A New Approach to Microfinance

Since the pioneering origins of Grameen Bank over three decades ago, microfinance has grown into a formidable industry.  While the sector has been showered with praise for its contribution to ending the cycle of poverty, it has also been attracting its share of controversy. Muhammad Yunus’ vision of microfinance was to break the cycle of poverty by lending to the poor for small businesses that were not serviced by the existing banking infrastructure.  In his experience, with the lack of any other option, the poor were being exploited by loan sharks that charged up to 10% interest per day.  Grameen would change all that by offering micro-loans at a tiny fraction of that interest rate.  In order to scale the model, Grameen offered one simple loan product, which required equal weekly repayments over 52 weeks.  This way, loan officers could physically collect all payments from a village with one weekly visit.  Grameen dealt with collateral by requiring loans to be “guaranteed” by 4 other residents of the village.

This was called the joint liability model, which essentially relied on peer pressure to ensure high repayment rates.  Indeed, the model scaled well, and by 2008, there were more than 3000 microfinance institutions with over 150 million customers and an estimated $30 billion in outstanding loans.  Most of these institutions have simply applied the Grameen model to their respective markets.  With its success and high returns has also come much criticism.  Some claim that microfinance is creating a debt trap for the poor.  Others believe the interest rates being charged are still too high (typically over 20% per annum).  Also, with all the fever behind the industry, it has attracted its share of unscrupulous players, some of which are simply cheating poor borrowers.

As with any kind of lending, there is no question that microfinance can be effective and has uplifted societies in all parts of the world.  The problem, as with any financial product, is when it is used in excess.  It is not uncommon these days to find households with micro-loans from multiple institutions, using one loan to pay off another.  Also, it is important to recognize that the Grameen model has its limitations.  For one, there is no real way to assess the viability of businesses that it funds.  As an example, it would not be unusual to find a multitude of cigarette shops in a small village, all funded through microfinance.  In addition, with a weekly repayment cycle, the model entirely ignores the agricultural sector, where the timing of repayment must match the harvest cycle.  In countries like India, this means ignoring 60% of the population.

Recognizing the need for a modified approach, BASIX was set up in Hyderabad in 1996 by social entrepreneur and visionary Vijay Mahajan.  BASIX is a livelihood promotion institution with three essential legs to its business—financial services,  agricultural/business development services and institutional development services.  Unlike most of its peers, BASIX wraps micro-lending with an array of services to enhance the sustainability of the businesses that it funds.  BASIX also offers a variety of loan products in order to cover the agricultural sector as well.  Services that BASIX offers include advisory for agricultural yield enhancement, value chain growth, improving access to suppliers and customers, formation of federations and cooperatives, and accounting and management systems.  Such a variety of offerings does call into question the ability for an organization to scale.  However, after 14 years, BASIX has over 1.5 million customers in 16 states in India.  This makes it the 4^th largest microfinance institution in India and amongst the top 10 in the world.

BASIX’s involvement with cotton farmers in the Adilabad district of Andhra Pradesh provides a unique insight into what makes it stand apart.  Starting in 1996, BASIX began extending micro-loans to groups of cotton farmers in the district.  Simultaneously, it began an extensive study of the cotton sector in the region.  The study uncovered a number of issues.  Farmers were overusing pesticides causing significant soil depletion and yield loss.  They were also being taken advantage of by commission agents.  These agents would extend credit to farmers for pesticides and fertilizers, but under the condition that farmers sell their crop to them at lower than market prices.  BASIX began by establishing a collaboration with the Andhra Pradesh Agricultural University to apply new integrated pest management (IPM) techniques on several farms.  This brought down the cost of pesticides from Rs 750 per month per acre to just Rs 75, immediately removing the shackles that the agents had on the farmers.  Having built trust with the farming community, BASIX then embarked on helping them organize into cooperatives to improve their buying and selling power.  Today, the district has over 20 cotton cooperatives, and operating margins on individual farms have improved by up to 10%.  One cooperative, Koutla-B, has 83 members and generates Rs 120 million in revenues and about Rs 1 million in net profits annually.  With its accumulated returns, the cooperative has since installed a price display terminal in the village and recently inaugurated a Rs 1.1 million ginning factory to convert raw cotton to tradable bales.  In 2005, the President of the cooperative received the Fellowship Award for Rural Prosperity by India’s President Dr. A.P.J. Kalam.

Over the years, BASIX has developed vertical knowledge in cotton, groundnuts, dairy, soybean, pulses and vegetables, and has applied similar models to enhance livelihood in these sectors.  While its approach takes longer to realize returns, the BASIX model fosters the creation of high margin, high growth businesses with exceptional loyalty—the kind of customers any institution would yearn for.  The effort involved is high, but it is certainly a powerful new approach to microfinance where everyone can win.