A Primer on Microfinance - UP Academy

A <strong>Primer</strong> on MicrofinanceU. B. DesaiSPANN Lab.Dept. of EEIIT-Bombaywww.ee.iitb.ac.in/~ubdesai

Some Basic Question Why do we need finance? Why the special need for finance for theunderserved communities? Why do poor still go to unorganized financialinstitutions (money lenders, shaukars, , ...)?Oct 2008 IT 625: ICT4SED2

Why is the spread of microfinance soslow? Why are commercial banks hesitant toenter microfinance?Oct 2008 IT 625: ICT4SED3

Some Basic QuestionWhy do we need finance?credit is an instrument for investment and growth.Why the special need for finance for the underserved communities?Same as aboveShift in Perspective: From poverty alleviation to wealth generation---microfinance will enable wealth generationWhy do poor still go to unorganized financial institutions (moneylenders, shaukars, , ...)?We will look at this during the talkWhy is the spread of microfinance so slow?Commercial financial institutions are not ready to enter this arenaWhy are commercial banks hesitant to enter microfinance?We will explore this in the talkOct 2008 IT 625: ICT4SED4

General Belief Poor are too difficult to reach. Small loans to poor is not a financiallyviable proposition Financial institutions will loose moneywhen they give microcredit to the poor Microcredit or microloans will only increasethe debt burden for the poorDo you agree? What is your opinion?Oct 2008 IT 625: ICT4SED5

Microfinance (mFI(mFI)A clever scheme forsmall-savings savings and small-loan for the underservedcommunityA financial service for thepoorA financial approachempowering the poorMicrofinance brings inincremental changesIt does not bring indramatic changes like theones that occur when acompany goes in for anIPOMicrofinance may also beconsidered a tool to givepoor people theopportunity to participatefully in economic lifeWill improve the villageeconomyFacilitate increase in cashflowBring more villages into themarket; monetize morevillagesHelp generate trade thrumicro-enterprisesOct 2008 IT 625: ICT4SED6

Microfinance: Interplay Among .. Institutions: Access points for the poor to get financial services(e.g. SEWA, Grameen Bank, etc.) These could be bank branches (could be virtualbranches), socially oriented financial institutions, or apartnership between the two Funding Sources: Domestic savings (~70%),“private socially responsible citizens” (~30%) Infrastructure: Here ICT can play a major roleOct 2008 IT 625: ICT4SED7

Unorganized mFI Institutions (mFI(mFI)Exorbitant interest ratesOn the low end 3% per month(36% per annum)can be much moreOften collateral, like cattle,jewelry, etc not returnedOften the poor get into a debtcycle for life!UmFI does not give loans forsustainability (for e.g. startinga micro-enterprise!)Oct 2008 IT 625: ICT4SED8Still the poor approach UmFI ---- Why?Always available (always on!)You get it when you reallyneed itQuick disbursementNegligible transaction timePoor go for micro-loans justbefore they really need itLoans without collateralDependence of low-incomehouseholds on informalsources for loans is nearly 78per cent.The poor not only has low income but irregular cycle of paymentsand withdrawals. The informal financial institutions (money lenders)satisfy this need to the tee

UmFI: : Case of Solapur District Collateral based lending Gold is typically the collateral Borrowers: small time officeclerks, peons, … people whohave permanent jobs Collateral amount is 1.5 timesthe loan value Loans taken for illness, familyfunction, etc. Interest is 3% per month Default rate 80% -- most ofthe time gold is confiscated About 100 lenders eachlending about a Rs.10 lakhs;totaling Rs.10 crs. Lending without collateral Interest rates are around 3%per month Repayment is on a daily basis Hawker, vegetable vendors willgo for such loans Often, most of the incomegoes in loan payment About 200 to 300 lenders inthis category Each loaning about 5 to 10lakhs Totaling about 20 crsOct 2008 IT 625: ICT4SED9

Some Facts There are an estimated 3,000 microfinanceinitiatives serving the world's poor scarcity of money and participation by commercialfinancial institutions has limited their expansion. More than 70 percent of them serve fewer than 2,500borrowers each. Only 30 microfinance initiatives have grown toserve more than 100,000 poor borrowers. The largest mFI, Grameen Bank in Bangladesh,reaches more than 3 to 4 million borrowers. A total of $4 billion has been disbursed sinceGrameen started giving loans in 1976 with seed loansstarting as small as $35.Oct 2008 IT 625: ICT4SED10

India …Earliest InitiativeShri Mahila SEWA (Self Employed Women’s s Association)Sahakari Bank was set up in 1974Since then, the bank is providing banking services to the poorself-employed employed women working as hawkers, vendors, domesticservant etc.SEWA bank has 1,75,000 depositors; about 70% from urbanarea, 30% from rural areasThe deposit and loan portfolio stood at Rs 623.9 million($13.86 million) and Rs133.6 million ($2.97 million)respectively.Though SEWA mFI is making profit, yet the SEWA bankmodel of mFI has not been replicated elsewhere in thecountryVery low default rateOct 2008 IT 625: ICT4SED11

