INTERNATIONAL FINANCIAL

MANAGEMENT
Prof. Mihir Desai
Term Paper

“Sustainability of Microfinance”
Key Issues driving the paper
™ Is there a need for microfinance in poverty alleviation?
™ Is microfinance sustainable?
™ What is the role of international and country level Institutions in microfinance?
™ An examination of microfinance in one country (India) - challenges and
recommendations

• Rajat Verma - HUID:10593298

• Justin Lemmon - HUID: 70613190
• Sumeet Narang - HUID:20605294

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TABLE OF CONTENTS
INTRODUCTION TO MICROFINANCE ................................................ 3
What is Microfinance? ................................................................................................. 4
History of Microfinance ............................................................................................... 4
Birth of Microfinance.................................................................................................. 4
Current State............................................................................................................... 4
How does Microfinance work? .................................................................................... 5
Key concepts in Microfinance...................................................................................... 5
Group formation ......................................................................................................... 5
Shortened loan cycle ................................................................................................... 5
Gender preference ...................................................................................................... 5
IS MICROFINANCE SUSTAINABLE?.................................................... 6
Microfinance Products: ................................................................................................ 6
Savings & Loans ......................................................................................................... 6
MicroInsurance........................................................................................................... 6
Key issues in sustainability........................................................................................... 7
What makes MFI sustainable?.................................................................................... 8
Microfinance as an asset class.................................................................................... 10
Microfinance Debt .................................................................................................... 12
Microfinance Equity.................................................................................................. 13
Foreign Exchange Risk in Microfinance................................................................... 14
ROLE OF DIFFERENT INSTITUTIONS IN MICROFINANCE ....... 16
Role of Multilateral Development Banks.................................................................. 16
Role of State................................................................................................................. 16
Role of Central Bank .................................................................................................. 18
CASE STUDY: INDIA ............................................................................... 18
Microfinance in India – Need..................................................................................... 18
Potential Microfinance Size and Impact in India .................................................... 18
Value Chain of Indian MF Industry.......................................................................... 19
Vision of Microfinance going forward:..................................................................... 20
Lessons from Microfinance in other South Asian Nations...................................... 20
Synthesizing Key Success Factors in Microfinance ................................................. 21
Key Challenges facing Microfinance Industry in India & Recommendations ..... 21
CONCLUSION ........................................................................................... 24
Evidence of Poverty reduction through microfinance............................................. 24
Lessons learnt .............................................................................................................. 24
EXHIBITS ................................................................................................... 25
REFERENCES............................................................................................ 32
Primary Research ....................................................................................................... 32
Secondary Research.................................................................................................... 32

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INTRODUCTION TO MICROFINANCE

Almost three billion people, approximately half the world’s population, survive on less than two
dollars a day1. As Mahatma Gandhi once said, “poverty is the worst form of violence.” Helping
the less fortunate has always been a common subject, especially for wealthy governments and
individuals, but little action beyond short-term handouts has been witnessed. The wealthy world
now faces a poignant juncture- to help or not to help. It may sound simple, but the time is now.
The wealthy populations of the world are becoming ever more connected and interlinked, and the
speed at which change is occurring is unprecedented. Globalization has created vast networks of
markets and communications, with diverse populations coexisting both physically and virtually.
The wealthy world must make a conscious decision right now whether to enable the impoverished
to participate in the global network or whether to further isolate them from it, which may lead to
substantial devastation. As a result, poverty is not a poor problem anymore; poverty is now a
world problem.

The efforts to connect the poor will not be easy. Such a monumental feat requires great
thoughtfulness, execution and perseverance. Such an effort also demands supreme cooperation
and understanding from all governments and institutions. If the decision is made not to connect
the poor, however, history may continue to remind civilization that a policy of poverty isolation
will not work. For example, Africa has witnessed astounding neglect regarding any concerted
effort to alleviate its overwhelming poverty, so it is not surprising to see most African countries
fall in the bottom fifteen percent of the per capita GDP rankings of 232 countries2. However, two
of the worst viruses in contemporary times, HIV and Ebola, both originated in Africa. Since
1981, twenty-five million people have died of AIDS3. Of the 6.5 million people in developing
and transitional countries that need critical AIDS drugs, only one million are receiving any4. And
though Ebola has been contained for now, the virus killed seventy-seven percent of the people
that contracted it, which is an alarming fatality rate5. Outside of this natural violence, the last
decade has witnessed an increase in large-scale terrorist attacks. Coincidentally, States such as
Yemen and Afghanistan, countries where two significant terrorist acts originated, are listed as
216 and 221 on the per capita GDP list of 232 countries6. Such statistics do not promote
continuing the policy of isolation and short-term solutions for poverty reduction. History has
clearly illustrated that, even though theoretically isolated from the network of wealthy nations,
indirect violence through nature and direct violence through terrorist attacks can penetrate the
wealthy network with devastating effects. These effects, and the speed at which the effects
disperse, will only compound in the future as the wealth nations become increasingly connected
through more advanced physical and virtual networks. Therefore, something must be done to
reverse, or at least temper, the negative effects of global poverty. The task of decreasing the
global poverty rate will require a number of initiatives, and the financial innovation of
microfinance is showing potential as one tool to assist in combating global poverty.

1
Unitus website
2
CIA Factbook (2005) webpage
3
Avert.org website
4
Avert.org website
5
Ebola FAQ website
6
CIA Factbook (2005) webpage

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What is Microfinance?

Part of the answer to global poverty reduction may exist in the concept known as microfinance.
Microfinance is the category of financial services offered to lower-income people, where the unit
size of the transaction is usually small (“micro”), typically lower than the average GDP per
capita, although the exact definition varies by country. In its most basic form, these financial
services include small loans, insurance and savings.

History of Microfinance

Birth of Microfinance

Though microfinance has gained more attention in recent years as an innovative financial
mechanism for the poor, its early roots can be traced back more than thirty years. In 1961, a
group of volunteers established an organization, the “ACCIONistas,” in Venezuela to assist in
community development. Through their efforts, many sewer lines, electrical lines, and schools
were built. At the same time thousands of rural workers were migrating to the cities each year in
search of industrial employment and better wages. However, once there, the employment
situation was difficult so many workers started their own small entrepreneurial businesses such as
belt weaving and potato sales. ACCION leaders observed the informal businesses budding in
many areas.. Though capital was available, the entrepreneurs had to borrow from local loan
sharks with high interest rates, as high as ten percent a day. Therefore most of the businesses
failed to grow because their profits went to interest payments. ACCION staff in Recife, Brazil
wondered if these business owners might be able to thrive and pull themselves out of poverty
through profitability with loans at commercial rates7. The project, termed “micro enterprise,”
started issuing loans and found a new way to generate prosperity among the poor. Hence,
microfinance was borne.

Microfinance practices were initiated in the 1970’s. Innovators saw a dire need for loan-type
markets in impoverished localities and created microfinance institutions (MFIs) that issued loans
at reasonable interest rates to poor women, often with no collateral. The initial results illustrated
that borrowers expanded their businesses and also demonstrated a high repayment rate. In
essence, the results disproved the common notion that the working poor could not alter their lives
if given the opportunity.

