MICROFINANCE MATTERS - ICICI Banks the Poor in India

The traditional image of microfinance is one of a charitable activity conducted mostly by non-profit organizations and separate from the mainstream financial system. However, this image has been changing in India in the last few years as commercial banks have been widely entering the sector, led by ICICI Bank. But why would ICICI, the largest private bank in India, be interested in serving low-income segments? Simply because it recognizes that poor people are bankable, and that microfinance provides a new, profitable opportunity. ICICI Bank sees an opportunity to make profits in untouched markets, while improving the lives of poor people. Who would not appreciate the win-win of this situation?

Rapid Growth

ICICI's microfinance portfolio has been increasing at an impressive speed. From 10,000 microfinance clients in 2001, ICICI Bank is now lending to 1.2 million clients through its partner microfinance institutions, and its outstanding portfolio has increased from Rs. 0.20 billion (US$4.5 million) to Rs. 9.98 billion (US$227 million). A few years ago, these clients had never been served by a formal lending institution.

There is an increasing shift in the microfinance sector from grant-giving to investment in the form of debt or equity, and ICICI believes grant money should be limited to the creation of facilitative infrastructure. "We need to stop sending government and funding agencies the signal that microfinance is not a commercially viable system", says Nachiket Mor, Executive Director of ICICI Bank.

As a result of banks entering the game, the sector has changed rapidly. "There is no dearth of funds today, as banks are looking into MFIs favorably, unlike a few years ago", says Padmaja Reddy, the CEO of one of ICICI Bank's major MFI partners, Spandana. And with banks entering the sector, interest rates have also dropped. "Interest rates have come down from 14% to 10%", says Reddy.

Partnership Models

But how has ICICI Bank been able to achieve such rapid growth in such a short time? This success is due to a series of innovative models and initiatives. While a model of microfinance has emerged in recent years in which a microfinance institution (MFI) borrows from banks and on-lends to clients, few MFIs have been able to grow beyond a certain point. Under this model, MFIs are unable to provide risk capital in large quantities, which limits the advances from banks. In addition, the risk is being entirely borne by the MFI, which limits its risk-taking.

The MFI as Collection Agent
To address these constraints, ICICI Bank initiated a partnership model in 2002 in which the MFI acts as a collection agent instead of a financial intermediary. This model is unique in that it combines debt as mezzanine finance to the MFI.[1] The loans are contracted directly between the bank and the borrower, so that the risk for the MFI is separated from the risk inherent in the portfolio. This model is therefore likely to have very high leveraging capacity, as the MFI has an assured source of funds for expanding and deepening credit. ICICI chose this model because it expands the retail operations of the bank by leveraging comparative advantages of MFIs, while avoiding costs associated with entering the market directly.

Securitisation
Another way to enter into partnership with MFIs is to securitize microfinance portfolios. In 2004, the largest ever securitisation deal in microfinance was signed between ICICI Bank and SHARE Microfin Ltd, a large MFI operating in rural areas of the state of Andra Pradesh. Technical assistance and the collateral deposit of US$325,000 (93% of the guarantee required by ICICI) were supplied by Grameen Foundation USA. Under this agreement, ICICI purchased a part of SHARE's microfinance portfolio against a consideration calculated by computing the Net Present Value of receivables amounting to Rs. 215 million (US$4.9 million) at an agreed discount rate. The interest paid by SHARE is almost 4% less than the rate paid in commercial loans. Partial credit provision was provided by SHARE in the form of a guarantee amounting to 8% of the receivables under the portfolio, by way of a lien on fixed deposit. This deal frees up equity capital, allowing SHARE to scale up its lending. On the other hand, it allows ICICI Bank to reach new markets. And by trading this high quality asset in capital markets, the bank can hedge its own risks.

Janet MacKinley, chairman of the Income Fund of America and Vice Chair of Grameen Foundation USA's Program Committee welcomes this deal; she says: "I believe it will encourage more of these types of transactions that can play a strategic role in making microfinance more widely available to the world's poorest communities". Another securitisation deal was also signed with Bhartya Samruddhi Finance Limited (BSFL), in which ICICI Bank securitised the receivables of a selected portfolio of microfinance loans by BSFL amounting to Rs 42.1 million (US$ 957,000). Both under the partnership model and under the securitisation deal, the bank provides organizations with financial support at a mezzanine level which enables them to offer credit protection in the microfinance portfolios to a reasonable extent.

Training New Partners
Despite rapid growth, the lack of NGOs and MFIs operating in India remains a constraint. According to ICICI Bank, there is a need for approximately 200 MFIs to cover the country, however there are only 15 large players capable of scale. New players are therefore needed: ICICI believes that new NGOs, entrepreneurs, and corporations who conduct development activities in rural areas can and should become MFIs. ICICI Bank has put in place its Micro Finance Development Team with the objective of identifying and training new partners. The Social Initiative Group of ICICI Bank (SIG) aims to partner with organizations to identify and support entrepreneurs in microfinance.

