A Primer to Microfinance

―Dhobis (washermen), tailors and barbers contribute more to the GDP of

Andhra Pradesh than the IT sector.‖

(Vikram Akula, SKS; Source CSO, 2004-05)

Indian Profile

Estimated that 32.7% people live

Below Poverty Line in India

Annual credit demand by the poor

in the country is estimated to be

about $ 15 Bn.

India: Market size estimated at $16-

22 bn

India: >33 mn HHs

India: >3000 MFIs

Only 1% of providers WW fully

financially self-sustaining

Only about 5 % of rural poor have

access to microfinance.

The active borrowers are estimated

to have a per capita outstanding of

only Rs. 2500.

While 10 % lending to weaker

sections is required for commercial

banks, they neither have the

network for lending and

supervision on a large scale nor the

confidence to offer term loans to

big MFIs.

The non poor comprise of 29 %

of the outreach.

At the Roots

The poor use finance for Growth and Survival

Growth (60%)

• Enterprise (30%)

• Buildup assets: education, home (30%)

Sustenance (40%)

• Fulfill basic consumption

• Protect against shocks

• Access lump sums for lifecycle needs

(Survey of Low Income & LMI urban and rural HouseHolds)

Financing Needs of the Poor

Financial Plans of Poor Households

Cost of burials, health care, replacement costs after natural disasters – Insurance Plans

Retirements, Migrations, Agri / Farm Equipment, housing upgrades – Pension Plans /

Long Term Deposits

Irrigation, transportation, livestock, microenterprises, education – medium term

deposits

Food security, health, festivals, social obligations, emergencies – short term deposits

Sending money home, microenterprise, working capital – fund transfers and cheques

Urgent family disasters like sickness / crop failure, payoffs – emergency loans

Microenterprise, working capital, livestock, equipment and machinery – short term

loans

Housing, wells, irrigation systems, heavier machinery – longer term loans

Managing Savings

Put aside as much money as

possible till you save a large

enough sum.

Take a large sum as an

advance and repay it

through a series of savings.

At the Roots..

They Need

Simple process

Door Step Banking

Flexible Timings

Timely Availability

Minimum Documentation

There have

No ‗acceptable‘ collateral/ surety

No unique ID

No record of previous

borrowings/ repayments

Irregular income flows

Low literacy

… but the poor face very high prices for finance.

At the Roots…

So the poor turn to a variety of old and new

providers to fill the gap…

Survey of 64 LI & LMI urban and rural HHs

18% 37% 26% 4% 16%

Formal Semi – Formal Informal 1-on-1 personal

Informal 1-on-1 impersonal

Informal mutual (Chit funds )

Banks, Insurance cos

Microfinance Institutions

Employers, relatives, neighbors. friends

Moneylenders, pvt financiers

Microfinance targets urban and rural low-income (<$2000

annual HH income) clients

Uses joint-liability social contracts

Provides affordable finance

Societal Exclusion in India

It has meant historically

that several communities

are unable to participate

effectively in the process of

development, economically,

socially and politically.

Overcoming Exclusion

• Community Mobilization

The role of the State?

Partnerships needed between State

and Civil society institutions?

• Capacity Building

Integrate rights and development

interventions

• Networking, Justice Delivery

Mechanisms and Advocacy

voice in decision making

Government Partnership

• Convergence

Across traditional divides

(rights/development, urban/rural,

national/local, genders)

Current Status

Limited access to Capacity Building support which is an important variable in

terms of quality of the portfolio, MIS, and the sustainability of operations.

About 56 % of the poor still borrow from informal sources.

70 % of the rural poor do not have a deposit account

87 % have no access to credit from formal sources.

Less than 15 % of the households have any kind of insurance.

Negligible numbers have access to health insurance and crop insurance 1 %.

Introduction to mF

Supply of Formal Financial Services in

India

An estimated demand for credit

ranging from $3-$9 Bn Annually

Formal Sector capability - $200-300

Mn.

More than 6 Lac Villages

About 30 K Bank Branches

Multiple Investment options for the

Poor.

Basic Financial Services still beyond

reach.

Access to Financial Services is the

major constraint for the poor.

The Poor may use a variety of

Financial Services if they manage

to save.

Micro Credit is not the only

requirement of the poor – they

need more services.

Microfinance: what is it?

What it often is

Micro-credit

Group lending

Social/charitable activity

What it really should be

Range of financial services

Group and individual lending

Profitable activity

Microfinance in India

About 60 % of the MFIs are

registered as societies.

