PROJECT ON LOAN APPROVAL

Contemporary Concerns Study

Financing Small Enterprises by
microfinance institutions

Final Report

Submitted by

Divya Ganesan (0411013)
Divya Roongta (0411047)

Signature

_________________________

Financing Small Enterprises by MFIs

Table of Contents

Need for credit for Small Businesses and Enterprises ............................. 3

Problems of Credit Supply ........................................................................ 3

SAFAL Activities ....................................................................................... 5

A Typical Retail Vendor............................................................................ 6

Origination of Janalakshmi....................................................................... 6

Credit Scoring Literature Survey............................................................... 7

Case study I..............................................................................................12

Case study 2..............................................................................................15

Case study 3..............................................................................................16

Product Features ......................................................................................18

Interest Rate Determination ....................................................................21

Loan Appraisal .........................................................................................23

Product Design ........................................................................................24

Supplementary Products ..........................................................................26

Loan Appraisal .........................................................................................30

Credit Scoring Model of Janalakshmi ......................................................32

Recommendations for the Credit Scoring Model of Janalakshmi ...........34

Annexure I (Loan Application Form) ......................................................35

Annexure II (Credit Scoring Model)........................................................39

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Need for credit for Small Businesses and Enterprises

Small businesses and enterprises in India suffer from a great deal of indebtedness1 and are
subject to exploitation in the credit market through high interest rates and lack of convenient
access to credit. They need credit to fund their working capital needs on a day-to-day basis as
well as long term needs like emergencies or other income related activities. They need credit
to smoothen out seasonal fluctuations in cash flow arising from agricultural activities and
consumer demand. They also need credit as an insurance against minor spikes and troughs
with respect to income and expenditure. Since cash flows for the majority of small businesses
like vegetable vendors are small and savings are small as well, they typically tend to rely on
credit for other consumption needs like education, food, housing, household functions etc.
And this is exacerbated by the fact that India has no social security net that will take care of
basic amenities like health, education and so on for the poor. To meet these credit needs they
need access to financial institutions that can provide them with credit at lower rates and at
reasonable terms than the traditional money lender.

Problems of Credit Supply

The main obstacles to the supply of credit arise from the following reasons2.

The Credit markets are imperfect and fragmented: Most localities have internal
political and economic hierarchies that create market segmentation in the demand and
supply of resources, including investment and working capital. For. E.g. The loan
requirements of a farmer i.e. its periodicity and its size will considerably differ from
those of a vegetable vendor. The farmer would require a substantial size, as he would
most probably utilize it for buying seeds or upgrading his machine. A vegetable
vendor on the other hand would need a smaller amount to finance his daily needs i.e.
to buy vegetables.

Supply of formal sector credit is inadequate: The credit is not easily available. Loans
from Banks involve a lot of paper work. There is a collateral requirement, which
becomes a burden to the borrowers. There are complex legal and operational

1
Ramachandran V.K and Madhura Swaminathan, Rural Banking and Landless Labour Households: Institutional Reform and
Rural Credit Markets in India, Journal of Agrarian Change, Vol. 2, No 4, October 2002, pp. 502-544
2
Ibid

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procedures, which result in delaying the loan disbursal. Hence, credit is not available
on time (takes as much as 2 to 18 months). Borrowers are generally assumed to be
non credit-worthy and their recovery rate unsatisfactory. Hence monitoring them,
getting their credit history for evaluation of loans adds to the transaction costs of the
bank.

Distribution of formal sector credit is unequal with respect to region, class, gender
and caste: There is an enormous concentration of the MFIs (Micro Finance
Institutions) in the south of India. This is primarily because of the general
dissatisfaction in the economy of the central, eastern and north eastern states, with
very little resultant demand for credit among the subsistence poor, and the absence
(for historical reasons) of good quality NGOs, that are willing to initiate Microfinance
programs in these states (there are a large number of small NGOs but all of them with
limited experience and outreach).

Informal credit is the main source at high rates of interest and adverse terms and
conditions implemented by coercion of different means both economic and non-
economic.

This problem of credit has been addressed through formal sector lending institutions, directed
lending and subsidized credit3. To address this inadequacy, Micro Credit has gained
importance over the past few years. This has had very good success in countries like
Bangladesh, Indonesia and other Asian countries and is gaining ground in India as well.

3
Rangarajan, C., 1996 ‘Rural India: The Role of Credit’, Reserve Bank of India Bulletin, May, Bombay: Reserve Bank of India

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Many microfinance institutions have developed large-scale operations by offering a few
highly standardized products. Offering “one-size fits all” loan terms and conditions has the
following advantages:

• Streamlines loan administration

• Simplifies decision-making for field staff

• Reduces information requirements from clients

• Low operational costs

• Simplified repayment obligations

However, this standardization has its own drawbacks. Many MFIs are reporting high dropout
rates and repeat borrowers do not demand the larger loan sizes assumed in many MFI market
projections. Also, there are potential clients who refuse to join programs even though the
products offered were supposedly designed for them.

