Microenterprise Financing by MFIs

Our analysis of the economic activities of microenterprises that can potentially be served by MFIs lead us to the following common contours of the products that MFIs can offer to microenterprises in enterprise clusters in general.

Nature of Facilities: The target microenterprises need finance for capital expenditures as well as for working capital. Accordingly, loan products for capital expenditures as well as working capital need to be provided.

Loan Limits: The targeted microenterprises have modest capital expenditure needs, as they do not desire to take excessive risks by borrowing excessive sums. Accordingly they can be served well by capital expenditure loans with the upper-limit at Rs 150,000. Similarly, these microenterprises will be served well by working-capital loans with limit at Rs 100,000. Sometimes entrepreneurs may be willing to finance a part of the asset through their own capital and hence may opt for lower sized loans.

Interest rates: The microenterprises have a high Internal Rate of Return (IRR) on their projects and are in a position to service loans which carry an interest between 24% and 26%. MFIs should offer loans to the microenterprises only if they can successfully provide products with these interest rates.

Repayment Periods: It emerges from our analysis that the microenterprises can comfortably service capital expenditure loans over a period of 12 to 24 months depending on their loan sizes. In some cases higher repayment periods not exceeding 36 months may also be considered. A repayment term of 12 months is also suggested for the working capital loan so that the microenterprise has adequate cushion. This is because even though the working capital cycles of the microenterprises may be less than a year, their payments are often delayed. A longer loan term would ensure that they are able pay the loan back without getting stressed.

Risk Management: In the case of capital expenditure loans which are utilized for creation of a productive asset, the MFIs may hypothesize the primary asset created. Also, MFIs may use the mechanism of joint liability or personal guarantees to manage the credit risk. However, the products they offer should not involve any other form of collateral.

Appraisal: Given the informal nature of these enterprises, they may not be able to provide statements of accounts. Under such circumstances, the appraisal of their business turnover would need to be made by independently verifying information from their buyers and suppliers. Also, experience in the enterprise, residence in the area, other existing liabilities as well as opinion of other microenterprises in the area should be included in the loan appraisal.

Documentation: Standard documentation pertaining to address (of the unit) and identity (of the owners) proofs need to be obtained from the potential clients.  Additionally standard loan documents pertaining to the facility being provided need to be executed. In case the loan is for the creation of an asset, a hypothecation deed pertaining to the primary asset may also need to be executed.

Emerging Paradigms - IRDP to SGSY to NRLM

The Integrated Rural Development Programme (IRDP) was launched by the Government of India in 1978. The focus in IRDP was provision of subsidized credit to the poor, to enable them to build productive assets and raise their income levels. 

IRDP evolved into the Swarnjayanti Gram Swarojgar Yojana (SGSY) which was introduced in 1999. SGSY hoped to cover all aspects of self employment (training, technology, infrastructure and marketing) and utilize the power of Self Help Groups (SHGs) of poor to overcome the deficiencies of IRDP. It also provided a role for NGOs, who apart from formation of SHGs, were also supposed to have a monitoring role. 

The National Rural Livelihood Mission has been initiated in 2010 to redesign SGSY. NRLM goes beyond self employment and includes wage employment as a means to reducing rural poverty. This follows from the realization that not everyone is able to utilize credit in a productive manner, and pushing credit can be counter-productive, particularly when assessment of repayment capacities have not been carried out.