Mainstreaming Microfinance: Bridging the NGO-Banker Divide

The role of non-governmental organisations (NGOs) in microfinance (mF) needs reviewing from an operational perspective. Based on research of selective studies and experts’ opinion, selected literature on microfinance, and the author’s own experience over the last decade, this paper seeks to establish two main points. First, it asserts that with a few notable exceptions, the record of NGOs in mainstreaming microfinance is a modest one viewed from the context of NGOs as microfinance institutions (mFIs). When judged by the two criteria of success that much of the microfinance world has adopted – outreach to the poor and financial sustainability – the results are not encouraging [Nair 2001]. NGOs as mFIs have thus far had trouble achieving both objectives simultaneously. There is also little evidence of any aggregate impact on poverty reduction as the result of mFIs’ forays. The success of NGOs has however been laudable where facilitating and social intermediation criteria are applied. It is here that the author feels that the strategic partnership between banks and NGOs is poised to change the developmental intervention map of India. Second, the essay suggests that banks, for all their laudable work, will be making a strategic error in focusing on financial intermediation while ignoring partnership with NGOs. While microfinance is never easy for other types of institutions trying to practise it (e g, NGOs or credit unions), it is not, as will be explained, a field where a banker has natural advantages.

Why Partnership?

To the extent that banks incorporate NGOs’ activities in mainstreaming their self-help group (SHG) portfolios, they stand to gain. To the extent NGOs reorient their mission, vision and personnel towards the microfinance agenda, as a large number have done in the last decade, they risk drawing themselves away from work they are uniquely suited to do. Some of this work, moreover, would play a critical role in preparing the ground for mF among poor people. In other words, NGOs have to move away from pure financial intermediation to investing in human and social capital at the grass roots and bankers have to tap this invaluable experience of NGOs in mobilising, graduating and enabling rural communities. This will prepare the ground by enhancing credit absorption capacity of SHGs and enhancing their creditworthiness. The following account will explain how.

In 1997, the World Bank’s Sustainable Banking for the Poor (SBP) project completed an ambitious survey. Until then those interested in microfinance had an intuitive sense of the movement’s growth, but no systematic attempt had yet been made to gauge its dimensions, nor look comprehensively at its results. The findings were unambiguous: NGOs acting as mFIs did not have any significant outreach vis-à-vis other financial institutions purveying microcredit.

Interestingly, commercial banks accounted for 78 per cent of the total number of outstanding microloans, and credit unions 11 per cent. NGOs accounted for only 9 per cent, and savings banks (which are not primarily in the credit business) just 2 per cent. Also, commercial banks accounted for 68 per cent of the total outstanding loan balance, savings banks 15 per cent, credit unions 13 per cent and NGOs 4 per cent. In terms of numbers of clients, commercial banks and credit unions showed significantly greater overall outreach than NGOs. While NGOs’ outreach, on average, was deeper, it was also narrow – NGOs reach some very poor people, but they do not reach many. On the other hand, credit unions and commercial banks also serve some wealthier clients so that their average outreach to the poor is not as deep. Still, the indications are that overall, credit unions and commercial banks serve more under-served poor clients than do NGOs.

This is not to rule out the role of NBFCs, NGOs with inchoate mFI activities or pure mFIs. The demand for financial services is high and as stated by the High Level Task Force on mF: “At least 25,000 bank branches, 4,000 NGOs and 2,000 federations of SHGs involving over 1,00,000 personnel of these institutions would have to be associated for scaling up and bank linkage of one million SHGs. Many of these NGOs will transform themselves into mFIs and will not only facilitate microfinancing, but will also themselves do the necessary financial intermediation. Similarly, many federations of SHGs will take on financial intermediation and act as mFIs.”

Indian Tale

We shift the focus to India.In the current context with over 4,60,000 SHGs credit-linked with banks, the SHG-bank linkage programme of microfinance has emerged as the biggest in the world. But besides banks, the major role played by NGOs in facilitating this transformation cannot be overemphasised. The National Bank for Agriculture and Rural Development (NABARD) which plays a role in promoting and facilitating bank linkages while networking and coordinating the activities of all players in the field has underscored the crucial role played by NGOs as facilitators in purveying bank credit to SHGs. The story of the three models of this massive programme has been brought out by NABARD in the table.