Current State

After nearly three decades, MFIs now serve over 80 million poor people in developing countries
with over seven billion dollars disbursed in micro credit loans. The loans are now generated from
credit unions, commercial banks and non-governmental organizations (NGOs). The historical
repayment rates average over ninety-five percent. Microfinance products such as small
microcredit loans, savings accounts, and health insurance provide possible vehicles to assist the
poor in emerging from poverty. This type of system has helped millions of people around the
globe raise their living standards and provide opportunity for a more financially secure life.

7
Accion website

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How does Microfinance work?

The traditional banking system demands that a borrower prove collateral in order to receive a
loan. However, the world’s poorest people have no collateral to secure the loan. Also, banks
prefer to issue large loans to minimize transaction costs, so these institutions are not typically
interested in disbursing fifty to one-hundred dollar loans. As a method to overcome these
challenges, microfinance institutions rely on social collateral and shorter loan cycles.

Key concepts in Microfinance

Group formation

Self Help Groups (SHGs) form the basic constituent unit of the microfinance movement. A SHG
is a group of a few individuals (five to twenty, usually from different families) – usually poor and
often women – who pool their savings into a fund from which they can borrow as and when
necessary. Such a group is linked with a MFI / bank – a rural, co-operative or commercial bank–
where they maintain a group account. Over time the bank begins to lend to the group as a unit,
without collateral, relying on self-monitoring and peer-pressure within the group for repayment of
these loans. The maximum loan amount is a multiple (usually 4:1) of the total funds in the group
account.

Shortened loan cycle

Another method to help facilitate lending under such circumstances is to reduce the loan cycle
and increase the payment periods. The shorter loan cycles and regular payment plans help
borrowers stay current with their loan and reduce the risk of default. This model does demand
higher transaction costs, particularly associated with the inefficiencies of collection. Therefore
MFIs charge interest rates of thirty to seventy percent, which appear high, but these rates are
significantly lower than the alternatives of 300 to 3,000 percent annual rates (nominal)8.

Gender preference

The current microfinance model focuses on administering loans to women. Women also are
usually the primary beneficiaries of loans because they are the primary caretakers of the family.
Historical evidence has shown that women are much more likely to distribute any economic
benefits to the family so that the benefits accrue to the children, as well. Another contributing
factor in the decision is that often men are off working away from the village seeking more
lucrative opportunities so the additional income from the woman’s earnings creates greater
possibilities for overcoming poverty.

8
Unitus website

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The next section will address the issue of sustainability of microfinance.

IS MICROFINANCE SUSTAINABLE?

Market demand for microfinance services is estimated at more than US$300 billion, while market
supply is just US$4 billion. Fewer than 18% of the world’s poorest households have access to
financial services. (Exhibit 1) Despite the important and catalytic role played by the international
donor community 9in promoting microfinance, it has invested only $1.2 billion. Domestic financing
represents the primary source of financing for microfinance.

In a number of countries, commercial banks have been compelled by their governments to

provide financial services, especially credit, to sectors such as small or agricultural enterprises
that are considered social priorities. Using moral or legal compulsion generally has not led to
sustainable models of giving finance to the poor. Hence, it is imperative to make microfinance
initiative a commercial success, so as to make it sustainable.

To understand sustainability of microfinance,

• We need to focus on the products and profitability of microfinance institutes.
• We need to understand the risk-return expectations of microfinance investors

Microfinance Products:

Savings & Loans

MFIs key product offering is savings & loans. Today, MFIs have approx. 100-120 million in
individual savings and loan accounts (Exhibit 2). On an aggregate basis, savings accounts in
MFIs outnumber loans by about four to one. In its first two decades, the microfinance
“movement” focused more heavily on loans than on savings, for three main reasons:
• The poor were not thought of as having much money to save.
• New credit techniques, not new savings techniques, launched the movement.
• Most of the institutions involved were NGOs, which were not legally licensed to collect
savings.

However, in recent years there has been an increasing recognition that most poor families do
save, and that this saving is usually in non-financial form (for instance, stockpiling goods). This is
not because the poor prefer non-financial savings, but because they often lack access to good
formal savings facilities.

MicroInsurance

There has been increased attention at the World Bank regarding the relationship between poverty,
risk and efforts to manage risk. This focus on risk is evidenced by the social risk management
framework that is the foundation of the Social Protection Unit’s Sectoral Strategy Paper (World

9
The term “international donor community” refers to below-market rate public and private financing from international
sources. This includes bi-lateral and multi-lateral donors (such as the United States Agency for Int’l Development and
the World Bank, respectively), foundations, networks, MFI partner institutions (such as GF-USA), and other
international funds offering financing at below market rates.

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Bank, 2001). The “social risk management” (SRM) approach concerns itself with how, and with
what instruments, society manages risks.

Microinsurance as a Social Risk Management tool

It is believed that Microinsurance (MI) can:

• reduce the negative impact of risky events on client’s ability to repay loans and serve as a
collateral substitute, thereby helping existing clients and expanding coverage to riskier clients
• Provide an additional financial service and source of revenue for the MFI

With the above mentioned benefits, MI as a product can be a powerful add-on offering with
savings and loan and thus improve the financial sustainability of a MFI.

Key issues in sustainability

Subsidy

Many MFIs do not generate enough revenue from clients to cover the costs of delivering their
financial services. Some people consider this acceptable because of the social mission of these
institutions. This point of view might be less problematic if one assumed that there are enough
subsidies available from governments and donors to provide financial access to all poor and near-
poor households, and that long-term continuance of these subsidies is assured. Obviously,
institutions that do not cover their costs will de-capitalize themselves and disappear unless
governments or donors continue to pump in subsidies. But even where such subsidies are
available, they are almost never large enough to meet more than a fraction of demand.

Competency or Political Interference

One of the biggest challenges to financial sustainability lies in the fact that most government-
owned MFIs, and some private institutions as well, do not know how to make and collect small,
uncollateralized loans well enough to avoid unsustainable levels of default. In more than a few
cases, the problem goes beyond simple ignorance of proper lending techniques: blanket
forgiveness of loans made by government MFIs is sometimes used for political purposes.

Apart from a few remarkable success cases, available data indicates that only 1 percent10 of
existing MFIs worldwide are financially stable. Perhaps the most striking aspect of the Grameen
experience has been its excellent repayment record, in sharp contrast with the experience of most
government development finance institutions.

Operating Costs

Like Grameen, several other MFIs have been quite successful at keeping loan losses small. In
most cases, however, low rates of borrower default combined with high lending rates have not
translated into profitability or even the ability to cover costs. The small scale of the loans and the
cost of reaching out to clients increase operational expenses, which absorb most of the interest
margins. Even among the most efficient MFIs, operational expenses are of the order of 15-20
percent of loans, compared to less than 5 percent for banks operating in developing countries.

10
Source: The microfinance exchange <www.themix.org>

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What makes MFI sustainable?

MFIs that have become financially self-sustainable tend to be larger and relatively more efficient.
The experience suggests that, by becoming larger, some MFIs have been able to lower their
operating expenses relative to the size of their loan portfolios.

