ABSTRACT BACKGROUNDThough India is one of the largest emerging markets for microfinance in the world, itcovers only one fifth of the country’s 75 million poor in need of financial assistance. Andof the total micro-credit demand estimated at Rs 150,000 crore, the actual disbursementtill now, according to the RBI, is only Rs 8,000 crore. That is the potential of microcreditin India. Sensing a large untapped market, even domestic and foreign retail banks areaggressively focusing on this sectorThe traditional image of lending to rural areas is one of a charitable activity conductedmostly by non-profit organizations and separate from the mainstream financial system.However, this image has been changing in India in the last few years as commercialbanks have been widely entering the sectorWhat's new is that India's biggest commercial lenders, such as HDFC and ICICI banks, aswell as the State Bank of India, have started to focus in on this sector in a serious way.Even multinational banks with operations in India like ABN Amro (ABN), StandardChartered (SCBFF), HSBC (HBC), and Citigroup (C) are moving into the microfinancesector.They are striking up partnerships with other microlending specialists in India, and thereis even talk of creating a secondary market for these loans. Microloans could be bundledtogether into larger bond issues and sold to Indian and global investors. If that happens,it could create the kind of liquidity that might take microlending in India into a higherrealm.The social need is definitely there. Despite India's spectacular growth this decade—itseconomy has clocked 8%-plus growth over the past three years—roughly 30% of India's1 billion-plus population lives below the poverty line.That's a huge market, and these bigger banks are discovering that lending smallamounts to credit-worthy rural borrowers is lucrative as well as socially progressive.Ranjan Ghosh, who heads financial institutions for India and South Asia at StandardChartered Bank, adds: "With fewer defaulters in this sector, clearly the risk return rate isacceptable to banks. We look at it as investment.Icici has set up more than 100 tie-ups with small-town lending specialists and has about3.2 million low-income customers. HDFC hopes to follow suit. Earlier this year, it createda microfinance unit with more than 100 employees and aims to double its lending levelsin rural India to $22 million.ABN Amro began microfinance operations in September, 2003, and has 24 Indianmicrofinance partners and $23 million in outstanding loans to this sector. Sarma predictsthe bank's lending to this sector will grow fivefold by the end of the decade. It hasalready surpassed the bank's microcredit operations in Brazil, which began four yearsago.Vijay Mahajan, who runs a leading microfinance lender called Basix in the southern stateof Hyderabad, thinks there is a $30 billion market for this kind of lending. There areabout 350 million Indians living in poverty conditions, and more than 100 millionhouseholds have no access to credit."SAFER ASSETS". For well-managed lenders with the right kind of credit-risk controls,there is a vast market for loans in the $40 to $200 range. And big banks want to supplantneighborhood money lenders who currently meet about 80% of that demand.The Reserve Bank of India wants the nation's major banks and foreign lenders operatingin India to complement the small-scale lending for small agricultural and business loans.It is also good business for Indian banks, given the diminishing market for lending tocompanies and consumers in major cities. "With cutthroat competition in the urbanmarket where basic credit is reaching a saturation point, banks are going into villages toseek safer assets," said Keya Sarkar, a board member of several microfinance

companies.Still, setting up an extensive rural base of branches is costly, so major banks are lookingfor tie-ups with established microlenders, who know local markets better and have grownincreasingly sophisticated. Typically, Indian banks have borrowed a page from GrameenBank in Bangladesh by lending money to local microfinance firms that have contacts insmall villages. They can identify worthy borrowers, which in many cases, means smallenterprises run by women.Some 30 million women have formed 2.2 million small businesses and another 400,000are expected to be in place by March, 2007, according to the National Bank ofAgriculture and Rural Development. About $2.48 billion has been extended to thesegroups, which predominantly run by women, over the last decade.Many lenders are also customizing their loans to reach out to more customers. ICICI isalso giving slightly larger loans to help families put their children through college. There'sa concern that's emerging that the standardized cookie-cutter approach that had takenmight not be suitable for all customers, hence the need to incorporate flexibility in loanproductdesign.Other products for the rural population are being rolled out, such as savings plans,insurance, and even mutual funds. For instance, UTI Mutual Fund has tied up with Bankof India to sell its array of mutual fund products through the bank's rural network. Add itall up, and microfinance seems to have a very robust future in India. Right now at least,small will continue to be beautiful for Indian banks that can get this market right.While this sector is growing fast in India, challenges must be addressed in order to makethis growth both effective and sustainable. Lending to this sector needs to become moreaccessible, more customized and more comprehensive.

Introduction:For the first time in history, India’s GDP has been growing at a rate greater than 8% forthree years in a row. However, many people are concerned about how inclusive thegrowth is i.e. whether this growth can be called “development”. This is becauseapproximately 400 million people in India still live below or close to the poverty line whichcould be roughly translated into 75 million households out of which around 60 million arerural household. So poverty in India has predominantly a rural character. While there areseveral structural dimensions to the rural poverty it is generally accepted that it arisesdue to the lack of capital or lack of surplus. The rural poor is perpetuating poverty andis the victims of the "vicious cycle of poverty"

On one hand, it is our responsibility to raise the quality of life of these people. On theother hand, taking a marketer’s perspective these masses represent a wholly untargetedmarket, especially, for banks and FIs i.e. a “Blue Ocean”. That's a huge market, andthese bigger banks are discovering that lending small amounts to credit-worthy ruralborrowers is lucrative as well as socially progressive.Even multinational banks with operations in India like ABN Amro, Standard Chartered,HSBC, and Citigroup are moving into the microfinance sector. They are striking uppartnerships with other microlending specialists in India, and there is even talk ofcreating a secondary market for these loans. Microloans could be bundled together intolarger bond issues and sold to Indian and global investors. If that happens, it couldcreate the kind of liquidity that might take microlending in India into a higher realm.Ranjan Ghosh, who heads financial institutions for India and South Asia at StandardChartered Bank, adds: "With fewer defaulters in this sector, clearly the risk return rate isacceptable to banks. We look at it as investment." Moumita Sen Sarma, head ofmicrofinance at ABN Amro Bank, says, "Even as it is part of our sustainabledevelopment agenda, the trigger has been the large number of poor people residing inIndia".The microfinance operations of most banks are also registering strong growth rates.ABN Amro began microfinance operations in September, 2003, and has 24 Indianmicrofinance partners and $23 million in outstanding loans to this sector. Sarma predictsthe bank's lending to this sector will grow fivefold by the end of the decade. It has

already surpassed the bank's microcredit operations in Brazil, which began four yearsago.This study intends to study the rural banking strategies of banks with an emphasis onmicrofinance in India. First we will study the basics of Microfinance and the prevalentrural banking scenario. Then we will move on to studying strategies of two major privatebanks in India – ICICI Bank and HDFC.

