GROWTH STRATEGY IN

MICROFINANCE

Amal Kapoor
13A1HP053
10/25/2014

Preface
I document my understanding, gained mostly during my internship days, about the sustainability of
one of the most celebrated forms of social enterprise that we have in our timesthe microfinance
institutions. Microfinance institutions, popularly termed as MFIs, work towards creating a financially
inclusive world, by providing financial intermediation services to the poor and hitherto excluded
masses. The major challenge before these institutions is to attain operational self-sustainability
(OSS), by earning enough self-generated revenue to cover its high intermediation costs. Therefore,
using a mixed-methods approach, I investigate the sustainability issues of Indian MFIs. What are the
determinant and discriminant factors for the sustainability of Indian MFIs? How are these factors
being managed by operationally efficient MFIs in India, which remained sustainable at reasonable
interest rates before the onset of the crisis and interest rate ceilings in the Indian microfinance
markets? What does the Indian microfinance crisis teach us about sustainability management and
mismanagement? Overall, the results of this mixed-methods investigation are expected to enable
Indian MFIs to march towards the attainment of efficiency and sustainability in their operations,
without losing their focus on client welfare and growth. Since the investigation uses a mixedmethods approach, but majorly focusing on the qualitative part, it has qualitative analysis, making
the results cut across disciplines, ensuring methodological replication of this investigation feasible
for any social venture facing sustainability and growth challenges.

Acknowledgements
This project draws inspiration from the innate goodness that I have seen latent in every human being
that I have interacted with. Therefore, I consider each of them my partner in bringing out this project.
They are simply too numerous to mention individually, but I owe a deep and genuine sense of
gratitude to each of them. In particular, however, I would like to thank my all those teachers out
there from whom I picked up what I consider, my mentors Mrs. Swati Panda (for whose timely
intervention in my academic life I would consider myself totally lost), my research supervisors Mr.
D. Panda, my friend Mr. Shakti (without whose sharp observations and contacts I would not have
been able to get data).

Contents
Introduction ..........................................................................................................................................................4
An Overview of the Concept of Microfinance .....................................................................................................5
Definition of Microfinance Institutions ........................................................................................................5
Objectives of Microfinance ..........................................................................................................................5
An Overview of the Emergence of Microfinance in India ...................................................................................7
Paradigm of microfinance ....................................................................................................................................8
New Paradigm of Microfinance ...........................................................................................................................9
Project Aim and Objectives ................................................................................................................................11
Methodology.......................................................................................................................................................11
Scope of the Project Work ..................................................................................................................................11
Sustainability Definition and Metrics .................................................................................................................13
Challenges Faced by Microfinance Institutions in Attaining Sustainability ......................................................13
Relevance of Sustainability for Microfinance Institutions .................................................................................15
Balancing the Dual Goals of Microfinance Institutions .....................................................................................15
Factors Affecting the Operational Self-Sustainability of Microfinance Institutions ..........................................16
Qualitative Phase ................................................................................................................................................17
Relationship Shared by the Five Factors with Operational Self-Sustainability of Microfinance Institutions ....21
Management of the Five Factors ........................................................................................................................23
Portfolio Risk Factor: Strategies and Policy Suggestions ................................................................................23
Growth Factor: Strategies and Policy Suggestions.............................................................................................25
Development Factor: Strategies and Policy Suggestions ...................................................................................27
Institutional Factor: Strategies and Policy Suggestions......................................................................................29
Recommended Strategies ...........................................................................................................................29
Cost-Efficiency Factor: Strategies and Policy Suggestions................................................................................30
Limitations of the Qualitative Phase ..................................................................................................................34

Introduction
Microfinance refers to the provision of financial services to low-income clients. By providing
financial access to the poor clients, microfinance plays a decisive role towards financial inclusion. It
economically empowers the poor and integrates them to the mainstreams of the economy. The
institutions that provide such financial services to the poor are called microfinance institutions
(MFIs). These MFIs act in an environment of high information asymmetric credit market risk, where
there is dearth of information about the credit history of the poor clients. These information
asymmetric credit market risks are mitigated by the MFIs by using unconventional group-lending
models that work on joint-liability principle, sans collaterals. Though this unconventional grouplending model has the potential to mitigate risk and facilitate financial intermediation at the bottom
of the pyramid, it has one major challenge associated with ithigh intermediation costs. To cover
these costs by generating a surplus from its operations and remain operationally self-sustainable are a
formidable task for MFIs. Considering this operational challenge and the pertinence of sustainability
as a means to an MFIs social goal of poverty alleviation, institutionalist MFI practitioners and
researchers advocate the practice of charging cost-covering interest rates in the microfinance
industry. This practice aids an MFI to attain an operationally self-sustainable status, but it has an
inherent danger associated with. The danger is that cost-covering interest rate charged by MFIs can
be considered to be unreasonable if the costs of the MFIs are excessively high due to inefficiencies in
its operating structure. Practices of charging unreasonably high interest rates have resulted in
vulnerabilities in several microfinance markets, as it is tantamount to client exploitation. It was one
of the reasons attributed to have doomed a crisis in Indiathe worlds largest microfinance
marketin the year 2010.

An Overview of the Concept of Microfinance

This section presents a generic introduction to the concept of microfinance, the definition of MFIs
and the objectives of microfinance.

