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April 2011

Benchmarking Performance
and Practices of Microfinance
Institutions in India
Performance rating
standards, benchmarks
for large, medium and
small MFIs in the
immediate aftermath of
the Microfinance Crisis
Study conducted by -
[Period: Oct 2010-Mar 2011]
Ayan Banerjee, Director

Aadhaar Micro-Enterprise Solutions Trust

In partnership with: Centre for Microfinance Research

Bankers Institute of Rural Development


DISCLAIMER

Aadhaar Micro-Enterprise Solutions Trust (“Aadhaar”) is submitting this Project Document (“PD”) in
connection with an engagement (“Project”) proposed to BIRD (“Partner”).

Information provided herein with respect to the industry - including but not limited to competitors, players,
suppliers, investors, clients, rating agencies, support service providers, consultants etc. - has been compiled
from publicly available sources, including official publications and research reports, and / or our own primary
research. It is either given as core of the Project or as relevant supporting information. Information
contained herein, directly or indirectly linked to the Project, has not been independently verified either by
Aadhaar or its Partner. Neither Aadhaar nor its Partner or any of their directors, officers, employees,
affiliates, representatives and advisors makes any representation or warranty with respect to the accuracy or
completeness of the information contained herein.

The PD does not purport to contain all the necessary information that the recipient may require in making a
prudent decision regarding any financial transaction. In making any decision regarding the Project, the
recipient should conduct their own investigation and analyses of information contained in this PD or
otherwise and the recipient must rely on their own examination and the terms of the Project, as and when
discussed. Recipients should not construe any of the contents herein as advice relating to business, financial,
legal, taxation or investment matters and are advised to consult their own business, financial, legal, taxation
and other advisors concerning the Project.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 3

ACKNOWLEDGEMENTS

We are extremely grateful to Mr. S.K. Chatterjee, Director, Bankers Institute of


Rural Development (BIRD) for giving us this opportunity to provide our various
insights on this much pertinent discussion. We would also like to thank Mr.
R.K. Das, Joint Director, BIRD for providing many a useful insight and for
providing us with pertinent guidelines and guideposts. We also express our
gratitude to Mr. S.K. Krishnan, AGM, BIRD and Mr. T. Sudheer, Manager, BIRD
for their strong support throughout the tenure of the project.

We express our deep gratitude to the selected NABARD and BIRD supported
microfinance institutions that reinforced the purpose of the study by sharing
their field experiences and vital information around their services portfolio,
financial position, strategic focus, beneficiary management etc that formed the
core of the research exercise. Their valuable and timely inputs provide quality
insights and direction to the study.
4 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

CONTRIBUTORS

Principal Investigator

Prof. Ayan Banerjee, Aadhaar

Prof. Ayan Banerjee enjoys a diverse portfolio of activities and endeavours but his core area of interest
are in leadership and organization development. Though his experience is eclectic spread across
Information and Communication Technology, management consulting which included working with the
largest of Indian conglomerates seeing their leadership take various strategic decisions, investment
banking with bulge bracket league and fund management.
Over the last few years, his conscious choice to work in the “development sector”; first, as an investment
banker in the “B-O-P” space and largely focused on microfinance and the eventual move to an all-
encompassing strategic advisory roles. To his credit, in making the consulting advice more meaningful
bottoms-up, he spent months at end at more than two thousand ‘back-of-beyond’ villages over the last
three of years. Specifically applicable to microfinance, he understands villages (clients), institutional
setups (systems processes) and management (and leadership). More recently, his vast experience with
work with more than fifty microfinance institutions – for profit and non-profit – as a strategy consultant
and chief investment advisor, was extremely resourceful towards the build up of this assignment.
As a serial social entrepreneur, he founded seven social enterprise initiatives to address some of the
ingrained socio-economic problems and leadership and change management concerns to drive
inclusive growth in India. Prof. Banerjee brings in eclectic scholastic research (with more than 20
published papers across Physics, Finance, Social and Economic Development, Computational
Mathematics) and his experience in academics with prominent business schools globally on social
entrepreneurship, finance and market-driven strategy. He immensely appreciates and inspires
breakthrough ideation and the power of youth-propelled innovative incubations to social change in
India. Connecting the dots, Prof. Banerjee has collaborated with public, private and voluntary
organizations and individuals to strengthen inclusive growth models.
An alumnus of Columbia Business School, New York, U.S.A. and International Capital Markets
Association (ICMA) Centre, London, U.K., his experience and intense interest came in as an asset to the
project and we hope that this action-oriented research piece can catalyze an inflexion point in the
growth of the microfinance sector.
Ayan can be reached at ayan@trustaadhaar.org.

Supporters Investigating Team


Aadhaar Partner MFIs who subtly backed the Aadhaar Research and Consulting
Investigating Team with field important trends and
developments Editor
Aarti Krishnan, Aadhaar
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6 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Executive Summary

Introduction
The growth and evolution of the Indian microfinance sector is constantly driving the need for adequate
and accurate information and therefore increased transparency from MFIs. However, in most cases, due to
poor standards of operations or pressed under the situation of mission drift, the MFIs struggle to provide
the basic information indicating their performance. With improved business practices implementation and
developing leadership models, MFIs are gradually taking the transition route to fully regulated financial
institutions, where augmenting competition at every level among growing numbers of MFIs for both
funding and clients has made improved financial performance a necessity for majority of the MFIs.

In this assessment, we adopted custom benchmarking models and assessment tools (through primary
research: qualitative and quantitative) to determine select sample of financial institutions’ performances
vis-à-vis other similar organisations. Performance parameters, practices and benchmarks will, eventually,
aid for improving communication, professionalizing the organisation/ processes or for budgetary reasons.

This action research started with the following principle set of objectives:
1. To assess on-field performance and practices through sampled examination
2. To ascertain the benchmarks across performance parameters used to gauge the health of any MFI
3. To analyse the selected NABARD supported MFIs along these measures. An aggregate level of
assessment could compare NABARD supported MFIs vis-à-vis the general sector
4. To enhance their operational efficiency through consulting them on organisational development
and sampled loan portfolio audit
Additionally,

1. Apart from the obvious benefits accrued to the sector, researchers and watchdogs could get a
status check on the MFI sector
2. Help create and put in place early warning systems and policies to address organisational
development issues and help enhance and measure growth imperatives

In recent times annual reports of Sa-Dhan and State of the Sector Report (2009 and 2010) suggest that
the difference in the market share is narrowing with increase in the credit flow to SHGs and
unprecedented growth of loans volumes offered by MFIs. This represented a massive opportunity for the
growth of Microfinance Institutions (MFIs). While the demand for microfinance in India is
phenomenal, there are a few (but a steadily increasing number) scalable microfinance institutions that
can/ could meet this demand. Furthermore, the concept of microfinance was traditionally projected as a
social commitment rather than potential business opportunity. However, with increasing need for funds
and sufficient market awareness about the product offerings and related benefits, the conventional
definitions went through a process of refurbishment. When it was clear to many that microfinance
presents the opportunity to “make profits” (and supernormal at that), there was a huge surge of
institutions to become microfinance institutions.

Regulatory environment was enabling. Suppliers were easy to find – bankers were the financiers of raw
materials. The demand was H-U-G-E, given the reports of “unbanked” sector in India. The only threat was

Centre for Microfinance Research, BIRD


An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 7

from replacement by Bank-SHG model and BC-BF model, both of which had their serious deficiencies.
Thus, in view of Porter’s model, only competition needed to be taken care of: And, the best way to
counter competition was to grow and grow fast. What followed were a set of common practices, which
were unethical and dubious from a long term strategic viewpoint.

The ‘current’ state of affairs in A.P.: The AP government issued ordinance seemed to many as an intent,
to quash private microfinance providers in the state, where it has grown explosively in the last five years
through a process of commercialization that has brought ample capital and made millions for some
investors and founders. Unfortunately, the ground truth remains murky for those removed from the
situation. On one hand, the harm of microcredit appears exaggerated in much of the current rhetoric. Yet,
there is good reason to worry that the fast expansion has gotten many poor people into debt traps – into
situations in which repayment is coerced, verbally or even physically, by peers and loan officers.
Subsequently, the repayment rates dropped (to an average of 8-10% in A.P.) and microfinance “culture”
suffered. What is beyond doubt - to most - is that the Indian microcredit industry, the largest in the world,
is in serious peril; and that this crisis is sure to seed discussion worldwide about whether and how
microfinance institutions (MFIs) can commercialize responsibly. It is, what we call, a Corporate Social
Conflict that the development sector should be looking to constantly balance. It’s not merely a
question of ‘’to profit or not to profit’’ but under what terms and conditions and how should
one go about balancing the double bottom-line objectives. From a financial literacy perspective,
through our research we find that several commonly levied criticisms - enumerated - against the current
microfinance brigade is not quite out of place:

Illiteracy and specifically financial illiteracy: The clients don’t know what they are signing. Lured by
promises of large loans (read: receipt of money) next day with no training (Group recognition etc.)
yields the agency problem. Straightaway the MFIs employees are standing outside the existing group
meetings (of another MFI or SHG) and asking en bloc formation of another group.

Adverse impact of commercialisation: High growth potential, profitability have hugely attracted
private investors. Since valuation were dependent on ‘client lifetime value’, a mad rush to acquire clients
at all costs resulted in reckless lending and client acquisition with minimum due diligence. Similarly,
required 99% repayment rates ensured profitability with <1% loan loss provision costs.
Proliferation of the pure microcredit model: Clients of non-deposit taking NBFC which provided
microfinance on the cushion of Private Equity had little at stake. Wilful default – with several MFIs lined
up waiting to provide (easy) credit – was easy. Unlike the Bank-SHG model which began with savings
and a waiting period of 6 months, was more holistic. The leverage (at 4x) was also balanced; those MFIs
registered as NBFCs, being non-deposit taking - are obligated to take complete unsecured loans.
Governance: Misappropriation of funds by leading microfinance practitioners / promoters.
With the financial sustainability falling in place, with the establishment of transformation (migration to
for-profit NBFC-MFI) trend gathering momentum since 2004-05, there are three several issues that
these newfound NBFC-MFIs faces from the Corporate Governance perspective. Clearly growth raises
implications for other key organizational functions such as governance and transparency.
Many NBFC-MFIs are new and having begun their operations on a clean slate, can adequate focus their
attention on establishing a strong board and internal control systems. MFIs which start with the NBFC
models are not alleged of mission-drift, misappropriation of donor funds or illegitimate accumulation
of personal wealth; these MFIs are clear of being with the principal objective of making profits.

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8 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Conflict of interest: Making profits by charging usuriously high interest rates (i.e. high income).
Accused of “Robbing the poor to make the rich richer.” While most MFIs – known – are within
“reasonable” interest rate charges, there is an occasional MFI that charges out of the ordinary.
A third party neutral should provide information to the end borrowers. Clients should be advised “what
is high” and educate them about alternative products and services. However, since the choice is
ultimately an individual choice and dependent of personal circumstances, the decision to take the loan
or not ultimately belongs to the client.
Employee Targets: Key Performance Areas (Maximum client enrolment, minimum default) leading to
alleged group hijacks and coercive recovery mechanisms. Setting targets are part of corporate
maximising of utility of employees. However, group hijacks leading to multiple lending and other
immoral and unethical practices must be contained. We should have a detailed process by which we
can escalate the malpractices to the management of the organisation in question and request their
immediate remedy as well as the regulator and local bodies (DDM, BDO etc.)
No consumer grievance redressal: In the absence of any regulatory body, there was no forum to
redress microcredit consumer grievance.
Can we facilitate the regulator in bringing on-ground problems and concerns of microfinance clients
and practices to their notice with a view to enhance microfinance governance and delivery. Non-
arbitrators/conflict resolvers and would not play a role in either of these.

With the microfinance sector entering a new phase of its life cycle, new stakeholders (public investors,
international funders etc.) organizations require new forms of external accountability (transparency);
expanded organization demands new internal accountability (governance); further growth, outreach and
sustainability demand new forward accountability (technology); and last but not least, holding course for
what we came to do in the first place demands new downward accountability (social performance).
Certainly, any MFI that does not live up to the demands to develop a holistic, transparent corporate
strategy and governance will find that functioning effectively is an increasingly difficult and complex
proposition.

Investments
The emphasis on adopting professional (commercial) behaviour and practices, which may (not)
strategically balance with their original social mission implied implicit risks. The size of the portfolio for an
MFI is held by two basic parameters – the outreach and the size of the loan disbursed. The dimensions of
quality and efficiency are identified by the depth of service offering, geographical coverage, target
clientele and the portfolio quality. The key challenge for MFIs lay in achieving growth constrained by
budget, efficiency and quality of services. Few managed remarkably well. And there were some more than
moderate achievements too.

Consequently, the private equity investments and consequently the valuations for MFIs in India rapidly
increased in this period. The three-year average, historical median valuations had been in the range 5x-6x
historical book value (with a few deals valued at as high as 10x; though few these valuation levels were
not massively shocking to privy insiders. Those who were not quite acclimatised to the microfinance
sector found these valuation numbers as preposterous and unsustainable).

Centre for Microfinance Research, BIRD


An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 9

Transaction value and net income growth are the


main drivers of valuation, as evidenced by our Ideally, an MFI has to have the following
statistical analysis. The following are eight other conditionality to deliver:
factors that were deemed important1:
External accountability to be provided
a. Type of buyer and its possible social to regulators
motivation; Internal accountability by the
b. Country of the MFI; organizational hierarchy
c. Legal status of the MFI, in particular if it is a Forward accountability to be provided
fully regulated; by continuous innovation
d. Operating efficiency; Downward accountability to be
e. Leverage; provided by delivering effective and
f. Reliance on retail deposits (financial transparent services to clients
intermediation);
g. Asset quality; and Evidently, the accountability will reflect an
h. Profitability (as measured by ROE) increased level of organisational
performance. Most importantly the MFI will
emerge as a client-centric organisation.
Additionally, we believe that the high valuations
were driven by:

a. Low cost of client acquisition; microfinance was a new concept; the word went around that
‘money’ was being given not loans. Also – the existing local groups (SHG) were not able to
disburse money (loans) and were deemed to be dysfunctional in many quarters. This implied that
there would be lower cost of acquisition of clients (poaching) and the lower cost implied faster
and more clients. Clients are eventually the revenue drivers. Greater the number of clients, higher
the valuation2. Hence, incentives to employees for quickest group creation and acquisition of
clients in a cookie-cutter professional model. In all fairness, this “professional” approach is not –
perhaps – too different from what telecom companies applied for bridging the telecom divide.
b. However, the maintenance of groups was not factored in. Much like in telecom where “active”
clients are important – as revealed by TRAI – active clients are important in microfinance. Of
course, there is no one to oversee the activities and activeness. The industry defined “active”
clients were defined as those with running loans.
c. Country level assessment not being good enough, especially in the Indian context, which is so
vastly diverse, the location of the MFI was important. Hence, the national level aggregate
demand-supply gap is a skewed perspective: Microfinance is a local business, much like retail
footprint. And the demand/supply & competitive landscape should ideally be looked at region-

1
“Shedding Light on Microfinance Equity Valuation: Past and Present” report by JP Morgan and CGAP, 2009
2
Multiples of price to number of clients were commonly used in the Indian context. The “client life time value” was derived
based on profitability per client (on average). The rationale is that an MFI should be able to extract “value” from each of its
customers. While many investors found those multiples of limited use, in the absence of benchmarks to draw conclusions ($50
per client was a rule of thumb); eventually, current book value and future earnings were used for triangulation. The idea of
valuation is similar to using any network based (e.g. airline and telecom). They are also reminiscent of the multiples method used
to value Internet companies (before the bubble burst)!

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10 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

wise; the more granular the better. It was generally assumed that the political risk is higher in the
northern states (viz., U.P., Uttarkhand, Jharkhand, Bihar, M.P., NCR, Rajasthan). The risk adjusted
expected returns were factored into these valuations.

Field Audit
Structured and unstructured questionnaires were used for data collection at the client group level.
Behavioural assessment of clients, field practices, challenges and opportunities were observed. Individual
interviews as well focussed group discussions were held. Discussions with field officers, branch managers
were held at individual level.

Bucketing into large, medium and small: Since we are selecting NABARD supported MFIs, we are
reducing a degree of freedom in the selection of the sample. We propose to study small, medium and
large MFIs across regions. Spandana, the second largest MFI, and has more than 4.5 million clients; in
contrast, Asomi, Mimo have less than 50,000 clients. Thus, the MFIs will be compartmentalised into three
buckets. We have separately looked into the classification of “MIX Market”. Additionally, we have classified
MFIs as “large” if they are systemically important.

The size and spread for the study is worked out based on the hypothesis, which indicates that with
increasing size of a MFI, the resource engagement, service delivery mechanism and the internal functional
and management structure get highly streamlined, and that there exists a commonality in their operations
and market reach. Hence, to test the veracity of this hypothesis, we conduct the study across growth
stages of MFIs in India.

Client level Data Collection and Exhibit 26: Approach to Data Analysis

Analysis Historical
For the study, having identified core set of parameters Research
 Secondary research
for performance measurement; benchmarking will
 Quantitative analysis
form the basis of data collection and reporting. While of existing data-
the ratio analysis will provide the technical support to points
the overall findings, the team and client discussions
will add insights to the garnered data in terms of
ethno-demographic understanding, need gap DATA
analysis, product expectation and competition ANALYSIS
assessment. Hence, the information gathered for the Parameter
ratio analysis will be quantitatively analysed and
TOOL Fieldwork
Assessment  Qualitative Analysis
summarized, while the inputs to operational  Qualitative analysis  Quantitative Analysis
performance and organizational development would to validate/confirm  Observatory exercise
be the outcome of the mix of qualitative-quantitative parameter accuracy
assessment.

The tools for collecting data were structured questionnaires with scaled, closed-ended question
(quantitative),open-ended leading questions (qualitative), Detailed personal interview technique for the
management and/or focus group discussions (FGDs) with the decision making team and executing team
at each MFI to obtain qualitative information about reasons for default, terms of repayment and knowing

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 11

the practices adopted for recovery; also, the initial secondary research conducted with the assistance of
the MFI team will provide us the foundation to the fieldwork. Important data-points in terms of
operational and financial performance provided inputs to designing of the questionnaire and discussion
guide, comprehensive on-field market research (with staff and clients) in order to gauge the need gaps
and expectation (mis)match between the MFIs and the end-beneficiaries, member Level Interaction: A
questionnaire that was (broadly) administered, the principal objectives from the field interactions with the
group members were to examine the integrity of the groups (social capital), look into field practices:
Group formations; trainings; collection, assess the financial awareness of the members about various
product offerings, check for frauds by the field staff of MFIs. To check for collusion with clients,
understand if there are “king-pins” within the loan clients; understand the deviations in the
implementation of the organisational policy, cross-check loan utilisation. The field Level Document
Verification involved branch audit involved interactions with branch staff i.e. Group Managers, Branch
Managers and Area Managers to assess their understanding on the systems and policies of MFI. We
assessed (sample) the loan documentation for the outstanding borrowers, conducted an audit trail for the
reconciliation of data maintained as per manual records against the records in the MIS, checked the
quality of maintenance of the registers and documents, and tracked/reconciled loan client data from HO
to field and from field to HO.

Survey Sampling

Potential State Sample


Existing* (10%)
Andhra Pradesh 28,491
(87%)
Tamilnadu 20,351
Orissa 8,140
Lapsed
(3%) * Includes single- and West Bengal 13,228
multi-source borrowers, Maharashtra 15,263
potential borrowers (i.e. not Karnataka 13,228
current MFI clients) and Assam 611
those who’ve dropped out
U.P. /Uttarakhand/NCR 4,477
Total Sample Surveyed = of microfinance products.
Total 1,01,753
1,01,753 borrowers

For this study, we conducted extensive research and closely interacted with borrowers group at the field;
spending days at end staying and cohabiting with them. This opens up opportunities for frank and open
discussions as well as helps appreciate their concerns and behavioural predilections.
These insights are not available on a field-trip organised by MFIs where “visitors” coming from MFI are
seen differently. Detailed personal discussions held and ethnographic studies (day-long observatory
exercise) conducted with rural clients and MFI management and staff members brought out some
significant insights indicated striking disparity between financial usage and understanding.

Centre for Microfinance Research, BIRD


12 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Perspectives from the Field


Based on our observations on the field, we have put together some of our thoughts. We summarise below
the most crucial of discussions pertaining to “performance”: Perhaps in a more appropriate platform we
can engage into a deep-dive into each of these.

• Is “social cohesion” working for microfinance? Collective repayment is translating as collective


default (e.g. in A.P.)

• The primordial question: Credit or Savings is the way going forward? Households seemed to
be impoverished, burdened by over-indebtedness.

• What about multiple borrowing and how to resolve it? Still up in the air. Can credit bureaux
be the answer?

• Who is doing the capacity building and micro-enterprise support that helps micro-
entrepreneurs to exploit growth opportunities? The poor institutional viability of micro
enterprises makes microfinance untenable. Is the environment enabling for a holistic
ecosystem? Prima facie: No. There is little or no support in the burgeoning micro-credit market
(NBFC-MFIs) to do this. It’s not their focus. NGO-MFIs are too small in number and shrinking.
There are not enough government support schemes to do this sustainable capacity building (vis-
à-vis access to micro-credit)

• What about concerns on general financial illiteracy at the target segment? MFIs are lending
to the same groups. Multiple lending is in epidemic proportions.

• Is there increased credit risk? Starting with higher disbursement quanta (compared to previous),
is a higher risk-higher (expected) returns game. Topping up loans is not the best practice. Without
creating the necessary credit history (important for microfinance), giving larger loan quanta is
increase of credit risk. Monthly (instead of weekly) is another determinant of higher credit risk.

• Isn’t this a systemic failure; then why blame just the MFIs? Absolutely! MFIs (NBFC or not) are
just players who may be called opportunistic by critics. Nothing wrong with that: Business thrives
on opportunity. However, it was the lack of regulation, the lack of definitive and timely policy
intervention which did not keep pace with the rampant growth. Lack of “eyes on the field” is what
made it a difficult challenge to deal with. Suddenly a crisis was staring one at the face.

Settling the interest rate debate


In our survey, interest rates charged by MFIs ranged from 10% flat to about 15% flat. This would
translate to in the ball park of 21% - 30% in terms of equivalent APR (including factoring upfront fees,
membership fees, compulsory insurance premium etc.). While the interest rates were higher for smaller
MFIs larger MFIs usually have lower interest rates. In that sense, even if limited, they were passing on the
benefits to the end consumer. We find that the key factors leading to the reduction of interest rates are:
competition, reputation/branding, economies of scale (reduced financial costs), governance, transparency
and social impact. The alternatives for end borrowers are higher cost local money lenders; competition
has drastically brought down their benchmark interest rates as well. Clients are generally comfortable with

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 13

the prevalent rate of interest. The “quality” of microfinance is what really needs to be looked into. The
transparency in interest rate calculation is missing. Most field officers themselves don’t know “flat” and
“reducing balance” calculations. Further, there is no “format” and MFIs charge different fee heads
(membership fees, loan processing fees, compulsory insurance premium, late payment charges etc.)
depending on tax and accounting considerations. Factors such as the compulsory savings for obtaining a
loan (used in the SHG-Bank linkage model), frequency of repayments, and the systems adopted to collect
repayments-also raise the effective interest rates.

For a sustainable business environment, interest rates cannot be pegged to only the prevalent “poverty”
of borrowers. Microfinance has to be sustainable as a business. Thus, if we factor administrative costs
consist (of rent, utility charges, transport, office supplies, depreciation of fixed assets etc.), a labour-
intensive operation, personnel costs are high. Making and recovering small loans is costly on a per unit
basis. Often loan recovery is executed by the staff who visits clients, increasing costs in time taken and
transportation used. Poor physical infrastructure– inadequate road networks, transportation, and
telecommunication systems– in many areas in which MFIs operate also significantly increases
administrative costs and adds significantly to the cost of microfinance operations.

On the other side, clients need to be better educated about what they are paying. While the transparency
norms have been greatly put into place for banks, NBFCs and MFIs are still to meet greater (and honest)
levels of disclosures. The current practices offer convenient level of disclosure for the lender (but not for
the borrower).

Should a sector-wise margin cap be considered necessary, 10-12% is reasonable bracket. However, an
interest rate cap of 24% would certainly dis-incentivise MFIs to venture into difficult terrains (virgin,
politically unstable, remote locations etc.) where operational costs are higher. The loan loss provisioning
would also be higher. Consequently, the economics would make sense if and only if the costs of funds
are lower or can be made lower. This means that only the larger MFIs (with a lower cost of funds) will be
in a position to make the foray. Question is: Why should they? As a strategy, it is likely to hamper their
(risk-adjusted) performance; from a policy perspective, the cost of funds in such terrains c/should be
subsidised (under PSL). It is imperative that the existing classification for priority sector lending
must be revisited and guidelines revised.

We examine Portfolio Yield, which measures how much MFI actually received in interest payments from its
clients during the period. It also provides an insight into portfolio quality, which in the current sample is
still looking at 99% repayment rates – even at an aggregate. However, the same study – taking into
account next financial year information – would be interesting to compare.

Predatory Lending
“Predatory” lending is the set of lending practices in the booming credit market, where predators prey on
the lower income and less educated households on the demand side of these growing consumer credit
markets. A first time perspective ever on the Indian microfinance sector, we look into the prevalent
practices and through mathematical models explore if microfinance in India is indeed predatory.

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14 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

We purport that our model throws light on the current, very real-world debate, around predatory lending
especially in the wake of microfinance crisis in A.P. From a policy perspective, the stakes in the debate are
high: millions of lower income households borrow regularly from thousands of microfinance institutions
around the country. Had MFIs raised low income households’ welfare by relaxing credit constraints,
legislation would have lowered it. As we deep-dive into general practices in the microfinance sector
(i) encouraging over-indebtedness, (ii) future income deception (iii) Uncertainty in household
Income (iv) higher risk (v) Equity stripping (vi) lack of proper credit counselling, we find that the
practices are predatory. While this is not in the least because of the interest rate charges; but
tempting certain households into over-borrowing, then that should be detectable as differences in
debt and delinquency rates with more liberal microfinance lending laws.

Multiple borrowing
The clients (assumed naïve; based on field interactions) in comprehending the complexity of assessing
their ‘debt service coverage’ capacity accurate give in to the temptation of easy availability of loan, which
may turn vicious. When borrowers and lenders were tied in a symbiotic relationship, lending without
incurring losses (loan loss provision was <1% until now; is the trend changing?) is relatively easy. MFIs
needed borrowers to repay their loans (99%+ OTR) in order to avoid losses. In early stage microfinance,
MFIs were “valued” since this relation balanced (with the shortage of supply of credit); the demand side
was still higher. Thus, to keep the MFIs in good mood, the borrowers would ensure that they repaid their
loans in the hope of getting higher valued loans (whether as fuel for working capital, capital investment or
consumption). The uncertainty was beneficial. On the side of caution, clients would repay loans. However,
with greater competition there was a paradigm shift (destabilizing?) of the dynamics of the relation in
favour of borrowers: The bargaining power was now vested in the clients and since the loans were
unsecured, they knew that there were other (several) options and alternatives.

Our assessments from the field study indicate the following findings:

1. It is only a matter of time – the level of indebtedness can become so large that it may render
repayments extremely unlikely.
2. The overall delinquencies of the sector to drop by 3-4% p.a. It is reckoned to be in the range of
80-85% of all clients (with at least 2/3 MFIs operating in the same region).
3. While the instances of multiple borrowings does not seem to have (yet) affected the repayments
in most cases; however, as a proactive measure, the area managers and BMs should capture this
information for every client appraisal.

Benchmarking Performance
The raison-d’être of this piece: This section forms part of the background work that is required to
benchmark, assess and develop NABARD supported MFIs into best-in-class MFIs. The research document
forms the basis of the action led ‘Organisation Development’ process initiated. The Tools: A rapidly
growing and fast maturing Indian microfinance sector needs standardized methods to measure,
benchmark and analyze financial performance and risk management of its operations. The existing study
seeks to address this need by selecting NABARD support MFIs. We peruse a set of Performance
Parameters tools so as to assess the health of MFIs and ascertain relevant benchmarks. These Performance
Parameters may be used by any microfinance institution (MFI) whether a non-profit organization or a

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 15

non-banking financial company or even commercial banks, regional rural banks, cooperatives etc.; and,
can be compared on a set of common parameters.

The phenomenal growth (return) of the sector – quoted at ~40% with many leading MFIs growing
manifold to that average number – must be revisited in terms of risk-adjusted-returns.

It is not difficult to establish that a significant part of the “high growth” of the Indian microfinance sector has
been achieved by, both
(a) Higher credit risk
(b) Higher operating risk
This is not to suggest that each MFI has intentionally increased the risk of the system. However, in aggregate,
the prevalent practices, über-competitive environment and soaring demand for higher valuations has led to
an increase in riskiness of the system.

We do acknowledge that a more robust set of performance standards may be needed, given the growing
number of MFIs that are regulated, accept deposits, and have increasingly complex capital structures, off-
balance sheet transactions etc. But – at this point – any more involved analysis than this does not make
sense since the underlying data is sticky. In the absence of any regulation, data is sparse; it cannot be
ascertained what adequately represents the industry; data in a fragmented industry is - unfortunately -
not entirely reliable; quantitative data based on sampling may be inconsistent with general observations
on field due to absence of any reporting standard. Further, these standards only address microfinance
financial performance.

Additionally, we should try and include other aspects of microfinance such as social performance, impact
investing etc. But that will be predominantly through a qualitative assessment. The formal literature on
these softer issues is still quite underdeveloped; though widely held that ‘social performance metric’
should be deployed and developed.

Through this assessment, we have endeavoured to set the tone not only on the processes but also a
common language of assessment so as to ensure microfinance performance metrics are calculated
consistently so as to bring into a common denominator MFIs from different regions, associations and
networks, regulators, donors, lenders and investors, rating agencies etc. Like any other business, MFIs are
subject to local crises, natural disasters, political and economic volatility, and weak regulatory structures.
Specific implications of this conservative approach are reflected in many of these ratios.

A maturing Indian microfinance industry needs standardized methods to measure and analyse financial
performance and risk management. These standards would address financial performance:

It allows the MFI to compare itself with other similar organizations. If the management realizes
that things within aren't particularly going too well, they can help pinpoint the problem through
comparing their ratios with other organizations (benchmark).
Also ratio analyses may help by comparing the organizational “evolution” over time by comparing
with prior periods through a trend analysis. The adverse trend analysis can help to diagnose a
particular problem and look for corrective solutions.

One of the principal goals of the Financial Performance Parameters is to ensure that microfinance financial
performance ratios are calculated in a consistent manner. The proposed Performance Parameters use a

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16 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

financially conservative and prudent approach to measuring financial performance ratios. The Performance
Parameters would persuade greater transparency in and disclosure of financial information. MFIs should
be as explicit as possible in reporting financial performance, particularly because many MFIs are subject to
local or national crises, natural disasters, political and economic volatility, and weak regulatory structures.
Specific implications of financially conservative approach are reflected in several ratios. To set quantitative
measures beyond this scope including other aspects of microfinance such as social performance, impact
investing, and Performance Parameters among others is difficult in the current context and project.

An MFI must have the capacity to regularly generate reliable financial performance and risk management
information that meets regulatory requirements and allows the MFI to manage its operations and risks
efficiently. MFIs must choose their management information systems (MIS) carefully in order to ensure
that they are capable of generating these reports. Additionally, MFIs that will have connectivity directly or
indirectly with information and communications technology (ICT) products and services will also need to
comply with additional reporting and analysis requirements relevant to this technology.

ROA and ROE remain valuable measures of an MFI’s profitability. They are financial metrics that are well
established and well understood across the commercial spectrum. As such, they are useful regardless of
the legal status or mission of an MFI.

Using DuPont Analysis, ROE= Profit Margin x Asset Turnover x Financial leverage

Asset quality remains a key indicator of an MFI's financial viability. Capital adequacy and solvency ratios
help measure an MFI’s strength and stability by looking at the relationship between the capital base and
asset base. The concepts of capital adequacy and solvency have both become more crucial as MFIs grow
and become more sophisticated, accept deposits, and are subject to national regulation. All MFIs need to
be solvent in order to weather the range of crises that can adversely affect a financial intermediary.

The ratios pertaining to liquidity are designed specifically to help MFIs anticipate, measure, and monitor
liquidity levels. Liquidity management can help MFIs make informed choices about the trade-offs between
maintaining certain liquidity levels and the opportunity costs of keeping resources liquid. When working
toward establishing optimal liquidity levels, MFIs will need to consider both internal and external factors
related to liquidity, ranging from sufficient funds for on-lending or payouts to depositors, to payment to
creditors, suppliers, and investors. Liquidity is inextricably tied to asset-liability management (ALM).
Unfortunately, no MFI does any explicit measure and analysis of ALM.

Competition and its discontent


As we explore policy problems affecting financial inclusion in India, we begin with the premise that the
microcredit market in India is (becoming) quite competitive; and that this could (generally) be regarded as
a good thing for the clients’ perspective. However, since competition involves “winners” and “losers”, this
may not always be so.

The regulator’s challenge in this case will be to encourage healthy forms of competition which do not
threaten the financial system stability or cause abuse of customers, especially for a service which is
targeted specifically for the weaker and underprivileged sections of the society. Certainly, we would need
to combine socio-economic-(politico?) rationale; creating an environment of constructive

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competitiveness. The evidence from credit markets elsewhere in the world, microcredit markets in
particular could serve as a helpful guidepost to navigate the impasse successfully. Increasing competition
among lenders holds out the prospect that borrowers will benefit from more flexible products, better
service and even lower interest rates. Thus, as we are beginning to observe in India, competition has also
increased the risks faced by individuals and firms–for example, building the pressure to lend recklessly in
ways which may result in over-indebtedness of some borrowers, or reducing borrower incentives to pay
back when other credit is freely available. On a large enough scale, such excesses can lead to the failure of
lending institutions3. Even if it does not produce “excess”, competition may be slow to lead to declining
interest rates; slower, that is, than consumer protectionist policy makers would like. Confronted by the
“regulator’s dilemma”, policy makers have to make trade-offs. Certainly, the dilemma is not whether to
allow competition or not, but rather how best to promote cost-effective, client-centric, “healthy”
competition through light regulation without burdening the players with the high costs of compliance
while mitigating the risks of negative shocks. In the microfinance context, since MFIs require incentives to
reach newer borrower groups (innovation and new product positioning), an appropriate policy to enhance
competition would involve balancing the interests of providers and borrowers. Given that microfinance
has for quite some time been working through market-based economic systems, effective competition
becomes an essential condition for ensuring allocation efficiency and for increasing and/or maximizing
societal welfare.

Considering this that effective corporate governance has been identified as a crucial bottleneck in
enhancing many MFIs financial performance and expanding their reach in the market, as an action plan,
there are the four foundation arms for setting up a highly ethical code of conduct and implementation:

Effective corporate governance would be achieved when the four arms together ensure an effective
communication within its each of the foundation arms and related activities. Field practitioners were
expecting an impending concern in A.P. The promoters of several MFIs knew the realities. The mistrust
developed in large part due to poor governance standards. This clearly called for Government
intervention and regulation. Was the intervention of the A.P. state government more of a regulatory
nature or more comparable to regulatory capture (since they are already looking to set up their own NBFC
for MFI operations)? From a client’s perspective, knowing that there were more loans to come, they kept
repaying. But the discipline of repayment was disrupted in Oct 2010. And most believe that this is a
structural change: the repayment rates to MFIs in A.P. will never go back to 99.5%+ in the near future.
Obviously, the performance standards would need to be revisited.

Using Porter’s Five-Force Model, one of the best tools for understanding competitive industry dynamics
and competitive advantage, which though was originally developed primarily to enable competitors in a
market to develop their own competitive strategies (and has been recently re-examined and extended—
see Porter 2008), policy makers may apply the analytical framework to achieve a deeper and richer
understanding about competition in a particular market.

Indian Micro-Credit Features Affecting Competition

3
Including banks which hold customer deposits! This has already happened in some places including Bolivia and South Africa.

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18 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Economists have long recognized that credit markets in general have distinct characteristics which make
them prone to failure and which affect the competitive behaviour of lenders.

• Asymmetric Information: Microcredit is typically characterized by such asymmetric information


dynamics, as the typical micro borrower is not formally employed, has no bank account, no credit
record and no formal housing, and thus the conventional sources of information are unavailable
to microcredit lenders.
• Difficulty in Switching Lenders: Credit markets are often characterized by a large number of
lenders of different sizes which compete in part by differentiating their products- a form of
competition which economists call “monopolistic competition”, where entry to the market is
possible in theory at least, and where borrowers can switch lenders. In practice, these conditions
do not always apply and there are several factors that impede switching, beyond simple inertia on
the part of customers.
• Unavailability of borrower credit records: For example, if the borrower’s credit record is not
accessible to other lenders (typical with micro-credit) it may be harder for her to switch lenders
for the next loan.
• Low levels of financial literacy: First time borrowers with low levels of financial literacy (typical
with microcredit) confronted by complex product information may also be less able to make truly
informed choices, and hence less inclined to switch lenders. Even the more financially literate have
behavioural tendencies which may be exploited by lenders in ways which increase the effective
costs of switching.
• Predominance of group-lending: Group-based lending (common with microcredit), which
requires that borrowers form groups to be able to borrow, may make it harder still for individual
consumers to substitute providers due to the costs of collective action. The incidence of bor-
rowing from multiple sources may increase as borrowers have more options; and because the
other borrowings are undisclosed to lenders, may lead them to make credit decisions based on
inadequate or inaccurate information about the borrower’s repayment capacity.
• Government Involvement: Going forward, the nature of competition may also be affected by the
actions of state lenders (A.P. has led the way; others may follow). For instance, the Bangladesh
government microcredit apex PKSF has substantial influence over some aspects of MFI competi-
tive behaviour, including pricing, through capping margins and controlling the supply of funds to
its clients which are retail MFIs.

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 19

Section 11.7: MIXMarket Microfinance Benchmarks


Table I: MIXMarket buckets of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Currency USD USD USD
Total assets 20,716,147 4,116,506 994,361
Offices 66 11 8
Personnel 453 104 41

Table II: Basic statistics of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Capital/asset ratio 14.79% 17.21% 15.90%
Debt to equity ratio 5.77 4.81 5.29
Deposits to loans 0.00% 2.06% 0.00%
Deposits to total assets 0.00% 1.69% 0.00%
Gross loan portfolio to total assets 82.91% 81.71% 77.02%

Table III: Benchmark (average) ratios of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 56 11 17
As of date 2010 2010 2010
Currency USD USD USD
Number of active borrowers 120,732 24,668 6,950
Percent of women borrowers 100.00% 99.78% 99.89%
Number of loans outstanding 128,042 24,668 6,950
Gross loan portfolio 14,960,924 3,378,157 824,207
Average loan balance per borrower 144 154 140
Average loan balance per borrower/GNI per capita 13.98% 14.94% 13.58%
Average outstanding balance 131 149 140
Average outstanding balance/GNI per capita 12.69% 14.41% 13.51%
Number of depositors 0 6,426 0
Number of deposit accounts 0 6,426 0
Deposits 0 65,452 0
Average deposit balance per depositor 28 40 72
Average deposit balance per depositor/GNI per capita 3.00% 4.00% 7.00%
Average deposit account balance 24 40 72
Average deposit account balance/GNI per capita 0 0 0

Table IV: Profitability benchmarks of Large, Medium and Small MFIs

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20 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Return on assets 2.66% 0.45% 0.27%
Return on equity 15.76% 3.07% 1.15%

Table V: Provision for loan impairment/assets

Mean 0.8%
Median 0.6%
Standard Error 0.05%
Range 2.94%
Minimum 0.01%
Maximum 2.95%
First Quartile 0.28%
Third Quartile 1.1%
Count 362

Table VI: Efficiency of staff

Cost per Cost per Borrowers per


borrower (USD) borrower (INR) staff member
Median 692.4 31,158 228.1
Standard Error 540 24,300 217
Range 1575 70,875 3.2%
Minimum 475 21,375 559
Maximum 2050 92,250 32
First Quartile 315 14,175 591
Third Quartile 855 38,475 141
Count 306 306 306

Table VII: Performance benchmarks of Large Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
Operational self sufficiency 119.37% 102.45% 100.42%
Financial revenue/ assets 20.37% 21.24% 19.67%
Profit margin 16.23% 2.39% 3.73%
Yield on gross portfolio (nominal) 23.95% 29.17% 21.64%
Yield on gross portfolio (real) 14.07% 18.87% 12.10%

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 21

Table VIII: Expense benchmarks of Large Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Total expense/ assets 17.67% 21.08% 22.63%
Financial expense/ assets 8.41% 8.28% 8.19%
Provision for loan impairment/ assets 0.53% 0.90% 0.29%
Operating expense/ assets 8.74% 7.96% 13.64%
Personnel expense/ assets 4.22% 5.51% 7.16%
Administrative expense/ assets 3.79% 3.10% 6.44%
Operating expense/ loan portfolio 9.94% 13.24% 15.06%
Personnel expense/ loan portfolio 0 0 0
Average salary/ GNI per capita 2 2 1
Cost per borrower 13 13 23
Cost per loan 12% 15% 19%

Table IX: Client-Personnel benchmarks of Large Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
Borrowers per staff member 258 198 136
Loans per staff member 270 198 140
Borrowers per loan officer 478 432 271
Loans per loan officer 484 432 280
Depositors per staff member 0 16 0
Deposit accounts per staff member 0 16 0
Personnel allocation ratio 63.96% 50.12% 58.52%

Table X: Risk benchmarks of Large Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
Portfolio at risk > 30 days 0 0 0
Portfolio at risk > 90 days 0 0 0
Write-off ratio 0.16% 0.00% 0.00%
Loan loss rate 0.14% 0.00% 0.00%
Risk coverage 96.76% 122.74% 234.74%
Non-earning liquid assets as a % of total assets 16.47% 8.58% 9.11%

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22 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 11.8: Comparative Statistics


The previous section dealt with MIX Market benchmarks for small medium and large MFIs. In the
following section, we will compare three buckets4 – MIX Market Universe, NABARD-supported MFI sample
and Aadhaar data on MFIs – with the same performance appraisal parameters.

Table XI: Return on Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 1.66% 1.89% 1.23%
Median 1.54% 1.66% 1.43%
Standard Error 0.21% 0.18% 0.29%
Range 12.49% N/A N/A
Minimum - ve - ve - ve
Maximum 30.62% 30.62% 30.62%
First Quartile 0.40% 0.43% 0.20%
Third Quartile 3.76% 3.84% 3.56%
Count 362 104 438

Table XII: Return on Equity

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 23.99% 28.29% 23.33%
Median 14.74% 16.34% 11.72%
Standard Error 2.27% 1.59% 1.97%
Range 28.59% N/A N/A
Minimum - ve -ve - ve
Maximum 2351.77% 957.10% 2351.77%
First Quartile 3.08% 4.69% 2.91%
Third Quartile 38.19% 40.29% 36.96%
Count 362 104 438

Table XIII: Operating Expense/Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 9.47% 10.03% 12.06%
Median 8.50% 9.32% 10.70%
Standard Error 1.33% 2.76% 1.88%
Range 26.46% 24.51% 30.79%
Minimum 2.09% 2.09% 2.09%
Maximum 28.55% 26.60% 32.88%
First Quartile 5.33% 5.20% 6.40%
Third Quartile 12.17% 10.30% 13.53%
Count 362 104 438

4
MIX Market has about 90 MFIs; NABARD-supported MFI sample is about 23. Aadhaar has about ~200 MFIs in its sample
base, however, mostly are small MFIs

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 23

Table XIV: Operating Expense/Loan Portfolio

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 11.99% 12.72% 15.27%
Median 10.67% 11.70% 13.43%
Standard Error 2.44% 1.47% 3.80%
Range 38.7% 30.5% 46.9%
Minimum 2.4% 2.41% 2.4%
Maximum 41.1% 32.86% 49.30%
First Quartile 6.9% 6.8% 7.7%
Third Quartile 15.6% 13.21% 16.5%
Count 362 104 438

Table XV: Financial Revenue/Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 19.67% 21.77% 17.37%
Median 19.67% 21.07% 17.56%
Standard Error 0.36% 0.86% 2.64%
Range 24.46% 27.70% 30.45%
Minimum 6.84% 3.60% 0.85%
Maximum 31.30% 31.30% 31.30%
First Quartile 15.30% 16.87% 15.34%
Third Quartile 24.20% 25.37% 22.23%
Count 362 104 438

Table XVI: Financial Expense/Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 7.58% 6.80% 8.60%
Median 8.0% 6.53% 8.84%
Standard Error 0.15% 2.60% 1.80%
Range 10.9% 17.62% 24.22%
Minimum 1.1% 1.10% 1.10%
Maximum 22.0% 18.72% 25.32%
First Quartile 9.2% 11.6% 12.7%
Third Quartile 14.4% 15.7% 18.1%
Count 362 104 438

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24 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Relating returns to scale and performance


Through simple regression statistics we find, by testing the following hypotheses: Are there economies of
scale? Are there increasing returns to scale? Is profitability better for the larger MFIs? – Scale and learning
curve?

The consistently low adjusted R2 reveals that the cost efficiencies are still not entirely discovered.
The strong correlation between portfolio and clients reveal that those MFIs that are unable to disburse are
likely to have failed (or dropped) clients leading to reduced active client numbers. Continuous and active
disbursement is critical to the business. On the other hand, the linear correlation between returns and
scale is quite weak. This could possibly be due to:

a) The focus on “expansion” to cover more ground and get more clients rather than efficiency, cost
reduction. Once the client outreach has been expanded (revenue driver), the next phase would
perhaps focus on greater cost rationalisation and higher profit margins
b) Greater cost efficiency is not possible. Small MFIs are equally efficient (unlikely). Or, the cost
economies cannot be exploited much further (unlikely scenario)
c) MFIs are passing off the cost efficiencies/ benefits to the end beneficiaries (for reasons extending
from competition to social impact)

There does not seem to be benefits of lower risk. This is because the credit risk is possibly is evenly
spread (client behaviour, clientele, client segment) across geographies.

Thus, on a risk adjusted basis, if there are no scale benefits, then should the microfinance model be
scaled or replicated? The R-A-R-O-R-A-C (risk-adjusted-return-on-risk-adjusted-capital) is a useful
indicator for decision on performance and efficiency of the “system” (sector) in terms of scale vs.
replication debate...a useful pointer for legislation and policy.

Need for Regulation


There has to be an external unbalanced force to help the sector out of inertia to ensure that the
sector performs to its potential. Based on this research we posit that two Nash Equilibria exist in the
current scenario in the microfinance sector. The equilibrium is two-fold:

(a) Client view: There is no unilateral profitable motive from any of the clients involved. If they are
currently paying, then they continue to do so. However, as is the case in A.P., where the current
repayment rates (Post A.P. Ordinance; Oct 2010– March 2011) are 10-15% on average, as nobody
wants to feel short-changed on ethical grounds.
(b) MFI view: There is no reason to play by ethical standards since generally everyone seems to be
looking at maximising profits.

Prima facie, in the status quo (equilibrium) each decision maker’s strategy – being largely “wait
and watch” – is optimal given the information of all other decision makers. Since there is no
unilateral profitable noticeable from any of the MFIs involved, i.e. in other words, no decision maker
would take a different action as long as others remain the same (Question is: Why should I be the first?),

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since the equilibria are self-enforcing, decision makers are at a Nash Equilibrium and they have no desire
to move because they will be worse off.

While we would neither speculate nor really have a loci-standing to even suggest a regulator for the
sector, (with the Malegam Committee’s hallmark recommending that microfinance be regulated by RBI),
but based on our assessment of the field and within the scope of the project from a performance
perspective, we believe that the District Development Manager (DDM), of NABARD c/would play a greatly
enhancing role in ensuring that bottoms-up regulation is taking place. Microfinance is a localised
business; the activities need to be policed in situ and this must not be undermined. Further, given that
NABARD is uniquely positioned to understand microfinance nuances at the operational level, right now
microfinance needs more than ‘light and careful’ regulation for it to survive as a sector and to continue to
achieve social and commercial benefits. Unless measured steps are taken to control the operational
deficiencies, we could be staring at massive defaults, issues at hand in direct loggerheads with the
commercial interests. With an already large microfinance client base – and risks of credit defaults –and
competition only intensifying by the day, the need to get 99%+ repayment does put undue pressure on
the MFI management. Speedy but well-thought out policy initiatives need to be taken. The Dual Mission:
MFIs combine a social mission- provision of financial services to the lowest-income population possible-
with a financial objective that drives the institution to achieve self-sufficiency. Several MFIs have attracted
private sources of capital to establish themselves in the market. The extent to which microfinance
institutions seek to maintain the dual focus of profitability and outreach to poor clients is in the approach
of the management. The two objectives are not mutually exclusive: The management with its strategic
decisions and policies can move institutions in the direction of achieving high profitability and reaching an
expanding clientele of low-income entrepreneurs. Local realities (especially those concerning
repayments) need to be factored in within the context of the double bottom-line challenge. While
DDMs would indeed need to be trained for the specific tasks, but given that they are aware of all
the local realities, the NGOs and that they are already on a rotation / transferrable job (reducing
the risks of collusion), on this ground, NABARD - perhaps - is better suited for playing the
regulator’s role.

Driving meritocracy through Policy


Keeping in view performance benchmarks and driving the sector to optimal performance, policymakers
have several instruments in their toolkit with which they may address anti-competitive practices and
patterns. This section discusses the main approaches in turn.

Barriers to entry in any market may arise from various sources. Depending on the source identified, the
policy maker may have different ways of reducing the barrier so as to make the credit market more
contestable.

Scrutinize pricing policies and patterns. Certain aspects of the lending process on the supply
side are subject to economies of scale, including the collection of information about clients and
the credit screening process. A new or small firm which does not have enjoy the benefits of scale
may find it hard to enter the market successfully if incumbent firms exploit their scale advantages
by lowering prices to pre-empt entry or eliminate a competitor. Regulators therefore have to look
carefully at pricing policies and patterns, especially of larger lenders, to ensure that the intent is
not anti-competitive.

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26 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Monitor network effects. On the demand side, certain credit products like credit cards exhibit
network-like features: the cards are more valuable the more widely they are accepted. These
aspects of credit card schemes have resulted in competition authorities in various jurisdictions,
including EU, UK, Australia, Mexico and South Africa, subjecting them to increased scrutiny in
recent years. Regulators have consequently paid more attention to the levels of interchange fees
set for transactions across network members, and to the terms of access to these networks.
Support the formation and growth of credit bureaus. High switching costs make it harder for
customers to change to a new supplier which offers better terms. In the absence of a credit
reference bureau which makes their track record accessible and “portable” to other lenders,
borrowers may be unable to switch to a new lender. Equally, the absence of ready access to
borrower histories constitutes a barrier to entry for new lenders. The introduction of a credit
bureau which enhances the portability of both good and bad credit records can therefore bring
substantial advantages to lenders and borrowers. Luoto et al (2007) and McIntosh and Wydick
(2007) demonstrated this using a randomized field experiment following the introduction of a
credit bureau in Guatemala. The effect of better screening of risky borrowers, and even to some
extent, the positive incentive effect on borrowers who know that their record is now being
monitored, reduced the risk of default to the lender. For this reason, the UK’s Competition
Commission ruled in 2007 that home credit lenders must in the future submit borrower profiles to
a credit reporting agency.
Avoid onerous licensing requirements. Government regulation, embodied in licensing
requirements to enter a market, may constitute a barrier to entry. These may take the form of
high minimum capital requirements or an approval process which adds delay and cost for
entrants. Typically, where lenders are required to be licensed for their lending business (rather
than, say, as deposit taking entities), the capital and general entry requirements are relatively
light5.For example, the South African National Credit Act of 2005 sets low qualification
requirements on lenders and imposes a registration fee which varies with size such that it is not
onerous on small lenders. This reflects the general situation in most jurisdictions that there are
already many lenders of differing sizes so that an onerous formal registration requirement is hard
to enforce. However, if lenders are also deposit taking institutions, then they face much more
onerous regulatory barriers to entry because of the additional prudential and systemic risks.
Regulators need to evaluate whether the requirements for entry to a particular regulated market
(e.g., credit as distinguished from deposit taking) are unduly onerous for that particular activity so
as to constitute an unnecessary barrier to entry which protects incumbents.

In addition to considering how these factors affect the height and extent of barriers to entry, policy
makers must consider expected retaliatory tactics which incumbents do or could use. To make markets
more contestable, competition law may explicitly prohibit certain forms of retaliatory behaviour such as
artificially lowering prices to deter or squeeze out a new entrant. This is taken up in the next section.

Charting the Territory

5
Civil code countries are often an exception to this, creating substantial barriers to entry for formal lending.

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 27

Financial sector policy should encourage healthy competition in microcredit markets. Policy makers have
at their disposal a range of instruments which can be used to pursue this goal. The starting point for
navigating the course of competition policy is to define healthy competition, in sufficiently clear terms so
that the intensity of competition can be assessed and monitored over time. At a minimum, it means the
absence of prohibited anti-competitive behaviour: when such behaviour is reported or identified,
authorities should investigate, and if warranted, penalize it.

However, a more pro-active approach would go further to look at diverse characteristics. For example:
healthy competition takes place: across different product characteristics or bases (i.e., not only in one
feature such as service level or location or price, but across the bundle represented by the offering); at an
intensity appropriate to the stage of market development; and in a way which is likely to lead to the
achievement of societal goals, such as broadened access to sustainable credit.

This definition requires that lenders compete extensively (through new products and distribution channels
to target new client segments) and intensively (among existing clients). In addition, policy makers usually
wish to see competition on interest rates as a manifestation of healthy competition. As shown earlier,
price competition in credit markets may usually start only at later stages of development but it is more
likely to start earlier if there is a diversity of lenders with different strategies in the market, than if one
product type or lending approach prevails. Competition policy should be directed toward encouraging
these market conditions.

In the long run, a healthy credit market is likely to deliver better products, higher quality service, higher
levels of access, as well as lower relative interest rates. One example of a credit market in which
competition has resulted in much greater access, together with diverse products and generally lowers
rates to mainstream borrowers is the credit card market in the U.S. Sidebar D describes some of the long
term effects of competition in this market. Although credit cards differ from microloans (because the card
offers transactional capabilities), credit cards increasingly compete with microcredit in some developing
markets as a flexible line of credit for individuals and small businesses.

Competition took a while to gather momentum in this market: while credit cards were introduced in the
U.S. in the 1950’s, only from the 1970’s did usage and access increase rapidly. Although the underlying
credit card product is essentially similar among all lenders, competition has long taken place on the basis
of differentiated product features. Only in the 1990’s (forty years after launch) did price-based
competition set in. This followed the entry of new mono-line card lenders which used marketing strategies
different from those of the incumbent commercial bank issuers. Increased access, greater choice, even
lower rates for at least the majority of customers are positive fruits of competition. However, this market
also shows one of the clear negative signs of competition listed earlier: the sector is beset with claims that
aggressive marketing and reckless lending by some lenders has led to over-indebtedness. This factor
combined with economic slowdown has caused rising stress in the default performance of credit card loan
portfolios. As microcredit evolves over time as a segment of the broader personal credit market, this
example from another developed market shows that, even in the long run, the predicament of how to
promote healthy market development through healthy competition does not easily or soon go away. But
policy makers can seek the knowledge and tools with which to better drive the path in microcredit.

Recommendations and next steps

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28 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Based on our study, we find that the standardisation parameters for a social business environment are
missing. For a sector that has been kindled by philanthropic funds, huge impetus given by government
aid (directed as well as direct), the transparency levels are abysmally poor.

The industry associations – Sa-Dhan and MFIN – have endeavoured to take huge measures to induce
greater accountability and transparency. That the number of MFIs volunteering information to MIX Market
is <100 is itself perhaps an indication of the disinterest that players have in a transparency and wider
accountability. The usual governance quarters too have failed to check the malpractices that are fast
becoming the norm in microfinance. For the others, the data is dated; leading to lesser value for Policy
level decisions.

One of the most commonly discussion points in microfinance, “transparency” (and accountability) is
indeed an issue. Unless they have reasons to hide, MFIs should forward with their honest statement of
performances. At the local level, the enabling regulatory environment can turn adverse – as happened in
the case of A.P. – in public interest should MFIs choose to not mend their ways.

It may not be challenged that microfinance is getting the benefits of ‘directed’ credit. The subsidisation
(and tax sops, where applicable) for financial inclusion is indeed coming in from the exchequer and the tax
of the different audience. This subsidisation is in the long-term political, economic and financial stability
of India. However, in the absence of social audits, the metrics of social impact cannot be measured.

There are a few efforts for social performance parameters; however, the literature and efforts are far from
developed to be practically applicable. Why can funders – specifically banks – not factor in a social rating
in their financial discussion? This way – the social aspects of the business can be protected.

This study was limited to studying the six states chosen. The findings are quite limited based on the small
sample of MFIs, the limited geographies and specifically the timing of the project.

A broader outlook may be evolved if we relax the degrees of freedom. Perhaps

The scope of study should be expanded to other geographies – apart from the six states
mentioned. Phase review of MFIs and expand to an overall India study
The scope should include – not just discussions with NABARD supported MFIs – but also a wider
population of MFIs to be more representative of the sector. Maybe some of these perspectives
can be done while conducting seminars and workshops.
The project has been conducted at a time when the sector was caught in the middle of a storm.
Not only A.P. microfinance was in doldrums, but also credit availability was (unusually) zero across
the country6. The general belief in the field that the “expectation” of further credit keeps the
status quo of repayment, also caused dishevels in the sector elsewhere. A different outcome and
may be expectation in the review phase after 3-4 months.

