Financial services for small businesses and low income households

January 28, 2014

Indias RBIs Mor Committee Report and consolidation At a time when we are consolidating our financial services sector, it is noteworthy that Sri an!a has "een "attling for years on this ve#ed issue of providing an efficient and responsive system of financial services to small "usinesses and low income households$ %he initiatives go "ac! to colonial times$ %he Co&operative Rural Ban!s have a history of over '(( years$ %ogether with other co&operatives li!e Sanasa and co&operative agricultural and fishery lending institutions, these were designed to "rea! the stranglehold the money lender and pawn"ro!er had on small entrepreneurs and low income households$ Money lenders were regulated "y legislation, also Seetu systems )Rotating Savings and Credit Associations *Roscas+,$ %he legality of Roscas is in dou"t due to recent legislation on -inance Business$ Most of these regulators are presently in deep slum"er$ .e"t relief was institutionalised "y the setting up the .e"t Conciliation Board "y law$ /resently Sri an!a presents to the small "orrower a mi#ed salad of institutional and informal financial service options, ranging from the money lender, pawn"ro!er, to seetus, to Co& operative Rural Ban!s, micro finance institutions, .ivi 0eguma "an!s, finance companies, licensed commercial "an!s, etc$ /resently nongovernmental, non "an!ing, non finance company, micro finance institutions and .ivi 0eguma, which succeeded Samurdhi, are not supervised "y an independent prudential regulator$ %his is high ris!, as!ing for trou"le$ Reforming the financial sector %he CBS is ta!ing steps to reform the financial sector$ Big micro finance players have "een encouraged to convert themselves to finance companies, so that they come within a regulated environment, this includes Sarvodaya Seeds, Seva an!a -inance and 1rameen Sri an!a$ After li"erally issuing licenses for new finance companies, the regulators

now are trying to consolidate them, reducing the num"er from the present around 23 to 4($ Ban!s and finance companies will "e encouraged to ac5uire one to three smaller firms$ %his includes nonperforming finance companies ta!en over and to which various types of lac!eys were appointed to run them$ %he "a6aar tal! a"out one worthy is that, other than his parents, all other relatives are wor!ing for one financial service provider or another7 %he State&controlled "an!s, perennial forci"le rescuer of disastrously performing para&statal enterprises is, it is alleged, "eing forced to intervene again7 %his master plan for consolidation of the financial sector is in the process of "eing unveiled$ It has "een estimated that as much as 8(9 of finance for asweddumisation of paddy lands is generated through pawning family :ewels$ In a country which has over a centurys history of rural credit schemes, this is a disgrace$ %he financial services sector has failed to come up with a financial instrument to service the largest demand for rural credit$ %his and related tas!s "y and large has "een left to the money lenders, pawn"ro!ers and the micro finance sector$ In Sri an!a today, the "ul! of micro finance activity is in the non commercial "an!ing sector$ %he Co&operative Rural Ban!s and Sanasa have a history of over '(( years in the sector$ Sarvodaya Seeds and its successor .eshodaya -inance, the 0ational ;outh Savings and Credit Cooperative *0;SC<+, have over a 5uarter centurys e#perience$ More recent interventions such as the Sewa an!a -inance, =anasha!thi Ban!u Sangamaya of the >omens .evelopment -ederation, ?am"antota, the >ilpotha @antha Iturum /arshadaya of >ilpotha, /uttalam, the Batticaloa ;MCA, have also "uilt up e#perience and capacity$ %he marginalised poor, youth and women have really "enefited from these interventions$ %he 0ational .evelopment %rust -und *0.%-, formerly the =anasaviya %rust -und )=%-,+ has "een operating from 'A3A and is the "iggest provider of wholesale funds for on lending to the M-I sector, including the Regional .evelopment Ban!s$ %he =%- credit window is now "eing operated "y the Sri an!a Savings Ban!$ %ogether with the 01<s in the sector there are huge num"ers of organisations, outside the commercial "an!ing sector, involved in M- in Sri an!a today$ >hen the States .ivi 0eguma "an!s are ta!en into consideration, the num"ers will increase e#ponentially$ ?owever there is a legal interpretation issue as to whether "y statutory definition .ivi 0eguma can lawfully operate in rural agricultural and fishery communities$ %he M-Is Ape# <rganisation the an!a Micro -inance /ractitioners Association has "een playing a role in trying to create a culture of self regulation among the M-Is as has "een reportedly successfully done in some parts of India, %imor& este and Bganda$ Impressive outreach A recent C1A/ *Consultative 1roup to Assist the /oor C of the >orld Ban!+ survey stated that microfinance in Sri an!a had achieved an impressive outreach, with more that '2 million deposit accounts and two million outstanding micro loans in 4((8, this from a population of 4( million people$ A Sri an!a Country evel Dffectiveness and Accounta"ility Review *C DAR+ "y C1A/, which too! place in 4((2, revealed that a handful of promising institutions that offer a wide range of services has

