Banks in Microfinance: Do They Have Any Strategy?

Microfinance in India has been a big thing for the past decade. In fact, for sometime it was felt that it was a solution for poverty in India before everyone realized that the expectations from it were over hyped. However, with so many players joining the bandwagon, banks have also joined in the fray, sometimes as an ally of MFIs and sometimes as competitors, and mostly as agencies fuelling the intense competition between agencies.

Although almost every bank has entered microfinance, from nationalized banks to private banks to foreign banks, there does not seem to be any focused strategy for the same. Apart from ICICI bank which is very aggressive in the field, all others have a policy of wait and watch, and have been very conservative. While a lot of the banks are there in this sector to fulfill their target of priority sector lending, a few banks believe in the bottom of the pyramid theory, and feel that this sector can actually be a rewarding source of revenue. Yet, no one seems to have a strategy in place, and currently each bank is doing a lot of trials and errors to find out what can be the best strategy, while in the process leaving the MFIs to make hay.

There are three ways that banks reach out to the Microfinance clients. One is by direct lending to such clients, which is usually and mostly through government schemes that come out from time to time. Also, they reach out to people individually. This is not much popular among the bankers as this method has seen large defaults and NPAs for banks. The second method is the SHG Bank Linkage model, where the groups formed by either the bank or some other NGO is given loans by the bank. Most nationalized banks, through NABARD have been following this method, but again, the results are not very positive. The third and the most popular way is to not give loans to the ultimate clients directly, but to lend to an intermediary, the MFI, which in turn onlends to clients. The MFI pays the money back to the bank. Again here there are different methods in which this is done. Term Loans, Cash Credit Loans or Agency model, where the MFI works as an agent of the bank and charges a commission for its services, while the loan portfolio and the clients belong to the bank.

As discussed earlier, the first two ways have not been very successful. The third is the most popular way but there are many problems with that too. One of the major problems there is that an intermediary in between increases the final cost of borrowing to the client by a huge margin. Another problem is that there are very few strong and well established MFIs which can be given loans to, and identifying and separating potential and good MFIs from the poor ones is really difficult, and certainly not an area which the banks are very capable at. Of course there are compatibility issues and the Partnership Model of the ICICI has gone through rough weather recently due to its over aggressive nature and RBIs guidelines. But all this has happened mostly because there has not been a very well thought out strategy on the part of the banks based on their own strengths and weaknesses and available resources. Even if there has been one, it has not been very well thought out or either has been too aggressive or too conservative.

Yes, there is a huge market for Microfinance out there, and yes there is fortune at the bottom of the pyramid, and banks, if they operate properly, can be the most efficient players in the sector, giving the poor clients very good deal on financial services, as banks can provide a full range of financial services at very reasonable rates. But for this to happen, they first need to have a concentrated, focused and well targeted strategy.

It’s a Quality vs. Price debate, Even for the Poor

While most people believed that the poor are highly price sensitive, microfinance has proved that this might not always be the case. Yes, the poor will choose the best deal on offer, and that may not always be the service that is available at the lowest price, and they are ready to pay a premium. There are various reasons and issues why this happens.

Let us first see what would happen if the poor do not have access to financial services at all as against paying for an expensive service. The poor has acute need for these services and even a high price justifies their opting for an expensive service. In case of emergencies like illness or death, there is no other option but to avail of such services, as not having any access to finance at such situations would have highly negative consequences. The other kind of need is that for education, housing, festivals, weddings etc. Just because someone is poor does not mean that he/she does not have any aspirations. Spending on these assumes great importance for these people and they do not mind paying higher rate of interest as long as they can access such services. The third, and probably the most frequent and important cause for which the need for such services arise is that of working capital or income generation needs. It has often been observed that the small businesses yield high returns, not on an absolute basis but on a percentage basis, and these returns are much higher than the high rates of interest charged on loans for these purposes, which is why the client is ready to pay that rate rather than go without doing the business. It is exactly for this reason that many people borrow from moneylenders rather than go without credit, even though the rates maybe usurious. Thus there is a huge scope for MFIs to operate, even at a little higher rate of interest, if they provide a high quality service and provided there are no political issues.