Contents

6
Except for Rs 100 Cr secured loan given to BASIX Group.

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 29

COMMON ABBREVIATIONS ......................................................................................................................... 34


PREFACE ...................................................................................................................................................... 35
CHAPTER 1: THE BACKGROUND ................................................................................................................. 37
SECTION 1.1: BENCHMARKING PRACTICES OF MFIS .............................................................................. 37
SECTION 1.2: WHAT ROLE IS INTENDED FOR THIS REPORT TO PLAY? ..................................................... 37
SECTION 1.3: APPROACH TO BENCHMARKING MFIS .............................................................................. 38
OBJECTIVES ............................................................................................................................................. 40
CHAPTER 2: THE MICROFINANCE CRISIS 2010-11 ...................................................................................... 41
SECTION 2.1: THE CONNECTING ISSUES .................................................................................................. 41
SECTION 2.2: THE MARKET STRUCTURE ................................................................................................ 41
SECTION 2.3: UNDERSTANDING THE MFI GROWTH CYCLE..................................................................... 42
SECTION 2.4: THE GROWTH STORY ......................................................................................................... 43
SECTION 2.5: SCENARIO PRECEDENT, THE GOLD RUSH .......................................................................... 44
SECTION 2.6: WHAT HAPPENED IN ANDHRA PRADESH? ......................................................................... 44
SECTION 2.7: GOVERNANCE.................................................................................................................... 46
SECTION 2.8: CORPORATE GOVERNANCE FOR NBFC-MFI .................................................................... 49
SECTION 2.9: ISN’T GOVERNANCE THE KEY?.......................................................................................... 49
SECTION 2.10: TRANSFORMATION OR MISSION DRIFT? .......................................................................... 51
SECTION 2.11: SOCIAL PERFORMANCE AND IMPACT .............................................................................. 51
SECTION 2.12: STRATEGIC ISSUES FOR THE FUTURE ............................................................................... 56
SECTION 2.13: LOOKING TO LEVERAGE .................................................................................................. 58
SECTION 2.14: THE ‘NUMBERS’ TREND PERIOD ..................................................................................... 59
SECTION 2.15: COMMERCIALISATION OF MICROFINANCE ...................................................................... 63
SECTION 2.16: THE MYSTERIOUS CASE OF SKS ..................................................................................... 65
SECTION 2.17: NEXT GENERATION, EXPANDING THE PRODUCT PORTFOLIO ........................................... 67
CHAPTER 3: FINANCIAL LITERACY ............................................................................................................. 69
SECTION 3.1: OPENING REMARKS ........................................................................................................... 69
SECTION 3.2: FINANCIAL LITERACY, A GLOBAL AGENDA ...................................................................... 70
SECTION 3.3: FINANCIAL LITERACY - THE INDIAN LANDSCAPE ............................................................. 70
SECTION 3.4: SUMMARY OF FINANCIAL LITERACY AND MICROFINANCE CLIENT INTERVIEWS .............. 72
SECTION 3.5: KEY FINDINGS THAT INDICATE THE DIRE NEED FOR FINANCIAL LITERACY ...................... 73
SECTION 3.6: FILLING THE NEED FOR FINANCIAL LITERACY .................................................................. 75
CHAPTER 4: RESEARCH SAMPLING AND METHODOLOGY .......................................................................... 79
SECTION 4.1: OVERVIEW ......................................................................................................................... 79
SECTION 4.2: RATIO ANALYSIS ............................................................................................................... 80

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30 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

SECTION 4.3: ORGANISATIONAL DEVELOPMENT .................................................................................... 80


SECTION 4.4: FIELD AUDIT ..................................................................................................................... 80
SECTION 4.5: SAMPLING.......................................................................................................................... 81
SECTION 4.6: CLIENT LEVEL DATA COLLECTION AND ANALYSIS .......................................................... 83
CHAPTER 5: PERSPECTIVES FROM THE FIELD ............................................................................................. 86
SECTION 5.1: THE DISCOURSES............................................................................................................... 86
SECTION 5.2: OVERVIEW OF GROUP DISCIPLINE .................................................................................... 98
SECTION 5.3: FIELD OBSERVATIONS ....................................................................................................... 98
SECTION 5.4: PREPAYMENT .................................................................................................................. 101
SECTION 5.5: SYSTEM EVALUATION, OPERATIONS AND CREDIT POLICY ............................................ 102
SECTION 5.7: RECORD KEEPING AT BRANCH LEVEL ............................................................................ 108
SECTION 5.8: INTERNAL AUDIT............................................................................................................. 111
SECTION 5.9: MANAGEMENT INFORMATION SYSTEMS (MIS) .............................................................. 114
KEY QUESTIONS TO ADDRESS ........................................................................................................... 116
BUILDING AN EFFECTIVE MIS ........................................................................................................... 118
SECTION 5.10: HUMAN RESOURCES ...................................................................................................... 122
SIGNIFICANCE OF HR IN MFIS .......................................................................................................... 122
MFI STRUGGLE FOR QUALITY TALENT ............................................................................................ 123
THE GAP AS AN OPPORTUNITY .......................................................................................................... 125
OPTIMIZING THE HUMAN CAPITAL ................................................................................................... 125
IMPROVING ON HUMAN CAPITAL MANAGEMENT ............................................................................ 127
CHAPTER 6: THE INTEREST RATE DEBATE ................................................................................................ 131
SECTION 6.1: “WHAT-IF” SURVEY AND ANALYSIS ................................................................................ 131
SECTION 6.2: THE FACTS PRÉCIS .......................................................................................................... 133
SECTION 6.3: DOES COMPETITION HELP RATIONALISE INTEREST RATES? ............................................ 137
SECTION 6.4: POST SCRIPT ON THE INTEREST RATE DEBATE ................................................................ 138
ARE MICRO-ENTERPRISES – FUNDED BY MICRO-FINANCE INSTITUTIONS – IMMUNE AND
DECOUPLED FROM ECONOMIC CYCLE? ............................................................................................. 139
ARE MICRO-BUSINESSES (WITH LOW CAPITAL INVESTMENTS) CAPABLE OF EXACTING
PROFITS CONTINUOUSLY? ................................................................................................................. 140
INVESTMENT RISKS AND TYPE OF INVESTMENT VEHICLE ................................................................ 141
WHAT DO ANGELS EXPECT (AND GET) ............................................................................................. 142

CHAPTER 7: PREDATORY LENDING ........................................................................................................... 145


SECTION 7.1: PROLOGUE ....................................................................................................................... 145
SECTION 7.2: ENCOURAGING OVER-INDEBTEDNESS ............................................................................. 146

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 31

SECTION 7.3: INCOME DECEPTION......................................................................................................... 148


SECTION 7.4: UNCERTAIN INCOME ....................................................................................................... 150
SECTION 7.5: DOES HIGHER RISK DETER PREDATION? .......................................................................... 151
SECTION 7.6: EQUITY STRIPPING ........................................................................................................... 151
SECTION 7.7: CAN CREDIT COUNSELLORS DISSUADE PREDATORS? ...................................................... 151
SECTION 7.8: SO, IS MICROCREDIT IN INDIA PREDATORY? ................................................................... 151
CHAPTER 8: MULTIPLE BORROWING ......................................................................................................... 153
SECTION 8.1: RESEARCH PRECEDENT ................................................................................................... 153
SECTION 8.2: MULTIPLE LENDING AND COMPETITION ......................................................................... 155
SECTION 8.3: RISK IMPLICATIONS ......................................................................................................... 155
SECTION 8.4: RECOMMENDATIONS FOR FUTURE .................................................................................. 155
SECTION 8.5: MULTIPLE LENDING: CRESA CASE STUDY..................................................................... 155
CHAPTER 9: STRATEGIC PERSPECTIVES USING SCOR .............................................................................. 159
SECTION 9.1: MICROFINANCE SUPPLY CHAIN ...................................................................................... 159
SECTION 9.2: PROCESS MODELLING ..................................................................................................... 159
SECTION 9.3: SUPPLY CHAIN CONFIGURATION .................................................................................... 161
SECTION 9.4: ALIGNING PERFORMANCE, LEVELS, PRACTICES AND SYSTEMS ..................................... 161
SECTION 9.5: IMPLEMENTING SUPPLY CHAIN PROCESSES AND SYSTEMS ............................................ 162
SECTION 9.6: CHALLENGES OF IMPLEMENTING THE SCOR MODEL FOR MFIS IN INDIA ..................... 162
CHAPTER 10: BENCHMARKING PERFORMANCE ........................................................................................ 163
SECTION 10.1: THE TOOLS .................................................................................................................... 163
SECTION 10.2: STANDARDISING PARAMETERS ..................................................................................... 165
SECTION 10.3: GROWTH AND RETURNS ................................................................................................ 166
SECTION 10.4: PORTFOLIO QUALITY .................................................................................................... 167
SECTION 10.5: LIQUIDITY...................................................................................................................... 170
CHAPTER 11: PERFORMANCE IN A COMPETITIVE ENVIRONMENT ............................................................. 171
SECTION 11.1 EVIDENCES OF THE EFFECT OF COMPETITION................................................................. 171
SECTION 11.2: THE STRUCTURE-CONDUCT-PERFORMANCE PARADIGM.............................................. 172
SECTION 11.3: WHAT IS THE RELEVANT MARKET? ............................................................................... 174
SECTION 11.4: MEASURING COMPETITION ........................................................................................... 175
SECTION 11.5: MICRO-CREDIT FEATURES AFFECTING COMPETITION ................................................. 176
SECTION 11.6: WHAT FORMS OF COMPETITION WE SEE IN PRACTICE? ................................................. 177
SECTION 11.7: MIXMARKET MICROFINANCE BENCHMARKS .............................................................. 179
SECTION 11.8: COMPARATIVE STATISTICS ........................................................................................... 184
SECTION 11.9: RELATING RETURNS TO SCALE AND PERFORMANCE ..................................................... 186

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32 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

CHAPTER 12: DRIVING PERFORMANCE THROUGH POLICY ....................................................................... 188


SECTION 12.1: DIRECT COMPETITIVE LENDING BY PUBLIC INSTITUTIONS.......................................... 188
SECTION 12.2: REDUCING BARRIERS TO ENTRY ................................................................................... 188
SECTION 12.3: COMPETITION POLICY ................................................................................................... 190
SECTION 12.4: SPECIALIZED “COMPETITION” REGULATORS ................................................................. 190
CHAPTER 13: NAVIGATING THE COURSE: CHARTING THE TERRITORY .................................................... 192
CHAPTER 14: REGULATION ....................................................................................................................... 194
SECTION 14.1: OUTLOOK OF POLICIES SINCE 1998 ............................................................................... 194
SECTION 14.2: STIMULATING THE SECTOR THROUGH INJECTION ......................................................... 196
THE UNION BUDGET 2011 ................................................................................................................ 196
SECTION 14.3: NEED FOR REGULATION ................................................................................................ 197
SECTION 14.4: NEED FOR EYES ON THE FIELD....................................................................................... 199
CHAPTER 15: NEXT STEPS......................................................................................................................... 201
SECTION 15.1: BRING TRANSPARENCY AND ACCOUNTABILITY ........................................................... 201
SECTION 15.2: SOCIAL AUDIT ............................................................................................................... 201
SECTION 15.3: EXPANDING HORIZONS .................................................................................................. 201
REFERENCES ............................................................................................................................................. 203
APPENDIX 1: MFI PROFILES ...................................................................................................................... 206
APPENDIX 2: REGULATORY CAPTURE ...................................................................................................... 233
SECTION A2.1: INITIAL IMPRESSIONS ................................................................................................... 233
SECTION A2.2: THE ECONOMIC RATIONALE ......................................................................................... 233
SECTION A2.3 WHAT’S UP WITH MICROFINANCE ................................................................................. 234
APPENDIX 3: RECOMMENDED PARAMETERS FOR PERFORMANCE APPRAISAL .......................................... 235
APPENDIX 4: NABARD SUPPORTED MFIS ............................................................................................... 253
APPENDIX 5: PERFORMANCE PARAMETERS .............................................................................................. 255
APPENDIX 6: ORGANISATION DEVELOPMENT INTERVENTION ................................................................. 257
APPENDIX 7: ON-FIELD RESEARCH AND ASSESSMENT .............................................................................. 259
OVERVIEW OF THE PROCESS ............................................................................................................. 259
APPENDIX8: SAMPLE QUESTIONNAIRE ADMINISTERED ........................................................................... 260
ADMINISTRATION.............................................................................................................................. 260
LOAN PASSBOOK ............................................................................................................................... 260
ATTENDANCE .................................................................................................................................... 260
LOAN ORIGINATION .......................................................................................................................... 260
LOAN DISBURSEMENT ...................................................................................................................... 260
LOAN REPAYMENT ............................................................................................................................ 261

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 33

LOAN UTILISATION CHECK ............................................................................................................... 261


APPENDIX 9: A FEW CHECKPOINTS FOR THE BRANCH .............................................................................. 262
CHECKING THE LOAN DOCUMENTS .................................................................................................. 262
CHECKING THE MIS .......................................................................................................................... 262
CHECKING THE CASH TRANSACTIONS AT BRANCH LEVEL .............................................................. 262
LOAN PREPAYMENT .......................................................................................................................... 262
APPENDIX 10: THE MICROCOSM AND MACROCOSM OF MICROFINANCE ................................................. 263
APPENDIX 11: ASSET-LIABILITY MANAGEMENT (ALM) ......................................................................... 266

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34 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Common Abbreviations
AP Andhra Pradesh
BC/BF Business Correspondent / Business Facilitator
BDO Block Development Office
BIRD Bankers Institute of Rural Development
BM Branch Manager
BOP Bottom of the Pyramid
CEO Chief Executive Officer
CRISIL Credit Rating and Information Services of India Ltd.
DDM District Development Manager
FGDs Focus Group Discussions
FWWB Friends of Women's World Banking
HDFC Housing Development Finance Corporation
HO Head Office
HR Human Resources
ICT Information and Communications Technology
JLG Joint Liability Group
MACTS Mutually Aided Cooperative Credit and Thrift Society
MFI Microfinance Institution
MFRC Micro Finance Regulatory Council
MIS Management Information Systems
NABARD National Bank for Agriculture and Rural Development
NBFCs Non-Banking Financial Company
NCAER National Council for Applied Economic Research
NGO Non-Government Organization
ODI Organisational Development Initiative
OE Operational Excellence
OSS Operational Self-Sufficiency
OTR On Time Repayment
PSL Priority Sector Lending
RRB Regional Rural Bank
SCOR Model Supply Chain Operations Reference Model
SHG Self Help Group
SIDBI Small Industries Development Bank of India
SME Small and Medium Enterprise
SCM Supply Chain Management

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 35

Preface
Even as we address the immediate problems of microfinance, we must keep in mind the medium and
long-term goals, and the constraints that need to be overcome in order to achieve these goals. As
inclusive growth becomes an expression of common usage now we should attempt to bridge the various
divides in our economy and society, between the rich and the poor, between the rural and urban
populace, and between one region and another. The essence of the formidable task through the inclusive
pursuit of growth has to be such that all sections of society benefit from the growth process.

One aspect of inclusive growth is financial inclusion7. The process of financial inclusion is an attempt to
bring within the ambit of the organised financial system the weaker and vulnerable sections of society.
Financial inclusion can be defined as the delivery of credit and other financial services at an affordable
cost to the vast sections of the disadvantaged and low income groups. With so much talk about financial
inclusion, microfinance, per se, needs no introduction. Or its importance needs stress. In our context of
discussion on “financial literacy” we summarily summarise, ‘Microfinance in India is currently being
delivered by three models’:

Table 1: Microfinance Delivery Models8

Model Concerns Improvement Areas


1 Bank-SHG Quality, delinquencies, Though NGOs were initially entrusted with financial
intermediation cost, rural literacy, it is a concern for all three models
banker attitudes9
2 MFI model (NBFCs, Profiteering, on field practices, Transparency, governance and monitoring can be
Section 25 Co., NPOs) Lack of regulation, improved. Can ICT play a role?
Conflicts of interest
3 BC/BF Sustainability, Application Last mile linkage using technology (mobile PDA,
internet kiosks etc.) BC/BF model to enhance
financial inclusion

7
The correlation and the causal effect relationship between finance and economic development has been amply studied in
literature. It is now believed that (access to) finance is a necessary but not sufficient condition towards economic development.
As above, so below and thus an effective tool for poverty alleviation is financial inclusion indeed.
8
In market microstructure terminology, the Bank-linkage models (SHG or BC/BF0 are broker models; the MFI model is the
dealer model. The theory of intermediation has interesting insights we can deduce to understand the efficacy and performance of
either, given the prevalent market condition(s),
9
“There are many things that can be said in order to improve the organisational efficiency of banks and other financial
institutions. Importantly, there is a need for a change in the attitude of the people who serve in the banks. Empathy with the poor,
empathy with those who need credit must be established and here, perhaps, improved training will help.” – C Rangarajan, ex-
Governor, RBI and Chair of Financial Inclusion Committee Report, Preface, “Speeding Financial Inclusion”, Skoch Foundation,
2010

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36 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

“...if we think that poverty can be eradicated by putting


more money in the hands of the poor, then, we should
have no poor people in India by now as we have been
doing that for several years. Eradication of poverty and
A constant endeavour
inclusive growth require much more than mere
of this research has
consumption credit. And savings should be a very critical
been to garner and component of any such strategy, as is in the SHG bank-
provide insights into linkage program. In fact every loan is like a discounted
the causes rather than long-term savings product and therefore, we must start to
the effects of refocus on savings and only then can we have a strong
(repeated) crises in resultant impact on the lives of the poor.” He further
microfinance and added that “given that much of the MFI related crisis has
what policy been happening time and again, it is clear that,, as Ms
Dalal had earlier said, we have not learnt from past crisis
interventions may be
situations and also, we seem to have tackled the
deployed to avert
symptoms more rather than the real causes.”
future failures.
Dr. Prakash Bakshi, Chairman, NABARD

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An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 37

Chapter 1: The Background

Section 1.1: Benchmarking practices of MFIs


The growth and evolution of the Indian microfinance sector is constantly driving the need for adequate
and accurate information and therefore increased transparency from MFIs. However, in most cases, due to
poor standards of operations or pressed under the situation of mission drift, the MFIs struggle to provide
the basic information indicating their performance. One of the reasons for lack of transparency is the
absence of a definite market and business structure – the diversity of the players, with organisations of
very different sizes and ranges of activities; second being each organisation measures different things
differently. With improved business practices implementation and developing leadership models, MFIs are
gradually taking the transition route to fully regulated financial institutions, where augmenting
competition at every level among growing numbers of MFIs for both funding and clients has made
improved financial performance a necessity for majority of the MFIs.

Section 1.2: What role is intended for this report to play?


Given that India is the largest microfinance market envisage the sector to evolve into. With more
in the world, and with its importance and IPOs in the pipeline in the microfinance sector10;
eminence in the sector, it is imperative that the regulation should bring about a little more
microfinance in India prospers. Ideas and insights transparency in a small number of these
that pave the path towards setting the Microfinance companies in financial regulatory
benchmarks in the MFI sector – with regards to terms. However, much of the operating insights
strategic vision, performance and excellence in would remain uncovered. Through this project,
delivery should be welcomed.
we aim to share the minute nuances among
BIRD is uniquely positioned to counsel MFIs and several players in the sector to identify
NABARD, a pre-eminent constituent in the improvement pointers in various respective
microfinance sector in India, on setting yardsticks operating models, performance parameters and
for performance which would strongly facilitate more than anything provide insights on the
the improvement in the standards of operations larger strategic vision. With this output, BIRD
within the sector through evolved and enhanced can play a significant role with its training,
training and organisation development, thereby consulting and organisational development
pushing MFIs towards operating on a more practices to enable the client MFIs operate at a
efficient and sustainable model, enhanced decision higher level.
making, as well as fortifying integrity in the sector.

The recent criticisms on the microfinance sector


of making poverty ‘a big and organised
business’ can be countered by running efficient,
transparent, sustainable organisations within the
free-market framework with low operating costs
and passing on the benefits to the end clients at
the base-of-the-economic pyramid, exactly how 10
SKS, for one, with its blockbuster IPO has shown the way.
the proponents the sector would perhaps Many other leading MFIs have aspirations to follow suit as
soon as possible.

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38 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 1.3: Approach to Benchmarking MFIs


Aadhaar proposes benchmarking – systematic and logical comparison of organisational processes at
various components of the value chain and benchmark performances (as per defined set of
parameters) across the sector– and map performance and identify best practices. Through this effort, we
intend to help the sector create enhanced standards and approaches in terms of human resource
planning, strategy implementation and overall organisation development.

Exhibit 1: Benchmarking Process

IDENTIFYING
AMENDMENTS SERVICES TO
Benchmarking is an involved IN PROCESSES BENCHMARK
process that would need a lot
of commitment to succeed.
IDENTIFYING
More than once, benchmarking IMPLEMENTATION COMPARABLE MFIs
AND ASSESSMENT
projects end with the 'they are
different from us' syndrome or
competitive sensitivity prevents MANAGING
the free flow of information that Systems People IMPROVING DATA
ACTION PLAN
is necessary. However DEVELOPMENT
COLLECTION
(QUAL-QUANT)
comparing performances and
Processes
processes with 'best in class' and
staying away from common bad
practices, is of paramount ESTABLISHING
important. The process TARGETS IDENTIFYING
PERFORMANCE GAP
improvement should ideally be MEASURING
done on a continuous basis.
COMMUNICATING
ASSESSING
TO BIRD FOR
PERFORMANCE
APPROVAL
POTENTIAL

The sector needs access to detailed product-service delivery approaches, governance standards, cost
reduction mechanism and human capital development models. While there are a large number of
mushrooming MFIs, the systems, operations and the overall sustainability impact remains a big question.
This information would allow existing and potential MFIs to build competency and growth models.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 39

In this assessment, we adopted custom benchmarking models and assessment tools (through
primary research: qualitative and quantitative)to determine select sample of financial
institutions’ performances vis-à-vis other similar organisations.

Performance parameters, practices and benchmarks will, eventually, aid for improving
communication, professionalizing the organisation/ processes or for budgetary reasons.

Traditionally, performance measures have been compared with previous measures from the
same organisation at different times11.

Specifically, we will use three types of benchmarking modes:

o Competitive12 (benchmark performance or processes with competitors)


o Functional13 (benchmark similar processes within an industry; elsewhere in the world)
o Generic (comparing operations across similar platforms e.g. SHG-linkage, banking)

Exhibit 2: The Benchmarking Assessment Model

FINANCIAL

OPERATIONS STRATEGY CLIENTS

LEARNING &
GROWTH

11
Although this can be a good indication of the rate of improvement within the organisation, it could be that although the
organisation is improving, the competition is improving faster.
12
Benchmarking for Best Practices: Winning Through Innovative Adaptation
13
Supply Chain Excellence: Using the SCOR Model
40 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Objectives
This action research started with the following principle set of objectives:

5. To assess on-field performance and practices through sampled examination


6. To ascertain the benchmarks across performance parameters used to ascertain the health of
any MFI
7. To analyse the selected NABARD supported MFIs along these measures. An aggregate level of
assessment could compare NABARD supported MFIs vis-à-vis the general sector
8. To enhance their operational efficiency through consulting them on organisational
development and sampled loan portfolio audit

Additionally,

3. Apart from the obvious benefits accrued to the sector, researchers and watchdogs could get a
status check on the MFI sector
4. Help create and put in place early warning systems and policies to address organisational
development issues and help enhance and measure growth imperatives

The focus of this study is to bring actionable results. WE propose to


assist any MFI interested in accentuating their performance; we will
focus on enhanced operational, financial efficiency and suggest ways
to manage operational and credit risks.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 41

Chapter 2: The Microfinance Crisis 2010-11

Section 2.1: The connecting issues


MFIs supply banking and financial services to micro-enterprises and poor householders enabling them to
raise their income levels and improve living standards. Nearly all MFIs state their dual mission of providing
financial aid to poor clients and building financial sustainability. Hence, their performance ought to be
measured along both these facets.

In India, microfinance is provided by apex development financial institutions such as NABARD, SIDBI and
RMK, commercial banks, regional rural banks, co-operative banks, Non-Banking Finance Companies
(NBFCs) and various not-for-profit entities. There are different mechanisms through which the delivery of
micro credit loans takes place. Though banks may lend directly to customers, NABARD sponsors the Bank
Self Help Group (SHG) contents Lending Program. In the last decade or so, a large number of MFIs have
set up that lend directly to borrowers at the BOP.

The Microfinance Institutions lend to SHGs and/or Joint Liability Groups (JLGs); also known as Grameen
groups). The number of MFIs in India involved in lending activities is estimated variously, broadly to be
around 3000. These MFIs vary significantly in size, outreach and credit, delivery methodologies. Presently,
the lending activities of MFIs are not regulated except for those registered as NBFCs.

Exhibit 3: Microfinance institutional flow of capital

Banks, Apex Self-help


Microfinance
institutions, Groups/Joint Individual Clients
Institutions
investors, Donors Liability Groups

Section 2.2: The Market Structure


Microfinance sector in India was in its embryonic stages in the early 1980s with the formation of informal
Self Help Groups (SHGs) that provided access to financial services to the needy people who are deprived
of credit facilities.

The microfinance sector can be classified into multiple tiers, with no real consensus on definitions. A large
number of rapidly scaling-up MFIs have expanded our view of tier 1 to include 100-150 MFIs. The tier-1
MFIs could be incorporated under a wide range of legal forms.

The tier-1 MFIs formed the epicentre for funds and activities in the microfinance sector in India. These
organizations are well established at the national level, with sufficient funds to park in the budding
market. NABARD, SIDBI, HDFC, RMK, leading Commercial Banks are a few examples of financial
institutions that were involved in transforming and creating the microfinance revolution. They helped in
enhancing access to microfinance services to the unbanked.

The increasing demand and rigid functioning of the MFIs gave rise to the subsequent tiers of MFIs,
categorized as alternative MFIs. These included MFIs setup as cooperatives, such as the SEWA Bank and
42 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

various Mutually Aided Cooperative Thrift and Credit Societies (MACTS); NGOs, mainly engaged in
promoting self-help groups (SHGs) and their associated federations in the region, and coupling SHGs with
banks for funds, under the NABARD scheme; NGOs directly lending to borrowers, who are either setup as
SHGs or organized into groups in line with the Grameen Bank model. They borrow bulk funds from
donors like SIDBI, FWWB etc.

MFIs are also currently registered as Non-Banking Finance Companies (NBFC) such as SKS, Share,
Spandana, Bandhan, S.M.I.L.E., Equitas, Asmitha etc. The mainstream financing institutions fund either (i)
NGOs or (ii) NGO promoted SHGs or (iii) alternative MFIs; a vast majority of the these institutions set up as
NGOs for getting access to funds transformed into NBFCs for a variety of reasons, most importantly -
sustainability. The market entry by organizations to offer such services has typically been through the
non-profit route. Increasingly, however, new generation MFIs are setting up directly as NBFCs to attract
private equity interest from MFIs.

Section 2.3: Understanding the MFI growth cycle


The needs and concerns for MFIs differ at different phases of its growth.

Exhibit 4: MFI growth curve – key initiatives and concern areas at each phase

• Building loan portfolio • Build economies of scale • Improve operational


efficiencies
Degree of maturity and market penetration

• Founder’s experience and • Strength of management • Depth of management team


vision team • Coherent strategic vision
• Depth of business plan • Strength of day-to-day • Strength of financials
operations
• Strength of financials

• Commercial equity • Commercial equity • Commercial equity


• Sponsor’s equity • Social equity • Social equity
• Social equity • Private equity • Private equity
• Donations/grants • Commercial debts • Equity from public
• Concessional debts • Public deposits • Commercial debts
• Retained earnings • Capital markets
• Retained earnings
• Public deposits

EARLY GROWTH TOP TIER

• Gestation period • Paradigm foundation • Developing potential and Time


• Unprofitable • Introduction of new funds expertise
• Local operational setup • Promoting success driven • Infuse large size funds
• Launch basic short term, small products, introduce new • Established operations
size loans products • Financial stability
• Gradually focus on setting
regional operations
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 43

For the early start-ups, the key areas on high priority are The constraints in bridging the gap of
creating loan plans, as these organizations are just about to the demand-supply
set up their management and operations and gradually move
towards sustainability and profit-making. Highly fragmented sector, which
eventually makes the organizations
MFIs need both capital and internal operating capacity to operate predominantly at a regional
achieve economies of scale in the growth phase. In this phase, or local level and in restricted
organizations typically tend to focus on establishing equity in channels
the market and retain earnings. As an effort towards this goal, Lack of proper corporate governance
they aim to build the management, develop product portfolio, and accountability, which typically
scale up operations and strengthen the financials. arises due to the absence of rules and
directives, also augmented by lack of
As the operations gradually ramp up- supported by clear
proper commercial guidance
management vision, strategic objectives and market
Due to poor governance, the
penetration- organizations approach to the top rung league
organizations face issues in gaining
in the sector. Organizations in this group emphasize the need
sufficient access to funds, therefore
for financial strength and the operational efficiencies, which
face financial instability and
eventually enables infusion of large scale funds from private
constraints which in the long run leads
equity and thereafter by going public, and therefore
to inappropriate legal structures.
encourage new product launches and market expansion.

Section 2.4: The growth story


The general view so far, has been that MFIs have not been able to sufficiently penetrate the target market
(despite an astounding 30-35% growth rates). The demand-supply gap remains huge and the untapped
potential for microcredit (or microfinance) is phenomenal:

Exhibit 5: Demand supply gap in Indian microfinance sector

Demand

Supply
US$40
billion

US$13
billion

US$1.5-2
billion

2005 2010 2015


44 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Many traditionally loss-making rural banks have shifted their portfolio away from the rural poor. SHG-
based microfinance aided by NGOs, which became an important substitute to traditional lending routes
for the poor without incurring huge operating and monitoring expenses, have successfully created the
model that works. Thus a large chunk of the credit supply was routed through the SHG-Bank association.
The remaining was attributed by MFIs backed by philanthropic donors and commercial banks.

In recent times annual reports of Sa-Dhan and State of the Sector Report (2009, 2010), suggest that, the
difference in the market share is narrowing with increase in the credit flow to SHGs and unprecedented
growth of loans volumes offered by MFIs. Just recently (as recent as a year ago), even the largest
Microfinance Institutions (viz., SKS, Share, Spandana, Asmitha, Basix, Bandhan), growing at ~100% (y-o-y),
did not have a portfolio that met even 10% of the total demand exhibiting a highly fragmented industry.
This represented a massive opportunity for the growth of Microfinance Institutions (MFIs). While the
demand for microfinance in India is phenomenal, there are a few (but a steadily increasing number)
scalable microfinance institutions that can / could meet this demand. Furthermore, the concept of
microfinance was traditionally projected as a social commitment rather than potential business
opportunity. However, with increasing need for funds and sufficient market awareness about the product
offerings and related benefits, the conventional definitions went through a process of refurbishment.

Section 2.5: Scenario precedent, the gold rush


When it was clear to many that microfinance presents the opportunity to “make profits” (and supernormal
at that), there was a huge surge of institutions to become microfinance institutions. Transformations,
NBFC fresh applications and loan proposals started pouring in. The cost of entry was low: It needed about
Rs 40 Lakhs (Rs 25 Lakhs as capital for meeting RBI norms of pre 1997 registered NBFC, and professional
and premium put together another Rs 15 Lakhs). Regulatory environment was enabling. Suppliers were
easy to find – bankers were the financiers of raw materials. The demand was H-U-G-E, given the reports of
“unbanked” sector in India. The only threat was from replacement by Bank-SHG model and BC-BF model,
both of which had their serious deficiencies. Thus, in view of Porter’s model, only competition needed to
be taken care of: And, the best way to counter competition was to grow and grow fast. What followed
were a set of common practices, which were unethical and dubious from a long term strategic viewpoint.

Section 2.6: What happened in Andhra Pradesh?


For completeness, we outline the ‘current’ state of affairs in Andhra Pradesh. On October 15, 2010 as the
government of Andhra Pradesh, issued an ordinance aimed at protecting women who “are being exploited
by private microfinance institutions through usurious interest rates and coercive means resulting in their
impoverishment and in some cases leading to suicides.” the ordinance seemed to many as an intent, to
quash private microfinance providers in the state, where it has grown explosively in the last five years
through a process of commercialization that has brought ample capital and made millions for some
investors and founders.

Unfortunately, the ground truth remains murky for those removed from the situation. On the one hand,
the harm of microcredit appears exaggerated in much of the current rhetoric. Yet, there is good reason to
worry that the fast expansion has gotten many poor people into debt traps – into situations in which
repayment is coerced, verbally or even physically, by peers and loan officers. In the last month or so, the
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 45

repayment rates have dropped14and microfinance “culture” suffered. What is beyond doubt - to most - is
that the Indian microcredit industry, the largest in the world, is in serious peril; and that this crisis is sure
to seed discussion worldwide about whether and how microfinance institutions (MFIs) can commercialize
responsibly. It is, what we call, a Corporate Social Conflict that the development sector should be
looking to constantly balance.

It’s not merely a question of ‘’to profit or not to profit’’ but under what terms and conditions and how
should one go about balancing the double bottom-line objectives. From a financial literacy perspective,
through our research we find that several commonly levied criticisms - enumerated - against the current
microfinance brigade is not quite out of place:

Illiteracy and specifically financial illiteracy: The clients don’t know what they are signing. Lured by
promises of large loans (read: receipt of money) next day with no training (Group recognition etc.) yields
the agency problem. Straightaway the MFIs employees are standing outside the existing group meetings
(of another MFI or SHG) and asking en bloc formation of another group.

Adverse impact of commercialisation: High growth potential, profitability have hugely attracted
private investors. Since valuation were dependent on ‘client lifetime value’, a mad rush to acquire clients
at all costs resulted in reckless lending and client acquisition with minimum due diligence. Similarly,
required 99% repayment rates ensured profitability with <1% loan loss provision costs.

Proliferation of the pure microcredit model: Clients of non-deposit taking NBFC which provided
microfinance on the cushion of Private Equity had little at stake. Wilful default – with several MFIs lined
up waiting to provide (easy) credit – was easy.

Unlike the Bank-SHG model which began with savings and a waiting period of 6 months, was more
holistic. The leverage (at 4x) was also balanced; those MFIs registered as NBFCs, being non-deposit
taking - are obligated to take complete unsecured loans.

Governance: Misappropriation of funds by leading microfinance practitioners / promoters.

Conflict of interest: Making profits by charging usuriously high interest rates (i.e. high income). Accused
of “Robbing the poor to make the rich richer.” While most MFIs – known – are within “reasonable”
interest rate charges, there is an occasional MFI that charges out of the ordinary.

A third party neutral should provide information to the end borrowers. Clients should be advised “what is
high” and educate them about alternative products and services. However, since the choice is ultimately
an individual choice and dependent of personal circumstances, the decision to take the loan or not

14
From 99%+, which every MFI boasted of to 0% at the lowest end to up to 70% (based on in our survey of >50 leading MFIs).
Of course, these repayment rates were given in confidence.
46 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

ultimately belongs to the client.

Employee Targets: Key Performance Areas (Maximum client enrolment, minimum default) leading to
alleged group hijacks and coercive recovery mechanisms. Setting targets are part of corporate
maximising of utility of employees. However, group hijacks leading to multiple lending and other
immoral and unethical practices must be contained. We should have a detailed process by which we can
escalate the malpractices to the management of the organisation in question and request their
immediate remedy as well as the regulator and local bodies (DDM, BDO etc.)

No consumer grievance redressal: In the absence of any regulatory body, there was no forum to
redress microcredit consumer grievance.

Can we facilitate the regulator in bringing on-ground problems and concerns of microfinance clients and
practices to their notice with a view to enhance microfinance governance and delivery. Non- arbitrators/
conflict resolvers and would not play a role in either of these.

Section 2.7: Governance


By definition, corporate governance is the set of processes, customs, policies, laws, and institutions
affecting the way an organization is directed, administered and controlled. Governance is also identified
by the transparency in relationships among the stakeholders involved (principally shareholders,
management, and the board of directors) and in line with the goals of the organization. Other
stakeholders will include employees, customers, creditors such as banks, regulators, and the community in
general.

As MFIs expand their outreach and increase their assets, transparency in the business model and clear
articulation of the functions and processes becomes essential for effective governance. Governance-
related issues constitute the biggest challenge to the sustainability of India's MFIs. The most progressive
MFIs, and a few newly established players with strong private investor support and sound governance
practices, are setting industry standards and benchmarks. But they're still the minority. And honestly, there
remains much to be desired from them too vis-à-vis their peers in other sectors. There is an urgent need
for MFIs to redefine and strengthen their governance model – establishing transparent legal structures,
management and board compositions, and internal hierarchies for communication and control – in order
to ensure growth and sustenance.

Governance, through which the Board can guide an institution in fulfilling its mission and protect its
assets, is grossly underrated in the Indian context. Those where they are valued, typically succeed. A check
for good governance lies in the ability of individual directors to work in partnership to balance strategic
and operational responsibilities. Effective governance occurs when management is able to provide proper
guidance regarding the strategic direction for the institution, and oversees functions and processes to
move in the proposed direction. While exercising governance responsibilities, the management must
consider the perspectives of participants like donors, governments, depositors or other financial
institutions; regulatory bodies such as banks; and other stakeholders, including clients, employees, and
shareholders.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 47

Are there governance concerns? Bluntly said, “Yes!” Widely recognised that transparency and
accountability form two areas where MFIs could do much. Governance related issues have emerged as a
major bottleneck to the sustainability of India's MFIs. With the financial sustainability falling in place, with
the establishment of transformation (migration to for-profit NBFC-MFI) trend gathering momentum since
2004/5, there are three several issues that these newfound NBFC-MFIs faces from the Corporate
Governance perspective:

Transformed MFIs: In “Commercialization of Microfinance in India: A Discussion on the


Emperor’s Apparel” Prof. Sriram, explores in great detail about the transformation processes:
The financial benefits accrued to the promoters, the salaries, the inexplicable changing stakes etc.
exhibit the falling standards. Unfortunately for the sector, the benchmark MFIs (top 4) have been
culled out for critical examination. We mention this here for completeness; we leave out the
details.

Co-existing NGO and NBFC has a problem


with the audit trail: The NBFC carries out its
operations with the assistance of the field setup Corporate Governance routinely finds
established by the NGO-MFI. Since the colour mention as a top reason in each of the
of money is the same, it is important to have a Banana Skins Report, 2008-11 about the
clear audit trail. Funds get parked from three microfinance sector.
sources: donors, banks and equity investors.
Competition, quality, staff and
The donors would provide grants to NGO-MFI
technology are other key concerns.
but not to NBFC-MFI, (as it is a for-profit entity).
Banks would typically disburse loans to both
NGO-MFI and NBFC-MFI. The Private Equity
investor would be investing in the for-profit NBFC-MFI and not in NGO-MFI. Thus, it is important
to insulate the two organizations for better corporate governance. It is good to have a “terms of
reference” or a “memorandum of understanding”. Unfortunately, the strong character of the
common point, the promoter, makes the formalising of the sister-concerns quite redundant.
Nevertheless for the organizations to sustain the operations successfully, as going concerns it is
imperative that formal institutional arrangements be made between the two entities.
48 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Exhibit 6: Effective corporate governance framework (1)

Private Equity Investors Banks Donors

NBFC-MFI NGO-MFI

Retail Operations: Branches > Centres > Groups > Borrowers

Is there a clear audit trail?

(i) Salary: The recurring salary costs of the (common) field staff needs to be factored in.
Which organisation?
(ii) What about capacity building?
(iii) Staff training and development: How about training and development costs?
(iv) Savings: Savings is undoubtedly an important poverty alleviation tool. Since NBFC-MFI
is a non-deposit taking NBFC, the NGO-MFI arm continues to perform the savings
function. However, the savings (at 6% p.a.) need to be deployed. What better than
home-grown micro-credit programme (at 24%)? Thus, against this deposit (which acts
as equity cushion), the NGO can leverage and give out loans in order to be utilized for
expanding micro-credit operations. If governance standards are held, this should create
an internal competition (in a typical arms-length relationship). The funding for the NGO
activities come from free-money or grants from donors (whether individual, corporate
or funding agencies). The resoluteness of the promoter invariably ensures that the NGO
cross subsidises the NBFC (another classic case of the poor subsidising the rich) thereby
deflating the real costs of operations of the NBFC and in turn enticing the equity
investor and enhancing the valuation.
(v) Profits: Since, NGO-MFI has been bearing the cost of the field (for one) the profits of
NBFC-MFI seem to be bloated. The underlying objective should be to clearly demarcate
costs of NBFC-MFI against that of NGO-MFI, in order to avoid a concern on money
laundering or cross-subsidizing and the total investment needs to be segregated
between the two organizations to achieve greater transparency. Would the promoters
do it is another question altogether?
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 49

Exhibit 7: Effective corporate governance framework (2)

NBFC-MFI NGO-MFI

Interest Income

Investors should ask the


Expenditure
critical question to ask,
• Business Development ? ‘Are the NBFC operations
sustainable if the right
• Field level Employee Cost ? activity based costing is
applied?’
• Administrative Cost ?

Distorted Profits ?

Section 2.8: Corporate Governance for NBFC-MFI


We recognize that microfinance is no more a nascent industry. Yet, it does require specialized training.
Most MFIs have detailed and structured training programs for its entire staff, both through in-house
trainings as well as external programs. Talking of external programmes, the microfinance sector remains
unrivalled in the total number of seminars, workshops, symposiums, conferences that keep happening in
the sector. This is a great thing: It articulates the significance (and promise) that the sector holds in the
development context.

Training can play a crucial role in improving information, knowledge and developing skills and bringing in
positive attitudinal change among the staff and thereby ensuring quality in service delivery. Several issues
engulfing the sector remain to be resolved. One such is the attrition rate. Attrition rates of 7%-10% are
called low in an industry where employee attrition is a commonly talked issue15. The achievers in the
sector have the ‘best practices’ employee retention strategies: Performance linked incentives. However, in
the case of microfinance this has – unfortunately – also been the undoing. The top tier MFIs has first class
credentials to infuse more investment and expand operations. However, this also entails bringing in
greater precision in the costing analysis.

Section 2.9: Isn’t Governance the key?


Governance related issues constitute the biggest challenge to the sustainability of Indian MFIs. While the
most progressive MFIs and a few newly established players are upbeat to set industry standards and
benchmarks, they are far and in-between. CRISIL16has been harping that the vast majority of Indian MFIs

15
Sa-Dhan resources
16
S. Venkatraman and T. Raj Sekhar, CRISIL Ltd., Indian affiliate of Standard & Poor's Ratings Services
50 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

need to reorient and strengthen their governance architecture: Legal structures, board composition and
internal controls for their survival and continued growth.

Over the last couple of years, microfinance in India has grown in size, number of service providers, and
prominence due to the increasing interest and participation of international and domestic banks, PE
investors, donors and even the private sector. Development financial institutions have played pivotal roles
in paving the way for funding and institutional strengthening of Indian MFIs. Institutional structures and
governance practices among Indian MFIs are quite varied and differ significantly from mainstream
financial intermediaries. This is essentially due to their incorporation under a wide range of legal
structures (Please refer Appendix: Legal Structures in Microfinance) and a lack of clarity in regulations and
low transparency compound the problem.

Moreover, many MFIs, particularly those that have evolved from non-government organizations (NGOs)
into "NGO-MFIs," are still struggling to strike the right balance between their conflicting, social and
commercial goals. This often results in poor internal control systems, a lack of accountability, and
suboptimal performances:

Table 2: Relating governance to investment prospect

We spoke to five investors who had NOT invested in the microfinance sector (in the buoyant market).
The top three reasons they cited were:

1) “Quality of management”
2) “Standards of governance”,
3) Prevalent “Hyper-valuation”

To summarise, they did not find the investments prospects good value-for-money buys.

Clearly, governance quality and institutional arrangements are the critical differentiators of higher-grade
tier-1 MFIs from the rest. Other than sustained improvement in a financial risk indicator, such as capital
adequacy, qualitative aspects such as management factors have become increasingly instrumental in
helping MFIs transition from lower to the higher grades. The greater exposure Indian MFIs have to
mainstream financial markets- both domestic and international- the greater their awareness of the
importance of improved corporate governance17. The legal structure and regulatory requirements of an
MFI have a strong bearing on governance practices since they influence management practices and
dictate the level of transparency18.

17
CRISIL's assessment is that the majority of MFIs in India are still below the median, if measured against the yardstick of
acceptable corporate governance standards-whether it pertains to management structures and control, management information
systems, disclosure standards, or board composition
18
Other than a formal company structure, all other legal structures, such as trusts and societies, suffer from the lack of any
meaningful regulation and disclosure standards
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 51

Section 2.10: Transformation or Mission drift?


Not that there are not non-profit that are successful and well-known (viz., Cashpor, RASS, LAMP are all
operating under the non-profit mode) but the lustre that microfinance had acquired as an economically
viable, profitable, scalable and sustainable applies to only some MFIs. Specifically, these are typically
structured as NBFCs (transformed or direct) with notable participation from PE funds. Many NBFC-MFIs
are new and having begun their operations on a clean slate, can adequate focus their attention on
establishing a strong board and internal control systems. MFIs which start with the NBFC models are not
alleged of mission-drift, misappropriation of donor funds or illegitimate accumulation of personal wealth;
these MFIs are clear that they are there with the principal objective of making profits.

With donor and grant-funding drying up and related voluntary services dwindling, microfinance as an -
income generating activity (for the NGO) - became a key source of livelihood for several NGOs. However,
usually, the management of these entities were not adequately adapted and equipped to manage this
evolution. The result: Governance, disclosure, and accountability suffered in many cases. The boards of
many of these organizations continue are surprisingly weak for the quantum of portfolio that they hold.
Since there was success, Banks also did not make take serious exception to 10th pass and 12th pass
members sitting on the Board (Not that we are positing that educational qualification is a disqualifier but
certainly a levelling hygiene factor; to make any meaningful contribution to the Board of an MFI having 2
Lakh clients and ~100 Crores and counted as “systemically important” by RBI, one must understand the
nuances that plague the organisation) These NGO-MFIs need to make board and management changes
to drive a reasonable professional orientation into their operating philosophy and mission. Unfortunately,
it seems that most MFIs are happy with their Board strength; the benefits of having better internal control
systems and transparency aren't likely to materialize anytime soon. Ultimately, poor governance standards
will impact performance and this in turn will hinder the sustainability of their operations.

Section 2.11: Social Performance and Impact


Recent accusations that many MFIs have failed to help the poor, are treating clients badly, are charging
high interest rates and has encouraged poor people to take on excessive debt burdens contrast
demonstrative evidence that many MFIs have had significant positive impacts, including democratization
of banking services, provision of secure savings facilities for poor people and social benefits. Pertinently,
how can microfinance resurrect its tarnished image?

A discussed in this report, other researchers19 on microfinance too recommend the way forward for the
microfinance sector a serious consideration for implementation by MFIs, banking authorities and
governments the following:

a) Induce transparencyin charges, terms and conditions;

19
What’s Wrong and Right with Microfinance - Missing an Angle on Responsible Finance? Jul 2011, Hulme, D. &Arun, T.
available at http://www.bwpi.manchester.ac.uk/resources/Working-Papers/bwpi-wp-15511.pdf
52 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

b) Moderation of claims about reaching the poorest and reducing poverty; microfinance should
keep a low profile, with low costs, incremental expansion and a focus on both savings services
and loans. The hype and hoopla has not helped the microfinance cause;
c) Changes in performance appraisal of field staff performance, placing equal importance on client
relationship management as on financial targets and client acquisition;
d) Regulating agencies need to introspect setting interest rate ceilings and/ or caps on microloans;
e) Banking regulations may be amended, so that well-managed MFIs can offer more savings services
to their clients; the rush of private capital as a necessary source of equity has not augured too
well for relevant social impact and poverty alleviation– the original cause of the microfinance
movement.

This brings us to the necessary importance of encouraging social impact and to adopt social performance
management systems. One strong and likely source is MFI and Non-profit networks. But why should NGO
networks encourage MFIs to adopt social performance management?

The following underscore the benefits to MFI and NGO networks of encouraging Social Performance
Management (SPM) practices and reporting among partner MFIs. Most NGO Networks recognize that
microfinance does not automatically produce social returns20. SPM helps them to improve and
demonstrate social outcomes among their MFI partners. Networks engaged with the social performance
of their partners benefit from:

a) Understanding the local context:Microfinance is a highly localized business proposition; being


sensitive to the local customs, traditions and customized – within economic boundary values;
b) Aligning activities on a social mission: While most MFIs come up with fancy mission, vision
statements, their activities and actions on the ground seldom connect back to the stated
objectives. The “social” must be reinserted on the agenda;
c) Providing relevant services: The products & services, terms and conditions, value-added
servicesetc. must be within the larger context of engagement; microfinance providers should not
be seen as organized loan sharks;
d) Improving partnerships with other MFIs:Partnerships are integral to success in the sector; as
against competition, can not the networks build platformsof “co-creation” and “co-option”, where
participants in the sector work together towards a greater common goal? ;
e) Supporting pro-microfinance policy: Lobbying and working with the government to explain the
multitude of benefits of microfinance and the massive potential social (and long-lasting) impact
that a promotional microfinance policy can create;
f) Supporting balanced growth: Profiteering and chasing very aggressive corporate goals can have
dire repercussions – it is a social business;
g) Reducing reputational risk, which can have adverse spill-over effects;

Networks have played a huge role in making the microfinance sector sustainable, viable and replicable:
Their global perspective, understanding of local contexts, ability to share industry experience and best
practices, offer of informed technical support can be extended to provide resources to develop new
approaches to SPM. To leverage on the benefits of the network, a higher standard of social impact as

20
“Why Social Performance Management? A Note for Microfinance NGO Networks” Feb 2010, Social Performance Task Force
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 53

prescribed by the network i.e. peer pressure may help MFIs to justify the incremental cost of
implementing SPM. To that end, networks can21:

a) Consider SPM during new partnership process and induction of MFIs;


b) Deliver training to partner MFIs (and other stakeholders like investors22 and banks!!) to raise
awareness about SPM, and increase MFI capacity to implement SPM initiatives;
c) Provide technical assistance and financial support for SPM;
d) Publish social performance data from MFIs to publicize their success;

However, can social rating (or social labeling) can reinforce an MFI’s social mission and /or will it become
a purely “branding” exercise23 to access more (social) capital? Microfinance indeed began with the
promise of poverty reduction and with a social bottom line. It gave loans to help poor people become
responsible and entrepreneurial. But it soon became clear that an MFI’s social impact is minimal if it is not
sustainable. This led to a focus on the double bottom line of profits and social impact. The double bottom
line mission (seems to have) gradually become reduced to a focus on profits.

How can MFIs integrate social goals into their organizational management24,25?SPM relates to how an
organization aligns its strategic planning and operational systems to understanding client vulnerability
and poverty. It has three principal components:

21
“Making the case for SPM – NGO Networks”, available at http://www.microfinancegateway.org/gm/document-
1.9.42870/MakingtheCaseforSPMNGONetworks.pdf
22
It must be noted that: (a) Most social performance tools are suited to MFIs, and not to Microfinance Investment Vehicles
(MIVs); (b) Social performance tools must be developed for MIVs so that the that builds the necessary standards for MFIs, in
search of capital support; (c) Most SPM tools for MIVs are developed and implemented in-house, suggesting the need for MIVs
to take full control of their SPM to address their specific needs; (d) MIVs should adopt client protection principles in order to
address investor concerns of over-indebtedness and lack of transparency; (e) MIVs should only use information that can be easily
gathered and tabulated to draw simple, meaningful conclusions for social performance reporting. The interested reader is referred
to “Social Performance Management of Microfinance Investment Vehice (MIV): Analysis of Recent Developments”, which
posits that the diverse nature of MIV structure is not a hindrance to its success. If managed properly, MIVs can monitor, control,
measure and replicate successful initiatives across countries of their partner MFIs.
23
An interesting discussion, Bumacov, V. &Ashta, A., “From Social Rating to Seal of Excellence: Utility or Futility?” July 2011;
available on http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1890682. The researchers argue, (a) MFIs do not need to invest
in ratings or certification in order to attract capital (not true in the Indian context); (b) Social ratings may be required to mollify
the government and the media; (c) Performance ratings are of academic interest only (not really: not in the Indian context); (d)
Researchers should first study the methodology of the rating agency to see what is being rated, if ratings are being undertaken.
But the most insightful perspective is brought in the questionthat research should determine whether the poor really discriminate
between labelled and non-labelled products and firms supplying them, before undertaking an exercise in labelling MFIs (As we
found out in this study, overwhelmingly “NO”!). True enough, MFIs exposed to international pressure may improve their
internal processes in response to labels.
24
Please refer Campion, A., Linder, C. & Knotts, K., “Putting the ‘Social’ Into Performance Management: A Practice-based
Guide for Microfinance”, Nov 2008. This guide captures knowledge and practice of Social Performance Management (SPM)
from a wide range of industry stakeholders, including MFIs, donors, investors, networks and support organizations. Written for
MFIs committed to managing both social and financial objectives, the guide looks at how they can integrate social goals into
organizational systems. It helps MFIs shape their performance management systems such that it helps them understand and
respond to the realities of their clients’ lives.
25
The Imp-Act Consortium provides a “how-to” guide for managing social performance. The step-by-step guide outlines the key
areas to consider in creating an action plan for an MFI. It covers: (a) Strategy for social performance management (b)
Strengthening your information system (c) Using information to improve performance (d) Getting started
54 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

a) Setting clear social objectives and creating a deliberate strategy to achieve them;
b) Monitoring and assessing progress towards achieving social objectives;
c) Using social performance information to improve overall organizational performance (specifically,
operational and strategic decision-making);
Thus,

a) Clients’ welfare (not profits) are at the center of SPM;


b) Balanced performance management responds to clients’ vulnerability;

Social Performance Management is an institutionalized process that involves setting clear social
objectives, monitoring and assessing progress towards achieving these, and using this information to
improve overall organizational performance. Social performance assessment is about evaluating the
extent to which institutions meet their social objectives. It includes analysis of the declared social
objectives of institutions, the effectiveness of their systems and services in meeting these objectives,
related outputs (for example, reaching larger numbers of very poor households) and success in effecting
positive changes in the lives of clients.

Different social performance assessment initiatives focus on different steps in this process. Some focus on
the institutional process and internal systems, while others assess social performance at the client level.
Still others are balanced and encompass both26.

Institutional Process27 Client Conditions28 Social Ratings29


These tools help institutions These tools help determine who Several rating agencies have
evaluate their intentions, is being reached and if client developed social rating
systems and actions to conditions are improving. tools to complement their
determine whether they have financial ratings. Some focus
the capacity to attain their only on internal processes
social objectives. The tools while others consider both
included here can be used to client-level indicators and
conduct social audits. internal processes.

CERISE Social Performance These following tools help These include:


Indicators Initiative: The determine the absolute poverty
CERISE Social Performance level of clients: • M-CRIL
Indicators (SPI) tool assesses • Microfinanza Rating
the social performance of • MicroRate

26
MFI user reviews of these tools are available (at http://www.sptf.info/sp-tools/user-reviews) from the Social Performance Task
Force.
27
For further information, please refer http://www2.microfinancegateway.org/p/site/m/template.rc/1.11.48260/1.26.9232/
28
For further information, please refer http://www2.microfinancegateway.org/p/site/m/template.rc/1.11.48260/1.26.9234/
29
For further information, please referhttp://www2.microfinancegateway.org/p/site/m/template.rc/1.11.48260/1.26.9233/
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 55

institutions by evaluating their • Planet Rating


intentions and actions.
Progress Out of Poverty Index Co-funding for social ratings
MFC Quality Audit Tool (PPI): The PPI scorecards use a is available from the Rating
(QAT): The QAT was designed small set of simple, easily Initiative, a program
by the Microfinance Centre observable, and objective designed to support and
(MFC) in Poland in conjunction indicators to estimate the share encourage the use of
with the Imp-Act Consortium of clients who are below an financial and social ratings.
to correspond with social established poverty line.
rating methodology used by
M-CRIL and Microfinanza USAID Poverty Assessment
Rating. Tool: The USAID Poverty
Assessment Tool is a set of
The Global Reporting country-specific surveys,
Initiative (GRI): The GRI aims developed under contract with
to make sustainability the IRIS Center at the University
reporting as routine and of Maryland, to predict the
comparable as financial prevalence of extreme poverty
reporting is by all within a group of people.
organizations—not just MFIs
or even just financial FINCA Client Assessment Tool
institutions. The GRI uses a set (FCAT): The FCAT employs a set
of core metrics designed to be of 13 individual screens to
applicable to all business record income sources and
enterprises, sector-specific dependents, monthly household
metrics for various types of expenditures, and daily per
enterprises, and a uniform capita expenditures and poverty
format for reporting levels.
information on a company's
sustainability performance. The following tools help
determine the relative poverty
level of clients:

CGAP Poverty Assessment


Tool: Multidimensional poverty
index which provides rigorous
data on client poverty levels
relative to people in the same
community, and allows for
comparisons between MFIs and
across countries. The tool
involves a survey of 200
randomly selected clients and
300 non-clients, takes about
four months to complete, and
56 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

costs around $10,000.

Housing Index: An index that


uses the structure of the house,
and sometimes the compound,
to differentiate between
economic levels of households
and identify those who are poor.

Means Test: Very simple


household surveys using a small
number of easily verifiable
indicators. These are used to
create a score which provides an
assessment of an individual
household’s poverty level.

Participatory Wealth Ranking


(PWR): A ranking by community
members of the relative poverty
or wealth of households using
perceptions and criteria defined
by community members
themselves.

Section 2.12: Strategic issues for the future


Clearly growth raises implications for other key organizational functions such as governance and
transparency. Adding to that perspective is the need for a balance in social performance30.

Transparency is about external accountability - towards funders/shareholders and any other outside
stakeholder. Governance is about internal accountability - towards board, management, shareholders'
assembly. Social performance is about "downward" accountability, towards the clients, in a broader
outlook towards the poor who are the target group. Technology is about "forward" accountability -
towards squeezing the opportunities of innovation and generally finding new ways of doing old things
better. Successful growth of the industry will require that all levels of accountability are met to the
satisfaction of the different stakeholders.

30
For appreciating what is "new" and "strategic" about these issues, please refer Rob Dixon, John Ritchie, Juliana Siwale Journal:
Accounting, Auditing & Accountability JournalYear:2006 Volume:19 Issue:3 Page: 405 – 427)
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 57

Exhibit 8: Accountability Matrix

Forward
Technology as an enabler for identifying new
opportunities; control on existing portfolio

Internal
Governance to rule External
roles and relationships Transparency towards
between stakeholders: ACCOUNTABI LITY external stakeholders
Board, management, like regulator(s),
investor and clients, media et al
employees

Downward
Social performance to account for value-
add towards target group

With the microfinance sector entering a new phase of its life cycle, new stakeholders (public investors,
international funders etc.) organizations require new forms of external accountability (transparency);
expanded organization demands new internal accountability (governance); further growth, outreach and
sustainability demand new forward accountability (technology); and last but not least, holding course for
what we came to do in the first place demands
new downward accountability (social
performance). Certainly, any MFI that does not Ideally, an MFI has to have the following
live up to the demands to develop a holistic, conditionality to deliver:
transparent corporate strategy and governance
External accountability to be provided
will find that functioning effectively is an
to regulators
increasingly difficult and complex proposition.
Internal accountability by the
Looking at the Accountability Matrix, the organizational hierarchy
opaqueness of the microfinance sector is so Forward accountability to be provided
deeply entrenched that eliciting basic by continuous innovation
information from MFIs is such a daunting task. Downward accountability to be
The management is every so often jumpy and provided by delivering effective and
suspicious of anyone wanting to see their books. transparent services to clients
The friendly auditor, the complacent funder, the
Evidently, the accountability will reflect an
absence of a regulator and the mere ‘voluntary’
increased level of organisational
disclosure to industry associations (e.g. Sa-Dhan
performance. Most importantly the MFI will
and MIX Market), all contribute to making data
emerge as a client-centric organisation.
aggregation difficult and decisions for policy
making based on solid findings quite daunting.
58 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 2.13: looking to Leverage

Exhibit 9: Microfinance in India – 30,000 ft overview The leverage of the industry (Mar-2009) was
20X: Wasn’t it too high?
NBFC-MFIs don’t have access to deposits.
They have unsecured loans. They are
counting on
Status quo (a self-propelling system).
Since the A.P. Ordinance, there has been
a structural shift. Will repayments go
back to the 99%+ levels?
Social cohesion. But does it work?
Carrot to clients: Clients will be
disciplined if they know there is a
follow-up loan (higher quantum) based
on ‘performance. Can this also be
interpreting that they were rotating the
loans and the consumption was being
fed by new entrants?
Professional Service: Attraction points
being better service quality (through
short waiting periods for loan
disbursement, business-like
professionalism does not “waste” time at
field for long meetings). It was easy to
gather mass / groups.
Self-propelling system: Positive
feedback to IPO: Get funds. Get clients.
Get more clients. Get more funds.
An Aadhaar
A Study | Performan
nce Rating Ben
nchmarks for Large,
L Medium
m and Small MFIs
M 59

Sectio
on 2.14: The ‘Nu
umbers’ Trend Period
P
Exhib
bit 10: Recent Investments in
n Microfinance
e

Source: Infformation provided by fund managers,


m fund websites and various
v news articles

Over the last three to four years, there


t have been
b a series of positively reinforcing development
d s and
growth-m marking milestones set byy the Indian MFI sector. In many circcuits, microfin nance was allready
branded “manna”. No ot just by asttounding gro owth in clientt outreach an nd loan porttfolios but also by
leveraging g their organiizational expe
ertise to expa and operation ns beyond the e existing functional areas,, MFIs
in India were
w showing the inclusive growth path h ahead. Fromm a positive perspective,
p M
MFIs began, by b and
large and in their own little ways, many
m Indian MFIs
M have been testing ou ut and innova ating continua ally to
move awa ay from the conventional
c definitions of
o SHG and corec Grameen n modelled operations,
o wiith an
intent to better
b cater to
o the needs of
o their marke ets more effecctively. MFIs have
h also subsstantially increased
their clien
nt coverage, geographically
g y and clientele e-wise. The quantum leap year, 2008: Sa-Dhan stated d that
MFIs have e recorded an n increase of almost 4 million clients du uring year 200 w southern India
08 (though, with
contributing a significaant portion), coupled
c with approximately
a y INR25 billio
on portfolio ouutstanding.

From the marketing standpoint


s (frrom websitess to personall interviews and
a from con nferences to press
releases), each MFI staarted defining g itself (comb
bining the so
ocial and commmercial outlo ook) from tw wo key
numbers: Portfolio Outtstanding (in Rs Cr) and nu umber of clients (in multip
ples of lakhs). This trend, missed
m
by most, does
d reflect much
m about th he state of the
e sector then..

It was at this point in time that as the microfin nance sector in India continued to be buoyant, the most
efficient and
a rapidly growing secto ors in the worrld, its high growth
g d the potentiial risks of mission
carried
drift. The emphasis on adopting professional
p (commercial) behaviour and a practices, which may (not)
strategically balance with
w their oriiginal social mission impllied implicit risks. Though h most MFIs have
managed to gain ope erational efficciency, a subbstantial amount of effortt is essential in the aspeccts of
clarifying social objectives, targeting
g poverty alleviation, enhan nced productt developmen nt and overall client
orientatio
on. The size of the portfolio for an MFI is held by tw wo basic para ameters – thee outreach annd the
e loan disbursed. The dimensions of qu
size of the he depth of service
uality and effiiciency are identified by th
offering, geographical
g coverage, tarrget clientele and the porttfolio quality. The key challenge for MFFIs lies
60 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

in achieving growth constrained by budget, efficiency and quality of services. Few managed remarkably
well. And there were some more than moderate achievements too.

Consequently, the private equity investments and consequently the valuations for MFIs in India rapidly
increased in this period. The three-year average, historical median valuations had been in the range 5x-6x
historical book value (with a few deals valued at as high as 10x; though few these valuation levels were
not massively shocking to privy insiders. Those who were not quite acclimatised to the microfinance
sector found these valuation numbers as preposterous and unsustainable).

Transaction value and net income growth are the main drivers of valuation, as evidenced by our statistical
analysis. The following are eight other factors that were deemed important31:

1. the type of buyer and its possible social motivation;


2. the country of the MFI;
3. the legal status of the MFI, in particular if it is a fully regulated;
4. operating efficiency;
5. leverage;
6. the reliance on retail deposits (financial intermediation);
7. asset quality; and
8. profitability (as measured by ROE)

Table3: Comparative Analysis of Valuation in the Microfinance Sector

Average Median
P/BV ROE (%) P/BV ROE (%)
Africa 1.9 -3 1.5 -3
Asia 3.3 -3 2.1 13
ECA 1.7 15 1.7 16
LAC 1.5 23 1.2 21
Ghana 2.3 8 1.7 13
Uganda 1.5 6 0.9 -4
India 6.7 9 7 17
Cambodia 2.1 23 1.9 23
Mongolia 1.8 19 1.8 18
Tajikistan 1.4 -3 1.4 3
Bolivia 1 22 1.1 23
Nicaragua 1.7 26 1.3 29
Peru 1.3 21 1.2 21

31
“Shedding Light on Microfinance Equity Valuation: Past and Present” report by JP Morgan and CGAP, 2009
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 61

Additionally, we believe that the high valuations were driven by

d. Low cost of client acquisition; microfinance was a new concept; the word went around that
‘money’ was being given not loans. This found easier acceptance and especially since they
believed – specifically in A.P. and Tamil Nadu – that sooner than later the Government will waive
off the requirements to repay. Also – the existing local groups (SHG) were not able to disburse
money (loans) and were deemed to be dysfunctional in many quarters. This implied that there
would be lower cost of acquisition of clients (poaching) and the lower cost implied faster and
more clients. Clients are eventually the revenue drivers. Higher the number of clients, higher the
valuation32. Hence, incentives to employees for quickest group creation and acquisition of clients
in a cookie-cutter professional model. In all fairness, this “professional” approach is not – perhaps
– too different from what the telecom companies applied for bridging the telecom divide.

Exhibit 11: Risk-Return consideration in various growth phases

Startup Phase Growth Phase Mature Phase


Growth Opportunities
driving value upwards

Corporate Governance
Business Model Management skills  Leadership
 Demand-Supply Gap  Growth trend  Growth potential
 Promoter track record  Transparency  Strategic thinking
 Geographical location  Risk Management  Professionalism
 Building partnerships  Leadership  Investment exit
 Relationship skills  Operational  Execution of vision
excellence
Risk factors driving

 Operational Risk
value downwards

 Legal & compliance


 Technical risk
 Financial  Geo-political risk
 Financial risk
 Geo-political risk  Market risk
 Credit risk
 Credit risk

32
Multiples of price to number of clients were commonly used in the Indian context. The “client life time value” was derived
based on profitability per client (on average). The rationale is that an MFI should be able to extract “value” from each of its
customers. While many investors found those multiples of limited use, in the absence of benchmarks to draw conclusions ($50
per client was a rule of thumb); eventually, current book value and future earnings were used for triangulation. The idea of
valuation is similar to using any network based (e.g. airline and telecom). They are also reminiscent of the multiples method used
to value Internet companies (before the bubble burst)!
62 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

e. However, the maintenance of groups was not factored in. Much like in telecom where “active”
clients are important – as revealed by TRAI – active clients are important in microfinance. Of
course, there is no one to oversee the activities and activeness. The industry defined “active”
clients were defined as those with running loans.

f. Country level assessment not being good enough, especially in the Indian context, which is so
vastly diverse, the location of the MFI was important. The southern states were being seen as
saturated. Hence, the national level aggregate demand-supply gap is a skewed perspective:
Microfinance is a local business, much like retail footprint. And the demand/supply & competitive
landscape should ideally be looked at region-wise; the more granular the better. It was generally
assumed that the political risk is higher in the northern states (viz., U.P., Uttarkhand, Jharkhand,
Bihar, M.P., NCR, and Rajasthan). The risk adjusted expected returns were factored into these
valuations.

g. The scatter-plot below reveals No Correlation between P/BV Multiple and Current
Profitability (ROE). Hence, it was assumed by many investors that the current profitability
of their MFI portfolio c/would be enhanced (e.g. by economies of scale, technology
intervention and better operations management) thereby driving higher valuations during
their exit (IPO). Their IRR expectations were very likely to be met. Thus, the valuations soared
since there was intense competition amongst investors (was it greed or was it fear of missed
opportunity?); the (supposed) demand-supply gap was massive! Client and employee attrition
rates were high but generally ignored. More investors were lining up...and spiralling the valuations
northwards.

Exhibit12: Globally, in microfinance, no correlation between P/BV and ROE

Source: CGAP. Median numbers are shown in this chart. Numbers correspond to medians.
LAC: Latin America and the Caribbean; ECA: Eastern Europe and Central Asia
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 63

Even with the current market uncertainties, and with a recent deterioration in asset quality at microfinance
institutions, the authors believe "the long-term outlook for equity investment in microfinance will remain
positive33."

Section 2.15: Commercialisation of Microfinance


At a point in time, when we started this project, it was asked, “Is this a tipping point for microfinance in
India?” We voice what we have observed and reported previously– the microfinance as currently being
practiced (more so by banks in the SHG linkage model) is not immune from commercial crisis nor is it
necessarily benign with respect to its borrowers, the world poor(est).

“The world’s biggest banks risk creating a subprime-style crisis for millions of the
planet’s poorest people if they continue to plough money into the booming
microfinance sector... If you build it up that ‘there’s a lot of money to make’ you
can get a subprime kind of thing, but this time it’s the really poor people who will
be in trouble...”

