SUCCESSFUL MANAGEMENT STRATEGIES TO REDUCE

COST & IMPROVE EFFICIENCY:

Raman Uberoi, Director –
MFI & Financial Sector Ratings
CRISIL Limited, India

1. Background

Many microfinance institutions (MFI) in India are facing the pressure of protecting their
net margins. Declining access to grants and long-term subsidized funds are pushing up
their borrowing costs. Besides, owing to their operating characteristics1 MFIs have
higher operating costs than other retail finance segments. Together, the two factors are
squeezing their net margins. This is not all. The competition too is intensifying, both
between MFIs and with banks, which are sharpening their focus on this segment. Even
government policies have sought to ensure the flow of low-cost funds to the
economically challenged through the banks’ large branch networks. This is altering the
very dynamics of microfinance lending and is likely to pose a key challenge for MFIs to
remain competitive. For, although MFIs charge a lower lending rate than the informal
sector, their rates are higher than those of formal lending institutions like banks. Hence,
their flexibility to increase their lending rates to protect their margins is limited. A CRISIL
study reveals that in such a scenario, MFIs need to optimize their cost structure,
specifically their funding and operating costs, to remain competitive and meet these
challenges. This paper highlights the insights from the study and suggests some
possible solutions that MFIs could adopt to improve their cost structure and thereby,
strengthen their competitive position.

2. Key Highlights

CRISIL has analysed the performance and operational procedures of a pool2 of 12

Indian MFIs. This pool has been sub-divided into two groups – Group A, which
comprises nine MFIs with moderate to weak cost structures, and Group B, which
includes three MFIs with a relatively better cost structure (see Box 1 on the
characteristics of the pool and Box 2 on the key operating factors of Group B).

2.1 Lower operating expenses have resulted in better operational self-sufficiency

As can be seen from the charts below, it is not their higher fund-based yields3 but their
lower operating expense ratios4 that have translated into a better operational self-
sufficiency5 (OSS) 1 Operating characteristics such as average loan size being small,
high transaction frequency and the like do not provide the necessary economies of scale
to optimize on the operating cost. Moreover, most MFIs incur significant time and effort
towards group formation and training, loan processing, disbursement, monitoring and
recovery. Repayments are typically collected on weekly, fortnightly or monthly basis by
way of cash thus translating into higher transaction costs. 2 The pool comprises MFIs
assessed by CRISIL that have completed at least three years of microfinance operations
as at March 31, 2003. 3 Fund-based yield is defined as the fund-based income to
average funds deployed and funds deployed is defined as total assets less net fixed
assets. 4 Operating expense ratio is defined as operating expenses (personnel and
administration expenses) to average funds deployed. 1 ratio for MFIs in Group B.
Although the MFIs in Group A have higher lending yields, their operating expense ratio is
almost twice that of Group B, which has affected their OSS ratio. 15% 9% 15% 6% 14%
7% 0% 5% 10% 15% 20% 2000-01 2001-02 2002-03 Chart 1B: Operating expense
ratio Group A Group B 20% 15% 22% 18% 24% 19% 0% 10% 20% 30% 2000-01 2001-

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 02 2002-03 Chart 1A: Fund based yields Group A Group B Chart 2: OSS
performance trend 99% 89% 91% 148% 137% 97% 0% 25% 50% 75% 100% 125%
150% 2000-01 2001-02 2002-03 Group A Group B

2.2 Better employee productivity has improved efficiency levels

The productivity indicators6 - branch productivity and field employee productivity – of

both groups have improved during the study period. While there is a marginal difference
between their branch productivity, the difference is quite stark in the case of the field
employee productivity. Group B’s field employee productivity is superior to that of Group
A and has doubled over the past three years. In other words, it has a higher field officer
productivity for a similar number of loan accounts for each branch, which has translated
into lower operating costs (see Table 1). Table 1 Group A Group B Productivity
Indicators 2002-03 2001-02 2000-01 2002-03 2001-02 2000-01 Active loan
accounts/credit officer 188 172 142 414 282 202 Active loan accounts/branch 1469 1205
1089 1624 1027 557 5 OSS is defined as total income to total expenses and indicates
whether an MFI earns enough income to cover its costs. Total income includes income
from lending operations, investment income and fee income. Total expenses include
financial expenses, operating expenses, loan loss provisions, write-offs and depreciation.
6 Productivity indicators: Branch productivity is defined as active loan accounts per
branch and field employee productivity is defined as number of loan accounts per credit
officer (field officer, credit officers and customer service agents).

