A summary of NBFC-MFI Directions – August 2012

By Prabal Goel, IFMR Capital

On August 03, 2012, RBI came out with its ‘Non Banking Financial Company-Micro Finance Institutions’ (NBFC-MFIs) – Directions – Modifications1 via which RBI has made changes to Directions issued on December 02, 2011 in light of representations received by it from NBFCs functioning in the microfinance sector. Let us look at the important provisions of the directions.

A procedural requirement introduced by the Directions is that to function as an NBFC-MFI, an NBFC must now seek registration with Reserve Bank of India as an NBFC-MFI. Failing this, an NBFC shall not be capable of advancing more than 10% of its assets to the Microfinance sector and shall not be treated as an NBFC-MFI. This change in classification shall be recorded in the Certificate of Registration of the NBFC. The last date for the application of registration is October 31, 2012.

In a move sure to bring relief to the NBFCs functioning in the sector in the country, Reserve Bank of India has decided to relax the criteria regarding the Qualifying Assets to some extent. As per the changes introduced, the assets existing on the January 1, 2012, whether or not they fall within the compass of “Qualifying Assets” as defined in the Master circular on NBFC-MFI2 , shall be taken into consideration in calculating the ratio of Qualifying Assets to the net assets. The aggregate amount of loans that an NBFC-MFI may extend for income generation activities may not be less than 70% of the total loans extended by NBFC-MFI. Earlier, the floor was 75%. Thus, a modicum of relaxation has also been introduced at this level, as the ground realities have been recognised that the target clientele of microcredit being at subsistence level, their basic human requirements cannot be overlooked. On multiple lending, RBI has clarified that a person who borrows as an individual cannot thereafter borrow from an NBFC-MFI as member of an SHG or JLG. Again, the same SHG/JLG/individual cannot borrow from more than 2 MFIs.

NBFC-MFIs have also been directed to be members of at least one credit information company and to provide them with timely and accurate data and use the data available with them to ensure compliance with the conditions regarding membership of SHG/ JLG, level of indebtedness and sources of borrowing. As a safety measure to avoid concentration in specific geographical locations, NBFC-MFIs may approach their Boards. All NBFC-MFIs have also been directed to become member of at least one Self-Regulatory Organization (SRO) recognized by the Reserve Bank of India.

The Directions introduce flexibility in terms of pricing individual loans. Earlier, the interest rate cap on individual loans given by MFIs was fixed at 26% and the margin at 12%. Post these directions, the average interest rate on the loans is still limited to the sum of average borrowing costs plus margin or 26%, whichever is lower but the interest rate on individual loans given by MFIs may be more than 26%. Also, the caps on margin have been revised to 10% for large MFIs (loans portfolios exceeding Rs.100 crores). The maximum variance permitted for individual loans between the minimum and maximum interest rate cannot exceed 4 per cent. The average interest paid on borrowings and charged by the MFI are to be calculated on average monthly balances of outstanding borrowings and loan portfolio respectively.

The Directions also recognise the problems faced by MFIs with respect to loans originated in Andhra Pradesh. With regard to the portfolio in Andhra Pradesh, NBFC-MFIs have been directed to ensure that the provisioning made towards the portfolio in Andhra Pradesh should be as per the current provisioning norms. For the purpose of calculation of Capital to Risk Weighted Assets Ratio(CRAR), however, the provisioning made towards portfolio in Andhra Pradesh shall be notionally reckoned as part of Net Owned Funds and there shall be progressive reduction in such recognition of the provisions for AP portfolio equally over a period of 5 years. No write-back or phased provisioning is permissible. As far as portfolio in other states is concerned, the provisioning will be as per the December 2, 2011 circular3 , with effect from April 1, 2013.

There has been a mixed response in the Microfinance sector to the Directions. While the directions relating to reduction in margin cap for larger MFIs have been criticised, the operational clarifications concerning MFIs being part of at least one Credit Information Company and at least one Self-Regulatory Organization (SRO) which is recognized by the Reserve Bank of India have been welcomed.4

1 – DNBS (PD) CC.No.300 /03.10.038/2012-13
2 – DNBS.(PD)CC.No.293/03.10.38/2012-13
3 – DNBS.CC.PD.No. 250/03.10.01/2011-12
4 – “RBI relaxes NBFC-MFI rules: Positives and negatives”, http://www.moneycontrol.com/news/business/rbi-relaxes-nbfc-mfi-rules-positivesnegatives_740629.html ( last visited on August 10,2012)


Notes from the IFMR Capital Partners Meet

On November 22nd and 23rd, IFMR Capital held its first partners meet, a two day meet with all its partners to re-envision access to finance for institutions that impact low income households. Industry participants and researchers came together to discuss a broader vision for the industry. While the two day event saw active participation and debate on issues that currently concern the sector, the emphasis of the meet was largely on the way forward. Held at a critical juncture, participants brainstormed and discussed strategies for reshaping the sector towards a shared vision.

