Past decade witnessed an unprecedented success of microfinance institutions in India. And when we thought nothing was going to break its stride; Andhra Pradesh crisis surfaced. It was an eye opener for many that surely confirmed microfinance is not the panacea for poverty. Since then MFIs have grappled hard to recover from the tight spot.
This MicroSave video is an attempt to understand the past, present and future of MFIs in India. Watch MSC’s Managing Director, Manoj Sharma, explain what it takes for MFIs to bring about the transformation for long term sustainability. He emphasizes on the unquestionable need for client focus, innovation in product and processes through effective use of technology, integration of social performance agenda, etc. to name a few. He concludes by drawing attention to the prominent role of donors and regulators for success of microfinance agenda.
The report of Reserve Bank of India’s Committee on “Comprehensive Financial Services for Small Businesses and Low-Income Households”, commonly known as the “Mor Committee report” has generated unprecedented levels of exuberance, interest, and debate. While most of the RBI committee reports are conservative and confirmatory in approach, this report talked about a paradigm shift in the sector. In addition, the report stands apart because of its focus on global learning, and an appreciative outlook towards India’s business entities and creating a vision for a financially included India.
Since insurance does not directly come under RBI’s regulatory purview, the report did not delve deep into the intended steps or activities for insurance. However, it suggested two important milestones that can impact the insurance and microinsurance sector in India.
The report suggests that all districts of India should have 30% sum assured (for life insurance) to GDP (of the district) ratio by 2016 and that this ratio needs to reach 80% by 2020; and
Banks and financial institutions need to insure their portfolio against natural disasters, or at least put rainfall insurance in place.
With a 3.17% insurance penetration (premium to GDP) level, overall the life insurance industry of India has probably already achieved more than 30% sum assured to GDP at a country level (minimum premium to sum assured is fixed at 10 times). However, Indian life insurers currently operate through a high operating cost model that requires them to focus on urban high-income segments (See Securing the Silent- I for details of cost and performance of life microinsurance in India). In the absence of low-cost distribution solutions, they are unable to provide quality insurance solutions to low-income areas and segments (See IFN 88: Challenges of Microinsurance in India).
Currently, less than 5% of low-income people in India are insured through micro life insurance products, a majority of which is contributed by term life products (individual and group) sold through microfinance institutions linked to their microcredit loan. If some alternative low-cost distribution does not emerge, insurance companies are unlikely to take microinsurance seriously. If they are obligated to balance their portfolio geographically, the cooperative and regional rural banks would probably become their preferred conduit. These entities can help insurers achieve the first milestone (30% sum assured to GDP in all districts) through credit-life policies through the banks’ existing exposure to a farmer and small value loans.
Achieving the next level of inclusion (80% sum assured to GDP), however, is going to be difficult for Indian insurers. The milestone demands overall growth of the industry (to achieve 5-7% insurance penetration) with a balanced geographical portfolio. To achieve this, insurers necessarily will need low-cost third party distribution channels, so that growth can take place without compromising profitability. The proposed mobile and digital finance entities, with their massive outreach potential and low cost of operation, are probably the only channels that can help insurers in the pursuit of this target (See Agent Banking and Insurance: Is There a Value Alignment?). So far insurers have shied away from using these entities due to considerations of quality and compliance. If the Mor Committee’s recommendations are implemented, Business Correspondents (BCs) and agent network managers may become more formal financial entities, giving confidence to insurance companies. In their new avatar, these entities can emerge to become the most attractive distribution partners for insurers to achieve the intended targets.
However, the insurance regulator needs to consider that achievement of this milestone will not help the sector get resolve two persistent and pertinent issues.
The milestone is biased in favor of life microinsurance and does not talk about other risk solutions, like health and property insurance. While state-sponsored Rashtriya Swasthya Bima Yojana (RSBY) covers the poorest of the poor (Below Poverty Line) segments, it still leaves a massive missing middle of the upper poverty line – lower middle-class segment for whom health insurance remains and will remain a pending need.
