Management of Microfinance Study Material

Course Teacher: Dr. Ramesh Kumar Chaturvedi

5.0 OBJECTIVES
After reading this chapter you will understand the:
 Recommendations of the Malegam committee governing MFIs in India
 RBI guidelines for MFIs
 Code of conduct for the MFIs-

5.1 INTRODUCTION
In the absence of a separate legal structure, each MFI takes the legal form as per the law/Act under
which it is registered. For example, if a MFI is registered under Companies Act, it is a company and a
MFT registered under the Societies Registration Act, will be a society and so on.

The process of bringing the microfinance sector under the regulatory regime has made significant
progress after AP crisis. Immediately after the AP crisis the RBI had constituted the Malegam
Committee. Based on this committee's recommendations, the RBI has issued a series of guidelines,
notifications and directives, starting with the creation of a separate category of NBFC-MFIs. The
regulatory guidance extends to capital requirement, qualifying asset category, asset classification and
provisioning norms, pricing of credit, fair practices in lending, ttansparency and disclosure in interest
rate, avoidance of multiple lending and excessive debt, recovery practices, corporate governance and
iMprovethent in efficiency through information technology. The two micro finance industry
associations, namely Sa-Dhan and MFIN (Micro Finance Institutions Network) have evolved a unified
code of conduct for their members. The much-awaited Microfinance Institutions (Development and
Regulation) Bill, 2012 was tabled in the Indian Parliament in May 2012 and is referred to the
Parliamentary standing committee on finance.

5. 1.1 Legal Formats and Governance

In relation to the vast demand, there is limited coverage of potential microfinance clients. Credit to
the poor is provided through the formal financial system, semi-formal and informal institutions. In that
backdrop, it is important to understand the laws and regulations that shape the financial sector. Laws
and regulations cause costs as well as create opportunities for entrepreneurs and/or investors who
supply micro-finance. Laws and regulations balance the interests of different groups of the
stakeholders. Stakeholders are all those concerned of a given enterprise. The most important
stakeholders of micro-finance are actual and potential clients, supplying institutions/ companies and
their owners (called "shareholders" because they put capital in the form of shares into the company),
their managements and their staff, and regulating agencies. The most important regulating agencies
are Reserve Bank of India (RBI), Government of India, Ministry of Finance, and State governments.

The Legal formats of MFIs that are provided by Indian laws can be classified by the profit motive. There
are Not-For-Profit Entities such as trusts, societies and Section 25 companies. The for-Profit enterprises
are Non-Banking Financial Companies (NBFCs). Co-operatives are also for profit but are Mutual-Benefit
enterprises. Cooperatives are formed and owned by members to support their own activities. This
includes Mutually Aided Co-operative Societies (MACSs), Multi State Co-ops, credit and non-credit co-
operative societies, Producer Companies; Co-operative Banks (See Box 4 for details of Legal forms of
Indian MFIs). Laws are made by Governments. The formal and central law-makers are Parliament and
State Legislatures (elected representatives of the people). Debate on the law takes place inside and
outside Parliament. Ministries have an important role in formulating laws, as the officials are consulted
by the politicians. In view of this, practitioners — owners and managers of micro-finance institutions
need engage in lobbying, i.e. consulting and counselling politicians and bureaucrats about what they
feel important for the sector.

Box 4: Snapshot of Legal forms of Indian MFIs (from SIJTSMA, 2007)

Micro-finance institutions in India can have different legal forms. In this box the different
legal forms are described:

Societies: These are membership organizations that may be registered for charitable
purposes. Societies are usually managed by a governing council or a managing committee.
Societies are governed by the Societies Registration Act 1860, which has been adapted by
various states. Unlike trusts, societies may be dissolved.

Cooperative societies: These are registered under the State Cooperative Societies Act or
Multi State Coop Society Act. These are supervised by the Registrar of cooperative societies.
These cooperatives are generally formed by people who have a similar objective like
farmers or workers etc. These work for sustainability and distribute profit to the member.
The members elect the leaders among themselves as Board Members to run the
cooperatives.

Trusts: The public charitable trust is a possible form of not-for-profit entity in India.
Typically, public charitable trusts can be established for a number of purposes, including the
relief of poverty, education, medical relief, provision of facilities for recreation, and any
other object of general public utility. Indian public trusts are generally irrevocable. No
national law (except the broad principles of the India Trusts Act 1882, which governs private
trusts) governs public charitable trusts in India, although many states (particularly
Maharashtra, Gujarat, Rajasthan, and Madhya Pradesh) have Public Trusts Acts.

S25 companies: A section 25 company is a company registered under companies Act with
limited liability that may be formed for "promoting commerce, art, science, religion, charity
or any other useful object", provided that no profits, if any or other income derived through
promoting the company's objects may be distributed in any form to its members. These
companies cannot distribute the profit or redeem the capital and as such cannot be listed in
the Stock Exchange.

Non-Banking Financial Companies (NBFCs): These are companies registered under the
companies Act and licensed by RBI as non-bank institutions known as loan companies,
housing finance companies, investment companies etc. These institutions are permitted to
lend, hire-purchase or lease. Deposit mobilitation is permitted only if they are rated by an
approved credit rating agency, and only time deposits of 1-5 years are permitted. In
addition, most deposits are allowed only in the province where the NBFC is registered.
Furthermore they are prohibited from providing micro-insurance and/ or fund transfers.

As the political debate results in such a number of laws covering various types of financial institutions,
the legal provisions of one law are sometimes contradictor), to the provisions of another law. The
understanding of following important laws/Acts may be useful to the microfinance professionals.
  Reserve Bank of India Act, 1934
 Companies Act, 1956: (Covers banks, NBFCs and S 25 companies )
 Co-operative Societies Act of 1904 ( State Acts are relevant)
 Societies Registration Act of 1860
 Mutually Aided Co-operative Societies Acts of various states • Indian Trusts Act --- 1882
 Banking Regulation Act 1949
 The Multi-State Co-operative Societies Act 2002
 Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980: Relates to
nationalization of banks; includes Local Area Banks (LAB)
 Bankers' Books Evidence Act • Banking Secrecy Act
 Negotiable Instruments Act, 1881
 National Bank for Agriculture and Rural Development Act, 1981
 The Regional Rural Banks Act, 1976, and the Co-operative Societies Act, 1904, cover RRBs and
co-operatives respectively.

5.2 RECOMMENDATIONS OF MALEGAM COMMITTEE

Microfinance institutions in India have made significant progress during the last two decades in terms
of outreach and penetration in unbanked areas. Over the last decade the for profit model of
microfinance Institutions have grown at impressive speed. These MFIs have attracted large volume of
bank credit support and also an increasing interest in equity investments.

The advent of NBFCs in the Microfinance sector appears to have resulted in a significant increase in
reach and the credit made available to the sector. Between 31' March 2007and 31' March 2010 the
number of outstanding loan accounts serviced by the MFIs is reported to have increased from 10.04
million to 26.7 million and outstanding loans from about Rs.3800 crore to Rs:18,344 crore. While this
growth is impressive, the specific areas of concern in the Indian context have been identified. They are
as follows:

Areas of concern
 Unjustified high rate of interest
 Lack of transparency in interest rates and other charges
 Multiple lending
 Upfront collection of security deposits
 Over-borrowing
 Ghost borrowers
 coercive methods of recovery

This high growth of MFIs has encountered serious setbacks in the last few years due to adverse
consequences of the Andhra Pradesh crisis (see Box for further details). The MFI sector, more
particularly the for profit model, which was in limelight for its rapid growth and success in Financial
Inclusion was suddenly seen in a bad light because a wide spread criticism of MF1s. The reason for the
criticism was due to the exorbitantly high profits earned by MFIs, which was on account of high
leverage of hank loans and high rates of interest. But what pushed the sector to the crisis are the
coercive money collection practices. It was seen that certain MFIs which followed the Grameen model
had incentivized collection which ran into unethical practices. These practices got highlighted with the
media reporting of suicides among mierofinance clients in AP- the state that has the largest chunk of
MR lending. This prompted the Andhra Pradesh Government to bring in the Andhra Pradesh
Microfinance institutions (Regulation of Money Lending) Ordinance 2010. As a result, repayment of all
MFI in Andhra Pradesh almost came to a halt. As more than 50 per cent of MFIs exposure is in AP
alone, the business of MFT got adversely affected. Banks and SIDBI had about Rs.19000 crore
exposures to MFIs which came to risk under circumstances. Ranks had extended CDR to the MFI's
which has been of little avail as the loan losses has been almost total.

Box 5: Background to Andhra Pradesh MF Crisis 2010

MFIs have emerged as important stakeholders in the Microfinance sector in lending to the
poor people. The advent of the Microfinance sector appears to have resulted in a significant
increase in outreach and the credit made available to the sector. Bet%Veen 2007-10 the
number of outstanding loan accounts served by MF1s was reported to have increased from
10.04 million to 26.7 million and outstanding loans from about Rs,3800 crore to Rs.18344
crore. The incessantly flourishing MFI industry providing credit to the doorsteps of the poor
has however also been correlated with excessively high interest rate, use of coercive
methods for recovery, number of suicides by the credit beneficiaries etc. It was alleged that
in Andhra Pradesh many microfinance clients committed suicides because of high
handedness of MFT staff to recover loans. This led the state government of Andhra Pradesh
to enact the AP MFI Act 2010 which had suddenly put brakes to the expanding MFT
industry. The provisions of the ordinance requires that each MF1 to register themselves
with district administration to keep records of all their clients, not to give loan to SIIG
members if they have already taken loan from other SHGs (to control over indebtedness)
without prior permission of district collectors and so on.

In view of the above mentioned development, RBI had set up a committee of its Board members under
the chairmanship of Shri.Y.H. Malegam to study the issues and concerns in Micro finance sector. The
committee reviewed the definition of MF and MFI, examined the alleged malpractices by MFTs
especially with respect to high interest rate and methods of recovery, specified the scope of regulation
by RBI of these MFIs and suggested a proper regulatory framework. It also examined the prevalent
money lending legislation and other relevant items at the state level, and suggested redressal
machinery.

The Committee has recommended that a NBFC --MFI may be defined as "a company (other than a
company licensed under section 25 of the Companies Act, 1956) which provides financial services
predominantly to low income borrowers with loans of small amounts, for short terms, on unsecured
basis, mainly for income generating activities with repayment schedules which arc more frequent than
those normally stipulated by commercial banks and which further conforms to the regulations
specified".

