Category: Finance

MUDRA Bank – How will it help?

First things first, a regulator cum re-financier (market player)  is bad design. Period. It leads to moral hazard where the regulator will shape policy to grow only its business. Yes, refinance is business.

But I hear that MUDRA Bank is expected to be a regulator and financier of microfinance institutions and micro-enterprises. Why?

The only other entity with such an entitlement, the National Housing Bank (which is a regulator and refinancier for Housing finance companies and bank housing loans) is expected to lose that status once the long pending NHB Bill is passed in its current form. The bill aims to move the regulatory powers of the NHB to the RBI and let NHB continue to operate as a sector focussed bank like NABARD and SIDBI. Obviously, the law makers realised that regulation and business do not go hand in hand.

That brings me to the second question, NABARD refinances MFIs, so does SIDBI. SIDBI refinances/ guarantees small/micro enterprise finance. So, basically, between the two they pretty much already do what the MUDRA Bank is supposed to do on the refinance side. So, why do we need a MUDRA Bank?  Yes, they don’t regulate. So, to regulate?

When the microfinance crisis broke out, there were discussions of NABARD being made a regulator for the MFI industry but that did not happen, primarily due to the fact that NABARD was actually a refinancier (a service provider) for MFIs and the significant majority wanted NABARD to continue as a service provider and not become a regulator in parts due to the lack of infrastructure and in parts to avoid the moral hazard issue. The only reason why NABARD was brought into the picture was microfinance institutions not only included the RBI regulated NBFC-MFIs but also societies and trusts not regulated by he RBI.  However, NABARD felt that they did not have some of the “missing links to operate in the sector” as a regulator.

What then, will the MUDRA Bank do differently? If the several decade old and experienced NABARD thinks they can’t handle the job, how will the MUDRA Bank manage?

Another interesting proposed change is that the FMC and SEBI are going to be merged, the logic seems to be that financial and commodity markets are, at the end of the day,markets and hence they should have a common regulator because this will streamline decision making and potentially trigger new products. Great!

And there comes my third question, why then are we trying to create multiple entities for microfinance and enterprise finance? Where is the coherence in “strategy”?

Instead of seeding new ideas, would it not be better to energise the NABARD and SIDBI to take the word “Development” in their names seriously for their respective sectors? To adopt innovation and  shake away  some of the bureaucracy that binds them down? To adopt proactive measures to tackle the problem of access to finance for small businesses?

And please, for the sake of humanity, why should a bank promoting entrepreneurship favour only the scheduled castes and tribes? Favour all enterpreneurs, if you can. Nobody does that in our country.

(Edited on 9th March, 2015 to add an article on the same topic by noted journalist/author Mr. Tamal Bandyopadhyay. He seems to point out similar concerns.)

Credit Scoring Vs Personalised Lending

In India, all banks have internal credit scoring models and it has not helped them in lending to SMEs.

Two key reasons why banks (formal lending institutions) do not lend to SMEs in India are
a.) Lack of information on actual profitability/cash flows. No official documented evidence of income can be found. This is primarily in keeping with practice of dealing in cash, belief in oral contracts and mostly absence of contracts (sale/purchase) altogether. In addition, the myopic tendency to avoid taxes leads to minimal documentation or under-reporting of incomes. If no concrete data is found, what do the bank feed into their credit scoring models?

b.) Small ticket size and hence high operating expense per loan. Ideally a credit scoring model reduces the high opex of small loans by taking an automated call on whether to do a loan or not without having a credit person go through the case in detail as he is expected to do in larger loan ticket sizes. But, then, for these kind of small loans with no concrete data, what does one feed into the credit scoring model? Subjective evaluations of the credit appraising officer?

It is undisputed that the effectiveness of a credit scoring model is dependent upon the quality of data being fed. However, since the quality/reliability of data that is available to be fed into the credit scoring model is poor and subjective, especially in case of SMEs in India, how does one use a credit scoring model? In fact, due to high level of subjectivity, the data being fed into the credit scoring model can jeopardise the credit scoring techniques.

Credit scoring models can speed up process but they can not replace personalized diligence based lending till the time good data is available. There is barely any electronic footprint left by SMEs that can be dug up for credit analysis. The bank account (if available) details wouldn’t show enough balance, their transactions would be fairly thin. Understood that visiting the customers for a small ticket size loan results in high opex but in the case of SMEs where transactions are primarily cash based, expecting to lend to customers in the SME segment without meeting the customers, suppliers, buyers of the SME and without visiting the location is a recipe for disaster.

