Micro-Finance in the new economy -India’s Experience

R. Krishnamurthy 1 and Makarand Ratnaparkhi 2

1 Chief General Manager, National Bank for Agriculture and Rural Development, Regional Office, Pune, India

2  Department of Mathematics and Statistics, Wright State University, Dayton, USA

Micro-Finance is emerging as a powerful instrument for poverty alleviation in the new economy. In India, micro-Finance scene is dominated by Self Help Groups (SHGs) - Banks linkage Programme, aimed at providing a cost effective mechanism for providing financial services to the 'unreached poor'. Based on the philosophy of peer pressure and group savings as collateral substitute, the SHG programme has been successful in not only designing financial products meeting peculiar needs of the rural poor, but also in strengthening collective self-help capacities of the poor at the local level, leading to their empowerment.

        IFAD and the National Bank for Agriculture and Rural Development, in association with several other agencies, implemented the 'Maharashtra Rural Credit Project' during 1995-2002, having micro-finance as a crucial component. The official statistics and related MIS for savings and purpose-wise loans to 73,454 members of 4921 Self Help Groups are now available. These data have some unique features. For example, the compositional multivariate time series nature of the savings and loans data is a valuable component of the knowledge base for future. Further, our analysis shows that SHG is a useful instrument for savings mobilization and enhancing access to credit for the rural, unreached poor. Besides consumption smoothening, SHG loaning had supported working capital requirements and other productive investments as well.

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Poverty persists

1.        Alleviation of poverty, for a long time, has remained a very complex and critical concern among third world countries. It has been at the top of the agenda of policy planners & development specialists  and a lot has been written on the subject right from the days of Adam Smith's 'Wealth of Nations' (1776) to Prof. Amartya Sen's ‘Public Action to Remedy Hunger’ (1991). Today, it virtually denotes the core of all developmental effort. Though conventionally identified with subsistence level of living - linked to lack of adequate food - it is  now widely accepted that the problem of poverty is more deep rooted covering several interlocked aspects such as assetlessness, underemployment, uncertain & relatively unproductive employment, low remuneration, lack of bargaining power, economic vulnerability, illiteracy, proneness to disease, social disadvantage and political powerlessness. A large number of government & non-governmental organizations and international funding agencies all over the world have been engaged in this seemingly unending war against poverty using several strategies and instruments.

2.        According to the latest estimates, [1] globally, 1.2 billion people live in extreme poverty (defined as subsisting on less than one dollar a day) of which 44% are in South Asia; 75 % live in rural areas. In India, as a result of sustained efforts aimed at poverty alleviation, despite an estimated number of over 300 million people crossing the poverty line during 1973-74 to 1993-94, the official data has maintained that 37.3 % of the population remained poor.  A more recent estimate [2] showed a further dip in poverty level down to 26 % in the year 2000. However, the sheer size of the population in the country would indicate that about 260 million people still subsist below poverty line, even if one were to go by the official estimates.

Institutional credit and poverty

3.        In India, institutional credit agencies (banks) made an entry in rural areas initially to provide an alternative to the rural money lenders who provided credit support, but not without exploiting the rural poor. After the nationalization in 1969, commercial banks in the country took upon themselves a massive task of improving access of the poor to formal credit and accelerate the flow of credit to the rural economy. Their role in poverty alleviation was more appreciated when the Government, as a major paradigm shift, decided to launch a direct attack on poverty, through its special employment generation strategies and productive asset creation programs like Integrated Rural Development Program (IRDP) [3].

4.        As a part of this strategy, a multi-agency rural credit delivery structure comprising Commercial Banks, Regional Rural Banks and Cooperative Banks, with a large network of more than 1,53,000 retail credit outlets (one  for every 4,100 population) was established across the country. Yet, reaching the poorest, whose credit requirements are very small, frequent and unpredictable was found to be difficult.  Further, the emphasis was on providing credit rather than financial products and services, including savings, insurance, etc. to the poor to meet their simple requirements.  The mismatch in perception - regarding how the poor actually use and value financial services - of those who demanded and supplied financial services, even resulted in some undesirable adverse impression in the minds of service providers regarding the credit worthiness of the poor.  Further, the systems and procedures of banking institutions with emphasis on complicated qualifying requirements, tangible collateral, margin, etc., also resulted in a large section of the rural poor shying away from the formal banking  sector.

