LOW INCOME HOUSING MICROFINANCE AS A SOLUTION

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1 LOW INCOME HOUSING MICROFINANCE AS A SOLUTION M.Valliammal, Research Scholar, Bharathiar University, Coimbatore & Dr.A.Chandra Mohan, Professor of Management Studies, SRM University Abstract The study focused on the status of low income housing in Chennai and the possibility of use of microfinance as a feasible solution for the same. The building practices of low income households and the mode of financing show that even though the practice is to build in small increments, the poor mostly rely on informal sources of funds. Even when the poor hold formal documents for their owned property, access to formal housing funds are not in their reach. The findings are important for design of credit programs for the government and Microfinance Institutions to offer their credit for housing for poor. Key words: Housing Finance, Microfinance, Low income group Introduction The increased level of urbanization is important for socio-economic development of the people and is to be encouraged but we require more development planning to do that. Due to the concentration of number of industrial units and other service sector activities near the existing cities, unplanned urbanization and unabated migration and concentration of poor population from the depressed rural areas to the urban settlements, numerous problems of complex nature have emerged. There has been acute shortage of housing in urban areas with the result that the cities face grim situation with the fast increasing number of slums in all the cities throughout India. Estimates for India s slum population is about 7 crores (NBO survey,2010), that is about a quarter of the country s total urban population. Out of that about 8% of the population lives in the slums in Chennai. The numbers are huge and it is clear that a sizable number of the 96

2 population live in slums with homes that are clearly inadequate for the development of their faculties. The India government, recognizing this has announced a new housing scheme for the poor in 2009 called the Rajiv Awas Yojana (RAY). The scheme takes a multi-pronged approach to improving conditions for the urban poor, including improving access to basic services within existing slums by formalizing them, addressing the financial, planning, and governance failures that led to slums, and increasing the availability of affordable urban land. The government initiative alone is clearly not the answer. A look at the progress of the RAY in Chennai gives a bleak picture of the two projects envisioned to build 1472 dwellings at a cost of about 117 crores, the projects have not started yet as of May This has been the driving thought behind this paper; how the poor can start having a better housing even with little action from government. Formal housing finance is not accessible to low-income households in India, even for those living in urban areas, because of the perception of high risks in lending to this income group. Still, despite the very low penetration of formal housing finance, families have clearly been able to make investments in their homes. For example, a survey commissioned by the Tamil Nadu Slum Clearance Board on unrecognized slums in Chennai found that the percentage of kutcha hut structures had decreased from 63% of slums to 38%, while the percentage of semi-pucca units increased from 23% to 49% of the total sample from 1986 to 2006, suggesting that slumdwellers are improving their own dwellings, even in the absence of tenure security. Clearly the marginal earners are somehow making their homes better. How? Unlike higher income residents, who construct or purchase completed homes in a single transaction, most of the investment in housing by the urban poor happens incrementally and over a long period of time. Incremental building means the progressive construction of a dwelling unit (adding a room, or adding a floor), or the improvement of existing structures with new or better materials (such as replacing a thatch roof to a brick and cement roof, etc.). 97

3 Experts estimate that anywhere from 50 to 90% of all new housing in developing countries is built incrementally (Painter and Sole 2006), but very little research has been conducted on incremental construction practices. Such research is extremely important for policy makers and organizations involved in bettering the lives of the poor, both from government and NGOs. Even if the government succeeds in building or facilitating the creation of much more decent housing for low-income residents, it will also need to create appropriate financial instruments that will enable them to pay for this housing. Such instruments will only be effective if they are based on knowledge about how residents are currently building and financing housing. Objectives This study attempts to fill some of these gaps in knowledge about incremental construction practices and how households currently pay for construction. Our findings are based on a detailed survey conducted in a low-income neighborhood in Chennai with varying levels of access to security of tenure. This report will detail the kinds of improvements commonly made in the settlement, their costs, final uses of the improvement, and how these improvements were constructed. It will also detail the sources of finance used for these improvements, methods of access, amount of loans taken if any, loan interest amounts and repayment periods where available. The report will also provide a background of the settlement, the types of tenure held by residents, the kinds of paperwork they have for their homes, and provide a profile of the residents themselves. The findings from our study can be used to better structure financial instruments for the poor that reflect existing conditions, even for those who live in informal settlements without any security of tenure. Literature Survey There are three broad areas of existing research and literature that are relevant for our research: literature on tenure and access to finance and the relationship between the two, literature on affordable housing and housing microfinance, and literature specifically on 98