Muhammad Yunus, the Nobel laureate pioneer of microcredit in 29 July 2008


Financial Times article titled “Microfinance commercialisation warning.”

The commercialisation of the microfinance sector in India has created a deep penetration,
phenomenal outreach and expansion of credit services to the poor and marginalised in India. The
rates of interest are (by world standards at least) relatively modest. With the growing scale of the MFIs,
the competition they provide for Government-sponsored SHG programmes are very serious. The massive
equity infusions in the sector in recent times – public and private equity and the enormous opportunities
to make more than modest profits have attracted heavy criticisms from several quarters. The state and
central governments, the RBI, are showing growing signs of disquiet. There are many that wish that
the path to growth had been more moderate, controlled, patient and focused on the double
bottom-line.

As the sole ranger in the listed microfinance institution, SKS is not only the epitome of management of
corporate-social conflict but also the recipient – rightly or wrongly – or many an ideological criticisms. As
the myriad other MFIs endeavour to emulate its hallmark of success, the unfortunately steady decline in

33
In a joint research report, "All Eyes on Microfinance Asset Quality: Microfinance Global Valuation Survey," issued by J.P.
Morgan in partnership with CGAP (Consultative Group to Assist the Poor), a World Bank organisation.
64 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

its value since its blockbuster listing on the Indian bourse has attracted its own share of misgivings in the
minds of several promoters.

Here we argue, if these MFIs are playing by the rules and as businesses are making profits – as the
government policies was to indeed incentivise them – then why pull them up? If you did not want
“transformation” why not have laws to illegitimatize them? After all, is it not their sheer dedication, hard
work and headwork in the sector where erstwhile the big corporate and the banks refused to enter that
has earned them the profits? Are they not alchemists?

Is it jealousy, a regret of “missed opportunity”, opportunism, the inability to handle the upcoming
competition or a pure concern for the masses (or a concoction of these), can we tell (with absolute
certainty)? If credit can be seen as a ‘product’ and microfinance as rural marketing of the product, then
what’s wrong with the current form of microfinance. The Fast Moving Consumer Goods (FMCGs), colas
and Consumer durables have forayed into rural markets and are profiting heavily. They are not being
targeted. Then why the big fuss about microfinance?

Is this about the focus on the underprivileged segment and help in attracting funds from donors
and Priority Sector Lending (PSL) from banks?

Exhibit 13: Connecting commercialisation and the cost drivers of microfinance

Maximize Revenues

Problem with
performance Maximum Profits? Implies charging high
‘possible’ interest rates.
measure as RoE?

Minimize Costs
How can for-profit
microfinance be
made sustainable? Loan Loss
Interest Cost Operating Cost
Provisioning Cost

+ Negotiating with funders


+ Priority Sector Lending
+/ - : Field practices such
+ Deploying technology that need to ensure 100%
- Cutting corners to processes repayment at all costs
- HR policies
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 65

Section 2.16: The Mysterious Case of SKS


Exhibit 14: SKS trading history –
Continuously decreasing stock price since blockbuster listing on August 16, 2010

1600

1400 12,030,000

10,030,000
1200
8,030,000
1000
6,030,000
800
4,030,000
600 2,030,000

400 30,000

Volume Adj Close

The trading volumes also drop dramatically since listing showing reduced liquidity and interest among
traders; signalling reduced confidence of the market on the stock (or sector?) amid abounding negative
press.SKS had a blockbuster IPO oversubscribed by about 13 times, listing at a massive premium.
Thereafter the mysterious sacking of SKS CEO Gurumani and the following regulatory tsunami of AP
microfinance Ordinance hit the state of Andhra Pradesh, where a third of SKS portfolio is concentrated
finds SKS at half-it listing price.

The consequent bearish run is not a great omen for microfinance. The 3-4 IPOs that were on the
anvil got pushed back. SKS remains the sole ranger. The PE valuations were also beginning to be
benchmarked from the SKS share price.

There are a few good, must read perspectives, on the argument and counter argument of
commercialisation (or more likely, the radical capitalism) of social enterprises:

“Commercialization of Microfinance in India: A Discussion on the Emperor’s Apparel” looks at the


growth and commercialization of Indian MFIs. It starts out by looking at how the commercial
microfinance has evolved internationally by discussing two specific examples and then moves on to
examine the specifics cases of four large microfinance institutions in India. The basic argument of the
paper is that most of the early microfinance in India happened through donor, philanthropic funds and
soft loans. These funds came in to not-for-profit organizations. However as the activities scaled up, it was
imperative to move to a commercial format. The paper examines the growth imperatives and the
transformation processes. The paper then proceeds to look at the implications of the transformation
process and its effect on the personal enrichment of the promoters of MFI as well as the governance
implications. Basically it questions the moral and ethical fabric on which some of the large MFIs are
66 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

built. It ends by answering a set of questions that may emanate out of this discussion.

With more than a decade of hardship, encountering personal bankruptcy and life threats to achieve this
success. At the time of bankruptcy, there was no recourse; at the time of success there are questions.
Vikram Akula’s Fistful of Rice is a captivating story of electing the socially significant idea, kick starting
its successful implementation, being increasingly recognised as the face of Indian microfinance and
eventually register as one of Time magazine's 100 most influential people. This is no mean achievement:
Through sheer hard work, SKS and Akula deserve their success. However34...“The move from a client-
poverty-focused model to an investor-prosperity-focused model is rapid.” To counterargument
presented, and within in the context of prevalent issues in microfinance, three quotes from the book,
“When we started... people decided to test us by not paying... We instructed our loan officers not to leave...
until the repayment came…” (Page 76); In an instance where the loan was taken to buy a goat but kept to
buy food, his assistant tells the customer: “Buying food doesn’t generate income, so you’ll be no closer to
getting out of poverty that way. Either buy a new goat, or give us back the loan money.”35 (Page 82);“…we
actually could have charged much higher interest rates… while… undercutting the moneylenders. But our
goal was not to be extractive; it was to make enough profit to cover our costs and fund further growth.”

Today, the microfinance controversy is also about coercive lending and the first quote exhibits the thin
line between coercion and persuasion. The second instance exemplifies the trade-off between current
consumption and future income. The third quote is perhaps not borne out by financials of 2009 and
2010: the proportion of transfer of reduced costs to borrowers is not in sync with the gains accruing out
of increased efficiency36.

Another historic figure for microfinance, the founder of RESULTS and CEO of Microcredit Summit Sam
Daley-Harris, raised concerns over the real intentions behind IPOs: “Did Grameen Bank raise money from
the market?37 How much of the Compartamos38 IPOs went to fund the loan portfolio? Zero. How much
of the SKS IPO will be going into the loan portfolio? It seems like it’s a lie.”

Niki Armacost, MD and co-founder of Arc Finance moderated the Oxford-style debate39 on “can-profit-
motive-improve-microfinance” between Vikram Akula (SKS) and Alex Counts (Grameen Foundation,

34
Purpose to profits: Akula's incredible journey by M S Sriram/ December 09, 2010 Business Standard available at
http://www.business-standard.com/india/news/purpose-to-profits-akula/s-incredible-journey/417565/
35
A first course in finance tells us that the present value of future income should – in inflationary environment like India – be
higher provided the income generating activity yields returns at least higher than rate of interest. Not sure, if it is so. It is
generally accepted (the denial phase is over) – by practitioners, theoreticians and microfinance experts alike – that a (significant
or not) part of the loans are being taken for consumption purpose. Multiple borrowing allows them to show the same underlying
asset in the “loan utilisation check”.
36
Ibid
37
Grameen is one of the largest MFIs; the 2006 Nobel laureate needs little introduction to those familiar with microfinance.
38
The largest microfinance bank in Latin America serves over more than 2 million clients. In 1990, it commenced operations as
an NGO; in 2006 it transformed into a commercial bank; and nearly one year since the well-publicized and successful IPO in
2007 its stock could not maintain its initial and sizable gains. In 2008 it incorporated to the IPC. The commercialization of
microfinance debate began with Compartmos and many an interesting discourses, perspectives can be found on it.
39
Available at http://asiasociety.org/business-economics/development/can-profit-motive-improve-microfinance
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 67

USA). Counts expressed his concern that SKS has become an organization whose main metric of success
is profit, for its shareholders, including ESOP driven managers, rather than focusing on social welfare at
the bottom of the pyramid. He Contrasts SKS to Grameen Bank, which not only gives microfinance loans
to the poor, but uses its profits "to go to student loans for the client's children, go to a beggars program
for the ultra-poor, and go to dividends to its owners, the poor women who borrow from it." Counts
argues that SKS, because it lacks clear social metrics and limits on profitability, hasn't done enough to
inoculate itself from the political backlash felt by microfinance institutions on account of their high, and
often controversial, interest rates. He added that opposing politicians have already and could again stall
loans to the poor, reversing the progress microfinance institutions have made in India."...if profit is the
sole source of innovation, we will see innovation around products that will be highly profitable –which
are not always the products that have the biggest poverty impact."

Before this section might seem like a preconceived agenda to pronounce profit-making MFIs in general
and SKS in particular guilty; we should clarify that there is nothing specific about – for or against – SKS.
SKS epitomises a school of thought “fighting poverty through business solutions”; a long held
perspective successfully demonstrated in action by SKS and Vikram Akula. There are also others who
follow similar views (likely the top 20-25 MFIs; most of who are NBFC-MFIs; some were quite close on
the heels of an IPO themselves having obtained one round or more rounds of equity funding, and
following a similar cookie-cutter model).Thus, it’s unfair to single out SKS.

It may be a temporal perspective but our observations from the field do suggest that the for-profit
model of microfinance needs a shift (certainly not suggesting a pendulum shift in reverse gear mode to
the non-profit option but more to a balanced centrist position.). Though theoretically – easier said than
done – this perspective revolves around finding this Poincare stability point that would be orbit
changing by shifting gears.

Section 2.17: Next generation, expanding product portfolio


While the products facilitate transactions, the underlying objective is to provide access to institutional
credit for the poor families and scope for entrepreneurial activities. There are loans that are provided for
conducting a wide range of income generating activities; a broad break-up is given below.

Micro-loans are granted for income generating activities40: The MFIs have established a strong base with
income generating microcredit program as its principal product offering. However, looking at a wider
perspective at the global level, there are numerous other microfinance products and services that can be
offered to the target market, which will increase the awareness of microfinance products and services
among the poor and act as a demand driver. Also, it could double up as bundled service offerings in the

40
There are around 350-400 such activities. These differ depending on the geography of operations. E.g. agriculture; allied
agricultural activities like dairy, sheep-rearing; small business ventures like flower shop, meat stall, tea shop, tiffin stall; retail
trade like vegetable vending, grocery, fruit vending; self-employment ventures like cycle shop, motor vehicles repair, watch
repair; village& cottage industries like carpentry, pottery, leather-goods
68 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

market, to increase the customer base for gaining financial sustenance, going forward. The exhibit below
explains the present product offering and the untapped potential of product offerings:

Exhibit 15: Potential product portfolio for MFIs

Consumer
Housing Finance Pensions
Household Group micro- loans
loans
Life Micro-
Savings
Bundled Insurance investment
loan funds
insurance Remittances
Target Market

Health
Agriculture
Education Insurance
finance
Loans

Leasing

Weather
Insurance

Individual
Small
micro-loans
business Insurance

Offered Product Offering May be Evaluated

Microcredit is not the only financial need of the poor: They also need financial institutions which will help
them save money at interest, transfer funds at low charges (remittances from immigrant workers in the
developed countries, for instance, account for more money than all foreign aid programs put together),
and receive short-term or emergency credit at non-usurious rates. Similarly, the poor need the skills,
education and political organization to make use of these opportunities, know their rights and be
represented without being victimized in the processes. This problem that calls for a trans-commercial
solution: something like the credit unions, run for the benefit of the members delicately balancing the
social and commercial objectives. Can and should we evolve hybrid associations between the for-profit
and not-for-profit that address this concern?

Assuming MFIs are generally keen on ensuring the overall development of the poor in their area of
operation; hence the focus on community welfare activities through the ‘extra mile service’ could counts
towards in brand building. Further, in the wake of growing competition and many new MFIs entering the
micro-finance sector, MFIs that administer credit+ services as an extra-mile service to its members in an
integrated approach will have an edge as it would enhance customer stickiness and multiple points of
connectedness. MFIs with the present decade-old experience in microfinance sector have fine-tuned its
field level techniques as is reflected in the near 100% repayment rate.

Thanks to their penetration, MFIs will become distribution and channel partners for FMCG, telecom and
industrial goods companies. While MFIs do need to offer expanded need-based product portfolio, better
financial intermediation is first required. Since the clients are from the economically weaker sections of the
society, collateral free microfinance is necessary. Are microfinance institutions mere microfinance
institutions or are they also strong delivery channels for rural marketing? SKS – being the leading MFI in
the sector – has taken the step and answered the question by opting for the latter. This cannot be
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 69

bundled with other essential and non-essential items. Should MFIs be mandated to remain “core” financial
delivery channels or is such restriction stepping into their sovereignty?

Chapter 3: Financial Literacy

Section 3.1: Opening remarks


We see financial literacy stand for the ability to make informed and effective decisions regarding the
deployment and management of money. At a deeper level the art can get complex, as any Fund Manager
would tell you, but we are really looking at judicious sourcing and application of household/ micro-
enterprise finance. Financial knowledge can aim at building awareness for making informed decisions on
financial markets, products and services, related risks and returns. To begin with, financial literacy should
enable individuals to take effective actions (and avoid distress and unexpected quandary), and graduate
to financial education.

While the financial markets have evolved distinctly, financial literacy is an ever increasing requisite in both
developed and the developing nations. In the developed countries, the number of financial products with
its complexities is growing rapidly; also, there is greater demand for providing social security to
individuals with clarity in the financial implications; and the importance of personal financial planning for
all age groups falling under financial decision making is on the rise. All these put together are making
financial literacy crucial. In the developing countries, more individuals are participating in the
developing financial markets, thus pushing the need for financial literacy to enable effective operations.
Further, the substantial growth of international transactions over the last decade, resulting from new
technologies and the augmenting mobility of individuals globally, makes the progress in financial literacy
a universal issue.

We wonder why is it that no MFI is ever evaluated on the number (and quality) of financial literacy it
imparts to the very special segment that it caters to. Should funders not want to know if the end
beneficiaries even understand their responsibilities and obligations before taking on credit?

Exhibit 16: Benefits of Financial Literacy

Benefits of Financial Literacy

Enables individuals Improves not only the Equips individuals with Financially educated
improve their quality and accessibility basic tools for consumers, in turn, can
understanding of levels for individuals but budgeting thus assists benefit the economy by
financial markets, also the performance them in acquiring the encouraging genuine
products and risks. and reliability of the discipline to save and competition, forcing the
Empowers citizens by markets ensuring stress free service providers to
protecting them from financial management innovate and improve
information their levels of efficiency
asymmetries that causes
financial distress
70 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 3.2: Financial Literacy, a global agenda


Even in the most developed countries, a worrying trend has been observed: While billions are spent on
formal education, which is very positive, they spend relatively small amounts of time, money and energy
educating people on the basics of their financial systems. Young people typically don’t seem to show the
inclination to saving practices and have at best a vague understanding of their finances and investment
opportunities and plans; the middle and the older age groups tend to get looped in a continuous debt
cycle, and often struggle with reaching month-end residual funds target due to limited knowledge of
planning funds41. Clearly financial knowledge has not deep penetrated in their learning and practice
system. Application wise, perhaps we could learn from international experiences42:

It is also important to devise ways to ascertain whether financial literacy has achieved its objective, such as
generating increased consumer awareness or a changed behaviour. For instance, in the United States, it
has been observed that workers increase their participation in retirement savings plans funded by
employee and employer contributions when the latter offers financial literacy programmes, whether in the
form of brochures or seminars. Consumers who attend one-on-one counselling sessions on their
personal finances have fewer delinquencies.

Section 3.3: Financial Literacy - the Indian landscape

“Financial inclusion is not only the process of ensuring access to financial services
or making available timely and adequate credit when needed by vulnerable
groups, such as weaker sections and low income groups, at an affordable cost. In
our context, definition of financial inclusion is much wider. It is not only providing
accessibility of the entire range of financial products and services, it must also be
appropriate, it must also be fair and it must be transparent. In that sense, we can
say that 95 per cent of the population is financially excluded, with most of us not
knowing what an appropriate financial product is suitable for us. So, we have to
go a long way forward”.

- Dr. K.C. Chakrabarty, DG-RBI, Introduction, “Speeding Financial Inclusion”, Skoch


Foundation, 2010

41
As has been studied in the US example, a lower marginal propensity to save, has a strong correlation on the nations
macroeconomic observation of twin deficits. High consumption, expenditure and lifestyle – as availed through credit rather than
savings – has left many families in the US paralyzed. It must be entrenched in the minds of the people, “DEBT IS A DOUBLE
EDGED SWORD!” Hardly any MFI field staff is aware of the same. How can one expect them to educate their clients then?
And even if should they choose to do so, would it not indeed be a conflict of interest with the ‘maximise shareholder value’
proposition!?
42
Excerpt from “The Role of Financial Education: The Indian Case” (Inaugural Address by Dr. Y. V. Reddy, Governor, Reserve
Bank of India at the International Conference on Financial Education organised by OECD and co-hosted by Pension Fund
Regulatory and Development Authority at New Delhi on September 21, 2006.) Source: www.rbi.org.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 71

There are incomplete and inadequate findings on financial literacy levels of acceptance and practice
among the Indian households (especially, here targeting the rural segments due to poor attention on
developing financial understanding), and it is precarious to create and offer financial planning and
growth opportunities to unapprised decision makers.

Due to poor levels of awareness, an individual is unable to understand the new-fangled products and
hence is highly vulnerable to push herself to financial distress. For instance, interestingly, in about 8 cases,
we did find questions about “equity investments” and “commodity trading...”...could microfinance
borrow money and invest in the stock market, we wondered? This level of awareness, when coupled
with absence of accurate demand assessment and financial consumption pattern and behaviour by
individual/household/group, financial firms cannot gauge the riskiness in their offerings and could lead to
market turbulences as is evident in the Indian context (specifically in A.P.). The troubles were brewing
despite a breakthrough model for poverty alleviation. Microfinance – with all its good intent – was
dedicated to support the financial need but did not encourage the necessary precedent financial
education.
72 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 3.4: Summary of financial literacy and microfinance


client interviews
Exhibit 17: Barriers to Financial Literacy Exhibit 18: Backgrounds of Poor Savers and Planners

2%
Occupational roadblocks Joint households
14% Earning for >=3 dependents
Need financial literacy
40% but don't have time Into Agriculture
9%
Caste-driven issues Waged Earners
Have earning < Rs. 25,000 p.m.
Don't feel the need to
have financial literacy Rural inhabitants
35%
Family/personal reasons Tribal inhabitants

Just-In-Time Approach: With easy access of money at the need hour, 0 500 1000
the consequences are not recognized by borrowers. They typically
Number of Households
raise the alarm bell at the time of first payment only.

Exhibit 19: Credit Perceptions and Behaviour Exhibit 20: Credit Borrowing Pattern

8% Credit is a burden. I'm fearful For household purchases


13% of taking it.
For renovation
Credit is not good to have but
I need to take it to survive. For education purpose
26% Credit adds to my income. It For medical reasons
helps us achieve our desires.
53% For business purposes
Credit is necessity. I can't
grow without credit. For family functions

Credit openness is more among young women, who typically take 0 200 400 600
credit for family driven expenses. This is leading to serious case of
multiple borrowing across sources. Number of Clients

Exhibit 21: Multiple Sources of Credit Exhibit 22: Barriers to Banking

9% Hesitation to approach banks


24% From SHGs
Don't know how banks work
20%
From local money lenders
Bank means complication
From banks
Bank staff are not friendly

Against gold/assets Banks are far from village


47%

The multiple borrowing practice is highest in Andhra Pradesh, 0 200 400 600
Tamil Nadu and West Bengal, with great dependency in parallel
MFIs, money lenders, and least in banks and SHGs Number of Clients
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 73

Section 3.5: Key findings that indicate the dire need for
financial literacy
1. In our cultural ethos, Indians have generally been cautious borrowers. With growing needs and
despite limited capacity to fully utilise the loans, and increasingly ready access to microfinance,
the rural borrowers have opened up more for credit as opposed to savings (the non-deposit
taking feature of NBFC is one plausible reason).While micro-credit is available to borrowers for
‘income generating activities’, many (most) households were typically borrowing for meeting the
increasing or contingent expenditure. It seems that certain rural segments which are targeted for
financial inclusion is not in sync with “money saved is money earned” practice.

2. While the borrowers attempt to adopt an income generating route, but due to family/social
demands they are unable to allocate funds as per priority and eventually fall in a debt cycle. The
opportunities of increasingly newer MFIs – which don’t do a background check of ‘existing’ debt
burdens - provides a relief to ‘default another day’. Unfortunately, much like an avalanche, with
time and access to more credit opportunities the loan outstanding quantum, as we found through
our survey, was gathering mass and momentum.

3. While women borrowers have historically shown greater tendency to save over men groups, in
general, in many areas people still really don’t know how to save. Expectedly, with increasing
and/or unexpected family/social demands, they find it very difficult to compartmentalise their
expenses and reserve money from their variable incomes and put it into savings. Though it is
undesirable, understandably, savings tends to become the last thing on their sustainability
agenda.

4. Most of the rural people are caught up with working out short-term financing, and there is not
much thought to long term investment planning. Most of them see gold as the only long term
investment. Having said that, they have a tendency to pledge gold for gaining access to larger
size credit. Gold loan companies/ pawn brokers are abounding and doing quite well in rural
market scenarios.

5. Most of the borrowers are not either unaware or low on confidence to deal with the banking
system. A few malpractices in the rural banking sector make them increasingly inaccessible – not
by virtue of the branch location but by virtue of the bank staff. There is little support and
understanding about the necessary documentation to available to avail the services. Those who
have managed to make an entry have, expressed strong hesitation to approach banks directly
with their queries (largely due to low literacy levels). Further, banks officials – either inadvertently
or otherwise – sound wilful to low income and poorly educated customers, especially women.
Such situations arising from poor financial literacy emerge as a huge barrier to improved
investment decisions for households. The rural banker must be trained to provide better quality of
service.

6. Further, despite the availability of no-frills savings product on offer by banks available for the rural
segments borrowers showed an inclination to investment in gold and land. Despite the volatility
74 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

of prices of gold, they see such assets as investments and as collateral to securing more loans in
the future. It works well!

7. Most women we interacted with, earned daily/weekly wages and thus functioned on variable
incomes. Since they always faced routine as well as unexpected expenses, they inadvertently end
up with little balance towards the end of the week or the month. Often they end up buying extra
time to repay loans, and in some extreme case, take loans from friends and relatives to repay the
MFI, if they are persistent in their recovery. They need to be educated enough to be able to make
regular, small-size savings (even for instance `10 per day). Since such small sums are not
acceptable as a deposit in every bank, the borrowers need to be taught to identify the best-fit
bank with no frills services.

8. In several cases, product consumption and behaviour patterns are skewed. While there is a
struggle for essentials of a household, but due to fast growing and converging markets, they have
shown an affinity to aspire for ‘beyond basics’. Education for children, healthcare, regular savings
in bank and insurance take a back burner against the options for entertainment, travel and
technology. This heavily disrupts the financial flow and allocation to meet the critical over the
aspirational. Insurance – compulsory or voluntary – becomes a huge boon to cover health risks.

9. Multiple-source borrowing has emerged as a common pattern among almost all borrowers. In
majority of the cases identified with the surveyed sample, there existed a great dependency on
sources that provide instant money when needed: usual order being local money lenders, MFIs
offering attractive loans, banks and SHGs. In most cases, the borrowers are unable to explain the
cost of borrowing, on being asked. They know that their interest rate is – say, 24% - or two
percent but don’t have a clue how it was calculated and whether the calculation is correct.
However, they are very conversant with the monthly/ weekly instalment quantum and know
exactly how much of their loan is their outstanding. Interestingly, in most cases (99%), the field
officer was not aware of it either.

10. Significant dependence on local money lenders, government, cooperative and private banks, and
SHGs (sources in the order of increasing financial empowerment) indicate the urge to gain quicker
access to funds, even if it is bundled with a large interest component. Aadhaar has identified that
while the source to credit to fill the borrower need-gaps may not be hard to find, however the
understanding of how the interest works is minimal. This makes the need for literacy in finance
critical.

11. There have been serious cases of SHG group hijacks due to poor stability of the SHGs which is
long-term driven. With growing demands and converging opportunities and with excess
promotion by MFIs on field to grab market share - the borrowers are tempted to switch from
their dedicated source of income growth.

12. Aadhaar through its microfinance projects over the last one year has attempted to conduct
financial literacy workshops in the local community centres for the women borrowers to educate
them on saving and investment planning. While they have exhibited interest, due to everyday
chase for earning wages and with focus on meeting family needs, most women are unable to
convene at a common location and at a particular time. Encouraging borrowers to take a step
ahead to attend the sessions is still a challenge the team experienced during the initiation phase.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 75

“Based on the study findings and initial market testing, Aadhaar is certain
that though it is not realised, yet imparting financial literacy should be a
high priority need among the rural masses. Predominant reason being that
they are completely unaware of the several financial products and services
offered, and are not fully capable of differentiating among options. Further,
one-day long session in a common gathering arena is not likely to create a
deep impact in borrowers’ financial practices.”

Section 3.6: Filling the need for financial literacy


In 2007, Max New York Life and NCAER conducted Financial Protection Survey43 of a sample of over
63,000 Indian households to understand how India’s income, expenditure and savings patterns, from risk
perspective. The survey has put a platter of incredible numbers in a country that is witnessing surging
growth of financial services – clearly indicating the need for financial literacy.

We carry out the same “beliefs-audit” based on members’ perception.

1. 96% of households across rural and urban India felt they would not survive for more than a year
in case of loss of their major source of income

Our survey exhibited: 78%

2. 54% of the household were confident about their financial buoyancy44, underpinned by the joint
family structure.

Our survey had exhibited: 37%

3. Top 20% of income earners save up to 44% of their income, while the bottom 20% borrows up to
33%. With maximum dependence on informal sources, principally households (40% of rural
sample) approach the local money-lenders for health, medical treatment and routine
household expenditure

Our survey had exhibited 58% approach the local money-lenders for additional financial
support: health, medical treatment and routine household expenditure

43
Economic Times (year 2007) coverage on Indians need better financial literacy to cut risk (by Gary Bennett & Rajesh Shukla)
44
As individual families, this assertiveness doesn’t hold true across the sample
76 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Insights from the Max New York Life and NCAER survey indicated that most households are tuned to
saving from their incomes (either at home, in banks, or in certain cases post office deposits), and they are
fairly optimistic about their financial future.

Through our FGDs45, we find:

Parameter % of Cases

1. Intent 95%+

2. Ability 40-45%

3. Do / Action 20-25%

The Max New York Life and NCAER survey too found (though as an anomaly to their previous read) that
for majority households, their income bracket is usually insufficient for their routine and unusual
expenditures, thereby creating a need for a reserve of financial assets for them to fall back upon.

In unison, the awareness of strategic financial planning of rural households is relatively primitive. While
governments have a role to play for the poorest households, in general, financial security is the
responsibility of each household, and both the needs and the options available are more complex today
than before. The survey points to a tremendous need for enhancement of financial literacy and education
of households to do better in achieving lasting financial security.

Why emphasise on it? How does it connect to microfinance sectoral performance?

1. Transparency in pricing: Individuals with lower levels of financial literacy fail to understand the
variation in market pricing. Many financial institutions (including microfinance institutions and
other socially responsible businesses), end up offering loans and other credit products with
marked up costs to what they promote. Our experiences have brought out cases where many
(most!) MFI field staff is unable to explain the effective annual interest rates applicable on savings
and credit offering to borrowers.
2. Cracking complex products: With increasing appreciation of development projects, the financial
services (here, focusing on serving the rural segments) is attracting innovative technology and
sophisticated means of communication. Further, the traditional approaches to understanding
finances are fast evolving and growing complex with superior technology intervention. Going
forward, for target individuals who are not financially literate, it could get tough to
comprehend the increasing sophisticated product offerings (for instance, micro-equity as
an innovation concept).
3. Gauging errors: Every sector experiences faux pas for better evolution. Having said that, it is
important to have discerning customers to financial services to identify the irregularities and
report it for immediate action. This way, fraudulent activities leading to great financial debacles

45
However, our sample is perhaps biased. These questions in FGDs were introduced in areas with high micro-credit
concentration, where SHG were either not present or quite inactive. Hence, we chose to ask these questions hoping to co-relate
and find a causal relationship between SHG movement and savings temperament. These specific FGDs were done on a smaller
sample; questions were asked in West Bengal, Andhra Pradesh and Tamil Nadu.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 77

can be forestalled. Further, financial literacy will encourage corrective actions to prevent or even
overcome the losses, if any.
4. Protecting consumer interest: While making choices for investment or credit opportunities,
clients must clearly be acquainted with what they are taking into their accounts. Disclaimer in fine
prints in all the financial products may not be elaborated at the time of promotion or sale, but it is
essential that consumer is well aware of the associated risks and rewards to avoid distress or even
mistreatment (unjust loss, fraud or unaware excessive risk).
5. Building financial inclusion: Inclusive financial services are important to create a holistic security
cover for any individual. With sophisticated technology (both telecom and IT), it becomes
essential for the citizens of the country to achieve financial literacy to overcome operational
challenges.

Given the phenomenal disarray of Why did the Andhra Pradesh government
delivery of microfinance, it emerges need to step in (in 2006 and again in
very clearly that financial inclusion 2010)? Obviously, profiteering does not go
through microfinance is not sufficient: well with any of us but, what are the
“Because Knowledge is power”, the concerns and criticisms of microfinance as
peoples must be made to understand a profit-making concept? If we educate the
what / where they are signing (thumb people on financial literacy and empower
impression) and what are the meanings them to decide for themselves what is good
and repercussions of these. In a free for them and what is not, can that be the
market democracy, like ours, people “free market” approach and create lesser
should be given the opportunity to be regulatory pressures and thereby, enhance
heard about unfair practices, products the smooth and effective functioning of
or people. microfinance?
78 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Exhibit 23: Financial Literacy Implementation Framework

Delivery

PRIVATE AND VOLUNTARY SECTOR


GOVERNMENT/PUBLIC SECTOR

Content

Technology

Human
Infrastructure Service
Resources
• Accessibility • Qualified • Customized
• Assistance educators and approach
Centres developers • Monitoring and
• Portable • Financial Evaluation
Equipments experts, analysts • Feedback
• Hi-speed researchers • Financial
Internet • Technical staff assistance
Connectivity

Bottom line: In our view, financial literacy levels should be an indicator which MFIs and their
funders (most notably, banks in turn) should look into. It should be part of the assessment matrix.

So far, the principal driver of further credit was “waiting borrowers”. If MFIs had ready groups, they were
given funds. However, their levels to handle the incoming debt finance constructively towards helping
their economic development and empowerment was either disregarded or de-prioritised. It was assumed
that a CGT and GRT would be sufficient to impart the necessary skills; these, then again, were not being
done too well since the processes of CGT and GRT are costs to the MFI (not investments, revenues or
returns).
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 79

Chapter 4: Research Sampling and Methodology

Section 4.1: Overview


We followed a structured method to address the question in play as shown below:

Table 5: Research Approach

Action

1 First we review relevant and related literature. The starting point of the brainstorming and
thinking process was the mindmap.

2 We start a preliminary quantitative assessment which would include last 5 years data (2006-
2010) from publicly available resources (forums, industry data aggregators, associations etc.);
this would help us with a quick overview about the sector and what we might expect on a
preliminary analysis

3 To test various hypotheses (judgements), next we triangulate our assessment spoken people
across the value chain from funders to MFI management to field staff-end beneficiaries

4 We return to the quantitative assessment, after clean-up of data, it translates to about 362 data
points. Based on our judgment of the organization and sector (and doing an organizational
interview), we’ve eliminated data that seemed to be incorrect in terms of data supplied (or data
entry). For instance, though the usual practice is to take (10%), we have taken eliminated 5%
and bottom 5% is eliminated (as errors in data-entry and deep outliers); looking at the scatter
(insert graph) we are more conservative in our accumulation of data points. A fragmented
industry is likely to experience more scatter.

5 We summarise our findings through this report.

Exhibit 24: Tour objectives

Operational
Benchmarking
Performance and Loan Portfolio
Performance
Organizational Audit
Ratios
development
80 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 4.2: Ratio Analysis


Detailed descriptive quantitative analysis; fundamental analysis will be done to ascertain benchmarks
on six factors:

1. Profitability
2. Capital Adequacy (and solvency)
3. Liquidity
4. Portfolio quality
5. Efficiency and productivity
6. Asset-Liability Management

Section 4.3: Organisational Development


This will involve detailed focused group discussions (FGDs) with the promoter(s), the top management
staff and other relevant stakeholders like banker(s), auditor(s), investor(s), rating agency/ies. The
report suggests weak-links, missing links; on request, an action oriented plan will be suggested to MFI
improve operational performance and lead each organisation to enhance its operational efficiency. In
this context, each organisation will be a dealt with as an individual case study.

Section 4.4: Field Audit


Structured and unstructured questionnaires were used for data collection at the client group level.
Behavioural assessment of clients, field practices, challenges and opportunities were observed.
Individual interviews as well focussed group discussions were held. Discussions with field officers,
branch managers were held at individual level.

Table 6: Key objectives of the Field Audit

1 To appraise the strengths and weakness of the field at the site of microfinance

2 To assess the adequacy of processes/systems (e.g. HR, MIS, and Internal Audit etc.) for the
proposed scale up business plan

3 To identify key potential risks that may have a negative impact on the portfolio of the
organizations in the light of its growth plans

In order to achieve the above mentioned objectives, our focus was on two activities described below
in Table 7 below:

Table 7: Audit and Evaluation

Arithmetic Audit System Evaluation

Using a random sample of borrowers, loan- Organizational policies, systems and processes
related details were cross-verified across the related to key areas such as operations, credit,
Head office, branch and client passbook levels. HR, MIS, Internal Audit and documentation was
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 81

Deviations, if any, were duly noted and reasons evaluated against the current implementation
thereof sough. and robustness to support the envisaged
In addition in a few cases, physical ‘loan growth.
utilization checks’ were carried out. In many cases, the data was gathered and
A cash audit trail was conducted to verify the observations made across the Head Office and
cash transactions in manual records with the branches.
branch MIS. A comparative assessment – benchmarks and
best practices was drawn out.

(a) Monitoring and Review

Once these observations are made, a monitoring (M1) will be undertaken to assess improvements in
processes and practices. A second review phase (M2) will be undertaken thereafter.

Section 4.5: Sampling


The main steps for sampling the study include the following:

i. Selection of the hubs (or states): The choice of destination hubs would have to be such that
the assessment would not only give a representational picture of the practices in the region
drawn from the study but also expose the various stages of development of the microfinance
practices. While the underlying assumption is that the MFIs are locally competitive and ‘learn’
from other MFIs in the region, MFIs have inherent constraints and challenges in their
organisational development depending on the stage of their development. This should be
exhibited in the choice of MFIs.

Based on NABARD data, each state has about three MFIs that are supported. The six states
proposed where the study will be conducted and their reasons for selection are:

Table 8: States studied in Research

ASSAM  The northeast is usually studied in isolation and there is no study (to our
knowledge), that would compare the North-east with those MFIs in Andhra
Pradesh.
 There is another reason to pick up Assam. Politically, there is an “element” of
isolation of the North-East region from the ‘main’ body. To include parts of
India into research is a small step to integrate socially marginalised states.

ANDHRA  Known to be the microfinance haven, AP becomes a necessary choice of


PRADESH study. Widely believed to be a saturated market, A.P. still is home to a large
number of mushrooming organisations that are born every day.

TAMIL NADU  It is important to take A.P. and Tamil Nadu since they are supposedly the
"most advanced" in MFI practices. Tamil Nadu, in particular is very advanced
82 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

in its microfinance practices and keeping them a part of the ‘best’ is


imperative.

WEST BENGAL  One of the most densely populated regions, microfinance has huge
potential here.

ORISSA  The fifth hub is Orissa, which is one of the poorest state and in urgent need
of proper microfinance. There is a huge potential for microfinance here as
the poverty levels are significantly higher than in most states. We reckon
that since it is plagued by natural calamities and prone to famine, this hub
would typically require customised microfinance services for its programs
and projects.

UTTARAKHAND  Finally, the sixth hub is which has supposedly the highest demand-supply
/UTTAR PRADESH gap for microfinance services.

ii. Bucketing into large, medium and small: Since we are selecting NABARD supported MFIs, we
are reducing a degree of freedom in the selection of the sample. We propose to study small,
medium and large MFIs across regions. Spandana, the second largest MFI, and has more than 4.5
million clients; in contrast, Asomi, Mimo have less than 50,000 clients. Thus, the MFIs will be
compartmentalised into three buckets. We have separately looked into the classification of “MIX
Market”. Additionally, we have classified MFIs as “large” if they are systemically important.

The size and spread for the study is worked out based on the hypothesis, which indicates that
with increasing size of a MFI, the resource engagement, service delivery mechanism and the
internal functional and management structure get highly streamlined, and that there exists a
commonality in their operations and market reach. Hence, to test the veracity of this hypothesis,
we conduct the study across growth stages of MFIs in India.

Table 9: Top-down assessment of NABARD supported MFIs

Number of states chosen 6


Number of MFIs NABARD has supported in these states[however, Nalbari (Assam) is a 25
defunct organisation46]:
Number of NABARD supported MFIs were taken in the study: 23
Given the study was for a five year period, expected number of data points: 115
However, for many 2010 (March) data was not made available (from MFIs). Thus, total data 104
points used, of which:
- Small 59
- Medium 37
- Large 8

46
As was advised by the DDM
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 83

Section 4.6: Client level Data Collection and Analysis


For the study, having identified core set of
Exhibit 26: Approach to Data Analysis
parameters for performance measurement;
benchmarking will form the basis of data
collection and reporting. While the ratio
analysis will provide the technical support to Historical
the overall findings, the team and client Research
discussions will add insights to the garnered  Secondary research
 Quantitative
data in terms of ethno-demographic
analysis of existing
understanding, need gap analysis, product data-points
expectation and competition assessment.
Hence, the information gathered for the
ratio analysis will be quantitatively analysed
DATA
and summarized, while the inputs to
operational performance and organizational ANALYSIS
development would be the outcome of the
mix of qualitative-quantitative assessment Parameter TOOL
during the study.
Fieldwork
Assessment  Qualitative Analysis
 Qualitative analysis  Quantitative Analysis
The tools for collecting data were to validate/confirm  Observatory exercise
parameter accuracy
(i) Structured questionnaires with
scaled, closed-ended question
(quantitative)
(ii) Open-ended leading questions (qualitative)
(iii) Detailed personal interview technique for the management and/or focus group discussions
(FGDs) with the decision making team and executing team at each MFI to obtain qualitative
information about reasons for default, terms of repayment and knowing the practices
adopted for recovery
(iv) Also, the initial secondary research conducted with the assistance of the MFI team will provide
us the foundation to the fieldwork. Important data-points in terms of operational and
financial performance provided inputs to designing of the questionnaire and discussion guide
(v) comprehensive on-field market research (with staff and clients) in order to gauge the need
gaps and expectation (mis)match between the MFIs and the end-beneficiaries
(vi) Member Level Interaction: While there was a questionnaire47 that was (broadly) administered,
the principal objectives from the field interactions with the group members were to:
Examine the integrity of the groups (social capital)
Look into field practices: Group formations; trainings; collection
Assess the financial awareness of the members about various product offerings48

47
Refer to Annexure 2
84 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Check for frauds by the field staff of MFIs. To check for collusion with clients
Understand if there are “king-pins” within the organisation
Understand the deviations in the implementation of the organisational policy
Check the loan purpose and utilisation49

(vii) Field Level Document Verification: The field level arithmetic audit involved checking
documentation at the group level to verify the consistency of data at borrower’s level and
match the same with the branch office MIS50.

(viii) The branch51 involved interactions with branch staff i.e. Group Managers, Branch Managers
and Area Managers to assess their understanding on the systems and policies of MFI. We
assessed (sample) the loan documentation for the outstanding borrowers, conducted an audit
trail for the reconciliation of data maintained as per manual records against the records in the
MIS, checked the quality of maintenance of the registers and documents, and
tracked/reconciled loan client data from HO to field and from field to HO.

48
To check the product awareness, we chose two groups within the Group and checked for their knowledge on the loan amounts
disbursed to them, the loan processing fees collected and the number of weekly instalments repaid till date.
49
The team conducted random Loan Utilisation Checks for at least 2 members per Group.
50
The set of documents checked were: Loan Passbooks for the collecting the information on the loan clients’ details.
Minutes Book for the regularity of the Group meetings, member attendance and recording of meeting minutes according to the
policy. To reconcile the loan client’s data for a particular Group, the data for two groups is collected from the MIS at the HO and
cross checked with the data recorded in the loan passbooks at the field level. The data for the rest of the members are noted from
the loan passbook and was cross checked with the data in the Branch and HO MIS.
51
Refer to the Annexure 4
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 85

Exhibit 27: Survey Sampling

Table 10: Survey Sample Size

Potential State Sample


Existing* (10%)
Andhra Pradesh 28,491
(87%)
Tamilnadu 20,351
Orissa 8,140
Lapsed West Bengal 13,228
(3%)
Maharashtra 15,263
Karnataka 13,228
Assam 611
U.P. / Uttarakhand / NCR 4,477
Total 1,01,753
Total Sample Surveyed =
1,01,753 borrowers

* Includes single- and multi-source borrowers,


potential borrowers (i.e. not current MFI clients)
and those who’ve dropped out of microfinance

For this study, we conducted extensive research and closely interacted with borrowers group at the
field; spending days at end staying and cohabiting with them. This opens up opportunities for frank
and open discussions as well as helps appreciate their concerns and behavioural predilections.

These insights are not available on a field-trip organised by MFIs where “visitors” coming from MFI
are seen differently.

Detailed personal discussions held and ethnographic studies (day-long observatory exercise)
conducted with rural clients and MFI management and staff members brought out some significant
insights indicated striking disparity between financial usage and understanding.
86 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Chapter 5: Perspectives from the Field

Section 5.1: The Discourses


Based on our observations on the field, we have put together some of our thoughts. This section should
perhaps be more appropriately titled “musings”. Each of these points requires a more detailed and
deliberate discussion. For want of time, and opportunity, we summarise below the most crucial of
discussions pertaining to “performance”: Perhaps in a more appropriate platform we can engage into a
deep-dive into each of these.

Social Is it working? If it were, would you see defaults? Valuables of reciprocity, exchange and
cohesion mutual trust constituted Durkheim’s “gemeinschaft” (community, or social cohesion).

The microfinance landscape towards credit consumerism at the BOP and borrower
behavioural pattern seems to suggest, prima facie, that the gemeinschaft has now
shifted to gessellschaft (business).

During the A.P. crisis, we heard lots of borrowers refusing to pay – in a circuitous
argument, saying, “If she pays, I will.”

Exhibit29: Social Cohesion or excuse to default?

8%

"If she pays, I will."

34% No comments
58% Individual reservations

An interesting view that the presence of non-local field and


branch managers made the social cohesion bond weaker
since the favour of the local field person who had the
historical knowledge of ‘before-and-after’ support was
missing. The “connect” was not there; and clients did not
hesitate or feel awkward to default on the loans.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 87

Is it pure First, in smaller MFIs, usually the NGOs, and which are yet to be systematised or
business? “professionalised”, the gratitude towards the Single Point of Contact (SPOC) is evident.
“Sir, please arrange to help get a loan from a bank. It’s been three months since the
previous loan closed...”The undercurrent of favour (flowing one way; gratitude the other)
is evident.

In the larger MFIs, the loan disbursement is more systematised. They are mostly,
completely transactional related and fewer enquiries – that are persuasive in nature –
occur.

Microfinance, “MFIs have created the myth that poor people always manage to repay their loans
microcredit or because of their ability to exploit business opportunities”52
micro-debt
“Clients have to pretend that they want microenterprise loans (when they need to pay
school fees, cope with a medical emergency, buy food etc.) and don not have access to
the type of micro-savings that they desire”

SHGs vs MFI In SHGs, the group member who assists in the transaction process: maintaining
model accounts, managing the cash (counting) etc. is not remunerated. Often, there is a latent
(sometimes explicit) that they should be paid as is done in the case of the MFI loan
officer.

Transactional As the microfinance haven in A.P. transforms, the idea of the “social achievements” and
Nature: Focus discussions about “local level changes” originally envisaged by SHG movement (but
on Credit eventually engulfed by the ever growing significance of the financial transaction) is fast
eroding.

Groups have preferred to have little time spend on the field; focus has been on
“availability of credit” with decreasing importance given to savings.

At the field, women have an intuitive way of calculating return on investment! Examples
of MFIs which can provide credit with lowest waiting period (2-3 days), lowest

52
David Hulme, “Is micro-debt good for poor people? A note on the dark side of microfinance”: Small Enterprise Development
XI (1), downrightly rejects the assertion above as “nonsense.” At Aadhaar, we’ve done calculations of ~400 micro-
entrepreneurial activities. Very few of these businesses (intrinsically) can routinely yield returns >25% (prevalent rate of interest
by MFIs.)
88 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

transaction time (15-20 minutes) and higher quantum of loans – without much care for
the 2% pm rate of interest – are deemed to be “best-in-class” and convenient53. Only
that monthly model – not weekly - is preferable.

Credit or The livelihood of the rural poor are poised almost constantly between just getting by
Savings? and impending catastrophe in the form of crop failure, adverse market conditions,
illness or death there is an abiding awareness of the terrible consequences.

Savings provide the necessary insurance. Will the combination of prevalent practice
microcredit and micro-insurance provide the same?

Exhibit 30: Micro-savings in Practice

Clients who understand


22% and follow microsaving
habits regularly

Clients who are hardly


78% able to save anything
from their earnings

Multiple In our view, the single most important issue plaguing the sector is “multiple
borrowings borrowing”54.A separate section is dedicated for this discussion.

Exhibit 31: Multiple borrowing or borrowing to repay?

Don't know, can't say

18%
34% Another MFI (Taking from both)

15%
Another MFI (They are charging high
interest rates. Closing the loan.)

33% Money lender. Borrowed under


emergency. Closing the loan.

However, there is no information captured at the field level whether it was used to
repay a loan with a higher interest rate or lower. It could as well be from another MFI
(with a higher interest rate since MFI seems to be most competitive in terms of interest
rates) and could potentially imply the client entering into a debt trap eventually

53
Shubahnkar Sengupta, CEO of Arohan is credited by Prof. Malcolm Harper, 2006 to have started this new way of thinking: “At
Arohan, there are no songs or anthems or oaths; nor have members seated in rows.”
54
Banerjee, Ayan A., “The Macrocosm and Microcosm of Microfinance” (October 21, 2010). Available at SSRN:
http://ssrn.com/abstract=1701662
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 89

defaulting on her obligations. It may be advisable, from a policy perspective, to do a


check one level deeper on the loan and inquire about the loan that is being repaid and
the details of it thereof.

Building The assumption that the poor would find it hard to save enough in enterprise
Assets and development – whether micro, small or medium –is dispelled by PWMACS (inspired by
Enterprise ASA, Bangladesh) – work which stands out as a case in example in that it has
Development constructed a mall, a real asset (of great utility to those in the vicinity) which is
community owned.

The “investment” of the mall by the members adds strength to social cohesion.
Ownership in a real asset shows “pooling of resources” and creation of a real
community based asset and “creation of value”. Shareholders’ wealth and utility can be
maximised by such needful investments.

From the microfinance perspective, this works as a collateral against future wilful
defaults. Should not more “mutual benefit” organisations or community based
organisations be floated; with the proceeds of reserves and surplus of the microfinance
operations to underprivileged “shareholders” than be exacted out as “profits” or
extraordinary “salaries” to professional?

A more socially-oriented, sustainable model of microfinance and microenterprise


development can certainly be worked out.

Exhibit 32: Aadhaar Field Survey Findings

"Microfinance"...but for what, actually?

Credit consumed for income


16% generating activities only
37%
Credit consumed for personal
expenses (upto 50%)

47% Credit consumed for personal


expenses (more than 50%)

Poor Poorly constructed business ideas with a lack of consideration of demand and costs
institutional render the micro venture unsustainable, and microfinance may incorrectly get the
viability of blame for it.
micro
enterprises For instance, in the case of micro crop farming, farmers often fail to account for their
personal consumption between the sowing and harvesting periods and realize they
face a shortage of money. As a result, they often end up using the loan for personal
90 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

matters. The problem arises when it’s time to pay back the loan – the farmer is forced
to take up a second loan to pay the original loan. This may lead to a vicious cycle where
the farmer gets inundated with debt55.

Financial Many societies living in remote rural areas - especially the tribal belt - have little formal
Illiteracy education (illiteracy rates ~100%) which lead to three issues:

Little access to microfinance services offered by MFIs. Group formation, training and
development costs are higher. [System promotes ‘crowding in’]

Lack of knowledge about the micro-credit services. The finer details are invariably not
known even to the field officers56.

Banks which thrive on their strength to initiate and enforce contract (source), when
“outsource” the banking activity to MFIs, don’t find the latter equipped with the
necessary strength. That the clientele is exclusively focussed at the B-O-P, with lower
levels of literacy, makes the effective enforcement and implementation of financial
contracts even more difficult57.

Exhibit 33: Qualitative Assessment of Financial literacy

14% "Reasonably" financially literate; can


19% compare different MF products and services

Aware of few local companies offering, but


decide with other's help

67% Not well aware of MF how products and


services work (but it seems to be working)

This part is in an analytical deduction and in continuum with the dedicated Chapter on
Financial Literacy.

55
To see how this problem was addressed as a challenge by Micro-Crop Loans in Philippines
http://fellowsblog.kiva.org/2010/02/12/life-on-the-farm-micro-crop-loans/
56
For instance, almost always, the EMI was known, remaining balance was known, but not the effective rate of interest.
57
In a very innovative and interesting aspect, PWMACS, was – legally rightly -
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 91

Exhibit 34: Client centric microfinance or exploitation through hidden costs?

98%
100%
80% 67%
60%
33%
40%
20% 2%
0%
As a client, were you Are there charges that
explained ALL the you don't quite
systems and processes? understand?

Yes No

Inability to A lack of access to funds means micro entrepreneurs cannot inject money into their
exploit growth businesses (say, to buy more resources or hire more people) to grow them after
opportunities observing a surge in demand beyond the Rs 50,000 (missing gap). Banks would still
find it small quanta for economic viability. (So these micro-entrepreneurs end up taking
multiple loans from MFIs,)

The remote locations of micro businesses means they have little information pertaining
to their markets, such as customer needs and competitor strengths and weaknesses
and so on. Suddenly, the growth may not be sustainable. As a result, many critics have
found faults with the idea of microfinance. This isn’t really a problem; but indeed a
challenge that can be overcome as the businesses are helped to grow and increases its
capital base.

Few Micro entrepreneurs have limited skills, qualifications and exposure to handling
organizational businesses. While they need to be trained through capacity building initiatives by the
resources and MFIs, many micro entrepreneurs may not grow as planned because of these problems.
poor For instance, they may borrow more money than needed, or misallocate it in their
governance business and end up bearing the burden of large interest payments instead of enjoying
the fruits of their business. Again, critics may say microfinance is an ineffective way of
alleviating poverty but this isn’t true. The flip side of this problem is linked to the
governance issues faced by MFIs, which is discussed in the first part of this article.
92 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Exhibit 35: Social-business blend? Clients choice

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Would you like to do more than just Do you think that there are things that
get loans (e.g. discuss common village the MFI can do better in terms of
issues?) in meetings? "service"?

Yes No

Low A problem for micro-entrepreneurs operate in competitive markets, their individual


bargaining bargaining power is diminished when dealing with customers e.g. those in the dairy
power business; bulk of the profits and margins are made by those high in the value chain!

Interestingly, the high sustainability – as was observed in micro-credit - is attracting


many MFIs to increasingly look at the forward linkage of dairy business thereby
expanding the scope of their activities and creating multiple touch-points with the
customers thereby creating stickiness to the loans.

Similarly, at the other end of the spectrum, there still isn’t any respite because micro-
entrepreneurs deal with MFIs, who offer standardised weekly repayment products –
“take it or leave it” –which also erode their bargaining power.

Exhibit 36: Repayment Roadblocks

Though convenient with the monthly


77%
MFIs, weekly replayments become priority

Clients juggling/struggling with repayments


29%
due to multiple borrowing ("acknowledge")

Clients prefer to repay the private MFI loans


65%
over SHG/bank loans

0% 20% 40% 60% 80% 100%


An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 93

Exhibit 37: Service differentiation

100% 89%
80% 73%

60%

40%

20%

0%
"There is hardly any difference On deep probing, "Frankly, I do
from one organization to still borrow (or consider)
another, so we have little or no moneylenders..."
choice. Agree?"

Vulnerability Micro entrepreneurs are particularly susceptible to sudden changes in customer


to economic demand, or the weather (even though microfinance can help with natural disasters)
shocks because their businesses cannot sustain losses owning to their small size (low capital).
It’s common to bundle portfolio insurance – often compulsorily – thereby increasing
the ‘effective rate’ of interest. While this may be a problem for the social objectives of
microfinance providers but MFIs ensure their economic performance is untarnished by
charging high interest rates to compensate this risk (read 4 ways to control high
interest rates).

Most problems faced by micro-entrepreneurs are due to their small size and
inadequate skill set. Naturally, once the venture secures a loan and begins to grow,
these problems will (eventually) subside. One may think the problems at the MFIs’ end,
therefore, need greater attention but that wouldn’t be correct because poverty
eradication is a very socially-integrated endeavour.

Technology Technology-related hurdles, such as the high costs involved in small loan transactions
related hurdles for microfinance providers.

Lack of awareness about sources of funds for microfinance providers to pass on to the
poor.

Management The good news is that the top management (6 out of 22 we met) straightway, honestly
and frankly, acknowledged that many of the field trips are doctored (those who were
more sternly) or rehearsed (the mildly referred ones). The field staffs – typically the loan
officer - prepares the groups for a “field visit”.

So the will and intent is there from the top managers to improve the on-field practices

This collusion ensures helps in that multiple borrowing is difficult to capture. The
94 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

members will rarely mention more than 1. Extraordinarily they would acknowledge that
they are members of three groups highest so as to not attract disciplinary action.

Exhibit 38: Borrower feedback as “visitor” of MFI HO, undermines the gravity
of incidence of multiple borrowing

1.4% 0.1%
8.2%

Single
Second
Third
90.3% More

However, the data when we stay on the field we do see an entirely different scenario!

Is there a “The microcredit paradox is that the poorest people can do little productive with the
resource credit, and the ones who can do the most with it are those who don’t really need
misallocation? microcredit, but larger amounts with different (often longer) credit terms.”

- Thomas Dichter

The Ever- An MFI can lend to pay off loan taken from another lender/MFI. This way, the second
greening MFI can save an account from going bad and thus reduce its non-performing assets.
menace The second MFI can then extend a similar facility to a borrower, which has not been
able to repay loans from the first MFI58.

Several MFIs have “pay off another loan” in their Information Systems under loan
utilisation. Since microfinance is supposed to protect poor borrowers from usurious
moneylenders and in so far as the loans are being graduated from ‘informal’ to formal.
However, there is no substantial evidence that the loans are not being used to for
paying off other debts.

Based on our research, in all likelihood, these loans are being rotated and used for
consumption. As the number of loans providers increased (highest was 19), in certain
areas the ‘erosion’ through rotation was camouflaged by availing of further credit (debt

58
The Reserve Bank of India had issued a stern warning to public sector banks against any attempt to 'evergreen' their balance
sheets way back in 2003-04.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 95

trap).

The hypothesis was confirmed in Andhra Pradesh when further loans from banks to
MFIs and MFIs to clients were not forthcoming. The chain was broken; from the
prevalent repayment rates of 99%+, delinquencies ~90-100%ensued (CRISIL report).

The Macro and Does credit really “initiate” poverty alleviation and inclusive economic growth? Did the
meso development of the advanced industrial countries depend on the average middle class
perspectives or poor person having access to credit?

If the large majority of people are not entrepreneurial (high risk appetite and a hunger
for excess returns) in other socio-economic-geographic strata, is it fair to assert that
the poor are all budding entrepreneurs?

If the borrowers have had little contact with financial services, and if most use credit,
when we do, for consumption (e.g. credit cards), why do we make the assumption that
in the case of the microfinance borrowers?

Can we be certain that without financial literacy, the microfinance borrowers will use
credit wisely for investment in income production, and are ready to graduate to higher
and more complex financial instruments?

Can we assume that simply because people are repaying those small loans that they
actually benefitted (remember Kenya?), or that they are indeed the ones most in need
of that credit.

If not, with the limited alternative enabling conditions (finance is necessary but not
sufficient for economic growth and development), then should not the access to
finance be more “limited” (measured)? In a rush for financial inclusion, are we causing
more harm than help?

How much of microfinance should be directed should be linked to the assessment of


“demand” for credit from micro-enterprises. Is such an assessment made?

Systemic Continuing from the previous point, if credit is not an end in itself, but a means to
failure; but generating economic opportunity and growth, in all the appreciation about
blame not just microfinance have we forgotten to question the basic premise: Is lack of finance really
MFIs the core problem? Or only one of many problems? If the latter is the case, credit must
be delivered only after – or alongside, at the least – other barriers have been removed.

Are we not wrongly and falsely blaming microfinance providers for the various
defaults? They’ve done their job of providing credit: Ready, cheap and affordable
financing options to MFI were made available as part of a closely monitored policy.
96 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

However, the lack of enterprise growth options, for myriad reasons, will
always result in default. How can MFIs be singularly responsible?

Brand: NGO Interestingly, many leading NBFCs field staff called themselves NGOs when talking to
vs. Company clients (since “Company is already a “bad word” and anathema in the South – especially
Tamil Nadu and Andhra Pradesh). The old NGO names (if brand names are different)
are usually retained.

Of Many MFIs – including some NABARD supported – are indulging in bulk lending. The
intermediaries larger MFIs, by virtue of their size or scale of operations are able to attract funding
and value (debt + equity) at slightly lower rates. Without incurring any further expense, they on-
chains lend it to smaller MFIs (which is struggling to attract funding) at a 2-4% interest rate
spread without any value-addition. The bulk lending is given to “partner” institutions
[readily seen in balance sheets].The end beneficiary is now paying a premium for
services, which could be availed at lower costs. The smaller MFIs are also struggling
since their cost of funds is shooting through the roof; they are not able to grow. In
contrast, the larger MFIs are acting as financing institutions and perhaps playing a role,
which the banks sh/could play. They are neither screening the groups (or NGO) nor
providing technology for increased efficiency and mitigating credit risks.

From an economic standpoint, this is an interest rate arbitrage! In an efficient market,


this should NOT be sustainable. However, this persists exhibiting that the source / cost
of funds in the microfinance market is inefficient.

It should be the responsibility of banks to ensure that the credit is being given directly
to groups / borrowers from the MFIs rather than have a multi-tiered MFI approach.
Alternatively, this should be checked / capped from a tier-1 financing perspective.

No mention of It was ubiquitous to observe microfinance borrowers ask for higher loan quanta,
interest rates reducing the waiting period in between loan cycles– where applicable, easing off of
repayment frequency (usually preferred monthly over weekly instalments).
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 97

Exhibit 39: Client view on “quality” of microfinance service

120% 91% 96%


100% 87%
80%
60%
40%
20% 3%
0%
Do you think that Do you think you Would you prefer Would you rather
the waiting period deserve to get monthly repayment deal with banks?
can/should be higher loans? Are over weekly?
reduced? you happy with the
amount of loan
given?
Yes No

Invariably comfortable with the 12% (banks) – 24% (not effective but quoted) rates
charged by MFIs. The prevalent interest rate as an “issue” was seldom cited. Based on
client feedback, it may be safely stated that MFIs are wrongly accused of usurious
interest rates.

If clients are comfortable with paying these interest rates, is an interest rate cap (even if
margin) induced through regulation – rather than brought down through competitive
forces - justified?
98 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 5.2: Overview of Group Discipline


An overview of the Group (Centre) discipline based on field observations for the Groups59 sampled; salient
observations on client discipline at the groups are:

1. More than ~90% attendance at the field for the MFIs; this compares significantly favourably to
~80% average attendance at the direct Bank-SHG linkage models.
2. In many MFIs, absentee members adopt the practice of passing on their passbooks to their co-
members for updating; in a few groups, passbooks of only those with outstanding loans were
presented while in others all members’ passbooks were available. Rarely were there instances
where clients had outstanding loans to whom passbooks were not issued. These observations
have been tightened in most MFIs in recent times. Even just Three to four years ago, such
instances were more common.
3. MFI should be commended for having shown some progress in building and enhancing the
financial awareness of its clients about the specific products on offer. This sh/would essentially
mean lower risk - (credit or fraud) - for the MFI.

Section 5.3: Field Observations


From our sample for the arithmetic audit60, our observations are tabulated as below:

Particular Harvey Comments

Financial Literacy. The questions In most cases clients knew answers to few of
revolved around: Did client have the questions. They were “told” that their
knowledge of disbursed loan amount? interest rate was 2% (i.e. 24%) so they
Did client have knowledge about the mentioned. Reducing balance and flat was
associated processing fees? Did client 25 something they did not know (or even care
know about the interest rates? How about). Clients were clear about their
they were calculated? Did clients know instalments due (obligation) and the
their weekly instalments? Did they quantum of loan. In most cases, they were
know how much of the loan was vague when it came to finer financial
serviced and how much remained? planning.

In most cases – the “problem” was that the


0
loan officer was not aware himself and was
no incentivised to teach the clients (non-
productive task from an incentive
perspective). “Quality” of financial delivery
comes into question.

59
Except the Andhra Pradesh MFIs where centre meetings were not taking place at the time we conducted this first phase of
research.
60
Records across data levels (Head Office-Branch-Groups) where applicable
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 99

Loan Utilization Checks (LUCs): For From a MFI process point of view, to look
instance, physical verification of loan into updating the passbooks has to be
utilization at client level differs from undertaken by the Group Managers and
that stated in the passbook; or, loan Branch Manager frequently. In addition to
purpose mentioned in loan passbook the audit team, the Group Manager, the
75
differs from that specified in the branch Branch Manager and the Area Manager
MIS. should increase the number of LUCs being
carried out as the mis-utilisation can affect
the repayment. Ideally, borrower’s signature
/thumb impression should be obtained on
the form which will act as a proof for loan
utilization check.

Honestly – beyond a certain point the LUC is


redundant (due to over-indebtedness and
multiple borrowing). If the ‘social cohesion’
which holds them jointly-liable turns to
50 social collusion, then the same group can
show the same assets to different MFIs to
counter the LUC. In fact, nothing prevents –
as we’ve experienced it elsewhere (but
outside this study) – that a client can always
pass-off another’s asset as their own since
there is no ‘owner-tag’ on a pair of milche
cattle. Is there?

The MIS has allocated codes (a priori) to


commonly noticed loan purposes. However,
there were several instances – all of them
25 with the smaller MFIs – of generic entries
stating loan purpose (e.g. ‘IG activity’)
despite presence of a specific code
allocated to that particular loan purpose.
This is a problem since it exhibits the client
inability to track purposes for client
segmentation and loan history.

Further, as explained, with portfolio


25 expansion it will be increasingly important
to track client level data accurately and
maintain a sound database that is
unaffected by resource constraints and is
capable of channeling information
effectively to the Head Office. Initiatives that
promote training of staff will allow for more
100 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

effective use of IT tools.

