Project Report on

“A Critical Analysis of Micro Finance in India”

SUBMITTED TO:-

PROF. S MITRA

SUBMITTED BY:-

Batch-Spring Summer SANJAY KUMAR SHAH

Year- 2009-11

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 ACKNOWLEDGEMENT

We acknowledge with gratitude and appreciation, our indebtedness to our mentor &
guide, Prof S Mitra for allowing us to work on a very intrinsic part of aviation sector,
“MICROFINACE IN INDIA” we also thank his for the ideas and basic concepts he delivered
and shared with us, as they helped us a lot in accomplishing this project.

It gave us enormous gratification to articulate our thankfulness and heart full sense of
indebtedness to our dearest friends for the great support in completion of this project

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 ABSTRACT

In recent years Microfinance has attracted widespread attention for its

developmental Impact for the poor, but it too has multitude of issues and complications. This
research project has adopted a mix of empirical and theoretical approach with the objective
to identify a comprehensive range of implementation and impact issues of microfinance.

This paper will seek to examine what is the current status of the microfinance in
India and the overall industry analysis and how they are contributing in achieving the financial
inclusion. A comprehensive survey in real-life setting of the donors, the practitioners and the
beneficiaries (the groups) through various means such as formal and informal talks has been
performed.

The deliberations are focused around examining the implementation issues; the
economics behind the issue, the complications involved thereon, the impact- individualistic
and wider context, providing practical solutions for the problems and the case for including
health and education among its domain of services.

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 CONTENTS

Page No.

Introduction 4

Microfinance Definition 4

Need in India 6

Role of Microfinance 8

Origin of Microfinance 9

Microfinance Today 11

Status of Microfinance 13

Activities 13

Legal regulations 15

MF industry analysis 18

Success factor of MFIs in India 26

Real life example 29

Issues 30

References 36

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 Introduction
Microfinance is defined as any activity that includes the provision of financial services
such as credit, savings, and insurance to low income individuals which fall just above the nationally
defined poverty line, and poor individuals which fall below that poverty line, with the goal of creating
social value. The creation of social value includes poverty alleviation and the broader impact of
improving livelihood opportunities through the provision of capital for micro enterprise, and insurance
and savings for risk mitigation and consumption smoothing. A large variety of factors provide
microfinance in India, using a range of microfinance delivery methods. Since the ICICI Bank in India,
various factors have endeavored to provide access to financial services to the poor in creative ways.
Governments also have piloted national programs, NGOs have undertaken the activity of raising donor
funds for on-lending, and some banks have partnered with public organizations or made small inroads
themselves in providing such services. This has resulted in a rather broad definition of microfinance as
any activity that targets poor and low-income individuals for the provision of financial services. The
range of activities undertaken in microfinance include group lending, individual lending, the provision
of savings and insurance, capacity building, and agricultural business development services. Whatever
the form of activity however, the overarching goal that unifies all factors in the provision of
microfinance is the creation of social value.

Microfinance Definition

According to International Labor Organization (ILO), “Microfinance is an economic

development approach that involves providing financial services through institutions to low income
clients”.

In India, Microfinance has been defined by “The National Microfinance Taskforce, 1999” as
“provision of thrift, credit and other financial services and products of very small amounts to the poor
in rural, semi-urban or urban areas for enabling them to raise their income levels and improve living
standards”.

"The poor stay poor, not because they are lazy but because they have no access to capital."

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 The dictionary meaning of ‘finance’ is management of money. The management of money
denotes acquiring & using money. Micro Finance is buzzing word, used when financing for micro
entrepreneurs. Concept of micro finance is emerged in need of meeting special goal to empower under-
privileged class of society, women, and poor, downtrodden by natural reasons or men made; caste,
creed, religion or otherwise. The principles of Micro Finance are founded on the philosophy of
cooperation and its central values of equality, equity and mutual self-help. At the heart of these
principles are the concept of human development and the brotherhood of man expressed through
people working together to achieve a better life for themselves and their children.

Traditionally micro finance was focused on providing a very standardized credit product. The
poor, just like anyone else, (in fact need like thirst) need a diverse range of financial instruments to be
able to build assets, stabilize consumption and protect themselves against risks. Thus, we see a
broadening of the concept of micro finance--- our current challenge is to find efficient and reliable
ways of providing a richer menu of micro finance products. Microfinance is not merely extending
credit, but is extending credit to those who require most for their and family’s survival. It cannot be
measured in term of quantity, but due weightage to quality measurement. How credit availed is used to
survive and grow with limited means.

Who are the clients of micro finance?

The typical micro finance clients are low-income persons that do not have access to formal
financial institutions. Micro finance clients are typically self-employed, often household-based
entrepreneurs. In rural areas, they are usually small farmers and others who are engaged in small
income-generating activities such as food processing and petty trade. In urban areas, micro finance
activities are more diverse and include shopkeepers, service providers, artisans, street vendors, etc.
Micro finance clients are poor and vulnerable non-poor who have a relatively unstable source of
income.

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The Need in India

 India is said to be the home of one third of the world’s poor; official estimates range from 26 to 50
percent of the more than one billion population.
 About 87 percent of the poorest households do not have access to credit.
 The demand for microcredit has been estimated at up to $30 billion; the supply is less than $2.2
billion combined by all involved in the sector.

