MICROFINANCE
Development Strategy for Microfinance
Microfinance is still an evolving sector in countries like India as compared to many developed countries where it is highly commercialized through created partnerships, leveraged public and private sectors assets, and shared know-how mechanisms. The lessons from some of the best-managed microfinance institutions around the world show that use of certain methods like group lending, peer guarantees, step-ladder lending, matching repayment terms with borrower cash-flows, etc., have contributed largely to their success.
Microfinance, today, has become one of the most debated and documented topics but is still a very much confused buzzword in the banking sector. In the most simplistic way, it can be explained as `banking for the poor'. As the name implies, most transactions under `microfinance' involve small amounts of money. The term actually has a much wider meaning. It is claimed to be a powerful tool, which can be used effectively to address poverty, empower the socially marginalized poor and strengthen the social fabric. And when it is directed at women, the benefits accruing out of the microfinancing activities are expected to multiply manifold. That is why it is supposed to be changing lives of those associated with it. Today, microfinancing is considered a more pragmatic way of providing financial assistance to the less privileged.
In India, microfinance has been defined as provision of thrift, credit and other financial services and products of very small amounts to the poor in rural semi-urban or urban areas for enabling them to raise their income levels and improve living standards.
But the way in which the banking sector has evolved the world over has not been truly inclusive. So, people with no or meagre physical collateral get completely marginalized. However, it is heartening to see that, of late, policymakers across the globe have realized that it is difficult to sustain the growth momentum unless the marginalized masses are brought into the mainstream economy. This has increased the general level of interest in newer and innovative ways of providing financial and banking assistance to the marginalized people.
Today, the concept of microfinance has become a major credit disbursement mechanism in many parts of the world. It now refers to loans, savings, insurance, transfer services and other financial products targeted at low-income clients. It covers the following activities:
Microcredit: It is a small amount of money lent to a client by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending.
Microsavings: These are deposit services that allow one to save small amounts of money for future use. Often without minimum balance requirements, these savings accounts allow households to save in order to meet unexpected expenses and plan for future investments.
Microinsurance: It is a system by which businesses and other organizations make a payment to share risks. Access to insurance enables entrepreneurs to concentrate more on developing their businesses, while mitigating other risks that could affect the business.
Remittances: These are transfers of funds from people in one place to people in another, usually across borders to family and friends. Compared with other sources of capital that can fluctuate depending on the political or economic climate, remittances are a relatively steady source of funds.
Relevance of Microfinance
At present, microlending to the economically active poor—both urban and rural—is pegged at around Rs. 7,000 cr in the Indian banks' credit outstanding. As against this, according to even the most conservative estimates, the total demand for credit requirements from this part of Indian society is somewhere around Rs. 2,00,000 cr. Hence, there is a need for a mix of banks and other intermediaries who can help to meet this demand-supply mismatch. This is a huge gap which the Indian banking industry alone can never be able to fill. Deprived of banking facilities, the rural and semi-urban Indian masses are still relying on informal financing intermediaries like moneylenders, etc. According to an estimate, moneylenders still meets more than 56% of rural people's credit needs. But, some government statistics reveal that the share of institutional credit is much more now.
Whatever be the quantum of non-institutional credit, there is no doubt that the share of institutional credit has to improve further. That is why more and more emphasis is now been placed on providing finance and other banking options to the unbanked masses through Microfinance Institutions (MFIs), Non-Government Organizations (NGOs), Self-Help Groups (SHGs) and other financial institutions.
Now, let us look at the way in which the relative share of different credit disbursing mechanisms has fared in the last 60 years.
The share of commercial banks in institutional credit has come down by almost the same percentage during this period. Though the share of cooperative societies is increasing continuously, the growth has flattened during the last three decades. One more startling fact that has come to the surface from the All-India Debt and Investment Survey was that the households with a lower asset size were unable to find financing options from formal credit disbursement sources. This was due to the requirement of physical collateral by banking and financial institutions for disbursing credit. For the households with less than Rs. 20,000 worth of physical assets, the most convenient source of credit was non-institutional agencies like landlords, moneylenders, relatives, friends, etc.
While almost 75% of the production credit was met by the formal sector, mainly banks and cooperatives, almost the entire demand for consumption credit was met by informal sources at high to exploitative interest rates that varied from 30% to 90% per annum. Due to the inability to offer any security for their small consumption loans, the poor were unable to take short-term consumption loans from the formal banking system even through the RBI guidelines did provide for granting of consumption credit by banks. Consequently, a large number of the rural poor continued to remain outside the fold of the formal banking system.
Banking Expansion
Increasing access to credit for the poor has always remained at the core of Indian planning in the fight against the poverty. Starting in the late 1960s, India was home to one of the largest state interventions in the rural credit market. This phase is known as the `social banking' phase. It witnessed the nationalization of the 16 private commercial banks in 1969, followed by six more in 1980, massive expansion of branch network in rural areas, mandatory directed credit to priority sectors of the economy, subsidized rates of interest and creation of a new set of regional rural banks at the district level and a specialized apex bank for agriculture and rural development at the national level.
