Unit: I: Micro Finance

Financial Inclusion:

·         Financial inclusion is a method of offering banking and financial services to individuals.

·         It aims to include everybody from every section of the society by giving them basic financial services regardless of their income or savings.

·          It focuses on providing financial solutions to the economically underprivileged.

·         The term is broadly used to describe the provision of savings and loan services to the poor in an inexpensive and easy-to-use form.

·         It aims to ensure that the poor and marginalised make the best use of their money and attain financial education.

Financial inclusion definition

Ø  Financial inclusion is the process of ensuring access to financial products and services needed by vulnerable groups at an affordable cost in a transparent manner by institutional players.

Ø  Financial inclusion refers to the provision of equally available and affordable access to financial services for everyone, regardless of their level of income.

Ø  It applies to providing services to both individuals and businesses.

Summary

• Financial inclusion refers to providing greater access to financial services for poor and low-income individuals, as well as businesses with limited resources.

• Financial inclusion initiatives help boost the economy of poorer regions and countries.

Objectives of financial inclusion

1.     Development – Greater access to financial services = Increase in savings + Decrease in income inequality & poverty + Increase in employment levels.

2.     Growth – It encourages the habit to save, thus enhancing capital formation in the country and giving it an economic boost. Also, the availability of sufficient and transparent credit from formal banking institutions will promote the entrepreneurial spirit among the people = increase in productivity and prosperity in rural areas.

3.     Service delivery – Direct cash transfers to beneficiary bank accounts rather than physical cash payments against subsidies will become possible = funds actually reach the targeted beneficiaries instead of being siphoned off along the way.

4.     Banks’ efficiency – Banks which are operating in a financial inclusion sector could experience higher operating efficiency in financial intermediation.

Financial inclusion in India

Initiation of financial inclusion concept in India

The concept of financial inclusion was first introduced in India in 2005 by the Reserve Bank of India.

PMJDY (2014): Around 192.1 million accounts have been opened under the Pradhan Mantri Jan Dhan Yojana (PMJDY). These zero-balance bank accounts have been accompanied by 165.1 million debit cards, a life insurance cover of Rs 30,000 and an accidental insurance cover of Rs 1 lakh.

Other than PMJDY, there are several other financial inclusion schemes in India — Jeevan Suraksha Bandhan Yojana, Pradhan Mantri Vaya Vandana Yojana, Pradhan Mantri Mudra Yojana, Stand Up India scheme, Venture Capital Fund for Scheduled Castes under the social-sector initiatives, Pradhan Mantri Suraksha Bima Yojana (PMSBY), Atal Pension Yojana (APY), Varishtha Pension Bima Yojana (VPBY), Credit Enhancement Guarantee Scheme (CEGS) for scheduled castes, and Sukanya Samriddhi Yojana.

What are the initiatives taken by the government to improve financial inclusion?

Banking initiatives

·         Regional Rural Banks (RRBs): On the basis of Narasimham Working Group 1975, RRBs were established to serve banking needs of rural population.

·         Priority Sector Lending: is an important role given by the RBI to the banks for providing a portion of the bank loans to few specific sectors such as agriculture or small scale industries.

·         Business correspondents: RBI permitted banks to engage business correspondents/facilitators for providing door-step delivery of financial and banking services.

·         The opening of no-frills accounts: No-frills accounts means the bank accounts which does not require a minimum balance (or low sometimes) = Accessibility to vast sections of the population.

·         KYC relaxation: Know Your Customer (KYC) requirements for opening bank accounts were relaxed for small accounts in August 2005. The opening of bank accounts became even easier with Aadhaar introduction.

·         To expand the network of ATMs, the RBI has permitted non-bank entities to start White Label ATMs.

·         Jan Dhan, Aadhaar and Mobile (JAM) –

§  It is a three-part strategy based on using digital technologies

§  Jan Dhan (banking), Aadhaar (Biometric Identity) and Mobile (transactions).

·         Establishment of payment banks and small finance banks.

·         Establishment of MUDRA bank to refinance micro-finance institutions to lend to non-formal sectors such as MSMEs through PM Mudra Yojana.

·         RuPay Cards have considerably enhanced its market share.

·         Financial literacy centres were launched by commercial banks at the request of the RBI.

