Mainstreaming Microfinance:

Bridging the NGO-Banker Divide

Bibhudutt Padhi
NBARD
bibhupadhi@hotmail.com

Abstract

While NGOs as microfinance institutions have had some success in facilitation and
social intermediation, there is little evidence of the fact that they have had much
success in poverty reduction. In this article, the author recommends the development
of a symbiotic relationship between NGOs and banks, with the former efficiently
utilising their strengths in social engineering and the latter focusing on pure financial
intermediation. Such a strategic partnership, the author feels, will help achieve the
otherwise elusive targets of outreach to the poor and financial sustainability.

The role of non-governmental organisations (NGOs) in microfinance (mF)

needs reviewing from an operational perspective. Based on research of
selective studies and experts’ opinion, selected literature on microfinance, and
the author’s own experience over the last decade, this paper seeks to
establish two main points. First, it asserts that with a few notable exceptions,
the record of NGOs in mainstreaming microfinance is a modest one viewed
from the context of NGOs as microfinance institutions (mFIs). When judged by
the two criteria of success that much of the microfinance world has adopted –
outreach to the poor and financial sustainability – the results are not
encouraging [Nair 2001]. NGOs as mFIs have thus far had trouble achieving
both objectives simultaneously. There is also little evidence of any aggregate
impact on poverty reduction as the result of mFIs’ forays. The success of
NGOs has however been laudable where facilitating and social intermediation
criteria are applied. It is here that the author feels that the strategic partnership
between banks and NGOs is poised to change the developmental intervention
map of India. Second, the essay suggests that banks, for all their laudable
work, will be making a strategic error in focusing on financial intermediation
while ignoring partnership with NGOs. While microfinance is never easy for
other types of institutions trying to practise it (e g, NGOs or credit unions), it is
not, as will be explained, a field where a banker has natural advantages.

Why Partnership?
To the extent that banks incorporate NGOs’ activities in mainstreaming their
self-help group (SHG) portfolios, they stand to gain. To the extent NGOs
reorient their mission, vision and personnel towards the microfinance agenda,
as a large number have done in the last decade, they risk drawing themselves
away from work they are uniquely suited to do. Some of this work, moreover,
would play a critical role in preparing the ground for mF among poor people. In
other words, NGOs have to move away from pure financial intermediation to
investing in human and social capital at the grass roots and bankers have to
tap this invaluable experience of NGOs in mobilising, graduating and enabling
rural communities. This will prepare the ground by enhancing credit
absorption capacity of SHGs and enhancing their creditworthiness. The
following account will explain how.

In 1997, the World Bank’s Sustainable Banking for the Poor (SBP) project
completed an ambitious survey. Until then those interested in microfinance
had an intuitive sense of the movement’s growth, but no systematic attempt
had yet been made to gauge its dimensions, nor look comprehensively at its
results. The findings were unambiguous: NGOs acting as mFIs did not have
any significant outreach vis-?vis other financial institutions purveying
microcredit.

Interestingly, commercial banks accounted for 78 per cent of the total number
of outstanding microloans, and credit unions 11 per cent. NGOs accounted for
only 9 per cent, and savings banks (which are not primarily in the credit
business) just 2 per cent. Also, commercial banks accounted for 68 per cent of
the total outstanding loan balance, savings banks 15 per cent, credit unions
13 per cent and NGOs 4 per cent. In terms of numbers of clients, commercial
banks and credit unions showed significantly greater overall outreach than
NGOs. While NGOs’ outreach, on average, was deeper, it was also narrow –
NGOs reach some very poor people, but they do not reach many. On the
other hand, credit unions and commercial banks also serve some wealthier
clients so that their average outreach to the poor is not as deep. Still, the
indications are that overall, credit unions and commercial banks serve more
under-served poor clients than do NGOs.

