ABSTRACT BACKGROUND Though India is one of the largest emerging markets for microfinance in the world, it covers only

one fifth of the country¶s 75 million poor in need of financial assistance. And of the total micro-credit demand estimated at Rs 150,000 crore, the actual disbursement till now, according to the RBI, is only Rs 8,000 crore. That is the potential of microcredit in India. Sensing a large untapped market, even domestic and foreign retail banks are aggressively focusing on this sector The traditional image of lending to rural areas is one of a charitable activity conducted mostly by non-profit organizations and separate from the mainstream financial system. However, this image has been changing in India in the last few years as commercial banks have been widely entering the sector What's new is that India's biggest commercial lenders, such as HDFC and ICICI banks, as well as the State Bank of India, have started to focus in on this sector in a serious way. Even multinational banks with operations in India like ABN Amro (ABN), Standard Chartered (SCBFF), HSBC (HBC), and Citigroup (C) are moving into the microfinance sector. They are striking up partnerships with other microlending specialists in India, and there is even talk of creating a secondary market for these loans. Microloans could be bundled together into larger bond issues and sold to Indian and global investors. If that happens, it could create the kind of liquidity that might take microlending in India into a higher realm. The social need is definitely there. Despite India's spectacular growth this decade²its economy has clocked 8%-plus growth over the past three years²roughly 30% of India's 1 billion-plus population lives below the poverty line. That's a huge market, and these bigger banks are discovering that lending small amounts to credit-worthy rural borrowers is lucrative as well as socially progressive. Ranjan Ghosh, who heads financial institutions for India and South Asia at Standard Chartered Bank, adds: "With fewer defaulters in this sector, clearly the risk return rate is acceptable to banks. We look at it as investment. Icici has set up more than 100 tie-ups with small-town lending specialists and has about 3.2 million low-income customers. HDFC hopes to follow suit. Earlier this year, it created a microfinance unit with more than 100 employees and aims to double its lending levels in rural India to $22 million. ABN Amro began microfinance operations in September, 2003, and has 24 Indian microfinance partners and $23 million in outstanding loans to this sector. Sarma predicts the bank's lending to this sector will grow fivefold by the end of the decade. It has already surpassed the bank's microcredit operations in Brazil, which began four years ago. Vijay Mahajan, who runs a leading microfinance lender called Basix in the southern state of Hyderabad, thinks there is a $30 billion market for this kind of lending. There are about 350 million Indians living in poverty conditions, and more than 100 million households have no access to credit. "SAFER ASSETS". For well-managed lenders with the right kind of credit-risk controls, there is a vast market for loans in the $40 to $200 range. And big banks want to supplant neighborhood money lenders who currently meet about 80% of that demand. The Reserve Bank of India wants the nation's major banks and foreign lenders operating in India to complement the small-scale lending for small agricultural and business loans. It is also good business for Indian banks, given the diminishing market for lending to companies and consumers in major cities. "With cutthroat competition in the urban market where basic credit is reaching a saturation point, banks are going into villages to seek safer assets," said Keya Sarkar, a board member of several microfinance

companies. Still, setting up an extensive rural base of branches is costly, so major banks are looking for tie-ups with established microlenders, who know local markets better and have grown increasingly sophisticated. Typically, Indian banks have borrowed a page from Grameen Bank in Bangladesh by lending money to local microfinance firms that have contacts in small villages. They can identify worthy borrowers, which in many cases, means small enterprises run by women. Some 30 million women have formed 2.2 million small businesses and another 400,000 are expected to be in place by March, 2007, according to the National Bank of Agriculture and Rural Development. About $2.48 billion has been extended to these groups, which predominantly run by women, over the last decade. Many lenders are also customizing their loans to reach out to more customers. ICICI is also giving slightly larger loans to help families put their children through college. There's a concern that's emerging that the standardized cookie-cutter approach that had taken might not be suitable for all customers, hence the need to incorporate flexibility in loanproduct design. Other products for the rural population are being rolled out, such as savings plans, insurance, and even mutual funds. For instance, UTI Mutual Fund has tied up with Bank of India to sell its array of mutual fund products through the bank's rural network. Add it all up, and microfinance seems to have a very robust future in India. Right now at least, small will continue to be beautiful for Indian banks that can get this market right. While this sector is growing fast in India, challenges must be addressed in order to make this growth both effective and sustainable. Lending to this sector needs to become more accessible, more customized and more comprehensive.

Introduction:
For the first time in history, India¶s GDP has been growing at a rate greater than 8% for three years in a row. However, many people are concerned about how inclusive the growth is i.e. whether this growth can be called ³development´. This is because approximately 400 million people in India still live below or close to the poverty line which could be roughly translated into 75 million households out of which around 60 million are rural household. So poverty in India has predominantly a rural character. While there are several structural dimensions to the rural poverty it is generally accepted that it arises due to the lack of capital or lack of surplus. The rural poor is perpetuating poverty and is the victims of the "vicious cycle of poverty"

On one hand, it is our responsibility to raise the quality of life of these people. On the other hand, taking a marketer¶s perspective these masses represent a wholly untargeted market, especially, for banks and FIs i.e. a ³Blue Ocean´. That's a huge market, and these bigger banks are discovering that lending small amounts to credit-worthy rural borrowers is lucrative as well as socially progressive. Even multinational banks with operations in India like ABN Amro, Standard Chartered, HSBC, and Citigroup are moving into the microfinance sector. They are striking up partnerships with other microlending specialists in India, and there is even talk of creating a secondary market for these loans. Microloans could be bundled together into larger bond issues and sold to Indian and global investors. If that happens, it could create the kind of liquidity that might take microlending in India into a higher realm. Ranjan Ghosh, who heads financial institutions for India and South Asia at Standard Chartered Bank, adds: "With fewer defaulters in this sector, clearly the risk return rate is acceptable to banks. We look at it as investment." Moumita Sen Sarma, head of microfinance at ABN Amro Bank, says, "Even as it is part of our sustainable development agenda, the trigger has been the large number of poor people residing in India". The microfinance operations of most banks are also registering strong growth rates. ABN Amro began microfinance operations in September, 2003, and has 24 Indian microfinance partners and $23 million in outstanding loans to this sector. Sarma predicts the bank's lending to this sector will grow fivefold by the end of the decade. It has already surpassed the bank's microcredit operations in Brazil, which began four years ago. This study intends to study the rural banking strategies of banks with an emphasis on microfinance in India. First we will study the basics of Microfinance and the prevalent rural banking scenario. Then we will move on to studying strategies of two major private banks in India ± ICICI Bank and HDFC.

