Microfinance

and
Development Banking

Unit-1
Over view:
Microfinance
Rural Banking and Development Finance
1
Books Recommended

• 1) Microfinance India
• State of Sector Report 2008
• by N. Srinivasan ,Sage Publications Pvt. Ltd.
• 2) Microfinance India
• Social Performance Report 2013
• by Girija Srinivasan ,Sage Publications Pvt. Ltd

• 3) Rural Banking, IIBF, Macmillan Publishers India

2
Quiz

• 1) What is Microfinance?
• 2) What is its purpose?
• 3) What is the scope for microfinance in India?
• 4) Can it be a business proposition?
• 5) Which sectors are involved in Micro finance in India?
(Public/ Private)
• 6) Is it important for India? Or for the entire world?

3
Micro credit has shown how you can reach out to the
people that conventional banking cannot.
It has demonstrated that it is a doable proposition.
Mohammad Yunus

4
There is expression of selfishness and there is expression of
selflessness-

but economists and theoreticians never touched that part.

they said go and become philanthropist.

I said no I can do this in the business world, create and

different kind of business- a business based on selflessness.

Mohammad Yunus

5
Introduction

• According to the World Bank, India is home to almost

one third of the world’s poor (surviving on an equivalent
of one dollar a day).
• Though many central government and state government
poverty alleviation programs are currently active in India,
• microfinance plays a major contributor to financial
inclusion.
• In the past few decades it has helped out remarkably in
eradicating poverty.
• Reports show that people who have taken microfinance
have been able to increase their income and hence the 6
standard of living.
Introduction
• About half of the Indian population still doesn’t have a savings
bank account (60% in rural areas and 40% in urban areas)and
they are deprived of all banking services.
• The poor need financial services to fulfil their needs like
consumption, building of assets and protection against risk.
• In spite of expansion of public sector banks on rural areas,
establishment of Regional Rural Banks and cooperative banks
financial services,
• the need of rural poor remain unfulfilled and there is large
demand for the same. Microfinance institutions serve as a
supplement to banks and in some sense a in a better way..
7
Microfinance
• Microfinance is generally interpreted as providing credit to
poor people.
• However it covers other financial services.
• It is the provision of a broad range of financial services such
as – deposits, loans, payment services, money transfers and
insurance products – to the poor and low-income households,
• for their microenterprises and small businesses, to enable them
to raise their income levels and improve their living standards.

8
Microfinance
• Microfinance

Micro-Credit

Deposit

Micro
finance
Money transfer

Insurance

9
Microfinance clients
• (1) The landless who are engaged in agricultural work on a seasonal
basis and manual labourers in forestry, mining, household industries,
construction and transport. These people require credit for
consumption needs and also for acquiring small productive assets,
such as livestock..
• (2) Small and marginal farmers, rural artisans, weavers and those
self-employed in the urban informal sector as hawkers, vendors and
workers in household micro-enterprises: - requires credit for working
capital, including a small part for consumption needs. This segment
largely comprises the poor but not the poorest.
• (3) Medium farmers/small entrepreneurs who have gone in for
commercial crops and others engaged in dairy, poultry .Among non-
farm activities; this segment includes those in villages and slums
engaged in processing or manufacturing activity. These persons live
barely above the poverty line and also suffer from inadequate access 10
to formal credit.
Microfinance Service Providers

• Microfinance providers:
• 1) Microfinance Institutions
• 2) Public Sector Banks
• 3) Regional Rural Banks
• 4) Cooperative Banks.
• 5) Local money lenders.

11
Microfinance Service Providers
• R.O.I.
• Charged
•
• Microfinance Institutions 24% to26%

• 7% to 12%
Public Sector Banks
Micro
• finance
7% to 12%
Regional Rural Banks
Service
• Providers 12% to 15%
Cooperative Banks
• 36% and
• Money lenders above 12
Core principles of Microfinance
• Core Principles for Microfinance
• 1) The poor needs access to appropriate financial services
• 2) It is possible to build up capacity of the poor to repay
loans, pay the real cost of loans and generate savings
• 3) Microfinance is an effective tool for poverty alleviation
• 4) Microfinance institutions must aim to provide financial
services to an increasing number of disadvantaged people.
• 5) Microfinance can and should be undertaken on a
sustainable basis.
• 6) Microfinance institutions must develop performance
standards that will help define and govern the microfinance
industry toward greater reach and sustainability
13
Microfinance as a Business Proposition
• It is possible to build up capacity of the poor to repay loans,
pay the real cost of loans and generate savings
• Real cost is around 14% to 16%
• R.O.I. charged is 24% to 26%. This gives a margin of 10%.
• Real cost includes:
• 1) Cost of acquiring funds.
• 2) Losses due to delinquencies.
• 3) Operational cost, which includes transaction cost and
establishment cost.
• Costs 2) and 3) should be minimized.