India … Today, there are about 60,000retail credit outlets of theformal banking sector in therural areas comprising 12,000 branches of districtlevel cooperative banks over 14,000 branches of theRegional Rural Banks (RRBs(RRBs) over 30,000 rural and semi-urban branches of commercialbanks besides almost 90,000cooperatives credit societies atthe village levelOn an average, there is atleast one retail credit outlet forabout 5,000 rural peopleWhile there is no publisheddata on private mFIs operatingin India, the number of mFIs isestimated to be around 800. Not more than 10 mFIs arereported to have an outreachof 100,000 microfinanceclients. An overwhelming majority ofmFIs are operating on asmaller scale with clientsranging between 500 to 1500per mFI.Oct 2008 IT 625: ICT4SED12

Target Populace for muF Rural Poor Women Asset value less than Rs. . 20,000/- Per capita income is less than Rs. . 350/-per month Live in poor housing conditions(from SHARE Microfinance Ltd.)Oct 2008 IT 625: ICT4SED13

Different type of Microfinance InstitutionsInstitutions that offers financial services to low incomepeople at the prevailing market rates.Most of these provide microcredit and accept small payments forsaving and repayment of loans.They do not take saving from the general public. They takesavings from their cliental – mainly the low income group.NGOs which are wholly involved in this or partly. Theones partly involved do several other work that is doneby an NGO.Credit UnionsPrivate commercial banksNon-bank financial institutionsOct 2008 IT 625: ICT4SED14

Often one classifies financial institutions like National Bank for Agriculture and Rural Development(NABARD) Small Industries Development Bank of India (SIDBI) Rashtriya Mahila Kosh (RMK)as mFIs; But, I feel ,they do not fit the bill, because theydo not cater to the kind of income talked aboutearlierOct 2008 IT 625: ICT4SED15

Appropriateness of mF mF works best for those who have identified anopportunity and the credit can be used to exploitthis opportunity to develop a sustainable sourceof income. Microfinance is not appropriate for Extremely poor, destitutes There has to be some viable way of micro-loanrepayment People who are extremely poor may get into debttrap with microfinance Numbers vary, but some feel that one has to have98% loan repayments rate for an MFI to succeed.Oct 2008 IT 625: ICT4SED16

Some Data on Financial Sector in RuralAreas (2002)For 630,000 villages we have32,443 bank branchesOf the ~67,000 bank branchesin India, ~32,500 or ~48 percent are in rural IndiaThe average population servedby a rural bank is approx.15,000Overall, 18 per cent of therural population has bankaccounts. The comparativefigure in urban Indiais almost 100 per centThe per capita deposit in ruralareas is Rs 2,000Dependence of low-incomehouseholds on informalsources for loans is nearly 78per cent.Oct 2008 IT 625: ICT4SED17

Share of Different Sectors in GDP(GDP at factor cost, 1993-94 Prices)Rs. In croresAgri.IndustryServicesTotalServices%1970-711373204615111343829627838%1980-811592937068717114840112843%1990-9122311415038331937469287146%2000-01285877263797649011119868554%2001-02302054272359691016126542955%2002-03292625288266739842132073356%-- RBI, Handbook of Statistics on the Indian EconomyOct 2008 IT 625: ICT4SED18

Breakup of Indian GDPGDP for India: $1000 billion 12 th largest in the word Approx. 4000 billion base dpn PPP Rural GDP: ~$250 billion (25%)Compare this withIT industry, which is~ $ 20 billion22%56%22%Oct 2008 IT 625: ICT4SED19

Credit to Deposit (CD) Ratio for banks in India• Rural CD ratio needs to brought upto 60%• Low CD ~ a lot of cash is idling, or cash collected in rural areas is usedto give credit to urban areasOct 2008 IT 625: ICT4SED20

Different Financial Services underMicrofinance Deposit services Credit lines Term loans Money transfers Micro-Crop and life insurance Micro health insuranceOct 2008 IT 625: ICT4SED21

Innovation in Microfinance Development of finance products for theunderserved Management of credit risk (minimizationlosses in giving credit) Scalability: how to reach a vast, diverse,not easy to reach and geographicallyscattered populace Efficient delivery of microcredit exploit technologyOct 2008 IT 625: ICT4SED22

Gautum Ivatury:Focus Notes, Jan 2006, CGAP(Consultative Group toAssists the Poor)www.cgap.orgOct 2008 IT 625: ICT4SED23

