CU -Sem II - Mcom -Microfinance Management

 Ledgerwo od, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006.  Rutherfor d, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 101 CU IDOL SELF LEARNING MATERIAL (SLM)

 UNIT -9 DEBT CAPITAL MARKETS FINANCING Structure 9.0. Learning Objectives 9.1. Introduction 9.2. MFI microloans and credits be financed in the debt capital markets 9.3. Requirements of the debt capital markets for MFI products 9.4. Role of rating agencies 9.4.1 M-CRIL`s Financial Rating 9.4.2 M-CRIL`s Social Rating 9.5. Summary 9.6. Keywords 9.7. Learning Activity 9.8. Unit End Questions 9.9. Suggested Readings 9.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Describe the relationship between debt capital markets & MFIs  Explain the Requirements of the debt capital markets for MFI products  State the role of rating agencies 9.1 INTRODUCTION In the past three years, international capital markets have awoken to the attractiveness of investing in microfinance. Approximately $500 million has been raised in one-off transactions –collateralized debt obligations, private placements and direct securitizations of microloans. In addition, private sector debt and equity microfinance funds have sprung up -- for investors who prefer to give discretion to professional managers-- and are now thought to control more than $2 billion. While traditional microfinance funders -- non-profit organizations, governmental development agencies and individuals -- are behind much of this surge of investment, the big change since 2004 is the introduction of private sector institutional investors seeking full market returns. These mainstream commercial investors, most located in Western Europe and the USA, are driving the opening of capital markets to microfinance. 102 CU IDOL SELF LEARNING MATERIAL (SLM)

How and why commercial mainstream investors have come into microfinance and the likely evolution of capital markets funding for microfinance is the topic of this paper. (Note that by “capital markets” we mean transactions or funds in which all or a major portion of the investment is raised from private sector institutional investors seeking fully risk-adjusted returns.) 9.2 MFI MICROLOANS AND CREDITS BE FINANCED IN THE DEBT CAPITAL MARKETS The debt moratorium given by the Reserve Bank of India till August during the covid-19 pandemic is a major relief for borrowers. This gives a breather for poor households facing wage cuts and job losses, but as research shows, could go on to disrupt the microfinance model of lending. In an Ideas for India article, Georgia Barboni of the University of Warwick and Misha Sharma of Dvara Research say microfinance institutions (MFIs) in India could be in trouble since they themselves have not got the moratorium from their own lenders, mostly banks. So the relaxation given to their borrowers could result in a liquidity crunch for them and credit ratings downgrades. A large share of poor households depends on small loans from MFIs. According to industry body Sa- dhan, around 85% of the borrowers have already opted for the moratorium by May-end. The mounting interests during the moratorium period pose a huge challenge for the sustenance and profitability of MFIs. In normal times, borrowers typically make repayments on a bi-weekly or monthly basis. The current situation can affect that repayment discipline and can also be mistaken as loan waivers by customers, the article says. Microfinance has been crucial in providing credit to the poor and the unbanked, but the scenario can result in MFIs pressurizing borrowers for repayments, the authors add. This could push poor households towards costlier and informal lending, thus getting into a debt spiral. In past crises such as the 2018 Kerala floods and demonetisation, the MFI sector recovered from the debt trap in six to nine months. However, this time, the sector needs to rethink its strategies and adopt technological solutions for collection of dues, maintaining customer relations and helping them plan repayment strategies, say the authors. 9.3 REQUIREMENTS OF THE DEBT CAPITAL MARKETS FOR MFI PRODUCTS Microfinance Institutions (MFIs) are in the process of diversifying their sources of funding by tapping the Non-Convertible Debentures (NCD) market. Though bank funding still contributes a larger share of funding for these MFIs, a growth in NCD issuances over the last few years has been the trend. 103 CU IDOL SELF LEARNING MATERIAL (SLM)

Data from IFMR Capital shows that in the last fiscal, MFIs had issued NCDs worth Rs 576 crore, recording a growth of 162% year-on-year while in the current fiscal they have already raised a little over Rs 300 crore. Bulk of the issuances are seen in the last quarter of the fiscal. “Their investments in long term NCDs issued by MFIs reflect the increased confidence in the microfinance sector by Developmental Finance Institutions (DFIs) over the last 6 months. The alternative source of funding will help MFIs diversify their borrowing sources, reduce concentration and meet their business plan requirements in a more efficient manner,” said Kshama Fernandes, CEO of IFMR Capital. According to data, during FY13 only 4 MFIs were able to secure funding through the NCD route while FY14 saw 17 MFIs issuing NCDs. NCD issuance as a proportion of total debt funding to MFIs has marginally increased from 3.4% in FY12 to 3.8% in FY14. However, NCD issuances in Q1 FY15 total almost 50% of the total volume of FY14 issuances. “Banks remain the dominant funding channel and enjoy priority sector lending benefit on their lending to MFIs. The NCD route for fund raising is relatively new and, at present, quite limited in its relevance to MFIs. It, however, does represent a significant shift in the funding strategy adopted by MFIs,” said Alok Prasad, CEO of the Microfinance Institutions Network (MFIN). 9.4 ROLE OF RATING AGENCIES M-CRIL was established in 1998 to mitigate investors’ lack of knowledge and experience of microfinance institutions (MFI) and to facilitate an increased flow of funds into the microfinance sector. The purpose behind setting up M-CRIL was both to sensitize the formal financial sector to the micro finance environment and also to assist prospective lenders and investors by providing a rigorous, standard and objective assessment of MFI creditworthiness. In a sector where rating was unheard of, the initial patronage of institutions like Ford Foundation, the Swiss Agency for Development and Cooperation (SDC) and Small Industries Development Bank of India (SIDBI) was critical to M-CRIL’s success. Over time, M-CRIL became well-known in South Asia, expanded to South-east Asia, and is now a knowledge partner of MFIs throughout the continent of Asia. M-CRIL has been instrumental in the recognition accorded to rating as a key factor in raising resources for microfinance. M-CRIL basically provides an assessment of the performance of institutions providing financial services to low income families, namely, microfinance institutions, NBFCs, rural and cooperative banks as well as commercial banks with a focus on micro-finance. This rating evaluates the creditworthiness as well as strengths and weaknesses of the MFIs or banks on a 10-point scale. It also assesses the risks associated with lending to the institutions. Evaluation of external risk, credit risk, market risk and the risk of fraud form the basis of its assessment. It also looks into the institution’s ability to effectively use grant funds received from various donors. The rating recommendations keep 104 CU IDOL SELF LEARNING MATERIAL (SLM)

in view the long-term prospects of the rated institutions, although the ratings are valid for one year only. M-CRIL periodically publishes a summary analysis of rating results in the M-CRIL Microfinance Rating Review. The MFIs rated by M-CRIL span a variety of organizational forms, from NGOs to cooperatives, NBFCs and commercial banks. The most important rating assignments undertaken include those from ADB, Blue Orchard, DFID, SDC, Hivos and SIDBI. It engages in constant introspection to improve its rating methodology and practices and is in regular dialog with other microfinance rating organizations to bring about a standardization in microfinance rating practices all over the world. M- CRIL and Micro Rate, the two largest microfinance rating agencies in the world went into an alliance to form Micro Rating International in February 2007. Together, they represent the largest pool of microfinance rating know-how covering 70% of the microfinance ratings conducted globally. Apart from providing financial advisory and business evaluation services, M-CRIL offers two types of rating services, namely, financial rating and social rating. 9.4.1 M-CRIL’s Financial Rating M-CRIL’s credit rating is a business information service for institutional and financial performance assessment of MFIs. M-CRIL aims to widen access to funding, complement regulatory oversight, to enable management to take corrective actions and enhance trust and market confidence in micro- credit sector. It uses a comprehensive rating tool comprising three categories of indicators: ■ Governance and Strategy: The evaluation depends on the nature of the board composition, its role and overall organizational strategy. ■ Management Systems: It is rated on operational efficiency, quality of human resources, value creation expertise of management, strength of accounting and management information systems. ■ Financial Performance: It is measured in terms of profitability, capitalization, liquidity, asset- liability management and efficacy of internal control system. 9.4.2 M-CRIL’S Social Rating M-CRIL has pioneered the concept of social rating in India in 2005. Most of the MFIs run with a social mission such as to provide financial services to the underprivileged who were previously excluded from the banking sector to support their micro and small enterprises but contributes to the empowerment of poor, especially women. But such mission statements are hardly backed up by evidence of whether they have actually been achieved. Social rating addresses this gap by contributing to greater transparency about what the MFIs achieved. M-CRIL’s social rating is an assessment of MFI’s missions, namely clarity, alignment of strategy and operational systems to the stated missions, social responsibilities and poverty outreach. External social reporting by MFIs and client feedback are compared for the assessment of their social performance. 105 CU IDOL SELF LEARNING MATERIAL (SLM)

