Viability Analysis Of Shg Lending In A Microfinance Institution

RURAL FINANCE PROGRAMME INDIA

Viability analysis of SHG lending in a microfinance institution

October 2006

microcredit Innovations Department NABARD, Head Office Plot No. C-24, ‘G’ Block nd 2 Floor, “E” Wing, Bandra Kurla Complex Post Box No. 8121, Bandra (East) Mumbai 400051 / INDIA

Rural Finance Programme L-20, Green Park Main New Delhi 110 016 / INDIA

Phone Telefax

+91-22-2653 9244 +91-22-2652 8141

Phone Telefax

+91-11-2652 6024 +91-11-2652 8612

Email Homepage

[email protected] www.nabard.org

Email Homepage

[email protected] www.gtz.de

Viability analysis of SHG lending in a microfinance institution final report

by Jan Meissner

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Table of Contents List of Abbreviations ......................................................................................................... 5 1.

Introduction.................................................................................................................6 1.1. 1.2.

2.

Overall profitability of BISWA’s Microfinance operations ......................................8 2.1. 2.2. 2.3. 2.4. 2.5.

3.

BISWA – the organisation ................................................................................................. 8 Financial Services offered................................................................................................. 9 Financial situation ........................................................................................................... 10 Performance.................................................................................................................... 14 Composition of lending rate – Step 1 .............................................................................. 15

Transaction cost analysis of SHG lending in service area 1 ................................18 3.1. 3.2. 3.3. 3.4. 3.5. 3.6.

4.

Background and objective of the study ............................................................................. 6 Methodology...................................................................................................................... 7

Methodology applied ....................................................................................................... 18 Analysing the profitability for pricing decision ................................................................. 20 Results ............................................................................................................................ 23 Composition of lending rate in service area 1 – step 2 ................................................... 24 Challenges and observations.......................................................................................... 25 Recommendations: ......................................................................................................... 26

Summary of findings and conclusions...................................................................27

Annex................................................................................................................................ 29

Acknowledgements The author is very grateful to Mr. KC Malick (Chairman of BISWA) and Mr. Asish Kumar Sahu (Project officer Microfinance). I would like to thank also the head office staff and field staff for providing valuable information for the pilot study. Furthermore, I am appreciative of the SHG members for their candid sharing of their experiences and their patience during the interviews. A list of persons met and organisations visited is presented in Annex A. Sincere thanks are due to Ms. Girija Srinivasan as backstopper of the study, who has been extremely helfpful in giving her honest comments and valuable inputs in the analysis of the study and on the presentation and interpretation of the results of the analysis.

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List of Abbreviations A/C

Account

AC

Administrative costs

AE

Administrative expenses

BISWA

Bharat Integrated Social Welfare Agency

CR

Cost of Risk

e.g.

Abbreviation of Latin 'exempli gratia': for example

FC

Financial costs

FE

Financial expenses

FI

Financial income (potential)

FLDG

First Loss Default Guarantee

FY

Financial Year

GTZ

Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH

HO

Head office

i.e.

Abbreviation of Latin 'id est': that is

LLA

Loan Loss Allowances

MBT

Mutual Benefit Trust

MFI

Microfinance Institution

NABARD

National Bank for Agriculture and Rural Development

NGO

Non-Governmental Organization

NPA

Non-Performing Assets

OD

Overdraft facility

p.a.

Per annum

PAR

Portfolio-at-risk

Rs.

Rupees

SA

Service area

SC

Staff costs

SHG

Self-Help Group

SHPI

Self-Help Promoting Institution

Ts.

Thousands

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1.

Introduction

1.1.

Background and objective of the study

The provision of viable and qualitative financial services to SHGs is necessary for the sustainability of the SHG-Bank Linkage Programme in India. At present there are three predominant models of linkage banking. In model one the bankers form and finance the groups. Under the model two, the self help promoting institution (SHPI) forms and nurtures the groups and the bank directly finances the groups. In the third model, the SHPI also acts as financial intermediary between the groups it has formed and the financing bank. Thus the SHPI acts as a micro finance institution. The linkage programme can be sustainable in the long run if the costs of these services are covered at all levels i.e. at banks’ level, at Self-Help Promoting Institutions’ (SHPIs)/MFI level as well as at SHG level. Therefore, sufficient intermediation margins are essential at each level. All the costs incurred by the financial intermediary will have to be reflected in the lending rate the institution charges to its costumers. In order to ensure the institution’s financial viability the intermediation margin or spread of lending must be sufficient to cover transaction costs and costs of risk. The spread must also cover opportunity cost of capital. As illustrated in the table below, the lending rate consists of two main components, namely cost of funds and transaction costs which comprises of operating costs, risk cost and opportunity cost of capital. Table 1: Components of lending interest rate effective lending rate Effective financial income

Components of the lending interest rate Cost of funds Operating costs Intermediation margin Cost of risk (spread) Opportunity cost of capital

It has been concluded from various studies that the transaction costs at SHG’s level are negligible or even non-existent.1 Several studies focusing on the transaction costs of banks have concluded that such costs at banks’ level are low for SHG lending and hence it is profitable business for the banks.2 But a recent study conducted by M-Cril3 revealed concerns about the ability of banks to assess, monitor and manage costs and risks of their SHGs portfolio and concluded that banks are not charging sufficient intermediation margins. A series of studies have been commissioned by GTZ under the NABARD – GTZ Linkage banking project to analyse the viability of the SHG bank linkage under different models. The studies shall provide practical tools for bank managers and MFIs for cost and activity analysis and interest setting for financing SHGs. The best practices of banks and MFIs’ in SHG lending will also be documented and disseminated. The present study is to assess the viability of SHG lending by BISWA, an NGO operating in Orissa. BISWA with its head office in Sambalpur is registered under Societies Registration Act XXI of 1860. The organisation is an SHPI which has been forming self help groups from the year 1996 onwards and as of March 2006 12,437 SHGs (March 2005: 4,699) are functioning in 42 districts (March 2005: 22 districts) in the states of Orissa and Chhattisgarh. BISWA is acting as a financial intermediary between the SHGs and the banks, i.e. directly from own funds and indirectly through the partnership with ICICI Bank. The present study was undertaken during March 2006.

1

Karduck/Seibel (2004): Transaction costs of SHGs in SHG Banking: a study in Karnataka, India Inter alias: Dave/Seibel (2002): Commercial Aspects of SHG-Bank Linkage Programme; Srinivasan/Satish (2000): Transaction costs of SHG lending – impact on branch viability; Puhazhendhi (1998): Transaction costs of lending to the rural poor. 3 M-CRIL (2003): The outreach/viability conundrum – Can India’s Regional Rural Banks (RRBs) really serve low-income clients, Gurgaon 2

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1.2.

Methodology

Two characteristics are of crucial importance for the profitability of micro financial institutions. First, the revenue mostly depends on the loan volume especially the amount of loan outstanding. Second, transaction costs (expressed in staff cost and related overheads) are more or less the same for a loan regardless of its size. Hence a MFI can reduce costs per unit of money lent by increasing the loan size to increase its profitability. The other possibility of improving profitability would be to charge a higher interest rate on loans of small size. The viability analysis of an MFI’s operations can be based on the profit centre accounting approach. A profit centre (which can be a branch, or a department, or a product) is an important tool of management accounting. The financial costs and benefits of the organisation are attributed to the profit centre and adjusted on the basis of accruals method of accounting and analysed for viability. BISWA delivers financial and non-financial services to the poor through Self-Help Groups. Three main departments – Micro Finance, Micro Enterprise and Social Development – are involved in providing the services. BISWA’s microfinance department is offering financial services as well as a range of non-financial services such as capacity building trainings, book keeping etc. The costs of financial and non-financial services (both direct and indirect) attributable to BISWA’s microfinance department are identified, allocated and then analysed. For the study, a field visit to BISWA’s head office in Sambalpur and district offices in Sambalpur and Bargarh was undertaken during March 2006. The audited financial statements for the FY 2003-04 and 2004-05 as well as unaudited financial statements for the FY 2005-06 were analysed. Loan portfolio details, allocation of salaries among projects and other details were provided by BISWA which are presented in Annex B. This exercise focuses on the FY 2004-05 but the development of BISWA during FY 2005-06 is also discussed. In the first step, the overall profitability of BISWA’s microfinance department is analysed for the FY 2003-04 and 2004-05 in a static perspective (chapter 2). In the second step, the actual income and expenditure of the FY 2004-05 are attributed to the profit center service area 1 and adjusted for the non financial expenditure in order to analyse the appropriateness of the interest setting of BISWA’s microfinance department in service area 1 (chapter 3). The annexes provide a detailed description of the methodology applied for this cost exercise. It shall give a deeper insight into the methodology to enable further discussions.

