A Primer on Microfinance

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1 A Primer on Microfinance U. B. Desai SPANN Lab. Dept. of EE IIT-Bombay

2 Some Basic Question Why do we need finance? credit is an instrument for investment and growth. Why the special need for finance for the underserved communities? Same as above Shift in Perspective: From poverty alleviation to wealth generation --- microfinance will enable wealth generation Why do poor still go to unorganized financial institutions (money lenders, shaukars,,...)? We will look at this during the talk Why is the spread of microfinance so slow? Commercial financial institutions are not ready to enter this arena Why are commercial banks hesitant to enter microfinance? We will explore this in the talk 2

3 General Belief Poor are too difficult to reach. Small loans to poor is not a financially viable proposition Financial institutions will loose money when they give microcredit to the poor Microcredit or microloans will only increase the debt burden for the poor Do you agree? What is your opinion? 3

4 Microfinance (mfi( mfi) A clever scheme for small-savings savings and small- loan for the underserved community A financial service for the poor A financial approach empowering the poor Microfinance brings in incremental changes It does not bring in dramatic changes like the ones that occur when a company goes in for an IPO Microfinance may also be considered a tool to give poor people the opportunity to participate fully in economic life Will improve the village economy Facilitate increase in cash flow Bring more villages into the market; monetize more villages Help generate trade thru micro-enterprises 4

5 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 virtual branches), socially oriented financial institutions, or a partnership between the two Funding Sources: Domestic savings (~70%), private socially responsible citizens (~30%) Infrastructure: Here ICT can play a major role 5

6 Unorganized mfi Institutions Exorbitant interest rates On the low end 3% per month (36% per annum) can be much more Often collateral, like cattle, jewelry, etc not returned Often the poor get into a debt cycle for life! UmFI does not give loans for sustainability (for e.g. starting a micro-enterprise!) (UmFI) Still the poor approach UmFI Why? Always available (always on!) You get it when you really need it Quick disbursement Negligible transaction time Poor go for micro-loans just before they rally need it Loans without collateral Dependence of low-income households on informal sources for loans is nearly 78 per cent. The poor not only has low income but irregular cycle of payments and withdrawals. The informal financial institutions (money lenders) satisfy this need to the tee 6

7 UmFI: : Case of Solapur District Collateral based lending Gold is typically the collateral Borrowers: small time office clerks, peons, people who have permanent jobs Collateral amount is 1.5 times the loan value Loans taken for illness, family function, etc. Interest is 3% per month Default rate 80% -- most of the time gold is confiscated About 100 lenders each lending 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 will go for such loans Often, most of the income goes in loan payment About 200 to 300 lenders in this category Each loaning about 5 to 10 lakhs Totaling about 20 crs 7

8 Some Facts There are an estimated 3,000 microfinance initiatives serving the world's poor scarcity of money and participation by commercial financial institutions has limited their expansion. More than 70 percent of them serve fewer than 2,500 borrowers each. Only 30 microfinance initiatives have grown to serve more than 100,000 poor borrowers. The largest mfi, Grameen Bank in Bangladesh, reaches more than three million borrowers currently. A total of $4 billion has been disbursed since Grameen started giving loans in 1976 with seed loans starting as small as $35. 8

9 India Earliest Initiative Shri Mahila SEWA (Self Employed Women s Association) Sahakari Bank was set up in 1974 Since then, the bank is providing banking services to the poor self-employed employed women working as hawkers, vendors, domestic servant etc. SEWA bank has 1,75,000 depositors; about 70% from urban area, 30% from rural areas The deposit and loan portfolio stood at Rs million ($13.86 million) and Rs133.6 million ($2.97 million) respectively. Though SEWA mfi is making profit, yet the SEWA bank model of mfi has not been replicated elsewhere in the country Mention default rate 9

10 India Today, there are about 60,000 retail credit outlets of the formal banking sector in the rural areas comprising 12,000 branches of district level cooperative banks over 14,000 branches of the Regional Rural Banks (RRBs( RRBs) over 30,000 rural and semi- urban branches of commercial banks besides almost 90,000 cooperatives credit societies at the village level On an average, there is at least one retail credit outlet for about 5,000 rural people While there is no published data on private mfis operating in India, the number of mfis is estimated to be around 800. Not more than 10 mfis are reported to have an outreach of 100,000 microfinance clients. An overwhelming majority of mfis are operating on a smaller scale with clients ranging between 500 to 1500 per mfi. 10

