By Anand Sahasranaman, IFMR Finance Foundation

The High Powered Expert Committee (HPEC) for estimating the investment requirements for urban infrastructure services released its final report recently. The committee was set up by the Ministry of Urban Development in 2008 under the chairmanship of Dr. Isher Judge Ahluwalia.

The objective of the group was to assess the challenges of urbanisation and project the quantum of investment required for the provision of public infrastructure and services in urban India. The report also outlines the reforms in governance and financing that will be essential for cities to discharge their responsibilities in provision of these public services.

The group comprised of eight experts – Nasser Munjee, Chairman, DCB; Nachiket Mor, Chairman, IFMR Trust; M. Vijayanunni, Former Chief Secretary, Kerala; Sudhir Mankad, Former Chief Secretary, Gujarat; Rajiv Lall, Managing Director, IDFC; Hari Sankaran, Vice Chairman and Managing Director, IL&FS; Ramesh Ramanathan, Co-Founder, Janaagraha; and Om Prakash Mathur, NIPFP.

The committee estimates the investment for urban infrastructure over the next 20 years at Rs 39.2 lakh crore (at 2009-10 prices), which is an indication of both the large current backlogs in public service provision as well as the scale of expected urbanisation till 2031.

In order to achieve this scale of investment, the committee states that fundamental reforms in governance will be essential. These reforms include increased focus on metropolitan and regional planning; service delivery reforms such as corporatisation of service delivery institutions; regulatory reforms such as the setting up of urban utility regulator; enhanced community participation through empowered area sabhas and preparation of citizen report cards and a strong focus on institutional capacity building.

The committee also recognises the critical need for financing reforms such as the adoption of an area based system of property tax appraisal by cities; the revision of user fees periodically to ensure recovery of overall O&M charges; the need for state level financial intermediaries to work with smaller cities; and the creation of regulatory guidelines for municipal borrowings.

IFMR Trust has been advocating some of the reforms that the HPEC has recommended in its report and this paper outlines these ideas in greater detail.

The Malegam Committee’s (referred to hereinafter as the “Committee”) recommendations to increase the supervisory capacity of the RBI, to make MFI regulation consistent at the national level, to promote good corporate governance and to increase bank lending to MFIs are welcome.

At the same time, many of the tactical and operational prescriptions made by the Committee require to be examined in the context of (a) broadening the RBI’s financial inclusion agenda, (b) regulatory approaches to pursuing this agenda (c) operationalising the recommendations in an effective and inclusive manner and (d) ensuring sustainable development and orderly growth of the industry by limiting externalities and developing a series of best practices.

Definition of the Sector

1. Under 2.1 of the Committee’s report, the Committee has defined microfinance as “an economic development tool whose objective is to assist the poor to work their way out of poverty. It covers a range of services which include, in addition to the provision of credit, many other services such as savings, insurance, money transfers, counselling, etc.”

2. At the same time, the Committee has confined itself to “micro-credit” for the purpose of the report.

3. The Committee has subsequently defined a separate category – NBFC-MFIs – for NBFCs operating in the microfinance sector, and stated that, in such firms, over 90% of assets must comprise of “qualifying assets”. At the same time, the Committee suggests that NBFCs should either allocate over 90% of assets to “qualifying assets” or less than 10%

4. We suggest that it is counter-productive to limit micro-credit or the supervision of micro-credit to NBFCs in the fashion as described above for the following reasons:

a) These recommendations, if accepted, would prevent the transformation of microfinance into full service finance for rural customers.

a. One of the main reasons for becoming an NBFC is that the entity is then able move beyond traditional JLG lending, and gradually start to offer larger loans, individual loans, enterprise loans, crop loans, equipment loans, etc. while continuing to offer the original JLG product.
b. This allows the entity to meet completely the requirements of those borrowers that need larger amounts as well as use the wider product-scope to spread its cost structures over a much larger pool of assets and bring its lending rates down, eventually well below even the caps specified by the Committee for the traditional JLG product.
c. Entities operating in this space would have to grapple with low value of transaction and still remain viable. Multiple sources of revenue would provide such viability to such entities.

b) The 90/10 recommendations (Clause Numbers 5.9 and 5.10), if accepted, would essentially freeze the sector to permanently stay in its current form since nobody else would even be allowed to address the needs of this sector and no other business models would evolve.

a. And for this reason, there would also then be no impetus for interest rates to come down further below the caps specified by the Committee. Costs of operations, using new technologies and economies of scope and scale can be brought down to as much lower levels relatively quickly.
b. This would also take away the entities’ incentive to invest effort in working in a challenging environment.

c) The recommendations would leave out significant microfinance providers from the regulatory framework

a. It is quite possible that Banks may emerge as substantial providers of micro-credit and other forms of microfinance, but microcredit (as defined by the committee) may not form 10% of their assets. This will leave out a significant institution-type from the regulatory ambit. The proposed regulation must cover all microfinance providers

i. However, it may be argued that microfinance, at present, is being provided by multiple non-profit entities that are not within the regulatory ambit of the RBI. Recognising this, we propose that microfinance regulation must cover at least all existing forms of entities regulated by the RBI, i.e. Banks and NBFCs
ii. The microfinance operations of such entities, be in micro-credit, micro-savings, distribution of micro-insurance etc., must be reported separately as an SBU to the RBI, to permit efficient information dissemination, transparency and effective regulation
iii. For entities outside RBI’s regulatory ambit, regulation could make the principals (in case of business correspondents) and lenders (in case of microcredit) to the providers aware of the importance adherence to client protection standards by the providers. These principals and lenders should be actively encouraged to broaden their due diligence and monitoring processes to ensure that the providers are not just maintaining financial discipline but also adhering to ethical standards of client protection.RBI must also actively use such measures to enforce covenants on entities not regulated by RBI to create a level playing field and uniform standards.

d) Further,

a. If entities were forced to concentrate over 90% of their assets in the microfinance sector, lack of diversification within their asset portfolios could emerge as a significant systemic risk.
b. In India, portfolio protection for institutions providing services to low income rural households against the vagaries of systemic and catastrophic losses, i.e. rainfall reduction, weather variations, crop losses, floods and other events etc. are still not available on a large scale

5. Hence, we recommend that the definition of microfinance be applied at a functional level, rather than at the entity level. This would imply that entities providing microfinance would be required to create separate business units, tailor internal policies to provide efficient service delivery and at the same time be able to leverage internal financial, technology and process strengths in this regard.

6. Ensuring complete access to finance for every individual and every enterprise in India will require continuous innovations in financial products, delivery channels, and human resource management by a wide array of strong firms competing with each other to do business with the low-income household in a responsible manner. By opening up the sector to multiple institutions will enhance competition and meet the regulator’s objectives

Capital adequacy requirement

7. The committee has not offered any rationale for the Rs. 15 crore minimum capital requirements even for pure non-deposit taking NBFCs despite recommending very conservative loan limits and being aware of the very low default rates that have been observed for this sector in India for over a decade.

