A

MAJOR RESEARCH PROJECT REPORT

ON

““A study of Microfinance– Udaipur district”

SUBMITTED IN THE PARTIAL

FULLFILLMENT FOR

DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

2009-2011

FACULTY OF MANAGEMENT STUDIES

MOHAN LAL SUKHADIA UNIVERSITY

UDAIPUR (RAJ.)

SUPERVISED BY: SUBMITTED BY:

DR. HANUMAN PRASAD ABHISHEK JAIN

FMS, Udaipur MBA-RMAT PART II

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CERTIFICATE

This is to certify that MR. ABHISHEK JAIN of MBA-RMAT PART-II of FMS, Udaipur has

successfully completed his Project Titled “A study of Microfinance– Udaipur district”.

This project has been done in partial fulfillment for the award of MBA for the academic session

2009-2011. The student has remained in touch with me and has completed the project as per the

norms and guidelines prescribed by the institute.

Date:

Signature:

DR. HANUMANN PRASAD

FMS, Udaipur

2

DECLARATION

I, ABHISHEK JAIN, a student of Faculty Of Management Studies, Udaipur, hereby declare that

this project on “A study of Microfinance– Udaipur district” is the record of authentic work

carried out by me during the academic year 2011 and has not been submitted to any other

university or Institute for the award of any degree.

An attempt has been made by me to provide all relevant and important details regarding the

topic to support the theoretical edifice with concrete research evidence. This will be helpful to

clean the fog surrounding the various aspect of the topic.

Date: (ABHISHEK JAIN)

Place: Udaipur

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ACKNOWLEDGEMENT

With regard to my Project related to “A study of Microfinance– Udaipur district”I would like to

thank each and every one who offered help, guideline and support whenever required, to all the

respondents who helped me in completion my survey.

I express my profound gratitude to DR. HANUMAN PRASAD. I want to give my sincere

thanks to his kind advice and guidance that had made my project successful. Many of the sound

advices have been well taken by me and it is largely due to his patience that I was able to achieve

my goals successfully.

I would also like to thank my Facutly- Professor Dr. P.K. Jain (Director), Dr. Karunesh Saxena,

Dr. Anil Kothari, Dr. Meera Mathur & Dr. Ashok Singh; and my Institution Faculty of

Management Studies, Mohan Lal Sukhdia University, Udaipur, Rajasthan for providing me this

magnificent opportunity to do research work and learn and for providing us such a wonderful

opportunity. I will not miss the opportunity of expressing gratitude towards all my professors for

the knowledge they shared with me which provided necessary ingredients to this project.

Also I would like to give regards to my Parents and friends who have in some way helped me in

completing this project.

ABHISHEK JAIN

MBA-RMAT PART II

(2009-2011)

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Table of Contents

Introduction 6

Evolution of microfinance 9

Definitions and categories 10

Microfinance market from an investment perspective 12

Challenges 16

Boundaries and principles 18

Financial needs of poor people 20

Ways in which poor people manage their money 21

Informal financial service providers 24

NGO’s 25

Survey Outcomes 30

Conclusions and Recommendation 31

Bibliography 32

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INTRODUCTION

Introduction to microfinance

Microfinance is the provision of financial services to low-income clients or solidarity lending groups including consumers and the self-employed, who traditionally lack access to banking and related services.

More broadly, it is a movement whose object is "a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers." Those who promote microfinance generally believe that such access will help poor people out of poverty.

Microfinance is a broad category of services, which includes microcredit. Microcredit is provision of credit services to poor clients. Although microcredit is one of the aspects of microfinance, conflation of the two terms is epidemic in public discourse. Critics often attack microcredit while referring to it indiscriminately as either 'microcredit' or 'microfinance'. Due to the broad range of microfinance services, it is difficult to assess impact, and very few studies have tried to assess its full impact.

One of the key assumptions of microfinance programmes is that it can help the poor, especially women, to develop new income generating activities (IGA) or at least strengthen existing IGA. Available empirical studies give controversial results. While some studies give positive results , other studies emphasize the very limited effects in terms of IGA nd some time the drawbacks of microfinance: loans mainly used for “non productive purpose” or appropriated by males, women confined into the least profitable sectors, market saturation and displacement effects, etc. In-depth analyses report a diversity of women profiles and therefore a diversity of effects and results. For instance, shows that in Bangladesh, the effects of microcredit depend in part on caste and class. The two contexts are characterized by strong ifferences in terms of education, entrepreneurial experience, social norms, exposure, dependence on men and opportunities and size of local markets. In urban areas one finds “real” women entrepreneurs: through microcredit and other services they manage to upgrade their activities from petty trading to market-stall holders. By contrast, rural women seek merely to supplement the family budget. They operate mainly through imitation. Their main objective is to mitigate risk and diversify rather than upgrade pre-existing activities. The justification for diversification often stems from the seasonality of available livelihood opportunities. They depend heavily on NGOs for any new idea. From the report differences between women according to their position in the life cycle. Older women are much more "aggressive" in generating employment than the young generation

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(and just as productive as male entrepreneurs). The authors make the assumption that younger women are forced by domestic charges, high marginal value of home time during certain periods of their time. From Cameroon, Mayoux (2001) finds large disparities in the success and sustainability of women enterprises financed by microcredit. Rather than class background - success also exists for women from very poor milieu - the difference seems to come from women's ability to mobilize and activate social networks.

