What Client Poverty Monitoring Over Time Is and Is Not Good For

I was recently out for a meal with several young employees of a profit oriented Indian microfinance institution (MFI). Like good young microfinance professionals, we got to speaking about the best ways to efficiently measure the impact of the small loans distributed by their organization. Though it was the most methodologically sound method, we all agreed that it was unrealistic for every MFI to be expected to run randomized evaluations (Randomized evaluations allow researchers to compare the effects of products on a set of randomly selected households which was offered the MFI’s products to a randomly selected set of households not offered the product from the same population). This is unrealistic because randomized evaluations call for an immense investment in time and money that would almost certainly not fit in the impact monitoring budget of even the largest MFIs. So what to do?

Last week, a former colleague kindly sent along the note “Scoring Change; Prizma’s Approach to Assessing Poverty,” published by the Microfinance Centre’s (MFC), a membership-based microfinance resource centre for MFIs in Eastern and Central Europe. The document describes the “scorecard” strategy developed by MFC, as a part of the “IMP-ACT” program, which was designed to monitor the economic profile of MFI clients, as well as observe the changes in their poverty status over time. The document also details how Prizma, an Eastern European MFI, implemented the approach. To oversimplify, the “scorecard” approach requires MFI’s to collect information for 7 consumption/education/wealth indicators that are used to create a poverty score. By using indicators that are also found in national living standards surveys, the correlation between these indicators and poverty can be ascertained. Thus, the poverty score can be used to make a robust guess at the economic status of that household. I have no ability to vouch for the methodology behind the approach, but nothing I read in the document led me to believe it is anything but credible.

The “scorecard” strategy seems to me to have several important uses, but not to be a strong tool for evaluating impact (and although developed under the “IMP-ACT” program, I am not sure that its creators themselves would claim it to be). Probably the most valuable information the “scorecard” can provide is whether an MFI is “reaching who it seeks (and claims) to be reaching…” I am personally not altogether convinced that serving poorer clients equals social performance (perhaps wealthier clients better use credit to develop the local economy), but if an MFI does believe this and asserts to their investors/donors that they serve a certain section of society, they should be able to prove it. MFC mention that other potential uses for a “scorecard” system are to “track dropout by poverty status enabling the Institution to better understand the appropriateness of its service to different [economic classes]” and to “better understand its cost structure…. and locus of cost associated with outreach to poorer clients.”

This type of information has proved to be valuable to MFIs before. See this link for how time series data of their customers reoriented the strategy of Indian MFI Basix.

As far as impact, it is rather cryptically suggested in the note that, “the System enables analysis of more or less discrete change in poverty status over time. While this does not assume attribution, measuring change in household poverty status over time does provide important signal on which to make inferences about outcomes of medium to long-term service provision and highlight areas for further investigation.” I believe what they are trying to say is if you find that your clients, or a segment of your clients, are doing much better or worse than their peers, you should look into this by doing a more thorough study.

Returning to the larger question of this post about how MFIs might understand the impact of their products in a way that has validity but is cheaper than a randomized evaluation, I think my colleague Lakshmi Krishnan’s suggestion that “there is no shortcut to impact” is almost surely right. This of course does not mean that tracking the status of clients over time is not useful, just that we should be clear on what it is useful for.

New Warehouse Financing Initiative by ITGC

Here at the Indian Development Blog we like to highlight the efforts of our partners. The IFMR Trust Guarantee Company (ITGC), a member of the IFMR Trust group of entities, is launching an exciting initiative in collaboration with the recently established National Spot Exchange (which is also a very exciting initiative – more on that later) to provide warehouse receipt financing to farmers. Below is a description of the initiative, along with a background on the reasons for the initiative in their own words. Thanks to Gaurav Kumar for the write up!

Current practices in commodities and problems
All agricultural commodities in India are traded in a wholesale market called a Mandi. Mandi forms a part of the spot market designed for the trading of commodities in India. The price of the commodity is set at a mandi. Mandis are set up with the permission of the state government. Each state government has a State Agricultural Marketing Board (SAMB) which sets up a mandi at the district level. Initially there was one mandi for a specific district. But now there are many mandis within a district, usually at the Taluka level. Today there are around 750 mandis all across India and around 140 commodities are traded in total across these mandis. Most mandis in the same district trade in a similar set of commodities. This makes for a fragmented market for a single commodity in the country.

All the quantity of commodities that are produced in excess of local consumption pass through the mandi. Hence mandi becomes an important source of information to understand the flow of commodities in the country. Every mandi deals with at least one primary commodity that is usually very specific to the region. It may also take up other primary and non-primary commodities for trading. Once the sellers come to the market yard, they usually approach a licensed trader at the yard. Traders are intermediaries between the farmers and the wholesalers. Traders can also have multiple roles. Some traders are only commission agents or brokers for major processing firms in the region, some are traders and stockiest and some are traders and hedgers as well. However any licensed trader at the APMC will have to pay two types of fees, a transaction fees that is a fraction of volume traded and tax which varies from state to state. However, the traders recover these charges by charging this to the farmers. Only in case of the primary commodities which are protected by using the MSP, the traders pay the full price for the produce.

