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Expanding access to finance for small businesses in India: A critique of the Mor Committee’s approach part 3. Assessing access to finance for small businesses?

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The first blog in this series highlighted the context of the Mor Committee’s recommendations and the significant gap between the supply of and demand for credit for small businesses. The second blog in the series examined the role of the banks, development finance institutions and non-bank financial institutions (NBFCs) to examine why they have been so backward in coming forward to meet this gap. This concluding blog looks at the ways of measuring access to finance for small businesses.

Credit to GDP Ratio – Is it a good measure to assess access to finance for small businesses?

The Mor Committee report recommends that by January 2016 every significant (more than 1 percent contribution to GDP) sector and sub-sector of the economy should have a credit to GDP ratio of at least 10 percent. The Committee recommends the use of credit to GDP ratio to assess the extent of credit reach to various sectors in the economy. The report highlights that India at its abysmal 70 percent credit to GDP ratio is way below the averages of high-income countries (200 percent) and the middle-income countries (100 percent). The Committee argues that targeting 10 percent credit to GDP ratio for all significant sectors by 2016 would catalyze inclusive growth and subsequently reduce poverty.

At the small businesses level, the report presents the finding that the credit to GDP is 35 percent at an aggregate level. Similarly, at industry and services level, the ratio stands at 56 percent and 25 percent respectively.

In our analysis of subsectors within the MSME segment at the two-digit level of NIC-2004 classification, MicroSave found that of 47 sub-sectors only five, namely Food Products and Beverages; Textiles; Chemicals and Chemical Products; Basic Metals; and Fabricated Metal Products contribute greater than 1 percent to the GDP. In terms of access to finance, these five subsectors had comfortable access ranging from 49 to 101 percent. Thus, we observe that while credit to GDP may be a good ratio to determine access to credit at the aggregate and sectoral level, at the sub-sector level it does not hold relevance.

Also, the targets assigned for January 2016, at 10 percent credit to GDP is not relevant for the MSME sector per se as all the sub-sectors within MSME segment have greater than 10 percent credit to GDP ratio. The credit flow is skewed in favor of medium enterprises with micro enterprises languishing for want to institutional credit.

A World Bank study highlights that access to credit is inversely related to firm size. Size is a significant predictor of the probability of being credit constrained and hence micro and small enterprises are highly credit constrained. In such as scenario, credit to GDP ratio would not sufficiently reflect the access to credit to small businesses. Lack of a clearly articulated and representative ratio may mean that the banks and financial institutions would expand access to credit to the MSME sector as a whole by focusing largely on medium-sized enterprises.

Thus, it would be worthwhile to use the formal credit to capital ratio to measure the access to credit by small enterprises. The underlying assumption upon which this indicator is suggested is the fact that it clearly defines the leverage of the enterprises. Also, in our opinion, instead of looking at MSME sector as a whole, it is important, for the purposes of measurement of access to credit to look at the micro, small and medium enterprises individually.

Another measure in line with the suggestions of World Bank’s report on the assessment of credit constraints for enterprises is the credit-constrained status of the micro, small and medium enterprises. World Bank suggest that the enterprises can be classified as below:

The status of all enterprises across the size ranges can be assessed periodically to estimate the access to finance. This will provide a better understanding of the access to credit amongst micro and small enterprises, and thus focus policymakers’ attention on these key drivers of Indian economic growth.

Who is the user in “user-centred design”?

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In 2000, we had completed two years of what we thought was outstanding work to understand the needs, perspectives, and aspirations of the end customers for banks and microfinance institutions. It was time for MicroSave–Africa’s first mid-term review, led by industry gurus Beth Rhyne and Marguerite Robinson … and they gave us a wake-up call.

They noted, “The mid-term review of MicroSave-Africa found the project to be outstanding in articulating client perspectives ….  MicroSave-Africa‘s … excellent market research training course has already given 16 MFIs a new perspective on clients and tools (focus group discussion and participatory rapid appraisal techniques) to learn about client needs more effectively.  MicroSave-Africa has not done as well on the supply side, in part because it has underestimated the complexity and scope of the work needed to introduce new products successfully inside MFIs.”

We had developed a series of qualitative research tools and techniques that helped (and continue to help) hundreds of financial institutions develop new and refined products that are used by millions of people in Africa, Asia, and Latin America.

