Viability analysis of SHG lending in a microfinance institution

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RURAL FINANCE P ROGRAMME INDIA

Viability analysis of SHG lending ina microfinance institution

October 2006


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microcredit Innovations DepartmentNABARD, Head OfficePlot No. C-24, G Block2nd Floor, E Wing, Bandra Kurla ComplexPost Box No. 8121, Bandra (East)Mumbai 400051 / INDIA

Rural Finance ProgrammeL-20, Green Park MainNew Delhi 110 016 / INDIA

Phone +91-22-2653 9244 Phone +91-11-2652 6024Telefax +91-22-2652 8141 Telefax +91-11-2652 8612

Email [email protected] Email [email protected] www.nabard.org Homepage www.gtz.de


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Viability analysis of SHG lending ina microfinance institution

final report

by Jan Meissner


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Table of Contents

List of Abbreviations ......................................................................................................... 5

1. Introduction.................................................................................................................6

1.1. Background and objective of the study ............................................................................. 6 1.2. Methodology...................................................................................................................... 7

2. Overall profitability of BISWAs Microfinance operations ......................................8 2.1. BISWA the organisation................................................................................................. 8

2.2. Financial Services offered................................................................................................. 9

2.3. Financial situation ........................................................................................................... 10

2.4. Performance.................................................................................................................... 14

2.5. Composition of lending rate Step 1 .............................................................................. 15

3. Transaction cost analysis of SHG lending in service area 1 ................................18

3.1.

Methodology applied....................................................................................................... 18

3.2. Analysing the profitability for pricing decision ................................................................. 20

3.3. Results ............................................................................................................................ 23

3.4. Composition of lending rate in service area 1 step 2 ................................................... 24

3.5. Challenges and observations.......................................................................................... 25

3.6. Recommendations: ......................................................................................................... 26

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

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

AcknowledgementsThe 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 forproviding valuable information for the pilot study. Furthermore, I am appreciative of the SHGmembers for their candid sharing of their experiences and their patience during the interviews. Alist 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 beenextremely 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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1. Introduction

1.1. Background and objective of the studyThe provision of viable and qualitative financial services to SHGs is necessary for the sustainabilityof the SHG-Bank Linkage Programme in India. At present there are three predominant models oflinkage 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 financesthe groups. In the third model, the SHPI also acts as financial intermediary between the groups ithas formed and the financing bank. Thus the SHPI acts as a micro finance institution. The linkageprogramme can be sustainable in the long run if the costs of these services are covered at alllevels i.e. at banks level, at Self-Help Promoting Institutions (SHPIs)/MFI level as well as at SHGlevel. 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 theinstitution charges to its costumers. In order to ensure the institutions financial viability theintermediation margin or spread of lending must be sufficient to cover transaction costs and costsof risk. The spread must also cover opportunity cost of capital. As illustrated in the table below, thelending rate consists of two main components, namely cost of funds and transaction costs whichcomprises of operating costs, risk cost and opportunity cost of capital.

Table 1: Components of lending interest rate effective lending rate Components of the lending interest rate

Cost of fundsOperating costs

Cost of riskEffective financial

income Intermediation margin(spread)Opportunity cost of capital

It has been concluded from various studies that the transaction costs at SHGs level are negligibleor even non-existent. 1 Several studies focusing on the transaction costs of banks have concludedthat 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 toassess, monitor and manage costs and risks of their SHGs portfolio and concluded that banks arenot charging sufficient intermediation margins.

A series of studies have been commissioned by GTZ under the NABARD GTZ Linkage bankingproject to analyse the viability of the SHG bank linkage under different models. The studies shallprovide practical tools for bank managers and MFIs for cost and activity analysis and interestsetting for financing SHGs. The best practices of banks and MFIs in SHG lending will also bedocumented and disseminated.

The present study is to assess the viability of SHG lending by BISWA, an NGO operating inOrissa. BISWA with its head office in Sambalpur is registered under Societies Registration Act XXIof 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 financialintermediary between the SHGs and the banks, i.e. directly from own funds and indirectly throughthe 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, India2 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 therural poor.3 M-CRIL (2003): The outreach/viability conundrum Can Indias Regional Rural Banks (RRBs) really serve low-incomeclients, Gurgaon


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1.2. MethodologyTwo 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 thesame for a loan regardless of its size. Hence a MFI can reduce costs per unit of money lent byincreasing 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 MFIs operations can be based on the profit centre accountingapproach. A profit centre (which can be a branch, or a department, or a product) is an importanttool of management accounting. The financial costs and benefits of the organisation are attributedto the profit centre and adjusted on the basis of accruals method of accounting and analysed forviability.

BISWA delivers financial and non-financial services to the poor through Self-Help Groups. Threemain departments Micro Finance, Micro Enterprise and Social Development are involved inproviding the services. BISWAs microfinance department is offering financial services as well as arange of non-financial services such as capacity building trainings, book keeping etc. The costs offinancial and non-financial services (both direct and indirect) attributable to BISWAs microfinance

department are identified, allocated and then analysed.For the study, a field visit to BISWAs head office in Sambalpur and district offices in Sambalpurand Bargarh was undertaken during March 2006. The audited financial statements for the FY2003-04 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 byBISWA which are presented in Annex B. This exercise focuses on the FY 2004-05 but thedevelopment of BISWA during FY 2005-06 is also discussed.

In the first step, the overall profitability of BISWAs microfinance department is analysed for the FY2003-04 and 2004-05 in a static perspective (chapter 2). In the second step, the actual income andexpenditure of the FY 2004-05 are attributed to the profit center service area 1 and adjusted for thenon financial expenditure in order to analyse the appropriateness of the interest setting of BISWAs

microfinance department in service area 1 (chapter 3).The annexes provide a detailed description of the methodology applied for this cost exercise. Itshall give a deeper insight into the methodology to enable further discussions.