This is not to rule out the role of NBFCs, NGOs with inchoate mFI activities or
pure mFIs. The demand for financial services is high and as stated by the
High Level Task Force on mF: “At least 25,000 bank branches, 4,000 NGOs
and 2,000 federations of SHGs involving over 1,00,000 personnel of these
institutions would have to be associated for scaling up and bank linkage of
one million SHGs. Many of these NGOs will transform themselves into mFIs
and will not only facilitate microfinancing, but will also themselves do the
necessary financial intermediation. Similarly, many federations of SHGs will
take on financial intermediation and act as mFIs.”
Indian Tale

We shift the focus to India.In the current context with over 4,60,000 SHGs
credit-linked with banks, the SHG-bank linkage programme of microfinance
has emerged as the biggest in the world. But besides banks, the major role
played by NGOs in facilitating this transformation cannot be overemphasised.
The National Bank for Agriculture and Rural Development (NABARD) which
plays a role in promoting and facilitating bank linkages while networking and
coordinating the activities of all players in the field has underscored the crucial
role played by NGOs as facilitators in purveying bank credit to SHGs. The
story of the three models of this massive programme has been brought out by
NABARD in the table.

Table: Three Patterns of SHG-Bank Linkage*

No of SHGs Per Cent Share

Model I: SHGs formed and financed by banks 142667 20

Model II: SHGs formed by NGOs and directly financed by

513005 72
banks.

Model III SHGs financed by banks through NGOs (onlending). 61688 8

Note:* Cumulative as on March 31, 2003.

Source: Progress of SHG-Bank Linkage in India: 2002-03, NABARD, 2003.

The writing is on the wall. The success story has been to a great extent
co-scripted by both banks and NGOs. However, it is pertinent to draw
attention here to the vast network of rural banking outlets that precludes the
necessity of a new breed of mFIs which as per experts’ opinion are ‘slow and
expensive to develop’ [Harper 2002]. In fact as aptly put by Harper “the SHG
system uses existing marketing channels, the banks, to bring formal financial
services to a new market segment, the poor and particularly women”.

Relationship Banking vs Parallel Banking

The distinct bloodline of mF in India can be traced to this genre that is

indigenously developed and called ‘Relationship Banking’ as opposed to the
Grameen model of ‘Parallel Banking’ [Chavan and Ramkumar 2002]. The
ground truth for SHG financing on a sustainable basis in India is that
bank-linkage is the bottom line with exceptions proving the rule. Inherent to
this success story but understated is the fact that NGOs have played a major
role in effecting SHG-bank linkages. Relationship banking is the result of
NGO-bank interface to leverage funds for SHGs. NGOs have achieved
significant success as promoters (helping and enabling SHGs to access bank
credit) and not as providers (direct purveyors of credit). This writer would
juxtapose the SBP study’s evidence against NGOs in mF with their success
as facilitators in India to make a case for NGOs as social scientists or change
agents rather than financial intermediaries. The latter role is arguably the
banker’s domain. Moreover, there are compelling institutional and regulatory
factors which counsel against any such misadventures.

First and foremost there are legal constraints to NGOs acting as mFIs as
noted by the Task Force: “Many NGO-mFIs are mobilising savings from their
clients/ borrowers with the sole objective of inculcating a habit of thrift and
savings among the poor and for enabling the use of such resources for
acquisition of assets or linkage with credit from mFIs or banks. In the context
of the amended Section 45 S of the RBI Act, the appropriateness of
NGO-mFIs in mobilising savings is questioned. Although NGO-mFIs provide
very useful financial services to the poor, including the opportunity to keep
their very small savings safe, almost at their own doorsteps, they cannot
convert themselves into other modes of constitution like NBFCs, banks or
cooperatives due to various intrinsic constraints. Hence, NGO-mFIs may have
to be given a special dispensation in regard to Section 45 S of the RBI Act.
Accordingly, it is recommended that they be allowed to mobilise savings only
from their poor clientele as part of the financial services provided to them and
the same may not be treated as violation of Section 45 S of the RBI Act.”

