Microfoinance Primer

8/4/2019 Microfoinance Primer

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A Primer on Microfinance

U. B. Desai

SPANN Lab.

Dept. of EEIIT-Bombaywww.ee.iitb.ac.in/~ubdesai


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Oct 2008 2IT 625: ICT4SED

Some Basic Question

Why do we need finance?

Why the special need for finance for theunderserved communities?

Why do poor still go to unorganized financialinstitutions (money lenders, shaukars, ...)?


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Why is the spread of microfinance soslow?

Why are commercial banks hesitant toenter microfinance?


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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


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General Belief

Poor are too difficult to reach.

Small loans to poor is not a financiallyviable proposition

Financial institutions will loose moneywhen they give microcredit to the poor

Microcredit or microloans will only increasethe debt burden for the poor

Do you agree? What is your opinion?


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Microfinance (mFI)

A clever scheme forsmall-savings and small-loan for the underservedcommunity

A financial service for thepoor

A financial approachempowering the poor

Microfinance brings inincremental changes It does not bring in

dramatic changes like theones that occur when acompany goes in for anIPO

Microfinance may also beconsidered a tool to givepoor people theopportunity to participatefully in economic life

Will improve the villageeconomy Facilitate increase in cash

flow Bring more villages into the

market; monetize morevillages

Help generate trade thrumicro-enterprises


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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 virtualbranches), socially oriented financial institutions, or apartnership between the two

Funding Sources:Domestic savings (~70%),

private socially responsible citizens (~30%) Infrastructure:Here ICT can play a major role


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Unorganized mFI Institutions (mFI)

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 debtcycle for life!

UmFI does not give loans forsustainability (for e.g. starting

a micro-enterprise!)

Still the poor approach UmFI ---- Why? Always available (always on!)

You get it when you reallyneed it

Quick disbursement Negligible transaction time

Poor go for micro-loans justbefore they really need it

Loans without collateral

Dependence of low-incomehouseholds on informalsources for loans is nearly 78per cent.

The poor not only has low income but irregular cycle of paymentsand withdrawals. The informal financial institutions (money lenders)

satisfy this need to the tee


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UmFI: Case of Solapur District

Collateral based lending Gold is typically the collateral Borrowers: small time office

clerks, peons, people whohave permanent jobs

Collateral amount is 1.5 timesthe 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


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Some Facts

There are an estimated 3,000 microfinanceinitiatives 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 2,500borrowers each.

Only 30 microfinance initiatives have grown toserve more than 100,000 poor borrowers. The largest mFI, Grameen Bank in Bangladesh,

reaches more than 3 to 4 million borrowers. A total of $4 billion has been disbursed since

Grameen started giving loans in 1976 with seed loansstarting as small as $35.


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India

Earliest Initiative Shri Mahila SEWA (Self Employed Womens Association)

Sahakari Bank was set up in 1974 Since then, the bank is providing banking services to the poor

self-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 623.9 million

($13.86 million) and Rs133.6 million ($2.97 million)respectively.

Though SEWA mFI is making profit, yet the SEWA bankmodel of mFI has not been replicated elsewhere in thecountry

Very low default rate


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India

Today, there are about 60,000retail credit outlets of theformal banking sector in therural areas comprising 12,000 branches of district

level cooperative banks over 14,000 branches of the

Regional Rural Banks (RRBs) over 30,000 rural and semi-

urban branches of commercialbanks

besides almost 90,000cooperatives credit societies atthe village level

On an average, there is atleast one retail credit outlet forabout 5,000 rural people

While there is no publisheddata on private mFIs operatingin India, the number of mFIs is

estimated to be around 800. Not more than 10 mFIs are

reported to have an outreachof 100,000 microfinanceclients.

An overwhelming majority ofmFIs are operating on asmaller scale with clientsranging between 500 to 1500

per mFI.


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Target Populace for muF

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.)


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Different type of Microfinance Institutions

Institutions that offers financial services to low incomepeople 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 takesavings from their cliental mainly the low income group.

NGOs which are wholly involved in this or partly. Theones partly involved do several other work that is doneby an NGO.

Credit Unions Private commercial banks

Non-bank financial institutions


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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 theydo not cater to the kind of income talked aboutearlier


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Appropriateness of mF

mF works best for those who have identified anopportunity and the credit can be used to exploitthis opportunity to develop a sustainable sourceof 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.


