Micro Finance

1. 1
Micro Finance in India
overview, challenges, and the role of
technology

2. 2
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

3. 3
Microfinance: what is it?

4. 4
Microfinance: what is it?
What are the words that come to your mind when
you hear the word microfinance?

5. 5
Microfinance: what is it?
R4
R3
R1 /
R2
Microfinance =
provision of financial
services to the poor
48%
15%
37%

6. 6
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

7. 7
Providing financial services to the poor:
challenges

8. 8
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

9. 9
Information asymmetry
Decision to take loan Loan usage loan repayment
Adverse
selection
Moral hazard

10. 10
Adverse selection: incomplete information
problem (before the loan)
Don’t know
Client’s type
Interest rate
reflects proba of default
Safer clients drop out
Need to increase interest
rate
Providing credit can
become
impossible

11. 11
Moral hazard: hidden action problem (after
loan)
Can not observe what client is doing
Bad loan usage
Strategic unwillingness
To repay

12. 12
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

13. 13
Staff
• Lack of trained staff
• Lack of motivated staff
• Difficult to incentives staff

14. 14
Delivering financial services to the poor in
India: an overview

15. 15
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

16. 16
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].

17. 17
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”)

18. 18
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.

19. 19
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.

20. 20
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)

21. 21
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.

22. 22
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

23. 23
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%

24. 24
Microfinance ahead: challenges

25. 25
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

26. 26
Scaling up: challenges

27. 27
Limitation of the predominant model
Bank SHG
NGO
Loan at
9%
No
liability
Group
formation
/linkage
SHG-Bank linkage model

28. 28
Financial Intermediation
Model
MFI JLG GroupBank
Loan at a
9%
Loan at
20%
Scaling up existing MFIs: challenges

29. 29
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

30. 30
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

31. 31
The ICICI Bank Partnership Model
MFI JLG GroupBank
Servicing
fees of 11%
Loan at 9%
Interest
charged:
20%
FLDG of
10%

32. 32
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

33. 33
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)

34. 34
Technology
Role of technology in microfinance:
• MIS
• Cash handling
• Data capture and subsequent management

35. 35
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

36. 36
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

37. 37
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.

38. 38
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

39. 39
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

40. 40
Internet Kiosks
Connectivity
STD/PCO:
•Enabling voice
communication
Printer& Other
Accessories :
Enabling job work
KioskOperator:
•Entrepreneur
•Provides commercial services
Internet KioskInternet Kiosk
Multimedia PC
with Power backup

41. 41
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

42. 42
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.)

43. 43
ICICI Bank strategy: summary
Conventional
Rural Banking
Conventional
Rural Banking
Branch
based
Branch
based
Manpower
intensive
Manpower
intensive
Product
driven
Product
driven
Single
product
Single
product
OurstrategyOurstrategy Hybrid
channels
Hybrid
channels
Technology
intensive
Technology
intensive
Customer
driven
Customer
driven
Multiple
products
Multiple
products

44. 44
Maximize impact of microfinance:
challenges

45. 45
Maximize impact
Vulnerability
Need for
More than credit
Differences among
customers
Need for
customized
products
Understand what programmes work the best
and for whom

46. 46
Maximize impact
Employment
scarcity
Other constraints
Finance other credit
constraint segments
MFI-sectoral experts
Partnerships
Local Financial Institution: serving all credit constraint-
Segments in 2-3 districts

47. 47
Range of Microfinancial services:
• Individual lending
– Information problem
– No unique ID
– No credit info sharing
– Need technology!
• Insurance
– Adverse selection, moral hazard, fraud

48. 48
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)

49. 49
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

50. 50
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

51. 51
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

52. 52
CMFR:
The Centre for Micro Finance Research

53. 53
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

54. 54
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

55. 55
Strategy
Research
Influence
practice
Advocacy
Strategy
building
Training

56. 56
Partnerships
CMFR
Banks/
Insurance
Companies
International
organizations
MFIs/NGOs
Universities
Regulators/policy
makers

57. 57
CMFR: Research Areas

58. 58
Impact of Microfinance
Access to
Financial services
Impact?
Advocacy based on rigorous results
?

59. 59
Constraints to Productivity
Impact
Health
infrastructure
entrepreneurship
Access to
Financial services
Inputs
•Build relevant partnerships
•Provide useful products through credit

60. 60
Economics of Micro-Enterprise
• Scale, Returns, Constraints of micro-enterprise
• Market linkages
• Documentation of best practices
Help increase productivity of micro-enterprise

61. 61
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

62. 62
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

63. 63
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

64. 64
Cost and profitability of SHGs/MFIs
Bank
Transaction
?
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

65. 65
Research: other initiatives

66. 66
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

67. 67
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
…..

68. 68
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

69. 69
MFI Strategy Unit at CMFR

70. 70
Strategy Building
MFIs
Sectoral
Experts
Pilots
Scale-up LFI

71. 71
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

72. 72
THANK YOU!