. Microcredit is

provision of credit services to poor clients. Microcredit is one of the aspects of
microfinance and the two are often confused. Critics may attack microcredit while
referring to it indiscriminatel y as either 'microcredit' or 'microfinance'.

Due to the broad range of microfinance services, it is difficult to assess impact, and ver y
few studies have tried to assess its full impact. Proponents often claim that microfina nce
lifts people out of povert y, but the evidence is mixed. What it does do, however, is to
enhance financial inclusion .

In developing economies and particularly in r ural areas, many activities that would be
classified in the developed world as financial are not monetized: that is, money is not
used to carry them out. This is often the case when people need the services money can
provide but do not have dispensable funds required for those services, forcing them to

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revert to other means of acquiring them. In his recent book The Poor and Their Money,
Stuart Rutherford cites several t ypes of needs .

1. Lifecycle Needs: such as weddings, funerals, childbirth, education,

homebuilding, widowhood and old age.
2. Personal Emergencies: such as sickness, injury, unemployment, theft, harassment
or death.
3. Disasters: such as fires, floods, cyclones and man -made events like war or
bulldozing of dwellings.
4. Investment Opportunities: expanding a business, buying land or equipment,
improving housing, securing a job (which often requires paying a large bribe),
etc.

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  SEVERAL TYPES OF NEEDS

Lifecycle Needs

home
childbirth weddings education funerals
building

Personal
Emergencies

death unemployment injury sickness harrasement

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 Disasters

cyclone earthquakes Floods dwellings dwellings

Investment
Opportunities

expanding buying land improving

securing a job equipment
business equipment housings

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People find creative and often collaborative ways to meet these needs, primaril y through
creating and exchanging different forms of non -cash value. Common substitutes for cash
vary from country to country but t ypically include livestock, grains, jewelry an d precious
metals. As Marguerite Robinson describes in The Microfinance Revolution, the 1980s
demonstrated that "microfinance could provide large -scale outreach profitabl y," and in the
1990s, "microfinance began to develop as an industry" (2001, p. 54). In the 2000s, the
microfinance industry's objective is to satisfy the unmet demand on a much larger scale,
and to play a role in reducing povert y. While much progress has been made in developing
a viable, commercial microfinance sector in the last few decades, several issues remain
that need to be addressed before the industry will be able to satisfy massive worldwide
demand. The obstacles or challenges to building a sound commercial microfinance
industry include

Inappropriate donor subsidies

1. Poor regulation and supervision of deposit -taking MFIs

2. Few MFIs that meet the needs for savings, remittances or insurance
3. Limited management capacit y in MFIs
4. Institutional inefficiencies
5. Need for more dissemination and adoption of rural, agricultural microfinance
methodologies

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 2. MAIN TEXT OF THE PROJECT

 MODELS

GRAMEEN BANK
SPANDANA
DANDA CREDIT
SOCIETY
SWAYAM KRISHI
SANGAM
GRAMEEN
KOOTA

 HISTORY OF MICROFINANCE

Over the past centuries, practical visionaries, from the Franciscan monks who founded the
communit y-oriented pawnshops of the 15th century to the founders of the European credit
union movement in the 19th century (such as Friedrich Wilhelm Raiffeisen ) and the
founders of the microcredit movement in th e 1970s (such as Muhammad Yunus and Al
Whittaker), have tested practices and built institutions desi gned to bring the kinds of
opportunities and risk -management tools that financial services can provide to the
doorsteps of poor people. While the success of the Grameen Bank (which now serves over
7 million poor Bangladeshi women) has inspired the world, it has proved difficult to
replicate this success. In nations with lower population densities, meeting the operating
costs of a retail branch by serving nearby customers has proven considerably more
challenging. Hans Dieter Seibel, board member of the European Microfinance Platform, is
in favour of the group model. This particular model (used by many Microfinance
institutions) makes financial sense, he says, because it reduces transa ction costs.
Microfinance programmes also need to be based on local funds.

The history of microfinancing can be traced back as far as the middle of the 1800s, when
the theorist Lysander Spooner was writing about the benefits of small credits to
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entrepreneurs and farmers as a way of getting the people out of poverty. Independentl y of
Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to
support farmers in rural Germany

The modern use of the expression "microfinancing" has roo ts in the 1970s when
organizations, such as Grameen Bank of Bangladesh with the microfinance pioneer
Muhammad Yunus, were starting and shaping the modern industry of microfinancing.
Another pioneer in this sector is Akhtar Hameed Khan.

Microfinance in India can trace its origins back to the earl y 1970s when the Self
Employed Women’s Association (“SEWA”) of the state of Gujarat formed an urban
cooperative bank, called the Shri Mahila SEWA Sahakari Bank, with the objective of
providing banking services to poor women employed in the unorganised sector in
Ahmedabad Cit y, Gujarat. The microfinance sector went on to evolve in the 1980s around
the concept of SHGs, informal bodies that would provide their clients with much -needed
savings and credit services. From humble beginnings, the sector has grown significantl y
over the years to become a multi -billion dollar ind ustry, with bodies such as the Small
Industries Development Bank of India and the National Bank for Agriculture and Rural
Development devoting significant financial resources to microfinance. Today, the top five
private sector MFIs reach more than 20 milli on clients in nearl y every state in India and
many Indian MFIs have been recognized as global leaders in the industry.

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  MICROFINANCE STANDARDS AND PRINCIPLES

A group of Indian women have assembled to make bamboo products that they intend to
resell.

Poor people borrow from informal moneylenders and save with informal collectors. They
receive loans and grants from charities. They buy insurance from state -owned companies.
They receive funds transfers through formal or informal remittance networks. It is not
eas y to distinguish microfinance from similar activities. It could be claimed that a
government that orders state banks to open deposit accounts for poor cons umers, or a
moneylender that engages in usury, or a charit y that runs a heifer pool are engaged in
microfinance. Ensuring financial services to poor people is best done by expanding the
number of financial institutions available to them, as well as by strengthening the
capacit y of those institutions. In recent years there has also been i ncreasing emphasis on
expanding the diversit y of institutions, since different institutions serve different needs.

Some principles that summarize a century and a half of development practice were
encapsulated in 2004 by CGAP and endorsed by the Group of Eight leaders at the G8
Summit on June 10, 2004:

1. Poor people need not just loans but also savings, insurance and money transfer
services.
2. Microfinance must be useful to poor households: helping them raise income, build
up assets and/or cushion themselves against external shocks.
3. "It 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.
4. Microfinance means building permanent local institutions.
5. Microfinance also means integrating the financial needs of poor people into a
country's mainstream financial system.
6. "The job of government is to enable financial services, not to provide them.
7. "Donor funds should complement private capital, not compete with it.[
8. "The key bottleneck is the shortage of strong institutions and managers."[ Donors
should focus on capaci t y building.
9. Interest rate ceilings hurt poor people by preventing microfinance institutions from
covering their costs, which chokes off the suppl y of credit.

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 10.Microfinance institutions should measure and disclose their performance —both
financiall y and socially.

Microfinance is considered a tool for socio -economic development, and can be clearl y
distinguished from charit y. Families who are destitute, or so poor they are unlikely to be
able to generate the cash flow required to repay a loan, should be rec ipients of charit y.
Others are best served by financial institutions.