Loan disbursement amount in the Cases were noted with such and similar
0
passbook and MIS differs discrepancies: sometimes the loan amount
was higher in the passbook and the second
where the loan amount was lower in the
passbook; the former carries the risk of
sabotaging part of a loan by a field level
staff while the latter the risk of the client
assuming that the amount is lower and
hence having an inaccurate repayment
schedule in mind; while the number of
deviations in the sample is quite
insignificant (statistically), in terms of a
systems (even aspiring for a four-sigma
process) this needs the attention of the BM,
AM and the internal audit team in their
respective monitoring visits.

Member photograph It is surprising that members’ photographs


are not tracked in the MIS. Given the
cost of a digital photograph using a
webcam at the branch is significantly lower
than a print – apart from a reduced carbon
footprint – MFIs are still not using the field
given by their software vendors.

Having photographs can also help


triangulate a new transferred field officer to
track the clients. In cases, where members
were availing subsequent loans, the
photographs from their earlier passbooks
are transferred to the new passbook. When
the photographs get damaged and will not
be in a position to be moved to the new
passbook. Given the difficulty in arranging
for a new photograph in a few remote areas,
many members delay / default in submitting
the same. Photographs are of utmost
importance: Given the lower levels of
documentation in comparison to formal
credit, it calls for a higher level of emphasis
on the photograph to identify the individual
from a KYC perspective. Given that
signatures are faulty (since the first
signatures of their lives are done only since
the loan application document demands;
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 101

these are invariably inconsistent with further


signature requirements), photographs
assume greater significance.

Joint photographs of member and her


spouse can be taken for loan
documentation across branches mandatory.

Obviously, signatures in the Loan


application forms, KYC forms and GRT forms
often done tally. Thumb prints are not so
easy to read. Theoretically, chances are that
the loan is being disbursed to ghost clients.
How can one be sure?

100 75 50 25 0

Legend:

Section 5.4: Prepayment


The MFI should dis-incentivise clients on prepayment. Instead, several MFIs wrongly top-up loans with
higher loans (i.e. next loan cycle) to those who prepay the loans. This creates a potential for over-
indebtedness compounded with the lower credit history. Several MFIs CEOs proudly were suggesting
“innovation” through a Rs. 5,000 “test” microcredit programme that would last six months. If they had
good repayments – which they would (by hook or by crook) – they would graduate to the next cycle: A Rs
10,000 loan. Obviously, higher loan quanta mean lower operating costs (marginal analysis) but higher
credit risks. In this model, within six months, a borrower would build a good credit rating.

The other side of the argument is: Prepayment is good. Why would we want poor and marginalized
people to remain indebted? It’s good if they are getting out of debt (through income and getting into
savings); but we can never know. There are a few MFIs who drop clients who prepay their loans. From a
business perspective, rightly so! But the systemic risk remains: In the incidence of such extreme
competition, the MFI has reduced its business risk; however, the sector would continue to have it since the
client can move on to another MFI. A prepayment penalty (as applied by banks) is conceivably a better
option to ensure that microfinance is not getting treated as a short-term (emergency, consumption) loan
but as a longer term income generating financing.

A prepayment will imply a loss of interest income for MFI. However, it was observed that in several
branches were not reporting the ‘dropout’ status of certain clients in the MIS; and instead were staggering
102 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

the information rolled back it to over 3-4 months. Since the system incentivises61 Group managers to
handle higher number of members (case load efficiency), it is possible that they may not report actual
dropouts on the field and can issue fresh loans against such dropout members as well as other members
in the group62.

Section 5.5: System Evaluation, Operations and Credit Policy


A system evaluation is carried out to evaluate MFI’s systems and processes, their effectiveness in
implementation and robustness to support the growth envisaged by MFI. With the non-availability of the
updated policy documents (most cases this is a one-time affair), the major part of the study involved
observations made at the field level and discussions with the staff and senior management.

Table 11: System Evaluation for Member Eligibility


Scope for
Policy Observations Risk Implications Improvement
Group size should be MFI increased the None
between 15 (for cost group size from 5 to 10
economics) and 45 (for to spread the risk to a
management and large group in case of
efficiency). defaults in the Group
and increase the peer
pressure.
No close relatives with There were no close That cannot be changed Wherever possible, MFIs
in a group. relatives within the and must be endured. should – and do – try to
Group / Groups in any form groups with
MFI! While the chances of members belonging to
defaults increase as different communities
But the Groups were peer pressure decreases and diversified
highly homogenous in / due to members backgrounds.
that members belonged belonging to same
to same community community.
(sometimes extended
family). It could spark off
community vs MFI
debates (e.g. Kolar issue
in Karnataka)

61
If a Group manager handles more than 400 members, he is rewarded with Rs. 2 per member
62
Only if the group maintains strength of >10 members, can they be issued fresh loans and hence the Centre/Group manager may
be incentivized to not report a dropout (less than the minimum) and retain her as an active member. There is also the risk of
‘back-end’ hijack or ‘dummy’ members or ‘kingpins’ coming into play.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 103

Residence: Members within the Tenants have a higher Thus, few MFIs insist
All members of the group knew each chance of migrating. houses be owned by
group should stay in the other’s houses. On an borrowers.
near neighbourhood. average, only 35%63 of
the members had own There should be a
houses. Different MFIs policy defining
have different policies eligibility criteria for
on the ratio of tenants tenants based on the
to house-owners in a number of years of
group. residing in the village/
locality.

Table 12: Evaluation for Group Formation


Scope for
Policy Observations Risk Implications Improvement
The ‘Basic Data’ of the The Member Basic Data None None
members should be Form is filled in for all
filled in the prescribed the members.
form at the respective
group member’s
houses.
Compulsory Group On an average the CGT Flexibility on the CGT The number of days for
Training is conducted was conducted for more period reduces the a CGT may be reduced
for all the new groups than 5 days because of efficiency of Centre based on the client
in new village for a lower understanding Manager for conducting awareness levels and
minimum of 5 days levels of the women. CGTs. random checks by BM
Centre Manager trains There are chances of during initial group
them till the members prolonging the process formation by Centre
are aware of all the by the Centre Manager Manager.
rules of taking loan based on his
from MFI convenience and group
formation rate slows
down.
Compulsory Group There are some Slight deviations in the None
Training is conducted instances that CGT for number of days for the
for all the new groups new groups / CGT can be
in existing centre for a replacement members accommodated in long
minimum of 3 days in existing Group being as the objective of the
done for 2 days. CGT is met and BM/AM

63
The data was collected at the field level during the interaction with the clients in the Group.
104 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

This is because the new are convinced of the


groups / members are same.
already well informed
by existing members
and presence of other
MFIs in the region.
BM should conduct re- The BM does the re There are chances of In view of MFI’s growing
interview for all new interview for all the new BM skipping the re- operations, this step can
groups during CGTs members, but there is interview process be clubbed with the
no documentation on relying more on the GRT and the BM be
the process. Centre Managers and mandated to conduct
the mandated GRT by the GRT and re-
the AM. interview. The AM may
do random checks
instead of all GRTs.

GRT should be done by The AM visits all the None Looking into the future
AM for all the new new groups and growth plans, the BM
groups and by the BM appraises the group as can be given this
for the replacement this serves as a third responsibility. AMs can
members. level check for play a monitoring role
sanctioning the loans. and do random checks.

The GRT form is filled


and signatures of the
new members taken

Table 13: System Evaluation for Group Administration


Scope for
Policy Observations Risk Implications Improvement
The centre meetings In a sample of 20 Group Continued conduct of None
should be conducted in meetings 3 meetings were meetings in a single
common places like conducted in member’s member’s house
schools, community halls houses and 3 in member’s might lead to a
or large open places houses that did not belong dominant behaviour
to that particular Group. by the member.
Although such decisions
may be taken due to
practical considerations like
non availability of common
places near to their residing
place.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 105

There should be a Group The above policy was being None The operations manual
Leader elected through followed. should stipulate the
Common consensus by policy on rotation of the
all the members of the In addition, there is rotation Group leaders and
Group. of Group leaders once in a Centre Manager.
year and documentation of
the rotation of the Centre The branch level MIS
Leaders is being recorded in should capture the
Group minutes book. progress on
implementation of this
There is rotation of Centre policy.
Manager once in 6 months.

However, the operations


manual was not updated for
the above policies.

Meeting Minutes book All the meeting books for None None.
should be updated for the sample of 20 Groups
fields prescribed in the visited were updated till
operations manual. date.

In addition, MFI also plans


to print the minutes book
to ensure standardization of
the format across branches.
106 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Group Meeting Attendance

Table 14: System Evaluation for Group Attendance

Policy Observations Risk Implications Scope for Improvement

The members Attendance is not Given the manual and There can be a MIS generated
should have at least recorded in the Portfolio tedious system of member attendance sheet to be
100 percent Tracker. tracking attendance, it carried by the Centre Manager
attendance for the may prove difficult to to the Group meeting and get it
first five months. Data is maintained check against the signed by the members. These
manually and attendance policy and hence sheets can be documented at
All the members registers were not up chances of a loan the branch level for cross
should maintain > dated in a majority of the sanction without a verification with MIS data
90% attendance in sample. check. whenever required64.
a year.
MIFOS proposes to Chances of
capture this information manipulation of
regularly. attendance
percentages for
irregular attendees are
high.

Fines are to be Fines were not collected None None


collected for for absenteeism; post a
absenteeism to revision of the policy
Group meetings although the same was
not updated in the
operations manual.

However, for absentee


members, there is a
disincentive of delaying
the disbursements in
proportion to the
absenteeism.

64
On introduction of member attendance sheets, the currently maintained member attendance registers can be avoided.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 107

Fines to be Usually fine amount of None None


collected for late Rs.1/- is collected from
attendance from members.
members.
Documented in the
minutes book and top
sheet register and treated
as income to MFI.

Policy Observations Risk Implications Scope for Improvement


Loan repayments are The passbooks in all the None None
collected by Group 20 Groups were updated
leader and handed There is a practice of each
over to the Group individual group meeting
Leader who gives it to the day before the Group
Centre Manager. meeting and pooling
Centre Manager their weekly instalments
counts the amount and and handing it over to
updates the loan pass Group Leader.
books. This is documented in the
mini minute’s book and
checked by Centre
Manager on the day of
meeting.

The centre attendance In all the 20 Groups, no None None


should be >= 90 % loan application or
and the presence of all disbursement was carried
the group members for out on the days when the
taking loan member attendance was
applications and loan below 90%.
disbursements.
Loan Utilization Report The practice of the group The importance of The policy of getting a formal
to be given by the leader submitting the LUC will be lost if the report of LUC for the loans
group leader for the LUC report to the Centre Centre Manager does disbursed from the members
loans disbursed in the Manager was not noticed not promote this of the Group adds strength to
previous week. in any of the 20 Groups. policy on field. the LUC policy.
MIS utilization of A record of this activity should
loans increases be mentioned in the minute’s
leading to increased book.
defaults.
108 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 5.7: Record Keeping at Branch Level


Table 15: Documentation and records at Branches

S.No Register/ Details Captured Risks Operational Suggestions for


Report Effectiveness improvement
Accounting Entries
1 Cash Daily records of Debits None Good None
Book/Day and Credits for the
book branch
2 General Daily Account (head) None Good None
Ledger wise Income and
Expenditure Records

3 Vault Book Daily record of Closing None Good None


Cash balance with
denominations. The
closing balance is
transferred to the Cash
Book for accounting
purpose.

4 Daily Collections records None Good None


Collections handed over to the
Book cashier
S.No Register/ Details Captured Risks Operational Suggestions for
Report Effectiveness improvement
Operational Records
1 Movement Group managers sign None Good None
Register this register before they
leave the branch office,
cash carried and
destination and timings
are also recorded.
2 Member Group Officer maintains This is marked Moderate While we have no
Attendance this register of the by the CENTRE evidence of
Register members attending the MANAGER manipulation, as it is
centre meetings. and there difficult to detect, we
could be do think that direct
scope for signature of the
manipulation. member treated as the
If the Centre attendance record for
Manager is checking before loan
incentivised to sanction, would be
promote more meaningful.
loans, he may
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 109

manipulate
these records.
3 Group Master Maintained at the None Good None
Register branch to record group
formation and
movement of members
i.e. drop out and
joinees.

4 Drop Out Details of drop out IDs, None Good 1. The drop out register
Register names and dates and exit poll could be
merged into one, thus
allowing the full case of
drop out to be viewed
in one entry. A separate
line below each record
could be used to enter
reason if space is an
issue.
2. Separate exit poll
register can be
maintained if desired to
track reasons. However
we suggest that these
are entered into
separate sections of the
register sorted into
sections by reason. I.e.
5 Exit Poll Details of drop out you will have a section
Register reasons each for reason
“migration”, “unable to
maintain discipline” etc.
and the entries made
depending on reasons

3. Tracking this in
system may allow for
easier access to the
data and could be an
option.
6 Loan Updated quarterly for a None Good None
Utilization 50 week loan cycle after
Check Register the checks done at field
level by the MFI staff.
110 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

7 Branch Daily records of None Good None


Outreach number of Group,
Register members and groups

S.No Register/ Details Captured Risk Operational Suggestions for


Reports Observations Effectiveness improvement
Miscellaneous
1 Visitor's Visitor details None -NA- None
Register
Reports
1 Glance Report Branch Member None Good None
outreach, Active Loan
Clients, Loan
Disbursements,
Portfolio Outstanding,
Drop Outs,
Prepayments, Branch
Staff etc. This is sent on
a weekly and monthly
basis.
2 Branch Cash Disbursement amount, None Good None
Confirmation Loan recovery and cash
Report brought back to office.

Additional Suggestions

1 Key Holding Presently key handover Not observed Moderate 1. A key register which
and Handover by a letter to the BM in records issue of keys to
case of leave the staff, and any
transfer of holding,
would be an effective
way to record key
movement
2. Mysore branch is
maintaining a note on
the vault register when
changing hands, but a
key register allows
retrieval of this data
more easily
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 111

2 Standardization Registers entries across None -NA- Pre-printed registers


of registers. branches are standard may increase efficiency
and user-friendliness

Section 5.8: Internal Audit


Internal Audit is a very critical function in the overall risk management system. Many MFIs see it as an
IT/MIS extension. However, while Internal Audit is a necessary function to mitigate risk it is not sufficient
to just to manage all risks. Most MFIs – including some of the very large ones – have this misplaced
opinion that by having an internal audit department one has managed most of its risk! However with all
the discussions above we can now fully appreciate that this is not true and risk management or overall
internal control is a much larger job and internal Audits is only a part of it.

Internal audit is an independent check on the performance of the MFI. Here it is extremely important to
grasp the interpretation of ‘independent’: Internal audit has to be completely independent function from
operations. Independence is ensured by having completely separate staff team and the department
reporting directly either to the Board of Directors or to the organization’s head.

(1) Independence and (2) Objectivity, therefore, are pivotal to the success of the function. The idea behind
Internal Audit is not just to catch frauds or malpractices but more constructive, i.e. to add value and
efficiency within the organization by mitigating the possibilities of malpractices. Internal Audit is done by
a specialized Internal Audit team who should be very well versed with the organization policies and
procedures. The next generation IA teams (3) c/should also be conversant with competitive best practice,
etc. so as to suggest ways and means of greater operational effectiveness, suggest improvements on
business processes etc.

Common objectives of the internal audit function are:

1. To detect fraud or misappropriation irrespective of its size, magnitude, other staff involved in it

2. To detect any malpractice, collusion or action on part of employees that is against the
organizational policies/culture or can bring disrepute to the institution

3. To see if operational policies/processes are being adhered to at all levels and to detect deviations

4. To check unethical staff behaviour and to get a sense of organizational image as perceived by
clients

5. To check the accuracy of reports, MIS and Accounting, accuracy of records maintained through
verification against evidences such as receipts, including records maintained at client level in the
form of passbook

6. To provide feedback/opinion related to operational risks such as staff dissatisfaction, competition,


inappropriate policies or areas of potential conflict
112 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Scope of Audit: It is a common feeling among several MFIs that audit means just checking of books of
accounts and cash vouchers. Rather, internal audit has a much larger scope to cover and to cross-check
various reports. The basic idea is to check any kind of policy deviation or identify any situation, which can
be a risk for the organization.

Internal audit should also (at least) cover the following:

1. Financial reports and records: receipts, vouchers, cashbooks, ledgers, client passbook, MFIs bank
passbooks, cash balances
2. Loan documents: Loan applications, promissory notes and other documents required as per policy
related data entered in MIS data
3. Client visits: Check meeting discipline – timing, conduct, staff and client discipline, passbooks
interact with clients, loan utilization
4. Other observation: Staff discipline, hygiene, file arrangements and cataloguing

Audit Policy: The audit process is guided by an Internal Audit policy that the organization has. The policy
clearly lays down the frequency of audit, objectives of audit, scope of audit, audit process, formats to be
used and format and frequency of reports.

Audit plan: Internal audit managers should prepare a quarterly audit plan, which discloses how the
department will go about carrying the audit exercises. It tells which branch will be audited when, resource
allocation, number of days of audit and tentative date of submission of report. Audit plan is a confidential
document and shared only with the Board of Directors or the Head of the organization.

Sampling: Since it is not viable to check all transactions or meet all clients, the internal audit has to rely
on sampling. Auditors have to sample out the transactions, records and reports to be checked and clients
to be visited. While sampling, following things have to be considered:

a. The sample should be unbiased and representative of entire portfolio and should be able
to cover all products, all geographic locations and all field staff
b. The sample pull out with greater emphasis on the vulnerable areas like cash handling,
groups having repayment problems

Auditing: Most organizations prepare auditing formats and have standardized templates. The auditors
generally follow these formats for various kinds of checks and cross-checks. However, as an external
auditor, we did find in many cases, auditors have been mechanically filling in forms. We wish that audit
managers were not proactive, inquisitive, observant and smart to identify anomalies, contradictions or
conflicts in reports, data or statements made by staff. To make the internal audit meaningful, MFIs must
have detailed operational policies.

Reporting and Follow Up: The auditors have to ensure that audit report is completely objective and
reports all observations and findings. The team should not be (too) judgmental and/or take decisions; it is
not their prerogative or place.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 113

Further Suggestions: The audit report should typically be presented to the Board of Directors. The IA
reports should be made available more standardized, more intense in terms of ‘risk implications’ and
peculiar to mention, the documents should be in English (so that it helps the funders to have a better
understanding of the reports and the corrections made in the field).

However, in most cases this is restricted to reporting to the CEO. The report must be discussed in the
board meeting as well as in the Audit Committee meetings. It is the responsibility of the management to
see that the findings are followed up properly and required actions are initiated.

Audit reports should also be shared with the Branch so that they can know of their shortcomings. Less
complaint sort: More improvement pointers. The auditors in the next auditing must verify if the
shortcomings reported in last report have been addressed or not. If not, then it should be mentioned in
report that no action has been taken despite mention in audit report last time.

As the Audit team works towards ensuring the compliance of practices with policies and laid down
procedures and monitoring the system (independently) to ensure that internal controls are working in the
organization, and to make recommendations for better control; since the internal audit is NOT
empowered to make suggestions about “potential and forward looking” risks emanating from the field!
This to us – is a hold-up in effective functioning of microfinance in the field.

So far it was working just fine; however, increasingly the small teams will be insufficient to cover the ever-
growing branches and client base. MFIs should focus on recruiting and training the more staff. Based on
our field review, our discussion with operations managers, internal audit team, we believe that the internal
audit – system, structure and the process – in general are quite inadequate for most MFIs. As we pointed
out to some of them, the frequency (even keeping in mind sampling) of internal audit was inadequate.
114 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 5.9: Management Information Systems (MIS)


State of the art MIS software dedicated to microfinance are available from listed companies to budding
entrepreneurs who have already acquired private equity funding themselves; MIS should ideally not be an
issue.

Technology can be a propeller to effective implementation of microfinance. It has become essential that IT
is adopted as one of the strategic objectives and is implemented in line with best practices in MIS to
achieve positive impact at the operational and beneficiary levels. As a result of having strong and flexible
MIS, many microfinance organizations have been able to introduce a wide range of products and services,
including loans, deposits, remittances and insurance. The system is used to obtain maximum information
to support timely decisions. Technology systems need to be established across three levels vertically and
horizontally in a microfinance organization:

(a) Managerial level


(b) Organization level (involving key stakeholders and beneficiaries), and
(c) Industry level

Exhibit 40: Operating Framework for an MIS

INDUSTRY ORGANIZATIONAL MANAGERIAL

DECISION
MAKING
POLITICAL
• Schemes and policies
• Legal support and developments RESOURCES SERVICES Strategic

ENVIRONMENTAL
• Competition Analysis and Position
• Market Trends and Developments MANAGEMENT Operations

SOCIAL
• Beneficiaries ORGANIZATION GOVERNANCE Control
• Impact Assessment

TECHNOLOGICAL
• Systems and Processes INFORMATION
• Control levels SEEKING
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 115

(a) Technology is very critical at the information seeking and


decision making stages (that encircles information from
across the internals and externals of the organization and
Case in Point: MIS at Equitas
the industry at large) to building an efficient/effective MIS
to manage data, information processes and activities. An Equitas is an example of appreciating the
appropriate MIS also helps the institution better- role and importance of a good MIS to
understand its client needs and thereby enables it to well-managed microfinance. Equitas
serve them better. An effective MIS is therefore necessary hired IT experts who to setup a world-
for MFIs to manage their client interface, their activities class MIS before launching the first loan
and their processes to drive in to operational efficiency product. They developed an innovative
process to deliver collection payment
and effectiveness.
receipts to customers with little scope for
misappropriation.
(b) At the organization level, technology is typically used for
delivering transaction reports and solutions. Here, the use Real-time monitoring: Within 15
of technology can promote efficiency and systemize the minutes of the end of a group meeting,
client products and field processes so that the overall cost loan officers send a text message by cell
of delivering financial services is minimized and phone with three information areas:
meeting attendance, loan collections,
beneficiary convenience is enhanced.
and when the meeting ended. This
information is picked up by the
(c) At the sector level, technology can facilitate capturing processing system which then compares
information on various aggregate segments of Individual it with what is expected, and creates a
clients and also individual institutions. It can serve as an branch-by-branch report.
interconnected model for reporting and analyzing
competition and thus virtually serve as a rating and Paperless process: At Equitas,
benchmarking bureau. Deploying effective technology membership and loan applications get
manually filled at the branch level and
can induce greater transparency and accountability, a
couriered to a central processing centre.
long standing folly of the microfinance sector. Despite
Here the documents are scanned to
the common understanding of the importance and make the processing paperless. The
utility of technology cannot be undermined, one forms use a series of checkboxes which
needs to ask the question as to why the use of such can be read by scanners and coded
technology has not percolated significantly within the automatically. Remaining manual
Microfinance industry in India. entries (e.g. names) are entered by a
dedicated back office processing unit.
(d) While a few MFIs are making good use of technology, the
Tracking cash tightly: Relying on real
majority are facing difficulties in getting the right and on- time data, cash withdrawals and deposits
going solution. Some of the reasons include: can be closely monitored: Opening and
a. Lack of commitment of management and key closing cash balance at the end of each
decision-makers within an MFI. For instance, business day is tracked. Thus, no cash
Bandhan still does not use a computerized MIS65. needs to left in branches overnight (risk
b. Insufficient resource capacity; most other MFIs take for operational
c. Insufficient understanding of suitable MIS reasons) and it is all fully banked and
tallied at the end of each day.
applications;

65
Source: Discussion with key stakeholders of microfinance sector; http://www.sidbi.in/micro/Bandhan.pdf
116 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

d. Diversity in business processes and frequent changes in procedures and inability of the
tech companies to keep pace and quickly adapt ;
e. Fear of failure of the MIS;
f. Diversity of geography and language;
g. Incapability of vendors to implement and support customized solutions;
h. High cost of IT solutions for MFIs;

Key questions to address


Looking at the current state of MFI sector - that is experiencing rapidly increasing beneficiary base,
growing players, increasing funding gaps, funds in circulation, discerning customers, more stringent
regulations, it is imperious for each MFI to give attention and deeply assess the need and the approach
for operating around an MIS:

1. Given that microfinance involves large numbers of small repetitive transactions, how is the MFI
currently managing information and field data on their clients, products, processes and activities?
How has been the decision making using the data established? Are the present systems of
recording and monitoring enabling them to understand the trends and patterns within the
operations? What changes does the MFI envisage to introduce in its processes?
2. Do MFI presently have or need a fully automated MIS/completely manual systems/using hybrid
systems? Are there differences around the legal structures, size of the organization, operating
states, and beneficiary base? What are good criteria to consider setting up MIS? Are there
challenges that the MFI is likely to face with regard to implementation of integrated MIS systems?
What are these and how can these be addressed?
3. In established MIS, are the functional modules integrated across products, processes, client
segments, branches and functions (like accounting and portfolio data)? If yes, how do these
systems perform in real time in terms of accuracy of data used/generated as well as time taken for
analysis and production of reports? If no, how are the MFIs and especially those with a large
number of clients and services deal with assessment of vital and connect data?
4. Are all features/aspects of all products for all clients in all locations available in the MIS? What is
the reliability and validity of this information in terms of accuracy?
5. Is the information (in the form of reports) provided by the MIS sufficient (for various
stakeholders) in terms of content, frequency and timeliness so as to give a fairly accurate
profile and status of the MFI’s financial position/condition and prospects? Is it information
suitable for decision making and risk management from an institutional perspective?
6. Are the data/information/reports in the MIS comparable to that in other institutions and as per
good practices/RBI norms?
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 117

7. Do the MIS of Indian MFIs have transparent business rules in line with regulatory norms66 in
critical areas including (but not limited to) the following:
i. Asset classification and provisioning: including methods for determining quality of assets
and related indicators (PAR, provisioning ratios etc). Some relevant aspects here are:
a. Transparency and verification must be possible with regard to the sequence of
appropriation of client repayments which needs to be as per RBI standards and
norms;
b. Grace periods, if any along with the number of instalments must be clearly
discernable and/or stated upfront, if hard coded in the MIS;
c. The specific conditions for calculating indicators like PAR - e.g., Whether PAR is
calculated based on principal overdue or all overdue - must be clearly stated and
transparently discernable;
d. There must be practices and procedures for regular monitoring and management of
past due or impaired assets/credit relationships, evaluating the adequacy of credit
(loan) loss provisions and credit (loan) loss allowances etc.;

ii. Accounting policies and practices: Those “options” followed in the MIS [or integrated
Enterprise Resource Planning (ERP)] must be as per requirements of accounting regulatory
body: Institute of Chartered Accountants of India (ICAI). The integration of the accounting,
portfolio and other modules must be through a transparent process and standards as
prescribed through RBI norms;
iii. Effective cost to client: The effective cost for various products (interest rates, fees, all forced
conditions67 including credit/ portfolio insurance etc.) must be transparently available to
funders and capable of being compared with actual portfolio yield and/or earnings;
iv. Other Aspects: Clarity and transparency in risk management aspects including controls,
ALM issues, exposure norms across products/regions/sectors/clients etc
8. Are the data from the MIS consistent with the financial and other statements that the MFI
generates and uses internally to measure, manage and monitor its portfolio and other risks?
9. Are the data from the MIS consistent with the financial and other statements that the MFI
generates and files with concerned regulators on a periodic basis?
Without question, there is a critical need to establish standards for certain non-negotiable terms of
minimum system requirements for the MIS in Indian MFIs.

66
Where clearly defined policy and disclosure norms do not exist or are not prescribed, practices must be brought in suomoto by
MFIs. This will induce greater confidence of investors, promote better sectoral values and bring in confidence to the
governmental institutions that “self-regulation” of the sector indeed has merit.
67
Point to note is that “forced” and “options” are two different things in so far as (financial) valuation and social impact is
concerned. Thus, this attribute impacts both bottom-lines, so very important to microfinance
118 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Regulating authorities should facilitate the sector progress and growth by enabling the Indian
microfinance industry to ‘arrive’ in so far as having transparent, integrated and comprehensive
management information systems that really work on the ground are concerned.

Building an effective MIS


Given below are a set of key lessons around design and implementation of an MIS68, based on close
observations of Indian MFI process and practices. These lessons could be useful for effectively integrating
technology and automating (or upgrading) MIS in MFIs.

Taking a phased approach. Some MFIs who have established an effective MIS for capturing integrated
microfinance activities. During our study, we found that many of the MFIs typically opt for one MIS (or in
fewer cases, an ERP) vendor to put together a customized program with necessary module inserts to
manage, control and act on its operational and strategic activities. This exercise involves continuous
monitoring and takes a significant portion of both management and technical teams’ time and attention.
Further pilot testing each module of the MIS automation ends up being expensive. Often, nascent MFIs,
which are experimenting with their basic and core processes, find themselves faced with the never ending
task of (re)designing the MIS to eternity. In such cases, automating the MIS is almost impossible and
further dents into the MFI budgets. Additionally, such pilot testing may lead to reduced enthusiasm for
the technical team and opens the door to errors and redundancies. Thus it is strongly recommended that
MFIs assess and prioritize their gaps and requirements and develop a flexible approach to automating the
MIS in a phased manner to ensure stability and usability of the systems.

Need assessment before automation. A detailed and holistic need assessment is very critical before
moving on to automating the MIS. Use of research techniques like group and personal discussions with
field, operating and management staff could provide valuable data and significant insights to the
automation plan. Adding more, the information needs must agree with the decision making hierarchy
followed in the MFI. An appropriate way to assess the mapping is with detailed process charts and flows
on various activities - with inputs, process descriptions and outputs and their sequential linkages. These
serve as valuable blueprints when automating an MIS.

Simple and effective MIS design. While automating, it is essential to ensure that the MIS design is kept
as simple as possible. Among other things, best efforts must be made to see that no information or
record is duplicated; all data going into the system must be cross-checked for utility and actual usage.
Therefore, rationalization of information flows (including possible re-engineering of business processes)
and also organization structure/hierarchy is extremely critical. A modular structure for the MIS, where
different elements are linked and share information is an attractive option. It affords significant flexibility,
facilitates compartmentalization apart from synergistic benefits.

Need flexible framework. The MIS design should also be flexible to the maximum feasible extent. The
best way to address this is by having a separate and transparent business rules module, with options for
alternative methods of interest calculation, interest rates, loan instalment repayment frequency, loan term
and several other aspects including generating user defined reports. Enabling generation of user definable

68
“Building a transparent MIS for microfinance” and “Understanding The State of MIS in Indian MFIs” by Ramesh S
Arunachalam. Ramesh S Arunachalam has over a decade of experience in designing and implementing MIS systems including
ERPs and CBSs.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 119

reports (in real time) would be very handy for different stakeholders with different interests and looking at
various perspectives of the business. This can save significant time and effort for the institution as well as
the vendor, especially, in the later years, when some of the elements, assumptions and activities in the
core processes may have to be changed and/or new information and decision making needs may arise. It
is important to recognize that for MFIs, like other organizations, it would be impossible to specify all
information requirements, at any given point in time. Therefore, mechanisms that can provide flexibility
like a user modifiable business rules module and user definable reports are very necessary requirements
and are best implemented. A flexible report generator could play a very useful role here as the users can
then choose parameters and generate the kind of report they require – which may sometimes be
necessary with changes to the regulatory framework.

Ensure regulatory compliance. This will also enhance transparency of the MIS, which is much need
today. Six practices aspects are very critical while automating an MIS for an MFI:

1. Sequence of Client Repayment: The sequence in which client repayments is being appropriated.
This should be as follows – fines (if applicable), penal interest (if any), interest overdue, interest
due (if due on the date on which repayment comes in), principal overdue and principal. If
principal is appropriated first, then, while portfolio quality would appear better (than is), the yield
on portfolio would reduce;
2. Ageing of Past Due Loans: The method of calculating age of a past due loan, should be through
the best practices method69. Using the instalment method of ageing requires adjustments to be
made as this method understates age of past due loan after the loan term and overstates age of
past due loan within the loan term;
3. Asset Classification and PAR: While selecting past due loans for calculating Portfolio-At-Risk (PAR)
of any age, the reference point is to choose every loan that has either fines or interest or principal
overdue70;
4. Weekly Instalments: in case of ageing with weekly/daily installments, define age categories based
on number of instalments skipped rather than in days71;
5. Factoring Grace Periods: Factor in unusually long grace periods or repayment moratoriums while
calculating portfolio quality72; and
6. Data Integrity for Financial Statements: Ensure automatic integration of portfolio and accounting
modules, in that data entered in one (Enterprise Resource Planning – ERP), for example, loan
disbursement through the portfolio module, automatically gets reflected in the other, as loan
outstanding under assets in the balance sheet;

69
Where age of past due loan = Date of calculating age – earliest unpaid overdue (in days)
70
Technically, it is possible to have past due loans with ‘0’ principal overdue and some interest/fines overdue and hence, using
only principal overdue to determine aggregate loan outstanding of past due loans could actually under state risk in the portfolio;
71
This is to ensure appropriate provisioning. For example, in a weekly payment model, 30 days past due could actually be four or
five installments missed. Compared that to a fortnightly repayment or a monthly repayment schedule, which – when compared to
banks – is one or two installments missed;
72
For example, repayment in 46 installments over a 50 week period could mean that at any time, a client could have skipped
4installments and still not be classified as a (past) due account, giving the portfolio a higher quality assessment;
120 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Migration of historical data. Migration of past data is very critical to continuity and it needs to be
reviewed even at the conceptualization and development stages, so that the new database is designed so
as to take care of various aspects with regard to past data. Typically, Many MFIs establish MIS and keep
the historical data in the migration or backup mode for a long period and use two systems in parallel. This
doesn’t serve the purpose of the automation or upgrade of the MIS. However tedious this process may
be, the integration of all past records with the new MIS matching modules greatly enhances the
robustness and credibility of the MIS. It also ensures smooth transition from one system to another and
thereby, results in minimal disruption of operations.

Maintenance is essential. Maintenance is an often ignored aspect with systems but the traditional ways
of working may not benefit any longer. Be it product development or product redesigning, it is necessary
to have access to the software code to self-manage the model within the MFI. As found in many cases,
there has been misunderstanding with vendors with regards to maintenance activities and the system
fades away in due course of time! Thus, the contract with the vendor should clearly define the
maintenance clauses.

However, there remained a few bugs in the MFIs reviewed – which the internal teams of the MIS/IT
departments of MFIs were tracking; the more savvy CEOs were tracking and suggesting improvement
themselves. Some very basic (and obvious features) were either not available or not implemented by the
MFI. Fortunately, everyone realizes the importance of having the MIS in place. Naively perhaps, most
people in the sector, when they have an MIS are immediate to claim that they have their “systems in
place.” Microfinance systems – for the record – go well beyond the MIS.

Observation Risk Implication Suggestion

Attendance is not tracked in It is an “optional” field in most MIS for There are biometric devices
many a MIS MFI. However, attendance is very which are increasingly being
critical not only for imparting financial used in the BC-BF model. The
discipline but also for the loan cost of implementing used to
disbursals. For instance, if there are be higher for MFIs. Not
policies that a minimum of 90% anymore. Can the same be
attendance is required, then it helps to used by MFIs? How about
know this at the branch/ HO level for mobile phones to track
disbursal. If not tracked, since there are attendance?
incentives for the centre level
managers and branch managers on
loan disbursal, there is a risk that the
attendance can be being manipulated.
Further, checking if the attendance was
>=90% before a loan sanction,
attendance of other group members
etc. can be tracked more easily if the
attendance data is captured.

Client’s credit history cannot be In many cases (4%), clients are Till such a time as the Unique
tracked by MIS dropped since they have repayment Identification Access Code
problems. Also many of them migrate. (UIAC) or “Aadhaar” card,
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 121

So it is possible for a dropped member comes into play, specific


who has had repayment issues (i.e. bad identification numbers like
credit history) to relocate to another the numbers on ration card /
branch/centre and begin afresh as a voter ID / PAN card / Driving
new client of the same MFI and licence can be noted in the
becomes eligible for a loan. Obviously, Member data Factsheet in
they can certainly go to another MFI in MIS customised to capture
the absence of a credit bureau. One of this data. It should be part of
the most important objectives of KYC. This reduces the risk of a
microfinance is to convert people client with a bad credit history
without credit history to create that all re-joining the MFI.
important information about credit
history (whether good or bad).

Loan Utilisation Check (LUC). In It is important that the loan is being The software should have the
many cases, the ‘purpose’ of loan utilised for income generating activity. option of ‘other’. This could
in the MIS has a dropdown and The HO should be able to monitor if be entered manually by the
~30-40 activities are listed. In the activity is indeed income Centre Manager. This would
many cases, default option IG generating. However, several MFIs do help add more fields at the
(income generating) activity was allow ‘payment of other loans’ as a local level. Local occupation
used. This does not add any term. It is nowhere indicated or can be can be factored. The more
value or information at the safely assumed that these are higher granular the data, the better.
branch/ head office level since all interest loans (from moneylenders).
activities are IG. This would enhance
consistency and transparency:
The data on the passbook,
the Loan Application Form,
MIS data at the Branch and
the HO.
122 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 5.10: Human Resources


Significance of HR in MFIs
Any microfinance institution survives on two major resources: capital and people. The microfinance
industry gives significant attention to the financial aspects of its operations. However, it is the people in it
who manage the finances optimally. Human Resource Management tools and systems are critical in
finding, training, managing, motivating, and developing a team of staff who will effectively carry out your
MFI’s mission. By building strong, well-functioning human resource systems and tools, your institution will
be poised for growth, ready to manage the challenges of an evolving environment, and responsive to the
needs of your clients.

Three main factors that affect the work and goals of Human Resource Management are noted in the top
three boxes in the figure. These three main factors are society, the MFI, and the staff. In managing your
MFI’s human resources, it is important to consider each of these stakeholders.

Society and Beneficiaries: The external environment in which MFIs operate can heavily influence human
resource planning and management. By its very nature, part of the MFI’s mandate is to respond to some
of beneficiary needs and challenges. Other external factors that will affect HRM could include competition
in the microfinance sector, and even your relationship with donors. In addition to dealing with these
challenges, your MFI must also understand and comply with the legal requirements and labour laws in
your region. This will impact your human resource management policies and procedures. Many informal
rules or expectations within society may also have an influence on the issues your MFI must address in
staff management. In Africa, one widespread societal issue that impacts microfinance is HIV/AIDS. Special
attention is given to this issue in the figure and throughout other sections in the toolkit.

The MFI: The major aim of Human Resource Management is to contribute to the success of your MFI.
Therefore, the mission, strategy and goals of your MFI will form the basis of how you approach human
resource issues. The structure and functions of HRM should be at a level that is appropriate to the size
and needs of your MFI. You could be wasting precious resources if HRM systems and tools are more or
less sophisticated than what your institution needs or can afford.

Staff: Effective Human Resource Management will seek success for your MFI through supporting the
contribution of each employee. As noted above, your institution’s success is highly dependent on the
success of each of your staff. Many Human Resource Management systems and tools are available to
support each employee to be productive, thereby contributing to your MFI’s success.

These three stakeholders (society, the MFI and the staff) are beacons that will help to guide the human
resource strategies and day-to-day activities. Not every HRM decision or activity will affect these
stakeholders every time or to the same degree. HR Managers will often need to find an appropriate
balance between the competing interests of these three stakeholders and will learn when and how to
compromise appropriately.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 123

Exhibit 41: Human Capital Strategy Interventions

Competency
Development

MFI Process Learning


Integration Management

HUMAN
STAFF CAPITAL
STRATEGY

Systems Performance
BENEFICIARIES Enhancement Evaluation

Process
Improvement

MFI Struggle for Quality Talent


The quality of service delivery in the microfinance sector (specifically post the crisis) depends on the
resource capabilities and relationship building on the field. Hence, it is more human capital-intensive.
Sourcing of skilled and quality human resources will play a critical role for sustaining the growth of this
sector. Unfortunately, human resource has been a neglected function in Indian microfinance sector.

Microfinance organizations across the globe are struggling to navigate financial, regulatory, political,
competitive and other challenges as they focus on reaching greater numbers of the poor and poorest.
Perhaps the single most important resource MFIs have for meeting these challenges is the capability of
their people. Whether developing and delivering financial products that meet the needs of the
underserved or working to help educate regulators on the needs of the industry, MFIs must depend on
their own internal resources. While some organizations recognize this imperative, for others achieving
long-term success requires a fundamental shift in focus, moving from viewing their staff as a necessary
but somewhat interchangeable resource to the understanding that a competent, capable, and committed
workforce can be the strategic differentiator and the key to successful growth. Maximizing staff strengths
depends not only on hiring right and providing appropriate learning and development opportunities; it
requires adoption of strategically focused human capital management practices.

The microfinance benchmarking field study brought come critical insights around human capital and
prevailing people practices that are underpinned to the performance of the organizations in the sector:

While MFIs (big, medium or small) attempt to achieve socio-economic impact through their
service offering, they seem to struggle to hold on to their best resources.
124 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Planning for human resource has predominantly been impromptu mostly around determining
new recruitments or promotions to estimate the salary expenses. Very little attention has been
given to vital matters like finding the right people for different MFI functions and their willingness
to compensate adequately for people with relevant experience.

There is a struggle for several MFIs to align commercial investment, culture and social objectives
constantly reinforce its mission. Many MFIs in the chase to expand customer base add staff and
deliver expected financial outcomes however the social returns tended to get overlooked. Top
management may continue to be mission oriented however there seems to exist diluted focus on
reinforcing this intent at the field level and little attention has been paid to it.

While the MFIs have a want for dedicated talent, they are equally resistant to delegate decision-
making down the organizational hierarchy, preferring instead to keep authority centred at the
head office, with senior leaders. This practice is at odds with the need to develop employees who
can take on ever-increasing responsibilities.

MFIs also hesitated sharing business specifics information with staff—on external regulatory or
political challenges, progress against overall organizational targets, or even the sharing of internal
best practices—out of a belief that the average employee won‘t understand, has nothing of real
value to add to existing operating procedures, or may share confidential information with
competitors. But what a lack of information and transparency really does is to reduce the
employee‘s ability to commit to the organization or to see the link between his or her own efforts
and what is needed to drive the organization forward.

Performance targets have been set for rewarded the accomplishment organization’s short term
objectives (usually without the inclusion of more qualitative assessment of service quality and
member stickiness). Thus, field officers tend to use aggressive tactics to secure repayments or cut
corners on credit underwriting in order to sign up new clients and expand the overall portfolio.

The sector has not attracted talent and human capital growth proportionate to the social and
financial expansion. There isn’t enough increase in the professionals with relevant experience
since the microfinance sector scaled up recently and there are limited training institutes or
business schools to churn out people with required attitude and skill sets.

There is a constraint of or clarity missing in the well-defined HR functional outline and a strong
need to formulate competent and well-serviceable policies, frameworks and procedures with
reference to MFI business to make available the right number of people with the right attitude
and skills in the right place at the right time.

Some MFIs have not developed any rewards and recognition systems or have eliminated
resources for malpractices. At the same time, there are some organizations that tether field officer
incentive structures and performance targets to the poverty categories of the clients captured.
This created a pressure among the field staff to drift from a digression of evenly strengthening
the customer base to inclined profiling. This eventually has a stark impact on the social and
financial performance.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 125

Portfolio This indicator has been looked from the point of view of attracting
size more clients and/or larger loans. This approach led to relaxed
credit approval norms and processes thus causing rise of the
potential over-indebtedness for members
Portfolio In an effort to minimize late repayments or defaults, loan officers
quality tend resort to collection tactics not approved by the MFI to
“encourage” repayment.
Client Base Similar to portfolio size, this indicator may also encourage relaxed
credit underwriting/approval processes.

Today, there exists constant and continuous need to develop sound and viable human capital
management in the foundation of MFI strategy to deal with roadblocks in microfinance sector. To
strengthen their financial and social impact objectives, the MFIs must aim to relook into the human
resource strategy to engage best talent, to retain and train, design appropriate compensation and
incentive structures and succession planning for effective service to the poor.

The gap as an opportunity


Time after time, it has been proven that
Providing efficient financial services and help
organizations that “engage” the people side of
protecting the clients’ interests are aligned
business are more successful and sustainable than
objectives that can be realized with phased
those that don’t. MFIs need strong, competent
approach efficiency in recruitment, selection,
leaders, especially in the field, who can manage
training, development and motivation systems.
current complex challenges, develop and manage
There has to be qualitative and quantitative
teams, and expand their operations. These field
performance goals that clearly define what are
leaders will evolve as next generation of senior
the expected attitudes and behaviours.
leaders to serve as guidepost for the organizations
and the sector. MFIs also need to hire the right
people - at all levels - but especially in the key field
officer role, describe by one CEO of a large Indian MFI as - the backbone of microfinance. And once hired,
MFIs need to make sure employees develop the technical skills and behaviours required to effectively
deliver the organization products and services while ensuring client interests are protected.

Optimizing the Human Capital


Almost all MFIs have a common concern regarding human capital management:

There is little scope for workforce reductions


Expansion is priority
Talent management gap continues to exist

People with skills remain in demand all the time, and it is important for microfinance teams to know when,
from where and how to attract, retain and engage talent with suitable reward strategies. MFIs must have
flexible strategies that can respond to market conditions, risks and constraints, and accordingly drive
performance and support growth. By optimizing its human capital, MFI can create a differentiation by
126 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

transforming its workforce into a strategic resource and core contributor to business strategy and
financial performance.

Human Capital Optimization means ensuring that the people in an organization are engaged and
managed in the way that most directly supports long term financial success and growth.

Optimization can be achieved across three critical areas:

Workforce: The people the organization has or will need programs and processes to retain and
engage them effectively, to maximize the value they can contribute and align their roles with
business objectives.
Reward programs: The broad and integrated set of financial and non-financial rewards that the
organization can put in place to meet employees’ financial, security and other needs across the
employment life cycle.
People-related risk management: The processes and programs required to effectively identify,
assess, manage and mitigate the financial and other risks associated with a wide range of
workplace and reward programs.

Exhibit 42: Human Capital Optimization Matrix

REDUCED COSTS ENHANCED PERFORMANCE

WORKFORCE  Staff reduction/  Talent management


OPTIMIZATION redeployment retention and
 Performance engagement strategies
differentiation  Business performance
 Work and process management
redesign  Integrated, effective
communication

REWARDS  Reduction of fixed cost  Reallocation of rewards


OPTIMIZATION rewards aligned with roles
 Elimination of programs  Alignment of incentives
with low contribution/ payout in line with
value performance
 Streamlined reward  Transparent reward
practices systems practices

RISK  Employee exit strategy  Return generating


OPTIMIZATION  Partial/full employee investment strategies
profile/location transfer  Governance compliance
and operational reviews

Integrated Change Management and Assessment Matrix


An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 127

Improving on Human Capital Management


With the Indian microfinance sector emerging out gradually from the impact of the crisis, it has created
scope of streamlining its human capital management models, to bring healthy people practices at the
forefront of their strategy and create new metrics of organizational performance. These practices play a
key role in determining the financial and strategic success of an institution.

Robust policies and procedures: Despite intentions of doing good, at times the human
resource policies and procedures tend to get inflexible and create roadblocks to holistic
performance and growth. It is suitable to establish minimum time and quality
requirements (that are realistic) in one’s roles and responsibilities before being eligible for
promotion. Further, for healthy growth, it is imperative that MFIs build its policies and
procedures around the core business need and not just past experience.

Target-based-incentives to performance-driven-growth: The management must


establish well design staff levels with clear roles, responsibilities and socially and financially
integrated reward and recognition models. Also there is a need to rework on the
incentives model that is achieving the balance of social and financial impact that supports
employee motivation and commitment across situations.

Exhibit 43: Integrating HR to Organization Growth

HUMAN EMPLOYEE IMPROVED


BUSINESS SUSTAINABILITY
CAPITAL ATTITUDES & FINANCIAL
STRATEGY & SCALABILITY
STRATEGY BEHAVIOURS PERFORMANCE

ALIGNED POLICIES & STREAMLINED


PROCEDURES COSTS
GREATER EMPLOYEE
COMMITMENT &
EFFECTIVE ENGAGEMENT
ENHANCED
COMMUNICATION &
PRODUCTIVITY
IMPLEMENTATION

OPTIMAL SOCIAL & FINANCIAL OUTCOMES

Decentralise decision-making: It will allow operational and field employees contribute to


social impact and profitability of the organization. It also increases the talent retention
power within the organization. In addition, making the structure more open, the MFI will
facilitate current and accurate information flow from field, clients and local conditions.

Balance of financial-social return: MFIs need to develop standards and best practices
that encourage both financial and social impact and ensure client protection and
sustainable growth intent from within the organization. Organizations must not look at
squeezing budgets for recruitment and training of new hires. During orientation, the
128 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

management must communicate the social mission,


values and long-term vision to the new hires and
assign the measurement metrics for periodic Case in Point: Best Practices
assessment, and subsequently ensure ethical at Ujjivan
implementation.
Ujjivan, a large MFI based in Bangalore,
Relevant learning and development: MFIs must India that provides a holistic range of
aim to offer specialised sector driven learning and services to poor working women in urban
development opportunities across its complexities and semi-urban areas, was ranked #14
(and #1 in MF) out of the 100 best places
to all field and management staff that focus on
to work in India, by the Great Place to
what is needed to drive both financial and social
Work Institute Inc. (GPTW). Ujjivan
results will increase capability and ensure that attained its human capital strength despite
decisions can be made at the levels closest to the major challenges that clouded the
challenge areas. MFIs as part of their strategic microfinance sector in India for many
growth must also keep identifying the additional months. Ujjivan made the commitment to
skills and competencies that the staff needs to keep employees engaged and feeling
deliver the desired levels of performance. The positive through the challenges that the
organization must also help the individual achieve industry faced.
this level of learning by providing necessary tools.
One of the key ways they accomplished
this was by focusing on communication
Creating an internal value: Valuing employees in
across the organization, helping employees
the same way that clients and other stakeholders in the field manage questions and issues
are valued helps understand the organization’s raised by customers and other
dedicated intent and how best to deliver it. Just like stakeholders. A set of frequently asked
client education is an important part of service questions was provided to all field
delivery, the MFIs should also make sure that staff employees that a) helped them understand
too gets an equal opportunity to access the the organization‘s stance and response to
learning and development they need. field issues and b) helped them to be
consistent and address client concerns.
Looking at forward needs: Along with establishing Concerns around job security and rumours
clear selection criteria for each position, MFIs must around the imminent collapse of MFIs and
the industry were not brushed aside, but
also plan for their future workforce requirements in
handled with care and information. The
order to facilitate anticipated growth. Expectations
CEO shared his analysis of the crisis and
of growth in client numbers, portfolio size, plans to what the next few months would be like –
add additional products and services and especially providing specific, transparent and clear
geographic expansion will all impact both the direction on how the organization would
number of employees needed and the skills respond to the challenges.
required. Moving from an NGO to a regulated
The organization also chose not to cut
institution may also require additional experience in
back on spending for training and staff
the risk, reporting and internal controls areas.
loans, even during the crisis. In keeping
Defining different potential scenarios and with its philosophy of Employees First and
developing a plan for each one will ensure the Customers Second, an employee stock
organization is prepared to move forward when the ownership plan was rolled out across the
way is clear. organization at certain levels. Employees
understood that Ujjivan was working to
Performance driven strategy: One of the most make their lives better, not just the lives of
critical drivers of employee engagement and their clients.
commitment is an understanding of how one‘s
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 129

individual efforts support organizational goals. Too often we have seen that even mid-
career managers cannot easily articulate the MFI‘s strategic objectives and are rather
unclear about the organization‘s plans beyond the expectations for their own
performance. Employees want to make a difference and organizations need to enable and
encourage this to ensure they are maximizing the value of their people. Creating this line-
of-sight starts with developing a robust performance planning process where broad
organizational goals and objectives cascade down to the various business units and
functional teams. These teams then translate their supporting goals and objectives to all
team members, where individual performance objectives support the team‘s goals. This
process results in proactive planning, which is then supported through structured, regular
check-ins to confirm progress and identify any course corrections or additional support
required. Performance reviews are then simply a summary of all the discussions during the
performance period, with no surprises. In this way MFIs can begin to maximize the
contributions of all their employees.

Leverage resource strengths: Great performances occur when people are able to do
what they’re best at. Managers and employees must discuss individual capabilities in order
to identify strengths, and have the flexibility to allow employees to draw on their strengths
in their jobs. One way to do this is to adjust responsibilities within the team in order to
give individuals the opportunity to do what they are best at.

Re-evaluating and revising these practices in the microfinance institutions and elsewhere will help support
the fundamental social mission of microfinance sector by focusing front-line employees on client
protection, as well as encouraging sound credit practices, and by creating and empowering loan officers
who are driven by a mission to serve the poor.

To that end, outlined below are some of the human resource policies, observations, risk implications, if
any and select recommendations for the future:

Policy Observations Future Considerations

Recruitment and This is currently being done at With the prospects of high growth and
Training- Group the HO level. expansion plans across different geographies,
Managers Trainees a decentralized process could cut down the
The trainees are given three days travelling and boarding costs and make the
in house training after logistics planning easier.
recruitment.

Process Adherence MFI incentivises employees for None


Incentives maintaining the processes in
order and is being implemented.

A good incentive system leading


to high job satisfaction and
retention amongst employees.
130 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Working hours of the It is not uncommon for field staff There is a risk of high attrition rates at the
field staff is to work to be putting on an average 30% field level due to long work hours.
for 8-11hrs with a to 50% overtime hours especially
break of 2-4hrs in the in those conditions where living MFI should brief the new recruits during the
interim and staying in the branch office interview process about the nature of job and
premise itself. Reduced work-life have competitive pay packages to attract and
balance is one of the major retain the employees.
reasons for extended work hours.

Confirmed Employees A good scheme for employees None.


who have completed giving them additional benefit of
two years of service working with MFI.
with MFI are eligible
for Loan Scheme In addition, this reduces the
chances of the utilization of loan
portfolio funds at the Group level
by the Group Managers.

Multi-tasking Training Employees in the offices should MFI can perhaps have a defined policy on the
be rotated across different periodicity of such transfers based on the skill
departments allowing them to set of the employees because going ahead
understand different job roles. employees with diversified skill set lead to
high work efficiency levels.
It is noticed that staff are easily
transferred and has commonly
found at the field level where few
Centre Managers were
transferred to IA team and vice
versa.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 131

Chapter 6: The interest rate debate73

Section 6.1: “What-if” survey and analysis


We conduct the survey asking existing borrowers the following questions. However, since they were
assumed ‘hypothetical’ expectation of behaviour may be different from actual behaviour. Through this
evaluation of price elasticity we find a measure of the ease of substitutability of microcredit (at prevalent
rates, structure and form) for consumers and for suppliers in a market.

For instance, in the absence of competition, as a “concept” was suddenly a bit hard for many of them to
revert to. They impulsive response was “if you don’t...there are others who will still give...” Explaining a
sectoral change rather than a firm-level change was difficult to explain. Unfortunately, too much
explanation runs the risk of creating a bias (towards a preconceived expected response) in qualitative
assessments.

Q: Would you be willing to pay74 up to 2% (p.m.; Q: In the absence of options (emphasised),


equivalent of ~23% APR) interest? would you be willing to pay 2.5% interest?

Exhibit 44: Borrowers comfortable with 2% per month Exhibit 45: Borrowers have moderate comfort with
interest rate 2.5% per month interest rate (APR~30%)

2%
6% 15%

10%

75%

92%

Yes Vague response / no comments No


Yes "It's fine, we already are" No

73
Banerjee, Ayan A., “The Macrocosm and Microcosm of Microfinance” (October 21, 2010), the same day the A.P. ordinance
was issued; available at SSRN: http://ssrn.com/abstract=1701662 is based on a sanitized case vignette prepared by Aadhaar’s
research and implementation of micro-finance through its research and consulting experience
74
No implied, that they will stop taking the loans. They understand that the interest rate is not sustainable for them to keep up
their obligations keeping in view their existing income levels and income potential
132 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Q: In the absence of options, would you be In the absence of options, would you be willing
willing to pay 3% interest? to pay 5%(~60% p.a.) rate of interest?

Exhibit 46: Low comfort with 3% pm rate of interest Exhibit 47: No comfort with >3-5% pm rate of interest

5%

45%
50%

95%

5%

Yes Vague response / no comments No Vague response / no comments No

However, the fallback option for the microfinance client, is the local money lender (who charge interest
rates from 3%~34% APR to 10%~116% APR). But clients were multiply borrowing at these rates; they were
OK with it. How come?

To understand this aspect, we spoke to 12 local money lenders: Their quantum of business has definitely
fallen (as has their interest rates based on ‘competitive’ pricing) but their core areas remain “immediate,
emergency” loans.

A detailed survey (with a reasonably larger sample across geographies) of moneylenders would be
interesting and imperative to understand the competitive structure of the local informal credit
market.

A survey to cull out the cross price elasticity would provide a measure of the extent to which
microcredit and loans are complementary or substitutable. Use of elasticity can be a useful as way
to measure market boundaries and effects.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 133

Section 6.2: The Facts Précis


Not only in India but also microfinance interest rates are the most widely discussed and possibly criticised.
In the Indian context, we put together a summary of facts, analysis and assessment (as presented
elsewhere in document):

1. Microfinance interest rates in India among the lowest in the world.

2. Interest rates in the Indian microfinance sector have not changed much in the last 3 years75, in the
period that microfinance has grown rapidly (~40% y-o-y).

3. Interest rates charged to clients are pegged to transaction costs. However, the (enormous) profit
that many MFIs have been making is largely76 due to their rapid expansion (the rate of client
acquisition coupled with reduced cost of borrowing) rather than higher interest rates charges or
enhanced operational efficiency.

4. Interest rates of MFIs in India are in the same neighbourhood as consumer loans (e.g. credit
cards). Interest rates, per se, are not usurious then.

5. In our survey, interest rates charged by MFIs ranged from 10% flat to about 15% flat77. This would
translate to roughly in the ball park of 21% - 30% in terms of equivalent APR (including factoring
upfront fees, membership fees, compulsory insurance premium etc.).

6. The interest rates were higher for smaller MFIs. Larger MFIs usually have lower interest rates. In
that sense, even if limited, they were passing on the benefits to the end consumer.

7. Key factors leading to the reduction of interest rates are: competition, reputation/ branding,
economies of scale (reduced financial costs), governance, transparency and social impact.

8. The alternatives for end borrowers are higher cost local money lenders; competition has
drastically brought down their benchmark interest rates as well.

9. Clients are generally comfortable with the prevalent rate of interest. The “quality” of microfinance
is what really needs to be looked into.

10. The transparency in interest rate calculation is missing. Most field officers themselves don’t know
“flat” and “reducing balance” calculations.

75
Microcredit rates have been dropping ~1.5% percentage points p.a. from 2008 -2010 (vis-à-vis ~2.3% from 2002-2005). Some
of this is a reflection of the learning curve but fundamentally driven by competition.
76
A vector component analysis confirms the hypothesis.
77
There were hot flashes in the press stating that BASIX was charging 60% APR rate of interest to clients. However, BASIX has
denied the same. They claim that their interest rate charges are 27-28% in APR terms. Details available at
http://www.moneycontrol.com/news/economy/do-not-have-any-product60-interest-rate-basix_495663.html
134 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

11. There is no “format” and MFIs charge different fee heads (membership fees, loan processing fees,
compulsory insurance premium, late payment charges etc.) depending on tax and accounting
considerations. Factors such as the compulsory savings for obtaining a loan (used in the SHG-
Bank linkage model), frequency of repayments, and the systems adopted to collect repayments-
also raise the effective interest rates.

12. For a sustainable business environment, interest rates cannot be pegged to only the prevalent
“poverty” of borrowers. If we factor administrative costs consist (of rent, utility charges, transport,
office supplies, depreciation of fixed assets etc.), a labour-intensive operation, personnel costs are
high. Making and recovering small loans is costly on a per unit basis. Often loan recovery is
executed by staff who visits clients, increasing costs in time taken and transportation used. Poor
physical infrastructure– inadequate road networks, transportation, and telecommunication
systems– in many areas in which MFIs operate also significantly increases administrative costs and
adds significantly to the cost of microfinance operations.

13. Clients need to be educated about what they are paying. While the transparency norms have
been greatly put into place for banks, NBFCs and MFIs are still to meet greater (and honest) levels
of disclosures. The current practices offer convenient level of disclosure for the lender (but not for
the borrower)

14. Should a sector-wise margin cap be considered necessary, 10-12% is reasonable bracket.

15. However, an interest rate cap of 24% would certainly dis-incentivise MFIs to venture into difficult
terrains (virgin, politically unstable, remote locations etc.) where operational costs are higher. The
loan loss provisioning would also be higher. Consequently, the economics would make sense if
and only if the costs of funds are lower or can be made lower. This means that only the larger
MFIs (with a lower cost of funds) will be in a position to make the foray. Question is: Why should
they? As a strategy, it is likely to hamper their (risk-adjusted) performance; from a policy
perspective, the cost of funds in such terrains c/should be subsidised (under PSL). It is imperative
that the existing classification for priority sector lending must be revisited and guidelines revised.

16. Computing an MFI’s minimum interest rate needed to cover cost of funding: An MFI can
determine the minimum lending rate needed to cover its costs by adding the Impairment Loss
Expense + Operating Efficiency ratio + Financial Expense ratio which is its “fully loaded” cost of
lending. This is an example of how to use the ratios to price the “product” on offer. Knowing what
interest rates are being charged by the sample of NABARD supported MFIs and how it compares
with their sustainability.

On aggregate, the fully loaded cost of lending:18%-24%


Financial expense: 12-14%
Impairment Loss expense: 1%-2%
Operating Expense: + 5-8%
Add to it a desired excess return of 3-6%, you get the “pricing” of interest at: 21% to 30%
Loan loss provision of 1-2% is not sustainable; as market saturates we should eventually
expect 8-10%.
The lower operating cost is connected to scale. As the growth rate of MFIs stagnates, they
will be looking at alternatives to reduce the operating cost. Fee based incomes would
change the calculations
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 135

The availability of finance (implicit) and the low financing cost (explicit) are perhaps the
most significant drivers to the costs. We may assume that microfinance would continue to
enjoy PSL status

17. We examine Portfolio Yield, which measures how much MFI actually received in interest payments
from its clients during the period. It also provides an insight into portfolio quality, which in the
current sample is still looking at 99% repayment rates – even at an aggregate. However, the same
study – taking into account next financial year information – would be interesting to compare. A
study on the yield on gross portfolio of 78 MFIs from 2006-2010 reveals the following descriptive
statistics.

Table 16: Yield on Gross Portfolio

Mean 23.0%
Returns have been quite high in the microfinance sector Standard Error 0.5%
across the world. The average real Yield on Gross Portfolio Median 23.4%
(source: Micro-banking Bulletin) was 22.8% for all the MFIs Mode 27.7%
combined and more than 20% for Asian MFIs in 2008 Standard Deviation 8.0%
Sample Variance 0.6%
Yields are about twice as much (adjusted) in the credit
First quartile 17.2%
portfolio of banks / PSUs, which cluster at 12-14%.
3rd Quartile 28.6%
Range 53.8%
Count 323

In contrast to the argument and view presented above, Asian Development Bank in “Understanding and
Dealing with High Interest Rates on Microcredit: A Note to Policy Makers in the Asia and Pacific Region,”
states:
136 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Exhibit 48: Impact of Microcredit ceiling rates

SUPPLY SIDE DEMAND SIDE

Short Term Short Term


• Lenders compelled to reduce their • Demand for loans increases at the
rates ceiling rate
• Excess demand creates incentives for • Some new potential clients seek loan
rent-seeking among lending staff at the new rates
• Viability of lending to the poor • An excess demand for loans created
reduced at the ceiling rate
• Lenders’ profits on loans reduced • Price of credit to some of those who
• Incentives to make loans to the poor actually get loans reduced
reduced • Some borrowers pay higher
• Incentives to increase investments to transaction cost that before
expand loans to the poor reduced
• Policy risk on lending to the poor
increased (threat of new ceilings)
• A negative signal sent to potential
investors
• Risk of lending to micro-lenders
increased
• Incentives to commercial banks to
enter to microcredit market reduced

Medium to Long Term Medium to Long Term


• Microlenders’ creditworthiness • Some borrowers shift to informal
declines commercial markets
• Price at which microlenders borrow in • Many former borrowers become
the market increases worse off by the decline in supply
• Microlenders’ profit declines • Increased defaults
• Supply of funds from some donors
declines
• Some lenders leave the market
• Supply of loans to the poor declines
• Microlenders’ quality of services to
the poor declines
• Interest rates paid on deposits
reduced by affected microlenders
• Microlenders increase transaction
costs of small deposits
• Supply of microlenders’ other
financial services to the poor also
declines
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 137

Section 6.3: Does Competition help rationalise interest rates?