5.        The banks too experienced that the rapid expansion of branch network was not contributing to an increasing volume of business to meet high transaction costs and  risk provisioning, which even threatened the viability of banking institutions and sustainability of their operations. At the same time, it was not possible for prudent banking to allow a population of close to 300 million - even if poor - to remain outside the fold of its business. The search for an alternative mechanism for catering to the financial service needs of the poor was thus becoming imperative.

Micro-finance - Instrument for poverty alleviation 

6.        Equitable gains from development on a sustainable basis and ensuring viability of financial services are key elements in a strategy of poverty reduction by means of credit support to the poor. As micro-finance is seen to be an approach addressing these concerns effectively, it has assumed significance in all the developing countries as an effective tool in fighting poverty.

7.        The micro-finance scene in India is dominated by Self Help Groups (SHGs) - Banks linkage program for over a decade now. As the formal banking system already has a vast branch network in rural areas, it was perhaps wise to find ways and means to improve the access of rural poor to the existing banking network. This was tried by routing financial services through  Self-Help Groups [4], formed as grass roots level institutions developed for social/economic and financial intermediation for focusing on the poor. Drawing lessons from experiments carried out in various parts of the world, particularly Asia - Pacific, an attempt was made to build financial relationship between informal groups of people and formal agencies like banks for catering to the financial service requirements of the poor, especially women. Over the years, SHG-Bank linkage model has emerged in India as a core strategy for the banking system to extend their outreach to the poorest among poor. Though SHGs existed even before the linkage program, the banks could not recognize their potential as business clients and both operated independently, without knowing the strength of the other. Intervening to forge a linkage, NABARD was instrumental in the emergence of a very strong micro-Finance movement in the country.

8.        The  SHG - Banks linkage program was conceived with the objectives of developing supplementary credit delivery services for the unreached poor,  building mutual trust & confidence between the bankers and the poor and encouraging banking activity both on thrift as well as credit and sustaining a simple and formal mechanism of banking with the poor. The linkage program combines the flexibility, sensitivity and responsiveness of the informal credit system with the technical, administrative capabilities and financial resources of the formal financial sector.  It is a design relying heavily on collective strength of the poor, closeness of NGOs to people and large financial resources of banks. Further, the SHGs have also undertaken effective social mobilization functions contributing to an overall empowerment process.  The banks have externalized what would otherwise have been high transaction costs for mobilizing savings of the poor, appraisal and sanction of loans and improved loan recovery through the financial intermediative role played by SHGs.

Micro-Finance initiatives under Maharashtra  Rural Credit Project : donor IFAD

9.        The International Fund for Agricultural Development (IFAD), Rome, since its inception in 1977, has directed it's financing to benefit the rural poor by using a wide variety of support mechanisms. Guided by the experience that banking with the rural poor is indeed a viable proposal, the  Maharashtra Rural Credit Project (MRCP) (1995-2002) was conceived with a large component of micro-Finance built into it. The project has been implemented in 12 districts of Maharashtra State [5] in association with the Government of Maharashtra, Non Governmental Organizations (NGOs) and a number of other para-statal agencies. The National Bank for Agriculture and Rural Development (NABARD) was responsible for Project Management. The project  aimed at increasing the outreach of financial services to the rural poor for poverty alleviation and rural development. A unique feature of the project was its participatory approach involving the village community in planning development and forging a strong relationship between the village community and the service area banks.  The objectives of the project were sought to be achieved through three components:

1. development of formal financial services,
2. informal sector savings and credit and
3. infrastructure support for project implementation.

Development of entrepreneurial skills for promoting micro enterprises, mainstreaming gender concerns and empowerment of women were other salient features of the project.

