Indian microfinance: History and models

History of Microfinance in India

• Group-based internal lending has been historically popular in India (e.g. the bhisi system common in Mumbai, the sheetu / chits system common in TN and AP, SEWA and Annapurna Mahila Mandal groups of working women etc.)

• In 1982, the state-sponsored NABARD initiated the Bank-SHG Linkage Programme with the objective of expanding the reach of existing banks to the rural poor

• The SHG-model has had issues in terms of scaling up and quality of groups and loans in the long-term

• In 1990s, private microfinance institutions (MFIs) were established primarily in AP, following the Grameen Bank model

• MFI model has grown relatively faster

• Govt. of India giving thrust to the SHG model

From Microfinance Models – Practitioners’ Perspective, IFMR Trust

Popularity of Microfinance

• Grameen Bank – started as a small initiative in Bangladesh in 1976 by Prof Muhammad Yunus

• Grameen Bank inspired several similar initiatives in other countries across the world

• Other institutions in Bangladesh – BRAC, ASA, PROSHIKA

• Microfinance has now evolved as an industry, with major activity in Latin American countries, Africa, Eastern Europe, India and South East Asia

• MF truly evolved when Prof. Yunus and Grameen Bank were awarded the Nobel Prize for Peace in 2006

• Following CK Prahalad’s theory of BoP markets, microfinance has attracted a lot of interest – seen as a means to reach out to this segment

• Mainstream commercial equity and debt investors have been showing a lot of interest in microfinance

From Microfinance Models – Practitioners’ Perspective, IFMR Trust

Agenda

• Two streams of microfinance in India

• Historical evolution of microfinance in India

Agenda 1

Two Streams of Microfinance in India

What is Microfinance

• Provision of financial services to people unreached by formal institutions

• Credit, savings, insurance and any other financial products typically of very small ticket sizes

• Usually involves ‘aggregation’ of clients – groups, centers, SHGs, federation etc.

• “Social collateral” replaces physical collateral

• Not a panacea to remove poverty

From Microfinance Models – Practitioners’ Perspective, IFMR Trust

7

How is microfinance defined in India?

Provision of financial services to low income clients and poor people

with the goal of creating social value.

Loans Savings Insurance Remittance

Methodology of microfinance

Identify the potential customers. Mostly by using a poverty index, thereby ensuring that the customers have a great deal of homogeneity

Organise them into groups- address the issue of information asymmetry and lack of collaterals by transferring what could be an individual liability into a group liability. Group responsible for payment

Provide standardized products (Mostly credit in India), standardized operating systems and discipline

Microfinance streams

Self Help Promoting Institution (SHPI)

Stream

Microfinance Institutions Stream

The Intermediary (SHPI) promotes client groups and links it to banks

The intermediary (MFI) promotes client groups and offers financial services to them. The MFI acts like a financial institution

10

Self Help Promoting Institutions (SHPI)

SHPI

Client Group

FinancialInstitutions (banks)

Provision of financial services

Prom

otion and

nurturin

g

Capacity building

support

MYRADA, PRADHAN, DHAN Foundation, Mann Deshi, Apex Banks, Government run SHPIs, RGVN, Hand-in-Hand

11

Micro Finance Institutions (MFI)

Capacity building support

Promotion and nurturing

Client GroupsMFI

FinancialInstitutions

FundsFinancial services

Most NBFCs in India- e.g. SKS, Spandana,

Microfinance Models

Models

SHG Model JLG ModelIndividual Banking Model

Microfinance Models in India

0

5

10

15

20

25

SHG-Bank Linkage MFI Model

Outreach (millions) Loan portfolio (USD billion)

Snapshot of Microfinance in India1

1. Source: Sa-dhan (2008). A Snapshot of Microfinance in India

From Microfinance Models – Practitioners’ Perspective, IFMR Trust

Self Help Group Model

Loans

SHG

Loans Savings

Financial Institutions (e.g. Banks)

Savings

Initiated in India in the 1980s Clients may be men or women A group of 10-20 individuals. Is an independent entity Is usually promoted by SHPIs or MFIs

Have their own bank accounts and books of accounts SHGs collect savings and give loans to their members Can borrow on their account. SHGs can execute documents Are recognized by government Also take up social issues SHG has its roots in social development Banks provide loans only after 6 months of group formation

