Financial services for small businesses and low income households
Tuesday, 28 January 2014 00:00
India’s RBI’s Mor Committee Report and ‘consolidation’
At a time when we are ‘consolidating ‘ our financial services sector, it is noteworthy that Sri Lanka has been battling for years on this vexed issue of providing an efficient and responsive system of financial services to small businesses and low income households.
The initiatives go back to colonial times. The Co-operative Rural Banks have a history of over 100 years. Together with other co-operatives like Sanasa and co-operative agricultural and fishery lending institutions, these were designed to break the stranglehold the money lender and pawnbroker had on small entrepreneurs and low income households.
Money lenders were regulated by legislation, also Seetu systems [Rotating Savings and Credit Associations (Roscas)]. The legality of Roscas is in doubt due to recent legislation on ‘Finance Business’. Most of these regulators are presently in deep slumber. Debt relief was institutionalised by the setting up the Debt Conciliation Board by law.
Presently Sri Lanka presents to the small borrower a mixed salad of institutional and informal financial service options, ranging from the money lender, pawnbroker, to seetus, to Co-operative Rural Banks, micro finance institutions, Divi Neguma banks, finance companies, licensed commercial banks, etc. Presently nongovernmental, non banking, non finance company, micro finance institutions and Divi Neguma, which succeeded Samurdhi, are not supervised by an independent prudential regulator. This is high risk, asking for trouble.
Reforming the financial sector
The CBSL is taking steps to reform the financial sector. Big micro finance players have been encouraged to convert themselves to finance companies, so that they come within a regulated environment, this includes Sarvodaya Seeds, Seva Lanka Finance and Grameen Sri Lanka.
After liberally issuing licenses for new finance companies, the regulators now are trying to ‘consolidate’ them, reducing the number from the present around 58 to 20. Banks and finance companies will be ‘encouraged’ to acquire one to three smaller firms. This includes nonperforming finance companies taken over and to which various types of lackeys were appointed to run them.
The bazaar talk about one worthy is that, other than his parents, all other relatives are working for one financial service provider or another! The State-controlled banks, perennial forcible rescuer of disastrously performing para-statal enterprises is, it is alleged, being forced to intervene again! This master plan for consolidation of the financial sector is in the process of being unveiled.
It has been estimated that as much as 40% of finance for asweddumisation of paddy lands is generated through pawning family jewels. In a country which has over a century’s history of rural credit schemes, this is a disgrace. The financial services sector has failed to come up with a financial instrument to service the largest demand for rural credit. This and related tasks by and large has been left to the money lenders, pawnbrokers and the micro finance sector.
In Sri Lanka today, the bulk of micro finance activity is in the non commercial banking sector. The Co-operative Rural Banks and Sanasa have a history of over 100 years in the sector. Sarvodaya Seeds and its successor Deshodaya Finance, the National Youth Savings and Credit Cooperative (NYSCO), have over a quarter century’s experience.
More recent interventions such as the Sewa Lanka Finance, Janashakthi Banku Sangamaya of the Women’s Development Federation, Hambantota, the Wilpotha Kantha Iturum Parshadaya of Wilpotha, Puttalam, the Batticaloa YMCA, have also built up experience and capacity. The marginalised poor, youth and women have really benefited from these interventions.
The National Development Trust Fund (NDTF, formerly the Janasaviya Trust Fund [JTF]) has been operating from 1989 and is the biggest provider of wholesale funds for on lending to the MFI sector, including the Regional Development Banks. The JTF credit window is now being operated by the Sri Lanka Savings Bank.
Together with the NGOs in the sector there are huge numbers of organisations, outside the commercial banking sector, involved in MF in Sri Lanka today. When the State’s Divi Neguma banks are taken into consideration, the numbers will increase exponentially. However there is a legal interpretation issue as to whether by statutory definition Divi Neguma can lawfully operate in rural agricultural and fishery communities.
The MFI’s Apex Organisation the Lanka Micro Finance Practitioners Association has been playing a role in trying to create a culture of self regulation among the MFIs as has been reportedly successfully done in some parts of India, Timor-Leste and Uganda.
A recent CGAP (Consultative Group to Assist the Poor – of the World Bank) survey stated that microfinance in Sri Lanka had achieved an impressive outreach, with more that 15 million deposit accounts and two million outstanding micro loans in 2004, this from a population of 20 million people.
A Sri Lanka Country Level Effectiveness and Accountability Review (CLEAR) by CGAP, which took place in 2005, revealed that a ‘handful of promising institutions that offer a wide range of services has emerged. However, many microfinance providers are not committed to transparency, thereby contributing to the fragile nature of the sector and weaknesses, such as substandard portfolio management and financial sustainability, poor level of microfinance specialisation, and widespread public sector involvement in credit delivery.’
