Column

Mukul G Asher
Professor of Public Policy, National University of Singapore

Savita Shankar
Research scholar, LKY School of Public Policy, Singapore

The institutions, so far restricted to rural areas, need to reach out to the urban poor

As India seeks to widen and deepen the microfinance sector, it is essential that needs of microfinance services for the urban areas are addressed.

According to a recent report by the United Nations Population Fund on ‘State of World Population, 2007’, India is urbanising at a rate higher than the world average.

The share of urban population in India is likely to increase from 28% currently to 41% by the year 2030. This translates into 600 million persons living in urban areas in 2030.

The size of the urban population will be significantly larger if the peri-urban areas (peripheral areas around currently-defined urban areas) are included.

The government has announced that peri-urban areas, which typically emerge due to rapid, unplanned settlement just outside city boundaries, are likely to be included in the revised definition of urban areas.

An increasing proportion of Indians will thus be urban, and their needs deserve much greater recognition in official planning and policies.

This has a bearing on the microfinance sector as a significant proportion of urban Indians will be poor and in need of microfinance services. This presents both a challenge and an opportunity for the sector.

Traditionally, the focus of microfinance has been on the rural rather than urban poor. A study by Bangalore-based Paradigm group suggests that while the number of bank branches in urban areas is greater than in rural areas, the informal sources of credit still account for 94% of the total credit accessed by the urban poor.

The primary reason for this overwhelming dependence on informal sources is the ease of access.

SEWA Bank, one of the pioneering microfinance institutions (MFIs), has been successfully operating in urban areas, but it remains more the exception rather than the rule.

There are, however, indications of emerging interest among MFIs to extend their reach to urban areas. At least four new and one existing urban MFIs are negotiating with equity investors, suggesting that newer sources are being actively explored.

It also appears that some of the non-banking financial companies (NBFCs) are downscaling to cater to microfinance customers.

In addition to the usual risks of microfinance, two additional risks of urban microfinance are a low level of trust among clients and high mobility.

MFIs will need to address the following factors to operate successfully in the urban microfinance market:

MFIs will need to reduce their disproportionate reliance on group lending.

While some of them have been able to successfully navigate group lending models in urban areas, this business model is unlikely to be sustainable over a longer period and on a larger scale.

They will need to offer individual-based lending (and eventually saving) options for sustainability, and for realisation of scale and scope economies. This is because, urban customers expect better service, have higher opportunity cost of time, and may experience lack of trust in group lending situations due to greater anonymity and mobility.

MFIs will therefore need to develop credit appraisal skills and more modern management information systems.

MFIs will need to choose their clients carefully to identify segments of the urban poor, which are relatively stable with regard to their residence. This calls for thorough ground work prior to offering loans.

Different lending models may need to be developed in order to cater to the migrant population. Aajeevika, an Udaipur based non government organization is working on designing just such a model.

MFIs will need to accept the fact that the urban poor are not always self-employed. The higher investment required and easier availability of employment sometimes make self-employment a less lucrative option.

The urban poor are likely to demand loans for consumption smoothing, emergencies and education, rather than for setting up micro enterprises. The loan sizes may be expected to be higher. Remittance products and loans for home improvement are likely to be in high demand.

The economics of the microfinance activity in urban areas may be different than in rural areas. While the MFI office rentals and the wage levels of MFI staff are bound to be higher, the cost of field worker travel may be lower and travel time less as clients are typically clustered together in a slum.

A larger outreach can be established within a smaller geographical area and in a shorter duration of time. Availability of superior infrastructure facilities would make access to clients easier and quicker. Due to the higher fixed costs such as office rentals, MFIs in urban areas need to quickly secure economies of scale and scope.

Innovative ways of reducing real estate and fixed costs would need to be examined. The use of well-equipped vans as mobile branches may be explored.

The higher rates of economic crime in urban areas may also necessitate more precautions as MFIs tend to have mostly cash transactions. This aspect underlines the need to explore innovative technology such as smart cards and other alternatives to a cash-based system.

There is considerable business potential in providing microfinance services to urban Indians, but as this discussion suggests, this will require professionalism and financial and technical innovations. The government’s main role should be the provision of a sound policy and regulatory framework.