India's Microfinance Institutions Seem to Have Stood the Test of Time
Small's Big Now

India's Microfinance Institutions Seem to have stood the test of time. But they need to hit the Country road and reduce cost of time. But they need to hit the country road and reduce cost of funds for any meaningful attempt at tackling poverty.

Garibi Hatao. Different versions of this slogan have been heard by generations of Indians since Independence. Sixty years later, such slogans are being replaced with the more sophisticated and less dramatic 'financial inclusion'. In the interim, several measures have come and gone. There have been subsidies, doles, one time grants, food-for-work programmes and employment guarantee schemes to mention a few. But the problem of poverty remained.

    One such intervention that has gained currency is microfinance. Started around two decades ago as a programme linking banks to women's self-help groups (SHGs), the microfinance sector in the country has, over the years, proved two simple facts. One, that it is sustainable, having passed the test of time by being around for twenty-odd years with significant impact on the lives of the poor, and two, that the poor are bankable.

    Though these were crucial in laying the foundation for the booming microfinance sector, a lot more is needed to define the way forward. The limited reach of the poor to funds remains a point of worry as does the high transaction cost. As Ms RV Bhavani, director, BV Rao Centre for Sustainable Food Security at the MS Swaminathan Research Foundation in Chennai puts it: "Cost of funds, spread of network and maintaining viability of operations
are issues they have to contend with."

    This apart, the uneven geographical spread also needs to be dealt with. Around 75% of all micro credit activity in the country is concentrated in the four southern states of Andhra Pradesh, Karnataka, Kerala and Tamil Nadu. In the coming days, micro finance must grow out of being just micro credit - delivering small loans to economically active poor - to
full-rounded financial services for the poor. That would involve an overhaul of the nature of financial products being delivered and delivery mechanisms.

Single product portfolios will have to make way for multi-product offerings, including insurance. That would also call for new systems and processes.

    That is not all. With the private sector having become equally active in this market, the days ahead will also probably redefine the relationship between the banks, the traditional funders and microfinance institutions (MFIs). Most bankers, of course, believe that bank lending will continue to remain the predominant source of funding except that the rules of the game may change. From a love-hate relationship between the formal banking sector
and the MFIs, "today the relationship is one of partnerships where MFIs co-exist with the big banks. While the MFIs are emerging as lead generators for the banks they themselves need access to funds to increase their loan size," says Ms Sakshi Varma of Lok Capital Group, a venture capital fund focused on investing in microfinance institutions in India.

    Some MFI players believe that a consolidation in the market is in the offing. According to Mr Vikram Akula, founder of Andhra-based SKS: "Most of the MFIs will become front-ends for banks. The former will originate and service the loans, like DSAs, and the latter will keep them on their balance sheets, much like ICICI Bank's existing partnership model." SKS was recently in the news for raising the first mainstream venture capital funding from
Sequoia Capital which lead a funds infusion of Rs 51 crore in the equity of
the MFI.

    Acknowledging that "MFIs are addressing a lacuna in the formal system,"
Ms Bhavani says, "banks can do without MFIs but not the other way round." Ms
Bhavani believes "while MFIs do have a role to play, I don't see them becoming too big in size. Banks with a solid deposit base would be better placed."

    Mr Akula, on the other hand believes that "a few MF players will become
large enough to be wholesalers, perhaps even get banking licences.
Meanwhile, some banks will get into direct front-end selling as well."

Typically, these would be the MFIs backed by private equity and venture
capital, he says.

    According to Mr Sandeep Farias of Unitus, a global microfnance accelerator, "consolidation is also another way some institutions will build scale and given the dynamic nature of the industry, it is possible that we will see the first attempts at consolidation in the next 12 months. However, this consolidation is not likely to see a significant change in the number of institutions that are involved in microfinance." Unitus works with a
clutch of large scale MFIs and has equity exposure in some of them.

    The flow of private equity, including VC funding, which is expected to increase in the coming days, will have an impact in the way the bank-MFI relationship is defined. Already private capital is flowing into the large MFIs which work on a for-profit model and have strong fundamentals. In the recent past private equity has come in from individuals like Mr Vinod Khosla, founder of Sun Microsystems, Unitus, the Michael and Susan Dell
Foundation, Bellweather fund and Sidbi, to name a few.

    From the simple bank-SHG linkage programme, essentailly patronised by
the government, today the sector presents a complex play of forces. The
sector's landscape is an agglomeration of institutions of varying forms,
sizes, financial support systems, methodologies and technologies marked by a
clash of philosophies and interests. There is intense competition, both for
resources and clients (read poor), leading to conflict and consequent social
tension. In fact, the lack of standardisation and regulation has often been
cited as one of the factors inhibiting the growth of the sector.