These measures resulted in impressive gains in rural outreach and volumes of credit. The branches of commercial banks increased from 8,262 in 1969 to 71,262 by the end of March 2007 and the average customers per branch office decreased from 64,000 to 14,000 during the same period. There has been a spectacular growth in providing banking services to the masses. However, there are certain underbanked states, such as Bihar, Orissa, Rajasthan, Uttar Pradesh, Chhattisgarh, Jharkhand, West Bengal and a large number of north-eastern states, where the average population per branch office continues to be quite high compared to the national average, particularly in rural areas.
The fact that bank expansion has been skewed becomes apparent when we consider deposits of scheduled commercial banks and bank credit as a proportion of Net State Domestic Product (NSDP) at current prices. The NSDP is a measure of the economic activity in the state and comparing it with the utilization of bank credits or bank deposits indicates how much of the economic activity banks are financing and whether there exists untapped potential for increasing deposits in that state. For instance, the percentage of bank deposits is pretty high in Bihar and Jharkhand, or these states are not as underbanked as they are thought to be. While it is well-known that the Northeastern states are underbanked, states such as Andhra Pradesh, Haryana and Rajasthan, too, have a low bank credit-deposit ratio. In contrast to this scenario, banks have already tapped most of the potential states, such as Punjab and Maharashtra as far as bank deposits are concerned.
Hill states, such as Sikkim, Himachal Pradesh and even Arunachal Pradesh have a surprisingly high proportion of bank deposits to state domestic product. If banks wish to expand into areas where the potential of deposits has been relatively untapped, they would have to expand in states, such as Andhra Pradesh, Haryana, Chhattisgarh, Madhya Pradesh, Orissa and Rajasthan.
This skewed banking expansion is also reflected in the per capita credit outstanding of some of the states and union territories. If closely observed, we can see a huge disparity in the per capita outstanding credit in Chandigarh and Delhi, on the one hand, and the rest of the states on the other. Bihar and Jharkhand stay at the bottom of the list with just around Rs. 2,000, whereas, the figures for Chandigarh and Delhi surpass the `one lakh' mark.
Due to the nature of the expansion of banking services in the country and constraints on banking entities, microfinance and microfinancing activities of banks and SHGs have grown to new heights. This depicts how the SHG-bank linkage program, initiated by Nabard, has helped millions of Indians in improving their lifestyle and also contributed to the development of the economy.
International Experience
Microfinance has changed many lives in diverse societal settings across the globe. It is being exploited as a tool for financial liberation in underdeveloped, developing and even developed countries. It helps in creating a more inclusive financial universe for the whole society. By trying to make more people a part of the network, an inclusive financial sector allows poor and low-income people to access credit, insurance, remittances and savings products. In many countries, the formal and institutional financial sectors do not provide these services to the lower income segments. An inclusive financial sector will support the full participation of the lower income levels of the population to promote economic growth.
Now, let us have a look at some of the best practices that are followed across the world.
Developing and Least Developed Countries
Asia, Latin America and Africa badly need a financial system that is more inclusive in nature. It is because there is already a scarcity of capital even for funding the basic minimum growth. The financial and banking institutions in these countries find themselves unable to address the microcredit demands. As a result, several new institutions emerged in these countries, which addressed the problem of unavailability of funds to the poor or people with small physical assets. Government regulators and international institutions have started giving assistance to these institutions for a better microfinancing institutional framework. Policymakers have realized that these MFIs are potentially a very significant contributors to gender equality and women's empowerment, as well as pro-poor development and civil society strengthening. Through their contribution to women's ability to earn an income, these financing programs have the potential to initiate a series of `virtuous spirals' of economic empowerment, increased well-being of women and their families and wider social and political empowerment. Microfinance services and groups involving women also have the potential to question and significantly change men's attitudes and behaviors as an essential component of achieving gender equality.
There are several examples that have been instrumental in improving the living conditions of small farmers, artisans, pensioners, etc. And these have been done with a `positive bias towards the women' of these segments of the society. Let us now look at some of them.
Grameen Bank, Bangladesh: The Grameen Bank is the brainchild of one of the prominent economists and Nobel laureate, Muhammad Yunus. The bank is the result of the experiment carried out by him in 1976. The bank was an immediate success and the project, with government support, was introduced in 1979 in Tangail district in Bangladesh. The bank continued to grow and prosper and it soon spread to various other districts of Bangladesh and in 1983, it was transformed into an independent bank by the legislature of Bangladesh. The bank provides small loans to the rural poor. As of December 2008, there were more than 2,319 branches and its services were being offered in approximately 74,462 villages, covering more than 89% of the total villages in Bangladesh. Ninety-seven percent of the borrowers are women.
The system is the basis for the microcredit and the SHG system. Every group, comprising around five individuals, is loaned, but if even a single person defaults, then the entire group is denied loans in future.
