Institutional Challenges in Micro Finance Sector

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1 Institutional Challenges in Micro Finance Sector By T.S.Anand Kumar 1, V.Praseeda Sanu 2 and Jeyanth K.Newport 3 Preamble In Indian Scenario, the present structure of microfinance technology reveals that it is poised for an economic transformation and livelihood restoration of the rural communities. Whereas the fact is obvious that there is gap in best practices in credit delivery, lack of product diversification, customer overlapping and duplications, consumption and individual loan demand with lack of mitigation measures, less thrust on enterprise loans, collection of savings/loans and malpractices by Self Help Groups (SHGs) and Micro Finance Institutions (MFIs) and highest interest rate prevailing in micro finance sector. All these are clear syndromes, which tell us that the situation is moving without any direction. The system does not any longer like to follow the traditional discipline and there is no Government Regulations to regulate the micro finance industry. On the contrary, microfinance practitioners (MFIs) are not seemingly prepared for commercialization but the situation is pushing them towards it, beyond their knowledge. There is no alternative to commercialization as it is the crux of competition. Competition here refers to the market share among the financial intermediaries that are targeting a market comprising customers having similar needs or wants. Clearly, to be successful, the Micro Finance Institutions marketing strategy must meet the customer s requirements. 1 Indian Association for Savings and Credit, I.A.S.C., Plot No. :9, 5 th Sarvodhaya Street, Opposite BSNL Towers, Ellis Nagar, Madurai , Tamil Nadu, India. 2 Indian Association for Savings and Credit, I.A.S.C., NMC XII/373/C, Rajatham, Convent Road, Neyatinkara , Trivandrum District, Kerala. 3 Indian Association for Savings and Credit, 57-A, Yesudian Street, Nagercoil , Kanyakumari District, Tamil Nadu, India. (jeyanthnewport@gmail.com)

2 The MFI that is onto microfinance delivery must effectively position itself against competition within the industry. Thus the importance of planning a marketing strategy is to find ways of effectively positioning the MFI against competition in the mindset of the customers. This, in other words, is to build an edge against the competition. In fact, the effectiveness of marketing programs depends on the reaction of both customer and the competitor. Also an MFI should frequently compare its products, prices, promotion and delivery of services with its close competitors to keep their market potential. Even though Microfinance institutions are driven by mere social commitment to combat poverty, the scale and performance of the microfinance sector is slowly approaching the banking system. Hence MFIs should focus their credit approach in a more marketoriented perspective. Microfinance Institutions Microfinance institutions are not a specific legal institutional form - typically, microfinance is considered a line of business. Among the Indian institutions offering microfinance services, there are Non-Government Organizations (NGOs), Private Foundations/Trusts, Cooperatives, Commercial Banks, Regional Rural Banks (RRBs), Local Area Banks (LABS) as well as specialized Non-Banking Financial Institutions (NBFCs) and Sec 25 Companies. Present Trend in Micro Finance Sector At present Reserve Bank of India is focusing on priority sector lending and hence banks have become more aggressive in lending to rural clients. Banks are regulated institutions having all infrastructures and reaching out to a substantial number of microfinance clients throughout India. Banks have well established internal controls, administrative and accounting systems to track large number of transactions, mobilizing private capital, trend to encourage sound governance structures, cost-effectiveness and profitability, all of which will lead to banks sustainability. Further banks can rely on their own sources of funds, deposits and equity capital and do not have to depend on scarce and volatile donor resources. They can offer a complete line of products, which is in attractive to a microfinance clientele with less interest rate.

3 The Pandyan Grama Bank, a regional rural bank in Tamil Nadu, sponsored by the Indian Overseas Bank, has become the best Regional Rural Bank in the country for the fiscal in extending credit to rural customers. According to the chairman, the bank, with its 168 branches in seven districts, was making a rapid progress in all parameters stipulated by its sponsoring bank. The bank had given loans to the tune of billion to thirteen thousand SHGs during against their yearly target of eight thousand SHGs. The Pandyan Grama bank has proposed to impart entrepreneurship development, training to members of the SHGs through agencies such as District Rural Development Agency and National Bank for Agriculture and Rural Development. The Pandyan Grama Bank is operating in seven districts in south Tamil Nadu, has proposed to set up separate micro-credit cell, in each district. The purpose of the bank is to enhance credit flow to the rural poor through self-help groups (SHGs) and joint liability groups, a new scheme to be implemented by the bank. The best example in Indian context of Nationalized Banks in Microfinance sector is the involvement of State Bank of India (SBI). The Chairman announced that SBI was targeting credit linkage to 0.2 million SHGs by the year and by 2008, it will link one million SHGs. As of now, it has extended billion to 181,000 SHGs. Recovery was close to 98 per cent and SBI is having plans to open 650 SHG cells in major branches to give focused attention to SHGs and introducing new loan products like `SAHAYOG NIWAS' (housing product) and 'SHAKTI' (insurance product) for SHG customers. Tamil Nadu Corporation for Development of Women has been established by the State Government to implement women development project by involving SHGs for their livelihood enhancement. The women membership has been increasing and as on , the membership has crossed 3 million women in 192 thousand SHGs. The women members of the Self Help Groups have mobilized a savings of 6.21 billion. Under this project, members of matured Self Help Groups are linked to banks for credit assistance. As on , 178 thousand SHGs have been linked with bank for a total financial outlay of millions for various economic activities such as Agriculture, Horticulture, Sericulture, Animal Husbandry, Cottage and Village Industries and other small businesses/micro enterprises in urban areas.

