Management Development Programme on Microfinance (May 9th to 29th, 2011)

Reading Material

Programme Director
Prof. Sanjeev Kapoor

Sponsored by

BANKENGRUPPE

Organized by

Indian Institute of Management Lucknow

Content
Sl. No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. Description Module 1 : Microfinance Basics Section 1: Section 2 : Section 3 : Section 4 : Section 5 : Economic Transformation and Rural Financial Markets Financial Intermediation What is Microfinance? Model for Savings Model for Micro-insurance Page No. 1 - 38 2 8 16 30 31 39 63 40 56 64 - 85 65 71 74 86 - 102 87 93 96 99 103 - 129 104 119 125

Module 2 : Basic Accounting and Financial Reporting Section 1 : Section 2 : Section 1 : Section 2 : Section 3 : Overview and scope of Financial Accounting Analysis of Financial Statements Raison Dtre Group Based Model in Microfinance Process and Methodology of Forming and Managing SHGs Mapping the ProcessesGroup Based Models of Microfinance Individual Lending: Definition, Usage and Significance Steps of Efficient Individual Lending Process Institutional Risks in Individual Lending for Microfinance Institutions Mechanisms of Mitigating Institutional Risks in Individual Lending Types of risks faced by Microfinance Institutions Microfinance Risks Management Risk Management Framework

Module 3 : Group Based Microfinance

Module 4 : Individual Lending in Microfinance Section 1 : Section 2 : Section 3 : Section 4 :

Module 5 : Risk Management in Micro Finance Section 1 : Section 2 : Section 3 :

Sl. No. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. Section 1: Section 2: Section 3: Section 4:

Description Module-6 : Managing Delinquency in Microfinance Defining Delinquency Identifying Delinquency Loan loss Reserve/Allowance Causes of Delinquency

Page No. 130 - 152 131 135 142 143 153 - 188 154 159 164 174 189 - 219 190 199 201 220 - 239 221 223 226 227 233 240 - 251 241 246

Module 7 : Management Information System in Microfinance Institutions Section 1 : Section 2 : Section 3 : Section 4 : What is Management Information System (MIS) Importance of MIS in MFIs MIS and Information Communication Technology (ICT) and

Designing and Implementing an MIS

Module 8 : Social Performance Management in Microfinance Section 1 : Section 2 : Section 3 : Introduction to Social Management (SPM) Performance

Social Performance Management

Incorporating Social Performance Management into Business Plan Module 9 : Product Development in Microfinance Section 1 : Section 2 : Section 3 : Section 4 : Section 5 : The Marketing Journey Concept: Historical

Factors Leading to Introduction of Marketing Concept in Microfinance Rationale for Product Development in Microfinance Product Development Process

Prerequisites for New Product Development: Factors, Drivers & Institutional Preparedness Module 10 : Valuation of Microfinance Institutions Section 1 : Section 2 : The Key Role of Valuation Valuation Methods

Module 1 : Microfinance Basics

Objectives 1. 2. 3. 4. 5. To make the participants aware about the role of rural financial market in economic transformation. To understand the role and need of microfinance in rural finance sector To familiarise the reader with the basics of microfinance and its utility in the economy of the poor. It also attempts to analyse various definitions of the microfinance in order to build a general understanding among the readers. This module also traces the various models of delivering credit, saving and insurance services to rural clients. It is expected that the module would hone the knowledge of the participants about different dimensions of microfinance.

Following sessions are based on the reading material given in this module : 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Economic Transformation Role of Rural Financial Markets Financial Exclusion Context of Microfinance in Rural Finance Sector Microfinance Basics Theoretical Foundation of Microfinance Concept of Trust, Social Collateral and Transaction Cost Understanding Financial Requirements of Poor Need of Microfinance Group based Microfinance Models: SHG, JLG, Federation Process and methodology of Group Formation SHG-Bank Linkage : Direct Model SHG-Bank Linkage : Indirect Model Importance of Savings Banking Correspondent Model Micro-insurance : Partner-Agent Model Microfinance Link with Livelihood

Section 1: Economic Transformation and Rural Financial Markets Indian economy has undergone a fundamental economic transformation during the past three decades. Economic growth has been accompanied by a rapid structural transformation of the rural economy, reflected in a decline in the relative importance of agriculture, increased use of sophisticated capital inputs in agricultural production, a greater specialization in production on large farms while small farms diversified their income sources, an explosion in the growth of rural cities and towns, and the emergence of a heterogeneous, rural non-farm economy. These changes created major new opportunities for rural financial markets and increased the demand for financial services.

1.1

Structural Transformation & the Role of Agriculture

Economic development involves a fundamental structural transformation of the economy. The size of the non-agricultural sector rises relative to that of the agricultural sector, agricultural employment declines relative to non-agricultural employment, and expenditures on agricultural products fall relative to products and services produced by the industrial and service sector. These changes occur because of the low income elasticity of demand for food and other products produced in agriculture, and because of specialization, in which many economic functions carried out by farm households in the countryside are transferred to specialist producers in towns. Indian agriculture has contributed to the structural transformation process in several ways. First, as agricultural income rose, demand increased for products and services produced in the non-farm sector. Second, through savings and taxation, large amounts of capital were transferred from the agricultural sector to finance the nonagricultural sector. Third, agricultural growth contributed to the emergence of the agro-industry sector, rural manufacturing, and the rural non-farm economy. Fourth, productivity increases permitted the release of agricultural labor to the emerging rural non-farm economy and urban industries. Fifth, agricultural growth generated foreign exchange, through increased exports or reduced imports, needed for industrialization. Agriculture had to undergo a productivity revolution to increase output and efficiency in order to perform these functions successfully.

1.2

The Emergence of Rural Non-Farm Activities

The specialization of economic functions that occurred as part of the structural transformation created an explosion in rural non-farm activities. Specialized nonfarm firms have emerged to supply seeds, fertilizers, foods, household utensils, clothing, and other goods previously made on farms. Blacksmith and equipment repair shops produce and repair farm machines and implements. Transport and trade services increase in importance as marketable surpluses rise on farms. Moreover, some of these rural firms produce goods sold in urban and export markets.

1.3

The Commercialization of Agriculture

The green-revolution technologies, involving the introduction in the late 1960s of high-yielding varieties of wheat and rice, application of chemical fertilizers and modern pest control methods, coupled with increased capital investments on farms and in institutional infrastructure, fueled the structural transformation of rural areas. The new technologies expanded agricultural production and induced demand for fertilizers, chemicals, and other purchased inputs. The commercialization of production had two impacts. First, the rise in marketable surpluses led to increased marketing of agricultural inputs and outputs. Cash incomes rose for many farm households, market exchanges substituted for barter, and the rise in use of money as the medium of exchange helped integrate the rural with the urban economy. Second, decisions about product choice and input use evolved from subsistence to a profit maximization orientation. Structural transformation has also been accompanied by an evolution in food production systems (Table 1). At low levels of economic development, most farms produce for subsistence, with the exception of export crops produced on plantations. Food self-sufficiency is the farmers primary objective, most inputs (labour, seeds, manure) are non-tradable, and a wide range of diversified products is produced. Income is derived largely from agricultural sources but, because production is low and mostly consumed, little cash income is generated. With new biological technologies, production rises and marketable surpluses begin to emerge, particularly in regions with better infrastructure. Semi-commercial farms regularly produce surpluses and use a mix of tradable and non-tradable inputs. Some specialization in production occurs at this stage, and farm households begin to earn larger amounts of non-agricultural incomes from on-farm sources (e.g. wage labour for other more specialized farms) and non-farm sources. Semi-commercial farms engage in many cash transactions. The last group of farms is fully commercialized; they operate almost exclusively in the market economy, and employ the full range of financial instruments to facilitate transactions of goods and services.
Table 1: Characteristics Commercialization
Level of market orientation Subsistence systems Farmers objective Food selfsufficiency

of

Food Production
Sources of inputs Householdgenerated (nontraded) inputs Mix of traded and non-traded inputs Predominantly traded inputs

Systems with

Increasing

Product mix

Household income sources Predominantly agricultural

Wide range

Semi-commercial systems Commercial systems

Surplus generation Profit maximization

Moderately specialized Highly specialized

Agricultural and non-agricultural Predominantly nonagricultural

Source: Pingali and Rosegrant (1995)

1.4

Markets and the Critical Role of Finance

The structural transformation process requires supportive institutions. Markets are required in order to enable a greater division of labour, by which a producer specializes in one activity and trades with others who have different specializations. Markets integrate these specialized producers and consumers, allowing them to engage in transactions involving an increasingly heterogeneous set of goods and services produced across space and time. As structural transformation begins to occur, markets for land, labour, capital, and finance emerge, multiply in number, and become more complex in response to the greater variety of goods and services demanded.

1.5

The Role of Finance

The theoretical literature on finance describes why financial contracts, markets, and institutions emerge in a market economy and contribute to economic growth. The costs of acquiring information and making transactions create incentives for the emergence of financial markets and institutions. The financial system has the primary role of facilitating the allocation of resources across space and time in an uncertain environment. The primary role consists of five basic functions: ameliatoring risk, allocating resources, monitoring managers and exerting corporate control, mobilizing savings, and facilitating the exchange of goods and services. When these functions are performed well, they contribute to economic growth through two channels: capital accumulation and technological innovation (Figure 1). The emergence of financial systems and especially banking can, therefore, be expected to influence the speed and pattern of capital accumulation and technological innovation in rural areas. The efficient functioning of markets affects the pace, speed, and pattern of economic development. Financial institutions-formal, semi-formal, and informal-represent an essential part of the institutional infrastructure required for an efficient market economy. Financial systems provide vital services in an economy. They provide payment services; they mobilize savings and allocate credit; and they price, pool, and trade risks. In this way they make it cheaper and less risky to trade goods and services and to borrow and lend. Without finance, economies would be reduced to the inefficiency of barter. Investors would be limited to self-financing their investments. Households with surpluses, but without good investment alternatives, would be forced to store their savings under the mattress or hold them in less productive assets. Limited access to financial services due to inefficient financial markets constrains economic development.

Figure 1: A Theoretical View of Finance and Growth Market frictions Information costs Transaction costs

Financial Markets and Institutions

Financial Functions Facilitate exchange of goods and services Allocate resources Exert corporate control Facilitate risk management Mobilize savings

Channels to Growth Capital accumulation Technological innovation

Economic Growth

Source: Adapted from Levine (1997).

1.6

Rural Development and the Demand for Financial Services

Financial services are important for the development of rural areas. Rural transformation provides opportunities for investments in farm enterprises. Technological changes often require complementary investments that increase demand for working and investment capital. Some of this demand is self-financed, some is serviced by informal sources, but still others require longer-term loans provided by formal institutions. Supplying reasonably priced loans, therefore, can speed the adoption of technology, expand the production of food supplies, and increase farm incomes. When a reliable supply of formal finance is established, farmers may alter their perceptions about the risks of investing. They may choose to invest more of their own funds knowing that their unused borrowing capacity will be available to meet future cash needs. A wide variety of rural non-farm enterprises also arises in response to new opportunities and demands for new goods and services that emerge with economic transformation. In the absence of financial services, income from non-farm enterprises may provide funds for farm investments, but they also generate a demand for loanable funds that cannot always be met by savings or informal finance. Taken together, farm and non-farm enterprises with their diverse economic activities comprise a large and heterogeneous pool of potential customers for formal loans. A safe and reliable place for savings is another important but largely overlooked financial service demanded in rural areas. All rural households must save; otherwise they would not survive seasons of the year when cash is in short supply or in bad years when crops fail and livestock die. They must also save for unexpected family emergencies of illnesses and death. Saving to make lumpy investments is also important. Insurance markets do not exist in most developing countries so rural households employ a variety of strategies to cope with risks and smooth consumption over time. Some households acquire assets that produce uncorrelated returns, and hold physical assets in the form of livestock that are easy to liquidate. But such liquidations may jeopardize the ability of households to recover after the emergency passes. Other households use risk-reducing strategies such as pesticides or engage in multiple and diverse income-earning enterprises. Those with access to financial services, however, have additional options of holding financial savings and borrowing in times of emergencies. Another financial service demanded in rural areas is a safe and reliable method to transfer remittances. Transfers by family members who have emigrated are an important source of income for many small farm households. The users of financial services in rural areas are heterogeneous and include farm households, plantations, agribusinesses, rural non-farm enterprises, and landless workers. Households and firms of all income and wealth levels demand financial services. Their demand includes short-term working capital and long-term investment loans, small quickly disbursed loans for emergencies, consumption loans, secure places to hold deposits, and efficient banking mechanisms to transfer payments and remittances.

Farm households employ a variety of methods to manage their cash inflows and outflows over time. Some have financial surpluses just at the time those other face deficits. This provides opportunities for financial intermediation within rural areas in spite of apparent similarities in the seasonality of farm enterprises.

1.7

Transaction Costs for Providers and Users

Finance is an information-intensive industry. Providing services requires significant expense in collecting, processing, storing, and manipulating vast amounts of information on clients, loans, and savings accounts. Institutions must learn how to use this information effectively to determine what services to provide, to whom, and at what price. They must design, monitor, and enforce financial contracts, and earn enough income to cover the costs of staff, the use of capital, taxes, adhering to regulations, and the cost of loan losses. Formal institutions must systematically collect and evaluate information needed for screening clients, making loan decisions, and monitoring borrower performance, and they must conform to rules set by owners, directors, and regulators. Informal rural moneylenders and traders have an advantage because they can access local information about their clients efficiently through living and working in villages. They have the freedom to decide whom to serve or not serve without being held accountable to others. The users of financial services also bear transaction costs including the value of time lost, travel costs, and other non-interest costs in getting and repaying loans and making deposits. Borrowers often have to visit distant bank offices to apply for loans, to provide documents and information demanded by the lender, and to make payments. Likewise, depositors incur travel costs and the opportunity cost of time in waiting to deposit and withdraw funds.

1.8

Risks of Providing and Using Financial Services

Providers and users of financial services face multiple risks that increase costs. Lenders face the credit risk that borrowers may default. They face price risks due to unexpected changes in interest rates and foreign exchange risks if they have liabilities in foreign currencies. There is systemic risk in which the default of one or a few large borrowers may endanger the whole financial system. Localized lenders with portfolios concentrated in small geographic rural areas are exposed to covariant income risk; that their clients will be simultaneously affected by a local drought or disease epidemic. Formal financial institutions with broader coverage have greater capacity to withstand the effects of highly localized shocks and can provide the liquidity needed by affected households and firms for recovery. Information asymmetries create lending risks because borrowers have more information about their projects and intentions than do lenders. Lenders attempt to reduce credit risk by improving their expertise in collecting and analyzing information about borrowers and their projects. The use of loan collateral is the most common method for reducing credit risks.

1.9

High Costs and Risks in Rural Areas

Rural areas present especially difficult and costly problems for the provision of financial services. Rural bank clients are more dispersed than urban clients and often demand relatively small loans and savings accounts, so per unit transaction costs are high for financial institutions. Information costs for providers and users are higher because transportation and communication infrastructure is usually less well developed. Agricultural loans are often considered inherently risky because of production and marketing risks. Moreover, the returns on firm investments are often low because of urban-oriented agricultural policies. Loan repayment by farmers may be contingent on the borrowers first meeting household consumption requirements. Many potential clients have little acceptable loan collateral, and property rights to mortgaged land may be uncertain and hard to enforce. Although farm households engage in a variety of enterprises, the concentration of crops and livestock in specific geographic locations results in high covariance of household incomes that makes localized institutions vulnerable to local disasters.

Section 2 : Financial Intermediation Intermediation in financial services sector offers the following services: It helps individuals to plan their differing needs of finance at differing points in time by an intervention that helps to balance these needs. The intermediation offers a mechanism of meeting the demand for finances of a person by the persons own supply. This is done by putting away some money (savings) to be used at a future point in time or using the money in the current point with a promise to replace it in future (loans). In either case, the service of intermediation is usually used to manage the time differences. There are several individuals who have these time differences; moreover, the differences across persons are not uniform. Therefore, there are cases where some persons are savers and have no current needs for money while there are some borrowers who have a current need for money to be met from future savings or to be taken away from past savings. Thus, there is a demand and supply situation where one could get/pay a price for the difference in timing. This creates opportunities for transaction between people. Since full information about who is willing to supply money and who is willing to borrow is not easily available, there is asymmetry. A person might have greater amount of information about the needs and reliability of a small circle of people with whom he/ she might have regular dealings. But, that small circle might not always be enough to take care of the demand-supply gap. So, there is a need to expand this pool of people with whom the exchange could be carried out. In case the exchanges are carried out with unknown people, there is further information required before the exchange could happen will the exchange contracts be honored? If they are not honored, how could the contracts be enforced? Who in the larger pool of people needs or can supply money and how reliable are they? This gap invites intermediation.
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So, intermediation bridges the timing gap within the persons own cash flows; it bridges the gap between the differing needs for money at the same time and also between reliability and trust to enable exchanges with unknown people. Banking and financial service institutions intermediate by providing a bridge for the information asymmetry in the market. The institutions get a fee for managing this asymmetry and managing the risk arising out of the asymmetry this fee is usually the differential between what they pay for savers and what they get from borrowers. It is also known that the lesser the information available to the lender, theoretically, a greater fee should be charged to keep the risk-return equation intact. However, this is not always true because the state has, from time to time, intervened by directing the intermediaries to exhibit certain behavior vis--vis a class of clients.

2.1

Problem of Financial Exclusion

The supply of financial products and services for agricultural and rural population has been largely deficient. Provision of timely and adequate credit has been one of the major challenges for banks in India in dispensation of credit to the farmers. In spite of 40 years of nationalization of banks in India, coupled with introduction of Regional Rural Banks, financial exclusion among the rural clients has been quite large in general. Using the NSSO data, the recent report of the Committee on Financial Inclusion reports that 45.9 million farmer households in the country (51.4%), out of a total of 89.3 million households do not access credit, either from institutional or non-institutional sources. Further, despite the vast network of bank branches, only 27% of total farm households are indebted to formal sources (of which one-third also borrow from informal sources). Farm households not accessing credit from formal sources as a proportion to total farm households are especially high at 95.91%, 81.26% and 77.59% in the North Eastern, Eastern and Central Regions respectively (RBI, 2008). The NSSO estimates of the year 2003 show that that 87% of all non-indebted farm households belong to the marginal (70.6%) and small (17.1%) farmer categories. Only around 45% of marginal farmer households (viz., up to 1 ha.) had access to both institutional and non-institutional credit. A major portion of the credit from financial institutions for weaker sections has supported small farmers. However, marginal farmers who account for 66% of all farm holdings remain by and large excluded from the formal financial system and by rough approximation, only around 20% of these households access credit from formal banking sources. Financing agriculture continues to be perceived as having high transaction cost coupled with high risks. This is primarily due to scattered nature of agricultural borrowers with demand of credit in low volumes. A study conducted by Central Bank of India indicates that the transaction cost total as per cent of loans up to Rs. 25,000 for the five branches range from 12.26% to 14.21% and the average transaction cost works out to 12.95% (RBI, 2008). As per the study conducted by ICICI Bank, the expenditure per transaction remains constant irrespective of loan size. Thus, as the loan size goes up, the transaction costs as percentage of loan comes down. For a loan size of Rs. 25,000, the transaction cost comes to 8.62% for the Bank, whereas for loan of Rs. 10,000, it is higher at 21.56% (RBI, 2008). Financial exclusion is also caused by demand side issues. Like the banks, the rural borrowers also face high
9

transaction cost of borrowing due to complicated procedure involved in getting the loan. This factor de-motivates them to approach to formal financial institutions for accessing the financial services. Access to financing, especially by the poor and vulnerable groups is now widely acknowledged as a path to meaningful financial inclusion, social cohesion and poverty reduction. Further, access to finance empowers the vulnerable groups by giving them an opportunity to have a bank account, to save and invest, to insure their homes or to partake of credit, thereby facilitating them to break the chain of poverty. Financial inclusion may be defined as the process of ensuring access to financial services and timely and adequate credit at an affordable cost to the poor and and low-income groups. Access to affordable financial services - especially credit and insurance - enlarges livelihood opportunities and empowers the poor to take charge of their lives. Given the severity of the problem, access to finance by the poor and vulnerable groups has become an integral part of Government of India efforts to promote inclusive growth. Financial inclusion denotes delivery of financial services at an affordable cost to the vast sections of the disadvantaged and low-income groups. The various financial services include credit, savings, insurance and payments and remittance facilities.

2.2

Financial Exclusion and Formal Financial Sector

The financial sector developed in India was largely supply driven and target driven, characterized by: Greater focus on credit rather than other financial services Lending targets directed for priority sectors Subsidised interest rate policy Significant government intermediaries subsidies channelled through the financial

Rural finance was taken with a perspective of social obligation but not a potential business opportunity

Worse still, the formal financial sector failed to recognize the mismatch between the hierarchy of credit needs and credit availability, resulting in adverse usage of credit (figure 2).

10

Figure 2: Hierarchy of credit needs and credit availability from formal sources, leading to adverse usage

Diversification needs

Production and productivity enhancement needs by increasing the asset base

Credit availability

Credit usage

Production and productivity needs increasing by using improved inputs

Consumption smoothening needs

Credit needs start with the consumption purposes. Higher needs come into play only when the lower needs are satisfied. However, credit from formal financial institutions is usually available for new enterprises (i.e., for diversification). Since money is fungible, loans are taken for diversification, but used in lower rungs of hierarchy. This means that any appraisal of the loan is not honored resulting in adverse usage and hence adverse repayment performance. Microfinance, in recent times, has emerged as a powerful tool to provide access to some financial services to the poor. It has tried to bridge the gap between formal institutions and the poor by providing some intermediary mechanisms of transaction aggregation and rationalizing transaction costs.

2.3

Information Asymmetry and Trust: Role of Social Intermediation

Social intermediation has been described most extensively in the microfinance literature by Lynn Bennett and her colleagues in the World Banks Sustainable Banking with the Poor project. As they define it, social intermediation is a process in which investment is made in the building up of both human resources and institutional capital, with the aim of increasing the self-reliance of marginalized

11

groups, and preparing them to engage in formal financial intermediation1. It is special efforts to integrate poor men and women into formal financial markets and link them to government services that may help them to become more productive and able to lead more satisfying lives.

2.4

Building Social Capital

Trust has a significant role to play in the various forms of exchanges that happen in the financial markets. Financial intermediation depends upon trust between the borrower and the lender that contracts will be honored. Historically, the basis for that trust has depended on two critical elements the applicants reputation as a person of honor and the availability of collateral against which claims can be made in case of default. The first element, reputation or character, was assessed based on the lenders intimate knowledge of the borrower, or, failing that, on the witness of other reliable persons and a documented history of past borrower behavior. But these are the two elements that formal lenders find lacking among the poor they are not known to the lender in any profound way, nor do they have material value to pledge against risk. Added to these two barriers are others that further increase the distance between lender and borrower. They may be policy and institutional barriers; they may be physical, such as poor infrastructure, remote difficult terrain, and, often, stagnant subsistence economies where there are few opportunities for successful businesses, or they can be socioeconomic, such as illiteracy, caste, and gender. The consequence of these barriers is that the lender perceives the administrative costs of gathering information and processing applications for poor people as too costly relative to the small size of the loans and the potential profit. Something needs to be created to overcome these barriers, and that something is social capital. Social capital was defined as, those features of social organization such as networks, norms and trust that facilitate coordination and cooperation for mutual benefit. Social capital enhances the benefits of investment in physical and human capital. The first element given in this definition, networks, norms, and trust, was further defined by Frances Fukiyama as local clubs, temple associations, work groups and other forms of association beyond the family and kinship group, and also large, publicly owned corporations. They are important for one key reason: Because both civil and commercial associations which reach beyond the family depend on and foster traditions of collaboration and a certain level of trust between members of society, they are able to reduce what economists call the transaction costs of doing business in that society. When access to financial intermediation services is the intent, it results in the formation of self-help groups that provide a new type of organization through which the poor can relate to others in society, and through which members can develop a substitute for the collateral they lack. That substitute, the peer guarantee mechanism, introduces shared liability and pressure from social groups as a replacement for security and business appraisals. In addition, this mechanism offers
1

Lynn Bennett, 1996a, Social Intermediation: Building Systems and Skills for Sustainable Financial Intermediation With the Poor, Washington, D.C., The World Banks Sustainable Banking with the Poor project, Rural Finance Seminar, May 1. 12

a vehicle for slashing administrative costs of the formal lender. Costs to lenders are reduced in gathering information about borrowers, and lenders can shift onto groups some of the loan-processing and loan-approval tasks. Shared liability and the promise of repeat loans in increasing amounts were also recognized as a key factor in motivating repayments. In effect, the self-help group called a solidarity group, a village bank, a savings and credit cooperative, or some other name creates an information asset for the poor. That information asset is first and foremost the collective endorsement of character that each member of the group provides the other, which is accepted by the financial intermediary in lieu of other assets. Second, it is the knowledge that each member has of each others economic activities (and household situation), which supports an accurate assessment of ability to pay. Exhibit 1 gives a brief description of the various types of institutions and a broad picture of the level of trust and the resultant transaction costs. The new generation microfinance institutions address the problem of erosion of trust on the basis of mutuality sorting out local demand-supply gaps locally and going out of the local orbit for incremental or residual needs. This model uses the information available in the best possible manner and gets trust as a major factor back into circulation. There is no doubt that wherever there is ready information, it is being used to reduce transaction exchanges and costs thereof. Over a period of time, aspects such as repeat transactions and documentation are building up institutional memory. This memory would help in codifying contracts and organizational trust might eventually replace the current inter-personal trust that is used in the transactions. One of the critical elements in fostering trust and information sharing is the relative degree of certainty that the relationship is going to be sustainable over a period of time. If the relationship is going to be terminal, then, each of the parties would resort to strategic behavior and would never find a reason to foster trust. Evidence of using trust to reduce transaction costs is reflected in the level and extent of documentation that is done. In case of several SHGs and cooperative movements, it is possible that the transaction costs which are kept low initially because of informality and access to information are no longer feasible when the movement grows. The necessary element of growth and formalization of the systems lies in increase in transaction costs and developing mechanisms of institutional memory.

2.5

Trust and Transaction Costs

We can say that trust which could also be a function of increased information has a significant impact on transaction costs particularly related to documentation and delay in procuring the loan. When the levels of trust are high, the decisions are taken immediately and the documentation formality is minimal. As institutions get more and more formal, the trust will have to be converted from interpersonal trust to institutional trust which requires recording, storing, and retrieval of information. This might increase transaction costs but would certainly make the transactions sustainable and repetitive in nature.

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Exhibit 1 : Level of Transaction, Degree of Trust, and Transaction Costs

Level of Transaction Threshold Size of Transaction Degree of Trust and Level of Information High level of information on the counterparty and, therefore, high degree of trust. Documentation and Transaction Costs Effect of Breach of Trust

Interpersonal transactions both the parties are professional intermediaries

Usually small, consumption smoothening in nature. Usually no costs (interest) or nominal costs involved.

Minimal documentation, usually word of mouth. Negligible or zero out-of-pocket expenses. Negligible processing time for transactions. Minimal documentation. Negligible processing time for transactions. Since there is a premium on information (there will be only a few people who know the borrower and also have the resources to lend), interest tends to be high. Flexibility very high. Moderate documentation more for the needs of accounts keeping and external reporting than for a decision on disbursal. Low transaction costs, low flexibility because of competing needs of different memebrs. Overall costs vary widely. Transaction costs have a potential to be low but are usually not. Information recorded more for external reporting than decisionmaking. Since the funds are cheap, there is excessive rent-seeking thereby getting total transaction costs

Break of relationships increase in documentation in case of future transactions. However, enough space for condoning nonwilful default. Drastic action in case of wilful default. In case of non-wilful default, the rent is extracted by a further loan and making the borrower more dependent on this particular source and charging higher risk premium in future transactions.

Interpersonal transactions with one party as a professional lender/deposit collector but operating on an informal basis

Threshold higher than informal interpersonal transactions. Interest cost on loans dependent on local conditions and risk profile of the borrower builds in the cost on inherent risk of non-wilful default. Threshold on savings low. Usually small, restricted to consumption, production, and effectivization needs.

High degree of information, transactions largely based on trust. Lender operating in a limited market where information is personality stored without formal recording in books. Very high covariance risk. High levels of information and trust because of homogeneity and access to each other within the group.

Transactions with local informal institutions (chit funds, SHGs)

If the breach of trust (wilful default) is an isolated case, there would be a tendency to regroup. If the breach is widespread, the institution (group) collapses.

Transactions with local formal institutions (coops)

Threshold size could be larger given the strength of the institution. Loans could go up to diversification needs of the customers.

Moderate to high level of information used effectively in institutions having significant member stake (Agrawal et al., 1994), used detrimentally where high external subsidy funds are pouring

Rampant breach of trust in most institutions at both levels wilful default and breach of trust of individual with the institution. No consequential action on wilful default leading to breach of trust by the institution against good

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Level of Transaction

Threshold Size of Transaction

Degree of Trust and Level of Information in.

Documentation and Transaction Costs

Effect of Breach of Trust

similar to that of informal channels. Minimal documentation but the method includes involving the spouse as a guarantor. Again, use of coercive trust in documenation as well. However, transaction costs on the documentation are low as it is done at the doorstep and with minimal formalities. Nominal cost of loan moderate. But, documentation requirements, inspection, and monitoring the usage high. Procedures are inflexible and elaborate to suit internal controls of the lending institution. Usually time-consuming. This leads to high transaction costs (delay or corruption) making it comparable to any other expensive source in the market.

borrowers. Effect: rampant sickness in the sector. Collapse of the outlet. The trust intricately links all the borrowing fraternity. If they gang up to snap the ties, the outlet collapses. However, the incentive of continuing transaction mitigates the possibility of collapse.

Transactions with local micorfinance institutions (Grameen type)

Moderate, as the programmes are poverty focused. Could be high in case of established borrower.

Use of coercive trust, externally dictated. Fostering trust by making the consequences of breach of trust expensive and treating it as a deterrent.

Transactions with branches of regional/national level formal instituions

Has the theoretical potential to be high. In fact, smaller transactions are usually seen as an obligation.

Level of information is low because of aspects relating to continuity of the persons at the cutting edge. Degree of trust is also low leading to excessive documentation and collateralbased lending. However, a high degree of trust is usually reposed by the saver when the issue of deposits come up.

No effective action on breach of trust by wilful default. Excessive documenation makes the transactions impersonal and there is no effective mechanism of converting the documentation into encashable collateral.

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Section 3 : What is Microfinance? Owing to its recent origin, microfinance has got several definitions and dimensions. However, till today the origin of the term is not clear yet. Siebel claimed to use the term microfinance for the first time in 1990 (Siebel, 2005, Bernstein, 2009), whereas Accion International claims that one of its staff in Recife, Brazil used the term microenterprise loans for the first time to initiate the field of microcredit (Accion, 2010). Many of the writers assert the origin of microfinance to the countries like Bangladesh and India (Burkett, 2003). However, the term just adds a gloss to financial transactions with the poor. Financing the poor is as old as the banking itself, nevertheless the concepts of organising the poor came much later. This can be seen in the following sections on the history of microfinance. Globally the term microfinance has been accepted as a gamut of financial services including credit, insurance, savings and remittance services for the poor. The Consultative Group to Assist the Poor (CGAP) and the Asian Development Bank (ADB) include a range of financial services in their definitions (see box 1). The definitions by these bodies also leave ample scope for adding other financial services such as pension or investment services of smaller amount. ADB, in fact, broaden the scope of its definition by including institutional microfinance and categorising these into formal, semi formal and informal (ADB). These definitions also recognise microfinance as a powerful instrument for reducing poverty, enabling them to build assets, improving living standards, increase incomes, and reduce their vulnerability to economic stress. Nevertheless, the low income or poor clients are remained at the centre of microfinance definitions.
Box 1: Defining Microfinance Defining Microfinance The Consultative Group to Assist the Poor (CGAP) defines microfinance as a service that offers poor people access to basic financial services such as loans, savings, money transfer services and microinsurance. The Asian Development Bank (ADB) defines microfinance as the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low-income households and, their microenterprises. The Basel Committee on the Banking Supervision defines microfinance as the provision of financial services in limited amounts to low-income persons and small, informal businesses which is increasingly being offered by formal financial institutions (BIS, 2010). In India, the task force set up by the National Bank for Agriculture and Rural Development (NABARD), under the chairmanship of Shri Y C Nanda defines microfinance as a provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and/or urban areas for enabling them to raise their income levels and improve living standards (NABARD, 1999).

3.1

Goals of Microfinance

An in depth analysis of available explanations in various literature provide three critical components of microfinance. These are

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Focus on people belonging to low income or poor categories Access to a range of customised financial services Increase in income levels or improvement in living standards of these low income or poor clients

These elements play a crucial role in determining the goals of social responsibility associated with microfinance. The utopian concepts such as equality of opportunity in order to access financial services, opportunity for personal growth and development and bringing people out of poverty, thus clearly bring forth the social motives at the forefront of any microfinance intervention. However, with the increasing demand for and potential of microfinance services, the concept of sustainability of the interventions got associated with it, thereby introducing commercial orientation to the sector. Lately the sector witnessed entry of several corporate and people with private capital for providing these services. But it is important to note that the entire microfinance concept borrows heavily from both the social as well as business orientations. It is driven by certain tested thumb rules and experiential learning of various microfinance institutions over the years which have been translated into the guiding principles of microfinance.
But why do poor need microfinance? Can also be used as case studies on the events for which poor need microfinance or reasons due to which they do not access financial services (listing out the factors and events) Have you ever wondered how do poor people meet their needs? Have you ever talked to them on how do they meet their financial requirementssuch as unexpected health problems which cause loss of income? Like us, poor also marry their children, spend on festive occasions, also do ceremonial expenditures, also fulfil capital requirements for a small business and save for unexpected events too. But not necessarily with the institutions or mechanisms we have!! The reasons being many such as access to mainstream banks, lack of knowledge, literacy levels, presence of financial institutions, attitude or understanding among the bank staff, past experience and many more. They have their own set of mechanisms through which they save, take loans or have some money for insurance. These are a mix of both formal and informal mechanism. There are various life cycle events which affect a poor and gives reasons as to why poor save. The list is not comprehensive and many more reasons can be added. Housingrepairing and maintenance, food and clothing Marriage of children Maternity and birth of children Death of a family member Health issues Education of children Capital requirements of their businesses Repayment of old debts Unfortunate events such as accident, death of a bread earner Buying new house Festivals Loss due to natural disasters Old age These events require poor to save in advance or take loans or one can say that the poor need a range of services including insurance and pensions. The microfinance services are an outcome of understanding of the real financial requirements of the poor. Lack of access to financial services or absence of financial institutions may lead to a vicious cycle of debt trap, which keeps the poor lingering at the same position where s/he is.

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3.2

Principles of Microfinance

Unlike the term microfinance recent origin, the key principles which govern microfinance are not new. Many of the principles have been in use for several years by development oriented activists or organisations.

1. Principle of Trust on the Poor Poor are bankable and it is proved by many microfinance interventions globally. Be it Grameen Bank of Bangladesh, SEWA Bank in India, Village Banks in Latin American countries, or other such solidarity and individual models. For any microfinance intervention to be successful, one needs to have a belief on the poor that they are bankable as like other people in the society. This principle in turn becomes a foundation for initiating activities to promote microfinance in any region. 2. Principles of Accessibility to Financial Services Like other people in our society, poor also need access to financial services. The microfinance services came into existence because of lack of access to even basic financial services by the poor and their heavy dependence on the informal mechanisms. Studies have also proved that lack of access to financial services drive the poor into a vicious cycle of debt trap which ultimately affects them to lead a vulnerable life (SEWA). In fact, one of the committees on rural indebtedness in India concluded that "the Indian farmer is born in debt, lives in debt and dies in debt". A microfinance intervention increases the accessibility of a poor household to the basic financial services thereby reducing its dependence on informal service providers. It also opens a gateway for the poor to increase their incomes and improve their standards of living. 3. Principle of Understanding of the Needs and Designing Customised Services It is important to understand the human needs for initiating microfinance. The needs of different economic segments are different and this should be fully understood that one size does not fit all. The needs of the poor are different because of many reasons like erratic cashflow from their small business activities, ability to save small amounts from their profits, less or low paying income streams etc. Therefore, the principle promotes customised financial services which the poor can afford and utilise. The learning from the sector shows that poor need affordable financial services in small volumes with flexibility, ease and high frequency of pay-ins or payouts. The poor clients also prefer safety and security of their money. 4. Principle of Sustainability of Interventions Experience across the globe has made it evident that any successful microfinance intervention needs to be sustainable in the long run. The donor dependent and subsidised microfinance programmes have not shown very effective results. Instead, subsidies at some places led to the failure of entire microfinance programmes (CGAP, 2004). Later the practitioners also felt the importance of sustainability of microfinance interventions and this is also visible in subsequent growth of number of
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players with private equity and volume of investment in the sector. The sustainability approach in microfinance came into being because of the negatives of donor dependence such as increase in the demands of the clients once the programme starts, popularisation of the programme because of its economic impact in the area, growth in number of clients and long waiting periods for services. This principle in fact guides microfinance interventions to get prepared for sustainability of the programme since its beginning. 5. Principle of Mutual Trust Financing the poor was started with a belief that poor can repay and based on this belief the interventionists started providing financial services to the poor especially loans. Later on when the bankability of the poor was established, other financial services like insurance and remittance were also introduced. The principle of mutual trust has been derived from the ancient history of banking and finance. Just like other financial institutions, both the parties in microfinance i.e. service provider and the client have to have mutual trust on each other. This is important for continuation of services, reputation of the area, and increasing competition in the area to get the services at competitive rate. This principle in effect also gives thrust on responsible and transparent functioning of the microfinance institution. 6. Principle of Progression The principle of progression implies that sustainability of any microfinance intervention depends upon the scales of business i.e. increase in outreach and volume of business. Client outreach and volume of business are still important indicators of measuring success of any microfinance programme. This principle is derived from the principle of sustainability of interventions. This also helps in achieving economies of scale in the long run. 7. Principle of Following Strong Financial Discipline and Systems This principle is also a corollary to the principle of sustainability. This principle focuses on devising rules and regulations for building a strong financial discipline and systems in any microfinance programme. Several of the programmes globally have demonstrated the need for ensuring discipline and financial systems among the clients and in the organisations. For an effective microfinance programme strong financial discipline and financial systems are the backbone of its success in the long run. Strategy and planning at all levels also play a crucial role in determining the growth of the organisation in the long run.

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3.3

Evolution of Microfinance

World History of Financing the Poor Although the term microfinance is of recent origin, Traditional Mechanisms the concept is Quite Old. There are several examples available for the poor to of traditional mechanisms (see the box) around the meet their financial needs world through which people used to meet their Susus of Ghana, financial services requirements. These were in the Marups, Committee & Chits in India form of savings and credit groups. Many of these are Tandas in Mexico still active and play a vital role in the lives of poor. In fact formal and semi formal mechanisms too have a Arisan in Indonesia rich history of several decades for providing financial Cheetu in Sri Lanka services to the poor. These mechanisms trace back Tontines in West Africa their history in the form of cooperatives and Pasanaku in Bolivia development financial institutions (Topstars, 2009). In the 18th century, loan funds became popularised in Ireland. The loan funds used peer monitoring to repay the loans availed from donated resources. These interest free loans were required to be repaid in weekly instalments. However, these loan funds received a thrust in the 19th century when a special law was passed in 1823, which turned charities into financial intermediaries by allowing them to charge interest on loans, and enabling them at the same time to collect interest-bearing deposits. This was followed by establishment of a Loan Fund Board in 1836 in order to regulate and monitor these funds in Ireland(Seibel, 2005). In later years, various forms of institutions such as People's Banks, Credit Unions, and Savings and Credit Co-operatives, started gaining grounds across Europe by organising the poor for financial services. These institutions came forward to save the poor from the clutches of moneylenders. Friedrich Wilhelm Raiffeisen, a German cooperative leader, and Hermann Schulze-Delitzsch brought the concepts of credit unions on the map of Germany. While Delitzschs promoted financial cooperatives focused more on urban areas, Raiffeisen later focused on organising credit in rural areas (Adams,1995). Seeing its benefits, the concept quickly spread in several parts of Europe and North America by the end of 19th century (Reimagine, California and Nevada Credit Union Leagues) and later became a worldwide phenomenon. Around 20th century, the Latin American Countries experimented with the local adaptations of the Irish and German models to provide access to basic financial services such as credit and deposits (Steger, et al., 2007). Later the concept of traditional village banking system also got a boost in these countries (Topstars, 2009). The Asian continent also joined this league around the same period. During 1900s, the concept of village owned credit organisations and village savings and loan institutions (also known as Peoples Credit Bankor Bank Perkreditan Rakyat, BPR) came into existence in Indonesia. These institutions aimed at promoting agriculture by providing loans to farmers but later on as the demand for money rose in other sectors, non-agricultural businesses were also included (BWTP). Other Asian countries such as Japan developed strong cooperatives which were later adapted by Taiwan and Korea in the 20th century (Adams, 1995). In the later parts of 20th century, the governments and donors concentrated on providing agricultural credit to small and marginal farmers. Various supply-led government interventions in the form of targeted credit through state-owned
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development finance institutions, or farmers' cooperatives were promoted in different parts of the world. However, experimental learning in lending to solidarity groups of women in few Asian and Latin American Countries such as Bangladesh and Brazil led to the emergence of group based models. In the late 90s, the Global Microcredit Summit organised in the United States, brought microfinance into the global map. The first lady of the United States, Hilary Clinton and the Queen Sophia of Spain pledged to support microcredit in this conference (Biswas, 2009). Since then various initiatives have been taken globally to promote microfinance. Recognising the need for financial services in the lives of poor, even the United Nations dedicated a year 2005 as International year of Microcredit.
Table 1: Historical Journey of Microfinance Across the Globe Period Early 1700s 1800s 1900 1950s to 1970s 1980s Late 1990s Events Irish Loan Fund system started by Jonathan Swift (300 funds by 1840) Various larger and formal savings and credit institutions began to emerge in Europe. These institutions were known as People's Banks, Credit Unions, and Savings and Credit Co-operatives Increase in commercialization in rural banking, esp Latin America Governments and donors focused on providing agricultural credit to small and marginal farmers Supply-led government interventions in the form of targeted credit through state-owned development finance institutions, or farmers' cooperatives Experimental programs in Bangladesh, Brazil, and a few other countries extended tiny loans to solidarity groups of poor women to invest in micro-businesses in which every member of a group guaranteed the repayment of all members Global microcredit summit organised in Washington DC. Grameen Bank showcased its work of the past two decades and was being acknowledged as an effective methodology to reach small loans to the poor. The high profile support from the then first lady Hilary Clinton and the Queen of Spain drew the attention of several interested parties. International Year of Microcredit (2005) declared by the UN Noble Peace prize conferred to Mohd. Yunus and Grameen Bank, Bangladesh

2000s

3.4

Indian History of Financing the Poor

The Indian history of lending to the poor traces its root in the Vedic literatures from 2000 to 1400 B.C. The literature of the Buddhist periods and recent archaeological discoveries supply evidence of the existence of sresthis, or bankers. There were moneylenders who belonged to Vaishya caste. Apparently, the caste system was dominant in deciding the interest rate. The Shudras which were considered to be the lowest in the caste structure could take money at the highest interst rate i.e. around 5% when compared to borrowers from other caste. The ancient Indian history also brings forth the pioneering work on devising rules for disputes and debt recovery in the past. However, Manus laws also focused on the problems related to money lending in ancient India (Reddy, 1999).

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The medieval history witnessed the growth of more formal institutions in the banking sector nonetheless the poor were out of this sector. The later periods of colonialism saw formation of cooperatives to aid small farmers and improve access to rural credit, which continued even after the independence (International Cooperative Alliance). After independence, several steps were taken to address the challenges in financing the poor. There was an All India Rural Credit Survey in 1950s to assess the rural indebtedness, which came out with striking findings with regard to indebtedness. This was followed by focus on extending credit to rural and poor areas by passing SBI act in 1955, nationalising banks in 1969 and 1980, establishing Regional Rural Banks & NABARD and introduction of lead bank scheme. Shri Mahila Sewa Sahkari Bank Limited (popularly known as SEWA Bank) in seventies was an effort by women in Ahmedabad, India to form their own cooperative and can be termed as the first microfinance intervention (as it provided both loans and savings) in the country. Later, the decade of eighties in India achieved a new milestone in the field of microfinance with the introduction of self help affinity groups (SAGs) by MYRADA with a grant support from NABARD. It was then followed by a pilot on peoples own group based model (popularly known as Self Help Groups-SHGs) promoted by external support in the year 1992 by NABARD (Kropp and Suran, 2002). This growth was furthered by Small Industries Development Bank of India (SIDBI) which promoted Microfinance Institutions (MFI) model for delivering small value of loan products to rural segment, particularly the women. After 90s, the group based microfinance model got popularised in various parts of Southern India which later succeeded across the country because of the apathy of formal financial sector towards the poor. The historical successes and astronomical growth in last decade resulted in adopting new models, technological advancements, and policy initiatives in the microfinance sector in India.

3.5

Microfinance Scenario across the Globe

Microfinance has been recognised world over as an important mechanism to reduce poverty by increasing access to financial services. Reaching out to around a 100 million clients (Microcredit Summit Campaign, and MIX, 2009), speaks volume about microfinance. Globally, there are numerous experiments on increasing the access like product diversification, banking correspondents or facilitators, point of sales, mobile banking, hand held devices, and many more are still on their way. These experiments ranged from Latin American Countries to Asian nations. While Canadian government implemented Access to Basic Banking Services rules for increasing financial inclusion and Accion with service company model, the Brazilian government pioneered banking correspondent models and used postal network to deliver financial services. In the Asian continent, the Grameen bank pioneered microcredit concept with solidarity groups, whereas SEWA bank used cooperation as a tool to promote microfinance in India. Indonesia experimented with Unit Desas specialised rural banking outlets on one hand, the Philippines experimented with partnership with mobile phone companies to provide mobile based banking services. The African nations were also not far behind. South Africa implemented hand held point of sale devices for providing banking services through agents. Some of the major microfinance institutions and postal banks also launched low cost transaction
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accounts (called Mzansi) for its low income population in South Africa. India has also experimented with dedicated funds for microfinance and no frills account (Khan, 2005 and Sengupta, 2007). The entry of microfinance institutions in the capital market in recent time also indicates the future of the sector.

3.6

Models of Microfinance

There is a four decades long history of providing microfinance services through group based models. But most of these group based models functioned only with credit as a major financial service, later other financial services, especially savings, were also added in the kitty. The historical efforts through cooperatives and informal channels, however, can be attributed as the mechanisms which offered a comprehensive set of financial services to the poor. There has been a lot of debates on the models of microfinance but it still lacks consensus among the stakeholders (see GDRC, Grameen Bank). While some of the studies classify models on the basis of institutional structures, others take into account the practices followed in the field. Usually, the former provides a classification of microfinance on the basis of various institutional structures such as formal, semi formal and informal, the later separates it out into individual, group based or hybrid model. There are various indigenous models too which have also been taken into account by some of the research studies. Global Development Research Centre and Grameen Bank of Bangladesh provide a comprehensive classification of various models of microcredit. They highlight around fourteen models of providing microfinance right from associations to village banking. However, studying these models gives a sense of overlapping and it appears that nomenclature remains primary objective of classification. Dasguptas model of microfinance provides a methodical classification in the Indian context. But in order to adopt it globally, there is a need to consider various factors such as institutions, delivery models, objectives of the programme, clients etc and the models prevailing across the globe. The model suggested in this text takes inspiration from Dasguptas model (Dasgupta, 2005). It classifies microfinance into institutional, mechanism and considers activities as a basis of segregation (see Figure 1). The core of this classification remains the clients (individually or in the group), which is a little different from the models proposed in the past. It is implied that a client can be serviced individually or in the groups with the spirit of cooperation. The spirit of cooperation has been used in this entire text to denote both formal and informal systems of cooperation. Any formal or legally registered structure, be it in the form of cooperative or local village/peoples banks or other institutionowned or managed by the people, is referred here as a formal cooperation structure. Informally, the unregulated peoples institutions such as solidarity groups or self help groups are classified as informal cooperation structures. Further, the institutional component in this model basically focuses on various roles of mainstream financial service providers or donors. The mainstream financial service providers can offer services directly or indirectly or in partnership with other service providers. Directly, a mainstream financial institution can offer microfinance services to the poor as its own customer. This component can leverage the expertise and volume of business of the institution to provide services to the clients. However,
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it may possible that it would lack the advantages of working with the people on ground. Providing services directly may add to the costs of servicing thereby impacting its profits in the long run. This was probably the basis for origin of two other components of this approach. The indirect thus lessens the risks of increasing costs and also provides opportunity to leverage the experience of working with the poor. It also fulfils the social mission of the business i.e. reaching out to the poorer section of society. The partnership approach thus forms an important part of indirect approach. Globally banks have experimented with various types of partnership approaches to provide microfinance services to its clients. The experiments range from partner-agent model to off balance sheet financing. In partnership approach, the mainstream financial institution enters into an arrangement with other authorised service providers like mobile network operators in order to offer various financial services to the poor. The partnership approach can further be divided into collaborative, agent or off balance sheet financing components. The collaborative component in this context refers to as an alliance between two or more service providers for delivering microfinance services. For instance, mobile based banking services wherein the mainstream banks enters into an agreement with cellular operator network and an agency capable of working with the people in order to deliver microfinance services on the ground. Similarly, the agent component in this approach refers to popular partner agent model, wherein the financial institution enters into an agreement with an agency to deliver microfinance services. The partner agent model is very popular in the insurance sector, however off late the banks have also popularised the correspondent banking models for delivering financial services in some countries. The off balance sheet financing is an alternative mechanism of receiving funds wherein the transactions are not reflected on the balance sheet of microfinance institutions. In this method, the microfinance service provider can sell, transfer or assign its portfolios to mainstream financial institutions in order to raise capital for its operations. The securitisation model in recent times has been very popular instrument of raising capital in India. Also the partnership model promoted by ICICI bank saw phenomenal growth in the portfolios of some of the renowned microfinance institutions in India. The indirect institutional approach encompasses financing (in the form of grants or loans) by the mainstream financial institutions or donors to the microfinance service providers. These providers later provide services to the poor through various mechanisms. Nonetheless to mention, that in partnership approach, the ultimate user i.e. the poor can access these services either individually or by using cooperation spirit mentioned above in the text. It is interesting to note here that informal cooperation has an important place in the microfinance movement. The group based lending models are the flag bearers of microfinance across the world. Even the microcredit movement, for which Dr Yunus and Grameen Bank, Bangladesh received noble peace prize, originated with group lending model only. Microfinance in India too is heavily dosed with group lending models. There are several important constituents and distinct features associated with group based models of delivering microfinance services. It is significant to study these models in order to develop a sound understanding of microfinance practices in India and the world over.
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A Discussion on Group Based Microfinance Models Self Help Group The self help group model is Indias own model of microfinance. It is based on cooperation and mutual help. A group of 10-20 members come together to form a group. They start with compulsory or voluntary saving to build their pool of reserve. Later on as per the requirements of the member and assessment of the group, a member is given loans from the contributed pool. Savings and interested thus collected are rotated among the group members. Self help is an eighteenth century old concept and was originated in Europe. In India, external financial assistance by MFIs or banks augments the resources available to the group-operated revolving fund. Savings thus precede borrowing by the members. These SHGs can later be federated into clusters or federations to increase their accessibility on external financial resources. Joint Liability Groups The joint liability groups undertake individual lending but on a strict condition of group responsibility of repaying the entire loans. The loans are given from external sources which promotes these groups. Joint Liability GroupCentre Model or Grameen Model This model was initially promoted by the well known Grameen Bank of Bangladesh. These undertake individual lending but all borrowers are members of 5-member joint liability groups which, in turn, get together with 7-10 other such groups from the same village or neighbourhood to form a centre. Within each group and centre peer pressure is the key factor in ensuring repayment. Each borrowers creditworthiness is determined by the overall creditworthiness of the group. Savings are a compulsory component of the loan repayment schedule but do not determine the magnitude or timing of the loan. Hybrid Model There are many variations of joint liability group model. Organisations across the world have experimented with certain changes in the joint liability model as per their requirements and other exogenous factors. These models have adapted key features of both SHG and JLG models to provide microfinance services to the clients in groups. Key Features of Group Based Models 1. Financial intermediation is done with group as an individual identity. 2. Formation of group is the foundation of microfinance transactions. 3. Group members are selected on the basis of principle of homogeneity which states that the members should belong to similar socioeconomic and physical backgrounds. 4. Groups are formed with certain rules and norms as decided or as agreed by all the members and it is continued till the group activity comes to an end. 5. Group is responsible for all the acts of the members associated with it such delivery of financial services to the members or repayments to the external agencies. 6. There are group leaders who moderates or facilitate the group meetings and transactions. 7. Group acts as an instrument of screening or weeding out of bad members thereby lessens the risks of defaults. 8. Peer pressure act as a substitute of collateral in cases of financing the group. 9. Group provides strength and voice to the members because of the feeling of association and cooperation. Group meeting also acts as a place of peer sharing and learning. 10. Group based model reduces cost of service delivery because of advantages of scale in the area.

