The Future of Microfinance in India:

Wednesday, 17 March 2010 16:59 What is so exciting about Indian Microfinance? A Task Force on Microfinance recognised in 1999 that microfinance is much more than microcredit. It stated: "Provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and or urban areas for enabling them to raise their income levels and improve living standards". The Self Help Group promoters emphasise that mobilising savings is the first building block of financial services. For many years, the national budget and other policy documents have almost equated microfinance with promoting SHG links to the banks. The Central Bank notification that lending to MFIs would count towards meeting the priority sector lending targets for banks offered the first signs of policy flexibility towards MFIs. One could argue that MFIs are small and insignificant, so why bother. The larger point is about policy space for innovation and diversity of approaches to meet large unmet demand. The insurance sector was partially opened to private and foreign investments during 2000. Over 20 insurance companies are already active and experimenting with new products, delivery methodologies and strategic partnerships. Microfinance programmes have rapidly expanded in recent years. Membership of Sa-Dhan (a leading association) has expanded from 43 to 96 Community Development Finance Institutions during 2001-04. During the same period, loans outstanding of these member MFIs have gone up from US$15 million to US$101 million. The CARE CASHE Programme took on the challenge of working with small NGO-MFIs and community owned-managed microfinance organisations. Outreach has expanded from 39,000 to around 300,000 women members over 2001-05. Many of the 26 CASHE partners and another 136 community organisations, these NGO-MFIs work with, represent the next level of emerging MFIs and some of these are already dealing with ICICI Bank and ABN Amro. In addition to the dominant SHG methodology, the portfolios of Grameen replicators have also grown dramatically. The outreach of

SHARE Microfin Limited, for instance, grew from 1,875 to 86,905 members between 2000 and 2005 and its loan portfolio has grown from US$0.47 million to US$40 million. Since banks face substantial priority sector targets and microfinance is beginning to be recognised as a profitable opportunity (high risk adjusted returns), a variety of partnership models between banks and MFIs have been tested. All varieties of banks - domestic and international, national and regional - have become involved, and ICICI Bank has been at the forefront of some of the following innovations: Lending wholesale loan funds. Assessing and buying out microfinance debt (securitisation). Testing and rolling out specific retail products such as the Kissan (Farmer) Credit Card. Engaging microfinance institutions as agents, which are paid for loan origination and recovery, with loans being held on the books of banks? Equity investments into newly emerging MFIs. Banks and NGOs jointly promoting MFIs.

The 2005 national budget has further strengthened this policy perspective and the Finance Minister Mr P. Chidambaram announced "Government intends to promote MFIs in a big way. The way forward, I believe, is to identify MFIs, classify and rate such institutions, and empower them to intermediate between the lending banks and the beneficiaries." Savings services are needed by many more customers and as frequently as access to phone services. Many poor households value access to savings services and find new providers and arrangements, despite hearing of unreliable savings collectors or even occasionally falling prey to such arrangements. Many customers are rich, literate and lucky to have banks working for them. But many others lack access to safe, secure and accessible savings services for the short, medium and long terms. In the past, many banks sent collectors to gather these savings but problems with monitoring, inability to tackle misappropriation and the rising aspiration of collectors to become permanent staff of public sector banks killed a useful service. The Central Bank has strictly forbidden commercial banks from

using agents in collection of savings services. This is unfortunate as: Effective microfinance delivery is about managing transaction costs for providers and customers. A combination of agents and technology can play a powerful role in rightly aligning incentives for the collector and customers, while keeping transaction costs manageable for everyone. The banks can only open so many branches, and fixed and operating costs are high, apart from approvals still needed from the Central Bank to open new branches or close existing ones. The appointment of agents can keep costs manageable and offer greater flexibility to Banks. Banking service may not be able to defy the commercial logic pursued by most other sectors where a variety of retailers provide services to customers, while companies focus on customer needs, product design, quality control, branding, logistics and distribution. Fortunately, the 2005 Budget opened a small window in this area and the Central Bank annual policy recently confirmed discussions on this: "As a follow-up to the Budget proposals, modalities for allowing banks to adopt the agency model by using the infrastructure of civil society organisations, rural kiosks and village knowledge centres for providing credit support to rural and farm sectors and appointment of micro-finance institutions (MFIs) as banking correspondents are being worked out." But it may be noted that between the budget and the annual policy statement, "credit" has again crept in as the key perceived need. A World Bank study assessing access to financial institutions found that amongst rural households in Andhra Pradesh and Uttar Pradesh, 59% lack access to deposit account and 78% lack access to credit. Considering that the majority of the 360 million poor households (urban and rural) lack access to formal financial services, the numbers of customers to be reached, and the variety and quantum of services to be provided are really large. Vijay Mahajan, Managing Director of BASICS, estimated that 90 million farm holdings, 30 million non-agricultural enterprises and 50 million landless households in India collectively need