But this success could not have been achieved without clearly understanding exactly who uses these products.

The obvious “users” are the end customers of the financial institution or mobile network operator. But as our mid-term review highlighted, there is another very important “user”: the organization that will deliver the product. MicroSave has been running training and technical assistance on product development and innovation for 15 years now, and we have repeatedly seen two challenges:

  1. When an external agency conducts market research and hands a beautifully constructed product prototype to a financial institution, it has a high chance of becoming a “product orphan” – unloved and rejected by its prospective parents. External agencies can rarely adequately understand the institutional needs, culture and operational realities of the financial institution. So, more often than not, the product prototype is not adequately profitable, or conflicts with other operational realities, or presents insurmountable challenges for the IT systems and so on. External agencies from different countries also often fail to understand the regulatory environment or cultural nuances of the target market – particularly if they insist on arriving with “optimal ignorance”.
  2. Even when the market research is conducted by staff of the financial institution in collaboration with MicroSave (our preferred model) we sometimes see their perspectives shift from being to an institution focused to the other end of the spectrum and being to customer focused. In between these two extremes lies the “sweet spot” for products that are market-led but meet the institution’s needs and realities. Institution-focused financial services ignore the market and end customers’ needs, perspectives and experiences; but over customer-focused products can be too complex, or simply not adequately profitable to deliver.

The solution lies in building qualitative market research capacity within institutions so that the tools and techniques can be used not just for product innovation but also for a myriad of other drivers of customer-centric or market-led financial services: customer service, marketing & communications, corporate brand & identity and so on. And so that the products developed are based on the needs of both the customers and the institution that serves them, as well as an adequate understanding of the regulatory environment.

Indeed, we at MicroSave would argue that the most successful financial institutions (and indeed other corporations) have in-house market research capability. Equity Bank is a very good example of this – we trained six of Equity’s staff on qualitative market research in 2001-02, and this team helped guide the bank from 75,000 customers in 2000 to over 1 million by end 2006. Equity then underwent a massive expansion, and in 2010 came back to MicroSave asking us to train a new cadre for its “Research and Product Development” cell because the original staff that we had trained had either moved up within the organization or had moved on. This new cadre is now working with us to develop the products for rollout across the bank’s digital finance channels and for its operations in Tanzania, Uganda, Rwanda, and South Sudan. Equity Bank now has 8.7 million customers in Kenya alone. They are perfectly positioned to balance the needs and perspectives of the customers and the bank.

The users in “user-centered design” are necessarily both the customers and institution that serves them … and not as one fresh-faced consultant announced to colleagues of mine, “the donor who pays my bills”!

Expanding access to finance for small businesses in India: A critique of the Mor Committee’s approach part 1. Background and the supply gap

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In 1966, the Hazari Committee on industrial licensing recommended nationalization of banks, which changed the Indian banking industry fundamentally. After a gap of nearly forty-five years, a similar path-breaking effort has been initiated by the Reserve Bank of India, in the form of the Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households. The Committee and its report are part of an explicit and dedicated effort to expand the ambit of financial services from partial to full inclusion of small businesses and low-income households in India. The Committee’s terms of reference included the formulation of design principles to develop institutional frameworks and regulation and development of new strategies to achieve full inclusion and deeper financial support. Chaired by Nachiket Mor, the Committee tabled its report in a record time of four months. The report, with its visionary and reformative recommendations, aims at significantly and fundamentally overhauling the entire banking industry in India. The report’s bold and ambitious recommendations have so far received a range of responses from critics, ranging from wholehearted support to skepticism, from wonder to bewilderment. While the report has its fair share of ambition and optimism, in our view there are parts that are aptly conceived and its recommendations in the light of best practices and global learning make sense. In this blog, we critique the Committee’s approach with respect to enhancing access to financial services for small businesses in India.

Considering that small businesses were an integral part of the target segment, the report’s following observations and recommendations have the potential to impact the delivery of financial services to small businesses fundamentally:

  1. “Close to 90 percent of small businesses have no links with formal financial institutions. There exists robust and visible demand by small businesses for a wide range of financial services. Currently, this demand is being serviced by informal sources.”
  2. “The current approach of full-service, national level, scheduled commercial banks using their own branches and a network of mostly informal agents is a case of “too much for too little” as access is low compared to risks and costs.”

