Where Angels Prey

Where Angels Prey is a novel by Ramesh S Arunachalam. Please refer to www.whereangelsprey.com for more information

Monday, February 7, 2011

Looking Beyond the Indian Micro-Finance Crisis: The Need For A Holistic Inclusion Paradigm, PART I

Ramesh S Arunachalam

Rural Finance Practitioner

Look at the following statement made by one of India’s leading private sector bankers – Mr Aditya Puri, MD, HDFC Bank

“Don't put onus of financial inclusion on banks alone: Aditya Puri, HDFC Bank

The government's financial inclusion agenda is desirable but that should not be discriminatory and lead to unmanageable burden on banks with specified lending targets for the poor, said Aditya Puri, managing director and chief executive at HDFC Bank

"We cannot have two worlds," said Mr Puri, winner of The Economic Times Business Leader of the Year Award. "We cannot have the haves and have-nots. I think financial inclusion is a political, economical and social necessity. That opening a banking account or giving a loan without creating a repayment capability is not the solution, so please do not have this priority sector targets only for banks."

Prime Minister Manmohan Singh's government has been pushing the 'financial inclusion' agenda to ensure that most citizens of the country have access to financial services. It is adopting various measures including mandating certain targets for banks in a nation where more than half don't have access to banks. But some of the efforts were in vain with a recent RBI report pointing out that no-frills accounts have been inoperative since people don't have enough money in the first place to deposit in banks.

The central bank has mandated that at least 40% of the total loans should be given to farmers, small businessmen, minority community and to individuals for purchase of home or to students to pursue education. However, there is no such mandate to government-owned or even private companies.

If companies from the food processing industry had priority sector targets, they could directly procure their inputs from farmers, said Mr Puri on the sidelines after receiving the award. This would not only bring down the cost for the corporates, but also improve the pricing for farmers. Banks, on other hand, would be more comfortable funding such farmers.”[i]

As various stakeholders including Mr Puri have noted, there are a large majority of (low-income) people in India who have fragile livelihoods[ii] - either because of greater dependence on agriculture and allied livelihoods and/or lesser scope for diversification into the non-farm sector for sustainable livelihoodswho cannot be easily and/or permanently included in a financial sense, primarily due to the lack of a good ecosystem for promoting such inclusiveness.

Read On…

Several factors like market imperfections[iii] and other factors (like poor market and other infrastructure and production practices etc) severely constrain these low income people in their efforts to build sustainable livelihoods and enhance their economic security - as a result of fragile livelihoods, they often go through a cycle of being financially included and excluded at various times.  The case of the erstwhile IRDP and/or other similar programs are cases in point where we did (financially) include several millions clients in the first place and then excluded them, when they defaulted on their bank/other FI loans (mainly) due to livelihood failure. There are numerous such cases available all over India…

The key point is that, in the absence of market and other infrastructure and related mechanisms, the use of loans by poor and vulnerable people renders them into greater debt. As Mr Aditya Puri, one of India’s leading bankers has argued, “Giving a loan without creating a repayment capability is not the solution”[iv] and that needs to be addressed squarely and fairly…

Two specific aspects deserve mention here:
a.      Risk, Effort, Investment and Value Vs Rewards/Returns in Supply Chain: A key issue here is that while small holder and excluded[v] producers[vi] bear a major portion of the risk, they are also primarily ‘takers’ of prices[vii] handed down by somewhat imperfect markets – in other words, they are not getting profits (returns/rewards) commensurate with the value they create, investment they make, efforts they put in and risks they bear[viii].
b.      Cycle of Inclusion and Exclusion: And these small and marginal producers face numerous risks and unless all of these major risks are simultaneously covered, the risk of even one of these risks wiping out the livelihood is a very high possibility and thus, people who have been temporarily included would be excluded again.

