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MMS (FI NANCE) 2007-09





This is to certify that Mr. Amitkumar Sharma student of Masters in
Management Studies (Finance) of N. L. Dalmia I nstitute of Management
Studies and Research has satisfactorily completed final project on Measuring
Performance and Viability of Microfinance I nstitutions-A case of Bandhan
Microfinance Society under my supervision and guidance as partial fulfillment
of requirement of Masters in Management Studies course, Mumbai
University, 2007 09.

Prof Anil Gor Prof. P.L.Arya
Project Guide Director

Place: Mumbai
Date: 30th March, 2009


At the completion of my project, I would like to thank all those who helped me knowingly
and unknowingly.
I would like to express my deep sense of gratitude towards Director Prof. P.L.Arya of
N.L.Dalmia Institute of Management Studies And Research for giving me an opportunity to
do my Final Project.
I would like to thank my guide, Prof. Anil Gor for helping me out at each and every point of
time. I am very grateful to him for guiding me throughout the project, who advised me at all
the right times. I also thank him for his valuable time and continued assistance for the
successful completion of the project.
And last but not least I would like to thank all the faculty, staff of the institute for their direct
or indirect help in making my project an unforgettable and great learning experience.


Executive Summary

Major impediments to poverty alleviation and rapid economic growth in developing countries
are the lack of capital resources, especially in rural areas. A vicious cycle of low capital, low
productivity, low incomes, low savings and consequently weak capital base is clearly
operating. This results in a permanent poverty syndrome.

A multi-agency approach for providing working capital and asset acquisition to rural
borrowers has been in operation in India since 1969 with the nationalisation of 14 large
commercial banks. Regional Rural Banks were formed since 1975 with increasing emphasis
on priority sector lending targeted to the poor and the weaker sections of society. The failure
of many supply-led state interventions in rural-credit involving capital or interest subsidies
(like IRDP) is an established fact.
This has been accompanied by the rise in the social entrepreneurs. Using strategies involving
groups of women, joint liability lending, small loans, weekly repayments, it has been proved
that lending to poor people is possible and profitable. Micro Finance has been emerging as a
tool in this regard.
The rapid expansion of MFIs and the ongoing interest of mainstream investors-even in the
current financial crisisconfirm to the belief that microfinance is on the path to becoming an
emerging market asset class.
To achieve this potential, the industry must continue to widen and mobilize the investor base,
especially given the current market turmoil, while expanding the universe of effective and
sustainable MFIs.
This paper aims to measure performance and viability of an MFI called Bandhan
Microfinance Society with the help of globally accepted metrics which could be used by
the possible investors and lenders.


1. INTRODUCTION .......................................................................................................................... 7
Microfinance Defined ..................................................................................................................... 7
Clients of Microfinance .................................................................................................................. 8
Economics of Microfinance ............................................................................................................ 9
2. MICROFINANCE VS TRADITIONAL BANKING ................................................................... 11
Self Help Group and Federation: .................................................................................................. 14
Societies ........................................................................................................................................ 14
Trusts ............................................................................................................................................ 15
Co-operative Societies .................................................................................................................. 15
Co-operative Banks ....................................................................................................................... 16
Regional Rural Banks ................................................................................................................... 16
Local Area Banks .......................................................................................................................... 16
Private Banks ................................................................................................................................ 17
Section 25 Companies ................................................................................................................... 17
Non Banking Financial Companies .............................................................................................. 17
Organizations under BC/BF guidelines of the RBI ...................................................................... 18
Microfinance Bill .......................................................................................................................... 19
4. Micro Finance Delivery Models in India ...................................................................................... 21
Self Help Group (SHG) Model: .................................................................................................... 21
Federated Self Help Group Model: ............................................................................................... 22
Grameen Bank Model: .................................................................................................................. 23
ICICI Bank partnership model ...................................................................................................... 24
5. INDIAN MICROFINANCE MARKET ....................................................................................... 27
Need for Microfinance in India ..................................................................................................... 27
Major Milestones .......................................................................................................................... 28
Recent Trends ............................................................................................................................... 31
The on-lending funds constraint ................................................................................................... 33
Private equity in microfinance ...................................................................................................... 35
6. BANDHAN MICROFINANCE SOCIETY ................................................................................. 43
Operational Methodology ............................................................................................................. 43
Loan Products ............................................................................................................................... 44
Determination of effective rates on the Loan Products ................................................................. 45
7. ADJ USTMENTS TO THE FIANCIAL STATEMENTS ............................................................. 50
Why adjust for subsidies and concessions? .................................................................................. 50

Why an adjustment for inflation? .................................................................................................. 52

Unadjusted balance sheet .............................................................................................................. 54
Unadjusted profit and loss account ............................................................................................... 55
Adjusted balance sheet .................................................................................................................. 56
Adjusted profit and loss account ................................................................................................... 57
8. PERFORMANCE INDICATORS ................................................................................................ 59
I. Portfolio /Asset quality ......................................................................................................... 59
II. Productivity and efficiency ratios ......................................................................................... 61
III. Financial Viability ................................................................................................................ 65
IV. Profitability Ratios ................................................................................................................ 69
V. Management ......................................................................................................................... 73
VI. Scale and Outreach ............................................................................................................... 75
VII. Resources and Asset Liability Management ......................................................................... 76
9. COST BENEFIT ANALYSIS OF TRANSFORMATION TO NBFC ......................................... 79
10. Conclusion ................................................................................................................................ 88
11. Bibliography ............................................................................................................................. 89

Interest in the microfinance industry has soared as participants gain a better understanding of
the potential for microfinance institutions (MFI) to alter lives and economies. The primary
business of these organizations is providing small loans and financial services to low income
and/or financially underserved clients.
The evolution and performance of the microfinance industry over the past 30 years has been
impressive. However, this success brings with it a myriad of challenges. Significant risks
exist, including management quality and staffing of MFIs, as well as their governance,
technological expertise, and ability to effectively manage growth while maintaining a
commitment to their original mission. As many MFIs continue to transform from not-for-
profit entities to for-profit banks, these risks may be exacerbated. Effectively managing and
mitigating them will be instrumental to expanding the industry. Therefore, the impetus to
attract global capital needs to be tempered by prudent codes of conduct and globally
recognized standards.
Microfinance Defined
Micro finance is defined as the provision of thrift (savings), credit and other financial
services and products of very small amounts to the poor for enabling them to raise their
income levels and improve living standards.
Thus the contours of Microfinance are as follows:
Piloted by the alternate sector (NGO-MFIs)
Focused on the poor / women /vulnerable groups
Having roots in development.

The proposed Microfinance Services Regulation Bill defines microfinance services as
providing financial assistance to an individual or an eligible client, either directly or through
a group mechanism for:
an amount, not exceeding rupees fifty thousand in aggregate per individual, for small
and tiny enterprise, agriculture, allied activities (including for consumption purposes
of such individual) or
an amount not exceeding rupees one lakh fifty thousand in aggregate per individual
for housing purposes

The proposed regulations further define an MFI as an organisation or association of

individuals including the following if it is established for the purpose of carrying on the
business of extending microfinance services:
a society registered under the Societies Registration Act, 1860
a trust created under the Indian Trust Act,1880 or public trust registered under any
State enactment governing trust or public, religious or charitable purposes,
a cooperative society / mutual benefit society / mutually aided society registered
under any State enactment relating to such societies or any multistate cooperative
society registered under the Multi State Cooperative Societies Act, 2002 but not
including :
o a cooperative bank as defined in clause (cci) of section 5 of the Banking
Regulation Act, 1949 or
o a cooperative society engaged in agricultural operations or industrial activity
or purchase or sale of any goods and services.
Clients of Microfinance
The typical micro finance clients are low-income persons that do not have access to formal
financial institutions. Micro finance clients are typically self-employed, often household-
based entrepreneurs.
In rural areas, they are usually small farmers and others who are engaged in small income-
generating activities such as food processing and petty trade. In urban areas, micro finance
activities are more diverse and include shopkeepers, service providers, artisans, street
vendors, etc. Micro finance clients are poor and vulnerable non-poor who have a relatively
unstable source of income.
Access to conventional formal financial institutions, for many reasons, is inversely related to
income: the poorer you are the less likely that you have access. On the other hand, the
chances are that, the poorer you are, the more expensive or onerous informal financial
Moreover, informal arrangements may not suitably meet certain financial service needs or
may exclude you anyway. Individuals in this excluded and under-served market segment are
the clients of micro finance.

As we broaden the notion of the types of services micro finance encompasses, the potential
market of micro finance clients also expands. It depends on local conditions and political

climate, activeness of cooperatives, SHG & NGOs and support mechanism. For instance,
micro credit might have a far more limited market scope than say a more diversified range of
financial services, which includes various types of savings products, payment and remittance
services, and various insurance products. For example, many very poor farmers may not
really wish to borrow, but rather, would like a safer place to save the proceeds from their
harvest as these are consumed over several months by the requirements of daily living.
Economics of Microfinance
Why Doesnt Capital Naturally Flow to the Poor?
One of the first lessons in introductory economics is the principle of diminishing marginal
returns to capital, which says that enterprises with relatively little capital should be able to
earn higher returns on their investments than enterprises with a great deal of capital. Poorer
enterprises should thus be able to pay banks higher interest rates than richer enterprises.
Money should flow from rich depositors to poor entrepreneurs. The diminishing returns
principle is derived from the assumed concavity of production functions. Concavity is a
product of the very plausible assumption that when an enterprise invests more (i.e., uses more
capital), it should expect to produce more output, but each additional unit of capital will bring
smaller and smaller incremental (marginal) gains. The size of the incremental gains matter
since the marginal return to capital determines the borrowers ability to pay. The poorer
entrepreneur has a greater return on his next unit of capital and is willing to pay higher
interest rates than the richer entrepreneur.
On a larger scale, if this basic tool of introductory economics is correct, global investors have
got it all wrong. Instead of investing more money in New York, London, and Tokyo, wise
investors should direct their funds toward India, Kenya, Bolivia, and other low-income
countries where capital is relatively scarce. Money should move from North to South, not out
of altruism but in pursuit of profit.
However this seldom happens. The first place to start in sorting out the puzzle is with risk.
Investing in Kenya, India, or Bolivia is for many a far riskier prospect than investing in U.S.
or European equities, especially for global investors without the time and resources to keep
up-to-date on shifting local conditions. The same is true of lending to cobblers and flower
sellers versus lending to large, regulated corporations. But why cant cobblers and flower
sellers in the hinterlands offer such high returns to investors that their risk is well
compensated for?

One school argues that poor borrowers can pay high interest rates in principle but that
government-imposed interest rate restrictions prevent banks from charging the interest rates
required to draw capital from North to South and from cities to villages. If this is so, the
challenge for microfinance is wholly political. Advocates must only convince governments to
remove usury laws and other restrictions on banks, then sit back and watch the banks flood
into poor regions. That is easier said than done of course, especially since usury laws (i.e.,
laws that put upper limits on the interest rates that lenders can charge) have long histories and
strong constituencies.
Once lack of information is brought into the picture (together with the lack of collateral), we
can more fully explain why lenders have such a hard time serving the poor, even households
with seemingly high returns. The important factors are the banks incomplete information
about poor borrowers and the poor borrowers lack of collateral to offer as security to banks.
The first problemadverse selectionoccurs when banks cannot easily determine which
customers are likely to be more risky than others. Banks would like to charge riskier
customers more than safer customers in order to compensate for the added probability of
default. But the bank does not know who is who, and raising average interest rates for
everyone often drives safer customers out of the credit market.
The second problem, moral hazard, arises because banks are unable to ensure that customers
are making the full effort required for their investment projects to be successful. Moral
hazard also arises when customers try to abscond with the banks money. Both problems are
made worse by the difficulty of enforcing contracts in regions with weak judicial systems.



What Makes Microfinance Financials Different?
Mainstream financial ratios and other factors used in analyzing banks remain relevant when
looking at MFIs. However, MFIs are a unique type of financial institution because of their
business model and clients.

Double Bottom Line
Most MFIs emphasize both their financial profitability and their social impact. The emphasis
on this double bottom line varies greatly among MFIs. However, it is a unifying feature of
MFIs to recognize the positive benefits that access to financial services brings to clients and
the need for responsible lending practices.
A double bottom line helps MFIs attract soft lending and investments from public and
socially responsible investorsa positive factor in the evaluation of risk. However, from an
equity perspective, a double bottom line justifies a discount to valuations. A socially
motivated business may undertake less profitable activities to achieve its social goals, such as
expanding to remote areas or working with clients who require training before they can
become customers. These efforts may be reflected in a higher cost structure for the business,
although in some cases, this may also be rewarded with higher yields.

High Net I nterest Margins Driven by High Lending Rates
MFIs have much higher NIMs than commercial banks in emerging markets. This is because
of the relatively high interest rates charged to microfinance clients and limited competition
for their business. In 2006, the average worldwide microfinance lending rate stood at 24.8%.
There are three main reasons to justify the level of interest rates in micro finance:
The financial explanation: higher costs (especially operating costs) justify higher rates.
Microlending incurs relatively higher costs than traditional lending, with higher personal
and administrative expenses because of the location of clients, small transaction size, and
frequent interaction with MFI staff.
The microeconomic explanation: microenterprises have the potential to generate high
returns, which enables clients to pay higher interest rates to MFIs.
The macroeconomic explanation: limited competition despite the rapid growth of
microfinance in most markets, there are still relatively few financial institutions that serve
low-income people, and competition on lending rates is limited.

High Asset Quality I s Driven by Original Collection Method

Historically, MFIs have had stronger asset quality than mainstream banks in emerging
markets. MFIs have developed original lending technologies. These include good
knowledge of customers, supported by frequent visits to clients businesses;
nontraditional guarantees, such as group guarantees; and excellent information systems
that track arrears weekly or even daily.
MFIs also have strong incentives for performance: clients who repay loans can build a
good credit history and get access to larger loans and better terms. MFI loan officers also
have strong financial incentives to ensure repayment, because the variable part of their
salaries depends on portfolio quality. All these factors translate into high asset quality.

High Operating Costs Are Driven by Small Transactions
The costs of providing microcredit are high because of the small size of loans, the
location of clients, and the high level of interaction clients have with MFI staff.
Efficiency is a key concern because MFIs require much more staff and administrative
efforts per dollar lent than mainstream banks.
However, the cost structure of MFIs tends to improve over time as a result of economies
of scale, better loan technology, and an increase in the average loan size. Competition
also can put pressure on MFI margins and drive efficiency improvements.

Longer Term Funding
In some markets, the credit squeeze is affecting MFIs by making funds more difficult to
obtain, more costly, and available in shorter maturity. Microfinance exhibits three major
differences vis-a-vis traditional banks. MFIs have overall lower leverage than traditional
banks Overall, MFIs tend to have lower leverage (measured as total equity to assets) than
traditional banks. However, leverage is increasing over time, and large and older MFIs
are reaching equity leverage levels comparable to traditional banks.
The cost of funding through retail deposits (in particular, demand deposits, which
typically are not remunerated) is not necessarily cheaper than other funding sources. This
is because capturing and servicing small deposits is costly and requires a more expensive
physical infrastructure.

As with traditional banks, some types of MFIs deposits are less stable than others. Large
institutional deposits and interbank deposits can move quickly, whereas retail deposits
(both demand and savings) tend to be more stable.
Borrowings: Key feature is longer maturity Because of their social agenda, MFIs are able
to attract longer term funding from public agencies, microfinance specialized funds, and
development institutions. This provides MFIs with a favorable tenor mismatch between
liabilities (longer tenor) and assets (typically less than a year).