According to Robinson, microfinance refers to small-scale financial servicesprimarily credit and

savings -provided to people who farm or fish or herd; who operate small enterprises or
microenterprises where goods are produced, recycled, repaired, or sold; who provide services; who
work for wages or commissions; who gain income from renting out small amounts of land, vehicles,
draft animals, or machinery and tools; and to other individuals and groups at the local levels of
developing countries, both rural and urban.
Definition of Microfinance Institutions
Morduch defines MFIs as specialized financial institutions, united under the banner of microfinance,
sharing the commitment to work towards financial inclusion. According to Asian Development
Bank, MFIs are defined as institutions whose major business is the provision of microfinance
services, such as deposits, loans, payment services, money transfers and insurance, to poor and lowincome households and their microenterprises.
Objectives of Microfinance
As microfinance envisions providing financial access to the poor in a sustainable manner, its main
objectives are as follows:

Financial Inclusion: MFIs aim to provide financial access to the poor and low-income
category, who are hitherto unreached by the traditional banks, on account of the high credit
risks associated with them. Thus, it aims to create a well-functioning financial system that is
more inclusive in nature. Sen, a well-functioning market system has the potential to confer
freedom of choice to the poor and to remove their sources of their unfreedom, through
broadening of their choice or reduction of their deprivation, itself resulting in their
development.

Poverty Reduction: By providing financial access to the poor and the weaker sections of the
society, MFIs address a major constraint faced by them: shortage of material capital, i.e. the
input necessary to generate income. Thus, MFIs enable the poor to create wealth, deal with
risks, develop their microenterprises and smoothen their consumption patterns. All these are
expected to reduce their vulnerability in facing the calamities of life and to improve their
quality of life.

Women Empowerment: Since women are relatively more disadvantaged than men in financial
matters, microfinance aims to empower women by providing them financial access. By
enabling women to secure access to financial sources and contribute to their family income,
microfinance equips them to gain more independence and confidence in running their family.
This objective of women empowerment complements its aim of poverty alleviation, due to
the fact that women tend to spend more of their increased income on their households,
childrens education and the familys welfare than men.

Sustainability: Microfinance differs from other poor-financing efforts, in that it aims to

alleviate poverty while paying for itself and perhaps even turning a profit. Though the
animating motivation behind the microfinance movement is poverty alleviation through the
financial inclusion, the industry emphasizes the need for its players to be financially
sustainable,

An Overview of the Emergence of Microfinance in India

Sriram and Upadhyayula, in their work, The Transformation of the Microfinance Sector in India:
Experiences, Options, and Future narrates the transformation experiences of Indian NGOs into
MFIs and contrasts this with international experiences. While the Indonesian experience has been
that of banks adopting MFI methods to mainstream financial services to the poor, the Bangladeshi
experience was seen to be the transformation of a project (Prof. Mohammed Yunus action oriented
research on credit delivery to the poor) into an MFI. The Bolivian experience was that of NGOs
transforming to MFI-banks, and it shared some common notes with the Indian story of NGO-MFI
evolution.

Paradigm of microfinance

Phase I
Competing
Old paradigm of microfinance
thinking
frames
Perception
Microfinance aims at the provision
about
of subsidized microcredit to the
microfinanc
poor. The poor are unbankable,
e and its
and therefore, microfinance
sustainabilit
cannot be rendered in an
y
economically profitable manner.
Continued external support in the
form of government subsidies is
needed to render these services
in a sustainable manner

Perception
Poor clients are treated as
about
the
beneficiaries,
who
avail
poor clients
subsidized microcredit to manage
their financial needs, without
much potential for savings
Perception
Presence of high information
about risk
asymmetric risks that cannot be
mitigation
mitigated by the individual credit
and
delivery models justifies the use
collaterals
of collaterals in microfinance
in
microfinan
ce
Perception
Microfinance services are best
about
rendered through formal and
microfinanc
semi-formal banks in the public
e
service
sector, i.e. via commercial banks,
delivery
regional rural banks (RRBs) and
co-operative societies

Phase II
New paradigm of microfinance

Microfinance aims at the provision of

sustained financial services to the
poorcredit, saving, insurance and
other payment services. The poor
are bankable, and therefore,
microfinance can be rendered in an
economically profitable manner.
Subsidies are needed to support
microfinance activities; but in the
due course with self-generated
revenues, these services can be
rendered in a self-sustainable
manner
Poor clients are treated as potential
customers, with savings potential.
The poor demand a range of
financial services, to be provided on
a sustained basis, in order to
manage their financial needs
Presence
of
high
information
asymmetric risks that can be
mitigated by group credit delivery
models justifies the practice of
trust-based
uncollateralized
microfinance

Microfinance can be rendered

effectively through private sector
MFIs, NGOs and Self-Help
Groups (SHGs)

New Paradigm of Microfinance

Indian Financial System did a lot of experimentations in the field of microfinance, before its
transition to the new paradigm of microfinance. Lessons learnt about the non-price barriers in old
microfinance paradigm and introspective assessments of informal group credit-lending methods like
chit-funds devised by the poor gradually led to this transition.
Microfinance in the new paradigm had its modest beginning as a grass-root development movement
among NGOs in the early 1970s. The Self-Help Groups (SHGs), formed by these NGOs, were
affinity groups of around 1520 poor individuals, mostly women with a homogeneous socioeconomic background, sharing the willingness to improve their living conditions. The group
members provided financial support to one another through internal credit assistance made from their
pooled savings. This was an informal credit-lending method designed by the poor themselves to meet
their consumption and productive needs. After inculcating financial discipline among themselves,
these SHGs, formed under the aegis of the NGOs, persuaded the government to link themselves to
formal financial institutions for sourcing additional funds and depositing their pooled savings. This,
when acceded to, paved way for the Indias celebrated SHG-Bank Linkage Programme. Later, some
of the Indian NGOs, instead of merely performing the role of a facilitator or promoter for
microcredit, transformed themselves into specialized financial intermediaries called MFIs,
constituting a niche industry with high growth potentials. The Indian MFIs assumed heterogeneous
forms comprising of nonbanking finance companies (NBFCs), societies, trusts and co-operatives.
They organized the poor into groups and catered to their financial needs, instead of linking them to
the banks. In 1973, an MFI called Self Employed Womens Association (SEWA) was registered as a
trade union in the district of Gujarat in India, to meet the financial needs of bottom of the population
pyramid. This institution called the Mahila SEWA Co-operative Bank was the first MFI in India.