Thus, financially including low-income people without addressing structural causes that result in failure of livelihoods simply cannot help. Here again, financial inclusion will ultimately result in greater exclusion among other things (especially in agriculture/allied sectors). Many of these low-income people will thus live in a wave of inclusion, exclusion, re-inclusion and re-exclusion because of the above aspects, as shown in figure 1 below.

Let us look to interpret the present crisis in AP in this light…and for genuine small production loans made to low-income people…

1.      In the wake of increasing market imperfections (caused by several structural changes in the larger environment) for products/produce/services made by them (as micro-entrepreneurs) and also given the imperfect markets for their labor, the sources of income/cash for low income people have been drying up.
2.      Thus, many of them have become more vulnerable and consequently, dependent on (MFI and other informal) loans for their survival, which they have increasing found difficult to repay.
3.      The is a very critical aspect that needs to be noted because, it stresses how loan after loan was being disbursed to enable several clients and households to subsist and survive and little did any one realize that this was a time bomb ticking away to explosion.
4.      And while these clients suffered on various counts, some of the institutions that lent them money, their equity investors and other stakeholders reaped very significant rewards[ix] during a very short time – and that too by lending to people and knowing very well that they were not in a position to repay, unless and until they had access to a subsequent loan. Almost like the sub-prime situation as Dr Y V Reddy has argued...

The following figure summarizes the above aspects diagrammatically…and the figure is self-explanatory…and situation I is symbolic of the erstwhile schemes in India like IRDP and situation II portrays what perhaps happened in the present Andhra Pradesh micro-finance crisis…

And that takes us to the most important lesson from the past and present crisis situations…

Indiscriminate (and multiple) lending (for consumption and/or small production needs) to low income people in pretext of furthering financial inclusion - without any regard for their (and their families) loan absorption and debt servicing capacity and especially in the wake of vulnerable livelihoods - can only prove to be a recipe of disaster and will ultimately exclude them altogether from the financial system.

As has been argued above, when people with weak and vulnerable livelihoods are lent large sums of money (> Rs 25,000), then repayment will either have to come from fresh loans (greening resulting in multiple lending) and/or restructuring of loans. At some point this cycle will (have to) stop and the bubble will then simply burst…and these clients will become financially excluded again…

Therefore, another key lesson from this crisis is that in reality, there are too many risks - caused by imperfect raw material/intermediate produce/final product as well as labour markets and other lack of infrastructure - all of which need to be tackled together for these low income people to build sustainable livelihoods in the first place[x]. And it is imperative that the government looks closely at this issue and promotes the much needed holistic inclusion paradigm, where by the Private Sector and Government institutions are incentivised to meet priority sector targets in several areas, just as banks are required to do so. Only then can India’s ambitious inclusive growth strategy perhaps succeed…

And as Mr Aditya Puri argues,

If priority sector lending targets are there for the banks, there should be priority sector purchase targets for companies. You can benefit the bottom by a multiple of 5. If I have financial inclusion targets, why shouldn’t there be industrial inclusion targets? Creating financial viability requires the entire eco system. So we should expand the mass - industrial inclusion, literacy inclusion, manufacturing inclusion – everything. Besides, what about changing the agriculture supply chain to eliminate the money lenders? Companies should buy from the farmers directly. Why shouldn’t a large manufacturer have their rural off take targets. One should follow the dairy model. They have created a cooperative and a commercial movement.”[xi]

The issue of including these people in other sectors through a priority sector mandate for private sector and government institutions is a very practical idea as suggested above and it is being explored and operationalised in greater detail in the coming posts. However, there is also a lot that can be done to re-orient the present (narrowly conceptualized) financial inclusion (access) paradigm to meet some of the aforementioned challenges…