    Mr Mark Straub of Lok Capital feels that the sector is not yet ready for
competition among different players in the same districts (as has happened
in Andhra Pradesh) to reach out to the same customer base. "There are many
underserved districts in India and it will be detrimental if players start
competition for the same client base at this stage," he says.

    The sector is serviced by two parallel systems. The bank-SHG linkage
programme is the over-arching model with an outreach of close to two million
SHGs, 75% of which are in the four southern states. Public sector banks with
rural outlets are the funders of this system, spearheaded by Nabard. It
covers around 30 million women and has around Rs 8,000 crore in
outstandings.

    The second system is that of private MFIs supported by new generation
private banks and Sidbi, essentially entities which do not have retail
channels in rural areas. Within this there are two models: one where MFIs
borrow money from banks and lend directly; and two where MFIs work in
partnership with banks where they become direct sales agents (DSAs) and the
loans sit on the banks' accounts. Close to 70% of the market serviced by
MFIs is also in the four southern states with total outstandings of around
Rs 2,500 crore.

While most MFIs in the country are either NGOs or trusts or
societies working on a not-for-profit model, the bigger players like
Spandana, SKS, Basix, Share Microfin in AP, Cashpor in UP, Grameen Koota in
Karnataka work on a for-profit model.

    Combinedly, the two systems are estimated to cover roughly 10% of the
poor households in need of credit. Though no precise estimates are
available, back-of-the-envelope calculations show that the combined appetite
of the rural and urban poor for credit stands around Rs 200,000 crore,
against which a meagre Rs 10,000 crore, as recorded in bank outstandings, is
flowing through the system.

    It is amply clear that the huge uncovered capital requirement cannot be
met through traditional sources like grants or donations and bank lending
alone. There is near unanimity of view among various stakeholders - MFIs,
banks, equity investors, regulators and academics - that substantial funds
need to be injected into the system to scale up rapidly and increase
outreach. Alongside, there is a felt need for standardisation, both of
products and processes, which could help in lowering transaction costs.

"The problem with the formal banking system has been its inability to reach out
to the really poor and needy and making the right amount of credit available
at the right time as well as the high transaction cost involved. A recent
survey of the National Sample Survey Organisation revealed that more than
45% of the rural poor do not have access to the formal banking system," Ms
Bhavani adds.

    Some argue that funds are not in short supply. In fact, with venture
capital and private equity already flowing into MFIs, alongside bank credit,
the system does have enough ammunition to increase outreach. But are the
systems and processes in place to tackle greater numbers?

    Says Samit Ghosh, CEO of Ujjivan Financial Services, an NBFC-MFI for the
urban poor: "There is more to successful growth than just systems and
processes. If the goal is just outreach in terms of giving loans, there are
organizations which certainly have the systems and processes. Our approach
is to develop microfinance + programmes in the areas of healthcare and
insurance, vocational training and job placements and education."

    The general belief, however, is that most MFIs do not have the
capability to handle a client base of more than one lakh. As Mr Farias puts
it: "Institutions that are willing to invest in building a strong management
team and strong systems can rapidly build scale. Most institutions however
will remain small."

    Scale is, of course, going to be very critical for reducing the cost of
transaction. It will not only bring in economies of operation but might also
help MFIs access innovative capital market instruments, says Mr Farias.
"Cost of funds will also come down through securitisation and other
structured financial instruments like bonds," says Mr Akula.

    Speaking for all NBFC-MFIs, Mr Ghosh of Ujjivan says, "The only way we
can reduce our cost of funds is if we are able to raise our own customer
deposits. The security deposit which is permitted by RBI goes a short
distance towards achieving this goal." He however puts in a word of caution:
"MFIs need very good systems, controls and audit, and should be well
capitalised to raise deposits even from their borrowing customers."

    The issue that remains central to all this is, how do existing micro
credit beneficiaries move to the next level of income. "Microfinance per se
cannot satisfy the requirement. A whole lot of support services and training
and capacity building in enterprise management is required. Otherwise, there
will not be any real vertical movement in terms of income," says Ms Bhavani.
The answer probably lies in the creation of forward and backward linkages
that will increase opportunities for the poor.

    "Poverty alleviation is not a short term process. The life of the poor
even with micro credit is not a straight linear graph. It is a wave. They
have so many exigencies to face, that microfinance, however much vital, is
only one of the required interventions," says Mr Ghosh.

Rs 2,00,000 cr

The combined demand for credit from rural and urban poor Rs 10,000 cr

Total advances flowing through the system as recorded in banks' books Rs
8,000 cr

Advances to self-help groups from public sector banks and Nabard Saswati
Chakravarty with inputs from Ishani Duttagupta


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