2 advocate that microcredit for entrepreneurship is only possible beyond the ‘minimalist proach’ .they are of the opinion that credit for enterprise development is important but can be achieved only with the provision of support services

3 preferable by other development promoters (government agencies, Non Governmental Oorganisations (NGOs), insurance companies, etc.) and not by the credit provider itself. Contrary to the minimalist approach, support services for livelihood promotion do have a long history in India promoted by the government, by the peoples movement, by the NGOs and the Corporate sector. Referring to the Government of India/ “the unhappy summary of nearly 60 years of government-run livelihood programmes is that they were well-conceived but poorly implemented” . Providing support services can be a challenge and there is more to successful enterprise development than provision of microcredit and support services together. Such efforts need to take some caution in their planning without undermining socio-economic dynamics. This is well demonstrated in Leach and Sitaram’s study on an NGO’s effort to empower scheduled caste women in the silk-reeling industry in South India by transforming them from wage labourers to independent entrepreneurs. The biggest fallout of this project was its concentration on women to the total neglect of men; the decision ‘authorities’ of the household. This led to women shouldering more labour and further subjected to intense ridicule from their husband’s when things went wrong in this highly volatile and seasonal silk industry. The significance of socio-economic dynamics is much broader than pertaining to gender roles. This is explored in Nair’s study on attitudes to income generation and work among fishermen. She discusses here how the introduction of microcredit financed fishing nets, “increased the productivity of fishing activity technically” but “the average income and consumption levels of many of the households” did not increase “to any significant extent”. She explains how this is linked to many fishermen cutting down on the number of fishing days. This reminds us not to forget that planning is not just done at the policy level but also at the beneficiary level where local social dynamics play a key role. Drawing on these lines, the paper suggests that further attention should be given to the socioeconomic dynamics and embeddedness of women’s activities. Why women decide to involve themselves into such or such activity? What are their motivations?

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Evolution of microfinance

Microfinance has been a success story over past decades. Nevertheless, core ele- ments of today’s microfinance framework have been used for centuries. In Ireland, the author Dean Jonathan Swift initiated entities called “loan funds”. These funds accommodated microcredits to entrepreneurs starting in 1720. About one hundred years later, the government established a statutory basis resulting in a boom of “loan funds”. A second example is the German “Sparkassen” and cooperative banking system. The first “Sparkasse” was established 1778 in Hamburg. In addition to saving deposits, services included loans for businesses and farmers. In 1846, Frie- drich Wilhelm Raiffeisen and Hermann Schulze-Delitzsch founded cooperatives focusing on saving and lending deposits for sma ll businesses and farmers. All three mentioned German banking institutions are major retail banks today: “Spar- kassen”, “Raiffeisen” and “Volksbanken”.

The roots of today’s microfinance in emerging markets lie in the mid 1970s.

Mohammed Yunus started in 1976 during a famine period to lend money to people of his community. Seven years later, Grameen Bank was founded and Bangladesh became a textbook example for microfinance. During the same period, ACCION in Brazil and Bank Rakyat in Indonesia developed similar microcredit business mod- els. Failed subsidy programmes are one of the major reasons for the popularity of these and other microfinance institutions in emerging markets. Local governments set up rural development programmes financed by development finance institutions (DFIs) such as the World Bank, its private sector affiliate, the International Finance Corporation (IFC) or the German Kreditanstalt für Wiederaufbau (KfW). However, several factors led to a failure of these subsidised development aid programmes.

Firstly, local banks were not able to work profitably with the regulated interest rates, because operating costs were too high in many regions. Secondly, many debt- ors considered the loans as donors of their government and hence did neither pay interest rates nor the credit amount at maturity. Thirdly, the rationing of credit pro- grammes fostered corruption in bank lending. Hence, locally originated microfinance proved to be the better solution. It has become one of the rare finan- cial and sustainable success stories of today’s emerging and developing markets84 financial system.

Definitions and categories

Microfinance institutions (MFIs) provide various products for mainly low-income clients mostly in emerging and developing markets. Among those are credits, savings deposits, insurances and pension products.

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The main product of microfinance is the microcredit concept. A clear definition and segmentation of the loan and credit segment is crucial. In fact, three main credit types exist in emerging markets. Firstly, consumer credits are used to finance a non-durable good and hence have to be financed by the clients’ per- sonal income. Secondly, entrepreneurs can draw on a credit to establish a business or moderately expand an existing one. This kind of credit is referred to as micro- credits. The interest payment is generated out of the business’ cash flow. Due to the entrepreneurial concept of microcredit, generally no or only insufficient collaterali- zation is possible. Thirdly, corporate credits with adequate collateral exist. This is a common pattern of (small) business lending. As a consequence, the distinction of income-financed consumer credits and cash-flow-financed microcredits is a critical differentiation factor in microfinance.

Microcredits are business loans and by definition not consumer loans. These loans shall support and initiate business concepts, which finance their capital costs out of the business. The clear separation from income-dependent consumer financing enables high repayment rates. However, interest rates are relatively high compared to developed country rates. Firstly, credits are in local currency and therefore refer to local rates.

Secondly, clients are widespread and the loan amount is comparably low. Thus, operating costs are on a very high level. Nevertheless, microfinance institutions offer rates which are far below money lender rates.

Savings deposits are a further product and gain importance for microfinance in- stitutions. On the one hand, it is a refinancing option especially in situations when local currency credit markets are limited. On the other hand, it enables MFIs to increase the commitment of their creditors, because these often have savings depos- its as well. However, due to regulatory issues MFIs cannot accept deposits in all countries and in general a banking licence is a prerequisite. Also clients can profit from savings deposits, because they get the opportunity to deposit money and get a small interest on the amount. From a western perspective this argument may sound unfamiliar, but in several countries clients would otherwise have to pay a fee for a deposit instead of receiving interest.88 In conclusion, MFIs as well as clients can profit from savings accounts.

Further products are offered in the segment of microinsurance and -pension.

The product range is equally to common insurance and pension products, but con- tract sizes are very low and operational costs high. Overall, this market is still in an early stage of development. However, in some countries such as Bangladesh with Grameen Bank it is already emerging rapidly. As a result, even major players such as Allianz, Munich Re and Swiss Re have entered this high growth potential market.

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Socially responsible investments rank high on investors’ agendas. In the Udaipur division, the volume of SRIs has increased by a compound annual growth rate of 13.6% in Rs 5,00,000 2010 while in SRI assets grew even faster by a CAGR of 27.3% .

1 In the Udaipur division, nearly a tenth of professionally managed assets is already related to socially responsible investment by now. These impressive growth rates demonstrate the growing weight investors attach to the social and environmental consequences of their investments. Amongst the great variety of SRIs, investments in microfinance have recently started to increasingly attract institutional and individual investors.

