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Microfinance Institutions

www.indiaratings.co.in 30 January 2015

Financial Services

Microfinance: Strong Comeback Sector to Grow 24% Annually Over FY15-FY19

Special Report

Microfinance Alive and Kicking: The microfinance sector is growing and attracting banks and

private equity (PE) investors again, says India Ratings & Research (Ind-Ra). However, this time

the growth is much lower than the over 100% annual growth seen during FY06-FY10 and

benefits from a tighter supervisory regime. The sector‟s outreach increased over 23% yoy and

gross loan portfolio grew 42% yoy in FY14. Ind-Ra expects the sector to grow at a CAGR of

24% and require an equity infusion of INR27bn over FY15-FY19.

Regulations De-risking MFIs: The Reserve Bank of India (RBI) has now emerged as the

central regulator for non-banking financial companies-MFIs (NBFC-MFIs; covering 90% of the

MFI universe). In addition to placing limits and defining procedures for MFI operations, RBI

guidelines have led to the establishment/prominence of credit information bureaus (CIB) such

as Equifax Credit Information Services Private Limited (Equifax) and CRIF High Mark Credit

Information Services (Highmark) and self-regulatory organisations (SROs) - Microfinance

Institutions Network (MFIN) and Sa-Dhan. It is mandatory for NBFC-MFIs to be members of at

least one CIB and one SRO to ensure credit checks and process adherence, respectively.

Most states barring Andhra Pradesh seem to have accepted the role of RBI to regulate NBFC-

MFIs and have not invoked the Money Lenders Act to regulate MFI operations. The

Microfinance Bill 2012 is pending in Parliament of India; if passed, it may eliminate the

possibility of an AP-like event in future.

Emerged Stronger from the AP Crisis: Ind-Ra believes the growth of MFIs is sustainable in

view of interest rate and margin caps, defined recovery procedures, caps on borrower

indebtedness and credit check procedures. Limitations have been placed on the earlier

observed lacunae of MFI operations.

The Joint Lending Group (JLG) model has survived and is the main reason of the high recovery

rates of over 98% in non-AP states. Many MFIs are spreading operations in several states so

as to minimise the impact of an AP-like event.

Funding Improves with Restored Confidence: MFIs have demonstrated strong growth in the

face of stringent regulations and limitations on lending, indicating that their model is strong and

viable. Also, RBI has maintained the priority sector status for lending to MFIs for microfinance

operations. As a result, bank funding that had dried up in the aftermath of the AP crisis is again

available to MFIs. Bank borrowing and securitisation deals for NBFC-MFIs increased to

INR274bn in FY14 from around INR206bn in FY12 and FY13.

The sector is again attracting PE participation (FY14: USD160m; FY15 till date: USD152m).

Given the growth trajectory of the sector, we estimate that the sector will require INR27bn

(USD449m) of equity infusion over FY15-FY19.

Evolution on the Cards: The government‟s focus on financial inclusion and introduction of

new delivery models such as business correspondents (BC) and small banks could intensify

competition for NBFC-MFIs and simultaneously present evolutionary opportunities to them. An

orderly evolution can have several positive impacts, including lower costs for borrowers and

greater systemic stability.

Analysts

Jindal Haria +91 22 4000 1750 [email protected] Cyrus Dadabhoy +91 22 4000 1723 [email protected]

mailto:[email protected]

mailto:[email protected]


Microfinance: Strong Comeback

January 2015 2

Possibilities and Business Models for MFIs

Microfinance is a one-dimensional business, providing credit to borrowers with limited access

to formal banking channels. The Indian government has over the years initiated various

schemes, under which bank accounts have been opened for the unbanked. Competition with

various existing and new microfinance delivery models, government thrust for financial

inclusion through public sector banks and relative credit saturation in some districts could prod

NBFC-MFIs to evolve into multi-services providers to the poor and the unbanked.

Increased Competition: The Jan Dhan scheme launched by the new government could

provide millions with access to banks and banking services. The number of BCs increased by

over 10x between FY10-FY14. Though efficiency of the BC model can be debated, there is no

denying that it could be a tough competitor to MFIs. Furthermore, market reports suggest that

some districts are saturated by micro-credits (within the extant RBI guidelines), especially in

West Bengal, Tamil Nadu and Karnataka. Differentiated banking licences and norms on rural

branches for scheduled commercial banks (SCBs) could pose a threat to MFIs‟ operations in

form of competition or an opportunity for evolution.

With around 120 million accounts opened in a matter of months, the scale and speed of the Jan

Dhan scheme have not been witnessed earlier. However, we believe that competition between

banks and MFIs could intensify only after four to five years when these large scale inclusion

programmes and diversified banks are established and achieve traction. This also provides

MFIs with a window to consolidate and grow based on their simple process and documentation

and the ability to closely interact with customers, deliver speedy and timely credit at customer

door-step, and to evolve into entities providing a range of financial services.

Opportunity to Make Strategic Shifts: The sector could see a high level of changes and

dynamism given the government‟s focus on financial inclusion. The speed at which the BC

model is adopted, the efficiency of the model as well as of emerging differentiated banking

models can provide opportunities to MFIs. MFIs may require evolving their models to serve

their customers rather than handing them over to banks on a platter.

BCs: BCs tie up with banks and provide access to borrowers to the partner bank‟s services

and assist the borrowers with banking processes through client servicing points (CSPs).

The Indian banking system set up over 3,00,000 CSPs by FY14 (FY10: 34,200). However,

the efficacy of the model leaves much to be desired. NBFC-MFIs have now been permitted

by RBI to act as BCs to SCBs. This could be an opportunity especially for many smaller

MFIs to compete with larger MFIs and remain in business.

Differentiated banking licences: RBI plans to establish payment banks and small banks

in proximity to borrowers. For an NBFC-MFI, this license could mean access to low-cost

funds (savings) and greater legitimacy in lending operations. Mid and large-sized NBFC-

MFIs could opt for the conversion to a small bank and evolve into a holistic financial

services provider.

Indian MFIs Could Follow Global MFIs: Most regulated MFIs in the world‟s 15 countries with

the largest MFI operations have access to savings as low-cost funds (Appendix 14). Although

savings could be partially ring-fenced, these regulated MFIs can provide a suite of services to

borrowers. In some countries in South and Central America, MFIs have migrated from group

lending to individual lending models. Some countries also allow MFIs to fund MSMEs.

In a bid to further the objective of financial inclusion, RBI could be somewhat liberal in the

issuance of small bank licences to NBFC-MFIs. RBI could, on being reasonably confident of

the sector, also relax the norms of qualifying assets and permit higher borrower indebtedness

as well as expansion in the scope of financial services provided by MFIs, making them

important participants in financial inclusion.

Applicable Criteria

Financial Institutions Rating Criteria (September 2012) Non-Bank Finance Companies Criteria (September 2012)

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January 2015 3

1. Re-emerging from the Crisis Gradually

The microfinance sector grew 40% yoy in FY14 which is still a far cry from the scorching pace

of growth of MFIs in their heydays (FY06-FY10) - Appendix 1. The sector has re-emerged from

the debilitating effects of the AP crisis (Appendix 2) and is experiencing strong, structural and

sustainable growth. The sector is back in favour with commercial banks (supported by RBI‟s

continued recognition of priority sector to microfinance) and PE investors. PE investors pumped

in USD160m in FY14 and USD152m in FY15 till date.

RBI has acknowledged the role of MFIs in financial inclusion and brought out a set of

guidelines. It has emerged as a central regulator for NBFC-MFIs and imparted a sense of

stability and regulatory certainty to an extent to the sector.

1.1. RBI Intervention Leads to a Stable Regulatory Environment

RBI had appointed a committee under Y. Malegam (Malegam committee) to suggest the

operational paradigms for microfinance operations and suitable regulatory structures. The

incumbent regulatory structure was pertaining to NBFCs in general and did not address the

specific needs of regulating MFIs. RBI issued a set of guidelines in December 2011

(Appendix 3) based on the Malegam Committee report, which led to the recognition of a new

class of NBFCs: NBFC-MFIs.

These guidelines made it clear that RBI acknowledged the role of MFIs in financial inclusion

and that is expected to continue in future. The guidelines led to the establishment of Credit

Information Bureaus (CIBs) and Self-Regulatory Organisations (SROs).

CIBs provide, maintain and update borrower records of the loans availed, payment history, etc.

They enable MFIs to perform credit checks on borrowers before providing credit (Appendix 4).

SROs act as industry representative to various forums as well as a check on compliance of

NBFC-MFIs to the code of conduct based on RBI guidelines. Member MFIs report operational

data periodically to SROs. (Appendix 4)

RBI also allowed NBFC-MFIs to act as BCs (Appendix 5) since their reach is deeper than

banks especially in unbanked villages and their employees/agents have closer and frequent

contacts with locals; they can facilitate deeper penetration of banking products through tie-ups

with various banks.

1.2. Growth Revival in Loan Portfolio and Outreach

RBI‟s acknowledgement that MFIs perform a very important role in financial inclusion of the

poor provides legitimacy to the regulated operations of MFIs. However, in a controlled

environment and where market participants have not shown enthusiasm for the sector, MFIs

managed respectable growth from FY12-FY14. In fact, total loans outstanding grew over 40%

in FY14.

Figure 1

1436

89

163183 179

197

279

0

50

100

150

200

250

300

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Gross Loans Outstanding of NBFC-MFIs

(INRbn)

Source: Sa-Dhan, MFIN, Ind-Ra



January 2015 4

Figure 2

The MFI universe consists of NBFCs, NGOs/societies, and Section 25 companies. RBI

acknowledged the importance of the role of MFIs in financial inclusion since it was a provider of

credit about 30 million poor households in FY11. MFIs are often present where banks are not

and provide doorstep facilities to borrowers. This reflects in the growing number of borrowers

from these MFIs.

Figure 3

Figure 5

1.3. Geographic Diversification Ensued

The sector is decreasing its dependence on the south, especially AP, and establishing a

greater proportion of new branches in Uttar Pradesh (UP), Maharashtra, Bihar and Madhya

Pradesh (MP). MFIs are spreading geographically because of the following two main reasons:

1. Minimise the possibility of an AP-like event: MFIs with a higher proportion of loans in AP suffered and many were restructured.

72

97

56

18

-3

7

37

158150

83

12

-2

10

42

-200

20406080

100120140160180

FY08 FY09 FY10 FY11 FY12 FY13 FY14

Growth in MFI Growth in NBFCs-MFIs

Growth in Gross Loan Outstanding

(%)


27 27

31

28

31

24

25

26

27

28

29

30

31

32

FY10 FY11 FY12 FY13 FY14

Client Outreach

(m)


6,997 6,621 7,668 8,160

9,708

6,621 6,955 6,766 7,533

0

2,000

4,000

6,000

8,000

10,000

12,000


Avg loan size CPI adjusted (base 2011)

Average Outstanding Loans Per Borrower

Source: MFIN, Sa-Dhan

(INR)

Figure 4

-15

-10

-5

0

5

10

15

20

FY11 FY12 FY13 FY14

Borrower Growth

(%)


NBFC-MFIs grew their loan portfolio

over 40% yoy in FY14.

NBFC-MFIs are only for-profit legal

form of MFIs and hence enjoy higher

growth. They account for over 90%

of MFI loan portfolios.

Most large MFIs converted into for

profit NBFC-MFIs between FY08 and

FY10.

In FY11-FY14, per capita outstanding

increased by about 40% on a nominal

basis but only by 14% on an inflation

adjusted basis.

Substantial growth in the MFI loan

portfolio is due to an increase in

penetration and not higher borrower

indebtedness.



January 2015 5

2. Possible saturation in some districts: Though there are no studies on the level of penetration of MFIs in districts, discussions with MFIs, SROs and CIBs indicate that some districts in West Bengal (WB), Tamil Nadu (TN) and Karnataka are witnessing micro-credit saturation rejection rates at CIB of 25%-30% (all India average: 15%-20%).

Figure 6

Figure 7 Regional Distribution of MFI Loans Outstanding (%)

Region 2008 2009 2010 2011 2012 2013 2014

South 61 58 55 48 49 46 39 East 20 20 21 20 23 22 25 North 1 3 3 3 4 4 4 West 7 6 8 12 8 10 12 Central 9 11 9 13 10 11 15 North East 1 1 3 3 6 7 5

Source: Sa-Dhan, MFIN

Performance of MFIs in the states with larger MFI operations has been illustrated in

Appendix 6.

1.4. PE and Debt Funding Returns

Banks have shown greater confidence in the sector and increased their funding to NBFCs

through debt and also securitisation primarily due to two reasons:

The sector has begun to perform well under relative regulatory certainty

On-lending to NBFC-MFIs is considered priority sector lending

Securitisation of MFI loans also has priority sector benefits

Figure 8

PE players are showing renewed interest in the sector, even when it is growing at a relatively

moderate pace (FY14: about 40%) as against over 100% growth in pre-AP crisis years. It is

important that PE players maintain their interest in the sector since it will require equity funding

to finance growth.

1,348

1,318

1,082

859

682

578

540

513

1,364

1,355

936

944

873

751

673

683

0 200 400 600 800 1,000 1,200 1,400 1,600

WB

TN

AP

KA

MH

UP

Bihar

MP

Q2FY15 FY13

Rapid Growth in Branches in Underpenetrated States


207 178 170

207 222

20 28 37 34

51

0

50

100

150

200

250


Borrowings (INRbn outstanding) Securitised portfolio

Bank Borrowings and Securitisation


Between 1QFY14 and 2QFY15, NBFC-

MFIs increased their branches by 33%

in MP, 30% in UP and 28% in

Maharashtra.

Share of South India in MFI loan

portfolio decreased to 39% in FY14

from 61% in FY08.



January 2015 6

Figure 9

1.5. Operational Performance Improved

RBI, in its guidelines for NBFC-MFIs, has placed caps on the margins of NBFC-MFIs at 10%

for MFIs with total assets above INR1.0bn and 12% for MFIs with total assets below INR1.0bn.

The interest rates have a cap of 2.75x the bank rate of SCBs as notified by RBI from time to

time.

In addition, MFIs have two main cost components: Finance costs (fees and interest on

borrowings) and operating costs (admin and overhead costs and employee costs).

Effectively, revenue upsides have been capped by RBI while MFIs have little control over

finance costs. MFIs can control only operating costs to increase return on assets (RoAs).

Operating costs for the sector declined to 8.4% of loan portfolio in FY14 of the loan portfolio

from 10.3% in FY13. This was the result of more borrowers/branches and borrowers/loan

officer, a drop in the number of employees and loan officers, and increased share of field staff

(Appendix 7).

Figure 10

2. Ind-Ra’s View on the Sector

Ind-Ra is of the view that MFIs are set for sustained, stable medium-term growth till FY19

based on the sector performance in the aftermath of AP crisis and the emerging landscape of

microfinance, with the government‟s thrust on financial inclusion and diversified banking

licenses. We expect that the other models of microfinance delivery (BC, small banks, Self Help

Group or SHG) could achieve traction by FY19, by then the current RBI guidelines may have a

larger impact in limiting the growth of existing MFIs in their current form. MFIs could evolve

their operations over the next five years to provide a full range of financial services to the poor

and withstand competition on a strong footing.

416

83

165 163

93

137149

160 152

0

30

60

90

120

150

180

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15(till Nov)

Private Equity Investment

(USDm)

Source: VC Circle

7.3 10.4 12.7 13.6 11.5 10.7

64.4

93.3

111.8 114.7

87.0 75.7

10.3

8.89.3 9.9

8.48.2

0

2

4

6

8

10

12

0

20

40

60

80

100

120

140

FY08 FY09 FY10 FY11 FY12 FY13

Branches (LHS) Staff (LHS) Operating expense/loan portfolio (RHS)

Operating Costs, Branches and Staff

Source: Sa-Dhan, mixmarket.org

(000) (%)

The number of branches and MFI staff

decreased while the outreach or the

number of borrowers increased to 31

million in FY14 from 27 million in FY11.



January 2015 7

2.1. Stage Set for Growth over Medium Term

Ind-Ra expects MFIs to grow at a CAGR of about 25% for about four to five years by increasing

their outreach and disbursements per borrower. However, the growth expectations are

constrained by the evolution of differentiated banking, banking penetration through the BC

model and government initiatives such as Jan Dhan and the impact of these models.