About 20 % are Trusts

About 65 % of the MFIs follow

the operating model of SHGs.

Large concentration in South India

600 MFI initiatives have a

cumulative outreach of 1.25 crore

poor hoseholds

NABARD‘s bank linkage program

has cumulatively reached a total of

9.4 lakh SHGs with about 1.4 crore

households.

Annual growth rate of about 20 %

during the next five years.

75 % of the total poor households

of 80 million (i.e. about 60 million

will be reached in the next five

years.

The loan outstanding will

consequently grow from the

present level of about 1600 crores

to about 42000 crores.

Microfinance Landscape

Niche Market MFIs

Private Banks (ICICI)

State Owned /

Commercial Banks

ADB

PE Firms

NABARD & SIDBI

Spandan, SHARE Microfin, SKS Microfinance have scaled microfinance reach

Expanding financial services. Multi pronged approach – directly providing

credit facilities to SHGs and wholesale credit facilities to microfinance NGOs

and NBFCs.

SBI, SyndicateBank, Andhra Bank, Indian Bank.

Microfinance Development Strategy to ensure permanent access to institutional

financial services for the poor.

Investing in low profile MFIs.

Perform a regulatory and promotional role.

Microfinancing

Individualistic Cooperation

Directly People’s Participation

Indirectly Institutions Solidarity group

Money Lenders

Others Grameen Group

Common Goal Group

Self Help Groups

Cooperatives

Cluster

Federation

Joint Liability Group

Models of Micro Finance

Self Help Group (SHG)

• Dominant microfinance methodology

in India

• A version of the village banking model

• Savings precede borrowings by

members

Individual Banking (IB)

• Entails provisions of financial services

to individual clients.

• Sometimes organised into joint liability

groups, co-operative or even SHGs

• Creditworthiness and loan security are

a function of co-operative membership

Grameen Model (GM)

• Initially promoted by the Grameen Bank of

Bangladesh

• Grameen MFIs undertake individual lending

but all borrowers are members of a 5 member

joint liability group which in turn gets together

with 6-9 other such groups from the same

village or neighborhood to form a centre.

• Within each centre, peer pressure and the

desire to maintain credit – worthiness in order

to qualify for a larger loan in the next cycle are

key factors which ensure repayment.

Mixed Model (MM)

• MFIs starting with the Grameen Model and then at a

later stage embraced the SHG Model without

completely doing away with the Grameen Model.

Microfinancing Systems

Informal financial service

providers

• Moneylenders, pawnbrokers,

savings collectors, money-

guards, input supply shops etc.

Member-owned

organizations

• self-help groups, credit unions,

and a variety of hybrid

organizations like 'financial

service associations' and

CVECAs

NGOs

• They have proven very

innovative, pioneering banking

techniques like solidarity

lending, village banking and

mobile banking that have

overcome barriers to serving

poor populations.

Formal financial institutions

Delivery Models

Self Help Groups

Home grown, co-operative

Savings Based / Led

Meeting Diverse Needs

Promoted by NABARD, PSU Banks, NGOs

Performance - Mixed

MFI / Grameen Replica

Group lending and regimented

Focused on self – sufficiency

NGO – MFI and NBFC – MFI

Major Concern – Pace of growth

Grameen II

Individual Lending

NBFC – MFI

Progressive Loan focused on enterprise

Futuristic products

Wholesome Microfinance Services

Regulation

Specialized activities

Major Concern – High Cost

Financing Models

Direct Financing Model

Most MFIs use groups as intermediaries for

transactions.

The NGO Promotes, trains and forms SHGs

SHGs are formed either by banks or by NGOs

and formal agencies but are financed by banks.

SHG-Bank Linkage Model

NGO to act as facilitator/financial intermediary

between bank and SHG.

Intermediation cost of around 6% of loan

amount

Cost is borne by the bank and Risk lies with the

banks as advances are reflected in bank portfolios.

Bank Partnership Model

MFIs can also be given long term financing by

Banks

Lack of trained staff still affects this model

MFI Joint Liability

Group Bank

Servicing fees of 11%

Loan at 9%

Interest charged: 20%

FLDG of 10%

Self Help Groups (SHGs)

Group of 10 people, create pool

of resources

Advance loans to each other from

pool (without collateral)

Loans recovered due to peer

pressure and group responsibility

SHG deposits resources with bank

Bank provides advances against

such deposits

Lower transaction cost for banks

due to group dealing

Lower transaction cost for banks

due to group dealing

Greater access to credit

Individuals learn to save

NGOs act as facilitator

Again, recovery is high because of

group responsibility

Issues

• Limited ―products‖ offered

• Scale-up of SHGs requires

government support

• Government involvement prone to

politicize movement; must be

guarded against

• NGO involvement not sustainable

in long run

Basic SHG Functions

Savings and Thrift

• The amount may be small, but

savings have to be a regular and

continuous habit with all the

members.

