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 nightmare. All of those factors contribute to the high interest rates for microfinance loans, according to Vikram Akula, founder and chairman of SKS Microfinance. He says the 28.3% rate that SKS charged until recently (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.

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.

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 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.”