·         Financial inclusion of women through Aadhaar implementation.

·         Unified Payments Interface (UPI) platform built by the National Payments Corporation of India (NPCI).

·         Self-Help Group (SHG) – Bank Linkage Programme (SBLP) was launched by NABARD to provide door-step banking to the poor with the help of SHGs.

Social security Initiatives

·         PM Suraksha Bima Yojana (PMSBY) – Accidental death cum disability insurance, renewable 1 year, for 18-70 age group.

·         Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY) – Life insurance, renewable 1 year, for 18-50 age group.

·         Atal Pension Yojana – Focus on unorganised sector.

At present regulation of the micro-finance institutions (MFI) is split.

The Reserve Bank of India regulates those MFIs which have registered themselves as companies. The regulations of other MFIs which are essentially societies are controversial because of which the RBI had suggested that those should be regulated through legislation by state governments.

Problems of MFI:

Any financial institution whether it is a banking or non banking institution it must be properly regulated.

Reserve Bank of India and a few major banks made the following observations find out the loopholes in the operation of MFIs:

1.      Some of the microfinance institutions (MFIs) financed by banks or acting as their intermediaries or partners appear to be focusing on relatively better banked areas, including areas covered by the SHG-Bank linkage programme. Competing MFIs were operating in the same area, and trying to reach out to the same set of poor, resulting in multiple lending and overburdening of rural households.

2.  Many MFIs supported by banks were not engaging themselves in capacity building and empowerment of the groups to the desired extent. The MFIs were disbursing loans to the newly formed groups within 10–15 days of their formation, in contrast to the practice obtaining in the SHG – Bank linkage programme, which takes about six to seven months for group formation and nurturing. As a result, cohesiveness and a sense of purpose were not being built up in the groups formed by these MFIs.

3.  Lack of transparency: Banks, as principal financiers of MFIs, do not appear to be engaging them with regard to their systems, practices and lending policies with a view to ensuring better transparency and adherence to best practices. In many cases, no review of MFI operations were undertaken after sanctioning the credit facility.

4.      Highly deregulated interest rate allowed MFI to charge a high rate of interest which become burden for the rural poor.

The Micro Finance Institutions (Development and Regulation) Bill, 2012

Highlights of the Bill 

• The Bill seeks to provide a statutory framework to regulate and develop the micro finance industry.

• The Reserve Bank of India (RBI) shall regulate the micro finance sector; it may set an upper limit on the lending rate and margins of Micro Finance Institutions (MFIs).

• MFIs are defined as organisations providing micro credit facilities up to Rs 5 lakh, thrift collection services, pension or insurance services, or remittance services.

• The Bill provides for the creation of councils and committees at central, state and district level to monitor the sector.

• The Bill provides for a Micro Finance Development Fund managed by RBI; proceeds from this fund can be used for loans, refinance or investment to MFIs.

• The Bill requires the RBI to create a grievance redressal mechanism.

Key Issues and Analysis

• The Bill provides safeguards against misuse of market dominance by MFIs to charge excessive rates.  It allows RBI to set upper limits on lending rates and margins.  However, there is no provision for consultation with the Competition Commission of India.

• The Bill allows MFIs to accept deposits.  Unlike banks, there is no facility for insuring customer deposits against default by MFIs.  The minimum capital requirement is also lower, though RBI may prescribe higher requirements. 

• The Development Fund for MFIs is to be managed by the RBI.  The Bill also enables regulatory powers to be delegated to NABARD.  Both these provisions could lead to conflict of interest.

• The Bill provides for the creation of micro finance committees at central, state and district levels to oversee the sector.  However, the formations of these committees are not mandatory.

• The Bill allows MFIs to provide pension and insurance services.  However, it does not provide for regulation by or coordination of RBI with the respective sector regulators.

NABARD and Microfinance

1.  Promotion of Self Help Group – Bank Linkage Programme (SHG-BLP) 

·         NABARD, initiated the the model of ‘SHG-BLP’ for providing financial services to the unreached and underserved poor households in 1992.

·          NABARD started pilot project by forming 500 SHGs of poor and linked to the formal financial institutions during the year 1992-93

·         Which is now the largest microfinance programme in the world, in terms of the client base and outreach

2.  Micro Credit Innovation

·         NABARD, through its’ Micro Credit Innovations Department has continued its role as the facilitator and mentor of microfinance initiatives in the country.