11 Target Populace 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.) 11

12 Different type of Microfinance Institutions Institutions that offers financial services to low income people at the prevailing market rates. Most of these provide microcredit and accept small payments for saving and repayment of loans. They do not take saving from the general public. They take savings from their cliental mainly the low income group. NGOs which are wholly involved in this or partly. The ones partly involved do several other work that is done by an NGO. Credit Unions Private commercial banks Non-bank financial institutions 12

13 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 they do not cater to the kind of income talked about earlier 13

14 Appropriateness of mf mf works best for those who have identified an opportunity and the credit can be used to exploit this opportunity to develop a sustainable source of income. Microfinance is not appropriate for Extremely poor, destitutes There has to be some viable way of micro-loan repayment People who are extremely poor may get into debt trap with microfinance Numbers vary, but some feel that one has to have 98% loan repayments rate for an MFI to succeed. 14

15 Some Data on Financial Sector in Rural Areas (2002) For 630,000 villages we have 32,443 bank branches Of the ~67,000 bank branches in India, ~32,500 or ~48 per cent are in rural India The average population served by a rural bank is approx. 15,000 Overall, 18 per cent of the rural population has bank accounts. The comparative figure in urban India is almost 100 per cent The per capita deposit in rural areas is Rs 2,000 Dependence of low-income households on informal sources for loans is nearly 78 per cent. 15

16 Share of Different Sectors in GDP (GDP at factor cost, Prices) Rs. In crores Agri. Industry Services Total Services% % % % % % % -- RBI, Handbook of Statistics on the Indian Economy 16

17 Breakup of Indian GDP GDP for India: $650 billion Rural GDP: $150 billion (25%) Compare this with IT industry, which is ~ $ 20 billion 22% 56% 22% 17

18 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 used to give credit to urban areas 18

19 Different Financial Services under Microfinance Deposit services Credit lines Term loans Money transfers Crop and life insurance 19

20 Innovation in Microfinance Development of finance products for the underserved Management of credit risk (minimization losses in giving credit) Scalability: how to reach a vast, diverse, not easy to reach and geographically scattered populace Efficient delivery of microcredit exploit technology 20

21 Microcredit Delivery of microcredit has to be done more and more efficiently Here ICT can play a major role Determination of a borrower's willingness and ability to repay a loan is critical if a microlender is to minimize credit risk Willingness to repay a loan are complex and determined 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 financial resources to make a scheduled loan payment. 21

22 Three operational areas on which a microlender should focus to minimize credit risk: loan design underwriting loan servicing 22

23 Micro-Loan Design Balance between affordability needs of borrowers and costs to micro-lenders Revolves on the design of interest rates (must( cover operating costs, 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 observed that the amount of monthly payment is much more important than interest As long as they are comfortable with the scheduled payment amount they do not worry too much about interest rates 23

24 Micro-loan Underwriting The process of determining a borrower's credit worthiness ability and willingness to repay a loan Most important from the microlender s point of view 24

25 Micro-Loan Servicing Loan servicing is the act of collecting payments and maintaining the balance of a loan In commercial banking, loan payments are made by bank draft or by directly 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 often does not receive a formal salary. This means that for many customers of microlenders making loan payments can be difficult and put them in the position of making the choice to take time off from work (and possibly get fired) in order to deliver a loan payment or choose not to make a payment. Successful lenders will set up payment kiosks in communities. The kiosks are typically open before the typical work day starts and after it ends. Another effective method, albeit more labor intensive is door-to to-door collections. 25

26 Micro-Loan Servicing Provide positive incentives for payment. Borrowers respond well to positive incentives for good payment history. h Microlenders and mortgage lenders have successfully used incentives such as payment rebates, small appliances and food to achieve very high levels of repayment. For example, one Mexican lender offered a free bag of corn meal if a borrower made timely payments for six months. The result was a delinquency rate of less than 1% Be proactive in dealing with delinquencies. Rather than wait until a loan goes into default, a microlender should investigate a loan within weeks of it first becoming delinquent. Often, the cause of a delinquency is due to illness or unemployment. ent. If caught early enough a lender can give the borrower assistance as well as workout a equitable repayment plan. 26

27 Challenges Establishing the idea of access to financial services as human right; just like health care, education etc. are basic rights (Mathew Bishop, Business Editor of The Economist) Managing credit risks in microlending operations Convincing, for profit organizations like established banks, non-bank financial institutions, that microfinance is a good business opportunity and they should commit large capital to establish this business. Also convincing them that charity (funds donated by established organization) is not a sustainable way for growth Developing a market driven interest rate schedule for the poor 27