The committee has also arrived at the concept of qualifying asset of NBFC which will decide if it is an
MFI. Accordingly not less than 90 per cent of its (NBFC-MFI's) total assets (other than cash and bank
balances and money market instruments) are in the nature of 'qualifying assets' it will be deemed all
NBFC-MFI. Qualifying asset shall mean a loan which satisfies the following criteria:
 The loan is given to a member of a household whose annual income does not exceed Rs.50,
000/.
 The amount of loan does not exceed Rs.25000/ and the total outstanding indebtedness of the
borrower including this loan also does not exceed Rs.25000/.
  The tenure of the loan is not less than 12 months where the loan amount does not exceed
Rs.15000/ and 24 months in other cases with a right to the borrower of prepayment without
penalty in all cases.
 The loan is without collateral.
 The aggregate amount of loans given for income generating purposes is not less than 75 per
cent of the total loans given by the MFIs.
 The loan repayable by weekly, fortnightly or monthly installments at the choice of the borrower
 The income it derives from other services is in accordance with the regulation specified.

An NBFC which does not qualify as a NBFC-MFI should not be permitted to give loans to the
microfinance sector which in the aggregate exceed 10 per cent of its total assets.

Interest rate related recommendations: The committee has recommended that there should be a
interest 'margin cap' of 10 per cent in respect of those MFIs which have an outstanding loan portfolio
at the beginning of the year of Rs: 100 crore and a 'margin cap' of 12 per cent in respect of MFIs which
have an outstanding loan portfolio at the beginning of the year of an amount not exceeding Rs.100
crore. There should also be a cap of 24 per cent on individual loans. This means that the NBFC-MFIs
cannot charge more than 22% or 24% p.a ROI and that on a reducing balance method too.

The committee recommends that (Transparency related issues)

 There should be only three _components in the pricing of the loan namely (a) a processing fee
not exceeding 1 per cent of the gross amount (ii) the interest charge and (iii) the insurance
premium.
 Only the actual cost of insurance should be recovered and no administrative charges should be
levied.
 Every MFI should provide to the borrower a loan card which shows (i) the rate of interest (ii)
the other terms and conditions attached to the loan (iii) information which adequately
identifies the borrower and (iv) acknowledgment by the MFI of payments of installments
received and the final discharge. The card should show this information in the local language
understood by the borrower.
 The effective rate of interest charged by the MFI should he prominently displayed in all its
offices and in the literature issued by it.
 There should be adequate regulations regarding the manner in which insurance premium is
computed and collected and policy proceeds disposed of. a There should not be any recovery of
security deposit. Security deposits already collected should be returned.
 There should be a standard form of loan agreement.

Committee also recommends that (About multiple lending, over borrowing and ghost borrowers)
 MFIs should lend to an individual borrower only as a member of a JLG and should have the
responsibility of ensuring that the borrower is not a member of another JIG.
 A borrower cannot be a member of more than one SHG 1 JLG.
 Not more than two MFIs should lend to the same borrower. This would require the NBFC to
have full details of the borrower.
 There must be a minimum period of moratorium between the grant of the loan and the
commencement of its repayment.
  Recovery of loan given in violation of the regulations should be deferred till all prior existing
loans are fully repaid. Ghost borrowers generally arise in two sets of circumstances: When the
borrower on record is a binami for the real borrower and
 Fictitious loans are recorded in the books

The first type of Ghost borrower is often used as a device for multiple lending or over borrowing. This
can be cured only by a better discipline in the system of identification and creation of data base of
borrowers and better follow up by the field worker.

The second type of Ghost Borrower can pose much greater systemic problem as it would create
fictitious repayments and thus hide the actual level of delinquencies.

The committee recommends that all sanctioning and disbursement of loans should be done only at a
central location and more than one individual should be involved in this function. In addition there
should be close supervision of the disbursement function.

The committee has recommended that a Credit Information Bureau be established for MFI
 One or more Credit Information Bureaus be established and be operational as soon as possible
and all MFIs be required to become members of such bureau.
 In the meantime the responsibility to obtain information from potential borrowers regarding
existing borrowings should be on the MFI.

As regards Coercive Methods of Recovery the committee recommends that

 The responsibility to ensure that coercive methods of recovery are not used should rest with
the MFIs and they and their management should be subject to severe penalties if such methods
are used.
 The regulator should monitor whether MFIs have a proper Code of Conduct and proper systems
for recruitment, training and supervision of field staff to ensure the prevention of coercive
methods of recovery.
 Field staff should not be allowed to make recovery at the place of residence or work of the
borrower and all recoveries should only be made at the Group level at a central place to be
designated.
 MFIs should consider the experience of banks that faced similar problems in relation to retail
loans in the past and profit by that experience.
 Each MFI must establish a proper Grievance Redressal Procedure.
 The institution of independent Ombudsmen should be examined and based on such
examination, an appropriate mechanism may be recommended by RBI to lead banks.

Customer Protection Code

 The regulator should publish a Client Protection Code for MFIs and mandate its acceptance and
which h observance by MFIs. This Code should incorporate the relevant provisions of the Fair
Practices assign Guidelines prescribed by the Reserve Bank for NBFCs. Similar provision should
also be made Where a applicable to banks and financial institutions which provide credit to the
microfinance sector.

Improvement of efficiencies
  MFIs should review their back office operations and make necessary investments in
Information Technology and systems to achieve better control, simplify procedure and reduce
cost.

Support to SHGs/JLGs
 Under both the SHG Bank Linkage Programme(SBLP) model and the MFI model, greater
resources Funding of should be devoted to professional inputs both in the formation of SHGs
and JLGs as also in the imparting of skill development and training and generally in handholding
after the group is formed. This would be in addition to and complementary to the efforts of the
State Governments in this regard. The architecture suggested by the Ministry of Rural
Development should also be explored

Corporate Size
All NBFC-MFIs should have a minimum Net Worth of Rs 15 crores.

Corporate governance
Every MFI be required to have a system of Corporate Governance in accordance with rules to be
specified by the regulator

Maintenance of solvency
 The provisioning for loans should not be maintained for individual loans but an MFI should be
required to maintain at all times an aggregate provision for loan losses which shall be the
higher of (i) 1 per cent of the outstanding loan portfolio or (ii) 50 per cent of the aggregate loan
installments which are overdue for more than 90 days and less than 180 days and 100 per cent
of the aggregate loan installments which are overdue for 180 days or more.
 NBFC — MFIs be required to maintain Capital Adequacy Ratio of 15 per cent and all of the Net
Owned Funds should be in the form of Tier I Capital.

Need for Competition

While regulations are important they cannot by themselves be the sole instruments to reduce interest
rates charged by MFIs or improve the service provided to borrowers. Ultimately this can only be done
through greater competition both within the MFIs and from other agencies operating in the
Microfinance Sector.

The Committee therefore recommends that bank lending to the Microfinance sector both through the
SHG-Bank Linkage programme and directly should be significantly increased and this should result in a
reduction in the lending interest rates.

Priority Sector Status

The MFI should continue to enjoy "priority sector lending" status. However, advances to MFIs which do
not comply with the regulation should be denied 'priority sector lending' status. It may also be
necessary for the RBI to revisit its existing guidelines for lending to the priority sector.

Assignment and Securitization

 Disclosure should be made in the financial statements of MFIs of the outstanding loan portfolio
which has been assigned or securitized and the MFI continues as an agent for collection. The
amounts assigned and securitized must be shown separately.
  Where assignment or securitization is with recourse the full value of the outstanding loan
portfolio assigned or securitized should be considered as risk based assets for calculation of
capital adequacy.
 Where the assignment or securitization is without recourse but credit enhancement has been
given, the value of the credit enhancement should be deducted from the Net Owned Funds for
the purpose of calculation of capital adequacy.
 Before acquiring assigned or securitized loans, banks should ensure that the loans have been
made in accordance with the terms of the specified regulations.

Funding of MFIs
 Creation of one or more "Domestic Social Capital Funds" may be examined in consultation with
SEBI.
 MFIs should be encouraged to issue preference capital with a ceiling on the coupon rate and
this can be treated as part of Tier II capital subject to capital adequacy norms.

Monitoring of compliance
 The primary responsibility for ensuring compliance with the regulations should rest with the
MFI itself and its management must be penalized in the event of non compliance.
 Industry associations must ensure compliance through the implementation of the code of
conduct with penalties for non compliance.
 Banks also must play a part in compliance by surveillance of MFIs through their branches.
 The RBI should have the responsibility for off-site and on-site supervision of the MFIs but the
on-site supervision may be confined to the larger MFIs and be restricted to the functioning of
the organizational arrangements and systems with some supervision of the branches. It should
also include supervision of the industry associations in so far as their compliance mechanism is
concerned. Reserve Bank should also explore the use of outside agencies for inspection.
 The RBI should have the power to remove from office the CEO and / or a director in the event
of persistent violation of the regulations quite apart from the power to deregister an MFI and
prevent from operating in the microfinance sector.
 The Reserve Bank should considerably enhance its existing supervisory organization dealing
with NBFC-MFIs.

Moneylenders Acts
NBFC-MFIs should be exempted from the provisions of the Money-Lending Acts as interest margin caps
and increased regulations are recommended.

The Micro Finance Institutions (Development and Regulation) Bill 2012

The Central Government has drafted a 'Micro Finance Institutions (Development and Regulation) Bill
2012' will apply to all microfinance organizations other than
(a) banks
(b) Co-operative societies engaged primarily in agricultural operations or industrial activity
or purchase or sale of any goods and such other activities
(c) NBFCs other than licensed under section 25 of the Companies Act, 1956
(d) Co-operative societies not accepting deposits from anybody except from its members
having voting rights or from those members who will acquire voting rights after a
stipulated period of their making deposits as per the law applicable to such co-operative
societies.
The Bill is being debated, off the parliament for a long time now. The Bill refined and it was tabled in
the Parliament in 2012 as the Micro Finance Institutions (Development and Regulation) Bill, 2012. It is
hoped that the Act will provide for all entities covered by the Act to be registered with the regulator.
Possibly entities where aggregate loan portfolio does not exceed Rs.10 crore may be exempted from
registration. Further as RBI regulates NBFC it has been suggested that if NABARD is designed as the
regulator under the proposed Act, there must be close co-ordination between NABARD and RBI in the
formulation of the regulations applicable to the regulated entities. Another important suggestion is
that the micro finance entities governed by the proposed Act should not be allowed to do the business
of providing thrift services.

Microfinance is not a single tool but a combination of tools. MFIs around the world serve different
types of clients, operate in diverse environments and offer different combination of services.

There have been many surveys, both in India and abroad as to the impact of microfinance on the lives
of the poor people it is intended to reach. The results have been both conflicting and confusing. These
surveys report many success stories but they also voice many apprehensions that microfinance has in
some cases created credit dependency and cyclical debt. Doubts have also been expressed as to
whether lending agencies have in all cases remained committed to the goal of fighting poverty or
whether they are solely motivated by financial gain. Mere extension of micro credit unaccompanied by
other social measures will not be an adequate anti poverty tool.