Table: Three Patterns of SHG-Bank Linkage*

No of SHGs

Per Cent Share

Model I: SHGs formed and financed by banks
142667

20

Model II: SHGs formed by NGOs and directly financed by banks.
513005

72

Model III SHGs financed by banks through NGOs (onlending).
61688

8

Note:* Cumulative as on March 31, 2003.

Source: Progress of SHG-Bank Linkage in India: 2002-03, NABARD, 2003.

The writing is on the wall. The success story has been to a great extent co-scripted by both banks and NGOs. However, it is pertinent to draw attention here to the vast network of rural banking outlets that precludes the necessity of a new breed of mFIs which as per experts’ opinion are ‘slow and expensive to develop’ [Harper 2002]. In fact as aptly put by Harper “the SHG system uses existing marketing channels, the banks, to bring formal financial services to a new market segment, the poor and particularly women”.

Relationship Banking vs Parallel Banking

The distinct bloodline of mF in India can be traced to this genre that is indigenously developed and called ‘Relationship Banking’ as opposed to the Grameen model of ‘Parallel Banking’ [Chavan and Ramkumar 2002]. The ground truth for SHG financing on a sustainable basis in India is that bank-linkage is the bottom line with exceptions proving the rule. Inherent to this success story but understated is the fact that NGOs have played a major role in effecting SHG-bank linkages. Relationship banking is the result of NGO-bank interface to leverage funds for SHGs. NGOs have achieved significant success as promoters (helping and enabling SHGs to access bank credit) and not as providers (direct purveyors of credit). This writer would juxtapose the SBP study’s evidence against NGOs in mF with their success as facilitators in India to make a case for NGOs as social scientists or change agents rather than financial intermediaries. The latter role is arguably the banker’s domain. Moreover, there are compelling institutional and regulatory factors which counsel against any such misadventures.

First and foremost there are legal constraints to NGOs acting as mFIs as noted by the Task Force: “Many NGO-mFIs are mobilising savings from their clients/ borrowers with the sole objective of inculcating a habit of thrift and savings among the poor and for enabling the use of such resources for acquisition of assets or linkage with credit from mFIs or banks. In the context of the amended Section 45 S of the RBI Act, the appropriateness of NGO-mFIs in mobilising savings is questioned. Although NGO-mFIs provide very useful financial services to the poor, including the opportunity to keep their very small savings safe, almost at their own doorsteps, they cannot convert themselves into other modes of constitution like NBFCs, banks or cooperatives due to various intrinsic constraints. Hence, NGO-mFIs may have to be given a special dispensation in regard to Section 45 S of the RBI Act. Accordingly, it is recommended that they be allowed to mobilise savings only from their poor clientele as part of the financial services provided to them and the same may not be treated as violation of Section 45 S of the RBI Act.”

The ‘intrinsic constraints’ noted above are not difficult to guess. Moreover, some NGOs that are mobilising savings purely may also face other risks. The problem for NGOs in dealing with savings is that from a risk-bearing standpoint, savings mobilisation and microcredit are not the same. That is why the law treats them differently. From the client’s point of view, the risks of saving with an NGO are masked by their growing confidence as NGOs show that they are here to stay. But NGOs are not in most cases operating in regulatory environments that permit them to mobilise deposits; they do not benefit from deposit insurance nor can their operations be controlled by bank supervision agencies. And when covariant risk is high, as it is when group members are all from the same sector and necessarily from the same community or locality, the tenuousness of the NGO position is even more dangerous to the saver. Besides propriety and prudence, savings custodianship necessitates statutory provisioning and creation of reserves to cover liquidity and other risks.

Credit Minimalism

While ‘savings only’ is a limited disaster story, the other side of the tale relates to NGOs who are employing ‘credit first’ or minimalist credit principles. When savings form part of the basis for credit in a financial institution, that institution does not have to take a problematic, often tortured, path to sustainability; it starts out on a more naturally sustainable path. But, NGOs have gone into microcredit with donor monies, and aim towards sustainability without, in most cases, the enormous benefit of voluntary savings mobilisation. In short, sustainability in NGO-run programmes is hobbled from the start. It looks as if the poor want its product (credit) less than they want savings, and all by itself, credit does little for productive asset creation.

