REFORMS REQUIRED IN MFIs

Students Name: - Abhishek Anand Present Address: - A-133, Patel Nagar Phase-2, Ghaziabad UTTAR PRADESH-201001 E-mail Address: - anandabhishek1212@gmail.com Mobile No: 9958239924

Course Name: - BACHELOR OF BUSINESS ADMINISTRATION 5TH College Name: - INSTITUTE OF TECHNOLOGY & SCIENCE MOHAN NAGAR, GHAZIABAD

SEM

Cigma/abs/158

ABSTRACT

Microfinance Institutions are the financial services provided for the poor masses so as to eradicate the poverty and to attain inclusive growth. With lots of people from rural and urban sections still far from microfinance institutions, serious measures need to be taken. It has been observed that, MFIs are able to reach the poor effectively mainly because they have designed products and channels. However, mainstream finance institutions are not suitable for the need of the poor thus, MFIs has the opportunity to grow and remove poverty from economy. This paper will cover the major problem faced by the NABARD due to which the poverty has not declined considerably. There has been two models on which the MFIs work those are JLP (Joint Liability Group) and SHG (Self Help Group) of these MFIs, such as SKS Microfinance, Ujjivan, SEWA etc. are widely distributed to and have branches in five to six states but in order to meet all the 350 million poor people approximately present in India with a vision of eradicating poverty by 2020 more revolutions are needed in these sectors. Thus the paper mainly focuses on the eradication of poverty from the economy, to attain inclusive growth and to provide services in all those areas which are still left by MFIs through new and innovative measures.

FOUR KEY WORDS I II III MICRO CREDIT ERADICATION OF POVERTY SOCIAL ENTREPRENEURSHIP

IV

POTENTIAL MARKET

INTRODUCTION Microfinance Institution has been practiced over a long period we can say since centuries. But they were called out by different names as they also follow the concept of savings and group credit. These includes chit funds in India, tandas in Mexico, arisan in Indonesia, cheetu in Sri Lanka, tontines in west Africa & many more. In the past two decades the MFIs has risen considerably giving the major economic in the world to put a wide eye on it. With the increase in the numbers MFIs have shown that even by extending Rs.500 can help the poor in many ways. It helps in increasing the assets, child education, better health facilities etc. Although MFIs has been more or less successful in reaching wider areas of the rural in urban areas poor are still lagging behind. With the urban market contributing 62% of the GDP upliftment is necessary for the poor people of urban area constituting 280 million people. And this market is expected to over 600 million by 2030. If microfinance has to continue expanding outreach and impact on the nations poor, the ability for instructions to overcome current constraints to offering financial services to the urban poor must be examined and addressed. India being a large democratic with 5, 93,643 villages constituting 70% of its population. Their primary occupation is agriculture. MFIs are providing loans to farmers too, where the banks has not reached to strengthen the economy and eradicating poverty. However, in India small and low marginal farmer faces problem everyday because of the poor quality of seeds, less profit due to intermediaries which leads them to commit suicide. Then there was a concern raised by the government because of the methods involved by the MFIs during the recovery of loans. The microfinance is becoming more of a business rather than their mainstream work of providing loans and to work for the upliftment of poor. Credit was viewed as essential part of fight against poverty which led to following measures:i. ii. iii. iv. Expansion of the institutional structure. Directed lending to disadvantaged borrowers and sectors. Interest rates supported by subsidies. Institutional vehicles: - cooperatives, commercial banks and regional rural banks. i

Many reforms happened as a developmental process for microfinance. Some of them were:i. ii. iii. iv. Increasing the number of branches so that more poorers come under the umbrella. Stimulate additional flows to the sector. Relaxation was granted to the rural banks on whom they should lend. Then there was a process of restructuring and recapitalizing of microfinance which becomes to be a hit in rural areas1ii

i ii

Annie Duflo (center for microfinance research) 28th oct05 Pg no:-18 Annie Duflo (center for microfinance research) 28th oct,05

With the increase in the number of branches from 1833 in 1969, to around 32,538 at present. 49% of all scheduled commercial bank branches are rural. The proportion of borrowings of rural households has also considerably rising from 7% in the year 1961 to 60 per cent. Now more than 31 per cent of the total deposit accounts are in rural India. But with all these measures success was not as high as it was hoped. There were many reasons:I. II. III. IV. High default rates. Improper implementation of programmes. Lack in policy design. Commercial banks were not accepting that lending to the poor could be a viable activity. Many measures have been taken but despite all these efforts large gaps remain unchanged.

i. ii. iii. iv.

