Risk Management - Microfinance

RISK MANAGEMENT IN SELECT
MICROFINANCE COMPANIES
Abstract
Risk is inherent in any financial activity and in the operations of a financial institution.
Microfinance movement, which started as a philanthropic activity, has gigantically grown into
a huge commercial business opportunity all over the world. This transformation has become a
challenge for the microfinance institutions in balancing their social and commercial missions.
Thus, microfinance is exposed to the risks related to the business environment (such as
competition, interest rate changes, dependence on banks for loans and so on), negative events
on the reputation of the MFIs, the regulations of the country and also the risks inherent in
balancing the interests of the investors and the poor customers. While risks cannot be totally
eliminated, MFIs have to devise ways and means to develop suitable risk management
framework in order to minimize their impact.
This study has analysed the perceptions of the one hundred executives of six select NBFC-
MFIs with regard to the statements pertaining to each of the four risk factors Institutional
risks, Operational risks, Financial management risks and External risks, using five point
Likert scale. Then the statistical technique of Factor analysis is used to group the statements
(falling under each of the risk categories) under a small number of factors and the results were
inferred. In addition, the risk management measures adopted by the six select NBFC-MFIs in
the wake of the Andhra Pradesh Microfinance crisis, 2010 has been presented in detail.
A risk is an exposure to the chance of loss (Craig Churchill and Dan Coster, 2001). Risk is
inherent in any commercial and financial activity. It cannot be eliminated altogether. However,
it can be controlled and minimised. The most common form of risk faced by the MFIs is the
risk inherent in the lending of loans and possible default by the borrowers. This is because the
loans are not backed by standard quality collateral. Moreover, MFIs have to take calculated
risks while increasing the client outreach and for the expansion of their business. There is also
risk involved with regard to screening of clients and checking the credit history of their
household indebtedness. Other forms of general risks faced by the MFIs relate to the fraud
committed by the field staff and risks with regard to the changing laws and regulations related
to the microfinance sector. A MFI has to satisfy both its commercial and social objectives. That
is it has to balance its own sustainability and also expand its outreach to the poor people. This
delicate balancing act exposes it to many kinds of risks.
According to Mike Goldberg and Eric Palladini (2010), there are three categories of risks.
They are: financial, operational, and strategic. The subcategories of financial risks are credit
risk, market risk and liquidity risk. The subcategories of operational risks are transaction risk,
fraud and integrity risk, technological risk, human resources risk, legal and compliance risk,
and environmental risk. The subcategories of strategic risk include performance risk, external
business risk, reputation risk, governance risk and country risk.
Risk management involves two aspects. One is the prevention of the occurrence of the
undesirable events and another is the early detection of actual problems when they occur. Thus,
risk management involves reducing the likelihood of a loss and minimising the scale of loss. It
helps achieve the twin objectives of prevention of potential adverse situations and early
detection of problems to prevent them from spiralling out of control. Churchill and
Frankiewicz (2006) have categorised risks into four primary categories, namely: institutional
risks, operational risks, financial management risks, and external risks. They have also
identified subcategories of risks in each primary category.
1 Institutional Risks
Institutional risks relate to the governance structure, management succession plans and
reputation of the corporate. One of the prominent instances of poor governance is the
lack of transparency in the accounting processes. Bad reputation undermines its efforts
to sell its products/services and its ability to access funds. Hence, reputation is an
intangible asset that needs to be guarded.
The institutional risks can be categorised as follows:
i. Social Mission: The social mission of MFI is the economic welfare of the poor
people by providing them a number of valuable financial services.
ii. Commercial Mission: This is also known as bankruptcy risk wherein a MFI has to
set its interest rates and fees to such a level as to cover its operational costs.
iii. Dependence: This risk determines the extent to which a MFI is dependent on the
financial support provided by the national and international donors.
iv. Strategy: Bad business decisions and ineffective leadership and governance
would cause strategic risks.
v. Reputation: Adverse issues such as charging of high interest rates, forcing the
clients to pay when in distress, using coercive methods of collection of loans etc.,
are the risk factors which would hamper the growth of the MFI.
2. Operational Risks
Operational risk arises because of dysfunctional processes, people and systems. A MFI faces
operational risks in the form of credit risks and risks due to fraud and theft. These risks occur
in its day-to-day activities.
i. Credit: This is the most common risk faced by the MFI wherein there is
a risk of lending money to the clients and not getting it back.
ii. Employee Fraud: The field staff of the MFIs interacts directly with the
clients. In poor economic environments, MFIs are vulnerable to fraud. It
is necessary to issue directions, train the field staff and maintain adequate
controls over them.
iii. Security: Due to large volume of money being handled, it is subjected to
theft. In addition, information systems are also subjected to misuse.
iv. Personnel: The management of human resources is very important in

MFIs. Retaining staff and motivating them is essential in order to
compete with other MFIs.
3. Financial Management Risks
Financial management risks for MFIs arise while balancing their assets and liabilities. This risk
reflects in the form of liquidity risk, interest rate risk and foreign exchange risk.
i. Asset and Liability Management: Different types of risk that are included in this
category are the interest rate risk, liquidity risk and foreign exchange risk. Interest
rate risk arises when there is a mismatch between the interest earned on the assets
and interest that needs to be paid on the liabilities. There should be sufficient
difference between interest earnings and interest payments so as to earn profit.
Liquidity risk arises when the MFI does not have sufficient liquid assets to
convert them into cash and pay off the short-term liabilities even though it may
appear to be profitable. Many MFIs also receive loans denominated in foreign
currency. Foreign exchange rate fluctuations will be a source of risk for MFIs.
Foreign exchange risks arises when a MFI borrows money in foreign currency,
converts it into local currency, lends to the microfinance borrowers and again has
to repay the loan to foreign creditors in foreign currency.
ii. Inefficiency: Financial resources should be managed in cost-effective manner

otherwise, the ultimate cost has to be borne by the poor clients.
iii. System Integrity: Assessing this risk involves checking the quality of information
entering the system, verifying that the system is correctly processing data and
churning out quality information.
4 External Risks
Along with the above mentioned risks, a MFI also faces risk due to changes in the business
environment in which it operates. While the above mentioned risks may be common for MFIs
operating in different countries, they face unique external risks because of the difference in the
local environments in which they operate. These risks are related to competition, legal
compliance and changes in the business environment. A MFI has to deal with regulatory
environment, adverse political influences, global economic changes, and changes in the
physical environment (such as natural disasters).
Objectives of the Study
To anaylse the perceptions of the microfinance executives with regard to each of the
four risk categories.
To analyse the risk management in select microfinance institutions.
Research Methodology
Sample Selection
For the proposed study, the required sample selection is done by selecting MFIs which are
NBFCs and having their headquarters in AP.
CRISIL brought out a report in 2009 titled India Top 50 Microfinance Institutions. In this
report, it listed Indias top 50 leading MFIs based on certain parameters. Out of the top 50
MFIs listed by CRISIL,
23 MFIs are NBFCs

13 MFIs are Societies
06 MFIs are Trusts
04 MFIs are Section 25 Companies
04 MFIs are Cooperative Societies
Out of the 23 MFIs which are NBFCs, 8 of them are having their headquarters in AP.
These are listed in Table 1.1.
Table 1
NBFC-MFIs with Headquarters in Andhra Pradesh
S. Headquarter
Name of MFI Legal Status
No. s
1. SKS Microfinance Ltd. Public Ltd. Company (NBFC) Secunderabad
2. Spandana Sphoorthy Financial Ltd. Public Ltd. Company (NBFC) Hyderabad
3. Share Microfin Ltd. Public Ltd. Company (NBFC) Hyderabad
4. Asmitha Microfin Ltd. Public Ltd. Company (NBFC) Hyderabad
5. Bhartiya Samruddhi Finance Ltd. Public Ltd. Company (NBFC) Hyderabad
6. Future Financial Services Ltd. Public Ltd. Company (NBFC) Chittor
SWAWS Credit Corporation

7. Private Ltd. Company (NBFC) Secunderabad
India Pvt. Ltd.
Annapurna Financial Services

8. Private Ltd. Company (NBFC) Hyderabad
Pvt. Ltd.
Out of the above given 8 MFIs, Future Financial Services Ltd. and Annapurna Financial
Services Pvt. Ltd. started their microfinance operations in the year 2008. Since these are new
MFIS, they have been dropped from the study and the remaining six NBFC-MFIs which have
been in existence from before 2004-05 have been considered for the study.
Data Collection and Analysis
The above mentioned four risk categories viz., Institutional risks, Financial Management risks,
Operational risks and External risks were considered to collect primary data in the form of
opinion or perception of 100 executives of the six select MFIs on the statements related to each
of the four risk categories. The designation of these 100 executives of the six select MFIs is
given in the Table 1.
Table 1
Executives of Select MFIs
S.No Designation of the Executives Number of the Executives