Let us take the other case, where there are many financial service providers in an area. On what basis do the poor choose their ‘bank’? I have been a part of many discussions with the clients as well as in various forums, and have found that the price charged for the services are very low on the priority list for selecting a service provider. While in many cases the clients demand a lower rate of interest, it is often seen that while actually selecting a financial product, they mostly go for a service that provided them more convenience and reliability, even if at a slight premium. While going for the financial products, the following is mostly the order of priority for the clients:

· Reliability

· Timeliness

· Adequacy

· Relevance and suitability

· Time taken to process applications

· Collateral requirements

· Simplicity

· Ease of repayment terms

· Product delivery mechanisms

· Bouquet of services available

· Behavior of staff

· Returns/Interest rates

We can thus see that price is at the bottom of their concerns, though it must be said that it is an important consideration. Now let us see what choices are there in front of the clients in terms of financial service providers. Let us start with banks. While it is inaccessible to most from the segment we are talking about, there are some who are eligible for such loans. Even those who are, I have seen most of them opt for loans either from MFIs or even from moneylenders. This is, even though the rates charged are the lowest of all available options. This is the classic example of clients preferring quality over price. Let us analyze the reasons. Taking up from the list of priorities, while a bank might be the best in terms of the topmost concern, in reliability, and best in terms of the price, and for many products it might also have very flexible repayment terms, all other factors go against it. A bank may not have products catering specifically to the needs of this segment of clientele, which makes the suitability, adequacy and timeliness a big issue. Time is a critical concern for these clients as well as doorstep delivery of services. Typically at a bank, it takes a lot of time for the applications of this segment of clients to be processed, during which time they need to visit the bank frequently. Not only does this means cost to them in terms of travel to and fro the bank, it also means loss of work for the days when they come to the bank, which results in loss of income. Hence the opportunity cost is also very high in this case. The other major factor is the complexity of the entire process with complicated processes and documentation which the clients do not always understand. Many times they might not even have all the documents that might be required. Another important aspect is the behavior of the bank staff and their acceptability in the bank. It is often seen that clients are overawed by the bank infrastructure and size and all the complex processes and they need to be relaxed. Many a times, the behavior of bank staff is not very good to these people and their needs are not paid much heed to, as the size of the transactions are small and the work of the staff gets increased. This is a reason why many clients do not prefer a bank inspite of its very low costs.

If we look at a moneylender, he is great in terms of timeliness and adequacy, as loans are available on the spot whenever required and mostly fulfills the entire requirement. The processes are also very simple and there is no fancy paperwork that a client needs to go through. All these make a moneylender highly flexible. As the moneylender is mostly a local person and available in the area itself, the product delivery is also smooth. The moneylender has knowledge of the credit history of the clients and based on that he charges differential rates and collateral terms. This makes the moneylender non transparent also. The rates of interest are very high and many a times there are very high collateral requirements. Most moneylenders have very unfavorable terms and conditions for loan repayment, like the loan can only be repaid at one go and not in instalments. This makes it very difficult for the clients to repay and leads them to a debt trap, and that trap very often follows them for generations. A moneylender also is not able to provide a wide array of products and services, like insurance and pensions, which is another reason why they are not the most preferred service provider.

We now come to the MFIs, which have over the last few years become the most preferred choice for financial services for the poor. This is despite the fact that they charge more than double the price of what the banks charge them, which is only because of the convenience and quality of the services provided by them. These institutions are also more popular than the moneylenders, and that is not just because of the lower interest rates that these institutions charge. There are a lot of other factors also that contribute to them being the preferred choice. This is not to say that all MFIs will be very popular, or can charge very high rates of interest. I am talking of those MFIs which cater to the needs of the clients, provide better and quality service and only against that do they charge a premium for their products. An MFI deals only with this segment of clientele, and it is more likely that their products would be timelier, adequate and suited to the clients’ needs. Successful MFIs are those which are market led, and have changed themselves to suit themselves to the needs of the clients, rather than being product led and thrusting their products on them. Time taken to process applications is usually lower than the banks, and the client need not go to the branch very often to follow up as the appraisal and the procedures are done at the doorstep of the client itself. The documentation is very simple and minimal and there are no collateral requirements. MFIs today offer a wide variety of products and services and a client can solve most of their financial needs with on institution itself like credit, savings, insurance, pensions, money transfers, even investments etc. It has been noticed that MFIs that offer a wider array of products are more popular than single product MFIs even if they charge a little higher than the others. Clients would not like to be part of one institution for one service and of another for another service, even if it cost them a little less, they are more than willing to pay a little higher to access more services from one provider itself. What is more, the other services might not even be available to them from any provider. There is another very important factor which is the ease of repayment terms. MFIs have easy repayment terms wherein the loans can be repaid in small instalments and are paid within a fixed time period. The loans are also usually waived off in case of death of the client so that the family does not have to bear the burden of such loans. The staff of MFIs is also usually trained in how to behave and deal with the clients. Many times the staff is picked from the community itself, which gives them a sense of belongingness. Because of these factors, clients are ready to pay a premium for a market led good MFIs products; hence we see that it is the quality of the products that the clients value more than the price they need to pay on such products.

This does not mean that MFIs should charge usurious rates of interest or they should pass on the cost of their inefficiencies to the clients. MFIs should, by all means, charge reasonable interest rates. This article is not about justifying high rates of interest by MFIs but it says that MFIs can cover the cost of providing quality service by charging it to their clients. Many MFIs, on the pretext that providing more to the clients will mean more costs which will increase the interest rate which the clients will not be ready to pay, do not improve the quality of their service, which, in the competitive scenario today, is suicidal, as clients prefer quality over low price. This article is about making this fact clear.

