Three cheers RBI, but there are riders

Updated: Feb 3 2006, 05:30am hrs
Microfinance is considered one of the important financial resources for poor people to conduct household economic and income-generating activities. Microfinance has also served as a means of helping micro entrepreneurs to expand their businesses to the point of becoming viable business and eligible for credit from commercial banks.

Informal mechanisms and services have always played an integral role in the Indian economy. A vast network of commercial banks, cooperative banks and regional rural banks as well as other financial institutions also provide such services. The other set of institutions include non-bank finance companies (NBFCs), insurance companies, provident funds and mutual funds.

There are more than 160,000 retail credit outlets in the cooperative and banking sectors, coupled with some 95,000 cooperative societies or their branches, approximately 66,0000 bran-ches of public sector commercial banks and 196 regional rural banks (RRBs). But the availability is a mirage.

Not surprisingly, the two decades of IRDP experience affected the credibility of micro-borrowers in the view of bankers and, ultimately, hindered access of the, usually less literate, poor to banking services. Similarly, the entire network of primary cooperatives in the country and the RRBsboth sets of institutions established to meet the needs of the rural sector in general and the poor, in particularhas proved a colossal failure.

Saddled with the burden of directed credit and a restrictive interest rate regime, the financial position of the RRBs deteriorated quickly while the cooperatives suffered from the malaise of mismanagement, privileged leadership and corruption born of excessive state patronage and protection.

There are some interesting issues in the light of the recent RBI decision on extension of banking services to appoint NGOs/ SHGs/ CSOs and MFIs as business facilitators and correspondents.

Microfinance emerged as a lesson learnt from the mistaken policies in the past. The initial development of microfinance was highlighted by supply-leading paradigm, which emphasised on subsidised credit support for farmers and massive donor funding for alleviating chronic poverty. The approach gradually shifted to a market-driven one, with more focus on providing financial services, including voluntary saving products to economically active poor and micro-entrepreneurs.

The poverty lending approach focuses on reducing poverty, through micro credit and other complementary services to the poorest of the poor, particularly women, at highly subsidised costs.

A demand driven and financial system approach from NGOs took root in 1992-93 with the launch of Nabards Self-Help Group (SHG)bank linkage programme. Up to March 2005, over 16.18 lakh such groups had been linked to banks, and cumulative disbursals amounted to Rs 6,898.46 crore. An estimated 24.25 million poor families were brought within the fold of formal banking services.

The demand for micro finance is enormous. The financial needs of this vast population, even at a conservative estimate of Rs 6,000 and Rs 4,500 per urban and rural family, respectively, per annum, adds to about Rs 40,000 crore. The need is to balance between credits and savings.

From the perspective of a microfinance institution (MFI), NGOs and SHGs, savings means source of funds that can be lent. In this context, a higher saving rate will increase the flexibility of such organisations to expand their loan portfolio, which can lead to higher involvement as intermediaries.

In reverse, a lower savings capacity will diminish the ability of the organisations to increase the business as well as profitability. Savings constitute cheaper funds if deposit services are priced properly.

Introducing savings facilities may improve the outreach and expand new services and products. This will help liberate organisations from donor and government aid in order to achieve self-reliant financing for the long term, as well as lower liquidity risk. This can also maintain balanced governance. The presence of net savers will create a pressure on management for prudent operations.

However, the prerequisites would be to hone the legal, regulatory and supervision framework, institutional structures and advanced financial management capabilities among the institutions. As well as a redesigning of the product base that is market-oriented and that fits the preferences of poor clients. The caveat would be sound human resource empowerment through capacity building programmes as well as incentive systems on staff performance.

It would also be prudent to balance a number of objectives and the interest of different parties by preventing unsound practices, protecting and providing legal support to small depositors, and protecting public funds in case the liabilities of MFI/ NGOs/ SHGs are covered as blanket guarantee from the government or by public deposit insurance.

Strengthening institutional capacity will be one of the key issues. Strong institutions, together with good governance that can provide good quality financial services to the poor, will be the order of the day. There are some critical issues that should be taken into account. These relate to ensuring efficiency in operations and lowering of transaction costs.

The path ahead spells the need to grow microfinance as an industry.

The writer is thrust area coordinator for micro enterprise and microfinance at the Entrepreneurship Development Institute of India, Ahmedabad