The one-shot single dose attack on poverty is the sustainable development planner’s biggest nightmare. A case in point is CARE’s Credit and Savings for Household Enterprises (CASHE) project in India which is more of a lending programme than a sustainable financial institution. Unfortunately the credit and non-credit financial needs of the clientele community are expected to outlive the six year shelf-life of one of the most ambitious projects in micro-lending to hit Indian shores. The flawed-in-conception status is palpable from the fact that the CASHE budget does not include an income generating component for skill-building. The best intentions are to give a shove across the poverty line without imparting financial sustainability to households or providing for repeat finance.

The incompatibility between the tendency of NGOs to upscale (for sake of grant continuance) and financial sustainability is aptly summed up by William F Steel, World Bank consultant, according to whom, “Grant-based methodologies are poorly suited for financial intermediation, especially providing credit funds (for which recovery, not disbursement is most critical)”. The other type of NGOs turned MFIs with both credit and savings services have a limited success which as the SBP study has shown is nothing to write home about in terms of outreach or sustainability. Many are facing teething problems while a few have folded up.

These dysfunctional aspects are further highlighted by Kanta Singh (WISE Development Authority) during a CARE-sponsored case study of its CASHE programme: “Low size of loan and long cycle time for loan disbursement are reported to be the largest irritants. Many groups that have successfully managed loans in the past lose energy when they do not get subsequent (credit) linkages.” Absence of training and handholding on income generating programmes are felt to be a major gap in the CASHE design by SHGs. This need is also felt by (partner) NGOs who are trying to increase loan demand and the ability of SHGs to handle larger loans.

In India the demand of the poor for safe and liquid savings instruments is very high. In fact, NGOs, with their sensitivity to the poor and intimacy with individuals, overcome the trepidation that illiterate and destitute villagers harbour about bank personnel (not known for their civility). The World Bank’s Consultative Group to Assist the Poorest (CGAP), part of whose mandate is to help microfinance institutions improve performance, has concluded “...most microfinance clients want to save all the time, while most want to borrow only some of the time.”

However, NGOs face a dilemma when savings overstrip credit demand, i e, interest paid out drastically cuts the margin from interest income. Their limited expertise and avenues for investing elsewhere compound this problem. CARE/Guatemala’s Village Banking Programme fuelled by donor monies, expanded lending outreach heavily in 1994. As a result outstanding loan balance grew at an annual rate of 78 per cent between 1993 and 1995. By contrast, voluntary savings mobilisation grew during the same period at an annual increase of 215 per cent.

Trade-Off Tribulations

The record from the SBP cases (a score of which were NGOs) suggests that as NGOs in microfinance, often encouraged by donors, come to accept the two goals of sustainability (subject to tough measurements) and outreach, (measured increasingly by loan size as a per cent of GNP per capita) the following trade-offs and adjustments are observed:

(1) Concentrating portfolio growth in high population density areas (thus focusing less on rural areas).
(2) Emphasising rapid initial loan volume growth, leading to poor portfolio quality.
(3) Keeping field staff salaries low (or alternatively raising the number of clients per loan officer) in order to control costs, thus tending to high turnover and low morale.
(4) Moving towards the retail trade and service sectors with high cash flow that enable high repayment rates, thus tending away from manufacturing and fixed asset lending.
(5) Emphasising short-term loans as a strategy for high repayment and loan size growth, thus eliminating cyclical sectors like agriculture.
(6) Tending to move up the poverty scale away from the very poorest in order to maintain loan demand and repayment rates (75 per cent of the SBP NGO cases showed this ‘upward creep’).

