Microfinance in India

Approaches, Outcomes, Challenges

Tara S. Nair

• Publisher: Routledge India
• Year: 2018
• Print ISBN:
  9780367177010
• eBook ISBN:
  9781317324515
• Topic: Business
• Subtopic: Business General
• Index: Business

This volume presents a comprehensive analysis of microfinance initiatives in India. Through substantive field research and case studies ranging across the country, it examines Indian microfinance within its distinct socio-economic realities — the role of women, financial inclusion, rural entrepreneurship, and innovation — its interactions with multiple institutions, the challenges, as well as future directions.

1

Vignettes in Transformation

Indian Microfinance since the 1990s

Tara S. Nair

Trying to tell the story of how microfinance was ushered in, took roots and expanded in India is no mean task. Over the past two decades since its official debut in the country in the late 1980s microfinance has traversed quite an eventful journey. Along the course, its role and relevance has been contested seriously in the circles of academia and development practice. It has been over-hyped for what it has done and severely under-rated for what it could have. It has been interpreted and examined in myriad ways — as an antipoverty strategy, as an approach to empower women, as a method for financial inclusion and as a way to nurture interaction between formal-informal financial sectors. The debates on Indian microfinance reflect the myriad imaginations and perceptions that surround its identity. Despite such inconclusive discourses, the reach of microfinance has expanded substantially across the country appropriating the spaces available within development planning and democratic politics.

The idea and technology of microfinance made its debut in India under peculiar circumstances. On the one hand the directed credit programmes¹ implemented since the 1970s in the country had come under serious criticism for their patently political and grossly inefficient ways of channelising financial resources to farmers and rural poor. It must be noted that starting from 1973 a series of research studies steered by a group of economists and funded by the United States Agency for International Development (USAID)² systematically projected the theme of the failure of state intervention in the financial markets of low income countries.³ They questioned the legitimacy and efficiency of stated owned development financial institutions in reaching out to sectors like agriculture in particular and rural poor in general. The findings of these studies entered the global discourse on financial systems development through publications like the World Development Report of the World Bank and had a significant influence on the policy thinking of countries that were also dependent on international aid in financing their development.

In India, three broad streams of critique had emerged out of the studies that interrogated the process of implementation as also the impact of the Integrated Rural Development Programme (IRDP), which was introduced during the Sixth Five Year Plan period (1980–85) as the flagship targeted antipoverty programme. The enquiries pointed to many design and delivery problems with respect to the Programme like faulty identification of beneficiaries and economic activities, inadequate financial assistance, delays in providing actual assistance, poor loan recovery, corruption, lack of motivation among bureaucracy, lack of local level planning and bankers’ indifference towards the poor (Kurien 1987; Saxena 1987; Swaminathan 1990). The inability of the beneficiaries to differentiate between grants and loans, channelisation of resources to the poor who lack the ability to handle such resources and the tendency on the part of banks to avoid the costly process of appraisal and monitoring in the case of low value advances are some of the specific factors highlighted by the evaluation studies as having led to poor performance of directed credit programmes (Wilson 2002).

The second set, though sparse in number, has delved deeper into the public policy aspects of IRDP. Rath (1985) questioned the very relevance of using assets and subsidy as strategies for helping the rural poor escape poverty:

Only a small proportion could be helped; what is equally true is that only a very small proportion can be helped in this manner … In a multipronged attack on rural poverty this approach surely has a legitimate place, but it cannot be the mainstay of such a programme (ibid.: 245).

Presenting some interesting evidence on the performance of IRDP, Dreze (1990) raised a few pertinent questions about the strategy of using subsidised loans for poverty alleviation. He argued that the obsessive concern of public policy with making the poor self reliant by extending them subsidised loans had led to the diversion of attention from a number of important influences on the living conditions of the poor. What they need is income, neither assets nor subsidy. Public policy should, hence, focus on the creation of more employment opportunities at least at the basic subsistence wage rate and public provision in health and education and social security measures.

The third critique was concerned with the commercial viability of banks if such programmes continued to be financed through bank loans. Many studies have argued that subsidy and concessions eroded the portfolio quality of the banking system and resulted in the neglect of monetary saving facilities in the rural sector. The other factors highlighted by these studies included leakage of benefits to undeserving households and underestimation of the ability of the poor to save or pay ‘market rate of interest’ (ACRC 1993; Mahajan and Gupta Ramola 1996; Yaron et al. 1997). It must also be noted that by the early 1990s the policy-induced social banking phase had resulted in a rather uncomfortable relationship between the fiscal and financial systems wherein the former could arm-twist the latter to support even the overtly political agendas of the parties in power. As pointed out by the successive rural credit committees, the misuse of the financial system by the fiscal system in doling out politically motivated financial subsidies had led to the widening of the geographical and emotional gaps between rural clientele and banking bureaucracy. The following observation made by the Agricultural Credit Review Committee (1993) in its report throws ample light on the crisis of confidence that resulted from the fiscal-financial overlap:

The targets are achieved mainly because the banks have been compelled to do so. In fact, considerable importance has been attached by government of India and other authorities to ensure that IRDP targets are achieved by banks without fail and this message has percolated to the field level. Several relaxations have been made by RBI in respect of eligibility criteria, procedures, rate of interest, collateral security and guarantee for the loan, etc, in view of the special status accorded to IRDP loans and these concessions have been extended despite the fact that viability of many of these loans is open to question.

