Beyond Micro Lending

Image: Alok Brahmbhatt

COUNT ME IN Vegetable vendor Ram Prasad feels welcome at last at a banking kiosk at Dharavi, Mumbai, even though his typical deposit is just Rs. 50

or over a decade now, the microfinance industry has been the poster child of financial inclusion in India. From being tiny non-profits at the start of the millennium, microfinance institutions (MFIs) have built up a base of 26 million clients and $2.6 billion in loan outstanding currently, taking the benefit of credit to some of the country’s most isolated communities untouched by four decades of nationalised banking. The sector is the new stock market darling and billions of dollars are waiting to tap into this seemingly unlimited potential. All reasons to call for a celebration.

But the microfinance industry received one jolt too many as it entered October. First, it was the unsavoury and hush-hush developments at SKS Microfinance, the first MFI to list on Indian stock exchanges. The unceremonious dismissal of its CEO and the lack of transparency from the management on the underlying problems hurt the credibility of the whole sector. But that was child’s play compared to what came later.

A series of suicides among borrowers in Andhra Pradesh quickly became a political whirlwind for MFIs. All the blame was laid on the high interest rates charged by them. The union finance ministry asked banks to cap the interest rates charged by MFIs they lend to. The state government rushed in with an ordinance imposing several restrictions and threatening criminal proceedings against coerced recovery. When this news spread, some borrowers stopped making even their usual repayments. There was talk of removing MFI loans from the priority sector category. The lone SKS stock plunged below its public issue price, affecting sector valuations and spoiling any hopes of other MFIs to raise money from the capital markets. And all of a sudden, the microfinance sector is facing a crisis.

“It is largely due to exuberant growth with exorbitant profits and no reduction of interest rates that regulators and society [are] taking such an adverse view of this sector,” says microfinance pioneer Vijay Mahajan. “All these years, we have told everyone that as we cut costs through scale and efficiency, we will pass on the benefits to the consumers. The regulators tolerated our interest rates on that promise. We let them down because we did the first, but we’re not doing the latter. Instead we have made extra normal profits.”

The ultimate objective of financial inclusion is to lift people out of poverty and bring them into the economic mainstream. It is a task that independent India has tried out in different forms over the decades, never getting it quite right. For a while, it looked the MFIs had cracked the formula, but society’s distrust and anger of the sector only shows they haven’t.
 
In fact, a study by MIT economists Esther Duflo and Abhijit Banerjee in Hyderabad and research by New York University professor Jonathan Morduch have shown that microfinance is not a magic wand that can automatically lift people out of poverty. Access to credit is only the first step. The poor need the entire gamut of financial services from savings to insurance and livelihood services that span health, farming practices, education and financial literacy, before they can break the shackles of destitution. This calls for dozens of innovations implemented in large scale across India, monitored and regulated by the state agencies and funded by the private sector.

“There is no one size fits all solution to financial inclusion,” says Vipin Sharma, CEO of ACCESS Development Services, a non-profit that incubates microfinance and livelihood enhancement institutions. “We aren’t going to see one single model that works across the entire country, what we will see however, is multiple innovations serving a variety of needs. That’s the future.”

Here are some such innovative experiments:

1. Loans Aren’t the Only Thing
Microfinance, by and large, is a one-trick pony. MFIs lend you money. And lend money they will, whether you are planning for a better future or trying to handle a serious illness at home. Their approach is to standardise the product and keep spreading to the nooks and corners of the country.

But that approach doesn’t work all the time. In fact, it can lead to a person borrowing money while all that she needs may be an insurance product or a savings account. This can set off a vicious cycle of indebtedness, frustration and even default.

Enter Kshetriya Gramin Financial Services (KGFS). It was founded to sidestep the weaknesses in microfinance model and is based on a simple principle: Financial services should be provided in much the same way as a physician prescribes medicines. Understand what customers need, and prescribe the products that would help them.

KGFS was set up by the IFMR Trust that is leading a lot of research and innovation in financial inclusion. Unlike a typical MFI, the KGFS companies in Tamil Nadu, Uttarakhand and Orissa focus on deepening reach within a specified area, say a couple of districts, rather than expanding reach to more and more areas. They now serve about 100,000 people through 93 branches.

Yes, KGFS operates through a branch-led model. Expensive as they are to run, the branches nevertheless gain from the economy of scope — that is, they offer a multitude of products and services to the same group of people and hence is able to do more business with each customer. And they use technology to cut costs.

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