Report on Microfinance

Prepared by,
Unnati A. Mehta
Unitedworld School of Business
Mumbai
 ACKNOWLEDGEMENT

I would like to express my gratitude to all those who gave me the possibilities to
complete this report. I would like to thank Prof. Jayanta Sengupta, Dean,
Unitedworld School of Business, Prof. Sangeeta Pandit , Prof. Jaymala S., Prof.
Pinaki Ghosh ,Unitedworld School of Business and also college authorities for
providing me the opportunity to work on the report.
With a deep sense of gratitude and humble submission I would like to express
my heartiest gratefulness to my Faculty Guide Prof Sangeeta Pandit, Unitedworld
School of Business , whose help, stimulating suggestions and encouragement
helped me in all the times of research for and writing of this report.

Date: 19Augest 2010

Signature: Unnati Mehta

 Index

 Executive Summary

 Introduction to Microfinance

• History

• Geographical Spread

• Book Review

 Microfinance Products

 Microfinance Clients

 Microfinance Services
 CRISIL List of Microfinance Institutions in India

 Business Model

 Legal forms of MFI’s in India

 Market Trends

 Investment Climate
 Microfinance Bubble

 Success factors

 Issues

 Exits

 Case study

 Conclusion
 References
 Executive Summary

 The microfinance sector in India has developed a successful and sustainable

business model which has been able to overcome challenges traditionally
faced by the financial services sector in servicing the low income
population by catering to its specific needs, capacities and leveraging
preexisting community support networks. As of March 2009, microfinance
institutions (“MFIs”) in India reached over 22 million borrowers and had a
portfolio outstanding in excess of $2.3 billion.

 The microfinance business model in India typically generates a Return on

Equity (“ROE”) of between 20% and 30%, driven by financing from
commercial banks, strong operating efficiency and high portfolio quality.

 Despite achieving rapid growth with a CAGR of 86% in loan portfolio

outstanding and 96% in borrowers over the last five years, the microfinance
sector still faces a large unmet demand which means that it still has great
potential for continued growth.

 The microfinance sector is maturing and beginning to diversify its product

and service base to address other unmet financial and non-financial needs
of the low income population either directly or by acting as a conduit for
third-party providers – savings, insurance, remittance and low cost
education and healthcare services being some of the key examples.

 Given this growth and maturity dynamic, the Indian microfinance sector is
increasingly becoming a viable investment sector with commercial
investors joining social investors who have been nurturing the industry thus
far.

 Equity valuations in the Indian microfinance sector are higher than the
financial sector due to the high growth expectations and substantial
availability of debt to fuel its rapid expansion. This availability of debt to
 support expansion is expected to grow as more domestic banks take
exposure to the industry and alternative debt providers enter the market.

 Over the short and medium term, MFI shares are expected to trade at
significant premia to book value as they realign their business models to
capitalize on unsatisfied demand, and cool down over the longer term as the
industry matures and begins to consolidate.

 Currently, several exit opportunities exist including secondary and trade

sales which are increasing as more mainstream investors enter the market.
Another likely exit scenario is M&A, as larger MFIs seek to acquire players
with product or geographical niches and banks also seek to enter the sector
by forming alliances with existing MFIs. Larger MFIs may also consider
IPOs although that may be a less likely exit option for most MFIs in the
short to medium term.
 Introduction to Micro Finance

Microfinance is defined as any activity that includes the provision of financial

services such as credit, savings, and insurance to low income individuals which
fall just above the nationally defined poverty line, and poor individuals which fall
below that poverty line, with the goal of creating social value. The creation of
social value includes poverty alleviation and the broader impact of improving
livelihood opportunities.

The concept of micro finance was popularized by Muhammad Yunus

tremendously in India. The growing understanding of achieving self
sustainability among the rural and urban poor has led to the acceptance and
implementation of this idea across India.

Microfinance loans serve the low-income population in multiple ways by:

(1) Providing working capital to build businesses;

(2) Infusing credit to smooth cash flows and mitigate irregularity in

accessing food, clothing, shelter, or education;

(3) Cushioning the economic impact of shocks such as illness, theft, or

natural disasters.

Moreover, by providing an alternative to the loans offered by the local

moneylender priced at 60% to 100% annual interest, microfinance prevents the
borrower from remaining trapped in a debt trap which exacerbates poverty.

The range of activities undertaken in microfinance include group lending,

individual lending, the provision of savings and insurance, capacity building, and
agricultural business development services. Microfinance loans in India range in
size from $100 to $500 per loan with interest rates typically between 25% and
35% annually.

History of Micro Finance

The history of microfinance can be traced back as long to the middle of the 1800s
when the theorist Lysander Spooner was writing over the benefits from small
credits to entrepreneurs and farmers as a way getting the people out of poverty.
But it was at the end of World War II with the Marshall plan the concept had an
big impact.

