The petty neighbourhood shopkeeper is your new banker, savior

IN ADARSH Nagar, a small slum district in north Delhi, Sandeep Kumar, a 30-year-old small-time shopkeeper, attends to a line of customers. But they — local ricshawaallahs, other small shopkeepers and housewives — are not looking to buy their daily groceries. They want to withdraw money from or deposit it into their bank accounts.

This may seem unusual, but it is a sign of how the business correspondent model launched by the Reserve Bank of India four years ago is gaining traction. Financial Information Network and Operations Ltd, or FINO, the business correspondent company operating in Kumar’s locality, has more than 25,000 customers, split between 15 agents, in the district. Kumar himself gets about 60 to 70 customers per day.

FINO’s plan is aimed at improving the reach of the services to the unbanked sections of the population. Lenders are allowed to hire intermediary companies that deploy agents in rural and underdeveloped areas to open accounts for people. FINO has been hired by 16 banks and has 15 million customers.

It is a win-win situation for all concerned. Banks are able to reach remote areas without incurring the heavy expenses that opening a branch entails. For the customers, it means a safe place to keep their money, an easier access to loans and a proof of identity by way of their bank cards.

Kasim, a customer at Kumar’s shop who gave only his first name, says he likes to keep his money safe in a bank, but cannot afford to spend half a day every time he needs to deposit his cash. That is not the case with the business correspondent, where he is able to put in and take out small amounts without thinking twice. He also saves on the Rs 10 bus fare to his regular bank.

Punit Bist, FINO’s district coordinator for the area, says that in unsafe neighbourhoods like this one, depositing their money gives people security. Additionally, since most of these people do not have guarantors and an official proof of residence, they cannot open accounts with banks the regular way. He claims that 80 percent of FINO customers are first-time account holders.

The system of withdrawing and depositing money at a FINO outlet is easy. Agents keep about Rs 5,000 with them at all times. Customers come to the agent, who is open for business 12 hours a day, to either deposit money or withdraw small amounts. But first, the person identifies himself or herself through a small ‘point of transfer’ machine by inserting a smart card and using the thumb impression, instead of a PIN. The money is then shown as withdrawn from or deposited into the customer’s account. The agent links the machine to FINO servers through the Internet at the end of the day. Where such connection is not available, the machine can link through wireless GPRS.

On Sundays and holidays, the agent even goes door-to-door to customers, so they can operate their accounts, and get more people to open accounts.

The business correspondent model is fast catching on, with several companies using different technologies.

EKO is one such company. It has tied up with the State Bank of India (SBI) and has over 70,000 customers and 500 service points in Delhi, Bihar and Jharkhand. EKO uses the mobile phone to offer similar service. When a customer makes a deposit with the agent, he or she enters a code and his account number on the agent’s cellphone, and the money is instantly shown as having been deposited in a customer’s account. Further, money can be transferred from an EKO customer’s account to any person with an SBI account, using the phone. This is useful for migrant workers who may work in different areas and may need to send money home.

THERE ARE between 1,500 and 2,000 transactions (deposits, withdrawals and transfers) per day, totalling between Rs 12 lakh and Rs 20 lakh, according to Abhishek Sinha, chief executive officer of EKO. He says cellphones have made financial transactions possible on the move, and his company is making a difference in rural areas.

In India, where only 40 percent of the population has bank accounts, the potential for such no-frills accounts may be large. Whether this potential will be realised will depend on how fast the business correspondent model spreads, but for people who now have a place to keep their savings, and an easy way to send money to their families, this has come as a blessing.

By VILASINI ROY

Boosting the Business Case for Agents

This is the second piece in the five-part series launching CGAP’s Agent Management Toolkit. The toolkit is based on more than a year of research that yielded data on more than 16,000 agents in Brazil, India, and Kenya. In-depth interviews were conducted with 466 agents, agent network managers and providers, including mobile network operators, banks, MFIs and technology companies.

Today’s guest blogger is Prakash Lal, from Financial Inclusion Network & Operations Ltd. (FINO), which we found to have sophisticated insights on managing agents. FINO agents and technology connect more than 27 million Indians with 23 banks, 10 MFIs, 5 insurance companies and 15 government entities, via more than 11,000 POS terminals covering one-third of India. We’ve asked FINO to shed some light on how they boost the business case for their agents (referred to in India as “Business Correspondents”).

FINO was founded on 13th July, 2006 with the single objective of building technologies to enable financial institutions (FIs) to serve the under-served and the unbanked sector and also to service the technology requirements of entities engaged in servicing the bottom of the pyramid customers. Every step we’ve taken on technology, we’ve taken an equally important step forward in developing a highly-distributed, reliable network of Business Correspondents (BCs), whom we fondly call “Bandhus”, connecting clients to our technology and onward to the financial institution of their choice.

BCs are a critical link in our service delivery channel, and we invest a great deal in ensuring that working as a BC is attractive. Most of our BCs have other sources of income as well, meaning FINO needs to provide enough income to ensure that BCs will devote an adequate share of their time to the FINO business. We calculate that extra income to be, on average, INR 2500-3000 (USD 55-65) per month. This amounts to around USD 2 per day, which may not sound significant, but for a rural Indian it is welcome incremental income. Further, many of our BCs are also motivated by the desire to help their community and the social standing which comes with being allied with a high-tech product.

