Micro Finance in India

overview, challenges, and the role of

technology

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

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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

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Microfinance: what is it?

3
Microfinance: what is it?

What are the words that come to your mind when

you hear the word microfinance?

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 Microfinance: what is it?

15%
R1 /
R2

37% R3
Microfinance =
R4 provision of financial
48%
services to the poor

5
Microfinance: what is it?

What it often is What it really should be

• Micro-credit • Range of financial

• Group lending services
• Social/charitable • Group and individual
activity lending
• Profitable activity

6
Providing financial services to the poor:
challenges

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

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 Information asymmetry

Decision to take loan Loan usage loan repayment

Adverse Moral hazard

selection

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Adverse selection: incomplete information
problem (before the loan)
Don’t know Interest rate
Client’s type reflects proba of default

Need to increase interest

Safer clients drop out
rate

Providing credit can

become
impossible

10
Moral hazard: hidden action problem (after
loan)

Can not observe what client is doing

Strategic unwillingness
Bad loan usage
To repay

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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

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Staff

• Lack of trained staff

• Lack of motivated staff
• Difficult to incentives staff

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Delivering financial services to the poor in
India: an overview

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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 crédit
by british government

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Providing financial services to the poor:
Independent India:
Credit was viewed as essential part of fight 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].

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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”)

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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.

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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.

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Results (cont’d)

• 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)

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However…Success 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.

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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

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Despite all these efforts…large 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%

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Microfinance ahead: challenges

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 Gaps in demand and supply

Demand: Rs. 450 billion/y Disbursed: 39 billion

Less than 2 million

500 million un-served poor
Households reached
Scaling
up
…to cover all parts of India 60% in South

Need protection
Insurance under-delivered Increase
against all risks impact
Need employment opportunities Market constraints

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Scaling up: challenges

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Limitation of the predominant model

SHG-Bank linkage model

Loan at
9%
Bank SHG

No Group
liability formation
NGO /linkage

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Scaling up existing MFIs: challenges

Financial Intermediation Model

Bank MFI JLG Group

Loan at a Loan at
9% 20%

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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

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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

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The ICICI Bank Partnership Model
Loan at
9%

Bank MFI JLG Group

Interest
charged:
Servicing 20%
FLDG of fees of
10% 11%

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Long-term finance: the ICICI bank response

• There is an underlying business model in the

MFI’s 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

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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)

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Technology

Role of technology in microfinance:

• MIS
• Cash handling
• Data capture and subsequent management

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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

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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

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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.

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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

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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

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 Internet Kiosks
Connectivity

STD/PCO:
•Enabling voice
communication
Multimedia PC
InternetKiosk
Internet Kiosk with Power backup

Kiosk Operator:
•Entrepreneur
•Provides commercial services

Printer & Other

Accessories :
Enabling job work

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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

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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.)

42
ICICI Bank strategy: summary

Conventional Manpower
Manpower Product
Product Single
Single
Conventional Branch
Rural Branchbased
based intensive driven product
RuralBanking
Banking intensive driven product

Hybrid Technology
Technology Customer
Customer Multiple
Our Hybrid Multiple
Ourstrategy
strategy channels
channels intensive
intensive driven
driven
products
products

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Maximize impact of microfinance: challenges

44
Maximize impact

Need for
Vulnerability
More than credit

Need for
Differences among
customized
customers
products

Understand what programmes work the best

and for whom

45
Maximize impact

MFI-sectoral experts
Other constraints Partnerships

Employment Finance other credit

scarcity constraint segments

Local Financial Institution: serving all credit constraint-

Segments in 2-3 districts

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Range of Microfinancial services:

• Individual lending
– Information problem
– No unique ID
– No credit info sharing
– Need technology!
• Insurance
– Adverse selection, moral hazard, fraud

47
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)

48
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

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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

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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

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 CMFR:
The Centre for Micro Finance Research

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 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

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 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

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 Strategy

Training

Influence
Research Advocacy
practice

Strategy
building

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 Partnerships

Banks/
Universities Insurance
Companies

CMFR
Regulators/policy
makers MFIs/NGOs

International
organizations

56
CMFR: Research Areas

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 Impact of Microfinance

Access to
Financial services ? Impact?

Advocacy based on rigorous results

58
 Constraints to Productivity

inf
ra

In
st r

p
uc

uts
tu
re
Access to
Financial services
Impact
en
tre
pr
a lth en
H e eu
rs
hi
p

•Build relevant partnerships

•Provide useful products through credit

59
 Economics of Micro-Enterprise

• Scale, Returns, Constraints of micro-enterprise

• Market linkages
• Documentation of best practices

Help increase productivity of micro-enterprise

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 Experimentation on Product Design

selection monitoring Enforcement

•Individual/group •Within group •Repayment schedule

liability monitoring •Communication
•Self/MFI selection •Staff supervision strategies
•Guarantors •Loan size
•Collaterals •Interest rate
•Interest rate

Design the most cost-effective products

61
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 don’t households adopt the most profitable activities?

Design the most effective communication strategies

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 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

63
Cost and profitability of SHGs/MFIs

Transaction
Bank 9% 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

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Research: other initiatives

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 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

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 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
…..

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 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

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MFI Strategy Unit at CMFR

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 Strategy Building

Sectoral
MFIs
Experts

Pilots

Scale-up LFI

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 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

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THANK YOU!

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