10

11

Project Aim and Objectives

The project objectives enumerated below in the order in which they are undertaken:
Identification of factors affecting the OSS of Indian MFIs: To identify the factors that affect the
OSS of Indian MFIs.
(b) Identification of factors discriminating the OSS status of Indian MFIs: To identify the factors that
can discriminate and predict the OSS status of Indian MFIs.
(c) Identification of the efficient and sustainable Indian MFIs: To arrive at a setof efficient and
sustainable Indian MFIs that can be benchmarked as peers or reference groups for other MFIs
operating in Indian microfinance industry. These are the set of efficient Indian MFIs, which
remain sustainable by charging a reasonable interest rate from the clients.
(d) Management of the factors affecting and discriminating the OSS status of IndianMFIs: To
understand how the identified efficient and sustainable Indian MFIs, are managing the factors
affecting and discriminating their OSS status and to seek confirmation from these MFIs on the
relationship shared by these factors with OSS. Also to reflect on the dangers involved in the
mismanagement of these factors, by taking Indian microfinance crisis as reference.
(a)

Methodology
The methodology used in this work is qualitative methods. It also involves a quantitative analysis to
identify the factors affecting and discriminating the OSS status of Indian MFIs and a qualitative
analysis to understand how efficient and sustainable MFIs are managing these factors. For the initial
quantitative analysis is already done and is taken as secondary data. A nonparametric data
envelopment analysis technique is conducted in this intermediary phase, on the same sample of 50
Indian MFIs to identify the participant MFIs for the subsequent qualitative analysis. For the ensuing
qualitative analysis, primary data is collected by interviewing four efficient and sustainable Indian
MFIs. Finally, the discussion is closed by citing literature on sustainability mismanagement issues,
taking Indian microfinance crisis as reference.

Scope of the Project Work

The focus of this project is to understand how these identified efficient and sustainable MFIs are
managing the factors affecting and discriminating the OSS status of Indian MFIs. Thus, the study
documents the managerial strategies used by these efficient and sustainable MFIs, with respect to
these significant determinants and discriminants of their OSS status. Since these strategies are used
by the efficient MFIs which operate sustainably at a reasonable interest rate, it can serve as a
reference to other MFIs operating in the industry. The discussions in this study are thus limited to the
managerial aspects of the significant determinant and discriminant factors identified in the
quantitative phase of the study. Operationally efficient MFIs which remain sustainable by charging
an interest rate of 26 % or lower and which are comparators to other MFIs in the industry are

12

regarded as efficient and sustainable peers. The rates the MFIs publish with MIX and in their annual
reports, which are inclusive of interest and all fee expenses, is taken as the interest rates levied. No
further adjustment for hidden costs alleged by media is made, as accounting for assumed costs would
make standardized comparisons across MFIs difficult. Therefore, the focus is only on how the
efficient and sustainable MFIs are managing their OSS, given the interest rate that they levy from the
clients.

13

Sustainability Definition and Metrics

Sustainability in microfinance could relate to organizational, managerial or financial sustainability.
Among the different forms of sustainability, the one that has received the most attention in
microfinance literature is financial sustainability. Financial sustainability is denoted in microfinance
by three prominent metricsoperational self-sustainability ratio (OSS), financial self-sustainability
ratio (FSS) and Subsidy Dependence Index (SDI). OSS is a subsidy independent accounting measure
of sustainability which denotes the ability of MFI to earn revenue to cover its costs and reach the
poor now and in future. More specifically, it is the ability of MFI to generate enough income from its
operations to cover its financing costs, operating costs and loan loss provisions, regardless of
whether it is subsidized or not. Such an operationally sustainable MFI is eventually expected to
attain an FSS status, a higher state that denotes the ability of an MFI to generate enough selfgenerated revenue to cover its financing costs, operating costs and cost of provisions for losses,
without resort to subsidies.
The MFIs belonging to the two different schools of welfarism and institutionalism cannot be treated
as comparables using FSS and SDI ratio, the OSS ratio is preferred as a more reliable measure for
relative sustainability assessment in this study. FSS and SDI, though a desirable status of
sustainability for MFIs, are often a difficult proposition for welfarist MFIs, who strictly hold on the
spiritual foundation of microfinance.

Challenges Faced by Microfinance Institutions in Attaining Sustainability

MFIs operate in an environment of high information asymmetric credit market risk. Information
asymmetric risk arises in credit-lending transactions, as the lender has less information about the
creditworthiness of the borrower than the borrower himself. Such risks are all the more exacerbated
in microfinance market as the poor borrowers lack credit history. Information asymmetric credit
market risks denotes the ex-ante risk of adverse selection, interim risk of moral hazard and the two ex
post risks of costly audits and enforcement.
MFIs mitigate these information asymmetric credit market risksadverse selection, by affecting
group formation among the poor borrowers with joint liability; moral hazard, by inducing group
members to influence the way other members select their projects; costly monitoring, by helping the
lender avoid external audits; and enforcement problems, by encouraging borrowers to repay their
loans without the lender having to impose sanctionsby its unconventional group-lending models.
But the group-lending model used by MFIs to mitigate these risk results in high intermediation costs
(i.e. operating costs) for the MFIs. The group-lending models entails peculiar costs, such as group

14

formation costs, costs of training the borrowers on the procedures, cost of higher degree of
supervision and higher frequency of instalment payments, all adding to the operating costs of the
MFI. Moreover since the average microfinance loan size is small, the transaction cost on a
percentage basis for such microfinance loan tends to be higher. Thus, the high operating costs
incurred by MFIs are a major challenge at the stake of its sustainability. To cover these high costs by
generating a surplus and remain operationally self-sustainable is a formidable task for MFIs. Though
a difficult task, attaining sustainability is considered to be imperative for an MFI. Notable works that
examined the relevance of the sustainability for MFIs are discussed in next section