4 incremental housing. All of these provide important insights for our study, even though very little of this research is focused on India. Early and influential theorists argued that formal property rights that allowed residents to buy and sell their housing were important for the poor, primarily because it would enable access to formal credit. By formal credit, we mean credit from a set of institutional sources including the government, cooperative societies and cooperative banks, commercial banks, insurance agencies, provident funds, microfinance institutions and self-help groups, and others. Informal credit includes moneylenders, traders, relatives and friends, pawn shops, chits, and others. Informal credit usually has extremely high interest rates, as much as 80% annually, but it is widespread in India because of very low penetration by banks in poorer and rural communities. This early writing about the importance of tenure led to a number of interventions in slums that tried to provide slum dwellers with individual property titles, including the widespread Sites and Services programs of the World Bank. However, tenure is a complex issue in India, especially in urban areas, and individual property titles may not always be feasible or desirable. Slum dwellers often squat on public or private land, but government interventions can give them some measure of tenure security. Tenure security can take the form of property title held by an individual or a household, also known as formal tenure. Tenure security can also be provided by official recognition of an entire neighborhood, a process known as slum declaration in Chennai, which provides residents freedom from eviction but does not necessarily allow for individuals to legally buy and sell their homes. Residents can also have de facto tenure security, which is based on the perceptions of residents that an area is safe from eviction (van Gelder 2010). Empirical studies showed that while tenure security does appear to be important for encouraging residents to invest in their own housing (van Gelder 2010), the links between 99

5 property titles and accessing formal credit are still unclear. Studies have also found that while property titles may lead to more efficient urban land markets in cities, they can negatively impact equity. This happens when tenants cannot afford the higher rents associated with legalized housing, or when poorer house-owners cannot pay for the costs of formalization or building infrastructure (Durand-Lasserve and Selod 2007). The formal housing finance sector has been reluctant to serve the low-income segment of the population because of the high costs of each individual transaction, especially in collecting repayment, and because of the variability and difficulty of verifying incomes in the informal sector where many of the urban poor are employed (Monitor Group 2013). Governments in many developing countries have attempted to pass legislation increasing access to finance for low-income communities to purchase homes, but where studies have been conducted, their impact has been limited. Employer loans for housing investment are also common in some countries. For example, a recent survey in South Africa found that small employer loans are frequently used for housing improvements, but very few larger loans were explicitly taken for housing purchases, despite government incentives for employers to provide housing loans (Melzer 2013). However, the bulk of finance for housing construction and purchase for lowincome residents in developing country cities today comes from informal sources. Experts who study affordable housing finance suggest that current models of formal housing finance do not reflect housing investment practices among the poor. As argued above, unlike wealthier city residents, the poor generally do not buy or build complete building units rather, construction is progressive or incremental and can take a long time to complete. Ferguson and Smets (2009), who have done the most extensive research on incremental housing in India, suggest that small, serial loans can greatly increase the speed and lower the high cost of the incremental housing process. Some examples of successful housing microfinance programs include SEWA, Grameen Bank, and K-Rep in Kenya, but expanding housing microfinance more widely faces large hurdles, especially in India. Many MFIs do not have the capital base required 100