Since sum assured is a function of premium collected, the milestone only indicates a revenue surrogate, instead of an outreach indicator. Therefore the milestone, in absence of other measures to ensure outreach, will not be able to stop the concentration of insurance business around high net worth individuals. Moreover, under the proposed targets, penetration of insurance will become a function of the area’s GDP and not the other way around. Given that the district level GDPs are skewed in India, poorer areas, where people live a life of enhanced vulnerability, might remain under-covered, even though the milestones are achieved.
The next milestone or recommendation proposes an extension of current practices followed in crop loan schemes in India. While the state-sponsored NAIS (National Agriculture Insurance Scheme), mNAIS (Modified National Agriculture Insurance Scheme) and WBCIS (Weather Based Crop Insurance Scheme) programmes reached impressive scale due to their linkage with crop loan schemes, the Mor Committee goes a step further to recommend that all exposed loans be insured. In the absence of such cover, banks generally avoid lending to areas prone to natural disasters. Such a paradigm shift, therefore, will not only ensure the soundness of the financial institutions but could also improve the flow of financial services to low-income communities in natural disaster-prone areas. However, such arrangements need to be supported by an increase in credit disbursements to the low income and vulnerable segments of the population. Otherwise, these segments will continue to be unable to access proper insurance cover to mitigate disaster shocks.
Overall, the Mor Committee report proposes a new economic framework for banking and financial inclusion in India. Most of the recommendations make sense only if other recommendations are implemented too. If the regulator/s pick and choose the “easier” recommendations to implement, while leaving the revolutionary ideas aside, it will cease to impact the sector in any substantial way. In the case of insurance inclusion too, the regulator needs to implement the economic logic of the recommendations, rather than translate the milestones blindly.
Regulation and government policies have been instrumental in the growth of microinsurance across different countries of the world. Though lot of countries have developed or are developing specific microinsurance regulation, the success and impact of those remain diverse. In this podcast, the microinsurance team of MSC discusses what aspects of regulation creates an effective and efficient microinsurance regulation.
In 2013, a significant number of banks did not meet their PSL targets – including 16 public sector banks that did not meet the their PSL targets. (See 16 PSU banks missed priority sector lending target). While a large number of banks are indeed meeting PSL targets on an overall aggregate basis, many fall particularly short on the PSL targets for categories like Direct Agriculture which includes loans to farmers, SHGs and producer companies, cooperative which are at the centre of the government’s focus on directed lending. The banks will continue to treat this as a burdensome portfolio unless PSL segments are made attractive by allowing the market-based pricing, where financial services providers price products based on inherent risk, cost to serve and competition. Therefore, the Committee’s suggestion is to do away with the hand-outs in the form of cheaper interest rates in priority sector lending. It recommends transferring subsidy directly through direct benefit transfer much like any other social benefits.
The Committee has also raised the debate of “access” versus “affordability” of financial services. In fact, MicroSave believes the issue here may be more than plain “access”. It is also about the “suitability” of the access. In modern India, economic sub-sectors are much more diversified than the ones envisaged under the current PSL segmentation, and need far more customisation in terms of financial and risk management products. This will not happen unless the banks follow a more granular approach to developing and offering products. If a free pricing regime is allowed, the banks are likely to be more innovative in offering “suitable” products since this will have a bearing on the profitability and risks on their books.
The Committee also makes a number of recommendations related to the NBFC-MFIs and the special conditions to be followed by them. These touch on the interest rate and margin cap conditions noting that these have led to no reduction in the interest rates for borrowers. This seems to be because of the current limit on the maximum number of lenders serving a borrower, which reduces the impact of competitive forces to bring the prices down. The Committee’s recommendations suggest some progressive steps like treating total indebtedness of borrowers in terms of their ability to service debt and not just their absolute total debt. Moreover, the Committee suggests looking at loans from all types of institutions rather than only from NBFC-MFIs. Another good recommendation is the requirement that all the lenders report to the Credit Bureau. This will make the regulation on maximum number of borrowers redundant.
