64966
Microfinance in India –
Banyan Tree and Bonsai
A Review Paper for the World Bank
By
Vijay Mahajan
Bharti Gupta Ramola
August 2003
i
Table of Contents
1 Status and Performance of India’s Microfinance Sector ........................................... 1
1.1 Introduction ......................................................................................................... 1
1.2 Microfinance Demand and Supply...................................................................... 3
1.3 What is the Microfinance Sector in India? ......................................................... 4
1.3.1 Definitional Issues ............................................................................................. 4
1.3.2 The Informal Sector ........................................................................................... 5
1.3.3 Mainstream Institutions ..................................................................................... 6
2 What Impact have Microfinance Programs had? .................................................... 12
2.1 Impact on the Livelihoods of the Poor .............................................................. 12
2.2 Impact on Sector Practices ................................................................................ 14
2.2.1 Informal sector interest rate and approach ...................................................... 14
2.2.2 Developing New Approaches by Banks and Insurance Companies ................... 15
3 Expanding Sustainable Outreach – Challenges and the Way Forward .................. 16
3.1 The Space for Microfinance .............................................................................. 16
3.2 Overcoming Geographic Concentration of the South ...................................... 18
3.3 Innovation and Value Creation......................................................................... 19
3.4 Offering Composite Microfinance Services ...................................................... 20
3.5 Need for Changes in Regulatory Framework................................................... 21
3.5.1 Need for Strategic Attention by the GoI and RBI .............................................. 21
3.5.2 Banks and Insurance Companies to Have Universal Service Obligation .......... 21
3.5.3 Need for a Graduated Legal and Regulatory Structure for Microfinance ......... 22
3.5.4 Permitting MFIs to Take Savings with Safeguards ........................................... 23
3.6 Enhancing Institutional Capacity ..................................................................... 24
4 Conclusion ................................................................................................................. 26
5 References.................................................................................................................. 27
ii
Microfinance in India –The Great Indian Hope Trick?
Vijay Mahajan and Bharti Gupta Ramola1
Status and Performance of India’s Microfinance Sector
Introduction
This paper is about microfinance, not only about microfinance institutions (MFIs). It deals
with the whole range of microfinance providers – from the village mahajan to self-help
groups (SHGs) to cooperatives, banks and insurance companies. The paper is also not just
about micro-credit but microfinance – covering savings, insurance, credit, and money
transfers. Finally, the paper is about the future but it also dwells on the past and the present,
since there are lessons to be learnt from experience. The central thesis of this paper is that
since the onset of reforms, the mainstream financial sector has turned its back to the needs of
India’s small farmers and informal sector producers. In the meanwhile, the growth of micro-
credit, mainly through Self-Help Groups, is distracting attention from the big picture of the
systematic financial exclusion of the majority.
Village moneylenders in India are as old as villages, agricultural credit cooperatives are about
a hundred years old, commercial banks’ involvement in agricultural and small loans nearly 50
years old, the regional rural bank network over 25 years old, and the first “new generation�?
microfinance efforts about 10 years old. Thus microfinance in India is still in its infancy,
though its growth rate is impressive, and particularly the SHG-bank linkage program appears
to have the potential of becoming a big banyan2 tree. However, if we view the microfinance
sector in context of the unmet demand, the image that comes to mind is that of a bonsai.
Outreach to small borrowers has declined since financial sector reforms were triggered. The
proportion of bank credit to small borrowers (below Rs 25,000) has come down steadily from
18.3 percent of total commercial scheduled bank credit in 1994 to 5.3 percent by March 2002.
Even the number of borrower accounts has reduced from 55.8 million to 37.3 million.
1
Vijay Mahajan is the Managing Director of the BASIX group of institutions, which comprises two non-bank
finance companies, a local area bank and a Section 25 company, all working in the field of micro-finance and
livelihood promotion. He co-founded PRADAN, BASIX, Sa-Dhan and APMAS.
Bharti Gupta Ramola is Executive Director, Corporate Finance, PricewaterhouseCoopers and co-founder of
BASIX, along with Vijay Mahajan and Deep Joshi of PRADAN. She is the Chairman of the Board of Bhartiya
Samruddhi Finance Ltd, the flagship company of the BASIX group.
The authors have written two previous papers reviewing rural and microfinance in India.. See “Financial
Services for the Rural Poor and Women in India - Access and Sustainability�? in the Journal of International
Development , Vol 8, No. 2, 1996 and “Dhakka Starting Microfinance in India�? jointly with Mathew Titus of
Sa-Dhan, in Basu, Kishanjit and Krishan Jindal (Eds.) “Microfinance: The Emerging Challenges�? Tata-
McGraw Hill, New Delhi, 2000.
The authors would like to thank L. Kumar and A. Vasundhari of BASIX for research assistance.
2
The Banyan tree acquired its English name because “banias�? or traders sat under it to do their business. The
tree is of religious and cultural significance. However, a popular proverb maintains that nothing else grows
under the Banyan tree because of its dense shade. In Japanese, a bonsai is a dwarf tree growing in a pot,
produced by special methods of cultivation and is usually used for ornamental purposes. (Oxford English
Dictionary).
1
Compare this to the fact that India has nearly 110 million farms (operational agricultural
holdings) and nearly 35 million non-agricultural enterprises3. Thus, even if there were to be
just one account per economic entity, the banking system should have been striving to
increase its base to 145 million borrower accounts rather than reduce the number of accounts
from 55.8 to 37.3 million.
3
The numbers have been rounded off. The latest available official estimates for agricultural holdings are from
1990-91, of 105 million holdings of which 62 million were below 1 hectare in size (Planning Commission) and
for non-agricultural enterprises (rural and urban), the Economic Census, 1998, which counted nearly 33 million
such enterprises.
2
Microfinance Demand and Supply
Estimates of demand are projected on the basis of average credit usage per household
multiplied by the estimated number of poor households. A NABARD staff study
(Puhazhendi and Satyasai, 2000), found that the average credit outstanding of SHG
households was Rs 4,282 before an SHG loan and rose to Rs 8,341 afterwards. Various other
micro-studies, cited below in section 1.3.1, show that the average annualised credit usage of
poor households varies from Rs 3,000 to Rs 9,000. Applying this to the rounded off estimate
of poor households in India to 50 million, we arrive at the demand for micro-credit at
between Rs 15,000 to 45,000 crore ($ 3.25 billion to $9.75 billion).
Since 1992, the Self- help Group (SHG)-bank linkage program has reached over 800,000
SHGs and through them, some 12 million women and their households, cumulatively
providing over Rs 2049 Crore (US$ 445 million) as credit from1992 to March 2003. Yet,
when we look at either the detail or the bigger picture, we find that microfinance supply is
far, far behind the demand. In 2003, the SHG member households got an average of Rs 1766
as credit, after being in a group and meeting monthly for anywhere between 9 to 24 months.
Thus impressive as the SHG bank linkage growth may be, the fact is that the poor of India are
not getting much credit, either compared to what they need, or compared to what the banking
sector is delivering to the rest of the economy, or even what it was delivering to them earlier
before reforms set in. The outstandings of the SHG program in March 2003 were around Rs
1000 crore ($ 217 million), thus catering to 2.2 to 6.6 percent of the estimated demand. Even
the microfinance institutions (MFIs) had outstandings of Rs 240 crore ($52 million) with less
than one million borrowers as on March 2003.
In terms of scope, microfinance is still largely micro-credit. Savings services are not easily
available to the poor. Banks raise a lot of deposits, but not much from the lower income
groups. This is in spite of a large number of branches. Banks do not have the products and
procedures tailored to meet the savings needs of the poor. Many of the poorer people use the
Post Office Savings Bank when they can. In 2001, there were 59 million savings accounts in
the post office with an average saving of Rs 1350 and another 44 million recurring deposits
with an average balance of Rs 3261. SHG members also have very limited, usually once a
month, fixed amount (Rs 10-50) opportunity to save. While MFIs would like to offer
savings services, because of regulatory reasons, they are not able to do so. The informal
sector also offers savings services, through money guards, chit funds, bishis and so on, as
also doorstep deposit collectors, but the cost of these is high and reliability is low. Thus, there
is little availability of safe savings services – the most important first step for a poor
household to enter the world of financial transactions.
Insurance, of lives and livelihoods, is important to the risk-prone economic life of the poor.
As per a study by David Gibbons (2001) of the clients of SHARE, “Almost half (49%) of the
mature client households had experienced a family crisis or natural disaster over [a period of]
four years, with one-third having experienced two or more�?. This is reflective of the
experience of all the people working in poverty alleviation. Yet micro-insurance services are
not widely available. The Life Insurance Corporation (LIC) insures a large number of poor
people, but mainly through government sponsored group insurance schemes. Only 5 percent
of the population is insured and the proportion among the poor is likely to be much less. Life
insurance is also being offered by MFIs as retailers of private insurance companies, but
perhaps no more than 200,000 lives have been covered. Asset or loss insurance coverage is
similarly negligible.
3
What is the Microfinance Sector in India?