The main complaint against MFI lenders are their high fees. The high annual percentage equivalent rate
strikes critics as usurious or unconscionable hence the state of A.P. imposed usury limits (24%) on
microfinance loans. Rationally, we might expect competition to drive prices down to the level that just
covered the costs of producing the loans78.

Predation in our model resembles advertising79; advertisers accentuate how much pleasure their product
brings, while predators attenuate how much a loan will cost (in terms of future well-being). We show that
lenders will prey as long as the extra revenue from larger loans exceeds the cost of coaxing households
into over-borrowing and any associated increase in default risk. Our concept of predatory lending may
not correspond to the specific practices of microfinance institutions that reformers condemn, but it comes
close. Lenders are accused of entrapping borrowers in a cycle of refinancing and delinquency by lending
more than households can afford. The predators in our model lend excessively, and the extra debt leads
to higher risk of delinquency. Reformers also condemn payday lenders for “targeting vulnerable
consumers” that are less sophisticated. The predators in our model naturally quarry on households that
are easier to take in. Our model helps distinguish predatory lending from the other kind of lending, the
kind that helps households maintain consumption even as their income fluctuates. While reformers tend
to focus on the interest rates charged by alleged predators, we suggest that predators do not necessarily
charge more than alterative regular lenders. However, predators do always lend more, however, and the
extra debt may push borrowers to the brink of default. Interestingly, if MFIs were exploiting gullible
households, we would expect to find high debt and delinquency rates among low income households. In
most cases – outside Andhra Pradesh – while we do find higher debt, in general, , we do not find higher
delinquency. At least, not yet! On the contrary, delinquency rates were marginally lower for poorer (and
hence riskier?) and less educated households80. They were also less likely to turn to MFIs for credit if bank
credit were readily accessible through the deep penetration of the Bank-SHG model. They usually
understood- roughly – their capacity to absorb loans and were not the ones asking continuously for top-
up.

78
There is currently no study on Indian Microfinance institutions to test the hypothesis if competition indeed does lower interest
rates. We have anecdotal evidence that competition (or perhaps that they could so afford due to improved economies of scale)
prompted Bandhan to reduce interest rates from 24% to 19.1% in the period of this study. In contrast, studies on Payday Finance
in the U.S., in many ways being sub-prime and quite comparable to microfinance on may counts, in their analysis, Fox and
Mierzwinski (2001, p. 14) observed that about half the lenders charged fees at or above the usury limit set by the states. ”If
competition were really working...” they conclude, ”…we would expect many more firms to offer and advertise lower rates.”
79
It is not surprising that the usual exemplary evidence of a certain Laxmi or Saraswati or Parvati and hear how she brought out
her family out of poverty due to the microcredit made available to her by Annapoorna, Sharada or Durga Microfinance.
80
Our finding that low delinquency and loose credit constraints applies to only to the very small subset of households in our
sample, but they are still very interesting. Despite high cost, perhaps microfinance loans do help risky households better manage
their finance? It will take more data to confirm that particular conjecture, however. In general, we caution that our data are very
indirect since we cannot specifically identify the income categories and who borrowed and what quanta.
138 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 6.4: Post script on the interest rate debate

The reason to bring this section up is to circle back “...The question is when the capital at its best
to the point (in the preface): Are we consistently use in India gives a post –tax return of 15%
making the same mistakes? To start with, is it an and a pre-tax return of 22.5%, by taking loan
interest rate debate or a larger issue? In the at an effective rate of interest of 21-30% (p-
following section, we set out to discuss the 112); it is but natural for the borrowers to
assumptions and the decision making framework default in the long run.”1
under which we are currently operating in the
microfinance sector:

- Is microfinance “coupled” (or not) with the economy?

o If so, then is the correlation significant? Significant correlation may be assumed as a weak
form of yes. This means that microfinance sector will be exposed to vulnerabilities of
economic cycles and shocks. Clients, then, are bound to be impacted default sooner or later
and default in their unsecured debt obligations.

o If not, can microfinance clients (i.e. the microenterprise sector) consistently (and over
sustainable periods) outrun the corporate sector (i.e. have 30-40% rates of return)?

 If so, charging prevalent rates of interest is indeed sustainable. The model needs
minor tuning only at the operational level

 If not, higher order question to ask: Assuming we are focusing on poverty alleviation
at the grassroots right at the bottom of the pyramid (a fair assumption)…for
promoting micro-enterprises (thereby creating employment) is “debt” the right
instrument of finance?

• If not: There is an inherent need for innovation in the current cookie


cutter model

• If yes: Are the prevalent rates of interest charged by MFIs (~20-30%) lower
(significantly, for an incentive to borrow) than the rate of return of the micro-
enterprise?

o If yes, then we are “creating value” and the policy of giving


huge impetus to microfinance (microcredit, really) or (not
decelerating the snowball) is indeed in place

o If not: Charging high (in the context of question) rates of


interest will not be sustainable
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 139

Are micro-enterprises – funded by micro-finance institutions – immune and


decoupled from economic cycle81?82
1. “But if you think about it, microfinance clients are less integrated into the formal economy. They
don't use or depend on imports; they rely instead on domestic goods and services. And even
there, consumer spending is a low percentage of their overall expenditure. They are also not
affected by currency fluctuations. On the other hand, the clients of conventional retail banks are
exactly the opposite-thoroughly integrated into the global economy…

2. …The other reason microfinance is decoupled is because micro-loans are primarily for income-
generating activities. Loans also usually have a shorter maturity and the staffs have much closer
ties to borrowers, often meeting with them weekly. This enables practitioners to reduce borrower-
specific risk as they can carefully monitor the repayment of micro-loans and adjust lending
practices if necessary." – Vikram Akula

After the initial claims of otherwise, when the financial crisis had begun to exhibit contagion, “Indeed,
microfinance is not decoupled from the global economy, but has proven to be utmost resilient in
comparison to conventional financial institutions.” 83 So, the merits of the argument are apposite. While
point 2 alongside is not – entirely – true (as has been discussed), point 1 is a very credible argument84. So
we examine if “petty trading”, “agribusiness”, “dairy”, “poultry” and other micro-enterprises decoupled
from growth and recession: Are these also not driven by the same underlying fundamentals85? This
counter argument also has sentiments in some other noted microfinance functionaries. "In a static village
economy, there is little scope to have too many petty traders. Two-thirds of the villagers directly live on
non-cash-crop agriculture, and another 20% are small-time artisans. The cycle of economic activities for
these people ranges from about six months to one year. None of them generate income to meet weekly
repayments, and none of these activities generate a rate of return to afford interest rates of 20-40%.And if
they borrow — and many are compelled to borrow at such interest rates because banks have failed to
provide them with credit that they deserve at affordable interest rates — they would never be able to rise

81
This refers to economy-wide fluctuations in production or economic activity over several months or even years. These
fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid
economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession. Please refer to
O'Sullivan, Arthur; Steven M. Sheffrin (2003), “Economics: Principles in action”, Pearson Prentice Hall. pp. 57, 310
82
Source: http://www.financialexpress.com/news/column-small-is-beautiful-and-efficient/386866/0
83
http://www.housing-finance-network.org/index.php?id=304
84
Dorado, S., 2006-08-10, "Decoupling in Social ventures: One step forward two step backwards? Commercial Microfinance
Organizations" Paper presented at the annual meeting of the American Sociological Association, Montreal Convention Center,
Montreal, Quebec, Canada Online, 2011-03-13 available at http://www.allacademic.com/meta/p104366_index.html
85
So we need to establish that with multiple connectedness – finance, import / export, basic services like housing, food, clothing –
can we configure a co-efficient of linkage (and find it low to state “decoupled”) of the micro-enterprise (the microfinance client)
and the rest of the economy.
140 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

from their levels of poverty, and very often just go back a few years in their economic status." - Dr.
Prakash Bakshi86

This is an important discourse: Whether microfinance is indeed decoupled, or not, will determine all
assessments microfinance demand, poverty alleviation (moving to newer clients or rotating amongst the
same clients through business cycles?), and most importantly if microenterprises can really stand up with
microfinance support to bring families out of poverty. While it has been comprehensively asserted and
argued with great conviction that finance is necessary but not sufficient for economic development87,
this discussion becomes an important factor in determining the success (and probabilities) of micro-
enterprise and hence the “riskiness” of the assets being funded. Fundamentals of finance: Higher risk,
higher should be the expected return i.e. interest rate.

Are micro-businesses (with low capital investments) capable of exacting profits


continuously?
We begin sequitar deductions but without extensive proof. First, the types of enterprise options for
microfinance clients- as seen in the microfinance sector MIS reports - are fixed and limited88. Assuming a
large population density (as is true in all areas of microfinance population – for operational efficiency
reasons), any sustainable & reasonable profits will be quickly sapped up by competing profit-seeking
micro-entrepreneurs. If finance were – readily, without prejudice, cheaply and without collateral (and
without adverse consequences for default) –available, it would only catalyze this process. Competition, as
it does, would bring down the rate of return of the business.

Then, we posit that the micro-enterprise market, as it were, is "informationally efficient" due to their
extremely localized nature. That is, one cannot consistently achieve returns in excess of average market
returns on a risk-adjusted basis, given the information available at the time the investment is made. Two
factors: (a) Information (i.e. knowledge) and (b) capital provide competitive advantage to any business. For
micro-enterprises, on both factors, this barrier is quite low. Given this understanding of micro-enterprises,
the random-walk model89(or the martingale model)is more appropriate fits to judge the success (rate)90.

Micro-enterprises need to be built: “Simple” models are not sustainable. So, the business is not scalable.
And, for reasons mentioned above, micro, small and medium enterprises will typically be “up-or-out”.
MFIs should work on building the underlying on which the financial asset if being built91.

86
Then Executive Director, NABARD in Economic Times (Mumbai print edition) dated Oct 13, 2010
87
A vast body of literature is available to support this assertion: Seminal paper by Levine, Ross, “Financial Development and
Economic Growth: Views and Agenda”, November 30, 1999. World Bank Policy Research Working Paper No. 1678 Available at
SSRN: http://ssrn.com/abstract=604955 available at http://ssrn.com/abstract=604955
88
Caveat: Discounting black swans, radical and disruptive innovation, the number of such business requirements in a local area
will be limited.
89
For further details, please refer Kendall, M. G.; Bradford Hill, A "The Analysis of Economic Time-Series-Part I: Prices",
Journal of the Royal Statistical Society, 1953, Blackwell Publishing, 116 (1): 11–34
90
Based on that, we ran a preliminary Monte Carlo Simulation to arrive at an 85% failure rate. But we withhold that judgment
since it was only back-of-the-envelope calculations. Interestingly, many scholastic studies also reveal the success rate of start-up
businesses at 10% or less (even 1% or 0.1%)
91
Operational risk arises from execution of the business functions. Inter alia, and very broadly, it focuses on the risks arising from
the people, systems and processes through which a business operates. What is the operational risk typical micro-enterprise
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 141

Investment Risks and type of investment vehicle


Before we jump onto the discussion of interest rate and risk, we must understand the financing business
cycle. Most proponents of microfinance and firm believers in the microfinance revolution would find it
most repulsive to even consider the comparison as plausible. But, for a moment, let us hold in, stop and
re-examine the premises on which microfinance is based upon.

Exhibit 49: Types of investment vehicle

MID/ LATE/
SEED EARLY EXPANSION MEZZANINE EXIT
REVENUES

Break Even Point Mezzanine Financing

Debt Investments

Private Equity

Venture Capital

Angel Investors

TIME
Source: http://www.privco.com/knowledge-bank/private-equity-and-venture-capital

Stages of the Business Life-Cycle: Seed capital92 > Early stage financing93 > Expansion capital94 >
Late Stage / Mezzanine / Bridge financing95

endures? Looking at the profile of the micro-entrepreneur, the business ideas, the processes (none?), is it fair to hazard a guess
and say “high”?
92
Private financing provided primarily by friends and family, angel investors, or very early stage venture capital firms. Seed
money is often used to fund initial operations, building a product prototype, and product testing. A private company receiving
seed capital is pre-revenue and may be in stealth mode, meaning that its operations and products are hidden from the public until
ready for market testing and beta launch.
93
Primarily provided by angel investors or venture capital firms and is used to fund the company’s transition to commercializing
its product and supporting the firm as it sells to its first customers - this may entail manufacturing and marketing the private
company’s product.
94
Helping the business acquire more assets, increasing the marketing budget etc. typically comes from VC and PE firms. Since
the private company has profits at this stage, it may not want to give up the equity necessary for taking VC money and will
instead turn to other financing methods like debt or mezzanine financing.
95
Private companies in this stage are profitable, expanding, and may be closing in on an Initial Public Offering (IPO) or
acquisition by a key player in its industry. An investment that often will lead to an exit. An exit is a liquidity event such as an
initial public offering, direct sale, or buyout that leads to a repayment of all shareholders.
142 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Are micro-enterprises funded by MFIs start-ups? Yes, usually. Is a start-up high risk? Conventional
wisdom: Yes. So, is micro-enterprise high risk?? Transitive logic may or may not hold in this case putting
the debate up in the air. Depending on this answer to this last question– we can deduce that the present
model of microfinance (implying microloans) will work (sustainable basis) or not! On the other hand, we
must also concur96 somewhere that most micro-entrepreneurs and microfinance clients, have multiple
source of income and that makes any detailed assessment quite difficult to delve into.

Conventionally, debt is usually included in the capital structure (later) once cash flows are uniform for the
business. Thus, venture capital97, or equity where risks are shared, is used for funding start-ups. One
cannot – logically – have steady stream of cash outflows (interest coverage) with a volatile stream (or
missing stream) of cash-inflows.

What do Angels expect (and get)


While very little information is available98 on expected returns by angel investors, they were seeking an
average of a seven-in-seven return; that is, they required seven times their invested capital over an
expected holding period of seven years. This renders an average expected return of 32%99. When an
entrepreneur puts into perspective the projected value of their business in five to seven years, the amount
of equity that angel investors receive, and their return outcome, they must establish to angel investors
that their business’ ROI is at least 30-40%100. Obviously, angels will simply not take the risk of financing a
business if there is no indication of profitability and a strong opportunity for the business growth.
However, these investments are risky and will receive on average a strong multiple return on only 1-3 out
of 10 business ventures; and a similar rate are said to go into the next level of growth and financing.

96
“Beyond Microfinance: Building Inclusive Rural Financial Markets in Central Asia”, Mario D. Lamberte (Editor), Robert C.
Vogel (Editor), Roger Thomas Moyes (Editor)
97
Venture Capitalists invest in high-risk, high-return investments, with an investment horizon of six or seven years. Venture
capital manages risk typically with staged investments in which the private company has to meet certain milestones before
qualifying for additional rounds of financing.
98
Most information we availed, were word of mouth and /or through conferences. “Five-times-in-five years” is a common phrase
we heard when we spoke to about 30 Angel and early stage investors for a different project. Some went so far as to say ten-times-
in-ten-years. However, for greater credibility of these claims, we refer The University of New Hampshire’s Center for Venture
Research recently conducted a study on angel investors who financed several software and early-stage high-tech companies in the
New England area
99
Not only did this approach demonstrate the tremendous amount of patience on the angel investors’ behalf (willingness to
remain in a deal for five-seven or even ten years), but it also showed their rather modest ROI prospective (since many early/seed-
stage investors actually earned on average a compound ROI of 60-70% over the last five years). As an instrument credit is not
patient: Patience in credit is default and / or restructuring.
100
Preston, Susan L., “Angel Financing for Entrepreneurs: Early Stage Funding for Long-Term Success”, John Wiley & Sons
Inc., 2007.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 143

Table 17: Investor Expectations

Whether the business proposal fits with the venture capital firm’s defined
Concept Fit investment objectives, the business/technology space, stage of growth and No
synergy with portfolio businesses;
Venture Capital will consider investing in a business with a strong
Management management team that shows organization, strong business concepts No
and having the ability to recruit a competent talent along the way;
Venture capital firms invest in businesses with a focus on filling a real
Market No
demand within a very large and growing marketplace;

Barriers Barriers to entry are necessary to maintain a competitive advantage101; No

Profitability Ideas with a reasonable, sustainable and verifiable path to profitability; No

An exit strategy that provides liquidity within an acceptable time frame is


Exit Strategy No102
critical to achieving the investment objective

Successful innovation is in large measure an issue of identifying and controlling risk. The smaller the
business, the more likely it is that survival will depend on its effectiveness of risk management. Typically,
small enterprises are caught in a double bind: As competitive pressures mount and customers press for
higher quality standards, tighter cost control and faster response times from suppliers, small firms find it
increasingly vital to accelerate process and product innovation. At the same time, the attendant risks of
innovation are higher for a small firm than a large one: usually, the smaller firm will have fewer technical
and managerial competences, more limited finance, and more limited access to information than a larger
organization103. To supplement start-up inadequacies, angels step in with some non-financial value-
addition on the table (experience, entrepreneurship, networks, technology background etc.) While the
“level and degree” of involvement of angels is subjective, some factors which have contributed to the
financial success of angel investors are:

101
Typically, such barriers to entry include things like proprietary intellectual property, a unique understanding and experience
within a market niche, or strong industry partnerships
102
Graduation options for client loans beyond Rs. 50,000 is missing. When MFIs have offered, they are usually <1% of the total
portfolio since they do not come under the priority sector lending norms. In fact, many (most?) MFIs are wary to let go off their
must esteemed clients. New client acquisition increase operational costs
103
The risk of getting it wrong comes into sharp focus for those firms where one major unsuccessful product or process
development may threaten the survival of the enterprise and possibly the entrepreneur's personal assets. The consequence is a
characteristic and understandable risk aversion. But this does not mean one can look solely to the large firm sector for innovation.
Innovation has to be seen in the context of a supply chain, the continued competitiveness of the whole being dependent on the
innovativeness of all links in the chain. Indeed, in industries such as engineering responsibility for aspects of technological
development is being pushed further up the chain towards smaller supplier firms. Then there is the “tomorrow as well as today”
problem: the need for suppliers to demonstrate to their end customers not only the production of a competitive, quality product
today, but also a commitment to developing the skills, resources and agility to remain a competitive supplier into the future
(Source: David Brown/ Warwick Risk Initiative 1997)
144 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Timely due diligence: When angels practiced more due diligence, they received more profitable
returns;

Industry expertise: Angel investors with more industry experience nearly doubled their returns;

Active participation: Through active venture involvement, including entrepreneur mentoring,


coaching and financial monitoring, angel companies received more returns;

Follow-on investing: More lucrative returns resulted when angels avoided follow-on investing;

Now, given microfinance is without collateral, highly understated loan loss provisions (of 1%; “system” and
funders expect to see 1%; 3% in MFIs makes them ‘unfavourable for funding’: Why?), should the expected
rate of return (interest) be high104?

Against this setting, if we reflect the cookie-cutter model of microfinance, risk-profile of businesses
they fund, the average cost of funds, operational expenses: Is a 30% rate of interest too high? We
reckon: No. Is it likely that micro-enterprises will consistently get rates of returns more than 30%,
without the supporting enabling environment? We reckon: No. The moot point is that microcredit
(and specifically just that) as a thrust sector is not a sustainable proposition. And, should this be
agreed, it calls for appropriate policy reforms.

104
And, we are placing an economic rather than emotional or social argument.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 145

Chapter 7: Predatory Lending

Section 7.1: Prologue


“Predatory105” lending is how reformers– consumer advocates, journalists, lawyers, legislators and some
bank regulators– condemn lending practices in the booming sub-prime credit market106. The alleged
predators are sub-prime mortgage, payday lenders, microfinance institutions and SME financiers. Their
prey: The lower income and less educated households on the demand side of these growing consumer
credit markets107.

While concern about predatory lending is mounting, to a certain quarter of rational economists, this
predator-prey concept of credit seems foreign. If credit is so expensive that lenders are earning abnormal
profits (given their risks and costs), why don’t new lenders enter the market to compete rates down to fair
levels. “Unaffordable” credit also sounds peculiar; how can lenders profit if borrowers cannot repay?

Information asymmetries are common in credit markets. However, the usual assumption in commercial
lending is that borrowers are better informed than lenders. Lenders have to screen and monitor to assess
whether firms are creditworthy. The information asymmetry assumed here is reverse and does not seem
implausible in the context of consumer lending: Fringe borrowers being less educated than mainstream
borrowers with many (most?) being first-time borrowers (or are rebounding from a failed first foray into
formal credit) would know less than institutional lenders. Given the subtleties involved with credit, and the
supposed lack of sophistication of microfinance borrowers, our assumption that lenders know better
seems reasonable108.

105
We define ‘predatory lending” as a welfare reducing provision of credit; a definition general enough to cover some of the
specific practices we have observed in the microfinance sector in India (2010-2011): Over-lending, overcharging, opacity and
through a multitude of upfront, fixed and interest-linked charges, targeting the poor, under-banked and prioritised and protected
consumer segment. We show how rural, poor households can be made worse-off by a voluntary credit transaction if lenders
deceive households about some variable that increases households’ demand for credit, like their income.
106
Despite growing concerns about predatory lending, and even regulation to curb it, there seems to be no general definition of
predatory lending. The usual criticism is of “unaffordable” credit—loans made at such high rates or in such large quantities that
borrowers cannot afford to repay the credit without sacrificing their future standard of living, or in the worst case, their home.
Even in the more advanced US financial system, Senator Phil Gramm, reputed American banker, said, “There is no definition of
predatory lending. I don’t know how we can hope to address the problem before we have decided what it is.”
107
For a critique of the predatory aspects of payday lending, see King, Parrish, and Tanik (2006)
108
Refer (Caskey 2003). Our model has several predecessors in formal literature: Most importantly, Morgan Donald P.,
“Defining and detecting predatory lending”, Federal Reserve Bank of New York Staff Reports, no. 273, January 2007. Others
like Ausubel (1991) argue that credit card lenders exploit their superior information about household credit demand in their
marketing and pricing of credit cards. But predators profit from their information advantage as well. The concept of income
delusion or deception also has a behavioural flavour. Brunnermeier and Parker (2004), for example, imagine that households
choose what to expect about future income (or other outcomes). High hopes give households’ current “felicity,” even if it distorts
borrowing and other income-dependent decisions. Our households have high hopes for income, and they make bad borrowing
decisions, but we do not count the current felicity from high hopes as an offset to the welfare loss from over-borrowing. Costly
falsification (of household income prospects) and costly verification (by counsellors) resemble Townsend’s (1979) costly state
verification and Lacker and Weinbergs’ (1989) costly state falsification. The main difference here is that the falsifying and
verifying comes before income is realized, not after.
146 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

We purport that our model throws light on the current, very real-world debate, around predatory lending
especially in the wake of microfinance crisis in A.P. From a policy perspective, the stakes in the debate are
high: millions of lower income households borrow regularly from thousands of microfinance institutions
around the country. Had MFIs raised low income households’ welfare by relaxing credit constraints,
legislation would have lowered it.

Section 7.2: Encouraging over-indebtedness109


Low income households can be made worse-off by borrowing if MFIs can/do deceive (low income)
households into borrowing more than is optimal. Excess borrowing reduces household welfare, and may
increase default risk. We illustrate the concept of predatory lending in a standard model of household
borrowing. But before we get to predatory lending, let us review the basic principles about welfare
improving lending, the type that lets households maintain their consumption despite fluctuations in their
income110.

The model has two periods: today (period zero) and payday111 (period one). Household income goes up
and down periodically, but not randomly (for now): income equals zero today and y on payday. If
households consume Ct in period t, their utility is U(Ct).Household welfare is the sum of utility over both
periods: U(C0)+ δU(C1), where δ equals the household’s time rate of discount. Households with high δ
value current consumption highly relative to future consumption. Thus, high discounters are impatient112.

Now, if the marginal utility of consumption (U0) is monotonically diminishing, households will demand
credit to reduce fluctuations in their standard of living. Households without credit, however, must fend for
themselves (autarky113). Welfare under autarky equals U(0) + δU(y). The fluctuations in consumption for
households without credit make autarky a possible worst case, and hence, a good benchmark for
comparing cases with credit. If households borrow B at interest rate r, welfare equals U(B)+ δU(y − (1 +
r)B). Borrowing increases utility in period zero, when the proceeds are consumed, but lowers utility in

109
From the MFI’s perspective, over-indebtedness affects an MFI’s portfolio quality. Thus, each MFI’s credit risk manager must
be made aware of potential financial impact of over-indebtedness on the MFI as well as the social impact on borrowers. While
each has a distinct perspective, all concerned recognize that over-indebtedness is a potential threat to the market and customers.
Interestingly, unlike MFIs in Latin America, most Indian MFIs do not have a dedicated credit risk manager. The “risk” team is
usually integrated with the MIS and they are only looking into post facto PAR rates for RBI compliance. Ten years ago
microfinance practitioners could hardly imagine that over-indebtedness would become a problem. Then the most pressing issue
was encouraging the establishment of MFIs in untapped areas and providing the necessary lending capital. Such severe shortages
of microfinance continue in certain regions, where MFIs don’t lend.
110
The welfare improving lending will be an in-effect SWAP instrument which trades off the volatility of cash flows to a steady
stream of cash-flows for the segment in question. Effective welfare improving micro-credit should play the role of smoothening
volatile cash in-flows for the household.
111
Most microfinance clients’ loan utilization is for micro-enterprise development. The proportion of microfinance to agricultural
credit is small (~15-20% depending on region and slicing). The payment cycles of these micro-enterprise can be on-spot and
hence equivalent to daily wage rates (e.g. petty shops) to 20-22 day cycles (dairy). Without loss in generality, the day there is a
cash-inflow for the borrower, we call it “payday”
112
A digression here on discount rates: In classical economics δ is constant. If δ changes over time, so does household behaviour,
even if nothing else changes. If δ(t) is hyperbolic, households will postpone unpleasant tasks until current consumption does not
seem so precious relative to future consumption (Laibson 1997). With hyperbolic discounting, that day never arrives, so
hyperbolic discounters have behavioural problems: they procrastinate. They may never repay debt, much less begin saving.
113
Autarky is the quality of being self-sufficient. Usually the term is applied to political states or their economic policies. Autarky
exists whenever an entity, state or peoples can survive without external assistance.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 147

period one, when households pay for their borrowing. Rational, informed households trade-off the good
and bad side of borrowing; they borrow until the marginal utility of consuming another unit today just
equals the marginal, discounted disutility of repaying the extra debt on payday:

U0(B)= δ(1 + r)U0(y − (1 + r)B)....................................... (1)

Equation (1) determines household loan demand as a function of their income, their discount rate, and
the market interest rate: B(y, δ, r). For standard utility functions, household loan demand is increasing in
income and decreasing in the discount factor and interest rate: By > 0; Bδ< 0; Br < 0. Household welfare
with optimal borrowing equals U(B(y, r, d)) + δU(y − (1 + r)B(y, r, δ)). As long as households follow (1),
their welfare with positive borrowing must be higher than without (autarky). Cost of lending $B to a
particular household equals (1 + ρ)B+ f, where ρ represents the opportunity cost per unit loaned and f is
the fixed cost per loan114. If the going price for loans is(1 + r) per unit borrowed, the lenders’ profits equal
(r − ρ)B− f. With perfect competition115 among lenders, the loan interest rate is competed down until it
just covers the costs of the loan: r = ρ + f/B. Equilibrium r and B are determined where that credit supply
curve equals demand (1).

If fixed costs per loan were prohibitively high, the microfinance market would not have existed116. The high
price of microfinance loans is partly reflected in the combination of fixed costs and small loan amounts117;
a usury limit lowers household welfare118.

Competition is another key determinant of how much low income households gain from borrowing. Even
in monopolistic conditions, households cannot be worse off than under autarky. The monopolist raises
interest rates until the marginal revenue from higher rates equals the marginal cost from lower loan
demand:

B(y, r)=−(r − ρ)Br(y, r)..............................(2)

114
Think of f as the cost of record-keeping and credit check required for each loan, however large or small the loan maybe.
115
Perfect competition describes markets such that no participants are large enough to have the market power to set the price of a
homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive
markets. Still, buyers and sellers in some auction-type markets may approximate the concept. Perfect competition serves as a
benchmark against which to measure real-life and imperfectly competitive markets. The motivated reader is referred to Roberts,
J. (1987). "Perfectly and imperfectly competitive markets," The New Palgrave: A Dictionary of Economics, v. 3, pp. 837–41;
Smith V. L. (1987). "Experimental methods in economics," The New Palgrave: A Dictionary of Economics, v. 2, pp. 241–49 and
Stigler J. G. (1987) "Competition," The New Palgrave: A Dictionary of Economics, 1st edition, vol. 3, pp. 531–46
116
A marginal analysis of ‘fixed costs per loan’ indicates that smaller loans will cost more on a rupee basis borrowed than larger
loans. That means households with low credit demand will pay higher rates than households with high loan demand. Loan
demand is increasing in income, so high income households who demand larger quantities of credit will enjoy a ”quantity”
discount, while lower income households will pay a ”small lot” premium, or penalty (cross-subsidising of the rich(er) by the
poor(er)). That price “discrimination” is not invidious, however; the higher cost of smaller loans reflects the fixed costs of
lending.
117
Please refer (Flannery and Samolyk), 2005
118
Suppose the maximum legal interest rate is r. At that maximum rate, the minimum loan that lenders’ cost is f/(r− ρ)= B. Low
income households with loan demand less than B face a beggar’s choice: borrow Bat r or do not borrow at all. Such households
would be willing to pay more to avoid going without credit, so raising the usury limit would raise welfare for those households.
148 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

At that monopoly interest rate, rm, household loan demand equals B(y, rm).

Household welfare under monopoly equals U(Br(y, rm))+ δU(y−(1+rm)Br(y, rm)).

Welfare is lower under monopoly because credit costs more and their standard of living fluctuates more
(because costly credit reduces their demand for credit) If households borrow from the monopolist,
however, they must better off than without credit. In sum, welfare for rational households is highest if
credit is available at competitive prices. If households choose to borrow, they must be at least as well-off
as they were without credit. Limiting loan rates cannot raise household welfare and may reduce it.
Monopoly lenders lower household welfare, but even with a monopolist, households cannot be worse-off
than without credit. The high cost of microfinance lending may partly reflect fixed costs per loan. Before
microfinance lending, those fixed costs were very prohibitive; very small, short-term loans may not have
been worthwhile for banks. The microfinance lending mechanisms and technology has lowered those
fixed costs, thus increasing the supply of credit to low income households demanding small loans.

This aspect of the genesis of microfinance suggests the innovation was welfare improving, not
predatory.

Section 7.3: Income deception


In the usual model, household welfare cannot be lower than under autarky because households are fully
informed and rational. Here we show households how can be made worse off than without credit if
predatory lenders can delude households about their (households’) future income. Suppose that by
spending C(τ), lenders can convince a prospective borrower that her income on payday will be y +τ. The
cost C can be interpreted variously as the cost of a guilty conscience, the risk of prosecution, or the
resources spent conning households into believe τ. Households are increasingly sceptical as deception
0 00
increases: C (·) > 0and C (·) > 0. C(τ) might be lower for more gullible households and higher for the
more sceptical ones. For the fully rational borrower, the costs of deception are infinite: C(0) = ∞.Costly
income deception takes us far from, and in some ways behind, current techniques for modelling
information asymmetries. Borrowers here not fully informed, as they operate under the assumption that
next period equals y + τ, and that is plainly wrong119.

Our income deception story is closer to the facts than it is to theory120. Though gullible, households
borrow optimally given their perceived income121. That means they are on their demand curve for credit,

119
The models in Townsend (1979) and Lacker and Weinberg (1989) feature costly income verification and falsification
(respectively), but we reverse the timing and roles. Here it is the financiers who falsify, not the borrowers, and the deception
occurs before deals are done. Alternatively, one could model the information asymmetry here as an adverse selection problem
where households know that some creditors misrepresent households’ creditworthiness, but the misrepresenters are hard to
distinguish from the honest creditors ("The Market for Lemons: Quality Uncertainty and the Market Mechanism", 1970 paper by
George Akerlof). While that might be an interesting problem, if subprime borrowers can solve that subtle inference problem, why
worry about them?
120
In a study of households’ choice of credit cards plans, Agarwal, Chomsisenghat, Liu, Souleles (2005) find that about 40
percent of households choose sub-optimal plans. Ausubel (1991, 1999) and Shui and Ausubel (2004) find evidence that credit
card holders systematically underestimate how much they owe or how long they (will) owe it. Underestimating borrowing is not
much different from overestimating future income.
121
The incentivised sales side of finance (professional outlook!?) drives income deception. Income deception is also a common
charge against another class of lenders accused of predatory lending: Subprime mortgage lenders. In a survey by Stock (2001)
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 149

where their demand reflects their deluded income expectations122. Thus, profits for a predatory lender are
(r−ρ)B(y+τ,r) −C(τ) −f. Optimal τ is determined by the first-order condition:
0
(r− ρ)By(y + τ,r)= C (τ).........................................................................(3)

The predator exaggerates income to the point where the marginal revenue from exaggerating household
income (due to increased loan demand) equals the marginal cost of exaggeration.

Note that the incentive to exaggerate income is increasing with the interest spread on loans. In a perfectly
competitive loan market spreads are zero so lenders would have no incentive to falsify. Indeed, they could
not afford to falsify; the costs of falsification would require higher spreads to compensate, so borrowers
would switch to cheaper, honest lenders. Costly predation can occur only if imperfect competition enables
predators to charge higher than competitive spreads.

A predatory-monopolist gets to set the loan rate as well.

The first-order condition for r is: B(y + τ,r)= −(r − ρ)Br(y + τ,r)......................................(4)

The predatory-monopolist raises interest rates until the marginal revenue from higher rates equals the
marginal cost in terms of lower loan demand. The predatory-monopolist does not always charge a higher
loan rate than an ordinary monopolist. To see this, express (4) in elasticity terms: r − ρB(y + τ,r)1 1 = − = r
rBr(y + τ,r) εr (y + τ,r)

where,εr (y + τ,r) is the elasticity of loan demand with respect to r.

Let rpm and rmdenote the optimal r charged by a predatory-monopolist and ordinary monopolist,
respectively. Then rpm >rm if and only if

rpm− ρrm− ρ >, rpm rm or equivalently, εr (y + τ,rpm) <εr(y,rm) .

For households with CRRA utility, the elasticity of loan demand with respect to r does not vary with
income, i.e., εr(y + τ,r)= εr(y,r). 123CRRA households with higher income are no less averse to high interest
than those with lower income, so when dealing with CRRA households, a predatory-monopolist lends
more than an ordinary monopolist but charges the same interest rate124. Utility is important, nonetheless,
as it implies predators are better detected by how much they lend, rather than how much they charge.

long before the advent of germ of thought of the sub-prime crisis of households with foreclosed subprime mortgages in Dayton,
Ohio, 42 percent reported that mortgage lender encouraged them to borrow more than they initially intended.
122
We would be entering into the realm of Behavioural Economics and Behavioural finance, which have anyway questioned the
"rational" postulate of microeconomics. It would be an interesting exercise to take that track and explore the underprivileged and
unbanked as “rational”; these studies would perhaps help formulate better policies to direct credit and microfinance at the base of
the pyramid.
1−γ
123
If U (c)=(c − 1)/(1 − γ), (1 ) implies B (y, r)= y · b (r) .
124
For other utility functions, exponential for example, the predatory-monopolist lends more and charges higher interest rates than
an ordinary monopolist.
150 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 7.4: Uncertain Income


When household income is uncertain, predators have another angle: they can exaggerate the probability
the household income (or micro-enterprise income or more appropriately profit) will be high, thus
boosting household loan demand. Uncertain income also means default is possible. If predators
accentuate the positive enough, they may push borrowers to the brink of default.

Suppose future income is high (Y) or low (y) with odds π and 1 − π. Expected utility depends on the risk of
default, and hence, π. It turns out that households with π below some threshold limit their borrowing to
avoid that risk. In deriving household’s loan demand below, we impose the no-default constraint that B ≤
y/(1 + r), but then show that the constraint will not bind for households with π below some threshold. Low
π households limit their borrowing to avoid owing all their income on when their pay is low. We then
show how predators, by exaggerating π, can push households to the brink of default.

Households choose B to maximize the Lagrangian function:

U(B)+ δ[πU(Y − (1 + r)B)+(1 − π)U(y − (1 + r)B)] + λ[y/(1 + r) − B],

The first order condition for B is:


0 0 0
U (B) − δ(1 + r)[πU (Y − (1 + r)B)+(1 − π)U (y − (1 + r)B)] = λ............ (5)
0 0
The no-default constraint is slack (λ =0) if and only if U (y/(1 + r))/δ(1 + r) − U (0)

π<π ≡...................................................................(6)
0 0
U (Y − y) − U (0)

Granting that, household loan demand increases with π: Bπ(Y, y, π, r) > 0. The higher odds of a high
payout decreases the expected marginal disutility of owing money when pay is low, so households borrow
more today. Suppose predatory lenders can exaggerate π by τ at cost C(τ). Predators’ exaggeration
cannot exceed π − π, or else households would borrow to the hilt (B = y/(1 + r)) and default would be
possible. Default is not necessarily bad for the lender if they raise rates to compensate, but once default is
possible, household loan demand decreases with π. It seems implausible to imagine predators that
exaggerate π to increase loan demand, then attenuate π to increase loan demand even further. The
predator maximizes the Lagrangian function:

(r− ρ) B(Y, y, π + τ,r) − C(τ) − f + µ(π − π − τ)................................ (7)


0
The first order condition for τ is: (r − ρ)Bτ(Y, y, π + τ,r) − C (τ) − µ =0............................. (8)

Optimal τ = π− π if and only if the marginal revenue from exaggerating π exceeds the marginal cost at
0
that point: (r − ρ)Bτ(Y, y, π, r) >C (π − π). In that case, predators exaggerate π until households borrow
y/(1 + r), putting them at the brink of default whenever their pay is low. Absent predation, low π
households would never default. Thus, when household income is uncertain, the over-borrowing
elicited by predators increases the probability of default. We test that prediction later.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 151

Section 7.5: Does higher risk deter predation?


If the probability of default is increasing in the amount households owe (unlike in the model above),
lenders incentive to exaggerate income is diminished. However, risk may not deter that incentive
altogether. Suppose household income is distributed f(y), with cumulative distribution F (y). If a household
owes (1 + r)B, they default with probability F[(1 + r)B]. At the margin, the incentive to exaggerate income
depends on the hazard rate of default: f[(1+r)B]/{1−F[(1+r)B]}. If that hazard rate is sufficiently flat at the
household’s optimal debt level (given the true distribution of income), predators still profit from
exaggerating micro-enterprise’s income prospects.

Section 7.6: Equity stripping


If lending is secured by an asset, then the incentive to prey does increase.125 Lending another rupee to a
household with home equity of INR E does not increase risk to lenders’ at all, even if the extra unit of
borrowing puts household debt service costs beyond current income or cash flow. As the borrower misses
a payments, home equity lenders can charge penalties and raise interest rates until the household owes
$E -where X represents foreclosure costs. If a predatory lender can con households into borrowing
more than their current income affords, predators can eventually strip homeowners’ equity.

Section 7.7: Can credit counsellors dissuade predators?


We also consider that a credit counsellor can correct borrowers’ income beliefs, at some cost, and thereby
raise borrower welfare by reducing their borrowing to the optimal level. Credit counselling may deter
predation, but it does not necessarily eliminate it. Credit counselling may not be profitable because it
entails lending smaller amounts at a higher rate (because counselling is costly). Predation can occur in
equilibrium if the welfare loss from predation is less than the cost (to a credit counsellor) from eliminating
the loss.

Section 7.8: So, is microcredit in India predatory?


Critics condemn microfinance lending as predatory partly because of the high interest charges. However,
the high price of micro-credit “could” reflect high fixed costs per loan, and/or, monopoly power126
(localised; i.e. before competition sets in, in a particular village or district). The other big criticism of
microfinance lenders is the frequent ever-greening and rollover of loans. Instead of repaying their loan
after certain weeks, a substantial fraction of borrowers do rollover their loans for another 50 weeks by
taking a larger loan at similar rates, while nothing would’ve changed in their credit worthiness or
microenterprise development. (Thus, this case becomes similar to predation of over-borrowing). If

125
In this microfinance crisis where the repayment of A.P. MFIs have gone to 10-15% from ~100%, many MFIs are considering
to trade their unsecured portfolio and replace it – as far as possible- to a secured portfolio (gold loan). The loan against gold
product continues to do quite well.
126
It’s not necessary that a predator-monopolist always charge higher prices than ordinary monopolists. Thus, higher prices are
neither necessary nor sufficient to conclude that a certain class of credit is predatory
152 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

microfinance lending tempts certain households into over-borrowing, then that should be detectable as
differences in debt and delinquency rates with more liberal microfinance lending laws.

In general, microfinance being a cookie-cutter model – everyone is offering a similar set of services (since
costs of customization is too high) which may not be very “customer-centric” and end “user-friendly”. The
practices are consistent; the malpractices are/ were initiated by the more aggressively growing MFIs
(many of which became larger). While myriad studies have been taken place in the microfinance space in
India, an assessment on predation is seminal. While, “the genesis of microfinance suggests the innovation
was welfare improving, not predatory”, prevalent practices such as “setting the loan rate”, creating “over-
indebtedness” for clients, excessive competition inducing harsh recovery practices indeed are predatory.
Predators still profit from exaggerating micro-enterprise’s income prospects.

To be read in conjunction with the section on interest rates, we summarise:

Microfinance practitioners are not predatory in that their interest rates are not outrageous
The prevalent practices are however predatory
We deduce that absent predation, poor households would never have correlated defaults in
A.P. (or other adjacent states)
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 153

Chapter 8: Multiple borrowing

Section 8.1: Research Precedent


The growth of the microcredit market has accelerated127; the rivalry amongst organizations has become a
growing concern128. Generally competition is a welcome feature from a consumer welfare perspective;
however, in so far as microcredit is concerned, we have our doubts (especially in the light of unruly and
unregulated competition).

The clients (assumed naïve; based on field interactions) in comprehending the complexity of assessing
their ‘debt service coverage’ capacity accurate give in to the temptation of easy availability of loan, which
may turn vicious.

When borrowers and lenders were tied in a symbiotic relationship, lending without incurring losses (loan
loss provision was <1% until now; is the trend changing?) is relatively easy. MIFs needed borrowers to
repay their loans (99%+OTR) in order to avoid losses. In early stage microfinance, MFIs were “valued”
since this relation balanced (with the shortage of supply of credit); the demand side was still higher. Thus,
to keep the MFIs in good mood, the borrowers would ensure that they repaid their loans in the hope of
getting higher valued loans (whether as fuel for working capital, capital investment or consumption). The
uncertainty was beneficial. On the side of caution, clients would repay loans. However, with greater
competition there was a paradigm shift (destabilizing?) of the dynamics of the relation in favour of
borrowers: The bargaining power was now vested in the clients and since the loans were unsecured, they
knew that there were other (several) options and alternatives129.

Management of MFIs suggest that competition not only reduces the borrowers’ incentives for repayment
but also the clients diversify their ‘sources’ of funds by taking multiple loans. The lack of credit bureaus
makes multiple borrowing go unscreened. Thus – it is only a matter of time – the level of indebtedness
can become so large that it may render repayments extremely unlikely130. Multiple borrowing could be

127
Not only myriad mushrooming MFIs have sprung up but also the size and quantum of loans has rapidly expanded with
“waiting periods” for client loans having significantly dropped.
128
A growing number of institutions enter the market: The spectrum of motivation ranging from self profit maximization to doing
social good.
129
“When we first entered the villages, we were highly respected. The women and their husbands alike looked up to us as if we
were doing them a great favour. There was respect in their eyes. And there was loyalty. The job gave me personal satisfaction
that I was bringing about welfare and improvement in the lives of people. I felt empowered too. But now there are so many MFIs
that the same clients look at me in the eyes and make demands. We’ve changed our model to more business-like. They also
understand that and treat us differently. They have options…”, “….It was better earlier…”. Interview, with a branch manager at a
reputed South Indian MFI (translated in English).
130
This view is endorsed by research: Olivares-Polanco (2005) finds that competition worsens poverty outreach in a cross-
sectional study of 28 Latin American MFIs. Rhyne and Christen (1999) also report that increased MFI competition has worsened
outreach. A survey by the Grameen Koota staff covering 200 borrowers (including 105 defaulters), suggests that 25 per cent of
these borrowers had taken loans from 6 or more MFIs. In another extreme example, one woman was found to have borrowed Rs.
4 million from different MFIs (Srinivasan, 2009). It is clear from most of these studies that such multiple lending can weaken
repayment discipline, with the borrowers using loans from one MFI to repay another (see, e.g., Srinivasan, 2009).Other empirical
studies (for example, McIntosh, de Janvry and Sadoulet, 2005) confirm the importance of double-dipping.
154 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

because of131 (a) Ex poste information asymmetry, i.e. after the loan is taken and invested, the risk of
negative shocks may hurt borrowers and their micro-enterprises. This can make it difficult for them to
repay the loan. Thus, borrowers might decide to take a second loan in order to repay the first, increasing
dangerously their level of indebtedness (b) (c) the loans are insufficient to cover the borrowers’ needs for
specific investments. In order to obtain the missing capital, they might find it convenient to hide their real
level of indebtedness and ask for additional loans from different institutions. However, this is purely a case
of wrong “positioning” of clients; MFIs should go closer to the base of the pyramid and need to do a
better credit assessment and ascertain whether or not the request of borrower is justified132.

Contrary to our findings and assessments, McIntosh, de Janvry and Sadoulet (2005) find no effect of
competition on average loan size, in spite of multiple-loan taking. Similarly, Parameshwar et al. (2009)
finds that incidents of over-indebtedness and default have affected less than 5% of the Indian
microfinance sector’s portfolio. Ceteris Paribus, this indicates, perhaps, that the time of the study is
important and that there is indeed a LAG factor as well as a tipping point for some of these effects to
show up.

Much of these assessments about multiple borrowing, over-indebtedness etc. can be better understood
from a behavioural economics perspective since it does involve social, cognitive and emotional factors in
the economic decisions of borrowers– whether as individuals or in a group – and microfinance institutions
too performing the economic functions including consumers, borrowers and investors, and their effects
on market prices, returns and resource allocations. We would be in the core of concerns on bounded
rationality (selfishness vs. self-control) of economic agents. Thus our outlook to policy formulations at the
bottom-of-the-pyramid necessarily needs to integrate insights from psychology with our existing
understanding of neo-classical economics.

Specifically, Prospect Theory133 has been used in experiments134. The value of prospect theory in the
understanding of individual decision-making process cannot be dismissed and it can give more insights to
help in the credit assessment of borrowers. With this objective in mind in the sequel, the present research
describes various scenarios emanating from the applications of prospect theory to explain multiple
borrowing, one of the burning issues in microfinance. Then a personal interview was conducted with
microfinance clients to understand their risk behaviour on these scenarios. Through games and
experiments135, it has been deduced that microfinance clients are (largely) irrational in their decision
making process.

131
Please refer McIntosh et al., McIntosh and Wydick, de Janvry et al
132
Interestingly, almost 100% of times – anywhere in India – borrowers feel that the loans given to them are highly insufficient:
That is their biggest complaint; and not interest rates. However, the self-appraisal of any performance (confident) is always going
to be higher than an objective assessment. Then again, credit is a low-risk, conservative financial instrument.
133
Theory of decision making under conditions of risk developed by Kahneman&Tversky (1979) asserts that decisions are based
on ‘judgment’ when it is difficult to clearly foresee the consequences of actions. How choices are framed and evaluated in the
decision making process between alternatives that involve risk.
134
Kumar Rahul, “Understanding customer behaviour of multiple borrowing through prospect theory: case study on Indian
microfinance clients”; 2009. Dr. Rahul is Chief Financial Officer at Mimo, a NABARD supported MFI. It was interesting to have
a tête-à-tête on the multiple-lending menace.
135
Ibid
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 155

Section 8.2: Multiple Lending and Competition


Andhra Pradesh, Tamil Nadu, West Bengal, Orissa where the bulk of the study was conducted also has
presence of many other MFIs (new entrants, other transformed NGOs and some old NGOS which have
gathered mass apart from a large number of local operators). Based on interaction with clients, it was
evident that there was a high incidence of multiple borrowings amongst clients. Overall (and
conservatively!), it is reckoned to be in the range of 80-85% of all clients (with at least 2/3 MFIs operating
in the same region). Credit must be given to MFIs, that “virgin” and “unbanked” has drastically been
reduced in most of these areas and in many cases been comprehensively eradicated. While it is difficult to
ascertain precise numbers – and put forward so with cent percent certainty – we can gather some ideas
based on clients’ responses despite the fact that they are often not forthcoming with the information for
fear of adverse implication(s).

Section 8.3: Risk Implications


Lack of information on multiple borrowing may lead to instances where the MFI staff may not be able to
ascertain the true cash flow status of the clients. Penetration by other MFIs with aggressive growth plans
seem to be increasing and in future, such overlaps of members can lead to portfolio quality issues due to
over-leveraging of loans by clients.

Section 8.4: Recommendations for future


While the instances of multiple borrowings does not seem to have (yet) affected the repayments in most
cases; however, as a proactive measure, the area managers and BMs should capture this information for
every client appraisal. Each MFI could also re-evaluate its current loan products and introduce products
that could meet the client needs better. Going forward, perhaps MFIs should also include the likely
disadvantages of multiple borrowings and the need for a true assessment of own cash flows in the
trainings imparted to its clients.

Section 8.5: Multiple lending: CReSA Case Study136


In 2007, when CReSA started its operations in Mulki Mohammad Puram (M.M. Puram)137 the recovery rate
was 100%. By 21st July 2010, exactly three months before the A.P. Ordinance, the repayment rates had
dropped to 27%! As is the case with most MFIs in A.P. their recovery rates are about 10% (90%
delinquencies), with little support and access to supplemental finance to recover the existing loans. {We
should not forget that starting from the experiences of Prof. Yunus the first cycle of loan was repaid with
the intent that a further loan could be availed; in that, repaying is a strategic decision as well].

136
V. Prabhudas, Chairman & Managing Director, CRESA Financial Services, Aadhaar partner.
137
A totally rural hamlet located in Pulla Grama Panchayat of Bhimadole Mandal in West Godavari District of Andhra Pradesh.
It is popularly known as “Pallapu Vooru”. It is on the northern bank of Kolleru Lake which spread over Krishna & West
Godavari Districts. The Chennai – Kolkata (NH5) Highway touches this village. The Chennai-Kolkata Railway line also passes
through this village which comes under South Central Railway Zone. A significant part of the clientele is Below Poverty Line
(BPL) belonging to Dalit Community.
156 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Coming back to the case study: Our hypothesis was that serious multiple lending could be a potential
reason for the village not taking to microfinance. A simple assessment was done; this village is selected as
a case-in-point for the broader study138.

In order to elicit the reasons for drop in the recovery rate in such a situation, CReSA conducted a meeting
on August 10, 2010 at the community hall of the locality. Village elders, beneficiaries of the Micro-finance
credit programme and members of their families in the village were invited. The outcome of the meeting
revealed the following interesting facts:

The necessary historical perspective: About thirty years ago, people living in the Kolleru Lake area were
allotted lands mostly belonging to Dalit community. They converted the land into small fish tanks and
getting their livelihood. Then due to the policy of Central Government to maintain ecological balance and
preserve the environment, these fish tanks were closed; the land was made ready for the purpose of green
plantation. In this process these Dalits lost their livelihood. Due to loss of livelihood, these displaced folk
were forced to go to upland areas in search of agricultural works. They start early in the morning
(travelling on Auto Rikshaws or tractors as a team) and travel to the upland areas and return home late
night at about 11pm. Life was difficult: Though both ‘wife & husband’ invariably worked in the fields from
morning till evening, only one wage used to come home as they have to depend on it for daily bread.
Some families migrated to distant Districts of Guntur, Prakasham & Khammam in search of better
livelihood opportunities. Some families travelled farther to Kolleru Lake area; thereby, the convenience to
attend the centre meetings at their ‘doorstep’ was missing.

Is this diversion of funds or urgent needs attended?

Some clients spent the loan amount towards hospitalization expenses. Medical insurance was
poor. Money being fungible, medical priorities and a high incidence of risk in this strata cause
them to cater to this “consumption.”

Some clients prioritised having their own house. Not only is the status symbol of owned-vs-
rented associated but also that several MFIs do use this parameter as a screening / credit-
appraisal parameter. Thus, they diverted their loan amounts for completion / commencement of
their house construction.

Many clients admitted that they utilised their funds from microcredit institutions to complete
unfinished latrines etc. With a growing sensibility, even in the rural folk, open air defecating – for
women – was a different socio-economic ballgame.

The truth about these can’t be verified, except being taken at face value, but those belonging to
certain groups ‘said’ that they ‘diverted’ the microfinance credit amounts to clear the bank loans
(Interesting!?)

Disturbingly, there were some kingpins who deceived the innocent poor women by making them
take loans from several institutions. These kingpins (moneylenders) are grabbing this loan
amount, in turn lending at high rate of interest. Another opportune interest rate arbitrage!

138
Observed a high incidence of multiple lending by many MFIs
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 157

The most important point is that the money they take from MFIs is not being utilized for productive/
income generating purposes. Due to multiple lending, these poor women were rotating the money taken
from one institution to other institution thereby not able to clear any loan. Due to heavy burden of
multiple borrowing some women, without informing anybody left the village overnight.

After hearing patiently their views, we conducted a detailed survey:

1. How many families availed loans?


2. From how many Micro Finance Institutions did they avail loans?
3. How much is the liability?
4. How much they have remitted? What is the Outstanding of loan?
5. What is their social status, their financial resource their health conditions etc.?

According to the survey, we append below the details of each microfinance institution and their date of
entry into the village.

Table 18: MFI entry, competitive assessment

No. of Name of the MFI First Loan is Recove No. Of Amount Average
MFIs disbursed in ry rates Clients outstanding Loan per
operating (Rs Lakhs) MFI
1 ASMITHA August 2003 100% 172 40.00 23,255
MICROFIN
2 CRESA June 2007 100% 136 13.25 9,742
3 SPANDANA August 2007 100% 132 30.00 22,727
4 SKS October 2008 96% 163 26.29 16,128
5 SHARE MICROFIN August 2009 93% 150 22.5 15,000
6 L&T FINANCE December ~90% 185 23.25 12,561
2009
7 HELP February 2010 ~25% 70 7.28 10,400
8 Bank-SHG 155 22.5 14,516
programme
Total 254 185

At this point, we note:

1. The strong correlation between no. of MFIs operating in the region and the dropping repayment
rates. However, the survey is for a single village and does not factor in ‘local geographical’
exogenous factors. And hence, we cannot generalise yet: While the hypothesis needs to be
examined with a larger number of samples; the observations are indeed alarming.

2. The causal-effect relationship is neither examined nor exemplified here. That would be interesting.
While it was ascertained qualitatively, through focussed group discussions, a rigorous the
quantitative assessment remains to be done.
158 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

3. The default rates are assumed to be applicable to the entire village. We have taken the proxy of
default to CRESA, the investigating agency. It is possible that the delinquencies experienced by
other MFIs would be different.

4. Most of the families who procured loans claimed to be and in all likelihood were engaged in
running petty shops, maintaining pan shops, maintaining auto-rikshaws, running tea stall, job
work in masonry, managing milch cattle for selling milk, agricultural work, painting jobs,
household electrical works/repairs, labour jobs in fish tanks etc.

Exhibit 50: Case-in-point –The multiple borrowing phenomenon

Loan outstanding (Rs) No. of clients

140,000 70
59
120,000 60

100,000 44 50
38
80,000 40
29 28 27
60,000 30
19
40,000 20
10
20,000 5 10

0 0
>8 7 6 5 4 3 2 1 0

Sources of funds (# of MFIs)


An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 159

Chapter 9: Strategic Perspectives using SCOR

Section 9.1: Microfinance Supply Chain


While we are not merely underplaying it by calling it an arbitrage opportunity, certainly and without a
debate, microfinance is indeed trading (in credit). Given that the microfinance model is largely sourcing
funds (raw material) and distributing to the beneficiaries, supply chain of the sector needs a review. Good
performance measurement should be both realistic and understandable.

Exhibit 51: Revisiting the Value chain

12-15% 18-30%
Microenterprise, a
Funder MFI MFI client (real) productive
asset

If >12-15% + If >18-30% net of profits If >18-30%, profits

l l i i t

Metrics of Supply-Chain Operations Reference-model(SCOR) Model can ensure that every function and
every player in supply chain can interpret the result in the same way.

Section 9.2: Process Modelling


Since SCOR has much to do with Operational Excellence (OE), performance attributes of SCOR Model are
usually linked to corporate strategy. We deploy could SCOR, a process reference model139 and the de facto
standard diagnostic tool for Supply Chain Management (SCM), for understanding microfinance SCM
related dynamics. Since SCOR is a management tool that describes the business activities associated with
all phases of satisfying a customer's demand, from a “social” impact perspective SCOR is additionally
empowering. It allows us to compare MFIs across legal structures andsimilar financial instructions (e.g.
RRBs) and banks (SHG linkage model and BC/BF model). SCOR enables users to address, improve, and
communicate supply chain management practices within and between all interested parties in the
“Extended Enterprise”, can not the same tool be used to assess the efficacy of the microfinance landscape,
to design policies, evaluate competitiveness and assess a general performance of the microfinance sector?

139
Developed by the management consulting firm PRTM and endorsed by the Supply-Chain Council (SCC).
160 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

By describing supply chains using process modelling building blocks, SCOR uses a common set of
definitions140 (easier to explain to MFI owners who usually don’t come from sophisticated financial
backgrounds). SCOR can be used to describe the depth and breadth of microfinance.The SCOR model is
based on 3 major "pillars":

1. Process Modelling
2. Performance Measurements
3. Best Practices

Exhibit 52: Deep-diving SCOR

The SCOR Model has 3 levels of process: Core Process, Sub-Process and Process Decomposition

CORE PROCESS SUB-PROCESS


LEVEL 3 OR PROCESS
•PLAN (P), •1 = Make-to-stock,
DECOMPOSITION is
•SOURCE (S), •2 = Make-to-order, provided by SCOR Model:
•MAKE (M), •3 = Engineering-to-order, Just pick level 2 process and
•DELIVER (D), •4 = Retail product you can get level 3 process
•RETURN (R) from SCOR Model. Level 4
may be drilled down from
level 3 process.

Best practices provided: After current performance is measured and processes are redesign, the
biggest thing we should contemplate is how to find the way to create improvement. In many occasion,
improvement plan becomes unsuccessful. The causes of failure are mainly from the lack of
understanding of root causes and best practices itself. Fortunately, SCOR Model is equipped with plenty
of best practices that associate with each process. Once poor process can be identified, best practices
will be at hands and ready to help fix problems.

140
(1) Standard language: Since supply chain management is full of jargon and hard to comprehend, simple language e.g.
“Plan”, “Source”, Make, “Delivery” and “Return” are standard language that almost all of the people will understand. With its
simplicity, it can gather more attention and help people from various disciplines to work on SCOR Model implementation
project. (2) Standard roadmap: SCOR Model provides framework for supply chain improvement, from the development of
operation strategy to the implementation of new management practices. There are 4 phases of implementation of SCOR Model,
namely, (a) Analyze Basis of Competition (b) Configure Supply Chain (c) Align Performance, Levels, Practices and
Systems(d) Implement Supply Chain Processes and Systems (3) Standard process: every supply chain improvement many
involve the redesign of business process. It takes longer time to learn other process redesign methodologies. SCOR Model
process mapping usually takes less than half a day to construct.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 161

Section 9.3: Supply Chain Configuration


- Since much of definitions of “competitive”, “saturated vs. virgin”, “pricing” etc. are closely linked to local
geographies; cash-flow will be captured and re-designed. Capture material flow by showing location of
‘source to last mile’ resources on the supply chain map; the result is “AS IS” Geographic map.

Redesign material flow and make “TO BE” Geographic Map. Possible issues to be considered in
material flow redesign include removal of non-value added facilities, relocation of distribution
warehouses.

Convert TO BE Geographic Map to AS IS thread diagram which focuses on inter-organization


processes. Each level 2 process of SCOR Model will be transformed into an arrow. Bold vertical
line distinguishes company entity. Dashed vertical lines indicates different department in the
same company.

Redesign inter-organization process by considering issue such as inconsistency of performance


measurement between trading partners.

From the above diagram, delivery performance of Vendor B who sells make-to-stock product is 80%. In
order to meet end customer’s requirement, warehouse may has to hold more inventory to protect
manufacturer against uncertainty. This type of metrics conflict should be resolved along the whole supply
chain. To finalize TO BE Thread Diagram, planning processes of SCOR Model should be added.

Section 9.4: Aligning Performance, Levels, Practices and


Systems
It’s time to do process mapping, level 3 processes should be drawn from SCOR Model manual and
translated into AS IS swim lane diagram. This diagram indicates each process under function name. The
example below illustrates S2 process at Vendor A.

Redesign of organization’s process should be done cross-functionally. Then, it’s recommended to


gather knowledgeable person representing each department. Brainstorming session from design
team indicates that root cause of sourcing processes is from lack of coordination and information
sharing. Then processes redesign will create TO BE swim lane diagram.

To identify product requirement appropriately, production planning work closely with marketing in
demand planning phase. Moreover, procurement join together with marketing and production planning
to ensure that products will be schedule in right time and right quantity inside planning time fence. The
team should also consider the following issues,

Missing processes of SCOR Model such as input, output, enable processes should be in place.
People responsible for particular process should be assigned and documented.
Company should compare what they are performing in each process with best practices.
Level 2 metrics of SCOR Model or industry specific metrics can be added.
162 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 9.5: Implementing Supply Chain Processes and


Systems
After processes are redesigned, company should consult manual of SCOR Model to create list of best
practices. Many firms consider improvement plan that requires no or minimum investment. In case it’s
necessary to implement technology related best practices, value from gap analysis will serve as guideline
for investment decision making.

