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A Primer on Microfinance U. B. Desai SPANN Lab. Dept. of EE IIT-Bombaywww.ee.iitb.ac.in/~ubdesai.

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Presentation on theme: "A Primer on Microfinance U. B. Desai SPANN Lab. Dept. of EE IIT-Bombaywww.ee.iitb.ac.in/~ubdesai."— Presentation transcript:

1 A Primer on Microfinance U. B. Desai SPANN Lab. Dept. of EE IIT-Bombaywww.ee.iitb.ac.in/~ubdesai

2 Oct IT 625: ICT4SED Some Basic Question Why do we need finance? Why do we need finance? Why the special need for finance for the underserved communities? Why the special need for finance for the underserved communities? Why do poor still go to unorganized financial institutions (money lenders, shaukars,...)? Why do poor still go to unorganized financial institutions (money lenders, shaukars,...)?

3 Oct IT 625: ICT4SED Why is the spread of microfinance so slow? Why is the spread of microfinance so slow? Why are commercial banks hesitant to enter microfinance? Why are commercial banks hesitant to enter microfinance?

4 Oct IT 625: ICT4SED Some Basic Question Why do we need finance? Why do we need finance? credit is an instrument for investment and growth. Why the special need for finance for the underserved communities? Why the special need for finance for the underserved communities? Same as above Same as above Shift in Perspective: From poverty alleviation to wealth generation --- microfinance will enable wealth generation 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,...)? Why do poor still go to unorganized financial institutions (money lenders, shaukars,...)? We will look at this during the talk We will look at this during the talk Why is the spread of microfinance so slow? Why is the spread of microfinance so slow? Commercial financial institutions are not ready to enter this arena Commercial financial institutions are not ready to enter this arena Why are commercial banks hesitant to enter microfinance? Why are commercial banks hesitant to enter microfinance? We will explore this in the talk We will explore this in the talk

5 Oct IT 625: ICT4SED General Belief Poor are too difficult to reach. Poor are too difficult to reach. Small loans to poor is not a financially viable proposition Small loans to poor is not a financially viable proposition Financial institutions will loose money when they give microcredit to the poor Financial institutions will loose money when they give microcredit to the poor Microcredit or microloans will only increase the debt burden for the poor Microcredit or microloans will only increase the debt burden for the poor Do you agree? What is your opinion?

6 Oct IT 625: ICT4SED Microfinance (mFI) A clever scheme for small-savings and small- loan for the underserved community A clever scheme for small-savings and small- loan for the underserved community A financial service for the poor A financial service for the poor A financial approach empowering the poor A financial approach empowering the poor Microfinance brings in incremental changes 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 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

7 Oct IT 625: ICT4SED Microfinance: Interplay Among.. Institutions: Institutions: Access points for the poor to get financial services (e.g. SEWA, Grameen Bank, etc.) 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 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%) Funding Sources: Domestic savings (~70%), “private socially responsible citizens” (~30%) Infrastructure: Here ICT can play a major role Infrastructure: Here ICT can play a major role

8 Oct IT 625: ICT4SED Unorganized mFI Institutions (mFI) Exorbitant interest rates Exorbitant interest rates On the low end 3% per month (36% per annum) On the low end 3% per month (36% per annum) can be much more can be much more Often collateral, like cattle, jewelry, etc not returned Often collateral, like cattle, jewelry, etc not returned Often the poor get into a debt cycle for life! Often the poor get into a debt cycle for life! UmFI does not give loans for sustainability (for e.g. starting a micro-enterprise!) 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 really 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

9 Oct IT 625: ICT4SED UmFI: Case of Solapur District Collateral based lending Collateral based lending Gold is typically the collateral Gold is typically the collateral Borrowers: small time office clerks, peons, … people who have permanent jobs Borrowers: small time office clerks, peons, … people who have permanent jobs Collateral amount is 1.5 times the loan value Collateral amount is 1.5 times the loan value Loans taken for illness, family function, etc. Loans taken for illness, family function, etc. Interest is 3% per month Interest is 3% per month Default rate 80% -- most of the time gold is confiscated Default rate 80% -- most of the time gold is confiscated About 100 lenders each lending about a Rs.10 lakhs; totaling Rs.10 crs. 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

10 Oct IT 625: ICT4SED Some Facts There are an estimated 3,000 microfinance initiatives serving the world's poor 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. 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. 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. Only 30 microfinance initiatives have grown to serve more than 100,000 poor borrowers. The largest mFI, Grameen Bank in Bangladesh, reaches more than 3 to 4 million 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 loans starting as small as $35. A total of $4 billion has been disbursed since Grameen started giving loans in 1976 with seed loans starting as small as $35.

