What is Microfinance ?
Microfinance is the provision of savings accounts, loans, insurance, money transfers and other banking services to customers that lack access to traditional financial services, usually because of poverty.
Microfinance is the provision of financial services to low-income clients or solidarity lending groups including consumers and the self-employed, who traditionally lack access to banking and related services.
What is Microcredit ?
Microcredit is one component of microfinance, which also includes other financial services such as savings accounts, insurance and money transfers.Microcredit is the extension of very small loans (micro loans) to impoverished borrowers who typically lack collateral, steady employment and a verifiable credit history. It is designed not only to support entrepreneurship and alleviate poverty, but also in many cases to empower women and uplift entire communities by extension.Microcredit is a variation on traditional credit service that involves providing small loans to people who would otherwise be unable to secure credit, typically because of poverty. Related barriers may include unemployment or underemployment and a lack of collateral and credit history.Microcredit is sometimes provided to fund a business initiative by the recipient. The entrepreneurs involved are sometimes referred to as “micro-entrepreneurs” because the scope of their projects and the sums required to fund them are very modest.
Microcredit is one component of microfinance, which also includes other financial services such as savings accounts, insurance and money transfers.Microcredit is the extension of very small loans (micro loans) to impoverished borrowers who typically lack collateral, steady employment and a verifiable credit history. It is designed not only to support entrepreneurship and alleviate poverty, but also in many cases to empower women and uplift entire communities by extension.Microcredit is a variation on traditional credit service that involves providing small loans to people who would otherwise be unable to secure credit, typically because of poverty. Related barriers may include unemployment or underemployment and a lack of collateral and credit history.Microcredit is sometimes provided to fund a business initiative by the recipient. The entrepreneurs involved are sometimes referred to as “micro-entrepreneurs” because the scope of their projects and the sums required to fund them are very modest.
Microfinance is a much broader concept than microcredit and refers to loans, savings, insurance, money transfers, and other financial products targeted at poor and low-income people. Microcredit refers more specifically to making small loans available to poor people, especially those traditionally excluded from financial services, through programmes designed specifically to meet their particular needs and circumstances.
Loans under micro credit are usually relatively short term, less than twelve months in most instances and often even six months or less, and generally for working capital with immediate regular weekly or monthly repayments – they are also disbursed quickly after approval. Loans are usually quite small to begin with. As borrowers regularly repay their loans and demonstrate their creditworthiness, they become eligible for larger loans. The traditional lender’s requirements for physical collateral such as property are usually replaced by a system of collective guarantee (or solidarity) groups whose members are mutually responsible for ensuring that their individual loans are repaid. Alternatively, borrowers may be requested to find one or two personal guarantors – often these are respected local community leaders.Loan application and disbursement procedures are designed to be helpful to low income borrowers – they are simple to understand, locally provided and quickly accessible with minimal paperwork.
Microfinance is not just about giving micro credit to the poor rather it is an economic development tool whose objective is to assist poor to work their way out of poverty. It covers a wide range of services like credit, savings, insurance, remittance and also non-financial services like training, counseling etc.
Salient Features of Microfinance :
- Borrowers are from the low income group
- Loans are of small amount – micro loans
- Short duration loans
- Loans are offered without collaterals
- High frequency of repayment
- Loans are generally taken for income generation purpose
What are Microfinance institutions ?
A number of organizations with varied size and legal forms offer microfinance service.Those institutions which have microfinance as their main operation are known as micro finance institutions.MFIs are an extremely heterogenous group comprising NBFCs, societies,trusts and cooperatives. They are provided financial support from external donors and apex institutions including the Rashtriya Mahila Kosh (RMK), SIDBI Foundation for micro-credit and NABARD and employ a variety of ways for credit delivery.These institutions lend through the concept of Joint Liability Group (JLG). A JLG is an informal group comprising of 5 to 10 individual members who come together for the purpose of availing bank loans either individually or through the group mechanism against a mutual guarantee.
Definition given by Malegam Committee :
MFI is a company (other than a company licensed under Section 25 of the Companies Act, 1956) which provides financial services pre-dominantly to low-income borrowers with loans of small amounts, for short-terms, on unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks and which further conforms to the regulations specified in that behalf.
The reason for existence of separate institutions i.e. MFIs for offering microfinance are as follows:
- High transaction cost – generally micro credits fall below the break-even point of providing loans by banks
- Absence of collaterals – the poor usually are not in a state to offer collaterals to secure the credit
- Loans are generally taken for very short duration periods
- Higher frequency of repayment of installments and higher rate of default
History of Microfinance in India :
The first thing to remember is that in India the history of rural credit, poverty alleviation and microFinance are inextricably interwoven. Any effort to understand one without reference to the others, can only lead to a fragmented understanding.The policy response of the then British Government to this problem of rural indebtedness was to initiate the process of organization of cooperative societies as alternative institutions for providing credit to the farmers as also to ensure settled conditions in the rural areas, so necessary for a colonial power to sustain itself.