I mportance of Legal Framework:
Legal structure determines
Clarity of ownership
Initial capital requirement
Ability of the MFI to mobilize deposits
Ability to raise equity
Ability to raise grants
Ability to raise funds from banks and FIs
Regulatory requirements
Tax implications
There does not exist any unique legal framework for MFIs in India. MFIs in India mainly one
of the following structures:
Self Help Group and Federation
A SHG is an unregistered entity of between10-20 individuals, having own rules and
regulations, office bearers and books of accounts.
SHGs are recognized by the RBI and government for specific purposes.
SHGs use savings of their members as well as funds from banks and MFIs for
providing credit to their members.
SHGs network in clusters and form in to Federations which are usually registered as
Societies or Co-operative Societies
Societies can be registered under the Societies Registration Act, 1860 or under
respective state acts.
A society can be registered by any seven persons associated for any literary, scientific
or charitable purposes by subscribing their names to a memorandum of association
and filing with the registrar.
Registration does not require any minimum initial capital contribution

Difficulty to determine ownership makes banks uncomfortable in lending large sums

Cannot raise equity so scalability is an issue
Cannot accept public deposit
Exempt from Income Tax if registered under Section 12A of the Income Tax Act.
Need registration under FCRA to be able to accept foreign grants
Public Trusts can be established under the respective state regulations. Private trusts
can be established under Indian Trusts Act 1882.
Difficult to attract commercial equity and loans
There is no minimum capital requirements
Cannot accept public deposits
Exempt from Income Tax if registered under Section 12A of the Income Tax Act.
Need registration under FCRA to be able to accept foreign grants
Co-operative Societies
Cooperative Societies can be registered under
Co-operative Societies Act, 1912, or
Relevant state Co-operative Societies acts, or
Relevant state Mutually Aided Co-operative Societies Act, or
Multi-state Co-operative Societies Act, 1995
Primarily regulated by registrar of co-operative societies
Can access equity as well as deposits from their members and can lend to their
Membership generally restricted to individuals, other co-operatives and government
(including government corporations)
Mobilization of equity is restricted as co-operative societies can raise equity only
from their members. The principle of one person one vote acts as disincentive to
equity mobilization from the members
Banks are reluctant to lend to co-operative societies because of non-equity based
ownership and their tendency to get political

Co-operative Banks
Could be -Primary co-operative bank (urban co-operative banks), State co-operative
bank, Central co-operative bank
Registered under central/state/multi-state co-operative acts. Regulated by Registrar of
Co-operatives for registration, management and audit
Regulated under the Banking Regulation Act, 1949 by the Reserve Bank of India for
licensing, area of operations and interest rates
Can undertake most of the banking activities
Difficulty in raising equity and tendency to get political.
Respective state governments have close control over central co-operative banks and
state cooperative banks. Many of these are not well-managed.
Series of irregularities have been noted by RBI in many primary co-operative banks
and it has taken action against several existing banks.
RBI is reluctant to give new licenses owing to failure of a large number of co-
operative banks in different parts of the country
Regional Rural Banks
Established by the Central Government through a notification in the official gazette
Minimum capital requirement is Rs2.5 million
The share capital of the RRBs is required to be held by the Central Government,
State Government and Sponsor Bank in the ratio 50:15:35
From the financial year 2006-07 RRBs have been brought under Income Tax net
RBI has also stipulated that RRBs need to maintain disclose CAR starting March
Local Area Banks
RBI allowed the establishment of Local Area Bank in 1996
LABs are registered as public limited companies under the Indian Companies Act
Minimum capital requirement for a LAB is Rs50 million
Are allowed to operate in three geographically contiguous districts
Can mobilise deposits from public

Prudential norms related to banks are applicable but rules relating to liquidity and
interest rates applicable to RRBs are applicable
At present only four LABs are functioning and no new licenses are being issued
Resumption of licensing of LABs with stricter capital requirements being considered
Private Banks
Private banks have to obtain license from RBI under the Banking Regulation Act -
A minimum capitalization of Rs3bn (Rs300 crores) is required for private sector
banks, including wholly owned subsidiaries of foreign banks
Can do normal banking activities
Section 25 Companies
Section 25 Companies are promoted for the purpose of promotion of commerce, arts,
religion, charity or any other useful purpose
They are prohibited from payment of dividends
RBI has exempted NBFCs licensed under section-25 of the Indian Companies Act
from registration, maintenance of liquid assets and transfer of profit to Reserve Funds,
They are engaged in micro-financing activities (Rs50,000 for small businesses and
Rs125,000 for housing)
they do not mobilize public deposits
Section-25 NBFCs find it difficult to mobilize equity owing to restrictions on
payment of dividends
Can mobilise foreign grants if registered under FCRA
Exempt from Income Tax if registered under Section 12A of the Income Tax Act.
Non Banking Financial Companies
Companies registered under Indian Companies Act 1956 can apply to RBI to carry on
the business of an NBFC
NBFCs are required to have net owned funds of Rs20 millions
Ownership can be defined precisely and they can raise equity
Mobilisation of public deposits, though allowed, is almost impossible given strict
guidelines of the RBI

Banks are comfortable lending to NBFCs which are well-capitalised and well-
NBFCs are for-profit entities and are taxable
FDI through automatic route is allowed subject the following limits
FDI up to 51% - US$0.5 mn to be brought upfront
FDI between 51% and 75% - US$5mn to be brought upfront
FDI between 75% and 100%- US$50mn out of which 7.5 million to be
brought up-front
NBFCs are subject to prudential regulations regarding income recognition, asset
classification and provisioning, prudential exposure limits and accounting/disclosure
requirements provided
they are mobilizing public deposits, or
they are systemically important
All non-deposit taking NBFCs having asset size of Rs1bn (Rs100 crores) or more as
per last audited balance sheet will be considered as systemically important NBFCs.
Non-deposit taking and systemically important NBFCs will be subject to capital
adequacy regulations, single/group exposure norms and disclosure pertaining to
derivative transactions
Capital Adequacy Ratio (CAR) requirement is now 12% and will be increased to 15%
from April 2009 for systemically important NBFCs
Organizations under BC/BF guidelines of the RBI

Business Facilitators
Business facilitators can be used by the banks for various pre-disbursement and post-
disbursement activities pertaining to lending.
Does not include disbursement and collection activities
No approval is required from the RBI for using Business Facilitators
Business Correspondents
NGOs Insurance agents
Farmers' Clubs Well-functioning panchayats
Co-operativeSocieties Village Knowledge Centers
Post-offices KVIC/KVIB centers
IT Enabled outlets of corporates Agri Clinics

BCs can undertake disbursement of loans as well as collection of principal. They can
also accept deposits on behalf of the banks.
Banks can compensate BCs but BCs cannot charge anything from the consumers
Transactions need to be accounted for and reflected in banks books by end of day or
next working day
Microfinance Bill
The Micro Financial Sector (Development and Regulation) Bill, 2007 seeks to
promote the sector and regulate micro financial organisations (MFO).
National Bank for Agriculture and Rural Development (NABARD) shall regulate the
micro financial sector.
Every MFO that accepts deposits needs to be registered with NABARD. Conditions
for registration include (a) net owned funds of at least Rs 5 lakh; and (b) at least three
years in existence as an MFO. All MFOs, whether registered or not, shall submit
annual financial statements to NABARD.
Every MFO that accepts deposits has to create a reserve fund by transferring a
minimum of 15% of its net profit realised out of its thrift and micro finance services
every year
The central government may establish a Micro Finance Development Council to
advise NABARD on formulation of policies related to the micro financial sector.
NABARD shall constitute a Micro Finance Development and Equity Fund to be
utilised for the development of the sector.
Key issues and analysis
While the Bill promotes the activities of MFOs, there are differing opinions on the
cost efficiency of the MFO model.
NABARD is designated as the regulator of the micro financial sector. However, its
dual role as a key participant in the sector and the regulator could lead to conflict of
Banks and deposit taking Non-Banking Financial Companies (NBFCs) have to
comply with Reserve Bank of India's (RBI) prudential norms designed to safeguard
Societies/Trusts Non-deposit taking NBFCs
Cooperative Societies Post offices
Section 25 Companies

depositors' funds. While the Bill enables NABARD to prescribe norms for MFOs, it
specifies some norms which are less stringent than for banks and NBFCs.
Unlike banks regulated by RBI, the Bill does not exempt registered MFOs from the
Usurious Loans Act, 1918 or state laws which cap interest rates.
The Bill defines 'micro financial services' to include insurance and pension services
without specifying to whom such services are to be provided. This implies that every
insurance and pension company would be regulated by NABARD.


4. Micro Finance Delivery Models in I ndia

There exist a wide range of microfinance models in India. It can be said that India hosts the
maximum number of microfinance models. Each model has succeeded in their respective
fields. The main reason behind the existence of these models in India may be due to
geographical size of the country, a wide range of social and cultural groups, the existence of
different economic classes and a strong NGO movement. Micro Finance Institutions (NGO-
MFIs, Mutual Benefit MFIs and For-Profit MFIs) in India have adopted various traditional as
well as innovative approaches for increasing the credit flow to the unorganized sector. They
can be categorized as follows:

Self Help Group (SHG) Model:
SHG has emerged as the Indian model of Micro Finance. It is so popular in India that
Government programmes have SHG as the core of their strategy.

Dynamics of SHG Model:
The SHG model has evolved in the NGO Sector. NGOs primarily have the functions
of enabling, educating and networking. This model has emerged as the capacity
building of community based institutions.
SHGs are small and informal groups (strength of members: - 10 to 20). Group
members are socio-economically homogenous. Groups are composed either by male
only or by female only. In India 90 percent of the SHGs are composed of female only.
Group members are self-selected. NGO acts as a facilitating agency to build in
processes and systems that make the SHGs viable and sustainable institutions.
The group members meet regularly at an appointed time and place for carrying out
their savings and credit activities and other issues of development.
The group mobilizes savings among the members and issues need based loans to the
members (only) out of the common funds created.
The rules and norms are determined by members themselves and the NGO does not
interfere in this matter.
After the SHG has been put on the path to sustainability, organizationally and
financially, the NGO may decide to withdraw from supporting the SHG and move on
to new groups.

The main motive of the SHG is to empower poor socio-economically and improve
their livelihood pattern.
Federated Self Help Group Model:
Federations of SHGs bring together several SHGs. In India FSHGs include those promoted
by the Dhan Foundation, PRADAN, Chaitanya and SEWA are famous in India.
Dynamics of Federated SHG Model:
Federations usually come under the Societies Registration Act. They have between 1000-
3000 members.
There is a distinct three-tier structure in federations the SHG is the basic unit; the
cluster is the intermediate unit and an apex body or a federation, represents the entire
Each SHG participates directly in the representative body at the cluster level. Two
members from each SHG attend the monthly cluster meetings. Information from the
groups to the apex body and vice-a-versa is channeled through the cluster level
representative body.
The cluster leaders are a highly effective part for group monitoring and strengthening. So
the operations of the apex body are decentralized through the clusters.
The executive body at the apex level is consists of 9 to 15 members.
Three common financial activities of Federations are: -
Acting as an agent and manager of external credit funds.
Assisting SHGs with loan recovery in difficult cases.
Strengthening weak SHGs, so that they are able to carry out their savings and credit
function smoothly.
Additional options for members to save: Federations often offers additional saving
schemes to the group members, which is apart from group savings. So the members have
savings with the group and in addition, with the Federation.
Satisfactory returns on savings to members.
Credit giving patterns also vary. Generally, federations have credit activities at the group
level, although federations provide credit to their members. These loans are disbursed
from members savings that may be deposited with the federation and from external funds
that it is able to access independently.
Federations are able to increase the amounts of credit available to members.

Federations even provide bridge loans.

Federations provide insurance and housing finance, and also support services to facilitate
productive use of credit. One federation in India (Chaitanya) started to provide insurance
services to its members. It has become an agent of the insurance company.
Grameen Bank Model:
The Grameen Bank Model of Bangladesh, developed by Muhammad Yunus, its former
chairman was considered as the pioneer microfinance institution. It has been highly
successful in its banking service to the poor as well as in its poverty alleviation programmes.
With its well-recognised success, many organisations in India, like SHARE Microfin Ltd,
Activities for Social Alternative (ASA) and CASHPOR Financial and Technical Services
Ltd. have adopted this methodology with little variations.
Dynamics of Grameen Bank Model:
Homogenous groups of five members are formed at the village level.
The field worker of the Grameen Bank facilitates the process of group formation.
All the group members undergo a 7day compulsory training of 1-2 hours per day.
Some groups undergo the Group Recognition Test (GRT). It is a screening test that
can distinguish between serious and non-serious groups. Actually it is an effective
tool to overcome the adverse selection problem.
Once the preliminary groups have passed GRT, and then the women become
members of Grameen Bank by paying a one-time member fee.
Eight joint liable groups affiliate together to form a center. Every weak Centre meets
at a defined time. Bank Assistant attends the meeting and it is mandatory for the
members to attend the weakly meeting and all the loan applications have to be
approved by other group members as well as Centre members. The loan is disbursed
from the bank fund and it is not linked with the group savings. Loan is given to the
individual not to the group or the center.
The loan disbursement is always done in the Centre. The housing loans are disbursed
at the Branch to maintain documentation.
Various loans are provided by the Grameen Bank such as General Loans,
Supplementary Loans, Special General Loans, Sanitation and Housing Loans etc. The
size of loan ranges from Rs. 4,000 to Rs. 10,000 for general yearly loans. The first
loan is Rs.4000 and there is an annual increase of Rs.1, 000 in loan size in each year

Every members save Tk.10 per weak and it is compulsory. This saving is deposited
with Bank. The bank funds their consumption with this deposit. This strategy
overcomes the problem of default as it is proved that nobody is likely to default on his
or her own money.
All loans are repayable within a year in 52 equal installments (over 52 weeks).
Bank charges 5 percent tax on all productive loans to a member. In this way group
fund is increasing.
The group leader collects the loan repayments and savings prior to the meeting and
hands it over to the Centre leader who gives it to the field worker during the meeting.
This collected amount is deposited in the branch on the same day. No new loan is
issued from this collected amount. It discourages all possible leakages in monetary
Peer pressure replaces the collateral. Member-borrowers who repaid the loan in time
are allowed to get repeated loans and continuous access to increasing credit from
Bank. The most significant aspect of the Grameen Bank Model has been its high loan
recovery rate (98% and above).
I CI CI Bank partnership model
ICICI's microfinance portfolio has been increasing at an impressive speed. From 10,000
microfinance clients in 2001, ICICI Bank is now lending to 1.2 million clients through its
partner microfinance institutions, and its outstanding portfolio has increased from Rs. 0.20
billion (US$4.5 million) to Rs. 9.98 billion (US$227 million). A few years ago, these clients
had never been served by a formal lending institution.
Partnership Models
A model of microfinance has emerged in recent years in which a microfinance institution
(MFI) borrows from banks and on-lends to clients; few MFIs have been able to grow beyond
a certain point. Under this model, MFIs are unable to provide risk capital in large quantities,
which limits the advances from banks. In addition, the risk is being entirely borne by the
MFI, which limits its risk-taking.
The MFI as Collection Agent

To address these constraints, ICICI Bank initiated a partnership model in 2002 in which the
MFI acts as a collection agent instead of a financial intermediary. This model is unique in
that it combines debt as mezzanine finance to the MFI. The loans are contracted directly
between the bank and the borrower, so that the risk for the MFI is separated from the risk
inherent in the portfolio. This model is therefore likely to have very high leveraging capacity,
as the MFI has an assured source of funds for expanding and deepening credit. ICICI chose
this model because it expands the retail operations of the bank by leveraging comparative
advantages of MFIs, while avoiding costs associated with entering the market directly.
Another way to enter into partnership with MFIs is to securitize microfinance portfolios. In
2004, the largest ever securitisation deal in microfinance was signed between ICICI Bank and
SHARE Microfin Ltd, a large MFI operating in rural areas of the state of Andra Pradesh.
Technical assistance and the collateral deposit of US$325,000 (93% of the guarantee required
by ICICI) were supplied by Grameen Foundation USA. Under this agreement, ICICI
purchased a part of SHARE's microfinance portfolio against a consideration calculated by
computing the Net Present Value of receivables amounting to Rs. 215 million (US$4.9
million) at an agreed discount rate. The interest paid by SHARE is almost 4% less than the
rate paid in commercial loans. Partial credit provision was provided by SHARE in the form
of a guarantee amounting to 8% of the receivables under the portfolio, by way of a lien on
fixed deposit. This deal frees up equity capital, allowing SHARE to scale up its lending. On
the other hand, it allows ICICI Bank to reach new markets. And by trading this high quality
asset in capital markets, the bank can hedge its own risks.
Another securitisation deal was also signed with Bhartya Samruddhi Finance Limited
(BSFL), in which ICICI Bank securitised the receivables of a selected portfolio of
microfinance loans by BSFL amounting to Rs 42.1 million (US$ 957,000). Both under the
partnership model and under the securitisation deal, the bank provides organizations with
financial support at a mezzanine level which enables them to offer credit protection in the
microfinance portfolios to a reasonable extent.
Training New Partners
Despite rapid growth, the lack of NGOs and MFIs operating in India remains a constraint.
According to ICICI Bank, there is a need for approximately 200 MFIs to cover the country,

however there are only 15 large players capable of scale. New players are therefore needed:
ICICI believes that new NGOs, entrepreneurs, and corporations who conduct development
activities in rural areas can and should become MFIs. ICICI Bank has put in place its Micro
Finance Development Team with the objective of identifying and training new partners. The
Social Initiative Group of ICICI Bank (SIG) aims to partner with organizations to identify
and support entrepreneurs in microfinance.
Working with Venture Capitalists
Another challenge in scaling-up the microfinance sector is the lack of equity capital. In order
to solve this shortage, ICICI Bank is encouraging venture capitalists to start entering the
sector. Several venture capital funds in the country have the capability of identifying and
mentoring entrepreneurs, including Lok Capital, Aavishkar and Bell Weather. Bell Weather
has made three equity commitments for start up, and its committee has decided to increase
the size of the fund from US$10 million, to US$25 million. Lok capital mobilizes and directs
private capital to fund microfinance activities and to fund long term management and
technical support for development of commercially sustainable MFIs. Aavishkar provides
micro-equity funding (Rs. 10 lacs to Rs. 50 lacs, approximately US$20,000 to US$100,000)
and operational and strategic support to commercially viable companies increasing income in
or providing goods and services to rural or semi-urban India. ICICI Bank has come to an
agreement with these three venture capitalists under which it will provide take-out financing
to the MFI to buy out the venture after a period of three to five years, provided the MFI
attains an operational sustainability rating from Micro-Credit Ratings International Ltd (M-
CRIL) and Credit Rating Information Services of India Limited (CRISIL).
Beyond Microcredit
Microfinance does not only mean microcredit, and ICICI does not limit itself to lending.
ICICI's Social Initiative Group, along with the World Bank and ICICI Lombard, the
insurance company set up by ICICI and Canada Lombard, have developed India's first index-
based insurance product. This insurance policy compensates the insured against the
likelihood of diminished agricultural output/yield resulting from a shortfall in the anticipated
normal rainfall within the district, subject to a maximum of the sum insured. The insurance
policy is linked to a rainfall index.