I. ABOUT MICROFINANCE
Micro finance includes thrift, credit and other financial services and products of very small amount. Micro Finance (MF) has now been widely accepted as an effective intervention strategy for poverty alleviation, which is easily accessible to the poor, reduces transaction cost and where repayments are designed to fit cash flow for the borrowers. The MF paradigm also fitted well with the adage of µGrowth with Equity¶,

which is integral to the neo-liberal agenda for linkages with the market.

Community Based Community Managed Community (self) financed Integrated (social & finance) Non profit / mutual benefit Only for poor 'Self regulated'

Investor Owned Professionally managed Accepting outside funds for onlending Minimalist (finance only) For profit For all under served clients Externally regulated

The four pillars of microfinance credit system (Fig. 1) are supply, demand for finance, intermediation and regulation. Whatever may the model of the intermediary institution, the end situation is accessibility of finance to poor. The following tables indicate the existing and desired situation for each component.

DEMAND
Existing Situation fragmented Undifferentiated Addicted, corrupted by capital & subsidies Communities not aware of rights and responsibilities Desired Situation Organized Differentiated (for consumption, housing) Deaddicted from capital & subsidies Aware of rights and responsibilities

SUPPLY
Existing Situation Grant based (Foreign/GOI) Directed Credit - unwilling and corrupt Not linked with mainstream Mainly focussed for credit Dominated Desired Situation Regular fund sources (borrowings/deposits) Demand responsive Part of mainstream (banks/FIs) Add savings and insurance Reduce dominance of informal, unregulated suppliers

INTERMEDIATION
Existing Situation Non specialized Not oriented to financial analysis Non profit capital Not linked to mainstream FIs Not organized Desired Situation Specialized in financial services Thorough in financial analysis For profit Link up to FIs Self regulating

REGULATION
Existing Situation
Focussed on formal service providers (informal not regulated) regulating the wrong things e.g. interest rates Multiple and conflicting (FCRA, RBI, IT, ROC, MOF/FIPB, ROS/Commerce) Negatively oriented

Desired Situation
include/informal recognise e.g. SHGs Regulate rules of game Coherence and coordination across regulators Enabling environment

I.1. Potential
Vijay Mahajan, who runs a leading microfinance lender called Basix in the southern state of Hyderabad, thinks there is a $30 billion market for this kind of lending. There are about 350 million Indians living in poverty conditions, and more than 100 million households have no access to credit. For well-managed lenders with the right kind of credit-risk controls, there is a vast market for loans in the $40 to $200 range. And big banks want to supplant neighborhood money lenders who currently meet about 80% of that demand. It is also good business for Indian banks, given the diminishing market for lending to companies and consumers in major cities. "With cutthroat competition in the urban market where basic credit is reaching a saturation point, banks are going into villages to seek safer assets," says Keya Sarkar, a board member of several microfinance companies. Some 30 million women have formed 2.2 million small businesses and another 400,000 are expected to be in place by March, 2007, according to the National Bank of Agriculture and Rural Development. About $2.48 billion has been extended to these groups, which predominantly run by women, over the last decade. I.2. Risk Return Profile "They have realized that the Indian poor are bankable," says Vikram Akula, head of SKS, a leading microfinance lender. The Reserve Bank of India wants the nation's major banks and foreign lenders operating in India to complement the small-scale lending for small agricultural and business loans. I.3. Issues & Challenge § High Administrative Cost: Setting up an extensive rural base of branches is costly, so major banks are looking for tie-ups with established microlenders, who know local markets better and have grown increasingly sophisticated. "What's also helped is the maturing of the intermediaries in India's decadeold microfinance industry," says Mahajan of Basix. Typically, Indian banks have borrowed a page from Grameen Bank in Bangladesh by lending money to local microfinance firms that have contacts in small villages. They can identify worthy borrowers, which in many cases, means small enterprises run by women. § Need for Flexible & Customized Products: Many lenders are also customizing their loans to reach out to more customers. That's the reason for ICICI Bank's $130 loan to that family in Uttar Pradesh. ICICI is also giving slightly larger loans to help families put their children through college. "There's a concern that's emerging that the standardized cookie-cutter

approach that we had taken might not be suitable for all customers, hence the need to incorporate flexibility in loan-product design," says ICICI's Mor. Other products for the rural population are being rolled out, such as savings plans, insurance, and even mutual funds. For instance, UTI Mutual Fund has tied up with Bank of India to sell its array of mutual fund products through the bank's rural network. Add it all up, and microfinance seems to have a very robust future in India. Right now at least, small will continue to be beautiful for Indian banks that can get this market right. I.4.Self-help Groups (SHG) There may be various medium of micro finance; however, the most prominent among them has been the medium of SHGs. So much so that for many, Microfinance and the concept of Self Help Groups go together. The SHG movement added a very significant dimension as it was to be linked with the micro finance. Let us now briefly look at SHGs and their role in rural finance sector. The uniqueness of these groups lies in the fact that to a large extent they are selfsupporting self-governing organizations free from bureaucratization and politicization. The process empowers the poor and enables them to control direction of own development by identifying their felt needs. Characteristics of SHG: Homogeneity has been the strongest feature of SHGs. The members are linked by a common bond like caste, sub-caste, community, the place of origin or activity. Even if the group members are from similar economic activity, say pottery, the basis of group affinity is a common caste or origin. Therefore, the nature of these groups is slightly different from what is globally known as µsolidarity groups¶ In 1992, national bank (NABARD) gave a fillip to the movement when it started the SHGBank linkage programme. This was the first major attempt to link the mainstream financial institutions with the informal groups, thereby, linking them with the market. It also aimed at the re-assertion of the basic principle that the magic of market succeeds where the governmental intervention failed. This belief is based on the certain structural advantages of the mF in the SHG mode: ‡ Financing becomes cost effective According to a study conducted by NABARD, there has been a 40 per cent reduction in transaction cost for banks due to externalizing banks¶ responsibilities in identification of clients, assessment of risk profile, loan monitoring and recovery ‡ Borrowing becomes cheaper. The borrowers¶ transaction cost declined by 85 per cent with doing away of complex documentation and procedures and opportunity cost of wage loss due to repeated visits to banks ‡ Easy accessibility due to door step delivery of the credit ‡ Credit is long-term and continuing in nature ‡ Peer pressure and peer monitoring act as intangible collateral; consequently repayment rates are high ‡ Avoidance of high cost intermediation between bankers and client by credit brokers ‡ The sense of ownership of the programme due to community involvement. The people themselves take their credit decisions
‡ Positive impact on the qualitative dimensions through empowerment

