Credit Delivery Methodologies used by Microfinance Institutions
by Abhay, India Microfinance –
MFI’s use two basic methods in delivering financial services to their clients.
(!) Group Method and
(2) Individual method
This is one of the most common methodologies for providing micro-finance. Group method primarily involves a group of individuals, which becomes the basic unit of operation for the MFIs. As we have discussed earlier, MFIs have to provide collateral free loans, group methodologies help in creating social collateral (peer pressure) that can effectively substitute physical collateral. Group becomes a basic unit with which MFIs deal. The advantage of group methodology is that
• Groups are trained to own joint responsibility for loans that are taken by individuals in the group.
• Groups ensure repayments from all individuals in that group and incase of a default
• Groups functions as the forum where the credit discipline and other related issues are discussed.
• Group may have to jointly own the responsibility of defaults and pay on behalf of defaulting client.
• Group also help credit appraisal and provide opinion on creditworthiness of each individual in the group.
• Groups methodology also helps in controlling cost
This ensures that even without taking any physical collateral, the MFI is able to manage its credit risk (loan related risk).
MFIs actually deliver the financial service at the client’s location which could be a village in rural areas or a colony/slum in urban area. Having a group helps the MFIs in getting all clients at one spot rather than visiting each individual’s house. This helps the MFI in increasing the efficiency of staff and controlling the cost. Group methodology creates a forum where individuals come and discuss, can provide opinion, and exert social pressure.
The advantage of Group methodology can easily be appreciated by the fact if the a MFI employee has to visit each individual house in isolation, it would be very difficult. Also in the absence of a group, if a client refuses to pay there is no forum where such a case can be discussed or there is no method through which the MFI can expert pressure on the client.
Group methodology is also important because in case of larger loan defaults a financial institutions can take recourse o legal action but in small loans legal recourse is not an economically sound option. An MFI who may have an outstanding or Rs 3,000 at default cannot apply legal pressure as the cost of recovery through that method can be higher than the amount to be recovered itself.
Moreover, the clients that the MFIs are dealing with are generally poor and may face genuine problems at times. Rather than taking an aggressive/legal approach, which such vulnerable clients it is always better to have more constructive and collective approach, which is provided by the Groups.
Due to the various advantages, as indicated above provided by groups, this methodology is widely accepted and used in micro-finance across the world.
Self –Help Groups (SHGs)
Self-help Group concept has its origin in India. SHGs are now considered to be very important bodies in rural development and are therefore found in almost all parts of the country and their number is still rapidly growing. SHGs are formed by Non-Government Organisations as well as Government agencies and are used as channels for various development programmes.
A Self-Help Group is an association of generally up to 20 members (not exceeding 20 members), preferably from the same socio-economic background. SHGs are facilitated by Government agencies or NGOs for members to come together for discussing and solving their common problems either financial or social through mutual help. An SHG can be all-women group, all-men group, or even a mixed Group. However, it has been the experience that women’s groups perform better in all the important activities of SHGs. Mixed group is not preferred in many of the places, due to the presence of conflicting interests.
Some of the distinct features of SHGs are;
(i) Recognized by government: SHGs are well recognized and accepted by government, SHGs can open bank accounts in the name of SHG. They can also receive government grants and funds for development activities.
(ii) SHGs are social intermediaries: SHGs do not restrict their functions only to financial transactions. SHGs are often involved in many social activities. There are example where SHGs have taken up social issues and fought against social evils like alcoholism, violence, against women, dowry, getting into village politics and being elected as Sarpanch.
(iii) Books of accounts: SHGs maintain their own books of accounts. These are simple books to keep records of their savings, loans income and expenditures. Strong SHGs also make their Balance sheets and Income statements.
(iv) Have office bearers: SHGs gave a structure where there is a Group President, Secretary and Treasure. They are elected by the group.
(v) SHGs are more autonomous as they decide their own rules and regulations.
(vi) SHGs mobilize thrift and rotate it internally.
