AGRAND PROJECT PROPOSAL

ON

A STUDY ON MICRO-FINANCE AS BUSINESS PROPOSITION FOR BANK FROM THE PERSPECTIVE

OF NABARD

TABLE OF CONTENT

Preface…………………………………………………………………………………1Acknowledgement……………………………………………………………………..2Executive Summary…………………………………………………………………...3

1. Overview of microfinance………………………………………………………...102. Micro-Finance and Poverty Alleviation…………………………………………..103. The system and procedure of microfinance ………………………………………104. Microfinance in India ……………………………………………………………..105. Microfinance in Gujarat through SHG…………………………………………… 106. Role of NABARD in microfinance………………………………………………..107. Problems of banks, SHGS, microfinance institutions in micro financing…………108. THE FUTURE OF MICROFINANCE IN INDIA: 9. Finding and Suggestions…………………………………………………………..10

Conclusion……………………………………………………………………………10

AbbreviationsBibliography

EXECUTIVE SUMMARY

The project here we have taken is the "_______________"

The first part gives an introduction of infrastructure sector in India. Followed by information on road sector. It gives an overview of various sector like port, Railways, Power, Airports, Roads etc. In the in infrastructure of India. It also studies the current

Microfinance may be defined by the as "provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban or urban areas for enabling them to raise their income levels and improve living standards"

OBJECTIVES

To study microfinance infrastructure and its usefulness to poor in India in

general and in Gujarat in particular.

To know the system and procedure of linking and financing of microfinance

To know the functioning and management of microfinance beneficiary group

To find problems of banks, SHGS, microfinance institutions, NGOs and SHG

Members.

To suggest the various measures to improve the micro credit system

OVERVIEW OF MICROFINANCE

Concept of microfinance

To most, microfinance means providing very poor families with very small loans (microcredit) to help them engage in productive activities or grows their tiny businesses. Over time, microfinance has come to include a broader range of services (credit, savings, insurance, etc.) as we have come to realize that the poor and the very poor who lack access to traditional formal financial institutions require a variety of financial products.

Microfinance is the provision of a broad range of financial services such as

deposits loans payment services money transfers insurance to poor and low-income households and their micro

enterprises

The important difference of microcredit was that it avoided the pitfalls of an earlier generation of targeted development lending, by insisting on repayment, by charging interest rates that could cover the costs of credit delivery, and by focusing on client groups whose alternative source of credit was the informal sector. Emphasis shifted from rapid disbursement of subsidized loans to prop up targeted sectors towards the building up of local, sustainable institutions to serve the poor. Microcredit has largely been a private (non-profit) sector initiative that avoided becoming overtly political, and as a consequence, has outperformed virtually all other forms of development lending.

Traditionally, microfinance was focused on providing a very standardized credit product. The poor, just like anyone else, need a diverse range of financial instruments to be able to build assets, stabilize consumption and protect themselves against risks. Thus, we see a broadening of the concept of microfinance--our current challenge is to find efficient and reliable ways of providing a richer menu of microfinance products.

Definition of microfinance:

The ‘TASK FORCE’ on Micro-finance constituted by National Bank for Agriculture and Rural Development (NABARD) suggested a working definition of micro-finance as “provision of thrift, credit and other financial services and products of very small amounts to the poor to enable them to raise their income and improve their living standards”. The upper limit of amount is fixed at Rs.25000 to be categorised as micro-finance.

Thrift implies savings created by postponing almost necessary consumption while savings imply the existence of surplus wealth.

Outreach and sustainability have often been cited as the twin pillars for successful micro-finance. Sustainable microfinance requires good social intermediation and prudent financial intermediation.

The micro-finance movement has gained acceptability and momentum in the developing community largely due to the recognition that the nature of financial markets in most developing countries creates a credit gaps for the poor. Most formal financial institutions do not serve the poor because they are perceived as high risk and high cost involved in small transactions relative to profitability and inability of the poor to provide the physical collateral required by MFIs.

Early efforts to provide financial services to the poor tied those services to specific economic activity. For example, between the 1950s and 1970s, governments and donors focused on providing subsidised agricultural credit to small and marginal farmers, in hopes of raising productivity and incomes. During the 1980s micro enterprise credit concentrated on providing loans to poor women to invest in tiny businesses, enabling them to generate and accumulate assets and raise household income and welfare.

The success of some micro enterprise credit programs led to bold experiments with product design, delivery methods, and institutional structures, performed mainly by practitioners in developing countries. These experiments resulted in the emergence of microfinance institutions (MFIs), specialised financial institutions that serve the poor. MFIs are called "micro" because of the small size of their transactions (with loans as small as Rs.2500 and savings deposits as small as Rs.50), and "finance" because they provide safe and reliable financial services to the poor.

“microfinance may be defined by the as "provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban or urban areas for enabling them to raise their income levels and improve living standards".

The difference between microfinance and microcredit

Microfinance refers to loans, savings, insurance, transfer services and other financial products targeted at low-income clients. Microcredit refers to a small loan to a client made by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending.

The clients of microfinance

The typical microfinance clients are low-income persons that do not have access to formal financial institutions. Microfinance clients are typically self-employed, often household-based entrepreneurs. In rural areas, they are usually small farmers and others who are engaged in small income-generating activities such as food processing and petty trade. In urban areas, microfinance activities are more diverse and include shopkeepers, service providers, artisans, street vendors, etc. Microfinance clients are poor and vulnerable non-poor who have a relatively stable source of income.

The Role of microfinance in helping the poor

Experience shows that microfinance can help the poor to increase income, build viable businesses, and reduce their vulnerability to external shocks. It can also be a powerful instrument for self-empowerment by enabling the poor, especially women, to become economic agents of change.

Poverty is multi-dimensional. By providing access to financial services, microfinance plays an important role in the fight against the many aspects of poverty. For instance, income generation from a business helps not only the business activity expand but also contributes to household income and its attendant benefits on food security, children's education, etc. Moreover, for women, who, in many contexts, are secluded from public space, transacting with formal institutions can also build confidence and empowerment.

Recent research has revealed the extent to which individuals around the poverty line are vulnerable to shocks such as illness of a wage earner, weather, theft, or other such events. These shocks produce a huge claim on the limited financial resources of the family unit, and, absent effective financial services, can drive a family so much deeper into poverty that it can take years to recover.

Why do MFIs charge such high interest rates to poor people?

Providing financial services to poor people is quite expensive, especially in relation to the size of the transactions involved. This is one of the most important reasons why banks don't make small loans. A Rs.5000 for example, requires the same personnel and resources as a Rs.100000 one thus increasing per unit transaction costs. Loan officers must visit the client's home or place of work, evaluate creditworthiness on the basis of interviews with the client's family and references, and in many cases, follow through with visits to reinforce the repayment culture. It can easily cost Rs.500 to make a micro loan. While that might not seem unreasonable in absolute terms, it might represent 10% of the value of the loan amount, and force the institution to charge a “high” rate of interest to cover its cost of loan administration.

The microfinance institution could subsidize the loans to make the credit more "affordable" to the poor. Many do. However, the institution then depends on permanent subsidy. Subsidy-dependent programs are always fighting to maintain their levels of activity against budget cuts, and seldom grow significantly. They simply aren't sustainable, especially if other microcredit operations have shown that they can provide credit and grow on the basis of “high” rates of interest—and along the wayserve far greater numbers of clients.

Evidence shows that clients willingly pay the higher interest rates necessary to assure long term access to credit. They recognize that their alternatives—even higher interest rates in the informal finance sector (moneylenders, etc.) or simply no access to credit—are much less attractive for them. Interest rates in the informal sector can be as high as 5 percent per month among some urban market vendors. Many of the economic activities in which the poor engage are relatively low return on labor, and access to liquidity and capital can enable the poor to obtain higher returns, or to take advantage of economic opportunities. The return received on such investments may well be many times greater than the interest rate charged.

Aren't the poor too poor to save?

The poor already save in ways that we may not consider as "normal" savings--- investing in assets, for example, that can be easily exchanged to cash in the future (gold jewelry, domestic animals, building materials, etc.). After all, they face the same series of sudden demands for cash we all face: illness, school fees, needs to expandthe dwelling, burial, weddings.

These informal ways that people save are not without their problems. It is hard to cut off one leg of a goat that represents a family's savings mechanism when the sudden need for a small amount of cash arises. Or, if a poor woman has loaned her "saved" funds to a family member in order to keep them safe from theft (since the alternative would be to keep the funds stored under her mattress), these may not be readily available when the woman needs them. The poor need savings that are both safe and liquid. They care less about the interest rates that they can earn on the savings, since they are not used to saving in financial instruments and they place such a high premium on having savings readily available to meet emergency needs andaccumulate assets.

These savings services must be adapted to meet the poor’s particular demand and their cash flow cycle. Most often, the poor not only have low income, but also irregular income flows. Thus, to maximize the savings propensity of the poor, institutions must provide flexible opportunities--- both in terms of amounts deposited and the frequency of pay ins and pay outs. This represents an important challenge for the microfinance industry that has not yet made a concerted attempt to profitablycapture tiny deposits.

The meaning Microfinance Institution (MFI)

Quite simply, a microfinance institution is an organization that offers financial services to low income populations. Almost all of these offer microcredit and only take back small amounts of savings from their own borrowers, not from the general public. Within the microfinance industry, the term microfinance institution has come to refer to a wide range of organizations dedicated to providing these services: NGOs, credit unions, cooperatives, private commercial banks and non-bank financial institutions (some that have transformed from NGOs into regulated institutions) andparts of state-owned banks, for example.

A great many NGOs that offer microcredit, perhaps even a majority, do many other non-financial development activities and would bristle at the suggestion that they are essentially financial institutions. Yet, from an industry perspective, since they are engaged in supplying financial services to the poor, we call them MFIs. The same sort of situation exists with a small number of commercial banks that offer microfinance services. For our purposes, we refer to them as MFIs, even though only a small portion of their assets may actually be tied up in financial services for the poor. In both cases, when people in the industry refer to MFIs, they are referring only to thatpart of the institution that offers microfinance.

There are other institutions, however, that consider themselves to be in the business of microfinance and that will certainly play a role in a reshaped and deepened financial sector. These are community-based financial intermediaries. Some are membership based such as credit unions and cooperative housing societies. Others are owned and managed by local entrepreneurs or municipalities. These institutions tend to have a broader client base than the financial NGOs and already consider them selves to be part of the formal financial sector. It varies from country to country, but many poor people do have some access to these types of institutions, although they tend not toreach down market as far as the financial NGOs.

Microfinance Can be profitable

Data from the MicroBanking Bulletin reports that 63 of the world's top MFIs had an average rate of return, after adjusting for inflation and after taking out subsidies programs might have received, of about 2.5% of total assets. This compares favorably with returns in the commercial banking sector and gives credence to the hope of many that microfinance can be sufficiently attractive to mainstream into the retail banking sector. Many feel that once microfinance becomes mainstreamed, massive growth in the numbers of clients can be achieved. Others worry that an excessive concern about profit in microfinance will lead MFIs up-market, to serve better off clients who can absorb larger loan amounts. This is the “crowding out” effect. This may happen; after all, there are a great number of very poor, poor, and vulnerable non-poor who are notreached by the banking sector.

It is interesting to note that while the programs that reach out to the poorest clients perform less well as a group than those who reach out to a somewhat better-off client segment, their performance is improving rapidly and at the same pace as the programs serving a broad-based client group did some years ago. More and more MFI managers have come to understand that sustainability is a precursor to reaching exponentially greater numbers of clients. Given this, managers of leading MFIs are seeking ways to dramatically increase operational efficiency. In short, we have every reason to expect that programs that reach out to the very poorest micro clients can be sustainable once they have matured, and if they commit to that path. The evidence supports this position.

Government’s role in supporting microfinance

Governments have a complicated role when it comes to microfinance. Until recently, governments generally felt that it was their responsibility to generate development finance', including credit programs for the disadvantaged. Twenty years of insightful critique of rural credit programs revealed that governments do a very bad job of lending to the poor. Short term political gain is just too tempting for politically controlled lending organizations; they disburse too quickly (and thoughtlessly) and they collect too sporadically (unwillingness to be tough on defaulters). In urban areas, governments never really got into the act, and subsidized micro enterprise credit is still relatively rare when compared to its rural counterpart

Now that microfinance has become quite popular, governments are tempted to use savings banks, development banks, postal savings banks, and agricultural banks to

move microcredit. This is not generally a good idea, unless the government has a clear acceptance of the need to avoid the pitfalls of the past and a clear means to do so. Many governments have set up apex facilities that channel funds from multilateral agencies to MFIs. Apex facilities can be quite complicated and there are few successful examples in microfinance. Successful apex organizations in microfinance tend to be built on the backs of successful MFIs, not the other way around. Finally, governments can also get involved in microfinance by concerning themselves with the regulatory framework that impinges on the ability of a wide range of financial actors to offer financial services to the very poor. This topic is treated below.

The financial regulator in supporting the development of microfinance

Many feel that the most important role of a financial regulator in supporting the development of microfinance is to create an alternative institutional type that allows sound financial NGOs, credit unions, and other community-based intermediaries to obtain a license to offer deposit services to the general public and obtain funds through apex organizations. In a few countries, this may be an appropriate strategy. In most countries, however, the general level of development of the microfinance industry does not yet warrant the licensing of a separate class of financial institutions to serve the poor. And, in most countries, budgetary restrictions faced by bank regulators make it very unlikely that they will be able to supervise a whole host of small institutions; these institutions' total assets may make up a tiny percent of the total financial system, but the cost of adequate supervision could eat up between 25and 50 % of the total budget of the agency.

Rather, regulators can work with the nascent microfinance industries of most countries on issues such as modifying usury limits as stated in the commercial code to allow appropriate levels of interest, generating credit information clearinghouses to share information on defaulting borrowers to limit their ability to go from one MFI to another, working with civil authorities to ensure that private loan contracts can be recognized by courts in those transition economies that lack even basic legislative infrastructure, and reporting requirements that will prepare MFIs to eventuallybecome regulated.

Regulators can also examine the laws, executive decrees, and internal regulations that limit the ability of traditional banking institutions to do microfinance. These regulations include limits on the percent of a loan portfolio that can be lent on an unsecured basis, limits on group guarantee mechanisms, reporting requirements, limits on branch office operations (scheduling and security), and requirements for the contents of loan files. Not least, banking regulators may need to look at the way in which they would evaluate micro loan portfolios with in large banks.

MICRO-FINANCE AND POVERTY ALLEVIATION

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

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

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

To the extent that microfinance institutions become financially viable, self-sustaining, and integral to the communities in which they operate, they have the potential to attract more resources and expand services to clients. Despite the success of microfinance institutions, only about 2% of world's roughly 500 million small entrepreneur is estimated to have access to financial services. Although there is demand for credit by poor and women at market interest rates, the volume of financial transaction of microfinance institution must reach a certain level before their financial operation becomes self-sustaining. In other words, although microfinance offers a promising institutional structure to provide access to credit to the poor, the scale problem needs to be resolved so that it can reach the vast majority of potential customers who demand access to credit at market rates. The question then is how microenterprise lending geared to providing short term capital to small businesses in the informal sector can be sustained as an integral part of the financial sector and how their financial services can be further expanded using the principles, standards and modalities that have proven to be effective.

To be successful, financial intermediaries that provide services and generate domestic resources must have the capacity to meet high performance standards. They must achieve excellent repayments and provide access to clients. And they must build toward operating and financial self-sufficiency and expanding client reach. In order to do so, microfinance institutions need to find ways to cut down on their administrative costs and also to broaden their resource base. Cost reductions can be achieved through simplified and decentralized loan application, approval and collection processes, for instance, through group loans which give borrowers responsibilities for much of the loan application process, allow the loan officers to handle many more clients and hence reduce costs.

Microfinance institutions can broaden their resource base by mobilizing savings, accessing capital markets, loan funds and effective institutional development support. A logical way to tap capital market is securitization through a corporation that purchases loans made by microenterprise institutions with the funds raised through the bonds issuance on the capital market. The Foundation for Cooperation and Development of Paraguay issued bonds to raise capital for microenterprise lending.

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

Convenience of location, positive real rate of return, liquidity, and security of savings are essential ingredients of successful savings mobilization.

Once microfinance institutions are engaged in deposit taking in order to mobilize household savings, they become financial intermediaries. Consequently, prudential financial regulations become necessary to ensure the solvency and financial soundness of the institution and to protect the depositors. However, excessive regulations that do not consider the nature of microfinance institution and their operation can hamper their viability. In view of small loan size, microfinance institutions should be subjected to a minimum capital requirement, which is lower than that applicable to commercial banks. On the other hand, a more stringent capital adequacy rate (the ratio between capital and risk assets) should be maintained because microfinance institutions provide uncollateralized loans.

Governments should provide an enabling legal and regulatory framework, which encourages the development of a range of institutions and allows them to operate as recognized financial intermediaries subject to simple supervisory and reporting requirements. Usury laws should be repelled or relaxed and microfinance institutions should be given freedom of setting interest rates and fees in order to cover operating and finance costs from interest revenues within a reasonable amount of time. Government could also facilitate the process of transition to a sustainable level of

operation by providing support to the lending institutions in their early stage of development through credit enhancement mechanisms or subsidies.

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

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

Microfinance institutions could also serve as intermediaries between borrowers and the formal financial sector and on-lend funds backed by a public sector guarantee. Business-like NGOs can offer commercial banks ways of funding microentrepreneurs at low cost and risk, for example, through leveraged bank-NGO-client credit lines. Under this arrangement, banks make one bulk loan to NGOs and the NGOs packages it into large number of small loans at market rates and recover them. There are many on-going research on this line but context specific research is needed to identify the most appropriate model. With this in mind we discuss various possible alternatives of formal-informal sector linkages in India.

In this context, following strategic, institutional and connectivity issues related to micro-finance arise.

Strategic Issues Is there a prevailing paradigm for micro-finance? Are there clearly visible pattern across the country? Is there a clearly defined foundation building blocks such as organizing

principles, gender preferences and operational imperatives? What are methodological issues?

Institutional Issues

Is there a need for a new institution? Should it operate all India or in a state? Where should it be located? Who can lead an institution of this sort? What will its contextual interconnections be? Who will be its beneficiaries?

Connectivity Issues

How should the Corporate Financial Sector be involved? What is the role of donor agencies? How should communities be involved? Are there political issues that should be explicitly considered? Are there government policy issues?

The Formal Sector Institutions:

Traditionally, the formal sector Banking Institutions in India have been serving only the needs of the commercial sector and providing loans for middle and upper income groups. Similarly, for housing the HFIs have generally not evolved a lending product to serve the needs of the Very LIG primarily because of the perceived risks of lending to this sector.

The formal sector financial institutions generally perceive following risks:

Credit Risk High transaction and service cost Absence of land tenure for financing housing Irregular flow of income due to seasonality Lack of tangible proof for assessment of income Unacceptable collaterals such as crops, utensils and jewellery

As far as the formal financial institutions are concerned, there are Commercial Banks, Housing Finance Institutions (HFIs), NABARD, Rural Development Banks (RDBs), Land Development Banks Land Development Banks and Co-operative Banks (CBs).

