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Cost of Delivering Rural Credit
in India
Deepti George
IFMR Finance Foundation
3rd June 2013
Overview
• Five channels covered in the Note
• Costs covered in the Note
–
–
–
–
Cost of Debt
Cost of Equity
Loan Loss Provisions
Transaction Cost
• Total Channel costs
• Implications for Policy
Five Channels
Through a Public Sector
Bank (PSB)
– Lending through its rural
branch
– Lending through SHG
– Lending through MFI
Central Bank of India
Through a Private Sector
Bank
– Lending through its rural
branch
– Lending through MFI
ICICI Bank
10,000 loans of Rs.10,000 each = Rs.100 million (Rs.10 cr)
Pertinent Costs
Cost of Debt
Cost of Equity
Loan Loss
Provision
Transaction Cost
• Marginal cost at which the banks are able
to raise money
• How much equity to be kept aside for
unexpected losses, and the cost of such
equity
• How much to set aside for expected loan
losses based on historical default data
• Administrative costs directly attributable
to the processing, delivering and
administering of loans
Cost of Debt
Source
Public Sector Bank
Private Sector Bank
Channel
Bank Branch
SHG Linkage
MFI
Bank Branch
MFI
• Lowest cost incurred by banks to raise money
• Costs of acquiring depositors – is not factored in
Cost of Debt
4%
4%
4%
4%
4%
Cost of Equity
and
Providing for Loan Loss
Cost of Equity and Loan Loss
• Economic capital and not regulatory capital
• Mean and volatility of default rates for bank and for channel
Mean
default
rates
Expected
Losses (EL)
Loan Loss
Provisions
Volatility of
default
rates
Unexpected
Losses (UL)
Cost of
Equity
Loan Loss = EL for the bank + EL for the channel
Total COE = COE for bank + COE for channel
Numbers needed
Source
Channel
Default observed by Bank
Mean
Default
Rate
Public
Bank
Sector Bank Branch
SHG Linkage
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Private Sector
Bank
Bank Branch
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Standard
Deviation
Default observed by Channel
Mean Default
Rate
Standard
Deviation
Calculating Cost of Equity
‘An approach to risk-pricing of loans’, by Chakrabarti, Ahmed, Mullick. 2002
I.
Unexpected loss (UL) = n* Standard Deviation of default rate*(1Recovery rate)
II. Hurdle Rate = Expected Return on Equity / (1- tax rate) – Risk
free Rate
III. Cost of Equity = Hurdle rate * Unexpected Loss (UL)
Assumptions used:
Recovery Rate
Confidence Level
Expected Return on Equity for Bank
Expected Return on Equity for MFI/SHG
Risk-free Rate
Tax Rate
0%
3σ
20%
25%
8%
33%
Assumes a normal distribution, therefore a 99% confidence level. This is consistent with an “A” credit rating aspiration for financial institutions.
Default on Bank lending through own branch
Channel / Observed
Defaults
Public Sector Bank Branch
(Central Bank of India)
Private Sector Bank Branch
(ICICI Bank)
2008
2009
2010
2011
2012
Mean
5.44% 4.04% 3.22% 2.73%
5.83%
4.25%
1.35%
3.58% 5.62% 7.61%
4.78%
5.40%
1.70%
*Annual Reports, calculations for NPAs on agri loans
SD
Default on Bank lending to SHG
Channel / Observed
Defaults
PSB - SHG Linkage
2008
2009
2010
2011
2012
Mean
2.90%
2.90%
2.94%
4.74%
6.38%
3.97%
*Microfinance State of the Sector Reports, NABARD
SD
1.56%
Default on Internal lending within SHG
State
# of SHGs
surveyed
% PAR (> 360)
Weighted Average
PAR
Average PAR
SD across regions
Karnataka
Orissa
Rajasthan
46
12.00%
37
9.00%
25
2.00%
Karnataka
Orissa
Rajasthan
5.11%
3.08%
0.46%
8.66%
5.13%
*Self Help Groups in India – A study of the lights and shades. EDA/APMAS, 2006
Default on Bank lending to MFI
Data from CRISIL one-year default matrix for 2004-2012
AAA
AA
A
BBB
BB
B
C
2012
0.00%
0.03%
0.74%
1.68%
5.15%
8.88%
18.44%
2011
0.00%
0.04%
0.82%
1.89%
5.80%
8.25%
21.36%
2010
2009
2008
2007
2006
2005
2004
0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
