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Developing products for rural markets


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Title: Developing products for rural markets

Developing products for rural markets
  • Annie Duflo
  • Centre for Micro Finance at IFMR
  • February 14, 2007

Appropriate products for rural markets
  • Need to be delivered through appropriate channels
  • Need to answer the demand of rural clients
  • Need to be appropriately priced
  • To allow sustainability
  • To be affordable

  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets status and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

Constraints to scaling access for the poor
  • Clients profile
  • Difficult geographical access
  • Poor require low value transactions
  • Informal activities need flexible access
  • Illiteracy difficult to deal with traditional
  • Lack of financial literacy need close supervision
  • Information Asymmetry
  • Higher for the poor
  • No credit history
  • Difficulty to evaluate enterprises potential
  • Inability of the poor to offer collateral

High transaction costs
Provision of financial services to the poor is
constrained by
Low level of Technology
Regulatory Issues
Staff Incentives within traditional organisations
not aligned to maximise access to financial
services for poor
Hence the need for local intermediaries
  • Local organizations have
  • Local knowledge, therefore can help reduce
    information asymmetries
  • Have less expensive operations, can therefore
    help reduce transaction costs.
  • But local organizations dont have capital
  • Banks have capital, but done have this local
  • Both should join hands!

Microfinance in India apparition
  • Until the 90s despite various efforts and
    achievements by the government, the banking
    sector was unable to internalise banking to the
    poor as a profitable activity
  • Financial sector reforms motivated policy
    planners to search for strategies for delivering
    financial services to the poor in a sustainable
    manner with high repayment rates.
  • NABARD empirical observation catalysed by NGOs
    that poor gather in informal groups
  • ? SHG-Bank Linkage Programme (92)
  • Recent emergence of MFIs professionally run
    institutions specialized in delivering credit
    with low cost staff and local knowledge
  • Key innovation in both models was to make use of
    local knowledge, which traditional banking system
    does not have.

The microfinance promise
New Management structures
New contracts
New attitudes
Microfinance what is it?
whereas objectives are
Often perceived as
  • Suite of financial services
  • Thrift / savings
  • Credit
  • Insurance and Investments
  • Transfer Payments and Remittances
  • Group and individual lending
  • Sustainable activity
  • Micro-credit
  • Group lending
  • Social/charitable activity

  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets status and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

Predominant model of microfinance in India
SHG-Bank linkage model
Efficient use of capital Y Incentive alignment
Branches assess credibility of SHGs and monitor
repayment process
6 months savings
Loan to group
No liability
Grants based
Group formation and linkage
Recently emerging model financial Intermediation
by MFIs
  • Double counting of capital by bank and MFI
  • Organization-based lending Higher pricing than
    warranted by riskiness of portfolio

These models have limited growth
  • With SHGs, relatively low rates of growth
    resulting from
  • NGO reliance on grant funds to meet costs
  • Banks wary of large portfolios in the absence of
    risk sharing structures
  • With MFI intermediation, although underlying
    portfolio exhibits very low loss rates,
    sub-optimal lending structures have resulted in
  • Lower flow of resources
  • Capitalization of intermediary is the
    constraining factor
  • Higher pricing than warranted by riskiness of
  • Charge on capital reckoned twice
  • Bank/FI take into account riskiness of the

These models could not resolve the paradox of
limited supply
  • A burgeoning segment with very large demand for
  • Grass-root agencies capable of providing
    origination and supervision support in a
    cost-effective manner
  • Banking system capable of providing large quantum
    of wholesale finance (owing to priority sector
  • However, there are no natural providers of risk
    capital for microfinance and this has constrained
    the growth of several MFIs
  • As a result, supply is still a small fraction of
    the demand for finance

Needed a model which
  • Addresses inability of MFIs to provide risk
    capital in large quantum, which limited advances
    from banks
  • Allowed rapid scale-up
  • Separates risk of MFI from risk inherent in the
    mf portfolio
  • But still provides a mechanism to continuously
    incentivise partners

