Discussions on microfinance have shown shifts in emphasis over the years.  In the early days of microfinance, we were discussing the ways and means of augmenting self-help programs and just to extend the reach of credit.  Now, the emphasis is on total solutions and also on how to make this a working model for both the financing organisation and the beneficiary.  In some circles this is being viewed as a huge business opportunity as well.

A country like India surely needs a perfect system of microfinance.  It is not that there is a dearth of Government-sponsored schemes for the rural poor or those intended to boost agriculture and the cottage industry.  But, by and large, these schemes are concentrated on specific activities and the conditions for availing these facilities do not always meet the specific requirement of a rural trader.

Among the several questions that have been debated over the years, is the one of the correct type of organisation to meet this requirement.  Arguments have ranged from having a devoted co-operative system to having banks extend their wings in a more pronounced way.  The role of non-banking finance (NBFC) entities has also been examined by the regulators from time to time. In an economy that is developing fast as India, we certainly need a well regulated and  transparent system which would address the needs, the processes, the servicing and final benefit from financing in a schematic manner.  While a number of steps have been taken in this direction, there is still a lot to be achieved.

The ideal structure

Ideally the operations being predominantly banking, would require to be run by either the banking sector – as a wing of the commercial banking network or as a local bank, or by the co-operative sector by setting up several co-operative banks duly regulated, or by the non-banking financial institution.  The most ideal result would have been the Reserve Bank of India (RBI) permitting existing banks to spread their wings into this sphere.  However, questions of expertise, specific training and having a more local flavor have resulted in this not taking off.  Since the operations were money-oriented and one that would involve the possible “exploitation” of the rural poor, the RBI has had to be necessarily stringent in permitting operations in this area and as to capital requirements.  As a result this did not look like a good prospect in the beginning.

Since NBFCs seemed to be the ideal institution for this, RBI laid down stiff rules on capital requirement.  Strategically, India did not have adequate coverage in this area, but, the scope was quite large.  For an ordinary borrower to graduate and become the customer of a regular bank and conduct regular banking transactions, it would require a period of growth and financial stability.  This was not forthcoming in the short run for many.  Microfinance offered the way out.  The problems that remained then and to an extent remain now, is the structure and appraisal on the one side and servicing and final goal on the other side.

International experience also shows a transformation from the non-profit level to the profit level.  Sriram (2010)1 has dealt with this aspect in detail and specifically looked at the examples of certain companies abroad.

The real need

Now that we have come to a situation where microfinance is a major part of the economy’s financing arm, we need to go beyond mere regulation aimed at smooth running to a strategic approach.  Occasional waiver of farm loans or slowing down the recovery process alone will not do.  The aim ought to be to have a sustained system for meeting the real needs of the rural sector without affecting the fortunes of the institution concerned.

The estimated number of microfinance clients (including those under the self-help groups) will be around 50 million.  As stated by the Deputy Governor of RBI (interview published in Microfinance India, State of the Sector Report 2008 by N Srinivasan2), the growth may not be great from pure quantum of money angle, but, the growth in the number of beneficiaries is noteworthy.  It has been pointed out that this is only one part of the microfinance sphere.  In reality, microfinance will also include small savings and loan accounts sanctioned and serviced by the banking sector.  This and the numbers from post office savings and co-operative disbursements the figure might well exceed 100 million.

Before addressing the actual question of regulation, what the Government and the regulators would need to do is to have a realistic assessment of the real needs.  Here one has to go beyond the conventional answer of trying to give support during the production time or an inventory support for starting the trade.  A full-fledged approach paper would need to be drawn up for sections of needy individuals.  The approach paper should contain the full operations of the borrower, the timing of cash flows, the need for replenishment of working capital, the timing of interest payments and how the whole thing will become operational.  Actually, the blank approach would be to treat this as a miniature corporate loan in many ways.

Risk management

Sriram (2010) relates the practice followed by Grameen Bank which became the role model for emulation and further refinement by other bodies.  This involved identification of a specific customer and his needs and then organising them into groups which are similar in nature and wants.  Now products could be launched in a standardised manner to suit their needs.

The managerial issue involved is one of anticipating risks at the beginning and combating risks that come about in the middle.  Unless the organisations that are in this business are flexible enough to handle this professionally (as one would expect in a corporate environment), the full need cannot be met.

Suppose we are looking at the needs of a trader who wants to stock inventory.  The realistic assessment should take into account the quantity of stock needed, the time period that this will be in stock (inventory turnover), the collection period (DSO), and supplementary contingency requirements.  This is at the appraisal stage.  Now the funds may be released in one installment or in several based on actual estimated needs.  Again the emphasis is not on the estimation as given by the borrower, but, buy the realistic estimate as worked out professionally.

The onward review is more important.  The assessments as originally done would need review with time.  This is also because the borrower being poor could divert funds for other uses, things may not work out as planned or the original estimates might be too optimistic.  Now, the review could be in the nature of a supplementary loan, interest waiver or a total restructuring.  The solution does not lie here.  The solution has to be based on the workability of the projections from now on.

All this has given rise to a heartening development.  Several microfinance units are looking at their businesses as not a small enterprise for small people, but, are professionalising things by recruiting management graduates and involving themselves in detailed financial analysis.  Hopefully, this should give rise to the development of customised products and a monitoring system that keeps tracks of deviations before it is too late.

The outlook

Microfinancing is here to stay.  More and more beneficiaries by the year and more and more companies coming into the fray will all add to the growth of this sector.  The need of the hour is localized innovations and customization.  The system of financing should be robust enough to handle different challenges.  While the financial fundamentals and imperatives of the lending organisations cannot be relegated, one should not forget that the broad purpose of microfinancing is the poor resident in the rural area.  There is a need to address the question of greater transparency in the dealings of the microfinance units and bringing about confidence and trust in their policies.

Ultimately one can see more and more management initiatives coming into play in the future.  Financing will be based on a total requirement cycle and the entire chain of activities from manufacture to sale will need to be dissected and financed on a need-based basis.  This is easier said than done. We would need more models, which the end user appreciates easily.

One can also envisage the growth of separate ancillary awareness programs where the true philosophy of financing is brought home to the borrower.  All in all, one can say that the fact that there has been a great deal of increase in the number of participants shows a very positive trend, but, one would need to handle this growth with care so that it is sustained and orderly.

• M.S.Sriram (2010), Commercialization of Microfinance in India, A discussion on the Emperor’s Apparel, IIMA Working Paper Series (https://indiamicrofinance.com/blog/microfinance/microfinance-articles/commercialisation-microfinance-india-discussion-prof-sriram.html) ( site visited on 3rd May,2010)
• N Srinivasan (2008) Microfinance India, State of the Sector Report, 2008, Sage Publications

About the author: Dr. N.R. Parasuraman is the Deputy Director and Dean – Academics, SDM Insititute for Management Development at Mysore. He has published 25 papers in leading journals on various topics in finance and has also authored a book titled ‘Fundamentals of Financial Derivatives’, published by Wiley India, which was rated amongst the  top 10 management bestsellers by Business World.