Annie duflo

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Developing products for rural markets

Annie DufloCentre for Micro Finance at IFMR

February 14, 2007

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Appropriate products for rural markets…

• Need to be delivered through appropriate channels

• Need to answer the demand of rural clients• Need to be appropriately priced

– To allow sustainability– To be affordable

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Outline

• Products for the rural market: The microfinance innovation in India

• Microfinance in India: delivery models

• Product innovations for rural markets: status and challenges– Credit products

– Non credit financial products

– Non financial services

• Pricing and transaction costs

• The role of the Centre for Micro Finance

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Information Asymmetry• Higher for the poor• No credit history• Difficulty to evaluate

enterprises potential success

• Inability of the poor to offer collateral

Clients’ profile • Difficult geographical access• Poor require low value transactions• Informal activities: need flexible access• Illiteracy: difficult to deal with traditional

services• Lack of financial literacy: need close

supervision

Regulatory Issues

Constraints to scaling access for the poor

Staff Incentives within traditional organisations not aligned to maximise access to financial services for poor

Provision of financial services to

the poor is constrained by…

High transaction costs

Low level of Technology

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…Hence the need for local intermediaries

• Local organizations have:– Local knowledge, therefore can help reduce

information asymmetries– Have less expensive operations, can therefore

help reduce transaction costs.

• But local organizations don’t have capital• Banks have capital, but done have this

local knowledge• Both should join hands!

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Microfinance in India: apparition

• Until the 90’s despite various efforts and achievements by the government, the banking sector was unable to internalise banking to the poor as a profitable activity

• Financial sector reforms: motivated policy planners to search for strategies for delivering financial services to the poor in a sustainable manner with high repayment rates.

• NABARD: empirical observation catalysed by NGOs that poor gather in informal groups

SHG-Bank Linkage Programme (92)• Recent emergence of MFIs: professionally run institutions

specialized in delivering credit with low cost staff and local knowledge

• Key innovation in both models was to make use of local knowledge, which traditional banking system does not have.

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The microfinance promise

Innovations

New Management

structures

New attitudes

New contracts

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Outline








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Predominant model of microfinance in India: SHG-Bank linkage model

SHG

NGO

Loan to group

No liability

6 months savings

commission

BankRepayment

Branches assess credibility of SHGs and monitor repayment process

Group formation and linkage

Efficient use of capital YIncentive alignment N

Grants based

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Recently emerging model: financial Intermediation by MFIs

Double counting of capital by bank and MFI Organization-based lending: Higher pricing than warranted by riskiness of portfolio

MFISHG, JLG

or ind. Bank

Loan Loan

Bank lends to MFIs based on their capital

MFI on lends

MFI’s capital sets risk absorption capacity hence limits for TL

On-lending of same fund at Bank interest rate+MFI trans. costs

Efficient use of capital NIncentive alignment Y

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These models have limited growth

• With SHGs, relatively low rates of growth resulting from– NGO reliance on grant funds to meet costs– Banks wary of large portfolios in the absence of risk

sharing structures

• With MFI intermediation, although underlying portfolio exhibits very low loss rates, sub-optimal lending structures have resulted in– Lower flow of resources

Capitalization of intermediary is the constraining factor– Higher pricing than warranted by riskiness of portfolio

Charge on capital reckoned twice Bank/FI take into account riskiness of the intermediary

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These models could not resolve the paradox of limited supply

•A burgeoning segment with very large demand for finance

•Grass-root agencies capable of providing origination and supervision support in a cost-effective manner

•Banking system capable of providing large quantum of wholesale finance (owing to priority sector targets)

•However, there are no ‘natural providers’ of risk capital for microfinance and this has constrained the growth of several MFIs

•As a result, supply is still a small fraction of the demand for finance

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Needed a model which:

• Addresses inability of MFIs to provide risk capital in large quantum, which limited advances from banks

• Allowed rapid scale-up• Separates risk of MFI from risk inherent in

the mf portfolio• But still provides a mechanism to

continuously incentivise partners

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The Partnership Model

•Intermediary assumes fraction of the credit risk, leading to reduction in capital required •Bank prices on basis of underlying asset rather than rating of intermediary ( ‘asset-based lending’)

MFI(servicer)

SHG, JLG or Ind.

