BNK 218: Micro Finance and

Rural Banking
BBM 7th semester
NCC- Kathmandu, Nepal
Course Objectives and Course Description
Course Objectives
Familiarize with the basic concept of microfinance, historical background,
products designing, operational procedures, infrastructure development for
micro finance, legal framework and prudential regulation with specific
reference to the Nepalese context; Provide knowledge of micro finance
practices in Nepal along with global development in microfinance sector, To
make able to understand the role of rural microfinance in poverty reduction
and give practical knowledge on microfinance practices.
Course Description
This course contains Introduction to Micro Finance, Approaches to Micro-
finance, Micro Finance Institutions, Product of Micro Finance, Directed or
Deprived Sector lending, Measuring the Performance of MFIs, Matter of
MFIs.
Course Details
Unit 1: Introduction to Micro Finance LH 5
Concept, Definition and principles of microfinance, Characteristics and importance of Microfinance, Historical
Background, Role of microfinance for elevation of poverty, Linkages between main stream financial services &
micro-finance
Unit 2: Approaches to Micro-finance LH 6
Saving led and credit led, Practices and different models (Special reference to Nepal) Grameen replication, Co-
operative, FINGO and Self Help Groups (SHG), Strengths and weaknesses of the various approaches, Social
Banking VS Commercial Banking, Financial access Vs Financial inclusion.
Unit 3: Micro Finance Institutions LH 5
Ownership and Legal Form of MFIs, Objectives of MFIs, The importance of institutions, Organizational
structure, Governance, Types of financial institutions, Offering microfinance services, Capital structure
Management structure, growth and transformation.
Unit 4: Product of Micro Finance LH 8
Saving product- Concept of saving, saving mobilization, Types of saving, compulsory saving, voluntary saving,
Non-financial services, Micro insurance, Pricing of saving product. Credit product: micro credit, individual
credit, Character and cash-flow based lending, Micro enterprises loan,Working capital loan, agricultural loan,
Loan against group guarantee, interest rate and services charges on micro credit,
Unit 5: Directed or Deprived Sector lending LH 6
Meaning and concept, Directed lending- importance, Pros and cons views, Priority sector lending vs. deprived
sector lending, NRB policies for DSL, Penalty in case of default in DSL, Direct lending Vs Indirect lending. Roles
of DSL for increasing productivity.
Course Details
Unit 6: Measuring the Performance of MFIs LH 8
Analyzing financial statements, Financial performance ratios, efficiency and productivity; liquidity and capital adequacy; asset and
liability management, Loan loss and provisioning, Benchmarking ,Rating MFIs, Social Performance Measurement and Impact
performance evaluation of microfinance institutions in the framework of WOCCU model, CGAP model, and SEEP model
Unit 7: Matter of MFIs LH 10
Viability, Efficiency, Sustainability, Self-reliance, Outreach Cooperation, coordination and co-financing with various donors agencies.
The role of governments in microfinance; national microfinance policies, Subsidizing, The Role of Subsidies and Donors, Measuring
subsidy dependence, Traditional microfinance donors and instruments, socially responsible investors Vs commercial investors: Equity
vs. debt financing options, Microfinance investment funds vs Microfinance investment vehicles, Culture of labor division,
Opportunities and challenges of MFIs in Nepal.
Reference
Christen R.P ( 2007). Banking Services for the Poor: Managing for Financial Success, Accion International, Washington DC
Joanna Ledgerwood. 2001. Microfinance Handbook: An Institutional and Financial Perspective:
Sustainable Banking with Poor. Washington D.C: The World Bank.
Rama Bashyal. MICRO FINANCE. Access to Finance for Nepal’s Rural Poor. Institute for Integrated Development Studies, IIDS. 2008.
SBP Micro- Finance Handbook. The World Bank 1997
Simkhada NR, Sharma N, Upreti T (2002) Review for Micro-finance Services in the hills of Nepal.
Centre for Micro-Finance(CMF), Kathmandu, Nepal
Uprety, T.P. (2005), Micro-finance in Nepal, Impact, Opportunities and Challenges, Seminar Paper, Kathmandu, Nepal.
Suggested Reading
Various publication and article published from Nepal Rastra Bank.
Unit 1: Introduction to Micro Finance
Concept of Micro Finance
What is Microfinance?
Finance that is provided to unemployed or low income people or groups.
 The provision of small loans (microcredit) to poor people to help them
engage in productive activities or grow very small businesses. The term
may also include a broader range of services, including credit, savings, and
insurance.
Microcredit is the extension of very small loans to those in poverty
designed to spur entrepreneurship.
Microfinance is a category of financial services targeted at individuals and
small businesses who lack access to conventional banking and related
services. Microfinance services are designed to reach excluded customers,
usually poorer population segments, possibly socially marginalized, or
geographically more isolated, and to help them become self-sufficient.
