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Micro finance is needed at the household, community and regional levels. But a
greater need for 100% financial inclusion is being felt because poor people are
trapped in poverty. The reasons being:

ñc 3ommercial banks not lending them money as they are often neither in a
position to offer collaterals nor are they considered ³creditworthy´ enough
ñc ¦ocal money-lenders, who are often their only source of credit, charge
exorbitantly high interest rates, thereby depleting them of whatever little
possible savings they can manage.

Generally microfinance is sought by small and marginal farmers, the economically

weaker sections etc. Women constitute a vast majority of users of microcredit and
micro savings facilities.

India¶s rural poor are dependent on agriculture as their primary source of

income.c Thec majority are marginal or small farmers, and the poorest households
are landless. Thus they have uncertain and irregular income streams and
expenditure patterns. Here the need for micro finance is felt.

In Urban areas, people have a very temporary address and are mobile
because the slums being evacuated. Also, unsteady livelihoods lead to migration
from one part of the city to another or from one city to another. The KY3 norms
require a proof of identity and residence, which urban poor cannot provide- They
remain excluded from formal ¿nance unless a voter identity card or a migrant
identity card is issued to them.

Housing loans are not taken off in a big way because of large volume of loans
required and long period of repayment.


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cDiffer on basis ofc

 
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Here the micro finance institutions lend to groups such as the self help groups
(SHG) and the Joint reliability groups (J¦ ) and also to the individual

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ñc Weekly or fortnightly repayment structure (J¦ model)

ñc Monthly repayment structure (SHG model)

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ñc J¦ model charges flat 12-18% interest on loans.

ñc SHG model charges 18-24% interest on reducing balance method
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ñc Micro credit, investments, insurance, saving, etc.

 
c 

ñc 3ooperatives, NBF3, unregistered, societies, trusts, for-profit, non-profit.

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Traditionally, banks have not provided financial services, such as loans, to clients
with little or no cash income. Banks incur substantial costs to manage a client
account, regardless of how small the sums of money involved. For example,
although the total gross revenue from delivering one hundred loans worth $1,000
each will not differ greatly from the revenue that results from delivering one loan
of $100,000, it takes nearly a hundred times as much work and cost to manage a
hundred loans as it does to manage one. The fixed cost of processing loans of any
size is considerable as assessment of potential borrowers, their repayment
prospects and security; administration of outstanding loans, collecting from
delinquent borrowers, etc., has to be done in all cases. There is a break-even point
in providing loans or deposits below which banks lose money on each transaction
they make. Poor people usually fall below that breakeven point. A similar equation
resists efforts to deliver other financial services to poor people.

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MFIs are dependent on borrowings from banks & FIs.

For most MFIs, funding sources are restricted to private banks & apex MFIs due to
risks involved & as huge amounts of funds are required.

Available bank funds are typically short-term (max. 2 years period)

Also, there is a tendency among some lending banks to sanction and disburse
loans to MFIs around the end of the accounting year in pursuit of their targets.

This leads MFIs to draw and deploy the funds sub-optimally for a period, till they
find better avenues for deployment in loans to the needy clients.

uc   c  c

eports tells us that SKS Micro-finance is charging approximately 24 per cent rate
of interest in Orissa, Karnataka and Andhra Pradesh; in southern India, Equitas
Micro-finance is seeking 21-28 per cent interest rate and Basix Microfinance is
providing small loans at 18-24 per cent interest rate. There are numerous other
players, and they all rake in money. Sewa in Gujarat and the Grameen Bank in
Bangladesh too thrive on a similarly high rate of interest.
People went on borrowing from the money lenders or ÷
 ÷ because they
needed the money and it must have and still is making a difference to them
otherwise the entire business of moneylending would have collapsed and become
unsustainable. All that micro-finance institutions are doing now is to replace that
class of moneylenders. Micro-finance institutions are also extracting their pound of
flesh. The ÷
 ÷ were using their own capital for lending and therefore
charging a very high interest of 60 per cent or above. The micro-fianance use the
bank finances and therefore charge a little less at 20-24 per cent.