.
1. Assistant Vice-President 6
2. General Manager (Finance) 6
3. Assistant Branch Manager 6
4. Area Manager 6
5. Senior Administrative Manager 6
6. Client Relationship Manager 12
7. Unit Manager 12
8. Client Relationship Officer 20
9. Finance Executive 14
10. Manager (Information Technology) 6
11. Manager (Corporate Communications) 6
Total 100
The degree of opinion or agreement level of the executives was secured for statements grouped
under each of the above-mentioned four risk categories. In order to reflect the opinion of
microfinance executives, the five point Likert scale was used.
Rating Scale: 1 = Strongly Disagree; 2 = Disagree; 3 = Neutral; 4 = Agree; and 5 = Strongly

Agree
Factor analysis was used to group the statements (falling under each of the risk categories)
under a small number of factors. The results of the factor analysis are given under:
7. Institutional Risks Factor Analysis
The statements related to the institutional risk factors are given in Table 2.
Institutional Operational Financial External Risks
Risks Risks Management
Risks
Kaiser-
Meyer-
Olkin
0.560 0.595 0.573 0.623
measure of
sampling
adequacy
Bartlett's
Test of
Sphericity, 275.797 737.180 346.985 331.251
Approx
Chi-Square
Df 28 78 28 36
Significance 0.000 0.000 0.000 0.000
KMO measure is an index which defines the measure of sampling adequacy. Ideally for any
factor analysis, the number of responses should be four to five times the number of variables.
If the KMO index is above 0.5 then the results of Factor Analysis are acceptable.
When the significant value of Bartletts Test of Sphericity is 0.000 which is less than 0.05
(5%), then at 95% confidence level, the null hypothesis is not acceptable while the the alternate
hypothesis that some of the variables are correlated is acceptable.
Institutional Risks - Variables Combined in Factors
Factors Risk Factors / Variables % of variance Cumulative

%
1. Role of External 1. By being a member of MFI

Stakeholders association, helps in reducing
political risks and
interference
4. Microfinance Institutions
need consultancy services to
28.457 28.457
reduce their costs.
7. MFIs major dependence

on banks and financial
institutions for loans is a
hurdle for carrying out
microfinance operations.
2. Strengthening of 2. Inadequate public relations
institutional and communication on part
framework of microfinance institutions
has affected their growth and
reputation in recent times.
5. Good rating from the

rating agencies helps in
securing loans from the 24.341 52.798
banks/financial institutions.
8. The minimum Net Owned

Funds of Rs. 5 crore
(stipulated by RBI for NBFC-
MFIs) paves the entry of only
serious companies in the
microfinance business.
3. Learning lessons 3. Negative reports in the

from the past mass media have hampered
incidents the growth and image of MFI
business.
6. Commercial MFIs failed to 17.117 69.916

build a strategy to prevent
the microfinance crisis of
2010 by not learning a lesson
from the microfinance crisis
of 2006.
Operational Risks -Variables Combined in Factors
Factors Risk Factors/Variables % of Cumulative

variance %
1. Ways to reduce 4. Client counselling sessions 19.178 19.178

default help in the recovery of non-
performing loans.
10. The risk of default is less

when all the members of a
group start a single business,
instead of individuals
starting their own
(independent) businesses.
13. MFIs lack professionally

skilled and trained personnel
to handle their managerial
and other functions.
2. Ways to 1. High attrition among the

increase field staff is the major
microfinance deterrent to the growth and
business expansion of your MFI.
5. Widespread financial
literacy awareness programs
about microfinance by the
government will help
increase the business of your
MFI. 18.924 38.102
6. Lending of loans to women

borrowers is less risky
compared to men borrowers.
11. Providing related services

such as micro-insurance,
remittance services etc.,
hampers the core business of
providing microcredit.
3. Strengthening 2. Incentives to the field staff

the gross loan helps in motivating them to
portfolio. increase the rate of loan
recovery.
3. Internal audit system

significantly reduces the 17.514 55.616
chances of frauds.
12. Repayment of loans is

dependent upon the
occupation or business of the
clients.
4. Group lending 7. Group lending is less risky
dynamics when compared to lending
individual borrowers.
13.829 69.445
9. Group leader plays a vital
role in reducing instances of
default in group lending.
5 8. Training and skill

development for starting
microenterprises should
11.067 80.512
precede lending of
microcredit and other
products to the clients.
Financial Management Risks -Variables combined in Factors
Factors Variables % of Cumulative

variance %
1. Ensuring financial 3. Your MFI should charge

sustainability and self- differential interest rates and
reliance charges (depending upon the
region, clients or occupation) to
increase the volume of business.
4. Lending of loans (at mutually

agreeable rates) among the MFIs to
one another would help in the
growth and expansion of 31.788 31.788
5. Government should allow NBFC-

MFIs to secure deposits from their
clients.
6. Size of the loan granted to the

clients has a significant bearing on
the sustainability of the clients
businesses.
2. Understanding clients 2. You would prefer reducing the
financial requirements processing charges, fees or interest
rates for clients who are loyal (i.e.,
borrow and repay regularly) from a
number of years.
7. Interest rates charged is an 25.373 57.160

important factor in clients decision
to borrow loans from your MFI for
the second time.
8. Loan rescheduling helps in

minimising default.
3. 1. Government should not restrict

the rate of interest charged to the 18.905 76.066
clients.
External Risks Variables Combined in Factors

Factors Variables % of Cumulative
variance %
1. Transition of MFIs and 3. The transition from Not-

Regulation For-Profit to For-Profit
microfinance institutions is
preferable in the Indian
context.
5. There should be an
independent regulatory
authority to approve the
interest rates and financial 26.998 26.998
products for the microfinance
industry.
9. Most of the provisions of the

Microfinance Institutions
Regulation and Development
Bill (2011) favour the growth
and development of the
microfinance sector.
2. Co-existence of MFIs in 1. Laws and regulations

different legal forms presently in force are
conducive for the growth of
2. Government should frame

separate rules and regulations
for For-Profit and Not-for-
Profit MFIs. 22.794 49.791
4. Existence of microfinance
organisations in different
forms (such as societies, not-
for-profit organizations,
NBFCs, NGOs, SHGs etc.)
hampers the growth of
microfinance industry.
3. Minimising legal and 6. Simultaneous borrowing by

political hassles for the the clients from two or more
clients and the MFIs MFIs increases the rate of
default.
7. Arbitration (between MFIs

and clients) through
Ombudsman should be given 19.311 69.103
due recognition to expedite the
process of loan recovery.
8. Political interference is a
significant factor in the conflict
between the clients and the
MFIs.
Strongly Disagre Neutra Agre Strongly
S.No
Risk Factor Disagree e l e Agree
.
(1) (2) (3) (4) (5)
1. By being a member of MFI
association, helps in reducing
political risks and interference.
2. Inadequate public relations and

communication on part of
microfinance institutions has
affected their growth and
reputation in recent times.
3. Negative reports in the mass

media have hampered the growth
and image of MFIs business.
4. Microfinance Institutions need

consultancy services to reduce
their costs.
5. Good rating from the rating

agencies helps in securing loans
from the banks/financial
institutions.
6. Commercial MFIs failed to build

a strategy to prevent microfinance
crisis of 2010 by not learning a
lesson from the microfinance
crisis of 2006.
7. MFIs major dependence on

banks and financial institutions
for loans is a hurdle for carrying
out microfinance operations.
8. The minimum Net Owned Funds

of Rs. 5 crore (stipulated by RBI
for NBFC-MFIs) paves the entry
of only serious companies in the
Table 2
Institutional Risk Factors
The results of the SPSS output of Factor Analysis for Institutional risk factors are shown
below:
The first table of the SPSS output gives the values for Kaiser-Meyer-Olkin (KMO) and
Bartletts Test.
KMO and Bartlett's Test
Kaiser-Meyer-Olkin Measure of Sampling Adequacy. .560

Bartlett's Test of Sphericity Approx. Chi-Square 275.797
df 28
Sig. .000
The first reading of the above given Table is KMO. KMO measure is an index which defines
the measure of sampling adequacy. Ideally for any factor analysis, the number of responses
should be four to five times the number of variables. If the KMO index is above 0.5 then the
results of Factor Analysis are acceptable. Here, the KMO index is 0.560 and hence the results
are acceptable.
The second reading of the above given Table is the Bartletts Test of Sphericity. We find that
the significant value of Bartletts Test of Sphericity is 0.000 which is less than 0.05 (5%).
Hence at 95% confidence level, the null hypothesis is not acceptable while the the alternate
hypothesis that some of the variables are correlated is acceptable. Hence, on both measures of
KMO and Bartletts Test of Sphericity, the results of Factor Analysis are acceptable.
The second Table of the SPSS output gives the total variance explained. We find that the eight
variables have been grouped into three components or factors. An Eigenvalue represents the
amount of variance associated with the factor. According to Kaiser criterion, it is suggested to
retain those factors with eigen values equal to or greater than 1. This is because factors with
Eigenvalue less than 1 are as good as the variables themselves. Therefore, we can neglect the
factors whose initial Eigenvalues are less than 1.
We also find that the cumulative variance is 69.916%. That means that nearly 70% of the
variance in the data is explained by the three factors. If more than 60% of the variance in the
data is explained by the Factor Analysis then we can accept the results of the Factor Analysis.
Total Variance Explained
Extraction Sums of Squared Rotation Sums of Squared