As regards the Co-operative Structures, the Urban Co.op Banks (UCB) or Urban Credit Co.op Societies (UCCS) are the two primary co-operative financial institutions operating in the urban areas. There are about 1400 UCBs with over 3400 branches in India having 14 million members.

Few of the UCCS also have external borrowings from the District Central Co.op Banks (DCCBs) at 18-19%. The loans given by the UCBs or the UCCS are for short term and unsecured except for few, which are secured by personal guarantees. The most effective security being the group or the peer pressure.

The Government has taken several initiatives to strengthen the institutional rural credit system. The rural branch network of commercial banks has been expanded and certain policy prescriptions imposed in order to ensure greater flow of credit to agriculture and other preferred sectors. The commercial banks are required to ensure that 40% of total credit is provided to the priority sectors out of which 18% in the form of direct finance to agriculture and 25% to priority sector in favor of weaker sections besides maintaining a credit deposit ratio of 60% in rural and semi-urban branches. Further the IRDP introduced in 1979 ensures supply of credit and subsidies to weaker section beneficiaries. Although these measures have helped in widening the access of rural households to institutional credit, vast majority of the rural poor have still not been covered. Also, such lending done under the poverty alleviation schemes

suffered high repayment defaults and left little sustainable impact on the economic condition of the beneficiaries.

The Existing Informal financial sources:

The informal financial sources generally include funds available from family sources or local moneylenders. The local moneylenders charge exorbitant rates, generally ranging from 36% to 60% interest due to their monopoly in the absence of any other source of credit for non-conventional needs. Chit Funds and Bishis are other forms of credit system operated by groups of people for their mutual benefit, which however have their own limitations.

Lately, few of the NGOs engaged in activities related to community mobilization for their socio-economic development have initiated savings and credit programmes for their target groups. These Community based financial systems (CBFS) can broadly be categorized into two models: Group Based Financial Intermediary and the NGO Linked Financial Intermediary.

Most of the NGOs like SHARAN in Delhi, FEDERATION OF THRIFT AND CREDIT ASSOCIATION (FTCA) in Hyderabad or SPARC in Bombay have adopted the first model where they initiate the groups and provide the necessary management support. Others like SEWA in Ahmedabad or BARODA CITIZEN's COUNCIL in Baroda pertain to the second model.

The experience of these informal intermediaries shows that although the savings of group members, small in nature do not attract high returns, it is still practiced due to security reasons and for getting loans at lower rates compared to that available from money lenders. These are short-term loans meant for crisis, consumption and income generation needs of the members. The interest rates on such credit are not subsidised and generally range between 12 to 36%. Most of the loans are unsecured. In few cases personal or group guarantees or other collaterals like jewellery is offered as security.

While a census of NGOs in micro-finance is yet to be carried out, there are perhaps 250-300 NGOs, each with 50-100 Self Help Groups (SHG). Few of them, not more than 20-30 NGOs have started forming SHG Federations. There are also agencies, which provide bulk funds to the system through NGOs. Thus organizations engaged in microfinance activities in India may be categorized as Wholesalers, NGOs supporting SHG Federations and NGOs directly retailing credit borrowers or groups of borrower.

The Wholesalers will include agencies like NABARD, Rashtriya Mahila Kosh-New Delhi and the Friends of Women's World Banking in Ahmedabad. Few of the NGOs supporting SHG Federations include MYRADA in Bangalore, SEWA in Ahmedabad, PRADAN in Tamilnadu and Bihar, ADITHI in Patna, SPARC in Mumbai, ASSEFA in Madras etc. While few of the NGOs directly retailing credit to Borrowers are SHARE in Hyderabad, ASA in Trichy, RDO Loyalam Bank in Manipur.

Mechanisms Adopted in Other South Asian Nations In Targeting Programmes for the Low Income Groups

The Grameen Bank in Bangladesh

The concept is the brainchild of Dr Muhammad Yunus of Chittagong University who felt concern at the pittance earned by landless women after a long arduous day's work labouring for other people. He reasoned that if these women could work for themselves instead of working for others they could retain much of the surplus generated by their labours, currently enjoyed by others.

Established in 1976, the Grameen Bank (GB) has over 1000 branches (a branch covers 25-30 villages, around 240 groups and 1200 borrowers) in every province of Bangladesh, borrowing groups in 28,000 villages, 12 lakh borrowers with over 90% being women. It has an annual growth rate of 20% in terms of its borrowers. The most important feature is the recovery rate of loans, which is as high as 98%. A still more interesting feature is the ingenious manner of advancing credit without any "collateral security".

The Grameen Bank lending system is simple but effective. To obtain loans, potential borrowers must form a group of five, gather once a week for loan repayment meetings, and to start with, learn the bond rules and "16 Decisions" which they chant at the start of their weekly session. These decisions incorporate a code of conduct that members are encouraged to follow in their daily life e.g. production of fruits and vegetables in kitchen gardens, investment for improvement of housing and education for children, use of latrines and safe drinking water for better health, rejection of dowry in marriages etc. Physical training and parades are held at weekly meetings for both men and women and the "16 Decisions" are chanted as slogans. Though according to the Grameen Bank management, observance of these decisions is not mandatory, in actual practice it has become a requirement for receiving a loan.

Numbers of groups in the same village are federated into a Centre. The organization of members in groups and centers serves a number of purposes. It gives individuals a measure of personal security and confidence to take risks and launch new initiatives.

The formation of the groups - the key unit in the credit programme - is the first necessary step to receive credit. Loans are initially made to two individuals in the group, who are then under pressure from the rest of the members to repay in good time. If the borrowers default, the other members of the group may forfeit their chance of a loan. The loan repayment is in weekly installments spread over a year and simple interest of 20% is charged once at the year-end.

The groups perform as an institution to ensure mutual accountability. The individual borrowing member is kept in line by considerable pressure from other group members. Credibility of the entire group and future benefits in terms of new loans are in jeopardy if any one of the group members defaults on repayment.

There have been occasions when the group has decided to fine or expel a member who has failed to attend weekly meetings or willfully defaulted on repayment of a loan. The members are free to leave the group before the loan is fully repaid, however, the responsibility to pay the balance falls on the remaining group members. In the event of default by the entire group, the responsibility for repayment falls on the centre.

The Grameen Bank has provided an inbuilt incentive for prompt and timely repayment by the borrower i.e. gradual increase in the borrowing eligibility of subsequent loans.

A survey has shown that about 42% of the members had no income earning occupation (though some may have been unpaid family workers in household enterprises) at the time of application of the first loan. Thus, the Grameen Bank has helped to generate new jobs for a large proportion of the members. Only insignificant portion of the loans (6 per cent) was diverted for consumption and other household needs.

About 50 per cent of the loans taken by male members were for the purpose of trading and shop keeping. 75 per cent of loans given to female members were utilized for livestock, poultry raising, processing and manufacturing activity.

Savings Programme

It is compulsory for every member to save one Taka per week, which is accumulated in the Group Fund. This account is managed by the group on a consensual basis, thus providing the members with an essential experience in the collective management of finances. Amounts collected from fines imposed on members for breach of discipline is also put into this account. The amount in the Fund is deposited with Grameen Bank and earns interest. A member can borrow from this fund for consumption, sickness, social ceremony or even for investment (if allowed by all group members). Terms and conditions of such loans, which are normally granted interest free, are decided by the group.

Factors behind success of the Grameen Bank are : participatory process in every aspect of lending mechanism, peer pressure of group members on each other, lending for activities which generate regular income, weekly collection of loans in small amount, intense interaction with borrowers through weekly meetings, strong central management, dedicated field staff, extensive staff training willingness to innovate, committed pragmatic leadership and decentralized as well as participatory style of working.

The Grameen Bank experience indicates the vital importance of credit as an entry point for upliftment programme for rural poor. If a programme is to have an appeal for people living in abject poverty, it must offer them clear and immediate prospects for economic improvement. Thereafter, it is easier to sell other interventions of social development, however unconventional they may appear, once improvements in standard of living are demonstrated.

The Grameen Bank clearly shows that lack of collateral security should not stand in the way of providing credit to the poor. The poor can utilize loans and pay them if effective procedures for bank transactions with them can be established. In case of the Grameen Bank, formation of groups with a small group of like-minded rural poor has worked well, and group solidarity and peer pressure have substituted for collateral security.

Linking Banks with Self-Help Groups: A Pilot Project from Indonesia

In Indonesia, financial liberalization since 1988, disenchantment with traditional subsidised credit programs and an openness to innovative approaches led the Central Bank to support a pilot project in which 13 participating banks, with the assistance of 12 NGOs, have lent to about 420 self-help groups (SHGs) in the first phase, to be onlent to their members.

Some of the principles underlying the project and the guidelines that were issued to the implementing groups are listed below:

The SHGs are to use part of their funds (almost 60%) for lending to their members and the rest for depositing in a bank to serve as the basis for refinancing from the bank.

Savings are to come first: no credit will be granted by the SHG without savings by the individual members of the SHG. These savings are to serve as partial collateral for their loans.

The joint and several liability of the members is to serve as a substitute for physical collateral for that part of loans to members in excess of their savings deposits.

Credit decisions for onlending to members are to be taken by the group collectively.

Central Bank refinance is to be at an interest rate equal to the interest rate at which the savings are mobilized.

All the intermediaries (the Central Bank, banks, NGOs and SHGs) will charge an interest margin to cover their costs.

Interest rates on savings and credit for members are to be market rates to be determined locally by the participating institutions.

Instead of penalties for arrears, the banks may impose an extra incentive charge to be refunded in the case of timely repayments.

The ratio of credit to savings will be contingent upon the creditworthiness of the group and the viability of the projects to be implemented, and is to increase over time with repayment performance.

SHGs may levy an extra charge on the interest rate for internal fund generation (which would be self-imposed forced savings).

Within the first ten months of the implementation period, by March 1990, 7 private banks and 11 branches of government banks had made 229 group loans to SHGs, which had retailed them to about 3500 members. Loans totaling about $0.4 million had been disbursed, on an average of about $2000 per group and $118 per member. SHG savings deposits with the bank amounted to about $400 per group, giving a credit to savings ratio of about 5. NGOs have received loans from the banks at 22 to 24 per cent, which is only slightly higher than the refinancing rate of large to small banks. Rates to end users have been between 30 to 44 per cent after the NGOs and SHGs have added their margins to cover costs and build funds to cover joint and several liability. Only one of the participating banks had sought a guarantee under the scheme from the Central Bank.

Pag IBIG Fund - Philippines

Pag IBIG Fund, is one of the most financially stable Government owned -and-controlled Corporations in Philippines today. Pag - IBIG, is an acronym for Pagtulungan sa Kinabukasan (Partnership for the Future), Ikaw (You), Banko (Bank) Industriya (Industry) Gobyerno (Government). To date, it has a total of 1.2 million members with a fund base of US $ 800 million. The fund is a provident savings fund and a housing credit system for the wage earners.

To make the fund a better instrument for the National Shelter Program (NSP) a Presidential Decree was signed in December 1980 establishing the Home Development Mutual Fund (HDMF) as a separate entity to administer the provident fund for housing.

The main objectives of the HDMF are:

To promote self-reliance and self-determination among workers through membership in an integrated nationwide savings system

To invest the provident savings of its members taking into consideration the profitability and safety of the funds as a means of providing them provident benefits upon termination of their membership in the Fund.

To promote home ownership through the establishment of an affordable and adequate housing credit system for its members

To provide small and short loans and other benefits to its members.

For the effective working and success of the Fund it was decided to make membership to the Fund mandatory and it was also based on the conviction that people deserve higher incomes and in the process they themselves must be savers and as savers they themselves be the capital base of the nation. Waivers were granted to employers who prior to the creation of the Fund already had superior retirement and provident plans for their employees or employers whose plans are similar to those of the fund or who are incapable of paying counterpart contribution due to financial losses.

Savings and Housing are closely intertwined and the first step was to take care of the member’s basic need for housing. The Fund instituted a systematic, regular and easy savings system and tapped new groups of savers who could not be reached by commercial banks and became a major source of funds for developing the economy.

Membership to the fund was made voluntary in 1987. A member could withdraw his accumulated savings upon maturity of his membership after 20 years, permanent departure from the country, total disability, retirement or separation from service due to health.

Housing loans were the Fund's greatest attraction, for which reason, a Trust Fund Agreement with the National Housing Mortgage and Finance Corporation (NHMFC) was entered into. The agreement allows the Fund to direct its lending through the NHMFC Secondary Mortgage Market System, where mortgage instruments are traded by NHMFC. The Fund was guaranteed a fixed return making it possible for the Fund to lend to its members at 9% p.a. and declare dividends.

The Government also established the Housing and Urban Development Coordinating Council (HUDCC) as the sole authority and policy making body on housing, to take charge of identifying and redefining the mandates of housing agencies. The HUDCC was to act as the lead funding agency and extend funding commitments to financial institutions who could act as loan originators for the home buyers'.

To meet its major objective of assisting low and middle income families in meeting their housing requirements through the provision of appropriate and affordable housing loan packages, the HUDCC offers loan packages with interest rates ranging from 9% to 16% per annum depending upon the loan amount. Maximum loan amount per borrower is 46 times his monthly income, consisting of his monthly basic salary plus cost of living allowance plus the monthly equivalent of the weighted average of other income during the last three years. Maximum loan repayment period is 25 years but shall not go beyond the age of 70 for the principal borrower.

There was also an Appliance and Furniture Loan Programme (AFLP) that granted short term loans . The loan amount was computed based on the length of the membership and the applicant's salary. The 2-year loan carries an interest of 10.75% p.a. Later the AFLP was expanded into the Multi Purpose Loan Program (MPL), which covers various needs: educational, medical & hospitalizations, livelihood, minor home improvement, purchase of appliances and furniture etc. To qualify for a Multi Purpose Loan, a member must have made at least 24 monthly contributions, must be an active Fund member and there must be a commitment from both employer and employee to continuously remit contributions at least for the term of the loan. The loan bears an interest of 10.75% p.a., paid in advance for the first year of the loan period. The second year interest is spread and paid equally over the 24-month term of the loan. The MPL continues to lend to members on a regular basis, it enables a member to borrow again after 50% of the outstanding loan has been repaid.

Thus Pag-IBIG helps every Filipino to have his own house by pooling the savings of its members and channeling them for the long term financing requirement of housing. Urban Community Development Office of Thailand: The People's Bank

Urban Community Development Office (UCDO) was established in 1992 as a government sponsored organization with the mandate of enhancing the capacity of slum dwellers and urban poor, through credit provision process, to generate income on a stable basis and to obtain adequate housing with secure rights and improved living environment. UCDO facilitates the formation and strengthening of savings and credit organizations in urban poor communities through technical assistance and training on organization and management of the savings groups.

The office provides wholesale loans to these member organizations to on-lend to individuals to support community development. Therefore, it serves as a bank for urban poor. To be eligible for UCDO loan, the saving group must have been engaged in savings activities for at least three months and demonstrate a clear management structure. Credit is provided as a tool to unleash communities' potential for self improvement.

The credit from UCDO consists of general purpose revolving loans to meet immediate household or community needs with a maximum three year, income enhancement

loans for up to five years to support equipment purchase and working capital, and housing loans of a maximum 15 year maturity to finance group housing projects including land purchase and non-project housing loans for up to 5 years. As of Mach 1996, $ 17.8 million of credit was disbursed to the benefit of about 3000 families in 62 communities. Housing loans accounted for $12.6 million, followed by income enhancement loans ($3.8 million) and general-purpose loans ($1.4 million).

All committee members of a community group must sign their names as guarantors for a loan. In the case of housing projects, land titles or the housing may have to be put as collateral as well. The lending rate is set based on cost of funds and provision for bad debts and a markup for community organizations. Current rates are kept below commercial rates thanks to UCDO's access to low cost funds. The community can decide upon the loan amount and the repayment period within the prescribed maximum terms. The community or savings group may repay daily, weekly, fortnightly or monthly. The method of repayment is flexible and arranged according to the needs and process decided by the community. The repayment rate stands at 98.7%.

Credit Mechanisms Adopted by HDFC (India) for Funding the Low Income Group Beneficiaries

HDFC has been making continuous and sustained efforts to reach the lower income groups of society, especially the economically weaker sections, thus enabling them to realize their dreams of possessing a house of their own.

HDFCs' response to the need for better housing and living environment for the poor, both, in the urban and rural sectors materialized in its collaboration with Kreditanstalt fur Wiederaufbau (KfW), a German Development bank. KfW sanctioned DM 55 million to HDFC for low cost housing projects in India. HDFCs' approach to low-income lending has been extremely professional and developmental in nature. Negating the concept of dependence, HDFCs' low cost housing schemes are marked by the emphasis on people’s participation and usage of self-help approach wherein the beneficiaries contribute both in terms of cash and labour for construction of their houses. HDFC also ensures that the newly constructed houses are within the affordability of the beneficiaries, and thus promotes the usage of innovative low cost technologies and locally available materials for construction of the houses.

For the purpose of actual implementation of the low cost housing projects, HDFC collaborates with organizations, both, Governmental and Non-Governmental. Such organizations act as coordinating agencies for the projects involving a collective of individuals belonging to the Economically Weaker Sections. The projects could be either in urban or rural areas.

The security for the loan is generally the mortgage of the property being financed.

The construction work is regularly monitored by the coordinating agencies and HDFC. The loans from HDFC are disbursed depending upon the stages of construction. To date, HDFC has experienced 100% recovery for the loans disbursed to various projects.

THE SYSTEM AND PROCEDURE OF MICROFINANCE

In the development paradigm, micro-finance has evolved as a need-based policy and programme to cater to the so far neglected target groups (women, poor, rural, deprived, etc.). Its evolution is based on the concern of all developing countries for empowerment of the poor and the alleviation of poverty. Development organizations and policy makers have included access to credit for poor people as a major aspect of many poverty alleviation programmes.

Microfinance programmes have, in the recent past, become one of the more promising ways to use scarce development funds to achieve the objectives of poverty alleviation. Furthermore, certain micro-finance programmes have gained prominence in the development field and beyond. The basic idea of micro-finance is simple: if poor people are provided access to financial services, including credit, they may very well be able to start or expand a micro-enterprise that will allow them to break out of poverty.

There are many features to this seemingly simple proposition, which are quite attractive to the potential target group members, government policy makers, and development practitioners. For the target group members, the most obvious benefit is that microfinance programmes may actually succeed in enabling them to increase their income levels. Furthermore, the poor are able to access financial services, which previously were exclusively available to the upper and middle-income population. Finally, the access to credit and the opportunity to begin or to expand a micro-enterprise may be empowering to the poor, especially in comparison to other development initiatives, which often treat these specific target group members as recipients.

For development practitioners, the success of microfinance programmes is encouraging. Too often in the past, costly large-scale development initiatives have failed to achieve any sustainable benefits, especially after funds have dried up.

Thus, microfinance has became one of the most effective interventions for economic empowerment of the poor.

Understanding the Development Process through Micro-finance

Microfinance is expected to play a significant role in poverty alleviation and development. The need, therefore, is to share experiences and materials that will help not only in understanding successes and failures but also provide knowledge and guidelines to strengthen and expand microfinance programmes.

