Microfinance: Time to move towards financial inclusion

As printed in the Economic Times

The numbers that describe India's economy are mindboggling. Just one-tenth of the population participates in the formal economy. Of these, only about 35 million pay taxes. That's less than 3%.

No wonder then that our economy produced a GDP of only $1.42 trillion at last count, about the same as that of the city of Tokyo which has a population of 35 million. There are simply too few producing value and wealth in India and so there is not enough to go around.

The financial inclusion agenda so far has been largely focused on redistribution of wealth while what is required is inclusion in the creation of wealth. Financial inclusion so far has meant debt distribution and nofrills bank accounts.

Microfinance has been one major channel of debt distribution to the poor. While the original assumption was that these loans were for investment in micro enterprise, the Malegam committee report in 2010 indicates that 75% of the loans went towards consumption. Contrast this with the distribution of bank debt in India where less than 20% were consumer loans.

Microfinance 2.0

As published in The Smart CEO as part of the 'Big Ideas' series

The last decade has seen a sensational rise and fall of microfinance in India. After the crisis in Andhra Pradesh (AP) that claimed debt related suicides on account of exorbitant interest rates and high pressure collection tactics, the Reserve Bank of India (RBI) has finally put in place regulations based on the recommendations of the Malegam committee. With massive defaults to contend with and the new regulation that places caps on the rates and spreads, the industry is struggling to find its feet again. Many of the less efficient players are out of luck and out of business. Others are tightening their belts and getting more efficient in their operations. But, is microfinance 2.0 just about process efficiency? Or can it be something greater?

Evaluating Social Impact

(As posted on YourStory.in)

For people engaged in the social entrepreneurship space, one of the most difficult questions is how to measure the positive social impact you make. How do you know you’re doing net social good?

What we typically do is assume that our product has intrinsic positive social value and so simply measure how many people have used our product or service. Then we make grand statements like ‘We have positively touched a million lives’. For some products this might be all it takes. Take d.light, for instance, a solar alternative to kerosene lamps that is cheaper, brighter and healthier. A simple count of product sales would be a pretty good indicator. For many other products and services though it is far more ambiguous. Microfinance, pharmaceuticals, health services, education. All of these have great potential for good but also for abuse, misuse or mistakes. Each instance of use is not always a net positive; a borrower who drinks away a loan, a person who commits suicide with an overdose of painkiler, a person who gets wrong medical advice resulting in a worsening of their condition. In some cases, the net positive impact is highly debated. Are people really better off if they took a loan? If they underwent a particular treatment? Took a particular course?

Social Entrepreneurship? Really?

(As on YourStory.in)

Social Entrepreneurship is the new buzz word in India and marks a shift in thinking away from non-profit models to market based solutions that can operate at large scale and therefore create social value more systemically.

But what puts the ‘social’ in social entrepreneurship? We all have a notion that it means starting a business that does good for less fortunate folk. So we commonly think of a social entrepreneur as someone who is addressing a low income market with a product that can raise standard of living, either by providing greater opportunity or convenience. However, as I have discovered over the past five years, simply product and market are not sufficient.

Caps, Drugs and Microfinance

(as posted on YourStory.in)

Of all the arguments I have heard in support of rapidly scaling microfinance the one I have heard the most is that there is huge demand for money among the poor. Of course there is huge demand. The less you have of it, the more desperately you need it – to tide over the pain and struggle of every day. The next meal, school fees, doctor fees, a pair of shoes, a movie to escape from reality, a drink or two to forget. It’s a painkiller.

When you’re in severe pain, you need a painkiller. What you care about is relieving the pain now. Today. When you are in desperate need of money you don’t have, and it is dangled in front of you, you will take it. But painkillers are insidious.

The Decade of the Cow

According to the microfinance calendar, the last ten years were the decade of the cow. We celebrated the cow as the path out of poverty. At Madura we even benchmarked the loan amount to the cost of a cow. What good is a loan if it’s not even enough to buy a cow? And so over the last decade the microfinance industry has supported the purchase of millions of cows across the country. Millions of scrawny cows with poor yield it turns out; a hallmark of the inefficiency of microenterprise. I for one am glad to be past the decade of the cow and am excited and hopeful that this decade we will do away with celebrating cows - and pigs and goats and chickens and antiquated sewing machines and cottage industries - and celebrate instead the human being and its capacity for extraordinary innovation.