For instance, in a sample of 124 MFIs striving for financial self-sufficiency in 2003, those
achieving the objective (roughly half of the sample) were more than two times larger than the
average, but operated a similar number of offices

Table A
Selected Indicators for a Sample of Microfinance Institutions, July 200311

(In percent, unless otherwise indicated) Financial Self-

All Sustainable
MFIs MFIs
Institutional Characteristics
Age (years) 8 10
Average Assets (million US$) 7.9 14.5*
Institutions (number) 124 66
Offices (number) 19 17
Financing Structure
Capital/Asset Ratio 42.7 40.4
Commercial Funding Liabilities Ratio12 44.1 76.0*
Deposits to Total Assets 12.3 16.4
Gross Loan Portfolio/Total Assets 70.9 73.1
Outreach Indicators
Active Borrowers (number) 15553 22841
Percent of Women Borrowers 62.9 61.9
Average Loan Balance per Borrower (US$) 532 621
Average Loan Balance per Borrower/GNP per capita 54.3 66.4
Voluntary Savers (number) 3345 6019
Average Savings Balance per Saver (US$) 269 258
Financial Indicators
Return on Assets 0.1 5.7*
Return on Equity 2.3 14.6*
Profit Margin13 0.3 19.4*
Operating Expense/Loan Portfolio 29.4 22.2*
NPLs (Overdue >30 days) to Gross Loans 2.8 2.5
NPLs (Overdue>90 days) to Gross Loans 1.5 1.5
Source: MicroBanking Bulleting, July 2003.

11
The sample of MFIs comes from the MicroBanking Bulletin. It is obtained by voluntary participation of
MFIs worldwide, and therefore vulnerable to self-selection bias. Participating MFIs are benchmarked, and
the information may be used by investors, donors and other service providers. A more detailed description
can be found at http://ww.mixmbb.org.
12
All liabilities with “market” prices in percent of average gross loans.
13
Net operating income/financial revenue

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Arguably, the increase in size facilitates a reduction in operating and personnel expenses per
dollar lent, which increases profitability. In addition, self-sustainable MFIs tend to reach a larger
number of borrowers and rely more heavily on deposits and other commercial sources of funding.
In other aspects, financially self-sustainable MFIs are similar to the industry average, including
with respect to loan quality, average yields on gross loans, and capitalization ratios.

Problem with the commercial approach

MFIs striving to become commercially viable do not target the very poor. MFIs aiming at
commercial viability tend to lend to individuals around the poverty line or slightly above it, thus
they do not reach the very poor. Targeting a relatively more affluent clientele (within poor) leads
to increases in loan sizes, and improved efficiency indicators. In contrast, most MFIs focusing on
the poorest of the poor remain dependent on donor funds. An open and contentious issue is
whether MFIs should focus more heavily on expanding their loan size in order to lessen
operational costs and attain financial independence, or remain focused on targeting poor
households and dependent on external subsidies.

Cases of a few commercially viable MFI s

While there are a many well-known success cases of MFIs growing from subsidized entities into
formal and profitable financial institutions, the majority of them remain dependent on external
funding. However, evidence shows that MFIs can become self-sustainable and profitable
improved by shielding them from excessive political interference and increasing their autonomy
in financial management, including freedom to choose their interest rates. Training and technical
assistance can also help improve the financial position of MFIs.

Few sustainable country examples are detailed below:

Case 1: In Bolivia, there are examples where increases in the outreach of MFIs have been
accompanied with the implementation of cost-effective financial intermediation techniques. The
most notable example is BancoSol, a commercial bank that focuses on microcredit in urban areas
which has been able to keep very low levels of arrears and achieve full independence from
subsidies. It now has the largest outreach among MFIs in Latin America, with roughly 60,000
clients (half of the microfinance market in Bolivia), and continues growing by internal revenue
generation.

Case 2: In Ghana, weaknesses in financial performance among S&Ls (savings and loans) and
credit unions engaged in microfinance were accompanied by a welfare focus and policies of low
interest rates. In recent years, the combination of a more commercial approach, sector
restructuring through re-capitalization and capacity building, and better regulation, have
contributed to reducing the proportion of distressed institutions. From 1996 to 2001, the
proportion of “unsatisfactory” credit unions declined from 70 percent to 60 percent and that of
those in the worst categories from 42 percent to 15 percent. The improvement in performance
indicators has been driven by the development of innovative microfinance practices, stronger
linkages between various actors of the sector, and a flexible regulatory and supervisory system.

Case 3: In The Philippines, substantial progress in commercialization trends in the microfinance

industry appears to be underway. After the formal recognition of microfinance by the government
in 1997, ongoing initiatives and donor-supported programs have encouraged the expansion of
microfinance outreach to the poor. Substantial progress has been attained, with the largest MFIs
considered now to be on a sound and commercially viable footing. Largely due to training and

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technical assistance provided by donors, rural banks are increasingly adapting their services to tap
the microfinance market.

Given that microfinance can be sustainable, a case can be made about Microfinance being an
asset class. This is important in order to draw more capital from the worldwide investor
community. The following section builds arguments about microfinance as an asset class.

Microfinance as an asset class

Today, MFIs can be categorized into multiple different segments. There are thousands of
microfinance programs worldwide and approximately 250 sustainable/commercial micro-banks.

Tier 1: Solid, well managed,

profitable, fast growing MFI
(1-2% of all MFIs)

Tier 2: Promising,
transforming, growing MFI
(25-30% of all MFIs)

Tier 3: Startup, NGO, small

scale, niche player MFI
(65-70% of all MFIs)

Source: The microfinance exchange <www.themix.org>

The financial success of Tier 1 institutions in particular, as measured by return on equity and
return on assets, has attracted the attention of several investors recently.

Competitive return: The leaders in micro-banks have had a strong track record (Exhibit 3). They
can be characterized by the following attributes:

• Excellent track-record over past 10 to 15 years

• Solid profitability
• Very fast growth
• Low portfolio at risk (average default rates of 3%), excellent diversification
• Products and services range adapted to client needs
• Low D/E ratios, high solvency
• Very good MIS systems and reporting capabilities
• Solid governance and high professionalism of boards and management
• Access to many commercial sources, no subsidies at all

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Consequently, Microfinance debt offers a better return than monetary instruments (an estimated
additional 150 to 200 basis points)14 with only a slightly higher level of risk. (See Exhibit 4 for
one such fund) It is an excellent alternative to fiduciary deposits or certificates of deposits.
Microfinance equity represents also an attractive longer term opportunity (ROE in the 20s is
usual)

Systematic risk: Low volatility - Microfinance offers a lower volatility than traditional equities or
bonds from emerging markets. It is materialized by instruments which are not yet quoted on stock
exchanges and its value is not influenced by hard to predict interest rates and credit spread
movements. Weak correlation - Microfinance is weakly correlated with political, economic15 or
even climatic events. The informal sector is by its very nature a thriving place of permanent
business creation, less directly linked to the fate of the formal economy. It is similarly weakly
correlated with global financial movements on the major market places.