10.        The project was implemented initially in four districts, (Pune, Chandrapur, Yawatmal and Nanded) commencing in 1995. Encouraged by the results, in its second phase (1998) eight more districts (Dhule, Jalgaon, Amravati, Bhandara, Gadchiroli, Thane Beed and Nandurbar), which are backward and tribal dominated, were included. The project resulted in financing 64850 individuals for taking up income generating activities, formation of more than 9000 micro-Finance groups and credit linking 7717 groups with the formal banking system.

Micro-Finance in MRCP : Database

11.        In order to build up a MIS for the project, an extensive sample survey (virtual enumeration) of 4921 SHGs covering 73,454 individual members, spread over the entire project area was conducted during the year 2001-02 which forms the basis for this paper. For the sake of simplicity, a one page schedule covering key parameters of the functioning of SHGs as on 31 March 2001 was canvassed with the help of trained workers of NGOs promoting the SHGs. Sample surveys of such a large coverage are rare in the literature on micro-Finance. Looking into the savings and borrowing behaviour of such a large number of rural poor groups has been made possible due to this survey. We are using the word sample, primarily to convey ‘a part coverage’ of the total population. (4921 groups out of about 9000 SHGs – 55 %). The coverage of SHGs is not representative or selective. It is practically an enumeration attempt. The objective of this analysis is to assess the role that micro-Finance groups have played in serving the financial service requirements of rural poor in the project area.

Survey results

Gender & age profile of the sample

12.        Women constituting half the population, have had much less access than men to productive means, including borrowed capital. It has been increasingly recognized that women are better managers of credit as ‘Women have plans for themselves, for their children, about their home, the meals. They have a Vision. A man wants to enjoy himself’[6]. Our sample shows that out of the 73,454 members, 70,384 respondents - nearly 95 %, were women, implying that the benefits from the project were overwhelmingly meant for women. The age profile of the members showed that about 43 % of the members were from the age group of 31 to 40 and nearly 95 % of the members were from the age group of  21 to 50 which is the age for the active work force.

Coverage of poor and vulnerable sections

13.        The composition of SHGs showed that 58.3 % of the sample members belonged to the poor category (known as Below Poverty Line or BPL) as per the definition of Government of India [7].  Those who are not covered under this category have been termed Non-BPL members [about 42 %].  The size of Non BPL which appears to be on the higher side, is insignificant as the saving and borrowing pattern of the BPL and Non BPL suggests that the dividing line between the two categories is very thin and difference in their economic status is more due to the process of listing BPL which has its own limitations.  Moreover, field experience suggests that in a typical Indian rural society, for initiating social mobilization functions, a mixed composition of BPL and Non BPL can be helpful.

14.        Nearly 38 % of the sample members belonged to the socially disadvantaged groups, known as Scheduled Castes and Scheduled Tribes (SC/STs)  the most vulnerable sections of the population. Within the BPL members, SC/STs constituted a much larger share of 48%. SC/STs membership of SHGs was nearly double their corresponding proportion in the State population (20%).

15.        The sample data suggest that the poor  and vulnerable sections had not only a sizable share in the membership, but more or less a corresponding share in availing credit as well. The total loans were shared almost equally by the BPL and Non BPL while the SC/STs had a share of about 40 % of funds provided as credit by SHGs to their BPL members.    

Poor can save

16.        Savings by members of SHGs enumerated were around Rs. 4,72,66,484 ( Rs. 47.26 million), with average saving per Group working out to Rs. 9605 (US $200 approx.) during the reference period.  It is interesting to note that this amount has come out of very small monthly contributions. Data show that in respect of 3922 SHGs (80%) the monthly contribution was upto Rs. 30 (about 0.6 US $) per member. The important point is that SHGS enabled the rural poor women even to save small amounts regularly and as a matter of discipline. In the absence of the SHG mechanism, it would have not been possible for the rural women to make deposits of a small amount of Rs 30 per month in a Bank. Even for the banks, it would not have been viable to transact such small and intermittent deposits. Not only was the saving regular, nearly 89 % of the SHGs had managed even to increase their monthly savings. The increase in savings contribution was upto Rs. 5 (about 16 % of the original contribution) for 73 % of the Groups. This can be viewed as an indicator of continued mutual trust  among members and increasing desire to save. Moreover, the pooled savings were managed very well by the SHG members, initially for internal lending among themselves and later, to establish a credit linkage with banks and avail larger group loans.