A few new age lenders are depending upon use of surrogates/proxies for assessment of actual cash flows, followed by close monitoring of loans. They depend exceedingly on customer visits. Their portfolios have performed well but yes, it is too early. While it is not free of subjectivity, this approach seems to be better than that of large banks who use an inflexible credit scoring model based on documented data. I agree that the rate of growth in such kind of specialized lending may not be as fast as mainstream financial institutions till the time sufficient electronic footprint is generated by the target SMEs. Meanwhile, using some form of credit scoring models in parallel can add a layer of check over the existing rigorous personalized appraisal procedure. This helps in reducing the impact of subjectivity in the personalized lending processes.

Credit scoring models are needed. The critical question that we need to answer today is, how do we improve the quality of data available to be fed into credit scoring models? If not immediately, how do we build the right data backend that provides high quality data in the future?

According to me, this kind of data backend will have two components, one that deals with general data points which can be used for bench marking and two that deals with individual specific data points that further become a part of the general database:

a.) Benchmarking: A good data backend can actually be a like a platform where location specific details on various businesses and margins are fed by staff of lenders. Over a period of time and volume, these numbers will give adequate guidance on the claims of margins/profitability made by the potential borrowers. Once the coverage of data collection efforts improve with time credit scoring models can play a better role.

b.) For individual evaluation: Individual credit/liability histories need to be pushed into this data back-end. Electricity bills, mobile phone bills, credit bureau details, need to be automatically fed or fed based on requests. The question is will the respective companies share data? Will a mobile company share prepaid recharge data of a customer?

Once this is done over a period of time, I believe a credit scoring model will start making more sense for SME lending in India. However, ditching personalized lending altogether, would continue being a distant dream for a fairly long time, if not for ever.

The approach can not be Credit Scoring VS personalized lending. The approach instead has to be Credit Scoring AND personalized lending.

Reading List – 2nd Ferbruary, 2014

1.) Framework for non-profits to have clear fundraising conversations.

Article: 10 Non-profit Funding Models

2.) Interesting article on how Amazon.com manages to be a favourite in spite of not churning profits!

Article: Amazon & nil profits

3.)Why Nokia is one of the greatest companies of the world.

Article: Nokia Bridge Programme

Payments, Banking and Cost implications of cash – India

Electronic Payments have always intrigued me. I have written about this in the past. I was reading through a few more documents on electronic payments and read through the Reserve Bank of India Vision Document on Payments. Quite an insightful document in terms of statistics. However, my feeling was it doesn’t quite clearly layout the strategic framework to be adopted for payments in India. SOme statistics from the vision document and some other sources.

 Penetration of banking services
  • Of the six lakh villages in India, the total number of villages with banking services stands at less than one lakh villages as at end March 2011 and nearly 145 million households are excluded from banking.
Penetration of Electronic payment
  • Only 0.6 million of the 10 million plus retailers in India have card payment acceptance infrastructure.
  • Mid-2011, the number of non-cash transactions per person stands at just 6 per year.
  • 32% of e-commerce takes place through the system of “cash on delivery” (COD) NOT online payment.
 Other numbers:
  • The Indian bill payment market is a US$ 160 billion market. Indian households pay on an average 50 -55 bills a year. Among the electronic payments infrastructure, ECS occupies a 50% share followed by cards and bank account funding.
  • It is estimated that Government subsidies alone constitute more than Rs. 2.93 trillion and if these payments are effected electronically, it may translate to 4.13 billion electronic transactions in a year.
  •  The penetration of ATMs is 63 per million population and that of PoS terminals is 497 per million population
 Banking Infrastructure
  • Today, the banking infrastructure in the country consists of 80,000 bank branches, 1,50,000 post offices, 88,000 ATMs, and 500,000 POS machines. Of these, the rural banking infrastructure only consists of about 30,000 bank branches and 1,20,000 post offices. In comparison, there are more than 10 lakh telecom retailers that operate throughout the country.
  • 18 million outstanding credit cards and 228 million debit cards.
 How much cost does the economy bear to support a cash economy?
Cost of cash to the economy is 5-7% of GDP.
-costs for rbi  include printing currency, currency chest management, and wear and tear
-cost for bank include cash logistics, cash management, security, storage, and the opportunity cost of idle cash in branches and ATMs

Pricing: Loan against property v/s home loan

Simplified Definitions

Mortgage Loan/Loan Against Property (LAP):A mortgage loan is given for an open end use and is given against the lien of a property.