Concept of Microfinance
Microfinance initially had a limited definition - the provision of
microloans to poor entrepreneurs and small businesses lacking access
to Credit. The two main mechanisms for the delivery of financial
services to such clients were:
(1) relationship-based banking for individual entrepreneurs and small
businesses.
(2) group-based models, where several entrepreneurs come together
to apply for loans and other services as a group.
Over time, microfinance has emerged as a larger movement whose
object is "a world in which as everyone, especially the poor and socially
marginalized people and households have access to a wide range of
affordable, high quality financial products and services, including not
just credit but also savings, insurance, payment services, and fund
transfers.”
Nature of microfinance
For many years microfinance overlapped with microcredit- small loans, often without
traditional guarantees, aimed at improving the lives of clients and their families of
sustaining small- scale economic activities. Traditionally, microfinance is associated with
programes that benefit clients with serious subsistence problems in developing counties.
Nature of microfinance can be outline below;
• Socio-demographic changes over the last few decades have significantly altered the
worked economic scent. For microfinance, the new situation has meant potential new
beneficiaries, new products and a greater involvement of financial intermediaries.
• Exclusion from the traditional financial system, seen as the inability to access basic
financial services, includes millions of people today, both in developing countries and
industrialized countries.
• Traditional poverty thresholds have shifted and new categories of ‘poor’ people have
appeared, even out with developing countries.
• New beneficiaries have brought new financial needs with them. Over the past decade,
new microfinance services have developed alongside microcredit.
• This development has also gained momentum from the observation that structured
financial assistance increased the efficacy of the programmes, while at the same time
improving the level of sustainability.
Evolution of micro-finance
• Microcredit can actually be traced back to the early 1800s when
Jonathon Swift tried to empower families in poverty through the Irish
Loan Fund. While the theory was there, the system was flawed and its
goal of financial independence for the rural population wasn’t
achieved.
• Over a century later, Muhammad Yunus provided a small amount of
his own money to a community in Bangladesh. He was astonished at
how his money was able to rebuild the community. In 1983 he
founded the Grameen (Village) Bank, which created a huge
microcredit industry in Bangladesh.
Growth of micro-finance industry
In 1976, Muhammad Yunus (Nobel Peace Prize Winner 2006) noticed
that small amounts of loans could make a big impact on the poor
peoples’ lives. Grameen Bank, ("Bank of the Villages", in Bangla) was
founded in 1983, was supported by the central bank of Bangladesh.

How does Microfinance work? - System of “microloans” (typically less

than $100) Instead of using collateral to gain credit, loans are secured
against the honor of a peer group: if one person fails to make their
payments, others in the lending circle will be denied future credit. It
has outperformed almost all other forms of development lending. It is
said that microfinance have lifted 100 million people out of poverty
over the last three decades
Principles of Microfinance
Principles of Microfinance, which were developed and practices with the
slogan of “Building financial systems for the poor” by the various institutions
are as follows;
1. The poor need a variety of financial services, not just loans. savings,
insurance and money transfer services
2. Microfinance is a powerful instrument against poverty. Access to
sustainable financial services enables the poor to increase incomes, build
assets, and reduce their vulnerability to external shocks.
3. Microfinance means building financial systems that serve the poor.
4. Financial sustainability is necessary to reach significant numbers of
poor people.
5. Microfinance is about building permanent local financial institutions.
6. Microcredit is not always the answer. small grants, infrastructure
improvements, employment and training programs, and other non-
financial services may be more appropriate tools for poverty alleviation.
Principles of Microfinance
7. Interest rate ceilings can damage poor people’s access to financial
services.
8. The government’s role is as an enabler, not as a direct provider of
financial services.
9. Donor subsidies should complement, not compete with private sector
capital. Donors should use appropriate grant, loan, and equity instruments
on a temporary basis to build the institutional capacity of financial providers,
develop supporting infrastructure (like rating agencies, credit bureaus, audit
capacity, etc.), and support experimental services and products.
10. The lack of institutional and human capacity is the key constraint.
11. The importance of financial and outreach transparency. Accurate,
standardized, and comparable information to adequately assess risk and
returns
Characteristics of Microfinance
Characteristics of Microfinance
• Collateral –Mostly it is collateral free
• Microfinance instructions go through client rather then clients go through MFIs
• Clients-are generally from low income backgrounds
• Simplified savings and loan procedures
• Small size of loans and savings
• The loan tenure is short
• Affordable interest rates
• Loan size increases in the repeated loans or subsequent cycles
• These loans are usually repaid at higher frequencies
• Social security schemes
• Micro financial activity like micro saving, micro insurance, micro payments etc.
