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• Loan terms compatible with enterprise needs. Loan packages, although partly standardised to reduce administrative costs, should retain enough flexibility to meet borrowers’ needs in terms of maturities and loan sizes. A variety of loan maturities should be available to meet short-term working capital needs and longer-term investment capital needs. Loans that do not match the income streams of an entrepreneur’s business activity can do more harm than good.

In general, loans provided to microentrepreneurs will need to be of shorter duration than those provided to larger enterprises and average loan sizes will be considerably smaller.

• High frequency of repayment collection. Weekly, fortnightly or monthly instalments facilitate loan repayment for the poor who may find it easier to repay small amounts regularly than a large lump sum after a long period. However, if a loan is used to finance a seasonal activity, a lump sum repayment may be more adequate.

• Incentives for timely repayment. These include the promise of (larger) repeat loans, appropriate loan products, flexible repayment schedules, low transaction costs and the use of joint liability groups. Bank Rakyat Indonesia, which administers one of the world’s largest microfinance programmes, provides interest rebates if loans are repaid on time.

• Repeat loans. In addition to providing borrowers with an incentive to repay, repeat loans with increasing loan sizes also reduce lenders’ initial risk. Repeat loans should not be extended automatically once a loan has been repaid and loan sizes should not routinely be increased since good business opportunities are not always available. Instead, amounts and maturities should only be increased with need and performance.

• Defaults are controlled rigorously. The existing credit culture depends crucially on how a lender deals with default. Immediate follow-up, threat of legal action and, in extreme cases, seizing of assets such as TVs have shown to impact significantly on repayment rates.

• Rescheduling or Refinancing of loans only under extreme circumstances. Write-offs should be avoided.


• Availability of voluntary savings facilities, also for non borrowers. Savings services should not be tied to credit uptake.

• Low opening and minimum balances.

• Availability of a variety of savings products. Clients value the availability of liquid savings products, semi-liquid savings products and fixed-term deposits and are likely to use a combination of them.

• Flexible interest rates. Interest rates should increase with the size of the savings account to provide an incentive for saving. Savings account balances below a certain minimum should be interest-free to partly compensate for the high administrative costs of small accounts.

• Savings accounts are kept confidential.

©United Nations Industrial Development Organization


• Regulation and Supervision. To protect small savers from losing their life-savings, microfinance providers mobilizing voluntary savings must be adequately regulated and supervised. Only institutions that have the institutional capacity to comply with prudential regulations should therefore consider deposit taking.

Administrative issues:

• Clients are treated with respect. Bank staff often treat poor clients rudely. Treating clients with respect is fundamental from a moral and business point of view and can have an important empowering effect on the poor.

• Unit costs are minimised for both the microfinance provider and clients. This can be achieved by standardising the lending procedure, i.e. making loan applications simple and approvable on the basis of easily verifiable criteria. Decreasing transaction costs for the microfinance provider should not lead to undue increases in transaction costs for borrowers.

Some microfinance providers (such as Swayam Krishi Sangam of Andhra Pradesh, India) reduced the transaction costs of lending through the introduction of so-called smart cards, which contain information about a client’s loan on a memory chip.

• Interest rates and fees are calculated to cover costs. Because the costs of frequently providing small, short-term loans to the economically active poor are much higher than conventional bank loans, financially viable microfinance providers must charge higher than commercial bank rates. However, in contrast to what many bankers believe, the poor are able to repay credit at commercial rates and do not require subsidised loans. Interest rates that are too low to cover costs not only make lending to the poor unprofitable and thus decrease the amount of loans available, they also reduce the rates lenders can offer on savings, encourage slow repayment and may result in elite capture and corruption.

Source: Harper (2003a); Hatch, Levine & Penn, 2002; Ledgerwood (1999); Robinson (2001) iii) Sensitisation of Bankers Once potential partner institutions have been identified, they must become interested in the project and willing to interact with cluster actors. Although the institutional framework for SHG-bank linkage exists in India, there is no obligation for bank branches and the ultimate decision to participate still remains with the branch manager. Whether financial services will be provided to poor cluster actors thus crucially hinges on the motivation of bankers.

This makes sensitisation of branch managers one of the most important tasks in linking SHGs. For commercial banks more sensitisation is likely to be necessary than for cooperative societies or specialised microfinance institutions.

In addition to the traditional deterrents for small-scale lending (see section 1Ai), there are several reasons why bankers may be reluctant to work with SHGs. Bankers sometimes think that they cannot compete successfully with moneylenders since these are believed to have better information about borrowers than banks could obtain cost-effectively (Robinson, 2001). They may fear that unregistered SHGs will cease to exist and that loans extended to groups cannot be recovered. Bank staff may also be reluctant to deal with poor borrowers and to visit groups which often meet at odd hours. They may perceive microfinance provision as a social activity, which should be undertaken by NGOs rather than by business-oriented financial institutions. Above all, many bankers - particularly in rural areas - have had bad experiences with past government programmes to improve credit extension to the rural poor. They are therefore likely to be sceptical of SHG-banking and to perceive it as simply another government scheme. To ensure branch manager’s cooperation, bankers must thus be convinced that SHG-banking is viable and can be profitable. In some cases, exposure visits for bankers may be necessary. Box 3.3. outlines

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the benefits of SHG-banking for financial institutions.