This has led MFIs to re-evaluate their business plans and pay closer attention to product
flexibility. Individual need-based loans are more suitable as they can be designed to cater to
the specific requirements of the clients.

SAFAL Activities

SAFAL is an organization based out of Bangalore that helps in gleaning produce (mainly
food and vegetables) for the retail vendors as well as the pushcart vendors. It aids the farmers
by giving them competent pricing for their yield by eliminating the middlemen in the supply
chain. It implements this by openly auctioning the farmer’s products and selling them to the
retail vendors. It also helps those retail vendors who have to buy from other vendors and thus
have to include the vendor’s margins while repaying them.

However the retail vendors who buy the produce from SAFAL have several issues with
financing their daily needs. They obtain the funds needed to buy the produce from SAFAL
from the local moneylenders. SAFAL also tried to create affinity groups (on the lines of Self
Help Groups) which brought together people from the same area in order to give them credit.

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However they concluded that, the strategy did not work as people didn’t seem to have the
affinity for each other when money was involved.

A Typical Retail Vendor

A Retail vendor is usually from the outskirts of the city (“around the area where veerappan
resides” is what an ex-official of SAFAL had to say). Due to low rains, arid land and such
similar severe conditions he turns to the city for survival. A few of them are also from other
south Indian cities like Chennai, Hyderabad, etc. Most of them do not even have a pushcart to
start off. Hence they have to source these amenities that they would need everyday from
different lenders. Most of the times the same person lends the money, produce and the push
cart. The vendors pay a huge amount by way of interest. Typically they borrow daily around
Rs.90 and agree to pay back Rs. 100 at the end of the day, which translates, to an exorbitant
4056% per annum! Instead of borrowing everyday the vendor also has the option of
borrowing around Rs. 3000 on a monthly basis depending on the kind of resources the lender
has to wring the money out of the vendor in case he decides to run with the money. In case
the vendor has borrowed the cart he has to pay an extra Rs. 20 daily. This money is taken
from the lenders the previous night before the market opens which is around 5:00 am in the
morning.

Origin of Janalakshmi

These issues of financing for the vendors led to the inception of Janalakshmi, an organization
set up as a body of Sanghamithra urban program with the objective to provide credit to urban
vendors. Apart from giving credit to traders on a periodical basis, Janalakshmi has created a
Credit Scoring Model that will score every trader who needs credit based on certain
parameters that we will look at below. The final score will decide whether the trader should
be given credit or not.

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Credit Scoring Literature Survey

A potential client’s credit risk level is often evaluated by the bank’s internal credit scoring
models4. These aim to determine whether an applicant has the capacity to repay by evaluating
the credit risk of his loan application. This is normally done using historical data and
statistical techniques. Such models offer banks a means for evaluating the risk of their credit
portfolio, in a timely manner. Credit scoring has both financial and non-financial aspects. The
dimensions that are analyzed in credit scoring are categorized under five main headings
namely:

(i) Capacity (ability to repay)

(ii) Character (willingness to repay)

(iii) Capital (wealth of borrower)

(iv) Collateral (security if necessary) and

(v) Conditions (external and economic)

These popular five categories of credit management establish the likelihood that a potential or
existing borrower will successfully meet scheduled interest and principal payments. Based on
the above categories the credit scoring model that we have devised for a vegetable vendor in
India incorporates these points as follows:

4
Ahmet Burak Emel and Muhittin Oral, 2003, A credit scoring approach for the commercial banking sector,

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Capacity (ability to repay)

We thought of capturing this category through the Trading History parameter. If a client has
had a significant trading record then he would obviously have the capacity to pay his interest
and principal repayments in time. Trading history parameter essentially has the following sub
parameters:

Period of trading

Frequency of transactions

Uniformity in value of transactions (to capture the borrowers stability in his trade)

Character (Willingness to repay)

This category has been incorporated into the model by way of the number of guarantees the
individual is able to get. Since the guarantors also form the borrower’s immediate neighbors
they would have maximum informal information about the character of the client and
whether he has a stable repayment history. The sub parameters for rating this category are:

Number of guarantors in the group

Familiarity with guarantors(members/non-members of the MFI)

Financial soundness of guarantors

Capital (Wealth of borrower)

This information is obtained from the Personal Security and the Business Information of the
client. These would essentially have the following sub parameters:

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Business Information

Total turnover

Total business expenses

Total personal expenses

Other commitments towards repayment of previous loans

Personal Security

Assets owned

Assets mortgaged/rented

Assets offered as security

Collateral (Security if necessary)