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2.

Overall profitability of BISWA’s Microfinance operations

2.1.

BISWA – the organisation

Orissa is one of the poorest states of India with more than 49 percent of the population living below poverty line. Nearly 85 percent of the population living in the rural areas belongs to SC/ST population, who is considered poor. Some of the villages where BISWA is operating have dominant presence of naxalites4. Thus BISWA is operating in a difficult environment. Donors and Government agencies are appreciative of the work of BISWA and are collaborating with its various activities. The General Body of BISWA comprises of 21 members which forms the apex decision making body of the organisation. The General Body elects the Governing Body members every 5 years. The governing body of BISWA has 11 members, headed by the chairman, and is entrusted with the governance of the organisation. BISWA has three main departments: Microfinance, Micro enterprise and Social development. Books of Accounts of BISWA are maintained by an independent accounting unit and checked and balanced by a concurrent audit unit. The management of the departments is done by the planning implementation unit which consists of 6 members. In respect to microfinance operations, the project officer of the planning unit and the chief financial officer of the accounting unit are looking after non-financial and financial affairs respectively. As of March 2005, BISWA’s microfinance department has in total 195 (March 2006: 413) paid staff members excluding 2 ICICI credit officers (March 2006: 17). A simplified organisation chart of BISWA and its MFI department as on March 2005 is presented in Figure 1. Figure 1: Organisational structure of BISWA

Governing Body of BISWA Chairman

Secretary

Planning & Management Department

Microentreprise

Social development

Microfinance MFI HO unit

Management

Administration

Insurance

Monitoring

ICICI Unit

MFI HO sub units 1 Federation coordination unit

22 SHG coordination units

MFI field units Field staff

Self-Help Groups

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According to http://en.wikipedia.org/wiki/Naxalite: Naxalite or Naxalism is an informal name given to revolutionary communist groups that were born out of the Sino-Soviet split in the Indian communist movement. The term comes from Naxalbari, a small village in West Bengal, where a leftist section of Communist Party of India (Marxist) (CPI(M)) led by Charu Majumdar and Kanu Sanyal led a militant peasant uprising in 1967, trying to develop a "revolutionary opposition" in order to establish "revolutionary rule" in India.

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The organisation structure of the microfinance department can be divided into three levels: 1. A head office unit with 17 staff and 2 ICICI credit officers (March 2006: 29 staff + 17 ICICI staff), comprising of a management, an administration (with MIS and loan desk units), a monitoring and an insurance department as well as an independent ICICI unit. Its costs are not directly attributable to the service area/loan product activities as they form part of overhead costs. 2. Two types of head office sub units, which directly impact either district or service/loan product activities, consisting of one federation unit comprising 1 federation officer and 2 unit coordinators (March 2006: 1 federation officer and 6 unit coordinators) operating in the district of Sambalpur and 22 district units (March 2006: 42 district units) with 33 coordinators and assistants (March 2006: 2 state, 24 district and 34 area coordinators and 10 assistants) taking care of both old and new districts. The district coordination units have their office premises normally in the respective districts. 3. 142 field staff (March 2006: 307), which directly impact either district or service/loan product activities and as such their costs are attributable to the district operations or loan products. These key field staff members of BISWA are called community organisers who are forming and promoting SHGs as well as delivering financial and non-financial services of BISWA-MFI with support and supervision of the head office and head office sub units. As of March 2005 service area 1, i.e. district units of Sambalpur and Bargarh, where BISWA started its financial activities in the year 1996, comprises of 10 coordinators and assistants, and 62 field staff (March 2006: 19 coordinators and assistants and 97 field staff). The mandate of BISWA is to enable socio-economic growth of the SHG members. The microfinance and micro enterprise department focus on the economic development, whereas the social development department addresses the other social needs of the SHG members, such as education, health, habitat and environmental protection needs. Most of the social development activities are executed through the SHGs. Various integrated projects/programmes have been implemented especially in Sambalpur district.

2.2.

Financial Services offered

The delivery of financial services is carried out through Self Help Groups (SHG). The SHG is formed by BISWA bringing together 10-19 homogenous individuals living in a compact geographical area (villages/wards). The SHGs are encouraged to practice thrift and are savingslinked to the nearest bank. After 3-4 months the SHGs are encouraged to lend their savings. After six months, the groups are graded according to pre-defined criteria and the groups obtaining ‘A’ or ‘B’ grade are considered to be eligible for external credit linkage. The C graded groups are further strengthened. During this capacity building phase of 6 months, the groups are imparted training on group dynamics, book/record keeping, leadership development etc. The demand for credit is generated among the eligible groups. The groups are educated on eligible criteria, terms of loan, rate of interest, repayment schedule and other aspects of the credit linkage by the respective community organizers. BISWA’s microfinance department is providing loans and insurance directly or indirectly via the newly formed federations to “its SHGs”. Although ICICI loans are contracted directly between the SHGs and ICICI, the members perceive BISWA as their “bank”. The average SHG loan term is 9 months and the average loan processing time is 15 days. The loan is granted by a ‘Loan Committee’ based on the amount of saving mobilized by the group. The maximum amount that can be sanctioned is 10 times the amount of the security deposit the SHG deposits out of the savings of the SHGs. The security deposits carry simple interest at 5% p.a. BISWA started lending to SHGs in 1996. Since then, BISWA’s outreach and loan business has expanded enormously. As of March 2006, BISWA’s microfinance department with a staff of 413 members is providing its financial and non-financial services to 12,437 functioning SHGs directly. BISWA also lends to SHGs indirectly through 40 NGOs and 56 federations. During the financial year (FY) of 2005-06, BISWA disbursed from its own funds 6,204 SHG loans, 40 NGO loans and 1,819 federation loans directly with a total amount of Rs. 211,808,290 and 4,705 loans indirectly

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via fund management on behalf of ICICI with a total amount of Rs. 440,000,000. The partnership with ICICI Bank has started in December 2004. BISWA offers also insurance products to the SHG members as well as encourages savings of the SHG members. Savings of the SHG members as on March 2005 amounted to Rs. 19,539,580 (March 2006: Rs. 56,324,851) out of which Rs. 1,033,780 (about 5%) (March 2006: Rs. 5,748,086 [about 10%]) are kept with the SHGs as cash and for internal lending purposes, Rs. 14,736,125 (about 75%) (March 2006: Rs. 33,236,114 [about 59%]) are kept with bank accounts and Rs. 3,769,675 (about 19%) (March 2006: Rs. 17,340,651 [about 31%]) are kept with BISWA as margin money (security deposit bearing an interest rate of 5% p.a.). BISWA-MFI is charging an interest rate of 18 percent per annum on reducing balance for the SHG loans. A lump sum loan processing fee of about Rs. 200 is also charged from the SHGs. ICICI loans which are managed on behalf of ICICI by BISWA-MFI to the SHGs5 since December 2004 are charged with an interest of 14.5 percent during FY 2004-05 and 18% during FY 200506.6 The SHGs formed by BISWA-MFI charge 24 percent from their members. All the interest rates are on declining balances. Banks pay 3-3.5% p.a. interest on savings deposit of SHGs whereas BISWA reportedly pays 5% on security deposits of SHGs7. BISWA-MFI is encouraging the members of the SHGs to procure insurance products. BISWA started offering the government subsidised Janashri Bhima Yojana Scheme of Life Insurance Corporation, a life insurance scheme. 15,610 SHG members have been covered until March 2006. During 2005-06 BISWA introduced ICICI-Lombard Health Insurance to 44,851 SHG members. Since 2006, BISWA and Oriental Insurance Company are jointly developing insurance products to dovetail the needs of their clients. BISWA-MFI promotes SHG federations. The federations are conglomeration of 11-50 SHGs in a cluster and legally registered under the Trust Act as Mutual Benefit Trusts (MBTs). They are promoted as client owned client managed institutions acting as financial and social intermediaries between SHGs and the service provider: BISWA. Until March 2006, 56 federations have been formed.

2.3.