15

Relevance of Sustainability for Microfinance Institutions

Sustainability is the means to the goal of outreach to the poor. Only by achieving sustainability will
microfinance programmes gain access to the funding they need over time, to serve the hitherto
unreached poor clients.
Only if an MFI achieves this sustainability, it will have the potential to:
Work towards the objective of poverty alleviation by rendering financial services to the poor
(b) Exist as permanent private financial institutions, which acts as a distributional channel to convert
economic growth to improved well-being among the poor
(c) Deepen a nations financial system, by serving as a financially transparent and regulated
institution.
(a)

According to the neo-liberal and neo-conservative economic agenda, microfinance is a marketoriented solution to poverty alleviation. As per this ideology, microfinance, being a market entity, is
required to eventually wean themselves off from all forms of financial control imposed by the state,
donors or subsidies. Therefore, MFIs are structured to operate as social businesses that are permitted
to charge cost-covering interest rates and earn profits from self-generated revenue, in order to attract
funds for their sustenance. Such profit orientation, sustainability consciousness and competition in
the microfinance industry were encouraged, so as to inculcate the spirit of cost minimization among
the MFIs, leading to the provision of financial services to the poor at a reasonable interest rate.

Balancing the Dual Goals of Microfinance Institutions

Researchers hold disputing views, about the ability of an MFI to pursue the dual goals of
sustainability (financial goal) and outreach to the poor (social goal). The two goals outreach and
financial sustainability of an MFIare complementary to each other. This is so, as the number of
clients increases, the MFI will experience economies of scale. This in turn will result in costefficiency for the MFI, which will help them to attain financial sustainability. On the other hand,
there is inverse relationship between outreach and financial sustainability. The rationale is that
higher outreach for an MFI means more transaction cost in mitigating the information asymmetry
among its clients, making it difficult for it to attain MFI financial sustainability. Trade-offs exists due
to the costly monitoring and control systems required for the highly information asymmetric
borrowers of MFIs, which serve as substitutes for their collaterals.

16

Factors Affecting the Operational Self-Sustainability of Microfinance Institutions

(i) Portfolio Risk Factor

This factor denotes the quality of MFIs loans. Sustainable MFIs maintain the quality of its
loan portfolio by disbursing group loans, with joint liability on all the group members. Peer
pressure and threat of social punishment within the groups effectively replaces the need for
physical collateral and ensures high recovery rates for MFIs. Repayment rate and efficiency
is seen higher under joint-liability contracts as compared to conventional individual-liability
contracts because the former exploits a useful resource that the latter does notthe
information borrowers have about each other in the groups. This reduces the information
asymmetric credit market risks in lending operations. Though this has been the experience in
India, the microfinance crisis in the district of Andhra Pradesh has deteriorated the portfolio
quality of Indian MFIs. Uncontrollable metrics of portfolio quality like portfolio at risk
greater than 30 days and recovery rates were found to be adversely affected due to the crisis.
This has implications for the sustainability of Indian MFIs.

(ii) Capital Structure Factor

This factor denotes the structure of an MFIs capital mix. The impact of capital structure
factors on the OSS of MFIs. The impact of leveraged capital structure on the sustainability of
MFIs and reports a positive relationship between the debt and sustainability. Bogan conforms
the same finding with respect to debt, but reports a negative association between donations
and financial self-sustainability of MFIs. In tune with these findings, this work uses two
proxy variables to capture the effect of capital structure on operational self-sustainability
equity to assets ratio and donation to assets ratio.

(iii)Development Factor
This factor denotes the development orientation of an MFI or depth of an MFIs outreach (i.e.
ability of MFI in reaching out to the very poor clientele). This can be captured by poverty
level and gender of the clients. The assumptions in these studies are that the greater the
number of poor clientele and women clientele served by the MFI, the deeper is the outreach.
These studies perceive average loan size per borrower of the MFI to be a proxy for poverty
level of clientele and regard women clientele to be poorer than men. They also deliberate on
the trend seen among MFIs, to adopt commercialized managerial practices to remain
sustainable, thereby drifting from the mission of serving the poor. This discussion makes it

17

interesting to study the relationship between an MFIs OSS and the mission drift issue faced
by it.

(iv) Growth Factor

This factor denotes the scale of MFIs operations. Scale is vital for an MFI to achieve its
OSS. Economies of scale to directly influence sustainability of MFIs in India. The results of
the studies confirm the positive influence that growth has on sustainability of MFIs. Scale
economies could be reaped by Indian MFIs by pursuing growth. In tune with the observations
of these prior works, this work also hypothesizes a positive relationship between growth and
OSS, using gross loan portfolio as proxy variable for growth.

(v) Institutional Factor

This factor denotes the aspects specific to an MFI, which affects its OSS. MFIs which are
regulated in nature to be well governed compared to their unregulated counterparts and to
have higher level of sustainability in India. Age as a variable sharing a direct relationship
with sustainability. Apart from age, the location of MFI, credit delivery model used by MFI
and savings facilities provided by MFIs to have an influence on an MFIs sustainability. This
work incorporates manageable institution-specific variables like location, credit delivery
model used by MFI, savings facilities provided by MFIs and regulatory status of MFIs to the
regression model. MFIs which use the home-grown Self-Help Group (SHG) model and
Bangladeshi Grameen model are differentiated using dummy coding. Age, an uncontrollable
institutional variable, is also tested in order to study its impact on OSS. Governance of MFIs
is not captured as a separate variable, as there is no data available on this aspect for all the
sample MFIs. Though it can be expected to be partially captured by regulatory status of the
MFI it is not a proxy capable of capturing the nuances of MFI governance. Other
uncontrollable factors pertaining to the macroeconomic conditions of an MFI are not tested in
this work, as the intention is to arrive at a set of factors that influences an MFIs OSS, which
are manageable by the MFI, if not wholly but at least partially.
Qualitative Phase
The method of semi-structured interviews is used in the qualitative phase of the study. The method
of interview is chosen as it will enable the participants to freely express their views and discuss the
strategies used for managing the OSS of their MFIs. An overview of the qualitative interview phase
is presented in this section by discussing the different steps involved in the interview protocol

