TERM PAPER PROJECT

Inception of An Micro credit institution and Structural Analysis

Of Micro Finance In India.

Under The Guidance Of :-

Prof. Namita Sahay &Prof. R.B.L.Goswami.

Presented by;
Abhishek Kumar Sinha (52),Shudhanshu Shekhar Rai
(55),Deepak Dwivedi (53),Ankita Srivastava
(60),ShraddhaVerma (57),Abhishek Kumar Singh (56),Swati
Ranjan Naidu (),Ankit Obediah (51),Saurabh Bajaj (54),Vivek
Kumar (59).
 Acknowledgement
The authors gratefully acknowledge the guidance
provided by the project guides Prof. R.B.L.Goswami and
Prof. Namita sahay throughout the project.
The authors also wish thank to all other faculty
members for their valuable suggestions and directions.
The authors also thank to their batch mates for
providing constant encouragement, support and valuable
suggestions during the completion of project.

: Group-06
Microfinance
Microfinance is the provision of financial services to low income clients, including
consumers and the self -employed, who traditionally lack access to banking and related
services.

More broadly, it is a movement whose object is "a world in which as many poor and near-
poor households as possible have permanent access to an appropriate range of high quality
financial services, including not just credit but also savings, insurance, and fund transfers."
Those who promote microfinance generally believe that such access will help poor people
out of poverty.

The Role of Microfinance

Microcredit is undoubtedly the most visible innovation in anti-poverty policy in the last half
century. In the three decades, the number of microcredit borrowers has crossed 150 millions. The
majority had no access to credit from banks before microcredit came to them. Nowadays, people
borrow from MFIs at significantly lower (though often high by US standards) rates. At the same
time MFIs have managed to find ways to be financially sustainable and to keep growing fast.This
is itself is a remarkable achievement. Very little works in many of these countries in terms of
delivering to the poor; some previous attempts to deliver credit, through state-run banks, for
example, collapsed in the face of widespread corruption and defaults. Many microcredit
institutions are led by dynamic entrepreneurs who have mastered quality service delivery.

However, many see microcredit as much more than a financial instrument: it has been suggested
that it has the potential to be entirely transformative. There is an influential view that argues that,
by putting more spending power in the hands of poor families, and, perhaps more importantly, in
the hands of women, microcredit can expand investment in child health and education, empower
women and reduce discrimination against them. There is even the suggestion that, by making
people feel that their lives could be better and giving women independent access to capital,
microcredit could fight the AIDS epidemic.Unfortunately, till very recently, there was little
rigorous evidence on either side—is microcredit transformative or ruinous? However this is
changing now, thanks to the courage and vision of a few leading MFIs (including Spandana in
India, Al Amana in Morocco, First Macro Bank in the Philippines, Compartamos in Mexico) that
have allowed researchers (each of us was involved in one or more of these) to evaluate
rigorously the impact of their programs.
The two programs evaluated are very different. First Macro Bank provides loan to existing
business owners, male or female, on an individual basis.
In the Philippines, male-owned businesses increase profits, although female-owned businesses
do not. In India, borrowers who already own a business buy assets for their business. One
borrower out of eight starts a business they would not have started otherwise. Others buy
durables for their homes. However, there is no evidence that microcredit has any effect on health,
education, or women’s empowerment, at least right now, eighteen months after they got the
loans. On the other hand, there is also no evidence that people are behaving irresponsibly. Indeed
in India we have evidence of people giving up some of the little daily pleasures of life (like tea,
snacks, betel leaves and tobacco), to pay for bigger things that they could not previously afford
(carts for their business, televisions for their homes).

Many seem to think that this is not enough. However, as we see it, microcredit seems to have
delivered exactly what a successful new financial product is supposed deliver—allowing people
to make large purchases that they would not have been able to otherwise. The fact that some
people expected much more from it (and perhaps they are right, may be it will just take longer),
is perhaps inevitable given how eager the world is to find that one magic bullet that would finally
“solve” poverty. But to actually blame microcredit for not promoting the immunization of
children is no different from blaming immunization campaigns for not generating new
businesses.

Definition of Micro Credit:

“Micro credit” is the name given to extremely small loans made to poor borrowers.
A typical micro credit scheme involves the extension of an unsecured,
Commercial - type loan at interest to a poverty stricken borrower. The definition of poverty
stricken varies with the situation, but in Bangladesh the typical definition is a borrower
who owns less than 0.5 acres of land and relies on wages for all income. Loans are
disbursed in a group setting to poor borrowers, with some amount of non-credit assistance
also being made available. The non-credit assistance typically ranges from skills training to
marketing assistance to lessons in social empowerment.
Microfinance is now accepted worldwide as one of the potent tools of poverty alleviation.
Awarding of the Nobel Prize (2006) to Dr. Muhammad Yunus and Grameen Bank has
rekindled interest in this form of banking services to the extent that the UN and even the
multi-lateral funding institutions are considering it as an effective tool for poverty
reduction. However there has always been a group of strident critics who continue to
debunk the claim of the Microfinance Institutions (MFIs) in this respect. It would therefore
be worthwhile to try to analyses this form of service in an impassioned way.
One can start by looking at how it works. Obviously the main instrument is micro credit or
small loan, which is offered to clients at a fixed service charge to be repaid in equal
installments over a fixed period of time. The loan is collateral-free. Some MFIs stresses
group liability while others give this loan on individual basis but who should however be a
member of a small group. The criteria for membership is simple, a cap on the amount of
asset they own makes them equal in each other’s eyes. However the products or
instruments the MFIs now offer has expanded to include small business/enterprise loans,
hardcore poor loans, supplementary loan to the members within the same family.
Importance is given to the savings, and in addition to the mandatory savings, members are
offered a variety savings products that they can avail on voluntary basis.
Some MFIs have instituted insurance schemes at very low premiums to protect the
borrowers in the event of sudden death where the outstanding amount including interest is
written off. Members are also entitled to taking recourse to a security fund where they can
contribute a fixed amount, say, tk.10 per week where on maturity after eight or ten years
they or their nominee in the event of their death are entitled to six times the principal
amount. male members get three to four times after four years. The main critique against
this form of credit is the service charge or the rate of interest charged.
This usually varies from 12 percent to 16 per cent among different MFIs. The principal and
the interest are calculated over the period the loan is given, which is to be repaid as a fix
amount on a weekly on a monthly basis. The bone of contention lies here. Critics point out
that whereas the services charge or the rate of interest is declared to be around 12 percent
to 16 per cent. The effective rates come out to be around 25 percent to 30 per cent. This is
true, but what one misses is these calculation is the fact that those people who are left out
of the institutional banking sector because of the inability to furnish any collateral as well
as hassle of paper works and the shuttling between the bank branches and their place of
abode, MFIs reach this services at the door step of the beneficiaries through the field
workers. Moreover the loan is to be paid on a weekly or monthly basis (in some cases of
business or enterprise loan) the burden on the members in tolerable. This becomes evident
when one looks the repayment rate of the MFIs, which varies between 90 per cent and 100
percent. The lesson here is that the poor who have so long been denied carried are now
using this tool of augment their lot. They do so by utilizing the credit income generating
activities (IGA) that also contribute to employment generation

Abstract

More than subsidies poor need access to credit. Absence of formal employment make them
non `bankable'. This forces them to borrow from local moneylenders at exhorbitant
interest rates. Many innovative institutional mechanisms have been developed across the
world to enhance credit to poor even in the absence of formal mortgage. The present paper
discusses conceptual framework of a microfinance institution in India. The successes and
failures of various microfinance institutions around the world have been evaluated and
lessons learnt have been incorporated in a model microfinance institutional mechanism for
India.
Micro-finance and Poverty Alleviation

Most poor people manage to mobilize resources to develop their enterprises and their
dwellings slowly over time. Financial services could enable the poor to leverage their
initiative, accelarating the process of building incomes, assets and economic security.
However, conventional finance institutions seldom lend down-market to serve the needs of
low-income families and women-headed households. They are very often denied access to
credit for any purpose, making the discussion of the level of interest rate and other terms of
finance irrelevant. Therefore the fundamental problem is not so much of unaffordable
terms of loan as the lack of access to credit itself (Kim 1995).