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2. Overall profitability of BISWAs Microfinance operations

2.1. BISWA the organisationOrissa is one of the poorest states of India with more than 49 percent of the population livingbelow poverty line. Nearly 85 percent of the population living in the rural areas belongs to SC/STpopulation, 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 andGovernment agencies are appreciative of the work of BISWA and are collaborating with its variousactivities.

The General Body of BISWA comprises of 21 members which forms the apex decision makingbody 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 withthe governance of the organisation. BISWA has three main departments: Microfinance, Microenterprise and Social development. Books of Accounts of BISWA are maintained by anindependent accounting unit and checked and balanced by a concurrent audit unit. Themanagement of the departments is done by the planning implementation unit which consists of 6members. In respect to microfinance operations, the project officer of the planning unit and thechief financial officer of the accounting unit are looking after non-financial and financial affairsrespectively. As of March 2005, BISWAs microfinance department has in total 195 (March2006: 413) paid staff members excluding 2 ICICI credit officers (March 2006: 17). A simplifiedorganisation 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

Self-Help Groups

Administration Insurance

Field staff

Planning & ManagementDepartment

Micro-entreprise Microfinance

Socialdevelopment

MFI HO unit

MFI HO sub units

MFI field units

22 SHG

coordination units

1 Federation

coordination unit

Management

Chairman Secretary

ICICI UnitMonitoring

4 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-Sovietsplit in the Indian communist movement. The term comes from Naxalbari, a small village in West Bengal, where a leftistsection of Communist Party of India (Marxist) (CPI(M)) led by Charu Majumdar and Kanu Sanyal led a militant peasantuprising 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 ICICIstaff), comprising of a management, an administration (with MIS and loan desk units), amonitoring and an insurance department as well as an independent ICICI unit. Its costs are notdirectly attributable to the service area/loan product activities as they form part of overheadcosts.

2. Two types of head office sub units , which directly impact either district or service/loan productactivities, consisting of one federation unit comprising 1 federation officer and 2 unitcoordinators (March 2006: 1 federation officer and 6 unit coordinators) operating in the districtof Sambalpur and 22 district units (March 2006: 42 district units) with 33 coordinators andassistants (March 2006: 2 state, 24 district and 34 area coordinators and 10 assistants) takingcare of both old and new districts. The district coordination units have their office premisesnormally in the respective districts.

3. 142 field staff (March 2006: 307), which directly impact either district or service/loan productactivities 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 andpromoting 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 BISWAstarted its financial activities in the year 1996, comprises of 10 coordinators and assistants, and 62field 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. Themicrofinance and micro enterprise department focus on the economic development, whereas thesocial development department addresses the other social needs of the SHG members, such aseducation, health, habitat and environmental protection needs. Most of the social developmentactivities are executed through the SHGs. Various integrated projects/programmes have beenimplemented especially in Sambalpur district.

2.2. Financial Services offeredThe delivery of financial services is carried out through Self Help Groups (SHG) . The SHG isformed by BISWA bringing together 10-19 homogenous individuals living in a compactgeographical area (villages/wards). The SHGs are encouraged to practice thrift and are savings-linked to the nearest bank. After 3-4 months the SHGs are encouraged to lend their savings. Aftersix months, the groups are graded according to pre-defined criteria and the groups obtaining A orB grade are considered to be eligible for external credit linkage. The C graded groups are furtherstrengthened. During this capacity building phase of 6 months, the groups are imparted training ongroup dynamics, book/record keeping, leadership development etc.

The demand for credit is generated among the eligible groups. The groups are educated oneligible criteria, terms of loan, rate of interest, repayment schedule and other aspects of the credit

linkage by the respective community organizers. BISWAs microfinance department is providingloans and insurance directly or indirectly via the newly formed federations to its SHGs. AlthoughICICI loans are contracted directly between the SHGs and ICICI, the members perceive BISWA astheir bank.

The average SHG loan term is 9 months and the average loan processing time is 15 days. Theloan is granted by a Loan Committee based on the amount of saving mobilized by the group. Themaximum amount that can be sanctioned is 10 times the amount of the security deposit the SHGdeposits 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, BISWAs outreach and loan business hasexpanded enormously. As of March 2006, BISWAs microfinance department with a staff of 413members 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 financialyear (FY) of 2005-06, BISWA disbursed from its own funds 6,204 SHG loans, 40 NGO loans and1,819 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 partnershipwith ICICI Bank has started in December 2004. BISWA offers also insurance products to the SHGmembers as well as encourages savings of the SHG members. Savings of the SHG members ason 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 cashand 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 aninterest rate of 5% p.a.).

BISWA-MFI is charging an interest rate of 18 percent per annum on reducing balance for theSHG 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 SHGs 5 since December2004 are charged with an interest of 14.5 percent during FY 2004-05 and 18% during FY 2005-06. 6 The SHGs formed by BISWA-MFI charge 24 percent from their members. All the interest ratesare 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 SHGs 7. BISWA-MFI is encouraging the members of the SHGs to procureinsurance products. BISWA started offering the government subsidised Janashri Bhima YojanaScheme of Life Insurance Corporation, a life insurance scheme. 15,610 SHG members have beencovered until March 2006. During 2005-06 BISWA introduced ICICI-Lombard Health Insurance to44,851 SHG members. Since 2006, BISWA and Oriental Insurance Company are jointlydeveloping insurance products to dovetail the needs of their clients.

BISWA-MFI promotes SHG federations. The federations are conglomeration of 11-50 SHGs in acluster and legally registered under the Trust Act as Mutual Benefit Trusts (MBTs). They arepromoted as client owned client managed institutions acting as financial and social intermediariesbetween SHGs and the service provider: BISWA. Until March 2006, 56 federations have beenformed.