Financial situation

In the early stage, BISWA-MFI provided credit facilities to SHGs either by linking them directly to banks or by availing small loans from banks such as State Bank of India (SBI) and Bolangir Anchalik Gramya Bank (BAGB). NABARD was supporting BISWA for its SHG promotion and capacity building activities. During 2002, Care-India, Orissa approached BISWA with the Credit and Savings for Household Enterprise (Cashe) project and has been partnering with BISWA-MFI since June 2002. Since then other lenders such as Bridge Foundation, Swoyangshree and Friends of Women World Banking India (FWWBI) have extended credit assistance. As a part of their phasing out process, Care-India introduced BISWA to various private banks and as a result BISWA is currently linked to ICICI Bank, ABN AMRO Bank. Presently BISWA has also received loan funds from Rashtriya Mahila Kosh (RMK), Small Industries Development Bank of India (SIDBI), Union Bank of India (UBI), National Minorities Development and Finance Corporation (NMDFC) and Sambalpur District Central Cooperative Bank (SDCC). BISWA-MFI was rated or graded by M-Cril as 8, by CRISIL as mfR49 and by Mix Market as ****10. BISWA is promoting a Non-Banking Financial Company (NBFC) shortly to minimise the constraints in mobilizing external commercial borrowings. The adjusted consolidated balance sheets of BISWA-MFI including Care project for the years March 2004-06 are presented in Table 2. 5

ICICI loans are contracted directly between the ICICI Bank and the SHGs. Therefore it does not reflect on the balance sheet of the BISWA-MFI directly. 6 The SHGs have to keep a set of book of accounts paid by the members for ICICI transactions, additionally to their own SHG book of accounts. 7 Though reported by BISWA, the interest paid could not be found in the auditor’s reports 8 Moderate safety, moderate systems → acceptable, needs improvement to handle large volumes 9 medium grading: mfR1 – mfR8 10 All MFIs are invited to participate in this unique portal. The level of disclosure for each MFI is indicated through a "diamond" system: the higher the number of diamonds (1-5), the higher the level of disclosure.

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Table 2: Consolidated Trial Balance Sheet (Microfinance department incl. Care-Cashe Project and Care-Acceleration Project), FY 2004-06, in Rs. Items

Notes

March 2004 INR

LIABILITIES Capital & Reserves Borrowings Security Deposit Other liabilities TOTAL ASSETS Fixed assets Fixed deposit Loans Other assets TOTAL

March 2005

%

INR

March 2006

%

INR

%

1 2 3 4

5% 668,789 10,738,600 81% 913,531 7% 7% 895,011 13,215,931 100%

6,881,767 18% 26,299,688 70% 3,769,675 10% 378,124 1% 37,329,254 100%

56,441,455 33% 97,516,225 56% 17,340,651 10% 1,567,750 1% 172,866,081 100%

5 6 7 8

1,824,708 14% 0 0% 11,305,028 86% 1% 86,195 13,215,931 100%

1,384,208 4% 2,575,000 7% 32,819,224 88% 550,822 1% 37,329,254 100%

4,055,816 2% 2,575,000 1% 164,035,884 95% 2,199,381 1% 172,866,081 100%

Source: auditors’ report FY 2004-05 and unaudited reports by BISWA The main source of funds for lending to SHGs, MBTs and NGOs directly is the MFI loan fund from various borrowers. In addition to these commercial funds, BISWA-MFI received security deposits from the SHGs – the margin money. Furthermore, BISWA corpus provides interest free loans to its microfinance department, which are defined as quasi equity as the funds are coming from its holding. In addition to its own funds, BISWA’s microfinance department manages funds on behalf of ICICI. BISWA has been partnering with ICICI since December 2004. The loan period of ICICI loans is longer, i.e. 3 years. BISWA-ICICI partnership (ICICI partnership model) has been conceptualised and executed with the following key characteristics:11 1. The ICICI loans are contracted directly between ICICI and the underlying borrower: the SHGs. It does not reflect on the balance sheet of BISWA who is managing these loans on behalf of ICICI by identifying clients, sanctioning and disbursing loans, collecting instalments and interest. 2. For these services BISWA is charging a service fee of 5% to ICICI during FY 2004-05 (FY 2005-06: 8.5%) comprising the margin between interests collected from the SHGs of 14.5% p.a. (FY 2005-06: 18%) and interests paid on ICICI fund of 9.5% p.a. on reducing balance to cover its transactions costs. 3. BISWA’s microfinance department provides a first loss default guarantee (FLDG) through which it shares the risk of the portfolio with ICICI. FLDG makes BISWA liable to bear losses up to 12.5% on the ICICI portfolio. The lower the defaults, the better the earnings of BISWA. BISWA has placed a fixed deposit with ICICI Bank amounting to Rs. 2,575,000 which is 12.875% of the provided fund during FY 2004-05 (FY 2005-06: 0.6%). BISWA receives interest of 5.5% p.a. on this fixed deposit from ICICI Bank. BISWA has not increased the fixed deposit amount during FY 2005-06 as an overdraft facility was provided by ICICI. 4. The overdraft facility (OD) which is a feature of the partnership model of ICICI is provided to BISWA during FY 2005-06 but has not been drawn yet.12 “The overdraft facility is equivalent to the amount which the MFI is liable to provide the FDLG normally. The overdraft represents funds committed, but not utilised. The OD is drawn only in the event of default. On default, the MFI is liable to pay an interest (“penal”) rate on the amount drawn down from the overdraft facility.”13

11

Partly taken from Bindu Ananth (2005): Financing Micro Finance – The ICICI Bank Partnership Model, www.icicisocialinitiatives.org 12 As stated by BISWA 13 See above

11

The consolidated mutual balance sheet of BISWA and ICICI or rather a hypothetical balance sheet of BISWA’s “Fund management on behalf of ICICI” is produced in table 3. Table 3: Hypothetical trial balance sheet of BISWA for fund management on behalf of ICICI, FY 2005-06, in Rs. Items

Notes

March 2005 INR

LIABILITIES Capital Loan from ICICI TOTAL ASSETS Current assets14 Loans to SHGs TOTAL

March 2006

%

INR

%

1 2

0 0% 17,631,892 100% 17,631,892 100%

2,611,175 1% 407,989,241 99% 410,600,416 100%

3 4

0 0% 17,631,892 100% 17,631,892 100%

16,915,188 4% 393,685,228 96% 410,600,416 100%

Source: auditors’ report FY 2004-05 and unaudited reports by BISWA The details of origin and use of the two types of funds of BISWA’s microfinance department, i.e. portfolio from various lenders and fund managed on behalf of ICICI, is presented in table 4. Table 4: Origin and use of funds, FY 2004-05 and 2005-06 Value of funds received Value of funds outstanding Average value of funds outstanding Interest paid (Average) nominal interest rate Value of loans disbursed Value of loan portfolio outstanding Average value of loan portfolio out. Interest received Nominal interest rate

MFI fund portfolio FY 2004-05 FY 2005-06 Change 25,904,500 93,682,800 262% 26,299,688 97,516,225 271% 61,907,956 234% 18,519,144 1,569,283 3,499,150 123% 9.70% 9.75% 1% 86,027,150 32,819,224 22,062,128 4,761,254 18.0%

211,808,290 155,007,253 93,913,237 14,156,474 18.0%

146% 372% 326% 197% 0%

Fund managed on behalf of ICICI FY 2004-05 FY 2005-06 Change 20,000,000 440,000,000 2100% 17,631,892 393,685,228 2133% 8,815,947 205,658,560 2233% 490,827 5,047,330 928% 9.50% 9.25% -3% 20,000,000 17,631,892 8,815,947 490,827 14.5%

440,000,000 393,685,228 205,658,560 15,361,418 18.0%

2100% 2133% 2233% 3030% 24%

The shares of average loan able funds according to their sources for the FY 2004-05 and FY 200506 are presented in figure 2 and 3 respectively. Figure 2: Share of average loan able funds Figure 3: Share of average loan able funds FY 2004-05 FY 2005-06 MFI loan portfolio 66%

Interest free hand loan 1%

Margin money 3%

Margin money 7%

Interest free hand loan 10%

ICICI loan portfolio 26%

14

ICICI loan portfolio 60%

MFI loan portfolio 27%

In auditor’s report (2006): Receivables = Rs. 14,107,171. The meaning of this item could not be verified.

