SUMMER PROJECT REPORT

Svasti Microfinance

Ltd.

Microfinance Industry – An Overview on the Industry

and Svasti Microfinance Ltd.

This project report is submitted as part of my 3-week internship at Svasti

Microfinance Ltd, Mumbai in June 2017. The report is strictly confidential and is not

to be used without the permission of the author.

Neel Malhotra,

Grade 11, Singapore International School, Mumbai June, 2017

INDEX

1. Acknowledgement

2. Executive Summary

3. Introduction to Microfinance

3a. Role of MFIs

3b. Why Micro Finance and not Banks? 3c. Use of MFI loans

3d. RBI Regulations governing MFIs

3e. Growth of MFIs

4. Business model of a Microfinance Institution

4a. Concept of Joint Liability 4b. Female gender- the most favored customer

4b. Use of technology

5. Introduction to Svasti Micro Finance

5a. Departments

5b. Operational metrics and key variables 5c. Strengths and weakness of the Svasti business model

6. Key Performance Metrics

7. Challenges facing the MFIs

8. Impact of demonetization

9. MFIs role in alleviating poverty

10.Recommendations and Reflection

1. Acknowledgement

I had an opportunity to work with Svasti Micro finance ltd., Mumbai during my

summer break in June-July 2017. This was a great platform for me to learn the basics

of finance and for professional development. I engaged with wonderful employees

and was impressed with the focus on processes and their dedication. I express my

sincere gratitude and special thanks to the Co-founders and CEO Mr. Arun- Kumar

and Co founder and CFO/ CIO Mr.Narayanan Subramaniam, who spent their

precious time in guiding me during my internship. The experience provided to me in

attending the joint meetings, some days spent on the ground with collection teams

and also the potential customers was extremely valuable. This opportunity to work

with an esteemed institution has broadened my perspective in the field of micro

finance. My belief is that these 3 weeks will go a long way in shaping my career

objectives and developing my professional skills. I would like to sincerely thank all

the senior executives and staff who took time out of their extremely busy schedule

and devoted their valuable time in order to support me in my research as well as

making me understand the company.

2. Executive summary

This report provides my experiences and findings while interning for three weeks at Svasti Micro

finance in the month of June 2017. I had interactions with different departments: Operations,

Information Technology, Accounts, and HR. The various meetings and interactions provided

beautiful insights into the broad sector of micro finance. The report captures my experience of

working with employees on the field, interacting with various households in the urban

unbanked/underserved communities and the clusters that generated potential customers. This report

tries to encapsulate my various discussions with the staff members at various levels and the

importance of financial inclusion in a developing country like India. The significance of technology

and its utilization in catering to the financial needs of the underserved, unbanked or under banked

areas was remarkable. The business model of MFIs is discussed along with the significance of few

critical components of Micro finance-the concept of Joint Liability as well as the use of “Aadhaar

card”, the CIBIL score, the distribution network helping collections and use of technology to drive

down the operational costs. The Joint Liability groups and the unsecured lending are the two key

differentiators from the normalized forms of bank lending and NBFC-MFI lending. The CIBIL

score of the borrowers was utilized in evaluation of all loan applications at Svasti. The use of credit

score has been more wide enough after the 2008 MFI crisis.

The MFIs also face lot of challenges. The economic cycles are short, the loans are unsecured and

then there are external macro environment factors. The demonetization in Nov 2016 had a huge

impact on the collections and growth in disbursements. The report discusses the impact and also

highlights the resilience of the micro finance sector in recovering fast. The collections that went

down to 70% recovered in 2 months and the growth in disbursements is also trending up post the

demonetization. Finally, analysis is done to evaluate whether the key objective of setting up MFIs-

- financial inclusion and alleviating poverty, have been achieved or not. The access to credit for

the unbanked people, the vegetable vendors, the small road side vendors, the unorganized sector,

definitely seems to be happening. The issue of alleviating poverty is little slow as compared to the

size of the population but MFI is a right step in that direction. The report includes a summary of

my findings and various ground level interactions through out the three weeks. The financial

perspective gained as part of this journey is immense and will help me in my career.

3. Introduction to Microfinance

Microfinance refers to an array of financial services, including loans and insurance available to

poor entrepreneurs and small business owners who have no meaningful collateral (tangible or

intangible collateral), lack steady employment, and lack creditworthiness, which is why they do

not qualify for standard bank loans. The aim of micro finance companies is mainly to cater to the

financial needs of the under-served, support entrepreneurship, alleviate poverty, empower women,

and uplift communities. This largely caters to small business and low-income households. They

are not able to access formal credit due to their socio-economic status. Thus, these micro

entrepreneurs and small businesses that cannot access the formal banking system tend to go to

micro finance institutions for their funding needs. This support of microcredit to poor clients helps

to enhance financial inclusion in the country. Financial inclusion as defined by the Reserve Bank

of India, as the “provision of affordable financial services” to those who have been left unattended

or under attended by formal finance corporations in order to bridge the gaps in last-mile

connectivity for vast sections at the base of the pyramid. Finally, this facility helps the poor people

to save and accumulate assets, which can ultimately be a source of income generation for micro-

entrepreneurs.

