Microfinance

Microfinance refers to the provision of financial services to low-income clients,

including consumers and the self-employed.

More broadly, it refers to a movement that envisions “a world in which as many

poor and near-poor households as possible have permanent access to an
appropriate range of high quality financial services, including not just credit but
also savings, insurance, and fund transfers.” Those who promote microfinance
generally believe that such access will help poor people out of poverty.

Principles followed by Microfinance

Theoretically, microfinance may encompass any efforts to increase access to, or
improve the quality of, financial services poor people currently use or could benefit
from using. For example, poor people borrow from informal moneylenders and
save with informal collectors. They receive loans and grants from charities. They
buy insurance from state-owned companies. They receive funds transfers through
remittance networks .

There are not many bright lines that can sharply distinguish microfinance from
similar activities. Claims could be made that a government that orders state banks
to open deposit accounts for poor consumers, or a moneylender that engages in
usury, or a charity that runs a heifer pool are engaged in microfinance.
Furthermore, correcting the problem of access is best done by expanding the
number of financial institutions available to them, as well as the capacity of those
institutions. In recent years there has been increasing emphasis on expanding the
diversity of those institutions as well, since different institutions serve different
needs.

Some principles that summarize a century and a half of development practice were
encapsulated in 2004 by Consultative Group to Assist the Poor and endorsed by
the Group of Eight leaders at the G8 Summit on June 10, 2004:

1. Poor people need not just loans but also savings, insurance and money
transfer services.
 2. Microfinance must be useful to poor households: helping them raise income,
build up assets and/or cushion themselves against external shocks.
3. “Microfinance can pay for itself.” Subsidies from donors and government
are scarce and uncertain, and so to reach large numbers of poor people,
microfinance must pay for itself.
4. Microfinance means building permanent local institutions.
5. Microfinance also means integrating the financial needs of poor people into
a country’s mainstream financial system.
6. “The job of government is to enable financial services, not to provide them.”
7. “Donor funds should complement private capital, not compete with it.”
8. “The key bottleneck is the shortage of strong institutions and managers.”
Donors should focus on capacity building.
9. Interest rate ceilings hurt poor people by preventing microfinance
institutions from covering their costs, which chokes off the supply of credit.
10.Microfinance institutions should measure and disclose their performance –
both financially and socially.

Microfinance can also be distinguished from charity. It is better to provide grants

to families who are destitute, or so poor they are unlikely to be able to generate the
cash flow required to repay a loan. This situation can occur for example, in a war
zone or after a natural disaster.

Evolution of Microfinance in India

• Microfinance has been in practice for ages ( though informally).

• Legal framework for establishing the co-operative movement set up in 1904.

• Reserve Bank of India Act, 1934 provided for the establishment of the
Agricultural Credit Department.

• Nationalisation of banks in 1969

• Regional Rural Banks created in 1975.

• NABARD established as an apex agency for rural finance in 1982.

• Passing of Mutually Aided Co-op. Act in AP in 1995.

The Profile of Microfinance in India
The scenario

• Estimated that 350 million people live Below Poverty Line

• This translates to approximately 75 million households.

• Annual credit demand by the poor in the country is estimated to be about Rs.
60,000 crores.

• Cumulative disbursements under all microfinance programmes is only about

Rs. 5000 crores.(Mar. 04)

• Total outstanding of all microfinance initiatives in India estimated to be Rs.

1600 crores. (March 04)

• Only about 5 % of rural poor have access to microfinance.

• Though a cumulative of about 20 million families have accessed

microfinance to the extent of Rs. 5000 crores, the total outstanding is
estimated to be only about Rs. 1600 crores. The active borrowers are
estimated to have a per capita outstanding of only Rs. 2500.

• While 10 % lending to weaker sections is required for commercial banks,

they neither have the network for lending and supervision on a large scale
nor the confidence to offer term loans to big MFIs.

• The non poor comprise of 29 % of the outreach.

The Status of Microfinance in India

 • Considerable gap between demand and supply for all financial services

• Majority of poor are excluded from financial services. This is due to, inter-
alia, the following reasons

1. Bankers feel that it is fraught with risks and uncertainties.

2. High transaction costs

3. Unfavourable policies like caps on interest rates which effectively limits the
viability of serving the poor.

• While MFIs have shown that serving the poor is not an unviable proposition
there are issues that have constrained MFIs while scaling up. These include

1. Lack of an appropriate legal vehicle

2. Limited access to equity

3. Difficulty in accessing low cost on-lending funds (as of now they are unable
to offer savings services in a legitimate manner.

4. Limited access to Capacity Building support which is an important variable

in terms of quality of the portfolio, MIS, and the sustainability of operations.

5. About 56 % of the poor still borrow from informal sources.

6. 70 % of the rural poor do not have a deposit account

7. 87 % have no access to credit from formal sources.