Against 741 million people 500 million people unserved. Population per branch is also very high touching 23k approx. Usage of savings account is as low as 18% The number of villages per branch is as high as 19.

There has been a huge gap in demand and supply as well. Demand:- Rs 450 billion per year Disbursed:- Rs 39 billion per year 500 million unserved poor.

MFI need to protect its customers against all risks involved. Although its branches are scaling up in South India with more than 60% of the branches there, other parts of the country remain unaffected. Another problem is a lack of debt and equity funds for MFIs to pass it on to the poor. Capital availability for microfinance is a big challenge and it is emerging as a bigger problem for both microfinance is a big challenge and it is emerging as a bigger problem for both microfinance sector and for loan taker. Media in Andhra Pradesh has reported that high interest rates and coercive loan collection by microfinance groups has led to some 30 suicides. Government has also kept a wide eye on it and gave a nod to all the MFIs that any unfair means of recovery shall be totally avoided. The high risk of micro entrepreneurship and small business entrepreneurship through the microfinance play a very crucial role in the economic development of their families and communities but certain obstacles such as poverty, unemployment, low household income, societal discriminations mostly in developing countries have hindered their performance of that role. As such most of them embark on entrepreneurial activities to support their families. It is discovered that entrepreneurship could be an effective strategy for poverty reduction in a country since entrepreneurs are the worst hit in such situation. It is however noted that discovered that women entrepreneurship have low business performed compared to their male counterparts and this is cause by factors which normally affect entrepreneurship performance. Such factors include lack of credit, savings, education or training and social capital. Dual mission of MFIs to be financially available as well as developed. There are very large numbers of institutions, both in the formal and non-formal sectors. The banks which provide microfinance along with their other usual banking services are also microfinance institutions. They are providing a variety of financial services using different delivery mechanisms. Besides, there are others who provide such services along with regular banking services to all types of customers. There is an adverse selection in terms of passing the loans to their clients. They are not aware of their client types i.e.; they need to have proper information about the repayment capacity of each and every client to reduce the default rates. One of the fastest growing sectors in India, microfinance market is dominated by SHG linkage. with many case studies suggests that progressive institutions have increasingly recognized microfinances business potential not only within the context of social responsibility and have taken steps to establish urban operations, yet the focus on social responsibility have taken steps to establish urban operations. Eventually, scalability and support from the public sector through a favorable legal and regulatory framework will become an issue if resources are going to be

made available for urban MFI to expand achieve significant outreach and volume to make their contributions to the development of the urban poor meaningful.

OBJECTIVES

Since Independence government in India is experimenting with a large number of grants and subsidies based on poverty alleviation programs. Statistics show that these programs have not been fully successful in meeting their economic objectives. A large number of small and marginal farmer, agriculture labour and women are excluded from wide range of financial services. Therefore the growth of all those development depends upon the microfinance global reach. 45.4 million Farmer households in the country of a total of 89.3 million household are deprived of credit either from institutional or non institutional sources. Objectives should be to facilitate all the micro services like the reduce the cost of loan taken. Major objectives of the MFIs are to accept deposits so as to promote savings. MFI must be able to capture the saving where money is earned because poor people are unable to frequently travel to deposit money at distinct branches. Because new infrastructure is costly, MFIs looking for leverage existing retail outlets. For this to be a great solution , secure technology platform is necessary, through transactions can be authorized and all the information can be accessed and provided by institutions through which transaction can be authorized and recorded in record span of time rather than approaching retail outlets individually. Postal services are not always reliable. Therefore payment facility should be made available to mobile operators as business correspondence. The argue that mobile networks operators are following common patterns for microfinance institutions working to expand financial access through the use of mobile phones. Microfinance could not lead to business performance without opportunity for entrepreneurial activity. Financial management theories believe that fund could only be sourced to finance a predetermined project, business or contract [Van horne, 1980].As such, micro finance could only lead to business performance. When there is the tendency to engage the new business or business expansion [antoncic 2006, Shan 2003].Limited studies are also available on attitude towards risk-taking moderating performance. Institutions provide assistance and stated that entrepreneur ability to discover and exploit opportunity for entrepreneurial activity differ between individuals and depends on individuals attitude towards risk-taking. Developing these tools institutions take initiatives so that an individual