2 Currently, the microfinance sector is in a transition process from donor-driven NGO-dominated framework towards an increasing involvement of capital markets. The reasons are that, on the one and, some microfinance institutions have begun to explore new funding opportunities, e.g. by securitising microfinance loan portfolios; some microfinance institutions have even gone public. On the other hand, private-sector investors increasingly appreciate microfinance investments for their dual nature: First, they allow investors to adopt a social investment strategy geared toward poverty alleviation and social development in developing countries. Second, they simultaneously offer an attractive risk-return profile that is marked by largely stable financial returns, low credit default rates and low correlation to the mainstream financial assets as well as the general domestic economy. Some evidence even indicates that microfinance investments might be conducive to the efficient portfolio diversification.

3 This study takes a closer look at the role that institutional and individual investors might play in the medium-term development of the microfinance sector. What contribution can private investors make to scaling up microfinance and narrowing its immense funding gap? Which market volume is already captured by institutional and individual investors and which volume may private-sector investments in microfinance reach by 2015? What do typical microfinance investments look like and what are the associated benefits and risks for private-sector investors? What are the major constraints on the development of the microfinance sector? What role can microfinance play as an emerging investment opportunity in the context of investors’ efficient diversification of portfolios? We conclude by summarising our main findings and providing a medium-term market forecast for the development of institutional and individual microfinance investments.

Microfinance market from an investment perspective

Market overview

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The microfinance market is structured horizontally along the financial value chain . MFIs grant entrepreneurs a loan with a fixed interest rate in local currency. In the strict sense, the debtor uses the loan to finance an entrepreneurial business and serves the interest payments out of the business’ cash flows. In some cases, debtors also have a savings deposit at a MFI with a small or sometimes even no accruing interest. This is one of the main refinancing options for MFIs. Further refinancing includes debt obligations from microfinance investment vehicles (MIVs) or direct investor, local credit markets and equity investments.

A broad spectrum of service providers complements the microfinance market. Be- sides the above mentioned market participants of the direct value chain several segments of service providers emerged. The service providers are segmented in three categories. Firstly, DFIs offer technical assistance as well as subsidized funding. Secondly, service providers in a broader sense such as specified data providers, specialised accountants and lawyers as well as FX hedging special- ists serve the niche market. Finally, rating agencies complement the microfinance market. These companies either focus on microfinance such as MicroRate or agen- cies extended their business to microfinance such as Fitch.

The microfinance market exhibits a mature market structure. However, the market is young and various segments as well as market participants are newly developed or incorporated. Nevertheless, the market is innovative and able to deal with nearly any kind of issue. But in some cases the processes are not defined strictly and mutu- ally agreed procedures are not arranged yet.

Microfinance users

The typical microfinance user is a debtor and client of a MFI. Generally, the per- son is to some extent a micro-entrepreneur working as a street vendor, farmer, fisherman, salesman, or service provider. Microfinance clients are also often de- scribed according to their poverty level. However, the idea of microfinance is not donating for the poor. In fact, it is enabling and supporting the entrepreneurial spirit.

Some clients are truly entrepreneurs. They create and run a busi- ness, while others ecame

entrepreneurs by necessity as the formal sector is less marked than in developed countries.

The average loan size differs region, in Udaipur Division RS 20000 to Rs 1,00,000. The credits

are in local currency, thus the interest rate refers to local currency rates and operating

costs. The credit period is in the vast majority between 12 and 36 months, averaging

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MFI

around 18 months.

The gender is a further important criterion in the microfinance segment. Overall, roughly 60%

of the credits are allowed to women.95 Furthermore, in some areas in Udaipur Division ending

is preferred as it generates social control. Another rarely stated reason for the group lending

phenomenon is the loan amount. In Udaipur loans are on average roughly ten times higher than

in other and therefore operating costs are assumed to be lower, which makes individual

lending more profitable. This might be another factor allowing indi- vidual lending, besides the

often stated cultural and social differences.

Microfinance institutions

MFIs are organizations offering microcredits and in some cases savings accounts. Hence,

t he balance sheet assets are credits allowed to micro-entrepreneurs. The liability structure

depends on the MFI’s refinancing strategy, corporate status and regulatory issues . Adequate

financing sources are equity, interna- tional capital markets, local capital markets, deposit

accounts and subsidies such as supranational funding or even donations.

The refinancing strategy of MFIs is dependent on their development stage. Mature and well-

known MFIs are clustered as Tier 1. These institutions are in the majority of the cases banks,

regulated by a governmental authority and also covered by rating agencies. Tier 2 MFIs are

smaller and not all processes are perfectly structured yet. However, these institutes are

candidates for a conversion into banks. The third group and majority of MFIs are NGOs or

start-ups. These organizations are mostly unprofitable and often follow exclusively social

objectives. As a result, MFIs can be clustered into a pyramid scheme with only a few

mature institutions. Nevertheless, these Tier 1 and 2 MFIs grant about 90% of the loan sum.

Microfinance investment vehicles (MIVs), local banks, development agencies, donators

and international credit markets facilitate the refinancing of MFIs. The mature MFIs have

access to local capital markets as well as investment funds to leverage their equity.

Furthermore, these institutions generally have a banking li- cense and consequently accept

deposits as further refinancing facility. For these reasons, mature MFIs are able to lever

their equity up to seven times. The aver- age debt to equity multiple of Tier 1 and 2

MFIs is about three. However, the majority of MFIs operates less professional and

refinances the microcredits with loans from development agencies or donations.

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The outstanding loan portfolio of about 1000 major MFIs was about Rs 1,00,000 according to

The Mix database. Indeed, these data are not exclusively based on microcredits, but also

contain consumer lending and small business lending. An amount of about Rs 50,000 seems

more adequate according to estimates of various microfinance experts from MicroRate or

responsAbility. These credits are funded by savings deposits, donations, paid in capital and

borrowings.

MFIs require local currency refinancing with matching maturities to their credits. But

international investors such as investment funds or even governmental invest- ments prefer

hard currency debt obligations. Accordingly, the MFI or the debtor would have to dare the

currency risk. In case of strong currency devaluation, the risk taker could default. Thus, MFI

and investor assign a reliable counterparty for foreign exchange risks. In some countries, the

international capital market offers derivative instruments such as non-deliverable forwards. In

the vast majority of cases, currency hedging can only be provided by local banks that take the

risk for high premiums. Overall, the foreign exchange risk for international investors such as

development agencies and MIVs has gained importance over the last years.