Collateral if available would increase the score of a vendor as risk associated with him both
credit and default is much reduced. He can also operate on a line of credit basis which we
have discussed in one of the previous sections. This information of the client is built-in in the
form of the Savings parameter. The sub parameters are:

Existing savings deposits

Current cash surplus available for saving

Expenses of avoidable activities like drinking, movies, etc

Interest of client in taking a savings product

Conditions (External and economic)

This category is important as this would determine how the future and the present conditions
if the vendor could affect his payments. E.g., if he has a greater number of young dependents
then it is likely that his expenses would increase in the future, as his dependents would come
of age. Also if he has an ailing family member, it is probable that it could increase his
everyday expenditure. Similarly his future prospects play a significant role under this

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category. If he is into a business that is not much in demand due to seasonal variation or
customer’s changing tastes, he needs to change his business. The sub parameters for these
are:

Individual Demographics

Age

Number of family members

Number of dependents

Number of family members in the same business

Growth Prospects

Current scale of operation

Interest/possibility of future expansion

However, there is a potential problem with credit scoring as it is usually done5. The statistical
models that are usually used to evaluate applicants are constructed from historical data. In
order to enter the sample used to build the model, an individual must have already been
`accepted'. Thus, the model after the initial pilot is a description of some aspect of the
behavior of individuals who have already received loans. The scoring model is to be used to
evaluate applicants who are drawn randomly from the entire population. The individuals
whose applications were accepted to begin with could have been qualitatively different
(difference in credit scoring) from individuals whose applications were rejected. Since, an
application which arrives randomly at the MFI could be of either type, i.e. the application
could be for a client applying for the first time or also for a regular client it is not certain that
the model being used is appropriate for the population being measured. Hence the main
challenge of the credit scoring model is to upgrade the model as frequently as possible for the
regular customers and have a set standard (e.g., define the score for certain parameters for
eligibility) when the client applies for the loan the first time.

5
William Greene, 1998, Sample selection in credit-scoring models

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We should also remember that Scoring works best for those with a solid individual lending
technology and a large database of historical loans6. Even when scoring works, it is only a
marked improvement, not a breakthrough. In particular, scoring will not replace loan officers
in microcredit completely because much of the risk of the self-employed poor is unrelated to
the information available for use in scoring.

6
Mark Schreiner, 2003, Scoring: The Next Breakthrough in Microcredit?

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Case study I

M. Nagappa is a fruit vendor who sells Apples, Oranges and Sweet Lemon in the crowded
Madivala market. He arrived in Bangalore three years ago from Tamilnadu. His decision to
carry out his daily routine in Bangalore was due to the frustration he experienced in
Tamilnadu because of the hostility of the local rowdies who asked him a share of his earnings
every day. The police officials were also totally indifferent to the existing conditions there.
As it is he was the only earning member in his family. Hence to support his two sisters and
his parents, he turned to Madivala Market in Bangalore where hundreds of vendors get their
push carts everyday at dawn and feel secure enough to leave their carts at night and depart
home.

Nagappa and his sisters completed their education upto 12th Standard in Tamil medium. His
elder sister got married and hence he has four members of his family dependent on him. His
family owns a house Villupuram, a small town in Tamilnadu, in a village called Mutathur.

Nagappa does not have a place to live in Bangalore. He spends his nights at his uncle’s shop
where he doesn’t have to pay rent. Daily routine for Nagappa consists of getting his pushcart
(which he bought sometime back) filled by his uncle with fruits and selling them in the
Madivala market. The fruits are mainly sourced from certain wholesale markets where his
uncle has been trading for a long time. His cart is filled 2 to 3 times in a week. However it
also depends on the season, weather, customer’s taste etc. For this daily activity of Nagappa,
his uncle charges him Rs.8500 for 3 months for which he has to repay Rs.10000. He
accomplishes this by repaying Rs.100/- everyday for 100 days (approximately 3 months)
through his everyday sales.

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His other expenses include paying for the following:

Expenses Amount (in Rs.)

Using the Bathroom 2/-

Washing his Face 3/-

Food 50/-

Bath (He has a bath once in 3 days and 10/-
otherwise manages by washing his face as
it becomes too expensive to have a bath
everyday)

Washed and ironed clothes (again once in 3 15/-
days)

When asked why he didn’t opt for only washing his clothes without ironing he said it
came as a bundled deal.

Liquor (especially when sales are 15/-
abysmally low)

Cigarettes 12/-

It becomes very difficult for him to carry out his daily routines without having at least 5-6
cigarettes everyday

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Apart from the above expenses Nagappa is also a sufferer of the ‘vaddi sala’ system which is
a highly popular lending practice amongst vendors. In this type of loan the loan payer keeps
repaying the interest till such time he has the whole lumpsum amount (i.e. the principal) to
repay the lender.

