Contemporary Concerns Study Financing Small Enterprises by microfinance institutions

Final Report

Submitted by Divya Ganesan (0411013) Divya Roongta (0411047)

Signature _________________________

Financing Small Enterprises by MFIs

Table of Contents
Need for credit for Small Businesses and Enterprises ............................. 3 Problems of Credit Supply ........................................................................ 3 SAFAL Activities ....................................................................................... 5 A Typical Retail Vendor............................................................................ 6 Origination of Janalakshmi....................................................................... 6 Credit Scoring Literature Survey............................................................... 7 Case study I..............................................................................................12 Case study 2..............................................................................................15 Case study 3..............................................................................................16 Product Features ......................................................................................18 Interest Rate Determination ....................................................................21 Loan Appraisal .........................................................................................23 Product Design ........................................................................................24 Supplementary Products ..........................................................................26 Loan Appraisal .........................................................................................30 Credit Scoring Model of Janalakshmi ......................................................32 Recommendations for the Credit Scoring Model of Janalakshmi ...........34 Annexure I (Loan Application Form) ......................................................35 Annexure II (Credit Scoring Model)........................................................39

IIMB

Financing Small Enterprises by MFIs

Need for credit for Small Businesses and Enterprises

Small businesses and enterprises in India suffer from a great deal of indebtedness1 and are subject to exploitation in the credit market through high interest rates and lack of convenient access to credit. They need credit to fund their working capital needs on a day-to-day basis as well as long term needs like emergencies or other income related activities. They need credit to smoothen out seasonal fluctuations in cash flow arising from agricultural activities and consumer demand. They also need credit as an insurance against minor spikes and troughs with respect to income and expenditure. Since cash flows for the majority of small businesses like vegetable vendors are small and savings are small as well, they typically tend to rely on credit for other consumption needs like education, food, housing, household functions etc. And this is exacerbated by the fact that India has no social security net that will take care of basic amenities like health, education and so on for the poor. To meet these credit needs they need access to financial institutions that can provide them with credit at lower rates and at reasonable terms than the traditional money lender.

Problems of Credit Supply

The main obstacles to the supply of credit arise from the following reasons2. The Credit markets are imperfect and fragmented: Most localities have internal political and economic hierarchies that create market segmentation in the demand and supply of resources, including investment and working capital. For. E.g. The loan requirements of a farmer i.e. its periodicity and its size will considerably differ from those of a vegetable vendor. The farmer would require a substantial size, as he would most probably utilize it for buying seeds or upgrading his machine. A vegetable vendor on the other hand would need a smaller amount to finance his daily needs i.e. to buy vegetables. Supply of formal sector credit is inadequate: The credit is not easily available. Loans from Banks involve a lot of paper work. There is a collateral requirement, which becomes a burden to the borrowers. There are complex legal and operational
1

Ramachandran V.K and Madhura Swaminathan, Rural Banking and Landless Labour Households: Institutional Reform and Rural Credit Markets in India, Journal of Agrarian Change, Vol. 2, No 4, October 2002, pp. 502-544 2 Ibid IIMB

Financing Small Enterprises by MFIs

procedures, which result in delaying the loan disbursal. Hence, credit is not available on time (takes as much as 2 to 18 months). Borrowers are generally assumed to be non credit-worthy and their recovery rate unsatisfactory. Hence monitoring them, getting their credit history for evaluation of loans adds to the transaction costs of the bank. Distribution of formal sector credit is unequal with respect to region, class, gender and caste: There is an enormous concentration of the MFIs (Micro Finance Institutions) in the south of India. This is primarily because of the general dissatisfaction in the economy of the central, eastern and north eastern states, with very little resultant demand for credit among the subsistence poor, and the absence (for historical reasons) of good quality NGOs, that are willing to initiate Microfinance programs in these states (there are a large number of small NGOs but all of them with limited experience and outreach). Informal credit is the main source at high rates of interest and adverse terms and conditions implemented by coercion of different means both economic and noneconomic. This problem of credit has been addressed through formal sector lending institutions, directed lending and subsidized credit3. To address this inadequacy, Micro Credit has gained importance over the past few years. This has had very good success in countries like Bangladesh, Indonesia and other Asian countries and is gaining ground in India as well.

Rangarajan, C., 1996 Rural India: The Role of Credit, Reserve Bank of India Bulletin, May, Bombay: Reserve Bank of India

IIMB

Financing Small Enterprises by MFIs

Many microfinance institutions have developed large-scale operations by offering a few highly standardized products. Offering one-size fits all loan terms and conditions has the following advantages: Streamlines loan administration Simplifies decision-making for field staff Reduces information requirements from clients Low operational costs Simplified repayment obligations

However, this standardization has its own drawbacks. Many MFIs are reporting high dropout rates and repeat borrowers do not demand the larger loan sizes assumed in many MFI market projections. Also, there are potential clients who refuse to join programs even though the products offered were supposedly designed for them. This has led MFIs to re-evaluate their business plans and pay closer attention to product flexibility. Individual need-based loans are more suitable as they can be designed to cater to the specific requirements of the clients.

