Professional Documents
Culture Documents
ON
MEASURI NG PERFORMANCE AND VI ABI LI TY OF
MI CROFI NANCE I NSTI TUTI ONS-A CASE OF BANDHAN
MI CROFI NANCE SOCI ETY
SUBMI TTED BY:
MR. AMI TKUMAR SHARMA
MMS (FI NANCE) 2007-09
UNDER THE GUI DANCE OF:
PROF. ANI L GOR
CERTI FICATE
This is to certify that Mr. Amitkumar Sharma student of Masters in
Management Studies (Finance) of N. L. Dalmia I nstitute of Management
Studies and Research has satisfactorily completed final project on Measuring
Performance and Viability of Microfinance I nstitutions-A case of Bandhan
Microfinance Society under my supervision and guidance as partial fulfillment
of requirement of Masters in Management Studies course, Mumbai
University, 2007 09.
Prof Anil Gor Prof. P.L.Arya
Project Guide Director
Place: Mumbai
Date: 30th March, 2009
3
ACKNOWLEDGEMENTS
At the completion of my project, I would like to thank all those who helped me knowingly
and unknowingly.
I would like to express my deep sense of gratitude towards Director Prof. P.L.Arya of
N.L.Dalmia Institute of Management Studies And Research for giving me an opportunity to
do my Final Project.
I would like to thank my guide, Prof. Anil Gor for helping me out at each and every point of
time. I am very grateful to him for guiding me throughout the project, who advised me at all
the right times. I also thank him for his valuable time and continued assistance for the
successful completion of the project.
And last but not least I would like to thank all the faculty, staff of the institute for their direct
or indirect help in making my project an unforgettable and great learning experience.
4
Executive Summary
Major impediments to poverty alleviation and rapid economic growth in developing countries
are the lack of capital resources, especially in rural areas. A vicious cycle of low capital, low
productivity, low incomes, low savings and consequently weak capital base is clearly
operating. This results in a permanent poverty syndrome.
A multi-agency approach for providing working capital and asset acquisition to rural
borrowers has been in operation in India since 1969 with the nationalisation of 14 large
commercial banks. Regional Rural Banks were formed since 1975 with increasing emphasis
on priority sector lending targeted to the poor and the weaker sections of society. The failure
of many supply-led state interventions in rural-credit involving capital or interest subsidies
(like IRDP) is an established fact.
This has been accompanied by the rise in the social entrepreneurs. Using strategies involving
groups of women, joint liability lending, small loans, weekly repayments, it has been proved
that lending to poor people is possible and profitable. Micro Finance has been emerging as a
tool in this regard.
The rapid expansion of MFIs and the ongoing interest of mainstream investors-even in the
current financial crisisconfirm to the belief that microfinance is on the path to becoming an
emerging market asset class.
To achieve this potential, the industry must continue to widen and mobilize the investor base,
especially given the current market turmoil, while expanding the universe of effective and
sustainable MFIs.
This paper aims to measure performance and viability of an MFI called Bandhan
Microfinance Society with the help of globally accepted metrics which could be used by
the possible investors and lenders.
5
Contents
1. INTRODUCTION .......................................................................................................................... 7
Microfinance Defined ..................................................................................................................... 7
Clients of Microfinance .................................................................................................................. 8
Economics of Microfinance ............................................................................................................ 9
2. MICROFINANCE VS TRADITIONAL BANKING ................................................................... 11
3. LEGAL FRAMEWORK OF MICRO FINANCE INSTITUTIONS IN INDIA .......................... 14
Self Help Group and Federation: .................................................................................................. 14
Societies ........................................................................................................................................ 14
Trusts ............................................................................................................................................ 15
Co-operative Societies .................................................................................................................. 15
Co-operative Banks ....................................................................................................................... 16
Regional Rural Banks ................................................................................................................... 16
Local Area Banks .......................................................................................................................... 16
Private Banks ................................................................................................................................ 17
Section 25 Companies ................................................................................................................... 17
Non Banking Financial Companies .............................................................................................. 17
Organizations under BC/BF guidelines of the RBI ...................................................................... 18
Microfinance Bill .......................................................................................................................... 19
4. Micro Finance Delivery Models in India ...................................................................................... 21
Self Help Group (SHG) Model: .................................................................................................... 21
Federated Self Help Group Model: ............................................................................................... 22
Grameen Bank Model: .................................................................................................................. 23
ICICI Bank partnership model ...................................................................................................... 24
5. INDIAN MICROFINANCE MARKET ....................................................................................... 27
Need for Microfinance in India ..................................................................................................... 27
Major Milestones .......................................................................................................................... 28
Recent Trends ............................................................................................................................... 31
The on-lending funds constraint ................................................................................................... 33
Private equity in microfinance ...................................................................................................... 35
6. BANDHAN MICROFINANCE SOCIETY ................................................................................. 43
Operational Methodology ............................................................................................................. 43
Loan Products ............................................................................................................................... 44
Determination of effective rates on the Loan Products ................................................................. 45
7. ADJ USTMENTS TO THE FIANCIAL STATEMENTS ............................................................. 50
Why adjust for subsidies and concessions? .................................................................................. 50
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1. I NTRODUCTI ON
Interest in the microfinance industry has soared as participants gain a better understanding of
the potential for microfinance institutions (MFI) to alter lives and economies. The primary
business of these organizations is providing small loans and financial services to low income
and/or financially underserved clients.
The evolution and performance of the microfinance industry over the past 30 years has been
impressive. However, this success brings with it a myriad of challenges. Significant risks
exist, including management quality and staffing of MFIs, as well as their governance,
technological expertise, and ability to effectively manage growth while maintaining a
commitment to their original mission. As many MFIs continue to transform from not-for-
profit entities to for-profit banks, these risks may be exacerbated. Effectively managing and
mitigating them will be instrumental to expanding the industry. Therefore, the impetus to
attract global capital needs to be tempered by prudent codes of conduct and globally
recognized standards.
Microfinance Defined
Micro finance is defined as the provision of thrift (savings), credit and other financial
services and products of very small amounts to the poor for enabling them to raise their
income levels and improve living standards.
Thus the contours of Microfinance are as follows:
Piloted by the alternate sector (NGO-MFIs)
Focused on the poor / women /vulnerable groups
Having roots in development.
The proposed Microfinance Services Regulation Bill defines microfinance services as
providing financial assistance to an individual or an eligible client, either directly or through
a group mechanism for:
an amount, not exceeding rupees fifty thousand in aggregate per individual, for small
and tiny enterprise, agriculture, allied activities (including for consumption purposes
of such individual) or
an amount not exceeding rupees one lakh fifty thousand in aggregate per individual
for housing purposes
8
climate, activeness of cooperatives, SHG & NGOs and support mechanism. For instance,
micro credit might have a far more limited market scope than say a more diversified range of
financial services, which includes various types of savings products, payment and remittance
services, and various insurance products. For example, many very poor farmers may not
really wish to borrow, but rather, would like a safer place to save the proceeds from their
harvest as these are consumed over several months by the requirements of daily living.
Economics of Microfinance
Why Doesnt Capital Naturally Flow to the Poor?
One of the first lessons in introductory economics is the principle of diminishing marginal
returns to capital, which says that enterprises with relatively little capital should be able to
earn higher returns on their investments than enterprises with a great deal of capital. Poorer
enterprises should thus be able to pay banks higher interest rates than richer enterprises.
Money should flow from rich depositors to poor entrepreneurs. The diminishing returns
principle is derived from the assumed concavity of production functions. Concavity is a
product of the very plausible assumption that when an enterprise invests more (i.e., uses more
capital), it should expect to produce more output, but each additional unit of capital will bring
smaller and smaller incremental (marginal) gains. The size of the incremental gains matter
since the marginal return to capital determines the borrowers ability to pay. The poorer
entrepreneur has a greater return on his next unit of capital and is willing to pay higher
interest rates than the richer entrepreneur.
On a larger scale, if this basic tool of introductory economics is correct, global investors have
got it all wrong. Instead of investing more money in New York, London, and Tokyo, wise
investors should direct their funds toward India, Kenya, Bolivia, and other low-income
countries where capital is relatively scarce. Money should move from North to South, not out
of altruism but in pursuit of profit.
However this seldom happens. The first place to start in sorting out the puzzle is with risk.
Investing in Kenya, India, or Bolivia is for many a far riskier prospect than investing in U.S.
or European equities, especially for global investors without the time and resources to keep
up-to-date on shifting local conditions. The same is true of lending to cobblers and flower
sellers versus lending to large, regulated corporations. But why cant cobblers and flower
sellers in the hinterlands offer such high returns to investors that their risk is well
compensated for?
10
One school argues that poor borrowers can pay high interest rates in principle but that
government-imposed interest rate restrictions prevent banks from charging the interest rates
required to draw capital from North to South and from cities to villages. If this is so, the
challenge for microfinance is wholly political. Advocates must only convince governments to
remove usury laws and other restrictions on banks, then sit back and watch the banks flood
into poor regions. That is easier said than done of course, especially since usury laws (i.e.,
laws that put upper limits on the interest rates that lenders can charge) have long histories and
strong constituencies.
Once lack of information is brought into the picture (together with the lack of collateral), we
can more fully explain why lenders have such a hard time serving the poor, even households
with seemingly high returns. The important factors are the banks incomplete information
about poor borrowers and the poor borrowers lack of collateral to offer as security to banks.
The first problemadverse selectionoccurs when banks cannot easily determine which
customers are likely to be more risky than others. Banks would like to charge riskier
customers more than safer customers in order to compensate for the added probability of
default. But the bank does not know who is who, and raising average interest rates for
everyone often drives safer customers out of the credit market.
The second problem, moral hazard, arises because banks are unable to ensure that customers
are making the full effort required for their investment projects to be successful. Moral
hazard also arises when customers try to abscond with the banks money. Both problems are
made worse by the difficulty of enforcing contracts in regions with weak judicial systems.
11
As with traditional banks, some types of MFIs deposits are less stable than others. Large
institutional deposits and interbank deposits can move quickly, whereas retail deposits
(both demand and savings) tend to be more stable.
Borrowings: Key feature is longer maturity Because of their social agenda, MFIs are able
to attract longer term funding from public agencies, microfinance specialized funds, and
development institutions. This provides MFIs with a favorable tenor mismatch between
liabilities (longer tenor) and assets (typically less than a year).
14
Co-operative Banks
Could be -Primary co-operative bank (urban co-operative banks), State co-operative
bank, Central co-operative bank
Registered under central/state/multi-state co-operative acts. Regulated by Registrar of
Co-operatives for registration, management and audit
Regulated under the Banking Regulation Act, 1949 by the Reserve Bank of India for
licensing, area of operations and interest rates
Can undertake most of the banking activities
Difficulty in raising equity and tendency to get political.
Respective state governments have close control over central co-operative banks and
state cooperative banks. Many of these are not well-managed.
Series of irregularities have been noted by RBI in many primary co-operative banks
and it has taken action against several existing banks.
RBI is reluctant to give new licenses owing to failure of a large number of co-
operative banks in different parts of the country
Regional Rural Banks
Established by the Central Government through a notification in the official gazette
Minimum capital requirement is Rs2.5 million
The share capital of the RRBs is required to be held by the Central Government,
State Government and Sponsor Bank in the ratio 50:15:35
From the financial year 2006-07 RRBs have been brought under Income Tax net
RBI has also stipulated that RRBs need to maintain disclose CAR starting March
2008.
Local Area Banks
RBI allowed the establishment of Local Area Bank in 1996
LABs are registered as public limited companies under the Indian Companies Act
1956
Minimum capital requirement for a LAB is Rs50 million
Are allowed to operate in three geographically contiguous districts
Can mobilise deposits from public
17
Prudential norms related to banks are applicable but rules relating to liquidity and
interest rates applicable to RRBs are applicable
At present only four LABs are functioning and no new licenses are being issued
Resumption of licensing of LABs with stricter capital requirements being considered
Private Banks
Private banks have to obtain license from RBI under the Banking Regulation Act -
1949
A minimum capitalization of Rs3bn (Rs300 crores) is required for private sector
banks, including wholly owned subsidiaries of foreign banks
Can do normal banking activities
Section 25 Companies
Section 25 Companies are promoted for the purpose of promotion of commerce, arts,
religion, charity or any other useful purpose
They are prohibited from payment of dividends
RBI has exempted NBFCs licensed under section-25 of the Indian Companies Act
from registration, maintenance of liquid assets and transfer of profit to Reserve Funds,
provided
They are engaged in micro-financing activities (Rs50,000 for small businesses and
Rs125,000 for housing)
they do not mobilize public deposits
Section-25 NBFCs find it difficult to mobilize equity owing to restrictions on
payment of dividends
Can mobilise foreign grants if registered under FCRA
Exempt from Income Tax if registered under Section 12A of the Income Tax Act.