These concerns received resounding support in the recommendations of the Committee on Financial System (1991, Chairman: M. Narasimham). The report underlined the need to enhance competitive efficiency, productivity and quality and range of banking services. The Committee expressed deep concern about the deterioration in portfolio quality and erosion of profitability of banks and held directed credit, directed investment and fixed interest rates largely responsible for these. Hence, it recommended phasing out of directed credit programmes and redefinition of the priority sector to restore the depositor and investor confidence.⁴ While acknowledging the impressive growth of banking business in the postnationalisation years, the Committee expressed its disapproval of ‘micro credit direction bordering on behest lending’ (Narasimham 1996–97: 224). As Narasimham puts it, the irresponsible and politicised lending operations during this period ‘made the credit system the subject of competitive populism and a hostage of electoral politics’ (ibid.: 224).

In short, the policy thinking in India around rural finance in the 1980s came to be heavily tilted against state intervention in financial markets, which, in turn prompted the development finance institutions like NABARD to look for institutional innovations that increase the outreach of credit without any rise in costs.

In Search for an Alternative: Group Lending as Financial Innovation

The experience of India with respect to directed credit programmes was shared by many low income countries in Asia, Africa and Latin America. Several of them had adopted the method of group lending to expand the flow of rural credit from formal financial institutions. Under this method, unsecured loans were given to informal groups with membership ranging from five to 30, which, in turn are distributed among members who hold joint liability for repayment (Adams and Ladman 1979). The proclaimed advantages of group lending over individual lending were (a) reduction in the lending costs of financial institutions; (b) use of peer pressure to reduce delinquency; (c) low per farmer cost of delivering technical assistance; (d) lower transaction costs for borrowers; and (e) increase in outreach without any escalation in costs (Ladman and Afcha n.d.; Adams and Ladman 1979).

A series of enquiries into group lending implemented by public sector development finance institutions in countries like Bolivia, Mexico, Ghana, Malawi, the Dominican Republic, and the Philippines led mainly by the researchers of the Ohio School and funded by the USAID generated an interesting debate on the advantages and limitations of group credit in the late 1970s.⁵ While appreciating the rationale of group loans using per pressure/joint liability these studies largely concluded that ‘it is most common that they (that is, group lending programmes) fail to live up to expectations’ (Ladman and Afcha n.d.: 2.). In many instances the transaction costs were reported to be far greater than that of informal lenders. A major reason for the limited success of group lending innovation, according to these researchers, was the concessionary interest rate policies followed by the low income countries that make it unviable for financial institutions to carry on with a high cost innovation. Flexible interest rate policies, it was argued, would provide a more healthy economic and political environment for financial innovations like group lending (Adams and Ladman 1979).

The merits of group lending scheme as an arrangement that helps to both counter the limitations of informal finance and circumvent the problems associated with borrower selection and cost of lending had been rediscovered in the international development making circles with the success of Grameen Bank (GB) of Bangladesh. Started as an experimental project in 1976 it turned into a formal financial institution in 1983 defying every single tenet of prudent banking by substituting individual lending by lending to small groups with carefully crafted norms — poor women borrowers, small loans, market rates of interest and no collateral.⁶ The GB model was the reigning paradigm of poverty lending in the 1980s through the 1990s. Its methodology came to be accepted unquestioningly as the sure-shot success formula for any rural credit initiative to be pro-poor and pro-women. The small group-based micro-credit approach employed by GB stipulates pooling of all the potential consumers whose risk profiles are assumed to be the same. They are offered loan contracts on identical terms. The important design feature GB approach is ‘peer monitoring system’ that involves incentives to the groups to monitor the actions of their members (Stiglitz 1990). Joint liability and denial of loans to groups with defaulted members were the incentives provided within the model for timely repayment. All these require careful formation of groups ‘to weed out bad borrowers who could jeopardize the creditworthiness of the group as a whole … and this induces a form of self-selction that no individual-based banking scheme can mimic’ (Ray 1998: 579). These attributes of the GB have come to be hailed by development economists as efficient methods of information use (ibid.) and price discrimination (Ghatak 1999) that are impossible within individual lending.