2.3. Financial situation

In the early stage , BISWA-MFI provided credit facilities to SHGs either by linking them directly tobanks or by availing small loans from banks such as State Bank of India (SBI) and BolangirAnchalik Gramya Bank (BAGB). NABARD was supporting BISWA for its SHG promotion andcapacity building activities. During 2002, Care-India, Orissa approached BISWA with the Creditand Savings for Household Enterprise (Cashe) project and has been partnering with BISWA-MFIsince June 2002. Since then other lenders such as Bridge Foundation, Swoyangshree and Friendsof Women World Banking India (FWWBI) have extended credit assistance. As a part of theirphasing out process, Care-India introduced BISWA to various private banks and as a resultBISWA is currently linked to ICICI Bank, ABN AMRO Bank. Presently BISWA has also receivedloan 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 orgraded by M-Cril as 8, by CRISIL as mfR4 9 and by Mix Market as **** 10 .

BISWA is promoting a Non-Banking Financial Company (NBFC) shortly to minimise theconstraints in mobilizing external commercial borrowings.

The adjusted consolidated balance sheets of BISWA-MFI including Care project for the yearsMarch 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 balancesheet 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 ownSHG book of accounts.7 Though reported by BISWA, the interest paid could not be found in the auditors reports8 Moderate safety, moderate systems acceptable, needs improvement to handle large volumes9 medium grading: mfR1 mfR810 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.

March 2004 March 2005 March 2006Items NotesINR % INR % INR %

LIABILITIESCapital & Reserves 1 668,789 5% 6,881,767 18% 56,441,455 33%Borrowings 2 10,738,600 81% 26,299,688 70% 97,516,225 56%Security Deposit 3 913,531 7% 3,769,675 10% 17,340,651 10%Other liabilities 4 895,011 7% 378,124 1% 1,567,750 1%TOTAL 13,215,931 100% 37,329,254 100% 172,866,081 100%ASSETSFixed assets 5 1,824,708 14% 1,384,208 4% 4,055,816 2%Fixed deposit 6 0 0% 2,575,000 7% 2,575,000 1%Loans 7 11,305,028 86% 32,819,224 88% 164,035,884 95%Other assets 8 86,195 1% 550,822 1% 2,199,381 1%TOTAL 13,215,931 100% 37,329,254 100% 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 fundfrom various borrowers. In addition to these commercial funds, BISWA-MFI received securitydeposits from the SHGs the margin money. Furthermore, BISWA corpus provides interest freeloans to its microfinance department, which are defined as quasi equity as the funds are comingfrom its holding.

In addition to its own funds, BISWAs microfinance department manages funds on behalf of ICICI.BISWA has been partnering with ICICI since December 2004. The loan period of ICICI loans islonger, i.e. 3 years. BISWA-ICICI partnership (ICICI partnership model) has been conceptualisedand 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 onbehalf of ICICI by identifying clients, sanctioning and disbursing loans, collecting instalmentsand interest.

2. For these services BISWA is charging a service fee of 5% to ICICI during FY 2004-05 (FY2005-06: 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 tocover its transactions costs.

3. BISWAs microfinance department provides a first loss default guarantee (FLDG) throughwhich it shares the risk of the portfolio with ICICI. FLDG makes BISWA liable to bear lossesup 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 is12.875% of the provided fund during FY 2004-05 (FY 2005-06: 0.6%). BISWA receivesinterest of 5.5% p.a. on this fixed deposit from ICICI Bank. BISWA has not increased thefixed 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 isequivalent to the amount which the MFI is liable to provide the FDLG normally. The overdraftrepresents 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 fromthe 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 BISWA13 See above


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The consolidated mutual balance sheet of BISWA and ICICI or rather a hypothetical balance sheetof BISWAs 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.

March 2005 March 2006Items NotesINR % INR %

LIABILITIESCapital 1 0 0% 2,611,175 1%Loan from ICICI 2 17,631,892 100% 407,989,241 99%TOTAL 17,631,892 100% 410,600,416 100%ASSETSCurrent assets 14 3 0 0% 16,915,188 4%Loans to SHGs 4 17,631,892 100% 393,685,228 96%TOTAL 17,631,892 100% 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 BISWAs 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 MFI fund portfolio Fund managed on behalf of ICICI

FY 2004-05 FY 2005-06 Change FY 2004-05 FY 2005-06 ChangeValue of funds received 25,904,500 93,682,800 262% 20,000,000 440,000,000 2100%Value of funds outstanding 26,299,688 97,516,225 271% 17,631,892 393,685,228 2133%Average value of funds outstanding 18,519,144 61,907,956 234% 8,815,947 205,658,560 2233%Interest paid 1,569,283 3,499,150 123% 490,827 5,047,330 928%(Average) nominal interest rate 9.70% 9.75% 1% 9.50% 9.25% -3%

Value of loans disbursed 86,027,150 211,808,290 146% 20,000,000 440,000,000 2100%Value of loan portfolio outstanding 32,819,224 155,007,253 372% 17,631,892 393,685,228 2133%Average value of loan portfolio out. 22,062,128 93,913,237 326% 8,815,947 205,658,560 2233%Interest received 4,761,254 14,156,474 197% 490,827 15,361,418 3030%Nominal interest rate 18.0% 18.0% 0% 14.5% 18.0% 24%

The shares of average loan able funds according to their sources for the FY 2004-05 and FY 2005-06 are presented in figure 2 and 3 respectively.

Figure 2: Share of average loan able funds FY 2004-05

Figure 3: Share of average loan able funds FY 2005-06

ICICI loanportfolio

26%

Margin money7%

Interest free handloan1%

MFI loan portfolio66%

MFI loan portfolio27%

Interest free handloan10%

Margin money3%

ICICI loanportfolio

60%

14 In auditors 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 2005-06and the share of MFI loan able funds decreased from 66% during FY 2004-05 to 27% during FY2005-06. It indicates a shift of BISWAs business orientation from an MFI to a partner of ICICI. Itwould be interesting to observe how this partnership develops in view of the policy direction of RBIto banks to adopt Business Facilitator and Correspondent Model and BISWAs intention topromote 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) andat 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 on-lending to SHGs as well as other loans 15 at the end of FY 2005-06 were outstanding. The share ofaverage loan outstanding per loan product is presented in figure 4 below.

