Forbes India 15th Anniversary Special

Beyond Micro Lending

There is no one magic wand that will take financial inclusion to the poor across all of India. The country needs dozens of local innovations that go beyond simple lending

Published: Nov 12, 2010 06:32:38 AM IST
Updated: Dec 15, 2010 05:00:10 PM IST
Beyond Micro Lending
Image: Alok Brahmbhatt
COUNT ME IN Vegetable vendor Ram Prasad feels welcome at last at a banking kiosk at Dharavi, Mumbai, even though his typical deposit is just Rs. 50

For over a decade now, the microfinance industry has been the poster child of financial inclusion in India. From being tiny non-profits at the start of the millennium, microfinance institutions (MFIs) have built up a base of 26 million clients and $2.6 billion in loan outstanding currently, taking the benefit of credit to some of the country’s most isolated communities untouched by four decades of nationalised banking. The sector is the new stock market darling and billions of dollars are waiting to tap into this seemingly unlimited potential. All reasons to call for a celebration.

But the microfinance industry received one jolt too many as it entered October. First, it was the unsavoury and hush-hush developments at SKS Microfinance, the first MFI to list on Indian stock exchanges. The unceremonious dismissal of its CEO and the lack of transparency from the management on the underlying problems hurt the credibility of the whole sector. But that was child’s play compared to what came later.

A series of suicides among borrowers in Andhra Pradesh quickly became a political whirlwind for MFIs. All the blame was laid on the high interest rates charged by them. The union finance ministry asked banks to cap the interest rates charged by MFIs they lend to. The state government rushed in with an ordinance imposing several restrictions and threatening criminal proceedings against coerced recovery. When this news spread, some borrowers stopped making even their usual repayments. There was talk of removing MFI loans from the priority sector category. The lone SKS stock plunged below its public issue price, affecting sector valuations and spoiling any hopes of other MFIs to raise money from the capital markets. And all of a sudden, the microfinance sector is facing a crisis.

“It is largely due to exuberant growth with exorbitant profits and no reduction of interest rates that regulators and society [are] taking such an adverse view of this sector,” says microfinance pioneer Vijay Mahajan. “All these years, we have told everyone that as we cut costs through scale and efficiency, we will pass on the benefits to the consumers. The regulators tolerated our interest rates on that promise. We let them down because we did the first, but we’re not doing the latter. Instead we have made extra normal profits.”

The ultimate objective of financial inclusion is to lift people out of poverty and bring them into the economic mainstream. It is a task that independent India has tried out in different forms over the decades, never getting it quite right. For a while, it looked the MFIs had cracked the formula, but society’s distrust and anger of the sector only shows they haven’t.
In fact, a study by MIT economists Esther Duflo and Abhijit Banerjee in Hyderabad and research by New York University professor Jonathan Morduch have shown that microfinance is not a magic wand that can automatically lift people out of poverty. Access to credit is only the first step. The poor need the entire gamut of financial services from savings to insurance and livelihood services that span health, farming practices, education and financial literacy, before they can break the shackles of destitution. This calls for dozens of innovations implemented in large scale across India, monitored and regulated by the state agencies and funded by the private sector.

“There is no one size fits all solution to financial inclusion,” says Vipin Sharma, CEO of ACCESS Development Services, a non-profit that incubates microfinance and livelihood enhancement institutions. “We aren’t going to see one single model that works across the entire country, what we will see however, is multiple innovations serving a variety of needs. That’s the future.”

Here are some such innovative experiments:

1. Loans Aren’t the Only Thing
Microfinance, by and large, is a one-trick pony. MFIs lend you money. And lend money they will, whether you are planning for a better future or trying to handle a serious illness at home. Their approach is to standardise the product and keep spreading to the nooks and corners of the country.

But that approach doesn’t work all the time. In fact, it can lead to a person borrowing money while all that she needs may be an insurance product or a savings account. This can set off a vicious cycle of indebtedness, frustration and even default.

Enter Kshetriya Gramin Financial Services (KGFS). It was founded to sidestep the weaknesses in microfinance model and is based on a simple principle: Financial services should be provided in much the same way as a physician prescribes medicines. Understand what customers need, and prescribe the products that would help them.

KGFS was set up by the IFMR Trust that is leading a lot of research and innovation in financial inclusion. Unlike a typical MFI, the KGFS companies in Tamil Nadu, Uttarakhand and Orissa focus on deepening reach within a specified area, say a couple of districts, rather than expanding reach to more and more areas. They now serve about 100,000 people through 93 branches.