Traders who are only ‘kachcha adathiya’ or only commission agent do not stock any commodity. They usually clear the traded commodity the same evening while the ‘pucca adathiyas’ store the traded commodity depending upon the cost they can bear on it. As can be seen, storage happens to be an important function in the flow of commodities.

A standard warehouse receipt is typically used only by traders and affluent farmers as a tool for financing. Warehouse receipt finance has thus become an exclusive product that is perceived to be non applicable to the small and marginal farmer. The apparent barriers to the farmer in participating in such a product are observed to have been

1. Non availability of reliable price information leading to information asymmetry
2. Lack of Storage Space: Curtailing the holding capacity of the small farmer
3. No fixed parameters of judging quality
4. Multiple layers of intermediaries
5. Hidden Charges, Documentation Challenges
6. High Transport Cost

In order to address many of these issues IFMR Trust has entered into a collaboration with National Spot Exchange Limited (NSEL) in line with which ITGC has structured a Warehouse receipt finance product to leverage the Warehouse Receipt as a liquidity smoothing financial instrument, by riding on a warehouse linked electronic market.
While the combination of ITGC Warehouse receipt finance and NSEL's warehousing and electronic price discovery would resolve many of the issues faced by the small and marginal farmer, it is felt that these would still not be sufficient to clinch the issue and catalyze him to move out of the traditional mandi system into a contemporary electronic mandi. Some issues involved in achieving this are:
The goal of the warehouse receipt financing product is to enable small farmers to access finance against their commodities at competitive rates using a process that is fairly simple to execute. To enable this, ITGC has signed a partnership agreement with National Spot Exchange Limited (NSEL). The alliance will create a seamless process for providing finance to farmers and traders against commodity warehouse receipts for the commodities deposited in NSEL approved warehouses. The pilot for this financing model is to be launched shortly at Kadi, Gujarat. Under the partnership, IFMR Trust will provide loans to farmers against agricultural commodities deposited in NSEL-approved warehouses, by way of warehouse receipts issued for these deposits. Such post-harvest financing will give farmers the option to wait out the usually low prices offered immediately after harvest, and sell at a later time, when prices tend to rise. It will also allow farmers to take advantage of changing market prices rather than being burdened by them. The loans backed by warehouse receipts will be pooled and repackaged into securities. ITGC will structure, arrange and sell these commodity loan-backed securities in the capital market.

Government's Role in Microfinance - How does India's compare?

Our conference a couple weeks ago with the Reserve Bank of India's training arm (RBI), the College of Agricultural Banking (CAB), made me think a fair amount about government's role in microfinance. Undoubtedly, India's government has played a large promotional role in Indian microfinance. The creation and growth of self-help groups through NABARD funding is quite impressive. Since the early 1990's, over 20 million Indian women have received credit through the government's SHG programme. At the same time, the fastest growing segment of microfinance, private microfinance institutions, does not seem to receive much government support (or that much regulatory supervision for that matter).

Accordingly, I have been doing a little research on the role government typically plays in microfinance. CGAP has an interesting piece that provides examples of government practices in several nations (e.g., Bosnia, Armenia, Brazil), which points out that governments often play 3 different type of roles:
1) Protector - The article argues that governments should develop appropriate regulations, or adapt existing banking regulations, to protect the solvency of large institutions that collect deposits from poor people. (In India, the government has largely not played much of a protector role. One reason may be that private MFIs are not allowed to take in formal savings deposits.)

2) Provider - Here I would argue India's government is a pioneer. By using public sector funds that did not go to the priority sector designees (e.g., agriculture, low-income households) to finance self-help groups, India's government created the foundation for microfinance in India.

3) Promotional - This could include financing or creating policies that facilitate the growth of microfinance. Going with my points above, I think (and the CGAP piece points out) that India's government does do a lot to finance the sector. On the policy side, there is room for improvement.

With regards to policy in India, in March of 2007 the Union Government introduced the Micro Financial Sector Development and Regulation Bill 2007 in the Lok Sabha – the lower house in the parliament of India. To this point, the bill has not been signed or rejected; I believe it still sits in the Lok Sabha.

My colleagues at CMF, Minakshi Ramji and Yusuke Taishi, wrote an interesting 2-pager on the bill's main characteristics and its possible implications for the sector. Interestingly, NABARD (which funds the government's SHGs) would become the regulator. As the authors point out, this could be a conflict of interest for agency. Additionally, the bill would allow some MFIs to mobilise savings, but it does not encompass non-banking financial companies or non-profit MFIs, which are two of the faster growing types of MFIs. Over the past year and a half, the draft bill may have changed significantly, but the initial draft is at the least the baseline for possible legislation.

I wonder which direction future policy and legislation will go in India. Personally, I hope that 1) savings are permitted, 2) any microfinance bill encompasses all types of MFIs, and 3) the government does develop a more concrete policy framework for microfinance.

