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The question is whether existing banks are ready to take the leap of faith to reach the poor and lead the transformation or wait for new banks to take the lead. Photo: Rituparna Banerjee/Mint
The question is whether existing banks are ready to take the leap of faith to reach the poor and lead the transformation or wait for new banks to take the lead. Photo: Rituparna Banerjee/Mint

Banks can be happy small lenders

The high cost of small loans is no longer a barrier for banks from entering the microfinance market in India

There is a growing realization that a large part of India’s population remains outside the formal banking system. This has led to exploitation of the poor by money lenders who charge exorbitant rates on loans and also lure them with get-rich-quick ponzi schemes thus robbing them of their precious savings. The alternate mechanisms of joint liability by microfinance companies, or self-help groups (SHG), run by non-governmental organizations and rural cooperative banks have failed to deliver. The poor continue to pay the poverty premium. It is time that banks took steps to reach out directly to the poor.

The outstanding amount lent by microfinance companies crossed Rs23,000 crore by June. This was the level it was prior to the issuing of an ordinance in Andhra Pradesh which led to a shut down of microfinance companies and writing off the portfolio of Rs6,000 crore. The Andhra crisis has made microfinance companies look at other markets which were underserved and build their franchise. With loan losses continuing to be under 1%, the sector is expected to grow at 40% over the next few years to a loan book of Rs60,000 crore by 2016. SHG lending funded by banks and refinanced by the National Bank for Agriculture and Rural Development (Nabard) had touched Rs86,000 crore by the end of March. Thus, there is a strong case for banks to enter directly to deliver the goal of financial inclusion through microfinance.

There is plenty for banks to do in this sector.

For starters, banks can bring down the cost to borrowers from the current band of 26-30% charged by microfinance companies. Then, banks can offer savings and remittances products which microfinance non-banking financial companies (MFI-NBFCs) cannot. The estimated potential for savings is in the order of Rs50,000 crore, which is currently untapped. Finally, the opportunity to offer upscale products such as insurance, loans to small and medium enterprises and low-cost housing can benefit the rural poor immensely while delivering financial inclusion at the same time.

There is a strong case for the entry of banks from the risk management perspective too. For example, the establishment of the microfinance credit bureau supplemented by Aadhaar card has created a framework for monitoring customer relationship across products. In addition, quality human resources are available for banks across the country with sound knowledge and understanding of the sector. Lastly, technology and connectivity across the country are available to banks for accessing real-time information to mitigate risks.

If the above factors offer possibilities, there is no shortage of challenges as well. One problem that banks are likely to face is the issue of customer segmentation and their delivery model. A way to overcome this problem is to build a bank within the bank. This can be through, for example, a wholly owned banking/deposit—taking a NBFC subsidiary focused on the low-income segment. That will be the best way to harness a bank’s risk, technology and treasury management skills while ensuring their main brand value is not diluted.

Another challenge is the high operating cost of these institutions given the low ticket size of loans. The best way is to accept savings from the borrowers in these markets and thus bring down the cost of servicing using the same group model. Grameen Bank and ASA in Bangladesh have demonstrated this successfully over the last two decades. New handheld devices, which can instantly capture savings account data and update passbooks, can ensure lower operating costs for the banks.

The risk of loan write offs due to political intervention remains the only big challenge that has to be managed by banks through proper engagement with government bodies at the state and Union level, duly supported by the Reserve Bank of India.

Banks stand to benefit from such ventures in the low-income segment. This segment is mature for profitable small-ticket banking and is not merely a social responsibility.

The way forward for banks is clear. As a beginning, they should set up separate divisions or subsidiaries to focus on the low-income segment.

While the lending system should follow the joint liability group (JLG) model, liability products should be driven on the back of JLG using handheld devices to deliver the savings products with minimal cost.

Then, there is the issue of identifying urban and rural markets where the microfinance culture is well established. States such as Karnataka, Tamil Nadu, Bihar and parts of Uttar Pradesh come to mind. These are good starting points for banks as it will be easy for them to form groups and also recruit field officers with experience in these markets.

The question is whether existing banks are ready to take the leap of faith to reach the poor and lead the transformation or wait for new banks to take the lead.

Suresh Gurumani is a former CEO and MD of SKS Microfinance Ltd.

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