Non Banking Financial Companies
Companies registered under Indian Companies Act 1956 can apply to RBI to carry on
the business of an NBFC
NBFCs are required to have net owned funds of Rs20 millions
Ownership can be defined precisely and they can raise equity
Mobilisation of public deposits, though allowed, is almost impossible given strict
guidelines of the RBI
18
Banks are comfortable lending to NBFCs which are well-capitalised and well-
performing
NBFCs are for-profit entities and are taxable
FDI through automatic route is allowed subject the following limits
FDI up to 51% - US$0.5 mn to be brought upfront
FDI between 51% and 75% - US$5mn to be brought upfront
FDI between 75% and 100%- US$50mn out of which 7.5 million to be
brought up-front
NBFCs are subject to prudential regulations regarding income recognition, asset
classification and provisioning, prudential exposure limits and accounting/disclosure
requirements provided
they are mobilizing public deposits, or
they are systemically important
All non-deposit taking NBFCs having asset size of Rs1bn (Rs100 crores) or more as
per last audited balance sheet will be considered as systemically important NBFCs.
Non-deposit taking and systemically important NBFCs will be subject to capital
adequacy regulations, single/group exposure norms and disclosure pertaining to
derivative transactions
Capital Adequacy Ratio (CAR) requirement is now 12% and will be increased to 15%
from April 2009 for systemically important NBFCs
Organizations under BC/BF guidelines of the RBI
Business Facilitators
Business facilitators can be used by the banks for various pre-disbursement and post-
disbursement activities pertaining to lending.
Does not include disbursement and collection activities
No approval is required from the RBI for using Business Facilitators
Business Correspondents
NGOs Insurance agents
Farmers' Clubs Well-functioning panchayats
Co-operativeSocieties Village Knowledge Centers
Post-offices KVIC/KVIB centers
IT Enabled outlets of corporates Agri Clinics
19
BCs can undertake disbursement of loans as well as collection of principal. They can
also accept deposits on behalf of the banks.
Banks can compensate BCs but BCs cannot charge anything from the consumers
Transactions need to be accounted for and reflected in banks books by end of day or
next working day
Microfinance Bill
Highlights
The Micro Financial Sector (Development and Regulation) Bill, 2007 seeks to
promote the sector and regulate micro financial organisations (MFO).
National Bank for Agriculture and Rural Development (NABARD) shall regulate the
micro financial sector.
Every MFO that accepts deposits needs to be registered with NABARD. Conditions
for registration include (a) net owned funds of at least Rs 5 lakh; and (b) at least three
years in existence as an MFO. All MFOs, whether registered or not, shall submit
annual financial statements to NABARD.
Every MFO that accepts deposits has to create a reserve fund by transferring a
minimum of 15% of its net profit realised out of its thrift and micro finance services
every year
The central government may establish a Micro Finance Development Council to
advise NABARD on formulation of policies related to the micro financial sector.
NABARD shall constitute a Micro Finance Development and Equity Fund to be
utilised for the development of the sector.
Key issues and analysis
While the Bill promotes the activities of MFOs, there are differing opinions on the
cost efficiency of the MFO model.
NABARD is designated as the regulator of the micro financial sector. However, its
dual role as a key participant in the sector and the regulator could lead to conflict of
interest.
Banks and deposit taking Non-Banking Financial Companies (NBFCs) have to
comply with Reserve Bank of India's (RBI) prudential norms designed to safeguard
Societies/Trusts Non-deposit taking NBFCs
Cooperative Societies Post offices
Section 25 Companies
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depositors' funds. While the Bill enables NABARD to prescribe norms for MFOs, it
specifies some norms which are less stringent than for banks and NBFCs.
Unlike banks regulated by RBI, the Bill does not exempt registered MFOs from the
Usurious Loans Act, 1918 or state laws which cap interest rates.
The Bill defines 'micro financial services' to include insurance and pension services
without specifying to whom such services are to be provided. This implies that every
insurance and pension company would be regulated by NABARD.
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The main motive of the SHG is to empower poor socio-economically and improve
their livelihood pattern.
Federated Self Help Group Model:
Federations of SHGs bring together several SHGs. In India FSHGs include those promoted
by the Dhan Foundation, PRADAN, Chaitanya and SEWA are famous in India.
Dynamics of Federated SHG Model:
Federations usually come under the Societies Registration Act. They have between 1000-
3000 members.
There is a distinct three-tier structure in federations the SHG is the basic unit; the
cluster is the intermediate unit and an apex body or a federation, represents the entire
membership.
Each SHG participates directly in the representative body at the cluster level. Two
members from each SHG attend the monthly cluster meetings. Information from the
groups to the apex body and vice-a-versa is channeled through the cluster level
representative body.
The cluster leaders are a highly effective part for group monitoring and strengthening. So
the operations of the apex body are decentralized through the clusters.
The executive body at the apex level is consists of 9 to 15 members.
Three common financial activities of Federations are: -
Acting as an agent and manager of external credit funds.
Assisting SHGs with loan recovery in difficult cases.
Strengthening weak SHGs, so that they are able to carry out their savings and credit
function smoothly.
Additional options for members to save: Federations often offers additional saving
schemes to the group members, which is apart from group savings. So the members have
savings with the group and in addition, with the Federation.
Satisfactory returns on savings to members.
Credit giving patterns also vary. Generally, federations have credit activities at the group
level, although federations provide credit to their members. These loans are disbursed
from members savings that may be deposited with the federation and from external funds
that it is able to access independently.
Federations are able to increase the amounts of credit available to members.
23
Every members save Tk.10 per weak and it is compulsory. This saving is deposited
with Bank. The bank funds their consumption with this deposit. This strategy
overcomes the problem of default as it is proved that nobody is likely to default on his
or her own money.
All loans are repayable within a year in 52 equal installments (over 52 weeks).
Bank charges 5 percent tax on all productive loans to a member. In this way group
fund is increasing.
The group leader collects the loan repayments and savings prior to the meeting and
hands it over to the Centre leader who gives it to the field worker during the meeting.
This collected amount is deposited in the branch on the same day. No new loan is
issued from this collected amount. It discourages all possible leakages in monetary
transactions.
Peer pressure replaces the collateral. Member-borrowers who repaid the loan in time
are allowed to get repeated loans and continuous access to increasing credit from
Bank. The most significant aspect of the Grameen Bank Model has been its high loan
recovery rate (98% and above).
I CI CI Bank partnership model
ICICI's microfinance portfolio has been increasing at an impressive speed. From 10,000
microfinance clients in 2001, ICICI Bank is now lending to 1.2 million clients through its
partner microfinance institutions, and its outstanding portfolio has increased from Rs. 0.20
billion (US$4.5 million) to Rs. 9.98 billion (US$227 million). A few years ago, these clients
had never been served by a formal lending institution.
Partnership Models
A model of microfinance has emerged in recent years in which a microfinance institution
(MFI) borrows from banks and on-lends to clients; few MFIs have been able to grow beyond
a certain point. Under this model, MFIs are unable to provide risk capital in large quantities,
which limits the advances from banks. In addition, the risk is being entirely borne by the
MFI, which limits its risk-taking.
The MFI as Collection Agent
25
To address these constraints, ICICI Bank initiated a partnership model in 2002 in which the
MFI acts as a collection agent instead of a financial intermediary. This model is unique in
that it combines debt as mezzanine finance to the MFI. The loans are contracted directly
between the bank and the borrower, so that the risk for the MFI is separated from the risk
inherent in the portfolio. This model is therefore likely to have very high leveraging capacity,
as the MFI has an assured source of funds for expanding and deepening credit. ICICI chose
this model because it expands the retail operations of the bank by leveraging comparative
advantages of MFIs, while avoiding costs associated with entering the market directly.
Securitisation
Another way to enter into partnership with MFIs is to securitize microfinance portfolios. In
2004, the largest ever securitisation deal in microfinance was signed between ICICI Bank and
SHARE Microfin Ltd, a large MFI operating in rural areas of the state of Andra Pradesh.
Technical assistance and the collateral deposit of US$325,000 (93% of the guarantee required
by ICICI) were supplied by Grameen Foundation USA. Under this agreement, ICICI
purchased a part of SHARE's microfinance portfolio against a consideration calculated by
computing the Net Present Value of receivables amounting to Rs. 215 million (US$4.9
million) at an agreed discount rate. The interest paid by SHARE is almost 4% less than the
rate paid in commercial loans. Partial credit provision was provided by SHARE in the form
of a guarantee amounting to 8% of the receivables under the portfolio, by way of a lien on
fixed deposit. This deal frees up equity capital, allowing SHARE to scale up its lending. On
the other hand, it allows ICICI Bank to reach new markets. And by trading this high quality
asset in capital markets, the bank can hedge its own risks.
Another securitisation deal was also signed with Bhartya Samruddhi Finance Limited
(BSFL), in which ICICI Bank securitised the receivables of a selected portfolio of
microfinance loans by BSFL amounting to Rs 42.1 million (US$ 957,000). Both under the
partnership model and under the securitisation deal, the bank provides organizations with
financial support at a mezzanine level which enables them to offer credit protection in the
microfinance portfolios to a reasonable extent.
Training New Partners
Despite rapid growth, the lack of NGOs and MFIs operating in India remains a constraint.
According to ICICI Bank, there is a need for approximately 200 MFIs to cover the country,
26
however there are only 15 large players capable of scale. New players are therefore needed:
ICICI believes that new NGOs, entrepreneurs, and corporations who conduct development
activities in rural areas can and should become MFIs. ICICI Bank has put in place its Micro
Finance Development Team with the objective of identifying and training new partners. The
Social Initiative Group of ICICI Bank (SIG) aims to partner with organizations to identify
and support entrepreneurs in microfinance.
Working with Venture Capitalists
Another challenge in scaling-up the microfinance sector is the lack of equity capital. In order
to solve this shortage, ICICI Bank is encouraging venture capitalists to start entering the
sector. Several venture capital funds in the country have the capability of identifying and
mentoring entrepreneurs, including Lok Capital, Aavishkar and Bell Weather. Bell Weather
has made three equity commitments for start up, and its committee has decided to increase
the size of the fund from US$10 million, to US$25 million. Lok capital mobilizes and directs
private capital to fund microfinance activities and to fund long term management and
technical support for development of commercially sustainable MFIs. Aavishkar provides
micro-equity funding (Rs. 10 lacs to Rs. 50 lacs, approximately US$20,000 to US$100,000)
and operational and strategic support to commercially viable companies increasing income in
or providing goods and services to rural or semi-urban India. ICICI Bank has come to an
agreement with these three venture capitalists under which it will provide take-out financing
to the MFI to buy out the venture after a period of three to five years, provided the MFI
attains an operational sustainability rating from Micro-Credit Ratings International Ltd (M-
CRIL) and Credit Rating Information Services of India Limited (CRISIL).
Beyond Microcredit
Microfinance does not only mean microcredit, and ICICI does not limit itself to lending.
ICICI's Social Initiative Group, along with the World Bank and ICICI Lombard, the
insurance company set up by ICICI and Canada Lombard, have developed India's first index-
based insurance product. This insurance policy compensates the insured against the
likelihood of diminished agricultural output/yield resulting from a shortfall in the anticipated
normal rainfall within the district, subject to a maximum of the sum insured. The insurance
policy is linked to a rainfall index.
27
It was in this cheerless background that the Microfinance Revolution occurred worldwide. In
India it began in the 1980s with the formation of pockets of informal Self Help Groups
(SHG) engaging in micro activities financed by Microfinance. But Indias first Microfinance
Institution Shri Mahila SEWA Sahkari Bank was set up as an urban co-operative bank, by
the Self Employed Womens Association (SEWA) soon after the group was formed in 1974.
