Micro Finance in India

overview, challenges, and the role of

technology
By Annie Duflo
Centre for Micro Finance Research
October 28, 2005

Outline of presentation
What is microfinance?
Providing financial services to the poor:
challenges
Providing financial services to the poor
in India: Overview
Microfinance: Challenges ahead and
potential solutions/initiatives
The Centre for Micro Finance Research

Microfinance: what is it?

Microfinance: what is it?

What are the words that come to your
mind when you hear the word
microfinance?

Microfinance: what is it?

15
%
37
%
48
%

R1 /
R2
R3
R4

Microfinance =
provision of
financial services
to the poor

Microfinance: what is it?

What it often is

What it really should be

Micro-credit
Group lending
Social/charitable
activity

Range of financial
services
Group and
individual lending
Profitable activity

Providing financial services to the

poor: challenges

Providing financial services to the

poor: challenges
Risk management challenges
due to information asymmetry
problems
Accessibility (geographic
accessibility and easiness to
deal with)
No collateral, Low value and
cash intensive nature of the
business
Staff training and motivation

High
transaction
costs

Information asymmetry

Decision to take loanLoan usage

Adverse
selection

loan repayment

Moral hazard

Adverse selection: incomplete

information problem (before the
loan)
Dont know
Clients type

Need to increase interest

rate

Interest rate
reflects proba of default

Safer clients drop out

Providing credit can

become
impossible

Moral hazard: hidden action problem

(after loan)
Can not observe what client is doing

Strategic unwillingness
Bad loan usage
To repay

Clients profile
75% population lives in rural areas:
geographical access difficult
Informal activities: need access at
flexible times
Illiteracy: difficult to deal with traditional
services
Low value of transactions
Lack of collateral

Staff
Lack of trained staff
Lack of motivated staff
Difficult to incentives staff

Delivering financial services to the

poor in India: an overview

Providing financial services to the

poor: occupied India
Deccan, late 19th Century:
peasant riots on account of coercive
alienation of land by moneylenders.

Organization of cooperative societies

as alternative institutions for providing
crdit by british government

Providing financial services to the

poor:
Credit was viewed as essential part of fight
Independent
India:
against poverty which led to following

measures:
Expansion of the institutional structure
Directed lending to disadvantaged borrowers
and sectors
Interest rates supported by subsidies
Institutional vehicles: cooperatives,
commercial banks and Regional Rural Banks
[RRBs].

Providing financial services to the

poor:
Timeline

1950 & 1969: emphasis on the promoting of

cooperatives.
1969: nationalization of the major commercial banks:
beginning of commercial bank branch expansion in the
rural and semi-urban areas.
1976: Regional Rural Banks (RRB), low cost institutions
mandated to reach the poorest in credit-deficient
areas
During this period, intervention of the RBI (Reserve
Bank of India) was essential: special credit
programmes for channeling subsidized credit to the
rural sector (concept of priority sector)

Financial reforms for RFIs

Enhance the areas of commercial fredon

Increase their outreach to the poor
Stimulate additional flows to the sector.
Liberalising interest rates for cooperatives and
RRBs,
Relaxing controls on where, for what purpose
and for whom RFIs could lend, reworking the
sub-heads under the priority sector,
Introducing prudential norms
Restructuring and recapitalising of RRBs.

Results
Access in terms of rural branches increased
from 1,833 in 1969 to around 32,538 at
present: 49% of all scheduled commercial
bank branches are rural
The population per rural branch declined from
2,01,854 in 1969 to around 16,000 at present.
The proportion of borrowings of rural
households from institutional sources
increased from 7 per cent in 1951 to more
than 60 per cent at present.