Specific risk: High solvency - The leading microfinance institutions make for very solvent
institutions with low risk profile. Their main assets are loan portfolios of very high quality, as
demonstrated by their exemplary low default rate (3% on average), usually much better than
many traditional commercial banks. Strong diversification - Microfinance institutions have very
well diversified portfolios. Their own credit risk is spread over thousands of micro-borrowers,
evolving on markets with good growth prospects.

14
The Blue Orchard fund.
15
In the wake of the Asian financial crisis, Bank Rakyat Indonesia (BRI) was forced to write-off 100 percent of its
corporate portfolio and 50% of its middle market loans. On-time repayment in its microfinance portfolio of four million
borrowers, however, slid only one percent to 97.5%.

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Given the nature of this asset class, we compute the returns expected by equity and debt
investors:

Cost of Capital Analysis for a MFI

Despite lack of perfect data across diversified MFIs and a long term horizon, we have
attempted to capture the key risks and arrive at a cost of capital for a MFI with an efficient
scale. The final numbers for the cost of capital are in-line with return expectation of
commercial institutions, who are aggressively foraying into microfinance.

Key Inputs into CAPM

Beta for an MFI institution:

Despite to lack of quantitative data, one can make an approximation of a Beta for an MFI.
Since MFI’s business model is not highly sensitive to overall economy, (as MFI touches basic
human needs and not luxury needs) one can expect the beta to be anywhere between 0.3-0.5
– an average of 0.4.

30 year Rf ($) being approx. 5.5%1

MRP (US markets) being 7.2%

We can reasonably conclude that US$ Ra for an MFI is 5.5% + 0.4* 7.2% = 8.38%

Adding a sovereign risk of 3%-6% (average 4.5%), make $Ra approx. 12.88%

US $ Ra into Emerging market currency Ra (Interest rate parity)

As most MFIs are in current with volatile exchange rates, we need to convert $ Ra into
emerging market foreign currency (EMFC). Assuming, 30 year EMFC interest rates are
between 10% - 15% (average 12.5%), we can calculate EMFC Ra, using interest rate parity
(Ra EMFC = Ra $ * ((1+RfEMFC)/(1+Rf$))) = 12.88% *(1+12.5%)/ (1+6%) = 13.6%

Hence, local currency Ra is approx. 14.2% - since MFIs are leveraged between 15-30%
(Equity/ Total Capital) – this leads to an approx. of EMFC Rd of 12% and Re of 20%

These numbers seem consistent with what we saw in Table A about the ROE on
profitable MFIs.
Let us now look at Microfinance Debt and Equity in a little more detail.

Microfinance Debt

Over the last few years, a number of significant transactions have been closed that involve
microfinance institutions and the financial markets. Some of the more interesting examples
include: A $15 million bond issue by Compartamos in Mexico in 2002; a partnership between India’s
second largest bank, ICICI, and CASHPOR, operating in northern India in 2003; a $4.3 million
securitization of India-based SHARE’s loan portfolio, again with ICICI in early 2004; and a US$40
million bond issue by Blue Orchard Microfinance Securities I in the international capital
markets in July, 2004.

However, commercial interest in equity has been negligible. No doubt, the requirement for equity
financing required to grow microfinance is low compared to debt financing. But debt does not

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come without the equity. Not only is equity critical for a growing organization, but it also
becomes a key consideration for those microfinance institutions that are regulated, and thus often
required to meet minimum capital requirements and capital adequacy standards.16

Microfinance Equity

Expected Equity Returns

The lore of traditional venture capital is for every 10 investments, 1 at best will be homeruns
(returns in the 100%s), 2 to 3 will survive (with modest returns or their money back) and the rest
will fail – portfolio giving averaged annual returns of 20% over the last generation. In the case of
microfinance, it is possible to argue that business risk is much lower than in traditional venture
capital investments. As such, the success rate of investments should be much higher – not in
terms of return, but in terms of fewer failures. It is possible to envision a scenario where all of 10
MFI investments offer returns comparable to the venture capital industry average, or slightly
higher. Given that shareholder’s equity should represent a small percentage of overall MFI
financing, say no more than 10% to 15% (and arguably much less if the MFI is not taking
deposits), and recognizing the nature of MFI cash flows, such returns should be possible. There is
no evidence to support this assertion, however, as there are no purely commercial equity investors
in poverty-focused microfinance. Yet, a clear case, based on historical financial performance,
could be made to investors.

Exit options

The issue of exiting an investment is critical to equity investors. However, one can identity few
possible exit opportunities for investors: trade sale to a local or international commercial bank;
trade sale to another MFI; a private placement to a group of eligible shareholders; a public listing,
or flotation, of shares; or a public listing of the shares of the private equity funds that hold MFI
shares.

Recently, there had been a spurt of equity investments in this asset class by renowned investors17.

Despite potentially attractive returns, investors have talked about several risks associated with
Microfinance. (Exhibit 5) We will try to understand the impact of one critical risk, the foreign
exchange risk in the next section.

16
International capital adequacy standards, which influence local regulation, are expected to be revised to better align
capital requirements to risk. It is possible that microfinance with its small, uncollateralized loans, will be required to
offer a capital premium. In essence, it will have to raise 50% more equity capital than it would have previously to meet
the minimum capital adequacy target. See Tor Jansson, “Microfinance: From Village to Wall Street” for a more
extended discussion of the topic.
17
Legendary Venture Capitalist Vinod Khosla and Grameen Foundation Make $500,000 Microfinance Equity
Investment into Indian Microfinance Institution.
Pierre Omidyar, founder of eBay and co-founder of Omidyar Network with his wife, Pam, both graduates of Tufts, will
invest $100 million in international microfinance initiatives.

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Foreign Exchange Risk in Microfinance

By looking at MFIs across the globe, one recognizes that there are minimal hedging instruments
for emerging market currencies where MFIs operate. So how do you manage foreign currency
risks in microfinance without passing the buck to poor people?

Risk mitigants

• The creation of a microfinance investment fund capitalized with a combination of hard

currencies (e.g., US dollar, euros, and/or yen) and lending across a diversified basket of
emerging market currencies.
• Taking benefit of low correlation of emerging market bonds with US Treasury bonds.
• The emerging market local currency debt universe can offer investors lower risk than dollar
denominated emerging debt, but also high returns in an environment of rising emerging
currencies or generalized dollar weakness.
• Medium to long-term lending, tracking interest and exchange rate relationships, and
rebalancing the currency exposure in the portfolio could further mitigate unexpected events.
• Hedging through an intermediate currency which has a high correlation with the
emerging market currency. We will look at this in detail below:

Scenarios of a $1million loan to an emerging market MFI (in this case India)18

If options are not available in emerging market foreign currency, then find a currency with high-
correlation of returns (vis-à-vis US$) and hedge through the intermediate currency.
• First, the historical mean was calculated for the Indian rupee and British pound rate vis-à-vis
over the past 10 years.
• The correlations run between the two currencies, which serves as a good indicator of potential
currencies to utilizing hedging. The rupee – pound correlation of returns is 68.97%, a
significant correlation. But, a higher correlation (i.e. another currency) may be required
by investors for a preferred hedge.