I. ABOUT MICROFINANCEMicro finance includes thrift, credit and other financial services and products of verysmall amount. Micro Finance (MF) has now been widely accepted as an effectiveintervention strategy for poverty alleviation, which is easily accessible to the poor,reduces transaction cost and where repayments are designed to fit cash flow for theborrowers. The MF paradigm also fitted well with the adage of ‘Growth with Equity’,

which is integral to the neo-liberal agenda for linkages with the market.

Community Based Investor OwnedCommunity ManagedCommunity (self) financedIntegrated (social &finance)Non profit / mutual benefitOnly for poor'Self regulated'

Professionally managedAccepting outside funds for onlendingMinimalist (finance only)For profitFor all under served clientsExternally regulated

The four pillars of microfinance credit system (Fig. 1) are supply, demand for finance,intermediation and regulation. Whatever may the model of the intermediary institution,the end situation is accessibility of finance to poor. The following tables indicate theexisting and desired situation for each component.

DEMAND

Existing Situation Desired SituationfragmentedUndifferentiatedAddicted, corrupted by capital &subsidiesCommunities not aware of rights andresponsibilities

OrganizedDifferentiated (forconsumption, housing)Deaddicted from capital &subsidiesAware of rights andresponsibilities

SUPPLY

Existing Situation Desired SituationGrant based (Foreign/GOI)Directed Credit - unwillingand corruptNot linked with mainstreamMainly focussed for creditDominated

Regular fund sources(borrowings/deposits)Demand responsivePart of mainstream (banks/FIs)Add savings and insuranceReduce dominance of informal,unregulated suppliers

INTERMEDIATION

Existing Situation Desired SituationNon specializedNot oriented to financial analysisNon profit capitalNot linked to mainstream FIsNot organized

Specialized in financial servicesThorough in financial analysisFor profitLink up to FIsSelf regulating

REGULATION

Existing Situation Desired SituationFocussed on formal service providers(informal not regulated)regulating the wrong things e.g. interestratesMultiple and conflicting (FCRA, RBI, IT, ROC, MOF/FIPB, ROS/Commerce)Negatively oriented

include/informal recognisee.g. SHGsRegulate rules of gameCoherence and coordinationacross regulators Enabling environment

I.1. PotentialVijay Mahajan, who runs a leading microfinance lender called Basix in the southern stateof Hyderabad, thinks there is a $30 billion market for this kind of lending. There areabout 350 million Indians living in poverty conditions, and more than 100 millionhouseholds have no access to credit. For well-managed lenders with the right kind ofcredit-risk controls, there is a vast market for loans in the $40 to $200 range. And bigbanks want to supplant neighborhood money lenders who currently meet about 80% ofthat demand. It is also good business for Indian banks, given the diminishing market forlending to companies and consumers in major cities. "With cutthroat competition in theurban market where basic credit is reaching a saturation point, banks are going intovillages to seek safer assets," says Keya Sarkar, a board member of severalmicrofinance companies.Some 30 million women have formed 2.2 million small businesses and another 400,000are expected to be in place by March, 2007, according to the National Bank ofAgriculture and Rural Development. About $2.48 billion has been extended to thesegroups, which predominantly run by women, over the last decade.I.2. Risk Return Profile"They have realized that the Indian poor are bankable," says Vikram Akula, head ofSKS, a leading microfinance lender. The Reserve Bank of India wants the nation's majorbanks and foreign lenders operating in India to complement the small-scale lending forsmall agricultural and business loans.I.3. Issues & Challenge

§ High Administrative Cost: Setting up an extensive rural base of branches iscostly, so major banks are looking for tie-ups with established microlenders,who know local markets better and have grown increasingly sophisticated."What's also helped is the maturing of the intermediaries in India's decadeoldmicrofinance industry," says Mahajan of Basix. Typically, Indian bankshave borrowed a page from Grameen Bank in Bangladesh by lending moneyto local microfinance firms that have contacts in small villages. They canidentify worthy borrowers, which in many cases, means small enterprises runby women.§ Need for Flexible & Customized Products: Many lenders are alsocustomizing their loans to reach out to more customers. That's the reason forICICI Bank's $130 loan to that family in Uttar Pradesh. ICICI is also givingslightly larger loans to help families put their children through college."There's a concern that's emerging that the standardized cookie-cutter

approach that we had taken might not be suitable for all customers, hencethe need to incorporate flexibility in loan-product design," says ICICI's Mor.Other products for the rural population are being rolled out, such as savingsplans, insurance, and even mutual funds. For instance, UTI Mutual Fund hastied up with Bank of India to sell its array of mutual fund products through thebank's rural network. Add it all up, and microfinance seems to have a veryrobust future in India. Right now at least, small will continue to be beautiful forIndian banks that can get this market right.

I.4.Self-help Groups (SHG)There may be various medium of micro finance; however, the most prominent amongthem has been the medium of SHGs. So much so that for many, Microfinance and theconcept of Self Help Groups go together. The SHG movement added a very significantdimension as it was to be linked with the micro finance. Let us now briefly look at SHGsand their role in rural finance sector.