Section 9.6: Challenges of implementing the SCOR Model for


MFIs in India
1. Fair human resource management system is a prerequisite for successful implementation of SCOR
Model. Reason: The model needs a lot of input (qualitative and quantitative) information from
employees in order to analyze business process correctly. However, microfinance has a history of
troubled employment141 which tends to be non-productive during brainstorming and process
redesigning sessions.
2. To get information from end users quickly, questionnaire based on process of SCOR Model. This
will allow you to obtain data easier. However, if we were coming from “on behalf” of an MFI
through the HO and then branch and then to the centre we elicit one type of response (“control”);
the reaction pattern and response was much different when we went directly in the field, stayed
with them in the villages and shared a day or two together.
3. While the existence of an Enterprise Resource Planning (ERP) system is not mandatory for SCOR
Model, however, in the absence of certain customer cost data, through a common accepted
accounting practice/ standard and record maintenance, we did resort to sampling. Then again,
getting client data is sensitive to an MFI: The tier-1 MFIs are not too excited to even share it with
the credit bureaus. Next step was to capture delivery performance, “perfect” customer satisfaction
(qualitative) and lead-time. Cost of funds, asset turns, cash-to-cash cycle time is available from
financial statement.
4. The SCOR is most suited for larger comparing MFIs with those of other similar financial
institutions.
5. Value from improvement from SCOR Model is quite subjective.
6. Most often simulation software is used in SCOR Model implementation to make improvements
and to configure supply chain. Perhaps, the next generation software will have the built in
mechanics to advice and guide management; right now an integrated MIS and accounting
package is considered “state of the art.”
7. Since the SCOR Model does not have metrics related to ‘quality’, other Key Performance
Indicators (KPI) in supply chain scorecard is used in conjunction.

141
Attrition problems due to compensation, career opportunities, posting etc. Source: Sa-Dhan and industry interviews
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 163

Chapter 10: Benchmarking Performance


The raison-d’être of this piece: This section forms part of the background work that is required to
benchmark, assess and develop NABARD supported MFIs into best-in-class MFIs. This document forms
the basis of the action led ‘Organisation Development’ process initiated.

Section 10.1: The Tools


A rapidly growing and fast maturing Indian microfinance sector needs standardized methods to measure,
benchmark and analyze financial performance and risk management of its operations. The existing study
seeks to address this need by selecting NABARD support MFIs.

We peruse a set of Performance Parameters142and Asset-Liability Management (ALM) tools so as to assess


the health of MFIs and ascertain relevant benchmarks. These Performance Parameters may be used by any
microfinance institution (MFI) whether a non-profit organization or a non-bank financial companyor even
commercial banks, regional rural banks, cooperatives etc.; and, can be compared on a set of common
parameters.143

The Performance Parameters chosen are consistent with International Financial Performance Parameters144
(IFRS), a set of global accounting standards increasingly adopted throughout the world; and, with the
Basel II framework as well. Additionally, all financial statement line items are aligned with the standardized
nomenclature developed for global financial reporting called eXtensible Business Reporting Language
(XBRL).145The ratios will reflect the growing attention to measuring, comparing and analyzing (a)
performance (b) risks in the microfinance industry.

The phenomenal growth (return) of the sector – quoted at ~40% with many leading MFIs growing
manifold to that average number - must be revisited in terms of risk-adjusted-returns.

We do acknowledge that a more robust set of performance standards may be needed, given the growing
number of MFIs that are regulated, accept deposits, and have increasingly complex capital structures, off-
balance sheet transactions etc. But – at this point – any more involved analysis than this does not make
sense since the underlying data is sticky. In the absence of any regulation, data is sparse; it cannot be

142
Adjustment to ratios allow for a more standardized approach to MFI performance measurement, as adjusted ratios are more in
line with commercial banking reporting. This facilitates comparison between different types of MFIs (such as non-profit and for-
profit) and enables MFI financial performance to be benchmarked against other MFIs and against commercial banks, RRBs etc.
Please refer Appendix for a detailed description of the ratios
143
Source for analytical adjustments can be found in the SEEP Framework
144
Further information about International Financial Reporting Standards may be found at www.iasb.org
145
Additional information may be found at www.xbrl.org
164 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

ascertained what adequately represents the industry146; data is not entirely reliable, since it’s a fragmented
industry; quantitative data based on sampling may be inconsistent with general observations on field due
to absence of any reporting standard.

Further, these standards only address microfinance financial performance. Additionally, we should try and
include other aspects of microfinance such as social performance147, impact investing etc.148. But that will
be predominantly through a qualitative assessment. The formal literature on these softer issues is still
quite underdeveloped; though widely held that ‘social performance metric’ should be deployed and
developed.

Through this assessment, we have endeavoured to set the tone not only on the processes but also a
common language of assessment so as to ensure microfinance performance metrics are calculated
consistently so as to bring into a common denominator MFIs from different regions, associations and
networks, regulators149, donors, lenders and investors, rating agencies etc. Like any other business, MFIs
are subject to local crises, natural disasters, political and economic volatility, and weak regulatory
structures. Specific implications of this conservative approach are reflected in many of these ratios150. The
Performance Parameters will induce transparency of financial and operational information by MFIs to
make reporting performance assessment as explicit as possible.

The ratios and tables are grouped into six categories:

1 Profitability
2 Capital adequacy and solvency
3 Liquidity
4 Asset quality (portfolio quality)
5 Efficiency and productivity
6 Asset-liability management

146
Supposedly there are 3000+ MFIs in India with many still operating in silos and highly localised. In terms of portfolio size
NBFC-MFIs claim that they are–supposedly – 85% of the entire micro-credit supply in India. But the micro-credit demand is not
known. Neither is an accurate measure micro-credit supply (aggregating bank credit supply should be >95%, though) since the
total size of the alternative channels is known; which are still operating in the informal setup of SHG revolving funds without
using external bank credit are still uncounted for.
147
Information about microfinance social performance is available at www.themix.org/standards/social-performance
148
Please see Global Impact Investment Network’s Impact Investing and Reporting Standards at http://iris-standards.org
149
National regulators generally request and rely upon source data; less upon externally derived ratios, when assessing for
regulatory compliance. Every effort has been made to approach these ratios in a manner consistent with regulatory financial
reporting requirements and compliance
150
For example, in ratios where a committed credit line previously was considered for liquidity, it has been excluded in the
Standards since committed credit lines may not be available in a financial stress scenario. Liquid Assets are defined as cash only
since cash-like line items such as Due from Banks may be encumbered and not available as liquid assets
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 165

When available, publicly available “benchmarks” from MIX Market are taken151. Over time, benchmark
rates, ratios and expectations would obviously shift.

Section 10.2: Standardising Parameters


A maturing Indian microfinance industry needs standardized methods to measure and analyse financial
performance and risk management. The proposed Performance Parameters152seek to address this need.
These Standards can be used for and by all MFIs: non-governmental organizations, non-bank financial
institutions or companies, commercial banks, rural banks, credit unions, and cooperatives. A fuller
description of each of the newly introduced ratios and tables follows in the body of this document.

The proposed Microfinance Financial Performance Parameters are consistent with International Financial
Performance Parameters153 (IFRS), a set of global accounting standards increasingly adopted throughout
the world, and with the Basel II framework. Additionally, all financial statement line items are aligned with
the standardized nomenclature developed for global financial reporting called eXtensible Business
Reporting Language (XBRL).154 Some new ratios reflect the industry’s growing attention to measuring and
analyzing risk.155 A more robust set of financial standards is appropriate given the increasing number of
microfinance institutions (MFIs) that are regulated, capture deposits, and have complex capital structures.

These standards would address financial performance:

The first thing is it allows the MFI to compare itself with other similar organizations. If the
management realizes that things within are aren't particularly going too well, they can help
pinpoint the problem through comparing their ratios with other organizations (benchmark). For
instance, they may have several ratios that are comparable, but a couple which are way off. That
might be where the problem is.

Also ratio analyses may help by comparing the organizational “evolution” over time by comparing
with prior periods through a trend analysis. The adverse trend analysis can help to diagnose a
particular problem and look for corrective solutions. Revisiting the ratios would be to find out
where the problem lies.

151
MIX Market MFI benchmarks cover a global cohort of ~1200 MFIs, found at www.mixmarket.org/mfi/benchmarks
152
Published in 2005, this document, known as the SEEP Network Framework, detailed 18 financial performance ratios
153
Further information about International Financial Reporting Standards may be found at www.iasb.org
154
Additional information may be found at www.xbrl.org
155
Due to evolution in microfinance reporting, a select number of ratios included from the 2005 Framework have been phased
out of the proposed set of Standards. Operational Self-Sufficiency (OSS) and Financial Self-Sufficiency (FSS) ratios, which
evolved as early and important sustainability ratios, are omitted in this edition. While OSS and FSS were helpful, once an MFI
exceeded 100 percent sustainability or breakeven level, the ratio became less helpful as a measure of profitability. Return on
Assets and Return on Equity are commercial measures better suited to analyze an MFI's profitability. In addition, some ratios
have been renamed to reflect industry evolution. The well-known Portfolio at Risk as of 30 Days (PAR30) ratio is called Non-
performing Loans as of 30 Days Past-Due. The Standards use mainstream terminology where possible to be more consistent with
vocabulary and language of the commercial banking sector.
166 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

One of the principal goals of the Financial Performance Parameters is to ensure that microfinance financial
performance ratios are calculated in a consistent manner. The proposed Performance Parameters use a
financially conservative and prudent approach to measuring financial performance ratios. The Performance
Parameters would persuade greater transparency in and disclosure of financial information. MFIs should
be as explicit as possible in reporting financial performance, particularly because many MFIs are subject to
local or national crises, natural disasters, political and economic volatility, and weak regulatory structures.
Specific implications of financially conservative approach are reflected in several ratios.156

To set quantitative measures beyond this scope including other aspects of microfinance such as social
performance,157 impact investing, and Performance Parameters,158 among others is difficult in the current
context and project.

A nation-wide effort to implement Performance Parameters has sought uniform financial information on
all MFIs, regardless of size, maturity, legal structure, or geographic location. A broad array of stakeholders
require timely and accurate financial information, including MFI management and boards, lenders,
investors, donors, rating agencies159, MIS software developers, and microfinance networks and
associations can use this information judiciously for better management of the institution.

Uniform standards would promote financial transparency, allow for comparability across institutions,
improve decision-making, and increase the potential for commercial and other investment by making it
possible to measure, track, and analyze an institution’s financial position. In the short run, MFIs will likely
need to increase their reporting efforts to meet new standards. In the long run, these changes should lead
to smoother, more efficient reporting for MFIs once regulation (by NABARD?) steps in.

An MFI must have the capacity to regularly generate reliable financial performance and risk management
information that meets regulatory requirements and allows the MFI to manage its operations and risks
efficiently. MFIs must choose their management information systems (MIS) carefully in order to ensure
that they are capable of generating these reports. Additionally, MFIs that will have connectivity directly or
indirectly with information and communications technology (ICT) products and services will also need to
comply with additional reporting and analysis requirements relevant to this technology.160

Section 10.3: Growth and Returns


The included Performance Parameters exclude the commonly discussed Operational Self-Sufficiency (OSS)
and Financial Self-Sufficiency (FSS) from the list of financial performance ratios. “Operating Self-
Sufficiency” or OSS and Financial Self-Sufficiency (FSS), the adjusted version of Operational Self-

156
For example, in ratios where a committed credit line previously was considered for liquidity, it has been excluded in the
Standards since committed credit lines may not be available in a financial stress scenario. Liquid Assets are defined as cash only
since cash-like line items such as Due from Banks may be encumbered and not available as liquid assets.
157
Information about microfinance social performance is available at www.themix.org/standards/social-performance
158
Please see Global Impact Investment Network’s Impact Investing and Reporting Standards at http://iris-standards.org
159
Data aggregators and regulators should generally request and rely upon source data, and less upon externally derived ratios,
when assessing and MFI for regulatory compliance. Every effort has been made to approach ratios in a manner consistent with a
broad view of regulatory financial reporting requirements and compliance.
160
The final draft of the Microfinance Financial Reporting Standards may include an appendix addressing the financial reporting
impact of mobile phone banking.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 167

Sufficiency, were the earliest attempts161 to measure whether an MFI could cover its costs and maintain it
programs.

As the microfinance industry is fast evolving, can MFIs not use more commercial approaches to measure
financial viability or profitability as is applicable to banks? This included more traditional financial
measures such as Return on Assets (ROA) and Return on Equity (ROE).

ROA and ROE remain valuable measures of an MFI’s profitability. They are financial metrics that are well
established and well understood across the commercial spectrum. As such, they are useful regardless of
the legal status or mission of an MFI.

Using DuPont Analysis, ROE= Profit Margin * Asset Turnover * Financial leverage

This will also help the MFI better understand its own operations and financial structure.

Section 10.4: Portfolio Quality


Asset quality (historically referred to as “portfolio quality”) remains a key aspect of financial performance
for MFIs. While MFIs continue to expand their provision of deposits, insurance and other financial
products, the loan portfolio is still typically the predominant component of its asset base. Accordingly,
asset quality remains a key indicator of an MFI's financial viability.

161
The SEEP Network Financial Services Working Group: “Financial Ratio Analysis of Micro-Finance Institutions.”
Washington, DC: The SEEP Network and Calmeadow, page 28. 1995
168 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Exhibit 53: Performance, Portfolio Quality and “risk-metry”

Capital adequacy and solvency ratios help measure an MFI’s strength and stability by looking at the
relationship between the capital base and asset base. Solvency refers to the availability of cash over the
longer-term to meet financial commitments as they come due. The concepts of capital adequacy and
solvency have both become more crucial as MFIs grow and become more sophisticated, accept deposits,
and are subject to national regulation. All MFIs need to be solvent in order to weather the range of crises
that can adversely affect a financial intermediary.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 169

Basel’s risk and capital adequacy protocols are the backbone of our choice Performance Parameters of
MFIs in terms of direct application to financial management, internal controls, and management reporting;
outlined below are the “three pillars”:

The First Pillar establishes minimum capital requirements based on enhanced measurement of risks:

Credit risk, operational risk, and market risk


The Second Pillar162 prescribes the supervisory review process
The Third Pillar163specifies disclosures to facilitate market discipline

Exhibit 54: the First Pillar

The First Pillar


Basel II calculates
Measure capital adequacy
operational risk as a The First Pillar also requires
by defining values of the
function of gross income. measurement of market
elements of Tier 1 and Tier 2
MFIs face operational risks risks (FX, interest rate
capital, categorizing assets
including: losses from fluctuations, asset values,
to assign risk weights,
performance failure of liquidity etc) ALM metrics
measuring Risk-Weighted
personnel, business help measures address
Assets (RWA), and
partners, data, market risks including
calculating distressed assets
reputation/trust, business liquidity, interest rate, and
relative to the impairment
segments and counterparty foreign exchange risk.
loss allowance.
risk.

162
Basel's Second Pillar addresses regulation and the oversight of risks by senior managers and boards. MFI managers have the
responsibility to ensure that their institution has adequate capital to support all of the risks associated with its business and to
develop techniques to monitor and manage these risks. Managers should set capital targets beyond the Basel II core minimum
requirements commensurate with the institution's risk profile and environment. Managers can address risks through risk
management, internal limits, strengthening provisions and reserves, and improving internal controls. Under Basel II, regulators
and management are responsible for undertaking actions that both plan for and correct variances.
163
The Third Pillar insists that adequate management disclosures to give rise to a market discipline that will complement capital
and risk limits, and contribute to a safe and sound business operating environment. The recent global financial crisis exposed
phenomenal flaws and weaknesses in this concept!! General Basel II guidance recommends that disclosures be consistent with
senior management and board practices on how to assess and manage risks. Additionally, Basel II accord advocates that
disclosures be consistent and understandable, and that they allow for comparability between institutions. Disclosure, risk
assessment and management, and comparisons to peer institutions, are useful concepts for the microfinance industry. The core
tenets of Basel II- namely capital adequacy, regulatory review, and market discipline - should be considered for inclusion in
overall management and reporting practices by MFI boards and managements, and appropriately adapted to the microfinance
context.
170 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 10.5: Liquidity


A financial asset may be uniquely identified and differentiated from another on its Risk-Return-Liquidity
profile. Thus, challenges access to liquidity may make MFIs face solvency challenges. Liquidity is defined
as “the ability to fund obligations on a timely basis as they come due, to accommodate business growth
and acquisitions, and to fulfil obligations under stress conditions.”164

The ratios pertaining to liquidity are designed specifically to help MFIs anticipate, measure, and monitor
liquidity levels. Liquidity management can help MFIs make informed choices about the trade-offs between
maintaining certain liquidity levels and the opportunity costs of keeping resources liquid. When working
toward establishing optimal liquidity levels, MFIs will need to consider both internal and external factors
related to liquidity, ranging from sufficient funds for on-lending or payouts to depositors, to payment to
creditors, suppliers, and investors. Liquidity risk management tables may be found as ALM1 and ALM4 in
the asset-liability management tables. Liquidity is inextricably tied to asset-liability management.

Table 19: Microfinance Financial Performance Parameters

Topic Issue
A lot of financial analyses include the due from banks as a cash item.
Financially However, we will exclude any non-cash items from liquid assets such as
conservative and due from bank that may be encumbered.
prudent approach Similarly, exclude committed credit lines from liquid assets since they
may be unavailable in a stress scenario.
Non-performing Loans as of 30 Days Past- Due (NPL30) and Portfolio at
Used interchangeably Risk as of 30 Days (PAR30)
“Financial Revenues”, “Operating Revenues” in place of “Financial
Revenues.”

164
Women’s World Banking. 2005. Developing and Using Financial Risk Management Tools. (E-course).New York, NY:
Women’s World Banking, Module 3: Assessing Liquidity Risk.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 171

Chapter 11: Performance in a competitive environment

Section 11.1 Evidences of the effect of competition


As we explore policy problems affecting financial inclusion in India165,we begin with the premise that the
microcredit market in India is (becoming) quite competitive; and that this could (generally) be regarded as
a good thing for the clients’ perspective. However, since competition involves “winners” and “losers”, this
may not always be so. Clearly, the regulator’s challenge in this case will be to encourage healthy forms of
competition which do not threaten the financial system stability or cause abuse of customers, especially
for a service which is targeted specifically for the weaker and underprivileged sections of the society.
Certainly, we would need to combine socio-economic-(politico?) rationale; creating an environment of
constructive competitiveness. The evidence from credit markets elsewhere in the world, microcredit
markets in particular could serve as a helpful guidepost to navigate the impasse successfully.

Increasing competition among lenders holds out the prospect that borrowers will benefit from more
flexible products, better service and even lower interest rates. Lenders themselves become more efficient
and innovative as a result. But, as Rajan and Zingales (2003) note166, “Competition naturally distinguishes
the competent from the incompetent, the hardworking from the lazy, and the lucky from the unlucky. It thus
adds to the risk that firms and individuals face... Ultimately, most people are better off, but the ride is not
always pleasant, and some do fall off.” Thus, as we are beginning to observe in India, competition has also
increased the risks faced by individuals and firms—for example, building the pressure to lend recklessly in
ways which may result in over-indebtedness of some borrowers, or reducing borrower incentives to pay
back when other credit is freely available. On a large enough scale, such excesses can lead to the failure of
lending institutions167. Even if it does not produce “excess”168 competition may be slow to lead to
declining interest rates; slower, that is, than consumer protectionist policy makers would like169.
Confronted by the “regulator’s dilemma”, policy makers have to make trade-offs (Porteous 2006).
Certainly, the dilemma is not whether to allow competition or not, but rather how best to promote cost-
effective, client-centric, “healthy” competition170 through light regulation without burdening the players
with the high costs of compliance while mitigating the risks of negative shocks. In the microfinance
context, since MFIs require incentives to reach newer borrower groups (innovation and new product
positioning), an appropriate policy to enhance competition would involve balancing the interests of

165
Other aspects of the decision making framework should encompass policies towards consumer protection, interest rates, and
prudential regulation. Clearly, these topics are very tightly linked. For example, capping interest rates has traditionally been seen
as a means of consumer protection; and while competition in credit markets can bring many benefits, it can also result in abuse of
borrowers leading to calls for protection (operational aspects).
166
Rajan & Zingales, “Saving Capitalism from the Capitalists,” Crown Business,2003
167
Including banks which hold customer deposits! This has already happened in some places including Bolivia and South Africa.
168
“…competition has produced success and a certain amount of excess” In an article referring to ‘fierce competition among US
Universities: even not-for-profits can compete’’! The Economist, 1 December 2007, P.42.
169
However, in areas of low competition – e.g. remote areas – can allowing monopolistic pricing setting be an interim solution?
170
Healthy competitive behaviour in lending should: 1) Improve the terms of credit for existing borrowers; 2) Broaden
access to those who lack it; and 3) Contain the negative effects
172 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

providers and borrowers. Instance: cross-subsidisation of existing customers who may gain from price
reductions; but these tactics may be used to preclude entry by competitors (on instrument being
predatory pricing) resulting in less incentive to grow the market over time: as Carlton (2007: 168) points
out, “It is easy to conclude that that one should weigh the costs versus the benefits for each potentially
exclusionary practice, but implementing such a test can be exceedingly difficult.”

Perhaps we need to first see how we can define and measure competition; our assessment of evidence
from various empirical studies in different countries about the varied observed effects of rising
competition in the “policy maker’s toolkit” to promote healthy competition.

Given that microfinance has for quite some time been working through market-based economic systems,
effective competition becomes an essential condition for ensuring allocation efficiency and for increasing
and/or maximizing societal welfare.

Section 11.2: The Structure-Conduct-Performance Paradigm


Considering this that effective corporate governance has been identified as a crucial bottleneck in
enhancing many MFIs financial performance and expanding their reach in the market, as an action plan,
there are the four foundation arms for setting up a highly ethical code of conduct and implementation:

Exhibit 55: Effective corporate governance framework

Board of Directors &


Committees • Legal & Regulatory
• Monitoring

Communication to
shareholders and
stakeholders
• Performance
Management
• Risk Assessment & • Business Practices & Ethics
Risk Management • Disclosure & Transparency

First: The board of directors (and committee members), who lay down the ground rules of
performance and conducting ethical business should continuously evaluate. There are three
mechanisms a board establishes to operate effectively: (1) the separation of the role of the board
chair and that of the Chief Executive Officer (CEO); (2) the role of the board chair in relation to
other board members; and (3) the use of board committees. The report calls for the splitting of
responsibilities between the CEO and the chair and discusses the important role a chair can play
in ensuring ample discussion, debate, and the achievement of consensus among board members
Second: The achievement of the overall performance of the company/ management in financial
terms led by the CEO. However, the growth should always be viewed in a ‘risk-adjusted’
framework. Taking cue from essentials of portfolio management, the focus should be on getting
‘alpha’ and not ‘beta’. This essentially, entails keeping checks and balances in place.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 173

Commendably, many a MFI management has shown superior risk management understanding.
They keep their loan amounts low, ensuring lower credit risk. Good systems (MIS, risk
management and control systems) for handling operational risk are also in place. Thus, it is
possible to get high returns by assuming higher risks; however, MFI management, under the
guidance from the Board, should seek moderate risk-adjusted but robust growth. It would help
them position their products vis-à-vis competitors in a cost-benefit analytical framework.
Third: Led by the Internal Audit and Compliance through the Company Secretary, legal and
regulatory supervision that ensures that the company conducts itself within the stipulated rules
and directives by regulators171
Fourth: Focus on carrying out the operations and financial management in line with the ethical
codes and practices and setting industry benchmarks. Disclosure and transparency norms
adherence presented to its stakeholders.172

Effective corporate governance would be achieved when the four arms together ensure an effective
communication within its each of the foundation arms and related activities.

Field practitioners were expecting an impending concern in A.P. The promoters of several MFIs knew the
realities! The mistrust developed in large part due to poor governance standards. This clearly called for
Government intervention and regulation. Was the intervention of the A.P. state government more of a
regulatory nature or more comparable to regulatory capture (since they are already looking to set up their
own NBFC for MFI operations)? From a clients perspective, knowing that there were more loans to
come...they kept repaying. But the discipline of repayment was disrupted in Oct 2010. And most believe
that this is a structural change: the repayment rates to MFIs in A.P. will never go back to 99.5%+ in the
near future. Obviously, the performance standards would need to be revisited.

The Structure-Conduct-Performance Paradigm (SCP) The Chicago School Of Thought

The neo-classical economists’ developed structural Chicago School economists (e.g. George
approach follows empirical observations of various Stigler) have long argued that a variety of
markets crystallized into the SCP paradigm. different market structures may still be
economically efficient.
Using the SCP paradigm, we can assert that market
structure—the relative concentration of suppliers (MFIs) Under this view, the “contestability” of a
—drives the competitive conduct of firms, and this in market, that is, its openness to potential entry
turn affects their profit performance. or substitution of the product is more
important than its structure. This approach is
therefore more concerned about identifying
and reducing barriers to entry.

171
Companies which aspires to set benchmarks in the industry while simultaneously being pioneers and driving innovation
172
Includes shareholders, bond holders, bankers, employees and clients
174 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

“Above average profitability” of firms in a market is a The mainstream policy debate has generally
sign of weak competitive forces: This is currently the moved beyond the sometimes simplistic views
case with microfinance in India. of causality implied by the SCP and Chicago
approaches, and hence beyond their starkly
SCP remedies this by changing the market structure by different remedies, towards a greater concern
reducing the level of concentration. with understanding and measuring what
forms of competition are in fact taking place
However, since it is vague how the “level of
at firm level.
concentration” is related to the “level of effective
competition”, SCP maybe viewed as a descriptive Michael Porter (2008) proposed one way of
instrument rather than a normative approach. understanding the forces affecting
competition in a market in a way that
Despite controversy over its applicability, the SCP
synthesized these views.
paradigm remains influential in policy and judicial circles
today: as Cook et al (2003) pointed, particularly where
market structure is affected by a change such as a
merger may be simpler and easier to apply (especially in
developing countries) than the measures favoured by
the Chicago School.

Section 11.3: What is the relevant market?


Microcredit shares some product features173 with consumer credit products like credit cards in that they
are unsecured, of low value, short term and offered through one of several distribution and marketing
channels. However, unlike credit cards, some microfinance is based on group-based lending
methodologies involving peer guarantees, monitoring and/or screening. Also, the purpose of
microfinance was ‘income-generating’ and not consumption. However, in several other markets, individual
micro lending is increasingly becoming more common and consequently some of the traditional
methodological distinctions of microfinance as a separate segment (interestingly, some web-content174
went so far as to call them a separate asset class!) are fast blurring. Specific product features and
methodology apart, microcredit has traditionally been differentiated from consumer credit by the profile
of borrowers (e.g., self-employed members of low and moderate income households) and/or by the main
usage of loan proceeds (working capital for micro-enterprises). Whatever the purpose stated at the time
of borrowing, borrowers in fact use the loan proceeds for a variety of purposes, often contrary to the
stated purpose. In markets with a weak formal lending sector, clients of MFIs have often had moderate
incomes. Microcredit clients have commonly accessed other sources of credit such as informal loans from
money lenders alongside their microloans. However, following the success of early MFIs, new and existing
formal lenders are more willing to provide credit to lower income borrowers. For these lenders, there may
be little if any practical difference between microcredit and consumer credit.

173
And also the price! The interest rate charged by Credit Card companies in India ~30-38% APR; not too different from what
MFIS are charging. Certainly, the cost (operational) of a credit card service is much lower.
174
For instance, http://microcapitalmonitor.com/cblog/index.php?/categories/2-An-Emerging-Asset-Class
An Aadhaar
A Study | Performan
nce Rating Ben
nchmarks for Large,
L Medium
m and Small MFIs
M 175

However, finer grained d analysis mayy show that th here remain distinct
d nichess of the credit market whicch are
not subjeect to pricingg pressures across
a them, qualifying them
t as distinct markets1751
. Similar careful
empirical analysis of bo
orrowing pattterns, available products an nd borrower preferences
p w
would be neceessary
in order to
t define the market for microcredit
m in
n a particularr context. Miccrocredit marrkets may eve en be
distinct within
w regions or even sma aller localitiess if geograph
hic disparitiess are wide annd if national scale
lenders doo not exist.

Sectio
on 11.4: Measuring Com
mpetition
n
Measuring g the strengthh of competittion rests first on the definiition of the re
elevant marke
et. At one leve
el, this
is easy: “A loose economic definittion of a ma arket is that it comprisess all products whose presence
constrainss the price of
o a particular product to o a particular level” (Carlton 2007:161)). However, in the
definition of a credit market
m one hass to incorpora ate twin dime
ensions of pro oduct and geo
ography.

Porter’s Five-Force
F Model,
M one of the best tools for understa
anding compe
etitive industrry dynamics and
a
competitivve advantage
e

Exhibit 56: Porter’ss Model (simplified schema)

175
For instaance, although UK
U borrowers havve widespread access
a to many mainstream
m consuumer credit prodducts, authoritiess found
after thorouugh investigation
n of borrower attitudes
a and pattterns that ‘home collected creddit’ (most similaar to traditional micro-
lending becaause of the perso
onal contact betw a lender’s agennt) was in fact “aa distinct credit sub-market”
ween borrower and
176 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Michael Porter (2008) proposed one way of understanding the forces affecting competition. Although
Porter’s model was originally developed primarily to enable competitors in a market to develop their own
competitive strategies (and has been recently re-examined and extended—see Porter 2008), policy
makers may apply the analytical framework to achieve a deeper and richer understanding about
competition in a particular market.

Other measures176 of market structure (or performance) are also used. In the Indian context, rather than
seek to measure the intensity of competition, it is easier (and more relevant) to look for signs that it is
failing (or lacking)177.

Section 11.5: Micro-Credit Features Affecting Competition


Economists have long recognized that credit markets in general have distinct characteristics which make
them prone to failure and which affect the competitive behaviour of lenders.

Asymmetric Information: The pioneering work of Stiglitz and Weiss (1981) demonstrated how dif-
ferences in the quality and amount of information between borrowers and lenders could result in lenders
being unwilling to lend to potentially creditworthy projects (credit rationing). In the presence of
asymmetric information, measures such as interest rate caps may bifurcate credit markets into a
mainstream credit market, which is subject to regulation and serves borrowers with a defined (low) risk
profile, and a parallel market, where borrowers perceived to be higher risk likely receive credit at sub-
stantially higher rates, if at all, from unregulated informal sources. Microcredit is typically characterized by
such asymmetric information dynamics, as the typical micro borrower is not formally employed, has no
bank account, no credit record and no formal housing, and thus the conventional sources of information
are unavailable to microcredit lenders.

Difficulty in Switching Lenders: Credit markets are often characterized by a large number of lenders of
different sizes which compete in part by differentiating their products- a form of competition which
economists call “monopolistic competition”, where entry to the market is possible in theory at least, and
where borrowers can switch lenders. In practice, these conditions do not always apply and there are
several factors that impede switching, beyond simple inertia on the part of customers:

Unavailability of borrower credit records: For example, if the borrower’s credit record is not accessible
to other lenders (typical with micro-credit) it may be harder for her to switch lenders for the next loan.

176
The concentration ratio (often abbreviated to “CR(n)”), which measures the sum of the income of the largest “n” firms (where
n is often 4 or 5) as a percentage of total income in the market; and the Herfindahl-Hirschman Index (HHI), which is the sum of
squares of the market shares of each of the firms in the market. Based on the data and literature review, we find that the MFI
industry (not counting the SHG programme) is highly concentrated and highly fragmented (counting the Bank-SHG programme).
The results of applying these latter two measures are strongly correlated. Though both are very sensitive to the size of the
denominator (i.e. the relevant market definition), are often calculated and presented as part of anti-trust proceedings. However,
market shares alone are a back-of-the-envelope calculation to estimate market power as a proxy for competition. Performance-
related measures (such as the Lerner Index, defined as the percentage by which price exceeds marginal cost, which can be hard to
measure) consider the divergence of price from a competitive norm.
177
For example, the UK’s Competition Commission lists five indicators which, in some combination and if sustained over time,
may point to the need for further investigation of competitive practices in a market: (1) High and static prices (2) A lack of
product innovation (3) High and sustained profits (4) Market share stability (5) Low consumer satisfaction. Some of these
indicators were found during the competition enquiry into the home credit market in the UK.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 177

Low levels of financial literacy: First time borrowers with low levels of financial literacy (typical with
microcredit) confronted by complex product information may also be less able to make truly informed
choices, and hence less inclined to switch lenders. Even the more financially literate have behavioural
tendencies which may be exploited by lenders in ways which increase the effective costs of switching.

Predominance of group-lending: Group-based lending (common with microcredit), which requires that
borrowers form groups to be able to borrow, may make it harder still for individual consumers to substi-
tute providers due to the costs of collective action. However, studies in countries where group-lending is
predominant in microcredit markets (such as Zohir (2003) for Bangladesh) find that consumers join
multiple groups in their individual capacity. The incidence of borrowing from multiple sources may
increase as borrowers have more options; and because the other borrowings are undisclosed to lenders,
may lead them to make credit decisions based on inadequate or inaccurate information about the
borrower’s repayment capacity.

Economies of Scale: Costs incurred in the lending process to screen and monitor borrowers may create
economies of scale for incumbents, forming a barrier to new entry at scale. Hoff and Stiglitz (1997) note
how these features are present in rural credit markets. Under these conditions, they then demonstrated
how competition may lead to perverse outcomes: increasing the supply of credit may in fact cause the
interest rate to borrowers to rise on average, because the decreased scale causes increased cost per
borrower, thereby requiring rates to increase in order to maintain profitability.

Market Share of Non-Profit Lenders: The nature of competition may also be different when not-for-
profit providers have significant market share, as is still the case in some micro-credit markets like
Bangladesh. Since their incentive is not profit maximization (even though they may seek financial
sustainability), a NGO’s competitive behaviour may well differ from that of commercial providers. While
Bangladesh’s large NGO microfinance institutions compete fiercely on some features such as location and
178
product flexibility, they had yet to compete substantially on price by 2005.

Government Involvement: The nature of competition may also be affected by the actions of state
lenders. As in other markets, the Bangladesh government microcredit apex PKSF has substantial influence
over some aspects of MFI competitive behaviour, including pricing, through capping margins and
controlling the supply of funds to its clients which are retail MFIs.

Section 11.6: What forms of competition we see in practice?


Porteous (2005) applied to microcredit markets a conventional theory of market development in which
different competitive behaviour was manifested at different stages of growth. This theory can explain why
price competition may not be expected in certain markets until later phases of development; and it was
tested using primary evidence of competitive intensity and behaviour in three important microcredit
markets: Uganda, Bangladesh and Bolivia. At the time, all three countries were considered by local
providers and external observers to have increasingly competitive microcredit markets; and in each, some

178
See Porteous (2005)
178 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

of the negative effects of competition, such as over-indebtedness, had been observed179, alongside the
positive features, such as increasing product.

Across the three countries, only in the case of Bolivia did microcredit interest rates substantially decline
(measured properly in real terms and relative to average commercial bank lending rates over time). And
this decline had started much earlier than predicted by the market development model. On closer
investigation, price competition set in sooner there because two dominant pioneering lenders competed
fiercely on a wider basis than usual (for example, on methodology, i.e., group versus individual lending,
rather than product features, from the outset). Price competition quickly became part of their
differentiation strategies. However, in contrast with Bolivia, in a relatively mature market like Bangladesh,
interest rates appeared to be “stuck”, albeit at a relatively low level in global terms. In Uganda in 2005, a
less mature market, microcredit spreads had yet to exhibit a clear downward trend.

Several studies have assessed different aspects and outcomes of competition in a range of countries, as
summarized in Table 1. In general, the intensity and basis of competition among microcredit varies over
time and by country; and while there is strong evidence of positive effects in many places, certain studies
from Latin America such as Vogelgesang (2003) and Navajas et al (2003) sound notes of caution regarding
possible negative side effects.

Table 20: Evidence on basis and effects of competition in different micro-credit markets

Finding Country (Source)

Competition provides benefits to customers in stages: Kenya (Johnson 2003), Uganda (Wright
first on access, then service, then price. &Rippey 2003); Pakistan (Burki&Shah 2007)

The degree of information sharing available about Uganda, Guatemala (McIntosh et al 2005,
borrowers is critical to the outcome of competition. 2007)

Competition may lead to increased efficiency but may be Bolivia vs Peru (Portocarrero&Bryne 2003)
unstable.

Competition may lead to multiple indebtedness of Bolivia (Vogelesgang 2003), Bangladesh


borrowers, resulting in lower repayment rates (Zohir 2003); however in India (Krishnaswamy
2007) finds that this is not the case.

More concentrated markets may in fact have more not Bolivia vs. Peru (Portocarrero&Bryne 2003)
less competition (i.e. contrary to SCP approach)

The social outcome of competition is ambiguous; Bolivia (Navajas et al 2003) Our findings disagree:
competition leads to innovation but reduces the ability of Like elsewhere in the world,
lenders to cross-subsidize less profitable smaller loans we find (a) over
indebtedness (b) multiple
lending (c) Strong risk of
increasing defaults

179
. In Bolivia, there were even systemic consequences flexibility and wider consumer choice after a credit bubble burst.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 179

Section 11.7: MIXMarket Microfinance Benchmarks

Table 21: MIXMarket buckets of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Currency USD USD USD
Total assets 20,716,147 4,116,506 994,361
Offices 66 11 8
Personnel 453 104 41
180 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Table 22: Basic statistics of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Capital/asset ratio 14.79% 17.21% 15.90%
Debt to equity ratio 5.77 4.81 5.29
Deposits to loans 0.00% 2.06% 0.00%
Deposits to total assets 0.00% 1.69% 0.00%
Gross loan portfolio to total assets 82.91% 81.71% 77.02%

Table 23: Benchmark (average) ratios of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 56 11 17
As of date 2010 2010 2010
Currency USD USD USD
Number of active borrowers 120,732 24,668 6,950
Percent of women borrowers 100.00% 99.78% 99.89%
Number of loans outstanding 128,042 24,668 6,950
Gross loan portfolio 14,960,924 3,378,157 824,207
Average loan balance per borrower 144 154 140
Average loan balance per borrower/GNI per capita 13.98% 14.94% 13.58%
Average outstanding balance 131 149 140
Average outstanding balance/GNI per capita 12.69% 14.41% 13.51%
Number of depositors 0 6,426 0
Number of deposit accounts 0 6,426 0
Deposits 0 65,452 0
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 181

Average deposit balance per depositor 28 40 72


Average deposit balance per depositor/GNI per 3.00% 4.00% 7.00%
capita
Average deposit account balance 24 40 72
Average deposit account balance/GNI per capita 0 0 0

Table 24: Profitability benchmarks of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Return on assets 2.66% 0.45% 0.27%
Return on equity 15.76% 3.07% 1.15%

Table 25: Provision for loan impairment/assets

Mean 0.8%
Median 0.6%
Standard Error 0.05%
Range 2.94%
Minimum 0.01%
Maximum 2.95%
First Quartile 0.28%
Third Quartile 1.1%
Count 362
182 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Table 26: Efficiency of staff

Cost per borrower Cost per Borrowers per


(USD) borrower (INR) staff member
Mean
Median 692.4 31,158 228.1
Standard Error 540 24,300 217
Range 1575 70,875 3.2%
Minimum 475 21,375 559
Maximum 2050 92,250 32
First Quartile 315 14,175 591
Third Quartile 855 38,475 141
Count 306 306 306

Table 27: Performance benchmarks of Large Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17

Operational self sufficiency 119.37% 102.45% 100.42%


Financial revenue/ assets 20.37% 21.24% 19.67%
Profit margin 16.23% 2.39% 3.73%
Yield on gross portfolio (nominal) 23.95% 29.17% 21.64%
Yield on gross portfolio (real) 14.07% 18.87% 12.10%
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 183

Table 28: Expense benchmarks of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
As of date 2010 2010 2010
Total expense/ assets 17.67% 21.08% 22.63%
Financial expense/ assets 8.41% 8.28% 8.19%
Provision for loan impairment/ assets 0.53% 0.90% 0.29%
Operating expense/ assets 8.74% 7.96% 13.64%
Personnel expense/ assets 4.22% 5.51% 7.16%
Administrative expense/ assets 3.79% 3.10% 6.44%
Operating expense/ loan portfolio 9.94% 13.24% 15.06%
Personnel expense/ loan portfolio 0 0 0
Average salary/ GNI per capita 2 2 1
Cost per borrower 13 13 23
Cost per loan 12% 15% 19%

Table 29: Client-Personnel benchmarks of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
Borrowers per staff member 258 198 136
Loans per staff member 270 198 140
Borrowers per loan officer 478 432 271
Loans per loan officer 484 432 280
Depositors per staff member 0 16 0
Deposit accounts per staff member 0 16 0
Personnel allocation ratio 63.96% 50.12% 58.52%
184 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Table 30: Risk benchmarks of Large, Medium and Small MFIs

Large MFIs Medium MFIs Small MFIs


Number of MFIs 54 11 17
Portfolio at risk > 30 days 0 0 0
Portfolio at risk > 90 days 0 0 0
Write-off ratio 0.16% 0.00% 0.00%
Loan loss rate 0.14% 0.00% 0.00%
Risk coverage 96.76% 122.74% 234.74%
Non-earning liquid assets as a % of total assets 16.47% 8.58% 9.11%

Section 11.8: Comparative Statistics


The previous section dealt with MIX Market benchmarks for small medium and large MFIs. In the
following section, we will compare three buckets – MIX Market Universe, NABARD-supported MFI sample
and Aadhaar data on MFIs – with the same performance appraisal parameters.

Table 31: Return on Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 1.66% 1.89% 1.23%
Median 1.54% 1.66% 1.43%
Standard Error 0.21% 0.18% 0.29%
Range 12.49% N/A N/A
Minimum - ve - ve - ve
Maximum 30.62% 30.62% 30.62%
First Quartile 0.40% 0.43% 0.20%
Third Quartile 3.76% 3.84% 3.56%
Count 362 104 438

Table 32: Return on Equity

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 23.99% 28.29% 23.33%
Median 14.74% 16.34% 11.72%
Standard Error 2.27% 1.59% 1.97%
Range 28.59% N/A N/A
Minimum - ve - ve - ve
Maximum 2351.77% 957.10% 2351.77%
First Quartile 3.08% 4.69% 2.91%
Third Quartile 38.19% 40.29% 36.96%
Count 362 104 438
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 185

Table 33: Operating Expense/Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 9.47% 10.03% 12.06%
Median 8.50% 9.32% 10.70%
Standard Error 1.33% 2.76% 1.88%
Range 26.46% 24.51% 30.79%
Minimum 2.09% 2.09% 2.09%
Maximum 28.55% 26.60% 32.88%
First Quartile 5.33% 5.20% 6.40%
Third Quartile 12.17% 10.30% 13.53%
Count 362 104 438

Table 34: Operating Expense/Loan Portfolio

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 11.99% 12.72% 15.27%
Median 10.67% 11.70% 13.43%
Standard Error 2.44% 1.47% 3.80%
Range 38.7% 30.5% 46.9%
Minimum 2.4% 2.41% 2.4%
Maximum 41.1% 32.86% 49.30%
First Quartile 6.9% 6.8% 7.7%
Third Quartile 15.6% 13.21% 16.5%
Count 362 104 438

Table 35: Financial Revenue/Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 19.67% 21.77% 17.37%
Median 19.67% 21.07% 17.56%
Standard Error 0.36% 0.86% 2.64%
Range 24.46% 27.70% 30.45%
Minimum 6.84% 3.60% 0.85%
Maximum 31.30% 31.30% 31.30%
First Quartile 15.30% 16.87% 15.34%
Third Quartile 24.20% 25.37% 22.23%
Count 362 104 438
186 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Table 36: Financial Expense/Assets

MIX Market Universe Sample NABARD supported MFIs Aadhaar Universe


Mean 7.58% 6.80% 8.60%
Median 8.0% 6.53% 8.84%
Standard Error 0.15% 2.60% 1.80%
Range 10.9% 17.62% 24.22%
Minimum 1.1% 1.10% 1.10%
Maximum 22.0% 18.72% 25.32%
First Quartile 9.2% 11.6% 12.7%
Third Quartile 14.4% 15.7% 18.1%
Count 362 104 438

Section 11.9: Relating returns to scale and performance


Through simple regression statistics we find, by testing the following hypotheses:

Are there economies of scale? Are there increasing returns to scale? Is profitability better for the larger
MFIs? – Scale and learning curve?

The consistently low adjusted R2 reveals that the cost efficiencies are still not entirely discovered. The
strong correlation between portfolio and clients reveal that those MFIs that are unable to disburse are
likely to have failed (or dropped) clients leading to reduced active client numbers. Continuous and active
disbursement is critical to the business.

On the other hand, the linear correlation between returns and scale is quite weak. This could possibly be
due to:

The focus on “expansion” to cover more ground and get more clients rather than efficiency, cost
reduction. Once the client outreach has been expanded (revenue driver), the next phase would
perhaps focus on greater cost rationalisation and higher profit margins

Greater cost efficient is not possible. Small MFIs are equally efficient (unlikely). Or, the cost
economies cannot be exploited much further (unlikely scenario)

MFIs are passing off the cost efficiencies/ benefits to the end beneficiaries (for reasons extending
from competition to social impact)

There does not seem to be benefits of lower risk. This is because the credit risk is possibly is evenly spread
(client behaviour, clientele, client segment) across geographies.

Thus, on a risk adjusted basis, if there are no scale benefits, then should the microfinance model be
scaled or replicated? The R-A-R-O-R-A-C (risk-adjusted-return-on-risk-adjusted-capital) is a useful
indicator for decision on performance and efficiency of the “system” (sector) in terms of scale vs
replication debate...a useful pointer for legislation and policy.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 187

Table 37: Regression Statistics – No. of borrowers vs. performance parameters

0 1 2 3 4 5 6 7 8 9 10 11
Regression MM- MM- MM- MM- NABARD NABARD NABARD- NABARD- Aadhaar- Aadhaar- Aadhaar- Aadhaar-
Statistics Universe Small Medium Big -Universe -Small Medium Big Universe Small Medium Big
Active Borrowers vs. Observations 362 281 69 12 104 59 37 8 438 356 70 12
1 Gross Loan Multiple R 0.979 0.980 0.970 0.960 0.978 0.970 0.960 0.930 0.990 0.980 0.970 0.980
Portfolio Adjusted R2 0.959 0.960 0.941 0.922 0.956 0.941 0.922 0.865 0.980 0.960 0.941 0.960
Outstanding Std. Error 1.082 1.761 1.771 2.677 2.882 3.442 3.823 4.442 4.925 4.120 3.953 4.044
2 Return on Multiple R 0.108 0.037 0.117 0.113 0.120 0.170 0.202 0.153 0.162 0.156 0.249 0.228
Assets Adjusted R2 0.008 0.001 0.014 0.013 0.014 0.029 0.041 0.023 0.026 0.024 0.062 0.056
Std. Error 4.281 4.357 3.870 3.665 3.655 3.457 2.693 1.550 3.457 2.756 2.299 1.937
3 Return on Multiple R 0.021 0.043 0.080 0.130 0.150 0.118 0.023 0.100 0.151 0.214 0.243 0.277
Equity Adjusted R2 -0.003 0.002 0.006 0.017 0.022 0.014 0.001 0.010 0.023 0.046 0.059 0.077
Std. Error 3.310 2.340 1.330 1.830 2.436 1.705 2.218 3.133 2.452 2.834 3.735 2.883
4 Asset Turnover Multiple R 0.120 0.221 0.150 0.160 0.210 0.190 0.190 0.180 0.160 0.110 0.130 0.160
Adjusted R2 0.014 0.049 0.023 0.026 0.044 0.036 0.036 0.032 0.026 0.012 0.017 0.026
Std. Error 5.273 2.389 3.515 2.181 3.636 4.861 1.462 3.760 2.985 1.359 1.611 3.126
5 Yield (on Multiple R 0.164 0.227 0.252 0.127 0.231 0.181 0.182 0.101 0.174 0.053 0.078 0.029
Portfolio) Adjusted R2 0.024 0.056 0.067 0.023 0.056 0.039 0.037 0.015 0.034 0.004 0.010 0.007
Std. Error 3.240 2.814 1.131 3.069 2.116 1.884 1.362 1.188 3.016 3.937 3.141 3.432
6 Financial Multiple R 0.112 0.091 0.041 0.074 0.156 0.094 0.118 0.141 0.118 0.114 0.066 0.121
Expense Ratio Adjusted R2 0.009 0.008 0.002 0.005 0.024 0.009 0.014 0.020 0.014 0.013 0.004 0.015
Std. Error 2.278 3.076 3.414 1.707 2.845 2.274 0.905 2.501 1.095 1.424 1.851 2.406
7 Loan Loss Multiple R 0.007 0.027 0.051 0.114 0.102 0.019 0.201 0.097 0.012 0.019 0.201 0.027
Provision Adjusted R2 -0.003 0.001 0.003 0.013 0.010 0.000 0.040 0.009 0.000 0.000 0.040 0.001
Std. Error 4.312 3.647 3.856 4.133 4.139 3.977 3.648 4.004 4.932 4.218 4.722 4.314
8 Operating Multiple R 0.042 0.025 0.022 0.013 0.204 0.152 0.022 0.166 0.069 0.024 0.121 0.105
Expenditure on Adjusted R2 0.001 0.000 0.000 0.042 0.023 0.001 0.028 0.005 0.001 0.015 0.011 0.011
Total Assets Std. Error 1.307 2.247 0.844 4.185 1.258 3.900 4.299 2.382 4.041 4.228 4.462 4.082
9 Operating Multiple R 0.074 0.104 0.128 0.158 0.239 0.158 0.194 0.173 0.043 0.035 0.154 0.039
Expenditure Adjusted R2 0.006 0.011 0.016 0.025 0.057 0.025 0.038 0.030 0.002 0.001 0.024 0.001
per loan Std. Error 1.900 1.766 3.791 2.919 2.248 4.170 3.211 2.472 5.421 4.174 3.214 5.687
10 Operating Multiple R 0.074 0.089 0.107 0.128 0.117 0.106 0.181 0.139 0.107 0.082 0.063 0.049
Expenditure Adjusted R2 0.006 0.008 0.011 0.016 0.014 0.011 0.033 0.019 0.011 0.007 0.004 0.002
per loan Std. Error 2.950 2.968 3.593 4.442 4.043 3.043 3.608 3.777 4.291 4.883 4.633 3.842
11 Cost per Multiple R 0.067 0.080 0.138 0.138 0.115 0.096 0.095 0.110 0.062 0.061 0.051 0.120
borrower Adjusted R2 0.000 0.006 0.019 0.019 0.013 0.009 0.009 0.012 0.004 0.004 0.003 0.014
Std. Error 1.968 4.918 3.925 4.442 3.120 4.841 1.289 3.432 6.160 1.226 4.461 3.235
12 PAR-30 Multiple R 0.065 0.099 0.128 0.140 0.231 0.175 0.172 0.184 0.184 0.109 0.186 0.216
Adjusted R2 0.004 0.010 0.016 0.020 0.053 0.031 0.029 0.034 0.034 0.012 0.035 0.046
Std. Error 2.952 5.902 2.950 0.993 0.517 1.322 1.722 3.553 2.143 2.728 4.934 3.235
13 Write-off Multiple R 0.019 0.013 0.002 0.002 0.005 0.009 0.010 0.018 0.030 0.032 0.039 0.062
Adjusted R2 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Std. Error 5.916 2.958 3.993 1.310 3.095 2.355 3.091 4.067 2.349 2.439 2.185 6.951
14 Personnel Multiple R 0.963 0.931 0.916 0.925 0.933 0.933 0.935 0.939 0.945 0.947 0.950 0.951
Adjusted R2 0.927 0.890 0.880 0.880 0.890 0.890 0.890 0.920 0.910 0.910 0.920 0.910
Std. Error 1.592 2.559 2.588 3.387 2.190 3.553 2.990 1.689 1.689 1.892 1.919 1.853
188 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Chapter 12: Driving Performance through Policy


Keeping in view performance benchmarks and driving the sector to optimal performance, policymakers
have several instruments in their toolkit with which they may address anti-competitive practices and
patterns. This section discusses the main approaches in turn.

Section 12.1: Direct Competitive Lending By Public


Institutions
If private lenders are not competing effectively, then a state-owned institution may be used to inject new
forms of competition into the market, for example, on price or type of borrower. While support for the
direct state provision of microcredit has declined in many places due to its demonstrated lack of
sustainability, some older and larger microcredit programs remain state-backed180: Indonesia’s BRI reports
some 3 million microcredit clients; and in Latin America, Banco del Estado de Chile has over 200,000
clients. Both of these programs have been pioneers in their own countries, promoting sustainable models
of microfinance and operating within internationally acceptable default parameters. State-ownership itself
may therefore not be the main issue, but rather whether the institution is able to maintain a sustainable
lending approach without causing negative market distortions.

Other than the two examples above, state-owned financial institutions in many places are less free to
pursue sustainable policies; so using them as challengers to provoke competition by private players is
risky strategies indeed, which could carry large fiscal consequences from failure, and may crowd out
private providers, further reducing supply to the market. It may not even sustain the directly targeted
objective, like lower rates181.

Section 12.2: Reducing Barriers to Entry


Barriers to entry in any market may arise from various sources. Depending on the source identified, the
policy maker may have different ways of reducing the barrier so as to make the credit market more
contestable.

Scrutinize pricing policies and patterns. As discussed in the previous section, certain aspects of
the lending process on the supply side are subject to economies of scale, including the collection
of information about clients and the credit screening process. A new or small firm which does not
have enjoy the benefits of scale may find it hard to enter the market successfully if incumbent
firms exploit their scale advantages by lowering prices to pre-empt entry or eliminate a
competitor. Regulators therefore have to look carefully at pricing policies and patterns, especially
of larger lenders, to ensure that the intent is not anti-competitive.

180
Refer to article by Bate in Microenterprise Americas 2007, p.16-18

181
As Hoff and Stiglitz (1997) showed: supplying more state credit at cheap rates to rural areas may in fact increase the general
interest rate, rather than decrease it.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 189

Monitor network effects. On the demand side, certain credit products like credit cards exhibit
network-like features: the cards are more valuable the more widely they are accepted. These
aspects of credit card schemes have resulted in competition authorities in various jurisdictions,
including EU, UK, Australia, Mexico and South Africa, subjecting them to increased scrutiny in
recent years182. Regulators have consequently paid more attention to the levels of interchange
fees set for transactions across network members, and to the terms of access to these networks.

Support the formation and growth of credit bureaus. High switching costs make it harder for
customers to change to a new supplier which offers better terms. In the absence of a credit
reference bureau which makes their track record accessible and “portable” to other lenders,
borrowers may be unable to switch to a new lender. Equally, the absence of ready access to
borrower histories constitutes a barrier to entry for new lenders. The introduction of a credit
bureau which enhances the portability of both good and bad credit records can therefore bring
substantial advantages to lenders and borrowers. Luoto et al (2007) and McIntosh and Wydick
(2007) demonstrated this using a randomized field experiment following the introduction of a
credit bureau in Guatemala. The effect of better screening of risky borrowers, and even to some
extent, the positive incentive effect on borrowers who know that their record is now being
monitored, reduced the risk of default to the lender. For this reason, the UK’s Competition
Commission ruled in 2007 that home credit lenders must in the future submit borrower profiles to
a credit reporting agency (see Sidebar B).

Avoid onerous licensing requirements. Government regulation, embodied in licensing


requirements to enter a market, may constitute a barrier to entry. These may take the form of
high minimum capital requirements or an approval process which adds delay and cost for
entrants. Typically, where lenders are required to be licensed for their lending business (rather
than, say, as deposit taking entities), the capital and general entry requirements are relatively
light183.For example, the South African National Credit Act of 2005 sets low qualification
requirements on lenders and imposes a registration fee which varies with size such that it is not
onerous on small lenders. This reflects the general situation in most jurisdictions that there are
already many lenders of differing sizes so that an onerous formal registration requirement is hard
to enforce. However, if lenders are also deposit taking institutions, then they face much more
onerous regulatory barriers to entry because of the additional prudential and systemic risks.
Regulators need to evaluate whether the requirements for entry to a particular regulated market
(e.g., credit as distinguished from deposit taking) are unduly onerous for that particular activity so
as to constitute an unnecessary barrier to entry which protects incumbents.

In addition to considering how these factors affect the height and extent of barriers to entry, policy
makers must consider expected retaliatory tactics which incumbents do or could use. To make markets

182
For a summary of the competition issues arising in card markets in particular, see “Competition Policy Issus in Retail Payment
Systems”, BFA, March 2009, Issues paper prepared for DFID

183
. Civil code countries are often an exception to this, creating substantial barriers to entry for formal lending.
190 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

more contestable, competition law may explicitly prohibit certain forms of retaliatory behaviour such as
artificially lowering prices to deter or squeeze out a new entrant. This is taken up in the next section.

Section 12.3: Competition Policy


While we have up to now considered general policy measures to improve competition, competition policy
and law has become a specialized domain in itself, following laws introduced in the US and Canada over a
century ago. Specific competition laws are new or not yet present in many developing countries, although
they are increasingly common (Cook et al 2003). The capacity to enforce them is however often still
limited. Unlike price regulation (such as price controls) or borrower protection laws, which are applied ex
ante, anti-trust or, more generally, competition law is usually applied ex-post at a particular time when
some condition has been violated: “anti-trust is designed to let markets work when they can work.
Regulation is specific, setting rules for prices and quantities. When markets fail—as in the case of natural
monopolies—anti-trust is not a substitute for regulation” (Carlton 2007: 173).An integrated legal
framework for regulating credit may help to stabilize an emerging credit sector by driving out bad
practice, and encouraging reputable lenders to enter the market. This may increase competition; although
not necessarily in all the desired ways—as the case of South Africa in Sidebar C shows, for example.

Section 12.4: Specialized “competition” regulators


Because financial sector regulation is pervasive and complex, competition issues in banking and financial
services have often been left in the domain of the prudential regulator, rather than the competition
authority, if there is one. Having a specialized competition regulator is a relatively new phenomenon in
many developing countries, as Table 2 shows: Mexico’s Commission has been in existence since 1993,
while India established its Commission only in 2003. In some places, the banking sector was even
exempted from general anti-trust law. However, there is growing recognition that competition in these
sectors should fall under the specialist competition authorities (Biggar and Heimler 2005). This is because
these agencies are better equipped to consider the competitive issues without being unduly affected by
prudential or systemic concerns, even though they are required to consult and co-operate with sectoral
regulators in reaching their decisions. Following this trend, a number of competition regulators, including
those in Mexico, South Africa and the UK, have undertaken recent investigations of patterns and
outcomes of competition among banks.

Undertaking investigations of patterns of competition in a sector can be resource intensive, but, since the
authorities may have the legal power to subpoena evidence, enquiries may bring to light information not
normally available. This approach has been used in the UK in recent years, especially to consider the
complex questions introduced by new technologies and retail payments systems. After a comprehensive
review spanning several years, the Cruikshank Commission found evidence of anti-competitive practices,
among other things, in the UK’s retail payments systems. A special Payment Systems Taskforce, chaired by
the Office of Fair Trading, was established in 2004 to consider necessary changes in consultation with the
industry. This Taskforce wound up in 2006, having proposed and overseen the implementation of far
reaching changes which improved competition in UK payments.

However, other than the review of the UK home credit market, summarized in Sidebar B, and apart from
investigations of the rules and pricing arrangements of credit card networks (which have anyway focused
more on the payment network elements than the credit offering), consumer credit markets have in
general not been as carefully scrutinized by competition authorities as other markets in the financial
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 191

sector184: their diverse and fragmented nature makes it a priori less likely, but by no means impossible,
that specific anti-competitive practices exist. Financial sector policy should encourage healthy competition
in micro-credit markets.

Table 38: Specialized competition authorities

India Mexico South Africa UK


Specialise Competition Commission Competition Office of Fair
Competition Commission (2003) Federal de Commission (1998) Trading/Competiti
Regulator (Date of Competencia on Commission
formation) (1993) (1999)
Jurisdiction over No- RBI Yes Yes- joint with Yes
banking sector Registrar of Banks
Has there been a No Yes- report to Yes – Banking Yes- supply of
recent special President in 2007 Enquiry into bank banking sevices to
enquiry about the fees (2006-08) SMEs
banking?

The absence of appropriate regulation can cause credit markets to bifurcate or fragment. Reputable
“mainstream” credit providers may stay out of a higher risk market segment because of the threat that
regulatory action (such as capping interest rates) will make it unprofitable or because of adverse
reputation effects in being associated with other providers whose market behaviour attracts unfavourable
public attention. This would reduce competitive pressures in the higher risk segment, making it more
likely to experience troubling lender conduct. Bringing all lending behaviour under one unified and ef-
fective regulatory umbrella should help to reduce the risk of this rift. This was part of the logic of creating
the Micro Finance Regulatory Council (MFRC) in South Africa in 1999. All lenders – large and small, bank
and non-bank – were required to register and comply with sound lending rules if they wished to enjoy an
exemption from price caps on small loans. The MFRC was charged with policing the behaviour of its
member lenders.

A review undertaken by consultants ECI in 2005 found that this unified regulatory structure had indeed
helped to encourage entry into formal micro lending by large banks and even furniture and clothing retail
chains. By 2004, nine banks were registered to do micro lending and contributed almost half of the value
of loans written.

184
For example: a special enquiry by the Competition Commission of South Africa finally reported in December 2008, following
a two year investigation into patterns of retail bank fees and pricing of payment instruments.
192 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Chapter 13: Navigating the Course: Charting the Territory


Financial sector policy should encourage healthy competition in microcredit markets. Policy makers have
at their disposal a range of instruments which can be used to pursue this goal.

The starting point for navigating the course of competition policy is to define healthy competition, in
sufficiently clear terms so that the intensity of competition can be assessed and monitored over time. At a
minimum, it means the absence of prohibited anti-competitive behaviour: when such behaviour is
reported or identified, authorities should investigate, and if warranted, penalize it.

However, a more pro-active approach would go further to look at diverse characteristics. For example:
healthy competition takes place: across different product characteristics or bases (i.e., not only in one
feature such as service level or location or price, but across the bundle represented by the offering); at an
intensity appropriate to the stage of market development; and in a way which is likely to lead to the
achievement of societal goals, such as broadened access to sustainable credit.

This definition requires that lenders compete extensively (through new products and distribution channels
to target new client segments) and intensively (among existing clients). In addition, policy makers usually
wish to see competition on interest rates as a manifestation of healthy competition. As shown earlier,
price competition in credit markets may usually start only at later stages of development but it is more
likely to start earlier if there is a diversity of lenders with different strategies in the market, than if one
product type or lending approach prevails. Competition policy should be directed toward encouraging
these market conditions.

In the long run, a healthy credit market is likely to deliver better products, higher quality service, higher
levels of access, as well as lower relative interest rates. One example of a credit market in which
competition has resulted in much greater access, together with diverse products and generally lowers
rates to mainstream borrowers is the credit card market in the U.S. Sidebar D describes some of the long
term effects of competition in this market. Although credit cards differ from microloans (because the card
offers transactional capabilities), credit cards increasingly compete with microcredit in some developing
markets as a flexible line of credit for individuals and small businesses.

Competition took a while to gather momentum in this market: while credit cards were introduced in the
U.S. in the 1950’s, only from the 1970’s did usage and access increase rapidly. Although the underlying
credit card product is essentially similar among all lenders, competition has long taken place on the basis
of differentiated product features. Only in the 1990’s (forty years after launch) did price-based
competition set in. This followed the entry of new mono-line card lenders which used marketing strategies
different from those of the incumbent commercial bank issuers. Increased access, greater choice, even
lower rates for at least the majority of customers are positive fruits of competition. However, this market
also shows one of the clear negative signs of competition listed earlier: the sector is beset with claims that
aggressive marketing and reckless lending by some lenders has led to over-indebtedness.185 This factor
combined with economic slowdown has caused rising stress in the default performance of credit card loan
portfolios. As microcredit evolves over time as a segment of the broader personal credit market, this
example from another developed market shows that, even in the long run, the predicament of how to

185
See Mann 2006.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 193

promote healthy market development through healthy competition does not easily or soon go away. But
policy makers can seek the knowledge and tools with which to better drive the path in microcredit.