The today use of the expression microfinancing has it roots in the 1970s when
organizations, such as Grameen Bank of Bangladesh with the microfinance
pioneer Mohammad Yunus, where starting and shaping the modern industry of
microfinancing. Another pioneer in this sector is Akhtar Hameed Khan. At that
time a new wave of microfinance initiatives introduced many new innovations
into the sector. Many pioneering enterprises began experimenting with loaning to
the underserved people. The main reason why microfinance is dated to the 1970s
is that the programs could show that people can be relied on to repay their loans
and that it´s possible to provide financial services to poor people through market
based enterprises without subsidy. Shore Bank was the first microfinance and
community development bank founded in 1974 in Chicago.

From modest origins, the microfinance sector has grown at a steady pace. Now in
a strong endorsement of microfinance, the National Bank for Agriculture and
Rural Development (NABARD) and Small Industries Development Bank of
India (SIDBI) have committed themselves to developing microfinance.

The microfinance sector has been "witnessing a tremendous growth" during the
last few years in India in terms of loan portfolio, geographical area and outreach.
With India’s GDP growing at the rate of 7.1 % the country’s socio-economic
pyramid is turning around the story with millions of poor people becoming
entrepreneurs.
Geographical spread of MicroFinance sector
in India

 Microfinance in India, through the channel of SHG-Bank Linkage

Programs (SBLPs) or microfinance institutions, has served over 76
million as of 2009 compared to 59 million a year before.

 MFI’s have recorded about 8.5 million clients during the year
2008-09, a growth of 60% over the previous year.

 More than 50 percent of low income households are covered by

some form of microfinance product.
  The total outstanding microfinance loans posted a growth rate of
30% or 359.39 billion over the last year’s level of Rs 229.54
billion.

 The overall coverage of the sector is estimated to have reached

76.6 million against 59 Million last year.

 The SHG loan outstanding has increased by Rs. 71.5 billion with
an addition of 6.9 million clients.

 MFIs so far reached 234 of the 331 poorest districts identified by

the government.

 SBLP registered a decline of number of women SHGs from 82.5%

in March 2007 to 80.4% in March 2008.

Despite the rapid expansion of microfinance, large areas of India continue to

be underserved it is estimated 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 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.
 “Banker to the Poor” Book Review
Muhammad Yunus was born in Chittagong, Bangladesh as the third of
fourteen children. He studied at Dhaka University and then Vanderbilt
University for his PhD. He did not set out to become a moneylender of any sort,
nor did he anticipate starting an organization that would affect the lives of
millions. While serving as the department head of Economics at Chittagong
University, Yunus began to get involved in the village, Jobra, next to the
University.

It was there that the story of a young woman named Sufiya sparked the
idea that in the next few years would become Grameen Bank. She was a twenty-
one year old mother of three who labored all day to make bamboo stools by
hand. Sufiya borrowed the money for each stool, about five taka (twenty-two
cents), from middlemen on the condition she would sell the finished stools back
to them for five taka, fifty poysha (twenty-four cents). Therefore, her net profit
for the entire day’s labor would be only fifty poysha, or two cents for her family.
It was a miserably small sum, but as she explained to Yunus, she had no other
choice. The middlemen were better than the moneylenders who charged
exorbitant rates and only dragged borrowers deeper into the cycle of poverty.

Muhammad Yunus was shocked. In his own words: “In my university

courses, I theorized about sums in the millions of dollars, but here before my
eyes the problems of life and death were posed in terms of pennies” . The next
day he and a student visited the village again, this time making a list of all the
people who were dependent on middlemen. In total he found forty-two
borrowing a total of 856 taka (roughly twenty-seven dollars). Again he was
shocked that such a small amount of money could affect so many people. Aware
that if the people were not dependent on the middlemen they could sell their
products for the highest possible return, he decided to distribute the money to
villagers, interest free, out of his own pocket. The Grameen Bank project was
born, which grew and eventually became an independent organization in 1983.

Grameen Bank is run off a strict set of principles. Yunus decided to have the
loan period last one year, with weekly repayments, after a one week grace period,
made to Grameen Bank employees who visit the villagers. Groups are an
important component of Grameen’s Banking system. Grameen Bank uses groups
of five individuals, having them self-formed rather than assigned to promote
solidarity. By having a prospective borrower, such as a village woman, seek out
and convince her friends to join her already starts the process of independence,
responsibility and social control the group members have over each other with

the loans. Once a group is formed, loans are only extended to two borrowers. If
they repay on time for the first six weeks, then two more members may take out
loans; the chairperson is usually the last to take a loan. However, for a group to
be recognized by Grameen as eligible for a loan, each member must undergo a
week of training on the bank’s policies and pass an oral examination.

One interesting goal Yunus set for Grameen Bank was to have at least
half the borrowers be female. This was a struggle given the low social status of
women in Bangladesh, but today 97% of Grameen borrowers are women. He
cites that women have been shown through studies to use their loaned money to
more successfully improve the status of their families (especially their children)
than men. When a woman receives a micro-loan her priorities are first improving
the life of her children and second improving her household - for example
building a stronger roof or buying beds for the family.

