When banks are struggling to reduce bad loans, Bandhan, with a recovery rate of more than 99.5% in microfi nance, has entered the banking industry. Will its microfinance experience help it meet the challenges of mainstream banking?
Bandhan Financial Services started full-fledged commercial banking operations on 23 August 2015. It received “in principle” approval last year in April alongside the Mumbai-based Infrastructure Development Finance Company (IDFC), to set up a bank. Bandhan has been working as a microfinance institution (MFI) for the past 15 years and will be the first such to be converted into a bank in this country. Its emergence as a bank happens at a time when the Indian banking industry is experiencing a steep rise in non-performing assets (NPA).
This rise over the past few years, primarily of the public sector banks (PSB) is a matter of concern. Overall the NPAs or bad loans, including private sector lenders, increased from 2.43% in 2012 to 4.04% at present. The gross NPA of the PSBs alone is even worse, rising from 2.77% in 2012 to 5.08% in 2015. The rising NPAs have set alarm bells ringing all across.
At this juncture, when banks are thinking of various strategies to reduce bad loans Bandhan, which has been successful in keeping its recovery at an unmatched rate of more than 99.5%, makes a foray into the banking industry. In 2014–15, its bad assets were only 0.1% of the loan book. As a MFI it provides loan to the poorest of the poor and does not collect any collateral against their loans with the loan size varying from Rs 1,000 to Rs 50,000 per individual. Presently it serves 67,17,331 borrowers. Bandhan has already disbursed loans amounting to Rs 11,000 crore approximately. Despite the huge number of borrowers some of whom are very poor, it has done exceptionally well in keeping the NPAs to a negligible amount. This seems like a puzzle. It is certainly worth examining how Bandhan has been so successful, as opposed to other commercial banks, in keeping its NPA levels to a meagre amount. In this article, we try to unravel this puzzle and also analyse some of the challenges that it might face in transforming from a MFI to a bank.
The rising incidence of NPAs has generally been attributed to the economic slowdown. It is often argued that with the slowdown and the rate of interest going up sharply, borrowers find it difficult to repay loans. The economy has been steadily recovering over the past few years but the NPAs have seen a sharp rise. Moreover, if economic distress is the only reason for increasing bad loans, almost all banks would have experienced similar kinds of bad loans in their portfolios. The PSBs have performed much worse than private sector banks and as pointed out earlier Bandhan has levels unmatched by any other bank. According to a speech delivered by R Gandhi, Deputy Governor, Reserve Bank of India (RBI) on 31 May 2014 (RBI website,
https://www.rbi.org.in),
…it is the shortcomings in the credit appraisal, disbursal and recovery mechanism of the banks, besides the economic slowdown that can in large part be held responsible for their high levels of NPAs. Lack of robust verification and screening of application, absence of supervision following credit disbursal and shortfalls in the recovery mechanism have led to the deterioration of asset quality of these banks.
Only Female Borrowers
While studying Bandhan’s success in keeping the size of bad loans to negligible amounts, we first need to discuss the process through which they screen loan applications, their repayment methods and supervision after credit disbursal. Bandhan provides loans to only female borrowers. A borrower who applies for a loan from Bandhan submits a detailed micro plan of the project along with the cash flow to the bank. A loan is sanctioned only when the bank authorities feel that the project is viable. Then once a loan is sanctioned, bank officials visit the project after 15 days from the day the loan is sanctioned to monitor whether it is being properly utilised. Bandhan delivers loans through the model of individual liability through group formation.
An individual borrower has to be part of a group to obtain a loan from the bank though she is individually liable for the loan. Individuals make repayments weekly at public meetings, which are held at one of the group member’s house. A loan officer from Bandhan leads these meetings. Members are persuaded, if not required, to attend these meetings and most of them comply unless there is some medical or other perceptible emergency. The weekly repayments start immediately after a week of the loan receipt.
How does this lending model contribute to the high repayment rates experienced by Bandhan? First, it is evident that the lending model involves a lot of external monitoring by the bank both at the stage of approval of loans and also after loan disbursement. Bandhan officials are often employed from local areas and know most of their borrowers and understand the local conditions better than outsiders. They remain in constant touch with the group members. It devotes a huge proportion of its revenues to monitoring, which is often cited as one of the primary reasons for the high cost of funds. To recover this cost they charge a yearly interest rate of 22.4%. In spite of the high rate of interest, a large number of borrowers prefer Bandhan to the PSBs because of the former’s quick disbursement of loans and no requirements of collaterals. Absence of strong and proper monitoring is common with most banks, particularly the PSBs and can be attributed as a major reason for the huge proportions of bad loans.