The lack of access to credit for the poor is attributable to practical difficulties arising from
the discrepancy between the mode of operation followed by financial institutions and the
economic characteristics and financing needs of low-income households. For example,
commercial lending institutions require that borrowers have a stable source of income out
of which principal and interest can be paid back according to the agreed terms. However,
the income of many self employed households is not stable, regardless of its size. A large
number of small loans are needed to serve the poor, but lenders prefer dealing with large
loans in small numbers to minimize administration costs. They also look for collateral with
a clear title - which many low-income households do not have. In addition bankers tend to
consider low income households a bad risk imposing exceedingly high information
monitoring costs on operation.

Over the last ten years, however, successful experiences in providing finance to small
entrepreneur and producers demonstrate that poor people, when given access to
responsive and timely financial services at market rates, repay their loans and use the
proceeds to increase their income and assets. This is not surprising since the only realistic
alternative for them is to borrow from informal market at an interest much higher than
market rates. Community banks, NGOs and grassroot savings and credit groups around the
world have shown that these microenterprise loans can be profitable for borrowers and for
the lenders, making microfinance one of the most effective poverty reducing strategies.

To the extent that microfinance institutions become financially viable, self sustaining, and
integral to the communities in which they operate, they have the potential to attract more
resources and expand services to clients. Despite the success of microfinance institutions,
only about 2% of world's roughly 500 million small entrepreneur is estimated to have
access to financial services (Barry et al. 1996). Although there is demand for credit by poor
and women at market interest rates, the volume of financial transaction of microfinance
institution must reach a certain level before their financial operation becomes self
sustaining. In other words, although microfinance offers a promising institutional structure
to provide access to credit to the poor, the scale problem needs to be resolved so that it can
reach the vast majority of potential customers who demand access to credit at market
rates. The question then is how microenterprise lending geared to providing short term
capital to small businesses in the informal sector can be sustained as an integral part of the
financial sector and how their financial services can be further expanded using the
principles, standards and modalities that have proven to be effective.
To be successful, financial intermediaries that provide services and generate domestic
resources must have the capacity to meet high performance standards. They must achieve
excellent repayments and provide access to clients. And they must build toward operating
and financial self-sufficiency and expanding client reach. In order to do so, microfinance
institutions need to find ways to cut down on their administrative costs and also to
broaden their resource base. Cost reductions can be achieved through simplified and
decentralized loan application, approval and collection processes, for instance, through
group loans which give borrowers responsibilities for much of the loan application process,
allow the loan officers to handle many more clients and hencee reduce costs (Otero et al.
1994).

Microfinance institutions can broaden their resource base by mobilizing savings, accessing
capital markets, loan funds and effective institutional development support. A logical way
to tap capital market is securitization through a corporation that purchases loans made by
microenterprise institutions with the funds raised through the bonds issuance on the
capital market. There is atleast one pilot attempt to securitize microfinance portfolio along
these lines in Ecuador. As an alternative, Banco Sol of Bolivia issued a certificate of deposit
which are traded in Bolivian stock exchange. In 1994, it also issued certificates of deposit in
the U.S. (Churchill 1996). The Foundation for Cooperation and Development of Paraguay
issued bonds to raise capital for microenterprise lending (Grameen Trust 1995).

Savings facilities make large scale lending operations possible. On the other hand, studies
also show that the poor operating in the informal sector do save, although not in financial
assets, and hence value access to client-friendly savings service at least as much access to
credit. Savings mobilization also makes financial institutions accountable to local
shareholders. Therefore, adequate savings facilities both serve the demand for financial
services by the customers and fulfill an important requirement of financial sustainability to
the lenders. Microfinance institutions can either provide savings services directly through
deposit taking or make arrangements with other financial institutions to provide savings
facilities to tap small savings in a flexible manner (Barry 1995).

Convenience of location, positive real rate of return, liquidity, and security of savings are
essential ingradients of successful savings mobilization (Christen et al. 1994).

Once microfinance institutions are engaged in deposit taking in order to mobilize

household savings, they become financial intermediaries. Consequently, prudential
financial regulations become necessary to ensure the solvency and financial soundness of
the institution and to protect the depositors. However, excessive regulations that do not
consider the nature of microfinance institution and their operation can hamper their
viability. In view of small loan size, microfinance institutions should be subjected to a
minimum capital requirement which is lower than that applicable to commercial banks. On
the other hand, a more stringent capital adequacy rate (the ratio between capital and risk
assets) should be maintained because microfinance institutions provide uncollateralized
loans.
Governments should provide an enabling legal and regulatory framework which
encourages the development of a range of institutions and allows them to operate as
recognized financial intermediaries subject to simple supervisory and reporting
requirements. Usury laws should be repelled or relaxed and microfinance institutions
should be given freedom of setting interest rates and fees in order to cover operating and
finance costs from interest revenues within a reasonable amount of time. Government
could also facilitate the process of transition to a sustainable level of operation by
providing support to the lending institutions in their early stage of development through
credit enhancement mechanisms or subsidies.

One way of expanding the successful operation of microfinance institutions in the informal
sector is through strengthened linkages with their formal sector counterparts. A mutually
beneficial partnership should be based on comparative strengths of each sectors. Informal
sector microfinance institutions have comparative advantage in terms of small transaction
costs achieved through adaptability and flexibility of operations (Ghate et al. 1992). They
are better equipped to deal with credit assessment of the urban poor and hence to absorb
the transaction costs associated with loan processing. On the other hand, formal sector
institutions have access to broader resource-base and high leverage through deposit
mobilization (Christen et al. 1994).

Therefore, formal sector finance institutions could form a joint venture with informal
sector institutions in which the former provide funds in the form of equity and the later
extends savings and loan facilities to the urban poor. Another form of partenership can
involve the formal sector institutions refinancing loans made by the informal sector
lenders. Under these settings, the informal sector institutions are able to tap additional
resources as well as having an incentive to exercise greater financial discipline in their
management.

Microfinance institutions could also serve as intermediaries between borrowers and the
formal financial sector and on-lend funds backed by a public sector guarantee (Phelps
1995). Business-like NGOs can offer commercial banks ways of funding micro
entrepreneurs at low cost and risk, for example, through leveraged bank-NGO-client credit
lines. Under this arrangement, banks make one bulk loan to NGOs and the NGOs packages it
into large number of small loans at market rates and recover them (Women's World
Banking 1994).