The uniqueness of these groups lies in the fact that to a large extent they are selfsupportingself-governing organizations free from bureaucratization and politicization.The process empowers the poor and enables them to control direction of owndevelopment by identifying their felt needs.Characteristics of SHG: Homogeneity has been the strongest feature of SHGs. Themembers are linked by a common bond like caste, sub-caste, community, the place oforigin or activity. Even if the group members are from similar economic activity, saypottery, the basis of group affinity is a common caste or origin. Therefore, the nature ofthese groups is slightly different from what is globally known as ‘solidarity groups’In 1992, national bank (NABARD) gave a fillip to the movement when it started the SHGBanklinkage programme. This was the first major attempt to link the mainstreamfinancial institutions with the informal groups, thereby, linking them with the market. Italso aimed at the re-assertion of the basic principle that the magic of market succeedswhere the governmental intervention failed. This belief is based on the certain structuraladvantages of the mF in the SHG mode:• Financing becomes cost effective According to a study conducted by NABARD,there has been a 40 per cent reduction in transaction cost for banks due toexternalizing banks’ responsibilities in identification of clients, assessment of riskprofile, loan monitoring and recovery• Borrowing becomes cheaper. The borrowers’ transaction cost declined by 85 percent with doing away of complex documentation and procedures and opportunitycost of wage loss due to repeated visits to banks• Easy accessibility due to door step delivery of the credit• Credit is long-term and continuing in nature• Peer pressure and peer monitoring act as intangible collateral; consequentlyrepayment rates are high• Avoidance of high cost intermediation between bankers and client by creditbrokers• The sense of ownership of the programme due to community involvement. Thepeople themselves take their credit decisions

• Positive impact on the qualitative dimensions through empowermentWeaknesses of the SHGThere are certain inherent weaknesses of the SHG mode of intervention. Such anintervention is being marketed as a ‘tool kit’ for poverty alleviation and tends to ignore

larger structural bottlenecks like inadequate agricultural infrastructure-irrigation, roadsand highly in egalitarian distribution of land.Given the preoccupation with regularity of repayment, the credit programme shows aclear bias towards activities like petty trading (Due to daily cash flows), which do notresult in significant value-addition to promote capital formation.Solidarity is an expensive input for financial services production as the costs of groupformation and interaction outweigh the benefits of high repayment with group control.The mFIs are generously assisted by grants and cheap credit. SHARE had a grantcomponent to the tune of 69 per cent of their total fund in 1998. It is thus anticipated thatto be effective and productive, the promotion of SHG for ensured assess credit isnecessary.I.5. Literature ReviewLet us now look at relevant findings of an extremely insightful study on Microfinance byBasix a Hyderabad based NGO in the field2.The Demand for Microfinance ServicesWith a population of 1000 million, India has nearly 400 million people below or justabove an austerely defined poverty line. Thus, approximately 75 million householdsneed micro-finance. Of these, nearly 60 million households are in rural India and the remaining 15 million are urban slum dwellers. The current annual credit usage by thesehouseholds is estimated to be Rs 495,000 million or US$ 12 biilion!• Annual credit usage by 60 million rural poor households at an average of Rs6000 is Rs 360,000 million per annum - about two-thirds for consumption andone-third for production needs (Based on a 1994 study carried out by the VijayMahajan and Bharti Gupta for the World Bank. The number has been rounded offand adjusted for 1998 prices).• Annual credit usage by 15 million urban poor households at an average of Rs9000 is Rs 135,000 million per annum - about 55percent for consumption and 45percent for production needs. (Based on a 1995 study carried out by the firstauthor for the SEWA Bank. The number has been rounded off and adjusted for1998 prices).The Demand Supply GapBridging the demand supply gap, even at high growth rates requires an environment thatattracts large numbers of microfinance providers. The approach recommended by Basixis a "three track approach", using mutually complementary strategies:• Incentivising existing mainstream FIs to enter microfinance seriously, byestablishing a supportive policy and regulatory environment.• Encouraging new microfinance institutions (mFIs) with a supportive policy andfinancial resources to enlarge and expand their services.• Building a strong demand system in the form of community-based developmentfinancial institutions (CDFIs), with the help of NGOs and others. Such a system isrequired to• convert latent demand into effective demand,• wean away microfinance customers from moneylenders,• remove the expectation of low interest rate and capital subsidies that havespoiled borrowers over the years • restore the repayment norm, and• build local stake in grassroots financial structuresThese CDFIs may be unregistered or registered. If registered, they may choose to besocieties, trusts, mutually aided cooperative societies (MACS) or even non-bankingfinance companies (NBFCs).I.5. Present Structure of Rural Finance

Let us now look at the present structure of rural finance sector in India, the rolesperformed by various institutions in the sector, and the evaluation of the present systemto find the problems and the drawbacks with the present structure. We begin by lookingat the institutional structure.

Institution Background CumulativeDisbursement(Rs million)

CumulativeIntermediaries(Number)

Access(Number)

National Bankfor Agricultureand RuralDevelopment(NABARD)

An apex refinanceinstitution set up in1982. Has promotedlinkage of self helpgroups with bankssince 1992. Data forSHG linkageprogramme only.

Mar 98: 214Mar 97: 118

Mar 98: 260Mar 97: 220

Mar 98:250,000(SHGslinked14,283)Mar 97:150,000(SHGslinked8,598)

Small IndustriesDevelopmentBank of India(SIDBI)

Set up in 1990. MicroCredit Scheme (a smallportfolio) started inMarch 1994.

May 98: 57(Sanctions Mar98: 166)

Mar 98: 116Mar 97: 79Mar 96: 47

Mar 98:89,000Mar 97:61,600Mar 96:20,900

HousingDevelopmentFinanceCorporation(HDFC)

Mainly involved inhousing financeincludingto low incomegroups through NGOssince 1992. Started support to Microfinanceinitiatives in1997

Jun 98: 1020 –sanctioned808 – disbursed,all of it except 8, for low incomehousing

Jun 98: 75 Jun 98118,000

RashtriyaMahila Kosh(RMK)

Department of Womenand Child Development(Govt. of India). Set upin March 1993 withcorpus of Rs 310million.