Microsavings and Privacy

One of my favorite moments of the recent conference held by the College of Agricultural Banking and the Centre for Micro Finance was Chetna Sinha’s description of her experience on how to effectively offer savings to microfinance clients. Sinha is the founder of Mann Deshi Mahila Sahakari Bank, an MFI located in Maharashtra that focuses on providing a wealth of services to their poor women clients. Mann Deshi is not a Non Banking Financial Company (NBFC) or NGO, but an actual registered cooperative bank, so like the more famous Gujarat based SEWA Bank, Mann Deshi is legally allowed to offer savings to their clients.

Sinha explained that many of her clients were unenthusiastic about saving if that meant having to go to a bank to make a deposit. The first reason why women might not want to take the time to go to a bank is intuitive. Going to a bank may represent a high transaction cost, both in the time it takes to get to the bank and the cost of the transport to get there. The second reason surprised me. Sinha believes that poor women do not want to be seen going to the bank to make a deposit because members of the community might see this and then seek her out for money. Worst case scenario, this member of her community might be her husband who wants to use the money for scurrilous purposes.*

This same argument holds true even more strongly for saving in an SHG. Quite reasonably, a large portion of poor women who want to save, may not want to make the amount public. SHGs may work well for small weekly savings payments, but surely not as well when a member’s family receives a large windfall and does not want to tell the world.

Sinha’s answer is that you must go door to door and collect savings in a structure that fits the clients needs. Generally this is structured as a commitment device, where the Mann Deshi member agrees to deposit a certain amount daily, monthly or weekly, but Sinha made it clear that the bank would be flexible if the client chose to make a larger payment into their account. But this means the transaction costs of mobilizing savings is assumed by the bank. This is probably generally a net gain for society as the bank may be able to have a collection officer spend the day attending to a number of clients, but it does make sustainability, much less profitability, tough on the bank. Sinha mentioned several times during her speech how difficult it has been to offer savings in a way that was sustainable for her organization and attractive for clients. Another reminder that nothing is as easy for MFIs as disbursing and collecting loans!

*Men are always getting an unfair rap in microfinance, and I want to apologize to all of my fellow sex for propagating this.

Financial Inclusion: Opening up Bank Accounts not Good Enough

Another interesting study that was presented at the microfinance conference in Pune at the College of Agricultural Banking (RBI) related to the Reserve Bank of India’s (RBI) financial inclusion drive (I am not the only one who found it interesting, a reporter from Business Standard recently wrote about the study). Hoping to reach unbanked populations, in 2006 RBI encouraged banks to make basic no frills savings accounts, either with nil or minimum balances, widely available. By November 2008, of the 342 districts identified by State Level Bankers Committee, 155 districts were declared to have achieved 100 percent financial inclusion, and by the end of March 2008, 15,788,919 no-frills accounts had been opened (according to an RBI 2008 progress report). But, as the pie graph above and to the right shows, 72% of the accounts were at minimum balance in the district the authors studied (minimum balance was either zero or a small number such as 30 rupees).

The study focused on Cuddalore district in Tamil Nadu, one of the 155 districts declared to be in 100% financially included. In collaboration with S. Thyagarajan at CAB, Jayaram Venkatesan at CMF analyzed the results of the financial inclusion project in terms of the following:
• Coverage by geography
• Account activity and usage
• Cost involved in opening of accounts and maintenance, as well as the transactional usage behaviour

The real success of the financial inclusion project would be measured by the actual quantity and quality of usage of the newly opened no frills accounts. Perusal of the sample accounts revealed that 72 percent of the accounts had zero or minimum balance even after one year of opening. Only 15 per cent of the accounts had a balance of more than Rs. 100, leaving 85 percent of the new no frills accounts inoperative. One of the most important reasons for lack of use seemed to be lack of awareness among households about savings and about the uses of no frills accounts. Many account holders were not even aware of the purpose of opening the bank account and obtaining the passbook in the first place. According to the authors, the need for financial literacy underlies the relative failure of these savings accounts.

The study is an interesting read, and one that several RBI executives referenced during the conference. To learn more, access the study here.

* I borrowed heavily from Jayaram’s 3-page summary that he wrote up for the conference to write this entry. Jayaram, I hope you don’t mind!

Multiple Borrowing: MicroPonzi Scheme, Underfunded Entrepreneurs or Understudied Topic?

As a few bloggers have mentioned, last week the Centre for Micro Finance and the College of Agricultural Banking held a conference in Pune with a focus on microfinance research results and implications for practitioners and policymakers. One of the research presentations, put forth by Prof. Rajalaxmi Kamath of IIM-Bangalore, engaged with the fascinating topic of multiple borrowing amongst MFI clients (a Powerpoint of her presentation will be online soon).