3a. Role of MFI’s

Microfinance institutions were licensed by the Reserve Bank of India with the objective to evolve

as an effective means of financial inclusion that is accessible and affordable for the excluded

regions and that can ensure permanent inclusion of the excluded sections in the ambit of formal

finance. This concept was brought to the market to replace the previous credit delivery system. The

basic principles of micro finance that distinguish itself from earlier modes of credit delivery

systems are:

➢ a lack of physical collateral i.e. unsecured lending

➢ smaller ticket size of loans,

➢ deep emphasis on peer monitoring and or joint liability groups

➢ focus on women borrowers.

This was to cover a vast majority of the unbanked population in need of financial services, in order

to grow one step closer to achieving an equitable society.

Microfinance is one of the most important and effective tools of reducing poverty. Micro finance

has a significant role in bridging the gap between the formal financial institutions like Banks and

the rural poor. MFI’s serve the economically marginalized strata of the society.

This move by the Reserve Bank of India has also stepped up against the dependence of poor

borrowers on various informal sources of credit. The primary objective to inculcate financial

inclusion was to fulfill both these objectives: give the underserved and under-attended/unattended

access to formal credit, and reduce the dependence of poor borrowers on vulnerable and

untrustworthy informal sources of credit.

3b. Why Microfinance (and why not banks)?

Banks are highly regulated by Reserve Bank of India and the Managements have been more

inclined to open branches in the urban areas and locations with adequate profit potential. The bank

lending involves loans against various collaterals while their liabilities are the savings of the

common people. The Banks are an integral part of the economy and cannot afford to any riskier

lending as failure of one may cause the domino effect as well as may cause a loss to the depositor’s

savings. This leaves the under- privileged, the down trodden devoid of the banking and lending

facility. The access to finance is one of the single most effective way to bring a person or family

out of poverty. With this objective in mind, RBI had given Licenses to various Micro Financial

Institutions. Similarly, to improve the income for the ladies, MFIs have been very helpful. Ladies

must have salary slips or credible businesses for them to avail loans. The reality is these small

borrowers will not have steady incomes or lack a credit history and as a result, banks are unwilling

to offer formal credit. This void in the financial sector is filled up by the MFIs. Minimal

documentation is required (only Aadhaar card and light bill) for gaining access to microcredit (by

micro finance companies) and less security is favorable for poor people due to their financial/socio-

political status.

With competitive interest rates of approximately 14% p.a., poor people not likely to have the above

minimum requirements of a bank tend to go to micro finance firms like Svasti. The interest rates

are also higher in some cases and are in the range of 14-20% since these loans are unsecured. The

higher rates may be a deterrent but the availability of credit is a big boon for these small ticket

borrowers to run their businesses.

3c. Use of Microfinance loans

The loans by MFIs including MFIs are business loans. Often, people don't have enough money or

haven't saved up to tackle a need, so they borrow. Impoverished borrowers with income range

between Rs 10,000 to Rs 30,000 use these financial credit to support small businesses such as

tailoring, doctor facilities, salon shops, etc. There are several guidelines which limit the use of

loans for personal expenses such as education for children, payment for medical bills, and payment

for other household expenditure, not directly or indirectly related to their small-scale businesses.

This was done to ensure a higher repayment rate, as loans for business expansion are more likely

to yield greater returns for the household, as compared to returns from education or medical bills

(either longer-term returns or no returns). Additionally, the idea is that the credit provided should

generate business income and help in repayment.

3d. RBI Regulations governing Micro finance firms

Reserve Bank OF India is the sole governing institution for Banks and Micro Finance Institutions.

RBI has laid out the requirements for a MFI to be operational including the funding and

disbursement requirements. The asset quality recognition also comes under this.

To be treated as a qualifying asset for a MFI, RBI has set a framework of policies which limit the

borrowing for personal uses. Any loan must have not less than 50% of the loan for income

generation/business-related purposes, for it to qualify as a qualifying asset.

In the case of emergencies, “a part (i.e., a maximum of 50 per cent) of the aggregate amount of

loans may be extended for other purposes such as housing repairs, education, medical and other

emergencies. However, the aggregate amount of loans given to a borrower for income generation

should constitute at least 50 per cent of the total loans from the NBFC-MFI.”