14
Characteristics and features of
Microfinance
Characteristics Distinguishing Features
Type of client Low Income
Employment in informal sector, Low wage bracket,
Lack of physical collateral
Closely interlinked household/business activities
Lending Technology Prompt approval and disbursement of micro loans
Lack of extensive loan records
Collateral substitutes; group-based guarantees
Conditional access to further micro-credits
Information-intensive character-based lending linked to cash
flow analysis and group-based borrower selection
Loan Portfolio Highly Volatile
Risk heavily dependent on portfolio management skills
Organizational Remote from/non-dependent on government
Ideology 15
Cost recovery objective vs. profit maximizing
Institutional Structure Decentralized Insufficient external control and regulation
Capital base is quasi-equity (grants, soft loans)
Micro Finance Institutions
• Those institutions which have microfinance as their main operation
are known as micro finance institutions.
• A number of organizations with varied size and legal forms offer
microfinance service.
• These institutions lend through the concept of Joint Liability Group
(JLG).
• A JLG is an informal group comprising of 5 to 10 individual
members who come together for the purpose of availing bank loans
either individually or through the group mechanism against a mutual
guarantee.

16
Micro Finance Institutions-Legal Forms
• MFIs in India exist as Non Government Organizations
• These are registered as in various acts as under:
A. Societies under The Indian Societies Registration Act.
B. Trusts under Indian Trusts Act
C. Section 25 companies and
D. Non-Banking Financial Companies (NBFCs) registered with
the Reserve Bank of India.
• (R.B.I. permits registration as MFI-NBFC).
• The different legal forms under different Acts makes regulation
of MFIs difficult.
• There is a need to bring MFIs under single regulatory 17
authority.
Section-25 Companies
• Thus, there are three criteria for determining whether a
particular company is section 25 company or not:

• 1) Its objects should be only to promote commerce, art,

science, religion, charity or any other useful object. CARSC

• 2) It should intend to apply its profits or other incomes only in

promoting its objects; and

• 3) Central government should have granted a license to such a

company recognizing them as such, these types of companies
can be either public company or private company having a
limited liability. 18
Channels of Micro finance in India
• Channels of Micro finance in India
• In India microfinance operates through two channels:
• 1. SHG – Bank Linkage Programme (SBLP)
• 2. Micro Finance Institutions (MFIs)

19
SHG – Bank Linkage Program
• This is the bank-led microfinance channel which was initiated
by NABARD in 1992.
• Under the SHG model the members, usually women in villages
are encouraged to form groups of around 10-15.
• The members contribute their savings in the group periodically
and from these savings small loans are provided to the
members.
• The group members meet periodically to discuss working of
group and the problems faced by them. Initially group takes
support of NGOs.
• In the later period when the group matures these SHGs are
provided with bank loans generally for income generation
purpose. 20
SHG – Bank Linkage Program
• The group’s members meet periodically and learn to manage
their own problems.
• So also the new savings come in.
• recovery of past loans are made from the members and also
new loans are disbursed.
• This model has been very much successful in the past and with
time it is becoming more popular.
• The SHGs are self-sustaining and once the group becomes
stable it starts working on its own with some support from
NGOs
• Finally the groups are linked banks for obtaining loan for
group activities. 21
SHG – Bank Linkage Program
The Role of NGOs
• The microfinance movement was initiated by NABARD (1992)in
collaboration with Banks and Non-Government Organizations (NGOs)
for unbanked population.
• The program was initiated by the government with refinancing to
banks from NABARD.
• SHG bank linkage program involved NGOs to form Self Help Groups
(SHGs) and train them.
• Each SHG typically consists of a group of women/men members
interested in accessing financial services including savings, credit
insurance etc. Post the training,
• NGOs provided SHGs access to funds by linking them to banks which
provided financial services (including thrift, credit etc) to them directly.
• NGOs’ role was to ensure financial discipline of the SHGs.
22
• Apart from this there were state government run SHG programs.
• Thus microfinance in this phase was government driven.
Growth of Microfinance in India
• The microfinance sector started evolving with private sector
participation leading to formation of microfinance institutions
(MFIs).
• The MFIs accessed bulk funds from banks and did on-lending
to the end borrowers (either SHG members or joint liability
group JLG members).
• From there on the microfinance activities were being
implemented by the two channels including MFI model and
SHG bank linkage model.