In addition, there are four points which strengthen the business case for our BCs:

Multiple Products: FINO has a complete suite of products to meet the financial inclusion needs of financial institutions. A multiple product suite roll-out enhances a BC’s option of increasing the number of transactions, hence an increase in their commission, as per the varied customer requirements. Product innovation in FINO is derived from its deep insight into the requirements of the client segment gained from pioneering work done with MFIs, banks and research organizations.

Financial Literacy: A regular saving habit by the customer will ensure regular transactions and thus more commission for the BC. FINO is doing various financial literacy projects with World Bank, International Finance Corporation (IFC), Microfinance Opportunities (MFO), UNDP and NABARD. FINO puts up the capital for our BCs and our staff play a large role in helping agents manage liquidity. FINO Block Coordinators manage approximately a dozen BCs and typically visits them every one to two days to retrieve excess cash or deliver new cash. In other words, if we look at the 9 drivers of the agent business case in CGAP’s Agent Management Toolkit, FINO removes the first two: upfront capital, liquidity management. We internalize that into our own business, making it much easier and more attractive for our BCs. We also pay our agents a fixed salary, in addition to per transaction commissions. This creates some certainty for our BCs as far as their income is concerned. We believe these are the best ways to build a viable network of agents in rural areas.

Take the case of one of FINO’s BC in Uttar Pradesh state, Md. Saleem. He runs a general store and also works with FINO. He handles 24 transactions on a typical day. His largest cash transaction on any given day is US$107 (INR 5,000), which effectively determines his cash-on-hand required to handle the largest transaction. A FINO Block Coordinator usually visits daily to pick up and deliver cash, and can get there within a few hours in case extra liquidity is needed for a very large deposit or withdrawal. Saleem uses his place of work—the general store—to conduct most agent transactions, obviating the need (and expense) for a dedicated agent location. As part of FINO’s “doorstep banking” model, Saleem also travels to client homes in three surrounding villages, incurring a transport expense. He nets a daily profit of US$1.84, which is very close to our target for BCs.

By FINO'S Prakash Lal for CGAP blog

A Humble question to Muhammed Yunus

The business model of for profit MFI-NBFCs – some of whom claim to follow the Grameen Model – is increasingly being questioned as an effective tool for poverty alleviation.

In a previous post [ Link ] I had presented a case for two strategies:

1. The SHG strategy (together with the SHG Bank Linkage program) which, from my experience over the past 27 years is appropriate to include poor families into the growth trajectory and also to increase their incomes in a sustained manner over a period of 6-8 years. Though the role of SHGs in the provision of credit has been highlighted, credit is only one factor; others are building self confidence and skills to negotiate and decide, joint action for lobbying to neutralize power relations which are oppressive and prevent entry into the growth trajectory (not only to credit institutions).These strengths are all incorporated in the word “empowerment” which well functioning SHGs generate. The dynamics of interaction among members generates the confidence and skills to take decisions and forge networks and federations of SHGs – these together provide the “power” to overcome hurdles and equip the poor to find entry into growth. The poor are in the status of “Pre-Clients” and need to equip themselves with the skills and resources required to be able to demand and access resources and entitlements which is the strength of “clients” who are the not poor.

However the SHG strategy (like any other strategy) cannot achieve its objective in isolation. It needs adequate investment in the area of operation from the Govt., private sector or NGOs which provides options for investment and/or reduces risk; it requires various support services to support value creation; it also needs up front investment in institutional capacity building (ICB) which includes training in at least 12 modules including how to analyse society, to foster participation, to arrive at consensus, to resolve conflict, what are the essential features of an SHG, the importance of sanctions etc – all this training in ICB takes time and money. Unfortunately this investment in ICB has been neglected in the rush to include the poor only in the financial system through no frills accounts etc. This is based on the mistaken assumption that the only reason to form SHGs is to access credit. Andhra Pradesh is a classic example of the rush to form SHGs and extend credit without adequate ICB and support services. Most of them were weak institutions. This was perhaps the major reason why the MFI-NBFC strategy to form JLGs - many of which were formed by poaching the SHGs - succeeded so well in the state.

2. The for profit MFI-NBFC model, I dared to suggest, is more appropriate for the not poor who have difficulty to access credit from formal institutions because of several reasons including distance to banks, long delays and paperwork required, no proper land records, previous defaults etc. They have the skills and resources - like good land 2-6 acres often irrigated or in good rainfall areas and/or potential to invest in non farm activities; but have to rely on money lenders who hold a monopoly situation. Apart from lack of access to formal credit, their major problems are poor infrastructure, corruption etc.

This paper attempts to take a step further - to raise a doubt that the MFI-NBFC strategy as practised by the major MFI-NBFCs in India is appropriate to create value even for the not poor. Since many of them claim to follow the Grameen Bank Model - more correctly the Grameen II model which was launched around 1999-2000 and which opened the door for the neo liberal features of Grameen Phase II - the question I raise is relevant. All evidence emerging from AP indicates that under the pressure from the neo liberal market forces and venture capital to commercialise micro finance - which means to grow fast, to earn high profits and offer high salaries, with an eye on valuations and IPOs , all the while stressing that self help and privatization is the best strategy to eradicate poverty - the business model of Grameen II very quickly begins to move from focusing on the objective of achieving financial sustainability of the MFI-NBFC to one where profit is maximized. And if office bearers in our national institutions support this model on the grounds that it is the fastest to include the poor in financial services and if the governance of these MFIs sees nothing amiss, then the business model becomes entirely driven by the profit motive; without any effective regulatory framework the course is clear. Both the private sector and the MFIs sniffed profit at the bottom of the pyramid; both looked at the poor as opportunities rather than responsibilities ; both ended up by catering to consumption aspirations and making profits higher than the most valued private banks.