Nagappa borrowed a sum of Rs. 20000/- from money lenders in Tamilnadu for his sister’s
marriage and his nephew’s ear piercing ceremony. He has since then (that was around 2 years
back) been paying interest of Rs.800 per month on the loan. He has to keep paying this
interest till he collects the amount of Rs. 20000 and repays it back as a whole.

From his sales, Nagappa makes a profit of Rs.5/- on an average on all the three types of fruits
that he sells. Hence in a period of one week he makes around Rs.750 as follows.

Refill (in numbers) in a week Profit (in Rs.)

90 (for Apples) Rs. 450

30 (for Oranges) Rs. 150

30 (for Sweet Lemon) Rs. 150

Btu the above calculation is subject to vagaries of weather and season to a very large extent.
For e.g. the recent heavy downpour of rains in Bangalore led to a huge loss in business for all
the vendors.

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Case study 2

Perumal, a 19 year old boy educated till 9th standard sells Bananas at Madivala market
everyday. His family consists of 12 members including his relatives and they altogether have
a total of 7 children. His family is well settled in Bangalore having operated in the market for
more than ten years now. Perumal hails from Tirupathur which is a village in Tiruchi.

His daily routine encompasses getting the produce from their wholesaler and farmer friend in
Tiruchi for an amount of Rs.20000/-. His source of income remains his sales and the loan
amount he occasionally borrows from his relative in Tiruchi which he repays back monthly
without any interest. He borrows Rs.10000 from him. His family also has a small shop in
Madivala market which is mainly used for stocking but they also sell Bananas there.

His family’s daily expenses include the following:


Food 200/-

Travel (to and fro) by bus for the members 40/-
of the family

Electricity Bill 50

Getting the produce from Tiruchi (weekly) 2500

Decay due to bad weather or poor sales 500
(weekly)

Repairing the pushcart i.e. replacing the 50
tyre etc (once a month)

He manages a yearly profit of around Rs.5000/- which is used for family expenses.

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Case study 3

Mallesh, a vegetable vendor is a 23 years old man who has had education till 4th Standard and
sells his produce in the Vijayanagar area in Bangalore. He arrived in Bangalore 3 years ago
leaving his factory Job where he was getting a monthly salary of Rs. 2000. The salary was
not enough to feed his brother’s family which was fairly large and his own. So he decided to
move to the city.

Mallesh starts for work at 7:30am everyday where he buys his produce from the wholesale
market and sells on the way home. He pushes his cart for one and a half hours on a steep
slope and reaches Yashwantpura. He reaches home at 1:00pm and again sets out for selling
with his pushcart at 4:00pm. However he works only for 4 days a week as it becomes too
strenuous to carry the cart everyday.

His daily expenses are as follows:


Rent 800/-

Electricity 150/-

Water 100-150/-

Kerosene 30/-

Miscellaneous expenses (watching a 50
movie, occasional drinking etc.)

Pushcart Repairs (replacing tyres etc) 1000
(once in 3-4 months)

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Mallesh takes a loan of Rs. 5000 every 3 months to finance his business as well as his daily
needs. The loan amount that he gets is Rs. 4250 and the amount he repays is Rs. 5000. He
repays Rs. 50 everyday for 100 days. Other than this Mallesh is repaying the loan of his
neighbor for whom he gave guarantee at some point. His neighbor disappeared with around
Rs. 14000/- of which Mallesh repays Rs.750/- every month as a part of the principal
repayment. Mallesh makes a profit of Rs.100 to 150/- everyday to support his daily needs.
He tries to save around Rs.50 everyday. From the saved money, he sends his family an
amount of Rs.2000 periodically for their requirements.

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Product Features

As inferred from the interviews, most of the pushcart vendors depend on their friends and
relatives for finance. In times of emergency and crisis, they resort to ‘vaddi sala’ from local
moneylenders on which they pay very high rates of interest. The main problems faced by the
vendors with the current type of financing can be enumerated as under.

• In two of the cases, we found that the vendors take 3-month loans on which they pay
an interest of 17.64% quarterly. This amounts to an exorbitant compounded annual
rate of 91.52%.
• In the case of a ‘vaddi sala’, they borrow a lumpsum amount and then keep paying
interest on it till the lumpsum amount is repaid. For instance, one of the vendors has
taken a loan of Rs. 10000 and is paying Rs. 500 per month as interest, which amounts
to a rate of79.59% annually. The vendors are not in a position to accumulate such a
big sum of money. Thus, they keep paying such high interests over a long period of
time.
• None of the vendors have a bank account, which may pay them some interest on their
savings. Therefore, they have little incentive to save and spend their surplus cash on
unnecessary activities like drinking, smoking, movies, etc.
• Due to non-availability of a collateral security, the moneylenders ask for a guarantee
by the vendor’s neighbor who is usually in the same trade and is from the same
village as the vendor. This agreement between the vendor and his neighbor is mutual.
Therefore, if one person defaults, the entire burden of repayment is shifted to the other
person.