0.04% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
0.93% 1.00% 0.94% 0.90% 0.98% 1.00% 1.01%
2.82% 4.10% 3.40% 3.30% 3.36% 3.40% 3.47%
8.90% 15.90% 15.21% 15.20% 15.34% 15.48% 15.85%
9.18% 16.30% 29.41% 29.40% 29.41% 29.41% 30.30%
24.98% 31.20% 28.05% 28.40% 28.40% 28.40% 28.57%
MEAN
0.00%
0.01%
0.92%
3.05%
12.54%
21.17%
26.42%
SD
0.00%
0.02%
0.09%
0.79%
4.56%
10.25%
4.08%
Default on MFI lending to customer
PAR 90 data from IFMR Capital on 20 MFIs from 2008-2012
Mean
Standard Deviation (SD)
0.22%
0.30%
To summarise the default numbers
Source
Public
Bank
Channel
Default observed by Bank
Default observed by Channel
Mean
Default Rate
Standard
Deviation
Mean Default
Rate
Standard
Deviation
Sector Bank Branch
4.25%
1.35%
0.00%
0.00%
SHG Linkage
3.97%
1.56%
8.66%
5.13%
MFI (rated BBB)
3.05%
0.79%
0.22%
0.30%
MFI (rated A)
0.92%
0.09%
0.22%
0.30%
MFI (rated AA)
0.01%
0.02%
0.22%
0.30%
Bank Branch
5.40%
1.70%
0.00%
0.00%
MFI (rated BBB)
3.05%
0.79%
0.22%
0.30%
MFI (rated A)
0.92%
0.09%
0.22%
0.30%
MFI (rated AA)
0.01%
0.02%
0.22%
0.30%
Private Sector
Bank
Loan Loss Provisions
Total Expected Loss (EL)
= EL for bank + EL for channel
Source
Public Sector
Bank (PSB)
Private Sector
Bank
Channel
Bank Branch
SHG Linkage
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Bank Branch
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
EL (Bank) EL (Channel)
4.25%
0.00%
3.97%
8.66%
3.05%
0.22%
0.92%
0.22%
0.01%
0.22%
5.40%
0.00%
3.05%
0.22%
0.92%
0.22%
0.01%
0.22%
Total EL
4.25%
12.63%
3.27%
1.15%
0.24%
5.40%
3.27%
1.15%
0.24%
Calculating Cost of Equity
“An approach to risk-pricing of loans” by Chakrabarti, Ahmed, Mullick. 2002
I.
II.
Cost of Equity = Hurdle rate * Unexpected Loss (UL)
Unexpected loss (UL) = n* Standard Deviation of default rate*(1Recovery rate)
III. Hurdle Rate = Expected Return on Equity / (1- tax rate) – Risk
free Rate
Assumptions we made:
Recovery Rate
Confidence Level
Expected RoE for Bank
Expected RoE for MFI/SHG
Risk-free Rate
Tax Rate
0%
3σ
20%
25%
8%
33%
Hurdle rates for banks and MFI/SHGs are 21.9% and 29.3%
Assumes a normal distribution, therefore a 99% confidence level. This is consistent with an “A” credit rating aspiration for financial institutions.
Cost of Equity
Source
Channel
Public
Bank Branch
Sector
SHG Linkage
Bank (PSB) MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Private
Bank Branch
Sector
MFI (rated BBB)
Bank
MFI (rated A)
MFI (rated AA)
UL
(Bank)
4.06%
4.68%
2.36%
0.28%
0.06%
5.09%
2.36%
0.28%
0.06%
Cost of
UL
(Bank)
0.89%
1.02%
0.52%
0.06%
0.01%
1.11%
0.52%
0.06%
0.01%
UL
(Channel)
0.00%
15.39%
0.91%
0.91%
0.91%
0.00%
0.91%
0.91%
0.91%
Cost of UL
(Channel)
Total
UL
0.00% 4.06%
4.51% 20.08%
0.27% 3.27%
0.27% 1.19%
0.27% 0.97%
0.00% 5.09%
0.27% 3.27%
0.27% 1.19%
0.27% 0.97%
Total
Cost of
UL
0.89%
5.54%
0.78%
0.33%
0.28%
1.11%
0.78%
0.33%
0.28%
Transaction Costs
Transaction Costs for Banks, MFIs
Report of the Committee on Financial Inclusion (Rangarajan Committee), 2008:
For banks,
Transaction Costs
Private Sector Bank
Public Sector Bank
Loan Size = Rs.25,000
8.62%
12.95%
Loan Size = Rs.10,000
21.56%
32.39%
For Bank to MFI lending, transaction cost is assumed at 0.5% of the loan
For MFI to customer lending, the Committee estimates 8.74% for a Rs.10000
loan
Transaction
Costs
Bank – MFI
MFI - Customer
Total
Transaction Cost
Total Transaction Cost
(%) Loan Size (Rs.) Number of Loans
(Rs.)
0.50%
8.74%
9.24%
100,000,000
10,000
1
10,000
500,000
8,740,000
9,240,000
Transaction costs for SHG
SHG
Group formation and
incubation
Ratings and postlinkage
SHPI
Bank
• Costs of opening savings bank account
• Training costs
• Ratings costs
• Bank transaction costs
• Panchayat Level Federation meeting costs
• Stationery and register maintenance costs
We make some assumptions
Number of members
Incubation period (months)
Loan duration (months)
Loan amount (Rs.)