Results (contd)
31% (131.1 million) of the total
deposit accounts are in rural India
43%(22.4 million) of total credit
accounts are in rural India
Positive impact on the poor (Rohini
Pande/Burgess paper)

HoweverSuccess was not as high

as hoped
Defects in policy design,
Infirmities in implementation
Inability of the government of the day to desist
from resorting to measures such as loan waivers.
High defaults
The banking system - was not able to internalise
lending to the poor as a viable activity but only as a
social obligation
More and more difficult for commercial bankers to
accept that lending to the poor could be a viable
activity.

Micro Finance: apparition

The financial sector reforms motivated policy
planners to search for products and strategies for
delivering financial services to the poor
microFinance - in a sustainable manner consistent
with high repayment rates.
NABARD: empirical observation that had been
catalysed by NGOs that poors gather in informal
groups
Create a formal interface of these informal
arrangements of the poor with the banking system.
Bank-SHG Linkage Programme.
Recent emergence of MFIs: professionally run
institutions specialiazed in delivering credit with low
cost staff and local knowledge

Despite all these effortslarge gaps

remain
Against rural population of 741.0 million, 500
million people un-served
Population per branch: 22,793
Penetration of savings accounts is below 18%
As against 104% in urban and semi-urban areas
Number of villages per branch: 19
High dependence on informal sources
36% of rural credit from informal sources
Dependence even higher for lower income households:
78%

Microfinance ahead: challenges

Gaps in demand and supply

Demand: Rs. 450 billion/y Disbursed: 39 billion
500 million un-served poor

Less than 2 million

Households reached

to cover all parts of India

60% in South

Need protection
against all risks

Insurance under-delivered

ed employment opportunities
Market constraints

Scalin
g up

Increa
se
impact

Scaling up: challenges

Limitation of the predominant

model
SHG-Bank linkage
model
Bank

No
liabilit
y

Loan at
9%

NGO

SHG

Group
formati
on/linka
ge

Scaling up existing MFIs:

challenges
Financial Intermediation
Model
Bank

MFI

Loan at
a 9%

JLG Group

Loan at
20%

Limitations to growth of MFIs:

Lack of adequate quantities of risk
capital
Lack of long-term finance to pay for
creation of the necessary infrastructure
and pre-operative expense
Lack of well trained staff in adequate
numbers at all levels
technology

Lack of adequate capital: the ICICI

Bank response

Searched for a model which:

Separates risk of MFI from risk inherent
in the mf portfolio
Provides a mechanisms to banks to
continuously incentivise partners
Inability of MFIs to provide risk capital in
large quantum, which limited advances
from banks

The ICICI Bank Partnership

Model
Loan at
9%

Bank

MFI

FLDG of
10%

JLG Group

Servicin
g fees
of 11%

Interest
charged
: 20%

Long-term finance: the ICICI bank

response
There is an underlying business model
in the MFIs expansion: no reason why it
cannot be funded by commercial debt
ICICI Bank is offereing to its MFI
partners long-term finance of a tenure
of 3-5 years

Lack of well-trained staff: ICICI Bank

response
Initiated partnerships with training
institutions (Indian Grameen Services, Care
India)
Establish a Financial Services Learning
School in collaboration with MicroSave India
Provide high level training in banking and
finance to MFI practitioners in collaboration
with IFMR (Institute for Financial
Management Research)

Technology
Role of technology in microfinance:
MIS
Cash handling
Data capture and subsequent
management

Technology: ICICI Bank response

Creation of rural connectivity in partnership
with telecom companies and internet
service providers
Assistance to emerging MFIs to adopt
scalable MIS solutions
Support to research and development on
technological devices that can reduce
transaction costs
Low cost ATMs, low-cost computing devices,
mobile and internet-based transaction platforms

Scaling up: creation of new MFIs

Need 200 MFIs to cover all India
ICICI Bank (SIG): support to entrepreneurs to start
MFIs
KAS Foundation, Orissa

Inputs are needed:

Organizational and staff incentive structures

Finance related issues (source of funds, capital structure)
Legal issues: regulations etc.
Business plan related issues: scale, expansion strategy etc.