Bank

Loan at 9%-11% to end customer

FLDG

Repayment collection

Risk Sharing Origination, monitoring, collection

Service feeService fee

OD Reduces capital needs

Efficient use of capital YIncentive alignment Y

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…leverages each entity’s advantage which are complementary

MFI Bank

Strength

Weakness

• Social Capital• Local knowledge• Low cost delivery

channel

• Access to financial markets

• Financial product expertise

• Technology

• Financial volume / expertise

• Product innovation• Technology

• Low outreach in remote areas

• Poor local knowledge• Inadequate cost of

delivery to serve the low income population

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Limitation of the partnership model for MFIs

• Most banks still using TL, hence reducing MFIs diversification of lenders

• Level of FLDG dependent on one single lender’s risk evaluation (vs. public market)

– Level of FLDG based on processes and PAR*

• No secondary markets for lenders reduces their own liquidity (microfinance not an asset class)

• Facilitate growth by reducing MFIs’ challenge to provide risk capital in large quantum

– Off-balance sheet– FLDG as OD (quasi equity)

• Improves RoE by equity freed up (leverage from 3-4 to 10-12)

• Separates institution and underlying portfolio risks

• Continuously incentivise partners on portfolio quality

Advantages Limitations

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Difference between SHG-Bank linkage and MFI model

• better savings habit• stronger group cohesion• lower interest rates

SHG

Grameen

• MFIs have to cover all intermediation costs– Interest rates are higher– However interest rates charged by SHGs to clients are

similar

• tighter control and monitoring• clients can borrow immediately without savings• loans disbursed are higher and individual• loan tenure shorter, allowing to increase loan size faster

•Choosing a model depends on the clientele the organization wants to cater to

• Grameen model is likely to be suitable to serve tiny enterprise owners and SHG model might be used to serve the wage labourers and farmers or group enterprises

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MFIs in India

• Currently, roughly 66% of the micro finance supply is via the Self Help Group (SHG)-bank linkage route

• However, MFIs grow faster now, in terms of number of clients and credit flow

• The share of MFIs is rapidly growing• There are about 800 MFIs in India

(NABARD)• However the top 15 MFIs account for about

70% of the credit through MFIs

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Comparison between SHG-Bank Linkage & MFI model

Sources : Rough estimate derived from a presentation at a Microfinance Stakeholder Consultation Meeting in Delhi in January organized by the World Bank. Major sources are NABARD Annual Report & Data collected by ICICI Bank.Assumption : MFI disburse 1.5 time of Yr-end O/s loans – Ratio from M-CRIL data

India annual Microfinance Disbursement

Share in microfinance disbursement by model

Rs

bil

lio

n

Year

% s

ha

re i

n A

nn

ua

l D

isb

urs

em

en

t

Year

billio

n $

0

5

10

15

20

25

30

35

40

45

50

1996 1999 2002 2005

0

0.2

0.4

0.6

0.8

1

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2001 2002 2003 2004 2005

MFIsSHG

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Outline



• Product innovations for rural markets: supply and challenges– Credit products





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MFIs Models and products (credit)

“Grameen” product

Individual lending

Emergency loans

• 50 weeks tenure• Weekly meetings and repayment• Joint liability in groups of 5 to 10 members• Often given for productive purposes only, often with close

monitoring of loan usage• Loan size range from Rs. 3000 to Rs. 15,000 – increases

with loan cycle

• For new borrowers or “star” borrowers (most of the time)• With or without collateral or guarantors/guarantees• Generally, not beyond Rs. 1 lakh• Different repayment schedules (for ex, daily or monthly)

•Existing clients•1000 to 2000 Rs•For emergency purposes such as health etc.

•“Grameen” product is the most widespread•So far products have been very standardized (which has advantages but also limits customization for clients)

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Repayment schedules: vary schedules

• Weekly schedules may be more or less appropriate depending on nature of businesses

• CMF-VWS study: Most businesses can be categorized in two types: piece based or independent businesses. – For the first type, weekly payments make more sense.

Market based clients seem to prefer monthly payments as they sell on credit and can not always recover their payments every week.

• Need longer term loans with moratorium– Existing product implies clients already have a business

or an income source, is not suited for financing start-ups

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Repayment schedules: allow flexibility

• Fixed debt contracts have a rationale– avoiding operational headaches, cash management

problems, risk of loan officer fraud and weakened repayment discipline of borrowers

• But benefits of flexibility could be huge– With fixed schedules, repayment capacity based on

incomes of worse weeks/months, limiting loan size– The rigidity of contracts may be keeping some borrowers

from borrowing or clients with rigid contracts may take actions which reduce the return on their investments.