SAFAL Activities
SAFAL is an organization based out of Bangalore that helps in gleaning produce (mainly food and vegetables) for the retail vendors as well as the pushcart vendors. It aids the farmers by giving them competent pricing for their yield by eliminating the middlemen in the supply chain. It implements this by openly auctioning the farmers products and selling them to the retail vendors. It also helps those retail vendors who have to buy from other vendors and thus have to include the vendors margins while repaying them. However the retail vendors who buy the produce from SAFAL have several issues with financing their daily needs. They obtain the funds needed to buy the produce from SAFAL from the local moneylenders. SAFAL also tried to create affinity groups (on the lines of Self Help Groups) which brought together people from the same area in order to give them credit.

IIMB

Financing Small Enterprises by MFIs

However they concluded that, the strategy did not work as people didnt seem to have the affinity for each other when money was involved.

A Typical Retail Vendor

A Retail vendor is usually from the outskirts of the city (around the area where veerappan resides is what an ex-official of SAFAL had to say). Due to low rains, arid land and such similar severe conditions he turns to the city for survival. A few of them are also from other south Indian cities like Chennai, Hyderabad, etc. Most of them do not even have a pushcart to start off. Hence they have to source these amenities that they would need everyday from different lenders. Most of the times the same person lends the money, produce and the push cart. The vendors pay a huge amount by way of interest. Typically they borrow daily around Rs.90 and agree to pay back Rs. 100 at the end of the day, which translates, to an exorbitant 4056% per annum! Instead of borrowing everyday the vendor also has the option of borrowing around Rs. 3000 on a monthly basis depending on the kind of resources the lender has to wring the money out of the vendor in case he decides to run with the money. In case the vendor has borrowed the cart he has to pay an extra Rs. 20 daily. This money is taken from the lenders the previous night before the market opens which is around 5:00 am in the morning.

Origin of Janalakshmi
These issues of financing for the vendors led to the inception of Janalakshmi, an organization set up as a body of Sanghamithra urban program with the objective to provide credit to urban vendors. Apart from giving credit to traders on a periodical basis, Janalakshmi has created a Credit Scoring Model that will score every trader who needs credit based on certain parameters that we will look at below. The final score will decide whether the trader should be given credit or not.

IIMB

Financing Small Enterprises by MFIs

Credit Scoring Literature Survey

A potential clients credit risk level is often evaluated by the banks internal credit scoring models4. These aim to determine whether an applicant has the capacity to repay by evaluating the credit risk of his loan application. This is normally done using historical data and statistical techniques. Such models offer banks a means for evaluating the risk of their credit portfolio, in a timely manner. Credit scoring has both financial and non-financial aspects. The dimensions that are analyzed in credit scoring are categorized under five main headings namely: (i) Capacity (ability to repay) (ii) Character (willingness to repay) (iii) Capital (wealth of borrower) (iv) Collateral (security if necessary) and (v) Conditions (external and economic) These popular five categories of credit management establish the likelihood that a potential or existing borrower will successfully meet scheduled interest and principal payments. Based on the above categories the credit scoring model that we have devised for a vegetable vendor in India incorporates these points as follows:

Ahmet Burak Emel and Muhittin Oral, 2003, A credit scoring approach for the commercial banking sector,

IIMB

Financing Small Enterprises by MFIs

Capacity (ability to repay) We thought of capturing this category through the Trading History parameter. If a client has had a significant trading record then he would obviously have the capacity to pay his interest and principal repayments in time. Trading history parameter essentially has the following sub parameters: Period of trading Frequency of transactions Uniformity in value of transactions (to capture the borrowers stability in his trade) Character (Willingness to repay) This category has been incorporated into the model by way of the number of guarantees the individual is able to get. Since the guarantors also form the borrowers immediate neighbors they would have maximum informal information about the character of the client and whether he has a stable repayment history. The sub parameters for rating this category are: Number of guarantors in the group Familiarity with guarantors(members/non-members of the MFI) Financial soundness of guarantors Capital (Wealth of borrower) This information is obtained from the Personal Security and the Business Information of the client. These would essentially have the following sub parameters:

