Taking Financial Services to the Poor

Reaching the Poor: Issues in Microfinance Outreach

The need for micro finance is overwhelming and the positives of its impact undeniable. The macroeconomic conditions such as low inflation economy with stable interest rates favour the growth and scaling up of sustainable microfinance. MFIs such as Share, Basix and Spandana have made an impact on the life of poor and yet have made profits, proving in the process, that sustainable micro finance achieves excellent social results. Experience drawn from various development initiatives suggest that subsidized credit has limited utility in terms of its effect on poverty alleviation and as some experts hold, it also discourages mainstream financial institutions from lending to the poor.

The evidence from microfinance practice world over is that the poor can save; they are willing to repay loans at commercial prices and display excellent repayment performance provided the loan products are suited to their income and consumption patterns. Microfinance has forced the traditional wisdom that the poor need subsidized credit to change. The scaling up of microfinance in India, thus, should be seen as a sustainable business activity rather than a social obligation. Despite the positives, microfinance outreach in the country is insufficient, geographically limited, and not organized - factors which limit its impact. In order to provide an enabling environment for realizing the latent potential of microfinance in India, a close scrutiny of policy issues such as capital constraints, legal and structural constraints and socio-cultural constraints is required.

Capital Constraints: The Real Impediment to Increasing Outreach
The liquidity condition of the financial sector in India is comfortable yet the microfinance sector faces a crunch in terms of smooth flow of funds. In the following paragraphs, we analyze the bottlenecks in the microfinance supply chain – areas where capital infusion can substantially help improve outreach.

Group Promotion
The success of the microfinance sector in India depends on the quality of SHGs and JLGs. The repayment performance of groups needs to be consistently high for any microfinance initiative to be successful. In addition, the groups need to be well trained in maintaining records of transactions to avoid any operational frauds. At times, SHGs also have to be provided with appropriate linkages in order to take up a productive enterprise. All this requires investment in terms of time, effort and money. The Ministry of Rural Development has established a norm of Rs 10,000 per group towards group promotion expense, which is quite realistic. Thus to form an additional one Million group, the amount required is Rs 1000 crore.

The availability as well as ensuring proper utilization of funds meant for SHG promotion is an issue that needs to be addressed. NABARD’s microFinance Development Fund (mFDF), set up in 2000-01, with a Rupees 100 crore corpus has identified capacity building of SHG as one of its objectives, however, the real need is much larger compared to the outlay made by mFDF. Funds for group promotions are also made available by the government under different development projects such as the SGSY and District Poverty Initiatives Project (DPIP).

However, keeping in mind the requirements of SHG creation, these initiatives are too small and spread out and need additional sources of funds. While the ideal way forward could be creating a capacity building fund for SHG, one can look at innovative ways to reduce grant component of capacity building. A possible solution could be extending soft loans with initial moratorium to MFIs and/or NGOs. The loan would help an MFI expand its outreach quickly while keeping the interest burden manageable and at the same time ensure financial discipline. The loan can be amortized over a period of six to nine years.

Equity investment in Non Banking Financial Company providing Micro Finance services may be another prudent investment tool for meeting the capacity building needs for the sector. It is important to note that these suggestions are applicable only to mature MFIs that are close to breaking even or are already profitable. Grant support is must for creating new SHG in areas where mature MFIs are not present.

Scaling-up Credit Operations
Presence of thousands of small MFIs across the country indicates the demand for micro finance programmes. Most of these institutions are small entities facilitating internal SHG savings and credit. Scaling up these initiatives presents a very complex challenge in terms of raising capital for expansion, which often undermines their outreach potential. In absence of scaled up operations, the small entities become grant dependent and are unviable and unsustainable. The only option that small MFIs have to achieve scale is either large grants or commercial debt, which cannot be the sole or the long term source of funds for lending .

Some other capitalization alternatives for scaling up operations may include:
• Equity capital,
• Client deposits,
• Capital market access,
• Foreign Borrowings,
• Strategic alliances with Financial Institutions,
• Increased flow of debt funds.

Equity Capital
Equity is an ideal instrument to grow a scalable and profitable business. Microfinance in India is still on the border of sustainability. Still, a high demand market and an opportunity to grow rapidly makes MFI a good equity invest prospect from the investor perspective. However, structural weaknesses in most MFIs’ operations, constraining legislations from Securities and Exchange Board on Venture Capital and difficult investment conditions under Non Banking Financial Company laws make MFIs very difficult investment vehicles for equity investors.

Most of the MFIs operate as charitable trust or societies ruling out any kind of equity intake. Migration to Section 25 Company status is not of much as these are non-profit in nature and cannot distribute dividends. Similarly, cooperatives are not designed to attract equity participation either.

The only institutional MFI that can attract equity capital is the one operating as an NBFC. However, setting up an NBFC means meeting Net Owned Fund requirement of Rs two crores and most MFI struggle to raise this start up capital. .

