Microfinance: A Comprehensive Guide

1. Models/Modes of Microfinance

Microfinance refers to the provision of financial services (loans, savings, insurance) to low-income
individuals or groups who lack access to traditional banking services. The following are the common
models/modes of microfinance:

1.1 SHG (Self-Help Group):

• A group of 10-20 individuals (usually women) who pool their savings and provide small loans
to members.

• SHGs are often linked to banks for additional funding.

• Focuses on social empowerment and financial inclusion.

1.2 JLG (Joint Liability Group):

• A group of 4-10 individuals who collectively take a loan from an MFI or bank.

• Members are jointly liable for repayment, meaning if one member defaults, the others must
cover the repayment.

• Commonly used for agricultural and small business loans.

1.3 MFI - Bank - SHG:

• Microfinance Institutions (MFIs) act as intermediaries between banks and SHGs.

• MFIs provide training and support to SHGs, while banks provide the funds.

1.4 NBFC - MFI - SHG:

• Non-Banking Financial Companies (NBFCs) partner with MFIs to provide financial services to
SHGs.

• NBFCs bring in additional capital and expertise.

1.5 Bank/MFI - NGO - SHG:

• NGOs act as facilitators, providing training and support to SHGs.

• Banks or MFIs provide the financial resources.

2. Difference Between SHG and JLG

Aspect SHG (Self-Help Group) JLG (Joint Liability Group)

Group Size 10-20 members 4-10 members

Purpose Savings and credit among members Collective borrowing from an external lender

Joint liability (group is responsible for

Liability Individual liability
repayment)

Often linked to banks for additional

Linkage Directly linked to MFIs or banks
funding
Aspect SHG (Self-Help Group) JLG (Joint Liability Group)

Social empowerment and financial

Focus Primarily focused on credit
inclusion

Loan
Internal savings and bank loans External loans from MFIs or banks
Source

3. Concerns of MFIs

3.1 Collateralization:

• Issue:
Most microfinance borrowers lack traditional collateral (e.g., property, assets), making it
risky for MFIs to lend.

• Solution:
MFIs rely on group liability (e.g., JLG) or social collateral (peer pressure within SHGs) to
ensure repayment.

3.2 Increasing Number of MFI Loans:

• Issue:
The rapid growth of MFIs has led to over-indebtedness among borrowers, as individuals take
loans from multiple MFIs.

• Solution:
MFIs need to improve credit assessment processes and share data with credit bureaus to
prevent over-lending.

3.3 Documentation of Loan Takers:

• Issue:
Many borrowers lack formal identification or financial records, making it difficult for MFIs to
assess creditworthiness.

• Solution:
Use alternative data (e.g., mobile phone records, utility bills) and digital tools to streamline
documentation and credit assessment.

4. Recent Trends in Microfinance

4.1 Digital Transformation:

• MFIs are adopting digital platforms for loan disbursement, repayments, and customer
engagement.

• Mobile banking and digital wallets are making financial services more accessible to rural and
low-income populations.

4.2 Partnerships with Fintech Companies:

• Collaborations between MFIs and fintech companies are improving efficiency and reducing
operational costs.

• Fintechs provide innovative solutions like blockchain for secure transactions and AI for credit
scoring.
4.3 Focus on Financial Literacy:

• MFIs are increasingly offering financial literacy programs to educate borrowers about savings,
credit, and debt management.

• This helps reduce default rates and improves financial inclusion.

4.4 Regulatory Changes:

• Governments are introducing stricter regulations to protect borrowers from predatory lending
practices.

• For example, in India, the Reserve Bank of India (RBI) has set guidelines for MFIs on interest
rates, loan sizes, and recovery practices.

4.5 Expansion into New Sectors:

• MFIs are diversifying into sectors like agriculture, education, and healthcare to meet the
specific needs of borrowers.

• For example, agricultural loans are tailored to the crop cycle, while education loans help
families pay for school fees.

4.6 Sustainability and Social Impact:

• There is a growing emphasis on sustainable lending practices and measuring the social impact
of microfinance.

• MFIs are aligning their goals with the United Nations Sustainable Development Goals (SDGs),
such as poverty alleviation and gender equality.