Derived from her field study which used financial diaries to track the cash inflows/outflows of MFI clients, Kamath's research showed that nearly all of the tracked households were indebted to multiple MFIs/SHGs (her sample size was approximately 20 households). As microfinance does not adhere to traditional banking’s credit rating/history infrastructure, nor do MFIs typically share client information with each other, the true extent of multiple borrowing must be ferreted out through informal means such as Kamath’s study. (A CMF study in 2007 tracked the extent of multiple borrowing amongst seven ICICI-partner MFIs through a database, but availability of such comparative data is rare)

Why would microfinance clients take out multiple loans? Potential causes might include a mismatch between the size of the loan and the business/personal needs of the clients, a lack of financial savvy, an abundance of financial savvy (aka ability to game the system) or the vacuum of oversight, among many other reasons. Kamath also found that there was some evidence of debt recycling, wherein loans were used to pay off preexisting debt and not for “productive purposes.” Furthermore, she believed that such debt recycling contributes to the phenomenally high repayment rates and excellent portfolio qualities of MFIs.

Could MFIs elicit this kind of credit information for their own records? The sector has in fact developed a number of tools, such as Microfinance Opportunities: Listening to Clients modules and the AIMS/SEEP Tools on Client Assessment, which produce financial snapshots of clients before and after receiving financial products. However, many microfinance institutions do not have the time, the will, nor the manpower to administer these tools. Additionally, I wonder what the incentives of NBFCs, funded by commercial debt (and possibly equity), are to further investigate multiple borrowing if JLG-driven credit continues to produce such low PARs and default rates? What are their incentives to engage with the infrastructure of a credit bureau if it will demonstrate the widespread nature multiple borrowing and raise eyebrows?

Professor Kamath's work raised a number of questions/internal dialogues for me:

- If multiple borrowing reflects underfunded entrepreneurs, would larger loan sizes result in less multiple borrowing, higher client productivity and greater financial/social impact? (Kamath mentioned the steep opportunity cost of client running from repayment meeting to repayment meeting) Yet, an “appropriately sized”(meaning one that matches the business needs of the client) loan might mean more operational costs in terms of a credit assessment by a loan officer. And, larger loan sizes might not be sustained in the joint liability model, dampening the sure-fire repayment rates and lessening the portfolio quality/appeal to investors of the microfinance sector.

- Are clients who take out multiple loans better off at the end of the day? Evidence from Bangladesh suggests that with BRAC clients from a certain district, repayment rates drop to 50% for households with loans from three or more MFIs. But is default really a bad thing for the individual client, given that loans are collateral-free and vouched for by JLG members, or simply for the MFI (or other members of the JLG)? Are some of these clients just engaged in a micro-Ponzi scheme? Or do the multiple loans ensnare them in a ceaseless merry-go-round of recycled credit from which they can scarcely augment their long-term standards of living?

- Finally, if NBFCs are not incentivized to investigate/mitigate against multiple borrowing, who should bring oversight?

I’m not sure of the answers to any of these questions but either way this was a thought-provoking study which I hope generates more research. Any comments/thoughts?

Sources: Presentation by Rajalaxmi Kamath at CMF/CAB Conference. "Microfinance in India: Small, Ostensibly Rigid and Safe." January 17th 2009

Statistical Analysis for Pirates

I'll never question the maxim "all the news that's fit to print" again. I always thought there were only a half dozen other people in the world that had mucked around with the R programming language. Apparently not.

Kashmir

One of the more interesting results to emerge from the field of behavioral economics over the past few decades is something called the “endowment effect”: people often over-value something which they already have relative to other options available. (For example, if I randomly give half of a group a free gift and then ask the half which I gave the gift how much they would be willing to sell the gift for and the other half how much they would be willing to purchase the gift for, the “sell” prices will usually be much higher than the “buy” prices.)

In my opinion, nowhere is the endowment effect stronger than in the debate over national borders. I’ve never heard someone from the North of the US say, “it’s too bad that the South wasn’t allowed to secede. We would have avoided the cost of the Civil War and wouldn’t be stuck with all those rabid Bush fans during election time.” For Americans, there is something sacrosanct about the current borders of our country and any attempt to imagine an alternate history in which there are not one, but many USAs, seems unpatriotic. Likewise, I’ve never heard an Indian say “It’s too bad a few of the princely states didn’t remain independent. India is simply too big to govern.”

I’ve just returned to a trip to Kashmir so the topic of national borders has been on my mind. I don’t know enough about Kashmir to have a solid opinion, but when I read things like this, it definitely seems like there is clear case of irrationality.

Almost Live Blogging: BASIX and SKS Executives Discuss "Microfinance Plus"

This past weekend CMF and the College of Agricultural Banking (CAB), which is the training and capacity building arm of the Reserve Bank of India (RBI), held a conference entitled “Conference on Microfinance: From Research to Practice”. The group of 70+ that gathered at CAB's Pune campus was an interesting combination of practitioners (from MFIs and public sector banks), policymakers (CAB and RBI), and researchers from CMF and universities across India.

