21.11.

2011

Debashree Nanda Sec- A Reg. No- 1226111111

MICROFINANCE IN INDIA

Introduction:Grameen replicators in India, using a for-profit Non-Banking Finance Company legal form, have grown rapidly in terms of client numbers. Loan sizes are relatively small compared to per capita income, while portfolio quality was until recently very high. There is evidence in field of multiple borrowing, with clients borrowing simultaneously from multiple sources including micro-finance institutions. We build a model of the microfinance sector that explains why such multiple borrowings result optimally in small loan sizes and high portfolio quality. MFIs in India:Indian microfinance covers several million borrowing clients,ii and is amongst the fastest growing globally. Five Indian MFIs were ranked in the top twenty fastest growing MFIs in 2005 (Microfinance Information Exchange Report, 2006). The growth in the number of clients outstrips growth in the aggregate loan portfolio. In 2006-07 for instance, some of the leading MFIs witnessed an 80 per cent per annum growth in terms of numbers of borrowers against a growth in terms of aggregate portfolio size of 40%.Microfinance institutions, in India, were typically structured as not-for-profits till a few years back; but there is an increasing tendency to use the for-profit Non-Banking Finance Company (NBFC) model, with the Grameen model dominating (Grameen MFIs have 50% of the total Indian MFI clients). The NBFC model has the advantage that it can attract both equity funding from venture capitalists and loans from commercial banks; facilitating rapid growth. The loan size of a typical MFI is small. While the average loan disbursed was Rs 6,391, the average outstanding balance was Rs 2,600. Indian microfinance clients have miniscule loans compared to the international average. The average loan size is 15% of local per capita income (the average in Asia is 21%). Transactions costs, while high by standard banking norms, are amongst the lowest in global microfinance and have declined steeply in the recent past: the cost per borrower was Rs 425 in 2007 compared to Rs 621 in 2003. A major driver of low transaction cost has been the high staff productivity at 273 borrowers per staff member in 2007 (compared to 146 in the year 2003). This has often been achieved by standardizing processes and reducing touch time with clients. In relative terms, for the typical Grameen MFI, the ratio of operating expenditure to the gross loan portfolio has reduced from 33.4% in 2003 to 21.1% in 2005 and to 16.4% in 2007v. While this reduction partly reflects economies of scale, it also reflects tokenism in group processes. There is evidence of entrant MFIs opening branches in areas where there are existing MFIs, to
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take advantage of the awareness and exposure to the group lending methodology among clients. This also lowers the costs of group formation and training for the entrant MFIs. The portfolio quality across all microfinance is variable. But large Grameen replicators have reported dramatically low Portfolio-at-Risk percentages. Grameen replicators had an average PARof 0.9% in 2005. The overall microfinance Top 10 average PAR was 2.2% to 4.6%. The need to show very high repayment rates reflects the growing commercialization of this sector, where Indian MFIs again lead the pack, having a commercial funding ratio of about 75% (Microfinance Information Exchange Report, 2006).( 12, July 2010 , NABRD) Micro-finance Development and Equity Fund (MFDEF):Microfinance has made tremendous strides in India. It has become a household name, in view of the variety of benefits reaped by the poor from microfinance services. Self-Help Groups (SHGs) have become the common vehicle of development process, converging all development programmes. SHGBank Linkage Programme launched by NABARD way back in 1992 synthesising formal financial system and informal sector, has become a movement throughout the country. It is considered as the largest microfinance programme in terms of outreach in the world and many other countries are keen to replicate this model. At present, a large number of Self-Help Promoting Institutions (SHPIs), all the banking agencies and Microfinance Institutions (MFIs) are pursuing this programme for upliftment of the poor. The RBI also recognised this as part of priority sector lending and normal banking business. It has removed the interest rate cap for the final beneficiaries under the mF investment. The programme is also the main contributor towards financial inclusion in the country. As on 31 March 2009, there were more than 61.21 lakh savings-linked SHGs and more than 42.24 lakh credit-linked SHGs and, thus, about 8.6 crore poor households have been covered under the programme. The share of SHG loan to Ground Level Credit (GLC) increased from 3.8 per cent in 2007-08 to 4.07 per cent in 2008-09. The Micro-finance Development and Equity Fund (MFDEF) is being utilised for promotion of various microfinance activities such as formation and linkage of SHGs through SHPIs, training and capacity building of stake holders, capital and soft loan assistance to MFIs, livelihood propagation, studies, documentation, etc. During 2009-10, an amount of Rs.80.91 crore was released, of which Rs.20.49 crore was grant support for promotional activities and Rs.60.42 crore was for Capital Support/Revolving Fund Assistance (RFA) to MFIs, as against Rs.18.73 crore and Rs.15.93 crore in the previous year, respectively.( 12, July 2010 , NABRD) Women Empowerment:Microfinance programmes like the Self-Help Bank Linkage Programme (SHG) in India have been increasingly hailed for their positive economic impact and the empowerment women. This is based on the view that women are more likely to be credit constrained, have restricted access to wage labour market and have limited decision-making and bargaining power within the household. A majority of microfinance programmes target women with the explicit goal of empowering them. There are varying underlying motivations for pursuing women empowerment. Some argue that women are amongst the poorest and the most vulnerable of the underprivileged and thus helping them should be a priority.