6 to expand into this sector, and non-banking finance companies (NBFCs) in India face regulatory hurdles (Monitor Group 2013). Research on incremental housing and incremental housing finance in India has been limited. One survey by Smets and Ferguson (2009) in Hyderabad found that residents used a range of informal lenders for incremental construction, from purely commercial lenders including pawn brokers and moneylenders, to personal lenders, to financial self help organizations like ROSCAs and ASCRAs, more commonly known as chit funds in India. Their research also revealed that different stages of construction usually rely on different sources of finance, and that each stage is usually dependent on primarily one source. Personal savings are used largely in later stages of construction, while earlier stages depend on borrowed funds. Understanding better the sources and amounts of credit used for current incremental construction practices as well as the existing obstacles to formal credit access, as this study does, will be important for the government to make targeted and effective interventions that support slum-dwellers in their efforts to improve their own homes. Methodology The sites were selected for the research was located in the northern part of Chennai, namely Tiruvottiyur. The project areas were selected because of the wide variation in tenure type. The data collection instruments used in the study was a community-level questionnaire and a household-level survey questionnaire. The community questionnaire was answered by key informants who were knowledgeable about community-level characteristics. Responses from key informants were cross-referenced with other residents. For the household-level survey, the research team conducted face-to-face interviews with 216 households across the site, all of whom identified themselves as owners of the houses they 101

7 lived in. Households were selected via systematic sampling. The questionnaire covered basic demographic details, household financial status, housing details, tenure security, access to finance, incremental improvements made, and their aspirations about their housing in the future. The questionnaire also asked details about specific improvements made in the house that included questions about the cost of improvements, sources of finance accessed and terms of repayment. The team asked for detailed information only about the most recent, highest cost improvements, and asked for such information about a maximum of five improvements per household. This was done to ensure accuracy, since many of the improvements had occurred more than ten years earlier. The survey elicited detailed information on 323 specific housing improvements from the 216 sample households. The survey was administered to the person in the household most knowledgeable about the housing history and financial decision-making; typically this was the head of household. The field researchers also collected observations about household amenities and building materials. Entire data collection process took four weeks to complete by four field researchers. There were no incomplete surveys. Findings and Discussions The site selected for the study has the three forms of tenure most commonly available to lowincome residents in the city. A part of the site was part of a program undertaken by the government in partnership with the World Bank in which residents received paperwork that enabled them to transfer ownership of their houses. This means that the residents have what is meant by formal tenure or property title, which means that they have paperwork to show that they own their homes and that they can sell their property and use it as collateral in loans from banks. This form of tenure is found in a number of sites-and-services projects and relocation sites in the city. The second set of homes, which was developed by the government 102

8 in partnership with a Chennai-based non-governmental organization (NGO) called Don Bosco and funded in part by an international aid agency, gave official recognition to the allotted families and provided residents freedom from eviction, but most residents did not get individual paperwork that would allow them to legally transfer ownership to another party. All officially recognized or declared slums in the city that have not explicitly been developed under specific schemes provide residents similar kinds of tenure. The third set of homes were part of a slum that has not been officially recognized or declared by the government as a slum. The slum is located along a waterway, which means that the government considers it to be an objectionable slum, and residents have no security of tenure. Since the government has not recognized any new slums since 1985, many slum settlements in the city do not have any tenure security. All three types of dwellings have been settled for longer than twenty-five years. Site demographics and household amenities The average age of the head of household was 52 years. Close to 80% of the respondents were Hindus, and the rest were Christians and Muslims. Nearly 50% of respondents identified themselves as being from the Scheduled Caste, while the overall Scheduled Caste population is 14% of the population of Chennai district (Department of Economics and Statistics 2012). 21% of the heads of the households had never attended school, while 45%, the majority, had studied as far as upper primary (through 8th standard). 25% had secondary and higher secondary education and only 9% had studied further. Across the site, 26% of residents were employed as daily wage laborers, while 15% were self-employed, 30% were salaried employees, and 29% reported themselves as currently unemployed or retired. In many low-income neighborhoods across India, residents use their homes for home-based enterprises that generate income to the household, most famously documented in the leather units and garment factories of Dharavi in Mumbai (Yardley 2011). Surprisingly, we found that 103