28 Challenges Reaching people in sparsely populated, diverse, not easy to reach, and geographically scattered areas Last mile problem of reaching the rural poor. Most important challenge is to exploit technology to reduce transaction costs so that financial institutions will indeed take e up microfinance as one of their major service. Reaching the poorest of the poor the destitute: Many ignore this segment Very difficult for a commercial institution to recover micro-credit credit given to this segment Here Government will have to step n develop a scheme for micro-grants Make microfinance part of main stream financial market Data Collection need to collect data that can indicate 28

29 One Approach exploiting ICT Rural ATM Providing ICT based Rural Banking Developed by the TeNet group of IIT-Madras To be deployed in village kiosks in 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 finger print authentication system (Rs.50/=) Use of plastic ID cards smart or otherwise not viable in rural areas 29

30 Another Approach exploiting ICT Exploit Cell-phone, Smart-Phone Platform Growing at a phenomenal pace Nov. 2003, 26.7 mil cell phones Oct. 2005, 55.0 mil Cost of deployment in urban areas: Landlines Rs.20,000 per line Cellular --- Rs.5,000 per line Annual business of handset reaching Rs.10,000 crore ($220 mil),, comparable to color televisions indicating affordability. 14 mil new connections across the country by all operators between Nov 03 to Nov 04, Only.7 mil connections were provided in rural areas by BSNL. Only ~12 mil PCs in India 30

31 Microfinance is a necessary input for rural wealth generation but by no means sufficient 31

32 Bollywood Star Aishwarya Rai to Serve as Spokesperson for the UN International Year of Microcredit The United Nations is pleased to announce that Bollywood leading actress Aishwarya Rai has graciously accepted an invitation to become a spokesperson for the International Year of Microcredit As a spokesperson for the Year, Rai will play an active role in raising awareness of the main goals and priorities of the United Nations' poverty alleviation efforts. She will also promote the activities of the International Year of Microcredit and work to extend its public outreach. In particular, she will be appearing in a public service announcement for the Year. 32

33 By Elizabeth Littlefield CGAP (Consultative Group to Assist the Poor) CEO and World Bank Director But perhaps the most important question facing our (microfinance) industry today is the extent to which technology will be able to bring down transaction costs to enable commercial players to really serve this market globally. The secret to microfinance has been that poor people repay faithfully. We know that they do so because they value the access to services. Do we think they might pay back money into a machine as faithfully as they have paid back their loan officer at weekly meetings? If the answer is yes - and if we were able to build national identity systems that underpinned credit scoring models, and to develop the t delivery technologies - could thousands of commercial banks reach the last mile of a poor, rural community profitably without loan officers, except perhaps at account opening? 33

34 India: Scaling-up Access to Finance for the Rural Poor Despite the large size and depth of the Indian financial system, the majority of the rural poor do not have access to formal finance and financial services. For this reason, innovative microfinance initiatives pioneered by nongovernmental organizations strove to create links between commercial banks, NGOs, and informal local groups. Better known as "SHG Bank Linkage," this model has effectively targeted poorer segments of the rural population and helped reduce their vulnerability. The remarkable growth of SHG Bank Linkage is largely attributable to good policy and skillful and committed leadership in conjunction with a facilitating government nt policy and legal framework. In addition, the emphasis on quality and product customization were also key elements in the SHG Bank Linkage's success. Even though several challenges lie ahead, the SHG movement has the right ingredients to be scaled-up into offering mass access to finance for the rural poor while improving sustainability. Bangladesh made remarkable progress in its micro-finance industry, providing credit access to some 13 million poor households 34

35 Progress Chart of SEWA Bank for the year Particulars No. of members 24,045 25,011 25,464 26,793 29,595 Share Capital (Rs.) 10,281,000 1,08,72,000 1,10,19,000 1,17,77,000 1,48,72,000 No. of Accounts 1,12,750 1,39,611 1,13,583 1,72,010 2,02,706 Total Deposits (Rs.) 1,76,437,000 21,09,71,000 26,81,22,000 46,43,91,000 62,39,28,000 Working Capital (Rs.) 2,59,226,000 30,75,30,000 38,99,79,000 62,54,26,000 84,90,95,000 No. of loans & Advances Accounts 30,936 33,709 39,284 44,187 50,849 Loans & Advances (Rs.) 90,036,000 9,05,74,000 8,97,26,000 10,67,49,000 13,35,85,000 Profit (Rs.) 22,59,000 24,22,000 18,22,000 35,70,000 51,76,00 35

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