Criteria for Selection	Wt.	Banks		Product Led MFIs with Single Product		Moneylenders		Market Led MFIs with Multiple Products
		Score	Total Score	Score	Total Score	Score	Total Score	Score	Total Score
Reliability	12	4	48	3	36	2	24	3	36
Timeliness	11	1	11	3	33	4	44	3	33
Adequacy	10	1	10	2	20	4	40	3	30
Suitability	9	1	9	2	18	4	36	3	27
Processing Time	8	1	8	3	24	4	32	3	24
Collateral	7	2	14	4	28	1	7	4	28
Simplicity	6	1	6	3	18	4	24	3	18
Repayment	5	4	20	2	10	1	5	4	20
Delivery	4	1	4	4	16	4	16	4	16
Service Bouquet	3	2	6	2	6	1	3	4	12
Staff behavior	2	2	4	4	8	2	4	4	8
Interest Rates	1	4	4	3	3	1	1	2	2
Total			144		220		236		254

The above table tries to show which service provider a client will prefer when he/she has the choice. The criteria that a client uses are listed in the order of preference and in importance that they attach to each criterion, which is reflected in the weight column. The scoring has been done on a 4 point scale with 4 being the most preferred option for a particular criterion and 1 being the least preferred. It must be mentioned though that the importance of these criteria may vary in some places and in some places there might be additional criteria. From the above table we can see that even if clients have the option of going to a bank, they put it at the last choice, even though it has the lowest interest rate. Again, a moneylender, who is much despised, would be the second best option for the clients even if they charge very high interest rates. This is because of the various flexibilities and conveniences offered. A product led MFI is worse than a moneylender as it may create more problems than it might actually solve. The best option is that of a market led MFI providing multiple products. It charges higher rates of interest than banks and single product MFIs, yet is popular for the quality of service and the suitability of service. It scores above the moneylenders not just in price but in many other factors which makes it the ideal choice for a poor client, even at a premium price.

Hence we see that it is the quality and convenience of services that matter more to a poor client than the price that they have to pay for it.

All in the Name of Development

Development is a tricky word. For the past few years, I have been trying to understand what it really means and who defines development, and what the measures of development are.

As a part of one of my projects, I went to a village in Northern India. It was a chance visit, and it was a hilly village and had a very difficult access route, with no roads and on a hill. I had my own agenda of trying to see the potential of microcredit in the state, and though this village was not on my planned schedule, I thought I might as well check out the potential of this village now that I was already there.

It was a small village of about 100 households. It was not yet connected to electricity; there was no road that connected the village to the outside world, no school (the children went to school in another village about 15 kilometers away). In short, the village was still untouched of development. Yet, they seemed a happy lot. They produced most of what they needed in the village itself, and shared it amongst themselves. I cannot call it a barter economy, as it was more of people sharing things rather than exchanging them. For example, a family which had a cow would consume milk, and whatever was leftover, it would give it away to anyone who needed it, not necessarily exchange it for something. If this family needed vegetables, they could get it from someone who had cultivated vegetables and had an excess, and that person need not have been the one who the previous family had shared its milk with. There were people who worked in the cities and some also in the Indian army, so people had the money to buy things they needed from outside the village. I hardly saw anyone using any luxury item in the village; most of the things were either the basic necessities, or those of traditional value.

I realized that the village was not developed. I knew it had immense potential as a market for microcredit and other developmental activities. I knew these people could be connected to the mainstream; they had quite a few income generation activities and could earn better money for themselves. Only if they started selling the excess produce that they had rather than just giving it away. Then it struck me. What does development actually mean? These people were happy the way they were. They were a community based on togetherness, trust, sharing and caring for each other. Were they not immensely developed already? Or bringing electricity to their lives, bringing them closer to the markets, making them earn more would mean development. What I realized was while I was uncomfortable without electricity, they were not, and they did not need it. While I felt they earned very less, it was something they had never felt, as they did not have many needs to speak of, they had enough for their bar necessities and that is what mattered to them. While I thought they could actually have a lot of fancy things if they were linked to the market, I also realized that it would create a demand and dissatisfaction when they will not be able to get those things. They were happy as they were without having too many demands. Again, development would mean them earning more by selling their produce rather than sharing it, would it not destroy the very fabric of the community based on trust and sharing. People would then be more commercialized and be unhappy, they would earn more but lose out on the brotherhood they shared.

I walked off, obviously happy to have seen such a community for myself but was also left confused as to what development actually means. Do these people need development? Or are they better left the way they are? What is more important? Being developed or being happy? Because I realized that happiness does not follow development always, neither is it imperative for development to precede happiness. So, what should be done with this village? I left it alone and did not make it a part of my report. I only hope that no one comes to this village and thrusts their brand of development on these simple people.