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: Re-Engineering the Financial Inclusion Paradigm…PART II

Ramesh S Arunachalam

Rural Finance Practitioner

Let us set the record straight in terms of some of the happenings in the financial inclusion space…

As noted in the earlier companion post, the mere delivery of credit and more of this standard credit (for consumption and/or small production needs) is not very useful, always. Further, the no frills accounts that often lie dormant, are also not the real solution. While a lot has happened, the financial inclusion paradigm however needs some re-engineering and that is the subject of this post…

Apart from suggestions mentioned in PART I, in my opinion - the focus of financial inclusion first needs to be re-engineered towards ensuring delivery of quality credit that will reduce risk and vulnerability of low income clients and give them more choices - through alternative channels that afford lower costs, have greater trust and high levels of mutual acceptance. Quality credit would therefore necessitate a greater focus on post harvest and/or postproduction financing for agriculture and other sectors that provide (or can provide) significant livelihoods opportunities for low-income people. In other words, among other things, this would call for financing of agriculture produce/other products[i] marketing – a very critical aspect for small/marginal producers as it has the potential to enhance choices for them in terms of buyers etc. Of course, here, the existing relationships would need to be better understood if financial products are to be developed and delivered through appropriate channels[ii].  

Second, the focus of financial inclusion must also be re-engineered such that the delivery of financial services are used to strategically to drive higher rewards, better remuneration and greater power down the value chain as shown later in Figure 3 – otherwise, it will be of limited use. And again, as said before, to achieve this, one needs to better understand existing relationships, particularly in post harvest and post production marketing situation in different value chains. An example of driving power down the value chain is the delivery of finance through a simple warehouse receipt mechanism as diagrammed in figure 2 below. While there have been attempts to do the same in India, large-scale frauds in small pilots have proved to be a deterrent. These should not however force us to abandon this excellent vulnerability reducing financial service that has worked rather well in other contexts:

Thus, financial inclusion must be re-engineered to emphasize delivery of financial services that can enhance the competition among middlemen and other buyers, who buy products/produce/labour from small producers. This would translate to financing marketing of agricultural produce, other products (including handicrafts) and labor of small scale producers[iii] and it can happen in a variety of ways (through various types of aggregators and channels). Some examples are given below:

a)      Enhancing Competition Among Buyers: Direct financing of middlemen and other intermediate buyers of produce/products[iv] so that small producers have greater choice of buyers and incentivising these middlemen to procure at better prices/rates;
b)      Risk and Vulnerability Reducing Mechanisms: Warehouse receipt and similar financing for other products whereby the small producer can store their produce/products, pledge the same, receive a loan and sell when the prices are higher. An example is leasing for urban vendors whereby they can store their produce on a daily basis at a cold storage facility and not sell their perishable item at a throw away price at the end of the day, just because they have no place to store it safely and being a perishable, it could get spoilt;
c)      Creation of Post Harvest Competitive Mechanisms: Financing of other post harvest mechanisms including special depots for auction so that small producers have choices – this has happened a lot in small scale marine fisheries and SIFFS has very successfully used auctions to help the fisher folk get better prices
d)      Other Strategies: Financing of small scale producers who use labor for their livelihood through an innovative mechanism like virtual livelihoods exchange, with appropriate aggregators etc

So, the challenge of reducing risk and vulnerability of all small producers is a key one and for this the financial inclusion paradigm must, among other things:
F     View People as producers of goods and services as against People as mere clients and borrowers
F     Provide a range of risk and vulnerability reducing financial services (based on value chains analyzed for their distribution of power and vulnerability) as opposed to mere credit for consumption and small production
F     Offer cash flow and business cycle based financing as against rigid fixed-term loans currently offered, and
F     Enhance the bargaining/staying power of small producers through value added financial services as opposed to merely offering financial services as part of the traditional access to finance paradigm

“Hence, a new paradigm[v] is required where financial products, mechanisms and instruments can be used to:
F     Reduce risk/vulnerability[vi] in the existing livelihoods of low income people, arising from various market imperfections – examples include urban vendor leasing, warehouse receipt financing, pro-poor value chain financing etc
F     Help create strong safety and security nets[vii] for these low income clients
F     Enable these low income clients to pursue diversified/migratory livelihoods where required
F     Facilitate re-inclusion of these low income people (who were once included but subsequently excluded because of fragile livelihoods), and
F     Create risk management mechanisms[viii] to ensure that they continue to stay financially included, in the context of their fragile livelihoods.

All of this mandates that the financial inclusion paradigm becomes an integral part of the overall livelihoods framework where financial services are - used to reduce risk and vulnerability and enhance staying/bargaining power of all kinds of producers and – therefore, viewed more as a means for livelihood security rather than as an end in themselves. And enhancing the staying power of small producers will result in their having better bargaining capacity which, in turn, will mean that they can negotiate better with market elements and get a return or price, that is due to them.

This is a very critical issue as otherwise, we will see finance being primarily used for funding consumption or making small production loans. This is fine but one which cannot guarantee anything beyond mere access to a loan or a financial service and certainly not, the long standing financial inclusion - that we are all aspiring to achieve - a very necessary but not sufficient condition for India’s inclusive growth strategy to succeed on the ground…

[i] Like handicrafts etc
[ii] Of course, this would need to be validated specifically for a context, product and partner but these are general suggested arrangements.
[iii] Some of these would apply to fisheries as well, where post harvest financing would be very critical. Much of the same would be applicable for tangible goods and here again, the focus would be to create a good supply of post-production financing and creating competition among buyers of produce/products made by small scale producers. Likewise, in the case of labor, innovative financing mechanisms like a livelihood finance exchange using the web could be explored.
[iv] BASIX tried this in the initial years but again we need to study why it could not be scaled up and thereafter try and create an environment for the success of such mechanisms
[v] Sourced with adaptation from Arunachalam “UNDP Financial Inclusion Strategy in 7 Focus States: Strategic Consideration and Suggestions, UNDP” (2007)
[vi] Weather and crop insurance are gaining ground. Contract farming schemes exist but are not producer oriented
[vii] Some innovations exist here for health as well as life coverage but much work is necessary in the nature of product design and also distribution. Micro-pension schemes are also available.
[viii] Post harvest loans in fisheries/agriculture and warehouse receipts are examples of such products.

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