In earl y 1980’s, the existing banking policies, procedures and systems were not suited to
meet the requirements of poor. For borrowings poor people usuall y resort to unorganised
sector. NABARD recommended that alternative policies, systems and procedures should
be put in use to save the poor from the clutches of moneylenders. Thus microfinance was
introduced in banking sector.

Microfinance is the provision of a broad range of financial s ervices such as deposits,

loans, payment services, money transfers and insurance to the poor and low income
households and their micro -enterprises. Microfinance is defined as “Financial Services
(savings, insurance, fund, credit etc.) provided to poor and low income clients so as to
help them raise their income, thereby improving their standard of living”.

Micro-financing is regarded as a tool for socio -economic up-liftment in a developing

country like India. It is expected to play a significant role in pov ert y alleviation and
development. Mohammed Yunus was awarded the Noble Prize for application of the
concept of microfinance, with setting up of the Grameen Bank in Bangladesh. Micro
credit and microfinanceare different. Micro credit is a small amount of mo ney, given as a
loan bya bank or any legall y registered institution, whereas, Microfinanceincludes
multiple services such as loans, savings, insurance, transferservices, micro credit loans
etc.

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  INTRODUCTION

Microfinance is the provision of microcredit and other financial services to the poor and
low-income people. It emerges as one of the most innovative intervention in the financial
sector and brings huge influence in economic development. Over the last few decades, it
has developed vigorousl y, becoming a powerful component of economic development,
povert y alleviation and economic regeneration strategies around the world.

Microfinance‘s growth and development has been extremel y rapid since its appearance in
the late 1970s. During the 1970s and 1980s, the microenterprise movement led to the
emergence of nongovernmental organizations (NGOs) that provided small loans for the
poor. By the end of 1997, microfinance institutions (MFIs) had 13.5 million clients. As of
December 31, 2007, 3552 microcredit institutions reported reaching 155 million clients,
106 million of whom were among the poorest when they took their first loan1. The United
Nations declared 2005 the International Year of Microfinance.

What factors ac count for the emergence and growth of microfinance? It was designed to
combat the market failure problem experienced in most of the underdeveloped and
developing parts of the econom y. For several reasons, the poor has little access to credit.
Due to lack o f information about poor borrowers‘ abilit y to repay and their inabilit y to
provide collateral, banks and other profit -oriented financial institutions t ypicall y cannot
provide credit to the poor. Thus, it has a direct adverse effect on povert y reduction.
Besides, lack of credit hampers growth of business and creation of jobs, thus contributing
to underdevelopment of the povert y-struck areas. In absence of formal credit sector, many
poor people in rural areas borrow money from informal moneylenders. On man y
occasions, informal money lending turned out to be more
exploitative and devastating to the poor‘s economic situation. Thus, a primary objective
of MFIs was to provide financial services for poor people and reduce exploitation by
informal lender. It promi ses to bring a series of exciting possibilities for extending
markets and developing small scale economy in a sustainable way.

Microfinance has also been recognized as an effective tool in alleviating povert y (Daley -
Harris 2002). The poorest and povert y reduction have become the object of unprecedented
attention at international summits in the 1990‘s. Canada, through the Canadian
International Development Agency (C IDA), has committed to the targets set by both the

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OECD International Development Goals and, most recently, the Millennium Goals which
focus on povert y reduction for those living on less than a dollar a day.

It is clear from the evidence that there are strong potential synergies between
microfinance and the provision of basic social services fo r clients (Morduch & Haley,
2001). The benefits derived from microfinance, basic education, and primary health are
interconnected, and programs have found that the impact of each can increase when the y
are delivered together. This recognition has caused th e government to carry out
microfinance as an important agenda in development.

Morduch (2000) has also emphasized the need to develop the institutional capacit y in a
cost effective way, in order to achieve sustainabilit y. However, it has been debated that
emphasizing financial sustainabilit y can have an adverse effect of excluding th e poorer
section of the economy because of the perception that the poor are at a greater credit risk
and that the unit cost of small loans tend to exceed the unit cost of large loans. Thus, as
microfinance movement progresses over the years, it has been co ntinuousl y evaluated and
modified accordingly to achieve the three important goals –

a) extending market and freeing borrowers from the clutches of informal

moneylenders,
b) reduce povert y through social development and
c) building the credit sector in a sustai nable way. Several microfinance programs have
been designed to achieve these goals. But the performances of these programs are
mixed. They have both positive and negative impacts.

Although microfinance gets considerable success in bringing basic financia l services to

rural areas and to the poor sections, it does not necessaril y reduce the volume of informal
money lending. Informal lenders seem to be thriving even in regions where MFIs have
built microcredit programs. Jain & Mansuri (2003) gave considerabl e evidence that MFI
clients not onl y borrow money extensively in the informal market but also use informal
loans to repay MFI debt.

What can explain such coexistence of MFIs with informal money lenders? I develop a
simple model to explore how informational asymmetries can constraint MFIs to raise its
borrowers‘ payoff from borrowing MFI loans. As a result, some borrowers are always wel l

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off borrowing from informal money lenders, provided that the lender has better
information about the project than MFIs do. Additionall y, MFIs are also constrained with
the fact the optimal contract they offer should also be able to screen good projects f rom
the bad projects. The objective to screen good projects gives an incentive to raise the
interest rate, and thereby reduces borrowers‘ incentive to borrow from MFIs. My model of
optimal MFI contract under asymmetric information shows that the installmen t structure
of the loan repaym ent schedule may allow the informal credit market to survive. M y
model also shows that informational constraint that MFIs have, reduces their abilit y to
reduce povert y. I provide a brief literature review of the mixed evidence on MFIs‘
performance on povert y reduction. Many MFIs have been able to lend money to the poor
in developing countries, while the poorest of the poor, generally, have not been reached.

Many microfinance programs are financiall y supported by governments a nd international

organizations. When these financial resources terminate, it will be difficult for MFIs to
maintain the operation of the microfinance programs. As a result of this, microfinance
programs face resource constraints and are not self -sufficient (Meyer 2002). MFIs‘ abilit y
to expand their service to the poor and the poorest of poor will be restrained. Therefore,
microfinance institutions should find possible solutions to survive and not to depend so
much on donors and governments. Thus, it is pra cticall y meaningful to explore and study
the sustainabilit y of MFIs. The thesis discusses the important issues related to financial
sustainabilit y and provides a review of the theoretical arguments from the existing
literature.

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  FEATURES OF MICROFINANCE

1. It is an essential part of rural finance.

2. It deals in small loans.
3. It basicall y caters to the poor households.
4. It is one of the most effective and warranted Povert y Alleviation Strategies.
5. It supports women participation in electronic activi t y.
6. It provides an incentive to grab the self employment opportunities.
7. It is more service -oriented and less profit oriented.
8. It is meant to assist small entrepreneur and producers.
9. Poor borrowers are rarel y defaulters in repayment of loans as they are sim ple and
God-fearing.
10.India need to establish several Microfinance Institutions.

 ROLE AND IMPORTANCE OF MICROFINANCE

Microfinance institutions are those which provide credit and other financial services and
products of very small amounts to poor in rural, semi-urban and urban areas for enabling
them to raise their income and improve their standard of living.