By March 2008, M-CRIL had undertaken 525 financial and social ratings covering over 300 MFIs in 27 countries of Asia, Europe and Africa (M-CRIL, Annual Report 2007-OS). It has spread its operation in a host of countries such as Afghanistan, Azerbaijan, Bangladesh, Cambodia, East Timor, Georgia, Indonesia, Kazakhstan, Myanmar, Nepal, Sri Lanka, Philippines and Russia. M-CRIL has undertaken work for world’s leading organizations which include ADB, ILO, UNCTAD, UNDP, Ford Foundation, SIDBI and NABARD. 9.5 SUMMARY Debt Capital Markets (DCM) groups are responsible for providing advice directly to corporate issuers on the raising of debt for acquisitions, refinancing of existing debt, or restructuring of existing debt. These teams operate in a rapidly moving environment and work closely with an advisory partner – the Investment Banking Division (IBD). Being part of such a team means being extremely up-to-date on fixed income markets, including, bonds, treasuries, money market instruments, and more. Debt securities provide an income stream (hence the name “fixed-income”) as well as capital preservation (in most cases) for investors. The level of risk measured against the level of reward is something that all investors take into account when making investment decisions, and different investors have different risk tolerances. Some investors like the concept of high risk / high reward and seek out opportunities in the equity capital markets. However, for those looking for a lower risk, fixed-income investment, debt securities in the debt capital markets are usually more attractive. 9.6 KEYWORDS  Debt Service Reserve: - Term used to refer to cash reserves set aside by a borrower, either by internal policy or lender covenant, to repay debt in the event that cash generated by operations is insufficient.  Debt Service: - Amount of payment due regularly to meet a debt agreement; usually a monthly, quarterly or annual obligation.  Debt: - An amount owed for funds borrowed. The debt may be owed to an organization's own reserves, individuals, banks, or other institutions. Generally, the debt is secured by a note, bond, mortgage, or other instrument that states repayment and interest provisions. The note, in turn, may be secured by a lien against property or other assets.  Default: - A failure to discharge a duty. The term is most often used to describe the occurrence of an event that cuts short the rights or remedies of one of the parties to an agreement or legal dispute, for example, the failure of the mortgagor to pay a mortgage instalment, or to comply with mortgage covenants.  Default: - Failure to make timely payment of interest or principal on a loan, or to otherwise comply with the terms of a loan. 106 CU IDOL SELF LEARNING MATERIAL (SLM)

9.7 LEARNING ACTIVITY 1. What are the examples of debt financing? _________________________________________________________________________________ _________________________________________________________________________________ 2. How do microfinance institutions get money? _________________________________________________________________________________ _________________________________________________________________________________ 9.8 UNIT END QUESTIONS A. Descriptive Questions 1. State how MFI microloans and credits be financed in the debt capital markets. 2. Discuss Requirements of the debt capital markets for MFI products. 3. What is Role of rating agencies? 4. Explain M-CRIL’s Financial rating. 5. Describe M-CRIL’s social rating. B. Multiple choice questions 1. Who has made credit rating is mandatory for any debenture that has maturity of more than 18 months? a. Governm ent of India SEBI b. RBI c. IRDAI d. 2. How many credit rating agencies are there in India? Four Five a. Six b. Eight c. d. 107 CU IDOL SELF LEARNING MATERIAL (SLM)

3. What is the India’s first credit rating agency? a. CARE b. ICRA c. CRISIL d. ONICRA 4. Which organization is the main promotor of the CRISIL? a. ICICI Ltd & UTI b. SBI & PNB c. ICICI & SBI d. ICICI & PNB 5. ICRA is the India’s second credit rating agency, what is the full form of I in the ICRA? a. Investment b. Information c. Indian d. Investment information Answers 2.a 3.c 4.a 5.d 1. b 9.9 SUGGESTED READINGS  Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications.  Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc.  Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc.  Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India.  Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006.  Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 108 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -10 EQUITY CAPITAL MARKETS FINANCING Structure 10.0. Learning Objectives 10.1. Introduction 10.2. MFI microloans and credits be financed in the equity capital markets 10.3. Requirements of the equity capital markets for MFI products 10.4. Role of rating agencies 10.5. Summary 10.6. Keywords 10.7. Learning Activity 10.8. Unit End Questions 10.9. Suggested Readings 10.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the relationship between equity capital markets & MFIs  Describe the Requirements of the equity capital markets for MFI products  Explain the role of rating agencies 10.1 INTRODUCTION Equity capital is raised in many ways; the major types of equity capital are unlisted equity, listed equity and hybrids. Equity capital market practices traditionally advise on a full range of equity, debt equity-linked, hybrid, asset-backed, credit-linked and derivative products that are offered in capital markets. The equity capital market (ECM) is where financial institutions help companies raise equity capital and where stocks are traded. It consists of the primary market for private placements, initial public offerings (IPOs) and warrants; and the secondary market, where existing shares are sold, and futures, options and swaps are traded. 10.2 MFI MICROLOANS AND CREDITS BE FINANCED IN THE EQUITY CAPITAL MARKETS MFIs secure funding from a variety of sources, which depend in part on their status. In this way, money granted through microloans may come from: 109 CU IDOL SELF LEARNING MATERIAL (SLM)

 g rants and subsidies, particularly during the MFI’s creation, m ember and customer deposits, for MFIs organized as cooperatives or mutual funds, as well as microfinance banks that also offer savings products,  t he MFI’s own capital, generally supplying a small portion of funding,  l oans granted by one or more partner banks, f unding from public investors, typically comprising bilateral or multilateral organizations like the European Investment Bank (EIB), IFC, KFW, AFD, Proparco, etc. p rivate investors, supplied directly or through investment funds specializing in microfinance (microfinance investment vehicles, or MIVs), which serve as the intermediary between the MFI and investors searching for a socially responsible investment. The latter two options provide a source of long-term funding. 10.3 REQUIREMENTS OF THE EQUITY CAPITAL MARKETS FOR MFI PRODUCTS The microfinance sector in India as well as across the globe have made headway in capital markets because MFIs are expanding their operations and are moving into newer geographies, with a significant increase in their funding requirements. The ever-expanding businesses of the MFIs have directed them towards capital markets to tap into the mainstream investor community and to benefit from new funding opportunities available in the capital markets. There has been a sense of optimism among MFIs as well investors that MFIs can be part of mainstream investment activity. The continued flow of funds from the capital market and its participants into the microfinance sector is an indication that this sector is a potential source of profitable investment opportunities. The entry of the microfinance sector into capital markets would enhance the liquidity of investors by providing them with an alternative route to exit and by widening/diversifying their investment portfolio. For MFIs, their debut in the capital market would provide better and transparent governance. Unlike traditional asset classes, the microfinance sector is still not accepted as a reliable asset class due to the paucity or even absence of historical prices and performance information about MFIs. This lacuna would gradually be filled once market value information is generated by MFIs, since foraying into capital markets would require MFIs to maintain and manage such information for meeting statutory and 110 CU IDOL SELF LEARNING MATERIAL (SLM)

investor requirements. It will also set the benchmark for similar institutions looking to access capital markets and for potential investors. The increased emphasis on capital markets as the source for funding of MFIs can be attributed to two peculiar reasons. Firstly, the microfinance sector has given positive returns to investments made during an economic downturn; secondly, the overall industry trends for the microfinance sector are positive, and the microfinance industry experienced double- digit returns over the last 30 years. A comparison of the performance of the microfinance debt fund indices with that of the major indices for the period 2003–2013. The performance of microfinance funds compared to that of the other indices was quite impressive—annualised returns were 3.87% against volatility of 0.61%. Microfinance funds have established themselves as an alternative to money market plus strategies—they have low returns compared to global bond returns, but they are associated with lower volatility. 10.4 ROLE OF RATING AGENCIES Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations. Large bond issuers receive ratings from one or two of the big three rating agencies. In the United States, the agencies are held responsible for losses resulting from inaccurate and false ratings. The ratings are used in structured finance transactions such as asset-backed securities, mortgage- backed securities, and collateralized debt obligations. Rating agencies focus on the type of pool underlying the security and the proposed capital structure to rate structured financial products. The issuers of the structured products pay rating agencies to not only rate them, but also to advise them on how to structure the tranches. Rating agencies also give ratings to sovereign borrowers, who are the largest borrowers in most financial markets. Sovereign borrowers include national governments, state governments, municipalities, and other sovereign-supported institutions. The sovereign ratings given by a rating agency shows a sovereign’s ability to repay its debt. The ratings help governments from emerging and developing countries to issue bonds to domestic and international investors. Governments sell bonds to obtain financing from other governments and Bretton Woods institutions such as the World Bank and the International Monetary Fund. 10.5 SUMMARY The equity capital market is a subset of the broader capital market, where financial institutions and companies interact to trade financial instruments and raise capital for companies. Equity capital markets are riskier than debt markets and, thus, also provide potentially higher returns. Equity Capital Markets (ECM) is the team / group that is responsible for providing advice on equity, equity-linked 111 CU IDOL SELF LEARNING MATERIAL (SLM)

and equity derived products, including shares, futures, swaps and options. An ECM group will work closely with a client to organize transactions, structure the equity offering, and to improve valuation. 10.6 KEYWORDS  Empowerment: - Impact of design for political participation, legal awareness, ability to exercise personal and socio-political rights and freedoms.  Endowment or Trust: - A fund that contains assets whose use is restricted only to the income earned by these assets.  Environment: - Impact of programs on the natural environment, creation of environmental initiatives. This literature includes environmentally-focused loan funds.  Equity Participation: - An ownership position in an organization or venture taken through an investment. Returns on the investment are dependent on the profitability of the organization or venture.  Equity: - The value of property in an organization greater than total debt held on it. Equity investments typically take the form of an owner's share in the business, and often, a share in the return, or profits. Equity investments carry greater risk than debt, but the potential for greater return should balance the risk. 10.7 LEARNING ACTIVITY 1. What are Private Placements? _________________________________________________________________________________ _________________________________________________________________________________ 2. Why Secure a Rating? _________________________________________________________________________________ _________________________________________________________________________________ 10.8 UNIT END QUESTIONS A. Descriptive Questions 112 1. Discuss MFI Microloans. 2. Describe the equity capital market. 3. State the requirements of the equity capital market for MFI products. 4. Analyse the role of rating agencies? 5. Illustrate how MFI microloans and credits be financed in the equity capital markets. CU IDOL SELF LEARNING MATERIAL (SLM)

