SHGs (Self-help groups) need to return to their original fundamentals of being strong grassroots institutions and the market for credit needs to be segmented
The focus of concern in the recent past, and leading up to the Andhra Pradesh microfinance crisis, has been the risk to commercialized microfinance organizations or MFI-NBFCs. Very little has appeared in the media on the risk borne by the clients, until the reported suicides in October brought their risk squarely into the political domain. This post focuses on the risk borne by clients.
First I would like to distinguish between two groups of clients: The first group is the poor who need credit and other opportunities for livelihood activities to survive. The second group is not poor; their livelihood strategy largely includes non-farm activities but they cannot grow to meet their aspirations without access to credit even at market rates.
My position is that the poor need substantial investment, besides credit, for them to move beyond survival and increase their incomes.
This investment includes institutional support- like the self help groups (SHGs) at the base – which provides the poor with the space to set their agenda to support their livelihood strategy. The services required to support livelihood strategies of the poor and to build these participatory institutions like SHGs need subsidy.
In short, this requires a long term perspective.
I do not think the business model of the MFI-NBFCs, which is driven by venture/private capital, quick disbursements, weekly repayments, high profits and remunerations for senior staff, a focus on valuations and IPOs and a quick exit, is appropriate for this group. Short term credit at commercial rates cannot help improve lives of the poor.
In fact, this business model increases the poor’s risk, often beyond a level that they can bear. The SHG model with links to banks (as it was originally conceived) is the appropriate strategy for this group.
Weekly repayments increase the borrowers risk and vulnerability to local power groups. Incomes from agriculture are lumpy not weekly; incomes from animal or dairy farming are usually monthly.
In order to repay the MFI loans weekly, clients are forced into activities that can help them earn daily, like wage-labor, or push them into a cycle of multiple borrowing, where they have space to borrow from one and repay to another.
The second group, the non-poor, who cannot get credit from banks because they do not have land records or fixed assets to provide collateral, are better suited to be clients of MFIs.
This group does not have the confidence and skills required to negotiate with banks if they need credit for activities in the non-farm sector and do not have access to working capital from formal financial institutions.
The business model of MFIs can meet the needs of this group provided profit is not maximized to an extent where there is little difference between them and the moneylenders. Good governance of MFIs can play a greater role than regulation; but evidence indicates that good governance is in short supply.
The SHG model is not an effective model for fast disbursement of credit. Therefore, it is not appropriate for this second group which needs credit.
Risk and the official policy promoting inclusion
Inclusion of the poor (the first group) into the formal financial system of the country involves considerable risks and costs on their part.
The SHG model was an attempt to lower this risk and costs for the poor by providing an intermediary institution which the poor managed. The banks that lent to them were satisfied even though the profits were low because their loans were categorized under “priority sector” lending and repayments far exceeded those from rural development programs in the past.
Between 2003 and 2008 the Reserve Bank of India (RBI) carefully managed India’s integration into the global financial system. Unfortunately the RBI did not take the same careful approach with the MFI-NBFCs in their rapid growth on the grounds that it was urgent to integrate the poor into the international financial sector.
Its focus was pushing the official financial system further into the interior on one hand and, on the other, a “hands off” approach as far as the MFI-NBFCs were concerned, encouraging them at most to self-regulate.
The MFI-NBFCs have not included the marginalized into the country’s financial system but instead included them directly into the international financial system which is not only inappropriate as a first step but raises the level of risk that clients have to bear.
Moreover, the emphasis on credit disbursement to SHGs increased when they were adopted by the Andhra Pradesh Government as part of its official strategy to mitigate poverty. Fortunately, high profits and remunerations were not part of the Government’s strategy.
The SHG Bank Linkage Model had grown till 2000 with adequate investment in building the institutional capacity. When it became part of AP state government policy in 2000, pressure was exerted by dedicated Government officers at the district levels to grow fast and achieve targets.
As a result, the quality of SHGs declined and their earlier emphasis on mobilizing savings, managing repayments and building a supporting environment for a livelihood strategy, considerably weakened.