Physics of Poverty at YourStory.in

I am now writing a weekly column for YourStory (www.yourstory.in), also called Physics of Poverty that will post every Monday. Some things taken from what I have already written here but also some new stuff. I will start posting the column here as well. Here is the first post that appeared last week.

What is the question?

Physics of Poverty series by Dr. Tara Thiagarajan, chairperson, Madura Microfinance Ltd.

Alright, I’ll come right out and say it. Microfinance has done very little to alleviate poverty. Practically speaking, even after five loan cycles, virtually all of our borrowers are still poor—poor enough to be eligible for yet another microfinance loan.

The premise of microfinance has been that giving poor people a loan is all they need in order to get out of poverty. This presumes that simply giving someone money will first turn them into an entrepreneur, and that once they are thus transformed, that their entrepreneurial abilities will far exceed that of even the most educated entrepreneurs who fail more often than they succeed. This premise makes light of the difficulties of entrepreneurship and of the greater problem of the impoverished ecosystem within which the poor operate. On the other hand, in poor rural areas, where employment opportunities are few and most of India’s poverty is thus concentrated, effective entrepreneurship is a crucial component of progress. So how else to catalyze entrepreneurship but through microfinance? What about those pictures of Rajalakshmi and Kannamma smiling broadly alongside their cowshed and petty shop, the poster women of microfinance success? Surely there is something to that? There is a little. But that’s just it. It’s a little, very little.

Social Impact Evaluation in Interconnected Evolving Systems

Today there are many development economists that focus on social impact evaluation studies. These studies typically compare groups receiving an intervention to groups that did not. For example, did the group that received microfinance do better than the group that did not? Although they attempt to ‘control’ for variability between groups, I see some fundamental flaws in this approach. First, to be meaningful comparison, a ‘control’ group must be independent of the intervention group. In society, which by definition is an interconnected system, this is virtually impossible and you can never control this way for network effects.

For example, lets say the people who received microfinance in the village used the money to buy goods from the people who didn’t. Its not impossible that this could result in the 'control group' getting richer because they could sell more. Compared to them, the microfinance takers could then look poorer because, while they may also have overall bought and sold more, they also had to pay back their loan with interest to the lender. This is a gross and very direct example of course, and it will never be so simple to parse out the network effects. Recognizing this, if you instead decide to move your control group to a distant location this will not really solve the problem. For one thing, the more distant the ‘control’ community, the more the variability in the circumstances and the more confounding this variation can be. But more important, network effects can be far reaching and change dramatically as the size of the network changes. So physical distance does not help unless you compare two communities that are completely self contained economies (in which case they have evolved so separately and so differently that it will be a useless comparison anyway).

This brings me to a second extremely important point. Networks like society are open feedback systems that evolve continuously over time. This means that the impact you find that microfinance has today (network effects notwithstanding) is completely irrelevant to tomorrow and therefore cannot be prescriptive or even diagnostic in any way. For example, cell phone penetration and use is climbing rapidly in rural India today and dramatically changes the way people interact and transact, opening up distant markets and changing the rate at which people can buy and sell. Just imagine the impact of being able to call a buyer in the neighbouring town to coordinate an order and delivery instead of having to travel the three hour distance by bus! So if you conducted your traditional microfinance impact study today, when cell phone penetration was low, maybe it has little impact because the opportunities to interact rapidly were low and therefore business was slow. Tomorrow it may have magnificent impact as the network conditions change.
So, not to sound too harsh, but in the interest of progress, having read various social impact studies on microfinance conducted at great expense and unveiled with great fanfare, I have to say What’s the point? As a practitioner interested in seeding social progress there’s nothing whatsoever I can take from these studies. It doesn’t tell me what is wrong or what should be done right. Rather it is a flawed comparison of one slice in time.

