Document Sample
                      IMPROVE EFFICIENCY:
                                                                       Raman Uberoi, Director –
                                                                  MFI & Financial Sector Ratings
                                                                            CRISIL Limited, India

     1. Background

     Many microfinance institutions (MFI) in India are facing the pressure of protecting their
     net margins. Declining access to grants and long-term subsidized funds are pushing up
     their borrowing costs. Besides, owing to their operating characteristics1 MFIs have
     higher operating costs than other retail finance segments. Together, the two factors are
     squeezing their net margins. This is not all. The competition too is intensifying, both
     between MFIs and with banks, which are sharpening their focus on this segment. Even
     government policies have sought to ensure the flow of low-cost funds to the
     economically challenged through the banks’ large branch networks. This is altering the
     very dynamics of microfinance lending and is likely to pose a key challenge for MFIs to
     remain competitive. For, although MFIs charge a lower lending rate than the informal
     sector, their rates are higher than those of formal lending institutions like banks. Hence,
     their flexibility to increase their lending rates to protect their margins is limited. A CRISIL
     study reveals that in such a scenario, MFIs need to optimize their cost structure,
     specifically their funding and operating costs, to remain competitive and meet these
     challenges. This paper highlights the insights from the study and suggests some
     possible solutions that MFIs could adopt to improve their cost structure and thereby,
     strengthen their competitive position.

     2. Key Highlights

     CRISIL has analysed the performance and operational procedures of a pool2 of 12
     Indian MFIs. This pool has been sub-divided into two groups – Group A, which
     comprises nine MFIs with moderate to weak cost structures, and Group B, which
     includes three MFIs with a relatively better cost structure (see Box 1 on the
     characteristics of the pool and Box 2 on the key operating factors of Group B).

     2.1 Lower operating expenses have resulted in better operational self-sufficiency

     As can be seen from the charts below, it is not their higher fund-based yields3 but their
     lower operating expense ratios4 that have translated into a better operational self-
     sufficiency5 (OSS) 1 Operating characteristics such as average loan size being small,
     high transaction frequency and the like do not provide the necessary economies of scale
     to optimize on the operating cost. Moreover, most MFIs incur significant time and effort
     towards group formation and training, loan processing, disbursement, monitoring and
     recovery. Repayments are typically collected on weekly, fortnightly or monthly basis by
     way of cash thus translating into higher transaction costs. 2 The pool comprises MFIs
     assessed by CRISIL that have completed at least three years of microfinance operations
     as at March 31, 2003. 3 Fund-based yield is defined as the fund-based income to
     average funds deployed and funds deployed is defined as total assets less net fixed
     assets. 4 Operating expense ratio is defined as operating expenses (personnel and
     administration expenses) to average funds deployed. 1 ratio for MFIs in Group B.
     Although the MFIs in Group A have higher lending yields, their operating expense ratio is
     almost twice that of Group B, which has affected their OSS ratio. 15% 9% 15% 6% 14%
     7% 0% 5% 10% 15% 20% 2000-01 2001-02 2002-03 Chart 1B: Operating expense
     ratio Group A Group B 20% 15% 22% 18% 24% 19% 0% 10% 20% 30% 2000-01 2001-

     02 2002-03 Chart 1A: Fund based yields Group A Group B Chart 2: OSS
     performance trend 99% 89% 91% 148% 137% 97% 0% 25% 50% 75% 100% 125%
     150% 2000-01 2001-02 2002-03 Group A Group B

     2.2 Better employee productivity has improved efficiency levels

     The productivity indicators6 - branch productivity and field employee productivity – of
     both groups have improved during the study period. While there is a marginal difference
     between their branch productivity, the difference is quite stark in the case of the field
     employee productivity. Group B’s field employee productivity is superior to that of Group
     A and has doubled over the past three years. In other words, it has a higher field officer
     productivity for a similar number of loan accounts for each branch, which has translated
     into lower operating costs (see Table 1). Table 1 Group A Group B Productivity
     Indicators 2002-03 2001-02 2000-01 2002-03 2001-02 2000-01 Active loan
     accounts/credit officer 188 172 142 414 282 202 Active loan accounts/branch 1469 1205
     1089 1624 1027 557 5 OSS is defined as total income to total expenses and indicates
     whether an MFI earns enough income to cover its costs. Total income includes income
     from lending operations, investment income and fee income. Total expenses include
     financial expenses, operating expenses, loan loss provisions, write-offs and depreciation.
     6 Productivity indicators: Branch productivity is defined as active loan accounts per
     branch and field employee productivity is defined as number of loan accounts per credit
     officer (field officer, credit officers and customer service agents).

