project on loan approval

Contemporary Concerns Study

Financing Small Enterprises by microfinance institutions

Final Report

Submitted by

Divya Ganesan (0411013)

Divya Roongta (0411047)

Signature

_________________________

Financing Small Enterprises by MFIs

Table of Contents

Need for credit for Small Businesses and Enterprises ............................. 3

Problems of Credit Supply ........................................................................ 3

SAFAL Activities ....................................................................................... 5

A Typical Retail Vendor............................................................................ 6

Origination of Janalakshmi....................................................................... 6

Credit Scoring Literature Survey............................................................... 7

Case study I..............................................................................................12

Case study 2..............................................................................................15

Case study 3..............................................................................................16

Product Features ......................................................................................18

Interest Rate Determination ....................................................................21

Loan Appraisal .........................................................................................23

Product Design ........................................................................................24

Supplementary Products ..........................................................................26

Loan Appraisal .........................................................................................30

Credit Scoring Model of Janalakshmi ......................................................32

Recommendations for the Credit Scoring Model of Janalakshmi ...........34

Annexure I (Loan Application Form) ......................................................35

Annexure II (Credit Scoring Model)........................................................39

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Need for credit for Small Businesses and Enterprises

Small businesses and enterprises in India suffer from a great deal of indebtedness1 and are

subject to exploitation in the credit market through high interest rates and lack of convenient

access to credit. They need credit to fund their working capital needs on a day-to-day basis as

well as long term needs like emergencies or other income related activities. They need credit

to smoothen out seasonal fluctuations in cash flow arising from agricultural activities and

consumer demand. They also need credit as an insurance against minor spikes and troughs

with respect to income and expenditure. Since cash flows for the majority of small businesses

like vegetable vendors are small and savings are small as well, they typically tend to rely on

credit for other consumption needs like education, food, housing, household functions etc.

And this is exacerbated by the fact that India has no social security net that will take care of

basic amenities like health, education and so on for the poor. To meet these credit needs they

need access to financial institutions that can provide them with credit at lower rates and at

reasonable terms than the traditional money lender.

Problems of Credit Supply

The main obstacles to the supply of credit arise from the following reasons2.

The Credit markets are imperfect and fragmented: Most localities have internal

political and economic hierarchies that create market segmentation in the demand and

supply of resources, including investment and working capital. For. E.g. The loan

requirements of a farmer i.e. its periodicity and its size will considerably differ from

those of a vegetable vendor. The farmer would require a substantial size, as he would

most probably utilize it for buying seeds or upgrading his machine. A vegetable

vendor on the other hand would need a smaller amount to finance his daily needs i.e.

to buy vegetables.

Supply of formal sector credit is inadequate: The credit is not easily available. Loans

from Banks involve a lot of paper work. There is a collateral requirement, which

becomes a burden to the borrowers. There are complex legal and operational

1Ramachandran V.K and Madhura Swaminathan, Rural Banking and Landless Labour Households: Institutional Reform and Rural Credit Markets in India, Journal of Agrarian Change, Vol. 2, No 4, October 2002, pp. 502-544 2 Ibid

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procedures, which result in delaying the loan disbursal. Hence, credit is not available

on time (takes as much as 2 to 18 months). Borrowers are generally assumed to be

non credit-worthy and their recovery rate unsatisfactory. Hence monitoring them,

getting their credit history for evaluation of loans adds to the transaction costs of the

bank.

Distribution of formal sector credit is unequal with respect to region, class, gender

and caste: There is an enormous concentration of the MFIs (Micro Finance

Institutions) in the south of India. This is primarily because of the general

dissatisfaction in the economy of the central, eastern and north eastern states, with

very little resultant demand for credit among the subsistence poor, and the absence

(for historical reasons) of good quality NGOs, that are willing to initiate Microfinance

programs in these states (there are a large number of small NGOs but all of them with

limited experience and outreach).

Informal credit is the main source at high rates of interest and adverse terms and

conditions implemented by coercion of different means both economic and non-

economic.

This problem of credit has been addressed through formal sector lending institutions, directed

lending and subsidized credit3. To address this inadequacy, Micro Credit has gained

importance over the past few years. This has had very good success in countries like

Bangladesh, Indonesia and other Asian countries and is gaining ground in India as well.

3 Rangarajan, C., 1996 ‘Rural India: The Role of Credit’, Reserve Bank of India Bulletin, May, Bombay: Reserve Bank of India

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Many microfinance institutions have developed large-scale operations by offering a few

highly standardized products. Offering “one-size fits all” loan terms and conditions has the

following advantages:

• Streamlines loan administration

• Simplifies decision-making for field staff

• Reduces information requirements from clients

• Low operational costs

• Simplified repayment obligations

However, this standardization has its own drawbacks. Many MFIs are reporting high dropout

rates and repeat borrowers do not demand the larger loan sizes assumed in many MFI market

projections. Also, there are potential clients who refuse to join programs even though the

products offered were supposedly designed for them.

