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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?

R4

R3

R1 / R2

Microfinance = provision of

financial services to the poor

48%

15%

37%

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Microfinance: what is it?

• Micro-credit• Group lending• Social/charitable

activity

• Range of financial services

• Group and individual lending

• Profitable activity

What it often is What it really should be

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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

Decision to take loanLoan usage loan repayment

Adverse selection

Moral hazard

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Adverse selection: incomplete information problem (before the loan)

Don’t know Client’s type

Interest rate reflects proba of default

Safer clients drop outNeed 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 usageStrategic 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 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 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 (cont’d)

• 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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However…Success 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 efforts…large 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

60% in South…to cover all parts of India

Less than 2 million Households reached

500 million un-served poor

Disbursed: 39 billion

Need employment opportunities

Need protection

against all risks

Market constraints

Insurance under-delivered

Scaling up

Increase

impact

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Scaling up: challenges

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Limitation of the predominant model

Bank SHG

NGO

Loan at 9%

No liabilit

y

Group formation/linka

ge

SHG-Bank linkage model

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Financial Intermediation Model

MFI JLG GroupBank

Loan at a 9%

Loan at 20%

Scaling up existing MFIs: challenges

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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

MFI JLG GroupBank

Servicing fees of 11%

Loan at 9%

Interest charged

: 20%FLDG of

10%

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Long-term finance: the ICICI bank response

• There is an underlying business model in the MFI’s 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

Printer & Other

Accessories : Enabling job

work

Kiosk Operator:•Entrepreneur•Provides commercial services

Internet KioskInternet KioskMultimedia PC with Power

backup

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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

Conventional Rural Banking

Branch based

Branch based

Manpowerintensive

Manpowerintensive

Productdriven

Productdriven

Single product

Single product

Our strategy

Our strategy

Hybrid channels

Hybrid channels

Technology

intensive

Technology

intensive

Customerdriven

Customerdriven

Multiple products

Multiple products

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Maximize impact of microfinance: challenges

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Maximize impact

VulnerabilityNeed for

More than credit

Differences amongcustomers

Need for customized

products

Understand what programmes work the bestand for whom

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Maximize impact

Employment scarcity

Other constraints

Finance other credit constraint segments

MFI-sectoral expertsPartnerships

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

ResearchInfluence practice

Advocacy

Strategybuilding

Training

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Partnerships

CMFR

Banks/Insurance Companies

International organizations

MFIs/NGOs

Universities

Regulators/policymakers

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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

Impact

Health

infrastructure

entrepreneurship

Access toFinancial services

Inputs

•Build relevant partnerships•Provide useful products through credit

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Economics of Micro-Enterprise

• Scale, Returns, Constraints of micro-enterprise

• Market linkages• Documentation of best practices

Help increase productivity of micro-enterprise

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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

Design the most cost-effective products

•Within group monitoring•Staff supervision

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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 don’t 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

BankTransaction

?Micro-loan9% 25%

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

MFIsSectoralExperts

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!