microfinance

MICROFINANCE

EXECUTIVE SUMMARY

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INTRODUCTION TO MICROFINANCE
Microfinance is a general term to describe financial services to low-income individuals or to those who do not have access to typical banking services. Microfinance is also the idea that low-income individuals are capable of lifting themselves out of poverty if given access to financial services. While some studies indicate that microfinance can play a role in the battle against poverty, it is also recognized that is not always the appropriate method, and that it should never be seen as the only tool for ending poverty. Microfinance is defined as any activity that includes the provision of financial services such as credit, savings, and insurance to low income individuals which fall just above the nationally defined poverty line, and poor individuals which fall below that poverty line, with the goal of creating social value. The creation of social value includes poverty alleviation and the broader impact of improving livelihood opportunities through the provision of capital for micro enterprise, and insurance and savings for risk mitigation and consumption smoothing. A large variety of actors provide microfinance in India, using a range of microfinance delivery methods. Since the ICICI Bank in India, various actors have endeavored to provide access to financial services to the poor in creative ways. Governments also have piloted national programs, NGOs have undertaken the activity of raising donor funds for on-lending, and some banks have partnered with public organizations or made small inroads themselves in providing such services. This has resulted in a rather broad definition of microfinance as any activity that targets poor and low-income individuals for the provision of financial services. The range of activities undertaken in microfinance include group lending, individual lending, the provision of savings and insurance, capacity building, and agricultural business development services. Whatever the form of activity however, the overarching goal that unifies all actors in the provision of microfinance is the creation of social value. ?Microfinance refers to small scale financial services for both credits and deposits- that are provided to people who farm or fish or herd; operate small or micro enterprise where goods are produced, recycled, repaired, or traded; provide services; work for wages or commissions; gain income from renting out small amounts of land, vehicles, draft animals, or machinery and tools; and to other individuals and local groups in developing countries in both rural and urban areas‘. Marguerite S. Robinson.
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STUDY OF MICRO FINANCE
1. HISTORY OF MICROFINANCE
Although neither of the terms microcredit or microfinance were used in the academic literature nor by development aid practitioners before the 1980s or 1990s, respectively, the concept of providing financial services to low income people is much older. While the emergence of informal financial institutions in Nigeria dates back to the 15th century, they were first established in Europe during the 18th century as a response to the enormous increase in poverty since the end of the extended European wars (1618 – 1648). In 1720 the first loan fund targeting poor people was founded in Ireland by the author Jonathan Swift. After a special law was passed in 1823, which allowed charity institutions to become formal financial intermediaries a loan fund board was established in 1836 and a big boom was initiated. Their outreach peaked just before the government introduced a cap on interest rates in 1843. At this time, they provided financial services to almost 20% of Irish households. The credit cooperatives created in Germany in 1847 by Friedrich Wilhelm Raiffeisen served 1.4 million people by 1910. He stated that the main objectives of these cooperatives ?should be to control the use made of money for economic improvements, and to improve the moral and physical values of people and also, their will to act by themselves.? In the 1880s the British controlled government of Madras in South India, tried to use the German experience to address poverty which resulted in more than nine million poor Indians belonging to credit cooperatives by 1946. During this same time the Dutch colonial administrators constructed a cooperative rural banking system in Indonesia based on the Raiffeisen model which eventually became Bank Rakyat Indonesia (BRI), now known as the largest MFI in the world. Microfinance Today In the 1970s a paradigm shift started to take place. The failure of subsidized government or donor driven institutions to meet the demand for financial services in developing countries let to several new approaches. Some of the most prominent ones are presented below. Bank Dagan Bali (BDB) was established in September 1970 to serve low income people in Indonesia without any subsidies and is now ?well-known as the earliest bank to institute commercial microfinance?. While this is not true with regard to the achievements made in
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Europe during the 19th century, it still can be seen as a turning point with an ever increasing impact on the view of politicians and development aid practitioners throughout the world. In 1973 ACCION International, a United States of America (USA) based non governmental organization (NGO) disbursed its first loan in Brazil and in 1974 Professor Muhammad Yunus started what later became known as the Grameen Bank by lending a total of $27 to 42 people in Bangladesh. One year later the Self-Employed Women‘s Association started to provide loans of about $1.5 to poor women in India. Although the latter examples still were subsidized projects, they used a more business oriented approach and showed the world that poor people can be good credit risks with repayment rates exceeding 95%, even if the interest rate charged is higher than that of traditional banks. Another milestone was the transformation of BRI starting in 1984. Once a loss making institution channeling government subsidized credits to inhabitants of rural Indonesia it is now the largest MFI in the world, being profitable even during the Asian financial crisis of 1997 – 1998. In February 1997 more than 2,900 policymakers, microfinance practitioners and representatives of various educational institutions and donor agencies from 137 different countries gathered in Washington D.C. for the first Micro Credit Summit. This was the start of a nine year long campaign to reach 100 million of the world poorest households with credit for self employment by 2005. According to the Microcredit Summit Campaign Report 67,606,080 clients have been reached through 2527 MFIs by the end of 2002, with 41,594,778 of them being amongst the poorest before they took their first loan. Since the campaign started the average annual growth rate in reaching clients has been almost 40 percent. If it has continued at that speed more than 100 million people will have access to microcredit by now and by the end of 2005 the goal of the microcredit summit campaign would be reached. As the president of the World Bank James Wolfensohn has pointed out, providing financial services to 100 million of the poorest households means helping as many as 500 – 600 million poor people.

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2. MEANING OF MICROFINANCE
According to International Labor Organization (ILO), ?Microfinance is an economic development approach that involves providing financial services through institutions to low income clients?. In India, Microfinance has been defined by ?The National Microfinance Taskforce, 1999? as ?provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban or urban areas for enabling them to raise their income levels and improve living standards?. "The poor stay poor, not because they are lazy but because they have no access to capital. "Microfinance is the supply of loans, savings, and other basic financial services to the poor." As these financial services usually involve small amounts of money - small loans, small savings, etc. - the term "microfinance" helps to differentiate these services from those which formal banks provide It's easy to imagine poor people don't need financial services, but when you think about it they are using these services already, although they might look a little different. "Poor people save all the time, although mostly in informal ways. They invest in assets such as gold, jewelry, domestic animals, building materials, and things that can be easily exchanged for cash. They may set aside corn from their harvest to sell at a later date. They bury cash in the garden or stash it under the mattress. They participate in informal savings groups where everyone contributes a small amount of cash each day, week, or month, and is successively awarded the pot on a rotating basis. Some of these groups allow members to borrow from the pot as well. The poor also give their money to neighbors to hold or pay local cash collectors to keep it safe. "However widely used, informal savings mechanisms have serious limitations. It is not possible, for example, to cut a leg off a goat when the family suddenly needs a small amount of cash. Inkind savings are subject to fluctuations in commodity prices, destruction by insects, fire, thieves, or illness (in the case of livestock). Informal rotating savings groups tend to be small and rotate limited amounts of money. Moreover, these groups often require rigid amounts of money at set intervals and do not react to changes in their members' ability to save. Perhaps most importantly, the poor are more likely to lose their money through fraud or mismanagement in informal savings arrangements than are depositors in formal financial institutions.
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?Poor rarely access services through the formal financial sector. They address their need for financial services through a variety of financial relationships, mostly informal."

3. ROLE OF MICROFINANCE
The micro credit of microfinance prename was first initiated in the year 1976 in Bangladesh with promise of providing credit to the poor without collateral , alleviating poverty and unleashing human creativity and endeavor of the poor people. Microfinance impact studies have demonstrated that, ? ? ? ? Microfinance helps poor households meet basic needs and protects them against risks. The use of financial services by low-income households leads to improvements in household economic welfare and enterprise stability and growth. By supporting women‘s economic participation, microfinance empowers women, thereby promoting gender equity and improving household well being. The level of impact relates to the length of time clients have had access to financial services.

4. ACTIVITIES OF MICROFINANCE
? Micro credit:

It is a small amount of money loaned to a client by a bank or other institution. Micro credit can be offered, often without collateral, to an individual or through group lending.

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?

Micro savings:

These are deposit services that allow one to save small amounts of money for future use. Often without minimum balance requirements, these savings accounts allow households to save in order to meet unexpected expenses and plan for future expenses Micro insurance: It is a system by which people, businesses and other organizations make a payment to share risk. Access to insurance enables entrepreneurs to concentrate more on developing their businesses while mitigating other risks affecting property, health or the ability to work. ?

Remittances:

These are transfer of funds from people in one place to people in another, usually across borders to family and friends. Compared with other sources of capital that can fluctuate depending on the political or economic climate, remittances are a relatively steady source of funds. ?

Micro insurance:

It is a system by which people, businesses and other organizations make a payment to share risk. Access to insurance enables entrepreneurs to concentrate more on developing their businesses while mitigating other risks affecting property, health or the ability to work.

?

Product Design:

The starting point is: how do MFIs decide what product s to offer? The actual loan products need to be designed according to the demand of the target market. Besides the important question of what risks to cover, organizations also have to decide whether they want to bundle many different benefits into one basket policy, or whether it is more appropriate to keep the product simple. For marketing purposes, MFI‘s sometimes prefer the basket cover, since it can make the policies sound comprehensive, but is that the right approach for the low-income market? After picking products, one must also understand how they are priced. What assumptions do the organizations make with regard to operating costs, risk premiums, and reinsurance, and how did they come to those conclusions? Would their clients be willing to pay
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more for greater benefits? From price, the logical next set of questions involves efficiency. Indeed, given the relative high costs of delivering large volumes of small policies, maximizing efficiency is a critical strategy to ensuring that the products are affordable to the low-income market. One way is to make the products mandatory, which increases volumes, reduces transaction costs and minimizes adverse selection. What does an organization lose by offering mandatory insurance, and how does it overcome the disadvantages? MFI?s can combine a mandatory product with some voluntary features to make the service more us to mar-oriented while. Techniques of Product Design: To design a loan product to meet borrower needs it is important to understand the cash pattern of the borrowers. Cash pattern is important so far as they affect the debt capacity of the borrowers. Lenders must ensure that borrowers have sufficient cash inflow to cover loan payments when they are due efficiency depends less on the delivery model than on the simplicity of the product or product menu. Simple products work best because they are easier to administer and easier for clients to understand. Another efficiency strategy is to use technology to reduce paperwork, manual processing and errors. MFIs need to conduct a costing analysis to determine how much they need to earn in commission to cover their administrative expenses.

5. PRINCIPLES OF MICROFINANCE
? The poor need a variety of financial services, not just loans. Just like everyone else, poor people need a wide range of financial services that are convenient, flexible, and reasonably priced. Depending on their circumstances, poor people need not only credit, but also savings, cash transfers, and insurance. ?

Microfinance is a powerful instrument against poverty. Access to sustainable financial services enables the poor to increase incomes, build assets, and reduce their vulnerability
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to external shocks. Microfinance allows poor households to move from everyday survival to planning for the future, investing in better nutrition, improved living conditions, and children’s health and education.

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Microfinance means building financial systems that serve the poor. Poor people constitute the vast majority of the population in most developing countries. Yet, an overwhelming number of the poor continue to lack access to basic financial services. In many countries, microfinance continues to be seen as a marginal sector and primarily a development concern for donors, governments, and socially-responsible investors. In order to achieve its full potential of reaching a large number of the poor, microfinance should become an integral part of the financial sector.

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Financial sustainability is necessary to reach significant numbers of poor people. Most poor people are not able to access financial services because of the lack of strong retail financial intermediaries. Building financially sustainable institutions is not an end in itself. It is the only way to reach significant scale and impact far beyond what donor agencies can fund. Sustainability is the ability of a microfinance provider to cover all of its costs. It allows the continued operation of the microfinance provider and the ongoing provision of financial services to the poor. Achieving financial sustainability means reducing transaction costs, offering better products and services that meet client needs, and finding new ways to reach the unbanked poor.