IIMB

Financing Small Enterprises by MFIs

Business Information Total turnover Total business expenses Total personal expenses Other commitments towards repayment of previous loans Personal Security Assets owned Assets mortgaged/rented Assets offered as security Collateral (Security if necessary) Collateral if available would increase the score of a vendor as risk associated with him both credit and default is much reduced. He can also operate on a line of credit basis which we have discussed in one of the previous sections. This information of the client is built-in in the form of the Savings parameter. The sub parameters are: Existing savings deposits Current cash surplus available for saving Expenses of avoidable activities like drinking, movies, etc Interest of client in taking a savings product Conditions (External and economic) This category is important as this would determine how the future and the present conditions if the vendor could affect his payments. E.g., if he has a greater number of young dependents then it is likely that his expenses would increase in the future, as his dependents would come of age. Also if he has an ailing family member, it is probable that it could increase his everyday expenditure. Similarly his future prospects play a significant role under this

IIMB

Financing Small Enterprises by MFIs

category. If he is into a business that is not much in demand due to seasonal variation or customers changing tastes, he needs to change his business. The sub parameters for these are: Individual Demographics Age Number of family members Number of dependents Number of family members in the same business Growth Prospects Current scale of operation Interest/possibility of future expansion However, there is a potential problem with credit scoring as it is usually done5. The statistical models that are usually used to evaluate applicants are constructed from historical data. In order to enter the sample used to build the model, an individual must have already been `accepted'. Thus, the model after the initial pilot is a description of some aspect of the behavior of individuals who have already received loans. The scoring model is to be used to evaluate applicants who are drawn randomly from the entire population. The individuals whose applications were accepted to begin with could have been qualitatively different (difference in credit scoring) from individuals whose applications were rejected. Since, an application which arrives randomly at the MFI could be of either type, i.e. the application could be for a client applying for the first time or also for a regular client it is not certain that the model being used is appropriate for the population being measured. Hence the main challenge of the credit scoring model is to upgrade the model as frequently as possible for the regular customers and have a set standard (e.g., define the score for certain parameters for eligibility) when the client applies for the loan the first time.

William Greene, 1998, Sample selection in credit-scoring models

IIMB

10

Financing Small Enterprises by MFIs

We should also remember that Scoring works best for those with a solid individual lending technology and a large database of historical loans6. Even when scoring works, it is only a marked improvement, not a breakthrough. In particular, scoring will not replace loan officers in microcredit completely because much of the risk of the self-employed poor is unrelated to the information available for use in scoring.

Mark Schreiner, 2003, Scoring: The Next Breakthrough in Microcredit?

IIMB

11

Financing Small Enterprises by MFIs

Case study I
M. Nagappa is a fruit vendor who sells Apples, Oranges and Sweet Lemon in the crowded Madivala market. He arrived in Bangalore three years ago from Tamilnadu. His decision to carry out his daily routine in Bangalore was due to the frustration he experienced in Tamilnadu because of the hostility of the local rowdies who asked him a share of his earnings every day. The police officials were also totally indifferent to the existing conditions there. As it is he was the only earning member in his family. Hence to support his two sisters and his parents, he turned to Madivala Market in Bangalore where hundreds of vendors get their push carts everyday at dawn and feel secure enough to leave their carts at night and depart home. Nagappa and his sisters completed their education upto 12th Standard in Tamil medium. His elder sister got married and hence he has four members of his family dependent on him. His family owns a house Villupuram, a small town in Tamilnadu, in a village called Mutathur. Nagappa does not have a place to live in Bangalore. He spends his nights at his uncles shop where he doesnt have to pay rent. Daily routine for Nagappa consists of getting his pushcart (which he bought sometime back) filled by his uncle with fruits and selling them in the Madivala market. The fruits are mainly sourced from certain wholesale markets where his uncle has been trading for a long time. His cart is filled 2 to 3 times in a week. However it also depends on the season, weather, customers taste etc. For this daily activity of Nagappa, his uncle charges him Rs.8500 for 3 months for which he has to repay Rs.10000. He accomplishes this by repaying Rs.100/- everyday for 100 days (approximately 3 months) through his everyday sales.

IIMB

12

Financing Small Enterprises by MFIs

His other expenses include paying for the following:

Expenses

Amount (in Rs.)

Using the Bathroom

2/-

Washing his Face

3/-

Food

50/-

Bath (He has a bath once in 3 days and 10/otherwise manages by washing his face as it becomes too expensive to have a bath everyday)

Washed and ironed clothes (again once in 3 15/days)

When asked why he didnt opt for only washing his clothes without ironing he said it came as a bundled deal.

Liquor

(especially

when

sales

are 15/-

abysmally low)

Cigarettes

12/-

It becomes very difficult for him to carry out his daily routines without having at least 5-6 cigarettes everyday

IIMB

13

Financing Small Enterprises by MFIs

Apart from the above expenses Nagappa is also a sufferer of the vaddi sala system which is a highly popular lending practice amongst vendors. In this type of loan the loan payer keeps repaying the interest till such time he has the whole lumpsum amount (i.e. the principal) to repay the lender. Nagappa borrowed a sum of Rs. 20000/- from money lenders in Tamilnadu for his sisters marriage and his nephews ear piercing ceremony. He has since then (that was around 2 years back) been paying interest of Rs.800 per month on the loan. He has to keep paying this interest till he collects the amount of Rs. 20000 and repays it back as a whole. From his sales, Nagappa makes a profit of Rs.5/- on an average on all the three types of fruits that he sells. Hence in a period of one week he makes around Rs.750 as follows.