2.1.1. Estimates of Market Size

An analysis of 15 countries with largest MFI operations reveals that average loan outstanding

per borrower is 18.7% of per capita GDP while it is 10.8% in India. Also, microfinance

penetration (borrowers) is above 30% in some countries while it is about 10% in India (SHG-

bank linkage and MFIs together).

Figure 11 Microfinance Market Potential

Wt. average outstanding per borrower as % of per capita GDP (Top 15 countries with MFI operations)

18.7

Wt. average outstanding per borrower as % of per capita GDP for India 10.8 Average outstanding per borrower - India (2013) (A) USD163 Potential growth in per capita outstanding (B) (%) 72 Potential per capita outstanding - India (C) = (A) + (A)*(B) USD280 Households with no access to credit (D) 180m Size of market outstanding basis (USD) = (C)*(D) *70%

a USD35bn

Current microfinance outstanding (SHG and MFI) USD12bn

All analysis on outstanding basis; 1USD = INR60 a Outstanding portfolio is about 70% of disbursements

Source: RBI, World Bank, Mix Markets, Ind-Ra

The microfinance universe can grow up to 3x its current size, indicating there is high latent

demand for micro-credit.

2.1.2. Caution in Newer Large Markets

MFIs are now taking up the challenge and growing in previously underserved states due to the

following reasons:

1. Faster expansion since RBI has through its guidelines tried to limit competition in markets currently served

2. Since an MFI customer cannot borrow from more than two MFIs, some regions/districts may have reached saturation. Discussions with market participants led us to believe that some districts in WB, TN and Karnataka are facing 25%-30% rejection rates at CIBs.

The new growth states such as MP, UP have shown higher defaults in the SHG-Bank linkage

programme than the South Indian states (Appendix 8). We expect that the JLG structure will

offer MFIs some protection against credit behaviours in these states (Appendix 16); however,

MFIs need to keep a watchful eye on portfolio quality, especially in these states.



January 2015 8

Figure 12

Source: Ind-Ra

2.1.3. Growth and Penetration Expectations

The growth that MFIs are experiencing now is structured, planned and systematic without

unbridled competition for the same set of borrowers. The growth of MFI portfolio is affected by

loans outstanding per borrower and increased penetration or borrower outreach.

Ind-Ra understands from market participants that the outreach can increase at the rate of 12%

CAGR over the medium term as the number of branches is increasing in previously under-

served regions. Further, the actual number of unique borrowers could be less since the SROs

add up the number of borrowers of individual MFIs; some borrowers could be counted twice.

The annual growth in outreach (number of borrowers as reported by SROs) in 1QFY15 was

about 23%.

Figure 13

Ind-Ra expects the sector to grow at a CAGR of 24% over the medium term given the confines

of RBI guidelines, an assumption that an AP-like crisis does not occur and the Microfinance Bill

(Appendix 9) does not impose debilitating conditions on the sector.

Growth in MFI Branches (Q1FY14 to Q2FY15) NPAs Under SHG Programme (FY14)

>25%

>10%,<20%

>0%, <10%,

<0%

Growth in MFI Branches (Q1FY14 to Q2FY15)

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Bihar

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Uttar Pradesh

Uttarakhand

Assam

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Haryana

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NPAs Under SHG Programme (FY14)

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Nagaland

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Gujarat

Haryana

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andKashmir

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and Diu

Dadra and Nagar Haveli

Map not to scale

Lowest (Red) to Highest (Green)

www.indzara.blogspot.com

Colour Gradient

Telangana

>25%

>10%,<20%

>0%, <10%,

<0%

<5%

>13%, <15%

>5%, <10%

>10%, <13%

>15%

Growth in MFI Branches (Q1FY14 to Q2FY15)

ArabianSea

Bayof

Bengal

Maharashtra

AndhraPradesh

Tamil Nadu

Odisha

Lakshadweep

Goa

Puducherry

Andamanand

NicobarIslands


Bihar

Jharkhand

Uttar Pradesh

Uttarakhand

Assam

Arunachal

Pradesh

Nagaland

Manipur

MizoramTripura

Sikkim

Meghalaya

Rajasthan

Gujarat

Haryana

HimachalPradesh

Punjab

Delhi

Chandigarh

Jammuand

Kashmir

Daman and DiuDadra and

Nagar Haveli

Telangana

NPAs Under SHG Programme (FY14)

ArabianSea

Bayof

Bengal

Indian Ocean

Maharashtra

AndhraPradesh

Tamil Nadu

Odisha

Lakshadweep

Goa

Puducherry

Andaman

and

Nicobar

Islands


Bihar

Jharkhand

Uttar Pradesh

Uttarakhand

Assam

Arunachal

Pradesh

Nagaland

Manipur

MizoramTripura

Sikkim

Meghalaya

Rajasthan

Gujarat

Haryana

HimachalPradesh

Punjab

Delhi

Chandigarh

Jammu

andKashmir

Daman

and Diu

Dadra and Nagar Haveli

Map not to scale

Lowest (Red) to Highest (Green)

www.indzara.blogspot.com

Colour Gradient

Telangana

>25%

>10%,<20%

>0%, <10%,

<0%

<5%

>13%, <15%

>5%, <10%

>10%, <13%

>15%

10.0

25.4

11.1

29.9

12.3

34.4

13.5

38.6

14.8

42.4

16.3

45.8

0

10

20

30

40

50

Average ticket size (INR 000s) Borrower outreach (m)


Growth Expectation in Borrower Outreach and Average Ticket Size

Source: MFIN, Ind-Ra

Loan outstanding per borrower or

average ticket size is likely to increase

at the rate of FY14 nominal GDP

growth rate (11.5%). MFIs were

focused on increasing penetration in

FY14. MFIN quarterly data shows that

the outreach increased to 26.49 million

in 1QFY15 from 21.54 million in

1QFY14, implying growth of 23%.



January 2015 9

Figure 14

The microfinance market can grow 3x its current size over FY15-FY19. The SHG programme is

not showing much growth since FY11 in terms of credit outreach. Hence, MFIs can obtain an

increased share of the microfinance lending business. We estimate that MFIs can increase

their portfolio from USD5.0bn in FY14 to USD12bn in FY19 while SHG lending could increase

to USD12bn from USD7bn. However, a credit demand-supply gap of USD11bn still will remain.

Figure 15

2.2. Profitability Expectations

Average RoAs and return on equity (RoE) improved from 2011-2012. However, they were also

limited by a cap on margins and minimum operating costs for delivery of microfinance products

during that time. Periodic physical interaction with borrowers and doorstep delivery is a

manpower-intensive method of providing services and will have high delivery costs.

NBFC-MFIs have operating costs in the range of 8%-13%. Any further increase in the

profitability will be driven by a reduction in operating costs or by increasing other income

through cross selling or acting as banking correspondents. Any margin pressure in case of

regulatory changes will adversely impact the return ratios.

253332

422

520

629

748

32

27

2321

19

0

5

10

15

20

25

30

35

0

100

200

300

400

500

600

700

800


Portfolio size (LHS) Growth (RHS)

Portfolio Size Estimates and Growth in Medium Term

(INRbn)

Source: Ind-Ra

(%)

5

137

11

11

0

5

10

15

20

25

30

35

40

FY14 FY19

MFI SHG Credit gap

Latent Credit Demand-Supply

(USDbn)

Source: NABARD, MFIN, Sa-Dhan, Ind-Ra, RBI (nominal growth rate)



January 2015 10

Figure 16 RoA Tree and Expected Returns

RoA Tree and expected returns

Gross loan portfolio (GLP)

above INR1.0bn GLP below

INR1.0bn Comments

Spread (%) 10 12 RBI stipulation (based on asset size) Margin (%) 11.5 13.8 Minimum Tier 1: 15% Fees and other income (%)

2 2 1% can be charged - RBI stipulation, disbursement usually 30% higher than GLP

Total income (%) 13.5 15.8 Operating costs (%) 8-10 10-13 Estimates based on experience of

MFIs Pre provisioning profit (%) 3.5-5.5 2.8-5.8 Provisioning (%) 1 1 Pre-tax profit (%) 2.5-4.5 1.8-4.8 Tax (%) 0.8-1.5 0.6-1.6 33% RoA (%) 1.7-3 1.2-3.2 Leverage (x) 6 4-5 Lower leverage for MFIs with GLP

below INR1.0bn because of lower bankability

RoE (%) 10.2-18 4.8-12.8

Source: Ind-Ra

2.3. INR27bn Equity Infusion Likely over Medium Term

Most MFIs have been maintaining tier 1 capital at 18%-25% as against the RBI stipulation of

minimum 7.5%. Given the bitter past experience, we believe that most MFIs will maintain

excess capital and will consider fund raising at the threshold levels of 20% of tier 1 capital.

Within the confines of RBI regulations, our calculations in the previous section suggest that the

largest 20-25 MFIs could maintain RoE in the range of 10%-18%. For our calculations of capital

requirement, we assumed average RoE at 15% and tier 1 capital at 20%. The capital

requirement could be higher if:

1. MFIs with lower tier 1 capital could bring it to par with better capitalised MFIs

2. MFIs could raise equity for non-microcredit portion of their business

3. MFIs could require higher capital if they opt for conversion to small banks

Figure 17

2.4. Lower Probability of AP-like Crisis

The AP crisis (Appendix 2) happened because of unbridled competition among MFIs, absence

of sector-specific regulations, process dilution, high interest rates and aggressive recovery

techniques. AP brought out the AP Microfinance Act in December 2010 (Ordinance in October

2010) which put severe restrictions on MFIs‟ operations in the state. Some large MFIs that

were restructured had over 50% of their portfolios in AP.

Much has changed since then. RBI is now the central regulator for NBFC-MFIs (which cover

over 90% of MFI borrowers). It has issued guidelines for various operational facets of MFIs‟

1618

2022

24

911

14

17

21

7 7 5 5

3

0

5

10

15

20

25


Min incremental capital required Profit Equity funding required

Capital Requirement

(INRbn)

Source: Ind-Ra

Under our assumptions of 28% loan

book CAGR over FY15-FY19, the

NBFC-MFI universe is likely to require

INR27bn (USD449m) of equity

investments. The requirements are

likely to change if some MFIs are

converted into small banks.



January 2015 11

operations, which have reduced credit and operational risks (Appendix 3). The guidelines have

resulted in interest rate caps, limit on loan amounts, limit on the number of micro-loans that a

borrower can avail and specifications for micro-loan tenor. MFIs are required to adhere to

capital stipulations, follow benign recovery means and exhibit transparency in interest and

other charges. This has limited the growth in loan portfolios and returns of MFIs (compared to

pre-AP crisis period). However, the RBI guidelines have resulted in stable growth, a steady

micro-finance structure and a higher degree of compliance to the code of conduct.

It is also mandatory for MFIs to conduct credit checks on borrowers through credit bureaus

(Equifax and Highmark) before disbursement (Appendix 4). This prevents indiscriminate

lending by MFIs and enables evaluation of borrower loan history and client borrowing against

RBI stipulations.

RBI has appointed MFIN as the SRO for NBFC-MFIs (which covered about 90% of

microfinance loan portfolio in FY14) and intends to implement a strong code of conduct and

self-regulation through the SRO (Appendix 4). Sa-Dhan is another body which has non-profit

MFIs among its members in addition to NBFC-MFIs.

No state other than Andhra Pradesh has decided to invoke provisions of the Money Lenders‟

Act to regulate MFI operations. The central government is evaluating the Microfinance Bill

(Appendix 9) to regulate microfinance operations. It was presented to the Parliamentary

Standing Committee in February 2014, which recommended the Finance Ministry to carry out

further studies especially on regulations, low interest microfinance programmes present in

some states and consumer protection in the sector.

The Microfinance Bill if passed could eliminate the possibilities of an AP-like event.

Figure 18

Passage of MFI Bill Last Step towards Ensuring Regulatory Certainty

Since NBFC-MFIs are regulated by the central regulator, some MFI constituencies are of the

view that the state has no role in regulating NBFC-MFIs. However, for the central bank‟s

authority to regulate MFIs to become a law, the Microfinance Bill has to be passed by the

Indian parliament (Appendix 9).

Source: Ind-Ra

RBI has emerged as the central regulator of

NBFC-MFI

• This limits the scope of interference by

individual state governments, which could

have otherwise used the Money Lenders

Act to control MFIs.

• It also provides huge legitimacy to the

sector and improves MFI‟s access to funds

from the commercial banking sector.

RBI has clearly defined process, rates and

code of conduct

• Margins have been capped at 10% for

large MFIs, thus limiting the scope for

charging excessive interest rates.

• Insurance expense and processing fees

are the only charges that an MFI can levy.

• Recovery practices have been clearly

defined.

CIBs provide an efficient monitoring

mechanism

• High indebtedness in AP was an outcome

of absence of any customer-related credit

information.

• CIBs generate an exception report when

more than two MFIs lend to a single

borrower, thus acting as a check on MFIs.

Geographic diversification has ensured

lower exposure to a state

• Top five AP-based MFIs had over 35% of

their portfolios in AP.

• Many MFIs have begun to diversify into

multiple states, partly under the fear of AP-

like event and partly in search of growth

opportunities.

Low

Risk

Summary of Major Changes in MFI Sector



January 2015 12

In our opinion, the major objections raised by the Parliamentary Standing Committee now

either have sufficient mitigants (considering global experience of the sector) or do not take into

account the difference between MFI and bank lending.

Figure 19

Why Has the Microfinance Bill Not Been Passed So Far? Key objections to the MFI bill Current mitigants

Global experience (top 17 countries MFI operations)

The bill proposed RBI as regulator for MFIs

RBI is the regulator for NBFC-MFIs (90% of MFI universe)

Mixed models of regulation for various forms of MFIs

High interest rates of 26% charged (some government programmes charge 12%)

Our analysis reveals Indian MFIs charge interest rates up to 3x the bank rate while global average is 4.5x the bank rates (Appendix 9)

Silent on multiple lending, coercive recovery and over-indebtedness

RBI has defined limits and procedures in regulations for NBFC-MFIs

Independent client protection agency or respective central banks

Source: Ind-Ra

2.5. Competitive Environment, Regulations Favouring Incumbents

The RBI regulations on borrower indebtedness have indirectly resulted in lowering the

competitive levels among MFIs. The key regulations to that effect are not more than two MFIs

can lend to the same borrower and a spread cap of 10% for large MFIs and 12% for small

MFIs.

The cumulative impact of these regulations is lower competition. A few scenarios could be:

1. Suppose two MFIs are already dominant players in a particular village.

2. A new entrant in this village will most likely have to tap new borrowers, who may not be easily available as the existing two MFIs have tapped most of the potential customers.

3. Thus, the costs for the new entrant will be significantly higher and the 10% spread cap will make the MFI‟s business model unviable or less profitable.

Thus, incumbents have an inherent competitive advantage. However, this does not prevent a

large MFI or a corporate house acquiring an MFI.

2.5.1. Increasing Share of Larger MFIs

Midsized MFIs are increasing their share of borrower outreach. Large MFIs have seen a

marginal dip in their share while small MFIs have seen a significant decrease in their share.

Figure 20

We expect mid- and large-sized MFIs, especially with strong holds in certain areas, to continue

to operate profitably for the medium term. Many small MFIs may have to merge with mid- or

large-sized MFIs or adopt the BC model to remain profitable. Small MFIs may also face

difficulty in obtaining bank funding, securitisations deals, or attract PE and hence this raises

71.6%83.3% 83.7% 79.6% 83.2%

15.7%

13.7% 12.9% 17.3% 14.2%

12.7% 3.1% 3.0% 3.4%2.6%

0%

20%

40%

60%

80%

100%

FY11 FY12 FY13 FY14 2QFY15

glp>5 (INRbn) glp 1-5 (INRbn) glp < 1 (INRbn)

Increasing Share of Large MFIs

Source: MFIN

Figure 21 Category of NBFC-MFI

GLP >INR5.0bn Large INR1.0bn>GLP<INR5.0bn Mid-sized GLP<INR1.0bn Small

GLP: Gross loan portfolio Source: Ind-Ra



January 2015 13

questions on their long-term viability unless they have specific niches or operate in a particular

state. This may expose them to state specific legislation risk.

2.5.2. High Entry Barriers

The root of AP crisis was unsustainable MFI debt outstanding per household. This was a

consequence of intense competition to acquire clients and thereby grow loan books. There

were instances of four to five MFIs operating in a single village.