Financial needs and financial services.

In developing economies and particularly in the rural areas, many activities that would be
classified in the developed world as financial are not monetized: that is, money is not used to
carry them out. Almost by definition, poor people have very little money. But circumstances
often arise in their lives in which they need money or the things money can buy.
Poor people find creative and often collaborative ways to meet these needs, primarily through
creating and exchanging different forms of non-cash value. Common substitutes for cash vary
from country to country but typically include livestock, grains, jewelry and precious metals.

As Marguerite Robinson describes in The Microfinance Revolution, the 1980s demonstrated that
"microfinance could provide large-scale outreach profitably," and in the 1990s, "microfinance
began to develop as an industry" (2001, p. 54). In the 2000s, the viable, commercial
microfinance sector in the last few decades, several issues remain that need to be addressed
before the industry will be able to satisfy massive worldwide demand. The obstacles or
challenges to building a sound commercial microfinance industry include:

 Inappropriate donor subsidies

 Poor regulation and supervision of deposit-taking MFIs
 Few MFIs that meet the needs for savings, remittances or insurance
 Limited management capacity in MFIs
 Institutional inefficiencies
 Need for more dissemination and adoption of rural, agricultural microfinance methodologies

microfinance industry's objective is to satisfy the unmet demand on a much larger scale, and to
play a role in reducing poverty. While much progress has been made in developing a

Top 50 Micro Finance Institutions

Rank Name Country

1 ASA Bangladesh

2 Bandhan (Society and NBFC) India

3 Banco do Nordeste Brazil

4 Fundación Mundial de la Mujer Bucaramanga Colombia

5 FONDEP Micro-Crédit Morocco

6 Amhara Credit and Savings Institution Ethiopia

7 Banco Compartamos, S.A., Institución de Banca Múltiple Mexico

8 Association Al Amana for the Promotion of Micro-Enterprises Morocco Morocco

9 Fundación Mundo Mujer Popayán Colombia

10 Fundación WWB Colombia - Cali Colombia

11 Consumer Credit Union 'Economic Partnership' Russia

12 Fondation Banque Populaire pour le Micro-Credit Morocco

13 Microcredit Foundation of India India

14 EKI Bosnia and Herzegovina

15 Saadhana Microfin Society India

16 Jagorani Chakra Foundation Bangladesh

17 Grameen Bank Bangladesh

18 Partner Bosnia and Herzegovina

19 Grameen Koota India

20 Caja Municipal de Ahorro y Crédito de Cusco Peru

21 Bangladesh Rural Advancement Committee Bangladesh

22 AgroInvest Serbia

23 Caja Municipal de Ahorro y Crédito de Trujillo Peru

23 Sharada's Women's Association for Weaker Section India

24 MIKROFIN Banja Luka Bosnia and Herzegovina

25 Khan Bank (Agricultural Bank of Mongolia LLP) Mongolia

26 INECO Bank Armenia

27 Fondation Zakoura Morocco

28 Dakahlya Businessmen's Association for Community Development Egypt

29 Asmitha Microfin Ltd. India

30 Credi Fe Desarrollo Microempresarial S.A. Ecuador

31 Dedebit Credit and Savings Institution Ethiopia

32 MI-BOSPO Tuzla Bosnia and Herzegovina

33 Fundacion Para La Promocion y el Desarrollo Nicaragua

34 Kashf Foundation Pakistan

35 Shakti Foundation for Disadvantaged Women Bangladesh

36 enda inter-arabe Tunisia

37 Kazakhstan Loan Fund Kazakhstan

38 Integrated Development Foundation Bangladesh

39 Microcredit Organization Sunrise Bosnia and Herzegovina

40 FINCA - ECU Ecuador

41 Caja Municipal de Ahorro y Crédito de Arequipa Peru

42 Crédito con Educación Rural Bolivia

43 BESA Fund Albania

44 SKS Microfinance Private Limited India

45 Development and Employment Fund Jordan

46 Programas para la Mujer - Peru Peru

47 Kreditimi Rural i Kosoves LLC (formerly Rural Finance Project of Kosovo) Kosovo

48 BURO, formerly BURO Tangail Bangladesh

49 Opportunity Bank A.D. Podgorica Serbia

50 Sanasa Development Bank

Micro finance scenario in India :

Since 2000, commercial banks including Regional Rural Banks have been providing
funds .The first thing to remember is that in India the history of rural credit, poverty
alleviation and microfinance are inextricably interwoven. Any effort to understand one
without reference to the others, can only lead to a fragmented understanding. The forces
and compulsions that shaped the initiatives in these areas are best understood in context of
State and banking policy over time. Thus, for e.g., there were peasant riots in the Deccan in
the late 19th Century on account of coercive alienation of land by moneylenders. The policy
response of the British Government to this problem of rural indebtedness was to initiate
the process of organization of cooperative societies as alternative institutions for providing
credit to the farmers as also to ensure settled conditions in the rural areas, so necessary for
a colonial power to sustain itself.

In the development strategy adopted by independent India, institutional credit was

perceived as a powerful instrument for enhancing production and productivity and for
alleviating poverty. The formal view was that lending to the poor should be a part of the
normal business of banks, Simple as that. To achieve the objectives of production,
productivity and poverty alleviation, the policy on rural credit was to ensure that sufficient
and timely credit was reached as expeditiously as possible to as large a segment of the rural
population at reasonable rates of interest.

The strategy devised for this purpose comprised :

• Expansion of the institutional structure,

• Directed lending to disadvantaged borrowers and sectors and

• Interest rates supported by subsidies.

The institutional vehicles chosen for this were cooperatives, commercial banks and

Regional Rural Banks [RRBs].

Between 1950 & 1969, the emphasis was on the promoting of cooperatives. The
nationalization of the major commercial banks in 1969 marks a watershed in as much as
from this time onwards the focus shifted from the cooperatives as the sole providers of
rural credit to the multi agency approach. This also marks the beginning of the phenomenal
expansion of the institutional structure in terms of commercial bank branch expansion in
the rural and semi-urban areas. For the next decade and half, the Indian banking scene was
dominated by this expansion. However, even as this expansion was taking place, doubts
were being raised about the systemic capability to reach the poor. Regional Rural Banks
were set up in 1976 as low cost institutions mandated to reach the poorest in the credit-
deficient areas of the country. In hindsight it may not be wrong to say that RRBs are
perhaps the only institutions in the Indian context which were created with a specific
poverty alleviation - microfinance – mandate. During this period, intervention of the
Central Bank (Reserve Bank of India) was essential to enable the system to overcome
factors which were perceived as discouraging the flow of credit to the rural sector such as
absence of collateral among the poor, high cost of servicing geographically dispersed
customers, lack of trained and motivated rural bankers, etc. The policy response was multi
dimensional and included special credit programmes for channeling subsidized credit to
the rural sector and operationalising the concept of “priority sector”. The later was evolved
in the late sixties to focus attention on the credit needs of neglected sectors and under-
privileged borrowers.

The strategies followed are as follow:

*helped to build a broad based institutional infrastructure for the delivery and deployment
of credit.

*ensured a wider physical access of financial services to the poor.