9 most households used their homes primarily for residential purposes, and not for home-based industries or petty shops. 95% of households used them primarily for residential purposes. We also found variation in their possession of personal identification documents and documents related to residence and house-ownership. Regarding house ownership documents, these included something called registered copy, which 32% of residents had. The registered copy is a document issued by the government when the household registers the property, and is legal proof of ownership of the home. Only about 30% of our sample in this site had this document, a legally binding document issued by the sub-registrar s office that shows the transfer of property from one owner to another and the only house-ownership document accepted by banks for loans. Then some of them also had allotment papers. These are documents provided to individuals from the original household that is allotted the tenement, plot, or unit from either the Tamil Nadu Housing Board or the Slum Clearance Board, depending on the site. Allotment papers provide tenure security and protection from eviction, but on their own, they do not confer on residents the right to legally sell and buy their homes. Nevertheless, we were told that many households with allotment papers alone had sold their homes informally, and that allotment papers could be used as collateral for informal lenders. Nearly all households who had the ownership documents paid water and house tax and have receipts documenting payments for these services, while about half of residents with allotment papers did. The only other form of paperwork signifying homeownership that rest of the residents had was the promissory note, an ad-hoc agreement to sell the home, issued and signed by the seller and not legally recognized. About 50% of the residents had access to a bank account. Despite a growing presence of microfinance institutions in urban Tamil Nadu, a surprisingly small number of households had 104

10 connections to microfinance institutions or were involved in self-help groups. Less than 20% of the residents said that they were part of an MFI and were involved in self-help groups (SHGs). This suggests that running new formal incremental housing finance programs through existing microfinance institutions and self-help groups may only reach a small percentage of the population of urban poor. Supplementary measures would be required to extend access to a wider segment of the population, especially residents in more precarious housing situations like our area of study. The use of formal versus informal sources of finance is an important indicator. The ratio of total borrowed money of all those interviewed from informal source of finance to formal sources like money lenders were as high as 65%. Improvements, costs, and finance used The total average number of improvements was 4.6, and the median was 3. The most common improvement was painting, which 51% of the households had undertaken. This was followed by improving flooring/adding tiles, adding an extra floor, adding electricity connections, and adding a hand pump. Incremental investment in homes in low-income communities frequently led to increases in residents access to basic services like water and sanitation, as well as to sources of rental income. Improvements were largely constructed with hired laborers or contractors. Across all the improvements, informal sources of finance were the most commonly used, with 80% of improvements built with informal sources of finance. Informal sources of finance identified by respondents included: loans from friends, relatives, and neighbors, often without interest; personal loans from employers, often also without interest; loans from moneylenders, often with collateral or with lenders that had a relationship to the community; pawnbrokers, usually using jewelry; and in few instances chit funds (chit funds made of personal friend or 105

11 local community with no legal sanctity). 12% of improvements were funded from residents savings or income. Formal sources made up an extremely small percentage of the sources used for improvements, only 8% of the total. The extremely low percentage of access to formal finance suggests that tenure security alone is not enough to improve access to formal finance it needs to be accompanied by other factors or changes. Interestingly, even though formal loans were used in the most expensive improvements, the loans often did not cover the total cost of an improvement. In 77% of improvements where formal finance was used, multiple sources of finance were used to fully pay for the improvement. In contrast, only in 47% of cases where informal finance was cited as the most significant type of finance was multiple source of finance used to pay for the improvement, suggesting that informal sources of finance were more flexible and able to meet residents needs. However, loans obtained through formal channels were much larger than informal loans. The average formal loan amount was Rs. 139,784 while the average informal loan amount was only Rs 51,350. The survey found that when heads of households were better educated, households were more likely to use formal finance over informal finance, or to rely on savings/income. Households where the head of the household was a salaried employee also relied much more on formal sources of finance than households where the head of the household was self-employed or a daily wage worker. This difference came about partly because many residents accessed formal loans through cooperative societies that were tied to formal or salaried positions. Formal finance was obviously difficult to access, even when residents had formal tenure and the required paperwork. In 40% of the cases where households used formal finance to pay for 106