The ‘intrinsic constraints’ noted above are not difficult to guess. Moreover,
some NGOs that are mobilising savings purely may also face other risks. The
problem for NGOs in dealing with savings is that from a risk-bearing
standpoint, savings mobilisation and microcredit are not the same. That is why
the law treats them differently. From the client’s point of view, the risks of
saving with an NGO are masked by their growing confidence as NGOs show
that they are here to stay. But NGOs are not in most cases operating in
regulatory environments that permit them to mobilise deposits; they do not
benefit from deposit insurance nor can their operations be controlled by bank
supervision agencies. And when covariant risk is high, as it is when group
members are all from the same sector and necessarily from the same
community or locality, the tenuousness of the NGO position is even more
dangerous to the saver. Besides propriety and prudence, savings
custodianship necessitates statutory provisioning and creation of reserves to
cover liquidity and other risks.

Credit Minimalism

While ‘savings only’ is a limited disaster story, the other side of the tale relates
to NGOs who are employing ‘credit first’ or minimalist credit principles. When
savings form part of the basis for credit in a financial institution, that institution
does not have to take a problematic, often tortured, path to sustainability; it
starts out on a more naturally sustainable path. But, NGOs have gone into
microcredit with donor monies, and aim towards sustainability without, in most
cases, the enormous benefit of voluntary savings mobilisation. In short,
sustainability in NGO-run programmes is hobbled from the start. It looks as if
the poor want its product (credit) less than they want savings, and all by itself,
credit does little for productive asset creation.

The one-shot single dose attack on poverty is the sustainable development

planner’s biggest nightmare. A case in point is CARE’s Credit and Savings for
Household Enterprises (CASHE) project in India which is more of a lending
programme than a sustainable financial institution. Unfortunately the credit
and non-credit financial needs of the clientele community are expected to
outlive the six year shelf-life of one of the most ambitious projects in
micro-lending to hit Indian shores. The flawed-in-conception status is palpable
from the fact that the CASHE budget does not include an income generating
component for skill-building. The best intentions are to give a shove across
the poverty line without imparting financial sustainability to households or
providing for repeat finance.

The incompatibility between the tendency of NGOs to upscale (for sake of

grant continuance) and financial sustainability is aptly summed up by William
F Steel, World Bank consultant, according to whom, “Grant-based
methodologies are poorly suited for financial intermediation, especially
providing credit funds (for which recovery, not disbursement is most critical)”.
The other type of NGOs turned MFIs with both credit and savings services
have a limited success which as the SBP study has shown is nothing to write
home about in terms of outreach or sustainability. Many are facing teething
problems while a few have folded up.

These dysfunctional aspects are further highlighted by Kanta Singh (WISE

Development Authority) during a CARE-sponsored case study of its CASHE
programme: “Low size of loan and long cycle time for loan disbursement are
reported to be the largest irritants. Many groups that have successfully
managed loans in the past lose energy when they do not get subsequent
(credit) linkages.” Absence of training and handholding on income generating
programmes are felt to be a major gap in the CASHE design by SHGs. This
need is also felt by (partner) NGOs who are trying to increase loan demand
and the ability of SHGs to handle larger loans.

In India the demand of the poor for safe and liquid savings instruments is very
high. In fact, NGOs, with their sensitivity to the poor and intimacy with
individuals, overcome the trepidation that illiterate and destitute villagers
harbour about bank personnel (not known for their civility). The World Bank’s
Consultative Group to Assist the Poorest (CGAP), part of whose mandate is to
help microfinance institutions improve performance, has concluded “...most
microfinance clients want to save all the time, while most want to borrow only
some of the time.”

However, NGOs face a dilemma when savings overstrip credit demand, i e,

interest paid out drastically cuts the margin from interest income. Their limited
expertise and avenues for investing elsewhere compound this problem.
CARE/Guatemala’s Village Banking Programme fuelled by donor monies,
expanded lending outreach heavily in 1994. As a result outstanding loan
balance grew at an annual rate of 78 per cent between 1993 and 1995. By
contrast, voluntary savings mobilisation grew during the same period at an
annual increase of 215 per cent.

