MICROFINANCE MODELS

A Comparative Study of Different Microfinance Models

04-Nov-15
IIFM
Raju Kumar & Sunil Verma
 MICROFINANCE MODELS 2015

Introduction

Global View
Microfinance is a collective term used for financial intermediation services to low income group
and poor customers. Services offered to them are Credit facility, saving accounts, Money
transfers, Remittances, Insurance and even Investments. Since access to financial services is
constraints for the poor and for those marginal farmers, so there is some mechanism in which
poor people use not only the credit but also saving services, insurance and affordable
remittance system to manage assets, generate income and improve their living standards.
According to Pati, Microfinance refers to small-scale financial services including both credits
and deposits provided to people who farm or fish or herd; operate small or microenterprises
where goods are produced, recycled, repaired or traded; provide services; work for wages or
commissions; gain income from renting out small amount of land, vehicles, draft animals, or
machinery and tools; in both
rural and urban areas (A P Pati,
2009).

However, microfinance may

mean the provision of banking
services to low-income group,
especially the poor and the
very poor but still poor can
save and can indeed use a wide
Figure 1: Developments in Microfinance-Global (Source: Piyush Madhukar, IIM
range of financial services. Indore)

Here is a global evolution picture of microfinance where it is shown that microfinance has an
immense potential to meet those poor people basic human need (half the world’s population
living less than US$2 per day). Currently, profitable MFIs are present in the most countries
reporting huge return on assets and return on equity in comparison to conventional banking
institutions with different financial approaches for lending loans and other benefits.

IIFM Page 2
 MICROFINANCE MODELS 2015
Indian Perspective
Even if we consider India only; that is 3 rd largest growing economy after US and China, there
also, approximately 67% population lives below US$2 per day. It is up to us to decide the lower
cap for the poor people where we want to put them in the continuum of poverty trap because
US$2 per day is not sufficient to sustain a healthy life for any individual. NABARD (National Bank
of Agriculture and Rural Development) & SIDBI (Small Industries Development Bank of India)
have taken initiatives and are devoting their time and financial resources towards the
development of microfinance to support poor people of rural India. However, their reach in
rural India is not so significant and
that is why they have collaborated
with different NGOs to turn on the
every corner stone of rural India.
Finance institutions discovered
various models for the disbursement
of microfinance products and services.

Success of any MFIs largely depends

upon the diversity of model they
Figure 2: Development of MF- India (Source: Piyush Madhukar, IIM
adopt for lending loans and providing Indore)

other financial benefits to poor. The credit lending can either be individual or group. In
individual lending, credit is provided to individuals whereas group lending involved formation of
a group and provision of credit to those groups. India has adopted home grown models in this
respect. For example- SHG, JLG and other learnt models from different countries like
Bangladesh, Thailand, and Bulgaria. Individual lending models are adopted by formal financial
institutions like banks whereas group lending models are used by microfinance institutions as
well as banks. MFIs shouldn’t be judged only by their financial contribution or financial models
that they have adopted but also by their impact on thinking, working habits, and attitude of
their clients and the business community in general.

IIFM Page 3
 MICROFINANCE MODELS 2015

Literature Review
According to ACCION, “Credit Unions are a non-profit, co-operative financial institution owned
and run by its members. Members pool their funds to make loans to one another. The
volunteer board that runs each credit union is elected by the members. Most credit unions are
organized to serve people in a particular community, group or groups of employees or
members of an organization or association”.

According to Reserve Bank of India (RBI), “A self-help group (SHG) is a registered or

unregistered group of micro entrepreneurs having homogeneous social and economic
background voluntarily, coming together to save small amounts regularly, to mutually agree to
contribute to a common fund and to meet their emergency needs on mutual help basis. The
group members use collective wisdom and peer pressure to ensure proper end-use of credit
and timely payment thereof. In fact, peer pressure has been recognized as an effective
substitute for collaterals”.

