FINO Shows a Low-cost Way Out of India's Microfinance Mess: India Knowledge@Wharton

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FINO Shows a Low-cost Way Out of India's Microfinance Mess

Published : November 18, 2010 in India Knowledge@Wharton

The small scale of microfinance has long presented a challenge to the

industry. Loans are seldom more than US$1,000; clients are widely
dispersed, most of them in difficult-to-access rural areas, and the paperwork
and procedures associated with a lending transaction can be a bureaucratic
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nightmare. All of those factors contribute to the high interest rates for Knowledge@Wharton. For multiple copies,
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SKS Microfinance. He says the 28.3% rate that SKS charged until recently x407.
(its rate is now 24%) comprised the cost of funds (8.5%); salary and
incentives for staff (6.4%); overhead and administrative costs (4%); loan-loss provisioning (1.5%); a
corporate tax (2.8%) and profits (5.1%).
SKS leadership is trying to combat the problem by taking the company public, increasing volumes and
using economies of scale to push down rates. Other companies also are trying to tackle concerns related
to the final stage of the lending process, where distribution, collection and servicing expenses form a big
share of overall costs because of the small ticket size of the loans and transactions.
Financial Inclusion Network and Operations (FINO), a provider of an electronic technology services is
one such organization. FINO operates through a network of some 10,000 bandhus (bandhu means friend
in Hindi), who serve, in a sense, as human ATMs in areas that often have no electronic teller machines.
Each bandhu is equipped with a small, handheld biometric device that they take into the field and use to
transact with clients, who access banking services through smart cards. Balance transfers, deposits and
withdrawals can all be done through the smart card system.
"FINO is a technology partner -- the interface between the bank and the account holder," says Jatinder
Handoo, the firm's manager of business strategy. "It is a financial inclusion enabler. It works as business
correspondent with prudentially-regulated banks and insurance companies and takes their financial
products and services to the end customer. FINO is just an extended arm -- a channel -- of banks." FINO's
mainstay is government business. It has a big chunk of the pension payments market (including the
government-run Social Security Pension system). Two other big-ticket areas are the Rashtriya Swasthya
Bima Yojana program (the government's health insurance initiative) and payments under the NREGA
(National Rural Employment Guarantee Act). The company's aim is to provide a fast, secure and
relatively corruption-free system of distributing money down the last mile.
Much of the criticism aimed at India's microfinance industry is focused on the high interest rates and
accusations of coercion on the part of loan recovery agents, which has allegedly led to more than a 100
suicides of rural loan recipients. When juxtaposed with the fortunes made by many microfinance
investors, those issues have created a backlash that experts say threatens the very survival of the
industry."Hara-kiri," read a cover story of Business India magazine. "Has the Indian microfinance
industry committed suicide?"
FINO is not principally a microfinance institution (MFI), although it has a US$1.5 million microfinance
loan portfolio spread across 8,500 borrowers. FINO CEO Manish Khera says his lending program was
created to demonstrate that there was another way to do business. FINO's lending operations use the
organization's existing infrastructure that was created for distributing government funds, which means
much of the expenditures on logistics and administration are already taken care of. Lending only accounts
for between 1% and 2% of FINO's business, but FINO had set targets of US$4.5 million for 2010 and a
10-fold jump to US$45 million in 2011. But now, the controversy surrounding India's microfinance
industry may hamper its expansion. "We have to see how the situation develops," says Khera.