The Partnership Model
Efficient use of capital Y Incentive alignment
Loan at 9-11 to end customer
Repayment collection
MFI (servicer)
SHG, JLG or Ind.
Service fee
Service fee
Risk Sharing
Origination, monitoring, collection
Reduces capital needs
  • Intermediary assumes fraction of the credit risk,
    leading to reduction in capital required
  • Bank prices on basis of underlying asset rather
    than rating of intermediary ( asset-based

leverages each entitys advantage which are
  • Social Capital
  • Local knowledge
  • Low cost delivery channel
  • Financial volume / expertise
  • Product innovation
  • Technology

  • Access to financial markets
  • Financial product expertise
  • Technology
  • Low outreach in remote areas
  • Poor local knowledge
  • Inadequate cost of delivery to serve the low
    income population

The Partnership Model structure combines debt and
mezzanine equity
  • MFI estimates individual and overall loan
  • Bank assesses historical loss rates to
  • Arrive at a pricing for the loan
  • Estimate the quantum of FLDG required from the
  • Objective
  • Keep the pricing on the loan portfolio close to
    AAA rates
  • Reflect riskiness in the quantum of the FLDG,
    assuming the character of mezzanine equity
  • MFI accesses an OD limit - equivalent to the
    amount of the FLDG which is drawn in the event
    of default up to the specified limit

Portfolio diversification through the partnership
  • MFIs
  • Single product
  • Single customer segment
  • Knowledge of local area
  • Poor included
  • Banks
  • Multiple products
  • Large customer variety
  • Large risk apetite
  • Poor / Vulnerable excluded
  • Partnership
  • Multiple products
  • Multiple segments
  • Large risk appetite combined with knowledge of
    local area
  • Poor / Vulnerable included

Limitation of the partnership model for MFIs
  • Most banks still using TL, hence reducing MFIs
    diversification of lenders
  • Level of FLDG dependent on one single lenders
    risk evaluation (vs. public market)
  • Level of FLDG based on processes and PAR
  • No secondary markets for lenders reduces their
    own liquidity (microfinance not an asset class)
  • Facilitate growth by reducing MFIs challenge to
    provide risk capital in large quantum
  • Off-balance sheet
  • FLDG as OD (quasi equity)
  • Improves RoE by equity freed up (leverage from
    3-4 to 10-12)
  • Separates institution and underlying portfolio
  • Continuously incentivise partners on portfolio

Difference between SHG-Bank linkage and MFI model
  • better savings habit
  • stronger group cohesion
  • lower interest rates

  • MFIs have to cover all intermediation costs
  • Interest rates are higher
  • However interest rates charged by SHGs to clients
    are similar
  • tighter control and monitoring
  • clients can borrow immediately without savings
  • loans disbursed are higher and individual
  • loan tenure shorter, allowing to increase loan
    size faster
  • Choosing a model depends on the clientele the
    organization wants to cater to
  • Grameen model is likely to be suitable to serve
    tiny enterprise owners and SHG model might be
    used to serve the wage labourers and farmers or
    group enterprises

MFIs in India
  • Currently, roughly 66 of the micro finance
    supply is via the Self Help Group (SHG)-bank
    linkage route
  • However, MFIs grow faster now, in terms of number
    of clients and credit flow
  • The share of MFIs is rapidly growing
  • There are about 800 MFIs in India (NABARD)
  • However the top 15 MFIs account for about 70 of
    the credit through MFIs

Comparison between SHG-Bank Linkage MFI model
Share in microfinance disbursement by model
India annual Microfinance Disbursement
Rs billion
share in Annual Disbursement
Sources Rough estimate derived from a
presentation at a Microfinance Stakeholder
Consultation Meeting in Delhi in January
organized by the World Bank. Major sources are
NABARD Annual Report Data collected by ICICI
Bank. Assumption MFI disburse 1.5 time of
Yr-end O/s loans Ratio from M-CRIL data
  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets supply and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