This has led MFIs to re-evaluate their business plans and pay closer attention to product

flexibility. Individual need-based loans are more suitable as they can be designed to cater to

the specific requirements of the clients.

SAFAL Activities

SAFAL is an organization based out of Bangalore that helps in gleaning produce (mainly

food and vegetables) for the retail vendors as well as the pushcart vendors. It aids the farmers

by giving them competent pricing for their yield by eliminating the middlemen in the supply

chain. It implements this by openly auctioning the farmer’s products and selling them to the

retail vendors. It also helps those retail vendors who have to buy from other vendors and thus

have to include the vendor’s margins while repaying them.

However the retail vendors who buy the produce from SAFAL have several issues with

financing their daily needs. They obtain the funds needed to buy the produce from SAFAL

from the local moneylenders. SAFAL also tried to create affinity groups (on the lines of Self

Help Groups) which brought together people from the same area in order to give them credit.

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However they concluded that, the strategy did not work as people didn’t seem to have the

affinity for each other when money was involved.

A Typical Retail Vendor

A Retail vendor is usually from the outskirts of the city (“around the area where veerappan

resides” is what an ex-official of SAFAL had to say). Due to low rains, arid land and such

similar severe conditions he turns to the city for survival. A few of them are also from other

south Indian cities like Chennai, Hyderabad, etc. Most of them do not even have a pushcart to

start off. Hence they have to source these amenities that they would need everyday from

different lenders. Most of the times the same person lends the money, produce and the push

cart. The vendors pay a huge amount by way of interest. Typically they borrow daily around

Rs.90 and agree to pay back Rs. 100 at the end of the day, which translates, to an exorbitant

4056% per annum! Instead of borrowing everyday the vendor also has the option of

borrowing around Rs. 3000 on a monthly basis depending on the kind of resources the lender

has to wring the money out of the vendor in case he decides to run with the money. In case

the vendor has borrowed the cart he has to pay an extra Rs. 20 daily. This money is taken

from the lenders the previous night before the market opens which is around 5:00 am in the

morning.

Origin of Janalakshmi

These issues of financing for the vendors led to the inception of Janalakshmi, an organization

set up as a body of Sanghamithra urban program with the objective to provide credit to urban

vendors. Apart from giving credit to traders on a periodical basis, Janalakshmi has created a

Credit Scoring Model that will score every trader who needs credit based on certain

parameters that we will look at below. The final score will decide whether the trader should

be given credit or not.

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Credit Scoring Literature Survey

A potential client’s credit risk level is often evaluated by the bank’s internal credit scoring

models4. These aim to determine whether an applicant has the capacity to repay by evaluating

the credit risk of his loan application. This is normally done using historical data and

statistical techniques. Such models offer banks a means for evaluating the risk of their credit

portfolio, in a timely manner. Credit scoring has both financial and non-financial aspects. The

dimensions that are analyzed in credit scoring are categorized under five main headings

namely:

(i) Capacity (ability to repay)

(ii) Character (willingness to repay)

(iii) Capital (wealth of borrower)

(iv) Collateral (security if necessary) and

(v) Conditions (external and economic)

These popular five categories of credit management establish the likelihood that a potential or

existing borrower will successfully meet scheduled interest and principal payments. Based on

the above categories the credit scoring model that we have devised for a vegetable vendor in

India incorporates these points as follows:

4 Ahmet Burak Emel and Muhittin Oral, 2003, A credit scoring approach for the commercial banking sector,

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Capacity (ability to repay)

We thought of capturing this category through the Trading History parameter. If a client has

had a significant trading record then he would obviously have the capacity to pay his interest

and principal repayments in time. Trading history parameter essentially has the following sub

parameters:

Period of trading

Frequency of transactions

Uniformity in value of transactions (to capture the borrowers stability in his trade)

Character (Willingness to repay)

This category has been incorporated into the model by way of the number of guarantees the

individual is able to get. Since the guarantors also form the borrower’s immediate neighbors

they would have maximum informal information about the character of the client and

whether he has a stable repayment history. The sub parameters for rating this category are:

Number of guarantors in the group

Familiarity with guarantors(members/non-members of the MFI)

Financial soundness of guarantors

Capital (Wealth of borrower)

This information is obtained from the Personal Security and the Business Information of the

client. These would essentially have the following sub parameters:

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Business Information

Total turnover

Total business expenses

Total personal expenses

Other commitments towards repayment of previous loans

Personal Security

Assets owned

Assets mortgaged/rented

Assets offered as security

Collateral (Security if necessary)