(vii) SHGs can hold bank account and can also borrow from banks and other financial institutions.
We see that SHGs are groups, which are more autonomous. While they are involved in financial transactions, their role is not just restricted to it. SHGs are also involved in various social issues.
As more SHGs are formed they have started federating themselves into clusters and clusters in turn as SHG Federations. The Federations are able to channelise funds to the SHGs and also help in improving the managing and financial skills of SHGs.
Joint Liability Group – Grameen Model
Grameen model is based on the concept of joint liability. It is the brainchild of Prof.. Muhammad Yunus, founder of Grameen Bank in Bangladesh. Grameen model is the most accepted and prevalent micro-finance delivery model in the world today. Many MFIs have accepted the model as it has high focus on standardization and discipline
Grameen model, as mentioned, is a joint liability group model. Here five-member groups are formed and eight such groups form a Center. Hence, in a full-capacity Center there are 40 members (8 x 5). However, over the years people have experimented with Centers of different sizes and now there are variations of 5-8 groups within a Center. Center is the operational unit for the MFI, which means that MFI deals with a Center as a whole.
Meetings also take place only at the Central level and individual groups do not meet. Group meetings take place only in front of the Field staff of the MFI. A Grameen model is focused on financial transactions and other social issues are generally not discussed. The Group and Center are Joint liability Groups, which means that all members are jointly responsible (‘liable’) for the repayment. MFI recovers full money from Center, if any member has defaulted: the group members have to pool in money to repay to the MFI. If Group members are unable to do it, Center as whole has to contribute and share the responsibility.
Some other features of Grammen Model are:
(i) The group meeting take place every week
(ii) Interest rate are charged on flat basis
(iii) MFI staff conducts the meeting
(iv) All transactions take place only in Center meetings
Grameen model is focused on providing financial services to the clients and hence there is an emphasis on standardization and discipline. The model suggests weekly meeting for frequent interaction with the clients to reduce credit risk. The meetings are conducted for carrying out the financial transactions only. The meetings are conducted systematically in a short-time and other social issues are not discussed. Flat interest is charged again for making the system standardized. In flat rate system installment size of repayment remains small for all weeks and hence is convenient and easier to explain. Also, it is easy to break the loan installment into the principal and interest component.
We see that the SHG and Grameen model have originated with two different approaches. SHG model has been developed with holistic view of development and empowerment of society where financial transactions are only one part of it. While Grameen model is specifically focused on providing financial services to the low-income clients. A broad comparison of the two models is presented in the Table 1.
Joint Liability Groups (JLG)
Grameen model is a particular form of joint liability Group but in India there are other forms of Joint liability Groups as well. MFIs, particularly in urban areas, form JLGs of five-members. These are group of individuals coming together to borrow from the financial institution. They share responsibility (“liability”) and stand as guarantee for each other. There is a Group Leader in such JLGs, many MFIs prefer such group in urban business areas. Such JLGs do not hold periodic meetings.
Typically members are shopkeepers from same locality. These forms of JLGs are somewhere between Group and Individual lending methods. While lending in such JLGs is to individual members small JLGs still provide some sort of comfort to the MFIs. Also collection can be done from a single point, generally from the Group leader rather than going to each individual. As in urban areas shopkeepers do not have time to hold meeting, these JLGs do not meet.
So far we have discussed the Group based lending method. However MFIs are also increasingly providing loans to individuals. In Individual lending method, MFIs provide loans to an individual based on his/her own personal credit worthiness. Individual lending is more prevalent with clients who generally need bigger size loans and have the capacity to produce guarantee and generate enough comfort to the MFI. MFIs generally base their decision on personal knowledge of the client, his/her reputation among peers and society, client’s income sources and business position. MFIs also ask for individual guarantors or take post-dated cheques from clients.
Individual guarantors come from friends or relatives well known to the borrower and who are ready to take liability of repaying the loan, should the borrower fail to do so. If the loan is significantly larger, then MFIs may also take some collateral security.