Savings in Microfinance Institutions – Legal Framework

Written By Sushma Singh

While credit is an important financial service provided by microfinance institutions in India there are other financial services as well. We will now look at Savings, which is another financial service provided by some MFIs in this post.


Saving is a very important financial service, which can help people in smoothening their cash flows and use money when it is required rather than when it is earned. Any extra or residual income after meeting all expenditures can be called saving. Savings play an important role in reducing the vulnerability of the poor. Earlier there was a notion that the poor don’t or cannot save. It was later realized that the poor too can save; there is only a need for a suitable product to capture these savings. Savers/Clients need someplace where they can store the amount saved. People having access to banks save in banks and not just save but also earn interest on their savings.

Low-income people/clients generally have volatile savings or very small savings and often do not have access to banks. The very small volume and uncertainty about savings make them unable to use banks for depositing their savings. MFIs however, can provide them the scope for keeping their savings…Savings are mutually beneficial for the clients as well as for the MFIS.

Savings can even out the cash-flow fluctuations that the poor often face. It can help them from overspending during high inflow periods. They can utilize these savings during lean periods. Past saving is an important source of capital for low-income clients, which can be invested in the business when needed. Savings can also help in acquiring livestock or business assets, which can help in creating a new source of income or enhancing the volume of existing income.

Personal savings are useful in meeting sudden unexpected expenditures such as a health or any accident. As getting credit for consumption purposes could be difficult, savings can complement credit and can be a source of funds for consumption purposes such as education or even social ceremonies for which the person would have otherwise borrowed. Therefore, savings help in absorbing shocks, thereby reducing the vulnerability of the poor.

While savings are important for the low-income groups, it is also a good source of funds for the MFIs. The cost of funds generated through savings is generally much lower than the cost of commercial borrowings. Hence savings can help an MFI in reducing its overall financial costs/expenses and therefore strengthen the sustainability of an MFI.

Savings is a more certain as a source of funds and could be a regular source of funds for the MFI whereas mobilization external funds is a more complex and specialized activity calling for fulfilling the requirements of the funders, getting credit-ratings or assessments done, providing security to funders, negotiating interest rates, etc.

Savings in Microfinance Institutions – Legal Framework

MFIs receive some amount of saving regularly from their members. Particularly, if MFIs have stipulated compulsory savings then a fixed amount of savings come to them on a regular basis. However, even as we discuss the positives of savings one must also appreciate that it requires the significant managerial capacity to handle savings.

Since savings are money collected directly from the public, who are generally the poor weak financial performance of MFI, bad intentions or inability to manage liquidity can result in loss of public money. This is one reason why raising public deposits is legally not allowed. In past, many finance companies in India have caused the loss of people’s savings.

Some MFIs make it mandatory for their clients to save with them and these savings are called ‘compulsory savings’. MFIs may also collect client savings according to their clients’ convenience. Clients may deposit any amount any time with the MFI, these are called ‘voluntary savings’.

Some MFIs may also offer compulsory as well as voluntary savings services to their clients. However, savings are seldom a sufficient source of funds. It must be noted that most MFIs will have to borrow from commercial sources if they want to have a large programme and want to expand fast. Savings, in such a case, can only be an additional source of funds and it cannot fully replace borrowings.

a) Compulsory Savings

Compulsory savings are those in which members have to definitely save a fixed amount at regular intervals with the MFI. Generally, such savings are collected in the meetings of the group or directly from individuals (in Individual model) on a regular basis. The frequency of saving could be weekly or monthly depending on the frequency of group meetings. Compulsory savings help MFIs to ascertain the genuine interest of the client in being associated with the MFI.

It is seen in the case of the SHG model that members have to compulsorily save internally for six-months before they can be considered for bank or MFI loans. Thus in the case of SHG-Bank linkage, six-months of regular savings is stipulated as an essential condition. These regular savings reflect the strength of the group and their motivation. Also defaults the outstanding loan can be adjusted against the savings of group members that MFI is holding.

Another feature of Compulsory savings is that the monies are generally non-withdrawable during the term of the loan. That means a client cannot withdraw her/his compulsory savings from the MFI as long as she/he has a loan outstanding. Hence, compulsory savings act as some sort of collateral. However, many MFIs also have the policy of non-withdraw ability of savings as long as the credit is a member of the MFI. Withdrawal of compulsory savings marks the drop out of a client.

b) Voluntary Savings

Voluntary savings are those savings, which the clients decide to make because they have funds and out of their own desire/will. Under this scheme, MFIs may design and offer different saving products to attract client savings but clients may or may not avail them. Voluntary saving is withdrawable but does not mean the end of the client relationship. The reasons for voluntary savings may also be many. Therefore just like a bank, MFIs come out with different savings products such as recurring deposits, monthly income schemes, or fixed deposits. Each product may have various features related to interest rate, withdrawal ability, etc.