Whereas, other believe that investing in womens capabilities empowers them to make choices which is a valuable goal in itself but it also contributes to greater economic growth and development. It has been well-documented that an increase in womens resources results in the well-being of the family, especially children (Mayoux, 1997; Kabeer, 2001; Hulme and Mosley, 1997). A more feminist point of view stresses that an increased access to financial services represent an opening/opportunity for greater empowerment. Such organisations explicitly perceive microfinance as a tool in the fight for the womens rights and independence. Finally, keeping up with the objective of financial viability, an increasing number of microfinance institutions prefer women members as they believe that they are better and more reliable borrowers.( Uppsala University Ranjula Bali Swain) Social responsibility:Microfinanace has become synonymous with inclusive growth and womens empowerment , which invariably has built in social responsibilities and obligations that any microfinancing arrangement has to necessarily adhere to. Therefore, it cannot and should not be looked upon as purely a financial arrangement, where an agency , lends money only to earn interest. There are a lot of hidden social social responsibilities attached to the concept of microfinanace and to the agencies that deal with this activity. These social responsibilities are: a. Women empowerment. b. Sustain minimum economic activity c. Levy affordable interest on the microfinance d. Facilitate inclusive growth e. Provide marketing support f. Remove red- tape and procedural bottlenecks g. Ensure adequate supervision and control For example , one such successful model that was implemented in Karnataka way back in 2003 by establishing an All Womens Mahila Bank the first of its kind in Karnataka. It was started with an initial share capital of about Rs. 6 lakhs has today about 13, 500 women members covering about 1000 SHGs and has grown to size of about Rs.3.00 cr. In its business activities. Some of the salient features of Mahila Bank includes with initial membership of 5404 women members, each contributing Rs. 115\- towards the initial share capital amount, this cooperative society to be managed exclusively by women members by electing a 11 women member executive body, DCC and NABARD provide necessary professional guidelines, it uses RDPR programs designed for SHGs , a mobile marketing van which would go to the respective villages to supply raw materials and also pick up the finished products and deliver it to marketing outlets , mainly at the taluk level.( September 10th 2011,Souvenier , GSIB) Legal regulations:Microfinance is offered by both the banking sector and also by organisations that operate outside the sector, the latter being more common. These associations have the capacity and willingness to be able to cover the higher transaction costs , MFI needs to change higher
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Ours is the largest emerging market for microfinance services with population of 1000million. It has nearly 400 million people below or just above an austerely defined poverty line. Thus approximately 75million households need microfinance. In our country, even though RBI Act , Banking Regulation Act and Companies Act etc., are somewhat regulating MFIs , there is yet to direct legislative framework to control them at central level. Some of the states like Andra Pradesh recently passed a legislation in 2010 to regulate the MFIs to meet the crisis of poor women. In spite of support from NABARD , most of the MFIs in our country have not reached anywhere near the scale of well known Bangladeshi MFIs because this sector in India is featured by a wide diversity of methodologies and legal forms. The concept of Local Area Bank with a lower start up equity of Rs. 50 million has not brought into operation by RBI. The Regional Rural Banks Act does not permit any private shareholding in any RRBs and the Cooperatives Act of all states does not permit district level cooperative banks to be set up except by the State Government. This result in rural credit has been a monopoly of state own institutions. Presently there are no regulatory mechanism in place of MFIs except for those that are registered as NBFCS. A vast majority of MFIs in India are non-profit NGOs which are legally not owned by anyone. There are some good examples of number of member controlled MFIs such as SEWA Bank , WTCS in Andra Pradesh and many more. .