4.7 Rise of Green Microfinance:

• Green microfinance focuses on funding environmentally friendly projects, such as solar

energy, organic farming, and waste management.

• This trend aligns with global efforts to combat climate change.

5. Malegam Committee Recommendations

The Malegam Committee was formed by the Reserve Bank of India (RBI) in 2010 to review the
functioning of MFIs and suggest measures to ensure their sustainability and transparency. Key
recommendations include:

5.1 Qualifying Assets:

• An NBFC-MFI must hold at least 85% of its total assets as qualifying assets (loans to low-
income borrowers).

5.2 Moratorium Period:

• A minimum moratorium period must be provided between loan disbursement and

repayment to allow borrowers to generate income.

5.3 Non-Coercive Practices:

• MFIs must avoid coercive practices during loan disbursement and recovery, such as
harassment or public shaming.

6. Recent Loan Generation Trends

6.1 Agri-Equipment Financing:

• MFIs are financing agricultural equipment (e.g., tractors, irrigation systems) to help farmers
improve productivity and income.

6.2 Handicraft and Handloom Financing:

• Loans are provided to artisans for raw materials, tools, and marketing, promoting traditional
industries and rural livelihoods.

7. Microinsurance and Regulatory Norms

7.1 Microinsurance Provision by MFIs:

• An MFI cannot provide microinsurance unless it registers under the relevant regulatory
framework (e.g., IRDAI in India).

• Common products include health insurance, crop insurance, and life insurance tailored to
low-income groups.

8. Risk Hedging Strategies for MFIs

8.1 Partnering with NBFCs/Banks:

• MFIs collaborate with NBFCs or banks to share risks and access additional funding.

8.2 Diversifying into Different Sectors:

• MFIs expand into multiple sectors (e.g., agriculture, education, healthcare) to reduce sector-
specific risks.

9. Key Takeaways

1. SHG vs. JLG:

SHGs focus on savings and social empowerment, while JLGs focus on collective borrowing and
joint liability.

2. Concerns of MFIs:

Collateralization, over-indebtedness, and documentation are major challenges, but solutions

like group liability, credit bureaus, and digital tools are helping address these issues.

3. Recent Trends:

Digital transformation, fintech partnerships, financial literacy, regulatory changes, and green
microfinance are shaping the future of microfinance.

4. Malegam Committee Recommendations:

Focus on qualifying assets, moratorium periods, and non-coercive practices to ensure ethical
and sustainable microfinance operations.

5. Risk Hedging:

Partnering with NBFCs/banks and diversifying into different sectors helps MFIs mitigate risks
and maintain financial stability.
1. AUM (Assets Under Management) and Its Relevance for Mid-Long Term Horizon

• What is AUM?

AUM stands for Assets Under Management. It refers to the total market value of all the assets
(stocks, bonds, cash, etc.) that a mutual fund or investment firm manages on behalf of its
clients. AUM is a key metric because it gives you an idea of the size and scale of the fund.

• Why is AUM Important for Mid-Long Term Investors?

For mid-to-long-term investors, especially those with a moderate risk appetite, AUM provides
insights into the fund's stability and credibility. A higher AUM often indicates that the fund is
trusted by many investors, which can be a sign of reliability. However, it’s not the only metric
to consider. A very large AUM might also mean the fund could struggle to generate high returns
due to its size, as it becomes harder to manage a large pool of money efficiently.

• Your Take/Stake:

AUM helps you gauge how much of your investment is part of a larger pool. If you’re investing
in a fund with a high AUM, your stake is relatively smaller, but the fund’s performance is
likely more stable. For moderate-risk investors, this is often a good balance.

2. Portfolio Turnover Rate and Precautions

• What is Portfolio Turnover Rate?

Portfolio turnover rate measures how frequently a mutual fund buys and sells its investments
within a year. For example, a turnover rate of 40% means that 40% of the fund’s holdings have
been replaced over the year.

• Why is a Low Turnover Rate (<40%) Important?

• A low turnover rate (below 40%) is generally a positive sign, especially for mid-to-long-term
investors. It indicates that the fund manager is not frequently trading, which reduces
transaction costs and capital gains taxes. This is beneficial for investors because it leads to
better net returns over time.

