The term Microfinance refers to small-scale financial services- both credit & savings, provided to the poor in rural, semi-urban & urban areas. The service providers in this space are banks, insurance companies, agricultural & dairy co-operatives & MFI s (Micro Finance Institutions) etc.
Since MFI s don’t have a banking license, they can’t take deposits which prevents them from offering the savings facility. So largely the savings facility in micro-finance is provided by banks only as of now. In fact in India microfinance is synonymous to micro-credit, the reason behind is that savings, micro-insurance etc comprise a very miniscule segment of the microfinance space here.
Now what is the definition of a micro-loan?
The Development & Regulation bill 2007 defines Microfinance loans as loans with amount not exceeding Rs 50,000 in aggregate per individual/enterprise. However, in practice most micro-loans are in the range of Rs 5000- Rs 20,000.
How big is this market we are talking about?
The microfinance sector and MFIs in India are estimated to have outstanding total loans of Rs.16,000 crore to Rs.17,500 crore, and Rs.11,000 crore to Rs.12,000 crore, respectively, as on March 31, 2009. The microfinance sector in India is fragmented – there are more than 3,000 MFIs, NGOs, and NGO-MFIs, of which about 400 have active lending programmes. However the good thing is that the top 10 MFIs account for about 74% of the total outstanding.
In the past the microfinance industry in India has witnessed astounding growth. One of the measures- the total loan amount outstanding has grown from Rs 1600 crore in March’06 to an impressive Rs 11,400 crore by March’09! (We hope it grows even faster going forward so as to fetch us all PGDM-DSF students at IFMR a worthy job 🙂 )
Understanding MFI s Better-
MFIs according to their lending model can broadly be classified under two heads- The ones lending as per the SHG(Self Help Groups) model & the ones lending as per the JLG( Joint Liability group) model. Now we will try to chalk out how these two models are different- Under the SHG model the MFI lends to a group of 10-20 people( women essentially in the present Indian context). Under the SHG-bank linkage model, an NGO promotes a group and gets banks to extend loans to the group. Under the JLG model, loans are extended to, and recovered from, each member of the group (unlike under the SHG model, where the loan is extended to the group as a whole). The most popular JLG models are the Grameen Bank model (developed by Grameen Bank, Bangladesh) and the ASA model (developed by ASA, a leading Bangladesh-based NGO-MFI). Most of the large MFIs in India follow a hybrid of the group models.
The model of lending to individuals is similar to the retail loan financing model of banks. In India, MFIs adopting the group-lending models extend individual loans to more successful borrowers who have completed a few loan cycles as part of a group (who have relatively large credit requirements and good repayment track record). Corporates and cooperatives, typically dairy farms and sugar mills, are also known to undertake
microfinance by extending credit to farmers; this helps the companies strengthen their procurement and distribution channels.
Now coming to the what I call the not-so-pleasant part of MFI operations 🙂 – the interest rates charged by these MFIs.
MFIs following the JLG model charge flat interest rates of 12 to 18% on their loans, while MFIs following the SHG model charge 18 to 24% per annum!! based on the reducing balance method. In addition to interest rates, some MFIs also charge a processing fee comprising a certain proportion of the loan amount sanctioned, at the time of disbursement. I know we all couldn’t agree more on that these interest rates are bit too high for the poor people we are serving. But if I may take the liberty to leave the complete humanitarian point of view and draw your attention to the MFI as a business..like any other business ( remember this business about doing well by doing good 🙂 ) we should see that the cost of loan disbursements in the case of MFIs is higher than a bank, also the risk involved( as no collaterals) is also on the higher side. So we can’t just blame the MFIs for leaching on to the poor..afterall they are still doing some good work, and so no reason they should be deprived of their credit, that they rightfully deserve.
We know that this sector has grown multitudes in the past..so what does the future hold for MFIs?
Well, the way I see it- taking SKS as the flag bearer of the industry ( I guess it’s not a vague assumption, after all it account for about 25% of loans outstanding alone!) – it’s cost-of-capital stands at 9.58%(sep’08), charges 23.6% in Andhra & 28% in other states!..it has a very healthy margin to operate in. Most if not all the MFIs are highly leveraged, now once SKS goes public for funds (which it plans to do in the current year) it will be able to de-leverage it’s financials considerably, bringing down the cost-of-capital. A reduction in cost of capital keeping other factors constant will surely provide the company a cushion in operations and profitability.
Also, I expect that going forward the MFIs will get a banking license ( well not all, but I hope a few big ones do). That will be the turning point in terms of reducing CoC, and probably then only we can expect the MFIs to charge a lower interest rate from the people. Looking at the way banking system in India is regulated it’s very unlikely to happen any time soon, but that is what I think can bring about the next big revolution in the MF industry, and so I sincerely hope it does.
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