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Microfinance is about building permanent local financial institutions. Building financial systems for the poor means building sound domestic financial intermediaries that can provide financial services to poor people on a permanent basis. Such institutions should be able to mobilize and recycle domestic savings, extend credit, and provide a range of services. Dependence on funding from donors and governments—including government9

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financed development banks—will gradually diminish as local financial institutions and private capital markets mature. ?

Microcredit is not always the answer. Microcredit is not appropriate for everyone or every situation. The destitute and hungry who have no income or means of repayment need other forms of support before they can make use of loans. In many cases, small grants, infrastructure improvements, employment and training programs, and other non-financial services may be more appropriate tools for poverty alleviation. Wherever possible, such non-financial services should be coupled with building savings.

?

Interest rate ceilings can damage poor people’s access to financial services. It costs much more to make many small loans than a few large loans. Unless microlenders can charge interest rates that are well above average bank loan rates, they cannot cover their costs, and their growth and sustainability will be limited by the scarce and uncertain supply of subsidized funding. When governments regulate interest rates, they usually set them at levels too low to permit sustainable microcredit. At the same time, microlenders should not pass on operational inefficiencies to clients in the form of prices (interest rates and other fees) that are far higher than they need to be.

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The government’s role is as an enabler, not as a direct provider of financial services. National governments play an important role in setting a supportive policy environment that stimulates the development of financial services while protecting poor people’s savings. The key things that a government can do for microfinance are to maintain macroeconomic stability, avoid interest-rate caps, and refrain from distorting the market with unsustainable subsidized, high-delinquency loan programs. Governments can also support financial services for the poor by improving the business environment for entrepreneurs, clamping down on corruption, and improving access to markets and infrastructure. In special situations, government funding for sound and independent microfinance institutions may be warranted when other funds are lacking.
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?

Donor subsidies should complement, not compete with private sector capital. Donors should use appropriate grant, loan, and equity instruments on a temporary basis to build the institutional capacity of financial providers, develop supporting infrastructure (like rating agencies, credit bureaus, audit capacity, etc.), and support experimental services and products. In some cases, longer-term donor subsidies may be required to reach sparsely populated and otherwise difficult-to-reach populations. To be effective, donor funding must seek to integrate financial services for the poor into local financial markets; apply specialist expertise to the design and implementation of projects; require that financial institutions and other partners meet minimum performance standards as a condition for continued support; and plan for exit from the outset.

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The lack of institutional and human capacity is the key constraint. Microfinance is a specialized field that combines banking with social goals, and capacity needs to be built at all levels, from financial institutions through the regulatory and supervisory bodies and information systems, to government development entities and donor agencies. Most investments in the sector, both public and private, should focus on this capacity building.

?

The importance of financial and outreach transparency. Accurate, standardized, and comparable information on the financial and social performance of financial institutions providing services to the poor is imperative. Bank supervisors and regulators, donors, investors, and more importantly, the poor who are clients of microfinance need this information to adequately assess risk and returns.

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6. FINANCIAL PRODUCT OF MICROFINANCE
? ? ? ? ? ? Insurance Plans This is basically risk coverage product. It works the way traditional insurance works. Pension Plans This includes retirement plans. Contributions are made by planholder and MFI for benefit of plan-holder. Trade Microcredit Provides working capital for poor entrepreneurs to keep their business. Group Micro Credit Provides loan to poor peoples in group for which group act as collateral. Emergency Micro Credit Provides instant cash flow to tackle with emergencies. Micro Mortgage Micro sector customers ranging from seasonal crop financing, purchasing shop inventory to buying of machinery and tools for business use have this kind of product available. ? ? ? Micro Leasing A product offered to lease out assets to clients. Micro Saving Time deposits ranging from 3 months to 1 year is offered on which return upto 13.25% is given. However this is not fixed rate Term Deposit MFI‘s also offer term deposits ranging from 3 months to 12 months with upfront profit or back load profits.

7. CLIENTS OF MICROFINANCE
Microfinance clients are often described according to their poverty level - vulnerable non-poor, upper poor, poor, very poor. This can obscure the fact that microfinance clients are a diverse group of people – and require diverse products. While women clients make up a majority of clients - and in some instances comprise 100 percent of an MFI‘s clientele, 33 percent of all microfinance clients are men . These clients operate small businesses, work on small farms, or work for themselves or others in a variety of businesses – fishing, carpentry, vegetable selling, small shops, transportation, and

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much more. Some of these microfinance clients are truly entrepreneurs – they enjoy creating and running their own businesses. Others become entrepreneurs by necessity when there are few jobs available in the formal sector. Recently, microfinance institutions have begun using poverty assessment tools to more accurately measure the number of their clients who are living on less than $1 a day. Serving the very poor and the destitute – those who lack shelter, income, or even sufficient food – is more challenging, and may require ongoing subsidy. Innovative schemes, such as the BRAC UltraPoor Program, have opened up pathways to economic activity and access to financial services for the extreme poor. CGAP has launched pilots in India, Pakistan and Haiti that are modeled on the successful BRAC program. The program targets destitute clients through a carefully sequenced combination of livelihoods grants and microfinance, with savings playing a critical role, so that clients ?graduate‘ out of poverty. Each pilot is accompanied by a rigorous impact study. Success in reaching poorer people with microfinance is determined by the mission of a microfinance institution, and its ability to translate that mission into effective products and services. With the industry‘s renewed focus on social performance – the term used within the microfinance industry to mean the effective translation of mission into action – we expect to see more clients overall, and very poor people in particular, served with appropriate, varied products from a variety of institutions.

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MICROFINANCE IN INDIA

There is a wide array of institutions and classifications that overlap in the India microfinance sector, making analysis difficult and identification of appropriate regulators confusing. Furthermore, the scope and reach of microfinance in India is hard to capture because direct bank lending is usually not included in microfinance analysis. Commercial banks in India are required to make a certain percentage of loans to designated "priority sectors." Microfinance is one of the priority sectors banks may choose from, and loans are made to institutions as well as individuals in order to fulfill the requirement. As of April 2011, microfinance loans must meet certain prudential requirements in order to qualify for priority sector status. The majority of microfinance is provided by commercial banks, regional rural banks (RRBs), self-help groups (SHGs) (with special linkage programs to banks), cooperative societies, and microfinance institutions (MFIs) that take a variety of forms, including NGOs (registered as societies, trusts or Section 25 companies) and non-bank financial companies (NBFCs). Banks and NBFCs are regulated by the Reserve Bank of India (RBI) with the National Bank for Agriculture and Rural Development (NABARD) supervising and inspecting RRBs; SHGs are regulated by NABARD; cooperative societies are regulated by the state-appointed Registrar of Cooperative Societies (RCS) and state government (with NABARD conducting supervision and inspections); and cooperative banks are regulated by RBI and RCS. Because not all register as NBFCs, most MFIs fall outside of the regulatory gambit though hundreds have joined umbrella self-regulatory organizations including Sa-Dhan and Micro Finance India Network (MFIN). Under pressure from RBI, MFIN has created a code of conduct in order to prevent over-lending to individual borrowers and plans to form ombudsmen offices to address grievances, while SaDhan is developing a code of conduct as well. NBFC MFIs have also come together to form Alpha Micro Finance Consultants P Ltd, in order to provide credit bureau services to MFIs in India. The widely-debated Micro Financial Sector (Development and Regulation) Bill was introduced in 2007, proposing important changes to the microfinance industry, but was never passed. In 2010, the Andhra Pradesh government issued the Microfinance Institutions Ordinance (later, the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act), which requires
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all MFIs to register as well as adhere to other rules set forth in the ordinance. In response, RBI formed the Malegam Sub-Committee to make recommendations on how RBI ought to regulate the microfinance industry. In response to the Malegam Committee report, RBI issued a May 2011 circular implementing some of the Malegam recommendations through prudential requirements for microfinance loans to qualify for priority sector status. RBI subsequently created a new category of NBFC-MFIs in December 2011 and issued directions aimed at addressing responsible pricing, transparency and over-indebtedness. Additionally, in late June 2011, a revised Micro Finance Institutions (Development and Regulation) Bill was introduced before Parliament, most notably proposing RBI as the sole microfinance regulator in the country.

1. THE NEED IN INDIA
? ? ? ? India is said to be the home of one third of the world‘s poor; official estimates range from 26 to 50 percent of the more than one billion population. About 87 percent of the poorest households do not have access to credit. The demand for microcredit has been estimated at up to $30 billion; the supply is less than $2.2 billion combined by all involved in the sector. Due to the sheer size of the population living in poverty, India is strategically significant in the global efforts to alleviate poverty and to achieve the Millennium Development Goal of halving the world‘s poverty by 2015. Microfinance has been present in India in one form or another since the 1970s and is now widely accepted as an effective poverty alleviation strategy. Over the last five years, the microfinance industry has achieved significant growth in part due to the participation of commercial banks. Despite this growth, the poverty situation in India continues to be challenging. ? Some principles that summarize a century and a half of development practice were encapsulated in 2004 by Consultative Group to Assist the Poor (CGAP) and endorsed by the Group of Eight at the G8 Summit on June 10, 2004: i. Poor people need not just loans but also savings, insurance and money transfer services.

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ii.

Microfinance must be useful to poor households: helping them raise income, build up assets and/or cushion themselves against external shocks. ?Microfinance can pay for itself.? Subsidies from donors and government are scarce and uncertain, and so to reach large numbers of poor people, microfinance must pay for itself.

iii.

iv. v.

Microfinance means building permanent local institutions. Microfinance also means integrating the financial needs of poor people into a country‘s mainstream financial system. ?The job of government is to enable financial services, not to provide them.? ?Donor funds should complement private capital, not compete with it.? ?The key bottleneck is the shortage of strong institutions and managers.? Donors should focus on capacity building.

vi. vii. viii.

ix.

Interest rate ceilings hurt poor people by preventing microfinance institutions from covering their costs, which chokes off the supply of credit. Microfinance institutions should measure and disclose their performance – both financially and socially.

x.

Microfinance can also be distinguished from charity. It is better to provide grants to families who are destitute, or so poor they are unlikely to be able to generate the cash flow required to repay a loan. This situation can occur for example, in a war zone or after a natural disaster.

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2. OPERATIONAL MODEL AND LEGAL FORM OF INDIAN MFIS

The different organisations in this field can be classified as "Mainstream" and "Alternative" Micro Finance Institutions (MFI). 1. Mainstream Micro Finance Institutions National Agricultural Bank for Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), Housing Development Finance Corporation (HDFC), Commercial Banks, Regional Rural Banks (RRBs), the Credit Co-operative Societies etc. are some of the mainstream financial institutions involved in extending micro finance. 2. Alternative Micro Finance Institutions These are the institutions, which have come up to fill the gap between the demand and supply for microfinance. The MFIs can broadly be classified as: a. NGOs mainly engaged in promoting self-help groups (SHGs) and their federations at a cluster level, and linking SHGs with banks, under the NABARD scheme. b. NGOs directly lending to borrowers, who are either organised into SHGs or into Grameen Bank style groups and centers. These NGOs borrow bulk funds from RMK, SIDBI, FWWB and various donors. c. MFIs which are specifically organised as cooperatives, such as the SEWA Bank and various Mutually Aided Cooperative Thrift and Credit Societies (MACTS) in AP. d. MFIs, which are organised as non-banking finance companies, such as BASIX, CFTS, Mirzapur, SKS Microfinance and SHARE Microfin Ltd.
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Some of the leading alternative microfinance institutions are SEWA Bank in Gujarat, which also runs federations of SHGs in nine districts; ASSEFA and its Sarva Jana Seva Kosh Ltd, the ASA in Tamil Nadu: SHARE, BASIX, CARE and MACTs in AP promoted among others by the Cooperative Development Foundation (CDF); MYRADA in Karnataka, which has promoted Sanghamitra, a company of its village savings and credit sanghas; PRADAN which has established a large number of SHGs and federated them under Damodar in Bihar, Sakhi Samiti in Rajasthan and the Kalanjiams in Tamil Nadu (the last now run by DHAN Foundation); ADITHI in Bihar has established Nari Nidhi, a federation of women‘s groups; PREM in Orissa has done the same through the Utkal Mahila Sanchay O Bikas; the Rashtriya Gramin Vikas Nidhi which runs credit and savings programs in Assam and Orissa, on the lines of the Grameen Bank, Bangladesh, as does SHARE in AP, ASA in Tamil Nadu and RDO in Manipur. MFIs in India have adopted different legal forms for carrying out MFI activity. Majority of the MFIs are registered as not-for-profit MFIs. As microfinance evolved as tool for alleviating poverty, many NGOs adopted this and started practicing along with other development activities. Thus majority of the institutions are working on not-for-profit model. MFIs have emerged broadly under following three categories –

1.