emerged$ ?owever, many microfinance providers are not committed to transparency, there"y contri"uting to the fragile nature of the sector and wea!nesses, such as su"standard portfolio management and financial sustaina"ility, poor level of microfinance specialisation, and widespread pu"lic sector involvement in credit delivery$ All these issues have solutions, mostly which could "e addressed "y the M-Is themselves, "y self regulation, e#cept the one of pu"lic sector involvement$ /oliticisation Sri an!as e#perience shows that State involvement means politicisation$ In the guise of protecting poor depositors if the State steps in to regulate the M-I sector, the resultant politicisation will "e a death warrant$ ?owever, a draft Micro -inance Regulation Bill has "een prepared and is pending enactment for an inordinate amount of time$ Self regulation "y the M-Is themselves is a much preferred option$ In any event, the fact is there is a regulatory process in place, first the mar!et itself, with so many lenders, the "orrowers have a clear choice, and there are a plethora of laws, which give the State immense supervisory power over the sector, ranging from the Cooperative Act, the Monetary Act, the Eoluntary Social Service <rganisations Act, the Companies Act to the .ivi 0eguma Act, to name only a few$ >e do not need new legislation, :ust proper implementation of the e#isting legal regime, in other words, improved governance$ <perational issues a"oundF the Institute of /olicy Studies recently did a study on Samurdhi and found that 8G9 of the real poor are not receiving the programs "enefits, whereas 8(9 of the "eneficiaries that get "enefits are not the targeted poor$ -urther, the Einstar Report of <cto"er 4((( reported that the Samurdhi Ban!u Sangam must "e counted as one of the most e#pensive large M-Is in the world$ %he operating cost *e#cluding cost of funds+ of an average performing SBS is around HG9 of its average gross loans outstanding7 1rameen in Bangladesh is only A97 Mor Committee report %he Reserve Ban! of India *RBI+ recently released the report of the Committee on Comprehensive -inancial Services for Small Businesses and ow Income ?ouseholds, which was chaired "y 0achi!et Mor, a "oard mem"er of the RBI, which was tas!ed with framing a clear and detailed vision for financial inclusion and financial deepening in India$ %he Mor Committee outlined vision statements to achieve this goalI Dvery Indian a"ove '3 must have a full service, safe and secure electronic "an! account$ Dvery resident of India must "e within '2 minutes wal!ing distance of a payment access point$ Dvery low income household * I?+ and small "usiness *SB+ must have access to a formally regulated lender that is capa"le of meeting their credit needs, with access to a provider that can offer them suita"le investment and deposit products at reasona"le charges$ Dvery I? and SB must have access to providers that have the a"ility to offer them suita"le insurance and ris! management products to manage ris!s such asI commodity price movements, longevity, disa"ility and death of human "eings, death of livestoc!, climate ris!s and damage to property$ Dvery I? and SB must have the right to "e offered only suita"le financial services and the legal right to see! redress, if due process to esta"lish suita"ility has not "een