Borrowing by SHG members

17.        Out of the total 73,454 members covered,  50,118 (68 %) were borrowing from the groups, implying access to credit by a large number of members. Those who had borrowed more than once after repaying old loans (active borrowers) constituted 63 % of the borrowers indicating that a substantial proportion of  borrowers had used the first loan very well, repaid it and had further access to credit.  Total loans mobilized by the members worked out to Rs. 17,87,20,624 (Rs. 178.7 million) with average loan amount per SHG being Rs. 36,318 and the savings to total loan ratio of 3.78. Forty four per cent of this amount was sourced as loans from the banks and the balance 56 % was from internally generated resources indicating the financial strength the SHGs have attained.  It is also interesting to note that the poor are able to meet margin requirements of close to 50% from their group savings.

Preponderance of small loans

18.        To analyze the pattern of borrowing by SHG members, the loans were classified according to different sizes. The size-class of loan accounts and loan amount are shown in the following table :

It can be seen that the size of loan accounts was very small as nearly about 91 % loan accounts were in the size class below Rs. 3000.( 60 US$). Even in the case of  amount of loan taken, nearly 64 % of the loans were below Rs. 3000 indicating preponderance of small loans. Catering to such ‘small’ demand has been virtually impossible for the formal banking system in the past, mainly due to the high transaction and process costs involved.

Utilization of borrowed funds

19.        For obtaining  further insight into the borrowing by SHG members, the purposes for which the borrowed funds were utilized were examined. These included meeting urgent consumption needs, agricultural expenses, financing off-farm enterprises and education. The percentage shares of each of these purposes in the total loan accounts and loan amount are given below.

The data show that agricultural loans (crop cultivation expenses) was the most important purpose having a share of about 53 % in the loan accounts and 57 % share in the loan amount. This was followed by consumption loans which accounted for about 35 % in the loan accounts and about 29% in the loan amount. Evidence of some diversification in terms of borrowing for enterprises for non agricultural purposes is also available. The purpose wise borrowing pattern for the BPL and Non BPL members remained more or less the same, indicating that such economic segregation between the two categories is only illusory.  In real life situations, money is fungible. Borrowing from the SHGs therefore, had given the borrowers the required flexibility to manage their consumption and  working capital needs simultaneously.  

20.        An attempt [8] was made to assess the volume of demand for loans by the rural poor by developing a model using compositional multivariate time series analysis using our database. It was observed [Fig.1 of 8 mentioned above] that the proportion of agricultural loans in the total loans was the highest during the month of July, which is a busy month as far as the agricultural operations are concerned. The element of seasonality observed in respect of agricultural loans in the multivariate time series and the corresponding lowest proportion of consumption loans during the period suggest that the SHG loans could offer the required flexibility for utilizing their borrowed amount. The volume of demand projected in [8] above also shows that SHGs can be useful financial intermediaries in stepping up the flow of working capital support to very small and marginal farmers in meeting the seasonal agricultural credit requirements. With the total number of SHGs financed by banks in India reaching 3,70,490 as on 31 March 2002, the potential volume could be large.

Impact on the banks

21.        As has been observed elsewhere [9], the participatory approach to micro-finance has improved the cost-effectiveness of poverty alleviation strategy by substantially lowering transaction costs. While commenting on the performance and impact of the project, the UNOPS Supervision Mission observed : 'there is a transformation in the attitude and approach of the participating banks to rural financial services and especially rural clients. The innovative methodology of MRCP has taken root and is now being perceived by bankers to be a cost effective, efficient and viable alternative for rural banking. Participating banks have become more confident and skilled in extending credit to the rural poor through groups and to individual clients'. A study of branch level operations conducted by NABARD revealed that the SHGs turned out to be a channel for social mobilization and women empowerment, as also new business with quality clients and significantly increased goodwill. Externalization of operating costs in deposit mobilization, credit management and recovery through Village development Councils and SHGs were other benefits which had a positive impact on the working results of  the branches.