Not-for-Profit MFIs
? ? ?

Societies registered under Societies Registration Act, 1860 or similar State Acts Public Trusts registered under the Indian Trust Act, 1882 Non-profit Companies registered under Section 25 of the Companies Act, 1956

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2. Mutual Benefit MFIs
? ? ?

State credit cooperatives National credit cooperatives Mutually Aided Cooperative Societies (MACS)

3. For-Profit MFIs
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Non Banking Financial Companies (NBFCs) registered under the Companies Act, 1956

Though the commercial NBFCs, which operate on a commercial basis are under regulation of the Reserve Bank of India (RBI), the NBFCs which act as non-profit entities, are not under RBI regulation as they are under the Section 25 of the Companies Act, 1956.
Table - Details of MFIs in India

Types of MFIs 1. Not for Profit MFIs a.) NGO - MFIs b.) Non-profit Companies 2. Mutual Benefit MFIs a.) Mutually Aided Cooperative Societies (MACS) and similarly set up institutions 3. For Profit MFIs a.) Non-Banking Financial Companies (NBFCs)

Estimated Legal Acts under which Registered Number* 400 to 500 Societies Registration Act, 1860 or similar Provincial Acts Indian Trust Act, 1882 10 Section 25 of the Companies Act, 1956 200 to 250 Mutually Aided Cooperative Societies Act enacted by State Government

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Indian Companies Act, 1956 Reserve Bank of India Act, 1934

Total 700 - 800 *The estimated number includes only those MFIs, which are actually undertaking lending activity.

Source: NABARD

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Types of Organizations
? Trusts

The public charitable trust is a possible form of not-for-profit entity in India. Typically, public charitable trusts can be established for a number of purposes, including the relief of poverty, education, medical relief, provision of facilities for recreation, and any other object of general public utility. Indian public trusts are generally irrevocable. No national law (except the broad principles of the India Trusts Act 1882, which governs private trusts) governs public charitable trusts in India, although many states (particularly Maharashtra, Gujarat, Rajasthan, and Madhya Pradesh) have Public Trusts Acts. ?

Societies

Societies are membership organizations that may be registered for charitable purposes. Societies are usually managed by a governing council or a managing committee. Societies are governed by the Societies Registration Act 1860, which has been adapted by various states. Unlike trusts, societies may be dissolved. ?

Co-Operatives

Co-operatives have legal sanction to work as financial intermediaries. The activities of State Cooperatives are restricted in the State. Their activities are heavily controlled by the controlling authority, Registrar of the Cooperative Societies and the State Government. National Cooperatives need lesser Government Control than State Cooperatives for multi-state operations. Co-operatives are allowed to raise share, to mobilize deposits. No tax is charged on Cooperatives. They can get foreign debt but are not allowed to raise foreign equity.

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In the mid-1990s, there had been growing demand in a number of states for the creation of truly member-controlled cooperatives without share capital contribution from government and reduced government control in the administration of cooperatives. The New Generation Cooperative Act (for example, Mutually Aided Cooperative Societies Act, 1995 in Andhra Pradesh) has become landmark legislation. It has been used by other organizations and as well as by associations like SHGs, Grameen joint liability groups. According to this Act there is less government control on mutually aided co-operative Societies but they can be incorporated within a state only. Presently co-operative societies in nine states (Andhra Pradesh, Jharkhand, Bihar, Jammu & Kashmir, Madhya Pradesh, Chattishgarh, Orissa, Karnataka and Uttaranchal) are registered under this new Act. This Act reduces the role of the Registrar; gives greater flexibility in savings mobilization and fund utilisation and organizations. Source: Report on Microfinance in India## allows co-operative to set up subsidiary

Figure 1 - Membership of MFIs by legal form

?

Section 25 Companies

A section 25 company is a company with limited liability that may be formed for "promoting commerce, art, science, religion, charity or any other useful object," provided that no profits, if

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any or other income derived through promoting the company's objects may be distributed in any form to its members. ?

Non Banking Finance Companies (NBFCs)

NBFCs are those types of companies which are not banking companies but engaged in the business activities related to loan, finance, investment, leasing, hire-purchase and other fund based activities. These companies are required to comply with the provisions of RBI Act and the rules and directions thereof, in addition to the provisions of Companies Act, 1956. Some of the NBFCs can take public deposits with the permission of RBI. But they cannot accept demand deposits. Minimum net owned funds (NOF) should be 200 lakhs. They are allowed to collect foreign equity up to 51% of US$ 0.5 million; more than 51% to 75% of US$5 million and 100% of US$50 million. A NBFC is also exempted from RBI registration if it does not deliver credit of more than Rs.50000 for a business enterprise and Rs.25000 for meeting the cost to raise the level of income of a poor person. This NBFC is licensed under Section 25 of the Companies Act, 1956. It is not allowed to accept public deposits.

3. CHARACTERISTICS OF MICROFINANCE OPERATING MODELS
Microfinance initiatives are being implemented by institutions which represent diverse organizational forms such as Charitable Trusts and Societies, Cooperatives, Non Profit (Section 25) Companies, Non Banking Financial Companies (NBFCs) and Banks. The MFIs have been following diverse methodologies to provide effective financial services to their clients. Each methodology has evolved with time according to local practices, economic conditions and culture.

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The dominant model of microfinance delivery through this channel is again the SHG model, where MFIs lend directly to SHGs. Here are different operating model used by various MFIs in India – ?

Self Help groups

Self Help Groups (SHGs) form the basic constituent unit of the microfinance movement in India. An SHG is a group of a few individuals – usually poor and often women – who pool their savings into a fund from which they can borrow as and when necessary. Such a group is linked with a bank – a rural, co-operative or commercial bank– where they maintain a group account. Over time the bank begins to lend to the group as a unit, without collateral, relying on selfmonitoring and peer pressure within the group for repayment of these loans. An SHG consists of five to twenty persons, usually all from different families. Often a group like this is given a name. Each such group has a leader and a deputy leader, elected by the group members. The members decide among themselves the amount of deposit they have to make individually to the group account. The starting monthly individual deposit level is usually low – Rs. 10 or Rs. 20. For a group of size 10, this translates to Rs. 100 to 200 of group savings per month. On the basis of the resolutions adopted and signed by all members of the group, the manager of a local rural or commercial bank opens a savings bank account. The savings are collected by a certain date from individual members and deposited in the bank account.
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Micro Finance Institution Model

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The main advantage of Self-Help Groups lies in their joint liability and consequent ?peer monitoring? of member borrowers. In association with sponsoring NGOs, they serve to reduce the transaction and monitoring costs of small lending for the banks as well as reach credit to the absolute poor. It is therefore hardly a surprise that they have attracted considerable attention in the rural banking sector as well as from the government in recent years. Several alternative models of SHG-NGO-bank relationship have emerged in recent years. One such model is where the bank lends directly to the SHG and the latter further lends it to individual members. As a variant of this model, an NGO may provide training and guidance to the SHG still dealing directly with the bank. This has been the most popular model in the Indian context. Alternatively, the NGO itself may act as an intermediary between the bank and the
Self Help Group Bank Linkage Model

SHG, borrowing from the bank and lending it to (usually multiple) SHGs. Yet another model involves the bank lending directly to the individual borrower with the NGO and the SHG acquiring an advisory role. Here the NGO assists the bank in loan

monitoring and recovery.

SHG programmes usually have voluntary deposit schemes in which the members themselves determine the amount of the recurring savings deposit. Since disposition of this amount is determined by the group rather than by the individual saver, this often results in minimalist norms and leads to deposits that are far lower than the members' savings potential. Deposits form

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just 4.0% of the average SHG MFIs' portfolio, though this excludes the far larger amounts revolved internally by SHG members.

As of 2010, the total number of SHGs directly linked to banks stood at 69.53 lakh, with a savings amount of Rs 6,199 crore and loan outstanding of Rs 28,038 crore, according to the recently released „Status of Microfinance in India? report by NABARD.

?

Grameen model

This model was initially promoted by the Grameen Bank of Bangladesh. Grameen MFIs undertake individual lending but all borrowers are required to form into five member groups popularly known as joint liability groups (JLGs). The groups, in turn, get together with 6-9 other neighboring groups to form a centre. Each borrower‘s creditworthiness is determined by the overall creditworthiness of the group. Loans are given to individual members upon recommendation of group. This feature distinguishes it from the SHG model in which the loan is given to the group which onlends to members. Savings are a compulsory component of the loan repayment schedule but do not determine the magnitude or timing of the loan. The important MFIs following Grameen model are Share Microfinance Limited (registered as NBFC) in Andhra Pradesh and Cashpor (Section 25) in Uttar Pradesh.
Group Lending

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?

Mixed model

Some MFIs display the characteristics of both the Grameen model and the SHG model. A prominent MFI that follows a hybrid model with features of both Grameen and SHG is Spandana, which operates in the Guntur region of Andhra Pradesh – which has larger JLGs of around 10 members.

There are others MFIs that follow both the Grameen and the SHG model to cater to individual market segments, while a few organisations also follow individual banking methodologies, in addition to group based methods to provide financial services. An important example is Basix that uses diverse methodologies each suited to a particular market segment. Others such as the Indian Association of Savings and Credit (IASC), a section 25 company promoted by the Housing Development Financial Corporation (HDFC) gives individual as well as group loans.

?

Individual Banking model

This is the provision of financial services by MFIs to individual clients – though they may sometimes be organized into joint liability groups, cooperatives or even SHGs. MFIs organized as Cooperative banks such as Pushtikar Samiti – a cooperative bank operating in Jodhpur, Rajasthan follow the individual banking model. They lend to individual lenders directly.

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Membership of MFIs by Micro Finance Methodology

Average savings per month by model (INR) Source: Report on Microfinance in India, ##

A highly restrictive legal framework for deposit taking has severely constrained the offering of thrift services so client savings form just 8.1% of outstanding loan balances. As per figure given above, all the methodologies have low average savings per member except for the individual banking model. Each of the bars reflects the nature of the methodologies and the legal framework in which the organisations operate.

4. FUNDING SOURCES FOR MFIS
Lifecycle of sources of funding for the MFIs Typical sources of financing are linked with four representative stages of MFI evolution. Donor grants and soft loans comprise the majority of the funding in the formative stages (Start-up, Operational Self-sufficiency) of the organization. As the MFI matures to Financial Selfsufficiency, private debt capital becomes available. However, the debt structures are often laden

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with restrictive covenants and often must have guarantees attached. It is usually in the last stage of MFI evolution that they spot for traditional equity financing.