B. Multiple Choice Questions 1. How much percentage of the net credits of small finance banks should be in priority sector lending? a. 75% b. 25% c. 30% d. 70% 2. Which of the following was launched the first small finance bank? a. Capital local area bank b. Ujjivan small finance bank c. Disha Micro fin private Ltd d. Equitas Holdings Private ltd 3. What is NOT a potential limit of group lending? a. Monitoring group members can be costly for borrowers b. Group lending uses social sanctions instead of collateral foreclosure c. Group lending brings added risks for borrowers, those of others members’ default. d. Exclusion of all group members after one of them default is too harsh a punishment. 4. What does the microfinance model NOT predict: a a. homogen decrease in interest rates when repayment is regular and in time self- b. None of ous risk groups c. selection of the best borrowers d. these 5. What option block the poor to get bank loans? Absence a. 113 of collateral CU IDOL SELF LEARNING MATERIAL (SLM)

b. High rates of interest Complexi None of c. ty of procedure d. these Answers 1.a 2.a 3.b 4.c 5.a 10.9 SUGGESTED READINGS  Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications.  Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc.  Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc.  Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India.  Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006.  Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 114 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -11 MICROFINANCE INVESTMENT VEHICLES Structure 11.0. Learning Objectives 11.1. Introduction 11.2. MFI Investments as an Asset Class & Microfinance Investment Vehicle 11.3. Venture Capital (VC) 11.4. SME Social Impact Investing 11.4.1 Impact Isn't Isolated 11.5. Summary 11.6. Keywords 11.7. Learning Activity 11.8. Unit End Questions 11.9. Suggested Readings 11.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Describe the MFI investment vehicles in detail  State the concept of venture capital  Explain the SME Social Impact Investing 11.1 INTRODUCTION Assessing whether investments result in the desired non-financial performance is a key concern in the fast-growing field of impact investments, including microfinance. The social performance of the institutions that offer financial inclusion services to underprivileged populations has come under increasing scrutiny, whereas the social performance of the investment vehicles that in turn finance these institutions is researched less. Drawing on methods from empirical social science and the literature on non-financial ratings of firms, we develop formal quality criteria that the selection of individual social performance indicators and their aggregation into a single metric need to satisfy. 11.2 MFI INVESTMENTS AS AN ASSET CLASS & MICROFINANCE INVESTMENT VEHICLE  The MIV’s growth rates have been driven by active distribution, financial innovation, and high involvement from International Finance Institutions and the private sector; 115 CU IDOL SELF LEARNING MATERIAL (SLM)

 Economie s of scale appearing with 13 funds have total asset of more than US$20million;  The fastest growing MIVs are the largest and over 70% of growth comes from just 6 MIVs;  Geograph ically, MIV microfinance portfolio is heavily concentrated in Latin America;  Commerc ial MIVs tend to invest in debt financing;  The highest growth rates are registered by those MIVs which have better resource placement in MFIs;  There exists tremendous diversity. Only a small number are funds others are specialized investment vehicles like Collateralized Debt Obligation (CDO). Finally the study concludes with the trends and implications:  Shift to more commercial source of funding will continue and accelerate;  As MIVs grow they will have to deal with social investors seeking real double bottom line returns;  More information on MIVs would be required to compare performance and judge MIVs;  MIV’s are a fast growing industry with eagerness for microfinance which might result in increased bad investment decisions. The MIV (Microfinance Investment Vehicle) Rating provides an independent and expert opinion on: T he soundness of the MIV governance and structure to ensure stability and viability of the business T he consistency and adequacy of the investment approach of the fund, compliance with investor’s expectations and soundness of its risk management approach in relation to the investment strategy T he MIV distribution strategy, implied risk exposure and the stability of the funding structure T 116 CU IDOL SELF LEARNING MATERIAL (SLM)

he performance of the Fund in terms of profitability and efficiency T he MIV capacity to manage its social performance and the responsibility of its investments The MIV rating is an effective management and reporting tool that is used to:  E nhance reputation, accountability and transparency, build trust S trengthen institutional governance and decision-making, risk management, systems and performance  Q ualify for hedging accounts and transactions with MFX 11.3 VENTURE CAPITAL (VC) Micro venture capital is money invested to seed early-stage emerging companies with amounts of finance that is typically less than that of traditional venture capital. In contrast to traditional venture capital which is money used to invest in companies looking to fund growth (also referred to as a Series A round of funding), micro venture capital consists of smaller seed investments, typically between $25K to $500K, in companies that have yet to gain traction. In the United States, the number of micro venture capital firms have continued to rise rapidly over the last 5 years, and have become an important source of finance for startup companies. Micro venture capital generally shares certain characteristics:  I nitial investment at the seed stage  I nvestment on behalf of 3rd party Limited Partners  M ost commonly have fund sizes that are less than $50MM Most micro venture capital firms pursue startups that are at their seed stage because of their lower initial cost basis. Though there is a high probability that the majority of these startups will not survive long enough to reach a Series A round of funding, micro venture capital firms are willing to make the investment because startups generally do not require large sums of capital to bring a product to market, and because they believe that it requires only a few successful companies for them to see profitable returns. 117 CU IDOL SELF LEARNING MATERIAL (SLM)

11.4 SME SOCIAL IMPACT INVESTING Impact investors stand to leave a mark both by investing in fintech’s that provide software (or a platform) related to loan origination, underwriting, disbursement, monitoring and collection for SMEs, or by utilizing financial technology to directly invest in impactful SMEs. Unlike mobile money, this is a path appropriate even for retail investors, with companies like Rabble allowing socially-motivated startups to crowdfund from investors who purchase equity or debt securities. Figure 11.1 SME Social Impact Investing Some SME finance lenders may provide similar services to the microfinance institutions now past their prime, but the technological component of fintech fundamentally changes its reach. Between more granular data (which informs better decision making to more candidates) and decentralized, trust-less ledgers to bridge the supply chain credit gap faced by SMEs who are often parting with their product in good faith, the next frontier of SME finance far exceeds that which is currently possible by microfinance. 11.4.1 Impact Isn't Isolated Infrastructure uniquely underpins the potential of fintech, and Mobile Network Operators are key to scale. While traditional financial inclusion investments still require infrastructural inputs (like 118 CU IDOL SELF LEARNING MATERIAL (SLM)

physical branches and employees), fintech applications instead incorporate more remote (and internet facilitated) features. Mr. Wilson contended that many investors and companies not accustom to working in developing markets drastically underweight the friction caused by poor infrastructure. He cited the example of an East African company that developed a solar panel productized for an everyday consumer, but when first released, was financially out of reach for the average family. It wasn’t until later innovations in mobile money and pay-as-go financing were interwoven that the average African could afford the US$100 panel. The company subsequently became one of the largest solar companies in the region. Disentangling and grasping the underlying forces of a region, like infrastructure, is perhaps more crucial to impact investors than to regular investors. Durreen Shahnaz, Founder and CEO of IIX, an organization that has supported investors and enterprises in impact investing for over a decade, pointed out that, in contrast to investors that have no 'skin in the game' if their successful investment collapses two days after they pull their money, impact investing is much more focused on the long term: IX looks not only at innovative solutions that may bring greater financial inclusion, but also the long- term sustainability of those solutions in achieving the UN Sustainability Development Goals. For this reason, impact investors must first focus on fundamental social and environmental needs, and then see if there is a role for technology to play in solving those challenges. But these extra ecosystem challenges could also reap extra reward. Emerging market telecom infrastructure paired with investments in financial technology also offer a promising path towards financial return. Industry analysts have been warning of telco market saturation and praising opportunities in cross-industry partnerships (mobile payments, mobile health, etc.), so these frontiers where telcos are tied to fintech’s are prime investment opportunities. Unbridled eagerness on the part of fintech’s without proper due diligence, however, could be a recipe for disaster. Ameya Upadhyay, a Principal at Omidyar Network, emphasized that while there are obvious opportunities for fintech startup-mobile network operator partnerships, fintech’s must approach such opportunities mindfully. The sales cycles of MNOs often outlive fintech startups’ cash flows, and the difference in size and influence gives the MNO leverage (even entrepreneurs just cinching a meeting with MNO decision makers is difficult). If fintech’s can understand the contingencies of such partnerships, Mr. Upadhyay sees potential for very productive innovation. 11.5 SUMMARY F oreign capital investment in microfinance is surging. Cross-border investment has more than tripled in the last two years to reach US$1.4 billion in 2006. Two main players are driving this phenomenon: international financial institutions (IFIs)-the private-investment arm of public 119 CU IDOL SELF LEARNING MATERIAL (SLM)