Definitional Issues
An “authoritative�? definition of microfinance in India was attempted by the Task Force on
Microfinance, 1999 as follows:
“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�?. (Report of the Task Force on Microfinance, 1999)
A number of features of this definition are not satisfactory. To begin with, “very small
amount�? has not been defined. In case of credit, the Reserve Bank of India, which, till 1999
used to define small loans (not “very small�?) as those below Rs 25000, changed the definition
to loans below Rs 200,000. In January 2000, the Reserve Bank of India (RBI) issued a
circular4 where it indirectly defined the ambit of microfinance as “Rs 50,000 for loans to a
business enterprise and Rs 125,000 for a “dwelling unit�?. How such a large limit was
accepted by the RBI for housing is still a mystery, since the Housing Development Finance
Corporation (HDFC), which administers concessional funds on behalf of the Government of
India from the KfW, Germany, puts an upper limit of Rs 33,000 per dwelling unit on housing
loans for the “economically weaker sections�?.
One can ask: what is in a definition? Unfortunately, a lot depends on such definitions.
Because the banking system is large and has to necessarily work on written guidelines, a
badly drafted definition can lead to operating problems. For example, since the January
2000 circular only mentions loans to business enterprises and dwelling units, it has left out
loans to agriculture, live stock rearing, forest-based activities, fishing and other allied
activities out of the purview of microfinance. Ironically, these activities account for the
livelihoods of over two thirds of India’s poor.
Another problem is that the definition of thrift is not given but the use of that word instead of
savings seems to imply some features such as regular and frequent savings of “very small
amounts�? perhaps mainly by women. A monthly saving of Rs10 to 30 in an SHG does not
really count towards thrift, and a number of micro-studies show that the poor can and want
to save more, provided they can do it at their doorstep and frequently, even daily. The
requirement is for what banks call “pygmy�? deposits but most banks are averse to offering
that service for cost as well operational reasons. On the other hand, the RBI does not allow
MFIs to offer savings services, since deposit taking is reserved for regulated banks.
Nor has “very small amount�? been defined in case of insurance, and this led some private
insurance companies to initially offer rather low coverage amounts in order to fulfil their
numerical obligations for social sector policy under the Insurance Regulatory and
Development Authority (IRDA) guidelines.
However, one good thing about the definition cited above is that, in line with second
generation developments all over the world, it recognises that microfinance is more than just
micro-credit: it also spans savings, insurance and also other financial services such as money
transfer and pensions.
4
Circular no. DNBS/138/CGM(VSNM)-2000
4
India’s microfinance sector can be divided into three segments, the predominant informal, the
emerging semi-formal MFIs and the formal financial sector’s various schemes and wings
engaged in microfinance directly or indirectly.
The Informal Sector
The informal sector continues to dominate the financial life of the poor, though the
proportion appears to be decreasing. The authoritative data on this comes from a large
decadal survey, first conducted in 1951 and repeated every ten years. This is the All India
Debt and Investment Survey (AIDIS).
The magnitude of the dependence of the rural poor on informal source of credit can be
observed from the findings of the AIDIS, 1992, which shows that the share of the non-
institutional agencies (informal sector) in the outstanding cash dues of the rural households
continued to be quite high at 36 percent even though the dependence of the rural households
on such informal sources had reduced from 83.7 percent to 36 percent over three decades
(1961-1991).
Outstandings from Informal Sources as a percentage of Total Dues of Rural Households
Year Cultivators Non-Cultivators All
1961 81.6 89.5 83.7
1971 60.3 89.2 70.8
1981 36.8 63.3 38.8
1991 33.7 44.7 36.0
If we look at the AIDIS data rearranged by household asset size, then we find that for
households in the lowest asset ownership category (less than Rs 5000) the share of the
informal sector was 58 percent.
A number of other studies shed light on the financial behaviour of the poor. Most of these
are micro-studies, and though they have smaller sample sizes, they are carefully carried out.
These include a study carried out by the authors on behalf of the World Bank (summarised in
Mahajan and Ramola, 1995), covering 600 rural poor households in two states, which found
that as much as 84 percent of the credit usage of these households was from the informal
sector. This contrasts with the figure of 58 percent for the lowest asset class households in
the AIDIS survey of 1991.
In a micro study (Nag and Bala, 2002) conducted in June 2002 in the Ganjam district of
Orissa with 263 respondents, it was found that only 72 percent households borrowed at all
and of the borrowers only 12 percent recevied loans from banks, although the amount
accounted for 29 percent of the total borrowings. The informal sector accounted for 70
percent of the credit usage of this sample (one percent was from a local finance company).
In a companion study, (Seth and Jamuar, 2002) in the Adilabad district of Andhra Pradesh, it
was also found that 70 percent of the credit used by households came from traditional
informal sources.
Another study (Sinha, and Patole, 2002), showed that the informal sector accounts for a vast
majority of the financials transactions in poor households, both in rural Allahabad district of
UP and of the poor living in Delhi’s urban slums. A study by the Paradigm group cited in
5
Supriti et al (2002), indicated that the informal sector provided fully 93.5 percent of the total
credit usage by the urban poor in Bangalore in 2002.
Thus the discrepancy between the data from the AIDIS and a number of carefully conducted
micro studies in different parts of the country by different individuals/NGOs shows that the
official data does not seem to capture the full extent of the dependence of the poor on money
lenders, pawn brokers, landlords and traders. Yet, there is no authoritative source of data on
microfinance services in India. Instead the numbers that keep getting reported are the
cumulative disbursements to SHGs. The fact is that we have a long way to go before either
the SHG-bank linkage program or MFIs make a significant dent on the credit dependence of
the poor on the moneylenders.
The other form of this self-deception that goes on is in the matter of comparison of interest
rates of banks, MFIs and the informal sector. It is important to measure the transaction cost
adjusted interest rates that borrowers effectively pay. This is shown in the table below:
Comparison of Interest Rates of Various Sources after Adjusting for Transaction Costs
Source/type of Quoted Effective interest rate Details
loan interest rate incl. transaction costs
Bank loans to 12-16.5% 22-33% (Source: Number of visits to banks, DRDA,
IRDP borrowers Mahajan and Ramola, documentation, and in some cases,
1996) bribes. All paid up front.
Bank loans to 12-13.5% pa 21%-24% pa (Source: Number of visits to banks, DRDA,
SHGs survey by APMAS, 2003) compulsory savings and costs
incurred for payments to animators/
DRDA staff /local leaders.
MFI loans to 15%-24% pa 15%-24% pa No transaction costs except time
micro borrowers spent in meetings.
Moneylenders, 36%-120% pa 48%-150% pa
Landlords,
Traders
Note: all interest rates have been converted into per annum rates, on a declining balance basis
Mainstream Institutions
Commercial banks in India can claim that they “have always been doing microfinance�?, at
least since 1980, the year that the “Integrated Rural Development Program�? (IRDP) was
launched. The IRDP was a nationwide program of poverty alleviation through self-
employment of the poor, and it involved banks in giving loans for purchase of productive
assets, while the government gave a subsidy. By the time the IRDP ended (or rather was
transformed into its successor program SGSY in 1999), it had reached 56 million households.
This is not the place to analyse the IRDP and its performance (instead, see Pulley, 1989) but
suffice it to say that while it provided millions of small loans to poor people, in spirit and
methodology it was quite the opposite of what microfinance stands for.
An attempt to define what microfinance stands for was made by the authors as follows:
The seven I’s of successful micro-finance programmes for the poor
Attribute New Generation behaviour
6
Image of the poor Not see them as the beneficiaries, but as entry level customers
Independence No political interference, such as loan waivers, no bureacuratic control
Interest rates For deposits: high enough to attract savings. For loans; high enough to cover
costs of funds, cost of operations, cost of loan losses, and cost of equity
capital.
Incentives For staff: to ensure good customer service but prudent lending. For customers:
to ensure deposits come in and loans are repaid on time
Intermediation Between local savers and borrowers; and between local surpluses and non-
local financial markets.
Increased capacity Larger scale; broader scope of services to include savings, consumption and
production credit, and insurance; better systems for MIS and internal
supervision; and greater ability to deal with regulatory authorities.
Integration With social intermediation (e.g. by Self-Help Groups) and technical assistance
(e.g. by NGOs and government bodies in micro-enterprise promotion.)
Source: Mahajan, Vijay and Ramola, Bharti Gupta 1996.
The SHG-Bank Linkage Program
NGOs working in rural development were the first to realise that the IRDP style of small loan
would do more harm than good, both to the poor as well as to the banking system. Thus,
some of them, such as MYRADA in Karnataka and PRADAN in Rajasthan and later in Tamil
Nadu and what is now Jharkhand, began to experiment with alternative methods of extending
credit to the poor. Out of this emerged what is now the SHG methodology. Between 1987 to
1992, NGOs experimented with SHGs and tried to persuade some local banks to try to lend to
such groups. However, in the command and control structure of the Indian financial sector at
the time, it could not be done in the absence of guidelines from the RBI, which were issued in
1992, to experiment with a pilot of 500 SHGs to link with banks. NABARD supervised and
refinanced these loans. By 1995, about 2500 groups had been linked with banks.
