Microfinance- Realizing true financial inclusion

Access to affordable finance holds key in bringing the socio economically weaker sections back into active participation in the mainstream economy. Financial inclusion also provides the much needed fillip to an economy’s growth by contributing to the goals of poverty reduction, greater employment, improved social security and easy access to healthcare.

Microfinance (micro-credit) in India, found its roots in the late 1980s, in response to the growing gap of availability of formal lending sources and increasing demand from low-income population. While a number of policy initiatives had been taken by RBI and the Government earlier to support and protect the interests of low income segments, 2006 marked a milestone year in the history of inclusive banking when RBI for the first time defined the term “Financial Inclusion” as the process of ensuring access to appropriate financial products and services needed by all sections of society in general and vulnerable groups such as ‘weaker sections and low income groups’ in particular at an ‘affordable cost’ and in a ‘fair and transparent manner’.

Today, Microfinance in India is a massive driver of economic transformation and financial inclusion. With a total loan outstanding portfolio of ~INR 150,000 Cr, it is undoubtedly empowering millions of economically backward sections of our society.

This article aims to briefly discuss the evolution of microfinance and challenges/ opportunities ahead while also attempting to answer few pressing questions including:

  • How has the industry evolved and transformed over the years?
  • What are the nuances of this customer segment?
  • How will the regulatory landscape influence growth going forward?
  • How can technology act as an enabler in bringing about financial literacy?

"Setting Context: The Narrative of “Inclusion” and rise of Microfinance

Financial Inclusion goes beyond just access to credit. It needs to facilitate access to the entire range of financial services including savings, insurance and remittances and payments. The cornerstone of micro finance is affordable, easy and accessible services specifically to the underserved and excluded sections of the society. There are multi-dimensional challenges associated with ensuring successful financial inclusion and hence, it comes as no surprise that it has become a priority action point for policymakers across all major developing economies.

Looking back, one can trace the roots of the popular rise of modern microfinance movement to Bangladesh in 1970s where it experienced very high traction and success. Similar to this, the history of financial inclusion in India can be linked to the two pronged approach of bank nationalization in 1960s and set-up of Regional Rural Banks in 1970s. Further, the establishment of NABARD (1982) and SIDBI (1990) provided the much needed impetus towards addressing the massively unmet financial needs of excluded and underserved segments of the society. The mid-90s saw the emergence of the new model of NGO-Microfinance Institution (NGO-MFI) who worked as an intermediary between large public finance institutions and the borrowing community. It was at this time that many of the popular microfinance institutions were formalized including the likes of RGVN, Grameen Koota (CreditAccess Grameen) and SKS (BFIL).

However, the biggest boon came in the form of Non-Banking Financial Companies specifically those formally recognized as NBFC-MFI which reflected the prominence of an official financial structure specifically to promote microfinance culture and joint lending model. Today NBFC-MFIs have become synonymous with financial inclusion, facilitating credit to the tune of thousands of crores and making headways into previously unbanked segments of the country.

During the last couple of decades, microfinance sector has experienced robust transformation by overcoming many challenges. But for a broader understanding, this journey can be split across three broad phases:

  • Phase 1 – Rapid Growth (inception to 2010)
  • Phase 2 – Volatility and Uncertainty (2010-2013)
  • Phase 3 – Recovery and Rediscovering Growth (2014 – Present)

The reason for rapid proliferation and growth of MFIs in Phase 1 could largely be attributed to the change in business models (from NGO-MFIs to Profit driven NBFCs). With access to larger funds from private equity investors, these new age NBFCs focused on rapid expansion. However, with a nascent regulatory framework it was fraught with political and social influences.

The infamous “AP (Andhra Pradesh) Crisis” highlighted the cracks in the preliminary MFI model. High exposure to certain geographies brought many MFIs to a grinding halt, few even resorting to bankruptcy.

Phase 3 can be viewed as the reemergence of the industry; thanks to a strong RBI regulatory framework, consolidation of multiple smaller MFIs, stable flow of funds (propagated by onward lending of bank funds by NBFCs) and wider customer/ geography base.