In its guidelines, RBI has built in provisions to lower competitive intensity by increasing

operating costs for late entrants in the same local area. An individual cannot be a member of

more than two JLGs and credit checks to be carried out before disbursement. Due to the above

provision, incremental cost for a new entrant to find suitable members and foster credit

behaviour is high and therefore a deterrent.

There have been only two new entrants among NBFC-MFIs since 2011; Svatantra Microfin

Private Limited of Birla group started operations in March 2013 and Altura Financial Services

Ltd, registered in Delhi in FY14.

However, a large corporate house may be able to enter into the sector by acquiring an MFI

without any significant entry barriers.

2.5.3. Competitive Landscape May Change with New Structures

Over the past few years, the government is increasingly focusing on financial inclusion as a

means to reduce poverty and bring the unbanked into the mainstream. The thrust of the

programmes is through banks. During 2005-2010, banks opened over 100 million bank

accounts supposedly to be used for MGNREGA payments, pension etc. However, surveys

reveal that these were generally target-driven programmes for the ministry and banks and over

70% accounts were dormant.

The new government has launched the Jan Dhan scheme (Appendix 10) that proposes to open

bank accounts for the unbanked with many facilities such as insurance, overdraft along with

savings accounts. Furthermore, RBI has issued banking licence to Bandhan Financial Services

(Bandhan), possibly for its role in financial inclusion (Appendix 11).

Competition from Jan Dhan Driven Bank Credit

If an overdraft facility is extended to all Jan Dhan account holders (as on 31 October 2014), it

would imply a credit of INR340bn (as large as the SHG programme). There has been no

experience of Indian banks extending unsecured credit at individual level of this magnitude and

hence portfolio performance cannot be estimated.

Our view is that it would be difficult for RBI to accept individual lending through Jan Dhan

accounts without collateral. Press reports suggest that even banks are sceptical about

extending an overdraft facility to Jan Dhan account holders.

Furthermore, the following advantages of MFIs over banks still exist:

Collateral free credit

Speed and timely availability of credit

Door step delivery; no opportunity cost of multiple bank visits

Less complex documentation; banks still viewed as complex entities

There could be a marginal loss of market share for MFIs, although it may not be disruptive in

the mid-term. Full-fledged credit could be made available to Jan Dhan account holders at

individual level only after satisfactory account behaviour and timely repayment of the initial

overdraft facility of INR5,000.



January 2015 14

Scope of Growth May be Limited Beyond 2019

Ind-Ra expects that the measures of the government such as appointing BCs at high speed,

trying to increase efficiency and transaction throughput of the BC model and permitting

diversified banks may achieve sufficient traction only by FY19 for financial inclusion and pose

competition to MFIs. These models could limit their growth in the long term. This may cause

MFIs to look at alternate models of evolution and expand their product suites for their

customers instead of handing over the customers to banks for additional services.

Figure 22

MFIs Can Adopt the BC Model

A BC acts as a third party agent between a borrower or a client and a bank (Appendix 5).

Smaller and mid-sized MFIs could look at a combined model of MFI and/or small bank and a

banking correspondent model.

The BC model provides an opportunity to MFIs to leverage their operational reach and

closeness to clients to provide them greater access to the banking services of the partner bank.

The BC need not require substantial capital for its operations and can leverage its equity much

higher than in MFI operations.

The model has its set of challenges where the transaction throughput may not provide

sustenance. However, the BC model could become a viable option especially for smaller MFIs

considering the increasing number of transactions through this channel and increased focus of

the government, regulators and banks on financial inclusion through it.

MFIs Can Apply for Small Bank Licence

MFIs largely have a one-dimensional business i.e. microfinance lending. With RBI allowing

MFIs to act as BCs for a bank, new areas for fee income growth are emerging. The small bank

license or the differentiated bank license may provide opportunity to MFIs to convert into a

multi-dimensional financial entity (Appendix 12).

Payment banks can remit money and pay utility bills or any other payments on behalf of its

client. The client‟s savings/deposits may be deployed only towards investments in government

securities (Appendix 12).

Small banks can provide a large suite of services to a client including savings, cross selling

insurance, remittance and loan products (Appendix 12). Furthermore, small banks are likely to

have a lower cost of funds (due to the ability to provide savings and deposits products) that

could translate into lower interest rates for borrowers. However, reserve requirements (in line

with scheduled commercial banks) will also put downward pressure on returns. Our estimates

Source: Ind-Ra

MFIs May Need to Look for Alternate Models

Marginal increase in loans

outstanding per borrower

Lower preference for more than 1

year loans (disb above INR15,000)

since RoA lower

Closer borrower indebetedness limits

Adding clients would be difficult –

easy additions made by FY19

Penetration may be limited by the

existence of other MFIs and new

models

1. Diversified banks

2. Bank credit through

Business

Correspondents

3. Expansion in scope

of SHG programme

Limitations placed by

current RBI guidelines

Competition from

other low-cost models

that accept

savings/deposits

Limitations on growth of

MFIs beyond FY19



January 2015 15

show that small banks could have 2%-3% lower cost of funds and 3%-4% lower operating

costs than MFIs‟ which could be passed on to customers. Most top 15 MFIs (about 80% of the

NBFC-MFI loan book in 2QFY15; Appendix 13) in our opinion are systemically important and

are better placed to benefit from the small bank licence.

The MFIs can adopt models based on their size and geographical spread.

Figure 23

Smaller MFIs may not be able to withstand competition from larger MFIs, small banks and the

government sponsored SHG programmes and hence may look at adopting the BC + MFI

model in its dominant states.

Mid-sized MFIs operating in a few states could adopt the BC+ MFI or SB model, while large

MFIs can transform themselves into small banks. The performance of top 15 MFIs on various

operational parameters may be referred in Appendix 13.

Migration to Individual Lending from Group Lending

In countries where microfinance has a presence since long, a category of borrowers have

moved up the value chain. They may have been successful in their micro-enterprises and their

requirements may not be satisfied by borrowings from MFIs. They may have relative certainty

of cash flow and/or business that may provide with steady income.

Their social status may increase and they may not want to be a part of the group lending

structure. In South and Central America, many countries have as a result migrated to the

individual lending mechanism. Many MFI borrowers could migrate to individual borrowing from

MFIs or banks in India also, considering increased income, increased status of the borrower

and higher credit needs and the fact that government and banks are pushing financial

inclusion.

Within the current contours of RBI guidelines, MFI loans above INR50,000 cannot qualify as an

MFI loan. Furthermore, the credit requirements of a borrower may exceed the RBI mandated

INR50,000 limit. If RBI does not modify the above stipulations, these clients may migrate to

banks. Alternatively, MFIs could serve these customers through the BC model or as small

banks.

Source: Ind-Ra

Evolution Model for MFIs

Diversified

presence

Concentrated in

few states

Large

Small

BC+MFI

BC+MFI/SB SB

BC: Business correspondent

MFI: MFI operations

SB: Small Bank

Figure 24 Category of NBFC-MFI

GLP >INR5.0bn Large MFIs INR1.0bn>GLP<INR5.0bn

Mid-sized MFIs

GLP<INR1.0bn Small MFIs

Source: Ind-Ra



January 2015 16

3. Appendix 1: Glimpse of Success (2006-2010)

In the early 2000s, the JLG model was experimented upon in India by societies set up by

NGOs for the specific purpose of lending to the poor. As non-profit organisations, they could

only accept donations/charity as funding sources. Subsequently, they realised that lending to

the poor can also be profitable and many converted into NBFCs. The high growth-high return

NBFCs attracted investments and debt, which fuelled the growth cycle. This increased the

competition for borrowers, equity etc and resulted in diluted standards of credit.

3.1. Conversion from Non-Profit to For-Profit

Most NGOs/societies/trusts realised that the microfinance business can be operated profitably

and hence converted into NBFCs (regulated by RBI). These NBFCs now constitute about 85%-

90% of the total MFI lending and are the subject of the report.

The interest rates charged in this sector (25%-35%) were higher than formal financial

institutions/sources due to the following two reasons:

1. Moneylenders, whom MFIs expected to replace, charged 50%-500% interest rate.

2. Operational and recovery costs were higher because of the small ticket size of the loans, and MFIs could not operate profitably if they charged interest rates of 12%-15% (which is typical bank lending rate).

Despite higher operational costs, NBFC-MFIs more than made up for it by charging higher

interest rates and some enjoyed ROAs of 4%-5% while the same for banks was 2%-3%. These

banks were also subject to prudential norms and reserve requirements. Among other

conditions conducive to growth, a favourable outlook of the world on microfinance led to the

flow of debt and equity capital into the sector. The sector had no shortage of funds and grew

over 100% annually from FY06-FY10.

Figure 25

3.2. Improved Access to Debt and Equity Funding

Globally, the microfinance sector was attracting a lot of attention and media and others viewed

it as a poverty alleviation tool without any shortcomings. The sector attracted funds from PE

investors and debt from banks. The story was no different in India.

4.10 4.40

1.90

27.50

25.00

9.70

0

5

10

15

20

25

30

2008 2009 2010

RoAs RoEs

Return Ratios of MFIs

Source: mixmarket.org

(%)



January 2015 17

3.2.1. PE and Other Equity Raising Plans

Figure 26

The high RoAs translated to RoE of 25%-35% and attracted PE investors. Though some of

these were long-term investors, others looked to maximise returns in three to four years and flip

their investments.

According to media reports, the investments were made at high valuations and the return

expectations were also high. The investors had a significant say in the strategy and

management of the company and possibly applied intense pressure on the management to

grow the loan books.

SKS Microfinance Limited, one of the top three Indian microfinance firms, raised USD357m in

August 2010 from the primary market and the stock doubled within a couple of months. The

listing happened at 4.2x its extant book value. Sequoia Capital India made 12x on its

investment in four years when it made a partial exit through the initial public offering (IPO).

Media reports suggested Bandhan and Spandana Spoorthy Financial Limited had also readied

IPO plans to raise INR30bn from the primary markets.

3.2.2. Bank Funding and Priority Sector

RBI and other regulatory bodies viewed MFIs as a means of financial inclusion for the poor.

Hence, banks‟ lending to these institutions qualified as priority sector loans. According to RBI

regulations, the adjusted loan book of Indian banks must have 40% of loans advanced to the

priority sector and most Indian banks usually fall short of this target. MFIs fulfilled this

requirement in the following two ways for Indian banks.

1. Borrowings by MFIs qualified as priority sector loans

2. MFIs securitised part of the loans originated by them. Some banks, as a part of their strategy, made investments in such securitised products to reduce their loan book size. This also reduced the priority sector loans they needed to advance.

As a result, bank funding increased to USD3.8bn in 2010 from USD1.2bn in 2007 (source: Mix

Markets). The increased availability of funds enabled MFIs to grow exponentially with high

returns attracting further confidence and funds.

3.3. Strong Growth Ensued

Sa-Dhan estimates that the number of MFI players across all legal forms increased to 318 in

2010 from 40 in 2006. Each player wanted to showcase its capability and growth to attract

capital. They undertook massive expansion and to achieve faster and easier growth, focused

on growing their portfolio in high penetrated states of AP, TN and WB.

416

83

165 163

0

30

60

90

120

150

180


Sector Attracted PE Investments

(USDm)

Source: VC Circle

Equity was over 25% of the MFI

balance sheet in 2010 (2007: 16%)

(Source: Mix Markets).



January 2015 18

3.3.1. Loan Book Doubled Almost Every Year

The over 100% growth in NBFC-MFI portfolios was due to overall growth in microfinance

portfolio and conversion of some non-profit MFIs to NBFCs. By FY10, a majority of large MFIs

that were societies were converted into NBFCs.

Figure 27

3.3.2. Blistering Operational Expansion

Flush with funds and in a hurry to show returns, MFIs expanded. Staff doubled in less than two

years and operating leverage (borrowers per loan officer) increased. MFIs also increased the

number of branches by 2x in three years.

Figure 28

Figure 29

14

36

89

163

158150

83

0

30

60

90

120

150

180

0

30

60

90

120

150

180

FY07 FY08 FY09 FY10

Portfolio (LHS) Growth in NBFCs-MFIs (RHS)

NBFC – MFI Portfolio Size and Growth

(INRbn)

Source: Sa-Dhan, State of Sector reports-Access Development Services

(%)

39,997

64,354

93,342

111,804

27,998

47,622

63,472

77,145

0

20,000

40,000

60,000

80,000

100,000

120,000

FY07 FY08 FY09 FY10

MFI staff Field staff

Number of MFI Staff and Loan Officers

(Staff)

Source: Sa-Dhan, mixmarket.org, State of Sector reports-Access Development Services, Ind-Ra

231

294

356 346

0

100

200

300

400

FY07 FY08 FY09 FY10

Borrowers Per Loan Officer

(Borrowers per credit officer)




January 2015 19

Figure 30

3.3.3. Piggybacking on SHG Model

MFIs realised that they could form JLGs and disburse faster if they included SHG members

(who had inculcated good credit behaviour) in the group formation. MFIs concentrated on the

regions where the SHG programme was implemented on a large scale and was reasonably

successful i.e. south India and especially Andhra Pradesh.

Figure 31

The incentives of a loan officer were based on portfolio growth/disbursements and recoveries.

As a result, the easiest and fastest way for him to acquire new borrowers was to invite existing

JLG and SHG members for the formation of a new JLG.

6,1897,252

10,435

12,690

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

FY07 FY08 FY09 FY10

Number of MFI Branches

(No of branches)


Source: Ind-Ra

Process of JLG Creation and Loan Disbursement from NBFC-MFI’s Viewpoint

New loan officer

to acquire 300

clients in a year

Pressure to form

a JLG

• The cluster may already have two-three existing MFIs with offices and

established JLGs. In case the officer looks for new members that may not be

members of existing JLGs and SHGs, he may find them either unworthy of credit

or not find such members at all.

• In addition, even if he is successful in arranging for creation of such a group, it

would take time for the members to inculcate behaviors suitable for credit and

involve significantly high operational costs.

• In FY08, each loan officer serviced 294 borrowers.

• A new loan officer is looking to set up operations in a cluster of villages is under a

lot of pressure to attract clients (who will not default) and also to disburse loans.

• He has to serve 294 borrowers in a year.



January 2015 20

Figure 32 Loan Portfolio: Regional Share Region (%) 2008 2009 2010

South 61 58 55 East 20 20 21 North 1 3 3 West 7 6 8 Central 9 11 9 North East 1 1 3

Source: Sa-Dhan and State of Sector Reports-Access Development Services

Over 50% SHGs in FY10 were concentrated in south India. MFIs mirrored SHGs and hence

south India had a share of over 50% in MFI loan portfolios.

3.3.4. Increased Concentration in South India esp. AP

The overdependence on south India, especially AP, after Kolar and Krishna crises (described

later) increased the concentration risk for MFIs.

Figure 33 Regional Break-up of the MFIs’ Portfolio Regions (INRbn) 2008 2009 2010

South 36.5 68.6 103.3 East 11.6 23.2 39.8 North 0.9 3.9 5.4 West 4.4 7.0 14.2 Central 5.6 13.5 17.4 North east 0.6 1.1 6.3 Total 59.6 117.3 186.4

Source: Sa-Dhan, Ind-Ra

The top four states constituted almost 70% of the total loan portfolios of MFIs. AP constituted

28% of the MFI loan portfolio in FY10.

Figure 34

Both these models concentrated majority of their efforts in growing their loan book in AP, which

resulted in the highest MFI debt per poor household in the state in 2010.

3.4. Lack of Regulatory Oversight Leads to Process Dilution

There was no regulatory body or supervisory structure for MFIs as they could be in various

legal forms such as NBFCs, NGOs, trusts/societies and Section 25 companies.

3.4.1. Favourable Regulatory Regime

No Supervisory Structure: Though NBFCs (over 85% of the MFI universe) were regulated by

RBI in terms of accepting deposits and prudential norms, there were no guidelines for their MFI

operations, credit appraisal etc. Global experience shows that in an unregulated environment,

0

5

10

15

20

25

30

35

AP WB Karnataka TN

FY08 FY09 FY10

Loan Portfolio: States with Largest Share

Source: Sa-Dhan, Ind-Ra‟s estimates

(%)



January 2015 21

MFIs grow at a breakneck pace, but the quality of their loan portfolios could suffer.

Many MFIs were members of SROs and required to adopt their code of conduct, however

again, there was no system of measuring the adherence.