Muhammed Yunus has done a fantastic job, but the Grameen bank he founded in 1983 is not the one that emerged after the Grameen II Project which was launched around 1999-2000. Though the ownership of the capital structure did not change, the delivery model did. Under the Grameen II framework, Phase II commercialized the business model: the poor have to pull themselves up by their bootstraps and by implication Government should keep its distance . Music to the ears of neo liberals and columnists who are given prominence in the Indian newspapers. Savings became compulsory – and compulsion whether of savings or in repayments adds a new dimension of power to the MFI. Commercial relations were established with MNCs like Telenor and Danone which surely rubbed off on Grameen since their representatives surely had a greater impact on governance than the client share holders. Yunus himself began to distance himself from day to day involvement in GB which came under others who did not share his convictions. Today GB is no longer eradicating poverty but bringing financial services to people many of whom are not poor. The original social mission of Muhammed Yunus has been consigned to the museum, not poverty. My question to Muhammed Yunus is this:

“ Why did you not react strongly to Grameen II –or Grameen Phase II when it had begun to develop all the markings of a neo liberal product... and when it was aggressively promoted as a model to be replicated all over the world?”

Perhaps Yunus did not react because he thought that good governance and commitment to the poor which characterized the first 15 years of GB would balance or neutralise these neo liberal structural features. But my experience is that once you plant an ‘Aam’ (mango) you will not get an Anaar (pomegranate) no matter how much you want one. You may say all the prayers and apply all types of fertilizer but you will still get a mango. So what do the supporters of Grameen II do? They paint the mango like an anaar. This can throw dust in peoples eyes for some time with aggressive PR - and GB has it - besides there are too many reputations in international financial institutions at stake; but the rains do come and the paint washes off and you are back to the mango!

It is easy to say as some international organizations promoting micro finance do: “Let us learn from the mistakes and move on”. Unfortunately they have not learned from their mistakes as is clear from their reaction to Mexico’s Compartamos experience as recently as 2007. Apart from continuing to aggressively promote the business model which maximizes profits, there are increasing signs that funds will start to pour in to AP from abroad to rescue the MFI-NBFCs without any structural change in the model being required. There is no evidence that international organizations are learning from the mistakes; no structural changes in the model are being envisaged; a few superficial changes will suffice ; the aam will again be painted like an anaar This is perhaps a bigger threat than the crisis that emerged a few months ago. The structural changes required are mentioned below.

The experience in AP adds weight to my position. In 2004-05 when the Krishna District crisis emerged, the MFI- NBFCs all agreed to change some features of their business model. A code of conduct was drawn up and agreed to. Did they observe it? No. ACCION and CGAP were involved in coming up with similar codes earlier as a fall out of their experience with Banco Sol and Compartemos. But their subsequent actions did not show that the code had any impact on the structure of the MFIs. In AP, as soon as funds started flowing again after the Krishna crisis, initially leveraged by private capital, the code of conduct was consigned to the museum. My contention is that the very structure (or business model) of the MFI NBFCs lends itself to the features which precipitated the Krishna crisis as well as the crisis in 2010 and will continue to lead to further crises in future if structural features are not addressed.

The major structural features of the NBFC- MFI model which lead to these crisis because it is inappropriate even for the not poor are:

1. The inability of the Grameen II model to cope with diversity because of standardisation – same size loans to all and same intervals ; if small differences are made in the second round it is mainly due to confidence levels in the client not on the potential for income from the activity proposed; the same repayment period for loans whether for agriculture, business or off farm activities . This in turn is conditioned by the software (ICT) which is often been promoted as a solution to most of the woes faced by the sector. So far ICT has helped to cut costs of the MFI; on the other hand it has imposed a standardised system on the clients (yet we celebrate diversity in other sectors). Together with standardisation, comes speed –including topping up with similar amounts which will be discussed later. In a second part of this post I will give some profiles of the livelihood strategy of SHG members who started out as poor but came out of poverty after 6-8 years; these livelihood strategies indicate that the requirements in all cases are diverse and that it takes at least 6-8 years with around 15 loans for various purposes and of various sizes amounting to Rs 2-4 lacs before people are firmly into the growth trajectory.The software of MFIs has to be made compatible with the diversity reflected in the livelihood strategies of the poor.

2. MFIs do not have the space or time to provide support to ensure that even the non poor have the services and information required to make investments productive. MFIs need to provide this support themselves from their profits or partner with others who can - like NGOs, Private sector or government institutions. The high rates of failure in income generating activities is due to this lack of timely, appropriate and adequate support. The present approach of MFIs however is entirely driven by competition - not by partnership and by speed to provide the next loan. I am not referring here to the practice of some MFIs to start health programs to present a soft and caring image to clients. This does not change the model. Rather the model must include partners who can add value to the investment.

3. The potential for rapid growth and high profits of the business model reduces the interest from financial institutions in investing in second level institutions which takes time, has higher risks and is not as profitable. Yet second level institutions to aggregate and add value to various farm products and to develop linkages with industry for design and marketing of farm and off farm products are a crucial step to sustain growth. This gap is increasing daily and must be addressed if growth in the rural sector is to take off. Financial institutions need to give this priority.

