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Micro Finance in Indiaoverview, challenges, and the role of
technology
By Annie Duflo
Centre for Micro Finance ResearchOctober 28, 2005
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Outline of presentation
What is microfinance?
Providing financial services to the poor:
challenges Providing financial services to the poor in
India: Overview
Microfinance: Challenges ahead and potentialsolutions/initiatives
The Centre for Micro Finance Research
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Microfinance: what is it?
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Microfinance: what is it?
What are the words that come to your mindwhen you hear the word microfinance?
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Microfinance: what is it?
R4
R3
R1 /R2
Microfinance =
provision of financialservices to the poor48%
15%
37%
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Microfinance: what is it?
Micro-credit Group lending
Social/charitableactivity
Range of financialservices
Group and individuallending
Profitable activity
What it often is What it really should be
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Providing financial services to the poor:challenges
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Providing financial services to the poor:
challenges Risk management challenges due
to information asymmetryproblems
Accessibility (geographicaccessibility and easiness to dealwith)
No collateral, Low value and cash
intensive nature of the business
Staff training and motivation
High transaction
costs
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Information asymmetry
Decision to take loan Loan usage loan repayment
Adverseselection
Moral hazard
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Adverse selection: incomplete information
problem (before the loan)Dont know
Clients typeInterest rate
reflects proba of default
Safer clients drop outNeed to increase interest
rate
Providing credit canbecome
impossible
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Moral hazard: hidden action problem
(after loan)
Can not observe what client is doing
Bad loan usage
Strategic unwillingness
To repay
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Staff
Lack of trained staff
Lack of motivated staff
Difficult to incentives staff
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Delivering financial services to the poor inIndia: an overview
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Providing financial services to the poor:
occupied IndiaDeccan, late 19th Century:peasant riots on account of coercive
alienation of land by moneylenders.
Organization of cooperative societiesas alternative institutions for providingcrdit by british government
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Providing financial services to the poor:
Independent India:Credit was viewed as essential part of fight
against poverty which led to following
measures: Expansion of the institutional structure
Directed lending to disadvantaged borrowersand sectors
Interest rates supported by subsidies
Institutional vehicles: cooperatives,commercial banks and Regional Rural Banks
[RRBs].
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Providing financial services to the poor:
Timeline 1950 & 1969: emphasis on the promoting of
cooperatives.
1969: nationalization of the major commercial banks:beginning of commercial bank branch expansion inthe rural and semi-urban areas.
1976: Regional Rural Banks (RRB), low costinstitutions mandated to reach the poorest in credit-
deficient areas
During this period, intervention of the RBI (ReserveBank of India) was essential: special creditprogrammes for channeling subsidized credit to the
rural sector (concept of priority sector)
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Financial reforms for RFIs
Enhance the areas of commercial fredon
Increase their outreach to the poor
Stimulate additional flows to the sector. Liberalising interest rates for cooperatives and RRBs,
Relaxing controls on where, for what purpose and forwhom RFIs could lend, reworking the sub-heads
under the priority sector, Introducing prudential norms
Restructuring and recapitalising of RRBs.
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Results
Access in terms of rural branches increasedfrom 1,833 in 1969 to around 32,538 atpresent: 49% of all scheduled commercial
bank branches are rural The population per rural branch declined from
2,01,854 in 1969 to around 16,000 at present. The proportion of borrowings of rural
households from institutional sourcesincreased from 7 per cent in 1951 to morethan 60 per cent at present.
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Results (contd)
31% (131.1 million) of the total depositaccounts are in rural India
43%(22.4 million) of total creditaccounts are in rural India
Positive impact on the poor (Rohini
Pande/Burgess paper)
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HoweverSuccess was not as high as
hoped Defects in policy design,
Infirmities in implementation
Inability of the government of the day to desist fromresorting to measures such as loan waivers.
High defaults
The banking system - was not able to internalise
lending to the poor as a viable activity but only as asocial obligation
More and more difficult for commercial bankers toaccept that lending to the poor could be a viableactivity.
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Micro Finance: apparition
The financial sector reforms motivated policyplanners to search for products and strategies fordelivering financial services to the poormicroFinance - in a sustainable manner consistentwith high repayment rates.
NABARD: empirical observation that had beencatalysed by NGOs that poors gather in informalgroups
Create a formal interface of these informalarrangements of the poor with the banking system.
