How to improve microfinance outreach in India?

Context
The microfinance sector in India is set to enter a phase of high growth. The top MFIs in the country have witnesses sustained growth and likely to continue on that path in the future. However, the combined outreach of these institutions is only fraction of the total demand. While there are over 600 institutions involved in microfinance some form, only a handful of them have managed to achieve any scale. They have been constrained by their own institutional capacities.

The experience of the top MFIs also reveal that their growth has been fuelled by commercial capital. This has ranged from simple term loans taken from banks, to innovative partnerships, to securitization microfinance assets, to equity investments and in the future may lead to bond and stock issues.

It is therefore important for emerging MFIs to develop capacities that will enable them to access commercial market funds in order to grow. At the same time these capacities are also essential for growing MFIs for continued performance. There is a case for channelling funds for capacity development of MFIs which can sustain high growth, provided they are able to upgrade their institutional capacity.

Issues that have to be addressed
The key questions within the above context, therefore, are:
Which MFIs are capable of growth maintaining a high institutional performance?
While growth is essential, growth management is an onerous task. Identifying MFIs that have a fair chance of successful growth is a formidable challenge.

How to build capacities in a number of MFIs so that they can cope with growth in a sustainable manner?
The Indian microfinance sector is characterised by diversity of institutions and methodologies. Thus, the capacity issues that these MFIs face are also unique. And it is difficult to have a standard solution for all of them.

How to prepare MFIs to stand scrutiny to the demands of formal financial institutions and access commercial funds?
Most microfinance initiatives have originated from social and charitable organizations and have little experience in financial reporting and accountability. Building their comfort and preparedness for a more intensive reporting system is another challenge.

How to improve the comfort level of commercial financial institutions as well as capital markets in dealing with MFIs?
The commercial sector has started taking notice of microfinance. However, there are apprehensions arising out of lack of information about the nature of microfinance operations. The fact that most MFIs have charitable roots also discourages commercial institutions from transacting with them.


Suggested Steps to Address these Issues
Identify capable MFIs: Identifying MFIs which are capable of achieving sustainability and scale has to be the first step. The following parameters may be utilised to identify them:
• Vision and MFI’s leader’s commitment to sustainability;
• Ownership structure;
• Institutional linkages;
• Portfolio quality;
• Present scale and growth potential.

Develop capacity building modules in critical areas including: Another step is having the right capacity enhancement modules in place. These modules must address the following:

Governance: The top leadership of an MFI should provide adequate strategy support. It must clearly articulate the institution’s vision. Besides, it is also responsible for building a functional board. It should ensure compliance with bylaws, procedures and other legal requirements. Additionally, in the case of microfinance institutions that become formal financial entities, the board must ensure that the institution understands and abides by the regulatory requirements that frame its activities. It must also work closely with management to ensure congruence between the institution’s strategic thinking and its operations. The top leadership is also responsible for the financial solvency of the institution. This responsibility requires oversight of resources available to the institution, their use to achieve the institution’s mission, and their proper management over time. Thus, the governance module would be aimed at the top leadership of the MFIs and would seek to inform them on their statutory as well as leadership obligations.

Legal structuring: Microfinance in India is practiced under all kind of legal forms. Some of these are followed more out of convenience rather then any strategic choices. However, some evolved entities choose forms to suit their business needs and implementing their long term vision. Some of the often used legal forms for micro credit and micro finance business include societies, trusts, Section 25-not for profit companies and Non Banking Financial Companies (NBFCs). While the presence of diversity in the legal form is not seen as a negative by most policy makers, it is important to note that the legal form chosen should be a strategic decision. This module will help the micro finance practitioner to make informed decisions while exercising his/her choice of a particular legal status.

Capital structure and Financial Planning: An institution’s capital structure is a function of its legal form, its credibility and its profit potential among other things. The sources of capital in the MFI sector in India have primarily been subsidised funds. However sustainability demands that the MFIs reduce their dependence on subsidies and become capable enough to absorb commercial funds. At the same time it is also essential that the interests of the existing stakeholders is safe guarded even when commercial funds come. This is possible only if MFI’s are able to measure their economic institutional value (more so for equity).