The first official effort materialized under the direction of NABARD. (National Bank for
Agriculture and Rural Development).The Mysore Resettlement and Development Agency
(MYRADA) sponsored project on Savings and Credit Management of SHGs was partially
financed by NABARD during 1986-87
Major Milestones
1904- Legal framework for establishing the co-operative movement set up in 1904.
1934-Reserve Bank of India Act, 1934 provided for the establishment of the
Agricultural Credit Department.
1969- Nationalization Of Banks
1971-Establishment Of Priority Sector Lending Norms
1975-Establishment Of Regional Rural Banks
1982-Establishment Of NABARD
1992-Launching of the SHG-Bank Linkage Programme
1993-Establishment of Rashtriya Mahila Kosh
1998-NABARD sets a goal for linkage one million SHGs by 2008
Formal
sector,
56.60%
Informal
sector,
39.60%
Unspecified
sources,
3.80%
29
Interest among investors (private equity, social investors, and specialized funds) in the Indian
microfinance industry is growing with the increasing number of MFIs that have a sizeable
asset base, established processes, and a track record of profitable operations. In addition to
loans from sector-specific funds, some Indian MFIs have attracted equity investments from
social investors and funds as well. Indian investors and funds have also started investing in
the sector; given the countrys relatively deep capital markets, it is expected that investments
in MFIs will increase significantly once this trend gathers momentum.
With directed priority-sector lending an explicit feature of the formal banking sector, India
has built up a network of rural banks that is rare if not unparalleled in the world. Today 196
RRBs has over 14,000 branches in 375 districts nation-wide, covering, on an average, about
three villages per branch. The rural banking system, in its entirety, has an even more
impressive coverage. Together, the RRBs, the nationalized commercial banks and the credit
cooperatives comprising of Primary Agricultural Credit Societies (PACS) and
Primary/State Land Development Banks (P/SLDS) have one branch for every 4,000 rural
residents.
In spite of such an impressive coverage, the formal banking sector has had a limited impact
on microfinance or lending to the poor. The RRBs were set up in the mid-70s with a clear
mandate for lending to the poor as it was felt that the cooperative banks were being
dominated by the rural wealthy and that the commercial banks had an urban bias. For the first
two decades of their existence, political pressure and focus on outreach at the expense of
prudent lending practices led to very high default rates with accumulated losses exceeding
Rs. 3,000 crores in 1999. The reforms in the mid-90s, following the recommendations of the
Narsimhan Committee Report, removed some of the constraints on the functioning of RRBs,
easing their interest ceiling and allowing them to invest in the money market. The financial
situation of the RRBs has improved since then with declining losses and over 80% of the
RRBs are now profitable. However, much of this turnaround has resulted from a shift to
investment in government bonds (that have gained with falling interest rates) and loans to the
non-poor in rural areas.
The lending portfolio of scheduled commercial banks also reflects this shift away from rural
areas. At the end of 2007-2008, the share of agriculture in the outstanding credit of scheduled
31
commercial banks was less than 10% which is even less than the share of personal loans
(housing loans and loans for consumer durables).
Small loans have also declined in importance in recent years. Since over 98% of rural loans
are below Rs 2 lakhs, this implies a concomitant shift out of rural areas. The logic of this shift
is easy to appreciate. In 2008, 45% of the borrowers of scheduled commercial banks were
from rural areas, but they accounted for only 13.4% of their outstanding loans. For metros,
the corresponding numbers were 15% and 54% respectively. With their focus shifted to
financial performance, the banks are naturally shifting their portfolio to the low cost segment.
Microfinance provides an important way to balance the outreach among the rural poor while
keep the cost of lending low. To the extent that the costs of credit risk assessment and
monitoring can be reduced with the help of NGOs, banks can actually reach out to a large
number of truly poor households without incurring heavy transactional expenses. The formal
banking sector has played an important role in microfinance in India.
Much of the microfinance initiative in India has involved Self-Help Groups (SHGs),
predominantly of poor women. NABARDs Bank Linkage Program, pilot-tested in 1991- 92
and launched in full vigor in 1996, has been a major effort to connect thousands of such
SHGs across the country with the formal banking system. By late 2002, it connected about
half a million SHGs to the banking system with total loan disbursement of about Rs. 1026
crores. Efforts of other organizations supplement that of NABARD. By March 2001, SIDBI,
for instance, had disbursed over Rs 30 crore to SHGs through 142 MFI-NGOs.
The emphasis on linking the self-help groups of rural poor to the formal banking system was
made in the mid-80s in the Asia and Pacific Regional Agricultural Credit Association and the
SHG-Bank Linkage emerged as a result of that. RBI included the program in its priority
sector lending and in 1999, the Government of India recognized in its Budget.
Recent Trends
The past 18 months have seen a series of critical developments in the Indian MFI sector.
These are both positive and negative. On the positive side, MFIs have started to leverage
their new found management expertise to achieve scale and to spread their operations well
beyond their traditional operational areas. Thus, some of the leading MFIs in the country
have recorded high growth rates of the order of 80% per annum in terms of numbers of
32
borrowers and around 40% per annum in terms of portfolio reaching from 300,000 to one
million clients each. Also positive is that a significant part of that expansion has been either
to less developed areas of the country Orissa, J harkhand, Rajasthan, Madhya Pradesh,
Tripura, Assam or to areas such as Maharashtra that also have substantial numbers of low
income families in some regions even if their overall development indicators are not as low
as those for the other states.
On the negative side, MFIs have been under attack from politicians and bureaucrats in some
of their traditional operational areas in Andhra Pradesh and Karnataka (with questions even
being asked in Orissa). Their loan recovery practices have been questioned and their interest
rates described as exorbitant. The related publicity has vitiated the credit culture in the
traditional microfinance states forcing a lowering of interest rates and increasing the
necessary level of loan loss reserves and provisioning. Operationally, the increase in costs
has been compounded by the spread of the operations of individual MFIs simultaneously (and
inorganically) to a number of non-traditional states. This has put pressure on operating
efficiency and resulted in slowing the trend to lowering unit costs.
The growth of the microfinance sector has been fuelled by continuing interest from banks in
increasing their exposure to microfinance resulting in a highly leveraged industry with capital
adequacy ratios down below 10% and debt-to-equity ratios of the order of 11:1. Given the
pressure on margins (which has already reduced the collective return on assets of the sector to
negligible, if still positive, levels) it is unclear for how long such high leverage ratios can be
sustained.
The increased coverage of clients made possible by the high growth rates of Indian MFIs is
laudable. Even as it increases outreach, the industry continues to be amongst the most
efficient in the world. But, high growth brings with it possible dangers of mission drift as
many MFIs emphasise commercial behaviour and may not strategically balance this with
their original social mission, or with social values expected in microfinance. The social
rating service offered by M-CRIL over the past couple of years has found that MFI poverty
outreach (the proportion of new clients below the $1 per day international poverty line at
purchasing power parity) is around 30-35%.
A substantial increase in the outreach of microfinance services in India has occurred, in
recent years, partly because of the phenomenal growth of the bank-SHG linkage programme
(promoted by the National Bank for Agriculture and Rural Development, NABARD), but
33
also from the substantial growth of the MFI sector. Yet, the number and size of microfinance
institutions in India is small in relation to the numbers of poor people in the country. MFIs in
India (including Self Help Groups) cover no more than 15-20 million clients, at best, 25-30%
of the 60-70 million poor families in the country.
The SHG-Bank Linkage Programme (SBLP) covered a further 9.6 million persons in 2006-
07, over 90 percent of them women, and about them half of them poor . The total number of
SHG members who have ever received credit through the programme has grown therefore to
41 million persons. Microfinance Institutions, (MFIs), the other model of microfinance in
India, grew even more strongly, and added an estimated 3 million new borrowers to reach a
total coverage of about 10.5 million borrowers. Both programmes taken together have
therefore reached about 50 million households. Only 36.8 million of these are being currently
being served, however.
About half of SHG members, and only 30 percent of MFI members are estimated to be below
the poverty line. Thus about 22 percent of all poor households (about 75 million) are
currently receiving microfinance services, or at least microcredit.
The sector continues to make strong progress towards the goal of extending financial
inclusion to the roughly fourth-fifths of the population who do not receive credit from the
banks, although there is still a long way to go.
MFI borrowers receive larger first loans than SHG members, but since
(i) the average duration of MFI loans is shorter (generally one year instead of
two)
(ii) MFIs have been expanding rapidly, bringing down average MFI loan size
(iii) the size of repeat loans to SHGs has been growing even faster than first
loans
the difference in average loans outstanding per borrower in the two models no longer
appears to be significant.
The on-lending funds constraint
There was a time when MFI managers had to devote most of their time and energy to dealing
with the uncertainty of where the next loan for on-lending funds was going to come from.
However the rapid expansion of commercial bank lending to the sector from 2004 led to the
happy situation in which this was no longer the case. MFI lending grew rapidly; both through
the expansion of existing MFIs and the incubation of new ones, and the Indian microfinance
34
sector became one the most highly leveraged in the world. However, developments during
the year have made it more difficult to be as sanguine as before that the onlending funds
constraint on continued growth of MFI's has for once and all been removed.
The rapid expansion of lending to MFIs was due largely to the introduction by ICICI Bank of
its "partnership model", under which loans to borrowers remained on the books of the bank,
off the balance sheet of the MFI partner, which only undertook loan origination, monitoring
and collection services for a fee. Thus the MFI performed the role of a social intermediary,
while credit risk was borne largely by the bank, although the MFI had to share the risk of
default up to a specified level, by providing a "first loss guarantee". This greatly reduced the
amount of equity with which an MFI required to support its borrowings, and the partnership
model in effect removed both the equity and the on-lending funds constraints at one stroke.
This major innovation unfortunately came unstuck during the year, initially due to the AP
crisis in March 2006 and regulatory concerns about KYC (Know Your Customer)
requirements, but thereafter because ICICI changed its own requirements under the
partnership model, and indeed its whole vision of the nature of the relationship it wants to
have with its partners. By March 2006, ICICI Bank's lending had grown to constitute about
two-thirds of total lending to the sector, with about 60 percent of its lending coming under the
partnership model. However, instead of increasing sharply again as in previous years, ICICI's
lending has declined in 2006-07, and is likely to stay relatively low in the current year. One
of the concerns raised by the AP crisis was the possibility of multiple borrowing by MFI
customers from both the major MFIs in the district concerned, both of who were major
partners of the bank under the partnership model. While there is no evidence that this led to
over-lending as reflected in an inability to repay loans, ICICI was urged by the RBI to
strengthen its KYC procedures now that the loans were on the bank's own books and not on
those of the partner.
It took some time for ICICI's partners to furnish the relevant information, during which time
fresh lending under the partnership model was suspended. It was partly substituted by term
loans, but not in sufficient amounts to alleviate the stress being experienced by partners who
were now strapped for funds. While other banks increased their lending, it was mostly to
existing partners, although some switching may have taken place.
35
SHG programmes, usually have voluntary deposit schemes in which the members
themselves determine the amount of the recurring savings deposit. Since disposition of this
amount is determined by the group rather than by the individual saver, this often results in
minimalist norms and leads to deposits that are far lower than the members' savings potential.
Deposits form just 4.0% of the average SHG MFIs' portfolio, though (as indicated earlier)
this excludes the far larger amounts revolved internally by SHG members.
Operating efficiency & portfolio quality
Staff productivity in India is now higher than in any other major region offering
microfinance. Some 326 staff members per MFI serve over 230 borrowers each while the
leading MFIs average 275 borrowers per member of staff. This results in some of the lowest
servicing costs for MFIs anywhere in the world.
Both Grameen and SHG MFIs record average servicing costs of the order of Rs400 ($10) per
borrower, lower than the MIX median even for Bangladesh. As MFIs have grown and staff
productivity has increased over the years, servicing costs have come down even in nominal
terms. With an inflation rate averaging 5% per annum in the mid- 2000s, this has resulted in a
decline of around 9% per annum in the cost of servicing borrowers.
Indian MFIs are now amongst the most efficient internationally. At 15.9% the average
operating expense ratio has not changed much since 2005 as growth focused MFIs have
accepted higher travel and other costs, while productivity gains have also been neutralised by
lower loan balances, hence smaller portfolios serviced per member of staff, in real terms.
