Microfinance in India

.11 Ashutosh Jaiswal

(2" Prize 2006-07)

one the opportunity

What is Microfinance?
As the name suggests,

the term

Microfinance

means 'very small credit facilities provided to the

to do good to oneself whi

doing good to others.

Over the last decade,

needy and most poor section of the society'. It is not

borrowers

just a tool for poverty

eradication

declined, both as a proportion of credit and in tern

individual development,

growth in entrepreneurial

but also for

(below

banks' outreach to srn:

Rs.25,000)

of total bank accounts.

has progressive

Microfinance

institutior

activities in economically backward areas.

(MFls) have, since emerged as key providers

So, microfinance

is a system for providing small

financial services for the poor. Majority of lndi:

loans

entrepreneurs,

MFls are not-for-profit

to

poor

typically

self-

However, now the microfinance revolutionaries are

setting their sights on a more ambitious goal, of
a more professional,

inclusive

financial system that reaches deep into rural and

urban areas. At the same time, microfinance

is

moving past its small business base to offer a wide

range

of financial

services

including

that facilita

the formation of self-help groups (SHG) and lir

employed and running a home based business.

trying to create

organizations

savings,

insurance, money transfers and broad array of loan

options, to the poor.

them with formal

activities

that

Championed

banks, often as a subset

extend

beyond

and Rural Development

(NABARD),

accounts for 70% of microfinance

typically

microfinanc

by the National Bank for Agricultu

consist

this mod

in India. SHC

of 15-25 members

and utili;

revolving savings funds. The size of individualloar

is determined

either by the volume of individu

savings or by the group's savings as a whole, ar

interest rates are determined by members. SHC

The modern origin of microfinance

dates back to

may borrow directly from an MFI / a bank and a

mid '70s. Among the key innovators was Professor

often organized into federations to obtain extern

Muhammad Yunus of Bangladesh who advocated

funds in bulk. Currently, the predominant financir

loaning to very poor people, especially women. He

model for SHGs is one in which the MFI acts

started the Grameen

Bank project in 1976 and

facilitator between banks and SHGs, while in oth

it into a bank in 1983. The bank now

cases lending goes to SHGs through the financi

transformed

has 6 million borrowers - 90% of them being women

intermediation

and almost 2000 branches in 64,000 villages. The

model, the remaining MFls employ the Grarner

repayment

rate for loans is 98% and bank has

of MFls. In addition to the SH

(group lending) model or offer individual loans. Wi

earned profit almost every year except. for three

75 million poor households

years since its inception.

financial services, the microfinance market in Ind

potentially

requirir

shows that it is

is amongst the largest in the world. Estimate

possible to make profit while doing good. It gives

household credit demand varies from a minimum

Microfinance is a system
for providing small loans to
poor entrepreneurs, typically
self-employed and running
a home based business.

urban settings. Given that 80% of poor househoh

The Grameen

Bank experiment

Rs. 2,000 to Rs. 6,000 in rural areas and Rs.9,000

* Regional

are located

in rural areas, total credit demar

ranges between Rs.255 billion and Rs.500 billio

Supply of microfinance
significantly

short

services,

of demand.

however;
Planet

fa

Flnam

reports that in 1997-1998, banks disbursed Rs.!

Office, Reserve Bank of India, Mumbai.

July - September

2007

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to combating poverty is hardly a new phenomenon.

In terms of scope, the

microfinance sector in India is
concentrated in the southern
states of Andhra Pradesh, Tamil
Nadu, Karnataka, and Kerala,
with Andhra Pradesh alone
encompassing 50 to 70%
of microfinance activities.

Over the last forty years, the Reserve Bank of India

(RBI) has encouraged

a significant

expansion of

bank branches in rural areas in order to extend

credit

services

to

the

disadvantaged

group,

including small and marginal farmers, rural artisans,

and other small borrowers. RBI has also required
commercial banks to direct 40% of their lending to
poorer members of society and to priority sectors
such

as

agriculture.