Corporate partnerships: attractive track to build

access to microfinance

Support new MFIs: The Venture

Capitalist model
VCs specifically focused on the micro-finance
space: Lok Capital, Aavishkar and Bellwether.
Bellwether
three equity commitments for start-ups
increased the size of fund from 10mn USD to 25mn USD.

ICICI Bank solution:

Each MFI will need to reach a minimal CRISIL or an
MCRIL operational sustainability rating
Then the entrepreneur buys out the stake of the VC and
ICICI Bank gives an option to the entrepreneur to take a
long-term debt to finance this buy out.

Scaling-up: what form of support is

needed?
Interest rates should reflect the costs of
transactions/probability of default and
be sustainable
Focus on diminishing the cost of these
transactions and expand access
Equity support, Remove
caps and floors, create facilitative infrastructure
to reduce transaction costs

Alternate channels
Agent model
Model of LIC
Challenge: control fraud

Internet connectivity
BSNL: if wireless system installed ate the
existing connected rural exchanges: 80-85%
of villages could be connected
Variety of devices that can work with
internet kiosks: biometric low-cost ATMs
Makes controlling fraud easier

Internet Kiosks
STD/PCO:
Enabling voice
communication

Connectivit
y

Internet Kiosk
Kiosk
Internet

Multimedia
PC with Power
backup

Kiosk Operator:

Entrepreneur
Provides commercial
services

Printer &
Other
Accessories :
Enabling job
work

Internet kiosks
ITC, nLogue, Drishtee: more than 6000
internet kiosks using Wireless in Local Loop,
VSAT terminals
ICICI partnered with some of these
organizations
Finance individual entrepreneurs to purchase
operating license and equipment
Break even within 1st year
Suite of financial services
2000 kiosks

Internet kiosks: remaining gaps

Providing constant connectivity
expensive
Finding motivated entrepreneurs
difficult
Break even has been delayed for
various reasons (required back-end
systems to service clients difficult tp
find etc.)

ICICI Bank strategy: summary

Convention
Convention
al
alRural
Rural
Banking
Banking

Branch
Branch
based
based

Manpower
Manpower
intensive
intensive

Product
Product
driven
driven

Single
Single
product
product

Our
Our
strategy
strategy

Hybrid
Hybrid
channels
channels

Technolog
Technolog
yy
intensive
intensive

Customer
Customer
driven
driven

Multiple
Multiple
products
products

Maximize impact of microfinance:

challenges

Maximize impact
Vulnerability

Need for
More than credit

Differences among
customers

Need for
customized
products

Understand what programmes work the best

and for whom

Maximize impact
Other constraints

MFI-sectoral experts
Partnerships

Employment
scarcity

Finance other credit

constraint segments

Local Financial Institution: serving all credit constrain

Segments in 2-3 districts

Range of Microfinancial services:

Individual lending

Information problem
No unique ID
No credit info sharing
Need technology!

Insurance
Adverse selection, moral hazard, fraud

Range of Microfinancial services:

Health insurance

Reimbursement model
Cashless model
How to identify illness?
How to avoid fraud?

Livestock insurance
Recognize cause of death
Identify animal (role of technology)

Range of Microfinancial services:

Weather insurance
Index-based: index created by assigning
weights to critical time periods
Past weather data mapped to this index to
arrive at normal treshhold index
If deviation: compensation

Commodity price derivatives

NCDEX: offers price discovery services: offer
farmers instruments to hedge pre and post
harvest risks
Makes using commodity as collateral possible

Range of Microfinancial services:

Savings and investments products
Could be offered through Money Market
Mutual Fund: MFI acts as agent

Remittances
10 million seasonal and circular migrants
(National Commission on Rural Labour)
Adhikar, Orissa
ICICI: remittance product through internet
kiosks

Key enablers needed for maximize

impact and scaling up

Credit Bureau
Unique identifier
Technology platform
Rural infrastructure
Change in regulations (interest rates et.)
Training institutions
Research

CMFR:
The Centre for Micro Finance
Research

Objectives
Fill gaps in understanding of
microfinance:
Extent and channels of impact
What programme designs work and what do
not?
What programme variants can increase impact?

