p hoto: MP hoto: A sso ci at e s

Innovation Spurs Growth Product innovations are different and specific to MFIs, but all focus on one feature: they are all geared toward providing a wider range of financial products and intermediation options. These innovations are the launching pad and competitive advantage for MFIs, but most people are confused about these innovations.

By Jasmine Mohanty and Debadutta K. Panda

ew institu- (SHGs). NGOs initiated lending to varies between Rs225 billion to tions have demonstrated SHGs in the mid 1980s. In 1992, the Rs500 billion (US$5.6 billion to slow pace in coming to National Bank for Agriculture and US$12 billion). NIndia. They’ve felt constraints from Rural Development (NABARD) and Many MFIs fill the gap between low levels of grants, an unfavorable the Reserve Bank of recognized the supply and the demand for policy environment, substantial tra- the benefits of SHGs and launched microfinance in India. These MFIs ditional banking infrastructure, and a pilot project to link five hundred are classified as: a lack of context-specific solutions. SHGs with banks. • NGOs engaged in promoting Even existing microfinance service Now, the microfinance market SHGs and linking them with banks. providers are quite limited in total in India covers approximately 75 • NGOs directly lending to bor- outreach because of late entry and million potential poor households rowers who are either organized into little field work. and is the largest in the world. The SHGs or into groups and centers. Indian banks are becoming average household demand varies These NGOs borrow bulk funds from increasingly more conscious of the from Rs2000 to Rs6000 (US$50 to various donors. potential of microcredit, however, US$150) in rural areas and Rs9000 • MFIs specifically organized as and they have started to compete (US$224) in urban settings. Eighty cooperatives. with MFIs. For instance, they’ve percent of the clients are from rural • MFIs organized as nonbanking started lending to self-help groups areas, and the total credit demand finance companies. research

The effective product penetration became the main focus. Rural finan- dent impact studies to discover the into remote areas and distribution to cial products like credit and insurance missing links and loopholes, thereby a large number of clients was due to dominated as the conventional saving increasing product customization two important innovations: (1) the style. The main difference between and innovation. individual counseling of clients by the two systems was the way people’s MFI/NGO staff and (2) the design- savings were viewed. Although the new Partnership and Intercollaboration ing of an income generation activity financial services were more flexible and of MFIs or business plan by the client with tailored closely to the preferences of In 2002, BASIX and Aviva jointly MFI/NGO support. An example of the clients, many people felt that a loan designed a group life insurance prod- MFI innovations in microfinance from an MFI should come without uct to provide life insurance to all comes from Adhikar, operating in interest, as in the former system. BASIX credit customers, where the Orrisa and working with local tribes. Product innovations are different sum insured was up to 150 percent of Adhikar helped bring nontimber for- and specific to MFIs, but all focus on the loan amount. BASIX entered into est products into SHGs and linked one feature: they are all geared toward agency relationships in December the SHGs to microfinance without providing a wider range of financial 2003 with nonclients too. Thus, the physical collateral. It also set up products and intermediation options. local area bank, KBS, which was a an organization of migrants and These innovations are the launching part of the BASIX group, could offer provided credit and saving services pad and competitive advantage for life insurance to all deposit holders through cooperatives, using remit- MFIs, but most people are confused of the bank. For livestock and health tances along with savings as an about these innovations. insurance, BASIX worked with Royal entry-point activity. Sundaram. It started the distribu- Self-Help Groups tion of livestock insurance in 2002, During 2004, mainstream MFIs worked with the insurance company • • • • expanded from female SHGs to toward product and process simpli- innovations by mfis include male SHGs in order to scale fication, and began to offer health The 1990s witnessed the SHG up the business; these male SHGs insurance to all its credit custom- revolution. SHGs were seen as a tool had a higher credit disbursal and a ers. BASIX, in collaboration with for initiating a developmental and regular repayment rate. One reason ICICI Lombard and with technical livelihood project. NGO-based MFIs for the continued success is that the assistance from the Commodity Risk rapidly introduced of a range of sav- loan was used to support an existing Management of the World Bank, ings and credit products to expand business. One problem in this model piloted the sale of rainfall-indexed their microcredit clientele. NGOs is that the male SHG benefits the weather insurance to 230 farmers were governed by grants, and parts of business group while the responsibil- during the monsoon season of 2003. those grants percolated as a grant for ity is individual, the loan is individ- Within a span of three years, this SHGs. The major focus at the time ual, and the repayment is individual. pilot program has become a full-scale was to initiate internal savings rather weather insurance program. than have a provision of external Structuring Repayment Schedule Economies of scale and imagina- credit. The external credit was gener- The change from a pre-active to an tive uses of technology and effec- ally covered by a grant from an NGO active SHG movement is certainly tive innovations have brought costs or a loan from a commercial, nation- a result of product innovation and and interest rates down for MFIs. alized bank with the support of more product customization in the micro- Analyzing and understanding the vast than six months of internal saving. In finance sector. MFIs now design the opportunity, many MFIs plan to offer this system, the provision of the grant repayment schedules according to the more microfinancial products to both or loan targeted the group rather than income realization pattern of the cli- rural and urban households. These individual clients. ents. Different repayment schedules include additional loan products, The scenario was changed by the are structured for different clients, such as housing, auto, and education; invasion of new generation MFIs in and the portfolio at risk is minimized new insurance schemes for health, the early 2000s. Credit became the at higher scale. The mainstream life, and assets; and unique services main theme, and individual clientele MFIs used to commission indepen- like remittances.