Initial Eigenvalues Loadings Loadings
% of Cumulative % of Cumulative % of Cumulative

Component Total Variance % Total Variance % Total Variance %
1 2.749 34.365 34.365 2.749 34.365 34.365 2.277 28.457 28.457

2 1.759 21.982 56.348 1.759 21.982 56.348 1.947 24.341 52.798
3 1.085 13.568 69.916 1.085 13.568 69.916 1.369 17.117 69.916
4 .967 12.086 82.002
5 .551 6.892 88.894
6 .454 5.671 94.565
7 .276 3.445 98.010
8 .159 1.990 100.000
Extraction Method: Principal Component Analysis.
The third Table of the SPSS output gives the Component Matrix. It shows the correlation of
each of the variable with each of the components or the factors that were extracted. A factor
loading is the correlation between a variable and a factor that has been extracted from the data.
For example variable 1 in the Table given below is highly correlated with Factor 1 and
negligibly correlated with Factor 2 and Factor 3. However, the Component Matrix does not
clearly shows which variable goes into which factor. We therefore have to consider the Rotated
Component Matrix.
Component Matrixa
Component
1 2 3
By being a member of MFI

association, helps in
-.750 .472 -.003
reducing political risks and
interference.
Inadequate public relations
and communication on part
of microfinance institutions
-.200 .903 .085
has affected their growth
and reputation in recent
times.
Negative reports in the mass
media have hampered the
-.366 -.019 .820
growth and image of MFI
business.
need consultancy services to -.686 .307 -.463
reduce their costs.
Good rating from the rating
agencies helps in securing
.550 .639 .028
loans from the
banks/financial institutions.
Commercial MFIs failed to
build a strategy to prevent
microfinance crisis of 2010
.764 .139 -.327
by not learning a lesson from
the microfinance crisis of
2006.
MFIs major dependence on
banks and financial
institutions for loans is a .389 -.077 .108
hurdle for carrying out
The minimum Net Owned
Funds of Rs. 5 crore
(stipulated by RBI for NBFC-
.710 .438 .268
MFIs) paves the entry of
only serious companies in
the microfinance business.
a. 3 components extracted.
The fourth table gives the communalities of each of the variables. It shows how much of the
variance in a given variable is measured or accounted for by the three factors that were
extracted. For example the communality of the first variable is given as:
(-0.750)2 + (0.472)2 + (-0.003)2 = 0.786.
Communalities
Initial Extraction
By being a member of MFI association, helps in

1.000 .786
reducing political risks and interference.
Inadequate public relations and communication
on part of microfinance institutions has affected 1.000 .862
their growth and reputation in recent times.
Negative reports in the mass media have
hampered the growth and image of MFI 1.000 .807
business.
Microfinance Institutions need consultancy
1.000 .779
services to reduce their costs.
Good rating from the rating agencies helps in
securing loans from the banks/financial 1.000 .712
institutions.
Commercial MFIs failed to build a strategy to
prevent microfinance crisis of 2010 by not
1.000 .710
learning a lesson from the microfinance crisis of
2006.
MFIs major dependence on banks and financial
institutions for loans is a hurdle for carrying out 1.000 .169
The minimum Net Owned Funds of Rs. 5 crore
(stipulated by RBI for NBFC-MFIs) paves the
1.000 .767
entry of only serious companies in the

The fifth Table of the SPSS output is the Rotated Component Matrix. Here the Varimax
procedure for rotation is used. This is a orthogonal method of rotation that minimises the
number of variables with high loadins on a factor, thereby enhancing the interpretability of the
factors. Orthogonal rotation results in factors that are uncorrelated. Thus, through Varimax
procedure of rotation we obtain clear information about which variable goes into which factor.
To determine which variable goes into which factor, we consider each variable with highest
correlation value (ignoring the sign) among the factors. Then we assign that variable to that
particular factor. For example, in the first row, the first variable goes to factor 1. In the second
row, the highest value is 0.697 in the 2nd column i.e., the second variable goes to factor 2.
Rotated Component Matrixa
Component
1 2 3
By being a member of MFI association, helps in

.830 .051 .308
reducing political risks and interference.
Inadequate public relations and communication on
part of microfinance institutions has affected their .592 .697 .161
growth and reputation in recent times.
Negative reports in the mass media have hampered
-.014 -.014 .898
the growth and image of MFI business.
Microfinance Institutions need consultancy services
.857 -.159 -.138
to reduce their costs.
Good rating from the rating agencies helps in
-.108 .812 -.201
securing loans from the banks/financial institutions.
Commercial MFIs failed to build a strategy to prevent
microfinance crisis of 2010 by not learning a lesson -.408 .409 -.613
from the microfinance crisis of 2006.
MFIs major dependence on banks and financial
institutions for loans is a hurdle for carrying out -.381 .140 -.062
The minimum Net Owned Funds of Rs. 5 crore
(stipulated by RBI for NBFC-MFIs) paves the entry of -.422 .766 -.049
only serious companies in the microfinance business.

Rotation Method: Varimax with Kaiser Normalization.a
a. Rotation converged in 5 iterations.
Variables Combined in Factors
Based on the Rotated Component Matrix, we obtain the grouping of the variables under each of the
five factors as given below:
% of
Factors Variable Cumulative %
Variance
1 1, 4, 7 28.457 28.457
2 2, 5, 8 24.341 52.798
3 3, 6 17.117 69.916
Factor 1: Membership of MFI association, seeking of consultancy services and dependency on

banks are the variables. Factor 1 can be named as Role of external stakeholders.
Factor 2: Inadequate public relations, role of rating agencies and minimum Net Owned Funds
(NoF) are the variables. Factor 2 is named as Strengthening of institutional framework.
Factor 3: Negative reports in mass media and failure to learn lessons of the past are the
variables. Factor 3 is named as Learning lessons from the past incidents.
Analysis of the factors
Here we shall analyse the importance of each of the above three factors in the risk management
of the MFIs.
Factor 1: The results of this factor suggest that MFIs need to give due consideration to the
external stakeholders such as microfinance associations. Thye also need to seek consultancy
services (when needed) and reduce their dependance on the banks for loans. Thus MFIs have to
give due attention to their relationship with external stakeholders.
Out of the six select MFIs, four of them BSFL, SHARE, SKS and SSFL are the members of
the MFIN which has been recognised as the SRO by the RBI. By being a member of MFIN,
these MFIs can get assistance in the matters related to responsible lending, client protection,
corporate governance issues and compliance with regulatory environment. Hence,
microfinance associations and SROs help in building strong and viable MFIs. By being
member of MFIN, these MFIs have to adhere to the Code of Conduct with regard to the
microfinance business. Hence, they can minimse the impact of institutional risks.
Commercialisation of microfinance business nessiaties the assistance for consultancy services.

Consultancy services will help MFIs cope with adverse situations and risks (such as those
arising from the AP microfinance crisis and the subsequent promulgation of the Microfinance
Ordinance by the GoAP). Also consultancy services will provide strategic direction for the
MFIs with regard to their business development plans and the design of products and services.
It will also help MFIs in anticipating adverse situations that may arise in future and take
precautionary measures.
MFIs are dependent upon banks to a very large extent with 70% of the assets of the MFIs being
funded by outside debt and Net Owned Funds contributing only 22% towards funding of assets
(Sa-Dhan, 2012). Also AP based MFIs have lions share of 74% of the total debt distributed
among the MFIs (Sa-Dhan, 2011). This is a risk factor for the MFIs because as we saw in
chapter 3, the fund flow from the banks reduced considerably due to the microfinance crisis
and the subsequent promulgation of the Microfinance Ordinance by the GoAP. This created a
risk of survival for the MFIs. Hence, to mitigate the risk of high dependance on the banks and
debt capital, MFIs have to increase their equity capital by working towards attracting private
equity investments.
Factor 2: The results of this factor suggest that in order to strengthen their institutional
framework, MFIs have to maintain adequate public relations, get ratings from rating agencies
specialised in the microfinance sector and maintain prescribed NOF prescribed by the RBI in
order to demonstrate their seriousness towards the cause of microfinance.
As we saw in Chapter 3, the RBI Directions with regard minimum Net Owned Funds (NOF)
for NBFCs to start microfinance would weed out non-serious players in the microfinance arena
and promote healthy competition. Otherwise entry of non-serious players might result in the
risk of bad publicity for the entire microfinance sector.
MFIs need to have specialised rating agencies that would rate them in an objective manner.
The rating agencies should understand the unique business model of the NBFC-MFIs. Thus,
rating agencies not specialising in the microfinance sector may create road blocks in the effort
of MFIs in securing funds from financial institutions and private equity investors.
MFIs need to strengthen their communications department so as to clear the apprehensions

with regard to the rate of interest, recovery practices and sanction of loans. Otherwise
miscommunication may turn out to be a risk hampering their business practices. As mentioned
in the Chapter 3, allegations of high-handed approach of the MFIs and the charging of high
interest rates in the mass media led to the GoAP taking harsh measures against the MFIs.
Hence, to manage the risk of negative reports in the mass media, MFIs have to strengthen their
public relations and communication system. They can also counter the allegations by
presenting a unified stand through the microfinance associations.
Factor 3: Negative reports in the mass media and failure to learn strategic lessons are the
variables. Factor 3 is named as Learning lessons from the past incidents. The results of this
factor suggest that MFIs have to give due attention to the incidents which had occurred in the
past and develop suitable strategies. For instance after the first microfinance crisis of 2006,
MFIs should have adopted a balanced approach towards social and commercial aspects of their
business so as to prevent the microfinance crisis from reoccurring the second time in 2010.
MFIs have to keep guard against the negative public perception and negative news
reports, which can have considerable adverse effect on their business prospects. Such
adverse reports in the mass media carry the risk of wiping out the goodwill that
microfinance movement had generated.
They need to maintain good relations with the mass media and frequently communicate
their stand and status with news reporters.
They have to learn lessons from any changes, which occur in their business environment and
have appropriate strategies in place to counter the adverse effects of those changes.
8. Operational Risks Factor Analysis
Table 3 presents the statements related to operational risks.
Table 3
Operational Risk Factors
S. Strongly Disagre Neutra Agre Strongly

