Serving the bottom of pyramid

Microfinance institutions
Microfinance institutions create wealth by harnessing the money at grassroot level

THE MICROFINANCE institutions (MFIs) play a vital role in providing short term loans and other financial services in remote areas and helping people and communities come out of the vicious poverty. Given the low presence of banking facilities in remote areas, the MFIs have potential to provide financial services to the last man in the society and help him create wealth. As over 60 per cent of our population lives in villages, microfinance can be critical to poverty alleviation strategies as MFIs mostly work in rural areas. Microfinance helps to improve access and efficient provision of savings, credit, and insurance facilities and enables the poor to smoothen their consumption, manage their risks better, build their assets gradually and develop their micro enterprises. Over the last few years, the reach of MFIs to the rural poor have been  impressive, but more stress is now required.

Nobel Laureate Muhammad Yunus is credited with laying the foundation of modern MFIs with establishment of the Grameen Bank, Bangladesh in 1976. The MFIs sector has grown rapidly over the past couple of decades, especially in developing economies, like India, where the governments work under severe financial constraints. MFIs in India exist as NGOs and Non-Banking Financial Companies (NBFCs). Commercial Banks, Regional Rural Banks (RRBs), cooperative societies and other large lenders have played an important role in providing financial services to MFIs. Banks have also leveraged the Self-Help Group (SHG) channel to provide direct credit to group borrowers. With financial inclusion emerging as a major policy objective in the country, Microfinance has occupied the center stage as a promising conduit for extending financial services to unbanked sections of population. At the same time, practices followed by certain lenders have subjected the sector to greater scrutiny and stricter regulation.

In focus for wrong reasons
In the last couple of years, the  microfinance activities have come under limelight as they aim toserve people who are otherwise excluded from the economic system. The Andhra Pradesh episode, in which farmers committed suicide, a first in MFI history after which the MFI in question had to leave the state, attracted a strong debate on the governance and ethics in the conduct of the MFIs. There are some other issues too that require a closure look, especially the ownership of the MFIs. The ownership structure of Indian MFIs is dominated by family and friends groups.  Mostly family members and friends are board members; thus the board structure is characterized by inadequate  checks and balance of executives, lack of transparency in reporting, lack of independent board nomination, insufficient transparency about ownership and conflict of interest at various levels of management. Moreover, remuneration payments are irrational and unusually high. It is characterized by unplanned bonuses, granting of shares and non-transparent pricing of shares. It is also often seen that that related party transactions are not transparent and MFIs provide huge loans to founders and board of directors to buy their own company shares.

Despite the fact that MFIs in India recorded a rapid growth, in the end, big MFIs have incurred losses and clients have been pressures from MFIs to pay back their loan. Such things have marred the reputation of microfinance sector.

Intervention required
There is no denial that the microfinance has brought hope to many, but without the government intervention, the potential cannot be utilized in full.

Pointing the need for policy intervention, HP Singh, CMD, Satin Creditcare Network, a Delhi based MFI offering short term loan to poor people, said: the government needs to bring into act the legislation and regulation of microfinance institutions under central government (under supervisory of RBI) so that states do not have any say in regulation and not have the authority to stop microfinance activity in the respective states on various pretexts. Singh also stressed on the importance of a steady flow of capital to the microfinance sector through formal banking sector and financial institutions so that the lending to  he bottom of the pyramid is not erratic. Also the cost of funds has to be brought down for the MFIs. Even though it falls under priority sector
guidelines, the bank’s cost of funds  to MFIs is still very high. Thus, it leads to an even higher lending rate for the microfinance borrowers.

Leveraging MFIs for financial inclusion
The central government has taken several initiatives on the financial inclusion front over last one year with a uniform focus on three key foundations of financial inclusion – credit, savings and insurance. The microfinance institutions are expected to play a vital role in delivery of various products and service offerings which are aimed at benefiting the vulnerable sections of the society. The formation of MUDRA is a significant step towards maximizing access of finance to the underserved socio-economic segments and underpenetrated geographies. Till date the focus of microfinance institutions has been limited to the micro-entrepreneurs who need very small loans (Rs 10,000 – 50,000) to start or grow a very small business.

mfi-gplThe advent of MUDRA bank which is aimed at promoting loans upto Rs 10 lakh, will act as a catalyst for microfinance and other  financial institutions to develop and promote appropriate products for small and medium level enterprises. This thrust goes in line with the government’s ‘Make in India’ program which is highly dependent on the success of MSME sector.

How to strengthen MFI sector
It becomes imperative to save MFIs in India because of their social cost and all steps must be taken to ensure their good health. To begin with, the policy regime will have to be friendly. The regulation was not a major concern when the microfinance was in its nascent stage and individual institutions were free to bring in innovative operational models. However, as the sector completes almost two decades of operation and move up to a high growth trajectory, an enabling regulatory environment that protects interest of stakeholders as well as promotes growth, is needed.

Secondly, in addition to proper regulation of the microfinance sector, field visits can be adopted as a medium for monitoring the conditions on ground and initiating corrective action whenever needed. This will keep a check on the performance of ground  staff of various MFIs and their recovery practices. This will also encourage MFIs to abide by proper code of conduct and work more efficiently. However, the problem of feasibility and cost involved in physical monitoring of this vast sector remains an issue in this regard.

It has been seen that in lieu of reducing the initial cost, MFIs are opening their branches in places which already have a few  MFIs operating. Encouraging MFIs for opening new branches in areas of low microfinance penetration by providing financial assistance will increase the outreach of the microfinance and check multiple lending. This will also increase rural penetration of microfinance in the state.Also in order to serve clients better, MFIs need to provide a complete range of products including credit, savings, remittance, financial advice and also non-financial services like training and support. As MFIs are acting as a substitute to banks in areas where people don’t have access to banks, providing a complete range of products will enable the poor and rural masses to avail all services.

Then there is a big issue of interest rate structure for the sector. It has been observed that MFIs are employing different patterns of charging interest rates and a few are also charging additional charges and interest free deposits (a part of the loan amount is kept as deposit on which no interest is paid). All this make the pricing very confusing and hence the borrower feels incompetent in terms of bargaining power. So a common practice for charging interest should be followed by all MFIs so that the sector becomes more transparent and competitive, and the beneficiary gets the freedom to compare different financial products
before buying.

MFIs should also use new technologies to reduce their operating costs. As the emergence of mobile and internet banking has  proven, it is possible to offer services without being present on ground. MFIs can use internet based technologies to collect data, monitor loan portfolios and manage workforce on the ground. Most NBFCs are adopting cost cutting measures, which is clearly evident from the low cost per unit money lent (9-10 per cent) by such institutions. NGOs and Section 25 companies are having  a very high value of cost per unit money lent, often in range of 15-35 per cent which puts enormous burden on profitability. Also initiatives like development of common MIS and other software for all MFIs can be taken to make the operation more transparent and efficient.

Moving forward, MFIs would be competing with small and payment banks who would also try to cater to rural market. To compete well. MFIs would have to become nimble, reduce cost and bring out innovative products in order to survive, which they must as they have a large social mandate to fulfil.