My favorite session was entitled “Optimizing Microfinance Distribution Channels”. During the session, my colleague Dan Kopf discussed CMF’s treated bednet study that we are conducting in collaboration with BISWA in Orissa, and Professor Raghabendra Chattopadhyay of IIM-Calcutta discussed our rainfall insurance project with SEWA Bank in Gujurat. I learned from both these presentations, but really enjoyed the practitioner responses from BASIX and SKS executives.

Dr. Sankar Datta, who is Managing Director of Indian Grameen Services, the research and development unit of the BASIX group, started off by discussing the economic logic of using microfinance distribution channels to provide multiple services. Dr. Datta explained that the transactions costs that come from loan officers visiting villages or certain areas of a city are relatively fixed. If this staff member can provide many services instead of just one (e.g., credit), than the distribution channel is more efficient because the fixed costs would remain relatively constant. Moreover, Dr. Datta noted that customer loyalty may increase from getting many services through one provider.

That said, there are on-the ground realities that could negate the possible benefits of a microfinance institution (MFI) providing multiple services. Paul Breloff, the VP of Business Development at SKS, did a great job of detailing some of the risks, which included 1) If the product does not work the MFI can get in trouble w/customers; 2) Selling non-core products can take too much management (and field staff) time; and 3) Regulatory risks.

Mr. Breloff also explained that an MFI’s core competency is disbursing and taking in cash. Outside of this key competency, field officers often struggle with logistics of distributing non-core products and educating customers about these products (e.g., cellphones, LED lights, etc.).

In the past, I have argued against the utility of MFIs providing non-financial services, and I think this session helped me refine my thoughts. As Breloff discussed, MFIs are not well-suited to educate customers about complicated products and there are real risks in opening up one’s own distribution channel to a specific provider. However, if an MFI can leverage its ability to collect and disburse cash, and rely on its partner to reliably provide other key services (e.g., education, the actual product, maintenance), such partnerships can work.

Thoughts?

There's a Natural Experiment in There Somewhere

But in 2006 the Liberal provincial government of Jean Charest introduced a provision for parental leave that is more generous than anywhere else in North America. And at last the children came. The number of births in the province jumped almost 8% that year (with a particular bump in January as parents delayed conception to qualify for leave). (Emphasis mine).

That comes from the latest edition of The Economist. I look forward to seeing what Canadian social scientists come up with.

Read the Small Print

This last Sunday I picked up the Indian Express while waiting for a train, and was baffled when I read the following headline, "People Say No to Israel-type Action Against Pakistan." The article details the results of a "six-question poll of over 600 residents of Chennai, Bangalore, Hyderabad and Kochi..." which indicated that 72% of those polled believed Israel was not "correct in attacking Gaza, first by airstrikes then by invasion, to sort out Hamas."

My initial reaction was twofold. 1) I was happy that Indian people seemed to be so averse to the use of force 2) I was skeptical of the polls methodology. It did not seem appropriate that the headline referred to the general "People" when it was only referring to those living in major cities. Plus, I thought it peculiar that so many of the people polled were aware of the attacks and the organization Hamas (a very small number of people responded "Don't know/Can't say" to any of the questions).

My detective skills led to to small print in the bottom right section of the article. It reads as follows:

"Methodology: Research organisation C fore conducted the survey on behalf of The New Indian Express in four cities of south India, Bangalore, Hyderabad, Chennai and Kochi, on 5-7 January 2009. A questionnaire was adminstered to a statistically selected sample of 608, and only those who were aware of the of the Israel atack on Gaza were selected. Person belonging to different socio-economic categories were interviewed. All figures are in percentages."

I don't think I am being a stickler in thinking that the fact that "only those who were aware" of the attacks were interviewed was probably worth mentioning in the body of the article and perhaps even in the headline. I believe this article in incredibly misleading because of a substantial and essentially unacknowledged selection bias. Regardless of education and economic status, the type of person who is informed about a certain international event is fundamentally different than their counterpart who is not informed. This is not to suggest that they should have conducted a poll that included a completely random cross section of the Indian population (as this would likely lead to the uninteresting result that most Indians are not aware of the organization Hamas), only that methodology deserves a greater space when presenting data.

For an article on how selection bias also affects microfinance impact research see Dean Karlan's excellent "Microfinance Impact Assessment: The Perils of Using New Members as Control Group." The article explains the faulty assumptions behind assuming that the difference between "veterans" of MFIs and "new members", even controlling for other variables, is the true impact of MF.

Uncrunch America

As one of more than 7,000 submissions to Change.org’s "Ideas for Change in America Contest," Uncrunch America provides an interesting solution to mitigate the credit crisis. The project proposes to bring peer-to-peer lending (first popularized by Kiva.org) to Americans. Kiva.org, which allows anyone with internet access to provide a small loan (typically $25-$50) to a micro-entrepreneur in the developing world, has been wildly successful in its three years of existence. So far, more than $55 million has been lent through the site.

Uncrunch America would allow Americans to benefit from the same lending methodology, while freeing idle money for productive use. Borrowers would be able to avail affordable loans to finance their small businesses, school loans, or health care expenses, while lenders would add social lending to their investment portfolios and earn a slight profit. Fast Company aptly summarizes the potential gains that could arise from this idea simply through the multiplier effect of money.