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The majority of the MFIs are structured and registered as societies, cooperatives,
trusts and not-for-profit companies. 3ompanies account for just 22% of 3 ISI¦
s
MFI grading assessments. The governance practices of these MFIs are to some
extent comparable with the good governance practices of mainstream corporations.
The legal structure and attendant regulatory requirements of an MFI have a strong
bearing on governance practices
because they influence management practices and the level of transparency. Other
than a formal company structure, All other legal structures, such as trusts and
societies, suffer from the lack of any meaningful regulation and disclosure
standards. This also creates a virtuous cycle/vicious cycle phenomenon: MFIs that
have the willingness and minimum capital funds to embrace a corporate structure
as a nonbanking finance company can more easily attract outside investors, which
in turn encourages better governance and disclosure standards. In contrast, MFIs
that are either unable (for lack of adequate sponsor funding capacity) or unwilling
to convert to a corporate structure tend to remain "closed" to transparency and
improved governance standards, and therefore continue to be
unable to attract outside capital.

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Poverty has literally become a big and organised business. There can be no better
business opportunity than starting a micro-finance institution with assured returns
and 100 per cent loan recovery. With high interest rates & proper resources it is
easy to make huge profits.

This has resulted in the huge amount of increase in the number of MFIs in India
today.
India
s microfinance sector is fragmented, having more than 3,000 MFIs, NGO-
MFIs present.

Also commercial banks are slowly coming into the picture and many are
partnering with regional microfinance institutions. Increasingly, loans as small as
$100 are being made by mainstream Indian banks such as I3I3I, HDF3, and UTI,
and often contain unconventional covenants typical of microfinance transactions.

Founded in 1977, HDF3 had net income for 2005 of about $200 million and 24
rural partners. ecent partnerships include: Ujjivan, Bellwether microfinance
fund, Avishkar-Goodwell Fund, ¦ok 3apital, and Activists for Social Alternatives.

Another example of a commercial bank that has partnered with local MFIs is
I3I3I, which has 72 such partnerships. I3I3I Bank had net income in 2005 of
about $500 million, and operates 614 branches and 2200 ATMs. Through about
100 rural partnerships, its portfolio of microfinance investments stood at $227
million and 1.2 million clients at year end 2005. A prominent partner of the bank
is Spandana. The Andhra-Pradesh-based microfinance institution disbursed loans
of $3.4 million in 2004 at an effective rate of 30%, of which 9.25% went to I3I3I.
In addition, in November 2005, I3I3I tied up with the Grameen Foundation USA
to create microfinance lender Grameen 3apital India. I3I3I has been micro
lending since 2001.

Mumbai-based UTI began in 1994, and is 72% publicly-owned. It had net income
in 2005 of $104 million, and operates 450 branches and more than a thousand
ATMs throughout India. In its Annual eport 2005-2006, reference is made to
increasing microfinance activities by offering new services to rural clients. UTI
works closely with the Grameen Koota program, which has outstanding loans of
$3.2 million, as well as SKS Microfinance of India.
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SKS Microfinance, promoted by Dr. Vikram Akula, was originally founded as

Swayam Krishi Sangam or SKS Society in 1997 and functioned as a non-
governmental organization (NGO) that provided microfinance in Andhra Pradesh.
SKS Society transferred its business and operations to SKS Microfinance as a
newly incorporated private limited company in India in 2003. SKS Microfinance is
the largest Microfinance Institution (MFI) in India in terms of total value of loans
outstanding, number of borrowers (called members) and number of branches.

SKS Microfinance is a non-deposit taking non-banking finance company (NBF3-

ND), registered with and regulated by the eserve Bank of India ( BI). It is
engaged in providing microfinance services to individuals from poor segments of
rural India.

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The company
s core business is providing small loans exclusively to poor women
predominantly located in rural areas in India. These loans are provided to such
members essentially for use in their small businesses or other income generating
activities and not for personal consumption.

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Borrowers take loans for a range of income-generating activities, including

livestock, agriculture, trade (such as vegetable vending), production (from basket
weaving to pottery) and new age business (photography to beauty parlours). SKS
also provides members with interest-free loans for emergencies as well as life
insurance and loan cover insurance to borrowers.

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The 3ompany utilizes a village centred, group lending model to provide unsecured
loans to its members. This model ensures credit discipline through mutual support
and peer pressure within the group to ensure that individual members are prudent
in conducting their financial affairs and are prompt in repaying their loans. Failure
by an individual member to make timely loan payments will prevent other group
members from being able to borrow from it in the future; therefore the group
typically make the payment on behalf of a defaulting member or, in the case of
wilful default, use peer pressure to encourage the delinquent member to make
timely payments, effectively providing an informal joint guarantee on the
member
s loan.

