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
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Microfinance: what is it?

Microfinance: what is it?

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

Microfinance: what is it?

15%
R1 / R2

37%
R3

48%
R4

Microfinance = provision of financial services to the poor

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

Providing financial services to the poor: challenges

Providing financial services to the poor: challenges

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

High transaction costs

Information asymmetry

Decision to take loan Adverse selection

Loan usage

loan repayment

Moral hazard

Adverse selection: incomplete information problem (before the loan)

Dont know Clients type
Interest rate reflects proba of default

Need to increase interest rate

Safer clients drop out

Providing credit can become impossible

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Moral hazard: hidden action problem (after loan)

Can not observe what client is doing

Bad loan usage

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

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HoweverSuccess was not as high as hoped

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

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

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Microfinance ahead: challenges

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Gaps in demand and supply

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

Disbursed: 39 billion
Less than 2 million Households reached 60% in South Insurance under-delivered Market constraints

Scalin g up

to cover all parts of India

Need protection against all risks

Increase impact

Need employment opportunities

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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 liability

NGO

Group formatio n/linkage

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Scaling up existing MFIs: challenges

Financial Intermediation Model

Bank

MFI

JLG Group

Loan at a 9%

Loan at 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 preoperative 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: 20%

FLDG of 10%

Servicing fees of 11%

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Long-term finance: the ICICI bank response

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

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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

Internet Kiosk

Multimedia PC 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.)

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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

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Maximize impact of microfinance: challenges

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Maximize impact
Vulnerability

Need for More than credit

Need for customized products

Differences among customers

Understand what programmes work the best and for whom

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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

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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

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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)

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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

Research

Advocacy

Influence practice

Strategy building
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Partnerships
Universities
Banks/ Insurance Companies

CMFR
Regulators/policy makers

MFIs/NGOs
International organizations

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CMFR: Research Areas

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Impact of Microfinance

Access to Financial services

Impact?

Advocacy based on rigorous results

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Constraints to Productivity

Access to Financial services

Impact

Build relevant partnerships Provide useful products through credit

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

Help increase productivity of micro-enterprise

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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

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Behavior and Psychology of Borrowers

How do households face shocks and risk? Do households save and how? What drives savings and credit behavior? Why do people default? Why dont households adopt the most profitable activities?

Design the most effective communication strategies

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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

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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
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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
MFIs

Sectoral 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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