Centre for Micro Finance at Institute for Financial Management and Research8th Floor, West Wing, Fountain Plaza, Khaleel Shirazi Estate31/2 A, Pantheon Road, Egmore, Chennai, 600 008, IndiaPhone: (91) 44 4289 2725 | Fax: (91) 44 4289 2799 | Web: www.ifmr.ac.in/cmf

Issue #6December 2007

cy of microfinance because of widespread use of micro-loans for consumption. This discrep-ancy between what has been suggested and the ground reality motivated us to find ways to better design loan contracts so that clients can make the best use of loans.

Social Cohesion

Microfinance is different from traditional debt contracts in the frequency of their meetings and repayments. Frequent meetings and repayment are believed to teach clients financial discipline, as well as build cohesion within groups so that clients will turn to each other in times of need and lack of verifiable collateral. Practitioners argue that with less frequent meetings, groups will not be as comfortable with each other and, as a result, clients will be reluctant to ask for help in making payments.

Due to the randomized nature of our interven-tion, we had a unique opportunity to test this proposition. We found, during the first interven-tion, that although clients that met more regu-larly had greater familiarity with fellow group members, this familiarity did not translate into greater financial reliance. Instead, clients relied on traditional networks for making payments – such as their husbands and family members – suggesting that group cohesion has a limited role to play in joint liability groups. We are still unsure whether this is a generalizable phenom-enon as these clients were first time borrowers and, thus, receive the smallest loan size that VWS offers. The fact that clients did not turn to their group members in times of need might be due to the small loan size or the age of the group rather than different meeting schedules.

Early Repayment

Another salient – but unexpected – result from the first intervention was the differing rates of early repayment between meeting schedules. VWS has a policy that after 33 weeks clients are allowed to repay the entirety of their loan. Results from our first intervention revealed that clients that met more frequently were more likely to repay the entirety of their loan earlier, suggesting that some aspect of more frequent

Variable Repayment Schedules & Default: The Effects of Introducing Flexibilityinto Microfinance Contracts A schism exists in microfinance between aca-demics – who believe that microfinance can only stand to gain from greater flexibility – and practitioners – who are reluctant to introduce greater flexibility in contracts for fear of in-creased client default and delinquency. Over the past year, Professors Erica Field and Rohini Pande and the Centre for Micro Finance (CMF), in conjunction with the Village Welfare Society (VWS), a microfinance institution (MFI) in West Bengal, have sought to rigorously test these contrasting views.

A first intervention with VWS took place be-tween April 2006 and June 2007 and ran-domly assigned different repayment schedules to first-time female borrowers in joint-liability groups. Clients could either be assigned to 1) the traditional weekly meeting and weekly re-payment schedule; 2) a weekly meeting and monthly repayment schedule; or 3) a monthly meeting and monthly repayment schedule. It soon became clear that introducing greater flexibility had no discernible effects on client default or delinquency: The rate of default in all three groups was virtually identical. These results are discussed in greater depth in Field & Pande, 2007.

However, over the course of the first interven-tion several other findings stood out as interest-ing and worth further research.

How Microfinance Clients Make Use of Their Loans

How clients make use of their loans has been an important question for any research on microfi-nance. From survey questionnaires, we ascer-tained that clients did not use their money for large upfront investments in productive capital. This finding defies conventional wisdom that suggests that clients use their loans to make productive investments. At the same time, there has recently been scepticism in the effica-

In ThIs IssueVariable Repayment Schedules & Default By Emmerich Davies and Anup RoyEmmerich and Anup are CMF research associ-ates. In addition to the VWS project, Anup is currently working on the smokeless chulha proj-ect in Orissa in collaboration with MIT. Emmer-ich joined CMF in October 2007. Pg. 1

Financial Inclusion Drive By Minakshi RamjiMinakshi is a CMF research associate. As a member of CMF’s SWAP (Sector-Wide and Policy Issues) team, she is currently working on projects that explore levels of financial literacy amongst microfinance clients and its effects on financial behavior. Pg. 2

Integrating the Poorest into MicrofinanceBy Jyoti Prasad MukhopadhyayJyoti is a CMF research associate. He has been working with Bandhan on the Ultra Poor Project since August 2007. Prior to this project, he was managing a project to study financial needs of migrant workers. Pg. 3

Full Disclosure: An interview with Kate McKee

By Amy MowlAmy is a CMF research associate. She is coordi-nating the panel survey on socio-economic mo-bility with Yale Economic Growth Center. Pg. 7

CMF Working Paper Summary: How do women in mature SHGs save and invest their money?By Lucie Gadenne and Veena Vasude-vanLucie and Veena were interns at the CMF this past summer.