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How the groups are formed: Stages of Group Formation As like the group models, there are various stages of group formation and development suggested by many psychologists. However, we consider Tuckmans model with a little variation for the ease of understanding that how the group works. Tuckman in 1965 suggested four organic stages of group development, but later last stage of group ending was also added. Once people come forward to form a group, there are different stages as mentioned below: Forming: Group members learn about each other, decides about the goals and the task at hand. There are some indicators like lack of clarity of objectives, lack of involvement of members in the group tasks, confusion, lack of sharing a feeling, apprehensions. Storming: This stage involves members in arguments about the goals, systems and processes to be followed. The stage is marked with emotions, feelings and struggle for reaching a status in the group. Hidden agenda, sharing of feelings, conflicts, resentment and anger are some of the indicators of this stage. Norming: As the name implies, this stage marks the formation of certain rules on achieving the goals and performance of activities. The indicators of this stage include performance review, role clarity, objective setting, and testing new grounds. Performing: In this stage, the group as a whole performs the tasks or activities at hand. The indicators include initiative, flexibility, leaning, confidence and concern for others. Ending: This phase marks the end of the group work. The indicators include emotional involvement, experience sharing and increased bonding. However, except the SHG model (promoted by NABARD and other government agencies gave ample time to experiment with the group i.e. for six months by introducing savings and thereby credit. The other type of group models applied a shortcut in forming groups. Now a days, usually the groups are formed in 5-10 days even. This might be because of the reason that people have gone enough experience and exposures to these models of microfinance. Major Differences in Joint Liability and Self Help Model Harper elucidates difference between two models of microfinance i.e. SHG and JLG (Grameen Bank Groups) (Harper, 2002). In the Indian context, it is important to study the differences as most of the microfinance service providers are still using the group based model to deliver the services. Pros and Cons of System Plusses for clients Self Help Groups Flexible No need for bank at all Highly empowering Members can save and borrow as needed Free to chose suppliers No enforced loan ladder Can evolve from existing groups, chit funds, credit unions etc. Can access the full range of bank Grameen Bank groups No need for literacy No need for members initiative Protected from internal and external exploiters Poorer people are included Belong to and are supported by the bank Bank can offer a range of additional tailor-made 26

 Minuses for clients Minuses for Banks Suitable conditions

services Can evolve into Federations, and Co-operatives Need management skills and time Depend on good accounts Can be hijacked internally or externally Cash may not be secure Lower transaction costs Can fit into any branch Graduation easier Can build on existing groups Savings mobilisation easier Groups can absorb odium of expelling members Hard to monitor May be tempted by other banks or by politicians Slow to develop May form own federations MIS more complex Need NGOs or highly committed staff to develop groups Existing bank network in rural and poor areas. Diffused communities, castes, wealth levels Tradition of informal financial services Wide variety of scale and nature of investment opportunities Some local leadership NGOs and/or committed bank staff

services

Plusses for Banks

Must meet frequently Little freedom or flexibility Group composition not wholly under members control Pressure to borrow Interest rates inflexible Can resist subsidised schemes Tighter control Standardised MIS Standardised procedures Easier to forecast need for funds Can use lower-grade staff Higher transaction costs Need continuous guidance and presence Need dedicated system Hard to evolve and change

Very poor, homogeneous communities Marginalised people, with little hope and initiative Few traditional informal financial mechanisms. Lack of financial institutions Resource poor, little hope of graduation Large numbers of small business opportunities Few NGOs

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Figure 3: Some Popular Models of Microfinance

28

Components of the Model Direct

Explanations Mainstream financial institutions providing microfinance services to clients individually or in groups A mainstream financial service provider collaborates with another service provider to provide microfinance services to its clients

Examples State Bank of India No Frills Account, or direct loaning to SHGs For instance mobile banking platforms. Eko has collaborated with various banks for providing microfinance services through mobile phones across the country. State bank of India has collaborated with Oxigen for providing microfinance service providers to its clients. Banking correspondent or facilitators models in India are examples of this. FINO has become a correspondent of various banks in India to provide microfinance services to its clients SKS securitisation deal amounting USD 22 million with Yes bank in India or Share securitisation deal of USD 4.3 million with ICICI bank. ICICI bank partnership model is also a good example of this model, whereby expertise of the mFIs were used to originate and manage loans given to the clients Donor driven projects are usually an example of indirect project financing. In India, SGSY is one example of providing grants to the NGO for promoting and financing SHGs. The SHG bank linkage of NABARD can also be categorised here.

PartnershipCollaborative

PartnershipAgent

A microfinance service provider becomes an agent of a mainstream financial institution for providing microfinance services to its clients Plainly speaking, under this arrangement, the mFI raises capital by transferring, selling or assigning its portfolios. It can be in the form of portfolio buyout, partnership and securitisation.

PartnershipOff Balance Sheet Financing

IndirectProject Finance

IndirectInstitutional Lending

CooperationFormal

Project financing is a method of providing funding to a project whether in the form of loan or grant (returnable or non returnable). Under this arrangement, mFIs are financed according to their project proposals and various indicators like background of the mFIs etc Simply this term indicates Loans to mFIs by banks. loaning to the mFIs for meeting their financial needs according to their business plans and proposals. In this, the mFIs area also required to pay charges levied by the bank as interest or other related charges. The formal cooperation Examples include member

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Components of the Model

Explanations method traces back its roots in the origin of cooperatives. The spirit in cooperation remains the same i.e. helping each other and contribution by each member. Informal approach of cooperation implies coming together of people to achieve a common goal or do a common activity. This system usually works on the principle of mutual trust, self help, peer pressure and commonality. The individual approach brings forth the concept of serving the poor by the individuals such as moneylenders, relatives or other such persons. The service provider may also charge some amount for providing these services. These are mostly informal though in some of the countries money lending has been regulated.

Examples based credit cooperatives and SEWA bank or village banking system in Latin American Countries or Indonesia. For example SHGs in India or joint liability groups promoted by Grameen Bank in Bangladesh wherein women come together to form a group to access credit. For example, existence of regulated money lending in various states of India. Also the neighbours lend money to individuals but normally the payee is required to pay higher amount as agreed earlier while taking the loan.

CooperationInformal

Individual

Section 4 : Model for Savings The debate whether poor can save or not has become obsolete. In the new microfinancial service area, large scale success of Self-help Group (SHG) or Joint Liability Group (JLG) methodology has proved the ability of poor to save. Accordingly, there are significant opportunities to broaden and deepen the range of financial services (credit, savings, insurance and money transfer) to poor. The importance of financial services, especially the savings to allow rural people to reallocate expenditure across time has been emphatically conceptualized by Rutherford (2000). Using three different approaches, namely `Saving up, `Saving down, and `Saving through, the author has demonstrated that savings are the basis of all financial services that the poor require to finance different expenditures when there is wide mis-match in the inflow of income and outflow of expenditures in their household economy. Millions of people in rural India remain without access to high quality, appropriate saving services from formal financial institutions. They have now very limited access to saving services through compulsory or mandatory savings in SHGs/JLGs. There is ample potential to tap the savings from rural people. The potential for savings arises from those very factors due to which poor households remain generally excluded from existing formal financial institutions schemes. First, formal institutions have not attempted much to reach out to those segments that are outside the mainstream formal economy. This reason is related to the viability of introducing low volume
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saving products in an environment characterized by imperfect information and high transaction costs. Under micro-finance program (like micro-credit), groups and associations of households can be used to gather information and reduce transaction costs and make micro clients more attractive to financial institutions. Secondly, poor people lack the empowerment and capacity to access formal financial institutions. This reason holds out promise that, in addition to better enabling clients to manage their income and expenditures, savings can help empower individuals, groups and associations which help them access to other benefits. The biggest hiccup in Indian Microfinance industry is that mobilizing savings from the clients is not a permissible activity for MFIs registered under Societies, Trust, and as Section 25 Company especially in the light of the amendment to Section 45 S of the Reserve Bank of India (RBI) Act. However, a big step forward for the MFI sector was in January 2006 when RBI permitted deposit mobilization by MFIs appointed as Business Correspondents by the banks (RBI/2005-06/288, DBOD.No.BL.BC. 58/22.01.001/2005-2006, dated January 25, 2006. The salient features of this circular can be summarized as follows: Under the "Business Correspondent" Model, NGOs/ MFIs set up under Societies/ Trust Acts, Societies registered under Mutually Aided Cooperative Societies Acts or the Cooperative Societies Acts of States, section 25 companies, registered NBFCs not accepting public deposits and Post Offices may act as Business Correspondents. The scope of activities to be undertaken by the Business Correspondents will include (i) disbursal of small value credit, (ii) recovery of principal / collection of interest (iii) collection of small value deposits (iv)sale of micro insurance/ mutual fund products/ pension products/ other third party products and (v) receipt and delivery of small value remittances/ other payment instruments.

Section 5 : Model for Micro-insurance Microfinance in India has brought a revolutionary shift in approach for providing financial services to poor since mid 90s. Over the past decade, it has been claimed vigorously that micro-finance has a positive impact on the poor in terms of increased household income. However, focusing only on static measures of household earnings and income ignores the other side of poverty, the vulnerability of the poor to risk. All rural people are highly vulnerable to various risks. Vulnerability has been defined as the inability of individuals and households to deal with various risks. Vulnerability and poverty interact with each other. Households in poverty trap are vulnerable to various risks whereas their poor response to risks further leads to depletion of assets and income. Unfortunately, in India microfinance remains primarily a supply-driven endeavor, with a limited number of methodologies applied to provide mainly working capital loans to poor female micro-entrepreneurs, who do not have tangible assets to offer as collateral. Over the past few years, the concept of vulnerability has been added to define the rural poverty. Accordingly, the focus of microfinance in India as well as in other developing countries has been shifted to providing financial services to a
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diverse group of vulnerable households engaged in complex livelihoods. With this perspective, practitioners in microfinance industry have recognized now that the poor require a wide range of financial services to manage the risks and thus, improve their economic condition. Simultaneously, the high prevalence of risk among the micro-finance clients has been well documented world wide (Rutherford, 2000). The analyst has shown the relationship between client level risk and micro-finance at two interrelated levels: how these risks may affect the quality of a Micro-finance Institution (MFI) portfolio; and how designing market oriented financial products can reduce client risk Feeble asset base and livelihood opportunities are widelyaccepted determinants of poverty which have in turn severe repercussions on resilience and vulnerability to risks and risk management strategies at the household level. Households caught in the poverty trap are vulnerable to various risks, and their poorly-backstopped responses to risks can further lead to lower quantities and qualities of assets, and subsequently to lower income flows and hence loss of welfare. Risk management strategies include: - ex ante (risk reduction and risk mitigation), and - ex post (risk coping) strategies Most poor people manage risk with their own means. Many depend on multiple informal mechanisms (e.g., cash savings, asset ownership, rotating savings and credit associations, moneylenders) to prepare for and cope with such risks as the death of a family breadwinner, severe illness, or loss of livestock. Very few low-income households have access to formal insurance for such risks. Prevention and avoidance: When possible, poor people avoid and/or actively work to reduce risk, often through non-financial methods. Careful sanitation, for example, is a non-financial way to reduce the risk of infectious illness, particularly among young children. Using family networks to identify business opportunities is another such mechanism. The imperative to avoid risk often leads to conservative decision making by poor people, especially in business considerations. Preparation: Poor people save, accumulate assets (such as livestock), buy insurance, and educate their children to handle future risks. For certain risks, informal community systems (e.g., Ghanaian burial societies) offer protection. However, such systems generally do not adequately protect against costly and unpredictable risks, such as the debilitating illness of a family income earner. Formal insurance products are beginning to be offered to low-income markets, such as simple credit life insurance (which covers an outstanding loan balance in the event of a borrowers death), but these insurance products sometimes appear to be designed to protect the lending institution rather than its clients. Coping: Ex post coping can result in desperate measures that leave poor households even more vulnerable to future risks. In the face of severe economic stress, poor people may take out emergency loans from moneylenders, microfinance institutions (MFIs), and/or banks. They may also deplete savings, sell productive assets, default on loans, and/or reduce spending on food and schooling. In general, prevention and planning are far less costly than coping strategies for the individual.
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While micro-credit has proven to date to be a valuable and effective way to protect the poor against risk in ex ante sense (ahead of time), the few types of credit products offered by most of the MFIs in India are less suited to provide poor households the support needed after a shock (ex post). Being small size, Self-help Groups (SHGs) or Joint Liability Groups (JLGs) can provide a limited risk pool to poor women by providing small size of loans. Constrained by the regulatory environment, very few MFIs in India are able to offer saving products, which provide the poor a safety net to deal with ex post shocks. In the absence of saving products, micro-insurance is another alternative for risk management among the poor. Micro-insurance, with proper design, enables the poor more proactive in managing the risk by reducing the chance of a loss resulting from unanticipated risk events. Micro-insurance is a subset of insurance that provides protection to the poor. The genesis of micro-insurance is similar to that of micro-credit. Like the credit products, the challenge with microinsurance is to design products that are appropriate in terms of cost, terms and coverage. Till date, the experience with micro-insurance has been limited in India in terms of coverage and impact.

5.1

Microinsurance

Insurance refers to a financial service that uses risk-pooling to provide compensation to individuals or groups that are adversely affected by a specified risk or event. Riskpooling involves collecting large groups (or pools) of individuals or groups to share the losses resulting from the occurrence of a risky event. Persons affected by a negative event benefit from the contributions of the many others that are not affected and, as a result, they receive compensation that is greater than the amount they have invested in the insurance policy. Thus, products that allow an affected individual to receive only up to the amount they have contributed are considered as savings products, not insurance. The micro- portion of the definition refers to the subset of insurance products that are designed to be beneficial to and affordable for lowincome individuals or groups.

5.2

Regulatory Environment for Micro-insurance in India

To understand the potential involvement of MFIs in delivering the insurance products, it is important to scan the recent regulatory context of micro-insurance in India. The Government of India liberalized the insurance sector in March 2000 with the passing of the Insurance Regulatory and Development Authority (IRDA) Bill, lifting entry restrictions for private players and allowing foreign players to enter the market with some limit on direct foreign ownership. Under the current guidelines, there is a 26 percent equity cap for foreign partners in an insurance company. Premium rates of most general insurance policies come under the purview of the government appointed Tariff Advisory Committee. The opening up of the sector is likely to lead to greater operating in both life and non-life segments. Companies have started selling their insurance policies since 2001 leading to widening and deepening of insurance in India and this may also cause restructuring and revitalizing of the public sector companies.

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The creation of IRDA was one of the most important milestones in Indian microinsurance sector. Two regulations promulgated by IRDA have laid the framework of micro-insurance in India. The first is related to regulations called Obligations of Insurers to Rural Social Sector passed in year 2002 and subsequently amended in July 2004. This is basically based on quota system, which forces the private insurers to transact a minimum percentage of their business in rural/social sector. In view of the guidelines issued by Insurance Regulatory and Development Authority, every insurer, who begins to carry on insurance business after the commencement of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999), shall, for the purposes of sections 32B and 32C of the Act, ensure that he undertakes the following obligations (as given in Chart 1.1) during the first five financial years.
Chart 1.1: Obligations of Insurers to Rural Social Sector (a) Rural sector (defined as population of not more than 5000, with a density of population not more than 400 per square kilometer and at least 75 percent of the male working population is engaged in agriculture) (i) in respect of a life insurer, (I) five per cent in the first financial year; (II) seven per cent in the second financial year; (III) ten per cent in the third financial year; (IV) twelve per cent in the fourth financial year; (V) fifteen per cent in the fifth year; of total policies written in that year; (ii) in respect of a general insurer, (I) two per cent in the first financial year; (II) three per cent in the second financial year; (III) five per cent there after, of total gross premium income written direct in that year. (b) Social sector (defined as unorganized sector, informal sector, economically vulnerable or backward classes both in rural and urban areas) (i) in respect of all insurers, -(I) five thousand lives in the first financial year;

(II) seven thousand five hundred lives in the second financial year; (III) ten thousand lives in the third financial year; (IV) fifteen thousand lives in the fourth financial year; (V) twenty thousand lives in the fifth year; Provided that, in case of a general insurer, the obligations specified shall include insurance for crops.

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The second regulation document is IRDA Micro-Insurance Regulation Act, 2005. This act has facilitated the MFIs and NGOs in India to get involved in delivering the insurance products. The salient features of this act are given in Chart 1.2.
Chart 1.2: Salient Features of IRDA Micro-insurance Regulation Act 1. In addition to an insurance agent or corporate agent or broker licensed under the act, micro-insurance products may be distributed through micro-insurance agents, namely NGOs, MFIs or SHGs on the specified remuneration basis. 2. The micro-insurance agents can perform one or more of the following functions: a. Collection of proposal forms and self declaration form from clients. b. Collection and remittance of premium amount. c. Distribution of policy document to clients. d. Assistance to the clients in settlement of claims. 3. Every insurer shall impart at least 25 hours of training at its expenses to all microinsurance agents in the area of insurance selling, claim administration and policy holder servicing.

In order to meet the conditions under these obligations, private insurers have started innovations in developing new products and delivery channels in micro-insurance sector.

5.3

Activities Involved in Offering Insurance

Product manufacturing activities include product development, risk management, and financial management. The institution responsible for these activities determines the coverage on the policies, sets the premiums and conditions to be applied, monitors and manages the risk exposure in the insurance portfolio, performs final verification on claims, issues claims settlements, and manages the investment of reserves and annual premiums. Formal insurers have a clear comparative advantage in product manufacturing, but can enter into interesting alliances with MFIs, for example, who have certain advantages for product servicing given their proximity to clients. Product sales activities include marketing, advertising, identifying potential policyholders, and selling the policies developed by the product manufacturing organization. Product servicing activities include all ongoing contact with existing policyholders, from the collection of premiums to the distribution of claims settlements. Institutions performing these activities act as a go-between for policyholders and the product manufacturing organization.

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5.4

Microinsurance delivery models Partnerships between MFIs (or other intermediaries) and insurers Full service provision where regulated insurers provide specific products to the low-income market Health care service providers offer a health care financing package and absorb the insurance risk MFI-based insurance where MFIs take on the risk offering insurance to their clients Community-based programs where communities pool funds and manage a relationship with a health care provider

Partner-Agent Model Agents act as intermediaries between an insurance company and its market. The MFI acts as the agent, marketing and selling the product to its existing clientele through the distribution network it has already established for its other financial services. The insurance provider acts as the partner, providing the actuarial, financial, and claimsprocessing expertise, as well as the capital required for initial investments and reserves as required by law. This partnership is very advantageous for MFIs, clients and the company. The company gains access to new market with reduced transaction cost; whereas the MFI can expand the portfolio of its financial products and gains a new income source. Partner Agent

Product Sales

Policy holder

Product Manufacturing Product Servicing

Service Provider

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References Seibel, H D (2003): History matters in microfinance, Small Enterprise Development An International Journal of Microfinance and Business Development, vol. 14, no. 2 (June 2003) Bernstein, A. (2009): Pecuniary Reparations Following National Crisis: A Convergence of Tort Theory, Microfinance, and Gender Equality, College seminar, 12 Mar 2009, College of Law, Australian National University http://law.anu.edu.au/news/2009_College_Seminars/Bernstein_Paper.pdf Accion International (2010): http://www.accion.org/Page.aspx?pid=797 Accions History

Burkett, I. (2003): Microfinance in Australia: Current Realities and Future Possibilities (2003), University of Queensland, http://www.social.uq.edu.au/research/MicrofinanceinAustraliaFinal.pdf Microfinance Development Strategy, Asian Development Bank http://www.adb.org/documents/policies/microfinance/microfinance0100.asp?p=po licies Basel Committee on Banking Supervision (2010): Microfinance Activities and the Core Principles for Effective Banking Supervision, A Consultative Document (Feb 2010), Bank for International Settlements, Switzerland http://www.bis.org/publ/bcbs167.pdf http://www.nabard.org/departments/publications.asp CGAP (2009): Helping to improve donor effectiveness in microfinance: The role of governments in microfinance, Consultative Group to Assist the Poor (Donor Brief No.19), http://www.cgap.org/gm/document-1.9.2371/DonorBrief_19.pdf TOPSTARS Micro Support Services (2009), The History of Microfinance, http://www.microfinancegateway.org/p/site/m//template.rc/1.9.45764 Seibel, H D (2003): History matters in microfinance, Small Enterprise Development An International Journal of Microfinance and Business Development, vol. 14, no. 2 (June 2003) Adams, D. W. (1995): Using credit unions as conduits for microenterprise lending: Latin-American insights, Enterprise and Cooperative Development Department, International Labour Organisation, Geneva, http://www.oit.org/wcmsp5/groups/public/---ed_emp/documents/publication/ wcms_118277.pdf California and Nevada Credit http://www.ccul.org/01consumers/cuhistory.cfm Union Leagues,

Steger, U., Schwandt, A. and Periss, M. (2007): Sustainable Banking with the Poor: Evolution, Status Quo and Prospects

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http://www.imd.org/research/publications/upload/CSM_Steger_Schwandt_Perisse _WP_2007_12_level_1.pdf Banking with the Poor Network (BWTP) http://www.bwtp.org/arcm/indonesia/II_Organisations/MF_Providers/BPRs.htm# BPR Biswas, N. (2009): Micro CreditThe Hidden Agenda, Mainstream, Vol XLVII, No 30, July 11, 2009, India http://www.mainstreamweekly.net/article1492.html Reddy, Y.V. (1999): Prof. G. Ram Reddy Third Endowment Lecture by Dr. Y.V.Reddy, Deputy Governor, Reserve Bank of India, Hyderabad, on December 4, 1999 Housing Cooperatives in India: International Cooperative Alliance, http://www.ica.coop/alhousing/attachments/Housing%20Cooperatives%20in%20India-FINAL.pdf Kropp, Dr. E.W. & Suran, Dr. B.S. (2002): Linking Banks and (Financial) Self Help Groups in India, Paper Presentation at a Seminar on SHG Bank Linkage Programme in New Delhi http://www.nabard.org/pdf/publications/sudy_reports/erhardkropp.pdf Khan, H.R. (2005): Report of the Internal Group to Examine Issues Relating to Rural Credit and Microfinance, Reserve Bank of India, Sengupta, A.K. (2007) Report on Conditions of Work and Promotion of Livelihoods in the Unorganised Sector" of the National Commission for Enterprises in the Unorganised Sector GDRC (2010): Credit Lending Models, Global Development Research Centre, http://www.gdrc.org/icm/model/1-credit-model.html Grameen Bank, Credit Lending Models, http://www.grameeninfo.org/index.php?option=com_content&task=view&id=43&Itemid=93 Dasgupta, R (2005): Microfinance in India: Empirical evidence, alternative models and policy imperatives, Economic and Political Weekly, March, 19, 2005 Harper, M (2002): Self-Help Groups and Grameen Bank Groups: what are the differences, Beyond micro-credit: Putting development back into micro-finance (edited by Thomas Fisher and M. S. Sriram, Vistaar Publication, New Delhi

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Module 2 : Basic Accounting and Financial Reporting

Objectives 1. 2. 3. 4. 5. 6. To know the need & users of financial statements To develop the basic understanding of B/S & Income Statement To develop the basic understanding of Cash Flow Statement To provide an overview of accounting mechanics To understand the role of regulatory framework of accounting To understand the tools of basic financial statement analysis

Following sessions are based on this module: 1. 2. 3. 4. 5. 6. Understanding Financial Statements-I: Income Statement & Balance Sheet, Accounting Equation Understanding Financial Statements-II: Cash Flow Statement Preparation of Financial Statements-I: Overview of Accounting Cycle Preparation of Financial Statements-II: Role of Accounting Standards and other Regulatory Requirements Financial Statement Analysis-I: Horizontal and Vertical Analysis Financial Statement Analysis-II: Ratio Analysis with emphasis on Du-Pont Analysis

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Section 1 : Overview and scope of Financial Accounting 1.1 Introduction

Accounting is a comprehensive information system for identifying, measuring (quantifying), recording, classifying, summarizing, interpreting and communicating events of financial character (monetary transactions) in a significant manner that permits informed judgments and decisions by the users of information2 (Figure 1.1). Thus accounting information is a means used for taking an informed decision by its users.
Figure 1: Accounting Information System

There are varied users of accounting information viz., owners, management, creditors, governmental regulatory bodies, labor unions, or the many other groups that have an interest in the financial performance of an enterprise. Each of the user groups has some unique information requirements for their decision making (Figure 1.2).
Figure 1.2: Accounting Information Needs of User Groups

This definition is adapted from the definition of American Institute of Certified Public Accountants (AICPA)

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1.2

Types of Accounting Information

As the information requirements vary across user groups, the accounting information categorized into three types (Figure 1.3): (a) Financial Accounting: It involves the recording and summarising financial transactions, and preparing the various statements, in strict conformity with the applicable generally accepted accounting principles (GAAPs) (Box 1). The information produced by financial accounting system helps the managers in judging the past performance and current status of their organization. Besides, it enables the current & prospective investors/creditors/lenders in deciding where to place their scarce investment resources. Such decisions are important to society to ensure efficiency in allocation of scare capital across companies and industries. (b) Management (or managerial) Accounting: The information produced by management accounting system facilitates the strategic and operational decision making by the managers. Management accounting produces a variety of reports. Some reports focus on how well managers or business units have performed-comparing actual results to plans and to benchmarks. Some reports provide timely, frequent updates on key indicators such as orders received, order backlog, capacity utilization, and sales. Other analytical reports are prepared as needed to investigate specific problems such as a decline in the profitability of a product line. And yet other reports analyze a developing business situation or opportunity. (c) Tax Accounting: Tax accounting is just concerned with the preparation of records and reports, considered necessary file the tax returns to the local, state and central governments, in a manner whereby maximum amount of tax could be legally avoided rather than illegally evaded.
Figure 1.3: Types of Accounting Information
Management Accounting Facilitating operations: Examples Payroll Purchasing Billing and Cash collections Cash disbursements Property records Tax returns Main types Income Tax VAT Main features: Three primary financial statements along with related footnotes disclosures as per the applicable GAAPs May be audited by external auditing firms Tax Accounting Financial Accounting External Financial reports

Management control reports Examples Performance reports-comparing actual results to plans and to benchmarks

Management Decision Making Examples Costing information for pricing decision Orders received, order utilization, and sales backlog, capacity

Product-wise profitability reports

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Box 1: Generally Accepted Accounting Principles The users of published financial statements need to be confident that they provide a true and fair view of the particular organization's financial affairs. For this reason a system of regulation has evolved to guide and control the content and presentation of published financial information. These regulations together are referred to as Generally Accepted Accounting Principles (GAAPs). The varied sources of GAAPs in India include the Companies Act, requirements of Stock Exchanges for the listed companies, series of applicable accounting standards issued by Institute of Chartered Accountants of India (ICAI). Besides, industry specific acts and regulatory bodies may prescribe the additional rules/guidelines to be adhered in preparation and presentation of financial statements. The GAAPs are continually reviewed and adapted in response to developments in business and economic needs. They have evolved in order to deal with practical problems experienced by a preparer and a user rather than to reflect pure theoretical ideal. World over there is drive to adopt the International Financial Reporting Standards (IFRSs) and International Accounting Standards (IASs) issued by the International Accounting Standards Board (IASB).

The focus of this study material is only on the financial accounting. The other types of accounting are intentionally kept outside the preview of this study material.

1.3

Financial Statements3

The primary questions about an organizations success that its stakeholders and managers want to know are: (a) what is the financial picture of the organization on a given day? (b) How well the organization did during a given period? (c) How much cash an organization is generating (using) through its various kinds of activities? The preceding queries get answered in form of following three major financial statements generated as output of the Financial Accounting System: (a) (b) (c) (d) Balance sheet shows financial picture on a given day (As if time stood still) Income statement shows profit performance over a given period (Is this company making profits?) Statement of Changes in Equity Earnings shows how the company's retained earnings have changed over the reporting period Statement of cash flows shows cash performance over a given period (How much cash a business organization is generating (using) through its various kinds of activities?)

The discussion on above statements is included below. First, financial statements of typical businesses are discussed as MFIs need to assess the financial performance and position of their current and prospective customers. Second, financial statements of MFIs are discussed as the financial performance and position of MFIs also need to be analyzed by those who may be providing capital to the MFIs or by the manager in charge of MFIs.
3

Accounting Standard (AS) 1 (Revised) deals with the presentation of financial statements. This is downloadable from: http://www.icai.org/resource_file/16763edaspfs.pdf.

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1.3.1 Financial Statements of Typical Business Firms Balance sheet: A balance sheet provides the snapshot of a firms financial position on a particular date. Ideally, firms can prepare their balance sheet every day to know their financial position; however in reality SEBI (securities market regulator in India) requires publicly listed firms to disclose only their quarter end financial position through their balance sheets. The balance sheet fail to disclose what the firms financial condition was on other than the balance sheet date. It displays the firms sources of funds (owners equity and other liabilities) and uses of funds (assets). It is also known as statement of financial position. For illustration purpose, figure 1.4 shows balance sheet of Hypothetical Ltd (hereafter referred to simply as HL). The balance sheet of HL is presented in a long-form (vertical-form) format. Most firms follow the long-form format, wherein first assets are listed and then liabilities are listed. Some firms present their balance sheet in the horizontal (Tform) format. Firms utilize their funds to get assets required to carry on their business activities. Assets may be viewed as valuable things that are owned or controlled by the business as a result of past transactions and are expected to increase or cause future cash flows.
Figure 1.4: Balance Sheet of Hypothetical Ltd.

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Firms assets are of various kinds and are classified on the basis of time period for which they contribute to the business operations: current vs. fixed assets. Current assets are cash and other assets expected to be converted to cash, sold, or consumed either in a year or in the operating cycle, whichever is longer. Examples of current assets in a typical business are: Cash and cash equivalents, trade receivable, inventory, pre-paid expenses. Non-current assets are all other assets other than that are not classified as current assets. Typically, non-current assets include --- plant, property and equipment; Intangible assets and investments. Firms sources of funds represent its liabilities. A liability may be defined as an obligation of an entity arising from its past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future. Every firm gets a portion of its funds through its owners equity, which may be defined as the portion of a firms assets that belongs to the owners (shareholders) after obligations to all other liabilities have been met. Practically, owners equity represents the original money contributed to the firm by its owners, adjusted for the accumulated profits that have not been paid out as dividends (retained earnings). Owners equity in the proprietorship and partnership form of business organization is referred to as capital. In the company form of business organization, it is referred to as stockholders equity or shareholders equity. Besides the owners equity, firms sources of funds include its: other long-term liabilities and current liabilities. A few examples of other long-term liabilities for a typical entity are: loans from financial institutions; bonds/debentures outstanding. They are referred to as long-term as their maturity is due a year or more after the date of the balance sheet. All such liabilities that are due within one year of the balance sheets date and will require cash payment or will need to be renewed are referred to as current liabilities. A few examples of current liabilities for a typical entity are: creditors/suppliers credit/bills payable, bank overdraft/cash (revolving) credit facility, accrued liabilities (outstanding expenses), advance (deferred) revenues received, current portion of long term debts. Income statement: It is also referred to as Profit and Loss (P/L) account and shows how profitable an organization has been over a specific time frame. It contains all revenues earned and all expenses incurred by the business firm during the period for which income statement is prepared. The terms revenue and income are frequently used interchangeably as are the terms income and profit. For illustration purpose, figure 1.5 shows income statement of Hypothetical Ltd. The sources of revenues for a typical firm includes its sales and other sources of revenues viz., interest income, dividend income, gains on sale of investments/old assets. The sale of a firm is the value of goods or services sold by the firm. When to recognize revenue from a transaction is, perhaps, most tricky accounting issue confronted by the accountants. For most firms, revenue generating process has several stages. Hence, for purpose of comparability, GAAPs usually suggest following prerequisites for the revenue recognition. Revenue is recognized: when it is earned, and when it is realized or realizable. This way of recognizing the revenue is referred to as accrual concept.

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Figure 1.5: Income Statement of Hypothetical Ltd.

The expenses for a typical firm include the: cost of goods sold, other operating expenses and non-operating expenses. Cost of goods sold is the cost of producing or acquiring the companys products for sale during a given time period. It is largest expense item for many firms. Operating expenses are other expenses incurred in doing business and may be recorded as follows: (a) Depreciation: The portion of the total cost of property, plant, and equipment that is charged each year to the actual operations of a business; (b) Selling expenses are operating expenses incurred through marketing and distributing the products that the company offers for sale; (c) General expenses are incurred in the overall administration of the business. They include office salaries, legal fees, insurance for office operations, utilities bill, and supplies. The expenses are recognized when they are incurred, means all such expenses that are required to be done to produce the current period revenue are included in the periods income statement. The payment of expense is not the precondition for expense recognition. This is referred to as matching concept.

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Statement of Changes in Equity Earnings: The surplus (deficit) of revenue over expenses is referred to as net profit (loss). At the end of period a firm may distribute entire or partial surplus to the owners. The decision regarding the distribution of surplus is referred to as Dividend decision. The profits that are not distributed are referred to as retained earnings. The dynamics of this decision are contained in the Statement of changes in equity. For illustration purpose, figure 1.6 shows Statement of Changes in Equity Earnings of Hypothetical Ltd.
Figure 1.6: Statement of Changes in Equity Earnings

Statement of cash flows: This statement provides detailed sources and uses of cash for the period covered by the cash flow statement. Thus, provides the cash performance of the organization. It is a well classified statement as the cash flows concerning the operating, investing and financing activities are separately recorded from each other. For illustration purpose, figure 1.7 shows Statement of cash flows of Hypothetical Ltd. The Operating activities include sale and purchase of goods and payment of items such as rent, taxes, and interest. The Investing activities include acquiring and selling assets and securities held for investment purposes. The Financing activities include obtaining resources from owners and creditors and repaying amounts borrowed.

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Figure 1.7: Statement of cash flows of Hypothetical Ltd.

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1.3.2 Financial Statements of MFIs Balance sheet: The balance sheet is a stock statement, which is a snapshot of the MFI at a moment in time. The statement reflects what the MFI owns and what is owed to it (assets), what it owes others (liabilities), and the difference between the two (equity or net assets). The balance sheet shows the net worth of an institution at that moment. Figure 1.8 depicts a recommended format to be used for the balance sheet of a MFI4.
Figure 1.8: Format for the Balance Sheet of a MFI

Lets first understand first the liabilities of MFIs. In case of non corporate MFIs such as societies and trusts, the term capital fund is used in place of shareholders funds and the term capital (denoted equity) in place of share capital. MFIs use different methods for calculating donated equity. For most, donated equity includes all donations, regardless of their use. For others, donated equity includes only inkind donations and donations for financing the gross loan portfolio or fixed assets.
4

See the Technical Guide on Accounting for Micronance Institutions issued by the Institute of Chartered Accountants of India (ICAI).

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All donations for operating and non-operating expenses are included in retained earnings. MFIs should indicate what donations are included in donated equity and are encouraged to break out those donations which remain restricted for a specific use from those which are unrestricted. Secured and unsecured loans should be classified into loans and advances (including overdraft/cash credit) from banks and financial institutions, from directors, managers and related concern, etc., and from others. Interest free loans should be disclosed separately from interest bearing loans. Interest accrued and due on loans (secured and unsecured) advanced to MFIs should be included under appropriate sub-heads. Loans may also be in form of deposits, which may be payable on demand to the depositor or may be a time deposit having a fixed maturity date. Deposits include any current, checking, or savings accounts that are payable on demand. A categorization into current and long-term loans is also expected. Current liabilities should be classified into sundry creditors, related concerns, interest accrued but not due on loans (secured and unsecured), client deposits (voluntary and compulsory savings), expenses payable and other liabilities. As far as possible, provisions should be classified into provision for taxation, proposed dividend, contingencies, staff benefits, loan losses and others. Where any item constitutes ten per cent or more of total current liabilities and provisions, the nature and amount of such item may be shown separately. The asset side starts with the gross loan portfolio, which is the outstanding principal balance of MFIs entire outstanding loans including current, delinquent and restructured loans, but not loans that have been written off. It does not include interest receivable, which should be separately recorded from the gross loan portfolio. The gross loan portfolio is frequently referred to as the loan portfolio or loans outstanding, both of which creates confusion as to whether they refer to a gross or a net figure. The gross loan portfolio should not be confused with the value of the loans disbursed. MFIs should further break down the components of the gross loan portfolio into three broad categories- regular loans outstanding (performing portfolio), past-due loans outstanding (Portfolio-at-risk) and restructured loans outstanding. The amount of the loan loss provision should also be disclosed. Performing portfolio is part of the gross loan portfolio which includes the value of all loans outstanding that do not have a principal installment of principal past due beyond a certain number of days and have not been rescheduled or restructured. A standard of 30 days is common, but regulations may require MFIs to use a different standard. The MFI should state clearly what the definition of the performing portfolio is. Portfolio-at-risk the value of all loans outstanding that have one or more installments of principal past due more than a certain number of days. This item includes the entire unpaid principal balance, including both the past due and future installments. It also does not include loans that have been restructured or rescheduled. Portfolio at risk is usually divided into categories according to the amount of time passed since the first missed principal installment.

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Restructured portfolio the principal balance of all loans outstanding that have been renegotiated or modified to either lengthen or postpone the originally scheduled installments of principal, or substantially alter the original terms of the loans. This item also includes refinanced loans, which are loans that have been disbursed to enable repayment of prior loans by clients who otherwise would have been unable to pay the originally scheduled installments. Impairment Loss Allowance previously known as Loan loss reserve. It is the portion of the gross loan portfolio that has been expensed (provisioned for) in anticipation of losses due to default. This item represents the cumulative value of the loan loss provision expenses less the cumulative value of loans written off. This is also referred to as an allowance for doubtful accounts. It should be noted that the loan loss reserve is usually not a cash reserve, but rather an accounting device to provide the reader information about the size of the anticipated loan losses from past due loans. The reserve is built up from specific provision expenses related to the portfolio at risk or in some cases general provision expense against the entire gross loan portfolio. Net loan portfolio is the gross loan portfolio less the impairment loss allowance. Investments classified as Trade Investments and Other Investments. Current assets should be classified under interest accrued on investments; inventories; cash balance in hand; bank balances with scheduled banks; and bank balances with others. The mode of valuation of inventories should also be disclosed. Fair values of items on inventories received as non-monetary grants and donations, existing on the balance sheet date, should be disclosed in notes to accounts. Where any item constitutes ten per cent or more of total current assets, the nature and amount of such item may be shown separately. As far as possible fixed assets of an MFI should be classified under land, buildings, leaseholds, plant and machinery, furniture and fittings, vehicles, computers, intangible assets and other office equipments. Under each head the original cost, and the additions thereto and deductions there from during the year, and the total depreciation written off or provided up to the end of the year should be stated. Separate disclosure under each head should be made in respect of donated assets (i.e. assets that have been received free of cost as non-monetary grant/donation by the MFI) and assets financed under a lease agreement. Fair value and quantitative details of fixed assets received as non-monetary grants and donations, during the year, should be disclosed in the notes to accounts. Fair value of all donate fixed assets, existing on the balance sheet date, should be disclosed in the notes to accounts. If it is not practicable to determine the fair values of the assets on each balance sheet date, then such values may be determined after a suitable interval, say, every three years. In such a case, date of determination of fair values shall also be disclosed along with the fair values of assets. Restrictions, it any, on the utilization of each asset should also be disclosed in the notes to accounts.

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An MFI must disclose all its contingent liabilities such as in case of guaranteed loans, unless the possibility of an outflow of economic resources is remote. Income statement: Figure 1.9 depicts a recommended format to be used for the balance sheet of a MFI.
Figure 1.9: Format for the Income Statement of a MFI

Typically, MFIs major revenues is in the form of interest earned, fees and commission (including late fees and penalties) on their gross loan portfolio. This item in the income statement is referred to as revenues (income) from loan portfolio. It not only includes interest paid in cash, but also interest accrued but not yet paid. Besides the revenues from their loan portfolio, MFIs receive interest, dividends or other payments on their investments other than the gross loan portfolio, such as

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interest-bearing deposits, certificates of deposits and government securities. This includes not only interest paid in cash, but also interest accrued but not yet paid. Interest and fee expense on funding liabilities all interest, fees and commissions incurred on deposits accounts of clients held by the MFI as well as commercial or concessionary borrowings by the MFI that are used to fund all financial assets. It generally does not include interest expense on liabilities that fund fixed assets, such as mortgage or leasing interest. It includes accruals as well as cash payments. Financial expense all interest, fees and commissions incurred on all liabilities, including deposit accounts of clients held by the MFI, commercial and concessional borrowings, mortgages, and other liabilities. It may also include facility fees for credit lines. It includes accrued interest as well as cash payment of interest. Loan loss provision expense a non-cash expense that is used to create or increase the loan loss reserve on the balance sheet. The expense is calculated as a percentage of the value of the gross loan portfolio that is at risk of default. It is common to use the term loan loss provision and loan loss reserve interchangeably. To avoid confusion between this expense and the loan loss reserve, analysts prefer to use the term reserve for the balance sheet account, and the term provision only for the expense account. It is also helpful to include the word expense when referring to this latter account. Personnel expense includes staff salaries, bonuses, and benefits, as well as employment taxes incurred by the MFI. It is also referred to as salaries and benefits or staff expense. It may also include the costs of recruitment and initial orientation; It does not include on-going or specialized training for existing employees, which is an administrative expense. Administrative expense non-financial expenses directly related to the provision of financial services or other services that form an integral part of the MFIs financial services relationship with its clients. Examples include depreciation, rent, utilities, supplies, advertising, transportation, communications, and consulting fees. It does not include taxes on employees, revenues, or profits, but may include taxes on transactions and purchase, such as value-added taxes. Net operating income total operating revenue less all expenses related to the MFIs core financial service operations, including total operating expenses, financial expenses, and loan loss provision expense. It does not include donations, revenues expenses from non-financial services. Many MFIs choose not to deduct taxes on revenues or profits from the net operating income; rather they are included as a separate category. MFIs are encouraged to indicate if taxes are included in this account. Non-operating revenue all revenue not directly related to core microfinance operations, such as revenue from business development services, training, or sale of merchandise. Donations and revenues from grants may also be considered nonoperating revenue, but it is recommended that they be included in their own account. It is strongly recommend that MFIs with significant non-operating revenue or expenses should produce a segmented income statement, organized so as to show net operating income, net non-operating income, and consolidated net income. At a
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minimum, MFIs should provide a footnote detailing non-operating revenue, if it is significant. Non-operating expense all expenses not directly related to the core microfinance operation, such as the cost of providing business development services or training (unless the MFI includes training as a requirement for receiving loans). This may also include extraordinary expenses, which are one-time expenses incurred by the MFI that are not likely to be repeated in coming years. When MFIs have significant non-financial programs, it is common to use segment reporting if possible or, at a minimum, provide a footnote detailing non-operating expenses if they are significant. Taxes includes all taxes paid on net income or other measure of profits as defined by local tax authorities. This item may also include any revenue tax. It excludes taxes related to employment of personnel, financial transactions, fixed-assets purchase or other value-added taxes, (which should be included in operating expenses). Net income total revenue less total expenses, operating and non-operating, including all donations and taxes, if any. Some MFIs prefer to present net income before donations and taxes. If so, the MFI should label it as such (such as net income before donations).

1.4

Accounting Equation

In the GAAP framework there must be a continuous equilibrium between assets on the one side and the total of liabilities and equity on the other side. This is represented by the fundamental equation of accounting: Assets = Liabilities + Equity This equation is also the basis for the most basic of accounting reports, the aptly named Balance Sheet. A balance sheet reports what a business owns (assets), what it owes (liabilities) and what remains for the owners (equity) as of a certain date. This equation must always be in balance. For an ongoing firm this equation takes the following expanded form to capture the retained earnings on account of the firms past operations. Assets = Liabilities + Owners Capital + Revenues - Expenses - Owners Drawings

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Practice Case Bhatia Clinic In the beginning of May 2005, Praveen Bhatia persuaded his family regarding his desire to quit his job with a renowned hospital in Mumbai to setup his own clinic at his native place. Bhatia spent his childhood in a small village located at the outskirts of Kangra in Himachal Pradesh. While Bhatia was a successful general physician at Mumbai, he always dreamed of providing better health care to his family & friends in his own village. Once his family agreed, Bhatia immediately resigned from his job and was subsequently relieved of his job responsibilities on 31st of May, 2005. Same day he vacated his rented apartment at Mumbai and set out on a train journey to reach his village at the earliest. As he waited for his destination, his mind was already embracing a plan that would have him start his own clinic within a fortnight. He was thrilled with the thoughts of employing his training in medicines for healing his own people. Bhatia was a graduate of the All India Institute of Medical Sciences (AIIMS) and had little exposure to the way businesses run. Nevertheless, his regularity in reading the business magazines and newspapers had given him enough wisdom for initiating his own venture. On June 20, 2005, he transferred all of his savings, Rs 30,000, to a new bank account with the clinic name, and two days later he added Rs 20,000 borrowed from his father to the account. After that things moved quickly as he signed a one-year lease agreement for acquiring an office space required for the clinic. He immediately deposited lease rental of Rs. 3,000 for July 2005. An additional deposit of Rs 3000 was kept with the owner as a security for the office premises to be refunded on vacating the office premises. Equipments inclusive of medical instruments and a used computer with software were purchased from vendors in Shimla for Rs 27,000. Office supplies viz., letter heads, stationary, stapler, files, punching machine etc. were ordered and paid for with an amount of Rs 5,000 when delivered on June 29. Bhatia clinic opened for patients on July 1, 2005. Although Bhatia was not an accountant, he took stock of his clinic's financial position as he began to seek his first client. The clinic had spent all but Rs 12,000 of the cash that had been put into the bank account, but it had some assets as well. ASSETS Cash in bank Office supplies Equipments* and software Prepaid rent including Security Deposit Rs12,000 5,000 27,000 6,000 LIABILITIES & OWNERS EQUITY Loan Bhatias equity Rs20,000 30,000

* Equipments included medical instruments and a used computer with software

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Bhatia was a little worried that the cash had gone so quickly, but he had confidence in his abilities. In the first few days, only a few villagers were aware of newly opened clinic. He had a few patients coming to him. So he spent part of his day diagnosing the patients, and the remaining of his time was spent doing an awareness campaign for his clinic by meeting his relatives & childhood friends. By early August he had a steady stream of new patients coming in by way of referrals from friends and relatives. He also felt far too busy to attend to any financial aspects of the business. When clients paid, the money went into the bank account. The salaries to the office staff inclusive of a medical assistant were paid monthly, and he paid rent and other bills when they were received. In the ninth week of operations, Praveen's father visited the clinic to ask how things were going, and he could not answer the question with any confidence. It was time for an accounting, and the end of August would be a good time to do it. Bhatia found the following information he had accumulated during the two months of operations till 31st August, 2005: 1. 2. 3. While consultation fee of Rs. 40,000 is received in cash, Rs 7,000 of consultation fee from two patients5 who consulted last week is still pending. Additional office supplies had been purchased for cash of Rs. 900, and office supplies that had cost Rs. 4,200 were still on hand. Rent of Rs. 6,000 for August and September was paid in cash. Utility bills, a repair of equipment, and the salaries paid to employees (including Bhatia) were paid in cash totaling Rs 33,000. Additional equipment and software was purchased on August 31 for Rs.11, 000, with half of that amount being paid in cash and the remainder due one month later.

4.

As Bhatia thought about the first two months operations, he was perplexed by the fact that cash in the bank had decreased by Rs 5,400 even though he was sure the business was operating profitably. He also wondered how to account for the following: 1. 2. He had agreed to pay his father interest (starting from July 1, 2005) on his loan of 6% per year, but no interest had been paid so far. The equipment and software were working out well, but Bhatia knew that they had a technological life of no more than three years from the time he purchased them.

In brief, Bhatia felt that the first two months had been successful, but he was puzzled about how to draft meaningful reports to mail to his father. He wanted to prepare financial statements of his clinic and approaches you for help in completing the partial financial statements prepared by him.

Those two patients later paid in full on 10th September, 2005.

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Section 2 : Analysis of Financial Statements When one thinks of analyzing the financial statements in context of Microfinance Institutions (MFIs), there are two angles here. First, MFIs need to assess the financial performance and position of their current and prospective customers. Second, the financial performance and position of MFIs also need to be analyzed by those who may be providing capital to the MFIs or by the manager in charge of MFIs. 2.1 Analyzing the current and prospective clients by MFIs

Here are list of ratios useful when MFIs want to do the financial statement analysis of their current and prospective customers. Profitability Ratios Return on ordinary shareholders funds (ROSF) Net profit after tax - preference dividend (if any) X 100 Ordinary share capital + reserves Means: Amount of profit available to shareholders Whats hot: The higher the better, although it doesnt mean shareholders will get it all Return on Capital Employed (Roce) Net profit before interest and tax X 100 Share capital + reserves + long term loans Means: The relationship between net profit generated and long-term capital invested in the business Whats Hot: Primary measure of profitability. Good if going up Net Profit Margin Net profit before interest and tax X 100 Sales Means: Measures relationship of one output sales to another output profit Whats hot: Depends on business. Needs to be compared to industry norm
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Gross Profit Margin Gross profit X 100 Sales Means: Difference between sales and cost of sales and therefore profitability in buying or producing and selling goods. Whats Hot: Hot if rising or stable, not good if going down. Efficiency Ratios Average stock turnover period (Days Inv) Average stock held X 365 Cost of sales Means: The average time (in days) stock is being kept for. Whats hot: The shorter time, the better it is. Means less funds being tied up in stock. Average settlement period for debtors (ACP or Days Sales) Trade debtors X 365 Credit sales Means: How quickly an average debtor takes to pay. Shown in days. Whats hot: The quicker the better. Means money comes in quicker. Average settlement period for creditors (Days Payables) Trade creditors X 365 Credit purchases Means: How long, on average, it takes a business to pay its trade creditors in days. Whats hot: Maximum time allowed. After that it looks bad to suppliers.

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Sales to capital employed Sales Long term capital employed (shareholders funds + long term loans) Means: How effectively the assets of the business are being employed in generating sales Whats hot: High, but not extremely so. Sales per employee Sales Number of employees Means: Relates sales generated to a particular business resource Whats hot: Higher the better, effective use of resources Liquidity Ratios Current ratio Current assets Current liabilities Means: There are sufficient current assets to cover current Liabilities as they fall due Whats Hot: 2:1 is quoted as good, but depends on type of business Acid Test Ratio Current assets (less stock) Current liabilities Means: Coverage of current liabilities by liquid assets Whats Hot: 1:1 is quoted as good, but again depends on business type.

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Operating cashflows to maturing obligations Operating cashflows Current liabilities Means: Ability to meet debts from cash flow Whats hot: The higher, the greater liquidity of the business Gearing Ratios Gearing ratio Long term liabilities X 100 Share capital + reserves + long term liabilities Means: Contribution of long-term lenders to the long-term capital structure Whats hot: Should not be too high, but optimal levels vary with the business type Interest Cover Profit before interest and tax Interest payable Means: Amount of profit available to cover interest payments Whats hot: The higher means more funds are available to meet interest payments. So long term lenders more secure. Investment Ratios Dividends per share Dividends announced during period Number of shares in issue Means: cash return an investor can expect from shares held in a company

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Whats Hot: High is good for investors. But too high and company could be funding from reserves Dividend Payout Ratio Dividends announced for the year X 100 Earnings for the year available for dividends Means: Proportion of earnings paid out to shareholders as dividends Whats hot: For shareholders, the bigger the better. Dividend Yield Ratio Dividend per share/ (1-t) X 100 Market value of shares Means: Measure of cash return against market price Whats hot: Bigger the better for shareholders Earnings per share (EPS) Earnings available to ordinary shareholders Number of ordinary shares in issue Means: Fundamental measure of share performance. Trend over time assesses the investment potential. Whats hot: Higher the better all round

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Operating cash flow per share Operating cash flow preference dividends Number of ordinary shares in issue Means: Operating cash flows are a better short-term indicator of a companys ability to pay dividends. Whats hot: High figures and compare for trends. Price/Earnings ratio (P/E ratio) Market value of shares EPS Means: Compares market value of the share with its earnings. Whats hot: A high figure shows the markets confidence in the future earnings potential of the company. The higher the confidence, the more investors will be prepared to pay for shares in relation to the current earnings level.

