Strengthening microfinance in India

India’s microfinance market presents a great opportunity to the financial sector due to its large underserved population seeking financial services. It is estimated that the annual demand of microcredit loans (which are characterized by high repayment rates) is nearly equal to Rs 50,000 Crore. Over the past 10 years a significant number of NGOs have entered microfinance with an objective of taking financial services to the poor. The number of such initiatives is estimated to range between 600-800. Initially many NGO microfinance programs were funded by donor support in the form of revolving funds and operating grants. In recent years, these initiatives have been supported by developmental financial institutions such as NABARD, SIDBI and microfinance promotion agencies such as RMK, which have provided bulk loans and capacity building grants. Lately commercial banks (with ICICI bank taking lead) have also partnered with NGOs and MFIs to provide microfinancial services.

The gap that exist between the demand for microfinance services and supply of such services remains huge despite a new thrust in the policy of banks and development financial institutions to channelise funds into the micro finance sector. Against an estimated annual demand of Rs 50,000 Crore per year, the supply is estimated to be not more than Rs2000crores.

While, successful microfinance initiatives such as Share Microfin Limited, SKS Micro Finance, Spandana, Basix, Cashpor, SHG linkages of some banks etc have demonstrated that it is possible to provide sustainable and profitable financial intermediation services to the poor, however these examples that have managed to grow at a fast pace and have been able to reach sustainability and finance growth are limited in number.

The successes of these initiatives have established that the practice of group based microfinance can lead to the creation of high quality assets, even in the absence of physical collateral, in the financial sector, provided:
• High quality is ensured for microfinance groups so that there is a strong group feeling which leads to a credible “social-collateral”;
• Groups are trained well and are capable of ensuring financial discipline;
• Continuous monitoring, follow-up and reporting is ensured.

Mainstream financial institutions have mostly partnered with NGOs/MFIs to provide financial services to the poor. As stated above banks and Development Financial Institutions have either lended to the NGOs/MFIs to on-lend to the poor or have taken their help for linking up with SHGs. A number of financial NGOs have come up with the objective of facilitating the flow of banking sector funds to the poorer sections of the society. While this has increased outreach and access of financial services, however, most of these initiatives are unregulated entities, with limited institutional capacities to undertake financial services.

On the other hand a few microfinance institutions such as SHARE, Spandana and SKS have witnessed phenomenal growth of nearly 100% in the past two years. While this provides evidence of the sector’s growth potential, it also raises some important questions. Most of the MFIs that have shown high growth are located in south Indian states of Andhra Pradesh and Tamil Nadu. There has been an increase in competition for commercial sector funds as well as competition for clients among MFIs operating in the same geographical areas.

The risks in such a scenario are manifold:
• Misutilisation of funds meant for microfinance;
• Creation of bad assets due to ineffective screening and monitoring;
• Risk of frauds;
• Compromise on the quality of JLGs/SHGs;
• Covariant and systematic risks arising from geographic concentration;
• Opportunistic behavior by NGOs/SHGs – borrowing from one institution to repay another and hiding delinquency.

Any of these risks can seriously hamper the credibility of the nascent microfinance industry in India. Thus, the question that the sector faces today is – How can microfinance in India be bolstered? Within this context exploring the following alternatives become imperative:

1. Creating a set of shared performance indicators for monitoring of MFIs and SHGs, so that the overall risk in the sector is brought down
A possible solution could be having a set of performance indicators for MFIs and SHGs in the public domain. This could be facilitated through the formation of a collective microfinance information center, which has indicative data on the performance of MFIs/NGOs and even SHGs accounts with banks and other financial institutions. Such an initiative could substantially improve the risk profile of the microfinance sector, and also help banks/financial institutions in appropriately pricing their loans. The experience of SERASA, Brazil is an enlightening example of a credit information exchange.

2. Building a network of mentor institutions for the MFI sector which can help the smaller MFIs in evolving the right processes and systemsMany microfinance initiatives start as neighborhood entities which are efficient in their operations. However, as their clientele increases, so does the demand on their internal technological, technical and managerial capacities. In the absence of required systems, these entities find it hard to control the portfolio. This often results in a steady decline in the quality of the microifinance portfolio and impedes sustainability. Having a network of mentors can help these institutions in increasing their institutional capacities to serve a larger clientele and benefit from the economies of scale.

3. Investing into the microfinance sector to develop appropriate delivery structures through an incubation fundSome banks have also taken initiatives to partner with MFIs and SHGs in developing innovative credit delivery mechanisms for the poor. In the present context the banking sector seems constrained by a lack of appropriate delivery structures. However, the number of MFIs which have achieved a reasonable scale of operations, and which have evolved sufficient systems to utilize banking sector funds are few. In the present scenario It is important to develop more delivery structures to provide financial services to the underserved parts. Start up microfinance initiatives have found it increasingly difficult to develop capacity, and identify resources so that they reach sustainability. A fund that provides risk capital for such initiatives to reach an economic size of operations, can lead to an increased provision of financial services to underserved areas.