We do not have any empirical evidence as to whether the limits on interest rates and margins have had any impact on MFIs’ ability to reach out to “more risky” segments and/or to the segments that are costlier to serve. But it is reasonably safe to assume that these limits do indeed reduce MFIs’ willingness or ability to serve remote and vulnerable communities. Essentially, the logic of liberalising PSL interest rates applies in the case of NBFC-MFIs also. While this is a difficult policy stance, the Committee could have offered a clearer opinion on this, even if there were no recommendations for the immediate term.
There are other interesting and welcome recommendations around doing away with the biased policy stance on consumption versus income generating loans. That poor need credit to smooth cash flows is a well-researched and widely accepted fact. Moreover, with smaller loans it is very difficult if not impossible, to ensure loan utilisation check for the MFIs. This is one regulation that is hard for MFIs to follow and even harder for RBI to ensure compliance, with no benefits for the client or for the MFIs. (See Are Loan Utilisation Checks Really Necessary?)
“Many Indian microfinance institutions (MFIs) introduced the individual lending (IL) methodology as a natural progression from the group lending methodology. The lure of “big ticket” loans and higher profitability is attracting growth oriented MFIs to aggressively push for IL without considering the inherent risks. IL has its own idiosyncratic needs like cash flow based lending; analysing business needs and risks; bringing flexibility in product features; building staff capacities and processes that must be followed for successful implementation”.
The recommendation to raise the borrowing limit to Rs.100,000 per person is obviously welcome; as is the recommendation to phase out the restriction on making large loans (above the current limit of Rs.50,000). Larger loans are required by more mature clients in later loan cycles, who (in some cases at least) may have been growing their businesses. Many clients who are able to expand their businesses would still like to avail higher loans from the MFIs as they do not have access to formal financial institutions to serve them as efficiently as the MFIs. Such clients lie on the lower band of the “missing middle” – the huge under-served segments of micro and small enterprises. However, perhaps an overall limit on average loan size (on overall portfolio basis and not on client basis) will still be needed to make sure the MFIs do not move away from serving the poorer segments. That said, an overall higher average loan size will enable the MFIs to balance their portfolio between large loan and small loans. With an overall average loan size limit the MFIs can continue to focus on poorer people while still having the flexibility to serve “not so poor” with higher loan sizes. (See Are You Poor Enough? Client Selection by MicroFinance Institutions).
The Mor Committee has made the case for an even more affirmative approach to ensuring credit for marginalised sectors by recommending hiking PSL targets to 50%. More importantly, the Committee has also recommended steps that enable the banks to achieve this. The liberalisation steps, most important of which is allowing free pricing regime, can change the way banks look at the priority sector. It is very likely that the banks will start to look at the PSL segments as potentially attractive segments and adopt more market-led solutions to achieving these targets. This will be a significant improvement over the current ‘push’ policy of the government, which works neither for the banks and nor for the priority sector segments. Keeping its liberal stance on pricing of financial services and in general following a market-led approach the suggestions of the Committee to increase the borrowing limit for microfinance borrowers is well taken. A liberal stance, but the one requiring absolute transparency on pricing by the MFIs, will allow these institutions to deepen their offerings and contribute to achieving ‘real’ inclusion. This perhaps could be the next transformational step for small businesses and low income households.
This podcast focuses on Dairy value chain and shares why it’s not only attractive to financing institutions but is highly endorsed to improve rural economy and aid food security. Speaking to MSC on the benefits and features of dairy value chain models, Value Chain expert, Mukul Singh, talks about the participants/aggregators involved in a typical value chain and how do they function.
This podcast also outlines the structures and the economics of a typical dairy value chain from the perspective of a producer and what does it mean for financial institutions. Talking on the financing models, Mukul explains two main financing models – Cash entrapment model and Direct financing model.