can develop the entrepreneurial skills and identify the opportunity and can better invest through the help of risk-taking skills. As such, a risk averse individuals and depends individuals attitude towards risk-taking. A person may not search for or discover entrepreneurial opportunity he/she has negative attitude towards risk-taking. In the same vein, an individual may have an innovative business or services idea and great livelihood To access micro-finance but may not utilize the opportunity if he/she fears risk. The institutions liability removes this misleading behavior. Micro-finance provides the needed opportunity for entrepreneur to start or improve business in order to make profit and improve their lives. Opportunity for entrepreneurial activity in terms of new business expansion, acts as a link between micro finance factors and women entrepreneur performance. It is reported that micro-finance factors create opportunity for entrepreneur performance to generate income [bagma 2008].The discovery of business opportunity and decision to exploit the opportunities leads to search of external funds. Its objective also aims at identifying opportunity in the market, identified through innovations, creates the need for micro-finance factors which in turns creates opportunity for entrepreneurs profits. Social capital provides opportunity for women entrepreneur to network so as to access information and resources for business [Tata and Prasad 2008].Traditionally, when a person wants to start a business venture they go to a bank for a loan. But what should a budding entrepreneur do if he is too poor to obtain financing to start a profitable business? The answer always lies in a relatively new branch of financial services such as loans, savings and insurance to poor people. A microfinance institution simply offers such services to the poor, according to consulting group to assist to poor. It can be a credit union, commercial bank financial nongovernmental organizations, or credit union cooperative. Following is a list of the main purpose of microfinance.

There are many challenges and objectives for microfinance. i. ii. iii. It needs to work on what kind of programs to be run? Which programs can show the impact? And up to what extent it can be increased.

There is also a necessity of filling up gaps in practice of microfinance. There is also a major drawback in case of micro-credit and lack of financial capability. Thus, all the MFIs are

necessarily needs to research the links between access to financial services and participation of the poor in the larger economy. The MFIs also needs to find answer to many questions such as:i. ii. iii. iv. v. What drives savings and credit behavior? What is the reason for default? Why dont poor people/households go for profitable activity? How do households face shocks and risks? Do household saves if so then how?

MFI does also need to see what the impacts on policies are. Whether it affects repayment behavior of clients or not. Staff incentives, combination of different products and compulsory savings or insurance plays a pivotal role in affecting loans and repayment behavior. Many MFI members simultaneously borrow and save. The lack of saving services results in the decline of savings, riskier and often lowers yielding ways such as through purchase of ornaments. For the MFIs this lack of access to deposits implies that they tend to be highly leveraged. Savings should be promoted more and more by the MFIs. Second, microfinance sector institutions are no longer solely socially motivated. Due to the growing perception that it is possible to earn high returns through microfinance lending, commercially driven entities are also being attracted to the sector. This further needs for supervision and consumer protection. Third, some MFIs have started offering products such as insurance, remittances and pensions by tying up with mainstream providers. While this helps in broadening the scope of microfinance services, it also calls for coordinated regulation of the sector particularly in view of the limited financial literacy of its participants. Such increasing overlap between various financial institutions is expected to continue. Finally, while the diversity of legal forms in the sector has arisen due to its unplanned, entrepreneurial growth, a uniform regulatory framework would enable a level playing field and prevent regulatory arbitrage. While regulation is essential, avoiding over regulation that hamper innovation and unduly increases transaction costs is also equally important. For small efforts of starting informal self-help groups (SHG) to access the much needed savings and credit services in the early 1980s the microfinance sector has grown significantly today. The fact that national bodies like SIDBI and NABARD are giving their time energy to reckon this sector. The most significant issue that triggers a transformation is growth. Both promoters and providers