1. Credit To Rural Poor :-

Usuall y rural sector depends on non -institutional agencies for their financial
requirements. Micro financing has been successful in taking institutionalized credit to the
doorstep of poor and have made them economicall y and socially sound.

2. Poverty Alleviation:-
Due to micro finance poor people get employment. It also helps them to improve their
entrepreneurial skills and encourage them to exploit business opportunities. Employment
increases income level which in turn reduces poverty.

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 3. Women Empowerment :-
Normall y more than 50% of SHGs are formed by women. Now they have greater access to
financial and economical resour ces. It is a step towards greater securit y for women. Thus
microfinance empowers poor women economicall y and socially.

4. Economic Growth :-
Finance plays a key role in stimulating sustainable economic growth. Due to
microfinance, production of goods and services increases which increases GDP and
contributes to economic growth of the country.

5. Mobilizations Of Savings :-
Microfinance develops saving habits among people. Now poor people with meagre income
can also save and are bankable. The financial resou rces generated through savings and
micro credit obtained from banks are utilised to provide loans and advances to its
members. Thus microfinance helps in mobilisation of savings.

6. Development Of Skills:-
Micro financing has been a boon to potential rural entrepreneurs. SHGs encourage its
members to set up business units jointly or individuall y. They receive training from
supporting institutions and learn leadership qualities. Thus micro finance is indirectl y
responsible for development of skills.

7. Mutual Help And Cooperation:-

Microfinance promotes mutual help and cooperation among members. The collective
efforts of group promote economic interest and helps in achieving socio -economic
transition .

8. Social Welfare:-
With employment generation the level of income of people increases. They may go for
better education, health, famil y welfare etc. Thus micro finance leads to social welfare or
betterment of societ y.

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 Credit To Rural Poor :-

Social Welfare:-

Mutual Help And Cooperation:-

Development Of Skills:-

Mobilizations Of Savings :-

Economic Growth :-

Women Empowerment :-

Poverty Alleviation:-

 BACKGROUND

The World Bank defines microfinance as a development tool through which government or
non-governmental organizations and financial institutions provide a variet y of financial
services to help poor and low -income people. These financial services include
microcredit, deposits, and micro -insurance and so on.

Poor people need a diverse range of financial services to run their business, build assets,
for smooth consumption and to manage risks. People living in povert y often meet their
need for money through in formal credit market. Credit is available from informal lenders,
but usuall y at a very high cost for borrowers. To be worse, traditional banks do not
necessaril y consider poor people as their clients.

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The major concern for commercial banks is the high ri sk associated with small -scale
lending to the poor. Due to the existence of adverse selection problem, banks cannot
easil y determine which customers are likel y to be more risky than others. Banks would
like to charge more interest rates to riskier borrower s in order to compensate for the
added probabilit y of default. However, the banks do not know who the riskier one is and
raise interest rate for everyone which drives safer borrowers out of the credit market.
Besides, the moral hazard problem also arises w hen borrowers try to abscond with the
bank‘s money. If the bank has cheap ways to gather and evaluate information about their
clients, these problems could be solved. But banks cannot afford the high transactions
costs for gathering and evaluating informat ion. Another potential solution would be
available if borrowers had assets to offer as collateral. If that were so, banks would lend
without risk. Since the poor borrowers cannot provide collateral, poor people often are
deprived of credit in market.

Hulme & Mosley (1996) has pointed that ―The further one proceeds down the income
spectrum, the harder it becomes to finance investment through borrowing from private
banks, and the enterprises of the poor – both in rural areas and in the shant y towns on th e
edge of the cities – generall y have no access to them at all.‖ They also emphasized two
important problems that prevent the poor from having access to formal financial services.
Firstl y, it is the ‗screening problem‘. Banks may be discouraged from provid ing loans to
the poor because they do not know them personall y. It is easy to see why the banks
consider it too risky to allow them to borrow money. Secondly, there is the ‗enforcement
problem‘. Banks would not shield themselves from these risks, since the se borrowers are
generall y too poor to offer collateral.
The government has made significant efforts to combat the povert y. Policymakers have
positivel y tried their best to extend financial markets in rural areas, but often with
disappointing results. What is the government‘s role in microfinance? The government
built development banks and gave them too much subsidies in order to support the rural
economy. However, heavy subsides were deployed to compensate the banks for entering
into markets where they fea r huge losses due to high transactions costs and risks

India‘s Integrated Rural Development Program (IRDP) is an example of inefficient

subsidized credit. This program has its ―social targets‖. In principle, the program
provided 30 percent of loans to soc iall y excluded groups and 30 percent toward women.

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Achieving social goals became as important as achieving efficiency. Between 1979 and
1989, IRDP got subsidies of almost $6 billion.

But these resources did not generate good institutional performance. Ac cording to Pulle y
(1989), IRDP repayment rate fell below 60 percent. In 2000, the IRDP repayment rate
decreased to 31 percent (Meyer 2002). Due to institutional performance remarkabl y
weakened, the IRDP failed to be a reliable and meaningful source of serv ice for the poor.

The Consultation Group to Assist the Poorest (CGAP) points out ―there‘s a positive role
for governments to play in adopting appropriate ―light -touch‖ consumer protection
policies and market conduct regulation, such as disclosure require ments, protections
against over- indebtedness, and simple, accessible recourse mechanisms, coupled with
client financial education.‖ In addition, when microfinance providers offer voluntar y
deposit services, there is also a role for government to play i n r egulation and supervision.
The reason for this is not onl y protecting depositors, but also to keep the stabilit y of the
financial s ystem.

Microfinance is a new way of delivering loans to poor borrowers. According to CGAP, a

microfinance institution is an organization that provides comprehensive financial services
to the poor. Different t ypes of financial services providers have emerged: non -government
organizations; cooperatives; communit y -based development institutions such as self -help
groups and credit unions; members (group) system of collective organizations; rural
savings and loan organizations; informal financial intermediaries; and semi -formal and
formal financial institutions, including commercial banks offering new possibilities.
These microfinan ce institutions differ in many aspects, including the range of offered
products, ownership structures and sources and suppl y of funds.
The target clients of these institutions are mainl y the poor or low -income people
(microenterprises included), especiall y the women of the poor farmers.

The programs of these MFIs are suitable for people in the rural areas. Microfinance
provides the funds needed for production for poor households and solve the problem of
funds for povert y alleviation, rather than consumer loans. Credit lines of microfinance are
small and short -term. Microfinance is generall y meets the seasonal production
requirement for poor households (especiall y in rural poor households), and they are

mostl y short term loans (one year 、3-6 months, etc.). T he amount of loans which is mainl y

Microfinance Page 27
used to purchase the necessary means of production, small machinery equipment, is
smaller. The most progress of microfinance is that there are no collateral or flexible and
diverse forms of collateral, and carry out the i nstallment repayment system. Because of
the lack of the valuable assets that can be disposed after loan defaults, MFIs use the mode
of installment repayment commonly. Thus, the entire loan and interest are decomposed
into a week or once every two weeks to repay. One can continuousl y loan after repayment.
So that is conducive to the recovery of loans, to some extent to reduce the risk of the
loans, but they also help recycling funds, reducing the backlog of funds and improving
interest income.