Please read PART II to view some such suggested solutions…in this regard…


[ii] As agriculture and allied activities have become very unreliable, because of fragile occupations/livelihoods, it has pushed the poor to migrate to urban areas, where they neither have the survival skills nor the distinctive competence. It has also led many of the poor into perpetual debt traps, which they cannot get out of, even when assisted by MFIs, as agriculture and allied activities are not remunerative and profitable enough. At the extreme, it has thrown the poor into bondage (called Jethum/Kothadimai), which is prevalent in several areas in Andhra Pradesh, Tamilnadu and other areas in the different states of India; At worst, it has even forced some of the poor, who really have no options, to commit suicide, as seen in AP, Maharashtra and other places – due to their recurring indebtedness
[iii] Imperfections exist in raw material, intermediate product, final product, labour/skill and financial markets
[v] The excluded disadvantaged groups are Dalits, women, scheduled tribes and other such low income groups who continue to live in poverty and suffer harsh and oppressive living and working conditions.
[vi] These include low income people engaged in producing goods and services in various sectors
[vii] As a recent study by FAO/UNTRS (2007) suggests, small scale marine fishers despite being primary risk bearers, are forced to take prices handed down by imperfect markets, domestic and international. In fact, they appear to be funding the working capital needs of exporters/processors, as can be gauged from the high level and slow turnover of accounts receivable of trader merchants with fishermen’s societies/CBOs. The same phenomenon exists right through the entire value chain up to the exporter/processor.
[viii] Examples are available in Agriculture/Allied Activities, Fisheries, Handicrafts, Leather, Silk and several sectors.
[ix] In fact, the above prompted a well known site www.indiamicrofinance.com to put up the following cartoon - on its website – highlighting the aspect of people using micro-finance to become rich (crore pathi)
[x] Sourced with adaptation from Arunachalam “UNDP Financial Inclusion Strategy in 7 Focus States: Strategic Consideration and Suggestions, UNDP” (2007)


  1. P N Vasudevan EquitasFebruary 17, 2011 at 8:21 AM

    hi Ramesh, i have a pretty big divergence on the approach in this post. let me divide the feedback into two broad heads:

    1. why banks are given a target for financial inclusion while industries are not given a target for industrial inclusion
    2. how banks can take up financial inclusion on a more serious footing

    1. Why only Banks and not industries?

    Getting a license to do the business of banking is a special privilege that is given to a select few in any country. A license permits the owner of a bank to put in just Rs. 1 of his own money and then mobilise money from the public upto Rs. 8 to 10 against his investment of just Rs. 1. Thus, he is allowed to take the risk on a very large amount of public money. hence if he is allowed to be doing banking, it is indeed a privilege that is given to such a person. Also, if I want to start a Banking company tomorrow, i would not be able to do this since i need a license and consciously the RBI keeps the number of such licenses extremely limited. so it is not just that i meet the norms as laid down for starting a bank such as minimum capital, a 'fit and proper' person profile etc. even if i meet all the norms for being eligible for commencing a Bank, RBI does not give me a permission to start one since they want to control the number of banks operating in the country. Thus, through regulation, not only the 'owner' of a bank gets the right to mobilise huge multiple of public money for doing his business, but also the regulation controls the amount of competition that he would have. This is indeed a special situation to be in and a great priviilege to have. For enjoying such a high privilege, there are obviously some obligatiions also that one is required to undertake and one of them is financial inclusion. If RBI has licensed a certain number of banks and none of them show interest in serving the rural or poor people, then they have no fall back at all. Hence regulated lending and regulated savings services are a must to ensure that the privileged entities work with some level of obligaitons also.

    however when we take industries such as say, HUL, they have no such regulatory privileges. if i want to start a similar company tomorrow, nothing prevents me from doing this. i can start a company, compete with HUL and do exactly what i want. hence if serving the rural areas or low income people is commercially viable for me, then i would just do it .. i dont need a regulatory prod. hence what happens in reality is that people and institutions of different sizes and charecteristics end up serving differnet segments of the population. While a large retailer serves the urban and concentrated market with a different level of service and cost point, a smaller retailer ends up serving the remote areas or low income people witha diifferent level of service and lower cost point. But since the market is totally open and anyone can start such companies, the competition flow is smooth and different service providers of different sizes and shapes end up serving differnet segments of the population.