In India, a variety of micro-finance schemes exist and various approaches have been practiced by both GOs and NGOs. In the development sector, credit has been viewed as one of the missing inputs and therefore, a growing emphasis on re-formulating and re-strengthening micro credit programmes is observed. There are examples of spectacular successes and there are also examples of not-so-successful programmes, which experienced high default rates and were unable to provide financial services in the long run. Ultimately the aim is to empower the poor and mainstream them into

development. Amongst different approaches of micro-finance schemes, the process and stages remain more or less the same.

The development process through a typical micro-finance intervention can be understood with the help of Chart - 2. The ultimate aim is to attain social and economic empowerment. Successful intervention is therefore, dependent on how each of these stages have been carefully dealt with and also the capabilities of the implementing organizations in achieving the final goal, e.g., if credit delivery takes place without consolidation of SHGs, it may have problems of self-sustainability and recovery. A number of schemes under banks, central and state governments offer direct credit to potential individuals without forcing them to join SHGs. Compilation and classification of the communication materials in the directory is done based on this development process.

Classifying Micro-Finance Interventions

There are several Micro-Finance implementing organizations, which provide small loans in India. Some of them have successfully expanded their services to thousands of borrowers. Given the fact that most of these borrowers would not have had access to formal financial institutions, that many of the borrowers utilize the loans to enter and/or expand their informal sector micro enterprises, and that the informal sector continues to be an important source of livelihood for many poor people, these microfinance Organizations (MFOs) may very well have had a major impact on improving the living standards of millions of poor persons as well as on promoting economic growth. The term MFO has been used for all types of implementing

organizations facilitating savings and credit and financial activities at individual and/or group level, not going into details of legal and technical aspects of MFOs.

Some of these organizations have evolved from small NGOs to become important providers of financial services. Realizing the potentially important role that MFOs play in deepening the benefits of economic growth, it is necessary that providing them experience-sharing opportunities, materials and training, should strengthen these MFOs. Furthermore, the relative success of many MFOs soundly refute the claims of some that "the poor are non-bankable" or that MFOs are a waste of scarce development funds. In fact, it would be difficult to find another type of developmental initiative which has been relatively effective on such a large scale in recent years.

In India, there exist a variety of microfinance organizations in government as well as non-government sectors. Leading national financial institutions like the Small Industries Development Bank of India (SIDBI), the National Bank for Agriculture and Rural Development (NABARD) and the Rashtriya Mahila Kosh (RMK) have played a significant role in making micro credit a real movement. In India, the size and types of implementing organizations range from very small to moderately big organizations involved in savings and or credit activities for individuals and groups. These groups also adopt a variety of approaches. However, most of these organizations tend to operate within a limited geographical range. There are a few exceptions like PRADAN, ICECD, MYRADA, SEWA who have been successful in replicating their experiences in other parts of the country and act as Resource Organizations. Also, many organizations are involved with SHGs, not only for credit, but for other purposes like watershed, agriculture, etc.

Micro-finance interventions can be identified based on their span of activity, source of funds, route through which it reaches the poor or the coverage. However, it seems that one of the most common practices and approaches prevalent is providing credit through Self-Help Groups. The approach is to make SHGs the main focal point to route all credit to members. Almost all national funding organizations (NABARD, RMK) as well as other Government schemes advocate forming of Self-Help Groups and thus providing or linking with credit. However, many organizations providing individual finance directly also exist. It has been explained in Chart - 3.

MICRO FINANCE IN INDIA

Background

The post nationalization period in the banking sector witnessed substantial amount of resources being earmarked towards meeting the credit needs of the poor. The banking network underwent an expansion phase without comparables in the world. The branch expansion1 was synergized with massive manpower recruitment drive for manning such branches. Credit came to be recognized as a remedy for many of the ills of the poverty. Credit packages and programmes were designed based on the perceived needs of the poor. Programmes also underwent qualitative changes based on the experiences gained. Besides the state governments with large resource allocations introduced the programmes initiated by the Central Government, a large number of credit-based programmes.

While the underlying objectives were laudable and substantial progress was achieved, credit flow to the poor, and especially to poor women, remained low. This led to initiatives that were institution led, that attempted to converge of the existing strengths of rural banking infrastructure and leverage this to better serve the unbanked poor. The pioneering efforts at this were made by National Bank for Agriculture and Rural Development (NABARD), which was vested with an enviable task of framing appropriate policy for rural credit, provision of technical assistance backed liquidity support to banks, supervision of rural credit institutions and other development initiatives.

NABARD during the early eighties conducted a series of research studies in association with MYRADA (a leading NGO from South India) and also independently which showed that despite having a wide network of rural bank branches that implemented specific poverty alleviation programmes and self-employment opportunities through bank credit for almost two decades, a very large number of the poorest of the poor continued to remain outside the fold of the formal banking system. These studies also showed that the existing banking policies, systems and procedures, and deposit and loan products were perhaps not well suited to meet the most immediate needs of the poor. It also appeared that what the poor really needed was a better access to these services and products, rather than cheap subsidised credit. Against this background, a need was felt for alternative policies, systems and procedures, savings and loan products, other complementary services, and new delivery mechanisms, which would fulfill the requirements of the poorest, especially of the women members of such households. The emphasis therefore was on improving the access of the poor to microFinance (mF) rather than just micro-credit.

The launching of its Pilot phase of the SHG (Self Help Group) Bank Linkage programme in February 1992 could be considered as a landmark development in banking with the poor. The SHG-informal thrift and credit groups of poor came to be recognised as bank clients under the Pilot phase.

1

The strategy involved forming small, cohesive and participative groups of the poor, encouraging them to pool their thrift regularly and using the pooled thrift to make small interest bearing loans to members, and in the process learning the nuances of financial discipline. Subsequently, bank credit also becomes available to the Group, to augment its resources for lending to its members. It needs to be emphasized that NABARD sees the promotion and bank linking of SHGs not as a credit programme but as part of an overall arrangement for providing financial services to the poor in a sustainable manner and also an empowerment process for the members of these SHGs. NABARD, however, also took a conscious decision to experiment with other successful strategies such as replicating Grameen, wholesaling funds through NGO-MFIs.

The NABARD led Pilot Project commenced with the support of the Central Bank of the country, i.e., Reserve Bank of India, from 1992 onwards aimed at promoting and financing 500 SHGs across the entire country, the SHG- bank linkage strategy has come a long way. The strategy includes financing of SHGs promoted by external facilitators like NGOs, bankers, socially spirited individuals and government agencies, as also promotion of SHGs by banks themselves and financing SHGs directly by banks or indirectly where NGOs and similar organizations act as financial intermediaries as well.

Mainstreaming of SHG Bank linkage programme

The Pilot phase was followed by setting up of a Working Group on NGOs and SHGs by the Reserve Bank of India in 1994, which came out with wide ranging recommendations on internalization of the SHG concept as a potential intervention tool in the area of banking with the poor. The Reserve Bank of India accepted most of the major recommendations and advised the banks to consider landings to the SHGs as part of their mainstream rural credit operations. Based on very successful feedback of the pilot run of the Programme, NABARD in 1998 crystallised its Vision for providing access to one third of the rural poor through linking of 1million SHGs by 20072. What followed was massive scaling up of the training and capacity building awareness programmes by NABARD covering a large number of officials and staff of NGOs, banks, government agencies and rural volunteers in SHG promotion, nurturing, appraisal and financing

Shift to the New Paradigm

i) The poor

Perceived thrift as their strength as also as the bonding factor among themselves

Realized that timely and adequate credit was preferable and productive than subsidies and doles.

They needed hassle-free delivery mechanisms.  ii) NGOs

Acted as catalysts of change Combined social and economic agenda with synergistic effect

2

Recognized sustainability as the core factor in development.

 iii) Banking system

Accepted SHG-bank linkage as a cost effective means of reaching the poor Accepted peer pressure as collateral substitute for excellent recovery of loans

 iv) Government

Formulated supportive policy framework Encouraged routing of social programmes through SHGs

 v) Reserve Bank of India

RBI policy pronouncements on microfinance led to increased involvement of banks.

Liberalized interest rates and deregulated interest rate structure for micro credit, leading to flexibility in lending rates.

 vi) NABARD

Provided inputs in capacity building for banks and partner agencies Promoted the idea of organizing thrift and credit groups among the NGOs as

an add-on activity and encouraged linking them with banks. Provided loanable funds to banks and financial support to eligible MFIs, to

ease the fund flow position to the sector.

A range of institutions in public sector as well as private sector offers the microfinance services in India. They can be broadly categorized in to two categories namely, formal institutions and informal institutions. The former category comprises of Apex Development Financial Institutions, Commercial Banks, Regional Rural Banks, and Cooperative Banks that provide microfinance services in addition to their general banking activities and are referred to as microfinance service providers. On the other hand, the informal institutions that undertake microfinance services as their main activity are generally referred to as microfinance Institutions (MFIs). While both private and public ownership are found in the case of formal financial institutions offering microfinance services, the MFIs are mainly in the private sector.

MICROFINANCE INSTITUTIONS IN INDIA

The micro-finance movement has gained acceptability and momentum in the developing community largely due to the recognition that the nature of financial markets in most developing countries creates a credit gaps for the poor. Most formal financial institutions do not serve the poor because they are perceived as high risk and high cost involved in small transactions relative to profitability and inability of the poor to provide the physical collateral required by such institutions.

In India there are broadly three types of Micro-finance organizations

1. Not for profit MFIs

Societies registered under Societies Registration act 1860 Public Trusts registered under the Indian Trust Act 1882 Non-profit companies registered under Section 25 of the Companies Act

1956 Self Help Groups / Federations

2. Mutual benefit MFIs

State Credit Co-operatives National Credit Co-operatives Mutually aided Co-operative Societies (MACS) Self Help Groups (SHGs) and Federations

3. For Profit MFIS

Non-Banking Financial Companies (NBFCs) registered under the Companies Act 1956.

Banks which provide MF along with their usual banking service

More than subsidies poor need access to credit. Absence of formal employment make them non `bankable'. This forces them to borrow from local moneylenders at exorbitant interest rates. Many innovative institutional mechanisms have been developed across the world to enhance credit to poor even in the absence of formal mortgage. This chapter discusses conceptual framework of a microfinance institution in India.

Microfinance Service Providers

The microfinance service providers include apex institutions like National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), and, Rashtriya Mahila Kosh (RMK). At the retail level, Commercial Banks, Regional Rural Banks, and, Cooperative banks provide microfinance services. Today, there are about 60,000 retail credit outlets of the formal banking sector in the rural areas comprising 12,000 branches of district level cooperative banks, over 14,000 branches of the Regional Rural Banks (RRBs) and over 30,000 rural and semi-urban branches of commercial banks besides almost 90,000 cooperatives credit societies at the village level. On an average, there is at least one retail credit outlet for about 5,000 rural people. This physical reaching out to the far-flung areas of the country to provide savings, credit and other banking services to the rural society is an unparalleled achievement of the Indian banking system. In the this paper an attempt is made to deal with various aspects relating to emergence of private microfinance industry in the context of prevailing legal and regulatory environment for private sector rural and microfinance operators. 

The Emergence of Private Microfinance Industry

The microfinance initiative in private sector can be traced to the initiative undertaken by Ms.Ela Bhat for providing banking services to the poor women employed in the unorganised sector in Ahmedabad City of Gujarat State. Shri Mahila SEWA (Self Employed Women’s Association) Sahakari Bank was set up in 1974 by registering it as a Urban Cooperative Bank. Since then, the bank is providing banking services to the poor self-employed women working as hawkers, vendors, domestic servant etc. As on March 2003, the mFI had a membership of 30,000, seventy per cent of whom are from urban area. The deposit and loan portfolio stood at Rs 623.9 million ($ 13.86 million) and Rs133.6 million ($2.97 million) respectively. Though the mFI is making profit, yet the SEWA bank model of mFI has not been replicated elsewhere in the country.

In the midst of the apparent inadequacies of the formal financial system to cater to the financial needs of the rural poor, NABARD sponsored an action research project in 1987 through an NGO called MYRADA. For this purpose a grant of Rs. 1 million ($22,222) was provided to MYRADA for an R&D programme related to credit groups. Encouraged by the results of field level experiments in group based approach for lending to the poor, NABARD launched a Pilot Project in 1991-92 in partnership with Non-governmental Organizations (NGOs) for promoting and grooming self help groups (SHGs) of homogeneous members and making savings from existing banks and within the existing legal framework. Steady progress of the pilot project led to the mainstreaming of the SHG-Bank Linkage Programme in 1996 as a normal banking activity of the banks with widespread acceptance. The RBI set the right policy environment by allowing savings bank accounts of informal groups to be opened by the formal banking system. Launched at a time when regulated interest rates were in vogue, the banks were expected to lend to SHGs at the prescribed rates, but the RBI advised the banks not to interfere with the management of affairs of SHGs, particularly on the terms and conditions on which the SHGs disbursed loans to their members.

The uniqueness of the microfinance through SHG is that it is a partnership based approach and encouraged NGOs to undertake not only social engineering but also financial intermediation especially in areas where banking network was not satisfactory. The rapid progress achieved in SHG formation, which has now turned into an empowerment movement among women across the country, laid the foundation for emergence of MFIs in India. 

MFIs and Legal Forms

With the current phase of expansion of the SHG – Bank linkage programme and other mF initiatives in the country, the informal microfinance sector in India is now beginning to evolve. The MFIs in India can be broadly sub-divided into three categories of organizational forms as given in Table 1. While there is no published data on private MFIs operating in the country, the number of MFIs is estimated to be around 800. However, not more than 10 MFIs are reported to have an outreach of 100,000 microfinance clients. An overwhelming majority of MFIs are operating on a smaller scale with clients ranging between 500 to 1500 per MFI. The geographical distribution of MFIs is very much lopsided with concentration in the southern India

where the rural branch network of formal banks is excellent. It is estimated that the share of MFIs in the total micro credit portfolio of formal & informal institutions is about 8 per cent.

Table 1: Legal Forms of MFIs in India

Types of MFIs Estimated Number*

Legal Acts under which Registered

1.  Not for Profit MFIs

a.) NGO - MFIs 400 to 500 Societies Registration Act, 1860 or

similar Provincial ActsIndian Trust Act, 1882

b.) Non-profit Companies 10 Section 25 of the Companies Act, 1956

2.  Mutual Benefit MFIsa.) Mutually Aided Cooperative Societies (MACS) and similarly set up institutions

200 to 250 Mutually Aided Cooperative Societies Act enacted by State Government

3.  For Profit MFIs

a.) Non-Banking Financial Companies (NBFCs)

6Indian Companies Act, 1956

Reserve Bank of India Act, 1934

Total 700 - 800  

* The estimated number includes only those MFIs, which are actually undertaking lending activity.

NGO MFIs: There are a large number of NGOs that have undertaken the task of financial intermediation. Majority of these NGOs are registered as Trust or Society. Many NGOs have also helped SHGs to organize themselves into federations and these federations are registered as Trusts or Societies. Many of these federations are performing non-financial and financial functions like social and capacity building activities, facilitate training of SHGs, undertake internal audit, promote new groups, and some of these federations are engaged in financial intermediation. The NGO MFIs vary significantly in their size, philosophy and approach. Therefore these NGOs are structurally not the right type of institutions for undertaking financial intermediation activities, as the byelaws of these institutions are generally restrictive in allowing any commercial operations. These organizations by their charter are non-profit organizations and as a result face several problems in borrowing funds from higher financial institutions. The NGO MFIs, which are large in number, are still outside the purview of any financial regulation. These are the institutions for which policy and regulatory framework would need to be established.

Non-Profit Companies as MFIs: Many NGOs felt that combining financial intermediation with their core competency activity of social intermediation is not the

right path. It was felt that a financial institution including a company set up for this purpose better does banking function. Further, if MFIs are to demonstrate that banking with the poor is indeed profitable and sustainable, it has to function as a distinct institution so that cross subsidization can be avoided. On account of these factors, NGO MFIs are of late setting up a separate Non-Profit Companies for their microfinance operations. The MFI is prohibited from paying any dividend to its members. In terms of Reserve Bank of India’s Notification dated 13 January 2000, relevant provisions of RBI Act, 1934 as applicable to NBFCs will not apply for NBFCs (i) licensed under Section 25 of Companies Act, 1956, (ii) providing credit not exceeding Rs. 50,000 ($1112) for a business enterprise and Rs. 1,25,000 ($2778) for meeting the cost of a dwelling unit to any poor person, and, (iii) not accepting public deposits. 

Mutual Benefit MFIs: The State Cooperative Acts did not provide for an enabling framework for emergence of business enterprises owned, managed and controlled by the members for their own development. Several State Governments therefore enacted the Mutually Aided Co-operative Societies  (MACS) Act for enabling promotion of self-reliant and vibrant co-operative Societies based on thrift and self-help. MACS enjoy the advantages of operational freedom and virtually no interference from government because of the provision in the Act that societies under the Act cannot accept share capital or loan from the State Government. Many of the SHG federations, promoted by NGOs and development agencies of the State Government, have been registered as MACS. Reserve Bank of India, even though they may be providing financial service to its members, does not regulate MACS.

For Profit MFIs (Non Banking Financial Companies)

Non Banking Financial Companies (NBFC) are companies registered under Companies Act, 1956 and regulated by Reserve Bank of India. Earlier, NBFCs were not regulated by RBI but in 1997 it was made obligatory for NBFCs to apply to RBI for a certificate of registration and for this certificate NBFCs were to have minimum Net Owned funds of Rs 25 lakhs and this amount has been gradually increased. RBI introduced a new regulatory framework for those NBFCs who want to accept public deposits. All the NBFCs accepting public deposits are subjected to capital adequacy requirements and prudential norms. There are only a few MFIs in the country that are registered as NBFCs. Many MFIs view NBFCs more preferred legal form and are aspiring to be NBFCs but they are finding it difficult to meet the requirements stipulated by RBI. The number of NBFCs having exclusive focus on mF is negligible.

Capital Requirements

NGO-MFIs, non-profit companies MFIs, and mutual benefit MFIs are regulated by the specific act in which they are registered and not by the Reserve Bank of India. These are therefore not subjected to minimum capital requirements, prudential norms etc. NGO MFIs to become NBFCs are required to have a minimum entry capital requirement of Rs. 20 million ($ 0.5 million). As regards prudential norms, NBFCs are required to achieve capital adequacy of 12% and to maintain liquid assets of 15% on public deposits.

Foreign Investment

Foreign investment by way of equity is permitted in NBFC MFIs subject to a minimum investment of $500,000. In view of the minimum level of investment, only two NBFCs are reported to have been able to raise the foreign investment. However, a large number of NGOs in the development - empowerment are receiving foreign fund by way of grants. At present, over Rs.40, 000 million ($ 889 million) every year flows into India to NGOs for a whole range of activities including microfinance. In a way, foreign donors have facilitated the entry of NGOs into microfinance operations through their grant assistance.

Deposit Mobilization

Not for profit the Reserve Bank of India, from mobilising any type of savings, bars MFIs. Mutual benefit MFIs can accept savings from their members. Only rated NBFC MFIs rated by approved credit rating agencies are permitted to accept deposits. The quantum of deposits that could be raised is linked to their net owned funds.

