Basics of Microfinance

Some Basic Question

• Why do we need finance?

• 􀂄 credit is an instrument for investment and growth.
• 􀂄􀂄 Why the special need for finance for the underserved
communities?
• 􀂄􀂄 Same as above - Shift in Perspective: From poverty alleviation
to wealth generation ---microfinance will enable wealth
generation
• 􀂄􀂄Why do poor still go to unorganized financial institutions (money
lenders, shaukars, ...)?
• 􀂄􀂄 We will look at this during the talk
• 􀂄􀂄 Why is the spread of microfinance so slow?
• 􀂄􀂄 Commercial financial institutions are not ready to enter this arena
• 􀂄􀂄 Why are commercial banks hesitant to enter microfinance?
• 􀂄􀂄 We will explore this in the talk
 General Belief

• Poor are too difficult to reach.

• 􀂄􀂄 Small loans to poor is not a financially
viable proposition
• 􀂄􀂄 Financial institutions will loose money
when they give microcredit to the poor
• 􀂄􀂄 Microcredit or microloans will only increase
the debt burden for the poor
• Do you agree? What is your opinion?
 Microfinance (mFI)
• A clever scheme for
small-savings and small loan
for the underserved
community
•􀂄􀂄A financial service for the
poor
• A financial approach
empowering the poor
• Microfinance brings in
incremental changes
• It does not bring in
dramatic changes like the
ones that occur when a
company goes in for an
IPO
• Microfinance may also be
considered a tool to give
poor people the opportunity to
Participate fully in economic life.
• Will improve the village
Economy.
• Facilitate increase in cash
Flow.
• Bring more villages into the
market; monetize more
Villages.
• Help generate trade thru
Micro-enterprises.
 Microfinance: Interplay Among ..

• Institutions:
• Access points for the poor to get financial services
(e.g. SEWA, Grameen Bank, Vikram Akula’s SKS
Foundation, BASIX, etc.)
• These could be bank branches (could be virtual
branches), socially oriented financial institutions, or a
partnership between the two Funding Sources:
• Domestic savings (~70%),
• “private socially responsible citizens” (~30%)
• Infrastructure: Here ICT (Information Communication
Technology) can play a major role.
 Unorganized mFI Institutions (mFI)
• Exorbitant interest rates
􀂄􀂄 On the low end 3% per month
(36% per annum)
􀂄􀂄 can be much more.
• Often collateral, like cattle,
jewelry, etc not returned
􀂄􀂄 Often the poor get into a debt
cycle for life!
􀂄 UmFI does not give loans for
sustainability (for e.g. starting
a micro-enterprise!)
Still the poor approach UmFI --
-- Why?
􀂄􀂄 Always available (always on!)
􀂄􀂄 You get it when you really
need it.
􀂄􀂄 Quick disbursement
􀂄􀂄 Negligible transaction time
􀂄􀂄 Poor go for micro-loans just
before they rally need it.
􀂄􀂄 Loans without collateral
􀂄􀂄 Dependence of low-income
households on informal
sources for loans is nearly 78%.

The poor not only has low income but irregular cycle of payments
and withdrawals. The informal financial institutions (money lenders)
satisfy this need to the tee
 Some Facts

• There are an estimated 3,000 microfinance

• initiatives serving the world's poor scarcity of money and
participation by commercial financial institutions has
limited their expansion.
• More than 70 percent of them serve fewer than 2,500
• borrowers each.
• Only 30 microfinance initiatives have grown to
serve more than 100,000 poor borrowers.
• The largest mFI, Grameen Bank in Bangladesh,
reaches more than three million borrowers currently.
• A total of $4 billion has been disbursed since Grameen
started giving loans in 1976 with seed loans starting as
small as $35.
 India …

• Earliest Initiative
• Shri Mahila SEWA (Self Employed Women’s Association) Sahakari
Bank was set up in 1974
• Since then, the bank is providing banking services to the poor self-
employed women working as hawkers,vendors, domestic servant
etc.
• SEWA bank has 1,75,000 depositors; about 70% fromurban area,
30% from rural areas
• The deposit and loan portfolio stood at Rs 623.9 million ($13.86
million) and Rs133.6 million ($2.97 million)respectively.
• Vikram Akula’s SKS Foundation (more recent)
• BASIX
• ICICI bank …
• MFIs are picking up in India
 India …

• Retail credit outlets of the formal banking sector in the rural areas
comprising 12,000 branches of districtlevel cooperative banks over 14,000
branches of the Regional Rural Banks (RRBs) over 30,000 rural and semi
urban branches of commercial banks besides almost 90,000 cooperatives
credit societies at the village level.

• On an average, there is at least one retail credit outlet for about 5,000 rural
people.

• While there is no published data on private mFIs operatin in India, the

number of mFIs is estimated to be around 800.

• Not more than 10 mFIs are reported to have an outreach of 100,000

microfinance clients.

• An overwhelming majority of mFIs are operating on a smaller scale with

clients ranging between 500 to 1500per mFI.
Typical Target Population for MFIs

• Rural Poor Women

• 􀂄􀂄 Asset value less than Rs. 20,000/-
• 􀂄􀂄 Per capita income is less than Rs.
350/- per month
• 􀂄􀂄 Live in poor housing conditions
 Different types of Microfinance Institutions

• Institutions that offers financial services to low income people at the

prevailing market rates.
• Most of these provide micro credit and accept small payments for
saving and repayment of loans.
• They do not take saving from the general public. They take
savings from their cliental – mainly the low income group.
• NGOs which are wholly involved in this or partly. The
ones partly involved do several other work that is done
by an NGO.