Second, we believe that the group-lending model significantly contributes to high repayment rates for the following reasons. The group members are often neighbours or friends residing in the same locality and in most cases have a fair amount of knowledge about one another’s economic background, the purpose for which the loans are taken, the repayment schedule and also any difficulties a fellow member might run into in paying the weekly repayment.
Group Dynamics
In our survey of 113 Bandhan clients in West Bengal, we observed that 55% of the respondents had an idea about the financial background of all or most of the members in their group. Around 49.5% knew the reason for which loans were taken by all or most other members in the group. Moreover in the group meetings, borrowers come to know about one another’s repayments in public and a default leads to huge social embarrassment for the defaulter. As observed by Aghion and Morduch (2010), when repayments are made in public, “the villagers know who among them is moving forward and who may be running into difficulties.” This kind of knowledge about fellow group members facilitates informal arrangements within the groups, which can lead to the observed high repayment rates. A group member can help another member in the group who might have difficulties in repaying a weekly instalment in the hope that she would also be helped when she is unable to repay her loan.
From our survey we also found that when an individual was on the verge of default, 23.8% of the times she obtained help from a fellow group member, which is also the second most used source of help. When on the verge of default, the primary sources of help for these individuals are their husbands. This is not surprising given that about 56% of the respondents were housewives. When asked what steps the group members take if they default, almost 43% said that the group members scold the defaulting member. Also, 39% said that the group members cooperate and even try to help the individual to repay in case of default. It is interesting to see that even though loans are individualised, the group members try to help and even admonish the defaulting members. Also the group members try hard not to default on their loans. We do not know the exact reason why they value repaying on time to Bandhan to such an extent though there are no “late fees” associated with delayed repayment. A possible reason could be that they consider Bandhan as the main potential source of credit available to them and recognise that their access to future loans would be compromised if they defaulted on loan repayment or were sufficiently delinquent.
Third, the weekly repayment schedule is the traditional model that MFIs have been following across the globe and microfinance practitioners argue that the fiscal discipline imposed by this system is critical to preventing loan default.
Fourth, it is also believed by MFIs around the world that women borrowers are more sincere about loan repayments than male borrowers.
Challenges Ahead
The biggest challenge for Bandhan now will be to strike a balance between keeping their NPAs to the existing level, use their present expertise in keeping a check on bad loans and still emerge as a commercial bank where they need to cater to all kinds of customers. Though Bandhan plans to cater to MFIs, the MSME (micro, small and medium enterprises) segment, SME (small and medium enterprises) segment and the middle class, which is a huge segment, as well as the upper middle class (relatively financially independent customers) they may not be as tolerant about the high degree of monitoring as the present customers. Also the present lending model, which is feasible due to the unique social environment of rural areas, will no longer hold when it has to cater to a larger section of the society as a bank.
However Bandhan’s Chairman and Managing Director Chandra Shekhar Ghosh is hopeful of striking the right balance and according to him,
…(with) close connections and weekly follow-ups with all our customers, we get to know their problems. It enables us to be helpful and them to be responsive. With the MSME and SME customers, we hope the same strategy will yield similar results. In fact, here we don’t need weekly follow-ups. Instead, we hope to have monthly critical meetings with our customers to cut down on any risk of loan repayment defaults. Building up trust through constant contact works to reduce the risks, not the profile of the customer (Outlook 2014).
Bandhan seems to maintain its focus on monitoring as the primary remedy to stay away from bad loans. However it has to find ways to keep monitoring costs low and still keep the lending model viable with low NPAs. Its competitors now will be other banks who have at present much lower interest rates than what Bandhan charges. On the other hand, by accepting deposits, especially in savings and current accounts, Bandhan will be able to reduce its cost of funds substantially. It is expected that this reduction in costs would be reflected in a reduction in lending rates as well.
Bandhan will carry on its micro-loan activities through its existing 2,022 low-cost service outlets. The commercial bank will start operations with 600 branches. The existing 2,022 offices will act like spokes and the new branches will be hubs. About 200 of those branches will be in metro and urban areas, while the rest will be in semi-urban and rural areas and it will have a pan-India presence across 27 states.
Its functioning as a microfinance organisation is in areas where clients do not have any other options for financial access. Hence another challenge for them now would be to tailor their services carefully to deal with competition. Then there is the problem of lack of proper infrastructure, like electricity and internet connectivity in the remote areas which are core to banking services. At present Bandhan has a workforce of 13,000. It has recently hired more personnel for the banking services and a proper restructuring of the entire organisation is a mammoth task. As a bank, it will need to collect and manage voluntary deposits, train staff to handle multiple products, showcase greater skills in asset and liability management and treasury operations. How Bandhan handles this transition will be a test case for others and the Indian banking industry as a whole. We have to wait and watch as we move towards a new beginning in the Indian banking Industry.