This pilot program as well the work of a number of NGOs was reviewed by a Working Group
on Bank Lending to the Poor through NGOs and SHGs (1995) and detailed guidelines were
drawn to encourage banks to use this method. NABARD was given the task of leading this
effort and it took to task with exemplary diligence. It involved NGOs, commercial banks,
regional rural banks and even cooperative banks in forming SHGs and then linking those up
with nearby bank branches.
Growth in volumes of SHG-Bank Linkage
By Mar 31 Number of SHGs linked to Cumulative bank loans (Rs.
banks, cumulative nos. million)
1999 32,995 571
2000 114,775 1,930
2001 263,825 4,809
2002 461,478 10,263
2003 717,306 20,487
As can be seen from the table above, banks have greatly increased their exposure to SHGs
over the last three years. The SHG-bank linkage program is now the predominant model for
7
delivering micro-credit. The program is both promising and problematic. There are a number
of problems with the SHG bank linkage program.
Cost of new SHGs: While the first few lakh SHGs were made available to banks by NGOs
and government agencies, thereafter virtually all the good SHGs have got bank loans. The
newer SHGs are either formed by government agencies or sometimes by banks themselves
and rarely display the quality and the principles of good SHGs. If new SHGs have to be
formed, someone has to incur the cost of organising meetings, training the members and
eventually linking with the banks. The estimate of this cost is controversial, with NABARD
claiming it to be as low as Rs 1000 per group and NGOs saying it takes as much Rs 12000.
The Ministry of Rural Development has established a norm of Rs 10000 per group which is
quite realistic. This is paid over four phases. Thus to form an additional one million group,
the amount required is Rs 1000 crore. Where will this come from and what mechanisms can
be put in place to ensure that if this money does become available that it is not frittered away
in the form of local favors.
Quality of SHGs: As the movement has caught the attention of government officials and
politicians, targets are beginning to be imposed and as a result the quality of groups is
suffering. A survey by APMAS in 2002 indicated that only 17 percent of all groups were of
adequate quality for bank linkage and this was in a state which is considered the leader in the
movement. Quantitative targets and government directed SHG formation are the main cause
of this deterioration. For example, under the SGSY, nearly 12 lakh SHGs have been formed
over the last three years but less than 10 percent of these are linked with banks. The main
reason is that the others are still new and relatively unformed groups. Many have come
together only because they want a loan.
Is SHG-Bank Linkage Headed Towards another IRDP?
There is also the problem of banks chasing targets without concern for quality and politicians using the
program for popularity. A survey of 400 randomly (multi-stage stratified sample) selected SHGs linked with
banks, was carried out by the Andhra Pradesh Mahila Abhivruddhi Society (APMAS) in eight districts of AP.
The survey found that only 67 percent of the SHGs were appraised by banks before giving loans. Further, in
APMAS’ assessment using NABARD criteria for bank linkage, only 60 percent of the bank- linked groups
were of adequate quality to get loans from banks. Further, the survey revealed that nearly 33 percent of the
funds had gone to the group leaders. Only 17 percent of the groups had ever changed their leaders.
In terms of services/favours and payments, some groups reported that animators were paid Rs 200 to 500 per
group, the EO (DWCRA) Rs 400 to 500 and/or local leaders Rs 1000 to 2000. However, the average of all
transaction costs, including fares and documentation was Rs 276 per group, or about 0.8 percent to an average
loan of Rs 34037. In addition, funds were borrowed from local moneylenders to show adequate savings in the
bank account. For this, money lenders charged 5 percent pm. The savings of the group were in the bank for
an average of around four months before loans were sanctioned and disbursed.
Moreover, as many as 10 percent of the groups reported that they were asked to take bank loans against their
wishes, because of pressure by bankers and animators who had to fulfil targets. Not surprisingly therefore, 12
percent of the bank-linked groups in AP have repayments overdue to banks. If this trend is not controlled, the
SHG-bank linkage program could get a bad name and suffer the same fate as IRDP lending to the poor.
(APMAS, 2003)
Actual Cost of SHG Lending: While banks have been increasing their SHG lending
dramatically, this has been done without any attention to the actual costs. Though, the
profitability of SHG lending is not yet fully established, banks believe they are able to do this
8
business without losses even when interest rates are capped at 12.5 percent. Indeed recently,
the State Bank of India and the Andhra Bank have announced their intention to lend at 9
percent per annum. About transaction costs, banks have the view that they any way have a
rural branch network with fixed costs and there are little incremental costs for SHG lending.
However, there is contrary data emerging from careful studies, notably by Sinha (2003),
whose study of five RRB branches seems to show that if all the costs of SHG formation and
lending are allocated and accounted for, it costs banks anywhere between 22 and 28 percent
to do SHG lending, and in one case, where the RRB was located in a low density, forested
district the cost was as high as 48 percent. It is very important for banks to pay attention to
this study and carefully work out their actual costs for SHG lending. While the SHG
portfolio is a small part of the total bank lending, and portfolio quality is good, it may be
possible to cross subsidise this but eventually full costs must be charged, even as all efforts
are made to reduce the costs. Thus the assertion that SHG lending is profitable at 12 percent
is questionable.
Politicisation: Since more than 12 million women are now part of the SHG bank linkage
program and perhaps an equal number of them are members of hurriedly formed groups in
the hope of getting bank loans, or gas connections or whatever other largesse that politicians
may want to distribute, this is a potentially huge vote bank. This point is not lost on
politicians. While, a number of Chief Minsters, notably those of AP and MP have supported
the SHG movement for good reason, as they saw it as a way of extending bank credit to the
poor and women in particular, this image is now changing in the election year. The reports
on the ground from AP show that SHGs are increasingly being used for political mobilisation
and distribution of pre-poll goodies. There is also a pressure on banks to increase their
lending to SHGs, while using the not yet matured SHGs for disbursing all kinds of
government subsidies. While this is disturbing enough, the biggest blow has come from
Tamil Nadu, where the state government promulgated an ordinance prohibiting loans at
exorbitant interest rates, this being defined as 12 percent. Legitimate MFIs trying to run
sustainable operations find that their staff are being harassed by local politicians and petty
officials. Karnataka has followed suit with a similar ordinance in September 2003.
The fact is that imposing an upper limit on interest rates is actually an anti poor step because
it is the surest way to ensure that legitimate lenders will be driven out and closed down. In
theory, the poor could then borrow from reluctant public sector banks but we all know in
practice that this will mean that they have no recourse except for the money lenders. Thus,
in the name of populism politicians are once again ensuring that the poor get no access to
credit. It is important that all truly pro-poor politicians and well meaning bureaucrats
should come out in favour of the deregulation of interest rates. Those who are not yet
convinced, should look at the experience of Indonesia where interest rate deregulation has
ensured the sustainable operation and nation wide outreach of a number of micro-finance
institutions.
Geographical Concentration: Despite its numerical success, we must note that the outreach of
the SHG-bank linkage program has remained a largely south Indian phenomenon, with nearly
75% of funds flowing to SHGs in the four southern states.
9
Other Models for Microcredit by Banks and FIs
Other models of banks giving microcredit are extant, the main one being on-lending through
MFIs. Though this approach was initiated by the Friends of Women’s World Banking and
the government sponsored Rashtriya Mahila Kosh, it was later developed and enhanced by
the Small Industries Development Bank of India (SIDBI).
Starting in 1994 with a micro-credit scheme, SIDBI upgraded its work into an internal
department called the SIDBI Foundation for Micro Credit (SFMC). The total amount
disbursed by SIDBI since the beginning of the scheme till March 31, 2003 was Rs 161.3
crore to 183 NGO/MFIs, eventually reaching an estimated 860,000 individual borrowers.
As can be seen, this “second channel�? of disbursing micro-credit is dwarfed in contrast to the
numbers achieved by NABARD through the SHG-bank linkage program. Nevertheless,
SFMC has played an important role in providing micro-credit in those locations where banks
were reluctant or tardy in providing credit through SHGs.
Microfinance Institutions (MFIs)
The MFIs are a middle ground in the sense that they offer some of the features of the
informal sector such as flexible products, customer friendly practices but at a higher interest
rate than formal sector, while brining in some features of the formal institutions – such as
documented loan contracts, detailed books of accounts, MIS, staff, and some degree of
supervision by a regulatory authority.
For all the excitement about MFIs in India, it should be noted that they are very small,
individually – the biggest being SHARE Microfin Ltd with loans outstanding of about Rs 50
crore and BASIX of Rs 35 crore in March, 2003. Even collectively, the MFI sector is small,
as can be seen from two recent estimates. The first is an estimate by Micro-Credit Ratings
and Guarantees India Ltd( M-CRIL) based on 69 MFIs rated by it (and thus most likely,
among the top 100). These MFIs had Rs 163.8 crore of outstandings and 14.2 lakh
“members�?, only 4.5 lakh of whom were borrowers by June 2002. (Sinha, 2003), which
averages to 6500 borrowers and Rs 2.3 crore loan outstanding per MFI.