All these issues have solutions, mostly which could be addressed by the MFIs themselves, by self regulation, except the one of ‘public sector involvement’.
Sri Lanka’s experience shows that State involvement means politicisation.
In the guise of protecting poor depositors if the State steps in to regulate the MFI sector, the resultant politicisation will be a death warrant. However, a draft Micro Finance Regulation Bill has been prepared and is pending enactment for an inordinate amount of time.
Self regulation by the MFIs themselves is a much preferred option. In any event, the fact is there is a regulatory process in place, first the market itself, with so many lenders, the borrowers have a clear choice, and there are a plethora of laws, which give the State immense supervisory power over the sector, ranging from the Cooperative Act, the Monetary Act, the Voluntary Social Service Organisations Act, the Companies Act to the Divi Neguma Act, to name only a few. We do not need new legislation, just proper implementation of the existing legal regime, in other words, improved governance.
Operational issues abound; the Institute of Policy Studies recently did a study on Samurdhi and found that 43% of the real poor are not receiving the program’s benefits, whereas 40% of the beneficiaries that get benefits are not the targeted poor.
Further, the Vinstar Report of October 2000 reported that the Samurdhi Banku Sangam must be counted as one of the most expensive large MFIs in the world. The operating cost (excluding cost of funds) of an average performing SBS is around 73% of its average gross loans outstanding! Grameen in Bangladesh is only 9%!
Mor Committee report
The Reserve Bank of India (RBI) recently released the report of the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households, which was chaired by Nachiket Mor, a board member of the RBI, which was tasked with framing a clear and detailed vision for financial inclusion and financial deepening in India.
The Mor Committee outlined vision statements to achieve this goal:
Every Indian above 18 must have a full service, safe and secure electronic bank account.
Every resident of India must be within 15 minutes walking distance of a payment access point.
Every low income household (LIH) and small business (SB) must have access to a formally regulated lender that is capable of meeting their credit needs, with access to a provider that can offer them suitable investment and deposit products at reasonable charges.
Every LIH and SB must have access to providers that have the ability to offer them suitable insurance and risk management products to manage risks such as: commodity price movements, longevity, disability and death of human beings, death of livestock, climate risks and damage to property.
Every LIH and SB must have the right to be offered only suitable financial services and the legal right to seek redress, if due process to establish suitability has not been followed or there was gross negligence.
The Mor Committee also laid down four design principles as a guide for development of institutional frameworks for financial services for LIH and SB; Stability, Transparency, Neutrality and Responsibility.
It is important to note that the Mor Committee has said that: “There is a need to move away from a limited focus on any one model to an approach where multiple models and partnerships are allowed to emerge, particularly between national full service banks , regional banks of various types, non bank finance companies and financial markets.”
Thus the recommendations of the Mor Committee seek to encourage partnerships between specialists, instead on focusing only on large and generalist institutions. The Mor Committee also recommends that the RRBI seriously considers licensing with lowered entry barriers, but otherwise equivalent treatment more functionally focused banks like payment banks, wholesale consumer banks and wholesale investment banks.
Tie-up with telcos
Payment banks would enable Indian mobile phone companies to replicate mobile payment technologies that have proved highly successful in African markets like Vodafone’s M-Pesa service which is used as a virtual currency by more than 70% of Kenya’s adult population, allowing users to store money, transfer funds to relatives or buy products in shops.
Chairman Nachiket Mor in an interview stated that allowing mobile phone companies (telcos) to offer bank like payment services would be one of the ‘most transformative steps’ in creating total financial inclusion a reality. Given Sri Lanka’s mobile phone penetration, this would apply here too.
It would be hugely popular, it means that you can remit money to your parents at your village using your mobile phone or receive funds from your brother in Dubai, and collect the cash at the local telco agent’s shop.
Boston Consulting Group’s Head of Financial Services in Mumbai Saurabh Tripathi agrees, saying: “A greater role for telcos would be transformative for the banking industry.” Presently regulations force telcos to tie up with established banks and do not allow mobile customers to gain access to money stored on their phones
Dr. C. Rangarajan, former Governor of the Reserve Bank of India and currently Chairman, Economic Advisory Council to the Prime Minister of India, recently said: “Financial inclusion is no longer an option but a compulsion and self help groups and NGOs can play a big role in making it a reality. I wish to stress upon the need for the larger spread of the business correspondent model for the penetration of financial services in rural areas.”
In India, under the business correspondent model, banking and non banking finance companies employ local people to carry out the activities of a banker in their villages so that a villager need not travel to a bank branch for every small transaction. For India this model which opens up opportunities for self employment by creating appropriate institutions and policies to help in livelihood creation may be appropriate, given her social indicators, but for Sri Lanka, given our virtual first world social indicators and the tremendous outreach of the MFIs, a more developed financial model is sensible and attainable.
