1. RESERVE BANK OF INDIA: COLLEGE OF AGRICULTURAL BANKING
Microfinance
Issues and Ways Forward
James Cumpson and Buneka Saif
8/4/2014

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Contents
Acknowledgements ............................................................................................................................4
Executive Summary ............................................................................................................................6
Microfinance andits Relevance in India ...............................................................................................9
Evolution of the Microfinance Sector...................................................................................................9
Credit Cooperative Movement.....................................................................................................9
Nationalization of Social Banking................................................................................................10
Introduction of SHG Bank Linkage Program and Growth of NGO-MFIs..........................................11
Commercialization of Microfinance............................................................................................12
Present Status and Progress..............................................................................................................12
India’s Self Help Groupsvs. Bangladesh’s Grameen model...........................................................12
The empowerment of women through Microfinance ..................................................................14
Success Story: Sasmita...............................................................................................................15
Issues and Challenges .......................................................................................................................15
Multiple Memberships and Borrowing........................................................................................15
Lack of Product Innovation.........................................................................................................16
Inadequate Outreach and Coverage ...........................................................................................16
Andhra Pradesh Crisis 2010........................................................................................................16
Latest and Likely Developments.........................................................................................................17
The Proposed Micro Finance Institutions(Development and Regulation) Bill 2012 ........................17
Ways Forward and Suggestions.........................................................................................................18
Increased Useof Microfinance Rating Agencies ..............................................................................18
Portfolio Quality:.......................................................................................................................19
Efficiency & Productivity:...........................................................................................................19
Financial Management: .............................................................................................................20
Profitability:..............................................................................................................................20
Social Performance:...................................................................................................................20
MicroRate Rating Process: .........................................................................................................20
Recommendation:.....................................................................................................................21
The Role of Technology in Microfinance..........................................................................................22
Costs of Implementing Technology.............................................................................................22

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The Right Data ..........................................................................................................................23
Management Information Systems (MIS)....................................................................................23
Costs Associatedwith MIS .........................................................................................................24
Creation of a Client Database.....................................................................................................25
Client Database Incentives.........................................................................................................26
Increased Need of Capital and MFI credit ratings.........................................................................26
Conclusion and Suggestions ..............................................................................................................27
References.......................................................................................................................................29

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Acknowledgements
We would like to take this opportunity to express our profound gratitude and deep regards to our
project guide Mr. S.V. Sardesai for his guidance, monitoring and encouragement throughout the
internship.
Special thanks must also be given to the Principal of the College of Agricultural Banking Ms. M.
Hemchandra, who allowed us the opportunity to undertake this project and the use of her highly
knowledgeable faculty.
Thanks must also be given to Mr S. Mugunthan, Mr E.R. Muthuselvan, Mr Neeraj Nigam, Mr R.L. Das
Mrs. S. Chatterjee-Banerjee, Miss A. Currie, as well as the rest of the faculty at the College of
Agricultural Banking, for their role in the creation and delivery of this fantastic opportunity.

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“We need to use the power of technology and the
creative power of young people. By combining these
together you can solve these problems.”
- Muhammad Yunus

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Executive Summary
In a period of 20 years, microfinance has boomed in India and is responsible for uplifting many people
out of poverty. Bangladesh leader, Muhammad Yunus, began the microfinance movement in 1983 to
provide poor people loans without collateral. His model, the Grameen Model, was often called the Win-
Win proposition because poor people were able to qualify for fair loans to expand their livelihoods or
use it for emergency purposes without relying on informal services like the local village money lender.
India has welcomed microfinance and now it has become one of the largest and most concentrated
markets. Although microfinance has overall widely been successful in India, it still needs a lot of
improvements. Some problems that currently plague the sector include multiple borrowing, uneven
coverage and lack of regulation. Indian state, Andhra Pradesh, was one the leading pro-microfinance
institutions states in India, however in 2010 the government of Andhra Pradesh decided to take action
against microfinance institutions (MFIs) because of rampant suicides caused by widespread over
indebtedness due to MFIs. The Andhra Pradesh Crisis of 2010 has become a turning point in India to
reform and the microfinance sector by addressing key issues. In light of these events, we have decided
to extensively focus on two improvements; third party rating agencies and introduction of cost saving
and efficienttechnological practices.
Following India, Latin America hosts the second largest microfinance market. Latin American countries,
Peru and Bolivia, are the two top performing microfinance countries in the world. They have been so
successful because their MFIs are subject to strict regulation standards and are evaluated by third party
microfinance institution rating agencies. One of the most popular rater is MicroRate; this agency
provides three types of ratings: microfinance institution ratings, social ratings, and credit ratings. In
about 6-8 weeks, MicroRate generates a full report analyzing the effectiveness of the particular MFIs. By
doing this, MFIs can see what they need to improve on while outside investors and commercial banks
can choose what MFIs to invest in or lend to. This process overall improves the entire microfinance
sector because MFIs are more likely to focus on both their financial and social performance, the double
bottomline.
Technology is going to be crucial in the renewal and revival of the microfinance movement in India, with
the technology sector playing vital role in the future major developments of microfinance. The use of
technology brings promise of a faster, easier and more efficient microfinance sector, with every player
involved benefitting. The hope is that expanding and building on the success of current technology in
thissectorwill enable the microfinance movementtoreachmore people thanever.