followed or there was gross negligence$ %he Mor Committee also laid down four design principles as a guide for development of institutional framewor!s for financial services for I? and SBF Sta"ility, %ransparency, 0eutrality and Responsi"ility$ It is important to note that the Mor Committee has said thatI J%here is a need to move away from a limited focus on any one model to an approach where multiple models and partnerships are allowed to emerge, particularly "etween national full service "an!s , regional "an!s of various types, non "an! finance companies and financial mar!ets$K %hus the recommendations of the Mor Committee see! to encourage partnerships "etween specialists, instead on focusing only on large and generalist institutions$ %he Mor Committee also recommends that the RRBI seriously considers licensing with lowered entry "arriers, "ut otherwise e5uivalent treatment more functionally focused "an!s li!e payment "an!s, wholesale consumer "an!s and wholesale investment "an!s$ %ie&up with telcos /ayment "an!s would ena"le Indian mo"ile phone companies to replicate mo"ile payment technologies that have proved highly successful in African mar!ets li!e Eodafones M&/esa service which is used as a virtual currency "y more than H(9 of @enyas adult population, allowing users to store money, transfer funds to relatives or "uy products in shops$ Chairman 0achi!et Mor in an interview stated that allowing mo"ile phone companies *telcos+ to offer "an! li!e payment services would "e one of the most transformative steps in creating total financial inclusion a reality$ 1iven Sri an!as mo"ile phone penetration, this would apply here too$ It would "e hugely popular, it means that you can remit money to your parents at your village using your mo"ile phone or receive funds from your "rother in .u"ai, and collect the cash at the local telco agents shop$ Boston Consulting 1roups ?ead of -inancial Services in Mum"ai Saura"h %ripathi agrees, sayingI JA greater role for telcos would "e transformative for the "an!ing industry$K /resently regulations force telcos to tie up with esta"lished "an!s and do not allow mo"ile customers to gain access to money stored on their phones -inancial inclusion .r$ C$ Rangara:an, former 1overnor of the Reserve Ban! of India and currently Chairman, Dconomic Advisory Council to the /rime Minister of India, recently saidI J-inancial inclusion is no longer an option "ut a compulsion and self help groups and 01<s can play a "ig role in ma!ing it a reality$ I wish to stress upon the need for the larger spread of the "usiness correspondent model for the penetration of financial services in rural areas$K In India, under the "usiness correspondent model, "an!ing and non "an!ing finance companies employ local people to carry out the activities of a "an!er in their villages so that a villager need not travel to a "an! "ranch for every small transaction$ -or India this model which opens up opportunities for self employment "y creating appropriate institutions and policies to help in livelihood creation may "e appropriate, given her social indicators, "ut for Sri an!a, given our virtual first world social indicators and the tremendous outreach of the M-Is, a more developed financial model is sensi"le and attaina"le$ M-Is are of utmost importance for financial inclusion as these institutions connect with the people constituting the lowest strata of society$ But it is o"vious that when an M-I targets