• CMF Case study in ASA and Cashpor: some forms of production (sari and carpet weaving) experience significant variance throughout the year– low availability of labor in harvest and festival seasons,

humidity and moisture from the rainy season etc.

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Loan size: often seems too small

• In some Hyderabad slums, before microfinance introduction, businesses were very prevalent (31% of households) – often low-skilled, very small

• It seems possible for most household to expand the business, and yet they have not expanded, so there was a clear role for an MFI

• Average monthly sales proceeds were Rs.13000 while average profit was Rs.3040 per month.

• A Rs 7,000 loan is probably not sufficient to greatly expand the business.

• Small loans have a rationale when there is no competition (teach clients financial discipline etc.)

• However when there is competition, MFIs may want to give larger loans directly..

• But too large loans would require evaluating the client, which is too costly to do for everybody.

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Therefore.. need for individual lending

• Group lending is constraining the most entrepreneurial clients

• After all, not everybody can be a successful entrepreneur. For example, in the OECD only 12% of households run a business

• Some clients need larger loans, and customized to the business

• Already exists, but preliminary stages• Makes more sense for MFIs to provide it for

existing clients

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Group Lending vs. Individual

• Individual lending model bears some additional risks:– Difficulty in evaluating individual credit risk in the

absence of sound credit-scoring mechanisms – Higher risk of default if the borrowers are unwilling to

repay• Group model, on the other hand, has the risks of

– Higher default due to problems in group dynamics – Increase in drop-out rates due to differences in credit

absorption capacity of clients and changing client needs– The individual model is suitable to serve the not-so-poor

population who can afford to provide some guarantee• The group-lending is best suited to serve the

poorer segments but does is not optimal for graduated customers

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Example of individual lending: SKS

• Loan given to borrowers which are in business for more then 1 year, and only old SKS clients

• Guarantee of a govt. employee/of a farmer with land of more than Rs. 1.5 lakh market value/ of a businessman having a business asset of Rs. 2-3 lakhs

• SKS should have min. of 8 months of operational experience in that area

• Loan amt: Rs. 20,000-100,000 • Term period:1-2years • Interest rate: 11% yearly flat• Repayment schedule: Monthly • Purpose: Income generation and asset development purpose

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Individual lending: WWB Methodology

Key activities in the lending process:

• Analysis of1. Balance Sheet of the business2. Income Statement of the business3. Family cash flow4. Investment Plan5. Character Assessment

• Operating Model1. Staff profile & training2. Branch location & infrastructure3. Efficient information system

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Outline








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What low income clients need?

Protection against Health

shocks

Need to build or improve homes

Lifecycle needs

Send money to their families when migrate

The needs of poor people are varied..

Protect against sudden death

Protection against weather shocks

Protection against loss of assets

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MFIs Models and products (non credit)

Insurance

Savings

Remittances

• Most often as agent of insurance company • Most common product is life insurance• Bundled with credit• Health insurance emerging

• MFIs not allowed to collect deposits• Banking correspondent model (few MFIs

have adopted it yet)

• Rare product• One MFI in Orissa: Adhikar• One MFI in Udaipur: Ajewika Bureau

Housing loans

• Rare product• Focus on individual loans• A few MFIs provide housing loans: IASC,

ESAF

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Insurance products

• Protect against loss of assets, damage of property etc. Example of Sewa Bank comprehensive insurance

• Protect against illness– often, failure of business is due to illness that led to low

availability of labor– Defaults or drop out often due to health shocks

• The delivery of insurance through MFIs is attractive: – Can keep costs relatively low (channels, compulsory product)– It protects the MFI as well

• Health insurance companies products start being sold by MFIs, where MFI is the agent

• Experience so far suggests that insurance literacy is low and proper awareness campaigns are necessary

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Remittances

• Substantial seasonal migration with large inter-regional financial flows. NSS surveys (’93) indicate 89% of permanent migrants send remittances back home. Likely to be higher among seasonal migrants.

• But high transfer costs associated with remittances limit propensity, distance and duration of migration. Cheap and reliable channels are rarely available in rural areas

• Program run by Adhikar, Orissa: 1600 members remitted almost Rs. 6,00,00,000 in 2 years of launching program

• Apart from being a viable program, MFIs can leverage existing client networks; provide cheap and safe transfer; add on services.

• Legal Issues in MFIs collecting savings–BC is a possible solution. Scope for MFI to act as money transfer agents also?