 GOALS

The goals are

1. Eradicate Extreme Povert y & Hunger.

2. Achieve Universal Education.
3. Promote Gender Equalit y & Women’s Empowerment.
4. Reduce Child Mortalit y
5. Combat Diseases
6. Developing Entrepreneurial Spirit

Microfinance Page 28
Previous researches have focused on different goals of microfinance and how they are
achieved. In m y thesis, I will pay attention to three main goals:
(1) solving the market failure problem,
(2) reducing povert y, and
(3) bringing out development in a sustainable way.

It is eas y to see why one of microfinanc e‘s goals is to solve the market failure problem -
reaching the poor and undeveloped sectors, and reducing exploitation by informal
moneylenders. The financial systems are not highl y advanced in the poor regions of the
world and the poor have little access t o credit through formal credit sector. One of the
reasons behind absence of formal credit sector is the information problem.

In particular, banks have little information about the t ype of projects the poor people
would invest in. Additionall y, the poor p eople can hardl y provide collateral for securit y.
As loans from the formal banking sectors are often refused, the potential borrowers
approach informal money lenders who provide loan at an extremel y high interest rate,
leading to further economic problem. The emergence of microfinance can possibly break
this circle. Microfinance programs emphasize small, frequent, regular payments and create
incentives for poor borrowers to make these payments. It has the promise to reduce the
informal lending by providing financial services to the poor.

With such a large proportion of the world‘s population living in povert y, the use of
microfinance should also be a key to reduce povert y and encourage economic growth. It
has many roles in reducing povert y. First, it target s the poorer section of the market,
which is otherwise deprived of formal credit. Thereby it expands the market. Second, it
converts savings of poor households to credit to others. Third, it works as a much needed
insurance for the poor people, who otherwi se have little support in smoothing
consumption. Finall y, it explores potential synergies between microcredit and other basic
development services such as health care, education etc. Many MFIs have developed a
range of services to address the requirement o f the poor, such as the Income Generation
for Vulnerable Group Development (IGVGD) program of BRAC, Bangladesh. CGAP‘s
Povert y Assessment tool can be used to compare clients and no -clients of MFIs in the
same communit y.

Microfinance Page 29
Although the microfinance service p rovides huge support to help the poor people and
change their life greatl y, many present microfinance institutions cannot achieve financial
sustainabilit y. The main reason is that most institutions are still small and vulnerable to
constraints on their fun ding resources. They are unable to continuousl y offer credit and
wide-ranging service for the poor and thus have limited function on regional povert y
alleviation.

Therefore, another goal of microfinance is to bring out development in a sustainable way.

Robinson (2000) has pointed ―The microfinance revolution is currentl y emerging in many
countries around the world. This term refers to the large -scale, profitable provision of
microfinance services -small savings and loans to economicall y active poor people by
sustainable financial institutions.‖ This means MFIs should bring out development in a
sustainable way, and then MFIs can offer large -scale provision of financial services to
low-income people.

 ROLE OF REGULARLY SCHEDULED REPAYMENT

Jain & Mausuri (2003) provides another explanation why regularl y scheduled repayments
by MFIs can allow informal money lenders to survive. They pointed out ―The potential
for moral hazard leads MFIs to use innovative mechanisms, such as regularl y scheduled
repayments, wh ich indirectl y co-opt the better-informed informal lenders, and this
installment repayment structure allows informal lenders to survive‖. The installment
repayment plan requires that borrowers must pay back their loan at fixed period. Since the
borrower know that repayment must begin almost immediatel y after loan disbursement,
and t ypicall y much before the returns are realized, they must have enough money to
finance the installment. Therefore, the borrowers might borrow from informal lenders. In
addition, the rigid repayment schedule considerabl y restricts the range of the borrower‘s
project, and then reduces the attraction of loan. Sinha and Matin (1998) suggested that the
use of small informal loans to meet the weekl y installment of the MFI loan is more
common among the poorest MFI borrowers.

In fact, the presence of the informal money lending can mitigate the informational
problems in an installment repayment plan that MFI provides. The reason is that the
installment plan allows the MFI to make use of th e superior monitoring capability of the

Microfinance Page 30
informal money lender. The informal money lender with perfect information of borrowers
can use his monitoring capacit y to monitor the borrowers. The installment repayment is a
good way of mitigating the information p roblems faced by the MFI.

Jain & Mausuri (2003) also showed that the opening up of a formal microfinance
institution in a village may lead to an increase in borrowing from the informal money
lenders. And as a result, the informal money lender may increas e their interest rate. In
addition, they established that the installment plan does better than cofinancing which
requires the borrower to raise part of the loan elsewhere.

Microfinance practitioners argue that the repayment schedule is critical to prevent loan
default. It is believed that repayment installment schedule play a role in reducing default
risk and making lending to the poor viable. However, this practice dramaticall y increases
MFI transactions costs, thereby limiting the set of loan size s and client t ypes. In addition,
the use of regular scheduled repayment allows the informal money lenders to survive.
Regular scheduled repayment is a good explanation for coexistence of the MFI and
informal money lenders.

Microfinance Page 31
 2. DATA ANALYSIS AND INTERPRETATION

 PRODUCTS OFFERED

 Loans:
which allow a lump sum to be enjoyed now in exchange
for a series of savings to be made in the future in the form of
repayment installments.

 Savings:
which allow a lump sum to be enjoyed in future in
exchange for a series of savings made now.

 Insurance:
which allows a lump sum to be received at some
unspecified future time if needed in exchange for a series of
savings made both now and in the future. Insurance also
involves income pooling in order t o spread risk between
individuals on the assumption that not all those who contribute
will necessaril y receive the equivalent of their contribution.

 Pensions:
which allow a lump sum to be enjoyed as a specified
and generall y distant date in future in exchange for a series of
savings made now.

Microfinance Page 32
  POVERTY REDUCTIONS

Povert y can be defined as an income level below a sociall y acceptable minimum

(Montgomery, 2005). To understand povert y, a simple distinction can be noticed. There
are ‗chronic poor‘ and ‗transitory poor‘3. The chronic poor always stay in povert y,
without welfare support. Those poor people lack assets and opportunities. Whereas the
transitory poor, those are suffer fluctuations in income that bring them close to or below
the povert y line. In other words, those people temporaril y fall into povert y due to adverse
shocks.

In the world, poverty remains a serious problem because the high economic growth is
mainl y driven by few rich and developed countries. According to the estimated data by th e
World Bank in 2008, there was the estimated number of 1,345 billion poor people in
developing countries who live on US$1.25 a day at 2005 international prices4. Extreme
povert y remains an alarming problem in the developing regions around the world. There
are still a lot of people suffered ‗chronic poor‘ or ‗transitory poor‘.

To help them and to combat povert y is a matter of growing concern by government. Many
governments have responded positivel y to this concern by implementing all kinds of
possible pol icies. The World Bank (2000) explained that the condition of povert y is
characterized by lack of access by poor households or individuals to the necessary assets
for a higher standard of income or welfare, whether assets contain access to education,
access to land, assess to infrastructure, access to networks of obligations or access to
credit. 5(Montgomery, 2005)

Policymakers and economists around the world always emphasize the link between
improving access to financial markets and reducing povert y, beca use lack of access to
finance is often considered as a key reason why poor people remain poor. Few recent
ideas have generated as much hope for alleviating povert y in low -income countries as the
idea of microfinance. The original objective of microfinance is to help the low -income
people and improve the position of the poor. It is easy to understand that microfinance is
used as a mechanism for povert y reduction. The poor are always refused by conventional
financial banks, because they cannot afford collater al. Due to the lack of access to credit
from conventional financial institutions, the poor relies on loans from informal

Microfinance Page 33
moneylenders at high interest rates. In this sense, povert y has reproduced povert y for
generations.