Apr 98: 353(Outstanding inMar 98: 160)

April 98: 257 April 98:250,462

The Existing Rural Finance SectorAs far as the formal financial institutions are concerned, there are Commercial Banks,Housing Finance Institutions (HFIs), NABARD, Rural Development Banks (RDBs), LandDevelopment Banks Land Development Banks and Co-operative Banks (CBs).As regards the Co-operative Structures, the Urban Co.op Banks (UCB) or Urban CreditCo.op Societies (UCCS) are the two primary co-operative financial institutions operatingin the urban areas. There are about 1400 UCBs with over 3400 branches in India having14 million members, Their total lending outstanding in 1990-91 has been reported atover Rs 80 billion with deposits worth Rs 101 billion.Similarly there exist about 32000 credit co.op societies with over 15 million memberswith their total outstanding lending in 1990-91 being Rs 20 billion with deposits of Rs 12billion.Few of the UCCS also have external borrowings from the District Central Co.op Banks(DCCBs) at 18-19%. The loans given by the UCBs or the UCCS are for short term andunsecured except for few which are secured by personal guarantees. The most effectivesecurity is the group or the peer pressure.The Government has taken several initiatives to strengthen the institutional rural creditsystem. The rural branch network of commercial banks have been expanded and certainpolicy prescriptions imposed in order to ensure greater flow of credit to agriculture andother preferred sectors. The commercial banks are required to ensure that 40% of totalcredit is provided to the priority sectors out of which 18% in the form of direct finance toagriculture and 25% to priority sector in favour of weaker sections besides maintaining a credit deposit ratio of 60% in rural and semi-urban branches. Further the IRDPintroduced in 1979 ensures supply of credit and subsidies to weaker sectionbeneficiaries. Although these measures have helped in widening the access of ruralhouseholds to institutional credit, vast majority of the rural poor have still not beencovered. Also, such lending done under the poverty alleviation schemes suffered highrepayment defaults and left little sustainable impact on the economic condition of thebeneficiaries.Following risks are generally perceived by the formal sector financial institutions:• Credit Risk• High transaction and service cost• Absence of land tenure for financing housing• Irregular flow of income due to seasonality• Lack of tangible proof for assessment of income• Unacceptable collaterals such as crops, utensils and jewelleryThe Existing Informal financial sources:The informal financial sources generally include funds available from family sources orlocal money lenders. The local money lenders charge exorbitant rates, generally rangingfrom 36% to 60% interest due to their monopoly in the absence of any other source ofcredit for non-conventional needs. Chit Funds and Bishis are other forms of creditsystem operated by groups of people for their mutual benefit which however, have theirown limitations.Lately, few of the NGOs engaged in activities related to community mobilizations for theirsocio-economic development have initiated savings and credit programmes for theirtarget groups. These Community based financial systems (CBFS) can broadly becategorised into two models: Group Based Financial Intermediary and the NGO LinkedFinancial Intermediary.The Present Legal and Regulatory Structure of Rural Finance – a critical Analysis

There are many aspects of the existing legal and regulatory framework which discourage

mainstream FIs from increasing outreach and achieving sustainability in microfinance.Further growth in microfinance can only be possible by redressing these limitations inthe legal and regulatory framework. Mainstream FIs find it difficult to significantly expandinto microfinance for the following reasons:• Policy makers’ view of the market for microfinance services stems from over a100 years of attempts to get farmers out of the clutches of "usurious"moneylenders. Thus, it is accepted wisdom that farmers and poor people needlow interest, subsidised credit. This shows up in policy: interest rates for loansbelow Rs 25,000 and Rs 200,000 by commercial banks are still capped at 12 and13.5 percent respectively. Some attendant beliefs are that the poor cannot save,they are unwilling to repay loans, and administrative costs of serving them arehigh.• Consequently microfinance has historically been seen as a social obligationrather than a potential business opportunity. The leadership and managers ofmainstream FIs see the microfinance market as difficult to serve, risky andhaving a low or negative net spread. Contributing to this position has been thefact that small loans (IRDP, DIR, SC/ST) have been utilised historically as a toolfor disbursing political patronage, undermining the norm that loans must berepaid. This has made bankers cynical about lending to the poor.• There are specific problems with legislation: for example the NABARD Act doesnot allow it to refinance any private sector FI and do any direct financing(NABARD’s direct lending to micro-finance NGOs so far has been out of donorfunds) NABARD also refinances commercial banks/RRBs/cooperative banks wholend to mFIs. Similarly, the SIDBI Act restricts it from extending loans to theagricultural and allied sectors, whereas many of the members of self-help groupsare engaged in such activities.• The Regional Rural Banks Act does not permit any private shareholding in anyRRBs, and the Cooperatives Acts of all states do not permit district level coop • banks to be set up except by the state government. The result of these two lawstogether is that rural credit has been a monopoly of state owned institutions.Some suggestions to improve the legal and regulatory framework• Deregulation of interest rates for all small loans and supporting the policy thatsmall loans can indeed be charged a higher rate.• Delinking poverty alleviation subsidised government programs from banks andmFIs.• Removing the government’s monopoly on establishing formal institutions in therural sector. This includes privatising RRB and allowing independent Rural CoopBanks on the lines of independent Urban Coop Banks. The LAB policy shouldalso be implemented.• Modification of the NABARD and SIDBI Acts to legitimately allow these apexbodies to finance mFIs as part of their regular operations and not as"promotional" activity.

Main text:As per the study done the rural banking strategies of some leading private banks isillustrated in the following pages:II. ICICI Bank – Rural StrategyWe believe that to break into the top league of global banks, ICICI will have to follow acourse that few banks in the world have done — and that is, leverage the rural economy.

- K V Kamath, Chairman ICICI Bank.II.1.The Opportunity:The opportunity as perceived by ICICI bank is best described in the following3:§ Though agriculture constitutes only 20% of India’s GDP, rural economy(agricultural + non agricultural) constitutes about 50% of GDP§ Rural population of about 780 million with limited access to financial servicesII.2. Challenges:Following are the major challenges identified§ Nature of demand§ Doorstep banking§ Flexibility in timings§ Low value and high volume of transactions§ Require simple processes with minimum documentation§ High costs of delivery through conventional§ ChannelsLooking at the above challenges, the bank evolved a comprehensive strategy tosucceed in the peculiar market of rural banking. The strategy at top level can be seen astwo pronged i.e. that of both Organic and Inorganic growth.II.3. Organic Growth Strategy:More than just aggressive, ICICI Bank’s rural banking strategy can be dubbed as highly“proactive” and “innovative” especially considering the prevalent banking scenario inIndia. The beauty of the strategy lies in the fact that it is in perfect synchronization ofrural realities on one hand and the bank’s strengths on the other.Comprehensive Channel StrategyØ Multiple channels targeting specific segments of the rural population