The refinancing structure of MFIs is dominated by local sources. Savings ac- counts of

microfinance clients make up on average 45% of the balance sheet. Additionally, roughly

30% are refinanced with domestic credit lines or equity in- vestments. Hence, less than 25%

are financed by foreign investors. However, this still amounts to about financed from foreign

sources such as MIVs and direct investments.

The funding structure of MFIs differs regionally. Interestingly, the refinancing gap with

respect to deposits is highest in Udaipur. In the other three main regions, roughly 50% of the

loans are funded by deposits. However, the data quality regarding microfinance is rather poor.

As a result, the tapping of various different refinancing sources especially client deposits

requires a sound asset liability man- agement for MFIs and is critical to assess and manage

financial risks.

Microfinance investment vehicles

Microfinance investment vehicles are funds or structured products that provide debt obligations

to or take equity stakes in MFIs. In general, institutional and private investors have three

channels to participate in the microfinance market. Firstly, they can invest directly in business

projects of micro-entrepreneurs. Secondly, direct investments can be allocated to MFIs that

accommodate a broad range of micro- credits with a regional focus. Finally, investors can place

money with MIVs that allocate their portfolio to a diverse range of MFIs.

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Direct investments in a single project or a regionally based MFI may generate a high social

impact, but also increase risks. Arguments such as regional diversifica- tion, selection skills

and access to the market are a clear advice to fund investments. However, philantrophic

investors and donators prefer the direct contact to their projects.

Microfinance investment vehicles are an increasingly important funding instru- ment of MFIs.

In 2007, MIVs accounted for about Rs 50000 of credit lines and equity investments. In 2009,

the boom in microfinance investments slowed down.

However, MIVs funding capacity increased also during the credit crises by about

30% per year. Especially governmental vehicles and private investors ensured money

inflows. For this reason, MIVS currently have a refinancing capacity of 50,00,000Rs.

Microfinance investment vehicles have different approaches. Firstly, pure micro- finance debt

obligation funds exist. They often offer a return of Libor plus 200 basis points and charge

around 2% management fees. The debt obligations have a matur- ity of 12 to 36 months and

are widely diversified across regions. Secondly, some microfinance equity funds invest

directly in equity stages of MFIs. These funds are set up like private equity funds with similar

return expectations and fee structures. Thirdly, there are funds combining debt obligations

with some equity exposure. Finally, structured vehicles have been set up. These credit loan

obligations (CLOs) are less regulated, have a fixed maturity and offer no liquidity. From an

investment perspective, these structures are not advisable as the whole investment is placed in

one maturity and time horizon. However, long maturities of the debt obligations offer a

premium.

A further distinction criterion of microfinance investment vehicles is the foreign exchange

approach. Almost every MIV purely invests in hard currency debt obliga- tion, despite the high

costs for foreign exchange hedging. However, as investors get more and more experienced this

might change in the future and local currency in- vestments will increase.

Some MIVs do not allocate purely to microfinance investments. There are two major reasons

for this. Firstly, raised capital cannot be invested at short notice. In the past, MFIs have often

aligned the lending policy to the availability of refinanc- ing opportunities. The allowance of

credits takes a while and currently the credit crisis also slowed down the need for

microcredits. Secondly, cash or liquid assets enhance liquidity options of the fund. In case of

withdrawals, the fund cannot liqui- date debt obligations as no secondary market exists.

A strict asset liability management is crucial. However, interest payments and the short

maturity of the debt obligations (on average about 18 months) lead to a constant cash flow.

But reinvestments have to be arranged well in advance in the illiquid microfinance mar- ket

environment. In conclusion, cash management is a major challenge for MIVs and hence some

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invest a smaller portion in other more liquid investments.

The market for microfinance investments shows strong and sustained growth. Every other

month, a new investment vehicle is launched. In most cases, the vehi- cles are managed by

one of the three big market players BlueOrchard, responsAbility or Symbiotics and

only distributed by a new market member. Be- sides, the debt obligations market for MFIs is a

person’s business. For example, a general market platform for debt obligations does not exist

and access to brokers is limited. Hence, market entry is complicated and only a few

companies have the skills and contacts to act successfully including the above mentioned as

well as Developing World Markets and Triodos.

Challenges

Traditionally, banks have not provided financial services, such as loans, to clients with little or

no cash income. Banks incur substantial costs to manage a client account, regardless of how

small the sums of money involved. For example, although the total gross revenue from

delivering one hundred loans worth Rs. 50,000 each will not differ greatly from the revenue

that results from delivering one loan of Rs.50,00,000. It takes nearly a hundred times as much

work and cost to manage a hundred loans as it does to manage one. The fixed cost of

processing loans of any size is considerable as assessment of potential borrowers, their

repayment prospects and security; administration of outstanding loans, collecting from

delinquent borrowers, etc., has to be done in all cases. There is a break-even point in providing

loans or deposits below which banks lose money on each transaction they make. Poor people

usually fall below that breakeven point. A similar equation resists efforts to deliver other

financial services to poor people.

In addition, most poor people have few assets that can be secured by a bank as collateral. As

documented extensively by Hernando de Soto and others, even if they happen to own land in

the developing world, they may not have effective title to it. This means that the bank will

have little recourse against defaulting borrowers.

Seen from a broader perspective, the development of a healthy national financial system has

long been viewed as a catalyst for the broader goal of national economic development.

However, the efforts of national planners and experts to develop financial services for most

people have often failed in developing countries.

Because of these difficulties, when poor people borrow they often rely on relatives or a local

moneylender, whose interest rates can be very high. An analysis of studies of informal

moneylending rates in Udaipur Division concluded that 76% of moneylender rates exceed 10%

per month, including 22% that exceeded 100% per month. Moneylenders usually charge

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higher rates to poorer borrowers than to less poor ones. While moneylenders are often

demonized and accused of usury, their services are convenient and fast, and they can be very

flexible when borrowers run into problems. Hopes of quickly putting them out of business

have proven unrealistic, even in places where microfinance institutions are active.

