MICROFINANCE MATTERS - The Future of Microfinance in India

I recently participated in the Microfinance India conference (New Delhi, April 12-14, 2005), organised by CARE India, PlaNet Finance India, the United Nations Development Programme, the Small Industries Development Bank of India, SADHAN, CGAP, ICICI Bank, Ford Foundation and Friends for Women's World Banking to mark the International Year of Microcredit. The key themes of this conference were "Inclusion, Impact, and Innovation in the Microfinance Industry".

This was the second annual event of what is now becoming a large annual gathering to celebrate successes, discuss perspectives and research, and build networks around the microfinance sector in India. Reconnecting after a few years, I was pleased to see all the buzz about microfinance and the number and diversity of stakeholders who collaborated on the conference. The number and diversity of delegates, the level of participation from senior policy makers and bankers and the quality of debates and media attention confirms that microfinance is no longer at the periphery of the financial sector in India. This short note is a personal reflection on what has changed, what may take a long time to change and what India and the rest of the World may learn from each other.

A Long History of Social Banking

India has supported social banking for a long time. Policy directions to rapidly expand rural branches, mandate credit allocations for priority sectors (including agriculture), deliver large subsidy oriented credit programmes to serve marginal communities and poor households and control interest rates have been tried for over 35 years.

The new generation microfinance was slow in coming to India. Low levels of grants to microfinance institutions, an unfavourable policy environment, substantial traditional banking infrastructure and a search for context specific solutions has constrained rapid scale up. The first breakthrough emerged from policy support to enable informal self help groups of 15-20 members (mainly women) to transact with commercial banks. These groups build up and rotate savings amongst themselves, open bank accounts and take responsibility for lending and recovering money financed by banks. With the missionary zeal of the National Bank for Agriculture and Rural Development (NABARD), insights gained by NGOs, the increasing enthusiasm of bankers and politicians and emerging successes in repayment and social impacts, this national movement now encompasses 1.4 million such groups (over 20 million members).

At a time when many questioned the need for specialised microfinance institutions (MFIs) in India, the Small Industries Development Bank of India recognised the opportunity and started implementation of an ambitious national programme. Providing loan and capacity building support to MFIs and capacity building and rating support for sector development, this programme already supports 70 MFIs and has disbursed US$46 million.

What is Exciting about Indian Microfinance?

A Task Force on Microfinance recognised in 1999 that microfinance is much more than microcredit, stating: "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". The Self Help Group promoters emphasise that mobilising savings is the first building block of financial services.

For many years, the national budget and other policy documents have almost equated microfinance with promoting SHG links to the banks. The central bank notification that lending to MFIs would count towards meeting the priority sector lending targets for Banks offered the first signs of policy flexibility towards MFIs. One could argue that MFIs are small and insignificant, so why bother. The larger point is about policy space for innovation and diversity of approaches to meet large unmet demand. The insurance sector was partially opened to private and foreign investments during 2000. Over 20 insurance companies are already active and experimenting with new products, delivery methodologies and strategic partnerships.

Microfinance programmes have rapidly expanded in recent years. Some examples are:

Since banks face substantial priority sector targets and microfinance is beginning to be recognised as a profitable opportunity (high risk adjusted returns),[1] a variety of partnership models between banks and MFIs have been tested. All varieties of banks - domestic and international, national and regional - have become involved, and ICICI Bank has been at the forefront of some of the following innovations:

The 2005 national budget has further strengthened this policy perspective and the Finance Minister Mr P. Chidambram announced "Government intends to promote MFIs in a big way. The way forward, I believe, is to identify MFIs, classify and rate such institutions, and empower them to intermediate between the lending banks and the beneficiaries."

What is beginning to happen in microfinance can be seen from the perspective of what has happened to phones in India. With the right enabling environment, and intense competition amongst private sector players, mobile phones in India expanded by 160% during just one year 2003-04 (from 13 to 33 million). Mobile tariffs fell by 74% during the same period. While this is heady progress, there is a less heralded but even more powerful nationwide success on access. In the late eighties, the phone infrastructure was the monopoly of public sector institutions. Phones were difficult to get and even more difficult to use for those lacking ownership. Realisation that users need not own a phone to access one led to privatisation of the last mile - where a phone user could interface with a private sector provider using the public sector telecom infrastructure. Even with this policy change, today there are 2.5 million entrepreneurs selling local, national and international phone services through the length and breadth of India. Many of these are now graduating to sell internet services and could potentially be banking agents - that is the evolving story.

Savings services are needed by many more customers and as frequently as access to phone services. Many poor households value access to savings services and find new providers and arrangements, despite hearing of unreliable savings collectors or even occasionally falling prey to such arrangements. Many customers are rich, literate and lucky to have banks working for them. But many others lack access to safe, secure and accessible savings services for the short, medium and long terms.[2] In the past, many banks sent collectors to gather these savings but problems with monitoring, inability to tackle misappropriation and the rising aspiration of collectors to become permanent staff of public sector banks killed a useful service. The central bank has strictly forbidden commercial banks from using agents in collection of savings services. This is unfortunate as:

Fortunately, the 2005 Budget opened a small window in this area and the central bank annual policy recently confirmed discussions on this: "As a follow-up to the Budget proposals, modalities for allowing banks to adopt the agency model by using the infrastructure of civil society organisations, rural kiosks and village knowledge centres for providing credit support to rural and farm sectors and appointment of micro-finance institutions (MFIs) as banking correspondents are being worked out." But readers may note that between the budget and the annual policy statement, "credit" has again crept in as the key perceived need.