During the early stage when subsidized funding predominates, the lack of clear ownership can distort incentive structures and undermine sustainability of the enterprise. This creates a "moral hazard" problem. So when costless verification of agent activities is impossible, arrangements should be made to establish incentive packages for agents to eliminate the moral hazard and/or consume resources to monitor the activities of and to direct agents. Furthermore, note that in the case of the early stage MFI, it may be unrealistic to find a fully engaged principal in the agent/principal relationship. The typical donor is unlikely to monitor the activities of the MFI to the same extent as a commercial investor anticipating a financial return. So then, another advantage to introducing equity into the capital structure of the MFI would be to introduce more discipline into operational activities and manager behavior.

As the enterprise progresses through Stages II and III, commercial loans become increasingly relevant for mature Non Governmental Organizations (NGOs). Properly structured, these vehicles can become a continuous source of reliable funding. Furthermore, these commercial loans begin to provide appropriate incentives and discipline to MFIs with the use of restrictive covenants. Also, MFI managers will begin to learn that good governance and management performance are important prerequisites for ongoing access to the capital market. When the MFI reaches Stage III, it typically begins to realize some retained earnings and is in a position to access quasi-equity. Again, this financing vehicle is more analogous to a structured debt offering than a standard equity structure. Also, at Stage III, we observe MFIs beginning to make use of asset securitization and often becoming regulated financial institutions.

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A primary advantage of regulated financial institution status is that the MFI can usually access voluntary client savings, which can provide a considerable source of funding. Stage IV characterizes MFIs and financial institutions that are beginning to achieve a significant level of retained earnings. At this stage, the institution should be in position to attract socially responsible equity.

Type of microfinance investment vehicles Figure:Sources of funds for microfinance operations

1. Tapped in India
80% 70% 60% 50% 40% 30% 20% 10% 0%

Source: Sa-Dhan report, 2007

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1.a) Institutional Debt
The Indian micro-finance sector is attracting more commercial debt in place of grants. The SaDhan study 2007 confirms earlier findings (e.g. M-CRIL 2005) that institutional debt is a major source of funds for microfinance operations especially in the case of NBFCs. Bulk lending to MFIs take the form of both term loans and cash credit. Security accepted is usually the hypothecation of book debts, but where the MFI lacks a track record or the bank is the majority lender, personal guarantees or pledged deposits are also taken. Tenor (which can range from 3 months to 5 years, with scheduling depending on the MFI's cash flows), and pricing, are individually determined based on risk assessments. Lack of on-lending funds and operational funds are faced by most of the MFIs due to limited availability of funders and donors. This hinders the fulfillment of the need of the poor clients and growth of the MFIs as well. Institutional debt emerged as one of the important sources of funds, not only fulfilling the on-lending need of the MFIs but also building up capacities to reach more poor clients in a short span of time. Under the Indian central bank‘s financial inclusion programme, banks have started looking at the rural unbanked population. They see this as an opportunity to make profits as urban Indians are increasingly becoming overexposed to bank credit. Banks are also exploring various partnership models with microfinance institutions. Also many foreign investors are availing this option of lending to the MFIs in India via External Commercial Borrowings (ECBs). In 2005, The Reserve Bank of India (RBI) allowed non government organisations (NGOs) engaged in micro finance activities to raise external commercial borrowing (ECB) up to $5 million during a financial year. ECBs are permitted by the Govt. as an additional source of funds to Indian firms for expansion of their existing capacity as well as for fresh investment to augment the
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resources available domestically. A prospective borrower can access ECB under two routes, namely the automatic route and the approval route. Here in case of MFIs which is a financial intermediary; have to take the approval route where RBI allows on case-by-case. 1.b) Private Equity Private equities are equity securities of unlisted companies. Private equities are generally illiquid and thought of as a long-term investment. Private equity investments are not subject to the same high level of government regulation as stock offerings to the general public. Private equity is also far less liquid than publicly traded stock. Capitalisation of MFIs via Equity (paid in or subscribed) as a measure has still a long way to go with only 5.3% of the total funds being leveraged as equity as opposed to debt which contributes to 75% of the total MFI funds. Building upon the equity base of an MFI would not only make its balance sheet healthier but would also reduce dependence on external funds for its portfolio growth. In India,
Table 1 - Debt-Equity Ratio by Legal status

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SHARE is India's largest MFI with over 1 million clients and has plans to grow to 6 million over the next five years. When lending under ICICI Bank's partnership model was suspended at the beginning of the year until partners could fulfill KYC requirements SHARE found itself strapped not just for lending funds, but short of the equity capital with which to borrow them as term

Two landmark private equity investments in Indian MFIs took place in the first part of the year 2007; an $11.5 million investment in SKS, led by Sequoia Capital, at the end of March, followed soon after by a $25 million investment in SHARE, by Legatum Capital. Hyderabad-based SKS is the third largest MFI in India and is growing perhaps the most rapidly, hoping to end the current financial year with an outreach of about 1.5 million borrowers in 11 states. Sequoia was joined by Unitus equity fund, which already has 2 equity investment partners in India and 8 other "capacity building" partners through an associated foundation with offices in Bangalore, as well as by Vinod Khosla and other investors. This infusion of fresh equity enabled SKS to leverage Rs. 180 crore financial arrangement with Citibank India to finance its expansion plans. Under the deal, Citibank will purchase loans originated by SKS under a limited guarantee provided by US-based Grameen Foundation, which also has an office in India.

loans from the banks.

Legatum's investment gives it majority control of SHARE. It was

accompanied by a $2 million investment by Aavishkaar Goodwell Microfinance Development Company, an Indo-Dutch JV, which becomes the fifth social venture capital company to have a presence in India. The size of these investments is unusual even by Latin American standards. One came just before, and the other just after Banco Compartamos, a Mexican bank specializing in microfinance, that had started life as an NGO, made an initial public offering of 30 percent of its
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stocks on Wall Street, in April. The success of the Compartamos floatation, and the size of the SKS and SHARE private placements have generated considerable excitement world-wide. These were investments by mainstream commercial (as opposed to socially-motivated) investors, whose support would accelerate the mobilization of private capital for massive expansion of outreach. They were seen as heralding the beginning of large private placements in microfinance as "investors now have a clear line of sight towards an exit". 1.c) Quasi Equity The Transformation Loan (TL) product is envisaged as a quasi-equity type support to partner MFIs that are in the process of transforming themselves/their existing structure into a more formal and regulated set-up for exclusively handling micro finance operations in a focused manner. For an NBFC the net owned funds should be 200 lakhs, for this kind of funds, the MFI would need capital to expand its operations and that is where TL funds are very useful. SIDBI has been a major promoter of this. Being quasi-equity in nature, TL helps the MFIs not only in enhancing their equity base but also in leveraging loan funds and expanding their micro credit operations on a sustainable basis. The product has the feature of conversion into equity after a specified period of time subject to the MFI attaining certain structural, operational and financial benchmarks. This non-interest bearing support facilitates young but well performing MFIs to make long term institutional investments and acts as a constant incentive to transform themselves into formal and regulated entities. 1.d) Grants Microfinance has received significant attention from the donor community, based upon its potential as a powerful tool for poverty alleviation. As such, millions of dollars have been spent on promoting microfinance programs around the world. For most MFIs, the principal source of
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funding is from grants and highly subsidized loans, or so-called soft loans. Soft loans are typically obtained from multilateral banks, government aid agencies, foundations and apex organizations. Usually such grants and soft loans include conditions and requirements as to how the funds should be spent and are in limited dollar amounts.

The traditional approach to raising capital from donors and philanthropic sources often begins with a proposal that includes descriptive information in a narrative form. A typical proposal requesting funding from potential donors includes background information of the organization, its current or proposed products and services, a target clientele, expected social benefits and the amount of funding required. The expected returns to potential investors are usually described in terms of the number of poor people to be served and the impact on the lives of the poor.

In India, NABARD and SIDBI are major players providing grants to various MFIs, according to their needs. SFMC, a subsidiary of SIDBI provides need-based capacity building support in the form of grants be provided to the partner MFIs, in the initial years, to enable them to expand their operations, cover their managerial, administrative and operational costs and provide technical support besides helping them achieve self-sufficiency in due course. A large number of NGOs in the development – empowerment are receiving foreign fund by way of grants. At present, according to NABARD over Rs.40 billion every year flows into India to NGOs for a whole range of activities including micro finance. In a way, foreign donors have facilitated the entry of NGOs into micro finance operations through their grant assistance. 1.e) Other Liabilities Securitization - Indirect (Loan Portfolio - Sale: Alternative to PTCs)

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MFIs can pursue this option of selling loans to banks. More to the point, they can sell microfinance loans to those banks that have not met their priority sector lending requirement for a premium. Although the cost of a formal credit rating does not exist, the bank has to conduct due diligence, something which will at least implicitly need to be priced into the interest rate that the bank receives from the loans. Furthermore, an SPV does not need to be set up, so costs are mitigated.

Figure 2 – Unique Wholesale model of ICICI, India

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SHARE Microfin Limited (SHARE) Microfinance Securitization – India
ICICI paid USD 4.3 million for 25% of SHARE‘s (a leading, poverty-focused MFI based in Andhra Pradesh state) loan portfolio. Share‘s cost of funds was approximately 8.75%; below the 12 to 13% it has traditionally paid borrowing from commercial banks, including ICICI. This deal is particularly exciting in that it recognizes, and adapts for, microfinance as an asset class. Two unique aspects should be highlighted. First, the securitization is not ?asset backed?, as many securitizations in the housing, credit card, and car markets usually are; ICICI will not have recourse to the assets the poor purchased with the proceeds of the loans they originally received from SHARE. Instead, ICICI has cash collateral in the form of a ?first loss guarantee? equal to 8% of the securitization value, of which Grameen Foundation-USA provided $325,000. Second, SHARE will act as the servicer in the transaction, collecting repayments from the underlying borrowers. While the servicer role is often outsourced to third parties in securitizations, appointing SHARE in the role recognizes that lending to the poor is a niche market. ICICI undertook this transaction despite the lack of secondary markets for such paper. Part of the reason goes back to the lending targets the Reserve Bank of India imposes on private banks. ICICI could have placed SHARE‘s assets on its books to meet the requirement. Instead, ICICI sold the entire portfolio to another bank just prior to fiscal year end, likely because the other bank need to meet its priority sector lending requirements. ICICI sold the assets at a premium, netting over 400 basis points on approximately USD 4 million. From SHARE's perspective, this transaction was important not only because it resulted in an injection of a large amount of capital at lower cost. An asset securitization provides a unique ?capital sparing? opportunity. By moving these assets off-balance sheet, SHARE was able to raise new debt without having to increase its capital base. And going forward, future loans originated in the 26 branches from which SHARE sold its portfolio will be financed using the Strategic Partnership Model pioneered by ICICI and CASHPOR.

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Credit Guarantee A credit guarantee is a financial instrument that encourages financial institutions and, in particular, commercial banks to lend to micro-enterprises that have good prospects of success but are unable to provide sufficient collateral or do not have a suitable record of financial transactions to prove their creditworthiness. The guarantee functions as a promise by the guarantor to the lender that, in the event that the borrower defaults, the guarantor will repay the lender according to the guarantee promised. Guarantee entities, either public or private, seek to familiarize banks with the client and, in this process, induce banks to lend to clients that otherwise would not be eligible for bank credit. There are three types of guarantee models currently used:

1)

Individual guarantee model

Figure 3 - Individual Guarantee Model

Under this model, the borrower and the bank are directly linked. The guarantor and the bank establish a cooperative agreement on the degree of risk sharing. The guarantor issues a guarantee

agreement or standby letter of credit to the bank. The bank appraises the loan application and, if borrowers fulfill their lending criteria, approves the loan. The guarantee entity, either public or private, is paid a fee for the guarantee by the borrowers, although the bank may collect this fee and pay the guarantor.