Over the past centuries practical visionaries, the founders of the microcredit movement in the

1970s (such as Muhammad Yunus) have tested practices and built institutions designed to

bring the kinds of opportunities and risk-management tools that financial services can provide

to the doorsteps of poor people. While the success of the Grameen Bank has inspired the

world, it has proved difficult to replicate this success. In nations with lower population

densities, meeting the operating costs of a retail branch by serving nearby customers has

proven considerably more challenging. This particular model (used by many Microfinance

institutions) makes financial sense, he says, because it reduces transaction costs. Microfinance

programmes also need to be based on local funds.

Although much progress has been made, the problem has not been solved yet, and the

overwhelming majority of people who earn less than Rs 100 a day, especially in the rural

areas, continue to have no practical access to formal sector finance. Microfinance has been

growing rapidly with Rs50,00,000 currently at work in microfinance loans in Udaipur

Division. It is estimated that the industry needs Crores to get capital to all the poor people who

need it.The industry has been growing rapidly, and concerns have arisen that the rate of capital

flowing into microfinance is a potential risk unless managed well.

As seen in the State of Andhra Pradesh (India), these systems can easily fail. Some reasons

being lack of use by potential customers, over-indebtedness, poor operating procedures,

neglect of duties and inadequate regulations.

Boundaries and principles

Poor people borrow from informal moneylenders and save with informal collectors. They

receive loans and grants from charities. They buy insurance from state-owned companies.

They receive funds transfers through formal or informal remittance networks. It is not easy to

distinguish microfinance from similar activities. It could be claimed that a government that

orders state banks to open deposit accounts for poor consumers, or a moneylender that engages

in usury, or a charity that runs a heifer pool are engaged in microfinance. Ensuring financial

services to poor people is best done by expanding the number of financial institutions available

to them, as well as by strengthening the capacity of those institutions. In recent years there has

also been increasing emphasis on expanding the diversity of institutions, since different

institutions serve different needs.

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1. Poor people need not just loans but also savings, insurance and money transfer services.

2. Microfinance must be useful to poor households: helping them raise income, build up

assets and/or cushion themselves against external shocks.

3. "Microfinance can pay for itself. Subsidies from donors and government are scarce and

uncertain, and so to reach large numbers of poor people, microfinance must pay for itself.

4. Microfinance means building permanent local institutions.

5. Microfinance also means integrating the financial needs of poor people into a country's

mainstream financial system.

6. "The job of government is to enable financial services, not to provide them."

7. "Donor funds should complement private capital, not compete with it."

8. "The key bottleneck is the shortage of strong institutions and managers." Donors should

focus on capacity building.

9. Interest rate ceilings hurt poor people by preventing microfinance institutions from

covering their costs, which chokes off the supply of credit.

10. Microfinance institutions should measure and disclose their performance – both

financially and socially.

Microfinance is considered as a tool for socio-economic development,and can be clearly

distinguished from charity. Families who are destitute, or so poor they are unlikely to be able to

generate the cash flow required to repay a loan, should be recipients of charity. Others are best

served by financial institutions.

Debates at the boundaries

There are several key debates at the boundaries of microfinance.

Practitioners and donors from the charitable side of microfinance frequently argue for restricting

microcredit to loans for productive purposes–such as to start or expand a microenterprise. Those

from the private-sector side respond that because money is fungible, such a restriction is

impossible to enforce, and that in any case it should not be up to rich people to determine how

poor people use their money.

Perhaps influenced by traditional Western views about usury, the role of the traditional

moneylender has been subject to much criticism, especially in the early stages of modern

microfinance. As more poor people gained access to loans from microcredit institutions however,

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it became apparent that the services of moneylenders continued to be valued. Borrowers were

prepared to pay very high interest rates for services like quick loan disbursement, confidentiality

and flexible repayment schedules. They did not always see lower interest rates as adequate

compensation for the costs of attending meetings, attending training courses to qualify for

disbursements or making monthly collateral contributions. They also found it distasteful to be

forced to pretend they were borrowing to start a business, when they were often borrowing for

other reasons (such as paying for school fees, dealing with health costs or securing the family

food supply). The more recent focus on inclusive financial systems (see section below) affords

moneylenders more legitimacy, arguing in favour of regulation and efforts to increase

competition between them to expand the options available to poor people.

Modern microfinance emerged with a strong orientation towards private-sector solutions. This

resulted from evidence that state-owned agricultural development banks in developing countries

had been a monumental failure, actually undermining the development goals they were intended

to serve. Nevertheless public officials in many countries hold a different view, and continue to

intervene in microfinance markets.

There has been a long-standing debate over the sharpness of the trade-off between 'outreach' (the

ability of a microfinance institution to reach poorer and more remote people) and its

'sustainability' (its ability to cover its operating costs—and possibly also its costs of serving new

clients—from its operating revenues). Although it is generally agreed that microfinance

practitioners should seek to balance these goals to some extent, there are a wide variety of

strategies, ranging from the minimalist profit-orientation. This is true not only for individual

institutions, but also for governments engaged in developing national microfinance systems.

Microfinance experts generally agree that women should be the primary focus of service

delivery. Evidence shows that they are less likely to default on their loans than men. Industry

data for 34 MFIs reaching 65000 borrowers includes MFIs using the solidarity lending

methodology (58% female clients) and MFIs using individual lending (51% female clients). The

delinquency rate for solidarity lending was 2.4% after 30 days. Because operating margins

become tighter the smaller the loans delivered, many MFIs consider the risk of lending to men to

be too high. This focus on women is questioned sometimes, however. A recent study of

microenterpreneurs from Sri Lanka published by the World Bank found that the return on capital

for male-owned businesses (half of the sample) averaged 11%, whereas the return for women-

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owned businesses was 0% or slightly negative.

Microfinancial services may be needed everywhere, including the developed world. However, in

developed economies intense competition within the financial sector, combined with a diverse

mix of different types of financial institutions with different missions, ensures that most people

have access to some financial services. Efforts to transfer microfinance innovations such as

solidarity lending from developing countries to developed ones have met with little success.