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Some Data on Financial Sector in RuralAreas (2002)

For 630,000 villages we have32,443 bank branches

Of the ~67,000 bank branchesin India, ~32,500 or ~48 percent are in rural India

The average population servedby a rural bank is approx.15,000

Overall, 18 per cent of therural population has bank

accounts. The comparativefigure in urban Indiais almost 100 per cent

The per capita deposit in ruralareas is Rs 2,000

Dependence of low-incomehouseholds on informalsources for loans is nearly 78per cent.


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Share of Different Sectors in GDP(GDP at factor cost, 1993-94 Prices)Rs. In crores

Agri. IndustryServices Total Services%

1970-71 137320 46151 113438 296278 38%

1980-81 159293 70687 171148 401128 43%

1990-91 223114 150383 319374 692871 46%

2000-01 285877 263797 649011 1198685 54%

2001-02 302054 272359 691016 1265429 55%

2002-03 292625 288266 739842 1320733 56%

-- RBI, Handbook of Statistics on the Indian Economy


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Breakup of Indian GDP

GDP for India: $1000 billion 12th largest in the word Approx. 4000 billion base dpn PPP

Rural GDP: ~$250 billion (25%)

56%

22%

22%

Compare this withIT industry, which is~ $ 20 billion


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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


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Different Financial Services underMicrofinance

Deposit services

Credit lines

Term loans Money transfers

Micro-Crop and life insurance

Micro health insurance


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Innovation in Microfinance

Development of finance products for theunderserved

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


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Gautum Ivatury:Focus Notes, Jan 2006, CGAP(Consultative Group to

Assists the Poor)www.cgap.org


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Microcredit

Deliveryof microcredit has to be done more andmore efficiently Here ICT can play a major role

Determination of a borrower's willingnessand

abilityto repay a loan is critical if a microlenderis to minimize credit risk Willingnessto 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 willingnessto repay a loan Abilityrefers to a borrower having the financial

resources to make a scheduled loan payment.


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Three operational areas on which amicrolender should focus to minimizecredit risk:

loan design

underwriting

loan servicing


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Micro-Loan Design

Balance between affordability needs of borrowers andcosts to micro-lenders Revolves on the design ofinterest 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 moreimportant than interest As long as they are comfortable with the scheduled payment

amount they do not worry too much about interest rates


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Micro-loan Underwriting

The process of determining a borrower'scredit worthiness

abilityand willingnessto repay a loan

Most important from the microlenderspoint of view


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Micro-Loan Servicing

Loan servicing is the act of collecting payments and maintaining thebalance 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 thechoice to take time off from work (and possibly get fired) in order todeliver a loan payment or choose not to make a payment.

Successful lenders will set up payment kiosks in communities. Thekiosks are typically open before the typical work day starts and after itends.

Another effective method, albeit more labor intensive is door-to-doorcollections.


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Micro-Loan Servicing

Provide positive incentives for payment. Borrowers respond well to positive incentives for good payment

history. Microlenders and mortgage lenders have successfully used

incentives such as payment rebates, small appliances and foodto achieve very high levels of repayment.

For example, one Mexican lender offered a free bag of corn mealif a borrower made timely payments for six months. The resultwas 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. If caught early enough a lender can give the borrower

assistance as well as workout a equitable repayment plan.


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Challenges

Establishing the idea ofaccess to financial services ashuman right;just like health care, education etc. arebasic rights (Mathew Bishop, Business Editor of TheEconomist)

Managing credit risks in microlending operations Convincing, for profit organizations like established

banks, non-bank financial institutions, that microfinanceis a good business opportunity and they should commitlarge 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


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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 reducetransaction costs so that financial institutions will indeed take upmicrofinance 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 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

One Approach exploiting ICT


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Rural ATMProviding ICT based Rural Banking

Developed by the TeNetgroup of IIT-Madras

To be deployed in village kiosksin 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 orotherwise not viable in ruralareas

One Approach exploiting ICT

E ploit Cell phoneAnother Approach


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Exploit Cell-phone,Smart-Phone Platform

Growing at a phenomenalpace

300 mil cell phones

Cost of deployment inurban areas:

Landlines Rs.20K per line

Cellular --- Rs. 3K to 3.5Kper line

Annual business ofhandset reachingRs.10,000 crore ($220mil), comparable to color

televisions indicatingaffordability.

7-9 mil new connectionsacross the country every

month

Only ~20 mil PCs in India

Another Approachexploiting ICT


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Microfinance is a necessary input

for rural wealth generationbut by no means sufficient


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O t 2008 35IT 625 ICT4SED

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Microfoinance Primer