8. Such a requirement clearly favours the established large microfinance providers, which making it even more difficult for smaller, locally focused entities to emerge.

The issue of “Qualifying Assets”

9. The Committee has defined a low income household as one with annual household income less than Rs 50,000

10. IFMR Trust’s experience is that though a large number of microfinance clients belong to households with less than Rs. 50,000 annual household income, there are also a very large number of households with higher incomes who can and do benefit from microfinance mechanisms.

a) This happens mainly because of limitations of the credit appraisal methods of traditional financial providers. Many rural and urban low income households cannot access credit through these mechanisms – their assets cannot be easily collateralised; their incomes are hard to estimate; and their past repayment records are not recorded in accessible databases.
b) So, though most poor are financially excluded, many financially excluded households have household incomes exceeding Rs 50,000. Much of urban microfinance caters to such clients. Restricting microfinance to the poor will make the financially excluded non-poor more vulnerable.

11. We believe that it would be detrimental to the interests of a large section of the population to define low income households in the manner as recommended by the Committee. Further, this definition implies that originators (and perhaps their lenders) have the wherewithal to collect information regarding household income, which is unlikely and expensive

12. The Committee has also stated that credit to individual clients be limited to Rs 25,000 per member

13. This is not clear and raises the following questions

a) What are such households to do when their credit needs outstrip Rs 25,000 per individual member?
b) Shouldn’t the committee focus on “regulating the lender” rather than “regulating the household’s debt needs”?
c) Is it not wasteful for such a household to approach multiple lenders, rather than avail of a single “one-stop shop” solution for financial needs?
d) Effect of inflation on household credit requirements are not factored in

14. Given the above negative effects on a household’s credit access, we find it difficult to believe this is the Committee’s intention. We suggest that it is up to the household to determine its own debt needs and requirements, and for the provider to determine the creditworthiness.

15. Given that the objective is to regulate the originators, we suggest the following approach

a) The Committee has opined that multiple loans given to a single household may increase the risk of non-repayment and amplifies systemic risk
b) At the same time, it is the objective of the committee to ensure that the maximum number of households come under the coverage of financial inclusion
c) Therefore, to incentivise organisations to enhance coverage and limit multiple lending to a single household it is proposed that a higher capital charge be levied upon institutions providing the third or further loan to a single household (at the time of providing the loan)

a. Therefore, the first loan to a household could attract a capital charge of 75%, the second loan 100%, the third loan 125% and so on
b. This could be tracked by stipulating the use of biometric authentication, and a credit bureau

16. It is useful to note that the group-based method (followed at present by MFIs as well as SHGs) ensures that each borrower is forced to assess his / her co-borrowers before forming a group. The ability of this methodology to impose credit discipline is well-documented. Even during the current crisis, IFMR Trust has monitored repayment behaviour in over 200 districts across the country outside Andhra Pradesh, where repayment behaviour has been flawless1

Our experience tells us that, contrary to popular belief, low income households are rational and well able to take complex financial decisions. Rather, such households are limited by the quality and depth of the financial instruments that they have access to. This evidence is bolstered by the book “Portfolios of the Poor” and a recent impact study2 conducted in Hyderabad by MIT researchers.

17. The committee seems to be taking a view that it not only needs to regulate the lenders, but also the households’ financial lives. It should focus on regulating the lenders and developing ways to indirectly reduce the risks of over-leveraging and systemic risks. Therefore, credit discipline on lenders through usage of capital charge, is a better risk management tool that will also form an effective check on over-lending, rather than imposing an external limit on the borrowing ability of households.

18. Further, it is incorrect to assume that rural households have no collateral at all to provide for raising debt. Banks are known to have substantial exposure to the agricultural sector that is collateralised through land holdings, household gold and farm equipment

a) We had earlier made the argument favouring using microfinance providers for delivery of multiple services for efficient service delivery at lower cost
b) Though much of microfinance has focused on credit, it should include other services as well. IFMR Trust’s experience with remote rural households across three states (Tamil Nadu, Uttarakhand and Orissa) shows the benefits clients can get from such complete offering, and how such a multi-service approach helps the institutions improve efficiency by leveraging economies of scope, which can be tapped in the context of financial services.
c) Therefore, we submit that organisations should be permitted to offer a complete suite of financial services to low income households viz.

a. Loans – both secured and unsecured. Secured loans that require a high penetration of distribution include crop loans, loans against warehouse receipt, MSME loans etc.
b. Distribution of savings, either through Banks or through mutual funds
c. Distribution of insurance – life, cattle, weather, crop, accident, health etc.
d. Remittances

d) It is necessary that such organisations develop the breadth of knowledge and understanding that is necessary to understand low income household needs and prevent mis-selling. This is something that can be periodically audited by the RBI

Pricing of Loans

19. The Committee feels that “Given the vulnerable nature of the borrowers, it becomes necessary to impose some form of interest rate control to prevent exploitation”

20. Evidence from other countries however shows that pricing caps have historically hurt the poor3 . Pricing caps and margin caps incentivise originators to expand only to easily serviceable geographies and ignore remote areas and lower income clients.

21. Further, the sharp increase in financing costs for MFIs post the AP Ordinance has indicated that originators are not insulated in any manner from high borrowing costs during either (i) a liquidity crunch or (ii) a credit situation / event risk

22. IFMR Trust has, on several occasions, opined that the current interest rates and margins charged by MFIs are high and there is room for reduction. However, at the same time, we believe that competition and transparency should pave the way for reduction of rates rather than impose a hard cap. This is indeed the view RBI has taken on pricing of services offered by banks through business correspondents, allowing banks to decide the price they want to charge, but requiring them to have the pricing approved by the boards, and transparently communicate it to RBI and other stakeholders.

23. Suggestions to this effect include enhancing competition, imposing transparency in pricing (already recommended by the Committee) and monitoring the originators by tracking reduction in interest rates over a period of time

a) Further, originators could be encouraged to augment lending revenues through fee based income achieved through distribution of specially tailored products for low income households, e.g. livestock insurance, low ticket savings and remittances. This would permit originators to reduce costs on lending products
b) Originators that provide other forms of secured products, together with unsecured loans, could also avail of cheaper funding from lenders that could be used to reduce lending rates for the unsecured loans

Purpose / end use of the Loan

24. The Committee believes that microfinance should largely focus on income generating purposes, and has opined that a minimum of 75% of microfinance loans should be for “income generating purposes”

25. This topic needs to be examined from three aspects:

a) What exactly is an “income generating loan”?
b) What are the current purposes for which borrowers are using loans?
c) Loans used for functions that other services usually fulfil

26. What exactly is an income generating loan? Evidence shows that loans are used by low income households for a variety of purposes including:

It is difficult to opine that households should be restricted from using external financing for any of the above activities, especially when the middle-class and the rich are permitted to borrow for all of the above purposes and have access to funds as well

27. It is clear from studies that low income households have utilised MFI loans for a variety of purposes. Recent evaluation of an MFI’s urban microcredit programme in Hyderabad revealed a variety of uses for the loans:

While such percentages vary widely across households, it is clear that each household is faced with a specific set of economic, social and risk variables that require a certain course of action. It is counterproductive to impute (or impose) a specific end-use pattern to a household.