For the borrowings, BISWA-MFI paidinterest of Rs. 1,569,283 during the FY2004-05 which leads to an average cost-of-funds ratio of 8.5% of average loan ablefunds. The Cost-of-funds ratio gives ablended interest rate for an MFIs fundingliabilities . The weighted average interestrate during FY 2004-05 is 9.25%. TheFunding-expense ratio shows the interestrate an MFI is paying to fund its financialassets: Interest expenses on fundingliabilities amount to 7.1% of the averagegross loan portfolio during FY 2004-05. Forthe loans, the clients paid interest and feesamounting to Rs. 5,074,079 during the FY

2004-05. Thus the financial revenue ratio (effective interest income) is 23% for FY 2004-05 onaverage gross loan portfolio. 16

The total number of loan accounts outstanding at the end of FY 2004-05 is 2,152 (out of whichICICI: 490). The average loan size outstanding is Rs. 28,099 for BISWA-MFI and Rs. 40,825 forICICI. The portfolio at risk (the value of all SHG loans outstanding that have one or moreinstalments of principal past due more than one day) constitutes 8.41% of the total value of loansoutstanding as on March 2005. In ICICI loans to SHGs there is no overdue at all as reported byBISWA in both the financial years 2005 and 2006. The Portfolio at Risk (PAR) for installments pastdue for more than 90 days is 2.39% during FY 2004-05. The aging of portfolio BISWA-MFIexcluding ICICI loans as of March 2005 are presented in figure 5. 17 The PAR data for FY 2005-06could not be provided in a satisfactory and accurate manner by BISWA. For further discussion seesection 3.5.

15 Other loans have 2 classifications 1. Social Security loans and 2. Staff loans. The Social security loans are the amountconverted into loans which have been paid by BISWA up-front for insuring clients (SHG members) under ICICI Lombardhealth insurance scheme. The Social security loans amounts to Rs 13,515,140 disbursed. The staff loans are extendedto 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 relativelysmall number. The shifting from direct MFI fund loans (9 months loan term) to indirect ICICI loans (started in December2004 with 3 years loan term) resulted in a lower average loan disbursement of MFI fund loans during the last quarter ofFY 2004-05 and hence to a lower loan outstanding at the end of March 2006. This fact leads to inappropriate highinterest earned on average loan outstanding. The monthly/quarterly data was not available so that it was decided to useonly reliable data.17 Reliable data on portfolio quality are not available for FY 2005-06, see section 3.5

Figure 4: Share of averaged loan products outstanding, FY 2005-06

Loan to MBTs

11%

Other loans4%

Loan to NGOs7%

Loan to SHGs78%


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Selected financial ratios for asset and liability management and loan portfolio quality of BISWA-MFI for the FY 2004-05according to CGAPs MicrofinanceConsensus Guidelines are produced inAnnex C. Some of these ratios arepresented here.

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

Risk coverage ratio shows how much ofthe portfolio at risk is covered by an MFIsloan loss reserve. 83.8% during FY 2004-05 of the portfolio at risk with principalpast due for more than 90 days is coveredby BISWA-MFIs yearly loan lossprovisions (FY 2004-05 [first loan loss provisioning]: Rs. 656,385 which is 2% of the total loanoutstanding; FY 2005-06: Rs. 2,322,864 which is about 1.5% of the outstanding MFI loanportfolio, i.e. Rs. 2,979,249 is loan loss reserve which is 1.8% of loan outstanding).

2.4. PerformanceThe consolidated profit and loss statement of BISWA-MFI including Care project for the FY 2004-06 is presented in table 5.

Table 5: Consolidated Profit and Loss Statement of BISWA-MFI incl. Care Project, FY 2004- 06, in Rs.

Items Notes FY 2004-05 % FY 2005-06 %Income earned from loans 1 4,761,254 21.6% 17,356,474 17.6%Loan processing fee 2 312,825 1.4% 874,540 0.9%Interest earned from fixed deposit 3 5,199 0.0% 8,522 0.0%Other Income 4 0 0.0% 403,370 0.4%TOTAL Operating revenue 5,079,278 23.0% 18,642,906 18.9%Interest paid on borrowings 5 1,569,283 7.1% 3,499,144 3.6%TOTAL Financial expense 1,569,283 7.1% 3,499,144 3.6%TOTAL operating income 3,509,995 15.9% 15,143,762 15.4%Salaries and provisions for employees 6 3,835,867 17.4% 4,903,674 5.0%Office & other expenses 7 923,676 4.2% 1,155,434 1.2%Depreciation of fixed assets 8 284,868 1.3% 547,450 0.6%Loan loss provisions 9 656,385 3.0% 2,322,864 2.4%TOTAL operating expense 5,700,797 25.8% 8,929,423 9.1%NET OPERATING INCOME -2,190,802 -9.9% 6,214,339 6.3%TOTAL non-operating items 10 7,689,396 34.9% 40,882,505 41.5%NET SURPLUS 5,498,594 24.9% 47,096,844 47.8%average Loan outstanding 22,062,126 100% 98,427,554 100%

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% ofaverage loan outstanding (FY 2005-06: Rs. 47,096,844/47.8%). Without donations and grantsas well as non-operating expenses, BISWA-MFI generated a total loss of Rs. 2,191,801 duringFY 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 Organisationcontribution 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 adequacyratio would be -2.64% for FY 2004-05 and 4.68% for FY 2005-06.

Figure 5: Share of classified SHG loans of BISWA-MFI as per 31 st March 2005

>90 days delay2%

61-90 days delay1%

31-60 days delay1%

1-30 days delay4%

On-time loans92%


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Without donor and grant contributions, the equity funds of BISWA-MFI would have been wipedout during FY 2004-05 (the financial operations of BISWA-MFI reported net surplus during FY2004-05 considering these grants).

Selected financial indicators for sustainability and profitability of BISWA-MFI for the FY 2004-05 according to CGAPs Microfinance Consensus Guidelines are produced in Annex C. Some ofthese 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 operatingrevenues.