Yes, KGFS operates through a branch-led model. Expensive as they are to run, the branches nevertheless gain from the economy of scope — that is, they offer a multitude of products and services to the same group of people and hence is able to do more business with each customer. And they use technology to cut costs.

Beyond Micro Lending
Image: Amit Verma
MOBILE MONEY When florist Kamala Devi wanted to withdraw Rs. 5,000 from her bank account, she went to the neighbourhood Medical Store

One of the cool products from KGFS is a money market mutual fund for poor people. It is a very liquid saving option, but villagers can’t typically get access to them for want of identity documents. KGFS acts as a conduit to aggregate their investments into one pool and route it through ICICI Prudential for asset management. This has become possible now that the RBI has cut the minimum amount of investment to Re. 1 from Rs. 100 earlier.

The challenge for KGFS will be to tweak its products to suit specific regions. “Early on, we figured out that even within a state, you can’t afford to roll out a single model across. The customer needs change. We have to ask basic questions like when do we need to keep the branches open. Nine-to-six will not be of help to all,” CEO Anil Kumar says.

2. Crowd Sourcing of Capital to Reduce Interest Rates
Four years ago, Smita Ram and Ramachandra were troubled by the extremely high interest rates that microfinance companies were charging the poor. It occurred to them that peer lending and using an Internet-based model could help reduce interest rates.

Their answer was The Web business has a list of micro entrepreneurs in need of funds. Lenders are people like you and me and the contribution can be as low as Rs. 100. Just log on to the Web site, chose the project you are interested in (or let the Web site choose it for you), and transfer the money. As a social investor, you don’t expect the sky-high returns that private equity may offer, but are OK with just 2 percent returns per year. You get to choose the ultimate beneficiaries. At the end of the tenure, you get back the capital plus interest.

Today, Rang De has over 2,100 investors, who together have lent money to over 5,000 borrowers. The lower cost of funds enables it to reduce the interest rate too. After paying off the lenders, Rang De takes 1 percent and puts away and 0.5 percent in a contingency fund. All told, the borrower pays 15.33 percent, almost half of what typical MFIs charge.
The model allows borrowers to raise money beyond the level MFIs would lend. A case in point is Boopalan, who wanted to set up plastic moulding unit and was looking for a loan of Rs. 50,000. The Rang De network gave him the money and helped him create three jobs.

Recently, Rang De opened its platform for education loans as well. The way it works is similar to income generation loans, except that borrowers will pay a lower interest rate of just 5 percent (4 percent goes to field partners and 1 percent to cover Rang De’s expenses) and the money will be paid in form of vouchers to schools. “We often hear about someone who owned 10 goats, now owning 15. That is not an indicator of richness. They are still open to all the risks. Our sense is if at all they escape poverty, it will be by having an access to education,” Ramakrishna says.

3. Why the Poor Want Branchless Banking

For Ram Prasad, who migrated from Uttar Pradesh to Asia’s largest slum, Dharavi in Mumbai, it took 40 years to open a bank account. A vegetable vendor like him could hardly save any money and in any case, the bank branch was too intimidating to enter and the officials too bossy.

But he grabbed the opportunity when a neighbourhood banking kiosk opened that accepted low value deposits and offered a convenient gateway to saving. “I only earn 150 rupees a day as a vegetable vendor, and I don’t save much at all.

But today I have come to put 50 rupees on my card.”

After the colossal failure of no-frills bank accounts targeting financially excluded Indians, the emergence of easy-access, technology-led ‘branchless banking’ solutions is radically changing the way that banks do business with the poor.

Financial Inclusion Network & Operations (FINO), a financial technology company, runs one such experiment. The Dharavi kiosk is run in an alliance with Union Bank of India and attracts more than 500 customers each day. FINO’s smart-card and finger-printing technology comes in handy while recording the identity of a customer and linking him to a bank account.

FINO’s model has been criticised for using proprietary technology and is often compared to models like the one in Kenya where the mobile phone network has been used to allow money transfers even without bank deposits. As the debate between smart cards and ‘mobile banking’ continues, Manish Khera, CEO of FINO, dismisses the technology itself as being secondary to the need for “proactiveness, being at the customer’s doorstep and simplified procedures” to get poor people to start banking.

4. Hitting the Loan Shark Where it Hurts the Most
If you are a moneylender in one of the most poverty-stricken parts of India and you are prying on hapless families to catch in your debt trap, what do you do? Look for families hit by ‘health shocks’. Poor families across India have long suffered the triple curse of sudden illness — the trauma associated with sickness, loss of wages and the financial burden of intensive healthcare. The Indian School of Business estimates that 30 percent of all personal debt in India is caused by such shocks. A fertile hunting ground for loan sharks indeed!