     2.3 Borrowing costs increasing and expected to rise further

     Both groups’ average borrowing costs have been rising, by about 200 basis points, over
     the last two years because of their declining access to subsidized long-term borrowings
     and greater dependence on commercial borrowings from banks and apex MFIs7. Chart
     4: Interest paid to avg. borrowings 7.5% 9.6% 9.9% 10.6% 10.8% 8.5% 7.0% 8.0%
     9.0% 10.0% 11.0% 12.0% 2000-01 2001-02 2002-03 Group A Group B

     2.4 Size of loan account has positive impact on operating efficiency

     Apart from employee productivity, the size of a loan account has also affected the MFIs’
     operating efficiency. As can be seen from chart 3, Group B’s average amount
     outstanding per loan account has improved and is higher than that of Group A. 93 93 83
     96 89 109 0 20 40 60 80 100 120 2000-01 2001-02 2002-03 Chart 3: Oustanding
     amount per loan account (in US $) Group A Group B NB: For the purpose of
     calculations, the following reference rates have been considered: US$1 = Rs. 47.55 as at
     March 28, 2003; Rs. 48.80 as at March 28, 2002 and Rs. 46.64 as at March 30, 2001. 7
     The two leading apex MFIs in India have disbursed loans at interest rates ranging from
     11% to 14% per annum to most MFIs. 3

     2.5 Higher proportion of interest-earning assets; better management of lending

     Group B not only has a lower proportion of net fixed assets to total assets but also has a
     relatively higher proportion of loan portfolio to total funds deployed (see Table 2). This
     clearly indicates that Group B has managed its lending operations better than Group A
     (see Table 3 for the MFI pool’s key financial indicators). Table 2 Group A Group B
     Interest Earning Assets 2002-03 2001-02 2000-01 2002-03 2001-02 2000-01 Net fixed
     assets/total assets (%) 4.44 5.02 4.81 0.91 1.36 2.80 Loan portfolio/total funds deployed
     (%) 81.48 71.88 79.02 90.82 89.82 80.59

     3. Key Inferences and Strategies for Efficient Management

     3.1 Addressing loan delivery and collection mechanism limitations

     Frequent cash-based and small-value transactions entail a significant amount of field
     time and limit the number of accounts that a credit officer can handle per visit and on the
     whole. An increase in the number of loan accounts per credit officer can significantly
     improve an MFI’s operating efficiency. Group B has attempted to address this by
     adopting different approaches such as:         The role of field officers is restricted to
     identifying and monitoring clients. Subsequently, clients deal directly with the MFI’s
     branch and transact through post-dated cheques. By eliminating the need to handle
     cash at the field level, the MFIs in Group B have optimized the number of field officers
     and branches.       Operating processes such as book keeping, accounting and data
     capture systems have been streamlined to reduce the time spent by field officers on
     paper work and eliminate the need for an accountant at each branch.              Eliminating
     processes and procedures that are redundant. For instance, if a MFI undertakes credit
     appraisal when the group is formed and there are controls at the group level to ensure
     that funds are not misused by clients, then for subsequent loan disbursals, especially for
     income generation loans, the MFI avoids loan utilization checks.

     3.2 Identifying target groups to avoid duplication of efforts

     MFIs can try and replicate the bank-group linkage model by lending to groups that are
     formed by other NGOs. In this model, government departments incur the expenditure of
     forming new groups, NGOs form the actual groups and MFIs focus on providing financial
     services. MFIs with a diversified funding base and regular access to funds can explore
     this route. 3.3 Enhancing non-fund based income to bolster revenues MFIs need to
     diversify and bolster their revenue streams by earning a fee income. They could play the
     role of an intermediary to insurance companies and channelise insurance services to
     their 4 clients. Some of them already trade in seeds, fertilizers and other such products.
     Such valueadded services not only enhance the MFIs’ franchise with their clients but
     also bolster their fee income. A higher fee income can be a perfect foil for any drop in
     fund-based revenues, as it would help an MFI to diversify its risks and sustain its
     operations over the long term.

     3.3 Investing in technology to optimize operating expenses

     Some MFIs have successfully introduced new technologies such as smart card readers
     and personal digital assistants (PDA) to reduce data collection and updation time.
     Similarly, as client history and repayment behaviour across sectors (agriculture, trading,
     tiny industries and the like) become available, MFIs can adopt credit assessment models
     or credit scoring tools to increase their productivity while maintaining portfolio quality.

     4. Conclusion

     Given the banks’ sharp thrust on microfinance and competition within the sector, MFIs
     will have to perforce improve their efficiency. It is critical that MFIs streamline their
     processes and enhance their productivity levels to offset the rising cost of commercial
     borrowings and thereby, remain competitive. 5 Table 3 Group A Group B Financial
     Indicators 2002-03 2001-02 2000-01 2002-03 2001-02 2000-01 Fund-based income
     (%) 23.74 22.30 19.53 18.60 18.48 15.34 Non-fund-based income (%) 1.03 0.99 1.51
     4.64 3.06 1.06 Total income8 (%) 24.77 23.29 21.03 23.24 21.54 16.39 Interest paid (%)
     7.87 7.72 6.18 8.68 8.39 5.89 Personnel expenses (%) 8.05 8.52 8.40 3.61 4.08 6.28
     Administrative expenses (%) 6.23 6.82 6.90 2.95 2.20 3.21 Operating expenses (%)
     14.28 15.34 15.30 6.56 6.28 9.49 Operating expenses including depreciation (%) 14.81
     16.02 15.91 6.69 6.43 9.84 Loan loss provisions & write-offs (%) 2.29 1.82 1.42 0.30