Borrowings

Initially, bulk of the funds required by MFIs for on lending to their clients were met by apex institutions like National Bank for Agriculture and Rural Development, Small Industries Development Bank Of India, and, Rashtiya Mahila Kosh. In order to widen the range of lending institutions to MFIs, the Reserve Bank of India has roped in Commercial Banks and Regional Rural Banks to extend credit facilities to MFIs since February 2000. Both public and private banks in the commercial sector have extended sizeable loans to MFIs at interest rate ranging from 8 to 11 per cent per annum. Banks have been given operational freedom to prescribe their own lending norms keeping in view the ground realities. The intention is to augment flow of micro credit through the conduit of MFIs. In regard to external commercial borrowings (ECB) by MFIs, not-for-profit MFIs are not permitted to raise ECB. The current policy effective from 31 January 2004, allows only corporate registered under the Companies Act to access ECB for permitted end use in order to enable them to become globally competitive players. 

Interest Rates

The interest rates are deregulated not only for private MFIs but also for formal baking sector. In the context of softening of interest rates in the formal banking sector, the comparatively higher interest rate (12 to 24 per cent per annum) charged by the MFIs has become a contentious issue. The high interest rate collected by the MFIs from their poor clients is perceived as exploitative. It is argued that raising interest rates too high could undermine the social and economic impact on poor clients. Since most MFIs have lower business volumes, their transaction costs are far higher than that of the formal banking channels. The high cost structure of MFIs would affect their sustainability in the long run.

Collateral requirements

All the legal forms of MFIs have the freedom to waive physical collateral requirements from their clients. The credit policy guidelines of the RBI allow even the formal banks not to insist on any type of collateral and margin requirement for loans upto Rs 50,000 ($1100). 

Regulation & Supervision

India has a large number of MFIs varying significantly in size, outreach and credit delivery methodologies. Presently, there is no regulatory mechanism in place for MFIs except for those that are registered as NBFCs. As a result, MFIs are not required to follow standard rule and it has allowed many MFIs to be innovative in its approach particularly in designing new products and processes. But the flip side is that the management and governance of MFIs generally remains weak, as there is no compulsion to adopt widely accepted systems, procedures and standards. Because the sector is unregulated, not much is known about their internal health. Following Committees have examined the road map for regulation and supervision of MFIs

o Task Force (appointed by NABARD) Report on Regulatory and Supervision Framework for MFIs, 1999. (Kindly see publications Section for a complete report

o Working Group (constituted by Government of India) on Legal & Regulation of MFIs, 2002

o Informal Groups (appointed by RBI) on Microfinance which studied issues relating to (i) Structure & Sustainability, ii) Funding (iii) Regulations and (iv) Capacity Building, 2003

o Advisory Committee (appointed by RBI) on flow of credit to agriculture and related activities from the Banking System, 2004

To address the issue of need for a differential regulatory framework, the latest committee sought answers to the following questions and concerns facing private MFIs in the Country:(i) Is non-existence of a separate differential regulatory framework a critical bottleneck hindering the growth of the sector?(ii) Will MFIs be sustainable in medium term? If so, will they continue to focus on the poor?(iii) Is access to public / member deposit the key issue for their sustainability?(iv) Can MFIs finance loans for income generation at interest rates, which are sustainable by the rural poor? (v) Is it possible to evolve commonly agreed standards for MFI sector covering performance, accounting and governance issues, which can open up possibilities of self-regulation?(vi) Has the sector reached a critical mass where regulation becomes important?

The Committee observed that while a few of the MFIs have reached significant scales of outreach, the MFI sector as a whole is still in evolving phase as is reflected in wide debates ranging around (i) desirability of NGOs taking up financial intermediation, (ii) unproven financial and organizational sustainability of the model, (iii) high transaction costs leading to higher rates of interest being charged to the poor clients, (iv) absence of commonly agreed performance, accounting and governance standards, (v) heavy expectations of low cost funds, including equity and the start up costs, etc.

The current debate on development of a regulatory system for the MFIs focuses on three stages. Stage one - to make the MFIs appreciate the need for certain common performance standards, stage two - making it mandatory for the MFIs to get registered with identified or designated institutions and stage three - to encourage development of network of MFIs which could function as quasi Self-Regulatory Organizations (SROs) at a later date or identifying a suitable organization to handle the regulatory arrangements. The Committee recommended that while the MFIs may continue to work as wholesalers of microCredit by entering into tie-ups with banks and apex development institutions, more experimentation have to be done to satisfy about the sustainability of the MFI model. Such experimentation needs to be encouraged in areas where banks are still not meeting adequate credit demand of the rural poor. 

In regard to offering thrift products, the Committee felt that, while the NGO-MFIs can continue to extend micro credit services to their clients, they could play an important role in facilitating access of their clients to savings services from the regulated banks. As regards allowing NGO-MFIs to access deposits from public / clients, the Committee considers that in view of the need to protect the interests of depositors, they may not be permitted to accept public deposits unless they comply with the extant regulatory framework of the Reserve Bank of India. As no depositors' interest is involved where they do not accept public deposits, the Reserve Bank of India need not regulate MFIs.

As regards the high interest rates being charged by the MFIs, the Committee felt that the lenders to MFIs may ensure that these institutions adopt a ‘cost-plus- reasonable-margin’ approach in determining the rates of interest on loans to clients.

Conclusions

Private MFIs in India, barring a few exceptions, are still fledgling efforts and are therefore unregulated. Their outreach is uneven in terms of geographical spread. They serve microfinance clients with varying quality and using different operating models. Regulatory framework should be considered only after the sustainability of MFI model as a banking enterprise for the poor is clearly established. Experimentation of MFI model needs to be encouraged especially in areas where formal banks are still not meeting adequate credit demand of the rural poor. 

MICROFINANCE IN GUJARAT

Gujarat State Profile

Gujarat ranks amongst the top states in terms of fresh investments attracted. Over 8.5 per cent of the total fresh investments are directed towards Gujarat. Most of the investment in the state is by private sector.

Location

Gujarat is the seventh largest state of the country having a geographical area of 1,96,024 Sq.Kms. The state is boundaries on northwest by Pakistan, on north by Rajasthan, on west by MP, on south and southeast by Maharastra. The plains of

Gujarat are watered by big rivers like Sabarmati, Mahi, Narmada, and Tapi and by smaller rivers like Banas, saraswati and Damanganga.

Gujarat has 25 revenue districts by 2001. The number of Class I (cities with population more than 1 lakh) are 26 and Class II (median town with population 50,001 to 1 lakh) and 132 Class III and Class IV towns with population less than 50,000.According to Gujarat Nagar Palika Act, 1963, at present there are seven municipal corporations and 142 municipalities.

As the 13th agro climatic zone, the state ha 6% of the geographic area where as 4.93% of the population of the country with 25 districts as administrative units. Out of 5.07 crore population of the state, 21.7% is agriculture work force and 13.2% of rural population is below poverty line. There are wide variations in the rainfall varying 2642mm in Dangs to 283 mm in Kutch. The 50.15% of geographic area is net sown area (NAS) with 111.27% cropping intensity with assured irrigation facilities from all sources. There are 182 regulated markets and cold storage/cold chain capacity around 2.59 crore metric tones. However, the share of agriculture in state GDP is only 18.9%. There are 2.93 lakh registered SSI units and 47.95% of population is depended on Non-Farm Sector activities. In past state has been severely affected by natural and man made calamities, Viz 2001 earthquake, 2002 drought, 2003 floods.

The State, which enjoys a 1,600 kms long coastline, has been witnessing substantial activities in the development of ports. Kandla port, one of the major ports of the country, is located in the Kachchh district in the north of Gujarat. Around 67 per cent of the total foodgrain port traffic of the country passes through the Kandla port. The State also has 18 minor ports. Mundra port, the first privately developed port in the country is located in the State.

Districts of Gujarat State.

Districts01. AHMEDABAD 14. MAHESANA 02. AMRELI 15. NARMADA 03. ANAND 16.NAVSARI04. BANASKANTHA 17. PANCHMAHALS 05. BHARUCH 18. PATAN 06. BHAVNAGAR 19. PORBANDAR 07. DAHOD 20. RAJKOT 08. DANGS 21. SABARKANTHA 09. GANDHINAGAR 22. SURAT 10. JAMNAGAR 23. SURENDRANAGAR11. JUNAGADH 24. VADODARA 12. KACHCHH 25. VALSAD 13. KHEDA

Demographic profile

Particulars Unit StateAdministrative unitsNo. of Districts Nos. 25No. of Taluka/Blocks etc. Nos. 222No. of Villages Nos. 18539Population(Provisional)Total Million 50.7Rural Million 31.8Urban Million 18.9Male Million 26.3Female Million 24.4Density of population Million 258 per sq. KMDecadal Growth of Population % of pa 22.66Literacy TotalTotal % 69.14Male % 79.66Female % 57.80Workforce engage in Agriculture % of total 52.05Population below poverty line Lakh 71.36Rural poor % 13.17Urban poor % 15.59

Banking Profile

The state has 53 commercial Banks (26 privet banks), 9 RRBs (Region Rural bank), 18 DCCBs (district central co-operative banks) and 1 State Co-operative Bank, 1Gujarat State Co-operative Agriculture & Rural Development Bank. The total branches of all banks in the state were 5124 at the end of March 2005. The population per bank was 9945. The deposit with schedule commercial bank was Rs.82083 crores

and advances was Rs. 35418 crores constituting credit deposit ratio of 43.15 as at end of March 2005.

As on 31 March 2005, the number of rural and semi urban branches of CBs were 3153, that of DCCBs 1145 branches, RRBs 408 branches and GDCARDB 181 branches. The statistic highlights relating to the banking profiles are given in last of the report.

Apart from these, urban cooperative banks also play a supplementary role in cooperative credit structure. As on 31.3.2005 there were 351 urban cooperative banks in Gujarat having 779 branches.

Key Economic Indicators

Gross State Domestic Product (GSDP) at factor cost at constant (1993-94) prices in 2003-04 has been estimated at Rs.103951 crore as against 90068 crore in 2003-04

The Microfinance channel in Gujarat

However we have seen earlier there are so many micro financial institutes in Gujarat. These organizations are classified in the following categories to indicate the functional aspects covered by them within the microfinance framework. The aim, however, is not to "typecast" an organization, as these have many other activities within their scope:

1. Organizations implementing micro-finance activities

2. Resource organizations or support agencies

3. Formal financial institutions - Banks and development organizations, like NABARD, SIDBI, Association of MFOs etc.

1. Organizations Implementing Microfinance Activities

Organizations implementing micro-finance activities can be categorized into three basic groups.

I) Organizations which directly lend to specific target groups and are carrying out all related activities like recovery, monitoring, follow-up etc. Some of these organizations are graduating to become exclusive MFOs, but such cases are few.

II) Organizations who only promote and provide linkages to SHGs and are not directly involved in micro lending operations.

III) Organizations which are dealing with SHGs and plan to start micro-finance related activities.

2. Resource Organizations or Support Agencies

These are the organizations that provide support to implementing organizations. The support may be in terms of resources or training for capacity building, counseling, networking, etc. They operate at state/regional or national level. They may or may not be directly involved in micro-finance activities.

A few associations to bring such MFOs on one platform have also been initiated in India. Experiences sharing through newsletters and/or meetings/ seminars/training are the methods adopted by the associations/collectives to support implementing organizations.

3. Formal Financial Institutions - Banks

Commercial Banks, Grameen Banks and Rural Banks provide funds to SHGs and also operate their accounts. Funding agencies and development institutions chanelise credit through these FIs. Building gender sensitivity and developmental dimensions amongst these agencies is a major need. Banks prefer to route credit through SHGs, though they directly lend to individuals also.

Development Agencies/Nodal Agencies in India, development agencies like NABARD, SIDBI and RMK provide funds for credit. They support MFOs and have separate allocations for SHGs and micro-credit. These organizations have developed guidelines and training materials to help MFOs implement micro-credit activities covered under their preview.

MICROFINANCE THROUGH SHG

Introduction

In most developing countries, the policies concerning rural credit were, by and large, based on certain assumptions, some of which were: commercial banks were reluctant to provide for the credit needs of the rural poor for reasons that were neither commercial nor economic; the rural poor did not have any capacity to save; they needed credit on concessionary rates of interest and relaxed terms for taking up income generating activities, more so for development works on their farms; the rural people needed external assistance for organizing themselves into groups and later close watch and regulatory measures to ensure that they work together; many of the target group borrowers would graduate after some doses of concessional credit and would start taking credit on normal terms and that informal finance did a positive developmental role and it was an evil that should be eliminated. Based on these assumptions, the policy framework which developed included setting up of credit oriented development banks and special credit programmes; generous credit guarantee schemes to induce banks to enlarge their lending operations; fixation of sectoral targets for credit dispensation; loans to rural borrowers on subsidised interest rates, easy loan terms including very low or nil down payment, long loan maturities and long grace periods, relegation of savings as a source of funds and reliance of the rural credit system on concessionary refinance from financial institutions and international donors.

Resulting consequences of the policy framework did not contribute to self-sustained growth of the rural credit system and it also did not adequately serve the rural poor. It is well known that people who were not poor captured a part of the subsidies and concessions involved in rural credit and substantial number of very poor could not be reached under this dispensation. Further, the rural credit delivery system in most of the developing countries was weakened by poor credit discipline among the borrowers resulting in low recovery of dues. High operating (intermediation) costs, burden of subsidised interest rates, non-viability of operations and heavy dependence on concessionary outside funding or refinance support were some of the other constraints in the development of self-sustaining systems. Many credit programmes started with support from the State or a donor agency operated as per their dictates and were abandoned due to poor results.

The erosion in credit discipline has been a fall out of the system of 'targeted credit' where loans were often made in a rush, carried a certain political aura, the lending institutions were identified by borrowers with the Government, and relationships between the lender and borrower rarely developed. In such systems, prospective borrowers were often identified by extension workers who assisted in sanction of grants (where applicable) from the state and generally escorted them to the bank who sanctioned the loan. While the involvement of the extension agents upto this stage was visible and common, their involvement in the recovery of loans so granted was most uncommon.

The Core Issue

The core problem of rural finance is high transaction costs to the banks in financing a large number of small borrowers who require credit frequently and in small quantities. The same holds true of costs involved in providing saving facilities to small, scattered savers in rural areas. The rural savers and borrowers also face high transaction costs while dealing with banks due to distances, small value of financial transactions etc. In a recent study [unpublished] in India, the transaction cost to a small rural borrower raising a loan from a commercial bank under a poverty alleviation programme was placed at 24.6 %. Further, the transaction costs of operating a saving account with a bank was placed as high as 10% of the saving, on the assumption of only one transaction per month.

Besides the high transaction costs, the perception of risks in financing small borrowers who are unable to offer physical collateral, articulate their case or submit proper loan proposals, the urban orientation and the lack of flexibility in their operations are the other constraints which restrict the out reach of the formal banking system for the poor. The poor also often perceive banks as alien institutions, which exist to serve the needs of "others". The physical and social distance [in stratified societies] constrain their approaches to bank branches which, for them, do not appear to be functioning with their needs in mind. Credit needs of the poor are determined in a complex socio-economic milieu where the dividing line between credit for 'consumption' and 'productive' purposes is rather blurred making it difficult to adopt the traditional banking approach to lending. The result is that financial services of the formal banking system have remained unaccessible to majority of the poorer sections of the rural population in most developing countries and their reliance for credit is mainly on the informal credit channels. Informal channels include moneylenders who operate outside the legal and policy framework of banks, market vendors, shopkeepers and others including friends and relatives. Credit in the informal system is usually available immediately, when and where required and often without collateral and lengthy documentation formalities, since the lender usually relies on personal knowledge of borrowers and their circumstances. However, interest rates are not only extremely high, but sanctions often include conditions, verbal or written, which are heavily loaded in favour of the lender and are sometimes carefully guised and are detrimental to the interests of borrowers. Often credit is associated with other transactions, for example, the purchase of raw material from a supplier, with deferred payment or pre-harvest sale of a crop with immediate payment.

Availability of alternative financial services could do much to improve the welfare of rural poor and their families. In most developing countries, attempts have been made to develop cooperatives by bringing together people of small means for fostering thrift and mutual help for their economic betterment. However, cooperatives have achieved only a limited success in selected pockets. On account of their large size, and the heterogeneous economic status of their members, the decision-making gets invariably delegated to a small number of usually well-off and influential members. Such influential members are often also able to corner benefits at the cost of those who are poor and do not command ownerships of productive assets or influence. Besides, since their resource base is often weak, the cooperative by and large depend on resources handed down vertically from higher financing agencies. With dependence for financial assistance and the role which most governments play in their development, growth and monitoring, cooperatives are sometimes seen by people as a "government agency" and not as their own institution.

Against this background, evolving mechanisms for meeting the economic aspirations and credit needs of the rural poor in the form of self-help groups (SHGs) seem another possibility.

The SHG Concept

Self-Help Groups (SHGs) or Thrift and Credit Groups are mostly informal groups whose members pool savings and relend within the group on rotational or needs basis. These groups have a common perception of need and impulse towards collective action. Many of these groups got formed around specific production activity, promoted savings among members and uses the pooled resources to meet emergent needs of members, including consumption needs. Sometimes the internal savings generated were supplemented by external resources loaned/donated by the Voluntary Agency, which promoted the SHGs. Since SHGs were able to mobilize savings from the poor who were not expected to have any savings and could also recycle effectively the pooled savings among members, they succeeded in performing/providing banking services to their members, may be ina primitive way, but in a manner which was cost effective, simple, flexible at the door step of the members and above all without any defaults in repayment by borrowers

Involvement of SHGs with banks could help in overcoming the problem of high transaction costs in providing credit to the poor, by passing on some banking responsibilities regarding loan appraisal, follow-up and recovery etc. to the poor themselves. In addition, the character of SHGs and their relations with members offered ways of overcoming the problem of collateral, excessive documentation and physical access, which reduced the capacity of formal institutions to serve the poor.

Based on local conditions and requirements, the SHGs have evolved their own methods of working. Some of the common characteristics of functioning of these groups are indicated below:

The groups usually create a common fund by contributing their small savings on a regular basis.

Most of the groups themselves, or with help of NGOs, evolve flexible systems of working and managing their pooled resources in a democratic way, with participation of every member in decision-making.

Request for loans are considered by the group in their periodic meetings and competing claims on limited resources are settled by consensus.

Loaning is done mainly on trust with a bare minimum documentation and without any security.

The amounts loaned are small, frequent and for short duration. The loans cover a variety of purposes, some of which are non-traditional and

rather un-conventional. Rate of interest differs from group to group and even with purpose. Interest

charged is generally higher than that charged by banks and lower than that charged by moneylenders.

Periodic meetings of members also serve as a forum for collecting dues from members.

Defaults are rare mainly due to group pressure and intimate knowledge of end use of credit.

SHGs are ‘small economical homogenous affinity groups of rural poor, voluntarily formed to save and mutually contribute a common fund to be lent to its members as per group decision’ [NABARD, 1997].