MFIs Models and products (credit)
Grameen product
  • 50 weeks tenure
  • Weekly meetings and repayment
  • Joint liability in groups of 5 to 10 members
  • Often given for productive purposes only, often
    with close monitoring of loan usage
  • Loan size range from Rs. 3000 to Rs. 15,000
    increases with loan cycle

Individual lending
  • For new borrowers or star borrowers (most of
    the time)
  • With or without collateral or guarantors/guarantee
  • Generally, not beyond Rs. 1 lakh
  • Different repayment schedules (for ex, daily or

Emergency loans
  • Existing clients
  • 1000 to 2000 Rs
  • For emergency purposes such as health etc.
  • Grameen product is the most widespread
  • So far products have been very standardized
    (which has advantages but also limits
    customization for clients)

Repayment schedules vary schedules
  • Weekly schedules may be more or less appropriate
    depending on nature of businesses
  • CMF-VWS study Most businesses can be categorized
    in two types piece based or independent
  • For the first type, weekly payments make more
    sense. Market based clients seem to prefer
    monthly payments as they sell on credit and can
    not always recover their payments every week.
  • Need longer term loans with moratorium
  • Existing product implies clients already have a
    business or an income source, is not suited for
    financing start-ups

Repayment schedules allow flexibility
  • Fixed debt contracts have a rationale
  • avoiding operational headaches, cash management
    problems, risk of loan officer fraud and weakened
    repayment discipline of borrowers
  • But benefits of flexibility could be huge
  • With fixed schedules, repayment capacity based on
    incomes of worse weeks/months, limiting loan size
  • The rigidity of contracts may be keeping some
    borrowers from borrowing or clients with rigid
    contracts may take actions which reduce the
    return on their investments.
  • CMF Case study in ASA and Cashpor some forms of
    production (sari and carpet weaving) experience
    significant variance throughout the year
  • low availability of labor in harvest and festival
    seasons, humidity and moisture from the rainy
    season etc.

Loan size often seems too small
  • In some Hyderabad slums, before microfinance
    introduction, businesses were very prevalent (31
    of households) often low-skilled, very small
  • It seems possible for most household to expand
    the business, and yet they have not expanded, so
    there was a clear role for an MFI
  • Average monthly sales proceeds were Rs.13000
    while average profit was Rs.3040 per month.
  • A Rs 7,000 loan is probably not sufficient to
    greatly expand the business.
  • Small loans have a rationale when there is no
    competition (teach clients financial discipline
  • However when there is competition, MFIs may want
    to give larger loans directly..
  • But too large loans would require evaluating the
    client, which is too costly to do for everybody.

Therefore.. need for individual lending
  • Group lending is constraining the most
    entrepreneurial clients
  • After all, not everybody can be a successful
    entrepreneur. For example, in the OECD only 12
    of households run a business
  • Some clients need larger loans, and customized to
    the business
  • Already exists, but preliminary stages
  • Makes more sense for MFIs to provide it for
    existing clients

Group Lending vs. Individual
  • Individual lending model bears some additional
  • Difficulty in evaluating individual credit risk
    in the absence of sound credit-scoring mechanisms
  • Higher risk of default if the borrowers are
    unwilling to repay
  • Group model, on the other hand, has the risks of
  • Higher default due to problems in group dynamics
  • Increase in drop-out rates due to differences in
    credit absorption capacity of clients and
    changing client needs
  • The individual model is suitable to serve the
    not-so-poor population who can afford to provide
    some guarantee
  • The group-lending is best suited to serve the
    poorer segments but does is not optimal for
    graduated customers

Example of individual lending SKS
  • Loan given to borrowers which are in business for
    more then 1 year, and only old SKS clients
  • Guarantee of a govt. employee/of a farmer with
    land of more than Rs. 1.5 lakh market value/ of a
    businessman having a business asset of Rs. 2-3
  • SKS should have min. of 8 months of operational
    experience in that area
  • Loan amt Rs. 20,000-100,000
  • Term period1-2years
  • Interest rate 11 yearly flat
  • Repayment schedule Monthly
  • Purpose Income generation and asset development

