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Primer on Micro Financing Institutions (MFI)

When the idea for this blog was still in an early stage and I was socializing it with close friends, I was frequently asked about which “verticals” of social enterprises I’d be focusing on. My answers ranged from “Don’t know yet” to “Will start in a breadth-wise fashion and then home in on verticals later”. I initially thought Micro Financing Institutions (MFI) could be skipped since there was already so much attention, coverage and mind-share in that sector by mainstream media and blogs. I realized later that this was akin to starting a technology blog in Silicon Valley in 2005 and saying “I’ll cover everything except Web 2.0 startups”. Now that we’ve settled that bit of evolution history, the rest of the post attempts to be a primer for MFIs in India.

Definitions

Microcredit is the extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit.

Microfinance is a broader category of services which includes microcredit and insurance. A Micro Finance Institution (MFI) can organize itself in the form of a trust, registered under the Commissioner of Trusts and Charity or a Section 25 company, registered with the Registrar of Companies or else an NBFC (see next) under RBI norms.

NBFC (Non Banking Financial Company): NBFCs perform functions similar to that of banks but an NBFC cannot accept demand deposits, hence they can’t support Savings accounts for their customers. MFIs incorporated as NBFCs can deal with loans (microcredit) and insurance. Most Indian MFIs have morphed into NBFC’s primarily because it enables them to borrow more from banks to invest in their expansion.

Financial Inclusion: Financial inclusion is the delivery of financial services at affordable costs to sections of disadvantaged and low income segments of society. In the Indian context, it’s a superset of microfinancing – i.e. the scope includes loans, insurance, savings, and remittances. According to Wikipedia, India has currently the second-highest number of financially excluded households in the world. Approximately, 40% of India s population have bank accounts, and only about 10% have any kind of life insurance cover, while a meager 0.6% have non-life insurance cover.

Microfinance Institutions Network (MFIN) is a self-regulatory organization of NBFC MFIs (34 of them) that aims to work with regulators (primarily Reserve Bank of India) to promote microfinance to achieve larger financial inclusion goals. MFIN is supported by Omidyar Network (philanthropic investment firm) and International Finance Corporation (IFC), a member of the World Bank Group.

Self Help Group (SHG): A self help group is a village-based financial intermediary usually composed of between 10-20 local women. Members make small regular savings contributions over a few months until there is enough capital in the group to begin lending. Funds may then be lent back to the members or to others in the village for any purpose. In India, many SHGs are ‘linked’ to banks for the delivery of microcredit. SHG’s predate MFI’s by a couple of decades but have been overshadowed in the last 10 years by MFIs.

SHG Bank Linkage Program: Under a NABARD scheme, SHGs borrow from banks once they have accumulated a base of their own capital and have established a track record of regular repayments. NABARD estimates that there are 2.2 million SHGs in India, representating 33 million members, that have taken loans from banks under its linkage program. The four Southern states (AP, Kerala, Tamil Nadu & Karnataka) accounted for 57 % of the SHG credits linked during the financial year 2005-2006.

Five Myths of Microfinance in India

Vijay Mahajan, Founder/Chairman of Basix and head of MFIN, debunks five myths pertaining to microfinance in India:

  • First is the idea that poor should be self-employed rather than work for wages. That is contrary to the whole history of successful economic development.
  • Second is the idea that loans are the main financial services needed by the poor, whereas they really need savings and insurance.
  • Third is the idea that credit is what builds enterprise, whereas the truth is that entrepreneurship and management are more important.
  • Fourth is the idea that the non-poor don’t need credit, whereas the truth is revealed in market-based banking: higher incomes can handle higher debt.
  • Fifth is the idea that micro credit institutions can become self-sustaining, whereas all experience shows that new enterprises in poor areas that are built on credit alone rarely emerge from dependency.

Stats around MFIs

  • 1,109 MFIs in India as of 2008 (Source: National Bank for Agriculture and Rural Development (NABARD))
  • Andhra Pradesh is the hub of micro financing in India. AP represents 21% of overall borrowers and 30% of overall loans with an average loan of 62,500 INR.
  • Indian MFI industry has close to 30,000 crores outstanding loans by end of 2010 to 30 million borrowers.
  • In 2009, borrowing households in AP had, on average, 10 Microfinance loan accounts and 3 microfinance loans for every 2 households.
  • 75% of NBFC MFIs funds come from banks and financial institutions. As of Mar 2010, this represented around 14,000 crores.
  • 85% of loan volume is generated by MFI’s incorporated as NBFCs. MFIs incorporated as societies and trusts represent 4.6% and 4% respectively of the loan volume.
  • 8 public & private banks (State Bank of India, Bank of India, Indian Overseas Bank, Punjab National Bank, Andhra Bank, SIDBI, Axis Bank and ICICI) have maximum exposure to MFI firms, estimated to be 70% of total outstanding credit.

In Oct 2010, the industry plunged into a crisis after two dozen farmer suicides in Andhra Pradesh were attributed to repayment pressures by MFI collection agencies. The AP government reacted quickly by enacting an ordinance with severe implications to the MFI industry. Changes to the collection schedule (monthly instead of weekly), capping of interest rates, tighter regulation of MFIs assets are some of the proposed changes. The operations of majority of MFIs (especially those with strong presence in AP) are affected. The immediate impact of the AP ordinance has been: a) Significantly reduced collections, b) Reduced loan approvals, c) Significant reduction (or stoppage) of inbound loans to MFIs from banks – some MFIs are facing a liquidity crisis due to this. More in the next MFI post – Indian MFIs at the Crossroads.