Micro Finance in India overview, challenges, and the role of technology

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Micro Finance in Indiaoverview, 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?
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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?
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Microfinance provision of financial services to
the poor
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Microfinance what is it?
What it often is
What it really should be

• Micro-credit
• Group lending
• Social/charitable activity

• Range of financial services
• Group and individual lending
• Profitable activity

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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
• 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
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Information asymmetry
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Adverse selection incomplete information problem
(before the loan)
Dont know Clients type
Interest rate reflects proba of default
Safer clients drop out
Need to increase interest rate
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 crédit
by british government
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Providing financial services to the
poorIndependent 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 poorTimeline

• 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 (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
Disbursed 39 billion
Less than 2 million Households reached
500 million un-served poor
Scaling up
60 in South
to cover all parts of India
Need protection against all risks
Insurance under-delivered
Increase 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
SHG
Bank
Group formation/linkage
No liability
NGO
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Financial Intermediation Model
Scaling up existing MFIs challenges
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 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
Interest charged 20
Servicing fees of 11
FLDG of 10
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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

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
Manpower intensive
Product driven
Single product
Branch based
Our strategy
Technology intensive
Customer driven
Multiple products
Hybrid channels
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Maximize impact of microfinance challenges
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Maximize impact
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Maximize impact
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

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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
Influence practice
Advocacy
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
Inputs
infrastructure
Impact
Access to Financial services
Health
entrepreneurship
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Economics of Micro-Enterprise

• Scale, Returns, Constraints of micro-enterprise
• Market linkages
• Documentation of best practices

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Experimentation on Product Design
selection
monitoring
Enforcement

• Individual/group liability
• Self/MFI selection
• Guarantors
• Collaterals
• Interest rate

• Repayment schedule
• Communication strategies
• Loan size
• Interest rate

• Within group monitoring
• Staff supervision

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?

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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

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Cost and profitability of SHGs/MFIs

• 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!