• 􀂄􀂄 Credit Unions
• 􀂄􀂄 Private commercial banks
• 􀂄􀂄 Non-bank financial institutions (foundations, etc.)
 Appropriateness of mF

• Opportunity and the credit can be used to exploit this

opportunity to develop a sustainable source of income.
• Microfinance is not appropriate for extremely poor,
destitutes
• There has to be some viable way of micro-loan
repayment
• People who are extremely poor may get into debt
trap with microfinance
• Numbers vary, but some feel that one has to have
98% loan repayments rate for an MFI to succeed.
 Some Data on Financial Sector in Rural
Areas (2002)

• For 630,000 villages we have

32,443 bank branches
• Of the ~67,000 bank branches
in India, ~32,500 or ~48 per • The per capita deposit in rural
cent are in rural India areas is Rs 2,000
• The average population served • Dependence of low-income
by a rural bank is approx. households on informal
15,000 sources for loans is nearly 78
• Overall, 18 per cent of the per cent.
rural population has bank
accounts. The comparative
figure in urban India
is almost 100 per cent
 Different Financial Services under
Microfinance

• Deposit services
• 􀂄􀂄 Credit lines
• 􀂄􀂄 Term loans
• 􀂄􀂄 Money transfers
• 􀂄􀂄 Crop and life insurance
 Innovation in Microfinance

• Development of finance products for the

underserved
• 􀂄􀂄 Management of credit risk
• 􀂄􀂄 minimization losses in giving credit
• 􀂄􀂄 Exploit Technology
• 􀂄􀂄 Scalability: how to reach a vast, diverse, not
easy to reach and geographically scattered
populace
• 􀂄􀂄 Exploit technology
• 􀂄􀂄 Efficient delivery of micro credit
 Micro credit

• Delivery of microcredit has to be done more and more

efficiently
• Here ICT can play a major role
• Determination of a borrower's willingness and ability to
repay a loan is critical if a micro lender is to minimize
credit risk
• Willingness to repay a loan are complex and
determined by economic, legal and moral incentives
• Legal systems and community pressure (for rural areas)
contribute to a borrower's willingness to repay a loan
• Ability refers to a borrower having the financial
resources to make a scheduled loan payment.
 Micro credit

• Three operational areas on which a

micro lender should focus to minimize
credit risk:
• 􀂄􀂄 loan design
• 􀂄􀂄 underwriting
• 􀂄􀂄 loan servicing
 Micro-Loan Design

• Balance between affordability needs of borrowers and costs to

micro-lenders
• Revolves on the design of interest rates (must cover operating
costs, credit risk and funding costs)
• Interest are very critical to microfinance institution
• mFI interest are not very low at present
• 15% to 36% per annum (SEWA charges 15% to 18%)
• Note: RBI interest ceiling is 21%
• On the other hand, for rural poor, it has been observed that the
amount of monthly payment is much more important than interest
• As long as they are comfortable with the scheduled payment
amount they do not worry too much about interest rates
 Micro-loan Underwriting

• The process of determining a borrower's

credit worthiness, ability and willingness to
repay a loan
• Most important from the micro lender's
point of view
 Micro-Loan Servicing

• Balance of a loan

• In commercial banking, loan payments are made by bank draft or by

directly debiting payroll or a bank account.
• Things are not easy in the world of microfinance.
• The typical borrower does not have access to a bank account and often
does not receive a formal salary.
• This means that for many customers of micro lenders making loan
payments can be difficult and put them in the position of making the choice
to take time off from work
• (and possibly get fired) in order to deliver a loan payment or choose not to
make a payment.
• Successful lenders will set up payment kiosks in communities. The kiosks
are typically open before the typical work day starts and after it ends.
• Another effective method, albeit more labor intensive is door-to-door
collections.
 Micro-Loan Servicing …

• Provide positive incentives for payment.

• Borrowers respond well to positive incentives for good payment
history.
• Micro lenders and mortgage lenders have successfully used
incentives such as payment rebates, small appliances and food to
achieve very high levels of repayment.
• For example, one Mexican lender offered a free bag of corn meal if
a borrower made timely payments for six months. The result was a
delinquency rate of less than 1%
• Be proactive in dealing with delinquencies.
• Rather than wait until a loan goes into default, a micro lender should
investigate a loan within weeks of it first becoming delinquent.
• Often, the cause of a delinquency is due to illness or
unemployment.
• If caught early enough a lender can give the borrower assistance as
well as workout a equitable repayment plan.
 Challenges

• Establishing the idea of access to financial services as human right;

just like health care, education etc. are basic rights (Mathew Bishop,
Business Editor of The Economist)

• Managing credit risks in micro lending operations

• Convincing, for profit organizations like established banks, non-bank

financial institutions, that microfinance is a good business
opportunity and they should commit large capital to establish this
business.

• Also convincing them that charity (funds donated by established

organization) is not a sustainable way for growth

• Developing a market driven interest rate schedule for the poor

 Challenges …

• Reaching people in sparsely populated, diverse, not easy to reach,

and geographically scattered areas
• Most important challenge is to exploit technology to reduce
transaction costs so that financial institutions will indeed take up
microfinance as one of their major service.
• Reaching the poorest of the poor – the destitute:
• Many ignore this segment
• Very difficult for a commercial institution to recover micro-credit
given to this segment
• Here Government will have to step in and develop a scheme for
micro grants
• Make microfinance part of main stream financial market