development agencies-and private investment funds, known as microfinance investment vehicles (MIVs). I FIs have played an important role in commercializing microfinance by providing seed capital to young microfinance institutions (MFIs) and bridging the gap between grant funding and domestic funding. IFIs were behind the creation of most of the early MIVs, which offered IFIs a more efficient way to invest in the sector than direct MFI investments. Now, MIVs are gaining ground and finding other investors, including private investors. A new CGAP survey shows that while IFIs’ microfinance portfolio (including investment in MIVs) more than doubled from US$1 billion in 2004 to US$2.3 billion in 2006, MIV portfolios grew more than threefold during the same period, from US$600 million to US$2 billion. T his note summarizes the survey findings and explores the implications of the rapid growth of MIVs for the microfinance industry. This Brief is based on two studies conducted in the last quarter of 2006: a CGAP study on IFI microfinance portfolios and a joint CGAP-Micro Rate research on MIV trends. S mall- and medium-sized enterprises (SMEs) are considered to have potential innovation capabilities and can create new market opportunities. Venture capital can financially support entrepreneurial activities for economic growth and governs and nurtures the growth of the SMEs. The aim of this study is to investigate the influence mechanism of venture capital on the development of SMEs in agri-food industry. Based on the enterprise growth theory, this study constructed an evaluation model, consisting of technological innovation, profitability, development capability, and solvency, to examine the effect of venture capital on the growth of agricultural SMEs. Using data of 40 agricultural SEMs from the SME and ChiNext boards in China, the empirical analysis has been conducted with the multivariate regression analysis method. The results show that the venture capital can significantly improve the technology innovation, profitability, and growth ability of SMEs. For the solvency of SMEs, the promoting role of venture capital is not obvious. T his review created an evaluation model to investigate the impact of venture capital and the share ratio of venture capital on the growth of SMEs in agriculture based on enterprise growth theory. These findings can help the entrepreneurs of SMEs set a reasonable development plan to attract venture capital. We found that the venture capital in China has its own 120 CU IDOL SELF LEARNING MATERIAL (SLM)

characteristics in selecting investee and promoting the development of SMEs. First, the venture capitalists prefer to invest in large-scale SMEs with stable operation, low debt ratio, low ownership concentration, and stable returns. Second, the venture capital can improve the technological innovation, the profitability, and the development ability of SMEs. Third, the venture capital has no significant impact on the solvency of SMEs. 11.6 KEYWORDS  Gross Loan Portfolio: - All outstanding principal for all outstanding client loans, including current, delinquent and restructured loans, but not loans that have been written off. It does not include interest receivable. It does not include employee loans.  Group Lending: - Grameen lending is a well-known form of group of groups lending. It utilizes a combination of peer group methodology and village banking.  Group Lending: - Lending mechanism which allows a group of individuals - often called a solidarity group - to provide collateral or loan guarantee through a group repayment pledge. The incentive to repay the loan is based on peer pressure - if one group member defaults, the other group members make up the payment amount.  Guarantee Fund: - Also known as bridge funds. A guarantee fund can provide the organization's initial access to the formal financial sector, strengthen the organization's capabilities as financial intermediaries and provide important leverage in terms of lending capability.  Guaranteed Loan: - A pledge to cover the payment of debt or to perform some obligation if the person liable fails to perform. When a third party guarantees a loan, it promises to pay in the event of a default by the borrower. 11.7 LEARNING ACTIVITY 1. Write note on investment vehicles. _________________________________________________________________________________ _________________________________________________________________________________ 2. Write a short note on MIV rating _________________________________________________________________________________ _________________________________________________________________________________ 11.8 UNIT END QUESTIONS A. Descriptive Questions 1. Illustrate Venture Capital with relevant examples. 121 CU IDOL SELF LEARNING MATERIAL (SLM)

2. Explain SME Social Impact Investing Commerc 3. Describe MIV? 4. Explain the concept of MFI Investments as an asset class. Debt Equity B. Multiple Choice Questions (MCQs) Capital 1. All of ial MIVs tend to invest in ________ financing. a. b. c. d. these 2. The highest growth rates are registered by those MIVs which have better resource placement in MFIs a. True b. False 3. Initial investment at the seed stage a. True b. False 4. Most micro venture capital firms pursue start-ups that are at their seed stage because of their __________ initial cost basis. a. Higher b. Reasonab le c. Lower d. None of these 5. Initial funding is also referred as ________ round funding 122 CU IDOL SELF LEARNING MATERIAL (SLM)

Answers: a. Series I b. First 1. c. Series A a d. None of these a 2. 3. a 4. c 5.c 11.9 SUGGESTED READINGS  Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications.  Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc.  Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc.  Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India.  Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006.  Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 123 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -12 MEASURING SOCIAL IMPACT Structure 12.0. Learning Objectives 12.1. Introduction 12.2. Measuring social and welfare impact of microfinance 12.3. Limits and biases of such measurements 12.4. Measurements suggest about microfinance and its impact and future 12.5. Summary 12.6. Keywords 12.7. Learning Activity 12.8. Unit End Questions 12.9. Suggested Readings 12.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Describe measuring social and welfare impact of microfinance  State the limits and biases of such measurements  Explain the measurements suggestions about microfinance and its impact and future 12.1 INTRODUCTION Analysis of the poverty emphasis of microfinance is almost exclusively focused on the direct impacts on microfinance clients. The Imp-A CI programme emphasizes the need to also consider the 'wider impacts' achieved through non-client beneficiaries of microfinance. To fully understand and achieve the social impacts to which microfinance aspires wider impacts need to be assessed and programmes designed to achieve these outcomes. This volume introduces methodologies. In most cases developed by practitioners, which measure these wider or 'social' impacts and use the results as a point of departure for understanding what institutional and policy interventions are required to make them more pro-poor. The principal wider impacts discussed are health, community governance, postwar reconstruction, labour and finance markets and. in relation to Bolivia and Indonesia, the economy as a whole. We represent research into such wide impacts as a public good which is beneficial for all microfinance institutions (MFb)-in particular for their public relations·-,md for the poverty impact of the sector as a whole. but which the individual institutions typically do not have the resources to assess. This indicates a clear role for donors. 124 CU IDOL SELF LEARNING MATERIAL (SLM)

12.2 MEASURING SOCIAL AND WELFARE IMPACT OF MICROFINANCE Some important new initiatives, however, have explored social aspects with a new definition of social performance that includes impact as the end-goal, but specifically unpacks the steps and practices taken to get there. The focus shifts from proving an end result to managing and reporting on those steps that are likely to lead to positive social outcomes. Social performance is seen not only as a result but as the process of achieving that result—and this can be reported on. The two main initiatives behind this shift are the Imp-Act program and the CERISE Social Performance Indicators Initiative (SPII).The Imp-Act program set out to establish what MFIs could do to improve (and prove) their impact. Social performance was defined as the effective translation of an institution’s mission into practice. This definition emphasizes that social performance is not only the end result (the impact) but a deliberate process of getting there. It reflects the concept of an impact pathway (derived from the conceptual framework for impact assessment research), anchored in mission and leading to change, but contains several steps to work through so as to achieve change systematically (i.e., ‘put into practice’). The impact pathway can be represented as an arrow, with the main shaft representing the MFI’s governance, management, and strategic systems—the process; the arrow head represents the results: reaching target clients, meeting clients’ needs in line with their capacities, and ultimately achieving impact (see figure 1). The arrow points in one direction, but there is an iterative flow of information about the results (represented by the dotted line in the figure) feeding back into decision making. This enables an MFI to keep track of whether it is achieving its social mission and objectives, and contributes to an overall process of social performance management. The CERISE approach adopts the same MFI-centered definition of social performance, but adds objective concepts of social value (improving the lives of poor and excluded clients and their families and widening the range of opportunities for communities) and social responsibility (to clients, communities, staff). These may not be explicitly spelled out in an MFI’s objectives, but are assumed to be implicit and to have broad applicability, whatever the MFI’s stated goals Social Value in Microfinance The social value of microfinance relates to:  i mproving the lives of poor and excluded clients and their families; and  w idening the range of opportunities for communities. To create this value, the social objectives of an MFI may include:  s 125 CU IDOL SELF LEARNING MATERIAL (SLM)

erving an increasing number of the poor (and people excluded from financial and other services) sustainably, and expanding and deepening outreach to poorer people; i mproving the quality and appropriateness of financial services available to the target clients through a systematic assessment of their specific needs; d elivering such services in a cost-effective way that offers low fees and fair interest rates on loans and deposits; c reating benefits for the clients of microfinance, their families, and communities, that relate to social capital and social links, assets, reduction in vulnerability, employment creation, income, access to services, and fulfillment of basic needs; i mproving the social responsibility of the MFI towards its employees, its clients, and the community it serves; and m onitoring and acting upon unintended negative side-effects of microfinance, such as over- indebtedness and multiple loans. 12.3 LIMITS AND BIASES OF SUCH MEASUREMENTS Limits of Micro finance Measurement Harsh repayment criteria In the absence of the legit working protocol and compliances, Microfinance Companies could adopt a harsh repayment approach that someone would not prefer in the state of the financial crisis. Easy debt never comes with relaxed conditions, and that is something true with microfinance companies as well. Since these companies work under strict compliances, they could manipulate their customer for repayment unethically. Small Loan amount Unlike mainstream financial banks, Microfinance Companies offers a smaller loan amount. Since these banks don’t ask for collateral against the credit, the disbursement of the large loan amount is practically impossible in their case. 126 CU IDOL SELF LEARNING MATERIAL (SLM)