customers with no recorded credit history, it increase the ris! for its "usiness$ It is due to this inherent ris! that it is e#tremely difficult for M-I to raise money other than through their mem"ers deposits$ %here was a time when donor agencies and a handful of I01<s were the source of funds for M-I$ %oday this is changingF there are investment funds which are showing interest in investing in M-Is$ %he potential in this "usiness is huge as Sri an!a in particular and South Asia in general is considered to "e under seriously under"an!ed$ -ortune at the "ottom of the pyramid %he late /rof$ C$@$ /rahalad of the Bniversity of Michigan wrote a"out %he -ortune at the Bottom of the /yramid and made the world aware of the real high volume purchasing power, al"eit in small units, availa"le at the "ase of the economic pyramid$ %his is "est e#emplified in Sri an!a "y the vast num"er of used u#, Sunsil!, @ohom"a, Clear, etc$ shampoo sachets found littered around any village "athing spot$ Commercial "an!s also today have got into the act "y using multiple platforms to reach this lucrative mar!et at the "ottom of the economic pyramid$ Connecting up and lin!ing with M-Is and self help groups is one method which has "een successfully used "y the ICICI Ban! in India$ ICICI Ban! ?ead of Rural Ban!ing Ra:iv Sa"harwal saysI JAs far as the role of the private sector is concerned, micro finance is not an e#ercise in charity$ Consensus is emerging in the industry that micro finance cannot "e relegated to "e a mere CSR activity$K Moumita Sensarma of AB0 Amro Ban! of India stresses the need to find last mile solutionsI JReading customers mindset presents a tough tas! for "an!s that need to reach un"an!ed areas$ Ban!s are culturally seen as a foreign entity, thus technology that the "an! chooses is crucial in approaching the poor$ As the micro finance industry matures more opportunities will "e created for domestic and international finance players to enter this mar!et profita"ly, while contri"uting to poverty reduction$K Biggest stum"ling "loc! %he "iggest stum"ling "loc! for M-I and other agencies which see! to tap the customers at the "ottom of the pyramid is the lac! of information on the credit worthiness of the "orrowers they deal with$ %his is "ecause such "orrowers do not have formal lin!ages with financial institutions and there is no record of their transactions li!e, loans and savings accounts, etc$ M-Is are una"le to ascertain the credit worthiness of the "orrowers in an o":ective way$ %he small group lending model provides the alternative of peer pressure as a method of ensuring a responsi"le repayment culture$ %he other more effective option is creating a data"ase of the credit history of "orrowers$ %his referred to as a credit "ureau, and the formal "an!ing system in Sri an!a has the Credit Information Bureau$ %he an!a Microfinance /ractitioners Association should seriously loo! at the possi"ility of setting up a data"ase of "orrowers of its mem"er M-Is$ Such a data"ase would "e "eneficial "oth to the lender as well as the "orrower$ %he lender gets vital information a"out the credit history of the potential "orrower$ %he "orrower in turn can "argain a deal with the lender citing the "etter credit record$ Sri an!a is fortunate that every citi6en has a uni5ue identification num"er C the 0ational Identity Card num"er$ %his facilitates data storage and access of information on individual "orrowers$ >here there is over&"orrowing in system due to high competition among M-I and distri"ution of credit varies from province to province, such a data"ase of "orrowers can "ring

a"out some uniformity of systems$ Creation of such data"ase of M-I "orrowers and integrating it with the Credit Bureau of Sri an!as data "ase will greatly strengthen the credi"ility of M-Is in Sri an! and their a"ility to access funds and investors$ ?uge "usiness potential %he formal financial system can realise the huge "usiness potential coming from unmet demand for financial services from the financially e#cluded$ %he focus should "e on creating customised, composite and simple products$ At the same time new products li!e micro insurance and foreign and local remittance services need to "e developed$ ?owever, the "an!s themselves will not "e a"le to reach the last mile easily and will need the assistance of intermediaries$ M-Is have proved, in Sri an!a, that they can reach the "ottom of the economic pyramid effectively and profita"ly at that$ It is logical in the ne#t phase of financial services development in Sri an!a that the formal financial sector enters into via"le wor!ing partnerships with the M-I sector$ %here is a need for innovation in the delivery of "an!ing products to the masses, including M&/esa type mo"ile "an!ing through telcos$ <ne way is for the commercial "an!s to offer a full range of financial services to the economic players at the "ottom of the pyramid, in partnership with M-Is and telcos, including savings, transfers, short and long term credit, mortgages, insurance, pensions, remittances, and leasing$ %his would necessarily involve an overhaul of the nature of financial products "eing offered, delivery mechanisms, a change in the mindset of commercial "an!ers and may "e even changes to e#isting law$ But if the country is to move forward in its "attle to overcome poverty, it is a logical and necessary step$ Consolidation of the "an!s and finance companies "y the CBS will result in a lesser num"er of institutions$ %he options for "orrowers will "e reduced$ Competition will "e less$ Monopolising "an!s and finance companies will ma!e higher profits$ %he "orrowers will lose out$ %he regulator will have less wor!$ .ivi 0eguma financial services and the nongovernmental, non "an!ing, non finance company, micro finance providers do not have an independent prudential regulator$ Is this an accepta"le financial services environment for Sri an!a todayL *%he writer is a lawyer, who has over G( years of e#perience as a CD< in "oth State and private sectors$ ?e retired from the office of Secretary, Ministry of -inance and currently is the Managing .irector of the Sri an!a Business .evelopment Centre$+