Apart from these observations, the Committee also recommends that by January 1, 2016, there should be:

“High-quality, affordable and suitable credit for all small businesses from conveniently accessible formally regulated lenders. It further establishes the need for full inclusion of small businesses with regard to basic payments and savings, and risk and investment products.”

For market making impact, the Committee suggests the following:

“DFIIs such as NABARD, CGTMSE, and SIDBI should re-orient their focus to be market makers and providers of risk-based credit enhancements rather than providers of direct finance, automatic refinance, or automatic credit guarantees for banks.”

In addition, the Committee recommends that by 2016, every sector and sub-sector of the economy with more than 1 percent contribution to GDP would have a credit to GDP ratio of at least 10 percent.

In three parts of this blog, we dissect each of these observations to assess why and how it can impact enhancing access to financial services by small businesses in India. We also showcase examples of similar initiatives that have yielded far-reaching impact in terms of bridging the demand-supply gap for financial services.

  1. Demand and Supply Gap for Small Businesses Financing in India

One of the key observations of the Committee is that 90 percent of the small businesses are self-financed. Regulators, donors and financial institutions have constantly raised this issue on several platforms and flagged it as a challenge that needs to be addressed on a priority if India is to attain its dream of full financial inclusion. The reason is obvious, as, in a developing nation like India where the country’s growth is being fuelled by vibrant small businesses, the lack of adequate finance mars the growth of the small business sector and in turn impacts on the growth of the nation.

An analysis of financing to enterprises reveals that small businesses face a major gap in financial services. India has 1.8 million registered and 29 million unregistered enterprises. 95 percent of registered enterprises and 99 percent of unregistered enterprises are micro-enterprises.

As per the annual report 2012 from the Ministry of MSME, Government of India, only about 7 percent of enterprises have access to finance from institutional and non-institutional sources.

93 percent of such enterprises rely upon self-finance, which includes the entrepreneur’s savings and short-term loans from friends, family, and relatives.

The International Finance Corporation, in its 2012 Research Report estimates that the finance gap for small businesses is a whopping 96 percent. The report estimates that of the INR 20.9 trillion MSME finance gap, INR 19 trillion is the debt gap and INR 1.9 trillion, is the gap in equity.

In the next blog in this series, we examine why financial institutions are unwilling or unable to sieze the market opportunity to fill this gap.

Whose cash is it anyway? Several agent solutions to cash security

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Agents everywhere have trouble breaking even. Reasons are numerous (click here for the easy blog overview and here for MicroSave‘s comprehensive Policy Brief on Indian Business Correspondents), but first and worst among their complaints is how to manage all that tempting, eminently stealable money—both in their shops or kiosks and en route to and from designated bank deposit/withdrawal locations.

Bank branches are too far, and often too unwelcoming, for poor, rural and urban clients expecting government disbursements and/or with their own earnings to remit or deposit.  This is particularly true in India where close to 70 percent still live in villages, internal migration to industrial cities continues apace (two out of every ten or ~240 million Indians are migrant workers), and many of them have too little income to ever really interest retail banks anyway. Agents, or business correspondents (BCs) as they are known here, manage cash-in and cash-out transactions for these individuals near their home and work with easier hours and surroundings.

For the past five years, the Reserve Bank of India (RBI) has been well aware of the daunting—and expensive–security risks these BCs experience daily in their role as local bank representatives. One RBI solution has been specified “cash routes” with transit insurance paid for by the sponsoring banks, but these secured routes are not available to all agents in all areas. Unreliable technology and lack of bank interoperability also complicate agents’ liquidity management and liability. The result is high BC turnover and dissatisfaction—plus too many robberies and very few bank reimbursements to date for these losses.

But wait…

This is not just another hand-wringing dirge about the Plight of the Poor Agent and the failure overall of the BC model. In fact, a MicroSave field research team recently came across BCs in Bihar, a state in Eastern India, who are competing successfully with, and even occasionally attracting more customers than, regional rural banks in the area with lower commissions and more flexible hours, most notably during peak-volume holidays and festivals.