M-CRIL’s analysis of the performance of 69 rated MFIs in India, June 2002
Indicators NGOs Individual Grameen Mixed All
lending lending Sample
to SHGs MFIs
Sample size 43 10 7 9 69
Total Membership (000s) 1.032 112 174 105 1423
Average Membership (000s) 24 14 24.8 11.7 20.6
Active borrowers/MFI (000s) 4.6 5.5 21.9 5.0 6.5
Loans outstanding (in Crore) 54.6 35.6 45.6 28.0 163.8
Average portfolio (in Crore) 1.3 3.6 6.5 3.1 2.4
Average loan outstanding (Rs) 2800 6500 3000 6200 3600
Savings (in Crore) 45.1 28.5 12.4 6.2 92.2
Savings per member (Rs) 440 2550 710 590 650
Source: Sinha (2003)
Another compilation, with assistance from V. Nagarajan & Co., who audit most of the larger
MFIs in India, shows that the top 10 MFIs had loans outstanding of Rs 159 crore in March
2003. Thus, at average of Rs 16 crore, even the big MFIs are still small, though growing fast.
10
Name of the MFI Outstandings Savings No of No covered under
(Rs crore) (Rs crore) Borrowers insurance
SEWA Bank 13.4 62.4 50,849 5584
SHARE Micro Fin Ltd. 49.4 9.5# 132,084
SHARE – Asmita 8.3 NA 22,168
Cashpor 8.8 0.5# 22,164 7028
BASIX – Samruddhi 38.8 No savings 51,379 25,600
BASIX- KBSLAB 5.0 2.5 3,898 163
BASIX –Sarvodaya 9.7 9.5# 45,082
Spandana 15.2 2.1 34,131 34,131
SKS 4.9 0.4 13,519
LEAD 5.1 1.5 26,661
Total 158.6 88.4 401,939 72,506
# Savings are kept with member SHGs/mutual trusts/MACS in cases marked by # above.
Source: V. Nagarajan & Co and compilation by BASIX team. Data is for March 31, 2003, or in some
cases for August 31, 2000.
Savings: In addition to small scale, MFIs also tend to have a limited scope. Due to
regulatory reasons, very few of them offer savings as a service. Some offer a vast range of
products – see for example the box below on savings products of VSSU, West Bengal. Apart
from promoting mutual savings among groups (SHG or Grameen type), a few NGO MFIs
offer savings services by taking deposits from their members. Others have had to use mutual
benefit trusts or mutually aided cooperative societies (MACS). Only the SEWA Bank,
Ahmedabad and the BASIX local area bank KBSLAB (in three districts of AP and
Karnataka) offer savings as RBI regulated entities.
Savings Products offered by Vivekananada Sevakendra-O-Sishu Uddayan (VSSU) Source: MCRIL, 2002
Product Features Clients Organisation’s Perspective
Daily Fixed amount to be deposited each day Daily wager Easier for clients to save daily
Deposit Lock in period of 18 months earners Early viability established thorough
7-in-1 facilities after lock in period (rickhsaw transaction cost analysis
4 percent interest after lock in period pullers)
Savings Additional withdrawable product for Bank savings Withdrawable savings option for
Deposit clients of other schemes. Min balance account existing clients; Lower collection
Rs 500, Max 4 transactions allowed holders costs due to add on transaction;
pm. Door step collection for > Rs 1000 Meets organisations’s fund
5 percent interest for period > 90 days requirement
Fixed Deposit up to Rs 45,000 for a Investors of Clients need investment options for
Deposit maximum of 78 months post office long term and bulk funds
(FD) 7-in-1 facility for depositors deposits/banks Source of long term funds for the
8-11 percent qtly compound interest organisation
Recurring Minimum monthly deposit Clients who do A flexible option for savers
Deposit Can be used as collateral for loans not have a augments deposits
7-in-1 facility daily income Increased member credit
10-11 percent compound interest worthiness, use as loan collateral
Monthly Pension plan Retired Reduced cost of funds for the
Income One time deposit for 60 months persons and organization.
Scheme Personal accident insurance pensioners Costing done on the basis of cost of
9 percent simple interest paid out external and idle funds
monthly More stable cash flow
11
What Impact have Microfinance Programs had?
Impact on the Livelihoods of the Poor
Since microfinance involves working in the public space, and almost always with some
implicit or explicit subsidies in the form of public funds at costs lower than market, it is
important to continue to measure the impact of microfinance programs. In practice, this is
quite difficult due to a number of operational and methodological reasons. MFIs, which are
responsible for providing microfinance services, are not always objective in assessing the
impact of their own work, even as this is based on day to day familiarity with the borrowers.
In India, there are no sophisticated studies on the impact of microfinance. However, a number
of simple studies have been conducted on the impact of microfinance programs. These
mostly focus on the impact of microcredit, and not of savings and insurance, since those
services are provided relatively less often. Two of these are summarized below:
A study by NABARD staff (Puhazhendi and Satyasai, 2000), which covered 560 SHG
member households from 223 SHGs spread over 11 States showed perceptible changes in the
living standards of the SHG members in terms of ownership of assets, increase in savings and
borrowing capacity, income generating activities and in income levels. Some highlights from
the study are presented below:
· Poverty outreach: “Member households were mainly from among the poor: landless
agricultural labourers 31 percent; marginal farmers 23 percent; small farmers 29 percent;
and others 17 percent.�?
· Increase in credit usage: “The average borrowing/year/household increased from Rs
4282 to Rs 8341. The share of consumption loans declined from 50 to 25 percent. About
70 percent loans taken in post SHG situation were for income generating purposes.�?
· Increase in employment and income: “Employment increased by 18 percent from 318
man days to 375 man days per household... The average income per household increased
from Rs 20,177 to Rs 26,889 or by about 33 percent.�?
· Reduction in proportion below poverty: “About 74 percent of the sample members had
income below Rs 22,500 in pre-SHG situation. During the post-SHG period, the
proportion came down to 57 percent reflecting improvement in the incomes of about 17
percent of the households.�?
· Increase in asset ownership and housing: “Average value of assets per household which
included livestock and consumer durables etc., increased by 72 percent from Rs 6843 to
Rs 11793. About 58 percent of the households reported increase in assets. Housing
conditions generally improved with a shift in the ownership form kuchha (mud walls,
thatched roofs) to pucca (brick walls, tiled roofs) houses.�?
· Increase in savings: “Almost all members developed saving habit in the post-SHG
situation as against only 23 percent of households who had this habit. Average annual
savings per household registered over threefold increase from Rs 460 to Rs 1444.�?
· Social Empowerment: “The involvement in the group significantly contributed in
improving the self confidence of the members. The feeling of self worth and
communication with others improved after association with the SHGs. The members were
relatively more assertive in confronting social evils and problem situations. As a result
there was a fall of incidence of family violence.�?
12
According to this study, the impact is considerable and all-round. The poverty outreach is
quite satisfactory, even though it could have had a higher proportion of landless households,
since they comprise the vast majority of the poor. The study does not mention the social
categories, such as scheduled castes, scheduled tribes and minorities. There is no mention
also of the proportion of women, but presumably it is very high since almost all SHGs are
women’s groups.
Very positive results have also emerged from an impact assessment of the clients of SHARE
Microfin Ltd (SHARE). This was carried out by Prof David Gibbons and his team in 2001.
The approach used was to track poverty reduction over time based on a composite index of
poverty based on the sources of income; the number of household members divided by
number of earning members; productive assets; and housing quality. The study report states
“Three out of four (76.8%) of SHARE’s mature clients have experienced significant reduction in their
poverty over the past four years, and half of these are no longer poor… Of the remaining 23.2% of the
sampled mature clients, who had been in the microfinance program for at least three years, 21.6% had
experienced no significant change in their poverty, and 1.6% had actually become more poor than
they had been at the time of entry into the program.
Poverty Movement Mature Clients % Cum. %
Very Poor to Moderately Poor 48 38.4 38.4
Very Poor to Non Poor 22 17.6 56
Moderately Poor to Non Poor 26 20.8 76.8
No Change 27 21.6 NA
Non Poor to Moderately Poor 1 0.8 NA
Moderately Poor to Very Poor 1 0.8 NA
Totals 125 100 NA
The poverty status of households at the time of joining SHARE’s program (three to four
years before 2001) and at the time of the study in 2001 is summarised below:
Poverty Status Upon availing of SHARE’s loan Three/four years later
Very Poor 64% 7.2%
Moderately Poor 36% 56.8%
No longer Poor 0% 36.0%
Totals 100% (n=125) 100% (n=125)
The study showed that
“An important path out of poverty … has been the purchase and care of a milch buffalo(es), with
loans provided by SHARE. Of the mature clients who did not purchase any buffalo with their loans,
only 68% have experienced a significant reduction in their poverty, as compared to 85% of those who
have one milch buffalo and 84% of clients who have two or more milch buffaloes…In general, clients
had reduced their poverty by using their loans to increase the number of income (cash) earners in the
household, often through the wife becoming an earner by investing all or part of her SHARE loans in
creating self employment for her.