28. Loans used for functions that other services usually fulfil: Since most of these households may not have a savings facility, they might be using a short-term loan to “save-down”, instead of “saving-up” as one does using a savings bank account. Some researchers have also posited that microfinance helps because it acts as a disciplining device for people to save, and they can use the discipline of weekly repayments to help bind themselves into putting money aside, which they otherwise would not have been able to do5 . Transformation of small amounts into lump sums is an important function for households6 , and in the absence of other mechanisms (like savings account, recurring deposits), microfinance serves as a mechanism to help make this transformation. These other purposes (consumption smoothing by transforming small amounts of money into lump sum; reducing cash outflows by repaying expensive old debts; etc) can be and often are welfare enhancing

29. Traditionally the low income household is only familiar with credit as a tool for financial needs and have developed coping mechanisms based on access to credit. While other financial products would clearly be useful to such households, they would need time to adapt to such tools.

30. While financing for certain end-use could be encouraged (i.e. through the priority sector guidelines), it is counter-productive to impose end-use restrictions on households when no such restrictions exist on higher income households. It is conceivable that, through disincentives on multiple-lending, originators would take greater care in ascertaining the repayment capability of the household, as well as diversify into products that would be directly linked to business activities, e.g. retailer loans, crop loans, small business loans etc.

31. The view the Committee eventually takes on the manner in which poor women conduct their financial lives and their maturity and sagacity is deeply disturbing. Microfinance plays multiple roles in the lives of low income households including seasonal cash management (so that school fees can be paid even during the seasonal troughs); asset transformation from small savings to larger valued assets (such as higher quality roofs and beds); refinance of high cost loans from money lenders; and as a substitute for good commitment-savings products. This is also acknowledged by the Committee but while making its recommendations it surprisingly reaches an opposite conclusion without citing any research or offering any rationale for overlooking its own earlier observations or suggesting any alternative solutions.

32. These recommendations of the Committee along with those restricting the amounts she can borrow and severely limiting the choice of providers that she can access, constitute an infringement of the rights of the low income household, particularly women, to conduct their own financial affairs as they think best fit. Similar stipulations, if imposed on middle and upper income households would be resisted very strongly, but have been recommended for imposition on poor women without any evidence that they are in any way less rational than high and middle income customers and good evidence that the opposite is actually the case.

Incentives for Orderly Growth

33. The Committee has recommended the creation of a Credit Bureau for ensuring orderly sharing of information. We wholeheartedly support this initiative and believe that fully functional (and competing) credit bureaus are essential for the orderly development of the sector

34. Further, and very critically, the Committee has suggested that a single regulator is necessary and sufficient to monitor microfinance activities. This is extremely important, especially in the context of the AP Ordinance, and will go a long way towards dispelling uncertainty on the legal and regulatory environment

35. We also have a few other suggestions regarding the role that the RBI can play in facilitating orderly growth. These include:

a) Ensuring incentive alignment of stakeholders to enable market-based regulation –

a. Use of the priority sector guidelines
b. Securitisation

b) Ensuring continuity of service
c) Promoting healthy competition amongst originators

36. Incentive alignment

a) The priority sector guidelines can be used very effectively by the RBI in controlling and at the same time incentivising originators and lenders to behave responsibly. The Committee has recommended continuation of priority sector for microfinance advances and we are in support

Some additional steps that could be brought in the priority sector guidelines:

a. Unsecured loans provided to a household could attract a higher priority sector weightage than secured loans (the RBI has already moved a step in this direction by stating that gold loans made for agricultural purposes may no longer be treated as direct or indirect agricultural advances)
b. First and second unsecured loans given to a household could have a higher weightage than subsequent loans – tracked through a credit bureau

b) Securitisation and other capital market transactions: traditionally, originators of financial services to low income households have been far too dependent on bank borrowings (the Committee estimates that 75% of loans to MFIs are from banks)

IFMR Trust has been working closely with high quality originators to assist them in availing capital market financing through securitisations and bond issuances. We strongly feel that the additional transparency imposed by a capital market transaction is very beneficial in incentivising originators to “raise the bar” in MIS, reporting, operational processes and systems, so as to be able to meet the scrutiny of rating agencies and investors

37. Continuity of service: Continuity of service delivery should be seen from the perspective of “who is taking risk on whom”, because based on this the importance of and strategy for ensuring continuity of service delivery will be determined.

Clients taking risk on the institution (Savings, Insurance, Investment, Remittance): For services like savings and insurance, there is a strong case for high level of prudential regulation to prevent failure of institutions, because of the need to protect clients’ savings and insurance. For these services, the regulation should continue on the path of letting prudentially regulated, well-capitalised, well-diversified institutions provide microfinance through agent-led models, like the business correspondent model. To ensure continuity of these services, the continuity of both the principal and the agents is necessary.

The principal institutions (banks, insurance companies, asset management companies, etc) are already governed by detailed prudential norms, which are meant to minimise the risk of failure. For such agent-led models, the regulator should make the principal financial institution (eg. banks appointing the business correspondent) responsible for ensuring continuity of service delivery to the clients, with penalties if an acquired client is not able to access the service continuously for a certain period of time. These principal institutions should then draft their own due diligence and monitoring criteria to ensure this.

At the same time, the model should ensure that every originator (who serves as an agent) has sufficient risk participation to prevent the risk of moral hazard.

Institution taking risk on the clients (Loans): Considering the fact that most of the microfinance providers (except banks) in India do not mobilise public deposits, we believe that the RBI need not take further steps towards regulating such institutions except defining basic prudential norms on institutions that are non-systemically important.

