In India sources of credit can be categorized into formal and informal sources.

Formal sources of
credit consist of commercial banks, regional rural banks, cooperative credit societies etc.
Informal sources of credit are friends and relatives, moneylenders etc. Today, India has over
32,000 rural branches of commercial banks and regional rural banks (RRBs), some 14,000
cooperative bank branches, 98,000 primary agricultural credit societies (PACS) (Basu and
Srivastava, 2005). However, despite the vast network of banking and cooperative finance
institutions the performance of the formal financial sector still fails to adequately reach out to, or
reflect and respond to the requirements of the poor (Imai and Arun, 2008, Basu and Srivastava,
2005, Zeller and Sharma, 1998). In India despite the hype of high growth rate of the Indian
economy still nearly 27 percent of the total population is poor (Government of India). If we
consider the ‘exclusion’ errors in estimating the poverty rate then the percentage is surely going
to increase. It is also true that majority of the poor population is landless or marginal farmers or
daily labour or petty self-employed. Unarguably these people do need some sort of assistance in
terms of credit to earn their day-to-day livelihood. Untill the 1990s financial services were
facilitated by state sponsored institutions. The late 90’s saw the emergence of the microfinance
institutions. The different organisations in this field can be classified as "Mainstream" and
"Alternative" Micro Finance Institutions. National Agricultural Bank for Rural Development
(NABARD), Small Industries Development Bank of India (SIDBI), Housing Development
Finance Corporation (HDFC), Commercial Banks, Regional Rural Banks (RRBs), the credit co-
operative societies etc are some of the mainstream financial institutions involved in extending
micro finance. These are the institutions, which have come up to fill the gap between the demand
and supply for microfinance. Microfinance combines the safety and reliability of formal finance
with the convenience and flexibility of informal finance. Many NGOs, either directly or
indirectly through the SHGs, offer microfinance. These are Alternative form of micro finance
institutions. The number of SHGs linked to banks has increased from just 500 in the early 1990s,
to over 800,000 by 2004 (Basu and Srivastava, 2005). These MFIs have become increasingly
important in societies like India mainly due to their better access to local knowledge and
information. The formal credit institutions suffer from lengthy paper works, unavailability of
easy access to loans etc (Basu and Srivastava, 2005, Zeller and Sharma, 1998). Also the structure
and policies of formal sector loans tend to concentrate more on productive loans. It also put
much emphasis on the credit worthiness of the borrower before sanctioning loans. But the
success of MFIs in different countries shows that the poor basically need consumption loans. A
rural marginal farmer might need loan in the lean season just to survive. Now it is very true that
people belong to the lowest income group spends most of the income on food. Consumption and
nutrition are important to a household’s ability to earn income. It has been found that mere
extension of financial services to the poor households does not reduce poverty. The purpose of
the loan (i.e., for what purpose the loan is used), the literacy level of the head, availability of
non-farm employment opportunities in surrounding area etc. play important role in it (Imai and
Arun, 2008). Households with improved access to credit are better able to adopt technology,
increase their incomes, and improve food expenditures and calorie intake than those who do not
have access to credit (Zeller and Sharma, 1998). So it has been argued that financial services
must be complemented with other services (like improving access to basic literacy level,
education in nutrition, health care etc.).

Basu Priya and Pradeep Srivastava (2005): “Scaling-up microfinance for India’s rural poor”,
World Bank Policy Research Working Paper 3646.

Imai Katsushi and Thankom Arun (2008): “Does Microfinance Reduce Poverty in India?”, EDP
0814, School of Social Sciences, The University of Manchester.