While the lender has the responsibility to provide timely and adequate credit at a fair price in a
transparent manner, the borrower also has the responsibility to honour his/her commitments for
payment of interest and repayment of principal. A financial system ultimately depends on the
circulation of funds within the system. If the recovery culture is adversely affected and free flow of
funds is interrupted the system will break down. This will affect the borrowers themselves as the slow-
down of recovery will inevitably reduce the flow of fresh funds into the system.

5.2.1 Comparison between Malegam Committee recommendations and RBI guidelines

The comparison between Malegam Committee recommendations and RBI guidelines is presented in
Table 9.

Table 9: Comparison between Malegam Committee recommendations and RBI guidelines

Particulars Malegam Committee RBI Guidelines
Recommendations
Qualifying assets The loan given to a borrower Loan disbursed by an MFI to
who is a member of a a borrower with a rural
household whose annual household annual income
income does not exceed not exceeding Rs.60,000 or
Rs.50,000/- urban and semi urban
household income not
exceeding Rs.1,20,000/-
Loan amount The amount of loan does not Loan amount not to exceed
exceed Rs.25,000/ and the Rs.35,000/- in the first cycle
total outstanding and Rs.50,000/- in
indebtedness of the subsequent cycles. Total
 borrower including this loan indebtedness of the
also does not exceed borrower not to exceed
Rs.25,000/- Rs.50,000/-
Pricing of interest There should be a 'margin Banks should ensure a
cap' of 10% in respect of margin cap of 12 per cent
MFIs which have an and an interest rate cap of
outstanding loan portfolio at 26 per cent for their lending
the beginning of the year of to be eligible to be classified
Rs.100 crore and a 'margin as priority sector loans
cap' of 12 per cent in respect
of MFIs which have an
outstanding loan portfolio at
the beginning of the year of
an amount not exceeding
Rs.100 cr. There should also
be a cap 24% on individual
loans.
Tenure of loan The tenure of the loan is not Tenure of loan not to be less
less than 12 months where than 24 months for loan
the loan amount does not amount in excess of
exceed Rs.15000 and 24 Rs.15000 without
months in other cases with a prepayment penalty. Loan
right to the borrower of extended without collateral
prepayment without penalty
in all cases
Loan from Income The aggregate amount of Aggregate amount of loan
Generating activities loans given for income given for income generation
generating purposes is not not to be less than 75 per
less than 75 per cent of the cent of the total loans given
total loans given by the MFIs. by the MFIs
Repayment The loan repayable by Loan to be repayable by
weekly, fortnightly or weekly, fortnightly, or
monthly installments at the monthly installments at the
choice of the borrower. choice of the borrower.
Loan issued by MFI to Loans by MFIs can be
individuals outside the SHGs extended MFI to individuals
individuals outside the
SHG/JLG outside the SHGs
mechanism. Bank loans to
other NBFCs would not be
reckoned as priority sector
loan with effect from April 1,
2011.
5.2.2 Other recent initiatives"
Consequent to Malegam Committee recommendations, the RBI has issued a series of guidelines,
notifications and directives, starting with the creation of a separate category of NBFC-MFIs. The
regulatory guidance extends to capital requirement, qualifying asset category, asset classification and
provisioning norms, pricing of credit, fair lending practices, transparency and disclosure in interest
rate, avoidance of multiple lending excessive debt, recovery practices, corporate governance and
improvement in efficiency through information technology.

Priority sector lending is a policy initiative, which requires banks to allocate a percentage of their
portfolios to investment in specified priority sectors at a reduced interest rate. Currently, the loans
from microfinance institutions registered as NBFC-MFIs are designated as a priority sector. In order to
register as an NBFC-MFI, an institution must meet requirements specified by the RBI. In December
2011, the RBI opened up the external commercial borrowings (ECBs) channel to NBFC-MFIs, something
that was previously open only to non-profit MFIs.

The network organizations, support institutions, research and policy advocacy groups have been
working to bring microfinance back to track and prepare it for orderly and responsible growth. The
lead initiative taken by SIDBI towards carrying out the Code of Conduct Assessments of MFIs has
helped pave the way for ensuring effective client protection principles in the operations.

Recognizing the importance of systematic compilation of credit information of clients for effective
monitoring and follow-up, RBI has made it mandatory for NBFC-MFIs to register with at least one
credit information company. The need of a Microfinance Credit Bureau Infrastructure in India was
triggered mainly by two factors.
1. Regulatory changes brought in by RBI allowing MFIs to register as NBFC-MFIs, and making it
mandatory for NBFC-MFIs to register with at least one credit information company (CIC) and
2. The strong need in the industry to know about the other liabilities of its borrowers and their
performance on those.
In this backdrop, High Mark Credit Information Services (High Mark) launched the country's first
Microfinance Credit Bureau in March 2011. The data captured in High Mark's database is of individuals
who have been given credit through--MG, SHG or direct lending. (Microfinance credit bureaus have
been operational, and are successfully helping the MFIs in screening multiple borrowing by customers
from MFIs).

5.3 CODE OF CONDUCT FOR MICROFINANCE INSTITUTIONS IN INDIA 18

Microfinance Institutions irrespective of legal forms, seek to create social benefits and promote
financial inclusion by providing financial services to clients of financially un-served and underserved
households. Over time, the Microfinance sector has become an integral part of the financial
infrastructure for the vulnerable sections of society in India. Hence it is important to define core values
and fair practices for the microfinance sector so as to ensure that microfinance services through MFIs
are provided in a manner that benefits clients and is ethical and dignified.

Code of conduct for Microfinance Institutions included (i) The core values of Microfinance (ii) Code of
conduct for Microfinance Institutions (The Code) (iii) Client Protection Guidelines for MFIs (iv)
Institutional Conduct guidelines.
The core values of Microfinance are stated as follows:

A. Integrity
 To provide low income clients women and men and their families , with access to financial
services that are client focused and designed to enhance their wellbeing and are delivered in a
manner that is ethical, dignified, transparent, equitable and cost effective

B. Quality of Service
 To ensure quality services to clients, appropriate to their needs and delivered efficiently in a
convenient and timely manner
 To maintain high standards of professionalism based on honesty, non discrimination and
customer centricity

C. Transparency:
 To provide complete and accurate information to clients regarding all products and services
offered.
 To create awareness and enable clients and all other stakeholders to understand the
information provided with respect to financial services offered and availed

D. Fair Practices:
 To ensure that clients are protected against fraud and misrepresentation deception or
unethical practices
 To ensure that all practices related to lending and recovery of loans are fair and maintain
respect for client's dignity and with an understanding of client's vulnerable situation

E. Privacy of client information

 To safeguard personal information of clients, allowing disclosures and exchange of relevant
information with authorized personnel only, and with the knowledge and consent of clients

F. Integrating social values into operations:

 To ensure high standards of governance and management
 To monitor and report social as well as financial data

G. Feedback and grievance redressal mechanism

 To provide clients formal and informal channels for feedback and suggestions To consistently
assess the impact of services in order to enhance competencies and serve clients better
 To provide a formal grievance redressal mechanism for clients
Code of Conduct for Micro finance Institutions
All MFIs are required to follow all regulatory norms as well as consumer protection practices
(specifically, RBI's Guidelines on Fair practices for NBFCs) laid down by the government and the
regulators in both letter and spirit. The Code of Conduct lays down additional requirements to enhance
and improve sector practices. The Code of Conduct is to be followed by all MFIs regardless of their
form.

Application of the Code

 The Code applies to the following activities undertaken by Microfinance Institutions
 Providing credit services to clients, individually or in groups
  Recovery of credit provided to clients
 Collection of thrift from clients, wherever applicable
 Providing insurance and pension services, remittance services or any other related products
and services
 ormation of any type of community collectives including Self Help groups, Joint Liability groups
and their federations
 Business development services including marketing of products or services made or extended
by the eligible clients or for any other purpose for the welfare and benefit of clients.

Micro Finance Institutions must agree to:

 Promote and strengthen the Microfinance movement in the country by bringing low-income
clients to the mainstream financial sector
 Build progressive, sustainable and client-centric systems and practices to provide a range of
financial document services (consistent with regulation) to clients
 Promote cooperation and coordination among themselves and other agencies in order to
achieve higher operating standards and avoid unethical competition in order to serve clients
better

In order to adhere to the core values of Microfinance, the Code of Conduct as mentioned below must
be abided by all institutions providing microfinance services.

Code of Conduct
Integrity and ethical behaviour
 MFIs must design appropriate policies and operating guidelines to treat the clients and
employees the client with dignity
 MFIs must incorporate transparent and professional governance system to ensure that staff
and shall not persons acting on their behalf are oriented and trained to put this Code into
practice
 MFIs must educate clients on the code of Conduct and its implication

Transparency
 MFIs must disclose all terms and conditions to the clients for all services offered. Disclosure
must be made prior to disbursement in accordance with the Reserve Bank of India's fair
practices code, in any one of the following ways.
a) individual sanction letter
b) Loan card
c) Loan schedule
d) Passbook
e) Through group/centre meetings (details can be printed in a paper and all borrowers can sign
on the same as acknowledgement of their acceptance)
f) MFIs must communicate all the terms and conditions for all products/services offered to
clients in the official regional language or a language understood by them
g) At the minimum, the MFI must disclose the following terms
a) Rate of interest on a reducing balance method
b) Processing fee
c) Any other charges or fees howsoever described
d) Total charges recovered for insurance coverage and risks covered.
 MFIs must communicate in writing charges levied for all financial services rendered. Fee on non
credit products / services will be collected only with prior declaration to the client
h) MFIs must declare all interest and fees payable as an all inclusive Annual Percentage
Rate (APR) and equivalent monthly rate
i) MFIs must follow RBI's guidelines with respect to interest charges and security deposit
j) Formal records of all transactions must be maintained in accordance with all
regulatory and statutory norms and borrowers' acknowledgement/acceptance of terms
and conditions must form a part of these records.

Client protection
Fair Practices:
 MFIs must ensure that the provision of microfinance services to eligible clients is as per RBI
guidelines.
 MFIs must obtain copies of relevant documents from clients, as per standard KYC norms.
Additional documents sought must be reasonable and necessary for completing the
transaction.
 Product should not be bundled. The only exception to bundling may be made with respect to
credit life, life insurance and life-stock insurance products, which are typically offered bundled
with loans. The terms of insurance should be transparently conveyed to the client and must
comply with RBI and Insurance Regulatory and development authority (IRDA) norms. Consent
of the client must be taken in all cases.