Collateral if available would increase the score of a vendor as risk associated with him both

credit and default is much reduced. He can also operate on a line of credit basis which we

have discussed in one of the previous sections. This information of the client is built-in in the

form of the Savings parameter. The sub parameters are:

Existing savings deposits

Current cash surplus available for saving

Expenses of avoidable activities like drinking, movies, etc

Interest of client in taking a savings product

Conditions (External and economic)

This category is important as this would determine how the future and the present conditions

if the vendor could affect his payments. E.g., if he has a greater number of young dependents

then it is likely that his expenses would increase in the future, as his dependents would come

of age. Also if he has an ailing family member, it is probable that it could increase his

everyday expenditure. Similarly his future prospects play a significant role under this

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category. If he is into a business that is not much in demand due to seasonal variation or

customer’s changing tastes, he needs to change his business. The sub parameters for these

are:

Individual Demographics

Age

Number of family members

Number of dependents

Number of family members in the same business

Growth Prospects

Current scale of operation

Interest/possibility of future expansion

However, there is a potential problem with credit scoring as it is usually done5. The statistical

models that are usually used to evaluate applicants are constructed from historical data. In

order to enter the sample used to build the model, an individual must have already been

`accepted'. Thus, the model after the initial pilot is a description of some aspect of the

behavior of individuals who have already received loans. The scoring model is to be used to

evaluate applicants who are drawn randomly from the entire population. The individuals

whose applications were accepted to begin with could have been qualitatively different

(difference in credit scoring) from individuals whose applications were rejected. Since, an

application which arrives randomly at the MFI could be of either type, i.e. the application

could be for a client applying for the first time or also for a regular client it is not certain that

the model being used is appropriate for the population being measured. Hence the main

challenge of the credit scoring model is to upgrade the model as frequently as possible for the

regular customers and have a set standard (e.g., define the score for certain parameters for

eligibility) when the client applies for the loan the first time.

5 William Greene, 1998, Sample selection in credit-scoring models

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We should also remember that Scoring works best for those with a solid individual lending

technology and a large database of historical loans6. Even when scoring works, it is only a

marked improvement, not a breakthrough. In particular, scoring will not replace loan officers

in microcredit completely because much of the risk of the self-employed poor is unrelated to

the information available for use in scoring.

6 Mark Schreiner, 2003, Scoring: The Next Breakthrough in Microcredit?

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Case study I

M. Nagappa is a fruit vendor who sells Apples, Oranges and Sweet Lemon in the crowded

Madivala market. He arrived in Bangalore three years ago from Tamilnadu. His decision to

carry out his daily routine in Bangalore was due to the frustration he experienced in

Tamilnadu because of the hostility of the local rowdies who asked him a share of his earnings

every day. The police officials were also totally indifferent to the existing conditions there.

As it is he was the only earning member in his family. Hence to support his two sisters and

his parents, he turned to Madivala Market in Bangalore where hundreds of vendors get their

push carts everyday at dawn and feel secure enough to leave their carts at night and depart

home.

Nagappa and his sisters completed their education upto 12th Standard in Tamil medium. His

elder sister got married and hence he has four members of his family dependent on him. His

family owns a house Villupuram, a small town in Tamilnadu, in a village called Mutathur.

Nagappa does not have a place to live in Bangalore. He spends his nights at his uncle’s shop

where he doesn’t have to pay rent. Daily routine for Nagappa consists of getting his pushcart

(which he bought sometime back) filled by his uncle with fruits and selling them in the

Madivala market. The fruits are mainly sourced from certain wholesale markets where his

uncle has been trading for a long time. His cart is filled 2 to 3 times in a week. However it

also depends on the season, weather, customer’s taste etc. For this daily activity of Nagappa,

his uncle charges him Rs.8500 for 3 months for which he has to repay Rs.10000. He

accomplishes this by repaying Rs.100/- everyday for 100 days (approximately 3 months)

through his everyday sales.

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His other expenses include paying for the following:

Expenses Amount (in Rs.)

Using the Bathroom 2/-

Washing his Face 3/-

Food 50/-

Bath (He has a bath once in 3 days and

otherwise manages by washing his face as

it becomes too expensive to have a bath

everyday)

10/-

Washed and ironed clothes (again once in 3

days)

15/-

When asked why he didn’t opt for only washing his clothes without ironing he said it

came as a bundled deal.

Liquor (especially when sales are

abysmally low)

15/-

Cigarettes 12/-

It becomes very difficult for him to carry out his daily routines without having at least 5-6

cigarettes everyday

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Apart from the above expenses Nagappa is also a sufferer of the ‘vaddi sala’ system which is

a highly popular lending practice amongst vendors. In this type of loan the loan payer keeps

repaying the interest till such time he has the whole lumpsum amount (i.e. the principal) to

repay the lender.