18

Formulating the Interview Guide

An interview guide is formulated in this project. The guide comprises of questions pertaining to the
five significant factors identified in the quantitative phase of the study. The broad areas of interest in
the interview guide are as follows:
To understand whether the MFI managers confirm the relationships with respect to the significant
factors affecting and discriminating the OSS status of Indian MFIs
(b) To understand how the MFIs manage the factors affecting and discriminating its OSS status
(a)

Conducting the Interviews

Before the conduct of the interview, in order to comply with the confidentiality norms of the MFIs, it
was agreed that the identity of the MFIs would not be disclosed in any published documents using
the data collected from the MFIs. Therefore, the interviewed MFIs are proxied namesA, B, C and
D. Telephonic interviews were conducted with MFI managers. It roughly took 34 h for an
interview. Data collected by these interactions was recorded.

MFI
A
B
C
D

Factor
Portfolio risk Growth
factor
factor
*
*
*
*
*
*
*
*

Development factor Institutional factor Cost-efficiency

factor
*
*
*
*
*
*
*
*
*
*

Preliminary Exploration of Data

Preliminary data exploration was done by reading through the transcripts associated with each of the
four interviews. Transcripts were then summarized by noting down the key points and narratives
made by the MFI managers with respect to each of the five factors addressed by the twelve
questions.

Data Analysis and Documentation of Strategies

Each of the key points discussed by the manager was initially identified as the first-order themes,
which represented diverse means for managing a factor. These first-order themes were then further
clustered and labelled as second-order themes. Second-order themes captured the aspects discussed
in the first-order theme in a more abridged form. Together, the first- and second-order themes
associated with a code, denote the strategies used by different MFIs to manage a factor. Thus, the
strategies used by each of the four MFIs to manage the five factors affecting and discriminating their
MFIs OSS status were documented for the reference of other MFIs operating in Indian microfinance

19

industry. Along with the strategies, the MFI managers also discussed some of the policy changes
they considered relevant for facilitating the management of the factors. The schematic overview of
the thematic coding process undertaken for documenting the strategies and policy suggestions, with
respect to each of the five factors.
Lo
g
Op
er
ati 0.00
ng
Co
st -0.50
to
Gr
os -1.00
s
Lo
an -1.50
Po
rtf
oli -2.00
o

1.80 2.00 2.20 2.40 2.60 2.80 3.00 3.20

Ra
tio

Lo
g

2.00

Op
er
ati 1.50
ng
Co
st 1.00
Pe
r
Bo 0.50
rro
we
r

0.00

1.80 2.00 2.20 2.40 2.60 2.80 3.00 3.20

20

Triangulation Using Quantitative Data

To ensure the validity of the strategies and policy suggestions, a triangulation process was
undertaken.. Thus, an iterative process of cycling among observed results of the interview
data of the qualitative phase was done to refine the findings, relate them to existing
microfinance literature and clarify the contributions of the work.

21

Relationship Shared by the Five Factors with Operational Self-Sustainability of Microfinance

Institutions
All the MFI managers confirmed the relationships associated with four factors as risk,
growth, development and cost factor. The MFIs which used the SHG credit delivery model
agreed their model to be costlier than Grameen model. But they did not confirm the negative
relationship shared by SHG model and OSS ratio. According to them the higher group
formation costs on SHG model can be overcome by using specific deliverance mechanisms.

Portfolio Risk Factor

All MFI managers mapped the negative association between portfolio riskiness and OSS of
MFIs by mapping an underlying positive association between an MFIs portfolio risk greater
than 30 days ratio and loan loss provision expenses

Growth Factor
Two of the MFI managers interviewed, mapped the positive association between growth and
OSS of MFIs to the enhanced operating income arising on account of growth. The other two
managers attributed it to cost reduction and scale economies arising on account of an
enlarged portfolio size. Thus, the qualitative phase proves that growth enhances sustainability
of Indian MFIs mainly due to the enhanced revenue associated with it.

Development Factor
All the MFI managers mapped the negative association between average loan size and OSS
of MFIs to the increased operating costs on large-sized loans. They have experienced the
screening and monitoring costs needed per borrower to be higher, when the loan size
increases. This is so because when the loan size increases, usually the credit officer will have
to do individual loan assessments for the borrower. This makes the operating cost per
borrower to be higher for larger loan sizes.

Institutional Factor
All the four MFIs observed the SHG model to have a higher operating cost per borrower than
Grameen model, because the group formation costs are higher in the former model. The

22

group formation costs and time associated with each of the credit delivery model is depicted
below

Institutional factor Group

Time for
(credit
deliveryformation cost group
MFI model)
(in INR)
formation
A
B
C
D

SHG model
SHG model
Grameen model
Grameen model

7,000
2,500
300
200

6 months
2 months
35 days
14 days

But as discussed in the confirmatory stage, the MFIs using SHG model had a rationale for
using this model and they observed that the higher group formation costs can be overcome by
using a specific deliverance mechanism. Details on this are presented while discussing the
managing strategies associated with this factor. In this section, the explanation for negative
relationship between usage of SHG credit delivery model and OSS of MFIs is focused on.

Cost-Efficiency Factor
Mapping the Discriminatory Relationship Shared by Operating Cost Per Borrower to
Operational Self-Sustainability Status. All the four MFI managers observe operating costs to
be the highest cost component of an MFI, with the power to discriminate the MFIs
sustainability status. Managers observe operating cost to account for nearly 2/3 of the total
cost of an MFI. This highest cost component, being the denominator of the OSS ratio,
distinguishes the sustainability status of the MFIs.