Need for Microfinance in I ndia
India is said to be the home of one third of the worlds poor; official estimates range from 26
to 50 percent of the more than one billion population. About 87 percent of the poorest
households do not have access to credit. The demand for microcredit has been estimated at up
to $30 billion; the supply is less than $2.2 billion combined by all involved in the sector.

The Indian state put stress on providing financial services to the poor and underprivileged
since independence. The commercial banks were nationalized in 1969 and were directed to
lend 40% of their loan able funds, at a concessional rate, to the priority sector. The priority
sector included agriculture and other rural activities and the weaker strata of society in
general. The aim was to provide resources to help the poor to attain self sufficiency. They had
neither resources nor employment opportunities to be financially independent, let alone meet
the minimal consumption needs.
To supplement these efforts, the credit scheme Integrated Rural Development Programme
(IRDP) was launched in 1980. But these supply side programs (ignoring the demand side of
the economy) aided by corruption and leakages, achieved little. Further, the share of the
formal financial sector in total rural credit was 56.6%, compared to informal finance at 39.6%
and unspecified sources at 3.8%. Not only had formal credit flow been less but also uneven.
The collateral and paperwork based system shied away from the poor.
The vacuum continued to be filled by the village moneylender who charged interest rates of 2
to 30% per month. 70% of landless/marginal farmers did not have a bank account and 87%
had no access to credit from a formal source. (World Bank NCAER, Rural Financial Access
Survey 2003)

It was in this cheerless background that the Microfinance Revolution occurred worldwide. In
India it began in the 1980s with the formation of pockets of informal Self Help Groups
(SHG) engaging in micro activities financed by Microfinance. But Indias first Microfinance
Institution Shri Mahila SEWA Sahkari Bank was set up as an urban co-operative bank, by
the Self Employed Womens Association (SEWA) soon after the group was formed in 1974.
The first official effort materialized under the direction of NABARD. (National Bank for
Agriculture and Rural Development).The Mysore Resettlement and Development Agency
(MYRADA) sponsored project on Savings and Credit Management of SHGs was partially
financed by NABARD during 1986-87

Major Milestones
1904- Legal framework for establishing the co-operative movement set up in 1904.
1934-Reserve Bank of India Act, 1934 provided for the establishment of the
Agricultural Credit Department.
1969- Nationalization Of Banks
1971-Establishment Of Priority Sector Lending Norms
1975-Establishment Of Regional Rural Banks
1982-Establishment Of NABARD
1992-Launching of the SHG-Bank Linkage Programme
1993-Establishment of Rashtriya Mahila Kosh
1998-NABARD sets a goal for linkage one million SHGs by 2008

2000-Establishment of SIDBI Foundation for Microcredit

2005-MFDEF doubled to 200 crores
2005- One million SHG linkage target achieved 3 years ahead of Date
2006-Committee on Financial inclusion
2007-Proposed bill on microfinance regulation introduced in parliament.
The projected demand for micro-finance in India is nearly Rs.450 bn (source: Basix,
Hyderabad) out of which only 25 mn are being served. In spite of the phenomenal expansion
of the outreach of the formal banking structure and the pro-poor directed policies 70% of the
rural poor do not have a deposit account, less than 15% of the rural households have any kind
of insurance, only a negligible percentage (0.4%) have access to health insurance and 56%
of the poor still borrow from informal sources.

MFIs in India can be classified into three categories: not-for-profit entities (societies and
trusts registered under the respective central and state acts, and companies registered under
Section 25 of the Companies Act, 1956); mutual benefit organisations (co-operative societies
and mutually-aided co-operative societies); and for-profit entities (non-banking finance
companies or NBFCs). There are an estimated 1,400 MFIs in the country. Regulation is
restricted to a handful of MFIs that are registered as NBFCs with the Reserve Bank of India

Over the past two years, private and foreign banks have replaced apex wholesale lenders
(SIDBI, NABARD, Rashtriya Mahila Kosh and Friends of Womens World Banking) as the
leading lenders to MFIs, and have contributed to rapid industry growth. The industrys
growth was slow during 2007-08, with the curtailment of microfinance loans in 2007 by
some banks that earlier used MFIs to originate loans and collect repayments on their behalf
(popularly referred to as the partnership model). The partnership model had become popular
as it allowed MFIs to increase their outreach without additional capitalization, since the loans
would be advanced by the banks.

However, time and cost related aspects of obtaining borrower details on a regular basis from
the MFIs are among the reasons for these banks decision to discontinue the partnership

Interest among investors (private equity, social investors, and specialized funds) in the Indian
microfinance industry is growing with the increasing number of MFIs that have a sizeable
asset base, established processes, and a track record of profitable operations. In addition to
loans from sector-specific funds, some Indian MFIs have attracted equity investments from
social investors and funds as well. Indian investors and funds have also started investing in
the sector; given the countrys relatively deep capital markets, it is expected that investments
in MFIs will increase significantly once this trend gathers momentum.

With directed priority-sector lending an explicit feature of the formal banking sector, India
has built up a network of rural banks that is rare if not unparalleled in the world. Today 196
RRBs has over 14,000 branches in 375 districts nation-wide, covering, on an average, about
three villages per branch. The rural banking system, in its entirety, has an even more
impressive coverage. Together, the RRBs, the nationalized commercial banks and the credit
cooperatives comprising of Primary Agricultural Credit Societies (PACS) and
Primary/State Land Development Banks (P/SLDS) have one branch for every 4,000 rural

In spite of such an impressive coverage, the formal banking sector has had a limited impact
on microfinance or lending to the poor. The RRBs were set up in the mid-70s with a clear
mandate for lending to the poor as it was felt that the cooperative banks were being
dominated by the rural wealthy and that the commercial banks had an urban bias. For the first
two decades of their existence, political pressure and focus on outreach at the expense of
prudent lending practices led to very high default rates with accumulated losses exceeding
Rs. 3,000 crores in 1999. The reforms in the mid-90s, following the recommendations of the
Narsimhan Committee Report, removed some of the constraints on the functioning of RRBs,
easing their interest ceiling and allowing them to invest in the money market. The financial
situation of the RRBs has improved since then with declining losses and over 80% of the
RRBs are now profitable. However, much of this turnaround has resulted from a shift to
investment in government bonds (that have gained with falling interest rates) and loans to the
non-poor in rural areas.

The lending portfolio of scheduled commercial banks also reflects this shift away from rural
areas. At the end of 2007-2008, the share of agriculture in the outstanding credit of scheduled

commercial banks was less than 10% which is even less than the share of personal loans
(housing loans and loans for consumer durables).

Small loans have also declined in importance in recent years. Since over 98% of rural loans
are below Rs 2 lakhs, this implies a concomitant shift out of rural areas. The logic of this shift
is easy to appreciate. In 2008, 45% of the borrowers of scheduled commercial banks were
from rural areas, but they accounted for only 13.4% of their outstanding loans. For metros,
the corresponding numbers were 15% and 54% respectively. With their focus shifted to
financial performance, the banks are naturally shifting their portfolio to the low cost segment.
Microfinance provides an important way to balance the outreach among the rural poor while
keep the cost of lending low. To the extent that the costs of credit risk assessment and
monitoring can be reduced with the help of NGOs, banks can actually reach out to a large
number of truly poor households without incurring heavy transactional expenses. The formal
banking sector has played an important role in microfinance in India.

Much of the microfinance initiative in India has involved Self-Help Groups (SHGs),
predominantly of poor women. NABARDs Bank Linkage Program, pilot-tested in 1991- 92
and launched in full vigor in 1996, has been a major effort to connect thousands of such
SHGs across the country with the formal banking system. By late 2002, it connected about
half a million SHGs to the banking system with total loan disbursement of about Rs. 1026
crores. Efforts of other organizations supplement that of NABARD. By March 2001, SIDBI,
for instance, had disbursed over Rs 30 crore to SHGs through 142 MFI-NGOs.

The emphasis on linking the self-help groups of rural poor to the formal banking system was
made in the mid-80s in the Asia and Pacific Regional Agricultural Credit Association and the
SHG-Bank Linkage emerged as a result of that. RBI included the program in its priority
sector lending and in 1999, the Government of India recognized in its Budget.

Recent Trends
The past 18 months have seen a series of critical developments in the Indian MFI sector.
These are both positive and negative. On the positive side, MFIs have started to leverage
their new found management expertise to achieve scale and to spread their operations well
beyond their traditional operational areas. Thus, some of the leading MFIs in the country
have recorded high growth rates of the order of 80% per annum in terms of numbers of

borrowers and around 40% per annum in terms of portfolio reaching from 300,000 to one
million clients each. Also positive is that a significant part of that expansion has been either
to less developed areas of the country Orissa, J harkhand, Rajasthan, Madhya Pradesh,
Tripura, Assam or to areas such as Maharashtra that also have substantial numbers of low
income families in some regions even if their overall development indicators are not as low
as those for the other states.
On the negative side, MFIs have been under attack from politicians and bureaucrats in some
of their traditional operational areas in Andhra Pradesh and Karnataka (with questions even
being asked in Orissa). Their loan recovery practices have been questioned and their interest
rates described as exorbitant. The related publicity has vitiated the credit culture in the
traditional microfinance states forcing a lowering of interest rates and increasing the
necessary level of loan loss reserves and provisioning. Operationally, the increase in costs
has been compounded by the spread of the operations of individual MFIs simultaneously (and
inorganically) to a number of non-traditional states. This has put pressure on operating
efficiency and resulted in slowing the trend to lowering unit costs.
The growth of the microfinance sector has been fuelled by continuing interest from banks in
increasing their exposure to microfinance resulting in a highly leveraged industry with capital
adequacy ratios down below 10% and debt-to-equity ratios of the order of 11:1. Given the
pressure on margins (which has already reduced the collective return on assets of the sector to
negligible, if still positive, levels) it is unclear for how long such high leverage ratios can be

The increased coverage of clients made possible by the high growth rates of Indian MFIs is
laudable. Even as it increases outreach, the industry continues to be amongst the most
efficient in the world. But, high growth brings with it possible dangers of mission drift as
many MFIs emphasise commercial behaviour and may not strategically balance this with
their original social mission, or with social values expected in microfinance. The social
rating service offered by M-CRIL over the past couple of years has found that MFI poverty
outreach (the proportion of new clients below the $1 per day international poverty line at
purchasing power parity) is around 30-35%.

A substantial increase in the outreach of microfinance services in India has occurred, in
recent years, partly because of the phenomenal growth of the bank-SHG linkage programme
(promoted by the National Bank for Agriculture and Rural Development, NABARD), but

also from the substantial growth of the MFI sector. Yet, the number and size of microfinance
institutions in India is small in relation to the numbers of poor people in the country. MFIs in
India (including Self Help Groups) cover no more than 15-20 million clients, at best, 25-30%
of the 60-70 million poor families in the country.

The SHG-Bank Linkage Programme (SBLP) covered a further 9.6 million persons in 2006-
07, over 90 percent of them women, and about them half of them poor . The total number of
SHG members who have ever received credit through the programme has grown therefore to
41 million persons. Microfinance Institutions, (MFIs), the other model of microfinance in
India, grew even more strongly, and added an estimated 3 million new borrowers to reach a
total coverage of about 10.5 million borrowers. Both programmes taken together have
therefore reached about 50 million households. Only 36.8 million of these are being currently
being served, however.

About half of SHG members, and only 30 percent of MFI members are estimated to be below
the poverty line. Thus about 22 percent of all poor households (about 75 million) are
currently receiving microfinance services, or at least microcredit.
The sector continues to make strong progress towards the goal of extending financial
inclusion to the roughly fourth-fifths of the population who do not receive credit from the
banks, although there is still a long way to go.
MFI borrowers receive larger first loans than SHG members, but since
(i) the average duration of MFI loans is shorter (generally one year instead of
(ii) MFIs have been expanding rapidly, bringing down average MFI loan size
(iii) the size of repeat loans to SHGs has been growing even faster than first
the difference in average loans outstanding per borrower in the two models no longer
appears to be significant.
The on-lending funds constraint
There was a time when MFI managers had to devote most of their time and energy to dealing
with the uncertainty of where the next loan for on-lending funds was going to come from.
However the rapid expansion of commercial bank lending to the sector from 2004 led to the
happy situation in which this was no longer the case. MFI lending grew rapidly; both through
the expansion of existing MFIs and the incubation of new ones, and the Indian microfinance

sector became one the most highly leveraged in the world. However, developments during
the year have made it more difficult to be as sanguine as before that the onlending funds
constraint on continued growth of MFI's has for once and all been removed.

The rapid expansion of lending to MFIs was due largely to the introduction by ICICI Bank of
its "partnership model", under which loans to borrowers remained on the books of the bank,
off the balance sheet of the MFI partner, which only undertook loan origination, monitoring
and collection services for a fee. Thus the MFI performed the role of a social intermediary,
while credit risk was borne largely by the bank, although the MFI had to share the risk of
default up to a specified level, by providing a "first loss guarantee". This greatly reduced the
amount of equity with which an MFI required to support its borrowings, and the partnership
model in effect removed both the equity and the on-lending funds constraints at one stroke.

This major innovation unfortunately came unstuck during the year, initially due to the AP
crisis in March 2006 and regulatory concerns about KYC (Know Your Customer)
requirements, but thereafter because ICICI changed its own requirements under the
partnership model, and indeed its whole vision of the nature of the relationship it wants to
have with its partners. By March 2006, ICICI Bank's lending had grown to constitute about
two-thirds of total lending to the sector, with about 60 percent of its lending coming under the
partnership model. However, instead of increasing sharply again as in previous years, ICICI's
lending has declined in 2006-07, and is likely to stay relatively low in the current year. One
of the concerns raised by the AP crisis was the possibility of multiple borrowing by MFI
customers from both the major MFIs in the district concerned, both of who were major
partners of the bank under the partnership model. While there is no evidence that this led to
over-lending as reflected in an inability to repay loans, ICICI was urged by the RBI to
strengthen its KYC procedures now that the loans were on the bank's own books and not on
those of the partner.