Microfinance institutions attempt to help the poor through innovative measures such as
group lending and regular saving schemes and so on. Microfinance increases the options
and self-confidence of poor people by helping them to access credit. If access to credit
can be improved, the poor can finance productive activities that will help income growth.
Microfinance is related to the chronic poor and to the transitory poor in different ways. As
for access to credit, there is a simple distinction between the needs of the chronic and
transitory poor. The chronic poor often access credit for the purpose of creating income,
whereas the transitory poor want to realize smoothing consumption through access to
credit. The policies which help households to smooth income can dramaticall y reduce
transitory povert y. But onl y large and sustained growth in household incomes will reduce
the long-term poverty.

There is general evidence that microfinance has a positive impact on the povert y
reduction. Remenyi and Benjamin (2000) gave the conclusion that house hold income of
families with access to credit is significantl y higher than that of comparable households
without access to credit based on case studies from Asia and the Pacific. Robinson (2001)
emphasized in her book: ―Among the economicall y active poor o f the developing world,
there is strong demand for small -scale commercial financial services -for both credit and
savings. Where available, these and other financial services help low income people
improved household and enterprise management, increase prod uctivit y, smoothing income
flows and consumption cost, enlarge and diversify their micro business and increase their
incomes.

Khandker (2005) confirmed that microfinance programs have an important effect on

reducing povert y among the participants, particu larl y for female participants and positive
spillovers on non -program participants in the villages. Mosley and Arun (2003)
demonstrated that a variet y of state sponsored institutions provided financial services,
which resulted in impressive achievements in expanding access to credit particularl y
among the rural poor. Katsushi, Thankom & S.K. Annim(2010) used national household
data from India and developed treatment effect model to estimate the povert y -reducing
effects of MFIs loans for productive purposes. They found that ―loans for productive
purposes were more important for poverty reduction in rural than in urban areas, however

Microfinance Page 34
in urban areas, simple access to MFIs has larger average povert y -reducing effects than
access to loans from MFIs for productive p urpose.

According to the survey from Microfinance Information Exchange (MIX) in 2009, there
are more than 1400 MFIs, representing 86 million borrowers and almost 100 million
savers from throughout the developing world6. Nevertheless, most parts of the dev eloping
world still remain characterized by the huge demand for micro financial services.
Obviousl y, microfinance is weak to reach the core poor people who live significantl y
below the povert y line and lack complementary inputs.

The reasons are as follows: Firstl y, due to the high cost, most microfinance institutions
charge higher and higher interest rates. Such high rates are unaffordable to the core poor.
Once the core poor cannot accept high interest rates, they will either giv e up the service
or accept it but then get into financial difficulties. Secondly, the very poor may be
excluded by other members of the group in group lending. The reason is that the very poor
are considered bad credit risk. They would jeopardize the posit ion of the group as a
whole. Thirdly, when professional staffs operate the loan, they may exclude the very poor
from borrowing because of the fear of defaulting. Amin et al. (2003) pointed that
microfinance programs are more successful at reaching poor, bu t less successful at
reaching vulnerable.

There is increasing acceptance that traditional microfinance programs are not reaching the
‗poorest of the poor‘-indeed they are rarel y reaching the bottom 10 -15% of the
population.‖ He pointed out that a MFI‘s a bilit y to attract the poorest depends on whether
the financial service it offers is appropriate for the needs of the poorest of the poor.
Coleman (2006) has shown that microfinance programs are not reaching the poor as much
as they reach relativel y wealthy people in Thailand. And the impact of village banks is
larger on richer committee members rather than on rank -and-file members. The concept
and practice of microfinance have changed over the last decade.

Hulme and Arun (2009) indicated that microfinance sector is increasingl y adopting a
financial s ystem approach. This approach supports the argument that MFIs should aim for
sustainable financial services to low income people, which may risk undermining the
potential of institutional innovation for povert y reduction and social empowerment
(Katsushi et al., 2010). Most MFIs probabl y do not consider their institutional mission to

Microfinance Page 35
be serving the poorest of the poor. From the report of MIX, minorit y MFIs identified
―specificall y targeting very poor clients‖ as their institutional mission.

How can the microfinance reach to the core poor? To answer this question, many aspects
should be considered. Firstly, for the government part, government should encourage more
MFIs to extend their loans and financial services to the poorest of the poor. Government
should also make some policies to improve basic education, basic health care and
infrastructure construction in poor region, thereby MFIs can easil y reach to these poor
regions. Secondl y, for the MFIs part, MFIs shou ld design special programs for the core
poor. The degree to which the programs meet the core poor people‘s needs lie in the
characteristics of the programs for them. The well known institution is the Bangladesh
Rural Advancement Committee (BRAC)7 in Bangla desh. The programs speciall y aim to
provide training, health provision and more social development for the core poor. It
combines credit with training, food subsidies, and other support. The core poor are
encouraged to realize their potential through econo mic and social programs.

The efficacy of microfinance as a povert y intervention tool may be related to the

sustainable development by itself. The MFI not onl y targets the poor, but also continues to
serve them. For the purpose of being successful, the MF Is must be self-sustaining. As
long as MFIs keep themselves sustainable, they can offer sustainable service to the poor.

The fundamental objective of sustainable microfinance is to be able to continue to serve

poor populations. Large -scale sustainable mi crofinance helps to create an enabling
environment for the povert y reduction. Sustainable microfinance expands the service
scope, scale and depth, through the realization of financial sustainabilit y and improves
efficiency of alleviating poverty.

Microfinance Page 36
 loan

saving

insurance

pension

poverty reduction

 OVER VIEW OF SUSTAINABILITY

Microfinance has been an integral part of the financial system, and the successful
experience of microfinance is also being learned by many countries. By constant practice
and development of microfinance, more and more people pa y their attention on the abilit y
of the sustainable development of MFIs. These sustainable MFIs can service a wide range
of the poor people because they can ensure their development by providing long -term
financial services. In the international microfinan ce experience, sustainabilit y graduall y
becomes an important standard to evaluate the success of a micro -financial institution.

Though the present microfinance service in practice gives strong support to help the poor
and improve their life to a certain extent the present MFIs are unable to achieve financial
sustainabilit y since most institutions are still small and vulnerable to constraints on their
funding resources, which makes them unable to continuousl y provide credit and
comprehensive service for th e poor and thus have limited function on regional povert y
alleviation.

Microfinance Page 37
We can understand the concept of sustainable development in microfinance from two
aspects. The first is organizational sustainabilit y. This means that the MFI has to focus on
management, organizational structure and hiring of motivated staff. (Johnson & Rogaly,
1997). The second is financial sustainability. The microfinance institutions‘ revenue
generated by their own credit services can cover their transaction costs and capital costs
to ensure that the profit is higher than the expenditure. To achieve this level, the
institutions will not need to be provided with any subsidies, and then their own
investments will grantee profit.

