By A Ramesh Kumar – Chairman and Managing Director, Swarna Pragati Housing Microfinance Pvt Ltd and Moin Qazi*
The Gaekwad family lives in a single room house in the outskirts of a growing metropolis. The family cooks, has meals and sleeps in the same room, which is also used as a play area by their three-year old child. Lack of credit has prevented the Gaekwads from getting loans to improve their living conditions. There are millions of low-income families in our country who live in overcrowded, inadequate, and even unsafe spaces—and who can’t afford to move or to remodel the homes they have.
Obstacles to providing loans to low-income households in the region are numerous: most of this population works in informal jobs and does not qualify for loans because it is considered very risky by potential lenders. There is little more critical to a family’s quality of life than a healthy, safe living space
From shacks in the shantytowns to tin-roofed mud huts in the slums, insecurity of tenure and uneven income streams force the poor to build their homes tentatively, one wall at a time. Yet the poor lack access to financial institutions and financial products tailored to the way they build. This, despite the fact that in so many developing cities around the world a majority of the population lives in slums.
Faced with the enormity of the housing need and the poverty of those in need, governments have traditionally reacted in one of two ways. First, they build low-income housing units and distribute them—at very high levels of subsidy—to the poor. Because of the high subsidy element, only a few such units are built and, because of the decent standards adopted, the housing units are attractive to members of the middle class, who often succeed in displacing the intended beneficiaries. Second, governments subsidize finance to the poor, providing loans at interest rates far below market. These interest rate subsidies also often end up in the hands of the middle class. Worse, they distort the financial markets, preventing nongovernment financial institutions from tapping funds for housing credits.
Neither of these approaches is appropriate for either the poor or low-income groups. A better approach is to finance their own preferences in housing development and building on the investment they have already made. However, both the poor and low-income households are excluded from formal sector finance for many reasons. In particular, the poor and low-income people
- find it difficult to service the debt for even a small formal sector house acceptable to many financial institutions;
- have no capacity to make regular monthly payments over a long period of time; do not have the full legal title to provide the secure collateral demanded by traditional financial institutions;
- are seen by these institutions as both expensive to service and high risk; and
- find the travel costs to—and application processes of—traditional financial institutions onerous.
The revealed preference of the poor is not housing as it is formally conceived: a solid structure of four walls, a hard floor, and a sound roof on its own piece of land or within a multi-unit complex. Some of the poor and many low-income households may want, and be able to afford, such a unit; but for the majority of the population this is not the case. More likely, they will want to fund the upgrading of an existing informal house or additions to an existing house. They will want funding on greenfield sites for incremental development—first the land, then a basic structure.
Revolutionary model in affordable housing
Recently a dedicated housing microfinance company based in New Delhi has come out with a revolutionary approach that that has the potential of transforming the landscape of housing finance for the low income groups. Swarna Pragati has innovated housing finance and mortgage systems to overcome the hindrances that impede the flow of credit to this segment. It is leveraging the grassroots community institutions to evolve a simple, flexible cost effective and fault proof mechanisms for administration of housing finance to this segment .
The company’s revolutionary model has blazed a new trail in the housing sector and has made housing finance accessible for the marginalised sections ..
Five unique features of the company’s model which make it a pioneer in Rural Housing Finance are:
- Firstly, apart from a component for housing loan there is a component for income generating activities so that the borrowers can generate income for repaying the loans;
- Secondly, it has introduced the concept of modular or incremental housing where a house is divided into numerous components viz., roof, flooring, kitchen, toilet, well, work shed etc., and financing is done for one or more modules at a time keeping in view the psychology of seeking short term loans with affordable repayment instalments (EMIs) which has not been captured by any other housing lender..
- Thirdly, the focus is on habitat and hence work-sheds, wells for water supply, toilets and renewable energy sources form an integral part of the product offering and are also financed.
- Fourthly, self help groups and joint liability groups are used as the delivery models.
- Fifthly the company uses paralegal titles to overcome the problem of lack of formal titles which is endemic in low income groups.
The Swarna Pragati model is the brainchild of A Ramesh Kumar a revolutionary social entrepreneur who headed the NABARD Committee on Rural Habitat and also pioneered a unique microfinance model in Maharashtra that enabled the state to emerge as the fastest growing region in Self Help Group Bank Linkage Programme.