High-interest rate Another problem with Microfinance Companies is that they were unable to render low-interest based loans. This is because they don’t follow traditional banks’ footprint, where the accumulation of funds is easy. Plus, they have to borrow money from these banks to execute appropriately and allocate some part of it for risk management. Hence operating cost per transaction is quite high for them despite the high volume of transactions per day. Unlike banks, the microfinance institution accumulates funds through private equity to render financial services. This primarily implies that these firms are under relentless pressure to create more profit for their investor, consequently forcing them to crank up the interest rate. Biases of measurement of microfinance Microfinance literature includes many studies on the effects of microfinance on female customers. Little knowledge exists, however, on whether bias towards women is good business for MFIs. The study uses a global dataset of 379 MFIs in 73 countries to investigate what characterizes MFIs that have a gender bias and how this bias affects various aspects of financial performance. Results indicate that gender bias: Is associated with group lending methodologies, international orientation, female leadership and non- commercial legal status; Is significantly associated with lower portfolio-at-risk and smaller loans; Does not significantly affect overall profitability measures. These findings suggest that, from a financial perspective, focusing on women has positive and negative implications. Women repay better, thereby lowering MFIs' risk and increasing profitability. But MFIs that focus on women usually distribute smaller loans, increasing operational costs. Therefore, MFIs with a female focus have, on average, similar overall profitability measures. 12.4 MEASUREMENTS SUGGEST ABOUT MICROFINANCE AND ITS IMPACT AND FUTURE In this collection, then we pursue the Ford Foundation's 'objective of seeking to understand and internalize processes by which microfinance influences social well-being, but with a focus on social or wider impacts which go beyond the immediate client, and on methodologies which may enable these impacts to be more accurately measured. In some cases (income. health, poverty), attempts to measure the impact in question have already been made in the literature. But as far as we are aware. In many ways. the results of these enquiries into wider impact give grounds for encouragement. 127 CU IDOL SELF LEARNING MATERIAL (SLM)

Halder and Mosley. Mosley and Rock, anu Velasco and Marconi, this issue. in particular. produce evidence of indirect impacts of microfinance on poverty. These operate through the following mechanisms:  Institutional inspiration (Halder and Mosley, this issue)-the innovative lGVGD scheme of financial services for the ultra-poor in Bangladesh (food aid, then a combination of mandatory savings and training in a low-input enterprise, then a small loan to support that enterprise) has provided ideas at no cost to other MFIs in Bangladesh and elsewhere wishing also to focus on the ultra-poor: E ncouragement of participation in community solidarity networks and political activities & social spillovers – This can take many forms. Olejarova et (II. (this issue) examine, in Russia and eastern Europe, the process by which mutual support between microfinance clients-which may or may not originate in trust groups of loan recipients-can extend outside the group of clients in terms of both membership and function, so that, for example, a group formed to receive loans finds itself also campaigning collectively for better public services or fighting local-level corruption - in the process benefiting many who are not microfinance clients. It is also possible for microfinance services which have a protection function, for example savings and insurance, to stabilize income at the community level, and the beneficiaries from this will be not just clients. but all investors who face a more stable level of demand (see for example Mosley, 2003); D erived demand and other economic spillovers (Mosley and Rock, this issue)-labour market impacts-specifically the hiring of poor employees by microfinance clients who are generally above the poverty line -add an important 'multiplier' to direct impacts mediated through clients, whose size depends on the propensity of loan assisted firms to take on low-income labour; P rovision of public goods in particular counter-cyclical influence (Velasco and Marconi, this issue). A few microfinance institutions-in Bolivia. mainly those using an 'integrated' model of microfinance service provision-have been able to assist micro enterprises to maintain an increased level of output and investment through the recession, and ill this way to lead the macro economy out of recession and provide a buffer against the continuing instabilities in the global economy. This is the 'widest impact' of all, and has potentially significant implications for finance industries as well as for regulators and lending institutions; but it appears, for reasons explained in Marconi and Velasco's essay, to vary between country cases--countries with a stronger savings and manufacturing base, and tougher political defenses against would-be defaulters, such as Indonesia, would appear to be in a better position for their micro finance sectors to provide a counter-cyclical impulse. But there are institutional design factors at work as well, and for philanthropic MFIs one of the pleasantest ironies of this volume will he that in the recent 128 CU IDOL SELF LEARNING MATERIAL (SLM)

Bolivian economic crisis, it is the financial institutions most driven by a naked profit motive-the consumer-credit houses-which have perished, and those motivated to live by a law beyond that of the market (in other words, to maximize 'wider impacts’)-the village banks-which have prospered. 12.5 SUMMARY T he first and most obvious action point from these essays is that if we are to understand wider impact and, therefore. possibilities for more effective action by microfinance against poverty, a mechanism for incentivizing MFIs to be involved in assessments of such external effects is needed. That this will be difficult is indicated by Khalili, who writes bluntly that even conventional impact assessments (which examine only effects experienced by clients, are much cheaper) are seen as 'donor-driven and useless from the point of view of practitioners'. A fortiori, the market will not produce assessments of social impact, because they are not profitable to any individual. And yet, we argue, such assessments are absolutely essential if any microfinance institution is to understand or publicize, or learn from. its social impact or if any sponsor is to properly understand the possibilities and comparative advantages or different instruments in the fight against poverty. Are these assessments just a classical 'public good’? Valuable to all but beyond the means of any individual institution, only to be produced by large charitable not-for-profit organizations such as the World Bank and the Ford Foundation? Encouragingly the range of lion-profit organizations which can wish to produce or commission such assessments is expanding, and now includes many Southern not-for- profit organizations such as BRAC (the author or co-author of three studies in this collection). In addition, in many environments in both North and South the not-for-profit sector is growing at the expense of the commercial sector, and so the question becomes how to persuade larger parts of the voluntary sector to produce assessments such as this on a regular basis, so that they convert from one-off exercises into a process of social impact monitoring. In some places there is evidence of this beginning to happen, often through the agency of networks of voluntary sector organizations. One place this is happening is Bolivia, and the article by Velasco and Marconi. In this issue, is the product of a co-authorship between the director of one such network (FINRURAL) and the director of a highly successful local MFI (ProMujer). In the end. progress in this area depends on NGOs being convinced that producing public goods or this kind is a useful way of advancing their corporate objectives. A bottleneck for MFIs to undertake impact assessments on a regular basis is lack of research capacities. Developing such capacities requires both commitments on the part of the organization’s and long-term investments of resources. As many MFIs are simply not resourced enough to make such an investment. the donors have a definite role to play in supporting the provision or this sectoral (if not global) public good. BRAC in Bangladesh, for 129 CU IDOL SELF LEARNING MATERIAL (SLM)

example. has been investing in developing its research capacities since its inception in the early 1 970s. One innovative funding mechanism it followed it by earmarking a certain proportion (2 to 4 per cent depending on the size of the project) of its budget for research (Strom, 2(00). A second important lesson is that complimentary (ire crucial, and that the size of wider social impacts is often determined by a crucial trait of institutional design or government policy. Two examples: (I) the poverty reduction impact of microfinance depends on the propensity or loan-assisted firms to take on low-income labour (the example of Uganda is illustrated in Mosley and Rock, this issue). which depends on wages and transactions costs in labour markets, which depend on complementary government policies such as infrastructure and smallholder agriculture. (2) the extraordinary growth and diversification of the microfinance and ~mall business sector in Bolivia in the 1990s would not have been possible without the proactive efforts of the regulatory authority, the Superintendencies de Bancos. in enabling non-profit MFTs to convert themselves into deposit-taking institutions (Johnson. in this issue, also Rhyne, 2002). 12.6 KEYWORDS I mpact Level: - The systemic level at which change can be quantified or qualified implying causality. I mpact/Target Market: - This category investigates the effects of programmatic activity on specified client populations. It also includes how to design programs for a specific client group. I ndigenous Populations: - Focusing on the unique micro financial needs of First Nations, Native Americans and Aboriginal populations. I ndividual Lending: - Single-client lending where repayment relies solely on the individual. 12.7 LEARNING ACTIVITY 1. What is the impact of Microfinance on living standards, empowerment and poverty alleviation of the poor people? 130 CU IDOL SELF LEARNING MATERIAL (SLM)