Secondly, processing charges, which includes document handling, of NBFC-MFIs (Non-Banking

Finance Company - Micro Finance Institution) must not exceed 1% of the gross loan amount.

NBFC-MFIs are not allowed to any other charges apart from the three mentioned here: interest

charge, processing fees, and insurance premium.

The overall rate of interest charged by any MFI to its borrowers shall not exceed 26% under Priority

Sector Lending norms. This is the maximum lending rate while due to the competitive intensity,

the market rates are in the range of 14-18% depending upon the location, the urbanization and the

credit history of the borrowers.

MFIs are required to ensure that the modes of recovery are non-coercive and should not charge

penalties on prepayment or delayed payments.

Source: http://www.sa-

dhan.net/Resources/flyer%20option%201.pdf

3e. Growth of micro finance

industry

The MFI industry has grown by leaps and bounds in the last decade. The growth has happened

because of the underlying need of credit for the unbanked population. Despite the crisis in 2008 in

Andhra Pradesh as well as shorter economic cycles, the MFIs players have become more matured

and have tweaked the business models to adapt to the fast changing consumers.

The growth is reflected in the following graphs:

Source: Data taken from India infoline (IIFL) report), MFIN India: Micrometer

4. Business model of a Micro Finance Institution

With minimal documentation and no collateral, Micro finance institutions, specifically, Svasti

Micro finance are willing to lend between Rs 15,000.00 to Rs 50,000.00, depending on the credit

history of the customer (attained by the Credit Bureau). These loans are primarily offered to ladies

in joint-liability in groups of five for Svasti with Aadhaar card. The minimum requirement of

documentation for these loans is Aadhaar card and light bill only (light bill not required if the

customer is the house owner). Covered in the initial payment is the processing fees which includes

insurance premium as well. Insurance is covered for these customers in the group to ensure, in the

case of death or any unforeseen circumstance, the firm receives the money from insurance. All the

meetings are done in the leader of the group’s house. Svasti follows various verification processes

too such as residence verification, to ensure that frauds are not attempted. After all the verification

process is done, for Svasti, there is a Centralized Disbursement location which disburses loans and

re-verifies all the details.

In all, it takes approximately 7 working days to process a loan and disburse it. The collections are

done on a daily, weekly basis and majority of them are in cash. The staff punches the daily data

into systems to enable updated information at all times. Various MIS reports are generated for the

Senior Management to monitor the operations.

4a. Concept of Joint-liability-an integral part of Micro Finance

The joint liability is an integral part of the whole credit process, this means the joint ownership and

liability of loan rests with a small group and the default by one individual is covered by and payable

by other members of the group. With a minimum of five people in a group, Svasti works on the

principle of Joint Liability group lending. This policy entails the responsibility, primarily financial

support from each member of the group to take responsibility for the other members, in case the

other members default. This is done on a consensus/guarantee that if one defaults, the other

members pay for them.

In case of accidental/natural death, insurance covered initially (recovered from the processing fees

taken by Svasti which includes cost of insurance premium)

In my opinion, this considerably reduces the risk of default. This is because joint liability, firstly

reduces the firm’s responsibility to recover the money, and secondly, due to fear of member’s

humiliation or being ostracized from the community, it reduces the risk of default. Peer discussion

and encouragement can act as a major boost to push them consistently in order to pay the

installments.

4b. Female gender — the most favored customer

The new trend for micro finance firms is to usually lend money to ladies with valid Aadhaar card.

This is because, firstly, it encourages women empowerment as they are able to adopt healthier

lifestyles. Secondly, women generally make better use of smaller loans than men, who regard these

loans as minimal and not worthy. Thirdly, women also have a better track record in terms of

repayment of loans. Lastly, women have less risk of loans being spent on consumables or at a

gambling operation, and hence more likely redistribute their future income to their children and

their community than men.

5. Introduction to Svasti Microfinance

Svasti is an urban “for-profit” micro finance firm started in October 2008 to primarily cater to the

financial needs of the underserved strata of society, with a Gross Loan Portfolio of Rs. 108 bln as

on 31st March 2017. It currently provides products and services suitable to the needs and capacity

of the customers. It currently operates across 3 states, namely Maharashtra, Gujarat and Madhya

Pradesh with a client base of more than 72,000 active customers. Svasti has matured, growing from

Svasti foundation to an Non Banking Finance Company –Micro Finance Institution (NBFC-MFI).