Under the Swarna Pragati model low-income families build their houses one step at a time in a process known as incremental or progressive build. They add water and sanitation facilities to a basic house, improve roofing and gradually add new rooms. This incremental build concept is in the design of housing microfinance products. Loan amounts average Rs. 25,000 to Rs 1,00,000 with average loan terms of 36-42 months, slightly larger and longer term than typical microenterprise business loans, but far smaller and shorter term than traditional mortgages.
The Company does not require a title to guarantee the loan and is willing to accept less formal types of collateral, making financing more accessible to low-income borrowers. Borrowers complete the construction of their homes through a series of loans. With this kind of financing, young families can begin improving their housing sooner because they don’t have to wait until they can afford a whole-house mortgage, and they pay less in total interest costs.
|Housing finance paradigm||Swarna Pragati paradigm|
|Finance must be for a complete housing solution. Loans large enough for a complete housing solution must be long-term and subsidized to be affordable for low income households.||Low-income households are accustomed to a “incremental build” process. “Incremental build” loans with market rates of interest can more easily be customized to households’ capacity to repay. Financing “stages” of a project with multiple, shorter-term loans rather than one larger, longer-term loan reduces interest paid by the household and risk for the lender.|
|Low-income “housing” finance follows a paradigm similar to the mortgage finance industry in India. The interest rate is the key factor in households’ decision to borrow. Investment in housing is “non-productive.”||Access to capital for housing investment, simplicity, flexibility and speed of disbursal are the primary factors in households’ decision to borrow. Interest rates are important, but secondary. In many, though not all cases housing investments directly generate additional income (e.g., rentals, additional space for home-based microenterprise).|
|Design, planning and construction must be done by outside, technical experts to reduce the cost of the project and ensure the quality of construction.||According to Swarna Pragati’s pilot experience, clients whose improvements are completed and well constructed are more apt to repay their loan and to return for additional services. Thus, while clients know what kind of house they would like to have, they often do not know how to develop a construction budget that will cover the full cost of the improvement or how to map out a series of improvements that are logical, structurally sound, and affordable. This lack of expertise typically leads poor families to focus on the cheapest, most available fix rather than on improvements that are part of a long-term housing development plan. It also can increase the default risk for the financer.|
|Requires a mortgage lien: full legal title to property||Works with paralegal or substitute titles|
Key feature of Swarna Pragati loan product are:
- Loans are for relatively small amounts and are based on clients’ capacity to repay;
- Repayment periods are relatively short (especially in comparison to mortgage lending) and are on par with mid- to high-end microfinance individual loans;
- Loan pricing covers the real, long run costs–operational and financial–of providing the service;
- Loans are not heavily collateralized, if at all, and collateral substitutes are often used;
- Loans tend to finance habitat needs in an incremental manner, a function of the purchasing power of loans with short repayment periods and relatively low monthly payments
A key feature of the company’s loan delivery system is that loans are delivered at the doorstep through mobile staff of NGOs who also collect the monthly instalments. This helps rural borrowers save time and overcome physical accesses barriers and considerably reduce transaction costs for them. The whole scheme has been suitably incentivized with incentive for prepayment. Prepayment allows borrowers to actively manage their own risks of fluctuations in income by paying ahead in good times. Since informal sector borrowers have lumpy cash flows, it helps them in overcoming prepayment penalties which is a critical issue in housing microfinance.
Swarna Pragati’s approach to collateral
Conventional finance institutions seldom lend down-market to serve the needs of low income families and women headed households. The fundamental problem is not so much of unaffordable terms of loan as the lack of access to credit itself. There are several problems that constrain the flow of housing credit to the informal sector. Risk is difficult to manage in this segment using traditional banking methodologies.
Poor households that own property may not have proper titles, and savings that could be used as collateral may be limited and informal; in addition, most people have no recorded financial history, since they have not used products via formal channels in the past. Members of these households typically work in the informal economy and do not receive pay stubs, which makes it hard to assess their work histories, and some may not have permanent addresses. Providers are thus unable to rely on traditional means for assessing risk. Product development lags significantly behind demand, and thus available products often fail to meet this population’s needs.
Low income households, particularly in rural areas, seldom have clear legal land titles, though they often have para-legal rights of some sort, which are not accepted as collateral by the banks and financial institutions. Many of them may not have a full land title but possess a documentary right to ownership, such as tax receipts and a legal protection from eviction. Swarna Pragati has tried to overcome this challenge by placing greater reliance on social collateral. Unlike other lenders it does not require a title to guarantee the loan and accepts less formal types of collateral and collateral substitutes making financing more accessible.
