Indian microfinance: History and models

History of Microfinance in India Group-based internal lending has been historically popular in India (e.g. the bhisi system common in Mumbai, the sheetu / chits system common in TN and AP, SEWA and Annapurna Mahila Mandal groups of working women etc.) In 1982, the state-sponsored NABARD initiated the Bank- SHG Linkage Programme with the objective of expanding the reach of existing banks to the rural poor The SHG-model has had issues in terms of scaling up and quality of groups and loans in the long-term In 1990s, private microfinance institutions (MFIs) were established primarily in AP, following the Grameen Bank model MFI model has grown relatively faster Govt. of India giving thrust to the SHG model From Microfinance Models – Practitioners’ Perspective, IFMR Trust

Popularity of Microfinance Grameen Bank – started as a small initiative in Bangladesh in 1976 by Prof Muhammad Yunus Grameen Bank inspired several similar initiatives in other countries across the world Other institutions in Bangladesh – BRAC, ASA, PROSHIKA Microfinance has now evolved as an industry, with major activity in Latin American countries, Africa, Eastern Europe, India and South East Asia MF truly evolved when Prof. Yunus and Grameen Bank were awarded the Nobel Prize for Peace in 2006 Following CK Prahalad’s theory of BoP markets, microfinance has attracted a lot of interest – seen as a means to reach out to this segment Mainstream commercial equity and debt investors have been showing a lot of interest in microfinance From Microfinance Models – Practitioners’ Perspective, IFMR Trust

Two streams of microfinance in India Agenda Two streams of microfinance in India Historical evolution of microfinance in India

Agenda 1 Two Streams of Microfinance in India

What is Microfinance Provision of financial services to people unreached by formal institutions Credit, savings, insurance and any other financial products typically of very small ticket sizes Usually involves ‘aggregation’ of clients – groups, centers, SHGs, federation etc. “Social collateral” replaces physical collateral Not a panacea to remove poverty From Microfinance Models – Practitioners’ Perspective, IFMR Trust

How is microfinance defined in India? Provision of financial services to low income clients and poor people with the goal of creating social value. Microfinance can be defined as any activity that includes the provision of financial services such as credit, savings and insurance to low-income individuals which fall just above the nationally defined poverty line, and poor individuals which fall below that poverty line, with the goal of creating social values. The creation of social values includes poverty alleviation and the broader impact of improvving livelihood opportunities through the provisions of capital, savings, insurance and remittances. Loans Savings Insurance Remittance

Methodology of microfinance Identify the potential customers. Mostly by using a poverty index, thereby ensuring that the customers have a great deal of homogeneity Organise them into groups- address the issue of information asymmetry and lack of collaterals by transferring what could be an individual liability into a group liability. Group responsible for payment Provide standardized products (Mostly credit in India), standardized operating systems and discipline

Microfinance streams Self Help Promoting Institution (SHPI) Stream Microfinance Institutions Stream The Intermediary (SHPI) promotes client groups and links it to banks The intermediary (MFI) promotes client groups and offers financial services to them. The MFI acts like a financial institution

Self Help Promoting Institutions (SHPI) Client Group Provision of financial services Financial Institutions (banks) Promotion and nurturing Capacity building support SHPI MYRADA, PRADHAN, DHAN Foundation, Mann Deshi, Apex Banks, Government run SHPIs, RGVN, Hand-in-Hand

Micro Finance Institutions (MFI) Financial services Client Groups Funds Financial Institutions MFI Promotion and nurturing Capacity building support Most NBFCs in India- e.g. SKS, Spandana,

Microfinance Models Individual Banking Model SHG Model JLG Model

Microfinance Models in India Snapshot of Microfinance in India1 1. Source: Sa-dhan (2008). A Snapshot of Microfinance in India From Microfinance Models – Practitioners’ Perspective, IFMR Trust

Financial Institutions (e.g. Banks) Self Help Group Model Financial Institutions (e.g. Banks) Initiated in India in the 1980s Clients may be men or women A group of 10-20 individuals. Is an independent entity Is usually promoted by SHPIs or MFIs Have their own bank accounts and books of accounts SHGs collect savings and give loans to their members Can borrow on their account. SHGs can execute documents Are recognized by government Also take up social issues SHG has its roots in social development Banks provide loans only after 6 months of group formation Loans Savings SHG Loans Savings

Joint Liability Group Model A group of 5-20 individuals. Is usually promoted by an MFI Mainly promoted for the loans No internal transactions No bank accounts No books of accounts are maintained by the JLGs Have to depend on the MFI for all their loan requirement Are not recognized by the government Cannot execute documents JLG has its roots in microfinance Loans provided immediately by the MFIs after group is formed MFI Loans Repayment Joint liability of the group