• ‗Savings first — Credit later‘

• Group members learn how to

handle large amounts of cash

through savings. This is useful

when they use bank loans.

Discussing problems

• Every meeting, the group will

discuss and try to find solutions to

the problems

Internal lending

• The savings to be used as loans for

members.

• The purpose, amount, rate of

interest, etc., to be decided by the

group itself.

• Proper accounts to be kept by the

SHG.

• Opening savings bank account

with bank.

• Enabling SHG members to obtain

loans from banks, and repaying the

same.

Unscalable Bank-SHG Model

Existing Branches

Limited outreach

Concentrated in urban

areas

High cost low ticket

items

Cash intensive

transaction

New Branches

High infrastructure costs

High operating

overheads

Long gestation period

Low technology usage in

rural areas

Characteristic Services

Majority of women

Face exclusion from formal institutions

Poor clients with relatively stable sources of income

Majority borrow for trading, working capital or setting up business.

Activities in rural areas - farming, food processing, petty trade, livestock, vending and

production like pottery or basket weaving.

Activities in urban areas – shops, services, street vendors and new age businesses

(beauty parlor, photography)

RoE RoIC Net Annual Returns ($)

Vegetable Vending 50 57 143

General Store 14 29 144

Sweet Making Shop 145 147 1010

Ice Cream Making 13 29 305

Leasing Mango Trees 184 185 511

Leasing irrigated farm land 160 161 667

Operating a Flour Mill 52 59 409

Tailoring 121 123 307

Roadside Micro-diner 245 246 1528

Goat Rearing 58 65 40

Buffalo Rearing 69 75 246

Production Pottery 235 236 520

Activity

Trade

Agriculture

Services

Livestock

Usual Lending Process Geo Economic

Survey

Based on geo economic information of the district or mandal and the constituent

towns and villages, the MFIs approach favourable villages

Village Appraisal MFI gathers first hand information about the population of the village, their

religion, cast, type of trades, skills, financial states, needs etc.

Village Selection Survey to evaluate potentiality for village operations. Data like total population,

poverty level, accessibility, political stability and safety etc. gathered.

Group Formation Interested people or women form self selected 4-6 member groups to serve as

guarantors for each other.

Training

Borrowers

After meeting basic requirements, compulsory group training is done to educate the

clients on the processes and procedures to build adequate credit discipline.

Scrutiny and

Underwriting

Customer Details, their business, earning capacity etc are closely scrutinized and

judged to access their repaying capacity.

Financial

Transactions

The collection meeting are held on a weekly/monthly basis by appointed Field

Assistants to conduct financial transaction and discuss new applications and issues.

Insurance (Near

Mandatory)

Insurance products are sold to cover death, accident or health of a group member

of the member‘s dependent's.

Business Strategies of MFIs

Geographical Expansion

Incorporation of Global Best Practices

Higher Technology Utilization

Social Services and initiatives

Leveraging Finance

Human Resource Capacity Building

Greater Portfolio of Financial Services

Business Strategies of Banks

Partnership Model Identification, training and promotion of mF clients by MFIs. Bank finances client

on MFIs recommendation. Customer and Portfolio rests in the bank‘s books.

MFI Portfolio

Securitization

Bank buys portfolios from MFIs. MFI continues to service clients and acts as the

collection agent. MFI shares credit risk with banks.

Technology Adoption of a core banking system for managing loan portfolios generated inder

the partnership model

Credit to MFIs /

NGOs

Wholesale linkage model implying extending a bulk loan to the MFIs for lending to

poor women.

Loan Portfolio

Evaluation

Involvement in providing mentoring services to clients including in areas of

governance and credit discipline.

Liaisons with NGOs Operating divisions at the regional and branch levels in close coordination with

local NGOs to generate movement.

High transaction costs, poor outreach and unavailability of quality manpower has obliged banks to adapt

various approaches to fulfill priority sector lending norms.

Growth Drivers

Need for Credit by

the Unpriveledged

Lack of Lending from Banks due to lack of collateral and exploitation from money

lenders has exemplified the potential demand and prospects for the sector.