It took some time for ICICI's partners to furnish the relevant information, during which time
fresh lending under the partnership model was suspended. It was partly substituted by term
loans, but not in sufficient amounts to alleviate the stress being experienced by partners who
were now strapped for funds. While other banks increased their lending, it was mostly to
existing partners, although some switching may have taken place.


Private equity in microfinance

Two landmark private equity investments in Indian MFIs took place in the first part of the
year; a $ 11.5 million investment in SKS, led by Sequoia Capital, at the end of March,
followed soon after by a $25 million investment in SHARE, by Legatum Capital. Hyderabad-
based SKS is the third largest MFI in India , and is growing perhaps the most rapidly, hoping
to end the current financial year with an outreach of about 1.5 million borrowers in 11 states.
Sequoia was joined by Unitus equity fund, which already has 2 equity investment partners in
India and 8 other "capacity building" partners through an associated foundation with offices
in Bangalore, as well as by Vinod Khosla and other investors. This infusion of fresh equity
enabled SKS to leverage a Rs 180 crore financial arrangement with Citibank India to finance
its expansion plans. Under the deal, Citibank will purchase loans originated by SKS under a
limited guarantee provided by US-based Grameen Foundation, which also has an office in
SHARE is India's largest MFI with over 1 million clients and has plans to grow to 6 million
over the next five years. When lending under ICICI Bank's partnership model was suspended
at the beginning of the year until partners could fulfill KYC requirements SHARE found
itself strapped not just for lending funds, but short of the equity capital with which to borrow
them as term loans from the banks. Legatum's investment gives it majority control of
SHARE. It was accompanied by a $2 million investment by Aavishkaar Goodwell
Microfinance Development Company, an Indo-Dutch joint venture, which becomes the fifth
social venture capital company to have a presence in India.
These were investments by mainstream commercial (as opposed to socially-motivated)
investors, whose support would accelerate the mobilization of private capital for massive
expansion of outreach.
Recent developments on the equity front have been welcomed by most observers as the only
means of meeting the huge equity requirements of a rapidly expanding, but increasingly
capital inadequate sector . The Indian sector is now seen to be attracting the whole spectrum
of funding from purely commercial private equity at one end to grants at the other, although
the latter are much less important than in other countries.


Distribution of I ndian Microfinance I ndustry:

Indian MFIs have minuscule outstandings Rs3400 ($82) compared to the international
average Rs19200 ($468) and has not grown over the past couple of years. The Grameen
clients have the smallest loan balances Rs2700 ($65). This has happened despite a high
growth rate of MFI portfolios (40%) because client outreach has expanded even faster (84%).
Large numbers of new MFI clients inevitably means small loan sizes. At an average loan
balance that is just 9.9% of GNI per capita, depth of outreach is apparently substantial.
However, field experience shows that significant numbers of not-so-poor women join
microfinance groups - often for social reasons - so the loan balance-GNI ratio is not a good
indicator of poverty outreach (at least for India).

A highly restrictive legal framework for deposit taking has severely constrained the offering
of thrift services so client savings form just 8.1% of outstanding loan balances. All the
methodologies have low average savings per member except for the individual banking
model. Each of the bars reflects the nature of the methodologies and the legal framework in
which the organisations operate.

SHG programmes, usually have voluntary deposit schemes in which the members
themselves determine the amount of the recurring savings deposit. Since disposition of this
amount is determined by the group rather than by the individual saver, this often results in
minimalist norms and leads to deposits that are far lower than the members' savings potential.
Deposits form just 4.0% of the average SHG MFIs' portfolio, though (as indicated earlier)
this excludes the far larger amounts revolved internally by SHG members.

Operating efficiency & portfolio quality
Staff productivity in India is now higher than in any other major region offering
microfinance. Some 326 staff members per MFI serve over 230 borrowers each while the
leading MFIs average 275 borrowers per member of staff. This results in some of the lowest
servicing costs for MFIs anywhere in the world.

Both Grameen and SHG MFIs record average servicing costs of the order of Rs400 ($10) per
borrower, lower than the MIX median even for Bangladesh. As MFIs have grown and staff
productivity has increased over the years, servicing costs have come down even in nominal
terms. With an inflation rate averaging 5% per annum in the mid- 2000s, this has resulted in a
decline of around 9% per annum in the cost of servicing borrowers.

Indian MFIs are now amongst the most efficient internationally. At 15.9% the average
operating expense ratio has not changed much since 2005 as growth focused MFIs have
accepted higher travel and other costs, while productivity gains have also been neutralised by
lower loan balances, hence smaller portfolios serviced per member of staff, in real terms.
OERs reported by Indian MFIs are, nevertheless, lower than those of MFIs in Bangladesh and
significantly lower than the medians for Asian and other MFIs worldwide. Analysis of

operating expense ratios by size of MFI, its age, microfinance methodology and loan size
shows that it is the last factor that is the major determinant of operating efficiency.
As the size of loans disbursed increases from Rs3,000 ($75) to Rs10,000 ($250), the
operating expense ratio declines from 25% down to an average of around 12%.

The effective interest rate paid by the average Indian microfinance borrower is no more than
25% - not significantly different from the ~24% usually charged even by commercial banks
on consumer finance. By and large, new institutions have low yields and high OERs but, as
expansion takes place, and economies of scale set in, yields improve and OERs decline to
acceptable levels. There are significant economies of scale up to a portfolio size of Rs2.5
crores ($600,000)

Portfolio financing
The structural shift indicated by an increase in debt financing among Indian MFIs has
continued while net worth as a proportion of the total has been reduced as current surpluses

and a very limited flow of grants have failed to keep pace with growth. Borrowings have
reached three quarters of total liabilities on MFI balance sheets as funds have been readily
available from both private and public commercial banks. Even small institutions with
relatively low exposure to financial markets have succeeded in sourcing half of their
liabilities through bank borrowings, bringing over 60% of MFIs under the 15% suggested
capital adequacy ratio.

Until now, with substantial historical grant funding and more recent operating surpluses
accompanied by relatively small portfolios, the Indian microfinance sector has been well
provided for in terms of owned funds. Now, the growth aspirations of MFI managements,
competition and the relative paucity of grant funds, on the one hand, and the availability of
liberal commercial debt funds, on the other, have taken their toll. The aggregate figures
suggest that capital adequacy is now an issue as even the Top10 MFIs fail to register the 15%
norm suggested above, though it is not alarming yet.

The trend towards commercialization becomes even stronger in the context of off-balance
sheet financing under the partnership model, which accounts for an additional 44% of the
overall portfolio in the sector. When managed loans are added back to the balance sheets of a
subset of leading Indian MFIs, the leverage ratio jumps from 10.7 to 11.9, far exceeding the
regional median of 5:1. While a limited amount of debt continues to be available at
concessional rates, much of it is contracted at commercial rates in the range of 10-14% per
annum. With such financing accounting for four-fifths of the portfolio of leading MFIs, the
commercialization of the Indian sector far exceeds that of other important markets in the

region, such as Bangladesh, where institutions source less than one-tenth of their portfolios
from commercial sources.

Indeed, Indian MFIs are increasingly turning to the banking sector as their access to grants
and customer deposits continues to diminish. The share of grants dropped from one third of
the balance sheet in 2003 to just 3% in 2006, barely covering cumulative losses among
smaller institutions. With the ability to raise equity capital limited to just a few legal entities,
reliance on net worth fell to 10%, less than one-third of that in 2003. Bank borrowings have
also had to fill in for customer deposits, which amounted to one-fourth of MFI resources in
2003 and are now under one-tenth of the balance sheet. Concerns over the legality of savings
mobilization combined with increasing transformation to NBFCs have phased savings out of
MFI balance sheets and mostly confined these to community-based institutions such as SHGs
and cooperatives.

Indian financing patterns, however, could look quite different in the next few years. Under
proposed legislation, societies, trusts and cooperatives will be able to offer thrift services.
While companies are excluded from this proposed regulatory regime, a number of these have
recently announced large investments by private equity funds. With the Top10 accounting for
two-thirds of the financing, debt may be ceding some of its share to equity capital.

Financial performance

The financial viability of microfinance institutions in India is under threat, despite
improvements in the yield gap. The 2.1% weighted return on assets of the 2005 sample has
been reduced to zero while typical MFI returns are -9.8%, well behind Bangladeshi
institutions reporting to the MIX, which lead the region in profitability. Low portfolio yields,

combined with poor portfolio quality and rising financial costs have reduced Indian MFI
surpluses though improvements in collection measures have boosted portfolio yields to 93%
of the expected figure, up from 85% in 2005.

Yields, however, remain low, with 43% of Indian MFIs earning less than 24% on their
portfolios. In comparison with 36-50% real costs of bank loans and moneylender interest
rates ranging from 36% to 120%, MFI average yields represent a substantial benefit for low
income clients. Nonetheless, these are not sufficient to cover rising costs brought on by
ambitious growth plans, deteriorating portfolio quality and hardening of domestic interest
rates on borrowings. Benchmarks for profitable Indian MFIs indicate that they charge more
sustainable rates than their unprofitable peers and earn 24.8% on their portfolios as compared
to 19.5%, but they also maintain tighter cost control. While both groups face similar financial
costs, sustainable institutions benefit from lower provisioning expenses because of their
superior portfolio quality. Moreover, they benefit from economies of scale as the typical
sustainable MFI manages a much larger portfolio than an unsustainable institution.

It is apparent that while MFIs have learnt much in terms of operational efficiency a
substantial effort is required in the areas of clarifying social objectives, poverty targeting,
product development and client orientation. The challenge for MFIs over the next few years
is to achieve growth with equity as well as efficiency.


The current Financial crisis and Microfinance

As of J anuary 2009, the effect of the current financial crisis on asset quality is not yet
apparent. Micro lending has proven to be resilient to economic shocks in the past, such as
during financial crises in East Asia and Latin America. This is because microfinance
customers tend to operate in the informal sector and to be less integrated into the global
economy. They also often provide essential products, such as food or basic services that
remain in high demand even in times of crisis. However, the current financial crisis and the
triple effect of economic downturn, fall in remittances, and higher food prices have not been
experienced before. It may well translate into lower asset quality for MFIs. Well-managed
MFIs that have a conservative credit policy and a focus on microenterprise lending should
remain resilient. MFIs with weak credit standards and large exposure to small and medium-
sized enterprises (SMEs), housing, and consumer lending are likely to be affected the most.

Effect of the crisis on operating costs -MFIs have seen their operating costs increase in the
first half of 2008 as a result of inflation and higher input costs. Staff costs and transportation
costs have been affected the most, with a spike of over 30% reported in Latin American
countries. In 2009, we expect inflation to return to lower levels, thus reducing the pressure on
wage increases and transportation costs. However, operational efficiency, as measured by
operating expenses to loans, may decrease as a result of slow or even negative growth in the
microfinance portfolio. MFI staff productivity might also suffer as credit agents allocate more
time to loan monitoring and collection.



Bandhan is among the top ten MFIs in the country in terms of loan outstanding, as on March
31, 2008, the portfolio was Rs.2783 million. It was set up in 2001 as a non-governmental
organisation (NGO) under the West Bengal Societies Registration Act, 1961. Bandhans
development work is much acclaimed and recognised in India and abroad: it won the Skoch
Challenger Award 2008 under the category of financial inclusion in March 2008 and ranked
second in the Forbes World Top 50 Microfinance Institution list.
Bandhan opened its first microfinance branch at Bagnan in Howrah district of West Bengal in
J uly 2002. Bandhan started with 2 branches in the year 2002-03 only in the state of West
Bengal and today it has grown as strong as 412 branches across 6 states of the country! The
organization had recorded a growth rate of 500% in the year 2003-04 and 612% in the year
2004-05. Till date, it has disbursed a total of Rs. 587 crores among almost 7 lakh poor
women. The repayment rate is recorded at 99.90%. Bandhan has staff strength of more than
2415 employees.
Operational Methodology
Bandhan follows a group formation, individual lending approach. A group of 10-25 members
are formed. The clients have to attend the group meetings for 2 successive weeks. 2 weeks
hence, they are entitled to receive loans. The loans are disbursed individually and directly to
the members.
Economic and Social Background of Clients
Landless and asset less women
Family of 5 members with monthly income less than Rs. 2,500 in rural and Rs. 3,500
in urban
Those who do not own more than 50 decimal (1/2acre) of land or capital of its
equivalent value
Monitoring System
The various features of the monitoring system are:
A 3 tier monitoring system Region, Division and Head Office
Easy reporting system with a prescribed checklist format
Accountability at all levels post monitoring phase
Cross- checking at all the levels

The management team of Bandhan spends 90.00% of time at the field

Liability structure for Loans
When a member wants to join Bandhan, she at first has to get inducted into a group. After she
gets inducted into the group, the entire group proposes her name for a loan in the Resolution
Book. Two members of the group along with the members husband have to sign as
guarantors in her loan application form. If she fails to pay her weekly installment, the group
inserts peer pressure on her. The sole purpose of the above structure is simply to create peer
The NGOs microfinance programme is based on the model developed by the Association for
Social Advancement (ASA), a leading MFI in Bangladesh. However, over a period of time
Bandhan had modified its lending mechanisms to suit the local need. The model is group-
based, and all the processes are standardised and documented.
Loan Products
Until 2005-06, Bandhan focused on a single loan product, micro credit loan. In 2006-07, the
MFI introduced two products: micro loan (at 12.5 per cent interest on flat basis, with 10 per
cent of the loan amount retained as security deposit which is refundable on completion of the
loan cycle) and micro-entrepreneur loan (at 12.5 per cent, flat basis, with 5 per cent
refundable security deposit after the completion of loan cycle). However, these loans are
given only to those members/borrowers who have completed more than one loan cycles.
In 2007-08, the MFI introduced another product, an emergency loan or health loan. These
loans are charged at 10 per cent (flat basis), with an optional repayment terms. The MFI
levies 1 per cent of the loan amount as insurance fee for all the loans. The loans are covered,
as the MFI has tied up with an insurance provider for these products.
Loan Products
Products Micro loan product Micro enterprise Emergency loan
/health Loan
Loan term/Duration 1 year 1 year 1 year
Loan amount Rural: Rs.1,000-Rs. 7,000 Rs.20,000-
Rs.1000 - Rs.5000
Interest rate (flat) 12.50% 12.50% 10%
Weekly Weekly Weekly or monthly

Membership fee Rs.10 Rs.20

Insurance fee 1% on the loan amount 1% on loan amount
Security deposit 10% on the loan amount 5% on loan

Determination of effective rates on the Loan Products
As a result of growing competition in its operational area, the NGO-MFI has over the years
reduced its prime lending rate to 12.5 per cent as on March 31, 2008, from 17.5 per cent in
Point that is to be noted here is that these rates are calculated on a flat basis rather than the
reducing balance method which results in a very high effective rate of interest.

The effective rate of interest is a concept useful for determining whether the conditions of a
loan make it more or less expensive for the borrower than another loan and whether changes
in pricing policies have any effect. Because of the different loan variables and different
interpretations of effective rates, a standard method of calculating the effective rate on a loan
(considering all variables) is necessary to determine the true cost of borrowing for clients and
the potential revenue (yield) earned by the MFI.

The effective rate of interest refers to the inclusion of all direct financial costs of a loan in one
interest rate. Effective interest rates differ from nominal rates of interest by incorporating
interest, fees, the interest calculation method, and other loan requirements into the financial
cost of the loan. The effective rate should also include the cost of forced savings or group
fund contributions by the borrower, because these are financial costs.

Variables of microloans that influence the effective rate include:
Nominal interest rate
Method of interest calculation: declining balance or flat rate
Payment of interest at the beginning of the loan (as a deduction of the amount of
principal disbursed to the borrower) or over the term of the loan
Service fees either up front or over the term of the loan
Contribution to guarantee, insurance, or group fund
Compulsory savings or compensating balances and the corresponding interest paid to
the borrower either by the MFI or another institution (bank, credit union)

Payment frequency
Loan term
Loan amount.

Estimating the Effective Rate
The estimation method considers the amount the borrower pays in interest and fees over the
loan term. The estimation method can be used to determine the effect of the interest rate
calculation method, the loan term, and the loan fee. An estimation of the effective rate is
calculated as follows:
Effective cost =
Amount Paiu in inteiest anu fees
Aveiage piincipal amount outstanuing

Aveiage piincipal amount outstanuing =
(sum of piincipal amounts outstanuing)
numbei of payments

To calculate the effective cost per period, simply divide the resulting figure by the number of
periods. With all other variables the same, the effective rate for a loan with interest calculated
on a declining balance basis will be lower than the effective rate for a loan with interest
calculated on a flat basis.