The project already has $1 million in backing from Lending Club, and if the project gains enough votes, it will be presented to the Obama Administration on January 16^th. Thoughts?

The darker side of staff incentives in MF operations

Very recently I had a great opportunity of interacting with top brasses of a couple of MFIs operating in the northern states of UP and MP. When I shared my notion of studying the phenomenon of fraud in districts of UP, I was enlightened by some "field truths" yet again. This time on staff incentives.

Grammling, M. & Holtmann, M. (thanks to CMF e-library) talk about staff incentives in detail. I will summarize the the two links I read. This article talks about the role of staff incentives. It outlines the negative effects in bar graph chart; loan portfolio quality, team spirit and social goals are found to have a little negative impacts. This supports my enquiries on some frauds lately (I will stick to frauds resulting from staff incentives only in this blog). MFI staff have formed groups of higher loan sizes by paying them some commission and that has resulted in non-repayments. Moreover the incentive on timely repayments lead to staff paying from their pockets, which later on leads to staff thinking of ways to get more money from clients. Setting targets and announcing linked incentives, result in loan officers looking around for clients. Since the whole hierachy has the incentive benefit, the loan officer and the higher officer, who approves loans just passes the loan. This leads to a very poor loan portfolio quality and huge losses for the MFI. I am sure that any survey on loan incentives for MFI officers would reflect much more negative impact on loan portfolio quality now (compared to 2007).

This paper talks about how some incentive schemes related to - 1. number of clients, 2. active clients, 3. Loan disbursed only lead to high speed growth of MFI and a drift from mission, which is essentially reaching out to poor families. My experience says that the loan officer tries to get those people in the group who, he thinks, can repay loans. So for example if the candidate's house is really dilapidated, loan officer would decide against providing loan to this candidate. Thus leaving a poor person and choosing a better off person, which is against the mission. This logic emerges from the fact that loan officers have to maintain a good loan portfolio quality for incentives and he does not want to take chances.

I liked the BancoSol's staff incentive scheme. They have separate officers for different loan sizes, the weights for various parameters of incentives vary for all officers. For example, for low size loan, the weights are higher for number of clients. In this case I am sure the loan officer for small loan sizes would spend time in accessing whether the person (as in previous example) would be able to repay loan, and would not just decide against providing the loan by looking at the house.

Any comments or follow up discussion is welcome.

Governance of MFIs

In a recent S&P report, Venkataraman and Raj Sekhar of CRISIL term governance-related issues are the biggest challenge to the sustainability of Indian MFIs. They specially point out that NGO-MFIs are likely to be floundering on this front, in their quest to balance the transition from a charitable entity to a commercial one.

In the S&P report as well as in other general discussions around governance issues, the focus is usually on balancing social and commercial interests of MFIs. Terms such as ‘mission drift’ have become popular and are topics of concern at major conferences. I think the more pressing ‘governance’ concerns are far more fundamental, where far more needs to be done to ensure greater transparency in the figures reported and in handling accounts. Highlighting this might seem morbid, but given the infancy of the sector and the pressures of expansion, such fears are far from being unfounded. Add to that, my banker friend's concerns...

My friend, a senior banker from a prominent lender to MFIs in India was complaining about the dismal state of governance in MFIs. According to this person, the bank has almost decided to pull out of MFIs which did not follow governance norms stipulated by the bank, irrespective of the levels of profitability of the MFI. Apparently, over 90% of the MFIs in that bank's portfolio showed one problem or the other with respect to its governance structure.

This scenario is truly worrying and it is easy to see how any interference by banks will be resisted by MFIs as a transgression of their autonomy. However, these arguments are unlikely to sustain themselves in the present circumstances. With the Satyam crash and the CEO's revelations about inflated cash/bank balances, revenues and operating margins, among much else, there are bound to be genuine fears of such rot taking root in other organisations. I cannot imagine how MFIs will escape increased scrutiny in this light.

Is the Liquidity Crunch Hitting Home in the Microfinance Industry?

There seems to be more and more indication that the decrease in bank lending is affecting microfinance in India, and around the world. For instance, a recent article in the Financial Chronicle, uses interviews with microfinance practitioners to highlight the increase in borrowing rates from banks in India.

Arjun Muralidharan, CEO of Grama Vidiyal Microfinance, had this to say:
“MFIs borrowing costs from banks has increased to 13.5-14 per cent from 12 per cent earlier. Earlier, we were facing difficulty in securing funds due to tight liquidity conditions and, therefore, had to cut back on our disbursement targets. While the recent RBI measures have enhanced liquidity and access to funds has become easier, rates are still on the higher side. The rates may come down in the fourth quarter, when banks would need to meet their priority sector disbursement targets,”

Anal Jain, managing director of MVA Ventures, which has a US$50 million fund to invest in Indian MFIs, said:
“MFIs are facing such a volatile interest rate conditions for the first time. Earlier, the micro finance institutions, instead of increasing rates charged from the customers, raised the processing fees to 2 per cent from 1 per cent. So, even if the banks cut rates at which they lend to MFIs, it would be difficult for the latter to pass on the benefit to their customers.”