    but as said before, banking is not a open competition category and hence normal market forces dont operate there. as the Governor of the Central Bank of Nigeria mentioned in one of the conferences, "Banking is a privilege given by the Government to the promoter. the Central Bank would keep breathing down the neck of the banker for various issues. if the promoter does not want this, he can hand over the license back and carry on other activities". Thus, my feedback would be that if any banker does not like being forced to do finanical inclusion, he should hand over the license back to the regulator and i would be personally very interested to take such a license and carry out banking activities, combined with all its conditions. but u cannot keep the privilege and get away from the obligaitons that follow such privilege.

  2. 2. how banks can take up financial inclusion on a more serious footing:

    as on date, banks regard any direction on financial inclusion as a heavy burden on them. when a person does not like a job, it looks heavier than it really is. the banks should go through a fundamental mind set change. they should start realising their social obligaiton as a necessary part of their financial privilege and not deme it as an interference. if the bankers go out and meet people who are urban poor or rural excluded, they would definitely realise the importance of financial inclusion. all the bankers need to do is try to run their lives for a period of 6 months wihtout being able to access any bank for any service like savings, deposits, withdrawals, cheque issuing, or availaing loan or using credit cards. if they live for 6 months as a 'financially excluded' person, they would realise the desparate need for financial inclusion and would probably then work to find out how they can do this rather than keep asking why they should do this.

    if they seriously want to do it, there is no way they would fail. after the banks have been able to put up some of the best technologies in the world of banking, at a cost which they claim is 1/10th of foreign banks, sport some of most intellectual people working for them, manage huge networks and providing high class services. if they can do all this, then why not set up similar services of high quality and hi-tech driven low cost services to the urban poor and rural?

    one shocking statistics from the 2001 census is that in Chennai out of 16 lac families residing, 9 lac families dont have even a bank account .. and in Chennai which probably hosts over a few hundred bank branches and probably a thousand ATMs!!!

    Banks need to come out of the 'profit' intoxicant and take their social obligation more seriously. and if any banker feels that he would not like to do this, they are free to hand back the licenses to the regulator and there would definitely be enough people willing to take it up and do better than such bankers .. and the author of this note is definitely one such who would be very happy to take over license from any such 'unwilling' banker and do a better job!

  3. Dear Mr Vasudevan

    I have sent the comments to Mr Aditya Puri and if and when he replies, I will post it here

    I too disagree with your perspective and will post my views on the same

    I would be very careful in asking India's best bank for its license back...we all are bound to loose out on the service


    Warm Regards


  4. hi Ramesh, you say 'we all are bound to loose out on the service'... but whom are u referring to? if you are referring to people like you and me, i completely agree with you, we will stand to loose out on service. but i was, in this post, referring only to the about 600 million indians who are excluded financially from the banking system. to them, i guess our current banking system and services dont make a difference since they are anyway not a part of it. my whole posting was from thier perspective and not our perspective

  5. Dear Mr Vasu

    Thanks and I am not talking of us. Given the kind of service that many MFIs have provided and the kind of practices that they have engaged in during 2007 - 2009 and summarised in this blog, I am not sure that your vision of financial including them via credit from MFIs alone is appropriate. I think Mr Puri makes a very valid point and that is, when you try to include everyone financially without a proper ecosystem, then, when they default, you may have to exclude them. Therefore, while trying to financially include people, attention must also be provided to the larger ecosystem. I think this makes a lot of sense and the experience of the last 63 years in India, post independence shows that. Having worked in over 550 districts in India, I can take you across India and show you in many places this. We have done this inclusion over and over again and the IRDP included 55 million clients – many of them were excluded in between and we are trying to include them again, without creating a conducive ecosystem. This is my final response to you and if you do not get this idea, let us please agree to disagree and move on


    Warm Regards