2.3 Borrowing costs increasing and expected to rise further

Both groups’ average borrowing costs have been rising, by about 200 basis points, over
the last two years because of their declining access to subsidized long-term borrowings
and greater dependence on commercial borrowings from banks and apex MFIs7. Chart
4: Interest paid to avg. borrowings 7.5% 9.6% 9.9% 10.6% 10.8% 8.5% 7.0% 8.0%
9.0% 10.0% 11.0% 12.0% 2000-01 2001-02 2002-03 Group A Group B

2.4 Size of loan account has positive impact on operating efficiency

Apart from employee productivity, the size of a loan account has also affected the MFIs’
operating efficiency. As can be seen from chart 3, Group B’s average amount
outstanding per loan account has improved and is higher than that of Group A. 93 93 83
96 89 109 0 20 40 60 80 100 120 2000-01 2001-02 2002-03 Chart 3: Oustanding
amount per loan account (in US $) Group A Group B NB: For the purpose of
calculations, the following reference rates have been considered: US$1 = Rs. 47.55 as at
March 28, 2003; Rs. 48.80 as at March 28, 2002 and Rs. 46.64 as at March 30, 2001. 7
The two leading apex MFIs in India have disbursed loans at interest rates ranging from
11% to 14% per annum to most MFIs. 3

2.5 Higher proportion of interest-earning assets; better management of lending

operations

Group B not only has a lower proportion of net fixed assets to total assets but also has a
relatively higher proportion of loan portfolio to total funds deployed (see Table 2). This
clearly indicates that Group B has managed its lending operations better than Group A
(see Table 3 for the MFI pool’s key financial indicators). Table 2 Group A Group B
Interest Earning Assets 2002-03 2001-02 2000-01 2002-03 2001-02 2000-01 Net fixed
assets/total assets (%) 4.44 5.02 4.81 0.91 1.36 2.80 Loan portfolio/total funds deployed
(%) 81.48 71.88 79.02 90.82 89.82 80.59

3. Key Inferences and Strategies for Efficient Management

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 3.1 Addressing loan delivery and collection mechanism limitations

Frequent cash-based and small-value transactions entail a significant amount of field

time and limit the number of accounts that a credit officer can handle per visit and on the
whole. An increase in the number of loan accounts per credit officer can significantly
improve an MFI’s operating efficiency. Group B has attempted to address this by
adopting different approaches such as: The role of field officers is restricted to
identifying and monitoring clients. Subsequently, clients deal directly with the MFI’s
branch and transact through post-dated cheques. By eliminating the need to handle
cash at the field level, the MFIs in Group B have optimized the number of field officers
and branches. Operating processes such as book keeping, accounting and data
capture systems have been streamlined to reduce the time spent by field officers on
paper work and eliminate the need for an accountant at each branch. Eliminating
processes and procedures that are redundant. For instance, if a MFI undertakes credit
appraisal when the group is formed and there are controls at the group level to ensure
that funds are not misused by clients, then for subsequent loan disbursals, especially for
income generation loans, the MFI avoids loan utilization checks.

3.2 Identifying target groups to avoid duplication of efforts

MFIs can try and replicate the bank-group linkage model by lending to groups that are
formed by other NGOs. In this model, government departments incur the expenditure of
forming new groups, NGOs form the actual groups and MFIs focus on providing financial
services. MFIs with a diversified funding base and regular access to funds can explore
this route. 3.3 Enhancing non-fund based income to bolster revenues 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 channelise insurance services to
their 4 clients. Some of them already trade in seeds, fertilizers and other such products.
Such valueadded 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.

3.3 Investing in technology to optimize operating expenses

Some MFIs have successfully introduced new technologies such as smart card readers
and personal digital assistants (PDA) to reduce data collection and updation time.
Similarly, as client history and repayment behaviour across sectors (agriculture, trading,
tiny industries and the like) become available, MFIs can adopt credit assessment models
or credit scoring tools to increase their productivity while maintaining portfolio quality.

4. Conclusion

Given the banks’ sharp thrust on microfinance and competition within the sector, MFIs
will have to perforce improve their efficiency. It is critical that MFIs streamline their
processes and enhance their productivity levels to offset the rising cost of commercial
borrowings and thereby, remain competitive. 5 Table 3 Group A Group B Financial
Indicators 2002-03 2001-02 2000-01 2002-03 2001-02 2000-01 Fund-based income
(%) 23.74 22.30 19.53 18.60 18.48 15.34 Non-fund-based income (%) 1.03 0.99 1.51
4.64 3.06 1.06 Total income8 (%) 24.77 23.29 21.03 23.24 21.54 16.39 Interest paid (%)
7.87 7.72 6.18 8.68 8.39 5.89 Personnel expenses (%) 8.05 8.52 8.40 3.61 4.08 6.28
Administrative expenses (%) 6.23 6.82 6.90 2.95 2.20 3.21 Operating expenses (%)
14.28 15.34 15.30 6.56 6.28 9.49 Operating expenses including depreciation (%) 14.81
16.02 15.91 6.69 6.43 9.84 Loan loss provisions & write-offs (%) 2.29 1.82 1.42 0.30