2.2

Analyzing MFIs Financial Statements

Sa-Dhan, as Association of Community Development Finance Institutions, took up the work of facilitating the setting of standards for financial performance of community development finance institutions. This followed finalization of a set of six financial standards and their respective performance benchmarks with extensive engagement of members through national and regional workshops and field tests. The set of six financial standards, recommended by Sa-Dhan cover three core elements of financial performance viz. Sustainability, Asset quality and Efficiency. This work has evolved into a composite set of financial performance benchmarks among community development finance institutions across operating models, size of operations, legal forms and variety of services.

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Case 1: Down load the latest annual report of SKS Finance Ltd. and analyze its financial statements.

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Module 3 : Group Based Microfinance

Objectives 1. 2. This module attempts to develop an in depth understanding about group based models of microfinance among the participants. It also endeavours to map the processes and systems in group based microfinance model.

Sessions 1. 2. 3. 4. Process and Methodology of Group Formation Introduction about Mapping Processes Steps of Processes Mapping Mapping Key Processes

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Section 1 : Raison Dtre Group Based Model in Microfinance Most of the microfinance institutions across the world have been using group models to provide microfinance services to the poor. Many of you might have seen, experienced or read about group based model of microfinance. But have you ever ponder over the question of why group based model in microfinance? Banks provide services to people like us (individuals) without organising in groups, so why the poor have been given financial services in groups. Why this model of organising people in groups to access microfinance services has become popular? Lets try to find out the reasons from some of the popular perceptions about this model. The group based model helps in replacing physical collateral with social collateral of joint responsibility and peer pressure Peer screening i.e. weeding out of unworthy member in the group It also reduces moral hazards and chances of adverse selection in financing the poor It also helps in reducing transactions cost for both the lender as well as the person who receives microfinance services (Puhazhendhi:1995, APMAS)

The general perceptions about group model stems from time tested models of organising peoples in the group in the western countries. The history of adopting formal approach for working with groups started with charities organisation societies and settlement house movement in the UK and the US in the late 19 th century and early 20th century (Coyle: 1930, Andrews: 2001). While tracing the history of working with the groups, Goldberg and Middleman (1988) rightly mention that group work was seen as a movement before it became a field. From a field, it became a method, and back to a field. In the microfinance sector, the group based service delivery model gained currency around late 70s when experiments by Accion International and Mohd. Yunus, founder of Grameen Bank, Bangladesh. Later on it became very popular model of financing the poor world over. Numerous studies and experiments were conducted on promoting group based models in different regions. In fact there are various instances of model experimentation even now but these emerge mostly from the joint liability or self help model.

1.1

Popular Models of Delivering Microfinance Services through Groups

All around the world, the microfinance or banking institutions are using various group models for delivering microfinance services to the poor. These group models differ in their nature and characteristics. Some of the common characteristics are mentioned below: 1. Groups provide a sense of belongingness and association for working together.

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2. The members of a group have mutual trust among them and this thus reduces the chances of leading to adverse situations like repayment of instalments by other members if there is some emergency with one member. 3. Groups have wealth and dearth of information about the members. It is upto the organisation on how it takes out from them. 4. It also reduces the risks of adverse selection and reduces transaction costs of delivering microfinance services. The following discussions detail out various forms of groups used by the microfinance institutions. Joint Liability Groups A Joint Liability Group (JLG) is an informal group of people comprising preferably of 4 to10 individuals coming together to attain a common goal. Essentially the common goal is to access financial services such as savings, credit and insurance when one talks about microfinance. The term joint liability denotes the concept of mutual guarantee of paying the instalments due or charges due for the products and services as agreed upon by both the clients as well as the microfinance service provider. However the concept of joint liability in India has been tested with credit or compulsory credit insurance products to the clients. For accessing credit either singly or through the group mechanism, the JLG members would offer a joint undertaking to the bank that enables them to avail loans. There are number of models with little variations in the concept of joint liability. Grameen bank model is one such concept which organises poor into small sub groups which in turn form centres. Each sub group consists of 4-5 members who are organised into a centre of 5-7 similar groups. The management of the JLG is to be kept simple with little or no financial administration within the group. Main Features of JLG JLGs are formed with people living in nearby localities and belong to same socioeconomic stratum of the society. Such groups work basically on the principles of mutual trust and discipline. The main features of joint liability groups are mentioned hereunder: Members belong to homogenous socioeconomic status Group size ranges from 4-5 members each, in some cases now there are 8-10 members Main role of a JLG is to facilitate the process of financial intermediation with the service provider Mutual guarantee among the members for giving instalments and repaying the dues

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1.2

Process and Methodology of JLG formation and Management

As mentioned above, a JLG is formed typically with 4-5 members. Grameen bank of Bangladesh has experimented with so called extended JLG model and made groups of 7-8 such JLGs and termed it as centre (see figure). The process of forming a JLG (for credit services) is described hereunder (it is given in context with the centre model, which is predominantly being used by microfinance service providers) 1.

JLG

JLG

JLG

JLG

JLG

JLG

JLG

JLG

JLG

Center

2. 3. 4. 5.

6.

7. 8. 9.

10. 11.

First of all, villages are identified on the basis of certain indicators like population, business environment, connectivity by roads and existing markets or occupations in the area. The information is collected through both secondary and primary sources. A village meeting is kept to make people aware the organizations goals and strategy. People are invited to form groups of five people, mostly women. A homogenous five member groups are formed at the village level. A representative of the microfinance service provider facilitates the process of group formation through a process called group training. Since such training is compulsory to the groups, at some places it is also called compulsory group training (CGT). All the group members have to compulsorily attend this 3-7 days training for 1-2 hours each day. The groups also have to go through certain qualification criteria often termed as group qualification test (GQT) or group recognition test (GRT). GQT or GRT is a screening mechanism that can distinguish between serious and non-serious groups. If the groups pass through this test, they undergo through the documentation process of the organisation. 6-9 such groups are associated to form a Centre (in Grameen Bank model only) It is mandatory for the members to attend the weekly meeting and all the loan applications have to be approved by other group members as well as centre members. After this process, loans are given to the individuals and not to the group or the centre. The loans are either given at the group or centre meeting or at the branches for building and maintaining peer pressure. The place of disbursement varies from organisation to organisation. However, in order to build the confidence of the clients and to avoid fraud risks, many organisations are now calling the clients to the branch offices for disbursing loans. An officer of the branch goes for random loan utilisation checks after disbursement of the loans. Groups/Centres meet every week or month, at a definite day and time. The meetings are very structured and officer or staff the organisation attends the meeting

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12. 13. 14.

Group discipline is enforced through peer pressure and is seen as a very important aspect for creating and building credit discipline in the program. Loans have to be repaid by the JLG members within a year in equal instalments spread over 52 weeks. Collateral is replaced by Peer Pressure. The incentive to timely repayment is repeat loans and continuous access to increasing credit from the organisation.

1.3

A Critique of JLG model

Despite of the claims of models being successful with repayment rates of over 90% world across, there are severe criticisms attached to the JLGs. In JLG the members are dependent are on external agencies for meeting their requirements. In addition, the groups formed with joint liability focus on regimented approach of following strict discipline and forcing member to repay. In addition very little time and emphasis are spent on the ensuring quality of the groups. The groups are formed within a weeks time. Nonetheless, the model has proved its worth and seen as growth model as there are many agencies adopting the approach with astronomical growths.

1.4

Self Help Groups

Self help groups (SHG) are formed with no less than ten members and maximum of twenty members belonging to same area and same socioeconomic status. The SHGs select members on their own, meaning the potential members have a choice of being in a group or other. It depends upon the level of their affinity towards the group. The SHG approach is developed on the basis of two basic assumptions which are primary to the field of social work Every human being has tremendous potential in her/himself. This hidden potential in the poor can be unleashed if the right environment is provided. As an individual, the poor are voiceless, powerless and vulnerable. By bringing them together as a homogenous collective, they have tremendous strength.

The concept of SHG is built up of three major components which can be described below: Self: The concept of self indicates the persons attitude towards her/his self image, dignity and worth. The concept also helps in inculcating feeling of instrumentality and initiative in a person. Help: The concept of help symbolises the attitude of mutual help, empathy and cooperation. Group: The concept of group means coming together to achieve a common purpose.
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1.5

Main Features of SHG

SHGs are unique in many ways, whether it is approach or methods. Some of the main features of an SHG are listed below: Informal association Non Political Voluntary participation Rotational leadership Affinity among members, the members bound by mutual trust, respect and affection that support one another Participatory methods in management Self help principles Mutual support Continuous capital building Common interest in all activities Own rules and regulations, Bye laws formed by the group members Opportunity to govern transactions in the hands of the members only.

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Important Features of an SHG* 1. Small and fixed savings at frequent intervals: Small and fixed savings made at regular intervals coupled with conditions like compulsory attendance, penal provisions to ensure timely attendance, saving, repayment etc forms a deterrent for the rich to join the SHG system- thereby enables exclusion of the rich. 2. Self-selection: The members select their own members to form groups. The members residing in the same neighbourhood ensure better character screening and tend to exclude deviant behaved ones. 3. Focus on women: As regular meetings and savings are compulsory ingredients in the product design, it becomes more suitable for the women clients- as group formation and participatory meetings is a natural ally for the women to follow. 4. Savings first and credit later: The saving first concept enables the poor to gradually understand the importance of saving, appreciate the nuances of credit concept using their own money before seeking external support (credit) for fulfilling future needs. The poor tend to understand and respect the terms of credit better. 5. Intra group appraisal systems and prioritisation: Essentials of good credit management like (peer) appraisal for credit needs (checking the antecedents and needs before sanction), (peer) monitoring- end use of credit; (peer sympathy) rescheduling in case of crisis and (peer pressure) collateral in case of wilful non-payment etc all seems to coexist in the system making its one of the best approaches for providing financial services to the poor. 6. Credit rationing: The approach of prioritisation i.e.: meeting critical needs first serves as a useful tool for intra group lending. This ensures the potential credit takers/users to meticulously follow up credit already dispensed, as future credit disbursals rely on repayments by the existing credit users. 7. Shorter repayment terms: Smaller and shorter repayment schedule ensures faster recycling of funds, greater fiscal prudence in the poor and drives away the slackness and complacency that tends to set-in, in long duration credit cycles. 8. Market rates of interest: Self-determined interest rates are normally market related. Sub-market interest rates could spell doom; distort the use and direction of credit. 9. Progressive lending: The practice of repeat loans and often-higher doses - is followed by SHGs in their intra-group loaning, thereby enticing prompt repayments. 10. A multiple-eyed operation: The operations of the SHG are transacted in group meetings thus enabling high trust levels and openness in the SHG system. SHG members facilitating openness and freedom from unfair practices also generally conduct the banking transactions. *Adapted from (Cropp and Suran: 2002)

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Section 2 : Process and Methodology of Forming and Managing SHGs SHGs in microfinance can be termed as a home grown model of India. National Bank for Agriculture and Rural Development (NABARD) and Mysore Resettlement and Development Agency (MYRADA) in India pioneered the concept of Self Help around 80s (for details see module 1). The SHG model of India requires coordination among banking system with several organisations in the formal and semi-formal sectors to facilitate the provision of financial services to a large number of poor. A lot of capacity building inputs are provided to the individual members as well as the groups and their leadership qualities are developed. The whole process is slow and no spectacular results are seen immediately. Formation of an SHG requires at least six months. 1. 2. 3. 4. 5. 6. First of all, poor families in a village are identified on the basis of certain indicators. It is also called preliminary survey. Trust winning is an important component before engaging people to form SHG. Community participation is also ensured by calling influential people to know about the purpose of forming SHG. Basic concepts of SHGs are also explained in the meeting. Formation of an SHG usually takes 3-6 months of time. It starts with motivating members to come for a meeting on a convenient time. It goes further to ensure discipline in regular meetings. When the group start meeting regularly, mostly weekly, at an appointed time and place, rules and norms for being a member of the groups are finalised by the members themselves. However, most of the facilitators (also read as organisations promoting SHGsee the box below) help in forming the norms. The facilitator helps in designing and installing systems for the transactions, conducting meeting, resolving conflicts and for networking. Leaders are also selected democratically to carry out different taskspresident, secretary and treasurer. After finalisation of norms, financial transactions start especially savings among the group members. The members are responsible for safe keeping of the amount. The group mobilises savings among its members (only) and makes need based loans to the members (only). After some time when the amount becomes bigger, the members, as agreed, are eligible for loans from the pool. The members themselves maintain the records or select a person to keep records of transaction of their accounts. Generally this person is a literate person from the group or a literate villager in the area. Thus while the SHG provides the members with financial services, the NGO provides them with the support services, training, system setting and in developing linkages. After strengthening the internal transactions systems, the groups are subsequently linked with financial service provider for supplementary financial assistance like bank savings and external loans. This is usually happened in the bank linkage model, else the service provider itself provide financial services to the SHGs. However all the transaction affairs are managed by the person selected for undertaking this task.

7.

8.

9. 10.

11.

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2.1

Critique of SHGs

However as like any other model, the SHG model of microfinance has downside too. Some of the common pitfalls are: 1. 2. 3. 4. Group formation is a long process and members are required for a long waiting period for reasonable amount of loans. The internal transactions of an SHG are small in nature and therefore it is difficult for all the members to take loan at a time. The foundation of forming an SHG depends upon the group dynamics and processes. This thus requires a high degree or quality of facilitation. Since the group formation takes time and is therefore cost intensive.

Despite these few disadvantages, definitely there are several advantages. The SHG derives its strength from the opportunity of transactions and control over the system being provided to the people. The fact that the members are all from the same settlement and know each other very well helps the members exert peer pressure on each other whenever required. The SHG carries out all the same functions as those required by the JLG or Grameen system, but they do this on their own behalf, since the SHG is effectively a micro-bank, carrying out all the familiar intermediation tasks of savings mobilisation and lending.
The SHG Bank Linkage Programme: What is unique about the programme? Decision making Members make decisions collectively. SHG concept offers opportunity for participative decision making on conduct of meetings, thrift and credit decisions. The participative process makes the group a responsible borrower. SHGs provide the needed financial services to the members at their doorstep. The rural poor needs different types of financial services, viz. Savings, consumption credit, production credit, insurance, remittance facilities etc. The platform of SHG provides the possibility to converge these services.

Financial services

Supplementary SHG linkage does not supplant the existing banking system, but it to formal supplements it thus taking full advantage of the resources and other banking advantages of the banking system. SHG linkage cuts costs for both banks and borrowers. In a study sponsored by FDC, Australia, it was observed that the reduction in costs for the bankers is around 40 % as compared to IRDP loans. The poor have a net advantage of 85 % as compared to individual borrowing. Similar finding was also observed in a NABARD study. The Linkage mechanism has proved that the repayments are as high as 95% - 100 % The SHG linkage emphasises peer pressure within the group as collateral substitute. The SHGs are turning out to be quality clients in view of better credit management, mobilisation of thrift, low transaction costs and near full repayments.

Cutting costs

NPA Savvy Peer pressure as collateral Quality clients

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Client preparation

The members of the SHGs could over a period of time, very selectively graduate to the stage of micro entrepreneurship and have been prepared with requisite credit discipline. Available statistics indicate dependency of 35%-40% of rural households on non-institutional sources for credit needs. SHG Linkage offers a better way of dealing with the magnitude of social agenda. Many NGOs/ Governments have recognised the SHG as a vehicle for carrying and deepening of their developmental agenda/ delivery of services. SHGs have exclusive focus on absolute have-nots, who have been bypassed by the banking system. Social banking does not have any meaning if the lowest strata and the unreached are not focused. The programme does not envisage any subsidy support from the government in the matter of credit. The issue is to build capabilities and enterprise of the individual members, blending with group cohesion and solidarity through training provided by a SHPI to set the ball rolling for the SHG.

Social agenda

Exclusive poor focus

No-subsidydependence syndrome

2.2

Common Drawbacks of Group Based Models

Group based microfinance models have both pros and cons. As we have seen above various characteristics, advantages and pitfalls of two main models i.e. JLG and SHG model. However, it is important to note here that the group models, though a popular model of microfinance, have their own set of limitations. It is because of this fact the microfinance sector across the world has witnessed shifting of large share of its group liability portfolio into individual liability. Even the well known microfinance service providers like Grameen Bank, Association for Social Advancement (ASA) in Bangladesh, Bank Rakyat Indonesia (BRI) and BancoSol in Bolivia. In many cases also the liability has been individualised, but some of the group process have been kept possibly for lowering transaction costs (Gine & Karlan: 2007). The evidence from many studies highlights some drawbacks in the group lending model (Besley & Coate: 1995, Madajewicz: 1999, Aghion & Morduch: 1999, Murdoch: 2000, Sadoulet: 2000, Gine & Karlan: 2007, Lehner: 2009). These are listed hereunder: 1. Attending group meetings increases opportunity cost for the client especially when the houses are not too close. In two Chinese microfinance programs studied by Park and Ren, 8% of clients had to walk more than an hour to get to meetings. On average, attending meetings and travel time took just over 100 minutes. Group performance also discounts the needs and performance of good members with growing businesses or those who perform better than others. This may lead to higher dropout and more difficulty in attracting new clients. Conversely, bad clients can free ride off of good clients and may cause high default rates. For example, a member does not repay the loan because she believes that another member will pay it for her because the service provider is indifferent on getting its money back.

2.

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3. 4.

5.

Borrowers may collude against the service provider and bring down the importance of harnessing social capital. Some of the clients also dislike the tension caused by group liability. Excessive tension among members is not only responsible for voluntary dropouts but worse still, can also harm social capital among members, which is particularly important for the existence of safety nets. Finally, after a few cycle of loans, members typically diverge in their demand for credit. Some might need higher loans, but some less. This can be a cause of stress in the group because clients with smaller loans can become reluctant to serve as a guarantor for those with larger loans.

Shakya (2010) presents a comparative picture of merits and demerits of group lending. It might help in making the concepts more clear.
Merits of group lending Accessibility of financing services to poor households have become possible though groups Loan administration cost to the lender is low Loan transaction borrowing cost is low Loan monitoring and supervision cost low Loan utilization is high Limitations of group lending Individual specific needs have chances of being isolated/overlooked Expression and need identification of individuals is difficult Individuals do not prefer to be attached with group loans for a long period Coordination of divergent needs is difficult Backward members may be kept at low profile and exploited by some forward members After certain duration (5 to 7 years) group members attain individual specific efficiency to run individual level credit facilities. Individual entrepreneurship may be under shadow

Tiny physical and financial resources can be utilized as collective collateral and capital for poor individual members Loans are available to clients at the door steps The group saving and centre fund also provide loans to members as factor of self reliance

Reference: Ms. Padmasana Shakya Vice President, Micro Finance AssociationNepal during Microfinance Summit, Nepal, 2010

Section 3 : Mapping the ProcessesGroup Based Models of Microfinance Most of us are now aware about the basic characteristics, merits and demerits of working with the groups. We have also learnt the art of forming different types of groups i.e. JLG and SHG. But have you ever wondered about the effort which goes in
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forming groups? Have you ever thought about the systems and processes which one needs to keep in mind while forming a group? Why do we need to learn the process and system of forming groups? Lets come again to understand the reasons of learning the processes and systems of forming groups. 1. 2. 3. 4. Understanding systems and processes of delivering group based microfinance enhances awareness about systemic risks associated with microfinance. It prevents us from the pitfalls and thereby helps in improving the efficiency in the systems and processes. It helps in avoiding the unnecessary costs which an organisation could incur if the leakages in the systems and processes are not stopped or prevented. It also helps in developing a system of internal control in the organisational processes.

Processes and systems can be understood if one maps the processes. MicroSave defines process mapping as a simple yet powerful method of looking beyond functional activities, such as marketing or accounting, to reveal an organisations core processes and discover how its different parts work together to serve customers. It has also developed a unique toolkit to map the processes. Mapping processes in simple language is a visual representation of the processes of any organisation. The processes are broken into smaller sub processes with the combined help of carefully selected and trained people who thereafter draw flow diagrams (usually called process maps) to understand the risks in the systems. A careful analysis of the process maps provides information about risks and the team consequently factor in risks mitigation strategies. Usually process maps are drawn with respect to three operational states of the organisationpresent, past and future. The present state in the process map indicates what is going on in any organisation. It is indicative of current processes and system and therefore it is named as As Is. However, there must be documented policies and guidelines in an organisation or thinking behind any process or system on how a system or process should go. This means there is a past associated with any process and this past is usually the guidelines for any process in an organisation. This, we term as Should Be. Then if we find any gap between present and past or as is and should be, we look for solutions. Finding and improvising a process or system is a future of the process and we call it as Could Be.

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3.1

Process Mapping Symbols

The most common symbols used in process mapping are

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The entire process mapping exercise is very time intensive and requires specific skill sets to perform the tasks. MicroSaves toolkit explains ten critical steps for process mapping which are mentioned hereunder:

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1. Identify and prioritise on operational gaps: In order to identify and prioritise operational gaps, it is important to look into the broader context in which they operate, especially with regard to the following: Evaluate client satisfaction o Consult market research data - satisfaction surveys and market research o Use in-house client data - retention rates, drop out analysis etc. Determine the institutions competitive position o How does the institution compare with its competitors on financial metrics growth, profit, prices, etc.? o How does the institution compare with its competitors on operational metrics time to disburse loans? Wait time in branch? etc. Benchmark against international standards

2. Choose process to be mapped based on prioritised operational gaps to be tackled: It is important to isolate the most important operational gaps and identify process directly linked with these prioritised operational gaps. From these, those process that needs to be mapped on a priority basis are chosen. While several operational gaps may be actually identified, in real terms, they need to be prioritised. This would involve categorising the operational gaps in clusters, prioritising them and identifying common processes that impact these gaps. This methodology however need not be adopted if only one operational gap and associated processes are identified. 3. Assemble an appropriate team that can really deliver: An appropriate and suitable need is an important consideration while mapping any process. It is also important to include personnel who can provide cross-functional perspectives. Generally speaking, the right people are those who are: Knowledgeable about the process. Provide cross-functional perspectives Interested in improving the process. Available and motivated to stay with the project until completion. Influential enough to facilitate implementation of the agreed-upon process changes. Careful composition of the team is important the team members must have skills, knowledge, experience, willingness, time and positions to positively influence the entire exercise. The team should include people directly involved in the operation at both the lowest and highest levels of the organisation (for example, the operations manager, branch manager, branch supervisor, and teller). The team must be empowered to make significant changes in work flow; it must be given not only responsibility, but also authority and flexibility.
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4. Define the process to be mapped and objectives of process mapping: Process maps can be used to document both broad organisational processes and the minutest details of work. An MFI could literally spend hundreds of person-hours mapping processes. What level of detail is appropriate depends on the objectives. In general, there are three levels of mapping possible: system (institutional level), macro-processing (core processes, such as lending activities or deposit-taking), and micro-processing (for instance, processing a savings withdrawal). Maps at these three levels resemble each other in format, but provide information at different levels. Some of the examples of objectives are Problem solving for specific bottlenecks, Identify process improvement opportunities General understanding of work flow Evaluate, establish or strengthen performance measures Create activity dictionary for ABC analysis Orient and train new employees Establish and document best practices Create detailed and easy to follow policies and procedures manuals Identify quick-win opportunities Development and document risks and risk management strategies risk analysis/mitigation Reduce specific types of risk, including: reputation risk, fraud, operating errors, human-resource-related risk, and system failure etc. 5. Gather required data using appropriate techniques and methods: During the mapping process, data can be gathered in two stages: at the beginning of the process, and during the analysis stage, prior to modifying the process map. Each input and output has a set of associated requirements. Once it is determined what these requirements are, this information can be used to construct a set of measures to determine output quality and customer satisfaction. To measure output quality, focus on the characteristics that cause the customers to value a particular output. To measure customer satisfaction, customer perception data should be collected and compared to the expectations data used to establish input, output, and process requirements. At this point, the focus will be on the initial stages of gathering data for a map. There are three basic methods of collecting the process information necessary to create a map: Self-generation. One-on-one interviews, Group interviews Observation

6. Construct as is process map and proofread process map: An as is process map is the current pattern of the work going on in an organisation. A beginning can be made with a rough draft and first, the level of process map to be constructed should be determined and an appropriate chart chosen. The boundaries should be defined and there should be focus on the following key

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elements of process: suppliers, inputs, tasks, outputs, and customers. The as is process map should clearly answer the following questions: What is being done? When is it being done? Who is doing it? Where is it being done? How long does it take? (Cycle Time) How is it being done? and Why is it being done?
Proof Reading Process Map It is vital that process maps are validated as complete and correct once they have been drawn. Dont draw the map too early: Ask two respondents about the process involved before drawing the process map, asking questions to get the process right is far quicker than drawing and redrawing the process map. Note down in full what is being said: It is difficult to know what information is going to be useful when the interviewing and observation starts so be sure to take comprehensive notes. Mark anything that is skipped over possibly due to the limited knowledge of the individual for further investigation. Obtain a list of documentation used during the process: Ask at least two people to provide a comprehensive list of documentation used / produced during the chosen process. Keep this list and check it against the documents used within the process map and resolve any differences. Ask the same question in a different way to the same people: A very useful way to validate information is to ask the same question to the same people in a variety of different ways. Focus on quality of map rather than quantity of coverage: Whether adopting process mapping for efficiency improvement or risk management, process maps take time to develop. Quality of analysis comes from spending time analysing correct maps. Allow sufficient time and resources to develop quality process maps. Consider total process time against the sum of the time for individual components: Validate the time of individual components by comparing the total of individual process times against the time for individual components. Note that process times may differ according to the specific nature of the transaction or the time of the month, or year. Perform observation at two sites: Perform observations / discussions at two representative branch sites where possible. This helps to establish where processes are likely to differ and/or ensures that the process being documented has been fully captured. Ensure external review: An external review should be carried out when the maps have been drawn, but before they have been finalized. The review does not have to be conducted by someone who knows the individual process, but ideally someone who is used to reading process maps should review it. Ask to see documentation: For some processes, such as loan applications, reviewing documentation such as loan files is especially important. This review can quickly enable you to see the extent to which the process has been applied as described. Review within the institution: Once the process map has been defined, internal audit can and should use it in their auditing, to ensure that the process are adhered to or amended as appropriate.

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7. Analyse process map brainstorming stage 1 where the map is analysed for risks and process improvement and fine-tune map: Constructing a process map is a learning experience, but getting bogged down in the construction could well result in losing sight of the chief purpose of mapping: analysis. Once a process map has been completed, it should be determined as to what the map is indicating about how to meet the goals of the project. The analysis, however, should not be constrained by the stated objectives. The map may reveal other conditionsnot apparent when the objectives were formulatedthat the MFI needs to address. Advantage must be taken of any secondary benefits of the mapping process. Suppose, for example, the mapping objective is to understand the savings-deposit process in order to train new cashiers. If the resulting map also identifies a delay in the savings-deposit process, bringing the problem to the attention of a supervisor may result in an unanticipated improvement of customer service, as well as a better training program.
Analysing Process Improvements 1. Look for: Non-value added steps, excessive handovers and task specialization Process inefficiencies such delays, rework, rejects, etc. Managing Risk Analysis 1. Look for: Risks in the processes Assess risks in the systems as 2. Key questions What risks have actually been experienced in a particular process o How often is this risk experienced? o How serious was the risk being experienced? What has been done in the past to strengthen internal control and why? How has this process evolved and changed over time and why? What happens to the process when the computer system goes down?

Wide separation of decisions from work activity Frequently repeated steps Shared responsibility among several people and excessive control points such as numerous layers of approval

2. Question: What value does this activity add? Which stakeholder benefits? Does the client care enough to pay for it?

3. Take Action to: 3. Take Action to: Combine activities Run them in parallel rather than serial Complete them faster or with reduced labor costs through automation Eliminate activities that are not required Balance risk and control Include only the top four or five risks Prioritise risks Make risks relevant to the subprocess Review history of risk associated with that process

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8. Analysis of should be and could be maps: A closer look needs to be taken at the fine-tuned process map. There are three basic questions need to be answered: Can the process be further optimized? Are there still uncovered risks that need redesign? How can implementation be further enhanced?

Then, the map should be updated using feedback from analysis to reflect above with options of Should Be Map and Could Be Map and everything should be rechecked meticulously. This should be done whenever a modification is made to the map. The substantive modifications made should be clearly highlighted. The date and time of modification to the map should always be noted. The team that worked on the proof reading and modifications should be clearly identified. After all possible actions have been identified, the group should agree on a set of final action steps. A map should be prepared on how the process could look. Some of the solutions identified during the brainstorming session, while not feasible given current constraints, may become possible if those constraints are modified or removed. 9. Summarise findings and distribute to stakeholders: To ensure that maximum benefits are derived from the work, it is required to distribute the findings in a clear, well-organized form. The as-is and should/could be maps should be finalised and a summary of the problems noted and the recommendations to improve the process should be prepared. The summary should present, as clearly as possible, the benefits of implementing the recommendations. The inclusion of excessive detail about the process should be avoided in the summary; that information is provided in the maps. Thus, the key tasks in this step include the following: Task 1 Preparation of a summary process mapping document Task 2 Identifying and addressing challenges Task 3 Distribution to stakeholders

10. Implement with action plan pilot test, monitor and evaluate and roll out new process: It is important to finalise action steps with specific timelines including test period for implementing changes and monitoring/feedback from testing. Persons (names) responsible for test implementation should be identified. The process map should be updated, as and when required, using test implementation results. The pilot test changes should be monitored and evaluated and the feedback should be integrated to finalise process, its map and other documentation. After this, the process can be rolled out through an implementation plan that has specific timelines, people (specific names) and locations identified. However, completing process

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map does not mean rolling it out immediately. It is important to pilot test the new procedures. This should be done in a systematic manner using: Compose the Pilot Test Team: A pilot test team with a clear mandate and Terms of Reference giving the team the responsibility and resources for conducting the pilot test. o Identify persons (names) responsible for test implementation o Define their terms of reference o Ensure that they are given the time to prepare, con duct and assess the pilot test adequately Define the Objectives: Benchmark process times before the pilot test with targets for after revised procedures are implemented Develop the Protocol: o Identify the branch(es) where the pilot test will be run o Finalize action steps with specific timelines including: i. Test period for implementing changes; ii. Monitoring plan and iii. How the feedback from testing from will be used to further optimise the procedures Training the Relevant Staff: Ensure that the staff in the pilot test branches are o Appropriately trained both in the new procedures o Prepared to document the lessons learned Monitor the Pilot Test: o Review the implementation of the new procedures o Time the revised processes and compare the timings with the benchmarks o Examine opportunities to further improve the processes Update Process Maps, as required (using test implementation results).

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3.2

Steps in Mapping Processes

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References http://indiamicrofinance.com/credit-delivery-methodologies-microfinanceinstitutions.html Puhazhendhi, V. (1995): Transaction Costs of Lending to the Rural Poor: NonGovernmental Organisations and Self-Help Groups of the Poor as Intermediaries for Banks in India and APMAS, http://www.indg.in/socialsector/microfinance/microfinance-self-help-groups-SHG Coyle, L. G. (1930): Social Process in Organized Groups (New York) Andrews, J (2001): Group work's place in social work: a historical analysis", Journal of Sociology and Social Welfare (2001) http://findarticles.com/p/articles/mi_m0CYZ/is_4_28/ai_83530630 Middleman, R. & Goldberg, G (1988): Toward the quality of social group work practice. In Leiberman, et. al. Roots and New Frontiers in Social Group Work. New York: The Haworth Press, 233-242 Kropp, E.W and Suran, B.S. (2002): Linking Banks and Self Help Groups in India-An Assessment; Paper presented at the National Seminar on SHG-Bank Linkage, New Delhi Gine, X & Karlan, D. S. (2007): Group versus Individual Liability: A Field Experiment in the Philippines, The World Bank and National Science Foundation http://siteresources.worldbank.org/DEC/Resources/Group_Versus_Individual_Lia bility_May_07.pdf Aghion, B.A., Morduch. J (2000): Microfinance beyond group lending, Economics of Transition Besley, T. J. and S. Coate (1995): Group Lending, Repayment Incentives and Social Collateral, Journal of Development Economics Madajewicz, M. (2005): Capital for the Poor: The Effect of Wealth on the Optimal Credit Contract, Columbia University Working paper Morduch, J. (1999): The Microfinance Promise, Journal of Economic Literature Sadoulet, L. (2000): The Role of Mutual Insurance in Group Lending, ECARES/Free University of Brussels. Lehner, M (2009): Group Lending versus Individual Lending in Microfinance, a discussion paper, University of Munich Shakya, P (2010): Microfinance Summit, Nepal http://microfinancesummitnepal.org/Day%201%20Breakaway%203/Abstract%20%20Individual%20VS%20Group%20Lending-MIFAN.doc

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Module 4 : Individual Lending in Microfinance

Objectives 1. 2. The present module intends to develop an understanding among the participants about individual lending in microfinance. This module also provides a detail explanation of the processes of individual lending in microfinance. It also details out the merits and demerits of individual lending in microfinance.

Sessions covered: 1. 2. 3. Introduction to individual lendingusage, need and significance Understanding client graduation systemissues and challenges Steps of efficient individual lending process

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Section 1 : Individual Lending: Definition, Usage and Significance 1.1 Definitions

Individual Lending (IL) is defined as the process of providing credit to one customer, thereby not requiring other group members to serve as guarantors, but rather to base loan eligibility on a customer character assessment and cash flow analysis. Ledgerwood (1999) defines individual lending in microfinance as the provision of credit to individuals who are not members of a group that is jointly responsible for loan repayment. Karlan and Goldberg (2007) also share the same views about individual lending as the provision of microfinance services to individuals instead of groups. However, they also emphasised on the challenges related to distinguishing traditional banking and providing individual services in microfinance as both of them have similar forms especially in lending cases where a microfinance service provider require collateral or similar substitutes from the potential customers. The Bank Rayat in Indonesia and ADEMI in the Dominican Republic (an ACCION affiliate) are institutions that have adopted this approach successfully. 1.2 Characteristics

In fact these definitions also bring out the characteristics of individual lending in microfinance i.e. lending to individuals only, individuals responsibility of repaying the loans, loan products are suitably tailored according to the needs and business viability, requirement of collateral or co-signers, past credit history, performance and references. A study in Bolivia highlights some of the characteristics of individual lending. It goes on saying that the principal characteristic of individual lending in microfinance is an individual guarantee, which allows the customers to formulate their own business plan in accordance with the business activity in which they are involved. This method provides an alternative for those micro-entrepreneurs who either do not want to or cannot participate under solidarity credit schemes, and whose only funding alternative is through informal mechanisms. This technology is also used for those entrepreneurs who normally need larger amounts of credit than those granted through solidarity groups, and are able to provide other guarantees (Funda-Pro). Effective individual lending models across the world have the following characteristics: guarantees of loans by a co-signer or through collateral, screening of borrowers by credit check/character reference, fitting loan size to business needs, increasing loan size over time, average loan amount larger than group loans, close personal relationship with individual customers, frequent, close contact with individual customers, long period of time spent with individual customers, loans largely for production (Babu and Singh, 2007). While taking into account microfinance customer preferences and loyalty, Churchill notes down some significant characteristics of individual lending product (especially for the customer who graduates to individual lending) such as history of repeat borrowing, shorter loan applications, less work for conducting on site business evaluations for each loan, and less stringent due diligence (Churchill, 2000).

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Referring to the discussions above, one can deduce certain prominent features of the individual lending model of microfinance, which are listed hereunder: Each loan is specifically tailored to the individual and business involved. Personal history with regard to past repayment performances of the customer is taken into consideration for lending to the customers. Viability of business is also tested before lending money to an individual. Collateral or collateral substitute such as co-guarantor/co-signer is often sought from the service provider. Relationship between the service provider and the customer for individual lending is personal in nature. Successful individual transactions. lending relationships often result in repeated

Successful individual micro-lending programs are usually highly modified variants of systems employed by commercial banks. Difference between Individual and Group Lending Methods of Microfinance

1.3

Womens World Banking, a leading institution in supporting microfinance interventions across the world, has differentiated the group and individual lending methodologies.
Group Lending Individual Lending

Highly standardised loan products and Detailed assessment of customers financial processes and economic information gathered and analysed by the loan officer Limited loan assessment and management Loan decisions are individually tailored on the part of the institution based on the specific needs of each applicant Loan screening, monitoring and enforcement issues are managed in large part by group members themselves driven by peer pressure mechanisms Responsibility for the screening, monitoring and enforcement of loans rests in the hands of loan staff and their managers

WWB has also detailed out differences between the process and systems in group and individual lending in its manual on individual lending.

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Processes and systems Screening character check

Group Lending

Individual Lending

and Focus on forming groups and self Individual character and selection of members by the credit history is verified potential clients before giving credit Involves assessment of capital, experience, skills human Assets, business and person financial history are assessed Repayment capacity is assessed on the basis of financial analysis of income from business and households

Capital assessment

Repayment capacity

Assessment of repayment capacity depends upon joint liability of members leading to standardised loans

Loan follow up and Primary responsibility of loan Loan officer is responsible arrears monitoring repayment rests with group for close tracking of members jointly, field staff plays a portfolio secondary role Enforcement: collateral incentives Transaction costs Group guarantee, peer pressure Assets as and and compulsory savings collaterals/guarantors are required for taking loan Likely to be lower as group selection and collection rests mostly with group members and economies of scale Likely to be higher as it involves additional costs of identification, assessment and personalised services

1.4

Usage and Significance

Typically individual lending in the microfinance sector is an outcome of customer graduation process i.e. a customer moving up in the ladder of its loan cycle usually from a group lending process to access individual loans. Individual loans are possible only when a customer shows a good repayment track record in group loans, needing higher credit volumes and has a stable business/ source of income (including the organisations willingness to introduce individual loan product). From an organisational perspective, it is monetarily beneficial to explore individual loans in microfinance. For example new customers are expensive to find and serve. An analysis of six MFIs in Latin America estimated that the average cost of attracting new customers is about one-fifth of the total unit loan cost. In addition to this, considerable amount of resources of microfinance service providers go into preparing and educating new customers. Take another example of completing documentation formalities such as filling up the application forms, drawing a cash flow statement, and physical verification of business etc may take significant amount of organisational time and resources (Churchill, 2000).

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An organisation or a microfinance service provider introduces individual lending in its product suite because of the some or all of following reasons (mentioned below), but the list is not comprehensive. To provide services addressing the needs and preferences of customers with good track record and growth orientation To cater to the mature customers who have improved their economic status To save the time and effort of the mature customers who have graduated well over a period of time. To cater to the needs of the market by providing services to the enterprise segments historically unbanked by evaluating repayment ability using cash flow based analysis as the predominant way to determine creditworthiness To improve customer retention rate (for mature customers dropping out due to the problems in group lending methodology) To diversify the risks associated with credit risks in group lending It reduces the cost of transactions for both the customers and the service provider To help the service provider in increasing the volume of services which can further improve the sustainability of the organisation

If we take into consideration the above mentioned drivers of individual lending, it appears logically that satisfying customers/ customers is a crucial aspect. Churchill also stresses on enhancing customer loyalty as the most important business strategy of a microfinance institution (Churchill, 2000). However it is important to consider the caveats associated with the individual lending. For example, there can be social, geographical, psychological, economic or legal restrictions in accessing microfinance services individually. For instance, a study of Sinapi Aba Trust (SAT) in Ghana highlighted a number of barriers to customers graduation to individual loans. First, solidarity group customers cited insufficient capital and lack of assets as the primary constraints to business growth. Second, small loan sizes didn't allow them to make lump sum investments - and SAT's rules even prohibited them from using their loans to buy needed business assets (GDRC country informationGhana). The Human Development Report of Pakistan (1998) points out that individual based lending can "perpetuate and reinforce the existing socioeconomic inequities and access to scarce financial resources" (UNDP, 1998). Geography also plays an important role in deciding the model of providing individualised services. Say if a customer needs to visit a branch in order to obtain financial services and if such facilities are not closely located where s/he lives, it might be a hurdle because the services will have a cost to pay for. Documentation and other formalities (legal or organisational) may also be a limiting factor for the potential customers e.g. producing the necessary documents
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(identification, proof of residence etc.), or collateral etc (Sderbom, 2009). The legal environment in the country might also play a significant role in promoting individual lending to the customers like licensing requirements for the institutions to provide microfinance services to individuals. Despite of these limiting factors, there are several benefits of individual lending in microfinance both for the customers and for the service providers. This is probably the reason why organisations and countries have adopted using lending to individuals in microfinance. Some of the merits of individual lending are given below:
Table 1: Merits of Individual Lending Customers perspective Service providers perspective

Less reliance on group members. Group Reduces loan risk through a diversified liability is more costly for customers who portfolio are good because they are often required to repay loans of their peers Immunity from bad members/defaulters Can potentially attract more customers loyal

Offers the opportunity to take larger Mature, high performing and volumes of loans customers can be served better

Loans are often less costly for the customer Rigorous customer assessment procedures because of rigorous customer assessment

1.5

Understanding Challenges

Customer

Graduation

System:

Issues

and

Experience across the globe suggests that most of the microfinance service providers which are into individual lending, have graduated their group lending system to individual lending because of many key drivers that have already been discussed in the previous sections. However, this graduation system involves both the parties i.e. the customer as well as the organisation, into the process of change. The graduation system is an organic process which is bound to happen once the business passes through a particular phase. This organic process is visible in the businesses of the customers with good repayment records and viable business or growing businesses and also in the needs of the microfinance service provider to reduce its costs and expand its business. The graduation system is a result of loyalty of both the parties, or in other words we can say that service provider takes advantage of the loyalty of the customer vis--vis customer taking advantage of being associated for a long term with the service provider. Lets understand how a customer enters into microfinance and her/his process of graduating in microfinance. As like all the human being, the poor have same needs. Maslow has categorised these needs in the following orderphysiological, security, social, esteem and self actualisation. The physiological needs comprise of basic needs of the human being which are necessary for his existence. Personal, financial, health and well being are some of the security needs which form a core part of human life. On the other hand,
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social needs are required for bringing a feeling of belongingness and acceptance in the human beings. Esteem needs are draws an element of self respect and mutual respect from the previous needs, which helps the individuals to overcome weaknesses and inferiority complex. The self actualisation stage makes an individual realise his full potential and achieve the desired goals. Putting Maslows need theory into practice, we would find many requirements of the people to be met by finance. And so does the case with poor. For example to meet even the basic physiological needsfood, shelter and clothing, one needs to have money. Money can be earned by getting engaged into productive work that means one has to have some source of income. It could be in the form of fixed income like from salary, wages or investments or variable from running a business or doing casual/seasonal work. In fact there are several life cycle needs such as social customs, working capital, education of children etc where a person requires money to meet the obligations. Since the poor do not have much to offer to prove their worth, microfinance through group lending come into play as it takes into account the intangibles available with the poor. This is social collateral which can be in the form of group guarantee for loan repayment. Later on when the poor receives money to invest in her/his business there are ample opportunity to increase its income flow.

Monitoring and Evaluation

Planning

Individual Lending Process

Programme Implementation Designing and Testing a Product

However, after a certain period of time, when the person (only a few members are good entrepreneurs from the group and not all) starts earning profits in the business, then her/his needs for additional money (capital) grows. It might be for extending the business activity or planning a new vertical in the business or in fact planning a new business. There are many other reasons for which the financing requirement would be high, but the focal point of discussion here is increasing business
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requirements of an individual. Since as discussed above the group methodology of microfinance has its own set of restrictions on amount to be lent and adhering to strict procedures and rules, it might possible that an individuals growing requirements could not be met by this method. Here comes individual lending in picture. This is because the customers needs change over a period of time and the service provider too acquires a deep knowledge about customers financial history.

Section 2 : Steps of Efficient Individual Lending Process Lending to individuals is a complex process as it requires an in depth understanding of the customers requirements and customers ability to repay. It starts with planning and organising by an institution, passes through designing of the product, its testing and roll out and finally to setting up a strong monitoring and controlling system. The entire process of implementing a successful individual lending may vary from organisation to organisation depending on many factors like organisational strengths, resources and market scenario. Given below are the steps of the individual lending process, though the same is not comprehensive. Modifications and adaptations vary from organisation to organisation, region to region, considering various factors. 2.1 Planning

Planning implies looking ahead and chalking out future courses of action. According to Koontz & ODonell, Planning is deciding in advance what to do, how to do and who is to do it. Planning bridges the gap between where we are to, where we want to go. It makes possible things to occur which would not otherwise occur. Urwick termed it as a mental predisposition of getting thing done in an orderly manner. Planning is deciding best alternative among others to perform different managerial functions in order to achieve predetermined goals. The first step in an individual lending process is putting together different thoughts in order. Planning gives a base to concretise the thoughts, putting things in perspective and define the scope and requirements. Basically planning in individual lending involves undertaking research and designing strategies to create a detailed plan of action. Planning aims at defining the scope and requirements of the microfinance individual lending programme by analysing various factors such as market demands, supply constraints, target customer etc assessing the impact of the proposed change on institutional mission, vision, strategies, culture, structures and processes examining the preparedness in the organisation chalking out detailed action plan for introducing individual lending like team building, leadership development, process designing and setting and implementation plan

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2.2

Designing and Testing a Product

Product development process occupies a significant position in the life cycle of any organisation. Microfinance Institutions have not been an exception to this, despite of huge demand from the customers. It starts with conceiving an idea for a new product, passing through the stages of evaluating the idea, background preparation for its designing and development, prototype design, pilot testing and finally ends with its launch and subsequent feedback cycles. This process aims at researching the markets for supplementing the information and understanding about the market, competition and the potential customers during the planning process designing a product prototype designing the process of delivery or the systems through which the programme can be implemented (explained in detail in later sections of this module) building institutional capacities on various aspects required before implementing the product

A more detailed account of this section is available on the Product Development Module. However, a model of the process of lending to individuals is given above.
Table 1: Model Individual Lending Process Process New Customer Introduction Sub Processes First contact with the customer Verification of eligibility criteria Supply of information to the customer Application process Obtaining personal and business information about the customer Application review with other senior colleagues

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Table 1: Model Individual Lending Process Process Loan Appraisal/ Screening Loan Approval Disbursements Monitoring and Evaluations Sub Processes Site visits to household and business of the applicant Review of collaterals External checks and references Loan appraisal and cashflow assessment Review by senior Information entry in MIS Review of the case by credit committee Verification of repayment capacities and business viability Decision of the credit committee communicated to the branch staff Loan documentation including contract preparations, supporting documentation etc Review of documentation by the branch manager and signature on disbursement request Regular repayments by the customer on a specified date and through appropriate/ agreed mechanisms Monitoring and follow up of the customer after disbursal Arrears monitoring and review Action on defaults Reporting (MIS)

Repayments

2.3

Programme Implementation

Once the product is successfully tested in the market, the actual process of implementing individual lending comes into the picture. The process involves rolling out of the product across the branches followed by further expansion plans. The goals of this process are developing a strategy for replication and standardisation of the product and processes across the branches and units designing marketing plans and strategies for growth in the portfolio of individual lending product in the organisation planning and budgeting for the further expansion

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managing growth by reducing the costs, bringing efficiency in the processes and systems, building capacities of the individuals and strengthening the existing channels of delivery and data management

2.4

Monitoring and Evaluation

Monitoring and evaluation plays a crucial role in identifying and bridging gaps and challenges in the system and processes of any programme. Monitoring can be defined as systematic, regular collection, and occasional analysis of the information to identify and possibly measure changes over a period of time, whereas evaluation is a process of making a judgement about the direction, effectiveness, progress and impact of an activity. This process provides feedback on the gaps and challenges in the plan which is being implemented in the field. The process aims at documenting the results and outcomes of the programme implementation conducting variance analysis of planned versus achieved results reshaping the programme in the light of changes or modifications required going back to step one again if required

Section 3 : Institutional Risks in Individual Lending for Microfinance Institutions Like any other programme, individual lending in microfinance institutions fraught with many risks. These risks arise out of some of the basic prerequisites for an individual lending programme which include, but not limited to: Comprehensive understanding about the market, customers and institutional capacity Trained and prepared human resources especially the field (frontline) staff Ability to analyse and prepare a cash flow statement of the customer Effective MIS/Reporting

Risks can be divided into three major categories viz. ecosystem risks, institutional risks and product risks. Usually the ecosystem risk comprises of the risks emanating from the external factors which can negatively impact the programme of an institution. Institutional risks includes the risks directly associated with the programme and portfolio of an institution and can impede the operations of the programme sooner than later. Product risks are generally associated with the products of an institution and can hamper the introduction, launch or roll out of the product. These risks are discussed in detail in another module Delinquency Management. However, the institutional risks which directly impacts the programme more often is discussed here in context to individual lending.
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The institutional risks can be divided into the following categories: (cases and reading materials on operations and credit risks can be given here).
Risk category Credit risks Description of the Institutional Risk Credit risk is directly related to the portfolio of the organisation. Since the loan portfolio holds the most significant portion of the asset of a service provider, the credit risks impact the organisational functioning rapidly. In addition, the portfolio of the institution depends upon the external borrowing at market rates, capital of the institution, profits reinvested and in some cases savings mobilised from the clients, which can impede the sustainability severely in case if the service provider is not able to meet its financial obligations. Credit risk is simply the possibility of the adverse condition in which the clients does not pay back the loan amount. In individual lending the credit risk is high and entails a significant cost to the microfinance service provider. Credit risk emanates from internal as well as external factors. GTZ has classified credit risk into two broad categories: Transaction risk is directly related to transactions of a microfinance institution with an individual borrower. A borrower may not be trustworthy and capable of repaying loan which will result in loss of loan. This risk also includes wilful defaults, business failure. Portfolio risk is related to factors resulting in loss of portfolio due to external risks like political, communal, failure of an industry /trade, etc. The risks which directly impact the operational processes and systems are termed as operational risks. The Basel Committee on Banking Supervision defines operational risk as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. In the simplest definition, this is risk of loss that arises directly from service or product delivery, resulting from human or systems errors. It is a risk that arises on a daily basis as transactions are processed. Operational risk transcends all divisions and products of a financial institution. This includes the potential that inadequate information systems, operational problems, unforeseen external events, or breaches of contracts (including fraud) that result in unexpected losses. Risks associated with human resources, governance, and information technology is included in this category (US Federal Reserve Bank). For microfinance service providers engaged in individual lending, the operational risks is important as it entails use of human and technological resources. The operational risks includes errors or frauds or misappropriations by human systems in the organisation, lack of standardisation in processes leading to process delays/ inconsistencies, cash management issues, lack of strong internal control and monitoring systems, issues in reporting mechanisms and systems like software updates, irregular updation of records, problems in data entry or MIS, and loss due to natural calamities like fire or riots or theft etc. A web based forum India Microfinance categorised risks into the following five categories each with an example: Human risks: Errors, frauds, collections, animosity 97

Operational risks

Risk category

Description of the Institutional Risk Process risks: Lack of clear procedures on operations suchg as disbursements, repayments, day to day matters, accounting, data recording and reporting, cash handling, auditing System and technology risks: Failure of software, computers, power failures Relationship risk: Client dissatisfaction, dropouts, loss to competitions, poor products Asset loss and operational failure due to external events: Loss of property and other assets or loss of work due to natural disaster, fires, robberies, thefts, riots etc

Strategic risks

Strategic risks are the risks which emanate from the adverse or poor decisions/ implementation by an organisation. Strategic risks include compatibility of the organisations strategic goals, its alignment with the business strategies, resources allocated and management capacities to take forward the decisions. Individual lending programmes can be hampered by adverse strategy like pitching in an area which is already delinquency, lack of knowledge and understanding of the market and the competitors, collection policies of loans etc. Liquidity risk is emerges from the bad strategic planning about managing cashflows of an organisation or lack of fund supply or losses in the programme. It is the risk of loss arising from the possibility that the MFI may not have sufficient funds to meet its obligations or be unable to access adequate funding. Since individual lending programmes require high volume of on lending funds, it is important for a service provider to make decisions which can lead to effective and efficient liquidity in the system. Else there are high chances of delinquency in the area or organisation going bankrupt in the long run. Lack of good governance and ownership can destroy a well running programme. Sometimes, these risks come as a natural extension of switching to a programme especially a new one. For example entrance of a microfinance institution in individual lending or from switching from group lending to individual lending. Some of the risks associated with ownership and governance are low calibre of boards, conflicts of interest among directors and executives, and a lack of independence and accountability (Lascelles and Mendelsons: 2009). Legal and compliance risks arise out of the failure to follow relevant legal and regulatory requirements. Violation of or non-conformance with laws, rules, regulations, prescribed practices, or ethical standards in a region fall under his category. The costs of non conformance to norms, rules, regulations or laws range from fines and lawsuits to the voiding of contracts, loss of reputation or business opportunities, or shut-down by the regulatory authorities (GTZ, 2000). There are other issues like transformation issues which needs following up of stringent regulatory norms. Individual lending as a product may be introduced in an organisation, but it is important to study the rules and norms of associated with individual lending. In some countries like India, there are restrictions on loan amount given under microfinance.