There are very few reliable time series analysis of market Structure, Conduct and Performance (“SCP”) data
which enable one to see the long run effects of competition in micro-credit markets in developing coun-
tries. However, arguably, the credit card market in developed countries like the U.S. shares at least some
of the same characteristics- a short term, unsecured credit product, accessible to lower income groups.

Access to and use of credit cards has massively expanded in developed countries like the U.S. over the last
three decades following liberalization of interest rate and other restrictions in the early 1980’s. Under the
Fair Credit and Charge Card Disclosure Act, the Federal Reserve Board is required to submit to Congress
an annual report on the profitability of the credit card operations of depository institutions. In July 2007,
the seventeenth such report was filed using information from bank call reports and special credit card
interest rate surveys. This report found that:

Structure: There has been considerable consolidation in market structure through the acquisition of
portfolios by larger lenders and through mergers. The largest 10 issuers control 90% of the cards in issue;
while the market for acquiring merchants is also highly concentrated (one firm, First Data, is estimated to
process 50% of MasterCard and Visa transactions from merchants in the US, although acquiring banks
take the risk).

Conduct: Thousands of firms compete in this market, using a variety of differentiating strategies; and the
Fed observes that the basis of competition has evolved since the early 1990’s from waiving annual fees
and enhancing program benefits to experiencing much greater interest rate competition. The Federal
Reserve survey collects information on card interest rates based on the simple average across all accounts;
and the average rate paid by those who incur finance charges. The data indicate that “credit card interest
rates fell sharply from mid-1991 through early 1994 after being relatively stable for most of the previous
twenty years, and fell again over the 1998-2003 period”

Performance: Since the early 1980’s, when credit card banks (banks with the bulk of their loans to
individuals and 90% or more of consumer lending through credit cards) were first licensed in the U.S.,
large U.S. credit card banks have consistently been more profitable than depository institutions as a
whole.
194 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Chapter 14: Regulation


The performance rating of MFIs must be taken in the context of the enabling / disabling environment. The
government intervention must be factored in; as well as the role of regulation must be discussed.
Streamlining operations, practices and setting benchmarks cannot be done without a discussion on
regulation and policies.

Section 14.1: Outlook of policies since 1998


“RBI’s role in giving MFIs policy support was remarkable, but an appropriate regulatory framework for the
sector is long overdue186”

As the debate on the future of microfinance continues, it is worth examining the Reserve Bank of India’s
(RBI’s) own discourse. RBI played a crucial and catalytic role in the development of microcredit by
encouraging and prodding banks to lend to micro-finance institutions (MFIs)187. Thus, contrary to popular
perception that microcredit grew on its own and RBI stepped in at this stage to take note of the current
practices, RBI has been instrumental in creating the MFI channel and effective in its financial inclusion
agenda. And this continues to be the case.188

In response to early foray of MFIs and the practitioners had asked for a policy framework, in 1998,
NABARD set up a task force on Supportive Policy and Regulatory Framework for Microfinance189,190.

In Dr. Bimal Jalan’s Monetary and Credit Policy Statement of April 1999, the word microcredit was
introduced in the credit policy statement which said, “Micro-credit Institutions … are important vehicles
for delivery of credit to self-employed persons, particularly women in rural and semi-urban areas.”And
further: “A special cell … is being set up in RBI in order to liaise with NABARD and microcredit institutions
for augmenting the flow of credit to this sector. The time frame for the cell … will be one year and its
proposals will be given the highest attention.”

The credit policy (and a notification in April 1999) drew a distinction between small loans given by banks
(with a ceiling on interest rates) and the loans given to MFIs for on-lending (without a ceiling). It
announced total deregulation of interest rates on loans by banks to MFIs and by MFIs to their
beneficiaries except in the case of case of government sponsored programmes. Thus, this notification
created a two-way incentive for the commercial banks:

186
M S Sriram, “Microfinance policy - Rewind or Turnaround?” available at http://www.business-standard.com/india/news/m-s-
sriram-microfinance-policy-rewind-or-turnaround/426937/
187
The interested reader is referred to one of ex-RBI Governor YV Reddy’s speech on the topic available at
http://www.isb.edu/caf/htmls/YVReddy_Speech.pdf
188
The Economic Survey 2011 and the Budget speech both make positive references to microfinance as being an important part
of the inclusion agenda.
189
Available at rbidocs.rbi.org.in/rdocs/notification/PDFs/40MCMC010709_F.pdf
190
This task force had a profound and simultaneous far-reaching impact on microfinance policy making. It was found that
microfinance was an emerging activity that deserved to be nurtured. Perhaps it was ahead of its times in calling for registration
(today it is suggested to have NBFC-MFIs separately), and self-regulation through an self-regulatory organisation (SRO). At the
same time, Sa-Dhan was established and was expected to evolve as the voice of the industry. Pending an SRO, the task force
recommended that RBI should put an interim regulatory framework.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 195

To absolve themselves to the extent possible their own responsibilities of financial inclusion;
to advance bulk loans to MFIs with no ceilings
The banks did not have a level playing field, but were possibly happy to outsource credit supply
to MFIs. This opened bank finance to the MFIs, who were largely dependent on donor money

Interestingly, in the last one year there have been several articles and reports which say that RBI has urged
banks to compete directly with MFIs on a level playing field.

“An internal Reserve Bank of India (RBI) panel has recommended that money advanced by
commercial banks to micro-finance institutions, or MFIs, should no longer be treated as priority
sector loans.” “The success of the initial public offer of SKS Microfinance Ltd, India’s largest MFI,
has also probably queered the pitch for such institutions.” 191
“Banks did not efficiently compete with microfinance Companies”192

Banks can compete with MFIs through three alternative channels

Bank-SHG linkage model


The BC-BF model
M-commerce

Given the importance of MFIs, RBI asked banks to include microcredit in their corporate strategy to be
reviewed on a quarterly basis; a detailed notification of February 2000 made several significant
points193.The problem is that RBI gave policy support without an appropriate regulatory framework194.

191
Source: http://www.livemint.com/2010/09/19222906/Allow-banks-to-compete-with-MF.html
192
YSR Thorat, ex-Chairman of NABARD, read more at: http://profit.ndtv.com/news/show/rbi-thorat-banks-did-not-efficiently-
compete-with-microfinance-cos-105459
193
Enumerating, (1) No interest cap on loans to MFIs (2) No interest cap on loans given to end-clients (3) Freedom to banks to
formulate their own model and intermediary for extending microcredit (4) No criteria for selecting MFIs (5) Banks to formulate
their own lending norms (6) Banks to formulate a simple system, minimum procedures and documentation for augmenting flow
of credit by removing all operational irritants (7)Banks to include microcredit at the branch, block, district and state credit plans
with quarterly progress to be reported to RBI.
194
RBI, on February 14, 2011 released a master circular on microcredit which refers to its historical circulars, with little addition:
“A joint fact-finding mission looked at the issues plaguing the microcredit sector and ends with saying that findings were brought
to the notice of the banks to enable them to take necessary corrective action where required.”
196 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Section 14.2: Stimulating the sector through Injection

The Union Budget 2011

Private capital inflows into Indian MFIs dropped 92% to Rs. 49.5 crore ($11 mn) through 2 transactions
in 4Q of calendar 2010 from Rs. 600 crore ($134 mn) via 32 deals in 4Q of calendar 2009.

Both these deals were “announced” in the period and were actually done much earlier. Several deals
are stuck in the advanced stages. This dramatic decline is largely due to investor paralysis in the wake
of the A.P. microfinance crisis.

The 2011 Union Budget presented to Parliament should have restored investor confidence. In addition,
the Budget should benefit current and potential MFI clients and businesses that increase their financial
access.

However, in our survey of 23 investment professionals, most of whom are active and have already
invested in the microfinance sector in India, a significant majority of them were in the “wait and watch”
mode (outlook till Sept 2011).

Exhibit 57: Current Investor Outlook on Microfinance

9% Active. Still looking out for


opportunities (outside AP, though)
9%

Inactive. Microfinance in negative


list for now

Let's see, not yet. However, if


82%
something emerges, then why not.

Table 39: What’s in it for Microfinance

The proposed Rs. 100 crore ($22 mn) India The India Microfinance Equity Fund reflects the
Microfinance Equity Fund with SIDBI for federal government’s explicit commitment to the
funding smaller MFIs coupled with sector. Appropriate regulation mitigates the risk of
government’s heightened focus on crafting populist backlash insufficient consumer protection
consumer protection regulation sh/would and unchecked growth. Government commitment
signal lower microfinance sector risk. combined with robust consumer protection should
reduce investor skittishness.
After the Malegam Committee recommended
capping interest rates at 24%, small MFIs, Equity infusions increase an institution’s liquidity
which are generally less profitable than large cushion. Domestic equity is very valuable to small
MFIs, would require greater liquidity as they Indian MFIs, given high NBFC minimum
adjust to the new constraints. However, Rs. 100 capitalization norms for majority foreign direct
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 197

crore represents only 0.33% of the current Rs. investment: Rs. 23 crore ($5 mn) for 51-75% FDI and
~30,000 crore ($6.7 bn) of outstanding Indian Rs. 230 crore ($50 mn) for 75%+ FDI.
microloans. Achieving broader financial
inclusion will require significantly more capital
infusion for the government to play any
market-linked part without direct regulatory
intervention.

For MFIs For SHGs

By allocating funds to traditionally underserved The Union Budget is creating an enabling


groups, such as minority communities and environment for the economically active poor and
farmers, and mandating delivery of banking the businesses focused on them. Creating a Rs. 500
services to all 73,000 habitations with 2,000+ crore ($111 mn) Women’s Self Help Group (SHG)’s
populations, the budget is directing capital – Development Fund should expand the reach of the
through MFIs – that serve those groups. Public 4.6 mn SHGs in India—25% of which are in A.P.—
sector banks will now be required under and help reduce their interest rates.
priority lending to allocate 15% of outstanding
loans to minority communities, many of which
include significant economically weaker
sections, up from 13.6% at present. The Union
Budget also raised credit for farmers by 27% to
Rs. 475,000 crore ($106 bn) in 2011-2012 vs. Rs.
375,000 crore ($83 bn) in 2010-2011.

Section 14.3: Need for Regulation


While we have discussed governance, (good and bad) on-field practices, financial performance,
performance linked incentives, sustainability, social impact etc. in great detail in preceding sections,
nothing much will move if the sector is left unregulated. There has to be an external unbalanced force
to help the sector out of inertia to ensure that the sector performs to its potential.

Based on this research we posit that two Nash Equilibria exist in the current scenario in the
microfinance sector. The equilibrium is two-fold:

(c) Client view: There is no unilateral profitable motive from any of the clients involved. If they are
currently paying, then they continue to do so. However, as is the case in A.P., where the current
repayment rates (Post A.P. Ordinance; Oct 2010– March 2011) are 10-15% on average, they
announce, “why is she not paying up?”,“Why don’t you ask her to pay?”, “why am i the only one to
pay?”.... Nobody wants to feel short-changed on ethical grounds. It can look foolish.
(d) MFI view: There is no reason to play by ethical standards since generally everyone seems to be
looking at maximising profits (While it may be called myopia, the obvious giving precedence to
the individual organisational shorter term profit oriented objectives over longer term sectoral
objective can also be called common-sense)
198 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Table 40: Based on Experiments in Behavioural Finance

YOU WIN LOSE

PEERS

WIN Despite Strong Pareto Optimality, Negative on utility. REGRET of not


neutral on utility. Exhilaration “following herd”
dampened since the relative dynamics
do not change.

LOSE Positive on utility since you are “one- Neutral. Again, the relative dynamics
up”; sustained success puts you on a don’t change. Comforted by the fact
relatively higher pedestal that you played with the crowd.
Common therapy sessions...

Prima facie, in thestatus quo (equilibrium) each decision maker’s strategy – being largely “wait and
watch” – is optimal given the information of all other decision makers.

A Nash Equilibrium exists when there is no unilateral profitable noticeable from any of the decision
makers involved. In other words, no decision maker would take a different action as long as others remain
the same (Question is: Why should I be the first?). Nash Equilibria are self-enforcing; when decision
makers are at a Nash Equilibrium they have no desire to move because they will be worse off.

Sa-Dhan, an established association of MFIs in India, proposed a Microfinance Bill to the finance
minister in 2005. The bill was later introduced in the parliament as the Micro Financial Sector
(Development and Regulation) Bill, 2007 and was referred by the Lok Sabha to the Standing
Committee of Finance. The bill, which was widely expected to be re-introduced in the parliament,
was first relevant to only three categories of not-for-profit MFIs: societies, trusts and cooperatives,
which are collectively referred to in the bill as Micro Finance Organizations (MFOs).

In the wake of the microfinance crisis, the press (headlines) reported that NABARD would be the
regulator. There are several the issue is more complex than that meets the eye. Changes are
expected; going ahead, this could have remarkable (and possibly positive) implications for NBFC-
MFIs as well as other MFOs. The Bill, which has identified NABARD195 as the regulator for the
micro financial sector, has primarily three objectives– one is to promote and regulate the micro
finance sector; and the second is to permit MFOs to collect deposits from clients. However, the
stalled session in Parliament stalled the process. In the interim, interestingly, the Malegam
Committee, constituted for the “review the definition of ‘microfinance’ and ‘Micro Finance
Institutions (MFIs)’ for the purpose of regulation of non-banking finance companies (NBFCs)
undertaking microfinance...”, NABARD shall be the regulator for the entities covered by the Act. In
our opinion, the following need consideration. i) NABARD currently is not only the agency

195
Interestingly, NABARD itself provides equity capital and debt funds to MFOs; further, it is the largest provider of
microfinance services in the world and, therefore, emerges as a player in the supply side of the microfinance market. This has
raised the issue of interest conflict between its two roles – as an efficient player and an effective regulator.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 199

responsible for the development of the micro finance sector but is also a participant, in that it
finances the sector. There may be a perceived conflict of interest if NABARD is also a regulator. If
therefore, NABARD is to act as a regulator, it may be required not to participate in the financing
of the sector. ii) If NABARD is to remain the regulator as provided in the proposed Act, then it is
necessary that there should be close co-ordination between Reserve Bank and NABARD in the
formulation of the regulations issued by each regulator. This is very necessary to ensure against
the risk of entities taking advantage of regulatory arbitrage.”

Based on our discussions with market participants, our assessment, and the recommendations of
Malegam Committee196it appears possible, but not likely, that the bill would allow MFIs to accept
thrift/deposits and mobilize savings197. However, Malegam Committee recommends “A separate
category be created for NBFCs operating in the Microfinance sector, such NBFCs being
designated as NBFC-MFI.”

The bill aims and needs to set up a consumer protection regime by enabling the regulator to
appoint Microfinance Ombudsmen with powers to redress grievances by issuing directions to
MFOs.

To stay ahead of the regulation and keeping in view the Bill, MFIs must already aspire to put in
place best practices and adopt superior governance practices.

Section 14.4: Need for eyes on the field


While we would neither speculate nor really have a loci-standing to even suggest a regulator for the
sector, (with the Malegam Committee’s hallmark recommending that microfinance be regulated by RBI),
but based on our assessment of the field and within the scope of the project from a performance
perspective, we believe that the District Development Manager (DDM), of NABARD c/would play a greatly
enhancing role in ensuring that bottoms-up regulation is taking place. Microfinance is a localised business
and this must not be undermined.

Further, given that NABARD is uniquely positioned to understand microfinance nuances at the operational
level, right now microfinance needs more than ‘light and careful’ regulation for it to survive as a sector
and to continue to achieve social and commercial benefits. Unless measured steps are taken to control
the operational deficiencies, we could be staring at massive defaults and larger and deeper Corporate
Social Conflicts: Social issues at hand in direct loggerheads with the commercial interests. With already
large microfinance client base – and risks of credit defaults –and competition only intensifying by the day,

196
“We have serious concerns regarding permitting entities to carry on the business of providing thrift services and thereby
attracting public deposits. At present, the size of the loan portfolio owned by such entities is small but there is a real risk that
microfinance institutions which are currently NBFCs may use this facility to do business through non-NBFC entities and gather
large public deposits. This could in time create a systemic risk. There is also the risk that once this facility is given to entities
governed by the Act, pressure will build up from NBFC-MFIs that they must also be given similar facilities and it may prove
difficult to resist this pressure.” in Section 24.5 (f)
197
The major issues that have been highlighted out of these objectives are as follows: (i) Are the MFOs the suitable vehicles to
address credit and thrift needs of the poor?; (ii) Are there sufficient defenders to protect depositors’ funds?
200 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

the need to get 99%+ repayment does put undue pressure on the MFI management. Speedy but well-
thought out policy initiatives need to be taken.

The Dual Mission: MFIs combine a social mission- provision of financial services to the lowest-income
population possible- with a financial objective that drives the institution to achieve self-sufficiency. Several
MFIs have attracted private sources of capital to establish themselves in the market. The extent to which
microfinance institutions seek to maintain the dual focus of profitability and outreach to poor clients is in
the approach of the management. The two objectives are not mutually exclusive: The management with
its strategic decisions and policies can move institutions in the direction of achieving high profitability and
reaching an expanding clientele of low-income entrepreneurs.

Local realities (especially those concerning repayments) need to be factored in within the context of the
double bottom-line challenge. While DDMs would indeed need to be trained for the specific tasks, but
given that they are aware of all the local realities, the NGOs and that they are already on a rotation /
transferrable job (reducing the risks of collusion), on this ground, NABARD - perhaps - is better suited for
playing the hawk’s role.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 201

Chapter 15: Next Steps

Section 15.1: Bring Transparency and Accountability


Based on our study, we find that the standardisation parameters for a social business environment are
missing. For a sector that has been kindled by philanthropic funds, huge impetus given by government
aid (directed as well as direct), the transparency levels are abysmally poor.

The industry associations – Sa-Dhan and MFIN – have endeavoured to take huge measures to induce
greater accountability and transparency. That the number of MFIs volunteering information to MIX Market
is <100 is itself perhaps an indication of the disinterest that players have in a transparency and wider
accountability. The usual governance quarters too have failed to check the malpractices that are fast
becoming the norm in microfinance. For the others, the data is dated; leading to lesser value for Policy
level decisions.

One of the most commonly discussion points in microfinance, “transparency” (and accountability) is
indeed an issue. Unless they have reasons to hide, MFIs should forward with their honest statement of
performances. At the local level, the enabling regulatory environment can turn adverse – as happened in
the case of A.P. – in public interest should MFIs choose to not mend their ways.

Section 15.2: Social Audit


It may not be challenged that microfinance is getting the benefits of ‘directed’ credit. The subsidisation
(and tax sops, where applicable) for financial inclusion is indeed coming in from the exchequer and the tax
of the different audience. This subsidisation is in the long-term political, economic and financial stability
of India. However, in the absence of social audits, the metrics of social impact cannot be measured.

There are a few efforts for social performance parameters; however, the literature and efforts are far from
developed to be practically applicable. Why can funders – specifically banks – not factor in a social rating
in their financial discussion? This way – the social aspects of the business can be protected.

Section 15.3: Expanding horizons


This study was limited to studying the six states chosen. The findings are quite limited based on the small
sample of MFIs, the limited geographies and specifically the timing of the project.

A broader outlook may be evolved if we relax the degrees of freedom. Perhaps

The scope of study should be expanded to other geographies – apart from the six states
mentioned. Phase review of MFIs and expand to an overall India study

The scope should include – not just discussions with NABARD supported MFIs – but also a wider
population of MFIs to be more representative of the sector. Maybe some of these perspectives
can be done while conducting seminars and workshops.
202 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

The project has been conducted at a time when the sector was caught in the middle of a storm.
Not only A.P. microfinance was in doldrums, but also credit availability was (unusually) zero198. The
general belief in the field that the “expectation” of further credit keeps the status quo of
repayment, also caused dishevels in the sector elsewhere. A different outcome and may be
expectation in the review phase after 3-4 months.

198
Except for Rs 100 Cr secured loan given to BASIX group.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 203

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206 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Appendix 1: MFI Profiles

ADHIKAR

Profile Snapshot

12,000,000
Gross loan portfolio: USD 9.0 million
Loan
Average loan USD 144.3 10,000,000
Portfolio
balance per 8,000,000
borrower: Total Asset
Number of active 62,652 6,000,000
borrowers: 4,000,000 Total Equity
Deposits: 0.0
2,000,000
Number of 0
depositors: 0 Deposits
Total assets: USD 10.9 million 2007 2008 2009
Total equity: USD 1.35 million

Year of Incorporation: Aug 19, 1991


Legal Status : NBFI
Regional Spread: Orissa
Existing sources of funds: Grants and Loans

Mission Microfinance:
• The estimated population of Orissa (India’s most Microfinance Operations
impoverished state) is 40 million people, and more
than 47 percent of the population lives on less
than USD1 per day. Adhikar targets to provide 9%
services throughout Orissa.
• Economic and political empowerment of the
MF
deprived communities of rural and urban areas of
Orissa Non-MF
• Ensuring them with an effective, flexible and
responsive financial services system and 91%
safeguarding the rights for their meaningful living.

Target Social Market: Development Goals:


• Adhikar’s clientele include poor migrant • Increase in access to financial services
workers, marginal and small farmers, • Poverty reduction
artisans, daily wage earners, domestic • Employment generation
servants, small entrepreneurs, and street • Development of start-up enterprises
vendors. • Development of existing businesses
• Schooling and health improvement
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 207

• Gender equality and women’s empowerment


• Water and sanitation
• Housing
Organization Background:
• Adhikar is an NBFC serving more than 100,000 clients across Orissa. They extend innovative financial services
through remittances, microfinance, and self-help groups.
• It is a not-for-profit organization registered under Societies Registration Act, 1860.
• Established in 1993, as the initiative of the present President, Mr. Md. N. Amin and group.]
• Adhikar started its microfinance operation in Mar 2001 by promoting SHGs and savings & credit cooperatives
• In Jul 2004, it came with a direct lending programme SANCHAYIKA, to scale up the programme. This was
initially supported by FWWB.
• Adhikar has reached out to about 50,000 villages, and 15 slums in 7 districts of Orissa.
• It has also been a part of national networks like Sa-Dhan, Sahanati, OSS UP and Forum Asia (an international
alliance dedicated to strengthening civil society and global peace.
• Adhikar deployed Mifos independently, receiving support from SunGard who helped them build out branch-
level reports and migrate data from the 35 separate databases of their previous MIS—Jayam Solutions' FIMO.
Adhikar is now working on building out a robust set of management-level reports to guide its operations with
full insight into their business performance and social impact.
Areas of Operations:
Due to lack of unemployment, many people work in sub urban areas in a cheap wages. For this Adhikar started the
remittance work from Gandhidham of Gujarat & subsequently created a wing of its organizational frame for the
purpose, named as ShramikShahajog.
Products and Services:
Credit: Credit Plus:
• Microcredit loans for micro enterprises • Enterprise skill development
• SME loans • Business development services
• Loans for agriculture, education and housing • Basic health, education services
issues • Leadership training for women, their rights,
• Life insurance gender issues
• Remittance services • Counseling/ legal services for female victims of
violence

Synergetic Engagements

Organization Areas of Collaboration


Dignity Fund, L.P. Funding
Unitus Network Affiliation

Location: Orissa Contact Person: Md. N. Amin


Address: 77/180/970, Subudhipur Designation: President
Bhubaneshwar, Orissa-751019
Phone:+91 6742384632 Contact No.:+91 933 809 2826
Fax:+91 6742475087, +91 6742475173 Official Email: adhikar@satyam.net.in
Email: adhikar@satyam.net.in Website: www.adhikarindia.org
208 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

ASOMI

An institution for promotion of Secure Sustainable Livelihood

Profile Snapshot

7000000
Gross loan portfolio: USD 4.7 million Loan
6000000 Portfolio
Average loan USD 117
balance per 5000000 (USD)
borrower: Deposits
4000000
Number of active 40449 (USD)
3000000
borrowers:
2000000 Total Assets
Deposits: USD 1.2 million
1000000 (USD)
Number of 40,449
depositors: 0 Total Equity
Total assets: USD 5.9 million 2007 2008 2009 (USD)
Total equity: USD 2.37 million

Year of Incorporation: 2001


Legal Status (Year): NGO registered the Societies Registration Act XXI 1860
Regional Spread: Assam : 30 locations spreading across 14 districts of Assam viz., Dhubri, Goalpara,
Kamrup,Nalbari, Barpeta, Bongaigaon, Kokrajhar, Darrang, Sonitpur, Morigaon,
Nagaon, North Lakhimpur , Dhemaji&Jorhat.

Existing sources of funds: North Eastern Development Finance Corporation Ltd; ICICI Bank, local RRB

Mission Microfinance:

• The mission is to “Endeavour for creating a self sustained habitat with secured livelihood for the poor and the
disadvantaged section of the society with the perspective of living in harmony with nature and one another”.
The mission is to reach the unreached by organizing rural and urban SHG, JLG, EDL so that the targeted
population may be covered within the planned period.

Target Social Market: Development Goals:

• Livelihood supporting projects in • Plans to get into rice and fish trading in 2008 through
agriculture and allied sectors microfinance
• Microcredit Program is aimed at providing • Under Suoni Gaon Program ,future objective is to revive
financial assistance the traditions, heritage and culture of the target village
• Welfare fund to provide life insurance along with its economic development
coverage to all group members at Asomi's • Marketing of products of rural artisans
cost • Certificate course in Management Development to
understand key principles for managing people and
resources.
• Plans to launch OPERATION RAINBOW which will be a
complete solution for farmers and the disadvantaged
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 209

Organization Background:

• Asomi is a leading MFI, currently operating in the state of Assam. With over 30 branches and 150 employees
Asomi has, just within a space of 6 years, established itself as one of Assam's leading non-government
organization (NGO) engaged in social transformation.
• Supported by leading governmental and private finance institutions, such as NABARD, SIDBI, AGV Bank, AXIS
Bank, etc., Asomi is a professionally managed organization that has been accredited by leading rating agencies
like CRISIL, M-CRIL etc.
• Asomi believes that economic inclusion is the key to realizing human potential and social harmony, and
microfinance is an answer to many of our current socio-political problems. Propelled by this belief, a team of
young people brings an almost missionary zeal to their work, with the result that Asomi has enjoyed
unprecedented growth.

Areas of Operations:

• Credit Services through SHG, joint liability group, enterprise development loan, dairy and agricultural
transportation loan
• Education through certificate course in management development for the target trainees
• Marketing of agricultural produce and products of rural artisans

Products and Services:


Credit: Credit Plus:
• SHG Loan with minimum loan to individual member of Rs. 2,000 & • Awarded to execute activities
maximum Rs 25,000 and maximum loan to 1 SHG of Rs 2,50,000 with of nodal NGO for
10% of flat interest implementation of World Bank
• If credit need is higher than Rs 10,000, loan through JLG method is aided Assam Agricultural
provided till Rs 50000 Competitiveness Project
• Enterprise Development Loan from Rs 10,000 to Rs 50,000 (AACP)
• Dairy Loan to provide improved variety of cattle to farmers through • Suoni Gaon Program
SHG / JLG/ individual method varies between Rs 20,000 to Rs 3,00,000
• Agricultural Transportation Loan to finance 75% of three wheeler
cost

Synergetic Engagements:

Organization Areas of Collaboration


SIDBI
AXIS Bank
HDFC Bank
Sir Dorabji TATA Trust

Location: Assam Contact Person: SubhraJyoti Bharali


Address: Asomi 2nd Floor, AT Road, Bharalumukh Designation: Chief Executive Officer
Guwahati 781009
Phone:+91-361 2763212/3 Contact No.: +91-361 2736212
Fax: +91-361 2763213 Official Email: sjbharali@gmail.com
Email: axomi@rediffmail.com Website: http://www.asomi.co.in
21
10 An Aadhaar Study | Performance
P R
Rating Benchm
marks for Larg
ge, Medium and
a Small MFIIs

BAND
DHAN

Profile Snapshot:
S

450,000,0
000
Gross loa
an portfolio: USD 332.5 million
m
400,000,0
000
Average loan balance USD 144.5 million
m Loan Portffolio
350,000,0
000 (USD)
per borro
ower: 300,000,0
000
Number of active 2.3 million 250,000,0
000
borrowerrs: 200,000,0
000 Total Asse
ets
Deposits: USD 53.9 miillion 150,000,0
000 (USD)
Number of NA 100,000,0
000
depositoors: 50,000,0
000
Total Equity
Total asssets: USD 424.2 million
m 0
(USD)
Total equ
uity: USD 44.3 miillion 2007 2
2008 2009

Year of Inccorporation: 2001


Legal Status (Year): Registered under Commpanies Act 195 56 & as a Non Banking Financcial Company with w
RBI
Regional Spread:
S Has 15553 branches in states & unionn territories
Existing so
ources of fund
ds: Allahabad Bank; IDBI bank;
b Axis Bankk; State Bank off India; SIDBI; Punjab
P & Sind Bank
B
Mission Microfinance:

• The organization works


w towards women
w
Microfinance Operatiions
emp powerment and d prime motive e is to touch the
e
livess of the poor. 10%
• To reduce
r econom mic and social poverty
p
MF
signnificantly, by cre
eating employm ment through
provviding cost effe ective, sustainable financial Non-MF
and other develop pment services.
• To be
b a world-classs international microfinance 90%
instiitution serving 8 million clientts by 2014

Target Soccial Market: Developm


ment Goals:

• Lo
ow income clients • In
ncreased accesss to financial services
• W
Women • P
Poverty reductio on
• A
Adolescents andd youth • E
Employment geeneration
• C
Clients in rural areas
a • G
Growth of existting businessess
• C
Clients in urbann or semi-urban
n areas • Y
Youth opportunities
• C
Children's scho
ooling
• H
Health improve ement
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 211

Organization Background:

• Bandhan (meaning togetherness) was started in 2001 under the leadership of Mr. Chandra Shekhar Ghosh. The
main thrust of Bandhan is to work with women who are socially disadvantaged and economically exploited.
Bandhan works for their social upliftment and economic emancipation. To achieve this objective, Bandhan is
engaged in the delivery of microfinance services to the poor women. Bandhan commenced microfinance
operations in West Bengal in July 2002. The model followed is individual lending through group formation. All
microfinance activities are carried under Bandhan Financial Services Private Limited (BFSPL).
• Aspiring to holistic development of the poor, Bandhan offers development activities in crucial fields of
education, health, unemployment, livelihood and the like through its not-for profit entity. Besides, Bandhan
also has a program exclusively for the hard core poor (generally believed to be bypassed by microfinance).
• Bandhan has 1553 branches in 18 states & union territories.

Areas of Operations:

• Microcredit loans for microenterprises and agriculture


• Life insurance
• Remittance services
• Enterprise skills development
• Business development services
• Leadership training for women
• Education

Products and Services:


Credit: Credit Plus:

• Suchana micro loan from Rs 1,000 to Rs 25,000 @ • Registrar for National Pension Scheme
18.97% to 23.56% interest rate services in India
• Srishti micro enterprise loan from Rs 25,000 to Rs • Remittance services as a international money
50,000 transfer with Western Union
• Samriddhi for medium enterprise loan Rs1,00,000 to Rs
3,00,000 for 1 year @ 17.97% interest
• Suraksha & Susikhsha varying between Rs 1,000 to Rs
10,000 loan

Synergetic Engagements:

Organization Areas of Collaboration


CORDAID Funding
CRISIL Rating
Freedom for Hunger Network Affiliation
MFIN Network Affiliation
Unitus Network Affiliation
212 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Location: Kolkata, West Bengal Contact Person: Chandra Shekhar Ghosh


Address: EC-76, sector –I, salt lake city Kolkata Designation: Chairman & MD
Phone:+91 33 2334 7602/6751-55 Contact No.: +91 33 23346751/55
Email: info@bandhanmf.com Official Email: csghosh@bandhanmf.com
Website:www.bandhanmf.com
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 213

Bharat Integrated Social Welfare Agency


(BISWA)

Profile Snapshot:

80,000,000
Gross loan portfolio: USD 58.9 million
70,000,000 Loan
Average loan balance USD 193 Portfolio
60,000,000
per borrower: (USD)
50,000,000
Number of active NA
40,000,000
borrowers:
30,000,000
Deposits: 0 Total
20,000,000
Number of depositors: 0 Assets
10,000,000 (USD)
Total assets: USD 71.8 million
0
Total equity: NA
2007 2008 2009

Year of Incorporation: January 1, 1995


Legal Status (Year): NGO
Regional Spread: Orissa, Chhattisgarh, Bihar, West Bengal, Jharkhand, Uttaranchal, UP, MP & Nagaland.
Existing sources of funds: NABARD, SBI and International Organizations

Mission Microfinance:

• To make a real and lasting psychological, social &


Microfinance Operations
financial impact on individuals; help build strong,
cohesive communities; and generate substantial job
opportunities and economic benefits for society 10%
• To increase the availability of a wider range of
microfinance services to poor (mainly rural) women MF
and their use of those services through the process of
Non-MF
expansion as well as consolidation of this micro
finance program 90%
• To facilitate of a sustainable community based MFIS
• Bring recognition, legitimacy, respect and opportunity
to the 100,000 of micro-entrepreneurs in the western
Orissa region
• Revive the roots of banking, so that credit is once
again based on trust and relationship instead of a
person’s wealth or poverty
214 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Target Social Market: Development Goals:

• Low income clients and women • Increased access to financial services


• Minority community • Poverty reduction
• Employment generation
• Development of start-up enterprises
• Children's schooling
• Health improvement
• Gender equality and women's empowerment
• Water and sanitation

Organization Background:
• BISWA started its endeavour in the year 1994 from Sambalpur and has since then come a long way with varied
of experiences to share with. BISWA is aiming to make the state of Orissa a poverty-free zone through
community empowerment and livelihood initiatives.

Areas of Operations:

• Social development
• Microfinance
• Social enterprise

Products and Services:


Credit: Credit Plus:
• Microcredit • Grain bank
• Innovative schools
• Healthcare
• Water & sanitation
• Renewable energy (TERI)
• Blood donation
• Water harvesting

Synergetic Engagements:

Organization Areas of Collaboration


IGSSS Vocational training
FVT-KatholocsheZentralstelle (Germany) Vocational Training
CARE-India MF Program, Promotion of SHGs
Orrisa Foundation Innovative Schools
NABARD SHG promotion
CPR Environment protection
National Child Labor Child labour education
Ministry of Health & Family Welfare RCH awareness

Location: Sambalpur, Orrisa Contact Person: Debabrata Mallick


Address: Danipati, Po –Budharaja Designation: Asst. General Manager
Phone: +91-663 2533597 Contact No.:+91-993723 4007
Fax: +91-663 2533597 Official Email: dmalick@biswa.org
Email: kc_malick@yahoo.com Website: www.biswa.org
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 215

Bullock-Cart Workers Development


Association(BWDA)

Profile Snapshot:

40,000,000 Loan
Gross loan portfolio: USD 25.8 million Portfolio
35,000,000
Average loan balance USD 117.1 (USD)
30,000,000
per borrower:
25,000,000 Deposits
Number of active 2,20,645 (USD)
20,000,000
borrowers:
Deposits: - 15,000,000
Total Assets
Number of depositors: - 10,000,000
(USD)
Total assets: USD 35.4 million 5,000,000
Total equity: USD 4.7 million 0 Total Equity
2007 2008 2009 (USD)

Year of Incorporation: January 1999


Legal Status (Year): NBFI
Regional Spread: Tamil Nadu
Existing sources of funds: CORDAID

Mission Microfinance:

• A poverty free, prosperous, equitable and sustainable society

Target Social Market: Development Goals:

• Low income clients • Increased access to financial services


• Women • Poverty reduction
• Clients in rural, urban or semi-urban areas • Growth of existing businesses
• Adult education improvement
• Youth opportunities
• Children's schooling
• Gender equality and women's empowerment
• Housing

Organization Background:

• "BWDA" was started on 2nd October, 1985, with the primary aim to strengthen the foundation of socio-
economic welfare of the bullock cart workers, rural artisans, poor women and children in Tamil Nadu,
Pondicherry& Andaman Nicobar Islands. It had been registered under Tamil Nadu Societies Registration Act on
13th January, 1986.
• BWDA started the formation of Women Self Help Groups for the family members of bullocks cart workers from
1988. The member of self help groups had been trained to save for the future and lend the savings to the
216 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

members as internal loan and it had spread to other areas wherever bullock cart workers lived. On seeing the
success of BWDA in the formation of women self help groups, Tamil Nadu Women Development Corporation
had selected BWDA - NGO as a partner and gave approval to implement women development programs in
Mailam and Koliyanur Blocks in Villupuram District, later Kanchepuram, Cuddalore, Tirunelveli, Kanyakumari
District, Pondicherry and Andaman Nicobar Islands.
• BWDA started 'BWDA Nursery &Primary School' (English Medium) at Rasapalayam in Cuddalore District and at
Kolliyangunam in Villupuram District. Further, BWDA started 'BWDA Community College' at Rasapalayam in
Cuddalore District. The Community College conducts various vocational courses like Diploma in Pre-Primary
Teacher Training, Diploma In Fashion Designing & Garment Making, Diploma in House Electrician and Diploma
in DTP & Computer Operator. Now , to cater the needs of the children of the bullock cart workers, self help
groups in the field of higher education and to provide good quality education at low cost, it is proposed to
open 'BWDA ARTS & SCIENCE COLLEGE' at Kolliangunam on the Tindivanam-Kootteripattu-Pondicherry Road
Near Mailam. TindivanamTaluk, Villupuram District, Tamil Nadu, India.

Areas of Operations:

• Microcredit through SHG


• Training
• Managing small & micro enterprises
• Credit aspect in rural development
• Socio economic empowerment
• SHG & enterprises development initiative
• Education
• Health & nutrition
• Women’s rights

Products and Services:


Credit: Credit Plus:

• SHG Loan • Product development


• Loans for agriculture, housing & education • Training on micro-insurance & individual lending
• Workshop on HIV Mainstreaming
• Life insurance
• Savings facilitation services
• Remittance services

Synergetic Engagements:

Organization Areas of Collaboration


Axis Bank, Citi Bank, KarurVysa Bank Business Partners
CORDAID Funding
MCRIL Rating
SA- DHAN Network affiliation

Location: Villupuram, Tamilnadu Contact Person: C. Joslin Thambi


Address: 858, East Pondicherry Road, 605602 Designation: M.D
Phone: 04146 240/ 243861 Contact No.: +91 04146 240683
Email: bwda1@sancharnet.in Official Email: hobwda@gmail.com
Website: www.bwda.org.in
An Aadhaar
A Study | Performan
nce Rating Ben
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L Medium
m and Small MFIs
M 217

Cashp
por Micro
o Creditt

Profile Snapshot:
S

70,000
0,000
Gross loa
an portfolio: USD 43.8 million
m Loan Po
ortfolio
60,000
0,000 (USD)
Average loan balance USD 105
per borro
ower: 50,000
0,000
Total Asssets
Number of active 417,039 40,000
0,000 (USD)
borrowerrs: 30,000
0,000
Deposits: 0.0 Total Eq
quity
20,000
0,000 (USD)
Number of depositors: 0
10,000
0,000
Total asssets: USD 62.0 million
m Depositts
Total equuity: USD 2.2 million 0
2007 2008 2009

Year of Inccorporation: Jan 01, 1997


Legal Status : NGO
Regional Spread:
S North Inddia (Uttar Prade
esh)
Existing so
ources of fundds: Grants, Loans
L & Sharehholder Capital

Mission Microfinance:

• he BPL women in the BIMARU


It targets all th U states having access to micrrocredit service
es and overcom
ming
the poverty.
218 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Target Social Market: Development Goals:

• Very poor clients • Increase access to financial service


• Women • Poverty reduction
• Employment generation
• Development of Start-up enterprises
• Growth of existing businesses
• Providing health, education services
• Gender equality and women empowerment
• Water and sanitation

Organization Background:

• Main aim is to identify and motivate poor women in the rural areas
• Targeting all the women in BPL states having access to microcredit services and utilizing them to lift
themselves and their families out of BPL.
• Delivering financial service in honest, timely and efficient manner

Areas of Operations:

• Full scale Financial Services


• Looking For: Loans in local currency, guarantees, capacity building grants, other investments, and equity
investments.

Products and Services:


Credit: Credit Plus:

• Microcredit loans for micro enterprises • Financial literacy education


• Loans for agriculture • Basic health/nutrition education
• Micro credit for other household • Other education and health services offered, like scholarship
needs/consumption opportunities, Community health leader training
• Credit life insurance • leadership training for women

Synergetic Engagements
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 219

Organization Areas of Collaboration


Cashpor Network Affiliation
Crisil Rating
Grameen Foundation, Network Affiliation
Sa-Dhan
M-Cril Rating

Location: Uttar Pradesh Contact Person: J.S. Tomar


Address:N-7/1-R-9 DLW-BHU Road, Designation: Managing Director
Bhikaripur, Varanasi, Uttar Pradesh-221001

Phone: +91 542 2316166 Contact No.: +91 542 231 6166
Fax: +91 542 2322281 Official Email:jstomarpersonal@yahoo.com
Email: headoffice@cashpor.in Website: www.cashporindia.net
220 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Liberal Association for Movement of People


(LAMP)

Profile Snapshot:

Gross loan portfolio: INR 34,411,347


Average loan balance INR 687
per borrower:
Number of active 50,103
borrowers:
Deposits: Chart not available
Number of depositors:
Total assets:
Total equity:

Year of Incorporation: 1978


Legal Status (Year): Society, 1979
Regional Spread: Delhi, Kolkata, Bankura, Burdwan, Darjeeling and Purulia districts of West Bengal, East
Singhbhum and Santhal Parganas of Jharkhand and Mayurbhanj district of Orissa.
Existing sources of funds: Net owned fund and Borrowings
Mission Microfinance:

• Making of an egalitarian society for equitable development of people especially women and children at risk
and environment with their active participation with full strength of mind, body and soul.
• To empower the people of weaker sections and improve their environment by undertaking all round
sustainable and equitable action programme.

Target Social Market: Development Goals:

• Women • To create opportunities for up gradation of knowledge and the level


• Street and Working children of awareness among the activists regarding legal provisions and
• Labourers in unorganized Govt. facilities for the tribals, dalits, indigenous people, Women,
sectors OBC, Children etc. and their rights & duties as human beings.
• Tribal’s • To organize training, meeting, seminar and workshop on different
• Dalits Social issues, problems and its perpetration from time to time.
• Indigenous people • To organize Micro Finance and Livelihood Development Programme,
• OBC programme for poor women of self help groups.
• To create opportunities for developing and strengthening Worker's
Action groups, Street and Working Children Action Groups,
Cooperatives, Network of Tribal’s, Dalits and other indigenous
people and establishment of a just Society based on human values.
• To create opportunities for the people to become self-employed
which ultimately with help them to become economically self-reliant.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 221

Organization Background:

• It was on April 16, 1978, a meeting was held at village Rangametya, P.S. Chhatna, District – Bankura, and it was
attended by 27 tribal young men and women of South Darakeswar area, who discussed with dedication and
commitment how the socio-economic conditions of oppressed and exploited communities could be developed
towards their empowerment.
• The organisation- LAMP- was registered on 10th January, 1979 and gradually marched on as a non- profit,
non-political and secular organisation; its mission and vision being to uplift the under-privileged. Today LAMP
has widened its multifarious activities to various parts of West Bengal, Jharkhand, Orissa and Delhi states. Truly,
therefore, it has now become a national level social welfare organisation.
• LAMP has been empowering the weaker sections of the Society, with all its efforts, specially targeting the poor
and oppressed women and the hopeless children living on city pavements and suburban slums and rural areas.
It is the sincerity of purpose, clarity of vision, strength of mind and dedication of its workers that have helped
LAMP to rise from its small beginning to its present position of happy and bright promises. Completion of 29
years is a remarkable milestone in the progress of an organisation in the matter of bringing about an
egalitarian society in areas steeped in illiteracy, poverty, poor health and sanitary conditions, as well as
ignorance and superstitions.

Areas of Operations:

• Education
• Action
• Reform
• Social Development
• Social Welfare
• Microfinance Funding

Products and Services:


Credit: Credit Plus:

• Microfinance loans • Agriculture


• Loans to Self Help Groups • Child welfare
• Development(General)
• Disadvantaged communities
• Education
• Environment
• Health
• Poverty
• Women’s issues
222 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Synergetic Engagements:

Organizations in collaboration
• Ministry of Social Justice & Empowerment, Govt. of India.
• Ministry of Health and Family Welfare, Govt. of India.
• Ministry of Science & Technology. Govt. of India.
• Central Social Welfare Board, New Delhi.
• Kolkata Child Labor Rehabilitation -cum- Welfare Society, Govt. of West Bengal.
• UNICEF, Kolkata.
• Dept. of Mass Education,Govt. of Orissa.
• UNESCO Co-Action Programme, Paris, France.
• DuetscheKalkuttaGruppe, Germany.
• BROEDERLIJK DELEN, Belgium.
• Hope for Children, United Kingdom .
• Virgin Atlantic Airlines, United Kingdom.
• SIMAVI, The Netherlands.
• The Ford Foundation, New Delhi.
• Stichting De Oude Beuk, Netherlands.
• ICICI Bank Limited
• HDFC Bank Limited
• HSBC Bank
• Rabo Bank Foundation, Netherlands
• State Bank of India

Location: West Bengal Contact Person: Malay Dewanji


Address: Pratapbagan, Bankura-722 101 Designation: General Secretary
Phone: + 91 -3242-250685 Contact No.: + 91 33-2241-8496
Email:dishari@vsnl.net Official Email: dishari@vsnl.net
Website:www.lamp-ngo-india.org
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 223

Mimoza Enterprises Finance Pvt. Ltd.

Profile Snapshot:

Gross loan portfolio: USD 7.7 million 12,000,000


Loan
Average loan 10,000,000 Portfolio
balance per USD 146.5
8,000,000 Deposits
borrower:
6,000,000
Number of active
52,345 4,000,000
borrowers: Total
Deposits: 0.0 2,000,000 Assets
Number of 0 Total
0
depositors: Equity
Total assets: USD 10.2 million
Total equity: USD 1.78 million

Year of Incorporation: Nov 9 2006


Legal Status (Year): NBFI
Regional Spread: N.A
Existing sources of funds: Loans & Shareholder Capital

Mission Microfinance:

• It provides financial services to micro and meso units. It also aims for sustainable access to microfinance, to
women, creating jobs, enabling families to health care. It is trying to provide microfinance services to all
individuals, and small entrepreneurs.

Target Social Market: Development Goals:

• Poor clients • Increased access to financial services


• Low income clients • Poverty reduction
• Women • Employment generation
• Clients in rural, urban or semi-urban • Development of start-up enterprises
areas • Gender equality and women’s empowerment
• Water and sanitation

Organization Background:

• The organization commenced operations on November 9, 2006 in Dehradun under the banner of Partners in
Prosperity, registered in Delhi.
• The company name was changed to MIMOZA ENTERPRISES FINANCE Co. Pvt. Ltd. (effective from Sep 2008)
• Plans to maintain financial self sufficiency by using a sustainable business model to bring all mainstream
financial services to poor households, also reaching 1million clients by 2015.
224 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

• Acquired M/s Shah Sandhu Finance Co. Pvt. Ltd. on Mar 24, 2007 and the management & control was
transferred to ManabChakraborty and Ravi Narasimham on behalf of Belllwether Microfinance Fund,
Hyderabad.
• M/s Shah Sandhu –
o Incorporated as a company on Jan 20, 1995(No. #15-15676 of 1995).
o Received license from Reserve Bank of India on May 10, 2000(B-06-00272).

Areas of Operations:

• Having established operations in Uttarakhand, Mimo now operates across the various states of North India.
Specifically, the organization has established regional hubs and branch offices in urban and peri-urban areas
along the major highways and towns in Uttarakhand, Uttar Pradesh, Haryana, Rajasthan, Himachal Pradesh and
Madhya Pradesh.

Products and Services:


Credit: Credit Plus:

• Loans for agriculture • Business development services


• JLG Loans
• Home Improvement Loans
• Individual Micro-enterprise Loans
• Insurance

Synergetic Engagements

Organization Areas of Collaboration


FWWB Network Affiliation
MicroSave Partner
PlaNIS Network Affiliation
SA-DHAN Network Affiliation
Unitus Network Affiliation
M-Cril Rating

Location: New Delhi Contact Person: Sujeet Raj


Address: 35/2/9 Kishangarh, Designation: Program Manager
Vasant Kunj, New Delhi -110070
Phone: +91 11-65154037 Contact No.: +91 9582321844
Fax: +91 1166173982/+91 135 2644006 Official Email:program.manager@mimofin.net
Email:info@mimofin.net Website:www.mimofin.net
An Aadhaar
A Study | Performan
nce Rating Ben
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L Medium
m and Small MFIs
M 225

Payak
karaopeta Wom men's Mu
utually Aided
A
Co-op
perative Thrift and
a Creddit Societty
(PWMMACS)
Profile Snapshot:
S

Gross loaan USD 7.0 millio


on 10,000,0
000
portfolio
o:
Loan
Average loan USD 191.8 8,000,0
000
Portfolio
balance per
p
borrowerr: 6,000,0
000 Deposits
Number of active 36,543
4,000,0
000
borrowerrs: Total Assets
A
Deposits: USD 1.8 millio
on 2,000,0
000
Number of 43,047 Total Eq
quity
depositoors: 0
Total asssets: USD 9.5 millio
on 2006 2007 2008 2009
Total equuity: USD 1.4 millio
on

Year of Inccorporation: 1997


Legal Status (Year): 1997
Regional Spread:
S Visakhapatna
am district andE
East Godavari district
d
Existing so
ources of fundds: Loans and Sa
avings
Mission Microfinance:

• The objective of th
he PWMACTCS is to Microfinancce Operation
ns
prom mote economicc and social be etterment
3% 0%
of itts members thrrough thrift, sellf-help,
and mutual aid in accordance witth the
prin
nciples of co-op
peration. MF

Non-MF

97
7%
226 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Target Social Market: Development Goals:

• Poor Women • To undertake Social Security Programs like Group Accident Insurances
• Agricultural laborers Policy by linking with the Oriental Insurance Company.
• Vegetable and fruit vendors • To help the community by organizing the health and immunization
• Flower nursery as subsidiary camps. Helping the water user associations along with another
occupation. Organization viz.,”Creative Organization & Rural development”.
• Providing drinking water bore wells.
• Constructing school sanitation facilities to schools in the villages.
• Providing environmental friendly fuel efficient crematoriums.

Organization Background:

• The Payakaraopeta Women’s Mutually Aided Co-operative Thrift and Credit Society (PWMACTCS) was
established on 23rd September 1997 under the APMACS Act 1995 and taken over the activity of thrift and
credit for the rural women from the Payakaraopeta Stri Sanghala Abhivruthi Samakya (PSSAS), which was doing
the program from 1994-95.

Areas of Operations:

• Business Development Services


• Health
• Other

Products and Services:


Credit: Credit Plus:

• Consumption • Voluntary Savings


• Education • Insurance
• Mortgage housing • Training and Consulting
• Household • Demand deposits
• Micro-enterprise • Time deposits
• Compulsory deposits

Synergetic Engagements:

Organization Areas of Collaboration


M-CRIL Rating
SA-DHAN Network Affiliation

Location: Vishakapatnam Contact Person: G. V. V. Satyanarayan


Address: Flat no 3&4 Siva Surya Apartments, Designation: Senior Manager
Main Road, Payakaraopeta-531126,
Vishakapatnam Dist, Andhra Pradesh
Phone: +91-8854-252045 Contact No.: 9347317989
Fax:+91-8854-256117 Official Email:pwmacs@yahoo.com
Email:pwmacs@yahoo.com Website:www.pwmacs.org
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 227

Rashtriya Seva Samithi (RASS)

Profile Snapshot:

20,000,000
Gross loan USD 15.0 million
18,000,000
portfolio: Loan
Average loan USD 317.6 16,000,000 Portfolio
balance per 14,000,000
Deposits
borrower: 12,000,000
Number of active 47,265 10,000,000
borrowers: Total Assets
8,000,000
Deposits: -
6,000,000
Number of -
4,000,000 Total Equity
depositors:
Total assets: USD 17.7 million 2,000,000
0
Total equity: USD 2.6 million
2006 2007 2008 2009

Year of Incorporation: 1981


Legal Status (Year): 1981
Regional Spread: Andhra Pradesh, Orissa, Tamil Nadu and Delhi.
Existing sources of funds: Equity and Borrowings
Mission Microfinance:

• RASS’s mission statement is to provide a better Microfinance Operations


future to the most vulnerable sections of
2%
society, namely women, children and disabled
persons, through education and by protecting
their health and environment and improving
their living conditions with popular MF
participation. Non-MF

98%

Target Social Market: Development Goals:


• Woman and child • Focused outlook on human resource development, economic
development development and encouraging attitudinal changes for self management
• Disabled of resources
• Disadvantaged sectors of • Eradication of Poverty
the people • The environmental degradation in terms of rapid denudation of forest
• Rural development cover, soil erosion, the declining water table and the poor maintenance
of water harvesting structures have added to the woes of this region.
• Reduce degree of gender inequality; rendering women voiceless, isolated
228 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

and deprived of access to productive resources.

Organization Background:

• Rashtirya Seva Samithi (RASS) has been established in 1981, with its registered office at Tirupati of Chittoor
District in Andhra Pradesh, South India, Rashtriya Seva Samithi (formerly known as Rayalaseema Seva Samithi)
presently operates in four States of India viz., Andhra Pradesh, Orissa, Tamil Nadu and Delhi.
• RASS is currently implementing 39 different welfare and development programmes with the funding support
from Government of India, State Governments and International donor agencies and philanthropists.
• The emphasis on woman and child development, the disabled, the disadvantaged sectors of the people and on
rural development. However, RASS serves all the sections of needy in the society who deserve its services.
RASS designed its programmes to suit the requirements of different positions in life cycle. It has programme
presence in over 2560 villages. Through these programmes RASS is serving around 3.10 million populations in
04 States. RASS HR comprises 2100 regular, part-time interns and volunteers 3000 volunteer workers, who
rendered their service for the humanity were relieved due to phase out of different program after 28 years
committed and rendered services.

Areas of Operations:

• Programs for children, women, youth and aged


• Agriculture and Livelihood
• Natural Resource Management
• Health
• Infrastructure
• Human Resource Development
• Credit Support

Products and Services:


Credit: Credit Plus:

• Consumption • Health
• Household • Education
• Microenterprise • Development Institutions

Synergetic Engagements:

Organization Areas of Collaboration


CRISIL Rating
M-CRIL Rating
The Rating Fund Partner

Location: Tirupati, Chittoor Dist. Contact Person: V. Poornachandra Reddy


Address: Annamayya Marg, AIR-Bye-Pass Designation: Project Director
Roadm Tirupati – 517 501
Chittoor Dist., Andhra Pradesh
Phone: + 91 - 877 – 2242404 / 2244210 Contact No.: + 91 -08574-29945
Fax:+ 91–877–2244281 Official Email:rassorg@gmail.com, rass_org@rediffmail.com
Email:rassorg@gmail.com Website:www.rassngo.org
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 229

RGVN(Rashtriya Gram Vikas Nidhi)

Profile Snapshot:

16,000,000
Gross loan portfolio: USD 12.5 million
14,000,000 Loan
Average loan balance USD 122.9 Portfolio
12,000,000
per borrower:
10,000,000 Total
Number of active 101, 389
8,000,000 Equity
borrowers:
Deposits: USD 2.1 million 6,000,000
Total
Number of depositors: 4,000,000
Assets
Total assets: USD 14.4 million 2,000,000
0 Deposits
Total equity: USD 0.344 million
2007 2008 2009

Year of Incorporation: Jan 01, 1996


Legal Status : NGO
Regional Spread: UP, Bihar, Jharkhand, Orissa, north-eastern Andhra Pradesh, and Bastar region of
Chhattisgarh
Existing sources of funds: IDBI, NABARD, and Tata social Welfare Trust(co sponsors), Grants, Loans, Savings
Mission Microfinance:

• Promote, support and develop voluntary Microfinance Operations


organizations engaged in social and economic
uplift of rural and urban poor, and physically & 9%
socio-economically handicapped people MF
• Improve the pace of quality of economic Non-MF
development
• It also aims for economic self-sustenance of
scheduled caste and tribes, women and children. 91%

Target Social Market: Development Goals:


• Poor clients, women • Increase access to financial services
• Unemployed young educated • Poverty reduction
• Employment generation
• Development of start-up enterprises
• Growth of existing businesses
• Youth opportunities
• Gender equality and women’s empowerment
• Health improvement
230 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Organization Background:
• In 1990, RGVN was promoted by IFCI as non-profit institutions and registered under Socities Registration
Act, 1860 for promoting social and economic upliftment of unprivileged sections of society.
• Also registered with the Foreign Contribution Regulation Act.
• Obtained exemptions under Section 80G of Income Tax Act providing tax concessions to donors.

Areas of Operations:

It has development programmes like:


• NGO support programme
• Credit and saving programme
• Capacity building programme
• Fellowship programme

Products and Services:


Credit: Credit Plus:

• Micro-credit loans for micro-enterprises • Enterprise skills development


• Loans for education, other household • Leadership training for women
needs/consumption • Gender issues, education, women’s rights
• Credit products for marriages etc.
• Credit life insurance

Synergetic Engagements

Organization Areas of Collaboration


M-CRIL Rating
Sa-Dhan Network Affiliation

Location: Assam Contact Person: Gunajit Bayan


Address: Bye Lane #8, Rajgarh Road, Guwahati 781003 Designation: Manager – Operations
Phone: 0361 2464612, +91 - 361 – 2452320 Contact No.: 0361 2464612
Fax: +91 - 361 – 2454376 Official Email:rgvn_csp@rediffmail.com
Email: info@rgvnindia.org Website:www.rgvnindia.org
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 231

Spandana Sphoorty Financial Ltd.

Profile Snapshot:

900,000,000
Gross loan portfolio: USD 787.3 million 800,000,000 Loan
Average loan USD 214.9 700,000,000 Portfolio
balance per 600,000,000
borrower: 500,000,000 Total
Number of active 3.7 million 400,000,000 Assets
borrowers: 300,000,000
Deposits: 0 200,000,000 Total
Number of 0 100,000,000 Equity
depositors: 0
Total assets: USD 647.3 million 2007 2008 2009
Total equity: USD 107.9 million
Year of Incorporation: 1998
Legal Status (Year): Non-Banking Finance Company
Regional Spread: NA
Existing sources of funds: JM financial Fund, Valiant Capital Management ,SIDBI
Mission Microfinance:

• To be in the global top 2 Microfinance Microfinance Operations


Organizations by 2012, offering a range of
financial and non financial products and services 10%
to low income households and individuals to
improve their quality of life. MF
• Constantly endeavor to provide quality services to
Non-MF
customers and remunerative returns to the
90%
investors by maintaining highest levels of
transparency and integrity.

Target Social Market: Development Goals:

• Economically active low-income households • Develop a sustainable community development model


• Clients who have slightly higher economic focused at low-income community – which is financially
well-being and have stable monthly cash- viable, non-grant based and scalable
flows • With the competency to reach out to low income
• Low/lower-middle-income people running households at their doorsteps efficiently, target is to
micro-enterprises leverage the other client segment
• Small and marginal farmers and tenant • Constantly working to identify the changing needs of
farmers clients and potential clients, and developing suitable
• Clients who want to finance purchase of products and services to address these needs thus
farm equipments keeping Spandana ahead of its competitors.
232 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Organization Background:

• Spandana started its operations in 1998 under the leadership of Mrs.Padmaja Reddy – a first generation
entrepreneur. Under her leadership, Spandana has grown at a CAGR of about 100% every year to reach out to
over 2% of India’s total households as on Sep 2010.
• Spandana started as an NGO, registered as a Society and then transformed into a Non-Banking Finance
Company, regulated by the guidelines of Reserve Bank of India. During the growth, Spandana has sustained its
operational efficiencies (sub 6% OER) and profitability and portfolio quality (cumulative repayment rate of over
99.5%).
• Main challenge is to continue to develop more and more credit and credit plus products suitable to different
customer sub-segments within the low-income segment. High degree of product diversification requires
supporting business processes and robust technology – and offers these services at scale while not diluting
controls and cost efficiencies.

Areas of Operations:

• Microcredit loans
• Drinking water
• Renewable energy
• Life insurance
• New market linkages

Products and Services:


Credit: Credit Plus:
• General Loan ( ABHILASHA) • Jaldhara as per Millennium Development Goal, has
• Micro enterprise loan (PRAGATHI) partnered with Unilever and PATH for safe
• Individual loan (SPOORTHY) drinking water to low income households
• Income generating loan (SAMRUDDHI) • Renewable energy product portfolio
• Agri-family loan • Curtail financial vulnerabilities through life
• Farm equipment loan insurance in association with MAX New York Life
• New Market linkages that can synergize with
existing MF operations

Synergetic Engagements:

Organization Areas of Collaboration


CRISIL Rating
Lok Capital Funding
SA-DHAN Network affiliation
WWB Network affiliation

Location: Hyderabad Contact Person: Padmaja Reddy


Address: Plot no. 79, Vinayaknagar, Care crystal Designation: Managing Director
Gachibowli
Phone:+91 040 44386648 Contact No.: +91 40 4438 6666
Fax: +91-40-44386640 Official Email: padmaja.reddy@spandanaindia.com
Email: contact@spandanaindia.com Website: www.spandanaindia.com
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 233

Appendix 2: Regulatory Capture

Section A2.1: Initial Impressions


Regulatory capture199 occurs when a state regulatory agency created to act in the “public” interest instead
advances the commercial or special interests that dominate the industry or sector it is charged with
regulating. Regulatory capture is a form of government failure, as it can act as an encouragement for
large firms to produce negative externalities. The agencies are called Captured Agencies.

The current debate surrounding microfinance and specifically the recurring state intervention in the case
of A.P. crisis is of particular significance. A nation that is plagued by poverty – and has been so for
millennia together; endeavouring to reach the Millennium Development Goals (MDG) is more complex
than can be articulated.

It is banal to state that though India is emerging but the vast majority Indians are not. Politically,
government interest (and hence, intervention) in inclusive growth can be seen both as a responsibility of
the State as well as a calculative effort since growth and development is likely to result in reinstate of the
government to power200.

Regulatory capture theory is a core focus of the branch of public choice referred to as the economics of
regulation; economists in this specialty are critical of conceptualizations of governmental regulatory
intervention as being motivated to protect public good201. The risk of regulatory capture suggests that
regulatory agencies should be protected from influence as much as possible, or else not created at all. A
captured regulatory agency that serves the interests of its patrons with the power of the government
behind it is often worse than no regulation whatsoever.

Section A2.2: The Economic rationale


The idea of regulatory capture has an obvious economic basis: Vested interests in any industry have the
greatest financial stake in regulatory activity and are more likely to be motivated to influence the
regulatory body than dispersed individual consumers, each of whom has little particular incentive to try to
influence regulators. As well, we would expect that when regulators form expert bodies to examine policy,
this will invariably feature current or former industry members, or at the very least, individuals with
contacts in the industry. Some, such as Jon Hanson and his co-author202, argue that the phenomenon
extends beyond just political outfits and organizations. Businesses and Politics both have an incentive to
control anything that has power over them, including institutions from the media to academia to popular

199
The theory of regulatory capture is associated with Nobel laureate economist George Stigler
200
A very simplistic argument is presented here. The issue needs further deeper introspection. Since this discussion is incidental
to the current study, the same is being left here for a more opportune moment.
201
Please refer Bernstein (1955), Huntington (1952), Laffont&Tirole (1991), Levine &Forrence (1990) and Ronald Coase.
202
Jon Hanson & David Yosifon, “The Situation: An Introduction to the Situational Character, Critical Realism, Power
Economics, and Deep Capture”, 152 U. Pa. L. Rev. 129 (2003).
234 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

culture, and thus will try to capture them as well. When this happens, they call this phenomenon "deep
capture."

