The Microfinance Profile Growth In India Finance Essay - Free Essay Example

Microfinance has emerged as an important sector in many countries for providing financial services such as savings, credit, insurance and remittance services to the poor. Microfinance has become a global phenomenon. Governments, central banks, donors, practitioners, and other development agencies promoting microfinance are increasingly involved in the developing suitable policy initiative for meeting local needs. In India, a range of institutions in the public sector as well as the primary sector, offers microfinance services. These can be broadly categorized into two categories namely, formal institutions. The formal category comprises apex development financial institutions, commercial banks, regional rural banks, and cooperative banks that provide microfinance services in addition to their general banking activities and are referred as to as microfinance service providers. On the other hand, semi-formal institutions that undertake microfinance services as their main activity are generally referred to as microfinance institutions (MFI). While both private and public ownership are found in the case of formal financial institutions offering microfinance services, the MFI are mainly in the private sector. Microfinance service providers Microfinance service providers include apex institutions like National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), and Rashtriya Mahila Kosh (RMK). At the retail level, commercial banks, regional rural banks (RRBs) and cooperative banks provide microfinance services. Today, there are about , over 60000 retail credit outlets of the formal banking sector in the rural areas comprising 12000 branches of district level cooperative banks, over 14000 branches of the regional rural banks (RRBs) and over 30000 rural and semi-urban branches of commercial banks besides over 90000 cooperative credit societies at the village level. On an average, physical reaching out to the far -flung areas of the country to provide savings, credit and other banking services to rural society in general, is un-paralled achievement of the Indian banking system. However, discussion on microfinance through formal banking institutions are excluded attempt made to deal with various aspects relating to emergence of the private microfinance industry in the context of prevailing legal and regulatory environment for private sector rural and microfinance operators. Emergence of Private Microfinance Industry The microfinance initiative in the private sector can be traced to the initiative undertaken by Ela Bhatt for providing banking services to the poor women employed in the unorganized sector in Ahmedabad, Gujarat. Shri Mahila SEWA (Self Employed Womens Association) Sahakari Bank was set up in 1974 by registering it as an urban cooperative bank. Since then, the bank has been providing banking services to poor self-employed women working as hawkers, vendors, domestic servants, and so on. In the midst of the apparent inadequacies of the formal financial system to cater to the financial needs of the rural poor, NABARD sponsored an action research project in 1987 through an NGO called MYRADA. For this purpose a grant of Rs 1 million was provided to MYRADA for an RD programme relates to credit groups. Encouraged by the results of the field level experiment in group- based approach for lending to the poor, NABARD launched a pilot project in 1991-92 In partnership with non-governmenta l organization for promotion and grooming self help groups of homogeneous members and keeping savings with existing banks and within the existing legal framework. MFI AND LEGAL FORMS Legal form of MFI in India Types of MFI Estimated Number* Legal Acts under which Registered Not for Profit MFI a.) NGO MFI 400 to 500 Societies Registration Act, 1860 or similar Provincial Acts Indian Trust Act, 1882 b.) Non-profit Companies 10 Section 25 of the Companies Act, 1956 Mutual Benefit MFI Mutually Aided Cooperative Societies (MACS) and similarly set up institutions 318 Mutually Aided Cooperative Societies Act enacted by State Government For Profit MFI Non-Banking Financial Companies (NBFCs) 6 Indian Companies Act, 1956 Reserve Bank of India Act, 1934 NGO MFI: There are a large number of NGOs that have undertaken the task of financial intermediation. Majority of these NGOs are registered as Trust or Society. Many NGOs have also helped SHGs to organize themselves into federations and these federations are registered as Trusts or Societies. Many of these federations are performing non-financial and financial functions like social and capacity building activities, facilitate training of SHGs, undertake internal audit, promote new groups, and some of these federations are engaged in financial intermediation. The NGO MFI vary significantly in there size, philosophy and approach. Therefore these NGOs are structurally not the right type of institutions for undertaking