Scenario 1: In the first scenario, an un-hedged investment, the model was simplified to yield
return in one year. The example shows if there is a 5% decrease in the value of the Indian rupee,
the one-year return is $1,045,000. This means that, un-hedged, if the rupee depreciated 5%, the
investor can expect reduced return of $55,000.

Scenario 2: reveals if the Indian rupee depreciated by 10% and so did the British pound, the
investor would be protected from the fluctuations and in fact, through hedging could expect
returns of $ 1,025,251 instead of $ 990,000 (a gain of $35,252).

18
Despite the fact the options are available on US$ - Indian Rupee; we have used this an illustration for other emerging
market currencies, which currency data for last 8-10 years is available

Page 14 of 32
Table B
Scenario Analysis:

Currency Historical Data

Year Rupee Rupee British pound British pound
BP Return (in
($/rp) Return (in%) Rate ($/BP) %)
1 Dec-95 0.0284 1.5496
2 Dec-96 0.0279 -1.76% 1.714 10.61%
3 Dec-97 0.0255 -8.60% 1.6451 -4.02%
4 Dec-98 0.0235 -7.84% 1.66 0.91%
5 Dec-99 0.023 -2.13% 1.6182 -2.52%
6 Dec-00 0.0214 -6.96% 1.4931 -7.73%
7 Dec-01 0.0207 -3.27% 1.4546 -2.58%
8 Dec-02 0.0208 0.48% 1.6101 10.69%
9 Dec-03 0.02189 5.24% 1.7705 9.96%
10 Dec-04 0.02289 4.57% 1.9221 8.56%
11 Dec-05 0.02168 -5.29% 1.7554 -8.67%
Historical Mean -2.56% 1.52%
Standard Deviations of Returns 4.87% 7.75%
Correlation between Indian rupee (IR) and British pound (BP) returns – 75.78%
Scenario 1: Investor's Unhedged U.S. Dollar Risk
Investment in US $ 1,100,000
Current Indian rupee rate 0.02168
Indian Rupee Volatility 4.87%
Return Price
Indian rupee -5% 0.0206
Revenue in one year (unhedged) $1,045,000 (in millions US$)
Scenario 2: Investor's Hedging Spreadsheet
Investment in US $ 1,100,000 in million IR
Strike Price of one-year British Pound put options 1.68
Cost per British pound put option 0.025 in US $
Number of British pound put options 1,100,000 in US $
Return Price
Indian rupee -10% 0.019512
British pound -10% 1.57986
Put Option Payoff 0.1001
Cost of Put Options 27500
based on typical costs of put options; does't reflect actual current put option costs for BP
Revenue in one year (unhedged) 990000
Revenue in one year (hedged) 1,025,252 1025251.51
Gain 35,252
NOTES: Currency exchange data from www.x-rates.com

To make microfinance sustainable and scalable, in addition to the aforementioned issues, it is

imperative to have efficient institutional and market mechanisms in place, both at an international
and country level. As microfinance becomes an integral part of mainstream financial sector, it
becomes increasingly important for multilateral institutions, state and central banks to play an
active and important role, in making microfinance a success.

Page 15 of 32
ROLE OF DIFFERENT INSTITUTIONS IN MICROFINANCE

Role of Multilateral Development Banks

MDBs provide finance for investments in human and physical capital that promote development.
These include the World Bank (WB) and the three regional development banks – the African
Development Bank (AfDB), Asian Development Bank (AsDB) and Inter-American Development
Bank (IADB). They are distinguished by their multilateral shareholding structure, preferred
creditor status and a subsidized capital base.

MFIs face a range of constraints, including: limited diversification of risks in client-base, limited
capacity coupled with high operating and administrative costs; low deposit mobilization; and
limited links to the formal banking system. The activities of MDBs should focus to address a
number of such constraints. They should include:
• attracting greater commercial investment and ensuring competition so as to provide
affordable and efficient service in the provision of microfinance;
• encouraging a more diverse range of MFIs and other financial entities to serve the variety of
financial needs of the poor;
• providing a suitable regulatory environment, while avoiding interference in the commercial
operation of MFIs.
• supplying appropriate training to both MFI and government/central bank officials;
• contributing to the efforts to improve data generation on the microfinance industry
• improving policy, legal and regulatory frameworks required to facilitate the development of
innovative financial institutions and instruments;

The MDBs should work at a country level, with the local authorities, in shifting emphasis from
regulating business operations to building institutions that facilitate business by supporting an
efficient and fair functioning of markets.

Role of State

As microfinance institutions grow, the question of their regulation has become an increasingly
important issue. The state has in theory a major role to play in providing and instilling confidence
in a regulatory framework, but governments have to know whether microfinance threaten
macroeconomic stability and whether regulators can have the capacities to regulate all these new
mushrooming institutions.

These issues raise questions about what role the state can assume in order to increase outreach,
impact, and sustainability of the MFIs: (1) What state-owned institutions are necessary? (2) What
level of subsidization of financial institutions is desirable? (3) What are the state’s choices among
alternative investments in financial institutions or complementary services? (4) How to create and
instill confidence in a regulatory framework for microfinance?

The following table detail the role a state could play to improving the sustainability of
microfinance industry.

Page 16 of 32
Functions of the State

Required state driven regulations for microfinance institutions vis-à-vis commercial banks

Source: CGAP

Page 17 of 32
Role of Central Bank

In addition to the state, central banks of individual countries have a potentially important role to
play in the development of sustainable microfinance and the integration of microfinance into the
broader financial sector.
• Regulating and supervising MFIs by means of self-regulation organizations (SROs).
• Introduction of compulsory registration with the regulatory authority for all MFIs.
• Introduction of reserve requirements
• Mainstreaming and up-scaling by linking SHGs with commercial banks
• The establishment of a microfinance development fund to increase equity risk capital
• Engaging in promotional activities: The promotional role is activity that generates
externalities and reduces transaction and information costs within the financial system. This
includes:
o support for pilot projects using innovative approaches
o conduct of research
o collection and publication of data
o advocacy, leadership, and training

After understanding the basics of microfinance, issues in its sustainability and role of key
institutions, we now focus on building our understanding about Microfinance’s need, potential
impact, accomplishments and challenges in a country in South Asia - India, which is a right place
to test and reap benefits of microfinance.

CASE STUDY: INDIA

Microfinance in India – Need

India has the world’s largest number of poor people in a single country. Of its nearly 1 billion
inhabitants, an estimated 350-400 million are below the poverty line, 75 per cent being in rural
areas. Hence, India has been a natural candidate for experimenting with microfinance as a
solution for poverty alleviation.

Potential Microfinance Size and Impact in India

The total demand (for 350-400 million under served) for microfinance is between $ 10-12 billion
($20-30 of average credit/ individual)19.The formal banking sector (rural branches, co-operative
banks etc) supply $ 200-300 million. Despite government’s thrust on priority sector and rural
lending, the success of such institutions has been limited in the last two decades.
Over the last five years, the total lending assets from microfinance sector have increased from $ 5
million in 1998 to $ 300 million in 2005 (an unprecedented growth). The leading MFIs have been
successful in building a profitable business model (Exhibit 6)

19
Interview with business heads for microfinance – Citigroup, India and ICICI, India

Page 18 of 32
 India 1998 2005
No of MFIs 10 138 (30 mature MFIs)
No of Customers 100,000 3,500,000
Total Assets ($ million) 5 300
Source: Sadhan, Network of MFIs in India

Hence, microfinance has been able to create close to 3.5 million jobs in few years of
implementation. If microfinance becomes sustainable and scalable, it can bridge the unmet
demand and can have a huge impact on the underserved Indian population and Indian economy as
a whole.