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The first step that needs to be taken by MFIs, is for there to be a large scale uptake of Management
Information Systems (MIS) across the sector. Technology is already in the sector, but many smaller and
medium sized firms have yet to fully adopt it. Many firms still rely on either basic software such as
Microsoft Excel, or are still up keeping their records using pen and paper. Using a computer based
system carries many benefits for an MFI, with many already surpassing the size where creating reports
and analyzing data by hand are efficient. The MIS allows all data to be inputted into the system,
reducing the time taken to create reports or access data. Those who work out in the field will also be
able to access and create data using PDAs and smart phones instead of having to carry around the
material theycurrently use.
The main issue with getting a large uptake of MIS by MFIs is the large initial and operating costs
involved. For many small and medium sized MFIs, it would be more efficient for them to adopt MIS
software, but they just lack the resources to do so. For it to become affordable there could either be a
subsidization of the software for the firms that would benefit from itfrom the government or the RBI, or
to make the software cheaperandmore customizable forfirmsin the firstplace.
After a broad uptake in technology and implementation of MIS, we suggest that a client database is
created. All those who are borrowing money from MFIs will have to register on the database, which is
shared between all MFIs. The database will contain all the personal details of the borrower, history of
their past and current borrowings which will allow a credit rating to be formed, and finally a unique
biometric feature such as an iris scan. We feel that this will allow MFIs to know more about who they
are lending to, allowing them to make more secure loans; clients will be able to take larger loans if
needed and if they have a good past credit rating, but mainly it will reduce the level of multiple
borrowings. The only way the data base would be effective is if all MFIs gave up their current data, and
all new clients allowed their data to be shared with a common database. So we feel that to encourage
MFIs to donate, they would not be allowed to benefit from the database if they have not contributed
towards it; and clients will not be allowed to receive loans unless they give permission for their personal
informationtobe crossreferencedonthe database.
The use of a client database, alongside the uptake of MIS by firms will allow the workers out in the field
to use their smart phones to access this data, speeding up the time of meeting a client, allowing the loan
officer to visit more clients in the same time. Therefore using this technology will allow for a greater
reach of each individual MFI,givingoutmore loansthanwere availablebefore.

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We suggest that there needs to be an MFI database set up in tandem with an independent credit
bureau, such as MircoRate. The data would be supplied by the MFIs and would include factors such as:
the current size of the MFI’s portfolio; their outreach; their client default track record; the age of the
institution; from which a credit rating would be produced. This credit rating can be used alongside the
database inallowingMFIstogain greaterand easieraccesstocredit.
Under RBI regulations, commercial banks have to set 40% of their lending to priority sector areas, with
18% of this having to go to agriculture. Finally suggest that a guaranteed lending scheme also be
implemented for MFIs, with a certain percentage of their lending portfolio having to go to MFIs. With
the credit bureau and database in place, banks will feel more comfortable lending to these institutions
in a fairly unregulated market. It will allow them to lend with more confidence, but also allow them to
lendtoMFIs that have a clientele suitedtowardthe banksaimsandpreferences.

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Microfinance and its Relevance in India
According to recent RBI estimates, there are currently 450 million “unbanked” people living in rural
India. The central government of India has made poverty alleviation its top priority by emphasizing
on financial inclusion. Many people living in rural areas are dependent on agricultural activities to
survive. Constant fluctuations of agriculture harvests make it impossible for the average farmer to
have a stable income. Episodes of misfortune such as illness and famine also hinder the average
farmer’s stability. However microfinance has proven to be an effective tool to prevent economic
disasters and lift people out of poverty while aligning itself with the Indian government’s goal of
financial inclusion.
Evolutionof the Microfinance Sector
India’s microfinance evolutioncan be broken down into 4 distinct phases.
CreditCooperativeMovement
India’s microfinance movement started in 1903 through its credit cooperative movement. Before
this movement, the poor often relied on the village’s money lender whenever they needed access to
cash. Money lenders were notorious for high interest rates; they would charge approximately 3%-
8% per month on loans. Although money lenders would prey on farmer, they had no other choice to
use them because they could not get access to banks. Farmers’ earnings were directly related to
how well their crops fared. High interest rates coupled with possible years of famine made
repayment impossible causing agrarians to riot. In 1904, the Co-operative Society Act extended
credit to Indian villages under government sponsorship as an alternative to traditional money
lenders (Arena, 2011). Cooperatives were the only option to most rural areas because of its spatial
spread and penetration in remote areas. During this phase commercial banks did not venture into
rural areas because they were in the private sector and had no incentive to extend their outreach to
rural areas. However they became unreliable because of Non-performing asset (NPA) inefficiencies
and they lacked professionalism (Nair et al, 2014). Credit cooperatives had trouble distributing
funds due to frozen assets from overdue repayments. Therefore rural areas stopped using credit
cooperatives and opted forhigh interest money lenders.

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NationalizationofSocial Banking
The next phase of India’s microfinance evolution was the Nationalization of Social Banking. In 1969,
former Prime Minister Indira Ghandi nationalized 14 major sector banks in part of her political
policy to eradicate poverty. After the nationalization of banks, regional rural banks (RRBs) were
created in order to strengthen the rural banking structure and reach more people. These banks
offered a hybrid service of the previous cooperative banks with a more localized approach.
Approximately a decade after, the government sponsored the Integrated Rural Development
Program (IRDP) to deliver Rs. 15000 to the poor. India’s IRDP is a great example of inefficient
subsidized credit. This program was set up in order to address the need to allocate funds according
to social targets, meaning that 30% of the fund was allocated to socially excluded groups (defined
using the caste system) and 30% towards women. Between 1979 and 1989, there was a huge
period of IRDP growth due to a huge subsidy budget of $6 billion. But despite the huge fund, the
scheme did not generate a good institutional performance (Arena, 2011). IRDP repayment rates fell
below 60% and only 11% of borrowers took out a second loan after the first loan was repaid; which
is particularly troubling given it is perceived that repeating lending in microfinance is essential. At
the turn on the 21st century, the IRDP loan rate fell to just 31%, and therefore the IRDP failed its
key purpose: being a reliable and meaningful lender to the poor.
According to the Rural Finance Program at the Ohio State University, the main mistake
government-led development banks (such as the IRDP) made, was to view offering credit as the
same as offering seeds. Ohio argues that credit should be thought of as a fungible tool of financial
intermediation, and as not as a specific input into a production process. They claimed that credit
could not just be directed towards any particular section of society; and when this was linked with
cheap credit policies, this caused havoc in rural financial markets (Sa-dhan.net, n.d.). This outcome
was due to the inadequate accounting of incentive effects and politics associated with subsidies. It
is argued that subsidizing banks created inefficient monopolies and removed market tests. Some
have even gone on to say that the households involved would have been better off without the
subsidies. Firstly subsidized banks pushed out the informal money lenders, a source of credit the
poor heavily rely on. Secondly, the use of subsidized credit means that the interest rate, a rationing
mechanism, is driven down below market rates, breaking down the rationing mechanism. This
meant that credit was no longer allocated to the most productive projects, and was often
distributed on the basis of political and social desires. Thirdly, with subsidized lending, bankers’
incentives to collect savings deposits were almost eradicated due to the constant flow of capital
from the government, so poor households were left with unattractive and inefficient ways to save