However, we strongly believe that the RBI should focus on ensuring that a microfinance originator’s practices do not have negative externalities for other originators. IFMR Trust’s experience is that maintaining high quality field processes is a must for microfinance. Hence, regulation that is focused on reducing negative externalities will be immensely useful. Some suggestions:

a) Develop an external audit mechanism through third parties: Such third parties auditors could (i) verify through sample checks the quality of origination and reported profiles of customers, (ii) define process standards for processes in origination, collection, risk management etc7 and audit the same, (iii) provide feedback to the institution on their findings, (iv) provide inputs to the lenders of such originators

b) Use differentiated capital charge, as outlined earlier, to prevent multiple lending

Client Protection

38. The Committee has recommended certain steps with regard to client protection including

a) Prevention of coercive collection practices
b) Customer protection code
c) Transparent pricing

39. We are in agreement with the broad line of thinking and offer a few suggestions regarding the same

a) While it is fair to state that borrowers of group-based lending are not to be visited for non repayment at their residence, the same is not true for borrowers of individual loans / business loans / crop loans etc. The RBI should make a distinction between loans where group liability serves as a cushion against individual default, and individual unsecured loans

b) Where security is available to the originator (property, gold, movable assets), the originator should have clearly defined, board-approved, policies regarding any appropriation, auction and disposal of such assets. Such policies must follow the Fair Practices Code and every such incident of recovery from security must be monitored at the highest level in the originator’s organisation

c) IFMR Trust’s stringent underwriting guidelines stipulate that no originator should use the services of or incentivise third parties to originate and service the loan clients. While it has been observed that originators use group leaders or center leaders for such purposes, this must be completely stopped

d) Transparent pricing to clients must be enforced, displayed in loan agreements, explained during customer interactions etc. The RBI could consider prescribing standard communication components which cover various methods of calculation of interest (Upfront fees, flat rate, reducing balances rate etc.) and also various repayment cycles (Equated, ballooning, variable) to bring them to ‘effective cost to client’ numbers so that clients can make informed decisions

e) Prevent mis-selling: Regulation should prescribe fair origination practices by microfinance providers. Some activities that should be actively discouraged are: compulsory bundling of products, miscommunication about product features and giving wrong advice to clients. Explicit confirmation from the clients that such practices have not been indulged in should be obtained by external process auditors to create pressure towards adherence

f) Mechanism for redressal of grievances: All originators must be required to have in place timely and responsive mechanisms for complaints and problem resolution for their clients. This requires ensuring that clients are able to contact a person who can then address their grievances effectively and in a time-bound manner. Apart from this the regulator must make available mechanisms outside of the institutional framework to address unresolved queries or queries of larger magnitude. The banking ombudsmen with enhanced capacity would be best placed to perform this function without conflict of interest

g) Privacy of client data: The privacy of individual client data must be respected in accordance with the existing laws and regulations, and such data cannot be used for other purposes without the permission of the client. Explicit regulations around when and how information sharing is possible should be notified. Severe implications must be notified to ensure that originators do not overstep on this requirement

IFMR Trust believes, and has learnt through experience, that small, local financial institutions are best placed to understand the financial needs of low income households and deliver financial services to their doorstep. It is critical to avoid a situation where regulation favours large players over smaller ones. Several provisions of the Committee’s report that may have this unintended consequence are:

➢    Interest rate/Margin cap
➢    Allowing only 2 lenders per household
➢    Minimum networth

These recommendations favour the largest existing originators, are likely to drive smaller MFIs out of businesses, and create entry barriers for any new players. The larger originators benefit from economies of scale and will be more easily able to comply with the increased capital requirements.  They will be more easily able to build the infrastructure recommended and move faster into the market place where they could corner the maximum market share thereby preventing the entry of smaller or newer MFIs in that market.

We strongly feel that such measures will be detrimental to the financially excluded and will not serve the RBI’s motive of financial inclusion. Permitting only larger originators to flourish will imply an oligopolistic situation, lesser product innovation, poor customer service and ultimately choking the household’s credit requirements.

We believe that there is an important role for the regulator to play in making sure that innovation is encouraged among responsible players in a manner that benefits low income households, and we are hopeful that the RBI will agree with our view when it reviews the Malegam Committee’s report.

—

(1) This observation is based on (a) over twenty field visits conducted in states outside AP, post the AP Ordinance, (b) data from securitized pools in over 200 districts, (c) behavior of borrowers of IFMR Trust’s own retail financial services venture in remote rural areas of Tamil Nadu, Uttarakhand and Orissa
(2) The paper titled “Miracle of microfinance? Evidence from a randomised evaluation” can be found here: http://econ-www.mit.edu/files/4162
(3) CGAP Occasional Paper No. 9. http://www.cgap.org/gm/document-1.9.2703/OP9.pdf
(4)These percentages don’t add up to 100 because some loans were used for multiple purposes.
(5)http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1598959
(6)See page 17 of http://www.portfoliosofthepoor.com/pdf/Chapter1.pdf
(7)IFMR Trust has developed detailed underwriting guidelines for such providers of financial services, including detailed process and system guidelines that such an institution must follow

By Farzana Najeeb, IFMR Finance Foundation &  Arun Seethamraju, IFMR Rural Finance

Efforts to promote financial inclusion achieved momentum in the country with the RBI guidelines in January 2006, allowing appointment of non-bank Business Correspondents (BC) as agents for the delivery of financial services outside bank branches. The BC model is a type of branchless banking wherein BC acts as an intermediary between the customer and the bank. The agents appointed by the BCs provide banking services to the customers on behalf of the principal Bank.

In spite of the model’s enormous potential to rapidly expand access to banking for the unbanked population, its implementation has been faced with significant challenges. Many of the efforts launched by various banks are still in the pilot stage and have not been able to scale up, on issues like viability and effectiveness.

State Bank of India – IFMR Finance Foundation partnership

Motivated by a common interest in improving the viability, effectiveness and scale of the business correspondent channel, State Bank of India (SBI) and IFMR Finance Foundation (IFF) have partnered to develop various approaches to implement the BC model. This involves a two-stage roll out, with the first stage focusing on testing and developing various approaches, and the second stage, a rapid scale up through various BC types. It was decided that some of the key ideas being developed need to be tested through field pilots.

Pilot project with Pudhuaaru KGFS as SBI’s Business Correspondent

It was in this background, Pudhuaaru KGFS (Section 25 Company) was appointed as a circle level Business Correspondent by SBI’s Local Head Office at Chennai. To ensure the viability of this model and round the clock accessibility to banking services to the customers, Pudhuaaru KGFS appointed retail shop owners as their CSPs (Customer Service Point) in each village. The retail shop owners with an already existing source of income would not exclusively depend on the BC business for viability, and this allows appointment of such CSPs even at low population levels, increasing the convenience for clients. These retail shop owners are responsible for dealing with the customers and providing banking facilities. The channel structure can be depicted as follows:

The CSPs have been identified by the BC after careful screening and selection process. Minimum education qualification of CSP is required to ensure that they get well versed in banking services. As accessibility to the CSPs have been found as an important factor affecting the frequency with which the customers transact, Pudhuaaru KGFS has made certain that the selected CSPs are located in areas where they can be easily accessed by all the people in the village. The customers can easily access the CSPs for transactions, save money and time by avoiding travel to the nearest bank branch or ATM. The CSPs are given training on banking products, technology, communication skills as well as their roles and responsibilities.