No Specific Norms for JLG Formation: JLGs were conceptually expected to operate in a

manner similar to SHGs. Under the ideal Grameen model, JLG members could be eligible for

loans after two weeks to one month from the formation based on the assessment of the group‟s

credit behaviour by a loan officer. Two aspects may be noted here: inherent conflict of interest

of the loan officer while assessing the group and the fact that these are mere guidelines, not

mandatory waiting periods.

The population of a particular region may exhibit a particular set of credit characteristics and

the formation and maturing of a JLG may be tweaked. For instance, NABARD („IND

AAA‟/Stable), in its studies undertaken for implementing a SHG-bank linkage programme

suggested that an SHG requires six months for maturing before it becomes eligible for credit.

3.4.2. Process Dilution Increased Credit Risk of MFIs

Competition was fierce in the barely regulated MFI sector. The cost of providing credit to a

borrower in the microfinance business was inversely proportional to the competitive intensity.

For example, for two MFIs operating in a large village with population of 5,000 and about 500

potential borrowers (considering the typical profile of a JLG member), two loan officers can

easily cover all the borrowers. Now if a third MFI decides to set shop, its loan officer would be

under intense pressure to attract borrowers and the following sequence of events may follow:

The loan officer may form a JLG out of the existing SHG/JLG members

The JLG may not be given time to mature

The loan officer does not carry out credit appraisal properly, or may not even confirm with other JLG members before inducting a new member or providing a loan to the borrower.

The loan officer may provide multiple loans of increasing sizes.

Once a JLG is formed after the competition-led process dilution, easy credit is available to

borrowers.

3.4.3. Multiple Loans of Increasing Size

As the number of MFIs operating in a region increase, the credit appraisal process is diluted

because of competitive intensity by under-regulated MFIs.

Multiple Loans

The borrower would potentially be a member of JLGs with all MFIs operating in the region and

could be a borrower with more than one MFI. He may borrow from other MFIs to service

existing MFI loans. The borrower is then caught in a debt trap where he borrows increasing

amounts to repay earlier obligations. A survey conducted by Microsave, an international

consulting organisation, on a sample of AP MFI borrowers revealed that 71% respondents had

borrowers from three or more MFIs.

Loan Size

It would be understandable if MFIs were growing most of their loan portfolios by increasing their

outreach. However, the bulk of the increase in the loan portfolios of MFIs was due to an

increase in average ticket size. The average loan outstanding per borrower increased at a

CAGR of 26% during FY08-FY10. The growth was much higher in some states.

Figure 35 Borrowers from Multiple MFIs Number of MFIs borrowed from

% respondents

1 5 2 24 3 51 4 12 >4 8

Source: Microsave



January 2015 22

Figure 36 Average Loan Outstanding Per Borrower (INR) FY08 FY09 FY10 CAGR (%)

Andhra Pradesh 5,177 7,008 8,270 26 West Bengal 3,345 4,924 6,023 35 Karnataka 5,468 6,471 6,895 12 Tamil Nadu 3,307 4,901 5,189 25 Uttar Pradesh 6,330 9,150 7,925 12 Maharashtra 3,195 2,555 6,447 42 Madhya Pradesh 4,433 5,759 5,930 16 Odisha 3,282 5,482 7,500 50 Total 4,223 5,192 6,870 26

Source: Sa-Dhan

AP was the only state with an average loan outstanding per borrower of over INR5,000 in FY08

and average CAGR 25% loan growth for two consecutive years.

Of the other states with an average loan outstanding per borrower of over INR5,000, Karnataka

and UP reported a CAGR of about 12% for the same period. This was marginally more than

India‟s GDP growth i.e. 9.32% in FY08 and 6.72% in FY09 and 8.59% in FY10 (Source: RBI).

3.4.4. Purpose of Loans

Though it is not entirely possible to monitor the end use of microfinance loans, ideally the loans

were to be provided for income generating purposes. According to Sa-Dhan, over 85% loans

were extended for income generating purposes in FY10.

Figure 37

However, the Microsave survey reveals that in AP over 40% of loans in 2009-2010 could have

been extended for non-income generating purposes including repayment of the existing loans.

3.4.5. Non-transparent Interest Rates, Fees and Hidden Costs

The fees and interest charged by MFIs came under a lot of criticism for their non-transparency.

1. Flat interest rate: MFIs charged a flat interest rate instead of on a diminishing principal

basis. It effectively means that a 20%-25% flat interest rate could actually be around 35%-40% interest rate on a diminishing principal basis.

2. Additional fees: Further five to six different kinds of fees were charged to borrowers,

amounting to an additional charge of about 3%.

3. Interest rates did not decrease in line with bank rates: In 2006-2009, interest rates

charged by banks were lowest in a decade, but that did not deter MFIs from charging high interest rates. Borrowers often have immediate cash requirements and thus interest rate is not such a concern.

4. Deposits/forced savings: A few press reports alleged that MFIs typically deducted 10%-

15% of the disbursements as security deposits without reducing the corresponding interest amount for debt service.

Income generating87%

Consumption8%

Housing3%

Others (includes health and education)

2%

Other13%

Purpose of Loans (FY10)

Source: Sa-Dhan

Non-income generating



January 2015 23

4. Appendix 2: AP Crisis and its Aftermath (2010-2012)

AP was the most penetrated state for microfinance loans during FY95-FY10. Even under the

SHG-bank linkage model, AP had over 50% share in a number of credit SHGs. In 2010, MFIs‟

exposure to AP was 29% (INR52.1bn on 31 March 2010).

The process dilution (refer section 3.4.2) and the related factors led to easy growth in terms of

number of customers and loan portfolio. It also led to easy customer acquisition and availability

of credit to JLG members. This led to a drastic increase in per household debt.

A Microsave report based on a survey reveals that 71% of the respondents had loans

outstanding from three or more MFIs. According to the State of the Sector reports by Sage

Publications, each poor household in AP had average loans of INR71,761 in FY10. Ind-Ra‟s

own estimates suggest that the average poor household debt in AP in FY10 could be up to

INR87,000.

Figure 38

Pressure to Lend and Recover Leads to Unsavoury Practices

Various operational aspects of MFIs, their charges, recovery were highlighted possibly in an

exaggerated manner. Profit-seeking nature, comparison with money lenders etc, further dented

MFIs‟ image. Various studies and surveys suggested that these press reports were not without

a reason, although it would be difficult to separate facts from exaggeration.

Increased fund availability increases pressure to grow and disburse

Management and employee incentives are based on growth in customers and loan portfolio

Members from SHG and other JLGs are poached for the quick formation of a JLG

Loans are extended to the members (even if they have substantial indebtedness to other MFIs)

Borrower may have loans from three to four MFIs and SHG and may be under pressure to make

repayments

As the income insufficient, MFIs use aggressive means for recovery

Source: Ind-Ra, Microsave



January 2015 24

4.1. High Household Debt and Correlation with Suicides

Due to unrestrained expansive strategies of MFIs and easy availability of debt, microfinance

debt per poor households reached high levels.

Figure 39 Household Microfinance Debt in Large States MF debt (2010) AP TN Karnataka WB UP Maharashtra MP

MFI debt (INRbn) 52.10 23.87 25.51 21.08 9.51 9.67 5.93 SHG debt (INRbn) 117.39 40.59 20.55 13.27 16.36 12.03 4.45 Total households (m) 21 19 13 20 33 24 15 Poor households (%) 9.20 11.28 20.91 19.98 29.43 17.35 31.65 Average borrowing/poor household (INR)

87,728 30,850 16,493 8,436 2,628 5,122 2,173

Source: State of Sector reports – Access Development Services, Census 2011 and Planning Commission (for poor households, 2011-2012)

A poor household in AP in FY10 held about INR87,728 as debt, out of which about INR27,000

was borrowed from MFIs. Considering the average outstanding of INR8,270 (Bharat

Microfinance Reports, FY10, FY11 – Sa-Dhan), each average poor household borrowed from

at least three MFIs at a time. Some press reports quoted surveys indicating some poor

households having outstanding debt of over INR60,000 from six to seven MFIs.

Given that servicing the level of household debt was beyond the means of some poor

households, MFIs employed harsh recovery practices which could have included public

humiliation, house visits, following the borrower, intimidation etc. Society for Elimination of

Rural Poverty reported over 70 suicides within nine months in FY10-FY11 because of the

inability of the poor to repay debt.

4.2. Unfavourable Institutional Perception

A combination of high returns made by investors, bad press in relation to high interest rates

and aggressive recovery means affected the perception of MFIs in the eyes of the public,

customers, politicians and the system.

1. Profit seeking image of MFIs: The Grameen model was ideally expected to charge

interest rates enough only to enable it to sustain and carry on its business of financial inclusion with nominal profits for stakeholders. In FY08-FY11, Indian MFIs were among the fastest growing in the world, attracting higher PE investments on the strength of their high RoAs and RoE of about 5% and above 30%, respectively. SKS Microfinance was ranked second in the world on the most profit parameters by Mix Market.

2. IPO plans: SKS Microfinance raised over USD350m from the primary market while

Bandhan, another large MFI, had made its IPO plans public. Early investors were making manifold returns on their investments (Sequoia Capital made 12x on its SKS investment). MFIs increasingly began to be viewed as entities making profit off the poor.

3. Local press highlighted extreme recovery measures and attributed suicides to the recovery means.

4.3. Political Interference

The grievances began to be highlighted to various departments, ministers in the government

and the press. Given the socio-political importance of the fact that the poor may have been

exploited, intense political interference followed partly due to resentment towards MFIs using

the SHG structure for profitable purposes and partly due to media reports on MFIs‟ recovery

means and suicides.

Reports and subsequent surveys suggest that local politicians and strongmen in some regions

may have prompted people not to repay MFIs claiming that the poor were being exploited. The

AP government, under intense pressure from its own ministers and the opposition, decided to

act tough. It promulgated what MFIs consider draconian, the Andhra Pradesh Microfinance

Ordinance, 2010.



January 2015 25

4.4. AP Act 2010

The AP government, based on reports received from district collectors on MFI operations,

passed the Andhra Pradesh Micro Finance Institutions (Regulation of money lending)

Ordinance 2010. The AP Ordinance (which subsequently became an Act) was aimed at

crippling the seemingly haphazard processes followed by MFIs when lending to the poor. MFIs

could not recover their loans, make fresh loans without government approvals, and had to

provide a list of employees involved in the recovery and lending parts of business. This,

coupled with active encouragement to borrowers from local politicians and strongmen to halt

repayments, resulted in a contagion effect in the state. The collection efficiencies dropped to

below 20% in January 2011 from 99% in September 2010.

4.4.1. Key Provisions of AP Act

Figure 40 Key Provisions of AP Act Feature Before AP Act After AP Act Implication

Registration of business

MFIs were registered either as NGOs or NBFCs and free to operate throughout the country

Register with following details with every district authority where they operate:

villages and town they operate in, proposed interest rate,

due diligence and recovery system

persons authorised for lending or recovery on behalf of MFIs

Operations permitted only after registration

Key feature of MFI loans was speed and timely availability to borrowers. These provisions led to the lending operations subject to the local bureaucracy Resumption of business (lending and recovery) only after registration

Cancellation of registration

n.a. On receipt of complaints of SHG or JLG members even if an inquiry is underway

Cancellation possible even on receipt of unjustified complaints to the authorities

Borrower sourcing

MFIs aggressively used the ready ecosystem developed by the SHG-bank linkage programme

No member of a SHG can be a member of other SHG or MFI

MFI desiring to lend to an SHG borrower has to apply to the district authority

Permission required from bureaucracy for lending to each existing microfinance borrower

Lending rates Typically between 30%-50%, which included multiple fees etc

Only interest to be charged Interest cannot exceed principal over the loan tenor

In case where the interest could / has exceeded the principal, the excess amount is to be returned to the borrower

Recovery practices

Recovery agents would make trips to borrower's residence if required

MFIs not to employee external recovery agents. Recovery to be done only at a central location and not to interfere with the borrower‟s routine Penalty: Criminal action

Total dependence of MFIs on willingness and intent of the borrower for recoveries. Fear of punitive action by the state

Submission of data to district authority

n.a. Monthly statements with borrower names, interest rate charged and loan amount

Additional bureaucracy

Undertaking by the CEO

n.a. CEO becomes directly responsible for any lapses in operations at branch level also

Even for a small lapse, CEO may be jailed. Highly disproportionate penal terms

Source: AP Act 2010

The bill was immediately enforced and the recoveries collapsed. As a result, MFI operations in

the state came to a grinding halt.

4.4.2. Could the Crisis Have Been Foreseen?

The AP crisis was not unique to AP. Similar crises occurred in Krishna district of AP in FY06-

FY07 and Kolar district, Karnataka in FY09-FY10. In addition, MFIs in many countries such as

Bolivia, Nicaragua, Bosnia and Herzegovina, Morocco and Pakistan suffered similar crises in



January 2015 26

the late 1990s and 2000s.

Krishna Crisis

The Krishna crisis occurred in the Krishna district of AP in 2006 and was the precursor to the

AP crisis where district authorities closed down 50 branches of MFIs.

The crisis started with a section of people alleging that MFIs charged extremely high interest

rates and were undertaking aggressive recovery tactics. This was similar to the AP crisis but

the scale was small (restricted to one district). There were three main allegations:

Lack of clarity on fees and other charges, calculation of interest on flat basis, forced savings/deposits increased borrowing costs for the poor

Unethical recovery means including confiscation of land documents etc.

Poaching SHG members for JLG operations; direct competition with the SHG-bank linkage programme (AP had undertaken significant initiatives in the SHG-bank linkage programme and extended several grants/interest)

The entire incident attracted lot of bad press for MFIs including many suicides being attributed

to them. Some MFIs alleged that local politicians instigated the unrest with respect to MFIs in

Krishna. MFIs made a strong appeal to the government not to act. Finally, the government

allowed MFIs to continue to operate based on MFIs‟ commitments of applying for SRO

memberships and adopting the code of conduct.

Figure 41 Some International Crises Bosnia and Herzegovina Nicaragua Morocco

MFI – nature before the crises

Direct lending preferred; Started as non-profit MFIs; later converting to for-profit joint stock companies (mostly foreign bank controlled)

Direct lending preferred; Mostly development NGOs; rural based; mostly for agriculture and cattle (33% of portfolio); MFIs still struggling and not out of the woods; almost no regulation till 2007

Direct lending preferred; dependence on bank borrowings for funding loan book growth; limited regulation by central bank; mostly NGO MFIs; Recovered after the crisis with moderate growth

MFI reach and growth

From 2003-2008: borrowers and loan portfolio increased 11x

From 2003-2008: average loan increased 3x and loan portfolio increased 5.5x (almost 16% of country‟s credit)

From 2004-2008: MFI loan portfolio grew 11x and borrowers increased 4x; Covered 44% population

Signs of stress/risks

From 2003-2008,

Leverage increased from 2.5x to 5x

Average loan outstanding increased from USD780 to USD2,200;

Write-offs increased from 0.61% in 2003 to 5.66% in 2009

50% of microenterprises failed, loans often used for consumption Saturation: 32% borrowed from three or more MFIs in 2006 Executives were among highest paid

From 2003-2007,

Average loan outstanding increased from USD1,203 to USD2,411

PAR 30 increased from 2.5% to 5.25%

Leverage increased from 2.8x to over 5x

2004 onwards, politicians challenged MFIs as usurious profit-seeking businesses Over 30% loans for cattle rearing; price shocks and import restrictions in Mexico

From 2003-2007,

PAR 30 increased from 0.4% to 5%

write offs increased from 0.4% to 1.9%

Average loan outstanding per borrower increased from USD200 to USD528

Leverage increased from 1.8x to 5x Larger loans with poor underwriting policies Women borrowers decreased from 74% to 59% Inadequate MIS and internal reporting

Trigger Started as non-repayment at individual level; no external catalysts or pro-consumer movement

In 2008, clients began resisting repayments and contesting seizure of collateral (land in particular) as illegitimate dispossession in northern region; this spread to other parts of the country

Global financial crisis in FY09 increased food prices; merger of one of the largest MFIs revealed high credit costs and it stopped disbursements; fear of insolvency could have triggered borrowers to avoid repayments without penalty implications

Analysis of main cause

Inflation and global economic crisis Political environment and market manipulation

Unrestrained, unsustainable growth with poor underwriting practices

Measures In progress MFI law passed in 2011; the law was stringent compared with those in other countries

MFIs consolidated operations by shrinking loan books; MFIs tightened their credit and recovery Processes; Set up CIBs; Banks supervised MFIs for processes; Central bank regulated MFIs

Source: Press reports and studies



January 2015 27

4.5. AP Act Fallout

Figure 42

The collapse set off a domino effect on borrowers and recovery rates collapsed to below 20%

in January 2011 in AP from above 99% in September 2010.