Ø Branches at major agricultural marketsØ Franchisees, internet kiosks, MFI & corporate partnersComprehensive product strategyü Suite of six key credit products: farmer financing, farm equipment financing,working capital loans, jewel loans, commodity based financing and microcreditü Savings and investment productsü InsuranceThe culmination of the whole strategy comes in the following words which should beconsidered as a meaningful contribution to marketing literature:“No White Spaces: Penetrate a cluster with all channels and products”.Let us now try to study this strategy in some detail.ICICI Bank has divided the rural market into R1, R2, R3 and R4 categories for identifyingthe rural markets. R1 and R2 represent the rich farmers, while R3 and R4 represent thepoor landless laborers. “ICICI Bank plans to increase its points of delivery five times -from 3,500 to 17,500 by March 2006,” said ICICI Bank executive director Nachiket Mor.He said the total demand for microfinance was around Rs 45,000 crore, while the supplywas just about Rs 2,000 crore. The bank will support over 200 microfinance institutions(MFIs) in creating an asset base of Rs 2,00,000 crore and also rollout “penetrationstrategy” to cover 60 districts in the country. ICICI Bank is significantly moving aheadwith its rural networking plan. Nachiket Mor, executive director, said, “There is immensepotential in the rural market. The requirement may be setting up around 100 ‘touchpoints’ in every district. So far, they have been able to establish 8,000 touch points.”“Our model for rural business will be establishing touch points, so that every rural citizencan access banking facility within decent distance. The aim is to have one franchise in

every block in the country. We may not end up with all the blocks but it will demanddriven,” he explained.About the bank’s strategy of reaching out to rural population through touch points, Morsaid informal credit in India was $82 billion, with around 780 million rural population withlimited access to financial services.

Around 400 million people do not have any access to financial service. The yearly creditdemand from poor and marginal poor population was around Rs 1,50,000 crore out ofwhich Rs 4,000 crore was actually met, he added. So their challenge is to invent a newbusiness model where they can create a distribution base effectively in 600,000 villagesin India, and to learn to do that at one-tenth the cost of urban India. Just to put that on ascale that someone could understand, they believe that to succeed in urban India, theyneed to do be able to do business at one-tenth the cost of the West. The reason is thatthe ticket size of the banking product in India is one-tenth that in the West. If it is adeposit of $10,000 in the West, it will be $1,000 in urban India and $100 in rural India.Loans operate at a similar scale.They will have to be able to work with partners because they believe that the branch-ledmodel will not work in this context. The branch-led model would simply replicate theirexisting structure. “The bank will be looking for franchise partner who will be willing todeliver full range of products to its customers,” Mor said.That is why they need to work with partners who are either already present in the localcommunity or who need to be there. For example, they might partner with a localfinancial institution, a micro-finance agency or a company — someone who is already inthe village for a business purpose. They might even partner with someone who is sellingfertilizer or seed or tractors. How can they leverage these partnerships to do business?That question drives the need for a new business model to reach out to this market. Ifthey can do this the rewards could be enormous.Meeting this challenge of lending to India's farmers also involves other complexities.Agriculture here heavily depends on the monsoons or rains. The biggest risk is thefailure of the monsoon. Now can you lend to rural India without fixing this risk? Whatthey did was to ask if this was an insurable risk. Could they get such insurance? Theanswer was yes. Could they then sell this insurance to the farmers? Again, the answerwas yes. Finally, they asked if this insurance could be further reinsured outside India sothat the risk was shared even more widely. Yet again, the answer was yes.

This strategy allowed them to develop a viable proposition where they could scale up therural lending model realistically. I don't believe anyone has implemented this modelbefore. The typical approach to rural lending has been through micro-loans, and that hascertainly had some degree of success. But a large-scale rural banking model where youare ultimately trying to reach a population of 600 million people has not been done. Thatis their challenge -- and also their opportunity.Let us take a specific instance. While foraying in the rural areas ICICI Bank encountereda particular problem. The bank had financed 200,000 villagers across the country to buybuffaloes. But these customers were unwilling to buy more than two to four buffaloes.The bank could not convince these customers to increase their stock to a sizeablenumber, such as 20 buffaloes. The rationale of the villagers was simple. More buffaloeswould mean hiring additional help to look after the herd.On the contrary, four buffaloes can be managed by the family members. Then, thebuffaloes could be accommodated in a small courtyard, rather than building a large shedfor the herd.Importantly, as Nachiket Mor, executive director, ICICI Bank points out, "The implication

of a financial risk is high when you own a large herd."The bank embarked on a pilot project with a company that supplies cattle feed. Around150 rural households who were the bank's customers were covered during this trialphase.Buffaloes owned by these households were put on a diet of cattle feed supplied by thecompany and the milk yield from these buffaloes increased by 50 per cent."We could now give loans for fodder. We had discovered a market for a new product,"says Mor. The company now plans to tap its existing client base (200,000 buffaloowners) for fodder finance.

"In a rural finance strategy it's important to find viable revenue chains," says Mor.The bank is also looking to provide a bundle of services i.e. looking at cross sellingopportunities. Provision of financial services to rural and urban poor is their most recenteffort. In this area, we have gone from serving fewer than 25,000 clients with less than$5 million of assets a few years ago, to over 2.5 million clients and about $350 million ofassets at the end of the current year. To this market, in addition to credit products, wehave also been able to sell over 1 million insurance policies comprising principally life,health, personal accident and weather insurance policies. However, India is a market ofover a billion people with anywhere between 300 million to 400 million un-banked. Thenumbers that we have achieved, while apparently large, barely represent a beginningand we have a very long journey ahead. I want to take this opportunity to briefly sharewith you how we have gone about addressing this market and what their plans for thefuture are.