Box 3.3 Benefits of SHG-Banking for Financial Institutions

• Development of new business activities. By actively targeting the “bottom of the pyramid” market rather than simply attempting to meet priority-sector lending targets, financial institutions can develop a new profitable business segment and thus diversify their activities.

• Achieving economies of scale. By working with SHGs, banks can reach a larger client base while only marginally increasing operating costs. Banks only have to maintain one account for the entire group, there is no need for individual loan appraisal, and loan monitoring as well as loan recovery are undertaken by group members. The SHG-Bank Linkage Model thus significantly reduces the high transaction costs involved in providing a large number of small loans at frequent intervals to poor people.

• Reduction of asymmetric information. Members of a community typically know who is credit-worthy and who is not. Group liability and self-selection of group members ensure that only reliable people will participate in SHGs.

• Reduction of moral hazard. Group monitoring and peer pressure increase members’ commitment.

• Reduction of risk. The reduction of asymmetric information and moral hazard reduces the risk for financial institutions.

• High repayment rates. Repayment rates of SHGs range between 95% and 100% and are higher than those of individuals.

• A profitable loan portfolio. The combination of high repayment rates and low transaction costs makes SHG-lending a profitable business segment for financial institutions.

• Increased savings mobilization. SHGs have proven to be reliable and regular savers that can significantly increase the deposit base of financial institutions.

• Absorption of underutilised capacities. Some bank branches may have excess capacities.

SHG-banking offers the opportunity to obtain additional savings and credit business to absorb fixed costs.

• Availability of refinance. Refinance, at a concessional rate, is available from NABARD, SIDBI and other apex organizations.

• Classification as priority-sector lending. SHG-banking is recognised by the Reserve Bank of India and is classified as priority sector lending. SHG-banking thus provides a good opportunity for banks to meet their targets through low risk and profitable loans to SHGs.

• Increase in banks’ overall repayment rates. There is evidence of spill-over effects on the repayment behaviour of non-members due to the influence of SHGs on their communities.

Several financial institutions report that recovery rates of outstanding loans have improved.

• Improvements in overall performance. Cooperative societies participating in SHG-banking have reported significant improvements in performance which they attribute to their SHG business. Some have turned from loss-making institutions into profitable entities (Seibel & Dave, 2002).

• Improvement of public image. In addition to being lucrative, providing financial services to self-help groups of the poor offers financial institutions the opportunity to improve their public image.

• Increased job satisfaction. Bankers participating in the SHG-Bank Linkage Programme have reported a new dimension of job satisfaction resulting from the increasing amount of loans disbursed, the good loan performance and the socio-economic achievements of their groups (Kropp & Suran, 2002).

©United Nations Industrial Development Organization


In addition to becoming aware of the benefits of SHG-banking, bankers must learn about cluster activities. Bank staff must have at least a limited understanding of the activities undertaken in the cluster and of the financial needs of cluster actors to ensure that adequate financial services are provided. In Sindhudurg, UNIDO’s CDA organised several visits for bankers to the cluster to increase awareness on credit needs. Involving bankers from the start of CDP intervention in meetings and workshops is a good strategy to improve bankers’ knowledge of the cluster programme and of cluster actors. It also influences cluster actors’ perception of bankers and can increase their trust in the bank. In fact, a borrower’s perception of a lender crucially influences his willingness to repay.

A regional rural bank in Sindhudurg has been working with SHGs since 2002. In total, the 15 branches in the district served 586 SHGs, of which 348 were below poverty line groups.

In autumn 2004, 173 groups had outstanding loans for a total of Rs 5.8 million (USD 127,600). Total savings of SHGs amounted to Rs 17.6 million (USD 387,200). Initially, the bank promoted the SHGs themselves but has now contracted an NGO to do so. The NGO receives a NABARD subsidy per SHG formed.

The branch manager perceived the main benefits of SHG-banking for his bank to be the margin between deposits on group savings (3%) and loans to groups (9%). The recovery rate for all branches in the district was about 94% despite the fact that many of the loans were used for consumption purposes. According to the branch manager, “only once the poor have filled their stomachs will they start economic activities”.

Women in particular may be reluctant to approach banks because the employees are typically men and are perceived to be ‘women unfriendly’. Bank staff may therefore need to be sensitised to gender issues. Their behaviour towards women can be an important determinant of whether gender inequalities in the community are challenged or reinforced.

iv) Sensitisation of Cluster Actors In addition to bankers and microfinance practitioners, poor cluster actors must also be sensitised on the SHG-Bank Linkage Programme and its benefits. To overcome prejudices, the CDA may have an important role to play as intermediary between poor cluster actors and bankers. There is often mutual distrust between bankers and the poor. Whereas bankers perceive the poor to be ‘wilful defaulters’, the poor often view banks as institutions for the rich and perceive the banks’ services to be inaccessible to them.

Men and women in Chanderi agreed that, despite their need for credit, banks are not accessible to the poor. Not only did most women not know how banks function, but the majority of them could not describe what the local bank looked like. They explained that they had no reason to know since they seldom had reason to go there. The widely held view among men weavers was that the bank was a non-performing, corrupt institution. It was judged to be poorly managed and non-responsive to their needs. Nevertheless, there was awareness among men weavers that banks are important for capital needs, to start a business and to grow independently of middlemen.

In Sindhudurg, it was believed that banks are ‘poor people unfriendly’ and that their procedures are too complicated and time-consuming.

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