Considering the afore-mentioned problems, we believe that the following features should be
incorporated in an ideal product for the vendors. These will not only help in overcoming the
current shortcomings, but will also give the vendors a greater sense of security.

• All the vendors prefer short-term loans of about 2-3 months maturity. Therefore, such
short-term loans should be available to them but at lower interest rates than the
current 17.64% quarterly.

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• To overcome the problem of non-saving, the following 2 features can be considered
o A person who has taken a loan can be encouraged to deposit his/her monthly
savings. This savings amount can be used to settle against the outstanding loan
amount leading to early repayment and thereby lower interest rates on the
outstanding balance.
o A separate savings product can be offered to the vendors where the vendors
can deposit their monthly savings on which the MFI can pay them some
amount of interest. This would also help the vendors to accumulate a lumpsum
amount, which they can withdraw in times of emergency or need.
• The MFI can adopt the joint liability model to overcome the problem of default in
repayment by any of the members in the affinity group. The loans in the group can be
given on individual basis whereas the group can share the liability of default. This
will prevent the problem of burdening a single person due to his neighbor’s inability
to repay. However, while creating the affinity groups, the MFI should ensure that all
the individuals in the group require a similar amount of loan such that the burden
created due to any member’s default is the same.

For implementing the savings schemes, the regulatory framework for banks and NBFCs must
be considered. As per the regulations, any institution requires a minimum equity capital of
Rs. 2 billion to be able to accept deposits. To acquire the status of an NBFC, an institution
requires a minimum equity capital of Rs. 20 million but it cannot accept deposits from its
clients. Therefore, to facilitate the savings products, the MFI can try to collaborate with banks
such as ICICI, which also works in the micro-lending space.

If the MFI collaborates with a private bank for sourcing of funds, there are primarily three
kinds of structures possible.
• Portfolio Buyout Structure: The existing assets of the MFI can be assigned to the
bank in return of a purchase consideration.
• On-tap Securitization: The MFI can continually source loans from the bank and can
assign the receivables under such loans to the bank under a mutually agreed
arrangement wherein sourcing criteria and operational guidelines are stipulated.
• Partnership Model: The MFI can source loans directly in the books of the Bank, and
continue to monitor and recover loans thus disbursed.

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However, all collaborations with any private banks would work best when the terms on using
the money are not dictated but left to the MFI to decide on and all relevant information is
disclosed and transactions are as transparent as possible.

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Interest Rate Determination

The interest rates charged by the MFIs are high essentially due to the high costs of bringing
micro-finance products and services to the poor. In addition, there are the costs of creating
delivery mechanisms at the community level (which are not included in determining the
interest rates). Then there is the cost of creating and setting the client base for micro-finance
products and services. These costs are difficult to integrate into the calculations of interest
rates. Hence each of these issues must be considered while determining interest rates in order
to avoid any operational difficulties in future. Apart from this recruiting, training and
monitoring staff is a key constraint. Monitoring of operations and transactions using IT based
systems is a must. All these will add up to the transactional cost and hence an increase in the
interest rates

If an MFI has to be sustainable, covering costs of funds, and transaction costs, than interest
rates have to be high. Talking about interest rates as a percentage on loans of Rs 2000 or
5000 might not be the most accurate method of expressing them. The transaction costs - of
finding a borrower, appraising her, disbursing money to her doorstep and then collecting it
back over 52 weeks or twelve months in small installments, is nearly fixed irrespective of
loan size. So if the cost is Rs 500 per loan, then the cost can amount to as high as 25% for Rs
2000 loan and will appear to be as low as 5% for Rs 10,000 loan. Thus interest rates of 24%
per annum charged by most MFIs are barely enough to cover their costs. We could specify a
minimum rate of 12% per annum on a declining balance, and a maximum of 25% per annum.
The lower interests if for people who might borrow in groups or have guarantee given by
others as our transaction costs would be lower there. E.g., for lending a large sum of Rs 2
lakh to a group of 10 vendors who might want to start a shop, we would charge 12%. But
where we have to give an individual loan of Rs 5000 to a marginal vendor, there the
transaction cost is high and hence we would charge 25%. In any case that would be far less
than the interest charged by moneylenders on a yearly basis.