( September 10th 2011,Souvenier , GSIB) Crisis:The microfinance industry in India is in the midst of the most severe crisis in its 25 year history. The genesis of the crisis lies with the actions taken by the government of the southern state of Andhra Pradesh in October 2010, when it passed legislation effectively shutting down all private sector microfinance institutions (MFIs) operating in the state. In the first half of FY2011, MFIs in Andhra Pradesh disbursed Rs 5,000 crore ($1.13 billion) to borrowers; in the second half of FY2011, these same MFIs could only disburse Rs 8.5 crore ($1.9 million)i. The Andhra Pradesh Government's stated aim was to protect the poor and yet its actions have resulted in a 600fold decrease in financing to the very poorest of Indias citizens. This should make everyone pause. The rural poor depend on access to consistent and dependable finance to help smooth patchy income streams and avert financial crises. The AP governments actions have effectively shut off finance to these most vulnerable of Indias citizens. Indeed, the very premise of the Andhra Pradesh Microfinance Institutions (Regulation of Money Lending) Act, 2010 (the AP Act) was fundamentally flawed. Quite apart from protecting the poor, the AP Act does just the opposite and risks creating a near term financial and human crisis amongst the rural poor in Andhra Pradesh, while also potentially jeopardizing the Indian governments broader financial inclusion agenda. The direct effect of the enactment of the AP Act has been to deny millions of Indias poorest citizens access to basic financial services. The impact of the AP Act has the potential to affect 450 million people. Since the AP Act was adopted, MFI disbursements in AP alone have diminished from Rs 5,000 crore ($1.13 billion) to a mere Rs 8.5 crore ($1.9 million), creating a severe shortage of much needed finance to the rural poor, Indias most vulnerable citizens.
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 The rationale for the AP Act is not to protect the poor, but to protect the uncompetitive government-backed Self- Help Group (SHG) program run by the Society for the Elimination of Rural Poverty (SERP). The AP governments claims that private sector MFIs are exploiting Indias poor by charging usurious interest rates and practicing coercive recovery techniques cannot be substantiated and, based on numbers from SERP, it appears that the suicide rates amongst MFI borrowers are dramatically lower than the statistical average in the entire state of Andhra Pradesh. Private sector MFIs have demonstrated to be the most scalable and sustainable way of helping the Indian government meet its stated policy of encouraging financial inclusion for the 450 million people in India who are currently unbanked, i.e., with no access to basic finance. If the World Bank provides the much discussed $1 billion in funding to the governmentbacked SHG program in AP, it will be complicit in snuffing out the private sector from Indian microfinance. The Reserve Bank of India (RBI) and central government must take immediate and decisive action to supersede, suspend or repeal the AP Act and introduce sensible legislation on a federal level which allows the private sector to grow and flourish. The Malegam Committees recommendations and their broad acceptance by the RBI give rise to a number of concerns, and the constraints proposed around loan limits, interest rates, provisioning norms and capital requirements must be revisited to avoid unintended and deleterious consequences that could permanently impact private sector MFIs. MFIs represent the only viable way for lenders to recover their loans to MFIs, given their relationship with the end customers. MFIs must be given the time to undo the damage inflicted by the AP Act and to recover the loans from borrowers. The social and economic consequences of the AP Act are stark and disquieting. Millions of poor people across India are presently denied their fundamental right to make their own financing choices and are without access to basic financial services, thousands of people employed in the microfinance sector have lost their jobs, countless MFIs are on the brink of financial ruin and the long-term fate of some of the largest MFIs in India is hanging in the balance. Private sector MFIs have an essential role to play if the goal of financial inclusion is to become a reality for the millions of Indias unbanked, and the RBI and central government must take immediate action to supersede, suspend or repeal the AP Act and introduce sensible legislation on a federal level which allows the private sector to grow and flourish. The Malegam Committee has proposed a number of welcome recommendations and indeed affirms the value that MFIs bring to the microfinance sector in rural India. These recommendations have now been broadly accepted by the RBI, subject