• Precautions to Take:

Even though a low turnover rate is good, you should still monitor the fund’s performance and
the sectors it invests in. If the fund has a low turnover rate but is heavily concentrated in a
few sectors or stocks, it could still be risky. Diversification and alignment with your risk
tolerance are key.

4. Growth Funds: Mid-Cap and Small-Cap Focus

• What are Growth Funds?

Growth funds are mutual funds that invest in companies with high growth potential. These
funds aim for capital appreciation rather than regular income (like dividends). They typically
invest in mid-cap and small-cap companies, which have higher growth potential but also
higher risk compared to large-cap companies.

• Mid-Cap Growth Funds:

o Sectors to Focus On:

 Mid-cap growth funds often invest in sectors like power, energy, infrastructure,
telecommunications, healthcare, and finance. These sectors are chosen because they
have strong growth potential, especially in emerging markets like India. For example:

▪ Power and Energy: With the global shift toward renewable energy,
companies in this sector are likely to grow.

▪ Infrastructure: Government spending on infrastructure projects can drive

growth in this sector.

▪ Telecommunications: The rise of 5G and digital transformation offers growth

opportunities.

▪ Healthcare: Increasing demand for healthcare services, especially post-

COVID, makes this sector attractive.

▪ Finance: Financial inclusion and digital banking are growth drivers.

o Why These Sectors?

These sectors are linked to long-term economic growth and are less sensitive to short-
term market fluctuations, making them suitable for mid-to-long-term investors.

• Small-Cap Growth Funds:

o Stock Price Movement:

For small-cap companies, it’s crucial to check the movement of their stock prices
over the last fiscal year. Small-cap stocks are more volatile, and their prices can
fluctuate significantly. A consistent upward trend in stock prices over the past year
could indicate strong growth potential.

o Why Focus on Past Performance?

Small-cap companies are often in the early stages of growth, and their stock prices
can be influenced by market sentiment, news, or even speculation. Analyzing their
past performance helps you understand whether the growth is sustainable or just a
short-term spike.

Mutual Funds (MF) and Stocks: Key Metrics and Selection Criteria

Mutual Funds:

1. Standard Deviation (SD) and Beta:

o Standard Deviation (SD):

SD measures the volatility or risk of a mutual fund. A higher SD indicates higher

volatility, meaning the fund’s returns can fluctuate significantly. For moderate-risk
investors, a fund with SD close to or below the category average is preferable.

o Beta:
Beta measures the fund’s sensitivity to market movements. A beta of 1 means the
fund moves in line with the market, while a beta greater than 1 indicates higher
volatility. For moderate-risk investors, a beta close to 1 is ideal, as it suggests the
fund is neither too aggressive nor too conservative.

2. Sharpe Ratio:
 The Sharpe ratio measures the risk-adjusted return of a fund. A higher Sharpe ratio indicates
better returns relative to the risk taken. For example, a Sharpe ratio of 1.5 is better than
1.0. Always compare the Sharpe ratio with the category average to assess performance.

3. Top 3 Sectoral Weightage:

This shows the sectors in which the fund has the highest exposure. For example, if a fund has
30% weightage in technology, 25% in healthcare, and 20% in finance, it means the fund’s
performance is heavily influenced by these sectors. Ensure the sectors align with your
investment goals and risk appetite.

4. Portfolio Size (5-10 Lakhs):

For a portfolio of this size, diversification is key. Invest in a mix of large-cap, mid-cap, and
debt funds to balance risk and return. Avoid over-concentration in a single sector or asset
class.

5. Latest NAV (Net Asset Value):

NAV represents the per-unit value of the fund. While NAV is not a direct indicator of
performance, it helps you track the fund’s current value. A higher NAV doesn’t necessarily
mean the fund is better; focus on consistent performance over time.

Stocks:

1. Market Price:

The current price at which the stock is trading. Compare it with the intrinsic value (calculated
using P/E ratio, growth potential, etc.) to determine if the stock is overvalued or
undervalued.

2. Face Value:

The nominal value of the stock as stated by the company. It’s used to calculate dividends and
is not directly related to market price.