The idea of the Unique Identification Authority of India (UIDAI) instructing banks to open accounts (waiving a direct application from the customer) is not well conceived. It assumes that every UIDAI registrant wants to open a bank account. A customer has to formally to apply for an account (a contract needs to be signed between the bank and the customer). This could be done without visiting a bank branch – such as authenticating with biometrics that he wants an account to be opened and authorizing UIDAI to provide the information to a chosen bank. Without an effort on the part of the customer, the legal requirements for providing a banking service are not fulfilled. In a related issue, waiving the requirement for the current address of customers will weaken the position of banks, with the current focus on anti-money laundering (AML) measures world over.
Payments Banks
While the idea of payment banks is a constructive one, the logic of low entry capital is not clear. The permission to invest in three month securities is also not clear as one does not expect payment banks to hold on to remittances and payments for a long period of time.
USSD charges
The suggestion (in Para 3.11) that the telecom companies should cap their charges for the use of USSD seems to have been influenced by the potential for over-charging for these services seen in other parts of the world. But financial sector entities should be able to negotiate better rates for use of USSD from time to time. The philosophy of reasonable charges is well taken, but a specific cap on these charges is not.
State Finance Regulatory Commissions
State Finance Regulatory Commissions The suggestion of setting up State Finance Regulatory Commissions (SRFCs) is intriguing. Some states have not shown adequate maturity in regulating finance related activities. Despite the proposed membership which represents most relevant institutions, there should be formal guidance from, and linkage to, the Reserve Bank of India (RBI), and not by state government.
Convergence of regulatory norms
The convergence suggested between banks and non bank financial companies (NBFCs) in the matter of regulatory norms is welcome in principle. However the committee has recommended for continuation of the difference in current reserve ration (CRR) and denial of deposit insurance to NBFCs; these recommendations are not tenable. Banks have both asset and liability side risks – as such there is no case for lower CRR for them when compared with NBFCs, which have mostly have an asset side risk. Deposit insurance is aimed at protecting interests of small savers. By denying the same to NBFCs, the committee is breaching its design principle of institutional neutrality.
Limits
In a number of places the committee has used absolute limits (in Paras 3.11, 4.24, etc.) such as small borrower loan limit of Rs.100,000, Rs.50,000 transaction limit per customer for new payment banks, security deposit of Rs.500,000 per business correspondent (BC) agent, etc. Any such limits should not be hardwired, but set at normative levels – as a percentage of some base business parameter. Otherwise within a short time the limit will be out of date and there would be a clamour for change.
Priority Sector Lending and outreach
While banks are asked to invest in technology, branch infrastructure, establish customer service points through BCs and increase priority sector lending (PSL) to 50% in Para 4.40, how banks will remain viable is not satisfactorily dealt with. Perhaps the pricing freedom on loans is meant to help banks remain profitable. The committee has not considered the past (and current) evidence that public sector banks do not use their pricing freedom in PSL – in agriculture and small loans in particular. Further the suggestion to have a point of presence in every square kilometer – such as small kirana store or mobile recharge seller – ignoring the presence of rural post offices and Primary Agricultural Credit Societies – is bound to result in unhealthy competition in some locations and make every competing institution unviable. Even while setting up new institutions, the existing ones, which have better knowledge of the local area should be strengthened.
“Suitability”
The section on suitability of products (starting with Para 6.1) is a welcome one. But asking RBI to issue regulations is not a satisfactory arrangement as the enforcement might suffer from a weak legal basis. As in some other countries a separate legislation on vendors’ liability – for providing suitable products and services and ensuring that these do not harm the customers – should be brought in. Such legislation will be able to prescribe the penalties for non-compliance (and means of enforcement) and remedies available to customers.
The Mor Committee’s report is full of outstanding ideas that build on the existing financial infrastructure, while challenging some of the established norms in India. If the RBI implements the committee’s recommendations, while addressing the challenges outlined in this blog, we have the very real potential of seeing significantly improved financial inclusion statistics by 2020.
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