Home Loan: is given for a restricted purpose of buying/ constructing a house to stay.

Typically a mortgage loan is often the most common way of raising funds for growing the business. Banks typically get comfort from the availability of fixed collateral to be able to recover from in case of loan default.

The rate of interest charged on a Loan Against Property is higher (much higher) than a Home Loan.

Historically, default rates of LAP (for business purposes) have been high justifying a high rate of interest.

Why?

Question 1: Is the assessment of loan eligibility for LAP done assuming that cash flows from the business will grow due to utilisation of the funded amount for capex/WC use? If that is not the case, why would the default happen?

Question 1 a.) why can’t we give the loan based on existing cash flows?

People say that the loan size would be too small and not meet the requirement for the capex. My comment on that response would be “Oh common! let’s grow step by step. Give me some other reason”.

Question 2: Why doesn’t the “emotional attachment” story that works in case of home loan doesn’t work for LAP?

Question 2. a.) Does the person seeking a LAP have multiple properties and so property offered on mortgage has lesser “Emotional attachment”?

Guess so.

(Also, the question is how enforceable is the mortgage? In a lot of cases, especially developing countries, legal recourse may just be too cumbersome/ inefficient. So, isn’t the collateral acting more as a deterrent. I guess it is.)

Question 3: Would a LAP given based on existing cash flows AND after taking the owners current residential home as collateral completely change the loan performance?

That is what a number of financial institutions are now trying out with the lower income/informal sector entrepreneurs. Assess loan eligibility based on current cash flows and take the residential property of the entrepreneur as collateral. However, the interest rates continue to be higher going with the notion that LAP has generally resulted in high defaults. Interestingly, last 3 year’s history in these kind of loans show very low (between 0.5- 1 % delinquency in the 90 days past due bucket). Off course, three years is not enough time but these 3 years have been the roughest phase for business in India in general as well. The other key reason for good portfolio performance could be that this type of lending is new and the good quality selection could be due to the initial “start-up precautions” taken by the financial institutions starting this product.

Assuming loan performance does show improvement in this kind of loans, is there a reason to suggest lower interest rates and hence greater affordability?

At last but very important, one oft stated reason for low home loan interest rates is that the purchase of home does not generate additional revenue but LAP for small business does and hence the borrower can pay a premium. For all practical purposes, this reasoning silences all the discussion and the confusion around the pricing by simply stating that the lender wants his pound of flesh! That’s all!

What do you think?

Housing and Housing Finance (Part-3)

In addition to the points discussed in the earlier post, there are a few other key elements that go a long way in ensuring access to finance. Two major aspects are discussed in this last post of this series.

Credit Infrastructure: In addition to the above, comprehensive credit information systems, reliable information on house transactions and prices and mortgage registries improve transparency in the process of credit evaluation for housing loans and thereby improve the ability of housing finance companies to build a less risky portfolio.  Interestingly, a lot of work has been done in these spaces over the last couple of years. Significant growth in borrower information in credit bureau databases and mortgage registries like CERSAI as well as measures like the RESIDEX are great beginnings.

Customer Protection: While all of the above are important in increasing the flow of credit to the lower income or informal sector households, an associated issue is that of customer protection. A robust financial architecture is built on strong customer protection norms and this can be achieved only if the originator is directly liable for the appropriateness of the financial product being sold by them to their customer. This becomes all the more important in the case of the informal sector and lower income borrower because the cash flows and risks faced by such a borrower are very different from a standard salaried home loan customer.

At this point of time, all of us in the financial sector need to take a hard look at the issue of customer protection and frame appropriate guidelines for the same. Regulators are best placed to initiate such measures which look at a shift from the conventional financial literacy and disclosure based approaches of customer protection to a more involved engagement of the originators, where they take responsibility for ensuring the right housing finance product is offered to each class of customer.

(While thoughts are mine, I can’t deny that a lot of these thoughts have been shaped by the organisation I work for. I owe a lot of the thinking to IFMR Trust. IFMR Trust does extensive work in the access to finance space and has built several high quality institutions that enable access to finance.)

Housing and Housing Finance (Part -2)

The Indian policymakers and regulators have been fairly active in ensuring that through a mix of adequate policies and regulatory measures there is the right kind of stimulus to keep the housing finance market growing in India. In fact, with the expansion of housing finance institutions and regulatory and fiscal support, mortgage interest rates have come down from 16% in the mid 1990’s to 9% in the early part of the last decade, especially for the middle and higher income segments. The mortgage industry has consistently grown at an average rate of 40% annually. Increased availability of affordable housing finance has resulted in home ownership amongst a much younger group of citizens. Studies reveal that the average age of a house owner has come down by twenty years in the last decade. However, this phenomenon has been limited to the middle class and high income segment of the country and the lower income groups and economically weaker sections have remained almost completely out of this growth story.