Due to the sheer size of the population living in poverty, India is strategically significant in the
global efforts to alleviate poverty and to achieve the Millennium Development Goal of halving the
world’s poverty by 2015. Microfinance has been present in India in one form or another since the
1970s and is now widely accepted as an effective poverty alleviation strategy. Over the last five years,
the microfinance industry has achieved significant growth in part due to the participation of
commercial banks. Despite this growth, the poverty situation in India continues to be challenging.

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

 Poor people need not just loans but also savings, insurance and money transfer services.
 Microfinance must be useful to poor households: helping them raise income, build up assets and/or
cushion themselves against external shocks.
 “Microfinance can pay for itself.” Subsidies from donors and government are scarce and uncertain,
and so to reach large numbers of poor people, microfinance must pay for itself.
 Microfinance means building permanent local institutions.
 Microfinance also means integrating the financial needs of poor people into a country’s mainstream
financial system.
 “The job of government is to enable financial services, not to provide them.”
 “Donor funds should complement private capital, not compete with it.”
 “The key bottleneck is the shortage of strong institutions and managers.” Donors should focus on
capacity building.

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 Interest rate ceilings hurt poor people by preventing microfinance institutions from covering their
costs, which chokes off the supply of credit.
 Microfinance institutions should measure and disclose their performance – both financially and
socially.

Microfinance can also be distinguished from charity. It is better to provide grants to families who
are destitute, or so poor they are unlikely to be able to generate the cash flow required to repay a loan.
This situation can occur for example, in a war zone or after a natural disaster.

Financial needs and financial services

In developing economies and particularly in the rural areas, many activities that would be
classified in the developed world as financial are not monetized: that is, money is not used to carry
them out. Almost by definition, poor people have very little money. But circumstances often arise in
their lives in which they need money or the things money can buy.

In Stuart Rutherford’s recent book The Poor and Their Money, he cites several types of needs:

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

Poor people find creative and often collaborative ways to meet these needs, primarily through
creating and exchanging different forms of non-cash value. Common substitutes for cash vary from
country to count dry but typically include livestock, grains, jewellery and precious metals.

As Marguerite Robinson describes in The Microfinance Revolution, the 1980s demonstrated

that “microfinance could provide large-scale outreach profitably,” and in the 1990s, “microfinance

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began to develop as an industry”. In the 2000s, the microfinance industry’s objective is to satisfy the
unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has
been made in developing a viable, commercial microfinance sector in the last few decades, several
issues remain that need to be addressed before the industry will be able to satisfy massive worldwide
demand.

The obstacles or challenges to building a sound commercial microfinance industry include:

• Inappropriate donor subsidies

• Poor regulation and supervision of deposit-taking MFIs

• Few MFIs that mobilize savings

• Limited management capacity in MFIs

• Institutional inefficiencies
• Need for more dissemination and adoption of rural, agricultural microfinance methodologies

Role of Microfinance:

The micro credit of microfinance progamme was first initiated in the year 1976 in Bangladesh
with promise of providing credit to the poor without collateral , alleviating poverty and unleashing
human creativity and endeavor of the poor people. Microfinance impact studies have demonstrated that

Ø Microfinance helps poor households meet basic needs and protects them against risks.

Ø The use of financial services by low-income households leads to improvements in household

economic welfare and enterprise stability and growth.

Ø By supporting women’s economic participation, microfinance empowers women, thereby promoting

gender-equity and improving household well being.

Ø The level of impact relates to the length of time clients have had access to financial services.

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The Origin of Microfinance
Although neither of the terms microcredit or microfinance were used in the academic literature
nor by development aid practitioners before the 1980s or 1990s, respectively, the concept of providing
financial services to low income people is much older.
While the emergence of informal financial institutions in Nigeria dates back to the 15 th century,
they were first established in Europe during the 18th century as a response to the enormous increase in
poverty since the end of the extended European wars (1618 – 1648). In 1720 the first loan fund
targeting poor people was founded in Ireland by the author Jonathan Swift. After a special law was
passed in 1823, which allowed charity institutions to become formal financial intermediaries a loan
fund board was established in 1836 and a big boom was initiated. Their outreach peaked just before the
government introduced a cap on interest rates in 1843. At this time, they provided financial services to
almost 20% of Irish households. The credit cooperatives created in Germany in 1847 by Friedrich
Wilhelm Raiffeisen served 1.4 million people by 1910. He stated that the main objectives of these
cooperatives “should be to control the use made of money for economic improvements, and to improve
the moral and physical values of people and also, their will to act by themselves.”
In the 1880s the British controlled government of Madras in South India, tried to use the
German experience to address poverty which resulted in more than nine million poor Indians belonging
to credit cooperatives by 1946. During this same time the Dutch colonial administrators constructed a
cooperative rural banking system in Indonesia based on the Raiffeisen model which eventually became
Bank Rakyat Indonesia (BRI), now known as the largest MFI in the world.

Origin of Indian Microfinance:

Microfinance as being practiced today was not always intended to be in this way when it
started. Initially microfinance was not the exclusive activity that the organizations were performing. It
all started with failure of government run poverty alleviation programs which motivated social
entrepreneurs to look outside India when they came across the powerful Grameen Bank model and
which was not dependent on government infrastructure.

