Tuesday, 23 August 2011

Sustainable Microfinance: Prospects, Challenges, & Implications

Microfinance includes a range of small scale financial services that provides assistance to the poor households. The main objective of Micro-Finance is to achieve financial inclusion by reaching out to those who are yet to be reached directly by the banks.

The underlining principle driving the growth of such initiatives across the globe is that low-income individuals are capable of lifting themselves out of poverty if given access to financial services. Given the shortcomings of macro-finance to cater to the needs of the otherwise neglected section of human society, micro-finance initiatives are essential for a holistic economic growth.

The pioneering of modern microfinance is credited to Dr. Mohammad Yunus who founded Grameen Bank (Bangladesh) in 1983 and won the Nobel Peace Prize in 2006. Since then, innovation in microfinance has continued and providers of financial services to the poor have continued to evolve. Today, the World Bank estimates that about 160 million people in developing countries are served by microfinance. Regionally the highest concentrations of these accounts are in India (188 million accounts representing 18% of the total national population). The lowest concentrations are in Latin American and the Caribbean (14 million accounts representing 3% of the total population) and Africa (27 million accounts representing 4% of the total population, with the highest rate of penetration in West Africa and the highest growth rate in Eastern and Southern Africa).


A microfinance institution (MFI) is an organization that provides microfinance services. MFIs range from small non-profit organizations to large commercial banks. The ownership structure in case of different MFIs determines the legal obligations under which it operates like government owned rural credit cooperatives, member-owned credit societies, socially minded NGOs, profit-maximizing microfinance banks. 

The nature of microcredit i.e. small loans is such that the interest rate needs to be high enough to return the cost of the loan. The lack of access to formal financial institution makes borrowing from informal market at a high interest rate the only
realistic alternative available to the poor households.

These loans cater to various needs like:
§  Lifecycle Needs: Weddings, funerals, childbirth, education, house building, widowhood and old age.
§  Personal Emergencies: Sickness, injury, unemployment, theft, harassment or death.
§  Disasters: Fires, floods, cyclones and man-made events like war etc.
§  Investment Opportunities: Business expansion, buying land or equipment, improving housing, securing a job etc.
       Source: http://www.opportunity.org.au
Poor people, with access to savings, credit, insurance, and other financial services, can better cope with the everyday crisis they face. However, money alone does not guarantee complete upliftment of livelihood and other development and technical services are essential on a revenue basis in order to be sustainable.  

1.) Micro entrepreneurs usually have little or no collateral to offer, which makes the commercial banks attribute a high risk of lending to these entrepreneurs.
2.) Small size loans increase the transaction costs for MFIs for which the
interest rates charged are high. This can be tackled by a central processing unit.
3.) Lack of fundings poses a problem at times. There is a wide gap between demand for and supply of new funds. The current economic crisis around the globe has also led to shortage in money, thereby affecting the liquidity in this sector. But, new opportunities like social and private investors, corporations, foundations and wholesale funds can be a support for expanding microfinance programs.
4.) If microfinance’s fail to protect themselves against default by the borrowers, they will end up prioritizing social objectives rather than financial sustainability.
5.) Micro finance entrepreneurs, unlike large companies, have varied needs. Failure to understand these needs leads to improper targeting by the MFIs. So, a large task of the MFIs is to get onto the field, spend proper time with clients and do an extensive research so as to develop customized micro finance tools.
6.) Working in the micro finance sector is altogether different than the traditional finance sector. Officers and volunteers need to be trained so as to build long lasting relationships with the entrepreneurs, evaluate their sustainability and know the cultural nitty-gritty of the borrower. Micro finance needs proper inputs so as to avoid under-serving or intimidating.
7.) The principle of ‘one micro entrepreneur- one loan’ is overlooked by some profit looking MFIs. This leads to targeting the same individual everytime, leading to high borrowing and high
interest rates, which eventually forces the borrower deep into poverty. This results from poor governance from the MFIs as well as the borrower’s side.
8.) According to the World Bank, of all the MFIs around the world, only 4% have the reach to the potential market. This may be due to complacency with regards to their clients in certain cities or remote accessibility of poor households. This causes the poorer households to be left out in the lurch.