It is only through competition that the interest rates can come down. It can happen if there are
a many MFI’s offering similar products to the retail vendors differentiating only on interest
rates and that would be good for the customer as well as for the business. The GoI and RBI
should encourage hundreds of institutions to come into this field, innovate and bring down

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the costs. But even then the interest rate might not come down to 8 or 10% because the cost
of lending small loans is intrinsically high

Also interest rates would not be the same way across all the products that we offer; it would
not be same even in the same location for different types of customers because along with the
transaction cost of disbursing the loan, the risk cost has to be kept in mind. We would do a
risk based pricing of the loan based on a credit-scoring model, which would rate the customer
on different parameters. If there is a class like a particular region, a particular activity or a
category of people where the default rate is 5% instead of 2% then the 3% has to be built into
the pricing because unlike in public sector banks, there is no government that would write off
loans and then recapitalize lending institutions.

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Loan Appraisal

Loan appraisal for micro lending has a number of complexities. Complexities arise due to
lack of data validation, high risk lending, financial constraints of the MFI, high transaction
costs, etc. for assessing the credit worthiness of clients, MFIs have two options: individual
case by case basis of evaluation by a loan officer or use of a standardized credit scoring
model.

In the individual case-by-case method, a loan officer collects all relevant information for each
client and then decides on the credit worthiness of the client. This method offers the
advantages of greater accuracy of information and better decisions about the disbursement of
loans. However, it involves very high transaction cost, higher loan processing time and very
highly skilled staff. Also, the loan appraisal decision is completely dependent on the
judgment of the loan officer.

Using a standardized credit-scoring model is simpler and less time-consuming. With a credit-
scoring model, a less qualified person can also assess the client’s credit worthiness and take a
suitable decision. The transaction costs and operating costs are reduced significantly.
However, it suffers from the problem of absence of on-site data validation giving rise to
greater risk of default by the clients.

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Product Design

We will segment all our clients, based on the purpose of their loan, into the following:

Loan for everyday (income generation) activities or Working capital Loans

Loans for Micro enterprise

Loans for Small Enterprise

Working Capital Loans implies full-time, often seasonal economic activities undertaken
for subsistence. At times several family members simultaneously engage themselves in a
wide array of such activities, in order to diversify the income sources of the household.
Similarly small enterprises are the entrepreneurs' primary source of income but they
reinvest the profits of the enterprise to further its growth. Microenterprise bridges the
gap between the loans for daily activities and those for Small enterprise.

Definitions:

We define Microenterprise activities as any individual or group of borrowers having
combined assets (to be offered as collateral) less than Rs. 10,000. Similarly we define Small
Enterprise activities as any owner having assets less than Rs.100,000. For Income Generation
or working Capital loans there need not be any collateral.

With working capital loans, the need is for loans for which borrowers are willing to pay
reasonably high interest rates, which would obviously be considerably lesser than what they
pay the moneylenders. However Microenterprises would need more flexible financial
products, which are more customized. Microenterprises might also require working capital
loans, but initially when they are about to set up their business or when they are about to
expand they would need fixed asset investment loans. Such investments require access to
larger loan amounts for longer periods of time, and as a consequence, borrowers can afford
interest rates significantly lower than those affordable by the working capital borrowers yet
higher than the commercial bank rate. Finally, Small enterprises have very different credit
needs, almost matching the credit conditions of the commercial banking loan sizes and terms
specifically matched to the investment and repayment capacity of the business, for which the
borrower is able to offer sufficient collateral, but can only afford commercial interest rates.

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Characteristic Daily Activity ME SE

Use of loan Working Cap Working Cap + Working Cap +

Fixed Assets Fixed Assets +

Infrastructure for
expansion

Loan term 1 week - 3 4 months – 1.5 1 - 5 years
months years

Loan size Rs. 500 – 10000 Rs. 10000 – Rs. 10000 –
100000 100000

Collateral Requirement None Low High

Interest Rates 25% - 40% 15% - 25% 5% - 15%

Repayment Daily Daily for a month Monthly
+ Weekly after
that

Collection By collecting At the nearest At the nearest
agents at the branch of the MFI branch of the MFI
specified markets

For all Loan products, the Clients are required to acquire guarantee of atleast three
independent parties forming a joint liability group. Each of the parties in the group guarantees
each other’s default. The individuals in the groups are from the same neighbourhood, as they
would have maximum information about the neighbour’s activities.

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Supplementary Products

Education Loan

Savings Product

Remittance Product

Microinsurance Products

Microentrepreneurs Products

Emergency Loan

Mutual Benefit Product

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Education Loan

This will be given for education of the immediate family members of the client. Maximum
loan would be decided based on the segment to which the client belongs.