·         The overall vision of the department is to facilitate sustained access to financial services for the unreached poor in rural areas through various microfinance innovations in a cost effective and sustainable manner. 

·         NABARD has been continuously focusing on bringing in various stakeholders on a common platform and building their capacities to take the initiatives forward.

·         This has resulted in tremendous growth of microfinance

3.  Financing of Joint Liability Groups (JLGs)

·         Financing of JLGs was introduced as a pilot project in 2004-05 by NABARD in 8 States with the support of 13 RRBs.

·         The scheme was later mainstreamed for the banking system in the year 2006. JLGs are informal groups of 4-10 members who are engaged in similar economic activities and who are willing to jointly undertake to repay the loans taken by the Group from the Banks.

·         JLGs basically are Credit groups of small/marginal/tenant farmers/ asset less poor who do not have proper title of their farmland.

4.  NABARD Financial Services Ltd. (NABFINS)

·         NABARD, while promoting NABFINS has envisaged that NABFINS shall evolve into a Model Microfinance Institution to set standards of governance among the MFIs.

·          It is a NBFC – MFI which commenced its operations in November 2009

5.  Support for training and capacity building of clients

·         Giving due recognition to training and capacity building of various stakeholders such as bankers, NGOs, Government officials, SHG members and trainers, NABARD has trained around 39.40 lakh participants as on 31 March 2018, in the process giving shape to a strong back up team for implementation of the programme.

6.  Micro Enterprise Development Programme (MEDPs)

·         NABARD since 2006 has been supporting need-based skill development programmes (MEDPs) for matured SHGs which already have access to finance from Banks.

·         MEDPs are on-location skill development training programmes which attempt to bridge the skill deficits or facilitates optimization of production activities already pursued by the SHG members.  

·          Over the years around 4.68 Lakh SHG members have been covered through 16,406 MEDPs.  

7.  Livelihood and Enterprise Development Programmes (LEDPs)

·         A new scheme titled Livelihood and Enterprise Development Programme (LEDP) was launched in December 2015 for skill up gradation and sustainable livelihood

·         It envisages conduct of livelihood promotion programmes in clusters.

·         There is provision for intensive training for skill building, refresher training, backward-forward linkages and handholding & escort supports.

·         It also encompasses the complete value chain and offers end-to-end solution to the SHG members.

·         It is to be implemented on a project basis covering 15 to 30 SHGs in a cluster of contiguous villages where from SHG members may be selected. 

8.  Scheme for promotion of Women SHGs (WSHGs) in backward & LWE districts of India

·         In 2011-12, a scheme for promotion and financing of Women Self Help Groups (WSHGs) in association with Govt. of India is being implemented across 150 backward and Left Wing Extremism (LWE) affected districts of the country.

·          The scheme aims at saturating the districts with viable and self-sustainable WSHGs by involving anchor agencies who shall promote & facilitate credit linkage of these groups with Banks, provide continuous handholding support, enable their journey to livelihoods and also take the responsibility for loan repayments.

·          Under the Scheme, in addition to working as an SHPI, the anchor agencies are also expected to serve as a banking / business facilitator for the nodal implementing banks. 

9.  Collaboration with NRLM

·         NABARD continues close coordination with all stakeholders in SHG BLP sector.

·         Collaboration with NRLM is being regularly maintained and enhanced for the support of SHG BLP.

·         Coordinated efforts like conduct of National level seminars and workshops, mutual dialogues and capacity building of stakeholders on SHG BLP have now become very regular.

·         Coordinated efforts in following areas have particularly proved immensely fruitful.

10.  Training of Trainers (TOT) programme

·         NABARD and NRLM are collaborating on capacity building needs of bankers and grass root level functionaries to strengthen the Self Help Group bank Linkage Programme through a number of initiatives.

·         With the goal of training all rural bank managers, a series of Training of Trainers (TOT) programmes for Bankers, SRLM staff, DDMs & Officers drawn from 17 states have been held at BIRD, Lucknow.

11.  Conduct of Village Level Programmes (VLPs)  

·         A Village Level Programmes (VLPs) are being conducted with the support of banks and NRLM.