8. Less than 15 % of the households have any kind of insurance.

9. Negligible numbers have access to health insurance (0.4 %) and crop

insurance (0.2 %).

Features of Indian MF
• About 60 % of the MFIs are registered as societies.
 • About 20 % are Trusts

• About 65 % of the MFIs follow the operating model of SHGs.

• Large concentration in South India

• 600 MFI initiatives have a cumulative outreach of 1.25 crore poor hoseholds

• NABARD’s bank linkage program has cumulatively reached a total of 9.4

lakh SHGs with about 1.4 crore households.

Projections for the future

• Annual growth rate of about 20 % during the next five years.

• 75 % of the total poor households of 80 million (i.e. about 60 million will be

reached in the next five years.

• The loan outstanding will consequently grow from the present level of about
1600 crores to about 42000 crores.

Challenges ahead
• Appropriate legal structures for the structured growth of MF operations

• Finding adequate levels of equity for the new entities to leverage loan funds

• Ability to access loan funds at reasonably low rates of interest.

• Ability to attract and retain professional and committed human resources.

• Design of apt MIS including user friendly software for tracking accounts and
operations.
 • Appropriate loan products for different segments.

• Ability to innovate, adapt and grow.

• Bring out a compendium of small and micro enterprises for the MF clients.

• Identify and prepare a panel of locally available trainers.

• Ability to train trainers.

• Capacity to provide backward linkages or create support structures for

marketing.

Related Issues
• Designing financially sustainable models

• Aim for community participation & ownership

• Increase outreach and scale up operations

• Demonstrate that banking with the poor is viable

• Build professional systems and processes.

• Ensure transparency and enhance credibility through disclosures.

• Provide support for capacity building initiatives.

Microfinance and Social Interventions

There are currently a few social interventions that have been combined with micro
financing to increase awareness of HIV/AIDS. Such interventions like the
“Intervention with Microfinance for AIDS and Gender Equity” which incorporates
microfinancing with “The Sisters-for-Life” program a participatory program that
educates on different gender roles, gender-based violence, and HIV/AIDS
infections to strengthen the communication skills and leadership of women ."The
Sisters-for-Life" program has two phases where phase one consists of ten one-hour
training programs with a facilitator with phase two consisting of identifying a
leader amongst the group, train them further, and allow them to implement an
Action Plan to their respective centres. Microfinance has also been combined with
business education, and with other packages of health interventions. The Village
Organizations of BRAC (NGO) also combine microfinance with other social
interventions.

Success story of microfinance in india

Microfinance has no doubt improved the lives of the poor in India but sometimes it
leads people to borrow too much, to the extent that over indebtness can lead to
suicides in extreme cases, says a new book. "The controversy in Andhra Pradesh
shows that the impact of microfinance needs to be more rigorously documented in
order to convince policy makers and regulators that the movement should be
supported," writes Prabhu Ghate in 'Indian Microfinance: The Challenges of Rapid
Growth'.

In March 2006, the Andhra Pradesh government raided and temporarily closed
down nearly all branches of microfinance institutions functioning in Krishna
district.The step led to widespread criticism in the media and did much to reverse
the slowly growing awareness and appreciation of the good work being done by
microfinance institutions. One short term impact of the crisis was a heightened
perception of political risk among banks, which both increased the interest rates as
well as reduced new lending to microfinance institutions in Andhra Pradesh.
Another impact has been a sharp diminution in the rate of growth of microfinance
institution model in Andhra Pradesh. The writer says though the rate of growth of
microfinance in India has accelerated to a great extent in the past few years,
making it the largest in the world, the sector continues to face persisting
challenges. The main challenge facing the sector is identified as the need to
enhance borrower, public and regulatory support and understanding, by increasing
transparency in dealings with borrowers and by educating the poor. Indian
microfinance has continued growing rapidly towards the main objective of
financial inclusion, extending outreach to a growing share of poor households and
to the approximately 80 per cent of the population, which has yet to be reached
directly by the banks. The larger of the two main models - the self help group bank
linkage programme - covered about 14 million poor households in March 2006 and
provided indirect access to the banking system to another 14 million, including the
borderline poor.  
Although firm estimates are lacking, the other, the microfinance institution (MFI)
model, served 7.3 million households, of which 3.2 million were poor. Even
allowing for a degree of overlap of borrowers from both models, the total number
of poor households being reached was roughly a fifth of all poor households, as
well as a smaller share of the larger number of non-poor households who have yet
to be reached by the formal financial sector. Apart from providing financial
services to both these segments of the population, there is widespread evidence that
the much stronger competition provided to the informal sector has significantly
improved the terms of credit provided to both segments by this sector, which is
losing its share to both the formal and the (semi-formal) MFI sector.