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The share of ICICI loan fund increased from 26% during FY 2004-05 to 60% during FY 2005-06 and the share of MFI loan able funds decreased from 66% during FY 2004-05 to 27% during FY 2005-06. It indicates a shift of BISWA’s business orientation from an MFI to a partner of ICICI. It would be interesting to observe how this partnership develops in view of the policy direction of RBI to banks to adopt “Business Facilitator and Correspondent Model” and BISWA’s intention to promote an NBFC with delivering its financial services through federations and NGOs. The total number of loan accounts outstanding at the end of FY 2004-05 is 2,152 (ICICI: 490) and at the end of FY 2005-06 it is 10,539 (of which ICICI: 4,314) which means a growth of about 390%. Additionally, 39 bulk loans to NGOs and 2,697 (of which ICICI: 878) loans to federations for onlending to SHGs as well as other loans15 at the end of FY 2005-06 were outstanding. The share of average loan outstanding per loan product is presented in figure 4 below. For the borrowings, BISWA-MFI paid interest of Rs. 1,569,283 during the FY 2004-05 which leads to an average cost-ofLoan to NGOs 7% funds ratio of 8.5% of average loan able Other loans funds. The Cost-of-funds ratio gives a 4% blended interest rate for an MFI’s funding Loan to MBTs liabilities. The weighted average interest 11% rate during FY 2004-05 is 9.25%. The Funding-expense ratio shows the interest rate an MFI is paying to fund its financial assets: Interest expenses on funding liabilities amount to 7.1% of the average gross loan portfolio during FY 2004-05. For the loans, the clients paid interest and fees Loan to SHGs 78% amounting to Rs. 5,074,079 during the FY 2004-05. Thus the financial revenue ratio (effective interest income) is 23% for FY 2004-05 on average gross loan portfolio.16 Figure 4: Share of averaged loan products outstanding, FY 2005-06

The total number of loan accounts outstanding at the end of FY 2004-05 is 2,152 (out of which ICICI: 490). The average loan size outstanding is Rs. 28,099 for BISWA-MFI and Rs. 40,825 for ICICI. The portfolio at risk (the value of all SHG loans outstanding that have one or more instalments of principal past due more than one day) constitutes 8.41% of the total value of loans outstanding as on March 2005. In ICICI loans to SHGs there is no overdue at all as reported by BISWA in both the financial years 2005 and 2006. The Portfolio at Risk (PAR) for installments past due for more than 90 days is 2.39% during FY 2004-05. The aging of portfolio BISWA-MFI excluding ICICI loans as of March 2005 are presented in figure 5.17 The PAR data for FY 2005-06 could not be provided in a satisfactory and accurate manner by BISWA. For further discussion see section 3.5.

15

Other loans have 2 classifications 1. Social Security loans and 2. Staff loans. The Social security loans are the amount converted into loans which have been paid by BISWA up-front for insuring clients (SHG members) under ICICI Lombard health insurance scheme. The Social security loans amounts to Rs 13,515,140 disbursed. The staff loans are extended to the staff members of BISWA (as they may be eligible from time to time and as per requirement). This amounts to Rs. 11,019,621 disbursed. Both of them totals Rs. 24,534,761 disbursed. 16 It is because of averages being worked out of year end balances so the average gross loan portfolio shows a relatively small number. The shifting from direct MFI fund loans (9 months loan term) to indirect ICICI loans (started in December 2004 with 3 years loan term) resulted in a lower average loan disbursement of MFI fund loans during the last quarter of FY 2004-05 and hence to a lower loan outstanding at the end of March 2006. This fact leads to inappropriate high interest earned on average loan outstanding. The monthly/quarterly data was not available so that it was decided to use only reliable data. 17 Reliable data on portfolio quality are not available for FY 2005-06, see section 3.5

13

Selected financial ratios for asset and liability management and loan portfolio quality of BISWA-MFI for the FY 2004-05 according to CGAP’s Microfinance Consensus Guidelines are produced in Annex C. Some of these ratios are presented here.

Figure 5: Share of classified SHG loans of BISWA-MFI as per 31st March 2005 1-30 days delay 4% 31-60 days delay 1% 61-90 days delay 1%

Capital adequacy ratio is 20.9% as on March 2005 (March 2006: 34.4%)18.

>90 days delay 2%

Risk coverage ratio shows how much of the portfolio at risk is covered by an MFI’s loan loss reserve. 83.8% during FY 200405 of the portfolio at risk with principal On-time loans 92% past due for more than 90 days is covered by BISWA-MFI’s yearly loan loss provisions (FY 2004-05 [first loan loss provisioning]: Rs. 656,385 which is 2% of the total loan outstanding; FY 2005-06: Rs. 2,322,864 which is about 1.5% of the outstanding MFI loan portfolio, i.e. Rs. 2,979,249 is loan loss reserve which is 1.8% of loan outstanding).

2.4.

Performance

The consolidated profit and loss statement of BISWA-MFI including Care project for the FY 200406 is presented in table 5. Table 5: Consolidated Profit and Loss Statement of BISWA-MFI incl. Care Project, FY 200406, in Rs. Items Income earned from loans Loan processing fee Interest earned from fixed deposit Other Income TOTAL Operating revenue Interest paid on borrowings TOTAL Financial expense TOTAL operating income Salaries and provisions for employees Office & other expenses Depreciation of fixed assets Loan loss provisions TOTAL operating expense NET OPERATING INCOME TOTAL non-operating items NET SURPLUS average Loan outstanding

Notes 1 2 3 4 5

6 7 8 9

10

FY 2004-05 4,761,254 312,825 5,199 0 5,079,278 1,569,283 1,569,283 3,509,995 3,835,867 923,676 284,868 656,385 5,700,797 -2,190,802 7,689,396 5,498,594 22,062,126

% 21.6% 1.4% 0.0% 0.0% 23.0% 7.1% 7.1% 15.9% 17.4% 4.2% 1.3% 3.0% 25.8% -9.9% 34.9% 24.9% 100%

FY 2005-06 17,356,474 874,540 8,522 403,370 18,642,906 3,499,144 3,499,144 15,143,762 4,903,674 1,155,434 547,450 2,322,864 8,929,423 6,214,339 40,882,505 47,096,844 98,427,554

% 17.6% 0.9% 0.0% 0.4% 18.9% 3.6% 3.6% 15.4% 5.0% 1.2% 0.6% 2.4% 9.1% 6.3% 41.5% 47.8% 100%

Source: auditors’ report of FY 2004-05 and unaudited reports by BISWA The following conclusions can be drawn from the financial statements: Overall, BISWA generated a net income of Rs. 5,498,595 in the FY 2004-05 which is 24.9% of average loan outstanding (FY 2005-06: Rs. 47,096,844/47.8%). Without donations and grants as well as non-operating expenses, BISWA-MFI generated a total loss of Rs. 2,191,801 during FY 2004-5 which is -9.9% of average loan outstanding (FY 2005-06: Rs. 6,214,339/6.3%).

18

Without grants and donations (FY 2004-05: Rs. 7,354,791; FY 2005-06: Rs. 10,723,822), the capital adequacy ratio is -1.44% for FY 2004-05 and 23.39% for FY 2005-06 (cumulative consideration). Furthermore, without Organisation contribution from BISWA organisation to the two Care Projects (FY 2004-05: Rs. 392,605; FY 2005-06: Rs. 1,234,566) and unclear transfer from general fund (BISWA) to BISWA-MFI (FY 2005-06: Rs. 29,064,116.70), the capital adequacy ratio would be -2.64% for FY 2004-05 and 4.68% for FY 2005-06.

14

Without donor and grant contributions, the equity funds of BISWA-MFI would have been wiped out during FY 2004-05 (the financial operations of BISWA-MFI reported net surplus during FY 2004-05 considering these grants). Selected financial indicators for sustainability and profitability of BISWA-MFI for the FY 200405 according to CGAP’s Microfinance Consensus Guidelines are produced in Annex C. Some of these ratios are presented here. 69.9% of the costs were covered by operating revenue during FY 2004-05 (FY 2005-06: 150%). Operational self-sufficiency measures how well a MFI covers its costs through operating revenues. The profit margin amounts to -43.1% of the operating revenue during FY 2004-05 (FY 2005-06: 33%). Profit margin measures what percentage of operating revenue remains after all financial, loan-loss provision, and operating expenses are paid. The return on average equity (ROE) is -73% (FY 2005-06: 19.6%). The return on average assets (ROA) is -8.8% (FY 2005-06: 5.9%). The adjusted profit and loss statements of BISWA-MFI’s fund management on behalf of ICICI for the 4th quarter of FY 2004-05 and FY 2005-06 are presented in Table 6. Table 6: Profit and Loss Statement of BISWA for fund management on behalf of ICICI, FY 2004-06

Items Income earned from loans TOTAL Operating revenue Interest paid to ICICI Other charges TOTAL Financial expense TOTAL operating income Salaries and provisions for employees Office & other expenses Depreciation of fixed assets Loan loss provisions TOTAL operating expense NET OPERATING INCOME TOTAL non-operating items NET SURPLUS Average Loan outstanding