OERs reported by Indian MFIs are, nevertheless, lower than those of MFIs in Bangladesh and
significantly lower than the medians for Asian and other MFIs worldwide. Analysis of
38
operating expense ratios by size of MFI, its age, microfinance methodology and loan size
shows that it is the last factor that is the major determinant of operating efficiency.
As the size of loans disbursed increases from Rs3,000 ($75) to Rs10,000 ($250), the
operating expense ratio declines from 25% down to an average of around 12%.
The effective interest rate paid by the average Indian microfinance borrower is no more than
25% - not significantly different from the ~24% usually charged even by commercial banks
on consumer finance. By and large, new institutions have low yields and high OERs but, as
expansion takes place, and economies of scale set in, yields improve and OERs decline to
acceptable levels. There are significant economies of scale up to a portfolio size of Rs2.5
crores ($600,000)
Portfolio financing
The structural shift indicated by an increase in debt financing among Indian MFIs has
continued while net worth as a proportion of the total has been reduced as current surpluses
39
and a very limited flow of grants have failed to keep pace with growth. Borrowings have
reached three quarters of total liabilities on MFI balance sheets as funds have been readily
available from both private and public commercial banks. Even small institutions with
relatively low exposure to financial markets have succeeded in sourcing half of their
liabilities through bank borrowings, bringing over 60% of MFIs under the 15% suggested
capital adequacy ratio.
Until now, with substantial historical grant funding and more recent operating surpluses
accompanied by relatively small portfolios, the Indian microfinance sector has been well
provided for in terms of owned funds. Now, the growth aspirations of MFI managements,
competition and the relative paucity of grant funds, on the one hand, and the availability of
liberal commercial debt funds, on the other, have taken their toll. The aggregate figures
suggest that capital adequacy is now an issue as even the Top10 MFIs fail to register the 15%
norm suggested above, though it is not alarming yet.
The trend towards commercialization becomes even stronger in the context of off-balance
sheet financing under the partnership model, which accounts for an additional 44% of the
overall portfolio in the sector. When managed loans are added back to the balance sheets of a
subset of leading Indian MFIs, the leverage ratio jumps from 10.7 to 11.9, far exceeding the
regional median of 5:1. While a limited amount of debt continues to be available at
concessional rates, much of it is contracted at commercial rates in the range of 10-14% per
annum. With such financing accounting for four-fifths of the portfolio of leading MFIs, the
commercialization of the Indian sector far exceeds that of other important markets in the
40
region, such as Bangladesh, where institutions source less than one-tenth of their portfolios
from commercial sources.
Indeed, Indian MFIs are increasingly turning to the banking sector as their access to grants
and customer deposits continues to diminish. The share of grants dropped from one third of
the balance sheet in 2003 to just 3% in 2006, barely covering cumulative losses among
smaller institutions. With the ability to raise equity capital limited to just a few legal entities,
reliance on net worth fell to 10%, less than one-third of that in 2003. Bank borrowings have
also had to fill in for customer deposits, which amounted to one-fourth of MFI resources in
2003 and are now under one-tenth of the balance sheet. Concerns over the legality of savings
mobilization combined with increasing transformation to NBFCs have phased savings out of
MFI balance sheets and mostly confined these to community-based institutions such as SHGs
and cooperatives.
Indian financing patterns, however, could look quite different in the next few years. Under
proposed legislation, societies, trusts and cooperatives will be able to offer thrift services.
While companies are excluded from this proposed regulatory regime, a number of these have
recently announced large investments by private equity funds. With the Top10 accounting for
two-thirds of the financing, debt may be ceding some of its share to equity capital.
Financial performance
The financial viability of microfinance institutions in India is under threat, despite
improvements in the yield gap. The 2.1% weighted return on assets of the 2005 sample has
been reduced to zero while typical MFI returns are -9.8%, well behind Bangladeshi
institutions reporting to the MIX, which lead the region in profitability. Low portfolio yields,
41
combined with poor portfolio quality and rising financial costs have reduced Indian MFI
surpluses though improvements in collection measures have boosted portfolio yields to 93%
of the expected figure, up from 85% in 2005.
Yields, however, remain low, with 43% of Indian MFIs earning less than 24% on their
portfolios. In comparison with 36-50% real costs of bank loans and moneylender interest
rates ranging from 36% to 120%, MFI average yields represent a substantial benefit for low
income clients. Nonetheless, these are not sufficient to cover rising costs brought on by
ambitious growth plans, deteriorating portfolio quality and hardening of domestic interest
rates on borrowings. Benchmarks for profitable Indian MFIs indicate that they charge more
sustainable rates than their unprofitable peers and earn 24.8% on their portfolios as compared
to 19.5%, but they also maintain tighter cost control. While both groups face similar financial
costs, sustainable institutions benefit from lower provisioning expenses because of their
superior portfolio quality. Moreover, they benefit from economies of scale as the typical
sustainable MFI manages a much larger portfolio than an unsustainable institution.
It is apparent that while MFIs have learnt much in terms of operational efficiency a
substantial effort is required in the areas of clarifying social objectives, poverty targeting,
product development and client orientation. The challenge for MFIs over the next few years
is to achieve growth with equity as well as efficiency.
42
Payment frequency
Loan term
Loan amount.
Estimating the Effective Rate
The estimation method considers the amount the borrower pays in interest and fees over the
loan term. The estimation method can be used to determine the effect of the interest rate
calculation method, the loan term, and the loan fee. An estimation of the effective rate is
calculated as follows:
Effective cost =
Amount Paiu in inteiest anu fees
Aveiage piincipal amount outstanuing
Aveiage piincipal amount outstanuing =
(sum of piincipal amounts outstanuing)
numbei of payments
To calculate the effective cost per period, simply divide the resulting figure by the number of
periods. With all other variables the same, the effective rate for a loan with interest calculated
on a declining balance basis will be lower than the effective rate for a loan with interest
calculated on a flat basis.
Eg. For a micro loan Product
loanamount Rs1000
term 52 week
repayment 19.23 weekly
interestrate 12.5% flatrate
fee 1% upfront
securitydeposit 10% upfront
Membershipfees Rs10
So according to flat rate method the weekly principal installment will be Rs 19.23 and
interest will be Rs 2 average outstanding principal is Rs 490. Total interest is Rs. 125 and 1%
upfront fees is Rs 10 which gives an effective rate of 29.57%.
According to declining method the weekly installment will be Rs 20 and interest will be
declining as major portion will be given out as principal, average outstanding principal is Rs
500 ,total interest is Rs. 65 and 1% upfront fees is Rs 10 which gives an effective rate of
16.97 %.
47
Use of I RR method
The above method ignores the time value of money, assuming the same data, if we calculate
the effective rate using the IRR method the effective rate comes to 33.96% annually for flat
rate of interest and 20.43% annually for declining balance method.
The following table illustrates the effect that a change in the loan fee and a change in the loan
term have relative to the effective cost:
IRRMethod
amoun
t
inter
est
met
hod
upfront
fees
security
deposit
loan
term
membershi
pfees
effectiv
ecost
Basecase1 1000
12.5
0% flat 1% 10%
52
weeks 10 33.96%
10000
12.5
0% flat 1% 10%
52
weeks 10 31.63%
incfeesto2% 1000
12.5
0% flat 2% 10%
52
weeks 10 36.58%
10000
12.5
0% flat 2% 10%
52
weeks 10 34.22%
REDUCETERM
TO45WEEKS 1000
12.5
0% flat 1% 10%
45
WEEK
S 10 34.82%
10000
12.5
0% flat 1% 10%
45
WEEK
S 10 32.15%
SECURITY
DEPOSIT5% 1000
12.5
0% flat 1% 5%
52
weeks 10 30.57%
10000
12.5
0% flat 1% 5%
52
weeks 10 28.49%
SECURITY
DEPOSIT5%AND
INCFEESTO2% 1000
12.5
0% flat 2% 5%
52
weeks 10 32.92%
10000
12.5
0% flat 2% 5%
52
weeks 10 30.81%
REDUCE
INTERESTRATE
BY100BPS 1000
11.5
% flat 1% 10%
52
weeks 10
31.75%
10000
11.5
% flat 1% 10%
52
weeks 10
29.43%
REDUCE
INTERESTRATE
BY100BPS 1000
11.5
% flat 1% 10%
52
weeks 15
33.05%
10000
11.5
% flat 1% 10%
52
weeks 15
29.56%
48
Other inappropriate comparisons of MFI interest rates include those charged by government-
owned MFIs or government-sponsored microfinance programs that are often compelled to
charge lower-than-cost-recovery interest rates based on political considerations. These
comparisons also overlook that most of these programs and institutions in general are
unlikely to survive in the long term to serve the poor. Moreover, the poor have to incur
unusually high transaction costs to access credit from these sources due to credit rationing
systems and rent-seeking practices adopted by their employees. Thus, a comparison based on
nominal interest rates charged by such institutions may be highly misleading.
50
Adjustments must be made to both the balance sheet and the income statement. The amount
of the subsidy is entered as an increase to equity (credit) under the accumulated capital
subsidies account and as an increase in financial costs (debit).
ADJUSTMENTFORCONCESSIONALDEBT AMOUNTINMILLION
PARTICULARS 2008 2007 2006 2005 2004
AVERAGEDEBT 1916.47 644.76 181.18 44.88 13.99
INTEREST 175.44 60.31 13.43 3.47 0.56
COSTOFDEBT 9.15% 9.35% 7.41% 7.73% 3.97%
BPLR 12.75% 12.50% 10.75% 10.75% 11.00%
RISKPREMIUMASSUMPTION 1.25% 1.25% 1.25% 1.25% 1.25%
ADJUSTEDFORRISKPREMIUM 14.00% 13.75% 12.00% 12.00% 12.25%
ADJFORSUBSIDY 92.870 28.345 8.309 1.917 1.158
Funds donated for loan capital (Equity)-
Funds donated for loan capital are often treated as equity by MFIs and therefore are not
always considered when adjusting for subsidies, since these funds are usually on the income
statement as revenue.
Funds donated for loan capital are reported on the balance sheet as an increase in equity(
sometimes referred to as loan fund capital) and an increase in assets (either as cash, loan
portfolio outstanding or investments depending on how the MFI chooses to use the funds).
Donations for loan fund capital differ from donations for operations in that the total amount
received is meant to be used to fund assets rather than to cover expenses incurred.
No subsidy adjustment needs to be made for funds donated for loan capital as donors are not
normally looking for any returns on their funds (as a normal equity investors would) nor are
they expecting to receive the funds back.
On the other hand, if an MFI did not receive donations for loan capital, it would have to
either borrow (debt) or receive investor funds (equity). Both debt and equity have cost
associated costs. The cost of debt is reflected as financing costs. The cost of equity is
normally the required return by investors. Equity in formal financial institutions is often more
expensive than debt, because th risk of loss is higher. It can be argued that MFIs receiving
donations for loan fund capital should make a subsidy adjustment to reflect the market cost of
equity.
To reflect the subsidy on donations for loan fund capital based on, market rates, a similar
calculation to the adjustment for concessional loans is made. A market rate is chosen and
52
simply multiplied by the amount donated. The resulting figure is then recorded as an expense
(financing costs) on the income statement and an increase is made to equity (credit) under the
accumulated capital- subsidies account.
ADJFORDONATIONS
PARTICULARS 2008 2007 2006 2005 2004
GRANTSDURINGTHEYEAR 0.00 3.51 3.46 1.49 0.00
INTERESTADJ 0.00 0.48 0.41 0.18 0.00
Why an adjustment for inflation?
Inflation is defined as a substantial rise in prices and volume of money resulting in a decrease
in the value of money. Conventional financial statements are based on the assumption that the
monetary unit is stable. Under inflationary conditions, however, the purchasing power of
money declines, causing some figures of conventional financial statements to be distorted.
Inflation affects the nonfinancial assets and the equity of an organization. Most liabilities are
not affected, because they are repaid in a devalued currency (which is usually factored into
the interest rate set by the creditor).
To adjust for inflation, two accounts must be considered:
The revaluation of nonfinancial assets
The cost of inflation on the real value of equity.
Nonfinancial assets include fixed assets such as land, buildings, and equipment. Fixed assets,
particularly land and buildings, are assumed to increase with inflation. However, their
increase is not usually recorded on an MFIs' financial statement. Thus their true value may
be understated.