Development of the Partnership ModelNo White Spaces (NWS)Starting with the Partnership Model we have gradually developed a comprehensive planfor the provision of financial services within rural India with a hybrid channel and productstructure designed around one coordinating branch per district, with franchisees, internetkiosks and micro finance institutions forming an interdependent delivery chain to delivercredit, savings, insurance and risk management products to the full range of ruralcustomers. The aim, over the next three to four years, is to go to 450 of the 640 districtsthat make up rural India with this No White Spaces (NWS) approach under which noindividual would be more than 5 to 10 kilometres away from an ICICI Bank touch point.This model allows them to offer a complete suite of products, with all of the necessarydocumentation and technical support close at hand, to the micro finance customer andsmoothly opens up graduation possibilities should an MFI client want to move to a levelof credit and other financial services that the MFI is not comfortable providing through itsown branch network. It also allows them as a bank to participate not just in lending to individuals but also in rural infrastructure finance and rural corporate finance5—both verynecessary for the comprehensive growth and development of rural India.Launch of the Centre for Micro Finance (CMF), Centre for Insurance and RiskManagement (CIRM), Small Enterprise Finance Centre (SEFC) and the Centre forDevelopment Finance (CDF) at the Institute for Financial Management andResearch (IFMR) in ChennaiThese centres have been launched with the help of leading finance and economicsprofessors from MIT, Harvard, Yale University and Columbia at IFMR in Chennai6.These Centres are staffed by well trained researchers and practitioners from around theworld and have the objective of carrying out product design, action-research, impactevaluation, training and course design and consulting in each of their areas of focus andwill be important partners of ICICI Bank in helping it fulfil its financial inclusion objectives.These Centres are in part sponsored by ICICI Bank but are completely independent and

are free to publish all their findings and work with all the other players in the system7.With the help of these centres an intensive development effort in areas such as healthinsurance for the poor, livestock insurance, livelihood partnerships, individual and smallenterprise lending and financing of rural infrastructure has already been launched.Facilitating the launch of FINO and www.MicroFinanceJobs.comTechnology both at the client interface end and the back-end has been identified as akey impediment to the growth of MFIs, along with a shortage of trained manpower. FINOhas been conceived of an ASP (Application Services Provider) platform which willprovide advanced banking and front-end technologies such as smart cards andbiometric POS (Point-of-Sale) terminals and will be formally launched shortly on acommercial scale – Proof-of-Concept Pilots have already been successfully completedat three MFI locations. An attempt is also being made to see if FINO can partner with theNational Bank for Agriculture and Rural Development (NABARD) and an internationallyaccredited Credit Bureau to launch a national rural identify card and a rural creditbureau.The micro finance job site is expected to recruit over 2,50,000 suitably qualifiedindividuals for these 200 MFIs in partnership with CMF’s MFI Strategy Unit (MSU) andprovide them with all the necessary training. In addition to seeking applicants from the market, it proposes to tie up with a number of local business schools so that graduatingMBA can find an opportunity to work in an MFI which is based in his or herneighbourhood itself—this will ensure that these employees will pursue longer-termcareers with the MFI and will come with, in addition tobusiness skills, a strong facility with the local language of the region.Launch of Grameen Capital India (GCI) to Provide Capital Market Solutions to MFIs andprovision of Equity Buy Back Loans to Assist Venture CapitalistsGCI is a joint effort between Grameen Foundation of USA, ICICI Bank and Citibank inIndia, to develop a deep domestic and eventually a global capital market for MFI issuedpaper, including straight bonds, Micro Finance Asset Backed Securities (MFABS) andEquity. GCI is expected to launch formally shortly and will act both as a credit guaranteecompany and a dedicated investment bank for MFIs. The MFI Strategy Unit (MSU) of theCentre for Micro Finance (CMF) at IFMR is also developing comprehensive consultingcapabilities in this area that it will offer to MFIs.ICICI Bank has also offered a committed equity-buy-back loan facility so that MFIs maybe able to repurchase the equity invested by Venture Capitalists (VCs) into new MFIs,offering both a take-out and a reasonable rate of return to the VCs.

IDBI Bank’s rural initiatives:Inorganic strategy:The amalgamation of United Western Bank (UWB) with Industrial Development Bank ofIndia is likely to change the rules of the game in the banking space. The merger ismarkedly different from takeover of Global Trust Bank and Nedungadi Bank by healthierrivals. In both the cases, shareholders went away without any consideration for the sharessurrendered.Apart from synergies to the participating banks, the IDBI-UWB merger is likely to be apositive for old private sector banks.A good fit for IDBI .The amalgamation of UWB with IDBI is likely to add value to the latter over the longterm. The merger is likely to help IDBI expand its retail presence, though its size may notincrease substantially.Of the several benefits the deal brings, we believe access to the branch network is mostsignificant. IDBI, with a balance-sheet size of Rs 81,700 crore, has a network of 181branches now. It scores poorly on this parameter compared to like-size peers. The merger would give IDBI immediate access to the 230-branch network of UWB, therebywidening its deposit franchise.

For IDBI, growing at 25 per cent over the past two years, addition of branches wouldhelp sustain the momentum. Deposits may expand by over 20 per cent and the asset baseby about 10 per cent. The Reserve Bank of India's (RBI) strict licensing norms thatrestrains opening new branches has placed a scarcity value on branches. The mergerwould, therefore, give IDBI access to a ready physical infrastructure, enabling it tomobilise low-cost funds.Second, the merger with UWB is likely to help IDBI diversify its credit profile.Dominant in industrial financing, IDBI should get exposure to agriculture credit throughUWB;nearly half the number of UWB its branches is in semi-urban and rural areas, andshould complement IDBI's loan book.The third aspect relates to the benefit of an improved deposit mix for IDBI. As it

manages its transformation from a financial institution to a commercial bank, it finds about 60 per cent of the liabilities in the form of long-term borrowings. Low-costdeposits are just about 9 per cent of the total. This perhaps explains IDBI's low netinterest margins (0.5 per cent versus industry average of three) and the high cost of funds(6.5 per cent versus the industry average of five). In this backdrop, the access to UWB'slow-cost deposit base should prove advantageous for IDBI in the long run.The IDBI itself lends heavily to SSI: the total assistance provided by it to the VSI sectorup to March, 1986 was Rs. 52850 million. Its annual financing has doubled between1979/80 and to 1982/83 when it reached Rs. 2902 millions, which included refinancing ofadvances made by other institutions.The interest rate charged by IDBI for refinance differs for various purposes. It is as lowas 6 percent in specified backward areas but range between 8.25 and 9.58 percent in nonbackwardareas.The IDBI is one of the apex financial institution providing assistance to industries of alltypes and sizes. IDBI has now established a separate Rs. 25 billion fund called “SmallIndustries Fund” to take over the bank's own existing and future assistance to SSIs. Thisnew fund is expected to pay particular attention to “micro” industries.In order to ensure that financial institutions do lend to small-scale industries, the ReserveBank of India requires all Commercial Banks and other financing institutions to ensurethat at least 12.5 percent of the total credit advances is reserved for weaker sections likerural artisans, village craftsmen, or cottage industries.The bills rediscount scheme is operated by the Industrial Development Bank of Indiawhich covers bills/promisory notes arising out of sales of indigenous machinery on adeferred payment basis. Bills/Promisory notes drawn in favour of or by the machinerymanufacturers are in the first instance discounted by them with their banks which in turn rediscount these bills with the IDBI at concessional interest rates of from 9 to 10.25percent.

