The briefing note is a case study on operational excellence path adopted by a microfinance-oriented thrift bank in the Philippines. The bank started its operational excellence drive in the year 2012 with focus on three key excellence parameters i.e. efficiency, productivity and quality. The bank reported positive results as an outcome of their initiative. In the period of 2012-13, the bank streamlined its systems and as a result achieved reduced expenses and increased process efficiency. The direct expenses have reduced by 30% and business income increased over 70% in the reporting period. As the bank nears break-even, it has set ambitious targets for both business and efficiency by 2016. The bank aims to increase its business by 3 -4 times from its existing levels and achieve this with a tight control on cost of delivery.
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Rebuilding a Bank – Case Study of OK Bank
The briefing note is a case study of OK Bank, a thrift bank in the Philippines, which is on its way to create a silent but effective turn-around story. A few years ago, the bank was struggling for survival. However, since the bank chose a path built on operational excellence as its core strategy it has experienced successes in its endeavours. The strategy is focused on three key strategic areas of brand building, superior credit management and leveraging technology, and efficient processes. The bank reported a 7 per cent increase in disbursements and a remarkable 30 per cent decrease in operational expenses. A key driver of this turn-around story is the vision to inculcate strategy as an institutional culture within the bank. MicroSave, has been associated with this turn-around story as technical advisors, supporting the bank on strategic planning and process efficiencies.
Sustainable Microfinance: What does it take?
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.
Mor Committee report – Is there a take away for insurance industry?
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.
Microinsurance Regulation: What drives the sector?
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.
The Mor Committee – Giving credit where credit is due (Part-II) Priority Sector Lending (PSL) and Credit Pricing
Priority Sector Lending (PSL) and Credit Pricing
The Mor Committee on “Comprehensive Financial Services for Small Businesses and Low Income Households has also made a number of suggestions related to the priority sector lending (PSL). The Committee recommends raising the overall PSL requirement to 50% of adjusted net bank credit (ANBC) or credit equivalent amount of off-balance sheet exposure, whichever is higher. This is likely to be unwelcome amongst banks, which often struggle to achieve the current 40% requirement. However, the Committee offers some “sweetners” in terms of weights for different sectors and proposals for a much more market-led approach to credit/risk pricing.
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”.
– Sandeep Panikkal, Venkata N.A. and T.V.S. Ravi Kumar in Risks and Challenges in Micro and Small Enterprises Lending
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.