Innovative Strategies Devised by Indian Microfinance Institutions

Innovative Strategies Devised by Indian Microfinance Institutions

Nadiya Marakkath (Tata Institute of Social Sciences, Mumbai, India)
Copyright: © 2014 |Pages: 7
DOI: 10.4018/978-1-4666-4635-3.ch021
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Abstract

This study is a discussion on the Non-Governmental Organization-Microfinance Institution Partnership Model and the Securitization Model used by Indian microfinance institutions to achieve cost efficiency. These two models are effective strategies devised and used by efficient and sustainable Indian MFIs to reduce their operating cost and financing cost. Achieving such cost efficiency is crucial for microfinance institutions to attain operational self-sustainability without levying high interest rates. Using the interview method, the study elicits information on these innovative strategies and recommends them to be worthy of emulation for other microfinance institutions operating in the Indian microfinance industry.
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Literature Review

Information asymmetric risk arises in credit-lending transactions, as the lender has less information about the creditworthiness of the borrower, than the borrower himself. Such risks are all the more exacerbated in microfinance market as the poor borrowers lack credit history. Information asymmetric credit market risks denotes the ex-ante risk of adverse selection*, interim risk of moral hazard** and the two ex-post risks of costly audits and enforcement*** (Akerlof, 1970; Scholtens & Wensveen, 2003; Stiglitz & Weiss, 1981).

MFIs mitigate these information asymmetric credit market risks—adverse selection, by affecting group formation among the poor borrowers with joint-liability; moral hazard, by inducing group members to influence the way other members select their projects; costly monitoring, by helping the lender avoid external audits and enforcement problems, by encouraging borrowers to repay their loans without the lender having to impose sanctions—by its unconventional group lending models (Ghatak & Guinnane, 1999; Ghatak, 2000).

But the group-lending model used by MFIs to mitigate these risks, results in high operating costs for the MFIs (Thorat, 2006; Savita, 2007). The group lending models entails peculiar costs such as group formation costs, costs of training the borrowers on the procedures, costs of higher degree of supervision and higher frequency of installment payments, all adding to the operating costs of the MFI. Moreover since the average microfinance loan size is small, the transaction cost on a percentage basis for such microfinance loan tends to be higher. Adding to this, the MFIs experience less control over their financing costs, as cost of funds sourced from banks and financial institutions usually comes in fixed ranges of pricing. Thus the high intermediation costs incurred by MFIs are a major challenge at the stake of its sustainability.

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