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UNITED NATIONS CAPITAL DEVELOPMENT FUND Microfinance |
Issue 17 / October 2005 |
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"Banking the Missing Middle" in India:
Symposium Focuses on Challenges in Involving Commercial Banks in Microfinance By Seema Desai, Programme Director, Emerging Economies, Foreign Policy Centre, London 
Indian Finance Minister Shri P. Chidambaram On September 8, 2005, the Foreign Policy Centre, in collaboration with Standard Chartered Bank, held a one-day conference in New Delhi on "Banking the Missing Middle: Strategies for Expanding Microfinance". The Confederation of Indian Industries (CII) was also a partner. We set out to understand how to improve access to finance of microenterprises, which are often excluded from conventional microfinance initiatives as well as mainstream commercial bank lending. Over 80 delegates from Indian microfinance institutions, commercial banks, national and international NGOs, the Reserve Bank of India (RBI), the National Bank for Rural and Agricultural Development (NABARD) and the World Bank attended the conference. The event began with opening remarks by the Indian Finance Minister Shri P. Chidambaram. He spoke about the phenomenal development of Self-Help Groups (SHGs) in the past two to three years. These are better known as SHG Bank Linkages, as they are credit-linked to banks. The Finance Minister highlighted the SHGs' remarkable rates of recovery - 98-99% - showing that their credit rating and ability to absorb credit and repay has increased. In his words, "most importantly, microfinance has created not just debt but an asset base: land, consumer durables and livestock increased over a three-year period". The session following the opening remarks was titled "The Challenges Facing the Missing Middle". The panel included Christina Barrineau, Chief Technical Advisor to the International Year of Microcredit, Lakshmi Venkatesan from Bharatiya Yuva Shakti Trust (BYST), an Indian NGO, Priya Basu from the World Bank in Delhi, Sandeep Farias from Unitus and Udaia Kumar from Share Microfin. Ms. Barrineau spoke about the lack of statistical validity of data sets, so that there are few reliable indications on the reach or quantity of microfinance. The UN, in collaboration with the World Bank, the International Monetary Fund (IMF) and the UK's Department for International Development (DFID) is working on constructing a headline indicator for access to microfinance. BYST is a not-for-profit organization that primarily assists disadvantaged Indian youth in developing business ideas into viable enterprises under the guidance of a mentor. Its founder, Lakshmi Venkatesan, spoke about the potential danger of a "microcredit trap", where sustainable businesses do not emerge and recipients do not graduate from vegetable selling or livestock. BYST believes that mentoring from the business community is critical, as enterprise growth is about much more than providing credit; it is also about financing a viable business idea. The importance of partnerships between the public and private sector, as well as between social entrepreneurship groups and microfinance institutions, was emphasised. The next speaker, Priya Basu from the World Bank, explained the distortions that government macroeconomic policy creates in bank lending to microenterprises. Despite a vast network of rural cooperative credit banks and commercial bank branches all over India, access to formal finance is extremely limited. Public sector banks in India operate in poor institutional frameworks, so that many rural banks in India are not in a position to lend. Interest rate controls that the government imposed on small banks have backfired, leading to credit rationing. The result is that funds are not reaching poor borrowers. This was followed by an interesting presentation by Sandeep Farias of Unitus, which describes itself as a global microfinance accelerator. Unitus' view is that the biggest challenge facing the microfinance industry is to develop a systematic growth mode. He outlined two main reasons for weak growth of microfinance institutions (MFIs): lack of capital, and lack of capacity. Most MFIs are unregulated non-profit organisations, which prevents them from building an equity base. Through a combination of grants, equity and debt, it is possible to assist with the transformation into a regulated financial institution and help to build an equity base that then allows MFIs to bolster their balance sheet and access local capital markets. Similarly, a lack of capacity can be attributed to a variety of factors: weak corporate governance, lack of management depth, absence of management and strategic planning systems and insufficient business infrastructure. MFIs can help to facilitate capacity building consultancy projects to improve MIS/Accounting, technology and human resources. This emphasis on Management Information Systems (MIS) as well as the innovative use of technology (virtual branches, ATMs, credit and debit cards) was echoed by a number of contributors to the seminar. The other issue Mr. Farius highlighted was the deal focus that is often on mature MFIs, forcing young and mid-tier MFIs to look for capital from local sources, primarily grants. Unitus expressed the view that this focus on mature MFIs may be stalling industry growth as only a small percentage (1-2%) of MFIs are sustainable, and young MFIs struggle to find adequate capital to achieve sustainable growth. A number of lessons emerged from this presentation. The first is the need to educate investors about risk in microfinance, and absorbing some initial risk while the MFI develops a track record, relationships and credibility. A second was in the need for upfront, longer-term involvement compared with commercial investments in mature markets. And finally, there is a need for MFIs to work with policymakers on current regulations that limit options for MFIs and investors. In India, there are a number of such hurdles: most MFIs are still NGOs so they can accept local debt but not equity; also, foreign investors have limited opportunities for investment in the microfinance sector. The final presentation of the day was made by Inez Murray of Women's World Banking. Her talk focused on factors that enhance the success of microfinance. Banks that have entered microfinance are not just getting the basics right, they are innovating, she said. This involves cutting costs to clients and the institutions, building new distribution channels, helping clients build assets (not just debt), as well as mobilising banks and capital markets for microfinance. The latter includes strategic alliances to test new lending approaches, equity investments, securitisations and bond issues. She also discussed a few challenges to the involvement of commercial banks in the microfinance industry. As Mr. Farius had earlier emphasised, there is only a small number of high-growth MFIs, and there are already several wholesalers in microfinance in India (such the Small Industries Development Bank of India and ICICI), so that bank wholesaling to strong microfinance institutions is a limited strategy. Commercial banks would also need to engage in deep customer outreach, understand their markets, and change attitudes and organisational structures. In conclusion, although there was some discussion of what was meant by the missing middle, over the course of the seminar participants broadly converged on a definition of loans between US$100 and US$3,000 to microenterprises. Discussion also focused around the high success rate of lending, with some participants of the view that this reflected the fact that very few of the loans were made for entrepreneurial investments, but were instead for income smoothing or consumption. It was also highlighted that MFIs need to offer a range of financial services - clients want business loans as well as housing finance and savings products. There were many lessons to take away for policymakers, from a review of the central bank's policy on priority lending, to the need for a national level business service provider. The general consensus was that we are looking at a landscape of tremendous potential growth and opportunity, but these can only be reached through appropriate partnerships and infrastructure, which is still being constructed. Microfinance is very much a work-in-progress in India, but it is providing important lessons on the building of adequate institutions in the financial sector. |