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 Typically these organizations were led by somebody who had a strong visible social
commitment and they mostly wanted to work around the areas which they either have known through
their upbringing or through their professional experiences. That’s how the entire microfinance sector
started to grow.

Suddenly private banks woke up to the potential of this sector and started lending to these
institutions. With the credits easily available the organizations started expanding their microfinance
initiatives and realized that their other activities had become quite negligible in comparison to their
microfinance initiatives. In the process financial institutions realized that these organizations were very
highly leveraged and they started becoming anxious about the risk associated with such lending.

At the same time regulatory authorities realized that the NGOs which otherwise are
supposed to be philanthropic in nature were making huge profits and regulatory authorities found it
increasingly difficult to reconcile to these two contradictory features of microfinance organizations.

These two factors started pushing the Indian microfinance organizations towards getting
formalized and that’s when the trend of getting converted into NBFC started.

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Microfinance Today

The groundbreaking efforts by pioneers in the microfinance industry have already begun to
yield substantial returns. Today, more than 150 million people worldwide have access to microcredit,
the industry’s flagship product - roughly equivalent to half the population of the United States. From
the perspective of microfinance institutions (MFIs), this growing market has been successful, as well.
Loans are being repaid, and many lenders are generating profits. It’s clear that the foundation for
microfinance has been established … but there is still plenty of room for growth. After all, 2.6 billion
people — over 40 percent of the world’s population — still live on less than USD2 per day and more
than 2 billion remain “unbanked” (i.e., without access to traditional financial systems).

An exceptional rate of growth has brought the microfinance industry to its current size. In 1997
— only 12 years ago — slightly more than 13 million people had access to microcredit. The market
nearly doubled by 2000 and registered a tenfold increase by 2006. Few markets have grown as quickly
in such a short period of time.

Even considering the industry’s profound recent rate of growth, there remains plenty of room for
more. If we assume (somewhat conservatively) the total market for microfinance product purchasers
(excluding children and the infirm) consists of about 1.5 billion people, market penetration is only
around 10 percent. While the immediate potential to generate profits from this untapped space is
enormous, the development of financial capabilities amongst customers at the bottom of the
socioeconomic pyramid (BOP) will also create a platform for future wealth generation, which in turn
will create the need for more robust financial services. Put simply, today’s low-income client will be
tomorrow’s middle-income client. Companies entering the market now have a unique opportunity to
build brand loyalty and familiarity with BOP customers as they move up the socioeconomic ladder.
This will likely yield substantial long-term opportunities — especially for early movers — which will
result in market preeminence as targeted economies develop.

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 Gaining access to the target market for microfinance clients, of course, is not easy.
Significant barriers exist, particularly the absence of an enabling infrastructure. Without the necessary
technology and institutional knowledge in place, it would be quite difficult for most commercial
enterprises to generate an immediate return on microfinance investments since the micro market has
several unique distinguishing characteristics which call for entirely different operational approaches
and business models.

This problem is particularly vexing for insurers and reinsurers looking to get involved in
micro insurance, given the lack of historical data necessary to inform traditional underwriting and
capital management decisions. In general, for commercial enterprises to succeed in the micro
(re)insurance space, some of their fundamental views regarding risk management and underwriting will
need to change.

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Status of Microfinance today

Strategic Policy Initiatives

Some of the most recent strategic policy initiatives in the area of Microfinance taken by the
government and regulatory bodies in India are:

 Working group on credit to the poor through SHGs, NGOs, NABARD, 1995
 The National Microfinance Taskforce, 1999
 Working Group on Financial Flows to the Informal Sector (set up by PMO), 2002
 Microfinance Development and Equity Fund, NABARD, 2005
 Working group on Financing NBFCs by Banks- RBI

Activities in Microfinance

Microcredit: It is a small amount of money loaned to a client by a bank or other institution.

Microcredit can be offered, often without collateral, to an individual or through group lending.

Micro savings: These are deposit services that allow one to save small amounts of money for future
use. Often without minimum balance requirements, these savings accounts allow households to save in
order to meet unexpected expenses and plan for future expenses.

Micro insurance: It is a system by which people, businesses and other organizations make a payment
to share risk. Access to insurance enables entrepreneurs to concentrate more on developing their
businesses while mitigating other risks affecting property, health or the ability to work.

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Remittances: These are transfer of funds from people in one place to people in another, usually across
borders to family and friends. Compared with other sources of capital that can fluctuate depending on
the political or economic climate, remittances are a relatively steady source of funds.

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Legal Regulations

Banks in India are regulated and supervised by the Reserve Bank of India (RBI) under the RBI
Act of 1934, Banking Regulation Act, Regional Rural Banks Act, and the Cooperative Societies Acts
of the respective state governments for cooperative banks. NBFCs are registered under the Companies
Act, 1956 and are governed under the RBI Act. There is no specific law catering to NGOs although
they can be registered under the Societies Registration Act, 1860, the Indian Trust Act, 1882, or the
relevant state acts. There has been a strong reliance on self-regulation for NGO MFIs and as this
applies to NGO MFIs mobilizing deposits from clients who also borrow. This tendency is a concern
due to enforcement problems that tend to arise with self-regulatory organizations. In January 2000, the
RBI essentially created a new legal form for providing microfinance services for NBFCs registered
under the Companies Act so that they are not subject to any capital or liquidity requirements if they do
not go into the deposit taking business. Absence of liquidity requirements is concern to the safety of
the sector.