Refill (in numbers) in a week

Profit (in Rs.)

90 (for Apples)

Rs. 450

30 (for Oranges)

Rs. 150

30 (for Sweet Lemon)

Rs. 150

Btu the above calculation is subject to vagaries of weather and season to a very large extent. For e.g. the recent heavy downpour of rains in Bangalore led to a huge loss in business for all the vendors.

IIMB

14

Financing Small Enterprises by MFIs

Case study 2
Perumal, a 19 year old boy educated till 9th standard sells Bananas at Madivala market everyday. His family consists of 12 members including his relatives and they altogether have a total of 7 children. His family is well settled in Bangalore having operated in the market for more than ten years now. Perumal hails from Tirupathur which is a village in Tiruchi. His daily routine encompasses getting the produce from their wholesaler and farmer friend in Tiruchi for an amount of Rs.20000/-. His source of income remains his sales and the loan amount he occasionally borrows from his relative in Tiruchi which he repays back monthly without any interest. He borrows Rs.10000 from him. His family also has a small shop in Madivala market which is mainly used for stocking but they also sell Bananas there. His familys daily expenses include the following:

Expenses

Amount (in Rs.)

Food

200/-

Travel (to and fro) by bus for the members 40/of the family

Electricity Bill

50

Getting the produce from Tiruchi (weekly)

2500

Decay due to bad weather or poor sales 500 (weekly)

Repairing the pushcart i.e. replacing the 50 tyre etc (once a month)

He manages a yearly profit of around Rs.5000/- which is used for family expenses.
IIMB

15

Financing Small Enterprises by MFIs

Case study 3
Mallesh, a vegetable vendor is a 23 years old man who has had education till 4th Standard and sells his produce in the Vijayanagar area in Bangalore. He arrived in Bangalore 3 years ago leaving his factory Job where he was getting a monthly salary of Rs. 2000. The salary was not enough to feed his brothers family which was fairly large and his own. So he decided to move to the city. Mallesh starts for work at 7:30am everyday where he buys his produce from the wholesale market and sells on the way home. He pushes his cart for one and a half hours on a steep slope and reaches Yashwantpura. He reaches home at 1:00pm and again sets out for selling with his pushcart at 4:00pm. However he works only for 4 days a week as it becomes too strenuous to carry the cart everyday. His daily expenses are as follows:

Expenses

Amount (in Rs.)

Rent

800/-

Electricity

150/-

Water

100-150/-

Kerosene

30/-

Miscellaneous

expenses

(watching

a 50

movie, occasional drinking etc.)

Pushcart Repairs (replacing tyres etc) 1000 (once in 3-4 months)

IIMB

16

Financing Small Enterprises by MFIs

Mallesh takes a loan of Rs. 5000 every 3 months to finance his business as well as his daily needs. The loan amount that he gets is Rs. 4250 and the amount he repays is Rs. 5000. He repays Rs. 50 everyday for 100 days. Other than this Mallesh is repaying the loan of his neighbor for whom he gave guarantee at some point. His neighbor disappeared with around Rs. 14000/- of which Mallesh repays Rs.750/- every month as a part of the principal repayment. Mallesh makes a profit of Rs.100 to 150/- everyday to support his daily needs. He tries to save around Rs.50 everyday. From the saved money, he sends his family an amount of Rs.2000 periodically for their requirements.

IIMB

17

Financing Small Enterprises by MFIs

Product Features
As inferred from the interviews, most of the pushcart vendors depend on their friends and relatives for finance. In times of emergency and crisis, they resort to vaddi sala from local moneylenders on which they pay very high rates of interest. The main problems faced by the vendors with the current type of financing can be enumerated as under. In two of the cases, we found that the vendors take 3-month loans on which they pay an interest of 17.64% quarterly. This amounts to an exorbitant compounded annual rate of 91.52%. In the case of a vaddi sala, they borrow a lumpsum amount and then keep paying interest on it till the lumpsum amount is repaid. For instance, one of the vendors has taken a loan of Rs. 10000 and is paying Rs. 500 per month as interest, which amounts to a rate of79.59% annually. The vendors are not in a position to accumulate such a big sum of money. Thus, they keep paying such high interests over a long period of time. None of the vendors have a bank account, which may pay them some interest on their savings. Therefore, they have little incentive to save and spend their surplus cash on unnecessary activities like drinking, smoking, movies, etc. Due to non-availability of a collateral security, the moneylenders ask for a guarantee by the vendors neighbor who is usually in the same trade and is from the same village as the vendor. This agreement between the vendor and his neighbor is mutual. Therefore, if one person defaults, the entire burden of repayment is shifted to the other person.

