Micro Finance

Assignment

Ayush Joshi
PGPF/01/010
Credit Loan Product

• A credit product involves disbursement of

principal amount and collecting it back wi
th interest in a certain period of time.
• For designing the loan product it is critica
l to understand the cash flows of the targ
eted clients.
• Clients’ cash flows decide their need for c
redit and define their repayment capacity
for allocating a loan product in sync with
their need and capacity
Loan Purpose
• The loan purpose defines the clientele and positioning
of the product

• MFI need to first identity the loan need for a certain

client segment and design a product such that the
product will satisfy a particular need of a segment of
client
• These segment and product are designed based upon
the market.ome of example for such products are
income generation loan, business setup loan, group
loan.
• These product are generic in nature so that they can
cater to a significant portion of a community
• They can be specific based on the need of the market
• Hence the purpose of the loan should be to cater the
need in the segment it is being focussed.
 Loan Size

• To control the risk the size of a loan is gradually changed based on the payment acti
vity of a client.
• MFI has to decide the maximum loan the MFI can give in each loan cycle and the ma
ximum amount that MFI can lend in that product category
• The loan size for micro enterprise loan in rural areas will be smaller than the loan siz
e for micro enterprise
• Another parameter is risk, an MFI entering into a completely new product line, or ge
ographic region runs a higher risk due to uncertainty and hence would like to restric
t the loan size in the initial period
Frequency of Repayment ang Tenure (Term) of Loan
Points to be focussed before making
a term structure
• The product should be designed in such a way that it
can match the cash inflows of the clients  Income structure of the client
• As the income of the client can be seasonal as in the
 Amount of inflow in every period
case of farmers.
• So a typical term structure sometimes doesn’t cater  Regular spending of client
to the need of such clients
 Size of EMI should be such that it
• Hence payment can be monthly, weekly, or even a
bullet payment. doesn't add pressure on client
• MFI generally issues loan with repayment period not
more than a year.  The term structure should match

• There should be sync in term structure of borrower the term structure of MFI’s
and lender of MFI to maintain cash flow balance.
repayment structure
Interest Rate and Pricing

Interest rate is another critical aspect of product development if not ‘the’ most critical issue.
Interest in micro-finance is comparatively high as the delivery costs in micro-finance are higher
Causes for high delivery costs for MFIs
 MFIs have to make a large number of small loans and need continuously interact with clients
 The operating expenses of MF loans are high initially when the scale of operations is small
 There are also costs involved in training and forming different groups.
All these factors together push the Operating costs up
 Cost Parameter MFI Formal Institution
Technology Limited, largely manual Large investment -> hi-tech
Fund source Commercial loan cost of fund Client savings lowers the
cost

• Government understands that MFIs should be given the freedom to decide their interest rate to be sustainable.
• RBI dictates NBFC-MFI should not charge more than 26% per annum.
Interest Rate Setting
• Operating costs of MFIs are generally higher and hence charge higher interest rates
• Dilemma whether the MFIs should charge interest on a fixed basis or declining basis
• Most important aspect is to determine the yield on portfolio
• Effective interest rate will decide the interest income the portfolio will generate :

Annualized Effective Rate = (Interest income of year * 100)/(Avg portfolio during year)

• Once the MFI knows how much effective rate it wants, it can either charge on either a flat or a declining

Declining Rate of Interest

• A close approximation of the interest rate being charged per annum.
• This is because interest is charged only on the loan outstanding and not the amount disbursed.
• So as and when the client repays an installment, principal outstanding gets reduce and the interest for the next
month is charged on a lower principal base.
• As the interest component pe down with every installment so does the total repayment to be made and hence in
declining interested method the installment size may change in every installment
• It is possible to have equalized monthly installments, with a declining rate of interest. In such a case. the principal component of the ins
tallment increases, and the interest component decreases, while the installment size remains equal. However, such products are difficu
lt to administer for MFIs, and therefore are not common. The flat rate of interest discussed next is much more common

Flat Rate of Interest

In flat rate method, the interest is always charged on the Principal disbursed rather than on the outstanding Therefore, even as
the client goes on repaying the principal, with every installment, the interest component remains same and is charged on the
disbursed amount. This means that the effective interest rate is much higher.

 Choosing between the two methods depends on the convenience of the MFI as well as its clients.
 Explaining flat rate to clients as well as calculation of demand from the MFI perspective is more convenient.
 Some MFIs go for declining rate because while the flat rate may appear low, it translates into a high effective rate of interest.
As against this the declining rate is very close to the effective interest rate.
 It is entirely on the MFI to choose between the two methods depending on its operational convenience
 MFI should ensure that it is well understood by the clients
 It is important that the product should give the MFI the desired yield.

There are a number of factors which affect product pricing, the most critical factors being :

• Operating cost of the MFI

• Loan loss risk
• Desired profitability
• Cost of Funds
Conclusion

In simple terms, interest, fees and other charges are the common sources of income fo
r an MFI. Hence ,the product has to be priced in such a manner that the MFI not only c
overs all its costs but also earns some margin or profits for further growth. If the produ
cts of the MFI are able to provide that kind of yield, then the product is viable or else it
is not.
THANK YOU