Improving the economic status of women also directly affects birth

rates, which are an issue in many developing countries. Compared to the general
ineffectiveness of government scare-tactics and family planning programs,
improving the status of women has been shown by UN studies to significantly
lower birth rates. Studies among Grameen clients have shown that the birth rate
is significantly lower than the national average. The clients are also much more
likely to educate the children they already have. Therefore, the simple loan has
not only immediate benefits, but actually improves the future of the next
generation.

Muhammad Yunus’ project has grown to serve a total of seven million

families in Bangladesh with loans totaling six billion dollars. There are over 250
institutions in 100 countries that operate off Grameen micro-credit principles. For
his work, Muhammad Yunus received the Nobel Peace Prize in 2006.
 Micro Finance Products

 Credit
Credit methodology lies at the heart of microfinance and its quality is one
of the most determinant factors for the efficiency, impact and profitability
of a microfinance institution (MFI). Credit methodology is comprised of a
host of activities involved in lending including sales, client selection and
screening, the application and approval process, repayment monitoring,
and delinquency and portfolio management. It is also linked to the
institutional structure and human resource policies such as hiring, training
and compensating staff. Getting the credit methodology and product mix
right is therefore one of the most demanding as well as rewarding
challenges MFIs face.

 Savings Products

For most of its history, the microfinance industry has focused on delivering
microloans to microentrepreneurs, and it is still in the process of seeking
greater scale at greater speed for delivering microcredit. The experience of
microfinance institutions (MFIs) across the globe that mobilize savings,
however, demonstrates that the demand for deposit products is many times
that of credit. Although low-income customers save in several forms, not
necessarily through formal means, there is a pervasive for safe
mechanisms.

Accordingly, savings mobilization is becoming a critical strategic goal for

MFIs, especially as microfinance markets become more competitive. MFIs
are looking to build their capacity to mobilize savings, either as a funding
 strategy to support growth while reducing financial costs of funds, or, as a
marketing strategy to promote customer loyalty and retention.

One of the challenges that MFIs will face when mobilizing deposits is
controlling expenses, as operating costs of managing and delivering savings
services are relatively high. Micro savings customers are also more sensitive to
charges and fees than wealthier clients, given the smaller average balances and
income levels.
Another key challenge is for the MFI to diversify its target segment, as
mobilizing savings usually requires attracting a different clientele than the typical
micro entrepreneur. Savings mobilization also requires certain standards for
quality in customer service, which depends on key resources and capabilities,
such as technology, processes and qualified staff.

For institutions transforming into financial intermediaries, the

challenges are great as other issues – such as changing a corporate culture,
implementing practices required by regulation, developing key functions like
treasury and risk management, and building a brand image – require commitment
and significant investment.

 Insurance Products
Losses due to natural disasters, fire or death of a family member can be
devastating for anyone. For microentrepreneurs and other low-income
populations, even common illness can wipe out a lifetime of work, leaving them
without any resources to start over. Microinsurance products can help mitigate
the effects of losses on clients and their families so that they can retain and build
on the gains they have worked so hard to achieve and continue on the path out of
poverty.
Micro insurance is a nascent industry, which has made significant strides in the
last few years. Products are specially designed to meet the needs of poor clients:
premium payments are kept to a minimum, terms and conditions are clear and
simple, and exclusions and requirements such as medical examinations are
avoided to the greatest extent possible. Micro insurance includes but is not
limited to: Life, Health, Accidental Death and Disability, and Property products.
There are also country-specific challenges faced by MFIs related to the
country's regulatory environment and the availability of insurance companies
willing and able to underwrite client-appropriate programs that are competitively
priced

 Remittances
These are transfer of funds from people in one place to people in
another, usually across borders to family and friends. Compared with other
sources of capital that can fluctuate depending on the political or economic
climate, remittances are a relatively steady source of funds.
 Clients of Micro Finance
The typical micro finance clients are low-income persons that do not have access
to formal financial institutions. They are typically self-employed, often
household-based entrepreneurs.

In rural areas, they are usually small farmers and others who are engaged in small
income-generating activities such as food processing and petty trade. In urban
areas, microfinance activities are more diverse and include shopkeepers, service
providers, artisans, street vendors, etc. Micro finance clients are poor and
vulnerable non-poor who have a relatively unstable source of income.
Global India

Total MFIs 1,859 144

Gross loan portfolio 44.2 billion 2.1 billion

USD, 2008

Number of borrowers 82.9 million 16.4 million

2008

Deposits USD, 2008 23.7 billion 90.0 million

Average loan balance per 552.0 109.1

borrower USD, 2008
The Indian microfinance sector is expected to grow nearly ten times by 2011 to a
size of about Rs250 billion from the current market size of Rs27 billion, at a
compounded annual growth rate of 76%.

Services Provided by Micro Finance Bank

 PROVIDING LOANS:
The important service is provided by MFI is given loan. These loans are provided
from some productive activities like; starting new business, expansion of
business; improving life etc.

 CAR FINANCING:
MFI also assist those people who cannot pay total amount at once. So, these MFI
gave them car on installments like UBL car financing scheme is too popular and
too many people taking advantage from this scheme.

 HOME FINANCING:
Pakistan is a poor country. Purchasing power of Pakistan is very low. So many
people are living on rent. They cannot have too many amounts to purchase
homes. MFI’s provide loans be considering their job stability and take security
for it.