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Different Roots
A roadblock to FINO's growth may hamper the microfinance industry as a whole because the company
was demonstrating how interest rates could be reduced. FINO is part of the MFI ecosystem, but while
most microfinance firms started as non-governmental organizations (NGOs) with a non-profit culture,
FINO's roots are more embedded in the establishment. It was incubated by ICICI Bank. "FINO was an
effort to open up a market segment that was not being seen by others as addressable," notes ICICI Bank
chairman K.V. Kamath.
FINO was originally set up by the ICICI Group to create a platform to facilitate "technology-enabled
financial inclusion," according to Rajiv Sabharwal, ICICI Bank executive director. "Our vision was that
this should be a shared platform working not just with the ICICI Group, but with a wide range of banks
and other financial sector participants. In line with this vision, various other entities have taken ownership
stakes in FINO." The company has an impressive line-up of investors today, including ICICI Bank (19%),
Intel Capital and IFC (15% each), Life Insurance Corporation (8%) and a clutch of Indian public sector
banks (22% together). Recently, Avendus Capital bought a stake for one of its clients.
"Enabling financial inclusion and bringing the rural population onto the mainstream financial channels
have significant long-term benefits which we hope the FINO platform will help realize," says Amit Behl,
director of Intel Capital India, who is on the board of several companies that Intel Corporation's global
investment organization has invested in. "Intel Capital has been an investor in FINO since 2007 and, as a
strategic investor, we hope our investment will enable a new technology and operations platform which
lowers the cost of banking transactions and helps banks reach and service the large hitherto unbanked
customer segment."
Khera, who has been with FINO from the beginning -- first as an employee of ICICI Bank -- has set for
his company an ambitious target of 25 million customers by July 2011. That would culminate the first
five-year plan for the company, which was set up in July 2006. The second five-year plan proposes taking
this figure to 100 million. "We are well on our way," notes Khera. Achieving these goals requires a very
fast pace of growth and the numbers in the FINO network are constantly changing. On September 11,
there were 21 million customers, 22 banks, 10 MFIs, 4 insurance companies and 12 government entities
covering 22 states, 266 districts and 5,884 gram panchayats (village councils). FINO's turnover was
US$22.5 million in 2009-10 and it has set for itself a target of US$52 million in 2010-11 -- a 130%
growth rate.
To get so many diverse elements on board, FINO needs to be institution-agnostic; it will do business with
everybody. "We work for several banks gathering customers for them in the same area," notes Khera.
"There is room for all. The question of competition hasn't arisen." With industry estimates at around 500
million potential customers, there's a long way to go for market saturation.
The Government Business
The government business is FINO's bread and butter, but there are other opportunities on the horizon.
Unlike MFIs that have been largely focusing on women in rural areas and enterprises involving one
product (micro-credit or small loans), FINO has an entire bouquet. For instance, it has Mitra (mobile
banking), Sure (insurance), Parichay (identification services), Sayana Ravi (financial advice), Tatkaal
(remittances) and several others. FINO delivers these services to the customers of its client banks and
insurance companies. According to Rajesh Chakrabarti, professor of finance at the Hyderabad-based
Indian School of Business, such a breadth of options is necessary. "Microfinance is extremely important
not just in the form of micro-credit, but as an avenue for creating micro-savings and micro-insurance,
arguably the most important element in the financial lives of the poor," he says. "Some companies have
been doing this with great results."
The diversity of services is what gives an added string to the FINO bow going forward, experts say. At
ICICI, Kamath and his successor, Chanda Kochhar, feel FINO also is useful in cross-selling financial
products. Their reasoning was that the cost of customer acquisition is much less if the person already has
an existing relationship with that company; for example, a mortgage holder would prefer an automobile
loan from the same source, other things being equal. That holds just as true for a NREGA payee in a
village who is now expecting monthly remittances from his son in the city, they maintain.