CENTRE FOR MICRO FINANCE

repayment schedules made it easier or more appealing to repay early. Two explanations are possible: 1) As having to repay more frequently imposes a higher effective interest rate, clients on weekly repayment schedules were eager to finish their loan payments faster and move onto more lucrative loan contracts, or 2) The more frequent meetings made it easier for clients to repay their loan faster.

Areas for Further Research

The results discussed above as well as the results discussed in Field & Pande, 2007 have created several avenues for further research. Two more interventions have been designed to test these questions presented above: loan contracts that incentivise clients to make larger investments at the beginning of the loan cycle and the early repayment effect.

The second intervention with VWS introduces a treatment group that has a two-month time lag before they are required to make their first loan repayment. This change in the loan contract was derived through our interactions with VWS clients who hinted that having a longer period before having their first repayment would give them an opportunity to use their loans for larger and more productive investments. This intervention is currently ongoing and we have about 800 clients who have already formed groups and received loans and we are hoping to add another 200 clients to the intervention.

The third intervention tries to tease out the mechanism behind the difference in early repayment results discovered in the first intervention. As one of the reasons behind weekly clients repaying earlier could have been a difference in effective interest rates between repayment schedules, we have equalized the interest rates faced by clients on all repayment schedules. As a result, clients on monthly repayment schedules will pay a slightly higher amount at each repayment. We hope to begin this intervention in the first quarter of 2008.

Financial Inclusion Drive: Perspectives from Gulbarga Background

In 2005, the Reserve Bank of India (RBI) – the central bank of India – announced a nation-wide drive for financial inclusion: in one district of ev-

ery state in India, every “unbanked” household in the target district would be provided with a savings account. Since then, many states have started the drive in more than one district and some states such as Himachal Pradesh and Kar-nataka have declared 100% financial inclusion in the entire state1,2.

Initiatives for financial inclusions are important for various reasons. First, from the equity point of view, bringing people into the ambit of formal finance is an important policy initiative in itself. Second, access to savings accounts is thought to improve access to other formal financial ser-vices over time like credit, insurance and pen-sion amongst others. Third, access to safe and secure savings is critical for low-income fami-lies to smooth their volatile consumption pat-terns. Lastly, it has been posited that lack of savings leads poor households to rely more on informal lending channels such as moneylenders who charge prohibitively high interest rates.

Given the time and resources devoted to this ef-fort, it would be pertinent to appraise the drive. CMF carried out a study to understand the process through which people become finan-cially included and how they perceive the drive. The study was conducted in Gulbarga district in Karnataka, one of first locations claimed to have achieved 100% financial inclusion. This article presents preliminary findings from the study and focuses on whether or not the drive succeeded in opening accounts for all unbanked households. A working paper that presents the full findings is forthcoming.

Unbanked households are defined as households with neither direct access to bank accounts nor indirect access through a SHG member in the household. While the responsibility for the co-ordination of the drive lay with the state lead bank3, the drive was to be implemented by all banks in the designated district. Typically, banks across the country have been assisted in this effort by the local NGOs. Each bank works with one or more NGOs in its service area to prepare a list of all unbanked households. Once this list is prepared, the NGOs allow for each of these households to apply for a basic bank account at their doorstep. These basic bank accounts or no-frills accounts (NFA) typically require a zero minimum-balance and lighter cli-

1. State achieves 100 p.c. financial inclusion. (2007, December 14). The Hindu Online Edition. Re-trieved from http://www.hindu.com/2007/12/14/sto-ries/2007121459970400.htm2. Financial inclusion: RBI external evaluation. (2007, September 13). The Hindu Online Edition. Retrieved from http://www.thehindubusinessline.com/2007/09/13/sto-ries/2007091351550600.htm 3. The lead bank of the state is typically the bank with the largest number of branches in a state.2

CMF Working Paper SummaryHow do women in mature SHGs save and invest their money? Evidence from Self-Help Groups in India

by Lucie Gad-enne and Veena Vasudevan

The Self-Help Group Bank Linkage Pro-gram (SBLP) is by far the

dominant model of microfinance in India, in terms of both number of borrowers and loans outstanding.The National Bank of Ag-riculture and Rural Development (NABARD) estimates that as of March 2006 over 33 million women have been linked to banks for financial services through 2.2 million Self-Help Groups (SHGs). Growth of the program has been spectacular over the past 5 years with the number of members linked to banks having increased nearly tenfold (the NAB-ARD website claims a growth rate of over “400 women per hour”). Given the level of outreach, growth and the huge impact of the program on the members and their communi-ties (both in terms of access to formal credit and the intangible impacts like empower-ment), understanding how SHGs function, mature and how they affect the members’ lives is of major importance to both research-ers and policy makers. There is, however, still a relative paucity of quality research on the SHG movement in India.