·         These VLPs sponsored by NABARD are also helping in opening of SHG accounts, their credit linkage and regular loan repayments.

Microfinance delivery model in India

1.  SHG - BLP Model                                                  2. Micro Finance Institution model

Under the SHG, the following three different models have emerged:

·         Model I: SHGs promoted, guided and financed by banks.

·         Model II: SHGs promoted by NGOs/ Government agencies and financed by banks.

·         Model III: SHGs promoted by NGOs and financed by banks using NGOs/formal agencies as financial intermediaries.

 Model II has emerged as the most popular model under the SBLP programme.

Commercial banks, co-operative banks and the regional rural banks have been actively participating in the SBLP.

1        . Under the SBLP, the following three different models have emerged:

·         Model I: SHGs promoted, guided and financed by banks.

·         Model II: SHGs promoted by NGOs/ Government agencies and financed by banks.

·         Model III: SHGs promoted by NGOs and financed by banks using NGOs/formal agencies as financial intermediaries.

 Model II has emerged as the most popular model under the SBLP programme. Commercial banks, co-operative banks and the regional rural banks have been actively participating in the SBLP.

SHG-Bank Linkage Model Under this program, NGOs and banks collectively interact with potential clients to form small homogenous groups. The most significant feature of such a system is that it allows for opening of bank accounts in the name of the entire group. This reduces transaction costs for banks significantly. Recovery of loans is based on peer review, the returns are empirically found to be higher. Furthermore, such a setup saves the members from usurious debt traps and strengthens decision-making and fund management within their groups. Gradually, as the pooled thrift grows, they are ready to receive external funds in multiples of their group savings.

2.  MFI Model:

 Microfinance in India suffers from severe semantic difficulties. Microfinance is defined not by form but by the intent of the lender. Therefore, a loan given by a market intermediary to a small borrower is not seen as microfinance. When an institution whose constituent intent is the distribution of such loans gives a similar loan, however, it is treated as microfinance. The institution may be constituted as a society, NGO or a company (profit or not for profit). The MFI model can be divided into examples which are state initiatives and private ones. National Bank for Agriculture and Rural Development (‘NABARD’) and Small Industries Development Bank of India (‘SIDBI’) are examples of state run MFIs. Besides, supporting small-scale financial institutions, commercial banks, RRBs, and co-operative banks provide separate retail services as well. The last decade has seen the emergence of private players MFI Model Microfinance in India suffers from severe semantic difficulties. Microfinance is defined not by form but by the intent of the lender. Therefore, a loan given by a market intermediary to a small borrower is not seen as microfinance. When an institution whose constituent intent is the distribution of such loans gives a similar loan, however, it is treated as microfinance. The institution may be constituted as a society, NGO or a company (profit or not for profit). The MFI model can be divided into examples which are state initiatives and private ones. National Bank for Agriculture and Rural Development (‘NABARD’) and Small Industries Development Bank of India (‘SIDBI’) are examples of state run MFIs. Besides, supporting small-scale financial institutions, commercial banks, RRBs, and co-operative banks provide separate retail services as well. The last decade has seen the emergence of private players

The Banking Regulation Act, 1949 is a legislation in India that regulates all banking firms in India.

Initially, the law was applicable only to banking companies. But, 1965 it was amended to make it applicable to cooperative banks and to introduce other changes

Overview

The Act provides a framework using which commercial banking in India is supervised and regulated.

The Act supplements the Companies Act, 1956. Primary Agricultural Credit Society and cooperative land mortgage banks are excluded from the Act.[2]

The Act gives the Reserve Bank of India (RBI) to power to license banks, have regulation over shareholding and voting rights of shareholders; supervise the appointment of the boards and management; regulate the operations of banks; lay down instructions for audits; control moratorium, mergers and liquidation; issue directives in the interests of public good and on banking policy, and impose penalties.[2]

In 1965, the Act was amended to include cooperative banks under its purview by adding the Section 56. Cooperative banks, which operate only in one state, are formed and run by the state government. But, RBI controls the licensing and regulates the business operations.[2] The Banking Act was a supplement to the previous acts related to banking.

The Banking Laws (Amendment) Bill, 2012 - An Insight

INTRODUCTION

After much delay and deliberation the Banking Laws (Amendment) Bill, 2012) ["Bill"] which seeks to amend the Banking Regulation Act, 1949 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980 has been passed in the winter session of parliament of India by both the houses.