Eg. For a micro loan Product
loanamount Rs1000
term 52 week
repayment 19.23 weekly
interestrate 12.5% flatrate
fee 1% upfront
securitydeposit 10% upfront
Membershipfees Rs10

So according to flat rate method the weekly principal installment will be Rs 19.23 and
interest will be Rs 2 average outstanding principal is Rs 490. Total interest is Rs. 125 and 1%
upfront fees is Rs 10 which gives an effective rate of 29.57%.
According to declining method the weekly installment will be Rs 20 and interest will be
declining as major portion will be given out as principal, average outstanding principal is Rs
500 ,total interest is Rs. 65 and 1% upfront fees is Rs 10 which gives an effective rate of
16.97 %.

Use of I RR method
The above method ignores the time value of money, assuming the same data, if we calculate
the effective rate using the IRR method the effective rate comes to 33.96% annually for flat
rate of interest and 20.43% annually for declining balance method.
The following table illustrates the effect that a change in the loan fee and a change in the loan
term have relative to the effective cost:

Basecase1 1000
0% flat 1% 10%
weeks 10 33.96%
0% flat 1% 10%
weeks 10 31.63%
incfeesto2% 1000
0% flat 2% 10%
weeks 10 36.58%
0% flat 2% 10%
weeks 10 34.22%
TO45WEEKS 1000
0% flat 1% 10%
S 10 34.82%
0% flat 1% 10%
S 10 32.15%
DEPOSIT5% 1000
0% flat 1% 5%
weeks 10 30.57%
0% flat 1% 5%
weeks 10 28.49%
0% flat 2% 5%
weeks 10 32.92%
0% flat 2% 5%
weeks 10 30.81%
BY100BPS 1000
% flat 1% 10%
weeks 10
% flat 1% 10%
weeks 10
BY100BPS 1000
% flat 1% 10%
weeks 15
% flat 1% 10%
weeks 15


Why Microcredit Rates are so High

An MFI's main objective is to provide poor and low income households with an affordable
source of financial services. Interest charged on loans is the main source of income for these
institutions and, because they incur huge costs, the rates are correspondingly high.

Four key factors determine these rates: the cost of funds, the MFI's operating expenses, loan
losses, and profits needed to expand their capital base and fund expected future growth.

Although micro lenders receive loan funds at concessional rates, they must cost these funds at
market rates when they make decisions about interest rates to ensure the sustainability of the
institution's operations. Donors provide concessional funds for a particular usage only for a
limited period, as do some governments. However, concessional funds cannot be considered
a permanent source of funds for MFIs, and provision must be made through interest rates to
sustain the lenders' operations.

Inflation adds to the cost of microfinance funds by eroding microlenders' equity. Thus, higher
inflation rates contribute to higher nominal microcredit interest rates through their effect on
the real value of equity.

Microlenders have two kinds of operating costs: personnel and administrative. Because
microlending is still a labor-intensive operation, personnel costs are high.

Administrative costs consist mainly of rent, utility charges, transport, office supplies, and
depreciation of fixed assets. Making and recovering small loans is costly on a per unit basis.
Often loan recovery is executed by staff who visits clients, increasing costs in time taken and
transportation used. Poor physical infrastructureinadequate road networks, transportation,
and telecommunication systems in which microlenders operate also increases
administrative costs and adds significantly to the cost of microfinance operations.

Commercial banks most often deal with large loans, and their transaction costs are lower than
those of MFIs on a per unit basis. Thus, commercial banks are able to charge lower interest
rates than MFIs. A financial institution receiving large subsidies may charge much lower
interest rates than other MFIs.


Other inappropriate comparisons of MFI interest rates include those charged by government-
owned MFIs or government-sponsored microfinance programs that are often compelled to
charge lower-than-cost-recovery interest rates based on political considerations. These
comparisons also overlook that most of these programs and institutions in general are
unlikely to survive in the long term to serve the poor. Moreover, the poor have to incur
unusually high transaction costs to access credit from these sources due to credit rationing
systems and rent-seeking practices adopted by their employees. Thus, a comparison based on
nominal interest rates charged by such institutions may be highly misleading.



Why adjust for subsidies and concessions?

Unlike traditional financial intermediaries that fund their loans with voluntary savings and
other debt, many MFIs fund their loan portfolios (assets) primarily with donated equity or
concessional loans (liabilities). Concessional loans, donated funds for operations and donated
equity are all considered subsidies for MFIs.
If an MFI receives a grant to cover operating shortfalls and records it as revenue, its net
income will be overstated. In this case a highly subsidized MFI appears more profitable than
a better- performing, subsidy-free MFI.
It is, therefore, necessary to separate out and adjust the financial statements for any subsidies
to determine the financial performance of an MFI as if it were operating with market debt and
equity rather than donor funds. In addition, as an MFI matures, it will likely find it necessary
to replace grants and concessional loans with market rate debt (or equity) and would thus
need to determine its financial viability if it were to borrow commercial funds.
To some extent, these adjustments also allow for comparison among MFIs, because it puts
all MFIs on equal ground analytically, as if they were all operating with commercially
available third-party funds.

Concessional Loans:

Concessional loans are loans received by the MFI with lower than market rates of interest.
Concessional loans result in a subsidy equal to the value of the concessional loans times the
commercial or market rate, less the amount of interest paid.
subsiuy = |{concessional loans x maiket iate] -amount of inteiest paiu]

To determine the appropriate market rate (cost of funds) to apply, it is best to choose the form
of funding that the MFI would most reasonably be able to obtain if it were to replace donor
funds with market funds.

For our calculations we have used the BPLR rates adjusted upward for a potential risk
premium due to the perceived risk of MFIs.


Adjustments must be made to both the balance sheet and the income statement. The amount
of the subsidy is entered as an increase to equity (credit) under the accumulated capital
subsidies account and as an increase in financial costs (debit).
PARTICULARS 2008 2007 2006 2005 2004
AVERAGEDEBT 1916.47 644.76 181.18 44.88 13.99
INTEREST 175.44 60.31 13.43 3.47 0.56
COSTOFDEBT 9.15% 9.35% 7.41% 7.73% 3.97%
BPLR 12.75% 12.50% 10.75% 10.75% 11.00%
RISKPREMIUMASSUMPTION 1.25% 1.25% 1.25% 1.25% 1.25%
ADJUSTEDFORRISKPREMIUM 14.00% 13.75% 12.00% 12.00% 12.25%
ADJFORSUBSIDY 92.870 28.345 8.309 1.917 1.158

Funds donated for loan capital (Equity)-

Funds donated for loan capital are often treated as equity by MFIs and therefore are not
always considered when adjusting for subsidies, since these funds are usually on the income
statement as revenue.

Funds donated for loan capital are reported on the balance sheet as an increase in equity(
sometimes referred to as loan fund capital) and an increase in assets (either as cash, loan
portfolio outstanding or investments depending on how the MFI chooses to use the funds).
Donations for loan fund capital differ from donations for operations in that the total amount
received is meant to be used to fund assets rather than to cover expenses incurred.
No subsidy adjustment needs to be made for funds donated for loan capital as donors are not
normally looking for any returns on their funds (as a normal equity investors would) nor are
they expecting to receive the funds back.
On the other hand, if an MFI did not receive donations for loan capital, it would have to
either borrow (debt) or receive investor funds (equity). Both debt and equity have cost
associated costs. The cost of debt is reflected as financing costs. The cost of equity is
normally the required return by investors. Equity in formal financial institutions is often more
expensive than debt, because th risk of loss is higher. It can be argued that MFIs receiving
donations for loan fund capital should make a subsidy adjustment to reflect the market cost of
To reflect the subsidy on donations for loan fund capital based on, market rates, a similar
calculation to the adjustment for concessional loans is made. A market rate is chosen and

simply multiplied by the amount donated. The resulting figure is then recorded as an expense
(financing costs) on the income statement and an increase is made to equity (credit) under the
accumulated capital- subsidies account.
PARTICULARS 2008 2007 2006 2005 2004
GRANTSDURINGTHEYEAR 0.00 3.51 3.46 1.49 0.00
INTERESTADJ 0.00 0.48 0.41 0.18 0.00

Why an adjustment for inflation?
Inflation is defined as a substantial rise in prices and volume of money resulting in a decrease
in the value of money. Conventional financial statements are based on the assumption that the
monetary unit is stable. Under inflationary conditions, however, the purchasing power of
money declines, causing some figures of conventional financial statements to be distorted.
Inflation affects the nonfinancial assets and the equity of an organization. Most liabilities are
not affected, because they are repaid in a devalued currency (which is usually factored into
the interest rate set by the creditor).
To adjust for inflation, two accounts must be considered:
The revaluation of nonfinancial assets
The cost of inflation on the real value of equity.

Nonfinancial assets include fixed assets such as land, buildings, and equipment. Fixed assets,
particularly land and buildings, are assumed to increase with inflation. However, their
increase is not usually recorded on an MFIs' financial statement. Thus their true value may
be understated.
Since most MFIs fund their assets primarily with equity, equity must increase at a rate at
least equal to the rate of inflation if the MFI is to continue funding its portfolio. If MFIs
acted as true financial intermediaries, funding their loans with deposits or liabilities rather
than equity, the adjustment for inflation would be lower because they would have a higher
debt-equity ratio. However, interest on debt in inflationary economies will be higher, so the
more leveraged an MFI the greater the potential impact on its actual financing costs. Most
assets of an MFI are financial (loan portfolio being the largest) therefore, their value
decreases with inflation (that is, MFIs receive loan payments in currency that is worth less
than when the loans were made). In addi- tion, the value of the loan amount decreases in real
terms, meaning it has less purchasing power for the client. To maintain purchasing power,

the average loan size must increase. At the same time, the price of goods and services
reflected in an MFI's operating and financial costs increase with inflation. Therefore, over
time an MFI's costs increase and its financial assets, on which revenue is earned, decrease in
real terms. If assets do not increase in real value commensurate with the increase in costs,
the MFI's revenue base will not be large enough to cover increased costs.
An MFI should adjust for inflation on an annual basis based on the prevailing inflation rate
during the year, regardless of whether the level of inflation is significant, because the
cumulative effect of inflation on the equity of an MFI can be substantial.
Note that similar to subsidy adjustments, unless an MFI is operating in a hyperinflationary
economy, adjustments for inflation are calculated for the purpose of determining financial
viability only. Inflation adjustments do not represent actual cash outflows or cash inflows.
Unlike adjustments for subsidies, adjustments for inflation result in changes to both the
balance sheet totals and the income statement. The balance sheet changes because fixed
assets are increased to reflect the effect of inflation, and a new capital account is created to
reflect the increase in nominal equity necessary to maintain the real value of equity. The
income statement is affected by an increase in expenses relative to the cost of inflation.

To adjust nonfinancial assets, the nominal value needs to be increased relative to the amount
of inflation. To make this adjustment, an entry is recorded as revenue (credit) (note that this
is not recorded as operating income because it is not derived from normal business
operations) on the income statement and an increase in fixed assets (debit) is recorded on the
balance sheet. The increased revenue results in a greater amount of net income transferred to
the balance sheet, which in turn keeps the balance sheet balanced although the totals have


To account for the devaluation of equity caused by inflation, the prior year's closing equity
balance is multiplied by the current year's inflation rate. This is recorded as an operating
expense on the income statement. An adjustment is then made to the balance sheet under the
equity reserve account "inflation adjustment."


EQUITY(OPENINGBALANCE) 108.46 20.93 1.52 0.51 0.08
INFLATION(CHANGESINCPI) 6.40% 6.83% 4.23% 4.00% 3.73%
ADJUSTMENT 6.942 1.428 0.065 0.020 0.003
BALANCE) 10.66 3.05 2.56 0.22 0.20
ADJUSTMENT 0.682 0.208 0.108 0.009 0.008

Unadjusted balance sheet

PARTICULARS(AMOUNT IN MN) 2008 2007 2006 2005 2004

GENERAL RESERVE 15.05 15.05 15.05 2.99 0.49
DONATED EQUITY PRIOR YEAR 8.45 4.94 1.49 0.00 0.00
DURING THE YEAR 0 3.510 3.46 1.49 0
CUMULATIVE GRANT 8.453 8.453 4.943 1.49 0
CUMULATIVE NET SURPLUS/DEFICIT 191.06 62.94 0.94 -2.95 0.02
BENEFICIARIES 22.03 22.03 0 0 0

NET WORTH 236.6 108.5 20.9 1.5 0.5

4 286.58 75.78 13.99
4 286.58 75.78 13.99

MEMBERS 457.7 208.4 81.7 22.0 3.7
INTEREST ACCRUED BUT NOT DUE 15.7 3.7 0.4 0.4 0.1
OTHER LIABILITIES 20.3 12.5 5.7 1.5 0.1
PROVISION FOR LOAN LOSS 29.3 25.2 7.4 0.1 0.1
TOTAL CURRENT LIABILITIES 522.97 249.80 95.15 24.00 3.97
0 402.66
0 18.47

0 371.12 85.81 12.04

CASH AND BANK BALANCES 65.13 60.35 20.52 9.25 3.31

DEPOSITS WITH BANKS 564.08 18.69 5.15 2.53 1.2
INTEREST RECEIVABLES 0.00 0.77 0.14 0.12 0.0
OTHER CURRENT ASSETS 141.50 9.43 2.68 1.04 1.03
TOTAL CURRENT ASSETS 770.71 89.25 28.49 12.94 5.56
5 399.60 98.74 17.60
NET FIXED ASSETS 36.05 10.66 3.052 2.56 0.22
OFF 0.00 0.00 0.65
0 402.66
0 18.47

Unadjusted profit and loss account

FOR THE YEAR ENDED ON MARCH 31 2008 2007 2006 2005 2004

INTEREST INCOME FROM LOANS 442.80 181.38 52.32 9.41 1.76
DEPOSITS 9.30 2.94 0.08 0.13 0.03
TOTAL FUND BASED INCOME 452.10 184.31 52.40 9.53 1.79

TOTAL FEE BASED INCOME 65.39 25.87 1.82 0.64 0.09

TOTAL INCOME 517.49 210.18 54.21
8 1.88

ON BORROWINGS 175.44 60.31 13.43 3.47 0.56
ON SAVINGS / SECURITY 0.00 0.00 1.91 0.35 0.06
PAID 175.44 60.31 15.34 3.82 0.62

PERSONNEL EXPENSES 154.73 47.54 18.68 6.10 0.90
ADMINISTRATIVE EXPENSES 48.28 21.29 8.27 3.07 0.33
LOSS 5.21 17.80 7.30 0.00 0.10
DEPRECIATION 5.80 1.24 1.99 0.45 0.05
MISC EXPENDITURE 0.00 0.00 0.11 0.00 0.00

TOTAL EXPENDITURE 389.45 148.18 51.70

4 1.99

3.26 -0.11
GRANTS 128.04 62.00 2.52
3.26 -0.11
ADD: GRANTS AND DONATIONS 6.89 4.16 3.13 1.49 0.15
GRANTS 6.89 4.16 0.00 0.18 0.10
SURPLUS/DEFICIT 0.00 0.00 3.13 1.31 0.05
NET SURPLUS/(DEFICIT) 128.04 62.00 5.65
1.96 -0.06
BALANCE B/F 62.94 0.94 -2.95 0.02 0.08
1.01 0.00
BALANCE C/F 191.06 62.94 0.94
2.95 0.02

Adjusted balance sheet

PARTICULARS 2008 2007 2006 2005

5 2.99 0.49
DONATED EQUITY PRIOR YEAR 8.45 4.94 1.49 0.00 0.00
THE YEAR 0 3.510 3.46 1.49 0
3 1.49 0
CUMULATIVE NET SURPLUS/DEFICIT 91.93 32.89 -7.74 -5.06
BENEFICIARIES 22.03 22.03 0 0 0
INFLATION ADJ USTMENT FOR EQUITY 6.94 1.43 0.06 0.02 0.00
SUDSIDIES ACCOUNT 92.87 28.83 8.72 2.10 1.16