Financial needs of poor people

In Udaipur Division and particularly in the rural areas, many activities that would be classified in

the developed world as financial are not monetized: that is, money is not used to carry them out.

Almost by definition, poor people have very little money. But circumstances often arise in their

lives in which they need money or the things money can buy.

In Stuart Rutherford’s recent book The Poor and Their Money, he cites several types of needs:

Lifecycle Needs: such as weddings, funerals, childbirth, education, homebuilding,

widowhood, old age.

Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or

death.

Disasters: such as fires, floods, cyclones and man-made events like war or bulldozing of

dwellings.

Investment Opportunities: expanding a business, buying land or equipment, improving

housing, securing a job (which often requires paying a large bribe), etc.

Poor people find creative and often collaborative ways to meet these needs, primarily through

creating and exchanging different forms of non-cash value. Common substitutes for cash vary

from country to country but typically include livestock, grains, jewelry, and precious metals.

As Marguerite Robinson describes in The Microfinance Revolution, the 1980s demonstrated that

"microfinance could provide large-scale outreach profitably," and in the 1990s, "microfinance

began to develop as an industry" (2001, p. 54). In the 2000s, the microfinance industry's

objective is to satisfy the unmet demand on a much larger scale, and to play a role in reducing

poverty. While much progress has been made in developing a viable, commercial microfinance

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sector in the last few decades, several issues remain that need to be addressed before the industry

will be able to satisfy massive worldwide demand. The obstacles or challenges to building a

sound commercial microfinance industry include:

Inappropriate donor subsidies

Poor regulation and supervision of deposit-taking MFIs

Few MFIs that meet the needs for savings, remittances or insurance

Limited management capacity in MFIs

Institutional inefficiencies

Need for more dissemination and adoption of rural, agricultural microfinance

methodologies

Ways in which poor people manage their money

Rutherford argues that the basic problem poor people as money managers face is to gather a

'usefully large' amount of money. Building a new home may involve saving and protecting

diverse building materials for years until enough are available to proceed with construction.

Children’s schooling may be funded by buying chickens and raising them for sale as needed for

expenses, uniforms, bribes, etc. Because all the value is accumulated before it is needed, this

money management strategy is referred to as 'saving up'.

Often people don't have enough money when they face a need, so they borrow. A poor family

might borrow from relatives to buy land, from a moneylender to buy rice, or from a microfinance

institution to buy a sewing machine. Since these loans must be repaid by saving after the cost is

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incurred, Rutherford calls this 'saving down'. Rutherford's point is that microcredit is addressing

only half the problem, and arguably the less important half: poor people borrow to help them

save and accumulate assets. Microcredit institutions should fund their loans through savings

accounts that help poor people. manage their risks.

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Most needs are met through mix of saving and credit. A benchmark impact assessment of

Grameen Bank and two other large microfinance institutions in Udaipur Division found that for

every Rs 50 they were lending to clients to finance rural non-farm micro-enterprise, about Rs125

came from other sources, mostly their clients' savings. This parallels the experience in the West,

in which family businesses are funded mostly from savings, especially during start-up.

Recent studies have also shown that informal methods of saving are unsafe. For example a study

by us in Udaipur Division concluded that "those with no option but to save in the informal sector

are almost bound to lose some money – probably around one quarter of what they save there."

The work has caused practitioners to reconsider a key aspect of the microcredit paradigm: that

poor people get out of poverty by borrowing, building microenterprises and increasing their

income. The new paradigm places more attention on the efforts of poor people to reduce their

many vulnerabilities by keeping more of what they earn and building up their assets.

While they need loans, they may find it as useful to borrow for consumption as for

microenterprise. A safe, flexible place to save money and withdraw it when needed is also

essential for managing household and family risk.

Current scale of microfinance operations

No systematic effort to map the distribution of microfinance has yet been undertaken. A useful

recent benchmark was established by an analysis of 'alternative financial institutions' in the

Udaipur Division in 2011. We counted approximately 150 client accounts at over 30, institutions

that are serving people who are poorer than those served by the commercial banks. Of these

accounts, 105 were with institutions normally understood to practice microfinance. Reflecting

the diverse historical roots of the movement, however, they also included postal savings banks

(150 accounts), state agricultural and development banks , financial cooperatives and credit

unions and specialized rural banks.

Regionally the concentration of these accounts was in Udaipur Division representing good

percentage of the total population. Considering that most bank clients in the developed world

need several active accounts to keep their affairs in order, these figures indicate that the task the

microfinance movement has set for itself is still very far from finished.

By type of service "savings accounts in alternative finance institutions outnumber loans by about

four to one. This is a worldwide pattern that does not vary much by region."

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An important source of detailed data on selected microfinance institutions is the MicroBanking

Bulletin, which is published by Microfinance Information Exchange. At the end of 2010 it was

tracking 34 MFIs that were serving borrowers.

As yet there are no studies that indicate the scale or distribution of 'informal' microfinance

organizations and informal associations that help people manage costs like weddings, funerals

and sickness. Numerous case studies have been published however, indicating that these

organizations, which are generally designed and managed by poor people themselves with little

outside help, operate in most countries in the developing world.

"Inclusive financial systems"

The microcredit era that began in the 1970s has lost its momentum, to be replaced by a 'financial

systems' approach. While microcredit achieved a great deal, especially in urban and near-urban

areas and with entrepreneurial families, its progress in delivering financial services in less

densely populated rural areas has been slow.

The new financial systems approach pragmatically acknowledges the richness of centuries of

microfinance history and the immense diversity of institutions serving poor people in developing

world today. It is also rooted in an increasing awareness of diversity of the financial service

needs of the world’s poorest people, and the diverse settings in which they live and work.

Brigit Helms in her book 'Access for All: Building Inclusive Financial Systems', distinguishes

between four general categories of microfinance providers, and argues for a pro-active strategy

of engagement with all of them to help them achieve the goals of the microfinance movement.

Informal financial service providersThese include moneylenders, brokers, savings collectors, money-guards, and input supply shops.