Understanding the customer segment and evolution of the operating model

The informal sector which constitutes for more than 90% of the total employment in India forms a very heterogeneous group with distinct needs and demands. This diversity has posed structural challenges in efficiently targeting the multitude of underserved segments. Further, there has never been a clear distinction between their personal and business finances nor have they maintained running bank accounts. These traits have made them largely ineligible for bank loans where standard financial statements and banking history are mandatory for assessing the credit worthiness of the borrower.

Microfinance overcame these challenges by leveraging aspects such as ‘relationship’, ‘trust’ and ‘joint responsibility’. Today, the main mechanism for delivering microfinance is through group based lending model (also known as Joint Liability Group) where all members of the group are equally responsible and liable for ensuring the members’ financial success and prompt loan repayment.

Since the early days of orchestrating microfinance lending, it was apparent that women of marginalized families are the fulcrum of financial interventions and decision making. Further, they provide the crucial link to all other members of the family. Despite the fact that women may not always necessarily be the end users of funds, the success of microfinance can be attributed to the social responsibility and repayment reliability demonstrated by these women.

Foreseeable Future: What does the future hold for financial inclusion?

Understanding the major influencing forces
  • The regulatory landscape has undergone multitude of changes, the most apparent of them being the conversion of MFIs into Small Finance Banks (SFBs). As these SFBs receive greater funding and access to technology, they will bring in strong innovations in the Microfinance space.
  • NBFCs are also actively pursuing lower end of the SME segment (a large part of which overlaps with the MFI customer base). There could be significant potential for partnership among larger banks/NBFCs and smaller MFIs as they explore portfolio synergies
  • Fintech has disrupted financial services significantly. One of the major pain points of NBFC-MFIs has been their high cost of operations. New digital lending models and technology solutions may address a large portion of these challenges. For example MFIs could look at alternative sources such as utility bills, DBT receipts, mobile phone data to assess customer credit worthiness. In order for this model to work, MFIs must ensure their core banking system/loan origination system is robust enough for easy API integrations to facilitate plug and play models with fintech services.

                                                    

          

                

Role of Regulators – Unlocking Potential

Can we potentially see the introduction of Deposit taking MFIs?

Recent incidents have shown the harrowing effects of credit crunch and rising cost of deposits on financial institutions.

MFIs today are faced with not just the above two problems but are also experiencing increasing competition from SFBs in particular. Allowing MFIs to accept deposits from their customers will reduce their cost of funds significantly and enable them to lend at lower rates (this will become self-fulfilling as MFIs can become the financial partner of choice to all their customers).

Such a move will also help MFIs move away from focusing purely on the joint lending model and explore more avenues such as unsecured working capital loans, home improvement loans, educations loans, third party product distribution etc.

Way Forward

In the last four years, the Government has launched hallmark initiatives and policy reforms to promote financial inclusion. Initiatives such as ‘Pradhan Mantri Jan Dhan Yojana (PMJDY)’ struck a chord with the masses. Today there are close to 33 crore basic savings account that have been opened under this initiative which translates to 33 crore people who have been brought into the formal banking segment. Similarly, other initiatives such as ‘Aayushman Bharat’ is also a reflection of increasing financial literacy among the underserved masses.

Given the current pulse of the nation and market potential, the MFI sector is set to continue its high growth as they attract funds and improve technological and operational efficiency.

However, it is of paramount importance to realize that financial inclusion in its true sense can only be achieved when all key stakeholders including financiers, RBI and Government come together to facilitate widespread digital and financial literacy programs, design the right regulatory framework and make efficient policy decisions.

As always, the future remains bright and we continue to hope for the best!

About the Author:

Siddharth Kadandale is a Management Consulting professional driven by the purpose to help organizations achieve their vision. He has rich experience in the Banking and Financial services sector. He has worked with KPMG India. You can read his other articles or connect with him on Linkedin