Average distance to and from bank (km)
Cost of travel (Rs. per km)
Period of apportionment of incubation cost (years)
15
6
24
150,000
24
3
4
Costs borne by the SHG
Group
Formation and
Incubation
Costs
Ratings and
Post-linkage
Costs
Total
Cost Head
Savings A/C
Bank
Transactions
Ratings Cost
Bank
Transactions
Panchayat
Level
Federation
Meetings
Stationery &
Registers
Cost (Rs.) Cost (%) Cost Detail
111
0.07% Stationery at Rs.300 +Travel
for 1 to bank
108
0.07% Travel for 1 to bank per month
for incubation period
150
0.10% Loan Documentation
1728
1.15% Travel for 1 to bank per month
for 24 months
1728
1.15% Travel for 1 to PLF meetings
per month for 24 months
1920
5,745
1.28% Assumed at Rs.80 per month
for 24 months
3.83%
Costs borne by the SHPI
Cost Head
Group
Group
Formation and Formation
Incubation
Training
Costs
Savings A/C
Monitoring
Ratings and
Post-linkage
Costs
Total
Cost (Rs.)
73
296
13
146
Ratings
Exercise
Monitoring
250
2,328
Bank Visits
600
3,704
Cost (%) Cost Detail
0.05% 3 visits for 1 hr each + Travel for
SHPI staff
0.20% 6 days of training for 5 hrs each +
Travel for SHPI staff
0.01% 1 visit to bank for 2 hrs by SHPI staff
0.10% 1 visit for 1 hr + Travel for SHPI staff
for each month of incubation period
0.17% 2 visits to bank for 5 hrs each by
SHPI staff
1.55% 1 visit for 1 hr each by SHPI staff for
24 months
0.40% 1 visit to bank for 1 hr each for 24
months
2.47%
*Salary of SHPI Staff at Rs.5000 / month
Costs borne by Bank
Cost Head
Group
Savings A/C
Formation and Bank
Incubation
Transactions
Costs
Ratings and
Ratings Cost
Post-linkage
Bank
Costs
Transactions
Total
Cost (Rs.)
6
38
Cost (%) Cost Detail
0.00% 15 mins. of bank staff time
0.03% 15 mins. of bank staff time per
month for incubation period
50
600
0.03% 30 mins. of bank staff time
0.40% 15 mins. of bank staff time per
month for 24 months
0.46%
694
*Salary of Bank Staff at Rs.20000 / month
Transaction cost for Bank-SHG
Transaction Cost (%) Transaction Cost (Rs.)
SHG level
SHPI level
Bank level
Total
3.83%
5,745
2.47%
3,704
0.46%
694
6.76%
10,143
Total Costs across Channels
Source
Channel
Public
Sector
Bank
(PSB)
Bank Branch
SHG Linkage
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Bank Branch
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Private
Sector
Bank
Total Cost
41.53%
28.93%
17.29%
14.71%
13.75%
32.07%
17.29%
14.71%
13.75%
Observed Price
to Customer
11.25%
24.00%
27.00%
27.00%
27.00%
14.00%
27.00%
27.00%
27.00%
Conclusions
•
Rural credit through bank branches exhibits the highest Total Cost but
lowest Observed Price to customer
•
Total Channel Cost ranged from 13.75% (lending through AA rated MFI) to
41.53% (Public Sector Bank lending directly through its branches)
•
For every Rs.100 million being lent out as small rural loans by Banks
through their branches, over Rs.27 million (Rs.2.7 crore or 27%) is being
“wasted” in the form of higher channel costs
•
Total Capital Consumption (only unexpected losses) ranged from 20.08%
(bank lending through the SHG) to 0.97% if the lending is done through
very high quality MFIs
Losses in each Channel
If price to customer is at 12%,
Source
Public Sector
Bank (PSB)
Channel
Bank Branch
SHG Linkage
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
Private Sector Bank Branch
Bank
MFI (rated BBB)
MFI (rated A)
MFI (rated AA)
•
Total Cost Total Loss of the
Channel
41.53%
29.53%
28.93%
16.93%
17.29%
5.29%
14.71%
2.71%
13.75%
1.75%
32.07%
20.07%
17.29%
5.29%
14.71%
2.71%
13.75%
1.75%
If the bank chooses to lend through a BBB-rated MFI, it will need to
provide for a subsidy of 5.29% or Rs.529 over the loan of Rs.10,000, as
compared to absorbing loss of 29.53% or Rs.2953 in direct lending
Implications for Policy
• The channel of delivery matters
– Inefficiencies in prescribing credit targets for a particular channel
– 12% can be achieved by permitting banks to work with low-cost channel
partners
– Current cross-subsidisation (between bank branches) can be passed onto such
partners to bring down the price to customer
• Bank branch and SHG channels consume a lot more capital
– SIFIs end up exposing themselves to much higher risk levels in the process
• Strong case for well-capitalised high quality intermediaries to
achieve the 3 policy goals of
– Achieving complete financial inclusion
– Building low-cost financial intermediation infrastructure
– Keeping systemic risks low
Thank you