The

Government's

1982

Integrated Rural Development Program (IRDP) was

and

one of the largest poverty alleviation programs to

NABARD's SHG Bank-Linkage program disbursed

include a microfinance component. Today, national

RS.1.4 billion

development banks play a crucial role in the growth

billion

in credit

to the

poor,

covering

while

MFls

20% of the estimated

demand. More recent data suggest that while the

of

gap between supply and demand may be shrinking,

microfinance,

it continues to exist. In March 2003, outstanding

between

microfinance.

Despite

there

promotion

general

appears
of

to

support

for

be a tension

the. sector

and

client

loans of the SHG Bank-Linkage Program amounted

protection. RBI has thus forbidden MFls from taking

to Rs.10 billion while MFls held RS.2.4 billion in

public savings

loans

capital. A similar tension exists at the state level as

outstanding.

Moreover,

SHG

member

remain unmet, but borrowers

Mutually Aided Co-operative Societies Act, which is

than

generally

required.

received

Additionally,

some

states

reduce their cost of

well,

loans

though

that would

households received an average of RS.1766 in

credit. Hence, not only did the bulk of demand
smaller

are more

active

in

microfinance than others. Andhra Pradesh's (AP)

being replicated in other parts of the country, greatly

in the

simplifies the formation and supervision of groups

form of credit and do not address the poor's need for

that can access microfinance services on behalf of

saving and insurance services. Regulation prevents

their members. AP's populist mandate, however,

most MFls from mobilizing savings; and, insurance

sometimes

schemes

the

exemplified by the decision that farmers need not

in the

repay the principal on a loan for the first six months,

microfinance services remain predominantly

are

limited.

In terms

of scope,

microfinance sector in India is concentrated

serves

to undermine

credit,

southern states of Andhra Pradesh, Tamil Nadu,

unless they are borrowing from a bank.

Karnataka, and Kerala, with Andhra Pradesh alone

National Initiatives

encompassing 50 to 70% of microfinance activities.

Banks, prompted
profit

motivation,

by priority lending targets and

are

increasingly

investing

in

microfinance. To date, however, they have shown

little or no interest in retail microfinance,

and the

predominant providers of microfinance services in

India continue to be SHGs and MFls.

as is

NABARD was established in 1982 as an apex bank

to provide and regulate credit for the promotion and
development of agriculture, small-scale industries,
cottage

and village

industries,

and handicrafts

in rural areas. Its SHG Bank Linkage

Program

consists of encouraging the formation of SHGs and

linking them with banks. Collaboration with external

lCICI, the largest private bank in India, has begun to

facilitators

partner with MFls to serve their clients and in some

Government agencies is an integral aspect of the

cases

strategy. In addition to concessional refinancing for

has bought out their portfolio

in lieu of

opening microfinance retail branches directly.

banks,

Policy Support

capacity

Given

such

as NGOs,

MFls,

banks,

NABARD

provides

policy guidance

building

support.

Since

and

and

its 1992 pilot

with

project, NABARD has provided 16.7 million families

economic

reforms with a "human face," it is not

with financial services through the formation and

surprising

that the current

credit linkage of 1,079,091 SHGs as of March 2004,

the

Government's

pledge

to deal

finance

minister

[Ij]

is

supportive of microfinance. The state's commitment

far exceeding

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its goal of one million SHGs by

July - September 2007

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2007. NABARD has since increased its target to

Guaranteed funds may be

used for various purposes,
including loan recovery
and insurance claims.

585,000 new SHGs by 2007.The Small Industries

Development Bank of India (SIDBI) was established
in 1990 as the main coordinator

and principal

financial institution forthe promotion, financing, and

development

of industry in the small scale sector.

The SIDBI Foundation for Micro Credit (SFMC) was

established

in 1999 to promote the growth and

sustainability

of

the

microfinance

providing

a range of financial

services

to MFls,

including

sector

by

and non-financial
loan funds,

grant

insurance, tax breaks and other protective measur

Distinction

is

community

made

groups,

and NGOs, etc., which are essentially

support, equity, and institution building support.

MicroFinance : The Paradigm

Bank Guarantees:

financial

planners
for

.sector

reforms

motivated

to search for products

delivering

financial

services

policy

and strategies
to

the

poor

associatio

organizations,

on one hand (which are mass, community bas

organization.