Working with Venture Capitalists

Another challenge in scaling-up the microfinance sector is the lack of equity capital. In order to solve this shortage, ICICI Bank is encouraging venture capitalists to start entering the sector. Several venture capital funds in the country have the capability of identifying and mentoring entrepreneurs, including Lok Capital, Aavishkar and Bell Weather. Bell Weather has made three equity commitments for start up, and its committee has decided to increase the size of the fund from US$10 million, to US$25 million. Lok capital mobilizes and directs private capital to fund microfinance activities and to fund long term management and technical support for development of commercially sustainable MFIs. Aavishkar provides micro-equity funding (Rs. 10 lacs to Rs. 50 lacs, approximately US$20,000 to US$100,000) and operational and strategic support to commercially viable companies increasing income in or providing goods and services to rural or semi-urban India. ICICI Bank has come to an agreement with these three venture capitalists under which it will provide take-out financing to the MFI to buy out the venture after a period of three to five years, provided the MFI attains an operational sustainability rating from Micro-Credit Ratings International Ltd (M-CRIL) and Credit Rating Information Services of India Limited (CRISIL).

Beyond Microcredit

Microfinance does not only mean microcredit, and ICICI does not limit itself to lending. ICICI's Social Initiative Group, along with the World Bank and ICICI Lombard, the insurance company set up by ICICI and Canada Lombard, have developed India's first index-based insurance product. This insurance policy compensates the insured against the likelihood of diminished agricultural output/yield resulting from a shortfall in the anticipated normal rainfall within the district, subject to a maximum of the sum insured. The insurance policy is linked to a rainfall index.

Technology

One of the main challenges to the growth of the microfinance sector is accessibility. The Indian context, in which 70% of the population lives in rural areas, requires new, inventive channels of delivery. The use of technologies such as kiosks and smart cards will considerably reduce transaction costs while improving access. The ICICI Bank technology team is developing a series of innovative products that can help reduce transaction costs considerably. For example, it is piloting the usage of smart cards with Sewa Bank in Ahmedabad. To maximize the benefits of these innovations, the development of a high quality shared banking technology platform which can be used by MFIs as well as by cooperatives banks and regional rural banks is needed. ICICI is strongly encouraging such an effort to take place. Wipro and Infosys, I-Flex, 3iInfotech, some of the best Indian information technology companies specialized in financial services, and others, are in the process of developing exactly such a platform. At a recent technology workshop at the Institute for Financial Management Research in Chennai, the ICICI Bank Alternate Channels Team presented the benefits of investing in a common technology platform similar to those used in mainstream banking to some of the most promising MFIs. It is hoped that this workshop will unite five to ten MFIs in creating an independent association that will lead these efforts.

The Centre for Microfinance Research

While the sector has been growing rapidly, and while the focus has been largely on growing outreach, there is an urgent need to fill gaps both in practice and understanding in order to maximize the impact of this growth. To fill these gaps, ICICI bank has created the Centre for Microfinance Research (CMFR) at the Institute for Financial Management Research (IFMR) in Chennai. Through research, research-based advocacy, high level training and strategy building, it aims to systematically establish the links between increased access to financial services and the participation of poor people in the larger economy.

The CMFR Research Unit supports initiatives aimed at understanding and analyzing the following issues: impact of access to financial services; contract and product designs; constraints to household productivity; combination of microfinance and other development interventions; evidence of credit constraints; costs and profitability of microfinance organizations; impact of MFI policies and strategies; people's behavior and psychology with respect to financial services; economics of micro-enterprises; and the effect of regulations.

The CMFR is involved in several studies with researchers from leading universities, including MIT, Harvard, and Yale. For example, it is implementing an impact evaluation of Spandana's microcredit programme in Hyderabad; as the first randomized evaluation of microcredit, it will allow estimating the effects of the MFI's programme in an unbiased manner. Other on-going projects include the impact evaluation of smokeless chulhas on health and productivity in Orissa, a study on the break-up of transaction costs of MFIs and SHGs, and an analysis of Sewa Bank's loans and accounts panel data base in Ahmedabad.

In order to bring together academics and practitioners, the CMFR also organizes regular seminars and conducts courses for managers and researchers from NGOs, government, international organizations, and academics.

In addition to undertaking research, the CMFR directly helps MFIs in terms of strategy building. In partnership with MicroSave, the CMFR Microfinance Strategy Unit will offer advanced financial management training for microfinance practitioners. A training series on Building Blocks of Banking and Finance will also be conducted, aimed at financial institutions both large and small that wish to acquire a comprehensive and detailed set of skills to effect their transformation.

Finally, the CMFR recognizes that while MFIs aim to meet the credit needs of poor households, there are other missing markets and constraints facing households, such as healthcare, infrastructure, and gaps in knowledge. These have implications in terms of the scale and profitability of client enterprises and efficiency of household budget allocation, which in turn impacts household well-being. The CMFR Microfinance Strategy Unit will address these issues through a series of workshops which will bring together MFI practitioners and sectoral experts (in energy, water, roads, health, etc). The latter will bring to the table knowledge of best practices in their specific areas, and each consultation workshop will result in long-term collaboration between with MFIs for implementing specific pilots.

While the microfinance sector is growing fast in India, challenges must be addressed in order to make this growth both effective and sustainable. Microfinance needs to become more accessible, more customized and more comprehensive. In order for microfinance to be a useful mechanism for poverty alleviation, several questions need to be answered. Is microfinance the solution? ICICI Bank believes it is, if growth is properly managed and questions are correctly answered.

(1) Mezzanine finance combines debt and equity financing: it is debt that can be converted by the lender into equity in the event of a default. This source of financing is advantageous for MFIs because it is treated like equity in the balance-sheet and enables it to raise money without additional equity, which is an expensive financing source.

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