4. The MFI practice of weekly/monthly repayments at the doorstep (or nearby) does not jell with the cash flow of income activities which is lumpy. This in turn forces them to take up daily wage labour or petty business or borrow from one MFI to pay another—most resort to the last option. This structural feature results in multiple borrowing. The doorstep offer which is touted as a major plus is a double ended sword especially when there is pressure from the MFI to grow rapidly backed up by incentives to staff. As a result multiple lending has been a feature in every country where the Grameen II model (or prior to it the commercialised model) has been introduced be it Mexico, Boliva or Bangladesh and now India. In the SHGs, (the real ones), there is no such pressure from incentives and further at least a third of the common fund is owned by the group in the form of savings and interest, hence they assess each loan request carefully and make sure that here is no multiple borrowing which will affect their group interests.

5. The pressure exerted by MFI staff on clients to repay; one study has identified 9 ways in which MFI staff exercised pressure which need not be described here . This is not socially acceptable and will continue to cause negative reactions from society. There are only four sources which exert pressure to repay: a) physical collateral; b) affinity among members which exists prior to MFI entry and which needs to be discovered by the MFI - on the basis of which SHGs are formed; the members self select themselves. This affinity is a strength and is further developed by institutional capacity building and management of a group common fund consisting of their own savings, interest earned on loans, fines, donations; the pressure to repay comes from the group. When social pressure does not work the group decides to go further ;there are several examples of the SHG group lodging police complaints against defaulters, seizing assets like agri or horticultural commodities or bullocks ; but because it was the group that acted there was no reaction from society; this shows that pressure may be required at times but the source of the pressure must be from the peoples institutions and d) the expectations of another loan within a short time even though there is no potential for investment.

6. MFI-NBFCS hide under the myth that JLGs which are formed by MFIs who select the members provide joint liability and build social solidarity. The question is - if the JLGs worked effectively (as the MFIs claim) why did the staff have to exert pressure. Further in many cases the clients who are members of JLGs are forced to pay up when others default; it does not come willingly; and in such cases the JLG breaks up.

7. Very high interest rates (often well hidden) on the grounds that transaction costs in micro lending are high. The experience of a Not For profit MFI called Sangamithra over the past 10 years does not validate this. I do not have the expertise or resources to conduct further studies on the reasons behind high interest rates. But I was referred to one study made by a D. Richardson who studied the high interest rates in Compartemos. He found that the high interest, bonuses etc, were required mainly to ensure that high salaries and other allowances were paid to senior management and share holders (“Compartemos IPO issues”). There needs to be a regulatory cap on interest rates.

By:-By Aloysius P. Fernandez,

*The author is Chairperson, Nabard Financial Services and Member Secretary Myrada; the views expressed here are personal .

What Do We Know About the Impact of Remittances on Financial Development?

Remittances, funds received from migrants working abroad, to developing countries have grown dramatically in recent years from U.S. $3.3 billion in 1975 to close to U.S. $338 billion in 2008. They have become the second largest source of external finance for developing countries after foreign direct investment (FDI) and represent about twice the amount of official aid received (see Figure 1). Relative to private capital flows, remittances tend to be stable and increase during periods of economic downturns and natural disasters. Furthermore, while a surge in inflows, including aid flows, can erode a country’s competitiveness, remittances do not seem to have this adverse effect.

Figure 1: Inflows to developing countries (billions of USD), 1975-2008

As researchers and policymakers have come to notice the increasing volume and stable nature of remittances to developing countries, a growing number of studies have analyzed their development impact along various dimensions, including: poverty, inequality, growth, education, infant mortality, and entrepreneurship. However, surprisingly little attention has been paid to the question of whether remittances promote financial development across remittance-recipient countries. Yet, this issue is important because financial systems perform a number of key economic functions and their development has been shown to foster growth and reduce poverty. Furthermore, this question is relevant since some argue that banking remittance recipients will help multiply the development impact of remittance flows.

Whether and how remittances might affect financial development—banking in particular—isa priori unclear. On the one hand, money transferred through financial institutions might pave the way for recipients to demand and gain access to other financial products and services that they might not have otherwise. As an added benefit, providing remittance transfer services allows banks to “get to know” and reach out to unbanked recipients or recipients with limited financial intermediation. For example, remittances might have a positive impact on credit market development if banks become more willing to extend credit to remittance recipients because the transfers they receive from abroad are perceived to be significant and stable (i.e., serve as collateral, at least informally). However, even if bank lending to remittance recipients does not materialize, overall credit in the economy might increase if banks’ loanable funds surge as a result of deposits linked to remittance flows.

Furthermore, because remittances are typically lumpy, recipients might have a need for financial products that allow for the safe storage of these funds, even if most of these funds are not received through banks. In the case of households that receive their remittances through banks, the potential to learn about and demand other bank products is even larger.

On the other hand, because remittances can help relax individuals’ financing constraints, they might lead to a lower demand for credit and have a dampening effect on credit market development. A rise in remittances also might not translate itself into an increase in credit to the private sector if these flows are instead channeled to finance the government or if banks are reluctant to lend and prefer to hold liquid assets. Finally, remittances might not increase bank deposits if they are immediately consumed or if remittance recipients distrust financial institutions and prefer other ways to save these funds.