Weaknesses of the SHG There are certain inherent weaknesses of the SHG mode of intervention. Such an intervention is being marketed as a µtool kit¶ for poverty alleviation and tends to ignore

larger structural bottlenecks like inadequate agricultural infrastructure-irrigation, roads and highly in egalitarian distribution of land. Given the preoccupation with regularity of repayment, the credit programme shows a clear bias towards activities like petty trading (Due to daily cash flows), which do not result in significant value-addition to promote capital formation. Solidarity is an expensive input for financial services production as the costs of group formation and interaction outweigh the benefits of high repayment with group control. The mFIs are generously assisted by grants and cheap credit. SHARE had a grant component to the tune of 69 per cent of their total fund in 1998. It is thus anticipated that to be effective and productive, the promotion of SHG for ensured assess credit is necessary. I.5. Literature Review Let us now look at relevant findings of an extremely insightful study on Microfinance by Basix a Hyderabad based NGO in the field2. The Demand for Microfinance Services With a population of 1000 million, India has nearly 400 million people below or just above an austerely defined poverty line. Thus, approximately 75 million households need micro-finance. Of these, nearly 60 million households are in rural India and the remaining 15 million are urban slum dwellers. The current annual credit usage by these households is estimated to be Rs 495,000 million or US$ 12 biilion! ‡ Annual credit usage by 60 million rural poor households at an average of Rs 6000 is Rs 360,000 million per annum - about two-thirds for consumption and one-third for production needs (Based on a 1994 study carried out by the Vijay Mahajan and Bharti Gupta for the World Bank. The number has been rounded off and adjusted for 1998 prices). ‡ Annual credit usage by 15 million urban poor households at an average of Rs 9000 is Rs 135,000 million per annum - about 55percent for consumption and 45 percent for production needs. (Based on a 1995 study carried out by the first author for the SEWA Bank. The number has been rounded off and adjusted for 1998 prices). The Demand Supply Gap Bridging the demand supply gap, even at high growth rates requires an environment that attracts large numbers of microfinance providers. The approach recommended by Basix is a "three track approach", using mutually complementary strategies: ‡ Incentivising existing mainstream FIs to enter microfinance seriously, by establishing a supportive policy and regulatory environment. ‡ Encouraging new microfinance institutions (mFIs) with a supportive policy and financial resources to enlarge and expand their services. ‡ Building a strong demand system in the form of community-based development financial institutions (CDFIs), with the help of NGOs and others. Such a system is required to ‡ convert latent demand into effective demand, ‡ wean away microfinance customers from moneylenders, ‡ remove the expectation of low interest rate and capital subsidies that have spoiled borrowers over the years ‡ restore the repayment norm, and ‡ build local stake in grassroots financial structures These CDFIs may be unregistered or registered. If registered, they may choose to be societies, trusts, mutually aided cooperative societies (MACS) or even non-banking finance companies (NBFCs). I.5. Present Structure of Rural Finance

Let us now look at the present structure of rural finance sector in India, the roles performed by various institutions in the sector, and the evaluation of the present system to find the problems and the drawbacks with the present structure. We begin by looking at the institutional structure. Institution Background Cumulative Disbursement (Rs million) Mar 98: 214 Mar 97: 118 Cumulative Intermediaries (Number) Mar 98: 260 Mar 97: 220 Access (Number) Mar 98: 250,000 (SHGs linked 14,283) Mar 97: 150,000 (SHGs linked 8,598)

National Bank for Agriculture and Rural Development (NABARD)

Small Industries Development Bank of India (SIDBI)

Housing Development Finance Corporation (HDFC)

Rashtriya Mahila Kosh (RMK)

An apex refinance institution set up in 1982. Has promoted linkage of self help groups with banks since 1992. Data for SHG linkage programme only. Set up in 1990. Micro Credit Scheme (a small portfolio) started in March 1994. Mainly involved in housing financeincluding to low income groups through NGOs since 1992. Started support to Microfinance initiatives in 1997 Department of Women and Child Development (Govt. of India). Set up in March 1993 with corpus of Rs 310 million.

May 98: 57 (Sanctions Mar 98: 166)

Mar 98: 116 Mar 97: 79 Mar 96: 47

Mar 98: 89,000 Mar 97: 61,600 Mar 96: 20,900 Jun 98 118,000

Jun 98: 1020 ± sanctioned 808 ± disbursed, all of it except 8, for low income housing

Jun 98: 75

Apr 98: 353 (Outstanding in Mar 98: 160)