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Managing voluntary savings is a complex issue and needs skill sets which are quite different from compulsory saving. Voluntary savings requires an MFI to fulfill regulatory requirements, which could be quite stringent. MFIs should have the high financial stability to protect client savings. MFIs also need strong management systems and supervisory capacity to manage liquidity and other financial requirements associated with mobilizing voluntary savings. Voluntary savings calls for a high level of credibility of institutions and the trust of the public.

The capacity of an MFI to diversify its investments and to keep savings protected even in unfavorable financial/market scenarios may be limited. Liquidity management gains a lot of importance while managing voluntary savings. Liquidity Management means that an MFI should be able to meet its commitment by returning the client savings as and when required by the clients. Savings mobilized by the MFI are primarily invested in the loan portfolios of the organization and to a limited extent in other financial instruments. While voluntary savings can be withdrawn by the clients anytime the loan portfolio or instruments in which the savings have been invested may not mature at the same time. Hence there is always a risk that MFI may not have sufficient liquidity to meet its repayment commitment.

Therefore, in financial institutions with strong voluntary savings leaning, a system to manage Liquidity management is a specialized function. It is for this reason that even banks give very high priority to liquidity management. Failure to meet commitments may risk the credibility of the organization and can jeopardize the reputation of the MFI resulting in problems spiraling into an uncontrollable situation. A few years back a reputed bank in India had to face this situation where due to liquidity problems it could not refund the savings of a few clients. This news immediately spread to all the clients who got the message that the bank may be in a financial crisis. The result was that suddenly many clients wanted to withdraw the savings.

Hence, MFIs need to be well-aware of all such technical issues and be very sound in their management to service voluntary savings effectively. In MFIs savings from the public is generally invested in loans. While people can withdraw voluntary savings anytime the loan will mature according to their own repayments schedule. Hence, any MFI can free the problem to repay if there is sudden or too much withdrawal of savings by clients as MFI will not have cash beyond a certain limit.

Also, MFIs do not prefer keeping too much cash: idle cash does not earn a return and MFI has to pay interest to sources from which the funds have been raised. Therefore, managing voluntary savings requires special skills and technical know-how to manage what is known as liquidity risk. More about this has been discussed in the Risk Management chapter.

c) Legal Framework for savings

Although savings is an important financial service and is beneficial for the MFI as well as for the clients mobilizing public savings by MFIs is a much-debated topic. Regulations not only in India but in many other countries too, do not allow MFIs to collect public savings.

In India, collection or savings except by banks and other specifically allowed institutions is not allowed. As regards various legal forms of MFIs it is seen that societies and Trusts cannot raise public deposit while cooperatives can collect savings only from their own members.

As far as Non-Banking Finance Companies (NBFCs) are concerned they can only collect savings after meeting certain stringent regulatory requirements as set by Reserves Bank of India, including investment-grade rating from an accredited Credit Rating agency. The requirements for the collection of savings are so stringent that most of the NBFC-MFIs are – in practice non-deposit taking.

These regulations have been formed by the Government to protect the savings of the poor. Many countries around the world including India still do not have dedicated regulations for the Micro-finance sector. The monitoring and regulations for MFIs, which exist in a variety of legal forms, are still weak as there is no single regulatory body. Due to the lack of strong controls, the credibility and intentions of different MFIs is difficult to ascertain. Hence, the Government is still not comfortable in allowing the MFIs to collect public savings.

There is always a threat that such MFIs may either intentionally dupe people of their savings or may not have the required management capacity to manage public funds. Losses to an MFI and its bankruptcy will eventually lead to poor people losing their hard-earned savings. Due to these threats, the government still does not allow MFIs in general to collect public savings.

However, many experts in the sector do not find this justification convincing enough. They are of the opinion that micro-finance without savings is like a sector limping on one leg. Due to extensive lobbying by the micro-finance practitioners and other stakeholders, the Government of India is in the process of instituting an Act to regulate the sector.

As a result of this, a Micro-finance Bill called the Micro-finance Sector (Development and Regulation) Act, 2007, had been prepared and is under consideration of the lawmakers. This new Bill may allow ‘thrift’ to be collected by the not-for-profit organizations.

‘Thrift’ means the regular compulsory savings of a fixed amount that members save. While the sector has welcomed the draft bill as a first – albeit small step towards the right direction, the proposals in the bill has left much of the sector dissatisfied. The Bill covers only the not-for-profit organizations and not other institutional forms such as NBFCs and Section-25 companies which account for major share micro-finance.

The draft bill allows only thrift to be collected, which is the regular compulsory saving and does not allow voluntary savings. Many in the sector do not agree with the over-cautious perspective of the Government on the collection of public savings.

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