Nevertheless, theft is an ever-present problem for them as well. Many of these agents in different districts of Bihar are handling INR.500,000 -1,000,000 /USD 8,333- 16,666 and 100+ customers a day. This can mean at least two visits to the link bank to replenish cash or deposit one morning’s intake. These frequent trips are not along the secure “cash routes” mentioned above, and most agents have no formal insurance, nor do their customers. The BC network managers and the link banks are theoretically responsible, but most apparently do nothing to reimburse the loss. So agents and customers must somehow cope.

Agent ‘Arrangements’

And cope they do. Surprisingly well in many cases. Here are several strategies we observed in our fieldwork:

  • Arrangement 1:  Amarendra Prasad Singh, age 38 years, has had all the usual problems most agents do: a large personal investment (INR100,000 /USD 1666) up front to establish his bona fides with his corresponding bank and to start the business; power shortages and weak internet connectivity which he must supplement with auxiliary electricity, data cards, and multiple SIM to create backups for system failures; and, of course, robbery which could easily erase his daily profits and INR 30,000/USD 500 monthly commissions.

Initially, Amarendra had high hopes RBI or his link bank would come up with a remuneration scheme in the event of theft, but he has since taken it upon himself to manipulate public perception regarding his cash flow. He opens his shop next to his house (where he has ample cash reserves) at 10 am sharp, but he allows no withdrawals until 10:45 because, as he tells his customers (and anyone else who might be listening), his associates are at the bank collecting cash and won’t be back before then.

He also lets it be known that he does his own bank business early when the branch opens. In fact, when he has to withdraw or deposit large sums, he goes at noon as inconspicuously as possible. And though he has business hours on Sunday, he only offers account opening and balance enquiries, again to deflect the notion that he keeps any cash at home.

  • Arrangement 2: Shailesh Kumar’s profile is similar to Amarendra’s, but his strategy differs.  He makes at least two trips a day to his link branch located 5kms away. Each visit he withdraws INR 200,000 – 300,000/USD 3,333- 5,000 and carries it back to the shop. But he never goes at the same time or takes the same route. And he tells no one his schedule except the person accompanying him. He varies his withdrawal routines as well, using ATMs instead of his link branch and multiple debit cards for smaller denomination withdrawals. Shailesh also uses only four-wheel vehicles instead of two-wheel bikes or motorcycles to conduct bank business as he believes cars are safer and the money is easier to hide.
  • Arrangement 3: Ajay Kumar, an agent operating in one of the more remote villages in the area, has already been robbed once. He claims he never even realized that his activities were being tracked on his regular visits to his link branch. He lost INR 80,000/USD 1,333 and even after six months of repeated requests to the bank and his network manager, he has received no reimbursement. Ajay now rents a shop much closer to the branch and has moved most of his business there. He well understands that this is very inconvenient for his village customers, but by substantially reducing his former operations, he also reduces his chances of losing large amounts of their money and his profits.
  • Arrangement 4: In a few cases, link branch managers actually seem to understand agents’ security concerns and try to co-operate to the extent they can. One manager granted agents in his operating area a “green channel” which meant the bank cashier allowed BCs to withdraw cash privately from a special chamber in back of the bank. (This practice ended when a new branch manager arrived and now all agents for that link bank wait in long queues along with everyone else, with minimal safety measures, often for hours at a time.)
  • Arrangement 5:  Several BC network managers are also making an effort to improve security for their agents and have created insurance pools whereby every agent contributes Rs.500 each month. These sums are then used to help cover losses. A four-member committee which includes the BCNM head decides which claims are valid and how much to award. At present, BCNMs are not in a sufficiently strong position to offer better money insurance and their agents do not earn enough to pay the premiums for real cash-in-transit insurance.

Arrangements 4 and 5 only serve to underscore what agents know already: they take the hit for cash that is never actually theirs. The money belongs to the customer while the bank, the institution with the full deposit-guarantee insurance, holds the funds until the customer withdraws them. Agents are only the luckless, uninsured intermediaries.

No one thinks this is fair (except possibly the banks) and RBI has finally, in a recent notification,  acknowledged that the responsibility of cash insurance should indeed rest with banks. BCNMs now have huge expectations. We would like to believe they are justified, and in the meantime, we look forward to more and ever-better coping strategies from enterprising agents.

Beware the OTC trap: Is there a way out?