April 98: 257

April 98: 250,462

The Existing Rural Finance Sector As far as the formal financial institutions are concerned, there are Commercial Banks, Housing Finance Institutions (HFIs), NABARD, Rural Development Banks (RDBs), Land Development Banks Land Development Banks and Co-operative Banks (CBs). As regards the Co-operative Structures, the Urban Co.op Banks (UCB) or Urban Credit Co.op Societies (UCCS) are the two primary co-operative financial institutions operating in the urban areas. There are about 1400 UCBs with over 3400 branches in India having 14 million members, Their total lending outstanding in 1990-91 has been reported at over Rs 80 billion with deposits worth Rs 101 billion. Similarly there exist about 32000 credit co.op societies with over 15 million members with their total outstanding lending in 1990-91 being Rs 20 billion with deposits of Rs 12 billion. Few of the UCCS also have external borrowings from the District Central Co.op Banks (DCCBs) at 18-19%. The loans given by the UCBs or the UCCS are for short term and unsecured except for few which are secured by personal guarantees. The most effective security is the group or the peer pressure. The Government has taken several initiatives to strengthen the institutional rural credit system. The rural branch network of commercial banks have been expanded and certain policy prescriptions imposed in order to ensure greater flow of credit to agriculture and other preferred sectors. The commercial banks are required to ensure that 40% of total credit is provided to the priority sectors out of which 18% in the form of direct finance to agriculture and 25% to priority sector in favour of weaker sections besides maintaining a credit deposit ratio of 60% in rural and semi-urban branches. Further the IRDP introduced in 1979 ensures supply of credit and subsidies to weaker section beneficiaries. Although these measures have helped in widening the access of rural households to institutional credit, vast majority of the rural poor have still not been covered. Also, such lending done under the poverty alleviation schemes suffered high repayment defaults and left little sustainable impact on the economic condition of the beneficiaries. Following risks are generally perceived by the formal sector financial institutions: ‡ Credit Risk ‡ High transaction and service cost ‡ Absence of land tenure for financing housing ‡ Irregular flow of income due to seasonality ‡ Lack of tangible proof for assessment of income ‡ Unacceptable collaterals such as crops, utensils and jewellery The Existing Informal financial sources: The informal financial sources generally include funds available from family sources or local money lenders. The local money lenders charge exorbitant rates, generally ranging from 36% to 60% interest due to their monopoly in the absence of any other source of credit for non-conventional needs. Chit Funds and Bishis are other forms of credit system operated by groups of people for their mutual benefit which however, have their own limitations. Lately, few of the NGOs engaged in activities related to community mobilizations for their socio-economic development have initiated savings and credit programmes for their target groups. These Community based financial systems (CBFS) can broadly be categorised into two models: Group Based Financial Intermediary and the NGO Linked Financial Intermediary. The Present Legal and Regulatory Structure of Rural Finance ± a critical Analysis There are many aspects of the existing legal and regulatory framework which discourage

mainstream FIs from increasing outreach and achieving sustainability in microfinance. Further growth in microfinance can only be possible by redressing these limitations in the legal and regulatory framework. Mainstream FIs find it difficult to significantly expand into microfinance for the following reasons: ‡ Policy makers¶ view of the market for microfinance services stems from over a 100 years of attempts to get farmers out of the clutches of "usurious" moneylenders. Thus, it is accepted wisdom that farmers and poor people need low interest, subsidised credit. This shows up in policy: interest rates for loans below Rs 25,000 and Rs 200,000 by commercial banks are still capped at 12 and 13.5 percent respectively. Some attendant beliefs are that the poor cannot save, they are unwilling to repay loans, and administrative costs of serving them are high. ‡ Consequently microfinance has historically been seen as a social obligation rather than a potential business opportunity. The leadership and managers of mainstream FIs see the microfinance market as difficult to serve, risky and having a low or negative net spread. Contributing to this position has been the fact that small loans (IRDP, DIR, SC/ST) have been utilised historically as a tool for disbursing political patronage, undermining the norm that loans must be repaid. This has made bankers cynical about lending to the poor. ‡ There are specific problems with legislation: for example the NABARD Act does not allow it to refinance any private sector FI and do any direct financing (NABARD¶s direct lending to micro-finance NGOs so far has been out of donor funds) NABARD also refinances commercial banks/RRBs/cooperative banks who lend to mFIs. Similarly, the SIDBI Act restricts it from extending loans to the agricultural and allied sectors, whereas many of the members of self-help groups are engaged in such activities. ‡ The Regional Rural Banks Act does not permit any private shareholding in any RRBs, and the Cooperatives Acts of all states do not permit district level coop ‡ banks to be set up except by the state government. The result of these two laws together is that rural credit has been a monopoly of state owned institutions. Some suggestions to improve the legal and regulatory framework ‡ Deregulation of interest rates for all small loans and supporting the policy that small loans can indeed be charged a higher rate. ‡ Delinking poverty alleviation subsidised government programs from banks and mFIs. ‡ Removing the government¶s monopoly on establishing formal institutions in the rural sector. This includes privatising RRB and allowing independent Rural Coop Banks on the lines of independent Urban Coop Banks. The LAB policy should also be implemented. ‡ Modification of the NABARD and SIDBI Acts to legitimately allow these apex bodies to finance mFIs as part of their regular operations and not as "promotional" activity.

Main text: As per the study done the rural banking strategies of some leading private banks is illustrated in the following pages: II. ICICI Bank ± Rural Strategy We believe that to break into the top league of global banks, ICICI will have to follow a course that few banks in the world have done ² and that is, leverage the rural economy.