23
Growth of Microfinance in India
• The sector witnessed high growth rate during the period from
2006 to 2010 supported by
• funding availability and
• potential demand in the sector.
• The growth was mainly driven by the MFIs due to large scale
availability of funding in terms of both debt and equity.
The overall loan portfolio increased from
• Rs.13,950 crores as on March 31, 2007 to
• Rs.38,186 crores as on March 31, 2010
• Rs93,800 crores as on March 31, 2017
• which included growth from SHG bank linkage and MFI
24
model.
Quality of Growth of Microfinance
• However focus of the microfinance sector is mainly on micro-
credit. The other products such as thrift, insurance and
remittance are yet to be evolved.
• The micro finance movement grew mainly in developed
Southern States of Andhra Pradesh , Karnataka, Kerala and
Tamil Nadu. It is not developed in The North, North East and
Eastern States.
• Upper strata of the poor are prioritized and not the lower strata
of the poor who need it most.
• A study of SHG Bank Linkage Program National Council of
Applied Economic Research (NCAER) has found that the non
poor member covered are as high as 49%.It was found that the
states of U.P.,A.P. and Maharashtra covered 63%,43% and 34%
25
non poor respectively.
Quality of Growth of Microfinance
• The present amount of microfinance lending is around Rs1 lac
crores with average exposure per customer is Rs45,400 which
is more than double the national average of Rs22000.
• Moreover ,70% of these borrowers have at least three loans
running at the same time.
• While Reserve Bank of India guidelines mandate that not more
than two microfinance Institutions (MFIs) can give loan to the
same borrower.
• There is a lack of supervision of microfinance industry.

26
Quality of Growth of Microfinance
• A much deeper structural change is set in microfinance
movement.
• It is the transformation of NGOs into lending institutions.
• There is a strong movement towards transformation of NGOs
promotional work into commercial micro finance operations.
• Urban microfinance has caught the attention of MFIs and the
funders.
• The industry leaders and mid level NGO/MFIs are foraying
into urban markets with large business plans.

27
Winds of change in
Microfinance movement
Funder
Self Help Groups

(Development and
Support)
(Funds)
(Funds)

NGOs

Banks

28
M.F.I.
Problems in growth of Microfinance
• 1) Financial illiteracy
• 2) Inability to generate sufficient funds
• 3) Dropouts and migration of SHG members
• 4) Non Transparent Pricing
• 5) Cluster formation – fight to grab established market
• 6) Multiple Lending and Over-Indebtedness

29
Problems in growth of Microfinance
• 1) Financial illiteracy: This makes it difficult in creating awareness
of microfinance and even more difficult to serve them as
microfinance clients . Many MFIs themselves do not know the
meaning of financial literacy . Some of the members are illiterate
and they do not know the rate of interest charged.
• 2) Inability to generate sufficient funds: Though NBFCs are able to
raise funds through private equity investments because of the for-
profit motive, such MFIs are restricted from taking public deposits.
Not-for-profit companies which constitute a major chunk of the MFI
sector have to primarily rely on donations and grants from
Government and apex institutions like NABARD and SIDBI. In
absence of adequate funding from the equity market, the major
source of funds for MFIs are the bank loans, which is the reason for
high Debt to Equity ratio of most MFIs. 30
Problems in growth of Microfinance
3)Dropouts and migration of SHG members : Microfinance loans
are disbursed on group lending concept and a past repayment record
of the group or a member. The two major problems with the group
concept are dropouts and migration. In absence of past record,
members are deprived of getting bigger loan amounts and additional
services.
4) Non Transparent Pricing: Non-transparent pricing by MFIs
confines the bargaining power of the borrowers and their ability to
compare different loan products, because they don’t know the actual
price. In absence of the proper understanding of the pricing, clients
end up borrowing more than their ability to payback which results in
over-indebtedness of the borrower.

31
Problems in growth of Microfinance
• 5) Cluster formation – fight to grab established market:
• MFIs’ drive to grab an established market and reduce their costs. By
getting an established microfinance market, MFIs reduce their initial
cost in group formation of clients, educating them and creating
awareness about microfinance. This is one of the reasons for the
dominance of the microfinance sector in the southern states. This
has created severe regional imbalances in growth of microfinance.
• 6) Multiple Lending and Over-Indebtedness: In order to eat
away each other’s market share, MFIs are ending up giving multiple
loans to same borrowers which in some cases is leading to over-
indebtedness (a situation where the borrower has taken loans more
than her/his repaying capacity) of the borrower. MFIs are getting
affected because borrowers are failing to make payments and hence
their recovery rates are falling, 32
Pricing of Microfinance Loans

• There are two approaches to pricing of microfinance loan

• 1) Putting cap on interest rates so that poor are not put to

unbearable interest burden. (Old Approach)
• 2) Market based interest rate regime. (New Approach )

33
Pricing of Microfinance Loans
(Old Approach)
• The old approach to loans for low-income borrowers
emphasized on putting cap on interest rates in order
• to lower interest burden on poor borrowers.
• Thus keeping the interest rates below market rates.
• Consequently some of the MFIs were not able to cover the cost
of lending and some of the MFIs closed the business, adversely
affecting microfinance movement.
• Some of them started charging service charges on ad-hoc basis.
• This raised burden on poor borrowers and not understanding
the basis of charges some of them went to money lenders.