3. P/E Ratio (Price-to-Earnings Ratio):

The P/E ratio compares the stock’s price to its earnings per share (EPS). A high P/E ratio may
indicate overvaluation, while a low P/E ratio may suggest undervaluation. Compare the P/E
ratio with industry averages for better insights.

4. Financial Leverage (Equity:Debt):

This ratio shows the proportion of debt to equity in the company’s capital structure. A high
debt-to-equity ratio indicates higher financial risk, as the company relies heavily on borrowed
funds. For moderate-risk investors, a lower ratio is preferable.

5. Beta of the Stock:

Similar to mutual funds, beta measures the stock’s volatility relative to the market. A beta
greater than 1 means the stock is more volatile than the market, while a beta less than 1
indicates lower volatility.

Risk-Based Selection Criteria:

• Moderate Risk:

Choose at least 3 factors to evaluate. For example:

 1. P/E Ratio: Ensure the stock is not overvalued.

2. Financial Leverage: Prefer companies with lower debt.

3. Beta: Select stocks with beta close to 1 for stability.

• High Risk:

Choose at least 2 factors and justify your selection. For example:

1. Beta: High-beta stocks (greater than 1) can offer higher returns but come with higher
risk.

2. Market Price: Look for undervalued stocks with high growth potential.

Factoring and Forfeiting:

1. Difference Between Factoring and Forfeiting:

• Factoring:
Factoring is a financial service where a business sells its accounts receivable (invoices) to a
third party (factor) at a discount. It is typically used for short-term financing and can be with
or without recourse.

• Forfeiting:
Forfeiting is a form of export financing where a forfaiter purchases medium- to long-term
receivables (usually in international trade) at a discount. It is always non-recourse, meaning
the forfaiter assumes all the risk of non-payment.

2. Recourse and Non-Recourse Factoring:

• Recourse Factoring:
In recourse factoring, the business (seller) retains the risk of non-payment by the debtor. If
the debtor fails to pay, the factor can recover the amount from the seller. This type of
factoring is cheaper because the factor assumes less risk.

o Why Factors Choose Recourse Factoring:

1. Client is Trustworthy: The factor trusts the seller to cover any defaults.

2. Risk Mitigation: The factor reduces its risk exposure.

3. Short-Term Need: Recourse factoring is ideal for short-term financing needs.

• Non-Recourse Factoring:
In non-recourse factoring, the factor assumes the risk of non-payment. If the debtor fails to
pay, the factor cannot recover the amount from the seller. This type of factoring is more
expensive due to the higher risk.

o Factors Check:

1. Debtor’s Creditworthiness: The factor assesses the debtor’s ability to pay.

2. Revenue Streams: The factor evaluates the debtor’s financial stability.

3. Sector Analysis: The factor analyzes the debtor’s industry for risks.

3. Documents Required for Factoring and Forfeiting:

 • Factoring:

1. Invoices (proof of accounts receivable).

2. Agreement between the seller and factor.

• Forfeiting:

1. Bill of Exchange or Promissory Note.

2. Export documents (e.g., shipping documents).

4. Recent Problems/Challenges of Factoring in India:

1. High Competition: Many players in the market have reduced profit margins for factors.

2. Regulatory Issues: Complex regulations and compliance requirements.

3. Credit Risk: Assessing the creditworthiness of small and medium enterprises (SMEs) is
challenging.

4. Liquidity Issues: Factors often face liquidity constraints due to delayed payments from
debtors.

5. Types of Factoring and Forfeiting:

• Types of Factoring:

1. Domestic Factoring: Involves domestic trade.

2. Export Factoring: Involves international trade.

3. Disclosed and Undisclosed Factoring: Whether the debtor is informed about the
factoring arrangement.

• Types of Forfeiting:

1. Medium- to Long-Term Forfeiting: Typically used for export financing with

maturities of 6 months to 5 years.

Sectors to Invest in for the Short Term:

1. Education Sector:

• Why Invest in Education?

The education sector is growing rapidly due to increasing demand for online learning, skill
development, and government initiatives like the National Education Policy (NEP) in India.
Companies offering edtech solutions, online courses, and vocational training are likely to see
growth in the short term.

• Key Players:

Companies like BYJU’S, Unacademy, and other edtech startups are worth considering.
Additionally, traditional education companies expanding into digital platforms may also offer
opportunities.