Singh and Jain [1995] have defined SHGs as ‘voluntary association of people formed to attain goals both social and economical’. Local saving groups and SHGs have as many names as languages. They are called Rotating Savings and Credit Associations [ROSAs], Revolving Funds, Chit Funds and even Merry Go Rounds. [Malcolm Harper, 1998].

Self Help groups find their financial resources inadequate due to their lower saving capacities while on the other hand; profitable investments are limited by social restrictions and lack of marketable skills amongst group members. In order to help groups to grow in terms of volume and socio-economic development external help becomes necessary.

A formal recognition and aid to these groups however came only in 1990s, when SHG bank linage program was introduced by NABARD. NABARD had outlined specific requirements amongst SHGs for becoming eligible for bank credit under SHG - Bank Linkage program.

The requirements were:

SHGs with not more than 20 members.

Registration of SHGs according to the by laws formed by the group members.

Member’s monthly savings were to be used for loaning. The repayment schedule and the loan installments were to be fixed after mutual agreement amongst members.

SHGs were required to adopt a democratic way of functioning with each member having the freedom to express her/his views on functioning of SHGs.

SHGs had to maintain regular books of accounts, including members, saving and loan register and meeting register.

SHGs were also required to open a saving bank account in the nearby Bank branch.

Further, SHGs could be established by any organization in village, taluka and city with the initiative of bank officials or NGO workers.

Linkage programm

BANKS, NGOs AND SHGs: A CONCEPTUAL FRAMEWORK(The Approach)

The present chapter provides a conceptual framework of Banks, NGOs and SHGs and studies their role in the SHG-Bank-Linkage program. The new micro credit approach

involves the participation of Banks, NGOs and SHGs. In India, the SHG-Bank-Linkage-Program was first implemented by NABARD though branches of Commercial, Co-operatives and Regional Rural banks in 16 states. The pilot project showed encouraging results in terms of increasing accessibility, recoveries, reducing costs and benefiting SHG members. It also gave banks some experience in working with NGOs/SHGs. RBI encouraged by this experience recommended, adoption of the SHG Bank Linkage Program at the national level and asked all the banks to make it a part of their corporate strategy.

Linkage with The Non Governmental Organizations [NGOs]/Voluntary Organizations [VOs]

The NGOs/VOs have been the pioneer innovators of the ‘new microfinance approach’. NGOs terminology itself is not yet well established since NGOs typology is unmodified. They operate under different ideology and nomenclature. NGOs are defined by only what they are, which suggest that they can be whatever they need to be for a particular purpose, has attributed three major functions to NGOs: Provisoners of services and assistance; creation of self-help capabilities; advocacy / education. As a developmental organization it mobilizes, utilizes and monitors economic and non-economic inputs, development culture by making necessary changes in values, attributes institutions of society.

NGOs encompass a wide spectrum of organizations with different ideologies, activities and typologies. VOs are a part of a more comprehensive NGO network. Lord Beveridge defined VOs as, “ an organization initiated and governed by its own members without external control.” Shivraman Committee in 1978 had suggested presence of objective conditions for VOs. Viz duly registered, statutory managing committee, competent staff, proper accounting and monitoring and a master plan for work. At present, we have VOs varying widely in size, functions, methodology and motivation.

The process of voluntarism and emergence of NGOs in India, composites of seven stages this is indicated by a study on NGOs and sustainable development conducted by the Center of America in 1993. The roots of voluntarism are traced to the functioning of social institutions in the ancient and the medieval period [1800-1850]. Reform movements during the time let to the recognition of evils of caste, sex and social status. In the second phase [19th century] after the World War I, a political awakening was witnessed amongst the intelligent. Consciousness and self-help emerged as a primary focus of socio –political movement. This voluntary movement acquired force in the struggle of independence in the third phase.

In the next phase, twenty years were spent in consolidating the nation. Voluntary action joined together in government responsibilities of education, health care, socio economic welfare etc. Government program failures in mid-sixties and seventies were manifested in the ‘trickle down’ approach of overall development. Severe income disparities between rich and poor led to emergence of the alternative rural development models.

The real fallout of voluntarism came with the national emergency, J.P. Movement and the heavy politics. This left many looking for constructive alternatives to canalize their energies and concerns for more human and just societies. This fall out also led to an increased voluntary movements both in quantity and quality. It was the period when ideas of concretization and peoples participation began to emerge. More focused work with target groups, landless laborers, tribal, small farmers, women, SC/ST etc., became a base for NGOs/VOs programs.

The seventh phase in the eighties was the reorganization and the visibility of NGOs work. NGOs in different parts of India were rooted in a specific socio political context and were inspired by the emergence and continuity of social change and political movements. Another stream of NGOs established by business industrial houses in India and religious institutions also surfaced. Since then, NGOs/VOs have grown and evolved in different forms.

Korten[1992], has classified NGOs into three categories people’s organizations, public service contractors and NGOs. While John Clark [1991], has identified six types of NGOs viz: relief and welfare agencies, technical innovation organizations to pioneer improved methods of progress, public service contractors to implement part of government programs, popular development agencies concentrating on self help and grass root level democracy along with education. World Bank on the other hand has tried to codify the typology of NGOs as philanthropic and self help organizations are classified into: welfare NGOs, Development NGOs, Donor NGOs and Local NGOs. Amongst the NGOs in India majority are individual development enterprises, trusts, co-operatives, voluntary organizations and mahila samagams.

NGOs were not only classified on the basis of typology but were distinguished by size too. In the Indian context, small organizations are pre dominant. They work in a few villages within a block of a district or a few slums in one part of the city. There are small medium sized, third big and large sized organizations too. Medium sized NGOs cover a block and work with a staff of 2-10 members and project grants unto 1 lakh. Third big and large sized organizations are relatively larger and work with 25-50 and even 100 member’s staff.NGOs have been working in partnerships with donors and government for some time now. These partnerships have different facets of linkages. NGOs and government organizations have worked in friendly co existence with freedom and little or no interference and maximum support from the government. NGOs work for behavioral and attitudinal change amongst people to support implementation of government programmers of health, education, technology development and women’s programs. NGOs also sometimes act as partners in implementation of government programs.

Partnerships however, between banks and NGOs are still at a premature. It all began when NABARD motivated by experiences of other countries and India, decided to adopt the SHG approach of lending though NGOs. In order to avail financial assistance, NGOs had to fulfill certain criteria’s like good track record of consistent work, maintenance and audition of the books of accounts for at least three years, capability of handling weak and poor and saving groups with a saving bank account in banks.

The Banks

Banks have been major purveyors of microfinance in rural areas. “Institutional Fit” is extremely important for the successful implementation of any program. The ideal institutions to deliver financial services to smaller users is one which initiates, develops the activity and carries it on for as long as it is needed. In India, institutions like commercial banks, RRBs, Co-operatives viz. CCBs. PACS, PLDBs and SLDBs, have deployed rural credit.

The linkages of SHGs with banks aims at using the intermediation of SHGs between banks and the rural poor for cutting down the transaction costs for both banks and their rural clients. The objective of the linkage programme could be:

a. to evolve supplementary credit strategies for meeting the credit needs of the poor by combining the flexibility, sensitivity and responsiveness of the informal credit system with the strength of technical and administrative capabilities and financial resources of the formal financial institutions.

b. to build mutual trust and confidence between bankers and the rural poor.

c. to encourage banking activity, both on the thrift and credit sides, in a segment of the population that formal financial institutions usually find difficult to reach.

There could be different models of the linkage between SHG and banks:

MODEL 1: The simplest and most direct is a model in which the banks deal directly with the individual SHGs, providing financial assistance for on-lending to the individual members.

MODEL 2: Another model, a slight variant of the first, is where the bank gives direct assistance to the SHG and the SHG promoting institution (SHGI), usually an NGO, provides training and guidance to the SHG and generally keeps a watch to ensure its satisfactory functioning.

MODEL 3: The third model places the NGO or SHGI as a financial intermediary between the bank and a number of SHGs. The linkage between the bank and the SHGs in this case is indirect. The NGO accepts contractural responsibility for repayment to the bank.

MODEL 4: The fourth model envisages bank loans directly to individual members of SHGs upon recommendations of the SHG and NGO. In this case, the NGO assists the bank in monitoring, supervising and recovery of loans.

It is possible that the linkage may follow an evolutionary process and move from model three to model two and to model one and finally to model four where individuals get direct access to the bank. However, the adoption or acceptance of a particular model would depend on the perception of the bank and the strength of the SHGs and the NGO. Where the banker is able to have a first hand information on the working of a SHG which is functioning satisfactorily and has rotated its pooled resources two/three times, he may well start with model two or even model one.

However, a more conservative banker may like to start with modeling three and relying on the NGO or SHGI.

The Financial Scheme

The financial scheme under the Linkage Programme could be based on the following broad principles:

Savings first, no credit without saving. Saving as partial collateral Bank loans to the group, for onlending to members Credit decisions for onlending to members by the group Interest rates and other terms and conditions for loans to

members to be decided by the group Joint liability as a substitute for physical collateral Ratio between savings and credit contingent upon credit

worthiness of the group; increasing with good repayment record.

Commercial banks have the necessary outlets, security, equipment, hierarchy of administrative systems, record keeping, and efficient staff to manage savings and lending operations.

The co-operatives operate through PACs and SLDBs at ground level, they lend largely for farm activities in small amounts. PACs lend essentially for crop loans while undertaking non-crop loan lending on marginal scale. PLDBs/SLDBs are essentially term lending institutions, which lend for purposes including: minor irrigation, land development, plantation, horticulture, fisheries, farm mechanization etc. Co-operative sector financing is in small amounts with exception of financing non-farming activities. The co-operatives have had a longer experience in delivering microfinance, but lack resources and dynamism and are subject to frequent interventions from government functionaries.

Public sector and co-operative banks in India, till liberalization worked with severe constraints in terms regulations and government interventions. Till date, government partnerships and priority sector impositions had hampered the banks profitability levels. The programs of rural development too have had limited success in terms of achieving income, employment and social benefits to the poor. The SHG approach of lending was introduced to banks as a new microfinance approach with innovativeness and flexibility. The SHG approach has been initiated against the backdrop of certain benefits to the banks. It is anticipated to decrease the banker’s burden of scruitinization of application, loan disbursals, monitoring and recovery of loan accounts. Decrease in individual loan procedures is anticipated to reduce the cost to the banks, increase profits and small savings in rural areas. It is envisaged that this approach shall bring proximity and affinity between bankers and rural people.

For implementation of SHG’s approach the formal RFIs viz. commercial banks, co-operatives and RRBs have been asked to deploy credit through SHGs. No specific targets have been set at, NABARD hopes to cover 50000 SHG linkages with banks by

2000. Banks through circulars have been asking their training centers to cover SHG bank linkage program as a part of their officers and staff training programs.

In order to enable banks to report their SHG lending without difficulty on account of divergent purposes in ‘ground level disbursements from SHGs to members’, an additional component under priority sector lending target has been incorporated. Banks now report their lending to SHGs or NGOs under a new segment viz., advances to SHGs irrespective of purposed for which members have been disbursed loans.

The scope for lending to SHGs would depend upon the extent of poverty, presence, availability, support from NGOs and the need and desire amongst poor to form groups. Bank branches have been allowed to fix their own programs under the service area approach. In order to help bank branches get catalytic services of NGOs the lead bank would indicate the names of NGOs block wise. Service area branch managers would have a continuous dialogue for effecting linkages with SHGs and NGOs/VOs. In case an NGO feels comfortable with working with another branch outside its service area it would be allowed to operate with another bank branch.

The lending to SHG would be included in the LBR system and reviewed at State Level Bankers Committee [SLBC] level. Banks have been prescribed to use a simple documentation procedure for lending to SHGs.

The Linkage

The self-help group, bank linkage program has two ways of linkages:

Directly by identifying or forming SHGs Indirectly financing SHGs through NGOs/VOs

In case of direct credit deployment, loans of the group had to be in proportion with the savings, this ratio was to be increased to 1:2 to 1:4 in a phased manner. Accumulated savings of SHGs for at least six months were strongly emphasized by banks. The RBI has also made it imperative for SHGs to deposit their savings in a saving bank account with the bank branches. The rate of interest was fixed at 12 percent for lending to SHGs. Repayment installment was to be decided with mutual consultation of SHG members.

The Linkage Project in India

Despite the vast expansion of the formal credit system in India, the dependence of the rural poor on moneylenders continues especially for meeting emergent credit requirements. Such dependence is more pronounced in resource poor areas and in the case of marginal farmers, landless labourers, petty traders and artisans belonging to the socially and economically backward classes and the tribal population. With a view

to developing a supplementary credit delivery mechanism to reach the poor in a cost effective and sustainable manner, the National Bank for Agriculture and Rural Development (NABARD) introduced a pilot project for linking 500 SHGs with banks in 1992 after thorough discussion with the Reserve Bank of India (the central banking authority for India), commercial banks and NGOs.

The operational guidelines from NABARD were deliberately kept flexible to enable the participating banks and field level bankers to innovate and contribute to building and strengthening the project concept. Stating the advantages of linkages to the bank, the guidelines observed:

"A recognition by the formal credit structure of self-management capabilities of the poor through SHGs and a link up between the two is expected to result in specific advantages to both systems. Under the linkage project, the main advantage to banks would be externalization of a part of the work items of the credit cycle - assessment of credit needs, appraisal, disbursal, supervision and repayment, reduction in the formal paperwork involved and a consequent reduction in transaction costs. Improvement in recoveries and also in the margins would lead to a wider coverage of the target group. A larger mobilization of small savings would be equally advantageous. For the groups, advantages lie in the access to a larger quantum of resources as compared to their corpus generated through thrift, access to better technology and skill upgradation through different schemes of banking sector and a general improvement in the nature and scale of operations that would accelerate economic development"

Besides providing policy input, coordination and 100% refinance facility at 6.5% interest p.a. to the banks, NABARD has been organizing exposure and dialogue programmes in the linkage project for banks and NGO officials. These exposure programmes, which invariably include field visits, have helped in disseminating the concept and convincing bank officials to participate in the project. So far, 17 such programmes, covering around 350 officials have been organized in collaboration with NGOs and reputed bankers training institutes like the College of Agricultural Banking (CAB) and the National Institute of Banking Management (NIBM).

In order to assess the results of the linkage project, quick studies were taken up by NABARD in three states viz. Karnataka, Andhra Pradesh and Tamil Nadu and certain trends in the implementation of this innovative concept have emerged. They are:

a. Larger participation in the project is of women savings and credit management groups, particularly in resource poor regions.

b. Membership of SHGs has come mostly from the poorest sections of the society.

c. Demand for credit is frequent and for small amounts, at unpredictable times and sometimes not necessariy for purchase of income generating assets.

d. Even the very poor are able to save and their savings increased with addition to their incomes.

Further, some good features have come to light such as shift in credit from consumption purposes to acquisition of income generating assests, use of credit for non-traditional economic activities, increase in income levels of group members, development of thrift and self-help among members, reduction in transaction cost for both banks and SHG members and an almost 100% recovery of loans.

Transaction Costs

The high transaction cost for rural credit is a core problem and viability of the system is critically affected by it. NABARD has recently conducted a study to quantify the effect of intermediation by NGOs/SHGs on transaction cost. The initial findings are:

a. The intermediation of SHG led to reduction in time spent by bank staff on identification of borrowers, documentation, follow-up and recoveries. This resulted in 40% reduction in transaction cost which could increase further with increase in loan sizes.

b. The intermediation also significantly reduced transaction costs for the borrower due to elimination of cumbersome documentation procedure and time spent and cost incured on repeated visits to banks etc. The reduction was place at 85%.

SHG BANK LINKAGE PROGRAMME

Status as on 31 March 2005

Sl.No. Particulars 

Cumulative as on 31 March

2005        

1 No.of SHGs linked     1,618,4762 % of women groups     903 No.of participating banks :   560  i. Commercial Banks     48  ii. Regional Rural Banks     196  iii.Co-operative Banks     3164 Bank Branches participating   35,2945 No. of States/UTs     316 No. of districts covered     5637 No.of Partners     30248 Bank Loan (Rs in billion )   68.989 NABARD refinance (Rs. in billion)   30.9210 No.of poor households assisted (in million)   24.2511 Average Loan/SHG Rs.     42,62012 Average Loan/Family Rs.   3,044

13 Model Wise Linkage ( Cumulative) (%)     i. SHGs formed and financed by Banks   21

  ii. SHGs formed by other agencies but directly financed by banks

 72

  iii. SHGs financed by banks using financial intermediaries

 7

      

MICROFINANCE IN GUJARAT THROUGH SHG

Gujarat experienced mild economic growth of 2.2 percent in 2001. The overall performance of the economy has been hurt by the impact of an earthquake in 2001, social unrest, droughts, increasing energy prices, depreciation of the rupee, and the general global economic slowdown. GDP per capita in Gujarat is $409, which has remained virtually unchanged over the last few years in real terms. Inflation is 3.8 percent (as of 2001), up from 3.4 percent in 2000. For Ahmedabad proper, the inflation rate was 3.9 percent, slightly higher than the 2001 national average.

With a population approaching six million, Ahmedabad is the sixth-largest city in India, and has experienced fast-paced growth during the last few decades, with its population increasing by about 22 percent between 1991 and 2001. Ahmedabad’s economy has suffered from earthquakes, social unrest, and droughts, and as a result its poverty rate is above the national average. Residents there earn an average of $409 annually, and 34 percent of the population—as compared with just 21 percent for India as a whole—lives below the poverty line. Given the rapid population growth, a stagnant economy, and the paucity of housing and basic services, the city has experienced the swift development of new slums, in which about two-fifths of the population now lives.

The demand for shelter financing from slum dwellers is outstripping the supply of loans. Though they are numerous and varied finance programs in Gujarat have not had a major impact on low-income employed in the informal sector. Most banks do offer housing loans, but most do not offer it to the informally employed poor, even though the government requires that 10 percent of all lending go toward the “weaker sections” of the economy (i.e., the poor). Loans for this group can still be tens of thousands of dollars, with loan terms approaching 20 years—not the sort of loans that are likely to be the most effective in improving the living conditions of the area’s poor. As a result, the economically active poor who work in the informal sector remain underserved, having to rely on savings and informal moneylenders for financing.

The state of Gujarat, which has a population of about 5 crore has 33 lakh population belonging to BPL category. Despite natural and man-made calamities faced by the state during the last 3 years, it has a vast potential for innovation projects and programmes, thanks to its hyperactive and highly enterprising population. The state of govt. is also committed to gearing up the SHG movement under SGSY and other schemes. The state also implementing swa-shakti project of govt. of India with assistance from IFAD and world bank in 8 district and about 2000 SHGs have been covered through the programme.

As far as SHGs formed under NABARD’s SHG-Bank linkage programme is concerned, the the number stood at 16563 as at the end of march 2002, of which the number of SHGs creadit linked with Banks stood at 9496 involving Bank loan and NABARD refinancing of Rs.8.49 Crore and 7.55 Crore respectively. The district covered is 24, out of 25 and the partnership position is about 35 bank and 80 NGO partners. The region wise distribution is that the nourth gujrat leading with 4022 SHGs and south Gujarat and saurashtra region creadit liking 3290 SHGs & 836

SHGs respectively. Two RRBs (viz. panchmahal – vadodara gramin bank & surat Bharuch gramin Bank ), 2 DCCBs snd 5 VVV clubs are acting as selp help promoting institutions (SHPs).