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-MFIs fund management on behalf of ICICI forthe 4 th 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 Notes FY 2004-05 % FY 2005-06 %Income earned from loans 1 490,827 5.6% 15,361,418 7.5%TOTAL Operating revenue 490,827 5.6% 15,361,418 7.5%Interest paid to ICICI 2 410,412 4.7% 5,047,334 2.5%Other charges 3 0 0.0% 2,744,073 1.3%TOTAL Financial expense 410,412 4.7% 7,791,407 3.8%TOTAL operating income 80,415 0.9% 7,570,011 3.7%Salaries and provisions for employees 4 3,893,827 1.9%Office & other expenses 5

80,415 0.9%1,075,008 0.5%

Depreciation of fixed assets 6 0 0.0% 0 0.0%Loan loss provisions 7 0 0.0% 0 0.0%TOTAL operating expense 80,415 0.9% 4,968,835 2.4%NET OPERATING INCOME 0 0.0% 2,601,175 1.3%TOTAL non-operating items 8 0 0.0% 10,000 0.0%NET SURPLUS 0 0.0% 2,611,175 1.3%Average Loan outstanding 8,815,946 100% 205,658,560 100%

Source: auditors report FY 2004-05 and unaudited report by BISWA

The following conclusions can be drawn:

The reported net operating income during the 4 th 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 4 th quarter of FY2004-05 (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 defaultwith ICICI.

2.5. Composition of lending rate Step 1The intermediation margin is usually calculated as the difference between the effective lendingrates and cost of funds, which comprises operating expenses (reflecting transaction costs ofmobilising 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 statementlargely depends on the number of loans while the revenue side solely depends on the loanamounts. The transaction costs (expressed in staff time and paperwork) are assumed to be moreor less the same per loan product regardless of its size, while revenues in form of interest receiptsare calculated on the nominal loan amount and thus vary proportionately with loan size. As a


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consequence, a lender can reduce costs per unit of money lent by making large loans and thusincrease his profitability. The other possibility would be to charge a higher interest rate on loans ofsmall 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 presentedin percentage of the lending rate.

Figure 6: Composition of the lending rate in a static perspective, Rs. in thousand 19

Financial revenue

Financial revenue

Financial expense

Financial expense

Loan loss

Personnel expense

Administrativeexpense

Administrativeexpense

0%

20%

40%

60%

80%

100%

BISWA-MFI including Care-Cashe Fund management on behalf of ICICIIncome IncomeExpenditure Expenditure

Sum

5,079,278 1,569,283 490,827 410,412

656,385

3,835,867

1,208,544 80,415

5,079,278 490,8277,270,079 490,827

-2,190,801 0 0 It may be concluded that:

the total financial revenue of BISWA-MFI including Care-Cashe project is not covering the sumof financial expenses, loan loss provisions and office and administrative expenses during FY2004-05. 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-MFIs fund management on behalf of ICICI is covering thesum of financial and administrative expenses during FY 2004-05. The service fee is sufficient tocover 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 actualeffective interest rate (23% p.a.)? (Number of loans is constant; Capacity of demand is notutilised fully)

o 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%.

19 Differences to previous table are caused by roundings.


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How many loans would have been sufficient to cover the costs in each year? (average loan sizemanaged 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(actual 20 : 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 clientbase is being developed and the benefits of which are yet to fructify.

The loan portfolio size and the number of loans managed of BISWAs microfinance departmentare growing in a tremendous way. The delivery methodology is becoming more complex withdifferent methodologies and many channels.

It is necessary to carry out the transaction cost analysis for a older profit center to arrive atconclusions.

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


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3. Transaction cost analysis of SHG lending in service area 1

BISWAs microfinance department has been extending its outreach of financial services wider, bygeographically increasing the area of operations and deeper by upgrading loan clients to accessand manage higher loan amounts and improving product range. This has led to the emergence offollowing profit and cost centers.

Profit & Cost centres Services Districts covered Characteristics Profit centre 1: Service area 1 (SA1) SHG lending and promotion(excl. ICICI fund management)

Sambalpur andBargarh

Started lending beforeMarch 2004

Profit centre 2: Service area 2 (SA2) SHG lending and promotion Deogarh, Boudh andSonepur

Started lending duringFY 2004-05

Profit centre 3: Service area 3 (SA3) SHG promotion 17 other districts Not yet started lendingProfit centre 4: Activity centre federation(AC-F)

Promotion of SHG federations Sambalpur Started formationduring FY 2004-05

Profit centre 5: HO-Insurance unit (HO-I) JBYS scheme of LIC Insurance All districts Receives service feefrom LIC

Cost centre: Head office (HO) Management & Servicing allprofit centres

All districts Heading all districtoffices/units of BISWA

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

3.1. Methodology appliedThis analysis focuses on the two districts Sambalpur and Bargarh named as service area 1 for thepurpose of the analysis where BISWA started its lending activities before 2004. In this section, onlydata 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 financialoperations have started already in 1996.

BISWA is expanding its operational area and its services in a tremendous way. The results forthe other districts were not conclusive. (The reported interest earned from SHG loans in otherdistricts where SHG lending started during FY 2004-05 were disproportionately high, i.e. over30% on average loan outstanding. There were no clear reasons cited).

PAR was not reported by BISWA for the districts other than Sambalpur and Bargarh. (fieldobservations 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 BISWAsmicrofinance department and their allocation among the profit and cost centres.The methodologyof allocating income and expenditure statement items and the correspondent allocation keys andweights are presented in Annex D. Fund management on behalf of ICICI is not considered in thisfirst exercise.

At the second step, the costs of financial and non-financial services in service area 1 (SA 1) ofthe FY 2004-05 are identified and analysed, cost of funds 21 and loan loss provisioning 22 areadjusted.

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 areamortized 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) asfederations are predominantly built for financial intermediation .