23

Management of the Five Factors

Portfolio Risk Factor: Strategies and Policy Suggestions

First Order Theme

Second Order Theme

Surrogate assessment
& design of customercentric products

Training Credit
Officers

Equip poor to indulge

in income generating
activities

Providing Capacity
Building Services

Mitigate risk on
account of
uncontrollable factors

Providing Insurance
Coverage

Portfolio at Risk > 30

days ratio & Write-Off
Ratio < 10 per cent

Tracking Portfolio
Indicators

Talk to Defaulter,
Enforce Joint Liability,
Write-Off

Following Up
Defaulting Loans

Take action against

Coercive Recovery
Practices

Deductive Code

Managing
Portfolio Risk
Factor

Appoint
Ombudsman

The MFI managers observed prevention of portfolio risk to be critical for ensuring loan
recovery performance. This is so, because once the loans become delinquent, MFIs, which
operate on uncollateralized lending models, will have less control over its recovery.
Nevertheless, they also discussed about risk detective and corrective strategies. The managers
also made suggestions to regulator for facilitating the management of this factor. Based on
these observations, the discussions on risk factor are categorized as (I) Preventive Strategies,
(II) Detective and Corrective Strategies and (III) Suggestion to Regulator.

24

Preventive Strategies
(i)

Training Credit Officers: The MFI manager who advocates this practice explained the
importance of adopting risk-preventive strategies that emphasize on training of MFI
credit officers. According to him training credit officers to do surrogate assessment
of clients creditworthiness is essential as it can facilitate in the design of customercentric products. In his view a product is called customer-centric if it matches with
the clients financial needs and repayment capacity. Provision of such customer
centric products which are in tune with the clients cash flow patterns is a means to
prevent default on loans.

(ii) Providing

Capacity Building to Clients: Two of the MFI managers interviewed

claimed that they could reduce the vulnerability to default, by providing capacity
building services to clients. Business development services, social welfare services
and financial literacy services were the capacity building services provided by these
MFIs.
(a) Business Development Services: Services that can help the poor to improve their
business performance, e.g. training in business skills for entrepreneurs
(b) Social Welfare Services: Non-financial services that can improve the quality of
life of the clients, e.g. health and hygiene camps and educational services
(c) Financial Literacy Services: Services that can educate the poor about personal
financial management, which in turn can help them to be a better customer of the
MFI.
(iii) Providing Insurance Coverage to Clients: One of the MFI managers observed that
defaults arising on account of uncontrollable and unexpected factors like death,
health issues, accidents and crop failure can be reduced by providing insurance
coverage to the clients.

Detective and Corrective Strategies

Tracking Key Indicators of Portfolio Risk: According to the manager, constant and
simultaneous monitoring of two risk indicators is crucial for an MFIportfolio at
risk greater than 30 days and write-off ratio. These two indicators need concurrent
monitoring, because an MFIs impressive portfolio at risk greater than 30 days ratio
should not be due to a high write-offs associated with its loans.
(v) Following-Up Defaulting Loans and Taking Corrective Action: When a weekly
payment is missed, the credit officer must follow-up this client immediately. The
officer must inquire the reason for non-payment and discuss with the defaulter the
possibility for repayment and the consequences of delinquency. As delinquency will
prevent further loan disbursements to the group, the client must be asked to make
good the default. If the client still does not arrange for making the payment, then the
joint-liability principle should be enforced on the group members.
(vi)
Appointment of Ombudsman to Handle Client Complaints:
Since overbearing and coercive collection practices at the credit officer-client
(iv)

25

interface have alleged concerns about client protection in Indian microfinance

industry, one of the managers suggested that RBI should set up a well-functioning
client complaint redressal mechanism to address this issue.

Growth Factor: Strategies and Policy Suggestions

MFI managers observed that frantic growth strategies, without considering its impact on the
cost and risk of MFIs, would not contribute to the sustenance of the MFI in the long run.
First Order Theme

Second Order Theme

Cost involved in expansion to

new areas supported by
capital: Horizontal Growth

Deciding Growth
Strategy

Market Penetration in
existing markets: increase
credit officer productivity,
standardized products

Achieving Vertical
Growth

Replication of Successful
Branch Staff Training,
Customized Products &
Monitoring Growth

Achieving Horizontal
Growth

Role of Credit Officer

Productivity in balancing
growth and risk

Balancing Growth
with Portfolio Risk

Prevent adverse effect of

growth: Multiple Borrowing

Formation of Credit
Information Bureau

Deductive Code

Managing
Growth
Factor

One of the managers explained how his MFI plans for growth, by choosing its growth
strategy(vertical and horizontal growth strategies) in relation to the capital base available
to support the costs involved in growth. Based on the observations, the discussion on growth
factor is categorized as follows: (I) Growth-Enhancing Strategies, (II) Growth-Balancing
Strategies and (III) Suggestion to Regulator.

26

Growth-Enhancing Strategies
Understanding the Costs Involved in Expansion and Deciding the Growth Strategy:
The estimates of costs involved in setting up of new branches, new product
development and hiring and training of new staff were assessed. Similarly, the cost
of installation of the infrastructure needed to support and monitor growth was
assessed. The capital base available to support this additional cost was then
ascertained. The MFI delayed their expansion plans, until the managers were
confident that there was a large capital base to support the increased costs.
(ii) Achieving Vertical Growth through Market Penetration in Existing Markets: Based
on the assessment of the client needs through market research, the MFI has been
providing standardized loan products which cater to the needs of the vast majority of
clients in that demography. Though such standardized product delivery was the usual
practice, variations in the basic products in accordance with customer requirements
was also done as and when required. But according to the MFI manager, the
emphasis on standardization has helped them to enhance the credit officer
productivity of their MFIs.
(iii)Achieving Horizontal Growth through Replication of Successful Branch: The
manager observes that while expanding operations in new markets, the existing MFI
staff should train the newly hired staff for a brief interval, until they are comfortable
to handle the new branch operations independently. Under the guidance of existing
staff, they should be trained to design customized products for the new market. The
cost and risks associated with the new operations needs to be monitored and the
managers advocate the use of a Management Information System (MIS) to serve this
purpose.
Growth-Balancing Strategies
(i)

