Microfinance Business Model
“Microfinance” is often defined as financial services for poor and low-income clients. In practice, the term is often used more narrowly to refer to loans and other services from providers that identify themselves as “microfinance institutions” (MFIs). These institutions commonly tend to use new Business Models developed over the last 30 years to deliver very small loans to unsalaried borrowers, taking little or no collateral. These methods include group lending and liability, pre-loan savings requirements, gradually increasing loan sizes, and an implicit guarantee of ready access to future loans if present loans are repaid fully and promptly.
Inception if MFIs
MFI came into existence when the lack of access to credit for the poor is attributable to practical difficulties arising from the discrepancy between the mode of operation followed by financial institutions and the economic characteristics and financing needs of low-income households. For example, commercial lending institutions require that borrowers have a stable source of income out of which principal and interest can be paid back according to the agreed terms. However, the income of many self employed households is not stable, regardless of its size. A large number of small loans are needed to serve the poor, but lenders prefer dealing with large loans in small numbers to minimize administration costs. They also look for collateral with a clear title – which many low-income households do not have. In addition bankers tend to consider low income households a bad risk imposing exceedingly high information monitoring costs on operation.
MicroCredit which is an integral part of Microfinance, is the extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit.
Business Model for getting financially viable
Over the last ten years, however, successful experiences in providing finance to small entrepreneur and producers demonstrate that poor people, when given access to responsive and timely financial services at market rates, repay their loans and use the proceeds to increase their income and assets. This is not surprising since the only realistic alternative for them is to borrow from informal market at an interest much higher than market rates. Community banks, NGOs and grassroot savings and credit groups around the world have shown that these microenterprise loans can be profitable for borrowers and for the lenders, making microfinance one of the most effective poverty reducing strategies.
To the extent that microfinance institutions become financially viable, self sustaining, and integral to the communities in which they operate, they have the potential to attract more resources and expand services to clients. Despite the success of microfinance institutions, only about 2% of world’s roughly 500 million small entrepreneur is estimated to have access to financial services.
The Grameen Bank which is a synonym for MicroFinance, makes small loans to the impoverished without requiring collateral. Established in 1976, the Grameen Bank (GB) has over 1000 branches (a branch covers 25-30 villages, around 240 groups and 1200 borrowers) in every province of Bangladesh, borrowing groups in 28,000 villages, 12 lakh borrowers with over 90% being women. It has an annual growth rate of 20% in terms of its borrowers. The most important feature is the recovery rate of loans, which is as high as 98%. A still more interesting feature is the ingenious manner of advancing credit without any “collateral security”. The Grameen Bank lending system is simple but effective. The system of this bank is based on the idea that the poor have skills that are under-utilized. A group-based credit approach is applied which utilizes the peer-pressure within the group to ensure the borrowers follow through and use caution in conducting their financial affairs with strict discipline, ensuring repayment eventually and allowing the borrowers to develop good credit standing.
The Business Model on which most of the Microfinance works is solidarity lending. Solidarity lending is a lending practice where small groups borrow collectively and group members encourage one another to repay. It is an important building block of microfinance. Solidarity lending lowers the costs to a financial institution related to assessing, managing and collecting loans, and can eliminate the need for collateral.
An early pioneer of solidarity lending, Dr. Muhammad Yunus of Grameen Bank in Bangladesh describes the dynamics of lending through solidarity groups this way:
“… Group membership not only creates support and protection but also smooths out the erratic behavior patterns of individual members, making each borrower more reliable in the process. Subtle and at times not-so-subtle peer pressure keeps each group member in line with the broader objectives of the credit program…. Because the group approves the loan request of each member, the group assumes moral responsibility for the loan. If any member of the group gets into trouble, the group usually comes forward to help.”