Instead, SHGs were formed to achieve targets, with the wives of the Panchayat president and secretary dominating proceedings. They borrowed from banks and lent outside the groups at higher rates, at the cost of neglecting their own members.
Official reports focused on disbursements; corrective measures were taken to balance the spread of credit in areas where growth was slow. However, no investment was made to add value or to support increases in productivity and diversification.
Investment in institutions, the very essence of SHGs, was no longer a priority. Instead, the Government was in a hurry to disburse and increase financial inclusion.
Risk and interest rates
MFIs argue that high interest rates are justified because the risk of lending to small borrowers is high, the cost of delivery at the doorstep is high and finally the rates are far less than those of the private moneylenders.
However, high interest rates when offered by MFIs increases risk for the poor.
The State of the Sector report 2010 (N. Srinivasan) indicates that out of 60 MFIs which reported on profitability, six had ROAs over 7%; thirty five had ROAs over 2%.
In contrast the public sector banks in 2009 had average ROAs of 0.6% with the best being 1.6%, while the best private bank had ROAs of 2%. The yield on portfolio confirms this picture; in the case of 23 MFIs it was above 30 %(the highest being 41.29%).
The report also says that economies of scale have not led to lower interest rates or lower yields. This implies that MFIs maximized their profits and competition did not decrease rates as it was expected to.
The largest MFI recorded a 116% jump in net profit at Rupees 81 crores ($18 million) in the second quarter ending September 2010 as against the corresponding period last year.
The level of profit required to meet all costs, cover risks and expand operations is lesser than the level of profit required to meet all these costs and, in addition, attract venture and private capital, and pay salaries higher than the remunerations of the CEOs of the largest private banks.
What should be the interest rate? The figure of 24% is floating around in official circles. The problem is that the effective interest rates of MFIs are far from clear. There appears to be a difference of 5% to 10% between the rates as provided by the MFIs and the rates that emerge from an analysis of the books of clients.
MFIs also argue that the cost of credit from banks is high and that they should be allowed to mobilize public deposits if interest rates are capped. Interviews with clients show clearly that they do not have an idea of what they actually pay over and above the capital. They are satisfied if credit keeps coming.
In fact interviews with those clients who had succumbed to the temptation of multiple borrowings showed clearly that they wanted to borrow from several MFIs to maintain a cash flow to cope with repayments as well as their expenditure. This increases their risk substantially. In contrast, interest rates of SHGs in Myrada stabilize after two years or so between 12% and 14%, which is about 3% -4% above cost of credit from banks.
Non-profit MFIs who do not pay high salaries but still pay adequately enough to attract experience and capital from banks manage to make a surplus at interest rates between 17% -19%, where the average cost of credit is around 9%-10% and annual growth rates are 40% -50%.
For-profit MFIs should be able to manage their affairs and attract sufficient capital (not venture capital and high valuations) by charging effective rates ranging from 15%-17% above the average cost of credit.
This would enable them to charge interest rates in the range of 24% -29% instead of their current rates which are 20%-30% above the average cost of credit. The poor in SHGs are able to manage interest rates of 12% -14%. They have also managed with interest rates higher than 14% in the initial period of group formation until they have built up their group’s common fund. In my experience, they can cope with interest rates of around 17%. The risk involved is manageable and the cushion provided by the SHG can help them tide over urgent needs.
The non poor in the second group can cope with higher interest rates levied by for profit MFIs but the rates should not exceed 30%.
Competition among MFIs has not reduced rates, neither has self regulation.
Interest rates, commissions, salaries, profits have to be regulated by the board of an MFI. A decision by the Board to opt for an IPO will force management to focus on quarterly figures because the logic of financial markets dictates that it should.
This will further integrate the marginalized into the free market system increasing the risk of the clients who are particularly vulnerable.
SHG is not a good model for speedy disbursement of credit; but it is a good model for lowering the risks of borrowers as well as lenders. SHGs have savings which they use to cushion irregular cash flows; they are able to adjust to urgent and unexpected situations. Myrada’s analysis of its SHGs shows that their common fund increases year on year.
The SHG model, with lower interest rates and risk, is most appropriate to financially include the poor, while the product offered by for profit MFIs is appropriate for the non-poor who are in need of credit.
