Banking on Rural India

By Lina Sonne, May 19, 2011

Woman rolling beedi cigarettes - photo by Lina Sönne

Woman rolling beedi cigarettes - photo by Lina Sönne

A new breed of financiers is offering alternatives to micro – and bank - finance to rural India's entrepreneurs. These financial organisations are innovating in the way they provide finance and integrated start-up support including incubation, mentoring and management training.

In recent years microfinance has been the fashionable answer to finance for the rural poor, and especially, poor rural entrepreneurs. There was the year of Microfinance in 2005, followed by the Nobel Peace Prize to Professor Yunus in 2006, and an increasing focus by development agencies and governments on microfinance lending models. Hand-in-hand with the emphasis on small individual or group loans went the notion of poor as entrepreneurs that needed just a small amount of financing to set up and run a micro venture to provide income for their family.

However, whilst a vast number of poor are entrepreneurs, most operate at subsistence level and out of necessity. Not only are their earnings frequently not enough, but they are likely to have a limited capacity or willingness to take on additional risks associated with scaling up to make a real impact on the local economy or make a profit.

Another type of entrepreneur currently enjoying increased focus are pro-poor entrepreneurs, especially those that are relatively less poor, that are driven by opportunities, pursuing a profitable business, innovating and looking to grow, often with a ‘dual bottom line’ approach, combining business acumen and for-profit with social aims. These innovative entrepreneurs are likely to have a large indirect effect on the rural poor through better services (such as ITC or electricity), better products (such as stoves) and improved livelihood opportunities that can reach more rural poor than any single microfinance entrepreneur.

Local taxi service – photo by Lina Sönne

Local taxi service – photo by Lina Sönne

A major problem facing many of these (dual bottom line) entrepreneurs is the lack of finance and related start-up support. Unlike the small-scale necessity entrepreneurs, these entrepreneurs do not attract microfinance as they require much larger amounts of finance for the kind of investments that innovative entrepreneurs seek to undertake. They also need different kinds of finance from the group loans offered by MFIs.

At the same time, in India, these entrepreneurs are hard pushed to attract financing from the banks. In spite of several decades of what the Indian Government called ‘Social Banking’, and credit specifically allotted to the rural poor as well as to entrepreneurs, banks are unwilling to lend as they perceive these entrepreneurs too risky and they have few incentives to provide anything but standard loans to trusted clients for what they consider safe financing. In fact, there has recently been a decrease in lending to both rural areas and to small and micro enterprises. So what we see in India is a large SME sector with plenty of innovative entrepreneurs, many of whom are providing products, services and jobs for the poor. However, there is a substantial financing gap which has serious implications for the ability of the sector to flourish and to play its role in further economic development among the poor.

But it is not all doom and gloom. An alternative financing sector is emerging in India to fill the funding gap in innovative ways. The pioneering organisations in this sector use similar models and instruments that exist in mainstream financial organisations, such as venture capital, business incubation and social merchant banking. However, the models are adapted to the needs of innovative entrepreneurs with a dual bottom line, often operating in rural areas.

Like conventional venture capital firms, Aavishkaar, a Mumbai-based micro venture capital organisation, invests equity in start-ups in exchange for a share of the investee company. However Aavishkaar is focussed on ventures that provide products and services for the rural poor, such as Vaatsaalya, a rural hospital chain, or Rangsutra which assists rural craftsmen in improving product designs and reaching a larger market. Aavishkaar not only provides equity investments, but also offers mentoring and helps with business management strategy and planning.

Chili pepper salesman – photo by Lina Sönne

Chili pepper salesman – photo by Lina Sönne

Further down the start-up support value chain from venture capital are business incubators. This is also the case in the alternative finance sector, where social business incubators support entrepreneurs at the very nascent stage of a venture, or idea. Villgro is a Chennai-based social business incubator that supports its rural-focussed entrepreneurs in much the same way as conventional business incubators. This includes writing or improving a business plan, building and testing prototypes, testing markets and help in reaching new markets as well as access to external finance. One such incubated company is Servals which provides energy efficient and low-cost stoves among other things. Villgro helped Servals to improve its product and business plan before introducing it to Aavishkaar, which later invested equity in the company. It is now a successful company which has diversified into other products.

The Small-Scale Sustainable Infrastructure Development Fund, or S3IDF for short, on the other hand operates as a social merchant bank that builds and implements infrastructure services which it trains local entrepreneurs and NGOs to run. This includes solar-charged lighting for street hawkers and improved electricity in rural villages. S3IDF does not invest directly in its entrepreneurs, but instead provides credit risk guarantees with which they are able to attract local bank finance. The organisation operates as a facilitator, linking their scaled down infrastructure solutions with entrepreneurs and NGOs that can manage the business, with local banks that can provide finance and with local technology suppliers that can provide technical support and improvements.

These organisations, and many other like them that are springing up in india are complementary and form an eco-system of financial support for varying types of dual bottom line entrepreneurship. In different ways they are all innovating in the provision of finance, so that they are able to provide finance and support beyond what banks and microfinance have offered. In fact, one of their key characteristics is a focus on providing non-financial support (such as mentoring or business management training) alongside finance in order to improve the quality of the company while reducing the risk it carries, therefore making more efficient use of the finance invested.

These organisations also work in partnerships. Networks are important to provide better services, acquire expertise and to co-invest, much like conventional start-up finance. The involvement in investee companies is also more long-term and more flexible than with other kinds of finance, as these organisations go beyond simple disbursement of credit. Often an investee can move from one kind of finance support to another, such as graduation from Villgro to Aavishkaar, or moving from a first financing round in Aavishkaar to a second financing round.

The sector is still at a nascent stage and most models have not yet been fully proven, with many financing organisations struggling to break even. However, it still holds much promise as an alternative to microfinance as the one-stop solution to finance for the poor. Increased quality finance for SMEs with a dual bottom approach is likely to have a significant impact on development in the coming years. This is something international organisations are increasingly waking up to, as a number of new initiatives and programmes focussed on financing entrepreneurs in developing countries are now being set up.

Lina Sönne is Assistant Professor, inclusive innovation and entrepreneurship, at Azim Premji University, Bangalore, India. She is also an affiliated researcher at United Nations University-MERIT, the Netherlands, where she recently defended a PhD thesis on ‘Innovation in Finance to Finance Innovation: Supporting pro-poor entrepreneur-based innovation’.

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