Since most MFIs fund their assets primarily with equity, equity must increase at a rate at
least equal to the rate of inflation if the MFI is to continue funding its portfolio. If MFIs
acted as true financial intermediaries, funding their loans with deposits or liabilities rather
than equity, the adjustment for inflation would be lower because they would have a higher
debt-equity ratio. However, interest on debt in inflationary economies will be higher, so the
more leveraged an MFI the greater the potential impact on its actual financing costs. Most
assets of an MFI are financial (loan portfolio being the largest) therefore, their value
decreases with inflation (that is, MFIs receive loan payments in currency that is worth less
than when the loans were made). In addi- tion, the value of the loan amount decreases in real
terms, meaning it has less purchasing power for the client. To maintain purchasing power,
53
the average loan size must increase. At the same time, the price of goods and services
reflected in an MFI's operating and financial costs increase with inflation. Therefore, over
time an MFI's costs increase and its financial assets, on which revenue is earned, decrease in
real terms. If assets do not increase in real value commensurate with the increase in costs,
the MFI's revenue base will not be large enough to cover increased costs.
An MFI should adjust for inflation on an annual basis based on the prevailing inflation rate
during the year, regardless of whether the level of inflation is significant, because the
cumulative effect of inflation on the equity of an MFI can be substantial.
Note that similar to subsidy adjustments, unless an MFI is operating in a hyperinflationary
economy, adjustments for inflation are calculated for the purpose of determining financial
viability only. Inflation adjustments do not represent actual cash outflows or cash inflows.
Unlike adjustments for subsidies, adjustments for inflation result in changes to both the
balance sheet totals and the income statement. The balance sheet changes because fixed
assets are increased to reflect the effect of inflation, and a new capital account is created to
reflect the increase in nominal equity necessary to maintain the real value of equity. The
income statement is affected by an increase in expenses relative to the cost of inflation.
REVALUATI ON OF ASSETS
To adjust nonfinancial assets, the nominal value needs to be increased relative to the amount
of inflation. To make this adjustment, an entry is recorded as revenue (credit) (note that this
is not recorded as operating income because it is not derived from normal business
operations) on the income statement and an increase in fixed assets (debit) is recorded on the
balance sheet. The increased revenue results in a greater amount of net income transferred to
the balance sheet, which in turn keeps the balance sheet balanced although the totals have
increased.
CALCULATI ON OF THE COST OF I NFLATI ON ON EQUI TY
To account for the devaluation of equity caused by inflation, the prior year's closing equity
balance is multiplied by the current year's inflation rate. This is recorded as an operating
expense on the income statement. An adjustment is then made to the balance sheet under the
equity reserve account "inflation adjustment."
54
PARTICULARS
31-Mar-
08
31-Mar-
07
31-Mar-
06
31-Mar-
05
31-Mar-
04
EQUITY(OPENINGBALANCE) 108.46 20.93 1.52 0.51 0.08
INFLATION(CHANGESINCPI) 6.40% 6.83% 4.23% 4.00% 3.73%
ADJUSTMENT 6.942 1.428 0.065 0.020 0.003
NONFINANCIALASSETS(OPENING
BALANCE) 10.66 3.05 2.56 0.22 0.20
ADJUSTMENT 0.682 0.208 0.108 0.009 0.008
Unadjusted balance sheet
BALANCE SHEET -BANDHAN
PARTICULARS(AMOUNT IN MN) 2008 2007 2006 2005 2004
LIABILITIES
GENERAL RESERVE 15.05 15.05 15.05 2.99 0.49
DONATED EQUITY PRIOR YEAR 8.45 4.94 1.49 0.00 0.00
CAPITAL GRANT/DONATED EQUITY
DURING THE YEAR 0 3.510 3.46 1.49 0
CUMULATIVE GRANT 8.453 8.453 4.943 1.49 0
CUMULATIVE NET SURPLUS/DEFICIT 191.06 62.94 0.94 -2.95 0.02
VOLUNTARY CONTRIBUTION FROM
BENEFICIARIES 22.03 22.03 0 0 0
NET WORTH 236.6 108.5 20.9 1.5 0.5
LONG TERM BORROWINGS 2830.0
1002.9
4 286.58 75.78 13.99
TOTAL LONG TERM BORROWINGS 2830.0
1002.9
4 286.58 75.78 13.99
SECURITY DEPOSIT/SAVINGS FROM
MEMBERS 457.7 208.4 81.7 22.0 3.7
INTEREST ACCRUED BUT NOT DUE 15.7 3.7 0.4 0.4 0.1
OTHER LIABILITIES 20.3 12.5 5.7 1.5 0.1
PROVISION FOR LOAN LOSS 29.3 25.2 7.4 0.1 0.1
TOTAL CURRENT LIABILITIES 522.97 249.80 95.15 24.00 3.97
TOTAL LIABILITIES 3589.55
1361.2
0 402.66
101.3
0 18.47
ASSETS
LOANS AND ADVANCES 2782.79
1261.3
0 371.12 85.81 12.04
55
million (0.10068%) as on March 31, 2007. This was mainly due to flood conditions in West
Bengal and other states where Bandhan is active, which impacted collections.
The MFI is susceptible to concentration risk, as just one state, West Bengal, accounts for
around 93 per cent of the total loan disbursements. To mitigate this, the MFI has plans to
diversify its operations to new states.
The MFI has managed to maintain good asset quality, as majority of its disbursements is
towards income generating activities: as on March 31, 2008, they constituted around 76 per
cent of disbursements. The MFI has started focusing on micro entrepreneur loans (individual
loans) and also likely to concentrate on urban market.
Provisioning policy:
Bandhan has adopted conservative loan loss policy measures, as it provides 1 per cent
provisioning on standard assets and 100 per cent provisioning on overdue loans beyond 180
days.
It is important to look at PAR in conjunction with the write-off ratio, to ensure that the MFI is
not maintaining a low PAR by writing off delinquent loans.
PARTICULARS(AMOUNTINMN) 2008 2007 2006 2005
LASTYEARPROVISIONBALANCESHEET 25.2 7.4 0.1 0.1
CURRENTYEARPROVISIONP&L 5.2 17.8 7.3 0.0
StatewisedistributionofloanportfolioasonMarch2008
61
c) Total amount disbursed in the period per credit officer- In accounting terms the
amount disbursed by a credit officer is a cashflow item whereas the amount
outstanding is a stock item.
Calculation of productivity ratios
RATIO 2008 2007 2006 2005 2004
AVERAGENUMBEROFACTIVE
LOANSPERCREDITOFFICER 498 468 398 319 259
PORTFOLIOOUTSTANDINGPER
CREDITOFFICER(mn) 1.36 0.98 0.73 0.52 0.46
TOTALAMOUNTDISBURSEDPER
PERIODPERCREDITOFFICER(MN) 3.56 2.68 1.93 1.34 0.97
LOANOUTSTANDING/BRANCH 5.52 3.55 2.19 1.53 1.27
Average number of active borrowers per credit officer has increased but the growth rate has
declined substancially from 17.48% in 2007 to 6.58% in 2008. This is an indication that
further scope for improvement in productivity is now limited. However the Portfolio
outstanding per credit officer and the amount disbursed per period per credit officer has
increased substantially because of higher portfolio turnover and higher ticket size.
Industry standard average number of active loans per credit officer-209
FORTHEYEARENDED
31STMARCH 2008 2007 2006 2005 2004
PORTFOLIO
TURNOVER
DISBURSEMENT/TOTALFUNDS
DEPLOYED 1.49 1.66 1.52 1.29 0.96
AVERAGEDISBURSED
LOANSIZE(RS) 5981 4421 3831 3021 2350
GROWTH 35.3% 15.4% 26.8% 28.5%
Efficiency ratios
Efficiency ratios measure the cost of providing services (loans) to generate revenue These are
referred to as operating costs and should include neither financing costs nor loan loss
provisions.
Total operating costs can be stated as a percentage of three amounts to measure the efficiency
of the MFI: the average portfolio outstanding (or average performing assets or total assets-if
an MFI is licensed to mobilize deposits, it is appropriate to measure operating costs against
total assets; if the MFI only provides credit services, operating costs are primarily related to
the administering of the loan portfolio and hence should be measured against the average
portfolio outstanding) per unit of currency lent, or per loan made.
63
Operating cost ratio:
The operating cost ratio provides an indication of the efficiency of the lending operations.
This ratio is affected by increasing or decreasing operational cost relative to the average
portfolio.
Successful MFIs tend to have operating cost ratios of between 13 and 21 percent of their
average loan portfolio.
Cost per unit of currency lent:
The cost per unit of currency lent ratio highlights the impact of the turnover of the loan
portfolio on operating costs. The lower the ratio, the higher is the efficiency. This ratio is
most useful to calculate and compare over time to see if costs are decreasing or increasing.
However, it can sometimes be misleading. For example while operating costs may increase
even though the size of the portfolio remains the same, the cost per rupee lent may actually
decrease. This would happen if more short term loans were made during the period and
therefore the turnover of the portfolio were higher. Although this ratio would be reduced, it
does not necessarily indicate increased efficiency.
Cost per loan made
The cost per loan made ratio provides an indication of the cost of providing loans based on
the number of loans made. Both this ratio and the cost per unit of currency lent need to be
looked at over time to determine whether operating costs are increasing or decreasing relative
to the number of loans made, indicting the degree of efficiency. As an MFI matures these
ratios should decrease.
RATIO FORMULA 2008
200
7 2006 2005 2004
OPERATING
COSTRATIO
OPERATINGCOSTS
10.0
4%
8.44
%
11.80
%
18.74
%
15.39
%
AVERAGEPORTFOLIOOUTSTANDING
COSTPERUNIT
OFCURRENCY
LENT(PAISE)
OPERATINGCOSTFORTHEPERIOD
3.83 3.07 4.43 7.18 7.26 TOTALAMOUNTDISBURSEDINTHEPERIOD
COSTPER
LOAN(RS)
OPERATINGCOST
229 136 170 217 171 NOOFLOANSMADE
64
The operating costs have gone up mainly because of 225% increase in the personnel
expenses, of which the salaries have increased by 252% and training expenses by 109%.
Even the administrative expenses more than doubled as compared to previous year.
2008 2007 2006 2005
SALARY(MN) 132.93 37.68 14.23 3.69
AVERAGENO.OFSTAFF 2032 1164 456 140.5
AVERAGESALARY 65416 32387 31197 26274
AVERAGESALARY/GNIPERCAPITA 1.58 0.88 0.96 0.91
The increase in salary was warrented because the average salary per GNI per capita is far
below that of industry standard of 3.7 times.
2008 2007 2006
Employee
turnover % 7.79 5.17 8.13
Another reason attributed to the loss in efficiency is the the fact that the MFI is expanding
aggressively into the least developed areas. The MFI has started focusing on higher ticket
sizes which requires better contacts with clients and stringent loan appraisal process which
adds to the cost of servicing such loans. The loss in efficiency is a cause of concern even as
the yields have come down from 21.06% to 18.44% due to competition.
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
0
1000
2000
3000
4000
5000
6000
7000
2008 2007 2006 2005 2004
LOANSIZES
OPERATINGEXPRATIO
65
III. Financial Viability
Financial viability refers to the ability of an MFI to cover its costs with earned revenue. To be
financially viable, an MFI cannot rely on donor funding to subsidize its operations.
To determine financial viability, self sufficiency indicators are calculated-Financial Self
sufficiency and Operational self sufficiency.
If the MFI is not financially self sufficient, the subsidy dependence index can be calculated to
determine the rate at which the MFIs interest rate needs to be increased to cover the same
level of costs with the same revenue base (loan portfolio).
To determine financial viabilty revenue is compared against the total expenses. If the revenue
is greater than expenses, the MFI is self sufficient. It is important to note that only operating
revenues (from credit and savings operations and investments) should be considered when
determining financial viability or self sufficiency.
Donated revenues or revenue from other operations such as training should not be included
because the purpose is only to determine the viability of credit and savings operations.
Expenses incurred by MFIs can be separated into four distinct groups: Financing costs, loan
loss provisions, operating expenses, and the cost of capital.
Financial spreads
Spread refers to the difference in the yield earned on the outstanding portfolio and the
average cost of funds. Spread is what is available to cover the remaing three costs that an
MFI incurs:operating costs, loan loss provisions and the cost of capital.