So what’s the alternative? If we want to come up with something valuable prescriptive, what we need to do is stop wasting time with such social impact evaluations and start trying to understand the network and its evolution. What we need to do is begin asking and answering questions like these:
1) What is the topology of the transport and communication networks? How does information and trade flow in these networks? What kinds of simple changes in the network could result in nonlinear benefits for the flow of goods, money and information?
2) How do ideas and innovations diffuse in these populations? How does this compare to more advanced segments of society? What can be done to create more productive diffusion?
3) What do group dynamics look like in these groups? Can we identify aspects of culture and interaction that predict why these groups fail to organize themselves and innovate? If so, what kind of innovations can we develop that shift these behaviours towards more productive dynamics?

What's a newspaper for?

We (Madura) recently launched a classified ad newspaper that reaches 400,000 poor rural households in Tamil Nadu. Our women borrowers can advertise their products, services and things they want to buy and sell free of charge while companies must pay. This is a hard to reach demographic that does not generally interact with print. One of our office locations used a women's day event that gathered 700 of our women borrowers to launch the paper in their area. I didn't attend this launch but our CEO reported to me that a very large number of women took the paper that was handed out and immediately used it to wrap up the snacks that were served to them.

(One useful statistic to put this in context is that about a third of our borrowers cannot read. Still....)

A physicists view of financial bubbles

Thought this would be interesting to all of you folks who are interested in making sense of the recent financial crisis (and/or trying to figure out if there is a microfinance investing bubble in India). Physicists Didier Sornette, Ryan Woodard and some others have been working to create predictive 'bubble diagnostics'. These diagnostics are based on non linear positive feedback models that have their basis in imitative human behavior. They are running The Financial Crisis Observatory which they describe as "a scientific platform aimed at testing and quantifying rigorously, in a systematic way and on a large scale the hypothesis that financial markets exhibit a degree of inefficiency and a potential for predictability, especially during regimes when bubbles develop".

Last year they published a paper called Financial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis in arXiv (arXiv is a database of physics papers that is openly accessible) that is more of an essay and a pretty easy read. Some of the data that they show is quite striking. For instance, the abrupt and extraordinary divergence between wages and consumption as a percentage of GDP beginning in the '80s (figure 6 on p15), showing just how dramatically US household wealth and spending came to depend on the stock markets and not any real indicator of productivity or output.

Somehow I'm not surprised by all the bubbling. It is hard to keep focused on creating real value when paper value is so much easier to generate ....

Microfinance, money flow and social impact

The traditional thinking in microfinance is that it is a way to help people extricate themselves from the clutches of local moneylenders who charge exorbitant interest rates. As microfinance institutions, we believe, that by charging less we are doing great social service. Typically, when academics study the impact of microfinance, they look at people who have received microfinance compared to people who haven’t in order to see who is better off across various dimensions. Evidence suggests that even if individual borrowers are not actually making profits that exceed the interest charges, they might do better on other dimensions that relate to patterns of consumptions. Access to a lump sum of money at once, for instance, allows borrowers to afford goods and services they would otherwise not be able to that give them a better quality of life. However, if we really want to understand the social impact, looking at how some individuals compare to others is not sufficient. Rather we need to understand the flow of money more systemically. Here’s why:

In my view the goal is to seed systemic change. Which means the system as a whole should thrive and not just select individuals within it. If we take a village that has its own local economic ecosystem along with some bilateral trade links to the outside world and try to unravel the impact of a loan, it is not so simple. As a microfinance institution we lend urban acquired money into the village, but then we take back more than we lend in the form of interest. The money we take back goes back to the village in part as salaries to the people we employ there. The rest goes to other stuff in urban areas, maybe out to shareholders who will spend part of it in another country (like me for example - most of my money seems to go to Lufthansa). The local moneylender, on the other hand, may charge a higher interest rate, but being local will probably spend most of that income in the village supporting the overall village economy. So potentially, local lending at higher rates could be more beneficial to the village if the money is in turn spent in the village, compared to lower rates where the money leaves the village. So the impact of microfinance on the village has a lot to do with the dynamics of money flow and not just what happens to the borrower who took the loan. (See also my related post, ’Where does the money go’).