The continuity of this micro-banking with support from the intermediaries gradually builds
financial discipline among the members. When the SHGs are mature in performing all the
necessary operations like saving, credit, group meeting, record keeping, and then they are
linked with banks and the linked banks are encouraged by the higher banking authority to make
loans to the linked SHG subjected to certain terms and conditions. In principle and practice, the
loan sanctioned by the banks to the SHGs amounts to certain multiples of the SHGs
accumulated savings. As per the SHG-Bank linkages program, the bank does not take any
collateral for security rather the bank loans are sanctioned against group peer pressure and
social collateral. The loan sanctioning bank charges interest rates as per the market interest
rates. The SHG retains the provision of deciding the terms of individual loan disbursement to its
own members. The peer pressure among the members works on the timely repayment of the
loan. Apart from thrift and credit functions, the SHG provides social security to its members.
(SOURCE: NABARD). The SHG-Bank linkages program in India is considered as one of the biggest
microfinance program in the world, and over the years this program is adopted as part of the
rural finance (Ansari, 2008).

IIFM Page 4
 MICROFINANCE MODELS 2015
According to ACCICON, “Village Banking is a lending methodology in which clients – typically
women – form groups of approximately 10-30 individuals that are autonomously responsible
for leadership, bye-laws, bookkeeping, fund management and loan super-vision. The group
pools funds to use for business loans, savings, and mutual support, and members cross-
guarantee individual loans”.

Figure 3: Institutional Credit Channel to the rural poor. Source: Bose & Khaklari (2007)

According to Kumar (2008), the key features of SHG-Bank linkage program are-

1) Emphasis on saving and linking to the credit amount provided by bank

2) Focus on self-reliance
3) Group dynamism
4) Group autonomy
5) Support mechanism
6) Cost effectiveness
7) Sustainability in terms of financial self-sufficiency.

NBFI (Non-Bank Financial Institution) is an institute that provides similar services to those of a
bank, but is licensed under a separate category. The separate license may be due to lower
capital requirements, to limitations on financial service offerings or to supervision under a
different state agency. Source: The MIX Market.

IIFM Page 5
 MICROFINANCE MODELS 2015
Number of SHGs having been financed by FFIs has increased from 0.2 million in 2001 to 1.1
million in 2004 at the rate of 128 per cent per annum. Number of SHGs financed during a year
as increased f rom0 .26 million in 2001-02 to 0.36 million in 2003-04 with an annual growth of
19.8 per cent. All this information relates to SHGs refinanced b y NABARD only. In the absence
of any centralized information on SHMC, information provided by NABARD has been used for
analysis (Rajaram Dasgupta, 2005).
In spite of the optimism generated in some of the states with regard to SHGs, the fact remains
that the commercial banks fall short of mandated 10 per cent of NBC to weaker sections. At the
same time 40 percent of rural credit which is mostly microcredit is met by Informal Financial
System (IFS) [RBI 2000] (Rajaram Dasgupta, 2005).
Grameen banking approach consists of releasing small loans to groups of five borrowers.
Groups are federated into centers of 20 to 50 borrowers each. Credit is provided to individual
members, while the repayment of loan is made through frequent installments guaranteed by

the group. The differentiating factor for this technique is the concept of joint liability (Swastika

Acharya, 2007).

Partnership model is unique in that it combines both debt as well as mezzanine finance to the
MFI in a manner that lets it grow outreach rapidly, while unlocking large amounts of wholesale

funds available in the commercial banking sector in India (Swastika Acharya, 2007).

MF sector offers an instructive context for exploring the different programmatic implications of
liberal and Marxian theories of social capital. Paradoxically, both perspectives and expression
within the dominant “Grameen model” now endorsed by most of the mainstream development
agencies. Based on that, the model evokes union and feminist traditions in its formulation of
the “solidarity groups” through which women receive credit collateralized by “group
guarantee” rather than by tangible assets (Katharine N. Rankin, 2002).