• Stiff competition from informal agents which are quicker and often cheaper

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Housing Finance

• Challenge worldwide to provide low cost shelter for urban and rural poor – a basic need for poor households. Constraints: for Big Banks/financiers – recovery is a problem and for Small organizations – Lack of capital

• MFIs are a great solution as they can act as agents for larger financiers and have expertise in dealing with small amounts and their recovery

• So far, unsophisticated product – usually just a larger loan. Otherwise, mostly NGOs who have implemented government subsidized programs

• Few MFIs currently providing housing finance but there is a lot of interest in the sector

• Challenges include: innovative product design for upgradation and ownership; issues of legal title to land; competitive interest rates etc.

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Product development: what about the poorest of the poor? • So far, MFIs and SHGs do not reach the poorest

– In AP, the 2 income quintiles above the poorest HH are more likely to receive microfinance through SHG-Bank model, while the poorest and those in the top 2 quintiles are less likely to be in SHGs (Priya Basu, WB)

• Poorest are not micro entrepreneurs yet – could they become one?

• Poorest have no ability to repay – at least not with standard product

• May need more flexible products• Or need to be pushed up to a level where they can

repay• BRAC Target the Ultra Poor (TUP) programme:

asset transfer, skill training, handholding, health grant

• Bandhan in India

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Outline








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Non financial constraints: Skills and Innovation

• Often, low skilled businesses and little innovation– Study in ASA and Cashpor: Of all clients interviewed, only

5 out of 105 demonstrated some entrepreneurial spirit (have begun businesses that are different than traditional activities chosen by most other members).

• When little specialized skills involved in the businesses, the more businesses start, the more they will crowd each other out.– CASHPOR clients weaving saris: returns per sari had

often decreased by as much as 60% in the past 5 years.

• Few businesses grow beyond the size of household business.

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Non financial constraints: Skills and Innovation

• Why is this happening and what should be the role of MFIs in this?

• Might be dangerous to advise people on what to do – but can create information sharing

• Some businesses fail due to poor management skills Need for financial training and basic business skills– Sewa Bank business and financial literacy training– Can partner with other agencies to provide business

development training or mentoring services (BYST)

• Credit is only one side of the story: need to link to a higher value chain, create links between the borrowers and potential buyers

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Outline








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MFIs’ strategies to provide affordable products while being sustainable

• Serve the poor, including the poorest of the poor– Interest rates as percentage of loan higher for small loans

• Offer affordable products for the poor– Need to find strategies to reduce transactions costs and

access cheap funds

• Be sustainable– Cover costs– Need good repayment rates, therefore requiring

expensive operations

• Serve as many poor as possible– Need profits to expand access

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How to calculate a sustainable interest rate?

The annualized effective interest rate (R) charged on loans will be a function of five elements, each expressed as a percentage of average outstanding loan Portfolio

• Administrative expenses (AE) – Administrative expenses of efficient, mature institutions tend to

range between 10%–25% of average loan portfolio (in india can be lower).

• Loan losses (LL) – Many good institutions run at about 1–2%.

• The cost of funds (CF), India 10%• The desired capitalization rate (K)• Investment income (II) income expected from the MFI’s

financial assets other than the loan portfolio (e.g., cash, checking deposits, legal reserves)

• Example (India context): 10+2+10+2+2-2=24%

Source: CGAP

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MFIs’ interest rates in the world

Indian MFIs are the most efficient in the world (M-Cril)

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Why are transaction costs of MFIs high?

• Door step services• Intense monitoring• Repeated interaction

– If one customer interaction may costs only US $0.25 due to the high number of interactions, this translates into 25 percent of operating costs relative to the average loan portfolio

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What are the drivers of costs?

• Group formation (17-23% of total direct transaction cost) and collection (28-36% of total transaction cost) are the main components of transaction costs

• The main driver of direct transaction cost is the level of compensation of the field worker

• This would vary according to geography: An MFI in a difficult geography has to pay a higher compensation level for its employees

• Location, degree of competition, maturity of branches, seem to have an impact on transaction costs.

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Possible strategies to reduce MFI transaction costs

• Increase field worker productivity– saturate a place before entering another place– Sell more products

• Experiment with staff Incentives Schemes– Focus not only on volume but also on retention as costs

higher for first time members• Simplify Systems and operations as much as

possible– ASA, Bangladesh: simplified operations so that they

could be performed by less-educated staff• Can supervision levels be relaxed/modified for

mature customer groups?