4 Also private bankers and corporates like ICICI., HDFC., Reliance, etc are coming in a big way to compete with the micro finance industry as the rural market is having huge potential for micro finance. There is no doubt that competitions will be more in the micro finance industry and hence small MFIs have to make customer specific strategies. The Micro Finance Institutions will henceforth have to bear in mind that they will not merely compete with themselves but also with other significant actors in the whole industry. Potential Competitors Other than the Banks and Regional Rural Banks the competition in micro finance sector is also from NGO-Micro Finance Institutions, Sec 25 companies and NBFCs. Nowadays focus of established NGOs is inclined towards microfinance activities for sustainability factor and also the priority of funding institutions. Even International Funding Organizations like CARE India, CORDAID, HIVOS, etc. are prioritizing micro finance activities for livelihood intervention through local NGO partners. Also Government Development Funding, Financial Institutions, even commercial Banks have opened up their financial lending activities to the NGO sector directly. The future competition level also depends upon the entry and exit barriers in Micro Finance Industry. In the case of NGOs there are neither clear-cut regulations nor entry/exit barriers for doing the microfinance activities in India. Hence depending on the capacity, many NGO-MFIs have initiated micro finance interventions with SHG model and also few MFIs have started lending to SHGs promoted by NGOs. In the case of Sec 25 companies the entry barriers are flexible as the initial capital requirement for floating a company is very low. In India, Sec 25 companies can be even floated with zero capital bases. Since Section 25 of Companies Act is non-profit in nature and also very flexible, many NGOs will float such type of companies in the near future. In case of NBFC registration under Sec 45 of companies Act, the act itself has an entry barrier, as the capital requirement is a minimum of 200 million. Corporates and industrialists will enter micro finance industry to tap rural markets under this registration.

5 Factors Influencing MFI Sustainability Since the competition will be more in micro finance industry in the upcoming years, the Five Fold Factors like Challenges in Interest Rate, Win Over, Marketing Strategies, Customer Feedback and Analysis and Marketing Audit have to be considered for catering to the needs of the rural customer need thereby sustaining the credit operations by Micro Finance Institutions. a) Challenges in Interest Rate In micro finance industry, the commercial banks charge 12% interest for the loan amount on a monthly diminishing method (monthly rest) for the principal loan amount outstanding. Hence the interest paid by a customer will be much less when compared to the flat interest method (annual rest) applied by the Micro Finance Institutions for their clients. In recent years, the SHG members are becoming aware of the latest prevailing rate of interest in the banking industry and have already started questioning the Micro Finance Institutions to reduce the interest rate. It is very difficult for Micro Finance Institutions to convince the SHG members by explaining their operational cost involved in the operations. Further competition will force Micro Finance Institutions to revise their interest rates towards survival. The pressure to lower interest rates may cause MFIs to look for ways and means to lower operational costs via efficiencies, technological innovations, etc. Hence MFIs who can use technologies and effective monitoring and management will be successful in lowering their interest rates will sustain in the industry. Those MFIs who are unable to lower their costs are stuck with high interest rates and eventually lose their client base. Hence interest rate will be a real challenge for the Micro Finance Institutions for their sustainable credit operations.

6 b) Win Over Competitiveness is a pre-requisite to remain in business. Competitors can be a resource rather than a threat; and hence MFIs can adapt and/or improve on a competitor's product to sustain their operations. In the competitive environment, developing creative means to increase operational efficiency is a must. As an example, some microfinance institutions have already experimented with credit rating systems and also have introduced palm pilots in the credit assessment process. The use of high-end information technology, however, has only started recently. It will play crucial role for the future success in the microfinance industry. Developing effective market research and marketing means is an additional key area of action to meet the challenges of competition. c) Marketing Strategies Microfinance like any other service businesses is more difficult to manage using traditional Marketing approach. MFIs require not only external marketing but also internal marketing mechanisms. Hence there is a felt need to motivate the employees and interactive marketing, to create employees skills in the service provider. MFIs planning to professionalize its services must deliver high touch as well as high tech in their delivery mechanisms. The Micro Finance Institutions can build an edge against the competition by means of adopting the Three Fold Marketing strategies to retain the customer base. i. Competitive Differentiation ii. iii. Product Differentiation Managing Service Quality