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2) Portfolio guarantee model
This model reduces the guarantee entity‘s involvement with each

borrower. Although the individual model requires the approval of

guarantees for each loan, under the portfolio model, the guarantor
Figure 4 - Portfolio Guarantee Model

negotiates portfolio criteria with the

bank. If the program is for micro-enterprise borrowers, criteria might include a maximum loan size, number of employees, and other limitations that ensure the borrower is part of the targeted sector. Loans that meet the required criteria are automatically guaranteed and disbursed. 3. Intermediary or “wholesale” guarantee model This model has been adapted especially for the microenterprise sector. Under this model, micro-entrepreneurs are separated from the bank‘s normal risk/transaction costs, which are handled by a specialized lending

organization that acts as an intermediary between the bank and the borrower. The intermediary organization undertakes the
Figure 5 - Intermediary/Wholesale Guarantee Model

appraisal, approval, monitoring, and supervising roles. The bank guarantees the loan to the intermediary institution. A number of microfinance networks have been experimenting with this model e.g. ACCION International Women‘s World Banking.

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1.f) Clients Savings As most of the legal forms, except NBFCs and Co-operatives are not allowed to access public deposits, they do access savings from their own clients. Once microfinance institutions are engaged in deposit taking in order to mobilize household savings, they become financial intermediaries. Consequently, prudential financial regulations become necessary to ensure the solvency and financial soundness of the institution and to protect the depositors. However, excessive regulations that do not consider the nature of microfinance institution and their operation can hamper their viability. These MFIs can also arrangements with other financial institutions to provide savings facilities to tap small savings in a flexible manner.

1.g) Retained Surplus
For NGOs like trusts and societies where surplus cannot be distributed among the promoters, all this is again ploughed back in microfinance activity. Legal form like NBFCs might have the obligation to distribute a part of their surplus among the equity investors and the remaining could be used for expanding the operations. Choosing the right funding option There is of course no single optimal capital structure for an MFI; rather, decisions on funding structures for the individual optimal funding mix is in practice based on a variety of determinants. On the one hand, internal factors such as growth of loan portfolio and savings mobilization and external factors such as the regulatory framework, the availability of donors and commercial lenders and, lastly, the development and openness of the domestic financial system are very important factors.

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Figure 6 - Cost of funding source varies with Maturity

The costs and maturity of individual funding sources play a key role in determining the optimal funding mix. For MFIs, issuing equity is the most costly source of finance (except of grant equity and other donations) followed by subordinated and unsecured debt, while retail deposits are reported to be the cheapest funding source. For foreign funding, potential currency risks must also be considered. However, decisions on capital structure also need to consider the maturity of each instrument. While equity capital primarily serves as a long-term funding source, debt has rather a medium-term maturity while deposits have usually a short-term maturity.

Exploring Alternate Funding options Many microfinance institutions (MFIs) in India are facing the pressure of protecting their net margins. Declining access to grants and long-term subsidised funds are pushing up their borrowing costs. Besides, owing to their operating characteristics MFIs have higher operating costs than other retail finance segments. Together, the two factors are squeezing their net margins. As microfinance evolves and becomes more complex so does its funding sources. Traditional loans from banks/financial institutions and grants from donor agencies will not be sufficient to satiate growing needs of sector. Exploring alternative sources of fund has become imperative and absolutely necessary for the microfinance institutions to scale up their operations and to attract more investors, as they move

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towards a global approach. Many MFIs are attempting to move away from donor funding towards more traditional sources of capital financing used by corporations. Traditionally the funding structure of an MFI globally too has followed a certain pattern over its life cycle. While start-up MFIs are characterised by a larger dependency on donations usually made in the form of equity grants, donations and technical assistance, the more advanced MFIs tend to display a higher debt leverage through domestic or foreign borrowing; over time some even evolve into more formalized financial institutions (e.g. non-bank financial institutions) or even regulated MFIs such as niche banks. Especially the most advanced MFIs use domestic deposits (if their legal status permits their doing so) and debt financing as their core funding source. Apart from deposits, debt financing usually comprises both subsidised and commercial borrowing from a large variety of domestic and foreign sources that range from (international) development agencies and social investors to quasi-commercial and commercial lenders. Some MFIs even access capital markets by issuing bonds, going public or securitizing their loan portfolios. 1. Listing of MFIs/ IPO Initial Public Offering (IPO) would mean selling an equity stake of the institution to the general public which can be traded on the various stock markets where the security is listed. IPOs and equity investments will speed up the growing recognition of microfinance as an emerging asset class. With increased recognition and competition, the industry will mature, costs will be reduced and returns will converge with those of other investments in emerging markets. Ratings given to these institutions by national & international rating agencies will increase confidence among commercial investors, allowing for continued growth. This growth coupled with reduced costs will allow for increased total profits and more customers, in other words: fewer in developing countries will be left ?unbanked?. In India, most of the MFIs are in the form of NGOs like Trusts, Societies which have no equity component. Only the MFIs in the legal form of NBFCs and companies which have equity component can sell their stake in return of funds. Some of the international MFIs which got listed are given below –

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Compartamos, Mexico became the 1st Latin America MFI to offer equity through IPO and raised US$468million in April 2007. It sold 30% ownership of the bank. The existing investors received $450 million, valuing the entire institution at $1.4 billion. More than 80% of the offer was placed in New York, with the rest on Mexico's stock exchange. Financiera Independencia, Mexico is one fine example of an MFI established in July 1993 and operating in Mexico. It also raised funds through initial public offering in Nov, 2007 on Mexico Stock Exchange and raised USD 300mn from the market. Independencia sold up to 20% shares of the company through primary and secondary offerings in Mexico and international markets.

2. Securitization Securitization involves pooling assets together and turning them into a tradable security. In the case of loans it is pooling the receivables from a loan and then selling them to a third party. Generally, the assets are held in a bankruptcy remote vehicle termed as a Special Purpose Vehicle or are otherwise secured in a manner that gives the investors a first ranking right to those assets. Most securitization issues are rated by an accredited credit rating agency. The rating applies to the securities that are issued to investors and indicates the likelihood of payment of interest and payment of principal in full and on time. In a securitization transaction, the assets to be securitized are transferred by the asset owner (the originator or transferor) to a special purpose vehicle as the asset purchaser. The SPV may be a corporation, trust or other independent legal entity.

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3. Issuing Securities (PTCs)

BRAC, Bangladesh - The world‘s first micro credit securitization deal was closed by BRAC in September 2006. BRAC is one of the largest MFIs in the world with over five million borrowers, primarily women. This was the first time securitization was carried out by a MFI. Average loan size was approximately $162 and the rate of repayment 99.27%. This securitization deal had been structured by RSA Capital, Citigroup, FMO and KfW. The investors had agreed to provide an aggregate of Bangladesh Taka - BDT 12.6 billion (USD 180 M) for BRAC over a period of six years BRAC's micro-credit receivables are in Bangladeshi Taka (BDT). A local currency transaction cuts out any currency mismatch and associated exchange risk to the local client. BRAC will also replenish all non-performing loans in the trust and there is a 150 % collateralization of receivables.

These securities could be issued to public or private investors by the SPV and the securities will be backed by the income flows generated by the assets securitized and sometimes also by the underlying assets themselves (in our case the loans issued by the MFIs). The net proceeds received from the issuance of the securities are used to pay the transferor for the assets acquired by the SPV in a couple of years. Internationally there have been many financial firms which have raised funds by Securitization and have helped many MFIs.

4. Collateralized Debt Obligation (CDO) Structured finance can be defined as securitization combined with a tranching of the issued assetbacked securities. The tranching is done by the SPV and splits the cash flows from the underlying pool of assets into several separate classes of securities with different risk-return profiles. The securities are typically constructed to have different seniority in the sense that ?junior? tranches alone keep absorbing losses up to a certain point before the more ?senior? tranches start to suffer losses. The original risk of the underlying asset pool is in this way split up into low-risk and high-risk securities and the holders of the senior tranche securities are therefore protected from the first defaults in the underlying asset pool. The different tranches attract
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different investors and one can expect less informed investors to be particularly willing to buy the senior tranches as alternatives to other low-risk investments like treasury bonds, and more informed investors to buy the much more risky junior tranches. Three important consequence of the tranching process are – ? that the most senior tranches can have a higher creditworthiness than the average asset in the underlying pool, ? that all but the most junior tranche can be rated despite the pool being made up of unrated assets, and ? that by joining forces, a few well-informed, or just risk-tolerant, investors can attract large numbers of less informed, or more risk-averse, investors to invest in a pool of assets they would otherwise not invest in. A CDO is a particular kind of structured finance instrument where the underlying pool to be securitized typically contains a smaller number of assets (perhaps 50-150) than that of a traditional securitization product (which can be made up of thousands of assets). The assets are also typically more heterogeneous than in a traditional securitization deal. Thus, the default risks of the individual assets and default correlations between the various assets are critical to determining the loss distribution of the pool. Furthermore, while the assets in a classical securitization typically are fairly small ordinary loans such as car loans and credit card loans, the assets in a CDO are often more innovative. Examples of assets are investment-grade bonds, leveraged loans, asset-backed securities or credit default swaps, and there are even examples of CDOs where the underlying assets themselves are CDOs. Compared to traditional securitizations the fairly small heterogeneous pool of complex assets in a CDO often requires active management by a skilled CDO manager.

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Collateralized Debt Obligation - SPV structure

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BOMS 1 Issue Details

Blue Orchard Microfinance Securities – I This was the first Securitization of Cross-Border Loans to Microfinance Institutions. Blue Orchard Microfinance Securities in the largest transaction in the US capital markets to fund microfinance, in July 2004, Blue Orchard Securities I, a special purpose company, issued a US$40 million bond to support MFIs in nine developing countries. The sevenyear deal has four tranches, one senior and three subordinated; the senior note is secured by a $30 million guarantee from the Overseas Private 43 Citigroup Inc. JP Morgan Securities placed the notes and JP Morgan Chase is the paying agent. Details of each tranche appear below: Tranche 1 – US$30 million senior notes guaranteed by OPIC at US Treasury + .25-.5% Tranche 2 – US$3-4 million subordinated A notes at US Treasury + 1% Tranche 3 – US$3-4 million subordinated B notes at US Treasury + 2% Tranche 4 – US$3-3.5 million subordinated C notes at US Treasury + 4% Here were 66 total investors – 12 foundations, 15 MFI practitioners/investors, 11 Social. This transaction allowed 9 MFIs – 7 in Latin America, 1 in Cambodia and 1 in Russia – to tap the US capital markets for lower cost, longer term financing, ultimately providing approximately 40,000 new loans to micro-entrepreneurs.

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Blue Orchard Loans Development-1 (BOLD) The Blue Orchard successfully closed its latest Collateralized Loan Obligation (CLO), Blue Orchard Loans for Development 2006-1, or BOLD, on 20 April 2006. The total amount raised was USD 99.1 million, and loans disbursed to 21 MFIs, in 13 different countries, and 5 different currencies. Although the financial structure of a CLO is not particularly complex, the completion of a CLO is a daunting task. All parts and all parties must be in place such that on one single day, the closing date, a special purpose vehicle can issue bonds to pre-identified investors at pre-negotiated conditions and subsequently fund a portfolio of loans to a diversified group of microfinance institutions (MFI) at pre-negotiated conditions. Blue Orchard Loans Development-2 Blue Orchard announced an important innovation: its second loan basket Blue Orchard Loans for Development (BOLD-2). It is the first transaction for financial institutions in microfinance to obtain the rating of a large rating agency, Standard & Poor's. BOLD 2 was oversubscribed and closed at 110 million dollars, which will finance 20 microfinance institutions in 12 countries: Azerbaijan, Bosnia, Cambodia, Colombia, Georgia, Kenya, Mongolia, Montenegro, Nicaragua, Peru, Russia and Serbia. The funds will enable some 70,000 very low income people to develop their micro businesses. Launched in partnership with Morgan Stanley, BOLD 2 is a CDO (Collateralized Debt Obligation, or an obligation depending on a basket of loans). This operation is the second of this type, following a transaction (BOLD 1) effected last year, also with Morgan Stanley. Thanks to its know-how, Blue Orchard was the first company to persuade a major investment bank to participate in a joint launch of a significant CDO (with no rating at the time), in order to finance microcredit institutions. BOLD-2 finances non-guaranteed loans to a diversified portfolio of microfinance institutions. Part of the loans will be in local currencies, with exchange rate risks being covered by derivative products. The CDO includes several types of bonds. The senior bonds are: A (44 million dollars) and B (16 million dollars), their ratings are AA and BBB respectively. The subordinated tranches have no ratings.