Financial sustainabilit y is very important to the survival and development of

microfinance. Microfinance as a financial service available to the poor is reflected in a
credit relationship. Credit contains lending, supervision of loan use and repayment of the
loan. Financial sustainabilit y of microfinance generall y experience four development
stages:

1. In the first stage, the operating cost is mainl y paid by donors and ―soft loans‖.
2. In the second stage, the value of funding sources close to the market price, loan
interest income can compensate capital cost and a part of operation cost.
3. In the third stage, subsidies greatl y reduced, and the ability of operational self -
sufficiency continuousl y enhanced.
4. In the fourth stage, microfinance institutions absorb deposits at commercial interest
rates; the interest income can sufficiently cover the operating cost, the losses of
loans and inflation.

Microfinance Page 38
  SUBSIDY AND SUSTAINABILITY

The role of subsidy in MFIs cannot be under -estimated. The truth is that numerous of the
MFIs continue to use subsidies from a variet y of sources —some from donors, some from
governments, and some from charities and concerned individuals. Financial self -
sufficiency is referred to the revenue that covers nonfinancial and financial expenses
calculated on a commercial basis. Sometimes also refer to as ―profit without subsidy‖
(Christen and others, 1995).

Microfinance Page 39
Sustainabilit y requires MFIs to have a positive return on equit y (net of any subsid y
received) while covering all transaction costs (loan losses, financial costs, administrative
costs, etc), and consequentl y to function without subsidies.(Ahmad Nawaz, 2010). What
are the debates about subsidy? A lot of studies have focused on the impact of subsidy, but
there are some competing views. Here are some conclusions as follows:

1. ---Subsidy can impact credit demand and suppl y. There are two conflicting effects.
One is that demand for loans by current borrowers may fal l when interest rates rise,
which is a standard result from demand theory. The second effect is that as
programs loosen themselves from subsidies, they can increase the suppl y of loans to
the underserved, delivering the opposite result.

2. ---Subsidy also impacts average returns to borrowers. Raising the interest rates
leads to screening out poor projects and increasing average returns. In contrast,
raising the interest rates will exacerbate moral hazard and adverse selection, and
result in worsen net return s

3. ---Subsidy impacts nonsubsidized lenders, who may change their interest rates. The
subsidized lenders squeeze out other lenders, so that removing subsidies should
both expand overall credit suppl y and allow those lenders to raise their rates.
Otherwise, the subsidized lenders helpfull y segment the credit market; and when
subsides fall, other lenders may be forced to lower their rates given a more diverse
pool of potential clients.

4. ---Subsidy impacts povert y reduction. Advocates think MFIs without subsid y can
get sustainable development. As long as MFIs keep sustainabilit y, they can
effectivel y play a role in povert y reduction. On the contrary, some people insist on
emphasizing financial sustainabilit y above other concerns can result in the
exclusion of t he poorest, most vulnerable people, and those living in isolated areas
from financial services.

Some insists that subsidization tend to put greater social power on consumption by the
poor. They assume that there are highly sensitive credit demand to int erest rates, low
impacts of interest rates on returns, but not extremel y high returns to investments by poor

Microfinance Page 40
households, and small or beneficial spillovers onto other lenders. On the other hand, those
who are against subsidization tend to support a relativ el y flat distribution of social
weights.

They think that there are low sensitivity of credit demand to interest rates, positive
impacts of interest rate on returns, very low returns to investments by poor households,
and negative externalities of subsidiz ed credit programs on other lenders. Those who are
skeptical about subsidization consider that the role of the subsidies still persists which
hinders the MFIs to achieve self -sustainabilit y. (Morduch, 2005)
Some experts persist in an opinion of ‘win -win’ proposition: microfinance reduces povert y
and in the process of that becomes subsidy free or sustainable. Microfinance institutions
will be able to grow without the constraints imposed by donor budgets. Morduch (2000)
pointed that there is no ‗win -win‘ situation in which an MFI can get the best of both sides
of this debate. Ahmad Nawaz (2010) did the ―with and without subsidy‖ analysis of
conventional financial ratios and confirmed the fact that MFIs financial performance
declines substantially without subs idies.

By understanding the role of subsidies in microfinance, one might want to quantify

whether the subsidies are used well or not and to know how large the subsidies are. Any
subsidy to the institution means that fewer costs have to be charged to cust omers. For
example, the Grameen Bank, despite of reporting profits, it is in fact subsidized on a
continuing basis (Morduch, 1999). Grameen‘s annual reports indicated that it has earned
profits every year and the sum of profits were up to $1.5 million betw een 1985 and 1996.
But during this period, Grameen also got subsidies from all kinds of sources.

According to the report by Grameen, their direct subsidies totaled $16.4 million between
1985 and 1996. It is clear that Grameen Bank took in more revenue th an it spent. By
subtracting the $16.4 million in grants from the $1.5 million reported profits, we can see
that in this period Grameen clearl y did not earn profits as calculated traditionall y. In
addition, there are other forms of subsidy from ―soft loans‖ from donors.
Sustainabilit y means the extent to which an institution, in addition to being viable,
mobilize its own financial resources internall y (equit y, savings deposit, and retained
profits) instead of depending on government subsidies or donor funds .(Seibel, 1999).

Microfinance Page 41
Different from traditional finance institutions, microfinance institutions not onl y combat
for financial sustainabilit y but also reduce povert y. This social nature of MFIs is mainl y
financed by subsidies from donors. The social welfare c oncept associated with MFIs along
with the shift towards commercialization warrants that their performance on the basis of
traditional financial ratios without unearthing their degree of subsidy dependence
provides onl y a partial and often meaningless or m isleading picture of the social cost of
maintaining the MFIs (Yaron, 2004).

The Microbanking Bulletin (2009) showed that 557 out of 1084 microfinance institutions
surveyed were financiall y sustainable, a rate just over 50 percent.8 From the data, we can
draw that subsidy is very important for MFIs. However, if MFIs would like to achieve the
sustainable development, they should find a new way to free from the subsidies. Morduch
(2005) highlights that some donors argue for a strategy which is ―subsidize st art-up
costs, not ongoing operations‖. We can consider a long -term situation where the institution
can be financiall y self -sufficient. The institution charges an interest rate as 30 percent per
year to customers. But, in the first ten years, 8 Source:
The MicroBanking Bulletin, NO. 19, December 2009 the 30 percent interest rate cannot
cover all costs. In fact, the lender should charge an interest rate as 45 percent. Then, the
strategy here would be to charge the customer 30 percent from the first day of op eration
and to take a subsidy of fifteen cents per dollar lent for the first ten years.

Microfinance Page 42
 4. RECOMMENDATIONS AND SOLUTIONS

 WAYS IN WHICH POOR PEOPLE MANAGE FOR THEIR

MONEY

Rutherford argues that the basic problem poor people as money managers face is to gather
a 'usefull y large' amount of money. Building a new home may involve saving and
protecting diverse building materials for years until enough are available to proceed with
construction. Children’s schooling may be funded by buying chickens and raising them for
sale as needed for expenses, uniforms, bribes, etc. Because all the value is accumulated
before it is needed, this money management strategy is referred to as 'saving up

Often, people don't have enough money when they face a need, so they borrow. A poor
famil y might borrow from relatives to buy land, from a moneylender to buy rice, or from a
microfinance institution to buy a sewing machine. Since these loans must be repaid by
saving after the cost is incurred, Rutherford calls this 'sa ving down'. Rutherford's point is
that microcredit is addressing onl y half the problem, and arguabl y the less important half:
poor people borrow to help them save and accumulate assets. Microcredit institutions
should fund their loans through savings accou nts that help poor people manage their
myriad risks.