11 Oct IT 625: ICT4SED India … Earliest Initiative Earliest Initiative Shri Mahila SEWA (Self Employed Women’s Association) Sahakari Bank was set up in 1974 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 women working as hawkers, vendors, domestic servant etc. 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 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. 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 Though SEWA mFI is making profit, yet the SEWA bank model of mFI has not been replicated elsewhere in the country Very low default rate Very low default rate

12 Oct IT 625: ICT4SED India … Today, there are about 60,000 retail credit outlets of the formal banking sector in the rural areas comprising 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 12,000 branches of district level cooperative banks over 14,000 branches of the Regional Rural Banks (RRBs) over 14,000 branches of the Regional Rural Banks (RRBs) over 30,000 rural and semi- urban branches of commercial banks over 30,000 rural and semi- urban branches of commercial banks besides almost 90,000 cooperatives credit societies at the village level 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 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.

13 Oct IT 625: ICT4SED Target Populace for muF Rural Poor Women Rural Poor Women Asset value less than Rs. 20,000/- Asset value less than Rs. 20,000/- Per capita income is less than Rs. 350/- per month Per capita income is less than Rs. 350/- per month Live in poor housing conditions Live in poor housing conditions (from SHARE Microfinance Ltd.)

14 Oct IT 625: ICT4SED Different type of Microfinance Institutions Institutions that offers financial services to low income people at the prevailing market rates. 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. 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. 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. 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 Credit Unions Private commercial banks Private commercial banks Non-bank financial institutions Non-bank financial institutions

15 Oct IT 625: ICT4SED Often one classifies financial institutions like Often one classifies financial institutions like National Bank for Agriculture and Rural Development (NABARD) National Bank for Agriculture and Rural Development (NABARD) Small Industries Development Bank of India (SIDBI) Small Industries Development Bank of India (SIDBI) Rashtriya Mahila Kosh (RMK) 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 But, I feel,they do not fit the bill, because they do not cater to the kind of income talked about earlier

16 Oct IT 625: ICT4SED 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. 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 Microfinance is not appropriate for Extremely poor, destitutes Extremely poor, destitutes There has to be some viable way of micro-loan repayment There has to be some viable way of micro-loan repayment People who are extremely poor may get into debt trap with microfinance 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. Numbers vary, but some feel that one has to have 98% loan repayments rate for an MFI to succeed.

17 Oct IT 625: ICT4SED Some Data on Financial Sector in Rural Areas (2002) For 630,000 villages we have 32,443 bank branches 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 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 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 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.

18 Oct IT 625: ICT4SED Share of Different Sectors in GDP (GDP at factor cost, Prices) Rs. In crores Agri.Industry ServicesTotalServices% % % % % % % -- RBI, Handbook of Statistics on the Indian Economy

19 Oct IT 625: ICT4SED Breakup of Indian GDP GDP for India: $1000 billion GDP for India: $1000 billion 12 th largest in the word 12 th largest in the word Approx billion base dpn PPP Approx billion base dpn PPP Rural GDP: ~$250 billion (25%) Rural GDP: ~$250 billion (25%) 56% 22% Compare this with IT industry, which is ~ $ 20 billion

20 Oct IT 625: ICT4SED 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

21 Oct IT 625: ICT4SED Different Financial Services under Microfinance Deposit services Deposit services Credit lines Credit lines Term loans Term loans Money transfers Money transfers Micro-Crop and life insurance Micro-Crop and life insurance Micro health insurance Micro health insurance

