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

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

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 Origination Process 1 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? Systems & Policies 2 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

5. Impact on Credit Quality of Microloan Portfolios Competition 3 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(eg Akmi, Alpha)?

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

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. Thank you 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 Internal 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

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.