How to fix flaws in the present microfinance model - The Economic Times Page 1 of 3

Tue, Nov 16, 2010 | Updated 05.28AM IST

12 NOV, 2010, 10.56AM IST, NAREN KARUNAKARAN,ET BUREAU

How to fix flaws in the present microfinance model

Five years after Vijay Mahajan started Basix, his confident, purposeful stride across the rural heartland of India briefly turned into a halting, ambivalent amble in
2001. While many of his swashbuckling compatriots in microfinance continued with their avowed task of 'alleviating poverty' through microcredit, Mahajan chose to
pause, unleash a blood-letting exercise and churn Basix from root to shoot.

The immediate provocation was an impact assessment of microcredit on the poor households he served. The Basix intervention into the lives of the poor, it turned
out, was sterile. Only 52% of its microcredit customers reported an increase in income - that too of a measly 10%. Another 23% reported no change in their status at
all; and worse, 25% of its borrowers, despite the loans, actually slipped deeper into despondence and poverty.

The revelations were humbling, hurting, even humiliating, for the serial social entrepreneur. An IIT, IIM and Princeton University alumnus, Mahajan cut his teeth in
developmental work with Bhoodan land awardees and later co-founded the hugely successful PRADAN (Professional Assistance for Development Action). "From my
earlier experience, I knew microcredit is necessary but not sufficient. Yet, we were stunned by the assessment," says Mahajan. "It changed us dramatically, it
changed the way we engaged with the poor."

Those at the Basix helm immediately revisited the tenets that govern the poor. Within a year, they devised the 'livelihood triad' it now swears by: financial services;
agriculture, livestock and enterprise development services (Ag/LEDS); and institutional development services (IDS), though not necessarily in that order. It wasn't
just about giving loans. It was also about creating livelihood mechanisms, which would build capacity among the poor to repay their loans easily, and leave them
better off than before.

"I believe in Schumpeterian creative destruction. Its time has come. The present MFI model has to go," predicts Mahajan, considered the high priest of Indian
microfinance. Mahajan, ironically, also presides over the Microfinance Institutions Network (MFIN), an industry coalition, and is currently engaged in dousing the fire
in Indian microfinance - cajoling bankers, assuaging governments, building confidence and seeking a shift in stratagems.

At a recent Mumbai conclave of MFI practitioners, loud voices in favour of a livelihood model were heard. "In the next decade, tier-II and tier-III MFIs will have to
focus on livelihood mechanisms and then weave microfinance around it," says Sundara Rao, country head of Oiko Credit, a global microfinance fund with a strong
focus on social performance and € 446 million in capital outstanding. Capacity building, therefore, gains precedence over credit.

The starting point of the Basix model is risk-mitigation. "The usual risk-mitigation tools aren't accessible to the poor," explains Mohammed Riaz, head of the north
Indian operations of Basix. Breadwinners of the family or cattle die. Crops fail. Nature ravages. Sickness debilitates. "One stray incident can wipe out the net worth of
a family," says Mahajan.

Basix, along with insurer Aviva, pioneered micro-insurance in India, in 2002. Riaz, an old Aviva hand, joined Basix three months ago. Basix has also implemented
the complex weather index-based crop insurance, in which claims are triggered by an adverse weather event and settled over a geographic area. Today, over 3.5
million of Basix customers hold policies covering life, health, crop and livestock, among others.

The livelihood triad, therefore, engenders a type of engagement that builds skills and capacities of individual households. It also strengthens entire communities,
rural or urban, through institution and local infrastructure building.

The triad rationale: microcredit by itself is of use only to the more enterprising of the poor and to those who live in areas that have a certain threshold of economic
activity. For the less enterprising, they have to first learn to cope with risks, through savings, insurance and acquisition of skills.

In backward areas, the poor require considerable handholding: input supply, training, technical support, market linkages. Services like Ag/LEDS cannot be delivered
to individuals, which means the people Basix works with have to necessarily coalesce into informal or formal groups, cooperatives, or producer companies. The
formation and nurturing of such groups require IDS.

Basix, therefore, through a bouquet of companies - Bhartiya Samrudhi Finance, the Krishna Bhima Samrudhi Local Area Bank, Indian Grameen Services, the
Livelihood School, and the Basix Academy for Building Lifelong Employability (B-ABLE ) - has evolved an entire livelihood ecosystem in its areas of operation.
Though rooted in microfinance, it is a completely different play from the neighbourhood MFI.

As Basix plunged into the painful, slow, yet robust livelihood matrix, its contemporaries like Spandana Sphoorthy Financial, Share Microfin and SKS Microfinance
flogged the typical touch-and-go method of loan disbursal and raced past Basix.