Two recent studies provide evidence in favor of the first hypothesis. They show that remittances have a positive and significant impact on financial development. Using municipality-level data for Mexico for 2000, my coauthors (Demirguc-Kunt, Lopez-Cordova, and Woodruff) and I show that remittances are strongly associated with greater banking breadth and depth, increasing the number of branches and accounts per capita and the ratio of deposits to GDP. These effects are significant both statistically and economically, and are robust to the potential endogeneity of remittances. The most conservative estimate suggests that a one-standard deviation change in the percentage of households receiving remittances—roughly a doubling of the mean remittance rate—leads to an increase of 1 branch per 100,000 inhabitants (against a mean of 1.79), 31 accounts per one thousand residents (relative to a mean of 42 accounts), and an increase of 3.4 percentage points in the deposit/GDP ratio (compared to a mean of 4.2).

Source:-MARIA SOLEDAD MARTINEZ PERIA

http://blogs.worldbank.org

How to Tell Good MFIs from Bad MFIs

Most of us working in microfinance want microloan clients to be paying interest rates that are as low as possible. While we have the same vision, there is disagreement about how to determine whether an interest rate is an appropriate one.

Some people, including Mohammed Yunus, are worried about the growing commercialization of microfinance, including the entry of profit-motivated owners and managers.  They are concerned, reasonably enough, about possible “mission drift,” especially in the form of interest rates rising to (or staying at) excessive levels. In his book and in many presentations, Professor Yunus offers a straightforward formula for judging MFIs and their objectives:

• If you’re a real microlender who cares about the poor, then your interest margin (the difference between the rate you charge when lending to your clients and the rate you have to pay when you borrow from your funding sources) should be no more than 10%. That’s the “green zone” where true microlenders operate.
• If your interest margin is 10-15%, a big warning sign is flashing because you’re in the yellow zone.
• Anything above 15% is the red zone, where you’ve left true microcredit behind and joined the loan sharks.

Unfortunately, when you look at the evidence, this appealingly direct formula turns out to be pretty far off the mark.

To begin with the conceptual problem, the formula doesn’t allow enough room for legitimate differences in administrative costs among MFIs. For an MFI that makes especially small loans or serves a sparse rural clientele, administrative costs will inevitably be a higher percentage of loan portfolio, and the lion’s share of the interest rate spread goes to cover those costs. Application of the proposed formula could actually discourage outreach by such MFIs to poorer clients.

But concepts aside, how does the formula match up against actual MFI experience? It turns out that this formula would place most of the world’s MFIs in the red zone—the average interest rate spread for MIX MFIs in 2008 was over 20%.  But to be fair to Prof. Yunus, that shouldn’t end the discussion.  After all, maybe plenty of the MFIs in the MIX are charging their borrowers rates that are way too high.

Now let’s test the green-yellow-red formula against a group of Grameen-approved MFIs. Christoph Kneiding and I analyzed MIX data on Grameen along with several dozen MFIs that received support from the Grameen Foundation and reported to MIX. In 2007, for instance, 33 MFIs (representing about two-thirds of the Grameen Foundation recipients) reported to the MIX.  The only one in the green zone that year (interest spread below 10%) was Grameen Bank itself. Seven were in the yellow warning zone (10-15%). All the other 25 were up in the red zone (above 15%) and most of them way up in the red zone (between 30 and 55%). The three preceding years looked pretty much the same.

The proportion of Grameen affiliates in the red zone was about the same as the worldwide proportion:for instance, 75% of all MIX MFIs were in the red zone in 2008, according to a new study by Adrian Gonzalez of MIX. NGOs were more likely to be in the red zone than for-profit MFIs, suggesting that interest spreads may be driven more by the higher costs of smaller loans than by profit maximization objectives. (Average loan size in NGOs is about a third of what it is in for-profit MFIs.)

Has the Grameen Foundation has been fooled into working with a bunch of red-zone partner MFIs that are wolves in sheep’s clothing? Far from it. The Grameen partner MFIs that look so terrible on the green-yellow-red test actually appear quite strong—in fact, well above average—on indicators normally thought to be associated with commitment to the poor, such as average loan size.  Nor do they appear to be inefficient: they average considerably lower on cost per borrower than the other MFIs in their countries.

It’s disappointing that simple formulas can’t help much when it comes to appraising things like mission drift or fairness of interest rates. It takes a more complex analysis (see, for example, the CGAP papers on microcredit interest rates and Banco Compartamos).  I hope we see a lot more MFI-by-MFI analysis, in which the reasonableness of interest rates is judged by the reasonableness of the costs and profits that produce those interest rates. We all want to see MFIs charging clients rates that are as low as possible, so we need analytic tools that can do a credible job of separating the sheep from the goats in that regard.

by Richard Rosenberg

Source:-CGAP

Remittance: a step towards financial inclusion

Financial Inclusion is the buzzword doing the rounds in the social sector these days. Financial inclusion is an umbrella term used to represent access to various financial services by the poor (bottom of the pyramid!). One of these services is the transfer of money i.e. remittance; a field which is seeing a lot of developments lately.

Remittance in common parlance refers to the transfer of money by a person abroad to his family/friends in his/her home country. Various reports by World Bank, United Nations University show that remittances form the second largest source of international finance to many developing countries of the world, often surpassing the official development flows. International Fund for Agricultural Development (IFAD) 2006 estimates put the total flow of remittances to developing countries at $301 billion (including informal channels) while the World Bank estimates are $250 billion (excluding informal channels), which mirrors the huge market potential.

And we are not just talking about the rich or middle-class but the poor too. We have known through personal experience or news stories about the sheer no. of unskilled labour who have migrated to areas for e.g. Gulf (from Kerala) in search of livelihoods. And it is this section of migrants that the development sector needs to concentrate on by ‘introducing’ formal channels to them which can be better leveraged to promote economic development.