NET WORTH 237.3 108.7 21.0 1.5 0.5




MEMBERS 457.7 208.4 81.7 22.0 3.7
INTEREST ACCRUED BUT NOT DUE 15.7 3.7 0.4 0.4 0.1
OTHER LIABILITIES 20.3 12.5 5.7 1.5 0.1
PROVISION FOR LOAN LOSS 29.3 25.2 7.4 0.1 0.1
0 3.97

2 9.25 3.31
8 18.69 5.15 2.53 1.2
INTEREST RECEIVABLES 0.00 0.77 0.14 0.12 0.0
0 9.43 2.68 1.04 1.03
1 89.25
4 5.56
NET FIXED ASSETS 36.05 10.66
2 2.56 0.22

Adjusted profit and loss account

FOR THE YEAR ENDED ON MARCH 31 2008 2007 2006 2005

2 9.41 1.76


DEPOSITS 9.30 2.94 0.08 0.13 0.03
0 9.53 1.79

TOTAL FEE BASED INCOME 65.39 25.87 1.82 0.64 0.09


9 1.89

4 60.31
3 3.47 0.56
ON SAVINGS / SECURITY 0.00 0.00 1.91 0.35 0.06
ADJ USTMENT FOR DONATION 0.00 0.48 0.41 0.18 0.00
ADJ USTMENT FOR SUBSIDY 92.87 28.35 8.31 1.92 1.16
1 89.14
6 5.92 1.78

3 47.54
8 6.10 0.90
ADMINISTRATIVE EXPENSES 48.28 21.29 8.27 3.07 0.33
LOSS 5.21 17.80 7.30 0.00 0.10
DEPRECIATION 5.80 1.24 1.99 0.45 0.05
MISC EXPENDITURE 0.00 0.00 0.11 0.00 0.00
INFLATION ADJ USTMENT FOR EQUITY 6.94 1.43 0.06 0.02 0.00
6 3.15

SURPLUS/DEFICIT BEFORE TAX 28.91 31.95 -6.16 -5.37
GRANTS 28.91 31.95 -6.16 -5.37
ADD: GRANTS AND DONATIONS 6.89 4.16 3.13 1.49 0.15
LESS: EXPENSES OUT OF REVENUE GRANTS 6.89 4.16 0.00 0.18 0.10
SURPLUS/DEFICIT 0.00 0.00 3.13 1.31 0.05
NET SURPLUS/(DEFICIT) 28.91 31.95 -3.03 -4.07
BALANCE B/F 62.94 0.94 -2.95 0.02 0.08
PRIOR PERIOD ADJ USTMENT 0.08 0.00 -1.76 -1.01 0.00
BALANCE C/F 91.93 32.89 -7.74 -5.06


Performance indicators collect and restate financial data to provide useful information about
the financial performance of an MFI. By calculating performance indicators, donors,
practitioners, and consultant can determine the efficiency, viability and outreach of MFI

The Performance indicators can be organized into six areas:
Portfolio quality
Productivity and efficiency
Financial viability
Leverage and capital adequacy
Scale, Outreach and growth
I . Portfolio /Asset quality
This provides information on the percentage of non earning assets, which in turn decrease the
revenue and liquidity position of an MFI.
The table below indicates the PAR for the years2008, 2007 and 2006.
ARE 31Mar08 %OFPAR 31Mar07 %OFPAR 31Mar06 %OFPAR
ONTIME 3234.69 99.90% 1260.03 99.90% 371.04 99.98%
130DAYS 0.68 0.02% 0.23 0.02% 0.07 0.02%
3160DAYS 0.37 0.01% 0.26 0.02% 0.01 0.00%
6190DAYS 0.46 0.01% 0.15 0.01% 0 0.00%
91180DAYS 0.5 0.02% 0.22 0.02% 0 0.00%
181360DAYS 0.39 0.01% 0.24 0.02% 0 0.00%
361DAYSANDABOVE 0.9 0.03% 0.17 0.01% 0 0.00%
TOTALPORTFOLIO 3238 100.00% 1261.3 100.00% 371.12 100.00%
PORTFOLIOATRISK>30DAYS 2.62 0.08% 1.04 0.08% 0.01 0.00%
PORTFOLIOATRISK>90DAYS 1.79 0.06% 0.63 0.05% 0 0.00%

PAR>30 days is far below industry standards of 2.7%
Bandhan has consistently maintained good asset quality, with an on-time repayment rate of
99.90% per cent as on March 31, 2008. In absolute terms, the overdue amount beyond one
day increased substantially to Rs.3.31 (0.1022%) million as on March 31, 2008, from Rs.1.27

million (0.10068%) as on March 31, 2007. This was mainly due to flood conditions in West
Bengal and other states where Bandhan is active, which impacted collections.

The MFI is susceptible to concentration risk, as just one state, West Bengal, accounts for
around 93 per cent of the total loan disbursements. To mitigate this, the MFI has plans to
diversify its operations to new states.
The MFI has managed to maintain good asset quality, as majority of its disbursements is
towards income generating activities: as on March 31, 2008, they constituted around 76 per
cent of disbursements. The MFI has started focusing on micro entrepreneur loans (individual
loans) and also likely to concentrate on urban market.

Provisioning policy:
Bandhan has adopted conservative loan loss policy measures, as it provides 1 per cent
provisioning on standard assets and 100 per cent provisioning on overdue loans beyond 180
It is important to look at PAR in conjunction with the write-off ratio, to ensure that the MFI is
not maintaining a low PAR by writing off delinquent loans.
PARTICULARS(AMOUNTINMN) 2008 2007 2006 2005

CLOSINGBALANCE 29.3 25.2 7.4 0.1

PORTFOLIOOUTSTANDING 2782.8 1261.3 371.1 85.8
OUTSTANDING 0.04% 0.00% 0.00% 0.00%

The industry standard for writeoff ratio is 1.1%

Risk coverage Ratio
Risk Co:crogc Rotio =
AJ]ustcJ impoirmcnt loss ollowoncc
PAR > Su Joys

2008 2007 2006
LOANLOSSRESERVES 29.27 25.23 7.42
PAR>30 2.62 1.04 0.01
Industry standard is just 86.8%
I I . Productivity and efficiency ratios
Productivity and efficiency Ratios provide information about the rate at which MFIs generate
revenues to cover their expenses. By calculating and comparing productivity and efficiency
ratios over time, MFIs can determine whether they are maximising their use of resources.

Productivity refers to the volume of business that is generated (output) for a given resource or
asset (input). Efficiency refers to the cost per unit of output. In micro-finance organizations,
two key factors influence the level of activity and hence operating costs and productivity: i)
turnover of the loan portfolio and ii) average loan size.

The various productivity ratios focus on the productivity of credit officiers, because they are
the primary generators of revenue.

The ratios include:
a) Number of active borrowers per credit officer- This varies depending upon the
method of credit delivery and whether or not loans are made to individuals, to
individuals as group members, or to groups.
b) Portfolio outstanding per credit officer-The size of the average portfolio
outstanding per credit officer will vary depending on the loan sizes, the maturity of
the MFIs clients and the optimal number of active loans per credit officer.

c) Total amount disbursed in the period per credit officer- In accounting terms the
amount disbursed by a credit officer is a cashflow item whereas the amount
outstanding is a stock item.

Calculation of productivity ratios
RATIO 2008 2007 2006 2005 2004
CREDITOFFICER(mn) 1.36 0.98 0.73 0.52 0.46
PERIODPERCREDITOFFICER(MN) 3.56 2.68 1.93 1.34 0.97
LOANOUTSTANDING/BRANCH 5.52 3.55 2.19 1.53 1.27

Average number of active borrowers per credit officer has increased but the growth rate has
declined substancially from 17.48% in 2007 to 6.58% in 2008. This is an indication that
further scope for improvement in productivity is now limited. However the Portfolio
outstanding per credit officer and the amount disbursed per period per credit officer has
increased substantially because of higher portfolio turnover and higher ticket size.
Industry standard average number of active loans per credit officer-209

31STMARCH 2008 2007 2006 2005 2004
DEPLOYED 1.49 1.66 1.52 1.29 0.96
LOANSIZE(RS) 5981 4421 3831 3021 2350
GROWTH 35.3% 15.4% 26.8% 28.5%

Efficiency ratios

Efficiency ratios measure the cost of providing services (loans) to generate revenue These are
referred to as operating costs and should include neither financing costs nor loan loss
Total operating costs can be stated as a percentage of three amounts to measure the efficiency
of the MFI: the average portfolio outstanding (or average performing assets or total assets-if
an MFI is licensed to mobilize deposits, it is appropriate to measure operating costs against
total assets; if the MFI only provides credit services, operating costs are primarily related to
the administering of the loan portfolio and hence should be measured against the average
portfolio outstanding) per unit of currency lent, or per loan made.

Operating cost ratio:
The operating cost ratio provides an indication of the efficiency of the lending operations.
This ratio is affected by increasing or decreasing operational cost relative to the average

Successful MFIs tend to have operating cost ratios of between 13 and 21 percent of their
average loan portfolio.

Cost per unit of currency lent:
The cost per unit of currency lent ratio highlights the impact of the turnover of the loan
portfolio on operating costs. The lower the ratio, the higher is the efficiency. This ratio is
most useful to calculate and compare over time to see if costs are decreasing or increasing.
However, it can sometimes be misleading. For example while operating costs may increase
even though the size of the portfolio remains the same, the cost per rupee lent may actually
decrease. This would happen if more short term loans were made during the period and
therefore the turnover of the portfolio were higher. Although this ratio would be reduced, it
does not necessarily indicate increased efficiency.

Cost per loan made

The cost per loan made ratio provides an indication of the cost of providing loans based on
the number of loans made. Both this ratio and the cost per unit of currency lent need to be
looked at over time to determine whether operating costs are increasing or decreasing relative
to the number of loans made, indicting the degree of efficiency. As an MFI matures these
ratios should decrease.
7 2006 2005 2004




229 136 170 217 171 NOOFLOANSMADE


The operating costs have gone up mainly because of 225% increase in the personnel
expenses, of which the salaries have increased by 252% and training expenses by 109%.
Even the administrative expenses more than doubled as compared to previous year.
2008 2007 2006 2005
SALARY(MN) 132.93 37.68 14.23 3.69
AVERAGENO.OFSTAFF 2032 1164 456 140.5
AVERAGESALARY 65416 32387 31197 26274
The increase in salary was warrented because the average salary per GNI per capita is far
below that of industry standard of 3.7 times.
2008 2007 2006
turnover % 7.79 5.17 8.13

Another reason attributed to the loss in efficiency is the the fact that the MFI is expanding
aggressively into the least developed areas. The MFI has started focusing on higher ticket
sizes which requires better contacts with clients and stringent loan appraisal process which
adds to the cost of servicing such loans. The loss in efficiency is a cause of concern even as
the yields have come down from 21.06% to 18.44% due to competition.

2008 2007 2006 2005 2004

III. Financial Viability

Financial viability refers to the ability of an MFI to cover its costs with earned revenue. To be
financially viable, an MFI cannot rely on donor funding to subsidize its operations.
To determine financial viability, self sufficiency indicators are calculated-Financial Self
sufficiency and Operational self sufficiency.
If the MFI is not financially self sufficient, the subsidy dependence index can be calculated to
determine the rate at which the MFIs interest rate needs to be increased to cover the same
level of costs with the same revenue base (loan portfolio).
To determine financial viabilty revenue is compared against the total expenses. If the revenue
is greater than expenses, the MFI is self sufficient. It is important to note that only operating
revenues (from credit and savings operations and investments) should be considered when
determining financial viability or self sufficiency.
Donated revenues or revenue from other operations such as training should not be included
because the purpose is only to determine the viability of credit and savings operations.
Expenses incurred by MFIs can be separated into four distinct groups: Financing costs, loan
loss provisions, operating expenses, and the cost of capital.

Financial spreads
Spread refers to the difference in the yield earned on the outstanding portfolio and the
average cost of funds. Spread is what is available to cover the remaing three costs that an
MFI incurs:operating costs, loan loss provisions and the cost of capital.
FORTHEYEARENDED31STMARCH 2008 2007 2006 2005
TOTALFUNDSDEPLOYED 3553.50 1350.55 399.60 98.74
AVERAGEFUNDSDEPLOYED 2452.02 875.08 249.17 58.17
2008 2007 2006 2005 2004

18.44% 21.06% 21.03% 16.39%
OUTSTANDINGLOAN 2782.79 1261.30 371.12 85.81
AVERAGEOUTSTANDINGLOAN 2022.05 816.21 228.46 48.92
PORTFOLIOYIELD 21.90% 22.22% 22.90% 19.23%
GROSSSPREADADJ AB 7.50% 10.88% 11.37% 6.22%
GROSSSPREAD AB' 11.28% 14.17% 14.87% 9.82%
INTERESTSPREADADJ AC 6.51% 9.78% 10.70% 6.14%
INTERESTSPREAD AC' 10.64% 13.43% 15.27% 10.38%

FUNDBASEDYIELD A 18.44% 21.06% 21.03% 16.39%
INTERESTSPREAD C=AB 9.28% 11.71% 13.62% 8.66%
OPERATINGEXPENSERATIO D 8.49% 9.90% 13.79% 15.76%
NPM C+ED 3.46% 4.76% 0.55% 5.99%

2008 2007 2006 2005

The profit margins are well below industry standard of 4.9% also the yield on portfolio is
21.90% as against industry standard of 29.9%.
The fee based income yield has declined because of lower turnover also due to increasing
competition compelled the MFI to reduce its onlending rate resulting in lower portfolio yield.
The fund based yield also declined as higher allocation was made to cash and bank deposits
which earn a lower return.

Operational Self sufficiency: Operational self sufficiency is generating enough operating
revenues to cover operating expenses, financing costs, and the provision for loan losses.
Operational self sufficiency thus indicates whether or not enough revenues has been earned to
cover the MFIs direct costs excluding cost of capital but including financing costs incurs.
Other MFIs argue that operational self sufficiency should not include financial costs because
not all MFIs incur financial costs equally, which thus makes the comparison of self
sufficiency ratios between institutions less relevant. Some MFIs fund all their loans with
grants or concessional loans and do not need to borrow funds or collect savings and thus
either do not incur any financing costs or incur minimal costs.
Other MFIs as they move progressively towards financial viability are able to access
concessional or commercial borrowings and thus incur financing costs. However all MFIS
incur operating expenses and the cost of making loan loss provisions and they should be
measured on the management of these costs alone. MFIs should not be panelized for
accessing commercial funding sources nor MFIs that are able to fund all their loans with
donor funds be rewarded.
opcrotionol sclsuicicncy =
opcroting incomc
opcroting cxpcnscs +pro:ision or loon losscs

If an MFI does not reach operational self-sufficiency, eventually its equity (loan fund capital)
will be reduced by losses (unless additional grants can be raised to cover operating
shortfalls). This means that there will be a smaller amount of funds to loan to borrowers
(which could lead to closing the MFI once the funds run out). To increase its self-sufficiency,
the MFI must either increase its yield (return on assets) or decrease its expenses (financing
costs, provision for loan losses, or operating costs).

RATIO 2008 2007 2006 2005 2004

Financial self-sufficiency
Financial self-sufficiency indicates whether or not enough revenue has been earned to cover
both direct costs, including financing costs, provisions for loan losses, and operating
expenses, and indirect costs, including the adjusted cost of capital.
The adjusted cost of capital is considered the cost of accessing commercial rate liabilities
rather than concessional loans.
Finonciol sclsuicicncy
opcroting incomc
opcroting cxpcnscs +inoncing costs +pro:ision or loon losscs +cost o copitol

RATIO 2008 2007 2006 2005 2004
FINANCIALSELFSUFFICIENCY 1.0704 1.1861 0.9268 0.6738 0.6061

Though the OSS has shown significant improvement the FSS has decreased because of
higher financing cost. The OSS and FSS are above the industry average of 1.136 and 1.051
times respectively.

Subsidy Dependence index

A third and final way to determine the financial viability of an MFI is to calculate its subsidy
dependence index (SDI). The subsidy dependence index measures the degree to which an
MFI relies on subsidies for its continued operations.
The subsidy dependence index is expressed as a ratio that indicates the percentage increase
required in the on lending interest rate to completely eliminate all subsidies received in a
given year.