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(Arena, 2011). During this phase, a trade union of self-employed women workers in Gujarat
established a Self-Employed Women’s Association (SEWA) bank in 1974. Approximately 4000
members contributed Rs.10 to register as a co-operative bank to provide banking services to poor
women. This successful bank was one of the first initiatives to introduce microfinance.
IntroductionofSHG BankLinkageProgramandGrowthofNGO-MFIs
The third phase of India’s microfinance evolution is the introduction of Self Help Group (SHG) bank
linkage program and the growth of NGO- MFIs. The National Bank for Agricultural and Rural
Banking (NABARD) was established in 1982 to focus primarily on agricultural and rural
development. In 1992, NABARD pioneered the first self-help group. These informal groups of
women promote savings among members and used these resources for meeting their credit needs.
A breakdown of this model is that in every meeting, the members would put aside a certain amount
for deposit. These deposits are then recorded and through accumulation they become a way for
members to lend to each other. Although the interest rates in this model are higher than what
banks offer, the SHG groups reap the benefits because the repayment goes directly into the group’s
savings (Sa-dhan.net, n.d.). This means that the group’s loaning capabilities increases the more its
members regularly save. In this model, there is no formal banking institution that provides loans.
The primary goal of this model is for all members to begin their own saving initiatives. Later this
model evolved to become part of Self Help Group Bank Linkage program (SBLPs); after analyzing a
SHG for 6 to 8 months, banks would pair up with groups to extend the credit of the group. After
another period of 6 to 8 months, banks would offer a larger credit line; the maximum a group could
borrow was four times their current savings account. Currently SBLPs account for 58% of current
loans outstanding (Arena,2011).
Microfinance Institutions (MFIs), Non Banking Financial Companies (NBFCs), comprise 34% of
current loans outstanding. These types of institutions are similar to Bangladesh’s Grameen Model.
In 1976 Muhammed Yunus created the Grameen Bank Model as a project to assist poor families by
offering credit. Grameen means “village” in Bengali. This type of banking was used to show that the
poor people of Bangladesh are indeed bankable and able to pay back loans without promising
collateral. The model success is based on the fact that there is no need for collateral however
through group peer pressure, 96% of all loans are repaid. By offering lower interest rates than the
Government of Bangladesh and weekly repayment schedules, the Grameen model has been very
successful. This model has been very successful in Bangladesh and has become a formal banking

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structure in 1983. India modified this banking structure and Joint Liability Groups (JLGs) became
the dominant model used in Microfinance institutions. This model is similar to Bangladesh’s
Grameen Model but it introduces an important concept, joint liability. In this model, there is usually
4 to 10 members who are self-selected. Due to self-selection, most of joint liability groups are
homogenous groups. Whenever the group decides to take out a loan, all members must sign a joint
liability contract; this ensures that if one member fails to repay the loans, the other members are
liable for it. This type of collateral is called social collateral because members often use peer
pressure to make sure that all members repay their loans (Sa-dhan.net, n.d.). This type of group is
intended to just be credit groups and regular savings by members are not required. The group only
exists because individual members are legally bound to one another. MFIs prefer this model to
provide credit to tenant farmers because the groups are easy to make and there are less restrictions
regarding the utilization of the loan. During this phase, MFIs experienced a boom because NGOs
coupled themselves with MFIs to attract commercial investment.
CommercializationofMicrofinance
India’s current phase of microfinance encompasses the commercialization of microfinance.
Throughout its history, microfinance has gone through an intense transformation to provide
microcredit for a wide range of services. Currently India uses a hybrid of the above models in its
MFIs. However MFIs are being criticized for its high interest rates. Many borrowers only apply for
loans between 5000-20000 rupees; the small value incurs high fixed costs for MFIs (Sa-dhan.net,
n.d.). To avoid losing money, MFIs often charge higher interest rates. Four key reasons why MFIs
charge high rates include: the cost of funds, MFIs operating expenses, loan losses, and profits
needed to expand their capital base and fund expected future growth. The costs that are associated
with microloans are the cost of the money to loan, cost of loan defaults and transaction and
operating costs (The Maturing of the Indian Microfinance,2005).
Present Status and Progress
India’sSelfHelpGroupsvs.Bangladesh’sGrameenmodel
Bangladesh is considered the birthplace of the modern microfinance movement, all starting in 1976
with Muhammad Yunus founding the Grameen Bank. Yunus developed the Grameen model of

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microfinance, starting with $27 of his own money, which is all based around the use of group
lending and peer pressure to get the clients to repay the money. Group lending in India took a
different form to the Grameen method, with the use of a Self Help Groups. Both systems have been
successful in their respective countries, with both methods coming with their unique advantages
and disadvantages.
With regards to the Grameen system, clients are organized by the MFI into groups of five, and these
groups are then organized into centers of five to seven groups. Members of the group are not
required to save to raise funds, but instead they are given a loan by the MFI with which they use to
fund their current businesses or ideas. The group will hold weekly meetings which are supervised
by a member of the MFI who have supplied the group with funds. Due to high illiteracy, the MFI
employee will help maintain the record books and collect the loan repayments. The group will
guarantee a loan to an individual member, and it is this that creates social pressures for the loan to
be repaid as there is no formal agreement between the MFI and the loan group, only trust.
In India however, group lending has taken a different form than the Grameen model. A SHG is made
up of many more member than the Grameen model, with groups usually consisting of around 20
members. The formation of one of these groups could be facilitated by an institution such as a Non-
Governmental Organization (NGO) or an MFI. The NGO will not play a financial role within the
process; they are there to train and assist the group, and later to introduce the group to a bank or
an MFI. Each individual group member contributes a small amount of money each week to a fund,
which can then be lent out to members of the group when they need it. This is partly where SHGs
differ from the Grameen model, as SHGs have to use their own savings to fund their loans, whereas
the Grameen model depends on an outside lender to fund the group. The loan can be for any use,
with needs ranging from investing in a business to paying for health treatment. Once lent, the
money is then repaid with interest (the rate is decided by the group but is usually around 2% a
month), so the fund can grow in size and be lent out to other members of the group. Once the group
has established a good track record of repayment, which can take many months or years, they are
linked up to a bank or an MFI who will lend them money and even create the group a bank account.
However, in the 2012-13 period the number of SHGs having a savings account with banks declined
by 8.1% from the year before (Nair et al, 2014), after twoyears of growth.
Both models have seen moderate success over the years, with the Grameen Bank lending to 8.35
million Bangladeshis (Grameen Bank, 2011) and 7.96 million SHGs having linked with a bank up to