Avoiding over indebtedness

 MFIs must conduct proper due diligence as per their internal credit policy to access the need
and repayment capacity of client before making a loan and must only make loans,
commensurate with the client's ability to repay.
 If a client has loans from two separate lenders, then irrespective of the source of the loans, a
MFI shall not be the third lender to that client.
 MFIs must not , under any circumstances, breach the total debt limit for any client as
prescribed by RBI or Central / State government

Appropriate interaction and collection practices

MFIs must have clearly defined guidelines for employee interaction with clients.
 MFIs must ensure that all staff and persons acting on behalf of the MFI
1. use courteous language maintain decorum, and respectful of cultural sensitivity
during all interaction with clients
2. Do not indulge in any behaviour that in any manner would suggest any kind of threat
or violence
3. Do not contact clients at odd hours as per the RBI guidelines for loan recovery agents.
4. Do not visit clients at inappropriate occasions such as bereavement, sickness etc to
collect dues
 MFIs must provide a valid receipt ( in whatever form decided by the MFI) for each and every
payment received from the borrower
 MFIs must have a detailed board approved process for dealing with clients, at each stage of
default.
  MFIs must not collect shortfalls in collections from employees and their HR policies must
categorically denounce this practice. An exception can however be made in proven cases of
frauds by employees.

Privacy of client information: MFIs must keep personal client information strictly confidential. Client
information may be disclosed to a third party subject to the following conditions
(a) Client has been informed about such disclosure and permission has been obtained in writing
(b) The party in question has been authorized by the clients to obtain client information from the
MFI
(c) It is legally required to do so
(d) This practice is customary amongst financial institution and available for a close group on
reciprocal basis (such as a credit bureau).

Governance: MFIs must incorporate a formal governance system, that is transparent and professional,
and adopt the following best practices of corporate governance
 MFIs must observe high standard of governance by inducting persons with good and sound
reputation as members of Board of Directors/ Governing Body.
 MFIs must endeavour to induct independent person to constitute at least one third of the
governing board, and the Board must be actively involved in all policy formulation and other
important decisions.
 MFIs must have a Board approved debt restructuring product / programme for providing relief
to borrowers facing repayment stress.
 MFIs will appoint an audit committee of the Board with an independent director as Chairperson
 MFIs must ensure transparency in the maintenance of books of accounts and reporting /
presentation and disclosure of financial statements by qualified auditor/s
 MFIs must put in best efforts to follow the Audit and Assurance Standard issued by the Institute
of Chartered Accountants of India (ICAI)
 MFIs must place before the Board of Directors a compliance report indicating the extent of
compliance with this Code of Conduct, specifically indicating any deviation and reasons
therefore, at the end of every financial year.

Recruitment: The Code covers all MFI staff

 As a matter of free and fair requirement practice, there will be no restriction on hiring of staff
from other MFIs by legitimate means in the public domain like general requirement
advertisement in local newspapers, web advertisements, walk-in interviews etc
 Whenever an MFI recruits staff from another MFI, it will be mandatory to seek a reference
check from the previous employer. The reference check will be sought from current employer
only after an offer is made and an offer letter is issued to the prospective employee
 MFIs should respond to the reference check request another MFI within two weeks
 MFIs must honour a one month notice period from an outgoing employee.
 No MFI shall recruit an employee of another MFI irrespective of the grade/ level of the
employee, without the relieving letter from the previous MFI employer. An exception can
however be made in instance where the previous employer (MFI) fails to respond to the
reference check request within 30 days. All MFIs must provide such relieving letter to the
outgoing employee in case she or he has given proper notice, handed over the charge and
 settled all the dues towards the MFI, except in proven cases of fraud or gross misconduct by
the employee.
 Whenever an MFI recruits from another MFI, at a level upto the branch manager position, the
said employee shall not be assigned to the same area he/she was serving at the previous
employer, for the period of one year.

Client Education
 MFIs must have a dedicated process to raise clients' awareness of the options, choices and
responsibilities vis-à-vis financial products and services available
 New clients must be informed about the organization's policies and procedures to help them
understand their rights as borrowers
 MFIs must ensure regular checks on client awareness and understanding of the key terms and
conditions of the products / services offered/ / availed (As part of the internal audit systems or
through some other regular monitoring)

Data sharing
MFIs will agree to share complete client data with all RBI approved Client Bureaus, as per the
frequency of data submission prescribed by the Credit Bureaus

Feedback / Grievance Redressal Mechanism

 MFIs must establish dedicated feedback and grievance redressal mechanisms to correct any
error and handle / receive complaints speedily and efficiently
 MFIs must inform clients about the existence and purpose of these mechanisms and how to
access them
 MFIs must designate at least one grievance redressal official to handle complaints and / or note
any suggestion from the clients and make his/her contact numbers easily accessible to clients
 Each MFI will have an appropriate mechanism for ensuring compliance with the Code of
Conduct
 Where complainants are not satisfied with the outcome of the investigation conducted by the
concerned MFI into their complaint, they shall be notified of their right to refer the matter to
the grievance redressal mechanism established by the industry Association

Client Protection guidelines for Microfinance Institutions (CPG)

The CPG states that all MFIs, regardless of their form
 Shall display the client protection code in all branches and offices, in plain view.
 Shall endeavour to provide microfinance services to all eligible clients, as per RBI guidelines.
 Shall educate clients, staff, and any person acting on their behalf on the code of conduct and its
implementation
 Shall disclose all terms and conditions to the client for all products, services offered, prior to
disbursement in any of the following ways.
(a) individual sanction letter
(b) loan card
(c) loan schedule
(d) pass book
(e) through group / centre meetings (details can be printed on a paper and all borrowers
can sign on the same as acknowledge of their acceptance)
 (f) Shall communicate all the terms and conditions for all products / services in the official
regional language or a language understood by clients
(g) Shall disclose the following terms
(a) rate of interest on a reducing balance method
(b) processing fee
(c) any other charges or fees howsoever described
(d) total charges recovered for insurance coverage and risk covered
 Shall communicate in writing, charges levied for all financial services rendered.
 Shall not collect fee on non credit product / services without prior declaration to the client
 Shall declare all interest and fees payable as an all inclusive APR and equivalent monthly rate
 Shall follow RBI's guidelines with respect to interest charges and security deposits
 Shall obtain copies of relevant documents from clients as per standard KYC norms. Additional
documents sought must be reasonable and necessary for completing the transaction
 Shall not bundle products, except for credit life, life insurance and Livestock insurance
products. The terms of insurance should be transparently conveyed to the customer and must
comply with RBI and IRDA norms. Consent of the client must be taken in all cases.
 Shall conduct proper due diligence to assess the need and the repayment capacity of clients
before making a loan and must only make loans commensurate with the client's ability to
repay.
 Shall not be the 3rd lender to a client if the client has loans from two other lenders (irrespective
of the source of loan)
 Shall not breach the total debt limit for any client as prescribed by the RBI or Central / State
Government.
 Shall ensure that all employees follow company guidelines for interaction with clients
 Shall ensure that all staff and persons acting for the MFI or on behalf of the MFI
(a) use courteous language, maintain decorum, and /or respectful of cultural sensitivities
during all interactions with clients
(b) do not indulge in any behaviour that in any manner that would suggest any kind of
threat or violence to clients
(c) do not contact clients at odd hours as per the RBI guidelines for loan recovery agents
(d) do not visit clients at inappropriate occasions such as bereavement, sickness etc to
collect dues
 Shall provide a valid receipt (in whatever form decided by the MFI) for each and every payment
received from the borrower
 Shall follow approved company procedure to deal with clients default sensitively
 Shall follow the debt restructuring mechanism adopted by the MFI for borrowers under
liquidity stress.
 Shall keep personal client information strictly confidential
 Shall disclose client information to a third party only under the following conditions
(a) Client has been informed about such disclosure and permission has been obtained in
writing.
(b) The party in question has been authorized by the client to obtain client information
from the MFI
(c) It is legally required to do so.
(d) This practice is customary amongst financial institution and available for a close
group on reciprocal basis (such as a credit bureau)
  Shall follow company approved process to raise client awareness of the options, choices and
responsibilities vis-à-vis financial products and services available.
 Shall inform all new clients about the organization's policies and procedures
 Shall inform clients about the existence and purpose of feedback mechanism and how to access
them

Institutional conduct guidelines for Micro Finance Institutions (ICG)

The ICG states that all MFIs regardless of their form
 Shall have an appropriate mechanism for ensuring compliance with the code of conduct
 Shall have appropriate policies and operating guidelines to treat clients and employees with
dignity.
 Shall maintain formal records of all transactions in accordance with all regulatory and statutory
norms and borrowers acknowledgement/ acceptance of terms / conditions must form a part of
these records
 Shall have detailed board approved process for dealing with clients at each stage of default
 Shall not collect shortfalls in collection from employees except in proven cases of frauds by
employees
 Shall have a Board approved debt restructuring product / program for providing relief to
borrowers facing repayment stress
 Shall seek a reference check from previous employer for any new hire.
 Shall provide within two week the replies to the reference check correspondence for another
MFI
 Shall honour a one month notice period from an outgoing employee.
 Shall not recruit an employee of another MFI without the relieving letter from the previous MFI
employer except where the previous employer (MFI) fails to respond to the reference check
request within 30 days
 Shall not assign a new employee recruited from another MFI, to the same area he / she was
serving at the previous employer for a period of one year. This restriction applies to positions
up to the branch manager level
 Shall have a dedicated process to raise clients awareness of options, choices, rights and
responsibilities as a borrower and shall conduct regular checks on client awareness and
understanding of the key terms and conditions of the products/ service offered / availed
 Shall agree to share complete client data with all RBI approved credit bureaus, as per the
frequency of data submission prescribed by the Credit Bureaus
 Shall establish dedicated feedback and grievances redressel mechanism to correct any error
and handle / receive complaints speedily and efficiently
 Shall designate an official to handle complaints and / or note any suggestions from the clients
and make his / her contact numbers easily accessible to clients

5.4 LET US SUM UP

In the existing regulatory environment, MFIs can set up under different legal forms viz., NBFCs or
Section 25 Company, Trusts, Co-operatives, Societies. The AP crisis 2010 led to setting of Malegam
Committee and various other developments such as regulatory initiatives by RBI, tabling of The
Microfinance Institutions (Development and Regulation) Bill, 2012 in Parliament, initiatives on Code of
Conduct for microfinance sector etc. The Bill is referred to the Parliamentary Standing Committee on
Finance. The mission of Micro-finance is to service low-income clients-women and men and their
families. Micro-finance aims at providing them short term and/or long-term access to financial
services. These services must be client focused, designed to enhance their well-being, and delivered in
a manner that is ethical, dignified, transparent, equitable and cost effective. Code of conduct for
Microfinance Institutions includes the core values of Microfinance, code of conduct for Microfinance
Institutions (The Code), client Protection Guidelines for MFIs and Institutional Conduct guidelines.