MFIs are of utmost importance for financial inclusion as these institutions connect with the people constituting the lowest strata of society. But it is obvious that when an MFI targets customers with no recorded credit history, it increase the risk for its business. It is due to this inherent risk that it is extremely difficult for MFI to raise money other than through their members’ deposits.
There was a time when donor agencies and a handful of INGOs were the source of funds for MFI. Today this is changing; there are investment funds which are showing interest in investing in MFIs. The potential in this business is huge as Sri Lanka in particular and South Asia in general is considered to be under seriously underbanked.
Fortune at the bottom of the pyramid
The late Prof. C.K. Prahalad of the University of Michigan wrote about ‘The Fortune at the Bottom of the Pyramid’ and made the world aware of the real high volume purchasing power, albeit in small units, available at the base of the economic pyramid.
This is best exemplified in Sri Lanka by the vast number of used Lux, Sunsilk, Kohomba, Clear, etc. shampoo sachets found littered around any village bathing spot. Commercial banks also today have got into the act by using multiple platforms to reach this lucrative market at the bottom of the economic pyramid.
Connecting up and linking with MFIs and self help groups is one method which has been successfully used by the ICICI Bank in India. ICICI Bank Head of Rural Banking Rajiv Sabharwal says: “As far as the role of the private sector is concerned, micro finance is not an exercise in charity. Consensus is emerging in the industry that micro finance cannot be relegated to be a mere CSR activity.”
Moumita Sensarma of ABN Amro Bank of India stresses the need to find last mile solutions: “Reading customers’ mindset presents a tough task for banks that need to reach unbanked areas. Banks are culturally seen as a foreign entity, thus technology that the bank chooses is crucial in approaching the poor. As the micro finance industry matures more opportunities will be created for domestic and international finance players to enter this market profitably, while contributing to poverty reduction.”
Biggest stumbling block
The biggest stumbling block for MFI and other agencies which seek to tap the customers at the bottom of the pyramid is the lack of information on the credit worthiness of the borrowers they deal with. This is because such borrowers do not have formal linkages with financial institutions and there is no record of their transactions like, loans and savings accounts, etc. MFIs are unable to ascertain the credit worthiness of the borrowers in an objective way.
The small group lending model provides the alternative of peer pressure as a method of ensuring a responsible repayment culture. The other more effective option is creating a database of the credit history of borrowers. This referred to as a credit bureau, and the formal banking system in Sri Lanka has the Credit Information Bureau.
The Lanka Microfinance Practitioners Association should seriously look at the possibility of setting up a database of borrowers of its member MFIs. Such a database would be beneficial both to the lender as well as the borrower. The lender gets vital information about the credit history of the potential borrower. The borrower in turn can bargain a deal with the lender citing the better credit record.
Sri Lanka is fortunate that every citizen has a unique identification number – the National Identity Card number. This facilitates data storage and access of information on individual borrowers. Where there is over-borrowing in system due to high competition among MFI and distribution of credit varies from province to province, such a database of borrowers can bring about some uniformity of systems. Creation of such database of MFI borrowers and integrating it with the Credit Bureau of Sri Lanka’s data base will greatly strengthen the credibility of MFIs in Sri Lank and their ability to access funds and investors.
Huge business potential
The formal financial system can realise the huge business potential coming from unmet demand for financial services from the financially excluded. The focus should be on creating customised, composite and simple products. At the same time new products like micro insurance and foreign and local remittance services need to be developed.
However, the banks themselves will not be able to reach the last mile easily and will need the assistance of intermediaries. MFIs have proved, in Sri Lanka, that they can reach the bottom of the economic pyramid effectively and profitably at that.
It is logical in the next phase of financial services development in Sri Lanka that the formal financial sector enters into viable working partnerships with the MFI sector. There is a need for innovation in the delivery of banking products to the masses, including M-Pesa type mobile banking through telcos.
One way is for the commercial banks to offer a full range of financial services to the economic players at the bottom of the pyramid, in partnership with MFIs and telcos, including savings, transfers, short and long term credit, mortgages, insurance, pensions, remittances, and leasing. This would necessarily involve an overhaul of the nature of financial products being offered, delivery mechanisms, a change in the mindset of commercial bankers and may be even changes to existing law. But if the country is to move forward in its battle to overcome poverty, it is a logical and necessary step.
Consolidation of the banks and finance companies by the CBSL will result in a lesser number of institutions. The options for borrowers will be reduced. Competition will be less. Monopolising banks and finance companies will make higher profits. The borrowers will lose out. The regulator will have less work.
Divi Neguma financial services and the nongovernmental, non banking, non finance company, micro finance providers do not have an independent prudential regulator. Is this an acceptable financial services environment for Sri Lanka today?
(The writer is a lawyer, who has over 30 years of experience as a CEO in both State and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)