*Access in terms of rural branches increased from 1,833 in 1969 to around 32,200 at
present,

*the population per rural branch declined from 2,01,854 in 1969 to around 16,000 at
present.

*The proportion of borrowings of rural households from institutional sources increased

from 7 per cent in 1951 to more than 60 per cent at present.

*This significant increase in the credit flow from institutional sources gave rise to a strong
sense of expectation from the state agencies. However, this expectation could not be
sustained because the emphasis, among others, was on achieving certain quantitative
targets. As a result, inadequate attention was paid to the qualitative aspects of lending
leading to loan defaults and erosion of repayment ethics by all categories of borrowers. The
end result was a disturbing growth in over dues, which not only hampered the recycling of
scarce resources of banks, but also affected profitability and viability of financial
institutions. This not only blunted the desire of banks to lend to the poor but also the
development impact of rural finance.

*This was the position on the eve of reforms, which marks the second watershed, in the
history of rural credit.

*The basic aim of the financial sector reforms was to improve the efficiency and
productivity of all credit institutions including rural financial institutions (RFIs) whose
financial health was far from satisfactory. In regard to RFIs, the reforms sought to enhance
the areas of commercial freedom, increase their outreach to the poor and stimulate
additional flows to the sector. The reforms included far reaching changes in the incentive
regime through liberalising interest rates for cooperatives and RRBs, relaxing controls on
where, for what purpose and for whom RFIs could lend, reworking the sub-heads under the
priority sector, introducing prudential norms and restructuring and recapitalising of RRBs.

The object of this narrative is to bring home to you two facts and four
effects.

The two facts are:

*From the time of independence, the overriding concern of development policy makers has
been to find ways and means to finance the poor and reduce the burden upon them.

*Between the concern of the policy makers and the quality of the effort, however, there has
been a gap. The efforts made were not able to achieve the success envisaged for a variety of
reasons mainly, defects in policy design, infirmities in implementation and the inability of
the government of the day to desist from resorting to measures such as loan waivers.

The four consequences flowing from these facts are:

That the banking system - was not able to internalise lending to the poor as a viable activity
but only as a social obligation – something that had to be done because the authorities
wanted it so.

This was translated into the banking language of the day : Loans to the poor were part of
social sector lending and not commercial lending ; the poor were not borrowers, they were
beneficiaries ; poor beneficiaries did not avail of loans they availed of assistance.

The language of the time resulted in an attitude of carefully disguised cynicism towards the
poor. The attitude was that the poor are not bankable, that they can never be bankable, that
commercial principles cannot be applied in lending to the poor, that what the poor require
are not loans but charity. Once this mindset hardened it became more and more difficult
for commercial bankers to accept that lending to the poor could be a viable activity. It is
significant to note that the system had to wait for almost a decade for the concept of
microfinance to become credible.

Micro Finance : The Paradigm

The financial sector reforms motivated policy planners to search for products and
strategies for delivering financial services to the poor – microfinance - in a sustainable
manner consistent with high repayment rates. The search for these alternatives started
with internal introspection regarding the arrangements which the poor had been
traditionally making to meet their financial services needs. I was found that the poor
tended to – and could be induced to - come together in a variety of informal ways for
pooling their savings and dispensing small and unsecured loans at varying costs to group
members on the basis of need. The essential genius of NABARD in the Bank – SHG
programme was to recognize this empirical observation that had been catalysed by NGOs
and to create a formal interface of these informal arrangements of the poor with the
banking system. This is the beginning of the story of the Bank-SHG Linkage Programme.

SHG - Bank Linkage Programme

The SHG – Bank Linkage Programme started as an Action Research Project in 1989. In
1992, the findings led to the setting up of a Pilot Project. The pilot project was designed as a
partnership model between three agencies, viz., the SHGs, banks and Non Governmental
Organisations (NGOs). SHGs were to facilitate collective decision-making by the poor and
provide 'doorstep banking’; Banks as wholesalers of credit, were to provide the resources
and NGOs were to act as agencies to organise the poor, build their capacities and facilitate
the process of empowering them.

Achievements
The programme has come a long way from the pilot stage of financing 500 SHGs

across the country. Cumulatively, they have so far accessed credit of Rs.6.86 billion.

About 24 million poor households have gained access to the formal banking system

through the programme.

The main findings are that:

i. Microfinance has reduced the incidence of poverty through increase in income,

enabled the poor to build assets and thereby reduce their vulnerability.

ii. It has enabled households that have access to it to spend more on education than non-
client households. Families participating in the programme have reported better school
attendance and lower drop out rates.
iii. It has empowered women by enhancing their contribution to household income,
increasing the value of their assets and generally by giving them better control over
decisions that affect their lives.

iv. In certain areas it has reduced child mortality, improved maternal health and the ability
of the poor to combat disease through better nutrition, housing and health - especially
among women and children.

v. It has contributed to a reduced dependency on informal money lenders and other non-
institutional sources.

vi. It has facilitated significant research into the provision of financial services for the poor
and helped in building “capacity” at the SHG level.

vii. Finally it has offered space for different stakeholders to innovate, learn and replicate. As
a result, some NGOs have added micro-insurance products to their portfolios, a couple of
federations have experimented with undertaking livelihood activities and grain banks have
been successfully built into the SHG model in the eastern region. SHGs in some areas have
employed local accountants for keeping their books; and IT applications are now being
explored by almost all for better MIS, accounting and internal controls.

(1) The first point is that the “poor are bankable”. Sounds simple, but, when we view this in
context of the attitudinal constraints which characterized bankers on the eve of the linkage
programme, one realizes what an immense learning point this has been. But, for this we
would still have been in the “middle ages”.

(2) The second point is that the poor, organized into SHGs, are ready and willing to partner
mainstream financial institutions and banks on their part find their SHG portfolios “safe”
and “performing”.

(3) The third point is that despite being contra intuitive, the poor can and do save in a
variety of ways and the creative harnessing of such savings is a key design feature and
success factor.

(4) The fourth point is that successful programmes are those that afford opportunity to
stakeholders to contribute to it on their own terms. When this happens, the chances of
success multiply manifold. This has been possible in the Bank - SHG linkage programme on
account of the space given to each partner and the synergy built in the programme between
the informal sector comprising the poor and their SHGs, the semi-formal sector comprising
NGOs, and the formal sector comprising banks, government and the development agencies.
(5) Yet another learning point has been that when a programme is built on existing
structures, it leverages all strengths. Thus, because the Bank- SHG programme is built upon
the existing banking infrastructure, it has obviated the need for the creation of a new
institutional set-up or introduction of a separate legal and regulatory framework. Since
financial resources are sourced from regular banking channels and members’ savings, the
programme bypasses issues relating to regulation and supervision. Lastly, since the Group
acts as a collateral substitute, the model neatly addresses the irksome problem of provision
of collateral by the poor.

(6) The last learning point is that central banks, apex development banks and governments
have an important role in creating the enabling environment and putting appropriate
policies and interventions in position which enable rapid upscaling of efforts consistent
with prudential practices. But for this opportunity, no innovation can take place.

Challenges :
Regional Imbalances – The first challenge is the skewed distribution of SHGs across States.
About 60% of the total SHG credit linkages in the country are concentrated in the Southern
States. However, in States which have a larger share of the poor, the coverage is
comparatively low. The skewed distribution is attributed to the over zealous support
extended by some the State Governments to the programme. Skewed distribution of NGOs
and

Local cultures & practices.