Zeller Manfred and Manohar Sharma (1998): “Rural Finance and Poverty Alleviation”, Food
Policy Report, IFPRI, Washington, D.C.
The modern banking system in India started in the colonial period. The Reserve Bank of India
was established in 1935 and it was nationalized in 1949. In the colonial period the usurious
money lenders were the main source of rural credit. The spread of banking system during that
time was very limited. Rural credit disbursement of the money lenders were characterized by
high rate of interest with high exploitation of the poor. The moneylenders often combined the
roles of crop buyer, labour employer and land lessor. This multiple role of the moneylenders
gave them immense power and upper hand over the borrowers (Shah, Mihir et al., 2007). In the
early 1950s it was found that the moneylenders, traders and rich landlords accounted for more
than 75 per cent of rural credit (Shah, Mihir et al., 2007). The immediate action plan of the
Government was to concentrate on Cooperative Credit Societies. In 1971, the share of
cooperatives in rural credit rise to 20 percent (Shah, Mihir et al., 2007). But later, these
cooperative societies had been seen to suffer from many shortcomings. The concept of mutuality
between savings and credit functions, that is very important for the successful functioning of the
cooperatives societies had been lacking in India. At the same time, the share of banks in rural
credit was meager. Also, some specific sectors (like agriculture, cottage industry etc.) and certain
disadvantaged groups (like dalits, STs etc.) were found to be out of the purview of the banking
sector. Keeping in these objectives the banks were nationalized in 1969. So only after 1969, the
provision of credit in the countryside and to the needy was brought under a proper Government
policy (Ramachandran, V.K. and M. Swaminathan, 2004). Agriculture and allied activities and
small-scale and cottage industries were identified as “priority” sectors for credit delivery by the
commercial banks. However, the nationalisation of banks in 1969, introduction of Regional
Rural Banks (RRBs) and priority sector lending had the desired impact in stepping up the supply
of credit to agriculture. The share of agriculture in the total credit provided by the formal
banking sector, which was only 7.1 per cent in 1969, increased to 15.72 per cent of the total net
bank credit by 1980 (Sahu, Gagan Bihari and D. Rajsekhar, 2005). Advances to the countryside
increased substantially but at the same time they were found to be biased towards some specific
regions and classes (Ramachandran, V.K. and M. Swaminathan, 2004). In the early 1980s
employment generation and poverty alleviation were recognized as very important objectives in
the Government policy. So inorder to benefit the “weaker section” of the society credit was
started directing towards the intended segment of the society. Integrated Rural Development
Programme, a scheme for the creation of productive income-bearing assets among the poor
through the allocation of subsidized credits, started. The IRDP strategy did lead to a significant
transfer of funds to the rural poor. The scheme failed in creating income-bearing assets in the
hands of rural poor. Also the expansion of the formal credit sector, even in the period of social
banking, showed a great imbalance, being concentrated in the hands of the rich and the already
developed regions. The poor still depended on the informal sector in a big way (Shah, Mihir et
al., 2007). But overall the phase between 1969 and 1990 saw unprecedented growth of
commercial banking in terms of geographical spread and functional reach (Shetty, 1997 cited in
Ramachandran, V.K. and M. Swaminathan, 2004). The phase of liberalization after 1991 came
up with banking policy which would be guided more by the market thsn by the regulations set by
the public authority. In order to use the premature policies of globalization the reform process
forgot the entire structure of social and development banking (Ramachandran, V.K. and M.
Swaminathan, 2001, Shah, Mihir et al., 2007). The number of rural and semi urban bank branch
offices steadily declined in the post reform period (Shah, Mihir et al., 2007, Ramachandran, V.K.
and M. Swaminathan). After 1990 mergers and swapping of rural branches became the norm.
The number of RRBs that rose to 196 by 1990 had fallen to 104 by 2006. The profitability of
public sector banks has improved following liberalisation. Total non-performing assets (NPAs)
of public sector banks as a proportion of total advances have declined .But the share of rural
credit has fallen continuously from the peak of 15.3 per cent in 1987 to 8.4 per cent in 2006. The
share of rural deposits has also fallen steadily from its peak of 15.5 per cent in 1990 to 10.8 per
cent in 2006. The share of agriculture in total bank credit has fallen from 19 per cent in 1990 to
under 11 per cent in March 2005. (Shah, Mihir et al., 2007). The small cultivators were the
worst affected by the post-1991 decline in credit to agriculture. In contrast advances to large
cultivators have risen in the same period (Ramachandran, V.K. and M. Swaminathan, 2001,
Shah, Mihir et al., 2007).

Ramachandran, V. K. and M. Swaminathan (2001): “Does Informal Credit Provide Security?

Rural Banking Policy in India”, ILO, Geneva.
Ramachandran, V. K. and M. Swaminathan (2004): “Financial liberalization and Rural Banking
in India”, Paper presented at the International Conference on “The Agrarian Constraint and
Poverty Reduction: Macroeconomic Lessons for Africa”, International Development Economics
Associates (IDEAS), Addis Ababa.
Sahu, Gagan Bihari and D. Rajsekhar (2005): “Banking Sector Reform and Credit Flow to Indian
Agriculture”, EPW. December 31, 2005.
Shah, Mihir, Rangu Rao and P. S. Vijay Shankar (2007): “Rural Credit in 20 th Century India:
Overview of History and Perspectives”, EPW, April 14, 2007.