Nagappa borrowed a sum of Rs. 20000/- from money lenders in Tamilnadu for his sister’s

marriage and his nephew’s ear piercing ceremony. He has since then (that was around 2 years

back) been paying interest of Rs.800 per month on the loan. He has to keep paying this

interest till he collects the amount of Rs. 20000 and repays it back as a whole.

From his sales, Nagappa makes a profit of Rs.5/- on an average on all the three types of fruits

that he sells. Hence in a period of one week he makes around Rs.750 as follows.

Refill (in numbers) in a week Profit (in Rs.)

90 (for Apples) Rs. 450

30 (for Oranges) Rs. 150

30 (for Sweet Lemon) Rs. 150

Btu the above calculation is subject to vagaries of weather and season to a very large extent.

For e.g. the recent heavy downpour of rains in Bangalore led to a huge loss in business for all

the vendors.

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Case study 2

Perumal, a 19 year old boy educated till 9th standard sells Bananas at Madivala market

everyday. His family consists of 12 members including his relatives and they altogether have

a total of 7 children. His family is well settled in Bangalore having operated in the market for

more than ten years now. Perumal hails from Tirupathur which is a village in Tiruchi.

His daily routine encompasses getting the produce from their wholesaler and farmer friend in

Tiruchi for an amount of Rs.20000/-. His source of income remains his sales and the loan

amount he occasionally borrows from his relative in Tiruchi which he repays back monthly

without any interest. He borrows Rs.10000 from him. His family also has a small shop in

Madivala market which is mainly used for stocking but they also sell Bananas there.

His family’s daily expenses include the following:


Food 200/-

Travel (to and fro) by bus for the members

of the family

40/-

Electricity Bill 50

Getting the produce from Tiruchi (weekly) 2500

Decay due to bad weather or poor sales

(weekly)

500

Repairing the pushcart i.e. replacing the

tyre etc (once a month)

50

He manages a yearly profit of around Rs.5000/- which is used for family expenses.

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Case study 3

Mallesh, a vegetable vendor is a 23 years old man who has had education till 4th Standard and

sells his produce in the Vijayanagar area in Bangalore. He arrived in Bangalore 3 years ago

leaving his factory Job where he was getting a monthly salary of Rs. 2000. The salary was

not enough to feed his brother’s family which was fairly large and his own. So he decided to

move to the city.

Mallesh starts for work at 7:30am everyday where he buys his produce from the wholesale

market and sells on the way home. He pushes his cart for one and a half hours on a steep

slope and reaches Yashwantpura. He reaches home at 1:00pm and again sets out for selling

with his pushcart at 4:00pm. However he works only for 4 days a week as it becomes too

strenuous to carry the cart everyday.

His daily expenses are as follows:


Rent 800/-

Electricity 150/-

Water 100-150/-

Kerosene 30/-

Miscellaneous expenses (watching a

movie, occasional drinking etc.)

50

Pushcart Repairs (replacing tyres etc)

(once in 3-4 months)

1000

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Mallesh takes a loan of Rs. 5000 every 3 months to finance his business as well as his daily

needs. The loan amount that he gets is Rs. 4250 and the amount he repays is Rs. 5000. He

repays Rs. 50 everyday for 100 days. Other than this Mallesh is repaying the loan of his

neighbor for whom he gave guarantee at some point. His neighbor disappeared with around

Rs. 14000/- of which Mallesh repays Rs.750/- every month as a part of the principal

repayment. Mallesh makes a profit of Rs.100 to 150/- everyday to support his daily needs.

He tries to save around Rs.50 everyday. From the saved money, he sends his family an

amount of Rs.2000 periodically for their requirements.

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Product Features

As inferred from the interviews, most of the pushcart vendors depend on their friends and

relatives for finance. In times of emergency and crisis, they resort to ‘vaddi sala’ from local

moneylenders on which they pay very high rates of interest. The main problems faced by the

vendors with the current type of financing can be enumerated as under.

• In two of the cases, we found that the vendors take 3-month loans on which they pay

an interest of 17.64% quarterly. This amounts to an exorbitant compounded annual

rate of 91.52%.

• In the case of a ‘vaddi sala’, they borrow a lumpsum amount and then keep paying

interest on it till the lumpsum amount is repaid. For instance, one of the vendors has

taken a loan of Rs. 10000 and is paying Rs. 500 per month as interest, which amounts

to a rate of79.59% annually. The vendors are not in a position to accumulate such a

big sum of money. Thus, they keep paying such high interests over a long period of

time.

• None of the vendors have a bank account, which may pay them some interest on their

savings. Therefore, they have little incentive to save and spend their surplus cash on

unnecessary activities like drinking, smoking, movies, etc.