22 Oct IT 625: ICT4SED Innovation in Microfinance Development of finance products for the underserved Development of finance products for the underserved Management of credit risk (minimization losses in giving credit) Management of credit risk (minimization losses in giving credit) Scalability: how to reach a vast, diverse, not easy to reach and geographically scattered populace Scalability: how to reach a vast, diverse, not easy to reach and geographically scattered populace Efficient delivery of microcredit Efficient delivery of microcredit exploit technology exploit technology

23 Oct IT 625: ICT4SED Gautum Ivatury: Focus Notes, Jan 2006, CGAP (Consultative Group to Assists the Poor)

24 Oct IT 625: ICT4SED Microcredit Delivery of microcredit has to be done more and more efficiently Delivery of microcredit has to be done more and more efficiently Here ICT can play a major role 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 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 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 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. Ability refers to a borrower having the financial resources to make a scheduled loan payment.

25 Oct IT 625: ICT4SED Three operational areas on which a microlender should focus to minimize credit risk: Three operational areas on which a microlender should focus to minimize credit risk: loan design loan design underwriting underwriting loan servicing loan servicing

26 Oct IT 625: ICT4SED Micro-Loan Design Balance between affordability needs of borrowers and costs to micro-lenders 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) Revolves on the design of interest rates (must cover operating costs, credit risk and funding costs) Interest are very critical to microfinance institution Interest are very critical to microfinance institution mFI interest are not very low at present mFI interest are not very low at present 15% to 36% per annum (SEWA charges 15% to 18%) 15% to 36% per annum (SEWA charges 15% to 18%) Note: RBI interest ceiling is 21% 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 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 As long as they are comfortable with the scheduled payment amount they do not worry too much about interest rates

27 Oct IT 625: ICT4SED Micro-loan Underwriting The process of determining a borrower's credit worthiness The process of determining a borrower's credit worthiness ability and willingness to repay a loan ability and willingness to repay a loan Most important from the microlender’s point of view Most important from the microlender’s point of view

28 Oct IT 625: ICT4SED Micro-Loan Servicing Loan servicing is the act of collecting payments and maintaining the balance of a loan 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. 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. 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. 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. 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. 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-door collections. Another effective method, albeit more labor intensive is door-to-door collections.

29 Oct IT 625: ICT4SED Micro-Loan Servicing … Provide positive incentives for payment. Provide positive incentives for payment. Borrowers respond well to positive incentives for good payment history. 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 food to achieve very high levels of repayment. 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% 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. 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. 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. 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. If caught early enough a lender can give the borrower assistance as well as workout a equitable repayment plan.

30 Oct IT 625: ICT4SED 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) 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 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. 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 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 Developing a market driven interest rate schedule for the poor

31 Oct IT 625: ICT4SED Challenges … Reaching people in sparsely populated, diverse, not easy to reach, and geographically scattered areas Reaching people in sparsely populated, diverse, not easy to reach, and geographically scattered areas Last mile problem of reaching the rural poor. 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 up microfinance as one of their major service. Most important challenge is to exploit technology to reduce transaction costs so that financial institutions will indeed take up microfinance as one of their major service. Reaching the poorest of the poor – the destitute: Reaching the poorest of the poor – the destitute: Many ignore this segment Many ignore this segment Very difficult for a commercial institution to recover micro-credit given to 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 Here Government will have to step n develop a scheme for micro-grants Make microfinance part of main stream financial market Make microfinance part of main stream financial market Data Collection – need to collect data that can indicate Data Collection – need to collect data that can indicate

32 Oct IT 625: ICT4SED 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 One Approach exploiting ICT

33 Oct IT 625: ICT4SED Exploit Cell-phone, Smart-Phone Platform Growing at a phenomenal pace 300 mil cell phones 300 mil cell phones Cost of deployment in urban areas: Cost of deployment in urban areas: Landlines – Rs.20K per line Landlines – Rs.20K per line Cellular --- Rs. 3K to 3.5K per line Cellular --- Rs. 3K to 3.5K per line Annual business of handset reaching Rs.10,000 crore ($220 mil), comparable to color televisions – indicating affordability. 7-9 mil new connections across the country every month Only ~20 mil PCs in India Another Approach exploiting ICT

34 Oct IT 625: ICT4SED Microfinance is a necessary input for rural wealth generation but by no means sufficient

35 Oct IT 625: ICT4SED


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