Its reach to urban customers has increased manifold, improved its availability of funds and the cost

of carrying cash has considerably improved over the years. The economies of scale achieved due

to the expansion of Gross Loan Portfolio will allow Svasti to reduce its operating costs and hence

be able to reduce its interest rate currently offered.

5a. Departments

• Human Resources Department

In the case of Svasti, the Human Resources department is responsible for recruitment,

advertisement, salary processing, training and employee engagement activities. In the case of

Svasti, at the branch level, the HR department conducts interviews and field visits to determine the

willingness of the employee to go to the field and do disbursements, collections, and meetings with

groups. They conduct a training program as well, to brief the employees of the core values of

Svasti. At higher levels, they require graduates with relevant experience.

Salary processing is done by a software known as ‘Spine’ which includes attendance, statutory

compliances, provident fund challah, and ESSC and electronically wires the monthly salary for the

employee.

Employment engagement includes medical camps for employees, sports days, picnics, team

lunches etc. This is primarily done to motivate employees and ensure staff retention.

• Information Technology Department

In the case of Svasti, the IT Department is responsible for taking care of the hardware and software

systems that run the firm. This entails programming of an online MERP platform available to all

employees of Svasti. This platform serves the purpose of recording all transactions, meetings, and

daily routines of employees, as well as for enterprise resource planning. The department also has

the responsibility to maintain the website by debugging it regularly, at end-user as well as in the

system. Moreover, all the devices used for identification and verification processes such as thumb

fingerprint scanner, webcam camera etc. are provided by the IT Department. To prevent security

issues such as deletion of data, corruption etc., the IT Department is responsible for back up and

installing anti-virus software on each of the computers in branches as well as offices. To prevent

employee misconduct, each employee is assigned limitations to access, to prevent unauthorized

and secretive data being leaked, corrupted or deleted. The use of IT in operations has enhanced

efficiency and reduced the turn around times for the loans. The MIS system also helps to monitor

the collections and repayments and take corrective action at the right time helping reduce the delays

and non payments.

Accounting Department

In the case of Svasti, the Accounting department deals with daily payments, borrowing money from

priority sector of banks, legal obligations such as filing returns, Income tax filings and registering

all loans in the Ministry of Corporate Affairs etc. The collections are in the form of Cash and hence

require extra diligence. The daily, weekly and monthly MIS are prepared and the cash reconciled

to ensure there is not leakage or mismatch in reporting.

5b. Operational metrics and key variables

Duration of loan

The tenure of the loan is usually between one year to two years both inclusive. It is possible to

repay the entire amount before the tenure ends, however, the instalments are designed to last for

the entire duration. The tenure is directly proportional to the loan amount. For example, for Rs.

15000, the tenure is 12 months, whereas for Rs. 50,000, it is 24 months.

The interest rate and its composition in case of MFIs

Svasti currently works on a lending rate of 25.7% reducing (as per June 2017) *, with additional

processing fees of 1% (maximum limit imposed by RBI) for document-handling and insurance

premium. The interest rate is roughly flat 14.0% and is very competitive in the industry. The

borrowers find it attractive even though much higher than the bank lending rates. The borrowers

want to and always aspire to be banked, their small size and other reasons as mentioned earlier

deprive them of economical rates.

* - Updated every quarter in accordance with the Repo rate.

• Cost of funding

The cost of funding for Svasti is currently 9% - 12%. The source of funding is the banks as banks

also require such lending to full fill their priority sector requirements.

The MFIs try to maintain a spread and are always looking at avenues to reduce their cost of funding

and to diversify the sources. The higher customer base will allow economies of scale, internal and

external, to kick in. Once economies of scale kicks in, Svasti will be able to reap the benefits of

lower interest rates when they borrow due to larger loan sizes and higher credibility in the industry.

For Svasti, it sources a majority of its funds from priority sector of Banks like HDFC Bank. It also

gains a lesser amount of funding from NABARD (National Bank of Agriculture and Rural

Development), due to higher interest rates.

• Operational costs

For Svasti, operational costs are approximately 9%. This includes employee costs such as employee

engagements, brokerage, and rent.

Employee engagement includes employee insurance for self, wife, and kids. It also includes 8-10

days of training of employees. This is primarily done to ensure staff retention and employees are

well-versed with their job expectations.

Insurance premium

The insurance is key to repayment in case of default or death of the borrower. The loan transactions

are insured so that the loans are repaid and closed in case of death of the main borrower. The main

insurance provider of Svasti’s customers, Kotak Mahindra Insurance has recently hiked the

premiums, from Rs 3.8 to Rs 5.9 of premium per Rs 100 of insurance. This is partly due to an

increase in claims of deaths, partly due to a decrease in health awareness. This move has further

surged up the costs of Svasti, possibly eating into their grim margins. To maintain the profit

percentage of GLA (Gross Loan Portfolio), Svasti has to either look for other insurance companies

like Sri Ram insurance (already looking into this firm) or further raise the processing fees that it

charges to its customers. If it chooses the latter, Svasti may further reduce its competitive position

in the industry.