 PERSONNEL LOANS:
MFI also obtain personnel loans. Those people who have permanent employment
and stable jobs. This credit facility depends on the income of an individual.

 TALEEMI LOANS:
MFI also provide financial aid to the students who cannot bare educational
expenses but want to study. MFI assist them in return of some security and it
would have to pay after completing the education.
Comparative Analysis of Micro-
finance Services offered
 CRISIL List of Top 20 Microfinance
Institutions in India

1. SKS Microfinance Ltd (SKSMPL)

2 Spandana Sphoorty Financial Ltd (SSFL)
3 Share Microfin Limited (SML)
4 Asmitha Microfin Ltd (AML)
5 Shri Kshetra Dharmasthala Rural Development Project(SKDRDP)
6 Bhartiya Samruddhi Finance Limited (BSFL)
7 Bandhan Society
8 Cashpor Micro Credit (CMC)
9 Grama Vidiyal Micro Finance Pvt Ltd (GVMFL)
10 Grameen FinancialServices Pvt Ltd (GFSPL)
11 Madura Micro Finance Ltd (MMFL)
12 BSS Microfinance Bangalore Pvt Ltd (BMPL)
13 Equitas Micro Finance India P Ltd (Equitas)
14 Bandhan Financial Services Pvt Ltd (BFSPL)
15 Sarvodaya Nano Finance Ltd (SNFL)
16 BWDA Finance Limited (BFL)
17 Ujjivan FinancialServices Pvt Ltd (UFSPL)
18 Futures Financial Services ChittoorLtd (FFSL)
19 ESAF Microfinance & Investments Pvt. Ltd (EMFIL)
20 S.M.I.L.E Microfinance Limited.
 MICROFINANCE BUSINESS MODEL
The microfinance business model is designed to address the challenges
faced by the traditional financial services sector in fulfilling the credit
requirement of the low income segment at an affordable and sustainable cost.
Most MFIs follow the Joint Liability Group (JLG) model.

A JLG consists of five to ten women who act as co-guarantors for the other
members of their group. This strategy provides an impetus for prudent self-
selection of reliable and fiscally responsible co-members. Moreover, the JLG has
an inbuilt mechanism that encourages repayment in at timely fashion as issuance
of future loans is contingent upon the prior repayment record of the group.

Metric Amount (in India)

Interest rate charged typically 25-35% p.a.

Interest on debt 12-16%; lower for larger MFIs

Operating expense ratio 6-15% depending on level of

efficiency

ROA typically 3-5%

Debt/Equity Typically 5-8x

ROE 20-30%
 Micro-loan sizes vary from an initial loan size between $100 and $150 to
subsequent loans of $300 to $500 with an annual interest rate between 25% and
35%.The term loans are structured with weekly or monthly repayment schedules
and a 6-month to 2 year term. Microfinance institutions typically charge a higher
rate of interest to their clients than traditional commercial banks as the
administrative costs of servicing smaller loans is far higher in percentage terms
than the cost of servicing larger loans.

Additionally, MFIs provide doorstep services to their customers, a strategy that

has a high cost associated with it, especially in rural areas where population
densities tend to be low. Because of this model, MFIs generally face an operating
expense ratio (“OER”) between 6% and 15%, depending on the scale and
efficiency level of the particular MFI as well its area of operations.

Additionally, today, MFIs face borrowing costs in the range of 12% to 16% per
annum, depending on the size and track-record of the individual MFI. This model
allows well-run MFIs to achieve a ROA of about 3% to 5% and a ROE of as
much as 20% to 30%. These high ROA and ROE numbers are contingent upon
low cost financing from commercial banks and the ability to maintain high
portfolio growth along with high portfolio quality.

The portfolio quality for MFIs is typically superior to commercial banks with
total Nonperforming Assets 180 days past due of 0.2% to 3% as opposed to 3%
to 10% for commercial banks.
Metric Amount (in India)
 Legal Forms of MFI’s in India

Types of MFIs Estimated Legal Acts under

Number which Registered
1. Not for Profit 400 to 500 Societies Registration
MFIs Act, 1860 or
a.) NGO - MFIs similar Provincial Acts
Indian Trust Act, 1882
b.) Non-profit 10 Section 25 of the
Companies Companies Act, 1956
2. Mutual Benefit 200 to 250 Mutually Aided
MFIs Cooperative Societies
a.) Mutually Aided Act enacted by State
Cooperative Government
Societies (MACS) and
similarly
set up institutions
3. For Profit MFIs 6 Indian Companies Act,
a.) Non-Banking 1956
Financial Reserve Bank of India
Companies (NBFCs) Act, 1934
Total 700 – 800
 Market Trends
As the Indian microfinance sector matures, it is expected the year-on-year growth
rate to decline to still high, but more sustainable levels. Over the next four years,
it is projected 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, it is expected 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.