The meet followed the appreciative inquiry format and drew out the best from the participants. The first part was designed to shift the focus of participants from being short-term reactive to long-term proactive. The second part focused on the positives of the industry and on what was valuable about the way the sector has functioned in the past. The participants broke into groups of two and interviewed each other. Each person described their high points and success stories, sharing instances of how and why being in this sector made them feel glad they belonged here.

The third part of the approach sought to use the output from the interviews to get a clear sense of what were the most important factors that contributed to the success in the sector. Later, organised in groups of six, participants worked on a vision of what the sector would be like in five years if the root causes of success were leveraged in specific areas of focus such as governance, customer focus, risk management, product development, etc. The end result was a shared vision that institutions in the sector could look up to.

Some important questions that emerged during the meet are listed below:

  1. How should we position MFIs so that they become an indispensable part of the financial system?
  2. How do we engage with the political groups more effectively?
  3. What are the unique and additional responsibilities of MFI boards, given that they deal with a segment that is financially and otherwise excluded?
  4. As a sector, what data do we need to collect and disseminate, internally and externally, to enable holistic risk management?
  5. What investments in training will organizations and the industry make in:
    • Moving from mono-line to a multi product model
    • Ensuring common minimum values are shared across the sector
    • Taking on the new role of a financial advisor
  6. How do we use technology or other disruptive methods to dramatically improve operating efficiencies?
  7. What is the regulatory framework which will allow MFIs to flourish and serve a wider range of financial needs?
  8. How do we resolve short-term funding & liquidity issues for the sector?

In the last part of the meet, the groups focused on developing tactical strategies on four areas : brand management, product development, political engagement and ensuring common minimum values, areas that needed immediate action to take the industry from where it is today to where the group would like to see it in the future.

Here is a brief summary of the themes that emerged from the meet.

a) Customer centric approach: The MFI industry’s main strength is its ability to reach out to and serve a vast number of clients. Client engagement is continuous and services provided are valuable. There was a clear consensus that going forward this customer centric approach must continue to be of key importance.

b) Innovation: Every growing sector continuously evolves. Institutions must be able to respond to the changes in the sector. The need is for an innovative and flexible approach which ensures sustainability and works in the interest of its end customers. The idea of MFIs offering multi-products was discussed at length. This was the way forward and MFIs must invest time, effort and capital towards this. MFIs already possess large amounts of granular financial data pertaining to their clients. This could help them understand the needs and capacities of their clients better and in turn aid the design of relevant financial products.

c) Operating efficiencies: The cost to serve low income households can potentially be dramatically reduced by disruptive innovations. Key pieces of infrastructure such as the UID have the potential of making KYC a public good. Enormous strides in technology such as the use of biometric identification, automated payment systems, mobile technology with improved authentication through the UID can also ensure that local branch staff leverages technology to perform their most repetitive day-to-day tasks, freeing up their time to perform their core duty of understanding the needs of clients and recommending appropriate solutions. There was a clear consensus that business models need to evolve and leverage such innovations.

d) Importance of the mission: While sustainability of business was crucial, it was agreed that the commitment to social and economic well-being of the client was crucial to the sector. Given the profile of the average client, MFIs perform the important role of giving access to finance to the most excluded segment of society. Going forward, organizations must not lose sight of this fact. Further, it is necessary that there is an alignment of objectives and vision across the entire company.

e) Positioning of the industry: Concerns were raised about the response of the industry to the recent crisis and the lack of a unified voice. The role of the board was stressed in this respect, many felt that the board should play a role in ensuring customer metrics are tracked continuously and senior management is held accountable to performance as measured against the metrics. This would also ensure that MFIs are collecting enough information during good times as well as bad, so an accurate picture can be presented to the media, investors and regulators.

f) Holistic risk management: The current business model of organisations in the inclusive finance sector is strong on operations and therefore manages operations related risks very well. However, in order to evolve into universal financial service providers, organisations need to focus on risk in a more holistic manner, ie look at all aspects of risk such as operational risk, credit risk, interest rate risk, liquidity risk, political and regulatory risk. Capacities need to be built internally, for instance, risk departments need to be set up, people need to be hired and adequate training needs to be provided, investment needs to be made in risk management systems. However, it was agreed that senior management buy-in was critical to the implementation of “holistic risk management”.