Importance of legal structure

• Clarity of ownership
• Initial capital requirement
• Ability of the MFI to mobilize deposits
• Ability to raise equity
• Ability to raise grants
• Ability to raise funds from banks and FIs
• Regulatory requirements
• Tax implications
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

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• 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 own rules and regulations,
office bearers and books of accounts.
• SHGs are recognized 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.

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
Issues in Transformation

Capital
• MFI promoters find it difficult to mobilize 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

Microfinance Bill
• Registered MFOs will be required to submit reports to the regulator
• MFOs will also be subject to inspection by the regulator in case of complaints of harmful practices

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• Bill to promote and regulate the microfinance sector. NABARD to be made the regulatory authority
• Microfinance is defined to include loans, savings, insurance and pension services. Loans cannot
exceed more than Rs50,000 (Rs150,000 for housing purposes)
• The bill defines an MFO as any organization that provides micro-finance services and includes
societies, trusts and cooperative societies.
• All MFOs that accept deposit from ‘eligible clients’ need to be registered with NABARD.
Minimum experience of three years and minimum net owned fund of Rs five lakhs has been fixed
as condition for registration.
• Different legal structures reflect diversity within the country and represent various stages of
evolution of the financial sector
• Each legal structure has a purpose, has its pros and cons and is more effective in a particular
situation

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ANALYSIS OF MICROFINANCE AS AN INDUSTRY

Due to the entry of more players in the business of small and medium loan & finance, the
sector turned in to an industry i.e. the microfinance industry. Gradually it is going to grab more market
and people in terms of its capitalization. The policy bound banking system is now-a-days unable to
meet the demand of the needy customer due to RBI’s norms regarding CRR & SLR. Hence the
revolution starts in terms of small and medium loan financing with the name called microfinance
popularly seen in terms of self help group (SHGs). Now this industry is in lime light of every investor
in terms of its growth and return. Even private equity firms are looking for it eagerly.

For that reason we are going to analyze the industry with the help of famous
PORTER’S FIVE FORCES MODEL of industry analysis.

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Competition: How strong is the rivalry posed by the present competition?

The number of firms in the industry- the more firms the stronger the competition because
there are more firms competing for the same customers. Here in this case the competitors are

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 Despite having competition the sector is growing, which signifies that there is vast market to
tap.

 market growth-as it is a growing sector the growth rate and the growing investment can be known
in the fig. below table:-

In addition to the SHG-Bank linkage model, Small Industries Development Bank of India (SIDBI)
has also supported MFIs. The details for the year 2009-10 are given below:-

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 By looking at the figure we can know that the growth of MFI (bank linkage model) is growing at a
faster rate than the SHG (bank linkage model).this indicate the attractiveness of the industry due to the
entry of all large private banks.

 Levels of product differentiation-this is pretty low here. This signifies more competition in the
industry. More competition leads to satisfaction of the customer in terms of lowering the operating
cost which will lead to low interest rate to the end user & capture more investor.
 Economies of scale-firms having low economic scale can survive in the competitive rivalry. I.e.
the fixed component is more than variable one. Here the bank lending rate is fixed but one can
manipulate in the operating rate in order to reduce the interest to attract more customer.
 Switching costs-switching cost here is very much high as someone is taken loan and he/she has to
repay it totally for switching over to another firm. Which signs an entry for new player by looking
at the vast market?
 High exit barriers- increase competition because firms that might otherwise exit the industry are
forced to stay and compete. The common factor is the recovery of debt and the large volume of
asset. This can known by seeing the below table

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1. Barriers to entry: What is the threat posed by new players entering the
market?

As this is capital based industry hence the barrier is basically the cost of capital. The more
factors are
 High capital costs of setting up a business in a particular industry
 Requirement of highly specialized instruments-no such factor is a constraint for microfinance as
an industry.
 Branding of existing competitors-as such for SHGs there no such provision for branding
needed but due to the entrance of new banking players it would be a constraint in future. But as
the market is growing it would take a lot time to happen.
 Government regulations-till now there is no such government intervention is found in this
sector. But due to increase in rate of interest government may interfere in it in near future.
Recently there was an article upon appointing NABARD as the regulatory authority for
microfinance. But as such government hindrances may be a negative factor for the growth of
industry like microfinance. Hence as of now there is no barrier for the new entrant.

2. Substitutes: What is the threat posed by substitute products and services?

As it is a service rendering organization hence the substitute are more but due to regulation of
government and the harassment of local lenders the substitute is less. They are

 The small loan of private banks-this is now a day’s not exactly the substitute of MFI although it’s
from banking industry. Because the mortgage and guarantee taken by then is not affordable by poor
people. After that they also can’t recover the money if failure. But MFIs & SHGs as such taken
more interest but help the poor in the time of requirement. And also the recovery is quite good here.
That we can see in fig.