The Lok Sabha which is the lower house of the Indian parliament passed the bill on 18th Dec'12 & the Rajya Sabha which is the upper house of the Indian parliament passed the bill on 20th Dec'12. The bill will be notified as a statute once it receives the assent of the President of India. The bill seeks to strengthen the regulatory powers of the Reserve Bank of India and to further develop the banking sector in India. This bill aims to address the issue of capital raising capacity of banks in India by enabling nationalized banks to raise capital by issue of preference shares or rights issue or issue of bonus shares. It would also enable them to increase or decrease the authorized capital with approval from the Government and RBI without being limited by the ceiling of a maximum of Rs. 3000 crore. The Bill would also pave the way for new bank licenses by RBI resulting in opening of new banks and branches.

COVERAGE OF THIS INSIGHT

This insight broadly highlights the key amendment brought in under the Bill and its effect on the Indian banking sector as a whole.

AMENDMENTS

Powers Granted to RBI Under The Bill

• New Bank Licenses and Greater Regulatory Oversight.
  
  The Bill enables the Reserve Bank of India (RBI) to issue new bank licenses to corporate houses which will give the RBI greater regulatory oversight over local banks.
  
  The Bill also seeks to increase the rates of existing monetary penalties that RBI can impose on a bank if it disobeys RBI rules, directives or gives false information.

• Power to Inspect
  
  The Bill shall give the powers to check the records inspect books of conglomerates, and account-books of mutual funds, insurance and other companies associated/connected with a bank. This is done to prevent and keep a check on connected lending practices.

• Unclaimed Bank Accounts
  
  The Bill gives power to RBI to transfer the money lying in the bank account which is not operated by the account holder for more than 10 years, to the "Depositor Education and Awareness Fund".

• Acquisition of Shares and Voting Rights
  
  Prior approval of RBI shall be needed for acquisition of 5% or more of shares or voting rights in a banking company by any person. The RBI shall be empowered to impose such conditions as it deems fit in this regard.
  
  For example: If any person wants to buy more than 5% shares of any bank, he'll have to take permission from RBI and before giving him approval, RBI can put conditions on him. For example ask for a deposit worth Rs.X, so that if any mischief, fraud etc is committed by the person then RBI shall take away the deposited amount.

• Regulating Cooperative Societies
  
  A license from the RBI is to be taken by primary cooperative societies to carry on the business of banking. RBI shall have powers to conduct special audits of the cooperative banks by extending applicability of Section 30 Banking Regulation Act, 1949 to them. The reason for special audits of these cooperative society is that because they're more liable to collapse and frauds.

• Cash Reserve Ratio (CRR)
  
  RBI is empowered by this Bill to demand penalty interest from the bank if the bank fails to maintain the prescribed minimum amount of Cash Reserve Ratio (CRR) on any day.

What is a Self-Help Group?

A Self Help Group is an association of the poor people specially women who belong to the same social & economic background. The SHGs are usually informal groups of a locality or area, whose members have a common need and importance towards collective action. These groups normally consist of 10 to 20 members. Members of the group meet regularly, make their share of contribution.

·         A Self Help Group is an association of the poor people specially women who belong to the same social & economic background.

·          The SHGs are usually informal groups of a locality or area, whose members have a common need and importance towards collective action.

·         These groups normally consist of 10 to 20 members.

·         Members of the group meet regularly, make their share of contribution.

·          The SHGs bank linkage model has become famous in rural areas where as without bank linkage SHGs are also functioning.

·         The SHG promotes small saving among its members, which are then kept with a bank.

·         This common fund is then given a name. SHGs have been generally formed for specific issues.

·         The main purpose of SHGs is to mobilize savings among their members and used resources to meet the emergent credit needs of the members of the group. SHGs generally work according to the local requirement.

 Objectives of Self-Help Groups

The SHGs comprise very poor people who do not have access to formal financial institutions. They act as the forum for the members to provide space and support to each other. It also enables the members to learn to cooperate and work in a group environment.

The SHGs provide savings mechanism, which suits the needs of the members.

 It also provides a cost effective delivery mechanism for small credit to its members.

The SHGs significantly contribute to the empowerment of poor.