- K V Kamath, Chairman ICICI Bank. II.1.The Opportunity: The opportunity as perceived by ICICI bank is best described in the following3: § Though agriculture constitutes only 20% of India¶s GDP, rural economy (agricultural + non agricultural) constitutes about 50% of GDP § Rural population of about 780 million with limited access to financial services II.2. Challenges: Following are the major challenges identified § Nature of demand § Doorstep banking § Flexibility in timings § Low value and high volume of transactions § Require simple processes with minimum documentation § High costs of delivery through conventional § Channels Looking at the above challenges, the bank evolved a comprehensive strategy to succeed in the peculiar market of rural banking. The strategy at top level can be seen as two pronged i.e. that of both Organic and Inorganic growth. II.3. Organic Growth Strategy: More than just aggressive, ICICI Bank¶s rural banking strategy can be dubbed as highly ³proactive´ and ³innovative´ especially considering the prevalent banking scenario in India. The beauty of the strategy lies in the fact that it is in perfect synchronization of rural realities on one hand and the bank¶s strengths on the other. Comprehensive Channel Strategy Ø Multiple channels targeting specific segments of the rural population Ø Branches at major agricultural markets Ø Franchisees, internet kiosks, MFI & corporate partners Comprehensive product strategy ü Suite of six key credit products: farmer financing, farm equipment financing, working capital loans, jewel loans, commodity based financing and microcredit ü Savings and investment products ü Insurance The culmination of the whole strategy comes in the following words which should be considered as a meaningful contribution to marketing literature: ³No White Spaces: Penetrate a cluster with all channels and products´. Let us now try to study this strategy in some detail. ICICI Bank has divided the rural market into R1, R2, R3 and R4 categories for identifying the rural markets. R1 and R2 represent the rich farmers, while R3 and R4 represent the poor landless laborers. ³ICICI Bank plans to increase its points of delivery five times from 3,500 to 17,500 by March 2006,´ said ICICI Bank executive director Nachiket Mor. He said the total demand for microfinance was around Rs 45,000 crore, while the supply was just about Rs 2,000 crore. The bank will support over 200 microfinance institutions (MFIs) in creating an asset base of Rs 2,00,000 crore and also rollout ³penetration strategy´ to cover 60 districts in the country. ICICI Bank is significantly moving ahead with its rural networking plan. Nachiket Mor, executive director, said, ³There is immense potential in the rural market. The requirement may be setting up around 100 µtouch points¶ in every district. So far, they have been able to establish 8,000 touch points.´ ³Our model for rural business will be establishing touch points, so that every rural citizen can access banking facility within decent distance. The aim is to have one franchise in every block in the country. We may not end up with all the blocks but it will demand

driven,´ he explained. About the bank¶s strategy of reaching out to rural population through touch points, Mor said informal credit in India was $82 billion, with around 780 million rural population with limited access to financial services. Around 400 million people do not have any access to financial service. The yearly credit demand from poor and marginal poor population was around Rs 1,50,000 crore out of which Rs 4,000 crore was actually met, he added. So their challenge is to invent a new business model where they can create a distribution base effectively in 600,000 villages in India, and to learn to do that at one-tenth the cost of urban India. Just to put that on a scale that someone could understand, they believe that to succeed in urban India, they need to do be able to do business at one-tenth the cost of the West. The reason is that the ticket size of the banking product in India is one-tenth that in the West. If it is a deposit of $10,000 in the West, it will be $1,000 in urban India and $100 in rural India. Loans operate at a similar scale. They will have to be able to work with partners because they believe that the branch-led model will not work in this context. The branch-led model would simply replicate their existing structure. ³The bank will be looking for franchise partner who will be willing to deliver full range of products to its customers,´ Mor said. That is why they need to work with partners who are either already present in the local community or who need to be there. For example, they might partner with a local financial institution, a micro-finance agency or a company ² someone who is already in the village for a business purpose. They might even partner with someone who is selling fertilizer or seed or tractors. How can they leverage these partnerships to do business? That question drives the need for a new business model to reach out to this market. If they can do this the rewards could be enormous. Meeting this challenge of lending to India's farmers also involves other complexities. Agriculture here heavily depends on the monsoons or rains. The biggest risk is the failure of the monsoon. Now can you lend to rural India without fixing this risk? What they did was to ask if this was an insurable risk. Could they get such insurance? The answer was yes. Could they then sell this insurance to the farmers? Again, the answer was yes. Finally, they asked if this insurance could be further reinsured outside India so that the risk was shared even more widely. Yet again, the answer was yes. This strategy allowed them to develop a viable proposition where they could scale up the rural lending model realistically. I don't believe anyone has implemented this model before. The typical approach to rural lending has been through micro-loans, and that has certainly had some degree of success. But a large-scale rural banking model where you are ultimately trying to reach a population of 600 million people has not been done. That is their challenge -- and also their opportunity. Let us take a specific instance. While foraying in the rural areas ICICI Bank encountered a particular problem. The bank had financed 200,000 villagers across the country to buy buffaloes. But these customers were unwilling to buy more than two to four buffaloes. The bank could not convince these customers to increase their stock to a sizeable number, such as 20 buffaloes. The rationale of the villagers was simple. More buffaloes would mean hiring additional help to look after the herd. On the contrary, four buffaloes can be managed by the family members. Then, the buffaloes could be accommodated in a small courtyard, rather than building a large shed for the herd. Importantly, as Nachiket Mor, executive director, ICICI Bank points out, "The implication of a financial risk is high when you own a large herd."

The bank embarked on a pilot project with a company that supplies cattle feed. Around 150 rural households who were the bank's customers were covered during this trial phase. Buffaloes owned by these households were put on a diet of cattle feed supplied by the company and the milk yield from these buffaloes increased by 50 per cent. "We could now give loans for fodder. We had discovered a market for a new product," says Mor. The company now plans to tap its existing client base (200,000 buffalo owners) for fodder finance. "In a rural finance strategy it's important to find viable revenue chains," says Mor. The bank is also looking to provide a bundle of services i.e. looking at cross selling opportunities. Provision of financial services to rural and urban poor is their most recent effort. In this area, we have gone from serving fewer than 25,000 clients with less than $5 million of assets a few years ago, to over 2.5 million clients and about $350 million of assets at the end of the current year. To this market, in addition to credit products, we have also been able to sell over 1 million insurance policies comprising principally life, health, personal accident and weather insurance policies. However, India is a market of over a billion people with anywhere between 300 million to 400 million un-banked. The numbers that we have achieved, while apparently large, barely represent a beginning and we have a very long journey ahead. I want to take this opportunity to briefly share with you how we have gone about addressing this market and what their plans for the future are.