“With subsequent loans from SHARE these processes of increasing the number of income earners in
the household and diversifying its sources of income continued, where possible. Those mature clients
who had three or more earners in their household, 84% of them had experienced significant poverty
reduction, as compared to only 33% of households with only one income earner. Diversification of
13
the source of household income also is strongly related to poverty reduction: 82% of client households
with three or more sources of income had experienced significant reduction in their poverty compared
to only 47% of households with one source of income. Adding income earners and diversifying
source of household income are about equally related with poverty reduction.�?
The results of the above two studies are quite at variance with international literature on
impact assessment. For example, Hulme (2000) argues that the poor benefit much less from
microcredit than the less poor and that many do not benefit at all and indeed, some are left
worse off due to the additional indebtedness which they are not able to pay off due to failure
in the activity or other contingencies. Indeed, if we look above at the first table, we find slight
evidence of this, with 0.8 percent of the moderately poor becoming very poor as a result of
the program. However, this is a very small percentage.
Impact assessment needs to be done but serious attention should be paid by donors to its cost-
benefit ratio. Outside evaluators necessarily have to draw samples and conduct surveys,
which are both tedious and expensive. Statistical rigour requires substantial samples and
establishing control groups, so that biases can be eliminated and secular changes can be
accounted for. But even the most sophisticated studies, such as Pitt and Khandker (1998), in
Bangladesh are open to different interpretations. For example, Morduch (1998), using thePitt
and Khandker data, states that he found no increase in [household] consumption [children’s]
education, even though the original authors estimated that household consumption increases
by 18 taka for every 100 taka lent to a women and schooling of children increased5.
Impact on Sector Practices
Informal sector interest rate and approach
One of the beneficial impacts of microfinance is reduction in informal sector interest rates
and a change in their approach from exploitative to business-like behaviour. It has been
argued by Al Fernandes of MYRADA in the recent Microfinance Roundtable (Srinivasan R.
and Sriram M.S., 2003) that one of the benefits of establishing SHGs or an MFI in an area is
the reduction in interest rates from informal sources.
“I question the assumption that the microfinance sector has to meet the total demand. The goal is to
promote an environment (policies, systems, culture and practices) in which the poor can access credit
and other financial services quickly easily at minimum cost. In some of our projects where the SAGs
have met around 20-25 percent of the demand, the entire interest structure in the private or the
informal sector has come down. The informal sector was always easy to access, it was the interest
rate that was exploitative…�?.
Similar results are reported in a number of micro impact studies. The dynamics of this are
two fold. First, the availability of credit from an SHG or an MFI simply opens up one more
channel for the poor to draw upon, thus creates a downward competitive pressure on
moneylenders. However, as the indebtedness and acute consumption needs come down due
to even a marginal increase in incomes resulting from economic activities pursued using
micro credit, the desperation for credit goes down and along with that the demand for
overnight hand loans at 10 percent per month, tied transactions and debt bondage, all of
which are abominable forms of usury.
5
Interestingly, as a side point, the increase in household consumption is lower at 11 Taka for every 100 Taka
lent to a man.
14
Indeed the positive results have encouraged some to go one step further – to involve
moneylenders and other informal financial service providers in the spread of financial
services, particularly to the poor.But the issue of involving informal lenders in microfinance
is still debatable, though attempts should be made through some pilots. This has been
suggested a number of times, most recently by Sharma and Chamala (2003) but is always
argued against in the same breath. See the excerpt below for example:
“…The second possibility is that of linking moneylenders with the banking institutions as a conduit.
This has an inherent problem, in addition to the problem of acceptability by the other socio-political
stakeholders, in the assumption of non-exploitative interest rate recovery from the clients by the
middlemen/moneylenders. It cannot be ensured by financing banks as it will require substantial
supervision and in turn tempering of the moneylending process according to formal set of rules.�?
Developing New Approaches by Banks and Insurance Companies
Banks have had a positive experience of lending to MFIs, where transaction costs for banks
are lower as compared to lending to SHGs, and the repayment rates are 98 percent and above.
Based on this, the new private sector banks, mostly notably the ICICI Bank, but also the UTI
Bank and the HDFC Bank are actively seeking exposure in the microfinance segment. While
this is small in terms of amount to make a difference to their over all portfolio for even to
their priority sector lending obligation, these new banks are pursuing microfinance with a
refreshing approach – as a potential business and not merely as a social or priority sector
lending obligation.
Further, though MFIs have not made a dent yet in terms of directly meeting the credit needs
of the poor, their customer-friendly practices and mutual competition have pushed banks to
adopt a number of products and procedures. In case of agriculture, the biggest innovation is
the Kisan Credit Card (KCC), of which 31.6million had been issued by March 31, 2003.
Though these are not truly credit cards in the sense normal card users understand, the KCCs
have significantly reduced the paperwork and delay that farmers faced earlier to renew their
crop loans every year. On the lines of KCC, banks have launched the Laghu Udhami Credit
Cards for small entrepreneurs. In addition, banks are promising a number of features, as can
be seen from a recent advertisement reproduced below:
United Bank of India : Charter for Small Scale Industries
Simplified loan application
Receipt of loan applications complete in all respect is acknowledged
Time norm for disposal of loan applications from the date of receipt:
• • Up to Rs 25,000 - 2 Weeks, Rs 25,000 to Rs 5 lakhs – 4 weeks
• • Over Rs 5 lakhs – 8-9 weeks
No collateral security for loans up to Rs 5 lakh and, for existing borrowers with good track
record, no collateral for loans up to Rs 15 lakh.
Composite loan available up to Rs 25 lakh
Working capital finance of 20 percent of projected annual turnover available up to Rs 5
crore of fund based limit
Hassle free Laghu Udhami Credit Cards available for loan limits up to Rs 2 lakh.
United Udyogshree Yojana provides hassle free credit facilities under SSI for borrowers
and depositors with good track record for last three years at reduced rate of interest by 0.5
percent. Lower margin and service charges are considered under the scheme.
Present rate and interest on SSI advances of loan limits:
• • Up the 25,000 8.25%, lend to MFIs and treat it as
In January 2000,to RsRBI allowed banks to Rs 25,000 to Rs 5 lakh 8.75% part of priority sector
Rs 1 lakh banks used this opportunity lakh to MFIs, mainly NGOs.
lending. •A number ofto Rs 2 lakh 9.50 %, Over Rs 2 to lendas per credit Risk Rating As a
•
15
result they have not only established friendly partnerships with a number of NGOs and MFIs,
but also have innovated a number of products and approaches. For example all the banks
offer lines of credit in addition to term loans. This enables MFIs to drawn down the loan at
the pace they build their portfolio, thereby reducing the effective interest payment.
The ICICI Bank is actively exploring portfolio securitisation of the micro loan portfolios of
some of the high performing MFIs, thereby reducing the need of MFIs to have increasing
levels of equity or risk capital as their portfolios grow.
The ICICI bank is also experimenting with using MFIs as management and collection agents,
where the loans are always on the books of the ICICI Bank, even though all the operations
with the customers are handled by the MFI staff. The ICICI Bank has launched a pilot
effort for this jointly with Cashpor Micro Credit, a section 25 company specially set up for
this purpose by Cashpor financial and Technical Services Ltd, in the Chandauli district of
Uttar Pradesh.
In the field of savings, however, the progress has been halting, mainly because of the
understandably conservative nature of the deposit regulator, the Reserve Bank of India,
particularly in view of a number of small bank failures that keep happening on a regular
basis. The long standing recommendation of the 1999 Task Force to establish graded
regulation on deposit taking has so far not found favour with the Reserve Bank of India. To
recall, the recommendation was to exempt MFIs raising savings up to Rs 2 lakhs: establish a
reserve requirement of 10 percent of savings raised up to Rs 25 lakhs and thereafter insist on
an RBI registration and a 15 percent reserve requirement. Further, the Task Force
recommended that deposit taking be not opened to the general public but only from members
i.e. clients or beneficiaries of MFIs.
In contrast to slow progress in savings, in the field of insurance, in a short period of three
years since the sector has been privatised, there have been a number of interesting
innovations and approaches and new product /channel developments. SEWA Ahmedabad is
by far the leader in developing and offering insurance products to its customers. SEWA
provides insurance services managed through its Vimo SEWA affiliate, which works as a
nodal agency for the LIC and a number of general insurance companies. Vimo SEWA is
perhaps the nation’s largest MFI insurer, covering over 100,000 women, for life as well risks
related to houses and assets used in earning their livelihoods. It also offers health insurance
covering maternity as well.
Expanding Sustainable Outreach – Challenges and the Way Forward
The Space for Microfinance
The demand for credit by poor households has been variously estimated at Rs. 15,000-45,000
Crore. Can we take this as the demand for micro-credit services? Or should we more
narrowly define demand for micro-credit in terms of affordability and credit worthiness?
Further, when we look at demand for finance for productive purposes, can we really say that
the demand is for credit or should we examine the requirement as demand for investible
funds with equity like features?
We propose a three dimensional approach to characterising demand for microfinance:
• Asset ownership of the poor households
16
• Economic Activity of the poor households (traditional occupations, extensions from
those, and new, non traditional)
• Access to input and output markets.