Individual lending WWB Methodology
  • Key activities in the lending process
  • Analysis of
  • Balance Sheet of the business
  • Income Statement of the business
  • Family cash flow
  • Investment Plan
  • Character Assessment
  • Operating Model
  • Staff profile training
  • Branch location infrastructure
  • Efficient information system

  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets status and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

The needs of poor people are varied..
Protection against Health shocks
Lifecycle needs
What low income clients need?
Protect against sudden death
Protection against loss of assets
Need to build or improve homes
Protection against weather shocks
Send money to their families when migrate
MFIs Models and products (non credit)
  • Most often as agent of insurance company
  • Most common product is life insurance
  • Bundled with credit
  • Health insurance emerging

  • MFIs not allowed to collect deposits
  • Banking correspondent model (few MFIs have
    adopted it yet)

  • Rare product
  • One MFI in Orissa Adhikar
  • One MFI in Udaipur Ajewika Bureau
  • Rare product
  • Focus on individual loans
  • A few MFIs provide housing loans IASC, ESAF

Housing loans
Insurance products
  • Protect against loss of assets, damage of
    property etc. Example of Sewa Bank comprehensive
  • Protect against illness
  • often, failure of business is due to illness that
    led to low availability of labor
  • Defaults or drop out often due to health shocks
  • The delivery of insurance through MFIs is
  • Can keep costs relatively low (channels,
    compulsory product)
  • It protects the MFI as well
  • Health insurance companies products start being
    sold by MFIs, where MFI is the agent
  • Experience so far suggests that insurance
    literacy is low and proper awareness campaigns
    are necessary

  • Substantial seasonal migration with large
    inter-regional financial flows. NSS surveys (93)
    indicate 89 of permanent migrants send
    remittances back home. Likely to be higher among
    seasonal migrants.
  • But high transfer costs associated with
    remittances limit propensity, distance and
    duration of migration. Cheap and reliable
    channels are rarely available in rural areas
  • Program run by Adhikar, Orissa 1600 members
    remitted almost Rs. 6,00,00,000 in 2 years of
    launching program
  • Apart from being a viable program, MFIs can
    leverage existing client networks provide cheap
    and safe transfer add on services.
  • Legal Issues in MFIs collecting savingsBC is a
    possible solution. Scope for MFI to act as money
    transfer agents also?
  • Stiff competition from informal agents which are
    quicker and often cheaper

Housing Finance
  • Challenge worldwide to provide low cost shelter
    for urban and rural poor a basic need for poor
    households. Constraints for Big Banks/financiers
    recovery is a problem and for Small
    organizations Lack of capital
  • MFIs are a great solution as they can act as
    agents for larger financiers and have expertise
    in dealing with small amounts and their recovery
  • So far, unsophisticated product usually just a
    larger loan. Otherwise, mostly NGOs who have
    implemented government subsidized programs
  • Few MFIs currently providing housing finance but
    there is a lot of interest in the sector
  • Challenges include innovative product design
    for upgradation and ownership issues of legal
    title to land competitive interest rates etc.

Product development what about the poorest of
the poor?
  • So far, MFIs and SHGs do not reach the poorest
  • In AP, the 2 income quintiles above the poorest
    HH are more likely to receive microfinance
    through SHG-Bank model, while the poorest and
    those in the top 2 quintiles are less likely to
    be in SHGs (Priya Basu, WB)
  • Poorest are not micro entrepreneurs yet could
    they become one?
  • Poorest have no ability to repay at least not
    with standard product
  • May need more flexible products
  • Or need to be pushed up to a level where they can
  • BRAC Target the Ultra Poor (TUP) programme asset
    transfer, skill training, handholding, health
  • Bandhan in India

  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets status and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

Non financial constraints Skills and Innovation
  • Often, low skilled businesses and little
  • Study in ASA and Cashpor Of all clients
    interviewed, only 5 out of 105 demonstrated some
    entrepreneurial spirit (have begun businesses
    that are different than traditional activities
    chosen by most other members).
  • When little specialized skills involved in the
    businesses, the more businesses start, the more
    they will crowd each other out.
  • CASHPOR clients weaving saris returns per sari
    had often decreased by as much as 60 in the past
    5 years.
  • Few businesses grow beyond the size of household