• Due to non-availability of a collateral security, the moneylenders ask for a guarantee

by the vendor’s neighbor who is usually in the same trade and is from the same

village as the vendor. This agreement between the vendor and his neighbor is mutual.

Therefore, if one person defaults, the entire burden of repayment is shifted to the other

person.

Considering the afore-mentioned problems, we believe that the following features should be

incorporated in an ideal product for the vendors. These will not only help in overcoming the

current shortcomings, but will also give the vendors a greater sense of security.

• All the vendors prefer short-term loans of about 2-3 months maturity. Therefore, such

short-term loans should be available to them but at lower interest rates than the

current 17.64% quarterly.

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• To overcome the problem of non-saving, the following 2 features can be considered

o A person who has taken a loan can be encouraged to deposit his/her monthly

savings. This savings amount can be used to settle against the outstanding loan

amount leading to early repayment and thereby lower interest rates on the

outstanding balance.

o A separate savings product can be offered to the vendors where the vendors

can deposit their monthly savings on which the MFI can pay them some

amount of interest. This would also help the vendors to accumulate a lumpsum

amount, which they can withdraw in times of emergency or need.

• The MFI can adopt the joint liability model to overcome the problem of default in

repayment by any of the members in the affinity group. The loans in the group can be

given on individual basis whereas the group can share the liability of default. This

will prevent the problem of burdening a single person due to his neighbor’s inability

to repay. However, while creating the affinity groups, the MFI should ensure that all

the individuals in the group require a similar amount of loan such that the burden

created due to any member’s default is the same.

For implementing the savings schemes, the regulatory framework for banks and NBFCs must

be considered. As per the regulations, any institution requires a minimum equity capital of

Rs. 2 billion to be able to accept deposits. To acquire the status of an NBFC, an institution

requires a minimum equity capital of Rs. 20 million but it cannot accept deposits from its

clients. Therefore, to facilitate the savings products, the MFI can try to collaborate with banks

such as ICICI, which also works in the micro-lending space.

If the MFI collaborates with a private bank for sourcing of funds, there are primarily three

kinds of structures possible.

• Portfolio Buyout Structure: The existing assets of the MFI can be assigned to the

bank in return of a purchase consideration.

• On-tap Securitization: The MFI can continually source loans from the bank and can

assign the receivables under such loans to the bank under a mutually agreed

arrangement wherein sourcing criteria and operational guidelines are stipulated.

• Partnership Model: The MFI can source loans directly in the books of the Bank, and

continue to monitor and recover loans thus disbursed.

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However, all collaborations with any private banks would work best when the terms on using

the money are not dictated but left to the MFI to decide on and all relevant information is

disclosed and transactions are as transparent as possible.

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Interest Rate Determination

The interest rates charged by the MFIs are high essentially due to the high costs of bringing

micro-finance products and services to the poor. In addition, there are the costs of creating

delivery mechanisms at the community level (which are not included in determining the

interest rates). Then there is the cost of creating and setting the client base for micro-finance

products and services. These costs are difficult to integrate into the calculations of interest

rates. Hence each of these issues must be considered while determining interest rates in order

to avoid any operational difficulties in future. Apart from this recruiting, training and

monitoring staff is a key constraint. Monitoring of operations and transactions using IT based

systems is a must. All these will add up to the transactional cost and hence an increase in the

interest rates

If an MFI has to be sustainable, covering costs of funds, and transaction costs, than interest

rates have to be high. Talking about interest rates as a percentage on loans of Rs 2000 or

5000 might not be the most accurate method of expressing them. The transaction costs - of

finding a borrower, appraising her, disbursing money to her doorstep and then collecting it

back over 52 weeks or twelve months in small installments, is nearly fixed irrespective of

loan size. So if the cost is Rs 500 per loan, then the cost can amount to as high as 25% for Rs

2000 loan and will appear to be as low as 5% for Rs 10,000 loan. Thus interest rates of 24%

per annum charged by most MFIs are barely enough to cover their costs. We could specify a

minimum rate of 12% per annum on a declining balance, and a maximum of 25% per annum.

The lower interests if for people who might borrow in groups or have guarantee given by

others as our transaction costs would be lower there. E.g., for lending a large sum of Rs 2

lakh to a group of 10 vendors who might want to start a shop, we would charge 12%. But

where we have to give an individual loan of Rs 5000 to a marginal vendor, there the

transaction cost is high and hence we would charge 25%. In any case that would be far less

than the interest charged by moneylenders on a yearly basis.