The pilot was launched with five CSPs in five different villages in the Thanjavur district of Tamil Nadu. On the day of the launch, a total of six customers were enrolled by the CSPs. The channel provides no frills savings account and any villager that fulfills the required KYC norms is eligible to open the account with SBI through the CSP. The project has been launched with the savings bank account and remittance products. Other products like Recurring Deposit, Fixed Deposit, mobile recharge and bill payments will be soon offered through the channel.

Technology and transaction process

Technology deployed has a bearing on the capital required and the ease of use, therefore influences the viability and effectiveness of the model. Pudhuaaru KGFS-SBI BC project has deployed the mobile banking technology with Eko as the technology provider. The technology is simple to use and the only investment required on the part of the CSPs and the customers is a basic mobile phone, which is usually available with most CSPs and clients.

Customer authentication happens entirely through a combination of one-time passwords contained in a Eko-issued booklet and a user-selected PIN. The solution is available to any customer owning a SIM card and therefore having a mobile phone number. Presently, customers of Airtel and BSNL can directly issue payment instructions using USSD codes, while customers of other networks need to use SMS for transactions. Owning a mobile handset is not necessary, because the customers can either insert his/her SIM card into another person’s phone for transaction, or do the transaction using the CSP’s phone in “assisted mode”. The assisted mode allows a special syntax to be used for transaction by clients using CSP’s phone.

Account opening process starts with the CSPs filling account opening forms, which are then digitised and sent to Eko and then to SBI. The actual account opening is done at the link branch, which receives the hard copy of forms from Pudhuaaru KGFS and the soft copy from SBI back-office, and uploads the account to the SBI Core Banking System. For starting the transactions, Pudhuaaru KGFS pre-purchases electronic value from SBI with the help of technology provider Eko, after depositing an equivalent amount with SBI. Pudhuaaru KGFS then allocates portion of this limit to the various CSPs. When customer deposits cash with the CSP, the CSP instantaneously transfers an equivalent amount of electronic value from his/her mobile account to the customer’s account, and collects the equivalent amount in cash from the customer. The opposite process is followed in a withdrawal transaction.  If the CSP faces a shortage of cash or account balance during the day, Pudhuaaru KGFS provides cash management support, which is built into the channel design.

Over the next few weeks, this pilot will be expanded to about 20 CSPs, and we will stay with this number till the basic objectives in terms of viability and usage of the channel have been met. The pilot experience is being documented carefully with the purpose of: recommending potential process improvements to SBI and Eko; identifying key channel and product design bottlenecks for viability and effectiveness; and highlighting the critical components of a successful BC roll out plan using a third-party technology provider.

This and other full-fledged pilots planned under the SBI-IFF partnership will help us to test the business model and technology innovations, and document the factors that can contribute to the viability and effectiveness of the BC channel. The learning’s would be incorporated to modify the model effectively thereby enabling SBI to scale up the model across the country in a viable manner.

As part of the working papers series of the Asian Development Bank Institute, Bindu, Suyash and Dr. Nachiket Mor have penned a working paper on ‘Universalizing Complete Access to Finance: Key Conceptual Issues’. Abstract below:

In this paper, we present two stylized models of the financial system. We make the case that in order to realize the potential of a well-functioning complete financial market, financial system designers and financial service providers will need to think about ways to deliver financial propositions that are customized to individual households by responding to their unique circumstances. This will entail the presence of proximate, well-trained providers that intermediate between the customer and those large “product manufacturers” whose goal is financial well being and not merely product sales. These providers would need to use expertise in financial advice or wealth management to develop integrated financial propositions for clients. We also highlight some of the important debates that arise in making this stylized financial system a reality.

To read the full paper click here.

By Suyash Rai, Advocacy, IFMR Finance Foundation

Markets typically exist within the boundaries set by the state. The financial markets are no exception to this. Mobilisation and allocation of capital – the key roles of the financial system – are done within the framework defined by the government. From nationalisation of banks and significant economic ownership, to guiding the allocation of capital to priority sectors and regulating various aspects of the financial sector, the Indian government has played just about every conceivable role in the nature of financial intermediation.

Programmes and policies

The government has also tried to increase financial access primarily through the Reserve Bank of India and other regulators. The most prominent strategy it has followed is the priority sector lending by banks, which requires banks to extend 40% of their lending to sectors defined as preferred (such as agriculture) by the government. Banks and insurance companies have been given targets to open savings bank accounts and provide micro insurance policies respectively. The government has also used direct influence over public sector institutions to ensure extension of services at its discretion.

The Self Help Group-Bank linkage programme (SBLP); Kisan Credit Card (KCC) scheme for farmers; Rashtriya Swashtya Bima Yojana (RSBY); financing and refinancing of various cooperative banks, regional rural banks and public sector commercial banks that extend credit to rural clients, especially farmers; and various state level programmes for extending credit to rural areas are examples of more direct efforts. Many of these steps have had significant positive impact on financial access. For example, by March 2009, there were over 61 lakh savings-linked SHGs and over 42 lakh credit-linked SHGs across the country with cumulative credit of over Rs. 50,000 crore accessed since 1992. KCC has become the main source of short-term credit for farmers. As on March 2010, over 5 crore ‘no frills accounts’ had been opened. Cooperative banks and regional rural banks have the highest outreach with respect to branch penetration in rural areas.

Intensions and consequences

However, these efforts are driven not just by an intention to enhance welfare, but also by electoral considerations, because financial services, particularly credit, are perceived to be effective tools for reaching the electorate quickly. Given the institutional infrastructure of India, credit can be quickly extended through the thousands of service points. Research by Professor Shawn Cole (Harvard University) shows that Indian public sector banks’ agricultural credit increases by 5-10 percentage points in an election year, with large increases in districts in which the election is particularly close. Clearly, the separation of political considerations and business objectives is hard to achieve, but this may have unintended consequences.

First, political exigency may not be compatible with innovation because the imagination and experimentation that goes into the development of real solutions cannot be dictated. So, for example, though it is good to have Rs. 47,000 crore disbursed to farmers through KCCs, a closer look at the scheme’s lending mechanism reveals significant weaknesses. It allows considerable repayment flexibility with negligible monitoring and relies on land as collateral, which is very challenging to enforce for a lender. Similarly, less than 11% of ‘no frills accounts’ opened at RBI’s behest are actually used. This is because though the banks fulfilled the “targets”, not enough was done to ensure that clients access these accounts conveniently.

Second, government’s continuous and relatively unconditional support for certain institutions has distorted their incentives. For example, though many cooperative banks have performed very poorly (according to the Task Force on Revival of Cooperative Credit Institutions (2004), a quarter of them had eroded their net worth), the government has continued to refinance and re-capitalise them. Recent revitalisation efforts have tried to improve capacities of these institutions, but there is still little emphasis on addressing the basic issues of incentive alignment and financial design (product mechanism and pricing). This has created a “too political to fail” implicit guarantee system, not unlike the “too big to fail” implicit guarantee. This leads to a differential playing field between institutions backed by the government and private efforts, rendering the latter at a disadvantage.