11 Reduction of the cost of bad debt ICICI’s microfinance portfolio has ing and buying out microfinance debt is achieved by intercollaboration of increased from ten thousand microfi- through the process of securitization. MFIs. For example, BASIX has col- nance clients in 2001 to 1.2 million Microloan securitization benefits laborated with local, grass-root level clients in 2006 through its partner MFIs in several ways. It decreases finan- NGOs, agribusiness firms, and com- MFIs, and its outstanding portfolio cial products to interested investors, mercial financial institutions. These has increased from Rs0.20 billion to like other banks that can register such a partners have better informal infor- Rs9.98 billion (US$4.9 million to security as a priority-sector investment. mation about the potential borrowers US$248 million). The rapid growth In a securitization deal, the MFI is still and a clearer understanding of the of ICICI was due to its partnership responsible for collecting the micro- borrower’s repayment history. model of action where: (1) the MFI loans from its clients but the risk of ICICI Bank, the second-largest acts as a collection agency instead of repayment default is not backed by any private commercial bank in India, has financial intermediary. Microloans are of the MFI’s assets. As collateral, the aggressively doubled its rural microfi- contracted directly between the bank bank uses a first-loss, default guarantee nance and agribusiness loan portfolio and the clients so the risk for the financed by either the excess spread on over a period of nine months. The out- MFI is separated from the risk inher- the MFI portfolio or by a third party. standing portfolio in the group’s total ent in the portfolio; and (2) the bank In 2004, the largest securitiza- rural microfinance and agribusiness secures microfinance portfolios before tion deal in microfinance was signed portfolio nearly doubled between 2005 entering into a partnership. between ICICI Bank and SHARE and 2006. This success comes from an Microfin Ltd, a large MFI operat- outreach of 3.2 million low-income cli- Securitization ing in rural areas of India. Under ents. Simultaneously, the bank has also Microfinance became a priority sector this agreement, ICICI purchased increased its partner strength of MFIs for banks due to high risk-adjusted SHARE Microfin Ltd’s portfolio and from 49 in 2005 to 102 in 2006. The returns, and many banks—private resold it as a package in the SHARE bank ultimately plans to partner with and government—partnered with deal. ICICI had purchased a part 200 to 250 MFIs, each serving three MFIs under diverse innovative mod- of SHARE’s microfinance portfolio districts in the country. els. One of these innovations is assess- against a consideration calculated by computing the net present value of receivables amounting to Rs215 he innovations in the microfinance sector have made a million (US$5.3 million) at an agreed dramatic change in the supply of credit to the neediest, discount rate. The interest paid by Tneglected sector by formal financial institutions. Now, the SHARE is almost 4 percent less than microfinance market in India covers approximately 75 million the rate paid in commercial loans. potential poor households and is the largest in the world. Partial credit provision was provided by SHARE in the form of a guarantee amounting to 8 percent of the receiv- p ables under the portfolio, by way of a MP hoto: lien on fixed deposit. This deal frees

up equity capital, allowing SHARE A sso to scale up its lending. On the other ci hand, it allows ICICI Bank to reach at e new markets, and by trading assets of s high quality in capital markets, the bank can hedge its own risks.

• • • • CONCLUSION The innovations in the microfi- nance sector have made a dramatic

12 ESR — FALL 2007 change in the supply of credit to the average portion of borrowed the neediest, neglected sector by funds used for production purposes ABOUT THE AUTHORS formal financial institutions. The increased from 72 percent to 85 most important innovation that has percent, and the portion of the loan Jasmine Mohanty and Debadutta K. come up is that societal upliftment used for consumption purposes came Panda began their consulting firm, and social development are no longer down from 28 percent to 15 percent. MPAssociates: A Development Consulting grant based. People have realized The portion of loans borrowed from and Research Company, in 2004. Mohanty that the formal credit is more flexible moneylenders with high interest rates is the managing director of the firm. She and yielding than grants. The most significantly decreased from 42 per- has previously acted as a consultant for important impact of this innovation cent of the total loan amount to 3 per- WWF, Gramin Vikas Trust India, United is the development of confidence cent. Also, the overall loan repayment Nations Development Programme, and among the poor and their realization by members of the SHG improved United Nations Population Fund. Panda is to grow according to their own plan from 84 percent to 94 percent. the director of operations and also serves rather than the grant provider. These achievements of microfinance as a consultant to World Bank, United According to the 2005 impact programs in India, and probably Nations Development Programme, WWF, assessment study of NABARD and similarly around the world, and other groups. GTZ, the average loan per SHG are largely due to the continued member nearly doubled between innovation and customization of 1998 and 2005. In the same period, financial products.