• To sensitize people of target area for the need of SHG and its relevance in their empowerment process.

• To create group feeling among members.

• To enhance the confidence and capabilities of members.

• To develop collective decision making among members.

• To encourage habit of saving among members and facilitate the accumulation of their own capital resource base.

• To motivate members taking up social responsibilities particularly related to development.

FeATURES

• A group of persons of small means.

• The SHGs create the common fund by contributing their small savings.

• A group can be registered or unregistered.

·         The limit of members of the group is restricted in between 10-20.

·         Members contribute a part of their earnings regularly to a common fund.

• Every member of the group actively participates in the functioning of SHGs and they meet regularly.

• Their accounts and proceeding are maintained by the leader and leader is selected or elected among the group members.

• Amount of loans are small and for short period.

• Loan is sanctioned on ‘trust’ with minimum documentation and without any security.

• The rate of interest differs from group to group. It is generally little higher than that of charged by banks.

• Repayment of loan amount is generally on time.

Difference between microfinance Institution and Commercial Bank

1.       Commercial bank is a bank (covering a whole gamut of financial services from savings to loans, insurance and pensions),

 while Microfinance companies are financial institutions (usually allowed only to lend).

2.       Funding to commercial banks usually takes place through public offers (stock markets) in the form of equity

while Microfinance institutions usually receive their funding from individuals/private equity holders in the form of debt.

3.       Most of the services provided by commercial banks are bank door services, which means the clients have to go to the banks to avail financial services.

Most of the services provided by Microfinance institutions are door step services, which means the staffs of the MFIs deliver their financial services at client’s door step.

4.       Commercial banks have relatively easy funding and engage in financial services with comparatively sound income households, which allow them to charge lower interest rate (10% to 16%) on their loans because the risk is low.

Why are interest rates higher in microfinance loans than in traditional banking?

Small loans are more expensive to process than large ones because they take longer to process. Without employment history or collateral, microfinance loans require a more hands-on, time-intensive assessment to determine creditworthiness. Microfinance institutions (MFIs) usually send a representative to visit the client as part of this process, making the process even more challenging and costly in remote or sparsely populated areas. Once a loan is approved, MFIs often send loan officers to disburse loans and collect payments in person, which also adds significant expense when compared with the way traditional banks operate. MFIs have to charge rates that are higher than normal banking rates to cover their costs and keep the service available.

The good news is that technology and new business models are creating opportunities to reduce costs and reach more people. For example, banks and MFIs can use mobile money and agent networks to disburse loans and collect payments instead of sending loan officers to remote areas to make these transactions. These types of innovations help to reduce the cost of doing business with poor clients and, in turn, can reduce charges to clients.

Microfinance Institution:

·         It is an organization

·         Cover a wide range of institutions

·         Institutions differ in their legal structure, missions and methodology

Institutions are having unique feature of providing  small amount of finance to the rural poor who are untouched by the formal banking system 

Microfinance: Why are the interest rates of micro finance institutions, higher than those of banks?

·         The main reason is that microfinance companies often lend money from other lenders

·         They're not allowed to offer saving services

·         MFI use a higher active interest rate to pay the loan they have and to make a profit

·         Another reason is risk, the clients often don't have a business model, and are from rural areas where banks don't go, which can lead to a big percentage of not paying customers.

·         The typical informal business people don't have documents needed for the bank to lend them.

Microfinance: Do the micro-loans contribute to the well-being of the people or do they leave them even poorer due to high interest rates?

Positive impact

·         Provide micro entrepreneurs with the capital needed to operate and expand their businesses. Indeed, having a reliable source of credit allows microentrepreneurs to better plan their

·         business activities and manage their cash flow.

·         Through the increased income generated by their businesses as well as the ability to save and obtain loans, microfinance allows poor people to build their assets, for example by acquiring land, constructing or improving their homes and purchasing livestock and poultry.

·         It can reduce poor people’s vulnerability. Access to credit as well as the savings and insurance facilities that often comes with credit, can help them to smooth cash flows and avoid periods when access to food, clothing, shelter, or education is lost. Microfinance can make it easier to manage shocks such as sickness to the family breadwinner or theft.

Negative:
In recent years microfinance institutions (MFIs) have focused increasingly on making their operations financially sustainable by charging interest rates that are high enough to cover all their costs.