Bank-SHG Linkage Programme. Recent emergence of MFIs: professionally run
institutions specialiazed in delivering credit with lowcost staff and local knowledge
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Despite all these effortslarge gaps
remain Against rural population of 741.0 million, 500 million
people un-served
Population per branch: 22,793
Penetration of savings accounts is below 18% As against 104% in urban and semi-urban areas
Number of villages per branch: 19
High dependence on informal sources
36% of rural credit from informal sources Dependence even higher for lower income households: 78%
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Microfinance ahead: challenges
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Gaps in demand and supply
Demand: Rs. 450 billion/y
60% in Southto cover all parts of India
Less than 2 million
Households reached500 million un-served poor
Disbursed: 39 billion
eed employment opportunities
Need protection
against all risks
Market constraints
Insurance under-delivered
Scaling up
Increaseimpact
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Limitation of the predominant model
Bank SHG
NGO
Loan at9%
Noliability
Groupformation/linkage
SHG-Bank linkage model
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Financial IntermediationModel
MFI JLG GroupBank
Loanat a9%
Loan at20%
Scaling up existing MFIs: challenges
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Limitations to growth of MFIs:
Lack of adequate quantities of risk capital
Lack of long-term finance to pay for creation
of the necessary infrastructure and pre-operative expense
Lack of well trained staff in adequatenumbers at all levels
technology
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Lack of adequate capital: the ICICI Bank
responseSearched for a model which:
Separates risk of MFI from risk inherent in the
mf portfolio Provides a mechanisms to banks to
continuously incentivise partners
Inability of MFIs to provide risk capital in largequantum, which limited advances from banks
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The ICICI Bank Partnership Model
MFI JLG GroupBank
Servicingfees of
11%
Loan at9%
Interest
charged:20%
FLDG of10%
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Long-term finance: the ICICI bank
response There is an underlying business model in the
MFIs expansion: no reason why it cannot be
funded by commercial debt
ICICI Bank is offereing to its MFI partnerslong-term finance of a tenure of 3-5 years
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Lack of well-trained staff: ICICI Bankresponse
Initiated partnerships with training institutions(Indian Grameen Services, Care India)
Establish a Financial Services LearningSchool in collaboration with MicroSave India
Provide high level training in banking andfinance to MFI practitioners in collaboration
with IFMR (Institute for FinancialManagement Research)
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Technology
Role of technology in microfinance:
MIS
Cash handling Data capture and subsequent management
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Technology: ICICI Bank response
Creation of rural connectivity in partnershipwith telecom companies and internet service
providers Assistance to emerging MFIs to adopt
scalable MIS solutions
Support to research and development on
technological devices that can reducetransaction costs
Low cost ATMs, low-cost computing devices,mobile and internet-based transaction platforms
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Scaling up: creation of new MFIs
Need 200 MFIs to cover all India
ICICI Bank (SIG): support to entrepreneurs to startMFIs
KAS Foundation, Orissa
Inputs are needed:
Organizational and staff incentive structures
Finance related issues (source of funds, capital structure)
Legal issues: regulations etc.
Business plan related issues: scale, expansion strategy etc.
Corporate partnerships: attractive track to buildaccess to microfinance
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Support new MFIs: The Venture Capitalistmodel
VCs specifically focused on the micro-finance space:Lok Capital, Aavishkar and Bellwether.
Bellwether
three equity commitments for start-ups
increased the size of fund from 10mn USD to 25mn USD.
ICICI Bank solution:
Each MFI will need to reach a minimal CRISIL or an MCRIL
operational sustainability rating Then the entrepreneur buys out the stake of the VC and
ICICI Bank gives an option to the entrepreneur to take along-term debt to finance this buy out.
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Scaling-up: what form of support isneeded?
Interest rates should reflect the costs oftransactions/probability of default and be
sustainable Focus on diminishing the cost of these
transactions and expand access
Equity support, Removecaps and floors, create facilitative infrastructure
to reduce transaction costs
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Alternate channels
Agent model Model of LIC
Challenge: control fraud
Internet connectivity BSNL: if wireless system installed ate the existing
connected rural exchanges: 80-85% of villagescould be connected
Variety of devices that can work with internetkiosks: biometric low-cost ATMs
Makes controlling fraud easier
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Internet Kiosks
Connectivity
STD/PCO:Enabling voicecommunication
Printer & OtherAccessories :
Enabling job work
Kiosk Operator:EntrepreneurProvides commercialservices
Internet Kiosk
MultimediaPC with Power
backup
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Internet kiosks
ITC, nLogue, Drishtee: more than 6000internet kiosks using Wireless in Local Loop,
VSAT terminals ICICI partnered with some of these
organizations
Finance individual entrepreneurs to purchase
operating license and equipment Break even within 1st year
Suite of financial services
2000 kiosks
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Internet kiosks: remaining gaps
Providing constant connectivity expensive
Finding motivated entrepreneurs difficult
Break even has been delayed for variousreasons (required back-end systems toservice clients difficult tp find etc.)