IIFM Page 6
 MICROFINANCE MODELS 2015

Models of Microfinance institutions

Grameen Bank Model of Bangladesh

The Grameen model was invented in 1976 by Professor Muhammad Yunus, the founder and
managing director of Grameen Bank. In this model a new branch of the MFI is set up in a village
with a field officer and some qualified workers, who have already done research on the
population there in advance and made their choice according to its potential demand and its
need of financial support. These employees of the MFI support then up to 15 to 20 villages in
the surrounding and are strive to make the local, poor people aware of the microfinance
possibilities through word of mouth and personal advisory. Groups of five are created. However
in the beginning only two members of the group receive a loan and are monitored for one
month. The credibility of the group will then be based on the repayment performance of the
first two individuals If they are reliable and could pay back their loan, the remaining members
qualify for a loan as well, since the group is jointly and severally liable for the single members.
The loan is given to first to two members of the group, then to another two, and then to the
fifth group member. Given that loans are being correctly and timely repaid, the cycle of lending
continues.

The MC2 Model (Fotabong, 2011)

The principal promoter of MC 2 model is Dr. Paul K. Fokam. MC 2 are rural development micro-
banks created and managed by a community in keeping to their local values and customs. MC2
is a community based micro banking approach whereby people and mostly the underprivileged
endeavor to be self-reliant, create wealth with a view to improving their living conditions in a
sustainable manner.

The model has two versions:

 A rural version, MC2 and an urban version dubbed MUFFA.

 The second version of the model is exclusively for women because studies and personal
research of the founder show that women in urban areas are those most hit by poverty.

IIFM Page 7
 MICROFINANCE MODELS 2015
Followings are the main objectives of the MC2 Model

 MC2 micro bank is economic and financial sustainability from the perspective of the
micro bank, the individuals and group members.

 MC2 is the social dimension. This involves targeting the poor, micro and small scale
activities and consequently restoring dignity to target beneficiaries to see the
importance of being masters of their destiny.

Stages involved in formation of MC2 Model

Financing Financing
Sensitising Carrying Out
Individual Common
the Poor and Mobilising Social
Income Interest
Raising their Resources Development
Generating Economic
Awareness Projects
Activities Projects

Figure 4: Stages of MC2 Model

1. Sensitizing the Poor and Raising their Awareness:- In the first stage of the MC 2 micro-
bank development, the target community population particularly the poor are sensitized
and their awareness raised on:

IIFM Page 8
 MICROFINANCE MODELS 2015
• The importance of savings in their struggle for self-reliance. This is done through
community gatherings, association gatherings and empowerment forums

• The need to firstly rely on oneself before expecting any external assistance

• The pride in remaining the sole masters of their own destiny.

2. Mobilizing Resources: - Second stage of the micro-bank development is mobilizing the

savings and resources. This involves getting stakeholders committed, raising the startup
capital, paying individual shares subscription and fees, registering the micro-bank, and
opening of individual accounts. These resources mobilized in stage two will enable the
micro-bank commence the lending functions in the third stage of the micro-bank
development.
3. Financing Individual Income Generating Activities: - Stage three, the micro-bank start
granting credits to individual’s income generating activities using the resources
mobilized in stage two. At this level the micro-bank now completes it intermediary
function of facilitating resources from areas of excesses to areas of deficits.
4. Financing Common Interest Economic Projects: - In the fourth stage of micro-bank
development, the micro-bank institution becomes involved in community development
economic activities such as the construction of hospitals, health centers, community
halls, schools, and public taps etc At this level, any MC 2 should be able of raising enough
money from loans and other facilities offered to pay off fixed charges and even show a
surplus that can be considered a profit. These surpluses should be built for a minimum
of two years

5. Carrying Out Social Development Projects: - Final stage of MC2, community social
projects are being financed and carried out with the resources generated in stage three
and four. That is the results are performance registered under stage three and four are
primary for this phase to be carried out.

IIFM Page 9
 MICROFINANCE MODELS 2015
Self-Help Group Model
In SHG model a number of individual of same gender (commonly women) come together and
formed a group and the loan is given to each member of the group seeing the repayment
capacity of each individual. SHG is basically is a small group of people from rural areas and
urban slum areas come together with the intention of solving their socio economic problem
through the regular saving and having access to credit which will lead to livelihood generation
with certain degree of self sufficiency. The main focus of SHG model is to generate livelihood
opportunity at local level and become self sufficiency in term of finance availability.