21 effective interest paid on borrowings and imputed interest payable on security deposit (which are not yet paid andbooked though promised by BISWA-MFI) are included. The remaining source of funds from capital & reserves areconsidered as not interest bearing. Subsidised interest free hand loan in the nature of quasi equity is provided for loaningby BISWA organisation where the cost of funds is zero. This item is not included/considered in the analysis should beincluded for a holistic transaction cost analysis. It couldnt be ascertained the source and other details of this fund. These(externalised) hidden costs are not considered in the above analysis22 according to international banking standards (see CGAP and Basel II) 23 Cost are allocated according to time estimates taken from interviews with staff.


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Capacity building of identified members with potentials to take over book keeping and writingdocuments (BoAs are provided and paid by BISWA-MFI 24).

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 termgroup development costs have been incurred by the service area during the precedent years whichare 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 microenterprise 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 savingsrelated 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-financialservices are identified according to the above mentioned separation. The methodology applied ispresented 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 allcosts and risks incurred in managing these funds.

The second is the partnership with ICICI . The SHGs are the borrower of this fund. BISWAscosts of handling this ICICI portfolio which is compensated by the margin between the rate ofinterest collected on the loan from the borrower and the interest paid to ICICI. However, underthe FLDG part of the default risk costs have to be borne by BISWA.

The effective intermediation margin of BISWA-MFIs fund management on behalf ICICI in the 4 th 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 theaverage 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 borrowingsduring 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 dont show the interest paid on margin money inspite of the declaration in BISWAsreports. In order to include these (future) hidden costs, the interest payable is calculated on theyearly 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%) aredrawn from capital & reserves. However, BISWA-MFI received loan funds/capital from BISWAorganisation and others. The cost of such funds are hidden (externalised) costs. 25 This fact will beconsidered in the interpretation of the return on capital/equity.

24 Separated BoA for ICICI loans are paid by the SHGs25 Applying the inflation rate, an appropriate market rate of return on capital, and subsidy adjustments (or just thenominal interest paid on savings accounts) for calculating the cost of funds drawn from capital & reserves would be moreaccurate.


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Figure 7: Share of source of funds in percentage of average loan outstanding, BISWA-MFI direct lending operations, FY 2004-05

84%100%

11%

5%

Loans

Capital & ReservesSecurity Deposit

Borrowings

Not imputed (0% p.a.):CapitalCare/BISWA contributionReserves & accumulated profit

Imputed (5% p.a.):Interest bearing 5% p.a. asstated by BISWA (not booked)

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

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

Source Use

The cost of funds (loan funds of BISWA-MFI) is Rs. 1,686,363 which is 7.6% on average loanoutstanding (Rs. 22,062,126). The share of service area 1 is 79%, so that Rs. 1,339,279 has to beborne by service area 1. 26

At the third step, the costs of service area 1 for fund management on behalf of ICICI are identifiedand attributed accordingly. In service area 1, BISWA started fund management on behalf of ICICIduring FY 2004-05 (December 2004). The existing delivery channels of BISWA are used for ICICIloans. For this exercise, the share of cost of financial services of BISWA-MFI are allocated to theactivity fund management on behalf of ICICI by identified/defined keys and weights as a share ofthe costs for financial services has to borne by activity fund management on behalf of ICICI. Themethodology applied is presented in Annex F.

3.2. Analysing the profitability for pricing decisionThe fact, that BISWAs 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 ICICIBank 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 BISWAs microfinancedepartment may lead to misinterpretation of the results as a considerable share of SHG lendingcosts are in fact investment cost for client development. These costs are amortized over a periodof six years. The costs of social services are not considered in the analysis of the profitability forpricing decision. The results and implications of this exercise are presented in table 7. There arefour scenarios possible:

Both long term client development and social services costs are accounted and included in theanalysis for the year.

Only long term client development cost are included and accounted fully in the analysis for thecurrent year

Only long term client development are accounted with its share of amortization amount (6years: 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-MFIs direct lending are forthe non-financial services delivered to SHGs in service area 1 and 29% in case of BISWA-MFIsindirect lending on behalf of ICICI. By amortization of long term client development over a periodof six years, the total transaction costs and overhead costs in SHG lending would be reduced by31% for BISWA-MFIs direct lending operations and by 26% for BISWA-MFIs indirect lendingoperations 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%) theaverage loan portfolio leads to: The cost of funds (loan funds of BISWA-MFI) would be Rs. 1,794,487 which is 8.1% onaverage loan outstanding (Rs. 22,062,126). The share average loan outstanding during FY 2004-05 of service area 1 is79%, so that Rs. 1,417,645 has to be borne by service area 1


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Care-India with its Credit and Savings for Household Enterprise (Cashe) project was awardinggrants for the initial investment costs for the implementation of microfinance services amounting toRs. 1,349,242 during FY 2004-05 for service area 1. Care-Cashe understands these grants as acost sharing contribution for start-up costs with phasing out their support in the next years.Considering BISWAs 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 financialservices. 27 This fact would lead to a different picture in the profitability analysis in section 3.4. 28

27 In this case the total cost for non-financial services are borne by the collaboration of Care-Cashe and BISWA.28

It would lead to profit in service area 1 during FY 2004-05. see also section 3.4.


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3.3. ResultsAfter adjusting the income and expenditure statement items according to the separation of profitand cost centres, imputing cost of funds, the differentiation into financial services and non-financialservices (analysis I and II) as well as attributing the share of staff and administrative cost to theprofit centre fund management on behalf of ICICI (analysis III) the results are produced. Table 8presents the operating income, the field transaction costs and the overhead cost. The financialcost and the amortized share of the determined long term investment cost (6 years) of service area1 are included in the analysis.