4.5.1. Asset Quality Declined

Figure 43

MFIs could not do business in the stifling environment. As an example, only 1,600 of the

73,000 applications made by SKS Microfinance were approved by the district office (source:

press reports). Business restrictions and an unsustainable drop in recoveries in AP (about 30%

of total MFI portfolio) made banks nervous.

Source: Ind-Ra

Collapse of Repayment Culture

Local

politicians

and

strongmen

exhorting

people not

to repay

If X

defaults,

others

know X is

not going to

pay if they

default

Members

realise that

if all default,

MFI

collapses

Implies no

access to

future credit

and no

penalty for

non-

payment

Mass

defaults

Press

praising AP

MFI Act

0 5 10 15 20 25

2006

2007

2008

2009

2010

2011

Writeoff PAR 90 PAR 30

Non-performing Assets of MFIs

Source: mixmarket.org

(As % of total loans)



January 2015 28

4.5.2. PE Investments and Debt Funding Dropped

The banks stopped lending and halted securitisation of MFIs‟ loan portfolios. PE investors

deserted them; the sector had become untouchable.

Figure 44

MFIs were required to liquidate their non-AP books to ensure repayment to the banks due to

the supply side shocks on the funding side. MFIs with heavy exposure to AP had to apply for

restructuring since it was expected that most of their loan portfolio would turn into NPAs.

4.5.3. Entry of MFIs in CDR

Due to a fall in recovery rates and impending huge write-offs, MFIs also defaulted on their debt

service. Five of the top six MFIs were asked by their banks to apply to the corporate debt

restructuring cell (CDR). However, after the initial terms of CDR were discussed, SKS

Microfinance and Bhartiya Samruddhi Investments and Consulting Services Limited (BASIX)

decided to opt out of restructuring. Reports suggested that they backed out because of

personal guarantee stipulations on the promoters.

Figure 45 Status of Portfolio of MFIs that Entered CDR

MFI (INRbn) Total debt

Total outstanding

FY11 AP share CDR deal Portfolio size

in 1QFY14 Portfolio size

in 1QFY15

Asmitha Microfin Limited 13.75 14.00 7.00 7.50 4.09 3.57 Future Financial Services Limited (FFSL)

1.60 2.01 0.46 1.10 1.77 2.31

Share Microfin Limited 24.02 20.00 10.00 19.00 8.29 7.56 SpandanaSphoorty Financial Limited

33.26 29.00 19.00 23.00 10.18 9.55

Trident Microfinance Pvt. Limited

1.49 1.36 1.12 1.25 0.24 0.6

Total 74.11 66.37 37.58 51.85 24.57 23.05

Source: Press reports, MFIN

The CDR was made available only to major MFIs operating out of AP. Five MFIs listed above

participated in the first round of CDR. RBI allowed for loans to be recast instead of being

labelled as nonperforming; banks need not assign higher provisions for these loans. Main

terms and conditions of CDR are as follows:

Two-year moratorium period on principal repayment and seven years of tenor

Banks will change part of the debt into convertible preferential shares, allowing banks to convert debt into equity if any of the five MFIs default.

Banks will have two to three nominees on each board and thus significant operational control on MFIs.

Promoters have to provide personal guarantees to maintain their stake in the business if banks convert debt to equity. Personal guarantee was accepted only by the promoter and MD of FFSL, G. Dasaratha Reddy.

207

178

170

150

160

170

180

190

200

210

FY10 FY11 FY12

MFI Borrowings

Source: Sa-dhan

(INRbn)



January 2015 29

All loans of the above MFIs in relation to AP exposure were restructured in FY12. Subsequently

BASIX (BSFL) entered into CDR in September 2012 for restructuring INR6.52bn of debt

(portfolio of INR12.50bn on 31 March 2011. Banks exercised the conversion into equity option

and now own 92% of BSFL while SWAWS Credit Corporation restructured INR0.9bn of debt).

4.5.4. Current Status of CDR MFIs

Figure 46 Current Status of CDR MFIs MFI Current status

SHARE, Spandana, Asmitha RBI rejected the request from SHARE, Spandana, Trident, Asmitha and BSFL (BASIX) for a second round of restructuring, following which banks restructured their loans again without the benefits on provisioning. Half of the INR55bn loans were converted into optionally convertible cumulative preference shares, which were supposed to be redeemed at specific intervals. The MFIs could not meet the repayment deadline of June 2013. This time no provisioning benefits were available to the banks.

FFSL It was the only MFI to repay its CDR loans and exit the programme in August 2013 (had lower exposure to AP).

Trident It is winding up its operations and the lenders may have to write off their loans to the MFI since the current book size of INR60m is inadequate to service outstanding debt.

Source: Business Standard

4.5.5. Court Battles Do Not Help

MFIs operating in AP filed a petition challenging the AP Act which was dismissed by the

Honorable High Court in February 2013.

Figure 47 Status of Various Court Cases

Who filed and which courts

SKS Microfinance in May 2011 in Supreme Court

MFIs operating in AP (including SKS) in High Court though MFIN in 2011

Group of borrowers from AP

Against whom/challenged and why

The AP Act because of extremely restrictive rules for lending; District Registrar had cancelled its licence in Mahabubnagar for allegedly not following rules

The restrictive and „draconian‟ AP Act considering that RBI issued regulatory guidelines for NBFC-MFIs

Challenged in Supreme Court an order by the AP high court asking the state government to review a law that reined in lending by MFIs

Result/output In March 2013, SKS Microfinance received an interim order from the apex court to resume micro-lending operations in AP without requiring government approval for every loan and interest/principal recovery.

The court dismissed the petition in May 2013 but asked the state government to review the Act as the central government was contemplating Microfinance Bill 2012.

Ongoing

Source: Live Mint

The High Court also requested the AP government to review the AP Act and its need given that

the Microfinance Bill is under consideration by the parliamentary Standing Committee.



January 2015 30

5. Appendix 3: RBI Guidelines

Figure 48 RBI Guidelines

Terms

Implication for NBFC-MFIs in relation to earlier complaints

Borrower loans

Borrower profile Maximum of two NBFC-MFIs can lend to the same borrower

Limit on loans a borrower can avail from MFIs

Income generating loan

Loans towards income generation activities more than 70% of overall book

Could prevent loans availed for consumption or for repayment of other loans

Loan terms 85% of net assets to be assets complying with following:

Borrower household annual income levels: rural below INR60,000; urban and semi-urban below INR1,20,000;

loan amount below INR35,000 in the first cycle and up to IN50,000 subsequently

total borrower indebtedness below INR50,000

Limit on total indebtedness of borrower May ensure loan availability to only the poor

Loan size limits MFIs can lend under SHG/JLG/individual level

Max loan amount = INR50,000

Max overall indebtedness = INR50,000

Limits indiscriminate lending/borrowing

Loan tenor Not less than 24 months for loan amount above INR15,000

Minimum moratorium equal to interest period

Since loan ticket size is limited, less repayment pressure on borrowers

Interest rate caps (linked to bank rates)

No interest rate cap

Margin cap 12% for small MFIs and 10% for other MFIs (based on asset size)

Interest to be calculated on diminishing outstanding basis

Transparency on interest rates

Interest periods and repayment

Weekly, fortnightly or monthly Borrower‟s choice

Penalty No penalty on delayed payments

No prepayment penalty

Provides borrower flexibility in repayment

Transparency on other charges

Only three forms of charges - interest, processing fee 1% of disbursement and insurance premium (including admin charges)

No collection of security deposits

Loan card to every borrower with details in vernacular language

Transparency on other charges, fees etc.

Recovery Recoveries at residence only if a customer fails to appear at the designated place more than twice

Benign recovery means

Funding and capital Capital ratios Min net owned funds: INR50m

(North east MFIs – INR20m) after 31 March 2014 Min CAR (Tier 1 + Tier 2): 15% of risk weighted assets Tier II capital cannot exceed 100% of Tier I capital Exceptions for AP portfolio of MFIs

Minimum capital stipulations for NBFC-MFIs

Priority sector Status to continue RBI accepts importance of the sector and wants banks to fund MFIs

Governance Code of conduct, customer protection code

NBFC-MFIs to ensure that a code of conduct and systems are in place for recruitment, training and supervision of field staff

Operational guidelines with regard to customer service, internal operations, staff hiring and training, etc

Provisioning Loan provision to be maintained by NBFC-MFIs shall be the higher of a) 1% of the outstanding loan portfolio, or b) 50% of the aggregate loan instalments which are overdue above 90 days and below 180 days; 100% of the aggregate loan instalments which are overdue for 180 days or more

NPA recognition and provisioning norms

CIB Mandated that all NBFC-MFIs be members of at least one credit information bureau

Credit checks on the borrower and his/her credit history

SRO Mandated that all NBFC-MFIs be members of at least one SRO

Internal controls, periodic data and portfolio quality reporting, etc

Source: RBI



January 2015 31

It may be seen that these guidelines addressed most of the complaints that the market had in

relation to the functioning and other aspects of MFIs. The newly christened NBFC-MFIs

welcomed it and are of the view that since they are regulated by RBI, they should not be

regulated under the Money Lenders Act or its derivatives by individual states. Regulation of

NBFCs and banks is a central subject while the Money Lenders Act is a state subject.



January 2015 32

6. Appendix 4: Supervisory structure and credit bureaus set up

RBI guidelines led to setting up of SROs and CIBs. RBI made it mandatory for each NBFC-MFI

to be a member of at least one SRO and one CIB.

6.1. Industry Bodies such as MFIN and Sa-Dhan Established

Sa-Dhan and MFIN were the two industry bodies that existed even before the AP crisis. They

attempted to address the data quality, credit and concentration risks and industry practices.

However, adherence to their guidelines was voluntary due to the limited means of supervising

MFIs. RBI appointed MFIN as the industry SRO in June 2014.

MFIN‟s code of conduct on RBI‟s fair practices code for NBFC-MFIs has been accepted by

RBI.

Figure 49 Brief Details of the Code of Conduct Part I: Core values Part II: Code of conduct

Maintain integrity, transparency towards clients and protect them from unethical practices and ensure privacy

Take client feedback and set up appropriate grievance redressal mechanisms

Promote and strengthen the microfinance movement

Build progressive, sustainable and client-centric systems, and provide a range of financial services complying with the applicable guidelines

Promote cooperation and coordination among themselves and other agencies to achieve higher operating standards

Part III: Client protection guidelines Part IV: Institutional conduct guidelines

Complete disclosure and transparency in all dealings and communication with the client

Educate and endeavor to provide appropriate financials services in compliance with RBI guidelines

Shall ensure employee behavior for lending and recovery operations in line with RBI guidelines

Complete adherence to code of conduct

Maintain all records and file them with regulators and other industry agencies

Adhere to employment and anti-poaching measures as per SRO guidelines

Agree to share complete data with CIBs

Source: MFIN

It is mandatory for MFIN members to adhere to these codes. As stated in its annual report,

MFIN has set up an enforcement committee which looks into complaints by any member

against any other member. MFIN has addressed 173 complaints in FY14. Currently, MFIN

does not proactively audit MFIs‟ operations. However, MFIN indicated that the process for the

same is under development.

Most NBFC-MFIs are members of MFIN and Sa-Dhan. In addition, Sa-Dhan members also

include co-operatives, Section 25 companies and NGOs/societies which together constitute

about 10% of the microfinance universe and are non-profit in nature.

These SROs periodically collect data on MFI loans, geographical distributions, portfolio

performances, etc. and publish it.

6.2. Credit Bureaus Established, Fully Functional

Before the AP crisis, MFIs had no way of knowing if a potential borrower was a member of

additional JLGs/SHGs and had to believe the member. A loan officer of the MFI was unable to

know the number of MFIs the member has borrowed from and his total indebtedness.

Additionally, a member could default on his/her borrowing from one MFI (could be wilful or

because of genuine reasons) and still avail loans from either SHG or another JLG if he/she was

a member. This does not foster encouraging credit behaviour since there is no penalty for non-

repayment of dues. Also, the segment of population served by microfinance companies has

many features that do not lend to easy record keeping (one of the reasons why mainstream

finance institutions have reservations to lend directly to the segment).



January 2015 33

High household microfinance debt was one of the contributors to the AP crisis. Surveys reveal

that over 70% of borrowers had borrowed from three or more MFIs just before the crisis. These

CIBs were expected to maintain databases of the borrowers of MFIs and records of their credit

history.

6.2.1. MFI Credit Bureaus

The CIBs have millions of accounts with loan histories and are periodically updated. All MFIN

members are members of both CIBs and provide periodic updations on the borrower accounts

to the CIBs.

Figure 50 Database Maintenance and Updation

Customer details Know your customer (KYC) details include name, age, family members, relationships, identification (most common documents are voter id and ration card)

Customer report contains Old loans, current loans, repayment history, days past due, etc. Updation methodology Database updation: Weekly or fortnightly, (monthly for non-

members). The systems of some MFIs provide live data. While others follow batch process.

Borrower credit reports: These are available on query. Typically, the credit reports are requested twice by an MFI before disbursement.

Source: Various press reports, Equifax, Highmark

An MFIN, RBI appointed SRO requires its members (servicing over 90% of the MFI borrowers)

to be members of both, Equifax and Highmark.

Better MIS and data quality: Earlier, some MFIs relied on their primitive data bases which

had duplication and did not cover loans from other MFIs. Over the years, MFIs started building better MIS to standardise and improve their data reporting while Equifax improved the search algorithms and improved database capabilities. External consultants from International Finance Corporation and MFIN aided the data improvement process.

Improved strike rate: The credit bureau uses „strike rate‟ to measure the efficiency of its

data quality and search algorithms. The strike rate is the probability of finding a match when the person actually exists in the records. During the initial years (2010-2011), the strike rate was about 70% (as data quality was low) which improved to 95% in FY14.

Frequency of data updation: The MFI borrower database is updated at least on a

fortnightly basis. MFIs reach over 30 million borrowers and hence are important contributors to the database. MFIs have also been updating the historic data on loans so that the credit bureaus can have accurate loan histories.



January 2015 34

7. Appendix 5: Business Correspondent Model

In 2005-2006, RBI, on the basis of the recommendations of the Khan Committee, permitted

banks to use intermediaries such as BCs. This increases the poor and the hard-to-reach

individuals‟ access to banking services using a network of third party agents.

The bank and BC are bound by a legal contract. The BC usually is a technological service

provider (TSP). It provides transaction devices, maintains database and provides hardware

and maintenance services. The BC employs customer service points (CSPs) who act as sub

agents of the banks. These could be NGOs, Section 25 companies, individuals, SHG

members, etc.

The environment of operations of BCs was as under:

Main objectives: Opening of no frills accounts. Over 100 million no-frill accounts were opened

during FY2005-FY2012, of which over 70% are still dormant (Source: press reports). The BCs

also facilitate savings, transfers, insurance selling and cash withdrawal by providing last mile

connectivity between the banks and their poor customers residing in remote villages.

Other activities

No frills savings accounts

Deposits, FDs and withdrawals

Remittances

Balance enquiry, statements, receipts

Enrollment of customers

Disbursal as per bank‟s instructions and limits

Other banking products such as overdraft/retail loans, kisan credit card, general credit card

Operational Scope of the Business Correspondent and the Bank

The BC will be an agent of the bank and the bank will pay commission to the BC for its services

The BC will function within 30km from the bank branch

BC and its CSPs are allowed to offer credit, savings, remittances and other products from more than one bank

All BC transactions are to be accounted by the bank on the same day

Bank permitted to reasonably charge the client as per its approved board policy

KYC adherence is the bank‟s responsibility

Models of Operations of CSP

The three main models of operations at CSP are kiosk, GPRS-based biometric model and

SMS-based mobile model. The initial investment in hardware is INR1,26,000 for the kiosk

model, INR40,000 for the GPRS-based biometric model and INR35,000 for SMS-based mobile

model.