of microfinance encounter this though at different stages of growth. Invariably the promoters of microfinance find that the existing institutions are unwilling to provide finance at the same pace at which the providers expect them to provide finance. Working with the attitudes of these organizations is not an easy task. For instance, MYRADA in India was working hard on linking SHGs to the local banks and often found that the mainstream organizations have their limitations. In several cases the initiative was individual driven and depended on the manager. In such a situation impatience creeps in and the NGO would get into action to either start lending on their own (they need not necessarily transform, but open a division for microfinance), or set up a MFO. The story appears familiar with several Indian MFOs, if one looks at their genesis carefully. 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. In view of small loan size, microfinance institutions should be subjected to a minimum capital requirement which is lower than that applicable to commercial banks. On the other hand, a more stringent capital adequacy rate (the ratio between capital and risk assets) should be maintained because microfinance institutions provide uncollateralized loans. To be successful, financial intermediaries that provide services and generate domestic resources must have the capacity to meet high performance standards. They must achieve excellent repayments and provide access to clients. And they must build toward operating and financial self-sufficiency and expanding client reach. In order to do so, microfinance institutions need to find ways to cut down on their administrative costs and also to broaden their resource base. Cost reductions can be achieved through simplified and decentralized loan application, approval and collection processes, for instance, through group loans which give borrowers responsibilities for much of the loan application process, allow the loan officers to handle many more clients and hence reduce costs (Otero et al. 1994). Microfinance institutions can broaden their resource base by mobilizing savings, accessing capital markets, loan funds and effective institutional development support. A logical way to tap capital market is securitization through a corporation that purchases loans made by microenterprise institutions with the funds raised through the bonds issuance on the capital

market. There is at least one pilot attempt to securitize microfinance portfolio along these lines in Ecuador. As an alternative, BancoSol of Bolivia issued a certificate of deposit which is traded in Bolivian stock exchange. In 1994, it also issued certificates of deposit in the U.S. (Churchill 1996). The Foundation for Cooperation and Development of Paraguay issued bonds to raise capital for microenterprise lending (Grameen Trust 1995). Most poor people manage to mobilize resources to develop their enterprises and their dwellings slowly over time. Financial services could enable the poor to leverage their initiative, accelerating the process of building incomes, assets and economic security. However, conventional finance institutions seldom lend down-market to serve the needs of low-income families and womenheaded households. They are very often denied access to credit for any purpose, making the discussion of the level of interest rate and other terms of finance irrelevant. Therefore the fundamental problem is not so much of unaffordable terms of loan as the lack of access to credit itself (Kim 1995). The lack of access to credit for the poor is attributable to practical difficulties arising from the discrepancy between the mode of operation followed by financial institutions and the economic characteristics and financing needs of low-income households. For example, commercial lending institutions require that borrowers have a stable source of income out of which principal and interest can be paid back according to the agreed terms. However, the income of many self employed households is not stable, regardless of its size. A large number of small loans are needed to serve the poor, but lenders prefer dealing with large loans in small numbers to minimize administration costs. They also look for collateral with a clear title - which many low-income households do not have. In addition bankers tend to consider low income households a bad risk imposing exceedingly high information monitoring costs on operation. Over the last ten years, however, 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 grassroots 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. Savings facilities make large scale lending operations possible. On the other hand, studies also show that the poor operating in the informal sector do save, although not in financial assets, and hence value access to client-friendly savings service at least as much access to