Table 8: Results of analysis for service area 1, FY 2004-05 Service area 1Cost and benefit statement

MFI % ICICI % quarter % annualInterest earned from SHG loans 3,299,167 18.92% 490,827 5.57% 22.27%Loan processing fee earned 221,793 1.27% 0 0.00% 0.00%Interest earned from fixed deposit 0 0.00% 5,199 0.06% 0.24%TOTAL financial revenue 3,520,960 20.19% 496,026 5.63% 22.51%Interest paid on borrowings direct/indirect 1,239,734 7.11% 410,412 4.66% 18.62%Imputed interest on margin money 99,545 0.57% 0 0.00% 0.00%TOTAL financial expense (cost of funds) 1,339,279 7.68% 410,412 4.66% 18.62%TOTAL OPERATING INCOME 2,181,681 12.51% 85,614 0.97% 3.88%TOTAL adjusted loan loss provisions (cost of risk) 294,437 1.69% 44,080 0.50% 2.00%TOTAL field staff cost 1,054,057 6.04% 193,347 2.19% 8.77%TOTAL administrative cost direct 0 0.00% 80,415 0.91% 3.65%TOTAL FIELD TRANSACTION COST 1,348,494 7.73% 317,842 3.61% 14.42%TOTAL HO staff cost indirect 258,262 1.48% 56,850 0.64% 2.58%TOTAL HO administrative cost indirect 592,426 3.40% 130,409 1.48% 5.92%TOTAL OVERHEAD COST 850,688 4.88% 187,259 2.12% 8.50%NET OPERATING INCOME FINANCIAL -17,501 -0.10% -402,822 -4.57% -18.28%Average Loan outstanding 17,438,931 100% 8,815,946 100% 100%

The total operating income of BISWA-MFIs direct lending in service area 1 (excluding ICICI) wouldbe Rs. 2,181,681 which is 12.5% of averaged value of loan outstanding. 29 The field transaction andoverhead cost would be Rs. 2,199,182 which is 12.6% of averaged value loan outstanding whichcomprises 1.7% for loan loss provisioning, 6% for field staff cost and 4.9% for administrative oroverhead cost on average loan outstanding. The net operating income of BISWA-MFI in servicearea 1 (excluding ICICI) would be a loss of Rs. 17,501 which is -0.1% of average value loanoutstanding. It is recognisable that the transaction costs of direct lending of BISWA-MFI are stillcomparatively high with 12.6%. The major cost drivers are the field staff cost and the overheadcost but the effective income from lending is almost sufficient to cover the total transaction costs inservice area 1.

The total operating income of BISWA-MFIs indirect lending on behalf of ICICI in service area 1 willbe Rs. 85,614 which is 1.0% (3.9% on annual basis) of average value of loan outstanding. Theattributed field total transaction and overhead cost of will be Rs. 505,101 which is 5.7% (22.9% onannual 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 indirectadministrative and overhead cost on average loan outstanding. The net operating income forfinancial 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 isrecognisable 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%) theaverage loan portfolio leads to: The total operating income of BISWA-MFIs direct lending in service area 1 (excludingICICI) would be Rs. 2,103,315 which is 12.0% of averaged value of loan outstanding. The net operating income would bea loss of Rs. 95,867 which is -0.5% of averaged value of loan outstanding.


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3.4. Composition of lending rate in service area 1 step 2In figure 8, the cost and benefit statements after analysis I-III of the profit centre service area 1 withits financial operations and of BISWA-MFI and financial operations of BISWA-MFIs fundmanagement on behalf of ICICI for the FY 2004-05 are presented in percentage of the lendingrate.

Figure 8: Composition of lending rate in service area 1 step 2

Financial income

Financial income

Financial expense

Financial expenseCost of riskCost of risk

Staff costStaff cost

Overhead cost Overhead cost

0%

20%

40%

60%

80%

100%

BISWA-MFI including Care-Cashe Fund management on behalf of ICICIIncome IncomeExpenditure Expenditure

Sum3,520,960 1,339,279 496,026 410,412

294,437

1,054,057

850,688267,673

3,520,960 496,0263,538,461 915,512

-17,501 -419,486

193,347

44,080

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 operatingincome 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 operatingrevenue during FY 2004-05.

After analysing the operations of service area 1, it appears that net operating income of BISWA-MFIs direct lending is on a stable path of the life cycle of a typical financial product. The break-even point seems to be reached during FY 2005-06 which is 9 years after introduction of directfinancial services by BISWA-MFI. Assuming the operating cost to be given, an income-generatingloan portfolio of Rs. 17,593,456 which is a growth of 1% would have been sufficient to cover theoperating 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) isnot yet covering the sum of financial expenses, adjusted loan loss provisions, adjusted personnelexpenses as well as overhead attribution of the head office during FY 2004-05. The effectivelending rate earned through the nominal interest rate of 18% p.a. is almost sufficient to cover thecosts 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-MFIs fund management on behalf of ICICI in servicearea 1:

The financial operations of BISWA-MFIs fund management on behalf of ICICI would havegenerated a net operating loss of Rs. 419,486 in the FY 2004-05 which is -4.8% for the quarterand -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, attributedpersonnel expenses and applied loan loss provisions as well as overhead attribution of the headoffice during FY 2004-05. The effective income from the nominal service charge fee of 5 % p.a. isnot sufficient to cover the costs viz., cost of funds, operating costs and cost of risk. The interestmargin during FY 2004-05 is too low in this starting stage when high appraisal and otherinvestments are necessary.

Considering the grants from the collaboration of Care-Cashe and BISWA and neglecting thedifferentiation 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 withan amount of Rs. 299,575 but excluding the contribution of BISWA amounting to Rs. 392,605 theoperations in service area 1 would be again loss-making.

3.5. Challenges and observationsDuring FY 2005-06, BISWA-MFIs activities in service area 1 are clearly shifting from direct toindirect lending of management on behalf of ICICI. Since the field visit was undertaken in themonth 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 portfolioespecially under partnership model with ICICI. BISWA had also increased the interest rate to SHGunder ICICI loan portfolio to 18 percent declining balance. It is possible that BISWA-MFs fundmanagement on behalf of ICICI generates already a profit. But this development should be seenwith caution. Both number of loans disbursed and average loan size has increased and potentialrisks exist which can lead to future cost.