Notes 1 2 3

FY 2004-05 490,827 490,827 410,412 0 410,412 80,415

% 5.6% 5.6% 4.7% 0.0% 4.7% 0.9%

80,415

0.9%

0 0 80,415 0 0 0 8,815,946

0.0% 0.0% 0.9% 0.0% 0.0% 0.0% 100%

4 5 6 7

8

FY 2005-06 15,361,418 15,361,418 5,047,334 2,744,073 7,791,407 7,570,011 3,893,827 1,075,008 0 0 4,968,835 2,601,175 10,000 2,611,175 205,658,560

% 7.5% 7.5% 2.5% 1.3% 3.8% 3.7% 1.9% 0.5% 0.0% 0.0% 2.4% 1.3% 0.0% 1.3% 100%

Source: auditors’ report FY 2004-05 and unaudited report by BISWA The following conclusions can be drawn: The reported net operating income during the 4th quarter of FY 2004-05 is zero (FY 2005-06: Rs. 2,601,175). The effective interest margin is 0.9% of loan outstanding averaged during the 4th quarter of FY 2004-05 (annualised: 3.6%) (FY 2005-06: 3.7%). BISWA-MFI is not making any loan loss provisions despite bearing a share of the risk of default with ICICI.

2.5.

Composition of lending rate – Step 1

The intermediation margin is usually calculated as the difference between the effective lending rates and cost of funds, which comprises operating expenses (reflecting transaction costs of mobilising funds and lending), provision for bad debts (reflecting costs of risk or default) and profit (reflecting the opportunity cost of capital). The cost side of the income and expenditure statement largely depends on the number of loans while the revenue side solely depends on the loan amounts. The transaction costs (expressed in staff time and paperwork) are assumed to be more or less the same per loan product regardless of its size, while revenues in form of interest receipts are calculated on the nominal loan amount and thus vary proportionately with loan size. As a

15

consequence, a lender can reduce costs per unit of money lent by making large loans and thus increase his profitability. The other possibility would be to charge a higher interest rate on loans of small size. In this section, only the actual income and expenditure of the FY 2004-05 is taken into consideration. It is assumed that the actual income and expenditure items reflect the accrued costs and activities of the financial year and that only one financial product (portfolio consideration) is offered. In figure 6 the income and expenditure items are presented in percentage of the lending rate. Figure 6: Composition of the lending rate in a static perspective, Rs. in thousand19 BISWA-MFI including Care-Cashe Income

100%

Expenditure Administrative expense

Fund management on behalf of ICICI Income

Expenditure Administrative expense

Financial revenue

80,415

1,208,544

Financial expense

Personnel expense

80% Financial revenue 60%

40% 3,835,867

Loan loss 20%

Sum

656,385

Financial expense

0%

5,079,278

1,569,283

490,827

410,412

5,079,278

7,270,079

490,827

490,827

0

0

-2,190,801

It may be concluded that: the total financial revenue of BISWA-MFI including Care-Cashe project is not covering the sum of financial expenses, loan loss provisions and office and administrative expenses during FY 2004-05. The effective lending rate is not sufficient to cover the costs viz., cost of funds, operating costs and cost of risk. The expenses exceed the effective income by 43%. the total financial revenue of BISWA-MFI’s fund management on behalf of ICICI is covering the sum of financial and administrative expenses during FY 2004-05. The service fee is sufficient to cover the cost of funds and operating costs but not the risk cost. The average gross loan portfolio of BISWA-MFI is obvious too small to generate sufficient effective interest income to cover the costs. There are two alternatives possible: What average gross loan portfolio would have been sufficient to cover the costs with the actual effective interest rate (23% p.a.)? (Number of loans is constant; Capacity of demand is not utilised fully) o

19

Rs. 7,270,079 of effective income is generated with an average gross loan portfolio of Rs. 31,609,039 (average loan outstanding size) which means a growth of 43.3%.

Differences to previous table are caused by roundings.

16

How many loans would have been sufficient to cover the costs in each year? (average loan size managed is constant; Capacity of staff is not utilised fully) o

Rs. 7,270,079 of effective income is generated with 1,463 averaged loans managed (actual20: 1,021) with a constant average loan outstanding size of Rs. 21,608.

This simplified static analysis serves limited purpose because of the following factors. There are districts where financial business just started during FY 2004-05 where the client base is being developed and the benefits of which are yet to fructify. The loan portfolio size and the number of loans managed of BISWA’s microfinance department are growing in a tremendous way. The delivery methodology is becoming more complex with different methodologies and many channels. It is necessary to carry out the transaction cost analysis for a older profit center to arrive at conclusions.

20

Average number of loans managed. Average of number of loan outstanding March 2004: 875 and March 2005: 1,168

17

3.

Transaction cost analysis of SHG lending in service area 1

BISWA’s microfinance department has been extending its outreach of financial services wider, by geographically increasing the area of operations and deeper by upgrading loan clients to access and manage higher loan amounts and improving product range. This has led to the emergence of following profit and cost centers. Profit & Cost centres Profit centre 1: Service area 1 (SA1)

Profit centre 3: Service area 3 (SA3) Profit centre 4: Activity centre federation (AC-F) Profit centre 5: HO-Insurance unit (HO-I)

SHG promotion Promotion of SHG federations

Districts covered Sambalpur and Bargarh Deogarh, Boudh and Sonepur 17 other districts Sambalpur

JBYS scheme of LIC Insurance

All districts

Cost centre: Head office (HO)

Management & Servicing all profit centres

All districts

Profit centre 2: Service area 2 (SA2)

Services SHG lending and promotion (excl. ICICI fund management) SHG lending and promotion

Characteristics Started lending before March 2004 Started lending during FY 2004-05 Not yet started lending Started formation during FY 2004-05 Receives service fee from LIC Heading all district offices/units of BISWA

The viability analyisis is carried out for service area 1 being the older profit center.

3.1.

Methodology applied

This analysis focuses on the two districts Sambalpur and Bargarh named as service area 1 for the purpose of the analysis where BISWA started its lending activities before 2004. In this section, only data of FY 2004-05 are used for the analysis because: The field visit was conducted only in the districts of Sambalpur and Bargarh, where the financial operations have started already in 1996. BISWA is expanding its operational area and its services in a tremendous way. The results for the other districts were not conclusive. (The reported interest earned from SHG loans in other districts where SHG lending started during FY 2004-05 were disproportionately high, i.e. over 30% on average loan outstanding. There were no clear reasons cited). PAR was not reported by BISWA for the districts other than Sambalpur and Bargarh. (field observations are very different and thus the reliability of the data questionable, see section 3.5) At the first step, the analysis focuses on the identification of costs and activities of the BISWA’s microfinance department and their allocation among the profit and cost centres.The methodology of allocating income and expenditure statement items and the correspondent allocation keys and weights are presented in Annex D. Fund management on behalf of ICICI is not considered in this first exercise. At the second step, the costs of financial and non-financial services in service area 1 (SA 1) of the FY 2004-05 are identified and analysed, cost of funds21 and loan loss provisioning22 are adjusted. There are two types of non-financial services identified during the field visit.23 1.) The following services can be considered as client/delivery channel development investment cost. The costs for these services are considered as long term investment cost for BISWA and are amortized over a period of six years (see also section 3.2). BISWA facilitates rural and urban poor to form federations (field staff of SA 1 is involved) as federations are predominantly built for financial intermediation . 21 effective interest paid on borrowings and imputed interest payable on security deposit (which are not yet paid and booked though promised by BISWA-MFI) are included. The remaining source of funds from capital & reserves are considered as not interest bearing. Subsidised interest free hand loan in the nature of quasi equity is provided for loaning by BISWA organisation where the cost of funds is zero. This item is not included/considered in the analysis should be included for a holistic transaction cost analysis. It couldn’t be ascertained the source and other details of this fund. These (externalised) hidden costs are not considered in the above analysis 22 according to international banking standards (see CGAP and Basel II) 23 Cost are allocated according to time estimates taken from interviews with staff.