_________________________________________________________________________________ _________________________________________________________________________________ 2. Why does microfinance focus on women? What are the reasons for promoting women's participation in microfinance programs? _________________________________________________________________________________ _________________________________________________________________________________ 12.8 UNIT END QUESTIONS 1. State the limits of measurement of microfinance. 2. Discuss Welfare impact of microfinance. 3. Analyse social impact of microfinance. 4. List impact of measurement about microfinance. 5. Discuss the biases of measurements of microfinance. B. Multiple Choice Questions 1. Which of the following statements related to Micro Finance System is wrong? a. It provides micro credit having scope for small savings and remittance of funds It based High b. None if on the principle of livelihood creation c. volume of low transactions done through system d. wrong 2. Loans to poor people by banks have many limitations including lack of security and high operating cost. So to help them which type of finance system developed? a. Ponzi schemes Micro Money b. Money finance system c. laundering schemes d. tempering finance 131 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Which of the following are loans of very small amounts given to low income groups or poor household? a. Simple Credit Rural Micro b. No Frills credit c. Credit d. loan 4. Micro credit or micro finance is a novel approach to bank with the poor. In this approach bank credit is extended to the poor through which of the following? a. Self Help Group Anganwa Co- b. RBI dees c. operative Credit societies d. 5. What is NOT a source of difficulty in the estimation of the impact of microfinance projects? a. We do not observe what would have happened in absence of the microfinance project b. Participan ts systematically doffer from non-participants in their propensity to benefit from micro- finance c. Microfina nce programs are not located randomly, they are often located in disfavoured areas d. Microfina nce programs are often targeted to women Answer 2. b 3. c 4. a 5. d 1. d 132 CU IDOL SELF LEARNING MATERIAL (SLM)

12.9 SUGGESTED READINGS  Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications.  Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc.  Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc.  Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India.  Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006.  Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 133 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -13 MFI MICRO INSURANCE Structure 13.0. Learning Objectives 13.1. Introduction 13.2. Characteristics 13.3. Challenges 13.4. Benefits of making microfinance a mandatory product 13.5. Summary 13.6. Keywords 13.7. Learning Activity 13.8. Unit End Questions 13.9. Suggested Readings 13.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Explain State the  Give the term micro insurance in detail List the  characteristics of micro insurance  details of the benefits of making microfinance a mandatory product  challenges in micro insurance 13.1 INTRODUCTION Micro insurance can boost resources for the rural poor, governments, and private sector. The entire economy gains as the insurance industry matures further, as well. There is robust need for micro insurance in India's poverty reduction strategy. With insurance, the vulnerable can prepare for an adverse event before it occurs, instead of being paralyzed by shocks afterwards. Micro insurance also increases the likelihood that the poor eat well, have health access, and send their children to school, since they would not have to save as much for emergencies. Potential clients would typically earn around $2 a day or even less. Six key areas, which need to be addressed to propel micro-insurance is - 134 CU IDOL SELF LEARNING MATERIAL (SLM)

1) D emand and supply P P 2) D roduct design P R 3) ricing 4) istribution and outreach 5) rocedure 6) egulation. 13.2 CHARACTERISTICS 1. P hysically accessible 2. I ntellectually accessible: Simple, easy to understand policy document 3. F inancially accessible: Small premiums that accommodate irregular cash flows 4. M ake the intangible tangible 5. B roadly inclusive, with few if any exclusions 6. S mall sums insured, often for short terms Small sums insured, often for short terms 7. P re-underwritten, community or group pricing 8. D istributed through alternative channels: aggregators 9. “ A t” t th ti t “Agent” aggregators may manage the entire customer relationship, premium 135 CU IDOL SELF LEARNING MATERIAL (SLM)

collection, claims payment O D 10. B ften integrated with another financial transaction 11. esigned to minimize claims rejections 12. ottom of the pyramid business model: small margins, large volumes 13.3 CHALLENGES 1. D istribution that reaches large numbers of low income households, and has their trust income households, and has their trust 2. I nvolving the market in designing simple products 3. E ducating the market 4. M aking insurance tangible to all, and beneficial to those who do not claim 5. M aximizing efficiencies. 6. R eaching huge numbers of people and keep them Reaching huge numbers of people, and keep them 7. E ncouraging claims! 8. D eveloping appropriate institutional arrangements that are viable and provide value to the poor 13.4 BENEFITS OF MAKING MICROFINANCE A MANDATORY PRODUCT 1. I t allows people to better provide for their families. Microfinance allows for an added level of resiliency in the developing world. Even when households are able to work their way out of poverty, it often takes just one adverse event to send them right 136 CU IDOL SELF LEARNING MATERIAL (SLM)

back into it. It’s often a health care issue that causes a return to poverty. By allowing entrepreneurs to become more resilient through their own efforts at their own business, it gives them the opportunity to make it through times of economic difficulty. Most of the households that take advantage of the microfinance offers that are available in developing countries live in what would be considered “abject poverty.” This is defined as living on $1.25 per day or less – though some definitions extend this amount to $2 per day or more. About 80% of that amount goes to the purchase or creation of food resources. By offering microfinance products that can be repaid with that remaining 20%, more households have the opportunity to expand their current opportunities so that more income accumulation may occur. 2. I t gives people access to credit. Muhammad Yunus, who is often credited as the modern father of microfinance, once gave $27 to women out of his own pocket because he saw how the cycle of debt affected their work crafting bamboo chairs. Most banks will not extend loans to someone without credit or collateral because of the risks involved in doing so, yet those in poverty do not have any credit or collateral. By extending microfinance opportunities, people have access to small amounts of credit, which can then stop poverty at a rapid pace. Yunus has always believed that credit is a fundamental human right. There are certainly some financial institutions which may disagree with his assessment. Yet without credit, it can be difficult, if not impossible for someone in poverty, to pursue an idea that could bring about a giant payday one day. Microfinance makes that pursuit possible. 3. I t serves those who are often overlooked in society. In many developing nations, the primary recipient of microloans tends to be women. Up to 95% of some loan products are extended by microfinance institutions are given to women. Those with disabilities, those who are unemployed, and even those who simply beg to meet their basic needs are also recipients of microfinance products that can help them take control of their own lives. Women are key figures in leadership roles in business, even in the developed world. Catalyst has reported that companies with female board directors are able to obtain returns that are up to 66% better in returns on invested capital and 42% better in terms of sales returns than companies with male board members only. Women also develop others more frequently when it comes to entrepreneurial roles. This comes from coaching, feedback, or investments. Even in the developed world, women helping women is an 137 CU IDOL SELF LEARNING MATERIAL (SLM)

economic force that poverty can’t stop. 4. I t offers a better overall loan repayment rate than traditional banking products. When people are empowered, they are more likely to avoid defaulting on a loan. Women are also statistically more likely to repay a loan than men are, which is another reason why women are targeted in the microfinance world. There’s also the fact that for many who receive a microloan, it is their only real chance to get themselves out of poverty, so they’re not going to mess things up. Zenger Folkman published a survey regarding ratings of high integrity and honesty in leadership roles that was separated by gender. The mean percentile of women displaying these traits was 55%, while for men, it was just 48%. In business, the bottom line is this: integrity matters. Microfinance institutions have recognized this and approached women because of this. As a side effect of this approach, many developing countries are taking a new look at what role women should play in society. Instead of treating a woman as a second-class citizen, or the “barefoot in the kitchen and pregnant” attitude that has been prevalent in the past, the success of women in bring their households out of poverty is evidence that proves women not only have an initiative to get things done, but they produce consistent results. For these reasons, microfinance institutions see total repayment rates of higher than 98%, though there can be several accounts that are overdue at any given time. 5. I t provides families with an opportunity to provide an education to their children. Children who are living in poverty are more likely to have missed school days or to not even be enrolled in school at all. This is because the majority of families who live in poverty are working in the agricultural sector. The families need the children to be working and productive so their financial needs can be met. By receiving microfinancing products, there is less of a threat of going without funding, and that means more opportunities for children to stay in school. This is especially important for families with girls. When girls receive just 8 years of a formal education, they are four times less likely to become married young. They are less likely to have a teen pregnancy. In return, this makes girls more likely to finish schooling and then either obtain a fair-paying job or go onto a further educational opportunity. 6. I t creates the possibility of future investments. The problem with poverty is that it is a cycle that perpetuates itself. When there is a lack of money, there is a lack of food. When there is a lack of clean water, there is a lack of sanitary living conditions. When people are suffering from malnutrition, they are less likely to work. A lack of 138 CU IDOL SELF LEARNING MATERIAL (SLM)