MFIs have offered microinsurance for long but a lasting solution that will keep the poor free from the moneylender’s grip has been elusive. Only 32 percent of MFI-led insurance covers health. And 90 percent of insurance is linked to credit and expires once the loans are paid off.

Beyond Micro Lending
Image: Amit Verma
THE MONEY MEET Self-help group women meeting at Argava village in UPís Amethi district

This is where Devi Shetty, the good heart doctor, stepped in seven years ago. Best known for slashing the cost of open heart surgery in India, Devi Shetty nevertheless extended his reach beyond the hospital. He started the Yeshasvini Co-Operative Farmers Health Scheme as a health cover plan independent of any insurance company, corporate entity or lender. Now the government of Karnataka has implemented the scheme across 135 hospitals across the state.

By paying a monthly premium of just Rs. 10 — or Rs.120 a year — a farmer can get access to free outpatient service, cashless treatment for up to Rs. 1 lakh covering as many as 1,600 surgical procedures.

The family health plan is marketed through the state’s many agricultural co-operatives. Many of these actively persuade their farmers to partake in the scheme, while others simply enroll their members mandatorily. As a result, 2.8 million people have been covered so far.

5. Mirchi, Dhaniya & Money Transfer
Chhatis Mahto, a 22-year-old illiterate migrant from Bihar, didn’t get a bank account in New Delhi either because he had no documents to prove his identity or he didn’t want to lose half-a-day’s wages each time he went to the bank. Till recently, he roamed around with Rs. 15,000 of his savings in his trouser pocket. And he used a friend’s bank account to send money home. One day he saw SBI’s s logo at a local store. Since it was a place he frequented, he decided to check out.

“It just took me Rs. 100 to open my account within 10 minutes. Now I can send back my savings as and when I desire,” says Mahto. Banking is now as quick as buying grocery. But then, how did SBI reach the local store?

Surely, the bank didn’t open a branch there or employ one of its officers. But it has appointed a banking correspondent called Eko (also a tech enabler) to take financial services to the migrants through a combination of mobile phone technology and the ubiquitous presence of neighbourhood provision stores.

Eko’s founder Abhishek Sinha says he worked on the system for several years before reaching a network of 700 customer service points — 500 in Delhi and 200 in Bihar. Today, Eko serves about 180,000 people, mostly Bihari migrant workers in Delhi. The company has so far transacted Rs.170 crore, out of which transfers alone accounted for Rs. 100 crore.

The system is deceptively simple. It is a mobile banking platform, given that even migrant workers carry phones. But Eko also enables those not carrying a phone to send or receive money. What’s more, part of the transaction uses special software that gets all the data it needs from just a ‘missed call’ from the customer’s phone.

For the local store keepers, the Eko service is both an avenue for extra income and a means to attract customers. For SBI, it is a surefire way to add customers from the unbanked segment without the usual staff and office costs. In the coming years, this model has the potential to become a major vehicle for banks to reach out to the remotest corners of the country.

There are others who have come up with similar innovations on the mobile phone — Paymate, for instance, is a hit with Mumbai’s tiffin box carriers, or dabbawallahs. For a 5 percent fee and service charges, Paymate transfers money through local public call offices.

Eko, on the other hand, charges Rs. 2 per transaction — be it transfer, withdrawal or deposit — but also offers the option to do unlimited transactions for an annual fee of Rs. 100.

6. Eat Now, Pay Later

These days, it is possible to find poor women in Chennai shop for grocery with credit cards. The city doubtless has a reputation for the high use of plastic money, but these aren’t the usual spenders. These are people whose incomes are so irregular that their families went to bed hungry whenever the day’s wages weren’t good. So, how did the credit card revolution reach such poor people?

Microfinance firm Equitas, founded by ex-Cholamandalam hand P.N. Vasudevan, could have remained content lending money using a standard financial product. But the company has branched out into many innovative avenues to provide the borrowing community a complete package of livelihood services. The ‘Food-for-Credit’ programme is just one example.
The objective is simple: The poor have volatile daily incomes but regular expenses. By lending food instead of money, this mismatch can be removed.

Under the plan, these women have a credit limit of Rs. 1,000 on their cards (each card carries a service charge of 2 percent on purchases and no interest charges). Irrespective of their daily wages, they can shop for essentials as and when they need them. They also get discounts ranging from 6-7 percent, which is adjusted against part of their dues. The repayment happens like in any other loan.