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Initially, FINO was envisaged as a pure technology company. Business correspondents (BCs) were to be
hired by MFIs and banks and FINO and others of its ilk were to provide the backbone. "It didn't quite
work out that way," says Khera. "The banks were reluctant to take the plunge. Eventually we had to set up
shop ourselves as BCs."
BCs came into existence after the Reserve Bank of India (RBI) issued guidelines for them in January
2006. "BCs are retail agents engaged by banks for providing banking services at locations other than [at]
a bank branch [or] ATM," the RBI states. "Basically, BCs enable a bank to expand its outreach and offer a
limited range of banking services at low cost, as setting up a brick-and-mortar branch may not be viable
in all cases. BCs, thus, are an integral part of a business strategy for achieving greater financial
inclusion." The model has been tweaked several times since then. In August this year, RBI issued another
discussion paper on BCs.
FINO's agents, or bandhus, function like BCs, although they are technically different. Marry
Paripoornam, a 38-year-old mother of three, is a bandhu but operates mainly as the other end of the
channel -- the source rather than the sink. Her husband is a driver, earning US$150 a month. She's a
teacher at a local NGO school in the heart of Dharavi, a deprived area of Mumbai. "Being a FINO bandhu
has not only given me around US$80 a month extra, it has also given me status as a banker," says
Paripoornam.
Bandhus in Action
Paripoornam's "office" could be anywhere. In the villages, she provides doorstep banking. In a big city
like Mumbai, she has a fixed place, in this case Dharavi itself. One customer -- Shyamkesh, a taxi driver
in Mumbai -- comes to her to send money home. A migrant from Uttar Pradesh, Shyamkesh's family
depends on him for remittances. He sends home around US$40 a couple of times a month. He previously
used money orders, but they took a few days to arrive and the village postman would wheedle the family
for his cut. "I tried sending the money with my friends who were visiting home," says Shyamkesh. "But
that would be a larger sum and they would get tempted to 'borrow' part of it." Anil Jain is a college
student in Mumbai who also works part-time at Nestle. His FINO account provides some financial
privacy; his original bank account has his parents as joint holders. Besides, he uses FINO to send
remittances of behalf of his friends. "I don't have to wait in a queue as at other banks," he says.
FINO's network of 10,000 bandhus puts it ahead of its competition. Companies in the sector include
Invest India Micro Pension Services, Integra Micro Systems, Atom Technologies, A Little World (which
has the largest number of affiliated banks) and Tata Consultancy Services, which has started a pilot
project. Just as the bandhus are often considered BCs, so too are the FINOs and the Little Worlds.
Technically, they are not. When RBI gave BCs the go-ahead, it allowed only certain types of
organizations, in which for-profit entities like FINO were not included, to act as BCs. So FINO set up a
not-for-profit arm, FINO Fintech Foundation. A Little World is associated with the Zero Mass
Foundation, which "creates the last mile operations network in villages, under pre-defined service
agreements with banks." The shareholders of FINO Fintech Foundation are employees of FINO. Their
shareholding will automatically pass to other employees in case they resign from the company or retire.
"We wanted FINO to own the company," says Khera. "This was the best way to do it."
Couldn't FINO convert to a non-profit? It would have needed a sea change, company leaders note. Almost
all the existing shareholders would have to move out. Besides, there were other imperatives. Explains
Behl of Intel Capital: "FINO is a technology platform provider which counts banks and government
schemes among its major customers. FINO works on behalf of leading Indian banks to extend their reach
to the rural population. Profitability of banks is essential to avoid any incidence of systemic risk, and the
FINO platform is intended to help reduce customer acquisition and customer service costs for banks,
enabling them to profitably extend banking services to the unbanked customer segment."
Below the 20% Interest Rate
Although FINO is going slow on its lending operations, Khera maintains that he can lower its interest rate
below 20%. The company borrows from the banks at the same rate as other MFIs, "but our cost of
operations is 4-6%," he says. Handoo explains that, first; lending operations would use the same bandhu
network, which means shared costs. Second, the average monthly payout for a bandhu is only around

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network, which means shared costs. Second, the average monthly payout for a bandhu is only around
US$35, though it could be higher in some cases. Some 95% of FINO's bandhus are in rural areas, whose
monthly compensation is less than that of urban bandhus. Third, the use of technology reduces the
paperwork associated with micro-banking and micro-insurance operations. "This saves time for bandhus,"
Handoo notes. "They can focus on acquiring new customers and selling multiple products, which
increases profitability and ultimately reduces costs."
High-cost lending will not be sustainable in the future "as technology intervention will enable the poor to
access credit easily," according to Vatti Vasant Kumar, Andhra Pradesh rural development minister. He
recently introduced an ordinance that seeks to rein in the microfinance industry in Andhra Pradesh in the
wake of suicides by several borrowers. Microfinance firms are not happy with the ordinance, and say it
has introduced so much cumbersome red-tape that fresh loans and repayments to MFIs have stopped.
They say the resulting cash flow problems have sent many microfinance companies scurrying to financers
for loans. Kumar defends his ordinance. "The endeavor should be to promote low-cost delivery systems
and ensure last-mile connectivity," he says. Adds Khera: "We [at FINO] have been very successful in
areas like costs, which really matter."
FINO is trying several new initiatives. For instance, the company has opened bank accounts for dairy
farmers who supply milk to the National Dairy Development Board in Gujarat. Along with a savings bank
account the farmers get bank loans and cattle insurance, all combined in a single product.
Not everybody is totally enthusiastic about the potential of FINO's bandhu network, however. "I am not
bullish on the BC model," says M.S. Sriram, until recently ICICI Bank Chair Professor of Microfinance
at the Indian Institute of Management in Ahmedabad. "It adds one more layer of intermediation, but four
more layers of costs: commission to the BC; cost of technology -- smart cards, point-of-sales terminals;
cost of regulation; and the cost of the carrier -- mobile or VSAT (satellite ground station). I am not sure
that there are enough margins to justify the costs. I suppose the BC model will work when the technology
is fully ported to the mobile-cashless platform."
Khera doesn't agree. He gives some numbers: A transaction costs US$1 at a bank, 40 cents at an ATM
and 10 cents at a BC. "This is not an additional layer," he says. "This is an alternative channel. If you are
comparing costs, you have to compare the costs of the channel."

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