No Risk Factor Disagree e l e Agree
. (1) (2) (3) (4) (5)
1. High attrition among the field staff is the
major deterrent to the growth and
expansion of your MFI.
2. Incentives to the field staff helps in
motivating them to increase the rate of
loan recovery.
3. Internal audit system significantly
reduces the chances of frauds.
4. Client counselling sessions help in the
recovery of non-performing loans.
5. Widespread financial literacy awareness
programs about microfinance by the
government will help increase the
business of your MFI.
6. Lending of loans to women borrowers is
less risky compared to men borrowers.
7. Group lending is less risky when
compared to lending individual
borrowers.
8. Training and skill development for
starting microenterprises should precede
lending of microcredit and other
products to the clients.
9. Group leader plays a vital role in
reducing instances of default in group
lending.
10 The risk of default is less when all the
. members of a group start a single
business, instead of individuals starting
their own (independent) businesses.
11 Providing related services such as
. micro-insurance, remittance services
etc., hampers the core business of
12 Repayment of loans is dependent upon
. the occupation or business of the
clients.
13 MFIs lack professionally skilled and
. trained personnel to handle their
managerial and other functions.
Bartletts Test of Sphericity.
KMO and Barletts Test

Df 78
Sig. .000
The first reading of the above given Table is KMO. KMO measure is an index which defines
the measure of sampling adequacy. Ideally for any factor analysis, the number of responses
should be four to five times the number of variables. If the KMO index is above 0.5 then the
results of Factor Analysis are acceptable. Here, the value of KMO index is 0.595 and hence the
results are acceptable.
Hence at 95% confidence level the null hypothesis is not acceptable while the the alternate
The second Table of the SPSS output gives the total variance explained. We find that the
thirteen variables have been grouped into five components or factors. An Eigenvalue represents
the amount of variance associated with the factor. According to Kaiser criterion, it is suggested
to retain those factors with eigen values equal to or greater than 1. This is because factors with
Eigenvalue less than 1 are as good as the variables themselves. Therefore, we can neglect the
factors whose initial Eigenvalues are less than 1. Thus, five factors whose Eigenvalues are
greater than 1 are obtained. It is found that the cumulative variance is 80.51%. That means that
nearly 80% of the variance in the data is explained by these fivee factors. If more than 60% of
the variance in the data is explained by the factor analysis then we can accept the results of the
factor analysis.

1 4.065 31.269 31.269 4.065 31.269 31.269 2.493 19.178 19.178
2 2.338 17.983 49.252 2.338 17.983 49.252 2.460 18.924 38.102
3 1.667 12.825 62.077 1.667 12.825 62.077 2.277 17.514 55.616
4 1.338 10.294 72.371 1.338 10.294 72.371 1.798 13.829 69.445
5 1.058 8.141 80.512 1.058 8.141 80.512 1.439 11.067 80.512
6 .686 5.274 85.786
7 .525 4.040 89.825
8 .462 3.557 93.383
9 .250 1.922 95.305
10 .217 1.669 96.973
11 .184 1.417 98.390
12 .128 .988 99.378
13 .081 .622 100.000
The third Table of the SPSS output gives the Component Matrix. It shows the correlation of
each of the variable with each of the components or the factors that were extracted. A factor
loading is the correlation between a variable and a factor that has been extracted from the data.
For example variable 1 in the Table given below is highly correlated with Factor 1 and
negligibly correlated with other factors. However, the Component Matrix does not clearly
shows which variable goes into which factor. We therefore have to consider the Rotated
Component Matrix.
Component Matrixa
High attrition among the field staff is the

major deterrent to the growth and -.645 .268 .262 .449 .132
Incentives to the field staff helps in
motivating them to increase the rate of .625 .616 .099 .029 .181
loan recovery.
Internal audit system significantly
.170 .815 .130 -.347 -.149
reduces the chances of frauds.
Client counselling sessions help in the
.708 .389 -.259 .327 -.047
recovery of non-performing loans.
Widespread financial literacy awareness
programs about microfinance by the
.702 -.338 -.095 -.265 -.332
government will help increase the
business of your MFI.
Lending of loans to women borrowers is
.647 -.310 .358 .194 -.156
less risky compared to men borrowers.
Group lending is less risky when
compared to lending individual .589 -.280 .266 .055 .562
borrowers.
Training and skill development for
starting microenterprises should precede
.041 -.256 .386 .752 -.247
lending of microcredit and other products
to the clients.
Group leader plays a vital role in
reducing instances of default in group .455 .145 .549 -.074 .344
lending.
The risk of default is less when all the
members of a group start a single
.696 .082 -.446 .154 .340
business, instead of individuals starting
their own (independent) businesses.
Providing related services such as
micro-insurance, remittance services
.552 -.483 .448 -.332 -.197
etc., hampers the core business of
Repayment of loans is dependent upon
.341 .658 .300 .118 -.414
the occupation or business of the clients.
MFIs lack professionally skilled and
trained personnel to handle their -.597 .154 .598 -.280 .168
managerial and other functions.
Extraction Method: Principal Component Analysis
The fourth table gives the communalities of each of the variables. It shows how much of the
variance in a given variable is measured or accounted for by the five factors that were
extracted. For example the communality of the first variable is given as:
(-0.645)2 + (0.268)2 + (-0.262)2 + (-0.449)2 + (-0.132)2 = 0.775.
Communalities
Initial Extraction
High attrition among the field staff is the major deterrent to the growth and
1.000 .775
Incentives to the field staff helps in motivating them to increase the rate of loan
1.000 .812
recovery.
Internal audit system significantly reduces the chances of frauds. 1.000 .852
Client counselling sessions help in the recovery of non-performing loans. 1.000 .829
Widespread financial literacy awareness programs about microfinance by the
1.000 .796
government will help increase the business of your MFI.
Lending of loans to women borrowers is less risky compared to men borrowers. 1.000 .705
Group lending is less risky when compared to lending individual borrowers. 1.000 .816
Training and skill development for starting microenterprises should precede
1.000 .844
lending of microcredit and other products to the clients.
Group leader plays a vital role in reducing instances of default in group lending. 1.000 .653
The risk of default is less when all the members of a group start a single
1.000 .830
business, instead of individuals starting their own (independent) businesses.
Providing related services such as micro-insurance, remittance services etc.,
1.000 .888
hampers the core business of providing microcredit.
Repayment of loans is dependent upon the occupation or business of the clients. 1.000 .824
MFIs lack professionally skilled and trained personnel to handle their managerial
1.000 .844
and other functions.
The fifth Table of the SPSS output is the Rotated Component Matrix. Here, Varimax procedure
for rotation is used. This is a orthogonal method of rotation that minimises the number of
variables with high loadings on a factor, thereby enhancing the interpretability of the factors.
Orthogonal rotation results in factors that are uncorrelated. Thus, through Varimax procedure
of rotation we obtain clear information about which variable goes into which factor.
To determine which variable goes into which factor, each variable with highest correlation
value (ignoring the sign) among the factors is considered. Then that variable to that particular
factor is assigned. For example, in the first row, the first variable goes to factor 2. In the second
row, the highest value is 0.666 in the 3rd column i.e., the second variable goes to factor 3.
Component
1 2 3 4 5
High attrition among the field staff is the major

-.347 -.747 .025 -.060 .304
deterrent to the growth and expansion of your MFI.
Incentives to the field staff helps in motivating them to
.413 -.010 .666 .434 -.100
increase the rate of loan recovery.
Internal audit system significantly reduces the chances
-.054 -.048 .849 .010 -.355
of frauds.
Client counselling sessions help in the recovery of
.765 .077 .455 .120 .129
non-performing loans.
Widespread financial literacy awareness programs
about microfinance by the government will help .305 .837 .037 .027 .005
increase the business of your MFI.
Lending of loans to women borrowers is less risky
.172 .547 .076 .365 .487
compared to men borrowers.
Group lending is less risky when compared to lending
.246 .227 -.182 .815 .073
individual borrowers.
Training and skill development for starting
microenterprises should precede lending of -.005 -.048 -.064 .043 .914
microcredit and other products to the clients.
Group leader plays a vital role in reducing instances of
-.060 .133 .301 .734 .051
default in group lending.
The risk of default is less when all the members of a
group start a single business, instead of individuals .837 .103 .019 .310 -.149
starting their own (independent) businesses.
Providing related services such as micro-insurance,
remittance services etc., hampers the core business of -.174 .842 -.016 .353 .155
Repayment of loans is dependent upon the occupation
.063 .051 .874 -.018 .231
or business of the clients.
MFIs lack professionally skilled and trained personnel
-.833 -.314 .084 .176 -.116
to handle their managerial and other functions.