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Deutsche Bank-- Germany Deutsche Bank, a global investment bank based in Germany, has launched “db Microfinance-Invest Nr. 1,” the world's first externally rated securitization of subordinated micro-credits. These subordinated loans will benefit 21 microfinance institutions (MFIs) in developing and emerging market countries. There are three tranches making up the transaction structure. The senior tranche is worth EUR 36 million (USD 50 million) has been subscribed to by the bank?s private clients such as high-net-worth individuals, foundations and church-affiliated institutions. It has been given a BBB rating by Fitch Ratings. This is an essential component for private client subscription, as many clients? investment guidelines would prohibit subscribing to an asset without a rating. The mezzanine tranche is worth of EUR 20 million (USD 28 million) and has been subscribed to by KfW Entwicklungs bank, a specialist bank for international development that is part of KfW Bankengruppe, which in turn is 80% owned by the German federal government. The junior tranche is worth EUR 4 million (USD 6 million) and has been taken up Deutsche Bank itself. The bank does not make public details about the rates of return. Investors have subscribed to tranches for periods of 7 to 7.5 years.

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11 Issuance of Bond Bond is a debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing. Although bonds are generally considered less risky than shares, there value can also change over time. At issuance the interest rate associated with a bond is dependent on the markets confidence in its ability to pay the loan back. Rating agencies such as CARE, CRISIL guide the market by rating the financial stability of organizations.

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Compartamos Bond Issue – Mexico In 2002, Compartamos – a regulated Mexican microfinance institution – issued a 100 million MXP (approximately US$10 million), 3-year, 13.1% coupon bond; this was the first tranche of a $15 million bond. The bond was rated mxA+ by local branch of S&P with no credit enhancement. The initial $10 million bond was privately placed by Grupo Financiero Banamex, a local Citibank affiliate, to institutional investors (20%) and individuals (80%). In the second tranche, institutional investors purchased 50%, while the remainder was taken up by individuals. Key financial covenants include: maintenance of debt to tangible net worth of no more than 5 to 1; maintenances of reserves greater than or equal to the larger of 2% of loans outstanding or 60% of past due loans (>30 days); current assets to total assets of no less than 5%; cash and cash equivalents, free of liens, no less than 3% of total assets; and maintain tangible net worth of at least US$4,000,000. As proof there is investor interest in such transactions, the Compartamos transaction was oversubscribed, even without any external support or guarantee. Following the success of its first bond, in 2004 Compartamos, again supported byBanamex and Acciones Valores de Mexico, issued the first MXN 190 million tranche (US$16.8 million) of a larger MXN 500 million (US$44 million) bond issue targeting local institutional investors. Mibanco – Peru Mibanco began as a non-govt. organization with strong social mission and then in May 1998 transformed into a regulated microfinance commercial bank. It issued bonds in 2002 worth $6 million with a 12% coupon rate for 2yrs with credit enhancement. In December 2002, as part of its $30 million bond program to raise funds from capital markets, Mibanco issued bonds for $6.0 million with a 50% guarantee from the United States Agency for International Development. Local pension funds bought 82% of the bonds.

Convertible Bonds A convertible bond is an issue giving the bondholder the right to exchange the bond for a specified amount of shares (equity) in the issuing company at some future date and under
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prescribed conditions. Convertible bonds are globally traded instruments. Convertible bonds provide the upside potential of stocks (the opportunity to participate in company earnings) with the downside protection of bonds (a fixed return and repayment of principal at maturity). As the price of the company stock increases, the convertible bond price also increases because the option to convert becomes more valuable. Almost all convertible bonds are callable. Even though they are a "hybrid" investment, convertibles (like all bonds) are sensitive to interest rate fluctuations. Local investors are being brought into microfinance through many types of instruments. In Colombia, Finamérica conducted a private offering in the first quarter of 2002 by issuing US$1.5 million in convertible bonds that will be swapped for shares when they mature in three years. The bonds were sold to Finamérica shareholders with the principal intention of expanding the company‘s capital. 12 Investments by fund of funds Funds of funds are those types of funds which invest in other funds who have invested in MFIs, so they can have indirect exposure in the MFI. MFIs can attract funds from fund of funds which invest in growth companies. Also exit options can be mutually decided by listing of the company in a particular time-frame. Internationally, there is The Gray Ghost Microfinance Fund, Inc, which is a $75-million, forprofit portfolio of investments aimed at connecting private social investors with microfinance opportunities worldwide. The Gray Ghost Fund is a fund of funds focused exclusively on investments in microfinance funds that supply start-up and expansion capital — both debt and equity— to microfinance institutions (MFIs) around the world. As a fund of funds, Gray Ghost aims to get dual benefits of microfinance investing as both a means of growing individual wealth and alleviating poverty. In 2003, The Gray Ghost Microfinance Fund, Inc. launched their first microfinance fund of funds. With initial committed capital of $50 million, the fund is the largest privately-owned microfinance fund in the world.

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13 Public Deposits Over the long-term, the main solution for raising the funds is to transform into a licensed and supervised financial institution, which can more easily access funding through savings account as well as from financial and capital markets. In India only regulated NBFCs with the consent of the RBI could access public deposits. But most of the MFIs in India are in the legal form of Trusts, Societies which can only provide thrift services. So in the long run these have to get transformed to NBFCs or companies which are allowed to access public deposits. Internationally, within the general category of deposits, savings accounts are becoming more important, though term loans still dominate. This is a positive development, which implies that the overall term structure of liabilities is changing for these institutions, as savings account are more liquid than either term deposits or bank financing. Most of the successful MFIs like Compartamos in Mexico, Mibanco in Peru, BancoSol in Bolivia, Grameen Bank in Bangladesh etc. use public deposits as a major source to lend to micro-entrepreneurs. 14 Enhancing non-fund based income MFIs need to diversify and bolster their revenue streams by earning a fee income. They could play the role of an intermediary to insurance companies and channelize insurance services to their clients. Some of them already trade in seeds, fertilizers and other such products. Such value-added services not only enhance the MFIs‘ franchise with their clients but also bolster their fee income. A higher fee income can be a perfect foil for any drop in fund-based revenues, as it would help an MFI to diversify its risks and sustain its operations over the long term.

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5.MICROFINANCE SOCIAL ASPECTS
Micro financing institutions significantly contributed to gender equality and women‘s empowerment as well as poor development and civil society strengthening. Contribution to women‘s ability to earn an income led to their economic empowerment, increased well being of women and their families and wider social and political empowerment. Microfinance programs targeting women became a major plank of poverty alleviation and gender strategies in the 1990s. Increasing evidence of the centrality of gender equality to poverty reduction and women‘s higher credit repayment rates led to a general consensus on the desirability of targeting women. Self Help Groups (SHGs): Self- help groups (SHGs) play today a major role in poverty alleviation in rural India. A growing number of poor people (mostly women) in various parts of India are members of SHGs and actively engage in savings and credit (S/C), as well as in other activities (income generation, natural resourcesmanagement, literacy, child care and nutrition, etc.). The S/C focus in the SHG is the most prominent element and offers a chance to create some control over capital, albeit in very small amounts. The SHG system has proven to be very relevant and effective in offering women the possibility to break gradually away from exploitation and isolation.

Savings services help poor people: Savings has been called the ?forgotten half of microfinance.? Most poor people now use informal mechanisms to save because they lack access to good formal deposit services,. They may tuck cash under the mattress; buy animals or jewelry that can be sold off later, or stockpile inventory or building materials. These savings methods tend to be risky—cash can be stolen, animals can get sick, and neighbors can run off. Often they are illiquid as well – one cannot sell just the cow‘s leg when one needs a small amount of cash. Poor people want secure, convenient deposit services that allow for small balances and easy access to funds. MFIs that offer good savings services usually attract far more savers than borrowers.

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Women?s indicators of empowerment through microfinance: ? ? ? ? ? ? ? Ability to save and access loans Opportunity to undertake an economic activity Mobility-Opportunity to visit nearby towns Awareness- local issues, MFI procedures, banking transactions Skills for income generation Decision making within the household Group mobilization in support of individual clients- action on.

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6. ISSUES RELATED TO MICROFINANCE IN INDIA
Problems faced by Borrowers 1. Coercion One of the most important moral issues being raised in relation to microfinance is that of coercion. After 54 people killed themselves in the state of Andhra Pradesh in October 2010, Indian authorities placed microfinance institutions (MFI) under a microscope, and drafted new rules the MFI companies must follow. The farmers were reportedly deep in debt to microfinance institutions (MFIs). "Microfinance institutions charge exorbitant interest rates. The poor are driven to take their own lives because of their burden of debt and the brutal methods used to call in the loans", the chief minister of Andhra Pradesh said.

2. Brutal and Aggressive Debt-Collection Tactics "The people calling in the loans are often not aware of the code of conduct of the MFIs”. Many of the MFIs have been resort to brutal methods for collection of debt from these borrowers. News items like the one below are quite common in India. Unable to repay Rs. 235, Farmer kills self MFI Loan Suicide, Hyderabad News A farmer committed suicide by consuming pesticides, allegedly after being harassed by the collection agents of a microfinance institution at in Nalgonda district, Andhra Pradesh.

3. Joint Microfinance Joint microloans are granted to a group of people who are jointly responsible for repaying the loan. Individual failures to pay (due to illness or a ?bad week?) are avoided and group pressure serves as a strong incentive in ensuring responsible behavior by making loans to individuals within a lending circle. The individuals meet regularly, ostensibly creating a self-help group. In reality, all the borrowers in the group are responsible for making the loan repayment if a member defaults, so peer pressure is a very strong factor."

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However, in case of default either due to business failures, unproductive expenditure or greed to consume more, all members are troubled. 4. High Interest Rates Many in the urban centres would commit suicide if the banks start charging us 24 per cent rate of interest. Even at 8.5 per cent rate of interest, those who have drawn housing loans, find it difficult to make monthly EMI payments. Imagine the stress and threat under which the poor in the rural areas are being made to borrow at 24 per cent rate of interest. Whatever the justification for charging 24 per cent rate of interest, how can human beings exploit a hungry stomach in the name of a successful business model?

5. Not aimed at lifting people out of poverty Micro finance serves not to lift people out of poverty but, assist those near or slightly above the poverty line. Money is given to those people who have a possibility of returning the principle amount. This leads to the fact that lending money to these people is feasible and sustainable, while lending to the poorest of the poor is not.