Over the summer, CMF interns, Lucie Gad-enne and Veena Vasudevan, conducted an in-depth study of 69 mature SHGs managed by the NGOs, MYRADA and Hand in Hand in the districts of Chitradurga (Karnataka) and Kancheepuram (Tamil Nadu) to find out more about loan usage among members of SHGs. Using results from surveys of SHG mem-bers and internal SHG records, the authors analyzed how SHG members use their loans and how patterns of loan usage change over time. While the degree to which results may be generalized is limited by several potential biases in the data1, the study is useful for

1 The SHGs for which data was collected are all at least five years old or older, come from two specific districts in Tamil Nadu and Karnataka and were pro-moted by high quality NGOs. Loan usage behaviour for SHGs which do not meet these criteria may in fact be very different. The fact that a large portion of SHGs never reach five years of age strongly suggests that this may be so.

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Field, E. & Pande, R. (2007). Repayment frequency and default in microfinance: Evidence from India. CMF Working Paper Series, 21. Download the document from here.

ent identification requirements. Banks prepare a passbook and it is either delivered through the NGOs at the doorstep of the account holder or the account holder picks it up at the bank. For this service, NGOs are paid a commission per account opened.4

Research Methodology

Gulbarga, in Northern Karnataka, is one of the most backward districts in the state, placing 26th out of 27 districts in the Karnataka Hu-man Development Report 2005.5 The financial inclusion drive was implemented in this district from August 2006 to January 2007. During this time, a total of four lakh no-frills accounts were opened.6 Gulbarga is also one of the districts where the National Rural Employment Guaran-tee Programme (NREGP)7 has been implemented. Under the scheme, the village panchayat opens bank accounts for all NREGP beneficiaries. The wages from the NREGP programme are depos-ited in these accounts. NREGP accounts, since the roll out of the financial inclusion drive, have also been zero-minimum balance no-frills ac-counts.

The data for this study was collected through household surveys administered to below pov-erty line (BPL) households who were identified through state-issued ration cards. The survey was conducted in Shorapur and Gulbarga blocks since these blocks have the highest proportion of BPL households in Gulbarga district. A to-tal of 999 respondents were surveyed in the study.

Findings

4. In Gulbarga, NGOs were paid approximately Rs. 18 per account opened. 5. Karnataka’s HDI Index is 0.650. The all-India HDI is 0.621 and Gulbarga HDI is 0.564. 6. Minority loans against RBI policy. (2007, January 19). The Times of India. Retrieved from http://timesofindia.in-diatimes.com/articleshow/1322687.cms 7. NREGP assures 100 days of employment for those who wish to earn wages through manual labor. 3

Among the study households, a total of 172 new ac-counts were opened between August 2006 and August 2007. Of these ac-counts, only 63 households have indicated that the minimum balance required on these accounts was nil. These 63 house-holds opened 77 ze-ro-minimum balance accounts, implying

that there are some instances of multiple account-opening. Of the 63, only 22 households had not had access to any other form of formal or semi-formal savings accounts previously. In other words, 41 house-holds who opened a bank account had already been financially included indicating the mistar-geting of the drive. As a result, six months af-ter the drive, approximately 36% of our sample population remains excluded from any kind of formal or semi-formal savings mechanisms. See also Table 1 for overall summary of the study.

The second striking finding from our study was the strong link between the NREGP and the opening of bank accounts. While only 11% of the entire sample knew that banks were open-ing zero-minimum balance accounts, over 80% of those who knew came to know about them through the village panchayat.

Table 1. Bank accounts opened during the drive

Before the drive% of households without bank accounts 82%

During the drive% of households who opened accounts 17%

% of households who reported zero minimum balance

6%

After the drive% of households without bank accounts 68%

% of households without savings ac-counts*

36%

* Savings accounts refer to any one of the following: bank accounts, post office accounts, neighborhood savings group, SHG groups, savings MFIs and chit funds.

Since village panchayats were responsible only for the NREGP accounts, this shows that most of the people who had knowledge of the drive obtained this knowledge because they were recipients of NREGP assistance rather than through the information campaign of the drive itself. This finding is reinforced by the fact that

82% of those who received help in opening the account were helped by village panchayat members and over 60% claimed that one of the primary reasons to open the account was to re-ceive NREGP payments.