Fill gaps in practice of microfinance:

limitation to micro-credit, lack of financial
capacity

Mission
The Centre for Micro Finance Research will
aim to help improve the life of the poor by:
Systematically researching the links between
access to financial services and the
participation of the poor in the larger economy
Participating in maximizing access to financial
services and its impact for poor through:

Research on micro finance and livelihood financing

Research-based policy advocacy
High level training for practitioners and institutions
Strategy building for Micro Finance Institutions

Strategy
Training

Research

Advocacy

Strategy
building

Influence
practice

Partnerships
Banks/
Insurance
Companies

Universities

CMFR
Regulators/policy
makers

MFIs/NGOs
International
organizations

CMFR: Research Areas

Impact of Microfinance

Access to
Financial services

Impact?

Advocacy based on rigorous results

Constraints to Productivity
pu
t
s

Access to
Financial services

In

in
fra
st
ru
ct
ur
e

Impacten
al
e
H

th

Build relevant partnerships

Provide useful products through credit

tr
ep
re
n

eu
rs

hi
p

Economics of Micro-Enterprise
Scale, Returns, Constraints of microenterprise
Market linkages
Documentation of best practices

Help increase productivity of micro-enterprise

Experimentation on Product
Design
selection
Individual/group
liability
Self/MFI
selection
Guarantors
Collaterals
Interest rate

monitoring
Within group
monitoring
Staff
supervision

Enforcement
Repayment
schedule
Communication
strategies
Loan size
Interest rate

Design the most cost-effective products

Behavior and Psychology of

Borrowers

How do households face shocks and risk?

Do households save and how?
What drives savings and credit behavior?
Why do people default?
Why dont households adopt the most
profitable activities?
Design the most effective communication strategies

MFI Policies: Impact

How do MFIs policies affect loans and
repayment behavior of clients?
Staff incentives
Combination of different products
Compulsory savings or insurance

Understand better impact of policies over time

Cost and profitability of

SHGs/MFIs
Bank

9%

Transaction
25% Micro-loan
?

Return?
How to reduce transaction costs?
Compare costs of SHG-Bank linkage and MFI model
Show investors risk return performance of microloans

Research: other initiatives

Research: Panel Databases

Construction of a panel database: repeated
observations of same households
Study vulnerability, consumption patterns over
time
Have a panel database for on-going research

Construction of a cross-sectional survey

Document access to financial services over time

Research: weekly seminar series

Foregone seminars
Prof Ashok Jhunjhunwala (IIT Chennai),
Prof Vaidyanathan (Madras Institute of Development
Studies)
Prof Sendhil Mullainathan, Harvard
GN Bajpai, ex-Chairman of SEBI
Greg Fisher, MIT
..

Forthcoming seminars:
Suresh Sundaresan, Columbia
Dr Narendra Jadhav, RBI
..

Research: Courses
Economics of Micro Finance
Prof. Adel Varghese, TAMU
Economic theory of microfinance

Evaluating Social Programmes

Professors from the Poverty Action Lab/MIT:
Esther Duflo (MIT), Abhijit Banerjee (MIT),
Sendhil Mullainathan (Harvard), Michael Kremer
(Harvard)
Teach practitioners and researchers how to
identify programs impacts without bias

MFI Strategy Unit at CMFR

Strategy Building
Sectoral
Experts

MFIs

Pilots

Scale-up

LFI

Training
Building blocks of Banking and
Finance Training Programs
Meet training needs of the sector:
In collaboration with MicroSave
India
Development of national curriculum
Collaboration with 6 Regional Training
Institutes

THANK YOU!