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We presented in our earlier blogs how over the counter (OTC) was growing in leaps and bounds due to various reasons but the key stakeholders were still not satisfied. The question we have been asked in various interactions is – is there a way out?

The clichéd statement appears true in this case – Getting in is easy, getting out very difficult! Whether it’s EasyPaisa in Pakistan or Tigo in Paraguay, the operators appear to be trying.

A key characteristic of OTC is that clients generally have no incentive to put their money in the mobile wallet. They just go to the agent, hand over the cash and the transaction gets done. This has a few fallouts, one the customer doesn’t keep any money in the wallet, all the transfers received are immediately withdrawn in full. As a result, no transactions can take place on an empty wallet.

If we trace the roots of such deployments, we see that the customers have actually witnessed several changes in the way they do financial transactions, one- it’s faster, two –it’s cheaper, three – it’s done at an agent nearby! So while the landscape has significantly changed, there has been negligible change in the behavior of the customer.

The quintessential question is – what will drive the customers to initiate the transactions themselves? In other words, change his behavior. In our view, there are several ways through which this could be attempted.

  • It is definitely important to know who these customers and their beneficiaries are why they have been doing assisted transactions till now and what are their needs (both stated and unstated). This could be easily provided the agent device captures this information. If it does not then put this in place this could be the first step towards moving from OTC to self-initiated transactions. This should then be supplemented with qualitative research to gain a deep understanding of and insights into why customers and beneficiaries are using OTC, as well as what might cause them to open and use a wallet.
  • One of the key change triggers is consumer marketing and education. The customer will need to know that it is possible for him to make transactions for himself and that it is not rocket science. The right kind of graphics and messaging is important to induce a trial. The protagonist has to be someone the customer can identify with – an uneducated person, or a middle-aged person seeing the agent doing the transaction and then attempting himself and saying, “It’s so easy, even I can do it!”. In addition to this, there has to be a clear message on why is it better than OTC – which of course will be built on the basis of the insights from the qualitative market research. This has economic fallout – the agents may be up in arms since we will be taking their customers away, but they will need to be explained that the cash-in commission would still be theirs. And to sweeten the pill, the cash-in agent could, initially, get a little bit more if the customer does a transaction himself after cash-in. That way he will help change in behavior as he thinks that his commissions are protected.
  • It’s also important to get funds into the wallet easily. If the customers were to get their salaries or benefit payments directly into the wallet, then there all chances that the customer would not visit the agent to withdraw cash and then hand it back to him to remit to some! This would naturally aid the change in behavior for the customer.
  • Technology led processes could be triggered to identify and deal with such transactions. Safaricom, for example, built logic in their platform to study patterns as customers actually asked the agents to deposit directly in someone else’s account. They focused on looking at the originating and terminating mobile numbers/locations. This allowed them to identify which transactions were being made OTC. On the basis of this information they were able to identify the location of the cash-in agent and the cash-out agent; and if there was no intervening P2P transaction before a cash-out is done, that would be classified as a direct deposit and the cash-in agent would be surcharged for that transaction. The operator would also use BTS’s (Base Transceiver Station) to validate their conclusions. An agent conducting a cash-in transaction in point A that leads to a cash-out transaction in B within a very short time, for example, would be considered to have made a direct deposit, and his commissions would be clawed back and warning letter issued.
  • The cash-in process could be tinkered with to make cash-in a bit more engaging for the customer. Warid Telecom created a two-step process for cash-in, making it a bit more involved for the customer and more secure. The transaction had two components. The cash-in was initiated by the agent, but the customer needed to complete it. This ensured that the customer could not deposit the cash in someone else’s account. Also, it solved for problems arising due to making deposits in the wrong accounts. Making cash-in complicated could also be done by the agent asking for and verifying the ID and the mobile number of the person depositing cash.
  • A more potent tool could be incentivizing self-initiated transactions. The customer could get benefits by way of getting some extra talk-time, some music downloads, some free internet-time. These offers could be for telecom products and will be easier to bundle since the telecoms usually “produce” them hence the perceived costs could be much higher than actual costs. These could be accompanied by lucky draws, lotteries, etc. where a much bigger prize, say a Motorbike, or television could be given away to a select few. The output will be much greater than the associated costs.
  • Introducing some exclusive payment products that are just not available with the agent version of that application could be another tool. For example, bill payments, for which the payer needs a receipt to confirm that they have paid, could be made self-initiated as the biller would issue an electronic receipt only to the payer. Making such payments OTC leaves no trail or scope for a personalized receipt. Or if the mobile money product offers the “best telecom deals” on self-usage. If the customer got “full talk time” on even small value recharges, then the customer is most likely to try and cash-in the benefits. This will trigger self-usage and overtime get him to try other products as well. This could initially result in the “Can you do this for me?” syndrome but over time this is likely to become self-initiated.
  • Another way of looking at this could be charging a differential pricing for services, by making transactions much cheaper if they are self-initiated rather than assisted by an agent. This may lead to the agent getting several customer accounts opened in the name of his family members but “adding a beneficiary” functionality (where the customer can only send to a pre-added beneficiary) could make it work. This will dis-incentivize the agent but incentivize the customer.
  • An alternate way of exploring this could be to ensure that the cash stays in the wallet for a longer time. For that, it may be a good idea to charge much higher for cash-out. So the customer could actually put the cash in the wallet and then start transferring the cash for remittances or payments. Cash-out pricing could be a deterrent and cash stays on the network. But for this to work there should be large enough network of merchants where the customer could ideally spend without hesitation – in most countries, this is some way into the future.
  • The agent could also be bound by velocity rules, which allow him to do only a certain number/value of transactions per day, a post which his wallet will not be able to initiate any transactions. Along with this, the operator will need to keep a tab on the number of agents in a specific location. It’s possible that the agent will seek other SIM/accounts to keep doing these transactions. But at some stage, they will have to decline a few customers. This method could leave the customers in angst since they will be denied service and may not augur well for the brand.
  • If nothing else works, there may be a need for change in regulation that will restrict the agents from doing certain types of transactions! For example, remittances could only be self-initiated while the agent could do train bookings or other payments for the customer.