To take a step back from India, this MicroCapital article details how earlier this week, the International Development Bank (IDB) provided US$20 million to an emergency fund for Latin American and Caribbean microfinance institutions. According to a press release on the IDB website, the funding is “to help Latin American and Caribbean microfinance institutions weather economic crises and natural disasters”.

These stories do not prove that microfinance institutions across many geographic regions are finding it harder to borrow and grow their operations, but the stories keep adding up (including this one about how the credit crunch affects customers from summer of 2008), and personally I am becoming convinced.

Which begs the question, would higher interest rates for customers deter them from taking loans from microfinance institutions in India? Also, do readers have examples which support, or go against, my above point that credit rates for borrowing microfinance institutions are on the rise?

Focus of Agent Based Banking Should be Disbursal of Government Benefits, Not Provision of Savings

A couple of years ago, the RBI generated a lot of optimism in financial inclusion circles by passing regulation allowing banks to outsource functions to third party agents. It was hoped that the RBI’s new model for agent based banking, called the “business correspondent” model, would reduce the cost to banks of providing financial services, especially savings products, to un-served populations while simultaneously reducing the cost to potential clients of accessing banking services.

Unfortunately, only two days after releasing the initial circular on the business correspondent model the RBI tacked on an additional restriction which effectively killed the new model: it prevented Non-Banking Finance Companies, a legal category which includes all of the largest MFIs, from acting as business correspondents. Despite recommendations from both the Rangarajan and Rajan committees as well as numerous independent observers to drop this restriction, the RBI has remained steadfast in its refusal to allow NBFCs to operate as business correspondents. The result is that two years on adoption of the business correspondent remains extremely limited.

The RBI’s motives for barring NBFCs from handling savings under the business correspondent model are not without merit. Up until the mid-90s ordinary NBFCs were allowed to accept savings deposits (certain types of NBFCs are still allowed to accept deposits but only if they have a very large capital base and are subject to numerous restrictions on how they handle funds) and the results were disastrous: by the end of the decade the acronym “NBFC” became virtually synonymous with “Ponzi scheme”. Worse still from the RBI’s perspective, NBFCs proved very adept at finding legal loopholes to continue to accept savings long after the RBI realized that it was a very bad idea for them to do so.

In my own opinion, this regulatory standoff over whether NBFCs should be allowed to handle savings misses the point: the real potential for agent based banking in India lies in delivery of government benefits rather than provision of savings products. Between NREGA, the national old age pension scheme, and Indira Awas Yojana, the government of India will disburse nearly 40,000 crore rs worth of benefits directly to individuals this fiscal year and that figure is set to grow substantially next year. Despite efforts by the central government to force these payments to be made via the formal banking system (for example, the Ministry of Rural Development recently mandated that all NREGA wages be made via a bank account), most of these payments are still made via GP officials or post offices due to the limited number of bank branches in rural areas. There is a huge need for an effective agent based model to allow these payments to be made through the formal banking system. Further, for potential third party agents such as MFIs, delivery of government benefits is a more attractive business proposition than handling savings. Unlike management of savings accounts, delivering government benefits is relatively straightforward and predictable business with relatively easy cash management requirements. In the case of a typical MFI, delivering government benefits might even reduce their cash handling cost as loan officers could collect cash from borrowers making repayments and then distribute the same cash to beneficiaries.

In fact, some companies are already using the business correspondent model to deliver government benefits. Technology companies FINO and ALW (among others) are currently delivering NREGA wages and other benefits on behalf of banks in AP through the use of biometric smartcards and a network of agents equipped with mobile smartcard readers. (In AP, the state government has tasked banks with the responsibility of delivering these government benefits. The banks in turn have outsourced the actual delivery to FINO and ALW, paying them 1.75% of the total amount disbursed as service fee.) An independent case study of the FINO payment system conducted by CMF found that the smartcard system led to greater convenience for the end beneficiary and reduced leakage from corruption all for a nominal cost.

If companies are already using the business correspondent to deliver government benefits then what’s the problem you may ask. The problem is that the business correspondent model doesn’t exactly allow FINO and ALW to do what they are doing. The business correspondent regulation excludes for profit companies, which both FINO and ALW are, from acting as business correspondents. To get around this restriction, FINO and ALW have set up semi-independent section 25 companies (non-profit companies) to interface with banks and clients. These section 25 sister organisations funnel money back to FINO and ALW through “technology license fees”.

Forcing companies to play this shell accounting game to act as third party agents and deliver government benefits has two main drawbacks. First, it leaves them in a state of regulatory limbo subject to the whims and fancies of the RBI. FINO and ALW are both doing great work and they obviously have the state governments in their corner in the case of a showdown with the RBI. Still, it would be better to normalize this practice and save FINO and ALW the worry of wondering whether the RBI will crack down on this practice in the future.