5.5 KEY WORDS

Core values; code of conduct; client protection; institutional conduct guidelines.

5.6 CHECK YOUR PROGRESS

1. According to the recommendation of the Malegam Committee, the amount of loan given to a
member of a household by the NBFC-MFI does not exceed_________
(a) Rs.20000/
(b) Rs.25000/
(c) Rs.30000/
(d) Rs.35000/

2. Ghost borrowing as a device leads to the following

(a). For multiple lending
(b) Over borrowing.
(c) It would create fictitious repayments and thus hide the actual level of delinquencies
(d) All the above

3. According to RBI guidelines, aggregate amount of loan to the total loans given by the MFI for income
generation not to be less than
(a) 75% (b) 70% (c) 72% (d) 80%

5.7 KEY TO CHECK YOUR PROGRESS

1-(b), 2- (d), 3-(a)
CHAPTER 6
EVOLUTION AND CHARACTERISTICS OF MICROFINANCE IN INDIA

6.0 Objectives 6.1 Introduction

6.2 SHG-Bank. Linkage Programme
6.2.1 Policy Support for Micro Finance in India
6.2.2 Objectives of SHGs Bank Linkage Programme
6.2.3 Criteria for SelectiOn of SHGs for Bank Linkage Programme
6.2.4 Uniqueness of SHG — Bank Linkage Programme
6.2.5 Advantages of SHG-Bank linkage Programme
6.2.6 Purpose of Loan Under SHG Bank Linkage Programme
6.2.7 Ten — Pillars of SHG-Bank Linkage Programme 6.2.8 Models under SHG-Bank
Linkage Programme
6.2.9 SHG — Bank linkage Model — Advantages and Limitations
6.2.9 Micro Enterprise Development Programme
6.2.10 Performance Under SHG-Bank Linkage Programme
6.2.11 Initiatives by NABARD
6.2.12 Role of NABARD for Other Microfinance Initiatives

6.3 Joint Liability Groups (JLGs)

6.4 Micro Finance Institutional Approach
6.5 Bank Partnership Model
6.6 Banking Correspondent Model
6.7 Penetration of Microfinance—MPI and MPPI
6.8 Micro-finance Institutional Structure: Types of MFIs
6.9 Constraints in Mainstreaming of MFIs and Challenges Faced by the Sector
6.10 Let Us Sum Up
6.11 Keywords
6.12 Check Your Progress
6.13 Key to Check Your Progress
6.0 OBJECTIVES
After reading this chapter you will understand:
 evolution of microfinance in India
 objectives, policy support and models of SHG-Bank Linkage programme
 characteristics of Microfinance institutional channel

6.1 INTRODUCTION
Microfinance in India can trace its origins back to the early 1970s when the Self Employed Women's
Association ("SEWA") of the state of Gujarat formed an urban cooperative bank, called the Shri Mahila
SEWA Sahakari Bank, with the objective of providing banking services to poor women employed in the
unorganized sector in Ahmedabad City, Gujarat. The microfinance sector went on to evolve in the
1980s around the concept of SHGs, informal groups of people that would provide their members with
much-needed savings and credit services. From humble beginnings, the sector has grown significantly
over the years to become a multi-billion dollar industry, with bodies such as the Small Industries
Development Bank of India and the National Bank for Agriculture and Rural Development devoting
significant financial resources to microfinance. Today, the top five private MFIs in the sector reach
more than 20 million clients in nearly every state in India and many Indian MFIs have been recognized
as global leaders in the industry.

The beginning of state led Microfinance movement in India could be traced to the SHG-Bank Linkage
programme started as a pilot programme in 1992 by NABARD with the RBI's recognition of Informal
groups in July 1991. Launched in 1992 in India, early results achieved by SHGs promoted by NGOs such
as MYRADA, led NABARD to offer refinance to banks for collateral-free loans to groups. The
programme has since then come a long way from the pilot project of financing 500 SHGs across the
country. It has proved its efficacy as a mainstream programme for banking with the poor who mainly
comprise the marginal farmers, landless labourers, artisans and craftsmen and others engaged in small
business. The programme not only proved to be successful but has also emerged as the most popular
model of microfinance in India. Other approaches like MFIs also emerged subsequently in the country.
Recognizing the potential of microfinance in influencing the development of the poor, RBI, NABARD
and SIDBI have taken a range of initiatives over the years to give a fillip to the microfinance movement
in India. This chapter traces the evolution of Microfinance movement in India, the supporting policies
and current status in this regard.

6.2 SHG-BANK LINKAGE PROGRAMME

NABARD has spearheaded the microfinance programme through partnership with various stakeholders
(including NGOs, co-operatives and banks) in formal and informal sector with the support from both
Government of India and RBI since the early 1990s. The SHG-Bank linkage Programme was launched by
NABARD as a pilot project in 1992. Encouraged by the positive results of the pilot project, RBI advised
the banks to mainstream the SHG-Bank Linkage programme. Under SHG-Bank Linkage programme,
RBI/ NABARD stipulated that no collateral security should be insisted from SHGs. The bank cannot hold
the savings bank account balance of the SHGs, as a security to the bank loan as it will prevent the SHG
to lend from its internal savings.

6.2.1 Policy Support for Micro Finance in India

The various policy supports from RBI/NABARD for microfinance in India is given in Table 10.

Table 10: Various Policy Support for Micro Finance in India

Year Policy Support
1991 — RBI (Circular to Commercial Banks) Pilot Project on SHG Bank Linkage — 500 SHGs —
MYRADA
1992 — NABARD (Circular) Operational Guidelines to Banks for implementation
of SHG Bank Linkage Programme
1993 — NABARD (Circular) Registrars of Linkage Programme extended to Co-operatives banks
Cooperatives)
1994 — NABARD (Circular) Clarified the legal position 'Sec 11 (2) of the
Companies Act' — only 20 members
1996 — KALIA Committee. NABARD SHG under priority sector SHG lending under service
area plan Lead Bank to include SHG under service area
credit plan, Service area norms for SHGs relaxed
Training to branch managers on SHG SHG linkage to
be added in corporate plan and training curriculum
Assistance to SHGs with default members.
1997 — NABARD Prohibits blocking of groups savings in groups SB
accounts by banks as collateral
2000 — NABARD Refinance support at the rate of 80% to banks for
financing MFIs
2002 — RBI Set up 4 informal groups to look into the issues
relating to (a)structure and sustainability (b)
funding(c) regulations (d) capacity building of MFIs.
2004 —Advisory committee on Flow of To protect the interest of the depositors, RBI
credit to agriculture and related activities announced in the Annual Policy Statement for the
from the banking system- chairman-V.S.Vyas year 2004-05, MFI would not be permitted to accept
public deposits unless they complied with the extant
regulatory framework of the RBI.
2005 — RBI —Internal group under the With the objective of ensuring financial inclusion and
chairmanship of H.R.Khan increasing the outreach of the banking sector, banks
were permitted in Jan 2006 to use the services of
NGO/SHG/MFIs (other than NBFCs) and other civil
society organizations as intermediaries in providing
financial and banking services through BC/BF models.

The SHGs were mainly promoted by many NGOs. The formation of SHGs involves cost. It requires
intensive efforts in identifying groups of people with common interests. Subsequently, these groups
have to be trained. The cost of group formation has been met by the NGOs through grant funds. In
case of non-availability of grant fund, this cost has to be built into the overall transaction cost.

Over the years the collateral-free loans increased progressively up to four times the level of the
group's savings deposits. SHGs thus 'linked' almost became micro-banks able to access funds from the
formal banking system. The linkage permitted the reduction of transaction costs of banks in two fold:
firstly through the externalisation (to the SHG) of costs of servicing individual loans, secondly by
ensuring their repayments with the peer pressure mechanism (among SHG-members).
6.2.2 Objectives of SHGs- Bank linkage Programme
 To evolve supplementary credit strategy for meeting the credit needs of the poor by combining
flexibility, sensitivity and responsiveness of the informal credit system with the strength of
technical and administrative capabilities and financial recourses of the formal credit
institutions.
 To build mutual trust and confidence between the bankers and rural poor.
 To encourage banking activity both on the thrift as wells credit side.

6.2.3 Criteria for selection of SHGs for Bank Linkage Programme

 The group should be in active existence for at least a period of six months.
 The group should have successfully undertaken savings and credit operations from its own
resources.
 The group must have demonstrated democratic functioning wherein all members feel that they
have a say.
 The group should maintain proper accounts/records.
 The group should be convinced that the group has not come into existence only for availing
loan.
 Members preferably have a homogeneous background and interest.

6.2.4 Uniqueness of SHG — Bank Linkage Programme

The Indian experience of SHG Bank linkage programme is unique and different from other models in
various aspects. RBI and NABARD have tried to promote "relationship banking" i.e. improving the
existing relationship between the poor and the bankers with the social intermediation by NGOs. The
Indian model is predominantly a linkage model which draws upon the strength of various partners —
NGOs who are involved in mobilizing and capacity building of the poor and the bankers involved in
financing. Thus as compared to other countries where parallel model of lending to the poor is
predominant, the Indian model tries to use the existing formal financial network to increase the
outreach to the poor while ensuring necessary flexibility of operations for both the bankers and the
poor. The uniqueness of the SHG —Bank linkage programme is presented in figure 4 and Table 11.
 Table 11: Uniqueness of the SHG —Bank linkage programme

Decision making Members make decision collectively. SHG concept

offers opportunity for participative decision making
on conduct of meeting, thrift and credit decision.
The participative process makes the group a
responsible borrower and contributes to
sustanibility.
Convergent Financial services HGs provide the needed financial services to the
members at their doorsteps. The rural poor needs
different types of financial services, viz., savings,
consumption credit, production credit, insurance,
remittance facilities etc. The platform of SHG
provides the possibility to converge these services
Supplementary to formal banking SHG Linkage does not supplant the existing banking
system but supplements it thus taking full advantage
of the resources and other advantages of the
banking system.
Cutting costs SHG linkage cuts cost for both banks (lending cost)
and borrowers (borrowing cost).
NPA savvy The linkage mechanism has proved that the
repayment rates could be, on a continuous basis as
high as 95 % -100%.
Peer pressure as collateral The SHG linkage emphasizes peer pressure within
group as collateral substitute
Quality clients The SHGs are turning out to be quality clients in view
of better credit management, mobilization of thrift,
low transaction cost and near full repayment.
Client preparation The members of the SHGs could over a period of
time very selectively graduate to the stage of micro
entrepreneurship. SHGs prepare them with the
requisite credit discipline
Social agenda Available evidence indicate dependency of 35% -40%
of rural households on non institutional sources for
credit needs. SHG-Linkage offers a better way of
dealing with the magnitude of social agenda. Many
NGOs and governments have recognized the SHGs as
a vehicle for carrying and deepening of their
development agenda / delivery of services.
Exclusive poor focus SHGs have exclusive focus on absolute have-nots
who have been bypassed by the banking system.
Social banking does not have any meaning if the
lowest strata and the unreached are not focused.
No subsidy dependence syndrome The programme does not envisage any subsidy
support from the government in the matter of
credit. The issue is to build capabilities and
enterprise of the individual members blending with
 group cohesion and solidarity through training
provided by a SHPI to set the ball rolling for the SHG.
Source: NABARD 2004

6.2.5 Advantages of SHG-Bank linkage Programme

The linkage between banks and SHGs, with the NGOs, as facilitator and financial intermediaries, serves
as a mechanism for channelling credit to the poor on a sustainable basis. It offers a number of
potential advantages. Banks:
 Reduction in transaction cost by way of externalization of a part of the credit cycle (appraisal,
disbursal, supervision and repayment).
 Mobilization of small savings.
 Assured and timely repayment leading to faster recycling of funds.
 An opportunity for expansion of business and coverage of poor clientele.