Clearly, there are several alternatives which could be tried. The above list is in no way exhaustive, there could be several other innovations that could be tried. But the fact remains that there is a need to start trying these to reduce the popularity of OTC.

As for the question we asked in the beginning, there definitely appears to be a way out, but it will need a will of steel and management commitment to implement it. Change in behavior is not easy and needs to be pursued continuously before any significant results are visible.

Expanding access to finance for small businesses in India: A critique of the Mor Committee’s approach part 2. Why are the banks not financing small businesses?

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The previous blog in this series highlighted the context of the Mor Committee’s recommendations and the significant gap between the supply of and demand for credit for small businesses. This blog looks at the role of the banks, development finance institutions and nonbank financial institutions (NBFCs) to examine why they have been so backward in coming forward to meet this gap.

Why have banks not made successful inroads into small businesses financing?

So why is there a yawning gap in finance for MSMEs when India has good banking presence across the country? Is the finance gap a result of banks’ limited experience of, and interface with, MSMEs? Or is it on account of MSMEs rather ‘informal’ financial profile? Or do MSMEs simply not present an adequately interesting business case for banks.

The Mor Committee report has aptly pointed out the reasons for the large institutional finance gap to small business, which can be summarised as a case of “too much for too little”.

The reasons for such dismal access to finance by small businesses are ingrained in the very business and financial nature of the enterprises. On the demand side, small businesses have limited managerial capabilities and financial management skills, lack appropriate documents and require small ticket size loans. On the supply side, banks lack credit information about the client segment, perceive small businesses to be risky, and see financing to small enterprises as a low revenue activity with high costs of customer acquisition and servicing.

The latter two are the key reasons for banks shying away from financing small businesses. For a bank to assess the credit viability of a loan it is imperative to have access to credit information and the repayment pattern of the client. However, in the case of micro and small enterprises, such information available is limited. Also, banks still do not have customized and suitably crafted credit appraisal mechanisms to appraise the debt needs of micro and small enterprises.

In terms of the cost of customer acquisition and servicing, with relatively smaller ticket sizes, it is not profitable for banks to source the customer through direct sales channels. Considering the costs, banks are willing to serve walk-in customers (which are limited in numbers) rather than acquiring customers through a sales representative/agent. Establishing and managing a direct customer-sourcing channel is an added cost as compared to the thin revenues and perceived risks in micro and small enterprise finance.

