Commercial Bank and Microfinance

The term microfinance (MF) refers to the provision of banking services to lowerincome people, especially the poor. In the history of MF, microfinance institutions (MFIs) have been the first to identify the large unserved demand for microcredit in developing countries, develop methodologies for delivering and recovering small loans, and begin credit programs for the poor. Given their nature, though, MFIs can normally meet only a fraction of the demand for microloans in their service areas. Commercial banks have begun to see MF as a potentially profitable business and are starting to venture into this field. . This paper aims at exploring the main aspects and future outlook in connection with commercial banks provision of MF services. A review is made of the incentives and disincentives for financial institutions to venture into the MF sector, and their specific advantages and disadvantages when competing in this market. A classification of the main operating models currently adopted by banks for entering the MF market is established as well as an analysis of the local regulations that could potentially apply to each of these models.

Status of micro finance in India:

Indian microfinance is basically driven by NABARD (National Bank for Agriculture and Rural Development). NABARD is an apex institution accredited with all matters concerning policy, planning and operations in the field of microfinance in India. Now as per this topic suggests and as per the role of NABARD in Indian microfinance sector, status of microfinance can be defined. Present scenario of microfinance states that With the small beginning as Pilot Programmed launched by NABARD by linking 255 SHGs with banks in 1992, the programmed has reached to linking of 69.5 lakh saving-linked SHGs and 48.5 lakh credit-linked SHGs and thus about 9.7 crore households are covered under the programmed, envisaging synthesis of formal financial system and informal sector. The major support provided by NABARD under Micro Finance Development and Equity Fund relates to promotion and nurturing of SHGs by Self Help Promoting Institutions and training and capacity building of the stakeholders in the Sector.
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NABARD is also experimenting innovative projects for further developing the micro Finance through Joint Liability Groups.

Role of Commercial bank in microfinance:

Banks in India have begun to enter the microfinance lending market, and many are partnering with regional microfinance institutions. Increasingly, loans as small as $100 are being made by mainstream Indian banks such as ICICI , HDFC , and UTI , and often contain unconventional covenants typical of microfinance transactions. Founded in 1977, HDFC had net income for 2005 of about $200 million and 24 rural partners. Recent partnerships include: Ujjivan , Bellwether microfinance fund, Avishkar-Goodwell Fund, Lok Capital, andActivists for Social Alternatives . Another example of a commercial bank that has partnered with local MFIs is ICICI, which has 72 such partnerships. ICICI Bank had net income in 2005 of about $500 million, and operates 614 branches and 2200 ATMs. Through about 100 rural partnerships, its portfolio of microfinance investments stood at $227 million and 1.2 million clients at year end 2005. A prominent partner of the bank is Spandana . The Andhra-Pradesh-based microfinance institution disbursed loans of $3.4 million in 2004 at an effective rate of 30%, of which 9.25% went to ICICI. In addition, in November 2005, ICICI tied up with the Grameen Foundation USA to create microfinance lender Grameen Capital India . ICICI has been micro lending since 2001. Mumbai-based UTI began in 1994, and is 72% publicly-owned. It had net income in 2005 of $104 million, and operates 450 branches and more than a thousand ATMs throughout India. In its Annual Report 2005-2006 , reference is made to increasing microfinance activities by offering new services to rural clients. UTI works closely with the Grameen Koota program, which has outstanding loans of $3.2 million, as well as SKS Microfinance of India.

Comparative Advantages of Commercial Banks in Microfinance:

At first glance, banks appear well positioned to offer financial services to everincreasing numbers of micro-finance clients and to earn a profit. Banks have several advantages over non-bank, micro-lending NGOs: They are regulated institutions fulfilling the conditions of ownership, financial disclosure, and capital adequacy that help ensure prudent management. Many have physical infrastructure, including a large network of branches, from which to expand and reach out to a substantial number of micro-finance clients. They have well-established internal controls and administrative and accounting systems to keep track of a large number of transactions. Their ownership structures of private capital tend to encourage sound governance structures, cost-effectiveness, and profitability, all of which lead to sustainability because they have their own sources of funds (deposits and equity capital), they do not have to depend on scarce and volatile donor resources (as do NGOs). They offer loans, deposits, and other financial products that are, in principle, attractive to a micro-finance clientele.