18

Capacity building of identified members with potentials to take over book keeping and writing documents (BoAs are provided and paid by BISWA-MFI24). BISWA field staff facilitates SHGs and its members to become self-functional. Important – Since the service area 1 has been forming self help groups since 1996 the long term group development costs have been incurred by the service area during the precedent years which are difficult to be calculated and amortised. 2.) The following non-financial services are considered as purely non-financial or social services and are separated from the analysis. BISWA is following an integrated approach of delivering social development and micro enterprise services to the SHGs through involvement of field staff (staff of SAs is involved). Awareness building for insurance products as well as processing. → All other activities are identified as financial services such as SHG book-keeping, SHG rating, and lending (appraisal, processing, monitoring, transactions [door-step banking]) and savings related activities. Furthermore, the auditors’ report of FY 2004-05 has details of capacity building measures which are part of the administrative and office expense of the head office. Financial and non-financial services are identified according to the above mentioned separation. The methodology applied is presented in Annex E. The SHGs are funded by BISWA by two kinds of arrangements. BISWA borrows from different lenders for on-lending to SHGs. BISWA as the borrower bears all costs and risks incurred in managing these funds. The second is the partnership with ICICI. The SHGs are the borrower of this fund. BISWA’s costs of handling this ICICI portfolio which is compensated by the margin between the rate of interest collected on the loan from the borrower and the interest paid to ICICI. However, under the FLDG part of the default risk costs have to be borne by BISWA. The effective intermediation margin of BISWA-MFI’s fund management on behalf ICICI in the 4th quarter of FY 2004-05 is 3.9% (annualised) of average ICICI loan outstanding. Figure 7 is presenting the source and use of funds for the FY 2004-05 as percentage of the average loan outstanding portfolio of BISWA-MFI. The average loan outstanding is funded by 84% of borrowings from several clients, 11% of margin money from SHGs, and the residual share of 5% is capital & reserves. The cost of funds are calculated as follows: 1. effective interest paid on borrowings: BISWA-MFI paid interest Rs. 1,569,283 on its borrowings during FY 2004-05 which is 8.5% on average borrowings (Rs. 18,519,144). 2. imputed interest payable on security deposit: The auditors’ reports of FY 2003-04, 2004-05 and 2005-06 don’t show the interest paid on margin money inspite of the declaration in BISWA’s reports. In order to include these (future) hidden costs, the interest payable is calculated on the yearly average basis. The imputed interest payable on such deposit (Rs. 2,341,603) would be Rs. 117,080 which is 5% on average security deposit. 3. imputed interest payable on capital & reserves: It is assumed that the remaining funds (5%) are drawn from capital & reserves. However, BISWA-MFI received loan funds/capital from BISWA organisation and others. The cost of such funds are hidden (externalised) costs.25 This fact will be considered in the interpretation of the return on capital/equity.

24

Separated BoA for ICICI loans are paid by the SHGs Applying the inflation rate, an appropriate market rate of return on capital, and subsidy adjustments (or just the nominal interest paid on savings accounts) for calculating the cost of funds drawn from capital & reserves would be more accurate. 25

19

Figure 7: Share of source of funds in percentage of average loan outstanding, BISWA-MFI direct lending operations, FY 2004-05 Not imputed (0% p.a.): Capital Care/BISWA contribution Reserves & accumulated profit

Source Capital & Reserves Security Deposit

Use 5% 11%

Imputed (5% p.a.): Interest bearing 5% p.a. as stated by BISWA (not booked) Borrowings

84%

Loans

100%

Effective (23% p.a.): Effective interest earned during FY 2004-05

Effective (8.5% p.a.): Effective interest paid during FY 2004-05

The cost of funds (loan funds of BISWA-MFI) is Rs. 1,686,363 which is 7.6% on average loan outstanding (Rs. 22,062,126). The share of service area 1 is 79%, so that Rs. 1,339,279 has to be borne by service area 1.26 At the third step, the costs of service area 1 for fund management on behalf of ICICI are identified and attributed accordingly. In service area 1, BISWA started fund management on behalf of ICICI during FY 2004-05 (December 2004). The existing delivery channels of BISWA are used for ICICI loans. For this exercise, the share of cost of financial services of BISWA-MFI are allocated to the activity “fund management on behalf of ICICI” by identified/defined keys and weights as a share of the costs for financial services has to borne by activity “fund management on behalf of ICICI”. The methodology applied is presented in Annex F.

3.2.

Analysing the profitability for pricing decision

The fact, that BISWA’s microfinance department is providing various services to the SHGs, i.e. financial and non-financial services, and has started with fund management on behalf of ICICI Bank during the FY 2004-05 makes it difficult to assess the viability of SHG lending from the income and expenditure statement alone. A stand alone static perspective to analyse the lending activities of BISWA’s microfinance department may lead to misinterpretation of the results as a considerable share of SHG lending costs are in fact investment cost for client development. These costs are amortized over a period of six years. The costs of social services are not considered in the analysis of the profitability for pricing decision. The results and implications of this exercise are presented in table 7. There are four scenarios possible: Both long term client development and social services costs are accounted and included in the analysis for the year. Only long term client development cost are included and accounted fully in the analysis for the current year Only long term client development are accounted with its share of amortization amount (6 years: starting in the current year) for the current year Both kind of non-financial cost are excluded from the analysis (i.e. borne by external agency) In this exercise, 34% of total transaction and overhead costs of BISWA-MFI’s direct lending are for the non-financial services delivered to SHGs in service area 1 and 29% in case of BISWA-MFI’s indirect lending on behalf of ICICI. By amortization of long term client development over a period of six years, the total transaction costs and overhead costs in SHG lending would be reduced by 31% for BISWA-MFI’s direct lending operations and by 26% for BISWA-MFI’s indirect lending operations on behalf of ICICI. For analysing the profitability the later method is applied. 26

Applying the market rate of interest of 9% on MFI borrowings to the share of capital & reserves funding (5%) the average loan portfolio leads to: The cost of funds (loan funds of BISWA-MFI) would be Rs. 1,794,487 which is 8.1% on average loan outstanding (Rs. 22,062,126). The share average loan outstanding during FY 2004-05 of service area 1 is 79%, so that Rs. 1,417,645 has to be borne by service area 1

20

Care-India with its Credit and Savings for Household Enterprise (Cashe) project was awarding grants for the initial investment costs for the implementation of microfinance services amounting to Rs. 1,349,242 during FY 2004-05 for service area 1. Care-Cashe understands these grants as a cost sharing contribution for start-up costs with phasing out their support in the next years. Considering BISWA’s contribution of Rs. 392,605 leads to an initial investment of Rs. 1,741,847 for FY 2004-05 in service area 1 exceeding the cost of non-financial services which are Rs. 1,107,170. The residual amount of Rs. 634,677 can be understood as subsidy for cost of financial services.27 This fact would lead to a different picture in the profitability analysis in section 3.4.28

27 28

In this case the total cost for non-financial services are borne by the collaboration of Care-Cashe and BISWA. It would lead to profit in service area 1 during FY 2004-05. see also section 3.4.

21

Scenario

Application Profit centre Results

Table 7: Consideration of social investment costs, FY 2004-05

3.) long term client development 4.) Purely social and long term 1.) Purely social as well as long 2.) long term client cost are accounted/distributed client development costs are not term client development costs development cost are over a period of six years accounted/borne are accounted fully in the accounted fully in the first year (starting in present year) present year Accounting practice of BISWA- Purely social cost are borne by Amortization of LTCD cost AND Purely social as well as long MFI external agency Purely social cost are borne by term client development costs external agency are borne by an external agency Financial and Non-Financial services of BISWA-MFI’s direct lending operations in service area 1 FS NFS I NFS II TOTAL

Rs. 1,819,524 511,322 417,400 2,748,246

M 10.4 2.9 2,4 15.6

The total costs for SHG lending are Rs. 2,748,246 as determined in the study. The transaction costs (excluding loan loss provisioning) for SHG lending is 15.6% of loan outstanding averaged.

Profit centre Results

Rs. 444,356 99,989 78,459 622,804

M 5.0 1.1 0.9 7.0

The total costs for SHG lending are Rs. 622,804 as determined in the study. The transaction costs (excluding loan loss provisioning) for SHG lending is 7.0% of loan outstanding averaged.

22

Rs. 1,819,524 511,322 2,330,846

M 10.4 2.9 13.4

The total costs for financial services and LTCD are Rs. 2,330,846 which would be a decline of 15%. The costs for SHG lending would decrease from 15.6% to 13.4%.

FS NFS I (A) TOTAL

Rs. 1,819,524 85,220 1,904,744

M 10.4 0.5 10.9

The total costs for financial services and amortized LTCD are Rs. 1,904,744 which would be a decline of 31%. The staff costs for SHG lending would decrease from 15.6% to 10.9%.

FS = TOTAL

Rs. 1,819,524

M 10.4

1,819,524

10.4

The total costs for financial services are Rs. 1,819,524 which would be a decline of 34%. The staff costs for SHG lending would decrease from 15.6% to 10.4%.