Challenges Remain

A World Bank study assessing access to financial institutions found that amongst rural households in Andhra Pradesh and Uttar Pradesh, 59% lack access to deposit account and 78% lack access to credit. Considering that the majority of the 360 million poor households (urban and rural) lack access to formal financial services, the numbers of customers to be reached, and the variety and quantum of services to be provided are really large. Vijay Mahajan, Managing Director of BASICS, estimated that 90 million farm holdings, 30 million non-agricultural enterprises and 50 million landless households in India collectively need approx US$30 billion credit annually.[4] This is about 5% of India's GDP and does not seem an unreasonable estimate.

A tiny segment of this US$30 billion potential market has been reached so far and this is unlikely to be addressed by MFIs and NGOs alone. Reaching this market requires serious capital, technology and human resources. However, 80% of the financial sector is still controlled by public sector institutions. Competition, consolidation and convergence are all being discussed to improve efficiency and outreach but significant opposition remains; for example, the All India Bank Employees Association has threatened to strike if the Government proceeds with its policy of reducing its capital in public sector banks, merging public sector banks or even enhancing Foreign Direct Investments in Indian private banks.

Many speakers at the Microfinance India conference talked about the significant and growing gap between surging growth in South India, which contrasts with the stagnation in Eastern, Central and North Eastern India. Microfinance on its own is unlikely to be able to address formidable challenges of underdevelopment, poor infrastructure and governance.

The Self Help Group movement is beginning to focus on issues of quality and there were some interesting discussions on embedding social performance monitoring as a part of the regular management information systems.

At the time of the conference, a leading and responsible MFI was being investigated by the authorities for charging "high" rates of interest. Per unit transaction costs of small loans are high but many opinion leaders still persist with the notion poor people cannot be charged rates that are higher than commercial bank rates. The reality of the high transaction costs of serving small customers, their continuing dependence on the informal sector, the fact that most bankers shy away from retailing to this market as a business opportunity, and the poor quality of services currently provided does not figure prominently in this discourse. While the central bank has deregulated most interest rates, including lending to and by MFIs, interest rates restrictions on commercial bank for retail loans below US$5,000 (all microfinance and beyond) remain and caps on deposit rates also discourage sharing transaction costs with customers.But most conference participants accepted the imperatives to build sustainable institutions.

There is still lot of policy focus on what activities are and are not allowed and not enough operational freedom as yet for banks and financial institutions to design and deliver programmes, and be responsible for their actions. Prescriptions and detailed circulars often limit organisational innovation and market segmentation. As Nachiket Mor of ICICI Bank said at the conference, if the right indicators are monitored and operational freedom and incentives are clear, both public and private banks have the capacity to rapidly address the remaining challenges.

Closing Remarks

In my view, savings service is the neglected daughter of the family of financial services. I use this metaphor because of the sustained discrimination against and frequent disregard for savings services, despite their productive and reproductive role in financial services[5]. This is evident from different nomenclature used at both the international (UN International Year of Microcredit, MicroCredit summit) and national levels (Priority Sector Lending; Annual Credit Policy; Credit/ deposit ratio). Savings services can be a useful entry point for the unbanked to build up a history with the formal financial institutions before customers are entitled to other financial services. With the greater spotlight on knowing the customer and the fact that poor households do not have a salary slip, utility bills, clear land titles or unique identity papers, a regular savings record could be the first building block to membership of the formal financial sector. What is more, with savings services, poor customers need to trust the financial institution and not the other way round.

Microfinance is not yet at the centre stage of the Indian financial sector. The knowledge, capital and technology to address these challenges however now exist in India, although they are not yet fully aligned. With a more enabling environment and surge in economic growth, the next few years promise to be exciting for the delivery of financial services to poor people in India.

I would like to congratulate CARE, as the lead organisers, for successfully hosting this global cross learning event. Unusually, the event ended with a statement of some objectively verifiable indicators (such as expansion of urban microfinance, increased conference participation by public sector banks and redressal of North South divide) on which the sector should track progress in a years' time.

* The views expressed herein are those of the author, and do not necessarily reflect those of DFID.

(1) See for example Small Customers, Big Market: Commercial Banks in Microfinance, Edited by Malcolm Harper and Sukhwinder Singh Arora.

(2) In 1996, Stuart Rutherford and I discovered many savers in Vijayawada city willing to pay informal deposit collectors (that is accept negative interest on deposits) to help them accumulate savings.

(3) Experimenting with offering low cost banking services, Standard Bank, South Africa test a particular site with branch in a large mobile container. If the business does not pick up, the branch is moved to another location.

(4) Estimated at modest $200 on average for each micro-enterprise and $100 for each landless household.

(5) This has some parallels to discrimation against daughters in many parts of India.