IDBI begins identifying needy farmers 7:IDBI Bank has started implementing the recentl policy initiatives on credit flow toagriculture by bringing in at least 100 new peasants under its lending operations for eachof its rural operations.The bank has started implementing the recently announced policy initiatives for doublingflow of credit to agriculture within the next three years and to achieve at least 30 per centgrowth in disbursement under agriculture credit. The bank had initiated steps to identifyfarmers who had suffered due to natural calamities, to reschedule or offer fresh finance asper RBI guidelines.The bank has also adopted few villages for providing community TV, solar energy-basedstreetlights and water coolers/fans to schools.IDBI has new scheme for farmers 8:IDBI has launched a new scheme to supplement farmers' incomes.Under the scheme, farmers are provided with credit for meeting expenditure on growingcrops, rearing animals and for purchase of farm assets like tractors, pump sets and farmequipment.

Besides, loans are also provided for non-farm sector activities like processing, storage,

post-harvest technology.Farmers who are owner-cultivators, tenants, lessee or allottee farmer with recordedoccupancy rights or farmers with ancestral/perpetual rights of cultivation are eligible forloan either individually or in groups under this scheme.A IDBI release said that need-based credit would be provided to the farmers in the formof cash credit, term loan, overdraft and composite loans.

HDFC Bank is possibly the only bank in India, and one of the very few in Asia, to haveembarked on a data-led marketing analytics campaigns initiative, using marketingautomation technology provided by Unica. Through this tool, bank has been able tointelligently use the 4-5 terabytes of customer data available in its warehouse. The bankhas set up a team to conduct marketing campaigns in a scientific manner using customerdata, usage patterns, preferences, lifecycle, etc, the bank also conducts event-basedmarketing.”There are several factors that are taken into consideration while selecting a bank, such astrust, service, number of products available, etc. And, last but not the least, a trait that thebank share with the hotel industry – location of its branches and ATMs. They have to benear the residence or offices of the bank’s customers. However, that is slowly changingwith the advent of the other direct banking channels like Home Banking, MobileBanking, Net Banking, etcHDFC Bank's aim so far has been clear. It wants to build sound customer franchiseesacross distinct businesses so as to be the preferred provider of banking services in thesegments that the bank operates. How does the bank hope to attain this goalThis now includes agricultural and rural sectors as well. HDFC Bank is targeting thissector through its 115 semi-urban branches. The bank follows the "supply chainmanagement" method.The bank targets the rural customer in the following way:Yes, it is much discussed in the banking circles. That is because urban markets hadreached saturation point for the banking sector in general. Any institution should looktowards the rural market The rural-urban divide and lower levels of per capita income coupled with lack of properconnectivity do become a major hindrance for technology-driven banks like HDFC Bank.The bank, however, is trying out several new information technology initiatives to reachthe rural customer.There was tremendous opportunity in the rural area, which could be tapped with properinfrastructure and specialised marketing.HDFC Bank plans to partner with non-banking finance companies and micro-financecompanies to reach the rural areas. Syndicating their services will be necessary for thebank.

The bank is lagging behind in its agriculture sector lending targets. Given the emphasisfrom the Finance Ministry and the Reserve Bank of India, on this sector over the past fewmonths, more needs to be done.Of the 18 per cent outstanding loans to the agriculture sector and a 13.5 per cent lendingtarget for direct lending to the sector during 2004-05, HDFC Bank has attained around 10per cent growth.The bank has met its indirect lending targets by investing in rural bonds and throughNABARD. The bank hopes to meet its target during this fiscal.HDFC Bank on oct 18th launched a corporate credit card for the small and mediumenterprises (SME) segment jointly with MasterCard9. The card, christened HDFC BankPowerPlus BusinessCard, can be used to pay for business expenses and is linked to thecash credit account of the company.

The credit limit for the card is Rs 25 lakh per company. Each company will get fiveindividual cards for their employees. Each individual card has a maximum limit of Rs 5lakh and minimum limit of Rs 2 lakh.The annual fee is Rs 25,000 and joining fee is Rs 500. The interest rate on the card is 1.5per cent per month.Other benefits include 50 per cent discount on 10,000 hotels worldwide, and insurancecover up to Rs 1 lakh in the case of lost or stolen cards.The bank's SME portfolio is now 15 per cent of the corporate portfolio. While thecorporate portfolio is expected to grow 20-25 per cent year-on-year, the SME segment islikely to grow at 50 per cent.Since the card is used solely for business purposes, any finance charges incurred may betax-deductible. The monthly statements will clearly show the business expenses and helpthe companies claim tax exemptions, said Mr K.S.V. Padmanabhan, Senior Vice-President, HDFC Bank.HDFC Bank has around two million cards, said Mr Pralay Mondal, Senior Vice-President, Head, Credit Cards. "For this card, we are looking at spending and penetration,not absolute numbers," he said.