• Bad loan provisions of 1-2%.

Despite the high repayment rate of approximately 99%, there is a bad loan provision to cover up

for potential losses in defaults of loans. Demonetization had recently abruptly disrupted the

repayment rate. There was a rapid manifold increase in the number of defaults. This was primarily

due to two reasons: people suffering from multiple lending (Debt fatigue) and lack of new notes to

repay. This has increased the portfolio at risk with overdue of more than 30 days. To cover up for

these losses likely to arise at any point of time, MFIs usually try to cover up for these losses from

these provisions in order to protect itself from a crisis situation.

• Cost of complete credit delivery

Currently, the components of this cost are primarily operational costs per customer, costs of

funding from priority sector and other sources per customer. Operational costs include many

components such as employee costs (salaries, employee engagements), office and administrative

costs.

However, automation of operations, e-KYC, and better awareness should improve the efficiency

and lower the cost of credit delivery. This will reduce operational costs significantly. Cashless ways

of loan collection could also prove significant in reducing the costs of credit deliver

5c. Strengths and weakness of Svasti business model

• Strengths of this model

The Svasti business model is very robust and has successfully passed various economic cycles. The

key strengths of the business are:

➢ Low ticket size of loans

➢ Joint liability groups

➢ Credit delivery using CIBIL (Credit Bureau)

➢ Distribution network and the meetings are conveniently done at the doorstep: The key to MFI

model is the distribution network; the ability to dispense and collect the loans. The field

employees also need to do the KYC and attend the group meetings. They are also in touch

with the borrower’s collecting, monitoring and following up in case there is a delay. The field

employees report back to their brand and the regional/zonal heads, who take care of their

respective regions’ monitoring. Any delays are continuously monitored and followed up with

the individual in the group meeting. The Aadhaar Card has become an integral part along

with the CIBIL scores.

➢ Collections and repayments- strong network to collect repayments. Demonetization had its

impact on the collection efficiency of the MFI’s including Svasti Micro finance. November

and December 2016 saw collections dropping down to 70% levels for some MFI’s. However,

post-January, the collections revived to low 90%. The 90-day overdue were at 17-20%

reflecting some stress in the rural and small ticket loans. Another aspect was that new

disbursements dropped as the small businesses took a hit. Additionally, the income lost on the

non-active days due to demonetization was a loss of income and could not be recovered.

➢ Credit monitoring and prompt action

➢ Expanding the customer base- An Important tool to raise access and awareness of financial

literacy, health, clean water and sanitation and stimulate the growth of businesses.

• Weaknesses of this model

The joint liability of MFIs has worked well in a majority of the times. However, the politicians

have distorted this procedure. The politicians, in an effort to garner the sympathy of poor people

and for additional political support for their party, have tried to influence these borrowers and

coerced them not to pay. Many communities have been asked not to pay by these politicians. Since

these are all unsecured loans, the politicians have even gone to the extent of providing the necessary

protection from any future penal actions. The 2007-2008 MFIs crisis, especially in states like

Hyderabad, was triggered by the politicians and their false promises that lead to huge defaults and

delinquencies. The moral hazard, the fear that this non-payment by the entire community may

jeopardize their future ability to borrow and may harm their business did not yield any result. The

2008-2009 cycle has taught many lessons to all the players and the MFIs have become more

stringent in their credit standards. The addition of CIBIL score for Svasti Micro finance borrowers

reduces any such possibility and further strengthens their business model.

Svasti, being focused on urban customers have been less prone to these risks. The use of CIBIL

score and motivated staff have helped them to maintain their profit margins and ensure better credit

quality.

6. Key performance metrics

• Asset quality

Asset quality is a key indicator of an MFI’s financial viability. While deposits provision, insurance,

and other financial services expand, the Gross Loan Portfolio remains the predominant component

of its asset base. Portfolio at risk for 30 days or more representing loans overdue by 30 days or

more is historically considered a portfolio of poor quality. This indicator shows us the current risk

inherent in the portfolio. MFI loans are considered higher risk as they are not collateralized and are

often disbursed to a more vulnerable and low-asset population. ALM (Asset and Liability

Management) helps MFIs to assess, monitor and carefully manage financial risk associated with

this business.

Svasti’s asset quality is one of the best in the industry. The demonetization had its impact on the

collections in the initial two months but from January 2017 onwards, the collections have resumed

to its original levels.