–Aloysius P. Fernandez, Chairperson, National Bank of Agriculture and Rural Development (NABARD) Financial Services, India and Founder of Myrada; the views expressed here are personal.
For more information on the history of the SHG movement in India, click here.
A longer version of this post was published by Microfinance Focus on December 13, 2010.
This is a dispassionate and clean assessment. Thank you Prof Aloysius for writing this. The deluge of articles after the MFIs biannual crisis starting from 2006, 2008 and the big bang 2010 has repeatedly focused on institutions and not the clients. While fast tracking SHGs have had its share of problems too.
As a corollary for me it appeared like the story of Lamborghini’s and the autorickshaws ( three wheelers) in the Indian’s rural roads / hinterlands. It often struck me, what is better and more people friendly??? The autorickshaws normally do an inclusive activity of packing & transporting 6 people in a three seater with 5 baskets , two poultry birds and at times a friendly goat too……”all in one” travelling at 25 kms speed in our mudtracks……perhaps or to the satisfaction of all packed in with a friendly smile and dialogues. For me, heart of heart it’s this ubiquitous auto which wins hands down.
SHGs ( read autos) are better suited , process oriented , patient finances with locally sourced capital…..I remember the local road signs on the edge of the village arteries which reads “ SPEED THRILLS BUT KILLS “ .its an apt caption too for the occasion.
A crisis is needed to talk about SHGs, a forgotton hero in the MF sector. Aloysius has suggested for adoption of a dichotomy in the MF sector. Two observations from my side to put the issues in the right perspective.
First on SHGs for the poor:
Since its formative stage in 1987 (with Myrada supported action research prog), then to the Pilot stage in Feb, 1992, thanks to NABARD’s leadership role and then to the expansion stage in 1996 with the blessings of the RBI, the focus of then the SHG linkage programme was on the poorest of the poor. Somewhere down the line, the poorest was ignored and the programme focused to cover only the poor (it was but natural because CGAP itself once stood for ‘Consultative—-Poorest’ and later redefined itself as ‘Consultative ——Poor’). Thereafter, as mentioned by Aloysius, in 2000 the AP govt with all its good intentions, tweaked and broad based it to run its DWCRA, a sub-component of the then IRDP. Subsequently, AP model was hijacked by the GOI in the form of SGSY, thanks to Dr J.P.Sharma, then Jt Sec, RDD, GOI and now Chairman TRAI. Then, a number of state governments through their Women Development Corporations (WDCs)/ Women and Child Development Departments had churned out their own versions of SHG models (Mahalir Thittam in Tamil Nadu, Kudumbashree in Kerala, Tejaswini in Maharashtra etc) and each political party in power also started claiming ownership to the birth of SHGs in their respective states (Recently, DMK govt in power in Tamil Nadu has made an announcement to the effect that SHGs were promoted by them as way back in 1980s). With the result, in most of the states, the SHGs became SHGs- BPL (those covered under SGSY and their local versions with exclusive focus [supposed to have] on only those who were below poverty line) and SHGs-APL (calling NABARD supported groups which were having members from BPL and those above poverty line). Alongside, a number of NGOs started promoting groups of women and calling them SHGs and claiming promotional support from NABARD and other agencies (one may find a number of examples where an NGO promoting SHGs with NABARD programme support (APL groups) and also promoting SHGs under SGSY (BPL groups) and getting support from the concerned state governments). One may also find examples of NGOs promoting groups which were adopting Grameen Bank principles ( a group comprising only 5 members each with fixed 50 weekly repayment period for repayment of loan etc) and claiming those groups as SHGs and also providing loans to those groups from funds raised from SIDBI, RMK, FWWB, NABARD, other donors etc. Now, if we ask for a definition of SHGs , say from 10 people associated with the MF sector, it may not be a surprise if we end up receiving 10+ versions of definitions of SHGs. So, in today’s context, an SHG has almost become a generic term and it will be difficult to get an SHG exclusive for the poor, leave alone the poorest of the poor, the original target group expected to be benefited under the concept of SHGs.