In our research we have visited some of the Co-operative banks, commercial banks, NGOs, and SHGs and collected data. On the basis of that we have studied some of the characteristic of the SHGs client, the fluctuations in the number of SHG district wise and the relation between geographical area and number of SHGs.the major findig are as under:-

Characteristic of the SHGs client

SHG’s clientele are poor, most of are self-employed women who mainly work in the informal sector. A recent study conducted by AIMS on working class women in Ahmedabad identified the following characteristics of SHGs clients:

Income: SHGs clients are very poor, with 87 percent of the women sampled living on less than 100 per day. The average annual income was Rs. 42,557.

Employment: Virtually all clients work in the informal sector as micro-entrepreneurs, dependent sub-contractors, or casual laborers, in that order. (See Table A)

TABLE A

SHGs Clients by Employment (sample average) Micro entrepreneurs 41% Dependent Sub-Contractors 36% Casual Laborers 22% Salaried Jobs 1%

Debt: Like most women in Gujarat, SHG clients maintain high levels of debt—roughly 27 percent of household income. The study found that borrowers use SHG to increase their outstanding debt, rather than to pay off loans from other sources.

Savings: While total savings is quite small among poor households, SHG clients have two to three times as much savings as non-clients and hold most of these funds in SHG. Chen and Snodgrass has said “No one in the sample seems to have much to do with banks other than SHG, either as a source of credit or as a savings vehicle.”

Vulnerability: SHG clients as well as most of the working poor are susceptible to a variety of financial shocks that interrupt normal income flows or necessitate extraordinary expenditures. A 2000 study of IDBI about SHG found that 71 percent of woman questioned experienced at least one significant financial shock over a two-year period. Their main physical asset is their house, which often also serves as their place of business.

Table 1

Grand totalNo. Of SHGs Formed Total since April-99 63033

During the current year 2005-06 upto the February

4569

No. of SHGs Passed Grade-I Total since 4-99 SHGs-I 18506During the current year 2005-06 upto the February

3637

No. of SHGs Passed Grade-II Total since 4-99 5531During the current year 2005-06 upto the February

1568

No. of SHGs Taken up Economic Activities

Total Since 4-99. 3680During the current year 2005-06 upto the February

1122

No. of Women SHGs Formed Total since 4-99 26046During the current year 2005-06 upto the February

1372

No. of Women SHGs Taken up Economic Activities up to Feb.- 2006 2445Table 2

No. of Members of SHGs assisted for Economic Activities

No. of Individual Swarozgaris assisted for Economic Activities

Total SC ST Women Disable

d Tota

l SC ST Women Disabled

5665 941 2120 3109 10122951 3711 6230 6587 431

Table3

No. of Members of SHGs Trained No. Of Individual swarozgaris trained Total SC ST Women Disabled Total SC ST Women Disabled

10169 1571 2844 5289 56 3778 559 1938 2034 100

(Source: - Gujarat Rural Development Department, Gandhinagar)

Impact of the SHG Bank Linkage Programme

Given these quantitative achievements, what has been the impact of the programme.

The main findings are that:

i. Microfinance has reduced the incidence of poverty through increase in income, enabled the poor to build assets and thereby reduce their vulnerability.

ii. It has enabled households that have access to it to spend more on education than non client households. Families participating in the programme have reported better school attendance and lower drop out rates.

iii. It has empowered women by enhancing their contribution to household income,increasing the value of their assets and generally by giving them better control overdecisions that affect their lives.

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

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

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

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

Highlights of Findings

I. SHG per se

1. NGO took 6 months to one year for forming the groups. The process of evolution of SHG was found to be voluntary.

2. Source of funds to SHG was initially savings and NGO's contribution. Bank credit came later.

3. Activities financed by the SHGs were need based and the SHGs were flexible in their approach.

4. The groups adopted flexible approach in charging interest on loans ranging from 18% to 36%, but the interest was lower that the rate charged by moneylenders.

5. Shorter repayment periods were fixed and the repayments were made from all available resources i.e. by also including other income besides income from activity financed through the SHG loan. The members were therefore able to take more than one loan in a year. The general opinion was that long periods of loan with grace years and infrequent loan installments lead to overdue as in the case of formal credit delivery system.

6. Conducting regular weekly meetings was one of the hallmarks of functioning of the groups.

7. Pattern of savings differs from one group to another mainly on the basis of income generating activities of the members.

8. Flexibility in norms for lending with least importance for documentation was found in all the groups. While some groups charge penal interest for delayed payment of principal, some others waive the same.

9. The groups which kept longer repayment period and high flexibility in the amount of installment to be repaid show a little higher percentage of overdues than the groups which keep more regulated and shorter loan period.

10. Only one loan is generally allowed to a member at a time. However, in case of emergency, second loan is also considered if the group agrees for such assistance.

11. Group activities by the SHGs are encouraged b the VA through its 'Seed Money Assistance' programme.

II. SOCIO-ECONOMIC BENEFITS

1. Income per member had registered a significant increase during the period of last three years of group formation.

2. Group formation helped the members in attending individual and common problems more effectively.

3. Some SHGs have started creating common assets owned by all members. These common assets also provide additional income to the group.

4. Role of NGO/VA is important for group formation, sustenance of SHG, fund support, training and advice. The VA had also helped in providing necessary linkage for economic activities.

5. Some of the members of Women SHG availed of IRDP, Sericulture loans etc. and were confident of increasing their activities through bank credit. The groups act as facilitators in recovering the dues of the members and remit to the banks.

6. Most of the purposes financed by the groups were for unconventional activities not covered by traditional banking.

7. The new groups show greater awareness of the need to graduate out of the present level and look for new opportunities through bank assistance.

8. There was a definate shift in the loan pattern of the members from non-income generating activities to income generating activities. 70% of loan availed was for productive purposes, while only 30% of the loans were for non-income generating activities.

III. BANK LINKAGE

1. All the SHGs were having savings account with the banks since inception.

2. After obtaining the loan application, group resolution, sponsorship letter from the VA and membership list, commercial banks sanctioned loans at branch level whereas branches of RRBs forwarded the proposals to their head offices for sanction.

3. The SHGs were regularly making monthly repayments, and recovery for banks under SHG lending was to the extent of 98%.

4. The bankers were concerned about sustainability of the groups in the long run. They were also concerned about the groups functioning in the event of withdrawal of the NGO.

5. Some branch managers have expressed that groups with members having defaulters to the banking system should not be financed.

6. The cost of lending through SHGs on a rough basis showed a decline of 38% in transaction cost compared to normal lending.

7. Recovery of loans by banks is excellent without any default. Other loans issued to the members are also repaid without any delay. Only 4% of the loans was found to be overdue at the groups level.

IV. ROLE OF VA

1. NGO has been playing a pivotal role in ensuring proper training, coordination to the groups and putting them on a scientific approach.

2. VA plans to withdraw from the existing group by creating an apex body in each of the areas it is operating. This 'Apex body' was expected to provide umbrella support the SHGs in future.

V. OPERATIONS 1. Before sanction of loans to the VA for on-lending to groups,

bank branch managers had visited the groups and participated in meetings to satisfy themselves about the functioning of the group.

2. Satisfied by the excellent recovery under the programme, the banks have shown interest in extending loans through the VA.

3. Bankers felt that direct lending to groups can be done once the groups attain maturity.

4. The VA provided training in maintenance of books of accounts at SHGs level either at its training centre or through the village animator.

VI. GROUP RESPONSIBILITY 1. The VA had pledged the savings of all the members of the SHG

as collateral for the loans availed even though at the SHG level only some of the members were financed. This has been done with the concent of all members to ensure buildup of groups’ pressure. This feature can be emulated by other SHGs.

2. The members have been regular in repayment of loan installments without any default.

3. Income from other sources such as farm labour was utilized for repayment of installment during the period where there was no income from existing milch animals bought through credit from SHG.

VII. LENDING OF OWN FUNDS 1. The SHGs maintained small amounts as 'emergency funds' to

meet consumption requirement of the members.

VIII. IMPACT OF CREDIT AND ASSET CREATION 1. The weavers expressed that their earnings owning to increased

production consequent to availability of loan for purchase of raw materials and other input.

2. Most of the SHGs were reported to have undertaken group activities such as plantation, running of Balwadis (kindergarten schools) and other community development work with financial assistance aquired from the VA. However, no bank finance was involved in undertaking these activities.

ROLE OF NABARD IN MICROFINANCE

History of NABARD

National Bank for Agriculture and Rural Development Act, the Indian Parliament passed 1981 and NABARD was established on 12 July 1982 with an initial capital of Rs. 100 crore. The capital is enhanced to Rs.2000 crore subscribed by Govt. of India and Reserve Bank of India.

NABARD is an apex institution, accredited with all matters concerning policy, planning and operations in the field of credit for agriculture and other economic activities in rural areas in India.

NABARD is established as a development Bank, in terms of the Preamble of the Act, "for providing and regulating Credit and other facilities for the promotion and development of agriculture, small scale industries, cottage and village industries, handicrafts and other rural crafts and other allied economic activities in rural areas with a view to promoting integrated rural development and securing prosperity of rural areas and for matters connected therewith or incidental thereto."

NABARD took over the functions of the erstwhile Agricultural Credit Department (ACD) and Rural Planning and Credit Cell (RPCC) of RBI and Agricultural Refinance and Development Corporation (ARDC). Its subscribed and paid-up Capital was Rs.100 crore which was enhanced to Rs. 500 crore, contributed by the Government Of India (GOI) and RBI in equal proportions. Currently it is Rs. 2000 crore, contibuted by GoI (Rs.550 crore) and RBI (Rs.1450 crore).

NABARD: (i) serves as an apex financing agency for the institutions providing investment and production credit for promoting the various developmental activities in rural areas; (ii) takes measures towards institution building for improving absorptive capacity of the credit delivery system, including monitoring, formulation of rehabilitation schemes, restructuring of credit institutions, training of personnel, etc. ; (iii) co-ordinates the rural financing activities of all institutions engaged in developmental work at the field level and maintains liaison with Government of India, State Governments, Reserve Bank of India (RBI) and other national level institutions concerned with policy formulation; and (iv) undertakes monitoring and evaluation of projects refinanced by it.

NABARD’s refinance is available to State Co-operative Agriculture and Rural Development Banks (SCARDBs), State Co-operative Banks (SCBs), Regional Rural Banks (RRBs), Commercial Banks (CBs) and other financial institutions approved by RBI. While the ultimate beneficiaries of investment credit can be individuals, partnership concerns, companies, State-owned corporations or co-operative societies, production credit is generally given to individuals.

NABARD operates throughout the country through its 28 Regional Offices and one Sub-office, located in the capitals of all the states/union territories.It has 336 District Offices across the country, one Sub-office at Port Blair and one special Cell at Srinagar. It also has 6 training establishments.

Vision 

To facilitate sustained access to financial services for the unreached poor in rural areas through various microfinance innovations in a cost effective and sustainable manner.

Mission Accomplished

Provision of financial access to 16.7 million poor families through formation and credit linkage of 1,079,091 self help groups as on 31 March 2004.

Mission-Ahead

Formation and credit linkage of 585,000 new self-help groups by the year 2007 with 60% of them coming from 13 priority underdeveloped states of the country. Facilitate mature SHGs to graduate from microfinance for consumption or production credit to microenterprise.

MICROFINANCE- NABARD'S STRATEGY

Overall Strategy

Forming and nurturing small, homogeneous and participatory self-help groups (SHGs) of the poor has today emerged as a potent tool for human development. This process enables the poor, especially the women from the poor households, to collectively identify and analyse the problems they face in the perspective of their social and economic environment. It helps them to pool their meagre resources, human and financial, and prioritise their use for solving their own problems.

The emphasis on regular thrift collection and its use to solve immediate problems of consumption and production not only helps to meet their most urgent needs, but also trains them to handle larger financial resources more skillfully, prudently and with a more lasting impact.

Encourage SHGs to become a forum for many social sector interventions.

SHG-Bank Linkage Programme

Facilitating SHGs to access credit from formal banking channels. SHG-Bank Linkage Programme has proved to be the major supplementary credit delivery system with wide acceptance by banks, NGOs and various government departments.

Region-specific Initiatives

NABARD has intensified its efforts for roping in new partners for promotion and linkage of groups in regions where the growth of groups has not been commensurate with potential.

Priority has been assigned to awareness- building and for identification of NGOs and other partners in 13 priority states, which account for 70% of rural poor in the country.

Capacity Building Initiatives

NABARD has supports/ sponsors capacity building programmes for various partners in the field of microfinance to sensitize and equip them with concept & nuances of SHG bank linkage programme. Upto the end of March 2004 about 687,000 persons have been trained by us through our regional offices, training establishments, resource NGOs and partner agencies.

NABARD provides training inputs on SHG financing to training establishments of participating banks, to help them to internalize the training requirements at their level.

NABARD gives technical support to banks to evolve suitable intermediate structures like Farmers' Clubs (Vikas Volunteer Vahini Programme of the National Bank) to increase the outreach of their branches in promotion and linking SHGs

NABARD supports and helps banking institutions (especially RRBs & cooperative banks) to take on the role of Self Help Promoting Institutions (SHPIs )

 Support to Governments

Necessary assistance is provided to the governments by NABARD for dovetailing mF practices with the poverty alleviation programmes

NABARD also encourages the association of Panchayati Raj Institutions ( PRIs ) in adopting group processes for maximization of empowerment.

NABARD , in association with Lal Bahadur Shastry National Academy of Administration, Mussoorie conducts tailor made exposure programme on self help group and microFinance for senior and middle level officers of Indian Administrative Services (IAS) who are posted as district collectors/ Chief Executive Offices of local administrative set ups (Zilla Parishad)

Support to NGO Partners

Several steps have been taken by NABARD for capacity building of NGOs which partner in promotion and nurturing of SHGs. The emphasis is on involving a large number of NGOs. Special focus is on those NGOs participating in watershed development, health, literacy and women development, to encourage them to take up promotion, nurturing and linkage of SHGs as an 'add-on' activity.

NABARD has a scheme of part-financing the cost of promotion of groups by NGOs.

NABARD has developed specialized programmes for use by CEOs of NGOs for appropriately envisioning this as an add-on concept. Separate programmes have also been designed for NGO field staff to appreciate the nuances of SHG functioning.

Alternate microfinance practices

The NGOs and other local bodies at village, block and district levels in the North Eastern States are encouraged to take up alternative micro-credit delivery mechanisms through direct funding.

Formation and operation of SHG Federations is supported and encouraged by NABARD. Similarly, networking of NGOs is also encouraged.

 Coordinating microfinance Efforts in India

NABARD coordinates the microfinance activities in India at international/ national/state/district levels. These include organizing international/national Workshops, Seminars, etc for experience sharing, Organizing National and State level Meets of Bankers and NGOs etc.

Dissemination of best practices in SHG / microFinance.

Monitoring and Review

Block/district/state level review meetings are organised and/or organised by NABARD. The relative documentation and database is also carried out by NABARD. In addition, periodical Monitoring studies are conducted through NABARD/Bank Officers. Internal Impact Studies and are conducted by NABARD periodically.

Future Agenda for NABARD 1. Presently, there are about 3 lakh credit-linked SHGs that are at least three

years old and could be considered for promotion of micro enterprises. The number of such mature groups would increase by about 2 lakh SHGs every year. The target audience, therefore, is huge.

2. There is no 'blue print' in the country for promotion of micro enterprises as the experience of most of the organizations working in this sector is limited and still at 'Pilot Stage'. 

3. As promotion of micro enterprises is a complex task and involves various types of interventions, it would be appropriate if NABARD can start off a few 'Pilot' projects with to view to help come out with a 'blueprint' for up scaling. Since the road map is not clear, the pilot would also provide the flexibility of changing the approach while learning from the field experience. The strategy proposed is as under:

a. We could identify 5-6 districts in the country from different regions for promotion of micro enterprises. The districts identified would be those, which have a large number of mature SHGs.

b. Microenterprise promotion is to be taken up only with mature groups. For the identification of right type of groups, a suitable mechanism will have to be devised for its use in the identified districts.

c. Market surveys can be carried out in the identified districts, if necessary with the help of outside consultants for resource mapping and identifying the right type of micro enterprises suiting to these districts.

d. Organizations can be identified in the districts that would be facilitating the identified groups for promotion of micro enterprises. NGO sector would be best suited for this task. However any other suitable agency in the Govt./ quasi Govt. sector may also be involved if available and found suitable.

e. Capacity building of selected NGOs/ agency SHPIs would be necessary as many of them though good in promotion of SHGs may have to build up their own capacity in skill development of microEnterprises. An organization having expertise or willing to develop the same in promotion of micro enterprises will be identified, in each district, and act ultimately as nodal Micro Enterprise Promotion Agency (MEPA). 

f. The role of identified NGO/ MEPA would be:

Identification of mature groups for promotion of microenterprise.

i. Building profiles of identified groups ii. Identifying groups/members who would like to work with the

on-going enterprises. iii. Identifying groups/members who would like to set up new

enterprises. iv. Assessing nature of facilitation required at group level v. Assessing training needs of group members

vi. Hand holding /escort services required by the group members  vii. Net working with various institutions for provision of

identified facilities including trainings and backward & forward linkages.

viii. The NGO/ MEPA should aim at empowering the group members to manage their affair on their own after a reasonable period of time for ultimate sustainability. In other words, a withdrawal strategy by NGO/ MEPA should work simultaneously with implementation of the project.

NABARD could assume the over-all responsibility for implementing the programme in identified districts.

PROBLEMS IN MICROFINANCING

These are the reasons about why SHGs, NGOs and Banks are sometime not interested in microfinance.

The SHGs and their members

If a marketing-oriented business is confronted with poor sales, it should look first at its customers, not to blame them but to find out if there is any way in which the product or its marketing are failing to satisfy their needs. The long history of subsidised schemes has, paradoxically, weakened the marketing skills of financial institutions. If a product is heavily subsidised it is natural, albeit erroneous, to assume that its beneficiaries will want it. The problem is perceived as one of ensuring that only those who deserve' it get it, not to market it.

There are in fact a number of reasons why many SHGs do not come forward as banking customers.

The SHG members have bad experiences of earlier schemes, which promised all manner of benefits, but which ended in disappointment; they do not wish to waste their time again.

The SHGs may not know that banks are willing to take their savings, and to lend them money; the banks have not marketed the new product successfully to them.

The SHG members may resent or be frightened of the intimidating or arrogant behavior of bankers or even the appearance of their offices. They feel that such places are not for them.

The SHGs may have sufficient uses for their own savings, and the rate of capital growth, because of the high interest rates they charge themselves, may build the fund at a rate which is commensurate with the growth in their investment opportunities; they do not need the banks.

The NGOs

The NGOs also have their own agenda, and there are good reasons why many of them too are unwilling to provide the escorting and linking service which is necessary in most cases.

The NGO staff, like the SHG members, may be disillusioned with schemes, and most bankers still call SHG linkage a scheme'.

NGOs are under pressure to become self-sustaining. They may prefer to become financial institutions themselves, rather than to develop customers for the banks.