Based on the Rotated Component Matrix, we obtained the grouping of the variables under each
of the five factors as given below:
Factors Variables % of variance Cumulative %

1 4, 10, 13 19.178 19.178
2 1, 5, 6, 11 18.924 38.102
3 2, 3, 12 17.514 55.616
4 7, 9 13.829 69.445
5 8 11.067 80.512
Factor 1: Client counselling, Reducing default through joint business and Need for
professionally skilled and trained personnel are the variables. Factor 1 is named as: Ways to
reduce default
Factor 2: High attrition, Financial literacy, Lending of loans to women borrowers and
Providing related services are the variables. Factor 2 is named as: Ways to increase
Factor 3: Incentives to field staff, Internal audit system and Repayment of loans are the
variables. Factor 3 is named as: Strengthening the gross loan portfolio.
Factor 4: Group lending and the role of a group leader is the variables. Factor 4 is named as:
Group lending dynamics.
Analysis of the Factors

Factor 1: The results of this factor suggest that by organising client counselling sessions,
giving loans to microenterprises started by a group of people and by appointing professionally
skilled and trained personnel, MFIs can reduce defaults.
MFIs deal more often with poor clients who may not be highly educated. Hence, it is necessary
to conduct client counselling sessions so as to explain them the benefits of repaying the loans.
As mentioned in Chapter 3, during the microfinance crisis, clients stopped repaying when
encouraged by their peers and political activists. In such situations client counselling session
would help in presenting factual information so that the clients are not misguided. Client
counselling sessions would help in the recovery of loans and help MFIs in minimising write-
offs. Another way to reduce default is to fund microenterprises started by a group of borrowers.
In group borrowing due to peer pressure, repayment will be prompt. Moreover, the liability to
repay will be equally divided in when compared to businesses started by individuals where the
liability will be more. Professionally skilled and trained manpower is needed to run the
commercial microfinance organisations so as to ensure the viability and efficiency of the
institutions.
Factor 2: The results of this factor suggest that by controlling attrition of the field staff,
through government sponsored financial literacy programmes, by lending loans to women
borrowers, and by concentrating primarily on providing micro credit, MFIs can improve their
business.
Microfinance business is manpower intensive. Hence, MFIs have to properly train their field
staff who constantly interact with the clients and provide valuable inputs with regard to client
aspirations and perceptions and the nature of products and services needed by them. Hence,
MFIs have to take measures to reduce the risk of attrition among the experienced field staff. In
large number of MFIs, the Human Resource (HR) department has mentioned the attrition
among the field staff is a major challenge and the rate of attrition ranged from 5.7% to 53%
(Access Assist, 2013). SKS microfinance has attrition levels of more than 25% (M.V.S.
Santosh Kumar, 2010).
Since microfinance operations are labour intensive, operational costs are. Hence, if the
government can take measures to increase the financial literacy levels then MFIs can reduce
their overheads and operational costs involved in explaining to the clients about the concept of
microfinance. In this regard, microfinance industry associations can partner with the
government in increasing financial literacy programmes. Many studies have concluded that
lending of loans to women borrowers is less risky when compared to lending to men
borrowers. Most of the select MFIs in the present study lend exclusively to women borrowers.
The microfinance industry has not reached the maturity level in India. Still there is no sector
specific law in the country. As mentioned in Chapter 2, the demand for micro credit is so high
and only a fraction of this demand is satisfied. Hence, MFIs should concentrate on core activity
of providing micro credit. For instance, MFIs can outsource the provision of micro-insurance
services to the insurance companies so as to reduce the operational costs.
Factor 3: The results of this factor suggest that by giving incentives to the field staff (which
acts as a motivating factor), by means of robust internal audit system (to prevent frauds) and by
giving due consideration to the businesses of the clients with regard to loan repayment, MFIs
can strengthen their gross loan portfolio.
It relates to the ways and means of strengthening the gross loan portfolio through prompt
recoveries, robust internal audit system and repayment of loans on the basis of business of the
clients. Field staff plays a prominent role with regard to increasing the microfinance business.
They can develop personal relationship with the clients and encourage them to repay in time.
When clients repay properly, the gross loan portfolio of the MFI is strengthened. Hence, MFIs
have to encourage field staff through incentives. MFIs have to install a robust internal audit
system that will ensure the financial integrity of the institution. For instance, during the
financial year 2013, there were financial frauds to the tune of Rs. 2.1 crore in SKS
microfinance, committed by the employees and this was mentioned in the companys annual
report (Frauds to the, 2013). Frauds are a risk that would have a negative effect on the
microfinance business, thereby weakening the gross loan portfolio. MFIs have to take into
account the businesses of their clients while lending loans. It should consider repayment
patterns, which are dependent on the seasonal business cycles of the concerned
microenterprises. This will help MFIs to make recoveries accordingly and thus strengthen the
gross loan portfolio.
Factor 4: The results of this factor suggest that MFIs should concentrate on group lending and
in the selection of the group leader.
MFIs lend loans to the clients without collateral. Hence, peer pressure plays an important role
in the repayment of loans. There is also a possibility that due to death, accidents or failure of
the microenterprise, an individual borrower may not be able to repay the loans. Hence it is
more risky to lend to individual borrowers. On the other hand, the risk is minimised when
loans are lent to a group with the sharing of liability among the group members. MFIs also
have to choose the group leader after due diligence while lending to a group. This is because an
influential group leader will turn out to be instrumental in the repayment of loans by the group
and thus strengthen the gross loan portfolio. In the six select MFIs considered for the study,
SKS, ASML and SWAWS microfinance institutions exclusively follow the Joint Liability
Group (JLG) lending model. On the other hand, SSFL and SHARE follow both JLG and
individual lending models. BSFL follows the diversified lending model.
9. Financial Management Factor Analysis
Table 4
Financial Management Risk Factors

. (1) (2) (3) (4) (5)
1. Government should not restrict the
rate of interest charged to the
clients.
2. You would prefer reducing the
processing charges, fees or interest
rates for clients who are loyal (i.e.,
borrow and repay regularly) from a
number of years.
3. Your MFI should charge
differential interest rates and
charges (depending upon the
region, clients or occupation) to
increase the volume of business.
4. Lending of loans (at mutually
agreeable rates) among the MFIs
to one another would help in the
growth and expansion of
5. Government should allow NBFC-
MFIs to secure deposits from their
clients.
6. Size of the loan granted to the
clients has a significant bearing on
the sustainability of the clients
businesses.
7. Interest rates charged is an
important factor in clients
decision to borrow loans from
your MFI for the second time.
8. Loan rescheduling helps in
minimising default.
Bartletts Test.

df 28
Sig. .000
The first reading of the above given Table gives the value of KMO index. KMO measure is an
index which defines the measure of sampling adequacy. Ideally for any factor analysis, the
number of responses should be four to five times the number of variables. If the KMO index is
above 0.5 then the results of Factor Analysis are acceptable. Here, the KMO index is 0.573 and
hence the results are acceptable.
The explanation given for the Total Variance Explained, Component Matrix, Communalities
and Rotated Component Matrix are the same as given for the Factor Analysis of institutional
risks and the operational risks. The eight variables have been combined into three factors based
on the Kaiser Criterion. We also find that the cumulative variance is 76.07%. This means that
nearly 76% of the variance in the data is explained by the three factors. If more than 60% of
the variance in the data is explained by the factor analysis then we can accept the results of the
Factor Analysis.