Considering the afore-mentioned problems, we believe that the following features should be incorporated in an ideal product for the vendors. These will not only help in overcoming the current shortcomings, but will also give the vendors a greater sense of security. All the vendors prefer short-term loans of about 2-3 months maturity. Therefore, such short-term loans should be available to them but at lower interest rates than the current 17.64% quarterly.

IIMB

18

Financing Small Enterprises by MFIs

To overcome the problem of non-saving, the following 2 features can be considered o A person who has taken a loan can be encouraged to deposit his/her monthly savings. This savings amount can be used to settle against the outstanding loan amount leading to early repayment and thereby lower interest rates on the outstanding balance. o A separate savings product can be offered to the vendors where the vendors can deposit their monthly savings on which the MFI can pay them some amount of interest. This would also help the vendors to accumulate a lumpsum amount, which they can withdraw in times of emergency or need.

The MFI can adopt the joint liability model to overcome the problem of default in repayment by any of the members in the affinity group. The loans in the group can be given on individual basis whereas the group can share the liability of default. This will prevent the problem of burdening a single person due to his neighbors inability to repay. However, while creating the affinity groups, the MFI should ensure that all the individuals in the group require a similar amount of loan such that the burden created due to any members default is the same.

For implementing the savings schemes, the regulatory framework for banks and NBFCs must be considered. As per the regulations, any institution requires a minimum equity capital of Rs. 2 billion to be able to accept deposits. To acquire the status of an NBFC, an institution requires a minimum equity capital of Rs. 20 million but it cannot accept deposits from its clients. Therefore, to facilitate the savings products, the MFI can try to collaborate with banks such as ICICI, which also works in the micro-lending space. If the MFI collaborates with a private bank for sourcing of funds, there are primarily three kinds of structures possible. Portfolio Buyout Structure: The existing assets of the MFI can be assigned to the bank in return of a purchase consideration. On-tap Securitization: The MFI can continually source loans from the bank and can assign the receivables under such loans to the bank under a mutually agreed arrangement wherein sourcing criteria and operational guidelines are stipulated. Partnership Model: The MFI can source loans directly in the books of the Bank, and continue to monitor and recover loans thus disbursed.

IIMB

19

Financing Small Enterprises by MFIs

However, all collaborations with any private banks would work best when the terms on using the money are not dictated but left to the MFI to decide on and all relevant information is disclosed and transactions are as transparent as possible.

IIMB

20

Financing Small Enterprises by MFIs

Interest Rate Determination

The interest rates charged by the MFIs are high essentially due to the high costs of bringing micro-finance products and services to the poor. In addition, there are the costs of creating delivery mechanisms at the community level (which are not included in determining the interest rates). Then there is the cost of creating and setting the client base for micro-finance products and services. These costs are difficult to integrate into the calculations of interest rates. Hence each of these issues must be considered while determining interest rates in order to avoid any operational difficulties in future. Apart from this recruiting, training and monitoring staff is a key constraint. Monitoring of operations and transactions using IT based systems is a must. All these will add up to the transactional cost and hence an increase in the interest rates If an MFI has to be sustainable, covering costs of funds, and transaction costs, than interest rates have to be high. Talking about interest rates as a percentage on loans of Rs 2000 or 5000 might not be the most accurate method of expressing them. The transaction costs - of finding a borrower, appraising her, disbursing money to her doorstep and then collecting it back over 52 weeks or twelve months in small installments, is nearly fixed irrespective of loan size. So if the cost is Rs 500 per loan, then the cost can amount to as high as 25% for Rs 2000 loan and will appear to be as low as 5% for Rs 10,000 loan. Thus interest rates of 24% per annum charged by most MFIs are barely enough to cover their costs. We could specify a minimum rate of 12% per annum on a declining balance, and a maximum of 25% per annum. The lower interests if for people who might borrow in groups or have guarantee given by others as our transaction costs would be lower there. E.g., for lending a large sum of Rs 2 lakh to a group of 10 vendors who might want to start a shop, we would charge 12%. But where we have to give an individual loan of Rs 5000 to a marginal vendor, there the transaction cost is high and hence we would charge 25%. In any case that would be far less than the interest charged by moneylenders on a yearly basis. It is only through competition that the interest rates can come down. It can happen if there are a many MFIs offering similar products to the retail vendors differentiating only on interest rates and that would be good for the customer as well as for the business. The GoI and RBI should encourage hundreds of institutions to come into this field, innovate and bring down

IIMB

21

Financing Small Enterprises by MFIs

the costs. But even then the interest rate might not come down to 8 or 10% because the cost of lending small loans is intrinsically high Also interest rates would not be the same way across all the products that we offer; it would not be same even in the same location for different types of customers because along with the transaction cost of disbursing the loan, the risk cost has to be kept in mind. We would do a risk based pricing of the loan based on a credit-scoring model, which would rate the customer on different parameters. If there is a class like a particular region, a particular activity or a category of people where the default rate is 5% instead of 2% then the 3% has to be built into the pricing because unlike in public sector banks, there is no government that would write off loans and then recapitalize lending institutions.