Type of Activity
Potential Space for micro-
finance
Present scope
of micro-finance
Access to markets Income
We further suggest that microfinance from both the formal sector and the MFIs is currently
largely available only to a small subset of the poor in India, perhaps primarily to the set
formed at the interaction of
• the top 3 quartiles (among the poor) in terms of income/asset ownership,
• the poor engaged in traditional or extension from traditional activities, and
• the poor with reasonable access to input and output markets.
This is the subset in which all three types of microfinance players are interested and
MFIs face “crowding out�? by both the extensive formal financial sector network and the
ubiquitous informal sector. The concentration of service providers is even more in Southern
India where credit discipline is better than in the rest of the country due to a variety of
reasons. Even within this subset, there are the unreached (the socially disadvantaged e.g. the
dalits) and even for the members of this subset who are relatively better served in terms of
credit by the informal and formal sector, savings and insurance services are conspicuous by
their absence. So why have MFIs not grown by tapping into this huge unmet demand? Can
microfinance reach be extended sustainably to the poor not in this subset?
17
Savings and Insurance are conspicuous by their absence as services available to the poor.
Demand for these services from the poor has not been rigorously estimated so far. The study
cited above (Ruthven, 2001) found that rural households had up to Rs 1000 of accumulated
savings among the very poor and up to Rs 3500 among the poor, while the numbers were Rs
2,000 and Rs 4,000 for the very poor and the poor in Delhi slums. The study by Puhazhendi
and Satyasai (2000) showed that the average saving per household in bank-linked SHGs was
Rs 1,444 per annum or 5.3 percent of the average income of Rs 26,889 per annum.
Extrapolating from this and various other micro-studies cited earlier, we can say that the poor
do have an appetite to save anywhere between 5-10 percent of their incomes if doorstep
savings services were made available. This can aggregate to between Rs 5,000-10,000 crore
per annum. If one looks at the collections by Sahara India and its customer profile in Eastern
UP, this figure does not seem too far from reality.
In case of insurance, again it is estimated that the poor are willing to pay between 3-5 percent
of their incomes per annum for “comprehensive�? insurance, that is one that covers their lives
and livelihoods – or in the parlance of the industry, life, health, livestock and other productive
assets as also crops. This could add up to a premium potential of Rs 3,000 to 5,000 crore a
year if access could be organised.
How big an issue is affordability in realising this demand for savings and insurance services?
No practical answers exist to these questions because as mentioned earlier in this paper, MFIs
in India have so far been almost exclusively focussed on credit.
We discuss below some of the challenges for expanding outreach and scope, while
maintaining sustainability of microfinance providers – mainstream or MFIs.
Overcoming Geographic Concentration of the South
One of the main issues of concern is that microfinance continues skewed in its geographical
distribution. Within the predominant SHG Bank linkage mode, the Southern region
accounted for 65 percent of the SHGs linked and 79 percent of the amount disbursed. In
contrast, the North- eastern region accounted for 0.6 percent of the SHGs and 0.3 percent of
the amount. Even the densely populated and highly poor Eastern region accounted for 12.6
percent of the SHGs linked and 5.9 percent of the amount. The situation is similar in case of
the work of MFIs. Some notable exceptions are NGOs which have promoted a large number
of SHGs for linkage with banks such as the IDSSS Indore, NBJK, Hazaribagh, PRADAN all
over Jharkhand, RGVN in Assam and Orissa, PREM in Orissa and VWS in West Bengal.
Among the top 10 MFIs in the country, all but CASHPOR in eastern UP are located in the
southern states. We believe that the underlying causes are three fold:
• the general malaise in the economy of the central, eastern and north eastern states, with
very little resultant demand for credit among the subsistence poor .
• the small number of good quality NGOs, which can initiate microfinance programs in
these states. There are a large number of small NGOs but all of them with limited
experience and outreach.
• the systematic destruction of credit discipline over the last three decades, starting with
government poverty alleviation programs such as the IRDP. Thus, only very committed
microfinance institutions would be willing to take the risk of working in these states.
Based on the above analysis, one can think of a number of ways to mitigate this situation, but
all of them will require a substantial number of years. To begin with, overall economic
growth has to be increased in these states and that requires enhanced investments in the
18
natural resource base (land, water and forests) for the predominant livelihoods of the area –
agriculture, livestock rearing and forest based occupations.
Investments are needed in things like watershed development, small-scale irrigation,
livestock upgradation and forest regeneration. Unfortunately, none of these are amenable to
the “ small, short and unsecured�? nature of microcredit loans. These require long term,
lumpy public investments. However, once made, they unlock the potential for enhancing the
livelihoods of millions of poor people, moving them up from subsistence production to
surplus production and thereby increasing the demand for credit. One simple example of this
is the dramatic increase that happens in the demand for credit when irrigation becomes
available to erstwhile rainfed farmers.
A concrete proposal for increasing the number of good NGOs in these states was made in the
Xth Plan Working Group on Poverty Alleviation Programs (Planning Commission, 2002),
which recommended that well established NGOs be asked to establish branches in selected
poor districts and that they be funded for this on an assured though declining basis for the
first three to five years. The experience of the Rashtriya Gramin Vikas Nidhi and the
Rashtriya Mahila Kosh in supporting hundreds of small NGOs all over the eastern region is
useful in this regard and lessons from such experience need to be taken into account. Another
proposal has been to incubate MFIs in poorer districts under the guidance of established
MFIs. This particular proposal by BASIX, known as the “3+3+3 program�? envisages
supporting a local social entrepreneur with operating funds and on lending funds till the
operations reach break even in an estimated three years.
The third cause – credit indiscipline - can only be overcome through a combination of
sensible government actions. State governments need to be prohibited from waiving loans
and interest whenever they think it is expedient. The laws related to foreclosure and debt
recovery need to be strengthened and their enforcement made speedier and surer. This
would not normally be needed for the microcredit customers, but it would create the right
atmosphere to reduce perceived risk. Finally, risk funds to be established specially for MFIs
working in central, eastern and north-eastern states. One way to finance such risk funds is to
impose a cess on those banks, which have CD ratios below 50 percent in these states, as
indeed most of them do.
Innovation and Value Creation
The lack of sustainable innovation in microfinance is another key concern. Competitive
financial markets naturally innovate in managing risk, lengthening term structures, reducing
transaction costs and refining valuation. Competition motivates experimentation to devise
self-sustaining instruments that survive because they create value for both their buyers and
their sellers (J D Von Pischke, 1991). There has been little sustainable innovation by the
formal financial sector in India in meeting the needs of the poor. This may be explained by
the lack of competition in the sector until recently wherein the Government owned, controlled
and /or funded institutions providing a majority of the services. The informal sector is equally
monopolistic (in that close multifunctional relationships lead to strong bilateral bonds with
the providers). In any case, the informal sector is amorphous and dispersed.
But have MFIs focussed on innovation? Are Indian MFIs capable of sustainable innovation
that will extend outreach sustainably? There are several examples of partially successful
innovations and a few of truly successful ones (e.g. methodologies developed for lending for
milch animals which are now prevalent in both the formal and the MFI sector, the SHG
19
methodology). But this pace of innovation is not enough. MFIs, save a few have tended to
exclusively follow practices that are typically used by the mainstream institutions or
successful models elsewhere such as the Grameen Bank.
Accelerating strategic use of Information and Communication Technology (ICT) is critical to
addressing the transaction cost problem. Some experiments in this direction have been made,
notably by BASIX to use to give out very small loans (below Rs 1000) and collect
repayments, using smart cards readable at devices placed in STD PCOs. Though the initial
experiment has not been successful, due to a combination of technical and financial reasons,
it certainly established that there is a market for “nano-credit�? (loans below Rs 5000 or $100)
which can be profitably and efficiently served using sophisticated ICT.
Offering Composite Microfinance Services
A recent set of studies sponsored by the Institute for Development Policy and Management,
UK, (Ruthven, 2001; Patole and Ruthven, 2001), found that the extent of financial
transactions (both borrowing and lending, often simultaneously, and at all levels of income)
characterised the financial life of the poor. The aggregate financial transactions were
between 113% to 167% of the income levels of the very poor and the poor respectively, in
rural Allahabad and 149% to 135% in urban Delhi slums. The poor are thus constantly
borrowing, lending, saving, withdrawing, using and losing money, through contingencies,
and calamities. They need someone to help them with all these transactions, not in a
specialised but a composite way. To use the paradigm suggested by Morduch and Rutherford
(2003) in this volume, the poor need “convenience, reliability, continuity, and a flexible
range of services financial services�?.
Thus as seen by the poor, the specialisation developed by the financial sector is perhaps
dysfunctional. What they need is a composite service which provides them at least the three
main components, savings, credit and insurance, and perhaps add on a few services such as
money transfer, which is increasingly needed by the poor as part of the family migrates in
search of a livelihood. There are only a few examples of composite financial services, mostly
to be found among MFIs. The three top MFIs of India, are all trying to offer a composite set
of services to their customers, in spite of a fragmented and unsupportive regulatory
framework. For example,
· SEWA Ahmedabad provides a combination of savings and credit through its Sri Mahila
SEWA Urban Cooperative Bank and insurance services managed through its Vimo
SEWA affiliate, which front ends for the LIC and a number of general insurance
companies.