Average Remuneration to CSPs

No frills account (NFA): INR25 (25% for the bank, 40% to CSP and 35% to BC)

Maintenance of NFA: INR4 p.a. (25% for the bank, 40% to CSP and 35% to BC)

Deposit services: 0.25% with INR6 as the upper limit (25% for the bank, 40% to CSP and 35% to BC) Minimum: INR1/transaction

Withdrawal: 0.5% with an upper limit of INR12 (25% for the bank, 40% to CSP and 35% to BC); Minimum: INR2

Issues with the current BC segment

The India Banking Agents survey conducted in FY14 revealed that of the total 2,358 agents

surveyed across India, 47% were untraceable/unreachable and 16% of the remaining had not

carried out a single transaction. This implies that about 55% of BCs are non-functional. A



January 2015 35

median agent conducts, on an average, nine transactions a day and earns INR2,700 per month

(Kenya, Tanzania and Uganda record over 30 transactions per day). This amount is lower than

the minimum wages prescribed by state governments.

As a result, the attrition is between 25% and 34% as the youth (mostly selected as BCs) may

not have the patience to wait for transaction through-puts to increase. Sa-Dhan carried out a

BC survey in 2012 and found that the breakeven for a CSP in a village of 500 households could

range from three to five years.

However, the government, regulator and the banks are focussing on the BC model as a means

of financial inclusion. The number of CSPs has increased by almost 10x over FY10-FY14.

Figure 51 Business Correspondents – Coverage Banking outlets in villages 2010 2011 2012 2013 2014

a) Branches 33,378 34,811 37,471 40,837 46,126 b) Villages covered by BCs 34,174 80,802 1,41,136 2,21,341

3,37,678 c) Other modes 142 595 3,146 6,276 d) Total 67,674 1,16,208 1,81,753 2,68,454 3,83,804 Urban locations through BCs 447 3,771 5,891 27,143 60,730

Source: RBI

The government is of the view that the sheer numbers of BCs/CSPs appointed by the banking

system will assist financial inclusion even if more than 50% of CSPs are not operational. It may

be seen that the number of transactions and the amounts of transactions have also increased

manifold.

Figure 52 Transaction Throughput of the BC Channel Year 2010 2011 2012 2013 2014

No of transactions (m) 26.52 84.16 155.87 250.46 328.6 Amount of transactions (INRbn) 6.92 58 97.09 233.88 524.4

Source: RBI

Jan Dhan is likely to increase the transactional throughput of the BC channel and provide more

people with increased access to banks. Countries such as Brazil, Kenya, Uganda, South Africa

have viable BC operations and this channel could emerge as a competitor to the MFIs or MFIs

could operate as BCs.



January 2015 36

8. Appendix 6: Geographical Diversification Ensues

The impact of AP crisis on the financials of some MFIs was debilitating since over 50% of the

portfolios of some MFIs were concentrated in AP; three of the top five Indian MFIs had to be

restructured. Many MFIs began to diversify geographically to minimise the impact of a similar

event in other states, if it could arise. The MFIs began to grow, mainly in TN, WB, Karnataka,

MP, UP, Maharashtra, Gujarat, Bihar and Assam.

The below table illustrates the growth in borrower loan outstanding (MFIs + SHGs) in the larger

states indicating two aspects:

1. Part of the growth is from an increase in per capita borrowing

2. Some of these large states are under-penetrated as compared to AP

Figure 53 Average Borrowing/Poor Household (INR) Average borrowing/poor household (INR) AP TN Karnataka WB UP Maharashtra MP

2010 87,728 30,850 16,493 8,436 2,628 5,122 2,173 2013 105,869 35,527 25,100 13,364 3,191 6,067 2,814

Source: State of Sector reports – Access Development Services, Census 2011 and Planning Commission (for poor households, 2011-12)

Assam and Bihar are the leading states in terms of growth but their portfolio size is slightly

lesser than that of Madhya Pradesh. The concentration of microfinance loans is higher in south

Indian states and WB but it is increasing in other large states too.

Declining share of MFI Loan Portfolios of AP and Increasing Share of Other States

Figure 54 Figure 55

Figure 56 Figure 57

Source: Sa-Dhan, MFIN, Ind-Ra‟s estimates

AP32%

TN9%

WB9%

UP6%

MP2%

Others18%

GLP Percentage Share (2008)

Karnataka18%

Maharashtra6%

AP28%

TN13%

WB12%

UP5%

MP3%

Others20%


Karnataka14%

Maharashtra5%

AP24%

TN10%

MP5%

Others25%


Karnataka11%

Maharashtra5%

WB13%

UP7%

TN14%

MP5%

Others30%


Source: Sa-dhan, MFIN, Ind-Ra

Karnataka9%

Maharashtra9%

WB14%

UP7%

AP12%



January 2015 37

The share of AP has been decreasing since FY08 while WB, TN, Maharashtra, MP and UP

have more or less maintained their share. The share of the remaining states has increased to

30% in FY14 from 19% in 2010, primarily led by Bihar and Gujarat. The fall in Karnataka‟s

share in 2011 from 2008 was due to the AP-like effect in three-to-four districts of the state.

However, post 2011, their impact has been contained.

Loans per District Indicate Increasing Share of Newer States

MFIs are expanding in south India but their dependence on TN and Karnataka is increasing in

terms of the number of borrowers and loans outstanding in each district. In addition to

Karnataka and TN, MFIs have experienced high growth in WB and moderate growth in

Maharashtra and MP.

Figure 58

0

500

1,000

1,500

2,000

2,500

AP WB Karnataka TN UP Mahrashtra MP

2011 2012 2013 2014

Loans in INRm/District




January 2015 38

9. Appendix 7: Operational Costs Key to Increasing RoAs

Below are the various cost and revenue components of the NBFC-MFIs and their drivers:

Figure 59 Revenue and Costs: Limited Control of MFIs Revenue components Description Controlling variables and implications

Yield/interest Interest on loan The interest rate depends on:

- Interest rates charged by other MFIs in the region

- RBI‟s yield cap 2.75x banks‟ base rates Fees Processing fees (restricted

to 1% p.a.) MFIs usually charge fees in full based on RBI guidelines.

Other income May consist of interest on deposits, commission from sale of insurance, etc.

Cost components Financing costs Fees and interest paid on

bank and non-bank debt MFIs have minimum control on these costs as banks independently charge interest rates, etc. based on their own assessment of the risk.

Operating costs Contains manpower, overhead costs, etc.

Costs can decrease by increasing loans/branches, borrowers/loan officer and the average loan ticket size.

Loan provisions Credit costs Costs depend on the credit behaviour of the borrowers and could be exacerbated by political reasons. MFIs have only limited control - through interest periods and persistence of collections – on these costs.

Source: Ind-Ra

NBFC-MFIs can only expand their margins by decreasing their operating costs since MFIs

have maximum control over them and marginal control over other cost factors.

Trend of Operating Costs

MFIs have tried to control operating costs by increasing branch throughput, loan officer

efficiency and through a higher proportion of field staff.

9.1. Reduction in Branches

The number of branches reduced in FY14 from FY11 but loans outstanding per branch

increased to INR31m from INR16m indicating that the strategy has changed from spreading too

thin to consolidating and then spreading.

Figure 60 Figure 61

12,690 13,562

11,459 10,697 10,763

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000


No of Branches (000)


14.46 15.89

18.25 20.88

28.37

0

5

10

15

20

25

30


Loans Outstanding/Branch


(INRm)



January 2015 39

9.2. Trimming Staff

Manpower costs can constitute up to 25% of an MFI‟s total costs. MFIs have decreased the

number of loan officers, increased borrowers/loan officer and thereby loans outstanding per

loan officer, indicating higher operating leverage. However, any further rise in the total number

of borrowers/loan officer can affect client service and thereby delivery of microfinance services.

Figure 62 Figure 63

Figure 64

9.3. Higher Share of Field Officers in Staff

Figure 65 Field Staff as Percentage of Total Staff The employees in MFIs could be of admin/manager grades or field staff (loan officers and branch manager). The field staff is at the business frontline. A higher proportion of field staff without compromising on the quality of compliances and reporting translates into higher staff efficiency.

2012 2013 2014

All MFIs 62 65 66 Glp>5 bn 66 67 67 Glp1-5 bn 48 59 60 Glp< 1 bn 67 65 62

Source: MFIN

Based on the trends observed in the sector after the AP crisis, we opine that the sector is

poised for steady strong growth, but there will not be complete recovery. The relative saturation

in some districts, expansion in the previously underpenetrated states (which exhibit relatively

poor portfolio quality under the SHG programme – Appendix 8) and the emerging strategy of

Indian government, regulators and banks might impart dynamism to the sector.

76 6

6

5 55

0

1

2

3

4

5

6

7


Loan Officers per Branch

Source: Sa-dhan, MFIN

(000)

1.8 2.4

2.8

3.6 4.2

6.1

0

1

2

3

4

5

6

7


Loan Outstanding per Field Officer


(INRm)

63

77 78

5754 50

0

15

30

45

60

75

90


Field Staff of MFIs


(000)



January 2015 40

10. Appendix 8: SHG-Bank Linkage Programme

10.1. Development of Microfinance Credit Delivery Models in India

Before the 1990s, the lack of access to formal credit systems drove the poor to borrow from

local moneylenders who would charge interest rates anywhere between 50% and 500%. These

moneylenders were often landowners, local strongmen or politicians and would not hesitate to

use unscrupulous means to recover their money, including bonded labour, taking possession of

the limited assets of the borrowers and other social evils. These practices were widely

prevalent across the country.

The earnings of the poor were cyclical and meagre. A bulk of their earnings would materialise

in the four-to-eight month crop season, part of which would go to clear the arrears of previous

borrowings. They would have availed credit for consumption-related purposes, health or

unforeseen personal and social events. The high interest rates charged by the informal sector

would catch the poor in a debt trap.

The pre-1990 models of poverty alleviation primarily included grants and subsidies by the

central and state governments through agencies such as NABARD. However, some NGOs

were trying to develop appropriate credit behaviours in small pockets in South India, especially

in AP, Kerala and TN.

NABARD recognised this and undertook various initiatives to bridge the supply-demand gap by

trying to evolve financial inclusion using credit. However, the end-users could not make out the

difference between state subsidies and the credit systems; they often ended up treating credit

as subsidy/grant. This indicated that the lack of financial literacy, financial discipline and regard

for credit institutions plagued large sections of the society. These are mandatory requirements

for the development of any economy where credit is an important source of capital and equity is

sparse.

The problem was compounded by low value credits and relatively high costs of appraisal,

monitoring and subsequently high credit costs which led banks to abandon most of these

programmes.

Figure 66

Microfinance Models in India

India is traditionally an underpenetrated state in terms of credit. Due to poverty and illiteracy,

the financially excluded population as a whole did not see appropriate credit behaviours.

Source: Ind-Ra

JLG - MFI model Individual lending

Microfinance Credit

Delivery Models in India

SHG-Bank linkage

• Involvement of MFIs

• Formation of JLG

consisting mostly of

poor women

• Eligible to avail credit

• Other members repay

on behalf of the

defaulter

• On continuing default,

group is ineligible for

credit

• MFI bears credit cost if

joint liability fails

• Involvement of any

lending institution and

individual borrower

• No group lending or

liability structure

• Individuals relatively

more credit worthy than

group-based models

• More suited for

populations with good

credit behaviours

• Involvement of bank

• Formation of SHG

consisting mostly of

poor women

• Development of credit

behaviour

• Eligible to avail credit

from banks

• Group members shall

not be eligible for future

credit in case of a

default

• Bank bears the loss



January 2015 41

Therefore, the government and its implementing agencies found it challenging to set up

structures for financial inclusion.

10.2. SHG-bank Linkage Programme

The SHG-bank linkage programme was started as an Action Research Project in 1989, an

offshoot of a NABARD initiative. It is currently the world‟s largest state-sponsored microfinance

programme at about USD7.0bn outstanding loans and with a reach of over 90 million

individuals.

Figure 67

Role of Participating Entities in SHG Handholding

NABARD‟s early experiences with the setting up of SHGs led to the pilot projects involving banks, SHGs and NGOs. The results were encouraging and led to the evolution of a streamlined set of RBI guidelines for banks to foster SHGs. NABARD provided promotion and refinance support to banks and reimbursement of costs to develop and mature an SHG to the corresponding NGOs.

Role of SHG-bank linkage participants

Bank:

Identifies areas for SHG formation

Appoints NGOs for forming and fostering an SHG

Monitors SHGs after formation through NGO

Provides SHG members with savings account

Provides SHG members credit after the SHG matures

NGO:

Forms SHG among villages with commanalities among members

Monitors intra-group credit and savings behaviour

Imparts basic financial literacy, book keeping and capacity building

Hand-holds the SHG though savings and credit processes

NABARD

Sets up nationwide programme guidelines and monitors performance

Provides grants to NGOs for expenses in fostering SHGs

Provides grants and refinance support to banks for their participation in the programme

Source: Ind-Ra

The overall strategy adopted by NABARD relies on two main planks:

expanding the range of formal and informal agencies that can work as SHG promoting institutions (self-help promoting institutions; typically NGOs)

building up capacities of the increasing number of stakeholders

NABARD developed the SHG-bank linkage approach as the core strategy that could be

implemented by the banking system in India to increase their outreach to the poor.

Main objective of the SHG-bank linkage programme: The programme‟s prime objective was

not only to provide credit to the poor, but also to empower them by providing sustainable

financial services. The strategy involved forming SHGs of the poor, encouraging them to pool

their savings regularly and using the pooled thrift to provide small, interest-bearing loans to

members, and in the process learning the nuances of financial discipline.

10.2.1. Characteristics of a Typical SHG

Consists of 10-20 members

One member per household

Either all male or all female groups

Regular meetings and compulsory attendance



January 2015 42

10.2.2. Process of Maturing of an SHG

Figure 68

SHG Formation Process

10.2.3. Borrower Coverage and Savings and Loan Portfolio Size of SHG-bank Linkage Programme

Borrower coverage and savings

The SHG-bank linkage is the largest state-sponsored microfinance programme. It has been in

existence since 1990s and covers all major Indian states. The mature SHGs are allowed to

operate a savings account where it is mandatory for each member to save some money on

behalf of the SHG in the savings account. These SHGs can also borrow from participant banks.

Savings are mandatory, credit is not.

Figure 69 Figure 70

Source: NABARD - Annual reports and State of Microfinance reports

Source: NABARD handbook on SHG formation, NABARD reports on SHG-Bank linkages

• SHPIs select SHG members (one per household) based on some commonalities (caste,

area, gender, livelihood, etc.)

• The households have to satisfy three-to-four of the following conditions: only one earning

member, drinking water available far off, old illeterate family members, women not having

access to toilets, drug addicts or drunkards, kuchha house, scheduled caste or tribe, etc.

• No introduction to credit at the time of initiation

• Members help each other

• Members decide on the time and place of meetings, penalty on non-attendance, agreement

on the amount of savings, giving small loans to each other, repayment habits

• The mentor involves SHG members in activities for inducing fraternal feelings and capacity

building

• In an SHG, all members are known to each other

• Initial loans are given from the common savings;

• Other members are aware that they may be denied future credit if the defaulter does not

pay

• After exhibiting appropriate credit behaviours, the SHG may be considered mature

• Based on members' decision, the SHG is ready to avail credit from banks

• The mentor may continue his/her relationship with the SHG

SHG formation

SHG members

set terms

Social pressure

SHG maturing

5870

97 97103

95 96

0

20

40

60

80

100

120


Client Outreach

(m)

170

227280

312363

394429

0

100

200

300

400

500


Loan Portfolio Outstanding Basis

(INRbn)



January 2015 43

The client coverage has increased to 96 million in FY14 from 58 million in FY08 under savings

SHGs. Each SHG has, on an average, 13 members and has remained more or less constant.

Also, the total loan outstanding under SHG-bank linkage programme increased to INR429bn in

FY14 from INR170bn in FY08. This indicates high latent demand of credit from hitherto under-

served segment of population.

Figure 71 Figure 72

Ind-Ra understands that banks determine their loan disbursement needs internally and

informally maintain a savings/credit ratio for SHG-bank linkage programme. For the banking

system, the ratio has been maintained between 4 and 5. In FY14, about 57% of savings SHGs

(4.2 million out of 7.4 million) had availed credit from the banks.

Though the number of credit SHGs has remained constant, the total loan portfolio grew at a

CAGR of 8% to INR429bn in FY14 from INR363bn in FY12. It indicates that the growth in loan

portfolio is due to an increase in outstanding loans per SHG.