The second, and more significant, drawback is that it effectively forces the organisation acting as the business correspondent to serve as both the technology provider and the deliverer of payments. This means that only large technology companies like FINO and ALW which have the capacity to both develop suitable technology and also set up and monitor a team of agents disbursing payments can really enter the market. (This is also why you probably don’t hear FINO or ALW complaining too much about the current regulatory framework: it effectively works to their favour by limiting the entrance of other players.)

Here’s what I propose: the RBI should create a new type of banking agent authorized to deliver government benefits (but not handle savings) and include NBFCs in the list of organisations approved to act as this type of agent. The benefit of this move would be that many more organisations – large MFIs such as SKS and Spandana, deposit taking NBFCs such as Sahara and Peerless, and others – could then serve as agents to deliver government benefits. For organisations such as MFIs, the business case of delivering government payments would be very attractive: after visiting a village to collect money from borrowers they could simply turn around and distribute the same money to beneficiaries. It might even reduce the overall cash handling costs.

From a regulatory perspective, allowing an organisation to disburse government benefits is a much less scary proposition than allowing it to handle savings. Down the road, if the RBI finds that NBFCs acting as agents to deliver government benefits are behaving prudently and responsibly they could gradually expand the number of activities these agents could perform on behalf of banks (for example, first they could add on remittances, then savings, and finally insurance).

Behavioral Microfinance

In light of my previous blog post pertaining to industries understanding and catering to their clients, I did some reading on a current hot topic: behavioral finance. This then led to research on behavioral microfinance and I came across a great article on Microfinance Gateway by Kate McKee, a Senior Advisor at CGAP, titled “Meditations on the U.S. Sub-Prime Crisis and the Lessons and Implications for the international microfinance industry.” She explains the importance of new and ongoing research conducted by consumer psychologists and behavioral economists in finance and microfinance.

McKee highlights 5 main observations upon which she draws parallels between the sub-prime crisis in the U.S. and microfinance:

1. Unsustainable products and practices

2. Buyer bias and wishful thinking

3. Shaky credit processes in the mortgage “value chain”

4. Investors in the world of “slice-and-dice” finance

5. Regulators in the hot seat

MFIs are starting to introduce more innovative and somewhat complex financial products and services to their clients. While we should not curtail innovation, it is important that researchers can keep up with the development of financial products by teaming up with behavioral economists and consumer psychologists to fully understand possible repercussions and implications for clients. Furthermore, it would be informative to see more collaboration with anthropologists and sociologists to better understand the impact that products may have on the livelihood of clients, especially when the growth of microfinance is so high and unregulated. Professors such as Hotze Lont and Otto Hospes have been doing research on this topic and published a book in 2004 called “Livelihood and Microfinance: Anthropological and Sociological Perspectives on Savings and Debt.” Although microfinance is largely considered in the context of Economics it is important to not neglect other spheres of study that are highly relevant to the well-being of those being included into the formal financial market and can provide insight to how institutions and their services can be structured.

How Green Is Your State?

Ever wondered how different Indian states compare in their stewardship of the environment? Well now thanks to the Centre for Development Finance you can find out. The team at CDF has created a state level environmental sustainability index which gauges the relative performance of each state in caring for the environment based on various data from air quality to forest preservation. You can check out the rankings here.

Equity Bank in Kenya: Flexibly Serving the Poor

I recently came across an article in The Hindu that details the growth of Equity Bank in Kenya, which just crossed the 3 million customer mark and now has 50% of Kenya's market share. Like microfinance institutions in India, Equity targets unbanked low-income segments.

I never had read about Equity before, and was surprised by the range of savings and credit products the bank offers. On the savings side, there are no minimum balances or fees, and the typical savings account balance is about US$150. On the credit side, not only are loan sizes and repayment lengths flexible, but also the social collateral clients offer to receive loans can take several forms.

As Xan Rice, the article’s author, explains:
“Loans can be for less than $8, repayable in just a few months. Since many of individual customers work in the informal sector and have few assets of value, the loans are often backed by what the bank calls 'social collateral.'

This can include accountholders grouping together to guarantee an individual’s debt. Women can offer up their matrimonial beds as security; the theory being that no wife is going to want to tell her husband that their bed is gone."

That Equity Bank was able to grow from 256,000 customers in 2003 to 3 million today, while also offering flexible credit and savings options to its customers, makes me think about the relatively inflexible nature of microfinance in India. Loans typically come in relatively standard sizes (Rs. 5,000 – Rs. 15,000), and are typically paid back in 1-year loan cycles. Due to regulatory barriers, microfinance institutions (MFIs) cannot offer savings products.

Is there a way for India’s (micro)finance industry to flexibly serve the poor? Equity Bank's range of offerings did not stop it from growing at a staggering rate, is there room for a couple of the larger MFIs to offer more flexible loan products? Could such a strategy actually help some MFIs better serve (and gain more) customers?