Central to the debate on access to finance for India, is the question of the most appropriate channel for credit delivery. Credit intermediation has traditionally been the stronghold of banks, driven by policy mandates and regulatory backing. Over the years, banks have also used intermediaries for channeling credit to the end customer and a few such credit intermediation channels have established themselves as sustainable routes – these include the NABARD promoted Self Help Group (SHG)-bank linkage model, as well as the Joint Liability Group-based Micro Finance Institution (MFI) model.
IFMR Finance Foundation has published a note titled “Cost of Delivering Rural Credit in India”, the first note in its series – Notes on the Indian Financial System. This note takes a first principles look at the costs incurred for various lending channels: namely direct lending by public and private banks though branches, and lending by banks via intermediaries such as SHGs and MFIs.
The note attempts to build up the total cost of credit delivery by assessing 4 components: cost of debt, cost of equity, loan loss reserves and transaction costs. Comparing the total costs of credit delivery across these different channels is intended to throw light on the most efficient channels that banks could leverage for rural credit delivery.
Findings and Policy Implications
- Total Channel Cost: Total cost ranges from 13.75% at the lowest end for transmission of this credit through a AA rated MFI to 41.53% for the same task being performed by a Public Sector Bank directly through its branches or using the current model of Business Correspondents. The cost is lower at 32.07% for a Private Sector Bank but still significantly above the number for an MFI, even one that is barely investment grade. The SHG channel at 28.93% fares better than the bank branch channel but worse than the MFI channel from a total cost perspective.
- Total Capital Consumption: Similarly Total Tier 1 Capital Consumption ranges from a high of 20.08% for lending through SHGs to a low of 0.97% if the intermediation were to be done through high quality MFIs.
The note is available here.