• Percentage of NPL

NPL or Non-Performing Loans are when the borrower is not making interest payments or repaying

any principal. This is normally overdue by 90 days or more. MFIs normally set aside a bad loan

provision in the micro finance interest rate to cover future potential losses on these loans. In Q1

FY16-17 in India, PAR (Portfolio at risk) remained under 1%. This shows a high repayment rate,

as well as commendable asset quality. A low PAR not only reflects on the performance of MFIs in

India but reveals the effectiveness of peer monitoring in Joint-Liability group loans (primary model

in India). This gives confidence to new entries to the micro finance sector and considerably reduces

the financial risk and liability to MFIs, thus making it easier and possibly profitable to do business.

This is a win-win situation; both for the underserved communities to gain access to a platform

where it caters to their financial needs, as well as profitable businesses for firms.

• Disbursement growth

This reflects the number of loans disbursed in a financial year. 29% increase in loan disbursement

in 2016, as reported by MFIN (Micro finance institutions network) is a signal of rapid growth in

the microfinance industry. The 28% increase in the number of branches has increased the outreach

of micro finance firms (MFIN report). This is facilitated by a rapid increase in the employee base,

by 43%. This increase in outreach, facilitated by an increase in field activities directly proportionate

to the number of employees, as well as an increase in branches has increased the client base by

48% and 27% increase in the average loan disbursed.

• Operating expense ratio and borrowers per staff ratio

The operating expense ratio, directly reflective of the efficiency of the firm takes into account cost

of delivering loan services, specifically portfolio size, loan size, and staff salary costs.

The formula is as follows:

Operating expenses

Operating expense ratio = ---------------------------------- X 100

Average gross portfolio

The lower the operating expense ratio, the better the micro finance firm is performing.

The global average of operating expense ratio is 30%. The firm’s objective is to keep reducing this

ratio and increase profitability. The use of technology has helped in reducing the costs of delivery

and monitoring the various legs of the whole delivery process. This monitoring helps in timely

intervention in case of delays and and inconsistent behavior of the joint liability groups.

To measure productivity, we use number of borrowers per staff ratio. Borrowers per staff ratio is a

ratio that finds out the number of borrowers per employee working full-time. This is an indication

of the strength of the distribution platform of the MFI.

Number of borrowers

Productivity = ---------------------------------

Total staff employed

The global average of borrowers per staff ratio is 150 borrowers per staff.

7. Challenges facing the MFIs

Despite the growth of MFIs, this industry has faced many challenges from time to time. Some of

the challenges are highlighted below:

• Debt fatigue (multiple lending)

Due to several MFIs competing in one location, many MFIs tend to over-lend. For their private

benefit, they may lend to people not actually needing a loan. For this, MFIs may offer attractive

rates with favorable packages to make it favorable for people to borrow. As a result, in a household,

more money may be borrowed than actually needed. Consequently, due to unavailability of funds

or assets to offer, they may default. This is a primary reason to default in many of the areas where

several MFIs are located. There are restrictions placed by RBI which limit the indebtedness of a

household to Rs. 100,000 as of June 2017. Multiple lending or Debt fatigue can be witnessed in

the graph below, which peaked in 3rd quarter of CY2016.

Source:Motilal Oswal Report- Sector:

Financials, 23 May, 2016.

• Lack of business awareness and prospects

It is indeed difficult to enhance financial inclusion if there isn't awareness about prospects of

business in the near future. This is why people in these communities are usually reluctant to borrow

money to invest in their businesses. In my opinion, to enhance financial inclusion, it is essential

for MFIs to simultaneously increase business awareness. Giving them knowledge about what could

potentially happen after this investment in their business, with the possibility to yield greater

household incomes could entice many people to borrow money.

• Stiff Business targets in disbursements

The monthly target of Field customer relation managers that incentivize on-field employees to

maintain a specific number of customer groups to receive regular salary and above that level, to

gain bonuses. It can be argued that this target incentive-based salary package for on-field

employees(CRM’s) may increase the customer base at a faster rate than when there are no targets.

Also, employees are made more efficient in this way. However, a huge flaw in this target-based

salary package is the compromise in quality of these financial services. CRM’s may offer loans to

customers that may not need it, or provide to those who do not have the wherewithal to repay or

provide to two people of the same house. These instances listed above may increase defaults of

customers and reduce the repayment rate.

This could potentially violate RBI norms as well as lay customers into debt traps. It is known that

due to the problem of Debt traps, some people may even be depressed, and suicide (not covered by

insurance) may happen.

