Multiple Borrowing & Competition Impact on Credit Quality

1. Multiple Borrowing & CompetitionImpact on Credit Quality Sucharita Mukherjee 9th January 2010

2. Agenda 1 Impact of competition and multiple borrowing on credit quality 2 Trends in the microfinance sector 3 Solutions for the future

3. Why is competition and multiple borrowing a concern? • Individual client default probability increases • Current level of credit versus credit capacity • Information asymmetry • Systematic risk (i.e. the risk inherent to the entire MFI)increases due to deterioration in origination and collection processes of the MFI

4. Impact on Credit Quality of Microloan Portfolios 1 • How is proof of identity and proof of residence checked? • Does the MFI educate the client adequately about the loan product, its features and financial discipline required? • Proxy questions on loans availed during the group recognition test to check multiple borrowings • Loan appraisal process: How is the ticket size decided? • Attendance in group meetings • Proxy for multiple borrowings? • Is it recorded in the system? Origination Process 2 • How strong are MFIs’ systems to check utilization of loans? • How is the staff trained and retained? • How is the staff incentivized? • Personal guarantees! • Loan recovery mechanisms • What are the processes for internal audit? • uniform implementation of systems and processes • Static pool analysis Systems & Policies

5. Impact on Credit Quality of Microloan Portfolios 3 • How does the MFI decide which areas/villages to enter? • Has the MFI made any changes to it’s operational model or products to counter competition? Are there any specific risks posed by the change? • Centre leader transforms into an agent! • Frequency of group meetings • Knowledge of competitors at the level of branch staff • How is this information being recorded/utilised? • How does the MFI build on its relationship with the client? • Is the MFI part of any regional forum or credit bureau initiatives(egAkmi, Alpha)? Competition

6. Why does this matter? • For the microfinance sector to scale up: • High quality origination or frontline provision of financial services • Orderly transfer of risk - well-capitalised financial institutions to manage risk • IFMR Capital: the vital link • Investment/holding of risk by well-capitalised diversified entities such as mutual funds, insurance companies and pension funds

7. Microfinance Sector Trends

8. Microfinance Sector Trends

9. Solutions for the future • Formation of Credit bureau at National level • 25 MFIs have formed a trust called Alpha to put together a credit bureau • Enables information sharing, capturing fraudulent transactions, solving localized common problems, and adopting a common code of conduct • MFIs to focus on origination quality • Proper assessment of borrowers including CGT, GRT and continuous monitoring • Assessment of overall credit capacity • Development of tailored financial products • Market development - IFMR Capital’s role • Market standards for MFIs • Continuous oversight • Encourage transparency regarding quality of operations : make information available to capital markets • Workshops/training programmes for partner MFIs to develop capacities in risk management, credit assessment

10. 1, Cenotaph Road | Teynampet | Chennai - 18 www.capital.ifmr.co.in

11. Appendix

12. Multiple Borrowings in Kolar – Context • Karnataka is a heavily banked state with a bank branch for every 11000 people*. • Total number of households = 11.16 million of which 2.77 million are poor • Total of 27 MFI’s (& 45 NGOs) operating with 18 of them headquartered in the state • In March ’09, no of estimated microfinance accounts = 7.31 Million • Hence, 7.31/11.16 = 65% households having MFIs loans (Assuming each house has a microfinance loan) • If loans cover only poor households, each household has 7.31/2.77 = 2.63 accounts • Average MFI loan size = 6600 Rs, about 10% higher than national average • Usually Microfinance loans don’t go to the poor, but ‘near’ poor which implies number of loan accounts per borrower is likely to be more than two • Credit deposit ratio of banks in March 08 = 304 percent • Compounded with SHGs , this region was heavy on debt. * RBI banking statistics, 2008

13. Problems in Kolar • Religious issue: Hurting the Islamic sentiments of people • Local economy was on the decline • Handicraft & silk industry not strong • Droughts visiting this district for 3 years; District dependent on rains for 70% of cultivable land • Farm loan waiver by government External Conditions • Product deficiencies: Sericulture & street hawkers required different types of loans – cash flow & loan repayment mismatch • Process infirmities, flawed incentive structure for staff, inadequate training and capacity building • Intense competition eroded the discipline • Neglected early warning signs Internal Conditions

14. CMF Study on Multiple borrowing & Competition in Indian Microfinance sector • The Study done in Sept, 2007 • Analyzing data set of over 500,000 clients loan and repayment records from 7 MFIs over a 3 year tenure funded by ICICI • The extend and effects of multiple borrowing and competition on repayment are quantified • Interviews with selected clients with multiple membership to understand clients’ key drivers • Qualitative interviews with leading sector experts and practitioners on the issues of competition and commercialization

15. The Results • The key finding - there is no negative relationship between multiple borrowing and repayment performance • A majority of the multiple borrowers interviewed reported that they used the second loan for investment purposes and none had repayment difficulties • All the MFIs, except one operating in urban locations only, had equal or better repayment rates in more competitive branch locations (defined as villages with at least 3 MFIs with multiple borrowers) – More rigorous examination is needed • On average, 7.28% of the MFIs’ clients in the sample are multiple borrowers. An estimated 10.28% of all the clients in the state are multiple borrowers.