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? 4 .

Microfinance: what is it? 15% R1 / R2 37% R3 48% R4 Microfinance = provision of financial services to the poor 5 .

Microfinance: what is it? What it often is ‡ Micro-credit ‡ Group lending ‡ Social/charitable activity What it really should be ‡ Range of financial services ‡ Group and individual lending ‡ Profitable activity 6 .

Providing financial services to the poor: challenges 7 .

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 8 .

Information asymmetry Decision to take loan Adverse selection Loan usage loan repayment Moral hazard 9 .

Adverse selection: incomplete information problem (before the loan) Don¶t know Client¶s type Interest rate reflects proba of default Need to increase interest rate Safer clients drop out Providing credit can become impossible 10 .

Moral hazard: hidden action problem (after loan) Can not observe what client is doing Bad loan usage Strategic unwillingness To repay 11 .

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 12 .

Staff ‡ Lack of trained staff ‡ Lack of motivated staff ‡ Difficult to incentives staff 13 .

Delivering financial services to the poor in India: an overview 14 .

Organization of cooperative societies as alternative institutions for providing crédit by british government 15 . late 19th Century: peasant riots on account of coercive alienation of land by moneylenders.Providing financial services to the poor: occupied India Deccan.

16 .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].

‡ 1969: nationalization of the major commercial banks: beginning of commercial bank branch expansion in the rural and semi-urban areas. low cost institutions mandated to reach the poorest in creditdeficient 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 ³priority sector´) 17 .Providing financial services to the poor: Timeline ‡ 1950 & 1969: emphasis on the promoting of cooperatives. ‡ 1976: Regional Rural Banks (RRB).

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. ‡ Introducing prudential norms ‡ Restructuring and recapitalising of RRBs. reworking the sub-heads under the priority sector. Relaxing controls on where. 18 . for what purpose and for whom RFIs could lend.

01.538 at present: 49% of all scheduled commercial bank branches are rural ‡ The population per rural branch declined from 2.Results ‡ Access in terms of rural branches increased from 1. 19 . ‡ 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.000 at present.833 in 1969 to around 32.854 in 1969 to around 16.

Results (cont¶d) ‡ 31% (131.4 million) of total credit accounts are in rural India ‡ Positive impact on the poor (Rohini Pande/Burgess paper) 20 .1 million) of the total deposit accounts are in rural India ‡ 43%(22.

‡ High defaults ‡ The banking system .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. 21 .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.

‡ 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.in a sustainable manner consistent with high repayment rates. ‡ Bank-SHG Linkage Programme.Micro Finance: apparition ‡ The financial sector reforms motivated policy planners to search for products and strategies for delivering financial services to the poor ± microFinance . ‡ Recent emergence of MFIs: professionally run institutions specialiazed in delivering credit with low cost staff and local knowledge 22 .

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%


Microfinance ahead: challenges


Gaps in demand and supply
Demand: Rs. 450 billion/y 500 million un-served poor «to cover all parts of India Need protection against all risks Insurance under-delivered Market constraints Increase impact Disbursed: 39 billion Less than 2 million Households reached 60% in South

Scalin g up

Need employment opportunities


Scaling up: challenges 26 .

Limitation of the predominant model SHG-Bank linkage model Loan at 9% Bank SHG No liability NGO Group formatio n/linkage 27 .

Scaling up existing MFIs: challenges Financial Intermediation Model Bank MFI JLG Group Loan at a 9% Loan at 20% 28 .

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 preoperative expense ‡ Lack of well trained staff in adequate numbers at all levels ‡ technology 29 .

which limited advances from banks 30 .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.

The ICICI Bank Partnership Model Loan at 9% Bank MFI JLG Group Interest charged: 20% FLDG of 10% Servicing fees of 11% 31 .

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 32 .

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) 33 .Lack of well-trained staff: ICICI Bank response ‡ Initiated partnerships with training institutions (Indian Grameen Services.

Technology Role of technology in microfinance: ‡ MIS ‡ Cash handling ‡ Data capture and subsequent management 34 .

low-cost computing devices.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. mobile and internet-based transaction platforms 35 .

