Tackling the Cost and Affordability Issue in Microfinance: The RDS Experiment by IBBL

The high cost of microfinance has been a subject an intense debate in the industry. Some well-known MFIs in Latin-America are perceived to engage in profiteering. The leading critics of the Latin-American providers themselves charge a price, which is perceived to be too high by others. Indeed, there is little agreement on whether MFIs should charge a price (i) that ensures high enough profits to finance growth and expansion and enhance access; or (ii) that provides a normal and fair return to financiers; or (iii) that is affordable to the poorest of the poor. The apparent justification offered under the first approach is that profits should be high enough to finance the rapid expansion of MF operations. There are no ethical issues here, as this would enhance access to larger number of clients and that cost of finance does not matter as far as the poor borrowers are concerned. Also provided is a fallacious justification that returns on investment in micro-enterprise are very high, the reason being the miniscule size of investments compared to the earning numbers. Hence, entrepreneurs can “afford” to pay high interest rates as cost of funds (sometimes as high as eighty percent) as long as the same are lower than rates of return; and that those interest rates are much less important to microenterprises than access, timeliness and flexibility. It is fallacious, because the so-called high rates of returns on micro-projects materialize only for the “successful” projects passing through “good times” and not true of all projects at all times. Interest related liability can compound and accentuate the financial problems of a project experiencing bad times and hasten its failure. The pace, frequency and intensity of such failure is directly related to the levels of interest rates. The second school of thought emphasizes on transparency and fair pricing in microfinance. Profits should only be fair and good enough to compensate for risk and ensure sustained operations. Prices should be high enough to recover the incremental operational costs associated with microfinance and include an element of normal profit. Since microfinance as compared to mainstream banking involves additional operational costs, it is not surprising that the price of a micro-loan is higher than that of a bank loan. Further, any attempt to set the price of a micro-loan at a level lower than the costs involved in the process (with absorption of certain cost elements by donations) is not a sustainable solution. Conventional wisdom asserts that donations should be used for capacity building of MFIs and not to absorb operational costs. This is because donations are not be seen as sustainable source of funds.

Moving from conventional to Islamic microfinance, however, the nature of donations change. Charity in Islam (zakat or waqf) by definition provides for a sustainable source of funds. Empirical data proves this contention. The Islamic Social Finance Report 2014 (http://sadaqa.in/2014/03/24/islamic-social-finance-report-a-new-initiative-by-irti-idb-thomsonreuters/) indicates that zakat collections have experienced a steady growth over time (for instance, increasing by 32 times over the last 10 years in Indonesia and by 27 times over the last 20 years in Malaysia). Not surprising therefore, Islamic MFIs have looked at zakat and waqf as a way of absorbing operational costs and bring down price to affordable levels, even to zero. (read the Akhuwat story (http://sadaqa.in/2014/04/08/from-zakat-beneficiary-mustahiq-to-zakat-givermuzakki-2-the-akhuwat-experiment/))

However, zakat, sadaqa and waqf are not the only source of absorbing costs. In this blog I discuss the case of Islami Bank Bangladesh which embarked on its Rural Development Scheme initiative as a replication of the Grameen model, but with significant differences. It sought to replace the interest-bearing loan with a Shariah-compliant bai-muajjal financing. More importantly, it sought to bring down the price of the financing by more than half, Compared to a Grameen loan priced at 20 percent flat rate, IBBL offered financing at 10 percent flat rate with a further 2.5 percent discount for timely repayment. The method was to use corporate charity or CSR funds absorb certain operational costs. IBBL launched in 1995, the Rural Development Scheme (RDS) that aims to develop the rural economy and establish model villages that are gradually freed from wide-spread poverty and destitution. The RDS began as a pilot project and as a CSR initiative of IBBL covering four villages, but currently benefits more than 730,000 Bangladeshi poor. In June 2008, Bangladesh Bank, the Central bank of Bangladesh, issued a Circular for corporate social responsibility (CSR) initiatives, which was addressed to all banks and financial institutions, calling on them to speed up financial inclusion of the large socially disadvantage rural and urban population segments. They were asked to provide appropriate financial service packages with financing programs innovatively designed to generate new employment, output and income. In the “Review of CSR Initiatives in Banks (2008-2009)” published by Bangladesh Bank, it stated that IBBL, was the first private commercial bank in the country who has been discharging social responsibility products by creating employment opportunities and ensuring healthy work environments. The document indicated that financial institutions need to expand their CSR programmes in the same light rather than just providing donations to different charitable organizations.
In both 2008 and 2009 IBBL received the best Corporate Social Responsibly Award.[1]

The stated objectives of RDS are:

• To extend investment facilities to agricultural, other farming and off-farming activities in the rural areas;
• To finance self-employment and income generating activities for the rural people, particularly the rural unemployed youth and able-bodied poorest of the poor;
• To extent facilities for hand tube-wells, sanitary latrines and rural housing to ensure safe drinking water, proper sanitation and decent living;
• To propagate the divine message of acquiring knowledge and education to have a humanly living.