In the development strategy adopted by independent India, institutional credit was perceived as a powerful instrument for enhancing production and productivity and for alleviating poverty. The formal view was that lending to the poor should be a part of the normal business of banks.
To achieve the objectives of production, productivity and poverty alleviation, the stance of policy on rural credit was to ensure that sufficient and timely credit was reached as expeditiously as possible to as large a segment of the rural population at reasonable rates of interest.
The strategy devised for this purpose comprised :
· Expansion of the institutional structure,
· Directed lending to disadvantaged borrowers and sectors and
· Interest rates supported by subsidies.
The strategy devised for this purpose comprised :
· Expansion of the institutional structure,
· Directed lending to disadvantaged borrowers and sectors and
· Interest rates supported by subsidies.
The institutional vehicles chosen for this were cooperatives, commercial banks and Regional Rural Banks (RRBs).
Between 1950 & 1969, the emphasis was on the promoting of cooperatives. The nationalization of the major commercial banks in 1969 marks a watershed inasmuch as from this time onwards the focus shifted from the cooperatives as the sole providers of rural credit to the multi agency approach. This also marks the beginning of the phenomenal expansion of the institutional structure in terms of commercial bank branch expansion in the rural and semi-urban areas. For the next decade and half, the Indian banking scene was dominated by this expansion. However, even as this expansion was taking place, doubts were being raised about the systemic capability to reach the poor. Regional Rural Banks were set up in 1976 as low cost institutions mandated to reach the poorest in the credit-deficient areas of the country. In hindsight it may not be wrong to say that RRBs are perhaps the only institutions in the Indian context which were created with a specific poverty alleviation - microfinance – mandate.
Between 1950 & 1969, the emphasis was on the promoting of cooperatives. The nationalization of the major commercial banks in 1969 marks a watershed inasmuch as from this time onwards the focus shifted from the cooperatives as the sole providers of rural credit to the multi agency approach. This also marks the beginning of the phenomenal expansion of the institutional structure in terms of commercial bank branch expansion in the rural and semi-urban areas. For the next decade and half, the Indian banking scene was dominated by this expansion. However, even as this expansion was taking place, doubts were being raised about the systemic capability to reach the poor. Regional Rural Banks were set up in 1976 as low cost institutions mandated to reach the poorest in the credit-deficient areas of the country. In hindsight it may not be wrong to say that RRBs are perhaps the only institutions in the Indian context which were created with a specific poverty alleviation - microfinance – mandate.
During this period, intervention of the Central Bank (Reserve Bank of India) was essential to enable the system to overcome factors which were perceived as discouraging the flow of credit to the rural sector such as absence of collateral among the poor, high cost of servicing geographically dispersed customers, lack of trained and motivated rural bankers, etc.The policy response was multi dimensional and included special credit programmes for channeling subsidized credit to the rural sector and operationalising the concept of “priority sector”. The latter was evolved in the late sixties to focus attention on the credit needs of neglected sectors and under-privileged borrowers.inadequate attention was paid to the qualitative aspects of lending leading to loan defaults and erosion of repayment ethics by all categories of borrowers. The end result was a disturbing growth in overdues, which not only hampered the recycling of scarce resources of banks, but also affected profitability and viability of financial institutions. This not only blunted the desire of banks to lend to the poor but also the development impact of rural finance.
The financial sector reforms motivated policy planners to search for products and strategies for delivering financial services to the poor – microfinance - in a sustainable manner consistent with high repayment rates.The search for these alternatives started with internal introspection regarding the arrangements which the poor had been traditionally making to meet their financial services needs. It was found that the poor tended to – and could be induced to - come together in a variety of informal ways for pooling their savings and dispensing small and unsecured loans at varying costs to group members on the basis of need.This is the beginning of the story of the Bank-SHG Linkage Programme.
Models of Microfinance in India
1. Self Help Group (SHG) Bank Linkage Model:
1. Self Help Group (SHG) Bank Linkage Model:
The microfinance movement started in India with the introduction of the SHG-Bank Linkage Programme in the 1980s by NGOs that was later formalized by the Government of India in the early 1990s. Pursuant to the programme, banks, which are primarily public sector regional rural banks, are encouraged to partner with SHGs to provide them with funding support, which is often subsidized.A self help group, or SHG, is a group of 10 to 20 poor women in a village who come together to contribute regular savings to a common fund to deposit with a bank as collateral for future loans. The group has collective decision making power and obtains loans from the partner bank. The SHG then loans these funds to its members at terms decided by the group. Members of the group meet on a monthly basis to conduct transactions and group leaders are responsible for maintaining their own records, often with the help of NGOs or government agency staff.