Conclusion

While Gulbarga claims 100% financial inclusion, the study revealed that a significant propor-tion (36%) of our sample households remain unbanked. It also appears that of the accounts opened, a majority of them have been opened under the NREGP. What does this tell us about the drive? The first possibility is that the drive has failed to target its beneficiaries appropriate-ly. The second possibility is that account hold-ers do not recall having opened these accounts since the accounts were opened without any purposes from the beneficiary’s perspectives.

Considerable amounts of money are currently being spent in extending no-frills accounts to unbanked households. Greater research needs to be done which examines how these accounts are used and how targeting techniques can be improved. Furthermore, such nation-wide ini-tiatives need to be accompanied by extensive marketing campaigns which publicise these campaigns and its benefits for users.

Integrating the Poorest into Microfinance: An Impact Assessment

Background

Over the last three decades, microfinance has emerged as a tool for the economic develop-ment of the poor across the globe. Nobel Lau-reate Muhammad Yunus’s pioneering Grameen model has been adopted in different countries and microfinance has become a global move-ment. But who are microfinance clients after all? There has been a persistent criticism about the discrepancy between whom microfinance claims to target and whom it actually reaches. Whether microfinance has been able to provide credit to the poorest of the poor remains a debatable topic.8 As a matter of fact, microfi-nance institutions (MFIs) generally neglect ultra poor households because they are extremely vulnerable to shocks and they are more likely

8. See Morduch, J. (1999). The Microfinance Promise. Journal of Economic Literature. 37 (4), 1569-1614. and Rabbani, M., Prakash, V.A. & Sulaiman, M. (2006) Impact Assessment of CFPR/TUP: A Descriptive Analysis Based on 2002-2005 Panel Data. CFPR/TUP Working Paper Series, 12.

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to end up spending loans for consumption purposes rather than investing in productive activities. So even if an ultra poor household is interested in starting a petty business, it is often denied loans and hence such households find emancipating themselves from the shackles of poverty extremely difficult. They con-tinue to face the tyranny of local moneylenders and other humiliations.

Take the case of Basanti of Hazrapara in Beldanga, West Bengal. She is keen to start a micro-enterprise but she could not start one due to a paucity of funds. No MFI approached her to join a microfinance group be-cause she belongs to an ultra poor household. Hence she thought that her dream would never turn into reality. This is the fate of many such “Basantis” who cannot afford a square meal ev-eryday. To reinforce this, Morduch (1999) once opined that “poorer households should be served by other interventions than credit” (p.1600). One such intervention would be to uplift ultra poor households by providing income generating assets so that they can eventually participate in regu-lar microfinance programs. With this objective, Bandhan started the “Chartering into Unventured Frontiers-Targeting the Hard Core Poor” (CUF-THP) program in 2006. This grant-based program is financially supported by the Consultative Group to Assist the Poor (CGAP) and draws inspiration and technical support from a similar program9 run in Bangladesh by the Bangladesh Rural Advance-ment Committee (BRAC).

Setting

Bandhan is an NGO-MFI based in Kolkata. Primarily focused on micro-credit, Bandhan started its operations in 2002. Within a span of five years, Bandhan became operational in five states: West Bengal, Tripura, Assam, Bihar and Jharkhand and was able to provide micro-credit services to more than 400,000 clients across these five states. Recently, Bandhan was ranked 2nd on the Forbes List of the World’s Top 50 Microfinance Institutions.10

Targeting Hard Core Poor (THP) Program at a Glance

Identification:

The aim of the THP program is to provide in-come generating assets, such as livestock and other inventories for non-farm enterprises, to the poorest of the poor to assist them in start-ing businesses and eventually graduating into

9. See BRAC website: http://www.brac.net/cfpr.htm10. See http://www.forbes.com/microfinance/.

small scale entrepreneurs. To make this pro-gram successful, area selection and ultra poor targeting are of utmost importance.

Bandhan selected Murshidabad for the inter-vention because the district performs poorly in terms of certain human development indicators compared to other districts in West Bengal.11 Once the village lists were finalized, Band-han conducted Participatory Rural Appraisals (PRAs) to identify ultra poor households in each hamlet. Under a PRA, social mapping and sub-sequent wealth ranking using information from neighboring households help Bandhan identify the dwelling units of ultra poor households in a particular hamlet and determine their relative socioeconomic status.

A few days after conducting a PRA in a par-ticular hamlet, Bandhan administers a detailed questionnaire to verify the results of the PRA and also to identify the beneficiary of each household. Ideally, an able-bodied woman mem-ber of a household is the target beneficiary of this program. Subsequently, the THP program coordinator carries out the final verification of households identified as ultra poor through visu-al inspection and informal conversation. During the final verification, special attention is paid to the condition of the house, the health and nutritional status of the women and children, educational attainment of the children, and employment status of the women. One manda-tory eligibility requirement is that the household must not be involved in any micro-credit activi-ties and/or should not obtain “adequate assis-tance12” from any government aided program.