financial intermediation activities, as the byelaws of these institutions are generally restrictive in allowing any commercial operations. These organiza tions by there charter are nonprofit organizations and as a result face several problems in borrowing funds from higher financial institutions. The NGO MFI, which are large in number, are still outside the purview of any financial regulation. Non-Profit Companies as MFI: (Non-Profit Section 25 NBFC-MFI) Many NGOs felt that combining financial intermediation with there core competency activity of social intermediation is not the right path. It was felt that a financial institution including a company set up for this purpose better does banking function. Further, if MFI are to demonstrate that banking with the poor is indeed profitable and sustainable, it has to function as a distinct institution so that cross subsidization can be avoided. On account of these factors, NGO MFI are of late setting up a separate Non-Profit Companies for there micro finance operations. MFI is prohibited form paying dividend to its member. Mutual Benefit MFI: Several State Governments therefore enact ed the Mutually Aided Co-operative Societies (MACS) Act for enabling promotion of self-reliant and vibrant co-operative Societies based on thrift and self-help. MACS enjoy the advantages of operational freedom and virtually no interference from government because of the provision in the Act that societies under the Act cannot accept share capital or loan from the State Government. Many of the SHG federations, promoted by NGOs and development agencies of the State Government, have been registered as MACS. Reserve Bank of India, even though they may be providing financial service to its members, does not regulate MACS. For Profit MFI: Non Banking Financial Companies (NBFC) are companies registered under Companies Act, 1956 and regulated by Reserve Bank of India. Earlier, NBFCs were not regulated by RBI but in 1997 it was made obligatory for NBFCs to apply to RBI for a certificate of registration and for this certificate NBFCs were to have minimum Net Owned Funds of Rs 25 lakhs and this amount has been gradually increased. RBI introduced a new regulatory framework for those NBFCs who want to accept public deposits. All the NBFCs accepting public deposits are subjected to capital adequacy requirements and prudential norms. There are only a few MFI in the country that are registered as NBFCs CAPITAL REQUIREMENTS NGO-MFI, non-profit section 25 company mFI, and cooperative MFI are regulates by specific Act under which they are registered and not by the Reserve Bank of India. These are therefore not subjected to minimal capital requirements or prudential norms. These MFI desiring to become NBFCs are required to have a minimum entry capital requirement of Rs 2 Crore. As regards prudential norms, NBFCs are required to achieve capital adequacy of 12 per cent and maintain liquid assets of 15 per cent on public deposits. FOREIGN INVESTMENT Foreign investment by way if equity is permitted in NBFC-MFI subjected to a minimum investment of US$ 500,000. INTEREST RATES Interest rates are deregulated not only for private MFI but also for the formal banking sector. In the context of softening of the interest rate s in the formal banking sector, the comparatively higher interest rate (12 to 26 per cent per annum) charged by the MFI has become a contentious issue. The high interest rate collected by MFI from their poor clients is being perceived as exploitative. It is argued that raising interest rates too high could undermine the social and economic impact on poor clients. As most MFI have lower business volumes their transactions costs are far higher than those of formal banking channels, the high-cot structure of MFI could affect their sustainability in the long run. COLLATERAL REQUIREMENTS All legal forms of MFI can waive physical collateral requirements from their clients. The credit guideline of the RBI allow even banks to wave any type of collateral and margin requirement for loans up to Rs 50000. Current status 2009-2010 The Indian microfinance sector presents a strong growth story. Its growth performance was impressively sustained through the liquidity crunch and continued at an increased rate in the second half of 2009. As of March 2009, the MFI in India reported a client base of 22.6 million with an outstanding portfolio of more than $2 billion. Over the past five years, the sector has delivered a CAGR of 86% in the number of borrowers and 96% in portfolio outstanding. In the 12 months from March 2008 to March 2009, the microfinance industry experienced a 59% growth in its client base from 14.2 million to 22.6 million and 52% growth in its portfolio outstanding which increased from $1.5 billion to $2.3 billion.8 this reflects a 14% increase in the absolute growth in portfolio outstanding and 33% increase in the absolute growth in the number of borrowers from 2008 to 2009. Table 1.1 Past trend