Remittances make a real difference to people, a difference that’s measured not in money but in its ultimate utilization for better food, medicines, education and healthcare. But what’s the connection between remittance flows and financial inclusion?

In countries like Ghana, remittances can account for up to half the household income. In Bangladesh, they can represent most of the household income. It is estimated that about 10% of the world’s households receive remittances (DFID). And while this money is used to support basic necessities like roti, kapada, makaan, it can have a multiplier effect. It is known that most often the excess money is further invested for genetrating profits for the family. The cumulative effect on the economy could be increased employments, increased money flow for investments, thereby stimulating growth. And it is this aspect that if encouraged, can help communities to come out of poverty.

Money is sent through formal channels like banking institutions or money transfer agencies or more frequently, as in case of poor migrants, through informal channels like friends, acquaintances or illegal Hawala channels. There a number of impediments faced in the informal fund transfer – higher charges, delivery issues, possibility of theft etc., which may not just mean reduced money to the beneficiary but may even further tax the family. On the other hand, the formal channels ensure easy transference of the entire amount in return for set charges. And as money transfers through formal channels often require the use of a bank account, remittances promote access to formal financial services for the sender as well as recipient.

However the problem lies in the fact that the penetration of the formal channels is much limited, due to the same demand and supply problems which are plaguing the banking sector - problems of availability and accessibility, identification, information gap, illiteracy, higher operational costs.

This situation if utilized efficiently can prove to be a win-win situation for all stakeholders. As Dilip Ratha(World Bank) points out, encouraging remittances through the banking channels (formal channel) can increase the development impact of remittances by encouraging more savings and furthering investment opportunities. Banks and other financial institutions can introduce their other products to its remittance customers thereby reducing their costs per customer. MFIs can make use of the history of the remittance receipts to map out the credit history of the potential customers.

Access to remittance services in rural and remote areas can be improved by encouraging the participation of the microfinance institutions, credit unions, and saving banks (including postal saving schemes) in the remittance market thereby effectively increasing the probability of usage of formal channels by the poor.

The opportunities are limitless; and if combined with initiatives by the financial institutions and policy and regulatory support by Governments have the potential to make a difference!

By Ms. Swati Vempati.

Need for sustainability in the quest for financial inclusion

A focus on “financial inclusion” has been there in India for quite some time now. If we look back we can see examples of policies aimed at financial inclusion at various instances in the past; most prominent amongst them being the policies that were enforced in the immediate aftermath of bank nationalization and in many subsequent policies even later. So if there existed policies for financial inclusion why it is that a vast segment of our population continue to remain outside the coverage of formal financial institutions and their products and services and continue to rely on informal sources of finances like moneylenders who charge exorbitant rates of interest.

Why it is that poverty characterizes vast tracts of rural India and people there aren’t able to use the ladder of access to alternative sources of finance to escape the clutches of poverty and the social and economic shackles that a poorly performing agricultural sector has imposed up on them. Why is it that large numbers of landless agricultural laborers AND farmers continue to be dependent on agriculture despite falling wages and incomes?

The answer to this is that though the architects of India’s poverty alleviation programs had their intentions right and realized that providing financial inclusion in the form of access to formal financial institutions and their services to the most impoverished segment of the population would help them to break away from their dependency on incomes from agriculture and also liberate them from the clutches of the moneylender (principally responsible for a large part of rural indebtedness); in implementation the “financial inclusion” did not go further than increasing the number of bank branches in rural India and emphasizing on credit requirements of the rural population; most of which again went to the land owning segments of the agricultural class who were able to muster sufficient collateral.

There was hardly any focus on providing the landless laborer with credit let alone other financial products and services including savings, insurance, etc. Thus the rural financial infrastructure that came about was quantitatively impressive but qualitatively poor.

What they forgot was that the approach towards making financial inclusion a reality needs to focus on perceiving the common man at the base of the pyramid not merely as a recipient of the financial services that institutions hand down but also as an important stake holder in the entire process; one for whom these products and services are a gateway to greater freedom from poverty and underdevelopment. The focus therefore needs to be not only on the quantitative but also on the qualitative. This poses interesting questions to us today. It forces us to ask ourselves are we providing the base of the pyramid with what they need or are we providing them with what we think they need? what difference is what we are doing making in terms of providing the base of the pyramid with a greater avenue of choices to escape the poverty and impoverishment that binds them?

It brings us to the realization that when we talk about financial inclusion we should not merely talk about the quantitative but also about the qualitative. There needs to be a focus on sustainability; on providing the base of the pyramid with access to financial services and products that are designed to help bring about transformational changes within the structure of rural society and economy that will help it escape from the clutches of poverty and grow while at the same time providing adequate protection to those making use of these products and services. The task of financial inclusion will be incomplete if the common man at the base of the pyramid, who is in a vulnerable position due to poverty and marginalization is not protected and is left even more vulnerable at the end of it.

it requires us to adapt and adopt newer systems and processes to cater to the demands of different geographical, economical and social environments with the purpose of breaking restraining forces that are inhibiting their economic development and hence fulfill the objective of achieving sustainable growth that is all inclusive

Posted By Vivek John Varghese. http://knowaboutvivek.blogspot.com

The nature of Financial Literacy

Ever since i have become familiar with the word "financial literacy" and the manner of its usage and the contexts in which it is used i have had reason to wonder whether it is actually necessary to differentiate between financial literacy for the rich, poor (and to do justice to what is a large segment of the Indian population) the middle class. The origins of this question is founded in the fact that today we live in an economic context where macro economic realities and happenings impact the lives of people, Rich and Poor with the same intensity (albeit in manners more dependant to their different contexts).