The SHG Model is based on four important concepts

 Unity is the strength

 Self-help is the best help
 United will stand and divided will fall
 We can make our own bank.

The SHG model focuses more on the overall socio Economic development through the concept
of saving and credit. This model is much in use in India, and almost all NGO use this model.

Credit Delivery to SGHs under microfinance programmes (K.Panda, 2015)

Banks

Direct Mode Indirect Mode

Financial intermediaries

Like NGO, NBFIs

SHGs

IIFM Page 10
 MICROFINANCE MODELS 2015
Methodology of forming Women SHGs (K.Panda, 2015)

Rapport Building with the Villagers

Visiting the village Explaning the Benefits of SHG

Baseline Study
Socio Economic Profile of Women

Formation of groups
Convincing women to orgnaize them Mapping inform ation about their livelihood

Organize SHG meetings

Holding meeting with village leaders

Shapping SHGs
Formation takes 3-4 months Regular visit at SHG palce

Facilating the SHG funcutioning

Common agreement on Deceding penalties for delay in Conducting trainning
date,time and place of meeting paymet programmes

SHG-Bank Linkage
Facilitates the SHG to open a Saving bank account in the name Faciltates SHG to get loan from
bank account of SHG group Bank

Self-sustainability
Training and Capacity Building Allow SHG to perform their function of its own

Figure 5: Flowchart for SHGs Source: (K.Panda, 2015)

IIFM Page 11
 MICROFINANCE MODELS 2015
How MFIs Generate Revenue
Revenue is the important part of any organization without which it cannot sustain for longer
period of time, same in case of microfinance institution also they generate their revenue from
the repayment made by the group members after decreasing the all expenses that are incurred
while carrying out the whole operation cycle. Followings are the main components in
calculating revenue for any MFI (Mia, Dec. 2014).

Cost
MFIs which are providing different financial services like insurance and others incurred many
types of cost they may be direct cost like cost of loan or indirect cost. In general, it can be
distinguished between costs related to financial services and functionally separated costs. Costs
are directly attributable to the micro-financial services included for instance personnel
expenses (e.g. salary for loan officers), refunding of staff transportation and training for loan
officers, loan loss provision, and interest expense on borrowings that refinance the loan
portfolio. Operating expenses of MFIs include most often personnel and administrative costs
and represent a major part of charges to borrowers.

MFIs often have the following categories of costs in their chart of accounts:

 Interest Expenses
 Loan loss Provision
 Staff trainings
 Telephone expenses
 Insurance
 Legal services and fees
 Bank charges
 Taxes
 Depreciation

Generally every MFI has a certain percentage of loan loss provision in its profit and loss account
that needs to be considered as major costs from the outset after operational expenses, reason

IIFM Page 12
 MICROFINANCE MODELS 2015
being that the loan portfolio represents the biggest asset of a MFI, the nonpayment of a loan is
only the biggest risk a MFI might face, Grameen Bank has a 1 percent loan provision on regular
loans and a 100 percent loan provision on overdue loans. The overall repayment rate of
Grameen Bank in 2007 was 98.02 percent (Grameen Bank, 2009). So, to reduce the risk for
those 2 percent buyers MFIs institutions makes loan loss provision.

Revenue
Revenue from the loan portfolio is the main source of revenue for any microfinance because
loan is the main assets for it from which they generate their income. This includes majorly two

components interest charges and fees and commissions. Almost every MFIs allocates ¾ th of its
assets as loan portfolio in order to maximize their returns, These returns in general represent
interest on investments, net gains on financial assets, insurance and other services provided by
MFIs. (Guntz, 2011)

The overall financial revenue can be summarized in the following formula:

Financial Revenue = Revenue from Loan Portfolio + Revenue from Other Financial Assets + Revenue from Other Financial Services

For the revenue from loan portfolio the formula is:

Revenue from Loan Portfolio = Interest on Loan Portfolio + Fees and Commissions on Loan Portfolio

For self sustaining and sustainable MFIs should cover all its expenses from the income
generated from interest, MFIs should also have Operational sustainability which is calculated
from operational self sufficiency ratio OSS in general includes all the cash costs of running a
MFI, depreciation and the loan loss reserve, If this ratio is greater than 100 percent, the MFI is
covering all of its costs through own operations and is not relying on contributions or subsidies
from donors to survive and sustain for longer period of time.