Because they know each other well and live in the same community, they understand each

other’s financial circumstances and can offer very flexible, convenient and fast services. These

services can also be costly and the choice of financial products limited and very short-term.

Informal services that involve savings are also risky; many people lose their money.

Member-owned organizationsThese include self-help groups, credit unions, and a variety of hybrid organizations like 'financial

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service associations' . Like their informal cousins, they are generally small and local, which

means they have access to good knowledge about each others' financial circumstances and can

offer convenience and flexibility. Since they are managed by poor people, their costs of

operation are low. However, these providers may have little financial skill and can run into

trouble when the economy turns down or their operations become too complex. Unless they are

effectively regulated and supervised, they can be 'captured' by one or two influential leaders, and

the members can lose their money.

NGO’s

They have proven very innovative, pioneering banking techniques like solidarity lending, village

banking and mobile banking that have overcome barriers to serving poor populations. However,

with boards that don’t necessarily represent either their capital or their customers, their

governance structures can be fragile, and they can become overly dependent on external donors.

Formal financial institutions

In addition to commercial banks, these include state banks, agricultural development banks,

savings banks, rural banks and non-bank financial institutions. They are regulated and

supervised, offer a wider range of financial services, and control a branch network that can

extend across the country and internationally. However, they have proved reluctant to adopt

social missions, and due to their high costs of operation, often can't deliver services to poor or

remote populations. The increasing use of alternative data in credit scoring, such as trade

credit is increasing commercial banks' interest in microfinance. With appropriate regulation and supervision, each of these institutional types can bring

leverage to solving the microfinance problem. For example, efforts are being made to link self-

help groups to commercial banks, to network member-owned organizations together to achieve

economies of scale and scope, and to support efforts by commercial banks to 'down-scale' by

integrating mobile banking and e-payment technologies into their extensive branch networks.

Microcredit and the web

Due to the unbalanced emphasis on credit at the expense of microsavings, as well as a desire to

link Western investors to the sector, platforms have developed to expand the availability of

microcredit through individual lenders in the developed world. In comparison, the needs for

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microcredit are estimated about crores as of end 2011. Most experts agree that these funds must

be sourced locally in countries that are originating microcredit, to reduce transaction costs and

exchange rate risks.

There have been problems with disclosure on peer-to-peer sites, with some reporting interest

rates of borrowers using the flat rate methodology instead of the familiar banking Annual

Percentage Rate. The use of flat rates, which has been outlawed among regulated financial

institutions in developed countries, can confuse individual lenders into believing their borrower

is paying a lower interest rate than, in fact, they are.

Evidence for reducing poverty

Some proponents of microfinance have asserted, without offering credible evidence, that

microfinance has the power to single-handedly defeat poverty. This assertion has been the source

of considerable criticism.Research on the actual effectiveness of microfinance as a tool for

economic development remains slim, in part owing to the difficulty in monitoring and measuring

this impact. The Innovations for Poverty Action/Financial Access Initiative Microfinance

Research conference, economist noted there are only one or two methodologically sound studies

of microfinance's impact.

The BBC Business Weekly program reported that much of the supposed benefits associated with

microfinance, are perhaps not as compelling as once thought. A point was raised concerning a

comparison between two groups: financed through microcredit and one control group. The

results of this study suggest that many of the benefits from microcredit are in fact loaned to

people with existing business, and not to those seeking to establish new businesses. Many of

those receiving microcredit also used the loans to supplement the family income. The income

that went up in business was true only for men, and not for women. This is striking because one

of the supposed major beneficiaries of microfinance is supposed to be targeted at women.The

conclusion was that whilst microcredit is not necessarily bad and can generate some positive

benefits, despite some lenders charging interest rates between 40-60%, it isn't the panacea that it

is purported to be. He advocates rather than focusing strictly on microcredit, also giving citizens

in poor countries access to rudimentary and cheap savings accounts.

To further the point stated, microfinancing the general tendency of a small business initially

supported on credit to gain profits with time and generate micro savings. In his latest study, the

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famous two time pulitzer prize winner, Nicholas Donabet Kristof states that there is no evidence

of any negative influence of micro financing but countless examples of people now looking at

the bigger picture and saving for better things have surfaced. The example, where the number of

savers has grown to twice as much as the number of borrowers, further strengthens his theory.

Sociologist found that much of the evidence on the effectiveness of microfinance for alleviating

poverty is based in anecdotal reports or case studies. Initially found over articles on the subject,

but included only the limited which used enough quantitative data to be representative, and none

of which employed rigorous methods such as randomized control trials similar to those reported

by Innovations for Poverty Action. One of these studies found that microfinance reduced

poverty. Two others were unable to conclude that microfinance reduced poverty, although they

attributed some positive effects to the program. Other studies concluded similarly, with surveys

finding that a majority of participants feel better about finances with some feeling worse.

Microfinance and social interventions

There are currently a few social interventions that have been combined with micro financing to

increase awareness of HIV/AIDS. Such interventions like the "Intervention with Microfinance

for AIDS and Gender Equity" (IMAGE) which incorporates microfinancing with "The Sisters-

for-Life" program a participatory program that educates on different gender roles, gender-based

violence, and HIV/AIDS infections to strengthen the communication skills and leadership of

women . "The Sisters-for-Life" program has two phases where phase one consists of ten one-

hour training programs with a facilitator with phase two consisting of identifying a leader

amongst the group, train them further, and allow them to implement an Action Plan to their

respective centres.

Microfinance has also been combined with business education and with other packages of health

interventions. A project undertaken in Peru by Innovations for Poverty Action found that those

borrowers randomly selected to receive financial training as part of their borrowing group

meetings had higher profits, although there was not a reduction in "the proportion who reported

having problems in their business".

Other criticisms

Most criticisms of microfinance have actually been criticisms of microcredit, delivered in the

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absence of other microfinance services such as savings, remittances, payments and insurance.