The Role of Development Finance Institutions and Non-Bank Financial Institutions in Expanding Access to Finance for Small Businesses

Another important point on which the Committee has expressed its opinion is related to the role of development finance institutions (DFIs) such as SIDBI and NABARD. The Committee aptly redefines the role of DFIs as market-making entities focused only on risk-based credit enhancement schemes. The Committee recognizes the fact that the DFIs with their limited capacities in terms of funds and branch coverage (SIDBI has a network of 85 branches with MSME portfolio of circa US$ 9 billion) need to leverage their infrastructure to have a greater multiplier effect on the sector. A number of adequately funded credit risk enhancement schemes on similar lines to the Credit Guarantee Trust Scheme for Micro and Small Enterprises (CGTMSE) are the need of the hour. CGTMSE with a corpus of US$ 0.66 billion has accounted for cumulative disbursements of US$ 6.7 billion through 135 member financial institutions. However, there is significant scope to further expand the guarantee scheme, since the current coverage of CGTMSE accounts for 7-10 percent of the small business lending portfolio of banks based on 2011 data from the RBI.

The Committee also acknowledges the need to maintain the principle of neutrality in the selection of participating institutions in credit risk enhancement schemes that should be in line with nature of activity instead of a type of institutional setup. MicroSave has long advocated the inclusion of NBFCs and MFIs under such schemes. One has to bear in mind that 77 percent of the total finance gap in the India MSME space is in the micro-enterprise segment. While small and medium enterprises have access to cluster financing programmes, microenterprises, which are often dispersed, lack such access. Thus, NBFCs/MFIs can effectively serve this rather dispersed segment of microenterprises. As of 2012, the share of NBFCs/MFIs share in the institutional supply of debt finance is at a meager 8 percent of the total flow. MicroSave’s clients (NBFCs/MFIs) in this space have shown their intent and revealed process efficiencies to deliver appropriate credit products to small businesses.

The success story of Utkarsh, an NBFC-MFI in North India is a testimony of the opportunities that abound in the micro-enterprise lending space. Utkarsh started its micro-enterprise lending initiative in 2012 with objectives of:

  • Addressing the credit needs of micro-enterprises which were not being served adequately either by MFIs or by commercial banks;
  • Diversifying its existing portfolio beyond group lending operations; and
  • Providing a bridge credit product to Utkarsh’s graduating JLG clients.

Utkarsh, with technical assistance from MicroSave, did a comprehensive market research study of the target segment and conceptualized a credit product with ticket sizes ranging from US$ 1,000 – 5,000. While the product suited the needs of the target segment, one thing that Utkarsh had to be mindful of was the flexibility it could offer to the segment on the collateral front. In order to make its product more flexible, Utkarsh introduced hypothecation option in addition to the more traditional option of property mortgage. The results of the initiative have been encouraging, with cumulative disbursements in excess of US$ 1 million within a span of 9 months. Also, Utkarsh was able to raise additional investments riding on the success of its micro-enterprise lending programme.

Another NBFC-MFI, Kshetriya Gramin Financial Services (KGFS), has an ecosystem approach that is built on more holistic principles of financial services.  The three fundamental principles that define the KGFS approach are:

  • Focussed geographic commitment – each KGFS institution and branch is responsible for a specific area;
  • Client wealth management approach – customized set of financial services based on careful assessment of the financial needs of the household; and
  • Access to a broad range of products – credit, savings, insurance, and payments.

The enterprise loan is just one of the products in a bouquet of around 15 financial products that KGFS offer through its branch-based model. However, what KGFS has been able to showcase is its success in offering products as complex as mutual funds customized to the needs of the target segment.

The KGFS model reaffirms the belief in taking a much broader view of financial services. The model also seems to be in agreement with the Mor Committee’s recommendations on high-quality, affordable and suitable credit along with basic payments and savings, and risk and investment products.

The example of both KGFS and Utkarsh highlight the innovation DNA in NBFC-MFIs, and how it is backed by the agility to execute the ideas. Given the right policy environment and incentives, such institutions can thrive and catalyze the MSME lending space.  However, lending to small businesses is a very different business as compared to group-based lending and presents challenges that need to be appreciated by MFIs/NBFCs in India.