Trade-Off Tribulations

The record from the SBP cases (a score of which were NGOs) suggests that
as NGOs in microfinance, often encouraged by donors, come to accept the
two goals of sustainability (subject to tough measurements) and outreach,
(measured increasingly by loan size as a per cent of GNP per capita) the
following trade-offs and adjustments are observed:

(1) Concentrating portfolio growth in high population density areas (thus

focusing less on rural areas).
(2) Emphasising rapid initial loan volume growth, leading to poor portfolio
quality.
(3) Keeping field staff salaries low (or alternatively raising the number of
clients per loan officer) in order to control costs, thus tending to high turnover
and low morale.
(4) Moving towards the retail trade and service sectors with high cash flow that
enable high repayment rates, thus tending away from manufacturing and fixed
asset lending.
(5) Emphasising short-term loans as a strategy for high repayment and loan
size growth, thus eliminating cyclical sectors like agriculture.
(6) Tending to move up the poverty scale away from the very poorest in order
to maintain loan demand and repayment rates (75 per cent of the SBP NGO
cases showed this ‘upward creep’).

The writer does not subscribe to suggestions that NGOs suffer from ‘grant
mentality’ (SBP study) or that they may have been seduced by microfinance
[Dichter 1986]. But with trade-offs like these, short-term sustainability seems
to be the best bet. While competition is deemed a good thing in the private
sector, NGOs in microfinance (while they may adopt some private sector
values), are not private sector institutions. Their (and their donors’) premise
when they go into an area is that there is an unfulfilled need for credit. This is
different from Pepsi and Coke lowering prices and (presumably) offering more
value to the customer in order to stimulate demand and deal with competition.
NGOs are not in microfinance to make money, but to alleviate poverty. By
concentrating on high volume areas in order to increase cost coverage, their
outreach to less dense, but just as needy, areas is curtailed.

Even then the problem of long-term profitability remains, as this comment on

Society for Helping Awakening Rural Poor through Education’s (SHARE)
activities underscores: “ The star performers among Indian mFIs like SHARE
have made sure that sophisticated management information and monitoring
systems are firmly established in the organisation to follow up on repayment
and check malpractices. The most relevant question here is, all other design
features remaining the same, if a successful mFI relaxes the intensity of grass
roots level supervisory measures, including its paid staff, and entrusts the task
of recovery and disbursal to group members, will its repayment performance
be the same?” [Nair 2001]. Clearly, balancing sustainability with outreach is
problematic, and may be more so for NGOs than for other types of institutions.

Having made a case for limiting the foray of the inexperienced into banking
one seeks here to emphasise the greater role of social intermediation
expected of NGOs in mainstreaming mF in India. We hope the following
section makes out a sound statement for dispelling NGO-phobia among
practising bankers (where it exists) and equally inspires motivated individuals
in the voluntary sector.

Competitive Advantage of NGOs

NGOs have a crucial role in group formation, nurturing SHGs in the

pre-microenterprise stage, capacity building and enhancing credit absorption
capacities. Group-based forms of lending (e g, solidarity groups, village
banking) originated mainly for the benefit of the lender as solutions to two
problems faced by microcredit organisations: (i) the problem of lack of
collateral, and (ii) the problem of high transaction costs involved in loan
appraisal, monitoring and enforcement. In theory, the group serves as a set of
co-guarantors operating through peer pressure and the group members’
incentive to keep each other solvent so that they themselves do not lose the
opportunity to receive a loan. The group serves also as a way to get around
imperfect information, since members of the group know each other. Thus the
transaction costs involved in loan appraisal are reduced if not eliminated.

It is here that NGOs play the crucial role in transforming the atypical destitute
village woman with two children to fend for into a responsible individual with
group commitments and group resources. This is a fact repeated in village
after village. Whether NGOs empower women in thrift and credit groups is a
moot question but it is an empirical fact that such groups provide effective
‘coping mechanisms’. Peer pressure is the best collateral. The banker in India
needs to recognise that high repayment rates of SHGs is not an inherent
structural feature of SHGs but a commitment to group values. The role of
NGOs in investing groups with values through human capital is an undeniable
specialisation. In the words of economist Jagdish Bhagwati: “Those values (of
civil society and of democracy) are better advanced...by the political and
financial support of the numerous and growing NGOs, both here and abroad,
that work ceaselessly to nudge the world in the right direction.”