Liquidity risks

Ownership and governance risks

Legal compliance risks

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Section 4 : Mechanisms of Mitigating Institutional Risks in Individual Lending The above mentioned risks can be classified also on the basis of occurrence and impact i.e. probability of occurrence and impact on the institution. The matrix below is divided into high and low axis. There are certain risks which have low chances of occurrence but have a very high impact on the institutional functioning. Some of the operational risks fall under this category. Then there are risks with low chances of occurrence having a low impact on the organisation like counting clerical errors. There are risks which have low impact but there are high probabilities of occurrence of such risks. Many operational and credit risks such as loan losses, small volume of frauds by field staff are examples of this category. In addition there are risks with the highest probability and high impact which impair the organisational functioning. These can be adverse selection of clients, loans in loss making sector etc. However, it is equally important to devise certain mechanisms to avoid occurrence of such events which lead to losses. The risk events can be dealt with comprehensive strategy depending on the impacts and frequencies of occurrence. A more detailed account of risks mitigation strategy is given the course module on Delinquency Management. Here only the problems related to collections of managing individual loans are discussed. Institutional risks can be mitigated through one or a combination of the following strategy:
Strategy Avoid Explanations There are certain risks which need to be avoided as over stretching the monitoring work may lead to increase in costs and volume of work in the organisation. For example counting errors by a staff while returning change to the clients. However, such needs should not be ignored, but a warning can be issued instead. Also choosing a particular area not for operations is an avoid strategy, which can be used if one knows the problems in the area. Transfer strategy is used to pass on the risks of loss to other parties. For example the probable loss of loans due to death of a client can easily be avoided by insuring the loan amount i.e. credit insurance. Accepting the risks is a strategy which requires acceptance of losses. This is invariably used when there are no other alternative available to tackle the situation. For example, strategic risks of entering into an area which hamper the payments of the loans. Many legal and compliance risks also fall under this category. Control strategy is a carefully designed tool to monitor and avoid risks in an institution. It requires careful identification of risks, prioritisation of those risks and finally designing strategy to tackle the risks in order to avoid losses.

Transfer

Accept

Control

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Problem loans in individual lending can be tackled through an appropriate mix of strategies especially the control strategies. As the saying goes prevention is better that cure, it is always advisable to continuously assess the risks and try to nip the problems in the bud itself. An efficient risk manager undertakes following steps regularly to prevent the possible risk occurrence. Designing and using appropriate lending practices Regular implementation of exhaustive due diligence Thorough examination of repayment capacities of the client and sanctioning of appropriate loans Regular and close monitoring of the loans systems and processes Continuous assessment of internal and external environment including market forces Taking stock of the risks events in team/board meetings

Once the risk manager identifies any risks, s/he should take following action: Noting down the problem events/ risks Prioritising the risks Conducting risk analysis (sample in the box) Designing appropriate strategies

Taking appropriate action at the right time can avoid various types of risks to the organisation. It is imperative to the long term sustainability of any programme whether it is individual lending or group lending. We will discuss the details of managing problems in lending in the next module on Delinquency Management. However, a sample of analysing risk events through a matrix is given below:
Table 2: Risk Analysis S. Risk Event Probability Impact Risk Driver No. 1 Loss of major funding source Low High Lack of proper implementation of program Lack of proper follow up on processes, Less internal control mechanisms, unsuitable products

Mitigation Strategy CONTROL New Proposal, contact donors CONTROL, Recovery of loans (incentives or stoppage of loans)

Risk Owner Executive Director Chief Operations Officers, Policies ED and Board

Delinquency High exceeded

High

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This matrix can be used for thoroughly analysing the risks, designing an appropriate plan of action and assigning responsibility to tackle delinquency.

Summing Up Individual lending in microfinance has become a popular model in many countries. Many countries have witnessed expansion in portfolios of some of the microfinance service provider. For instance, Association for Social Advancement (ASA) in Bangladesh or the Bank Rakyat Indonesia (BRI) have expanded rapidly using individual liability loans. BancoSol in Bolivia has converted a large share of its group lending portfolio into individual lending. In fact some of the institutions have also experimented with little variations in the group lending models like keeping the group as it is while liability of repayments rests with the individuals. This shift has occurred because of the learning which has been gained over the years about the drawbacks of the group lending model of microfinance (Gin and Karlan: 2007). However, as like other models, individual lending is also not free from risks. One needs to understand the systems and processes of lending to individuals thoroughly. There are inherent systemic risks attached with the individual lending model and more often than not these risks impact the entire functioning of the organisation. A cautious service provider needs to consider these issues before entering into individual lending.

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References Ledgerwood, J. (1999): Microfinance handbookAn institutional and financial perspective, The World Bank, Washington, D.C. Karlan, D. and Glodberg, N. (2007): Impact Assessment for Microfinance, Poverty Reduction and Economic Management, The World Bank (No. 7) Funda-Pro (N/A): The Development of Microfinance in Bolivia, La Paz, Bolivia http://www.gdrc.org/icm/country/bolivia.pdf Babu, S. and Singh A. (2007): The need for individual lending in mature MFIs, Centre for Microfinance, IFMR, India http://www.ifmr.ac.in/cmf/eomf4needforindividual.html Churchill, C. (2000): Banking on Customer Loyalty, Journal of Microfinance, Vol.2 No.2, Fall 2000 Dellien, H., Burnett, J., Gincherman, A., and Lynch, E. (2005): Product Diversification in Microfinance: Introducing Individual Lending, Womens World Banking Dellien, H. and Leland, O. (2006): Introducing individual lending, Womens World Banking Adapted from MicroSave, A Toolkit on Individual Lending for Microfinance Institutions ibid Churchill, C. (2000): Banking on Customer Loyalty, Journal of Microfinance, Vol.2 No.2, Fall 2000 ibid Churchill, C. (2000): Banking on Customer Loyalty, Journal of Microfinance, Vol.2 No.2, Fall 2000 Kuhn, L. F. (2004): Chipping away at the glass ceiling: Identifying and overcoming obstacles to business expansion for women, Opportunity International (http://www.gdrc.org/icm/country/africa-ghana.html) UNDP (1998): Human Development in South Asia 1998, Islamabad, Oxford University Press. Sderbom, M (2009): Advanced Development Economics: Credit and microfinance, 22 October 2009 http://www.soderbom.net/microfinance_final.pdf Reference taken from the Delinquency Management Toolkit, MicroSave, India http://indiamicrofinance.com/microfinance-risks-operational-risk-part-2.html Lascelles, D. and Mendelsons, S. (2009): Microfinance Banana Skins, Confronting Crisis and Challenges, Centre for Study of Financial Innovation, UK GTZ (2000): A Risk Management Framework for Microfinance Institutions, Prepared by Microfiannce Network and Shorebank Advisory Services, Financial Systems Development and Banking Services, Deutsche Gesellschaft fr Technische Zusammenarbeit (GTZ) Sinha, G. (2010): Adapted from the Risks in MicrofinanceSupervisory Concerns, Presentation at the Bankers Institute of Rural Development, India Gine, X & Karlan, D. S. (2007): Group versus Individual Liability: A Field Experiment in the Philippines, The World Bank and National Science Foundation.
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Module 5 : Risk Management in Micro Finance

Objectives : The module introduces the participants about : The various kinds of Risk a Financial Institution is exposed to Credit Risk Operational Risk Market Risk Interest Rate Risk Liquidity Risk

Following sessions are based on the reading material given in this module: 1. Risk Management: Identification, Measurement and Mitigation 2. Credit Risk Accounting and Market Based Models 3. Credit Risk: Loan Pricing, Provisioning, Loan Accounting, Capital Adequacy

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Section 1 : Types of risks faced by Microfinance Institutions There are number of risks that an MFI has to face these risks could be of delinquencies, frauds, staff turnover, interest rate changes, liquidity, regulatory etc. But all these risks can broadly be classified into four major categories; 1. 2. 3. 4. Credit risk Operational risk Market risk and Strategic risk

Of the above four categories Credit risk and Market risk are directly of financial nature and hence are called Financial risks while Operational risk and Strategic risk are of non-financial character and result mainly from human errors, system failures, frauds, natural disasters or through regulatory environment, weak board, poor strategy, etc. However, it must be remembered that operational and strategic risk, as and when materialize will also translate into financial losses for the organisation.

1.1

Credit Risk

Credit risk is directly related to the portfolio of the organistion and is one of the most significant risks from an MFI perspective. Whenever an MFI lends to a client there is an inherent risk of money not coming back, i.e. the client turning into a defaulter, this risk is called the Credit risk. Credit risk is simply the possibility of the adverse condition in which the clients does not pay back the loan amount. Credit risk is the most common risk for the MFI. The risk is of greater significance for MFIs as it has to deal with large number of clients with limited literacy. Further, MFI provides unsecured loans, i.e. loans without any collateral. In case a client default the MFI does not have any asset to meet its loss, which makes the credit even riskier. MFIs fund their portfolio through external borrowings, through their own capital and through client savings that the MFI has mobilized. By giving a loan, an MFI also attracts risk to these sources of funds. It is therefore said that an MFI deals in public funds, acquired through banks, clients savings or through donors who trust the MFI to carry out its activities effectively. If an MFI loses money it may not be in a position to meet its own financial obligations to its depositors or lenders thereby becoming a defaulter itself. This results in loss of confidence of the funders and the direct financial loss for the MFI as the organisation loses not only interest but also its principal amount. We have discussed why risk is inherent to the financial activities that financial institutions undertake. MFIs can neither afford to be too conservative on their lending as it will restrict their growth nor can they be over enthusiastic which will result in losses. Hence, an MFI need to have effective risk management system to have reasonable growth without letting the risk cross the thresholds of acceptable
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limits. Credit risk emanates from internal as well as external factors. GTZ, a German development agency with a strong financial sector department, in its Risk Management Framework has classified Credit risk into two broad categories. a. Transaction risk: which is related to the individual borrower with which the MFI is transacting. A borrower may not be trustworthy and capable of repaying loan which will result in loss of loan. All loss of loan related to delinquency of individual clients which can be because clients migration, willful defaulting, business failure etc is called transaction risk. b. Portfolio risk: Portfolio risk is related to factors, which can result in loss in a particular class or segment of portfolio. For example an MFI may lose a portfolio with a particular community, locality or a particular trade due to some external reasons. These reasons could be political, communal, failure of an industry /trade, etc.

1.2

Indicators of Credit Risk

Although credit risk is inherent to all loan of the MFI, it materializes in the loans which start showing overdues. An amount is called overdue if it is not received by the MFI on its scheduled time. Every loan that an MFI provides have fixed schedule for repayment. This is called Repayment schedule, which provides the schedule of payment and acts as the reference point for the MFIs to estimate their overdues. At the time of loan disbursement every client is given a repayment schedule, which shows the amount to be paid in each installment and the date of payment. If the amount is not received on or before the schedule date it is called overdue. If any loan has any amount overdue it is termed as a Delinquent loan or a case of delinquency. MFIs try to have an objectives view of their credit risk and want to measure the extent of credit risk, which is the risk on their portfolio. There are various indicators, which help in measuring the credit risk profile of an MFI. Of these indicators portfolio at risk or commonly known as PAR is considered to be the most effective and is now very common indicator across MFIs. Apart from PAR, Repayment rate and Arrear rate are other ratios, which also provide information about the portfolio quality of an MFI. PAR; Portfolio at risk or PAR tries to measure the amount of loan outstanding that the MFI stands to lose in case an overdue client does not pay a single installment from the day of calculation of PAR. PAR is the proportion of loan with overdue clients to the total loan outstanding of the organization. PAR% = (Loan outstanding on overdue loans/Total loan outstanding of the MFI) x 100 PAR is further refined by MFIs to make it meaningful by including ageing in ilt. So MFIs often calculate PAR30, PAR 60, and PAR 90 etc. PAR30 means outstanding of all loans, which have overdues greater than 30 days as a proportion of total outstanding of the MFI, similarly PAR60 means outstanding of all loans, which have overdues greater than 60 days as a proportion of total outstanding of the MFI and so on and so forth. One thing noticeable here is that overdue amount is not used anywhere in the formula. Overdues are simply taken as indicators to identify risky
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loans. Loan outstanding is used in the formula, as it is the maximum amount an MFI stands to lose if a client defaults. For example an MFI has five clients, each has taken 10,000 loan and have to repay on monthly basis and loan term is 10 months. Therefore each month each one of them makes principal repayment of Rs 1,000. After five months of loan disbursement, it is necessary than 5 installments had to be paid which means each client should have paid back Rs 5,000 of principal amount. But say the actual repayment was as shown in the table below.
Clients 1 2 3 4 5 Total Disbursed 10,000 10,000 10,000 10,000 10,000 50,000 Due 5,000 5,000 5,000 5,000 5,000 25,000 Principal paid 2,000 3,000 5,000 4,000 5,000 19,000 6,000 1,000 Principal overdue 3,000 2,000 Principal Outstanding 8,000 7,000 5,000 6,000 5,000 31,000

To calculate PAR, we have to take the following steps; Identify loans with overdues; in the given example loan 1,2 and 4 have overdues Find outstanding on overdue loans and add; in example outstanding on overdue loans (1, 2 and 4) are 8,000 7,000 and 6,000. On adding them we get 21,000 Divide sum of outstanding of overdue loans by total outstanding

Arrear rate; Arrear rate is the principal overdue as a proportion of the total loan outstanding of the MFI. Arrear rate = (Total overdue/Total loan outstanding) x 100. In the given example it is Rs 6,000/Rs 31,000 = 19.35% This ratio tells the proportion of loan portfolio the MFI is currently losing, i.e. the principal amount that should have been recovered out of the total portfolio but has not been recovered. Repayments rate; Repayment rate on the other hand is the ratio of the amount received by the organization against the total amount due. Repayment rate;(( Total principal collection during a period prepayments)/Total amount due for the period) x 100

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Prepayments, if any have to be deducted from the collections, as this amount was not due for the period. Prepayment is the principal amount paid by clients before it was due. As mentioned earlier, all these ratios, MFIs and financial institutions lay maximum emphasis on PAR and consider it as the best indicator for risk. This is because PAR is a forward looking ratio and provides an estimate of the total loss that an MFI is likely to make should the risky clients default. While arrear rate and repayment rate only provide information of current loss and indicate the past performance. Arrear rate and repayment s rate are not able to capture the future risk.

1.3

Causes of High Credit Risk and Managing them

Now that we know that MFIs have to undertake the credit risk, the question is why different MFIs have different degrees of credit risk indicated by their different values of PAR? Even in the same geographic location with similar client profiles, different MFIs have different values of PAR, reflecting different degree of credit risk they are exposed to. This leads us to an important conclusion that the credit risk is a function of multiple variables of which client profile is only one. In fact risk emanates from reasons external to the organization such as client running away, any accident happening with the client migration, loss of business/crop etc and reasons internal to the organization such as MFIs policies, processes, systems and culture. Some of the major reasons for delinquencies observed in MFIs are discussed below. 1. Poor MIS MIS on loan outstanding, collection etc plays a critical role in generating reports and making them available in minimum time to the right people. If an MFI does not have a good MIS, it may not know how much to collect, it may not know its overdues or age-wise overdues. A with weak reporting system on overdue will result in delayed input on overdues to the top management and consequently result in delayed action by the top management. Sometimes weak MIS also results in generation of inaccurate report. If the correct and timely information is not generated and report the problem cannot be dealt with resulting in delinquencies getting aggravated. 2. Poor screening of borrowers Poor choice of clients results in delinquencies. If client with bad reputation or history of defaults are selected then it can result in delinquencies 3. Weak appraisal Poor or weak appraisal of loans is one of the major reasons for delinquencies. Before giving any loan, clients repaying capacity, status of business and cash flows must be assessed. This helps in taking loan decision that whether a client should be a given a loan and about appropriate volume of loan. Poor appraisal can lead to loans going to unworthy clients or disbursement of higher amount loans. Loans given beyond repaying capacity puts clients in stress situation as they do not have sufficient income to repay installments resulting in delinquencies. 4. Unclear communication about product and methodology- Clear communication of policies and procedures is very important. If the clients do not know the policies and procedures it can result in confusion and delinquencies even if clients are capable of paying
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5. No immediate follow-up MFI having strong overdue follow up system can control overdues to a large extent. It also gives clear message to the clients that the MFI is serious on repayments and thus prevents the future occurrences. MFIs which are weak in overdue follow up give a signal that it is not serious in overdue collection resulting other clients to imitate. Also if the overdues are immediately followed up the chances of recovery are quite high but if the case becomes old then the chances of recovery also goes down. 6. Mixing other social activities with micro-finance Sometimes delinquencies may also result if MFIs carry out grant based activities along with micro-finance with the same set of clients and with same staff. Mixing activities of two different nature confuses the client wherein one activity is being provided free while repayment is asked on micro-finance. This confuses the clients who may think that loans to be given to them may also be grants for them and they need not return it. Also enforcing repayments and discipline through a staff who is involved with the community in other social activities also will be very difficult and hence results in delinquencies. 7. Poor product Delinquencies occur if the product is not suitably designed. If the repayments do not match with the cashflow of the client then it may result in delinquencies. Client cashflow means that when do the clients receive income and when they need to spend. In agriculture economy, clients may need to spend during sowing season and hence need money. While they may receive income during harvest. Other important point is if the repayment period is too long or too short or frequency of payments and installments size are not well thought off, it can all lead to delinquencies. 8. Natural disasters Delinquencies can also happen as an aftermath of a natural dis aster such as flood, drought, earthquakes or epidemic. 9. Corruption Corruption at field staff level such as taking bribe for loans or frauds can result in delinquencies. A staff taking favor from clients cannot enforce discipline or strict repayments. If the staff is committing fraud it will also show up as delinquency. 10. De-motivated employees If the working conditions or incentive systems are not good, it will result in staff de-motivation and ultimately delinquencies. Motivated staff can make a lot of difference in enforcing policies in the field but of staff is demotivated then they will not put sufficient efforts to enforce polices with the clients resulting overdues. Thus we see that delinquencies do not occur, exclusively on account of client related reasons. Much of it can be attributed to internal systems and policies of the MFIs. It also means that if internal reasons related to the organization are taken care of then delinquencies can be controlled to a large extent. It is also important to understand why MFIs, investors and assessment agencies give so much importance to delinquencies and portfolio quality. This is one of the most (if not the most) critical parameter for investors and assessors to rate and MFI and taking lending decisions. This is because portfolio is the most o important asset for the MFI and the only or the main source of its income. Any problem with the portfolio can adversely affect the

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MFI in a number of ways. In the next section we will see what different affects delinquency can have on an MFI.

1.4

Impact of Delinquencies

Delinquencies adversely affect the MFI in many ways. We will see how delinquencies can result in multi-dimensional affect for an MFI. 1. Loss of portfolio for the MFI the major impact of delinquency is the loss of portfolio. The money given to a client by the MFI is lost if client defaults. MFI lends to clients and interests along with principal. However, default by client can result in even principal getting lost. 2. Loss of interest income if a client does not repay its loan then the MFI loses interest income as well. Interest is the main source of income for an MFI and loss of it directly impacts its profitability and sustainability. 3. Growth hampered -an MFI having overdues has to invest lot of its time and other resources in recovering the overdues. This diverts the focus of the MFI from expansion and growth to controlling the overdues thereby hampering its growth. 4. Cost escalation in order to recover overdues MFI has to spend its staff time on recovering overdues. Extra visits by staffs at various level also adds to travel costs. 5. De-motivated staff increase in overdues de-motivates the staff. Staffs of a branch having no overdues are zealous as they expand the operations, get incentives and promotions. While staffs associated with bad portfolio are mostly engaged in overdue recovery, growth is slow; staff does not get incentives and instead may be criticized for poor performance resulting in de-motivation. 6. Cash flow mismanagement MFI disburses new loans or meets its liabilities such as repayments of its owing to banks, through repayments that it receives from the field. If the repayments are timely then the MFI will not be able to collect enough cash from the field and hence will not be able to meet disbursement target or even pay back to its lenders. MFI plans its disbursements assuming certain amount of collection from the field but there are defaults then it disturbs these plans. This makes cash planning and fund management very difficult. 7. Loss credibility of the MFI an MFI suffering from delinquency may lose reputation and credibility with other peer MFIs, lenders and donors. Most of the investors put a lot of weightage on portfolio quality as it is the most important asset for the MFI and this is where the investors money will be utilized. Poor portfolio quality makes investors uninterested and fund raising becomes difficult. 8. Loss due to competition MFI struggling with delinquencies may lose out on completions with other MFIs. While good MFIs may focus on growth, experiment with new products and other service, the MFI struggling with overdues has to concentrate on recovering overdues. It may also lose out on its staff and clients as the MFI is not performing well.

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The above list of potential losses shows the multiple impacts or chain reaction delinquencies can spur. So we see that there is a lot to be lost if the credit risk is not proactively managed and contained within the acceptable limits.

Apart from the MFI itself, delinquencies also impacts those associated with it and otters as well. Some of the other impacts of delinquencies are; 1) Bad reputation to sector; Today micro finance has gained lot of important and recognition as it has proved that good recoveries are possible even from the poor clients. If delinquencies become rampant across MFIs, the sector will lose its creditability and recognition. Investors, government, researchers, etc. Will lose interest and the industry will die out. 2) Staff employability; Micro-finance has created a lot of jobs. It has created jobs for moderately educated people. We see that now micro-finance is a specialized field. The good staff who have performed well get ready employability with other agencies across the sector. They command higher salaries and an exciting career. However, staff associated with delinquencies and poor portfolio loses out on such opportunities. If staff is dismissed from an MFI because of delinquencies it may be difficult for him/her to find jobs at other places. Hence delinquencies can be harmful for the staff at all levels too at the personal level. 3) Loss of reputations of an area; Delinquency in a particular area can result in loss of reputations a locality or region. Many finance companies blacklist certain villages, areas or even districts because of delinquencies in those regions. So delinquencies of one MFI may result in even other MFIs not venturing in those areas and thus denying those areas of financial services.

1.5

Managing Credit Risk

Clarity of Vision We saw that delinquencies have wide spread impacts and are harmful not just for the MFI but also for others. It is therefore important to manage credit risk. In order keep credit risk under acceptable limits an MFI must have clarity on its business. From visions and missions statement to the fine policies for the day-to-day operations, everything they should be clearly said/written and documented to avoid any confusion. A clear mission statement gives the right direction to the organization and it does not mix up too many things creating confusion. Clear mission helps the MFI defining its path and where it wants to go. Lack of clarity in mission can result in loss of focus. Such an MFI may get involved in diverse activities, without knowledge of what it wants to achieve. Segregation of Business functions MFIs should also be aware that different interventions on the field would have impact on each other. It is therefore, important to maintain clear segregations among

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programmes of different natures. The social activities should be separate from microfinance and the community should not be confused with the two programmes. Product Designing Appropriate product designing can also curb credit risk to a significant extent. A poorly designed product puts stress on the client who may not be able to repay the amount. The products have to be designed suitable to the local livelihood context and general household cashflow of the target group. In general it is good to have frequent repayments as it maintains contacts with clients. If the frequently is too low it results in loss of contact with client and escalates the risk of delinquencies. The higher the frequency of repayments the better it is from risk perspective however the repayments has to match the cashflow of the client group. One may not go for a daily repayment if people do not earn on daily basis or do not have surplus cash on daily basis. But repayments not exceeding monthly are generally recommended. This means that at least one installment must be collected each month, a frequency of less than this can enhance risk. MIS The importance of a good MIS cannot be overemphasized. MIS collects data and transforms it into the information which can ensure decision making. MIS should be able to generate overdue information almost on a daily basis. This information should also be reported up to Head Office level in a timely manner. If information takes too long to reach the right people, it loses its importance. A strong MIS is very important from the perspective of controlling risk as unless someone knows about delinquency, one cannot take actions to manage it. A strong MIS is characterized by regular and focused record keeping and reporting system. Many people often confuse that a good MIS always means an elaborate software and computer driven system. A strong MIS may not necessarily mean big software. Many MFIs in India have grown to fairly large size with manual MIS and their manual MIS were very strong. A good MIS means a systematic and simple record keeping system, which can generate timely and accurate reports needed for decision making and making the information available to the right people at the right time. A simple and systematic record-keeping system could also be manual. It should be able to generate important reports such as on disbursements, collections, demand/due, overdue, prepayments and loan cycles. Any field staff going to field should know how much to collect from a group, how much are the overdues/prepayments. Branch Manager should have the information on disbursements and repayments, saving collections, number of clients, overdues, ageing etc. Similarly, Head Office should get details of all branches/units on disbursements, collections and number of borrowers without much time lag. If the information is not available in time then effective decision-making is not possible and thereby increasing risk. Internal Control System Delinquencies also occur on account of policies not being followed or misappropriations. Therefore, a strong internal control system is very important for any financial institution. MFIs deal in a lot of cash and hence without proper monitoring anyone in the system can try to take advantage. Regular monitoring by staffs at various levels as well as an independent internal audit at regular frequency
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can significantly control risk. We had earlier divided credit risk into two categories, transaction risk and portfolio risk. We will now discuss on management of these two categories of credit risk.

1.6

Managing Transaction Risk

Transaction risk is related to the individual borrower with which the MFI is transacting. A borrower may be trustworthy, holds good intentions to repay and may be capable of repaying loan or the borrower may not be trustworthy or capable of paying, which will result in loss of loan. All loss of loan related to delinquency of individual clients because of clients migration, willful defaulting, business failure, etc. is called Transaction risk. As transaction risk is related to individual clients, it has to be controlled by having right policies at various stages of loans. Transaction risk management starts from the first step of client selection. MFIs focus on selecting right clients who match their criteria. NFIs develop clear policies and procedures for client identification and selection. The staff at MFI has to be very clear on the process of client selection and group information. It has to be seen that clients who do not enjoy trust of the community or have dubious past do get into the system. Once the clients have been identified, the next step is of grouping formation. At the time of group formation it is extremely necessary that a proper training covering all aspects of the MFI and its products, procedures and other policy are clearly told to the clients. After the training it is also necessary to ensure that clients have understood all procedures and there is no confusion. If the policies of the organization are not clear it can lead to delinquencies in the future. MFIs have procedures of training the clients and then conducting a test to verify the clients understanding. Once the group has qualified the test the next step is of taking loan application and loan appraisal. It is the responsibility of the field staff to see that all information is filled according to the policies in the application form. These policies could be such as loan amount as per the cycle, loan purpose should be verify the group member should agree to the loan amount, past repayment history should be good, clients family income expenditure should be verified or any other policy that the MFI has. Apart from the loan application all other documentation has to be in order this may include taking client id, address and promissory notes. Once the application has been prepared it has to be appraised by a senior person. All loans have to be appraised according to the merit of the enterprise in which it is being invested. While appraising a loan application casflows, income of household and repaying capacity of the household has to be seen. Often it is seen that MFI instead of focusing on the cashflow from the enterprise in which loan is being invested: focus on the casflow of the entire family. The MFIs then access the household expenditures and based on that decide the final amount to be disbursed. Also past repayment history of the client is taken into consideration while taking loan decisions. Other parameters used in loan appraisal are feedback from peers, experience in business, permanent address of client and other loans if any from other sources. MFIs also take extra precautions while funding a new business; MFIs are more comfortable in lending in expansion of existing business rather than investment in a new business. Strong loan appraisal often controls the transaction risk to a large extent. After the appraisal, the case may be presented to a Credit
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Officer and Area Manager. Or sometimes it could be just branch level committee or committee composition can also change with the size of loan. This means that for loans above certain size credit committee could be at regional level rather than branch level or even head office level for very high loans. There is no fixed rule about the credit committee composition by the main idea is that every loan that is disbursed should be a very though out decision taking all potential risk aspects into consideration. For larger size loans particularly in individual loans, MFI may resort to taking some security such as personal guarantees, taking post-dated cheques or even some assets. These guarantees and securities also help in managing transaction risks. After disbursement of loan many MFIs also carry out loan utilization checks to see if the loan has been utilized for the purpose the loan has been given. Once the loan has been approved the disbursement has to take place strictly in accordance with the organization policies. MFIs have policies of disbursement through cheque or cash, disbursement to take place only at branch or lonely at group meetings, signatures of clients to be taken at the time of disbursement, issuing of passbook and issue of repayment schedule at the time of disbursement. Again a clear disbursement procedure can help in controlling frauds or corruption at the time of disbursement and can control transaction risk. After disbursement there have to be clear policies on collection and deposition of money. There are lots of delinquencies on account of unclear or weak collecting and money handling policies. A clear policy such as where collection should take place, how money has to be transferred and depositing money in bank can also help in controlling risk related to frauds and misappropriation. Transaction risks can be managed effectively with strong internal systems such overdue management system, strong management information system (MIS) as explained above. Strong overdue management system starts with having a good MIS. Once the information is made available the information is analyzed and decisions are taken. With availability of accurate information organization can manage its delinquencies effectively by framing clear policies on overdue management. Overdue management means what actions have to be taken by different levels in overdue situations. It is important to acknowledge here that field staffs can play a vital role in managing overdues as field staff is the first one to know whenever a delinquency occurs. Field staff who are well trained can manage the overdue situation well thereby cutting the transaction risk. Clear policies on overdue management will help the field staff in reacting to overdue situation in an appropriate manner. MFIs have policies of enforcing group pressure such as field staff may hold longer meeting to discuss overdue, can ask other members to pool in money. Field staff may call other colleagues, to visit client house etc. Pressure can also be applied by not disbursing fresh loan to a defaulting group or not increasing the loan size in the next cycle. It is important to act sensitive and knowledgeable here pressure to recover the loan can cause risks itself, e.g. devastating the community or driving the creditor to desperate actions which will not help anybody. The right way to manage collection i.e. manage the credit risk signaled by overdues depends on accurate assessment of the situation at hand. It is seen that MFI have developed appropriate e policies to handle overdues in different age class differently. For example, overdues above 30 days have to be
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followed up by Branch Manager along with the concerned field staff. Overdue above 60 days will be followed up by Area Manager, etc. Immediate response by the MFI to overdue situation and regular follow up is extremely important in cutting down credit risks as it gives strong signal to the clients that the MFI is very serious on overdues. If the MFI does not react to overdues then this may spread the overdue problems to other clients/groups who will start taking advantage of the weak credit culture of the organization.

1.7

Managing Portfolio Risk

Portfolio risk is related to factors, which can result in loss in a particular class or section of portfolio rather than an individual. For example an MFI may lose a portfolio with a particular community or a particular trade due to some external reasons. These reasons could be political, communal, failure of an industry/trade etc. Portfolio risks are low probability and high impact kind of risks, it is necessary for the MFIs to manage this risk as they can impact a large portfolio. For managing portfolio risk it is very important that MFI diversifies its portfolio. Funding/assessing agencies consider a concentrated portfolio as a big risk. The portfolio may be concentrated geographically or in a particular trade or with a particular group of people. Whenever the portfolio is concentrated over any parameter, it increases the risk. Failure or adversity with the particular parameter on which the portfolio is concentrated can seriously impact the MFI. If the portfolio of the organization is diversified geographically, or usage of loan it reduces the risk. For example if the 100% of portfolio of the organization is in agriculture in one or two blocks of a district then in case of drought or crop failure for any other reasons will impact 100% of MFIs. Similarly, if an MFI has a major proportion of its portfolio in a particular city then in any adverse situation such as bandh or riots will impact a major proportion of the MFIs portfolio. Therefore it is important that MFIs keep their portfolio diversified so that impact on a particular parameter will impact only limited proportion of the MFIs total portfolio. It is necessary that MFI has transparent policies on interest rates, fees, penalties and all other procedures. Clients should not feel that there are hidden charges or any other policy of exploit them. It is seen that if full transparency with clients is maintained it can reduce the risk of client dissatisfaction and sudden adverse reactions. It is important to maintain transparency from the ethical point of view as well. MFIs deal with vulnerable sections of the society; it is necessary for the MFIs to carry out business ethically. In order to control risk from any external entities such as administration, it is important to maintain relations with the other stakeholders such government agencies, local politicians. It is important to also inform about the MFI, its objectives and working methodology. Working in isolation may sometimes spread inaccurate information in the society or other stakeholders may not understand about the activities of the MFI, which can go negative for the organization. MFIs in order to control risk may adopt the strategy of avoiding or restricting the exposure. Some category of business, which are considered risky or certain locations which are risky because of reasons such as frequent occurrences of natural disaster
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or security issues, can be avoided by the MFI or even if it wants to work in such areas or with such business then exposure can be restricted to certain percent of the total portfolio. Credit risk is definitely the most common risk for the MFIs but the with the right policy framework, it can be kept under acceptable levels. But credit risk is not the only risk that MFIs face.

1.8

Operational Risk

Operational risk relates to the risks emanating from failure of internal systems, processes, technology and humans or from external factors such as natural disasters, fires, etc. Basel Committee on Banking Supervision defines operational risk as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. Earlier, any risk, which was not categorized, as credit risk or market risk was considered to be operational. However this was a vague definition of operational risk. As per the new definition strategic risk is not considered under Operational risk. Operational risk has gained a lot of importance over the years with increased used of technology and also recognition of importance of human resource in the success or failure of enterprises. Another facet of operational risk is that it cuts across all departments, as human resource and technology are central to all departments. Technological interventions are now something very perceptible in all walks of our life including in banking and finance. Today financial markets and banking has changed dramatically with lot of reliance on technologies such as ATM, e-banking, tele-banking, credit cards, etc. Secondly, over the years industries across world have recognized the importance of human resource. Human Resource departments within enterprises have gained a lot of importance. Companies now believe in investing g in employees, their capacity building, employee retention, benefits and perks. Salaries and other benefits in India have risen dramatically in the last one decade. This clearly shows that human resource is getting the due recognition and importance that it commands. To this larger change, micro-finance industry is no exception. Micro-finance has seen its own share of technological advancement. From use of computers for simple desk jobs to the use of advance software, introduction of swipe cards and biometric MFIs have witnessed changes in the IT usage. Strong internal processes, systems, good human resource and preparedness against external events are needed for managing the operational risk. Operational risk is enhance by increased dependence on technology, low human and business ethics, competition, weak internal systems, in particular weak internal controls.

1.9 a) b)

The Operational risks that an MFI faces can broadly be categorized into five categories. Human risks; Errors, frauds, collections, animosity. Process risks ; lack of clear procedures on operations such as disbursements, repayments, day to day matters, accounting, data recording and reporting, cash handling, auditing.
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c) d) e)

System and technology risks; failure software, computers, power failures. Relationship risk; client dissatisfaction, dropouts, loss to competitions, poor products. Asset loss and operational failure due to external events; loss of property and other assets or loss of work due to natural disaster, fires, robberies, thefts, riots etc.

Human Risks As we discussed earlier human resource plays a key role in success or failures of enterprises. An organization with good human resource can meet most challenges effectively whereas weak human resource enhances the operational risks. Human resource is a complex subject. The issue of keeping employees motivated and to encourage them to be honest and uphold integrity and values is something very subjective and does not have any unique solution. MFIs have to deal with large number of small loan clients and this requires them to keep more number of employees with diverse skill sets at various levels. These employees are expected to mange cash as well as records, which could be manual, or on computers. Managing these operations of the field with set of staff who have limited education qualification is a challenge of enhances operational risk. MFIs mostly transact in cash, which increases the probability of frauds, misappropriation either by employees or even by clients. Frauds consist of intentional embezzlements and misappropriations careered out by the staff or client of an MFI. Frauds may vary in degree and the extent of financial damage caused to the MFI. But irrespective of the size of fraud, it brings disrepute to the MFI and threaten the credibility of the organization. Frauds can be caused by simple embezzlement of the organizations money to more complex thefts and misappropriations in nature, which can go on unnoticed for a long period of time. Some of the most common frauds in MFIs are field staff taking bribes for loans, creating fake clients, misreporting information, fudging data and forgery. Most often it has been seen that frauds occurs a result of weak monitoring and audit systems. Staff or clients tend to take advantage of the gap between the senior officials and the field and hence manipulate the situation to their personal advantage. Similarly, an employee may commit loss to the organization by lack of knowledge, capacity or by error. Human errors can occur anytime at any place. There could be errors in record-keeping, data entry, accounting, MIS, etc. Generally, the field staff of MFI are people with limited education qualification or computer sills making them prone to such errors. Regular training of staff and careful monitoring are therefore very important in micro-finance institutions. Lack of training or monitoring escalates the operational risk due to errors, which are although unintentional but can nevertheless but can nevertheless bring loss to the organization. Humans can also be destructive sometimes. Employees against whom an action has been taken by the MFI may turn hostile and start working against the organization. They may spread rumors in the community, instigate people, may create problems in the working of the organization in field, may deliberately misreport data, etc.

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Process Risk Process is designed sequence of actions to be taken by different components of a system so that the system can work effectively. In simple terns it means the systematic actions to be taken as part of regular activities for accomplishing various functions. Lack of clearly defined process within an organization can result in confusion, conflicting g actions, duplicity of work resulting in loss of time and other resources. If an organization does not have clearly defined processes, different staff may take different actions to same situation resulting in conflicts and sometimes serious consequences. Lack of internal processes or inadequacy of the process also weakens the internal control as there are no set parameters against which an action of a staff can be judged. Weak internal systems such procedures for loan disbursement, collection, reporting cash handling etc. Can lure staff and clients to take advantage of the weakness and result in frauds and misappropriation. Lack of standard policies complicates work, as there could be variances in record keeping and reporting making consolidation difficult and to get as there could be variances in record keeping and reporting making consolidation difficult and to get information on time. This impacts decision-making and ultimately results in overall management failure. Strong internal management systems such as cash planning, cash handling, disbursement procedures, internal checks monitoring and audits help in managing process related operational risks. System and Technology Risk As MFI becomes more and more dependent on technology such as computers, software, hand-help devices, etc. it also enhances their technology related operational risk. Hard disk crash, virus attacks, software or hardware failures, password misuse can impact MFIs to different degrees based on their extent of dependence on technology. MFIs working in rural areas often have to face other such risks as long power cuts which can again disrupt normal operations if proper alternative arrangements such as generators or invertors are available. To manage this it is important to have proper software backup policies in the organization. It is necessary to invest in updated software and anti-virus, protecting computers from misuses, restricting accesses and limiting authorization of data access to different levels of staff. Daily back ups and storing back-ups at different locations can help in managing such risks. While designing software it is necessary to have strong security features, which can prevent data tempering. A good and efficient process of troubleshooting can help in addressing software or hardware related problems, which can prevent MFIs from losing valuable data or data theft. Relationship Risks Clients are very valuable for MFIs. With competition more and more clients have options of choosing one MFI over another. Loss of clients or high drop out is a big cost to the MFIs. MFIs invest a lot of time and money in identifying clients, training them and nurturing them. Therefore loss of clients results in resource loss, which has been invested on these clients and hence is a big risk. MFIs are increasingly realizing the importance client relation. It is important to be sensitive to client requirements
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clients can drop out on account of poor products, unfavorable policies and procedures, poor staff behavior or a strong competitor. As the sector becomes more competitive importance of strong client relation and meeting client requirement will only gain more significance. Managing good client relations can help the MFIs is not only managing this risk but turning it into an opportunity to maximize profits by not losing to competition and building client loyalty and instead attract clients from the competitors. Basis for effective relationship management is collecting, regularly information about the clients satisfaction. This appears to be costly and has not been done by most MFIs so far. However, as MFI-staff interact much more regularly with their clients than other financial institutions do, this offers vast opportunities to drop question on satisfaction which are simple and not burdensome.The greatest opportunity to learn about client satisfactions and to forge a strong relationship is through complaints, though. Most companies do miss the chance of complaint handling. So do MFIs. But complaints are a great opportunity, because it means that a client comes fully self-motivated and willing to convey his feeling s and perceptions of the MFIs services. It is a kind of information that field staff and managers alike otherwise rarely get hand s on. Therefore, well managed MFIs encourage clients to voice their grievances and provide channels for addressing them.

1.10 Asset Loss and Operation Failure Due to External Events There are various external factors, which are direct threat to an MFI. Such threats may include fire, natural disasters such as floods, draughts, earthquake, tsunami, epidemic etc. There could be other human related external threats as well such as robbery, thefts and rots. Such events although low in probability can cause high damage to the property of the MFI as well as can hamper normal operations for an extended period if time. Such risks can be managed through a variety of strategies. Natural disasters have the capacity to cause very high impact. Natural disasters not only adversely impact the infrastructure such as roads, telecommunications, which will ultimately hamper the MFIs working. Even if a natural disaster has not affected the infrastructure of an MFI directly it may completely destroy client business, which will ultimately result in loss for the MFI. Riots, wars, communal problems can quite significantly impact the operations of an MFI as such situations may bring an MFI to a complete halt. Riots and other such situation are directly related to the issue of personal security of the staff as well as of the clients and hence are serious risks. An MFI must keep its portfolio diversified to limit its loss on account of such external factors. If cases of robberies or thefts are common then it is better to transfer risk through insurance, cash carrying by staff can be limited and there can be polices on cash limits at branch. Again insurance for cash in branch or cash in transit can be taken by working out the cash benefit. Insurance involves payments of premium hence it is necessary to evaluate probability of such incident, potential loss possible against the premium the MFI has to pay.

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Section 2 : Microfinance Risks Management If potential losses or chances are high then it is better to take insurance. For dealing with fire or riot situation MFIs may have standard operating procedures, which could be stepwise set of rules to be followed under such emergency situation. This will help the staff to react in a more coherent manner and can control loss due to frivolous action taken by any staff under emergency. Personal safety and security of staff and client has to be given priority. Keeping backups at alternative places can help in preventing data loss and small fire extinguishers, fire proof vaults and help in controlling losses. Policies on storage and custody of important documents such as checkbook, client documents, cash etc., can again control losses. Market Risk Market risks are risks of financial nature, which occur due to fluctuations in the financial market or due to mismatch in assets and liabilities of an organization. As the MFIs become bigger in size and complex in terms of their asset and liability composition market risks become more pertinent. The assets and liabilities composition of MFIs, expose them to various kinds of market volatilities. As a result changes in market conditions, through external to MFIs, impact them either favorably or unfavorably and are therefore risks. For MFIs there are three most important market risks. a. Liquidity risk b. Interest rate risk and c. Foreign exchange risk: Foreign exchange risk arises due to fluctuation in exchange rate of currency in which the MFI has borrowed funds, against local
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currency: they can be mitigated (hedged) by accessing financial products offered by banks. Foreign exchange risk is not relevant from Indian micro-finance perspective as Indian MFIs are generally not dependent on foreign sources of funds. a. Liquidity Risk The financial position at any point in time of any organization is reflected by its Balance Sheet, which shows the position of Assets and Liabilities. Assets are the resources owned by the organization through which it generates its revenues. These are application of funds and reflect where all the funds available with the MFI are deployed. Funds could be lying in the form of cash, fixed assets or be invested in portfolio, fixed deposits or other securities. Liabilities on the other hand are sources of fund; these are the obligations of organization, which need to be fulfilled according to the contract. Borrowings, savings raised, other payables are all examples of liabilities as they are the obligations on the organization. An organization meets its committed payments or fulfills its obligations through the assets it has. In order to use the assets to meet obligations they should be available to the organization in liquid form that is cash. From the example of assets such as cash, fixed deposits, loan portfolio or other receivables and fixed assets we see that not all assets can be used, immediately to fulfill obligations. It is well known that to repay a loan from a bank an organization cannot send fixed deposit certificate or a fixed asset means its ability to be turned into cash. A fixed deposit for 3 years cannot be turned into cash before three years and hence is not a liquid asset but an investment. An investment which is maturing in next one month is liquid as it will be turned into cash in one months time. Asset liability management is therefore, a process through which an organization has to match maturing of its assets (that is when they can be turned into cash) with maturing of its liabilities (that when they are falling due for poor payments). If an organization does not have sufficient assets maturing to fulfill its liabilities falling due then there is a risk that the organization may not be able to honor its committed obligation and this risk is called Liquidity Risk. Assets, maturing within one year period are termed as Current Assets, while liabilities which are falling due within one year period are called Current Liabilities. Liquidity management is therefore, basically managing current assets and currents liabilities. If an organizations current liabilities are more than current assets than such an organization has an immediate liquidity risk. Liquidity risk in financial institutions is considered to be one of the most sensitive issues and a risk of high priority. As liquidity problem can result in a financial institution failing to honor its obligations it can result in loss of reputation, loss of credibility among lenders and depositors and has the potential to snow ball into a big crisis. If an MFI is not able to pay back savings of depositors when they come for withdrawal because they dont have enough cash then it can immediately give wrong signal in the market. Rumors may spread that either MFI does not have intention to pay back savings or is financially bankrupt. Spread of this news with other depositors can result in panic situation who may also come for withdrawal and this could lead to a situation called run on savings, where everyone wants to withdrawal their savings compounding the entire problem. Similarly, defaulting on repayments to be made by the MFI to its lenders can result in loss of confidence of not only of current lender but also other

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lenders, which can make borrowings very difficult in the future. Credit rating of the MFI can also fall down which can create further problems in its fund raising. As we now understand the downside of the lack of liquidity: should we suggest that MFIs remain highly liquid (that is having sufficient cash) at all the times to meet any contingency The answer to the question is No. One must understand that liquidity comes at a cost and if the assets are held in cash the MFI may not be able to earn any fee or interest. Idle assets should be avoided. An organization maintaining high liquidity will be losing on the returns from the asset it could have invested the money in. For an MFI it is generally the loan portfolio. If an MFI keeps high amount of cash it loses out on the interest it could have earned had that amount been invested in portfolio. The loss does not end there; the MFIs generally have this cash either from the borrowed funds or from the clients deposits and both sources of funds have cost attached to them. MFI has to pay interest on its borrowing as well as deposits irrespective of the fact that they are deployed in loans or not .Any cash laying idle means that MFI is losing on income from that cash while it has to pay charges on it in the form of interest. Hence idle cash results in losses. It is the responsibility of MFI to deploy its cash as efficiently as possible so that it (Cash) does not sit idle. So we see that while high liquidity brings the profitability and sustainability of an MFI down; insufficient liquidity results in the risk of defaulting on obligations. All financial institutions including MFIs have to juggle their assets and liabilities to strike the right balance. This balancing, to strike the right mix of not having too much idle funds while at the same time having enough funds to meet all obligations, is called liquidity management or asset liability management (ALM). The MFIs need efficient cash planning and management systems within the organization to make required funds available to all branches for their operations. Any excess fund lying anywhere in the system has to be timely transferred to a place where it is required. b. Interest Rate Risk Interest rate risk arises due to the fluctuations in the interest rates at which the MFI has borrowed from financial institutions. Such as banks can change their interest rates (at which they lend to MFIs) based on their own change in internal policies/strategies or due to changes in marco-economic conditions. Changes in rate may mean increase or decrease in the cost of fund for the MFI which directly affects its margins. If the bank interest rates drop it may result in extra income for the MFI while exactly opposite may happen if the interest rates go up. It is this uncertainly, which brings in the element of risk for the MFI and is called interest rate risk. One may argue that an MFI may also revise its own interest rate to match the bank interest rates to manage the risk. However, in practical terms revising interest rates frequently is not possible for the MFIs because of various operational reasons such as: 1. Increasing interest upward in an issue of controls and is not easy even though MFIs put a clause that interest rate can be changed from time to time. Therefore, normally once an interest is indicated in a loan it is not varied till the end of the agreed terms. In case of investments the issuer may not. Floating rate loans and investments are not popular in the country.

2.

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3.

With simple MIS that MFIs generally have, revising interest rate means managing different sets of data, which becomes source of confusion and is very cumbersome. MFIs generally have printed cards, formats for its loans, it involves cost to change these formation to a new interest policy Staff training is also an issue; staffs are used to working with a certain policy and generally get completely accustomed to it. A new loan system requires the staff to learn new installment size etc. which against is time consuming and difficult. It is also difficult to retrain the clients on new polices, new installment systems particularly when the clients may be used to a particular kind of repayments schedules.

4. 5.

6.