NABARD is presently operating three models of linkage of banks with SHGs and NGOs.
2. Micro Finance Institution (MFI) Model:
The MFI model has gained significant momentum in India in recent years and continues to grow as the viable alternative to SHGs. In contrast to an SHG, an MFI is a separate legal organization that provides financial services directly to borrowers.MFIs have their own employees, record keeping and accounting systems and are often subject to regulatory oversight. MFIs require borrowers from a village to organize themselves in small groups, typically of five women, that have joint decision making responsibility for the approval of member loans. The groups meet weekly to conduct transactions.MFI staff travel to the villages to attend the weekly group meetings to disburse loans and collect repayments. Unlike SHGs, loans are issued by MFIs without collateral or prior savings.MFIs now exist in a variety of legal forms, including trusts, societies, cooperatives, non-profit NBFCs registered under Section 25 of the Companies Act, 1956, or Section 25 Companies, and NBFCs registered with the RBI. Trusts, cooperatives and Section 25 companies are regulated by the specific act under which they are registered and not by the RBI.
Problems & Need for Regulation
With financial inclusion emerging as a major policy objective in the country, the concept of MFI has grown over the past two decades. Microfinance has occupied centre stage as a promising conduit for extending financial services to unbanked sections of population. At the same time, practices followed by certain lenders have subjected the sector to greater scrutiny and need for stricter regulation.Although the microfinance sector is having a healthy growth rate, there have been a number of concerns related to the sector, like grey areas in regulation, transparent pricing, low financial literacy etc. In addition to these concerns there are a few emerging concerns like cluster formation, insufficient funds, multiple lending and over-indebtedness which are arising because of the increasing competition among the MFIs.
Over the years, major commercial banks and multinational corporations have decided to sponsor it.However, this type of financing has a darker side too. Most of studies are qualitative which tell that more than 90 per cent of the people who receive micro credit are poor and most of them succeed in businesses started with these loans.But the suicides committed by Indian farmers after being harassed by the microfinance institutions (MFIs) for their inability to repay the debt have raised serious moral and ethical issues against the institutions.The aggressive debt-collection tactics of these MFIs have left us wondering if the government has been playing ignorant to the modus operandi of MFIs.Moreover, the interest rates charged by micro financing institutions are usurious.Today, MFIs pay little attention to the core concerns of the poor. For them the critical concern is to sustain services against emerging odds.We’ve seen a major mission drift in micro finance, from being a social agency first, to being primarily a lending agency that wants to maximise its profit.Thus, there is a great need to set out rules limiting interest rates and stipulating legal consequences for the MFIs who badger/ harass borrowers for payments.
Malegam Committee recommends regulation of MFIs for following reasons :
1.All NBFCs are currently regulated by Reserve Bank under Chapters III-B, III-C and V of the Reserve Bank of India Act. There is, however, no separate category created for NBFCs operating in the Microfinance sector.
2. First, the borrowers in the Microfinance sector represent a particularly vulnerable section of society. They lack individual bargaining power, have inadequate financial literacy and live in an environment which is fragile and exposed to external shocks which they are ill-equipped to absorb. They can, therefore, be easily exploited.
3. Second, NBFCs operating in the Microfinance sector not only compete amongst themselves but also directly compete with the SHG-Bank Linkage Programme. The practices they adopt could have an adverse impact on the programme. In a representation made to the Sub-Committee by the Government of Andhra Pradesh,it has been argued, that the MFIs are riding “piggy-back” on the SHG infrastructure created by the programme and that JLGs are being formed by poaching members from existing SHGs. About 30% of MFI loans are purportedly in Andhra Pradesh.The Microfinance in India- A State of Sector Report 2010 also says that there are many reports of SHGs splitting and becoming JLGs to avail of loans from MFIs.The A.P. Government has also stated that as the loans given by MFIs are of shorter duration than the loans given under the programme, recoveries by SHGs are adversely affected and loans given by the SHGs are being used to repay loans given by MFIs.