Increase in the

sources of Finance

Commercial debt and equity, grants and donations, PE, VC Funding. The capital

structure of the industry is changing for the better.

Innovation Diversification of Lender base, consolidating internal controls, strengthening

policies on compliance and disclosures.

Government Policy

and Support

Microfinance Bill, NABARD, SIDBI and RBI have recognized the sector as the

need of the hour.

Industry

Consolidation

Increase in number of partners enabling a diversification of the existing product

portfolio.

Migration and

Urbanization

Use of smart cards, wireless connectivity along with higher loan size increasing

penetration of urban micro-financing.

Human Resources The sector is slowly attracting specialized talent for growth.

LEGAL EVOLUTION

Legal Evolution

Legal framework for establishing the co-operative movement set up in 1904.

Reserve Bank of India Act, 1934 provided for the establishment of the Agricultural Credit Department.

Nationalisation of banks in 1969

Regional Rural Banks created in 1975.

NABARD established as an apex agency for rural finance in 1982.

Passing of Mutually Aided Co-op. Act in AP in 1995.

Microfinance Bill 2012

Legal Structures

SHGs and federations

Societies and Trusts

Co-operative societies

Co-operative Banks

Regional Rural Banks

Local Area Banks

Public and private sector banks

Companies incorporated under

Section 25 of the Companies Act

Companies registered with the RBI

as NBFCs

Eligible organizations under

BC/BF guidelines of RBI

SHGs and Federations

An SHG is an unregistered entity of between10-20 individuals,

having its own rules and regulations, office bearers and books of

accounts.

SHGs are recognised by the RBI and government for specific

purposes.

SHGs use savings of their members as well as funds from banks

and MFIs for providing credit to their members.

SHGs network in clusters and form in to Federations which are

usually registered as Societies or Co-operative Societies

Societies

Societies can be registered under the Societies Registration Act, 1860 or under

respective state acts.

A society can be registered by any seven persons associated for any literary,

scientific or charitable purposes by subscribing their names to a memorandum of

association and filing with the registrar.

Registration does not require any minimum initial capital contribution

Difficulty to determine ownership makes banks uncomfortable in lending large

sums

Cannot raise equity so scalability is an issue

Cannot accept public deposit

Exempt from Income Tax if registered under Section 12A of the Income Tax Act.

Need registration under FCRA to be able to accept foreign grants

Trusts

Public Trusts can be established under the respective state regulations. Private

trusts can be established under Indian Trusts Act 1882.

Difficult to attract commercial equity and loans

There is no minimum capital requirements

Cannot accept public deposits

Exempt from Income Tax if registered under Section 12A of the Income Tax

Act.

Need registration under FCRA to be able to accept foreign grants

Co-operative Societies

Cooperative Societies can be registered under

• Co-operative Societies Act, 1912, or

• Relevant state Co-operative Societies acts, or

• The Mutual Benefit Cooperatives Act

• Relevant state Mutually Aided Co-operative Societies Act, or

• Multi-state Co-operative Societies Act

• any other law relating to cooperatives in force in India.

Primarily regulated by registrar of co-operative societies

Can access equity as well as deposits from their members and can lend to their

members

Membership generally restricted to individuals, other co-operatives and government

(including government corporations)

Mobilization of equity is restricted as co-operative societies can raise equity only from

their members. The principle of ‗one person one vote‘ acts as disincentive to equity

mobilization from the members

Banks are reluctant to lend to co-operative societies because of non-equity based

ownership and their tendency to get political

Co-operative Banks

Could be

• Primary co-operative bank (urban co-operative banks)

• State co-operative bank

• Central co-operative bank

Registered under central/state/multi-state co-operative acts. Regulated by Registrar of

Co-operatives for registration, management and audit

Regulated under the Banking Regulation Act, 1949 by the Reserve Bank of India for

licensing, area of operations and interest rates

Can undertake most of the banking activities

Difficulty in raising equity and tendency to get political.

Respective state governments have close control over central co-operative banks and

state cooperative banks. Many of these are not well-managed.

Series of irregularities have been noted by RBI in many primary co-operative banks

and it has taken action against several existing banks.