Some Encouraging Trends in the Microfinance Sector

Trend 1 – Diversification of MFIs: microfinance providers are beginning to

broaden the range of services offered under the microfinance umbrella which
started with microcredit, but now includes micro-insurance, micro savings and
money transfer facilities as well.
Trend 2 – Specialization of MFIs: microfinance providers are beginning to
focus on certain livelihoods such as crop insurance, or handicraft financing, etc.
As MFIs study each business model, they can produce services that are aligned
with the unique cash flow cycles or the varying demand patters of the client’s
business.
 Trend 3 – Turnkey Solutions: some MFIs are beginning to provide non-
financial services to support their clients’ businesses, such as assisting them with
their supply chain, or sharing ‘marketing infrastructure to enhance these micro-
businesses’.

Trend 4 – New channels: clients no longer have to visit physical offices of

MFIs in order to avail certain services. Franchise-based business models
and branchless banking are becoming effective ways of reaching potential clients
who often live in disparate rural areas.
 Investment Climate
Today, microfinance is gaining prominence as a viable asset class globally,
particularly in India. MFIs in India have continued to attract large amounts of
capital despite the global economic recession. Currently, it is reported that over
100 microfinance investment vehicles (“MIVs”) exist globally, and India is a
focus for many of them due to its large market size, growth capacity, profitable
business models and potential development impact. Moreover, mainstream
investors are beginning to participate in this sector, picking up larger stakes than
the social investors that have been dominant so far. The entrance of mainstream
investors is indicative of an industry that is maturing, but is still expected to grow
at a high rate.

Even though the microfinance industry is reaching maturity, the large amounts of
untapped geographical territory and client base combined with the MFIs’ wide
network create potential for enormous sustainable growth in the future.
MFIs and other service providers are beginning to realize the significant value of
the network that has been created by MFIs and efforts are underway to utilize
them to deliver both, financial and nonfinancial products and services. These
factors will continue to impact the supply of equity for Indian microfinance and
hence the equity valuations. Furthermore, since this untapped demand is unlikely
to be satisfied in the short or medium term, while valuations will be tempered by
cautious investors, premia driven by fundamental growth expectations can be
expected to prevail through the short and medium term as MFIs re-engineer their
strategies to take advantage of the unsatisfied microloan demand.
 Microfinance Bubble
Microfinance has grown at a sharp clip in recent years. Large amounts of capital
are flowing to the sector as major banks like Morgan Stanley, Citigroup, and
Barclays Bank, among others, prove that investing in microfinance is not a
charitable activity anymore. In addition to the involvement of banks and other
large companies, microfinance is flooded with funding from a new breed of
philanthro-capitalists such as Bill Gates, Warren Buffett, and e-Bay founder
Pierre Omidyar. Overall, the microfinance sector can expect to see a sixfold
increase in foreign funding over the next several years.. Despite the increasing
amount of investment in microfinance, most of these dollars are chasing the same
mature and commercially sustainable microfinance institutions that provide a
predictable return. An example of this is the wildly successful initial public
offering of Mexico's Banco Compartamos, which took place in April 2007. In ten
years Compartamos went from a financially self-sufficient NGO to a bank with
five successful bond offerings in the market, all rated investment grade by
Standard and Poor's and Fitch Ratings. The recent success of Compartamos and
Microvest demonstrates that commercial capital now provides an important
source of funding for microfinance. As the handful of investment banks and large
companies active in the sector establish the business potential of microfinance,
others will want their piece of the profit from this emerging asset class. Standard
& Poor's2 notes that the USD 15 billion-plus in microloans that are currently on
the books pales next to the potential of some USD 150 billion in lending. With a
large amount of capital chasing a limited amount of quality assets, microfinance
could be the next asset bubble.
 Success Factors of Micro-Finance in India
Over the last ten years, 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 grass root 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

A. For NGOs

The field of development itself expands and shifts emphasis with the pull of
ideas, and NGOs perhaps more readily adopt new ideas, especially if the
resources required are small, entry and exit are easy, tasks are (perceived to
be) simple and people’s acceptance is high – all characteristics (real or
presumed) of microfinance. Canvassing by various actors, including the
National Bank for Agriculture and Rural Development (NABARD), Small
Industries Development Bank of India (SIDBI). Induced by the worldwide
focus on microfinance, donor NGOs too have been funding microfinance
projects.

B. For Financial Institutions and banks

Microfinance has been attractive to the lending agencies because of

demonstrated sustainability and of low costs of operation. Institutions like
SIDBI and NABARD are hardnosed bankers and would not work with the
idea if they did not see a long term engagement – which only comes out of
sustainability (that is economic attractiveness).
 On the supply side, it is also true that it has all the trappings of a business
enterprise, its output is tangible and it is easily understood by the
mainstream.

This also seems to sound nice to the government, which in the post
liberalization era is trying to explain the logic of every rupee spent. That is
the reason why microfinance has attracted main stream institutions like no
other developmental project.

Real life Examples:

Lakshmi, a 22-year-old school dropout, lived in a remote village of

Tamil Nadu. Instead of getting married and starting a family like any other
village girl of her age in India, she wanted to set up on her own business.
Lakshmi started an Internet kiosk in her village, offering services like e-mail,
Internet chat and tips on health and education. The kiosk was partially financed
by ICICI Bank and was set up in association with n-Logue Communications.