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the end of March 2013 (Nair et al, 2014). In Bangladesh, it has been estimated that micro-credit
loan is lifting 1% of its population out of poverty every year (Shukranet al, 2011), with the average
loan size lent equaling $189 (Grameen Bank, 2011).
India is also seeing positive results from the microfinance sector. After the 2010 Andhra Pradesh
Crisis, India has seen positive growth in both its SHG and NBFC-MFI structures. As of 2013, there
are 4,451,434 SHGs linked with commercial, regional rural and cooperative banks, with their
outstanding loans at 393.75 billion rupees (Nair et al, 2014). The number of SHGs linked with banks
is up from the year before, with the 2012 figure at 4,354,442 (Nair et al, 2014). As of June 2013, 43
of India’s top NBFC-MFIs have a gross loan portfolio of 2,170 billion rupees, an 11.87% increase
from the previous year (Nair et al, 2014).
TheempowermentofwomenthroughMicrofinance
As do nearly all countries, India still suffers from the problem of gender in equality. However,
microfinance has played a huge role in women’s empowerment all over the world, with 96%
Bangladesh’s Grameen Bank’s members consisting of women (Grameen Bank, 2011). In India
women are faced with a gender specific barrier to essential services such as employment and
education. The difference in educational access is shown by a huge gap in literacy rates, with a rate
of 75.3% for men and 53.7% for women (Government of India, 2011). This disparity between
genders is stronger in rural areas, and with 70% of India’s population living in rural areas
(Government of India, 2011) a large proportion of women in India still faces gender inequality.
Through microfinance, the empowerment of women can be seen and measured through a number
of factors including: economic empowerment; improved standard of living; increased self-
confidence; enhanced awareness; increased social interaction and network; participation in solving
problems related to women and community (Rasure, 2013). With microfinance, empowerment will
be externally induced, so women can exercise a level of autonomy. It will allow them to start or
develop their own business ideas, giving them a level of income so they are no longer dependent on
their spouse. By bringing income in for the family, it allows them to have more of a say in day-to-
day issues, becoming more independent and breaking their traditional role of being a housewife.
Empowering women leads to an overall family empowerment which increases socio-economic
conditions in rural areas, thereby leading to an overall increase in economic development and
inclusive growth (Rasure, 2013).

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SuccessStory:Sasmita
An example of how microfinance can empower and change the lives of women can be seen in the
small state of Orissa. In Orissa, five small SHG groups were supported by the NGO “Fellowship” in
Bhadrak. The five SHGs were formally linked to the Balasore Rural Bank in 1993, with a total loan
disbursement of 19,220 rupees. One woman, named Sasmita, was left by her husband in Bombay
and had to support herself and her young child. Being a single woman with a child, she was
struggling to find somewhere to stay; an issue that was made worse by the fact her parents was not
able to financially support her. The NGO “Fellowship” approached Sasmita and convinced her to
join hr local SHG, Sagar Self Help Group, while taking part in a financial literacy program. After
joining the SHG she was able to secure a loan from the group, who all recognized that she was under
a lot of financial stress. Sasmita used the loan to open a small retail shop of essential home items,
located at the front of her home. Through the help of the loan, the SHG, and the financial literacy
program, Sasmita was able to expand her business giving her a level of financial security and
independence that she had not experienced before (Nabard.org, 2014).
Issues and Challenges
Although microfinance has uplifted the lives of many there are still key issues that must be
addressed to improve the India’s microfinance sector.
MultipleMembershipsandBorrowing
The Indian Government made financial inclusion one of its top priorities. Currently 50% of India
does not have a formal bank account. These people are often reliant on their village’s respective
money lender when they need a loan; however money lenders are notorious for charging
exorbitant interest rates. To enforce financial inclusion, the Indian government has required
commercial banks to lend 40% towards the priority sector. There a lot of different fields that
contributes to the priority sector such as agriculture, fishing, etc. Most of the rural poor comprise
the agriculture sector; microfinance institutions play an important role in this sector because they
act as a fair emergency buffer for unexpected situations. Banks often used microfinance institutions
to fulfill their priority sector requirements because MFIs only charged about 12-13% interest on
their services while the banks enjoyed risk free full repayment rates (Microfinance in India, 2013).
However it was later realized that MFIs only achieved this high rate of repayment because many of
its borrowerswere joining multiple MFIs and SHGs to repay previous loans.

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Lack ofProductInnovation
According to the Microfinance Information Exchange, the formal definition of microfinance is “a
variety of financial services that target low income clients, primarily women. These services include
savings, credit, pensions, remittances and insurance.” However India’s microfinance sector only
focuses on microcredit loans. The most popular type of microloan is productive loans;
emergency/consumption loans are the next popular at 30% while housing loans comprise the last
15% of loans (Map of Microfinance Distribution in India, 2013). Although microcredit loans play a
large role in poverty alleviation, it does not encompass all financial services needed. Approximately
15% of registered MFIs provide savings services, 60% MFIs provide life and cattle insurance while
remittances and pension products are not widely offered (Map of Microfinance Distribution in
India, 2013). It is important to provide these services because in many situations these
microfinance institutions are acting as substitutes to banks.
InadequateOutreach andCoverage
One of the main issues of microfinance in India is inadequate outreach and coverage. Southern
Indian states are completely saturated with microfinance movements while the Northeastern,
Northern and Central states are very underdeveloped. Currently the southern states clients account
for 52% of all MFI borrowers and 54% of the entire outstanding loan portfolio (Map of
Microfinance Distribution in India, 2013). MFIs are reluctant to penetrate northern areas because of
the high costs associated with creating a new MFI establishment in a new area. Most of the northern
and central areas are very rural; these people are often referred to the “bottom of the pyramid”
because they are very poor (Map of MicrofinanceDistribution in India, 2013).
MFIs would incur a lot of fixed costs to establish a brick and mortar MFI institution in these types
of areas. Therefore MFIs are likely to cluster in urban or semi-urban areas to reduce costs. This
clustering effect reduces costs however it negatively impacts rural areas because many villages lack
any access to formal financial services. Although microfinance is supposed to uplift many out of
poverty,presently it is not targeting a large portion of poor people whoreally need these services.
AndhraPradeshCrisis2010
Leading up to 2010, India became the largest and most concentrated microfinance market in the
world with the state, Andhra Pradesh, leading the reform. However it was soon realized that MFIs
were using unethical practices to collect payments from borrowers. These practices escalated to
cause many borrowers to commit suicide, multiple of borrowing and accept high interest rates to
avoid MFIs. The state government of Andhra Pradesh responded by enacting the Andhra Pradesh