     0.83 1.03 NB: All the above ratios are as a percentage of average funds deployed Box
     1: Characteristics of MFIs in CRISIL’s Sample Pool * Predominantly group-based
     lending mechanism: All the MFIs in the pool lend to groups and 80% of them form their
     own groups. Only one MFI primarily focuses on individual loans but it also lends to
     groups. Of the MFIs that lend to groups, most of them have adopted the Grameen Bank
     model9 or variants of the same. A few of them have adopted the self-help group model.
     Mainly cash-based transactions: Except for one MFI, all the others in the pool collect
     repayments in cash. Similarly, only two MFIs disburse loans through cheques while the
     rest disburse them in cash. Two-thirds of the MFIs also collect their clients’ savings along
     with loan repayments. Frequent repayment collections and short loan tenures:
     Eighty per cent of the MFIs in the pool disburse loans and collect repayments on a
     weekly basis and the tenure of their loans ranges from 10 to 24 months. The rest collect
     repayments on a monthly basis and apart from short-term loans, they also provide
     medium-term (up to 36 months) and long-term (beyond 60 months) loans such as crop
     and housing loans. Most borrowers are women: Two-thirds of the MFIs lend only to
     women. These loans are primarily for income generation, either to fund existing income
     generation activities or first-time loans to set up new enterprises to diversify the
     borrowers’ income stream. MFIs registered as not-for-profit organisations: About 75
     percent of the MFIs are registered as societies or trusts and the rest are registered as
     companies. Unlike the latter, the former have limited access to capital, which can affect
     their ability to scale up and sustain their operations. * * * * 8 Total income = Fund-based
     income + non-fund-based income. It does not include any extraordinary income.
     Fundbased income comprises interest income and investment income. Non-fund-based
     income comprises registration fee, pass book fees, consultancy income and other fee-
     based income. 9 In the Grameen Bank model, groups of five prospective borrowers are
     formed and loans are disbursed to the group’s members on a staggered basis. For
     instance, two members are disbursed loans in week 1, another 2 in week 5 and the rest
     in week 9. The loans usually have a tenure of 50 weeks. Loans are given to individuals
     within the group but the collective responsibility of the group in terms of loan repayments
     offers comfort. The MFI and not the group maintains group-related accounts. Unlike
     under the self-help group or village-banking model, the group’s savings are not rotated
     among members but are collected by the MFI for on-lending and collateral purposes. 6 7
     Box 2: Key Operating Factors of Group B * Unique lending mechanism: One of the
     MFIs does not form groups on its own, rather, it lends to groups formed by other NGOs.
     This strategy is more common to banks than MFIs in India. This MFI has been able to
     save on group formation and training costs.

         Field staff productivity: All disbursements and repayment collection mechanisms of
          one of the MFIs are similar to those adopted by other financial intermediaries, that is,
          post-dated cheques. Thus, field officers spend most of their time on prospecting
          clients and evaluating NGOs that they can work with. This translates into higher
          productivity at the field level. Customized data collection sheets and pass books,
          simplified accounting and record keeping systems also allow field officers to handle
          the paper work themselves without needing a branch accountant. One of the MFIs
          operates in high-density regions, which allows field officers to conduct more meetings
          a day in rural and urban areas.

         Good loan documentation and monitoring mechanisms: Relatively better credit
          appraisal mechanisms, good loan documentation, the involvement of NGOs in
          monitoring the groups and restricting the loans to three-fourths of the members in a
          group have enabled one of the MFIs to manage its operations well.

         Blend of lending mechanisms: Initially, one of the MFIs adopted the Grameen
          Bank model in a few branches and the self-help group model in other branches. Over

          a period, however, it evolved its own lending methodology based on both these

         Flexible lending mechanism: As in the Grameen Bank model, loans are disbursed
          to clients within one month of the group’s formation. Clients are given an option to
          repay existing loans and go in for higher loan amounts subject to certain terms and
          conditions including the payment of penalties. New loan products such as
          educational, infrastructure and enterprise loans are offered in subsequent loan
          cycles, encouraging clients to pay promptly. As the size of the loan increases, the
          operating cost per loan account decreases gradually.

         Sharing operational expenses across divisions: One MFI runs multiple
          developmental programmes besides providing microfinance services. It shares
          infrastructure and related operational costs between these divisions, thereby
          optimising its overall expenses.

     Contact Details Raman Uberoi:

     Director - MFI & Financial Sector Ratings
     Tel: +91 (11) 23721603