sanitation creates the potential of illness that prevents working days. Microfinance changes this by making more money available. When basic needs are met, families can then invest into better wells, better sanitation, and afford the time it may take to access the health care they need. As these basic needs are met, it also means that there are fewer interruptions to the routine. People can stay more productive. Kids can stay in school more consistently. Better healthcare can be obtained. This creates a lower average family size because there are more guarantees of survival in place. And when that happens, the possibility of future investments will occur because there is more confidence in being able to meet basic needs. 7. I t is a sustainable process. How much risk is there with a $100 loan? Some investors might pay that for a decent dinner somewhere. Yet $100 could be enough for an entrepreneur in a developing country to pull themselves out of poverty. This small level of working capital is sustainable because it’s essentially a forgettable amount. If there is a default on that money, the interest and high repayment rates of other microloans will make up for it. Then repayments are reinvested into communities so that the benefits of microfinance can be continually enhanced. Each repayment becomes the foundation of another potential loan. This is why many microfinance products have relatively high interest rates. Some institutions may charge the equivalent of a 20% APR, but others have interest rates which exceed 800%. Although interest is high, recipients are invested into making these products work because virtually all institutions put repayments back into new loans that target the most vulnerable households in the developing world. 8. I t can create real jobs. Microfinance is also able to let entrepreneurs in developing countries be able to create new employment opportunities for others. With more people able to work and earn an income, the rest of the local economy also benefits because there are more revenues available to move through local businesses and service providers. It’s not just the entrepreneurial level that benefits from job creation through microfinance. Grameen Bank in Bangladesh employs over 21,000 people and their primary financial products are related to microfinance. That’s tens of thousands of jobs that are created by the industry with the sole purpose of being able to drag people up and out of poverty. 139 CU IDOL SELF LEARNING MATERIAL (SLM)

9. I t encourages people to save. Microloans are an important component of microfinance, but so is saving money. When people have their basic needs met, the natural inclination is for them to save the leftover earnings for a future emergency. This creates the potential for more investments and ultimately even more income for those who are in the developing world. Some microfinance institutions have seen an extraordinary number of savings occur when products are extended. The Unit Desai of Bank Rakyat Indonesia counts 28 million savers to just 3 million microloan borrowers. Now saving isn’t always seen, especially from borrowers, but this is part of the expected microfinance process. Small loans make small financial improvements for households living in poverty. The difference between making $1.90 per day and $2.30 per day is not much in reality, but by definition, that amount takes someone out of extreme poverty. Instead of big improvements, microfinance allows for small improvements. When enough of those improvements occur, then there is a safe place for people to store their income thanks to this industry. 10. I t reduces stress. There is a valid argument to be made that some microloans go to cover household expenses instead of business needs. Some are using these loans to pay bills or purchase food. It’s true. Yet without this product available, there wouldn’t be an ability to pay bills or purchase food. So even though it may not always be used for business purposes, it still serves a purpose by reducing stress. Stress cannot be underestimated when it comes to poverty. Even in the developing world, the stresses of poverty can be overwhelming. It causes people to seek out coping mechanisms that are not always healthy. And, in some cases, it may even cause families to break apart. Sometimes childbirth is a coping mechanism for poverty simply because an extra set of hands means an extra chance for income. By reducing these stress markers, households can focus on the job at hand to provide for themselves, even if that means net income levels for that family may not rise in the near future. 11. I t allows people to feel like they matter. The feeling of receiving a credit product for the first time cannot be ignored. It’s a feeling like you’ve made it. That you really are somebody because you’ve been trusted with credit. This feeling applies to everyone, even in the developed world. When a person feels like they matter, it changes who they are at a core level. Instead of focusing on how they can just survive, then begin to look for ways to 140 CU IDOL SELF LEARNING MATERIAL (SLM)

thrive. This brings us back to the stress that poverty creates on people. People, when they are approved for a microloan for the first time, will often have a reaction that is similar to Steve Martin’s reaction in The Jerk when he discovered his name in the phone book. And this is why Yunus feels that credit is a fundamental right. Without credit, survival is often the best possible outcome. With credit, there is hope that anything can be possible. 12. I t offers significant economic gains even if income levels remain the same. The gains from participation in a microfinance program including access to better nutrition, higher levels of consumption, and consumption smoothing. There is also an unmeasurable effect which occurs when women are empowered to do something in their society when they might not normally be allowed to do so. As spending occurs, these benefits also extend outward to those who may not be participating in the program so that the entire community benefits. The most important weakness of microfinance is that the effects of raising income levels for the poor can often be questionable. Although it raises the possibility of income accumulation and savings, microfinance products also raise the possibility of creating a further indebtedness that may potentially extend the cycles of poverty for an infinite period of time. Although some may look at consumption in a negative view, those who have gone without for so long will see improved consumption as a sign that things are getting better. Consumption smoothing allows an entire community to realize the benefits that microfinance can provide. It isn’t always about the money. Sometimes economic success comes from stability. 13.5 SUMMARY T he term \"microinsurance” typically refers to insurance services offered primarily to clients with low income and limited access to mainstream insurance services and other means of effectively coping with risk. M ore precisely, microinsurance is a means of protecting low income people against specific risks in exchange for a regular payment of premiums whose amount is proportional to the likelihood and cost of the relevant risk. The principal distinction from traditional insurance is in the targeting of low income people, which leads to distinct characteristics and objectives, including addressing the particular risks of low income people, affordability and inclusiveness, simplicity and clarity in documentation, accessible processes, and building trust 141 CU IDOL SELF LEARNING MATERIAL (SLM)

among target clients. L ike most other schemes of assistance provided by various State governments and Union government the implementation of Self Help Groups has not been free from problem and hurdles. In spite of numerous problems pertaining to identification, training and financing of beneficiaries, the scheme has made much headway. Most of the beneficiaries, who availed of financial assistance under the Self-Help Groups have succeeded in employing themselves and generating reasonably adequate returns out of their activities. It is an undisputed fact that a little money, guidance, support and practical knowledge would embolden women, financially and mentally. It would lead to the opening of new avenue and improve the quality of their life. S elf Help Groups are about people coming together with others who are affected by a particular issue to support each other and to work together to change the disadvantage affecting them. Self Help Groups are self-governed, peer-controlled small and informal association of the poor, usually from socially and economically homogeneous families, who are organized for savings and credit activities. I n the meetings they discuss general issues and plan solutions, share information, make efforts to improve their health and literacy skills. Self Help Groups are not charity groups they are simply society based groups. They are controlled by the people who are leading the groups. Group members are not volunteers. Although the work is usually unpaid, members work to change their own situation and support is mutual. Self Help Groups build on the strength of their members. Self Help Groups are playing an important role in the transfer of technology to user group population. It has been found by the members of Self-Help Groups that they offer them organizational base, large resources and access to modern technology leading to employment and income generation. S elf Help Groups are playing a crucial role in harmonizing the society and strengthening rural economy; hence they must avail themselves of training programmes and should manufacture diversified quality products that are of high quality. Self Help Groups are expected to be one of the major programmes of poverty alleviation in India with full participation from the formal banking system and without any interference from the government. However, considering the magnitude of poverty, the outreach of the programme needs to be strengthened and enhanced. T 142 CU IDOL SELF LEARNING MATERIAL (SLM)

he present study revealed that the socio-economic conditions derived from the members on the activities of Self Help Groups are at a satisfactory level. Further, the Social Welfare Department and Rural Development and Panchayat Raj Department of Government of Tamil Nadu, Non-Governmental Organizations, Banks, Financial Institutions, Entrepreneurial Training Centre and Social Workers might help the members of Self-Help Groups by educating them in all ways and providing more opportunities by relaxing the rigid rules. F inally there is a need for high level review committee on Self Help Groups and its functions. Such an independent committee must be set up to study Self Help Groups based programmes, in order to assess the extent to which these programmes address the women empowerment. It must recommend changes related to the framework, approach and design of Self Help Groups programmes, as well as changes that might be required in the major policy and changes to have an impact in the alleviation of poverty. 13.6 KEYWORDS  Lending Rate: - Lending Rate is the bank rate that usually meets the short and medium term financing needs of the private sector. This rate is normally differentiated according to creditworthiness of borrowers and objectives of financing.  Leverage: - Using long-term debt to secure funds for an organization. In the social investment world, often refers to financial participation by other private, public or individual sources.  Liabilities , Total Liabilities: - Total value of financial claims on a firm's assets. Equals total assets minus net worth.  Limited Liability: - Limitation of shareholders' losses to the amount invested.  Limited Recourse: - Rights only to specifically stipulated assets to satisfy an unpaid debt.  Line of Credit: - Agreement by a bank that a company may borrow at any time up to an established limit. 13.7 LEARNING ACTIVITY 1. Write a short note on Micro Insurance _________________________________________________________________________________ _________________________________________________________________________________ 143 CU IDOL SELF LEARNING MATERIAL (SLM)