Joint Liability Group Model

MFI

Loans Repayment

Joint liability of the group

A group of 5-20 individuals. Is usually promoted by an MFI Mainly promoted for the loans No internal transactions

No bank accounts No books of accounts are maintained by the JLGs

Have to depend on the MFI for all their loan requirement

Are not recognized by the government

Cannot execute documentsJLG has its roots in microfinance Loans provided immediately by the MFIs after group is formed

Individual Banking Model

MFI, Rural banks

Loans Savings

Loans given to individualsPhysical collateral or personal guarantees are taken

There is no role of SHGs or groups

The MFI has to conduct appraisal of the individuals borrowers

Operational Structure of an MFI

MFI

Group center

•Started by the Grameen Bank of Bangladesh

•Highly standardized processes •Many adopters all over the world

Five-members groups are the basic units.

5-8 such groups constitute a branch (Centre)

Centers meet once a weekDisbursement and collections are made in center meetings

Groups and centers appraise the loans and undertake joint liability

All center meetings are attended by the staff of the MFI

Flat rate of interest calculation

Mixed models

• Numerous mixes of SHG and JLG models• NGOs that have a significant no. of SHGs are quite

willing to form MFIs to provide loans directly to the clients

• Banks are willing to provide funds to such NGOs as they are able to provide bulk loans instead of having small accounts on their book.

• Different MFIs are also going back to creating SHGs. Most MFIs on attaining a certain scale become conscious of the need to take development work – set up NGO

Agenda 2

Historical Evolution of Microfinance in India

Evolution of microfinance

The next big innovation to address the poverty issues in India

The next big innovation to address the poverty issues in India

The language of microfinance

has undergone a fundamental change in the

two decades of its evolution

The next big investment opportunity

Wave 1: Not-for profit

Large part of the 80s was spent in organizing groups, being focused on community owned and integrating them with the banks (Known as SHG model). Slow process.

Global Microcredit Summit-1997. Event used by Grameen Bank to showcase its work. Shown as an effective methodology to reach small loans to the poor.

Current large MFIs were setting shop in India. (1996-1997) They were all registered as public societies with grant money and came with a developmental orientation.– SHARE Society for Helping and Awakening the Rural poor through

Education

Wave 2: Move from not-for-profits to for-profits

People in the developmental sector discovered a methodology to reach a large number of poor clients, scale rapidly and count the direct impact of their work.

Within 3-4 years of the operations of these NGOs, MFIs were growing much bigger than they should in their original form of not-for-profit incorporation

It was difficult to maintain capital adequacy or attract commercial capital because profits could not be distributed in a non-for-profit format

From 2002 onwards, these institutions move from a non-profit format to a for-profit format

Some reasons

Not possible to follow the Grameen Bank pattern in terms of ownership, where the borrower members also have a strike in the capital of the bank. Grameen was incorporated under a special act.

In case of Indian microfinance the first wave institutions did not find a legal framework under which they could involve the community in the ownership structure of a MFI.

CMF – Debt instruments for MFIs, Jan 07

Wave 3: Entry of Venture Capital

As MFIs started growing, it was difficult for them to explain their form to the commercial world, while the development world started stopping funding them after a stage (given that the operations were largely profitable).

Some of the early investors, including from the silicon valley-(Vinod Khosla, Michael and Susan Dell, Pierre Omidiyar) started looking for investments which not only gave them returns, but also an enhanced image.

A poll of 50 investment banking firms/companies brought out in 2010 that microfinance is the top ranked destination for investments in financial sector today.

SKS, India’s largest MFI, has gone public in July 2010.

AP Crisis (Post October 2010) – News Headlines….

MFIs: Wolf in sheep’s clothing?- The Times of India (October 9)

New ordinance may hit Andhra MFIs- The Economic Times (October 13)

Suicides spark scrutiny of Indian microfinance- Forbes News (October 19)

Is Microloan Backlash Fueled by Sexism?- Wall Street Journal (November 1)

Microfinance warns of collapse over credit freeze- Financial Times (October 26)

AP Crisis – News Headlines….

A string of suicides puts microlending under the spotlight - The Economist (November 4)

The Backlash In Microfinance- Huffington Post (November 10)

Death now stalks India’s microfinance institutions- Rediff News (November 18 )

India’s micro-finance suicide epidemic- BBC News (Dec 17)

The very future of microcredit in India is in danger, which is a shame for the country’s poor- The Economist (Dec 9)