Even if an MFI could change its own interest rate, it will not be possible to do that for the running loans. This is also knows as the reprising risk. If an MFI has a taken a loan on which the bank has put a clause that it can reprise (change the interest rate) the loan every six months and the MFI has invested these borrowed funds in oneyear fixed rate loans to its clients, the MFI cannot change the interest rate before one year, although bank can changes its rate in every six months, which can result in losses. MFIs have to be very cautions while they sign loan agreements with banks or other financial institutions. It is important to read such clause, be aware of them and their implications. Generally, it is better to have funds, which have long reprising terms or are of fixed rates even if they come at a slightly higher rate, as this will not expose the MFI to risk of interest rate fluctuation. Specialized financial institutions take calculated risks reading the market situation and expecting the market trend and try to take advantage of it. If the long-term fixed interest rate investments are funded through short-term floating rate funds, then if the interest rates in the market fall it results in profit for the organization. For example if an organization gives a loan for 18% for two year and the rate is fixed for two year. The organisation has given this loan from funds, which it has borrowed at 12% floating rate, which will be reprised every 3 months. If the overall interest rates in the market fall then the cost of funds for the MFI will fall down from 12% while its own interest rate will remain fixed at 18% thereby increasing the organizations profit. Interest rate risk for financial institutions with a large portfolio will be subject to greater complications. In the case of such institutions, a change in interest rate not only affect immediate profitability but can also change the value of the underlying assets and liabilities because of the change in the present value of the future cash flows. However, for MFIs interest rate risk is mainly related to the immediate pressures on the margin and adapting to new market conditions. It is important that while raising funds such clause on reprising are carefully considered and compared between sources of funds. A s MFIs are not specialized in handling such kind of market risks it is often better to go for fixed interest borrowing even if they cone at a slightly higher rate. If there is a certainly about borrowings even if they come at a slightly higher rate. If there is a certainty about borrowing rates MFIs can have strategic such as higher scale of operations, cutting operational expenses or setting
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its own interest rates to factor in higher cost of funds. But if the rates are fluctuating then it can be difficult fro the MFIs to manage it. We discussed three types of marker risks: liquidity risk, interest rates risk and foreign exchange risk. One can now appreciate the varied kind of risks that MFis are exposed to and which are all of very different nature be it credit risk, operational risk or market risk. This again underscores the need for strong risk management system with in MFIs. Strategic Risks Strategic risks are risks related to weak governance, weak leadership, poor strategic decisions as well as risks due to regulatory and administrative reasons. These are high impact risks and can adversely affect the organization for a long-term. Providing governance is the job of the Board of Directors. It is a process through which Board ensures that the organization achieves its mission. Board directs and guides the management on various strategic issues, designs policies and reviews various reports to see that the organization is on the right way to achieving its vision and mission. However, if the Board of Directors were to take wrong decisions, design poor strategies or fail to review performance or take corrective measures in time, the organization runs. Board has to ensure that regulation s of the land are followed otherwise the organization may go out of the regulatory framework prescribed by the government and jeopardize the existence of the institution. For providing good governance it is very important that the individual Directors of the Board are themselves well qualified and experienced and have clarity about the mission of the organization. The Directors themselves have to be convinced with the mission. The Directors have to work as a cohesive unit, if there are conflicts among the Directors then the Board will not be able to provide right direction to the MFI. As the MFI s evolve into structured organization, Strategic risk gains more and more importance. Since MFIs have to deal in issues of varied nature it is advisable that MFIs have Directors who also have diverse skills. There could be a mix of people with social, finance, banking and law background. An important aspect of micro-finance business is that although MFIs strive to become sustainable profit maximization is generally not the objective. The Board and the top management of the MFIs have to strike a balance between social objectives and commercial viability of an MFI. Therefore, it is necessary that the Board have people who can appreciate this kind of mission. If the Board cannot appreciate this kind of mission then there is a high probability that the MFI can from its mission. Another very important aspect of strategic risk is regulatory risk. Regulatory risk refers to risk on non-compliance of the legal requirement as prescribed by the regulations. Micro-finance in India have mostly evolved from the not-for-profit societies or Trusts, which are not strictly regulated as compared to finance companies. As the MFIs grow in Societies and Trust may not be a suitable legal from the carrying out Micro-finance. MFIs are aware of this is why we now see many MFIs transforming from one legal entity into another for the sheer reasons of controlling the regulatory risk by adopting the suitable legal form. MFIs have option to cooperative, not-for-profit Company or non-banking finance company. It is a strategic choice for the MFI to adopt a correct legal form, which is most silted to its vision and mission and enables it to do what it is meant for.
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Here again Board has an important role to play in deciding the suitable legal form for the MFI and to oversee smooth transformation. When the micro-finance started many MFIs were accepting public deposits even though it was not allowed. However, the increasing awareness and the realization of the risk it accompanied had most of the MFIs refund client savings. Regulatory risks are very serious in nature as they can bring the MFI in conflict with the law of the land. It is the responsibility of the top management to comply with all the legal requirements to avoid attracting such risk. It is also good to maintain cordial relations with the authorities by updating them on the MFIs activities. Another form of strategic risk that has become important in recent times is of Political or administrative interference. As the MFIs are generally dealing with the poor their performance is subject to the scrutiny of politicians, administrators and the civil society. Various stakeholders have different interest in the clientele that MFIs serve. It could be a vote bank for some, while some stakeholders may genuinely be concerned about the protection of basic rights of the vulnerable sections. Issues of interest rate, recovery process, penalties, staff behavior with clients are all very sensitive matters and can easily become big socio-political issues. Any behavioral lapse or any poor policy on part of MFI can bring disrepute to the institution. There could be violent protest, which can result in loss of portfolio, fixed assets and can even be dangerous from the perspective of staff security. There have been cases in India where MFI staffs have been threatened and offices vandalized over issues of interest rates and MFI staff coercion for repayments. These are risks, which have to be dealt immediately by the top management and the Board. It is also necessary to always be aware of this kind of strategic risk, which can fast spurn out of control. Strategic risk can also emanate from very rapid growth and expansion. This is quite a pertinent risk in the current scenario with most of the MFIs growing very rapidly. Rapid expansion means going to new areas, recruiting new staff and operating through them, making fast disbursements and also arranging for funds. Fast growth increases the volatility in the system and is therefore risky. Going to new areas or running operations through new staff has its own risk. It is also necessary that all the systems such MIS, internal controls also keep pace with the growth. If the systems do nit keep pace with the rapid expansion it can result in losses. Also it requires high coordination at the top management particularly between the Operation Manager and the finance Manager. This issue was discussed while discussing liquidity risk. Coordination is also required among other department such as HR, which is responsible for recruitment, training and promotion of staff. With expansion staff has to be fast recruited, trained and promoted. It is important therefore that growth is planned and coordinated. MFI has to ensure that all the systems and funding plans are in place to support rapid growth. Managing Strategic Risks In order to manage strategic risk it is necessary for the MFIs to have a clear vision and mission. Many MFIs still do not consider vision and mission statement as important and many consider it just a mere formality. However, it is absolutely necessary for an MFI to clearly define what it wants to achieve. A clear vision can guide the organization and often help it in taking many strategic decisions. Once an MFI has clarity of it own mission then it has to choose a right kind of Board members who agree with the mission of the organization. The Board should be a mix of people
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having variety of skills and strengths. They should be able provide strategic guidance when the organization needs to make critical decisions. Board should also be proactive in assessing risk and set the acceptable levels of risk. Transparency is an important issue, which can help, in managing political and administrative risks to a large extent. MFIs should maintain transparency on its interest rates and other polices. It should also regularly report its information through Annual reports and at other forums. Board device strategies to keep various stakeholders informed about the activities of the organization and direct the management to implement fair policies. MFIs should try and involve and interact with various stakeholders such government authorities, local political lenders and media persons on the organizations philosophy, its activities and other policies. Business ethics is another important factor that cannot be comprised with. With micro-finance sector having gained a lot of recognition and is exposed to the larger audience. This makes it indispensable to define ethical behavior and code of conduct while dealing with clients. Any deviation from this should be seriously dealt with. It has to be considered that sometimes strict policies on repayment and staff benefit linked to repayments can also boomerang. While designing such policies it is necessary to be aware of its pros and cons and limitations. The effect of organizations policies as well as impact of regular operations has to be monitored Mechanisms within the organization are needed which can provide direct feedback to the management and the Board on the field realities, client satisfaction levels and small issues which can emerge as big strategic threats. There should be immediate response from the top to address sensitive issues of socio-political, regulatory, administrative or communal nature. With growth in the size of MFIs as well as of the sector the complications also increase making governance increasingly complex. In a big size institutions the stake of all involved parties such equity investors, lenders, regulators also increase and hence Board has to assume greater responsibilities in providing good governance, which only can keep strategic risk under control.

Section 3 : Risk Management Framework We have discussed the various risks that MFIS are exposed to. We had discussed earlier that risk management is a continuous process of identifying risk and addressing them to keep them under acceptable limits. Also risk managements framework has to be pro-active and forward looking rather than just reactionary. MFIs need to constantly identify the risks and measure them and then design suitable policy intervention to address those risks. GTZ has come out with an effective risk management framework. According to it a good risk management framework in an organization should have the following features. MFI should have processes in its regular operations to identify measure and monitor different types of risks that an MFI is exposed to. Should have continuous feedback loop between identification, measure and risk and processes to manage them. In simple terms, there should be processes to identify risk and the repot on this should be provided to
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departments managing them. Based on this feedback management will improve the process to manage risk. Management should consider different risk scenarios and be prepared with some solution if the risk comes true. Should encourage cost-effective decision-making and more efficient use of resources Create an internal culture of self-supervision that can identify and manage risks long before they are visible to outside stakeholders or regulators.

For effective management of risk Risk Management Feedback Loop, which is a six-step cycle, can be followed. The six steps of the cycle are: 1. Identifying, assessing, and prioritizing risks 2. Developing strategies and policies to measure risks. 3. Designing policies and procedures to mitigate risks. 4. Implementing and assigning responsibilities 5. Testing effectives and evaluating results 6. Revising policies and procedures as necessary This feedback loop is a management tool and can be followed are various levels. E.g. a Branch Manager can follow the loop for his/her branch while a CEO can follow it at the organization level. The exercise can be done from time to time to take to take stock of the risk scenario and be prepared accordingly. The type of risks identified and their severity will changes from time to time, hence it is necessary to constantly carry out this risk analysis. This section draws from GTSs Risk Management Framework for MFIs, July 2000. Identifying, assessing, and prioritizing risks: The first step in risk management cycle is to identify different risks. In above sections we had discussed the genepageral categories of risks that MFIs face. However, here specific risks pertinent to the MFI have to be identified. E.g. liquidity, legal compliance, competition, portfolio quality, reputation etc can be identified as the risks for an MFI. Once the risks have been identified it necessary to assess the possibility of the adverse event occurring. Based on this information the MFI has to prioritize the risks. This can be done using a risk management matrix. The MFI can lay down all risks in the form of a risk management matrix, which can help it in prioritizing the risks. In the risk management matrix MFI lists down all the risks it is exposed to. In the second column of the table above, it tries to assess whether that threat is low, moderate or high for it. In the third column it is assessed that how are the existing risk management system within the organization to counter that threat; whether they are weak, acceptable or strong. The fourth column makes the final
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assessment on the risk exposure of the organization based on the aggregate of the previous two columns. If the quantity of risk is high and quality of risk management is weak then the aggregate risk is high. The management needs to take as action as it is exposed to that particular risk and does not have sufficient systems to counter it. The fifth column shows the trend of risk as compared to last time when similar exercise was done. E.g. the first risk Credit Policy and underwriting shows aggregate risk profile as moderate and direction as stable. This means that while last time such an exercise was done, the aggregate risk on this parameter was moderate. Since, it was moderate last time and now, the direction is stable. This means that it is not going up or down. Similarly, in Portfolio monitoring and collection risk profile is high and direction is stable. This is not good as despite being recognized high last time it still remains high which is not good. Effort should be made so that the trend is decreasing for high risks and stable for low risks. The direction gives the information that whether the steps taken to counter that risk have yielded sufficient results or not. If the risk profile has been stable at high level or it has been increasing then it is warning for the management to react fast or modify its risk management approach for that particular risk. However if it has been coming down then it is a signal that risk management for that particular risk is in the right direction. Developing strategies and policies to measure risks: Once the risks have been identified and prioritized the MFI has to design suitable policies to measure these risks. The top management and the board generally set policies for the measurement of risk and the acceptable limits of risk. It is a strategic decision to decide the levels of risk that the organization is willing to take. An organization may take aggressive stand and go for rapid growth in the beginning and way be willing to take the associated risk while another organization may like to have gradual growth keeping the risk profile low. The Board plays a crucial role in designing such strategic and deciding what kind of risks have to be avoided, controlled, accepted or transferred. Cost-benefit evaluations, business targets, capacity to absorb risk and external environment are some of the factors that are taken into consideration while taking decision on risk strategy. Designing policies and procedures to mitigate risks: Once the policies for risk measurement and acceptable thresholds of risks have been set, the MFIs then have to design policies and systems to mitigate risks. All policies and procedures of each department are documented in the form of manuals. Operation Manual is one of the most important manuals, which documents all the policies and procures for the operation department and plays a vital role in controlling credit and operation risk. All policies related to disbursement, collection, cash handling, cash deposition, cash limits, process of recording, reporting, reconciliation of records, signatories, limits and authorities are to be clearly defined in the Operation Manual. Similarly, clear policies on human resource regarding recruitment, training, incentive/disincentive systems, disciplinary action, promotions, employee benefits and code of conduct has to defined. Another important manual is on Internal Audit, it is necessary that clear policies on internal audit are developed. It should lay down the policies on frequency of audit, forms and formats for audit, scope of audit, methodology to be followed, samples to be taken and reporting system. Such clearly laid out policies and processes are critical for risk management. Lack of polities results in lack of standards to be followed and in dilution of control.
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Implementing and assigning responsibilities: Once the policies have been framed it is very important that they are implemented by assigning specific roles and responsibilities to each staff. Without setting responsibility it is not possible to hold anyone accountable for the lack of implementation or for any deviation. It is also important that policy deviations be taken as a serious issue within the organization. If there are deviations those responsible for implementing such as Branch Manager, Area Manager, Operation Manager, Internal Auditor etc. have to be held accountable. There should be clear procedures for handling cases of policy deviations. These could be in the form of asking for written explanation, marking in the personal staff file impacting promotion, adversely influencing the incentives, supers ions or even dismissals based on the severity of deviation from the policy. It is also important that any modifications or changes in policies are clearly communicated across the staff and the manuals are regularly updated and copies of manual are made available to staff at all levels. Testing effectiveness and evaluating results: Once the policies have been implemented the top management has to evaluate the results. It should receive regular information from the field and should evaluate how effective the policies have been in mitigating the risks and whether the policies have been able contain the risks within the acceptable limits or not. MIS and reporting system plays a crucial role in this. Effective MIS can generate timely and accurate repots, which has to reach in appropriate form to different levels. Field information should reach the branch on daily basis. This could be in form of details of groups, new clients formed, dropouts, overdues, etc. While Area office should get the consolidated branch information. An Area office may have several branches under it, so all the repots of various branches should get added at the area level and to form an area level report. The same information should be further consolidated Area wise to be sent to Head Office. Head Office should also receive this information in reasonable time, which could be weekly. Although with intervention of technology, particularly MFIs working in urban areas can consolidated all information and Head Office can receive it on daily basis. However, even in remote areas, information should reach Head Office can evaluate results and see the effectiveness of its policies. Performance should be reported to the Board, which can then take further actions based on the results. The Board must receive concise reports, which can enable it to understand the overall performance through critical indicators. Report to Board must include. (i) (ii) (iii) (iv) (v) (vi) Details of disbursements, repayments, saving collection product wise breakups New clients formed, drop outs, net growth in borrowers and savers product wise breakups Variance analysis: comparison of targets and achievements and variances Portfolio quality PAR with ageing, repayment rates Profitability: Operation Self-sufficiency, Return on asset Trend of ratios: PAR, OSS, Return on portfolio, capital adequacy, staff/branch efficiency
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(vii)

Funding situation funds required and current position (debt/equity)

(viii) Financial statements: Balance sheet and income statements This is the most critical information that must be reported to the Board. In addition to operation reports, Internal Audit report, which is presented directly to the Board, provide valuable feedback on the overall risk environment of the organisation. It enables cross-verification of the operation reports and results being presented to the Board, as Internal Audit is an independent check. Revising policies and procedures as necessary: If on evaluation of results it is found that the policies and processes have not been effective in managing the risks then they have to be revised and redesigned and then re-implemented. It has to be evaluated whether the policy implementation has brought the risk down to the acceptable levels and has it been working as expected. If the results are not as per expectation then the policies have to be revised and fine-tuned and re-implemented. The risk management loop is a good tool that can help in proactively managing the risk and keeping them under the limits that the MFI considers acceptable.

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Module 6 : Managing Delinquency in Microfinance

Objective This objective of this module is to familiarise the participants with the concepts of delinquency in microfinance institutions. The module discusses the causes, costs and consequences associated with delinquency in microfinance. It also aims at providing information about key ratios to track and measure delinquency and steps in dealing with various types of delinquencies. Sessions 1. 2. 3. 4. 5. 6. 7. Defining Risks and Delinquency, Common symptoms of delinquency, Costs and consequences of delinquency Portfolio based indicators of measuring delinquency Repayment based indicators of measuring delinquency Ageing of Portfolio Managing Delinquency Distortions Causes of Delinquency Controlling Delinquency

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Section 1: Defining Delinquency Delinquency is a condition that arises when an activity or situation does not occur at its scheduled (or expected) time and date i.e. it occurs later than it expected. In other words, delinquency means obligations have not been discharged or activities have not occurred as per the scheduled time.To consider an activity delinquent, performance of the activity is to be compared with a predefined schedule. No activity can be considered as delinquent in the absence of a schedule. Thus, a major condition for defining delinquency is the existence of a scheduled date/time. In microfinance, delinquency can happen in all the type of activity, namely credit, savings and insurance. In the case of credit, delinquency occurs in the case of delayed loan repayments interest and principal. In the case of savings, delinquency occurs in the case of delayed savings deposits. In the case of insurance, delinquency occurs in the case of delayed payment of premium.

Authorities on microfinance have defined delinquency in many ways (see Box 1).
Box 1: Definitions of Delinquency In a monetary context, something that has been made payable and is overdue and unpaid (Renz and Massarsky, GDRC) The situation that occurs when loan payments are past due. A delinquent loan (or loan in arrears) is a loan on which payments are past due. Delinquency is also referred to as arrears or late payments (Clark and Stephens and International Association of Microfinance Investors, IMAFI) A delinquent loan (or loan in arrears) is a loan on which payments are past due CALMEADOW also referred to as arrears or late payments, measures the percentage of a loan portfolio at risk - USAID Delinquent payments/ payments in arrears are loan payments which are past due; delinquent loans are loans on which any payments are past due. - adapted from SEEP

As per best practices norms, the following are the definitions of delinquency: Delinquency is a situation that occurs when loan payments are past due Delinquent loans are loans in which any payment is past due

Being past dues is also referred as being in arrears. The four definitions of arrears are: Delinquent loans are also called as loans in arrears.
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Delinquent payments are also called as payments in arrears. Thus, a borrower who does not make the scheduled repayment on the due date is considered to be in arrears. Even if a part payment has been made, the borrower is still considered to be in arrears.

At any one time, if the actual outstanding balance is greater than the scheduled outstanding balance, then the member is deemed to be in arrears (or delinquent).

1.1 Importance of Credit Delinquency in Microfinance Delinquency in any form would be contagious and riskiest especially in the loan products of any microfinance business because principal amount of loan outstanding or the outstanding portfolio forms a significant portion which earns almost all the incomes for a microfinance institution. It is the largest and main asset for MFI. Most microfinance loans are not secured by tangible collateral to recover defaults. The expectation to get fresh loan in case of prompt repayment is the major motivation for a clients prompt repayment. In these situations, any serious outbreak of loan delinquency can quickly spin out of control. Hence, ensuring that loan portfolio is safeguarded from delinquency is very crucial for any MFI. 1.2 Cost and Consequences of Delinquency Delinquency can have far reaching impacts on the financial and non financial performance of the financial institution as it affects not only the financial operations but also the brand and image of the organisation in the long term. Though all the financial institutions are affected due to delinquency but the situation becomes more critical for MFIs which hardly takes any collateral or security for providing group /and individual loan. So, MFIs are hardly left with any other option but to write off the defaulted amount in absence of any collateral. The consequence of delinquency if not managed properly can prove fatal and may even lead to the closure of the organisation in worst situations. Some of the financial and non-financial consequences that the MFI faces on account of delinquency are given hereunder: Depletion of loan portfolio: MFIs loan portfolio starts depleting due to non repayment by the customers. Take for example, if an MFI makes 3-month loans repayable weekly and collects Rs. 95 out of every Rs. 100 it lends, it can lose almost 40 percent of its loan portfolio in a year. (adapted to INR for this module from Rosenberg, 2009) Delinquency postpones income: Partial or non repayment by the customer affects the expected income on the due date and thereby rotation of funds for financial operations of the organisation. (CGAP, 2009) Increase in operation costs The regular follow up and repeated visits of the frontline staff to the delinquent customer for the repayments, involvement of
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senior staff in delinquency management, opportunity cost due to postponement of disbursement, legal actions (if any) ultimately increases the operations cost of the organisation due to delinquency. Loss of brand value of organisation in market - Delinquency affects the normal operations of the financial institutions like disbursement of loans to customer, payment to the creditors and investors, and salary to staff etc and acts as a speed breaker in carrying out the normal business affecting the image of organisation. This affects image of the organisation in the market and cause creditors and investors loose trust in the financial institution and they may no longer prefer to lend funds in future. Late disbursement of loan: The disbursement of loan to the customers is planned on the basis of scheduled repayments receivable by the MFI on a specific day. So, disbursement of loan to customers in a branch may get affected, in case repayment is less than expected, leading to reduced disbursements resulting in unhappy customers returning home without loan. Delinquency can spread fast: A local delinquency problem can become a wider crisis fuelled by mobile telephone, press, word of mouth and political or religious intervention. Some customers also take delinquency crisis as an opportunity to not to repay and wilfully default. Threatening long term institutional viability: Staff making repeated visits to the delinquent customer for repayment of loan may get discouraged and start losing belief in the success of the institution. Soon, they start realising that there is neither any learning nor any advantage by chasing the customers for repayments time and again. In extreme cases, senior management may also lose interest in the programme itself and close the organisation. (CGAP, 2007)
Table 1: Impact of Delinquency On the Customer On the Staff Decrease in trust on the organisation Lowering motivation for on time repayers Indiscipline in other on time repayers Lack of possibility in getting further loans Loss in reputation of the delinquent customers Low morale and motivation Extra pressure on work Loss of control on other customers Low payouts On the Investors Loss in the image and reputation of the organisation Refusal of further funding to organisation in the area Closure of the branches

On the Service Provider Increase in cost and expenses Less income

Reduction in no. of customers Loss in the reputation and image of the organisation Contagious portfolio Limiting the spread of the programme

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1.3 Difference between Delinquency and Default Delinquency is a situation that occurs when payments are past due. However, default is when the MFI no longer expects to receive repayment (although it keeps trying) i.e., when the borrower cannot or will not repay the loan. Default occurs when the delinquency continues to exist beyond the time frame set by MFI. Usually, a loan is declared to be in default when the borrower has not made three consecutive payments, and therefore, has three loan instalments as arrears. Another definition of default is when the borrower will not make his/her payment and the MFI no longer expects to receive this payment. All default loans are delinquent loans, but not all delinquent loans are in default. The followings are the costs and consequences of default: Loan Loss Provision (provision for bad debts), increases expenses and therefore reduces profit. Interest income from the loan is never received. Non-recoverable portion of outstanding loan is lost. Will have to write-off loans, resulting in decapitalisation.

1.4 Types of Delinquency Generally delinquency has a ripple effect on the operations of the microfinance service provider. However, as discussed above delinquency gives early warning signals when it starts and then later on spread across the entire portfolio if not contained as soon as possible. The former where we start getting instances of delinquency can be termed as emerging delinquency while the later when it expands to affect other portfolio it is called endemic delinquency.
Table 2: Types of Delinquency Emerging Delinquency Emerging delinquency refers to early delinquency situation when customer misses a repayment instalment. It is important for the microfinance service providers to have a set of policies and rules in place to deal with the instances of delinquency as soon as possible. Endemic Delinquency If emerging delinquency is not contained as early as possible, there are high chances of it getting contagious because the customers start taking on time repayments as not so serious matter which later increases the cases of delayed payments other customers also stop repaying when they see no harm to the late payers

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Section 2: Identifying Delinquency

Delinquency does not start in a day or two, but it gives several warning signals before it spreads out: In the group based lending, the customer stops or becomes irregular in attending group meetings Problems faced by the customer in her/his business activities or instances of crisis in the family Customer does not pay the due amounts on time Customer has migrated

The loan officer or MFI may encounter following signs that provide the warning signals of a loan that is going to be delinquent/default: Slow payments Borrower refuses to answer or return calls Borrower cannot be located Borrower is not open about the businesss situation Family problems make collection awkward

2.1 Portfolio Ageing In addition to these signals, there are quantitative indicators and ratios which help in understanding and assessing the extent of delinquency. Loan portfolio ageing gives status of the health of portfolio. It shows the distribution of loans from the date they are delinquent, and is an indication of the overall portfolio quality or the probability of repayment. Ageing of loans also reveals delinquency patterns, for example, any loan past-due 30 days, 60 days, and 90 days and above.Loans 90-days delinquent are generally categorised as default loans, which means the MFI is no longer posting interest due on the Income Statement. If this situation persists, these loans may have to be written-off as Bad Debt. Ageing report shows how long, the loans receivable have been outstanding. It gives the percentage of loan receivables not past due and the percentage past due by 1 month (30 days), 2 months (60 days), or other periods. It also gives the percentage of loan principal of outstanding loans that are not past due and the percentage past due by 1 month, 2 months, or other periods. Once portfolio ageing is done on a periodic basis, then it would be possible to distinguish between good loans and problem loans that are even one day past due.
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Therefore, in any MFI, at all levels, the crucial task is to get an aging analysis on a regular and periodic basis, which, of course, will vary with the level of analysis. The key issue here is that the farther that a borrower is from making a payment, the greater the likelihood (or probability) that the payment would not be received by the MFI. Therefore, ceterus paribus, loans which are more than 365 days past due are less likely to be received than loans which are just 30 days past (due) their scheduled date.
Loan Category Current Loans Aging Analysis Loans where repayments have been made as per the due dates or all repayments (that are due) have been paid

Loans that are <30 days Loans with payments overdue for less than 30 days (from the due scheduled date) Loans that are Between Loans with payments overdue for between 31 60 days (from the 31-60 days due scheduled date) Loans that are Between Loans with payments overdue for between 61 90 days (from the 61-90 days due scheduled date) Loans that are Between Loans with payments overdue for between 91 180 days (from the 91-180 days due scheduled date) Loans that are Between Loans with payments overdue for between 181 365 days (from 181-365 days due the scheduled date) Loans that are Above 365 days due Loans with payments overdue for over 365 days (from the scheduled date)

Always take the first payment (that is overdue) for calculating the overdue age of the loan.

2.2 Key Indicators for Measuring Delinquency A delinquency measure helps predict how much of the portfolio will eventually be lost because it never gets repaid. Delinquency measure must help Loan officers to take timely response to day-today repayment issues To foresee the long term consequences To cushion the risk that may happen in future To predict the cash flow from portfolio for better cash management

There are two broad generic measures that can be used to measure and monitor delinquency in microfinance program:

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2.3 Repayment Based Indicators Many financial institutions use repayment rates to assess portfolio quality based on the past and present performance of the organization. Repayment Rates measure the amount of payments received with respect to the amount due. Three kinds of repayment rates are generally computed by microfinance institutions.
Current Repayment Rate (CRR) Current Repayment Rate (or CRR) shows the current repayment performance of an MFI. For MFIs, which are into operations since long, CRR becomes extremely useful, as it provides a reflection of how much of amount due in the current period is being paid by their customers. The formula for CRR is

Amount received during the period prepayments x 100 Amount due ( to be collected during period)

CRR helps in revealing the current repayment performance especially if the loan disbursed in current period is small. Having the current period repayment rate is useful in such cases. It also helps in understanding the behaviour of the customer in the existing period.

Cumulative Repayment Rate (CuRR) Cumulative Repayment Rate or CuRR helps get a sense of a repayment performance over a long period of time. The formula to calculate CuRR is:

Amount received till date (current and past due) prepayments Amount due till date (current and past due)

CuRR provides an overall measure of what proportion of the amount due over the entire life of MFI has been paid by customers till date. It smoothes out the random or seasonal volatility caused by the timing of pre-payments and late payments. However, CuRR can hide the poor performance in the current period, of the MFIs who have been into microfinance for several years with a large disbursement amount, which can usually camouflage 'poor' performance in the current period. The collection of overdues increases the CuRR as overdues collection is also taken into consideration in the formula. A higher ratio indicates ability and consistency of the MFIs in managing their portfolio effectively.

On Time Repayment Rate (OTRR) On Time Repayment Rate (or OTRR) is a measure of the credit discipline. It gives instant and unambiguous feedback about promptness of the customer in repayment. It is a very good tool for day-to-day portfolio management and cash flow management. The formula for OTRR is 137

Amounts paid on time (till date as per schedule) prepayments Amounts Due (till date as per schedule) On-time repayment is primarily concerned with how much borrowers repay as per their original schedule. There is a provision to factor in the overdue payments in the current and cumulative repayment rates but not in OTRR. The better the OTRR means the lower the postponement of the interest income.

2.4 Portfolio Based Indicators Repayment based measures only indicate the past performance of the MFI but do not measure the potential risk of default in future. Keeping this in purview, portfolio based measures become important to forecast the potential risk in a portfolio. There are two basic portfolio based measures that are used to quantify delinquency:
Arrears Rate (AR) Though a widely used measure of asset quality, Arrears Rate (Portfolio in Arrears) is not necessarily the most accurate one. It denotes the proportion of an MFI's gross total outstanding loan portfolio that is overdue or in arrears. The formula for AR is Sum of Past Due (Overdue or Arrears) Amounts (1 to 365 Days and more) for all overdue loans Total Gross Outstanding Loan Portfolio (Sum of Principal Outstanding of All Loans) AR estimates default risk in a portfolio by taking into account the actual past dues in a portfolio i.e., how much of the total outstanding portfolio is overdue or in arrears. This makes it an optimistic estimate of the default risk. Usually, an MFI with less than or equal to one percent of the AR is considered to be the standard one. However, apart from absolute percentage values, two other factors are important while using AR: trends, in terms of decreasing/increasing values as compared to the last (reference) period, as well as the aged values of AR. As far as trends for AR is concerned, a decreasing Portfolio at Risk is positive. However, this trend can be misleading, because a lower ratio can be obtained by decreasing the numerator and/or increasing the denominator. In other words, sudden and large disbursements of loans could mask the actual default risk. Also, in an MFI that is fast expanding in terms of loan disbursements, the same limitation applies. And when the repayment periods for these loans are yet to begin, the problem is magnified. Likewise, re-scheduling, refinancing and loan write-offs can portray a lower PAR ratio, while the (default) risk may still be high (Sa-Dhan). Portfolio at Risk (PAR) PAR is one of the most important tools today to assess the health of the portfolio of an MFI. It signifies the proportion of gross outstanding loan portfolio that is at default risk. PAR attempts to measure the default risk in a portfolio by using past as well as future data. In addition, it also estimates the amount of probable loss in case all the delinquent customers default to pay the rest of the loan amount. 138

The Formula for PAR is: Sum of Unpaid Principal Balance of All Loans with Payments Past Due (1 to 365 Days and more) Total Gross Outstanding Loan Portfolio (Sum of Principal Outstanding of All Loans) PAR therefore provides a pessimistic estimate of the default risk of the portfolio of an MFI. The most common standard of PAR for an MFI is less than or equal to two per cent. However, apart from absolute percentage values, two other factors are important while using PAR: trends, in terms of decreasing/increasing values as compared to the last (reference) period, as well as the aged values of PAR. As far as trends for PAR is concerned, a decreasing Portfolio at Risk is positive. However, this trend can be misleading, because a lower ratio can be obtained by decreasing the numerator and/or increasing the denominator. In other words, sudden and large disbursements of loans could mask the actual default risk. Also, in an MFI that is fast expanding in terms of loan disbursements, the same limitation applies. And when the repayment periods for these loans are yet to begin, the problem is magnified. Likewise, re-scheduling, refinancing and loan write-offs can portray a lower PAR ratio, while the (default) risk may still be high (SaDhan).

2.5 Under what circumstances can PAR be distorted and misleading? 1. Disbursement of new loans: It increases outstanding portfolio the denominator, but will not have an impact on the unpaid principal balance of past due loans the numerator, especially, if the repayment schedule has not begun. 2. Rescheduling of past due loans: Rescheduling is extending/re-organizing the repayment schedule for the loan. A loan is restructured, usually by lengthening the maturity, in order to avoid default. It reduces the unpaid principal balance of past due loans the numerator, by making them current; there is no impact on outstanding portfolio. 3. Refinancing of past due loans: Refinancing is replacing one loan with another, usually, larger loan. This ensures that the previous (default) loan is repaid, and the new loan becomes current. It reduces the unpaid principal balance of past due loans the numerator, by making them current and also increases the outstanding portfolio. 4. Loan write-offs: It reduces the unpaid principal balance of past due loans the numerator, and also reduces the outstanding portfolio the denominator.

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Box 7: Be Cautious!! Caution while Using Ratios

Ratios must be used judiciously as they can be misleading to the organisation at times. There are many pitfalls associated with using ratios. So, Managers should have a very clear understanding about the ratios for correctly interpreting them and should never be dependent on a single ratio, thereby ensuring that they have a clear picture of the portfolio. Listed below are some examples of ratios explaining how misleading interpretation may arise if adequate adjustment or interpretation is not made (CGAP)

Cumulative Repayment Rate might be a good measure to check the historical performance of MFI but it may barely notice the current repayment crisis. So, it would be too late for the management to act before it notices a fall in cumulative repayment rate.

Current Repayment Rate does not capture the late payments done during the period. So dependence on only on this ratio, would leave the manager being unaware of problem of late repayments if they happened during the period. And, thus the ratio could be misleading to him.

On Time Repayment Rate (OTRR) gives an instantaneous measure about timeliness of customer repayments. The late payments can be tracked easily and becomes handy for Managers in day to day portfolio management. The same can be measured on daily, weekly or monthly basis. But, the same measure cannot be used alone for determining future cash flow as prepayment and late payment also contributes to the cash flow.

Arrear Rate can be misleading if delinquent loan is rescheduled or refinanced by MFI. As rescheduling or refinancing converts a delinquent loan into current loan, it can prove fatal for organisation if misappropriated. So, the arrear disappears but the crisis remains.

Arrear Rate may not look very significant as amounts past due may be small relative to the total loan amount. Thus an arrears rate is usually a small number. It becomes a point of concern only when repayment crisis continue for a long period. So, MFI may remain under dark if dependent only on Arrear rate.

The PAR measure does not hold good for loans that are repaid in single repayment. Crop loans with single repayment disappear from the loan portfolio and the PAR calculation, when repayment is made. PAR calculation can also be distorted by doing rescheduling or refinancing or write off. Thus, appropriate adjustments need to be carried out to make the best use of the ratios and get true status of the performance of the MFI and identifying the areas for improvement in time.

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2.6 Making Adjustments to PAR The adjustment to loan portfolio quality due to recent loan disbursements can be assessed using the following ratio:

PAR (adjusted for Recent Disbursements) Unpaid Principal Balance of Loans with Payments Past Due ---------------------------------------------------------------------------Outstanding Portfolio Loan outstanding for which the repayment is yet to begin

Portfolio at risk (PAR) (Adjusted for Rescheduling) Unpaid Principal Balance of Loans with Payments Past Due + Unpaid Principal Balance of re-scheduled loans (when rescheduled) ------------------------------------------------------------Outstanding Portfolio

Portfolio at risk (PAR) (Adjusted for Re-financing) Unpaid Principal Balance of Loans with Payments Past Due + Unpaid Principal Balance of re-financed loans (when re-financed) ---------------------------------------------------------------------Outstanding Portfolio

PAR (adjusted for Write-offs) Unpaid Principal Balance of Loans with Payments Past Due + Write-off amounts ----------------------------------------------------------------------------------------------Outstanding Portfolio + write-off amounts

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Section 3: Loan loss Reserve/Allowance A well - defined policy that establishes a Loan Loss Reserve and periodically recognizes non-recoverable loans save a programme from declaring a large amount unrecoverable all at once and thereby drastically reducing its assets. Maintaining loans on the books that are unlikely to be repaid, overstates the portfolio size Having past due loans that are non-recoverable (still in the books) has a negative impact on repayment rates A Loan Loss Reserve is an accounting entry that represents the amount of outstanding loan principal that is not expected to be recovered by a microfinance organisation. It is either recorded as a negative asset on the Balance Sheet as a reduction of the outstanding portfolio, or as a liability. Loan Loss Provision is an expense set aside as an allowance for bad loans (customer defaults, or terms of a loan have to be renegotiated, etc). Each year the Loan Loss Provision should be made on the basis of the ageing analysis. Loan Loss Provision is the amount shown on the Income and Expenses Statement. The provision so made, gets added to, and increases the Loan Loss Reserve.

Internationally Recommended Best Practices Norms for Reserve Rates Status of Loans Current 1-30 days past due 31-60 days past due 61-90 days past due 91-180 days past due 181-365 days past due > 365 days past due Reserve Rate % 0% 10% 25% 50% 75% 90% 100%

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Section 4: Causes of Delinquency

Delinquency can occur due to a number of factors, some are controllable and internal to organisations while there are other factors which are uncontrollable and are external to the organisations. For managing the risks it is particularly important to understand the reasons causing the risk in detail. The following section discusses the cause for delinquency.

Organisational Causes Delay in loan disbursement Customers may miss the business opportunity for which s/he wanted to take the loan and, delayed receipt of loan does not yield the desired profit to the customer thereby resulting in delinquency. For example, many customers want to take loan during the festival season (Eid, Diwali) for doing small businesses and in these cases delay in disbursements hamper the earnings opportunity/ capacity of the customers.

Unsuitable loan products where the loan products were inappropriately structured, the customers are unable to make repayments because of the nature of the product. The most common example of this is where the tenure of the loan is relatively short, resulting in relatively large instalments. Concentration of the service providers in the same geographical area: There is an intense competition amongst the service providers in the same geographical area. It prompts the organisations to adopt fast disbursement of loans compromising on the loan processes and procedures. Such condition easily allows customers to borrow from more than one MFI. For example, repayment crisis in all the 12 MFIs of Morocco in 2007 after seeing a period of high growth from 2004-08. According to a study in 2007, approximately 40% of the customers had borrowed from more than one MFI (CGAP). Lack of user-friendly and proper MIS Staff handling MIS struggle to use if MIS is not user friendly. So, finally s/he reverts back to the old system of maintaining MIS of the organisation which might not be effective in the current scenario. Especially smaller-mid-sized MFIs do not have an MIS that provides timely, accurate and reliable information which facilitates the prompt identification of default/delinquent groups. This in turn, results in the lack of proper (delinquency) follow-up by management, causing accumulation of over dues. Erosion of MFI Credit Discipline: Cost savings approach, target led growth and competition for more market share prompt managers of the MFIs to go for reduced number of group meetings, dealing with customers through agents, short term focussed staff incentive and loose internal audit and monitoring of loan portfolio.
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Causes related to Customers Mismatch of schedule between customers cash flow and loan repayment schedule: Customers income (cash flow) does not match with repayment schedule, and sometimes find it difficult to save the amount till the repayment date. For example, in case the customer has monthly income flow and the MFIs loan repayment is weekly, the customer will find it difficult to make the repayment on time regularly and end up being delinquent. Migration of the customer : Sometimes customer especially one living on rent migrate to the new place without giving any information to group members and not paying balance loan amount to the organisation. Thus, the loan becomes delinquent. For example, many of MFIs operating in Mumbai face delinquency problem due to migration of customers. Seasonality factor in income generation: Some income generating activities like handloom, agriculture, dairy farming are seasonal in nature, which results in cash flow becoming irregular and thus create repayment problems during the lean periods.
Box 2: Seasonality and Delinquency Ram Singh purchased a cow with the loan (Rs.20,000) he received from the MFI. He sells the milk to the milkman who in turn sells it in the nearby market. This is the only source of income for Ram Singh and repayment if the MFIs loan is dependent on this income. The cow became dry and stopped giving milk when it was in advance pregnancy state. Ram Singh could not pay rest of the installment in spite of all good intentions and the loan became delinquent for 3 months.

Lending to customer without reference check: Reference check is considered to be a very important aspect of loan appraisal in case of individual loan product. MFIs ignoring reference check may give loan to customer who has a poor past record of repayment to the creditors in the market, thereby raising probability of loan becoming delinquent

Lack of facility of advanced training to the customers: Many of the existing customers have some basic skills but lack specialised skills which act as a constraint in further growth of their business. Such customers may become delinquent if receives a bigger loan in repeat cycle. Customers taking loans from multiple sources: Customers take loan from multiple sources and sometimes use it for repayment of loan to the moneylenders and other creditors. And, thus do not use loan for the business purpose as mentioned in the loan application. It leads to less income to customer than projected and ultimately customer becomes delinquent. For example, some customers have been found borrowing from 5 MFIs simultaneously. Borrowing from more than one MFI has become a very common phenomenon in recent times. Many customers do not reveal about their borrowing status which result in poor estimation of creditworthiness of customer raising a probability of delinquency. No proper utilisation of loan Use of the loan for non productive purposes (like marriage, health/sickness, death, etc.) fully or in part can choke the cash
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flow required for investing into the income generating activity. It ultimately results in failure of business thereby creating delinquency of the loan. Customer receiving loan on the basis of business projections: Loans disbursed based on the business projections may land into delinquency because loans might have been given without a grace period and without the proper analysis or knowledge of the income generating activity e.g. Giving loan for piggery without understanding of value chain for the same can prove to be disastrous for the MFI offering the loan. External Causes (CGAP): There are a number of uncontrollable external factors which are not under the control of either the customer or the organisation, but have serious implications on the repayments of loan and cause delinquency. These are: Natural Calamities: Flood, earth-quake, drought etc can leave the people in serious financial problems and directly impacting the portfolio leading to delinquency. Political: The political situation of the area of operations of the MFI can have serious implications on the delinquency and overall performance of the MFI. For example, interest rate issues and farmers suicides became a political issue in Andhra Pradesh and thus affected repayments. Economic: Includes the economic parameters of the country/state as whole such as interest rates, inflation, economic growth and other economic events impacting local economy and thereby entrepreneurs; example seasonality factors in a locality which is dependent on tourism. Social: Includes factors impacted by religion and/or castes impacting the delinquency of loans, if are. For example, In Kolar district of Karnataka, Muslim cleric issued summoned the community customers to stop repayment to MFI as paying interest was against their religion. Eventually, loan repayments stopped and the crisis moved to three other towns in the state Sidlaghatta, Ramnagaram and Mysore. (Callard, 2009)

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Box 3: Is the Non RepaymentDelinquency or Default? Though the term delinquency is synonymously used with default many times, there is a thin line of difference in both these terms. Whereas delinquency refers to payments not made on the due date default on the other hand refers to occurrence of an event where the payments will not be made at all. Delinquency refers to a state when loan repayment is not received by the organisation on the due time/date. The financial organisation normally starts follow up with the customer for the repayment of amount due when delinquency arises. In case, the customer does not make repayment in spite of all the efforts made by the organisation and the same no longer is expected to come, the loan can be said in default. CGAP rightly defines default as a state when a customer cannot or will not repay his or her loan and the MFI no longer expects to receive repayment. ACCION also pointed out at the failure of meeting the loan obligation through its definition which states that default is a failure to make timely payment of interest or principal on a loan or to otherwise comply with the terms of a loan. Further amount in default is the outstanding loan amount when customer stops making repayment. But, the same amount cannot essentially be counted as write off as it depends upon the organisation policy for collection of security pledged by the customer while taking loan (CGAP,2007).There is hardly any MFI in India which does hypothecation/perfection of security but the same is mostly done by Banks and Non Banking Finance Companies (NBFCs) for providing loan to the customers.

3.1 Dealing with Delinquency As far as possible, delinquency management process should start when it is noticed. Since microfinance is based mostly on intangible assets as collateral such as goodwill, trust and collective responsibility, the proposition of delinquency in microfinance becomes a risky one. It is also suggested to have a well documented delinquency management procedure in place. In addition, there should be qualified staff trained to deal with delinquency as soon as it emerges. Further, on time information collection and sharing it with seniors are the steps which can further nip delinquency in its bud.
Table 3: Dealing with Delinquency Emerging Delinquency Endemic Delinquency

Ask the customer to repay the amount due who Identify and mark up the areas where does not repay the loan, as agreed the delinquency is endemic Motivate the group members to share the joint Build a team of experts in the responsibility of repaying the amount due organisation or outside the organisation. Follow up by the field staff on the day when an Diagnose the problem causes of non instalment due is not repaid repayment Reporting in person to the branch head or seniors Prepare a plan for dealing when an instalment due does not come delinquency and pilot test it. with

Follow up by the Branch Manager over phone For example, develop and implement an and personal visit awareness building programme

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Table 3: Dealing with Delinquency Emerging Delinquency Endemic Delinquency

targeting both staff and customers to Ask the Centre or group leader (if there is a build institutional commitment to ongroup), to arrange for a meeting next day. time payments by providing information and incentives as well as conducting Follow up with the customer on repayment of events such as Recovery Week to loan create the momentum to recover the delinquent instalments (Prakash et al). Warn the customer about going to guarantor Follow up with the guarantor and share the consequences such as legal notices etc Rescheduling or refinancing, but on a case to case If successful, roll it out to other areas basis after approval by senior management and try to recover the dues. If repayment does not come, reminder and notices to the customer and guarantor Legal action Write off policies Box 4: Dealing with Endemic Delinquency A Case of Janashakti, Sri Lanka (Prakash et al) The Janashakti case demonstrates how Janashakti Womens Development Foundation in Sri Lanka worked with Womens World Banking (WWB) to rein-in a widespread delinquency problem. In 2002, Janashakti had a portfolio at risk > 30 days of 41.86% the organisation was set to fail. As is so often the case, much of the portfolio problem was rooted in Janashaktis staffs attitudes and the organisations policies and procedures. The staff either believed that the customers were too poor to pay or that they required a little leniency but would pay eventually ... and the portfolio monitoring and management systems reflected this confusion. WWB worked with Janashakti to: 1. Diagnose the problem and identify branches where it was acute, and those where delinquency was not such an issue so that they could learn lessons from both. 2. Conduct due diligence through a specially created Delinquency Management Core Team which oversaw the entire recovery programme, starting with an effort to process map and analyse the success factors of the branches that had a high portfolio quality. In addition, this team visited other MFIs with excellent portfolios to understand the drivers of their portfolio quality and draw lessons for Janashakti. 3. Develop and implement an awareness building programme targeting both staff and customers to build institutional commitment to on-time payments by providing information and incentives as well as conducting events such as Recovery Week to create the momentum to recover the delinquent instalments. 4. Pilot-test a new delinquency management programme to improve loan tracking, clearly define roles and responsibilities, segment customers based on repayment behaviour and train staff in nine branches. 5. Monitor and adjust the pilot and delinquency management activities to ensure that resources were appropriately allocated, action plans were implemented, obstacles were removed and targets were achieved. 147

6. Rollout the finalised delinquency management programme to all branches. The news of the success of the pilot had spread and so the other branches were keen to implement it too. Janashakti implemented a phased rollout starting with a training programme which culminated in each branch setting SMART action plans. By the end of June 2005, 64 of the 72 branches had been trained in the new delinquency management system. By September 2005, despite the effects of the devastating tsunami in December 2004, which affected many of Janashaktis customers, portfolio at risk > 30 days had fallen to 4.90%.

Box 5: Lessons from Mass Defaults (CGAP Microfinance Blog) Kolar is a tranquil little town in the southern Indian state of Karnataka, not far away from the state capital, where around 15,000 MFI customers defaulted on their loans, as local Muslim organisations through their clerics had summoned all Muslim borrowers to stop repaying until further notice, claiming that paying interest contradicted the teachings of Koran (the Muslim holy book). Just a few months later, similar instances were reported in three neighboring towns, following more or less the same pattern. The defaults came as a surprise to the 8 MFIs operating in these areas, which saw 30- 50% of their portfolio in these towns being affected; roughly 53,000 loans amounting to USD 11.6 million were found to be in arrears. It has also been reported that MFIs staff was physically threatened while trying to enter Muslim districts for collection. Also, Muslim borrowers were not allowed to get in touch with loan officers and loan documentation was destroyed. Many blame the intervention of local clerics for this crisis. But in his article on a potential microfinance bubble in South India Daniel Rozas made an important point, its hard to inflame a happy crowd. Several loan officers spoken to reported that MFIs had managed customer relationships more and more passively over the past years by focusing solely on repayment. In some cases, loan officers were relying on center leaders for customer acquisition and sometimes even repayments; staff gets transferred often, which can prevent an MFI from taking a responsible long-term perspective in these areas. Instances in which center meetings went on for extended hours with group members being prohibited from leaving the site until the last borrower had paid her installment were also reported. This kind of zero tolerance approach can easily lead a customer to become alienated from her MFI. Many customers, also no longer seem to be comfortable with the concept of center-level joint liability, and prefer to be liable only at the group level. MFIs quickly tried mitigating their risk by lowering loan amounts, shortening loan durations, demanding higher security deposits, and restricting new loans to Muslim borrowers. But the real lesson should be that microfinance is a relationship business, more than anything else. Once you lose your customers loyalty, risk can quickly spin out of control. Kolar has been a vivid reminder of this, and a call for action to MFIs.

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3.2 Preventing Delinquency Apart from a fire fighting mode or crisis situation, it is equally important for the MFIs to chalk out a long term strategy and partnership in order to deal with any kind of delinquency. Preventing the delinquency from happening is the best strategy for MFI than any remedies after delinquency has taken place. Some of these strategies involve designing suitable products, sharing information in the Credit Information Bureau, putting more emphasis on customer relationship and internal controls, geographical diversification, setting up strong management information system (MIS) are important steps to mitigate the risks lying under microfinance business. Designing suitable loan product for customers: Financial institutions like MFIs offer the same loan product across the country. But, the requirement of the market could be different at different places. So, it is important for the financial institution to design a suitable loan product to cater specific needs of the specific market. It should clearly establish the loan delivery process, repayment schedule, instalment amount, loan size etc. to suit the customers needs. Sunil Bhatt et al (2010) have very rightly pointed out that the Mumbai market is unique and needs to be approached in a different way by MFIs. Encourage on time repayment by customers: Existing customers make on time repayment in the expectation of certain benefits like next loan, bigger loan, interest rebate etc. from the financial institution in future. It has been also widely observed MFIs experience a wave of defaults if stops disbursing loans in an area as customers stop perceiving any benefit from them in future. Therefore, CGAP advise to ensure customers perspective the benefits of on-time repayment and costs of late repayment should far outweigh the benefits of late repayment and costs of on-time repayment looks very relevant and must be taken into consideration for lending operations. Appropriate Incentive Scheme for Field Staff: Financial institution should be very careful while designing the incentive system for the Field Officer/Branch Manager and should give sufficient weight to on time repayment variable in the incentive scheme to ensure good portfolio quality. Ratios like Portfolio at Risk (PAR), On Time Repayment Rate (OTRR) can be used by MFIs to measure on time repayment rate of loan portfolio of the concerned staff. For better repayment rate, MFIs should also ensure reasonable target for making new groups/customers to the frontline staff so that they appraise the creditworthiness of customer efficiently and do not chase after numbers for incentives. Sharing Information with Credit Information Bureaus (CIBs): CIBs are important to control multiple borrowings, a cause of over indebtedness and thereby delinquency in future. CIBs provide credit history of individual borrowers, but only a few countries have well functioning CIBs. In 2009 MFIs in India had decided to invest in CIB to become more responsible towards lending (CGAP).

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Strong Internal Control: There is a link between fraud and delinquency. Strong internal controls being in place, coupled with effective audit helps in preventing fraud and ensuring that the MFIs processes are running as per the policies and procedures of the organisation. Regular monitoring by supervisors can also help in evaluating the results of delinquency reduction efforts (CGAP). With growth MFIs become complacent with internal control systems and overlook monitoring, compliance of the organisation with set policies and procedures and internal audit. Inadequate internal controls were cited as the most common weakness by MFIs in Bosnia, Morocco and Nicaragua, responsible for repayment crisis in year 2008-09 (Chen et al). Therefore not only MFIs facing repayment crisis but also other MFIs too must consider sealing the gaps created by loose internal control in the organisation. Customer Relationship: Delinquency crisis always reinforces the belief that microfinance is a risky business and early management of such risks is of paramount importance for continued performace of the business. MFIs should balance the growth with customer services to strengthen customer relationships to ensure long term sustainability. Emphasis on customer satisfaction and credit discipline is required be maintined consistently by the MFIs. Regarding the importance and strength of customer relationship, one of SKSs Area Manager shares One time the local communist party threatened to close our offices because we would not hire their nominees. In response, our customers surrounded their party office to tell them to leave SKS alone as it was providing a valuable service (Wright and Sharma). Geographical Diversification: Several times, MFIs prefer to concentrate in the areas where other MFIs too are operating because of an established credit history of the customers as well as reduction in cost. This leads to unhealthy competition amongst the MFIs and sometimes regulatory wraths which often lead to mass default. Geographical diversification gives a boost to operate if something happens in a particular area. MFIs should approach new markets to geographically diversify their business and mitigate underlying risks of being concentrated in limited locations. Management Information System: Growth becomes difficult to manage, if internal capacity of MFI does not keep pace with the expanding operations. Enhanced geographical penetration, increase in the number of customers, diversification in range of products and requirement of daily reporting by the branch managers, demands a strong MIS. In the absence of strong management information system, false and late reporting becomes a routine leading to more complex problems on back of misguided management. In Morocco for example, a leading MFI grew by 150% in 2006 with an obsolete management information system producing false reports, which soon after lead to delinquency crisis (Chen et al). In addition, an MFI is also exposed to vulnerabilities if there is inadequate and timely portfolio information in not generated because of lack of strong and effective MIS support. Detailed and quick information about performance of portfolio is essential for the managers in tracking the non-performing portfolio or delinquency and thereby helping them in taking appropriate remedial measures promptly for better portfolio management.
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Compliance with and Action on Audit Findings: The success of the programme depends upon the efficient interaction between the Audit, Operations Department and Compliance department. Once the Audit report is prepared, it is the duty of the Operations department for complying with the Audit findings. The Compliance department should do regular follow up on all pending compliance issues to ensure that the compliance is achieved within the stipulated time.