High Quality Origination: The households falling under low income and economically weaker sections category, especially from the informal sector have little or no means to access finance from an organised channel. The current structure and processes within large housing finance companies and banks do not permit them to lend to these segments primarily due to lack of evidence of income. Recently, a number of specialised housing finance companies have come up that are catering to the housing finance needs of the economically weaker sections and lower income informal segment households. Such housing finance companies have developed well defined processes that help them to evaluate the informal sector customer. This is something that banks and large HFCs find difficult to do. Such new and specialised originators are fairly small in size but are growing at a rapid pace. They understand the real cash flows and risks faced by the low income or informal sector borrower and have better capability to underwrite the loans given to an informal sector customer. This is a good sign and more such institutions need to be promoted on the ground.

Risk Aggregation and Orderly Risk Transfer: While these specialised housing finance companies have developed expertise in evaluating the low income informal sector customer, what many of them  lack is the balance sheet strength to hold on to the risk, especially since housing loans are also of longer tenor.  There is also a great need to diversify funding sources for each of these originators to reduce the shocks that these companies might face due to drying up of limited sources of funding. There is significant opportunity in this space for larger financial institutions to activate triggering the growth of smaller financial institutions by lending to the smaller HFCs or participating directly in the process of lending to the lower income and informal segment borrowers through adequate risk sharing mechanisms with the small HFC. In addition, off balance sheet structures like securitisation need to be considered for a well-rounded risk management strategy for such small entities. It is essential that there is regular and orderly flow of assets from these high quality specialised originators to larger debt capital market investors who have the capacity to hold on to risk and have long-dated liabilities, thus enabling the smaller specialised originators to reach out to more and more borrowers in the informal and low income segment.  Strengthening the domestic debt capital markets through participation of institutions/investors such as insurance companies and mutual funds in mortgage-backed securities will go a long way in complementing the efforts of domestic commercial banks.

NHB has an important role to play in the development of these markets and may wish to explore further its role as a market maker of these securities and loans, act as a second-loss provider or guarantee provider for bonds of smaller lower rated but high quality originators to add to its role as a direct lender and re-financier. Significant work also needs to be done on rationalising the legal framework around mortgage backed transactions to permit more cost efficient and flexible structures. The legal framework around mortgages has held back the development of mortgage backed securitisation market in India. This has to be altered to lead to a more conducive environment.

Housing and Housing Finance in India (Part-1)

Housing is a significant engine for growth and development of any economy. Safe, hygienic and affordable housing has a direct impact on the quality of life and health of households, leading to a better civil society and higher productivity at work. Moreover, the housing construction sector itself leads to direct and indirect employment to a large number of people in several associated industries. The Government, the RBI and the NHB have been consistently working towards achieving the goal of housing for all.

A major policy concern, however, with respect to housing has been the severe mismatch between the demand and supply of housing units especially for the economically weaker section and lower income groups. As per Technical Group on Urban Housing Shortage (2012-17), more than 95% of such housing shortage in urban areas is in the EWS and LIG category. The Working Group on Rural Housing for the Twelfth Five Year Plan (2012-17) has estimated the total housing shortage in rural areas at 43.67 million units. It is also of major concern that 90% of the rural housing shortage (approximately, 39.30 million units) are in respect of Economically Weaker Sections.

In this backdrop we have to note a few key underlying issues. There has been large scale migration of people from rural and smaller urban centres to a handful of large cities over the past few decades. This has resulted in extremely high demand for housing in these cities leading to escalation of property prices and thereby making most housing in big cities beyond the reach of even the middle class. This has not only led to the peculiar problem of large number of highly priced unoccupied/unsold houses in spite of the country having a large housing shortage, it has also led to severe challenges to the civic infrastructure and service delivery capabilities of these cities adding to the exclusion. It is imperative that for a more inclusive future, in addition to direct measures like improving affordability of housing in the larger cities and enabling easier home finance options, alternate strategies like building rental housing options for economically weaker sections and development of smaller urban centres would be key.

While there are a host of issues to be addressed in order to create an enabling environment in the country that results in adequate and proper housing for all, let us focus on the access to housing finance challenge in the next few posts.