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 td, 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 met 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 were 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 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: Chart from Report from Motilal Oswal on 3rd July 2017.

Source: Graph from Report from 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. MFIs 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.