It is only through competition that the interest rates can come down. It can happen if there are

a many MFI’s offering similar products to the retail vendors differentiating only on interest

rates and that would be good for the customer as well as for the business. The GoI and RBI

should encourage hundreds of institutions to come into this field, innovate and bring down

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the costs. But even then the interest rate might not come down to 8 or 10% because the cost

of lending small loans is intrinsically high

Also interest rates would not be the same way across all the products that we offer; it would

not be same even in the same location for different types of customers because along with the

transaction cost of disbursing the loan, the risk cost has to be kept in mind. We would do a

risk based pricing of the loan based on a credit-scoring model, which would rate the customer

on different parameters. If there is a class like a particular region, a particular activity or a

category of people where the default rate is 5% instead of 2% then the 3% has to be built into

the pricing because unlike in public sector banks, there is no government that would write off

loans and then recapitalize lending institutions.

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Loan Appraisal

Loan appraisal for micro lending has a number of complexities. Complexities arise due to

lack of data validation, high risk lending, financial constraints of the MFI, high transaction

costs, etc. for assessing the credit worthiness of clients, MFIs have two options: individual

case by case basis of evaluation by a loan officer or use of a standardized credit scoring

model.

In the individual case-by-case method, a loan officer collects all relevant information for each

client and then decides on the credit worthiness of the client. This method offers the

advantages of greater accuracy of information and better decisions about the disbursement of

loans. However, it involves very high transaction cost, higher loan processing time and very

highly skilled staff. Also, the loan appraisal decision is completely dependent on the

judgment of the loan officer.

Using a standardized credit-scoring model is simpler and less time-consuming. With a credit-

scoring model, a less qualified person can also assess the client’s credit worthiness and take a

suitable decision. The transaction costs and operating costs are reduced significantly.

However, it suffers from the problem of absence of on-site data validation giving rise to

greater risk of default by the clients.

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Product Design

We will segment all our clients, based on the purpose of their loan, into the following:

Loan for everyday (income generation) activities or Working capital Loans

Loans for Micro enterprise

Loans for Small Enterprise

Working Capital Loans implies full-time, often seasonal economic activities undertaken

for subsistence. At times several family members simultaneously engage themselves in a

wide array of such activities, in order to diversify the income sources of the household.

Similarly small enterprises are the entrepreneurs' primary source of income but they

reinvest the profits of the enterprise to further its growth. Microenterprise bridges the

gap between the loans for daily activities and those for Small enterprise.

Definitions:

We define Microenterprise activities as any individual or group of borrowers having

combined assets (to be offered as collateral) less than Rs. 10,000. Similarly we define Small

Enterprise activities as any owner having assets less than Rs.100,000. For Income Generation

or working Capital loans there need not be any collateral.

With working capital loans, the need is for loans for which borrowers are willing to pay

reasonably high interest rates, which would obviously be considerably lesser than what they

pay the moneylenders. However Microenterprises would need more flexible financial

products, which are more customized. Microenterprises might also require working capital

loans, but initially when they are about to set up their business or when they are about to

expand they would need fixed asset investment loans. Such investments require access to

larger loan amounts for longer periods of time, and as a consequence, borrowers can afford

interest rates significantly lower than those affordable by the working capital borrowers yet

higher than the commercial bank rate. Finally, Small enterprises have very different credit

needs, almost matching the credit conditions of the commercial banking loan sizes and terms

specifically matched to the investment and repayment capacity of the business, for which the

borrower is able to offer sufficient collateral, but can only afford commercial interest rates.

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Characteristic Daily Activity ME SE

Use of loan Working Cap Working Cap +

Fixed Assets

Working Cap +

Fixed Assets +

Infrastructure for expansion

Loan term 1 week - 3 months

4 months – 1.5 years

1 - 5 years

Loan size Rs. 500 – 10000 Rs. 10000 – 100000

Rs. 10000 – 100000

Collateral Requirement None Low High

Interest Rates 25% - 40% 15% - 25% 5% - 15%

Repayment Daily Daily for a month

+ Weekly after

that

Monthly

Collection By collecting

agents at the

specified markets

At the nearest

branch of the MFI

At the nearest

branch of the MFI

For all Loan products, the Clients are required to acquire guarantee of atleast three

independent parties forming a joint liability group. Each of the parties in the group guarantees

each other’s default. The individuals in the groups are from the same neighbourhood, as they

would have maximum information about the neighbour’s activities.

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Supplementary Products

Education Loan

Savings Product

Remittance Product

Microinsurance Products

Microentrepreneurs Products

Emergency Loan

Mutual Benefit Product

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Education Loan

This will be given for education of the immediate family members of the client. Maximum

loan would be decided based on the segment to which the client belongs.