6. Poverty alleviation mission has now been reduced to a Money making tactic of MNCs Micro finance has now, become a weapon for multinational companies to sell their products, by collaborating with such institutions. This in turn, is destroying the spirit of micro credit. For instance: Recently a mobile phone manufacturer offered a micro financing scheme on a pilot basis in Andhra Pradesh and Karnataka, to sell their handset to the poorest. Under this project, the company was offering an easy payment scheme of Rs 100 per week over a period of time. Andhra Pradesh has promulgated an ordinance to check malpractices in microfinance institutions (MFIs). The state should not throw out the baby with the bathwater: it should check malpractices without checking MFI growth. Globally, MFIs have expanded at phenomenal rates largely because they lend without loan scrutiny to groups of women, and peer pressure of the group keeps defaults below 2% despite the absence of any collateral or legal procedures for loan recovery. MFIs are, in effect, benevolent moneylenders, charging interest rates of around 30% to cover high operational costs. They are a great improvement on moneylenders charging 60% and using force to seize assets. However, the AP media accuse some MFIs of using force too, and claim that some suicides have
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been caused by such coercion. Proving the connection is difficult: Persons commit suicide for several reasons, ranging from psychological to financial issues. The global suicide rate is 14 per lakh persons, it is even higher in rich countries like Finland and Japan which have no MFIs. No rules or regulations can end suicides. But rules should certainly be framed to stop forcible loan recovery. The top MFIs agree on the need to ensure there is no coercion, and have adopted a code of conduct on this. But while bad apples among MFIs must be dealt with firmly, care must be taken not to create new regulations that encourage corruption or crimp legitimate and desirable MFI lending. Proposals to prevent members of self-help groups from borrowing from MFIs are terribly wrong, and will penalise poor borrowers and hit financial inclusion. People should be free to borrow from all sources, and members of self help groups should not require a no-objection certificate before applying for an MFI loan — it will be one more avenue for corruption and harassment. The use of force is an issue that must not be mixed up with the separate question of how the RBI should regulate MFIs. MFIs have reached 20 million people in a few years, a success owing something to light regulation that facilitated much innovation and experimentation. Some MFIs have become large institutions, and large ones need tougher regulation. But care should be taken to give MFIs, especially smaller ones, continued scope for innovation and experimentation.

Problems faced by Lenders 1. Sustainability The first challenge relates to sustainability. MFI model is comparatively costlier in terms of delivery of financial services. An analysis of 36 leading MFIs by Jindal & Sharma shows that 89% MFIs sample were subsidy dependent and only 9 were able to cover more than 80% of their costs. This is partly explained by the fact that while the cost of supervision of credit is high, the loan volumes and loan size is low. It has also been commented that MFIs pass on the higher cost of credit to their clients who are ?interest insensitive‘ for small loans but may not be so as loan

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sizes increase. It is, therefore, necessary for MFIs to develop strategies for increasing the range and volume of their financial services. 2. Lack of Capital The second area of concern for MFIs, which are on the growth path, is that they face a paucity of owned funds. This is a critical constraint in their being able to scale up. Many of the MFIs are socially oriented institutions and do not have adequate access to financial capital. As a result they have high debt equity ratios. Presently, there is no reliable mechanism in the country for meeting the equity requirements of MFIs. The IPO issue by Mexico based ?Compartamos‘ was not accepted by purists as they thought it defied the mission of an MFI. The IPO also brought forth the issue of valuation of an MFI 3. Financial service delivery Another challenge faced by MFIs is the inability to access supply chain. This challenge can be overcome by exploring synergies between microfinance institutions with expertise in credit delivery and community mobilization and businesses operating with production supply chains such as agriculture. The latter players who bring with them an understanding of similar client segments, ability to create microenterprise opportunities and willingness to nurture them, would be keen on directing microfinance to such opportunities. This enables MFIs to increase their client base at no additional costs. Those businesses that procure from rural India such as agriculture and dairy often identify finance as a constraint to value creation. Such businesses may find complementarities between an MFI‘s skills in management of credit processes and their own strengths in supply chain management. ITC Limited, with its strong supply chain logistics, rural presence and an innovative transaction platform, the e-choupal, has started exploring synergies with financial service providers including MFIs through pilots with vegetable vendors and farmers. Similarly, large FIs such as Spandana foresee a larger role for themselves in the rural economy ably supported by value creating partnerships with players such as Mahindra and Western Union Money Transfer. ITC has initiated a pilot project called ?pushcarts scheme‘ along with BASIX ( a microfinance organization in Hyderabad). Under this pilot, it works with twenty women head load vendors selling vegetables of around 10-15 kgs per day. BASIX extends working capital loan of Rs. 10,000/- , capacity building and business development support to women. ITC provides support
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through supply chain innovations by: ? ? Making the Choupal Fresh stores available to the vendors, this avoids the hassle of bargaining and unreliability at the traditional mandis (local vegetable markets). Continuously experimenting to increase efficiency, augmenting incomes and reducing energy usage across the value chain. For instance, it has forged a partnership with National Institute of Design (NID), a pioneer in the field of design education and research, to design user-friendly pushcarts that can reduce the physical burden. ? Taking lessons from the pharmaceutical and telecom sector to identify technologies that can save energy and ensure temperature control in push carts in order to maintain quality of the vegetables throughout the day. The model augments the incomes of the vendors from around Rs.30-40 per day to an average of Rs.150 per day. From an environmental point of view, push carts are much more energy efficient as opposed to fixed format retail outlets

7.SUCCESS FACTORS OF MICRO-FINANCE IN INDIA
Over the last ten years, successful experiences in providing finance to small entrepreneur and producers demonstrate that poor people, when given access to responsive and timely financial services at market rates, repay their loans and use the proceeds to increase their income and assets. This is not surprising since the only realistic alternative for them is to borrow from informal market at an interest much higher than market rates. Community banks, NGOs and grass root savings and credit groups around the world have shown that these microenterprise loans can be profitable for borrowers and for the lenders, making microfinance one of the most effective poverty reducing strategies. A. For NGOs 1. The field of development itself expands and shifts emphasis with the pull of ideas, and NGOs perhaps more readily adopt new ideas, especially if the resources required are small, entry and exit are easy, tasks are (perceived to be) simple and people‘s acceptance is high – all characteristics (real or presumed) of microfinance.
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2. Canvassing by various actors, including the National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), Friends of Women‘s World Banking (FWWB), Rashtriya Mahila Kosh (RMK), Council for Advancement of People‘s Action and Rural Technologies (CAPART), Rashtriya Gramin Vikas Nidhi (RGVN), various donor funded programmes especially by the International Fund for Agricultural Development (IFAD), United Nations Development Programme (UNDP), World Bank and Department for International Development, UK (DFID)], and lately commercial banks, has greatly added to the idea pull. Induced by the worldwide focus on microfinance, donor NGOs too have been funding microfinance projects. One might call it the supply push.

3. All kinds of things from khadi spinning to Nadep compost to balwadis do not produce such concrete results and sustained interest among beneficiaries as microfinance. Most NGO-led microfinance is with poor women, for whom access to small loans to meet dire emergencies is a valued outcome. Thus, quick and high ?customer satisfaction‘ is the USP that has attracted NGOs to this trade.

4. The idea appears simple to implement. The most common route followed by NGOs is promotion of SHGs. It is implicitly assumed that no ?technical skill‘ is involved. Besides, external resources are not needed as SHGs begin with their own savings. Those NGOs that have access to revolving funds from donors do not have to worry about financial performance any way. The chickens will eventually come home to roost but in the first flush, it seems all so easy. 5. For many NGOs the idea of ?organising‘ – forming a samuha – has inherent appeal. Groups connote empowerment and organising women is a double bonus.

6. Finally, to many NGOs, microfinance is a way to financial sustainability. Especially for the medium-to-large NGOs that are able to access bulk funds for on-lending, for example from SIDBI, the interest rate spread could be an attractive source of revenue than an uncertain, highly competitive and increasingly difficult-to-raise donor funding.

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B. For Financial Institutions and banks Microfinance has been attractive to the lending agencies because of demonstrated sustainability and of low costs of operation. Institutions like SIDBI and NABARD are hard nosed bankers and would not work with the idea if they did not see a long term engagement – which only comes out of sustainability (that is economic attractiveness). On the supply side, it is also true that it has all the trappings of a business enterprise, its output is tangible and it is easily understood by the mainstream. This also seems to sound nice to the government, which in the post liberalisation era is trying to explain the logic of every rupee spent. That is the reason why microfinance has attracted mainstream institutions like no other developmental project. Perhaps the most important factor that got banks involved is what one might call the policy push. Given that most of our banks are in the public sector, public policy does have some influence on what they will or will not do. In this case, policy was followed by diligent, if meandering, promotional work by NABARD. The policy change about a decade ago by RBI to allow banks to lend to SHGs was initially followed by a seven-page memo by NABARD to all bank chairmen, and later by sensitisation and training programmes for bank staff across the country. Several hundred such programmes were conducted by NGOs alone, each involving 15 to 20 bank staff, all paid for by NABARD. The policy push was sweetened by the NABARD refinance scheme that offers much more favourable terms (100% refinance, wider spread) than for other rural lending by banks. NABARD also did some system setting work and banks lately have been given targets. The canvassing, training, refinance and close follow up by NABARD has resulted in widespread bank involvement. Moreover, for banks the operating cost of microfinance is perhaps much less than for pure MFIs. The banks already have a vast network of branches. To the extent that an NGO has already promoted SHGs and the SHG portfolio is performing better than the rest of the rural (if not the entire) portfolio, microfinance via SHGs in the worst case would represent marginal addition to cost and would often reduce marginal cost through better capacity utilisation. In the process the bank also earns brownie points with policy makers and meets its priority sector targets. It does not take much analysis to figure out that the market for financial services for the 50-60 million poor households of India, coupled with about the same number who are technically above the poverty line but are severely under-served by the financial sector, is a very large one.
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Moreover, as in any emerging market, though the perceived risks are higher, the spreads are much greater. The traditional commercial markets of corporates, business, trade, and now even housing and consumer finance are being sought by all the banks, leading to price competition and wafer thin spreads. Further, bank-groups are motivated by a number of cross-selling opportunities in the market, for deposits, insurance, remittances and eventually mutual funds. Since the larger banks are offering all these services now through their group companies, it becomes imperative for them to expand their distribution channels as far and deep as possible, in the hope of capturing the entire financial services business of a household. Finally, both agri-input and processing companies such as EID Parry, fast-moving consumer goods (FMCG) companies such as Hindustan Levers, and consumer durable companies such as Philips have realised the potential of this big market and are actively using SHGs as entry points. Some amount of free-riding is taking place here by companies, for they are using channels which were built at a significant cost to NGOs, funding agencies and/or the government. On the whole, the economic attractiveness of microfinance as a business is getting established and this is a sure step towards mainstreaming. We know that mainstreaming is a mixed blessing, and one tends to exchange scale at the cost of objectives. So it needs to be watched carefully. A real life Examples : Lakshmi, a 22-year-old school dropout, lived in a remote village of Tamil Nadu. Instead of getting married and starting a family like any other village girl of her age in India, she wanted to set up on her own business. Lakshmi started an Internet kiosk in her village, offering services like e-mail, Internet chat and tips on health and education. The kiosk was partially financed by ICICI Bank and was set up in association with n-Logue Communications. Latha, a 29-year-old married woman with three children borrowed Rs.18,000 to set up a small provision store in Kothaipalli, a small village, in the north of Andhra Pradesh. Within a year, she started earning Rs.3500 a month from the store. With this money, she was able to provide her children a good education at a local private school. She was a part of a self help group in Andhra Pradesh which received financial assistance from ICICI Bank. These are real-life examples to illustrate how the micro-lending initiatives of ICICI Bank affected the lives of poor women in India. By becoming a part of self-help groups, several rural women were able to move out of poverty.
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Apart from financial benefits, the initiatives helped the women to develop self confidence, improve their communication skills and raise their position in society. By becoming a part of self-help groups, several rural women were able to move out of poverty. Apart from financial benefits, the initiatives helped the women to develop self confidence, improve their communication skills and raise their position in society.