The writer does not subscribe to suggestions that NGOs suffer from ‘grant mentality’ (SBP study) or that they may have been seduced by microfinance [Dichter 1986]. But with trade-offs like these, short-term sustainability seems to be the best bet. While competition is deemed a good thing in the private sector, NGOs in microfinance (while they may adopt some private sector values), are not private sector institutions. Their (and their donors’) premise when they go into an area is that there is an unfulfilled need for credit. This is different from Pepsi and Coke lowering prices and (presumably) offering more value to the customer in order to stimulate demand and deal with competition. NGOs are not in microfinance to make money, but to alleviate poverty. By concentrating on high volume areas in order to increase cost coverage, their outreach to less dense, but just as needy, areas is curtailed.

Even then the problem of long-term profitability remains, as this comment on Society for Helping Awakening Rural Poor through Education’s (SHARE) activities underscores: “ The star performers among Indian mFIs like SHARE have made sure that sophisticated management information and monitoring systems are firmly established in the organisation to follow up on repayment and check malpractices. The most relevant question here is, all other design features remaining the same, if a successful mFI relaxes the intensity of grass roots level supervisory measures, including its paid staff, and entrusts the task of recovery and disbursal to group members, will its repayment performance be the same?” [Nair 2001]. Clearly, balancing sustainability with outreach is problematic, and may be more so for NGOs than for other types of institutions.

Having made a case for limiting the foray of the inexperienced into banking one seeks here to emphasise the greater role of social intermediation expected of NGOs in mainstreaming mF in India. We hope the following section makes out a sound statement for dispelling NGO-phobia among practising bankers (where it exists) and equally inspires motivated individuals in the voluntary sector.

Competitive Advantage of NGOs

NGOs have a crucial role in group formation, nurturing SHGs in the pre-microenterprise stage, capacity building and enhancing credit absorption capacities. Group-based forms of lending (e g, solidarity groups, village banking) originated mainly for the benefit of the lender as solutions to two problems faced by microcredit organisations: (i) the problem of lack of collateral, and (ii) the problem of high transaction costs involved in loan appraisal, monitoring and enforcement. In theory, the group serves as a set of co-guarantors operating through peer pressure and the group members’ incentive to keep each other solvent so that they themselves do not lose the opportunity to receive a loan. The group serves also as a way to get around imperfect information, since members of the group know each other. Thus the transaction costs involved in loan appraisal are reduced if not eliminated.

It is here that NGOs play the crucial role in transforming the atypical destitute village woman with two children to fend for into a responsible individual with group commitments and group resources. This is a fact repeated in village after village. Whether NGOs empower women in thrift and credit groups is a moot question but it is an empirical fact that such groups provide effective ‘coping mechanisms’. Peer pressure is the best collateral. The banker in India needs to recognise that high repayment rates of SHGs is not an inherent structural feature of SHGs but a commitment to group values. The role of NGOs in investing groups with values through human capital is an undeniable specialisation. In the words of economist Jagdish Bhagwati: “Those values (of civil society and of democracy) are better advanced...by the political and financial support of the numerous and growing NGOs, both here and abroad, that work ceaselessly to nudge the world in the right direction.”

The term social intermediation is meant to suggest that there is another kind of intermediation (other than financial) that institutions can engage in which also supports microfinance. Social intermediation implicitly acknowledges that many poor clients of microfinance are simply not in a position to use loans productively. Social intermediation refers to a range of activities that prepares people to become good borrowers and savers, better manage their own finances or their own financial groups and help them to put whatever ‘social capital’ they have to more productive use.

Because social intermediation activities imply interacting closely with people at the grass roots, these activities are a good fit with the classic characteristics of NGOs. The trade-off, of course, is that such interventions are not likely to be financially self-sustainable. They need instead to be seen as human capital investments.

The banker must accept that this is a role which the NGO, as a committed social engineer, is better suited to execute. This is not to deny qualities of empathy, humanism, social engineering to bankers. But the stark truth is that there is a need for a sensible division of labour. If bankers want to reach the poorest with financial services, they need to face certain realities. First, what they are doing is poverty lending and not economic development or enterprise development. Second, they should realise what the likely impacts may be. Changes in people’s lives will be immediate in terms of lightening the burdens of poverty, but small loans to the poorest will not bring them permanently out of poverty.