NGOs:
 Facilitate deepening of their developmental efforts.
 Synergy in operating social Programmes with economic Programmes.
 Increase the outreach to the poor through credit plus approach.
 Emergence as a bridge between banks and the poor.
 Avenue for performing financial intermediation in unbanked and backward areas.

6.2.6 Purpose of Loan under SHG Bank Linkage Programme

Loan may be granted by the SHGs both for consumption purpose and production purpose. The group
will discuss and decide about the purpose for which loans are to be given to the individual members by
the SHG. The bank does not decide the purpose for which the SHG gives loans to its members.

6.2.7 Ten — Pillars of SHG-Bank Linkage Programme

 Participative financial services management is more efficient and responsive
 Poor can save and are bankable
 The capacities of the banking system can match the expectations of the poor.
 Poor need credit support as well as savings and other services
 Small cohesive group of poor with/without support can effectively manage and supervise micro
credit.
 Collective wisdom of the group and peer pressure are more effective securities than the
collaterals
 SHG is a pre micro enterprise stage for majority of the rural poor.
 SHG as client facilitates wider outreach
 Lower transaction cost including risk costs.
 Empowerment of poor especially women could be one of the major outcomes

6.2.8 Models under SHG-Bank Linkage Programme

Under the SBLP the following three different models have emerged.

Model I — (Direct Model) SHGs Formed and financed by Banks

Model II — (Indirect Model, NGO Acting as Social Intermediary) SHGs formed by NGOs or other
agencies but financed by Banks
Model III — (Indirect Model, NGO acting as Financial Intermediary)

These three models have certain advantages and limitations on account of parameters such as i)
Transaction cost of lending for the banks ii) Transaction cost of borrowing for the SHGs iii) Risk of funds
and guarantee of repayments iv) Ease of adoption by the stakeholders v) Reliability vi) Social and
economic impact of SHG movement vii) Extent of social investment required. The advantages and
limitations of the above three SHG- Bank linkage models are presented in Table 12.

Table 12: SHG — Bank linkage Model — Advantages and Limitations

Models Advantages Limitations

Model I Exposes bankers to social realities first Wide scale application may
hand Possible solution where NGOs are not be feasible because of
not present other priorities of bankers.
Model II Each partner institution plays a role Despite the wider
best suited to it. NGOs organize the acceptability of the model,
poor into SHGs and SHGs manage small all the bankers are not yet
group finance in their own interest. sensitized and do not view it
Banks lend. as banking mandate.
The whole system is localized. In many places, it is still
SHGs and local NGOs learn to deal with difficult for a SHG to open a
an accessible bank branch and vice savings account..
versa. Absence of NGOs in many
areas.
Model III It further reduces the transaction cost NGOs are not traditionally
and risk cost of the bank as the banks equipped to work as
lend a larger sums to an NGO which financial intermediaries.
guarantees. Calls for substantial
Easier for the poor to deal with an investment in capacity
institution which they know and trust. building of NGOs.
Easy to be adopted by stakeholders. Wide scale adoption not
possible.

6.2.9 Micro Enterprise Development Programme

NABARD launched the MEDP for skill development in March 2006 with the basic objective of
enhancing the capacities of matured SHGs to take up micro enterprises through appropriate skill
upgradation. The programme envisaged development of enterprise management skills in existing or
new livelihood activities both in farm and non-farm sectors. More than 60000 SHG members have so
far been benefited under this programme and many of them have turned micro entrepreneurs.

6.2.10 Performance under SHG-Bank Linkage Programme(SBLP)

The coverage of the SHG-bank linkage programme (SLBP) is given in Table 13. At present it is claimed
that it is the largest micro-finance programme worldwide. The SHG Bank linkage programme has
passed through various stages like Pilot Testing (1992-96), mainstreaming (1996-98) and expansion
 (1998 onwards) and has transformed into a microfinance movement in the country. The SLBP was
accelerated growth path till recently and it has slowed down during the last two years. The growth
performance of SBLP during the last two years has reached a stage of a plateau, and it is time for giving
it new direction for future expansion.

Table 13: Growth Trends in SBLP

Particulars 2006 2007 2008 2009 2010 2011 2012 2013
Indicators
No. of SHGs 2.238,56 2,924,97 3,625,94 4,224,33 4,587,17 4,813,68 4,354,56 4,451,43
with bank 5 3 1 8 8 4 7 4
loans
Of which in 1,214,43 1,522,14 1,861,37 2,283,99 2,421,44 2,663,56 2,355,73 2,415,19
southern 1 4 3 2 0 9 2 1
region
Average 37,574 44,343 46,800 74,000 115,820 122,744 144,086 168,757
disbursed
loan per
group (Rs.)
Outstandin 123.66 169.99 226.76 272.66 306.19 363.41 393.75
g loans (Rs.
billion)
Incrementa 0.69 0.70 0.60 0.36 0.22 0.45 0.10
l groups
(million)
Incrementa 123.66 46.33 56.77 45.90 33.53 57.22 30.34
l loans 0/S
(Rs. billion)

Source: Microfinance India SOS Report, 2012 and status of Microfinance in India (NABARD) 2012-2013

The commercial banks had a share of 59 per cent of all groups with outstanding loans followed by
Regional Rural Banks with a 30 per cent share and the co-operative banks with a share of 1 per cent.
Commercial banks had 67.66 per cent of all loans outstanding with SHGs, followed by regional rural
banks with a 26.72 per cent share. The share of cooperative banks in loans was at a measly 5.62 per
cent. The average outstanding loan per group was the highest in the case of commercial banks Rs 1
lakh followed by RRBs at Rs 0.79 lakh. In the case of cooperative banks, the average outstanding loan
was only Rs 0.46 lakh, which is less than 50 per cent of that of commercial banks (Table 14).
Table 14. Bank loans outstanding against SHGs as on 31st March 2013

Type of Bank No. of SHGs Loan Outstanding (Rs. lakh)

Commercial Bank 2643971 2663944.38
Cooperative Bank 480096 221462.43
Regional Rural Bank 1327367 1052122.91
Total 4451434 39337529.72
During the financial year ending March 2013, the percentage share of groups linked with loans in the
southern region had a share of 69 per cent followed by eastern region with 15 per cent. The region-
wise SHG loans outstanding is given in Table 15.
Table 15. Region wise SHG loans outstanding as on 31st March 2013
Region Loans 0/S Amount (Rs. In % share
lakh)
Northern 116068 2.95
Northeastern 79676 2.02
Eastern 553813 14.06
Central 277685 7.06
Western 146752 3.73
Southern 2763536 70.18
All 3937530 100.00
Source: NABARD, 2013, 'Status of Microfinance in India 2012-13

Qualitative aspects of SHG Lending

With fast all-round spread of the SHG —bank linkage programme having credit linkages with a huge
number of SHGs the quality of the SHGs has come under stress and is reportedly getting impaired.
 The instances of client drop outs from SHGs is increasing.
 As the target for group coverage increases , the gap between the number of saving group and
borrowing groups is on the rise.
 Perceived reluctance on the part of the banks to deal with numerous small SHGs. o Pressure
from government sponsored programmes for linking groups promoted by them.
 Falling repayment rates.
 The southern markets which seemed to have unlimited potential have now hit road block.
Retaining existing customers in the southern is probably a greater challenge for banks than
penetrating new market.
 The low average loan prevents the members of the SHGs taking up enterprise activities.
 The original sets of discipline adopted by the SHGs have become increasingly difficult to
maintain. Regularity in attendance, timely repayment and prioritization of member needs do
not seem as important as they were a few years back. The study commissioned by NABARD in
Karnataka and Tamilnadu has revealed that (a) loans are being equally being divided among the
members as they do not want to take a credit risk on others (b) default rates show an
increasing trend after farm loan waiver and (c) meeting attendance is not regular as members
perceive the opportunity cost of time spent in meeting to be high.
 Individual banks (both commercial banks and RRBs) in many cases had perceived a higher risk
perception and gave smaller size loans. Inadequate loans tend to encourage multiple borrowing
by members and force them access informal sources of funds. This increases the risk of default
which the banks want to avoid. Under-financing has been a major reason for multiple loans and
multiple borrowing.
 The continuing pressure of government sponsored programmes for formation of groups tended
to split the existing groups and reduce the average number of members in groups. Smaller
groups push cost of intermediation as also costs of group maintenance. Going forward, the
current emphasis on number of groups should give way to number of members as an indicator
of outreach. Efficiency and productivity of SHPIs should be measured on number of members
per group and costs incurred per member rather costs per group.
  The impact of SGSY on SHG —bank linkage programme is adverse. There is no subsidy element
in SHG-Bank linkage programme, whereas the government is giving some amount of subsidy to
the SHOs promoted by SGSY. Various reports and studies point out that many members of
existing SHGs are inclined to join SGSY groups in view of the subsidies being offered and as a
result quite a few quality groups disintegrate. It is also pointed out that SGSY groups lack
quality and the poor do not get long term benefits under the programme.
 The failure to make use of the groups to secure their livelihoods represents an economic loss.

Box 6: Findings of NABARD study (2010) conducted in seven states in India

The study findings of NABARD (2010) conducted in seven states in India revealed the
following:
 SHGs have helped to reduce the dependence on local moneylenders (upto 66% of
the members are now free — either fully or partially from the clutches of local
moneylenders in TamilNadu and as high as 92 % in Karnataka).
 Bankers continue to take long time to provide the first loan to SHGs and only a few
groups were able to get bank loans after six months.
 While NGOs and Government departments provided skill training to the SHG
members, bankers as SHPIs were not very pro active in providing vocational training
to members.
 The training given by the SHPIs did not meet the skill requirements of the members
for taking up suitable income generating activities.
 There is laxity in enforcing group discipline like regular attendance and regular
savings in the meetings.
 Asset creation out of the SHG loan is seen in about 28 per cent cases while in other
cases loans are used for consumption / purchase of utility items of household goods.
 Competition among various SHPIs and emphasis on achieving targets also resulted in
multiple memberships by SHG members.