References http://www.gdrc.org/icm/glossary/#D Clark, H. and Stephens, B. (2005): Distance Learning Course on Microfinance, UNCDF, http://www.uncdf.org/mfdl/workbook/pages/glossary.htm http://www.iamfi.com/glossary.html#d MicroSave (N/A): Toolkit for Delinquency Management in Group-Based Lending MFIs, MicroSave MicroSave (N/A): Toolkit for Delinquency Management in Group-Based Lending MFIs, MicroSave MicroSave (N/A): Toolkit for Delinquency Management in Group-Based Lending MFIs, MicroSave Rosenberg. R. (2009): Is 95% a good collection rate?, Consultative Group to Assist the Poor (CGAP) blog http://microfinance.cgap.org/2009/09/17/is-95-a-goodcollection-rate/ CGAP (2007): Delinquency Measurement and Control and Interest Rate Calculation and Setting, Participants Course Material, http://www.cgap.org/gm/document-1.9.8955/DQIR%20rev%2008.pdf CGAP (2007): Delinquency Measurement and Control and Interest Rate Calculation and Setting, Participants Course Material, http://www.cgap.org/gm/document-1.9.8955/DQIR%20rev%2008.pdf Sa-Dhan (N/A): What is Arrears Rate? How to use it in Microfinance, Sa-Dhan Microfinance Manager Toolkit#2, New Delhi Sa-Dhan (N/A): What is Portfolio at Risk? How to use it in Microfinance, Sa-Dhan Microfinance Manager Toolkit#1, New Delhi Rosenberg, R (1999): Measuring Microcredit Delinquency: Ratios Can Be Harmful to Your Health, CGAP Occasional Paper #3, http://www.cgap.org/gm/document1.9.2698/OP3.pdf Rosenberg, R (1999): Measuring Microcredit Delinquency: Ratios Can Be Harmful to Your Health, CGAP Occasional Paper #3, http://www.cgap.org/gm/document1.9.2698/OP3.pdf CGAP (2007): Delinquency Measurement and Control and Interest Rate Calculation and Setting, Participants Course Material, http://www.cgap.org/gm/document-1.9.8955/DQIR%20rev%2008.pdf

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Callard, A. (2009) Religion Not Only Factor http://microfinanceinsights.com/blog-details.php?bid=186

in

Kolar

Crisis

CGAP (2007): Delinquency Measurement and Control and Interest Rate Calculation and Setting, Participants Course Material, http://www.cgap.org/gm/document-1.9.8955/DQIR%20rev%2008.pdf http://www.iamfi.com/glossary.html#d CGAP (2007): Delinquency Measurement and Control and Interest Rate Calculation and Setting, Participants Course Material, http://www.cgap.org/gm/document-1.9.8955/DQIR%20rev%2008.pdf Prakash, L.B., Paul, A., Sharma, M. and Wright, G.A.N.(2008): Toolkit for Delinquency Management in Group-Based Lending MFIs, Training to Participants (May, 2008), MicroSave Prakash, L.B., Paul, A., Sharma, M. and Wright, G.A.N.(2008): Toolkit for Delinquency Management in Group-Based Lending MFIs, Training to Participants (May, 2008), MicroSave Kneiding, C. (2009): What can we learn from mass defaults?, CGAP http://microfinance.cgap.org/2009/11/25/what-can-we-learn-from-mass-defaults/ Bhatt, Sunil (2010): Characteristics of Mumbai Microfinance Market MicroSave India Focus Note 50, http://www.microsave.org/briefing_notes/india-focus-note50-characteristics-of-mumbai-microfinance-market CGAP (2007): Delinquency Measurement and Control and Interest Rate Calculation and Setting, Participants Course Material, http://www.cgap.org/gm/document-1.9.8955/DQIR%20rev%2008.pdf Andhra Pradesh 2010: Global Implications of the Crisis in Indian Microfinance www.cgap.org/gm/document-1.9.48945/FN67.pdf Sabetta. Janis et al: Operational Risk Management For Microfinance Institutions http://www.cgap.org/gm/document1.9.34371/CGAP%20Operational%20Risk%20Management%20Course.pdf Chen, G., Rasmussen, S., and Reille, X. (2010): Growth and Vulnerabilities in Microfinance, Focus Note 61, CGAP, February http://www.cgap.org/gm/document1.9.42393/FN61.pdf Wright, G. A.N. & Sharma, M. (2010): The Andhra Pradesh Crisis: Three Dress Rehearsals and then the Full Drama, MicroSave India Focus Note 55, www.microfinancegateway.org/.../IFN_55_The_Andhra_Pradesh_Crisis.pdf Chen, G., Rasmussen, S., and Reille, X. (2010): Growth and Vulnerabilities in Microfinance, Focus Note 61, CGAP, February http://www.cgap.org/gm/document1.9.42393/FN61.pdf

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Module 7 : Management Information System in Microfinance Institutions

Objective 1. 2. 3. 4. This module intends to develop understanding of the participants on the management information system (MIS) and its components. This module also provides detailed information on the functionality and importance of MIS in an organisation, especially in a microfinance institution (MFI). It covers critical, information related issues and helps MFIs conceptualise their information requirements. The module also introduces a decision making framework and tools for objective selection, acquisition and implementation of technology/MIS that fulfils the need of the organisation.

Sessions 1. 2. 3. 4. Management Information System in MFIs - Introduction Importance and Role of MIS in Microfinance Records and Formats for MIS Designing and Implementing an Effective MIS

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Section 1 : What is Management Information System (MIS) Management Information System (MIS) is a series of processes and actions involved in capturing raw data from various activities in an organisation, processing the raw data into usable information, which is disseminated to the users in a required format (Waterfield et al, 1998). The MIS of an organisation can be conceptualised as a virtual, parallel process that closely shadows the actual physical processes (operational activities) of the organisation. The virtual process captures data from the actual operational activities and then converts it into information delivered, to the designated stakeholder in the desired formats (Bagchi, 2009) (See figure 1 below).
Figure 1: MIS Process and Physical Process

MIS provides information necessary to manage an organisation effectively. It is not simply a computerised or manual program or just calculating numbers but it is a tool which better connects people communicating with one another about events that drive their work in any organisation. It helps generating information that provides essential inputs for prudent and reasonable business decisions in an organisation. For Microfinance Institutions (MFIs), MIS is a key to the effective management of their tiny loans portfolio with the high frequency (daily and weekly) repayments and other transactions. An effective MIS can easily help an MFI to track and monitor its social and financial performance for informed decision making. 1.1 Components of MIS: Data and Information

An MIS comprises of two main components i.e. data and information. While data is a gathered body of facts generally unprocessed, information is a formal presentation of
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processed data in order to take decision. Usually data is a formal representation of raw facts used as a basis for reasoning, discussion or interpretation. By its own, data does never provide insights. For example, a loan repayment transaction does not show whether the payment was on time, nor does it shed light on the status of the loan. Information, on the other hand is a result of processing, manipulating and organising data in a way that adds value to the body of knowledge. It is the data that has been processed and presented in a form suitable for interpretation often with the purpose of revealing trends or patterns. It involves analysis and interpretation of data to describe a fact or an aspect of the management, which helps someone make a decision or gain insight (See figure 2).
Figure 2: Link between Data, MIS and Information

RAW DATA
(Input)

MIS

USABLE INFORMATION (Output)

1.2

Purpose and Characteristics of MIS

The management information system is a set of information systems designed to help an organisation in gathering, processing, storing, distributing and using of information to address strategic, managerial and operational activities. It provides management with accurate and timely information necessary for decision making. The system provides information on the past, present and projected future and on relevant events inside and outside the organisation. It may be defined as a planned and integrated system for gathering relevant data, converting it in to correct information and supplying the same to the concerned executives. The main purpose of MIS is to provide right information to the right people at the right time and in the right format. The output of an MIS is information that subserves the managerial function of decision-making. When a system provides information to persons who are not managers, then it will not be considered as part of an MIS (Management Hub). An MIS is also not simply a computer programme and it involves more than just calculating a few ratios/performance indicators. To be effective, MIS should include certain key aspects such as: User friendliness for maintenance and reporting Timely, accurate and reliable information Design and output flexibility to suit the organisations changing needs Links to ensure data flow within an organization Secure and stable

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1.3

Type of Information Systems used by MFIs

The microfinance institutions generally use one or all of the three types of information systems mentioned below. According to Ali Ahmad (CIO at First Microfinance Bank Ltd) the three categories are: Manual System In this system, data is mainly recorded and maintained on paper forms/formats and ledgers. At times, computer is used with basic spreadsheets. The flip side of this system is that it increases the load of work for staff and causes delay in reporting. This thus undermines the accuracy, timeliness and reliability of information generated.

Semi-Automated System It is a manual system that is partially automated. With this category, the spreadsheet is the common tool being used, as per the manual system, in conjunction with an MIS application that does not fulfil the information requirements of the MFI. Here also, the accuracy and reliability of the information may be limited. At times, information consolidation is a challenge (especially for MFI with multiple branches) and spreadsheet systems collapse when an institutions structure becomes more complex.

Fully Automated System This system is fully automated and integrated MIS fulfilling the whole information requirements of the organisation. After the raw data is entered into the MIS, the whole range of information is generated in the required format for management and for decision making purposes. In such system (if well-setup) reliable information and all reports are timely generated with accuracy. Nonetheless it is important to point out that because of the high cost involved in acquiring an effective and well-integrated MIS system, it may not be possible acquire it, for an MFI with a low capital base.

1.4

MIS and its SubSystems

An effective MIS includes all the sub-systems that an institution uses to generate the information which guides managements decisions and actions. A microfinance institution generally has two main systems: The accounting system, centred on the chart of accounts and general ledger, and The portfolio tracking system, covering the performance of accounts for each financial product offered by the institution.
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However, some institutions also maintain a third sub-system, for gathering data regarding impact on customers, often on the request of donors. Microfinance institutions have other information management needs, such as for human resource management. But financial and customer activities generate by far the heaviest volume of data for processing.
Figure 3: The Sub-Systems of an MIS Data
Chart of Accounts Accounting Loan, Savings, Insurance Accounting Sub-system Portfolio Sub-System Methodology Policies, Procedures

Information
Financial Statements Choice of Indicators Management Reports

Figure 3 above shows the relationship between accounting and portfolio systems, together with other elements that affect the MIS. As shown in the figure, the accounting system is influenced primarily by the chart of accounts. On the other side, the portfolio system is influenced by policies, procedures and methodology. Data are processed into information, which is then presented in financial statements and management reports. Influencing the form and content of these reports are the indicators chosen by the institution to monitor performance. Many indicators and reports are generated by combining information from the accounting system (such as income and expenses statement) with information from the portfolio system (such as number, amount, and size of loans, or number of staff). Although independent, the two systems share data and must be compatible with each other for an effective information system. (Waterfield, et al: 2007).

1.5

The Accounting Sub-System

The basic principles that determine the underlying logic of the accounting side of MIS has almost always been the same from one country to another, despite the great variation in the standards guiding accounting and auditing procedures. Therefore, finding an existing accounting programme that performs at least the basic functions required of a microfinance institution, and that will provide the essential accounting reports (income statement, balance sheet, and cash flow), tends to be fairly straightforward. Management should clearly define the kinds of variations on these basic reports that it will need in order to oversee operations effectively, such as income statements by branch or balance sheets by funding institution.

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The core of an institutions accounting system is its general ledger. The skeleton of the general ledger is, in turn, the chart of accounts. The design of the chart of accounts reflects a number of fundamental decisions by the institution. The structure and level of detail established will determine the type of information that it will be able to access and analyse in the future. Management must be clear about its information needs and be able to reach a balance between two contrasting considerations. If the chart of accounts captures information at too general a level (for example, by not separating interest income from fees), the system will not provide the kind of detailed information that management needs to make informed decisions. On the other hand, if the chart of accounts is designed to capture too great a level of detail, the system will track needless amounts of data and generate information that is so disaggregated that management cannot identify and interpret trends properly. In addition, the greater the level of detail, the longer and more costly it will be to gather the data and process the information.

1.6

Financial Product Monitoring System or Portfolio Sub-System

While well-established accounting practices are reflected in general ledger-based MIS, there are currently no standards or widely accepted guidelines for the financial products tracked by an MIS. As a result, each MIS designed for portfolio management has its own approach to what information is tracked, what kinds of reports are generated, and most importantly, what kinds of features are included. Some of the key features that vary widely among loan portfolio systems, for example, include: the types of lending methodologies supported (such as group vs. individual vs. village banking), the methods of calculating interest and fees, the frequency and composition of loan payments, and the format of the reports. Each institution tends to have its own idiosyncratic way of structuring its credit operations, and so an MFIs loan tracking MIS attempts to reflect the operational procedures and workflow of the institution. For the reason that there are no agreed upon standards for loan tracking systems and due to the relative complexity of the information to be tracked and reported upon, institutions face a number of challenges when considering how to improve the loan management component of their MIS. A portfolio system should be designed to work with all major types of financial products offered and likely to be offered in the future. All MFIs offer loans, the most complex product for the system to track. Some may also offer other products such as savings accounts, time deposits, insurance policies, or other products. The portfolio system will need to accommodate each of these distinct products. Within each major type of financial product, the system should be designed to establish distinct sets of rules for the different kinds of products. For example, an institution may offer working capital loans, fixed asset loans, small business loans, solidarity group loans, etc. Each of these types of loans will have distinctly different characteristics, or sets of rules. Interest rates, interest calculation methods, maximum allowable amounts and terms, definition of overdue payments, eligible collateral, and many other factors will vary among the different loan products.

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Section 2 : Importance of MIS in MFIs Each microfinance institution has an information system of some kind. Many might see a minimal system as sufficient; like a manual accounting system. However, it is important to build a strong MIS because having good information is essential for an institution to perform efficiently and effectivelythe better its information, the better it can manage its resources. In a competitive environment the institution with better information has a distinct advantage. Figure 4 below shows the diaries of a microfinance institution suffering from a weak information system.
Figure 4: Some Issues of an MFI with Weak Information System
The senior accounting staff are reconciling bank accounts from months ago and trying to prepare a trial balance for the upcoming board meeting. A task that theyll be unable to complete in time. In the lobby clients queued up at the Cashier are waiting impatiently while staff look for a misplaced account register.

In the credit department several loan officers are sifting through the account registers to see who has paid and who hasnt. Operations manager presents the new project proposal under development; much of the information requested by the donor is unavailable or embarrassingly outdated. Client complains that although his loan is approved, he misses out on buying the used machine he wanted due to delay of issuing contract and other paperwork

Another client is complaining about a seemingly arbitrary calculation of interest and penalties

Weak Information System

In the back of the room the credit department supervisors, busy as usual dealing with crises, have little idea how their department or staff are performing

In the accounting department stacks of paper are everywhere. Some junior staff are reconciling savings account balances with the general ledger, others are calculating interest on passbook savings accounts.

A good information system could transform an institution. The organisation may have capable and motivated staff, but if they lack information, they will be unable to perform up to their potential. A good information system can revolutionise the work of field staff, enabling them to better monitor their portfolio and serve their customers, all while working with a growing number of customers. It can enable supervisors to better monitor the work under their responsibility, provide better guidance to their staff, and pinpoint the areas that most require their attention. It can also help executive managers to orchestrate the work of the entire organisation by allowing them to monitor the institutions health through a set of well-chosen indicators and by informing critical operational and strategic decisions (Waterfield et al: 2007). For microfinance institutions (MFI), MIS has special relevance since their operations involve large number of customers doing repetitive transactions of small amounts at frequent intervals of time.. These transactions have to be constantly monitored to assess the health of the organisation and decide on future actions. The recent focus on the Double Bottom Line requires that MFIs keep track of the customers they serve, the extent and the changes/impact in them. Requirements of different stakeholders both internal and external play a key role in the way an MIS is designed. The difference between a good and a bad MIS is the extent to which stakeholders needs are satisfied by the MIS. The list below captures the importance of MIS in an MFI (Ahmad): Easy access to accurate and up-to-date information: For example, loan officers get information on loans that need follow-up, branch managers can
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monitor daily progress of the branch and senior management can get a full picture of the portfolio performance and quality. Customers also get quick information on their accounts, payments and balances The right information is generated to the right users in the required formats at the right time, which facilitates better understanding, setting priorities, objectives and strategy Information on customers activities is captured in reasonable detail, which can be used to assess customers business as well as impact of financial provided on financial and social well being. It is also useful in tracking historical information of each customer. For example, the Poverty Progress Index (PPI) of Grameen Foundation is used to track MFIs social performance by relying on historical and actual data gathered for a particular customer The operational activities, such as deposits, loan disbursement, repayment, withdrawals and money transfers are completed faster, better controlled and with minimum opportunity for errors Performance indicators can be quickly tracked and generated to provide an overview of the organisations performance and efficiency so that timely adjustments can be made. Use of MIS helps make MFI services more interactive, accessible and transparent. For financial services innovation, to fulfil needs in the market, MIS can provide full flexibility to structure products and services to suit the MFIs target customers. Also, new policies and procedures setting is easy and can be quickly applied throughout the branch network. Efficiency and productivity of staff is increased, as they are able to manage more products, customers and transactions in less time with better accuracy. It provides flexibility to integrate with other applications and delivery mechanisms. MIS lowers transaction cost, increases productivity, reduces risk of failure and pushes the boundaries beyond bricks and mortar infrastructure to carryout sustainable business.

2.1

Role of MIS in an MFI

Generally, MIS deals with information that is systematically and routinely collected in accordance with a well-defined set of rules. Thus, an MIS is a part of the formal information network in an organisation. Normally, the information provided by an MIS helps the managers to make planning and control decisions. Every organisation in order to function must perform certain operations on a ongoing basis. Beyond current operations, an organisation must plan ahead for future ones. Also, an organisation must control the operations in the light of the plans and targets developed in the planning process. The MFIs managers must know if operations are in line with the targets and if not, they must make decisions to correct the deviation or revise their plans. MIS has all the ingredients that are used for the provision of information that supports the management decisions. More often, managers use historical and current data of an organisations activities to make plans and take informed
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decisions. Such data are contained in various manual files/folders maintained by the organisation, which are essential components and foundation of an MIS. The manual procedures that are used to collect and process information and computer hardware are other obvious ingredients of an MIS. In short, the MIS helps to achieve efficiency in the functions of the management (Weihrich: ), which are: 2.2 Planning Organising Staffing Directing Controlling MIS and Planning

According to Koontz and ODonell, Planning is deciding in advance what to do, how to do and who is to do it. Planning bridges the gap between where we are and where we want to go. It makes possible things to occur which would not otherwise occur (Koontz and ODonell). It is necessary to ensure proper utilisation of resources. In order to achieve this, one needs to understand the organisation in its current scenario, where a SWOT (Strength, Weakness, Opportunity and Threat) analysis is indispensable. Therefore, past and present data are necessary to draw key information from the organisations historical performance and articulate its future vision in quantitative terms: indicators and targets. In a microfinance institution, these indicators and targets, along with other stakeholders needs, should drive the design of the MIS. These targets must be welldefined, SMART (Specific, Measurable, Achievable, Results oriented and Time bound) and linked to the key objectives and goals of the MFIs, so that tracking the level of their achievement can be easier. The sub-systems of the MIS should be designed to be in line with the mission, vision and objective of the MFI. Then, the MIS truly becomes useful in measuring actual performance against these targets, and understanding how the MFI is progressing in achieving its vision. Such an MIS would then be robust enough to provide regular, accurate and timely reports that would assist management in reviewing the targets and re-strategising, if needed.

2.3

MIS and Organising Staffing Directing

Organising, managing staff and providing effective direction to the organisation are key functions of the management that must be done on the basis of solid information. Such information must be retrieved from the MIS that has been setup to achieve specific goals in the organisation. The management will provide and bring together all financial, physical and human resources required as per the planning to meet the targets set for the entire organisation including branches and the head office. Based on the plan and targets, the management must track the progress in the organisation and then identify the constraints and gaps that hinder the organisation in reaching its goals as well as to capitalise on the strengths that need to be sustained
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and reinforced. Therefore, there is a need of reliable information to set ground of decisions such as: Manpower planning, recruitment, training and development Defining staff remuneration and motivation Staff performance appraisal Staff promotions and transfer Leveraging on lending funds Supervision and leadership decisions as well as maintain effective communication across the organisation

Data must be gathered through the physical process (operational activities) and then processed to the usable information in the desired format. To do so, an effective information system is needed to provide timely, accurate, secure and consistent information to the management. Such system must be well designed thereby being user friendly for collection, maintenance and reporting of data with output flexibility, to suit the organisations changing needs. The MIS should be designed in such a way that it is able to track and help evaluate the measures and targets identified in the strategic business plan.

2.4

MIS and Controlling

Controlling implies measurement of accomplishment against the standards and correction of deviation if any to ensure achievement of organisational goals. The purpose of controlling is to ensure that everything occurs in conformities with the standards. An efficient system of control helps to predict deviations before they actually occur. According to Theo Haimann, Controlling is the process of checking whether or not proper progress is being made towards the objectives and goals and acting if necessary, to correct any deviation. But Koontz and ODonell will add that Controlling is the measurement and correction of performance activities of subordinates, in order to make sure that the enterprise objectives and plans desired to obtain are being accomplished. Therefore, controlling has following steps (Management Study Guide): Establishment of standard performance Measurement of actual performance Comparison of actual performance with the standards and finding out deviation if any Corrective action

Fulfilling these steps requires reliable information, hence adequate management information system. The most important aspect to be controlled in an MFI is risk and MIS plays a supportive role in the overall internal control system because it helps to identify risks, which are assessed accordingly. Risk assessment is the process of identifying, prioritising and implementing risk management strategies, policies and procedures. Systems, policies and procedures must be regularly reviewed and systematically revised in order to prevent repeating mistakes of the past and to protect the MFI from new risks. Risk Management Feedback Loop (figure 5 below)
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(Campion, 2000) is used as a tool for risk assessment. The role of information is significant in each of the steps of the loop depicted in the figure below.
Management Information System: A Controlling Tool in an Organisation MIS and Internal Audit and Control

As risk analysis and management strategies are critical to building and ensuring sustainable microfinance institutions, operating risks are among the primary risks to address; and this because they are internal, and within the realm of managements direct influence and control. So a strong internal control system is one of the best Risk Management Feedback Loop mitigation strategies for managing internal operational risks in an MFI 1. Identify risks. (Mbeba: 2007).
For sure information is needed 6. Revise policies and 2. Develop strategies but the good and the real one. The procedures. to prioritize risks. information and communications component of an internal control 5. Test effectiveness and 3. Design policies to system is not a stand-alone monitor results. mitigate risks. component. It intersects, interacts with, and is part of each of the four steps of controlling. Strong 4. Implement policies and MFIs and their portfolio assign responsibility. management is highly dependent on good information, particularly financial and portfolio information. In order to be useful, it must be relevant, correct and timely. Loan officers who do not know the status of their portfolio at any given time cannot make adjustments or be held fully accountable for their performance. Branch managers need to know their branchs financial status its revenues and costs need to be known, to be managed and controlled. Sudden changes in portfolio performance may signal a variety of problems, but without portfolio reports, managers will not be aware of the potential risks. All these reports form the crux of the MIS in an MFI. Internal audit gathers its inputs from the MIS. For example, whether the policy on weekly balances with the branches is being followed or not is an audit aspect to be checked and can be known from the MIS reports. MIS can be designed to have inherent controls on the day-to-day activities. For example, a cap on daily balance, if incorporated into the MIS, will automatically indicate amounts to be transferred from/ to the branch and head offices accounts at the end of the day. MIS also helps in designing better policies and procedures by identifying gaps in the current policies and procedures. For example, recurring arrears in a specific geography as known from the MIS reports might lead to changes in credit policy for that region. MIS and External Audit The external audit is a review of the financial statements or reports of an organisation by a third party which is not affiliated to the entity. It plays an important role in the financial oversight, and is commonly performed at regular intervals by the organisation. It is typically required on yearly basis. It verifies the consistency and concordance of information provided, and uncovers discrepancies between the statements/reports presented by the organisation. As it is being said, also information is the key to this exercise. For example, an external audit performed based on erroneous and inaccurate information due to a weak information system can negatively influence the investment decision of shareholders and funders of an MFI even thought the entity is promising. In sum, effective management information system is the heart of any organisation and this is true for MFIs as well. It is the key to achieve sustainability as it helps in providing the right information at the right time in achieving sustainability and profitability. Also, it helps in reducing default, optimal

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rotation of portfolio, establishing sustainable interest rates, improving operational efficiency, generating reports at various levels for various stakeholders and reviews the progress. The design of the MIS needs to take care of all the functions of the management including planning, organising, staffing, directing and controlling. As information has different characteristics, depending on the purpose for which it is used, MIS must be designed accordingly to meet the requirements of stakeholders. The same information may need to be presented in different forms for different uses or users.

Section 3 : MIS and Information and Communication Technology (ICT) Simply put, ICT is a technology-combination of computer hardware, software and connectivity that captures, converts, stores, processes, protects, transmits and retrieves information. It is a tool that automates activities and enhances productivity. Most of the time, people tend to confuse MIS with ICT, since the use of information technology in the modern organisations, is prevalent in the data capture, information creation and communication process. However, it is important to note that ICT only helps to improve the data capture, conversion and communication process by facilitating the accuracy, objectivity and communication of information (Bagchi: 2009). Amongst the various information systems, only the fully and semi-automated systems using computer (software and hardware) can be enabled by an information and communication technology.. The computer only facilitates the data capturing and processing, while the associated MIS produces the desired information in the required format. Also, the computer helps in information dissemination and communication. ICT-enabled MIS is always recommended as it has many advantages for the microfinance institutions. The right choice of technology can offer numerous benefits among which are: Accurate and real time inter-branch, head and branches offices information flow Improved productivity in transaction recording (data capture) Faster and more accurate report generation Generation of relevant social impact information of customers etc. Also, the above benefits in turn help the MFI improve its bottom-line and support its growth and expansion plans by: Lowering costs of data capture and transaction processing Enabling better control, supervision and strategic decision-making Removing impediments to growth and outreach. Nevertheless, adopting any technology necessitates both one time and recurring costs, which many MFIs cannot afford to support. It has been proven that MFIs that have invested in technology extremely successfully, was on the strength of a purely manual MIS. Any ICT-Enabled MIS is as good as the quality of its design, implementation and use. Best of technological sophistication and the best of software features will do no good, unless the basic operating workflow is sound from the business perspective and the MIS system is effectively implemented and used. So a decision has to be taken whether to automate, partially or fully an information system according to the MFIs operations, resources and growth strategy.

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3.1

Manual and Automated MIS: Advantages and Disadvantages

As we have seen that it is important that the right information at the right time at the right place is crucial for informed decision making. Therefore, information and data are considered among the most valuable assets fundamental to the success of an organisation. There are pros and cons of each type of MIS. However, as discussed above the use of the type of MIS depends upon the needs and requirements of that organisation. The present section discusses in detail the challenges of both manual as well as automated systems. 3.2 Advantage and Disadvantage of Manual MIS

Some of the advantages and disadvantages of manual management information system are presented in the table 1 below:
Table 1: Advantage and Disadvantage of Manual MIS Advantages Disadvantages Tools are more easily created, altered, and maintained than databases Tools are easy to understand for field staff with less qualifications and low or zero computer literacy Costs of implementation and maintenance are lower. Tools are easier to implement at the field level Tools can work in remote areas where communication and power facilities remain challenging Maintenance of large amount of data is almost impossible. Systems collapse when MFIs structure become complex Data and information consolidation (manual and/or spreadsheet) become challenging especially when there is rapid growth Typically slow, time consuming in producing reports and too laborious Manual systems are the most inefficient methods of storing and retrieving financial data. Tools are prone to abuse, fraud, mathematical error, and information loss through improper storage. Data manipulation is easy and analysis is very difficult Security and integrity of data and information, loosely controlled, are always an issue Business continuity is at risk in case of damage to information due to fire, water or any other disaster

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3.3

Advantage and Disadvantage of Automated MIS

The table 2 below shows some of the advantages and disadvantages of automated MIS:
Table 2: Advantage and Disadvantage of Automated MIS Advantages Disadvantages Easy access and update, fast data capturing and processing, timely reports generating with accuracy Very low error risks and help controlling fraud Ensure confidence among investors, funders and regulators with respect to transparency Generate information in the user required formats that facilitates analysis and decision making Provide full flexibility to structure and modify products and services to suit the need of customers Improve quality of customer service Increase staff and overall organisational efficiency and productivity Reduce risk of failure, lower transaction cost and push the boundaries beyond bricks and mortar infrastructure to carryout business Enable innovations, flexible integration with other application to enhance the delivery mechanisms High acquisition and maintenance costs Application may be easily corrupted due to power failure, manipulation errors, viruses and hackers Information may be lost if there is no proper backup system Inappropriate programming and/or validation can cause wrong information generation that can negatively affect decisions Danger of computer fraud if proper level of control and security whether internal and external are not properly been instituted Cannot be fully effective in rural areas due to lack of infrastructure: May limit the accessibility of information Difficult to understand by field staff with less qualifications and low or zero computer literacy

Although, it is clear that fully automated MIS is preferred, the high cost associated to its acquisition and maintenance obstructs MFIs accessibility to such MIS systems. This is the reason why most microfinance institutions are still using the semiautomated information system. The issues (disadvantages) related to the fully automated system can easily counter if it is well-designed with comprehensive users manual, secured, regularly maintained and monitored with proper backup system. 3.4 Information Needs of Various Stakeholders at Different Levels

An effective MIS is the one that provides the right information to the right users in the right formats at the right time. Users must be able to draw the needed information from the MIS so that appropriate decisions can be made in the organisation. Therefore, before starting designing an MIS, one must effectively assess the information need of each user within the MFI, and then for stakeholders of
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the entire organisation. Hence, the conceptualisation and programming of the MIS have to be based on the information needs identified as well as the required formats, in which they should be generated. According to Waterfield and Ramsing, the problems with MIS in MFIs are not just related to a poor programming, rather begin with poor conceptualisation of the information people need to fulfil their responsibilities. As they advice, number of questions should be asked to the users or group of users to help evaluate and identify what information they need and in which formats it should be presented. Also, the MFI should explore how reports can be shaped to meet the needs of a number of users at a time; and then reports frequencies and how easy they can be modified or adjusted based on future needs. The process of assessing the information need does not consist of simply asking each user and stakeholder the type of information they want. But mainly, it also consists of getting information of the best practices in the industry. The MFI must learn from the experiences of other institutions in the same geographical area and in the entire industry as well. However, the right, essential and useful information must be generated for each user. Having information more than it is required can confuse users and end up, to time and resources wastage.

3.5

Various Reporting Needs

In an MFI, reports are essential for information dissemination and communication and thus enabling users of that particular information to perform their jobs well and make appropriate decisions. One of the most common weaknesses of information systems is poorly designed reports. An MIS may have a wealth of data and track all activity accurately, but if this information does not reach staff in a useful form, the MIS is worthless. For example, the report need for a Loan Officer is different from the one for an Area Manager or Operations Manager. It may have the same information/substance but the detail that each category of user requires may vary. The table below is showing the possible reports that an MFIs key stakeholders may need:
Table 3: Stakeholders and their Reporting Requirements

Stakeholders Customers

Field Staff

Reports Savings Account Activity Loan Repayment Schedule Loan Account Activity Comprehensive Client Status Savings Account Activity Teller Savings Report Loan Repayment Schedule Loan Account Activity Comprehensive Client Status Group Membership Report Teller Loan Report Active Loans by Loan Officer Pending Clients by Loan Officer Daily Payments Report

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Stakeholders

Branch and Regional Managers

Senior Managers in the Head Office

Board of Directors

Donors and Shareholders

Regulators

Reports Delinquent Loans by Loan Officer Summary of Portfolio at Risk by Loan Officer Staff Incentive Report Summary Report for Field Staff Active Savings Accounts by Branch and Product Dormant Savings Accounts by Branch and Product Upcoming Maturing Time Deposits Savings Concentration Report Pending Clients by Loan Officer Detailed Aging of Portfolio at Risk by Branch Delinquent Loans by Loan Officer Delinquent Loans by Branch and Product Summary of Portfolio at Risk by Loan Officer Summary of Portfolio at Risk by Branch and Product Detailed Delinquent Loan History by Branch Loan Write-off and Recuperations Report Aging of Loans and Calculation of Reserve Staff Incentive Report Detailed Actual-to-Budget Income Statement Summary Report for Branch Manager Savings Concentration Report Portfolio Concentration Report Delinquent Loans by Branch and Product Summary of Portfolio at Risk by Branch and Product Loan Write-off and Recuperations Report Aging of Loans and Calculation of Reserve Detailed Income Statement Income Statement by Branch and Region Income Statement by Program Detailed Actual-to-Budget Income Statement Adjusted Income Statement Detailed Balance Sheet Program Format Balance Sheet Cash Flow Review Projected Cash Flow Gap Report Summary Report for Senior Management Summary Actual-to-Budget Income Statement Adjusted Income Statement Summary Balance Sheet Cash Flow Review Summary Report for Board Summary Income Statement Summary Balance Sheet Summary Report for Shareholders and Donors Reports for regulatory bodies vary from country to country and region to region; and also depend on the type of MFI

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Therefore, appropriate reporting framework for an institution depends on its circumstances, users and purpose of the report. Reports can be issued branch-wise and for the entire organisation. Generally, a typical MFI reports (See Annexure 2 that provides sample formats of the reports indicated below) can be grouped as: 3.6 Savings reports Loan activity reports Portfolio quality reports Income statement reports Balance sheet reports Cash flow reports Operational Summary reports Key Issues in Report Design

Reports design is one of the key steps in the design of an information system. An MIS may have a wealth of data, but it will be useless if it is not able to provide needed information to the staff in the right format. Many MFIs face this issue by ignorance or negligence, where their MIS is good in tracking data with accuracy but generate useless, confusing information. Therefore, the step of report design in an MIS must be seriously taken into consideration by MFI to meet effectively their needs and stakeholders requirements. Waterfield and Ramsing insist on the following factors that must be well-considered when designing the reports in an MIS.

3.7

Content of the Reports

As microfinance operation is concerned, reports should essentially focus on pointing out the issues related to the loan portfolio quality, liquidity management, human resources and other specific information that the MFI judges important. And then, the content of the report will fit users need according to the level of information they belong to. Figure 7 shows three levels of information use (Strategic planning, Management and operation). Strategic and management information is needed at the top management level of the organisation, whereas the operational one is used by the vast majority of employees. The characteristics of the information vary along several lines, depending on the level of use.

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Figure 7: Usage of Information

The information source varies according to its use; it may be external or internal. For operational and management purpose, majority of needed information is collected internally, whereas an organisations strategy planning information may require more input from the external environment. For example, the information needed by management to monitor the loan portfolio quality is internal, while developing a new product will require more external information regarding the need of clients in the targeted market segment, competition analysis, etc.

Coverage As per the figure 7, information is more specified and narrower when it is related to the operations. This helps the management to make informed operational decisions. Such decision may be regarding a particular staff, branch, product etc. But, when it comes to strategic information about the organisation as a whole, information needs become diverse and cover a large range of topics and issues. Therefore, as per the information source, the coverage also varies according to its use.

Aggregation Information for strategic planning of the organisation, as whole, does not require too much detail as compared with operational information where detail is a key to the understanding of the operations trend. For example, strategic information may
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consider the portfolio at risk (PAR) of the MFI as a whole, whereas for operation and management purpose, PAR may be looked at branch and/or staff wise with all the required details.

Time Scope The pyramid on the figure 7 shows that strategic information is, most of the time, oriented toward the future, and is predictive and speculative; whereas operational information is based on historical data. For example, operation may be observing and analysis the trend of loan repayment over last 3 years, while the strategic planning may be projection the repayment rate of one, two or many years ahead.

Age For operations, the more recent is the information better it helps to make effective decisions. Branch managers and Field Officers need to know as soon as possible the loan portfolio quality so that decision can be taken accordingly. However, strategic information can be old and still useful for management to make an informed decision.

Precision Precision on information is required at each level of the operation to make users perform effectively their role and responsibility in the organisation. In the same time, management and strategic information may abide imprecision and uncertainties.

Frequency of use As microfinance deals with a high volume of transactions of small value, the operations information must be tracked on regular basis to allow users at various levels to take the right decision early before it gets too late. Information must be generated frequently (monthly, weekly and daily) to give the operations status to staff and other users. In MFIs, management information is generally issued on monthly and/or quarterly basis, while strategic information is needed intermittently; sometimes on yearly basis.

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3.8

Categorisation and Level of Detail in Reports

The level of detail in a report and the categorisation depends on the size of the MFI, users and uses of the information. The detail required in a report will vary along with the organisational structure (Organogram). To track the increase in number of clients, the branch office needs a report that shows the increase of clients per field officer, whereas the area office will just need a report that shows branch-wise increase in clients. At the head office, the same information can be generated regionwise. When it comes to information comparison across the MFI, the user must be able to access the same information for different branches, areas and/or regions in the same format with the same level of details to perform the required analysis. Therefore, MFI should be able to present the needed information in the way that it eases the understanding and analysis of users at various levels of the organisation.

3.9

Frequency and Timeliness of Reports

Reports have to be generated on timely manner to suit its need. The repayment schedule should be issued at least a day before the collection day so that the field officer plans his road map accordingly. Also, before a loan is disbursed, the loan sanction report must be timely generated so that the accountant can issue cheques/ bundle cash of the corresponding amount before the disbursement time. Every useful information must be timely generated at the frequency (daily, weekly, monthly etc.) defined by the MFI, for its operations to be effective.

3.10 Identifying information in Reports To make information identification easier throughout reports and organisation, the same information should be presented under the same heading or title. Reference should be provided to explain figures and/or add more precision. The MFI must have standard vocabulary across its reports for the same information. And this standardisation must take consideration of terms used in the industry (region-wise and /or worldwide) so that information from one MFI can be compared with the same in another MFI to facilitate analysis. As it is known that a report is mainly a snapshot of an organisation at a particular time (day, week, month, year etc.) for the particular information, it must be dated and timed (if possible).

3.11

Trend Analysis in Reports

Key reports should include trend information whenever it is possible to allow comparison, progress monitoring and analysis, social and financial performance assessment etc. For example, to monitor financial performance of an MFI, the key indicators must be calculated to provide information on the current period; and then be compared with previous periods indicators to help analysing the trend of the
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performance. A report may have a table with columns showing information calculated for consecutive periods of time (weekly, monthly etc.).

3.12 Period Covered by Reports The period covered by a report can be determined by the organisation according to its users and uses. It can be influenced by the best practices in the industry and the needs of various stakeholders (Staff, management, investors, donors, regulatory bodies, directors, etc.). Thus, reports may be generated on daily, weekly, monthly and yearly basis as well, to provide insight on a specific aspect of the organisation. For example, financial statement can be monthly, quarterly and yearly generated as per the exigency of stakeholders.

3.13 Usability of Reports The presentation of a report counts a lot for its understanding. A report should display the required information so that its content can be easily captured. The language used should match with the category of its user. For a field officer, which generally does not have higher level of education, the language used in his report must be simple and display clearly the information he requires. Hence, to design a report, one must take consideration of the users, and the circumstances in which such information is needed. Report should also include clear references, legends, symbols and abbreviations to provide better understanding and avoid any misinterpretation of the information.

3.14 Report Templates The report templates vary according to the organisation, the use of information and what is prevalent in the industry. For microfinance industry, we can identify single and multiple level users reports, which present information for a specific period (daily, weekly, monthly etc.) and the trend of the particular information overtime. The templates must respect the usability, trend analysis, information identification, categorisation and level of detail needed.

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3.15 Graph Analysis in Report Graphs help the users to easily capture/understand the message that the report is veiling. They must be well-designed and updated regularly so that staff can appreciate the trend of the particular information. There are various types of graphs that can be adapted to each report accordingly. The table below presents some key information of MFIs along with the proposed graph to welldescribe them:
Table 4: Information and Proposed Graphs Information Portfolio in arrears more than a certain number of days Portfolio in arrears by aging category Average loan size Total loan disbursements Total outstanding portfolio Total active clients Number of new clients and number of dropouts Income and expenses Expenses by category Yield compared with inflation rate Proposed Graphs Line Chart Area Chart Bar Chart Bar Chart Bar Chart Line Chart Bar Chart Bar Chart Line Chart Area Chart Line Chart

Section 4 : Designing and Implementing an MIS Designing and implementing an MIS is a complex task for an MFI. It necessitates enough time to effectively go through all the steps from conceptualising, designing, programming, testing, to the implementation of the system (Waterfield, et al.: 1998). The organisation must set realistic goals, assess the needs to be satisfied by the MIS and then articulate them clearly and simply, so that the design process can take consideration of each of them. Therefore, creating a successful MIS tailored to the needs of the institution requires an integrated, forward-looking approach. The design process can be divided into four phases described as:

Phase 1: Conceptualisation The conceptualisation phase focuses on: Identifying the organisations needs Determining what is feasible with respect to technology, staff capabilities and financial resources Performing an initial assessment of the alternativespurchasing an off-theshelf system, customising a standard system or developing a custom in-house system.

By defining its needs and performing an initial assessment of viable alternatives, the MFI develops a strategy document based on findings, which outlines the course of actions that guides the second phase.

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Phase 2: Detailed Assessment and Design If an organisation decides to introduce MIS, then it has to review the needs of the entire system in detailfrom the database table structures to the information to be collected, the rules to be applied, and the report formats to be generated. It also has to assess and design the systems accordingly. Finally, a detailed implementation plan, timetable, and budget need to be prepared. The process described above can be summarised into 3 steps: Step 1: Performing a detailed assessment of software Step 2: Completing the design Step 3: Finalising the MIS plan

Phase 3: System Development and Implementation Once an MFI conducts a detailed analysis of its systems and structures, it needs to develop and implement the MIS. The list below mentions the steps followed in this process, not necessarily in the same order: Step 1: Developing the software Step 2: Setting up the needed hardware Step 3: Preparing and revising documentation Step 4: Configuring the system Step 5: Testing the system Step 6: Transferring data to the new system Step 7: Provide Training to users Step 8: Running parallel operations to verify the accuracy of the new system

Phase 4: System Maintenance and MIS Audits At this level, the MFI focuses on issues that must be addressed after the MIS has been developed and implementedsystem maintenance, modifications, and periodic audits to ensure that the system is functioning properly. It is also important to draw contract with the software vendor to share the responsibility. The software firms responsibility does not end with the installation. It must provide reliable and timely support to the microfinance institution, to ensure that if the system does go down, it does not stay down long. The cost of support depends on the systems stability and reliability, with a relatively new system that has not been thoroughly tested requiring much more support. The cost normally declines as the microfinance institution grows more experienced with the MIS and thus more capable of solving problems.
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The software firm may charge additional fees for upgrades of the source code and for customised modifications. Also, regular reviews of the program (Audits of the MIS) will be needed to ensure that the system continues to function properly, reflects the institutions current policies and procedures, and meets its information and management needs.

4.1

MIS: Recording and Formats

It is very important to emphasise on the recording and formats which are at the crux of the MIS effectiveness. An MIS is only as effective and accurate as the records and books that provide it the basic data. Hence, this is a crucial aspect that requires attention in the design of the MIS. Records must be kept from the field to the head office. If the MFI is practicing a group methodology, the record format used for information gathering should match with the requirements from the MIS. Similarly, the branch recording system must fit the proposed/designed MIS. One should assess and enhance the formats and recording documents available so that only the required data is collected. Remember, the basic philosophy of the MIS should be to reduce record keeping work at the group and field level through standardisation of transactions. The MIS should help to reduce the load of reporting and recording work. However, this will be done while considering or putting in place an effective internal audit and control system.

Conclusion A management information system is one of the most critical tools indispensable for the development and the efficiency of any microfinance institutions; but it is the least understood. Ideally, it must be the first element to be thought of before initiating a microfinance activity. Information is as important as capital in the provision of financial services. Banks and all big financial service providers invest in it, why not an MFI that manages small and frequent financial transactions from the poor. Therefore, reliable MIS is a must for an MFI. To get into this venture, managers must assess the technology of their institution, define the reporting structure of the MIS sub-systems, search for a reliable technical service provider in the market and then make the decision, while considering its goals, strategy, operation system and resources available.

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Annexure Annexure 1 Indicators for measuring performance (SEEP Network, Measuring Performance of MFI, 2005)

There are a multitude of financial ratios and indicators, each of which may provide useful information to a microfinance institution (MFI) manager. Ratios and indicators help managers evaluate the performance of their organisation in several different aspects of its activity. The 18 indicators selected in this Framework recommended by the SEEP network reflect the areas of measurement that are priorities for most MFIs. The SEEP 18 are divided into the following four groups: Profitability and sustainability, Asset/liability management, Portfolio quality, and Efficiency and productivity. This handout begins by listing the term for each ratio, its formula, and an explanation of its purpose. Each ratio is then discussed in the context of its group, including a brief introduction to each group and a definition of each ratio. For each ratio, the Framework includes a description of the following: The formula, Why the ratio is important, and How to use adjusted data in the calculations and the effects of using adjustments. Taken as a whole, the ratios in this Framework provide a multidimensional perspective on the financial health of the lending and savings operations of the institution. The ratios must be analysed together; selective ratio use can create an incomplete picture.

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Annexure 2 Sample Formats of the Reports in an MFI

(a) Balance sheet
Initial Balance 2008 2009 2010

Assets Current Assets Cash and Bank current accounts Interest bearing deposits Loans outstanding Current Past due Restructured (loan loss reserve) Net loans outstanding Other current assets Fixed Assets Long term Investment Property and Equipment (Accumulated depreciation) Net Property and equipment Liabilities Short term Liabilities Short term borrowing (commercial) Customers savings Long term liabilities Long term loan Commercial rate Long term loan Concessional rate Equity Loan fund capital Grants Retained surplus/(Deficit) prior periods Retained surplus/(Deficit) this period

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(b) Income statements

2008 Financial Income Interest on current and past due loans Interest on restructured loans Interest on investment Loans fees / services charges Late fees on loans 2009 2010

Financial cost Interest on debt Interest paid on deposits

Gross financial margin Provision for loan loss Net financial margin Operating expenses Salaries and benefits Administration cost Occupancy expenses Travel Depreciation Other expenses

Net income from operations

Grants for OP

Surplus / (deficit)

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(c) Loan Portfolio Report

MFI: BRANCH: Month Particulars P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 P11 P12 P13 Total value of loans disbursed during period Cumulative value of loans disbursed Total number of loans disbursed during period Cumulative number of loans disbursed Number of loans outstanding (End of period) Value of loans outstanding (End of period) Average outstanding balance of loans Value of payments in arrears (End of period) Value of outstanding balance of loans in arrears (End of period) Value of loans written off during period Average loan size Average number of loans/officer during period Number of field officers

Aging Report

(A) Number of Loans in Arrears

(B) Outstanding Balance

(C) Loan loss Reserve(%) 0% 10% 25% 50% 75% 90% 100% 100%

(D) Loans loss Reserve (Rs) (B)*(C) 0 0 0 0 0 0 0 0 0

P14 P15 P16 P17 P18 P19 P20 P21 P22

Current <30 Days past due 31-60 Days past due 61-90 Days past due 91-120 Days past due 121-180 Days past due 181-365 Days past due >365 Days past due TOTAL

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(d) Sample Cash Flow Statement

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(e) Loan Tracking Sheet MFI Name Area Name: S.N. Group Name Loan ID Loan Amt. Date of Disb. Opening Balances During the Week Month : Closing Balances

Pri. O/S

Pri. O D

Pri. Prepaid

Current Pri. Due

Pri. Demand

Pri.Coll.

Pri. O/S

Pri. O D

Pri. Pre.

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(f) Active Savings Accounts Branch: Date: Prepared by:

Number

Name

Customer number

Account Balance

Last interest posting

Last Transaction date

Days without activity

Accrued Interest

Linked account

Total

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(g) Sample Loan Repayment Schedule Branch Customer name: Customer Number: Loan Number: Approved Date: Term: Prepared by: Amount Approved: Interest Rate: Fees:

Date

Disbursement

Principal

Fees

Savings

Interest

Total Payment

Loan Balance

Savings Balance

Total

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References Waterfield, C. And Ramsing, N. (1998): Management Information System for MFI: A Handbook, CGAP / World Bank, http://www.microfinancegateway.org/gm/document-1.9.29228/1631_044.pdf Bagchi, S. (2009): Lets Get It Right, MIS Toolkit, MicroSave Management Hub: Various advantages of Information Management Systems http://www.management-hub.com/information-management-advantages.html Ahmad, A: Management Information System for MFI, First Microfinance Bank Waterfield, C. & Ramsing N. (1998): Management Information System for MFI: A Handbook, CGAP / World Bank, http://www.microfinancegateway.org/gm/document-1.9.29228/1631_044.pdf Waterfield, C. (2007): The Importance of Management Information Systems for Successful MFIs, Presented at First Annual Seminar on New Development Finance, Frankfurt Germany, http://www.microfinancegateway.org/redirect.php?mode=link&id=20137 ibid ibid Ahmad, A: Management Information System for MFI, First Microfinance Bank Weihrich, H. (1993): Management: Science, Theory and Practice, University of San Francisco, San Francisco, California, http://media.wiley.com/product_data/excerpt/08/08186800/0818680008.pdf Koontz H., and ODonnell, C. (1968): Principles of Management: An Analysis of Managerial Functions, 4th Ed., McGraw-Hill, New York Management Study Guide: Functions Management http://www.managementstudyguide.com/management_functions.htm Campion, A (2000): Improving Internal Control: A Practical guide for Microfinance Institutions, Technical Guide No. 1. Washington D.C. Mbeba, R.D. (2007): MFI Internal Audit and Control Training Manual, MEDA and MicroSave Bagchi, S. (2009): Lets Get It Right, MicroSave MIS Toolkit Prakash, L.B. and Babu, K.S. (2008): Management Information Systems: Participants Manual, MicroSave Bruett, T. (Ed.) (2005): Measuring Performance of Microfinance Institutions: A framework for Reporting, Analysis and Monitoring, Small Enterprise Education and Promotion (SEEP) Network, United States

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Module 8 : Social Performance Management in Microfinance

Objective 1. 2. 3. 4. This module intends to familiarise the participants with the concept of Social Performance Management (SPM) in microfinance. This module also discusses the need, importance and impact of SPM on the organisations functionality and provides a detailed comparative analysis with financial performance of an MFI. It briefly discusses the issues related to adoption of ethics and transparency in the microfinance service delivery as microfinance deals with the poor and vulnerable sections of the society. The module also introduces a framework and indicators for assessing social performance of the MFIs.

Sessions 1. 2. 3. 4. Introduction to Social Performance Management (SPM) : Social Vs Financial Performance Importance of measuring social as well as financial performance Incorporating social performance into Strategic business plan Responsible Finance and Client Protection Principles

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Section 1 : Introduction to Social Performance Management (SPM) Lending to poor is as old as the civilisation itself. Formally, lending to poor started with Raiffeisen in mid 19th century with the introduction of cooperatives in Germany. Soon after this, the cooperative movement spread in other parts of the world which was later followed by several similar experimentations. (Topstars:2009). However, the term microcredit believed to be originated from the donor-led developmental programmes for the poor in Latin America and Bangladesh in early 1970s (Seibel:2005, Steger, et al.:2007). Since then, lending to poor witnessed several experiments such as introduction of new models and designs for delivery of microfinance services or transition from donor led to self sustaining independent financial organisations (Doran: 2008, CGAP). In fact this rapid transition of microfinance into an independent for-profit commercial activity around the world is rightly connoted by Sinha (2010) as overcharged bull growing at 70-100% per annum in some markets which traces its origin as a slow moving tortoise of the 1990s to the nimble hare of the early noughties (2000-05).This trend can be characterised by increased competition in the microfinance market resulting in more than one microfinance service providers operating in an area.
How Perception Changed: The Case of However, this unprecedented Indian Microfinance growth towards commercialisation led the microfinance sector to face In the quest of commercialisation, in India, , soon the challenges of astronomical after the financial successful IPO of Compartamos growth such as insufficient on the New York Stock Exchange (in 2007), managerial controls, increasing Sequoia made the first private equity (PE) interest rates while lending to the investment in Indian microfinance, buying shares poor, multiple lending leading to in SKS for an investment of $11 million. This move over indebtedness among the fundamentally changed the nature of microfinance customers (Venkata & in Indiaor perhaps accelerated the trend that had Yamini:2010), lack of staff training already started (Wright: 2010). In this phase the sector saw rapid growth on back of easy access to on dealing with customers, capital and debt from PE players, social investors deteriorating work condition for and Commercial Banks. The fallout from the SKS employees and increasing IPO has also been enormous and the investor got government/ regulatory an exit through the successful IPO. This however, interference and so on and so led to a stream of negative press explode into a forth. (Sinha:2010). The list does frenzy of accusations over foreign PE firms and not end here. Many MFIs were unscrupulous Indian promoters profiteering on the accused of being strict with back of the nations poor (Sharma and Wright: delinquent client, at times using 2010) post the successful SKS IPO. inhuman means for the recovery of loans. Particularly the pressure of lending institutions and investors also played an important role in unprecedented growth of microfinance.

These problems and inability of the sector to deal with these challenges were seen as drift of the MFIs from their social mission and being focused more on the commercial goals. Even the MFIs were blamed for showing shylockian streak and even termed new age money lenders by some. Given the nature of microfinance which is basically to deal with the poor and involvement of a diverse set of stakeholderspolicy makers, bankers, investors, governments, funders, and institutions, recent years have witnessed a push for MFIs to be more accountable
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both socially and ethically. Nonetheless, the core of a also implies that financial results must ensure sustainability at the same time. As CGAP rightly states that much of the passion and commitment to microfinance is anchored in the belief that access to financial services can help clients improve their lives, it becomes therefore equally important for MFIs to balance both the social and financial goals simultaneously.

