What Could Replace the Microfinance Sector?

There have been a number of claims that the Microfinance sector is indispensable for poverty alleviation by delivering credit to the poor thereby expanding financial inclusion. Some have even gone to the extent to claim that if the microfinance sector is hurt then it is akin to hurting the poor. Ironically, even the banks seem to subscribe to this view. This is rather unfortunate as it is the banks which have subsidised the microfinance sector due the simple fact that they have lent nearly Rs.10,000 crores (some estimates place it at Rs.30,000 crores). It is clear that the microfinance sector has a number of structural flaws which may be difficult to overcome. Moreover, the risks associated with lending money (for onward lending) which could get caught up in a political quagmire (as in Andhra Pradesh) is not worth the risk for the banks from a business point of view and due to the risks it has in eroding the credibility of the banking sector ,which now stands accused of implicitly encouraging strong arm loan collection methods.

One route that has succeeded in a number of countries and is likely to succeed (if the banks make a serious attempt) is that of Banking Correspondents (henceforth BC) route. Unlike, the microfinance sector, which has emerged as nothing more than an exalted corporate version of  private moneylenders, a banking correspondent is responsible to the banks. Since Banks are regulated by the Reserve Bank of India, which is a regulator that has a lot of credibility there is a likelihood that these banking correspondents may actually be more efficient in serving the poor and expanding financial inclusion, if at all that is possible in capitalism.

McKinsey Consulting has illustrated the case of Brazil where about 1600 municipalities (approximately one-third of the total) are served by banking correspondents, which has reduced the cost of delivering credit and other banking services to the poor. Its study has reported similar success in Mexico and Kenya.

A Banking Correspondent (either individuals or Companies) as per RBI guidelines will be attached to a bank and will be expected to work in rural areas that are within a 30 kilometers vicinity of the branch with which they are attached. These BCs will be expected to market various banking services offered by the branch to which they are attached. The bank will pay the BC a commission on the business they are able to generate, thereby reducing the costs for the banks since they are not direct employees of the banks.

In the case of India, a Banking Correspondent model will enable banks to directly lend to rural borrowers thereby eliminating the need for a intermediary (either the moneylender or the microfinance company). This is not to claim that a BC based system can be built overnight. Instead, it probably makes better sense for the State to subsidises the banks (which they already are through priority sector lending norms) which in turn can deliver credit and other services directly at a lower cost. This could replace the present model  wherein the State subsidises the banks and the banks subsidise the MFIs.  As the economies of scale are built  over a period of time, the cost of delivering services to the poor will decline - the unique selling point of the MFI sector in the present day. Since banking is one of the most heavily regulated sector (and is likely to remain due to its systemic importance) this could be a better way to attempt financial inclusion.