What is Indianmicrofinance?

"Indianmicrofinance is the supply of loans, savings, and other basic financial services to the poor."

As the financial services of microfinance usually involve small amounts of money – small loans, small savings etc. – the term "microfinance" helps to differentiate these services from those which formal banks provide.

Why are they small? Someone who doesn't have a lot of money isn't likely to want to take out a $5,000 loan, or be able to open a savings account with an opening balance of $1,000. Hence – "micro".

In the past few years, Indian microfinance has seen unprecedented growth. For instance, during 2005–6, major Indian microfinance institutions (MFIs) were able to expand their active borrower base by about 110 per cent making the sector one of the fastest growing world wide. Loans outstanding of Sa-Dhan’s members almost doubled from Rs 1095.1 crore to Rs. 2070.2 crore during the same time period. In fact, in 2005, five leading MFIs from India ranked in the list of top 20 fastest growing MFIs in the world.12 This trend was reinforced by and in turn further accelerated the commercialization of the industry. Commercialization is characterized by increased competition for clients and a clear objective to seek profitability. The majority of India’s top 25 MFIs already are, or are working to become, profit-oriented NBFC–MFIs (Non-bank finance company–microfinance institutions).

Despite the growth, there is considerable unmet demand for credit in India. According to a World Bank report, only 9% of poor families in India are covered by microfinance. Of the projected credit requirement of $10909 million, only $1050 million is met by microfinance. Although the demand for credit is widespread, MFIs are not evenly distributed geographically. MFIs are clustered primarily in the south, with two-thirds of all MF clients being in AP, TN and Karnataka. Interviews with about twenty sector experts and practitioners suggests that fast growing MFIs tend to expand to areas where there is already an incumbent, similar to banks which tend to open new branches in more financially developed areas.3 The reason for this strategy is to leverage training and screening of client by the incumbent MFI and general awareness of microfinance in the area. MFIs in India, by and large, do not distinguish themselves by geographic areas or by offering differentiating products to different client segments.

In general, competition is beneficial to MFIs and clients. MFIs improve their product lines to meet client demands; prices become lower; the quality of services provided improves; and overall, MFIs become more client-driven. In terms of governance, MFIs become more efficient and conscious of risk management issues. The effective interest rate charged is often made more transparent. Better governance complements commercialization of the MFIs. Banks and other private investors feel more comfortable investing in well-managed MFIs that adopt good governance practices. As a result, such MFIs enjoy continuous inflow of funds that makes further outreach of clients possible. Indian MFIs lead the way in access to commercial funds with a commercial funding ratio of about 75 per cent.

However, a review of the literature and interviews with leading practitioners reveal the negative aspects of competition. There are sector-wide concerns about unethical client and staff poaching, violation of the ‘code of conduct’ and reckless lending without suitable assessment of clients’ repayment capacities and increase in multiple borrowings. Furthermore, recent trends in commercialization have given rise to the apprehension that social objectives of microfinance – to provide a means for poor to improve their livelihood through financial inclusion – is diluted by targeting richer clients to increase profits, the so-called “mission drift.”

Multiple memberships have critical importance to MFIs and the industry as a whole because it is an issue that inevitably arises in the evolution of microfinance. It is considered to cause over-indebtedness among clients and deteriorate repayment rates. Theoretically, competition and multiple memberships, without sharing of client repayment information between the different lenders, lead to weakening of the incentive of the client to repay since if the first MFI denies further loans to the client, she has outside options now.4 Despite the sector’s grave concerns about unregulated competition and multiple borrowing, however, this stance is not consistently supported by rigorous evaluations. Due to unavailability of primary data, the extent and impact of multiple borrowing has been gauged by surveys which are constrained by small sample sizes and the dependence on respondents’ self-reporting.

The Centre for Micro Finance (CMF) has conducted a study on the subject to bridge this gap in the literature to an extent. The scope of the study includes a literature review of issues related to rapidly intensifying competition in the microfinance sector throughout the world. Further, we conduct interviews with leading practitioners and sector consultants on the extent of competition in India and consequences for the borrower, the lender and the industry as a whole. In addition, using a large data set on clients’ borrowings from seven selected MFIs in a competitive region in India, the CMF aims to quantify the prevalence of multiple memberships across these MFIs, and compare the repayment performance of borrowers. The study consolidates the quantitative results with a qualitative report based on interviews with selected multiple borrowers.

The key finding of this study is that multiple borrowers have an equal or lower arrears rate than their single borrowing peers in the same branches and lower than the average rate for the overall sample. A majority of the multiple borrowers interviewed said they used the second loan for investment purposes and none reported repayment difficulties. Compared to the sample average, all the MFIs (except one urban MFI) have equal or better repayment rates in more competitive branch locations.

While this does not necessarily mean that competition improves repayment, it appears that MFIs by and large are managing risk well in the face of competition at this point.

Based on their repayment performance and the interviewees’ unanimous desire for larger loan sizes, it appears that credit rationing is occurring. Each individual MFI is offering less credit to multiple borrowers than what they demand and are able to repay.

Our study reveals that there is no evidence that multiple borrowers are experiencing repayment problems. Therefore, the conventional notion that a credit bureau is necessary to prevent “over-dipping” was not substantiated in this study. Nonetheless, this does not eliminate the necessity of a credit bureau all together. A credit bureau could be justified on the grounds of being able to discern between different types of clients and to view their past credit history. This could be used to target different client groups with customized products, loan sizes and interest rates.