1 2.805 35.065 35.065 2.805 35.065 35.065 2.543 31.788 31.788

2 1.893 23.657 58.723 1.893 23.657 58.723 2.030 25.373 57.160
3 1.387 17.343 76.066 1.387 17.343 76.066 1.512 18.905 76.066
4 .707 8.839 84.905
5 .510 6.375 91.280
6 .359 4.484 95.764
7 .201 2.509 98.273
8 .138 1.727 100.000
Component Matrixa
Component
1 2 3
Government should not restrict the rate of interest charged to the clients. .249 .297 .832
You would prefer reducing the processing charges, fees or interest rates for
.001 .931 -.152
clients who are loyal (i.e., borrow and repay regularly) from a number of years.
Your MFI should charge differential interest rates and charges (depending upon
.732 .109 -.550
the region, clients or occupation) to increase the volume of business.
Lending of loans (at mutually agreeable rates) among the MFIs to one another
.613 .179 -.130
would help in the growth and expansion of microfinance business.
Government should allow NBFC-MFIs to secure deposits from their clients. -.669 -.408 .060
Size of the loan granted to the clients has a significant bearing on the
.786 .228 .274
sustainability of the clients businesses.
Interest rates charged is an important factor in clients decision to borrow loans
.618 -.625 -.280
from your MFI for the second time.
Loan rescheduling helps in minimising default. .619 -.533 .442

Communalities
Initial Extraction
Government should not restrict the rate of interest charged to the clients. 1.000 .843
You would prefer reducing the processing charges, fees or interest rates for
1.000 .889
clients who are loyal (i.e., borrow and repay regularly) from a number of years.
Your MFI should charge differential interest rates and charges (depending upon
1.000 .851
the region, clients or occupation) to increase the volume of business.
Lending of loans (at mutually agreeable rates) among the MFIs to one another
1.000 .425
would help in the growth and expansion of microfinance business.
Government should allow NBFC-MFIs to secure deposits from their clients. 1.000 .618
1.000 .745
Interest rates charged is an important factor in clients decision to borrow loans
1.000 .852
from your MFI for the second time.
Loan rescheduling helps in minimising default. 1.000 .863
The fifth Table of the SPSS output is the Rotated Component Matrix. Here the Varimax
procedure for rotation is used. This is a orthogonal method of rotation that minimises the
number of variables with high loadins on a factor, thereby enhancing the interpretability of the
factors. Orthogonal rotation results in factors that are uncorrelated. Thus, through Varimax
procedure of rotation clear information about which variable goes into which factor is
obtained.

Component
1 2 3
Government should not restrict the rate of interest charged to the
.042 -.051 .916
clients.
You would prefer reducing the processing charges, fees or interest
rates for clients who are loyal (i.e., borrow and repay regularly) from a .366 -.863 .099
number of years.
Your MFI should charge differential interest rates and charges
(depending upon the region, clients or occupation) to increase the .865 .118 -.298
volume of business.
Lending of loans (at mutually agreeable rates) among the MFIs to one
another would help in the growth and expansion of microfinance .643 .066 .080
business.
Government should allow NBFC-MFIs to secure deposits from their
-.747 .109 -.219
clients.
.677 .149 .514
Interest rates charged is an important factor in clients decision to
.425 .775 -.266
borrow loans from your MFI for the second time.
Loan rescheduling helps in minimizing default. .217 .794 .431
Rotation Method: Varimax with Kaiser Normalization.
Variables combined in Factors:

Factors Questions % of variance Cumulative %

1 3, 4, 5, 6 31.788 31.788
2 2, 7, 8 25.373 57.160
3 1 18.905 76.066
We shall consider two factors since they explain nearly 57% of the variance in the data. The
third factor contains only a single variable and hence can be neglected.
Factor 1: Differential rates of interest, Lending of loans amongst the MFIs, Securing deposits
from the clients, size of the loans granted are the variables in this factor. Factor 1 is named as:
Ensuring financial sustainability and self-reliance.
Factor 2: Giving discounts to loyal customers, Influence of interest rates on client decision to
re-borrow and Rescheduling of loans to avoid default are the variables in this factor. Factor 2
is named as: Understanding Clients financial requirements.

Factor 1: The result of this factor suggests that MFIs may have to adopt diffeential interest
rates to the clients, lend and borrow amongst themselves, secure deposits from the clients and
take into account the size of the loans granted to the clients in order to become financially self-
reliant.
RBI has permitted NBFC-MFIs to charge differential rate of interest to its clients such that the
maximum variance in the interest rate does not exceed 4% (Source: RBI). Differential rate of
interest scheme comes under social banking programmes which will help improve the
economic conditions of the people living below the poverty line. MFIs can charge a little
higher interest rates to the clients who are poor and a lower rate of interest to the clinets who
are the poorest of the poor. This will help them in not only increasing their outreach but also
expand their business. Lending of loans amongst MFIs can help reduce their dependance on
the banks and financial institutions. As mentioned in Chapter 3, that during the AP
Microfinance crisis, banks reduced their lending to the MFIs. Moreover, banks may impose
certain conditions while lending loans to the MFIs. In order to mitigate such risks, MFIs can
lend their surplus amount to one another so as to tide over risk of tight financial situation.
Securing deposits from the borrowers helps MFI reduce their dependence on the banks and
financial sources. As mentioned in Chapter 3, the draft Micro Finance Institutions
(Development and Regulation) Bill 2011 and the draft Micro Finance Institutions
(Development and Regulation) Bill, 2012 have recognised collection of thrift (i.e., deposits) as
one of the financial services under microfinance services. If MFIs succeed in collecting
substantial deposits from the clients then they can use those deposits to lend to the clients at a
reduced rate of interest. MFIs have to determine the apporpriate size of the loans granted to the
clients. Sometimes if the loan granted to the client is not adequate, the microenterprise may
become non-functional. Thus, the client would not be able to repay the loans, resulting in the
credit risk for the MFIs. Therefore, MFI may have to consider all these risk factors in order to
ensure financial sustainability.
Factor 2: The results of this factor suggest that MFIs have to forego their benefit or profit by
giving discounts to loyal clients and flexibility to other clients. This will ensure understanding
of the financial requirements of the clients.
As the old and loyal clients of the MFIs intend to expand their businesses, they require more
loans from the MFIs. Hence MFIs should consider giving such clients discounts with regard to
the processing fees, charges and interest rates. It is less risky for the MFIs (in terms of credit
risk) to lend loans to loyal clients than to scout for new clients. Interest rates have a major
influence on the borrowing decision of the poor clients. If a MFI is able to attract clients by
designing appropriate interest rate structure, then the volume of the MFIs business would also
increase. MFIs should also have an appropriate financial policy for the restructuring of the
loans. This is because they deal with clients who do not have regular source of income. MFIs
can reschedule the loans with regard to the loan tenure or the amount of loan instalment.
Rescheduling of loans would be a win-win situation for the clients and the MFIs. During the
AP Microfinance crisis (which occurred in 2010), MFIs could have convinced the GoAP, the
clients and the banks with regard to loan rescheduling. Through loan rescheduling, MFIs can
avoid loan write-off and clients would not become stressed to repay their loans.
10. External Risk Factor Analysis
Table 5
External Risk Factors

. (1) (2) (3) (4) (5)
1. Laws and regulations presently in
force are conducive for the growth
of microfinance business.
2. Government should frame separate
rules and regulations for For-
Profit and Not-for-Profit MFIs.
3. The transition from Not-For-
Profit to For-Profit microfinance
institutions is preferable in the
Indian context.
4. Existence of microfinance
organisations in different forms
(such as societies, not-for-profit
organizations, NBFCs, NGOs,
SHGs etc.) hampers the growth of
microfinance industry.
5. There should be an independent
regulatory authority to approve the
interest rates and financial
products for the microfinance
industry.
6. Simultaneous borrowing by the
clients from two or more MFIs
increases the rate of default.
7. Arbitration (between MFIs and
clients) through Ombudsman
should be given due recognition to
expedite the process of loan
recovery.
8. Political interference is a
significant factor in the conflict
between the clients and the MFIs.
9. Most of the provisions of the
Regulation and Development Bill
(2011) favour the growth and
development of the microfinance
sector.
Results of Factor Analysis
Bartletts Test.

df 36
Sig. .000
The first reading of the above given Table gives the value of KMO index. KMO measure is an
index which defines the measure of sampling adequacy. Ideally for any factor analysis, the
number of responses should be four to five times the number of variables. If the KMO index is
above 0.5 then the results of Factor Analysis are acceptable. Here, the KMO index is 0.623 and
hence the results are acceptable.
The analysis for the Total Variance Explained, Component Matrix, Communalities and Rotated
Component Matrix are the same as given for the factor analysis related to the institutional risk
factors, operational risk factors and the financial risk factors. The nine variables have been
combined into three factors. We also find that the cumulative variance is 69.103%. That means
that nearly 69% of the variance in the data is explained by the three factors. If more than 60%
of the variance in the data is explained by the factor analysis then we can accept the results of
the factor analysis.

Cumul
% of Cumulative ative % of Cumulat
Component Total Variance % Total % of Variance % Total Variance ive %
1 2.972 33.020 33.020 2.972 33.020 33.020 2.430 26.998 26.998

2 1.817 20.190 53.210 1.817 20.190 53.210 2.051 22.794 49.791
3 1.430 15.893 69.103 1.430 15.893 69.103 1.738 19.311 69.103
4 .893 9.920 79.023
5 .579 6.428 85.451
6 .544 6.043 91.494
7 .370 4.107 95.602
8 .226 2.513 98.115
9 .170 1.885 100.000
Component Matrixa
Component
1 2 3
Laws and regulations presently in force are conducive for the growth of microfinance
-.452 -.498 .403
business.
Government should frame separate rules and regulations for For-Profit and Not-for-
.653 .242 -.433
Profit MFIs.
The transition from Not-For-Profit to For-Profit microfinance institutions is preferable
.681 -.571 .239
in the Indian context.
Existence of microfinance organisations in different forms (such as societies, not-for-
profit organizations, NBFCs, NGOs, SHGs etc.) hampers the growth of microfinance .818 .039 -.362
industry.
There should be an independent regulatory authority to approve the interest rates and
-.720 .429 -.063
financial products for the microfinance industry.
Simultaneous borrowing by the clients from two or more MFIs increases the rate of
.174 .717 .401
default.
Arbitration (between MFIs and clients) through Ombudsman should be given due
.462 .655 .366
recognition to expedite the process of loan recovery.
Political interference is a significant factor in the conflict between the clients and the
.250 .006 .742
MFIs.
Most of the provisions of the Microfinance Institutions Regulation and Development
.620 -.237 .206
Bill (2011) favour the growth and development of the microfinance sector.