Figure 73

The loan disbursement per SHG and the outstanding loans per SHG grew at a CAGR of about

11% over FY12-FY14.

The data shows that banks are finding it difficult to expand their reach or penetration since the

past two years. In fact, the number of savings SHGs has decreased FY12 onwards and the

SHG portfolio growth is sourced by increasing per SHG disbursement and thereby loans

outstanding.

SHGs under the National Rural Livelihood Mission (initiative started in FY13) can borrow unto

INR2.5m in stages (as the SHG and its micro/medium scale enterprises mature and increase in

size and scope). According to NABARD, chances are that incremental growth can stem mainly

from an increase in SHG limits under NRLM rather than expansion of reach.

0

3

6

9

FY

200

8

FY

200

9

FY

201

0

FY

201

1

FY

201

2

FY

201

3

FY

201

4

SHGs (savings) SHGs (credit)

SHGs

Source: Ind-Ra

(m)

0

20

40

60

80

100

120

FY

200

8

FY

200

9

FY

201

0

FY

201

1

FY

201

2

FY

201

3

FY

201

4

Total SHG Savings

Source: Ind-Ra

(INRbn)

0

40

80

120

160

200


Avg loan outstanding Avg loan disbursed

Loan Disbursed and Outstanding per SHG

Source: NABARD

(INR 000)



January 2015 44

10.2.4. Socio-economic Impact

Similar to most microfinance programmes across the world, SHG-bank linkage programme

focuses on women, SC/ST and minority SHGs.

Figure 74

10.2.5. Regional Biases and Portfolio Performance

The SHG-bank linkage programme first took root in south India in AP and thereafter in

Karnataka, TN and Kerala. The main reason for this was that NABARD wanted to employ the

services of Mysore Resettlement and Development Agency (MYRADA), an NGO with large

presence in these states working in the field of financial inclusion of the poor. As the

programme matured, it penetrated deeper into these states and currently over 55% of credit

SHGs are in south India.

Figure 75

SHG programme is slowly expanding in central, north and east India while maintaining South

India‟s share of credit SHGs.

The regional bias, combined with other factors, throws up some interesting insights on the

credit behaviour of people of these regions.

Figure 76 NPA Percentage in the SHG Programme Area (%) FY2009 FY2010 FY2011 FY2012 FY2013 FY2014

All India 2.90 2.94 6.92 6.09 7.08 6.83 South 1.40 1.87 3.79 4.98 5.11 4.64 North 6.60 6.61 7.05 6.92 11.19 13.67 East 3.40 3.21 4.31 7.28 10.30 11.07 West 5.60 4.46 7.26 8.22 8.63 11.11 Central 8.90 8.07 10.74 13.20 17.28 18.87 North east 8.50 5.51 8.42 5.17 8.56 8.88

Source: NABARD

80 79

76

81

79

81

84

72

74

76

78

80

82

84

86


Women SHGs

Source: NABARD

(%)

0

10

20

30

40

50

60

70

South North East West Central North east


Credit SHGs as Percentage of Total SHGs

Source: NABARD



January 2015 45

It may be accepted that these kinds of programmes can have high NPAs and the socio-

economic benefits may outweigh the credit costs of such loans. However, the trend of

increasing NPAs in central and north India is disturbing. NABARD‟s data shows that some

north eastern states such as Manipur and Mizoram have NPAs over 50% of the total loans

outstanding under this programme, while Gujarat, Haryana, Punjab and Odisha have lower

NPAs in the range of 18%-25%.

On mining even deeper, we find that the private sector SCBs have lower NPAs than those of

public sector and co-operative banks.

Figure 77 Bank Category-wise Share of SHG NPAs Banks (%) FY2009 FY2010 FY2011 FY2012 FY2013 FY2014

Public sector SCBs 2.40 2.60 4.76 6.48 8.39 7.02 Private sector SCBs 1.70 5.44 10.10 5.30 3.69 4.22 Regional rural 4.20 3.56 3.67 4.95 4.10 6.26 Cooperative 6.80 3.88 7.04 6.84 8.13 8.67

Source: NABARD

The above performance data suggests that:

1. All banks except private sector banks have weak recovery standards under the programme.

2. The banks may have own compulsions to meet SHG targets and hence intense pressure to disburse.

3. These credit costs can, on a system-wide basis, become materially important if the programme increases two-to-three times its current size.

4. Outreach in south India has not increased over the last two years indicating certain level of saturation in formation of SHGs with new members. Future growth in the loan portfolio can come from other regions which suffer high credit costs.

Public sector banks have actually decreased their efforts on client coverage and are growing

their SHG loan books by increasing per SHG disbursements. The share of commercial banks in

total credit SHGs fell 7% from FY10 to FY14 while their share in outstanding SHG loans

reduced only 4%.

Figure 78 Figure 79

Surprisingly, the actual no of SHGs to which SCBs extended credit fell 23% over FY10-FY14.

The SCBs have also increased per SHG disbursements at a higher rate than co-operative

banks and RRBs.

High credit costs imply that lending to SHGs is not sustainable on a standalone basis. SCBs

are lending to SHGs because (i) it is a minuscule part of their loan books, (ii) these loans hold

priority sector status for the SCBs and (iii) the fact that NABARD and certain government

programmes/schemes reimburse SHG formation charges to self-help promotion institutions

(SHPIs; i.e. partly subsidise SHG formation costs for the banks). It may be difficult for the

programme to exist without government push and support.

32.330.5

26.1 26.4 25.0

0

5

10

15

20

25

30

35


Credit SHGs Covered by SCBs

Source: Ind-Ra

(Lacs)

62 72

99 101 118

49 54 60

70 80

0

20

40

60

80

100

120

140


Comm bank: Outstanding per credit SHG

Co-ops and RRBs: Outstanding per credit SHG

O/s per SHG

Source: Ind-Ra

(INR 000)



January 2015 46

11. Appendix 9: Microfinance Bill 2012

The Microfinance Bill was introduced in the Parliament in 2012 and later referred to a Standing

Committee. A parliamentary panel rejected the bill in February 2014 and asked the government

to bring fresh legislation citing the need for additional groundwork, wider consultations and

deeper study of certain vital aspects. The Standing Committee was of the view that instead of

RBI, a new regulator could be proposed.

Other objections of the Standing Committee were:

Inadequate focus on regulatory and supervisory structure

Silent on issues such as client protection, over-indebtedness and coercive collection/recovery methods

The study of lower interest government schemes under SHG (Kudumbashree and StreeNidhi) not conducted

Can Kudumbashree and StreeNidhi Programmes be Replicated?

Kerala's Kudumbashree scheme provides loans at 11%-13% and the AP government's

StreeNidhi programme is offering loans at 14% with an operating cost of just 1%. Despite that,

it says, "No study has been conducted to evaluate and replicate these existing successful

schemes in achieving financial inclusion.”

These schemes are piggybacking on

1. The SHG structure

2. Credit behaviour fostered on a mass scale for over 20 years where the states, especially has continually focused on the micro borrowers

3. Government grants for interest subvention etc

NABARD is of the view that states other than those in southern India have not looked at

microfinance as a powerful means of financial inclusion. Also, social aspects such as relative

independence to women in allocating for household expenditure, meeting male representatives

of MFIs/banks, starting a micro-enterprise, financial literacy is relatively less in these states.

Agency professionalism and credit behaviour are other important aspects where these states

score low. Consequently, credit costs are likely to be higher. Also, southern states have

undergone years of conditioning on credit behaviours and SHGs are functioning relatively

better even when compared with a mature SHG not belonging to south India. Hence, these

schemes are likely to be difficult to implement across India.

NABARD is of the view that the executive is increasingly focused on interest rates charged by

MFIs. The comparison with banks is difficult as the cost of delivery of credit is higher for MFIs.

The global experience shows that a slew of regulations in the microfinance sector of various

countries, the interest rates or the margin are regulated in some form (the extent of interest/

margin caps may vary for non-regulated structures).

However, door-step microfinance has high operating costs and therefore charges high interest

rates. MFIs in some countries charge interest rates ranging from 12.3%-56.5%. However, for

countries charging interest rates lower than 20%, the bank rates are also 3%-4% as against 8%

in India.



January 2015 47

Figure 80 Countries with Large Microfinance Operations Country Portfolio (USDbn) Interest yield Central bank rates Operating costs Margins

Indonesia 10.94 37.3 7.5 24.4 12.9 Peru 10.61 25.9 3.5 13.0 12.9 Colombia 6.76 21.5 4.5 13.4 8.1 Vietnam 5.89 22.3 8.0 12.6 9.7 India 4.51 20.9 8.0 8.4 12.6 Mexico 3.83 56.5 3.0 37.8 18.7 Bolivia 3.58 17.5 3.7 11.6 5.9 South Africa 3.42 33.3 5.8 12.1 21.2 Bangladesh 3.15 25.8 7.8 9.5 16.2 Ecuador 2.78 21.5 8.2 12.8 8.7 Azerbaijan 2.49 25.7 3.5 12.5 13.2 Cambodia 2.09 23.7 1.4 10.6 13.1 Chile 1.90 12.3 3.0 8.0 4.3 Kenya 1.85 22.1 8.5 13.1 8.9 Mongolia 1.77 20.5 11.5 6.7 13.9 Brazil 1.68 23.9 11.3 13.6 10.3 Paraguay 1.24 23.1 6.8 15.8 7.3 Weighted average 27.3 5.9 15.3 12.0

Source: mixmarket.org, Portfolio size as on 31 December 2012; Interest yield and operating costs: For year ended December 2013; relies on self-reporting by the MFIs Central bank rates: http://www.cbrates.com All numbers in percentage unless stated otherwise

In 2013, the weighted average interest rates charged by MFIs were 27.3%, their operating

costs were 15.3% and central bank rates were 5.9%. (weighted against their share in the MFI

market).

http://www.cbrates.com/



January 2015 48

12. Appendix 10: Features of Jan Dhan

The new government has launched the Jan Dhan scheme that proposes to open bank

accounts for the unbanked with many facilities including savings account.

Some of the features are:

1. Banks may offer Jan Dhan account holders INR5,000 overdraft facility if they are satisfied with the borrower history and repayment capability; INR1,00,000 accident cover if the account is linked with Aadhar card; INR30,000 life insurance if the accounts are opened before 26 January 2015

2. Each account holder shall be provided a RuPay debit card

3. Account holders cannot transfer over INR100,000 in one year

Similar initiatives in the past have not resulted in meaningful financial inclusion, but the sheer

speed and numbers that this scheme has achieved may have a positive impact on financial

inclusion. Press reports suggest that states like Haryana, Goa, Kerala, and Union Territories

like Puducherry, Chandigarh have covered 100% households under the scheme.

Figure 81

Status of Jan-Dhan on 24 January 2015 No of accounts (m)

Bank Rural Urban Total

No of RuPay debit card

(m)

Balance in accounts

(INRbn)

No of accounts with zero balance

(m)

Public sector 51.5 43.6 95.2 88.3 79.48 63.5 Regional rural banks 17.9 3.2 21.1 14.5 15.28 15.6 Private banks 3.2 1.9 5.1 4.3 6.37 3.0 Total 72.6 48.7 121.4 107.1 101.13 82.1

Source: Department of Financial Services, Ministry of Finance; The numbers may not match due to rounding off

The Finance Ministry is taking additional measures to prevent Jan Dhan accounts from meeting

the same fate as the No Frills Accounts:

1. Other accounts may be included under Jan Dhan and existing account holders need not open Jan Dhan accounts separately to avail the above benefits

2. Direct transfer of LPG subsidies

3. National Rural Employment Guarantee Scheme payments to be directly made to these bank accounts (Rajasthan and MP have already started)

4. The overdraft facility is linked with the savings account and the behaviour of the account

5. The plan also envisages channelling all government benefits (from centre/state/local body) to the beneficiaries‟ accounts and pushing the direct benefits transfer (DBT) scheme of the Union Government.

6. Mobile transactions through telecom operators and their established centres as cash out points are also planned to be used for financial inclusion under the scheme.



January 2015 49

13. Appendix 11: Banking Licence Awarded to Bandhan

RBI granted a full-fledged scheduled commercial bank licence to Bandhan, the largest NBFC-

MFI in India, in April 2014 (only two applicants granted licence out of 25, three more expected).

Markets are viewing it as a cautious experiment in financial inclusion.

Ind-Ra expects Bandhan to play an important role in financial inclusion with its reach (over

2,000 branches) and proximity to the unbanked. Other MFIs are not expected to be awarded

banking licences in the current set of issuances.

MFIs may now also have to compete with banks (such as Bandhan) in their own operating

regions. Since Bandhan will now have access to low cost funds (savings), it can charge lower

interest rates, and offer savings products and other financial services that the MFIs cannot

provide. Further, the trust perception could be higher in favour of banks. Competition with

banks is bound to have a negative impact on the top-line and bottom-line of NBFC-MFIs.



January 2015 50

14. Appendix 12: Diversified Bank Licenses

Based on the recommendations of the Mor Committee on financial inclusion, RBI announced in

April 2014 that it will work on the policies of having various categories of „differentiated‟ bank

licenses which will allow a wider pool of entrants into banking. Differentiated banks serving

niche interests, local area banks, payment banks, etc. are contemplated to meet credit and

remittance needs of small businesses, unorganised sector, low income households, farmers

and migrant work force. The summary of guidelines (issued in November 2014) and

implications for MFIs is as below:

Figure 82 Key Provisions Applicable to Diversified Banks Payment banks Small banks

Entity description and function

Small savings accounts,

Payments/remittance services

Provision of savings products to under-banked population

Supply of credit to small business units, small farmers, micro and small industries, and other unorganised sector entities

Eligible ownership

Existing non-bank pre-paid payment instrument (PPI) issuers, NBFCs, corporate BCs, mobile telephone companies, super-market chains, corporates, cooperatives and public sector entities

Banks may have a stake in these entities

Resident individuals/professionals with 10 years of experience in finance

Companies and societies, NBFCs, MFIs, local area banks (LABs)

Business houses and NBFCs promoted by them may not be eligible

Scope of activities

Acceptance of demand deposits (under deposit cover)- Initially restricted to holding INR1,00,000 balance in accounts

Payments and remittance services

through various channels including branches, BCs and mobile banking

Internet banking

Can function as a BC of another bank

Payment banks to be ring-fenced from

the other businesses of the promoter group

Distribution of simple financial products

such as insurance and mutual funds

Utility bill payment

Credit and savings functions

Distribution of simple financial products such as insurance and mutual funds

Cannot set up NBFC subsidiaries

Expansion to be monitored; at least

25% of branches in unbanked rural areas

Capital requirements

Net worth of INR1,000m at all times

Capital Adequacy Ratio (CAR): 15%

Leverage ratio: >=3%

Minimum paid up equity capital is INR1,000m.

CAR: 15% of RWA

Deployment of funds

No lending activity

CAR as per Basel I standards since the banks are not expected to deal with sophisticated products

To maintain cash reserve ratio (CRR) with RBI

Cash for operational activities and liquidity management

Investments, mainly in government securities/treasury bills with maturity up to one year (statutory liquidity ratio equivalent)

Access to call and money market for liquidity management

Subject to all prudential norms and regulations of RBI as applicable to commercial banks

High priority sector requirement

At least 50% of its loan portfolio to

constitute of loans up to INR2.5m primarily to micro enterprises

Source: RBI



January 2015 51

Figure 83 Can NBFC-MFIs Opt for any of these Licences? Bank category Advantages Disadvantages Remarks

Payment banks not a preferred option for MFIs

Provide MFIs‟ promoters with greater operating leverage (common branches and operating premises)

Expand the role of NBFC-MFIs in fostering savings habits of its JLG members (currently under the role as a banking correspondent, this is not the top-most priority of the BC)

Reach/penetration could be as deep as MFIs‟

Giving up on loaning business/another promoter arm may carry out the banking business

CRR requirements

Restrictions on investments

No access to low-cost funds mobilised through savings

Unable to lend and hence not suitable for the existing NBFC-MFIs as they may have to stop their lending operations. However, MFIs can have a payment bank as a group company and can act as a banking correspondent of the payment bank.

Small banks could be the natural evolution for large MFIs

It can provide access to lower cost of funds for MFI operations (if savings are not ring-fenced/partially ring-fenced and can be used a funding source by the small banks).