Calculating the subsidy dependence index involves aggregating all the subsidies received by
an MFI. The total amount of the subsidy is then measured against the MFI's on-lending
2008 2007 2006 2005 2004

interest rate multiplied by its average annual loan portfolio Measuring an MFI's annual
subsidies as a percentage of its interest income yields the percentage by which interest
income would have to increase to replace the subsidies and provides data on the percentage
points by which the MFI's on-lending interest rate would have to increase to eliminate the
need for subsidies.

SI =
totol onnuol subsiJics rccci:cJ
A:crogc onnuol intcrcst incomc

RATIO 2008 2007 2006 2005 2004
SDI 20.97% 15.89% 16.67% 22.27% 65.85%

A subsidy dependence index of 100 percent indicates that a doubling of the average on-
lending interest rate is required if subsidies are to be eliminated. Similarly a subsidy
dependence index of 200 percent indicates that a threefold increase in the on-lending interest
rate is required to compensate for the subsidy elimination. A negative subsidy dependence
index indicates that an MFI straight forward not only fully achieved self-sustainability, but
that its annual profits, minus its capital (equity) charged at the approximate market interest
rate, exceeded the total annual value of subsidies, if subsidies were received by the MFI. A
negative subsidy dependence index also implies that the MFI could have lowered its average
on-lending interest rate while simultaneously eliminating any subsidies received in the same

IV. Profitability Ratios

Profitability ratios measure an MFI's net income in relation to the structure of its balance
sheet. Profitability ratios help investors and managers determine whether they are earning an
adequate return on the funds invested in the MFI.
Return on Assets Ratio
The return on assets (ROA) ratio measures the net income earned on the assets of an MFI.
For calculating the return on assets, average total assets are used rather than performing
assets, because the organization is being measured on its total financial performance,
including decisions made to purchase fixed assets or invest in land and buildings.
Factors that affect the return on assets ratio are varying loan terms, interest rates and fees and
the change in delinquent payments.

Analysis of this ratio will improve the ability of an MFI to determine the revenue impact of
policy changes, improved delinquency management or the addition of new products.
To further analyze the financial performance of an MFI it is useful to decompose the return
on assets ratio into two components: the profit margin and asset utilization.
Asset utilization examines revenue per dollar of total assets. This can be further broken down
into interest income per dollar of assets and non interest income per dollar of assets to
provide an indication of where the revenue is earned based on where the assets are invested
(loan portfolio versus other investments)
RATIO 2008 2007 2006 2005 2004
ROA NETINCOME/AVERGEASSETS 5.17% 7.03% 2.24% 3.27% 0.32%
ROAADJ NETINCOMEADJ/AVERAGEASSETS 1.17% 3.62% 2.45% 8.97% 6.84%

The adjusted ROA is far above industry standard of 0.6%.

2008 2007 2006 2005 2004
1.17% 3.62% 2.45% 8.97% 6.84%
2008 2007 2006 2005 2004 2008 2007 2006 2005 2004
5.58% 15.19% 11.35% 52.73% 66.84% 20.93% 23.85% 21.55% 17.01% 10.23%
2008 2007 2006 2005 2004 2008 2007 2006 2005 2004
1.01% 8.46% 13.44% 0.00% 5.22% 18.26% 20.89% 20.79% 15.92% 9.69%
2008 2007 2006 2005 2004 2008 2007 2006 2005 2004
51.78% 42.37% 44.30% 58.09% 94.05% 2.67% 2.96% 0.76% 1.09% 0.54%
2008 2007 2006 2005 2004
41.64% 33.98% 53.60% 94.64% 67.58%


The ROA has substantially declined from 3.62% in the year 2007 to 1.17% in 2008. This was
due to decline in profit margin from 15.19% in 2007 to 5.58% in 2008. Though the expense
related to provision for loan losses has declined both interest expense and non interest
expense increased.
Asset utilization has also declined due to reduction in interest income as the MFI reduced its
interest rate from 15% in 2007 to 12.5% in 2008.

Return on Equity Ratio
The return on equity (ROE) ratio provides management and investors with the rate of return
earned on the invested equity. It differs from the return on assets ratio in that it measures the
return on funds that are owned by the MFI. The return on equity ratio also allows donors and
investors to determine how their investment in a particular MFI compares against alternative
investments. This becomes a crucial indicator when the MFI is seeking private investors.
RATIO 2008 2007 2006 2005 2004
TOTALEQUITY 74.21% 95.83% 50.34% 192.38% 11.70%
TOTALEQUITYADJ 16.71% 49.27% 26.85% 396.03% 233.48%

The reduction in both profit margin and asset turnover had a very negative effect on the ROE
due to higher leverage.
Leverage and Capital Adequacy

Leverage refers to the extent to which an MFI borrow money relative to its amount of equity.
It is important for all organizations to maintain a proper balance between debt and equity to
ensure that the equity or viability of the organization is not at risk. If an MFI has a large
amount of equity and very little debt, it is likely limiting its income-generating potential by
not making use of external sources of debt. Therefore, it may be better for the MFI to
increase its liabilities, if possible, to increase its income-generating assets (its loan portfolio).
The degree of leverage greatly affects the return on equity ratio of an MFI. An MFI that is
more highly leveraged than another will have a higher return on equity, all other things being
equal. When an MFI is regulated, the degree to which it is allowed to leverage its equity is
based on capital adequacy standards.
2008 2007 2006 2005 2004
D/E 11.11 9.97 16.14 44.08 27.32
D/EADJ 11.08 9.94 16.06 43.72 26.92


Capital Adequacy
Capital adequacy refers to the amount of capital an MFI has relative to its asset. Capital
serves a variety of purposes: as a source of security, stability, flexibility, and as a buffer
against risk and losses. As the possibility of losses increase, the need for capital increases.
This is particularly relevant for MFIs because the borrowers or members often lack
occupational and geographical diversity to help spread risk.

Capital must be sufficient to cover expected and unexpected losses. In addition, capital is
required to fund losses when new services are introduced, until those services generate
adequate income, or when an MFI is expanding. Expansion of the number of branches or the
area covered by each branch requires substantial capital investment. The planned growth of
an MFI requires capital to increase in proportion to its asset growth.

Capital adequacy is based on risk-weighted assets (as set out under the Basle Accord, which
identifies different risk levels for different assets types. There are five standard risk weights
ranging from 0 percent to 100 percent risk.

For most MFIs, only the first category-0 percent weight; includes cash, central bank balances,
and government securities, and the last category-100 percent weight; includes loans to private
entities and individuals are relevant, because MFIs do not generally have fully secured loans-
50 percent weight-or off-balance sheet items. Capital adequacy is set at 8 percent of risk-
weighted assets. This means that a regulated MFI can have up to 12 times the amount of debt
as equity based on the adjusted (risk-weighted) assets being funded.
As on March 31, 2008, Bandhan had an adjusted net worth of Rs.237.3 million, a substantial
improvement from Rs.108.7 million as on March 31, 2007. This improvement was mainly
because of increase in internal accruals to Rs.191.06 million for the year ended March 31,
2008, from Rs.62.94 million in the previous year.
The accumulated surplus accounted for 81 per cent of the net worth, with the balance being
distributed among grants and general funds.
Capital adequacy has slightly gone down by 0.1% to 8.50% from previous year figure of
8.60%. The cash and bank deposits constituted about 18% of the total assets as against 6% in
the previous year. The improvement in internal accruals along with higher liquid assets in the

form of cash and bank balance for which the risk weight is zero has assisted the MFI to
maintain its capital adequacy although there has been more than 120% increase in the
outstanding loan portfolio.

2008 2007 2006 2005 2004
CAR 8.50% 8.60% 5.64% 1.78% 4.25%
ASSETS 17.53% 5.81% 6.38% 11.62%
INCINLOANOUTSTANDING 120.63% 239.87% 332.49% 612.83%
INCINNETWORTH 118.12% 418.34% 1272.46% 197.76%

V. Management
Credit approval mechanisms
Bandhans credit approval mechanisms are better than that of most MFIs in the country. It
has decentralised its operations, as even branch managers have loan sanctioning powers. The
credit officer verifies the loan documents with reference to the members profile and the
loans are sanctioned by the respective managers after doing a mandatory pre-sanction visit to
the household. However, given the increase in lending operations and loan ticket size in
recent times, mainly in the wake of competition, it is important that the MFI strengthens its
loan documentation and approval mechanisms going forward, given its diversification plan.
2008 2007 2006 2005

Loan monitoring mechanisms

The MFI has adequate loan monitoring mechanisms. The credit officer has to complete the
loan utilisation check within fifteen days of disbursements and then submit the report to the
branch manager. Also, the field officer needs to personally attend all the self help group
(SHG) meetings. Moreover, the branch manager, as well as the regional and the divisional
managers, conduct surprise visits to the SHG for verifying the records maintained at the SHG
The level of cash management mechanism at the MFI is relatively better, as fund requisition
is taken up every month, during the staff meeting and is submitted to head office during first
week of every month. However, the cash-in-transit insurance is yet to be implemented.
The management information system (MIS) at the branch level is effective, though manual.
Given this, the MFI faces significant challenges in providing the data on time. Because of the
manual process, information from across branches is delayed by a week and the same is then
consolidated at the head office. To overcome this blip, the MFI is closely working with
Bangladesh Rural Advancement Communities (BRAC), Bangladesh on a customised
software. Bandhan intends to implements the software at all regional offices, across states.
The data from branches will then be consolidated at the regional offices before being
transferred to the head office. On the other hand, the MFI needs to adopt robust disaster
management practices, as it stores all data at one place. As per the management, the
customised software will become fully operationally by March 2009.
Bandhans human resource management structure is good compared with other MFIs of its
scale and scope. The pay structure is fixed and the performance is reviewed every year.
Promotions are based on employee performance. Most assistant directors and divisional
managers have a good knowledge of Bandhans operational policies. The role and
responsibility of the employee and the growth path for each employee is clearly defined. One
distinguishing feature of Bandhan is that the employees at the head office have to visit the
branches regularly to understand the operations at the grass root level.
Bandhan has instituted processes and controls to manage its microfinance operations.
Recently, it strengthened the internal audit team, which spends considerable time over each
branch: audits are done thrice every year. However, given the increase in the size of
individual loans and competition from other players, the MFI needs to strengthen its control

systems across branches. Given the diversification plans, CRISIL believes that there is a need
for the MFI to decentralise and strengthen its control mechanisms to manage the operational
risk in the business.
VI . Scale and Outreach
As on March 31, 2008, Bandhan had 8,66,381 members, spread across 427 branches, 29
districts, and six states. It plans to start operations in Patna (Bihar) and New Delhi shortly.
The MFI has presence in all the 19 districts of West Bengal and 6 districts in Assam. These
two states account for 98.5 per cent of the total disbursements.
The number of active borrowers per member has significantly increased from 62% in 2004 to
88% in 2008. This shows the effectiveness of the model employed which does not allow a
member to remain dormant for more than 2 week. Members who do not take the next cycle of
the loan dropout of the programme.
PARTICULARS 2008 2007 2006 2005 2004 CAGR
NOOFCLIENTSORMEMBERS 866,381 498444 176063 51,586 9,282 311%
GROWTH 73.8% 183.1% 241.3% 455.8%
%WOMEN 100% 100% 100% 100% 100%
NUMBEROFACTIVEBORROWERS 757903 433324 149886 40286 5734 339%
GROWTH 74.9% 189.1% 272.1% 602.6%
OFMEMBERS 87.5% 86.9% 85.1% 78.1% 61.8%
NUMBEROFSTAFF 2415 1649 678 234 47 268%
GROWTH 46.5% 143.2% 189.7% 397.9%
NUMBEROFCLIENTS/STAFF 359 302 260 220 197
NUMBEROFBRANCHES 427 305 155 54 10 256%
GROWTH 40.0% 96.8% 187.0% 440.0%
MEMBERS/BRANCH 2029 1634 1136 955 928
LOANACCOUNT/BRANCH 1775 1421 967 746 573
VILLAGES 11,902 9,371 6,353 5,241 1,635 164%
GROWTH 27.0% 47.5% 21.2% 220.6%
LOANOUTSTANDING(MN) 2783 1261 371 85.81 12.04 390%
GROWTH 120.7% 239.9% 332.4% 612.7%
LOANOUTSTANDING/BRANCH(MN) 6.52 4.13 2.39 1.59 1.20
YEAR(MN) 5299.13 2,239.48 608.46 127.53 16.89 421%
GROWTH 136.6% 268.1% 377.1% 655.1%
YEAR 886057 506595 158834 42211 7186 333%
GROWTH 74.9% 218.9% 276.3% 487.4%
AVERAGEDISBURSEDLOANSIZE(RS) 5981 4421 3831 3021 2350

GROWTH 35.3% 15.4% 26.8% 28.5%

GNIPERCAPITA 41416 36950 32372 28920 25696
PERCENTAGEOFGNIPERCAPITA 14.44% 11.96% 11.83% 10.45% 9.15%
NOOFCREDITOFFICERS 1776 1199 471 158 32
GROWTH 48.1% 154.6% 198.1% 393.8%
OFFICER(MN) 3.56 2.68 1.93 1.34 0.53
PORTFOLIOTURNOVER 1.491 1.658 1.523 1.292 0.960

Scalability and Sustainability
Bandhan may revise its business plan as there has been a significant increase in lending rate
by the lending institutions, given the market conditions. Moreover, given the increasing
competition faced by Bandhan, it may not be able to pass on the increase in lending rates to
its borrowers. In such a scenario, the MFI may need to increase its fee-based income.
Need to transform into an NBFC
As of now, the MFI is registered under the societies act; the legal structure as a society
restricts its ability to raise big money. Also, following the recent changes in the tax policy by
the central government, societies and trusts will now have to pay tax on the surplus earned.
The positive benefits of becoming an NBFC are greater access to commercial sources of
funding, therefore greater outreach in terms of loan portfolio size and clients reached and thus
greater profitability. Transformation will also lead to greater transparency and efficiency as it
will be regulated by the RBI.
On the operations side, the MFI needs to implement a more robust MIS system. Further, it
also needs to re-look its credit appraisal systems, as the MFI intends to increase its lending
towards higher ticket loans, and that too in West Bengal, accentuating the regional
concentration risk.
VI I . Resources and Asset Liability Management
Bandhan has access to various financial institutions and private and public sector banks. It
accessed around Rs.3.98 billion in 2007-08. During the year, the MFI sourced funds from
nine new lending institutions, taking the tally of its lending institutions to 20. However, now

the MFI intends to rationalise its borrowing sources and plans to concentrate on a few big
lending institutions.
Bandhans average cost of borrowings deteriorated by around 200 basis point to 7.80 per cent
as on March 31, 2008, from 5.76 per cent as on March 31, 2006. This is mainly because the
MFI has borrowed resources at commercial rates. The weighted average cost of funds from
varied sources stood at 11.02 per cent as on March 31, 2008. The MFIs asset-liability profile
is comfortable, as most of the borrowings are long term.
FORTHEYEARENDED31STMARCH 2008 2007 2006 2005

There is no Asset Liability Mismatch as the MFIs micro finance programmes borrowings
are of long tenure while the assets are short-term assets.
Borrowing Profile:
( In months)
Interest rate (%) Loan
March 2008
(Rs. million)
SIDBI-1 42 9.00 5.29 Quarterly
SIDBI -2 - 1.00 10.00 Quarterly
SIDBI -3 24 8.50 77.50 Quarterly
SIDBI -4 24 11.50 380.00 Monthly
SIDBI -5 24 11.00 100.00 Monthly
FWWB-1 36 11.50 2.50 Quarterly
FWWB -2 54 11.50 40.55 Monthly
FWWB 3 54 10.50 2.22 Monthly
HDFC bank -1 24 9.00 64.92 Monthly
HDFC bank-2 24 12.50 75.00 Monthly
ICICI Bank Ltd.-
1 36 9.00 1.33 Quarterly
ICICI Bank Ltd.-
2 36 9.50 6.51 Quarterly
ICICI Bank Ltd.-
3 36 13.00 85.71 Quarterly
Rashtriya Mahila
Kosh 33 8.00 0.14 Quarterly
Bank-1 36 8.50 4.08 Quarterly
Bank-2 36 8.75 17.50 Quarterly
ABN AMRO 36 9.25 16.55 Quarterly