Connected we succeed, divided we default

At Madura Microfinance, one of our primary assumptions is that women who are more informed and better connected will be more successful and make more productive use of loans. So, much of our efforts are aimed at increasing networks and access to information among our members. A PhD Student from Oxford, Sangamitra Ramachander, recently studied our women’s borrower groups to see what kind of factors predicted whether a group went successfully on to the next higher level loan or would default. This is still a work in progress but there are some very interesting results. Here is one odd one that stood out to me. She found that women that travelled more frequently to neighbouring villages (but surprisingly not the nearest towns) were several times more likely to be successful rather than default. It’s not clear whether this factor is causal or the outcome of their success but it’s something worth exploring further. Possibly, women who travel more to neighbouring villages are more informed about local markets and better connected within them?

Driving socioeconomic change by making women more dependent

Yes, I meant to type dependent. Here’s why.

One of the great drivers of mankind’s progress has been our ability to specialize in our knowledge and functions, organize as groups or entities that share knowledge and create amazing things that no individual could do on his or her own. Done well, the outcomes of organizations are far greater than the sum of its parts. The most awesome things that mankind has created – jet planes, space stations, the power grid, they are all borne of interconnected, highly dependent networks of people. Our (Madura’s) women micro-entrepreneurs are the antithesis of this dependence. They are highly unspecialized and operate independently (women, only because that’s who we serve, but this applies to men too). These micro-entrepreneurs strategize, produce, market, manage accounts and do everything on their own. This means that they rarely have the opportunity to benefit from the knowledge of others and rarely have the opportunity to gain deep functional expertise as they are so busy doing a little of everything. That’s a huge limitation on what they are able to achieve. It is remarkable how few of our women borrowers think to band together and create something bigger than any one of them could do alone and I often wonder why this is. Most of the women I have talked to who have grouped in twos or threes have only done so in order to pool their loans to afford an asset, not for aspirational reasons. I’ve been thinking about what drives organization in society and not coming up with a satisfying hypothesis yet. If we could figure this out, it could be very powerful. Ideas folks?

Where does the money go?

Was chatting recently with Sitabhra Sinha from the Institute of Mathematical Sciences in Chennai, India about some ideas to study the network structure and dynamics of money and information flow in rural Tamil Nadu and he passed along a bunch of papers to me. One of them was Patterns of dominant flows in the world trade web by Serrano, Boguñá and Vespignani. This mix of people from Europe and the U.S. took international trade data and reconstructed the trade network to look at imbalances between countries. They then asked where one dollar generated in any given country ends up being ‘absorbed’ or accumulated in the world. They called this the ‘dollar game’. For big consumer nations like the U.S. no surprise that a big chunk ends up in Japan and China. Where the money ends up accumulating is not completely informative about which country is better off though, since this doesn’t tell you anything about who can generate more currency to begin with. However, it did get me thinking about what it would look like to reconstruct this for rural and urban India and track where our microfinance loan money is ‘absorbed’. My guess is that the rural borrowers are net consumers and much of it ends up in Chennai or Mumbai or someplace like that rather than actually staying in the rural areas. If anyone has data to the contrary (or supporting my guess), I would love to hear about it.

The Madura Experiment

Madura is a for-profit social enterprise whose core business is providing small unsecured loans to the poor. In India and around the world microfinance is very much an evolving sector. Today microfinance is practiced either for-profit or not-for-profit, each with its own unique drivers.

The prevalent for-profit approach is scale focused and profit driven. In this model the goal is to create a streamlined process for the disbursement and collection of loans that allows loans to be pushed out as rapidly as possible. Interest rates for this model generally range between 25 to 40% in India today. This is profitable business. Unfortunately it has also been widely publicized and hyped as a path out of poverty. On the positive side, it provides a conduit for more fund flow into the ‘subsistence’ economy and over time competition will result in innovations to reduce the cost of capital, and interest rates will come down. However, the social benefits are not sufficiently large or even noticeable from the outside and the social impact has been vociferously debated. In the quest for rapid growth, as people start getting multiple loan offers, a number of people who never wanted to go into debt find themselves in debt. Think of it like the temptation of getting multiple preapproved credit card offers. Yet this is not why microfinance has failed to have substantial socioeconomic impact. Rather it is because with poor knowledge levels and very limited exposure to markets and market opportunities, borrowers are not in a position to make productive and innovative use of the loans. So here one must resort to showing and glorifying as success a woman who has taken a loan of $300 and now nets an additional $10 a month, if you don’t factor in the opportunity cost of her time and labour. Personally, I find this depressing.