• The purpose of most microfinance loans is income generation
• Building relationship and financial literacy
Historical Background of Microfinance
• The history of micro financing can be traced back as far as the middle of
the 1800s, when the theorist Lysander Spooner was writing about the
benefits of small credits to entrepreneurs and farmers as a way of getting
the people out of poverty. Independently of Spooner, Friedrich Wilhelm
Raiffeisen founded the first cooperative lending banks to support farmers
in rural Germany.
• The modern use of the expression "microfinancing" has roots in the 1970s
when Grameen Bank of Bangladesh, founded by microfinance
pioneer Muhammad Yunus, was starting and shaping the modern industry
of microfinancing. The approach of microfinance was institutionalized by
Yunus in 1976, with the foundation of Grameen Bank in
Bangladesh. Another pioneer in this sector is Pakistani social
scientist Akhtar Hameed Khan.
• Since people in the developing world still largely depend on subsistence
farming or basic food trade for their livelihood, significant resources have
gone into supporting smallholder agriculture in developing countries.
History of Micro finance in Nepal
The term microfinance was not used in earlier part of the history of rural
microfinance. It has been found used in Nepal only in the later part of 1990s.
Rural credit in Nepal began in 1956 with the opening of Credit Cooperatives
in Chitwan Valley to provide loans to the re-settlers coming from different
parts of the country.
In 1963, the government established the Cooperative Bank, which was later
converted into the Agricultural Development Bank Nepal (ADBN) in 1968.
The government of Nepal introduced the Cooperative Revitalization Program
in 1971. It authorized the Agricultural Development Bank Nepal to run
cooperatives under its guidance and management.
Nirdhan and the Centre for Self-help Development (CSD) also launched
microfinance programs replicating Grameen model in 1993 and 1994
respectively.
History of Micro finance in Nepal (cont…)
Rural credit in Nepal began in 1956 with the opening of Credit Cooperatives in Chitwan
Valley to provide loans to the re-settlers coming from different parts of the country
In 1963, the government established the Cooperative Bank, which was later converted
into the Agricultural Development Bank Nepal (ADBN) in 1968.
Nepal government introduced the Cooperative Revitalization Program in 1971. It
authorized the Agricultural Development Bank Nepal to run cooperatives under its
guidance and management.
ADBN launched the Small Farmers Development Program in 1975 – first as pilot project
at two sites, Sakhuwa Mahendranagar of Dhanusha district in the Terai and Tupche of
Nuwakot district in the hills.
The government enacted a new Cooperative Act in 1992 to ease promotion and
development of cooperatives as a vehicle of economic development in the rural areas.
The Grameen Bank model of Bangladesh was replicated in Nepal with the
establishment of Eastern and FarWestern Grameen Bikas Banks (GBBs) in 1992. The
target groups included in Tarai the farmers with holding less than 1 Bigha (0.67 ha) and
in the hills with holding less than 10 ropani (0.5 ha), and the landless.
 Nirdhan and the Centre for Self-help Development (CSD) also launched microfinance
programs replicating Grameen model in 1993 and 1994 respectively.
 Importance of Microfinance
Microfinance is important because it provides resources and access to capital to the
financially underserved, such as those who are unable to get checking accounts, micro
insurance, transfer, payment, credit, or loans from conventional and modern banks.
Without microfinance, these groups may have to resort to using loans or payday
advances with extremely high-interest rates or even borrow money from family and
friends. Microfinance helps them invest in their businesses, and as a result, invest in
themselves.
Importance of Microfinance in developing countries are;
1. Supporting microfinance institutions to ensure funds for low-income borrowers.
2. Empowering women by financing micro, small and medium-sized enterprises.
3. Delivering access to education as well as finance for rural women.
4. Helping to rebuild post-conflict communities and revive women’s livelihoods.
5. Leveraging microfinance to help businesses and livelihoods outside capital cities.
6. Nurturing small businesses to help diversify economies.
Role of microfinance for elevation of poverty
Transmission mechanism for Microfinance to
Poverty Alleviation
Role of microfinance for elevation of poverty
Provide small loans to start Business and productive activities
Economic empowerment and increased self reliance- The transfer of resources in
terms of credit does not only give the poor access to resources but also the
economic empowerment and increased self reliance.
Helping the poor to accumulate their own capital and invest in employment
generating activities
Provide basic financial services which are essential for them to manage their lives
Charge very low or affordable interest rate
Protecting against risk- providing insurance facilities
Do not demand any security while granting loan
Providing entrepreneurial skills and efficient markets to reduce poverty-A rural
micro- entrepreneur may need access to one or more of the following: transport,
communications, power, water, storage facilities, a legal system for enforcing
contracts and settling disputes.