Many NGOs are welfare oriented. They do not want to become involved in banking transactions, even as facilitators, but prefer to remain in their traditional fields of health, education and community development.

The Banks

This are the reasons that banks are not interested in microfinance:

Lack of knowledge and skills Organizational factors

Negative attitudes

Doubts to the profitability of the product

External factors such as government policies

These are the solutions:

Lack of Knowledge and Skills.

It is dangerously easy to exaggerate what can be achieved by training, but deficiencies such as the following are susceptible to well designed and well delivered classroom training, particularly if on-the-job training and effective communication support it.

In spite of the extensive programme of training and exposure which has been undertaken by NABARD through a range of institutions for some eight years, there are still many bankers who are unaware of the existence of the SHG market, or who believe it to be another scheme, rather than a market opportunity.

Even those bankers who are aware of the SHG market perceive it to be an exclusively rural phenomenon; they do not realise the potential in the fast growing urban areas.

It is possible to assess a SHG just like any other prospective borrower, but it requires different techniques, closer to those needed for inter-bank business, although on a much smaller scale.

SHG members and their elected officers are usually women. More than half of all women in India are illiterate, and a far higher proportion of poorer women cannot read and write. It is possible to communicate effectively with illiterates, but it requires different skills.

SHGs, and their members, may have no accounts, or if they do have some written records they are likely to be very different from what is expected of a traditional banking customer. Bankers can learn how to deal with such clients, but it needs training.

Organization Factors

Banks are usually large and necessarily bureaucratic organizations, with their own culture and methods of operation. The public sector banks in India have only survived many decades of political interference and mandated loss-making activities by building strong walls around themselves. They are thus even more resistant to change than most large organizations. Present conditions, however, are conducive to change, and a number of financial and other institutions are undertaking ambitious programmes of institutional development which are designed to remedy problems such as those listed below:

Staffs are punished for mistakes, but are not rewarded for innovation.

Even the most routine decisions are not delegated to branch level, or within branches. The long hierarchy of decision-making prevents the branches from offering the kind of service that SHGs need.

Banks, unlike the providers of almost every other product or service, from toothpaste to insurance or scooters to air travel, do not recognize their need for marketing intermediaries or middlemen/women, which is what SHGs are.

Banks and bankers are perceived by themselves and by their customers as operating from fixed premises at fixed hours, which are often inconvenient for SHGs.

Attitudes

It is harder and slower to change personal attitudes than to acquire skills, or even to re-engineer an organization. Such attitudes are even more difficult to change when they are unarticulated and strongly rooted in cultural tradition. Nevertheless, a combination of persuasive leadership and role models, realistic exposure, and the possibility of attractive reward or the threat of unemployment can change even deeply seated attitudes such as the following:

Bankers have been conditioned to believe that poorer people are weaker sections', for whom any form of banking service must necessarily be subsidised, and is only undertaken as an act of charity or because government regulations require it. They are not seen as potentially profitable customers.

The history of government sponsored and often politicized co-operatives not unreasonably leads bankers to believe that group activities are necessarily doomed to fail.

Bankers, if they are aware at all of NGOs, see them as radical activists or admirable social service organizations, but not as potential business partners.

Bankers are generally drawn from the educated middle class, and are socially, economically and physically distant' from poorer people.

Bankers are predominantly male, and SHG members are mainly women. Women are not perceived by men as capable of making business decisions, still less of managing a micro-bank' such as an SHG.

The banks have been repeatedly battered by a succession of ill-conceived and unprofitable schemes'; many not unreasonably regard SHG linkage and micro-finance as more of the same.

Profitability

There are some quite justified business reasons why bankers should hesitate to enter this new market, in spite of its apparent attractions. These must be clearly acknowledged.

Banks are under increasing competitive pressure in the urban corporate market, particularly as financial chaos elsewhere leads multinational institutions to look to India for new business opportunities. They may decide to focus their efforts on fighting this competition, and to withdraw from less profitable markets as fast as government and public opinion will allow.

A number of new generation' specialist micro-finance institutions are emerging, with funding from SIDBI and other sources. Some banks may make a conscious policy decision to leave this market to them in order to concentrate on their traditional and more familiar clientele..

Recent research (Harper, Esipisu, Mohanty and Rao) showed that the cost of developing and assessing an SHG is approximately Rs 7000. Although some groups develop themselves without assistance, and most come to banks ready made' by NGOs which are funded form other sources, this is clearly a high cost to acquire even some twenty new customers, since their individual business is very small, and some bankers are nervous of having to incur this cost themselves.

The vast majority of bank loans to SHGs are refinanced with heavily subsidised funds from NABARD. The spread of about 5.5% which this refinance allows is probably sufficient for traditional operations but may not be enough to cover the extra costs involved in entering this new and unfamiliar market.

SHGs cannot offer full collateral for their loans. The high rates of recovery may make collateral unnecessary, and much collateral is effectively uncollectible, but nevertheless bankers are always nervous to take on unsecured advances, particularly form a quite new group of customers.

Many SHG members, or more often their husbands, have defaulted on their repayments of earlier loans which they took under government sponsored schemes. Default has often been the norm rather than the exception on such schemes, but bankers are not unnaturally nervous to lend to people with a bad credit record.

The legal and position of SHGs is not altogether clear. It may not be possible to pursue recoveries through the courts, and they may be liable for taxation on the profits they earn by on-lending bank funds. Bankers rightly dislike uncertainty.

Policy Makers.

Bankers prefer to claim that things, which they cannot change, such as government policies, are responsible for their problems. This is always easier and less uncommon microfinanceortable than recognizing and then changing the things, which are under our control. Banking has been substantially deregulated over the last seven years, but some distortions still survive which make it more difficult, although by no means impossible, for bankers to start doing business with SHGs.

SHGs are willing and able to pay 18% or even more for their money, but the available subsidised refinance is only available if it is on lent at 12%. Banks are thus prevented from treating SHGs like any other customer, by using their own money and taking the higher spreads which some may find necessary. There is nothing, which actually stops them from doing this, particularly on larger loans to SHGs, but the 12% rate has been widely publicized and it would be very difficult for a bank to justify charging a higher rate.

Co-operative and Regional Rural Banks are free to charge any rate of interest they wish on any size of loan, but the commercial banks are still constrained for the smallest loans. SHG loans, particularly at the early stages, fall into this class.

Government still operates and indeed widely publicizes subsidised schemes such as the IRDP, although some of the worst abuses have now been corrected. Recovery rates on these loans are still low, and this inevitably continues to pollute the credit culture of the same communities from which SHG members are drawn.

Political interests in some states continue to promise debt forgiveness at election time. Such promises may not be fulfilled, but they would clearly include loans to SHGs.

One strong motivator for rural bankers in particular to do business with SHGs is their desperate need for new business, in order to make their branches profitable. Branch closures, as opposed to relocation, and the associated staff redundancies, however, are still unheard of. This substantially reduces the incentive to innovate.

The Way Ahead

This list of constraints is somewhat daunting, but it is hoped that it at least to some extent explains the disappointing progress of the SHG linkage programme. It might even be argued that the progress has been remarkable, rather than disappointing, given all these reasons why SHGs, NGOs and banks themselves may be reluctant.

Management has been described as 80% identifying the problems and 20% designing solutions, but it may be easier in this case to explain why progress has not been faster than to suggest how it can become so. The title, and the aim, of this paper, is to explain rather than to remedy, and many of the necessary changes are implied in the above statements of the problems.

It may nevertheless be useful to conclude with some suggestions as to ways in which some of the constraints may be removed. It should be stressed, however, that the present record demonstrates that doing business with SHGs can be and is profitable business for banks, in spite of the constraints. Bankers who are interested in entering this new market, or in expanding their present position in it, should not be discouraged or feel that they can go no further unless these constraints are removed. Their performance thus far shows quite clearly that it can be done, and the best way to encourage others to do it is for the pioneers to continue and indeed redouble their efforts.

The suggested remedies are given under the same four headings that were used to identify the problems.

The SHGs and their members.

The customer is king, or in this case more commonly queen, and is always right. Banks should, however, try to overcome SHG members' well-founded misconceptions by regarding SHG linkage as a product to be promoted rather than a scheme to be implemented. New savings and loan products are vigorously and effectively promoted with posters and in other ways. Why should the concept of group formation and saving, and eventual borrowing, not be similarly promoted?

NGOs

NGOs should decide whether or not they wish to be involved in SHG development. There is, sadly, far more than enough work for them in the traditional fields of health, education and community development, and NGOs, which wish to continue their work in these and other fields should not be diverted from what they are good at by the promise of donor funds. Donors, both local and foreign, should also avoid tempting NGOs into micro-finance when they are more than fully occupied in other work.

Those NGOs which do decide they should be involved should make micro-finance a major thrust area, rather than regarding it as a peripheral support activity for their other work. They should decide clearly whether they wish to evolve into micro-finance institutions themselves, by taking bulk funds and on-lending them, or whether they wish to focus on developing SHGs and then introducing them to banks. If they chose the latter course, they should attempt to share at least part of the cost of group development with the banks, so that the product can be self-sustaining rather than dependent on donor funding.

They should also themselves become as business-like as they expect their micro-finance clients to be; they should keep up-to-date records, they should

assess and attempt to reduce the cost of developing clients for the banks, and should train their staff to perform as efficient and effective client development staff for the banks.

Banks

The regulatory environment for banks has been largely liberalized, but the internal management environment is often as tightly controlled and illiberal as the external environment used to be. Organizational change is needed not only for micro-finance, but for the challenge of operating in the new and competitive market place, whether national or international.

Many of the branch managers and staff who have done business with SHGs have done it without any encouragement or even recognition from their superiors, and their initiative is to be congratulated. Senior management should, however, decide as a matter of policy whether they wish to be involved in micro-finance as an act of charity or public relations, or whether they wish to make it a part of their mainstream business. If they decide on the latter, they should ensure that all their staff, at all levels, receive the necessary training and support, and should monitor and encourage the growth of this component of their business as vigorously as any other.

Banks should also attempt on their own or in collaboration with NGOs to develop less costly and more rapid ways of developing groups, as at least two Regional Rural Banks are already doing. They should recognize that it costs money to acquire new customers, even rather poor ones, and should be willing to pay this cost, whether by contracting the task out to NGOs or by undertaking it themselves.

Policy makers.

The policy environment has already been very significantly liberalized, and the process is unlikely to be reversed, or even much delayed, by political intervention or for any other reason. Total interest rate liberalization is bound to come, but the single most positive step, paradoxically, might be for refinance to be stopped for SHG lending. This would force the banks to look at micro-finance as a market opportunity and not as a subsidised programme. Even if some banks decided not to pursue it further, others would almost certainly realize that there was money to be made from dealing with SHGs, and would aggressively pursue the market. The eventual result would be that far more groups would be reached.

As has been already pointed out, large segment of the poor in India still do not have access to institutional credit. Therefore making credit available and accessible remains crucial for long-term development strategy to end poverty. The absence of supportive law and regulation is one of the main constraints in the credit flow to the poor and needy. Therefore, there is need for creating microfinance specific law for regulation and supervision of microfinance organizations to facilitate and increase the size of credit and other finance flow to the poor particularly those in rural areas engaged in agriculture, allied activities and the non-farm sector. The government must

play a pro-active role in bringing about such policy reforms suitable to the needs and changing demands of the microfinance industry and the poor in particular.

The government must make efforts to;

1. Encourage the existing mainstream financial institutions to enter micro-finance seriously by establishing supportive and enabling policy and regulatory environment

2. Encourage new micro-finance institutions with a supportive policy and financial resources to enlarge and expand their services and

3. Promote community based development institutions with the help of NGOs/MFIs and others and facilitate adoption of best practices for micro-finance activities.

There is money available with considerable constraints for microfinance. There is a huge market but there is clear lack of retail institutions with very thin organizational / human resource capacity who can get involved and utilize for the emerging opportunities in social protection finance. Capacity building for the mission microfinance, for achieving scale, mobilizing resources in the form of borrowings and equity to ramp up the existing operations and organizations / human resource capacity that have complementary missions like insurance, social protection finance / housing is clearly lacking. Strategic recruitment for scale at the current scenario is not possible as the pool of human resource, who may get involved in this type of work is limited even though front loaded approach is cost-effective. So strategy that involves capacity building of organizations/ human resource both from the front-loading and back loading is important. This will involve anchored efforts of networks to create resource for social protection finance.

Recognizing that microfinance has impacted the lives and living conditions of the poor, the need of the hour is to bring a new architecture of building a wide network of microfinance institutions, NGOs and Self help groups and link them with formal financial institutions. At present the setting up of SHGs or NGOs/MFIs to support the microfinance sector is proceeding at a snails pace and a sense of urgency is lacking. We cannot wait for generations for such networking to emerge autonomously. Therefore, drawing up of a blue print for a structural transformation of the credit delivery system mainly targeting the poor and rural areas merits serious consideration.

The poor who have been left out in the development and designs of programs often meant for their development should be brought into the mainstream by empowering them through their own institutions. Microfinance programs helps in mobilizing the poor into groups, building community based, owned and managed institutions. Therefore, there is need for the establishment and growth of microfinance institutions, as these subsidiary institutions would provide a link between the rural poor and the mainstream financial system. Involving the poor in developing and designing programs for their own development would not only help in tackling the root cause of poverty but also trickle down the benefit of such development programs to the poorest of the poor.

In India, agriculture still holds the key to faster and over all GDP growth of the country because more than 75 percent of the population continues to depend on it. It also accounts for 60 percent of the total workforce and contributes 20 percent of

exports. Though, considered as a priority sector, it experienced credit squeeze in recent years. It is said that India could graduate into a high growth league of 9 or 10 percent by ensuring agricultural growth of 4 or 4.5 percent per annum. In order to make this happen, policies including credit and public investment must be put in place to facilitate the attainment of 4 to 4.5 percent growths in agriculture and supported by an explosion in non-farm employment in the rural sector. In addition, identifying and supporting new ventures such as floriculture, aquaculture, tissue culture and wormy culture etc. are new options and opportunities available and ensuring institutional credit flow to these segments is equally important. Similarly, identifying and promoting economically viable avenues of employment or projects and mobilizing financial institutions to support such enterprises, either directly or through the linkage of subsidiary institutions like micro credit institutions is vital in helping the poor.

Often finding donors who could bear the start up costs of forming groups is difficult. Since start up costs cannot be easily recouped, providing start up costs are under supplied. Thus there is a role for the Government and other donor agencies to support such start up schemes and encourage the poor to form their own groups by making use of the existing SHGs and community based organizations. Government and donors must also support institutional development programs such as management training, capacity building of NGOs/MFIs in the category of seed, sapling and trees etc. This will ensure the healthy growth of each organization in each and every stage of their growth and development and achieve their aim and objects of helping the poor as envisaged in their organization’s vision and mission.

A New Paradigm

A new paradigm that emerges is that it is very critical to link poor to formal financial system, whatever the mechanism may be, if the goal of poverty alleviation has to be achieved. NGOs and CBOs have been involved in community development for long and the experience shows that they have been able to improve the quality of life of poor, if this is an indicator of development. The strengths and weaknesses of existing NGOs/CBOs and microfinance institutions in India indicate that despite their best of efforts they have not been able to link themselves with formal systems. It is desired that an intermediary institution is required between formal financial markets and grassroot. The intermediary should encompass the strengths of both formal financial systems and NGOs and CBOs and should be flexible to the needs of end users. There are, however, certain unresolved dilemmas regarding the nature of the intermediary institutions. There are arguments both for and against each structure. These dilemmas are very contextual and only strengthen the argument that no unique model is applicable for all situations. They have to be context specific.

Dilemmas

Community Based Investor Owned

Community Managed Community (self)

financed Integrated (social &

finance)

Professionally managed Accepting outside funds for

on-lending Minimalist (finance only) For profit

Non profit / mutual benefit

Only for poor

'Self regulated'

For all under served clients

Externally regulated

The four pillars of microfinance credit system (Fig. 1) are supply, demand for finance, intermediation and regulation. Whatever may the model of the intermediary institution, the end situation is accessibility of finance to poor. The following tables indicate the existing and desired situation for each component.

DEMAND

Existing Situation Desired Situation

fragmented Undifferentiated Addicted, corrupted by

capital & subsidies

Communities not aware of rights and responsibilities

Organized Differentiated (for

consumption, housing) Deaddicted from

capital & subsidies

Aware of rights and responsibilities

SUPPLY

Existing Situation Desired Situation

Grant based (Foreign/GOI)

Directed Credit - unwilling and corrupt

Not linked with mainstream

Mainly focussed for credit

Dominated

Regular fund sources (borrowings/deposits)

Demand responsive Part of mainstream

(banks/FIs) Add savings and insurance

Reduce dominance of informal, unregulated suppliers

INTERMEDIATION

Existing Situation Desired Situation

Non specialized Not oriented to financial

analysis Non profit capital Not linked to

mainstream FIs

Not organized

Specialized in financial services

Thorough in financial analysis

For profit Link up to FIs

Self regulating

REGULATION

Existing Situation Desired Situation

Focussed on formal service providers (informal not regulated)

regulating the wrong things e.g. interest rates

Multiple and conflicting (FCRA, RBI, IT, ROC, MOF/FIPB, ROS/Commerce)

Negatively oriented

include/informal recognise e.g. SHGs

Regulate rules of game Coherence and

coordination across regulators

Enabling environment

Possible Alternatives/Options

The three options that emerge out of above discussion regarding structure of intermediary institution is discussed below.

Option-I One possible option is to increase the flow of funds to informal

lenders to supplement their own funds. The formal sector will take advantage of the lower transaction costs and risk premia of the informal sector so as to reach the low income group borrowers beyond the profitable reach of the formal sector. As for the beneficiaries, inspite of the transaction cost of the formal and the informal sector being transferred on to them, the cost of borrowing will remain low as compared to what exists through money lenders.

In addition, access to the formal sector funds could promote competition within the informal sector and check the exhorbitant profits being made in this sector. It also promotes allocative efficiency by offering a broader choice for the productive use of savings by beneficiaries, irrespective of which sector they are mobilised by.

Thus this approach of promoting linkages combines the strengths of both sectors to supplement the resources of the informal sector. Here it is imperative to avoid the pitfall of discouraging informal savings by substituting cheaper formal funds for informal lenders.

The existing modes of borrowing for the low income group through the Co-operative Societies like Thrift and Credit Co.op Societies are already gaining momentum. The Formal Financial Institutions can establish linkages with these co-operative bodies. Funds could be channelised from the formal financial institutions at market rates to the low income group beneficiaries through the intermediaries like the co-operative bodies stated above. The credit worthiness of the intermediaries would be the basic security for the loans advanced by the formal financial institutions. However, the savings mobilised by the intermediaries from the informal sector could also be accepted as collaterals.

The intermediaries could then lend to groups of beneficiaries. The transaction cost of the formal sector would be transferred on to the intermediaries who would pass on the same to the beneficiaries.

In the process, the intermediaries would also charge additional fees to borrowers to cover their costs. It would also aid them in strengthening themselves. However, it would be aimed to make the funds reach the beneficiaries at applicable rates of the two institutions.