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The company also uses its distribution channel to provide other services and goods
that it founds that its members need. For instance, it also distributes and
administers life insurance policy products for its members and has pilot programs
to provide loans to its members to purchase select consumer products that increase
their productivity.

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The operational statistics of SKS are nothing short of phenomenal. SKS has
recorded a growth of around 200% ever since it has become a NBF3 in 2003. The
statistics below speak for themselves.

  
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Total no. of Branches 80 275 771 1,676

Total no. of Districts 19 102 217 345

Total no. of Staff 574 2,389 6,425 17,520

Total No. of Members 0.20 0.60 1.87 5.30

(In Millions)
Amount Disbursed 1,525 4,454 16,789 31,994

(IN . In Millions)
Portfolio Outstanding 921 2,756 10,506 32,080

(IN . In Millions)

 
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Similar to the operational statistics of SKS, financial statistics of SKS too are
outstanding. Their revenues and profits too have been shown to grow by leaps and
bounds.

 
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Incremental Debt 88 277 1,063 1,247

(IN in 3rores)

Total evenue 10 46 170 385

(IN . In 3rores)

PAT 0.44 3.67 16.64 55.60

(IN . In 3rores)

Total Assets 98 332 1,083 3,643

(IN . In 3rores)

OA 0.48% 1.00% 2.51% 4.09%

OE 3.08% 18.1% 16.3% 15.15%

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SKS charges interest sufficient enough to cover its costs.

Yet, SKS is among the ones which provide the lowest cost to the borrowers.
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SKS has been a sector leader in sourcing capital. In July 2009, Bajaj Allianz made
a strategic investment of $ 10 million(IN 50 crore) in SKS Microfinance which
was the first-ever investment by an insurance company in an Indian microfinance
institution. In November 2008 SKS raised equity worth $ 75 million( s 366 crore),
the largest equity raised by an MFI in the world. The third round of equity worth
s 147 crore was raised in January 2008. In March 2006, SKS closed its first
round of equity investment; the largest microfinance investment in India to date - $
3.2 million from some of the world¶s leading microfinance investors, and then
eclipsed this accomplishment with a second round equity investment of $11.5
million in March 2007.

It leverages its equity to raise debt from public sector, private sector and
multinational banks operating in India. This capital has helped the organisation
scale up operations and reach out to millions of poor households across the length
and breadth of India.

To meet future capital requirements arising out of growth in business, SKS came
out with an IPO in july-Aug. 2010, worth s.1653.97 crores.

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Huge gap in Microfinance demand and supply: According to the 2008 Inverting
the Pyramid eport by Intellecap, an independent industry research firm, the total
estimated demand for micro-credit in India was approximately s. 2,39,935 crore
with estimated total loan disbursements at approximately s. 20,072 crore.

As of March 31, 2010, the company had 2,029 branches in 19 states across India
with no state accounting for more than 28.8% of its outstanding loan portfolio.

3apital adequacy ratio as of March 2010 stands at comfortable 28.3% compared to

the EBI mandated minimum of 12% as of March 2010 and 15% as of March 2011.

Gross NPA and Net NPA are just 0.33% and 0.16% respectively at the end of
FY
10.

The company lends to micro enterprises who earn returns in the range of 29% to
246% mainly due to use of family labours, low infrastructure costs and no taxes or
legal costs. This helps SKS Microfinance to charge higher interest rate from its
customers.

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3urrently there is no interest rate cap on the lending by the microfinance

institutions. MFIs typically charge high interest rate to its customers ranging
between 26% to as high as 31%. There is risk perception that regulator may pitch
in and put a cap on interest rate charged and regulate the sector. As the costs and
risks in this business are also high, any unreasonable cap will severely impair the
business prospects.

Microfinance as a business is still in the evolution stage.

Due to the unsecured nature of advances and very low income earning capacity of
the borrowers with little savings, the default risk in this business is high.
Natural calamities like floods etc, political instability, social strife in certain areas
can severely impair the borrowers
ability to pay and lead to mass defaults in
particular areas/states.

Due to the nature of operations, large amount of cash is handled with attendant
risks of theft, fraud, misappropriation, violent crimes against its employees etc.

Microfinance has been traditionally met through informal sources including non-
government organizations, or NGOs; cooperatives; community-based development
institutions like Self Help Groups, or SHGs, and credit unions. Better flow of
funds to these institutions, or more involvement of banks in direct financing of
small borrowers or government sponsored schemes for facilitating flow of funds at
lower cost to the poor segments of the society can pose stiff competition to the
company as it charges comparatively high interest rates.