Savings Product

We would have the following features in the Savings product that we would offer:

Product Minimum Balance Term of Amount and Interest
for withdrawal deposit frequency of
deposit

Regular 1000 or 10% of his 4 months Weekly 8%
current balance deposit of 1%
whichever is higher of the loan
amount

Combined (for None Anytime Monthly 6%
non borrowers) deposit of

Long term 50000 or 5% of 1-5 years Monthly 8%
the current balance deposit of 5%
whichever is higher of the loan
amount

The amount that would be obtainable would be reduced if the amount is withdrawn before the
expiry of the term.

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Remittance Product

For a client like Nagappa who sends most of his earnings to his family back in Tamilnadu, it
will be highly convenient if a product is devised for him wherein we will pay his family on a
monthly basis and charge the repayment from Nagappa. This will however include the
transaction costs in sending the amount to Nagappa’s village which he anyways would end up
paying himself. This would fall under the income generation activities and the rates will be
charged accordingly.

Microinsurance Product

Disastrous losses such as those caused by fire, theft, or natural disasters can be disturbing for
any business owner. To help mitigate these catastrophic losses, we will offer an insurance
product to our clients. Since we are largely looking at a client base that consists of vendors
who would want everyday finance for their income generation activities, we are not planning
to get into Life insurance at this stage. We would provide insurance for the vendor’s pushcart
for instance. Other insurances products would be insurance against calamities and seasonality
changes where we could relax the repayments cycle for our clients at a higher interest or take
a premium from them every month and repay a lumpsum amount during the calamity.

Microentrepreneurs’ Product

Microentrepreneurs’ would be financed for fixed assets or for infrastructure and the interests
would be charged as given in the above Table based on the purposes that the client needs the
loan.

Emergency Loan

This loan will be given in case of unforeseen emergencies. E.g., accidents, for performing the
last rites of a person, etc. This loan is different from Microinsurance in the sense that the
amount for this loan will be decided based on the savings the client has or his repayment
history or his cash flows. The client would not have to pay any premium on a periodical basis
for this type of product.

Mutual Benefit Product

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This product is applicable only to working capital loans. Here the client can combine a
regular savings scheme with the basic working capital loan. He can achieve this by depositing
a percentage of his daily earnings in his account every evening. He can then withdraw a
certain amount based on his daily working capital needs everyday and keep repaying the
amount along with interest that evening. In essence the borrower would get to operate on a
line of credit. The interest rates on his deposit could be increased or his repayment interest
rates could be reduced if client additionally wants to save a portion of his daily earnings.

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Loan Appraisal

Application form (Refer Annexure I for the actual application form)

For the purpose of loan application, we are using a standardized application form. The
application form will provide information pertaining to the following, which will help in
assessing the credit worthiness of the applicant by using the credit scoring model.

• Personal details
• Financial information (business and personal)
• Personal security
• Product details
• Details of guarantors

Verifications

The application form will be filled by a loan officer by visiting the residence of the applicant.
This will enable verification of various information provided by him/her. Due to the lack of
adequate security, the verification process becomes very important to avoid incorrect data.
The following key information requires thorough investigation and verification.

• Location of residence
• Place of business (fixed/mobile)
• Bank details
• Details of guarantors

Verification of guarantor details is most important, as they are the only source of security
provided by the applicants. This is the reason for carrying out the application form filling
process at the residence of the vendor as the loan officer can visit the neighbours who have
given guarantee and verify their details. It is especially necessary to ensure that the
guarantors do not belong to the same family or are closely related in order to diversify the
risk of default.

Monitoring and collection

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For keeping a periodic check on the business of the vendors, we will assign one person in
each region to carry out the process of form filling, monitoring and collection. Since the same
person will carry out filling and monitoring, a better understanding between the client and the
officer will be established which will provide better access to their operational information.
Fixed pushcart vendors can repay their daily/weekly loans to their area in charge while
mobile pushcart vendors can choose their place of repayment based on their convenience.

Approval

While the form filling will be carried out by the area in charge, the approval of the loans and
adjustments in the repayment requested by the vendors will be done by a superior, in charge
of a number of areas. Therefore, the area in charge can be less skilled and his task will
become simpler. Also, it will help in keeping a checking on the performance of the area in
charge.

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Credit Scoring Model of Janalakshmi

The Credit Scoring Model of Janalakshmi rates the traders according to the following
parameters with their respective weights:

Parameters Weights

Trading History 30

Success of Data Validation 20

Financial Viability 15

Credit officer’s Recommendation 10

Feedback from neighborhood 10

Cross-sell Opportunity 10

Security 5

Saving’s History 0 (as of now)

Total 100

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Trading History: This parameter establishes the familiarity of the trader with SAFAL.
This parameter as the highest score as the higher a trader the greater are the chances that
he will execute his repayment. The following sub-parameters are used to measure the
parameter

o Period of trading

o Frequency of transactions

o Consistency in value of transactions

o Familiarity of SAFAL representative

Success of Data Validation: The data that has been entered in the appropriate forms by
the vendor is verified by the officer. Based on the accuracy of that information this
parameter is scored.