In the past 1-2 years, commercial financial institutions like ICICI, Citigroup, HDFC and others
have made microfinance a key part of their consumer business. They are aggressively trying to
create a robust business model so as to grow their consumer portfolios and play on India
demographics to build a sustainable banking business for the masses. The involvement of such
organizations would expedite the realization of the vision, which is detailed below.

Value Chain of Indian MF Industry

Wholesalers
SHG Oriented MFIs (or
(Government SHG
NGOs) (Exhibit 7)
Agencies)

Financiers
(Commercial banks/
Developmental / MFIs / NGOs (Exhibit 7)
Individuals
Donor agencies)

Few Wholesale Financiers Few NGOs/ MFIs supporting SHGs

• NABARD • SHARAN in Delhi
• Rashtriya Mahila Kosh • FTCA in Hyderabad
• Friends of Women's World • MYRADA in Bangalore
Banking in Ahmedabad • BARODA CITIZEN's COUNCIL in Baroda
Commercial Banks • SEWA in Ahmedabad
• ICICI • PRADAN in Tamilnadu and Bihar
• HDFC • ADITHI in Patna
• Citibank • SPARC in Mumbai
• SBI • ASSEFA in Madras etc
Few NGOs / MFIs directly retailing credit to Borrowers
• SHARE in Hyderabad
• ASA in Trichy
• RDO Loyalam Bank in Manipur

Page 19 of 32
Vision of Microfinance going forward:

For Microfinance to have an India wide impact, the following vision would have to be realized.
• Creation of 200 mature MFIs across the country.
• One MFI for every 3 districts with an average population per district of 2 million. This base
gives adequate diversification and sufficient concentration of local knowledge.
• Each MFI to have on average 0.5 million customers (households).
• Average credit outstanding per customer being USD 60.
• Each MFI to provide a comprehensive range of financial services to the customer including
insurance, savings, credit and derivatives (weather etc).
If these numbers are achieved, and if each MFI customer represents a single household, then
financial services would be available to 100 million households. With USD 60 per household,
the total amount of credit outstanding would go to $ 30 million per MFI and $ 6 billion across the
200 mature MFIs. This would meet almost all of the current estimated demand for credit.

To achieve this vision, we will look at few successes in other South Asian Nations where
Microfinance has been implemented profitably and synthesize key success factors in making
microfinance scalable and sustainable. We will then apply the learning to solve the challenges
being faced by MFIs in India.

Lessons from Microfinance in other South Asian Nations

The Grameen Bank in Bangladesh

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, 1.2 million borrowers with over 90% being women.. Key transferable
lessons from the Grameen bank’s business model:
• Participatory process in every aspect of lending mechanism.
• Peer pressure of group members on each other.
• Lending for activities which generate regular income.
• Weekly collection of loans in small amount.
• Intense interaction with borrowers through weekly meetings.
• Strong central management, dedicated field staff, extensive staff training, willingness to
innovate, committed pragmatic leadership and participatory style of working.

Linking Banks with Self-Help Groups: A Pilot Project from Indonesia

With the support of the Central Bank, a pilot project in which 13 participating banks, with the
assistance of 12 NGOs, lent to about 420 self-help groups (SHGs) in the first phase. Given the
project’s mixed success, it is helpful to look at key principles behind this program, which made it
work:
• The SHGs used part of their funds (almost 60%) for lending to their members and the rest
for refinancing from the bank
• Savings are to come first as partial collateral
• The joint and several liability of the members
• Credit decisions for lending to members are to be taken by the group collectively

Page 20 of 32
 • Instead of penalties, the banks impose an incentive for timely repayments

Synthesizing Key Success Factors in Microfinance

A synthesis that can be evolved out of the success of microfinance institutions based on certain
preconditions, operational indicators and facilitating factors.

Preconditions:
Those MFIs have been successful that have
• Instilled financial discipline through savings
• A recovery system based on social intermediation
• Another important feature has been the community governance
• Making households direct stake holders
• Making both savings and credit critical for success and savings should precede credit
• Chances of success more with women

Operating Indicators:
The operating indicators for success are outlined below:
• Programs taking into account the localized and geographical differences have been
successful
• Effective and responsive accounting and monitoring mechanisms
• Lending at interest rates at or near market rates
• A combination of the three i.e. interest rates, amount and repayment period if decided by
community, the program is most likely to succeed.
• The programs which have taken care of other needs such as consumption, marriage etc.

Facilitating Factor
• A facilitative environment and enabling regulatory regime.
• Merging the formal (lower cost of funding, capital raising, risk analysis) and informal
sectors strengths (operating cost and local understating)

Key Challenges facing Microfinance Industry in India & Recommendations

The key challenges can be divided into two parts – First, challenges being faced by current MFIs
to scale their existing operations. Secondly, challenges being faced at Industry level to make
MFIs ubiquitous.

• Inadequate availability of “equity risk capital” to provide the degree of coverage

required to absorb the risks inherent in this business and inadequate debt funds:

Today, a balance sheet of a Indian MFI looks as follows:

Liabilities Assets
Promoters Equity - 25% Loans to SHGs/ Individuals – 100%
SHG Savings – 30%
Debt – 45%

Page 21 of 32
The balance sheet is already leveraged and as there is a constraint in equity capital contribution, it
leads to a constraint in increasing asset base. Solutions on two fronts can tackle this issue:
a) Attracting equity capital: The sources of equity capital would be donor agencies, venture
capitalists, corporate funds oriented towards development projects, wealthy individuals.
Commercial financial institutions providing debt are playing an important role in attracting
equity to the sector.
b) Partnership model: A partnership model vis-à-vis direct lending to MFIs is being attempted
by commercial banks like ICICI, Citibank, HDFC to address the gaps:
• Separating the risk of the MFI from the risk inherent in the micro finance portfolio.
• Incentivize partner MFIs, to play the role of an agent, when bank lends directly to
borrower.
This resolves the inability of MFIs to provide equity risk capital in large quantum which
limited the advances from banks despite a greater ability of the latter to provide implicit
capital.

• Investment Horizon and cost of funding

Efforts are on to develop a secondary market for securitized papers to expand the investor horizon
and consequently lower the cost of funding. In partnership with Grameen Foundation, USA and
Citigroup, ICICI bank is in the process of forming a Non Banking Financial Company (NBFC),
Grameen Capital India (GCI). GCI is modeled on the lines of Fannie Mae and the Small Business
Administration Fund20 in the USA which has served to catalyze secondary markets for new asset
classes, in this case micro finance. This entity will provide credit enhancement to micro finance
portfolios and enable MFIs to access mainstream capital markets.