FORTHEYEARENDED31STMARCH 2008 2007 2006 2005
YIELD
TOTALFUNDSDEPLOYED 3553.50 1350.55 399.60 98.74
AVERAGEFUNDSDEPLOYED 2452.02 875.08 249.17 58.17
0
1
2
3
4
5
6
7
8
2008 2007 2006 2005 2004
costperunitcurrency
lent
turnover
66
FUNDBASEDYIELD A
18.44% 21.06% 21.03% 16.39%
OUTSTANDINGLOAN 2782.79 1261.30 371.12 85.81
AVERAGEOUTSTANDINGLOAN 2022.05 816.21 228.46 48.92
PORTFOLIOYIELD 21.90% 22.22% 22.90% 19.23%
FEEBASEDINCOME/AVERAGEFUNDSDEPLOYED 2.67% 2.96% 0.73% 1.11%
COSTOFFUNDS
INTERESTPAID/AVERAGEFUNDSDEPLOYEDADJ B 10.94% 10.19% 9.66% 10.17%
INTERESTPAID/AVERAGEFUNDSDEPLOYED B' 7.15% 6.89% 6.16% 6.57%
INTERESTPAID/AVERAGEBORROWINGADJ C 11.93% 11.29% 10.33% 10.25%
INTERESTPAID/AVERAGEBORROWING C' 7.80% 7.64% 5.76% 6.01%
GROSSSPREADADJ AB 7.50% 10.88% 11.37% 6.22%
GROSSSPREAD AB' 11.28% 14.17% 14.87% 9.82%
INTERESTSPREADADJ AC 6.51% 9.78% 10.70% 6.14%
INTERESTSPREAD AC' 10.64% 13.43% 15.27% 10.38%
NETPROFITABILITYMARGIN 2008 2007 2006 2005
FUNDBASEDYIELD A 18.44% 21.06% 21.03% 16.39%
INTERESTPAID/AVERAGEBORROWINGS B 9.15% 9.35% 7.41% 7.73%
INTERESTSPREAD C=AB 9.28% 11.71% 13.62% 8.66%
OPERATINGEXPENSERATIO D 8.49% 9.90% 13.79% 15.76%
FEEBASEDINCOME/AVERAGEFUNDSDEPLOYED E 2.67% 2.96% 0.73% 1.11%
NPM C+ED 3.46% 4.76% 0.55% 5.99%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2008 2007 2006 2005
fundbasedyield
portfolioyield
costoffunds
grossspread
67
The profit margins are well below industry standard of 4.9% also the yield on portfolio is
21.90% as against industry standard of 29.9%.
The fee based income yield has declined because of lower turnover also due to increasing
competition compelled the MFI to reduce its onlending rate resulting in lower portfolio yield.
The fund based yield also declined as higher allocation was made to cash and bank deposits
which earn a lower return.
Operational Self sufficiency: Operational self sufficiency is generating enough operating
revenues to cover operating expenses, financing costs, and the provision for loan losses.
Operational self sufficiency thus indicates whether or not enough revenues has been earned to
cover the MFIs direct costs excluding cost of capital but including financing costs incurs.
Other MFIs argue that operational self sufficiency should not include financial costs because
not all MFIs incur financial costs equally, which thus makes the comparison of self
sufficiency ratios between institutions less relevant. Some MFIs fund all their loans with
grants or concessional loans and do not need to borrow funds or collect savings and thus
either do not incur any financing costs or incur minimal costs.
Other MFIs as they move progressively towards financial viability are able to access
concessional or commercial borrowings and thus incur financing costs. However all MFIS
incur operating expenses and the cost of making loan loss provisions and they should be
measured on the management of these costs alone. MFIs should not be panelized for
accessing commercial funding sources nor MFIs that are able to fund all their loans with
donor funds be rewarded.
opcrotionol sclsuicicncy =
opcroting incomc
opcroting cxpcnscs +pro:ision or loon losscs
If an MFI does not reach operational self-sufficiency, eventually its equity (loan fund capital)
will be reduced by losses (unless additional grants can be raised to cover operating
shortfalls). This means that there will be a smaller amount of funds to loan to borrowers
(which could lead to closing the MFI once the funds run out). To increase its self-sufficiency,
the MFI must either increase its yield (return on assets) or decrease its expenses (financing
costs, provision for loan losses, or operating costs).
RATIO 2008 2007 2006 2005 2004
OPEARTIONALSELFSUFFICIENCY 2.42 2.39 1.49 1.06 1.37
68
Financial self-sufficiency
Financial self-sufficiency indicates whether or not enough revenue has been earned to cover
both direct costs, including financing costs, provisions for loan losses, and operating
expenses, and indirect costs, including the adjusted cost of capital.
The adjusted cost of capital is considered the cost of accessing commercial rate liabilities
rather than concessional loans.
Finonciol sclsuicicncy
=
opcroting incomc
opcroting cxpcnscs +inoncing costs +pro:ision or loon losscs +cost o copitol
RATIO 2008 2007 2006 2005 2004
FINANCIALSELFSUFFICIENCY 1.0704 1.1861 0.9268 0.6738 0.6061
Though the OSS has shown significant improvement the FSS has decreased because of
higher financing cost. The OSS and FSS are above the industry average of 1.136 and 1.051
times respectively.
Subsidy Dependence index
A third and final way to determine the financial viability of an MFI is to calculate its subsidy
dependence index (SDI). The subsidy dependence index measures the degree to which an
MFI relies on subsidies for its continued operations.
The subsidy dependence index is expressed as a ratio that indicates the percentage increase
required in the on lending interest rate to completely eliminate all subsidies received in a
given year.
Calculating the subsidy dependence index involves aggregating all the subsidies received by
an MFI. The total amount of the subsidy is then measured against the MFI's on-lending
0
1
2
3
4
2008 2007 2006 2005 2004
FSS
OSS
69
interest rate multiplied by its average annual loan portfolio Measuring an MFI's annual
subsidies as a percentage of its interest income yields the percentage by which interest
income would have to increase to replace the subsidies and provides data on the percentage
points by which the MFI's on-lending interest rate would have to increase to eliminate the
need for subsidies.
SI =
totol onnuol subsiJics rccci:cJ
A:crogc onnuol intcrcst incomc
RATIO 2008 2007 2006 2005 2004
SDI 20.97% 15.89% 16.67% 22.27% 65.85%
A subsidy dependence index of 100 percent indicates that a doubling of the average on-
lending interest rate is required if subsidies are to be eliminated. Similarly a subsidy
dependence index of 200 percent indicates that a threefold increase in the on-lending interest
rate is required to compensate for the subsidy elimination. A negative subsidy dependence
index indicates that an MFI straight forward not only fully achieved self-sustainability, but
that its annual profits, minus its capital (equity) charged at the approximate market interest
rate, exceeded the total annual value of subsidies, if subsidies were received by the MFI. A
negative subsidy dependence index also implies that the MFI could have lowered its average
on-lending interest rate while simultaneously eliminating any subsidies received in the same
year.
IV. Profitability Ratios
Profitability ratios measure an MFI's net income in relation to the structure of its balance
sheet. Profitability ratios help investors and managers determine whether they are earning an
adequate return on the funds invested in the MFI.
Return on Assets Ratio
The return on assets (ROA) ratio measures the net income earned on the assets of an MFI.
For calculating the return on assets, average total assets are used rather than performing
assets, because the organization is being measured on its total financial performance,
including decisions made to purchase fixed assets or invest in land and buildings.
Factors that affect the return on assets ratio are varying loan terms, interest rates and fees and
the change in delinquent payments.
70
Analysis of this ratio will improve the ability of an MFI to determine the revenue impact of
policy changes, improved delinquency management or the addition of new products.
To further analyze the financial performance of an MFI it is useful to decompose the return
on assets ratio into two components: the profit margin and asset utilization.
Asset utilization examines revenue per dollar of total assets. This can be further broken down
into interest income per dollar of assets and non interest income per dollar of assets to
provide an indication of where the revenue is earned based on where the assets are invested
(loan portfolio versus other investments)
RATIO 2008 2007 2006 2005 2004
ROA NETINCOME/AVERGEASSETS 5.17% 7.03% 2.24% 3.27% 0.32%
ROAADJ NETINCOMEADJ/AVERAGEASSETS 1.17% 3.62% 2.45% 8.97% 6.84%
The adjusted ROA is far above industry standard of 0.6%.
ROA:ADJ
NETINCOME
TOTALASSETS
2008 2007 2006 2005 2004
1.17% 3.62% 2.45% 8.97% 6.84%
PROFITMARGIN: ASSETUTILIZATION:
NETINCOME TOTALREVENUE
TOTALREVENUE TOTALASSETS
2008 2007 2006 2005 2004 2008 2007 2006 2005 2004
5.58% 15.19% 11.35% 52.73% 66.84% 20.93% 23.85% 21.55% 17.01% 10.23%
PROVISIONFORLOANLOSSES INTERESTINCOME
TOTALREVENUE TOTALASSETS
2008 2007 2006 2005 2004 2008 2007 2006 2005 2004
1.01% 8.46% 13.44% 0.00% 5.22% 18.26% 20.89% 20.79% 15.92% 9.69%
INTERESTEXPENSE NONINTERESTINCOME
TOTALREVENUE TOTALASSETS
2008 2007 2006 2005 2004 2008 2007 2006 2005 2004
51.78% 42.37% 44.30% 58.09% 94.05% 2.67% 2.96% 0.76% 1.09% 0.54%
NONINTERESTEXPENSE
TOTALREVENUE
2008 2007 2006 2005 2004
41.64% 33.98% 53.60% 94.64% 67.58%
71
The ROA has substantially declined from 3.62% in the year 2007 to 1.17% in 2008. This was
due to decline in profit margin from 15.19% in 2007 to 5.58% in 2008. Though the expense
related to provision for loan losses has declined both interest expense and non interest
expense increased.
Asset utilization has also declined due to reduction in interest income as the MFI reduced its
interest rate from 15% in 2007 to 12.5% in 2008.
Return on Equity Ratio
The return on equity (ROE) ratio provides management and investors with the rate of return
earned on the invested equity. It differs from the return on assets ratio in that it measures the
return on funds that are owned by the MFI. The return on equity ratio also allows donors and
investors to determine how their investment in a particular MFI compares against alternative
investments. This becomes a crucial indicator when the MFI is seeking private investors.
RATIO 2008 2007 2006 2005 2004
ROE
NETINCOME/AVERAGE
TOTALEQUITY 74.21% 95.83% 50.34% 192.38% 11.70%
ROEADJ
NETINCOMEADJ/AVERAGE
TOTALEQUITYADJ 16.71% 49.27% 26.85% 396.03% 233.48%
The reduction in both profit margin and asset turnover had a very negative effect on the ROE
due to higher leverage.
Leverage and Capital Adequacy
Leverage refers to the extent to which an MFI borrow money relative to its amount of equity.
It is important for all organizations to maintain a proper balance between debt and equity to
ensure that the equity or viability of the organization is not at risk. If an MFI has a large
amount of equity and very little debt, it is likely limiting its income-generating potential by
not making use of external sources of debt. Therefore, it may be better for the MFI to
increase its liabilities, if possible, to increase its income-generating assets (its loan portfolio).
The degree of leverage greatly affects the return on equity ratio of an MFI. An MFI that is
more highly leveraged than another will have a higher return on equity, all other things being
equal. When an MFI is regulated, the degree to which it is allowed to leverage its equity is
based on capital adequacy standards.
2008 2007 2006 2005 2004
D/E 11.11 9.97 16.14 44.08 27.32
D/EADJ 11.08 9.94 16.06 43.72 26.92
72
Capital Adequacy
Capital adequacy refers to the amount of capital an MFI has relative to its asset. Capital
serves a variety of purposes: as a source of security, stability, flexibility, and as a buffer
against risk and losses. As the possibility of losses increase, the need for capital increases.
This is particularly relevant for MFIs because the borrowers or members often lack
occupational and geographical diversity to help spread risk.
Capital must be sufficient to cover expected and unexpected losses. In addition, capital is
required to fund losses when new services are introduced, until those services generate
adequate income, or when an MFI is expanding. Expansion of the number of branches or the
area covered by each branch requires substantial capital investment. The planned growth of
an MFI requires capital to increase in proportion to its asset growth.
