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Archive for the month “July, 2011”

MFI’s, MAC’s, NPO’s and NGO’s – Part 1(Micro Finance Institutions or MFI’s)

A lot of queries have been pouring in, asking us to differentiate between MFI’s, MAC’s, NPO’s and NGO’s. We, at Ekjaa, believe in simplifying things. Hence we decided it was time to do a post on the differentiation and the commonality between the four terms. There are some common areas between some of these institutions, which we shall also discuss.

For a beginning, we shall start with MFI’s and every week we would explain each term in details.

MFI’s or Micro Finance Institutions, are organisations that provide financial products and services, including loans, savings, insurance, transfer services and other financial instruments targeted at low-income clients.

Yeah, we heard you ! That was jargon ! To put it simply – MFI’s provide credit/loan/savings to people who need the money but have no/poor/limited access to proper Banking Credit channels. They may utilize the money to start new activities that may provide them with a regular income, reduce the risk of them being jobless when there is a natural calamity or sickness and support self empowerment.

MFI’s are the primary players in the Indian Micro-Credit Market and the numbers are simply mind boggling. To quote a CRISIL paper on the growth of MFI’s in the country, there is a demand for upto 1.2 Trillion INR. That translates into a whopping US$ 24 Million, a whole new economy unto itself ! As per popular literature available, there are 8 Microfinance Lending Models.

We will not go into the details of the models, but will provide a small information on how the model works.

1.) Associations – Self Help Groups are a typical example.

2.) Bank Guarantees – where a government agency guarantees the microloans made by a MFI or Bank to an individual or a group of borrowers.

3.) Community Banking – Grameen Bank is a good example.

4.) Co-operatives – Very similar to Associations and Community Banking except that the targeted population falls into the middle and upper class individuals.

5.) Credit Unions – Members come together, pool their money and make loans to one another at low interest rates. These are usually smaller than Community Banks, and charge minimal interest rates.

6.) Non Governmental Organizations – External Organizations whose activities differ from offering microfinance services to training/education and research.

7.) For-Profit Banks – Commercial Banks that offer services for the purpose of high return on investment, in a very short period of time, however aiming at financial progress and sustainability.

8.) Rotating Savings and Credit Associations – where regular cylic contributions are made into a common fund (on a monthly basis) and is taken up in entirety by any one member. The cycle repeats the next month, with the amount taken up by another member. Advantages are, No interest rates, Trust-Building measure and No Over Head Costs.

How a loan is repaid provides an interesting insight into the lending practices of MFI’s. Loan Repayment Terms must include, Duration of the Loan Contract, Repayment intervals, Holiday Period (grace period). Then there are the price aspects. Interest payments. The loan terms determine both the yield on an MFI’s portfolio and the real cost to the borrower. Interest payment mechanisms use different rates according to the individual.

When the declining balance method is used, interest is computed based on the balances that remain in the borrower’s hands. As successive installments of principal are repaid, these balances decline. In this case, interest is not charged on the amount of the loan principal that the borrower has already repaid.

When the flat method is employed, interest is computed based on the original face amount of the loan rather than on the declining balances. This means that the loan is more costly to the borrower and, equivalently, that the loan generates more income for the lending institution.

Then there is the question of Effective Interest Rate or EIR:  The effective interest rate is the rate that the borrower is “really” paying, based on the amount of loan proceeds actually in the client’s hands during each period of the life of the loan. Apart from the above, some other factors that MFI’s include in their loan pricing are Administrative expenses, including rent and utilities, salaries, travel and transportation, office supplies, Inflation and depreciation, the cost of loan losses, the cost of the funds that the MFI borrows.

Despite being a “hub” of microfinance, a recent series of assessments by CRISIL in India, has indicated that over 47% of MFI’s are only at an “average” level while not a single MFI is at the “excellence” level. The “mfR4” grading given by CRISIL for “average” is the median score and indicates “satisfactory level of management quality, governing board structure, financial performance and funding stability”. It also noted that several young MFI’s (in terms of number of years of operation) have quickly grown up the quality ladder while many other “older” MFI’s are still at lower ranks. As on March 2009, MFI’s outstanding loans have risen to 114 Billion INR, however the disbursements are also seeing a bull-run with a CAGR of 90% ! Of the 287 Billion INR distributed during the financial year 2009-2010, it is estimated that more than 180 Billion INR was disbursed by MFI’s. But with the growing demand for micro-credit and MFI’s comes the equation with more unknowns.

Access to more capital for MFI’s: MFI’s till now have predominantly been funded by government agencies and have been getting aid from a number of organizations. But as the number of people requiring Micro-Credit is increasing so is the need for capital.

Heavy Leaning on Banks and Financial Institutions: As CRISIL notes, public sector banks are not going gaga over the “Micro-Credit Phenomenon”. PSU’s argue that in a growing economy which has about 40% of its people in the lower-income group, this is expected behavior. Banks are now looking at MFI’s that have a solid lending model. Some prefer to lend only to MFI’s which have a proven track record, or there is a guarantee of repayment. With the subsidies slowly going away, MFI’s are now looking out for other sources of capital.

Absence of Regulatory Control: In 2006, the Government of India sought to bring about a legislation that would standardise the behavior of the MFI’s in the fray. As of today, balance sheets of most MFI’s are highly non-uniform and are lopsided.

Interest Rate Fluctuation: An April 1999 RBI circular instructed MFI’s to fix interest rates on the loans they give out. However, MFI’s do micro-credit based on a number of factors, political, castest and socio-economical factors as well. Given the state of operations of MFI’s and the cost of running them, most MFI’s are forced to charge high rates of interest to recover costs and to stay in business. RBI and CRISIL believe that introduction of more players in the Micro-Finance Industry will result in lowering of Interest Rates and more transparency in the process that determines the Lending Interest Rates. With grants from developed countries drying up, and related voluntary services withering up, micro-finance is a key activity in the Indian economy.

However their management has not been upto the mark. As the CRISIL report notes “the boards of these organizations continue to have strong developmental and social project bias and limited micro-finance or banking experience.” For MFI’s to function efficiently and to play a major role in the socio-economic development of the country it is necessary for them to take note of the fallacies pointed out by regulatory bodies and act on them.


Reference : INDIA – Top 50 MicroFinance Institutions – October 2009 – CRISIL report.


– Charan Hari


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