to certain adjustments. However, the constraints proposed around loan limits and interest rates, as adjusted by the RBI, together with those around provisioning norms and capital requirements must be revisited to avoid unintended and deleterious consequences that could permanently impact private sector MFIs. The one thing that the RBI and central government would benefit from at this stage is being afforded the time to further develop, modify and refine the Malegam Committee recommendations in collaboration with stakeholders to ensure that the new regulatory framework introduced allows the sector to continue in its quest to meet the burgeoning social and economic needs of a rapidly growing India.( May 2011, Legatum Ventures) Goes public:on 28 July 2010 SKS (www.sksindia.com), Indias largest microfinance institution (MFI) with 5.8 million clients, became the first MFI in India to float its shares through an initial public offering (IPO).1 The IPO was successful by any financial market standard: the offering was 13 times oversubscribed and attracted leading investment groups, such as Morgan Stanley, JP Morgan, and George Soros Quantum Fund. The company valuation reached the top of the offer band price at US$1.5 billion,2 and five weeks after trading began, the share price rose 42 percent. Conclusion:The strength and sustainability of the Indian microfinance business model lies in the fact that it is serving a large unmet need for financial inclusion. It has thus far successfully tackled challenges that have faced other financial service providers in meeting the demands of this sector through creative product innovation with awareness of the segments particular needs and capacities and use of the joint liability group mechanism to manage risk. The model has been successful in maintaining excellent portfolio quality even with extremely rapid expansion over the last few years. The large size of the currently unbanked population in India and diversity of geography means that the microfinance sector has great pote will be increasing attention focused toward client and geographical diversification for continued high growth. Moreover, as the sector approaches maturity, there and product innovation, financial and non-financial. Besides expanding their own services, MFIs are also being viewed as potential channels for delivery of other products and services to low income and rural populations. Since the scale of the Indian MFI industry has exceeded 20 million clients, other consumer product and service providers are beginning to attach greater value to the microfinance distribution network. Given this growth and maturity dynamic, the Indian microfinance sector is increasingly seen as a viable investment target with commercial investors joining the social investors who have been nurturing the industry thus far. Equity valuations in the Indian microfinance sector are higher than the financial sector in general and global MFIs in particular due to the high growth expectations and substantial availability of debt to fuel its rapid expansion. MFI shares are expected to trade at significant premium to book over the short and medium term as MFIs realign their business models to capitalize on unsatisfied demand, and cool down over the longer term as the industry matures and begins to consolidate. As more investors enter the market, exit opportunities are also increasing in the form of secondary and trade sales. Larger MFIs may also consider IPOs, although that may not be a realistic exit option for most MFIs in the short to medium term. Another likely exit scenario is M&A, as larger MFIs seek to acquire players with product or geographical niches. The industry is in its initial stage and its development could take many forms, but we expect growth,
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innovation and financial performance to continue on an encouraging path.

References:1. 12, July 2010 , NABRD , Letter of transmittal (pdf) 2. M .S Sriram and Rajesh Upadhyula , The transformation of micro-finance on India : Experiences , options, and future (pdf)

3. Sept 2011 , The World Bank Development Research Group , Jordi la Torre , Xavier Gini , Tara Vishwanath Policy research working paper after the micro finance crisis assessing the role of government led micro credit alternatives (pdf) 4. Dept . of Economics , Uppsala University Ranjula Bali Swain Can micro finance empower women? self help groups in India.(pdf) 5. June 2009, Rajalaxmi Kamath and R. Srinivasan Micro finance in India Small , ostensibly , and safe (pdf) 6. 2009-2011 ,RUME , Thanuja Mummidi , Women and income generating activities : Undertaking motivations by prioritising skill , knowledge , and capabilities. (pdf) 7. Malegam panel eyes 24% rate ceiling for MFI , http://indiatoday.intoday.in/story/malegam- panel-eyes-24percent-rate-ceiling-formfis/1/127247.html 8. May 2011, Legatum Ventures , Microfinance in India: A crisis at the bottom of the pyramid.(pdf)