4. Fourth, over 75% of the finance obtained by NBFCs operating in this sector is provided by banks and financial institutions including SIDBI. As at 31stMarch 2010,the aggregate amount outstanding in respect of loans granted by banks and SIDBI to NBFCs operating in the Microfinance sector amounted to 13,800 crores. In addition, banks were holding securitized paper issued by NBFCs for an amount of 4200 crores. Banks and Financial Institutions including SBIDBI also had made investments in the equity of such NBFCs. Though this exposure may not be significant in the context of the total assets of the banking system, it is increasing rapidly.
5. Finally, given the need to encourage the growth of the Microfinance sector and the vulnerable nature of the borrowers in the sector, there may be a need to give special facilities or dispensation to NBFCs operating in this sector, alongside an appropriate regulatory framework. This will be facilitated if a separate category of NBFCs is created for this purpose.
2. First, the borrowers in the Microfinance sector represent a particularly vulnerable section of society. They lack individual bargaining power, have inadequate financial literacy and live in an environment which is fragile and exposed to external shocks which they are ill-equipped to absorb. They can, therefore, be easily exploited.
3. Second, NBFCs operating in the Microfinance sector not only compete amongst themselves but also directly compete with the SHG-Bank Linkage Programme. The practices they adopt could have an adverse impact on the programme. In a representation made to the Sub-Committee by the Government of Andhra Pradesh,it has been argued, that the MFIs are riding “piggy-back” on the SHG infrastructure created by the programme and that JLGs are being formed by poaching members from existing SHGs. About 30% of MFI loans are purportedly in Andhra Pradesh.The Microfinance in India- A State of Sector Report 2010 also says that there are many reports of SHGs splitting and becoming JLGs to avail of loans from MFIs.The A.P. Government has also stated that as the loans given by MFIs are of shorter duration than the loans given under the programme, recoveries by SHGs are adversely affected and loans given by the SHGs are being used to repay loans given by MFIs.
4. Fourth, over 75% of the finance obtained by NBFCs operating in this sector is provided by banks and financial institutions including SIDBI. As at 31stMarch 2010,the aggregate amount outstanding in respect of loans granted by banks and SIDBI to NBFCs operating in the Microfinance sector amounted to 13,800 crores. In addition, banks were holding securitized paper issued by NBFCs for an amount of 4200 crores. Banks and Financial Institutions including SBIDBI also had made investments in the equity of such NBFCs. Though this exposure may not be significant in the context of the total assets of the banking system, it is increasing rapidly.
5. Finally, given the need to encourage the growth of the Microfinance sector and the vulnerable nature of the borrowers in the sector, there may be a need to give special facilities or dispensation to NBFCs operating in this sector, alongside an appropriate regulatory framework. This will be facilitated if a separate category of NBFCs is created for this purpose.
Major recommendations of Malegam Committe :
The Malegam committee has said that NBFCs with microfinance operations should be classified as an NBFC-MFI, and said that bank loans to these NBFC-MFI should be included in the priority sector. An NBFC-MFI will be a company that provides loans largely to low-income borrowers and gives small amount, short-term loans on unsecured basis. The report says that an NBFC MFIs cannot give more than Rs 25,000 as loan to single borrower and can provide loans only to families with income less than Rs 50,000.The Malegam Committee recommends a interest rate cap of 24% on individual loans and a margin cap of 10-12% depending on the size of the MFI. The report also attempts to address concerns about multiple-borrowing by placing restrictions on the number of MFIs an individual may borrow from (maximum of 2) and maximum number of groups to which an individual may belong(The report has recommended to disallow more than two microfinance companies to lend to one borrower.).It recommended setting up of a microfinance credit information bureau .The committee proposed to set up an ombudsman for the MFI sector. It also called for the Reserve Bank of India to draft a customer protection code for MFIs.
The Malegam committee has said that NBFCs with microfinance operations should be classified as an NBFC-MFI, and said that bank loans to these NBFC-MFI should be included in the priority sector. An NBFC-MFI will be a company that provides loans largely to low-income borrowers and gives small amount, short-term loans on unsecured basis. The report says that an NBFC MFIs cannot give more than Rs 25,000 as loan to single borrower and can provide loans only to families with income less than Rs 50,000.The Malegam Committee recommends a interest rate cap of 24% on individual loans and a margin cap of 10-12% depending on the size of the MFI. The report also attempts to address concerns about multiple-borrowing by placing restrictions on the number of MFIs an individual may borrow from (maximum of 2) and maximum number of groups to which an individual may belong(The report has recommended to disallow more than two microfinance companies to lend to one borrower.).It recommended setting up of a microfinance credit information bureau .The committee proposed to set up an ombudsman for the MFI sector. It also called for the Reserve Bank of India to draft a customer protection code for MFIs.
More Info :
The Microfinance Institutions (Development and Regulation) Bill details - Click Here
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