Conversion to bank can invoke greater trust in people

Avenues for the borrower to save

The range of financial services can expand to include all forms of credit , deposit and other financial services

Reach/penetration could be as deep as MFIs‟

Monitored expansion

Subject to reserve requirements

Developing trust with potential customers will take time (gestation for deposit services)

Industry discussions suggest that mid and large MFIs are favourably considering applying for small bank licences.

Source: Ind-Ra



January 2015 52

15. Appendix 13: Performance of Top 15 MFIs

In the MFI sector, the top 15 MFIs constitute about 80% of the sector in terms of the GLP. Of

them, only SKS Microfinance Limited is listed while Bandhan is expected to start banking

services in FY16.

The list below represents the top 15 MFIs ranked by their portfolio size (2QFY15)

Figure 84 Largest Indian NBFC-MFIs (excluding restructured MFIs) Microfinance Institution GLP (INRbn)

Bandhan Financial Services Pvt Ltd (Bandhan) 67 SKS Microfinance Ltd (SKS) 32 Janalakshmi Financial Services Pvt Ltd (Janalakshmi) 26 Ujjivan Financial Services Pvt Ltd (Ujjivan) 24 Equitas Microfinance India Pvt Ltd (Equitas) 19 Satin Creditcare Network Limited (Satin) 12 Muthoot Mahila Mitra (Muthoot) 10 Grameen Financial Services Pvt Ltd (GFSPL) 9 ESAF Microfinance (ESAF) 7 Grama Vidiyal Microfinance Ltd (GVML) 6 Utkarsh Microfinance Private Limited (Utkarsh) 5 Sonata Finance Private Limited (Sonata) 4 Suryoday Microfinance Private Limited (Suryoday) 4 Future Financial Services Ltd (FFSL) 3 Arohan Financial Services Pvt. Ltd (Arohan) 3

Source: MFIN

The list excludes the MFIs that are currently under restructuring (Spandana, Share, Asmitha,

BSFL)

Figure 85

Vintage and first mover advantages enable established MFIs to have a higher share in GLP

and borrowers with lower share in branches.

0

15

30

45

60

75

90

Ban

dh

an

SK

S

Ja

na

laksh

mi

Ujji

va

n

Equ

itas

Satin

Muth

oo

t

GF

SP

L

ES

AF

GV

ML

Utk

ars

h

Son

ata

Sury

od

ay

FF

SL

Aro

ha

n

Top

15

Share in MFI GLP Share in branch network Share in borrowers

Share of Top 15 MFIs

Source: MFIN



January 2015 53

Figure 86

The large and mid-sized MFIs (except Bandhan and SKS) have experienced higher growth in

2QFY15 over 2QFY14.

-20

0

20

40

60

80

100

120

140

Ban

dh

an

SK

S

Ja

na

laksh

mi

Ujji

va

n

Equ

itas

Satin

Muth

oo

t

GF

SP

L

ES

AF

GV

ML

Utk

ars

h

Son

ata

Sury

od

ay

FF

SL

Aro

ha

n

Top

15

YoY growth (GLP) YoY growth (Branches)

Growth of Top 15 MFIs

Source: MFIN



January 2015 54

16. Appendix 14: Global Models of Development of the MFIs

We have taken a sample of 15 countries with the largest MFI sectors and analysed sector

trends:

Legal forms and regulators

1. There could exist multiple forms of MFIs (for-profit and non-profit). In most countries, for-profit MFIs are regulated by the respective central banks.

2. Non-profit MFIs may be partially regulated or be regulated by other institutions (only in a couple of instances, Central Bank regulates them)

3. However, in most markets, efforts are on to strengthen regulation and supervision mechanisms, more so for non-profit MFIs

4. Credit bureaus existing for all markets

5. Micro insurance and remittance offered by most formal financial institutions (regulated)

Savings and other products

1. Most regulated entities accept savings deposits as funding sources

2. In some countries, even unregulated entities can accept savings deposits

3. Most countries have common consumer protection agencies for financial services or all services including microfinance (not under main regulators)

4. MFIs are also permitted to lend to the SME, MME industry segments

Other features/trends

1. Brazil has a strong banking correspondent model working in parallel with the MFIs

2. At a country level, MFIs have not changed their model from group lending to individual lending or vice-versa. Individual borrower may have upgraded

Globally, regulators have viewed MFIs as important to achieve financial inclusion. Norms have

been changed to accommodate the increased maturity of the MFIs and provide them adequate

business scope. With the growing confidence in the sector, RBI may relax certain limiting MFI

norms or grant small bank licences liberally to strong MFIs and increase their role in financial

inclusion.



January 2015 55

17. Appendix 15: The JLG Model

In the 1970s, Muhammad Yunus experimented with lending USD40-equivalent each in local

currency to 42 families affected by a famine in Bangladesh to reconstruct their lives. He

believed the absence of collateral was not a reason to deny the poor and the disadvantaged

access to financial services, especially credit. Providing this access would immediately allow

them to put in practice their skills in the field of agriculture, animal husbandry, primitive garment

industry and other rural services.

His experience in lending to these below-poverty-line borrowers and various other experiments

culminated into the grameen model of microfinance and led to the establishment of the

Grameen Bank. The model, with local alterations, is operational in most parts of the developing

world and to a certain extent, among the poor in certain developed countries.

17.1. Features of a „Grameen‟ or JLG Model

Figure 87

The JLG model is the widest model implemented globally for financial inclusion. Asian, South

and Central American countries dominate the microfinance universe. Some of these large MFIs

became so important to the national economy that they were converted into banks (Grameen

Bank - Bangladesh, Tameer Microfinance Bank - Pakistan, BancoCompartamos, S.A - Mexico).

Source: Ind-Ra

• Borrowers form a group of 5-20 members.

• Typically, they are from the same local area and

know each other.

• Group members are encouraged to meet

frequently and help each other solve problems.

• They may not have access to formal banking

channels

• They may have minimal assets to offer as

colleteral.

• Group members are the borrowers.

• They follow the concept of joint liability where the

group pays on behalf of the defaulter.

• Joint liability brings intense social pressure on the

defaulter.

• If the group also defaults on the joint liability,

members become ineligible for future access to

credit.

• Loans generally are used for income generating

purposes.

• The loan officer is the pivotal representative of the

MFI.

• The loan officer forms JLG.

• The loan officer fosters credit behaviour and

explains the concept to the members.

• MFIs offer door step service to JLGs. The loan

officer goes to each village under his coverage and

forms JLGs.

• MFIs loan money to group members on higher

interest than banks (high operatings costs and lack

of collateral).

• In addition to credit, MFIs may offer savings

deposits, microinsurance and other financial

services.

• The loan officer interacts with the JLG periodically

and performs credit, recovery and other functions

Clients or Borrowers Microfinance Institutions (MFIs)



January 2015 56

17.2. Global Market

The JLG model spread as a means of financial inclusion from Bangladesh to Central and South

America and then other parts of the world. The global microfinance market is over USD84bn

according to Mix Market.

Figure 88

The global MFI sector grew at a CAGR of over 23% over 2006-2012 as the market is under-

penetrated and the demand is high. Asia and South and Central America (S&CA) constitute

almost 40% of the MFI universe each in 2012. The data may exclude government-run

independent microfinance programmes such as India‟s SHG-bank linkage programme.

Figure 89 Figure 90

17.3. How does an Ideal Grameen or JLG Model Work

Even when the MFI offers savings services in most regulated MFI markets, they cannot be

offset against outstanding dues. The process of JLG formation may be adopted by the MFIs to

suit local needs or dynamics.

This low credit cost model primarily works on two main factors:

1. High involvement: The MFI officer is in touch with the borrowers as frequently as once a

week. The financial services are offered at the doorstep. The follow-up for repayments is as frequent as the group meetings.

2. The joint liability structure: The entire group pays on behalf of the defaulting member to ensure continued access to credit.

25.7

38.244.6

55.966.4

77.784.6

0

15

30

45

60

75

90

2006 2007 2008 2009 2010 2011 2012

Global MFI Outstanding Book Size

Source: mixmarket.org, ex-China ; Data as on December 2012; reporting as on December 2013 is inadequate in our opinion

(USDbn)

South & Central America

41%

Asia35%

Europe16%

Africa8%

Regional Share (2006)

Source: mixmarket.org, ex-China

Asia42%

South & Central America

41%

Africa11%

Europe6%

Regional Share (2012)

Source: mixmarket.org, ex-China



January 2015 57

Figure 91

Formation and Operations of JLG Model

Figure 92 NPA Experience of MFIs in Various MFI Markets The credit costs borne by the MFIs are typically low except at the time of microfinance crises in various parts of the world as was the case in India in October 2010.

The portfolio quality of MFIs is measured by PAR (portfolio at risk) and write-off ratio. PAR 30 indicated the percentage of loan portfolio for which dues are over 30 days.

Write-off includes the percentage of loan portfolios that have been written off according to local institutional regulations or MFI‟s guidelines as applicable.

Country (%) PAR 30 PAR 90 Write-off

Indonesia 0.0 0.0 0.0 Peru 5.8 4.8 3.3 Colombia 6.1 4.9 1.6 Bolivia 1.0 0.8 0.5 Ecuador 3.0 1.9 0.5 India 14.0 13.9 2.2 Mongolia 1.6 1.2 0.7 Kenya 6.0 3.1 0.0 Chile 9.8 7.0 0.1 Brazil 6.0 5.3 2.9 Mexico 4.7 4.1 8.9 Paraguay 10.1 8.6 2.8 Cambodia 0.0 0.0 0.1 Bangladesh 6.5 5.9 1.2 Azerbaijan 1.9 1.7 0.8

Source: mixmarket.org 2012

The facilitator/officer (could be an employee of the MFI or NGO assisting MFI increase

its outreach) would set up an office in a suitable location covering a cluster of villages

He would search for potential borrowers and explain to them the concept of joint

liability and how it acts as an enabler for access to credit

He would foster groups of 5-10 individuals as a JLG. The group meets periodically in

presence of the officer and the individuals discuss the problems faced by them,

potential solutions, business plans, economic needs, etc.

When the group exhibits certain saving behaviours and requisite group dynamics,

about two members become eligible for loans

If the two borrowers in the JLG exhibit no delinquency and repay the principal and the

interest for a year, all the group members become eligible for loans

In case a borrower fails to pay up, other members pay on his behalf



January 2015 58

The JLG model was characterised by joint liability and as a consequence low credit costs.

Global thinkers and policy makers heralded the model as a means of financial inclusion of

about two-thirds of the global population profitably. The MFIs enjoyed sky-high valuations and

were the darlings of the street.



January 2015 59

18. Appendix 16: Indian Experience: SHG vs. JLG Model

The Grameen model adopted in early 2000s by various NGOs/societies followed the one

followed in Bangladesh. It was realised that MFI lending could be profitable under the JLG

model and hence many NGOs converted themselves into NBFCs or for-profit organisations.

The for-profit NBFCs grew over FY06-FY11; the adopted JLG model has stood on its own

against the world‟s largest microfinance programme – Bank-SHG linkage - supported by

various government agencies in India. The key features of the JLG model and the Bank-SHG

linkage models are enumerated in the table below:

18.1. Structural Differences (FY11 and Earlier)

Figure 93

Key Differences in the SHG and JLG Models SHG-Bank linkage JLG model

Participating institutions (features and form)

Lending institutions:

Commercial banks, co-operative and regional rural banks

Regulatory and implementation: RBI, NABARD, SIDBI, etc.

Group fostering: NGOs and other SHPIs for up to six months

Lending institutions:

NBFCs, Section 25 companies, Societies and trusts (other than NBFCs, all are non-profit)

Regulatory and implementation: RBI (with regard to prudential and deposit related norms)

Group fostering: Two weeks to one month

Group size 10-20 members 5-10 members Liability structure Banks open the account in the name of

the SHG. The lending is to the group and hence the liability is on the group as well. In case a group member and thereby the group defaults, the group is no longer eligible for credit

The liability is on the group. In case a member defaults, other members pay on his behalf to maintain their access to credit. If the group defaults, the members are not eligible for credit

Set-up costs High; the initial costs are borne by the SHPIs, part of which is reimbursed by NABARD

Medium; group fostering guidelines not as long and stringent as those for SHG

Loan features and tenor

Two-to-four years Interest rates between 3% and 12%

Maximum one year Interest rate up to 35%-40%

Credit costs All India: 6.8% in FY14, 18%-25% in some large states

0.5%-1% of the portfolio on account of JLG structure

Sustainability The programme sustains on government sponsorship and support and NABARD reimbursements and refinance facilities available to banks

For-profit entities can continue running their business till it is profitable

Institutions: Perception and acceptability

Government and banks are viewed with relatively higher level of trust. However, banks are viewed as complex entities with complex documentation and multiple requirements (an applicant may need to make three-to-four trips to the bank and forgo the income for that period). NGOs and other entities are trusted if they have been around for some time.

MFIs are trusted more if they have been around for some time or are famous through the word of mouth. They are perceived as easier to deal with than banks, with less documentation, quick credit, door-step service. On default, MFIs are very strict with the borrowers and hence score lower than banks on the trust factor.

Source: Ind-Ra

Though the size and scale of SHG-bank linkage in India was multiple times that of MFI

operations in FY08, MFIs flourished. This was because of MFIs‟ many features such as

penetration, profit incentives, door-step service, regular involvement with JLG members, etc.

This reflects in the relative growth observed in both the models of microfinance.



January 2015 60

18.1.1. Borrower Outreach

Figure 94

Under the SHG model, the borrowing is in the name of the SHG and the amount may be

distributed to four-to-10 members, depending on their need and the group approval. However,

all the members have access to credit. The MFIs report their data based on the number of

borrowers/loans. MFIs have increased their outreach by over 2x from FY08 till date. The fall in

the number of borrowers in FY12 and FY13 can be attributed to the AP crisis.

18.1.2. Portfolio Size: JLG Based Institutions Catching Up

Figure 95

MFIs‟ pace of increase in the loan portfolio size is higher than that of the SHG-Bank linkage

programme. MFIs‟ portfolio has increased by over 9x in eight years while that of SHGs has

increased by 3.5x.

The easy availability of MFI credit and other features as described earlier, the share of MFIs

increased to 42% in FY14 from 22% in FY07 in the Indian microfinance universe.

0

20

40

60

80

100

120

SHG-Bank channel members MFI channel (borrowers)


Borrower Outreach of SHG and JLG Models in India

Source: NABARD annual reports, Sa-Dhan, MFIN and Ind-Ra‟s estimates

(m)

124170

227

280312

363394

429

3560

117

183216 209 223

305

0

100

200

300

400

500


SHG-Bank Channel MFI Channel

Portfolio of SHG and JLG Models in India (Outstanding Basis)


(INRbn)



January 2015 61

18.1.3. Share of MFIs Increasing in Indian Microfinance Universe

Figure 96

One of the reasons for the high returns in MFIs was controlled credit costs due to the JLG

model. This factor contributed to the growing perception that the poor are bankable and their

willingness and intent to repay cannot be questioned. However, the credit for the same can be

attributed to the joint liability of the borrowers and having continuous access to credit.

18.1.4. JLG-based Model has Lower NPAs

Figure 97

0%

20%

40%

60%

80%

100%


SHG JLG

Share of MFIs Increasing vs. SHG in Indian Microfinance Universe


0.38 0.38 0.35 0.35

2.90 2.90 2.94

6.92

0

1

2

3

4

5

6

7

8

2007 2008 2009 2010

JLG NPA SHG NPA(%)

Pct of Portfolio Outstanding

Source: mixmarket.org (MFI; year ending December), NABARD (SHG; Financial Year)



January 2015 62

18.1.5. Share of for-profit NBFC-MFIs Increasing

The earliest MFIs were run by NGOs and societies since they were already in this field and

close to the borrowers. Experience showed that MFI lending could be a profitable business;

and the profits could be ploughed back into the business to further the goal of financial

inclusion. The share of NBFCs in the MFI space increased because of two main reasons:

1. MFI business was spun off by NGOs/societies/trusts into NBFCs

2. For-profit NBFCs can attract debt and equity funding for expansion

3. Management incentives linked to portfolio expansion

Figure 98

0%

20%

40%

60%

80%

100%


NBFCs MFIs Non-NBFC MFIs

Increasing Share of NBFCs in the Indian Microfinance Sector

Source: Sa-Dhan, MFIN, Ind-Ra‟s estimates



January 2015 63

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