A classic example of this is the economic phenomenon called as inflation (or in common parlance "price rise") and the kind of different impacts it has on all segments of society. While on one hand it is necessary to rein in inflation (and often this reigning in is done through stricter monetary policy like raising interest rates) as it can make the life of the common man hell by pushing up the prices of most essentials like vegetables and fuel etc, the same stricter monetary policy can also force loss of confidence in equity markets and by making credit expensive push down industrial growth rates. Whose concern should the government address in such a situation is a question of choice and i believe that the only way this dillema can be addressed is democratically.

This is where the question that i posed earlier becomes of paramount importance. If financial literacy is provided tailor made depending upon what we feel should people be made aware of it can leave some people better informed and others ignorant; thereby giving the better informed a better chance at shifting the decision making towards themselves and in disfavour of the ignorant (mostly the poor and the middle classes) who constitute the greater number and who should have been the recipients of redressal.At the same time it is also necessary to inform people that many at times macro economic happenings over which they are not responsbile can also have severe and sometimes shocking impacts on their economic and financial contexts. Many of you might say that it would be unfair to think that all people; whether rich or the poor or whether educated or uneducated; have the same level of understanding and hence can be dealt with in the same manner. I say i agree with you too. All people might not have the same level of understanding but the differentiation should not be in what constitutes the curriculum for financial literacy programmes but the methodology of carrying out the financial literacy initiatives; which should differ according to the socio-economic contexts of the audiences involved; so that all people have some idea about the financial and economic issues that to greater or lesser degrees affect them and their lives.

Savings and loans and explaining them to people are absolutely important in the case of a country like India where the greatest segment of people remain outside the purview of formal financial services, products and institutions.but at the same time it is also important to realize that as greater numbers of people are coming into the fold of formal financal institutions they are increasingly going to be exposed to newer dangers and threats - many of which remain outside their control and under the influence of macro economic factors. It is time the common man was made more aware of these threats and informed about information assymetries so that he can claim his protection and what is due to him in the new socio-economic and financial context.

Posted by Vivek John Varghese

SHGs for the Poor; MFIs for the Non-Poor

SHGs (Self-help groups) need to return to their original fundamentals of being strong grassroots institutions and the market for credit needs to be segmented

The focus of concern in the recent past, and leading up to the Andhra Pradesh microfinance crisis, has been the risk to commercialized microfinance organizations or MFI-NBFCs. Very little has appeared in the media on the risk borne by the clients, until the reported suicides in October brought their risk squarely into the political domain. This post focuses on the risk borne by clients.

First I would like to distinguish between two groups of clients: The first group is the poor who need credit and other opportunities for livelihood activities to survive. The second group is not poor; their livelihood strategy largely includes non-farm activities but they cannot grow to meet their aspirations without access to credit even at market rates.

My position is that the poor need substantial investment, besides credit, for them to move beyond survival and increase their incomes.

This investment includes institutional support- like the self help groups (SHGs) at the base - which provides the poor with the space to set their agenda to support their livelihood strategy. The services required to support livelihood strategies of the poor and to build these participatory institutions like SHGs need subsidy.

In short, this requires a long term perspective.

I do not think the business model of the MFI-NBFCs, which is driven by venture/private capital, quick disbursements, weekly repayments, high profits and remunerations for senior staff, a focus on valuations and IPOs and a quick exit, is appropriate for this group. Short term credit at commercial rates cannot help improve lives of the poor.

In fact, this business model increases the poor’s risk, often beyond a level that they cannot bear. The SHG model with links to banks (as it was originally conceived) is the appropriate strategy for this group.

Weekly repayments increase the borrowers risk and vulnerability to local power groups. Incomes from agriculture are lumpy not weekly; incomes from animal or dairy farming are usually monthly.

In order to repay the MFI loans weekly, clients are forced into activities that can help them earn daily, like wage-labor, or push them into a cycle of multiple borrowing, where they have space to borrow from one and repay to another.

The second group, the non-poor, who cannot get credit from banks because they do not have land records or fixed assets to provide collateral, are better suited to be clients of MFIs.

This group does not have the confidence and skills required to negotiate with banks if they need credit for activities in the non-farm sector and do not have access to working capital from formal financial institutions.

The business model of MFIs can meet the needs of this group provided profit is not maximized to an extent where there is little difference between them and the moneylenders. Good governance of MFIs can play a greater role than regulation; but evidence indicates that good governance is in short supply.

The SHG model is not an effective model for fast disbursement of credit. Therefore, it is not appropriate for this second group which needs credit.

Risk and the official policy promoting inclusion

Inclusion of the poor (the first group) into the formal financial system of the country involves considerable risks and costs on their part.

The SHG model was an attempt to lower this risk and costs for the poor by providing an intermediary institution which the poor managed. The banks that lent to them were satisfied even though the profits were low because their loans were categorized under “priority sector” lending and repayments far exceeded those from rural development programs in the past.

Between 2003 and 2008 the Reserve Bank of India (RBI) carefully managed India’s integration into the global financial system. Unfortunately the RBI did not take the same careful approach with the MFI-NBFCs in their rapid growth on the grounds that it was urgent to integrate the poor into the international financial sector.