Swarna Pragati believes that flexible and multiple guarantees are as good as, or even better than, mortgages. Then there is the challenge of leasehold properties. Several state governments in India have provided a degree of tenure security to poor households which grants residents of unauthorized settlement specific period licenses to their land, which provides reasonably good security of tenure.
Unlike other lenders, Swarna Pragati does not require a title to guarantee the loan and is willing to accept less formal types of collateral, making the financing more accessible to low-income borrowers. While providing housing loans Swarna Pragati model also extends loans to clients where the title of the land is in the name of the husband/or other family members or there are joint rights to the land/house without specific title documents, on the basis of the Panchayat certificate and an indemnity bond/undertaking executed by the husband/concerned family members.
Experience to date shows that the use of land title as collateral in rural finance particularly microfinance remains limited. One common assumption in housing finance is that the land on which property is built will lower the risk for the lender, but for rural housing finance enforcement of mortgage on land as collateral may not be real collateral. Land security has different connotations in conventional housing finance and housing microfinance.
Freehold title entitles ultimate control over the land to its owners. It permits the owner to improve, sell or use it as collateral or mortgage. It may be transferred or bequeathed by the owner. Conventional lenders like banks favor individual freehold title. Land security on the other hand is a de-facto arrangement in housing microfinance allowing an individual or a group of individuals to use land and residential property for an extended period. In the context of microfinance land security is the right to use property, assurance that the user will not be forced to vacate the property and evidence that usual and customary local practices support this assurance.
This land security is created through two components
1. A document that establishes that right
2. Explicit community acceptance of that right
Swarna Pragati believes that community and multiple guarantees are as good as, or even better than full proof mortgages. This assumption is based on the company’s experience as well as the established wisdom of microfinance practice. Most housing microfinance institutions extend housing finance on the strength of multiple guarantees. Hence the Company is open to financing leasehold properties and properties with traditional rights supported by para-legal documents.
Several state governments in India have provided a degree of tenure security to poor households which grant residents of unauthorized settlement specific period licenses to their land, which provides reasonably good security of tenure. The company finances only those clusters where declaration, possession and communal tenancy provide increased security from eviction. Further, considering that the tenure of the housing microfinance loan of the company is quite short (less than 4 years), the legal security/security of tenure established ensures that there are no disproportionate risks in financing.
Swarna Pragati has tried to use the traditional community based strengths of grassroots people’s institutions like Gram Sabha (Village Assembly), Gram Vikas Samiti (Village Development Council) etc. which are also constitutionally mandated grassroots institutions with community ownership, to overcome arcane legal complications and necessity of elaborate documents and also in aiding the screening and scrutiny of borrowers.
The Gram Sabha is a constitutional public body under the Constitution of India. A Gram Sabha is convened for the purpose of ratifying the process of creation of charge of the company in the revenue records of the gram Panchayat. The company’s list of potential borrowers with the copies of the extracts of the revenue records evidencing ownership of the land /house property is put up to the Gram Sabha in which the Gram Sewak, the government functionary, is present. After necessary deliberations the Grams Sabha endorses the names of borrowers whose land ownership is established by revenue records and customary occupation.
On the strength of the ratification by the Gram Sabha, the Gram Sewak notes the company’s charge in the revenue records and issues the necessary confirmation .The borrowers also swear an affidavit on oath affirming their ownership and tenure of residency and indemnify the company against any infirmity in title and against any default in the event of dispossession by municipal or revenue authorities.
There is a strong need for efforts like that of Swarna Pragati to revolutionize the housing finance scenario for low income groups particularly in rural areas .There is need for housing finance companies to innovate systems and processes to make housing finance both accessible and affordable for this class of people .
* Moin Qazi is an award winning poet and an independent researcher and consultant who has spent three decades in microfinance with State Bank of India, India’s largest bank, where he was involved in microfinance as a grassroots manager and as head of its microfinance operations in Maharashtra. He belongs to the first batch of managers of commercial banks who were associated with the launch of India’s microfinance programme. He has doctorates in economics and English literature He writes regularly on development finance and environmental issues. He was a Visiting Fellow at the University of Manchester specializing in microfinance. He can be contact by email at email@example.com