NABARD has since identified 13 states where the volumes of SHGs linked are low and has
already initiated steps to correct the imbalance.

From credit to enterprise :-

The second challenge is that having formed SHGs and having linked them to banks, how can
they be induced to graduate into matured levels of enterprise, how they be induced to
factor in livelihood diversification, how can they increase their access to the supply chain,
linkages to the capital market and to appropriate/ production and processing technologies.

A spin off of this challenge is how to address the investment capital requirements of
matured SHGs, which have met their consumption needs and are now on the threshold of
taking off into “Enterprise”. The SHG Bank-Linkage programme needs to introspect
whether it is sufficient for SHGs to only meet the financial needs of their members, or
whether there is also a further obligation on their part to meet the non-financial
requirements necessary for setting up businesses and enterprises. In my view, we must
meet both.
Quality of SHGs – The third challenge is how to ensure the quality of SHGs in an
environment of exponential growth. Due to the fast growth of the SHG Bank Linkage
Program, the quality of SHGs has come under stress. This is reflected particularly in
indicators such as the poor maintenance of books and accounts etc. The deterioration in
the quality of SHGs is explained by a variety of factors including

The intrusive involvement of government departments in promoting groups,

•Inadequate long-term incentives to NGOs for nurturing them on a sustainable basis and

•Diminishing skill sets on part of the SHG members in managing theirgroups.

In my assessment, significant financial investment and technical support is required for

meeting this challenge.

Impact of SGSY – Imitation is the best form of flattery – but not always. The success of the
programme has motivated the Government to borrow its design features and incorporate
them in their poverty alleviation programme. This is certainly welcome but for the fact that
the Government’s Programme (SGSY) has an inbuilt subsidy element which tends to attract
linkage group members and cause migration generally for the wrong reasons. Also, micro
level studies have raised concerns regarding the process through which groups are formed
under the SGSY and have commented that in may cases members are induced to come
together not for self help, but for subsidy. I would urge a debate on this, as there is a need
to resolve the tension between SGSY and linkage programme groups. One way out of the
impasse would be to place the subsidy element in the SGSY programme with NABARD for
best utilisation for providing indirect subsidy support for purposes such as sensitisation,
capacity building, exposure visits to successful models, etc.

Role of State Governments – A derivative of the above is perhaps the need to extend
the above debate to understanding and defining the role of the State Governments vis-à -vis
the linkage programme. Let’s be clear: on the one hand, the programme would not have
achieved its outreach and scale, but for the proactive involvement of the State
Governments; on the other hand, many State Governments have been overzealous to
achieve scale and access without a critical assessment of the manpower and skill sets
available with them for forming, and nurturing groups and handholding and maintaining
them over time.
Emergence of Federations – The emergence of SHG Federations has thrown up another
challenge. On the one hand, such federations represent the aggregation of collective
bargaining power, economies of scale, and are fora for addressing social & economic issues;
on the other hand there is evidence to show that every additional tier, in addition to
increasing costs, tends to weaken the primaries. There is a need to study the best practices
in the area and evolve a policy by learning from them.

While we are upbeat about the success achieved and the potential that the SHG – Linkage
programme offers, we need to be realistic and not to view this instrument as a one-stop
solution for all developmental problems. SHGs are local institutions having an inherent
potential to flower as decentralised platform for development, but multiple expectations
could overload them and impair their long-term sustainability. Second, in focusing on the
poor let us not forget the rest. The rural sector is a large field and even today the need for
good old-fashioned rural credit and investment in agriculture and infrastructure continues
with the same rigour as yesterday.

Emergence of MFIs :
Having indicated my thoughts on the SHG-Bank Linkage programme, may I now briefly
turn to the MFI model ? MFIs are an extremely heterogenous group comprising NBFCs,
societies, trusts and cooperatives. They are provided financial support from external
donors and apex institutions including the Rashtriya Mahila Kosh (RMK), SIDBI Foundation
for micro-credit and NABARD and employ a variety of ways for credit delivery.

MFIs for on lending to poor clients. Though initially, only a handful of NGOs were “into”
financial intermediation using a variety of delivery methods, their numbers have increased
considerably today. While there is no published data on private MFIs operating in the
country, the number of MFIs is estimated to be around 800. One set of data which I have
indicate that not more than a dozen MFIs have an outreach of 1,00,000 microFinance
clients. A large majority of them operate on much smaller scale with clients ranging
between 500 and 1,500 per MFI. It is estimated that the MFIs’ share of the total institution-
based micro-credit portfolio is about 8%.

5. MFIs : Critical Issues

MFIs can play a vital role in bridging the gap between demand & supply of financial
services if the critical challenges confronting them are addressed.
Sustainability : The first challenge relates to sustainability. It has been reported in
literature that the MFI model is comparatively costlier in terms of delivery of financial
services. An analysis of 36 leading MFIs2 by Jindal & Sharma shows that 89% MFIs sample
were subsidy dependent and only 9 were able to cover more than 80% of their costs. This
is partly explained by the fact that while the cost of supervision of credit is high, the loan
volumes and loan size is low. It has also been commented that MFIs pass on the higher cost
of credit to their clients who are ‘interest insensitive’ for small loans but may not be so as
loan sizes increase. It is, therefore, necessary for MFIs to develop strategies for increasing
the range and volume of their financial services.

Lack of Capital – The second area of concern for MFIs, which are on the growth path, is that
they face a paucity of owned funds. This is a critical constraint in their being able to scale
up. Many of the MFIs are socially oriented institutions and do not have adequate access to
financial capital. As a result they have high debt equity ratios. Presently, there is no reliable
mechanism in the country for meeting the equity requirements of MFIs. As you know, the
Micro Finance Development Fund (MFDF), set up with NABARD, has been augmented and
re-designated as the Micro Finance Development Equity Fund (MFDEF). This fund is
expected to play a vital role in meeting the equity needs of MFIs.

Borrowings – In comparison with earlier years, MFIs are now finding it relatively easier to
raise loan funds from banks. This change came after the year 2000, when RBI allowed
banks to lend to MFIs and treat such lending as part of their priority sector-funding
obligations. Private sector banks have since designed innovative

2 Issues in Sustainability of MFIs, Jindal & Sharma products such as the Bank Partnership
Model to fund MFIs and have started viewing the sector as a good business proposition.
Being an ex-regulator I may be forgiven for reminding banks that they need to be most
careful when they feel most optimistic. At a time when they are enthusiastic about MFIs,
banks would do well to find the right technologies to assess the risk of funding MFIs. They
would also benefit by improving their skill sets for appraising such institutions and
assessing their credit needs. I believe that appropriate credit rating of MFIs will help in
increasing the comfort level of the banking system. It may be of interest to note that
NABARD has put in position a scheme under which 75% of the cost of the rating exercise
will be borne by it.

Capacity of MFIs - It is now recognised that widening and deepening the outreach of the
poor through MFIs has both social and commercial dimensions. Since the sustainability of
MFIs and their clients complement each other, it follows that building up the capacities of
the MFIs and their primary stakeholders are preconditions for the successful delivery of
flexible, client responsive and innovative microfinance services to the poor. Here,
innovations are important – both of social intermediation, strategic linkages and new
approaches centered on the livelihood issues surrounding the poor, and the re-engineering
of the financial products offered by them as in the case of the Bank Partnership model.