12 improvements, they reported that it was difficult to access the formal loan. In contrast, in less than a quarter of the cases where households used informal finance did they report that it was difficult to get that loan. Formal finance also frequently required collateral, unlike many forms of informal finance. 60% of improvements that were financed with formal financing required collateral for the loan. 49% of all formally financed improvements used housing or land as the collateral, 5% used jewelry, and 6% used other forms of collateral. On the other hand, among all improvements that were financed with informal sources, only 28% required collateral. Interestingly, only 3% of the informal sources used housing or land as the collateral, and 23% used jewelry. The loans where housing or land was used as the form of collateral were the largest loans, whether informal or formal. The study found that many respondents were unable to give reliable information on repayment schedules, loan tenure, and interest rates, details that are necessary to create a common interest rate to compare formal and informal financial loan products. Only for 11% of all improvements, 35 improvements, could respondents provide adequate information about interest rates, how frequently the interest was charged (per week, month, or year), and the repayment period of the loan. 10 of these improvements used formal finance, 8 of which were from a bank or cooperative society. 7 of 10 formal sector loans had interest rates between 0 to 5% per month, and one household reported a loan with 15% interest per month. 24 improvements for which respondents provided detailed information about interest used informal finance, 14 of which were loans taken on the basis of mortgaging jewelry. 11 improvements reported interest rates of 0-5% a month, but two had extremely high interest rates of 12% and 30% per week. The informal finance loans had to be repaid within a year, and for 5 improvements, households reported no stipulated time period to repay the loan as long as interest was paid regularly. 107

13 Concluding Discussion on Findings SAMZODHANA Journal of Management Research This study set out to describe the ways that residents of low-income settlements in Chennai with varying kinds of tenure improved their own homes, and how they paid for these improvements. The study was conducted in order to provide more information about existing construction practices so that such information could be used to better shape government programs like the RAY, programs geared towards improving housing conditions for the urban poor. The survey would be particularly relevant for those programs related to increasing access to formal finance for slum-dwellers for housing and housing improvements. The snapshot of incremental construction practices in community provide both information that will be immediately useful for policymakers and information that points the way forward for future research. The survey found that the community, was a place of economic and social vulnerability where interventions to improve the lives of residents are urgently needed. A high percentage of the population identified as SC (50%). The survey also revealed that residents did not have amenities like a separate kitchen, running water within the household, or attached latrines. Significantly, the survey found that the most frequently constructed improvements adding electricity, hand-pumps, and toilets contributed towards increasing their access to basic services, suggesting that such improvements should be encouraged by government policy towards slums in the future. Further, the results of the survey have important implications for the physical design of sluminterventions. Unlike many settlements across India, less than 5% of households in our study used their home for income-generating enterprises. However, homes were still important sources of income. 21% of the total sample of households rented out parts of their homes to tenants and reported an average monthly rental income of Rs. 2,695. Rental incomes were possible because residents added another room, another floor, or even multiple floors to their 108