Non financial constraints Skills and Innovation
  • Why is this happening and what should be the role
    of MFIs in this?
  • Might be dangerous to advise people on what to do
  • but can create information sharing
  • Some businesses fail due to poor management
    skills ? Need for financial training and basic
    business skills
  • Sewa Bank business and financial literacy
  • Can partner with other agencies to provide
    business development training or mentoring
    services (BYST)
  • Credit is only one side of the story need to
    link to a higher value chain, create links
    between the borrowers and potential buyers

  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets status and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

MFIs strategies to provide affordable products
while being sustainable
  • Serve the poor, including the poorest of the poor
  • Interest rates as percentage of loan higher for
    small loans
  • Offer affordable products for the poor
  • Need to find strategies to reduce transactions
    costs and access cheap funds
  • Be sustainable
  • Cover costs
  • Need good repayment rates, therefore requiring
    expensive operations
  • Serve as many poor as possible
  • Need profits to expand access

How to calculate a sustainable interest rate?
  • The annualized effective interest rate (R)
    charged on loans will be a function of five
    elements, each expressed as a percentage of
    average outstanding loan Portfolio
  • Administrative expenses (AE)
  • Administrative expenses of efficient, mature
    institutions tend to range between 1025 of
    average loan portfolio (in india can be lower).
  • Loan losses (LL)
  • Many good institutions run at about 12.
  • The cost of funds (CF), India 10
  • The desired capitalization rate (K)
  • Investment income (II) income expected from the
    MFIs financial assets other than the loan
    portfolio (e.g., cash, checking deposits, legal
  • Example (India context) 1021022-224

Source CGAP
MFIs interest rates in the world
Indian MFIs are the most efficient in the world
Why are transaction costs of MFIs high?
  • Door step services
  • Intense monitoring
  • Repeated interaction
  • If one customer interaction may costs only US
    0.25 due to the high number of interactions,
    this translates into 25 percent of operating
    costs relative to the average loan portfolio

What are the drivers of costs?
  • Group formation (17-23 of total direct
    transaction cost) and collection (28-36 of total
    transaction cost) are the main components of
    transaction costs
  • The main driver of direct transaction cost is the
    level of compensation of the field worker
  • This would vary according to geography An MFI in
    a difficult geography has to pay a higher
    compensation level for its employees
  • Location, degree of competition, maturity of
    branches, seem to have an impact on transaction

Possible strategies to reduce MFI transaction
Staff costs
  • Increase field worker productivity
  • saturate a place before entering another place
  • Sell more products
  • Experiment with staff Incentives Schemes
  • Focus not only on volume but also on retention as
    costs higher for first time members
  • Simplify Systems and operations as much as
  • ASA, Bangladesh simplified operations so that
    they could be performed by less-educated staff
  • Can supervision levels be relaxed/modified for
    mature customer groups?

Operations levels
  • Increase branch activity sell more products
  • Less layers of operations models without
    branches (for ex, only area offices and mobile

Possible strategies to reduce MFI transaction
  • Repayment schedules experiment with less
    frequent schedules! If no more defaults, could
    lead in less transaction costs
  • Take into account the lifecycle cost also when
    pricing the loans. Merely looking at first year
    costs may result in overpricing of loans
  • may drive away some good borrowers

Products and pricing
  • Maintenance centralization of customer's record
    (bio-metric identification, credit bureau) to
    avoid many legal documents (eg. KYC) - So that
    credit worthiness of clients can be access
  • Role of technology Innovative delivery channel
    (rural kiosks, mobile telephony, smart cards
    etc.) - This helps in serving large client base
    with less resources but one time investment is

What can banks do?
  • Provide funds to MFIs, either through term loans
    or partnership model
  • Lend to Self Help Groups
  • Provide grants or long-term loans for
    infrastructure development