Individual Banking Model Loans given to individuals Physical collateral or personal guarantees are taken There is no role of SHGs or groups The MFI has to conduct appraisal of the individuals borrowers MFI, Rural banks Loans Savings

Operational Structure of an MFI Five-members groups are the basic units. 5-8 such groups constitute a branch (Centre) Centers meet once a week Disbursement and collections are made in center meetings Groups and centers appraise the loans and undertake joint liability All center meetings are attended by the staff of the MFI Flat rate of interest calculation MFI Branches center Group Started by the Grameen Bank of Bangladesh Highly standardized processes Many adopters all over the world

Mixed models Numerous mixes of SHG and JLG models NGOs that have a significant no. of SHGs are quite willing to form MFIs to provide loans directly to the clients Banks are willing to provide funds to such NGOs as they are able to provide bulk loans instead of having small accounts on their book. Different MFIs are also going back to creating SHGs. Most MFIs on attaining a certain scale become conscious of the need to take development work – set up NGO The cost of intermediation by the MFI would have to be borne by the customer who earlier were able to gain the intermediation margin which got added to their corpus. The SHGs would possibly pay a much higher interest for the loans that they would now receive from the MFIs/NGOs instead of from the banks in the past.

Agenda 2 Historical Evolution of Microfinance in India

Evolution of microfinance The next big innovation to address the poverty issues in India The language of microfinance has undergone a fundamental change in the two decades of its evolution The next big investment opportunity

Wave 1: Not-for profit Large part of the 80s was spent in organizing groups, being focused on community owned and integrating them with the banks (Known as SHG model). Slow process. Global Microcredit Summit-1997. Event used by Grameen Bank to showcase its work. Shown as an effective methodology to reach small loans to the poor. Current large MFIs were setting shop in India. (1996-1997) They were all registered as public societies with grant money and came with a developmental orientation. SHARE Society for Helping and Awakening the Rural poor through Education Unlike other development interventions of the past- be it joint forest management, natural resource management and marketing interventions that benefit the poor, microfinance caught the imagination of the NGO sector in a big way in the 1980s. Large part of the 80s was spent in organising groups, being focused on community owned and managed structures and integrating them with the banks. BASIX had had a regional rural bank type of product portfolio- trying to address the needs of the poor and non-poor

Wave 2: Move from not-for-profits to for-profits People in the developmental sector discovered a methodology to reach a large number of poor clients, scale rapidly and count the direct impact of their work. Within 3-4 years of the operations of these NGOs, MFIs were growing much bigger than they should in their original form of not-for-profit incorporation It was difficult to maintain capital adequacy or attract commercial capital because profits could not be distributed in a non-for-profit format From 2002 onwards, these institutions move from a non-profit format to a for-profit format

CMF – Debt instruments for MFIs, Jan 07 Some reasons Not possible to follow the Grameen Bank pattern in terms of ownership, where the borrower members also have a strike in the capital of the bank. Grameen was incorporated under a special act. In case of Indian microfinance the first wave institutions did not find a legal framework under which they could involve the community in the ownership structure of a MFI. CMF – Debt instruments for MFIs, Jan 07

Wave 3: Entry of Venture Capital As MFIs started growing, it was difficult for them to explain their form to the commercial world, while the development world started stopping funding them after a stage (given that the operations were largely profitable). Some of the early investors, including from the silicon valley-(Vinod Khosla, Michael and Susan Dell, Pierre Omidiyar) started looking for investments which not only gave them returns, but also an enhanced image. A poll of 50 investment banking firms/companies brought out in 2010 that microfinance is the top ranked destination for investments in financial sector today. SKS, India’s largest MFI, has gone public in July 2010.

AP Crisis (Post October 2010) – News Headlines…. MFIs: Wolf in sheep’s clothing?- The Times of India (October 9) New ordinance may hit Andhra MFIs- The Economic Times (October 13) Suicides spark scrutiny of Indian microfinance- Forbes News (October 19) Microfinance warns of collapse over credit freeze- Financial Times (October 26) Is Microloan Backlash Fueled by Sexism?- Wall Street Journal (November 1)

AP Crisis – News Headlines…. A string of suicides puts microlending under the spotlight - The Economist (November 4) The Backlash In Microfinance- Huffington Post (November 10) Death now stalks India’s microfinance institutions- Rediff News (November 18 ) The very future of microcredit in India is in danger, which is a shame for the country’s poor- The Economist (Dec 9) India’s micro-finance suicide epidemic- BBC News (Dec 17)