Lessons learnt

22.        In India, economic reforms with a human face have been accepted as the guiding principle of sustainable development.  Keeping the poor at center stage, the policies need to be reoriented so as to develop and optimize the potential of such a large segment of the population and enable them to contribute in the growth process significantly in terms of output, income, employment and consumption. Viewed form this angle, our survey results show that  

1. Micro-Finance can be a powerful instrument initiating a cyclical process of growth and development.

1. Micro-Finance activity improved access of rural poor to financial services, both savings and credit.

1. Increased access signifies overcoming isolation of rural women in terms of their access to financial services and denial of credit due to absence of collateral.

1. The pool of savings generated out of very small but regular contributions improved access of the poor women to bank loans.

1. It could also help in strengthening poor families’ resistance to external shocks and reducing dependence on moneylenders.

1. The observed support for consumption smoothening would not have been possible, but for the SHGs internal support.

1. The predominance of borrowing for crop cultivation reflects support for meeting working capital needs.

1. Possibilities could be of explored for using SHGs as a strong conduit for purveying crop cultivation loans to very small and marginal farmers to step up crop loan finance.

Notes & References

1. Rural Poverty Report 2001: The Challenge of Ending Rural Poverty  International Fund for Agricultural Development, (IFAD), Rome.
2. According to the 55 th round of the Household Consumer Expenditure Survey of the National Sample Survey Organization (NSSO) covering the period July 1999 to June 2000, the proportion of people below poverty line has fallen to 26.1 %.
3. Integrated Rural Development Programme (IRDP) was the single largest credit based poverty alleviation programme of its type anywhere in the world, in terms of magnitude, number of borrowers, level of investment and operational area. IRDP aimed at providing income generating assets and self-employment opportunities for the rural poor below poverty line with specific coverage targets for women (40%) and physically handicapped (3%). Since the inception of the programme till 1998-99, 53.50 million families have been covered under IRDP at an expenditure of Rs.1370 million. Though there have been patches of good performance, broadly speaking, the experience particularly with the credit linked IRD programme was not found to be as encouraging as envisaged.
4. Self-Help Group (SHG) is a small voluntary association of poor people, preferably from the same socioeconomic background. They come together for the purpose of solving their common problems through self-help and mutual help. The SHG promotes small savings among its members. The savings are kept with a bank. This common fund is in the name of the SHG. Usually, the number of members in one SHG does not exceed twenty. The concept of SHGs is based on the following principles viz., Self help supplemented with mutual help can be a powerful vehicle for the poor in their socio economic development; Participative financial services  management is more responsive and efficient; Poor need not only credit support, but also savings and other services; Poor can save and are bankable and  SHGs as clients, result in wider outreach, lower transaction cost and much lower risk costs for the banks.
5. Maharashtra is the second largest State in India having 9.37 % in the total geographical area & 9.1 % in  total population). The State occupies a place at the economic & industrial forefront of the Indian economy, having a substantially higher per capita income of Rs. 15410 (at constant 1993-94 prices) as compared to the all India income of Rs. 10204. Despite credentials of an industrially developed State, Maharashtra has a large population living  below poverty line ( 37 % in 93/94) with a high rural - urban disparity.
6. Dr. Muhammad Yunus Founder of Grameen Bank, Bangla Desh.
7. According the official definition, a family (of five persons) is said to fall below poverty line if the annual income is less than Rs. 24,000.
8. Compositional Multivariate Time series analysis of savings and loans by the micro-finance Institutions in Maharashtra State (India). Makarand V. Ratnaparkhi and R. Krishnamurthy. Submitted to IAOS 2002 Conference, London, UK.
9. MRCP Supervision Mission (11-22 September 2001) AIDE MEMOIRE