IIMB

22

Financing Small Enterprises by MFIs

Loan Appraisal
Loan appraisal for micro lending has a number of complexities. Complexities arise due to lack of data validation, high risk lending, financial constraints of the MFI, high transaction costs, etc. for assessing the credit worthiness of clients, MFIs have two options: individual case by case basis of evaluation by a loan officer or use of a standardized credit scoring model. In the individual case-by-case method, a loan officer collects all relevant information for each client and then decides on the credit worthiness of the client. This method offers the advantages of greater accuracy of information and better decisions about the disbursement of loans. However, it involves very high transaction cost, higher loan processing time and very highly skilled staff. Also, the loan appraisal decision is completely dependent on the judgment of the loan officer. Using a standardized credit-scoring model is simpler and less time-consuming. With a creditscoring model, a less qualified person can also assess the clients credit worthiness and take a suitable decision. The transaction costs and operating costs are reduced significantly. However, it suffers from the problem of absence of on-site data validation giving rise to greater risk of default by the clients.

IIMB

23

Financing Small Enterprises by MFIs

Product Design
We will segment all our clients, based on the purpose of their loan, into the following: Loan for everyday (income generation) activities or Working capital Loans Loans for Micro enterprise Loans for Small Enterprise Working Capital Loans implies full-time, often seasonal economic activities undertaken for subsistence. At times several family members simultaneously engage themselves in a wide array of such activities, in order to diversify the income sources of the household. Similarly small enterprises are the entrepreneurs' primary source of income but they reinvest the profits of the enterprise to further its growth. Microenterprise bridges the gap between the loans for daily activities and those for Small enterprise. Definitions: We define Microenterprise activities as any individual or group of borrowers having combined assets (to be offered as collateral) less than Rs. 10,000. Similarly we define Small Enterprise activities as any owner having assets less than Rs.100,000. For Income Generation or working Capital loans there need not be any collateral. With working capital loans, the need is for loans for which borrowers are willing to pay reasonably high interest rates, which would obviously be considerably lesser than what they pay the moneylenders. However Microenterprises would need more flexible financial products, which are more customized. Microenterprises might also require working capital loans, but initially when they are about to set up their business or when they are about to expand they would need fixed asset investment loans. Such investments require access to larger loan amounts for longer periods of time, and as a consequence, borrowers can afford interest rates significantly lower than those affordable by the working capital borrowers yet higher than the commercial bank rate. Finally, Small enterprises have very different credit needs, almost matching the credit conditions of the commercial banking loan sizes and terms specifically matched to the investment and repayment capacity of the business, for which the borrower is able to offer sufficient collateral, but can only afford commercial interest rates.

IIMB

24

Financing Small Enterprises by MFIs

Characteristic

Daily Activity

ME

SE

Use of loan

Working Cap

Working Cap + Fixed Assets

Working Cap + Fixed Assets + Infrastructure for expansion

Loan term

1 week months

3 4 months 1.5 years Rs. 10000 100000 Low 15% - 25%

1 - 5 years

Loan size

Rs. 500 10000

Rs. 10000 100000 High 5% - 15%

Collateral Requirement Interest Rates

None 25% - 40%

Repayment

Daily

Daily for a month Monthly + Weekly after that

Collection

By agents

collecting At at the

the

nearest

At

the

nearest

branch of the MFI

branch of the MFI

specified markets

For all Loan products, the Clients are required to acquire guarantee of atleast three independent parties forming a joint liability group. Each of the parties in the group guarantees each others default. The individuals in the groups are from the same neighbourhood, as they would have maximum information about the neighbours activities.

IIMB

25

Financing Small Enterprises by MFIs

Supplementary Products
Education Loan Savings Product Remittance Product Microinsurance Products Microentrepreneurs Products Emergency Loan Mutual Benefit Product

IIMB

26

Financing Small Enterprises by MFIs

Education Loan This will be given for education of the immediate family members of the client. Maximum loan would be decided based on the segment to which the client belongs. Savings Product We would have the following features in the Savings product that we would offer:

Product

Minimum Balance Term for withdrawal deposit

of Amount and Interest frequency of deposit

Regular

1000 or 10% of his 4 months current balance whichever is higher

Weekly deposit of 1% of the loan amount

8%

Combined

(for None

Anytime

Monthly deposit of

6%

non borrowers)

Long term

50000 or 5% of 1-5 years the current balance whichever is higher

Monthly deposit of 5% of the loan amount

8%

The amount that would be obtainable would be reduced if the amount is withdrawn before the expiry of the term.