The portfolio quality is important for a MFI to provide viable and sustainable lending products. Withthe growth in portfolio, several growth related issues were also noticed which can affect theportfolio quality and sustainability of the programme.

1.) It was observed that the book keeping at field level and MIS at head office level is notadequate 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 ICICIloans 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 seenthat 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 otherdistricts as well as in ICICI no PAR (>1 day) was reported during FY 2004-05 as well as FY2005-06. This needs verification since during field visit to Bargarh, it was seen that at least fiveloans were overdue for more than 3 months with an overdue amount of more than Rs. 200,000where as the reports show no overdues. Moreover, BISWA reportedly makes no rescheduling ofloans 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 arechecking the books and visiting the SHGs.

2.) Staff related issues:The number of staff employed especially for micro finance and where their salaries are beingbooked is not very clear especially for the year 200506.


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The training of the staff is inadequate to sustain a good loan portfolio quality. The capacitybuilding expenses have decreased during FY 2005-06 as compared to FY 2004-05 though thestaff strength and number of SHGs increased three fold.

Except chief accounting officer and Chairman others have very little experience in banking andmicro 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 mindthat the loan portfolio reporting is weak, and the understanding of NPA or Portfolio at risk is notpresent 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 loanportfolio as cost of risk (First default loss guarantee) through a overdraft facility provided byICICI.

It may be concluded that BISWA-MFIs direct lending operations can be considered as viable in thelong-run only under the following conditions:

The value of loan outstanding increases in a sustainable manner considering an active credit-

risk management.The capacity building costs for staff should be increased in order to have qualitative personalmanagement and this cost is likely to be substantial.

A timely, accurate and actively managed Management Information System isessentialespecially for proviiding information on portfolio quality, the transaction costs, and quality ofprofit centres.

Adequate loan loss provisioning in regard to asset classification is necessary to avoid highyearly fluctuations.

Thus the conclusions drawn on the adequacy of interest rate to cover all the costs may beconsidered 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 areincurred for capacity building of staff, computer based MIS etc., the viability of present interest ratecan be under stress.

3.6. Recommendations:BISWAs 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 whichmay be done through appropriate mechanisms, be it by charging the profit centre financialoperations for the services provided by BISWA or by the same methodology applied in thisanalysis. This will help in pricing the products.

Implemenation of computer based MIS is the need of the hour for BISWA MFI which isrecording exponential growth rates through the partnership mode of ICICI. Inadequate portfolioinformation can increase the default risk of the organization. Poor quality book keeping, lack ofdata flow on portfolio from SHG level to higher levels can have serious impact on the operationsof the MFI. BISWA MFI based on the portfolio information needs to devise loan lossprovisioning for direct loans as well as for partnership with ICICI.

Training of staff in loan processing, assessing capacity of loan absorption and MIS are theother area which requires immediate attention of BISWA MFI. Similar training for SHGs toimbibe good practices of lending will be needed.

SHG will need a host of services to maintain their quality such as MIS and loan monitoring byfederation/NGO, training, audit of books, other need based linkages etc., BISWA needs toensure provision of such services to ensure absorption capacity of SHG. Mere increase of loansize to the SHG without sustainable services can be counterproductive and affect theperformance of SHGs.


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4. Summary of findings and conclusionsThe pilot study on viability of SHG lending in a microfinance institution has generated a number ofinteresting findings which are relevant for policy makers and for the institutions involved in thelinkage banking. However, a word of caution is necessary. Firstly, the pilot study was confined totwo single branches/districts of BISWA-MFI only; hence, the findings are specific to thoseparticular 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 alsotowards refining the methodology for future - possibly more extended - studies. Secondly, thestudy examined the cost structure of one operational year only and did not take into accountdevelopments and changes over time. Thirdly, the field observations leave some doubts about thereliability of the data given by BISWA. Fourthly, the grants from the collaboration of Care-Casheand BISWA are not considered in the profitability analysis though these subsidies affect theresource allocation of BISWA-MFI. With these caveats in mind, the major results are summarizedin the following.

Under the given parameters and assumptions, the generated effective intermediation margin ofBISWA-MFIs SHG lending activities, i.e. direct lending from own funds and indirect lending onbehalf 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 theright perspective. Firstly, BISWA-MFI has started its direct lending activities to SHGs in 1996 andsince then, BISWA-MFI has increased its investment and business activities extensively but thegrowth of the income-generating loan portfolio is lagging behind the growth of the transactioncosts. Secondly, the fact, that BISWAs microfinance department is providing various services tothe SHGs, i.e. financial and non-financial services, and has started with fund management onbehalf of ICICI Bank during the FY 2004-05 makes it difficult to assess the viability of SHG lendingin the short run. Thirdly, with the growth in portfolio, several growth related issues were alsonoticed during the field visit which affect the significance and interpretations of the results.

Field staff cost and overhead cost of SHG lending at BISWA-MFIs district level in Sambalpur andBargarh are the major cost driver. The high staff and overhead cost of direct and indirect SHGlending, however, is overestimated in a static analysis which covers only one year. The staff costinclude social investment cost of forming and promoting new and existing SHGs as well as othernon-financial (social) service cost. An amortisation of social investment cost over several yearswould reduce staff cost to some extent but not to the level of profit-making as SHG lending is stillvery time- and overhead cost-intensive.

The relatively high nominal interest rate of 18% p.a. is mainly justified by the high cost of funds ofBISWA-MFI, as with all MFIs. The intermediation margin of 8-9% p.a. may be sufficient if the sizeand quality of the loan portfolio is adequate as it is indicated in the FY 2005-06. But theconclusions drawn on the adequacy of interest rate to cover all the costs may be consideredtentative since costs of capacity building, loan loss provisioning costs and financial costs such aspayment of interest on savings of SHGs can impact the margins. When costs are incurred forcapacity 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 DistrictCentral Co-operative Bank branch and an affiliated Primary Agricultural Credit Society

Viability analysis of SHG lending in a microfinance institution

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