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I3I3I Bank was originally promoted in 1994 by I3I3I ¦imited (a development

financial institution for providing medium-term and long-term project financing to
Indian businesses), and was its wholly-owned subsidiary. After consideration of
various corporate structuring alternatives the managements of I3I3I and I3I3I
Bank formed the view that the merger of I3I3I with I3I3I Bank would be the
optimal strategic and legal structure for both entities. 3onsequent to the merger in
January 2002, the I3I3I group
s financing and banking operations, both wholesale
and retail, have been integrated in a single entity.

I3I3I Bank has a network of about 610 branches and extension counters and over
2,000 ATMs. I3I3I Bank offers a wide range of banking products and financial
services to corporate and retail customers through a variety of delivery channels,
specialised subsidiaries and affiliates. I3I3I Bank set up its international banking
group in fiscal 2002 to cater to the cross border needs of clients and to offer
products internationally. I3I3I Bank currently has subsidiaries in the UK, 3anada
and ussia, branches in Singapore and Bahrain and representative offices in the
United States, 3hina, United Arab Emirates, Bangladesh and South Africa. I3I3I
Bank
s equity shares are listed in India and its American Depositary eceipts
(AD s) are listed on the New York Stock Exchange (NYSE).

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Banking with the poor is a challenging task as the nature of demand requires
doorstep services, flexibility in timings, timely availability of services, low value
and high volume transactions and require simple processes with minimum
documentation. The nature of supply however involves high cost of service
delivery, rigid, inflexible timings and procedures and high transaction costs for the
customers. With these features on the supply side, traditional banking is not poised
to meet the requirements of the demand side. The reach of the banking sector in
the rural areas was as low as 15% in terms of credit potential, and 18% in terms of
population with physical access to a bank branch.
I3I3I Bank chose to pursue the unreached rural markets as part of its strategy of
being a universal bank. However, instead of taking the conventional branch
banking model for increasing its outreach, the Bank decided to work with models
which would combine the strengths of intermediary forms of organization with the
financial bandwidth of a banking institution.

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To enable its foray into the rural markets, I3I3I Bank merged with the Bank of
Madura (est.1943), which had a substantial network of 77 branches in the rural
areas of a South Indian state ± Tamil Nadu. The Bank of Madura had an expertise
in catering to the needs of the small and medium sector and had a strong network
of SHGs. At the time of the merger the Bank of Madura had 1200 SHGs.
However, the program was not yet sustainable. To reach profitability I3I3I Bank
devised a three-tiered structure. The highest level was to be a project manager,
who would be an employee of the bank. Six coordinators would report to each
project manager and would in turn oversee the work of 6 promoters. The target for
promotion of groups was 20 groups within 12 months, upon which the promoter
would receive financial compensation from the Bank. The coordinator would
usually be an SHG member who would coordinate the activities of the promoters.

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The women who had finished a year of promoting the requisite 20 groups were
given the designation of Social Service 3onsultant. These would travel within a
radius of 15 kilometres, in order to promote as many groups within their area as
possible. Strict guidelines were set for selection of SHG members and SHGs
would focus on those who were illiterate and below the poverty line so that there
would be homogeneity in the socio economic background as well. The SHGs
followed the normal pattern of saving until they had internally collected an amount
of s 6000 in a bank account held in the group
s name, through a weekly payment
of a small amount by each member of the group. After this, the amount collected
would be lent internally at 24% p.a. This rate of interest was much less than was
available from the informal lenders, and the entire groups stood to gain as the
interest was churned back into the group.

I3I3I Bank achieved a high rate of growth, reaching 8000 SHGs in March 2003,
with its team of 20 project managers. Within three years of the merger with Bank
of Madura, I3I3I Bank had extended its reach to 12000 SHGs. However, the pace
of outreach was still slow, and the Bank began to experiment with other models of
reaching the unreached. This was because existing branches could be leveraged for
outreach, but in areas where there were no I3I3I Bank branches, it would not be
viable to set up branches solely for the purpose of rural outreach, as such branches
would have a very long gestation period and would costly in terms of overheads.
ATMs were also costly proposition and the infrastructure required was not in place
in most of the remote areas.