Bank Partnership Model :

This model is an innovative way of financing MFIs. The bank is the lender and the MFI acts
as an agent for handling items of work relating to credit monitoring, supervision and
recovery. In other words, the MFI acts as an agent and takes care of all relationships with
the client, from first contact to final repayment. The model has the potential to significantly
increase the amount of funding that MFIs can leverage on a relatively small equity base.

A sub - variation of this model is where the MFI, as an NBFC, holds the individual loans on
its books for a while before securitizing them and selling them to the bank. Such
refinancing through securitization enables the MFI enlarged funding access. If the MFI
fulfils the “true sale” criteria, the exposure of the bank is treated as being to the individual
borrower and the prudential exposure norms do not then inhibit such funding of MFIs by
commercial banks through the securitization structure.

Banking Correspondents :

The proposal of “banking correspondents” could take this model a step further extending it
to savings. It would allow MFIs to collect savings deposits from the poor on behalf of the
bank. It would use the ability of the MFI to get close to poor clients while relying on the
financial strength of the bank to safeguard the deposits. Currently, RBI regulations do not
allow banks to employ agents for liability - i.e deposit - products. This regulation evolved at
a time when there were genuine fears that fly-by-night agents purporting to act on behalf
of banks in whom the people have confidence could mobilize savings of gullible public and
then vanish with them. It remains to be seen whether the mechanics of such relationships
can be worked out in a way that minimizes the risk of misuse.

Service Company Model :

In this context, the Service Company Model developed by ACCION and used in some of the
Latin American Countries is interesting. The model may hold significant interest for state
owned banks and private banks with large branch networks. Under this model, the bank
forms its own MFI, perhaps as an NBFC, and then works hand in hand with that MFI to
extend loans and other services. On paper, the model is similar to the partnership model:
the MFI originates the loans and the bank books them. But in fact, this model has two very
different and interesting operational features :

(a) The MFI uses the branch network of the bank as its outlets to reach clients. This allows
the client to be reached at lower cost than in the case of a stand–alone MFI. In case of banks
which have large branch networks, it also allows rapid scale up. In the partnership model,
MFIs may contract with many banks in an arms length relationship. In the service company
model, the MFI works specifically for the bank and develops an intensive operational
cooperation between them to their mutual advantage.

(b) The Partnership model uses both the financial and infrastructure strength of the bank
to create lower cost and faster growth. The Service Company Model has the potential to
take the burden of overseeing microfinance operations off the management of the bank and
put it in the hands of MFI managers who are focused on microfinance to introduce
additional products, such as individual loans for SHG graduates, remittances and so on
without disrupting bank operations and provide a more advantageous cost structure for
microfinance. We need to pilot test this.

The Road Ahead : -

I recently wrote an article together with Graham Wright called “Banking for the Poor and
not Poor Banking”. What we wanted to say was that notwithstanding our significant
achievements, there are still large sections of the population without access to financial
services. A conservative estimate for example suggests that just 20% of low-income people
have access to them. Thus, there is an urgent need to widen the scope, scale and outreach
of financial services to reach the vast unreached population.

In this context may I quote from the recent Annual Policy Statement (2005-06) of the
Governor RBI. Drawing attention to the expansion, greater competition and diversification
of ownership of banks leading to enhanced efficiency and systemic resilience in the
banking sector, the Governor has said that notwithstanding this “there are legitimate
concerns in regard to the banking practices that tend to exclude rather than attract vast
sections of population, in particular pensioners, self-employed and those employed in
unorganised sector. While commercial considerations are no doubt important, the banks
have been bestowed with several privileges, especially of seeking public deposits on a
highly leveraged basis, and consequently they should be obliged to provide banking
services to all segments of the population, on equitable basis.” He has clarified that against
this background, the RBI will implement policies to encourage banks which provide
extensive services while disincentivising those which are not responsive to the banking
needs of the community, including the underprivileged. Further, the nature, scope and cost
of services will be monitored to assess whether there is any denial, implicit or explicit, of
basic banking services to the common person. He has advised banks to review their
existing practices to align them with the objective of financial inclusion.

I have come to the end of my presentation. Looking back I find that the key players are
banks as partners in the linkage programme and emerging MFIs. Banks through their rural
branches have played and continue to play an important role in providing financial services
to the poor on a stand-alone basis. Banks need to introspect on the quality and coverage of
these portfolios. Further as key stakeholders in the Bank-SHG linkage programme, they,
together with other partners need to take forward the good work they have been doing.
The SHG – Bank Linkage Programme has done well, has made a tremendous contribution to
“scale” and is on a high growth path. However, the programme is confronted with many
challenges and these need to be addressed through appropriately structured policies and
strategies. In so far as MFIs are concerned it is recognized that they hold significant
potential. However, MFIs need to be challenged to make an increasing contribution to
“scale” consistent with cost, sustainability and efficiency of operations. Given these and
other challenges embedded in the microfinance context, this conference has been
organised so that we can all deliberate on the issues involved and come up with
appropriate recommendations for policy formulation.

We are living through challenging and upbeat times. Yet anyone who has worked in the
field of development knows the ‘highs’ and ‘lows’ of working in this sector. Sometimes
when I look at the vast unfinished agenda, the tasks undone, done partly or done poorly,
when I factor in the forces of apathy and status quo, when I see how slowly things move
when in fact they should be moving rapidly I feel a sense of despair - a realisation that in
the end human endeavour is meagre and that the distance between effort and achievement
is indeed long. At times such as these I recollect a message given to us many years ago
when we were emerging from the trauma of the sub-continent’s partition between India
and Pakistan, when there was great despair for the future of the two nations. In those dark
and troubled days, a poet, Dr Sir Mohammad Iqbal - later the national poet of Pakistan- said
to us :
Which translated into English means that “when light fails and you are surrounded by
darkness, do not despair, take heart - for a thousand million stars must die each night just
so that a new dawn can be born tomorrow”.

On this note of hope for a better tomorrow and with a sense of sincere appreciation for all
those working in the sector – practitioners and policy makers, researchers and regulators
and academicians and activists – I take leave and thank you for having given me this
opportunity of sharing my thoughts with you today.

Bank Partnership Model :

This model is an innovative way of financing MFIs. The bank is the lender and the

MFI acts as an agent for handling items of work relating to credit monitoring,

supervision and recovery. In other words, the MFI acts as an agent and takes care

of all relationships with the client, from first contact to final repayment. The model

has the potential to significantly increase the amount of funding that MFIs can

leverage on a relatively small equity base.

A sub - variation of this model is where the MFI, as an NBFC, holds the individual loans on
its books for a while before securitizing them and selling them to the bank. Such
refinancing through securitization enables the MFI enlarged funding access. If the MFI
fulfils the “true sale” criteria, the exposure of the bank is treated as being to the individual
borrower and the prudential exposure norms do not then inhibit such funding of MFIs by
commercial banks through the securitization structure.