Management and operations: MFIs derive create real value through their operations. Good management is essential for successful MFI operations. This module will have several sub sets such as Information Systems (Accounting, Portfolio Tracking), Planning (Budgeting, Control), Product Development and Client Retention, Human Resources (Recruitment, Training, and Incentives). In addition the module will also help MFIs in assessing their risk management capacities primarily in the areas of credit risk and default recognition.

1. Information System: Timely availability and use of information are very important for the success of microfinance operations. The basic requirements of a functional Information System are:
• It should have all accounting as well as portfolio related information;
• It should lead to timely availability of information which facilitate management decision making;
• Information generated should be simple, reliable and adequate, having a smooth flow with the necessary aggregations at various levels;
• Computerised Information Systems should be stable and secure, complete with the necessary backups.

2. Budgeting and Control: This is necessary for the institution to determine its own funds requirements, as well as allocating resources for optimal results. Further an integrated planning and control system can help MFIs identify areas of underperformance and therefore help in bringing about improvements. MFIs also need to manage surplus funds through a well defined investment policy avoiding excessive exposure in any particular sector or instrument.

3. Product Development and Client Retention: These are important areas where MFIs need to focus on. The products offered by MFIs should be market friendly and the returns on these should adequately cover costs. Equally important and closely related to product development is Client Retention. As substantial resources are spent in generating a worthy client, loss of clients impacts sustainability negatively.

4. Human Resource Management: This is a critical element for MFIs, as in microfinance its people which undertake all activities that generate revenue. The critical areas here are:
• Acquiring the right people, and ensuring sufficiency all staff roles;
• Developing the right skill sets among staff members;
• Maintaining motivation among staff members by having appropriate incentive systems;
• Retaining competent staff for operational continuity.

Research the capacity gaps in the identified MFIs
This would require a detailed assessment of the capacity of selected MFIs. Broadly, the following frame may be used to review their performance and identify gaps:
• Governance
• Vision and mission
• Governing body
• Internal review and audit committee
• Internal disclosures
• Business planning

• Techno-Managerial
• Definition and documentation of systems and procedures
• Budgeting and financial control
• Accounting systems
• Management Information Systems (MIS)
• Product costing and analysis
• Human Resource Management (HRM)
• Levels of computerization

• Legal and Structural
• Financial reporting and disclosures
• Capital structure
• Outreach potential in a particular structure
• Raising equity, savings and making loans
• Institutional linkages and relationships allowed in a particular structure

• Financial Performance
• Portfolio Quality
• Financial viability
• Profitability
• Leverage and Capital adequacy
• Break even, scale, outreach and growth

• Environmental Issues
• Market definition
• Market Size and potential
• Market share and outreach potential

Administer capacity building modules and monitor progress
Once a review of the MFIs has been completed, suitable modules can be selected for administering to each of these MFIs.

The module on governance and legal structuring can be administered through workshops and presentations in a centralised manner. The expected outcome of these modules would be:
• Articulation of board’s roles and responsibilities by the participating MFIs;
• Articulation of vision and strategy;
• Informed choices on legal-structural options;

The module on capital structure would require dialogue with the concerned institution in order to establish their growth projections. Once this is complete a financial modelling of their projections can be undertaken by building spreadsheet models or using packages like microfin. Further the MFI staff can be given orientation on how to use the financial model as a tool to improve institutional performance.

The modules on management and operations would require close interactions with the MFIs so that incremental improvements can be made in their systems ensuring a smooth transition.


Dialogue with regulators and financial sector players
This is an important step in order to increase the acceptance of MFIs among commercial institutions. This can happen through group discussions with representatives from RBI, SEBI, rating agencies, banks and MFIs as participants. These discussions mayl cover the following broad areas:
• Securitisation and takeover of MFI assets by banks,
• Credit enhancement and Rating of securitised MFI assets,
• Secondary markets for derivatives developed from securitised MFI portfolio,
• Access of capital market funds by MFIs,
• MFI regulation – legal issues affecting MFI participation in formal financial markets,
• Compliance standards and disclosure norms for MFIs,
• Capital adequacy and solvency requirements for MFIs, vis-a-vis their need to mobilise savings,
• Building MFI’s internal capacities.

Identify financial linkage opportunities for these MFIs The final step would be identifying financial linkage opportunities for the MFIs and helping them in their efforts to form these linkages. This requires helping them in writing proposals, getting right registrations, and valuing their businesses.