7 i) Competitive Differentiation Micro Finance Institutions frequently face difficulty of differentiating their services from those of competitors, particularly when the market is facing intensive price competition. The solution to price competition is to develop a differentiated offer, delivery and brand image. The offer can include innovative features to distinguish it from competitor offers. The customer expects loans for income generation/consumption/education/housing Micro Finance Institutions or banks. These loan products can be constituted under Primary Loan Service Package (PLSP). To retain customers and also for loan value addition, along with PLSP, the Micro Finance Institutions can add Secondary Loan Service Packages (SLSP) such as information dissemination on low cost housing technology, housing insurance for Housing customers, EDP trainings, market support services, etc to non farm loan customers and setting up agriculture clinics along with respective MFI branches to give technological inputs like soil testing, pesticides, yield seeds, fertilizers, drip irrigation, crop insurance, monsoon/rainfall insurance etc. to the agriculture loan customers. Also credit counseling and education/career guidance cell can be established in each branch for the education loan applicants. ii) Product Differentiation The marginal communities who are the customers of MFIs should be perceived as valuable customers. By designing products to the evolving needs of clients, the MFI can build client loyalty through customer service thereby increasing the customer base. This means that the financial services offered by a Micro Finance Institution must be designed in response to the needs and capacities of the clientele. MFI Terms and condition on loans, and repayment should respond to the particular needs and capacity of the client group. It is more important, that the products should be tested before launching in the market. Product testing is used to gauge the perception of the customers on the suitability and demand of the new products. This practice is yet to be made popular among the financial intermediaries.

8 Microfinance should operate at ever new frontiers facilitated by research and development leading to new products, demand and services in: Social security such as pension plan, life and health insurance Area Specific Loan Products (Loan for disaster, consumption, housing, education, micro-enterprise, Marriage etc and various poor- friendly savings products) Managing risk associated with natural calamities and personal/social disasters iii) Managing Service Quality The prime focus of MFIs to differentiate from Banks is to deliver consistently higher quality service. The key factor is to meet or exceed the target customer s service quality expectations in providing timely credit. The MFIs must change the attitude of seeing the borrowers as beneficiaries into customers. Further the MFIs should retain their customers from one time borrower towards permanent customers by taking into consideration of five determinants of service quality viz. reliability, responsiveness, assurance, empathy and tangibles. d) Customers' Feedback and Analysis MFIs should be tuned and responsive to the client needs by product evolution, financial viability, institutional soundness and social impact. For these reasons, marketing research has to be pursued and new product ideas should be explored surveying customer needs, reacting towards client demands and actions taken by competitors. This should be the basis of drawing a marketing plan and the way of serving the customers. A Micro Finance Institution can explore new opportunities through signals from the market about customers, competitors and overall environment in which the Micro Finance Institution operates. Customers can voice their demand in the form of direct feedback to credit supervisors or field workers or during group meetings for designing need based products.

9 e) Marketing Audit A financial intermediary like MFI may find that performance problems occur in regular frequencies. In fact, trying to deal with such problems the credit managers may neglect other important responsibilities. Realistically, marketing is one of the major areas, where rapid changes in objectives, policies, strategies and programs has to be reviewed and redesigned periodically. Because of the rapid changes in the marketing environment, each MFI should periodically assess its marketing effectiveness through marketing audit. Marketing audit is an in-depth assessment of marketing function to sustain micro finance interventions. Conclusion The Micro Finance Institutions should realize that real customer service through commercialization should be the bottom line for moving forward. In a competitive environment, customer satisfaction and commercialization should be the driving force for survival and growth. It is expected that competition will promote good governance and prudential management in MFIs, improve access to finance, more innovations and variety and pave the way for commercialization of microfinance sector. It is not a miss to conclude that the MFIs should consider the Five Fold Factors like Challenges in Interest Rate, Win Over, Marketing Strategies, Customer Feedback and Analysis and Marketing Audit as institutional challenges for catering to the needs of the rural customer need thereby sustaining the credit operations by Micro Finance Institutions.

10 References 1. Christen, R.P. (2006), Microfinance and sustainability: International experiences and lessons for India, in Towards a Sustainable Microfinance Outreach in India. New Delhi: NABARD, GTZ and SDC, pp Rangarajan, C. (2006) Microfinance and its future directions, in Towards a Sustainable Microfinance Outreach in India. New Delhi: NABARD, GTZ and SDC, pp Thorat, Y.S.P. (2006), Microfinance in India; Sectoral issues and challenges, in Towards a Sustainable Microfinance Outreach in India. New Delhi: NABARD, GTZ and SDC, pp Titus, M. (2006), Expanding secular growth: The role for innovations in microfinance, in Towards a Sustainable Microfinance Outreach in India. New Delhi: NABARD, GTZ and SDC, pp