Capital adequacy is based on risk-weighted assets (as set out under the Basle Accord, which
identifies different risk levels for different assets types. There are five standard risk weights
ranging from 0 percent to 100 percent risk.
For most MFIs, only the first category-0 percent weight; includes cash, central bank balances,
and government securities, and the last category-100 percent weight; includes loans to private
entities and individuals are relevant, because MFIs do not generally have fully secured loans-
50 percent weight-or off-balance sheet items. Capital adequacy is set at 8 percent of risk-
weighted assets. This means that a regulated MFI can have up to 12 times the amount of debt
as equity based on the adjusted (risk-weighted) assets being funded.
As on March 31, 2008, Bandhan had an adjusted net worth of Rs.237.3 million, a substantial
improvement from Rs.108.7 million as on March 31, 2007. This improvement was mainly
because of increase in internal accruals to Rs.191.06 million for the year ended March 31,
2008, from Rs.62.94 million in the previous year.
The accumulated surplus accounted for 81 per cent of the net worth, with the balance being
distributed among grants and general funds.
Capital adequacy has slightly gone down by 0.1% to 8.50% from previous year figure of
8.60%. The cash and bank deposits constituted about 18% of the total assets as against 6% in
the previous year. The improvement in internal accruals along with higher liquid assets in the
73
form of cash and bank balance for which the risk weight is zero has assisted the MFI to
maintain its capital adequacy although there has been more than 120% increase in the
outstanding loan portfolio.
CAR =
INIESIE CAPIIAI +RESERvES +RETAINEB EARNINuS
RISK wEI0EIE ASSEIS
2008 2007 2006 2005 2004
CAR 8.50% 8.60% 5.64% 1.78% 4.25%
CASH&BANKDEPOSITS/
ASSETS 17.53% 5.81% 6.38% 11.62%
INCINLOANOUTSTANDING 120.63% 239.87% 332.49% 612.83%
INCINNETWORTH 118.12% 418.34% 1272.46% 197.76%
V. Management
Credit approval mechanisms
Bandhans credit approval mechanisms are better than that of most MFIs in the country. It
has decentralised its operations, as even branch managers have loan sanctioning powers. The
credit officer verifies the loan documents with reference to the members profile and the
loans are sanctioned by the respective managers after doing a mandatory pre-sanction visit to
the household. However, given the increase in lending operations and loan ticket size in
recent times, mainly in the wake of competition, it is important that the MFI strengthens its
loan documentation and approval mechanisms going forward, given its diversification plan.
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
0.00%
200.00%
400.00%
600.00%
800.00%
1000.00%
1200.00%
1400.00%
2008 2007 2006 2005
CASH&BANK
DEPOSITS/ASSETS
INCINLOAN
OUTSTANDING
INCINNETWORTH
CAR
74
systems across branches. Given the diversification plans, CRISIL believes that there is a need
for the MFI to decentralise and strengthen its control mechanisms to manage the operational
risk in the business.
VI . Scale and Outreach
As on March 31, 2008, Bandhan had 8,66,381 members, spread across 427 branches, 29
districts, and six states. It plans to start operations in Patna (Bihar) and New Delhi shortly.
The MFI has presence in all the 19 districts of West Bengal and 6 districts in Assam. These
two states account for 98.5 per cent of the total disbursements.
The number of active borrowers per member has significantly increased from 62% in 2004 to
88% in 2008. This shows the effectiveness of the model employed which does not allow a
member to remain dormant for more than 2 week. Members who do not take the next cycle of
the loan dropout of the programme.
PARTICULARS 2008 2007 2006 2005 2004 CAGR
NOOFCLIENTSORMEMBERS 866,381 498444 176063 51,586 9,282 311%
GROWTH 73.8% 183.1% 241.3% 455.8%
%WOMEN 100% 100% 100% 100% 100%
NUMBEROFACTIVEBORROWERS 757903 433324 149886 40286 5734 339%
GROWTH 74.9% 189.1% 272.1% 602.6%
NUMBEROFACTIVEBORROWERS/NO
OFMEMBERS 87.5% 86.9% 85.1% 78.1% 61.8%
NUMBEROFSTAFF 2415 1649 678 234 47 268%
GROWTH 46.5% 143.2% 189.7% 397.9%
NUMBEROFCLIENTS/STAFF 359 302 260 220 197
NUMBEROFBRANCHES 427 305 155 54 10 256%
GROWTH 40.0% 96.8% 187.0% 440.0%
MEMBERS/BRANCH 2029 1634 1136 955 928
LOANACCOUNT/BRANCH 1775 1421 967 746 573
VILLAGES 11,902 9,371 6,353 5,241 1,635 164%
GROWTH 27.0% 47.5% 21.2% 220.6%
LOANOUTSTANDING(MN) 2783 1261 371 85.81 12.04 390%
GROWTH 120.7% 239.9% 332.4% 612.7%
LOANOUTSTANDING/BRANCH(MN) 6.52 4.13 2.39 1.59 1.20
LOANDISBURSEDDURINGTHE
YEAR(MN) 5299.13 2,239.48 608.46 127.53 16.89 421%
GROWTH 136.6% 268.1% 377.1% 655.1%
NOOFLOANDIBURSEDDURINGTHE
YEAR 886057 506595 158834 42211 7186 333%
GROWTH 74.9% 218.9% 276.3% 487.4%
AVERAGEDISBURSEDLOANSIZE(RS) 5981 4421 3831 3021 2350
76
the MFI intends to rationalise its borrowing sources and plans to concentrate on a few big
lending institutions.
Bandhans average cost of borrowings deteriorated by around 200 basis point to 7.80 per cent
as on March 31, 2008, from 5.76 per cent as on March 31, 2006. This is mainly because the
MFI has borrowed resources at commercial rates. The weighted average cost of funds from
varied sources stood at 11.02 per cent as on March 31, 2008. The MFIs asset-liability profile
is comfortable, as most of the borrowings are long term.
FORTHEYEARENDED31STMARCH 2008 2007 2006 2005
INTERESTPAID/AVERAGEBORROWINGADJ 11.93% 11.29% 10.33% 10.25%
INTERESTPAID/AVERAGEBORROWING 7.80% 7.64% 5.76% 6.01%
There is no Asset Liability Mismatch as the MFIs micro finance programmes borrowings
are of long tenure while the assets are short-term assets.
Borrowing Profile:
Lending
Institution
Tenure
( In months)
Interest rate (%) Loan
outstanding
March 2008
(Rs. million)
Repayment
Frequency
SIDBI-1 42 9.00 5.29 Quarterly
SIDBI -2 - 1.00 10.00 Quarterly
SIDBI -3 24 8.50 77.50 Quarterly
SIDBI -4 24 11.50 380.00 Monthly
SIDBI -5 24 11.00 100.00 Monthly
FWWB-1 36 11.50 2.50 Quarterly
FWWB -2 54 11.50 40.55 Monthly
FWWB 3 54 10.50 2.22 Monthly
HDFC bank -1 24 9.00 64.92 Monthly
HDFC bank-2 24 12.50 75.00 Monthly
ICICI Bank Ltd.-
1 36 9.00 1.33 Quarterly
ICICI Bank Ltd.-
2 36 9.50 6.51 Quarterly
ICICI Bank Ltd.-
3 36 13.00 85.71 Quarterly
Rashtriya Mahila
Kosh 33 8.00 0.14 Quarterly
ABN AMRO
Bank-1 36 8.50 4.08 Quarterly
ABN AMRO
Bank-2 36 8.75 17.50 Quarterly
ABN AMRO 36 9.25 16.55 Quarterly
78
Bank-3
ABN AMRO
Bank-4 36 9.15 69.85 Quarterly
ABN AMRO
Bank-5 36 12.10 90.00 Quarterly
ABN AMRO
Bank-6 36 11.60 66.60 Quarterly
ABN AMRO
Bank-7 24 11.50 150.00 Quarterly
Axis Bank-1 21 9.25 35.71 Quarterly
Axis Bank -2 21 11.00 114.29 Quarterly
Standard
Chartered Bank-
1 24 8.60 12.50 Quarterly
Standard
Chartered Bank-
2 24 8.35 0.63 Quarterly
Standard
Chartered Bank-
3 24 11.25 135.00 Quarterly
State bank of
India-1 36 9.50 75.00 Monthly
State bank of
India-2 36 11.00 197.49 Monthly
State bank of
India -3 36 10.50 200.00 Monthly
YES Bank 13 9.50 7.69 Monthly
CitiBank 25 12.50 36.53 Monthly
Cordaid 60 7.50 32.25 Half Yearly
IDBI Bank 36 12.00 96.67 Monthly
Tamilnadu
Mercantile Bank 12 12.50 20.00 Monthly
Maneevaya
Holding 60 11.90 100.00 Annual
BNP Paribus 12 11.75 100.00 Quarterly
Indian Bank 30 9.50 50.00 Quarterly
Bank of India 36 11.75 250.00 Monthly
Indian Overseas
Bank 24 10.50 100.00 Monthly
Grand Total 2830.00
79
a total of ten branches with one branch achieving self sufficiency. With this, SHARE felt it
had a viable model that could be replicated all over India. Up until this point, SHARE had
been a non-profit organization registered as a charitable society.
SHARE decided to transform for several reasons, one of which was the legal constraints it
faced as an NGO. However, it also felt that transformation would allow it to attain financial
self-sufficiency which its NGO legal status did not permit. SHARE saw the profit motive as
against the principles of charity. We might expect then, to see an improvement in the
financial sustainability of SHARE after transformation.
On the other hand, we might also expect to see a change in the social impact of SHARE if the
profit motive results in lending to clients that are more profitable, and thus, likely less poor.
Of course, this might not happen if SHARE is able to cross-subsidize its poorer clients with
the larger returns it earns from lending to better off clients. Also, we might see a loss of
innovation and flexibility in product development as an NBFC due to the requirements and
restrictions placed on regulated organizations.
There was a recognition that the activities of SHARE needed to be transformed in order to
achieve financial sustainability. The legal status of SHARE at that time did not permit it due
to a conflict of interest between the profit motive and the notion of a charity embedded in the
legal identity of NGOs. According to SHARE, the two major limitations of being registered
as a society were that the income tax law in India does not recognize charitable institutions
carrying on microfinance activity and thus, the MFI loses its tax exemption. Secondly, raising
funds becomes a difficult task when financial leverages cannot be optimized because the net
worth and equity of the MFI do not work for profit.
Recognizing these constraints, SHARE transformed to a community owned and managed for-
profit regulated financial institution registered under the companies act in the year 2000.
Sources of Capital
SHAREs sources of capital, both historically and going forward, are critical to its viability as
an MFI and its ability to grow and reach more clients. Since MFIs are in the business of
lending, a steady and growing stream of capital is central to its business.
SHAREs 2001 annual report states that 99% of the equity in SHARE has been contributed
by its clients with the remaining 1% from unspecified individuals. In the 2004 audited
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financial statements, share capital was listed at Rs. 152.12 mn with debt equity ratio rising to
5.64 times as against 0.57 times in 1998.
This shows that SHARE has accessed capital for growth mainly from debt. Therefore, while
becoming and NBFC might increase an MFIs access to commercial capital, if this capital is
mainly in the form of debt it could increase the risk of the organization if it becomes too
highly leveraged.
Financial Analysis
The financial data is taken from the two years before SHARE transformed, 1998 to 1999, and
the periods 2004 and 2005 in order to give a picture of the MFI both before and after the
transformation.