Development of the Partnership Model
No White Spaces (NWS) Starting with the Partnership Model we have gradually developed a comprehensive plan for the provision of financial services within rural India with a hybrid channel and product structure designed around one coordinating branch per district, with franchisees, internet kiosks and micro finance institutions forming an interdependent delivery chain to deliver credit, savings, insurance and risk management products to the full range of rural customers. The aim, over the next three to four years, is to go to 450 of the 640 districts that make up rural India with this No White Spaces (NWS) approach under which no individual would be more than 5 to 10 kilometres away from an ICICI Bank touch point. This model allows them to offer a complete suite of products, with all of the necessary documentation and technical support close at hand, to the micro finance customer and smoothly opens up graduation possibilities should an MFI client want to move to a level of credit and other financial services that the MFI is not comfortable providing through its own branch network. It also allows them as a bank to participate not just in lending to individuals but also in rural infrastructure finance and rural corporate finance5²both very necessary for the comprehensive growth and development of rural India. Launch of the Centre for Micro Finance (CMF), Centre for Insurance and Risk Management (CIRM), Small Enterprise Finance Centre (SEFC) and the Centre for Development Finance (CDF) at the Institute for Financial Management and Research (IFMR) in Chennai These centres have been launched with the help of leading finance and economics professors from MIT, Harvard, Yale University and Columbia at IFMR in Chennai6. These Centres are staffed by well trained researchers and practitioners from around the world and have the objective of carrying out product design, action-research, impact evaluation, training and course design and consulting in each of their areas of focus and will be important partners of ICICI Bank in helping it fulfil its financial inclusion objectives. These Centres are in part sponsored by ICICI Bank but are completely independent and are free to publish all their findings and work with all the other players in the system7.

With the help of these centres an intensive development effort in areas such as health insurance for the poor, livestock insurance, livelihood partnerships, individual and small enterprise lending and financing of rural infrastructure has already been launched. Facilitating the launch of FINO and www.MicroFinanceJobs.com Technology both at the client interface end and the back-end has been identified as a key impediment to the growth of MFIs, along with a shortage of trained manpower. FINO has been conceived of an ASP (Application Services Provider) platform which will provide advanced banking and front-end technologies such as smart cards and biometric POS (Point-of-Sale) terminals and will be formally launched shortly on a commercial scale ± Proof-of-Concept Pilots have already been successfully completed at three MFI locations. An attempt is also being made to see if FINO can partner with the National Bank for Agriculture and Rural Development (NABARD) and an internationally accredited Credit Bureau to launch a national rural identify card and a rural credit bureau. The micro finance job site is expected to recruit over 2,50,000 suitably qualified individuals for these 200 MFIs in partnership with CMF¶s MFI Strategy Unit (MSU) and provide them with all the necessary training. In addition to seeking applicants from the market, it proposes to tie up with a number of local business schools so that graduating MBA can find an opportunity to work in an MFI which is based in his or her neighbourhood itself²this will ensure that these employees will pursue longer-term careers with the MFI and will come with, in addition to business skills, a strong facility with the local language of the region. Launch of Grameen Capital India (GCI) to Provide Capital Market Solutions to MFIs and provision of Equity Buy Back Loans to Assist Venture Capitalists GCI is a joint effort between Grameen Foundation of USA, ICICI Bank and Citibank in India, to develop a deep domestic and eventually a global capital market for MFI issued paper, including straight bonds, Micro Finance Asset Backed Securities (MFABS) and Equity. GCI is expected to launch formally shortly and will act both as a credit guarantee company and a dedicated investment bank for MFIs. The MFI Strategy Unit (MSU) of the Centre for Micro Finance (CMF) at IFMR is also developing comprehensive consulting capabilities in this area that it will offer to MFIs. ICICI Bank has also offered a committed equity-buy-back loan facility so that MFIs may be able to repurchase the equity invested by Venture Capitalists (VCs) into new MFIs, offering both a take-out and a reasonable rate of return to the VCs.

IDBI Bank¶s rural initiatives: Inorganic strategy: The amalgamation of United Western Bank (UWB) with Industrial Development Bank of India is likely to change the rules of the game in the banking space. The merger is markedly different from takeover of Global Trust Bank and Nedungadi Bank by healthier rivals. In both the cases, shareholders went away without any consideration for the shares surrendered. Apart from synergies to the participating banks, the IDBI-UWB merger is likely to be a positive for old private sector banks. A good fit for IDBI . The amalgamation of UWB with IDBI is likely to add value to the latter over the long term. The merger is likely to help IDBI expand its retail presence, though its size may not increase substantially. Of the several benefits the deal brings, we believe access to the branch network is most significant. IDBI, with a balance-sheet size of Rs 81,700 crore, has a network of 181 branches now. It scores poorly on this parameter compared to like-size peers. The merger would give IDBI immediate access to the 230-branch network of UWB, thereby widening its deposit franchise.

For IDBI, growing at 25 per cent over the past two years, addition of branches would help sustain the momentum. Deposits may expand by over 20 per cent and the asset base by about 10 per cent. The Reserve Bank of India's (RBI) strict licensing norms that restrains opening new branches has placed a scarcity value on branches. The merger would, therefore, give IDBI access to a ready physical infrastructure, enabling it to mobilise low-cost funds. Second, the merger with UWB is likely to help IDBI diversify its credit profile. Dominant in industrial financing, IDBI should get exposure to agriculture credit through