• Staff retention

Staff retention at the branch level is indeed a task for MFIs. In the case for Svasti, Customer

relationship managers working in the field may find it difficult for the first two months to cope up

with the amount of hard work put in to go to houses, collecting details, collecting instalments,

amongst others, at a very low salary. Therefore, many employees choose to leave the job, tired of

either the long working hours or the amount of traveling. To counter this problem, many MFIs

including Svasti take into importance employee engagements, incentive + fixed based salary

packages. Employee engagements include lunches with staff, annual day function held for staff etc.

Non-wage benefits could also be in the form of free family insurance of life or health.

• Interest rate changes

Repo rates changes are quarterly evaluated by the RBI. This changes the interest rate charged to

MFIs or their borrowing costs. As a result, the micro finance rates for MFIs change quarterly. This

frequent change of rates transmitting into changes in micro finance lending rates can lead to several

problems at the customer end as well as the back office. For customers, frequent changes can be

large enough to distort consumer behavior. Secondly, for administrative reasons too, updating new

micro finance rates on a quarterly basis will involve costs and time. If it is not updated on time, the

firm may have to suffer.

• Employee misconduct

Misconduct can be involved at various stages, from registering and collecting details to processing

the customer. This can range from intentionally mistyping data, intending to cause malicious

damage, or accepting bribes. Furthermore, while disbursement or collection, money can leak out

without any evident trace. To counter this too, it will be highly beneficial to mitigate these

situations by integrating this model with technology, so as to make everything transparent.

8. Impact of demonetization

Micro finance institutions in India have a history of downfall every 3 years. The shorter economic

cycles of MFIs reflect the higher risks involved in the industry. Demonetization, one of the most

acclaimed actions by the new government of India led by Mr. Narendra Modi, was the biggest hit

to MFI’s in India, since November 2016. It had a massive impact on the repayment rate,

specifically. As micro finance collections are largely in cash, it is one of the most vulnerable

businesses (due to demonetization) in the financial services space. Demonetization has caused

many households to default. This is partly due to several issues addressed here.

The disappearance of cash from the system impacted the small businesses much than the

organized sector. Since the MFIs unit of currency is cash, the business daily income got impacted

leading to lower collections and repayments. Many breadwinners of the family earned 6 months

of advanced salary in old currency on the day of demonetization. As these MFI’s would not

generally accept old currency, these households would not be able to repay back the instalments

for several months after demonetization. Especially, outside metropolitan cities like Mumbai,

MFI’s like Svasti are really facing challenges to recover money. Some were even waiting for new

currency in notes to repay the installments, however, this process took about one month. This

further compounded the problem.

Another major impediment to the growth of Svasti was a social media campaign

questioning the true motive/mission of these MFI’s. They publicly insulted MFI’s as a mere ‘Black

money business’. Average collection efficiency in the industry fell down to approximately 80%

from 99% pre-demonetization, disbursements slumped to 50%.

MFIs have recovered from this downturn that happened in November 2016. Several companies

have emphasized that they had spent significant amounts of money on awareness campaigns to

stress the importance of credit history. As customers realize the importance of maintaining a good

CIBIL score / good credit record to get access to future credit. It has engaged in awareness

campaigns, press notices, and extensive media advocacy to manage negative media reporting.

Source: Graph from Report by Motilal Oswal on 3rd July 2017

Source: Chart from Report by Motilal Oswal on

3rd July 2017

“Collection efficiency in Uttar Pradesh (UP) is back to 98-99% levels, up from less than 50% post

demonetization. Other major states like Karnataka and MP are also displaying much-improved

collection trends. PAR >90dpd in most troubled states, including UP, has dropped below 15%.

However, Maharashtra continues to witness significant delinquency pressures, with PAR >90dpd

at 17-20%” . (Source:Verbatim from Report from Motilal Oswal on 3rd July 2017)

Delinquency on the rise after demonetization

Another aspect that can impact MFI’s serving the rural areas is the recent government action to

waive off farm loans. Although I have no data to substantiate my claim, my feeling is that these

loan waivers are a moral hazard to the Indian economy and cultivate a bad credit culture amongst

the borrowers.

9. MFI’s role in alleviating poverty

It can be argued that these micro finance loans can generate returns from business expansion and

hence eventually increase the household incomes for the borrowers. These financial services

mitigate market failures, spurs micro enterprise growth and boosts the well-being of the borrowers.

These loans help to tackle problems of higher unemployment and minimal access to adequate

nutrition and education. These micro finance loans, not only does it encourage business expansion

so that it generates employment, but also increases purchasing power/household incomes in these

poor areas, improves access to sanitation, nutrition, and education.

Secondly, as these loans are offered to women, it encourages them to work too, thus

empowering women and fostering gender equality. This improvement of macroeconomic

indicators listed above can eventually help to raise standards of living and ultimately mitigate

poverty in the long run.