· SHARE in Andhra Pradesh provides savings services to its members through the Sneha
Mutually Aided Cooperative Society (MACS), in the same weekly meeting where they
gather to repay loan instalments and seek fresh loans from Share Microfin Ltd, the NBFC.
The members also insured against death.
· The BASIX group’s Krishna Bhima Samruddhi Local Area Bank, is able to provide all
the services – savings, including daily deposits collected from the doorstep of its
borrowers, credit for a range of purposes from crop loans to non-farm activities and to
SHGs; and crop insurance to farmers under the Kisan Credit Card / Rashtriya Krishi Bima
Yojana. BASIX retails life insurance on behalf of AVIVA Life Insurance Company and
provides livestock insurance to its borrowers through Royal Sundaram General Insurance
Company.
20
What is the logic for such composite services? As far as the poor are concerned, it reduces
their problem of having to deal with a number of agencies and thus reduces the transactions
costs. Moreover, if they are good savers in an agency’s record, but want to borrow from
another, this does not count in the absence of credit history registries. But if the agency is a
composite and has a good internal MIS, it can use the savings history as a “collateral�? for
loans. Similarly, if the same agency provides insurance for lives or livelihoods, it will be
more willing to give a loan. From the MFIs’ point of view, transaction costs come down as
the same delivery system can be used, with the addition of training, software and some staff.
There is need for regulators to also look at this issue. It may even be time to think about a
Microfinance Services Act, which would recognise the composite and special needs of the
poor and of institutions serving them.
Need for Changes in Regulatory Framework
Need for Strategic Attention by the GoI and RBI
Microfinance in India suffers from the fact that it is not the official responsibility of any
particular department in the Government of India or in the Reserve Bank of India. For
example, the Banking and Insurance Division of the Ministry of Finance has a Joint Secretary
in charge of priority sector lending, but that is a much bigger category than micro finance and
includes things like credit to small scale industry, agriculture, exports, small road transport
operators, professionals and self employed. On the other hand, the Joint Secretary, SGSY, in
the Ministry of rural Development is much more concerned about micro-credit, since the
SGSY program cannot move forward unless banks give out the loan component. Neither, in
any case looks after issues other than microcredit.
In the Reserve bank of India, similarly, the Rural Planning and Credit Department looks after
all rural lending (including things like Rs 3 lakh tractor loans) and micro finance is a small
subset of its charge. On the other hand, a number of issues effecting MFIs are handled by
other departments, such as the Department of Non-Banking Supervision, which looks after
NBFCs, and the Exchange Control Department. There is no department to look at the needs
of urban micro-credit.
This lack of a single point of oversight for the sector is a major lacuna. It has been
recommended by a number of task forces that micro finance should be brought within the
purview of the Banking and Insurance Division of the Ministry of Finance by redesignating
one of the Joint Secretaries as JS (Micro Finance). Similarly, in the RBI, a special cell for
microfinance, which was constituted to process the 1999 Task Force report and was dissolved
thereafter, needs to be re-established so as to coordinate across various RBI departments and
with the GoI, NABARD, SFMC, Sa-Dhan and the major MFIs. There is also a continuing
need for the sort of group established by the Prime Minister’s Office in 2001 on financial
flows to the informal sector.
Banks and Insurance Companies to Have Universal Service Obligation
The next most important change that needs to be made in the policy thinking is the need to
establish the equivalent of the universal services obligation for banks and insurance
companies. This concept is widely accepted in case of other infrastructure utilities such as
telecom and electric power. Yet for something as fundamental as savings and credit services,
the Reserve Bank of India does not assure that these are available to all and thus over two-
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thirds of the productive enterprises and farmers in the country do not even have bank
accounts, leave alone credit.
The regulator should be held accountable for market development and ensuring that a
reasonable level of service by mutually competing service providers is available to all
citizens of India and in all parts of the country, without discrimination. We cannot have a
situation where the regulator accepts for decades a credit deposit ratio of 20-30 percent for all
the states in the eastern and north-eastern regions. It is not enough to hold banks accountable
for this, the RBI has the responsibility as well. The present definition of the priority sector is
so broad that loans of a few crore to diamond polishing small scale units in Surat also counts
as priority. This needs to tightened to its original intent. At the same time, interest rates on
priority lending should be deregulated so as to encourage banks to look at this as a profitable
business. The same thinking should be applied to premiums on small insurance policies.
Need for a Graduated Legal and Regulatory Structure for Microfinance
The MFIs will benefit substantially by the streamlining of an appropriate legal and regulatory
structure for them. Given the fact that most MFIs are NGOs to start with, we suggest the
following step-wise legal and regulatory structure (see table below).
The main changes from the existing regulation is to establish a specialised NBFC for
microfinance with Rs 25 lakh as a start up equity instead of Rs 200 lakh at present. The
second change suggested is to reduce the entry level equity requirement for three district local
area banks from Rs 500 lakh to Rs 100 lakh. In both cases, we are recommending that
capital adequacy of 20 percent be maintained as the loan assets of these entities grow. The
reduction in capital requirement is only at the start.
Finally, in line with nearly 40 other countries it is time that India though of allowing the
establishment of RBI licensed microfinance banks. These should be allowed, like the RRBs
to undertake lending only to micro finance customers as defined by RBI and should be
allowed to take deposits from anyone. Since they would have an all India licence, they
should be bringing in at least Rs 25 crore of equity at start up and thereafter maintain a capital
adequacy of 12.5 percent. All the other prudential norms should be applicable, save and
except the requirement that no more than 15 percent of the portfolio be unsecured, since a
large part of micro finance loans are unsecured.
Similarly, the IRDA needs to examine ways to reduce the capital requirements for insurance
companies or cooperatives which would be engaged in micro-insurance exclusively. There
should be a provision for insurance mutuals at lower entry level capital, but perhaps with
mandatory re-insurance.
Proposed legal forms, capital requirement and regulatory framework for MFIs
Legal Form Minimum Capital To be regulated Functions Allowed
Requirement and capital by
adequacy
NGO-Society or Nil but limit micro-credit Self –Regulating Only micro-credit up to
Trust outstandings to Rs 50 lakh Organisation Rs 20 lakhs
(SRO)
Section 25 company Rs 5 lakh, but limit micro- SRO and Micro –credit and
credit outstandings to Rs 50 Registrar of insurance retailing
lakh Companies
Microfinance Rs 25 lakh and 20 percent RBI Micro-credit, savings
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Non-Banking of risk assets after Rs 125 from borrowers and
Finance Company lakh of risk assets. insurance retailing
Microfinance Local Rs 100 lakh and 20 percent RBI – DBS Micro-credit, savings and
Area Bank of risk assets after Rs 500 insurance retailing,
lakh of risk assets. limited to 3-5 districts
Micro Finance Bank Rs 25 crore and 12.5 RBI – DBS Same as above but with
percent of risk assets after no area restriction. Some
Rs 200 crore of risk assets. changes in prudential
norms needed.
Mutual Insurance At present Rs 110 crore, to IRDA Allow to offer life and
cooperatives be reduced appropriately livelihoods insurance by
this to members, with
reinsurance
Encouraging Multiple Sources of Equity and ECBs to MFIs
In order to ensure that MFIs have a possibility of being incubated, a number of sources for
equity need to be encouraged. Since NGOs are often the progenitors of MFIs, they should
be allowed to invest in MFI equity. This is currently not allowed due to the charitable status
of NGOs under the Section 11 and 12 of the Income Tax Act. However, the government can
use the provision of Section 11(4)(xii) of the IT Act which gives the power to allow
charitable entities to invest in specified securities. This could be used to permit investments
in selected MFIs meeting pre-specified criteria so that the danger of misuse is limited.
Another route would be to encourage equity investments in MFIs by the new generation
private banks, which today do not have an extensive branch network, particularly in rural
areas and small towns. They could thus be investing in MFIs as compared to say, ATM
networks. Conceptually both are ways of extending outreach to customers.
Third, equity investment by foreign donors, development finance institutions and persons of
Indian origin should be encouraged. While this is allowed at present, the minimum amount
allowed is $ 500,000 which far too high for most such investors and indeed for most
recipients. This is particularly so because the foreign equity cannot be more than 51 percent
and bringing in $ 500,000 requires raising an equal amount (almost Rs 2.3 crore) from India.
This is much too high for requirement of most specialised MFI NBFCs. Finally, the only
source of equity in India, the SIDBI Foundation for Micro Credit (SFMC) should be
encouraged to disburse from its DFID supported MFI equity fund of Rs 45 crore.