UWB;nearly half the number of UWB its branches is in semi-urban and rural areas, and should complement IDBI's loan book. The third aspect relates to the benefit of an improved deposit mix for IDBI. As it manages its transformation from a financial institution to a commercial bank, it finds about 60 per cent of the liabilities in the form of long-term borrowings. Low-cost deposits are just about 9 per cent of the total. This perhaps explains IDBI's low net interest margins (0.5 per cent versus industry average of three) and the high cost of funds (6.5 per cent versus the industry average of five). In this backdrop, the access to UWB's low-cost deposit base should prove advantageous for IDBI in the long run. The IDBI itself lends heavily to SSI: the total assistance provided by it to the VSI sector up to March, 1986 was Rs. 52850 million. Its annual financing has doubled between 1979/80 and to 1982/83 when it reached Rs. 2902 millions, which included refinancing of advances made by other institutions. The interest rate charged by IDBI for refinance differs for various purposes. It is as low as 6 percent in specified backward areas but range between 8.25 and 9.58 percent in nonbackward areas. The IDBI is one of the apex financial institution providing assistance to industries of all types and sizes. IDBI has now established a separate Rs. 25 billion fund called ³Small Industries Fund´ to take over the bank's own existing and future assistance to SSIs. This new fund is expected to pay particular attention to ³micro´ industries. In order to ensure that financial institutions do lend to small-scale industries, the Reserve Bank of India requires all Commercial Banks and other financing institutions to ensure that at least 12.5 percent of the total credit advances is reserved for weaker sections like rural artisans, village craftsmen, or cottage industries. The bills rediscount scheme is operated by the Industrial Development Bank of India which covers bills/promisory notes arising out of sales of indigenous machinery on a deferred payment basis. Bills/Promisory notes drawn in favour of or by the machinery manufacturers are in the first instance discounted by them with their banks which in turn rediscount these bills with the IDBI at concessional interest rates of from 9 to 10.25 percent. IDBI begins identifying needy farmers 7: IDBI Bank has started implementing the recentl policy initiatives on credit flow to agriculture by bringing in at least 100 new peasants under its lending operations for each of its rural operations. The bank has started implementing the recently announced policy initiatives for doubling flow of credit to agriculture within the next three years and to achieve at least 30 per cent growth in disbursement under agriculture credit. The bank had initiated steps to identify

farmers who had suffered due to natural calamities, to reschedule or offer fresh finance as per RBI guidelines. The bank has also adopted few villages for providing community TV, solar energybased streetlights and water coolers/fans to schools. IDBI has new scheme for farmers 8: IDBI has launched a new scheme to supplement farmers' incomes. Under the scheme, farmers are provided with credit for meeting expenditure on growing crops, rearing animals and for purchase of farm assets like tractors, pump sets and farm equipment. Besides, loans are also provided for non-farm sector activities like processing, storage, post-harvest technology. Farmers who are owner-cultivators, tenants, lessee or allottee farmer with recorded occupancy rights or farmers with ancestral/perpetual rights of cultivation are eligible for loan either individually or in groups under this scheme. A IDBI release said that need-based credit would be provided to the farmers in the form of cash credit, term loan, overdraft and composite loans.

HDFC Bank is possibly the only bank in India, and one of the very few in Asia, to have embarked on a data-led marketing analytics campaigns initiative, using marketing automation technology provided by Unica. Through this tool, bank has been able to intelligently use the 4-5 terabytes of customer data available in its warehouse. The bank has set up a team to conduct marketing campaigns in a scientific manner using customer data, usage patterns, preferences, lifecycle, etc, the bank also conducts event-based marketing.´ There are several factors that are taken into consideration while selecting a bank, such as trust, service, number of products available, etc. And, last but not the least, a trait that the bank share with the hotel industry ± location of its branches and ATMs. They have to be near the residence or offices of the bank¶s customers. However, that is slowly changing with the advent of the other direct banking channels like Home Banking, Mobile Banking, Net Banking, etc HDFC Bank's aim so far has been clear. It wants to build sound customer franchisees across distinct businesses so as to be the preferred provider of banking services in the segments that the bank operates. How does the bank hope to attain this goal

This now includes agricultural and rural sectors as well. HDFC Bank is targeting this sector through its 115 semi-urban branches. The bank follows the "supply chain management" method. The bank targets the rural customer in the following way: Yes, it is much discussed in the banking circles. That is because urban markets had reached saturation point for the banking sector in general. Any institution should look towards the rural market The rural-urban divide and lower levels of per capita income coupled with lack of proper connectivity do become a major hindrance for technology-driven banks like HDFC Bank. The bank, however, is trying out several new information technology initiatives to reach the rural customer. There was tremendous opportunity in the rural area, which could be tapped with proper infrastructure and specialised marketing. HDFC Bank plans to partner with non-banking finance companies and micro-finance companies to reach the rural areas. Syndicating their services will be necessary for the bank. The bank is lagging behind in its agriculture sector lending targets. Given the emphasis from the Finance Ministry and the Reserve Bank of India, on this sector over the past few months, more needs to be done. Of the 18 per cent outstanding loans to the agriculture sector and a 13.5 per cent lending target for direct lending to the sector during 2004-05, HDFC Bank has attained around 10 per cent growth. The bank has met its indirect lending targets by investing in rural bonds and through NABARD. The bank hopes to meet its target during this fiscal. HDFC Bank on oct 18th launched a corporate credit card for the small and medium enterprises (SME) segment jointly with MasterCard9. The card, christened HDFC Bank PowerPlus BusinessCard, can be used to pay for business expenses and is linked to the cash credit account of the company. The credit limit for the card is Rs 25 lakh per company. Each company will get five individual cards for their employees. Each individual card has a maximum limit of Rs 5 lakh and minimum limit of Rs 2 lakh. The annual fee is Rs 25,000 and joining fee is Rs 500. The interest rate on the card is 1.5 per cent per month. Other benefits include 50 per cent discount on 10,000 hotels worldwide, and insurance cover up to Rs 1 lakh in the case of lost or stolen cards. The bank's SME portfolio is now 15 per cent of the corporate portfolio. While the corporate portfolio is expected to grow 20-25 per cent year-on-year, the SME segment is likely to grow at 50 per cent. Since the card is used solely for business purposes, any finance charges incurred may be

tax-deductible. The monthly statements will clearly show the business expenses and help the companies claim tax exemptions, said Mr K.S.V. Padmanabhan, Senior VicePresident, HDFC Bank. HDFC Bank has around two million cards, said Mr Pralay Mondal, Senior VicePresident, Head, Credit Cards. "For this card, we are looking at spending and penetration, not absolute numbers," he said.