34
Pricing of Microfinance Loans
(New Approach)
• The new approach which has been demonstrated by global
experience is characterized by a market-based interest rate
regime which permits the institution providing microfinance
services to cover administrative costs, provisions for loan
losses and intermediation/funding costs.
• This basis is consistent with financially sustainable rural
finance and microfinance.
• Invariably, the global experience continues to validate the
proposition that what matters most to the poor and undeserved
segments is access to financial services rather than their
interest-rate cost – most especially because microenterprise
and small business borrowers will take a microfinance loan
whose repayment periods match the additional cash flows they
hope to generate. 35
Legal structure and regulation
• Currently there is no proper regulatory body for the supervision
of MFIs.
• The presence of institutions with a variety of legal forms makes
it difficult for the regulation of all such institutions by a single
regulatory body in the current Indian legal structure.
• Though NBFCs, which cover the major part of the outstanding
loan portfolio by the microfinance channel, are regulated by the
Reserve Bank of India,
• other MFIs like societies, trusts, Section-25 companies and
cooperative societies fall outside the purview of RBI’s
regulation.

36
Legal structure and regulation
• The sector is eagerly awaiting the passing of Microfinance
Development and Regulation Bill (pending) by the parliament.
• The Bill envisages that R.B.I. will be the regulator of MFI
sector irrespective of legal structure.
• The Bill aims at protecting customers interest and
• Avoiding different regulations state wise.
• Making registration compulsory will bring some of the money
lenders under RBI control who are acting as MFIs.
• The report on Committee on Financial Sector Reforms has set
up agenda for growth MFIs as Micro Finance Banks.
• License to Bandhan Bank is indicative of this approach.
37
Legal structure and regulation
(Present Status)
• The microfinance bill which was introduced in the year 2007 is
still pending.
• The most recent and the strongest step taken by the
government,
• The Micro Finance Institutions (Development and regulation)
Bill, 2011 is a major step in the microfinance sector.
• The proposed bill clarifies all doubts pertaining to regulation
of the MFIs by appointing RBI as the sole regulator for all
MFIs.
• This bill is yet to passed.

38
 Suggestions
for
Growth and Development of Microfinance sector:
• 1) Proper Regulation
• 2) Field Supervision
• 3) Encourage rural penetration
• 4) Development of complete range of products
• 5)Transparency of Interest rates
• 6) Development and use of technology to reduce operating
costs.
• 7) Alternative sources of Fund
• 8) Portfolio Buyout
• 9) Securitization of Loans
39
Innovations by Private Sector Banks
• Private sector banks are developing unique business models for
lending to poor and low income population.
• After having trying different models private sector banks are coming
round the view that direct lending to these clients is better than
lending through SHGs or MFIs.
• It is better in case of microcredit which requires direct supervision
and control.
• Outsourcing is better which does not require client interface , but
requires understanding clients needs.
• ICICI, HDFC Bank and AXIS Bank are experimenting with direct
lending through JLGs formed and nurtured though their own staff.

40
 Innovations by Private Sector Banks
• This staff is placed with a separate business hub attached to a
particular branch.
• Banks follow norms set out by RBI for MFIs
• Interest rates are comparable to MFIs.
• These efforts are yet to reach break even and are thus at pilot
stage.
• As such private sector banks have realized that MFI Bank lending
model has limitations.
• Hence they are trying direct lending model as well.
• They are trying this as business model as margins permitted are
high and are cost plus margin basis.
• The banks have invested in systems and technologies of the
partner MFIs. 41
Rural Banking and Development
Finance
• The key mechanisms through which the Government of India has
attempted to improve rural banking services has been through

• 1) Maximizing the spread of the commercial banking system

• 2) Development of the co-operative banking system including
primary cooperatives as well as cooperative banks, and
• 3) Creation of an extensive network of Regional Rural Banks
(RRBs).

42
Rural and Semi-urban branches of banks

43
Rural Branch Network of commercial
Banks: Post reforms period
• Rural Branch Network of commercial Banks during post
reforms period

Year Rural Branches

1990 34,791
2008 31,076
2009 31,667
2010 32,624
2011 33,683
2013 32,744

• The number of rural branches of commercial banks increased

from 1833 in the year 1968 to 34,791.
• After introduction financial sector reforms, the rural branch 44
expansion commercial banks has slowed down.
Major Issues in Rural banking

1) Low penetration
2) Low Credit Deposit Ratio
3) Existence of non-institutional credit in rural
areas
4) High Non-Performing Loans
5) High cost of servicing
6) Higher risk of credit
7) Small size of loans
8) Information Asymmetry 45
Rural Credit Institutions

• 1) Co-operative Credit Societies and Banks

• (Cooperative Credit Structure)
• 2) Regional rural banks
• 3) Commercial Banks

46