RBI is reluctant to give new licenses owing to failure of a large number of co-

operative banks in different parts of the country

Regional Rural Banks (RRBs)

Established by the Central Government through a notification in the official

gazette

Minimum capital requirement is Rs2.5 million

The share capital of the RRBs is required to be held by the Central

Government, State Government and Sponsor Bank in the ratio 50:15:35

From the financial year 2006-07 RRBs have been brought under Income Tax

net

RBI has also stipulated that RRBs need to maintain disclose CAR starting

March 2008.

Local Area Banks (LABs)

RBI allowed the establishment of Local Area Bank in 1996

LABs are registered as public limited companies under the Indian Companies

Act 1956

Minimum capital requirement for a LAB is Rs50 million

Are allowed to operate in three geographically contiguous districts

Can mobilise deposits from public

Prudential norms related to banks are applicable but rules relating to liquidity

and interest rates applicable to RRBs are applicable

At present only four LABs are functioning and no new licenses are being

issued

Resumption of licensing of LABs with stricter capital requirements being

considered

Private banks

Private banks have to obtain license from RBI under the Banking

Regulation Act -1949

A minimum capitalization of Rs3bn (Rs300 crores) is required

for private sector banks, including wholly owned subsidiaries of

foreign banks

Can do normal banking activities

Section-25 Companies

Section 25 Companies are promoted for the purpose of promotion of commerce,

arts, religion, charity or any other useful purpose

They are prohibited from payment of dividends

RBI has exempted NBFCs licensed under section-25 of the Indian Companies

Act from registration, maintenance of liquid assets and transfer of profit to

Reserve Funds, provided

They are engaged in micro-financing activities (Rs50,000 for small businesses and

Rs125,000 for housing)

they do not mobilize public deposits

Section-25 NBFCs find it difficult to mobilize equity owing to restrictions on

payment of dividends

Can mobilise foreign grants if registered under FCRA

Exempt from Income Tax if registered under Section 12A of the Income Tax Act.

Non-Banking Financial

Companies (NBFCs) Companies registered under Indian Companies Act 1956 can apply to RBI to carry on the

business of an NBFC

NBFCs are required to have net owned funds of Rs20 millions

Ownership can be defined precisely and they can raise equity

Mobilisation of public deposits, though allowed, is almost impossible given strict guidelines

of the RBI

Banks are comfortable lending to NBFCs which are well-capitalised and well-performing

NBFCs are for-profit entities and are taxable

• FDI through automatic route is allowed subject the following limits

• FDI up to 51% - US$0.5 mn to be brought upfront

• FDI between 51% and 75% - US$5mn to be brought upfront

• FDI between 75% and 100%- US$50mn out of which 7.5 million to be brought up-front

NBFCs are subject to prudential regulations regarding income recognition, asset classification

and provisioning, prudential exposure limits and accounting/disclosure requirements

provided

• they are mobilizing public deposits, or

• they are systemically important

Systemically Important

NBFCs All non-deposit taking NBFCs having asset size of Rs1bn

(Rs100 crores) or more as per last audited balance sheet will be

considered as systemically important NBFCs.

Non-deposit taking and systemically important NBFCs will be

subject to capital adequacy regulations, single/group exposure

norms and disclosure pertaining to derivative transactions

Capital Adequacy Ratio (CAR) requirement is higher for

systemically important NBFCs

Organizations under BC/BF

guidelines of RBI Business Facilitators

Business facilitators can be used by the

banks for various pre-disbursement

and post-disbursement activities

pertaining to lending.

Does not include disbursement and

collection activities

No approval is required from the RBI

for using Business Facilitators

NGOs, Farmers‘ Clubs, Co-operative

Societies, Post-offices, IT Enabled

outlets of corporates, Insurance agents,

Well-functioning panchayats, Village

Knowledge Centers, KVIC/KVIB

centers, Agri Clinics

Business Correspondents

BCs can undertake disbursement of

loans as well as collection of principal.

They can also accept deposits on

behalf of the banks.

Banks can compensate BCs but BCs

cannot charge anything from the

consumers

Transactions need to be accounted for

and reflected in bank‘s books by end of

day or next working day

Societies/Trusts, Non-deposit taking

NBFCs, Cooperative Societies, Post

offices, Section 25 Companies

The MicroFinance Bill

empowering the Reserve Bank of India (RBI) to regulate all microfinance

institutions (MFIs).

it would be mandatory for micro finance institutions (MFI) to be registered

with the Reserve Bank and have a minimum net-owned funds of Rs 5 lakh.