6.2.11 Initiatives by NABARD

NABARD has been playing a crucial developmental role for the micro finance sector in India. NABARD
has been organizing / sponsoring training programmes and exposure visits for the benefit of bank
officials, NGOs, SHGs and Government agencies to enhance their effectiveness in the field of micro
finance.

6.2.12 Role of NABARD for other Microfinance initiatives

A number of innovative projects in microfinance have been funded by NABARD. Important among
them are as follows:
 SHG-Post office Linkage Programme
 Social Security system for SHG members
 Financial assistance for developing software — MYRADA
 Pilot project on processor cards and branch automation
 Piloting alternative mechanisms for book-keeping and accounting in SHGs: Setting up of
Computer Munshi
 Grain Banks and SHGs

The role of NABARD in microfinance area is presented in the figure 5

 Figure 5: NABARD and Microfinance

6.3 JOINT LIABILITY GROUPS (JLGs)

JLGs are informal groups of 4-10 members who are engaged in similar economic activities like crop
production and who are willing to jointly undertake to repay the loans taken by the groups from the
banks. Unlike in the case of SHGs, JLGs are intended basically credit groups for tenant farmers and
small farmers who do not have proper title of their farmland and such regular savings by the groups is
purely voluntary and their credit needs are to be met through loans through financial institutions and
such loans could be individual loans or group loans. Financing of JLGs was introduced as a pilot project
in 2004-05 by NABARD in eight states with the support of 13 RRBs. Apart from extending refinance
support of cent per cent of such finance to banks, NABARD also extends financial support for
awareness creation and capacity building of all stakeholders of the programme. NABARD also extends
grant support for formation and nurturing of JLGs to banks and other JLG promoting agencies.

6.4 MICRO FINANCE INSTITUTIONAL APPROACH

While the SHG Bank Linkage Programme remains the most widely used model of microfinance in India,
other MFI models have also gained momentum in the recent past. The MFI landscape in India is
characterized by a diversity of institutional and legal forms. MFIs in India exist in a variety of forms like
Trusts registered under the Indian Trust Act, 1882 / Public Trust Act 1920, Societies registered under
the Societies Registration Act 1860, Cooperatives registered under the Mutually Aided Cooperatives
Societies Acts of the States and non-banking financial companies (NBFC)-MFIs which are registered
under Section 25 of the Companies Act, 1956 or NBFCs registered with the Reserve Bank of India.
These MFIs are scattered across the country and due to the multiplicity of registering authorities there
is no reliable estimate of the number of MFIs.

The overall industry outreach under MFI Approach is presented in Table 16. As against 264 MFIs that
reported information during the year 2010, only 167 MFIs (two thirds of the 264 that reported in 2010)
shared information with Sa-Dhan in 2012 which at best indicated the lack of motivation among MFIs
and at worst the closure/dormancy of the rest. Though the regulatory environment is becoming clear,
the lack of funding to the MFIs has resulted in a negative growth of the MFIs19.
Table 16: Progress of MFIs
Particulars 2010 2011 Growth rate 2012 Growth rate
(%) (%)
No. of MFIs 264 170 167
Reporting
Customer 26.7 31.80 19.10 26.80 (-)15.70
outreach
(Million)
Outstanding 183.44 215.56 17.50 209.13 (-)3.00
loans (Rs
billion)
Source: Data from Sa-Dhan's Bharat Microfinance Quick Report-2012

The regional distribution of outreach and loan portfolio estimates based on the Sa-Dhan Bharat
Microfinance Quick Report-2012 revealed that the dominance of the southern region still continues.
The Southern region accounts for almost 50 per cent in both outreach and portfolio followed by the
Eastern region (25 per cent).The outreach share of the Northern region remains below 5 per cent.
When compared to the previous year, the Southern region registered an increased share both in terms
of client outreach as well as loan portfolio. The share of the North East and Eastern regions has
registered impressive growth while the Western region lost its share significantly.

6.5 BANK PARTNERSHIP MODEL

Banks can use MFIs as their agent for handling credit, monitoring, supervision and recovery. The MFI
acts as an agent - it takes care of all relationships with the client, from first contact through final
repayment. Another variation of this model is where the MFI, an NBFC holds the individual loans on its
books for a while before securitizing them and selling them to the bank. Such refinancing through
securitization enables the MFIs a greater funding access

6.6 BANKING CORRESPONDENT MODEL

In January 2006, the RBI permitted banks to utilize the services of NGOs/MFIs other than NBFC and
other civil society organizations as intermediaries in providing financial services through the use of
BC/BFs. The BC model allows banks to do banking transactions at a location much closer to the rural
population thus addressing the last mile problem. The BC model uses the MFI's ability to get closer to
the poor clients —a necessity for savings mobilization from the poor — while relying on the financial
strength of the bank to safeguard the deposits.

6.7 PENETRATION OF MICROFINANCE — MPI AND MPPI

The penetration of Microfinance is measured by computing two indices — Microfinance Penetration
Index and Microfinance Poverty Penetration Index. These two indices are computed and reported ever
since 2007 in the Microfinance India State of the Sector Report. The methodology adopted by the
author of SOS report to calculate these indices is given below:

The number of credit clients of MFIs and members of SHGs with outstanding loans to banks were
computed and each state's share to the country's total microfinance clients was worked out. The
intensity of penetration of microfinance (MPI) was computed by dividing the share of the state in
microfinance clients with its share of population. The Intensity of Penetration of Microfinance among
Poor (MPPI) was derived by dividing the share of the state in microfinance clients by share of the state
in population of the poor. Since the microfinance clients are in the numerator, a value of more than
one indicates that clients acquired were more than proportional to the population. The higher the
score is above one, the better the performance. The lower the score from one, which is the par value,
the poorer is the performance in the state. The values of MPI and MPPI as reported in SOS 2012 are
given in Table 17.

The low value of MPPI in states like Bihar and UP coincides with a large proportion of households
under poverty line in these states. This indicates the need for considerable work to be done in these
states by the microfinance sector.

Table 17: Ranking of select states based on MPI and MPPI

Name of State MPI Name of State MPPI

Manipur 4.13 Manipur 7.06
Pondicherry 3.46 Andhra Pradesh 6.24
Andhra Pradesh 3.34 Pondicherry 4.67
Tamil Nadu 2.32 Tamil Nadu 2.76
Odisha 2.19 Sikkim 3.28
LAST 5
Jammu and Kashmir 0.07 Mizoram 0.23
Mizoram 0.32 Jammu and Kashmir 0.46
New Delhi 0.24 New Delhi 0.45
Punjab 0.27 Bihar 0.42
Meghalaya 0.21 Uttar Pradesh 0.38
Source: Microfinance India SOS Report 2012

The Manipur state has taken the top position both in MPI (with a ratio of 4.13) and MPPI (with a ratio
of 7.06). Puducheri (Pondicherry) has occupied second position in MPI and third position in MPPI. The
last five ranks occupied by Jammu and Kashmir, Mizoram, New Delhi, Punjab and Meghalaya in case of
MPI ratio and Mizoram, Jammu and Kashmir, New Delhi, Bihar and Uttar Pradesh in case of MPPI ratio.

6.8 MICRO-FINANCE INSTITUTIONAL STRUCTURE: TYPES OF MFIs

The organizations in the field of mF can be classified as 'mainstream' and 'alternative' Micro-finance
Institutions (MFIs). All India Financial Institutions are involved in mainstreaming Micro-finance. These
are National Bank for Agriculture and Rural Development (NABARD), Small Industries Development
Bank of India (SIDBI), Housing Development Finance Corporation (HDFC), HUDCO, etc.

The Commercial Banks, the Regional Rural Banks (RRBs), and the credit cooperative societies, also play
a substantive role in the micro-finance. These banks extend financial support and participate in the
SHG linkage programme as also financing the MFIs directly or financing the clients in partnership with
MFIs. These financial services to the poor are provided mainly by the rural and semi urban branches of
commercial banks and branches of RRBs (The RRBs were established in 1975 to serve the credit
requirements of the poor).RRBs could now emerge as major sources of micro-finance. and by
cooperative outlets — either bank branches or village level societies. State-owned cooperatives,
moribund and politicized have proved that they may not be able to provide sustainable financial
services to the poor.

The Commercial banks have been varying actively in the field of micro-finance. Funds have flowed to
MFIs through advances from banks (either on their own accord or through directed credit
programmes), linkage programmes between self-help groups and banks and wholesaling by apex
agencies, notably SIDBI and Friends of Women's World Banking/Ananya Finance for Inclusive Growth.
Because of the role of the RBI, NABARD and the directed credit programmes, the banking system
overall has a great role in micro-finance.

A more detailed generic list of stakeholders along with the constrictive features of their role with
possible issues that they face in the development of the micro-finance sector is given in the Table 18.
 Table 18: The Role of Stakeholders in Developing the Micro-Finance Sector

Stakeholder Action Constructive Issues/Constraints

Government 1.Policy formulation Allocating Only working with
A. Identifying areas in line appropriate government owned agencies
with political preferences resources Governments expect diverse
B. Monitoring Efficiencies Defining priorities competencies from single
2. Policy Instruments: and increasing agencies rather than seeing
A. Policy measure allocations the need for a wider range of
B. Resources Allocation Sharing knowledge diverse organisations within
C. Incentives such as tax and information with the sector
break other stakeholders Concentrating resources:
Piece meal and reactive
policy making structures
Not focused on market and
demands of poor clients.
Regulatory Regulation and Removing distortions Primary reliance on main
agencies supervision including (interest rates, etc.) stream idea and primary
defining financial and in markets. attention to formal
legal forms Increasing intermediaries to micro
acceptance diversity finance organisations.
of financial Lack of investment in
intermediaries that is internal capacity among
neutral to the model regulators and supervisors.
adopted and also
allows products
diversity
Investments in
understanding
entities and their
asset and liabilities.
Apex bodies Resources flows for public Sharpening Conflict of interest between
goods, debt, equity. organizational different resources functions,
competences. such as lending capacity and
Develop skill sets to supervisory functions.
match objective of Many of the same
instruments and constraints that apply to
resources (e.g. government also apply to the
through bank linkage publicly owned apex bodies.
programmes)
Monitoring and
improving asset
quality.
Banks Providing debt and equity Improving services Only understand collateral
quality and costs based debt appraisal.
Potentially taking up May view lending to mE a an
equity positions. obligation rather than
 Access to large business opportunity.
volume of funds.
Donors Resources flows for public Increasing flows to Limited instruments for
goods, debt, equity. appropriate bodies interventions.
and intermediaries Concentrating both loan and
Resources for development funding in the
specialiation same organizations.
Limited allocation of
resources for learning by
doing.