(iv)

Balancing Growth with Portfolio RiskUnderstanding the Role of Credit

Officer Productivity: When the credit officers increase their caseload of borrowers,
the quality of credit assessment and relationship building with clients can suffer. So
an MFI aiming to achieve growth by enhancing credit officer productivity must be
wary of this downside risk.
Suggestion to Regulator
(v)

Formation of a Credit Information Bureau: One of the MFI managers

observes overleveraging of clients to be an adverse effect of MFIs growth strategies.

But MFIs have little control over this problem as clients seldom reveal their correct
leverage information and there is no credit history available to verify what they
report. MFIs usually become aware of the overleveraging problem only when the
client faces defaults and become trapped in multiple borrowings.

27

Development Factor: Strategies and Policy Suggestions

First Order Theme

Small loan size does not

fulfill clients growing
needs as they graduate

Creates tendency to borrow

from moneylenders &
other MFIs

Second Order Theme

Deductive Code

Small Loan Size Alone

Does Not Result in
Development

Small Loan Size Results

in Multiple Borrowing

Provide loans in a manner

that suits clients
repayment capacity and
financial needs

Progressive Increase in
Loan Size Results in
True Development

Design flexible loan

products matching clients
financial needs

Removal of Cap on
Average Loan Size

Managing
Development
Factor

All the managers interviewed negated the theoretical belief that development for the poor can
be attained by providing small average loan size per borrower. They observe that when loan
size is limited to small amounts, the financial needs of clients would remain partially
unfulfilled, making them resort to multiple borrowings from informal sources.

(i) Small Loan Size Alone Does Not Result in True Development: Majority of the poor
clients financial needs during the initial loan cycles is small. But gradually their
needs increase. When we asked why the poor could not resort to formal financial
institutions like banks for large-sized loans, the MFI managers said that non-price
barriers like elaborate documentation and income assessments make them reluctant to
do so. The manager cites the low share of MFIs in this research and states that, if
MFIs could meet the larger financial needs of the poor, it would not lose its clients to
other informal players like money lenders.

28

(ii) Small Loan Size Induces Tendency for Multiple Borrowing Among Clients: The poor
resort to multiple borrowing to meet their unfulfilled financial needs. Multiple
borrowing from different financial intermediaries who do not understand the cash
flow pattern of the clients would result in over indebtedness making the clients unable
to repay their loans. This problem of multiple borrowing is alleged to have caused
client suicides, leading to a microfinance crisis in India.
Recommended Strategy
(iii) Progressively Increase Average Loan Size Based on Clients Needs: As the MFI
managers were of the opinion that small loan size need not necessarily connote true
development for the poor, they progressively increased the loan size based on the
client needs.
Suggestion to Regulator
(iv) Remove Cap on Average Loan Size: Currently, RBI imposes the following caps on
MFI loans:
(a)

Maximum loan size of INR 35,000 (first cycle) and INR 50,000 (subsequent
cycles)

Maximum borrower total indebtedness of INR 50,000

According to the MFIs only a flexible loan size that matches the repayment capacity
(b)

and financial needs of the clients will result in true development, not mere provision
of small-sized loans.

29

Institutional Factor: Strategies and Policy Suggestions

First Order Theme

Grameen Model has lower

Group Formation Cost &
Time Compared to SHG
model

SHG model spends more

time for group formation
and nurturing of clients

Second Order Theme

Deductive Code

Grameen more
cost effective
than SHG

SHG model suitable

when clients
need empowerment and
not just credit

SHG group formation cost

reduced by outsourcing
group formation task

Managing
Institutional
Factor

NGO-MFI
Partnerships

In the case of the institutional factor (credit delivery model), the MFI managers agreed that
cost-wise Grameen model is more economical than SHG model, as the group formation cost
is lower for the former. Though there was a consensus on this, two MFI managers, who used
SHG credit delivery model, were of the opinion that this cost disadvantage could be
minimized by adoption of partnership models.

Recommended Strategies
(i)

Low-Cost Grameen Model for Sustainability Enhancement: The MFI managers who
were interviewed observed that the operating cost on Grameen model is lesser when
compared to the SHG model. This is so because they have experienced the group
formation cost and time to be lesser for the former model.

(ii)

Self-Help Group Model Recommended when Empowerment of Clients Are Needed:

Though the MFI managers who use SHG model agree their model to have more
operating cost, they rate and recommend their model to be more appropriate for dealing
with clients for whom credit is not the only missing link to development.

(iii)

Use of Non-Governmental Organization-Microfinance Institution Partnership Model

to Reduce Cost of Self-Help Group Formation: The MFI managers, who use the SHG
model, observed that it is possible to reduce the higher group formation costs of SHGs
by entering into NGO-MFI partnerships. The MFI partners with NGOs and outsources
the group formation and nurturing activities to NGOs at a nominal cost.

30

Thus having discussed the different strategies and policy suggestions for managing credit
delivery model, the institutional factor, the next section focuses on how the efficient and
sustainable

MFIs

were

managing

the

cost-efficiency

factor.

Co
MFI mm to
3
Pay issioNG
s

NGO: Forms
SHG & Links with

Os

MFI

2 . Links SHGs

1 . Forms &
Nurtures

to MFIs

SHGs

4 . Disburse Loans to SHG

MFI

5 . Makes Repayments to MFI

SHG

Cost-Efficiency Factor: Strategies and Policy Suggestions

Though operating cost per borrower was the variable used in quantitative phase of the study,
during the interviews, the managers were asked to discuss the strategies used for managing
both operating costs and financing costs.
Based on the interactions with the MFI managers, the discussions on cost efficiency factor
are categorized as (I) Strategies for Reducing Operating Costs, (II) Strategies for Reducing
Financing Costs and (III) Suggestion to Regulator.