Microcredit Delivery of microcredit has to be done more andmore efficiently Here ICT can play a major role Determination of a borrower's willingness andability to repay a loan is critical if a microlenderis to minimize credit risk Willingness to repay a loan are complex anddetermined by economic, legal and moral incentives Legal systems and community pressure (for rural areas)contribute to a borrower's willingness to repay a loan Ability refers to a borrower having the financialresources to make a scheduled loan payment.Oct 2008 IT 625: ICT4SED24

Three operational areas on which amicrolender should focus to minimizecredit risk: loan design underwriting loan servicingOct 2008 IT 625: ICT4SED25

Micro-Loan DesignBalance between affordability needs of borrowers andcosts to micro-lendersRevolves on the design of interest rates (must(cover operatingcosts, credit risk and funding costs)Interest are very critical to microfinance institution mFI interest are not very low at present 15% to 36% per annum (SEWA charges 15% to 18%) Note: RBI interest ceiling is 21%On the other hand, for rural poor, it has been observedthat the amount of monthly payment is much moreimportant than interestAs long as they are comfortable with the scheduled paymentamount they do not worry too much about interest ratesOct 2008 IT 625: ICT4SED26

Micro-loan Underwriting The process of determining a borrower'scredit worthiness ability and willingness to repay a loan Most important from the microlender’spoint of viewOct 2008 IT 625: ICT4SED27

Micro-Loan ServicingLoan servicing is the act of collecting payments and maintaining thebalance of a loanIn commercial banking, loan payments are made by bank draft or by bdirectly debiting payroll or a bank account.Things are not easy in the world of microfinance.The typical borrower does not have access to a bank account and oftendoes not receive a formal salary.This means that for many customers of microlenders making loanpayments can be difficult and put them in the position of making thechoice to take time off from work (and possibly get fired) in order todeliver a loan payment or choose not to make a payment.Successful lenders will set up payment kiosks in communities. Thekiosks are typically open before the typical work day starts and after itends.Another effective method, albeit more labor intensive is door-toto-doorcollections.Oct 2008 IT 625: ICT4SED28

Micro-Loan Servicing …Provide positive incentives for payment.Borrowers respond well to positive incentives for good paymenthistory.Microlenders and mortgage lenders have successfully usedincentives such as payment rebates, small appliances and foodto achieve very high levels of repayment.For example, one Mexican lender offered a free bag of corn mealif a borrower made timely payments for six months. The resultwas a delinquency rate of less than 1%Be proactive in dealing with delinquencies.Rather than wait until a loan goes into default, a microlendershould investigate a loan within weeks of it first becomingdelinquent.Often, the cause of a delinquency is due to illness orunemployment.If caught early enough a lender can give the borrowerassistance as well as workout a equitable repayment plan.Oct 2008 IT 625: ICT4SED29

ChallengesEstablishing the idea of access to financial services ashuman right; just like health care, education etc. arebasic rights (Mathew Bishop, Business Editor of TheEconomist)Managing credit risks in microlending operationsConvincing, for profit organizations like establishedbanks, non-bank financial institutions, that microfinanceis a good business opportunity and they should commitlarge capital to establish this business.Also convincing them that charity (funds donated by establishedorganization) is not a sustainable way for growthDeveloping a market driven interest rate schedule forthe poorOct 2008 IT 625: ICT4SED30

Challenges …Reaching people in sparsely populated, diverse, not easy to reach,and geographically scattered areasLast mile problem of reaching the rural poor.Most important challenge is to exploit technology to reducetransaction costs so that financial institutions will indeed take e upmicrofinance as one of their major service.Reaching the poorest of the poor – the destitute:Many ignore this segmentVery difficult for a commercial institution to recover micro-credit credit givento this segmentHere Government will have to step n develop a scheme for micro-grantsMake microfinance part of main stream financial marketData Collection – need to collect data that can indicateOct 2008 IT 625: ICT4SED31

One Approach exploiting ICTRural ATMProviding ICT based Rural Banking• Developed by the TeNetgroup of IIT-Madras• To be deployed in village kiosksin collaboration with ICICI bank• Low cost rural bank• Deposits, withdrawal, and loans• Cost of rural ATM: Rs40,000/=• Conventional ATM costs:Rs.7,50,000/=• Uses extremely low cost fingerprint authentication system(Rs.50/=)• Use of plastic ID cards “smart orotherwise” not viable in ruralareasOct 2008 IT 625: ICT4SED32

Another Approachexploiting ICTExploit Cell-phone,Smart-Phone PlatformGrowing at a phenomenalpace 300 mil cell phones Cost of deployment inurban areas:Landlines – Rs.20K per lineCellular --- Rs. . 3K to 3.5Kper lineAnnual business ofhandset reachingRs.10,000 crore ($220mil), , comparable to colortelevisions – indicatingaffordability.7-99 mil new connectionsacross the country everymonthOnly ~20 mil PCs in IndiaOct 2008 IT 625: ICT4SED33

Microfinance is a necessary inputfor rural wealth generationbut by no means sufficientOct 2008 IT 625: ICT4SED34

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