Banking Correspondents :

The proposal of “banking correspondents” could take this model a step further extending it
to savings. It would allow MFIs to collect savings deposits from the poor on behalf of the
bank. It would use the ability of the MFI to get close to poor clients while relying on the
financial strength of the bank to safeguard the deposits. Currently, RBI regulations do not
allow banks to employ agents for liability - i.e deposit - products. This regulation evolved at
a time when there were genuine fears that fly-by-night agents purporting to act on behalf
of banks in whom the people have confidence could mobilize savings of gullible public and
then vanish with them. It remains to be seen whether the mechanics of such relationships
can be worked out in a way that minimizes the risk of misuse.

Service Company Model :

In this context, the Service Company Model developed by ACCION and used in some of the
Latin American Countries is interesting. The model may hold significant interest for state
owned banks and private banks with large branch networks. Under this model, the bank
forms its own MFI, perhaps as an NBFC, and then works hand in hand with that MFI to
extend loans and other services. On paper, the model is similar to the partnership model:
the MFI originates the loans and the bank books them. But in fact, this model has two very
different and interesting operational features :

(a) The MFI uses the branch network of the bank as its outlets to reach clients. This allows
the client to be reached at lower cost than in the case of a stand–alone MFI. In case of banks
which have large branch networks, it also allows rapid scale up. In the partnership model,
MFIs may contract with many banks in an arms length relationship. In the service company
model, the MFI works specifically for the bank and develops an intensive operational
cooperation between them to their mutual advantage.

(b) The Partnership model uses both the financial and infrastructure strength of the bank
to create lower cost and faster growth. The Service Company Model has the potential to
take the burden of overseeing microfinance operations off the management of the bank and
put it in the hands of MFI managers who are focused on microfinance to introduce
additional products, such as individual loans for SHG graduates, remittances and so on
without disrupting bank operations and provide a more advantageous cost structure for
microfinance. We need to pilot test this.

The Road Ahead

I recently wrote an article together with Graham Wright called “Banking for the Poor and
not Poor Banking”. What we wanted to say was that not with standing our significant
achievements, there are still large sections of the population without access to financial
services. A conservative estimate for example suggests that just 20% of low-income people
have access to them. Thus, there is an urgent need to widen the scope, scale and outreach of
financial services to reach the vast unreached population.
In this context may I quote from the recent Annual Policy Statement (2005-06) of the
Governor RBI. Drawing attention to the expansion, greater competition and diversification
of ownership of banks leading to enhanced efficiency and systemic resilience in the
banking sector, the Governor has said that notwithstanding this “there are legitimate
concerns in regard to the banking practices that tend to exclude rather than attract vast
sections of population, in particular pensioners, self-employed and those employed in
unorganised sector. While commercial considerations are no doubt important, the banks
have been bestowed with several privileges, especially of seeking public deposits on a
highly leveraged basis, and consequently they should be obliged to provide banking
services to all segments of the population, on equitable basis.” He has clarified that against
this background, the RBI will implement policies to encourage banks which provide
extensive services while disincentivising those which are not responsive to the banking
needs of the community, including the underprivileged. Further, the nature, scope and cost
of services will be monitored to assess whether there is any denial, implicit or explicit, of
basic banking services to the common person. He has advised banks to review their
existing practices to align them with the objective of financial inclusion.

We have come to the end of my presentation. Looking back I find that the key players are
banks as partners in the linkage programme and emerging MFIs. Banks through their rural
branches have played and continue to play an important role in providing financial services
to the poor on a stand-alone basis. Banks need to introspect on the quality and coverage of
these portfolios. Further as key stakeholders in the Bank-SHG linkage programme, they,
together with other partners need to take forward the good work they have been doing.
The SHG – Bank Linkage Programme has done well, has made a tremendous contribution to
“scale” and is on a high growth path. However, the programme is confronted with many
challenges and these need to be addressed through appropriately structured policies and
strategies. In so far as MFIs are concerned it is recognized that they hold significant
potential. However, MFIs need to be challenged to make an increasing contribution to
“scale” consistent with cost, sustainability and efficiency of operations. Given these and
other challenges embedded in the microfinance context, this conference has been
organised so that we can all deliberate on the issues involved and come up with
appropriate recommendations for policy formulation.

*What is Exciting about Indian Microfinance?

A Task Force on Microfinance recognised in 1999 that microfinance is much more than
microcredit, stating: "Provision of thrift, credit and other financial services and products of
very small amounts to the poor in rural, semi-urban and or urban areas for enabling them
to raise their income levels and improve living standards". The Self Help Group promoters
emphasise that mobilising savings is the first building block of financial services.

For many years, the national budget and other policy documents have almost equated
microfinance with promoting SHG links to the banks. The central bank notification that
lending to MFIs would count towards meeting the priority sector lending targets for Banks
offered the first signs of policy flexibility towards MFIs. One could argue that MFIs are small
and insignificant, so why bother. The larger point is about policy space for innovation and
diversity of approaches to meet large unmet demand. The insurance sector was partially
opened to private and foreign investments during 2000. Over 20 insurance companies are
already active and experimenting with new products, delivery methodologies and strategic
partnerships.

Microfinance programmes have rapidly expanded in recent years. Some examples are:

 Membership of Sa-Dhan (a leading association) has expanded from 43 to 96

Community Development Finance Institutions during 2001-04. During the same
period, loans outstanding of these member MFIs have gone up from US$15 million
to US$101 million.
 The CARE CASHE Programme took on the challenge of working with small NGO-
MFIs and community owned-managed microfinance organisations. Outreach has
expanded from 39,000 to around 300,000 women members over 2001-05, Many of
the 26 CASHE partners and another 136 community organisations these NGO-MFIs
work with, represent the next level of emerging MFIs and some of these are already
dealing with ICICI Bank and ABN Amro.
 In addition to the dominant SHG methodology, the portfolios of Grameen replicators
have also grown dramatically. The outreach of SHARE Microfin Limited, for instance,
grew from 1,875 to 86,905 members between 2000 and 2005 and its loan portfolio
has grown from US$0.47 million to US$40 million.

Since banks face substantial priority sector targets and microfinance is beginning to be
recognised as a profitable opportunity (high risk adjusted returns), a variety of partnership
models between banks and MFIs have been tested. All varieties of banks - domestic and
international, national and regional - have become involved, and ICICI Bank has been at the
forefront of some of the following innovations:

 Lending wholesale loan funds.

 Assessing and buying out microfinance debt (securitisation).
 Testing and rolling out specific retail products such as the Kissan (Farmer) Credit
Card.
 Engaging microfinance institutions as agents, which are paid for loan origination
and recovery, with loans being held on the books of banks.
 Equity investments into newly emerging MFIs.
 Banks and NGOs jointly promoting MFIs.
The 2005 national budget has further strengthened this policy perspective and the Finance
Minister Mr P. Chidambram announced "Government intends to promote MFIs in a big way.
The way forward, I believe, is to identify MFIs, classify and rate such institutions, and
empower them to intermediate between the lending banks and the beneficiaries."