The RBI, can increase this further to 10 lakh, the bill adds.

a Micro-Finance Development Council will be set up to advise the

government on formulation of policies, schemes and other measures required

in the interest of orderly growth and development of the sector with a view

to promote financial inclusion.

capping the interest rate charged by MFIs at 26%. A cap is untenable,

irrespective of the fact that it is 2% higher than the ceiling recommended by

the Malegam panel. Price control will only dampen the supply of

microfinance and compel the poor to turn to moneylenders.

Transformation

MFIs registered as societies, trusts and

Section-25 companies want to

transform to a for-profit NBFC as

For profit structure allows them to

raise commercial equity

Banks are more comfortable lending to

the NBFCs

Access to commercial equity and Bank

funds helps them scale-up faster

Issues in Transformation

• MFI promoters find it difficult to mobilise

Rs20mn of minimum capital required for an

NBFCs

• Many MFI promoters have ‗acquired‘ old

NBFCs having lesser minimum capital

required but have to pay significant premium

to the existing owners. There are also legacy

issues.

• Transfer of assets and liabilities Option 1: Assets from the old entity can be purchased

by the new entity

Option 2: All new disbursement to be made by the

new entity and the loan portfolio of the old entity is

allowed to come down gradually

Option 3: New entity gives loans to the clients who

can pre-pay loans in the old entity

Triggers of Transformation

The biggest challenges are

usually the greatest triggers

of transformation – its all a

matter of perception and

necessity

• Size

• Diversity of services

• Financial sustainability

• Focus

• Taxation

Bolivia and Africa:

Transformation of NGOs

• To Banks

• To FFPs

Indonesia: Transformation

of mainstream to

MicroFinance methods

Bangladesh: Transformation

of a project into

• Grameen Bank

• Other NGOs transforming to

Banks

Role of Central Bank and

Regulator

Role of RBI

(Central Bank)

Support financial liberalization and create conditions favorable to the sector

Good Regulation and Supervision

Supporting MicroFinance Pilot Projects

Collection and Publication of Data

Training and Advocacy

Role of NABARD

(Regulator)

Framing policy and guidelines for rural financial institutions

Providing credit facilities to issuing organisations

Preparation of potential-linked credit plans annually for all districts for

identification of credit potential

Monitoring the flow of ground level rural credit.

Division of Responsibilities

NABARD SIDBI

Oversees program linking Banks and SHGs Lends to MFIs through SIDBI Foundation

CHALLENGES AND WAY

FORWARD

Challenges in India

Size

• Growth in geographic area

• Growth in portfolio/client size

• Ability to train trainers.

Diversity of Services

• MFOs wanting to offer Savings

• MFOs wanting to offer Risk Products

• Appropriate loan products for different

segments.

Financial Sustainability

• Internal growth

• Access to funds

• Finding adequate levels of equity for

the new entities to leverage loan funds

• Ability to access loan funds at

reasonably low rates of interest.

Focus

• Other Developmental activities V/s

MicroFinance

• Degree of specialisation needed for

MicroFinance

Others

• Ability to attract and retain professional

and committed human resources.

• Capacity to provide backward linkages or

create support structures for marketing.

Legal

• Appropriate legal structures for the

structured growth of MF operations

• Taxation For-profit mF activity V/s not-

for-profit NGO activities

• Tax status of donor money

Information asymmetry

Don‘t know the type of

Client requesting loan

Interest rate reflects

probability of default

Safer clients always

drop out

Need to increase

Interest rate

Providing credit can

Become impossible

Decision to take a loan Loan usage Repayment

Can not observe what the client is doing with

the loan amount

Bad loan usage Unwillingness to repay

High Costs

Most popular business model in India is SHG or JLG which incurs peculiar

costs like group formation, training , supervision, higher frequency of

installment payments.

Average microfinance loan size is small – transaction cost / loan is higher

Lending large loans would need due diligence and evaluation of client –

increasing cost.

High Operational cost, esp. at loan origination and during monitoring due to

doorstep service and lack of technology.

Intense Monitoring and Repeated Interactions

Increased competition would lead to better service quality, lower loan sizes,

lower interest rates, product diversification and use of technology.

Technology innovation, improved rural infrastructure, borrower education and

urban microfinance would mitigate the high transaction cost.