In 12 years, SKS, with its 'acceleration model' , offering highly standardised loan products of around Rs 12,000, to be repaid in 50 equal weekly instalments,
acquired 7 million clients. Basix, by comparison, is at 1.5 million. Grameen Bank , set up by Muhammed Yunus, took three decades to reach out to 7 million
Bangladeshis.

Vikram Akula, SKS founder, has always maintained: "There is no need to tutor the poor, they are smart enough to organise their lives." It is now beginning to
become clear that the SKS model of microfinance, with its heightened emphasis on rapid scale and high profitability, is flailing. Worse, Indian microfinance has been
shying away from outcome studies. Impact measurement tools like the Progress out of Poverty Index (PPI) are largely ignored.

"As MFIs scale up, grow and make profits, shareholders shouldn't be the only ones to benefit," says Samit Ghosh of the Bangalore-based Ujjivan Financial Services.
Ujjivan, in 2009-10 , its very first year of making profits, dropped interest rates on loans from 24.5% to 22%, one of the first MFIs to do so along with the Kolkata-
based Bandhan.

http://economictimes.indiatimes.com/articleshow/6912025.cms?prtpage=1 11/16/2010
How to fix flaws in the present microfinance model - The Economic Times Page 2 of 3

The profit-maximisation breed - and a large section of MFIs, overtly or covertly, yearn to be one - have hit a roadblock, as can be seen by the turmoil within the
sector. These MFIs are under a cloud. And for good reason.

Take, for instance return on assets (RoA), which indicates how much profit a company generates from each rupee in assets. The RoA of Spandana was a
stupendous 8.99% in 2009; it's 4.96% for SKS and a modest 3.12% for Basix. For a sector that sets great store on serving the poor, the pursuit of extraordinary
returns is inexplicable.

"When dealing with the poor, boards of MFIs should decide what constitutes a reasonable profit. Good governance demands a laxman rekha," says N Srinivasan,
chairman of the US-based coalition Microfinance Transparency (MFT). Mahajan agrees. "Such RoAs in microfinance are embarrassing, it's unjustifiable. It's four
times the returns even a Citibank would have made in its peak profit-making days," he exclaims.

It's not only profits that cause concern. Take, for instance, transparency in interest rates charged. In the absence of a Truth-in-Lending Act, as prevalent in the EU
and US, the Indian microfinance client is not really aware of the 'effective interest rate' he or she is paying. The difference in what is stated and what is extracted can
be huge indeed.

A few years ago, Chuck Waterfield of MFT studied the interest rates charged by Mexico's Banco Compartamos, the first MFI in the world to go public. Compartamos
advertises its loans as a 4% interest per month product. Chuck examined the quaint manner in which Compartamos computes its interest rate. He also incorporated
all fees, commissions and taxes it charged, and arrived at a figure of 129%! This is the interest rate a Compartamos client was actually paying.

What is the Indian scenario? There is no systematic data collation by the industry. Effective interest rates (EIRs) or annual percentage rates (APRs) are unknown,
although it is agreed they may not be as usurious as Compartamos. "Product pricing and overall transparency among MFIs is an issue that needs to be addressed,"
concedes Sanjay Sinha, managing director, Micro-Credit Ratings International (M-CRIL).

Srinivasan goes even further. "Even the 99% repayment rate claimed by most MFIs is a myth, an illusion," he insists. "It's too good to be true." Portfolio audits of
MFIs, conducted by a few mainstream banks lending to them, indicate the data offered and the ground reality differ. How deep the rot is, only those engaged in the
exercise would know.

These and numerous other distortions linked to untrammelled MFI growth - relaxing of controls to gain numbers, frauds at centre-head levels, loss of focus, design
flaws, lack of transparency and consequent ad-hoc governmental intervention - are beginning to rear their heads.

Unnervingly, these were the typical signs betrayed by Latin American countries. The sheer pace of growth has overwhelmed scores of Latin American MFIs and may
have gone belly up. "Here too, systems are apparently not holding up to match growth," says Sinha. Over a 100 MFIs have failed in Latin America. "We have to learn
from the Latin American experience," says Ujjivan's Ghosh.

The upheaval of the recent past has brought Indian microfinance, especially the big players, under the sustainability scanner like never before. Its relevance in a
political economy as it is today and continued societal acceptance are suspect. Competing models like the 'business correspondent' model, which are increasingly
finding favour with regulators, are knocking on the doors.

Also the joint-liability fabric, central to MFI functioning, is withering. This is prompting MFIs to focus on deepening relationships with existing clients, which means
more of individual loans and collaterals; are we heralding microbanking ? All of this presage change, gradual or cataclysmic. Change is inevitable.