Operational self sufficiency (OSS) is calculated as follows:

From the above we can easily calculate the revenue earned by any MFI for any period of time.

IIFM Page 13
 MICROFINANCE MODELS 2015
Revenue generation model (Self)

Banks/ Financial Institutions

La Int
rg er
e es
t

Microfinance Institutions

l
o
Loan
Interest and Penalties and a Interest and Penalties and
Premium n And other Premium

Services
Individual Group

Conclusion:-
Microfinance is one of the important sectors of every economy. It not only falls in the
development of sectors but also forms an important part of the formal financial system of every
country. It plays its own role in eradicating the poor and provides them a platform from where
they can easily increase their living standards and earn a sustainable livelihood, microfinance
can contribute to solving the problem of inadequate housing and urban services as an integral
part of poverty alleviation programmes, also at the same time contributing to the society there
should be some revenue generation is another part of any organization without which it cannot
sustain for longer period of time. So there is need to find synergy between profit making and
social responsibility of these microfinance institutions so that it becomes sustainable for longer
period of time.

IIFM Page 14
 MICROFINANCE MODELS 2015

References
Acharya, S. (2005). Models in Microfinance.

Ananth, B. (2005). Financing microfinance–the ICICI Bank partnership model.Small Enterprise Development, 16(1), 57-65.

Beck, T., & Levine, R. (1999). A new database on financial development and structure (Vol. 2146). World Bank Publications.

Copestake, J., Dawson, P., Fanning, J. P., McKay, A., & Wright-Revolledo, K. (2005). Monitoring the diversity of the poverty outreach and impact of microfinance:
A comparison of methods using data from Peru. Development Policy Review, 23(6), 703-723.

Dasgupta, R. (2005). Microfinance in India: empirical evidence, alternative models and policy imperatives. Economic and Political Weekly, 1229-1237.

Devi, G., Zala, Y. C., & Jain, D. K. (2014). Micro-finance: A tool for fight against poverty in rural India through self-help group formation. African Journal of
Agricultural Research, 9(53), 3864-3878.

Fotabong, L. A. (2011). Comparing Microfinance Models: MC2 Model versus Other Microfinance Model. Available at SSRN 2007874.

Fotabong, L. A. (2011). Comparing Microfinace Models.

GUPTA, S. L. Loan Portfolio of a Faith-based Microfinance Institution: An Empirical Analysis Najmul HODA.

Guntz, S. (2011). Sustainability and profitability of microfinance institutions.

Kumar, B., & Mohanty, B. (2011). Financial Inclusion and Inclusive Develoment in SAARC Countries with Special Reference to India. Vilakshan: The XIMB Journal
of Management, 8(2).

Mia, M. A. ( Dec. 2014). Does lending to women affect the revenue generation of microfinance institutions.

Pati, A. P. (2009). Financial Sustainability of Micro Financing. Gyan Publishing House.

Rankin, K. N. (2002). Social capital, microfinance, and the politics of development. Feminist economics, 8(1), 1-24.

Sheldon, T., & Waterfield, C. (1998). Business planning and financial modelling for microfinance institutions. The Consultative Program to Assist the Poorest
(CGAP). Technical Tool Series, (2).

Yaron, J., Benjamin, M. P., & Piprek, G. L. (1997). Rural finance: Issues, design, and best practices (Vol. 14). Washington, DC: World Bank.

Zeller, M., Schrieder, G., Von Braun, J., & Heidhues, F. (1997). Rural finance for food security for the poor: Implications for research and policy (Vol. 4). Intl Food
Policy Res Inst.

https://www.accion.org/

http://www.grameenfoundation.org

http://www.mixmarket.org/

https://www.nabard.org/

https://www.rbi.org.in/

http://www.slideshare.net/kabrapiyush/microfinance-introduction-small

IIFM Page 15