Microfinance expansion, in the years to come, depends a lot on the existing players in the market and how many new institutions come up later. There may be several participants in the process which can be as follows:-
1.) Existing institutions can expand their reach so as to bring the neglected areas under their ambit.
2.) Cooperative/credit unions can leverage upon the opportunity.
3.) Government channels at the grassroot levels can be effective in areas which have not been included yet.
4.) More NGOs and commercial banks can participate.
5.) International NGOs can step up their activity and make microfinance available to areas that have not been under its purview.

In case of NGOs, availability of funds will be difficult for start up or scaling up. Unless the funding problem is taken care of, they will face issues pertaining to lending and increasing their overall reach,
unlike regulated MFIs which can mobilize savings.

Attention should also be focused on the ‘middle people’ and not just the bottom poor. Small scale enterprises, if nurtured properly, can not only increase the available of funds to the poor but will also increase the outreach of micro finance. The role of the government, donors, channels, etc will also remain important for channelizing funds and creating awareness for the fast expansion of micro finance.

Many action plans have been drawn out by various institutions which will affect the operation of this sector in the near future. Some of these are as follows:
1.) The draft Micro Finance Bill 2011 makes the Reserve Bank of India the sole regulator of the industry. The bill brings all aspects of microfinance under the purview of the RBI. This will redefine the future regulation of this sector.
2.) Small Industries Development Bank of India (SIDBI) is planning to disburse Rs 1000 core in credit to MFIs for the FY 2012, which is 19% more than the loaned amount last fiscal. SIDBI is also trying to pull in foreign private equity investors to invest in Indian MFI sector. It hopes to continue giving the boost to economically viable MFIs.
3.) L&T Finance Holdings Ltd. part of country’s largest engineering company Larsen & Toubro is planning to re-evaluate its microfinance business model. It is now planning to shift the microfinance business to a newly-incorporated wholly-owned subsidiary L&T Unity. The company
would also look into expanding its operations in new locations.
4.) Private sector lender Yes bank has planned a threefold increase in its micro lending. It is planning to disburse around Rs 1000 core as against Rs 300 core in the last financial year.
5.) Bharatiya Samruddhi Finance is in talks with banks and private equity investors to raise around Rs 300 crore. This would allow the company to sustain its operations in the future.
However, SKS microfinance, India’s only listed microfinance institution, reported a net loss of Rs 218.7 crore for the quarter ended June 30, due to impact of Andhra Pradesh Microfinance Act and re-classification of assets and provisioning. It is said that it may raise up to Rs 900 crore through private placement of securities.

Despite several criticisms, Microfinance has come a long way ahead. The pioneers in the field have demonstrated their enthusiasm, commitment and power in reaching out to the rural area and providing better financial support to the rural households. But there is a long way ahead. About 300 million people in India still live below the poverty line. Continuous work is required to channelize funds from private and foreign players, to develop personnel and to make it more poverty-focused and profitable. 

Fortunately there has been an increase in the awareness for microfinance in India, and thereby government participation and NGO-MFI partnerships are on the rise. The question that remains unanswered is, how fast the microfinance sector will grow? The answer to this will largely depend on the environment created by the governments, macroeconomic stability, liberalization of interest rates, savings mobilization, availability of alternatives to subsidized credit schemes and domestic and foreign participation. Some legal and regulatory frameworks have already been developed by the governments of different countries to facilitate progress. The sooner the environment is created across countries, the better the chance for achieving the goals of the sector.

Chandan Dikshit and Karishma Prasad (PGDM 1)

6.) H.I.Latifee, ‘The future of Microfinance: Visioning the Who, What, When, Where, Why, and How of Microfinance Expansion Over the Next 10 Years