2. Illustrate advantages of micro insurance _________________________________________________________________________________ _________________________________________________________________________________ 13.8 UNIT END QUESTIONS A. Descriptive Questions 1. State the characteristics of micro insurance. 2. Describe the challenges faced by micro insurance. 3. Explain the benefits of making microfinance a mandatory product. 4. State who offers a better overall loan repayment rate than traditional banking products? 5. Discuss how micro insurance offers significant economic gains even if income levels remain the same? B. Multiple Choice Questions (MCQs) Micro 1. True insurance provides small premiums that accommodate irregular cash flows False a. b. 2. What do we call the money charged for the insurance coverage? a. Premium b. Policy Lapse c. Morbidity risk d. Package Policy 3. When two or more distinct insurance policies combined into a single contract, it is known as a. CMO b. Package Policy 144 CU IDOL SELF LEARNING MATERIAL (SLM)

c. Mortgage Insurance d. Micro Insurance 4. If a person experience illness, injury, or other physical or psychological impairment, whether temporary or permanent, then it is which type of risk? a. Morbidity Risk b. Preferred Risk c. Standard Risk d. None of these 5. If a general or life insurance policy with a sum assured of Rs. 50000 or less, then it denotes which type of insurance category? a. Mortgage Insurance b. Micro Insurance c. Multi-Peril Insurance d. Non-admitted Insurance Answer 1. a 2.a 3. b 4. a 5. b 13.9 SUGGESTED READINGS  Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications.  Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc.  Hirschlan d, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc.  Sapovadi a, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India. 145 CU IDOL SELF LEARNING MATERIAL (SLM)

 Edgewoo d, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006.  Rutherfor d, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 146 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -14 MFI COMMERCIALIZATION Structure 14.0. Learning Objectives 14.1. Introduction 14.2. Positive and negative effects of MFIs Commercializing 14.2.1 Negative effects 14.2.2 Positive effects 14.3. Net impact of commercial banks entering the Microfinance market 14.4. Summary 14.5. Keywords 14.6. Learning Activity 14.7. Unit End Questions 14.8. Suggested Readings 14.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Describe MFI commercialization  State the positive & negative effects of MFIs Commercializing  Explain the net impact of commercial banks entering the Microfinance market 14.1 INTRODUCTION The topic of commercialization has been hotly debated, largely because it raises fundamental questions about whether the dual social and financial missions of microfinance can coexist. It has become clear in recent years that not only can these two priorities coexist, but when done right, they are mutually reinforcing, creating a healthier long-term business model for both clients and investors. This is not to say it is easy. Many MFIs Grameen Foundation partners with – particularly those that are for-profit entities with strong social missions – work hard at maintaining a strong focus on both social and financial goals. What is interesting, however, is that that some publicly-traded U.S. companies appear more committed to and more convinced of the need for mission-focused business than many in microfinance, an industry that has received billions of dollars of subsidized funds over the decades. Why is it — after years of talking just of scale and not of clients, of crises from India to Morocco, of governments stepping in because the industry has failed to self-regulate – that there still 147 CU IDOL SELF LEARNING MATERIAL (SLM)

debate around whether social and financial goals are mutually reinforcing? PT Ruma, a micro franchise-based social enterprise Grameen Foundation helped found in Indonesia, is an example of a business that has built social goals into its incorporating documents. Ruma’s articles of association require that its social goals be met before shareholders receive any financial dividend payouts. This innovative approach ensures that the social bottom line does not get shorter shrift in a “commercialized” entity and has supported, rather than hindered, Ruma’s ability to raise investment capital. Capital raising presents another challenge for many MFIs, since the way an institution funds itself can drive very different behaviors, priorities, and business models. For example, commercial lenders do not typically seek to influence a borrower’s direction and strategy; most often they simply want to be repaid on time at a pre-determined rate of interest. Strategic equity investors, on the other hand, often expect to have a seat at the table advising on the direction of the institution and, as such, have the potential to alter the behavior of management or the strategic priorities of the institution. If investors’ goals are focused on their own short-term financial returns, it may drive decisions that conflict with an institution’s ability to meet its social goals – in other words, to put clients first. Grameen Koota (GK), a long-time Grameen Foundation partner in India with a deep social mission, has grappled with this balance. GK’s ability to scale has been largely funded over the years by local commercial banks, an effort we have supported through our Growth Guarantee program. However, when it comes to securing strategic equity investors, GK expressed concern that taking on more commercially-minded equity investors might force it to place profits ahead of mission, for example, by pushing it away from the more difficult-to-reach clients who cost more to serve. GK has managed this by securing a balanced mix of both social and commercial investors, and in doing so, being extremely clear about its plans (target segment, mission, how their business will evolve), so that investors know upfront what they are “buying” and do not expect GK to shift course after their investment. This balanced approach has allowed GK to continue to focus on achieving robust social and financial results. Grameen Bank, of course, offers one of the earliest and longest-standing visions for microfinance as a business that puts mission first and views profits as a means, not an end – and is a strong example of a local, deposit-driven model. As the microfinance industry grapples with the very real challenges of how to shift from years of over-focus on institutional growth at the expense of clients to a deeper understanding of what clients need and want, there are lessons to be taken from the private sector, where at least among certain segments, it has long been understood that a successful business approach requires that your clients thrive. 148 CU IDOL SELF LEARNING MATERIAL (SLM)

14.2 POSITIVE AND NEGATIVE EFFECTS OF MFIS COMMERCIALIZING 14.2.1 Negative Effects The main reasons given by bankers in large commercial banks to not enter the market of microfinance are the risk of default, high costs, and socio-economic and cultural barriers. They also face some internal constraints such as (see Baydas, Graham and Valenzuela, 1998; Barlet, 2003): i. Market knowledge: commercial banks lack an understanding of the microfinance market and its clientele, and often dismiss this segment as both too risky and too expensive. Even if a bank recognizes that microfinance can be profitable, the resulting portfolio size may be viewed as too small relative to the level of effort required to manage a microfinance operation ii. Organizational structure: commercial banks find it difficult to integrate microfinance within a larger bank culture and structure that is not geared toward a high volume, small loan size business. iii. Financial methodology: most commercial banks lack the financial methodologies to reach and retain low-income clients who require small amounts of capital. iv. Human resources: microenterprise credit requires staff who are comfortable working in the neighborhoods where clients live and work, and who must be highly productive in order to succeed. Monetary incentive systems are often used to spark such productivity. These requirements of microfinance are often incompatible with the human resources profile and policies of commercial banks. v. Cost-effectiveness: traditional bank mechanisms and overhead structures make it difficult for banks to minimize processing costs, increase staff productivity, and rapidly expand microfinance loan portfolios. vi. The policy environment: in countries with interest rate ceilings and heavy government intervention, banks will be prevented from even contemplating microfinance (Rhyne, 2003). 14.2.2 Positive Effects Despite these constraints, commercial banks have several organizational and structural features that can lend themselves to successful microfinance operations: i. Large commercial banks often have an extensive network of branches, frequently covering all major cities in a country. ii. They have well-established internal controls and administrative and accounting systems to keep track of large numbers of transactions. 149 CU IDOL SELF LEARNING MATERIAL (SLM)

iii. Banks that have been in the market for a long time are well known to the public and have a recognized brand. In many cases the brand carries a high degree of trust. iv. The ability to offer loans, deposits, and other financial products make them attractive to microfinance clients. 14.3 NET IMPACT OF COMMERCIAL BANKS ENTERING THE MICROFINANCE MARKET Banks and financial institutions have been entering the microfinance market in increasing numbers over the past years. This phenomenon (known as downscaling), together with that of upgrading, is resulting in a growing number of formal regulated institutions partially or totally moving into MF. It is necessary to analyze what drives a traditional banker to engage in MF in order to fully understand why downscaling has developed so much worldwide. There are several factors that motivate the bank to start making microloans. These factors are related both to the bank’s internal organization and to the market in which this bank operates. However, the main incentive is basically related to the fact that profits are in line with the risks incurred. Growing competition in markets traditionally served by banks —e.g., loans to big companies, small and medium-sized businesses and consumers— along with the resulting fall in banks’ returns has encouraged the search for new market niches. In countries with no experience in MF, there exists an unattended market segment which may be viewed by banks as a potential source of rapid growth and positive returns. The first products generally developed by institutions entering MF are microloans. However, as the business progresses, institutions start offering a broader range of products. The possibility of cross- selling is another positive aspect that commercial banks take into account when deciding to enter this sector. Commercial banks can offer their clients a range of products, including banking services, means of payment, money transfer services and insurance. Major banks have adapted their structure (contacts with insurance providers, branches abroad for fund transfers, ATM networks across the country) precisely for the delivery of these products. Entering a new sector enables banks to diversify their loan portfolio, focusing on a population segment previously unattended by them. By making loans to thousands of small borrowers, the microlending portfolio itself achieves substantial diversification in terms of number of clients served, although the level of diversification by activity and geographical area is usually low. Commercial banks can overcome this obstacle thanks to their branch networks across the major cities in the country. In addition, the performance of the micro lending portfolio may have low correlations with traditional bank business lines due to the very different nature of the clients and activities. Similarly, having a sector specialized in MF may help commercial banks improve their public image, as caring for the most disadvantaged social sectors is welcomed by clients and society in general. 150 CU IDOL SELF LEARNING MATERIAL (SLM)