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 As regards recovery percentage of SHG loans by banks under SGSY, out of total 165 Banks
reported the recovery data of SHGs under SGSY, 86 banks (52.2%) had more, Than 80%recovery of as
on 31 March 2010 as against 58.9% as on 31 March 2009.

Agency-wise percentage distribution of banks according to recovery performance is Given in

the table below:-

 Local money lender-but it’s not an organized one. Hence after some days it’s going to vanish.
Because they quite harsh in terms of their recovery. Due to the more lucrative future of this sector
many big players are including in it.
 There is less substitute of microfinance till now. So this industry is more advantageous than other
to get in.

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 Relative price-performance of substitutes-the relative price –performance of substitute is not as
good as the substitutes are not good in terms of accessibility and affordability.

3. Supplier bargaining power: How much bargaining power do suppliers have?

While deciding the bargaining power of suppliers we have to look upon to the
 Number of possible suppliers and the strength of competition between suppliers-here the number
is not more as per the market required. But till now the suppliers are playing games in terms of rate
of interest due to more demand of the loner. Hence their power is more till now. Hence good to
enter.

There are also more players newly entered in MFIs. But by having a glance at it we can easily get
to know that the scope here is pretty much.

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 The services of the competitors are nearly similar. But only looking at the demand and their
accessibility they are tapping the marketing.
 Importance of sales volume to the supplier-the supply has less importance then the recovery.
Hence the volume is less effective.
 Cost to the firm of changing suppliers (switching cost)-the switching cost is more. Hence the
suppliers are less concern about the buyers.
 The presence of substitute inputs-due to less substitute services the bargaining power of is more in
comparison to allied services.
 Vertical integration of the supplier or threat to become vertically integrated-here the integration is
more due to the merger between lender MFI and the loner business.

4. Customer bargaining power: How much bargaining power do customers have?

Customers bargaining power here is less because they are having need for finance. The points
under it are
 Volume of goods or services purchased- in this scenario the chunk is taken by the needy people
but they don’t have any alternative for that. Hence they don’t have bargaining power here. The
volume of fund has given in the previous table.
 As such maximum people don’t go for any brand for this matter. Hence here is no brand
recognition. In fact people believe in local funding organization.

Success Factors of Micro-Finance in India

Over the last ten years, successful experiences in providing finance to small entrepreneur and
producers demonstrate that poor people, when given access to responsive and timely financial services
at market rates, repay their loans and use the proceeds to increase their income and assets. This is not
surprising since the only realistic alternative for them is to borrow from informal market at an interest
much higher than market rates. Community banks, NGOs and grass root savings and credit groups
around the world have shown that these microenterprise loans can be profitable for borrowers and for
the lenders, making microfinance one of the most effective poverty reducing strategies.

A. For NGOs

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 1. The field of development itself expands and shifts emphasis with the pull of ideas, and NGOs
perhaps more readily adopt new ideas, especially if the resources required are small, entry and exit
are easy, tasks are (perceived to be) simple and people’s acceptance is high – all characteristics
(real or presumed) of microfinance.
2. Canvassing by various factors, including the National Bank for Agriculture and Rural Development
(NABARD), Small Industries Development Bank of India (SIDBI), Friends of Women’s World
Banking (FWWB), Rashtriya Mahila Kosh (RMK), Council for Advancement of People’s Action
and Rural Technologies (CAPART), Rashtriya Gramin Vikas Nidhi (RGVN), various donor funded
programmes especially by the International Fund for Agricultural Development (IFAD), United
Nations Development Programme (UNDP), World Bank and Department for International
Development, UK (DFID)], and lately commercial banks, has greatly added to the idea pull.
Induced by the worldwide focus on microfinance, donor NGOs too have been funding
microfinance projects. One might call it the supply push.
3. All kinds of things from khadi spinning to Nadep compost to balwadis do not produce such
concrete results and sustained interest among beneficiaries as microfinance. Most NGO-led
microfinance is with poor women, for whom access to small loans to meet dire emergencies is a
valued outcome. Thus, quick and high ‘customer satisfaction’ is the USP that has attracted NGOs
to this trade.
4. The idea appears simple to implement. The most common route followed by NGOs is promotion of
SHGs. It is implicitly assumed that no ‘technical skill’ is involved. Besides, external resources are
not needed as SHGs begin with their own savings. Those NGOs that have access to revolving funds
from donors do not have to worry about financial performance any way. The chickens will
eventually come home to roost but in the first flush, it seems all so easy.
5. For many NGOs the idea of ‘organising’ – forming a samuha – has inherent appeal. Groups
connote empowerment and organising women is a double bonus.
6. Finally, to many NGOs, microfinance is a way to financial sustainability. Especially for the
medium-to-large NGOs that are able to access bulk funds for on-lending, for example from SIDBI,
the interest rate spread could be an attractive source of revenue than an uncertain, highly
competitive and increasingly difficult-to-raise donor funding.