ShoreBank, US: There are some communities even in the developed economies, which are at a comparative disadvantage in acquiring loans. The ShoreBank was founded in 1973 for lending to underserved communities and in the development of microcredit and microfinance loans for the benefit of the local residents in the South Side of Chicago. Frequently called the `inventors' of community development banking, ShoreBank's successful community lending models have been a source of inspiration for the community development banking institutions around the world.
Over the last 30 years, loans made by ShoreBank, especially home mortgage loans and loans to small businesses, have contributed to the economic resurgence of Chicago neighborhoods, such as Austin, Bronzeville, Chatham, Kenwood, and most dramatically, South Shore. Over one-quarter of all mortgage and rehabilitation loans in the South Shore area have been made through ShoreBank. The bank has helped finance the purchase and renovation of 49,000 affordable housing residences. Between 2000 and 2008, it issued nearly 900 million in loans to citizens in Chicago, Detroit and Cleveland.
Key Issues for Indian Banks
Now, let us look at some of the major issues, which are related to the microfinance activities and institutions. The issues range from the necessity to the viability of the programs itself.
Indian Banks' Perspective
Risk-return Analysis: Risks involved in lending to small borrowers imply a high probability of default of repayments. There are many interesting observations in this regard.
Experience of different social agencies in microlending suggests that poor people are more prompt in repaying debts. For example, the repayment rate of Grameen Bank is 98%; SEWA is more than 92%, etc. The repayment rate is as high for almost all microlending institutions, as the default rate hovers around a maximum of 10% only.
However, according to statistics, the default rate for banks in the same segment is as high as 40%. That is why they are a bit hesitant in providing microcredits to the poor. Apart from the default risks, microcredit also has yield risks and price risks attached to it. Banks and other formal credit disbursement institutions are exposed to several risks and impediments in this area.
But when we look at the returns that can accrue from this segment, it will be a good business proposition to increase lending to this sector. Looking at the Indian scenario, the size of the credit requirement is expected to be much more than the estimation of the market size of 50 million families and between Rs. 30,000 and Rs. 45,000 cr. If the dimension is expanded to include the relative poor rather than only the absolute poor, the market size may expand to 50% of the population. This is a market that any business entity can hardly ignore and it is for this reason that more and more banks and other institutions are coming to this sector.
Barriers faced by Indian banks in Microfinancing
The barriers to the banks in India are mainly regulatory, policy-related and operational. As per the regulatory norms, there are caps on the number of branches or extension counters that any bank can open. This puts a serious limitation on banks even when they want to open more branches in profitable area vis-à-vis microfinance operations.
Standard and regulatory requirements with which commercial banks have to comply, particularly with regard to unsecured lending and interest rates, are not suitable for microfinance operations. The organizational structures, procedures, products and methods used by these banks are not suitable to microfinance, and changing them would be time-consuming, as well as expensive. Our banks' marketing, appraisal and supervision capacity for microfinance lending is quite inadequate. There are also cultural barriers, which are difficult to overcome. Often the staff of perceives the poor as unbankable and do not show any interest in reaching out to them.
Microfinance Development Strategy for Commercial Banks
First of all, it is necessary to realize that microfinance is not a panacea but is one of the effective tools to help the poor from a self-development perspective. Hence, extremely poor people like those suffering from malnourishment and other ailments cannot be considered. This is because intervention in the form of microfinance will not be an efficient solution for them. The problems of such people have to be tackled at the government level through an appropriate mix of welfare measures. So, the prime task for the commercial banks is to examine and identify the target groups for microfinance operations. Once identified, rest of the activities can be started by focusing attention on their needs _ as deprived people require much broader interventions. For instance, micro entrepreneurs, with meager capital require not just financial capital or services but a home, good health, education, etc. Our banks have to create specialist cells to study the total requirements of these groups and come up with tailor-made products and services for them. They must also understand that these groups are heterogeneous in nature and, hence, products and services developed for them have to be highly diversified and target-specific.
Conclusion
Indian commercial banks are, no doubt, involved in microfinance both indirectly and directly. In the first case, they offer operational banking support to MFIs or NGOs; or refinance MFIs; or participate in the equity of such an institution. Similarly, in some cases, they have directly created products and services for targeted clients and opened branches with dedicated windows to provide microfinance. The staff at these branches also undertakes primary, as well as secondary, market research on the types and size of activities run by micro entrepreneurs and the characteristics of the industries they work in. However, microfinance is still an evolving sector in countries like India, as compared to many developed countries, where it is highly commercialized through created partnerships, leveraged public and private sectors assets, and shared know-how mechanisms. The experiences from some of the best managed MFIs around the world show that use of certain methods like group lending, peer guarantees, step-ladder lending, matching repayment terms with borrower cash-flows, etc., have contributed largely to their success. So, time has come to competently use information technology and performance-linked incentives for staff to improve the outreach of microfinance.
-- Dr. BK Swain
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