Most needs are met through a mix of saving and credit. A benchmark impact assessment of
Grameen Bank and two other large micro finance institutions in Bangladesh found that for
every $1 they were lending to clients to finance rural non -farm micro-enterprise, about
$2.50 came from other sources, mos tl y their clients' savings. This parallels the experience
in the West, in which famil y businesses are funded mostl y from savings, especially during
start-up.

Recent studies have also shown that informal methods of saving are unsafe. For example,
a study b y Wright and Mutesasira in Uganda concluded that "those with no option but to
save in the informal sector are almost bound to lose some money —probabl y around one
quarter of what they save ther e.

Microfinance Page 43
The work of Rutherford, Wright and others has caused practitioners to reconsider a key
aspect of the microcredit paradigm: that poor people get out of povert y by borrowing,
building microenterprises and increasing their income. The new paradigm places m ore
attention on the efforts of poor people to reduce their much vulnerabilit y by keeping more
of what they earn and building up their assets. While they need loans, they may find it as
useful to borrow for consumption as for microenterprise. A safe, flexi ble place to save
money and withdraw it when needed is also essential for managing household and famil y
risk.

1. Suryoday Micro Finance Pvt Ltd is a registered Non -Banking Finance Company,
engaged in providing loans to women from Economicall y Weaker Sections, Below
Povert y Line and the Marginal Poor who do not have access to traditional banking,
with an objective to reduce povert y in its area of operation.

2. Trident Microfin Private Ltd.is a new generation microfinance institution

established in 2007 and headquartered at Hyderabad in Andhra Pradesh, India. The
Company was promoted by highl y qualified microfinance professionals with the
motto 'to reach the unreached'. The overarching goal of the company is to provide
comprehensive financial and business solutions to low income individuals and
enterprises.

Microfinance Page 44
Examples

Microfinance is defined by the process of formulating groups within a communit y to assist

povert y stricken people by lending them money without the need of credit or collateral.
An example of microfinance is the Saving Up program. In the Saving Up Program people
put aside a certain amount of money, for example $1 per week which is collected and
dispersed as a lump sum by an external agent minus a fee for holding the funds. The
Saving Up Program assists the poor in saving their money and teaches them how to save.

Microfinance Page 45
  Interest rates

One of the principal challenges of microfinance is providing small loans at an affordable

cost. The global average interest and fee rate is estimated at 37%, with rates reaching as
high as 70% in some markets. The reason for the high interest rates is not primarily cost
of capital. Indeed, the local microfinance organizations that receive zero -interest loan
capital from the online micro lending platform Kiva charge average interest and fee rates
of 35.21%. Rather, the main reason for the high cost of microfinance loans is the high
transaction cost of traditional microfinance o perations relative to loan size.

Microfinance practitioners have long argued that such high interest rates are simpl y
unavoidable, because the cost of making each loan cannot be reduced below a certain
level while still allowing the lender to cover costs such as offices and staff salaries. For
example in Sub -Saharan Africa credit risk for microfinance institutes is very high,
because customers need years to improve their livelihood and face many challenges during
this time. Financial institutes often do no t even have a system to check the person's
identit y. Additionally they are unable to design new products and enlarge their business to
reduce the risk. The result is that the traditional approach to microfinance has made onl y
limited progress in resolving the problem it purports to address: that the world's poorest
people pay the world's highest cost for small business growth capital. The high costs of
traditional microfinance loans limit their effectiveness as a povert y -fighting tool.
Offering loans at int erest and fee rates of 37% mean that borrowers who do not manage to
earn at least a 37% rate of return may actuall y end up poorer as a result of accepting the
loans.

Example of a loan contract, using flat rate calculation, from rural Cambodia. Loan is for
400,000 riels at 4% flat (16,000 riels) interest per month.

According to a recent survey of microfinance borrowers in Ghana published by the Center

for Financial Inclusion, more than one -third of borrowers surveyed reported struggling to
repay their loan s. Some resorted to measures such as reducing their food intake or taking
children out of school in order to repay microfinance debts that had not proven
sufficientl y profitable.

Microfinance Page 46
In recent years, the microfinance industry has shifted its focus from the ob jective of
increasing the volume of lending capital available, to address the challenge of providing
microfinance loans more affordabl y. Microfinance anal yst David Roodman contends that,
in mature markets, the average interest and fee rates charged by micr ofinance institutions
tend to fall over time. However, global average interest rates for microfinance loans are
still well above 30%.

The answer to providing microfinance services at an affordable cost may lie in rethinking
one of the fundamental assumpti ons underl ying microfinance: Those microfinance
borrowers need extensive monitoring and interaction with loan officers in order to benefit
from and repay their loans. The P2P microlending service Zidisha is based on this
premise, facilitating direct interaction between individual lenders and borrowers via an
internet communit y rather than physical offices. Zidisha has managed to bring the cost of
microloans to below 10% for borrowers, includi ng interest which is paid out to lenders.
However, it remains to be seen whether such radical alternative models can reach the
scale necessary to compete with traditional microfinance programs.

 Use of loans

Practitioners and donors from the charitable si de of microfinance frequentl y argue for
restricting microcredit to loans for productive purposes —such as to start or expand a
microenterprise. Those from the private -sector side respond that, because money is
fungible, such a restriction is impossible to enforce, and that in any case it should not be
up to rich people to determine how poor people use the ir money

 Gender

Microfinance experts generall y agree that women should be the primary focus of service
delivery. Evidence shows that they are less likel y to default on their loans than men.
Industry data from 2006 for 704 MFIs reaching 52 million borrowers includes MFIs u sing
the solidarit y lending methodology (99.3% female clients) and MFIs using individual
lending (51% female clients). The delinquency rate for solidarit y lending was 0 .9% after
30 days (individual lending —3.1%), while 0.3% of loans were written off (individual
lending—0.9%). Because operating margins become tighter the smaller the loans

Microfinance Page 47
delivered, many MFIs consider the risk of lending to men to be too high. This focus on
women is questioned sometimes, however a recent study of micro entrepreneurs from Sri
Lanka published by the World Bank found that the return on capital for male -owned
businesses (half of the sample) averaged 11%, whereas the return for women -owned
businesses was 0% or slightl y negative.

 BENEFITS AND LIMITATIONS:

The benefits of microfinance are that it helps to manage the assets of the poor and
generates income. Through microfinance institutions such as credit unions, financial non -
governmental organizations and even commercial banks poor people can obtain small
loans and safeguard their savings. The limitations of microfinance are that through this
savings plan participants are losing money by having to pay a fee. The user can also pay
back their loans whenever they chose therefore encouraging a borrower to have various
outstanding loans. The lender is also vulnerable in that there is no guarantee of the loan
being repaid in the given arranged timeframe, and the consequences to defaulting are not
defined.