14 units. This has implications for the design of future slum interventions. In order for slum redevelopment to support increases in income for residents, they should allow for the construction of additional space that can be rented out to tenants. Such construction may also limit the expansion of existing slums, by allowing growing families to accommodate more people by building upwards, or by accommodating new migrants in rental units. The survey also found that residents are regularly investing large amounts of money in their homes, even in instances where they did not have property title or even tenure security, and that most of this investment is coming from informal sources of finance. The average cost of an improvement was Rs. 70,000,. More than half of the improvements were funded with loans. These improvements were usually more expensive, while savings were used for cheaper improvements. 80% of improvements were financed with informal sources, 12% with savings/income and only 8% using formal finance. The most frequently used informal sources of finance include moneylenders, pawnbrokers, employers, and loans and gifts from friends and relatives. The most frequently used formal sources of finance include formal housing loans from nationalized banks, loans from mortgaging jewelry in which the purpose was not limited to housing, loans from cooperative societies usually formed by government workers, and loans from MFIs and SHGs, neither of which required any collateral. Formal loans were used in the most expensive improvements, but the loan frequently did not cover the total cost of an improvement. However, formal loans were much larger an average of Rs. 120,000 while average informal loan amounts were smaller, only Rs. 51,000. When heads of households were better educated or held salaried work rather than being daily laborers or self-employed, households were more likely to use formal finance over informal finance. In fact, cooperative societies tied to particular salaried jobs were the most frequently used formal source of formal financing. These usually had very low interest rates or no interest. 109

15 The findings from the survey suggest that there is an urgent need for formal credit for housing improvements, including for loans that are much smaller than what traditional housing finance companies offer, even those that focus on the affordable housing sector. Encouraging such small loans for housing improvements could be an important means through which the Rajiv Awas Yojana increases access to basic services in low-income communities. In the absence of access to formal loans, our study found that residents relied on informal loans with extremely high interest rates. In many cases, households were not able to give us adequate information about their interest payments, suggesting that residents also need financial literacy training to understand the implications of the kinds of debts they are taking on. Conclusions The survey found large hurdles to accessing formal finance, hurdles that will require innovative incentives for banks to lend to low-income households. Some of these hurdles are straightforward. For example, most households in our study lacked the basic paperwork required for bank loans, because residents did not have sale deeds. But just ensuring that households get formal tenure or property titles is clearly not enough. Even where the households had all the paperwork needed to be eligible for bank loans, only 21% of improvements were financed with formal sources, and households reported that formal bank loans were difficult to access. This meant that many households resorted to informal loans with high interest rates. This means policies have to look beyond just ensuring that residents are eligible for bank loans, and think about actually incentivizing banks to serve poorer residents, especially in urban areas where other, more suitable clients are plentiful. Policymakers will also have to think carefully about new mechanisms to increase access to formal credit. More than a third of households did have a bank account even in the poorest and most insecure site, but membership in self-help groups or microfinance institutions was far more limited, suggesting that SHGs and MFIs should not be the only focus of policies to expand access to formal credit. 110

16 References 1. Bhattacharya, Suryatapa and Samanth Subramanian, India proposes state-level support for slum-dwellers, The National, 4 Jun Web. 30 Jan Chennai Metropolitan Development Authority Draft Master Plan II for Chennai Metropolitan Area: A short version of the main report, Government of Tamil Nadu, n.d. Web. 30 Jan Department of Economics and Statistics, Area and Population Tables, Statistical Handbook 2012, Government of Tamil Nadu, n.d. Web. 30 Jan Durand-Lasserve, Alain and Harris Selod, The formalization of urban land tenure in developing countries, Paper presented at the World Bank s Urban Research Symposium, May 14 16, Ferguson, Bruce and Peer Smets, Finance for incremental housing: current status and prospects for expansion Habitat International, 2009: Web. 30 Jan Madras Metropolitan Development Authority, Shelter Programmes in Madras, Madras: Government of Tamil Nadu, Print. 7. Melzer, Illana, Access to housing finance in the low-income market: A review of recent data, Report prepared for the Finmark Trust, 15 June Web. 30 Jan Ministry of Housing and Urban Poverty Alleviation, Rajiv Awas Yojana: Guidelines for Slum Free City Planning, New Delhi: Government of India, n.d. Web. 30 Jan Monitor Group, India, Brick by brick: Making a market in low-income housing, n.d. Web. 30 Jan