MFIs Must Increase Range, Volume of Services
Chairman, NABARD, India, Financial Express, June 04, 2007

Micro Finance Institutions (MFIs) can play a vital role in bridging the gap between demand and supply of financial services if the critical challenges confronting them are addressed.

The first challenge relates to sustainability. It has been reported that the MFI model is comparatively costlier in terms of delivery of financial services. An analysis of 36 leading MFIs by Jindal and Sharma shows that 89% of the MFIs sample were subsidy dependent and only 9% were able to cover more than 80% of their costs. This is partly explained by the fact that while the cost of supervision of credit is high, the loan volumes and loan size is low. It has also been commented that MFIs pass on the higher cost of credit to their clients who are "interest insensitive" for small loans but may not be so as loan sizes increase. It is, therefore, necessary for MFIs to develop strategies for increasing the range and volume of their financial services.

Lack of Capital: The second area of concern for MFIs, which are on the growth path, is that they face a paucity of funds. This is a critical constraint in their being able to scale up. Many of the MFIs are socially- oriented institutions and do not have adequate access to financial capital. As a result, they have high debt equity ratios. Presently, there is no reliable mechanism in the country for meeting the equity requirements of MFIs. The Micro Finance Development Fund (MFDF), set up with Nabard, has been augmented and redesignated as the Micro Finance Development Equity Fund (MFDEF). This fund is expected to play a vital role in meeting the equity needs of MFIs.

Borrowings: In comparison with earlier years, MFIs are now finding it relatively easier to raise loan funds from banks. This change came after 2000, when the RBI allowed banks to lend to MFIs and treat such lending as part of their priority sector-funding obligations. Private sector banks have since designed innovative products such as the Bank Partnership Model to fund MFIs and have started viewing the sector as a good business proposition. Banks need to be most careful when they feel most optimistic. At a time when they are enthusiastic about MFIs, banks would do well to find the right technologies to assess the risk of funding MFIs.

They would also benefit by improving their skillsets for appraising such institutions and assessing their credit needs. An appropriate credit rating of MFIs will help in increasing the comfort level of the banking system. Nabard has put in position a scheme under which 75% of the costs of the rating exercise will be borne by it.

Capacity of MFIs: It is now recognised that widening and deepening the outreach of the poor through MFIs has both social and commercial dimensions. Since the sustainability of MFIs and their clients complement each other, it follows that building up capacities of MFIs and their primary stakeholders are pre-conditions for the successful delivery of flexible, client responsive and innovative microfinance services to the poor. Here, innovations are important – both of social intermediation, strategic linkages and new approaches centred on the livelihood issues surrounding the poor, and the re-engineering of financial products offered by them as in the case of the bank partnership model.

The bank partnership model is an innovative way of financing MFIs. The bank is the lender and the MFI acts as an agent for handling items of work relating to credit monitoring, supervision and recovery. In other words, the MFI acts as an agent and takes care of all relationships with the client, from first contract to final repayment. The model has the potential to significantly increase the amount of funding that MFIs can leverage on a relatively small equity base.

A sub-division of this model is where the MFI, as an NBFC, holds the individual loans on its books for a while before securitising them and selling them to the bank. Such refinancing through securitisation enables the MFI enlarged funding access. If the MFI fulfills the ‘true sale’ criteria, the exposure of the banks is treated as being to the individual borrower and prudential exposure norms do not then inhibit such funding of MFIs by commercial banks.

The proposal of ‘banking correspondents’ could take this model a step further extending it to savings. It would allow MFIs to collect savings deposits from the poor on behalf of the bank. It would use the ability of the MFI to get close to poor clients while relying on the financial strength of the bank to safeguard the deposits. Currently, RBI regulation do not allow banks to employ agents for liability. This regulation evolved at a time when there were genuine fears that fly-by-night agents purporting to act on behalf of banks in which the people have confidence could mobilise savings of gullible public and then vanish with them. It remains to be seen whether the mechanics of such relationship can be worked out in a way that minimises the risk of misuse.

The service company model developed by the international non-profit organisation in microfinance, ACCION, and used in some of the Latin American countries is interesting. The model may hold significant interest for state-owned banks and private banks with large branch networks.

Under this model, the bank forms its own MFI, perhaps as an NBFC, and then works hand in hand with the MFI to extend loans and other services. On paper, the model is similar to the partnership model: the MFI originates the loans and the bank books them. But in fact, this model has two very different and interesting operational features:

1. The MFI uses the branch network of the bank as its outlets to reach clients. This allows the client to be reached at lower cost than in the case of a stand-alone MFI.

2. The partnership model uses both the financial and infrastructure strength of the bank to create lower cost and faster growth. The service company model has the potential to take the burden of overseeing microfinance operation off the management of the bank and put it in the hands of MFI managers who are focused in microfinance.