Financial Viability: This decides whether the vendor has any means of financial
capability. To score this parameter the cash flows of the vendors are considered after
deducting all business expenses which include equipment expenses like replacing
damaged tyres etc.

Feedback from neighborhood: This parameter is scored by gaining feedback from
neighbors and business community.

Cross-Sell Opportunity: This parameter is scored depending on the number of products
the vendor would be able to afford i.e. Educational Loan, General purpose Loan,
Enterprise Loan, Education Loan. The more the number of products the vendor is
interested in the higher the score he gets.

Security: This parameter is scored based on the savings of the vendor which is highly
unlikely; hence the lowest weights are given to this parameter.

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Recommendations for the Credit Scoring Model of Janalakshmi

Trading History: This parameter has been given the highest weights i.e. 30. Hence it
becomes really important. Since SAFAL is an organization that came into being only 1.5-
2 years ago, this parameter will be able to capture only the recent past of the trader.
Instead of familiarity with SAFAL the Trading History should look at the familiarity of
the trader with the trade itself i.e. the parameter should capture how long he has been in
the trade instead of how long he has been with SAFAL.

Financial capability should be given the lowest weight (similar to the Security parameter)
because it is extremely difficult to establish the cash flows of a pushcart vendor. Also, if
the vendor would have a stable cash flow he would be eligible for a loan in the
commercial bank instead of a microfinance institution. For a pushcart vendor losing a 15
weight would mean a huge loss and that would be judged only on his cash flow.

There should be some way of capturing the reason why the trader has come to Bangalore.
This is essential because if the trader has come here for survival it is highly likely that he
would stick around for a longer time than a trader who has come here to expand his
business, etc. Most vendors seek out a way to protect their families who usually stay in
the villages amidst their dry and barren lands. Hence, these traders are more trustworthy
as they would not easily leave their source of income once settled.

There needs to be a parameter to capture the movement of a vendor within the city
because how frequently the vendor changes his market would provide some indication
about how long he might stick to SAFAL and since Janalakshmi is initially targeting
SAFAL customers, it would also give them an idea about how long the customer would
have a registered information at SAFAL to be traceable.

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Annexure I (Loan Application Form)

PERSONAL INFORMATION

1) First Name

2) Middle Name

3) Last Name

4) Address

5) Telephone: Residence

6) Age

7) Sex:

8) No. Of Family Members

9) No Of Earning Members

10) No. Of Dependents

11) Education Qualifications if any

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FINANCIAL INFORMATION (Monthly)

Personal

Total Expenditure

Expenditure on house rent

Expenditure on Food

Expenditure on Commission

Expenditure on Education

Expenditure on Utilities

Expenditure on Miscellaneous

Business

Nature of Business

Specify Turnover

Specify Cost of Rent

Specify Cost of Transportation

Specify Cost of Electricity

Miscellaneous Costs

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PERSONAL SECURITY & PRODUCT DETAILS

1) Details of Bank Accounts held
Bank Name
Bank Account number

2) Sources of income other than business

3) Assets
Savings
Immovable Properties
Others

4) Amount repaid Routinely to Pay of Other Loans (Specify time period and amount)

5) Source of Loans

6) Purpose of Loans Taken

7) Details of Loan Taken (Amount, Term & Interest)

Money Lenders
Friends & Relatives
Banks
Others (specify)

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PRODUCT DETAILS

1) Type of product applied for
Scheme of product

2) Amount

3) Preference of Repayment
Duration
Location
Collateral

DETAILS OF GUARANTORS
1) Name
2) Address
3) Relationship with client
4) Specify for each member whether he/she is our client

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Annexure II (Credit Scoring Model)

Parameters with their weights Sub parameters
Existing savings deposits
Current cash surplus available for saving
Savings (20%)
Expenses of avoidable activities like drinking, movies, etc.
Interest of client in taking a savings product
Assets owned
Personal security (20%) Assets mortgaged/rented
Assets offered as security
Number of guarantors in the group
Number of Guarantees (15%) Familiarity with guarantors (members/non-members)
Financial soundness of guarantors
Total turnover
Total business expenses
Business information (15%)
Total personal expenses
Other commitments towards repayment of previous loans
Period of trading
Trading History (15%) Frequency of transactions
Consistency in value of transactions
Age
Number of family members
Demographics (10%)
Number of dependents
Number of family members in the same business
Current scale of operation
Growth prospects (5%)
Interest/possibility of future expansion

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PROJECT ON LOAN APPROVAL

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