Staff costs

Operations levels

• Increase branch activity: sell more products• Less “layers” of operations: models without

branches (for ex, only area offices and mobile branches)

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Possible strategies to reduce MFI transaction costs

• Repayment schedules: experiment with less frequent schedules! If no more defaults, could lead in less transaction costs

• Take into account the lifecycle cost also when pricing the loans. Merely looking at first year costs may result in overpricing of loans– may drive away some good borrowers

Products and pricing

Technology

• Maintenance & centralization of customer's record (bio-metric identification, credit bureau) to avoid many legal documents (eg. KYC) - So that credit worthiness of clients can be access quickly

• Role of technology: Innovative delivery channel (rural kiosks, mobile telephony, smart cards etc.) - This helps in serving large client base with less resources but one time investment is high

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What can banks do?

• Provide funds to MFIs, either through term loans or partnership model

• Lend to Self Help Groups• Provide grants or long-term loans for

infrastructure development

Delivery channels

Product development

• Help MFIs with expertise in product development

• Link MFIs with other companies that have expertise in product development, for ex. Insurance companies

Products pricing and costs

• Help MFIs with back-end technology• Through risk sharing with MFI, help reduce

costs of funds

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Outline








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CMF’s objectives and mission

• Established in Feb 2005 at IFMR

• CMF’s objectives– To address knowledge and practice gaps in micro finance sector– Experiment on ground solutions

• CMF’s mission: help the poor by– Systematically researching the links between access to financial

services and participation of poor in larger economy

– Participate in maximizing access to financial services

Research on micro finance and livelihood financing (RU)

Strategy building for MFIs (MSU)

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MSU and RU

Strategy (MSU)

Research (RU)

Impact of microfinance• Impact Evaluation Studies• Economics of micro enterprise• Insights on HH "financial behavior"• Constraints on HH productivity• Experimentation on product design• Micro finance transaction costs

MFIs Strategy for growth•Definition and implementation of

innovative business models–Market research, creation of linkages

•MFIS best practices sharing•Design/test of new financial products •Capacity building

–capital structure, HR, MIS, processes, customer segmentation, governance…

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4 Research areas to maximize micro finance impact

Micro finance plus

Finance andOrganizational

issues

Policy

Impact and product design

1 2

4 3 Maximize impact

On client

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The role of research

• Evaluate impact, and find out what works and what does not– Impact evaluation of Spandana’s micro credit programme– Impact evaluation of health and weather insurance (SKS,

Sewa)

• Improve existing products– In theory flexibility or less frequent repayment schedules

could have some benefits, but could also create some complications.. What is better?

– Repayment schedule research with VWS– Flexible repayment schedules with KAS foundation

• Diversify financial products– Remittances product project with Adhikar– Sectoral study on Housing finance

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The role of research

• Find out what can maximize the impact of loans– Impact evaluation of Sewa Bank’s business training: is it

cost effective: how can it be improved?

• How can organizations be more cost effective while achieving their goals? – Study on effect of staff incentives

• Understand what is going on– Find out the risk that small business face that financial

services can help with– Understand non financial constraints– Why are businesses not expanding: what are labor

markets constraints?

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The role of MFI Strategy Unit

• Help MFIs with their business and expansion strategies

• Provide help to MFIs in the following areas:– Human Resources– Access to capital (securitization etc.)– Individual lending

• Create market linkages for clients– Provide them with lower costs and high quality inputs

(Godrej Agrovet-Spandana)– Provide clients with production/selling opportunities

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The role of MSU: encourage vertical growth

Channel

Backward integration

Capability adjacencies

Forward integration

Customer segment

Geography

Horizontal growth => replicate similar model in new geographies•Same products•Same customers profiles

Vertical growth => deepen share of wallet of existing customers => capture new customer segments

•New products•New customers profiles

Coreactivity

Product

Technology adjacencies

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IFMR Trust

• Credit is only one side of the story• Example: Wavers may organize themselves in cooperatives

but they need to sell the saris, and for a good price• Need to link to a higher value chain, create links between

the borrowers and potential buyers• Sandhi provide market linkages to garments confectioners –

one of the entity of the • Trust for Networked entities: to fill this missing market

– Will act like a holding company having a part of equity in each entity formed– to promote outside investment

– Will mobilize fund from social investors in form of grant or soft loans for the incubation period

– Will retain a part of profit for itself as revenue– Will be based at IFMR - different centers under it will provide specialized

services to entities – link to MFIs etc.

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Thank you• For any question: [email protected]

mailto:[email protected]

Annie duflo

Economy & Finance

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