The intermediaries would accept the savings from groups as collaterals and would transfer the same to the formal sector for getting the deposits serviced better. Thus the two way flow of funds would benefit both the formal and informal sector.

The beneficiaries would benefit as the cost of borrowing would be low for them and their savings would be safe and would be serviced better.

An analysis of community-based finance systems highlights the high establishment costs of NGOs. They suggest that loan service costs are lower amongst co-operative societies, as compared to NGO-linked CBFIs, because of decentralized loan administration and availability of voluntary staff. The NGO-linked CBFI operations are generally supported by grants from national and international donor agencies.

NGO-linked CBFIs must aim at an adequate scale of operation and while it may be supported by grants to meet establishment costs in the initial period, dependency on such grants should be reduced over time. An adequate interest rate spread must be available to meet the transactions costs. CBFIs should be able to recover all costs through its financial operations, by building up their capacity for financial management, through training and interaction with the Formal sector institutions.

Option-II Since it is now being felt that the existing structures are

inadequate to meet the housing and economic credit needs of the participating community, an Institution that would combine the strengths of an NGO and the expertise of a financial institution, with participation from the community will be appropriate.

Thus, the concept of Development Association for Savings and Credit (DASC) could be utilised to address the issue of providing better access to housing finance and economic loans for the participating community in the project area. The DASC is built on the strength of the informal groups to create and improve access to skills, resources and markets. These Groups mobilize savings from their constituent members and other formal/informal sources. The funds mobilized are thus used for meeting the credit needs of the members. The DASC is proposed to be a registered company which will affiliate the Groups based on affiliation criteria and have community representation on its decision making body.

The DASC will be initiated with the objective to create an alternate, self-sustainable, community based financial organization appropriate to meet the shelter development and livelihood needs of the weaker section belonging to the rural community.

The long term perspective of DASC will include :

Establishment of a resource centre for shelter and livelihood development for the weaker sections of the society.

Demonstration of a viable community based credit system in operation where the communities have access to and control over financial resources based on their own strength.

Developing group based approach as a sustainable development paradigm for community development.

Option-III As mentioned before, a review of the cooperatives and NGOs

illustrates a wide variety of arrangements as well as different stages of development of community-based financial institutions. In all cases, the strength of the community based systems is their close rapport and linkages with the community and its members. The broad arrangement involves a bulk loan from the Formal Financial Institution to the Community Based Financial Institution (CBFI) with specified terms and conditions for lending to households. The CBFI will have the responsibility for loan origination and servicing and therefore would also bear the credit risk.

In terms of specific arrangements, two forms of intermediation are envisaged by the strategy. The multi-tiered structure is one in which the bulk loans from the Formal Sector are routed through a Federation or Apex Agency or an NGO, which in turn lends to a primary CBFI. In the single-tiered structure, the Formal Sector Institution deals directly with the CBFI. It is felt that the administrative costs incurred with lending through the multi-tiered model are much higher than under the single-tier model.

In promoting these linkages between the Formal Institutions and CBFIs, directly or through the NGO, it is important that basic financial principles are developed for giving bulk credit to community-based financial institutions. The purpose of the loan, credit terms and underwriting criteria should be clearly defined for the bulk credit that is provided to the CBFI.

It is essential that a delinquency risk fund (DRF) be placed as a deposit with the Formal Institution to cover delinquency risk which may draw against the DRF if the CBFI fails to make a regularly scheduled loan payment. In order to meet the the DRF requirment, CBFIs should be encouraged to start a savings scheme. An appropriate legal status for the CBFI to be able to receive the bulk credit is essential. This may involve a simple registration under the Societies Act. The legal form should permit the receipt of bulk credit for onlending to the individual members.

JUMPSTARTING INDIA'S RURAL ECONOMY

Can India's rural economy be an engine for growth? If India's economic liberalisation initiatives haven't delivered the desired results; it is because they have largely excluded over 700 million people who live in rural India.

Economically empowering India's rural population will have a significant impact on India's economic growth. Economic empowerment is defined here as access to inexpensive credit (which Professor Muhammad Yunus, founder of Bangladesh's Grameen Bank, describes as a fundamental human right) and other microfinance services, including savings and insurance.

Here we will looks at new ways of encouraging rural enterprise by reducing the exorbitant interest rates that India's rural population currently pay.

The modern banking system has failed to deliver inexpensive credit to India's 600,000 villages - despite several expensive attempts to do so. Do we need to rethink the appropriate institutional structure for rural banking in India? Some suggestions for achieving this are offered here.

The problems of widespread poverty, growing inequality, rapid population growth and rising unemployment all find their origins in the stagnation of economic life in rural areas. There can be no national development without rural development.

The economic prospects for rural development are far from bleak (indeed, they show an astonishing robustness), as can be seen from the following facts:

Small scale and cottage industries (despite their comparatively restricted access to credit) employ ten times as many workers as heavy industry in India, upwards of 30 million people.

While capital-output ratios have been steadily deteriorating since independence in the heavier capital intensive industries, they look a lot healthier in small and cottage industries. Furthermore, heavy industry usually needs to be located in urban areas.

Small scale and cottage industries, on the other hand, can be located almost anywhere throughout the country, and facilitate the dispersion of economic wealth rather than its concentration.

Many small scale and cottage industries don't even require access to electricity, the scarcity of which is a major bottleneck for industrial output. Wide range of output: Modern small-scale industries produce a wide range of goods from comparatively simple items to sophisticated products such as television sets electronic control systems etc.

Among traditional village industries, handicrafts possess the highest labour productivity, besides making a significant contribution to earning foreign exchange for the country.

Stemming rural-urban migration: The Industrial Policy Resolution of 1956 notes that "Some of the problems that unplanned urbanisation tends to create will be avoided by the establishment of small centres of industrial production all over the country."

The Lewis-Fei-Ranis model offers us the insight that urban wages would have to be at least 30 per cent higher than the average rural income to induce workers to migrate from their home areas. At this urban wage level, the supply of rural labour is considered to be perfectly elastic. The Todaro migration model, however, postulates that migration proceeds in response to urban-rural differences in expected rather than actual earnings.

However, the rural economy's development potential - and with it, the growth prospects of the entire Indian economy - are not going to be achieved without the availability of (a) affordable credit, (b) in adequate quantities (c) at the right time.

But how does one go about creating an efficient credit delivery system that offers affordable credit, in adequate quantities, at the right time, in India's 600,000 villages?

It is known that the organisation and structure of commercial banks are not identical in all countries. The differences are dictated by a number of local factors like geographical spread, political factors, economic conditions and traditions, not to mention population density and dispersion.

Although the branch-banking structure that we adopted from Britain's banking tradition has served India's urban centres well, all attempts to extend this institutional structure to India's rural areas have resulted in inadequate coverage, and frequently proved to be expensive failures.

The earliest form of commercial banking was necessarily unit banking which simply means that the entire banking operations were conducted from a single office.

Unit banking has already proven its effectiveness for providing an efficient credit delivery system under conditions similar in several important respects to those prevailing in rural India today:

Until recently, large areas of the U.S.A. were underpopulated. The considerable distances between population centres, the difficulties in travel and communication, and the agrarian nature of the economy all fostered the development of unit banks that were locally organised, owned and operated.

Unit banks financed the development of the U.S. economy, and are still prevalent there to this day. They offer many of the advantages of branch banking like providing remittance facilities through a system of `correspondent banks', not dissimilar to our own `lead banks'.

Although unit banks today are able to offer the same range of financial services that branch banks provide, they tend to be closer to the communities they serve, and understand their needs better.

Another advantage of the unit banking system - not insignificant from the perspective of a Central Bank and `lender of last resort', is that the `domino effect' of an individual bank's failure is limited in comparison to that within a branch banking system.

How does one establish Unit Banks in 600,000 Indian villages? The answer is that `unit banks' already exist in every Indian village, and the RBI doesn't have to spend a single rupee in capital outlays for establishing them...

It is known that the writings of Manu dating back five thousand years contained references to banks in India, as did the writings of Kautilya. India's indigenous bankers have a presence in every Indian village, and supported a thriving rural economy prior to colonial rule and the onslaught of the industrial revolution which devastated India's rural economy and marginalized the majority of India's people. The Industrial Commission Report (1918) notes that "At a time when the West of Europe, the birth place of the modern industrial system, was inhabited by uncivilised tribes, India was famous for the wealth of her rulers and for the high artistic skill of her craftsmen."

Having survived the vagaries of time - famines and floods, colonial policies, and more recent attempts by the organised financial sector to marginalia them - India's indigenous bankers continue to occupy a prominent position in India's financial markets. According to the Shroff Committee on Finance for the Private Sector, between 75 and 90 per cent of the total internal trade of the country is being financed by India's indigenous bankers.

The Banking Commission (1972) recognised that the indigenous bankers play a useful role in as much as they make credit available to those sectors (small-scale business units and the retail trade) which are productive but which are generally not assisted by commercial banks either on grounds of cost or the risk involved. The Commission noted that the indigenous banker's methods of operation are both expeditious and flexible...

Integration of India's financial markets is essential for effective monetary policy. Despite the predominant role played by the indigenous bankers in India's economic life, they have always remained outside the pale of organised banking, and beyond the influence of the Reserve Bank of India.

Yet an integrated financial market that responds to the guidance and leadership of the Reserve Bank of India is an essential prerequisite for an effective monetary policy.

As early as 1931, the Central Banking Enquiry Committee emphasised the necessity of unifying the two sectors of the Indian money market, and recommended the linking of the indigenous bankers with the Reserve Bank of India, after the Reserve Bank was established.

Having (with one interesting exception) been treated with undeserved contempt by the modern, largely westernised financial sector led by the RBI, it's hardly surprising that the Reserve Bank's influence with India's indigenous bankers has regrettably been limited.

The key to reversing this unhappy situation lies in cultivating and demonstrating greater respect for the rich heritage, and continuing contribution, of India's traditional financial sector.

An important lesson can be learnt from the State Bank of India's predecessor, the Imperial Bank of India, which achieved a measure of influence in the early years of this century with the indigenous bankers (even influencing the interest rates they charged) which had never been achieved before, and hasn't been achieved since.

The Imperial Bank of India achieved its unprecedented influence simply by respecting the indigenous bankers age-old ways of doing business, and offering them rediscount facilities without cumbersome conditionalities. The impact of providing refinance to

indigenous bankers, particularly during the busy agricultural season between November and June, was lower rural interest rates…

THE FUTURE OF MICROFINANCE IN INDIA:

A Long History of Social Banking

India has supported social banking for a long time. Policy directions to rapidly expand rural branches, mandate credit allocations for priority sectors (including agriculture), deliver large subsidy oriented credit programmes to serve marginal communities and poor households and control interest rates have been tried for over 35 years. The new generation microfinance was slow in coming to India. Low levels of grants to microfinance institutions, an unfavorable policy environment, substantial traditional banking infrastructure and a search for context specific solutions has constrained rapid scale up. The first breakthrough emerged from policy support to enable informal self help groups of 15-20 members (mainly women) to transact with commercial banks. These groups build up and rotate savings amongst themselves, open bank accounts and take responsibility for lending and recovering money financed by banks. With the missionary zeal of the National Bank for Agriculture and Rural Development (NABARD), insights gained by NGOs, the increasing enthusiasm of bankers and politicians and emerging successes in repayment and social impacts, this national movement now encompasses 1.4 million such groups (over 20 million members). At a time when many questioned the need for specialised microfinance institutions (MICROFINANCEIs) in India, the Small Industries Development Bank of India recognised the opportunity and started implementation of an ambitious national programme. Providing loan and capacity building support to MICROFINANCEIs and capacity building and rating support for sector development, this programme already supports 70 MICROFINANCEIs and has disbursed US$46 million.

What is Exciting about Indian Microfinance?

A Task Force on Microfinance recognised in 1999 that microfinance is much more than microcredit, stating: "Provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and or urban areas for enabling them to raise their income levels and improve living standards". The Self Help Group promoters emphasise that mobilising savings is the first building block of financial services. For many years, the national budget and other policy documents have almost equated microfinance with promoting SHG links to the banks. The central bank notification that lending to MICROFINANCEIs would count towards meeting the priority sector lending targets for Banks offered the first signs of policy flexibility towards MICROFINANCEIs. One could argue that MICROFINANCEIs are small and insignificant, so why bother. The larger point is about policy space for innovation and diversity of approaches to meet large unmet demand. The insurance sector was partially opened to private and foreign investments during 2000. Over 20 insurance companies are already active and experimenting with new products, delivery methodologies and strategic partnerships.

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

Lending wholesale loan funds. Assessing and buying out microfinance debt (securitisation). Testing and rolling out specific retail products such as the Kissan (Farmer)

Credit Card. Engaging microfinance institutions as agents, which are paid for loan

origination and recovery, with loans being held on the books of banks. Equity investments into newly emerging MICROFINANCEIs. Banks and NGOs jointly promoting MICROFINANCEIs.

The 2005 national budget has further strengthened this policy perspective and the Finance Minister Mr P. Chidambram announced "Government intends to promote MICROFINANCEIs in a big way. The way forward, I believe, is to identify MICROFINANCEIs, classify and rate such institutions, and empower them to intermediate between the lending banks and the beneficiaries."

What is beginning to happen in microfinance can be seen from the perspective of what has happened to phones in India. With the right enabling environment, and intense competition amongst private sector players, mobile phones in India expanded by 160% during just one year 2003-04 (from 13 to 33 million). Mobile tariffs fell by 74% during the same period. While this is heady progress, there is a less heralded but even more powerful nationwide success on access. In the late eighties, the phone infrastructure was the monopoly of public sector institutions. Phones were difficult to get and even more difficult to use for those lacking ownership. Realisation that users need not own a phone to access one led to privatisation of the last mile - where a phone user could interface with a private sector provider using the public sector telecom infrastructure. Even with this policy change, today there are 2.5 million entrepreneurs selling local, national and international phone services through the length and breadth of India. Many of these are now graduating to sell internet services and could potentially be banking agents - that is the evolving story. Savings services are needed by many more customers and as frequently as access to phone services. Many poor households value access to savings services and find new providers and arrangements, despite hearing of unreliable savings collectors or even occasionally falling prey to such arrangements. Many customers are rich, literate and lucky to have banks working for them. But many others lack access to safe, secure and accessible savings services for the short, medium and long terms.In the past, many banks sent collectors to gather these savings but problems with monitoring, inability to tackle misappropriation and the rising aspiration of collectors to become permanent staff of public sector banks killed a useful service. The central bank has strictly forbidden commercial banks from using agents in collection of savings services. This is unfortunate as:

Effective microfinance delivery is about managing transaction costs for providers and customers.

A combination of agents and technology can play a powerful role in rightly aligning incentives for the collector and customers, while keeping transaction costs manageable for everyone.

The banks can only open so many branches, and fixed and operating costs are high, apart from approvals still needed from the central bank to open new branches or close existing ones. The appointment of agents can keep costs manageable and offer greater flexibility to Banks.

Banking service may not be able to defy the commercial logic pursued by most other sectors where a variety of retailers provide services to customers, while companies focus on customer needs, product design, quality control, branding, logistics and distribution.

Fortunately, the 2005 Budget opened a small window in this area and the central bank annual policy recently confirmed discussions on this: "As a follow-up to the Budget proposals, modalities for allowing banks to adopt the agency model by using the infrastructure of civil society organisations, rural kiosks and village knowledge centres for providing credit support to rural and farm sectors and appointment of micro-finance institutions (MICROFINANCEIs) as banking correspondents are being worked out." But readers may note that between the budget and the annual policy statement, "credit" has again crept in as the key perceived need.

Challenges Remain

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

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

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

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

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

Closing Remarks

In my view, savings service is the neglected daughter of the family of financial services. I use this metaphor because of the sustained discrimination against and frequent disregard for savings services, despite their productive and reproductive role in financial services.This is evident from different nomenclature used at both the international (UN International Year of Microcredit, MicroCredit summit) and national levels (Priority Sector Lending; Annual Credit Policy; Credit/ deposit ratio). Savings services can be a useful entry point for the unbanked to build up a history with the formal financial institutions before customers are entitled to other financial services. With the greater spotlight on knowing the customer and the fact that poor households do not have a salary slip, utility bills, clear land titles or unique identity papers, a regular savings record could be the first building block to membership of the formal financial sector. What is more, with savings services, poor customers need to trust the financial institution and not the other way round. Microfinance is not yet at the centre stage of the Indian financial sector. The knowledge, capital and technology to address these challenges however now exist in India, although they are not yet fully aligned. With a more enabling environment and surge in economic growth, the next few years promise to be exciting for the delivery of financial services to poor people in India. I would like to congratulate CARE, as the lead organisers, for successfully hosting this global cross learning event. Unusually, the event ended with a statement of some objectively verifiable indicators (such as expansion of urban microfinance, increased conference participation by public sector banks and redressal of North South divide) on which the sector should track progress in a years' time.

SUGGESTIONS

CONCLUSION

Some valuable lessons can be drawn from the experience of successful Microfinance operation. First of all, the poor repay their loans and are willing to pay for higher interest rates than commercial banks provided that access to credit is provided. The solidarity group pressure and sequential lending provide strong repayment motivation and produce extremely low default rates. Secondly, the poor save and hence microfinance should provide both savings and loan facilities. These two findings imply that banking on the poor can be a profitable business. However, attaining financial viability and sustainability is the major institutional challenge. Deposit mobilization is the major means for microfinance institutions to expand outreach by leveraging equity (Sacay et al 1996). In order to be sustainable, microfinance lending should be grounded on market principles because large scale lending cannot be accomplished through subsidies.

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

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

FINDING

ABBREVIATIONS

ADB Asian Development Bank AIRCSC All India Rural Credit Review CommitteeAMC Ahmedabad Municipal Corporation CCBs Central Co-operative BanksDIC District Industrial CenterDCCB District Central Co-operative BankDWCRA Development of Women and Children in Rural AreasFRFI Formal Rural Financial InstitutionsGDP Gross domestic product GSFC Gujarat State Financial CorporationHDFC Housing Development Finance Corporation HFI Housing Finance InstitutesHUDCO Housing and Urban Development Corporation ICAR Indian Council of Agricultural ResearchIRDP Integrated Rural Development ProgramLIG Low income groupsMAK Mahila Antodaya KendraMICROFINANCEI Microfinance Institution MICROFINANCEO Microfinance OrganizationMHT Mahila Housing Trust NABARD National Bank for Agriculture and Rural DevelopmentNGOs Nongovernmental organizations PLDBs Primary Land Development BanksRBI Reserve Bank of India (for cooperative banks) RRBs Regional Rural BanksSEWA Self Employed Women’s Association SC Scheduled CasteSCBs State Co-operative BanksSEBC Socially Economic Backward ClassSFT Shroff Foundation TrustSHG Self-help groupsSLDBs State Level Development BanksST Scheduled TribesVOs Voluntary Organizations

BIBLIOGRAPHY

www.microfinancegaeway.orgwww.nabard.orgwww.rbi.gov.in

“MICROFINANCE Emerging Challenges” BY Kishanjit Basu & Kridhan Jindal“State Focus Paper-Gujarat 2006-07” By NABARD Gujarat Regional Office“Jumpstarting India's Rural Economy” By Imon Ghosh