• Creation of the necessary field infrastructure

MFIs need to build a high-quality and low-cost operation base; do investments to create a trained
staff etc. To invest in such infrastructure, MFIs should be able to borrow on a project finance
basis, a market which is developing slowly. A strong push in long-term debt financing to MFIs
needs to be given to scale their business model.

• Human capital constraint - Well-trained staff at all levels

Micro finance, regardless of the model followed, is a very human resource intensive intervention.
If a target of 200 MFIs is to be achieved for the sector, each employing an average of 100 field
personnel, this implies that a capability to train 20,000 individuals needs to be built on an urgent
basis. Hence, focused training institutes need to mushroom to provide human capital to the
industry. Few such organizations are Indian School of Micro Finance for Women, Dhan
Academy of Micro Finance, M-TRIL, EDA Rural Systems and Bankers Institute of Rural
Development (BIRD). An impetus could be added through corporate volunteering program.

• Regulatory developments

Today, as per RBI, cash can only be disbursed either through a bank branch or an ATM. This
regulatory bottleneck doesn’t allow the use of widespread postal network, cell phone company
outlets as a distribution mechanism of maintaining accounts and disbursing cash. The industry

20
Fannie Mae is the largest source of financing for home mortgages in USA. (www.fanniemae.com). SBA deals with
small business financing (www.sba.gov)

Page 22 of 32
will have to work along with RBI to modify the regulations to increase the footprint of
distribution, while keeping costs low.

• Operating Cost Effective deployment of technology

As of date, an analysis of P&L and Balance sheet of MFIs suggest the following structure:21
Loan Rate to SHG Average of 22% (18-26% )
Cost of Funds Average of 8%
Operating Cost Average of 9% (Significant cost)
Credit Cost 3%
Profit Margin (+others) Average of 1-2%

Comparing this MFI data to a well-managed commercial bank data would suggest that the
operating cost is the key issue in MFI business model. Hence, effective technology is very critical
for MFIs because it gives opportunities for reducing costs of delivery and process management,
besides bringing about transparency in operations. It assumes significance because of the
manpower-intensive nature of business (which gives rise to control issues), underlying financial
risks and regulatory sensitiveness.
The aspects of the micro finance business where technology plays a key role include management
information Systems, cash handling, data capture and subsequent management.

• Offering comprehensive financial services – leveraging distribution network

This would lead to efficient use of the MFI distribution platform and would reduce operating
cost/ transaction and thus offering lower interest rates to end consumers of capital.
Development of well-designed products that cater to various needs (both risk management as well
as growth) of the poor is an important aspect of universal access. Other areas in which work
needs to commence is in other financial services including insurance (life and non-life),
investment, remittance and derivatives. Few such products are individual loans, health insurance,
livestock insurance, weather insurance, commodity price derivatives, savings and investment
product, warehouse receipt finance, remittances etc.

• Making MFIs ubiquitous - Entrepreneur led model

The hypothesis is that micro finance is a profitable activity that will attract entrepreneurs to start
MFIs, provided key inputs are made available and initial pre-operative expenses funded.
Therefore, a financial institution, like ICICI, Citigroup, HDFC etc. (which have an incentive in
increasing number of MFIs) should set up internal groups to provide inputs to potential
entrepreneurs. This initiative would trigger the growth in number of MFIs.
Key inputs potential entrepreneurs would need:
o Organizational and staff incentives structure
o Finance related – break even, source of funds, capital structure
o Legal issues - form of incorporation, regulation on various products
o Business plan related - scale, outreach strategy

21
Interview with Mona Kachhwaha, Citigroup India head – Microfinance business

Page 23 of 32
CONCLUSION

When we started this paper, we stated that the goal of microfinance was to serve as a useful tool
to alleviate poverty. Over the course of the paper, we saw MFIs and institutions trying to solve
this problem. We discussed the various issues facing MFIs and we discussed the potential
solutions in different sections. In conclusion, we would like to investigate if microfinance is
meeting its stated goals.

Evidence of Poverty reduction through microfinance

Despite the extensive spread of microfinance, research studies on the actual impact of MFIs
(Exhibit 8) are often more ambivalent about its impact than is the aid community. There are two
reasons for this – One, it is difficult to establishing appropriate statistical control and two, there is
obviously a range of variation found in practice in the way in which micro finance operates.

The evidence shown in the exhibit clearly suggests that whilst micro finance clearly may have
had positive impacts on poverty it is unlikely to be a simple panacea for reaching the core poor.
Reaching the core poor is difficult and some of the reasons that made them difficult to reach with
conventional financial instruments mean that they may also be high risk and therefore
unattractive micro finance clients.

Thus, there is obviously a need to continually improve design and outreach and to see MFIs as
part of the package for targeting the poor, rather than the whole solution. We conclude our paper
with the lessons learnt and how can we further improve the offerings of microfinance.

Lessons learnt

Some valuable lessons can be drawn from the experience of successful Microfinance operations.
The poor repay their loans and are willing to pay for higher interest rates than commercial banks
provided historically. The peer-pressure and group-lending decision provide strong repayment
motivation and produce extremely low default rates. However, for microfinance to have a
financially viable and sustainable model, following key factors will play an important role:

• Minimum Efficient Scale: Scale is going to play an important role as operating and
transaction costs are the biggest part of the cost structure.
• Attracting both equity and debt capital: Given that leading MFIs have demonstrated success,
it is important for financial institutions to allocate both equity and debt investments towards
this new emerging asset class. Microfinance industry would only be able to flourish and have
a meaningful impact when investments reach a certain level.
• Role of multilateral, state, and corporate institution: Institutions at various levels will have
to create a regulatory and market mechanism, for making microfinance industry part of the
mainstream financial sector.
• Attracting human capital: To make microfinance ubiquitous, the industry has to play a pro-
active role in attracting human capital and training them to run and spread the concept of
microfinance22.
• Key enabling factors like infrastructure: Microfinance will only be able to grow and become
a significant contributor to poverty reduction with the appropriate infrastructure to maximize
commercial opportunities and minimize transaction costs in an economy.

22
Interview with Regina Galang

Page 24 of 32
EXHIBITS

Exhibit 1:
Regional Breakdown of Market access by the poor

Exhibit 2:

Combined Loans and Savings Accounts in Alternative Financial Institutions†

Source: CGAP (Occasional Paper, July 2004)

Page 25 of 32
Exhibit 3: Performance of microbanks and a measure of their risk

UMU Share Compartamos

December 2004 Uganda India Mexico TSKI Philippines

Assets M$ 17.05 M$ 32.50 M$ 133.4 M$ 11.80

Loan Portfolio M$ 10.08 M$ 28.70 M$ 101.2 M$ 7.40
Clients 36,864 328,846 309,637 122,832
Average loan
size $273 $87 $327 $60
PAR(30 days)23 4.5% 0.00% 0.57% 1.65%

23
PAR: Portfolio at Risk - the outstanding balance of all loans with at least one payment at least 30 days overdue.

Page 26 of 32
Exhibit 4:

Dexia Micro-Credit Fund (Manager)