The

between

people's

exter

As the name suggests, a bank guarantee is

to obtain a loan from a commercial

U!

bank. 1

guarantee may be arranged externally (throug

MicroFinance - in a sustainable manner consistent

donor / donation,

with high repayment

rates. The search for these

internally (using member savings). Loans obtair

alternatives

with

started

internal

regarding the arrangements

been traditionally

introspection

which the poor had

making to meet their financial

government

agency,

etc.)

may be given directly to an individual, or to a s

formed group.
A Bank Guarantee is a form of capital guaran

services needs. It was found that the poor tended to

scheme. Guaranteed funds may be used for varf

and could be induced to come together in a variety

purposes, including loan recovery and insurai

of informal

claims. Several international and UN orqanlzath

ways for pooling their savings

and

dispensing small and unsecured loans at varying

have been creating international

costs to group members on the basis of need. The

that banks and NGOs can subscribe to, to onlem

essential

start microcredit programmes.

genius of NABARD

programme

was

to

in the Bank SHG

recognize

this

empirical

observation that had been catalysed by NGOs and

to create

a formal

interface

of these

informal

guarantee fu

Community Banking:
The Community

Banking model essentially

tre

arrangements of the poor with the banking system.

the whole community as one unit, and establishe

This is the beginning of the story of the Bank-SHG

semi-formal

Linkage Programme.

microfinance

Microfinance-Credit

is dispensed.

Such institutions

usually formed by extensive help from NGOs ,

lending models

MFls, the" world-over,

or a formal institution through wt

other organizations,

are using various

Credit

members

who also train the commu

in various

financial

activities

of

Lending Models; some of which are as listed below:

community

Associations:

savings components and other income-genera

This is where
'association'
(and

other)

the target

community

forms

an

through which various microfinance

activities,

including

savings,

are

bank. These

development

programmes

of youth, or women; they can be formed around

Co-operatives:

political/religious

A co-operative

and other

cas

community banks are also part of larger commu

inducement for action.

/ cultural issues and can create

may h

projects included in their structure. In many

initiated. Associations or groups can be composed

support structures for micro-enterprises

institutions

which use finance

is an autonomous

associatior

persons united voluntarily to meet their comr

work-based issues.

economic, social & cultural needs and aspirati

In some countries, an 'association' can be a legal

through

body with certain advantages viz., collection of fees,

controlled enterprise. Some co-operatives

July - September

2007

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a jointly

- owned and democratical

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member - financing and savings activities in their

mandate.
Credit Unions:
A credit union is a unique member-driven,

self-help

Non Governmental Organizations

(NGOs) have emerged as a key
player in the field of microcredit.
(I)

financial institution. It is organized by and comprise

members of a particular group or organization, who
agree to save their money together and loan to each

individual level afforded by the formation of a group

is used for a number of purposes: viz., educating and

n
:r.:-

awareness

-n

of such individuals.
The collective coming together of individual members

other at reasonable rates of interest.

The members are people of some common bond:
e.g. working for the same employer; belonging to the
same church, labour union, social fraternity, etc.; or
living / working in the same community.

A credit

building, collective

bargaining

power,

peer pressure, etc.

union's membership is open to all who belong to the

This

wherein

A credit

borrower. It does not include the formation of groups,

is a democratic,

not-for-profit

is a straightforward
micro

credit-lending

model

loans are given directly

to the

financial co-operative. Each is owned and governed

or generating peer pressures to ensure repayment.

by its members who have a vote in the election of

The individual model is, in many cases, a part

directors and committee representatives.

of a larger 'credit plus' programme,

education, and other outreach services are provided.

The Grameen
focussed

where other

socio-economic services such as skill development,

Grameen:
model

grassroots

emerged
institution,

from the poorGrameen

Bank,

Intermediaries:

started by Prof. Mohammed Yunus in Bangladesh.