FINANCIALINFORMATIONSHAREMICROFIN
FORTHEPERIODENDING31ST
MARCH 2005 2004 2003 2002 2001 2000 1999 1998
NBFC NGO
GROSSLOANPORTFOLIO(MN) 1757.94 819.43 493.98 282.60 164.05 104.66 43.96 23.56
%GROWTH 115% 66% 75% 72% 57% 138% 87% 185%
TOTALASSETS(MN) 1956.54
1009.8
3 572.08 355.57 197.11 145.53 71.26 40.78
%GROWTH 94% 77% 61% 80% 35% 104% 75% 263%
TOTALEQUITY(MN) 277.07 152.12 65.94 56.89 53.07 62.13 43.09 25.94
%GROWTH 82% 131% 16% 7% 15% 44% 66%
TOTALDEBT 1679.47 857.71 506.14 298.68 144.04 83.40 28.18 14.84
%GROWTH 96% 69% 69% 107% 73% 196% 90% 27%
FINANCINGSTRUCTURE
2005 2004 2003 2002 2001 2000 1999 1998
CAPITAL/ASSETRATIO 14.16%
15.06
%
11.53
%
16.00
%
26.92
%
42.69
%
60.46
%
63.60
%
DEBT/EQUITY 6.062 5.638 7.676 5.250 2.714 1.342 0.654 0.572
GROSSLOAN
PORTFOLIO/ASSET 89.8% 81.1% 86.3% 79.5% 83.2% 71.9% 61.7%
57.8
%
OVERALLFINANCILPERFORMANCE
2005 2004 2003 2002 2001 2000 1999 1998
ROA 3.15% 3.17% 1.21% 0.89% 1.13% 0.54%
82
2.94% 12.78
%
ROE 21.76%
22.88
% 9.18% 4.46% 3.35% 1.10%
4.77%
26.73
%
OPERATIONALSELF
SUFFICIENCY
120.03
%
118.16
%
107.02
%
103.99
%
108.82
%
97.52
%
87.26
%
55.58
%
ASSETTURNOVER 29.77%
32.25
%
30.61
%
30.24
%
16.47
%
21.06
%
20.13
%
16.00
%
PROFITMARGIN 16.69%
15.37
% 6.56% 3.83% 8.11% 2.55%
14.60
%
79.91
%
TOTALEXPENSE/AVERAGE
TOTALASSETS 24.80%
27.30
%
28.60
%
29.08
%
15.13
%
21.59
%
23.07
%
28.78
%
FINNCIALEXPENSERATIO 10.59%
11.25
%
11.62
%
10.95
% 2.67% 3.98% 1.97%
3.04
%
LOANLOSSPROVIONEXPENSE
RATIO 0.00% 0.00% 0.00% 0.00% 0.00% 0.24% 1.34%
1.43
%
OPERATINGEXPENSERATIO 14.21%
16.05
%
16.98
%
18.66
%
12.65
% 7.37%
19.77
%
24.31
%
EFFICIENCY
2005 2004 2003 2002 2001 2000 1999 1998
OPERATINGEXPENSE/LOAN
PORTFOLIO 16.36%
19.35
%
20.28
%
23.08
%
16.16
%
25.37
%
32.84
%
39.59
%
COSTPERBORROWER 748 746 717 780 559 850 1044 1319
PRODUCTIVITY
BorrowersperStaffmember 184 197 146 124 183 112 101 59
PAR>30 0.19%
LOANLOSSRESERVERATIO 0.00% 0.00% 0.00% 0.00% 0.90% 1.05% 2.62%
1.62
%
It is interesting to note that between 1999 and 2004, since SHAREs transformation to an
NBFC, SHAREs loan portfolio grew by 687%. Of course, this should be taken in light of the
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quality of these loans by looking at SHAREs portfolio at risk which is surprisingly low in
2004 at 0.19% indicating that the quality of SHAREs portfolio seems to have not diminished
with its rapid growth. Also, SHARE shows a return on equity of 21.8% in 2005 up from -
1.10% in 1999-2000 before transformation because of increase in both asset turnover and
profit margin.
Its ROE is now above the benchmark adjusted return on equity of 16.6%. Overall, the trends
seem quite positive regarding the financial impact of transformation. SHAREs operating
expense ratio decreased from 19.77% before transformation to 14% in 2004-2005 after
transformation and its cost per borrower went down over the same period from 850 to 748.
Also, SHAREs ROA and ROE have gone from negative before transformation to positive
after transformation and its operating self sufficiency has increased from 97.52% before
transformation to 120.03% after transformation. Lastly, SHAREs borrowers per staff
increased from 112 in 1999 to 184 in 2004 after transformation, showing higher level of
productivity per staff member.
The indicators that raised some red flags were the debt to equity ratio, return on assets, and
net income margin. SHAREs financial leverage is significantly larger than the benchmark
(1.9 times), showing that SHARE is highly leveraged, which could potentially pose risks to
its shareholders and its clients. In 2005, SHARE had a debt to equity ratio of 6.06 times up
from 1.34 in 2000 before transformation, which is quite high compared to other MFIs of the
same asset size and age who have an average ROE of 190%.
There has been concern about microfinance banks taking on such high leverage in
comparison to the commercial banking sector. Commercial banks are able to be highly
leveraged because of the years of empirical data on the risk of commercial banking as a
business, data which is not available for microfinance banking. Thus, the risk to shareholders
is higher absent of guarantees, especially when shareholders are poor clients. SHAREs
return on assets is also 3.15% in 2005 up from -0.54% compared to the benchmark ratio of
7.70%, which shows that SHARE lags its peers on productive use of assets even though it has
gone from a negative ROA to a positive one after transformation. Lastly, SHAREs Net Profit
Margin was 17% in 2005 up from -2.55% in 2004 which is a significant improvement
although it is still below its peers with a Profit margin of 23.5%. This new profit margin
makes SHARE more attractive to commercial investors because SHARE is now covering its
costs with revenues sufficiently to generating income. Also, the higher the profit margin the
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more funds SHARE has to reinvest and loan, as well as dividends to pay to its shareholders,
who also happen to include its clients.
Social I ndicators
OUTREACH
INDICATORS 2005 2004 2003 2002 2001 2000 1999 1998
NBFC NGO
NUMBEROFSTAFF 2,006 1,004 906 688 267 273 140 129
Growth 100% 11% 32% 158% 2% 95% 9% 223%
NUMBEROFACTIVE
BORROWERS 368,996 197,722 132,084 85,644 48,868 30,629 14,155 7,637
Growth 87% 50% 54% 75% 60% 116% 85% 254%
NUMBEROFACTIVE
BORROWERS/STAFF 184 197 146 124 183 112 101 59
AVERAGELOAN
BALANCE
PERBORROWER 4764 4144 3740 3300 3357 3417 3105 3084
WOMENBORROWERS 100% 100% 100% 100% 100% 100% 100% 100%
AVERAGELOAN
BALANCEPER
BORROWER/GNIPER
CAPITA 14.92% 15.17% 14.85% 14.41% 15.67% 17.43% 16.63% 18.60%
The number of active borrowers per staff increased significantly also the average loan
balance per borrower as a percentage of GNI per capita has decreased but marginally. This
proves that there has not being any significant negative effect on the social outreach because
of transformation as we would have expected.
We might also be concerned about trends in the financial analysis of SHARE which could
indicate a tendency to move away for poorer clients, such as the increase in SHAREs profit
margin after transformation as well as the increase in the number of clients per staff member.
There are two main reasons we might attribute SHAREs increased Profit margin, higher
interest rates and reduced costs. SHARE does in fact show a decrease in its operating margin
of approximately 3.5% over the period of transformation, but this does not exactly offset the
roughly 17% increase in SHAREs profit margin over this period. While SHAREs the
interest rate SHARE charged before transformation or after is not readily available, we can
still estimate a likely increase in the interest rate charged from the financial analysis. To sure,
however, we would want more information on the interest rates SHARE has charged. Also,
we might consider the possibility that charging higher interest rates might not necessarily
85
result in a loss of targeting the poor if SHARE is able to cross-subsidize the cost of reaching
poorer clients with the higher returns it might make on lending to less poor clients. Therefore,
SHAREs evolving loan methodology as an NBFC will be a key part of its targeting of poor
clients. Also, SHAREs increase in borrower per staff member post transformation might lead
to the concern that less staff effort is being put into finding poorer clients. For this, we would
need to see how SHAREs field agents might have changed in their loan practices post
transformation, information that is hard to glean from published information on SHARE. We
would be most interested in finding out whether these improvements in efficiency per staff
member have contributed to lower levels of poorer clients targeted or whether they truly are a
result of greater incentives and training for staff to reach more of the same poor clients they
are currently reaching.
Organization & Management Analysis
Strategic Vision
SHAREs stated mission is the reduction of poverty by providing financial & support
services to the poor, particularly women. Since SHARE has converted from a society under
the Societies Act in India to an NBFC under the Companies Act it has become a regulated
entity. We might be concerned about the impact on SHAREs mission of transforming to an
NBFC, in that it might become overly concerned with financial sustainability and outreach at
the cost of its social mission. This does not seem to be the evidence with SHARE thus far, in
fact, part of their reasoning for the transformation is that it is in the interest of reaching more
of their target client base, the poor. Therefore, the organizations commitment to its social
mission does not seem to have waned with transformation. Overall, SHAREs operations still
seem to support its mission thus far with its continued focus as an organization to reduce
poverty.
Also, now that SHARE has made the transition to an NBFC, should it consider raising equity
for growth in the future, it will have to find a way to balance its heavily socially motivated
mission with the imperative to improve shareholder value. This will partly depend on the type
of shareholders it might attract and whether they are motivated by social as well as financial
gains. Currently, 99% of its shareholder is its clients so this is not as much a concern.
However, the balancing of social and financial goals is one of the challenges of becoming an
NBFC. An MFI will have to work that much harder to maintain the same focus on social
impact that it had as an NGO while also dealing with the regulatory constraints and financial
86
pressures that come with being a regulated financial entity. This makes the clarity and
strength of an MFIs mission very important as well as staff having a good understanding of
that mission in their work.
Transparency
SHARE has regular publication of audited financial statements as of 2002.This is a direct
result of transformation to an NBFC as annual reports are now legally required of the
organization, and SHARE did not publish such reports prior to transformation. Very little
incentive exists for an NGO to publish audited financial statements because of the time
consuming process and cost of putting together these reports on an annual basis. However, on
the social impact side, there is greater incentive for an NGO than an NBFC to do a careful
impact assessment of poverty alleviation because donors might often require it. Therefore, it
remains to be seen whether SHARE will continue to conduct such careful poverty alleviation
impact assessments now that greater pressure is placed upon it to report on its financials
annually.
I nformation Technology System
SHARE also computerized every branch before transformation to an NBFC which it uses to
monitor individual sources and uses of funds. It also claims an effective MIS system,
however we are unclear about the quality of that system. In SHAREs 2001 annual report it
also announced the launching of a Smart Card which allows it to automate data capturing and
transactions processing to increase efficiency and coverage.
Loan Methodology
SHARE employs the Grameen loan methodology. This involves providing small loans to
groups of women along with some training, consulting, and business development services.
SHAREs products are all loans, with some housing and sanitary loans and six different types
of loans in total. The longest term loans are housing loans which have duration of 4 years.
This loan methodology has not changed with transformation.
Summary
As of 2001, just after transformation, SHARE reported a loan repayment rate of 100%.
SHAREs profit margin has gone from -2.55% in 1999-2000 before transformation to 17% in
2004-2005. With the improvement in the asset turnover the ROE moved from a negative
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territory to an impressive 21% in 2005. This indicates that SHARE has become more
financially sustainable during the time period after transformation to an NBFC. Our analysis
of SHARE shows that the financial impacts of transformation for SHARE appear positive
overall, both in profitability as well as outreach.
Therefore it will be prudent decision to transform the MFI from an NGO to an NBFC.
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10. Conclusion
Although Bandhans financials remain strong the cause of concern is the low capital
adequacy ratio which is far below recommended 15%. This is due to the exorbitant growth
rate in operations and because it is a NGO its inability to access external commercial equity
will hinder its growth.
There has been steep increase in the cost of borrowing and as a result of the growing
competition it is not in a position to transfer the rise to its customers. There also seems to be
limited scope for decreasing the operational costs. Going forward these factors will hinder the
NPM of the MFI. What is even suprising that in these circumstances it has stopped taking
deposists from its members.
As we have seen from the case of SHARE which has successfully transformed itself from a
NGO to a NBFC and the transformation had a positive effect on both the profitability and the
outreach aspects. We recommend that the MFI convert itself to a NBFC. This will enable the
equity starved MFI to accelerate the growth further.
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11. Bibliography
www.bandhanmmf.com
www.mixmarket.org
Microfinance state of the sector report 2008
Microfianance Handbook- J oanan Ledgerwood
Economics of Microfinance- J onathan Morduch
www.cgap.org
Institute for Financial Management and Research Centre for Micro Finance- Working
Paper Series 21
Microfinance in India: A critique-by Rajarshi Ghosh
www.themax.org