Financial and Non-Financial services of BISWA-MFI’s indirect lending operations on behalf of ICICI in service area 1 FS NFS I NFS II TOTAL

List of Abbreviations M FS NFS I NFS I (A) NFS II

FS NFS I TOTAL

FS NFS I TOTAL

Rs. 444,356 99,989 544,345

M 5.0 1.1 6.2

The total costs for financial services and LTCD are Rs. 544,345 which would be a decline of 13%. The costs for SHG lending would decrease from 7.0% to 6.2%.

FS NFS I (A) TOTAL

Rs. 444,356 16,665 461,021

M 5.0 0.5 5.2

The total costs for financial services and amortized LTCD costs are Rs. 461,021 which would be a decline of 26%. The staff costs for SHG lending would decrease from 7.0% to 5.2%.

Margin in % of SHG-loan outstanding averaged in service area 1 (Rs. 17,438,931) Financial services costs in SHG lending Social investment costs in SHG lending (non-financial) Amortization amount present year of social investment costs in SHG lending Purely social costs in SHG lending (non-financial)

FS = TOTAL

Rs. 444,356

M 5.0

444,356

5.0

The total costs for financial services are Rs. 444,356 which would be a decline of 29%. The staff costs for SHG lending would decrease from 7.0% to 5.0%.

3.3.

Results

After adjusting the income and expenditure statement items according to the separation of profit and cost centres, imputing cost of funds, the differentiation into financial services and non-financial services (analysis I and II) as well as attributing the share of staff and administrative cost to the profit centre “fund management on behalf of ICICI” (analysis III) the results are produced. Table 8 presents the operating income, the field transaction costs and the overhead cost. The financial cost and the amortized share of the determined long term investment cost (6 years) of service area 1 are included in the analysis. Table 8: Results of analysis for service area 1, FY 2004-05

Cost and benefit statement

Interest earned from SHG loans Loan processing fee earned Interest earned from fixed deposit TOTAL financial revenue Interest paid on borrowings direct/indirect Imputed interest on margin money TOTAL financial expense (cost of funds) TOTAL OPERATING INCOME TOTAL adjusted loan loss provisions (cost of risk) TOTAL field staff cost TOTAL administrative cost direct TOTAL FIELD TRANSACTION COST TOTAL HO staff cost indirect TOTAL HO administrative cost indirect TOTAL OVERHEAD COST NET OPERATING INCOME FINANCIAL Average Loan outstanding

Service area 1

MFI % 3,299,167 18.92% 221,793 1.27% 0 0.00% 3,520,960 20.19% 1,239,734 7.11% 99,545 0.57% 1,339,279 7.68% 2,181,681 12.51% 294,437 1.69% 1,054,057 6.04% 0 0.00% 1,348,494 7.73% 258,262 1.48% 592,426 3.40% 850,688 4.88% -17,501 -0.10% 17,438,931

100%

ICICI % quarter % annual 490,827 5.57% 22.27% 0 0.00% 0.00% 5,199 0.06% 0.24% 496,026 5.63% 22.51% 410,412 4.66% 18.62% 0 0.00% 0.00% 410,412 4.66% 18.62% 85,614 0.97% 3.88% 44,080 0.50% 2.00% 193,347 2.19% 8.77% 80,415 0.91% 3.65% 317,842 3.61% 14.42% 56,850 0.64% 2.58% 130,409 1.48% 5.92% 187,259 2.12% 8.50% -402,822 -4.57% -18.28% 8,815,946

100%

100%

The total operating income of BISWA-MFI’s direct lending in service area 1 (excluding ICICI) would be Rs. 2,181,681 which is 12.5% of averaged value of loan outstanding.29 The field transaction and overhead cost would be Rs. 2,199,182 which is 12.6% of averaged value loan outstanding which comprises 1.7% for loan loss provisioning, 6% for field staff cost and 4.9% for administrative or overhead cost on average loan outstanding. The net operating income of BISWA-MFI in service area 1 (excluding ICICI) would be a loss of Rs. 17,501 which is -0.1% of average value loan outstanding. It is recognisable that the transaction costs of direct lending of BISWA-MFI are still comparatively high with 12.6%. The major cost drivers are the field staff cost and the overhead cost but the effective income from lending is almost sufficient to cover the total transaction costs in service area 1. The total operating income of BISWA-MFI’s indirect lending on behalf of ICICI in service area 1 will be Rs. 85,614 which is 1.0% (3.9% on annual basis) of average value of loan outstanding. The attributed field total transaction and overhead cost of will be Rs. 505,101 which is 5.7% (22.9% on annual basis) of value of average loan outstanding which comprises 0.5% (2.0% on annual basis) for proposed loan loss provisioning, 2.2% (8.8% on annual basis) for attributed staff cost, 0.9% (3.6% on annual basis) for direct administrative cost and 2.1% (8.5% on annual basis) for indirect administrative and overhead cost on average loan outstanding. The net operating income for financial services of BISWA-MFI on behalf of ICICI in service area 1 would be a loss of Rs. 402,822 which is -4.6% (-18.3% on annual basis) of average value loan outstanding. It is recognisable that transaction costs of indirect lending of BISWA-MFI are higher than direct lending. 29

Applying the market rate of interest of 9% on MFI borrowings to the share of capital & reserves funding (5%) the average loan portfolio leads to: The total operating income of BISWA-MFI’s direct lending in service area 1 (excluding ICICI) would be Rs. 2,103,315 which is 12.0% of averaged value of loan outstanding. The net operating income would be a loss of Rs. 95,867 which is -0.5% of averaged value of loan outstanding.

23

3.4.

Composition of lending rate in service area 1 – step 2

In figure 8, the cost and benefit statements after analysis I-III of the profit centre service area 1 with its “financial operations and of BISWA-MFI” and “financial operations of BISWA-MFI’s fund management on behalf of ICICI” for the FY 2004-05 are presented in percentage of the lending rate. Figure 8: Composition of lending rate in service area 1 – step 2 BISWA-MFI including Care-Cashe 100%

Income Financial income

Expenditure

Fund management on behalf of ICICI Income

Overhead cost

Overhead cost

80%

Expenditure

850,688 267,673

Staff cost Staff cost 60% 1,054,057

Cost of risk

40%

Financial income

294,437

193,347

Cost of risk 44,080 Financial expense

Financial expense

20%

Sum

0%

3,520,960

1,339,279

496,026

410,412

3,520,960

3,538,461

496,026

915,512

-17,501

-419,486

Direct lending operations of BISWA-MFI in service area 1 (excluding ICICI): The financial operations of BISWA-MFI in service area 1 would have generated a net operating income of Rs. -17,501 in the FY 2004-05 which is -0.1% of average loan outstanding. Operational self-sufficiency of financial operations would have been 99.5%. The loss margin of BISWA-MFI in service area 1 would have amounted to 0.5% of the operating revenue during FY 2004-05. After analysing the operations of service area 1, it appears that net operating income of BISWAMFI’s direct lending is on a stable path of the life cycle of a typical financial product. The breakeven point seems to be reached during FY 2005-06 which is 9 years after introduction of direct financial services by BISWA-MFI. Assuming the operating cost to be given, an income-generating loan portfolio of Rs. 17,593,456 which is a growth of 1% would have been sufficient to cover the operating cost of BISWA-MFI.30 It may be concluded that the total financial revenue of the profit centre service area 1 with its financial operations for BISWA-MFI” (excluding ICICI portfolio) is not yet covering the sum of financial expenses, adjusted loan loss provisions, adjusted personnel expenses as well as overhead attribution of the head office during FY 2004-05. The effective lending rate earned through the nominal interest rate of 18% p.a. is almost sufficient to cover the costs viz., cost of funds, operating costs and cost of risk in the long run. But the return on equity or capital is still negative. 30

with the current effective interest rate margin of 12.5%

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Indirect lending operations of BISWA-MFI’s fund management on behalf of ICICI in service area 1: The financial operations of BISWA-MFI’s fund management on behalf of ICICI would have generated a net operating loss of Rs. 419,486 in the FY 2004-05 which is -4.8% for the quarter and -19% on annualised basis of average loan outstanding. Operational self-sufficiency of financial operations of BISWA-MFI would have been 54%. The profit margin would amount to -85% of the operating revenue during FY 2004-05. The total financial revenue of profit centre service area 1 with its indirect financial operations of fund management on behalf of ICICI is not covering the sum of financial expenses, attributed personnel expenses and applied loan loss provisions as well as overhead attribution of the head office during FY 2004-05. The effective income from the nominal service charge fee of 5 % p.a. is not sufficient to cover the costs viz., cost of funds, operating costs and cost of risk. The interest margin during FY 2004-05 is too low in this starting stage when high appraisal and other investments are necessary. Considering the grants from the collaboration of Care-Cashe and BISWA and neglecting the differentiation of financial and non-financial services in service area 1 would lead to a different picture. The operations in service area 1, i.e. direct and indirect lending, would be profitable with an amount of Rs. 299,575 but excluding the contribution of BISWA amounting to Rs. 392,605 the operations in service area 1 would be again loss-making.