The scheme is unique because Equitas has set up 10 stores on its own to let these women buy goods. More stores are coming — 35 by March 2011 and 65 by end of 2011. Also, the company aims to increase the discounts to 10 percent which will further ease the burden on these poor families.

Each store gets an average of 800 customers at present, according to H.K.N. Raghavan, the head of this initiative.

He says it will be expanded to other cities soon.

Beyond Micro Lending
Image: Amit Verma
TOO HIGH FOR COMFORT Microfinance pioneer Vijay Mahajan questions the current level of interest rates MFIs charge

7. Small Loans for Small Homes
When Jaithirth ‘Jerry’ Rao, founder of outsourcing firm mPhasis, started a low-cost housing company in 2009, the biggest challenge he faced was the inability of poor people to get mortgage loans. Without the kind of employment or income profile that home loan companies chase, and without adequate documentation to back their applications, they often fail to achieve their home dreams.

Rao has sought to solve this problem by getting better-off people to offer partial guarantees to the poor. His tie-up with HDFC Bank enables people to deposit money against which the bank will lend money to low-income borrowers. When the loan is repaid, the depositor gets back the money. If there is a default, the bank dips into the deposits.

You could call it shifting of risk from the banks to helpful individuals. And now, Rao has gone one step forward and started his own micro-mortgage company.

In fact, several entrepreneurs are starting home loan companies with a completely different business model. They question the relevance of traditional risk assessment procedures when it comes to lending to the poor.

The potential is huge. A report by consultancy Monitor Group, the market for mortgages for houses in the Rs. 300,000-Rs. 10 lakh range is 20 million households worth $182 billion.
Mumbai-based Micro Housing Finance Corporation, founded by Rajnish Dhall, is the first company to exclusively focus on this segment. It is solving the identification problem the hard way. The company spends a lot of time collecting and verifying information about the prospective borrowers like daily wage earners, small vendors and drivers.

The other issue facing micro lenders is collection. “Our customers will be wage earners, self employed, vegetable vendors and so on. If you don’t have a mechanism to collect their surplus on a daily or weekly basis something might come in between, and the money will find other uses.” John Muthoot of Muthoot Fincorp, says. Muthoot plans to start a micro housing finance company soon.

But the biggest challenge of them all is to keep the interest rates affordable. Monitor Group says the lending rate to this segment must be no more than 4 percent above cost of funds (1-1.5 percent going for operating costs, 1 percent to cover bad loans and 1.5-2 percent for margins).

8. Who Will Help the Self-Help Groups?
 It is a well-known irony that Amethi may be the bastion of India’s most powerful political family, but it is also one of the poorest districts of the country. The roads are terrible, electricity is sporadic and poverty runs deep. Job opportunities are rare and so is access to financial services. But  Argava, a tiny hamlet in Amethi, presents a picture in contrast.

Here, the villagers are not just getting credit but enjoy a slew of supporting services such as livelihood training, community education, access to public healthcare and lessons in best agricultural practices. They get taught financial literacy before they are given loans. The idea is to provide people training in handling the money so that they can use it for income generation and hopefully come out of poverty.

Ask Sakiru Nisha, a 60-year-old widow. In the gender-biased and casteist community in Uttar Pradesh, she might not have had a chance at good life but for the scheme operating in Argava. There, she could enroll in a women’s Self-Help Group (SHG) and borrow Rs. 100,000, a princely sum in these parts, to set up her own poultry farm. But then, she wasn’t a master of handling chicken and she got lessons on that too. “I used the money I made to start a store alongside. I now earn Rs. 3000 every month,” she says.

The catalyst for this mini revolution in Argava is the Rajiv Gandhi Mahila Vikas Pariyojna (RGMVP), the flagship poverty alleviation programme of the Rajiv Gandhi Charitable Trust (RGCT) set up by the family of the late leader.

Now, SHGs are not a new concept; thousands of women-led SHGs operate all over the country and banks and MFIs tap them to reach rural poor. Their scale however, is nowhere near what it should be. They have largely been top-down, federally organised groups, unable to scale up. But the Rajiv Gandhi Trust is changing that. It has adopted a grassroots approach under which existing SHGs seed the beginning of others. This has made scaling up easier.

RGMVP now covers nearly 300,000 families spread across more than 24,000 SHGs. It has led to savings of Rs.10.8 crore by these extremely poor people and has got a total credit line of Rs.72.8 crore from banks. Its experience tells us something about the missing link between financial inclusion and poverty alleviation across the country.

(Additional reporting by Sahil Waslekar)

(This story appears in the 19 November, 2010 issue of Forbes India. To visit our Archives, click here.)