Conclusion:The nation has been experimenting with various alternatives to reach the bankingservices, primarily credit, in rural areas through several initiatives. Early initiatives in thisregard were taken by building an institutional framework beginning with the focus on thecooperative credit institutions followed by the nationalisation of major domestic banksand later the creation of the Regional Rural Banks (RRBs). Simultaneously, severalmeasures including establishment of the Lead Bank Scheme, directed lending for thePriority Sectors, banking sector's linkage with the Government sponsored programmestargeted at the poor, Differential Rate of Interest Scheme, the Service Area Approach, theSHG-Bank linkage programme and introduction of the Kisan Credit Card were taken.Given the social responsibility to reach the rural areas and the poor, the banks and cooperativeinstitutions with guidance from the Reserve Bank of India (RBI), the NationalBank for Agriculture and Rural Development (NABARD) and other apex levelinstitutions made serious efforts in meeting the needs and demands of the rural sector. As

a result, the outreach of Indian banking system has seen rapid growth in rural areas. In sofar as all the Scheduled Commercial banks (SCBs) including RRBs are concerned, 48percent of their total branches (32,3031 branches which translates to a population ofabout 23,000 per branch), 31 percent (13.67 crore) of their deposit accounts and 43percent (2.55 crore) of their borrowal accounts are in the rural areas. Such anunprecedented expansion of the formal financial infrastructure has reduced thedependence of the rural populace on the informal money lending sector from 68.3 percentin 1971 to 36 percent in 1991. (All India Debt and Investment Survey, 1991). However,there continues to be wide gaps in the availability of banking services in the rural areas asthe SCBs have covered only 18.4 percent of the rural population through savings/deposit accounts and even a lower percentage of 17.2 percent of the rural households,10 by wayof loan accounts. Though the Primary Agriculture Credit Societies (PACS) with aboutone lakh outlets4 have a deep and wide presence in rural India their impact in terms ofextension of deposit and credit products has not only been minimal but concentrated in afew states only. The decline in productivity of the rural branches of the commercialbanks, fragility of the co-operative credit structure and weakness of RRBs witnessedsince early the 90s, have further accentuated the problem of inaccessibility of bankingservices for a large part of the rural population. Furthermore, as the banking sector hasshown propensity towards the larger size accounts, the number of loan accounts of smallborrowers with credit limit range of less than Rs.25,000/- has decreased from 5.88 crorein 1991 to 3.69 crore in 2003. It is important to understand both the supply and thedemand side perspectives that lead to such a wide gap in availability of financial services.The exclusion of large numbers of the rural population from the formal banking sectormay be for several reasons from the supply side, such as: (a) persons are unbankable inthe evaluation/perception of bankers, (b) the loan amount is too small to invite attentionof the bankers, (c) the person is bankable on a credit appraisal approach but distances aretoo long for servicing and supporting the accounts and expanding branch network is notfeasible and viable, (d) high transaction costs particularly in dealing with a large numberof small accounts, (e) lack of collateral security, (f) inability to evaluate and monitor cashflow cycles and repayment capacities due to information asymmetry, lack of data baseand absence of credit history of people with small means, (g) human resources relatedconstraints both in terms of inadequacy of manpower and lack of properorientation/expertise, (h) adverse security situation prevailing in some parts of rural India,(i) lack of banking habits and credit culture, (j) information-shadow geographical areas,and (k) inadequacy of extension services which is crucial to improve the productionefficiency of the farmers leading to better loan repayments. From the demand side, thereare several reasons for the rural poor remaining excluded from the formal banking sector,such as : (a) high transaction costs at the Estimated number of rural households : 147.90

Million ( NSSO – 2003)11 client level due to expenses such as travel costs, wage losses,incidental expenses, (b) documentation, (c) lack of awareness, (d) lack of social capital,(e) nonavailability of ideal products, (f) very small volumes / size of transactions whichare not encouraged by formal banking institutions, (g) hassles related to documentationand procedures in the formal system, (h) easy availability of timely and doorstep servicesfrom money lenders/informal sources and (i) prior experience of rejection by/indifferenceof the formal banking system.

It needs to be noted that the initiatives that may be taken further to expand the bankingoutreach have to necessarily provide solutions for the comprehensive financial services tothe rural sector. Thus, for example, the inability to save or withdraw savings from theformal sector may revert even those who are brought into the banking mainstream to theinformal sector as it responds well to emergency needs. In this context, it needs to benoted that with good credit take off, the incremental Credit Deposit Ratio of banks areclimbing to over 100 percent in recent times. Thus, the need to increase resources of thebanks is currently imperative. The potential to tap the rural areas for rising low costdeposits is high. It is now being widely accepted that by extending their reach to the vastnumbers of untapped small and marginal clients in the rural areas at the bottom of thepyramid, banks can increase their business, enhance their profit and spread the risk. It isalso increasingly recognised that the rural credit market offers good opportunity forprofitable retail loan business. There is considerable upward mobility in terms incomeand savings potential among large sections of rural population, which the banks areunable to effectively reach due to the supply and demand side reasons mentioned earlier.Similarly, lack of remittance facilities may drive the people to continue to depend oninformal sector and at the same time deprive the banking system the benefit of otherincome. The situation described above has been responded to in some ways by bankswith the involvement of Non-Government Organisations (NGOs) and other Civil SocietyOrganisations (CSOs)/voluntary agencies in facilitating the flow of financial services tothe poor. The most significant in this context is the SHG-Bank linkage programme.Another attempt in this approach is the delivery of credit through Joint Liability Groups.

Further, in the recent times, several new generation banks who came into existence with aheavy reliance on technology but with a very limited branch network, have takeninnovative steps, such as, bulk lending to microfinance institutions (MFIs), using them as"pass through" agencies, to tap the rural credit marketThe arrangements suggested are expected to be substantially beneficial to both thedemand and supply sides. The rural customers shall benefit by increased access tocomposite financial services in a relatively hassle free manner, inclusion of those inremote and resource scarce regions/ areas into formal system, significant reduction inborrower level transaction costs in view of doorstep/near doorstep availability of services,and better understanding of their needs by empathetic functionaries of outreach entitiesengaged by banks. The banks shall benefit by a substantially increased client base in ruralareas large numbers of which are upwardly mobile. The increased outreach will also helpbanks to include a large number of excluded farmers and others in the unorganised sectorinto the banking fold. Better identification of clients and the possible diversification ofactivities shall spread risks. These benefits can be achieved at much lower costs than thatis feasible under the conventional systems and procedures. The arrangements will alsoprovide an opportunity for a large number of socially proactive organizations andindividuals to work in tandem with resource rich financial sector. This is likely to lead toa financial inclusion oriented growth model that aims at achieving socioeconomicempowerment of the less advantaged sections. This will also provide an ideal platformfor the microfinance institutions to grow at a faster pace.