2. MSME and Allied Sectors:

 • Why Invest in MSMEs?

Micro, Small, and Medium Enterprises (MSMEs) are the backbone of the economy, especially
in emerging markets like India. Government schemes like the Atmanirbhar Bharat Abhiyan
and easier access to credit are boosting this sector.

• Allied Sectors:

Look at sectors that support MSMEs, such as logistics, supply chain management, and digital
payment platforms.

3. Infrastructure and Allied Sectors:

• Why Invest in Infrastructure?

• Infrastructure development is a priority for governments worldwide, especially in developing

countries. Investments in roads, railways, airports, and urban infrastructure are likely to
yield short-term gains.

• Allied Sectors:

• Consider companies in construction, cement, steel, and engineering services that benefit
from infrastructure projects.

4. New Energy Sector:

• Why Invest in New Energy?

The global shift toward renewable energy (solar, wind, hydrogen) and electric vehicles (EVs)
is creating significant opportunities. Governments are offering incentives for clean energy
projects, making this sector attractive for short-term investments.

• Key Areas:

Solar panel manufacturers, EV battery makers, and companies involved in energy storage
solutions.

Short-Term Mutual Funds (MF):

1. NAV/Price Should Be Moderate:

• Why Moderate NAV?

A moderate NAV allows for better diversification. If the NAV is too high, you may end up with
fewer units, limiting your ability to spread risk across multiple funds or sectors.

• Diversification Strategy:

Invest in a mix of equity, hybrid, and sectoral funds to balance risk and return.

2. Lower Expense Ratio:

• Why Lower Expense Ratio?

Short-term investments are sensitive to costs like expense ratios, Short-Term Capital Gains
(STCG) tax, and exit loads. A lower expense ratio ensures that more of your returns are
retained.

• Ideal Expense Ratio:

Look for funds with an expense ratio below 1% for equity funds and below 0.5% for debt funds.
3. Ensure Small-Cap Funds Do Not Invest in Debt Instruments:

• Why Avoid Debt Instruments in Small-Cap Funds?

Small-cap funds are meant to invest in high-growth, high-risk equities. If they invest in debt
instruments, it dilutes the fund’s growth potential and may not align with your short-term
goals.

• Check Portfolio Composition:

Review the fund’s portfolio to ensure it is fully invested in equities.

4. Cess/Surcharge Will Be Charged Separately:

• Tax Implications:

Short-term capital gains (STCG) on equity funds are taxed at 15%, plus a 4% health and
education cess. For debt funds, STCG is taxed as per your income tax slab. Factor these taxes
into your returns calculation.

5. Check the Cycle of the Top 5 Sectors:

• Sectoral Cycles:

Different sectors perform well at different stages of the economic cycle. For example:

o Early Cycle: Infrastructure, consumer discretionary.

o Mid-Cycle: Technology, industrials.

o Late Cycle: Utilities, healthcare.

• Low Turnover Rate Funds:

If the fund has a low turnover rate, ensure the sectors it invests in are currently in a growth
phase.

Short-Term Stocks:

1. Check for Liquidity Issues in Debt-Free Companies:

• Why Check Liquidity?

• Even if a company has zero debt, it may face liquidity issues if it cannot convert its assets
into cash quickly. This can impact its ability to meet short-term obligations.

• Indicators of Liquidity Issues:

Look at the company’s cash flow statements and working capital management over the last
3-6 months.

2. Key Ratios to Analyze:

• Quick Ratio:

Measures the company’s ability to meet short-term obligations without selling inventory. A
ratio of 1 or higher is ideal.

o Formula: (Current Assets - Inventory) / Current Liabilities.

• Interest Coverage Ratio (if debt is present):

 Measures the company’s ability to pay interest on its debt. A higher ratio indicates better
financial health.

o Formula: Earnings Before Interest and Taxes (EBIT) / Interest Expense.

• ROCE (Return on Capital Employed):

Measures the efficiency of capital utilization. A higher ROCE indicates better profitability.

o Formula: EBIT / Capital Employed.

• Solvency Ratio:

Measures the company’s ability to meet long-term obligations. A higher ratio indicates lower
risk.

o Formula: (Net Income + Depreciation) / Total Liabilities.