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Microfinance Institutions (regulation of money lending) Act in 2010. The act made it punishable for
forceful recovery of loans however many borrowers assumed that they didn’t have to pay back the
loans and the government would protect them. This led the repayment rate to plummet from 99%
less than 20% (Ghiyazuddin et al, 2012). The act was trying to protect the borrower and punish
MFIs for charging exorbitant interest rates and causing over borrowing. Critics of the act state that
SHGs were also part of the crisis and that they were not negatively affected by the act as MFIs were.
They state that government backed SHGs were also part of over borrowing and the act limits MFIs
business and successfully reduces competition between microfinance institutions (Kaur and Dey,
2013). The act negatively affected MFIs profitability, loan recovery and their overall operations. The
result of the crisis left many MFIs at negative worth; this in return limits their accessibility to
garner fresh funds and their overall ability to reach the rural poor. According to the norms, banks
are not allowed to lend to banks that have negative worth (Microfinance in India, 2013). The crisis
left microfinance companies like SHARE Microfin, Ashmin Microfin, Spandana Sphoorty Financial,
Trident Microfin, and Future Financial Services unable to disburse fresh loans to clients (Kaur and
Dey, 2013). Banks also lost trust in MFIs and there has been a serious liquidity crunch. Increased
costs of borrowing coupled with the inability to access new funds further strained the profitability
of MFIs. In conclusion, the enactment of the Andhra Pradesh Act stifled the access of basic financial
services to the poorest of India citizens.
Latest and Likely Developments
TheProposedMicro FinanceInstitutions(DevelopmentandRegulation)Bill 2012
After the 2010 Andhra Pradesh Crisis, the government was worried over the state of MFIs and
proposed a bill to the development and regulation of MFIs. The bill allows the central government
to be the sole regulator and supervisor of MFIs by creating the Micro Finance Development Council
to oversee the development of MFIs. The main features of the Bill are as follows: the Bill allows the
central government to create a Microfinance Development Council with officers from different
ministries and Departments. The Bill requires all MFIs to obtain a certificate of registration from
RBI. The RBI has the authority to set maximum annual percentage rate charged by MFIs and sets a
maximum limit on the margin MFIs can make. Margin is defined as the difference between the
lending rate and the cost of funds. It is also responsible for grievances for beneficiaries of
microfinance services. Specifically the bill wants all MFIs that are Non-Banking Financial

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Companies (NBFCs) to be regulated by RBI while MFIs that aren’t companies would be regulated by
the respective state governments because they will be able to take a more localized approach and
be better equipped to serve them. The bill would also require MFIs to provide an annual balance
sheet, profit and loss account for audit to RBI at the end of each fiscal year. RBI becoming the prime
regulator for MFIs increases uniformity and stability. However critics of the bill would rather have a
whole entire new body to regulate the microfinance sector such as Microfinance Regulatory and
Development Authority. Key issues that still need to address: relating to margin, interest rate cap,
allowing collection of thrift by MFIs, enabling MFIs to render other services than credit like
pensions, insurance, etc., ceiling limit on credit, and regulation. Critics don’t want a cap on interest
rates or margins because they believe that it negatively affect the entire private microfinance
sector. Specifically price controls only benefit a few while restricting the available finance. These
initiatives may go long way in strengthening the microfinancestatus in India.
Ways Forwardand Suggestions
Historically microfinance has only focused on the financial performance of MFIs and SHGs; common
measures of performance include number of microfinance institutions found, outstanding loans and
repayment rates. However some institutions are making a conscious effort to include social
performance as a performance indicator. This is type of methodology is called the double bottom
line. The double bottom line approach has been increasingly popular in Latin America and has seen
a lot of success. We believe that India MFIs should adopt the double bottom line to restore
confidence in private MFIs. We specifically proposed two improvements: implement a third party to
rate and evaluate MFIS and use technology such as Management Information Systems (MIS) and
client databases to improve efficiency inthe entire microfinancesector.
Increased Use of Microfinance Rating Agencies
South America and India are two biggest markets for microfinance. Although India is the second
most advanced market, its private MFI market has been struggling because of the 2010 Andhra
Pradesh Crisis. Latin America has avoided similar incidents to the Andhra Pradesh Crisis by having
a third part microfinancerating agency evaluate performance and risk in microfinanceinstitutions.
MicroRate has conducted over 750 MFIs throughout Latin America, Africa, Europe, and Central
Asia. MicroRate’s CEO, Damian von Stauffenberg, created this company to provide transparency to
MFIs and attract commercial investment. Currently MicroRate has become the leading social rater
and has become the largest Microfinance Investment Vehicle (MIV) evaluator in the industry.