Social engineering is a full-time activity which has no substitute for the limited community contacts that a committed banker might indulge in. Moreover, the calling of retail banking has its own demands while credit plus initiatives are the forte of NGOs. Similarly, the NGO’s salvation lies in channelising formal credit to his clientele through innovations so as to meet the overall needs of socio-economic empowerment. The banker’s goal is to secure loans through credit plus interventions which improve creditworthiness of SHGs. But certainly NGOs are positioned at the community level to educate and prepare local institutions and people to be able to make more effective use of the opportunities and better use of finance.

The business of a rural branch can move from sustainability to high profits when SHGs make the important shift from pre-microenterprise stage to microenterprise stage but a lot of social and technical inputs from outside the quintessential rural SHG are required for this.

Small businesses (and dynamic micro-enterprises) need to develop skills. NGOs can assist by creating institutions to train and teach, or work with existing institutions to make what they teach more relevant to the clients. Small businesses (and dynamic micro-enterprises) need to develop the capacity to become and remain competitive. NGOs with good community organising skills can work to get businesses to pool resources within a sub-sector to develop new products, new product designs, or new techniques for production that maximise local resources. Policy level constraints at the sub-sector level can be identified by NGOs who know the local market terrain, and NGOs can bring these issues to the policy-making table.

Arguably, banking is more of a system than an art. Unarguably, working to facilitate the productivity of small businesses is really an art. And again, because of their grass roots orientation, because of their commitment, because they are less bureaucratic and encumbered than large development assistance organisations, NGOs are capable of overcoming a subtle but important barrier to successful facilitation – the ‘packaging of knowledge and skills’.

Once again, this is no case for discouraging NGOs from mF but to emphasise the role of emotional capital which will bring in an element of quality. The more NGOs, who are in microfinance, face the challenge of helping to bring about an increased articulation of the parts and the players in a local economy, the more they may need to get involved in such non-financial services. The effects of such services are difficult to measure in the short run. But NGOs can take on such tasks, many already do so.

Thus, NGOs will fill up an important void in quality at the grass roots level which will help the poor not only to borrow but also to become good investments for banks. This will help boost business at rural branch level and cover up inadequacies and constraints that might hamper a banker with the conflicting demands of his workload. Many banks and FIs have recognised the role of NGOs and have effected suitable policy initiatives. A larger recognition of this need is reflected in the statistical evidence on linkage patterns, which we have cited earlier (see the table), which establishes NGO-bank partnership over the Indian mF spectrum. A truer recognition at individual banker level might lead to business sense replacing customary scepticism for NGOs. This will be the strategic turning point in making India’s relationship banking a showpiece and paradigm for the world’s NGOs and bankers.

References

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Chavan, Pallavi and R Ramkumar (2002): ‘Micro-Credit and Rural Poverty: The Evidence’, Economic and Political Weekly, March 9.
Christen, R, E Rhyne and R Vogel (1994): ‘Maximising the Outreach of Microenterprise Finance: The Emerging Lessons of Successful Programmes’, IMCC, September.
Client Satisfaction Study of CASHE Project of CARE India: A Case Study Compiled by Kanta Singh, WISE Development Representative with the support of local Care officials in India.
Dichter, Thomas (1986): ‘Demystifying Policy Dialogue – How Private Voluntary Organisations Can Have an Impact on Host Country Policies’, Technoserve Findings Series.
Harper, Malcolm (2002): ‘Promotion of SHGs under the SHG-Bank Linkage Programme in India’, NABARD, Thompson Press.
Nair, Tara S (2001): ‘Institutionalising Microfinance in India: An Overview of Strategic Issues’, Economic and Political Weekly, January 27.
SBP Study Findings as highlighted in Working Paper, No 19126, Sustainable Banking with the Poor.
Steel, William F (2002): ‘Microfinance and Community-Driven Development’, Strengthening Operational Skills in Community Driven Development, Washington, DC, April 15-19.
Task Force on Supportive Policy and Regulatory Framework for Microfinance in India (2003): Progress of SHG-Bank Linkage in India: 2002-03, NABARD, Mumbai.
Waterhouse, Price (1997): ‘Financial Services for the Rural Poor and Women in India: Access and Sustainability’, Sustainable Banking with the Poor, World Bank, April.