31

First Order Theme

Second Order Theme

Means for reducing

group formation cost

NGO-MFI
Partnerships

Recruit local staff who

share clients household
economics

Monitor loan portfolio,

maintain data integrity,
transparency and coordinate

Deductive Code

Increase Credit
Officer
Productivity

Use of IT-enabled
Management
Information System

Maintain over-night cash

at the minimum

Managing
Operating
Costs

Cash Flow
Management

Strategies for Reducing Operating Costs

(i)

Non-Governmental Organization-Microfinance Institution Partnership for Reducing

Group Formation Cost: The strategy of outsourcing group formation and nurturing
tasks to NGOs for a nominal commission was cited by one of the MFI managers as a
means to reduce their operating costs.

Increasing Productivity of Credit Officers: All the four MFIs interviewed state that by
increasing the productivity of credit officers in credit delivery process, cost reduction
can be achieved.
(iii)Usage of Information Technology (IT)-Enabled Management Information System
(MIS): All the four MFIs use back-end MIS at their branches, which are updated by
the on-field information captured by credit officers usage of point of sale (POS)
technology. This according to them augments the MFIs operational efficiency.
Personal digital assistants (PDAs) are used by credit officers to record the on-field
transactions. After every transaction, a printed receipt is issued to the customer.
Thereafter, the data pertaining to the transactions are transferred by the credit officer
into the MIS, by connecting the PDA to the computers located at the branch.

(ii)

(iv) Cash

Flow Management: To attain operational efficiency, cash management

techniques are used by MFIs. Managing the treasury in such a manner that cash

32

never remains idle is a technique used for effective utilization of cash flows.

Strategies for Reducing Financing

Costs
First Order Theme

Injection of Large
Amount of Capital at
Lower Costand Fast
Recovery of Loans
Cost efficient MFIs can
negotiate with investors
and donors to obtain low
cost funds
Efficient MFIs rewarded
by permitting below
base rate financial rates

Second Order Theme

Deductive Code

Securitization of
loans

Lower operational
cost resulting in
lower financing
costs

Reward Cost
Efficiency

Managing
Financing
Costs

Deposit a source of
Relax Deposit
finance if rating norms
on deposits are
Norms
relaxation
In the case of financing costs, MFI managers observe that it is almost uncontrollable as
cost of funds always averages around 1213 % for majority of MFIs in the industry. It is
the rate at which MFIs source funds from banks. Nevertheless, the following strategies
are used by the interviewed MFIs to reduce their cost of funds:

33

(v) Securitization: Reserve Bank of India permits only NBFC MFIs to use the
securitization refinance option. One of the NBFC MFIs uses this route to reduce their
cost of finance.

Reducing Operating Cost to Reduce Cost of Financing: By being cost-efficient in

its operations, MFI can negotiate with financial institutions and donors to get funds
at lower rate. MFI which has low cost of operations and which charges low interest
rates, it can attract considerable amount of low cost of funds. Its cost of funds
average can be reducded to 6%, when the normal cost of funds for the industry will
amount to 1213 %.

34

Limitations of the Qualitative Phase

This phase experiences the inherent limitations of interview method. The findings of this
phase are dependent on the skill of the interviewer in eliciting explanation from the MFI
managers and also on the level of participation and expertise of the interviewee.
(ii) The strategies discussed by the MFI managers, though based on managerial experience,
will have some element of subjectivity in it. Considering this aspect, earnest efforts were
put in to triangulate and validate the strategies using available quantitative figures. But
unavailability of perfect surrogates for validation was a limitation in this process.
(iii) The issues on microfinance crisis and mismanagement of sustenance factors could have
been backed with interviews but was limited to a literate-based discussion; as after the
out-break of the crisis, players were busy contemplating on the pros and cons of the
forthcoming regulatory changes, making respondent availability a constraint.
(i)

35

Conclusion
The strategies used by the MFIs to manage these five factors affecting and discriminating
their OSS status were of interest and this was then understood through the interview process.
An elaborate discussion on the each of the strategies used for managing the five factors
affecting and discriminating the OSS of MFIs is presented. This section concludes these
strategies and presents it schematically using a fishbone diagram. The diagram portrays
attaining OSS as the effect. Managing the five factors using the above discussed strategies is
depicted as the causes contributing to this effect.

Sustainability is a matter of pertinence for all MFIs to ensure perpetuity of its operations.
Sustainability therefore deserves managerial attention as it is not something to be left to
serendipity. Conscious efforts from the management side are required to make an MFI trim
down its inefficiencies and make a move towards the path of sustenance. The study shows
efficient and sustainable MFIs in India to have devised specific managerial strategies to
ensure that they turn a surplus out of their socially oriented operations. These strategies are
worth a reference for any other player aiming to trend the path of efficiency and
sustainability. The research investigation undertaken in this book depicts that with proper
strategies in place, efficient MFIs are able to sustain operations, at the capped rates or even
much lower rates, ranging from 13 % to 16 %. But while striving for sustenance, as an
unintended consequence of the best of the intentions, MFIs may experience the tendency to
deviate its focus from the larger picture of client welfare. To portray these possibilities and to

36

pre-empt its further occurrence, a discussion on sustainability mismanagement, with

reference to the crisis that hit Indian microfinance sector, is brought forth in this book. The
discussion depicts that though the enthusiasm for permanence, captured by the pursuit for
sustainability, is commendable, it would lose all its sheen if the priorities are messed up in the
process. Sustainability has significance for an MFI only as a means to the end of achieving its
social goals and not otherwise.

37

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