This approach ensures that they can continue to operate and indeed expand to serve more people. If they do not make their operations sustainable then they must continually be reliant upon subsidies from donors, which may or may not be forthcoming, or they may have to close down altogether since they cannot cover their costs in which case many poor people would certainly be worse off.

It is worth pointing out that as MFIs mature over time and become more efficient, transaction costs usually decrease and this can mean lower interest rates.

Furthermore, it is also worth emphasising that the interest rates charged by MFIs are still far below what poor people can expect to pay to local moneylenders, who often charge annual interest rates of several hundred percent. By providing interest free capital to MFIs through peer-to-peer lending site like lendwithcare, one of our aims is to enable local institutions to lower interest rates whilst continuing to serve the poorest in their communities.

Need of Risk Management of the MFI

1.   Increase in size of the scale of operation- Maximum MFI are large in size and NBFCs in form.

2.   Innovations: With the initiation of lot of innovations in microfinance Sector like federation of SHGs , federation of federations etc, are being created. The ‘mega finance structure’ are highly sophisticated and require a proper risk management technique.

3.   Need for early System for the MFI: As MFI pass through various phases of life cycle , it need a early warning system for risk management.

4.   To avoid adverse effect on weaker section of the society.

5.   Limited capacity and qualification of staff may lead to risk.

Risk Management:

1.   Clarity of Vision by the MFI: With engaging in diverse activities by the MFI , they should be clear about their aims and visions.

2.   Clear segregation should be there in between financial and social activities.

3.   Product Designing: A properly designed product reduces credit risk, and on the other han a poorly designed product create credit risk.

4.   MIS should be capable of depicting all information clearly like overdue of loan and it should be reported immediately to the head office.

Types of Risk of MFI

1.   Financial Risk                                                                                 2.  Non Financial Risk

a)   Credit Risk                                                                               a) Operational Risk

v  Transaction Risk                                                                                    Human Risk

v  Portfolio Risk                                                                                          process risk

                                                                                                                     System technology risk

                                                                                                                     Relationship Risk                                                                             

b)  Market Risk                                                                            b) Strategic

§  Liquidity Risk                                                                          Weak Leadership

§  Interest risk                                                                            Regulatory Risk

§  Foreign Exchange risk                                                         Poilitical risk

1.   Financial Risk

a)   Credit risk: Credit risk is the risk to earnings or capital due to borrowers’ late and non-payment of loan obligations.

Transaction Risk: Transaction risk refers to the risk within individual loans.

§  Collateral free loan creats credit risk

§  Non repayment of loan amount – client’s migration,  willful defaulting, business failure etc.

Portfolio Risk: Portfolio risk refers to the risk inherent in the composition of the overall loan portfolio.

Management of Credit Risk:

Effective approaches to managing credit risk in MFIs include: ƒ

v  Well-designed borrower screening, careful loan structuring, close monitoring, clear collection procedures, and active oversight by senior management.ƒ

v  Good portfolio reporting that accurately reflects the status and monthly trends in delinquency, including a portfolio-at-risk aging schedule and separate reports by loan product. ƒ

v   A routine process for comparing concentrations of credit risk with the adequacy of loan loss reserves and detecting patterns (e.g., by loan product, by branch, etc.).

v  Clarity of Vision by the MFI: With engaging in diverse activities by the MFI , they should be clear about their aims and visions.

v  Clear segregation should be there in between financial and social activities.

v  Product Designing: A properly designed product reduces credit risk, and on the other han a poorly designed product create credit risk.

v  MIS should be capable of depicting all information clearly like overdue of loan and it should be reported immediately to the head office.

b)      Market Risk: Market risk includes interest rate risk, foreign currency risk, and investment portfolio risk.

Interest rate risk is the risk of financial loss from changes in market interest rates.

Liquidity risk is the risk that an MFI can not meet its obligations on a timely basis.

Microfinance institutions most often experience foreign exchange risk when they borrow or mobilize savings in one currency and lend in another. For example, MFIs that offer dollar savings accounts and lend in the local currency risk financial loss if the value of the local currency weakens against the dollar.

2.       Non Financial Risk:

Operational Risk:

The MIS does not correctly reflect loan tracking, e.g. information disbursed, payments received, current status of outstanding balances.