Second on MFIs for the non-poor:
If the suggestion is that the MFIs would finance non-poor, then the definition of mF should be related to the maximum quantum of finance one can get which can be classified as mF and also the income range for the person (s) to get supported by an MFI. If not, even a small loan given to people like me and Aloysius will be treated as mF. I am sure, this is not the intention of mF.
Dear Aloysius Fernandez
Your posting on SHG for poor is very interesting although it by and large delves on micro credit related services only under Micro finance platform. I would like to share
some perspectives on the original fundamentals of being strong grass root institutions for SHG
1. 1.SHG is a fragile ‘social capital’ based institution in the informal sector and it has more values when it is nurtured as means for the holistic development of poor women ( socio, economic cultural and political) and poverty reduction and not necessarily as principal ‘market for credit needs’ Under Microfinance concept, any financial services including NABARD Financial services need to include all MF services viz., micro savings, micro credit, micro insurances , transfer services collectively for the poor instead of provision of micro credit only. Micro credit alone is not adequate for reaching the mission goal of Micro finance being poverty reduction. The negative impact of multiple lending and multiple borrowing in MF sector crisis in AP case recently had taught enough lesson.
2. Under Micro finance arena with the ultimate goal –poverty reduction , the above MF packages of services need to be institutionalized collectively either singly or severally(along with development partners) by the so called MFI.NGO to the target group – that poor only . There is no room for non poor category since here is where shoe pinches. Once the mission drifts the ethical values of MF are lost Certainly there is a need to make some distinction among the poor clients as the poor and the poorest since the former need micro credit plus services (for IG purpose ) while the latter need MF plus (graduation purpose).
3. The SHG institutional conduit is an innovative venture in the process of poverty reduction but of late the group cohesion becomes a shaky and polluted (politically) one due to more focused attention on micro credit linkages without looking into other supporting financial and non financial linkages for enhancing the productivity of the micro credit .The poor need substantial investment and subsidy (as quoted) but without other supporting inputs it leads to only delinquency.(C.Rangarajan’s ‘Financial inclusion report’ in page 106 highlights that in the absence of physical support mere insistence of financial inclusion will not work ) Eventualities include over financing, over consumption , peer pressure for recovery and over dues with very little income generation and other sordid events as happened in AP . In this context SHG-Bank linkage propgramme with mere provision of credit to the poor need to relooked into.
4. As a corollary to the point 4, the ‘drop out’ / ‘push out’ phenomenon is causing very much in SHG-MF system resulting ‘financial exclusion’ of the poorest or most disadvantaged segment of the poor . The MF India –state of the sector report ( N.Srinivasan) brings out the fact that 43% of the SHGs reported drop out and the dropout rate was 8.2 % of members. The facts about Group mortality / broken group have also been highlighted. The most significant reason as reported, was the dissatisfaction of the members of SHG with 43.5 % reporting the same followed by migration. Neither the Apex institution nor MFIs /SHGs at grass root level appear to concern over this recurring negative factor posing a threat in SHG system so long they satisfy with outreach quantitatively in the poverty sector.. This phenomenon raises a few questions a) why are the poor who were once ceremoniously financially included , excluded unceremoniously? At what social and economic cost? Where have drop outs gone? Does this ‘drop out’ factor facilitate alleviation of poverty or aggravation of poverty or sustainment of poverty despite massive outreach in MF sectr ? These issues merit immediate attention of all concerned with Micro finance if one wants to make SHG as a strong grassroots institution for the true concern of the poor.
5. Last but not the least, intensive research for institutional innovation, adjustment and linkages with more pro poor Micro finance products are needed besides micro credit In this regard similar to SHG-Bank linkage programme, there is an urgent need for SHG- Insurance Companies linkage for protecting the poor clients’ livelihood ( created out of micro credit) against the risk. Another area of concern pertains to migratory poor for whom the transfer of payments (wage income from the place of work to their native village for meeting consumption and other financial needs including dues to be paid to their respective SHG being a member.) assumes significance. Here, I reiterate these micro insurance and transfer payment services are also equally valued MF services like micro credit in the process of poverty reduction but remain neglected meriting immediate attention of both policy makers and the MF practitioners as well
Micro finance -Consultant