Starting around 1995, there were serious signs of widespread disaffection on the part of Grameen clients due mainly to the rigid rules the programme had been following. The resultant crisis in repayment led the leadership to redesign the methodology around 2000. The new methodology called the Grameen Generalised System or Grameen II is a complete antithesis to its predecessor. Yunus describes the new system thus:

[G]one are the general loans, seasonal loans, family loans, and more than a dozen other types of loans; gone is the group fund; gone is the branch-wise, zone-wise loan ceiling; gone is the fixed size weekly instalment; gone is the rule to borrow every time for one whole year, even when the borrower needed the loan only for three months; gone is the high-level tension among the staff and the borrowers trying to steer away from a dreadful event of a borrower turning into a ‘defaulter’, even when she is still repaying; and gone are many other familiar features of Grameen Classic System.⁷

In a nutshell, while the earlier system uses a one-size-fits-all kind of methodology, the new one emphasises the importance of custom-made credit.

Substituting Social Banking: The Indian Experiment with Linkage Banking

Three major developments may explain the rise of group lending based microfinance activities in India by the beginning of the 1990s. First, many NGOs in India, especially in the southern states, had by then come to acknowledge group-based saving/credit activities as the fulcrum of their development activities. In states like Andhra Pradesh, they had been working closely with the governments for the mobilisation of self-help groups (SHGs) for the implementation of the scheme Development of Women and Children in Rural Areas or DWCRA (a group-based anti-poverty scheme piloted as part of IRDP in 1982–83) (Aiyar et al. 2007). Second, several replicators of the GB model had emerged in India as in other countries financed mainly by foreign donor money.⁸ Third, the senior management of NABARD was inspired by the idea of linkage banking as an innovative alternative to increase outreach.

Being mandated ‘to provide focused and undivided attention to the development of rural India by facilitating credit flow for promotion of agriculture and rural non farm sector’, NABARD had undertaken some enquiries in the mid-1980s, which highlighted the need for rural households to safe-keep thrift and access loans to meet production and consumption related expenditure (Kropp and Suran 2002; Wilson 2002). Within the Bank there was a thinking that if a product were introduced which could reduce the transaction costs and provide substitute collateral, banks would come forward to lend to these farmers.⁹ At the regional level GTZ had already been supporting a pilot project in Indonesia (started in 1988) linking groups with banks. The project was a unique innovation in that the central bank had authorised its public and private banks to accept informal groups as customers and lend to them without physical collateral (Seibel 2005). It received widespread publicity through the Asia Pacific Rural and Agricultural Credit Association or APRACA.¹⁰ Between 1984 and 1986 the major discussion on the APRACA platform was how to use informal financial institutions like SHGs to improve credit access to rural poor and micro producers in cost efficient ways (Kropp and Suran 2002).

In 1986 with APRACA’s recommendation a study team was formed under the leadership of NABARD to identify and survey the existing self-help groups in India and plan for action research with focus on savings mobilisation and channelisation of credit through linking banks to such groups. The team undertook case studies of 46 SHGs promoted by 20 agencies in 11 states (NABARD 1989). The survey excluded informal institutions working in various parts of the country¹¹ from its purview, reflecting a rather limited vision of the Bank regarding SHGs as collectives formed and nurtured by self-help promoting agencies.¹² Many such initiatives were being piloted in India during the time including that of the SHG-based women’s empowerment programme of the Tamil Nadu Corporation for Development of Women funded by the International Fund for Agricultural Development (IFAD) and the projects by Professional Assistance for Development Action (PRADAN) in Rajasthan and Madhya Pradesh.

Formal credit linkage was found negligible among the groups selected for the survey; whatever existed was individual lending. According to the report the three major bottlenecks faced by the poor in accessing bank loans were (a) cumbersome loan processes which were made further difficult by the indifference and often outright hostility of village/block/bank officials, (b) the time lag between application and actual receipt of loans and (c) corruption. Procedural and attitudinal factors were found to be act...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Tables and Figures
• Preface
• Acknowledgements
• 1. Vignettes in Transformation: Indian Microfinance since the 1990s
• 2. SHG Intermediation and Women’s Agency: A View from Tamil Nadu
• 3. The Transformational Potential of Microfinance: Two Case Studies
• 4. Financial Inclusion of Microfinance Clients: A Village-level Study
• 5. Microfinance and the Dynamics of Financial Vulnerability
• 6. Matching Finance with Client Needs: Some Pointers from a Field Study
• 7. Supporting Rural Entrepreneurship and Innovation: Beyond Microfinance
• 8. Microfinance and Cooperatives: An Overview
• 9. The Seen and the Unseen: Revisiting the Impact of SEWA Bank
• 10. Issues and Challenges before Liberal Microfinance Cooperatives: A Case Study
• About the Editor
• Notes on Contributors
• Index