• Luxembourg SICAV part 2, launched in September 1998 by Dexia-BIL
• Targeting leading and transforming MFI with short term debt (max. 3 years);
• 6-year track record, over 230 loans made, no default, net USD return 34.3%
• Total assets : $ 60 millions, 51 MFI, 21 countries
• Fast and flexible delivery of loans

Investor Profile
• Individual (private banking) and institutional
• Mid to long-term investment horizon
• Trust based on excellent > 6 year track record
• Tickets range from $10,000 to $5,000,000

Fund performance
• Net return of $Libor + 2% delivered each of the past 5 years
• Very low volatility of financial returns
• No correlation with other asset classes
• Good liquidity (monthly) at no cost

Source: Blue Orchard website

Share Price USD

Source: Blue Orchard Website

Page 27 of 32
Exhibit 5:

Assessment of key risks by investor type

All Institutional Financial Brokers

Investors Planners
Lack of Country Intelligence 3 3.1 2.8 2.8
Foreign Exchange Risk 2.9 3 2.5 3
Lack of Experience in
Emerging Market Investments 2.8 3.5 2 3
Insufficient Social Impact
Measurement 2.7 3.3 2 4
Inadequate Risk/Return Profile 2.3 2.2 1.9 2.6
Lack of Appropriate Vehicle 2 1.8 2 2.5

(Note: On a scale of 1-5, 5 representing the highest level of concern)

Exhibit 6: Statistics: SEWA Bank (India) and UNITUS MFI Partners

Page 28 of 32
Exhibit 7: Statistics on current SHGs - India 24

Success in Andhra Pradesh

is attributed to pro-active
role played by the state
government, under the
leadership of chief minister,
Mr. Chandrababu Naidu.

24
Chakrabarti, Rajesh; India microfinance experiences – accomplishments and challenges

Page 29 of 32
Exhibit 8:

Results of studies trying to find the relation between microfinance and poverty

Coverage (in Asia

Study only) Methodology Results
Hulme and Indonesia (BKK, Borrowers and control Growth of incomes of
Mosley (1996) KURK, BRI), India samples, before and after. borrowers always exceeds that
(Regional Rural of control group. Increase in
Banks),Bangladesh borrowers income larger for
(Grameen, BRAC, better-off borrowers.
TRDEP), Sri Lanka
(PTCCS)
MkNelly et al Thailand (village Non-participants in non- Positive benefits, but no
(1996) banks - Credit with program villages used as statistical tests for differences
Education) controls reported.
Pitt and Bangladesh (BRAC, Difference-in-difference Positive impact of program
Khandker (1998) BRDB, Grameen estimation between eligible participation on total weekly
Bank) and non-eligible households expenditure per capita,
and programs with and women’s nonland assets and
without microfinance women’s labor supply. Strong
programs. Estimations are effect of female participation
conducted separately for male in Grameen Bank on schooling
and female borrowings. of girls Credit programs can
change village attitudes and
other village characteristics
Coleman (1999) Thailand (village Comparison between No evidence of program
banks) participant and non- impact. Village bank
participant households and membership no impact on
between villages in which asset or income variables.
program introduced and
villages where not yet
introduced

Chen and India (SEWA bank) Control group from same Average income increase rose
Snodgrass geographic area for bank’s clients in
(2001) comparison with control
group. Little overall change in
incidence of poverty, but
substantial movement above
and below poverty line.
Coleman (2001) Thailand (village Difference-in-difference Programs are not reaching the
banks) estimation between poor as much as they reach

Page 30 of 32
 Duong and Vietnam (VBA 84% Tobit estimation of (i) Poor have difficulties in
Izumida (2002) of total lending), VBP, participation in rural credit accessing credit facilities:
PCFs, commercial market; (ii) behavior of lender livestock and farming land are
banks, public funds) toward credit-constrained determinants of household
household and (iii) weighted participation; reputation and
least square estimation for amount of credit applied for to
impact on output supply. MFI are determinants of credit
rationing by lenders. Impact
estimation showed positive
correlation between credit and
output
Kaboski and Thailand (production Two-staged LS and MLE test Production credit groups and
Townsend credit groups, rice of microfinance impact on women groups combined with
(2002) banks, women groups, asset growth, probability of training and savings have
buffalo banks) reduction in consumption in positive impact on asset
bad years, probability of growth, although rice banks
becoming moneylender, and buffalo banks have
probability of starting negative impacts. Emergency
business and probability of services, training and savings
changing job. Separate help to smooth responses to
estimation according to type of income shock. Women groups
MFI and policies of MFI. help to reduce reliance on
moneylenders.
Pitt et al (2003) Bangladesh (BRAC, Maximum likelihood Significantly positive effect of
BRDB, Grameen estimation controlling for female credit on height-for-age
Bank) endogeneity of individual and arm circumference of both
participation and of the boys and girls. Borrowing by
placement of microfinance men has either negative or
programs. Impact variables non-significant impact on
are health of boys and girls health of children.
(arm circumference, body
mass index and height-for-
age)

Amin et.al. Bangladesh (Grameen 1) Nonparametric test of Members are poorer than
(2003) Bank, BRAC, ASA) stochastic dominance of nonmembers. Programs are
average monthly consumption more successful at reaching
of members and nonmembers poor, but less successful at
2) Maximum likelihood test reaching vulnerable. Poor
of microcredit membership vulnerable are effectively
on vulnerability, consumption excluded from membership.
and household characteristics.

Source: ADBI Institute and Various Paper

Page 31 of 32
REFERENCES

Primary Research

• Interview with Mona Kachhwaha – Head, Microfinance business, Citigroup India

• Interview with Bindu Ananth – Microfinance Initiative, ICICI India
• Interview with Regina Galang – Women in Business, Somoa

Secondary Research

• Sharma, Ashok: Developing sustainable microfinance systems

• Fries, Steven and Buiter Willem (2001); What should the multilateral banks do?
• Desai U.B. (2005); A primer on microfinance
• Cohen, Monique, (2000); “Microfinance, Risk Management and Poverty”.
• Coulter, Jonathan and G. Ramachandran, (2000); “A strategy for development of warehouse
receipt system for agriculture in India”.
• Duggal, Bikram, Bindu Ananth and Kartikeya Saboo (2002); "Micro Finance: Building the
capacities of the Poor to participate in the larger economy"
• Khandelwal, Rajiv & Sudhir Katiyar, (2004); “Between Two Worlds”, Humanscape, March
2004.
• Mor Nachiket and Bindu Ananth, (2003); “Issues in Improving Access to Finance”
• Morduch, Jonathan and Stuart Rutherford (2003); "Microfinance: analytical issues for
India", Essay for the World Bank, South Asia Region -- Finance and Private Sector
Development, April 2003.
• Rao, Laxman and Priya Deshingkar, (2004);”Labour on the Move”, Humanscape, March
2004.
• Rutherford, Stuart (2000) “The Poor and their Money”, Oxford University Press.
• Sinha Sanjay (2003); “Financial Services for Low Income Families: An Appraisal”, IIMB
Management Review, June 2003.
• World Bank, (2003); “Rural Financial Access Survey”.
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• World Development Report, (2000), “Risk and Vulnerability”.
• Ingves Stefan (2005); Microfinance: A view from the fund
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