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It was felt that in the case of the SHG formation, there was no risk sharing or
financial stake/ performance stake of the social intermediary (NGO) in the process
of group formation. Once the groups were formed and linked to Bank credit, there
was no more responsibility on the part of the NGO. The SHGs had been repaying
at very good rates, above 95%, yet there was a need to control the quality of group
formation and link it to credit discipline. I3I3I Bank also worked with Self Help
Promotion Institutions to outsource the work of group formation institutions whose
core competence was in social intermediation. In this case, the alignment of
incentives remained the same, as the bank staffs were replaced by an external
entity, who albeit with the best of intentions and competencies, would not be able
to vouch for the quality of groups created by it. Thus, despite having good increase
in outreach, the model failed to scale up further.

 
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I3I3I Bank began to experiment with the micro finance institution (MFI) as a
substitute for the more granular Self Help Group. The MFIs were willing to take
on the risk of the financial performance of the groups/ individuals that were being
lent to. Therefore the stake in good quality group formation was also built in. Also,
this channel was better for leveraging large amounts of funds without necessarily
having a grassroots level presence of the bank staff. The MFI would undertake the
processes and operationalization in terms of group formation, cash management,
disbursal and recovery, and also record keeping. The Bank would lend to the MFI
on the basis of its balance sheet and portfolio performance and the MFI would
repay the bank.

The MFI-Bank linkage model paved the way for taking a wider range of services
to the financially underserved populace. These financial services include provision
of micro insurance tailored to the cash flows and insurance needs of the low-
income clients. The micro insurance ensured the end client a support in case of
accidents/ disablement as well as loan insurance in case of death. This was a
significant step towards reducing household vulnerabilities.
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The intermediation model at first looked scalable, but there seemed to be

constraints in this model as well. For instance there was a double charge on capital
created, once at the level of the Bank lending to the MFI and secondly at the level
of the MFI on lending to the client. This seemed to be a sub optimal lending
structure due to the double counting that also, because the small balance sheet size,
unduly affected the risk perceived about the MFI, even if it had very robust
systems and processes. Other key challenges to performance were that the MFIs
could not grow and scale as fast as their capabilities would permit, because of
severe capital constraints. Most MFIs had potential access to large debt funds, but
because of their small size balance sheet (which would represent the very limited
initial capital of the promoters); they were constrained to operate with limited debt
funding. In the complete absence of equity investors in the microfinance
institutions, there was hardly any scope for the MFI to scale up rapidly.

MFIs on the other hand, were exposed to the entire risk of lending to the end
clients, despite their constrained risk appetite. Most MFIs were operating in a
single geography, and the systematic risk that they were exposed to was large. This
put undue risk bearing on these organisations, especially in the light of their
limited geographical risk diversification capabilities. Banks, which were lending
ostensibly to the end- clients, could not get access to any information regarding the
repayment capacity, or repayment behaviour of the end clients, as the MFI not only
acted as an operating and servicing agent, but also assumed the entire risk. If the
MFI collapsed due to any internal organisational issues as opposed to client
default, the entire client segment which had demonstrated credit-worthiness would
be deprived of a service provider. On the one hand were the competencies of the
Bank (which had a large amount of finances waiting to be channelled into the
sector) and on the other, the social intermediation expertise of the MFI (which had
a grassroots presence, customer outreach and contact, and could also achieve better
economies of scale if it scaled up and extended outreach faster). There was a need
to combine the strengths of both players, while also building in the correct
incentives and using capital parsimoniously to leverage the maximum value and
client outreach from it. Furthermore, there was a need for close supervision and
information tracking so that at no stage would rapid expansion lead to undetected
default due to slackness in monitoring. 3osts would have to be recovered to
ensure sustainability. The model would also have to incentivize growth and
preserve the incentives of the originator (of the portfolio) to maintain portfolio
performance.

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Both the SHG Bank ¦inkage model and the MFI-Intermediation model hit the
ceiling in terms of scale up. In the case of the SHG Bank ¦inkage model, there was
lack of incentive alignment and in the case of MFI Intermediation there was ³no
capital´ on the balance sheet of MFIs to lend on. Despite impressive results by
2004, the I3I3I decision-makers faced further challenges to scaling up their
outreach and service. New solutions were required. Should I3I3I modify their
existing models in some way? Is a new structure altogether required? What kind of
structure would be able to use capital parsimoniously and be scalable in the long
run? How could incentives for the originator of the portfolio (MFI) be structured?
How can I3I3I ensure that the new model be commercially viable and incentivize
growth?