MFOs, Service provision Innovative and risk Weak MIS and monitoring.
community taking Limited learning from
based service Focus on expansion, operations and peers.
providers targeting, Inadequate attention to
experimentation, micro enterprises demand
etc, with client group and to demand constraints.
Building of skills and
products to suit
client group
Support (third Bridging different Verifying information Limited specialization.
party) experiences ; Audit, and data Inappropriate application of
organizations rating,data verification; Establishing quality tool and methods.
Organization and human benchmarks.
resource dev, evaluation , Investing in research
impact , assessment. and refinement.

6.9 CONSTRAINTS IN MAINSTREAMING OF MFIs AND CHALLENGES FACED BY THE SECTOR

To increase the outreach of micro-finance services to the needy, the issues/problems associated with
the legal, regulatory and organizational systems should be addressed. Also attitude related issues need
to be addressed.

The formal financial institutions are having large volume of funds and have access to equally large
amounts of low-cost savings deposits. Credit Deposit Ratio (the ratio of credit outstanding to deposits
outstanding) is an indicator of banks involvement in a given area. This ratio gets discussed in Lead Bank
forums. Herein, it is observed that, the poorer the region, the lower the credit-deposit ratio. This can
be inferred to mean that poor regions save more compared to what they borrow than richer regions.
Most of eastern Uttar Pradesh (UP), Bihar, Orissa and the North-east have credit-deposit ratios of 20-
30 per cent. Thus while banks are physically present in rural areas and offer concessional interest
rates, rural producers are not able to access loans, with the result that the rest of the deposits are
finding their way as credit into other regions. Some of the main reasons for the above are as follows:

Borrower-unfriendly Products and Procedures: Most bank products are standardized/straight jacket
type loans. The branches do not have the right to modify the projects. For example a majority of the
rural/ poor customers are illiterate and in need of consumption loans. As per banks' policy,
consumption loans require more documentation and collateral security. Other products have similar
constraints. Hence, the products do not reach the rural poor.

Inflexibility and Delay: Banks follow rigid systems and procedures which result in a lot of delays.
Borrowers are de-motivated from taking further loans. Particularly in the case of small and micro
loans, banks are not able to offer flexibility in the product. Thus the amount of loan and terms of loan
are pre-fixed for a given set of clients which is often inadequate.

High Transaction Costs: The interest rate offered to the borrowers is regulated. However, the
transaction costs are high. The borrowers have to make a large number of trips to provide the
documents. The disbursements are not convenient. The different constituents of transaction cost of
borrowing are as follows:
 transport cost,
 incidental cost,
 opportunity cost and
 intermediary cost.

This makes loans less attractive for borrowers particularly as the loans are very small and the
repayment period is very short.

Social Obligation and not a Business Opportunity: Micro-finance has historically been seen by the
formal institutions as a social obligation rather than a potential business opportunity.

Financing to Alternative MFIs: The NABARD Act does not permit NABARD to refinance a private sector
financial institution and undertake direct financing. The direct lending to NGOs that NABARD has done
so far has came out of donor funds. Similarly the SIDBI Act restricts it from extending loans to the
agricultural and allied sectors„ whereas many of the SHGs are engaged in such activities.
Legal and Regulatory Framework: The policymakers feel that farmers and poor people need low
interest and subsidized credit. They believe that the poor cannot save, they are unwilling to repay the
loans, and the administrative costs of servicing them are high.

Also small loans have been used as a tool for disbursing political patronage, undermining the norm
that loans must be repaid. Thus the mainstream institutions feel that these loans are risky, difficult to
serve and have a low or negative net spread.

The RRBs Act does not permit private shareholding in any RRBs, and the Cooperative Acts of all states
do not permit district level cooperative banks to be set up except by the state government. The result
of these two laws together is that rural credit has been a monopoly of state-owned institutions.

Up scaling of the programme: The SBLP is facing problems of up scaling as there is lack of credible
NGOs and other agencies/individuals that could do social intermediation. The absence of quality
agencies for social intermediation is limiting the spread of the programme.

Capacity building: The capacity building of various partners in the programme namely bank officials,
NGO officials, animators, SHG group leaders and SHG members is a gigantic task. NABARD has been
paying attention to the capacity building of all partners. However the enormity of the programme
warrants other agencies which could also include donor agencies to collaborate in capacity building of
the partners in the programme.

Sustainability of SIIGs: Sustainability of the SHOs depends to a great extent on the quality of the SHGs
which in turn is dependent on the care and attention given by the SHPIs in the formation stage. It has
been observed that there has been a tendency at the field level to hasten the process of formation of
SHGs to achieve the targets which affects the sustainability of the groups on the long run.

Graduation of Microfinance to Micro enterprise: There are a vast number of SIIGs which have come of
age and are struggling to graduate from the stage of microfinance to the stage of micro enterprises.
Lack of adequate skills as also marketing linkages comes in the way of graduation of SHGs to micro
enterprise stage. Not many NGOs / agencies are in a position to provide SHGs the requisite backward
and forward linkages as also market survey reports. This affects setting up of micro enterprises on a
sustainable basis.

Sustainability with outreach: The cost of outreach to the poor is high and the MFIs have a major issue
before them. They need to address the issues of minimizing costs for the poor by having operating
efficiency, administrative effectiveness, maintaining portfolio quality, tracking future risks in portfolio,
covering expenses and fixing appropriate interest rates. Self regulation: The MFIs are handling savings
of the poor people. Savings being an inherent part of microfinance, MFIs need to operate in a self-
regulatory framework.

Constraints Faced by Micro-finance Institutions.

The main aim with which the alternative MFIs have come up is to bridge the increasing gap between
demand and supply of financial services. A vast majority of them function as NGOs to get access to
funds. The existing practice of SIDBI and NABARD is to fund only NGOs or NGO-promoted SHGs. As a
result, most institutions enter such services through the non-profit route. The micro-finance finance
institutions also have not been fully successful in reaching the needy. There are many reasons for this:
 Financial problems leading to setting up of inappropriate legal structures
 Lack of commercial orientation
 Lack of proper governance and accountability
 Isolated and scattered institutions

Inappropriate forms of organization (legal constraints)

NGOs invented micro-finance but NGOs are not the best type of agencies to carry out micro-finance on
a long-term sustainable basis. If an NGO opts to become an MFI, it could face the following problems:
 The major sources of funds of NGOs are grants, which are very limited.
 If the NGOs earn a substantial part of their income from lending activity, they violate section
11(4) of the Income Tax Act and can lose their charitable status under Section 12.
 Moreover, NGOs do not have the appropriate financial structure for carrying out micro-finance
activities. NGOs, being registered as societies or trusts, do not have any equity capital and can
never have adequate capital.

It is a well recognized fact that capital adequacy is an important parameter to ensure risk bearing
capacity. The other alternative for an MFI is to become a cooperative or a company. As in the long run,
the primary source of lending funds for MFIs is deposits, till that stage, the MFI has to rely on
borrowings. To attract borrowings, the MFI has to have equity capital. Thus it is only possible to
establish a financially sustainable MFI either as a cooperative or as a company.

In most states, with the exception of Andhra Pradesh, Maharashtra and Gujarat, cooperatives are
politicized and state controlled and thus not an appropriate form of incorporation for an MFI. That
leaves an MFI with the choice with the choice of being incorporated as a company and then becoming
a Non Banking Finance Company (NBFC) or a Local Area Bank (LAB). The latter requires a licence and
minimum start-up equity of Rs 100 erore. The minimum start-up equity is very difficult for an MFI to
mobilize.

If an MFI opts to become an NBFC, it has the following problems:

 The miniminn entry-level capital requirement is Rs 5 crorc by 30 March 2014 (in case Rs 2 crore
in case of North-eastern rcgion)21.
 It is difficult to mobilize any borrowings from Indian financial institutions due to the negative
image of NBFCs in general. Further, deposit mobilization is not possible at least for the first
three years, till a satisfactory credit rating is obtained.
 This leaves the portion of borrowing from foreign institutions. Borrowing from such institutions
however is difficult in the first place, due to RBI's requirement of at least two credit ratings.
Further, very few foreign institutions are willing to give rupee-denominated loans. Thus the MFI
taking foreign currency loans are subject to exchange risks, which they cannot handle.

Lack of Commercial Orientation

In the initial period, most of the MFIs are highly successful in making credit to customers available at
low cost on account of subsidies and grants that the MFIs are able to attract. However, they failed to
maintain the same record in the long run because of the lack of commercial orientation, thus making it
unsustainable.

Isolated and Scattered

The MFIs are isolated and scattered. There is no proper coordination among them and also there is the
lack of information dissemination.

Lack of Proper Governance and Accountability

Governance and accountability are limited in case of not for profit organizations which need to be
improved. Their boards must be made aware of their financial liabilities in case of failure. The lenders
should be more stringent and insist on nominating a few directors.

6.10 LET US SUM UP

The state led microfinance movement started in India with the introduction of SHG Bank Linkage
Programme in the early 1990s. At present there arc two models of microfinance delivery in India-the
Self Help Group Bank Linkage Model and MFI model. The chapter describes the evolution of
microfinance in India and the policy measures extended by NABARD. The SHG Bank Linkage Model has
emerged as dominant model in terms of number of borrowers and loan outstanding. In terms of
coverage the model is considered to be the largest microfinance programme in the world. Reserve
Bank of India, NABARD and SIDBI have taken a range of initiatives to provide a momentum to the
Microfinance Movement in India. The objectives, uniqueness of SBLP, advantages, credit linkage
models have been presented. The developments relating to evolution of various SHG bank linkage
models of the Microfinance movement arc detailed. The chapter also discussed the institutional
channel of Microfinance and the challenges faced by the Microfinance sector.

6.12 CHECK YOUR PROGRESS

The intensity of penetration of microfinance (MPI) is computed by dividing the share of state
(a) In microfinance clients by its share of population
(b) Income by the share of population
(c) In microfinance clients by share of the state in population of poor
(d) GDP by BPL population

2. The micro-finance institutions have not been fully successful in reaching the needy due to the
(a) Financial problems leading to setting up of inappropriate legal structures
(b) Lack of commercial orientation
(c) Lack of proper governance and accountability
(d) All the above

3. Opportunity cost of the transaction cost arises on account of

(a) The borrowers have to make a large number of trips to provide the documents.
(b) Inconvenient disbursements of loans.
(c) Intermediary cost
(d) Wages that arc foregone by the borrowers

6.13 KEY TO CHECK YOUR PROGRESS

I-a, 2-a, 3-a