Conclusion:

The nation has been experimenting with various alternatives to reach the banking services, primarily credit, in rural areas through several initiatives. Early initiatives in this regard were taken by building an institutional framework beginning with the focus on the cooperative credit institutions followed by the nationalisation of major domestic banks and later the creation of the Regional Rural Banks (RRBs). Simultaneously, several measures including establishment of the Lead Bank Scheme, directed lending for the Priority Sectors, banking sector's linkage with the Government sponsored programmes targeted at the poor, Differential Rate of Interest Scheme, the Service Area Approach, the SHG-Bank linkage programme and introduction of the Kisan Credit Card were taken. Given the social responsibility to reach the rural areas and the poor, the banks and cooperative institutions with guidance from the Reserve Bank of India (RBI), the National Bank for Agriculture and Rural Development (NABARD) and other apex level institutions made serious efforts in meeting the needs and demands of the rural sector. As a result, the outreach of Indian banking system has seen rapid growth in rural areas. In so far as all the Scheduled Commercial banks (SCBs) including RRBs are concerned, 48 percent of their total branches (32,3031 branches which translates to a population of about 23,000 per branch), 31 percent (13.67 crore) of their deposit accounts and 43 percent (2.55 crore) of their borrowal accounts are in the rural areas. Such an unprecedented expansion of the formal financial infrastructure has reduced the dependence of the rural populace on the informal money lending sector from 68.3 percent in 1971 to 36 percent in 1991. (All India Debt and Investment Survey, 1991). However, there continues to be wide gaps in the availability of banking services in the rural areas as the SCBs have covered only 18.4 percent of the rural population through savings/deposit accounts and even a lower percentage of 17.2 percent of the rural households,10 by way of loan accounts. Though the Primary Agriculture Credit Societies (PACS) with about one lakh outlets4 have a deep and wide presence in rural India their impact in terms of extension of deposit and credit products has not only been minimal but concentrated in a

few states only. The decline in productivity of the rural branches of the commercial banks, fragility of the co-operative credit structure and weakness of RRBs witnessed since early the 90s, have further accentuated the problem of inaccessibility of banking services for a large part of the rural population. Furthermore, as the banking sector has shown propensity towards the larger size accounts, the number of loan accounts of small borrowers with credit limit range of less than Rs.25,000/- has decreased from 5.88 crore in 1991 to 3.69 crore in 2003. It is important to understand both the supply and the demand side perspectives that lead to such a wide gap in availability of financial services. The exclusion of large numbers of the rural population from the formal banking sector may be for several reasons from the supply side, such as: (a) persons are unbankable in the evaluation/perception of bankers, (b) the loan amount is too small to invite attention of the bankers, (c) the person is bankable on a credit appraisal approach but distances are too long for servicing and supporting the accounts and expanding branch network is not feasible and viable, (d) high transaction costs particularly in dealing with a large number of small accounts, (e) lack of collateral security, (f) inability to evaluate and monitor cash flow cycles and repayment capacities due to information asymmetry, lack of data base and absence of credit history of people with small means, (g) human resources related constraints both in terms of inadequacy of manpower and lack of proper orientation/expertise, (h) adverse security situation prevailing in some parts of rural India, (i) lack of banking habits and credit culture, (j) information-shadow geographical areas, and (k) inadequacy of extension services which is crucial to improve the production efficiency of the farmers leading to better loan repayments. From the demand side, there are several reasons for the rural poor remaining excluded from the formal banking sector, such as : (a) high transaction costs at the Estimated number of rural households : 147.90 Million ( NSSO ± 2003)11 client level due to expenses such as travel costs, wage losses, incidental expenses, (b) documentation, (c) lack of awareness, (d) lack of social capital, (e) nonavailability of ideal products, (f) very small volumes / size of transactions which are not encouraged by formal banking institutions, (g) hassles related to documentation and procedures in the formal system, (h) easy availability of timely and doorstep services from money lenders/informal sources and (i) prior experience of rejection by/indifference of the formal banking system. It needs to be noted that the initiatives that may be taken further to expand the banking outreach have to necessarily provide solutions for the comprehensive financial services to the rural sector. Thus, for example, the inability to save or withdraw savings from the

formal sector may revert even those who are brought into the banking mainstream to the informal sector as it responds well to emergency needs. In this context, it needs to be noted that with good credit take off, the incremental Credit Deposit Ratio of banks are climbing to over 100 percent in recent times. Thus, the need to increase resources of the banks is currently imperative. The potential to tap the rural areas for rising low cost deposits is high. It is now being widely accepted that by extending their reach to the vast numbers of untapped small and marginal clients in the rural areas at the bottom of the pyramid, banks can increase their business, enhance their profit and spread the risk. It is also increasingly recognised that the rural credit market offers good opportunity for profitable retail loan business. There is considerable upward mobility in terms income and savings potential among large sections of rural population, which the banks are unable to effectively reach due to the supply and demand side reasons mentioned earlier. Similarly, lack of remittance facilities may drive the people to continue to depend on informal sector and at the same time deprive the banking system the benefit of other income. The situation described above has been responded to in some ways by banks with the involvement of Non-Government Organisations (NGOs) and other Civil Society Organisations (CSOs)/voluntary agencies in facilitating the flow of financial services to the poor. The most significant in this context is the SHG-Bank linkage programme. Another attempt in this approach is the delivery of credit through Joint Liability Groups. Further, in the recent times, several new generation banks who came into existence with a heavy reliance on technology but with a very limited branch network, have taken innovative steps, such as, bulk lending to microfinance institutions (MFIs), using them as "pass through" agencies, to tap the rural credit market The arrangements suggested are expected to be substantially beneficial to both the demand and supply sides. The rural customers shall benefit by increased access to composite financial services in a relatively hassle free manner, inclusion of those in remote and resource scarce regions/ areas into formal system, significant reduction in borrower level transaction costs in view of doorstep/near doorstep availability of services, and better understanding of their needs by empathetic functionaries of outreach entities engaged by banks. The banks shall benefit by a substantially increased client base in rural areas large numbers of which are upwardly mobile. The increased outreach will also help banks to include a large number of excluded farmers and others in the unorganised sector into the banking fold. Better identification of clients and the possible diversification of

activities shall spread risks. These benefits can be achieved at much lower costs than that is feasible under the conventional systems and procedures. The arrangements will also provide an opportunity for a large number of socially proactive organizations and individuals to work in tandem with resource rich financial sector. This is likely to lead to a financial inclusion oriented growth model that aims at achieving socioeconomic empowerment of the less advantaged sections. This will also provide an ideal platform for the microfinance institutions to grow at a faster pace.