49020142 Micro Finance
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A STUDY ON SUSTAINABLITY OF SMALL MICROFINANACE INSTITUTIONS
SUBMITTED TO:PROF. RANJANI SRINIVASAN
SUBMITTED BY:ANKIT PATEL
A PROJECT REPORTON
SUSTAINABLITY OF SMALL MICROFINANACE INSTITUTIONSBy
SECONDARY DATAPART1INTRODUCTIONMicrofinance has received increasing attention in many discussions about the never ending problems of poverty and economic growth promotion. The role of microfinance institutions (MFI) assumed increased importance after the financial crisis in the USA. Microfinance has demonstrated that poor people are viable customers as long as their financing is approached in a right was such that moral hazard, adverse selection and other agency problems are mitigated. Microfinance development led to a number of strong institutions focusing on poor peoples finance and it begun to attract the interest of private investors. But despite these achievements, there is still a long way to go to extend access to all who need financial services.
Following this point of view, we first describe the position of MFI, products and services in modern microfinance and their position in developing countries. After this exposition we concentrate on role and performance of MFIs worldwide in the light of financial and economic crisis in recent years. Robinson defines Microfinance as small-scale financial services for both credits and deposits that are provided to people who farm or fish or herd; operate small or micro enterprises where goods are produced, recycled, repaired or traded; provide services; work for wages or commissions; gain income from renting out small amounts of land, vehicles, draft animals, or machinery and tools; and to other individuals and local groups in developing countries, in both rural and urban areas. Subsidized credit has long been believed to be the panacea for the eradication of poverty for decades now. But perhaps the only thing subsidized credit could create was Non Performing Assets (NPAs). The realization that the core issue for the poor was access to credit rather than the cost of credit came very late. Microfinance is often credited with putting an end to the interest rate debate for the poor. A host of players have entered microfinance space, each having a reason of its own. It is believed that, Microfinance, unlike other developmental efforts, gives quick and tangible results. Many NGOs that were early entrants gradually metamorphosed into full fledged lenders, developmental professionals left their cushy careers to set up microfinance firms. Even many banks have experimented with working exclusively with self help groups and therefore have .microfinance branches.
WHAT IS MICROFINANCE?
As the name suggests, microfinance is the field of offering financial services to people on a small (micro) scale, such as businesses with low or moderate incomes, but you can read more meticulous definitions here and here. According to Forbes, microfinance is probably the best known means of helping small business owners in developing countries move out of poverty.The definition for according to The Asian Development Bank (ADB) is any financial service targeted toward the poor, such as: Deposits Finance schemes or micro loans up to $3,000 Payment services Money transfers Insurance to poor and low-income households and their micro-enterprises
Microfinance Institutions (MFIs) provide micro services through a variety of lending models, while micro entrepreneurs use these services. The theory is that if the poor have access to these services, their financial lives will be more stable, predictable and secure, allowing them to plan and improve their livelihoods through education, healthcare and empowerment.In other words, microfinance converts poverty into an economic opportunity that evades the idea of exploitation.
WHAT ARE THE SOURCES OF MICROFINANCE?
Microfinance providers come in various forms which can be broadly grouped as follows: Formal Microfinance Institutions rural/microfinance/village banks, commercial banks, telecom firms, and cooperatives (see examples)Semi-formal Microfinance Institutions nongovernmental organizations
SUSTAINABILITY: SOME DEFINITIONS
From bankers perspective, a microfinance institution is said to have reached sustainability when the operating income from the loan is sufficient to cover all the operating costs. This definition adopts the bankers perspective and sticks to accounting approach of sustainability. However, Shah (1999) adopts for an integrated approach in defining the term sustainability as the accounting approach to sustainability that takes into account the financial aspect of the institution is too narrow for him. For Shah, the concept of sustainability includes, amongst other criteria, - obtaining funds at market rate and mobilization of local resources. Therefore, his performance assessment criteria for the financial viability of any microfinance related financial institution are: repayment rate, operating cost ratio, market interest rates, portfolio quality, and demand driven rural credit system in which farmers themselves demand the loans for their project. From bankers perspective, sustainability of microfinance institution includes both financial viability and institutional sustainability (self-sufficiency) of the lending institution (Sharma and Nepal, 1997). The frames of reference in bankers definitions are therefore, more financial, administrative and institution focused.
MICROFINANCE INSTITUTIONS (MFIs)Most MFIs started as not-for-profit organizations like NGOs (non-governmental organizations), credit unions and other financial cooperatives, and state-owned development and postal savings banks. An increasing number of MFIs are now organized as for-profit entities, often because it is a requirement to obtaining a license from banking authorities to offer savings services. For-profit MFIs may be organized as non-bank financial institutions (NBFIs), commercial banks that specialize in microfinance, or microfinance departments of full-service banks.Some MFIs provide non-financial products, such as business development or health services. Commercial and government-owned banks that offer microfinance services are frequently referred to as MFIs, even though only a portion of their assets may be committed to financial services to the poor.CREDIT DELIVERY METHODOLOGIES USED BY MICROFINANCE INSTITUTIONSMFIs use two basic methods in delivering financial services to their clients.These are:(1) Group Method(2) Individual methodGROUP METHODThis is one of the most common methodologies for providing micro-finance. Group method primarily involves a group of individuals, which becomes the basic unit of operation for the MFIs. As we have discussed earlier, MFIs have to provide collateral free loans, group methodologies help in creating social collateral (peer pressure) that can effectively substitute physical collateral. Group becomes a basic unit with which MFIs deal. The advantage of group methodology is that Groups are trained to own joint responsibility for loans that are taken by individuals in the group. Groups ensure repayments from all individuals in that group and incase of a default Groups functions as the forum where the credit discipline and other related issues are discussed. Group may have to jointly own the responsibility of defaults and pay on behalf of defaulting client. Group also help credit appraisal and provide opinion on creditworthiness of each individual in the group. Groups methodology also helps in controlling costThis ensures that even without taking any physical collateral, the MFI is able to manage its credit risk (loan related risk).MFIs actually deliver the financial service at the clients location which could be a village in rural areas or a colony/slum in urban area. Having a group helps the MFIs in getting all clients at one spot rather than visiting each individuals house. This helps the MFI in increasing the efficiency of staff and controlling the cost. Group methodology creates a forum where individuals come and discuss, can provide opinion, and exert social pressure.The advantage of Group methodology can easily be appreciated by the fact if the a MFI employee has to visit each individual house in isolation, it would be very difficult. Also in the absence of a group, if a client refuses to pay there is no forum where such a case can be discussed or there is no method through which the MFI can expert pressure on the client.Group methodology is also important because in case of larger loan defaults a financial institutions can take recourse o legal action but in small loans legal recourse is not an economically sound option. An MFI who may have an outstanding or Rs 3,000 at default cannot apply legal pressure as the cost of recovery through that method can be higher than the amount to be recovered itself.Moreover, the clients that the MFIs are dealing with are generally poor and may face genuine problems at times. Rather than taking an aggressive/legal approach, which such vulnerable clients it is always better to have more constructive and collective approach, which is provided by the Groups.Due to the various advantages, as indicated above provided by groups, this methodology is widely accepted and used in micro-finance across the world.Self-help Group and Joint Liability Groups (Grameen model and its variants) are two common credit delivery models in India. SELF HELP GROUPS (SHGS)Self-help Group concept has its origin in India. SHGs are now considered to be very important bodies in rural development and are therefore found in almost all parts of the country and their number is still rapidly growing. SHGs are formed by Non-Government Organisations as well as Government agencies and are used as channels for various development programmes.A Self-Help Group is an associati