For example, there has been much criticism of the high interest rates charged to borrowers. The

real average portfolio yield cited by the sample of 35 microfinance institutions that voluntarily

submitted reports to the MicroBanking Bulletin in 2011 was 42.3% annually. However, annual

rates charged to clients are higher, as they also include local inflation and the bad debt expenses

of the microfinance institution. Muhammad Yunus has recently made much of this point, and in

his latest book argues that microfinance institutions that charge more than 15% above their long-

term operating costs should face penalties.

Milford Bateman, the author of Why Doesn't Microfinance Work?, argues that microcredit offers

only an "illusion of poverty reduction". "As in any lottery or game of chance, a few in poverty do

manage to establish microenterprises that produce a decent living," he argues, but "these isolated

and often temporary positives are swamped by the largely overlooked negatives." Bateman

concludes that "The international development community is now faced with the reality that,

overall, microfinance has been a development policy blunder of quite historic proportions." Here

Bateman, like many writers, confuses microfinance as a broad sector with microcredit, a single

microfinance intervention (see delineation above).

The role of donors has also been questioned. The Consultative Group to Assist the Poor (CGAP)

recently commented that "a large proportion of the money they spend is not effective, either

because it gets hung up in unsuccessful and often complicated funding mechanisms (for

example, a government apex facility), or it goes to partners that are not held accountable for

performance. In some cases, poorly conceived programs have retarded the development of

inclusive financial systems by distorting markets and displacing domestic commercial initiatives

with cheap or free money.”

There has also been criticism of microlenders for not taking more responsibility for the working

conditions of poor households, particularly when borrowers become quasi-wage labourers,

selling crafts or agricultural produce through an organization controlled by the MFI. The desire

of MFIs to help their borrower diversify and increase their incomes has sparked this type of

relationship in several countries, where hundreds of thousands of borrowers effectively work as

wage labourers for the marketing subsidiaries of Grameen Bank. Critics maintain that there are

few if any rules or standards in these cases governing working hours, holidays, working

conditions, safety or child labour, and few inspection regimes to correct abuses. Some of these

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concerns have been taken up by unions and socially responsible investment advocates

Other criticism was raised by the IPO (Initial Public Offering) of a MFI in 2007. As the company

put its shares on Stock Exchange it was able to generate very high profits that were achieved by

rising interest rates on their micro-loans that at some point reached 86% per year. In May 2011

India's biggest MFI, SKS Microfinance also went public. In both instances Muhammad Yunus

publicly stated his disagreement, saying that the poor should be the only beneficiaries of

microfinance.

Microcredit has been blamed for many suicides in India: aggressive lending by microcredit

companies in Andra Pradesh is said to have resulted in over 80 deaths in 2010.

The authorities discovered that 500 aid from Udaipur Divisin and other division contributed to

the Grameen Bank was being diverted by Mohammed Yunus and his closest associates to a

company that was engaged in an entirely different sector.

When the alarm is raised about the relationship, more than 50 aid money had already been

transferred to the For-Profit company Grameen Phone. The whole matter had been kept a secret

until now.

The film reports that money was set aside by the very most central person of microloans

establishing a secret company in order to not pay tax. The film also documents that when Hillary

Clinton visited a village in Bangladesh, women from outside were transported into the village

and out of the 50 to 80 people in the village who had received microloans, none were ever asked

for their views regarding microloans. Only 3 or 4 of the people in the village had been able to

successfully build a house using microloans and at least one man in the village considered

attempting suicide. The film suggests that the house which Hillary Clinton was shown as an

example of microloan success was actually a house uninvolved with any microloan. even visiting

the same places following a 2-year interval, and found the same results, namely. The condition

of people got worse because of the high interest rates and mafia-like ways of collecting interest

payments from the poor. The film interviewed the mother of a girl who lit herself on fire to

commit suicide after her sewing machine was repossessed.

The documentary also looks at the effectiveness of Grameen Bank along with its "miraculous"

stories of transforming people’s lives and concludes that it has had little impact on poverty in all

these years. In one segment the home of the celebrated original grameen loan-taker – Sufiya

Begum in Udaipur division village. Celebrated in grameen folklore that is. He finds some very

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uncomfortable stories and comes to know that she died in poverty and all her daughters today are

beggars.

SURVEY OUTCOMES

A survey of 200 target population was done with the objective of gaining insight into the

popularity and use of microfinance in Udaipur division.

• 32% of the respondants had heard of microfinance

• 20% of those who had heard about microfinance had opted for it.which is pretty close to

the national average 18%

• Of those who had opted for microfinance, 45% agreed that microfinance is easily

available, rest 55 % were not satisfied with the availability.

• 46% of those who had opted for microfinance found the process of taking microfinance

hasslefree while the rest 54% wanted the process to be simplified.

• 38% of those who had opted for microfinance were given personalized plans to suit their

needs.

• 68% of those who had opted for microfinance found the repayment options suitable as

per their needs.

• 54% of the microfinance opters found the interest rate justified.The rest of them

demanded a deficit in the interest rate of microfinance.

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Conclusions and Recommendation

From our research and analysis conducted on the local level, we conclude that microfinance is

certainly a boon for growth of small level investors, and farmers. But there is a lack of

knowledge and awareness among the target audience. Which should be addressed properly if the

benefits of this scheme has to be penetrated deeper into the masses.

Moving on, the interest rates should be lowered to attract more potential consumers.

Another noteworthy point is that the availability of finance should be improved so as to serve a

larger bunch of potential customers.

Single window clearance and reduction of red tapism is suggested so as to reduce the

inconvenience that the customers face.

In general the respondants were satisfied with the repayment options and the relaxation given to

those who were in dire need.

From the point of view of the bank, the main concern lies in the fact that the return received from

numerous microfinance loans is equivalent to one loan of big amount, but the hassle in handling

so much more loans is more than that of a single loan. To address this issue, the process of

providing microfinance should be simplified and uniformity should be inculcated in the process..

One more point to look at is the high percentage of defaulters which lead to heavy losses to the

bank, to curb this problem, a higher percentage of assets should be kept as assets in custody of

the company, and recovery mechanisms should be empowered with more powers.

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Bibliography

-The Indian Journal of Finance

-Investing in microfinance- Philip M. Becker

-En.wikipedia.org/wiki/microfinance

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