Savings Product

We would have the following features in the Savings product that we would offer:

Product Minimum Balance

for withdrawal

Term of

deposit

Amount and

frequency of

deposit

Interest

Regular 1000 or 10% of his

current balance

whichever is higher

4 months Weekly

deposit of 1%

of the loan

amount

8%

Combined (for

non borrowers)

None Anytime Monthly

deposit of

6%

Long term 50000 or 5% of

the current balance

whichever is higher

1-5 years Monthly

deposit of 5%

of the loan

amount

8%

The amount that would be obtainable would be reduced if the amount is withdrawn before the

expiry of the term.

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Remittance Product

For a client like Nagappa who sends most of his earnings to his family back in Tamilnadu, it

will be highly convenient if a product is devised for him wherein we will pay his family on a

monthly basis and charge the repayment from Nagappa. This will however include the

transaction costs in sending the amount to Nagappa’s village which he anyways would end up

paying himself. This would fall under the income generation activities and the rates will be

charged accordingly.

Microinsurance Product

Disastrous losses such as those caused by fire, theft, or natural disasters can be disturbing for

any business owner. To help mitigate these catastrophic losses, we will offer an insurance

product to our clients. Since we are largely looking at a client base that consists of vendors

who would want everyday finance for their income generation activities, we are not planning

to get into Life insurance at this stage. We would provide insurance for the vendor’s pushcart

for instance. Other insurances products would be insurance against calamities and seasonality

changes where we could relax the repayments cycle for our clients at a higher interest or take

a premium from them every month and repay a lumpsum amount during the calamity.

Microentrepreneurs’ Product

Microentrepreneurs’ would be financed for fixed assets or for infrastructure and the interests

would be charged as given in the above Table based on the purposes that the client needs the

loan.

Emergency Loan

This loan will be given in case of unforeseen emergencies. E.g., accidents, for performing the

last rites of a person, etc. This loan is different from Microinsurance in the sense that the

amount for this loan will be decided based on the savings the client has or his repayment

history or his cash flows. The client would not have to pay any premium on a periodical basis

for this type of product.

Mutual Benefit Product

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This product is applicable only to working capital loans. Here the client can combine a

regular savings scheme with the basic working capital loan. He can achieve this by depositing

a percentage of his daily earnings in his account every evening. He can then withdraw a

certain amount based on his daily working capital needs everyday and keep repaying the

amount along with interest that evening. In essence the borrower would get to operate on a

line of credit. The interest rates on his deposit could be increased or his repayment interest

rates could be reduced if client additionally wants to save a portion of his daily earnings.

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Loan Appraisal

Application form (Refer Annexure I for the actual application form)

For the purpose of loan application, we are using a standardized application form. The

application form will provide information pertaining to the following, which will help in

assessing the credit worthiness of the applicant by using the credit scoring model.

• Personal details

• Financial information (business and personal)

• Personal security

• Product details

• Details of guarantors

Verifications

The application form will be filled by a loan officer by visiting the residence of the applicant.

This will enable verification of various information provided by him/her. Due to the lack of

adequate security, the verification process becomes very important to avoid incorrect data.

The following key information requires thorough investigation and verification.

• Location of residence

• Place of business (fixed/mobile)

• Bank details

• Details of guarantors

Verification of guarantor details is most important, as they are the only source of security

provided by the applicants. This is the reason for carrying out the application form filling

process at the residence of the vendor as the loan officer can visit the neighbours who have

given guarantee and verify their details. It is especially necessary to ensure that the

guarantors do not belong to the same family or are closely related in order to diversify the

risk of default.

Monitoring and collection

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For keeping a periodic check on the business of the vendors, we will assign one person in

each region to carry out the process of form filling, monitoring and collection. Since the same

person will carry out filling and monitoring, a better understanding between the client and the

officer will be established which will provide better access to their operational information.

Fixed pushcart vendors can repay their daily/weekly loans to their area in charge while

mobile pushcart vendors can choose their place of repayment based on their convenience.

Approval

While the form filling will be carried out by the area in charge, the approval of the loans and

adjustments in the repayment requested by the vendors will be done by a superior, in charge

of a number of areas. Therefore, the area in charge can be less skilled and his task will

become simpler. Also, it will help in keeping a checking on the performance of the area in

charge.

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Credit Scoring Model of Janalakshmi

The Credit Scoring Model of Janalakshmi rates the traders according to the following

parameters with their respective weights:

Parameters Weights

Trading History 30

Success of Data Validation 20

Financial Viability 15

Credit officer’s Recommendation 10

Feedback from neighborhood 10

Cross-sell Opportunity 10

Security 5

Saving’s History 0 (as of now)

Total 100

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Trading History: This parameter establishes the familiarity of the trader with SAFAL.