8.TOP 50 MICROFINANCE INSTITUTIONS IN INDIA
The above report includes detailed profiles and ratings of India?s top Microfinance Institutions: CRISIL List: Top 50 Microfinance Institutions in India by Loan Amount Outstanding for 2010. 1. SKS Microfinance Ltd (SKSMPL). 2. Spandana Sphoorty Financial Ltd (SSFL). 3. Share Micro fin Limited (SML)4. Asmitha Micro fin Ltd (AML). 5. Shri Kshetra Dharmasthala Rural Development Project (SKDRDP). 6. Bhartiya Samruddhi Finance Limited (BSFL). 7. Bandhan Society. 8. Cashpor Micro Credit (CMC). 9. Grama Vidiyal Micro Finance Pvt Ltd (GVMFL). 10. Grameen FinancialServices Pvt Ltd (GFSPL). 11. Madura Micro Finance Ltd (MMFL). 12. BSS Microfinance Bangalore Pvt Ltd (BMPL). 13. Equitas Micro Finance India P Ltd (Equitas). 14. Bandhan Financial Services Pvt Ltd (BFSPL). 15. Sarvodaya Nano Finance Ltd (SNFL). 16. BWDA Finance Limited (BFL). 17. Ujjivan FinancialServices Pvt Ltd (UFSPL). 18. Future Financial Services Chittoor Ltd (FFSL). 19. ESAF Microfinance & Investments Pvt. Ltd (EMFIL). 20. S.M.I.L.E Microfinance Limited. 21. SWAWS Credit Corporation India Pvt Ltd (SCCI). 22. Sanghamithra Rural Financial Services (SRFS). 63

MICROFINANCE 23. Saadhana Micro fin. 24. Gram Utthan Kendrapara. 25. Rashtriya Seva Samithi (RASS). 26. Sahara Utsarga Welfare Society (SUWS). 27. Sonata Finance Pvt Ltd (Sonata). 28. Rashtriya Gramin Vikas Nidhi. 29. Arohan Financial Services Ltd (AFSL). 30. Janalakshmi Financial Services Pvt Ltd (JFSPL). 31. Annapurna Financial Services Pvt Ltd. 32. Hand in Hand (HiH). 33 Payakaraopeta Women‘s Mutually Aided Co-operative Thrift and Credit Society (PWMACTS) 34 Aadarsha Welfare Society(AWS) 35 Adhikar 36 Village Financial Services Pvt Ltd (VFSPL) 37 Sahara Uttarayan 38 RORES Micro Entrepreneur Development Trust(RMEDT) 39 Centre for Rural Social Action (CReSA) 40 Indur Intideepam Federation Ltd (IIMF). 41 Welfare Organization for MultipurposeMass Awareness Network (WOMAN) 42 Pragathi Mutually Aided Cooperative Credit and Marketing Federation Ltd(PMACS) 43 Indian Association for Savings and Credit(IASC) 44 Sewa Mutually Aided Cooperative Thrift Societies Federation Ltd (Sewa) 45 Initiatives for Development Bangalore, Foundation (IDF) 46 Gandhi Smaraka Grama Seva Kendram (GSGSK) 47 Swayamshree Micro Credit Services (SMCS) 48 ASOMI 49 Janodaya Trust 50 Community Development Centre (CDC)

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EXECUTIVE SUMMARY

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CASE STUDIES

1. Swadhaar – India Nearly two thirds of India‘s more than 1 billion people live in rural areas, and almost 170 million of them are poor. Although urbanization is on the rise, three out of four of India‘s poor live in the vast rural regions of the country. For more than 21 percent of the population, poverty is a chronic condition. A major cause of poverty among rural communities is a lack of access to productive assets and financial resources. High levels of illiteracy, inadequate health care, and extremely limited access to social services only aggravate the situation. Swadhaar is a new microfinance institution (MFI) which operates primarily in the urban slums of Mumbai – largely regarded as one of the most difficult areas to alleviate poverty. According to the 2001 Indian Census, 54.1% of Mumbai‘s residents live in Mumbai‘s slums, generally without even basic amenities such as running water or indoor plumbing. Until very recently, urban microfinance was thought to be impossible -- especially in Mumbai, regarded as one of the most complex markets due to its client base. The Solution Swadhaar is changing all of that. Headquartered in Mumbai, Swadhaar opened its doors for business in March 2006 and already serves 2,500 individuals. Swadhaar is a non-profit organization whose mission is to assist the poor in building their own capacity in breaking out of poverty through access to financial services. Swadhaar provides an average loan of $85 USD and enjoys high repayment rates. ?We formed Swadhaar to bring opportunity and hope to the hardworking poor people of Mumbai trapped in poverty. A strategic partnership with Unitus and microfinance expertise from ACCION will move us much closer to our goal of providing financial services to 195,000 clients by 2011,? says Urmee Mehta Mankar, Swadhaar. Historically, the urban poor have been chronically underserved by microfinance institutions in India – Swadhaar is hoping to change that. Swadhaar commenced operations in March 2006. By the end of 2011, Swadhaar has the visionary plan of reaching 195,000 clients with access to microfinance services. Unitus is excited to partner with Swadhaar as they enter into the field of microfinance. Even as a recent start-up,
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Swadhaar already boasts an impressive pilot project history, a strong management information system and the willingness to invest in the technology and professional expertise that will make their institution a success.

2. Institute of Integrated Research Management – India While economic growth in India has benefited a growing middle class in India, it has also created great disparities — disparities between urban and rural areas, prosperous and lagging States, and skilled and low-skilled workers. The Northeast states of India have sustained a particularly high rate of poverty during this period of economic growth. With 213 tribal communities, 175 languages, and many non-tribal communities, the region presents a unique cultural, ethnic, linguistic, and religious profile not to be found in any other region in India. Difficult terrain, political volatility, and vast cultural differences have made Northeast India particularly difficult to operate poverty alleviation efforts. Typically, small and marginal farmers, unable to access financial loans to grow their businesses, have been forced to purchase loans from local agents at outrageously high interest rates. Though formal lending institutions are available, they are not traditionally geared towards small-scale entrepreneurs. This predicament inspired Dhattateya Hosagrahar to establish the Institute of Integrated Resource Management (IIRM) in 2000 to provide the hard-to-reach communities of Northeast India with life-changing access to microfinance. The Solution To navigate the region‘s communities, IIRM took a traditional development approach of relationship building in each village to successfully launch microfinance. Today, IIRM is focused on providing socio-economic support to rural and urban poor communities, operating exclusively in India‘s Northeast region. IIRM currently serves nearly 8,000 clients with an average loan size of $80 USD. IIRM clients include farmers, tea plantation workers, and small-scale entrepreneurs. The organization offers a range of loan products for different client segments. Borrowers use tailored loan programs to expand their businesses and typically redirect extra income towards improved education, healthcare, and housing for their families. IIRM will be expanding throughout the Northeast over the next few years. Currently a nongovernmental organization (NGO), IIRM plans to evolve into a non-banking financial
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company (NBFC) by 2008 in order to increase its impact and reach. By 2010, the organization plans to grow to serve 157,000 clients.

3. Moksha Yug Access – India Karnataka is one of India‘s largest states, home to Bangalore, India‘s third most populous city. The dichotomy of urban slums and extreme rural communities illustrate the depth of poverty throughout Karnataka.

The Solution MokshaYug Access (MYA) is employing innovative business models and its experience in large scale infrastructure projects to expand the reach of microfinance throughout Karnataka. MYA aims to establish poverty-free villages by leveraging the financial resources and innovation of the private sector, the knowledge and commitment of non-governmental organizations, and the vast outreach of the public sector. Launched in 2006, MYA has expanded across Karnataka to reach the poorest communities and intends to reach 5.3 million rural poor by 2012. While MYA‘s mission is broad and looks to achieve poverty alleviation and access to financial services across India, the organization is currently focused on just three districts in Northern Karnataka. Through a laser sharp focus on a few distinct districts, MYA intends on successful expansion into new products and services to further support existing clients in Karnataka to empower them to improve their lives. MYA currently serves nearly 25,000 clients. It provides an array of services including savings, loans, and insurance services in rural areas of Karnataka. In addition to life and health insurance, MYA offers livestock and goat insurance to marginalized farmers, helping ensure they don‘t lose critical income should an animal become ill. MYA has also generated additional economic opportunity for local entrepreneurs, most recently working with India‘s leading incense maker to aggregate and supply raw materials at lower rates – increasing its clients‘ profits by 60 percent. Additionally, MYA is building a comprehensive supply chain model and will franchise it throughout India to provide rural households with additional products and services. Harsha Moily, CEO of MYA holds multiple degrees in Business and Management and has a background in agribusiness and venture capital. He is a young and dynamic entrepreneur who combines a discipline in business with experience in infrastructure sectors such as hydrocarbon, power,
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healthcare and telecom to provide solutions to poverty alleviation. Determined to make a difference in his home state of Northern Karnataka, Moily shifted his career from the world of international corporate finance to address economic development at home. He brings commercial experience and genuine enthusiasm to the fight against poverty in India.

4. Fondo de Inversion Social (FIS) – Argentina There are an estimated 3.5 million people living under the national poverty line in Buenos Aires.Only 2% of them have access to financial services. The economic crisis of the late 90?s left Argentina suffering the world?s largest debt default in history and massive currency devaluation. What had been a snowball of poverty and unemployment turned into an avalanche as more than half of Argentines fell below the official poverty line. The hardest struck were the middle class and urban poor, previously classified as middle-income. The Solution One of the first of its kind in Argentina, FIS was established in 1999 to provide financial services to the working middle class and urban poor. Founded and led by Julian Costabile, FIS‘s mission is to bring urgently needed microfinance to millions of Argentines lacking access to financial services. In contrast to Asian and African microfinance markets, there is still a significant need to educate Argentineans about the benefits of microfinance. The lack of a micro-entrepreneurial tradition in Argentina and widespread distrust in the financial system has been a barrier to its growth. However, it is FIS‘s belief that through microfinance, business and the pursuit of social benefit can be combined. Their goal, to empower poor micro-entrepreneurs to improve their own lives, has begun to gain traction. Today, FIS operates three branches throughout greater Buenos Aires, serving approximately 5,000 clients to date. It is currently the largest microfinance institution in Argentina, and has plans to expand its operations beyond Buenos Aires to the rest of the country. Beyond traditional microfinance, FIS also offers untraditional loan products that provide other means for financial security. For example, to relieve families from the monthly costs of lighting and electricity (i.e. in the rural region of Boquerón, monthly expenditures for candles, kerosene or gas is estimated at $20 USD a month), FIS provides clients loans to purchase solar panels.

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Once the loan has been repaid, families can then reallocate monthly expenditures for education, health, or other important services. FIS is also the administrator of a Social Investment Fund through which channels private and institutional investment funds to finance its loan portfolio. This was the first fund in Argentina to offers its investors both financial returns and social impact.

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CONCLUSION
Microfinance refers to a movement that envisions “a world in which many poor and nearpoor households, have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance and fund transfers.” The microfinance sector in India has developed a successful and sustainable business model which has been able to overcome challenges traditionally faced by the financial services sector in servicing the low income population by catering to its specific needs, capacities and leveraging pre-existing community support networks. The concept has grown over the past two decades. Over the years, major commercial banks and multinational corporations have decided to sponsor it. However, this type of financing has a darker side too. Most of studies are qualitative which tell that more than 90 per cent of the people who receive micro credit are poor and most of them succeed in businesses started with these loans. But the suicides committed by Indian farmers after being harassed by the microfinance institutions (MFIs) for their inability to repay the debt have raised serious moral and ethical issues against the institutions. The aggressive debt-collection tactics of these MFIs have left us wondering if the government has been playing ignorant to the modus operandi of MFIs. Moreover, the interest rates charged by micro financing institutions are usurious. Today, MFIs pay little attention to the core concerns of the poor. For them the critical concern is to sustain services against emerging odds. We‘ve seen a major mission drift in micro finance, from being a social agency first, to being primarily a lending agency that wants to maximise its profit. Thus, there is a great need to set out rules limiting interest rates and stipulating legal consequences for the MFIs who badger/ harass borrowers for payments.

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