Technology to the rescue of MFIs

– By Sameer Segal, Founder & CEO, Artoo

[Artoo Slate is a software solution designed for microfinance field staff that takes the entire process of data collection and loan disbursement online. Sameer has been recognized as one of Asia-Pacific’s most promising young social entrepreneurs by the Paragon100 Fellowship. He holds a B Tech from the National Institute of Technology, Karnataka and is a StartingBloc Fellow (MIT Sloan). His passion is inclusive technology, something he discovered during his internship with Ujjivan. He, along with Co-founder of Artoo, Indus Chadha, has developed Artoo Slate which helps microfinance companies cut down on operation costs. He shares with us in this guest blog, how technology can make a difference to microbanking institutions that cater to the bottom of the pyramid.]

The Malegam Report is finally here. At first glance, we were all glad to see how well balanced it appeared. But now we have to begin to make sense of the constraints that it places on MFIs in the short term. In the words of Vijay Mahajan of BASIX: “some provisions are so severe that some MFIs will be facing death by April”.

Indeed, most MFIs must be grappling at the moment with what changes they will need to make to stay alive.

If MFIs need to reduce costs, remove redundancies, and improve efficiencies at all levels, they need to centralize their operations. Centralizing will also help MFIs ensure the quality of the customers they acquire and thereby reduce risks. To centralize operations and still maintain competitive TATs for all customer-centric activities (e.g. customer acquisition, loan disbursement, and repayments) is the hardest part of the puzzle that needs to be cracked. It will be only possible for MFIs to consolidate branches and have their field agents operate over larger geographies (improving borrower to employee ratio) when they can monitor and remotely manage their staff and activities. For that they need technology. 

We believe, however, that this needn’t be a question of the survival of the fittest. It could serve as an opportunity for visionary MFIs, regardless of their size and strength, to re-imagine their operations in a way that, while respecting the RBI’s imminent mandates, dramatically reduces their Operating Expense Ratio (OER) and enables them to remain profitable and survive in the face of the Malegam Report.

At Artoo, we wish to catalyze development through inclusive technology and empowering communication. Our software framework, Artoo Slate, can help MFIs bring down their OERs to meet the RBI’s requirements in a timely manner while enabling them to remain profitable. We believe it has the potential to help MFIs become more productive in helping their customers rise out of poverty. Here’s our take on what the Malegam Report is asking MFIs to do and how we might be able to help.


 Artoo Slate is a software solution that takes the entire process of data collection (under 18 minutes for complete customer acquisition process*) and loan disbursement online (70+% of Loan Applications can be processed in the field on the same day*). It will capture rich data from the field, do away with the back and forth of paper, avoid innumerable delays (reduction in turn-around-time (TAT) from 3+ days to 1 hour*), and drastically reduce expenses (courier, Document Management System Hubs & outsourced data entry). It will allow for easy exchange of data between field staff and backend systems (CBS/MIS) in a way that will reduce time spent (41% of center meetings take under 1 min to update paper work) on customer query clarification and identification and resolution of errors in customer profile and loan application forms. Even while the credit bureau is stabilizing, it will enable MFIs to implement a field credit check upfront for renewal loans based on internal data and assessment. 


Our framework enables field agents to operate remotely and helps distributed MFIs to centralize their operations, while improving their TAT for all customer-centric activities. MFIs can monitor their business on a real time basis: pick up on trends (mass default, political/economic turbulence) as and when they happen directly from the field (defaulter information available instantaneously as compared to 10-15 days lag in previous implementation*). In addition, MFIs can track their social performance on a daily basis.

It is an intuitive interface that has been designed keeping in mind field staff’s educational training and exposure to technology. It will also serve as platform through which MFIs can train (e.g. basic English skills, computer skills, updates on new products and offerings) their field staff on-the-go and monitor them on a real time basis to improve their overall service quality. MFIs can improve their field agent quality and build their capacity, reducing their attrition to short-term focused aggressive competitors.


Artoo Slate, in the hands of the field agent, promises to be a scalable way for the MFI to engage more effectively with their end customers through videos, graphics, and other interactive media (imparting life skills, financial planning, healthcare information, conversational English, etc.) Engaging with the end customer will not only give them a reason to attend center meetings but also allow them to recognize their MFI as a real partner in their struggle to climb out of poverty, giving forward-thinking MFIs an opportunity to differentiate themselves, improving customer loyalty and therefore profitability.


We have been really lucky to pilot our solution, Artoo Slate, at Ujjivan microfinance, and are happy to share the interim results of our pilot here. The pilot covers a branch in urban Bangalore and includes processes of customer acquisition, collections, branch transactions, and field agent training.


Where is the Ponzi scheme?

We have recently read comments on various blogs which suggest that MFIs are comparable to Ponzi schemes. These bloggers suggest that once new MFI loan disbursements slow down, borrowers will not be able to make the payments on their old loans.