Bank-4 36 9.15 69.85 Quarterly
Bank-5 36 12.10 90.00 Quarterly
Bank-6 36 11.60 66.60 Quarterly
Bank-7 24 11.50 150.00 Quarterly
Axis Bank-1 21 9.25 35.71 Quarterly
Axis Bank -2 21 11.00 114.29 Quarterly
Chartered Bank-
1 24 8.60 12.50 Quarterly
Chartered Bank-
2 24 8.35 0.63 Quarterly
Chartered Bank-
3 24 11.25 135.00 Quarterly
State bank of
India-1 36 9.50 75.00 Monthly
State bank of
India-2 36 11.00 197.49 Monthly
State bank of
India -3 36 10.50 200.00 Monthly
YES Bank 13 9.50 7.69 Monthly
CitiBank 25 12.50 36.53 Monthly
Cordaid 60 7.50 32.25 Half Yearly
IDBI Bank 36 12.00 96.67 Monthly
Mercantile Bank 12 12.50 20.00 Monthly
Holding 60 11.90 100.00 Annual
BNP Paribus 12 11.75 100.00 Quarterly
Indian Bank 30 9.50 50.00 Quarterly
Bank of India 36 11.75 250.00 Monthly
Indian Overseas
Bank 24 10.50 100.00 Monthly
Grand Total 2830.00



One of the issues that is impeding Bandhans growth is the lack of equity capital. With the
MFIs leverage being at the upper threshold, access to more debt is limited.
Assuming the current growth rate and the existing capital structure the following projections
regarding the capital requirement are made.
AMOUNTINMN 2008 2009 2010 2011
LOANOUTSTANDING 2783 6142.0 13555.3 29916.3
ASSETS 3590 7922 17484 38586
EQUITY 237 522 1152 2543
DEBT 3353 7400 16331 36043

One of the options before the MFI is that of transformation to a for profit NBFC.
In this section we shall try to analyse the cost and benefit associated with the transformation
to NBFC using a case of SHARE Microfin which transformed from a society into an NBFC
in the year 2000.
Share Microfin Ltd.
SHARE is Indias largest MFI in terms of outreach or number of loans given. SHARE
(Society for Helping, Awakening Rural poor through Education) was originally registered
under the Societies Act as a service organization in the year 1989 by Mr. M. Udaja Kumar,
Founder and Chairman. It then transformed into SHARE Microfin Ltd, a regulated Non-
banking Financial Institution (NBFC) under the companies act in the year 2000. SHARE
operates mostly in the rural areas of the states of Andhra Pradesh and Karnataka.
SHARE is uses the Grameen Bank model and thus focuses on providing loans to groups of
women. SHAREs target clients are women whose per capita income is less than Rs. 250 per
month (Approx. US$5.80) and their asset holding is less than Rs. 20,000 (Approx. US$465).
During the years 1991-1994 SHARE had started its microcredit operations as a two year
action research project with a US$25,000 recoverable grant from the Asia Pacific
Development center and a soft loan of US$35,788 from the Grameen Trust in Bangladesh.
SHAREs major expansion however, began in 1997 with the opening of six new branches to

a total of ten branches with one branch achieving self sufficiency. With this, SHARE felt it
had a viable model that could be replicated all over India. Up until this point, SHARE had
been a non-profit organization registered as a charitable society.
SHARE decided to transform for several reasons, one of which was the legal constraints it
faced as an NGO. However, it also felt that transformation would allow it to attain financial
self-sufficiency which its NGO legal status did not permit. SHARE saw the profit motive as
against the principles of charity. We might expect then, to see an improvement in the
financial sustainability of SHARE after transformation.
On the other hand, we might also expect to see a change in the social impact of SHARE if the
profit motive results in lending to clients that are more profitable, and thus, likely less poor.
Of course, this might not happen if SHARE is able to cross-subsidize its poorer clients with
the larger returns it earns from lending to better off clients. Also, we might see a loss of
innovation and flexibility in product development as an NBFC due to the requirements and
restrictions placed on regulated organizations.
There was a recognition that the activities of SHARE needed to be transformed in order to
achieve financial sustainability. The legal status of SHARE at that time did not permit it due
to a conflict of interest between the profit motive and the notion of a charity embedded in the
legal identity of NGOs. According to SHARE, the two major limitations of being registered
as a society were that the income tax law in India does not recognize charitable institutions
carrying on microfinance activity and thus, the MFI loses its tax exemption. Secondly, raising
funds becomes a difficult task when financial leverages cannot be optimized because the net
worth and equity of the MFI do not work for profit.
Recognizing these constraints, SHARE transformed to a community owned and managed for-
profit regulated financial institution registered under the companies act in the year 2000.
Sources of Capital
SHAREs sources of capital, both historically and going forward, are critical to its viability as
an MFI and its ability to grow and reach more clients. Since MFIs are in the business of
lending, a steady and growing stream of capital is central to its business.
SHAREs 2001 annual report states that 99% of the equity in SHARE has been contributed
by its clients with the remaining 1% from unspecified individuals. In the 2004 audited

financial statements, share capital was listed at Rs. 152.12 mn with debt equity ratio rising to
5.64 times as against 0.57 times in 1998.
This shows that SHARE has accessed capital for growth mainly from debt. Therefore, while
becoming and NBFC might increase an MFIs access to commercial capital, if this capital is
mainly in the form of debt it could increase the risk of the organization if it becomes too
highly leveraged.
Financial Analysis
The financial data is taken from the two years before SHARE transformed, 1998 to 1999, and
the periods 2004 and 2005 in order to give a picture of the MFI both before and after the
MARCH 2005 2004 2003 2002 2001 2000 1999 1998
GROSSLOANPORTFOLIO(MN) 1757.94 819.43 493.98 282.60 164.05 104.66 43.96 23.56
%GROWTH 115% 66% 75% 72% 57% 138% 87% 185%
3 572.08 355.57 197.11 145.53 71.26 40.78
%GROWTH 94% 77% 61% 80% 35% 104% 75% 263%
TOTALEQUITY(MN) 277.07 152.12 65.94 56.89 53.07 62.13 43.09 25.94
%GROWTH 82% 131% 16% 7% 15% 44% 66%
TOTALDEBT 1679.47 857.71 506.14 298.68 144.04 83.40 28.18 14.84
%GROWTH 96% 69% 69% 107% 73% 196% 90% 27%
2005 2004 2003 2002 2001 2000 1999 1998
DEBT/EQUITY 6.062 5.638 7.676 5.250 2.714 1.342 0.654 0.572
PORTFOLIO/ASSET 89.8% 81.1% 86.3% 79.5% 83.2% 71.9% 61.7%
2005 2004 2003 2002 2001 2000 1999 1998
ROA 3.15% 3.17% 1.21% 0.89% 1.13% 0.54%

2.94% 12.78
ROE 21.76%
% 9.18% 4.46% 3.35% 1.10%


% 6.56% 3.83% 8.11% 2.55%


% 2.67% 3.98% 1.97%
RATIO 0.00% 0.00% 0.00% 0.00% 0.00% 0.24% 1.34%
% 7.37%
2005 2004 2003 2002 2001 2000 1999 1998
COSTPERBORROWER 748 746 717 780 559 850 1044 1319
BorrowersperStaffmember 184 197 146 124 183 112 101 59
PAR>30 0.19%
LOANLOSSRESERVERATIO 0.00% 0.00% 0.00% 0.00% 0.90% 1.05% 2.62%

It is interesting to note that between 1999 and 2004, since SHAREs transformation to an
NBFC, SHAREs loan portfolio grew by 687%. Of course, this should be taken in light of the

quality of these loans by looking at SHAREs portfolio at risk which is surprisingly low in
2004 at 0.19% indicating that the quality of SHAREs portfolio seems to have not diminished
with its rapid growth. Also, SHARE shows a return on equity of 21.8% in 2005 up from -
1.10% in 1999-2000 before transformation because of increase in both asset turnover and
profit margin.
Its ROE is now above the benchmark adjusted return on equity of 16.6%. Overall, the trends
seem quite positive regarding the financial impact of transformation. SHAREs operating
expense ratio decreased from 19.77% before transformation to 14% in 2004-2005 after
transformation and its cost per borrower went down over the same period from 850 to 748.
Also, SHAREs ROA and ROE have gone from negative before transformation to positive
after transformation and its operating self sufficiency has increased from 97.52% before
transformation to 120.03% after transformation. Lastly, SHAREs borrowers per staff
increased from 112 in 1999 to 184 in 2004 after transformation, showing higher level of
productivity per staff member.
The indicators that raised some red flags were the debt to equity ratio, return on assets, and
net income margin. SHAREs financial leverage is significantly larger than the benchmark
(1.9 times), showing that SHARE is highly leveraged, which could potentially pose risks to
its shareholders and its clients. In 2005, SHARE had a debt to equity ratio of 6.06 times up
from 1.34 in 2000 before transformation, which is quite high compared to other MFIs of the
same asset size and age who have an average ROE of 190%.
There has been concern about microfinance banks taking on such high leverage in
comparison to the commercial banking sector. Commercial banks are able to be highly
leveraged because of the years of empirical data on the risk of commercial banking as a
business, data which is not available for microfinance banking. Thus, the risk to shareholders
is higher absent of guarantees, especially when shareholders are poor clients. SHAREs
return on assets is also 3.15% in 2005 up from -0.54% compared to the benchmark ratio of
7.70%, which shows that SHARE lags its peers on productive use of assets even though it has
gone from a negative ROA to a positive one after transformation. Lastly, SHAREs Net Profit
Margin was 17% in 2005 up from -2.55% in 2004 which is a significant improvement
although it is still below its peers with a Profit margin of 23.5%. This new profit margin
makes SHARE more attractive to commercial investors because SHARE is now covering its
costs with revenues sufficiently to generating income. Also, the higher the profit margin the

more funds SHARE has to reinvest and loan, as well as dividends to pay to its shareholders,
who also happen to include its clients.
Social I ndicators
INDICATORS 2005 2004 2003 2002 2001 2000 1999 1998
NUMBEROFSTAFF 2,006 1,004 906 688 267 273 140 129
Growth 100% 11% 32% 158% 2% 95% 9% 223%
BORROWERS 368,996 197,722 132,084 85,644 48,868 30,629 14,155 7,637
Growth 87% 50% 54% 75% 60% 116% 85% 254%
BORROWERS/STAFF 184 197 146 124 183 112 101 59
PERBORROWER 4764 4144 3740 3300 3357 3417 3105 3084
WOMENBORROWERS 100% 100% 100% 100% 100% 100% 100% 100%
CAPITA 14.92% 15.17% 14.85% 14.41% 15.67% 17.43% 16.63% 18.60%

The number of active borrowers per staff increased significantly also the average loan
balance per borrower as a percentage of GNI per capita has decreased but marginally. This
proves that there has not being any significant negative effect on the social outreach because
of transformation as we would have expected.
We might also be concerned about trends in the financial analysis of SHARE which could
indicate a tendency to move away for poorer clients, such as the increase in SHAREs profit
margin after transformation as well as the increase in the number of clients per staff member.
There are two main reasons we might attribute SHAREs increased Profit margin, higher
interest rates and reduced costs. SHARE does in fact show a decrease in its operating margin
of approximately 3.5% over the period of transformation, but this does not exactly offset the
roughly 17% increase in SHAREs profit margin over this period. While SHAREs the
interest rate SHARE charged before transformation or after is not readily available, we can
still estimate a likely increase in the interest rate charged from the financial analysis. To sure,
however, we would want more information on the interest rates SHARE has charged. Also,
we might consider the possibility that charging higher interest rates might not necessarily

result in a loss of targeting the poor if SHARE is able to cross-subsidize the cost of reaching
poorer clients with the higher returns it might make on lending to less poor clients. Therefore,
SHAREs evolving loan methodology as an NBFC will be a key part of its targeting of poor
clients. Also, SHAREs increase in borrower per staff member post transformation might lead
to the concern that less staff effort is being put into finding poorer clients. For this, we would
need to see how SHAREs field agents might have changed in their loan practices post
transformation, information that is hard to glean from published information on SHARE. We
would be most interested in finding out whether these improvements in efficiency per staff
member have contributed to lower levels of poorer clients targeted or whether they truly are a
result of greater incentives and training for staff to reach more of the same poor clients they
are currently reaching.
Organization & Management Analysis
Strategic Vision
SHAREs stated mission is the reduction of poverty by providing financial & support
services to the poor, particularly women. Since SHARE has converted from a society under
the Societies Act in India to an NBFC under the Companies Act it has become a regulated
entity. We might be concerned about the impact on SHAREs mission of transforming to an
NBFC, in that it might become overly concerned with financial sustainability and outreach at
the cost of its social mission. This does not seem to be the evidence with SHARE thus far, in
fact, part of their reasoning for the transformation is that it is in the interest of reaching more
of their target client base, the poor. Therefore, the organizations commitment to its social
mission does not seem to have waned with transformation. Overall, SHAREs operations still
seem to support its mission thus far with its continued focus as an organization to reduce
Also, now that SHARE has made the transition to an NBFC, should it consider raising equity
for growth in the future, it will have to find a way to balance its heavily socially motivated
mission with the imperative to improve shareholder value. This will partly depend on the type
of shareholders it might attract and whether they are motivated by social as well as financial
gains. Currently, 99% of its shareholder is its clients so this is not as much a concern.
However, the balancing of social and financial goals is one of the challenges of becoming an
NBFC. An MFI will have to work that much harder to maintain the same focus on social
impact that it had as an NGO while also dealing with the regulatory constraints and financial

pressures that come with being a regulated financial entity. This makes the clarity and
strength of an MFIs mission very important as well as staff having a good understanding of
that mission in their work.
SHARE has regular publication of audited financial statements as of 2002.This is a direct
result of transformation to an NBFC as annual reports are now legally required of the
organization, and SHARE did not publish such reports prior to transformation. Very little
incentive exists for an NGO to publish audited financial statements because of the time
consuming process and cost of putting together these reports on an annual basis. However, on
the social impact side, there is greater incentive for an NGO than an NBFC to do a careful
impact assessment of poverty alleviation because donors might often require it. Therefore, it
remains to be seen whether SHARE will continue to conduct such careful poverty alleviation
impact assessments now that greater pressure is placed upon it to report on its financials
I nformation Technology System
SHARE also computerized every branch before transformation to an NBFC which it uses to
monitor individual sources and uses of funds. It also claims an effective MIS system,
however we are unclear about the quality of that system. In SHAREs 2001 annual report it
also announced the launching of a Smart Card which allows it to automate data capturing and
transactions processing to increase efficiency and coverage.
Loan Methodology
SHARE employs the Grameen loan methodology. This involves providing small loans to
groups of women along with some training, consulting, and business development services.
SHAREs products are all loans, with some housing and sanitary loans and six different types
of loans in total. The longest term loans are housing loans which have duration of 4 years.
This loan methodology has not changed with transformation.
As of 2001, just after transformation, SHARE reported a loan repayment rate of 100%.
SHAREs profit margin has gone from -2.55% in 1999-2000 before transformation to 17% in
2004-2005. With the improvement in the asset turnover the ROE moved from a negative

territory to an impressive 21% in 2005. This indicates that SHARE has become more
financially sustainable during the time period after transformation to an NBFC. Our analysis
of SHARE shows that the financial impacts of transformation for SHARE appear positive
overall, both in profitability as well as outreach.
Therefore it will be prudent decision to transform the MFI from an NGO to an NBFC.


10. Conclusion
Although Bandhans financials remain strong the cause of concern is the low capital
adequacy ratio which is far below recommended 15%. This is due to the exorbitant growth
rate in operations and because it is a NGO its inability to access external commercial equity
will hinder its growth.

There has been steep increase in the cost of borrowing and as a result of the growing
competition it is not in a position to transfer the rise to its customers. There also seems to be
limited scope for decreasing the operational costs. Going forward these factors will hinder the
NPM of the MFI. What is even suprising that in these circumstances it has stopped taking
deposists from its members.

As we have seen from the case of SHARE which has successfully transformed itself from a
NGO to a NBFC and the transformation had a positive effect on both the profitability and the
outreach aspects. We recommend that the MFI convert itself to a NBFC. This will enable the
equity starved MFI to accelerate the growth further.


11. Bibliography
Microfinance state of the sector report 2008
Microfianance Handbook- J oanan Ledgerwood
Economics of Microfinance- J onathan Morduch
Institute for Financial Management and Research Centre for Micro Finance- Working
Paper Series 21
Microfinance in India: A critique-by Rajarshi Ghosh