Stimulating economic growth of the country
Linkages between main stream financial services &
micro-finance
Microfinance today is a far-ranging and dynamic sector that offers loans, provides savings
and remittance services, and sells insurance to the poor and needy group of
people/individuals. Microfinance companies have increased in complexity and diversity in
the income levels of the customers they serve, their use of subsidies, regulation and
governance structures, and the breadth and quality of services offered.
Linkages between established or formalized financial institutions and less formal or
informal financial systems create new possibilities for delivering microfinance to the poor.
Financial linkages is based on how the information and enforcement problems in credit
markets result in a mismatch of resources and abilities between formal and informal
lenders. While formal financial institutions have extensive infrastructures, systems and
access to funds, they are usually further removed from poor clients, making it very difficult
to obtain adequate information and reducing risks.
In contrast, informal financial institutions operate close to rural clients, possess quite good
information and enforcement mechanisms and are typically more flexible and innovative.
However, they are constrained in the services they can offer since informal institutions lack
resources and infrastructure to serve clients beyond a small geographic area, resulting in
highly concentrated loan portfolios.
Linkages between main stream financial services & micro-finance
Microfinance industry is becoming mature and more dynamic, associated with market
changes. Recently, microfinance sector has changed radically and will continue to develop
over the next several years as there are millions of poor demanding financial services for
livelihoods.
To challenge their needs, MF industry must move beyond from credit oriented to be more
variety products and services such as deposit facilities for accumulating capital and
investment, payments services, money transfer and foreign exchange transactions.
In addition, there is a concern of other financial services such as micro leasing as an
alternative for business financing and micro insurance for coping with risk.
The microfinance revolution is a commercial revolution, based on new financial technology
and greatly accelerated by information revolution that developed concurrently”. This
implies that there is a need to combine advance financial technology and the rapid
development of Information communication and technology(ICT) to driven MF industry to
be part of modern financial mainstream.
Balancing Between Credits and Savings -The root of MF was micro-credit which most of
discussions, initiatives and activities focused on how to deliver credit and how to assure
money safe in the hands of poor people.
The Role of ICT- There is no doubt, that ICT has rapidly transformed the way of human
life and provided huge opportunities and advantages including for MF industry.
Linkages between main stream financial
services & micro-finance
• 1.4.6 To help the poor out of poverty: It is argued that stimulating economic growth, making markets work
better for the poor and building their capacity is the key out of their poverty situation. There is need to
change the whole context of the lives of the poor and economic activities which do not produce enough
surplus to lift their standard of living. Some critics argue that the necessary infrastructure has been put in
place in some areas for microfinance to trigger economic growth but very little success has been recorded
which makes the problem of poverty and the poor very tricky. Indeed, microfinance is not a panacea to the
problem of poverty but improved access to capital and other financial services are significant to the poor.
The problem is that market failures weaken the effectiveness of microfinance, this is because if the market is
no efficient then it will not enable the producers to sell their goods and services and therefore they will be
unable to make enough revenue to reinvest back to business at the same time be able to pay back their
loans in time and this will lead to depression thus creating unemployment, but efficient market operations
G.J.C.M.P. DOI: 10.24105/gjcmp.6.3.1702 20 will lead to high market demand which will result to more
revenues enabling the clients to pay back their loans in time and the excess reinvested back to business
bringing creation of more jobs leading to high economic growth. According to (Ferrand, et al 2004) argues
that efficient functioning market is critical for poverty alleviation. The danger is that it does not work
effectively for the poor. Ferrand outlines three steps for the markets to work efficiently, namely: i)
Understanding markets, ii) Focusing on factors that inhibit their improved performance and opportunities for
their development and iii) Developing a vision of the future, a picture of how markets can work effectively,
acting to build markets, to make markets more effective and inclusive.
Principles of Microfinance
Key principles of microfinance were developed in 2004 by Consultative
Group to Assist the Poor (CGAP) and endorsed by the leaders at the G8 Summit on
June 10th, 2004. Among the key principles, are the following:
• Poor people need a variety of financial services, not just loans.
• Microfinance can pay for itself, and must do so if it is to reach very
large numbers of poor people.
• Microfinance is about building permanent local financial institutions.
• The job of government is to enable financial services, not to provide
them.
• The key bottleneck is the shortage of strong institutions and managers.
• The Principles assert that “Microfinance means building financial
systems that serve the poor.” Financial systems include strong financial
institutions but also much more: more competitive financial markets, better
government regulatory services and better complementary services (practitioner
education, auditing, etc.)
Because sustainable microfinance is a key element in creating solid
financial markets in developing countries, donor members developed
and endorsed these Key Principles of Microfinance. The G8 also
endorsed these principles at their June 2004 Summit in Sea Island,
Georgia, USA, as part of their commitment to expanding the access of
microfinance. Principles address how sustainable microfinance can be a
powerful instrument against poverty.