Credit Risk

Irregular flow of income due to seasonality

High dependence on monsoons

Uncertainty of Market Conditions

Lack of skills leading to un-employability

Lack of tangible proof of Income Assessment

Lack of Information Sharing / Better Technology

Other Risks

Operational Risk

Business Promotion

Literacy and Skill levels of clientele

Diversion of funds to unproductive activities

Regulatory issues

Reasons: Failure of Objectives

Availability of less risky and more rewarding customers (hawkers and traders

in urban areas vs farmers)

Opportunities to become intermediaries of commercial banks (banks lend

under compulsion – foreign banks facilitate securitization of these loans)

Providing short term loans based on cash trading transactions (minimum

defaults)

Resistant loans to farmers (dependence on monsoons, inadequate irrigation

facilities, lack of modernization)

Wrong MFI assessment tools (still assessed based on coverage, profitability

and repayment – should be assessed on success in alleviating poverty and

aiding inclusive growth)

Urban Microfinance

Clientele

High proportion of wage earners among Urban Poor

Average Family size of 5 with an expenditure of $100 (~Rs. 5000)

67% HH live in own houses – 29% rent a house

31% run atleast one business

69% have atleast one outstanding loan

Loans are usually taken from Moneylenders (49%), family members (13%), friends and / or

neighbours (28%) and rarely from a commercial source.

Opportunities

Quicker Scale up – Quicker Breakeven

Higher Loan sizes as compared to Rural Areas

Opportunity for better utilization of technology

Individual lending is more feasible

Greater Economic opportunity – Greater available market landscape

Social Advantage – Alleviation of housing shortages that create slums.

Challenges

No dedicated funds for support – capacity building or technological assistance for sector

growth

No NABARD advantage as it is for rural microfinance

Urban Poor have access to savings but no access to loans

Startup cost and loan sizes are higher in cities – only big MFIs may set up operations

Highly competitive sector due to the presence of major financial players.

The Role of Women

Fewer women leaders in Micro –finance because:

• Separation between micro-finance and development

• Image of microfinance as highly technical, requiring

professionals (read men) from banking sector

• Women relegated to ―softer‖ issues of development – where

funding is scarce

• Paucity of investment by the sector in capacity building of

women leaders

• Lack of trained human resources (especially women staff) for

building cadre of women leaders

The Role of Women

Women leadership is important because:

• Efficiency paradigm - Community leaders help reduce cost - it is better

management!

• Business point of view - women leaders who can take risks, are role

models, show how loans can benefit family – can increase business

• Increases ownership of the program –risk mitigation

AND OF COURSE FOR A MINORITY:

To achieve the dream of women having access to and control of

financial and non- financial resources

A PRACTICAL APPROACH TO

SHG FORMATION

Types of families to visit

Questions to ask:

Does the family have only one earning member?

Does the family bring drinking water from far away place?

Are the members compelled to go far in the open in the absence of toilets?

Are there old illiterate members in the family?

Are there permanently ill members in the family?

Are there children in the family who do not go to school?

Is there a drug addict or a drunkard in the family?

Is their house made of kuccha material – do they live in a slum?

Do they regularly borrow from any moneylender – what do they pay back?

Do they eat less than two meals a day?

Do they belong to scheduled castes or scheduled tribes?

Yes > 3 Questions = Poor Family

Community Meetings

Community leaders and elders of the village

Explain to them your plan to form SHGs

This is the right time to tell everyone that the

meetings are not for ―giving‖ anything, but to

―enable‖ the poor families to come together and

help each other.

Explain the basics of SHGs

SHG Building

Member attrition and addition are common phenomenon – do

not get disheartened.

A group member should take the lead – all external parties

should be facilitators only.

Trainings required:

• Basic Mathematics

• Book Building (Minutes, Loan Register, Weekly register, Member‘s Pass

Books)

• Scheduling Meetings

• Basics of money lending and interest calculation

• Social Aspects – Women Empowerment.

Linking of SHGs to Bank

Opening SB A/c for SHGs

• Resolution from the SHG: The SHG has to pass a resolution in the group

meeting, signed by all members, indicating their decision to open SB A/c

with the bank. This resolution should be filed with the bank.

• Authorisation from the SHG: The SHG should authorise at least three

members, any two of whom, to jointly operate upon their account.

• Copy of the rules and regulations of the SHG: This is not a must but is

highly advisable and should be looked into by facilitators. If the group

has not formulated any such rules or regulations, loans can be sanctioned

without them.

• A savings bank account passbook may be issued to the SHG. This should

be in the name of the SHG and not in the name of any individual/s.

Internal Lending

Saving for a minimum period of 2 to 3 months to build

a common savings fund.

Purpose, terms and conditions for lending to its

members, rate of interest etc., may be decided by the

group through discussions during its meeting. Interest

is usually 2-3% per month.