Obstacles for Commercial Banks in Micro-finance:

Banks lack, however, some key ingredients most of all, the financial methodologies to reach a low income population. Our study of banks in micro-finance identified at least six key related issues banks need to resolve to enter the micro-finance market successfully: Commitment: The commitment of commercial banks (particularly the larger banks) to micro-enterprise lending is often fragile, and generally dependent on one or two visionary board members rather than based solidly in its institutional mission. Organizational structure: Micro-finance programs need to be inserted into the larger bank structure in such a way that they have relative independence and, at the same time, have the scale to handle thousands of small transactions efficiently.
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Financial methodology: Banks need to acquire an appropriate financial methodology to service the micro-enterprise sector financial innovations that permit a cost-effective analysis of creditworthiness, the monitoring of a large number of relatively poor clients, and the adoption of effective collateral substitutes. Human resources: Given that micro-finance programs differ so radically from traditional banking, banks must recruit and retain specialized staff to manage these programs. Issues of recruitment, training, and perfor-mance-related incentives require special consideration. Cost-effectiveness: Micro-finance programs are costly because of the small size of their loans and because banks cannot operate them with their traditional mechanisms and overhead structures. Regulation and supervision: Banks must communicate with banking authorities to ensure that reporting and regulatory requirements take into account the specialised nature of micro-finance programmes.

Conclusion:
Microfinance sector has grown rapidly over the past few decades. Nobel Laureate Muhammad Yunus is credited with laying the foundation of the modern MFIs with establishment of Grameen Bank, Bangladesh in 1976. Today it has evolved into a vibrant industry exhibiting a variety of business models. Microfinance Institutions (MFIs) in India exist as NGOs (registered as societies or trusts), Section 25 companies and Non-Banking Financial Companies (NBFCs). Commercial Banks, Regional Rural Banks (RRBs), cooperative societies and other large lenders have played an important role in providing refinance facility to MFIs. Banks have also leveraged the Self-Help Group (SHGs) channel to provide direct credit to group borrowers. With financial inclusion emerging as a major policy objective in the country, Microfinance has occupied centre stage as a promising conduit for extending financial services to unbanked sections of population. At the same time, practices followed by certain lenders have subjected the sector to greater scrutiny and need for stricter regulation. This report, which contains only a part of the actual report is based on the research work done as a part of the summer internship project at Reserve Bank of India, Kanpur. The research involved study of the past literatures about the microfinance sector, related online research papers and journals. The study also involved survey
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of all MFIs in the state of Uttar Pradesh through field visits and online survey. The annual reports and the sector reports published by regulatory bodies, MFI associations and major microfinance players facilitated the study, especially in understanding the size, growth and past trends. Interactions with some of the industry experts helped in understanding and analysing the emerging concerns in the microfinance sector and also to look for some possible solutions. Although the microfinance sector is having a healthy growth rate, there have been a number of concerns related to the sector, like grey areas in regulation, transparent pricing, low financial literacy etc. In addition to these concerns there are a few emerging concerns like cluster formation, insufficient funds, multiple lending and over-indebtedness which are arising because of the increasing competition among the MFIs. On a national level there has been a spate of actions taken to strengthen the regulation of MF sector including, enactment of microfinance regulation bill by the Government of Andhra Pradesh, implementation of sector-specific regulation by Reserve Bank of India and most recently, release of Draft Microfinance Institutions (development and regulation) Bill, 2011 for comments. Based on the research work, a few major recommendations made in the report include field supervision of MFIs to check ground realities and the operational efficiency of such institutions. Offer incentives to MFIs for opening branches in unbanked villages, so as to increase rural penetration. Also MFIs be encouraged to offer complete range of products to their clients. Transparent pricing and technology implementation to maintain uniformity and efficiency are among the others which these institutions should adopt. Inability of MFIs in getting sufficient funds is a major hindrance in the microfinance growth and so these institutions should look for alternative sources of funds. Some of the alternative fund sources include outside equity investment, portfolio buyouts and securitization of loans which only a few large MFIs are currently availing.

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