approximately US$30 billion credit annually. This is about 5% of India's GDP and does not seem an unreasonable estimate. A tiny segment of this US$30 billion potential market has been reached so far and this is unlikely to be addressed by MFIs and NGOs alone. Reaching this market requires serious capital, technology and human resources. However, 80% of the financial sector is still controlled by public sector institutions. Competition, consolidation and convergence are all being discussed to improve efficiency and outreach but significant opposition remains; for example, the All India Bank Employees Association has threatened to strike if the Government proceeds with its policy of reducing its capital in public sector banks, merging public sector banks or even enhancing Foreign Direct Investments in Indian private banks. Many speakers at the Microfinance India Conference talked about the significant and growing gap between surging growth in South India, which contrasts with the stagnation in Eastern, Central and North Eastern India. Microfinance on its own is unlikely to be able to address formidable challenges of underdevelopment, poor infrastructure and governance. The self help group movement is beginning to focus on issues of quality and there were some interesting discussions on embedding social performance monitoring as a part of the regular management information systems. At the time of the conference, a leading and responsible MFI was being investigated by the authorities for charging "high" rates of interest. Per unit transaction costs of small loans are high but many opinion leaders still persist with the notion that poor people cannot be charged rates that are higher than commercial bank rates. The reality of the high transaction costs of serving small customers, their continuing dependence on the informal sector, the fact that most bankers shy away from retailing to this market as a business opportunity, and the poor quality of services currently provided does not figure prominently in this discourse. While the Central Bank has deregulated most interest rates,

including lending to and by MFIs, interest rates restrictions on commercial banks for retail loans below US$5,000 (all microfinance and beyond) remain and caps on deposit rates also discourage sharing transaction costs with customers. But most conference participants accepted the imperatives to build sustainable institutions. There is still lot of policy focus on what activities are and are not allowed and not enough operational freedom as yet for banks and financial institutions to design and deliver programmes, and be responsible for their actions. Prescriptions and detailed circulars often limit organisational innovation and market segmentation. As Nachiket Mor of ICICI Bank said at the conference that if the right indicators are monitored and operational freedom and incentives are clear, both public and private banks have the capacity to rapidly address the remaining challenges. Savings service is the neglected daughter of the family of financial services. This metaphor is used because of the sustained discrimination against and frequent disregard for savings services, despite their productive and reproductive role in financial services. This is evident from different nomenclature used at both the international (UN International Year of Microcredit, Micro Credit summit) and national levels (Priority Sector Lending; Annual Credit Policy; Credit/ deposit ratio). Savings services can be a useful entry point for the unbanked to build up a history with the formal financial institutions before customers are entitled to other financial services. With the greater spotlight on knowing the customer and the fact that poor households do not have a salary slip, utility bills, clear land titles or unique identity papers, a regular savings record could be the first building block to membership of the formal financial sector. What is more, with savings services, poor customers need to trust the financial institution and not the other way round. Microfinance is not yet at the centre stage of the Indian financial sector. The knowledge, capital and technology to address these challenges however now exist in India, although they are not yet

fully aligned. With a more enabling environment and surge in economic growth, the next few years promise to be exciting for the delivery of financial services to poor people in India. In this context, BISWA as an NGO- MFI is rapidly carving its identity. The BISWA module of convergence in micro finance and social development is being watched very keenly by all. In its convergence mode the five services, micro finance, micro insurance, micro enterprise, micro marketing and social development, are being delivered through a single window service system. This unique experiment in elevating poverty is coming through a successful module.