Where and when Microfinance started?

From 1950s to 1970s, the provision of financial services by donors or governments

was mostly in the form of subsidized rural credit programs. These often resulted in

high loan defaulters, losses and was unable to reach rural poor households.

However, the birth of ‘modern’ microfinance is said to have occurred in mid 1970s,

when organizations such as Grameen Bank of Bangladesh with the microfinance

pioneer, Mohammad Yunus started and shaped modern industry of Micro financing.

Another pioneer in this industry is Akhtar Hameed Khan.

Moreover, microfinance in India can trace it origins, back to early 1970s when the Self

Employed Women’s Association (SEWA), formed an urban cooperative bank called the

Shri Mahila SEWA Sahakari Bank, with the objective of providing banking services to

poor women employed in the unorganized sector in Ahmedabad city, Gujarat.

The microfinance sector went on to evolve in 1980s around the concept of SHGs,

informal bodies that would provide their clients with much needed savings and credit

servings.

Today, microfinance serves as an umbrella term to describe the delivery of lending

services by poverty–focused institutions to developing populations not served by

mainstream financial service providers.

Major Players in India

1. SKS Microfinance Ltd. (SKSMPL)

2. Spandana Sphoorty Financial Ltd. (SSFL)

3. Share Microfin Limited (SML)

4. Asmita Microfin Ltd (AML)

5. Shri Kshetra Dharmasthala Rural Development Project (SKDRDP)

6. Bhartiya Samruddhi Finance Limited (BSFL)

Some key terms.

Microfinance Institutions Network (MFIN) is a self-regulatory organization of the Indian

microfinance sector. The Microfinance Institutions Network (MFIN) is a trade association of

Indian microfinance lenders that is presided over by Chairman Vijay Mahajan of microfinance

institution BASIX. MFIN consists of 39 non-banking finance company-MFIs (NBFC-MFIs) in

India, which reportedly account for more than 80 percent of the Indian market.

Microfinance: The practice of providing financial services in very small increments to the working

poor.

Micro entrepreneur: Micro entrepreneurs are people who own small-scale businesses that are known

as microenterprises.

Microenterprise: A small-scale business in the informal sector. Microenterprises employ fewer than 5

people and can be based out of the home. Microenterprise is often the sole source of family income but

can also act as a supplement to other forms of income. Examples of microenterprises include small

retail kiosks, sewing workshops, carpentry shops and market stalls.

Capital Adequacy Ratio: - CAR is an indicator of an MFI’s ability to meet its obligations and absorb

unexpected losses. CAR measures an MFI’s strength and stability by looking at the relationship between

its capital base and asset base. It measures the amount of capital relative to risk-weighted assets that an

MFI should have.

TIER 1 Capital or Core Equity Capital = (paid up capital + statutory reserves + disclosed free reserves)

- (equity investments in subsidiary + intangible assets)

TIER 2 Capital or Supplementary Capital = A) Undisclosed Reserves + B) General Loss reserves +

C) hybrid debt capital instruments and subordinated debts.

In 2015, Under Basel III, minimum total capital ratio is 8%, which indicates the minimum tier 2

capital ratio is 2% and 6% Tier 1 capital.

Portfolio at Risk- It is a percentage (%), which represents the “proportion of an MFI's total gross

outstanding loan portfolio that is at default risk.

Sum of Unpaid Principal Balance of All Loans with Payments Past Due (1 to 365 Days and

more)

Total Gross Outstanding Loan Portfolio (Sum of Principal Outstanding of All Loans)

PAR > = 1 Day Sum of PAR 1-30 Days + PAR 31-60 days… + PAR > 365 Days

PAR > 30 Days Sum of PAR 31-60 Days + PAR 61-90 Days … + PAR > 365 Days

PAR > 60 Days Sum of PAR 61-90 Days + PAR 91-120 Days… +PAR > 365 Days

PAR > 90 Days Sum of PAR 91-120 Days + PAR 121-180 Days ... +PAR >365 Days

PAR > 180 Days Sum of PAR 181-365 Days + PAR >365 Days

PAR > 365 Days (1 year) Sum of PAR > 365 Days

PAR has desirable standards. Generally speaking, sustainable MFI institutions have a PAR <= 2%.

Return on Assets- RoA ratio is a percentage (%), which measures the net income earned on the

assets of a Microfinance Institution (MFI). it measures how well the institution uses all its assets. RoA

is an overall measure of profitability that reflects both the profit margin and the efficiency of the

institution.

Net Income (Excluding Donations)

____________________________

Average Total Assets

Fixed Obligation Ratio- This ratio includes all the fixed obligations that a borrower is supposed to

meet regularly on a monthly basis. MFIs calculate the eligibility based on the fixed obligation to income

ratio (FOIR). Here, a MFI takes into account the instalments of all other loans already availed of by the

applicant and still due, including the present loan applied for.