IIMB

27

Financing Small Enterprises by MFIs

Remittance Product For a client like Nagappa who sends most of his earnings to his family back in Tamilnadu, it will be highly convenient if a product is devised for him wherein we will pay his family on a monthly basis and charge the repayment from Nagappa. This will however include the transaction costs in sending the amount to Nagappas village which he anyways would end up paying himself. This would fall under the income generation activities and the rates will be charged accordingly. Microinsurance Product Disastrous losses such as those caused by fire, theft, or natural disasters can be disturbing for any business owner. To help mitigate these catastrophic losses, we will offer an insurance product to our clients. Since we are largely looking at a client base that consists of vendors who would want everyday finance for their income generation activities, we are not planning to get into Life insurance at this stage. We would provide insurance for the vendors pushcart for instance. Other insurances products would be insurance against calamities and seasonality changes where we could relax the repayments cycle for our clients at a higher interest or take a premium from them every month and repay a lumpsum amount during the calamity. Microentrepreneurs Product Microentrepreneurs would be financed for fixed assets or for infrastructure and the interests would be charged as given in the above Table based on the purposes that the client needs the loan. Emergency Loan This loan will be given in case of unforeseen emergencies. E.g., accidents, for performing the last rites of a person, etc. This loan is different from Microinsurance in the sense that the amount for this loan will be decided based on the savings the client has or his repayment history or his cash flows. The client would not have to pay any premium on a periodical basis for this type of product. Mutual Benefit Product

IIMB

28

Financing Small Enterprises by MFIs

This product is applicable only to working capital loans. Here the client can combine a regular savings scheme with the basic working capital loan. He can achieve this by depositing a percentage of his daily earnings in his account every evening. He can then withdraw a certain amount based on his daily working capital needs everyday and keep repaying the amount along with interest that evening. In essence the borrower would get to operate on a line of credit. The interest rates on his deposit could be increased or his repayment interest rates could be reduced if client additionally wants to save a portion of his daily earnings.

IIMB

29

Financing Small Enterprises by MFIs

Loan Appraisal
Application form (Refer Annexure I for the actual application form) For the purpose of loan application, we are using a standardized application form. The application form will provide information pertaining to the following, which will help in assessing the credit worthiness of the applicant by using the credit scoring model. Personal details Financial information (business and personal) Personal security Product details Details of guarantors

Verifications The application form will be filled by a loan officer by visiting the residence of the applicant. This will enable verification of various information provided by him/her. Due to the lack of adequate security, the verification process becomes very important to avoid incorrect data. The following key information requires thorough investigation and verification. Location of residence Place of business (fixed/mobile) Bank details Details of guarantors

Verification of guarantor details is most important, as they are the only source of security provided by the applicants. This is the reason for carrying out the application form filling process at the residence of the vendor as the loan officer can visit the neighbours who have given guarantee and verify their details. It is especially necessary to ensure that the guarantors do not belong to the same family or are closely related in order to diversify the risk of default.

Monitoring and collection

IIMB

30

Financing Small Enterprises by MFIs

For keeping a periodic check on the business of the vendors, we will assign one person in each region to carry out the process of form filling, monitoring and collection. Since the same person will carry out filling and monitoring, a better understanding between the client and the officer will be established which will provide better access to their operational information. Fixed pushcart vendors can repay their daily/weekly loans to their area in charge while mobile pushcart vendors can choose their place of repayment based on their convenience.

Approval While the form filling will be carried out by the area in charge, the approval of the loans and adjustments in the repayment requested by the vendors will be done by a superior, in charge of a number of areas. Therefore, the area in charge can be less skilled and his task will become simpler. Also, it will help in keeping a checking on the performance of the area in charge.