Third, some government interventions, though looking beneficial in the stage one analysis, may have negative effects on the financial system in the long run. For example, the loan waiver schemes may help some people in the short run, albeit not the poorest, but they do so at the cost of changing the incentives facing the rural borrowers, giving a strong reason to delay repayments till the next loan waiver. A more complex example is of the interest rate cap on savings bank account. This cap, which probably comes with the implicit understanding that banks will use these low cost funds to lend to priority sectors, becomes regressive especially in rural areas, where, given the high transaction costs for using bank accounts, this low return on savings might act as an incentive to hold cash. This goes contrary to financial inclusion efforts.

Fourth, when governments venture into direct financial services provision, it creates competition between the government and the market. Since the government has discretionary powers, it can legislate or regulate its way out of any competitive situation. The recent micro finance Ordinance issued by the Andhra Pradesh government is an example of this. In AP, the commercial microfinance sector seemed to be posing a direct challenge to the government-run programme, which was reportedly leading to attrition in the latter. This then leads to the question: Can a market participant regulate objectively?

Creating distortions in the long-run

All these indicate that many of the government’s efforts, though often well-intentioned and having positive outcomes in the short-run, create distortions that may lead to inferior outcomes in the long-run. The exigencies of the political process have three underlying features: a) they restrict thinking only about immediate outcomes; b) their timelines are dictated by electoral cycles; and c) their focus is on easily visible outcomes. Perhaps that is why there is so much focus on disbursing credit and opening bank accounts, with little importance to sustainability and effectiveness of services.

The governments could improve the design of their programmes and interventions, but the structural differences in workings of a political process and market institutions will remain. Should the government step back and just focus on regulating the system? There is no simple answer to this question. One way to approach this question is to ask: if the governments don’t intervene, would the markets anyway enter and contribute to financial inclusion? It is difficult to say for sure, because this requires predicting behaviour of markets under completely different situations. But what one can say is that markets more or less respond to incentives and are likely to pursue profitable strategies under conducive environments with low reputation and political risk.

Creating a conducive environment

So, the Government should focus on creating an environment where financial institutions and markets can expand in an orderly manner, minimising the need for direct government intervention. This can be done in many ways, especially by: a) providing public infrastructure (like connectivity; UID (one of the biggest contributions by the government to financial inclusion probably is the creation of the UID infrastructure compared to many direct interventions over the years); law and order; and currency chests to enable cash movements) that helps reduce transaction costs for serving remote areas; b) encouraging competition among financial providers (giving more bank licenses, creating level playing field); c) focusing on rules-based regulation to minimise political risk that springs from discretionary regulation by governments/regulators; and d) using quality research to assess the long-term implications of big policy decisions like loan waiver. These steps should help gradually improve the sustainability and quality of financial inclusion. Otherwise, we will continue with this sub-optimal equilibrium of short-term financial inclusion numbers at the cost of long-term sustainability and high quality service.

Abridged version of this article first appeared in The Hindu Business Line.

- By Anand Sahasranaman, IFMR Trust

Gram panchayats in India are independent, constitutional bodies of governance that operate at the level closest to the people or the grass-roots. They are constitutionally vested with powers and responsibilities to foster economic development and social justice. The statutory functions of gram panchayats, as defined by the Tamil Nadu Panchayati Raj Institutions (PRI) Act, include the provision and maintenance of public infrastructure for services such as water supply, public hygiene, garbage disposal, roads, street lights and rural housing among others. IFMR Finance Foundation’s ‘Financing Rural Infrastructure’ initiative aims to gain a deeper understanding of gram panchayats, their responsibilities, their financial wherewithal, their ability to attract debt to finance public infrastructure, and use insights gained from these explorations to design financing programs for rural infrastructure provision.

IFMR Finance Foundation conducted an analysis of three villages – Karambayam, Nattuchalai and Alakkudi in Thanjavur district to better gauge the state of public infrastructure in these villages, the financial status of the gram panchayats, their investments in public infrastructure and how these investments have been financed. The initiative also explored alternative funding channels and how these can be exploited to enhance infrastructure development and delivery of services in the three villages.

In order to perform its statutory duties, the PRI act provides for a number of levers of financing that are available to gram panchayats-

• Own revenues – These are taxes and levies like house tax, professional tax and water charges that a gram panchayat is empowered to levy.
• Assigned Revenues – Assigned revenues are revenues directly due to the gram panchayat, but are collected by the state government and remitted to panchayats once every six months.
• Devolved Revenues – Devolved revenues are direct grants from the state governments to panchayats based on the recommendations of the State Finance Commission (SFC). These revenues are transferred to panchayats on a monthly basis.
• Loans – The TN Panchayati Raj Act empowers panchayats to access loans for the purposes of infrastructure development and service delivery. However, it does not appear that any gram panchayat in India has used this power.
• Scheme based financing – Panchayats also have access to funds from central and state government schemes, but these tend to be tied funds that are to be used for a specific purpose. Examples of scheme based (tied) funds include the National Rural Employment Guarantee Scheme (NREGS) and the Indira Avas Yojana (IAY).

IFMR Finance Foundation’s analysis revealed that panchayat incomes are largely dependent on SFC devolutions (up to 80% of overall revenues), which to a large extent are predictable and timely.

All panchayats seem to suffer from poor collections in their own revenues base, especially house tax and water charges. The issues underlying under-collection and non-collection of revenues are manifold- lack of incentive to pay water charges, poor auditing mechanisms, lack of up-to-date housing survey information and the thin structure of panchayat staffing. In addition to these efficiency considerations, there is also the overhanging problem of low tax rates and charges.

On the expenditure front, water supply infrastructure and roads and street light maintenance forms a substantial portion of panchayats’ budgets. One of things to note is that sanitation and waste disposal are major concern areas in all panchayats, but there is no substantial investment in solutions to these problems. Of the three villages, only Alakkudi has a drainage system and even this is an open drainage system that is choked with garbage, rendering it useless. Maintenance of infrastructure assets is an area of grave concern.

Therefore, there is substantial room to improve the performance of panchayats in terms of own revenues generation and collection. The predictability of the devolved revenues, in addition to a well functioning own revenues base, can be a powerful mechanism to drive planned infrastructure provision.

The fundamental set of reforms that is required for the effective functioning of panchayats and that will enable the entry of debt to finance infrastructure are listed below –

(i)    Computerising of financial statements of the panchayat
(ii)    A regular physical survey of houses in the panchayat domain, once every 5 years
(iii)    SFC to recommend upper and lower bounds for house tax rates every five years with all panchayats required to set their own rates within this band
(iv)    The need for a ‘panchayat service’ cadre of officers to improve the capacities of a panchayat.