Methodology of the study:

CMF is currently undertaking a study led by Profs. Abhijit Banerjee (MIT), Esther Duflo

11. Murshidabad was ranked 15th among 17 districts of West Bengal in Human Development Index Ranking, 2004. Source: West Bengal Human Development report 2004. 12. “Adequate assistance” is determined on a case-by-case basis.

gaining a better understanding of what actu-ally goes on in the field when it comes to SHGs and may point to potential subjects for future research. Listed below are their key findings from the study. In addition, the full report includes a number of in-depth case studies of individual SHG members and their loan histories so that readers may get a bet-ter sense of the ground reality behind the statistics.

There was no clear shift from con-• sumption to production loans.

Over the past few years, the microfinance community has come to accept that a large portion of microfinance loans are used for consumption purposes. In some corners of the microfinance community, this perception has been replaced by a belief that the share of loans used for consumption purposes gradually declines over time as borrowers spend a greater portion of their loan money for productive purposes. This was not the case for the SHG members we surveyed: there was no clear shift in the purpose of loan use from consumption to production. This result, if found to hold true among a more representative sample of SHGs, sug-gests that the livelihood programs of SHG promoting NGOs may not be effective in in-ducing members to spend more of their loan money on productive assets.

Members value the savings compo-• nent of SHG membership.

The low levels of voluntary savings among SHG members and the relative insecurity of SHG savings have led some to believe that SHG members save only because they are re-quired to do so in order to receive loans.2 The SHG members we interviewed overwhelm-ingly indicated that this was not the case and that they did in fact value the savings component of SHG membership as much as they do the credit component. When asked why they valued the savings component of SHG membership given the obvious disadvan-tages of SHG savings3, members responded that they would not have been able to gather the motivation to save regularly without the support of the other group members.

2 See, for example, “Sustainability of Self-Help Groups in India: Two Analyses” by Robert Peck Christen, Syed Hashemi, Jennifer Isern, Gautum Ivatury, Anuradha Pillai, L.B. Prakash, and Richard Rosenberg published by CGAP. 3 One of the biggest disadvantages of SHG savings is its illiquidity. Members are not able to withdraw sav-ings until the time they leave the group.

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(MIT) and Raghabendra Chattopadhyay (IIM-Cal) to assess the impact of the THP program through a randomized control trial. CMF is now conducting baseline surveys to identified house-holds. After the completion of the survey, half of the identified beneficiaries (treatment) will be randomly selected for asset distribution. Sub-sequently, these selected beneficiaries will be asked by Bandhan to select the enterprise they would like to undertake. The other half consti-tutes the control group.

In the initial phase of this intervention, assets worth $100 are given to each ultra poor ben-eficiary. In addition to grants, beneficiaries are also provided $2.27 (Rs. 91) per week as part of the operational costs to run the enterprise they selected.

Prior to asset distribution, Bandhan will orga-nize enterprise training for the targeted ben-eficiaries. After asset transfer, Bandhan will carry out monitoring and supervision of assets through regular household visits.

The objective of this study is to assess the impact of grants given in the form of tangible assets and subsequent enterprise development on social and economic outcomes which include income, assets, school attendance of children, family health and food security. Further, this study will help us better understand the needs of the ultra poor households and will provide some evidence regarding the viability of “gradu-ating” the ultra poor to microfinance programs.

Future plans:

18 months after the asset distribution and training, CMF will conduct a follow-up survey to gauge the impact of the asset distribution. These beneficiaries will then become eligible to participate in Bandhan’s microfinance pro-grams. CMF has also proposed a second-phase randomization to make the impact of access to microfinance clearly discernible. Finally, in 2009 an endline survey will be administered by CMF to assess the impact of the overall intervention. See also the text box below.

Full Disclosure:

CMF Chats with CGAP’s Kate

McKeeMicrofinance in India has experienced unprec-edented growth over the last decade. Because of this rapid growth, millions of the poor have gained access to credit and millions of dollars were disbursed. But this rapid growth also gave rise to intensified competition among microfi-nance providers, some undesirable methods of loan recovery, and subsequent calls to overhaul regulations of the microfinance sector. As a re-sult, codes of conduct and consumer protection became key topics in the sector. Today, CMF talks with Kate McKee, CGAP’s senior adviser on policy who has extensive experience cover-ing this issue.

Kate McKee joined CGAP in September 2006 as Senior Advisor for Policy, Outreach and Aid Effectiveness. She is acting director of the sav-ings team and is carrying out several special projects focused on issues including: perfor-mance and policy issues of state-owned retail financial institutions; the next generation of consumer protection and market conduct issues for microfinance; and strategies for combining livelihoods/enterprise support and financial ser-vices to benefit poorer clients.