The Basix livelihood model is finding traction across India. While many NGOMFIs are comfortable with the livelihoods approach, many NBFCMFIS are also
beginning to weave in livelihood components into operations, to varying degrees; Ujjivan, Equitas and Grameen Koota, for instance.

A quick look at Rajasthan, a market Basix entered recently, reveals the typical build-up of the livelihoods approach. Shravan Kumar, a marginal farmer with 4 bighas
of land in Chandrana village, near Dausa town, purchased a buffalo with a cattle loan of Rs 15,000 from Basix a year ago. He also avails of its Ag/LED service, for
which he pays Rs 450 a year. As part of this, a livestock service provider (LSP) on the rolls of Basix vaccinates, deworms the animal and conducts preventive
checks once a fortnight.

Ramkaran Saini, the LSP for Chandrana village, says he instructs his customers - 150 from the village alone - to follow nutrition and fodder plans. The incidence of
disease has dropped. Laxman Bairwa, Shravan's neighbor, also an Ag/LEDS customer, says his animal yield more output - 3 litres of milk a day, from the earlier two
litres.

Basix is not only providing credit, but is also expending considerable resources and time on support services, securing livelihoods and building capacities . It is
helping the Rajasthani villager to tend to cattle in a more studied manner. This is just the beginning. The Basix plan is to foster a legion of dairy farmers. Even as it
does this painstakingly, working with individual farmers, it is simultaneously talking to Hariyali Kisaan Bazaar (HKB) of the DCM Shriram Group, which has recently
set up a milk-chilling plant at Khertal in Alwar for supply to Nestle.

"The 15,000 litre plant barely collects 5,000 litres a day," says Riaz, who is grooming his farmers for HKB, desperate to bridge the supply gap. This is not all. HKB
plans to increase capacity to 100,000 litres a day, the viable quantity for processing of milk. Basix is ready to extend credit to HKB to scale up and also set up chilling
plants elsewhere in Rajasthan. Its IDS is already tweaking plans to help create federations of milk suppliers. It's a microcosm of the Basix livelihood triad at work. .

Jaipur is a fine example of an urban livelihood intervention. In Rajasthan, most households, even those at the lower rung, own a sewing machine. It's a socio-cultural
thing. But, only a fraction is involved in commercial stitching activities. The potential is huge for Jaipur exports home furnishings and garments worth 5,000 crore a
year. The temptation would have been to immediately link households with the garment cluster.

"We are not doing that, not yet," says Vishal Singh Amarawat, a garments exporter who is now spending time with Basix. Instead, a graduation model is in place.
Amarawat is hawking a training package to enable women to maintain their own machines. The fee is 200 for 6 days training, with a free toolkit thrown in. Anita Sein,
wife of a barber, has already learnt the ropes. "Earlier, a mechanic charged me 100 a visit; 300 if parts were changed," she says.

"Once they are equipped with the requisite skills, they will be linked to the garments chain, and also command a premium for quality of stitching services," explains
Vishal. Over a 1,000 women from Jaipur and two other cities have signed up. Next, an 18-day course on product making, costing 400, is being tweaked. In the final
stage, women will be taught on button-hole and embroidery machines. The target is to reach 10,000 customers by December. "We can easily reach a 100,000
tailoring customers across Rajasthan," says Riaz.

http://economictimes.indiatimes.com/articleshow/6912025.cms?prtpage=1 11/16/2010
How to fix flaws in the present microfinance model - The Economic Times Page 3 of 3

In Rajasthan, Basix is not only pushing its own initiatives, but is also involved with the Rajasthan Mission on Livelihoods (RMoL) a unique community-NGO-public-
private partnership, funded by the Government and the UNDP. It's entirely managed by Basix. In fact, over 25 Basix employees have been seconded to the RMoL,
including its managing director, Rakesh Malhotra.

Over the years, RMoL has impacted over 300,000 families in Rajasthan. Over 74,000 youngsters have been skilled in various vocations. As livelihood opportunities
are sparse, RMoL has devised a unique migration platform where the youth are handheld from source to destination, to Mumbai, or elsewhere. "A private entity
cannot match the infrastructure, influence and the immense outreach of the government," explains Malhotra.

Engaging with governments, despite its occasional perils, is something Mahajan strongly advocates, an imperative for a livelihoods strategy to thrive. Akula, with a
singular, narrow approach can get away with saying: "Our standard instinct is we don't want to work with the government. We just want them not to interfere." Vijay
Mahajan is turning popular perception on its head. And it seems, his way, the livelihoods way, is the right way, for now.

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http://economictimes.indiatimes.com/articleshow/6912025.cms?prtpage=1 11/16/2010