The initiative also analysed in detail the risks involved in the provision of debt to panchayats: operational, credit and political risks. Local financial institutions that have physical presence in villages are very well placed to mitigate almost all of these risks. This puts them in a position to participate as debt providers to the panchayat in financing local public infrastructure projects.

Using the insights gained from their analysis, IFMR Finance Foundation has come up with a few financing programs which are being piloted currently:

a) Sanitation Finance – provision of a loan from a local financial institution to household for the construction of a toilet. Households can build the toilet and access the grant available to them through the Total Sanitation Campaign. The one-year loan is repaid by the household on a monthly basis

b) Rural Housing Finance – a loan is provided to households who have been chosen under central and state government housing schemes. This loan can be used by clients both a bridge financing to enable them to access the tranches of grants under government schemes (and repay the loan) or as additional financing, that they can use over and above the grants available to them. Households can then repay the loan over three years or choose to pre-pay at any time prior.

These programs are designed to be easily replicable so that they can be taken to scale by rural financial institutions across India.

By Suyash Rai, IFMR Finance Foundation

In what could become a welcome trend, the RBI has started putting out detailed discussion notes on future policy steps. Recently, the central bank released a discussion paper presenting the pros and cons of various approaches to new bank licenses . Though the paper doesn’t clearly favour any particular structure, it does seem to be tilting towards or away from certain possibilities. One possibility that the paper seems to be almost squarely opposed to is of allowing more small banks to be set up in the country. The paper lays out some arguments opposing the idea of small banks, and cites experience with small banks like local area banks and urban cooperative banks to make a case against them.

As far as performance of local area banks is concerned, the record in itself doesn’t prove that the small banks don’t stand a chance. The Indian experience with such banks has been a mixed one, and there are examples of well performing banks in almost every category of small banks (local area banks, district credit cooperative banks, urban cooperative banks, etc), as there are of non-performing ones. This is true for big, national banks as well. This process is inherent to the process of development of institution-types, and the key is to ensure learning and application of “design principles” that make banks successful, rather than writing off entire categories of institutions. If there are indeed inherent weaknesses in the model, which are unmanageable, then the model should very well be discarded. If there are advantages in the model, and weaknesses that can be managed by some structural innovations, then there is no real need to discard the small banks model itself.

Before we consider the challenges to stability and continuity of small banks, and ways of managing these challenges, the key question to ask is: what really are the advantages of small, local banks? Interestingly, the RBI paper cites financial inclusion (i.e. expanding access to financial services) as the main objective for providing more bank licenses. Let’s stay with this objective. Firstly, small banks have proven advantages in processing “soft” information, which is crucial for lending. Professor Jeremy Stein of Harvard University has argued that such institutions are likely to be more successful when information is “soft” and cannot be credibly transmitted. In contrast, large hierarchies perform better when information can be costlessly “hardened” and passed along . There is documented tendency for bank mergers to lead to declines in small-business lending. Studying the empirical evidence on large/multi-national banks, Professor Atif Mian of University of California, Berkeley, shows that greater cultural and geographical distance between a foreign bank’s head quarter and the local branches, leads it to further avoid lending to “informationally difficult” yet fundamentally sound firms requiring relational contracting . Greater distance also makes them less likely to bilaterally renegotiate, and less successful at recovering defaults. The small/domestic banks have been shown to have more smaller/local (profitable) clients. Such differences can be economically large enough to permanently exclude certain sectors of the economy from financing by such large banks.

This ability to process soft, local information is particularly crucial in India, where “hard” information (credit history etc) about a vast majority of people is not readily available. In other words, the main way for banks to know about most clients in India is to access and process local knowledge, mostly captured through local presence, and small banks have proven to be much better at doing this. Big banks tend to skim the surface, where small banks can and usually do go deeper and provide services to many more.

Complete financial inclusion means providing financial services in a high quality, so that people use the services actively. Quality can be understood in terms of the convenience, flexibility and reliability of these services, which are universal terms, but must be defined locally. For example, different timings for bank branch may be deemed convenient in different parts of the country, and this has to be managed on the basis of local understanding. The second big advantage of a small bank is its ability to be agile about local preferences for providing convenience and flexibility required to use banking services effectively. Thirdly, if an institution’s horizontal growth (across geographies) possibilities are limited, it has greater incentives to try harder to grow vertically, by serving more people in the geography and providing more services to the same clients, enhancing the financial inclusion agenda.

Now, let’s consider some of the weaknesses/challenges identified by the RBI discussion paper. According to the paper, the key inherent weaknesses of the small, local area bank model are: a) unviable and uncompetitive cost structures due to small size, b) high concentration risk and higher risk of adverse selection due to geographical concentration, c) limited ability to attract professional staff and competent management due to salary and location constraints, and d) lax governance standards because of concentrated ownership. Though these could be critical challenges to stability and continuity of small banks, there are ways to mitigate most of these weaknesses. For example, the concern about costs is primarily related to the inability of small banks to incur large capital expenditures for deploying systems like core banking systems, or risk management platforms. Innovations in recent times have made it possible to develop and offer these systems Application Service Provider (ASP) form, wherein the user doesn’t need to incur large establishment expenses, but pays on the basis of usage. The software industry is churning out such solutions regularly.

The concentration risk can also be managed if the risk is properly managed by the bank, with systematic risk regularly transferred to entities or markets able and willing to hold the risk for a fee. For example, a local area bank is highly vulnerable to risk of flood in the area, which would lead to a run on the deposits and high defaults on loans. A big part of such systematic risks should be transferred out from the small bank’s balance sheet, while the bank should hold the risks it can manage. This could be done by securitization or parametric insurance on the portfolio, and could be made mandatory by RBI. Also, these banks can be asked to maintain higher capital adequacy. In some cases, the regulator could severely restrict the ways in which the bank can use the savings mobilized. For example, it could make it mandatory to invest most or all of the short-term savings in cash or government securities (narrow banking). Other such solutions could be considered for managing this weakness.

Attracting professional staffs and management is easier if the bank, true to its nature, focuses on recruiting and nurturing local talent. Corporate governance issues can be best addressed by requiring that the ownership is not very concentrated, and the board composition is a healthy mix of independent directors, executives and promoters. Also, oversight of these institutions could be strengthened by regular and close monitoring by investors and lenders to the bank. If the system is made transparent and market-based, the market participants would be incentivised to monitor the institutions and ensure quality, thus adding to the regulation and supervision by the regulator.

The key point is that, if we do acknowledge the important advantages of small banks in meeting the objective of financial inclusion, we can find many ways of addressing the challenges cited in the RBI paper. There are strong reasons to believe that the advantages are substantial enough to find and deploy these solutions.