Debt equity Ratio- The debt-to-equity ratio indicates the relationship of debt to equity financing. This

Ratio expresses the relationship between capital contributed by creditors and that contributed by

owners. It expresses the degree of protection provided by the owners for the creditors. The higher the

Ratio, the greater the risk being assumed by creditors. A lower Ratio generally indicates greater long-

term financial safety. Creditors generally prefer a low DER, since this provides a large cushion of

protection. Also, a Microfinance Institution (MFI) with a low DER usually has greater flexibility to

borrow in the future. A more highly leveraged MFI has a more limited debt capacity.

Total Liability

______________

Total Asset

Qualifying Assets- Qualifying assets” shall mean a loan which satisfies the following criteria:-

i. loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not

exceeding Rs. 1,00,000 or urban and semi-urban household income not exceeding Rs. 1,60,000;

ii. loan amount does not exceed Rs. 60,000 in the first cycle and Rs. 1,00,000 in subsequent cycles;

iii. Total indebtedness of the borrower does not exceed Rs.1, 00,000; Provided that loan, if any

availed towards meeting education and medical expenses shall be excluded while arriving at

the total indebtedness of a borrower.

iv. tenure of the loan not to be less than 24 months for loan amount in excess of Rs.15,000 with

prepayment without penalty;

v. loan to be extended without collateral;

vi. aggregate amount of loans, given for income generation, is not less than 50 per cent of the total

loans given by the MFIs;

vii. Loan is repayable on weekly, fortnightly or monthly installments at the choice of the borrower.

Minimum 85% of qualifying assets should be there.

Loan Utilization Check- Typically MFIs provide working capital, which in many cases, are not used

as per the stated purposes by the clients. Subsequently, this note questions the necessity of utilization

checks in microfinance service delivery. However, the note also maintains that loan utilization checks

are extremely important for larger individual, enterprise development loans due to its large loan size

and sanctioned on the basis of the credit officers’ assessment of the cash flow of that particular business.

Generally after 15 days of disbursement MFI officials does LUC.

Credit appraisal and credit rating agencies

In MFI, the credit appraisal is carried out by different credit bureaus. The assessment

of the various risks that can impact on the repayment of loan is credit appraisal. In

short, you are determining "Will I get my money back?”. Depending on the purpose of

loan and the quantum, the appraisal process may be simple or elaborate. For small

personal loans, credit scoring based on income, life style and existing liabilities may

suffice. But for project financing, the process comprises technical, commercial,

marketing, financial, managerial appraisals as also implementation schedule and

ability.

The credit bureaus are companies that collects information from various sources and

provides consumer credit information on individual consumers for a variety of uses. A

Consumer Reporting Agency is an organization providing information on individuals'

borrowing and bill-paying habits. Credit information such as a person’s previous loan

performance is a powerful tool to predict his future behavior. Such credit information

institutions reduce the effect of asymmetric information between borrowers and

lenders.

High Mark Credit Information Services is a credit information company based

in Mumbai. It keeps a record of loan repayment history on credit facilities extended

to an individual across the board. The service helps lenders to analyze the risk profile

of individuals before extending credit. This can also help keep non-performing loans in

check.

Equifax Inc. is a consumer credit reporting agency in the United States, considered

one of the three largest American credit agencies along with Experian and TransUnion.

Founded in 1899, Equifax is the oldest of the three agencies and gathers and maintains

information on over 400 million credit holders worldwide.

Sources of fund for MFIs

MFIs can borrow from big banks and investors or issue bonds; take deposits (savings)

from clients; and accept equity investments, which are ownership stakes that earn a

share of the profits. Therefore, sources of funds for an MFI can be-

o Venture Capitalist

o Grants and Donations

o Bank loan

o Crowd Sourcing

o Private equity investment

o Many institutions are also adopting P2P (Peer to Peer) lending technique.

2008 MFI crises

The presence of large MFI in AP leads to a rapid proliferation of credit across Andhra

Pradesh and wide use of multiple loans by borrowers. In Andhra Pradesh, the average

debt outstanding per household was Rs.65000 as compared to a national average of

Rs.7700 of outstanding microfinance debt per poor household. According to the study

done by IFMR, it was found that 83% of household of AP have loan from more than

one source including from moneylenders, with many households managing as many

as four loans at a time.

In October 2010, keeping in view a series of suicides of borrowers of microcredit, the

state government of Andhra Pradesh passed an Ordinance to regulate working of

microfinance institutions. The ordinance was passed to stop alleged abusive practices

like higher interest rates and unlawful collection mechanism undertaken by a few

microfinance institutions.

The ordinance itself was passed within no time which was a knee jerk reaction by the

government. However no microfinance institution was allowed to carry out its

operations until they registered with the government. As all operations came to a

standstill, precious time was lost. Borrowers began to lose their discipline and even

took advantage of the situation – many refusing to repay the loan. Many were also

instigated by local politicians to refuse repayments. With this becoming a

phenomenon across the state, default rates soared for the first time ever. The obvious

result of it was a reduction in cash flow and fresh capital from financial institutions

drying up.

In part – II of microfinance industry analysis, following topics would be

covered-

Issues of SHG vs. JLG model.

Issues and benefits of microfinance.

CIBIL ratings.

RBI circular on MFI/NBFC.

Different types of banking licenses.