Q: We’ve had a decade of very rapid growth in the Indian microfinance sector, accompanied by recent calls for more and better industry regulation. Would you explain some of the dif-ferent concepts related to ongoing discussions of microfinance codes of conduct and consumer protection?

A: If we start from the perspective of the re-tail provider of microfinance services, there are some different concepts that come together around codes of conduct and consumer protec-tion. Starting with the operations and practices of the MFI, the concept of client transparency is a useful thing to think about.

We tend to think of the term transparency in terms of transparency of the financial institu-tion about its financial or social performance. But if we are talking about client transparency, then we’re considering whether the institution

made clear the terms and conditions of the fi-nancial services, disclosure of interest rates or prepayment penalties, or whether it’s fair or not. Having a clear contract is a key building block of what might go into a code of conduct.

Customer care is another concept that layers onto what we’re looking for. This is the ques-tion of what your customers should be able to expect, what happens in the case of disagree-ments or misunderstandings or how you can protect them against fraudulent or corrupt be-havior by your staff.

A third very micro-level concept that is, at the frontline interaction of the customer and the fi-nancial institution is client education or client literacy. Client education, in at least a very ba-sic form, is necessary to make client transpar-ency and customer care meaningful.

That said, there are definitely reasons that any single MFI is going to underinvest in the amount and type of client education that’s desirable from a societal perspective.

Q: What are some of the reasons we’ll see un-derinvestment?

A: For instance, when it’s against their own business interest: For example, why should I educate my clients that the MFI down the road has a better product? And why should I demon-strate to clients that more debt may not be such a good thing, as long as they are able to manage the debt [payments]? Underinvestment in broad consumer education is also likely. Should we ex-pect MFIs to do education in financial literacy for people who are not their clients? Society has an interest in a broader pool of consumers being financially literate than any single finan-cial institution would have reason to educate.

Q: So simply as a public good we’d expect to see underinvestment in financial literacy educa-tion.

A: The public goods aspect of consumer educa-tion is one important policy issue in India. What do we expect financial institutions to be doing in terms of basic financial literacy when there is clearly a broader public interest that goes be-yond their narrow self-interest?

Q: In markets where there’s innovation with more complex products to reach unserved cus-tomer segments – say, in India with insurance to reach the poor – we’re seeing low product take-up. Some of this may be due to low financial literacy. In this case, would it be in the MFI’s interest to do financial literacy education?

A: Absolutely. There are cases where, if you’re

Experience for Asiya BewaAsiya of Maheshpur in Murshidabad is a widow who got assets (saris) under the THP program to start a small sari business. Asiya used to live a pitiful life with no food security and borrowed money from local moneylenders to meet daily expenses. When asked about her feeling on get-ting the first set of saris, she replied “I was very happy. I hoped I could buy some more saris for sale.” She successfully sold the first set of saris given by Bandhan and reaped enough money to finance the purchase of the second set of saris after meeting consumption and other household expenditures. Asiya feels that her dependence on local moneylenders has diminished and even hopes to repay her debts in near future. Bandhan has made her self-confident and now she says

“I don’t have any home, any room to live in. I want to build these.”

trying to reach a new customer segment, you need to make clear to clients what the value proposition might be. At the same time, a public education campaign focused on ‘What is insur-ance, and what does it do for you?’ would help all financial institutions in the market wanting to provide insurance. So you can see what the state’s role could be in an immature market.

Any one of these objectives – client transpar-ency, customer care, client education — can be achieved through regulation or self-regulation or a combination of the two. Self-regulation can in-volve coordination among financial institutions. It can also occur at the level of an individual MFI that chooses to observe certain standards.

Q: Now, can you tell us about consumer protec-tion?

A: Thinking of the concept of consumer protec-tion, we’re stepping above the whole market and asking, ‘how do we achieve that reason-able protection of consumers while not choking off access?’

This requires looking, from a public policy per-spective, at three different broad sets of mea-sures: regulation, self-regulation, and con-sumer education. These are the three pillars.

Regulation includes but is not limited to pruden-tial regulation. Probably the worst thing that can happen to microfinance clients is that they lose a large chunk of savings that’s put in an institu-tion that’s unregulated or poorly regulated. Oth-er bad things that can happen to microfinance clients is when clients become overindebted or if they think they have insurance and they don’t. One of the issues for both self-regulation and regulation is what kind of consumer protec-tion problems should we focus on. In an imma-ture market, it’s harder to make those choices. It’s useful to ask ‘what are the big problems that are not so common?’ versus ‘what are the small prob-lems that are really much more common?’ For example, we probably see price-gouging all across the market. On the other hand, the consequences probably aren’t so dire for any single consumer.

