May 06, 2016 by Raunak Kalow income segments and Sharada Ramanathan
Editor’s note: This is the fourth post in a series on Grameen Foundation’s journey with an Indian microfinance institution, Margdarshak Financial Services Pvt. Ltd, as we help it transform from an organization focused on credit alone into a sustainable and scalable business correspondent of a commercial bank. You can read our first three blogs here: blog 1, blog 2 and blog 3.
This blog series is based on interviews with three leading banks in India that are rolling out the business correspondent model, and that together operate more than one hundred partnerships with microfinance institutions (MFIs).
Background: Why Partnership Makes Sense for Banks
Banks can realize tremendous advantages by partnering with MFIs to act as business correspondents, carrying out transactions on behalf of a bank. Because MFIs operate in areas where banks do not have branches, partnership allows banks to cost-effectively reach unbanked clients in far-flung areas without investing in brick-and-mortar branches. The model also allows banks to expand their offerings, as MFIs are geared towards the provision of low-ticket size financial products that have traditionally been a challenge for banks.
Crucially, the model also helps banks to meet the priority sector lending targets set by the Reserve Bank of India, which specify that 40 percent of a bank’s loan portfolio should target sectors such as education, low-income housing, small farms, and micro-enterprises.
However, there are also significant challenges to scaling the model to reach hundreds of millions of low income segments people across India.
The Challenges & Solutions
Our last blog discussed three of the top five challenges banks face as they partner with microfinance institutions (MFIs): vetting partners; managing differences in work culture; and meeting compliance standards. This blog explores the remaining top-two challenges as described by banks: aligning processes and technology, and adapting management structure.
Challenge: Technology and Process Integration
Banks and microfinance institutions have very different operating processes and technology capabilities. Their technology platforms and applications were not originally designed to work together seamlessly. An inability to interface adequately with each other’s technology systems can lead to increased costs, turn-around-times, and customer service issues, which have particularly negative implications for the bank. Further, each microfinance institution customizes its work flow as appropriate for its own operations and clients. For banks, synchronizing their own processes with that of multiple microfinance institutions can be daunting.
Solutions: Banks should recognize that as long as regulatory norms are not violated, there may be merit in allowing microfinance institutions to retain their current processes and minimizing disruptions to their workflows. One of the banks we interviewed, for example, has instead invested in a technology middleware solution that allows partner MFIs to directly upload their data on bank servers via SFTP (secure file transfer protocol).
Microfinance institutions often find that their service delivery times increase once they start operating as business correspondents. This is natural given the addition of a partner in the overall process flow. Banks should attempt to improve their own processing times and minimize disruption to their partner’s processes. Some are opting for a decentralized model where the bank branch closest to the MFI branch sanctions loans or opens accounts. Others are tweaking their processes and opting to make credit decisions based on scanned documents rather than waiting for physical documents.
In addition, a related concern is the timely reconciliation of accounts between banks and business correspondents. MFI customers often make partial payments based on their cash flows. Banks levy interest on the outstanding balance every day, so it is critical that the correspondent MFI’s receipts are updated in the bank’s system. Reconciliation issues could lead to incorrect computation of Portfolio at Risk (PAR) and other key metrics that measure the health of a bank’s loan portfolio. Similarly, correspondents also need to know the outstanding amount that is due for collection from clients every day, before loan officers set off on their beat.
To address this, banks are investing in solutions for faster reconciliation. For example, one of the banks we interviewed has invested in mobile handheld devices for every MFI branch. These devices are provided with an inbuilt application, which offers the partner’s branch staff secure access to customer information, and allows them to update receipts. Another offers its partners real-time access to customer account status through a VPN network via a web interface.
For more on this, please read our blog on quick technology fixes for banks and MFIs to streamline integration.
Challenge: Management Structure
Banks face tradeoffs in selecting a management structure for the Business Correspondent model. Banks can follow either a centralized approach with a single regional office being responsible for business correspondent model operations, or a decentralized model where this responsibility is disseminated to individual bank branches. Both models have their advantages and disadvantages. A centralized model allows for greater control and quicker decision-making but can easily become bureaucratic, impacting scale and productivity. A decentralized model is far easier to scale but makes it difficult to ensure consistency of operations, which can itself impact productivity.
Solutions: In a decentralized model, managing the relationship between individual bank branches and the local MFI teams becomes critical. Establishing mutual trust takes time. Each bank branch might have a slightly different way of working. The local microfinance institution needs to appreciate this and make adjustments in its key processes. Both parties should encourage transparency and have visibility into each other’s system, processes and policies. Ideally, monthly meetings should be organized to discuss issues, set targets, review business numbers, and identify areas of improvement.
In a centralized model, an MFI ideally would also have centralized operations designating their regional teams to coordinate with the bank’s regional team. The quality check should be done at a regional level before sending forms and data to the bank, instead of individual MFI branches coordinating directly with regional offices of the bank.
India’s financial services ecosystem is at a critical inflection point with regulators experimenting with newer models and entities to boost financial inclusion. India’s Reserve Bank has recently granted approval for setting up Payment Banks and Small Finance Banks. These new entities are likely to spur competition and drive players to deliver differentiated and high-quality products and services to survive. Our assessment is that Small Finance and Payment Banks will gradually shift towards more mainstream banking and focus their efforts on India’s burgeoning middle and lower middle class segment with higher ticket size loans. Traditional MFIs will continue to serve low income communities, with the BC model playing a significant role in the expansion of their services.
The business correspondent model poses significant challenges for banks, particularly at the start of operations. However, banks that invest in resolving these issues find that the model is a promising channel to expand services among the unbanked at low costs. If you are a bank who has partnered with MFIs on the Business Correspondent model, we would love to hear your experiences. Please write in to us at rkalow income email@example.com.