In addition to equity funds, MFIs need lending funds, which at present they can only raise as
loans. While Indian banks have been lending more easily to MFIs than earlier, the supply
is still limited. Till 2002, a number of foreign donors and development finance institutions
were lending money to MFIs under the external Commercial borrowing scheme, which had
been considerably simplified by the RBI over the years. . However, in 2002, the RBI has
stopped allowing ECBs to NGO-MFIs and from donor agencies, on the grounds that neither
are regulated financial institutions. Given the fact that the country has over $ 80 billion of
foreign exchange reserves, there is no reason why the RBI should stop small ECBs of 1 or 2
million dollars when the lender and the borrower are legitimate and agree on the terms. .
Permitting MFIs to Take Savings with Safeguards
However, borrowings cannot be the sole or the long term source of funds for lending. Thus,
MFIs have to be allowed to take deposits. While, the RBI is rightly concerned about
allowing deposit taking to loosely regulated entities the safeguard we suggest is to confine the
deposit taking by MFIs to only its borrowers and to impose an appropriate level of Statutory
23
Liquidity Reserve. This can be monitored on a quarterly basis and any misuse should be
dealt with by closure of the concerned MFI. Given the fact that the poor need to save much
more than they need to borrow, the offering of saving services by MFIs is useful for this
purpose also.
Another problem is that regulations, such as high entry-level capital requirements, restrictions
on deposit taking and on use of agents, upper limits on unsecured part of the loan portfolios,
are all designed for the mainstream financial sector. The regulators, jointly with the MFIs,
must also evolve prudential norms which are more appropriate to institutions serving the poor
and set up supervision mechanisms around those.
How the conventional wisdom of financial sector regulation is not always right for the good
of the majority can be seen from an article on the Bank for Agriculture and Agricultural
Credit, (BAAC), Thailand, by Townsend and Yaron (2002). They have taken a contrarian
view of the real worth of development banks, even if those are subsidised, as the BAAC is.
They describe the de facto operations of BAAC, which includes roll-overs of loans to farmers
in bad years, thereby offering a kind of insurance-cum-loan package. These roll-overs,
earlier criticised as attempts to disguise defaults, are now seen as a form of welfare enhancing
device for farmers, who can continue to access cheap credit the following year and then repay
both the current and the earlier loans. They conclude:
“the bottom line, and the main policy implication of the article, is a new system for the evaluation of
financial institutions, including state development banks, which should not be assessed merely on
their financial profitability grounds… Overly stringent and ill-conceived regulation of financial
institutions…can have welfare-reducing effects…financial institutions with dear accounts and
reasonable profit margins may fail nevertheless to provide desirable financial services…likewise
financial institutions in developing countries that allow exceptions and delayed repayments should not
be judged a priori to be inefficient as was the BAAC…�?
Enhancing Institutional Capacity
The banyan tree and bonsai metaphor really comes to mind when one focuses attention on
issues of institutional capacity building for microfinance in India. We deal with this in three
streams:
Cooperatives, including SHG Federations, Banks and MFIs. Each of these have shown the
promise to grow into Banyan trees but the promise has been belied and their effectiveness
limited by a variety of factors.
Cooperatives were the original modality conceived to deliver “microfinance�? – at that time
mainly agricultural credit. Starting as early as 1904, the sector received increasing levels of
state patronage which eventually became state control. The growth of institutions in the
cooperative sector has been inhibited because of state cooperative laws permitting, indeed
encouraging, interference by the government in the day-to-day affairs of the cooperatives.
While these laws are extant in states like Tamilnadu, the government can appoint an
administrator, supercede the elected board, defer or cancel elections, appoint auditors and so
on. This has made cooperatives effectively into government departments. Yet, credit for
agriculture, the most important livelihood, is largely supposed to be extended through this
channel. It is only when it became apparent that this channel is not working that alternatives
were established for agricultural credit through commercial banks (which were nationalised
partly for this objective) and then the network of Regional Rural Banks (RRBs). The laws
related to cooperatives have been reformed in some states, with Andhra Pradesh leading in
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1995, and similar laws spreading to the Madhya Pradesh, Chhattisgarh, Bihar, Jharkhand,
Uttaranchal, Rajasthan, Punjab, Jammu and Kashmir, Orissa and Karnataka.
In AP, over 2600 mutually aided thrift and credit cooperatives (MACS) have sprung up since
the 1995 Act was promulgated. This modality is found to be quite useful for establishing
community based microfinance institutions, as has been done in a concentrated way in
Karimnagar and Warangal districts by the Cooperative development Foundation (CDF,
renamed in 2003 as Saha Vikasa). Unlike CDF, which promotes MACS of 300-500 members
living a village or two-three nearby villages, the other design that has emerged in AP is to
establish MACS of self-help groups. Such SHG federations are gain at two levels – at the
village, comprising 10-15 SHGs in a village, and at the higher level, comprising 100-300
SHGs in a cluster/mandal of 20-20 villages.
However, a number of “top-down�? MACS have also been established, either by enthusiastic
government officials or by promoters where the erstwhile government control has been
replaced by “promoter control�? and member involvement is limited to carrying out
transactions. These MACS are already showing signs of a number of shortcomings of earlier
generation cooperatives, such as cornering of funds by a few member-“leaders�?, lack of
accounts and accountability, and dependence on outside funds and human resources. Thus
the lesson is that capacity building of microfinance institutions has to be done step by step
and from the bottom up, by patient support agencies like the CDF. In their absence, the
chances of truly member-managed cooperatives emerging are little.
In the formal banking sector, an attempt was made to establish a second tier of banks, the
RRBs, aimed at the rural, micro market, as far back as 1976. But, with few exceptions, RRBs
have been stunted by a three way split in their ownership (50 percent, Government of India,
35 percent Sponsor bank and 15 percent, State Government), with the main shareholder too
distant and distracted to play an effective governance role. Thus, the RRBs suffered and
never achieved more than 8 percent of the total formal institutional credit in rural areas. Since
1996, their mandate to serve exclusively the small and marginal farmers, landless labourers
and rural artisans was diluted and RRBs were allowed to lend up to 60 percent of their
advances to the “non-target group�?. The Credit-Deposit ratio of RRBs as a whole is at
around 40 percent and a majority of RRBs continue to have low capital adequacy if not
negative net worth, in spite of recapitalisation. Thus the RRB story is a case of neither access
nor sustainability. The issue of delivering microfinance through banks remains unresolved,
though the SHG-Bank linkage program is promising in this respect. The Ministry of Finance
appointed Chalapati Rao Committee to Review RRBs (2002) has made a number of
recommendations to improve the governance, management, operations and products of RRBs
and make them more oriented to their original target group. These must be implemented
forthwith.
For MFIs, institutional capacity building has been inhibited because MFIs are often NGOs
and microfinance is just one of a suite of development interventions used by them. This has
had implications for the type of skill sets drawn to the sector as well as scope and ambition of
such initiatives. The MFI sector, with few exceptions, has not been able to attract talent from
the mainstream financial sector. Nor has it been able to attract mainstream capital. For this to
happen, at least the larger NGOs’ microfinance programs have to be moved over to newly
incorporated non-bank finance companies (NBFCs) or even Local Area Banks
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Conclusion
The microfinance sector in India cannot be seen in isolation of the overall economy – the
economy comprising nearly 110 million agricultural holdings, over 60 percent of those with
an area below 1 hectare, and nearly 35 million non-agricultural enterprises. The financial
system of India must respond to this large base, only one-third of which is perhaps reached
by the formal sector in any significant way. The thrust of the policy since the onset of
financial sector reform in 1993 has been on restoring the profitability of banks and reducing
their non-performing portfolios without adequate attention to outreach. The stark reduction
of bank credit proportion to small borrowers from 18 percent in 1994 to 5.3 percent in 2002
shows that the challenge of extending financial services, at least to all the productive citizens
of the country, must be tackled afresh. The microfinance sector, particularly the Self-Helf
Group – bank linkage program appears to have the potential of becoming a big banyan tree
(including the adage that nothing may grow under its shade). However, if we review the
details of the microfinance efforts in the last two decades, the image that comes to mind is
that of a bonsai. There is a need for a policy and regulatory thrust to facilitate not banyan
trees but a bio-diverse forest, with plurality of institutions and methods in symbiosis with
each other. And the mainstream must play its role in this bio-diverse forest.
The citizens of this country have a right to demand that basic financial services be universally
be available at reasonable rates and from a number of mutually competing sources.
Regulatory authorities, particularly the RBI, need to accept their responsibility for the state of
affairs where banks shirk from serving over two-thirds of India’s households. Thus “universal
service obligations�? must be imposed on banks and insurance companies. At the same time,
regulations on interest rates and insurance premiums and use of any type of distribution
methodology or intermediary must be removed so that the service providers can address this
market profitably and out of self-interest rather than as a social obligation.
The regulators must also evolve a framework, if necessary jointly between the RBI and the
IRDA, to ensure that the poor get access to composite financial services and do not have to
deal with four different entities for savings, credit, life insurance and livelihood insurance
needs. The use of advanced information and communication technologies and multiple
methodologies must be encouraged, to lower costs and promote competitive services. For
this, the regulations related to the legal framework, entry-level capital, raising equity and
borrowings, and deposit-taking, need to be reworked to encourage a larger number of players
to enter this field and provide reliable microfinance services on a sustainable basis.
26
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