credit. Savings mobilization also makes financial institutions accountable to local shareholders. Therefore, adequate savings facilities both serve the demand for financial services by the customers and fulfill an important requirement of financial sustainability to the lenders. To the extent that microfinance institutions become financially viable, self sustaining, and integral to the communities in which they operate, they have the potential to attract more resources and expand services to clients. Despite the success of microfinance institutions, only about 2% of world's roughly 500 million small entrepreneurs are estimated to have access to financial services (Barry et al. 1996). Although there is demand for credit by poor and women at market interest rates, the volume of financial transaction of microfinance institution must reach a certain level before their financial operation becomes self sustaining. In other words, although microfinance offers a promising institutional structure to provide access to credit to the poor, the scale problem needs to be resolved so that it can reach the vast majority of potential customers who demand access to credit at market rates. The question then is how microenterprise lending geared to providing short term capital to small businesses in the informal sector can be sustained as an integral part of the financial sector and how their financial services can be further expanded using the principles, standards and modalities that have proven to be effective.

DISCUSSION & METHODOLOGY

An important feature of microfinance in India is the success of various operating models. From the imported model of joint liability groups (JLGs) to domestically developed self-help groups (SHGs), many urban MFIs have opted to implement activities through peer-based lending. As explained below, some practitioners have even chosen to work as cooperatives, thereby not only providing members access to financial services but preparing them to understand and take part in household and decision-making. The JLG model pioneered in Bangladesh is based on the Grameen Banks model, which involves issuing group credit with joint liability. According to the National Bank for Agriculture and Rural Development (NABARD), the main purpose of JLGs is to facilitate mutual guaranteeing and execution of a joint liability agreement making members jointly liable for interest payments and loan repayments obtained from a MFI. JLG management is intended to be simple, with little or no financial administration within the group. The benefits of this model include reduced transaction costs for both lenders and borrowers. MFIs gain by having to handle only a single group account instead of a large number of small individual accounts; borrowers benefit by reducing travel expenses to and from local branches in addition to lessening the amount of time needed to complete paperwork to obtain the loan. But with all these measures farmers and poor people started committing suicide due to various reasons. Several responses came from major financial institutions such as ICICI which served as a model which Separates risk of MFI from risk inherent in the mf portfolio Provides a mechanisms to banks to continuously incentivize partners inability of MFIs to provide risk capital in large quantum, which limited advances from banks. There is an underlying business model in the MFIs expansion: no reason why it cannot be funded by commercial debt. Borrowers demand. While MFIs currently serve an estimated 100 million micro-borrowers, the total potential demand is roughly estimated at 1 bn. This ratio illustrates the considerable unexplored growth potential. In geographic terms, the untapped demand is unevenly spread around the globe. The largest fraction of poor people is located in India (~310 m), Bangladesh (~70 m), Indonesia (~60 m), Nigeria (~45 m) and Brazil (~40 m). Assuming that national poverty rates are related to the portion of the population that already has access to microfinance services,

penetration rates for different countries can be computed. While the penetration rate is the highest in Bangladesh at 35% it is as little as 2 to 3% in India, Brazil and Nigeria, i.e. in these countries only two to three persons out of a hundred are already served with microfinance while 97-98 people are potentially in need of it. To meet demand fully over the long run a total funding mix of debt, subordinated debt, equity, deposits and guarantees for MFIs of roughly USD 275 bn would be required. In the light of the current level of microfinance loans outstanding of around USD 25 bn, a funding gap of USD 250 bn results. Borrowers demand. While MFIs currently serve an estimated 100 million micro-borrowers, the total potential demand is roughly estimated at 1 bn. This ratio illustrates the considerable unexplored growth potential. In geographic terms, the untapped demand is unevenly spread around the globe. The largest fraction of poor people is located in India (~310 m), Bangladesh (~70 m), Indonesia (~60 m), Nigeria (~45 m) and Brazil (~40 m). Assuming that national poverty rates are related to the portion of the population that already has access to microfinance services, penetration rates for different countries can be computed. While the penetration rate is the highest in Bangladesh at 35% it is as little as 2 to 3% in India, Brazil and Nigeria, i.e. in these countries only two to three persons out of a hundred are already served with microfinance while 97-98 people are potentially in need of it. To meet demand fully over the long run a total funding mix of debt, subordinated debt, equity, deposits and guarantees for MFIs of Roughly USD 275 bn would be required. In the light of the current level of microfinance loans outstanding of around USD 25 bn, a funding gap of USD 250 bn results. Debt, equity, deposits and guarantees for MFIs of roughly USD 275 bn would be required. In the light of the current level of microfinance loans outstanding of around USD 25 bn, a funding gap of USD 250 bn results.