of loan to SHG. Year Ending March 31st 2004 2005 2006 2007 2008 2009 Outstanding Portfolio($ million) $80 $252 $496 $824 $1,535 $2,346 Growth Rate 215.00% 96.80% 66.10% 86.30% 52.80% Borrowers (million) 1 2.3 4.9 7.9 14.2 22.6 Growth Rate 130.00% 113.00% 61.20% 79.80% 59.20% Source: Microfinance India State of the Sector Report 2009 National Bank for Agriculture and Rural Development (NABARD) NABARD is the apex financial institution for agriculture and rural development. We examine the role of NABARD in microfinance later. But the linkage between banks and NABARD is worth a discussion. NABARD is expected to re-finance the rural portfolio of the banks and cooperatives. With the falling interest rates, banks do not find it attractive to borrow from NABARD. The other role that NABARD performs is to manage the Rural Infrastructure Development Fund (RIDF). In case the banks are unable to achieve the priority sector lending targets for agriculture, the banks are expected to deposit the shortfall with NABARD under the RIDF. This fund is used by NABARD to fund rural infrastructure projects. While the banks falling short of there targets have been depositing the amounts with NABARD, NABARD has not deployed these funds effectively. NABARD has disbursed only around Rs.13,000 crores out of the total corpus Rs. 23,000 crores available under various phases of RIDF. Therefore the amou nt that should have rightfully reached the rural economy has not reached them, either directly or indirectly. Policy Support Given the governments pledge to economic reforms with a human face, it is not surprising that the current finance minister is generally considered to be supportive of microfinance. The states commitment to combating poverty is hardly a new phenomenon. Over the last forty years, the Reserve Bank of India (RBI) has encouraged a significant expansion of bank branches in rural areas in order to extend credit services to disadvantaged groups, including small and marginal farmers, rural artisans, and other small borrowers. RBI has also required commercial banks to direct 40 percent of there lending to poorer members of society and to priority sectors such as agriculture. The governments 1982 Integrated Rural Development Program (IRDP) was one of the largest poverty alleviation programs to include a microfinance component. Today, national development banks play a crucial role in the growth of microfinance. Despite general support for microfinance, there appears to be a tension between promotion of the sector and client protection. RBI has thus forbidden MFI from taking public savings that would reduce there cost of capital. A similar tension exists at the state level as well, though some states are more active in microfinance than others. Andhra Pradeshs (AP) Mutually Aided Cooperative Societies Act, which is being replicated in other parts of the country, greatly simplifies the formation and supervision of groups that can access microfinance services on behalf of there members. APs populist mandate, however, sometimes serves to undermine credit, as is exemplified by the decision that farmers need not repay the principle on a loan for the first six months, unless they are borrowing from a bank. MARKET TRENDS As the Indian microfinance sector matures, c expects the year-on-year growth rate to decline to still high, but more sustainable levels. Over the next four years, Lok Capital projects the number of borrowers to grow at 34%, which is 60% less than the historical 5-year CAGR of 86% and the portfolio outstanding to grow at 40%, which is 58% less than the historical 5-year CAGR of 96%. Even with these cautious assumptions, Lok Capital expects MFI borrowers to increase from 22.6 million to 64 million and portfolio outstanding to increase from $2 billion to $8 billion by 2012. With maturity, MFIs will have to begin reassessing and re-engineering their growth strategies in a couple of years. They will have to take into account market opportunities and risks and adjust their geographical exposure, client base and product offering to remain competitive. Hints of market conditions that MFIs will have to navigate in the coming years are present even today, and MFIs are beginning to recognize these factors as they continue to grow. Below we explore the changing market dynamics in terms geographical spread of microfinance, client profile and product offerings and evaluate how MFIs might respond. Despite the rapid expansion of microfinance, large areas of India continue to be underserved. Lok Capital estimates that the penetration potential of the existing microfinance model is between approximately 43 million and 52 million households, out of which 22.6 million are existing customers. This implies an unaddressed demand of 20million to 29 million customers. Currently, as many as 54% of all microfinance clients are concentrated in the Southern States: Andhra Pradesh, Karnataka, Kerala and Tamil Nadu.15 Alternatively, there is an extremely limited microfinance presence in the North and North-east. MFIs are beginning to realize, however, that the South is becoming overly saturated and there is a commercial need to expand to newer geographies to ensure continued growth and mai ntain the quality of their portfolio. It has become imperative that MFIs diversify their operational base and limit overexposure to heavily serviced areas and clients. The Karnataka episode (detailed below) has demonstrated the urgent need to re-engineer expansion strategies to avoid over-lending to a cluster of clients and hedge against regional disturbances, economic, political and social. 