The Securities and Exchange Board guidelines on Venture Capital prohibit equity investment by Venture capital in a Non Banking Financial Company ruling out institutional equity to NBFC-MFIs. Social Venture Capital Funds located outside India may have keen interest to invest in promising MFI but the Foreign Investment Promotion Board Norms for financial services and RBI guidelines on NBFC on foreign investment does not allow more then 50% holding for foreign investor for investment below US $ 5 Million. This dissuades serious social venture capital investors to invest in equity of Indian MFIs.

Some of the solutions proposed to overcome the equity problems include setting up a National Microfinance Equity Fund (NmEF) for supporting MFI entrepreneurs. Encouraging institutional equity to MFIs from NABARD, SIDBI, NHB can help MFIs to significantly strengthen their capital structures and also bring them under the supervision of these institutions. Another option that policy makers may consider is to allow cash rich NGOs to invest in companies undertaking microfinance without prejudicing their tax status. This may require an amendment in the Income Tax Act for allowing NGOs to contribute equity to for profit MFIs.

Some other policy initiatives that can boost the Microfinance sector should include lowering the initial paid up capital requirements for MFIs to register as NBFCs to Rs 25 Lakhs and considering extending the “sweat equity" scheme (wherein the promoters' contribution of effort and experience is counted in monetary terms) to the microfinance sector.

A major boost to sustainable microfinance can be made by reviewing the limits for foreign investment in Micro Finance NBFCs. This may encourage socially conscious foreign investors to invest in young MFIs with NBFC status and provide a strong impetus to growth and scalability of the entire sector. The SKS Micro Finance deal with Unitus and TMSV LLC attracting US$ 0.5 Million as equity is possibly the most significant equity investment from foreign social venture capital funds and is an evidence of global interest in the Indian MFI Sector.

Client Deposits
Savings is a crucial service for the poor people. However RBI Regulation concerning mobilization of public deposits by MFIs allows only banks (which require a paid up capital of Rs100 crores), NBFCs (having a minimum capital of Rs five crores) or member owned institutions to raise deposits from public. While member owned institutions can raise deposits, they suffer from problems of dual control- a cooperative bank is regulated both by the registrar of cooperatives as well as the RBI. The MACS Act adopted in some states, notably Andhra Pradesh, overcomes this lacuna.

The NGOs, NBFCs (having lower capital base) or Section 25 companies are unable to provide legal saving services to the poor. Funds mobilized through deposit services are at a lower cost and enable MFIs to scale up their credit operations by rotating client savings. There is a strong case for allowing MFIs to take deposits with adequate safeguards. Mahajan and Ramola have suggested that MFIs should be allowed to provide savings services with the safeguard that deposit taking by MFIs is confined to only its borrowers. Additionally, imposition of an appropriate level of Statutory Liquidity Reserve could act as a buffer. This can be monitored on a quarterly basis and any misuse can be dealt with, by closure of the concerned MFI. Moreover, MFIs undertaking savings may be asked to maintain high levels of capital adequacy (upto 20%) so that they approach the capitalization levels of mainstream FIs as they scale up and evolve. MFIs should also be provided positive incentives to maintain a very high portfolio quality, with a regular reporting of non performing assets. The MFI policy needs to evolve prudential norms appropriate to institutions serving the poor and should have supervision mechanisms to meet the inherent challenges.

Capital and money markets
Evolved NBFC MFIs may look at capital markets as a solution to capital constraints. Securitization of MFI loan portfolio is an important initiative that provides a possible role for financial markets in addressing capital constraints that MFIs face today. Trading papers derived from securitized assets in secondary markets can possibly be an important determinant in resolving the issues of capital constraint and limited outreach for MFIs. ICICI bank has undertaken a securitization deal with Share Microfinance Ltd worth Rs 20 crores (US$ 4.3mn). The deal has enabled Share to access funds at lower costs. The securitized portfolio has been rated (AAA by CRISIL) and traded. Such initiatives need to be encouraged and promoted. Similarly venture capital funding of MFIs can also help them in strengthening their capital structures.

Foreign Borrowings
With increased confidence in India’s economy, as well as the promise shown by some MFIs in creating value many foreign investors and donors are willing to provide loans and guarantees to Indian MFIs. However the recent ban imposed by the finance ministry on accessing External Commercial Borrowing by financial intermediaries has had a major impact on the outreach plans of many Micro Finance Institutions, which were looking up to these funds for scaling up their operations. Hence, MFIs may be provided a special exemption for accessing foreign debts.

Strategic Alliances and Partnerships
Another way to beat capital constraints is for the MFIs to enter into strategic partnerships with banks. Such partnerships can allow for risk sharing between the two. The competence of the MFI in building a high quality portfolio coupled with the access of low cost funds to a bank can lead to synergies and hence help in overcoming outreach constraints. The ICICI bank is also experimenting with using MFIs as management and collection agents, where the loans are always on the books of the ICICI Bank, even though all the operations with the customers are handled by the MFI staff. The ICICI Bank has launched a pilot effort for this jointly with Cashpor Micro Credit, a section 25 company specially set up for this purpose by Cashpor Financial and Technical Services Ltd, in the Chandauli district of Uttar Pradesh. However cost of funds and additional burden of service tax being charged towards management and collection services is the major hurdle in the growth of such innovative alliances.