Communalities
Initial Extraction
Laws and regulations presently in force are conducive for the growth of microfinance
1.000 .614
business.
Government should frame separate rules and regulations for For-Profit and Not-for-Profit
1.000 .672
MFIs.
The transition from Not-For-Profit to For-Profit microfinance institutions is preferable in the
1.000 .846
Indian context.
Existence of microfinance organisations in different forms (such as societies, not-for-profit
1.000 .801
organizations, NBFCs, NGOs, SHGs etc.) hampers the growth of microfinance industry.
There should be an independent regulatory authority to approve the interest rates and
1.000 .707
financial products for the microfinance industry.
Simultaneous borrowing by the clients from two or more MFIs increases the rate of default. 1.000 .705
Arbitration (between MFIs and clients) through Ombudsman should be given due
1.000 .777
recognition to expedite the process of loan recovery.
Political interference is a significant factor in the conflict between the clients and the MFIs. 1.000 .613
Most of the provisions of the Microfinance Institutions Regulation and Development Bill
1.000 .483
(2011) favour the growth and development of the microfinance sector.

Component
1 2 3
Laws and regulations presently in force are conducive for the growth of
.077 -.751 -.212
Government should frame separate rules and regulations for For-Profit
.213 .789 .066
and Not-for-Profit MFIs.
The transition from Not-For-Profit to For-Profit microfinance institutions
.918 .014 -.063
is preferable in the Indian context.
Existence of microfinance organisations in different forms (such as
societies, not-for-profit organizations, NBFCs, NGOs, SHGs etc.) .477 .757 .015
hampers the growth of microfinance industry.
There should be an independent regulatory authority to approve the
-.810 -.216 .066
interest rates and financial products for the microfinance industry.
Simultaneous borrowing by the clients from two or more MFIs increases
-.158 .118 .816
the rate of default.
Arbitration (between MFIs and clients) through Ombudsman should be
.083 .290 .828
given due recognition to expedite the process of loan recovery.
Political interference is a significant factor in the conflict between the
.418 -.359 .556
clients and the MFIs.
Most of the provisions of the Microfinance Institutions Regulation and
Development Bill (2011) favour the growth and development of the .668 .135 .135
microfinance sector.


Factor % of Cumulative
Questions
s variance %
1 3, 5,9 26.998 26.998
2 1, 2, 4 22.794 49.791
3 6, 7, 8 19.311 69.103
We shall consider all the three factors since they explain nearly 69.103% of the variance in the
data.
Factor 1: Transition of MFIs from Not-for-Profit to For-Profit institutions, Regulatory

authority for interest rate approvals and products and Microfinance Bill are included in this
factor. Factor 1 is named as: Transition of MFIs and Regulation.
Factor 2: Laws and Regulations for MFIs in force, Separate rules for For-Profit and Not-
For-Profit MFIs and Existence of MFIs in different legal forms are the variables included in
this factor. Factor 2 is named as: Co-existence of MFIs in different legal forms
Factor 3: Simultaneous borrowings by the clients from two or more MFIs, Arbitration through
Ombudsman, and Political interference in the loan recovery process are the variables included
in this factor. Factor 3 is named as: Minimising legal and political hassles for the clients and
the MFIs.

Factor 1: The results of this factor suggest that it is beneficial for the MFIs by transforming
into For-profit from Not-for-profit entities; through the appointment of a regulatory
authority for approving interest rates and products; and by the passage of a uniform law for the
entire microfinance industry in the country.
The select MFIs in the present study started as Not-for-Profit MFIs and then transformed into
For-Profit NBFC-MFIs. By this transition to For-Profit institutions, MFIs became regulated
institutions. They can increase their scale and scope of their operations and also tap
commercial sources for funds. In this way they can increase their credibility in the eyes of the
investors and reduce the risk of not getting enough funds for their expansion. A regulatory
authority for deciding the interest rates and financial products for the microfinance sector
would standardise and legitimise the products and services offered by the MFIs. The
enactment of the microfinance Bill in the Parliament would help in implementing a uniform
law for this sector throughout the country. This will help MFIs in mitigating the risk of having
to comply with a number of laws of different states in different geographies of the country.
Factor 2: The results of this factor suggest that might be a risk for the microfinance industry
due to the existence of MFIs in different legal forms and this risk can be mitigated through
separate laws for For-profit and Not-for-profit entities.
Even in the absence of uniform law for the microfinance sector, the Directions of the RBI with
regard to the NBFC-MFIs have reduced legal ambiguity. The business mission, purpose and
the governance aspects of For-Profit and Not-for-Profit MFIs is different. While NBFC-
MFIs are governed by the prudential norms of the RBI, there are no such norms for the Not-
for-Profit MFIs. Hence, it is necessary to have separate legal framework for the Not-for-
Profit and For-Profit MFIs for their coexistence. MFIs in India exist in different legal forms.
For instance, NBFC-MFIs who are members of the MFIN follow a code of conduct and have
to charge a uniform rate of interest on the loans given to the clients. There is no association or
code of conduct for the MFIs existing in other legal forms such as societies, Trusts and so on.
Therefore, microfinance clients will not get same level of service and products from MFIs
existing in different legal forms. Moreover, there will be unfair competition between MFIs
existing in different legal form. These factors pose a risk of survival to the entire microfinance
industry.
Factor 3: The results of this factor suggest that the problems faced by the clients due to
indebtedness and the problems faced by the MFIs due to political interference can be solved
through the appointment of an Ombudsman for the microfinance sector.
The clients of microfinance are poor with no regular source of income. In addition to loans for
business needs, they also need loans to satisfy their personal requirements. Hence, they may
borrow from two or more MFIs and become indebted. As mentioned in Chapter 3, there were
allegations of MFIs using harsh measures of recovering loans from the indebted clients.
Moreover, political activist encouraged microfinance clients not to repay their instalments.
When the clients failed to repay their instalments, MFIs stopped giving fresh loans. Thus, the
clients had to resort to borrowings from the money lenders at exorbitant interest rates. An
Ombudsman for the microfinance sector will help in solving the disputes between the MFIs
and the clients without resorting to time consuming and costly legal recourse. This will also
prevent the poor clients from being misguided by the vested political elements.
11. Risk Management Measures of Select MFIs
Table 5.6 presents the portfolio exposure and loan collection details of SKS, SSFL and
SWAWS in AP and outside AP due to the impact of AP microfinance crisis in 2010.
Table 6
Name of the MFI Portfolio (Rs. in crore) Collection (%)**

Percentage
Outside
In AP Outside AP Total Portfolio in In AP
AP
AP
SKS Microfinance 1,250 3,750 5,000 25
30 99
Spandana
Spoorthy Financial 2,000 2,000 4,000 50 33 99
Limited
SWAWS* 75 25 100 75 1 Normal
AP Microfinance Crisis (2010) Portfolio Exposure and Loan Collection
*Portfolio of SWAWS is of September 2010; for others it is current

** Collections are as a percentage of loans
Source: The Economic Times, January 13, 2011
Risk Management Measures of Select MFIs
i. With reference to Table 6 and other sources, we find that
Loan portfolio Exposure in AP of the six select NBFC-MFIs is as follows:

SKS25%; SSFL50%; SWAWS75%; BSFL45% (Tamal Bandyopadhyay,
2011); SHARE 50%; Asmitha50%. Hence, SKS having less portfolio
exposure in AP suffered the least while SWAWS having 75% of its loan
portfolio exposure in AP suffered the most.
Collections in AP: SKS and SSFL being large MFIs (in terms of gross loan
portfolio and geographic diversification) were able to collect about 30% of their
dues in AP while SWAWS being a small MFI was able to collect only 1% in AP.
Hence, SWAWS suffered more. The collections of BSFL in Andhra Prdesh was
just 10% (Dinesh Unnikrishnan, 2011).
ii. Risk Management measures of SKS: SKS has decided that their exposure in any single state
will not be more than 15% of the total portfolio outstanding and will not cross 50% of the reported net
worth. It has also strengthened internal audit controls, control over cash management and over
field staff (Procuring indemnity bond, surprise checks, Employee-wise daily reconciliation of
cash balances etc.) (Source: Annual Report of SKS).
iii. Geographical diversification: The geographical spread of operations of the six select
MFIs is as follows: SKS-213 districts and 18 states; SSFL-74 districts and 8 states; Asmitha-
120 districts & 13 states; SHARE-167 districts & 16 states; BSFL-77 districts & 11 states;
SWAWS-20 districts & 4 states (Source: Sa-Dhan, http://www.sa-dhan.net/files/Sa-dhan-
indian-map.htm). Thus, those MFIs which had diverse geographical operations suffered less
impact of the AP Microfinance crisis.
iv. Size of the MFIs: SWAWS is a smaller MFI compared to SKS and SSFL. Such MFIs faced
severe cash crunch as equity investors were reluctant to invest additional funds in the wake of
the crisis. SKS completed securitization transactions through qualified institution placement
(QIP) and it witnessed increase in foreign institutional investors. Large MFIs could survive
crisis and in the aftermath of the crisis, competition for them reduced.
v. Diversified products: For SSFL, even though the micro-loan repayment is almost nil in Andhra
Pradesh, the tractor finance division has up to 90% repayments as they are mortgage loans. It also
started to lend more money under its Karshak scheme which advanced money to farmers for buying
tractors and other farm equipment (G. Naga Sridhar, 2011). Similar is the case with SKS which is
concentrating on giving gold loans.
vi. Simple credit and Credit Plus models: All the MFIs (except BSFL) followed simple
credit model. Simple credit model only involves distribution of loans and their collection once
a week. Hence there is less travelling and operating costs. On the other hand BSFL followed
Credit Plus model under which it also provided Livelihood & enterprise development services,
involving higher operating costs. It is found that MFIs which have adopted just simple credit model
(such as SKS and SSFL) show more growth compared to MFIs like BSFL which have adopted credit
plus model (Rajesh Chakrabarti and Shamika Ravi, 2011).
vii. Corporate Restructuring: All the MFIs reduced operating costs by closing down or
merging their branches. Hence, their Active Borrowers per credit officers (ABCO) was higher.
But for BSFL its ABCO decreased or remained constant (resulting in higher operating costs)
viii. Corporate Debt Restructuring (CDR) arrangement: Asmitha, SHARE and SSFL went
for CDR in 2011 while SWAWS and BSFL went in for CDR in 2012. There was a delay of 1
year for SWAWS and BSFL. CDR helped MFIs in coping with adverse financial situation.
ix. Merger Plans: To cope with the adverse financial situation arising out of the AP
Microfinance crisis (2010), Asmitha, SHARE and SSFL had earlier planned to go merger but
dropped it after CDR was cleared.
x. Equity Investment: Due to no equity investment in SWAWS on account of microfinance crisis,

its promoters had to put in Rs 1.25 crore, as sacrifice value to satisfy the Corporate Debt Requirement
(CDR)(Namrata Acharya, 2012). However, in case of SKS, as of March 2013, the company witnessed
increase in its foreign institutional investors to 36% and increase in their financial holding by more than
1.5 times over the previous financial year. This helped it secure the much needed equity capital
(Arlene Chang, 2013). During 2012-2013 also SKS completed 12 securitisation transactions
aggregating to Rs. 1,207 crore through a qualified institution placement (QIP). It also raised almost Rs.
300 crore from equity investors. Thus, it faced no difficulty in raising equity capital (Arlene Chang,
2013). Similarly, SHARE has received fresh equity capital of Rs. 4.8 crore from its investors Legatum
Ventures and Aavishkaar Goodwell (Vishwanath Pilla, 2011).
xi. Corporate Debt Restructuring: While other MFIs (except for SKS) opted for CDR in 2011,
BSFL did not do so at that time. However, it opted for CDR in 2012. Thus, there was a delay of one
year for it in restructuring its financial plan after the crisis. Thus, other MFIs took quick action by
accepting CDR to mitigate the financial crisis arising out of the AP Microfinance crisis (2010).
xii. Competition: During and after the AP Microfinance crisis, many small MFIs withdrew from the
market. This reduced the competition for SKS and helped it to expand its business by attracting
borrowers of other MFIs (Arlene Chang, 2013).
xiii. Credit Rating: The ratings of Asmitha improved from CRISIL C to CRISIL B/Stable. This
improved rating is on account of timely servicing of its debt and its improved liquidity position. CDR
team has also permitted Asmitha to raise funds through securitisation. Improved rating has helped
Asmitha in securitization deals and in raising funds (Abhay Nayak, 2013). On the other hand due to
bad loans BSFL faced insolvent financial position and liquidity problems. Thus, it found difficulty in
servicing its debt. This resulted in CRISIL downgrading its rating from CRISIL C to CRISIL D.
This down grade in rating would negatively affect BSFLs position in attracting equity capital.
xiv. Strategy in aftermath of crisis: Asmitha and SHARE distributed loans even during crisis
in AP since new loans would help customer repay old loans. The repayment rate was 100%.
xv. Exploring new market segments: Previously SHARE and Asmitha concentrated on the
urban market in order to ramp up their business growth. Now they have found that there is a
55% to 60% gap in the market for serving the poorest of the poor to whom availability of
credit is very scarce. Hence, these companies are planning to increase their outreach in this
market segment. Thus, diversifying their operations helps them avoid financial and operational
risks (Trushna Udgirkar, 2012).
xvi. Customers: Except for BSFL, for all other MFIs majority of the customers are women.
For BSFL, 50% customers are men and farmers.
xvii. Loan Product: Unlike other MFIs, BSFL gave crop loans wherein repayments are not
regular due to drought and delay in agricultural output. Other MFIs provided loans for trading
activities where weekly repayments are almost ensured.
xviii. Urban and rural geographies: Cost of operations for BSFL is higher since its focus is
rural areas where long travel is involved to reach remote customers.
xix. No lesson from the first microfinance crisis: At the time of first microfinance crisis
(2006), the ROA of the MFIs was very high (example, SSFL 9%). Again just before the
second microfinance crisis (2010), ROA was high. Rapid commercialization is risky for the
microfinance business. For BSFL, ROA never exceeded more than 3%.
xx. Heavy Dependence on Banks: 80% funding to microfinance sector is from banks. When
banks stopped lending, equity investors became reluctant to invest further (In case of BSFL
and SWAWS). For instance, in September, 2011, the net worth of BSFL reduced to between Rs. 150
crore to Rs.200 crore from its earlier value of Rs. 900 crore. Hence, banks decided not to offer fresh
loans to BSFL until its financial position improves. Thus, it suffered from paucity of funds.
References
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RISK MANAGEMENT IN SELECT

The institutional risks can be categorised as follows:

iv. Personnel: The management of human resources is very important in

3. Financial Management Risks

ii. Inefficiency: Financial resources should be managed in cost-effective manner

Objectives of the Study

23 MFIs are NBFCs

NBFC-MFIs with Headquarters in Andhra Pradesh

2. Spandana Sphoorthy Financial Ltd. Public Ltd. Company (NBFC) Hyderabad

3. Share Microfin Ltd. Public Ltd. Company (NBFC) Hyderabad

4. Asmitha Microfin Ltd. Public Ltd. Company (NBFC) Hyderabad

5. Bhartiya Samruddhi Finance Ltd. Public Ltd. Company (NBFC) Hyderabad

6. Future Financial Services Ltd. Public Ltd. Company (NBFC) Chittor

SWAWS Credit Corporation

Annapurna Financial Services

Data Collection and Analysis

S.No Designation of the Executives Number of the Executives

Rating Scale: 1 = Strongly Disagree; 2 = Disagree; 3 = Neutral; 4 = Agree; and 5 = Strongly

7. Institutional Risks Factor Analysis

Significance 0.000 0.000 0.000 0.000

Institutional Risks - Variables Combined in Factors

Factors Risk Factors / Variables % of variance Cumulative

1. Role of External 1. By being a member of MFI

7. MFIs major dependence

5. Good rating from the

8. The minimum Net Owned

3. Learning lessons 3. Negative reports in the

6. Commercial MFIs failed to 17.117 69.916

Operational Risks -Variables Combined in Factors

Factors Risk Factors/Variables % of Cumulative

1. Ways to reduce 4. Client counselling sessions 19.178 19.178

10. The risk of default is less

13. MFIs lack professionally

2. Ways to 1. High attrition among the

6. Lending of loans to women

11. Providing related services

3. Strengthening 2. Incentives to the field staff

3. Internal audit system

12. Repayment of loans is

5 8. Training and skill

Financial Management Risks -Variables combined in Factors

Factors Variables % of Cumulative

1. Ensuring financial 3. Your MFI should charge

4. Lending of loans (at mutually

5. Government should allow NBFC-

6. Size of the loan granted to the

7. Interest rates charged is an 25.373 57.160

8. Loan rescheduling helps in

3. 1. Government should not restrict

External Risks Variables Combined in Factors

1. Transition of MFIs and 3. The transition from Not-

9. Most of the provisions of the

2. Co-existence of MFIs in 1. Laws and regulations

2. Government should frame

3. Minimising legal and 6. Simultaneous borrowing by

7. Arbitration (between MFIs

2. Inadequate public relations and

3. Negative reports in the mass

4. Microfinance Institutions need

5. Good rating from the rating

6. Commercial MFIs failed to build

7. MFIs major dependence on

8. The minimum Net Owned Funds

KMO and Bartlett's Test