19. 19
MicroRate’s evaluation is based on five categories: portfolio quality, efficiency and productivity,
financial management, profitability and social performance (Microrate.com,2014) .
Portfolio Quality:
A MFIs largest asset as well as its largest source of risk is its portfolio quality. MicroRate analyzes
portfolio quality by calculating a MFI’s Portfolio at Risk (PAR).PAR measures the portion of the loan
portfolio affected by delinquency as a percentage of the total portfolio. It is calculated by dividing
the outstanding balance of all loans with arrears over 30 days, plus all renegotiated (or
restructured) loans, by the outstanding gross loan portfolio, PAR30, PAR60, PAR90 or PAR180
represent the balance of loans with arrears over 30, 60, 90, 180 days. PAR30 is used as the standard
measurement in microfinance. PAR is a more conservative measure of institutional risk than
repayment rates or arrears because both the numerator and the denominator include the
outstanding balance of the delinquent loans (instead of the balance of the late payments only in the
numerator)-therefore, it measures the total risk of the remaining balance of the loan not being
repaid and not only the immediate threat of the missing payments. PAR is comparable indicator is
non-performing loan ratio (NPL)—occurs when payments on the interest expense and/or the
principal are past due for 90 days or more and the sum of these two amounts is taken as the
balance of the non-performing loan. MicroRate emphasizes on this ratio because it is easily
understandable, doesn’t understate risk and it is comparable across institutions. Other ratios
MicroRate uses to evaluate portfolio quality are the write-off ratio, provision expense ratio and risk
coverage ratio (Microrate.com,2014).
Efficiency&Productivity:
MicroRate uses four key indicators to evaluate the efficiency and productivity of an MFI, they
include: operating expense ratio, cost per borrower ratio, personnel productivity and loan officer
productivity. These ratios give an indication of how well an institution performs operationally. MFIs
have lower rates of efficiency than commercial banks because on a dollar per dollar basis, as
microcredit is highly labor intensive therefore efficiency ratios may be 10-30% compared to
commercial banks with 1.5%-3%. The Operating Expense Ratio is calculated by dividing all expense
related to the operation of the institution (including all the administrative and salary expenses,
depreciation and board fees) by the annual average gross loan portfolio. The Cost per Borrower
Ratio is calculated by dividing all expenses related to the operation of the institution (including all
the administrative and personnel expenses, depreciation and board fees) by the average number of
activeborrowers for the period (Microrate.com,2014).

20. 20
Financial Management:
The next item MicroRate evaluates MFIs on is financial management. This set of evaluations assures
that there is enough liquidity to meet an MFI’s obligation to disburse loans to its borrowers and to
repay loans to its lenders. Unregulated MFIs tend to have higher cost of funds than regulated MFIs
because they have more access to commercial funding. As MFIs grow and mature, Debt/Equity will
continue to increase and MFIs must balance the corresponding increase in funding expenses with
improved profitability and efficiency.
Profitability:
Since many MFIs have become for profit institutions, MicroRate also looks at individual MFIs
profitability. Key indicators of a profitable MFI are low PAR ratios and write-offs reduce the
portfolio yield, donations, extraordinary accounts, and accounts from previous transactions can
distort these ratios.
Social Performance:
Many MFIs in Latin America already embrace the double bottom line and strive to improve their
financial and social performance. Therefore a MFI with a high social performance score has an
average loan size that should be contextualized according to the country’s income level, low
borrower retention rates could indicates client dissatisfaction. Also high staff turnover is one of the
main problems in mature markets.
MicroRateRatingProcess:
The entire MicroRate rating process takes approximately 6-8 weeks. During the first two weeks,
MicroRate performs a pre-visit data collection and desk analysis and on-site evaluation. After an
MFI hires MicroRate, they will conduct a prescreening of the client before two analysts visit several
MFI’s branch offices to interview all levels of management and personnel. Weeks three through five
is dedicated to analysis of all the information collected and consolidated into a final report. The final
two weeks consist of client feedback and rating committee and report publication. Prior to
publication, the MFI is provided with a draft version of the report before MicroRate gives a final
grade. MicroRate gives three different types of rating: microfinance institution, social and credit
ratings.
This rating provides an opinion on the long term institutional sustainability and creditworthiness of
a MFI by evaluating the MFI’s management of risk, its performance relative to industry benchmarks
and its responsible practices in microfinance environment, governance and management,

21. 21
organization and operations, portfolio credit risk and financial profile. The objective of MFIs hiring
MicroRate is to attract investment, strengthen internal management and operations,
professionalize and improve a MFI’s image, and enable comparison with similar MFIs through
benchmarking. The Microfinance Institution Rating (MIR) grading scale is split into three grades: α,
β, Υ. A MFI that receives a “α” rating shows that they have successfully balanced the financial,
operational and strategic considerations of sound microfinance practices. These MFIs are also low
risk or the risk is well managed and has a good future outlook. A MFI that receives a “β” is working
to define a relationship among the financial, operational and strategic considerations of sound
microfinance institution. “β” rated MFIs are moderately risky and have a satisfactory future outlook.
MFIs that “Υ” have to make a lot of improvements because they have clear financial, operational or
strategic weaknesses that have the potential to threaten their viability and are high risk. Along with
a Greek letter grade, MicroRate also includes a rating outlook. These ratings range from positive,
stable, negative and uncertain grades; these ratings show the expected direction of the rating grade
over the next 12 months.
The next type of ratings MicroRate provides is social ratings. As more investors are interested in
companies that excel financially and socially. The final grading allows MFIs to demonstrate their
social performance capabilities to funders, increase awareness of opportunities to improve social
performance and compare social performance with other MFIs. Each MFI is assigned a star rating;
higher star ratings show that the MFI is achieving high levels of social results and social
commitments.
Lastly, MicroRate provides a credit rating to measure the risk of default in MFI obligations. By
analyzing both qualitative and quantitative factors of a MFIs country and microfinance sector risk,
credit risk, operation risk, market and liquidity risk and financial risk MicroRate assigns a letter
grade from “A+ to E”. An “A” rating of a particular MFI means that the institution has a high capacity
to pay back their obligations according to the terms and obligations agreed upon (Microrate.com,
2014).
Recommendation:
The Microfinance Bill should propose that all private MFIs must be subject to an annual
microfinance institution rating. MFIs should join MicroRate or expand m-Cril to include social and
credit ratings. Currently m-Cril is similar to MicroRate in the sense that it uses both qualitative and
quantitative factors to assess a microfinance institution. Qualitative measures that they measure
include management depth and experience, strategic position, competitive advantage, funding