B. For Financial Institutions and banks

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 Microfinance has been attractive to the lending agencies because of demonstrated
sustainability and of low costs of operation. Institutions like SIDBI and NABARD are hard nosed
bankers and would not work with the idea if they did not see a long term engagement – which only
comes out of sustainability (that is economic attractiveness).
On the supply side, it is also true that it has all the trappings of a business enterprise, its output is
tangible and it is easily understood by the mainstream. This also seems to sound nice to the
government, which in the post liberalisation era is trying to explain the logic of every rupee spent. That
is the reason why microfinance has attracted mainstream institutions like no other developmental
project.
Perhaps the most important factor that got banks involved is what one might call the policy
push. Given that most of our banks are in the public sector, public policy does have some influence on
what they will or will not do. In this case, policy was followed by diligent, if meandering, promotional
work by NABARD. The policy change about a decade ago by RBI to allow banks to lend to SHGs was
initially followed by a seven-page memo by NABARD to all bank chairmen, and later by sensitisation
and training programmes for bank staff across the country. Several hundred such programmes were
conducted by NGOs alone, each involving 15 to 20 bank staff, all paid for by NABARD. The policy
push was sweetened by the NABARD refinance scheme that offers much more favourable terms
(100% refinance, wider spread) than for other rural lending by banks. NABARD also did some system
setting work and banks lately have been given targets. The canvassing, training, refinance and close
follow up by NABARD has resulted in widespread bank involvement.
Moreover, for banks the operating cost of microfinance is perhaps much less than for pure
MFIs. The banks already have a vast network of branches. To the extent that an NGO has already
promoted SHGs and the SHG portfolio is performing better than the rest of the rural (if not the entire)
portfolio, microfinance via SHGs in the worst case would represent marginal addition to cost and
would often reduce marginal cost through better capacity utilisation. In the process the bank also earns
brownie points with policy makers and meets its priority sector targets.

It does not take much analysis to figure out that the market for financial services for the 50-
60 million poor households of India, coupled with about the same number who are technically above
the poverty line but are severely under-served by the financial sector, and is a very large one.
Moreover, as in any emerging market, though the perceived risks are higher, the spreads are much
greater. The traditional commercial markets of corporate, business, trade, and now even housing and

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consumer finance are being sought by all the banks, leading to price competition and wafer thin
spreads.

Further, bank-groups are motivated by a number of cross-selling opportunities in the market, for
deposits, insurance, remittances and eventually mutual funds. Since the larger banks are offering all
these services now through their group companies, it becomes imperative for them to expand their
distribution channels as far and deep as possible, in the hope of capturing the entire financial services
business of a household.

Finally, both agri-input and processing companies such as EID Parry, fast-moving consumer
goods (FMCG) companies such as Hindustan Levers, and consumer durable companies such as Philips
have realised the potential of this big market and are actively using SHGs as entry points. Some
amount of free-riding is taking place here by companies, for they are using channels which were built
at a significant cost to NGOs, funding agencies and/or the government.

On the whole, the economic attractiveness of microfinance as a business is getting established

and this is a sure step towards mainstreaming. We know that mainstreaming is a mixed blessing, and
one tends to exchange scale at the cost of objectives. So it needs to be watched carefully.

A real life Examples :

Lakshmi, a 22-year-old school dropout, lived in a remote village of Tamil Nadu. Instead
of getting married and starting a family like any other village girl of her age in India, she wanted to set
up on her own business.

Lakshmi started an Internet kiosk in her village, offering services like e-mail, Internet chat
and tips on health and education. The kiosk was partially financed by ICICI Bank and was set up in
association with n-Logue Communications. Latha, a 29-year-old married woman with three children
borrowed Rs.18,000 to set up a small provision store in Kothaipalli, a small village, in the north of
Andhra Pradesh. Within a year, she started earning Rs.3500 a month from the store. With this money,
she was able to provide her children a good education at a local private school. She was a part of a self
help group in Andhra Pradesh which received financial assistance from ICICI Bank. These are real-life

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examples to illustrate how the micro-lending initiatives of ICICI Bank affected the lives of poor
women in India.
By becoming a part of self-help groups, several rural women were able to move out of
poverty. Apart from financial benefits, the initiatives helped the women to develop self confidence,
improve their communication skills and raise their position in society.

Issues in Microfinance
Sustainability

The first challenge relates to sustainability. MFI model is comparatively costlier in terms of delivery
of financial services. An analysis of 36 leading MFIs by Jindal & Sharma shows that 89% MFIs
sample were subsidy dependent and only 9 were able to cover more than 80% of their costs. This is
partly explained by the fact that while the cost of supervision of credit is high, the loan volumes and
loan size is low. It has also been commented that MFIs pass on the higher cost of credit to their clients
who are ‘interest insensitive’ for small loans but may not be so as loan sizes increase. It is, therefore,
necessary for MFIs to develop strategies for increasing the range and volume of their financial
services.

Lack of Capital

The second area of concern for MFIs, which are on the growth path, is that they face a paucity of
owned funds. This is a critical constraint in their being able to scale up. Many of the MFIs are socially
oriented institutions and do not have adequate access to financial capital. As a result they have high
debt equity ratios. Presently, there is no reliable mechanism in the country f or meeting the equity
requirements of MFIs.