Intermediary

It essentially adopts the following methodology:

'go-between' organization between the lenders and

A bank unit is set up with a Field Manager and

a number of bank workers, covering an area of
about 15 to 22 villages. The manager and workers
start by visiting villages to familiarise themselves
with the local milieu in which they will be operating.
They identify their prospective clientele, and explain

model of credit lending position is a

borrowers. The intermediary plays a critical role of

generating

credit awareness

the

in some cases. These activities are geared towards

raising the 'credit worthiness' of the borrowers to a
level attractive enough to the lenders.

the purpose, functions, and mode of operation of

The links developed

the bank to the local population.

cover

Groups of five

and educating

borrowers, apart from starting savings programmes

funding,

by the intermediaries

programme

links,

training

could
and

prospective borrowers are formed; in the first stage,

education, and research. Such activities can take

only two of them are eligible for, and receive,

place at various

a loan. The group is observed for a month to see

national to regional, local and individual levels.

if the

members

are

conforming

to

rules

of

Intermediaries

levels

could

from

be

international

individual

and

lenders,

the bank. Only if the first two borrowers repay the

NGOs, microenterprise / microcredit programmes,

principal plus interest over a period of fifty weeks do

and commercial

the other members become eligible for a loan. Due

programmes).

to these restrictions,

agencies, commercial banks, intemational donors, etc.

there is substantial

group

pressure to keep individual records clear. In this

banks (for govemment

Lenders

could

be

Non-Governmental

Organizations:

Non Govemmental

Organizations

financed

government

sense, collective responsibility of the group serves

as collateral on the loan.

(NGOs)

have

emerged as a key player in the field of microcredit.

Group:

They

The Group Model's basic philosophy

fact that the collective
overcomes

responsibility

shortcomings

THE JOURNAL

acted

as intermediaries

in various

lies in the

dimensions. NGOs have been very active in starting

and security

and participating in microcredit programmes. This

and weaknesses

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Individual:

group, regardless of race, religion, colour or creed.

union

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July - September 2007

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microcredit within the community, as well as various

The real potential of microfinance

is far from being realised, owing
to various institutional and
political factors.

national and infernational donor agencies. They have

developed resources and tools for communities and
microcredit organizations to monitor progress and
identify good practices. They have also created
opportunities

to learn about the principles

practice

microcredit,

of

through

and

publications,

Policies

have

generally

focussed

on

direct

workshops and seminars, and training programmes.

interventions in the form of support systems such as

Peer Pressure:

training, technical advice, management

Peer pressure
between

uses moral

borrowers

and

and other

project

linkages

participants

to

etc.; and indirect interventions

principles

in the form of an

enabling policy and market environment.

ensure participation and repayment in microcredit

A key component that is always incorporated as a

programmes.

sort of common denominator

Peers could be other members in a

has been finance,

borrower's group (where, unless the initial borrowers

specifically microcredit - in different forms and for

in a group repay, the other members do not receive

different uses. Microcredit

loans. Hence pressure is put on the initial members

SMEs directly, or as a part of a larger enterprise

to repay); community

development programme, along with other inputs.

leaders (usually identified,

nurtured and trained by external

NGOs); NGOs

themselves and their field officers; banks, etc. The

has been provided to

Village Banking:
Village

banks are community-based

credit and

'pressure' applied can be in the form of frequent

savings associations. They typically consist of 25 to

visits to the defaulter, community meetings where

50 low-income individuals seeking to improve their

they are identified and requested to comply etc.

lives through self-employment

Rotating Savings and Credit Associations:

capital for the village bank may come from an

Rotating

Savings

external source, but since the members themselves

(ROSCAs)

are a group of individuals

and

Credit

Associations

activities. Initial loan

who come

run the bank: they choose their members, elect their

together and make regular cyclical contributions to

own officers, establish their own by-laws, distribute

a common fund, which is then given as a lump sum

loans

to one member in each cycle. For example, a group

savings. Their loans are backed, not by goods or

of 12 persons may contribute Rs.1 00 per month for

property, but by moral collateral: the promise that

12 months. The Rs.1 ,200 collected each month is

the group stands behind each individual loan.

given to one member. Thus, a member will 'lend'

Problems with the existing Microfinance system

money to other members through his / her regular

Even after half a century since independence,

monthly

still has the dubious distinction of having the world's

contributions.