22. 22
stability, and risk management capabilities. Quantitative measures include historical performance,
trend analysis, analysis of risk appetite, assessment of market, credit, liquidity, counterparty and
reputation risks, and reviews of capital and leverage. However m-Cril should expand to include
social and credit ratings on MFIs. It is important for MFIs to engage in the double bottom line and
focus on financial and social performance. After the Andhra Pradesh Crisis, banks were reluctant to
lend to MFIs because they were considered too risky since many MFIs defaulted. If MFIs focused on
social performance, commercial banks would be likely to invest more because MFIs that rank
higher on social performance tend to have better overall performing and more risk adverse MFIs.
With increased investments, MFIs then can use costsaving technologies to improve overallMFIs.
The Role of Technology in Microfinance
Technology is going to be crucial to the renewal and revival of the microfinance movement in India,
with the technology sector playing a vital role in the future major development of microfinance. The
use of technology brings promise of a faster, easier and more efficient microfinance sector, with
every player involved benefitting. The hope is by expanding and building on the success of current
technology in the sector, this will enable the microfinance movement to reach and benefit more
people than ever. The use of technology is not completely alien to the sector, with many agents
involved already using and benefitting from it. However, it is not yet widely used, especially by
smaller player due to a number of essential reasons that need to be addressed if its use is going to
expand.
CostsofImplementingTechnology
Currently for MFIs, the biggest barrier holding back the much needed implementation of technology
is the costs involved both the upfront and running costs. Depending on the size of the institution,
costs can vary from a few hundred of thousands of rupees, to many millions; and that is just the
upfront cost. The financial cost of monitoring and maintaining this system must also be
acknowledged by firms when deciding whether or not to embrace technology. Many of the reasons
for the lack of technological take up involve the frequent absence of infrastructure, such as
electricity or internet, especially in rural areas, where the use of microfinance is needed the most.
Without a reliable source of electricity and internet access, the use of smart phones and computers
will be very difficult and inevitably more expensive, as will be installing permanent fixtures such as
ATMs. Access to internet is crucial for microfinance if technology is going to be successfully

23. 23
integrated into it, as it allows for the access and creation of data out in the field by the loan officers.
With the officer having access to the MFIs data via smart phones, it will enable the individual
impact of a single officer to increase significantly. Higher efficiency makes each loan officer more
profitable than before, and the client willbe getting a quicker, more effectiveservice.
TheRightData
Each stakeholder has different needs that technology must address if its long term implementation
in the sector is going to be as successful as it has the potential to be. The Indian government and the
RBI will want to see sector transparency and accountability, enabling them to encourage the sector
to grow in a stable and sustainable way, especially after the Andhra Pradesh crisis. Commercial
banks and other lenders to MFIs will also want to see the sector as transparent as possible, but
these players are also concerned on profit so they would like to see the frequent creation of data
and report on the profitability of individual MFIs, and the sector as a whole. Microfinance
institutions and non-governmental organizations are going to want to know the financing costs of
the industry, to enable to become as efficient as possible in their operations. The right data will
allow for MFIs to grow sustainably, avoiding overspreading themselves or lending to risky clients.
Loan officers will harness technology to correctly identify clients, being able to check a client's
credit history, allowing the MFI to avoid incidents such as multiple lending or lending to those who
do not have the capability to repay the money. As mentioned before, loan officers will be able to
access and upload information while out in the field, decreasing their transaction time with clients,
meaning more can be met by one officer than was possible than before. Finally, clients such as SHGs
and individuals could harness technology to access the services provided by the MFIs to become
more readily available, with a wider number of financial products on offer. As there are usually two
or three MFIs operating in an area, potential clients for MFIs could compare the products offered by
different institutions, as well as other factorssuch as repayment terms and the interest rates.
ManagementInformationSystems (MIS)
A Management Information System (MIS) provides information that an organization requires to run
their operations effectively and efficiently. We see the first step in a more technology based
industry as getting MIS into as many MFIs as possible. There are three core systems that all MFIs
would benefit from using: an accounting system which would allow the MFI to track and manage
their financials; a portfolio management tool for all transactions made; and a deposit tracking tool

24. 24
(but this is rarely offered by MFIs). A MIS will allow for management reports to be created much
quicker than was possible than before, for decisions to be made with more accuracy, and for data to
be readily available to anyone who needs it, whether they are out in the field or in the office.
Many MFIs are still reliant on basic tools for their data management such as Microsoft Excel, or are
even up-keeping their records using a pen and paper approach. For smaller firms this may still be a
cost effective method for them to use, but many MFIs will have surpassed the point in which
analyzing data and creating reports by hand is efficient. Before implementing an MIS, an MFI has to
ask itself some questions to see if they are ready to make the investment, such as: ‘What are the
projected returns of investing in this software?’; ‘How much would the initial investment cost, and
what fees would be incurred later down the line?’; What benefits would the MFI gain from MIS
technology,or could they functioneffectively withoutit?’.
CostsAssociatedwithMIS
After making the decision on whether to implement MIS or not, the MFI will then need to decide on
how it will acquire the technology; do they buy, build, modify or rent? For an MFI to buy MIS
technology, this will allow them to implement the technology at a relatively low cost and fairly
quickly, but it will mean that they are dependent on outside support, as well as struggling to find a
package that caters to their individual needs. If an existing product does not meet the requirements
of the MFI then there is the option to modify a current package on offer, using the MIS package as a
base to develop it exactly how the MFI would like it. This obviously would be more expensive in
time and money, but the MFI would gain more benefit from the software than if it was left as the
standard package. If an MFI is willing to spend the time and money modifying a current software
package, then they could consider building their own custom package from scratch, developing it
based on the exact functioning of their procedures. This would be the most expensive and time
costly option for the MFI as they would need an in-house team to build and upkeep the system, but
has the added benefit of not being reliant on outside help, and being fully flexible on the running of
the software. The common rule is that if a current package is available that caters for over 75% of
the MFIs needs, and then it would be sensible to acquire that instead of building their own package.
However for many MFIs coming up with the upfront cost is just not possible, which leads to the last
and most plausible options for firms, renting. Many MIS providers allow the renting of their
product, with firms either paying a fixed fee per month, or signing up to a pay-per-use system. They
allow the software to be downloaded on to the MFIs computers and smart phones, with tech
support and softwareupdates all included in the renting fee.