Interestingly, the issue of optimal size of the banks is being debated internationally, especially in wake of the recent financial crisis, which has once again brought forward questions about the optimal size of banks from the point of view of service quality as well as systemic risk. Emergence of more high quality small banks could create a more fragmented and competitive banking sector, which will also minimize the “too big to fail” threat that much of the world banking sector faces.

This argument for more small banks in no way undermines the importance of other financial institutions. World Bank’s Chief Economist Justin Lin recently wrote a paper arguing that small local banks are the best entities for providing financial services to the enterprises and households that are most important in terms of comparative advantage. While his argument for small banks is spot on, he also argued that the size and sophistication of financial institutions and markets in the developed world are not appropriate in emerging markets. This is not necessarily true, because small banks and larger financial institutions/markets complement each other in many ways. While the former have distinct advantages in delivering high quality services at the front-end, the latter are required for managing certain systematic risks at the back-end, providing support to small banks for designing appropriate products, and supplying capital for small banks and large projects.

High quality small banks can carry forward what effectively started in the last round of bank licensing in 1993. From the cohort that started with that round of licensing, the banks that managed to succeed (like ICICI Bank and HDFC Bank) carried the paradigm of banking to the next level, taking it forward from what the then existing banks were doing, thus expanding access to a much larger number of people. They did so with increasingly sophisticated products and higher levels of efficiency. Small banks can take this process to the next stage, picking up from what these banks have done (or are doing), and taking the banking revolution to the next frontiers – the remote, rural areas, and the under-served parts of population in urban areas.

Finance Matters column in The Hindu Business Line – Farzana Najeeb of Advocacy writes the fifth article in the series.

Excerpt:

In the past few weeks with microfinance under public scrutiny, the self-help groups (SHG) channel is being positioned as a cheaper alternative of delivering microfinance compared to MFIs. A close look at the characteristics of the SHG model, its cost structure and interest rates to the ultimate customer shows that its cost is comparable to the MFI model despite a lot of implicit subsidies.

The SHG Bank Linkage Programme (SBLP) has contributed significantly to making credit available to the rural poor, but the true costs and risks inherent in this model need to be better understood. Understanding the SBLP

Under the SBLP, a SHG with 10-20 members (usually women) is formed with the support and guidance of a self-help promoting institution (SHPI). The SHG members are encouraged to make voluntary savings, which is internally lent.

To read the full article click here.

By Natalie Colatosti, Advocacy Team Member, IFMR Finance Foundation

The announcement of National Pension System (NPS) Lite, a pension plan geared towards economically disadvantaged populations, brings hope for much needed money during non-productive years. By offering a pension plan for low-income individuals, the Pension Fund Regulatory and Development Authority (PFRDA) has provided a mechanism by which the elderly poor can smooth consumption at a time in their lives when they typically rely on family members.

PFRDA’s pension plan is accessible and affordable. NPS Lite will be offered through aggregators – such as NGOs, MFIs and NBFCs – that already work with economically disadvantaged communities. The plan makes small individual investments possible by availing group platforms through aggregators. This structure allows for low administrative and transactional costs; thereby facilitating low contribution requirements.

The success of the NPS Lite pension scheme relies heavily on high quality aggregators, and IFMR Finance Foundation (IFF) presented recommendations pertaining to this aspect to PFRDA. Given the important role aggregators play as the interface between customers and NPS architecture, PFRDA has provided regulations addressing multiple aspects of operation. For instance, aggregators must have three or more years of experience working in financial services or commodity development, must adhere to ‘Know Your Customer’ requirements, and are not authorized to collect fees for their services to the customer.

NPS Lite is an important step along the path of total financial inclusion. The scheme offers savings to a population that typically does not have resources for their non-productive years. However, it is imperative that the scheme is well organized and maintained, so that the most deprived populations can reap the benefits of their working years later in life.

For more details on NPS Lite regulation, view the Regulations for Aggregators Under NPS Lite-2010 document.

Business Correspondence (BC) model or the third-party agent banking was launched in 2006 in India, with the intent of increasing the ambit of the formal banking sector. Since its inception in 2006, various banks have promoted the BC model in all corners of the country.

In the rural areas around Bangalore, FINO has partnered with a bank towards the extension of banking services through the BC model. FINO is delivering the BC services through “FINO Fintech Foundation” which is a section 25 company.

Recently members from IFMR Finance foundation (IFF) and IFMR Rural Finance visited the FINO Customer Service Points (CSP) in the area to understand better the working of their BC model and to interact with the FINO CSPs and their clients.  The team visited the Ramanagar and Gulberga blocks near Bangalore along with the respective block-coordinators, and was guided by Mr. Sharan, District coordinator of FINO. The visit enabled us to have deeper insights into the pros and cons of the BC model.

The FINO BC model offers no-frill account services involving savings and withdrawals, few CSPs had also tried selling insurance products on a very small-scale. Each CSP at the client level reports to the Block Coordinator, who is in turn, headed by a District Coordinator. The CSP is a contract employee of FINO Fintech foundation, who is a local resident, and is given a fixed remuneration of Rs 750 plus a commission of 50ps on every transaction irrespective of the amount transacted. These CSPs work an average of 4 hours per day and have this job as either the only source of income or as a part-time business.

On an average each CSP handles around 700-800 clients in her/his service area. Each CSP is provided with a POS machine for transactions and has to deposit an initial amount of Rs 10,000 with FINO Fintech foundation (Rs 5000 for the POS and Rs 5000 for the CSP) as guarantee money. A transaction limit of Rs 5000 is imposed on the CSP and once the limit breaches, the POS machine of the CSP gets blocked. It would then require a visit by the Block Coordinator to collect the cash and unlock the machine to carry out further transactions.

The CSPs, with whom the team interacted, found it difficult to sustain the business, as the income obtained from the present BC model was difficult to cover the costs incurred; the door-to-door services provided by the CSPs added to their cost. Apart from this, only 30-40% of the clients were active which further reduced the commissions for the CSP. However it was feasible for CSPs who ran Kirana stores, as majority of their clients visited the store as part of their daily chores and also made transactions with the CSP; he made fewer door step services than other CSPs who were housewives or working in other companies.

On interactions with the clients, the team could infer that the transaction limits imposed on the CSP was a major hindrance to the clients in utilizing these services efficiently and frequently. Many a times, any client who wants to withdraw or deposit amount that is greater than the limit would have to inform the CSP prior hand, thus it would usually take around three days to complete the transaction, consequently undermining the efficiency of the system.

Currently dealing with a minimal set of services, FINO is looking to widen its base by including NREGA payments and Insurance to ensure the sustainability of the model for all the partners.
—
Farzana Najeeb of IFMR Finance Foundation contributed to this post.