What is beginning to happen in microfinance can be seen from the perspective of what has
happened to phones in India. With the right enabling environment, and intense competition
amongst private sector players, mobile phones in India expanded by 160% during just one
year 2003-04 (from 13 to 33 million). Mobile tariffs fell by 74% during the same period.
While this is heady progress, there is a less heralded but even more powerful nationwide
success on access. In the late eighties, the phone infrastructure was the monopoly of public
sector institutions. Phones were difficult to get and even more difficult to use for those
lacking ownership. Realisation that users need not own a phone to access one led to
privatisation of the last mile - where a phone user could interface with a private sector
provider using the public sector telecom infrastructure. Even with this policy change, today
there are 2.5 million entrepreneurs selling local, national and international phone services
through the length and breadth of India. Many of these are now graduating to sell internet
services and could potentially be banking agents - that is the evolving story.

Savings services are needed by many more customers and as frequently as access to phone
services. Many poor households value access to savings services and find new providers
and arrangements, despite hearing of unreliable savings collectors or even occasionally
falling prey to such arrangements. Many customers are rich, literate and lucky to have
banks working for them. But many others lack access to safe, secure and accessible savings
services for the short, medium and long terms. In the past, many banks sent collectors to
gather these savings but problems with monitoring, inability to tackle misappropriation
and the rising aspiration of collectors to become permanent staff of public sector banks
killed a useful service. The central bank has strictly forbidden commercial banks from using
agents in collection of savings services. This is unfortunate as:

 Effective microfinance delivery is about managing transaction costs for providers

and customers.
 A combination of agents and technology can play a powerful role in rightly aligning
incentives for the collector and customers, while keeping transaction costs
manageable for everyone.
 The banks can only open so many branches, and fixed and operating costs are high,
apart from approvals still needed from the central bank to open new branches or
close existing ones. The appointment of agents can keep costs manageable and offer
greater flexibility to Banks.
 Banking service may not be able to defy the commercial logic pursued by most other
sectors where a variety of retailers provide services to customers, while companies
focus on customer needs, product design, quality control, branding, logistics and
distribution.
Fortunately, the 2005 Budget opened a small window in this area and the central bank
annual policy recently confirmed discussions on this: "As a follow-up to the Budget
proposals, modalities for allowing banks to adopt the agency model by using the
infrastructure of civil society organisations, rural kiosks and village knowledge centres for
providing credit support to rural and farm sectors and appointment of micro-finance
institutions (MFIs) as banking correspondents are being worked out." But readers may
note that between the budget and the annual policy statement, "credit" has again crept in
as the key perceived need.

*Challenges Remain

A World Bank study assessing access to financial institutions found that amongst rural
households in Andhra Pradesh and Uttar Pradesh, 59% lack access to deposit account and
78% lack access to credit. Considering that the majority of the 360 million poor households
(urban and rural) lack access to formal financial services, the numbers of customers to be
reached, and the variety and quantum of services to be provided are really large. Vijay
Mahajan, Managing Director of BASICS, estimated that 90 million farm holdings, 30 million
non-agricultural enterprises and 50 million landless households in India collectively need
approx US$30 billion credit annually. This is about 5% of India's GDP and does not seem an
unreasonable estimate.

A tiny segment of this US$30 billion potential market has been reached so far and this is
unlikely to be addressed by MFIs and NGOs alone. Reaching this market requires serious
capital, technology and human resources. However, 80% of the financial sector is still
controlled by public sector institutions. Competition, consolidation and convergence are all
being discussed to improve efficiency and outreach but significant opposition remains; for
example, the All India Bank Employees Association has threatened to strike if the
Government proceeds with its policy of reducing its capital in public sector banks, merging
public sector banks or even enhancing Foreign Direct Investments in Indian private banks.

Many speakers at the Microfinance India conference talked about the significant and
growing gap between surging growth in South India, which contrasts with the stagnation in
Eastern, Central and North Eastern India. Microfinance on its own is unlikely to be able to
address formidable challenges of underdevelopment, poor infrastructure and governance.

The Self Help Group movement is beginning to focus on issues of quality and there were
some interesting discussions on embedding social performance monitoring as a part of the
regular management information systems.

At the time of the conference, a leading and responsible MFI was being investigated by the
authorities for charging "high" rates of interest. Per unit transaction costs of small loans are
high but many opinion leaders still persist with the notion poor people cannot be charged
rates that are higher than commercial bank rates. The reality of the high transaction costs
of serving small customers, their continuing dependence on the informal sector, the fact
that most bankers shy away from retailing to this market as a business opportunity, and
the poor quality of services currently provided does not figure prominently in this
discourse. While the central bank has deregulated most interest rates, including lending to
and by MFIs, interest rates restrictions on commercial bank for retail loans below US$5,000
(all microfinance and beyond) remain and caps on deposit rates also discourage sharing
transaction costs with customers. But most conference participants accepted the
imperatives to build sustainable institutions.

There is still lot of policy focus on what activities are and are not allowed and not enough
operational freedom as yet for banks and financial institutions to design and deliver
programmes, and be responsible for their actions. Prescriptions and detailed circulars
often limit organisational innovation and market segmentation. As Nachiket Mor of ICICI
Bank said at the conference, if the right indicators are monitored and operational freedom
and incentives are clear, both public and private banks have the capacity to rapidly address
the remaining challenges.

*Closing Remarks

In my view, savings service is the neglected daughter of the family of financial services. I
use this metaphor because of the sustained discrimination against and frequent disregard
for savings services, despite their productive and reproductive role in financial services[5].
This is evident from different nomenclature used at both the international (UN
International Year of Microcredit, MicroCredit summit) and national levels (Priority Sector
Lending; Annual Credit Policy; Credit/ deposit ratio). Savings services can be a useful entry
point for the unbanked to build up a history with the formal financial institutions before
customers are entitled to other financial services. With the greater spotlight on knowing
the customer and the fact that poor households do not have a salary slip, utility bills, clear
land titles or unique identity papers, a regular savings record could be the first building
block to membership of the formal financial sector. What is more, with savings services,
poor customers need to trust the financial institution and not the other way round.

Microfinance is not yet at the centre stage of the Indian financial sector. The knowledge,
capital and technology to address these challenges however now exist in India, although
they are not yet fully aligned. With a more enabling environment and surge in economic
growth, the next few years promise to be exciting for the delivery of financial services to
poor people in India.

I would like to congratulate CARE, as the lead organisers, for successfully hosting this
global cross learning event. Unusually, the event ended with a statement of some
objectively verifiable indicators (such as expansion of urban microfinance, increased
conference participation by public sector banks and redressal of North South divide) on
which the sector should track progress in a years' time.

*Conclusion
A main conclusion of this paper is that microfinance can contribute to solving the problem
of inadequate housing and urban services as an integral part of poverty alleviation
programmes. The challenge lies in finding the level of flexibility in the credit instrument
that could make it match the multiple credit requirements of the low income borrowers
without imposing unbearably high cost of monitoring its end-use upon the lenders. A
promising solution is to provide multi-purpose loans or composite credit for income
generation, housing improvement and consumption support. Consumption loan is found to
be especially important during the gestation period between commencing a new economic
activity and deriving positive income. Careful research on demand for financing and
savings behaviour of the potential borrowers and their participation in determining the
mix of multi-purpose loans are essential in making the concept work (tall 1996).

Eventually it would be ideal to enhance the creditworthiness of the poor and to make them
more "bankable" to financial institutions and enable them to qualify for long-term credit
from the formal sector. Microfinance institutions have a lot to contribute to this by building
financial discipline and educating borrowers about repayment requirements.