Self-regulation may cover a lot of the same ar-eas as regulation, particularly market conduct, but also often gets down to more specific cus-tomer care standards and client transparency measures. For instance, in Uganda, the national association — the analog of Sa-Dhan – is build-ing agreement among its members that in the fairly near future they will agree on a common

Many groups made financial contribu-• tions to their community – but only after some time.

Many of the groups we interviewed had made significant financial contributions to their communities, often in the form of cash donations to schools or for festivals. How-ever, in nearly all cases these contributions were made after the SHG had been in exis-tence for at least three years. If one takes a financial contribution to the community as a sign of the empowerment of the members, this suggests that these empowerment gains take some time to accrue. This result also implies that a strategy which focuses effort on creating high quality SHGs which last for several years may have greater benefits to the community at large than one which fo-cuses on creating many bank-linked SHGs without regard to longevity.

There was a high level of equity in • loan allocation.

In interviews and focus group discussions, all of the groups surveyed reported that all group members have equal access to loan money. Analysis of loan usage data showed little variance in loan amounts across mem-bers confirming these claims. Furthermore, econometric analysis of loan and survey data revealed no correlation between mem-bers’ personal and socio-economic charac-teristics and the loan amounts they received. These results are certainly encouraging from the perspective of fairness and group cohe-sion. However, practitioners should also be aware that there is a potential negative con-sequence of equity loan allocation. Dividing loans up equally may make it hard for mem-bers to take out big loans if amounts are automatically ‘capped’ to avoid too unequal distributions.

Members continue to use alternative • savings and credit options.

In interviews and focus group discussions, SHG members in both districts expressed that they still utilize other savings and credit options. Several SHG members and their re-spective families utilized outside sources like banks, moneylenders and, less frequently, family and friends when they needed addi-tional credit. Some members also mentioned the use of alternative saving mechanisms. Savings options included chit funds, banks and purchases of gold and livestock.

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format for disclosing their pricing.

They’re building what they call the “House of Transparency.” Not only have they agreed to a code of conduct and to principles, they also have a process and a campaign that definitely includes education of clients (and MFI staff!), and they are working toward figuring out price transparency later in the campaign.

Q: So operationalizing the principles is taking a lot of time.

A: That’s universally the challenge. Whether we look at an industry code of conduct done at a national level, or we look at an international net-work like ACCION or Opportunity International trying to get its members to agree on a code of conduct that would function worldwide, it’s not so hard to agree on the principles and the broad areas. The hard part is to figure out how to operationalize it, particularly how to get it into policies and procedures at the MFI level.

Q: If codes of conduct are difficult to opera-tionalize, and some aspects – such as not tak-ing staff from other MFIs– might not be in the self-interest of any individual MFI, are volun-tary codes of conduct enough in the absence of sanctions or enforcement mechanisms?

A: Sanctions are a key issue. You can have vol-untary codes where the sanctions are managed by the members of whoever is subscribing to that code. In the case of Opportunity Interna-tional, if one of its affiliates if not toeing the line, the board can take action. In the case of ACCION, it’s a voluntary network but they could disaffiliate a partner.

Similarly, sanctions are one of the key issues at the national level. It’s great for Sa-Dhan to have a code, but the question they must ask them-selves is ‘how are we going to sanction mem-

bers that don’t toe the line?’

In the UK, there is a lot of self regulation. The

content of it and the rules and process to be followed, tends to follow the regulatory norms pretty closely. You have policy guidance that an industry group uses to regulate its members with the threat always on the horizon — if the group doesn’t do a very good job of that, the regulator might step in.

Q: Has this worked?

A: It’s worked reasonably well. In the UK, there are different self-regulatory bodies for different types of financial institutions. To some extent you may have lower standards among institu-6

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[Thinking of the concept of consumer protection] requires looking, from a public policy perspective, at three different broad sets of measures: regulation, self-regulation, and consumer education.

tions like pawnshops, but there’s a fair amount of protection and consistency.

Though the content of the codes is not that different across financial institutions, the banks do a better job with their sanctions than some of the other trade associations. The main sanction that’s effective in the UK is simply ‘naming and shaming.’ A financial institution will go to great lengths to avoid having its name published in the papers as being out of compliance with the voluntary standards. You can imagine in some coun-tries this would work better than in others.

The big issues with codes of conduct are: who’s writing them; what’s their self inter-est; how far can they go; how hard is it to translate them operationally into policies and procedures, and are there effective sanctions to encourage high levels of com-pliance.