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 The IPO issue by Mexico based ‘Compartamos’ was not accepted by purists as they thought it
defied the mission of an MFI. The IPO also brought forth the issue of valuation of an MFI. The book
value multiple is currently the dominant valuation methodology in microfinance investments. In the
case of startup MFIs, using a book value multiple does not do justice to the underlying value of the
business. Typically, start ups are loss making and hence the book value continually reduces over time
until they hit break even point. A book value multiplier to value start ups would decrease the value as
the organization uses up capital to build its business, thus accentuating the negative rather than the
positive.

Financial service delivery

Another challenge faced by MFIs is the inability to access supply chain. This challenge can be
overcome by exploring synergies between microfinance institutions with expertise in credit delivery
and community mobilization and businesses operating with production supply chains such as
agriculture. The latter players who bring with them an understanding of similar client segments, ability
to create microenterprise opportunities and willingness to nurture them, would be keen on directing
microfinance to such opportunities. This enables MFIs to increase their client base at no additional
costs.

Those businesses that procure from rural India such as agriculture and dairy often identify finance
as a constraint to value creation. Such businesses may find complementarities between an MFI’s skills
in management of credit processes and their own strengths in supply chain management.

ITC Limited, with its strong supply chain logistics, rural presence and an innovative transaction
platform, the e-choupal, has started exploring synergies with financial service providers including
MFIs through pilots with vegetable vendors and farmers. Similarly, large FIs such as Spandana foresee
a larger role for themselves in the rural economy ably supported by value creating partnerships with
players such as Mahindra and Western Union Money Transfer.

ITC has initiated a pilot project called ‘pushcarts scheme’ along with BASIX (a microfinance
organization in Hyderabad). Under this pilot, it works with twenty women head load vendors selling
vegetables of around 10- 15 kegs per day. BASIX extends working capital loans of Rs.10, 000/- ,
capacity building and business development support to the women. ITC provides support through
supply chain innovations by:

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1. Making the Choupal Fresh stores available to the vendors, this avoids the hassle of bargaining and
unreliability at the traditional mandis (local vegetable markets). The women are able to replenish
the stock from the stores as many times in the day as required. This has positive implications for
quality of the produce sold to the end consumer.
2. Continuously experimenting to increase efficiency, augmenting incomes and reducing energy usage
across the value chain. For instance, it has forged a partnership with National Institute of Design
(NID), a pioneer in the field of design education and research, to design user-friendly pushcarts that
can reduce the physical burden.
3. Taking lessons from the pharmaceutical and telecom sector to identify technologies that can save
energy and ensure temperature control in push carts in order to maintain quality of the vegetables
throughout the day. The model augments the incomes of the vendors from around Rs.30-40 per day
to an average of Rs.150 per day. From an environmental point of view, push carts are much more
energy efficient as opposed to fixed format retail outlets.

HR Issues
Recruitment and retention is the major challenge faced by MFIs as they strive to reach more
clients and expand their geographical scope. Attracting the right talent proves difficult because
candidates must have, as a prerequisite, a mindset that fits with the organization’s mission.

Many mainstream commercial banks are now entering microfinance, who are poaching staff
from MFIs and MFIs are unable to retain them for other job opportunities, 85% of the poorest clients
served by microfinance are women. However, women make up less than half of all microfinance staff
members, and fill even fewer of the senior management roles. The challenge in most countries stems
from cultural notions of women’s roles, for example, while women are single there might be a greater
willingness on the part of women’s families to let them work as front line staff, but as soon as they
marry and certainly once they start having children, it becomes unacceptable. Long distances and long
hours away from the family are difficult for women to accommodate and for their families to
understand.

4. Adverse selection and moral hazard

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 The joint liability mechanism has been relied upon to overcome the twin issues of adverse
selection and moral hazard. The group lending models are contingent on the availability of skilled
resources for group promotion and entail a gestation period of six months to one year. However, there
is not sufficient understanding of the drivers of default and credit risk at the level of the individual.
This has constrained the development of individual models of micro finance. The group model was an
innovation to overcome the specific issue of the quality of the portfolio, given the inability of the poor
to offer collateral. However, from the perspective of scaling up micro financial services, it is important
to proactively discover models that will enable direct finance to individuals.

5. Microfinance Interest rates:

This is perhaps the most contentious issue in this whole debate. It has been reported in the media
that MFIs charge between 26-60% p.a. effective rates. The truth is MFIs do charge higher rates than
banks and very few, if any, charge more than 36%, all inclusive. Someone who is doing it at more than
40% is probably not the MFIs as we know them. It would be good to check the credentials of these
entities just to be sure if they really qualify to be a part of the industry or just wearing MFI hats to get
away with their exploitative businesses.

Having said that, let us put these interest rates (26-36%) in perspective. In order to do so it is
important to start with a comparison to loans that are available to relatively well off people. Keeping
aside the intended purpose for a moment, a credit card loan can probably be considered the closest
comparative to a microfinance loan.