The model generally practiced by non-profits takes a more holistic view of the borrower. Here, recognizing the disadvantaged conditions in which the poor operate, non-profits offer loans at low interest rates that are subsidized by grants and donations. Frequently they help the borrowers set up their businesses and market their products. The focus is on ‘enterprise creation’ and they become involved in every aspect. This approach has inherent limitations in its ability to scale. It is also implicitly paternalistic. To me it’s analogous to having a protectionist government where much of the industry is nationalized and subsidized. This breeds complacence and a lack of confidence. Those of us who remember India fifteen years ago, remember a nation that felt it held a secondary place on the global stage, a nation whose leaders assumed it could not compete on a global platform and closed its doors out of fear. But we have seen in urban India what liberalization can do. When the doors are opened, information and opportunities flow more freely and people who once thought that they could not rise to a global standard now find that they can. This is a systemic change that altered the paradigm in which we, its citizens, operate, the standard to which we are held, and slowly we all rise to it.

So at Madura we are embarking on a different journey that is socially motivated but profit driven. The for-profit aspect is extremely important from the point of view of accomplishing anything with scale. In the absence of profit it will eventually fizzle out or hit a limit in its transformative potential. However, this has to encompass more than just loans and its impact has to be systemic in nature. Our belief is that the poor are not very different in the way they will respond to opportunity. However, they have to be connected in a network in which information and knowledge flows more freely so that they more rapidly encounter opportunities. Today they encounter new information and form new links or relationships at a very slow rate. The challenge is to speed this up. The belief is that with the right network conditions, people will become more innovative and productive in their interactions and socioeconomic transformation will be a natural outcome of these interactions.

So where does this fit in with microfinance? Putting ideas into action needs money (most of the time) whereas money without ideas is just a piece of paper. Our strategy is thus based on the premise that if we have a network of credit enabled people sharing information and ideas, the network dynamics will work its magic. (What magic you might ask – I will talk about this in future posts).

We have thus embarked on a journey of building a monetizable information delivery network that, together with efficient delivery of finance, creates a strong growing business. The test, however, is how well we leverage this to turn it into something far beyond a business. Succeeding in the ultimate goal will require some clever understanding of the properties of the human network we are working with so that we can affect it as intelligently as possible. And that, I think, is the exciting challenge in this whole effort.

Visit us at www.maduramicrofinance.com

Where is this blog leading? Who’s your audience?

Yesterday someone I know very well (no names will be named) asked me ‘What’s the purpose of your blog? Who do you want as your audience?’ So I said ‘What! Can you give me a break? This blog is only a couple days old’. ‘It’s just not evident to me what this is leading up to,’ unnamed person persisted. I won’t tell you what I said then, but grudgingly I’ll admit those are good questions. So here are the answers.

My posts will encompass the following range of topics:

1) Explanations of different concepts underlying networks in nature, and network principles in general, and how they relate to the issue of poverty. These will be a little didactic but are concepts that will help in understanding other posts. Initially there will be more of these but over time that ratio will change in favour of the categories below.

2)Discussions of different approaches to tackling poverty and their successes and shortcomings.

3)Discussion of a network based approach to solving the problem of poverty using a for-profit enterprise model which will include empirical data and network models.

4)An update on the practical approaches and outcomes at Madura Microfinance where we will use network understanding to drive socioeconomic change.

The audience I envision are people with an interest in the issue of poverty who 1) work in companies, government, non profits and other organizations who are curious about what science may have to offer as an approach on the frontlines 2) are scientists in the areas of nonlinear dynamics, condensed matter physics and other related fields who are interested in taking on research that can have immediate practical relevance.