Q: In the UK example it seems that the insti-tutions were using this only as a strategic approach to avoid unwelcome regulation.

A: But I think that’s almost always true. There are basically three incentives for financial institutions to do self-regulation: first is to fend off real regulation. You’re probably going to have more flexibility, and if you can manage yourself through self-regulation without a lot of prob-lems arising, then you may be able to stave off regulation.

A second is reputation risk: the good guys don’t want to be tarred with the shady be-havior of the bad guys. This is where the concept of a “quality seal” is useful.

And a third is — and this is particularly im-portant for MFIs — that you don’t want to threaten your funding sources. Donors and investors might have ethical, transparency, or consumer protection standards that they expect to see among their investees. It might become the price of doing business with those donors and investors.

Q: How does this growing consensus on the benefits and contents of consumer codes of conduct relate to the broader discussions of social performance?

A: We need to make client transparency and consumer protection more prominent in the social performance work we are doing. So-cial performance toolkits tend to have two kinds of approaches. One is monitoring the processes. In this approach, we would look for what process indicators we would find in financial institutions that protected their cli-

ents and treated them in an ethical way. For ex-ample, is there a code of conduct, a complaints procedure, staff training, internal controls that deal with potential for corruption of individual staff or client abuse, and so on?

And the second broad approach is using actual impact proxies — an area that’s more difficult to develop. We need to understand better the ex-tent to which microfinance might have negative consequences for borrowers, and our impact indicators need to take into account the pos-sibility of certain types of abuse that we think might be problematic or common in our industry. On the demand side, for example, understanding whether clients really understand the terms and conditions of their financing is important. This is an area that CMF has looked at.

Q: What are some of the other gaps in knowl-edge?

A: We have a long way to go – including in markets like the US and the UK – in having meaningful disclosure that really works. One of the areas needing more attention is the as-sumption of economic rationality that underlies the basic approach to designing products and

disclosing their features. We all need to take on board what we’re learning from behavioral psychology, work that the CMF is out in front on, in terms of what really motivates people. This would shape the most effective ways to do disclosure, for example.

Q: What is some of CGAP’s work on the issues we’ve discussed?

A: The interest rate issue — interest rate caps, disclosure, client understanding of rates and fi-nancing — is clearly a hot one. We’re looking at what kind of research will help shed light on these issues, and what alternate approaches to this issue might be appropriate in different types of markets.

We’ve been doing quite a lot of work on branch-less banking and this area will continue to be important to us. These are technologies and new business processes that are supposed to make it possible for large numbers of people to enter the formal financial system for the first-time. This definitely raises consumer protection and client education issues.

Q: Certainly issues of information asymmetry with first-time borrowers.

A: And managing a business model where you might have tens of thousands of agents — not banks — who are at the front line of delivering financial services. In India the regulators have taken quite a conservative regulatory approach, where under the business correspondent model only NGOs can be agents of banks. In other countries, all kinds of businesses can be agents of banks: lottery outlets, retailers, and so on. There are quite a few issues around the agency relationship of branchless banking that we need to probe.

I think it’s important to note that the new tech-nologies could be a real boost to consumer edu-cation, by making sure that clients really have the information they need at their fingertips to make good choices.

There are data security and privacy issues with branchless banking that are also different than those you’d have with more traditional bank-ing, and that’s an area we’re definitely going to work on. These issues are very much on regu-lators’ minds in countries that are considering branchless banking.

The Social Performance Task Force in CGAP will shift its focus from mainly practitioners to working more with investors. As part of that process, we want to see if investors see it in their interest to create stronger incentives for ethical treatment of clients, or consumer pro-tection measures. It could be a part of the self regulatory structure to have investors that are encouraging this as well. And we want to see these principles, specific processes, and proce-dures brought into the social performance man-agement toolkit.

We’re also thinking about ways to support the national networks. National networks like Sa-Dhan are particularly important players here, be-cause some of these issues are best addressed by a group of like-minded institutions working in one market. If you think of an international net-work, the problem is that international network may just have one partner in any single market. It’s hard to enforce higher standards, because this may put the local partner at a disadvantage unless prospective clients choose the partner MFI based on the international network’s brand and perceived quality. But that’s a pretty dicey proposition, at least for now. National net-works offer a lot of potential, whether you take Uganda or India, for practitioners who have a collective interest in distinguishing themselves from the shady operators to come together, and represent enough of the market to have some influence and really encourage incremental im-provements in behavior.

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One of the areas needing more attention is the assumption of economic rationality that underlies the basic approach to designing products and disclosing their features. We all need to take on board what we’re learning from behavioral psychology....

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