54% of all microfinance clients are concentrated in the Southern States: Andhra Pradesh, Karnataka, Kerala and Tamil Nadu.15 Alternatively, there is an extremely limited microfinance presence in the North and North-east. MFIs are beginning to realize, however, that the South is becoming overly saturated and there is a commercial need to expand to newer geographies to ensure continued growth an maintain the quality of their portfolio. It has become imperative that MFIs diversify their operational base and limit overexposure to heavily serviced areas and clients. The Karnataka episode (detailed be low) has demonstrated the urgent need to re-engineer expansion strategies to avoid over-lending to a cluster of clients and hedge against regional disturbances, economic, political and social. CLIENT PROFILE We have begun to see greater microfinance activity in states such as Maharashtra and Madhya Pradesh, but MFIs are approaching the North and North-east with more caution and hesitancy because these areas present a very different type of client base compared to South or Central India. Nonetheless, the trend toward expanding in uncharted territories will continue, albeit slowly. In addition, MFIs are trying to start tapping different portions of the low income segment. Thus far, a very narrow band of the low-income population segment has been served through microfinance. There is an ultra-poor segment as well as a wealthier one which have drastically different needs and capacities from the segment currently being served. Small efforts are underway to explore these segments needs and capacities and evaluate what kind of products and services would allow them to be brought under the financial inclusion umbrella. For example, with help from Lok Foundation, Ujjivan is currently participat ing in a pilot program for the urban ultra poor which seeks to equip them with knowledge and skills that will allow them to eventually avail microfinance services. Moreover, the government has also of late turned its focus toward financial inclusion. This means that policy and regulatory attention on microfinance has increased with the government constituting two high-level committees to provide suggestions on how to improve the financial inclusion scenario in India. This new trend will provide impetus to devise strategies for more inclusive growth that makes commercial as well as social sense. PRODUCT OFFERING Thus far, microfinance institutions have largely limited their product and service offering even within the confines of financial inclusion. In fact, their product innovation has been limited to credit which is intended to serve a variety of needs as shown by the box below. The limited product innovation is understandable given the sectors primary focus has been on refining its business model and gaining scale to become financially sustainable. Despite following a single-product model, the sector has experienced remarkable growth. This growth can only be expected to continue as product innovation and diversified service offerings attract and retain greater number of customers with a variety of needs. The very same clients that the sector currently serves have a plethora of alternate needs for basic products and services, financial and non-financial which can affect sustainable, long-term achievements in their quality of life. Fortunately, recognizing this pent-up demand, mature MFI s are beginning to take concrete steps toward expanding their product basket, at least within the context of financial services. Along with credit, MFIs are heavily exploring the possibility of providing savings/deposit services, micro-insurance and remittance services. SAVINGS Access to a savings mechanism, like that which is available through commercial banks, is usually held by the microfinance industry to be the most urgent need to enhance the economic security of the poor. Due to RBI regulations, Non Banking Microfinance Company (NBFC) MFIs cannot currently accept interest-bearing deposits, unless they provide the service through a Section 25 Business Correspondent conduit. This structure prohibits the conduit from charging any fees to execute this function and limits its reach within a limited radius of the bank branch. MFIs are lobbying the RBI to relax these regulations to allow NBFCs to operate as business