1.1

SPM Defined

Being socially motivated in providing microfinance services is on the agenda of the stakeholders now. Many institutions, associations and countries have their own set of social agenda and ethical codes for servicing their customers. However, there is one thing common in all the efforts of assimilating social performance in microfinance i.e. the people which includes the customers as well as the human resources. Lets see what the definitions say:
Social Performance Management: What the Experts Say Social Performance as defined by Social Performance Task Force (SPTF), is the effective translation of an institution's social goals into practice in line with accepted social values. Further it states an MFI that manages its social performance needs to deliberately: Translate its mission and values into clear, measurable objectives to capture intentional social benefits Design and implement systems for social responsibility, including client protection Track, understand and report on whether it is achieving its social objectives Align its business processes to achieve both social and financial objectives Ensure that decision-making considers both social and financial outcomes.

Social performance is the effective translation of an MFIs social mission into practice by achieving certain goals/performance standards set out by the MFI itself, social performance management (SPM) focuses on: setting clear objectives and creating a deliberate strategy to achieve them designing and implementing systems that are aligned with social objectives monitoring and assessing progress towards achieving the social objectives using social performance information to improve overall performance and decision-making.

As per IFADs publication on Assessing and Managing Social Performance in Microfinance; the concept of social performance focuses not only on the final impact, but also provides a framework to understand the process by which social objectives are achieved.

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These definitions sets the tone for adopting SPM as an institutional process through which an MFI defines its social goals and objectives and further monitors the extent of achievement based on the implementation. These definitions also highlight that SPM seeks to ensure social goals in tune with the financial targets and growth of the organisation. Based on these definitions, one can infer some of the important features of SPM: SPM seeks to balance social and financial goals of any organisation. It ensures focus of organisation on the target segment i.e. the poor by factoring in social angles in the strategic and operational decisions of the organisation. SPM tracks impact of the services on the lives of the customers as well as changes promoted by the service providers. It monitors performance of the products and services by assessing their usage by the customers. It analyses needs and characteristics of the customers, which in turn helps in identifying opportunities for growth in the market and helps in segmentation of the portfolio. SPM also improves satisfaction and loyalty of the customers through improved customer focused services and products.

In addition to these customer oriented features, adopting SPM can be useful for the organisations in the microfinance sector. This is mainly because It brings in greater transparency which increases the confidence level of the donors and funders and makes fund raising relatively easier for the organisation. It helps understand the customers need and requirement and develop the products and services accordingly. Given the high level of competition helps bring in staff and customers loyalty and garners economies of scale in the long run. SPM also takes leverage of the public image being built through regular assessments and thereby helps in the growth of the volumes and scales of the microfinance programme.

1.2

Social Vs Financial Performance

As it has already seen above, there is a remarkable shift in the focus and approach of providing microfinance services. Sustainability has taken a prime position and with the advent of PE investors and bankers in financing microfinance initiatives, there is an increasing trend towards commercialisation, which resulted in Professionalisation of governance, management, accounting, human resources (HR) and other important sub systems of the institutions Financial systems approache.g. creating efficient operating systems, standardisation, cutting costs, increasing productivity thereby achieving sustainability

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Focus on reporting of financial data and ratios (number of clients, portfolio size, Operation Self Sufficiency (OSS), Return On Equity (ROE) and portfolio quality) Access to commercial banks and investment funds --- resulting in scaling up of MFIs and greater sustainability.

These criteria have always played an important role in ensuring financial sustainability of any organisation as it helps organisations to maintain quality portfolio, optimum client retention, staff retention and balanced financial ratios, which are imperative for any organisation- for its growth and survival. However, there is a trade-off between financial and social goals of microfinance as the services owe their success to retained and satisfied customers and the staff vis--vis strong financial systems. The sector till date struggles to achieve a balance between rapid growth, increasing customer outreach, maintaining healthy portfolio quality, becoming financially sustainable and at the same time ensuring accomplishment of its development goals like womens empowerment, rural outreach, and social responsibility towards customers (MIX). Given this current scenario, there is an acute need being felt amongst the industry stakeholders to take necessary measures to balance the double bottom line of microfinance. There is a need for MFIs to constantly check and keep track of the extent of accomplishment of their developmental mission and goals. Further, it is important to constantly take measures to align strategies and policies to achieve the stated social performance. In addition, there is a strong relationship between the social and financial performance of an organisation. Both have a substantial role to play in its overall growth and hence are interrelated. While financial performance always provides inputs and checks for optimising the performance standards to achieve sustainability, social performance also contributes in improving these standards. Gonzalez (Gonzalez:2010) tested the relationship between social and financial performance and concluded that social aspects bring positive results; contributing to the overall growth of the organisation. He stated that it has direct relationship with financial performance and productivity of the employees, client retention rate, and outreach and portfolio quality go up if the staff of the microfinance institutions (MFIs) are trained on social performance. In fact, several other researches too have pointed out at improvement in the following financial parameters after implementation of social performance (Gonzalez:2010, Simanowitz and Walter:2002, Imp-Act, Carboni, Et al: 2010, MicroSave): Improved outreach and client retention ratio, reduced portfolio at risk (PAR) and write off rate; leading to better portfolio quality. Healthy portfolio increases staff efficiency in terms of higher caseload management; leading to reduced cost per borrower. Better quality portfolio increases the motivation level of the staff thereby reducing the staff turnover rate.

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It brings in transparency, spirit of ownership and healthy competition amongst staff members.

1.3

Components of Social Performance Management

Integrating social performance and implementing it as the very part of the organisation processes and policies bring about lots of benefits to the stakeholders of the industry. The imp-act consortium focuses on three important components of SPM include setting up of clear objectives and goals, monitoring the progress on such goals and using the social performance information in the overall improvisation of the organisational policies. As Social Performance Management (SPM) aims to help the MFI fulfil its social mission by improving its systems, products and outreach, all the stakeholders must have something of their interest for ensuring their buy-in and acceptance. The section below summarises the key benefits and importance of SPM to the key stakeholders (Simanowitz et al:2005).

Managers / Board The entire idea of SPM in any organisation is essentially driven by the understanding and philosophy of the promoters, directors and senior managers. The top management and board of the organisation therefore have following important benefits of integrating SPM into the organisational strategies: Balancing financial and social goals for a sustainable performance. Too much focus on the financial goals may make the institution drift from its mission and take it away from the needs of its customers. Tracks organisations performance against its social goals and improvise policies for better implementation and outcomes. Brings in more transparency and breed spirit of customer protection within the organisation. Helps position itself publicly as a socially responsible organisation and better link with the local communities and increase their support To help attract socially-minded investors To align and improve systems, e.g. Management Information System (MIS), Operations, HR, etc for improved efficiency.

Clients: Improving Outreach, Services and Products SPM seeks to serve and preserve the best interest of the clients. The very objective of SPM is to understand customers needs and customise products and services best suited to their needs. Integrating SPM indicators brings in following benefits to the organisation:

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Since the organisation strives to design the products and services matching the needs and requirements of the organisation, it is more likely to bring in customers loyalty and satisfaction. Improves customer targeting of the MFI wherein it is more likely that an attempt is made to bring in customers who are vulnerable and financially excluded. Bring in transparency in the system wherein the customers are given true and complete information of the products, services and associated costs. This helps them to take informed decisions. If desired, track progress as to the MFIs impact on the customers lives (and make necessary changes as needed)

Investors: Improving Operational and Financial Performance In quest of profits many of the MFIs today are seen as having forgotten their social responsibility to the sector. The focus of the MFIs shifted more towards commercialisation; despite the fact that microfinance is considered to be a social activity. Many likeminded social investors invest in MFIs not for high return but for social reasons, expecting just reasonable returns. The integration of SPM in an organisations strategy brings in a higher level of comfort to these investors and donors. As a result of SPM the following operational and financial aspects of the organisation are improved, leading to improved confidence of the investors:

Better retention of customers/lower drop-outs Higher customer growth Lower portfolio at risk (PAR) due to more appropriate products and more satisfied customers Higher staff productivity and lower turnover Improved financial performance and profitability Better understanding of and involvement of the staffs in implementing the MFIs mission Greater transparency in dealing with stakeholders

SPM not only can help ensure that an MFI meets its mission and manages growing risks, but the organisation also has to improve its overall performance. Ensuring that customers are not over-indebted and that they clearly understand prices and terms and conditions of the loanwhether through strong communication, simple cashflow analysis and/or credit bureauswill not only assist customers, but also helps maintaining portfolio quality. Listening to cusotmes and adapting products and services can likewise lead to improved customer retention. Hiring and retaining the right staff, putting in place strong internal controls and even reaching out to the community are also ways to help mitigate risks. Indeed, a recent study concludes that
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being responsible to employees and the community are correlated with lower PAR (Leonard: 2010, MicroSave).

1.4

Measuring Social Performance: Tools and Techniques

There are various tools to measure social performance that can help MFIs and stakeholders through an analysis of a range of social performance parameters. Further these tools also help the management in integrating these into day today operations. The section below highlights various tools through which the social performance of an organisation can be measured. The benefit of using any of the tools or a combination thereof helps the organisation to be focused on providing valuable and usable information that will improve the business of the MFI through improving its products and services offered and the operational systems thus yielding improved customer satisfaction and loyalty (MicroSave).

Source: Social Performance Map, p. 133

As the social performance industry has evolved and a myriad of social assessment tools have emerged. These can be divided into five groups (Woller, et al: 2008): Social Audits/Assessments (blue section in figure above) These tools help institutions evaluate their intentions, systems and actions to determine whether they have the capacity and have addressed the internal processes adequately to attain their social objectives. These tools are often used for internal purposes only, for the MFIs to improve their systems and processes. These tools focus on the Intent and Design, Internal Systems, and Outputs stages of the social performance framework.

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CERISE Social Performance Indicators Initiative: The CERISE Social Performance Indicators (SPI) tool assesses the social performance of institutions by evaluating their intentions and actions. MFC Quality Audit Tool (QAT): The QAT was designed by the MicroFinance Centre (MFC) in Poland in conjunction with the Imp-Act Consortium to correspond with social rating methodology used by M-CRIL and Microfinanza Rating. ACCION SOCIAL: The ACCION social diagnostic tool is a framework through which it assesses social performance of the institution to evaluate the success of the MFI in fulfilling its social mission and its contribution to broadly accepted social goals (Microfinance Gateway). USAID Social Performance Audit (SPA) Tool: The USAID social audit tool uses a "process auditing" approach that evaluates the MFIs processes with reference to its stated social mission. Social Ratings (red section in figure above)

Social Ratings are generally used by MFIs for external purposes to be shared with donors, lenders or investors and focus on the same three areas as Social Audits but also include outcomes. Several rating agencies have developed social rating tools to complement their financial ratings, to fulfil the expectations of social investors from the institutional ratings. These include: M-CRIL: Based in India and affiliated with EDA Rural Systems, M-CRIL pioneered the social rating concept. According to M-CRIL, the purpose of the social rating is to assess the likelihood of an MFI achieving its social mission in line with accepted social values. The analysis focuses on several dimensions of social performance such as:
1. Social mission and systems 2. Policies and systems for fulfilling social responsibility 3. Outreach of the MFI

Microfinanza: (Italian-based, global rating agency) The MicroFinanza social rating is based on the audit of the social performance management system of an MFI and on a detailed assessment of its social results. Planet Rating: The rating agency of Planet Finance offers a tool that provides an opinion on the capacity of the MFI to achieve its social goals. It relies on evaluating the quality of MFIs social accounts coupled with an analysis of country data. They focus on the institutionalisation of the mission, outreach, service offerings and social responsibility. MicroRate: Their Social Rating combines an assessment of the MFIs social performance with an assessment of social risk defined as the risk that the
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MFI deviates from its social mission and fails to produce forward looking outcomes. Poverty Assessment Tools (green section) Poverty assessment tools typically consist of those tools used by MFIs (particularly those with a focus on poverty) to understand if it is reaching its target market and/or predict the likelihood their success of poverty alleviation. They include: Progress out of Poverty Index (PPI): Developed by Grameen Foundation, it is a set of country-specific poverty scorecards. Based on statistical analysis of national household expenditure surveys, it uses a small set of simple, easily observable and objective indicators to estimate the poverty likelihood of a person or group of persons, defined as the probability that they fall under an identified poverty line. USAID Poverty Assessment Tool: It is a set of country-specific surveys to predict the prevalence of extreme poverty within a group of people. The surveys include between 16 and 33 poverty questions derived from national household surveys. The tools make poverty calculations based on an aggregate for a group of people but are often less accurate (and not explicitly designed) for measuring poverty on an individual basis. FINCA Client Assessment Tool: This is an open source tool that employs a set of 13 individual screens to record income sources and dependents, monthly household expenditures, daily per capita expenditures and documenting spending on 6 social factors (food security, housing, education, etc). The Food Security Survey: This a nine-question survey developed by Freedom from Hunger that measures household access to food through available resources to purchase or barter for food. Housing Index: The housing index implemented by Cashpor uses the structure of the house, and sometimes the housing compound, to differentiate between economic levels of households and identify those who are poor. CGAP Poverty Assessment: CGAP collects rigorous data on poverty level of clients by using a survey on 200 randomly selected clients and 300 nonclients, but takes about four months to complete.

Impact Assessments The purpose of an impact measurement is to provide in-depth understanding of changes occurring in microfinance clients status and to further assess whether they can be attributed to (or are caused by) the MFI itself. It involves conducting research with the objective of attributing observed outcomes to organisational activity. Impact is determined by counterfactual, which requires comparing a treatment group to a valid control group. There are several academic institutions and individuals that
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conduct impact assessments but they are all constructed differently (and having evolved significantly over the years). SEEP/AIMS Tools: This tool is a quantitative impact survey based on a questionnaire applied to both sample and comparison group. It is important to note that the SEEP/AIMs toolkit uses many other tools that consist of indepth individual interviews (Client Exit surveys, Client Empowerment, Loan use over time) and group discussions (Client Satisfaction survey) that can assist evaluation of outcomes.

Section 2 : Social Performance Management This tool does an overall institutional assessment (via a rapid diagnostic) for the identification of quick wins and alongside providing technical assistance so that these can be integrated into the MFIs management systems. (Leonard M. et al, 2009) MicroSaves SPM Tool: This tool too focuses on assessing the alignment of the MFIs mission with their Management Information Systems (MIS), operational processes and human resource management systems. Thus evaluating their ability to serve and meet the needs of the clients they target.

2.1

Key indicators to measure social performance

For the various tools as listed above there are a set of indicators, which have been identified by the respective organisation by whom they have been designed. These are usually adopted by the MFI based on their understanding of the tool and depending on which would best suit their systems and policies which are already in place. Annexure 1 has a list of social performance indicators as indentified by various sector experts. The following table indicates a few indicators as developed by MicroSave.
Table 1: Social Indicators Developed by MicroSave S. No. MicroSave Social Indicators (1) Customer Satisfaction Higher client retention rate not only indicates high customer satisfaction levels, but is one predictor of strong financial performance (active clients at the end of the period/ active clients at the beginning of the period+ new clients) Measures the level of client satisfaction directly based on survey Shows the real cost of borrowing from an institution Remarks

Client Retention Rate

2 3

Client Satisfaction Level (score) Effective Annual Interest Rate (EIR)

Staff Satisfaction

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S. No.

MicroSave Social Indicators (1) Staff Retention Rate Staff Satisfaction Level (score) Average Salary per Field Staff Average Salary per Managerial Staff Lowest to Highest Salary Ratio

Remarks May indicate level staff satisfaction levels, but is one predictor of sustainability and higher financial performance (active staff at end of period/active staff at beg. of period+new staff) Measures the level of staff satisfaction directly based on survey Reflects the compensation structure of the MFI and may be compared with Cost of Living to assess its fairness Reflects the compensation structure of the MFI and may be compared with Cost of Living to assess its fairness Reflects the compensation structure of the MFI and shows the care SMT and Board takes of the lower level staff Proxy for depth of outreach relative to GDP per capita Proxy for depth of outreach (takes out bias effect of long-term clients graduating to higher cycles) Proxy for of depth of outreach (effected by longterm clients) Measures the efficacy of client targeting, especially if the mandate is to target rural clients Measures the efficacy of client targeting, especially if the mandate is to target urban poor Measures the average economic profile of clients using $1/day, PPI, national poverty level standards Some parameters like distance from the nearest block/ nearest bank branch etc. may be used Measures the efficacy of client targeting and inclusiveness if the mandate is to target vulnerable populations (Scheduled Castes / Scheduled Tribes/Other Backward Castes) Measures percentage previously unbanked of clients who were

2 3

Client Outreach 1 2 3 4 5 Outreach Ratio Average Starting Loan Size Average Loan Size Percentage of Rural Clients/Total Clients Percentage of Slumdwelling Clients/Total Clients Average Poverty Level Remote Customers Ratio Percentage of SC/ST/OBC Clients Previously Unbanked Ratio

6 7

Gender 1 2 Gender Ratio Determine the percentage of female clients accessing services Determine how accessible higher positions in MFI are to women

Female Staff to Female Management/Board ratio Outputs

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MicroSave Social Indicators (1) Percentage of clients accessing products which may improve the quality of life Insurance payout to actual expense ratio Percentage of clients accessing non-financial services Average Savings per Client (and per year) Average Education Level of Client's Wards Average Education Level of Client's Daughters Child Enrollment Ratio Mortality rate among Clients Average marriage age of Clients' Daughters

Remarks E.g. Education Loan, Health Loan, Emergency Loan, NFS etc. Measures the performance of MFI on mission if it aims to improve the quality of life Measures the efficacy of insurance if mission/MFI is interested to reduce vulnerability Measures the number of clients benefitting from NFS such as health, business skills, education, other training, etc. May show the client's capacity to save (even if in bank, etc.)

2 3

Outcomes and Impact* 1 2 3 4 5 6

Measures the performance of MFI on mission if it aims to improve the quality of life

Section 3 : Incorporating Social Performance Management into Business Plan A Strategic Business Plan (SBP) of any organisation is a document which is prepared for the benefit of the stakeholders, is the guiding plan for the foreseen future of the institution and hence is at many a time shared with the external stakeholders of the organisation. It is often considered as the face of the organisation. The SBP is essentially an initiative of the people higher up in the organisational hierarchy giving insights on the strategic direction that the organisation proposes to follow for years ahead. Therefore organisations stand on SPM is also important to be depicted in its SBP focusing also on how the same would evolve over time. Based on the understanding of the directors and senior managers of the organisation, the mission and vision of the organisation is set in place and so should SPM be. Integrating social performance indicators in the SBP may bring about following benefits to the organisation: Clarity of the social and development aspect of the organisations microfinance program. Offers clarity on the target market segment and clients of the organisation; which highly benefits the working of the second level management.

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Gives clarity to the other stakeholders on the organisations strategies, goals and policies.

The Strategic Business Plan (SBP) process should ensure that social as well as financial aspects and objectives are adequately covered. This is the key document that reemphasises the mission and vision of the MFI and as such forms the base for objectives and goals.. The mission of the MFI should contain social concepts and the business plan, through its key objectives and goals, should aim to fulfil the stated mission. Every MFI has a different mission and therefore the social performance analysis (and the tools to be used) will be different. For instance, an MFI targeting the poor, Poverty Wealth Ranking may be used, whereas for the one targeting women and aiming to empower them, the Empowerment Focus Group Discussion may be used. The following are examples of important questions/ concerns that need to be addressed in the SBP of the organisation, on the basis of the social goals set by an organisation (MicroSave):

Do you set targets based on social objectives? The business plan should help the MFI to act on the mission by setting social objectives and determining measures to achieve it. To probe this question, it is necessary to examine the KOGMA of the MFI. The MFIs KOGMA should reflect the social objectives in line with the mission statement.

Is the performance against your social objectives monitored? Setting objectives is easier than monitoring their actual implementation and evaluation results which, is far more difficult to do. If the performance is being measured, it demonstrates that the MFI already has a strong social focus. However, equally important is what is done with the monitoring of social performance or assessment of achievement of its social objectives. This information should not sit on a desk rather it should be used to take informed key decisions, form an integral part of regular reporting, and timely adjustments should be made if performance is off target.

3.1

Ethics in Microfinance

The microfinance sector is believed to be a place where there is deliverance of the poor out of poverty through access to financial services like savings, credit and insurance. This access to financial services can enhance poors capacity to take advantage of livelihood opportunities that would allow them to lift themselves out of poverty. As such, it aims to provide the right and quality services to the poor on a coordinated, permanent, and sustainable basis (MCPI). However with rapid growth the orientation of the sector moved towards commercialisation and then started a conflict between commercial and developmental aspirations. Given the types of
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customers and purpose that the microfinance activity seeks to serve; it is very important that the MFI follows certain ethical principles. Being ethical in approach brings in following benefits to the organisation: Promotes Development of the Sector

Understanding the need for adopting ethical practices, the microfinance sector has experimented with self-policing their conduct of business using written codes of conduct and other means across the globe. For example, in Cambodia ACLEDA Banks Code of Ethics covers issues such as personal behaviour; relationships with colleagues, customers, and regulators; confidentiality; conflicts of interest; acceptance of gifts; money laundering; and whistle blowing. Sa-Dhan and Microfinance Information Network (MFIN) in India both have come out with a specific set of code of conducts which emphasise on promoting the sector. Similarly, CGAP and Smart Microfinance came out with the principles that have been distilled from the path-breaking work by microfinance service providers, international networks, and national microfinance associations for developing pro-client codes of conduct and practices (see Annexure-2). All such activities taken up by the MFIs help in the development of the sector as a whole and immensely help in striking a balance for the double bottom line of microfinance players. Better Customer Protection

Client protection if done with desired efforts can immensely contribute to the overall institutional growth. Probably this is why all the codes of conducts across the world focused on protecting the customers. Customer protection can result in several important benefits to an organisation, for instance: Protect portfolio quality through responsible pricing and risk measurement Make access to quality human resources easy Ensure customer loyalty and trust Make funds mobilisation and accessibility easy Add immensely to the institutions goodwill. Help clients make an informed decision for themselves by providing them access to all necessary information.

Helps Bring in Higher Levels of Transparency

Being ethical is not only protecting customers, but also it means fair in dealings with all the other stakeholders and in transparent management functions. Transparency is an important aspect not for the clients and donors/ funders but all the stakeholders of the organisation. Transparency in microfinance can be brought though the proper functioning of the distinct parts of the organisation. Therefore it is important that the overall architecture of the organisation is set in place including MIS, internal control systems, communication, reporting, benchmarking, supervision, ratings etc (CGAP). There are several benefits of being transparent (CGAP):
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Improve performance: Right information to the managers at the right time helps them identify the areas of improvement and make informed decisions. Attract funders: Accurate, standardised information let donors and other investors better understand the performance of an MFI and make informed funding decisions. Protect clients: MFI clients deserve clear, straightforward disclosure of product terms, especially interest rates. This ensures healthy client relationship and brings in client loyalty.
Transparency in Pricing: Making Customers Understand the Cost

An important area for focusing on transparency in the microfinance industry is pricing policy of MFIs. The microfinance industry of the late has witnessed lot of unethical and non-transparent pricing policies and practices. Transparency as defined by Sa-Dhan national association of Community Development Finance Institutions in Indiaimplies complete and accurate information and educate the customers about the terms of financial services offered in a manner that is understandable by them. The two major reasons for non-transparent pricing in the microfinance industry are: No single market interest rate for micro-loans. The industry recognises that the rate of interest on micro-loans is higher than the commercial loans but it is seldom recognised that there really is no single market rate for micro-loans. It is because of the fact that, though the MFIs operate in a market where they all deal with almost the same cost structures yet the smaller the micro-loan, the higher the interest rate necessary for that MFI besides considering different other factors like geographies of operation, density of population, quality and cost of human resources and so on, to cover the costs of that loan in order to achieve sustainability. Lack of standardised pricing practices: All MFIs employed pricing practices based on their understanding of the same and eventually it became very difficult for any one MFI to convert to transparent pricing. As in case any if any MFI discloses its true price, it would end up advertising what would appear to be the highest price in the market, even though their true price could actually be the lowest. As a result, the vast majority of MFIs practice non-transparent pricing even though many would prefer to do otherwise.

Hence, it can be safely concluded that by practicing pricing transparency MFIs can contribute to building a healthy and vibrant market for microcredit products in each country by providing a valuable component necessary for free and competitive markets to develop transparent, open communication about the true cost of our products. By doing this we can make sure that our micro loan clients receive the same information that we expect to receive when we take out a loan for ourselves.

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Annexure Annexure I
Additional MIX Market Social Indicators S.No. Additional MIX Market Social Indicators (2) Client Outreach What percentage of all entering/recently joined clients is estimated to be below the poverty line, at the end of the reporting year? What percentage of all entering/recently joined clients are estimated to be in the bottom 50% of the poverty line), at the end of the reporting year? Of your clients who have been with your institution for 3 years, what percentage is estimated to be below the poverty line? Of your clients who have been with your institution for 5 years, what percentage is estimated to be below the poverty line? Client Protection Percentage of your clients that are borrowing from other institutions Percentage of your clients that are borrowing from money lenders Client Outputs Number/Percentage of Clients who received enterprise services Number/Percentage of Clients who received education services Number/Percentage of Clients who received health services Number/Percentage of Clients who received women's empowerment services Client Outcomes / Impact* Percentage of clients who have graduated from group loans, during the reporting year: Enterprises financed and employment generation Enterprises financed Number/Percentage of Start-up enterprises People self-employed (including household) in financed enterprises Hired workers (non-household) in financed enterprises Number/Percentage of full-time self-employed workers Number/Percentage of full-time hired workers Number/Percentage of part-time self-employed workers Number/Percentage of part-time hired workers Percentage of clients' daughters of primary school age who are attending primary school regularly (all vs. old clients - more than 3 years) Percentage of clients' daughters of secondary school age who are attending secondary school regularly (all vs. old clients - more than 3 years) Of your clients who have been with your institution for 3 years, what percentage is estimated to be above the poverty line now? What percentage of these clients (now above the poverty line) were below the poverty line when they joined the institution? Of your clients who have been with your institution for 5 years, what percentage is estimated to have moved above the poverty line What percentage of these clients (now above the poverty line) were below the poverty line when they joined the institution?

1 2 3 4 1 2 1 2 3 4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

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Social Performance Management Indicators as per MIX Market Social Performance Indicator Report SOCIAL PERFORMANCE QUESTIONNAIRE S. No. 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4 3.0 3.1 3.2 3.3 3.4 3.5 3.6 CATEGORY Mission Clarity What is your MFI's mission? Define what key terms mean Specific social goals and objectives Has there been any change in vision/mission? What is the poverty level of those clients that your institution wishes to reach? Is the mission communicated to all levels? What is target market of your institution? What development goals do you pursue through the provision of financial & non-financial services? Are you meeting your social goals presently? Governance Is there a diversity of backgrounds and expertise (social, financial and legal) on your board? How many times a year do they meet? Does your board monitor achievement of mission? Do your social objectives influence the setting of policy and strategic objectives at the board level? Alignment of Systems SBP: Do you set targets based on social objectives? SBP: Is performance against these objectives monitored? MIS: Does your MIS contain social indicators linked to your mission? Describe MIS: Is social data analysed and used in decision-making? HR: Does your induction / training include an emphasis on mission and social performance? HR: On which areas of social performance does training focus: preventing indebtedness, clear communication of prices, proper client treatment. Answer Score Comments / Description / Examples

Describe: If yes, describe: Other: Describe: Other: Other:

Describe:

Describe: Examples:

Describe:

If yes, describe: If yes, give examples:

Describe:

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SOCIAL PERFORMANCE QUESTIONNAIRE S. No. 3.7 3.8 3.9 CATEGORY Answer Score Comments / Description / Examples If yes: which? If yes, describe: If yes, describe how:

4.0 4.1 4.2 4.3 4.4 4.5 5.0 5.1 5.2 5.3 6.0 6.1 7.0
7.1

HR: Do your institution's staff performance appraisals of staff relate to social objectives? HR: Does your institution have in place a staff incentives scheme related to its social objectives? Internal Audit and Control: Are social objectives and criteria integrated into the institutions internal audit and control system? Social Goal - Client Services Lending methodology Number of products Offers some form of insurance? Offers some form of savings? Flexible services (terms, size, grace, top up) Market Research on Clients Has ways to understand Client Needs / Preferences (market surveys, client feedback) How often does your institution use such means Tailors products to reflect those needs/preferences Client Retention Calculates and Reports Exit/Dropout Rate? Responsibility to Clients: Client Protection
Do you have policies or practices designed to protect clients? (Privacy of clients data, proper treatment, nondiscrimination etc.) Measures to ensure Client Protection (training staff, supervision, clear instruction in ops manual, staff performance review, financial literacy etc) Does your institution ensure transparent communication with clients about prices, terms and conditions of financial products? Do staff provide clients with receipts for payment Does your institution have a practice/policy to avoid client overindebteness? Does your institution ensure that appropriate collections and delinquency management practices are followed?

List: Describe: Describe: Describe: Describe:

Examples:

If so, describe how:

7.2

7.3

How:

7.4 7.5 7.6

Describe: Describe: Describe:

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SOCIAL PERFORMANCE QUESTIONNAIRE S. No. 7.7 8.0 8.1 8.2 8.3 9.0 9.1 9.2 10.0 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 11.0 11.1 11.2 CATEGORY Does your institution have client feedback and complaint mechanisms in place? Cost of Services How are interest rates on loans stated? Do you know the percentage of clients borrowing from other institutions? Do you know the percentage of clients borrowing from moneylenders? Non-financial Services Does your institution offer any nonfinancial services to meet clients other needs? Links with partner organisations to provide NFS? Responsibility to Staff Do you have a clear HR policy to ensure fair and equal treatment of staff? Do you have a clear salary scale that reflects competitive or market rates? Does your institution provide staff with a full range of benefits (health insurance, pension, etc.) Do you monitor employee satisfaction? Are there clear policies for staff development (training plan, performance reviews, promotions) How often do staff receive feedback and performance reviews? Does your institution monitor staff turnover rates? Do you perform exit interviews with departing staff? Group Systems Do all members participate in governance and normal operations of the self-help group? Are members, or member representatives, involved or consulted in some way in the decision-making and management of your institution? Ensures accountability to its JLG/SHG groups? Answer Score Comments / Description / Examples

How does this compare with competition? ____% ____%

List: Describe:

Explain: Describe: How? (If not, why not?)

Why not? Describe: Describe:

11.3

How?

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SOCIAL PERFORMANCE QUESTIONNAIRE S. No. 11.4 11.5 11.6 12.0 12.1 CATEGORY Answer Score Comments / Description / Examples How? Describe: Describe:

12.2

13.0 13.1 13.2 13.3

13.4

14.0 14.1 14.2 14.3 14.4 14.5 15.0 15.1

Ensures accountability of group leaders to members? Regular rotation of group/centre leadership? Any activities to build capacity of groups? Gender Approach Do you have any policies/strategies to address gender inequality in society? (eg. through client targeting, products or methodology)? Do you have any gender policies/strategies to address gender inequality in your institution (eg. hiring, advancement; anti-sexual harassment)? Responsibility to Community and Environment Has a policy for responsibility to the community (eg. job creation, no child labour)? Undertakes other activities or initiatives for the benefit of the community? Has a formal/informal policy for responsibility to the environment for the type of client enterprises/activities for which you give loans? Do you have an environmental policy for the internal functioning of your MFI (eg. water/electricity conservation) Social Goal - Outreach There is a clear selection process for villages? Your institution has a clear client targeting strategy (eg. eligibility criteria)? If yes or partiallly, are you reaching who you think you are? Does your institution measure the poverty level of entering / recently joined clients? If yes or partially, how does it measure poverty? Social Goal - Impact Does your institution track the changes in poverty over time in its clients?

Describe: Examples: Describe:

Describe:

Describe:

How do you know?

0 How?

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SOCIAL PERFORMANCE QUESTIONNAIRE S. No. 15.2 15.3 CATEGORY Does your institution track any other changes in socio-economic outcomes of clients? Which of the following does it track? Answer Score 0 Comments / Description / Examples

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Annexure 2 Ethical Principles in Microfinance

CGAP and Smart Microfinance Principles of Client Protection:

Avoidance of Over-Indebtedness: Financial Service Providers will take reasonable steps to ensure that credit will be extended only if borrowers have demonstrated an adequate ability to repay and loans will not put the borrowers at significant risk of overindebtedness. Similarly, the service providers will take adequate care that only appropriate non-credit financial products (such as insurance) are extended to clients. Transparent and Responsible Pricing: The pricing, terms and conditions of financial products (including interest charges, insurance premiums, all fees etc.) will be transparent and will be adequately disclosed in a form understandable to clients. Responsible pricing means that pricing, terms, and conditions are set in a way that is both affordable to clients and sustainable for financial institutions. Appropriate Collections Practices: Debt collection practices of providers will be neither abusive nor coercive. Ethical Staff Behavior: Staff of financial service providers will comply with high ethical standards in their interactions with microfinance clients and such service providers will ensure that adequate safeguards are in place to detect and correct corruption or mistreatment of clients. Mechanisms for Redress of Grievances: The financial service Providers will have in place timely and responsive mechanisms for complaints and problem resolution for their clients. Privacy of Client Data: The privacy of individual client data will be respected in accordance with the laws and regulations of individual jurisdictions, and such data cannot be used for other purposes without the express permission of the client (while recognising that providers of financial services can play an important role in helping clients achieve the benefits of established credit histories).

Sa-Dhans Core Values and Voluntary Mutual Code of Conduct

Introduction Microfinance institutions seek to create social benefits and promote financial inclusion by providing financial services to low income households, including those who were previously excluded. As these institutions build partnerships with their clients and the microfinance sector grows more complex, it is getting increasingly important to define core values and fair practices, so as to ensure that microfinance services are provided in a manner that benefits and respects clients. This document states core values for microfinance (Part-I), a voluntary mutual code of conduct for microfinance institutions to abide by these values (Part-II) and a process of compliance (Part-III). All microfinance institutions, which are members of SaDhan, unanimously and whole-heartedly agree to abide by the core values and the code of conduct as set out hereunder: Part- I Sa-Dhans Core Values In Microfinance Integrity Our mission is to service low-income clientswomen and menand their families, providing them short term and/or long-term access to financial services, that are client focused, designed to enhance their well-being, and delivered in a manner that is ethical, dignified, transparent, equitable and cost effective. Quality of Service We believe that our clients deserve fair and efficient microfinance services. We will provide these services to them in as convenient, participatory and timely manner as possible. 211

Transparency We shall give our clients complete and accurate information and educate them about the terms of financial services offered by us in a manner that is understandable by them. Fair Practices We are committed to ensure that our services to our clients are not unethical and deceptive. In providing microfinance services including lending and collection of dues, we are committed to fair practices, which balance respect for clients dignity and an understanding of a clients vulnerable situation, with reasonable pursuit of recovery of loans. Privacy of Client Information We will safeguard personal information of clients, only allowing disclosures and exchange of such information to others who are authorized to see it, with the knowledge and consent of clients. Integrating Social Values into Operations We believe that high standards of governance, participation, management and reporting are critical to our mission to serve our clients and to uphold core social values. Feedback mechanism We shall provide our clients formal and informal channels for their feedback and suggestions for building our competencies to serve our clients better.

Part-II
Voluntary Mutual Code of Conduct To ensure that all our activities and dealings with clients are in compliance with the above core values, we all agree to adopt the code of conduct as elaborated hereunder: 2.0 Application of the Code: i) This code applies to all categories of member microfinance institutions - irrespective of their constitution (a society or a trust or company or cooperative society under any state enactment or Multi-State Cooperative Societies Act) - whose principal activity is microfinance. ii) This code applies to following activities undertaken by member microfinance institutions: a) Formation of any type of community collectives including self-help groups, Joint liability groups and their federations. b) Providing financial literacy to the clients. c) Collection of thrift from clients. d) Making arrangement for remittance of funds collected from clients through banking channels or by any other means. e) Providing credit services to clients individually or in groups; f) Recovery of credit provided to clients for economic activities or for any other purpose for the welfare and benefit of clients. g) Business development services including marketing products or services made or extended by the eligible clients or for any other purpose for the welfare and benefit of clients. h) Providing insurance or pension benefit products as partners or agents of insurance companies, or pension or mutual fund schemes duly licensed to undertake microfinance or insurance or pensioners benefit schemes by a competent authority. iii) Certain key words used in this code are defined in the Annexure at the end of this code. iv) This code comes into effect from 18 January 2007 unless otherwise indicated.

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2.1 We all agree to i) Promote and strengthen the microfinance movement in the country by bringing the lowincome clients to the mainstream financial sector. ii) Build progressive, sustainable and client-centric microfinance institutions in the country to provide integrated financial services to our clients. iii) Promote cooperation and coordination among microfinance institutions and other agencies to achieve higher operating standards and avoid unethical competition in order to serve our clients better. 2.2 In order to achieve the aforesaid, we all agree to follow the following practices mentioned below: 2.2.1 INTEGRITY We agree to i) Act honestly, fairly and reasonably in conducting microfinance activities. ii) Conduct our microfinance activities by means of fair competition, not seeking competitive advantages through illegal or unethical microfinance practices. No officer, employee, agent or other person acting on our behalf shall take unfair advantage of anyone by manipulation, concealment, abuse of privileged information, misrepresentation of material facts or any other unfair practice. iii) Prominently display the core values and code of conduct on the notice board of head office and all branches, and put systems in place to ensure compliance. iv) Ensure that our staff and any person acting for us or on our behalf are trained or oriented to put these values into practice. 2.2.2 TRANSPARENCY We agree to i) Disclose to clients all the terms and conditions of our financial services offered in the language understood by the client. ii) Disclose the source of funds, costs of funds and use of surpluses to provide truthful information to clients. iii) Provide information to clients on the rate of interest levied on the loan, calculation of interest (monthly/quarterly/half-yearly), terms of repayment, and any other information related to interest rates and other charges iv) Provide information to clients on the rate of interest offered on the thrift services provided by us. v) Provide information to clients related to the premium and other fees being charged on insurance and pension services offered by us as intermediaries. vi) Provide periodical statements of our accounts to the clients.

2.2.3 FAIR PRACTICES

We are committed to follow fair practices built on dignity, respect, fair treatment, persuasion and courtesy to clients. We agree toi) Provide micro finance services to low income clients irrespective of gender, race, caste, religion or language. ii) Ensure that the services are provided using the most efficient methods possible to enable access to financial services by low income households at reasonable cost. iii) Recognize our responsibility to provide financial services to clients based upon their needs and repayment capacity. iv) Promise that, in case of loans to individual clients below Rs 25,000, the clients shall not be asked to hand over original land titles, house pattas, ration cards, etc as collateral security for loans except when obtaining copies of these for fulfilling know your 213

customers norms of the RBI. Only in case of loan to individual clients of Rs 25,000/and above can land titles, house pattas, vehicle RC books, etc. be taken as collateral security. v) Interact with the clients in an acceptable language and dignified manner and spare no efforts in fostering clients confidence and long-term relationship. vi) Maintain decency and decorum during the visit to the clients place for collection of dues. vii) Avoid inappropriate occasions such as bereavement in the family or such other calamitous occasions for making calls/visits to collect dues. viii)Scrupulously avoid any demeanour that would suggest any kind of threat or violence. ix) Emphasize using social collateral which includes various forms of peer assurance such as lending through groups and group guarantees at the village, hamlet or neighbourhood level, or guarantees by relatives, friends, neighbours or business associates; and explain clearly to clients what are the obligations of social collateral.

2.2.4 GOVERNANCE We agree to

i) Observe high standards of governance, ensuring fairness, integrity and transparency by inducting persons with good and sound reputation, as members of Board of Directors. We shall ensure that the majority of the directors are independent directors and/or duly elected representatives of the community we serve, and that we will involve the Board in all policy formulation and other important decisions. ii) Ensure transparency in the maintenance of books of accounts and reporting/ presentation and disclosure of financial statements by qualified auditor/s. iii) Put in our best efforts to follow the Audit and Assurance Standards issued by the Institute of Chartered Accountants of India (ICAI). iv) Place before the Board of Directors, a compliance report indicating the extent of compliance with this Voluntary Mutual Code of Conduct, specifically indicating any deviations and reasons therefore, at the end of every half financial year. 2.2.5 FEEDBACK/ GRIEVANCE MECHANISMS We agree to i) Establish effective and efficient feedback mechanism ii) Take steps to correct any errors and handle complaints speedily and efficiently. iii) Provide; where a complainant is not satisfied with the outcome of the investigation into her complaint, she shall be notified of her right to refer the matter to the Ethics and Grievance Redressal Committee constituted by Sa-Dhan.

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Code of Conduct of Microfinance Institutions Network (MFIN)

I. INTRODUCTION Microfinance Institutions Network (MFIN), a self regulatory organization of NBFC-MFIs is formed during 2009. MFIN aims to work with regulators to promote microfinance to achieve larger financial inclusion goals. Our organization is a member of MFIN. The MFIN board has adopted the code of conduct (COC) for its members. The COC of MFIN is designed to ensure that its members follow the RBI guideline as also few self imposed guidelines to improve the quality of lending, transparency, self discipline, coordination among MFIs &healthy competition, grievances redressal mechanism, anti-poaching activities etc. It is therefore mandatory for us to implement the COC of MFIN at all levels. II. MFIN CODE OF CONDUCT The list of the code of conduct as relevant to the branches is mentioned here below: A. Fair Practices with Borrowers: MFIs should clearly convey to the borrowers by way of loan card, passbook or through Kendra meeting the following terms of the loan: a) All the important terms and conditions of the loan agreement b) Rate of interest on declining balance method c) Processing fee d) Any other charges e) Security or any other deposit. f) Systematic advance collections g) Total charges recovered for insurance coverage and risks covered h) Any other services rendered and charges for the same Recovery mechanism: a. Though each MFI should ensure timely recovery of dues, it is imperative that the MFIs shall not use any abusive, violent, or unethical methods of collection and the recovery efforts should be in line with RBI guidelines issued from time to time. b. A valid receipt should be provided by MFI for each collection from the borrower. B. Multiple Lending & Lending Limits: a) The maximum number of MFIs who can lend to one client is three, and the maximum loan outstanding from all the three MFIs together to a single client is restricted to Rs. 50,000/- at any point of time. b) This cap will cover only unsecured loans given within the joint liability group mechanism c) Any secured loans or individual business loans will not be covered under this cap. d) The code will not cover the credit norms to be fixed by individual member MFIs. C. Data Sharing /Incident Sharing In addition to the formatted data supplied to the Credit Bureaus like CIBIL and High Mark, the MFIs should agree to participate in a forum to share qualitative credit information. a) Whenever any member comes across Incidents of High Default (IHD), the member should inform the Association of the same so that the other members are made aware of it. However whether any other member would further lend to clients in such an area would be the choice of each individual MFI based on their credit policies b) In case of any Incidents of High Default is faced by one MFI, all members shall cooperate in a recovery drive and restrain lending in that area till things are streamlined.

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D. Recruitment: a. The code covers all MFI staff, in particular field staff up to the branch manager cadre. b. Any member MFI should have at least 50 percent of its net new recruitment in any particular year as people whose immediate previous job has not been with another member MFI. c. As a matter of free and fair recruitment practice, there will be no restriction on hiring of staff from other MFIs by legitimate means in the public domain like general recruitment advertisements in local newspapers, web advertisements on site, walk-in interviews, etc. d. Whenever a member MFI recruits from any other member MFI, it will be mandatory to seek a reference check from the previous employer. e. All member MFIs also agree not to recruit anybody from the other members without the relieving letter / no due certificate from the previous MFI employer. f. All member MFIs agree to provide such relieving letter / no due certificate to the outgoing employee in case he has given proper notice, handed over the charge and settled all the dues towards the MFI. g. Any staff member who is discovered to have lied about his background of working with any other MFI, will be asked to leave immediately by the recruiting MFI. e. Whistle Blowing: a. Any person or MFIN member is entitled to report an incident of improper conduct by another MFIN member, to the Code of Conduct Enforcement Committee (CCEC) of MFIN. b. The CCEC shall investigate such instances within 30 calendar days of receiving such report. For this purpose the CCEC may depute its own staff or use the services of outsourced agencies as the CCEC thinks fit. D. Enforcement Mechanism: a) The CCEC has developed a mechanism to conduct the inquiry in a fair manner on receipt of any incident reported by any person or MFIN member. It takes appropriate action against the erring MFI. b) This mechanism is developed to ensure that all member MFIs should strictly follow the COC. E. Ombudsperson Mechanism: a) MFIN Board will appoint one or two individuals of high professional reputation and integrity, as Ombudsperson in each of the six RBI regions East, West, Central, South, North and Northeast, to provide an independent mechanism to individual consumers or staff members to complain against an MFI and seek redressal. b) Any person desiring to complain against an MFIN Member shall write a letter to the Ombudsperson c) The Ombudsperson, on receipt of the complaint will send copies to the Chairman of the CCEC and the Chairman of MFIN Board. The Ombudsperson can cause an initial inquiry to be conducted to determine prima facie if there exists a case for investigation d) The Ombudsmen will have the power to ask the errant MFI to make good any damages incurred by the consumer, and in addition impose a fine on the MFI, commensurate with the seriousness of the complaint.

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References Topstars:2009, http://www.google.co.in/#sclient=psy&hl=en&q=interest+rate+ethics&aq=f&aqi=& aql=&oq=&gs_rfai=&pbx=1&fp=b63669bddff54f57 TOPSTARS Micro Support Services (2009): The History of Microfinance, http://www.microfinancegateway.org/p/site/m//template.rc/1.9.45764 Seibel, H D (2003): History matters in microfinance, Small Enterprise Development, An International Journal of Microfinance and Business Development, vol. 14, no. 2 (June 2003) Steger, U., Schwandt, A. and Periss, M. (2007): Sustainable Banking with the Poor: Evolution, Status Quo and Prospects, http://www.imd.org/research/publications/upload/CSM_Steger_Schwandt_Perisse _WP_2007_12_level_1.pdf Doran, A. (2008): Private Sector Microfinance, From Poverty to Power, Background Paper, Oxfam, UK http://www.oxfam.org.uk/resources/downloads/FP2P/FP2P_Priv_Sector_Microfin ance_BP_ENGLISH.pdf Wright, G.A.N. (2010): Microfinance In India: Built On Sales Targets or Loyal Clients?, MicroSave India Focus Note 42, http://www.microsave.org/briefing_notes/india-focus-note-42-microfinance-inindia-built-on-sales-targets-or-loyal-clients Sharma, M. and Wright, G. A. N. (2010): Commercialisation of Microfinance in IndiaIs it all bad?, MicroSaves India Focus Note 43, http://www.microsave.org/briefing_notes/india-focus-note-43-commercialisationof-microfinance-in-india-is-it-all-bad. Venkata N.A and Yamini V. (2010): Why do Clients Take Multiple Loans? ,MicroSaves India Focus Note, 33 http://www.microsave.org/briefing_notes/indiafocus-note-33-why-do-microfinance-clients-take-multiple-loans Sinha, S. (2010): How to calm the Charging Bull, An Agenda for CGAP in the decade of teenies,, M-Cril, India, http://www.google.co.in/url?sa=t&source=web&cd=3&ved=0CCcQFjAC&url=http% 3A%2F%2Fwww.m-cril.com%2FBackEnd%2FModulesFiles%2FPublication%2F1003-16%2520 %2520How%2520to%2520calm%2520the%2520charging%2520bull.pdf&rct=j&q= how%20to%20calm%20the%20charging%20bull%2C%20sanjay%20sinha&ei=uIgtT absBoqurAfQzrD8CQ&usg=AFQjCNHoe0m4nWh_43Hkq01V6VtfOR7B5A&cad=rja http://www.cgap.org/gm/document-1.9.2581/FN41.pdf Inspired by the definition put forth by the Social Performance Task Force: www.sptf.info Imp Act (2009): Adapted from Putting the Social into Performance Management, Campion et al, Imp-Act Consortium/IDS and the SPM Principles IFAD: Assessing and Managing Social Performance in Microfinance http://www.google.co.in/#sclient=psy&hl=en&q=IFAD%2C+managing+social+per formance+in+microfiancne&aq=f&aqi=&aql=&oq=&gs_rfai=&pbx=1&psj=1&fp=b6 3669bddff54f57
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www.themix.org/publications/microbank Gonzalez, A. (2010): Microfinance Synergies and Trade-offs: Social vs. Financial Performance Outcomes in 2008 http://www.themix.org/publications/data-briefno-7-microfinance-synergies-and-trade-offs-social-vs-financial-performance-o Gonzalez, A. (2010): Microfinance Synergies and Trade-offs: Social vs. Financial Performance Outcomes in 2008, http://www.themix.org/publications/data-briefno-7-microfinance-synergies-and-trade-offs-social-vs-financial-performance-o Simanowitz, A. and Walter, A. (2002): Ensuring ImpactReaching the Poorest while Building Financially Self-sufficient Institutions, and Showing Improvement in the Lives of the Poorest Families, Occasional Paper No. 3, Imp-Act, Institute of development Studies, UK Imp-Act is a collaborative programme between 30 MFIs in 20 countries and a team of academics from the UK universities of Bath and Sheffield, and the Institute of Development Studies, Sussex University. Carboni, B.J., Caldern, M.L., Garrido, S.R., Dayson K and Kickul, J (2010): Handbook of MicroCredit in EuropeSocial Inclusion through Microcredit Development, Edward Elgar, UK MicroSave (2010): SPM Assessments in South east http://www.microsave.org/newsletter/e-bulletin-on-social-performancemanagement-november-2010 Asia

Simanowitz et al, (2005): Social Performance Management in Microfinance Guidelines, Imp-Act Consortium / IDS Leonard M. (2010): Social Performance Management in India, MicroSave India Focus Note 35, http://www.microsave.org/briefing_notes/india-focus-note-35social-performance-management-in-india Leonard M., Linder C., Feris M., Lal N., Meggs A.(2009): Social Performance Management Toolkit, MicroSave This section draws from Social Performance Map, SEEP Network, http://communities.seepnetwork.org/sites/hamed/files/SPMap_2ed.pdf Microfinance Gateway: http://www.microfinancegateway.org/p/site/m/ SPA is an audit tool that falls under the red section of the framework as it also focuses on outcomes but is primarily used for internal purposes and has therefore been positioned in this section. The FFH Food Security Survey, Cashpor Housing Index and CGAP PAT are not mentioned in the SEEP Performance Map Leonard M., Linder C., Faris M., Lal N., Meggs A., (2009): Social Performance Management Toolkit, MicroSave Ville, A. Moors, K. and EMP (2008): Adapted from MIX Market "Social Performance Standards Report", and MicroRates Performance Indicators for Microfinance Institutions, M-CRIL and CGAP Leonard M., Linder C., Feris M., Lal N., Meggs A.(2009): Social Performance Management Toolkit, MicroSave

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KOGMA: stands for Key Objectives, Goals, Measures/targets and Activities which together provide a clear, simple framework for the implementation of your Strategy. From MicroSaves Strategic Business Planning for Market-led Financial Institutions Toolkit MCPI code of ethics (code of ethics in Philippines) Scmidt, R.H.: Microfinance Commercialisation (http://www.finance.uni-frankfurt.de/wp/1704.pdf) and Ethics

ACLEDA Bank Plc (2007): Annual Report, (also in Cambodia Consumer Protection Diagnostic Report) Microfinance Focus Article Strategic Benefits of Adopting Client Protection Principles in Microfinance on http://www.microfinancefocus.com/news/2010/10/08/strategic-benefits-ofadopting-client-protection-principles-in-microfinance/ Donorbrief07 by 1.9.2429/DonorBrief_07.pdf) Donorbrief07 by 1.9.2429/DonorBrief_07.pdf) Refer article on: Need (www.mftransparency.org) Refer article on : Need (www.mftransparency.org) CGAP CGAP for for pricing pricing (http://www.cgap.org/gm/document(http://www.cgap.org/gm/documenttransparency transparency in in microfinance microfinance

Adapted from MIX Market Social Performance Standards Report http://www.smartcampaign.org/about-the-campaign/smart-microfinance-and-theclient-protection-principles http://www.cgap.org/p/site/c/template.rc/1.26.4943/ http://www.sa-dhan.net/Resources/corevalues.pdf

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Module 9 : Product Development in Microfinance

Objectives 1. 2. 3. The present course module focuses on strategic marketing and product development process in microfinance. It intends to familiarise participants with the reasons, concepts, features and process of product development in a microfinance organisation. The module also discusses environmental and institutional prerequisites and risks while adopting strategic marketing by a microfinance institution.