This parameter as the highest score as the higher a trader the greater are the chances that

he will execute his repayment. The following sub-parameters are used to measure the

parameter

o Period of trading

o Frequency of transactions

o Consistency in value of transactions

o Familiarity of SAFAL representative

Success of Data Validation: The data that has been entered in the appropriate forms by

the vendor is verified by the officer. Based on the accuracy of that information this

parameter is scored.

Financial Viability: This decides whether the vendor has any means of financial

capability. To score this parameter the cash flows of the vendors are considered after

deducting all business expenses which include equipment expenses like replacing

damaged tyres etc.

Feedback from neighborhood: This parameter is scored by gaining feedback from

neighbors and business community.

Cross-Sell Opportunity: This parameter is scored depending on the number of products

the vendor would be able to afford i.e. Educational Loan, General purpose Loan,

Enterprise Loan, Education Loan. The more the number of products the vendor is

interested in the higher the score he gets.

Security: This parameter is scored based on the savings of the vendor which is highly

unlikely; hence the lowest weights are given to this parameter.

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Recommendations for the Credit Scoring Model of Janalakshmi

Trading History: This parameter has been given the highest weights i.e. 30. Hence it

becomes really important. Since SAFAL is an organization that came into being only 1.5-

2 years ago, this parameter will be able to capture only the recent past of the trader.

Instead of familiarity with SAFAL the Trading History should look at the familiarity of

the trader with the trade itself i.e. the parameter should capture how long he has been in

the trade instead of how long he has been with SAFAL.

Financial capability should be given the lowest weight (similar to the Security parameter)

because it is extremely difficult to establish the cash flows of a pushcart vendor. Also, if

the vendor would have a stable cash flow he would be eligible for a loan in the

commercial bank instead of a microfinance institution. For a pushcart vendor losing a 15

weight would mean a huge loss and that would be judged only on his cash flow.

There should be some way of capturing the reason why the trader has come to Bangalore.

This is essential because if the trader has come here for survival it is highly likely that he

would stick around for a longer time than a trader who has come here to expand his

business, etc. Most vendors seek out a way to protect their families who usually stay in

the villages amidst their dry and barren lands. Hence, these traders are more trustworthy

as they would not easily leave their source of income once settled.

There needs to be a parameter to capture the movement of a vendor within the city

because how frequently the vendor changes his market would provide some indication

about how long he might stick to SAFAL and since Janalakshmi is initially targeting

SAFAL customers, it would also give them an idea about how long the customer would

have a registered information at SAFAL to be traceable.

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Annexure I (Loan Application Form)

PERSONAL INFORMATION

1) First Name

2) Middle Name

3) Last Name

4) Address

5) Telephone: Residence

6) Age

7) Sex:

8) No. Of Family Members

9) No Of Earning Members

10) No. Of Dependents

11) Education Qualifications if any

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FINANCIAL INFORMATION (Monthly) Personal Total Expenditure Expenditure on house rent Expenditure on Food Expenditure on Commission Expenditure on Education Expenditure on Utilities Expenditure on Miscellaneous Business Nature of Business Specify Turnover Specify Cost of Rent Specify Cost of Transportation Specify Cost of Electricity Miscellaneous Costs

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PERSONAL SECURITY & PRODUCT DETAILS

1) Details of Bank Accounts held

Bank Name

Bank Account number

2) Sources of income other than business

3) Assets

Savings

Immovable Properties

Others

4) Amount repaid Routinely to Pay of Other Loans (Specify time period and amount)

5) Source of Loans

6) Purpose of Loans Taken

7) Details of Loan Taken (Amount, Term & Interest)

Money Lenders

Friends & Relatives

Banks

Others (specify)

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PRODUCT DETAILS

1) Type of product applied for

Scheme of product

2) Amount

3) Preference of Repayment

Duration

Location

Collateral

DETAILS OF GUARANTORS

1) Name

2) Address

3) Relationship with client

4) Specify for each member whether he/she is our client

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Annexure II (Credit Scoring Model)

Parameters with their weights Sub parameters

Savings (20%)

Existing savings deposits

Current cash surplus available for saving

Expenses of avoidable activities like drinking, movies, etc.

Interest of client in taking a savings product

Personal security (20%)

Assets owned

Assets mortgaged/rented

Assets offered as security

Number of Guarantees (15%)

Number of guarantors in the group

Familiarity with guarantors (members/non-members)

Financial soundness of guarantors

Business information (15%)

Total turnover

Total business expenses

Total personal expenses

Other commitments towards repayment of previous loans

Trading History (15%)

Period of trading

Frequency of transactions

Consistency in value of transactions

Demographics (10%)

Age

Number of family members

Number of dependents

Number of family members in the same business

Growth prospects (5%) Current scale of operation

Interest/possibility of future expansion

project on loan approval

Business

supply of credit

credit history

benon creditworthy

supply of formal sector

daily needs

working capital needs

south of india

supply of resources