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How Lending Mechanisms in Rural & Semi Urban Markets Function Customers keep shifting in this ecosystem from money lender to BANKS via NBFC's & new set of customers reach out to local money lenders, thereby adding to the market size.

By Mohit Sahney

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In order to better understand the ecosystem surrounding the lending mechanism in rural & semi-urban markets, we need to first delve deeper into the finance segment and its presence in these areas.

Finance, in rural and semi-urban areas exist in several forms viz. Nationalized Banks, Private Banks, Credit Societies, Co-operative Banks, and Informal Loans such as money lenders or borrowing money from relatives. With these varied forms of financial institutes and aids, the segment has proliferated itself well in the rural market, wherein Regional Rural Banks and Co-Operative Banks make for approximately 66% of rural finance penetration. Nevertheless, the segment accounts only for a meager 5.6% of the total business as reported by RC&M India Experiential Rural Marketing firm. These numbers reflect that even though the financial institutions are present in the rural areas to a certain extent, stringent loan disbursementpolicies; never ending documentation prerequisites; lack of awareness and basic financial literacy, the lending ecosystem in rural and semi urban markets haven't been able to realize its maximum potential.

Another research by D&B research published a while ago, talking about rural finance branch office network, 13% of all private sector branches are in Rural India. Likewise, Branch network of Scheduled Commercial Banks is 40% in rural India. However, one must understand that these numbers are only suggestive of the presence of financial aids in these areas and does not indicate anything about the lending mechanism there.

The complete ecosystem surrounding the lending mechanism in smaller markets is very complex and has cascading effects.

As discussed above in this write up, ensued by drawbacks such as stringent loan disbursement policies; never ending documentation prerequisites; lack of awareness and basic financial literacy, small businesses in smaller markets are compelled to resort to informal routes of raising funds such as borrowing money from relatives or local money lenders. These informal money lenders at times charge interests to the tune of 40-50% on flat basis. Most of the time they quote rates on flat basis, which appears to be way less than reducing basis. Despite such soaring interest rates, small business owners in rural and semi-urban areas are bound to go to them, driven by easy access to credits in quick cash. Conversely, these kinds of loans reek of disadvantages, as the borrower has to adjust a major chunk of his/her profit or revenue to regular monthly repayments towards interests and principle never comes down. Moreover this money is available in cash, which is difficult to deploy in formal segment. I would also like to bring to the fore, the fact that in the whole scheme of things, it is only these lenders who make the maximum profit. Most of these MSMEs start their fund raising journey through these money lenders in the smaller markets and gradually shift to the formal segment.

Having said that, there are some NBFCs that also charge high interest rates on flat basis, which goes up to 25%-30% on reducing basis, however, their interest rates are better than the informal money lenders, where nothing is accounted for. Loan EMIs have both the component of principal and interest and also helps people in building CIBIL score, which improves their credentials.

Over the past few years, the microfinance segment has grown by leaps and bounds and also witnessed the introduction of institutional provisions of RBI guidelines for NBFC-MFI operations, launch of MUDRA bank and small bank licenses.

These organized professionally run NBFCs charge 18%-20% on reducing basis and charge relatively lesser rate than unstructured NBFCs. After this, comes larger old NBFC with PAN India presence, wherein rate of interest further comes down to 13-14 %. At top of the pyramid are the banks that offer best interest rates, however, their process of procuring loans is cumbersome and time consuming.

Customers keep shifting in this ecosystem from money lender to BANKS via NBFC's & new set of customers reach out to local money lenders, thereby adding to the market size.

Mohit Sahney

Managing Director & CEO, Finova Capital

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