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 0.83 1.03 NB: All the above ratios are as a percentage of average funds deployed Box
1: Characteristics of MFIs in CRISIL’s Sample Pool * Predominantly group-based
lending mechanism: All the MFIs in the pool lend to groups and 80% of them form their
own groups. Only one MFI primarily focuses on individual loans but it also lends to
groups. Of the MFIs that lend to groups, most of them have adopted the Grameen Bank
model9 or variants of the same. A few of them have adopted the self-help group model.
Mainly cash-based transactions: Except for one MFI, all the others in the pool collect
repayments in cash. Similarly, only two MFIs disburse loans through cheques while the
rest disburse them in cash. Two-thirds of the MFIs also collect their clients’ savings along
with loan repayments. Frequent repayment collections and short loan tenures:
Eighty per cent of the MFIs in the pool disburse loans and collect repayments on a
weekly basis and the tenure of their loans ranges from 10 to 24 months. The rest collect
repayments on a monthly basis and apart from short-term loans, they also provide
medium-term (up to 36 months) and long-term (beyond 60 months) loans such as crop
and housing loans. Most borrowers are women: Two-thirds of the MFIs lend only to
women. These loans are primarily for income generation, either to fund existing income
generation activities or first-time loans to set up new enterprises to diversify the
borrowers’ income stream. MFIs registered as not-for-profit organisations: About 75
percent of the MFIs are registered as societies or trusts and the rest are registered as
companies. Unlike the latter, the former have limited access to capital, which can affect
their ability to scale up and sustain their operations. * * * * 8 Total income = Fund-based
income + non-fund-based income. It does not include any extraordinary income.
Fundbased income comprises interest income and investment income. Non-fund-based
income comprises registration fee, pass book fees, consultancy income and other fee-
based income. 9 In the Grameen Bank model, groups of five prospective borrowers are
formed and loans are disbursed to the group’s members on a staggered basis. For
instance, two members are disbursed loans in week 1, another 2 in week 5 and the rest
in week 9. The loans usually have a tenure of 50 weeks. Loans are given to individuals
within the group but the collective responsibility of the group in terms of loan repayments
offers comfort. The MFI and not the group maintains group-related accounts. Unlike
under the self-help group or village-banking model, the group’s savings are not rotated
among members but are collected by the MFI for on-lending and collateral purposes. 6 7
Box 2: Key Operating Factors of Group B * Unique lending mechanism: One of the
MFIs does not form groups on its own, rather, it lends to groups formed by other NGOs.
This strategy is more common to banks than MFIs in India. This MFI has been able to
save on group formation and training costs.

• Field staff productivity: All disbursements and repayment collection mechanisms of

one of the MFIs are similar to those adopted by other financial intermediaries, that is,
post-dated cheques. Thus, field officers spend most of their time on prospecting
clients and evaluating NGOs that they can work with. This translates into higher
productivity at the field level. Customized data collection sheets and pass books,
simplified accounting and record keeping systems also allow field officers to handle
the paper work themselves without needing a branch accountant. One of the MFIs
operates in high-density regions, which allows field officers to conduct more meetings
a day in rural and urban areas.

• Good loan documentation and monitoring mechanisms: Relatively better credit

appraisal mechanisms, good loan documentation, the involvement of NGOs in
monitoring the groups and restricting the loans to three-fourths of the members in a
group have enabled one of the MFIs to manage its operations well.

• Blend of lending mechanisms: Initially, one of the MFIs adopted the Grameen
Bank model in a few branches and the self-help group model in other branches. Over

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 a period, however, it evolved its own lending methodology based on both these
models.

• Flexible lending mechanism: As in the Grameen Bank model, loans are disbursed
to clients within one month of the group’s formation. Clients are given an option to
repay existing loans and go in for higher loan amounts subject to certain terms and
conditions including the payment of penalties. New loan products such as
educational, infrastructure and enterprise loans are offered in subsequent loan
cycles, encouraging clients to pay promptly. As the size of the loan increases, the
operating cost per loan account decreases gradually.

• Sharing operational expenses across divisions: One MFI runs multiple

developmental programmes besides providing microfinance services. It shares
infrastructure and related operational costs between these divisions, thereby
optimising its overall expenses.

Contact Details Raman Uberoi:

Director - MFI & Financial Sector Ratings

ruberoi@crisil.com
Tel: +91 (11) 23721603

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