The term social intermediation is meant to suggest that there is another kind
of intermediation (other than financial) that institutions can engage in which
also supports microfinance. Social intermediation implicitly acknowledges that
many poor clients of microfinance are simply not in a position to use loans
productively. Social intermediation refers to a range of activities that prepares
people to become good borrowers and savers, better manage their own
finances or their own financial groups and help them to put whatever ‘social
capital’ they have to more productive use.

Because social intermediation activities imply interacting closely with people

at the grass roots, these activities are a good fit with the classic characteristics
of NGOs. The trade-off, of course, is that such interventions are not likely to
be financially self-sustainable. They need instead to be seen as human capital
investments.

The banker must accept that this is a role which the NGO, as a committed
social engineer, is better suited to execute. This is not to deny qualities of
empathy, humanism, social engineering to bankers. But the stark truth is that
there is a need for a sensible division of labour. If bankers want to reach the
poorest with financial services, they need to face certain realities. First, what
they are doing is poverty lending and not economic development or enterprise
development. Second, they should realise what the likely impacts may be.
Changes in people’s lives will be immediate in terms of lightening the burdens
of poverty, but small loans to the poorest will not bring them permanently out
of poverty.

Social engineering is a full-time activity which has no substitute for the limited
community contacts that a committed banker might indulge in. Moreover, the
calling of retail banking has its own demands while credit plus initiatives are
the forte of NGOs. Similarly, the NGO’s salvation lies in channelising formal
credit to his clientele through innovations so as to meet the overall needs of
socio-economic empowerment. The banker’s goal is to secure loans through
credit plus interventions which improve creditworthiness of SHGs. But
certainly NGOs are positioned at the community level to educate and prepare
local institutions and people to be able to make more effective use of the
opportunities and better use of finance.
The business of a rural branch can move from sustainability to high profits
when SHGs make the important shift from pre-microenterprise stage to
microenterprise stage but a lot of social and technical inputs from outside the
quintessential rural SHG are required for this.

Small businesses (and dynamic micro-enterprises) need to develop skills.

NGOs can assist by creating institutions to train and teach, or work with
existing institutions to make what they teach more relevant to the clients.
Small businesses (and dynamic micro-enterprises) need to develop the
capacity to become and remain competitive. NGOs with good community
organising skills can work to get businesses to pool resources within a
sub-sector to develop new products, new product designs, or new techniques
for production that maximise local resources. Policy level constraints at the
sub-sector level can be identified by NGOs who know the local market terrain,
and NGOs can bring these issues to the policy-making table.

Arguably, banking is more of a system than an art. Unarguably, working to

facilitate the productivity of small businesses is really an art. And again,
because of their grass roots orientation, because of their commitment,
because they are less bureaucratic and encumbered than large development
assistance organisations, NGOs are capable of overcoming a subtle but
important barrier to successful facilitation – the ‘packaging of knowledge and
skills’.

Once again, this is no case for discouraging NGOs from mF but to emphasise
the role of emotional capital which will bring in an element of quality. The more
NGOs, who are in microfinance, face the challenge of helping to bring about
an increased articulation of the parts and the players in a local economy, the
more they may need to get involved in such non-financial services. The
effects of such services are difficult to measure in the short run. But NGOs
can take on such tasks, many already do so.

Thus, NGOs will fill up an important void in quality at the grass roots level
which will help the poor not only to borrow but also to become good
investments for banks. This will help boost business at rural branch level and
cover up inadequacies and constraints that might hamper a banker with the
conflicting demands of his workload. Many banks and FIs have recognised the
role of NGOs and have effected suitable policy initiatives. A larger recognition
of this need is reflected in the statistical evidence on linkage patterns, which
we have cited earlier (see the table), which establishes NGO-bank partnership
over the Indian mF spectrum. A truer recognition at individual banker level
might lead to business sense replacing customary scepticism for NGOs. This
will be the strategic turning point in making India’s relationship banking a
showpiece and paradigm for the world’s NGOs and bankers.
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Source: http://www.gdrc.org/icm/country/shg-padhi.html
Accessed on 11/11/2004