Also the recent microfinance crisis in Andhra Pradesh has laid bare a fundamental mismatch between instruments and objectives. Directed credit such as microfinance or its broader counterpart called the priority-sector lending is economically justified only if the beneficiary entities use it to finance projects that are profitable at the market rate of interest but go unfounded by the market. When this condition is satisfied, on average, we would observe the same default rates on directed credit as on market-driven credit.

But the high rates of default and repeated loan waivers point to the failure of microcredit to satisfy this condition. Indeed, prima facie, the availability of profitable projects in rural

Andhra Pradesh at the market interest rate on a scale commensurate with the current volume of microcredit lending would seem to be highly improbable. A plausible conclusion is that at least in rural areas the principal aim of microcredit is not to correct a market failure in the credit markets.

The argument made here is not intended to suggest that credit markets are working perfectly in rural India and no government intervention is required. Instead, it calls for a better alignment of objectives and policy instruments. Where the issue is to assist the poor rather than supporting profitable activities that the market fails to finance, adequate income transfers - entirely feasible in view of increased GDP and continued high rates of growth - are the proper instrument. Indeed, these transfers will even confer a by-product benefit related to the credit market: they will significantly cut the dependence of the poor on the moneylender.

In so far as credit-market imperfections are concerned, careful thinking is required to reform the current system.

The existing providers of microcredit fall into three broad categories: SHGs, microfinance institutions (MFIs) and the village moneylender. The form these providers take varies across states, sometimes even across regions within the same state. Any policy reform must take into account these differences in local conditions and must be designed at the level of the state. Here I offer some tentative thoughts taking Andhra Pradesh as the context.

In Andhra Pradesh, the government has been the principal promoter of SHGs. This fact partially, though not wholly, explains the government's hostility towards MFIs that have largely non-governmental origins. These latter initially grew as extensions of the nongovernmental organizations (NGOs). Banks with priority sector-lending targets and donors keen to promote microfinance found it difficult to lend their funds to numerous small borrowers. Instead, they found it more cost-effective to loan their funds to NGO-cum-MFIs, which had the local knowledge of potential borrowers. Initially, MFIs operated as non-profit entities. But over time many responded to the calls for the adoption of the full-cost-recovery model in order to scale up their operations and eventually became for-profit entities. Today, the market includes some very large and highly aggressive for-profit MFIs.

CONCLUSION

The microfinance institutions can contribute a lot to eradicate poverty from the economy. But there are certain steps/measures are needed to attain inclusive growth. The challenge lies in finding the level of flexibility in the credit instrument that could make it match the multiple credit requirements of the low income borrowers without imposing unbearably high cost of monitoring its end-use upon the lenders. A promising solution is to provide multi-purpose loans or composite credit for income generation, housing improvement and consumption support. Indias poor vary from self-employed vegetable vendors and small shop owners to salaried employees working as maids, cooks, and factory-workers. In spite of the large network of bank branches and ATMs that exist in cities, many of the poor find their financial needs largely unmet. Reasons such as a lack of documentation, regular incomes, and a low degree of comfort in visiting banks for transactions help explain why the urban poor feel forced to rely on informal credit from moneylenders who demand interest as high as 10% per day from borrowers. In fact, the lack of access to basic services and productive inputs, trading spaces for vendors, and skill and livelihood training further pushes the poor into poverty, in spite of their status as an essential component of the countrys workforce.

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AUTHOR BIOGRAPHY

Vivek Siddharth is a BBA final year student studying at Institute of Technology & Science. He has excellent academic record securing scholarship successively for two years in a category for the top candidate in the programme. He has won several prizes in business plan, debate, extempore, inter quiz competition.

Shashank Vikram Singh is a BBA final year student studying at institute of Technology & Science. He has excellent academic records and has participated in various extra co-curricular activities.