The above cited Model helps in minimizing the delinquency rate. The source of income for most of the Microfinance Institutions (MFIs) are the high rate of interest they charge to the borrowers, The real average portfolio yield cited by the a sample of 704 microfinance institutions that voluntarily submitted reports to the MicroBanking Bulletin in 2006 was 22.3% annually. Microfinance institutions can broaden their resource base by mobilizing savings, accessing capital markets, loan funds and effective institutional development support. A logical way to tap capital market is securitization through a corporation that purchases loans made by microenterprise institutions with the funds raised through the bonds issuance on the capital market. There
is atleast one pilot attempt to securitize microfinance portfolio along these lines in Ecuador. As an alternative, BancoSol of Bolivia issued a certificate of deposit which are traded in Bolivian stock exchange. In 1994, it also issued certificates of deposit in the U.S. (Churchill 1996). The Foundation for Cooperation and Development of Paraguay issued bonds to raise capital for microenterprise lending (Grameen Trust 1995). Successfull MFIs like Grameen Bank even generate revenue by providing training programs / research programs to journalists or upcoming MFIs.
Another kind of MFI in India is indigenously developed system known as Chit funds; they are the closest thing to a bank in many parts of India. They mobilize huge amounts of small savings and offer the same as some sort of microfinance. Properly used chit funds are an effective tool to meet unplanned, unforeseen and unexpected expenses, especially for the middle class and small businessmen. Chit fund is a dual-purpose instrument for both borrowing and saving. It has no financial intermediation. Each chit group is in a way a self-help group. Members invest a fixed amount every month. This collection is available for borrowing. Auctions are conducted every month. The members who bid for the highest discount win. The dividend at every auction is distributed to the subscribers out of the discount (the difference between the chit amount and the amount bid), after deducting the group foreman’s commission. Shriram Chits has more than 22 lakh subscribers.
Proposed Model for MFIs
If we consider the fact that MFIs role is to lend loan to impoverished sector of the society so that they raise their living standards and can provide a stable lifestyle to their families, which can be possible only when a group of member can come up with an business idea. But how successful the entity is going to be after its formation and will result in timely repayment of the loan cannot be guaranteed. I personally feel, instead of letting the inexperienced group to decide upon the venture all the time, MFIs or NGO’s should set up ventures which can be either be an subsidiary of existing stable company or something which can traded outside the community, guaranteeing the flow of funds. This will bring an stable or regular source of income for many households without the worries of loan. The reason behind this though is the criticism behind the Microcredit institutions. Some experts argues that most microcredit institutions are overly dependent on external capital. A study of microcredit institutions in Bolivia in 2003, for example, found that they were very slow to deliver quality microsavings services because of easy access to cheaper forms of external capital.Global data tables from The Microbanking Bulletin show that savings represent a small source of funds for microcredit institutions in most developing nations.
Because field officers are in a position of power locally and are judged on repayment rates as the primary metric of their success, they sometimes use coercive and even violent tactics to collect installments on the microcredit loans. Some loan recipients sink into a cycle of debt, using a microcredit loan from one organization to meet interest obligations from another.
Recent move by indian govt to repay the loan taken by the farmers of certain segment is the result of delinquency. To avoid such incidences again, its better to invest in upbringing of this segment by bringing an regular source of income to the households.
The need for Technology
Technology in Microfinance will not only help in retrieving the data for deserving borrowers but can also help in tracking the flow of funds. Theoretically, microfinance may encompass any efforts to increase access to, or improve the quality of, financial services poor people currently use or could benefit from using. For example, poor people borrow from informal moneylenders and save with informal collectors. They receive loans and grants from charities. They buy insurance from state-owned companies. They receive funds transfers through remittance networks (like Hawala). Technology can help monitoring and improving the accessibility of funds to the deserving section of the society and at the same time can help Microfinance institutions to measure and disclose their performance both financially and socially to the government.
On the lines of corebanking solutions, all MFIs in a country can be interlinked to each other through network which will ultimately help govt. organization to follow the flow of source of funds. This in other way can help in AML.
Proper Consulting can help MFI’s or NGO’s to decide upon the right industry which can be established to an particular location. Taking a place like vidarbha into account, which lacks in proper irrigation facilities, can be best judged to be the right place for an power sector company to establish an solar power system. This will be financially much viable then lending loans to struggling families of farmers who end-up in repaying their existing loans.
Some valuable lessons can be drawn from the experience of Microfinance operation.
First of all, the poor repay their loans and are willing to pay for higher interest rates than commercial banks provided that the venture they decide to start from the loan executes successfully.
Technology should be used for proper streamlining the flow of funds and at the same time creating a transparent business model for the MFIs.
Consultancies should be used to decide if establishing a large scale industry is better for providing stability to target segment.
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