Latha, a 29-year-old married woman with three children borrowed

Rs.18,000 to set up a small provision store in Kothaipalli, a small village, in the
north of Andhra Pradesh. Within a year, she started earning Rs.3500 a month
from the store. With this money, she was able to provide her children a good
education at a local private school. She was a part of a self-help group in Andhra
Pradesh which received financial assistance from ICICI Bank.
These are real-life examples to illustrate how the micro-lending initiatives
of ICICI Bank affected the lives of poor women in India.
 Issues in Microfinance
Sustainability

The first challenge relates to sustainability. MFI model is comparatively costlier

in terms of delivery of financial services. An analysis of 36 leading MFIs shows
that 89% MFIs sample were subsidy dependent and only 9 were able to cover
more than 80% of their costs.

This is partly explained by the fact that while the cost of supervision of credit is
high, the loan volumes and loan size is low. It has also been commented that
MFIs pass on the higher cost of credit to their clients who are ‘interest
insensitive’ for small loans but may not be so as loan sizes increase. It is,
therefore, necessary for MFIs to develop strategies for increasing the range and
volume of their financial services.

Lack of Capital

The second area of concern for MFIs, which are on the growth path, is that they
face a paucity of owned funds. This is a critical constraint in their being able to
scale up. Many of the MFIs are socially oriented institutions and do not have
adequate access to financial capital. As a result they have high debt equity ratios.

Presently, there is no reliable mechanism in the country for meeting the equity
requirements of MFIs.The book value multiple is currently the dominant
valuation methodology in microfinance investments.

In the case of startup MFIs, using a book value multiple does not do justice to
the underlying value of the business. Typically, startups are loss making and
hence the book value continually reduces over time until they hit breakeven
point. A book value multiplier to value startups would decrease the value as the
organization uses up capital to build its business, thus accentuating the negative
rather than the positive.
Financial service delivery
Another challenge faced by MFIs is the inability to access supply chain.
This challenge can be overcome by exploring synergies between microfinance
institutions with expertise in credit delivery and community mobilization and
businesses operating with production supply chains such as agriculture.

The latter players who bring with them an understanding of similar client
segments, ability to create microenterprise opportunities and willingness to
nurture them, would be keen on directing microfinance to such opportunities.

This enables MFIs to increase their client base at no additional costs. Those
businesses that procure from rural India such as agriculture and dairy often
identify finance as a constraint to value creation. Such businesses may find
complementarities between an MFI’s skills in management of credit processes
and their own strengths in supply chain management.

HR Issues

Recruitment and retention is the major challenge faced by MFIs as they

strive to reach more clients and expand their geographical scope. Attracting
the right talent proves difficult because candidates must have, as a
prerequisite, a mindset that fits with the organization’s mission.

Many mainstream commercial banks are now entering microfinance, who

are poaching staff from MFIs and MFIs are unable to retain them for other
job opportunities. 85% of the poorest clients served by microfinance are
women. However, women make up less than half of all microfinance staff
members, and fill even fewer of the senior management roles.

The challenge in most countries stems from cultural notions of women’s

roles, for example, while women are single there might be a greater
willingness on the part of women’s families to let them work as front line
 staff, but as soon as they marry and certainly once they start having
children, it becomes unacceptable. Long distances and long hours away
from the family are difficult for women to accommodate and for their
families to understand.

Microinsurance

First big issue in the microinsurance sector is developing products that really
respond to the needs of clients and in a way that is commercially viable.
Secondly, there is strong need to enhance delivery channels. These delivery
channels have been relatively weak so far. Microinsurance companies offer
minimal products and do not want to go forward and offer complex products that
may respond better.

Microinsurance needs a delivery channel that has easy access to the low-income
market, and preferably one that has been engaged in financial transactions so that
they have controls for managing cash and the ability to track different
individuals.

Thirdly, there is a need for market education. People either have no information
about microinsurance or they have a negative attitude towards it. We have to
counter that. We have to somehow get people - without having to sit down at a
table - to understand what insurance is, and why it benefits them. That will help
to demystify microinsurance so that when agents come, people are willing to
engage with them.

Adverse selection and moral hazard

The joint liability mechanism has been relied upon to overcome the twin issues
of adverse selection and moral hazard. The group lending models are contingent
on the availability of skilled resources for group promotion and entail a gestation
period of six months to one year.

However, there is not sufficient understanding of the drivers of default and credit
risk at the level of the individual. This has constrained the development of
individual models of micro finance.
The group model was an innovation to overcome the specific issue of the quality
of the portfolio, given the inability of the poor to offer collateral.

However, from the perspective of scaling up micro financial services, it is

important to proactively discover models that will
enable direct finance to individuals.
 EXITS
For early stage investors the most likely source of exit remains secondary or
trade sales. In terms of potential M&A exit scenarios, the most likely scenario is
the entry of banks as acquirers in the medium term with the RBI’s and the
government’s emphasis on using banks to deliver more effective financial
inclusion – they could leverage MFIs as the last-mile distribution platform for the
existing banking system.