correspondents, charge an extra fee for the deposit-taking service and delimit the geographical reach of their operations. These changes would not only make deposits a viable commercial product, but also allow MFIs to offer it to a broader set of clients. INSURANCE While credit can serve to enhance a households income, insurance can serve to cushion the negative economic impact in the event of an emergency. Without insurance, a single incident can often impoverish a household, even with access to micro-credit, especially if the emergency affects the main earning members. A number of MFIs already offer micro-insurance products to their clients. The most basic products insure against health and accidental death. Companies such as Satin and BASIX usually tie the insurance products to their credit products, which makes the availability of credit contingent on the client availing insurance. The rationale behind packaging the loan and insurance together is that often clients do not understand the importance or benefit of insurance until they face an emergency. From a commercial viewpoint, the MFI is in effect insuring its loan against a crisis in the clients household, since insurance hedges against total financial collapse and thus ensures repayme nt of the loan, albeit in a delayed fashion. Similar to customers, BASIX also links livestock loans to livestock insurance for a similar reason it cushions the financial blow and increases the likelihood of a successful loan recovery. We can expect the number of insurance products available to increase as MFIs expand beyond their core credit product and clients become more aware of the benefits of insurance. REMITTANCE Domestic labor migration has a long history in India and is on the rise given disparities in growth across states migrants need a fast, low-cost, convenient, safe and widely accessible money transfer service. In India, remittance services can be enabled by the provision of savings and thus need to be provided in tie ups with banks and post offices. In some cases, MFIs provide remittance services by establishing their presence in a migrant destination to channel remittances back to the community in the migrants area of origin or by establishing a tie-up with another MFI, bank or money transfer company in the area of origin. Going forward, the role of technology will become more important in facilitating the development of alternative channels and payment mechanisms. NON-FINANCIAL PRODUCTS Within product offerings, MFIs are considering expanding their activities beyond the realm of financial services since this can provide synergies linked to future expansion. Microfinance clients have myriads of unmet needs such as healthcare and education as well as livelihood requirements which can enhance their income, employment potential or quality of life. Given MFIs existing relationships with this population segment, they would be an ideal channel to provide these services. While MFIs may not want to delve into product lines that are fundamentally different from their core business, they could easily act as conduits to allow other agents to deliver these services to their customers. The microfinance industry as a whole is now experimenting with a wide variety of potential models that could be used to deliver non-financial services. For example, BASIX offers a host of alternative services to its clients. Beyond the basket of credit and other financial products and services, B ASIX also provides low income customers with livelihood services, including agricultural and business development consulting services, to help microfinance clients use their loans more effectively. BASIX offers these alternative services to its clients through different entities housed under one umbrella. These groups have tremendous synergy and contribute to each others growth and prosperity. The credit business enables customer acquisition, while the insurance business mitigates risk, and agricultural and business development service enables customer retention. The consulting and IT business enhances BASIXs revenues, while the social businesses enable research and development which contribute to BASIXs strategy development. In addition to livelihood services, several MFIs are examining the feasibility of providing critical basic services to deliver low cost healthcare, education and vocational training. For example, Spandana is currently developing a comprehensive low cost heal thcare delivery model focused on the healthcare needs of women and children. BASIX has launched a vocational training academy to impart education in rural development and management to potential job seekers from low income communities. These participants would be deployed in the rural/semi urban areas with BASIX or other organizations offering financial services to the poor. In addition to being important avenues for productive utilization of credit by MFI clients, these types of services have a strong potential.