IIMB

31

Financing Small Enterprises by MFIs

Credit Scoring Model of Janalakshmi

The Credit Scoring Model of Janalakshmi rates the traders according to the following parameters with their respective weights:

Parameters

Weights

Trading History

30

Success of Data Validation

20

Financial Viability

15

Credit officers Recommendation

10

Feedback from neighborhood

10

Cross-sell Opportunity

10

Security

Savings History

0 (as of now)

Total

100

IIMB

32

Financing Small Enterprises by MFIs

Trading History: This parameter establishes the familiarity of the trader with SAFAL. This parameter as the highest score as the higher a trader the greater are the chances that he will execute his repayment. The following sub-parameters are used to measure the parameter o Period of trading o Frequency of transactions o Consistency in value of transactions o Familiarity of SAFAL representative Success of Data Validation: The data that has been entered in the appropriate forms by the vendor is verified by the officer. Based on the accuracy of that information this parameter is scored. Financial Viability: This decides whether the vendor has any means of financial capability. To score this parameter the cash flows of the vendors are considered after deducting all business expenses which include equipment expenses like replacing damaged tyres etc. Feedback from neighborhood: This parameter is scored by gaining feedback from neighbors and business community. Cross-Sell Opportunity: This parameter is scored depending on the number of products the vendor would be able to afford i.e. Educational Loan, General purpose Loan, Enterprise Loan, Education Loan. The more the number of products the vendor is interested in the higher the score he gets. Security: This parameter is scored based on the savings of the vendor which is highly unlikely; hence the lowest weights are given to this parameter.

IIMB

33

Financing Small Enterprises by MFIs

Recommendations for the Credit Scoring Model of Janalakshmi

Trading History: This parameter has been given the highest weights i.e. 30. Hence it becomes really important. Since SAFAL is an organization that came into being only 1.52 years ago, this parameter will be able to capture only the recent past of the trader. Instead of familiarity with SAFAL the Trading History should look at the familiarity of the trader with the trade itself i.e. the parameter should capture how long he has been in the trade instead of how long he has been with SAFAL. Financial capability should be given the lowest weight (similar to the Security parameter) because it is extremely difficult to establish the cash flows of a pushcart vendor. Also, if the vendor would have a stable cash flow he would be eligible for a loan in the commercial bank instead of a microfinance institution. For a pushcart vendor losing a 15 weight would mean a huge loss and that would be judged only on his cash flow. There should be some way of capturing the reason why the trader has come to Bangalore. This is essential because if the trader has come here for survival it is highly likely that he would stick around for a longer time than a trader who has come here to expand his business, etc. Most vendors seek out a way to protect their families who usually stay in the villages amidst their dry and barren lands. Hence, these traders are more trustworthy as they would not easily leave their source of income once settled. There needs to be a parameter to capture the movement of a vendor within the city because how frequently the vendor changes his market would provide some indication about how long he might stick to SAFAL and since Janalakshmi is initially targeting SAFAL customers, it would also give them an idea about how long the customer would have a registered information at SAFAL to be traceable.

IIMB

34

Financing Small Enterprises by MFIs

Annexure I (Loan Application Form)

PERSONAL INFORMATION 1) First Name 2) Middle Name 3) Last Name 4) Address 5) Telephone: Residence 6) Age 7) Sex: 8) No. Of Family Members 9) No Of Earning Members 10) No. Of Dependents 11) Education Qualifications if any

IIMB

35

Financing Small Enterprises by MFIs

FINANCIAL INFORMATION (Monthly) Personal Total Expenditure Expenditure on house rent Expenditure on Food Expenditure on Commission Expenditure on Education Expenditure on Utilities Expenditure on Miscellaneous Business Nature of Business Specify Turnover Specify Cost of Rent Specify Cost of Transportation Specify Cost of Electricity Miscellaneous Costs

IIMB

36

Financing Small Enterprises by MFIs

PERSONAL SECURITY & PRODUCT DETAILS 1) Details of Bank Accounts held Bank Name Bank Account number 2) Sources of income other than business 3) Assets Savings Immovable Properties Others 4) Amount repaid Routinely to Pay of Other Loans 5) Source of Loans 6) Purpose of Loans Taken 7) Details of Loan Taken (Amount, Term & Interest) Money Lenders Friends & Relatives Banks Others (specify) (Specify time period and amount)

IIMB

37

Financing Small Enterprises by MFIs

PRODUCT DETAILS 1) Type of product applied for Scheme of product 2) Amount 3) Preference of Repayment Duration Location Collateral

DETAILS OF GUARANTORS 1) Name 2) Address 3) Relationship with client 4) Specify for each member whether he/she is our client

IIMB

38

Financing Small Enterprises by MFIs

Annexure II (Credit Scoring Model)

Parameters with their weights Sub parameters Existing savings deposits Savings (20%) Current cash surplus available for saving Expenses of avoidable activities like drinking, movies, etc. Interest of client in taking a savings product Assets owned Personal security (20%) Assets mortgaged/rented Assets offered as security Number of guarantors in the group Number of Guarantees (15%) Familiarity with guarantors (members/non-members) Financial soundness of guarantors Total turnover Business information (15%) Total business expenses Total personal expenses Other commitments towards repayment of previous loans Period of trading Trading History (15%) Frequency of transactions Consistency in value of transactions Age Demographics (10%) Number of family members Number of dependents Number of family members in the same business Growth prospects (5%) Current scale of operation Interest/possibility of future expansion

IIMB

39