Sessions 1. 2. 3. 4. 5. 6. 7. 8. Rationale for Product Development in Microfinance Process of product development Prerequisites for product development processinternal preparations and requirement of resources Understanding Clients needs through Market Research Pilot Testing of Financial Services Strategic marketing and launch of new product New Product Development in MFI Drivers Product Rollout

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Section 1 : The Marketing Concept: Historical Journey Attracting and retaining customers is always a challenge for any organisation. Successful organisations strive for high customer retention as well as attracting new customers at the same time through various types of marketing strategies like offering new products, giving add ons, discounts, etc. However, the concept of keeping consumers/end users at the core of any organisational strategy has traversed a long path before its assimilation in the so called corporate domain. Long ago when the markets were not developed and there were only few organisations, the companies used to follow product approach. The basic reason of following this approach was scarcity of goods and services in which the companies were involved. The product approach was later on gradually replaced by a newer humane concept of people or market approach, which places importance on people (i.e. customers) and values their needs and demands for a particular product or service. In fact there are fundamental differences in these two approaches. The former approach is based on the hypothesis that whatever organisation produces or make available to the customer, it will be sold in the market. It assumes that the company knows what to make and the market will buy enough units to produce profit for the company. However, the later believes in catering to the demands of the market i.e. needs of the end users. This approach propounds that organisations tend to choose the approach which suits their business goals based on certain drivers like availability of similar product/service in the market, competition, to business philosophy or more importantly philosophy of promoters and many such factors. Nonetheless, the two theories emerged from various schools of thought (mentioned hereunder) in different time periods which can be characterised by both demand and supply needs of the organisations as well as of the customers. 1.1 Production concept: Make it and it will sell

The production concept is as old as the industrial revolution and dates back its origin around 1920s. This concept lays its focus on mechanical creation of demand assuming that the supply of low cost products would itself create the demand for the products. Plainly speaking, the production-oriented businesses focus on producing as much of their product or service as cheaply as they possibly can because they assume that consumers are primarily interested in product availability and low prices. The key questions asked in this concept are: can the organisation produce the product? Or can it produce enough of it? The production concept works well in those organisations engaged in production of the goods fulfilling basic necessities thereby creating a high level of demand. Comparably, the job of the sales team is quite simple and only involves executing the transactions on the price as per the cost of production. Till today the production concept is common and relatively effective in new industries where a product is in high demand and there is very little supply. 1.2 Selling concept: Promote it well and it will sell

With the increased competition in the market followed by mass production of goods fulfilling the most unfulfilled demand, the firms tried to reach out to the buyers in the market and thus the sales concept (or selling concept) was originated. Under this business philosophy, the companies not only produce the products, but also heavily use advertising and personal selling to convince the customers for buying those
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products. This approach raises the key questions such as: can the organisation sell the product? Or can it charge enough for it? In real terms, the sales-oriented businesses focus on persuading customers to buy whatever goods or services they are producing. It lays its foundation on the belief that the consumers are naturally hesitant to make purchases and are often illinformed or confused about their purchase options and therefore, they should be pushed to buy the product through aggressive promotions. However, the basic drawback of this concept lies in its little focus on the product actually needed in the market. It aims only at selling the produce as far as possible as a strategy to beat competition prevailing in the market without having a focus on customer satisfaction. 1.3 Product concept: Make it well and it will sell

The focus of this concept rests on producing the highest quality goods and services as possible and improving them over time. It is assumed under this strategy that highest standards of goods and services would be the most sought items by the customers. This philosophy also emerged as a result of competition in the market rather than quality of products. It took into consideration the following questions before producing the product: can the organisation produce quality products? Or can the organisation meet the highest quality standards in the market? 1.4 Marketing concept: Make something the market values and it will sell

With increase in income levels over time, the consumers started taking decisions on choosing a product and being selective while buying only those products that precisely meet their changing needs. The questions in this concept focus more on customers rather than product or sales, such as what do customers want? How can the organisation keep its customers satisfied? In fact, market-oriented approach focuses on understanding target market needs and responding to them in all aspects of their operations. It believes that by trying to understand the consumers perspective, organisations will be in the best position to develop products that are valuable to the market and, therefore, can be easily sold at a profit. Marketing also offers benefits to the society at large and includes (Christ, 2009) Developing products that satisfy needs, including products that enhance societys quality of life Creating a competitive environment that helps lower product prices Developing product distribution systems that offer access to products to a large number of customers and many geographic regions Building demand for products that require organisations to expand their labour force Offering techniques that have the ability to convey messages that change societal behaviour in a positive way

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With the growing needs of survival in the market, companies and organisations have now adopted the concept of marketing globally. Customer needs and preferences are kept at the nucleus of organisational strategies. Various product development strategies have been adopted by the companies to attract more and more customer vis--vis retain old customer. Microfinance has not been an exception to this, as primarily the success of microfinance business is directly related to increase in its customer outreach.

Section 2 : Factors Leading to Introduction of Marketing Concept in Microfinance Microfinance was originally methodology driven or in simpler terms production driven. This was mainly because poor people did not have access to financial services. Initially many of the microfinance institutions offered highly standardised loans only. Even till now many microfinance service providers continuing the legacy and are offering highly standardised loans with little variations only. However, the situation saw a silver lining when competition increased and market matured. This created intense pressure on the service providers to retain their customers as well as increase their customer base. In order to attract more and more customers, which are vital to the sustainability of any microfinance intervention, the microfinance institutions across the globe started experimenting with a line of products. This customer driven product approach was adopted mainly because of the following factors (Brand: 2001 and Bamako: 2000). Increase in competition with the introduction of newer and commercial players Increasing customer dropout rates resulting inappropriateness of current product offerings from inflexibility or

Enhanced organisational understanding of customer needs and realisation of the fact about change in customer preferences due to improvement in their economic conditions Growth in organisational competencies to handle multiple products

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Figure 1: Typical Phases in the Growth of Microfinance Market (adapted from WWB, 2005)

A growth curve of market development of microfinance presented by Womens World Banking (WWB) gives an overview of the factors responsible for introducing marketing in microfinance (Dellien et al: 2005). Even the precedent of microfinance industry across the world endorses this. First of all the standardised loan products across the geographies were supplemented by forced and eventually to voluntary savings services (wherever legally permitted). In later years microfinance service providers also experimented with provisions of insurance, remittance and pension services to their customers.

2.1

Environmental and Marketing in MFIs

Institutional

Considerations

affecting

Marketing offers a great deal of benefits to both the organisation as well as the customers. On one side it gives visibility to the organisation in the market while on the other it gives an opportunity to the customer to decide its preference for a product. However there are many factors which affect an organisation or a microfinance service provider while taking decisions about introducing marketing in the organisation. The factors can be internal or external, of low or high impact.

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The external factors also termed as environmental factors include political, social, ecological, cultural, technological and ethical factor/s. Every organisation needs to assess the impact of these factors before introducing a new product. On the other side, the internal factors also termed as institutional factors include mission, vision, governance, organisation culture and policy, and institutional capacity.
Table 1: Environmental Factors in Marketing Political Generally these factors are related to countrys political situation. For a microfinance service provider it is important to take into consideration the countrys current political scenario and government rules and regulation for the microfinance sector. Take for example, in India the microfinance service providers are not authorised to collect savings from their customer directly. Also current political situation like the one in India, which has impeded the fund flow by the banks to the mFIs, should be taken into consideration while deciding marketing strategy. Countrys current economic situation like inflation rates, interest rates, economic growth/crisis in the market, space for small businesses in the economy etc also impacts the mFIs viability. These factors therefore play an important role in the introduction of a new product to the customers. and Public perception about microfinance, social harmony, religion, demographic and health indicators etc come under the social and cultural factors which impact growth of mFIs. Therefore a service provider should keep social and cultural factors in mind and frame marketing strategy accordingly. For example in many countries (following Islam) do not accept interest on loans. This may impact a new service provider or it requires products which suit this criteria. Another example is low health indicators which also restrict growth of mFIs in an area. Technology helps in reduction of costs but should be used with proper security and efficiency. Infrastructure for communications should be in place while adopting a strategy. For example, a well designed MIS helps in getting information easier and also strengthens internal control systems. Ethical considerations walk on a very thin line. At some places violating legal norms is considered as unethical, while at others violating societal norms are considered as unethical. Ethical factors include business norms, making customer aware about pros and cons etc and vary according to the area. Geographic factors like lack of approach road to an area, hilly terrain, sparse housing etc significantly affect the growth of an mFI or increase the cost of operations. Therefore, it is important to consider these factors before going in for a particular marketing strategy.

Economic

Social Cultural

Technological

Ethical

Geographic

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Table 2: Institutional Factors in Marketing Mission Vision and Mission and vision are at the core of strategic planning to achieve desired results. Corporate history, legal status, financial resources, external environment and specialisation are some of the factors which influence the mission and vision of any organisation. These also have significant impact on the marketing strategy of any company. Governance is a process by which a board of directors, through management, guides an institution in fulfilling its corporate mission and protects the institutions assets (Rock Et al.:1998). Expertise of the board members, quality of participation in the board, executive management and decision making capability, and history of promoters play a decisive role in deciding suitable marketing strategy.

Governance

Organisation Culture differentiates not only countries but organisations too and culture and differentiates one organisation from other. Policies flow from the policies organisation culture and have the same impact. The culture and policies also contribute significantly to decide marketing strategies. Information flow, organisational norm for risk taking, and valuing innovation are some of the factors affecting organisational culture and policies. Institutional capacity Institutional capacity refers to the resources, systems and processes, and infrastructure available with the organisation. These play an important role in introducing a new product in the market.

Section 3 : Rationale for Product Development in Microfinance Organisations require new ideas and techniques to achieve their goals of reaching out to more and more customers. They respond to changing demands of the target market and of the pressure exerted by competitors in order to remain in the market. These changes are manifested in decisions related to all the functions of organisations including the development of new products. Some of the reasons for new product development are listed below: Demand from mature customers Feedback from the staff Considering to reposition the company Plans for increasing revenues for further growth Organisational mandate for providing new products and services to its customers Creating a niche of its own

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However it is also important to note that the product development process requires a considerable amount of time and volume of resources (monetary and human) and therefore is not advisable to all the mFIs all the times. Introducing a new product depends largely on the institutions stage of development or level of competition in the market. In fact, many times refinement of existing product helps the service providers meeting their organisational goals.

Section 4 : Product Development Process Product development plays a vital role in increasing the customer outreach for any organisation. This increase in customer base, in turn, catalyses the efforts of any organisation for achieving sustainability and increasing profitability. The product development process occupies a significant position in the life of any organisation. It starts with conceiving an idea for a new product, passing through the stages of evaluating the idea, background preparation for its designing and development, prototype design, pilot testing and finally ends with its launch and subsequent feedback cycle. The entire process can be divided in distinct phasesidea generation, evaluation & preparation, design & development, pilot testing and product launch (Figure 1). However organisations adopt various steps in product designing process by customising it as per their needs.

4.1

Idea Generation

Idea Generation is the first step of new product development and requires gathering ideas which are further evaluated to consider for a new product. For many companies idea generation is an ongoing process with contributions from inside and outside the organisation. There are many factors which contribute to an idea for designing a new product in any microfinance institution. These can be: Feedback from the customers: Regular and timely customer feedback reports is a good source of information to think about customer requirements in the market. It can be through customer satisfaction surveys or random survey of the products or customers need survey etc. Existing Market Scenario: The existing market scenario and studying competitor products may also provide useful information on the popularity and demands of products. This can provide idea for new product development. Literature Survey and Secondary Data: Studying available literature and analysing secondary data also provides information on newer products
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studying across the geographies e.g. studying information provider websites can help in cross cultural learning. Promoters and Senior Management Experience: Promoters and senior management experience also contributes in designing a new product. Role model and philosophies of the promoters and senior management play important role in taking decisions about new products.

4.2

Evaluation and Preparation

Evaluation and preparation begins when the institution decides to formally investigate the development of a new product. The institution mobilises staff and other resources to work on the development effort and create a work plan for a new product development. It includes assessment of institutional and environmental capacities and putting a qualified team in place to design a product. Assessing Institutional Capacities: Examining ones strengths and weaknesses help in designing an appropriate product. It is important to assess the financial, technical and human resources capacities of the institution to achieve its objectives by introducing a new product. It should also determine whether and how the new product idea helps promote its mission, its competitive strategy, its financial goals, and its social impact (Bamako, 2000). Assessing Environmental Factors: Environmental factors such as political, social, ecological, cultural, technological and ethical factor/s also affects the design of a new product. These have already been discussed above. Putting a Suitable Team in Place: A product cannot be designed without assessing its cost and benefits. It also requires a qualified team in place to design and introduce a new product.

4.3

Design and Development (including Market Research)

Design and development of a product prototype involves drafting the initial features and characteristics of the new product. The team first design a prototype of the new product. To design a prototype, the product development team must understand customers needs and the competitive landscape to determine what the market (customers) will buy. This can be done by: Selecting the target market: Since microfinance directly works with the people, it is important to develop understanding about the people, their geographies, economics, and behaviour. It can be done by market segmentationa process by which an institution can gather information about its customer and their needs. Segmentation helps in identifying market niches as well as areas where product requirements are high.

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Understanding the Existing Market: Before designing a new product, it is important to focus on what the existing market is offering and how. It also requires knowing what the competitor is doing. This can be done through market research and market survey, environmental analysis and competitor analysis which act as a source of information for designing the product. Assessing the Cost Benefit: Once the team designs a prototype, it is important to assess the cost and benefits of the product. The analysis should take into consideration every factor of cost such as hiring and training of staff, management information systems, marketing/promotion costs, delivery costs, operational overheads, fund costs, revenues and expected losses. Designing appropriate Processes: The product development team should design operationally viable processes and systems to test the new product.
MARKET RESEARCH: AN ESSENTIAL COMPONENT OF NEW PRODUCT DEVELOPMENT

he first step for the new product development team is to design a prototype. To become a successful product, the prototype must be based on market intelligence that is gained from the potential customers, institutional experience, and the local environment. Market research is an essential activity which help a microfinance service provider to better understand the environment in which it is operating, its customer needs and preferences, and its position vis--vis the competition. Market research involves: o o o Gathering available market data Analysing the information Refining the prototype based on the analysis

Market research can help a service provider in answering the following questions: o o o o What do the present customers dislike about the products which the institution offers? What is in offer to potential customers that will make them want to purchase the new product? How can this new product be offered, so that it differs from what is currently available? Why will the customer come to the institution to purchase a new product?

However, in order to develop a prototype for a new product one must also keep in mind the following factors: o o o What do the customers want? How much will they pay for it? What other options do they have and which do they prefer?

Certainly this needs information from the various sources both internal and external which are available to a service provider. Broadly these can be divided into Primary and Secondary Market Research:

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Secondary Market Research Information previously collected for another purpose that can be reviewed and re-analysed is termed as secondary research. This helps in developing research hypothesis and narrowing the questions will still need to answer to refine the product.

Sources: o Current product information (MIS Sources: reports, management information) o Focus-group discussions with o Ongoing market research customers, noncustomers, and undertaken by your institution dropouts o Industry data from trade o Participatory rapid appraisal periodicals, publications, or the exercises (in group settings) Internet o One-on-one interviews and minio Government-sponsored market surveys studies or census reports o In-depth quantitative surveys to quantify and verify qualitative research Additionally, primary market research can be undertaken in two ways using the following techniques: Qualitative techniques, such as focus groups, seek to examine and understand the reasons and motivations behind consumer behaviour. Quantitative techniques, which are usually conducted by means of pretested questionnaires administered to a representative sample of the population, seek to verify the statistical significance of observed behaviour and opinions. Distinction Between Qualitative and Quantitative Market Research Generally, qualitative research helps explain customer attitudes and actions in an indepth and nuanced manner, whereas quantitative methods seek to measure the degree and frequency of this consumer behaviour. In other words, qualitative research uncovers why customers make certain purchasing decisions, and quantitative research measures how representative those reasons are in the broader market population. Other distinctions are described below. Point Distinction Use/objective Method Participants Output Required skills of Qualitative In-depth understanding of consumer behaviour and attitudes Facilitated questioning Homogeneous, small groups Consumer words descriptions Focus-group facilitation Quantitative Measure degree and extent these attitudes are representative Structured surveys Statistically representative sample of population & Coded responses Statistical analysis and survey design

Primary Market Research In the primary market research information is collected by the institution to confirm the secondary market research. This guide gives an overview of competitive analysis and different ways to solicit customer feedback. It is important to review existing sources of market information to save time and money.

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4.4

Pilot Testing

Pilot testing of the prototype is an opportunity to offer the product to a sample group of customers to determine whether these customers need, and will buy, the product. The results of the pilot test helps the organisation to determine whether demand exists for the new product, what modifications or changes to the terms and conditions are needed to make the product more appealing, and what features or processes need adjustment. Decision on Experimentation: Pilot test decisions are taken on the basis of test sites, samples and duration. It is important to note here that the product development team should control these variables on one hand, while take appropriate representative sample to test the product. Testing: The product development team has to go for field testing of the product keeping in view the processes and systems suggested on a specified number of people. An appropriate marketing strategy is also need to be put in place. Monitoring and Evaluation of the Results: The monitoring and evaluation of the test results helps in assess the effectiveness, popularity and demand of the product. It also gives an idea about possible operational processes and systems in addition to costs associated with it. The product development team should measure possibility of introducing the product on a full scale. It can be done by assessing the financial viability and institutional capacity simultaneously with the test results.
THE ELEMENTS OF PILOT TEST It is important to focus on crucial factors which determine the success of a pilot test. These can be Defining Indicators of Success: To determine whether the pilot test was successful, the institution has to identify performance indicators and establish targets for these indicators. Common performance indicators include: o o o o Volumenumber of customers, level of sales, market share; Profitabilityrate of return for product; Productivitynumber of customers per loan officer; and Resource efficiencymoney and/or time invested.

Setting UpWhere, How Many, and How Long? Critical elements of the pilot test are test sites, sample size, and duration. The number of sites should be manageable and easily accessible by the product development team. The location, or locations, for testing should represent a subset of the institutions target market for the product and must have the internal capacity to sell and monitor the product being tested. The number of customers involved in the test, or the sample size, should be large enough to ensure a reasonable level of confidence that the data reflect the broader target market, yet small enough so as not to make information gathering expensive or monitoring difficult. The duration of the pilot test will depend on the terms and structures of the product as well as market conditions. In deciding the time frame, the institution should consider the trade-off between cost and reliability of test results, the opportunity cost of being late to market versus prematurely entering the market, and the length of time needed for administrative and operational adjustments necessary for product implementation.

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Preparing the Test Site. Critical operational functions of the institution must be prepared and equipped to handle the requirements of the new product or service. Each test site should put in place the appropriate processes, from the application process to policies and procedures as to how the product is evaluated, approved, and managed. The product development team has to ensure that the management information system can track and monitor customer information, and produce reports. In addition, sales staff have to be trained to have a thorough understanding of the product and the procedures and policies for product delivery. A marketing and promotional strategy has to be developed, including promotional materials such as fact sheets and brochures, to generate interest and publicize the new offering. Monitoring and Evaluating Results. Three major areas that the product development team should focus its monitoring efforts on are the delivery process, loan terms, and competitive response. The delivery process is monitored to assess the efficiency and timeliness of the application, approval, and disbursement processes. The reaction of customers to the terms and conditions of the product also is monitored to inform potential refinements and adjustments. The team should monitor whether the new product has resulted in a price war with the competition or whether it has cannibalized other products in the institutions portfolio. Once the information has been gathered, the product development team must evaluate whether commercializing the new product is worth the investment to the institution. The following evaluation criteria should be considered in arriving at a Go/No-Go decision. o Financial viability. Administering a diverse product line is a costly, complicated endeavour. Products or services that do not help cover the costs of running the institution may jeopardize its long-term viability. Consequently, there must be strong market prospects to ensure that the loss in short-term profits will be more than offset by expected revenues generated from capturing a larger share of the market. Competitive considerations: Financial projections and the products ultimate commercial success are tied to the products competitive position in the marketplace. Three factors determine the products competitivenessmarket share, product mix, and market position. Market share relates to the retention of customers, the capture of customers from the competition, and the luring of new customers who were previously unserved. Product mix looks at whether the new product complements or dilutes current offerings. An MFI should consider its market position when contemplating a product line expansion. For example, an MFI that is transforming into a formal financial institution may have to incorporate certain core products, such as savings accounts, so that potential customers can treat it seriously as a bank substitute. Or, an MFI may want to identify itself with a particular market segment, such as a village bank focusing on poverty alleviation. The important thing to remember is to have a coherent product mix and not try to be all things to all people. Institutional capacity: Introducing a new product is resource intensive and a potentially disruptive process for employees who are accustomed to certain operating procedures. A critical consideration in deciding whether to move forward with product development is the potential for internal collaboration and institutional change. Institutional capacity entails having a number of systems in place: delivery channels (physical infrastructure and communications channels) to market the product to the target customer group; management information systems to track the disbursement and collections, as well as monitor portfolio performance; and human resources who understand the terms and characteristics of the new product and who are able to sell and market the product.

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4.5

Product Launch

Product launch involves making the new product available to organisations entire market. Introducing the new product to the bigger market assumes that organisation is confident that the characteristics and features of the product are in line with the needs of the customers and that the institution is prepared internally to incorporate a new line of business. An organisation needs to focus on: Designing an Implementation Plan: A proper action plan should be in place before introducing a new product. It should also include the place from where the new product will be introduced, timing, price of the product, human resources required, and marketing techniques etc. Nonetheless, an appropriate marketing mix (discussed later) should follow the action plan. Refining the Systems and Processes: Before final launch of the new product, all the systems and processes should be reviewed for leakages. A proper coordination plan should be developed among different departments like accounts, human resources, MIS etc. In addition there should be a proper authority and responsibility allocation charts stating who should be doing what, when and how. Building Capacities of the Human Resources: The most important part of launching a new product is the human resources of the organisation. Therefore, these need to be trained and properly equipped with handling systems and processes of the new product. An organisation should also take note of the education level, attitude and present workload of the staff so as to put in place right person at the right work.

However, the product development process does not end once the product is launched. It is an ongoing process of refining the terms, characteristics, and conditions of a product based on customers feedback and market analysis. In fact, most often product refinement (rather than new product development) is precisely the innovation that is needed. This process should be a strategic and integral part of any institutions ongoing business operations so that one can maintain competitive advantage in the marketplace.

Section 5 : Prerequisites for New Product Development: Factors, Drivers & Institutional Preparedness As seen above, the process of new product development is a complicated one and requires investment of time and resources of any organisation. It requires substantial amount of resources (human and capital) and time commitment, it might not be appropriate for all organisations. However, when an organisation considers introducing a new product, it should keep the following things in mind (Bamako, 2000): 5.1 Governance Structure and Control: The MFI should have a board of directors that has a clear strategic vision for the institution, is committed to market233

driven strategies, and is able to provide the level of oversight needed to hold management accountable for performance.

Kapoor and Sinha (2010) have identified factors and drivers which play crucial role in new product development in a microfinance institution. These are: Institutional mission and vision Promoters philosophy and role model Board and governance Organisational policies culture, strategy &

Nature of the market Institutional capacity

5.2 Systems and Operational Procedures: The MFI should have in place an appropriate management information system to handle its information and reporting requirements. The management information system should be able to record and track customer data, portfolio performance, and cost structures. Policies and procedures for field and branch staff should be well defined, and appropriate internal controls should be in place to minimize the risk of fraud, waste, and abuse.

5.3 Organisational Structure: The institution should have an open communications channel to allow ideas to flow vertically between management and the field, as well as horizontally across departments. The corporate culture should be an environment where innovation and experimentation are rewarded through properly designed incentives.

5.4 Organisational Resources: The institution should have a sufficient capacity in terms of trained and qualified human resources to carry out the work, sufficient funds to experiment, strong information flow systems, robust internal controls, and sufficient physical infrastructure before going for launching a new product in the market. Nonetheless, external factors discussed above also play a decisive role while introducing a new product. In fact one key factor i.e. market conditions play an important role, which can make the mFIs follow a push strategy rather than pull strategy in the marketing their financial products. An organisation should consider both internal preparedness and external environments while going for a new product development. A sample of institutional capacity assessment format is given hereunder:

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The microfinance gateway also offers suggestions while introducing a new product (saving). 1. Effective governance 2. Financially sustainable operations 3. A sound business plan showing continued viability and indicating where savings can be invested profitably 4. Adequate capital 5. A system for measuring and monitoring financial performance 6. Sufficient internal controls supported by a culture, policies and human resource management that prioritise the security of funds 7. Technical capacity to manage liquidity and interest rate risk 8. A management information system, whether manual or computerised, that can handle the volume of anticipated transactions and can provide information that is sufficient, accurate, timely and transparent 9. Necessary physical infrastructure including secure premises in safe and convenient locations, a strong room or vault, and sufficient office space with counters.

Assessing Institutional Capacity (Sample)

Factors Financial Resources 1. Do we have sufficient funds to experiment? 2. What can be the possible sources of funds? 3. Can our financial system bear unexpected losses? 4. Other issues Human Resources 5. Are staff knowledgeable and informed about the new product? 6. Are staff members describing the product to customers in an informed way? 7. Is there a training mechanism to educate staff about the new product? 8. Other issues Delivery Mechanisms 9. Are there enough branches or distribution channels in the target areas? 10. Does appropriate staff have the computer hardware and software needed to deliver the new product? 11. Can existing customer service quality standards be maintained for the new product? 12. Is the information provided in the marketing material sufficient? 13. Other issues Information/Operation Systems 14. Have your information systems been adapted to track the new product? Yes No Ideas

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Factors 15. Can you obtain all the necessary details about the product to inform the product development process and manage the product once it has been fully launched? 16. Does the accounting system reflect the performance of the new product? 17. Have the loans been disbursed in a timely manner? (How does the new products loan turnaround time compare with that of other products?) 18. Other issues

Yes

No

Ideas

Source: Inspired and some portion adapted by Brand (2001) Marketing Mix and Microfinance: Tools for Competitive Advantages Marketing mix is a planned combination of controllable elements for product marketing in an organisation (Business Dictionary). It can also be defined as marketing mix as the variables, such as price, promotion, and service, managed by an organisation to influence demand for a product or service (Collins English Dictionary). The term marketing mix was coined by Neil Borden in 1953. However, it only got popularised after Borden published his 1964 articleThe Concept of the Marketing Mix. Borden began using the term in his teaching in the late 1940's after James Culliton had described the marketing manager as a "mixer of ingredients". The ingredients in Borden's marketing mix included product planning, pricing, branding, distribution channels, personal selling, advertising, promotions, packaging, display, servicing, physical handling, and fact finding and analysis. Later E. Jerome McCarthy proposed Four Ps classification in 1964 by grouping these ingredients, which has seen wide use across the countries. Judd proposed another (fifth) P i.e. people. Booms and Bitner added 3 Ps (participants, physical evidence and process) to the original 4 Ps to apply the marketing mix concept to service. Kotler however added political power and public opinion formation to the Ps concept. Goldsmith suggested 8 Ps (product, price, place, promotion, participants, physical evidence, process and personalisation) as the product mix (Goi, 2009). MicroSave, a premier consulting organisation, suggested 8Ps as a set of tools that any institution can use to pursue its objectives in the market (Frankiewicz et. Al, 2004). These tools can be used by microfinance institutions to create perceived value and generate a positive response among their customers. It also helps in understanding the customer and market requirements in a better way. A detailed explanation of the 8Ps of marketing mix for microfinance institutions is given below: 1. Product The term "product" refers to tangible, physical products as well as services. In microfinance, it refers to features associated with a financial product. For example, a loan product has features such as ticket size of the loan, loan terms and conditions, disbursement place and time, repayment schedules, etc. 2. Price The price is the amount a customer pays for the product. It is determined by a number of factors including competition, customer's perceived value of the product and market share. Pricing in microfinance includes interest rate, fees, operations costs, and penalties.

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3. Promotion Promotion represents all of the communications that a marketer may use in the marketplace for its image building. It has four distinct elements - advertising, public relations, word of mouth publicity and point of sale. Basically microfinance is promoted through word of mouth by the customers themselves. 4. Place Place represents the location from where a product can be purchased or sold. Generally microfinance uses direct interaction with the customers at their houses. However, the trend has change with branch and branchless banking techniques such as mobile technology etc. 5. Positioning Positioning refers to a process by which marketers try to create an image or identity in the minds of their target market for its product, brand, or organisation. Examples in microfinance include quick service delivery, delivery at the doorstep, high customer satisfaction in the area, lowest price in the market etc 6. Physical Evidence This is what makes the MFI and its invisible, intangible services visible. It helps the customer to make judgments on the organisation. It includes the presentation of the product, how the branch physically looks, whether it is tidy or dirty, newly painted or decaying, the appearance of the brochures, posters and passbooks, etc. (MicroSave) 7. People People refers to all the persons that are directly or indirectly involved with the organisation especially the employee and the customers. Employees add significant value to the services that are offered by any microfinance institution, while customers play an important role by helping the business to scale up. It therefore includes hiring appropriate staff, training and performance monitoring vis--vis retention of the customer. 8. Process Process represents the operational flow of the work in an organisation. It is the system which assists an organisation in delivering the products and services to the customer. It includes transaction systems, documentation, planning and monitoring processes in any microfinance institution. If tactfully used, these marketing mix tools helps an organisation to scale up its business, particularly by increasing suitable products to its customers.

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References Kapoor, S. and Sinha, G. (2010): Adapted from Paper on The Process of New Product Development in Microfinance: A Perspective from Indian Microfinance Institutions Christ, P. (2009): Know this: Marketing Basics, Know This http://www.knowthis.com/principles-of-marketing-tutorials/what-ismarketing/role-of-marketing/ Media,

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Dellien, H., Burnett, J., Gincherman, A., and Lynch, E. (2005): Product Diversification in Microfinance: Introducing Individual Lending, Womens World Banking Rock, R., Otero, M., and Saltzman, S. (1998): Principles and Practices of Microfinance Governance, Microenterprise Best Practices, Development Alternatives and Accion International http://www.uncdf.org/mfdl/readings/MFGovernance.pdf Brand, M (2001): The MBP guide to New Product Development, Accion International, Microenterprise Best Practices, Development Alternatives, http://www.ruralfinance.org/servlet/BinaryDownloaderServlet?filename=11261053 34399_MBP_guide_to_new_product_development.pdf Bamako (2000): Innovations in http://pdf.usaid.gov/pdf_docs/PNACQ693.pdf Microfinance, USAID

Brand, M (2001): The MBP guide to New Product Development, Accion International, Microenterprise Best Practices, Development Alternatives, http://www.ruralfinance.org/servlet/BinaryDownloaderServlet?filename=11261053 34399_MBP_guide_to_new_product_development.pdf Bamako (2000): Innovations in Microfinance, http://pdf.usaid.gov/pdf_docs/PNACQ693.pdf (Adapted) Bamako (2000): Innovations in http://pdf.usaid.gov/pdf_docs/PNACQ693.pdf Microfinance, USAID USAID

Kapoor, S. and Sinha G. (2010) New Product Development in Microfinance: Factors and Drivers : A Perspective from North Indian Microfinance Institutions http://www.microfinancegateway.org/p/site/m/template.rc/1.11.48257/1.26.9215/ http://www.businessdictionary.com/definition/marketing-mix.html Collins English Dictionary - Complete & Unabridged 10th Edition, 2009, William Collins Sons & Co. Ltd Banting, P.M. and Ross, R.E. (N/A): The Marketing Mix: A Canadian Perspective, McMaster University, Hamilton Ontario, Canada,

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http://www.springerlink.com/content/mn58860185200184/fulltext.pdf http://www.netmba.com/marketing/mix/

and

Goi, C.L. (2009): A Review of Marketing Mix: 4Ps or More?, International Journal of Marketing Studies, Vol.1, No.1 (May 2009) Cheryl, F., Wright, G. A.N. Wright and Cracknell, D. (2004): Product Marketing Toolkit, MicroSave http://www.prosperousartists.com/Library/12864224-The-Extended-MarketingMix.pdf

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Module 10 : Valuation of Microfinance Institutions

Objectives The module creates an awareness among the participants about : Role of Valuation Role of Equity Valuation Methods: Discounted Cash Flow Methods Relative Valuation Residual Income

The following sessions would be covered based on this module. 1. Valuation of MFI Need 2. Equity Valuation DCF Approach 3. Equity Valuation Relative/Multiple Approach 4. Case Study of MFI IPO SKS 5. What Explains the Valuation Financial Indicators v/s Social Performance

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Section 1 : The Key Role of Valuation In the discussion to date on each of the above paths for the industry, one crucial element for all three has been largely ignored, namely the valuation methodology to use with respect to MFIs. Fernando (2004) has commented that: It is not reasonable to expect a quantum leap in private investment in an industry that most private investors find difficult to evaluate for the lack of benchmarks and transparent data. Consistent valuation methodology is an essential part of attracting more microfinance investors, for the following reasons: Valuation is the most comprehensive way of objectively measuring the financial performance of an MFI. It can also be used to compare one MFI with another and to monitor improvements over time. Indicators, such as the many used by the MIX Market and the Micro Banking Bulletin (MBB), are very useful, but they can be misleading in isolation. For example, a high Return on Equity could reflect the small net asset base of the MFI which may not be in its long-term interest. Secondly, by better communicating the value of MFIs, the attention of more investment funds can be extended to a broader universe of institutions. The method chosen should incorporate all of the investors value concerns into the analysis. Increasingly, investment funds will need to monitor the value of their investments and report the funds Net Asset Value to its own investors: the minimum for a mainstream open-ended investment fund is a quarterly valuation. Thirdly, by applying a greater focus on valuation, and the increment added through a merger, the appeal of such a combination of MFIs can be made more compelling. In most of the mergers between MFIs to date, there was no exchange of value other than assets and liabilities, meaning that each transaction generally had to be a merger of equals, which is often not possible. By attributing a value to the two or more entities, a cash consideration can be part of the transaction, making the whole process more feasible to achieve.

It is often said that valuation is more of an art than a science. At the end of the day, the buyer or investor will pay what he believes the company is worth, taking into account a range of quantitative and qualitative factors, some of which will be personal to the particular party, for example synergy benefits. Any under-valuation of an MFI favours the investor and means that the MFI or its shareholders are issuing or selling shares at too low a price, or are giving away more equity than is really necessary, in order to raise the same amount of new capital or sale proceeds. Examining the issue of valuation in much greater detail is important for the future of microfinance. A theoretically sound and thoroughly road tested valuation approach will help the buyer, investor or merging parties find the right value for the transaction and be confident that it is right. It will provide comfort to the MFI and other interested observers that an appropriate price is being paid for an MFI or attributed to an investment funds assets.

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1.1

The Role of Equity

There has been an enormous debate in recent years about the commercialization of microfinance, particularly the importance of accessing the capital markets. If the ambitious client outreach targets associated with the Microcredit Summit and the Millennium Development Goals are to be realized, the Micro Finance Institutions (MFIs) serving the rapidly growing number of clients must rely increasingly on commercial sources of financing, such as wholesale bank debt and private equity. Equity is fundamental in itself, as NGOs transform to formal financial institutions, with share capital and minimum capital requirements imposed as conditions of obtaining a bank license. Equity is also a more flexible form of funding, which then allows the MFI to take on commercial debt through the leveraging of its balance sheet. According to the MIX Market (www.mixmarket.org) there are now 77 investment funds offering capital markets services to MFIs, of which 67 provide debt and 46 make equity investments2. The number and approach of such funds prompted Elizabeth Littlefield of CGAP to comment at the Opportunity International Global Conference in February 2004 that there are now too few investment opportunities for such funds, because they are nearly all focused on the top 200 or so MFIs out of a global total estimated to be as high as 10,000.

What is the answer? The obvious solution is for the quality of MFIs to improve so that they are more appealing to investors. Whilst part of the solution may be an organizational structure that allows for equity investment (ie not an NGO) and better communication by MFIs, improved financial performance will be the key. Secondly, this transformation will then attract a more commercial investor to the field of microfinance. There are some private investors already investing in MFIs, either directly or through investment funds, including individuals and institutions. However, even where the shares in MFIs are privately held much of the investment capital of many private investors originally comes from public sources: A third solution is for the microfinance industry to rationalize, so that some of the smaller, unsustainable players are combined with others to produce MFIs more likely to attract commercial sources of funds.

1.2 What Makes Microfinance Financials Different from Traditional Banks Mainstream financial ratios and other factors used in analyzing banks remain relevant when looking at MFIs. However, we believe MFIs are a unique type of financial institution because of their business model and clients. In this chapter, we introduce five major characteristics of microfinance that differentiate MFIs from traditional banks.

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Double Bottom Line Most MFIs emphasize both their financial profitability and their social impact. The emphasis on this double bottom line varies greatly among MFIs. However, it is a unifying feature of MFIs to recognize the positive benefits that access to financial services brings to clients and the need for responsible lending practices. A double bottom line helps MFIs attract soft lending and investments from public and socially responsible investorsa positive factor in the evaluation of risk. However, from an equity perspective, a double bottom line justifies a discount to valuations. A socially motivated business may undertake less profitable activities to achieve its social goals, such as expanding to remote areas or working with clients who require training before they can become customers. These efforts may be reflected in a higher cost structure for the business, although in some cases, this may also be rewarded with higher yields.

High Net Interest Margins Driven by High Lending Rates MFIs have much higher NIMs than commercial banks in emerging markets. This is because of the relatively high interest rates charged to microfinance clients and limited competition for their business. In 2006, the average worldwide microfinance lending rate stood at 24.8%. We believe that there are three main reasons to justify the level of interest rates in micro finance: 1. The financial explanation: higher costs (especially operating costs) justify higher rates. Micro lending incurs relatively higher costs than traditional lending, with higher personal and administrative expenses because of the location of clients, small transaction size, and frequent interaction with MFI staff. The microeconomic explanation: microenterprises are profitable. Microenterprises have the potential to generate high returns, which enables clients to pay higher interest rates to MFIs. The macroeconomic explanation: limited competition. Despite the rapid growth of microfinance in most markets, there are still relatively few financial institutions that serve low-income people, and competition on lending rates is limited. Additionally, the sector lacks some clear standards for the disclosure of interest rates charged to clients. For example, some MFIs express their interest rate as a flat rate using the beginning balance of the loan.

2.

3.

1.3

Effects of the crisis on NIMs

The financial crisis is having a significant effect on MFI NIMs. MFIs report increased liquidity pressures to CGAP and funding cost increases between 200 basis points (bps) to 500 bps since September 2008, because of tighter credit conditions in the local interbank market and from foreign lenders. To preserve their margins, MFIs are increasing their lending rates, but some are experiencing difficulties in passing the full cost increase onto their clients. These measures are unpopular in the context
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of the economic downturn and may conflict with the MFIs social agenda. Not all MFIs will be affected by credit scarcity. MFIs with a large share of demand and savings deposits depend less on bank borrowing. Also, MFIs with access to government funding or concessional funding from development investors should fare better and maintain comfortable NIMs.

High Asset Quality Is Driven by Original Collection Method Historically, MFIs have had stronger asset quality than mainstream banks in emerging markets. MFIs have developed original lending technologies. These include good knowledge of customers, supported by frequent visits to clients businesses; nontraditional guarantees, such as group guarantees; and excellent information systems that track arrears weekly or even daily. MFIs also have strong incentives for performance: clients who repay loans can build a good credit history and get access to larger loans and better terms. MFI loan officers also have strong financial incentives to ensure repayment, because the variable part of their salaries depends on portfolio quality. All these factors translate into high asset quality. Over the past 10 years, MFIs reporting to the Micro Banking Bulletin have demonstrated high asset quality, with an average portfolio at risk over 30 days (PAR30) consistently below 4%. PAR30 shows the value of all loans outstanding (principal and interest) that have one payment past due for more than 30days. It is important to look at PAR30 in conjunction with the write-off ratio, to ensure that the MFI is not maintaining a low PAR30 by writing off delinquent loans.

1.4

Effect of the crisis on asset quality

As of January 2009, the effect of the current financial crisis on asset quality is not yet apparent. Micro lending has proven to be resilient to economic shocks in the past, such as during financial crises in East Asia and Latin America. This is because microfinance customers tend to operate in the informal sector and to be less integrated into the global economy. They also often provide essential products, such as food or basic services that remain in high demand even in times of crisis. However, the current financial crisis and the triple effect of economic downturn fall in remittances, and higher food prices have not been experienced before. It may well translate into lower asset quality for MFIs. Well-managed MFIs that have a conservative credit policy and a focus on micro-enterprise lending should remain resilient. MFIs with weak credit standards and large exposure to small and mediumsized enterprises (SMEs), housing, and consumer lending are likely to be affected the most.

High Operating Costs Are Driven by Small Transactions The costs of providing micro-credit are high because of the small size of loans, the location of clients, and the high level of interaction clients have with MFI staff. Efficiency is a key concern because MFIs require much more staff and administrative efforts per dollar lent than mainstream banks. MFIs exhibit much higher operating
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costs than mainstream banks. However, the cost structure of MFIs tends to improve over time as a result of economies of scale, better loan technology, and an increase in the average loan size. Competition also can put pressure on MFI margins and drive efficiency improvements. In terms of indicators, the ratios of operating expenses to total assets or operating expenses to total loans appear to be the most relevant. Other popular measures are the cost per borrower (Operating Expenses/ Average Number of Active Borrowers), staff productivity (Number of Active Borrowers / Total Staff), and the loan officer productivity (Number of Active Borrowers / Number of Loan Officers).

1.5

Effect of the crisis on operating costs

MFIs have seen their operating costs increase in the first half of 2008 as a result of inflation and higher input costs. Staff costs and transportation costs have been affected the most, with a spike of over 30% reported in Latin American countries. In 2009, we expect inflation to return to lower levels, thus reducing the pressure on wage increases and transportation costs. However, operational efficiency, as measured by operating expenses to loans, may decrease as a result of slow or even negative growth in the microfinance portfolio. MFI staff productivity might also suffer as credit agents allocate more time to loan monitoring and collection.

Longer Term Funding In some markets, the credit squeeze is affecting MFIs by making funds more difficult to obtain, more costly, and available in shorter maturity. Therefore, in our analysis, we paid special attention to the liabilities side of MFIs balance sheets: equity, deposits, and other funding. Microfinance exhibits three major differences vis--vis traditional banks. MFIs have overall lower leverage than traditional banks. Overall, MFIs tend to have lower leverage (measured as total equity to assets) than traditional banks. Our unweighted average leverage for the 45 largest MFIs (with assets above US$150 million) stands at 19%, significantly lower than the J.P. Morgan emerging markets benchmarks. However, leverage is increasing over time, and large and older MFIs are reaching equity leverage levels comparable to traditional banks. Deposits are not necessarily a more stable and less expensive source of funding. The cost of funding through retail deposits (in particular, demand deposits, which typically are not remunerated) is not necessarily cheaper than other funding sources. This is because capturing and servicing small deposits is costly and requires a more expensive physical infrastructure. 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.

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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).

1.6

Effect of the crisis on the liquidity position of MFIs

Large MFIs should not face a major liquidity squeeze in 2009 because of their favorable maturity gap and access to emergency liquidity facilities of public investors and governments funds, such as IFC, KfW, and IDB. However, most of this foreign investment is in hard currency, leaving MFIs with large and often unhedged foreign exchange exposure. MFIs exposed to hard currency debts have already suffered severe exchange losses since September 2008 as a result of the depreciation of emerging markets currencies vis--vis the U.S. dollar. Unhedged currency exposure will likely be a key theme for MFIs in 2009. Overall, we think MFIs with access to public funds, and with a strong retail savings base and covered foreign exchange risk exposure, will better weather the current financial crisis.

Section 2 : Valuation Methods 2.1 Discounted Cash Flow

A DCF is particularly apt when recent performance is not representative of the outlook or the business has a fixed life, such as a coal mine. Use of a DCF in the microfinance sector would be most appropriate for fast growing MFIs or one transitioning into a regulated bank, with all the consequent changes to its management, culture and systems. One of a DCFs advantages is that it makes the future cash flows accruing to an MFI, and hence any investor, much more explicit. As Meehan (2004) notes, a lack of understanding of the nature of microfinance cash flows is one major reason holding back the interest of commercial investors. However, whilst a DCF valuation is a more sophisticated method, allowing for the examination of a range of alternative possible scenarios, it is also more complex. The first issue raised is the quantity and quality of the forecast financial information. Secondly, it can be very difficult to project future cash flows beyond the years provided to the valuer in a reliable manner and to choose an appropriate discount rate. Thirdly, small changes in the underlying assumptions, such as client numbers, branches, employees and loan default rates, can have a large impact on the result, as the companys projections are extrapolated by the valuer. Fourthly, where the future cash flows are very large, more than half of the value can be contained in the terminal value, which may not be capable of accurate forecasting.

Pros Detailed valuation method

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 Cons

Conceptually sound method, because investor should be willing to pay for the present value of the future cash flows.

Not appropriate for young MFIs, for which future assumption may be unrealistic. Valuation is very sensitive to terminal value and discount rate used in the valuation, which by nature are subject to error. Not the best method in the case of minority shareholders, because only majority shareholders can decide the use of future cash flows.

2.2

Multiple of Net Assets

Because the factors identified above in regard to a DCF can make the exercise of valuing MFIs a complex one, the inclination of many experts is to start with Book Value, as it does provide at least a tangible base value. It can also be argued that it is more appropriate for a financial institution that derives its income mainly from leveraging its assets, such as the loan portfolio, as opposed to other industries that rely more on their intangible assets, such as technology or know how, which are not always carried on the balance sheet. However, the uncomplicated nature of a Book Value approach to value can also betray its shortfalls. The net value figure itself is a reflection of historical performance by the MFI. The multiple can be an over-simplified composite of many different factors, such as growth and risk. Whilst it may appear to obviate the need to make the sorts of projections required for a DCF, the same sorts of factors are implicit in the choice of multiple. Moreover, a small change in the multiple, say from 1.0 to 1.1 times, increasing the valuation by 10%, could have a resulting price impact of many millions of dollars.

Pros Cons Comparison with other transaction is difficult because of differences in context, accounting standards, tax treatment, and different leverage of the institutions( no true comparable) Book value does not indicate future earnings power of the institution. Book value could be subject to impairments. Multiples comparison is subject to market exuberance(bubbles). Simple and most widely used in the industry Book value being a positive number, P/BV is always meaningful. Looking at multiples is an alternative way to address the issue of premium/ discount.

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2.3

Earnings Multiple

The use of a price/earnings ratio will be more appropriate for a mature company that requires less capital expenditure. Its use shows that the valuer believes the entity should be run as a profitable business. This approach can reasonably be employed if the MFI has a profit history. If not, a maintainable earnings figure can be deduced either from a number of recent historic periods and/or reliable forecasts, some or all of which may need to be adjusted. To the resulting figure is then applied a multiple based on precedent transactions or comparable companies.

Pros Cons Comparison with other transaction is difficult because of differences in context, accounting standards, and tax treatment(no true comparable) Cannot be used if earnings are negative; mostly used in the case of a stable and predictable earnings stream. Historical earnings do not indicate future earnings power of the institution. Multiples comparison is subject to market exuberance(bubbles) Simple and widely used in the industry Looking at multiples is an alternative way to address the issue of premium/ discount.

2.4

Residual Income

Unlike the pure DCF techniques, which forecast future cash flow values and discount them back to the present, the residual income model is a hybrid that starts with the current book value and adds the present value of expected future residual income. Residual income is the difference between net income and the opportunity cost to shareholders to invest in the MFIs equity (calculated as the cost of equity multiplied by book value). The main advantage of this method over pure DCF is that the terminal value represents a smaller part of the total valuation. It is particularly useful in situations where the firm is either not paying dividends or is paying them in an irregular pattern. Also, for young, growing MFIs that will start generating a positive free cash flow only in the future, it is easier to use the current book value as a base for valuation. However, the method may not be appropriate for companies that will see their capital structure change dramatically, in particular in the case of an MFI that increases its leverage or is expected to make acquisitions.

Pros Detailed valuation method Conceptually sound method, because it adds the present value of expected future residual income to the current book value.
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 Cons

Conceptually sound method because it includes a charge for equity capital. Terminal value represents a smaller portion of total valuation, if compared with discounted cash flow method. Appropriate for young MFIs that may have no earnings in the short term.

Valuation is very sensitive to discount rate. Not appropriate if the capital structure of the MFI is expected to change significantly.

2.5

Variables Important for Valuation

Size: Transaction size(US$mn) Larger transactions command a higher multiple, in particular for transactions above US$2 million, because they allow for a more diverse pool of investors. Institutional investors typically have a minimum threshold. For smaller transactions, we believe that the scarcity of investors can put pressure on valuations.

Financial Intermediation: Savings to total assets The level of financial intermediation (reliance on savings) is a key variable. We feel that retail deposits help diversify the funding base of an MFI, which is positive, and savings-based institutions have proven to be more resilient in times of economic shocks. However, to nuance this statement, we note that deposits are not always cheap to attract.

Buyer type: Buyer is a DFI DFIs tend to pay more than MIVs in transaction. Our view is that the investment rationale of some DFIs (such as AFD and NORFUND) can be less geared towards pure profitability, and they may assign a greater value to microfinance because of its social agenda. However, we note that this holds true for socially oriented DFIs only.

Geography: Country This is possibly the most relevant variable for investors. Four country-specific factors are influencing valuation: (i) favorable regulations, (ii) country outlook (macroeconomic stability and political risk), (iii) market structure (size of the market and competition), (iv) the supply of capital (the presence of large private equity funds in some countries can affect valuation). Those four aspects are eminently country specific.

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Legal Status: MFI is a bank Our statistical analysis suggests no clear MFI is a bank relationship between the legal status of the MFI and valuations because the P/BV multiples do not differ, while the P/E multiple is noticeably higher for banks. However, we believe that MFIs that are banks should trade at a higher multiple for two reasons: (i) in most countries, only fully regulated banks are allowed to capture demand and savings deposits, providing a stable funding base and (ii) being regulated imposes some disclosure requirements, which are likely to make investors more willing to take a stake in the company.

Asset Quality: PAR30 A low PAR30 indicates high asset quality and therefore should command higher valuation. The statistical analysis shows no significance because 90% of the surveyed institutions have a PAR30 below 5.4%, which limits the variation within the sample considerably. We believe that equity investors will be concerned as soon as PAR30 is over 3%, and MFIs will have great difficulty to raise capital if PAR30 is over 10%.

Efficiency: Operating expenses/ Average gross loan portfolio Even though the statistical analysis shows no correlations, we think this is a very important variable. We do not focus too much on P/E, because earnings are impacted directly by operating expenses. Therefore P/E multiples look higher portfolio for MFIs with a higher ratio of expenses-to-loans, because of the lower earnings base. On a P/BV basis, MFIs with a lower ratio demand a higher multiple. We note that a limitation of this ratio is that it benefits MFIs that offer larger loans.

Leverage: Debt to Equity Less leverage commands a higher premium in the current context of scarce funding. We believe that a ratio of debt-to-equity below 3x (equity-to-assets ratio above 25%) commands a premium. However, we recognize that this is not reflected in the statistical analysis.

ROE Our statistical analysis shows no effect on valuation, but a high ROE indicates high profitability; positive effect on the price-to-book multiple is expected. Net Income Growth High net income growth indicates a young institution at the beginning of its growth path; positive effect expected.
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Outreach: Average loan balance We do not find any clear conclusions based on our sample. MFIs with lower loan balances exhibit a higher P/BV but a lower P/E than MFIs with larger balances. A smaller average loan size causes higher expenses but is compensated by higher NIMs. The lower loan balance could indicate that the MFI is putting a bigger emphasis on its social agenda, justifying a premium for some DFIs or a discount for buyers focusing on profitability only.

Size: Market Capitalization Our statistical analysis shows no clear correlation. We believe that the size indicator that is most relevant is the size of the transaction.

Outreach: Average savings balance We do not find any clear conclusions based on our sample. MFIs with lower savings balances per customer exhibit a higher P/BV but a lower P/E than MFIs with larger balances.

Geography: Region We do see patterns in the averages per region. However, to us, the country of the MFI is more relevant because of the large disparities among countries within the same region.

Scale: Number of borrowers We do not find any clear conclusions based on our sample. MFIs with a smaller scale exhibit a higher P/BV but a lower P/E than MFIs with larger scale.

Age of MFI What matters is growth outlook, not so much the no age of the MFI, in our view. Our sample suggests that new MFIs (not older than 4 years) command a higher P/E multiple. We think this is mostly driven by a lower earnings base rather than by a higher price, making P/E an inappropriate multiple to look at in this case. Median P/BV multiples show no clear differentiation among new, young, and mature MFIs.

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