Simple and clear books of account of savings and

lending should be kept by the SHG.

Assessment of SHGs

SHGs with 12 to 16 "very good‖ factors can get loans immediately.

SHGs with 10 to 12 "very good‖ factors need 3 to 6 months‘ time to improve, before loan is

given.

SHGs with rating of less than 10 ―very good‖ factors will not be considered for loan.

S. No Factors to be checked Very Good Good Unsatisfactory

1 Group Size 15-20 10-15 <10

2 Type of Members only very poor 2-3 not poor many not poor

3 Number of Meetings 4 / month 2 / month <2 / month

4 Timing of Meetings After 1800 hrs between 0700 and 0900 hrs Other timings

5 Meeting Attending >90% 70-90% <70%

6 Member Participation Very High Medium Low

7 Savings Collection 4 / month 3 / month < 3 / month

8 Amount Saved Fixed amounts Varying amounts -

9 Interest on Internal Loans Depending upon purpose 24-36% >36%

10 Utilization of Savings Amount Fully used for loans Partially used for loans Poor Utilization

11 Loan Recoveries >90% 70-90% <70%

12 Maintainence of Books All books maintained Atleast important books maintained Irregular maintainence

13 Accumulated Savings > 5000 3000-5000 <3000

14 Knowledge of SHG Rules Known to all Known to all

15 Education Levels >20% can read or write <20% can read or write

16 Knowledge of Govt. Progs. All are aware Most are aware None are aware

Sanction of Credit Facility

The loan is always sanctioned and

issued in the name of the group.

The amount of loan to the SHG can

be to the tune of 1 to 4 times of its

savings.

Savings

• The group‘s balance in the SB A/c

• Amount held as cash with the

authorised persons

• Amount internally lent amongst the

members

• Amount received as interest on the

loans

• Any other contributions received by

the group like grants, donation, etc.

The bank does not decide the purposes

for which the SHG gives loans to its

members. The purpose can be

emergency needs like illness in the

family, marriage, etc. or buying of

assets for income generation /

acquisition of assets.

The SHG makes the repayment to the

bank.

RBI/NABARD rules stipulate that no

collateral security should be taken from

SHGs by banks.

The bank cannot hold the SB A/c

balance of the SHG as a Security as

this will prevent the SHG from lending

from its internal savings.

Sanction of Credit Facility

The Reserve Bank of India has allowed the

banks freedom to decide on the interest

rates to be charged to the SHGs

The rate of interest to be charged by the

group to its members is left to the group. It

is usually 2-3% per month.

The group members are collectively

responsible for the repayment of loans to

the bank. Under no circumstance, the SHG

should allow any of its members to default

to the bank.

Documents required by banks for

Loans

Inter-se Agreement to be executed by

all the members of the Self Help

Group.(authorising a minimum of 3

members to operate the account)

Application to be submitted by SHG to

bank branch while applying for loan

assistance. (includes details of the

purposes for which the SHG gives

loans to its members)

Articles of Agreement for use by the

bank while financing SHGs (contains

the duly stamped agreement between

the bank and the

SHG wherein both the parties agree to

abide by the terms and condition)

THANK YOU

References

Microfinance Sector – Legal and Regulatory Framework, Trilegal, Asian Development Bank, Discussion Paper,

Microfinance, November 2004

Emerging Scenario for Microfinance Regulation in India, some observations from the field, GTZ, 2004.

Microfinance: Reserve Bank‘s Approach. Speech of Mr YV Reddy in Indian School of Business

RBI Circulars/Press Releases/Notifications

Financial Regulation of Systemically Important NBFCs and Banks‘ Relationship with them – for NBFCs,

RBI/2006-07/204, DNBS.PD/ CC.No. 86/ 03.02.089 /2006-07. 12 December 2006.

Financial Inclusion by Extension of Banking Services - Use of Business Facilitators and Correspondents.

RBI/2005-06/288. DBOD.No.BL.BC. 58/22.01.001/2005-2006.

25 January 2006

Application of Capital Adequacy Norms to RRBs, RBI/2007- 2008/218

RPCD.CO.RRB.No. BC.44 /05.03.095/2007-08.. 28 December 2007.

Guidelines for Setting-up Local Area Banks in the private Sector. Press Release 1996-

97/103. 24 August 1996

FAQ on NBFCs. 5 February 2007.

Amendments to NBFC regulations, Ref.DNBS.(PD).CC.No. 12 /02.01/99-2000, 13 January 2000.