After

having

received

to

individuals,

and

collect

payments

&

India

the lump sum amount when it is his / her turn to

largest number of poor people in a single country. Of

'borrow' from the group, he / she then pays back the

its nearly 1 billion inhabitants, an estimated 350-400

amount in regular / further monthly contributions.

million are below the poverty line, with 75% of them

The decision about who receives the lump sum is

staying in the rural areas. In such a scenario, the

arrived at through consensus, by lottery, by bidding

importance

or other agreed methods.

eradication can't be overemphasised.

of microfinance

as a tool for poverty

Small Business:

Microfinance

The prevailing vision of the 'informal sector' is one of

versions through various delivery channels. So far,

survival,

low productivity

the experience has been a mixed one with varying

addition.

But this

and very

scenario

has

little value

been

steadily

has

been

promoted

in different

result across the states. However, the real potential

changing, with increased importance being placed

of microfinance is far from being realised, owing to

on small

various institutional and political factors. The major

and medium

enterprises

(SMEs)

for

generating employment, for increasing income and

stumbling

providing services which are lacking.

enumerated here:

July - September 2007

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blocks

in microfinance

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1) Lack of awareness / education about microfinance

services in the area and availability of viable option

2) Lack of enabling policy for MFls.

of entrepreneurial activities.

3) Skill development.

However, an attempt is made here to explore areas

4) Politicisation of Government funded \ subsidised

programmes.

where improvements

can be made or the process

may be redesigned and the guiding principles may

be redefined. As we have already discussed the

5) Non availability of intermediary between the Fls

and the borrower who lack collateral security.

existing models and problems with microfinance in

India, we take a fresh look at it by dividing the

6) High administrative cost where multiple intermediaries

entire research in areas of Guiding principles of

microfinance,

are involved.
7) Lack of skilled labour with the knowledge of local

Role of Government

MFls and Financial Institutions,

and NGOs /

delivery channel

and effectiveness of assessment methodologies.

level accounting.
8) Highly disorganised and fragmented intermediation
between Fls and the borrowers.

Apart from these factors, the attitude of the financial

its stated objective:

Poor are ready to pay higher than market rate

of interest.

something that

had to be done because the authorities wanted it so.

Administrative cost is a major stumbling block for

banks in providing the loan to the poor.

This was translated into the banking language of the

The government subsidy should be channelised

day : loans to the poor were part of social sector

lending and not commercial lending; the poor were
not

borrowers,

they

were

beneficiaries;

poor

to the really needy and viable projects.

Poor should be instilled with the spirit of savings.

assistance.

Technical knowledge is integral to skill development

and viability of any entrepreneurial activity.

This language resulted in an attitude of carefully

Government

beneficiaries did not avail of loans - they availed of

disguised cynicism towards the poor. The attitude

rather

role should

than

be that of facilitator

of a regulator.

was that the poor are not bankable, that they can

regulatory

never

formulate best practice code.

be bankable,

that commercial

principles

organisation

can

Model
be

of Self-

adopted

to

cannot be applied in lending to the poor; what the

poor require are not loans but charity. Once this

Existence of speciality microfinance institutions

to provide a focussed approach to the sector.

mindset hardened it became more and more difficult

Role of Government:

for commercial bankers to accept that lending to the

poor could be a viable activity. It is significant to note
that the system had to wait for almost a decade for

The diagram below describes the manner in which

the microcredit is generally delivered-

the concept of microfinance to become credible.

An Alternative Approach
Given the plethora of research papers available on

I Directlending>

microfinance and its various aspects, it is difficult to

find an altogether
efficiency

new approach

of microfinance

stated objective.