Banks could potentially find it easier to complete acquisitions compared to large

MFIs as they are less promoter driven and have better institutional capacity to
integrate acquisitions. Acquisitions of regional MFIs by large national MFIs is
also possible given certain conditions – the regional MFI would need to have
strong penetration in its local market, a similar basic operating model as the
acquiring MFI and a certain minimum portfolio size of approximately $50
million to $75 million.

The MFI sector could also see a merger of equals between two mid to large
sized MFIs as the industry matures and consolidates over the medium term.
Some large MFIs including two to three in portfolio could consider a potential
listing in one to two years, but IPOs will be a challenge for the sector
overall given limited market experience in listing socially-focused firms.

Criteria for a successful IPO will include size; the capacity to absorb large
amounts of capital and generate post-issue liquidity of the listed shares; operating
experience of the management team; track-record of value creation; and
institutional capacity to deal with the listing process, compliance requirements
and public scrutiny.
 In this regard, the experience of SKS Microfinance in executing its proposed
IPO in 2010 will be a useful learning experience for the microfinance sector to
determine the extent to which a social business model such as microfinance can
be accepted by mainstream and particularly retail investors, and the value these
investors are willing to ascribe to its potential.

That exits are still uncommon in microfinance means that for early stage
investors like entrepreneurs need to be made aware of their exit obligations, and
investors’ relationships with entrepreneurs will be key in realizing exits,
especially for minority shareholders.

The ability to work with different mainstream investors, MFI promoters, banks
and industry regulators as well as investors’ prior experience and track-record of
executing exits in the Indian market will be the key to completing successful
exits in Indian microfinance companies.
CASE STUDY
SKS Microfinance Ltd
SKS Microfinance (SKSMF) is the largest microfinance company in
India with loan portfolio of ~US$1bn, 2,000+ branches spread across 19
states and 6.8mn members. Its strengths include pan-India presence,
scalable operating model, diversified product revenues and access to
various sources of capital. Lending primarily to poor women, the
business model involves village centered group lending, thereby
ensuring a check on asset quality. The huge demand-supply credit gap
and inability of banks to penetrate into unbanked areas have driven the
growth of microfinance industry. While valuations appear expensive,
the scalable business model, market leadership position and high
earnings growth provide comfort.

Rural centric business model

The success of SKS has evolved around five key elements: a)
village selection, b) focus towards women, c) member training, d)
group lending and e) village level lending and collection. With
lending primarily to poor women, the company has expanded its
reach to 2,029 branches spread across 19 states and over 6.8mn
members. The pan-India presence has further helped mitigate the
risk towards local economic slowdowns and disruption. Through
systems and solutions in place, it has developed a scalable 3C’s
model – Capital, capacity and cost reduction, which in turn has
helped reach rural masses in large.
Diversified sources of revenue and capital
In addition to core business towards providing traditional loan
products, the company has started offering productivity loans
directly linked to business. This involves strategic alliances with
Nokia, Airtel, Bajaj Allianz, HDFC, METRO and FAL. Despite being a
NBFC-ND, the company has benefited from benign interest rate
regime and enhanced sovereign ratings. Historically, it has raised
funds via alternate channels including – equity and debt issuance,
loans with various maturities raised from domestic and
international banks, and the securitization of components of loan
portfolio.

Limited concerns over asset quality

The village centered, group lending model has ensured SKSMF an
adequate check on asset quality. Innovative product structuring,
focus on income generating loans and primary focus at women
have enabled the company to maintain its GNPA and NNPA at low
0.33% and 0.16% respectively. In case of default by an existing
member, the group is required to typically make the payment on
behalf of a defaulting member. Any negligence towards payment
bars the group from further borrowing.
Financial highlights
(Rs FY07 FY08 FY09 FY10
(I(Rs mn FY07 FY08 FY09 FY10

Revenues 445 1625 5060 8736

yoy growth - 265.1 211.5 72.6
(%)
Operating 457 1700 5540 9589
profit
PAT 22 166 797 1748
yoy growth - 651.3 380.6 119.5
(%)
EPS (Rs) 0.8 3.7 14.0 27.1
BV per share 26.8 47.8 116.0 146.6
(Rs)
RONW (%) 3.1 7.8 12.2 18.4

Issue details
Issue opens 28-Jul-10
Issue closes* 2-Aug-10
Price band (Rs)** 850-985
Face value (Rs) 10
Lot size 7
Total Issue size(mn) 16.79
- Offer for sale (mn) 9.34
Issue size (Rs m) 16,540
Issue type 100% Book building
IPO rating CARE IPO Grade 4
Industry - Finance
*Closure date for institutional investors is 31st July, 2010
**Rs50 discount has been offered to retail investors
Shareholding pattern (%)
Shareholding pattern (%) Pre IPO Post IPO
Promoters &
promoters group 55.8 37.1
Non Promoters 44.2 39.6
Public - 23.3
Share reservation (%) (%)
QIB 60
Non institutional 10
Retail 30
Company managementmanagement
Dr. Vikram Akula Chairman
Mr. Suresh Gurumani Managing Director
Issue manager
Lead manager Kotak Investment Banking,
Citi,Credit Suisse
Registrar Karvy
Listing NSE, BSE
Objective of issues (Rs m)

Objective of issues
To augment capital base to
meet future capital requirements
To achieve the benefits of
listing on the Stock Exchanges

SKS Microfinance, microfinance firm, listed at Rs. 1,036 a share on the

Bombay Stock Exchange, reflecting a gain of five per cent over the
issue price.