However, it is important to note that these services by micro finance firms are beneficial for them

only if the liability of the borrowers, i.e. micro finance interest rate (approximately 14% p.a) does

not exceed the profits attained from the investment undertaken from the loan.

10. Recommendations and Reflection

Based on my observations and interactions with the senior Management, employees, collections

staff, attending joint group meeting, I hereby recommend the following:

• Awareness campaigns

It is essential to disseminate financial literacy skills to these communities in order for them to be

fully aware and be able to understand the potential impact of these financial services in their

lives/businesses. If they are unable to understand the basic concept of micro finance and why loans

are helpful to provide an impetus in their businesses. I believe, tackling the mindset, informing

them of the preciousness of this investment is of utmost importance, in order to enhance financial

inclusion.

• Increase importance of credit history

Credit history is one of the most important factors, currently not stressed enough, in my opinion.

Credit history determines the credibility and affordability of a particular size of the loan. This

availability of past transactions history that will help you to determine the loan amount, or may

even be a decisive factor to refuse a loan. According to me, this is critical as this will considerably

reduce NPL (Non-performing loans), reduce PAR30, and ultimately increase the asset quality in

the market. This will help create a high degree of reputation in the market, and possibly be the

distinguishing factor in the industry. More importantly, this will allow bad loan provision to

decrease since the financial risk decreases, and hence ultimately decrease micro finance rates for

the firm.

• Make CIBIL score as the key decision maker

CIBIL, through extensive research on credit history based on its database, will be able to correctly

and most accurately assess the credibility and behavior to liability and hence be a part of the

decision making in the loan amount. Microfinance institutions may, for their private benefit, give

loans that do not match their credibility or affordability. As a result, that loan will be likely to

default and hence increase NPL. To prevent this, CIBIL score should be the final decider and also

should indicate the amount of loans that can be sustained by a borrower based on a particular CIBIL

score.

• E-KYC norms

If KYC is done online (e-KYC), it can considerably reduce operational costs. This will allow MFIs

to reduce their interest rates. This online platform will also make the process smoother, transparent,

and more efficient. This will reduce the need for employees working in the field, reduce the

already-high employee costs such as salary costs, employee engagements and other benefits such

as free insurance of their families. Furthermore, any leakages or briberies taken in the process can

be mitigated through this integration with technology. This will, considerably increase the

efficiency of the firm as well as reduce its costs, possibly increasing its profits.

Though this may greatly benefit the firm in terms of reducing its costs, on the contrary, this may

cause structural unemployment, and indeed affect the customer relationships with the employees.

Moreover, in this industry, as the understanding of the policies of repayment, joint-liability group

responsibilities are of utmost importance, integrating technology may have a huge opportunity cost.

These factors listed above will affect the repayment rate and asset quality of the firm.

By assessing the net benefits or losses for each of these procedural improvements suggested above

mathematically, MFIs will be able to know if these recommendations would potentially prove

sustainable and yield a greater level of profits.

Recommendations to reduce customer turn around time

The operational costs are higher as compared to banks and NBFCs. The use of technology has

helped in reducing the overall loan approval and disbursement costs. Use of cash is high, more in

the collection, and increases the operational cost. The efforts are to push the borrowers to deposit

their installment directly in the bank account. The higher spreads enjoyed by the MFIs takes care

of the higher operational costs. The use of technology, RFID technology is slowly reducing the

time taken for processing and application. It has also helped to store the documents electronically

and hence access them smoothly, thus allowing for more efficient risk management. OPEX costs

will decline rapidly, as a result of these changes. The Regional manager monitors the MIS and has

on-time data of the disbursements and the collections. This helps them to take quicker action on

any delays and inconsistencies.

I am confident that these steps will ensure rapid financial inclusion and will also improve the credit

quality thereby reducing the defaults.

Reflection

I have always been driven by thoughts of how I would converge Economics and technology.

Working with a company that gives me an opportunity to explore financial inclusion gives me

immense happiness and satisfaction, firstly because of my desire to scrutinize financial inclusion,

and secondly, because I wanted to gain an insight into how the professional world works. Most

importantly, this 3-week internship has brought me immense understanding of the company. I truly

understand now, how some experiences like these are impossible to replicate in the academic

domain of the classroom.

This internship has broadened my horizon of how I view the world and changed my perspective

and notions that I generated in the past years. I believe, more than anything, I have achieved an

understanding of how a business works, the unique concept of micro finance and

financial penetration. To conclude, I would like to once again take this opportunity to thank all the

people who have made this possible to give me this exposure.