NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Thursday, July 28, 2005

Just 25 km from Udaipur, the tourist town in Rajasthan famous for its luxurious Lake Palace hotel, lies the village of Chapra, a warren of earth huts and crumbling concrete shelters. This low-status tribal community is on the point of becoming integrated into India?s financial system through self-help groups that provide simple saving and lending services.

Radhi, whose husband owns the village mill and tea stall, maintains a neat ledger for one of the four self-help groups (SHGs) that have started to bring some rudimentary banking services to Chapra?s 1,500 inhabitants. Supervised by a local NGO, she and 15 women, by saving half a dollar each per month, have accumulated Rs5931 ($138) since September.

Of this pool, $80 is circulating in the Chapra economy in the form of loans to group members to buy seeds, pay for family events and meet unexpected costs. The loans bear a fraction of the 48 per cent average interest rate charged by money lenders. The rest of the kitty is lodged with a local bank, which after the scheme has been active for a year, will lend additional money.

The villages of this desert state are some of the poorest in India. They are also the least likely to have access to formal finance. Without the impetus of these groups, few manage to accumulate finance in a district where unemployment nears 60 per cent and almost all able bodied men migrate to low-paid work as contract labourers.

Improving access to finance in poor rural areas is one of the biggest developmental challenges facing India today. Of the 260m – 26 per cent of the population – who live in poverty, the overwhelming majority eke out a subsistence existence in rural villages cut off from formal sources of credit and dependent on the services of pitiless loan sharks.

A World Bank-National Council of Applied Economic Research survey found rural banks primarily served the needs of richer borrowers. Whereas two-thirds of large farmers had a deposit account and nearly half had access to credit, 87 per cent of marginal farmers lacked access to formal finance, with 44 per cent borrowing from moneylenders at rates near 50 per cent per annum.

Priya Basu, financial sector specialist at the World Bank in India, says banks do not want to serve rural poor. ?It?s a high-risk, high-cost proposition. There?s uncertainty about the repayment capacity of rural borrowers with volatile and irregular income streams and transaction costs are high because of high levels of illiteracy and small loan sizes.?

Small, rural borrowers find local banks just as unattractive. Procedures for opening an account or seeking a loan are cumbersome and costly and villagers often have to pay large bribes (ranging from 10 to 20 per cent of the loan amount) to access funds, pushing the cost to exploitative levels. The World Bank calculates it takes on average 33 weeks to have a loan approved.

Self-help groups and microfinance institutions have grown rapidly in recent years to provide finance to the rural poor but their reach is limited. The number of SHGs linked to banks has grown from 500 in the early 1990s to 700,000 in 2003. But with only 12m women linked to banks via group savings accounts, the World Bank says the SHG movement ?has a long way to go before it can really make a dent.?

Microfinance institutions (MFIs) have yet to attain anything like the scale achieved in comparable developing countries such as Indonesia and Bangladesh. Fewer than 1m borrowers accessed finance through MFIs in 2003. This reflects restrictions imposed by the Reserve Bank of India on the deposit-raising activities of unregulated MFIs, as well as the dearth of high-quality professionals to manage them.

ABN AMRO, for example, a top five player in the Indian microfinance sector, started its programme in late 2003, working through 13 local MFI partners concentrated in southern India. It has created a small but profitable business, with a return on equity of 21 per cent, in excess of the bank?s target of 20 per cent. The bank wants to reach 1m borrowers by 2009, with an average loan size of $90 to $120.

?The challenge for us is that there aren?t enough MFIs of the quality we need to turn this into a big business,? says Moumita Sen Sarma, ABN?s head of microfinance in India. ?Nor is there an enabling regulatory environment because the RBI, which scarcely has the resources to regulate the existing banking network, is reluctant to take on regulation of MFIs and makes it difficult for them to mobilise savings.?

This leaves the burden of ?banking the poor? on public sector banks, whose extensive branch networks provide a distribution channel no private institution can match.

Ms Sen Sarma says: ?India has one of the densest branch networks, but the people who run them regard their postings as a punishment and look forward to returning to the cities. The whole structure is not geared to lending to the rural poor.?