Micro-finance & Poverty - The Fundamentals.

Today in 2011, poverty is still a part of everyday existence for around 460 million Indians, surviving on the local equivalent of $1.25 per day. For most poverty is a trap, a continuous cycle of daily subsistence that can last for generations. These people are often wracked by health issues, poor (or no) education and bad nutrition.

There are a number of sources of poverty. For some it is caste in history, the way it has been as long as anyone can remember.  Misfortune, natural or man-made disaster displacing and destroying communities. Personal tragedy such as ill-health or foul play. While for many it is the lure of fabled fortunes of the bright lights of megalopolis that draw thousands of people every day to migrate from rural lifestyles to be consumed by teeming urban slums in Bombay, Delhi, Calcutta and elsewhere.

A key is needed to break the cycle. A change in circumstances to enable a step up in lifestyle. A step out of poverty. Living on less than $1.25 per day normally means hand-to-mouth use of all available resources including money, leaving little or nothing for growth. With current capacity it is not possible to save for education, health care, emergencies, or to develop a business. So why not give the poor money for these things? For one thing, at such vast scale the Indian government is not capable of providing adequate social security to the poor masses. Furthermore, there is much validity to the famous quip... give a man a fish and feed him for a day, teach a man to fish and feed him for a lifetime. Aid handouts have been proven to build dependency not personal capabilities.

The lack of access to financial resources is one of the major underlying links in the poverty cycle. The world revolves around economics, dollars and rupees. Without the ability to save money, borrow money, insure against unforseen events, and build nest eggs, India’s poor cannot improve their circumstances.

So, what is the answer? Currently there is no silver bullet. No one response that can be deployed to immediately dispel the tyranny of poverty. Poverty is an extremely complex economic, cultural and social issue. However, many important commentators believe that providing poor people with access to small financial loans is a major step in the right direction.

All this is hard to believe coming from Australia, a place where everyone can open a bank account relatively easy, and anyone with even a relatively meagre income can access literally hundreds of different financial loan products for almost any purpose. Once accounts are set up, consumers can simply go to an ATM for instant cash.

India’s poor have not traditionally had access to finance for a number of reasons. No collateral, zero proof of address, age, identity. Little or irregular income. Nothing to get the foot in the door of financial institutions like banks. Inequity in access to finance is rife in India.  In fact, even now in the year 2011 slum dwellers are scowled at, discouraged and shown the exit no sooner than they set foot into their local bank branch. Arrogance? Ignorance? Prejudice?  A little bit of each.

The alternatives have been less than attractive. Without access to formal banking, India’s poor have for generations been forced to deal in the informal finance sector. Money lenders such as local business people, loan sharks such as local mafia and even politicians. Always at astronomically high rate of interest (regularly in the region of 100% a year) with repayments often enforced with intimidation and even retribution. A high suicide rate in rural areas has often been attributed to the intense strain felt by those under a mountain of informal debt.   

Enter, micro-finance. Essentially this involves adapting formal banking lending systems for poor borrowers, lending relatively small sums of money. Thus providing India’s financially disadvantaged with the means to borrow, save and insure themselves and their assets. Loans of 8,000 to 12,000 rupees (AUD$177 - $266). For this to happen in a sustainable self-sufficient way, micro-finance institutions (MFIs) have developed a series of business model innovations. The most critical, in my opinion, was converting strong community bonds and values into group lending. Manifested in the two main fundamental business models, joint liability groups (JLGs) and self-help groups (SHGs).  These both rely on group liability for repaying, all but eliminating customer repayment default. There are key differences between the two, with both serving slightly different markets. In addition to developing these models, key early players in the industry developed complex levels of identity and income checks. Effectively nullifying issues surrounding lack of official documentation. Furthermore, specifically targeting women borrowers is another key element and has assisted the empowerment of women in these mostly highly conservative (old-fashioned) communities. To prove the worthiness of these innovations, microfinance has enjoyed near exponential growth in India over the last 5 to 10 years, with the industry now servicing 20 Million clients and over AUD$200 Billion in loans outstanding from over 12,000 different MFIs in India.   

To explain how this all works, I will take a step-by-step overview of major MFI, Ujjivan.

Ujjivan is an established micro-finance institution, currently operating from 351 offices in 20 states across India. Set up in 2005, Ujjivan was the first MFI in India to solely target the urban poor. It was previously thought that micro-finance was only suitable for rural communities. What also sets Ujjivan from much of the competition is their overriding mantra of poverty reduction – not profit maximisation.

Recognising that a micro-loan of a few thousand rupee does not eliminate poverty in itself, Ujjivan strive to provide a bridge for people to enter the financial system so to eventually be eligible for regular commercial loans by developing credit discipline, credit history and official documentation. To build individual economic capacity, loans given are predominantly for business creation and expansion. The standard time period is 12 months, with the option of further loan cycles on completion. Ujjivan operate a joint liability group structure. The following is a brief description of how this works;

Initial office establishment

• A new urban area is entered by first scoping out the area. There must be not more than 3 other MFIs already operating (to limit multiple lending), also important that there is not unmanageable levels of crime or other social problems;
• Projection meetings determine the potential market size in the area. To be economically sustainable it must be capable of providing around 4000 customers per Ujjivan office. Projection meetings are also used to spread word-of-mouth promotion and to educate the community on micro-finance and business lending;

New customer attainment and verification process

• Potential customers are encouraged to form groups of 5 people. All groups members must reside close to one another and know each other. This group will take on joint liability meaning that each member is responsible for each other member’s repayments. If one person cannot repay, the rest must help out to ensure repayment.
• A series of tests are undertaken to prove the customers identity including group recognition tests and home visits;  
• Once all these tests have been passed, the first cycle loan amount is dispersed to each customer, a total of 8000 rupees (AUD$177).

On-going customer processes

• Monthly repayments made in group meetings, facilitated by the Ujjivan field officer. This involves a ‘centre’ of 5 groups. All groups reside in the same community and are known to one-another;
• Monthly meetings to implement social programs, such as financial literacy training, general business skills, and to build group cohesion and discipline;
• Checks are made to ensure that the loan amount is being used for the state purposes (especially for business loans);
• Top-up loans are available after 6 months, so too are smaller loans for specific education (5000 rupees) and emergency (2000 rupees) purposes;
• After the first micro-finance loan is repaid after 12 months, the group can enter a second cycle loan, usually a slightly higher loan amount (10,000 rupees or AUD$222) to assist in growing business capacity. It is hoped that by the end of the third loan cycle (12,000 rupees or AUD$266) the customer will have sufficient credit history and official documentation to enter the formal banking sector and use retail banking products just like you and I are able to.

Stories from the slums to follow...