We would like to present data from some of our partner organisations operating across India which soundly refutes this notion.

Out of 13 MFIs whose data has been shared here, only one operates in Andhra Pradesh.

In the following table the data on the collection rate is split into before and after the Andhra Pradesh Ordinance came into effect.  As one can see collections rates remain above 99% despite the fact that many MFIs have significantly cut disbursements.



MFIs, markets need each other

By Kshama Fernandes, IFMR Capital

The goal of an investment professional is to maximise the risk-adjusted return on the overall portfolio through diversification within and across asset classes. High repayment rates, low volatility of returns and low correlation with other asset classes make microfinance an interesting asset class.What drives the high repayment rates and low volatility of returns? How can unsecured loans made to borrowers with no credit history be of higher credit quality than more established asset classes? To understand these questions, one has to look at the underlying model.

Social collateral

The joint liability group (JLG) system is an operationally intensive model with strong emphasis on adherence to simple, yet well-designed processes. The product is typically a one-year loan with equal weekly repayments. A group of borrowers get together and form the basic unit — the joint liability group. Coming from the same neighbourhood, they know each other well enough to understand the cash flows and requirements of households, and have insight into the ability and willingness of the members to repay.

The group members collectively guarantee the loan given to members in their group. If a member fails to pay an instalment, the others in the group pool together and pay.Very often, non-payment of an instalment is due to reasons of liquidity, not wilful default. Most low-income households have no collateral to provide. The model effectively replaces physical collateral with social collateral.

While this may appear simple, the implementation is complex. Borrowers, who have never availed loans in the past or experienced the discipline of repayments, need to be educated about the product, group formation process and the liability they take on being a member of the group.

Educating borrowers

MFIs spend a lot of time educating their borrowers through a well-defined CGT (Continuous Group Training) and GRT (Group Recognition Test) process before a loan is sanctioned and disbursed. While most MFIs insist on borrowers engaging in an income generation activity, often the loans are utilised to smoothen lumpy cash flows, typical of an agriculture-based economy.

Most rural households engage in multiple income-generating activities. They grow seasonal vegetables, rear livestock and work as daily wage labourers. Thus, repayments often come from within the existing household balance sheet, rather than from new business income.

The small weekly repayments match well with the high frequency cash inflows. The group guarantee, based on self-selection, repayment discipline with close group monitoring, and a financial product that matches the household’s cash flow patterns, results in high repayments.

The low correlation observed between returns on this asset class and mainstream asset classes, such as equities, bonds, commodities and bullion, is because in the short run, the small-scale activities and occupations engaged in by borrowers continue irrespective of the happenings in mainstream markets.

As markets for end products/services produced by clients are largely local, the micro economy continues to function irrespective of whether inflation skyrockets, stock index nosedives, interest rates strengthen or exchange rates collapse.

Distinctive features

The features distinguishing microfinance from other asset classes are:

Very high granularity resulting in portfolio diversification: Microfinance loans have small ticket sizes that average Rs 12,000. As explained earlier, these loans are used for income generation, to smoothen cash flows and repay high-cost debt. The granular nature of loans with diversified business activity underlying them makes for a well-diversified underlying loan portfolio;

Short-term assets: These are short tenor loans where the frequency of repayment is far higher than standard loans. The principal outstanding steadily reduces with every week of repayment. Hence the duration of a typical loan with a one-year maturity is around six months. From a risk-return perspective, this is an attractive feature; and

Superior credit quality due to underlying model: Except for instances triggered by political risk, losses in this sector have been in the range of 1.5-2.5 per cent. Pool performance has been consistently good for originators who have tapped capital markets through well-structured securitisation transactions; this enables investors to take an exposure to this asset.

Efficient geographical diversification can be achieved by pooling loans originated by multiple MFIs across States and districts. The collection efficiency of such transactions structured by IFMR Capital has been 99 per cent. These numbers are far superior to those exhibited by other retail asset classes.

Wider Investor Base

For an investor pursuing risk-adjusted returns, microfinance is certainly an asset class worth looking at. MFIs have been able to tap capital markets through securitisation transactions and non-convertible debentures (NCDs), attracting mainstream investors such as mutual funds, bank treasuries, and private wealth investors. As the investor base for microfinance diversifies, the sector is also likely to experience lower liquidity risk.

For instance, after the recent Andhra Pradesh crises, while banks reduced lending to the sector, NBFCs continued lending, preventing a liquidity crunch.

The professionalism and rigour of capital markets has resulted in increased transparency, operating efficiency and improved risk management practices in this sector. Market oversight and performance monitoring by investors and rating agencies will go a long way in establishing microfinance as a high-quality asset class.

This article first appeared in The Hindu Business Line.