In line with market expectations, SKS Microfinance opened at Rs.

1,036, up 5.17 per cent over its issue price of Rs. 985 per share. Within
minutes of trade, the scrip soared nearly 18 per cent to touch a high of
Rs. 1,159.90 per piece.
The company made a smart debut on the National Stock Exchange as
well opening with a premium of over five per cent at Rs. 1,040 a share.
It was later trading up 16.24 per cent at Rs. 1,145 a share.

On the volume front over 44 lakh shares of the Hyderabad- based firm
changed hands on the bourses in early trade. "The brilliant listing of
SKS reflects investor confidence. No doubt it is a pleasant listing and
clearly shows sign of market recovery. The IPO had generated a huge
response and the company's debut on the bourses are in line with market
expectations," SMC Capitals Equity Head Jagannadham Thunuguntla
said.

The company which entered the capital market on July 28 raised Rs.
1,654 crore through its initial public offer. The public issue of 1.6 crore
shares was priced in the range of Rs. 850 to 985 a share.

SKS, founded by Vikram Akula, had fixed the issue price of its IPO at
Rs. 985 per share, the upper band of the price range. Retail investors got
SKS shares at a discount of Rs. 50 per piece at Rs. 935 per share.

Meanwhile, the broader market was quoting down 21.97 points at

18,144.81 points.

Analysis
 SKS Microfinance has a high capital adequacy ratio (of 28.3 per
cent which may further improve to excess of 40 per cent post-
offer) and strong risk-management systems which address two
concerns MFI are facing today — access to capital and
maintenance of asset quality.

 Most of the portfolio comes under ‘priority lending’ norms of the

RBI enabling the sale of this portfolio to other mainstream lending
institutions; this also reduces funding costs for SKS to that extent.

While the yields are high, so are operating costs. Operating costs
are higher than interest costs and are likely to remain so. However,
SKS’ cost-income ratio fell to 52per cent for 2009-10 from 62 per
cent.

Over-leveraging by the borrowers is a key risk, as there have been

instances where borrowers accessed funds from multiple lenders.

 Another concern is the seasonalityof the earnings, which are back-

ended to the second half of the year. Given that the MFI loans are
to low income groups, during natural calamities, the loan
portfolios may result in NPAs due to the inability of the borrower
to pay.

 Retaining a skilled workforce is a challenge (SKS has attrition

rates upwards of 25per cent), which may expand the already high
operating costs, given substantial costs involved in training
employees.
 CONCLUSION
The strength and sustainability of the Indian microfinance business
model lies in the fact that it is serving a large unmet need for financial
inclusion. It has thus far successfully tackled challenges that have faced
other financial service providers in meeting the demands of this sector
through creative product innovation with awareness of the segment’s
particular needs and capacities and use of the joint liability group
mechanism to manage risk.

The model has been successful in maintaining excellent portfolio

quality even with extremely rapid expansion over the last few years.
The large size of the currently unbanked population in India and
diversity of geography means that the microfinance sector has great
potential for continued high growth. Moreover, as the sector approaches
maturity, there will be increasing attention focused toward client and
geographical diversification and product innovation, financial and non-
financial. Besides expanding their own services, MFIs are also being
viewed as potential channels for delivery of other products and services
to low income and rural populations. Since the scale of the Indian MFI
industry has exceeded 20 million clients, other consumer product and
service providers are beginning to attach greater value to the
microfinance distribution network.

Given this growth and maturity dynamic, the Indian microfinance sector
is increasingly seen as a viable investment target with commercial
investors joining the social investors who have been nurturing the
industry thus far. Equity valuations in the Indian microfinance sector are
higher than the financial sector in general and global MFIs in particular
due to the high growth expectations and substantial availability of debt
to fuel its rapid expansion.
MFI shares are expected to trade at significant premium to book over
the short and medium term as MFIs realign their business models to
capitalize on unsatisfied demand, and cool down over the longer term as
the industry matures and begins to consolidate.

As more investors enter the market, exit opportunities are also

increasing in the form of secondary and trade sales. Larger MFIs may
also consider IPOs, although that may not be a realistic exit option for
most MFIs in the short to medium term. Another likely exit scenario is
M&A, as larger MFIs seek to acquire players with product or
geographical niches.

The industry is in its initial stage and its development could take many
forms, but we expect growth, innovation and financial performance to
continue on an encouraging path.
 References
 www.microfinancegateway.org
 www.grameenfoundation.org
 www.sksindia.com
 www.mixmarket.org
 www.cgap.org
 Banker to the poor- Muhammad Yunus