25. 25
Even with renting many smaller firms may not have the spare resources to afford this, or the MIS
technology offered to buy or rent may not be suitable for some firms. For this to become more
affordable and accessible there needs to be a reduction in the cost of the software for MFIs. For
medium sized firms, who unlike smaller firms would benefit more from the implementation of a
Management Information System, yet unlike larger MFIs may not have the finances to fully invest in
a system could be given financial aid towards acquiring a system of their own. This could be
through subsidization from government, or for the creators of the MIS to make their product
cheaper and more easily customizable.
Creationofa ClientDatabase
After a broad uptake in technology and the implementation of MIS in MFIs, we suggest that a client
database is created. The database will be there to solve many of the issues and risks that are faced
by agents in the microfinance sector, and it will store all the information on the recipients of the
products from MFIs, specifically microcredit. The database would contain the clients name, birth
date, place of residence, credit history, and a history of their past and current borrowings, current
profession, skills, performance of the sector of employment, allowing a credit rating to be given.
According to a 2011 report on the microfinance sector, credit history is the biggest danger facing
the sector, with regions including India that once boasted a close to 100% repayment record, now
observing increasing delinquency rates, much of this down to multiple lending. From a clients
perspective multiple borrowing increases stress from attempting to meet multiple repayment
schedules, as meeting two or more schedules increases the risk of defaulting. With increasing
default rates some areas are facing a drying up of credit due to MFIs acknowledging the increasing
risks. We feel if steps are taken, such as the creation of this database, will help reinstall some
confidenceback into the sector.
When the client, current or future, is receiving a service from an MFI, as well as their personal and
financial details being taken, there will also be biometric information taken such as an iris scan.
Such information will be used to ensure the client is who they say they are, and then allow for their
information to be cross checked on the common database to see if they have any other outstanding
loans with an MFI, and to check their past credit history. With the right investment in technology,
the loan officer will be able to do this out in the field using their smart phones internet capabilities
to access the databases. They will also be able to utilize the capability of technology to create a
repayment plan and loan forms forthe client.

26. 26
ClientDatabaseIncentives
Many western MFIs, who have a higher technological presence than their Indian equivalents, when
surveyed were least concerned with sharing their data with a credit bureau, but we see this as the
key procedure for greater MFI success in India, helping bring about a reduction in the multiple
lending issue. Therefore to make the database system as effective as possible, incentives would
need to be created for MFIs to give up their current and future data, as although the system as a
whole would benefit, on an individual level firms are always wary of sharing their data. To
encourage MFIs to comply they would not be allowed to benefit from the database if they have not
contributed towards it. With the significant potential benefits to the MFI, this should be incentive
enough join the system and contribute towards it. Clients would also have to agree to their
information being shared with a third party agency. Policy would have to be created where MFIs
are not allowed to give out loans without potential clients allowing their details to be cross
referenced on the database. Getting MFIs to agree to this policy would not be too hard, as it would
be in their favorto ensure they are not lending to a multiple borrower.
The use of a client database, alongside the uptake of MIS by MFIs, will allow the workers out in the
field to use their smart phones to access data, speeding up the time of meeting a client, allowing the
loan officer to visit more clients in a day than was possible before. The use of this technology will
allow for a greater reach of each individual MFI, giving out more loan than were available before,
but in the knowledge that they are lending to more creditworthy clients.
IncreasedNeedof Capital andMFI creditratings
With an increase in loans granted by MFIs comes with the greater need for capital by the MFIs, but
as they currently cannot take deposits, they are always needing new ways to raise it. We suggest
with a combination of a slight re-regulation, the implementation of an MFI data and the creation of
an independent credit bureau, there could be a better flow of funds to MFIs. The database would be
similar to that suggested for the client database, with the recording of information about all MFIs in
India, such as aforementioned MicroRate. Categories of data that would be recorded would include:
the current size of the MFI’s portfolio, their outreach in the area; their client default track record;
age of the institution; and social indicator . From the data collected a credit rating would be given
by the independent credit bureau such as MicroRate.
Currently under RBI regulations, commercial banks have to set 40% of their lending portfolio to
priority sector areas, with 18% guaranteed to go to agriculture. We suggest a guaranteed lending
scheme also be implemented for MFIs, whereby a certain percentage of the commercial banks
lending portfolio is set for MFIs. Banks can use the credit bureau ratings and the database to choose

27. 27
where they would like to lend, making them feel more comfortable in an unregulated market. It will
allow them to lend with more confidence, to MFIs whose clientele is suited towards the banks aims
and preferences.
Commercial banks are already lending to the types of client the MFIs are currently dealing with, so
if the bank is able to lend to the MFI, they are decreasing the amount of work that needs to be
completed to find the borrowers to lend to. Lending to the MFIs instead, will allow the money to be
lent and recycled more efficiently, as the MFI should know the local area better than the larger bank
does. Success has already been seen from CIBIL that is operating a credit bureau for consumer,
retail, and mortgage check and fraud prevention. The credit bureau should allow for faster credit
and on better terms for the MFI.
Conclusionand Suggestions
To summarize, we feel that getting MIS into MFIs is essential for the continuation and successful
spread of microfinance, whether through subsidies or a reduction in the cost of installing such
software. Next, this system should be linked to a client credit bureau, an essential tool in the fight
against multiple lending and creating the opportunity to lend to even more credit worthy clients
than was possible before. To develop this idea in the further, credit bureaus would need data from
all types of institutions that offer microfinance services if it is to have a coherent database.
Currently, MFIs only capture a small section of the rural finance sector. Although there is a shift
towards more MFI borrowing, the Self Help Group Bank Linkage Program (SBLPs) continues to
dominate the market.
As well as a MFI client database, the creation of an MFI database will be highly beneficial for the
sector because it would provide better transparency and comparability within the entire sector.
This database would offer the same ratings found on MicroRate.com: microfinance institution
ratings, credit ratings and social ratings. Since a reputable third party would be conducting these
ratings, it would be an easier way to compare MFIs. Commercial banks can then use this
information to make accurate judgments to decide which MFIs they would like to lend to. This
would be even more essential if there was a regulatory change, in which commercial banks were
forced to lend a certain percentage of their portfolio under the premise of Priority Sector lending.
Borrowers wouldalso be able to use this database to choosethe MFI that suits their needs.

28. 28
Microfinance has already had a positive impact on many millions of people around the world,
changing the lives those living in poverty by offering them access to financial services, something
that was once seen as impossible. Despite the problems the microfinance sector in India faces, the
movement is still a cause for good and needs to be continued and expanded to reach as many of
those who would benefit from it. As discussed in this report, technology has a huge role to play in
the near future in aiding the development and spread of microfinance in India, but for this to be as
successful as possible encouragement may need to be given from the Indian government or the RBI.

29. 29
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