3.5.

Challenges and observations

During FY 2005-06, BISWA-MFI’s activities in service area 1 are clearly shifting from direct to indirect lending of management on behalf of ICICI. Since the field visit was undertaken in the month of March, the financial results for the year 2005-06 were not available for analysis. However, the important changes that were noticed include exponential growth in loan portfolio especially under partnership model with ICICI. BISWA had also increased the interest rate to SHG under ICICI loan portfolio to 18 percent declining balance. It is possible that BISWA-MF’s fund management on behalf of ICICI generates already a profit. But this development should be seen with caution. Both number of loans disbursed and average loan size has increased and potential risks exist which can lead to future cost. The portfolio quality is important for a MFI to provide viable and sustainable lending products. With the growth in portfolio, several growth related issues were also noticed which can affect the portfolio quality and sustainability of the programme. 1.) It was observed that the book keeping at field level and MIS at head office level is not adequate for a financial institution registering exponential growth: The field staff and office staff were not able to give the amount overdue of BISWA-MFI or ICICI loans for each SHG clearly. BISWA had not inculcated systematic portfolio reporting. No schedules for loan repayment were found in any books/ledger. It is a matter of concern. Though BISWA claims that no rescheduling of loans is done, during the filed visit it was seen that at least four loans had been rescheduled in the district of Bargarh. Only in Sambalpur PAR is reported by BISWA where an MIS is implemented but in all other districts as well as in ICICI no PAR (>1 day) was reported during FY 2004-05 as well as FY 2005-06. This needs verification since during field visit to Bargarh, it was seen that at least five loans were overdue for more than 3 months with an overdue amount of more than Rs. 200,000 where as the reports show no overdues. Moreover, BISWA reportedly makes no rescheduling of loans though it was observed by checking the books during the field visit. ICICI is not monitoring their funds adequately as only once in three months, ICICI officers are checking the books and visiting the SHGs. 2.) Staff related issues: The number of staff employed especially for micro finance and where their salaries are being booked is not very clear especially for the year 2005–06.

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The training of the staff is inadequate to sustain a good loan portfolio quality. The capacity building expenses have decreased during FY 2005-06 as compared to FY 2004-05 though the staff strength and number of SHGs increased three fold. Except chief accounting officer and Chairman others have very little experience in banking and micro finance. The capacity building needs are tremendous. 3.) It was observed that loan loss provisioning is not adequate befitting a growing MFI: Though the loan portfolio of MFI is increasing, the loan loss provisioning is decreasing (from 2% of loan outstanding (March 2005) to 1.5% of loan outstanding (March 2006). Keeping in mind that the loan portfolio reporting is weak, and the understanding of NPA or Portfolio at risk is not present in the other districts except Sambalpur, this can lead to substantial future cost. There is no loan loss provisioning for ICICI loans though BISWA is bearing 12.5% of the loan portfolio as cost of risk (First default loss guarantee) through a overdraft facility provided by ICICI. It may be concluded that BISWA-MFI’s direct lending operations can be considered as viable in the long-run only under the following conditions: The value of loan outstanding increases in a sustainable manner considering an active creditrisk management. The capacity building costs for staff should be increased in order to have qualitative personal management and this cost is likely to be substantial. A timely, accurate and actively managed Management Information System isessential especially for proviiding information on portfolio quality, the transaction costs, and quality of profit centres. Adequate loan loss provisioning in regard to asset classification is necessary to avoid high yearly fluctuations. Thus the conclusions drawn on the adequacy of interest rate to cover all the costs may be considered tentative since costs of capacity building, loan loss provisioning costs and financial costs such as payment of interest on savings of SHGs can impact the margins. When costs are incurred for capacity building of staff, computer based MIS etc., the viability of present interest rate can be under stress.

3.6.

Recommendations:

BISWA’s microfinance department has to separate its income and expenditure statements for financial and non-financial operations as well as fund management on behalf of ICICI which may be done through appropriate mechanisms, be it by charging the profit centre “financial operations” for the services provided by BISWA or by the same methodology applied in this analysis. This will help in pricing the products. Implemenation of computer based MIS is the need of the hour for BISWA MFI which is recording exponential growth rates through the partnership mode of ICICI. Inadequate portfolio information can increase the default risk of the organization. Poor quality book keeping, lack of data flow on portfolio from SHG level to higher levels can have serious impact on the operations of the MFI. BISWA MFI based on the portfolio information needs to devise loan loss provisioning for direct loans as well as for partnership with ICICI. Training of staff in loan processing, assessing capacity of loan absorption and MIS are the other area which requires immediate attention of BISWA MFI. Similar training for SHGs to imbibe good practices of lending will be needed. SHG will need a host of services to maintain their quality such as MIS and loan monitoring by federation/NGO, training, audit of books, other need based linkages etc., BISWA needs to ensure provision of such services to ensure absorption capacity of SHG. Mere increase of loan size to the SHG without sustainable services can be counterproductive and affect the performance of SHGs.

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4.

Summary of findings and conclusions

The pilot study on viability of SHG lending in a microfinance institution has generated a number of interesting findings which are relevant for policy makers and for the institutions involved in the linkage banking. However, a word of caution is necessary. Firstly, the pilot study was confined to two single branches/districts of BISWA-MFI only; hence, the findings are specific to those particular branches/districts and cannot be generalized. The results should rather be treated as indicative, geared towards identifying major parameters, cost drivers and trade-offs but also towards refining the methodology for future - possibly more extended - studies. Secondly, the study examined the cost structure of one operational year only and did not take into account developments and changes over time. Thirdly, the field observations leave some doubts about the reliability of the data given by BISWA. Fourthly, the grants from the collaboration of Care-Cashe and BISWA are not considered in the profitability analysis though these subsidies affect the resource allocation of BISWA-MFI. With these caveats in mind, the major results are summarized in the following. Under the given parameters and assumptions, the generated effective intermediation margin of BISWA-MFI’s SHG lending activities, i.e. direct lending from own funds and indirect lending on behalf of ICICI, in the districts of Sambalpur and Bargarh is not sufficient to cover the comparatively high transaction costs during the FY 2004-05.31 But these results must be put in the right perspective. Firstly, BISWA-MFI has started its direct lending activities to SHGs in 1996 and since then, BISWA-MFI has increased its investment and business activities extensively but the growth of the income-generating loan portfolio is lagging behind the growth of the transaction costs. Secondly, the fact, that BISWA’s microfinance department is providing various services to the SHGs, i.e. financial and non-financial services, and has started with fund management on behalf of ICICI Bank during the FY 2004-05 makes it difficult to assess the viability of SHG lending in the short run. Thirdly, with the growth in portfolio, several growth related issues were also noticed during the field visit which affect the significance and interpretations of the results. Field staff cost and overhead cost of SHG lending at BISWA-MFI’s district level in Sambalpur and Bargarh are the major cost driver. The high staff and overhead cost of direct and indirect SHG lending, however, is overestimated in a static analysis which covers only one year. The staff cost include social investment cost of forming and promoting new and existing SHGs as well as other non-financial (social) service cost. An amortisation of social investment cost over several years would reduce staff cost to some extent but not to the level of profit-making as SHG lending is still very time- and overhead cost-intensive. The relatively high nominal interest rate of 18% p.a. is mainly justified by the high cost of funds of BISWA-MFI, as with all MFIs. The intermediation margin of 8-9% p.a. may be sufficient if the size and quality of the loan portfolio is adequate as it is indicated in the FY 2005-06. But the conclusions drawn on the adequacy of interest rate to cover all the costs may be considered tentative since costs of capacity building, loan loss provisioning costs and financial costs such as payment of interest on savings of SHGs can impact the margins. When costs are incurred for capacity building of staff, computer based MIS etc., the viability of present interest rate can be under stress.

31

Cf. Viability analysis of SHG lending in a Regional Rural Bank branch; Viability analysis of SHG lending in a District Central Co-operative Bank branch and an affiliated Primary Agricultural Credit Society

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