Lack of effectiveness and insecurity of the portfolio management system, e.g. external environment is not safe, software does not have internal safety features (i.e. no backups), inaccurate MIS and untimely reports.

Inconsistencies between the loan management system data and the accounting system data. Misrepresentation of loan payoffs, e.g. through refinancing, payoffs with inadequate collateral or post dated checks.

Rescheduling disguises loan quality problems, e.g. rescheduled loans treated as on-time. Inconsistent implementation of the loan administration.

 Lack of portfolio related fraud controls, e.g. no client visits to verify loan balances Loan tracking information is not adequate, e.g. no aging of portfolio outstanding, inadequate credit histories.

Strategic risks include internal risks like those from adverse business decisions or improper implementation of those decisions, poor leadership, or ineffective governance and oversight, as well as external risks, such as changes in the business or competitive environment.

Ø  Governance risk is the risk of having an inadequate structure or body to make effective decisions.

Ø  Reputation risk refers to the risk to earnings or capital arising from negative public opinion, which may affect an MFI’s ability to sell products and services or its access to capital or cash funds. Reputations.

Ø  Business environment risk refers to the inherent risks of the MFI’s business activity and the external business environment.

Ø  Regulatory and legal compliance risk Compliance risk arises out of violations of or non-conformance with laws, rules, regulations, prescribed practices, or ethical standards, which vary from country to country.

1.    

a)  Management of Credit Risk:

Effective approaches to managing credit risk in MFIs include: ƒ

Transaction risk

v  Well-designed borrower screening, careful loan structuring, close monitoring, clear collection procedures, and active oversight by senior management.ƒ

v   Good MIS that accurately reflects the status and monthly trends in delinquency, including a portfolio-at-risk aging schedule and separate reports by loan product. ƒ

v   Clarity of Vision by the MFI: With engaging in diverse activities by the MFI , they should be clear about their aims and visions.

v  Product Designing: A properly designed product reduces credit risk, and on the other han a poorly designed product create credit risk.

Portfolio Risk

v  Diversification of portfolio will reduce portfolio risk

v  Transparent policies on interest rates, fees, penalties etc.

v  Restricting operation in risky areas

b)      Market Risk:

v  Liquidity Risk

Cash Planning

Coordination of operation manager and Finance manager

Regular analysis of Balance Sheet

v  Interest Rate Risk

v  Foreign Exchange Risk

Unavoidable

2.       Non Financial Risk

a)      Operational Risk:

Diversify portfolio and client base

Standard Operation Procedure should be prepared for the time of emergency

Fire extinguisher should be there

Daily backup of MIS data

Strong monitoring and independent audit system

Insurance of office, cash in transit should be there

Emphasis should be given on customer retainment

b)  Strategic Risk

Good governance should be there. To be effective, the board should have a clear understanding of its mandate, including its duties of care, loyalty and obedience.

A comprehensive risk management approach and good management information reporting helps an MFI speak the “language” of financial institutions and can strengthen an MFI’s reputation with regulators or sources of funding.

Additional Challenges for MFIs

·         MFIs face additional risks resulting from rapid growth, management succession, and new product development.

MFIs use several risk management strategies when faced with rapid growth: ƒ

·         Careful attention to staff recruitment and training. The MFI can reduce operational risk by carefully growing staff and ensuring that employees’ interests are aligned with those of the goals of the organization. ƒ

·          Control growth to allow time to develop internal systems and prepare staff for changes resulting from the expansion. ƒ

·         Carefully monitor loan growth and portfolio quality to better understand growth (e.g., number of loans per client, average loan size, growth in number of borrowers) and to not let growth mask increases in delinquency. ƒ

·          Good communication from senior managers to reinforce the MFI’s culture and commitment to quality service and integrity.

·          These efforts should motivate new employees, as well as existing employees who are being asked to do more.

Effective Risk Management Classic risk management requires an organization to take four key steps:

(1) Identify the risks facing the institution and assess their severity (either frequency or potential negative consequences)

(2) Measure the risks appropriately and evaluate the acceptable limits for that risk;

(3) Monitor the risks on a routine basis, ensuring that the right people receive accurate and relevant information; and

(4) Manage the risks through close oversight and evaluation of performance