Its focus was pushing the official financial system further into the interior on one hand and, on the other, a “hands off” approach as far as the MFI-NBFCs were concerned, encouraging them at most to self-regulate.

The MFI-NBFCs have not included the marginalized into the country’s financial system but instead included them directly into the international financial system which is not only inappropriate as a first step but raises the level of risk that clients have to bear.

Moreover, the emphasis on credit disbursement to SHGs increased when they were adopted by the Andhra Pradesh Government as part of its official strategy to mitigate poverty. Fortunately, high profits and remunerations were not part of the Government’s strategy.

The SHG Bank Linkage Model had grown till 2000 with adequate investment in building the institutional capacity. When it became part of AP state government policy in 2000, pressure was exerted by dedicated Government officers at the district levels to grow fast and achieve targets.

As a result, the quality of SHGs declined and their earlier emphasis on mobilizing savings, managing repayments and building a supporting environment for a livelihood strategy, considerably weakened.

Instead, SHGs were formed to achieve targets, with the wives of the Panchayat president and secretary dominating proceedings. They borrowed from banks and lent outside the groups at higher rates, at the cost of neglecting their own members.

Official reports focused on disbursements; corrective measures were taken to balance the spread of credit in areas where growth was slow. However, no investment was made to add value or to support increases in productivity and diversification.

Investment in institutions, the very essence of SHGs, was no longer a priority. Instead, the Government was in a hurry to disburse and increase financial inclusion.

Risk and interest rates

MFIs argue that high interest rates are justified because the risk of lending to small borrowers is high, the cost of delivery at the doorstep is high and finally the rates are far less than those of the private moneylenders.

However, high interest rates when offered by MFIs increases risk for the poor.

The State of the Sector report 2010 (N. Srinivasan) indicates that out of 60 MFIs which reported on profitability, six had ROAs over 7%; thirty five had ROAs over 2%.

In contrast the public sector banks in 2009 had average ROAs of 0.6% with the best being 1.6%, while the best private bank had ROAs of 2%. The yield on portfolio confirms this picture; in the case of 23 MFIs it was above 30 %(the highest being 41.29%).

The report also says that economies of scale have not led to lower interest rates or lower yields. This implies that MFIs maximized their profits and competition did not decrease rates as it was expected to.

The largest MFI recorded a 116% jump in net profit at Rupees 81 crores ($18 million) in the second quarter ending September 2010 as against the corresponding period last year.

The level of profit required to meet all costs, cover risks and expand operations is lesser than the level of profit required to meet all these costs and, in addition, attract venture and private capital, and pay salaries higher than the remunerations of the CEOs of the largest private banks.

What should be the interest rate? The figure of 24% is floating around in official circles. The problem is that the effective interest rates of MFIs are far from clear. There appears to be a difference of 5% to 10% between the rates as provided by the MFIs and the rates that emerge from an analysis of the books of clients.

MFIs also argue that the cost of credit from banks is high and that they should be allowed to mobilize public deposits if interest rates are capped. Interviews with clients show clearly that they do not have an idea of what they actually pay over and above the capital. They are satisfied if credit keeps coming.

In fact interviews with those clients who had succumbed to the temptation of multiple borrowings showed clearly that they wanted to borrow from several MFIs to maintain a cash flow to cope with repayments as well as their expenditure. This increases their risk substantially. In contrast, interest rates of SHGs in Myrada stabilize after two years or so between 12% and 14%, which is about 3% to 4% above cost of credit from banks.

Non-profit MFIs who do not pay high salaries but still pay adequately enough to attract experience and capital from banks manage to make a surplus at interest rates between 17% to 19%, where the average cost of credit is around 9% -10% and annual growth rates are 40% to 50%.

For-profit MFIs should be able to manage their affairs and attract sufficient capital (not venture capital and high valuations) by charging effective rates ranging from 15% to 17% above the average cost of credit. This would enable them to charge interest rates in the range of 24% to 29% instead of their current rates which are 20% to 30% above the average cost of credit.

The poor in SHGs are able to manage interest rates of 12% -14%. They have also managed with interest rates higher than 14% in the initial period of group formation until they have built up their group’s common fund. In my experience, they can cope with interest rates of around 17%. The risk involved is manageable and the cushion provided by the SHG can help them tide over urgent needs.

The non poor in the second group can cope with higher interest rates levied by for profit MFIs but the rates should not exceed 30%.

Competition among MFIs has not reduced rates, neither has self regulation.

Interest rates, commissions, salaries, profits have to be regulated by the board of an MFI. A decision by the Board to opt for an IPO will force management to focus on quarterly figures because the logic of financial markets dictates that it should.

This will further integrate the marginalized into the free market system increasing the risk of the clients who are particularly vulnerable.

SHG is not a good model for speedy disbursement of credit; but it is a good model for lowering the risks of borrowers as well as lenders. SHGs have savings which they use to cushion irregular cash flows; they are able to adjust to urgent and unexpected situations. Myrada’s analysis of its SHGs shows that their common fund increases year on year.

The SHG model, with lower interest rates and risk, is most appropriate to financially include the poor, while the product offered by for profit MFIs is appropriate for the non-poor who are in need of credit.

–Aloysius P. Fernandez, Chairperson, National Bank of Agriculture and Rural Development (NABARD) Financial Services, India and Founder of Myrada; the views expressed here are personal.