Group Guarantee: Each member of the group is required to provide a guarantee against defaults and negligence of other members of his/her group. If any member of a particular group does not comply with the principles or rules of the group, then the remaining members are expected to pressurize him/her to observe group discipline. In case of default, they are held liable and responsible for recovery. A defaulting member is invariably expelled from the group for breach of group discipline and is never allowed any financing facility or any other benefit from the Bank in future.

Savings Plans: RDS stipulates mandatory savings for its members. Each member is required to individually open a mudharabah savings account that is a non-checkable account with the Branch from the very inception of the group activity. The compulsory savings of a minimum Tk.20.00 per week is intended to inculcate a savings habit among members. The deposits may be withdrawn by a member if he/she does not have any other liability with the Branch. Members are encouraged to deposit more in view to develop their own equity quickly. The volume of savings of RDS members reached Tk. 3,300.85 million as on 31^st December, 2012.

Table. Growth of RDS 

Financing Plans: Under RDS, three types of financing are provided to the beneficiaries:

• collateral-free microfinance up to Tk.50,000 provided to the poor in different income generating activities; (total outstanding finance currently stands at million Tk 5985.75)
• microenterprise finance, i.e. collateralized finance up to Tk.300,000 provided to the graduated and other micro-clients (total outstanding finance currently stands at million Tk 4321.67)
• qard program, i.e. cost-free loan up to 10,000 provided to the distressed & hardcore poor for rehabilitation and water & sanitation. (total outstanding finance currently stands at million Tk 7.79)

The microfinance schemes use bai-muajjal mode. For the flagship program for the poor, no collateral is required. A request for financing is considered eight weeks after the date of enrollment of an individual as a member of the group. The initial financing is kept in the range of Tk. 10,000 (US$145). The upper limit for financing under the scheme is Tk.50,000 (US$725). Each member is required to make a compulsory savings of Tk.20 (US$0.30) every week. The total debt (principal amount plus profit) is to be cleared by the client member over a one-year period in forty-four equal weekly installments. No payment is to be made during remaining eight weeks to allow for holidays.

The profit rate is uniform and reasonably low at 12.5 percent (increased from 10 percent earlier) with a further discount of 2.5 percent for timely repayment. If compared with bank interest rates on a declining balance basis, the relevant rate for RDS would be around 20 percent.

Micro-Takaful: In addition to individual savings plan, RDS also requires each member of a group to deposit a minimum Tk.2.00 per week in a pool in the name of its centre. The pool of funds – maintained with IBBL as a mudharabah savings account in the name of the respective centre essentially aims to provide a kind of micro-takaful against unforeseen adversities. Assistance is provided to members by way of qard as per decision of the centre in the weekly meeting. The mudharabah account that is refundable, is jointly operated by the leader and deputy leader of a center.

Linkage with Charity: Donations have played a major role in the micro finance scenario in Bangladesh. Most of the mainstream MFIs, such as, Grameen, BRAC, ASA and others have been recipients of recurring doses of support from overseas donors. While donations are deemed indispensable by many especially in the initial stages of a non-profit organization venturing into microfinance, such dependence is supposed to decline as organizations become self-sustaining. In case of RDS, the initial support has come not in the form of donations, but through hand-holding by its parent. Another form of support that enables RDS to take on competition is the linkage it has established between its financing and other development activities that are funded through charity. While provision of education and healthcare are not profit yielding commercially viable sectors especially in the rural areas, these constitute important dimensions of development. Such activities are undertaken and financed by Islami Bank Foundation, a non-profit service oriented sister organization of IBBL, but linked to financing scheme of RDS. A member-borrower of RDS with a good track record of repayment over two years may seek financing based on qard-hasan for purchase of hand tube-well for safe drinking water and the articles for sanitary latrine.

Safety Net Activities: As poverty alleviation needs a combination of financial and non-financial programs, different welfare services are conducted under RDS in the areas of (1) education, (2) training, (3) health, (4) relief & rehabilitation and (5) environment. In this respect a Welfare Fund has been developed by segregating 1% profit against RDS investment. An amount of Tk.82.98 million has so far been spent for social safety-net programs under RDS during the year 2012. The qard financing program is funded by the Welfare Fund as well.

The performance of RDS has been spectacular compared over time and across other leading MFIs. It has used a very successful model of attacking poverty – the Grameen model – but without the “cultural and religious negatives” from the standpoint of a highly conservative Muslim society of Bangladesh. Like Grameen it has embarked on empowerment of women with 94 percent of its clients being women. However, this has been attempted in a culturally compatible manner that promotes family integration and cohesiveness by popularizing the concept of “family empowerment”. Like Grameen it has attempted to promote healthy social practices by ensuring participation of all members in center activities. However, the practices now exclude behavior that are repugnant or unacceptable to Islam and detrimental to the institution of family and include codes of ethics and morality that promote unity and cohesiveness in society. Like Grameen it has provided collateral-free finance to the poor using the concept of group and graduated financing. However, it has brought in Shariah-compliant modes of financing that do not involve riba. Notwithstanding the laudable achievements of RDS, several areas of concern remain.

RDS is a humane scheme. By successfully combining CSR with microfinance, it has been able to provide microfinance at below-market and affordable rates to the poor. At the same time, its sustained growth has firmly placed its model in the front-burner of global microfinance providers where affordability and sustainability are key concerns.

Mohammed Obaidullah | April 25, 2014