When looking at a micro -finance initiative, there are three main benefits and limitations
for the model. These are based on a basic micro -finance initiative though they can be
applied to many variations. When looking at the three benefits and li mitations, they
revolve around three key ideas, povert y, mistrust, and promoting change.
A micro-finance initiative wishes to address these issues in a positive way. For example,
micro-finance can be an alternative program to address poverty reduction where the tools
needed to raise an individual or a family out of povert y are given to them directly. In a
micro-finance project these tools include money primaril y, and may also be accompanied
with a savings program, and financial help. Along with poverty reduction, a micro-finance
initiative can aim to avoid a general sense of mistrust between the citizens and their
national banks. The money in this case, is not coming from a bank, but rather within the
communit y which allows those participating to foster social capital and communit y
cohesion. Lastl y, a microfinance initiative can promote larger povert y reduction
movements by increasing the financial knowledge of the average citizen.

Microfinance Page 48
However, these initiatives are not without limitations. These limitations focus on the same
issues as stated before, but the negative consequences that may occur. For example, while
there may be mistrust in the national banking system, there can be microfinance
initiatives where the outside creator takes advantage of those parti cipating. The mone y
may not end up in the right places, resulting in distrust to all who have interest in
monetary programs, and could potentially ruin the chance of any further microfinance
projects becoming successful. Secondl y, when creating a microfina nce project, time may
be an issue. What happens when the program is finished and the people who were
participating are still in povert y? In this case, it may be more beneficial for there to be an
on-going program. To see what would be an appropriate choice in regards of time, the
communit y must be assessed before the project is put in place. Lastly, in regards to
limitations, someone is always going to be left out. Not everyone can be a part of the
program, and therefore one must decide who is going to part icipate. Often, for a
communit y development project to be sustainable, all must be affected positivel y.

There are two ways in which the needs of the poor are not being met by micro finance.
Firstl y, the poor need to store savings for the long run; such as for their retirement,
widowhood or their heirs but the examples such as saving up, down and through do not
directl y meet these needs. Secondl y, the poor ’s abilit y to save fluctuates with time and s o
they may not be able to save the fixed rate of saving. T hese two shortcomings are difficult
for the poor and they often get excluded or exclude themselves (Rutherford, 2009). Poor
people have to take a risk to turn their savings in to large lump sum of money because
there is no perfect system that would protect their deposits. For example, there is a lack
of trust among the members and the organizer; most communit y micro finance projects
onl y include famil y and close friends and do not reach beyond that. Also, there is no or
very little growth in the amount of m oney that they save if saving up but if saving down,
there is an interest rate that the members have to pay.

Also, there are complications associated with implementing micro -finance projects in
Canada. For an example, inflation rates make it difficult to anal yze interest rates across
countries, so ASCA’s in high inflation would have to charge more interest on their loans
which may result in their funds to decline in value themselves (Rutherford, 2009). In
many countries, ASCA’s have become permanent instit utions referred to as Credit Unions,
Savings and Credit Co -operatives. Rutherford argues that credit unions are not owned by
the poor because they require specialized skills and higher educated personals to regulate

Microfinance Page 49
the operation of these institutions them selves (Rutherford, 2009). Although thes e
institutions aim to benefit the poor, they are very different from neighborhood ASCA’s
and issues arise when they purse collateral or securities for loans given. Similarly, there
are language barriers between forma l federal banks and credit unions that causes
complications (McMillian,2010).

The major benefit of microfinance projects is that it allows low income families to save
their money; most of the poor live day to day with the little money that they earn and
cannot afford to save. Poor people need such alternatives in order to turn their savings in
to large lump sums or receive large sums and pay monthl y with low interest rates. Banks
and other money lending institutions have high interest rates and simpl y won’ t extend
loans to poor people with little or no assets or employment. Microfinance helps the poor
people get access or save funds over a period of time with low interest rates. Also, the
poor could solve their own issues by working together as a communit y and this creates
trust and social capital in their communities. It also leads to stabilit y and growth in their
households, as well as their communities.

 CONCLUSION

By the extensive spread of microfinance, there is a growing concern about the sustainable
development of microfinance institutions. Empirical researches provide convincing
evidences for this issue. This thesis has given theoretical arguments based on infor mation
as ymmetry that may constraint MFIs to target poor section.

We construct a qualit y three -sided model consisting of the borrower, the MFI, and the
informal money lender. The result of the model demonstrate how MFI reduces informal
money lending and how a MFI can design the optimal contract for attracting more clients.
To realize this, the MFI can improve its profit, and then it can achieve sustainable
development.

It is believed that the entry of MFIs would adversel y impact informal sector lenders. It is
puzzling that even with enormous growth of MFIs over the last few decades; we still see
coexistence of these two forms of lending. The simple theoretical model explores the role
Microfinance Page 50
of informational constraint on the optimal contract offered by MFIs. Am ong other
findings, we see that MFIs objective to screen good projects from the bad projects may
put additional constraint in removing informal sector lending or in increasing borrowers‘
payoff. So it follows that the MFIs can ensure their profits by keepi ng away risk. The MFI
could provide financial service without subsidy if it keeps its profit.

Finall y, the MFI can develop a sustainable way. Sustainable microfinance expands the
service scope, scale and depth, through the realization of financial sustai nabilit y and
improves efficiency of alleviating poverty.

Microfinance Page 51
  QUESTIONNARIE

1. How many years you are dealing in finance?

 Most of the people says its for many years.

Column1

1 2
5% 11%

10
56% 5
28%

2. Are u interested in microfinance?

 Yes, mostly people answered that as it is useful for them in growing themselves and
place them into the market.

20
18
16
14
12
10
yes
8
6 no
4
2
0 no
anamika yes
babita
chetna
danish

Microfinance Page 52
 3. Does it works good as compared to banks?
 Yes because banks has many rules n regulations which an individual cannot cope up
easily.

4. Is microfinance working as per our needs?

 Yes as per rating it is needed by each person for fulfilling their demand.
20
18
16
14
12
10
yes
8
6 no

4
2
0
anamika
babita
chetna
danish

5. Which strategies are used for microfinance?

 Paying the loans in installments as per our convenience.

6. What do you think about growth of microfinance companies?

 Yes it is growing very faster and it should be more faster for good future.
25

20

15
yes
no
10

0
anamika babita chetna danish

Microfinance Page 53
 7. Do you think interest rate charged are in proper ways?
 Yes interest rates are charged in proper manner in microfinance.

25

20

15
no
yes
10

0
anamika babita chetna danish

8. Is microfinance helpful for economic growth?

 As per the survey report the microfinance is helpful for individual and economic
growth.

yes

mumbai pune delhi nashik

Microfinance Page 54
 9. Which risk is concerned in the microfinance?
 Loan repayment and issue of communication.

10.Is it trust worthy or not?

 Yes of course it is trust worthy as per the public opinion.

100.00%

80.00%

60.00%

40.00%

20.00%

0.00% yes

mumbai
pune no
delhi
nashik

no yes

Microfinance Page 55
  BIBILIOGRAPHY
1. Internet
2. Text book of Vipul`s Prakashan (FSM & IBF)

 WEBLIOGRAPHY

1. http://www.microcreditsummit.org/papers.

Microfinance Page 56