Section A2.3 What is up with Microfinance?

With so much frenzy against microfinance practices, and requests from many quarters to not repay
the existing loans to MFIs, is microfinance sector in A.P. under a deep capture?
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 235

Appendix 3: Recommended parameters for performance


appraisal
We would like to see greater transparency in the sector. These measures, indicate below, would be very
helpful for MFIs to track for a competitive assessment as well as benchmark performance. These should
ideally be made available in the MIS as “analytics”.

Table 41: Performance Parameters

Term Explanation

1 Portfolio Yield Indicates the MFI’s ability to generate cash from interest,
fees, and commissions on the Gross Loan Portfolio.
= (Cash Received from Interest, Fees, Revenues that have been accrued but not paid in cash
and Commissions on Loan Portfolio should be excluded.
/Average Gross Loan Portfolio

2 Operating Profit Margin A measure of an MFI’s profitability in terms of its


effectiveness in managing its costs, and converting all of its
= Net Income Before Taxes and operating and non-operating revenues into income (before
Donations / Operating and Non- taxes and donations, if relevant).
Operating Revenue
The Operating Profit Margin ratio is an important measure
of pre-tax profitability from recurring earnings. It measures
the MFI’s ability to generate income relative to the revenues
generated from its activities. This ratio may include non-
financial revenue on the income side, and non-operating
expenses on the expense side, iff these are likely to be
recurring in nature.

A high ratio suggests an effective transformation of


revenues into residual income and a greater portion of
income derived from revenues. An MFI can track this ratio
over time to more effectively manage its cost structure. MFIs
offering non-financial services (credit + activities) should
factor these services into the resulting operating profit
margin of the overall institution.

Median values may vary based on the age of the MFI, legal
structure, size, profit status, and region of operation.

3 Return on Assets (ROA) Measures how well the MFI uses its assets to generate
returns. This ratio is net of taxes and excludes donations.
= Net Income After Taxes and Before
Donations / Average Assets
236 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Adjusted Return on Assets (AROA)

= Adjusted Net Income After Taxes


and Before Donations / Average
Adjusted Assets

4 Return on Equity (ROE) Return on equity is the definitive measure of commercial


profitability. This ratio calculates the rate of return on
= Net Income After Taxes and Before Average Equity for the period. The numerator does not
Donations / Average Equity Adjusted include donations and is net of taxes.
Return on Equity(AROE)=Adjusted
Net Income After Taxes and Before
Donations / Average Adjusted Equity

5 Debt to Equity (Leverage) Measures the overall financial leverage (or gearing) of an
institution and how much cushion the MFI has to absorb
= Liabilities/ Equity losses after all liabilities are paid.

6 Equity to Assets Ratio A measure of the solvency of an unregulated or regulated


MFI. The information derived from this ratio helps an MFI to
= Total Equity / Total Assets assess its ability to meet its debt obligations and absorb
unexpected losses. This ratio is equivalent to 1 –
(Debt/Equity).

The denominator would exclude Goodwill and Intangible


Assets for MFIs that include these line items on their balance
sheet. NBFC MFIs will likely have a higher solvency ratio as
defined by RBI.

Expected losses should generally be covered through


provisioning by the MFI’s accounting policies, which
removes expected losses from both assets and equity. Thus,
the ratio measures the amount of capital required to cover
additional unexpected losses to ensure that the MFI is well
capitalized for potential shocks.

Regulated MFIs, lenders or investors may require an MFI to


maintain a certain minimum threshold of Equity to Assets
ratio through financial covenants.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 237

R7 Capital Adequacy Ratio (CAR) The Capital Adequacy Ratio measures more accurately than
the Equity to Assets Ratio (in accordance with Basel II
= Total Capital/Risk-Weighted Assets calculations) the MFI’s amount of capital and the risk level of
assets. It is a more finely-tuned indicator of an MFI’s
solvency and its ability to meet its obligations and absorb
unexpected losses203. The denominator should exclude
Goodwill and Intangible Assets for MFIs that include these
line items in their assets.

Specifically, CAR shows the relationship between capital and


risk-weighted assets as defined in by Basel II. A higher CAR
represents a higher level of solvency. CAR indicates the
amount of capital that an MFI has to cushion against future
losses and ensure that it is able to cover its expenses and
debt obligations over the long term.

CAR uses Basel II definitions and calculations (please refer


Appendix 1). CAR incorporates two Basel II concepts: it
recognizes and limits components of capital in addition to
equity capital, and it assigns risk weights to assets. CAR also
factors in any off-balance sheet activity and related risks.
Finally, the ratio adapts the concept of impairment reserves
for expected losses and capital for unexpected losses. The
minimum CAR benchmark for banks under Basel II is 8%.
RBI stipulated 9% for Banks and 10% for all NBFCs.
Adopting a higher level would factor in the higher risk level
of uncollateralized microfinance lending. However, any
CAR>20% is generally seen as insufficient leverage and
inefficient use of capital. Since Basel II requires additional
capital to cover operating risks, the metric may be used to
ascertain MFI benchmark for risks inherent in its business
model, as well as for risks the particular MFI faces from
external factors (like delinquency in specific pockets e.g. the
Kolar region).

203
Internal factors might include the type of lending performed (i.e. individual agricultural loans constituting a higher probability
of default than commerce group loans), the collateral held against potential loan portfolio losses, or diversification of operations
to lessen concentration risk (by geography, sector, etc.): External factors might include weather or environment-related shocks,
political crises, economic shocks such as high inflation or bank failures, or rapid changes in regulatory requirements. The best
way for an institution to anticipate unexpected losses is to assess previous experience, both internal and external, such as
unexpected losses suffered by other lenders engaged in microfinance in the region. MFIs must take each of these factors into
consideration when setting an appropriate target level of CAR.
238 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

8 Uncovered Capital Ratio (UCR) Indicates how the MFI is managing its level of loan portfolio
risk relative to the amount of capital it has. The lower the
=(Non-Performing Loans >30 days + ratio the better. NGOs and other non-regulated MFIs may
Value of all Renegotiated Loans – substitute Equity for Total Capital in the denominator to
Impairment Loss Allowance)/Total measure this ratio.
Capital
The UCR is also known as the Open Exposure ratio, Open
Adjusted Uncovered Capital Ratio Credit Exposure ratio, or Open Loan Exposure ratiomeasures
the amount of capital which may be at an elevated risk of
(UCR)
unexpected losses as measured by “un-provisioned” NPL30.
= Non-Performing Loans PAR>30
UCR indicates how the MFI is managing its level of loan
days + Value of all Renegotiated
portfolio risk relative to its capital. It is an enhancement to
Loans – Adjusted Impairment Loss
the NPL30 ratio as a more revealing ratio to assess
Allowance / Total Capital
vulnerability and potential loss. Because the UCR ratio tracks
NPL30, it is useful as an MFI’s warning signal of excessive
portfolio delinquency relative to the capital base that
supports it. An increased focus on the UCR as a measure of
capital adequacy may become best practice for the
microfinance industry going forward. When considered in
conjunction with the CAR, the UCR provides managers with
an additional analytical dimension to understand and report
on an MFI’s capital adequacy. An MFI should seek to
maintain a lower UCR, which signifies that the MFI has a
greater capital or equity base to support its risky loan
portfolio.

MFIs that do not currently calculate capital levels may


substitute equity for total capital in the denominator of the
ratio. The equity version of the UCR can provide NGOs and
other MFIs not measuring capital with a good sense of the
equity base available to support the uncovered deterioration
of the non-performing loan portfolio.

This ratio can change quickly as a consequence of rapid


portfolio deterioration, and thus can have an immediate
(and sometimes adverse) affect on an MFI's solvency
position.204

The adjustment indicates how the MFI is managing its level

204
This phenomenon is corroborated in a recent Basel document, which notes that, “Microloans manifest deterioration in portfolio
quality faster than commercial loans, due to their shorter average duration and more frequent repayments. Also, so-called
contagion effects amongst low-income borrowers in the same location can increase delinquencies exponentially.”Basel
Committee on Banking Supervision. 2010. Consultative Document. Microfinance Activities and the Core Principles for Effective
Banking Supervision. Basel, Switzerland: Bank for International Settlements, page 19. The Basel II framework does not require
monitoring and reporting of this ratio, but does require risk rating of loans, assignment of risk weights, and asset disclosures.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 239

of risk relative to the amount of capital based on


adjustments to the Impairment Loss Allowance.

9 Liquid Ratio, (Quick Ratio or Acid- Indicates level of cash and cash equivalents the MFI
test Ratio) maintains to cover short-term liabilities. Short-term liabilities
refers to assets or liabilities, or any portion thereof, that have
= (Cash + Trade Investments) / a due date, maturity date, or may be readily converted to
(Demand Deposits+ Short-term Time cash within 12 months.
Deposits + Short-term Borrowings +
Interest Payable on Funding Liabilities
+ Accounts Payable + Other Short-
term Liabilities)

10 One-Month Stressed Liquidity Ratio A forward-looking ratio that measures whether there is
sufficient liquidity for one/ three/six month of
= Current Assets/(Current Liabilities + disbursements, including portfolio growth. An MFI can also
One Month Operating Expenses + calculate this ratio under the assumption that committed
One Month Net Portfolio Growth) credit lines may be available (added to the numerator). The
most conservative approach is to exclude credit lines.

It measures whether the MFI has sufficient liquidity for MFI


loan disbursement growth.

As demonstrated by the credit crisis that began in 2008, a


financial institution needs to stress test its ability to handle a
liquidity shock that may occur unexpectedly at any time
from a variety of causes. The financial crisis was a lesson that
liquidity shortages can occur with little advance warning,
and may affect MFIs very differently, and in different time
frames. The Stressed Liquidity Ratio helps MFIs to plan for
stress scenarios before they occur, and to know that they
have planned sufficiently to maintain “business as usual”
microfinance operations. Maintaining smooth MFI
operations involves, at a minimum, maintaining adequate
liquidity levels necessary to finance operations and fund
anticipated portfolio growth. In addition to this one-month
ratio, an MFI may want to stress test its operations and
determine liquidity plans for longer multi-month time
frames. An MFI can also increase liquidity levels by delaying
capital expenditures.

Consistent with a conservative approach, this ratio excludes


an MFI’s committed credit lines. These lines have been
excluded because in a stressed scenario, the MFI may not
have access to these credit lines. The financial crisis also
240 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

demonstrated how committed credit lines might not be


available when an MFI needs them. Though MFIs cannot
presume to rely on committed credit lines during crises, the
Standards recommend that MFIs include committed credit
lines as part of liquidity planning.

11 Liquid Assets to Total Assets An important liquidity management tool205 to assess on


ongoing basis the extent liquid assets can support its asset
= Cash / Total Assets base. Most MFIs hold very little cash, preferring to put liquid
assets to productive use. This approach can yield a Liquid
Assets to Total Assets ratio of near to 0-1%. While asset
productivity is important, in a liquidity crisis, a low Liquid
Assets to Total Assets ratio can be hazardous to an MFI’s
financial health and survival.

The Standards uses a financially conservative approach to


this ratio by excluding “Due from Banks” and “Committed
Credit Lines”. Any cash-like instrument other than cash is
excluded since it may become encumbered, and therefore
unavailable as a liquid asset. As noted above, a committed
credit line may become unavailable in a financial stress
scenario.

An MFI that does not mobilize savings can maintain a lower


Liquid Assets to Total Assets ratio. The deposit-taking
institution must plan for potential unanticipated withdrawals
of deposits in addition to its lending program’s liquidity
needs. If an MFI needs greater liquidity, it may want to
consider increasing its cash position. Additionally, if the MFI
has not already done so, it should establish committed
credit lines with financial institutions that can provide
potential liquidity sources, although these cannot be
counted on in a financial stress situation.

Another way to increase this ratio in the short term is to


delay capital expenditures. Planning for this ratio is
important, so that an MFI is not forced to decrease the
intended on-lending due to a liquidity shortage.

205
Fitch Ratings cites this ratio as one of its five liquidity ratios that measure the basic structure of bank funding. When including
non-cash liquid assets, it is called Non-earning Liquid Assets as % of Total Assets by MIX Market. The 2008 median ratio was
12.2 percent for all MFIs reporting to MIX Market. The benchmark will vary depending on whether an MFI captures deposits.
For example, the MIX Market median in 2008 for banks was 18.6 percent and 18.4 percent for rural banks, as compared with
11.8 percent for NGOs. Women’s World Banking recommends the following ratio triggers at which point the MFI should
consider increasing its liquidity: 3-5% for MFIs that do not collect deposits; 5- 20% for MFIs that do. An MFI will want to
develop and monitor its own liquidity policy benchmarks and triggers as part of its overall internal controls policy.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 241

12 Savings Liquidity Provides information on the cash available to meet


withdrawals in demand deposits accounts. Generally the
=(Reserves against deposits as national regulator will require a statutory reserve against
required by regulators + Unrestricted demand deposits that may directly affect this ratio. MFIs
Cash)/ Total Demand Deposits should note such requirements in accounting statements
and financial reports.

The Savings Liquidity ratio is specifically suited for


monitoring and reporting by deposit-taking institutions. The
ratio measures an institution’s ability to accommodate cash
withdrawals from deposit accounts alongside desired and
optimal liquidity levels. Committed lines of credit are
excluded from the numerator because MFIs may not have
access to committed credit lines in a financial stress
situation. The national regulator may require statutory
reserve against demand deposits, which may have an
adverse impact on this ratio. Specifically, the higher the
reserve requirement by the regulator, the higher this ratio
will be.

Even in the absence of regulatory requirements, an MFI


should ensure that an adequate amount of cash is available
to cover possible withdrawals. Appropriate targets may be
derived from given benchmarks206 or use historical
experience of the institution, and local operating and
economic conditions, but should also be forward-looking to
incorporate the evolving business profile of the MFI and the
operating environment.

MFIs have tended to maintain higher levels of savings


liquidity than local banks to guard against a weaker
reputation and as a way to engender client confidence. If an
MFI does not hold a sufficient amount of cash to cover large
or unanticipated withdrawals from its deposit accounts, it
risks a liquidity crunch or even insolvency207. The ability to
cover a sudden and substantive volume of deposit
withdrawals is particularly important for MFIs serving clients
with uneven consumption patterns, including irregular loan

206
Women’s World Banking recommends a trigger level of 20 percent. At this point, an MFI should consider increasing its cash
position, or even reducing deposits if insufficient liquidity is available.
207
There is much anecdotal and rich literature of the microfinance revolution in India. However, given that failures are the biggest
source of learning, there is little or no literature available for those organizations that went kaput due to either fraud or
mismanagement.
242 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

cycles, or seasonal loans (e.g. agricultural loans). An MFI


must also be prepared for unexpected and high deposit
withdrawals that might result from clients facing exogenous
shocks, such as a national economic or political crisis, or
natural disasters.

13 Loans to Deposits Ratio Measures the relative portion of the MFI’s portfolio that is
funded by deposits. Combined with the Effective Financial
=Gross Loan Portfolio / Deposits Expense of Deposits ratio, this ratio can give an informed
analysis of the role of deposits as a funding source (in
Ideally, compulsory savings should be
addition to being an important client product)
excluded from this ratio but two
versions of the formula may be drawn. The Loans to Deposits ratio is for use by MFIs that capture
deposits.

The Loans to Deposits ratio measures that portion of the


MFI’s portfolio funded by deposits. The lower the ratio, the
greater is the MFI’s capability to fund its loan portfolio from
deposits.

A proportionally larger deposit base as a percentage of the


loan portfolio will typically lead to an overall lower cost of
funds, assuming that the deposits program is cost efficient
in its operational and financial expense of deposits ratios.

The higher the ratio, the more the MFI must rely on external
funding, which is often a more costly source of funding than
deposits. Deposits should always be considered both as a
source of funds for on-lending and also as an important
client product.208

14 Non-performing Loans as of 30 Non-performing Loans as of 30 Days Past-Due was


Days Past-Due (NPL30) previously called Portfolio at Risk as of 30 Days (PAR30).
Historically, PAR30 has been the most accepted measure of
= (Non-performing Loans > 30 Days+ microfinance portfolio quality. The most common
Value of Renegotiated Loans)/Gross international measurements of Non-performing Loans are
Loan Portfolio Adjusted NPL30Ratio greater than 90 days. Based on the microfinance business
model, 30 days is a more appropriate time horizon for this
=Adjusted Non-performing Loans >
ratio, as it has been for PAR30.
30 Days + Value of Renegotiated
Loans / Adjusted Gross Loan Portfolio The adjusted NPL30 reduces Gross Loan Portfolio in the
denominator by the Impairment Loss Allowance and the
Write-off Adjustment.

208
Fitch Ratings,pg 13 cites this ratio as one of its five liquidity ratios that measure the basic structure of bank funding
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 243

15 Renegotiated Loans Ratio The Renegotiated Loans ratio includes all rescheduled,
restructured, refinanced, and renegotiated loans.
=Value of Renegotiated Loans /Gross Renegotiated loans are usually undisclosed and cannot be
Loan Portfolio Adjusted Renegotiated identified separately with the NPL30. This ratio discloses the
Loans Ratio volume that these loans comprise as a percentage of an
MFI’s loan portfolio and discloses the risk level of the
= Value of Renegotiated Loans
renegotiated loan portfolio.
/Adjusted Gross Loan Portfolio
These loans are important to measure, disclose, and monitor
since they consist wholly of loans that could not be repaid
under the original terms. Renegotiated loans are not
considered delinquent because they have new terms. Yet
these loans would likely have become delinquent had they
not been renegotiated in some way. Hence, the value of all
renegotiated loans is added to the numerator of the Non-
performing Loans as of 30 Days Past-Due ratios. The
renegotiated loans portfolio is a higher risk loan book. The
renegotiated loans portfolio should be appropriately
reserved given its risk category. As with NPL, MFI should
prepare a delinquency breakout table for renegotiated loans
showing those due >1 day, 2-30 days, 31-90 days, 91-180
days, 181-365 days, and > 365 days. These delinquency
tables should be made available to regulators, donors,
creditors, investors, rating agencies etc.who are reviewing
the MFI’s overall portfolio quality. Regulatory authorities
should require MFIs to disclose the renegotiated portfolio
separately. Rating agencies should also include a
renegotiated loans ratio in their respective rating reports.209
The adjusted Value of Renegotiated Loans reduces Gross
Loan Portfolio in the denominator by the Impairment Loss
Allowance and the Write-off Adjustment.

16 Write-off Ratio The percentage of the MFI’s loans that has been removed
from the balance of the Gross Loan Portfolio because they
= Value of Loans Written Off/ Average are unlikely to be repaid. MFIs’ write-off policies vary; it is
Gross Loan Portfolio recommended that managers calculate this ratio on an
adjusted basis. National regulators may require MFI
Adjusted Write-off Ratio
adoption of specific write-off ratio. See Appendix 3 for
= (Value of Loans Written Off + details on how to make adjustments.
Write-off Adjustment)/Adjusted
The adjusted Write-offs Ratio is the preferred version of this
Average Gross Loan Portfolio

209
Microfinanza Rating calls these “restructured loans.” Planet Rating calls them “rescheduled loans”
244 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

ratio. See Appendix 3 for details.

17 Non-performing Loans as of 30 This ratio gives the most comprehensive measure of asset
Days Past-Due + Write-offs Ratio quality. It includes all NPLs>30 days, all renegotiated loans,
and write-offs. In the past, troubled loans could be shifted
= (Average Non-performing Loans > among these categories. This ratio shows the combined
30 Days + Value of Renegotiated impact of these three components of asset quality.
Loans + Value of Loans Written Off)/
This metric is the most comprehensive measure of asset
Average Gross Loan Portfolio quality. This ratio includes all overdue loans greater than 30
days, as well as all renegotiated loans and write-offs and
Adjusted Non-performing Loans as of
shows the combined impact of these three components of
30 Days Past-Due + Write-offs
asset quality. The write-offs component of the ratio excludes
Ratio= (Average Adjusted Value of
the value of any loans recovered. For ratios that include
Non-performing Loans > 30 Days +
delinquent loans, accrued interest income on past due loans
Value of Renegotiated Loans + Value
on the income statement should be reversed so that an MFI
of Loans Written Off+ Write-off
does not overstate its income.
Adjustment)/Average Adjusted Gross
Loan Portfolio The adjusted version of NPL30+ write-offs ratio factors in
adjustments to NPL30, write-offs, and to the gross loan
portfolio. Some microfinance lenders have historically had
NPL 30 ceilings of 5% of the gross loan portfolio, and write-
off ratios of 2%, so an initial benchmark rate could
tentatively be established at 7%. As a point of comparison,
the median 2008 MIX Market benchmark for all reporting
MFIs was 3.1%for NPL 30 and 1% for write-offs. However,
both of these ratios were higher in 2009 (~5%), and may
increase in 2010/11.

The adjusted version of NPL30+ write-offs is the preferred


version of this ratio as it incorporates the adjusted version of
write-offs and incorporates Impairment Loss Allowance and
Write-off Adjustments to the Gross Loan Portfolio.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 245

18 Loan Loss Rate= Provides a true picture of loan losses from write-offs by
including the offsetting value of recovered loans. This ratio
(Write-Offs – Value of Loans will tend to vary far more than the Write-Off Ratio, since
Recovered) / Average Gross Loan loan recovery tends to be sporadic and occurs irregularly in
Portfolio time and amounts.
Adjusted Loan Loss Rate= (Adjusted The Loan Loss Rate ratio provides a more comprehensive
Write-Offs– Value of Loans picture of loan losses from write-offs by adding back the
Recovered)/ Adjusted Average Gross value of recovered loans into the overall ratio calculation.
Loan Portfolio This ratio will tend to vary far more than the Write-Off Ratio,
since loan recovery tends to happen irregularly in both time
and amount210. For the same reason, the Loan Loss Rate
ratio is one of the more challenging ratios to forecast. The
adjusted Loan Loss Rate ratio factors in adjustments to
write-offs and to the average gross loan portfolio.

The adjusted version of the Loan Loss Rate is the preferred


version of this ratio as it incorporates adjustments for Write-
Offs and Impairment Loss Allowance in the Gross Loan
Portfolio.

19 Risk Coverage Ratio Measures how much of the Non-performing Loans as of 30


Days Past-Due + Value of Renegotiated Loans (R14) are
= Impairment Loss Allowance / (Non- covered by the MFI’s Impairment Loss Allowance.
performing Loans > 30 Days Past-due
+ Value of Renegotiated Loans) The adjusted ratio incorporates the Impairment Loss
Allowance Adjustment and the Write-off Adjustment.
Adjusted Risk Coverage Ratio

=Adjusted Impairment Loss


Allowance / (Adjusted Non-
performing Loans > 30 Days + Value
of Renegotiated Loans – Write-off
Adjustment)

20 Impairment Loss Allowance Ratio Measures the Impairment reserve as a proportion of the
gross portfolio. It can also be measured as a proportion of
= Impairment Loss NPL30 with NPL30 in the denominator.
Allowance/Average Gross Loan
Portfolio The ratio measures the loan loss reserves held as a

210
The MIX Market median benchmark adjusted Loan Loss Rate for all MFIs in 2008 was 0.8%. While the levels vary by MFI
cohort type, the range typically falls between 0.2 and 0.3 % lower than the median write-off ratio. Once this ratio has been
tracked over time, more methodical analyses can better determine the relationship between the Write-off ratio and the Loan Loss
Rate ratio.
246 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

proportion of the gross loan portfolio. The higher the ratio,


Adjusted Impairment Loss the more conservatively the MFI has provisioned in
Allowance Ratio anticipation of losses due to default in its portfolio. This ratio
can be distinguished from the Risk Coverage Ratio, which
= Adjusted Accumulated Impairment
measures the impairment loss allowance as a percentage of
Loss Allowance/Adjusted Average
the Non-performing Loans as of 30 Days Past-Due.
Gross Loan Portfolio
The Impairment Loss Allowance ratio gives a broader view of
the Impairment Allowance and reflects the MFI’s approach
to reserving for loss on its overall portfolio.

The Adjusted Impairment Loss Allowance aligns this ratio


with the quality of the loan portfolio.

21 Impairment Loss Expense Ratio Provides an indication of the expense an MFI incurs to
anticipate future loan losses. It measures actual expense
=Impairment Losses on Loans incurred on loan losses on an income statement as a
/Average Gross Loan Portfolio percentage of gross loan portfolio. This net figure on the
income statement excludes the value of any loans recovered.
The higher the ratio, the more is spent on portfolio losses.
While expense will increase if the portfolio grows, the ratio
will only rise if the proportion of losses to the portfolio
increases.

22 Portfolio to Assets Measures the MFI’s allocation of assets to its lending


activity- considered to be the core activity for a microfinance
=Gross Loan Portfolio/Total Assets lender.

23 Operating Efficiency Ratio Highlights personnel and administrative expenses relative to


total revenues. This is a commonly used efficiency indicator
=Operating Expense/Revenues in the commercial banking sector. Historically referred to as
the Operating Expense ratio, this ratio was defined as
Adjusted Operating Efficiency Ratio
Operating Expenses/Average Gross Loan Portfolio, and
= Adjusted Operating measured the costs incurred to deliver loans.
Expense/Revenues
Including adjustments, such as in-kind subsidies, will
typically decrease the absolute value of this ratio.

24 Operating Expense of Deposits Tracking this ratio is important to ensure that deposit
Ratio(Cost per Unit of Deposits mobilization is cost effective for the MFI. Moreover, this
Mobilized) ratio can guide the MFI on how to price its deposit products.
Calculating this ratio requires that the MFI disaggregate all
= (Direct + Indirect Operating direct and indirect deposit- related costs, which may be a
Expenses Allocated to challenge for some MFIs. Thus, this ratio may be less
Deposits)/Average Savings Balance commonly tracked and used. It is only relevant for deposit-
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 247

(Average Deposits) taking MFIs. Efficiency and productivity ratios measure how
well an MFI uses financial and human resources.

The Operating Expense of Deposits ratio is important to


ensure that deposit mobilization is cost effective and
compensates the MFI for the cost of administering the
program. The ratio is only relevant for deposit-taking MFIs.
Specifically, it reveals how expensive it is for the MFI to run
its savings program in terms of all non-interest expenditures,
including administrative fees and personnel expenses. This
ratio indicates if an MFI accrues financial gains or losses
from deposit mobilization net of costs incurred
administering deposits. If the cost of the deposits program is
too high, then the institution should consider replacing
deposits with cheaper short-term borrowings. The ratio can
also guide the MFI on how to price its deposit products.

Calculating this ratio requires an MFI to disaggregate all


direct and indirect deposits-related costs, which may be a
challenge for some MFIs. Currently, most MFIs do not
segment operating expenses by line of business but rather
track only aggregate institutional operating expenses. As a
result, this ratio may be less commonly tracked and utilized
by MFIs. This is an indicator of operational performance as
well as financial performance. Any decision taken on the
basis of this indicator should include a comprehensive
understanding of operations. For example, this ratio could
indicate the need for operational improvements within the
MFI, or the need for adopting a different financial strategy
within the MFI's operational and business plan.

This ratio should be viewed in tandem with Financial


Expense of Deposits. The effective financial expense of
deposits (or average interest rate paid on deposits) should
be lowered if financial expense plus operating expense is
greater than the cost of other forms of an MFI’s liabilities or
equity. From a profitability perspective, deposits should be
the most cost-effective form of liabilities in order to justify
the expense of maintaining the deposit program.
248 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

25 Cost of Funds Ratio= Calculates a blended interest rate for all of the MFI’s funding
liabilities.
=Financial Expenses on Funding
Liabilities / Average (Deposits, The adjusted ratio will usually be higher due to the effect of
Borrowings) deducting the Subsidized Cost of Funds Adjustment.

Adjusted Cost of Funds Ratio

= Adjusted Financial Expenses on


Funding Liabilities / Average
(Deposits, Borrowings)

26 Financial Expense Ratio The Financial Expense ratio measures the total interest
expense the MFI incurs to fund its lending portfolio. This
= (Interest + Fees Expense on ratio can assist an MFI to determine the minimum interest
Funding Liabilities)/Average Gross rate that it must charge borrowers in order to cover its
Loan Portfolio funding expense. An MFI that captures deposits will likely
have a lower financial expense ratio than an MFI that
Adjusted Financial Expense Ratio
borrows through commercial sources. An MFI that receives
= (Adjusted Interest + Fees Expense subsidized borrowings may also have a lower rate than an
on Funding Liability)/Adjusted MFI borrowing from commercially priced funding sources.
Average Gross Loan Portfolio An MFI borrowing in other currencies will need to convert
the foreign currency interest and fees into local currency in
order to calculate the Financial Expense ratio correctly using
local currency denomination.

The financial expense ratio is adjusted to deduct out


subsidies. A subsidized MFI will thus have a higher adjusted
Financial Expense ratio.

This ratio represents the MFI's financial expense position


with subsidized cost of funds deducted. A subsidized MFI
will have a higher adjusted financial expense ratio.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 249

27 Financial Expense of Deposits If an MFI tracks the line item inputs in this ratio, it allows the
Ratio(Cost of Deposits) institution to directly compare the cost of funds of its
deposit program to borrowing opportunities in the market.
= Total Interest Expense of Deposits / This ratio does not factor in the benefits of deposits as a
Average Savings Balance (Average product for its clients. It is only relevant for deposit-taking
Deposits) MFIs.

The ratio measures how much of its overall funds an MFI


pays out in interest for its deposits program. It is only
relevant to deposit-taking MFIs. The ratio allows the
institution to compare directly the cost of funds of its
deposit program to other borrowing opportunities in the
market. This ratio does not factor in the benefits of deposits
as a product for its clients. When weighed against interest
expense presented by other options, the information yielded
from this ratio allows an institution to evaluate the
opportunity cost of its deposits program relative to other
potential or actual strategies. Given the complexities of
deposit mobilization, an institution should ensure that
deposits are the most cost-effective liabilities in its capital
structure. If the deposits program incurs higher financial
expense than other market-based sources of funding, MFI
management may consider lowering interest rates offered
on deposits, or restructuring its program in some manner.
These decisions should take into account the financial
viability of offering alternative deposits products to their
clients.

This ratio can also be useful for analyzing comparisons


between institutions within a given market as well as
comparison to a deposit market benchmark. It provides a
method to conduct a crosscheck between the stated interest
rate paid to depositors and the actual interest expense that
an MFI incurs on its income statement. The ratio itself does
not provide information on any possible offsetting benefits,
for example, if the savings deposits attract good loan clients
who would otherwise go elsewhere, resulting in net revenue
gains.
250 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

28 Cost per Active Client A simple but effective measure of an MFI’s average cost of
maintaining an active client. Costs per client may vary
=Operating Expense/Average Number significantly depending on the type of product being
of Active Clients serviced by the MFI. “Client” should be interpreted as
“unique client" for this ratio, since an MFI client may access
Adjusted Cost per Active Client
multiple products. The MFI should also clearly define “active
=Adjusted Operating client.” One example definition would be a client that has
Expense/Average Number of Active used an MFI’s lending, savings, or insurance product in the
Clients last 12 months. This distinction helps set apart active clients
from “dormant” clients who may be sitting out one or more
loan cycles, but who are still satisfied with the MFI's products
and services.

Adjustments to operating expenses include any in-kind


subsidy that may reduce operating expenses, and thereby
decrease this ratio on an adjusted basis.

29 Borrowers per Loan Officer Measures the average caseload of the average number of
borrowers managed by each loan officer.
=Number of Active
Borrowers/Number of Loan Officers

30 Active Clients per Staff Member Measures the overall productivity of the MFI’s personnel in
managing clients, including borrowers, voluntary depositors,
=Number of Active Clients/Total and other clients. As noted above, client should be defined
Number of Personnel as “unique client.” This ratio will vary both by productivity
and by the nature of the MFI’s products and services mix.

31 Client Turnover Measures the net number of clients continuing to access


services during the period. It is used as one measurement of
= (Number of Active Clients, client loyalty and satisfaction. MFIs should distinguish
Beginning of Period + Number of between exiting clients and dormant clients who may be
New Clients During Period – Number sitting out loan cycles but are still satisfied overall with MFI
of Active Clients, End of service and products.
Period)/Average Number of Active
Clients

32 Average Outstanding Loan Size Measures the average outstanding loan balance per
borrower. This ratio is a profitability driver and a measure of
=Gross Loan Portfolio / Number of how much of each loan is available to clients. While median
Loans Outstanding or monthly outstanding Gross Loan Portfolio size would be a
preferred indicator of loan size rather than using the
Adjusted Average Outstanding
average, these metrics maybe more difficult to obtain than
Loan Size
average figures requiring only beginning and end of period
=Adjusted Gross Loan Portfolio / amounts. In an effort to approximate the relative precision
Adjusted Number of Loans of a median value, MFIs using average calculations should,
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 251

Outstanding at the very least, remove upper limit outliers from their
calculations in an effort to approximate more closely the
true average loan size of its client base.

The adjusted form of this ratio incorporates the Write-off


Adjustment. This ratio can be measured as a percentage of a
local poverty line so that it can be benchmarked against
other institutions.

33 Average Loan Disbursed Measures the average value of each loan disbursed. This
ratio can be used to project disbursements. It can be
= Value of Loans Disbursed/Number compared to GNI per capita or as a percentage of a national
of Loans Disbursed poverty line as an outreach indicator While median or
monthly loans disbursed would be a preferred indicator,
these metrics may be more difficult to obtain than average
figure requiring only beginning and end of period amounts.

34 Average Deposit Account Balance Information may be interpreted as either client loyalty
and/or socio-economic level of the client base. This
= Total Deposits / Number of Deposit denominator is best to use when measuring for efficiency,
Accounts and is more readily available as compared to number of
depositors. It is only relevant for deposit-taking MFIs (not
applicable to ND-NBFCs).

Tracking the Average Deposit Account Balance ratio enables


a deposit-taking institution to assess its client base in terms
of the amount and volume of deposit accounts placed in the
MFI. This denominator is best to use when measuring for
efficiency, and is more readily available than the number of
deposit account holders used in the Average Deposit
Account Balance per Depositor ratio. The Average Deposit
Account Balance ratio also reflects the degree to which
savings products address client needs, and can thus be
considered a measure of client confidence in the institution.

Analysis of this ratio can provide useful information about


average deposit account size (usually considered a proxy for
client wealth but in Indian context storage in gold must be
calculated). Tracking clients' average deposit account sizes
can, help MFIs assess their mission adherence.

An appropriate average deposits balance target will depend


on an institution’s mission and objectives in the local market.
Trends over time will provide market demand information
that can be used to test different savings products and
252 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

expand into different geographical regions of a country.


Ratio results can also be cross-indexed with non-financial
data, such as GNI per capita, to allow analysts to make
comparisons across countries.

MFI managers should look closely at this ratio’s trend over


time. The ratio’s trend pattern should increase over time
since the goal of the MFI is to scale-up service delivery. A
drop in this ratio could signal a loss in confidence from the
clients, an increase in membership, a change in the target
population, or large deposit withdrawals due to a specific
external event. Each MFI should set its own optimal
objective based on the MFI’s business plan and mission. If
the MFI is growing quickly, managers may want to use
period averages for the denominator.

35 Average Deposit Account Balance The preferred ratio to use for measuring and analyzing client
per Depositor outreach, assuming that the number of depositors' data is
available. It is only relevant for deposit-taking MFIs.
= Total Deposits / Number of
Depositors The ratio is targeted to measuring and analyzing an MFI’s
client base and the deposits held by the institution. This
ratio is preferable for measuring and analyzing client
outreach – a measure of social impact. An appropriate
average deposits balance target per depositor will depend
on an institution’s mission and objectives. Tracking this ratio
over time provides MFIs with valuable information about:
client confidence in the institution; client wealth; and the
MFIs’ ability to expand into new geographic or product
areas.

We believe MFIs should aim for a rising ratio level, indicating


that clients are increasingly using savings products and have
more disposable capital to save. A declining trend could
indicate depositors withdrawing money or a decrease in
their ability to save. Conversely, an MFI may want a decrease
in the ratio, which could indicate growth in the number of
depositors, or a move “down market.”

A lower or declining average ratio has beneficial implications


for an MFI’s risk management, as a smaller average loan
amount indicates a more dispersed deposit base and less
concentration risk, and therefore lower deposit flight impact
per account.
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 253

Appendix 4: NABARD Supported MFIs


Financial details of MFIs extended support in the form of Capital Support (CS) and / or Revolving Fund
Assistance (RFA) as on February 2010 (Rs. lakh)

Table 42: NABARD supported MFIs


254 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

@ Security Deposit not taken into account while calculating the effective rate of interest since it will be adjusted towards last
instalment or refunded after loan is fully repaid
# Security Deposit taken into account while calculating the effective rate of interest
CS: Capital Support
RFA: Revolving Fund Assistance
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 255

Appendix 5: Performance Parameters


A fast maturing Indian microfinance industry needs standardized methods to measure, benchmark and
analyse financial performance and risk management of its operations. The existing study seeks to address
this need by selecting NABARD support MFIs.

We would’ve liked to peruse a set of Performance Parameters tools so as to assess the health of MFIs and
ascertain relevant benchmarks. These Performance Parameters may be used by any microfinance
institution (MFI) whether non-governmental organisations or non-bank financial companies as well as
commercial banks, regional rural banks, cooperatives etc. and can be compared on a set of common
parameters.

The Performance Parameters chosen are consistent with International Financial Performance Parameters
(IFRS), a set of global accounting standards increasingly adopted throughout the world; and, with the
Basel II framework as well. Additionally, all financial statement line items are aligned with the standardized
nomenclature developed for global financial reporting called eXtensible Business Reporting Language
(XBRL). The ratios will reflect the growing attention to measuring, comparing and analyzing (a)
performance (b) risks in the microfinance industry.

The phenomenal growth (return) of the sector – quoted at ~40% with many leading MFIs growing
manifold to that average number - must be revisited in terms of risk-adjusted-returns.

We acknowledge that a more robust set of performance standards may be needed, given the growing
number of MFIs that are regulated, capture deposits, and have increasingly complex capital structures,
off-balance sheet transactions etc. But – at this point – any more involved analysis than this does not
make sense since the underlying data is sticky. In the absence of any regulation, data is sparse; it cannot
be ascertained what adequately represents the industry; data is not entirely reliable, since it’s a
fragmented industry; data may be inconsistent with observations on field (unless a detailed portfolio audit
is conducted); due to absence of any reporting standard.

Further, these standards only address microfinance financial performance. Additionally, we will try and set
up other aspects of microfinance such as social performance, impact investing, and Performance
Parameters. But that will be predominantly through a qualitative assessment as an “also done” piece and
not be a principal focus since the formal literature on these softer issue is still quite underdeveloped.

Finally, through this effort, we will set the tone not only the processes but also a common language of
assessment so as to ensure microfinance performance metrics are calculated consistently so as to bring
into a common denominator MFIs from different regions, associations and networks, regulators, donors,
lenders and investors, rating agencies etc.

Like any other business, MFIs are subject to local crises, natural disasters, political and economic volatility,
and weak regulatory structures. Specific implications of this conservative approach are reflected in many
256 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

of these ratios. The Performance Parameters will induce transparency of financial and operational
information by MFIs to make reporting performance assessment as explicit as possible.

Table 43: Ratios for Performance Assessment

1 Profitability
2 Capital adequacy and solvency
3 Liquidity
4 Asset quality (portfolio quality)
5 Efficiency and productivity
6 Asset-liability management

Adjustment to ratios allow for a more standardized approach to MFI performance measurement, as
adjusted ratios are more in line with commercial banking reporting. This facilitates comparison between
different types of MFIs (such as non-profit and for-profit) and enables MFI financial performance to be
benchmarked against other MFIs and against commercial banks, RRBs etc.

The problem, in our view, the data available from MIXMarket are inadequate for a very detailed
assessment. While ratios are given and available, they can at best be taken as indicative for a rigorous
assessment.

However, benchmarks in this report are only an initial metric. Over time, benchmark rates, ratios and
expectations would obviously shift. The benchmark assessment may be extended to include:

a. Optimal in the cohort [e.g. All MFIs in India]


b. Median in the cohort
c. Global benchmarks [optimal and median]
d. Banks and other Financial Institutions
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 257

Appendix 6: Organisation Development Intervention


OD is a planned and sustained process of change to improve organisational effectiveness. Its target of
change is the total organisation applying the tools and techniques of applied Organisational Behavioural
(OB) and behavioural sciences. OD is a strategy of change with employee participation and is being
practiced world over in various organisations.

While there is a proliferation of OD approaches as different approaches are found succeeding in different
organisations and environments, working with main centre at BIRD, we will closely follow their advice and
experience on the OD intervention they had earlier conduced on 49 public sector RRBs. Since the
intervention was designed as a HRD component of revamping process of these banks initiated by the
Central Government/Central Bank in the wake of banking sector reforms, we can look into our project as
an intervention in NABARD supported MFIs in the wake of a much needed microfinance sector process
update.

Organisation Development Intervention (ODI) for 15 MFIs is proposed as a planned process of change; a
process that has been known to being useful for improving organisational effectiveness for the RRBs as
intervened by BIRD.

At the instance of BIRD, Aadhaar would like to take up the responsibility of designing an appropriate OD
intervention in select MFIs. The intervention by Aadhaar may not be invited by the MFIs themselves but by
key funders (i.e. NABARD, which has supported these MFIs either through the Revolving Fund Assistance
or through the Equity Schemes through their wholly owned subsidiary BIRD) and stakeholders and policy
advisors.

Objectives Den Criteria and Methodology Expected results

Normally, O.D. objectives are While the data on the business It is expected that the initiative will
set by the client organisation. parameters will be collected from help to create a healthy work
Contrary to this, in the bank's records, the data on culture in MFIs, increase employee
present case, the objectives of organisational processes were satisfaction and, thereby, lead to
O.D. Initiative will be evolved collected by interviews, group higher productivity.
by Aadhaar in consultation meetings and process
with BIRD to make the MFIs observations.
efficient, transparent and
viable organisations. The O.D. Initiative will be designed
by Aadhaar in consultation with
BIRD incorporating the O.D.
principles and objectives.

Sensitizing MFI employees to The design criteria to be The expected outcomes are:
appreciate the new realities in established: • Building a mission statement,
the context of potential vision, goals
regulation, changing market The process will insist on complete • Formulation of strategies and
scenarios and emerging involvement and participation of a workable action plans for
competition in the large cross section of employees achieving the goals
258 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

microfinance sector from all levels and pressure • Exhaustive debate on various
groups. issues for diagnosing the
Developing among them a organisation's problems and
sense of belonging to their Encourage the participants to think arriving at a consensus on the
organisation. Employee and analyze and sort out the strategies and Action Plans
retention has been a constant, problems themselves; the • Identification of internal
documented concern of many facilitator will not provide any Facilitators to take the O.D.
MFIs training inputs or prescriptions to Initiative message to other
solve the MFIs problems staff (who did not participate
Integrating their personal
in the process) and sustaining
goals with Organisational Through brainstorming, the
the tempo generated by the
goals employees will find answers to the
initiative
problems identified by them as
Building confidence and belief • Conducting studies and
critical
in their own capabilities to research on the MFI and
shoulder higher O.D. interventions are to be carried giving feedback to policy
responsibilities out in the MFIs premises, with makers for suitable policy
minimum dislocation of the normal correction
Enabling them to internalize schedule
and own up to their problems At the end of the O.D. Initiative
The methodology adopted had the program, the MFI employees will
Developing problem solving following components: be expected to do the following:
abilities among them • Communicate more openly
Sensitization of the Promoter and • Collaborate more effectively
Developing collaborative top manager to the concepts of • Take more responsibility
attitude and team spirit O.D., group dynamics prior to O.D. • Share a common vision for
among them intervention and enlisting their the organisation
support to O.D. process. • Solve problems more
Building a climate of trust,
effectively
openness, and transparency Intervention at the MFIs own • Show more respect and
environment involving a large support for others
In brief, the task is to find an
cross section of employees and • Interact with each other more
appropriate intervention
senior executives, creating a effectively
strategy enabling the MFI’s
climate and setting in which • Be more open to
human resources to create
hierarchies are broken to facilitate experimentation and new
congenial conditions for
frank and open discussions. ways of doing things
accelerating organisational
Brainstorming and group process • Be more prepared for change
growth and development
to identify bank's problems and to • Actively participate in
find solutions thereto by planning and decision making
examining all possible alternatives. • Promote free flow of
Analysis of MFI’s performance data information
and benchmarking it and • Function strategically rather
examination of the replicability of than simply in response to
success stories and best practices stimulus
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 259

Appendix 7: On-field research and assessment


Overview of the process
1. Centres/groups were selected at random (and Data collection processes during the
which could be readily mobilised) fieldwork includes:
2. Sometimes the discussions had to be one-to-one
long interviews; sometimes they were group (a) Respondent recruitment (through
discussions. This would depend much on the initial screening guide) specifically
group (dynamics) and individual sociability and through group discussions
extrovert nature. (b) In-depth personal interviews and
3. We study and document the loan policies and group discussions
procedures; basic legal and financial documents (c) Transcription and content analysis
for Due Diligence (DD) of the discussions
(d) Quantitative data collection
4. At the implementation/audit level:
(e) Conversion of interview transcripts /
a. Select borrowers randomly; loans sufficiently audio and/or video into key findings
seasoned for documentation
b. Examine financial literacy Trace the loan
status (with outstanding/closure/written-
off)of these borrowers down to the branch office records
c. Trace the loan status (with outstanding/closure/written-off) of these borrowers
d. Trace regular and overdue repayments and reconcile into the MFIs PAR analysis including
method of assessment of age of overdue, sequence of appropriation of client repayments
and the like. If difference exists in the loan outstanding/closure/write-offs for a client across
various levels of analysis, then all concerned transactions need to be reviewed and reconciled
5. Reconciliation with other records like cash-book, receipts, vouchers and cross-verifying these with
loan ledgers and the like for selected clients
6. Verify whether loan administration is in accordance with policies and procedures
7. Verification of loan accounts for rollovers and re-structuring to ascertain whether the clients really
proved willingness and ability to satisfy the loan obligation or is the loan repayment affected by a
follow-up fresh loan disbursement
8. Review of loan portfolio management (credit policy, delinquency measurement and management,
loan loss provisioning and write-off etc.) policies/procedures/systems. Comments on each of
these should be documented and form a part of the final report
9. Verification of internal and external controls for loan portfolio management. Control mechanisms
should be elaborated and commented upon
10. Overlap of microloan with other MFIs
260 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Appendix8: Sample Questionnaire Administered


The questions are those that were useful for a qualitative assessment. Given below are an indicative set of
questions. We have put together a few other questions in the main report.

Administration
Have you taken a loan from MFI?
Do you know the name of the organisation / company/ies?
Do you know the rate of interest charged? You view...
Do you know the amount of Loan Processing Fees charged? You view...
Do you know the amount of membership fees collected? You view...
Does the field staff conduct meeting every week?
Do you know other staff of the organisation? (at least recognize him by face)
Who are the “best” MFIs?

Loan passbook
Is the loan passbook updated?
If no, reasons for not updating?

Attendance
Have you attended all the centre meetings conducted till date?
Are there any penalties for coming late?
If no, then how many meetings you missed?
Reasons for not attending the meetings...
Did any other person represent you in your absence?

Loan Origination
How were the groups formed? Who formed them?
Are there close relative of yours in the centre? ...in the group? ...inthe field staff?
Does it help to own a house / property in the village?
Are the centre leader elected by the centre members? ... If no, then who elected the centre leader?
For how many days was the Group Training conducted?
Was the Group Recognition Test Conducted at the field level by BM?

Loan Disbursement
Was the loan disbursed to you in the centre meeting?
Were all group members present at the time of loan disbursement?
Why do you think loan the disbursed to only those members who have minimum attendance?
Was the consent of the centre taken for all the loans disbursed?
Do you know that the maximum eligible loan amount for the first cycle is? ...the second cycle?
...the third cycle loan?
How much amount of loan have you availed from MFI?
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 261

Check it with loan passbook for any discrepancy? (Reasons for discrepancy to be noted down)
Have you availed any other supplementary loan from MFI?
o If yes, then the amount of EL taken?
o Did you approach any other (MFI, moneylender, relatives / friends...)?
Were your spouse / any family member present during the loan disbursement?

Loan Repayment
Do you know the concept of Joint Liability within the Centre / Group?
Is there any loan client who is not repaying regularly in the centre? How do you deal with it?
Is yes, then what are the reasons for not paying?
Does the group / centre taking the joint responsibility of repaying her arrear amount?
Are you willing to take the joint responsibility to repay the loan account overdue?
Does it make sense to you that you are responsible for someone else whom you are not related
to? What if this person is someone who you don’t like?
How many instalments have you paid till date? How many remain?

Loan Utilisation Check


Was the Loan Utilisation Check done by the field staff?
What kind of investment you made with the loan taken? (Specify as per the interaction with the
client)
(Smilingly)...since you’ve taken X (X>=3) many loans, do you show the same underlying asset to
all for LUCs?
Are you advised on how you are “supposed to” use the loans?
Do you see it as “loans” being given or “money”? Are your decisions to take more loans (on the
same underlying asset) based on expectations that the government will waive off repayment?
Is there a problem in using the loan for children’s education, medical emergencies and running
the regular needs of household?
What if the stead source of your husband drops suddenly? You think you should be using the
loans to do “business”?
262 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Appendix 9: A few checkpoints for the branch


Checking the Loan Documents
Are the membership data forms completed?
Are Group Recognition Training forms completely filled?
Are the Loan Application and Disbursement Forms completely?
Do signatures on the membership, loan agreement, loan application documents tally?

Checking the MIS


Is the CGT date done properly? What is the process?
Is the GRT getting done properly (broadly as per the MFI policy)?
Date of joining the group?
Who sanctions the loans: AM/BM?
Was the loan sanctioned in the weekly meeting (or outside)? ( Check any register if available)

Checking the Cash Transactions at Branch Level


The top sheets of a particular field staff match with the consolidated sheets for the particular date
The consolidated figures of loan recovery and disbursement on a particular day tally with the
vouchers?
The Opening balances and Closing balances for the particular day tally?
The Closing Balance on the particular day is not more than the expected disbursement on the
next day?
The details in the day book tally
The Details in the general ledger tally
All the transactions tally with the MIS
All the members of the group were present on the date of disbursement
Are the Bank Reconciliation Statement collected monthly as per organizational policy?
Tally BRS with Opening Balance (General Ledger)

Loan Prepayment
Present Loan Cycle of the Client
Has the client made any prepayments prior to this loan cycle? If yes, did it fall in line with policy?
Was there any behaviour of irregular repayments prior to prepaying the loan? If yes, why?
Would you prepay your loans? Why and under what circumstances?
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 263

Appendix 10: The Microcosm and Macrocosm of


Microfinance211
As microfinance becomes the flavour of discussion with abounding literature being presented earlier that
applauded the poverty alleviation that microfinance has catalysed, there is also this growing body of
evidence that criticises the ‘dark side’ to the extent of almost overlooking the benefits that the sector has
brought about. Though microfinance, in large part, has ‘transformed’ from a ‘social’ business to a (social)
‘business’, it is still unequivocally acknowledged that microfinance is additionally endowed with keeping
societal impact in consideration catering to those who are not only underserved but also economically
and socially underprivileged (and may thus need state protection).

Market risk is very little understood, credit risk even less. Long Term Capital Management, arguably the
most famous hedge fund, which had two Nobel laureates on board collapsed despite having, supposedly
a 15 sigma, implying probability of default an infinitesimal fraction of a percent. Then hedge funds,
recognised as highly leveraged businesses, and with little and no regulation then, caught greater focus.
Subsequently, they were brought into ‘light and careful’ regulation. While there is no rational comparison
between microfinance and hedge funds, ‘leverage’ is a creator of many a financial crisis, as pointed out by
Hyman Minsky, the surrounding paranoia in the macro-perspective is understandable. The fear of any of
the big four MFIs failing, as has lurked in the minds of many industry observers, will create a massive
impact on perspectives on financial inclusion and beyond. And, they can’t be bailed out212!

The current popular press bashing Non-Banking Finance Companies (NBFC) microfinance operators, as
exploitative, should not overlook the tremendous positive macro-economic impact that microfinance in
the last 3-4 years has created; special contribution of the resounding positive impact created by the
NBFC-MFIs: Rural employment opportunities, access to affordable finance (compared to interest rates of
300-500% charged by moneylenders), propensity towards a (Gandhian-type) self-sufficiency at the village
level and deepening the financial infrastructure. Greed and fear create the bullish and bearish runs and
concerns loom large in the minds of the investor (valuations being driven downwards). Think tanks have
now begun to assess several questions from a policy and regulatory perspective, with a greater sense of
urgency.

For instance, should proliferating for-profit NBFCs be encouraged? Would this, essentially, entail
deepening the financial divide or facilitate bridging it? Given that the original reason of microfinance to
come away from loan sharks and usurious money lenders, should there be a cap on interest rates? Or
spreads? There a trade-off between outreach and efficiency of MFIs in India: should the economic benefits
be shared with the clients? Are the operational costs of MFIs really that high; or, can interest rates be
brought down? Should we have a fragmented, localised large number of local suppliers who are more
emotionally rooted to poverty alleviation or should we have a few large NBFC-MFIs consolidated through

211
Banerjee, Ayan A., “The Macrocosm and Microcosm of Microfinance” (October 21, 2010). Available at SSRN:
http://ssrn.com/abstract=1701662
212
The erstwhile 99%+ repayment rate is now of little consequence. While assessing risks, anyway, these numbers will soon need
to be revised downwards as more mature MFIs sectors in Latin America have experienced.
264 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

rapid organic or inorganic growth, who are well positioned to be suppliers for most of the microcredit
supply and, thereby creating an efficient sector? Should the lending be secured or unsecured? Should
NBFC-MFIs be allowed to mobilise deposits? Will the consolidation of NBFC-MFIs through M&A create
value or destroy value, since they will have an effectively eroded client base due to multiplicity of loans?
Depending on the policy view, if should there be a distinction between the rural marketing of bottled cola
and microfinance delivery? We understand that the outcome of these debates will have important
implications for the potential direction for regulation of the sector. There is a serious implication of these
on macroeconomic indicators: obviously, inflation levels; employment rate (yes, the sunrise sector has
generated a huge employment opportunity in the rural areas, a path to poverty eradication; GDP – as
soon these micro-enterprises become formalised institutions as Micro and Small Enterprises through
various credit cycles; as well as various social and human development indicators.)

At the micro-level: With a lot of thirty thousand feet above the ground discussions and opinions are
being liberally churned out, the view is less likely to help unless one understands the basics of the current
concerns in microfinance. We begin by outlining the micro-perspective.

Any loan by any entrepreneur results in having fixed cash outflows mapped against variable cash inflows.
The excess of all costs, including debt obligations is the surplus that is available to the household as
‘profit’. As it accumulates over time, the profits saved form as cushion for taking more credit and against
credit defaults. However, when the same erodes - ceteris paribus - because of rising (debt) costs
bankruptcy begins to envelope the household. Few MFIs are doing their credit checks diligently.

Application of debt: Many micro-


entrepreneurs have been blessed in Exhibit 58: Why the famous repayment rates of 99% are
recent times with ample access to not sustainable in Microfinance?
microfinance. While the loans were
intended for enhancing income
generation, in a large number of Assuming that expenses
cases they are used for consumption N Has Y are not increasing, the
increased accumulated savings
purposes. Any ‘loan purpose-
income? should increase implying
utilisation’ check can’t verify it. Even a general increase in
when they are used for income ? wealth and welfare of the
purposes, it must be noted that the Applica Income household
relationship between financing and tion of Expenditure
returns to scale is not elastic. There Debt… Savings
are indeed myriad other ingredients
that would be necessary (marketing
Debt Trap!
and business development for one)
for success of the enterprise. Thus, a Savings erosion .The expenditure would
higher supply of credit, if availed, is include consumption and /or also
only likely to only create a debt repaying previous loans. To maintain
living standard, take further debt.
burden without the proper
application of the finance. So what is
the ‘optimum’ supply of credit to the
entrepreneur and how does one ascertain it? This necessitates financial literacy, which is alarmingly poor
in all socio-economic segments, more so here. It’s not that easy to reason: When and how much should
you take a loan? Financial literacy needs to be imparted at the grassroots level to make micro-
entrepreneurs more discerning, since debt can be a double edged sword!
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 265

Micro-enterprise development is critical: Without loss in generality, let us take the case of
Lalitha, a vegetable vendor in Chennai. She takes a loan of Rs 20,000 from an MFI. Availing of the
debt she prospers, when cash flow rises beyond what is needed to pay off debt and consumption;
soon thereafter a speculative euphoria develops. Then two other MFIs offer her loans of Rs 15,000
each. Underestimating the entrepreneurial skill in an individual is a ‘missed opportunity’ (as Prof.
Yunus highlights) but overestimating it is a risk! Lalitha, assuming a constant (or even increasing)
returns to scale for the vegetable business, taken the loans. Alas, she subsequently realises that it
may not be that simple. As she struggles, suffering losses, she is reminded of the loans she has to
repay. Ever-greening is rampant; one loan has already been sized up. Unable to repay, she takes
yet another loan from another new age MFI. This slow movement from stability to crisis leads to
impoverishment. As these repayments continue to pile up, coupled with extortionist of recovery
agents, she either contemplates suicide to avoid humiliation or forms a group with other similar
defaulters and tries to get the debt waived by approaching the local government.

Cutting corners: The creation and formation of a group and training them to appreciate
microfinance costs Rs 4,000–5,000. It is tempting for an MFI to cut costs and time by acquiring
entire groups of other MFIs and enrol them. The shortcuts inflate client numbers and portfolio,
with limited incremental cost of acquisition. Balance sheet analysis will wrong herald them as
“efficient” with the valuations looking shinier. This encourages field operators to overlook multiple
lending. Yet, another case of competition not driving in best! Over-indebtedness in saturated
places; first mover disadvantage is in virgin areas which nobody finds attractive (‘microfinance-
able’) due to genuinely higher operational costs as well as costs of explaining microfinance. The
tip of the iceberg is coming into view; the downside of everyone chasing the same low hanging
fruits.

The Innovation buzz: Several enthusiasts have been talking about customisation and innovation
as soon as a mass market product is rolled out. It’s the most obvious thing to do. In today’s
microfinance scenario, innovation and customisation are far outcries; the T-model microcredit
delivery needs radical uplifting. The quest for positioning a financial institution as service provider
of blind spots is chronic (‘new age banks’ have been doing for more than three decades!). The
need to deliver the same, though mesmerizing, is not acute. As has been comprehensively argued
in leading scholarly circles, this is neither the time for innovation (e.g. securitisation, being one
such attempt to free capital; we’re not talking about bilateral portfolio sales here) nor
customisation but to do damage control of the potential miscarriage of the vanilla product.

The crux of the issue today: The real concern in microfinance today is not interest rates. The average
rate of interest on credit cards is 34 percent is acceptable. Interest rates, even if brought down by 2-4%
from 20-30% today, would bring down the weekly instalment to only about Rs 5-10, quite an
inconsequential amount even for the end borrower. A second loan doubles the weekly burden. In many
villages, borrowers routinely take loans from as many as 10-12 MFIs! And there is no way to do this credit
check, yet. It’s like having ten loans from ten banks on the same vehicle! Should even a single borrower
default or the loan be waived at the local level, there is likely to be multiple delinquencies for the sector.
The gravest concern today is that there is no mechanism being implemented to sort out multiple lending.
Fortunately, thoughts are on.
266 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Appendix 11: Asset-Liability Management (ALM)


We would’ve really liked if we could help MFIs with ALM. Surprisingly, most MFIs are still not acquainted
with ALM practices common in any other financial institution. Thus, for the greater common benefit, we
put together a quick primer.

Each ALM tables is divided up into vertical time horizon columns called “tenor buckets.” The time frames
may be modified depending on the MFI. MFIs that experiences short-term changes in the values of their
assets and liabilities, such as MFIs that do agricultural lending prone to seasonality and cyclical variation,
may need to shorten the smallest tenor bucket to a period of one week, and the duration for each tenor
bucket may be shorter. Each of these tables measures the mismatch (excess or deficit) of assets over
liabilities, as a percentage of an MFI’s total equity. An MFI that measures total capital rather than equity
(such as for use in Capital Adequacy ratio and Uncovered Capital ratio) may compute the asset-liability
mismatch as a percentage of total capital.

Liquidity risk measuring, disclosing mismatches in maturities of MFI assets and liabilities.
Re-pricing risk through analysis of the time horizons in which interest rates on assets and
liabilities reset and re-price. This table includes a sensitivity analysis of the impact of a one
percent increase or decrease in interest rates.
Foreign exchange risk exposure for an institution that holds assets or liabilities in a foreign
currency or currencies. It also measures the aggregate net foreign exchange open position of all
of the MFI’s foreign currency holdings as a percentage of equity. This table includes a sensitivity
analysis of the impact of a 10 percent currency depreciation or appreciation.
Foreign exchange risk liquidity, combining foreign exchange risk exposure in tenor buckets to
get a view of the entire balance sheet. It discloses the maturation of assets and liabilities per
foreign currency.

Table 44: Performance Parameters for Asset-Liability Management

Table No. Explanation


ALM 1 Liquidity Risk Measures the maturities of assets and liabilities on an MFI’s balance
(Maturity Risk) sheet. This table helps an MFI to determine where funding gaps exist,
allowing it to adjust maturities as possible, and plan for liquidity
needs. In line with the conservatism and prudent approach on
reading financial ratios, this table should be based on asset and
liability contractual maturity dates. An MFI may also model this table
using the expected behaviour approach of depositors in terms of
deposits’ maturity assumptions.
ALM 2 Interest Rate Risk (Re- Looks at mismatch between when an MFI’s assets and liabilities
pricing Risk) interest rates re-price. Interest rate re-pricing mismatch affects cost of
funds, the rate charged on client loans, and institution profit. Re-
pricing can occur when an asset or liability matures, or when a
variable rate changes (such as loans based on LIBOR / EURIBOR). For
a conservative and prudent approach, this table should be based on
the contractual re-pricing dates, as opposed to actual behavioural
An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs 267

maturity of depositors.

ALM 3 Foreign Currency Risk Provides information regarding aggregate exposure to foreign
(F/X Risk) exchange risk by potential exchange rate movements. The risk
exposure is measured by looking at foreign currency amounts held in
an MFI’s assets and liabilities. It includes disclosure for each foreign
currency held. If the MFI operates 100 percent in one local currency,
the table is not needed. Matching assets and liabilities lessen
currency risk exposure. ALM4 details full currency foreign exchange
risk analysis factoring in asset and liability tenors.
ALM 4 Liquidity Risk per This table breaks out balance sheet assets and liabilities by maturity
Foreign Currency and by currency, into tenor “buckets” showing when foreign currency
(Currency Maturity obligations come due. It can help an MFI with exposure plans if / how
Risk) to hedge exposure. Or, at a minimum, closely monitor this risk. This
table is important since foreign exchange risk exposure is eliminated
only if the duration of the assets and liabilities are fully matched.
268 An Aadhaar Study | Performance Rating Benchmarks for Large, Medium and Small MFIs

Aadhaar Micro-Enterprise Solutions Trust


Aadhaar Micro-Enterprise Solutions Trust (Aadhaar) is a not-for-profit entity established with the objective of contributing to
and driving social change in India through social enterprises. Aadhaar aims to assist socially relevant organizations achieve
sustainability without diluting their multiple bottom-line objectives. We, at Aadhaar, achieve this by providing strategic
consulting, financial advisory and technical support.

Copyright Aadhaar Micro-Enterprise Solutions Trust ©  April 2011


www.trustaadhaar.org | info@trustaadhaar.org

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