Delivery channels
Product development
  • Help MFIs with expertise in product development
  • Link MFIs with other companies that have
    expertise in product development, for ex.
    Insurance companies

Products pricing and costs
  • Help MFIs with back-end technology
  • Through risk sharing with MFI, help reduce costs
    of funds

  • Products for the rural market The microfinance
    innovation in India
  • Microfinance in India delivery models
  • Product innovations for rural markets status and
  • Credit products
  • Non credit financial products
  • Non financial services
  • Pricing and transaction costs
  • The role of the Centre for Micro Finance

CMFs objectives and mission
  • Established in Feb 2005 at IFMR
  • CMFs objectives
  • To address knowledge and practice gaps in micro
    finance sector
  • Experiment on ground solutions
  • CMFs mission help the poor by
  • Systematically researching the links between
    access to financial services and participation of
    poor in larger economy
  • Participate in maximizing access to financial

Research on micro finance and livelihood
financing (RU)
Strategy building for MFIs (MSU)
MSU and RU
  • MFIs Strategy for growth
  • Definition and implementation of innovative
    business models
  • Market research, creation of linkages
  • MFIS best practices sharing
  • Design/test of new financial products
  • Capacity building
  • capital structure, HR, MIS, processes, customer
    segmentation, governance

Strategy (MSU)
  • Impact of microfinance
  • Impact Evaluation Studies
  • Economics of micro enterprise
  • Insights on HH "financial behavior"
  • Constraints on HH productivity
  • Experimentation on product design
  • Micro finance transaction costs

Research (RU)
4 Research areas to maximize micro finance impact
Impact and product design
Micro finance plus
Maximize impact On client
Finance and Organizational issues
The role of research
  • Evaluate impact, and find out what works and what
    does not
  • Impact evaluation of Spandanas micro credit
  • Impact evaluation of health and weather
    insurance (SKS, Sewa)
  • Improve existing products
  • In theory flexibility or less frequent repayment
    schedules could have some benefits, but could
    also create some complications.. What is better?
  • Repayment schedule research with VWS
  • Flexible repayment schedules with KAS foundation
  • Diversify financial products
  • Remittances product project with Adhikar
  • Sectoral study on Housing finance

The role of research
  • Find out what can maximize the impact of loans
  • Impact evaluation of Sewa Banks business
    training is it cost effective how can it be
  • How can organizations be more cost effective
    while achieving their goals?
  • Study on effect of staff incentives
  • Understand what is going on
  • Find out the risk that small business face that
    financial services can help with
  • Understand non financial constraints
  • Why are businesses not expanding what are labor
    markets constraints?

The role of MFI Strategy Unit
  • Help MFIs with their business and expansion
  • Provide help to MFIs in the following areas
  • Human Resources
  • Access to capital (securitization etc.)
  • Individual lending
  • Create market linkages for clients
  • Provide them with lower costs and high quality
    inputs (Godrej Agrovet-Spandana)
  • Provide clients with production/selling

The role of MSU encourage vertical growth
  • Vertical growth gt deepen share of wallet
    of existing customers
  • gt capture new customer segments
  • New products
  • New customers profiles

Customer segment
Core activity
Backward integration
Forward integration
Capability adjacencies
Technology adjacencies
  • Horizontal growth gt replicate similar
    model in new geographies
  • Same products
  • Same customers profiles

IFMR Trust
  • Credit is only one side of the story
  • Example Wavers may organize themselves in
    cooperatives but they need to sell the saris, and
    for a good price
  • Need to link to a higher value chain, create
    links between the borrowers and potential buyers
  • Sandhi provide market linkages to garments
    confectioners one of the entity of the
  • Trust for Networked entities to fill this
    missing market
  • Will act like a holding company having a part of
    equity in each entity formed to promote outside
  • Will mobilize fund from social investors in form
    of grant or soft loans for the incubation period
  • Will retain a part of profit for itself as
  • Will be based at IFMR - different centers under
    it will provide specialized services to entities
    link to MFIs etc.

Thank you
  • For any question