THE JOURNAL

its

It is also to be realized that the

ground situation varies drastically

place; depending

of improving

models to achieve

from place to

upon the spread

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should form the basic

non-supportive.

it did so only as a social obligation

-n
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The following assumptions

Poor are bankable.

to internalise lending to the poor as a viable activity;

n
:z::.

institutions towards lending to the poor has been

The banking system was not able

."m

Guiding Principles of Microfinance :

principle of microfinance lending in order to achieve

9) Dominance of informal / deregulated financiers.

en

Microcredit

can

be

provided

by the

financial

institutions either directly or through intermediaries

& FINANCE

July - September 2007

:a

like

NGOs,

MFls,

&

Government

agencies.

scheme

has been successful

in providing

new

Government agencies provide various subsidies for

employment, generating income, improving health

projects

and

under specified

schemes.

Bankers

are

literacy

level,

etc.

quite comfortable in lending under such schemes as

can be an indicator

the subsidy is directly given to the banks. However,

frequency

bankers

have

to

use

their

own

Additionally,
provide

the

most

generation,

the

and repayment

rate show how fast the productivity

assessment

Role of NGOs :
MFls

rate

of income

and cash cycle is reduced.

repayment

of loan disbursement

techniques to evaluate the viability of the project.

NGOs

While

effective

intermediation in microfinance lending. They not only

is improved

the number of MFls working in the

area, total number of beneficiaries,

proportion of

women

geographical

in the total

beneficiaries,

identify the right kind of borrower but also ensure the

spread are some of the tools that can be used to

success of the project through development of skills

assess the reach and effectiveness of microfinance.

and community

The MFls should get themselves

participation.

Their direct regular

contact with the borrower, pressurises

him / her

into timely repayment. However, their involvement

only adds up to the cost of financing. This higher
cost may be sustainable in the short run but as the
competition intensifies, the high interest cost makes
the microfinance
the market.

entrepreneurs

uncompetitive

in

Conclusion
Banking on poor can be a profitable business which
has been successfully demonstrated
Bank,

Bangladesh.

Deposit

by Grameen

mobilisation

major means for MFls to expand

leveraging

Delivery Channel:

rated so as to

reduce their cost of borrowing / deposits.

equity.

microfinance

In order

lending

is the

outreach

by

to be sustainable,

should

be

grounded

on

In any delivery channel, the lesser the number of

market principles because large scale lending can't

intermediaries, the better it is as, it reduces the cost

be accomplished through subsidies.

of operation.

Owing to prevailing

atmosphere,

it

becomes very difficult to foresee any substantial

direct lending to the poor in near future,

until

enabling policies are framed for MFls.

Creating

an

environment

Microfinance can contribute to solving the problem

of inadequate
integral

housing and urban services as an

part of poverty alleviation

programmes.

The challenge lies in finding the level of flexibility

conducive

for

MFls

in the credit instruments

that can make it match

to access low cost funds can reduce the cost of

the multiple credit requirements of the low income

funds

borrowers without imposing unbearably

substantially.

through
entire
the

subsidies

Government

is the most abused

microfinance

decision

of

intermediation

system.
subsidy

Instead
to

part in

of leaving

respective

Block

Development Officers' discretion, it should allow tax

breaks to financial

institutions

for lending under

high cost

of monitoring its end use upon its lenders.

A promising

solution is to provide multi-purpose

loans or composite

credit for income generation,

housing improvement,

and consumption.

research

for financing

on demand

Careful

and savings

microfinance. This will induce more banks to build a

behaviour

positive attitude towards this sector. Access to low

participation in determining the mix of multi-purpose

cost funds through deposit mobilisation

loans are essential in making the concept work.

from the

general public is another source of low cost funds.

Hopefully, the Government, in consultation with the
RBI will come out with policies that are supportive
to this idea.

it would

creditworthiness

borrowers

and their

be ideal to enhance

the

of the poor and make them more

'bankable' to financial institutions and enable them

to qualify for long term credit from the formal sector.

Effectiveness Assessment:
The

Eventually,

of the potential

microfinance

should

go beyond

value

of

loan

MFls have a lot to contribute

effectiveness

assessment

the traditional

disbursement

parameter

and

of

financial discipline
about repayment.

to this by building

and educating

the borrowers

repayment

rate. It should evaluate the extent to which the

July - September 2007

THE JOURNAL

OF INDIAN INSTITUTE

OF BANKING

& FINANCE