Orissa ‡ Inputs are needed: ± ± ± ± Organizational and staff incentive structures Finance related issues (source of funds. expansion strategy etc.Scaling up: creation of new MFIs Need 200 MFIs to cover all India ‡ ICICI Bank (SIG): support to entrepreneurs to start MFIs ± KAS Foundation. Business plan related issues: scale. capital structure) Legal issues: regulations etc. ‡ Corporate partnerships: attractive track to build access to microfinance 36 .

‡ 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. ‡ Bellwether ± three equity commitments for start-ups ± increased the size of fund from 10mn USD to 25mn USD. 37 . Aavishkar and Bellwether.Support new MFIs: The Venture Capitalist model ‡ VCs specifically focused on the micro-finance space: Lok Capital.

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 38 .

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 39 .

Internet Kiosks Connectivity STD/PCO: ‡Enabling voice communication Internet Kiosk Multimedia PC ith Po er backup Kiosk Operator: ‡Entrepreneur ‡Provides commercial services Printer & Other Accessories : Enabling job work 40 .

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 41 .Internet kiosks ‡ ITC. nLogue. Drishtee: more than 6000 internet kiosks using Wireless in Local Loop.

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 Rural Banking Branch based Manpower intensive Product driven Single product Our strategy Hybrid channels Technology intensive Customer driven Multiple products 43 .

Maximize impact of microfinance: challenges 44 .

Maximize impact Vulnerability Need for More than credit Need for customized products Differences among customers Understand what programmes work the best and for whom 45 .

Maximize impact Other constraints MFI-sectoral experts Partnerships Employment scarcity Finance other credit constraint segments Local Financial Institution: serving all credit constraintSegments in 2-3 districts 46 .

fraud 47 . moral hazard.Range of Microfinancial services: ‡ Individual lending ± ± ± ± Information problem No unique ID No credit info sharing Need technology! ‡ Insurance ± Adverse selection.

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 49 .

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 50 .

) Training institutions Research 51 .Key enablers needed for maximize impact and scaling up ‡ ‡ ‡ ‡ ‡ ‡ ‡ Credit Bureau Unique identifier Technology platform Rural infrastructure Change in regulations (interest rates et.

CMFR: The Centre for Micro Finance Research 52 .

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 53 .

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 54 .

Strategy Training Research Advocacy Influence practice Strategy building 55 .

Partnerships Universities Banks/ Insurance Companies CMFR Regulators/policy makers MFIs/NGOs International organizations 56 .

CMFR: Research Areas 57 .

Impact of Microfinance Access to Financial services ? Impact? Advocacy based on rigorous results 58 .

Constraints to Productivity Access to Financial services Impact ‡Build relevant partnerships ‡Provide useful products through credit 59 .

Returns.Economics of Micro-Enterprise ‡ Scale. Constraints of microenterprise ‡ Market linkages ‡ Documentation of best practices Help increase productivity of micro-enterprise 60 .

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 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 62 .

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 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 64 .

Research: other initiatives 65 .

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 66 .

± Prof Vaidyanathan (Madras Institute of Development Studies) ± Prof Sendhil Mullainathan. MIT «.Research: weekly seminar series ‡ Foregone seminars ± Prof Ashok Jhunjhunwala (IIT Chennai). ex-Chairman of SEBI ± Greg Fisher.. ‡ Forthcoming seminars: ± Suresh Sundaresan.. RBI «. 67 . Columbia ± Dr Narendra Jadhav. Harvard ± GN Bajpai.

Research: Courses ‡ Economics of Micro Finance ± Prof. Abhijit Banerjee (MIT). Sendhil Mullainathan (Harvard). TAMU ± Economic theory of microfinance ‡ Evaluating Social Programmes ± Professors from the Poverty Action Lab/MIT: Esther Duflo (MIT). Michael Kremer (Harvard) ± Teach practitioners and researchers how to identify programs¶ impacts without bias 68 . Adel Varghese.

MFI Strategy Unit at CMFR 69 .

Strategy Building MFIs Sectoral Experts Pilots Scale-up LFI 70 .

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 71 .