Average credit card balances are typically smaller than other loans and, most importantly,
unsecured. You pay anywhere between 24-36% effective on these loans. One could still argue that poor
people should have access to this service at a cheaper price compared to the rich. In theory it sounds
good but in practice we are yet to see a viable and scalable model that can achieve this. Several
industry experts touched on this subject and tried to explain why MFIs charge high rates and why
indiscriminate subsidies do not go a long way in serving the needs of the poor. Notwithstanding high
operating costs in delivering loans at clients’ doorstep which primarily drive the interest rates to the
levels mentioned above, let us try and understand in simple terms what these interest rates really mean
for cash flows of the poor: MFIs in India lend an average of Rs. 10,000 ($200) per borrower and charge
12% – 15% flat rate + 2-3% upfront fees (translates into 26-36% effective rate). Without bothering

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about how much is it in terms of effective interest rate, let us understand how these rates translate into
absolute amount and how that could affect the borrowers.  15% flat rate literally means Rs. 1,500 ($30)
interest on a Rs. 10,000 ($200) loan because the interest is computed on disbursed amount and not
declining loan balance. It is perhaps  safe to  assume that upfront fee of 2-3% i.e., Rs. 200-300 ($4-$6)
is good for covering initial group formation, loan processing and disbursement costs, considering the
number of trips (4 to 6) a loan officer makes to the client location before the loan is issued.

One should also note (and make sure) that the borrower pays nothing else to obtain or repay
the loan, not even a visit to MFI office except on the disbursement day. Most MFIs collect loans in 50
weekly cycles. Rs. 1,500 ($30) interest literally means Rs. 125 ($2.5) per month or Rs. 30 ($0.75) per
week. From MFIs’ standpoint, Rs. 15 ($0.38) of this weekly interest collected is remitted directly to
banks in the form of interest on borrowed funds, it costs at least Rs. 11-12 ($0.30) to deliver the
services at the clients’ doorstep, if managed efficiently, and Rs. 2 ($0.05) is set aside to cover for
possible defaults leaving Rs. 1-2 ($0.05) as margin.  Not much of a margin really. This does not mean
to say though that there are no greedy players in the industry. They are however exceptions than the
norm.

Profit is good for any business but profiteering is not. If we consider credit as a service
similar to any others such as phone, cable, electricity and so on, it is not unusual for someone of the
profile of an MFI client to be buying a talk time of Rs. 125 ($2.5) or paying for electricity in similar
amount in a month. We know that these services offer great value and intended to improve the quality
of life of clients and their families in addition to making profits for the provider. Similarly a Rs. 10,000
($200) loan goes a long way in meeting working capital needs of a small shop or a dairy unit or a small
farm or treatment of a sick family member or fees for a college student.

Now, let us assume that MFIs reduce the interest rates to 7.5% flat (half of the original rate)
which translates into approx. 15% effective rate, close to commercial bank lending rates. The interest
obligation ends up to be Rs. 62.5 ($1.25) per month or Rs. 15 ($0.38) per week. So, it sounds like the
argument is essentially about the difference of Rs. 62.5 ($1.25) per month or Rs. 15 ($0.38) per week
per average MFI loan. It is hard to believe that someone would end his/her life for less than Rs. 100
($2). Even for someone with 5 loans of similar nature total interest obligation does not seem worth
one’s life. Based on this logic the real problem seems to lie somewhere else, certainly not in interest
rates per se.

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6. Report of the Committee on CREDIT RELATED ISSUES UNDER SGSY

India had experimented with numerous self-employment programmes. These were modified,
consolidated and integrated into Swarnajayanti Gram Swarojgar Yojana (SGSY) in April 1999.
Since then, SGSY has made rapid progress over time covering more than 31 lakh Self-Help Groups
(SHGs).

However, only 22 per cent of the SHGs were provided with bank finance for undertaking
income generating activities including micro enterprises.  What is worse, the bank assistance was
abysmally low leading to low level of investment activity.  This shortcoming has been attributed to
failure of public intervention to enhance the credit absorption capacity of SHGs as well as to the
failures of credit delivery systems to reach the poor.  Since most of the SHGs were engaged in low
technology and less productive traditional activities, the income gains to SHGs were very meagre.

Hence, SGSY had not been able to make substantial impact on the living standards of the
swarojgaris.   The proposed two pronged strategy of universalization of coverage of SHGs with
doubling the proportion of SHGs assisted by bank credit and providing skills at least to one youth of a
Below Poverty Line (BPL) family necessitates restructuring of SGSY.

There is also need to strengthen the capabilities of the poor for bringing them into
mainstream of development as active partners.  It is in this context, the Ministry of Rural Development
(MoRD), Government of India (GOI), constituted a Committee on Credit Related Issues under SGSY
in April 2008 to analyze the constraints in the adequate flow of credit to SHGs of SGSY and to suggest
measures and strategies for promoting effective credit linkages to the SHGs.

The Committee is mandated to analyze innovative experiments initiated by the government

as well as Non-Government Organizations (NGOs), and also examine the issue of provision of interest
subsidy in place of capital subsidy.  The members of the Committee comprised of government
functionaries dealing with rural development both from the Centre and States and representatives of the
Planning Commission, Reserve Bank of India (RBI), National Bank for Agriculture and Rural
Development (NABARD) and State Bank of India (SBI).

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References
- www.ifmr.ac.

– www.google.com

– www.microfinanceinsight.com

– www.investopedia.com

– www.books.google.com

– www.seepnetwork.org

– www.forbes.com

– www.nationmaster.com

– www.thaindian.com

– www.authorstream.com

– www.knowledge.allianz.com

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