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ICICI Bank strategy: summary
ConventionalRural
Banking
Branchbased
Manpower
intensive
Product
drivenSingle
product
Our strategyHybrid
channels
Technology
intensive
Customer
drivenMultipleproducts
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Maximize impact of microfinance:challenges
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Maximize impact
VulnerabilityNeed for
More than credit
Differences amongcustomers
Need for
customizedproducts
Understand what programmes work the bestand for whom
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Range of Microfinancial services:
Individual lending
Information problem
No unique ID No credit info sharing
Need technology!
Insurance
Adverse selection, moral hazard, fraud
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Range of Microfinancial services:
Health insurance
Reimbursement model
Cashless model How to identify illness?
How to avoid fraud?
Livestock insurance
Recognize cause of death
Identify animal (role of technology)
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Range of Microfinancial services:
Weather insurance Index-based: index created by assigning weights
to critical time periods
Past weather data mapped to this index to arriveat normal treshhold index
If deviation: compensation
Commodity price derivatives
NCDEX: offers price discovery services: offerfarmers instruments to hedge pre and post harvestrisks
Makes using commodity as collateral possible
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CMFR:The Centre for Micro Finance Research
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Objectives
Fill gaps in understandingof microfinance:
Extent and channels of impact
What programme designs work and what do not? What programme variants can increase impact?
Fill gaps in practiceof microfinance:
limitation to micro-credit, lack of financialcapacity
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Mission
The Centre for Micro Finance Research will aim tohelp improve the life of the poor by:
Systematically researching the links between access
to financial services and the participation of the poorin the larger economy
Participating in maximizing access to financialservices and its impact for poor through: Research on micro finance and livelihood financing
Research-based policy advocacy
High level training for practitioners and institutions
Strategy building for Micro Finance Institutions
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Partnerships
CMFR
Banks/InsuranceCompanies
Internationalorganizations
MFIs/NGOs
Universities
Regulators/policymakers
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CMFR: Research Areas
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Impact of Microfinance
Access toFinancial services
Impact?
Advocacy based on rigorous results
?
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Constraints to Productivity
ImpactAccess to
Financial services
Build relevant partnershipsProvide useful products through credit
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Economics of Micro-Enterprise
Scale, Returns, Constraints of micro-enterprise
Market linkages Documentation of best practices
Help increase productivity of micro-enterprise
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Experimentation on Product Design
selection monitoring Enforcement
Individual/groupliabilitySelf/MFI selectionGuarantorsCollateralsInterest rate
RepaymentscheduleCommunicationstrategiesLoan sizeInterest rate
Design the most cost-effective products
Within groupmonitoringStaff supervision
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Behavior and Psychology ofBorrowers
How do households face shocks and risk?
Do households save and how?
What drives savings and credit behavior?
Why do people default?
Why dont households adopt the most profitable
activities?
Design the most effective communication strategies
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MFI Policies: Impact
How do MFIs policies affect loans andrepayment behavior of clients?
Staff incentives
Combination of different products
Compulsory savings or insurance
Understand better impact of policies over time
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Cost and profitability of SHGs/MFIs
BankTransaction
?Micro-loan9% 25%
Return?
How to reduce transaction costs?Compare costs of SHG-Bank linkage and MFI modelShow investors risk return performance of microloans
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Research: other initiatives
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Research: Panel Databases
Construction of a panel database: repeatedobservations of same households
Study vulnerability, consumption patterns overtime
Have a panel database for on-going research
Construction of a cross-sectional survey Document access to financial services over time
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Research: weekly seminar series
Foregone seminars Prof Ashok Jhunjhunwala (IIT Chennai),
Prof Vaidyanathan (Madras Institute of DevelopmentStudies)
Prof Sendhil Mullainathan, Harvard
GN Bajpai, ex-Chairman of SEBI
Greg Fisher, MIT
..
Forthcoming seminars: Suresh Sundaresan, Columbia
Dr Narendra Jadhav, RBI
..
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MFI Strategy Unit at CMFR
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Strategy Building
MFIsSectoralExperts
Pilots
Scale-up LFI
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Training
Building blocks of Banking and FinanceTraining Programs
Meet training needs of the sector: Incollaboration with MicroSave India
Development of national curriculum
Collaboration with 6 Regional TrainingInstitutes
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THANK YOU!