INTRODUCTION

OF

MICRO FINANCE IN INDIA

Meaning of Microfinance
Microfinance is a term used to refer to the activity of provision of financial
services to clients who are excluded from the traditional financial systems on account
of their lower economic status. These financial services will most commonly take the
form of loans (see micro credit) & savings, through some microfinance institutions will
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offer other services such as insurance & payment services. The Microfinance is
changing the landscape of banking across the world. It has changed the ivies of people
& revitalized communities in the world’s poorest as well as richest countries. The
microfinance is a better targeted financial help to a clientele that is poorer & vulnerable
than traditional bank clients. The broad classification of microfinance includes rural
credit through specialized banks traditional informal microfinance like loans from
friends & relatives money lenders etc.

Microfinance as a Development Tool

People living in poverty –like everyone else need access to a diverse range of
financial services, including loans, saving services, insurance & money transfers.
Access to financial services can help enable the poor to increase income & smooth
consumption flows, & thus expend their asset base & reduce their vulnerability to the
external shocks that are a part of their daily existence. The availability of financial
services acts as a buffer against sudden emergencies, business risk & seasonal slums
that can push a family into destitution. More & better financial services specifically
geared towards low income groups can help poor households to move from everyday
survival to planning for the future, investing in better nutrition, improver living
condition & children’s health & education.

Microfinance has the potential to benefit poor people both indirectly, through increased
growth, & directly as they gain access to needed services. Impact studies show that in
money cases ,microfinance reduced poverty through increasing income levels. Studies
also show that microfinance improves poor people’s lives by contributing to improved
healthcare, children’s education & nutrition & women’s empowerment.

In particular, the ability to borrow, save & earn income reduced economic vulnerability
for women & their households, increased financial & food security can bring a new
confidence & hope which often translates to a greater sense of empowerment to a
person.

Nonetheless, microfinance is not a panacea. Even the most innovative & participative
programmes can lead to unwanted negative impacts. Microfinance has in many cases
been shown to benefit the better off poor more than the truly destitute. Many early
impact studies on microfinance showed increasing income levels, but more recent &
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better designed studies have shown that in many cases the impact varies per income
group. In most cases the better off benefit more from micro credit, due to their higher
skills level, better market contacts & higher initial resource base. Lower income groups
may be more risk-averse & benefit more from saving & micro insurance.

Many microfinance & micro credit programmed target women in particular, largely due
to their (generally) higher repayment rates, but in many cases this is mixed blessing. If
a programmed excludes men, particularly in areas where access to financial services is
limited, the man may require his wife to get the loan for him. Others have argued that
exclusive access for women actually increases her bargaining power within the
household. While inspiring examples abound of women taking loans & then using the
income from their business to provide employment to others, feed their children’s send
them to school, & become empowered members of their community & their household,
many more examples exist of vivacious circles of debt, family violence & increased
workloads.

How Many People Have Access to Microfinance?

The consultative group to assist the poor (CGAP) estimates that of the three
billion poor people of working age who could be making use of these services about
500 million-one sixth currently have access to formal financial services.

If we are ever to reach the estimated three billion poor people who could use financial
services, it will require a whole range of institutions, not just traditional NGO
microfinance institutions to do it. Microfinance institutions have played a key role in

the development of microfinance & they will continue to do so. But what is really
needed-to reach both further & deeper-is a whole range of institutions that will jostle &
compete with one another to serve poor people & to innovate to reach more & more
poor people.

Sustainable Microfinance

Microfinance is unique as a development tool because of its potential to be self-

sustaining. Successful microfinance institutions have proven that providing financial
services to the poor can be an effective means of poverty reduction & be a profitable

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business. Dozens of institutions have proven that financial services for poor people can
cover their full costs, through adequate interest spreads, relentleless focus on efficiency
& aggressive enforcement of repayment. A large & growing proportion of today’s
microfinance services are being provided by institutions that are profitable even after
adjusting for subsidies that they may have recd.

There will never be enough aid funding available to make an appreciable client the
scale of poverty that still exists around the world. The financial viability of institutions
is what will ultimately guarantee the long term provision of financial services for poor
people and today there’s greater consensus than even before on what is needed to make
microfinance sustainable.

How Does Microfinance contribute to the Millennium Development

Goals?

Extreme Poverty & Hunger

The poor, those who participated in microfinance programmed were able to

improve their living standards-both at the in individual & household level – much
better than those without access to financial services.

Universal Primary Education

poor households with access to financial services. Children are not sent to
school in longer nos.-including girls-but they also stay in school longer.

Women’s empowerment

The Indian School of Microfinance for Women, an organization based in

Ahmadabad, is a unique initiative in the discipline of Microfinance. The School has
been set up with the purpose of addressing the huge capacity building gap that exists in
the Microfinance sector.

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Launched on 4th October 2003, The School’s aim is to strengthen and spread
Microfinance as a strategy for poverty alleviation through development of knowledge
and skilled human resources. It believes that microfinance is an effective tool for the
alleviation of poverty and betterment of the lives of women. It looks to bring the
realities of the lives of women to organizations and people working with microfinance
to help them reach the women better in turn.

The Current State of Microfinance

These are interesting time for these involved in the provisioning of financial
services for the poor. The boundaries between microfinance and the formal financial
sector are finally breaking down. In some areas, microfinance is now an inherent part
of the financial system. In other areas, new & innovative financial delivery methods are
being developed to overcome the barriers of sparse, population & large distance
between settlement, as well as poor infrastructure. Technology can play an important
role but we may have to accept that for the moment, some areas truly are unbreakable.

Many microfinance institutions, many whose origins were social, are

professionalizing becoming sustainable & in some cases even profitable. Many of these
institutions are have seeking commercial funding. To attract this type of funding, they
must become transparent in their financial reporting. The microfinance Information
Exchange (MIX) is an information exchange website where more than 600 MFIs and
75 funds post information on their organizations & their performance.

At the same time, commercial institutions are also beginning to get involved in
providing financial services to poorer clients. CGAP has identified over 200 domestic
retail banks or consumer credit companies getting involved in microfinance, often
driven by competition & technologies that promise to allow then to make small
transactions more cost effectives. E-Banking, smart cards & telephone are beginning to
be used by microfinance providers to reduce transaction costs, a key to reaching poorer
clients.

Challenges Ahead

The real challenge facing the microfinance industry today is scaling up services
to reach the estimated three billion people in developing countries will still lack access
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to formal financial services. Successful microfinance institutions have proven that
providing financial services to the poor can be an effective means of poverty reduction
& be a profitable business. A major bottleneck to the development of sustainable
microfinance is limited institutional & managerial capacity at the level of retail
microfinance institutions, as reflected in inadequate man information system, poor
strategic planning, & high operating costs. This is also a marked storage of
organizations that can provide safe saving facilities for the poor & that can sustainably
mobilize these domestic savings for on-lending.

Many of the necessary elements needed to scale up microfinance are already in place.
A great deal of knowledge about the requirement of sustainable microfinance already
exists. High-performing microfinance institutions have developed methodologies to
extend credit, saving & other services to the poor clients. A no. of banks & other
institutions with nationwide distribution system are beginning to take defective interest
in reaching poorer clients. Advances in information technology have the opportunity to
lower the cost & risk of providing microfinance to the poor. The challenge is to mobilize
this knowledge & apply it on a much vaster scale, creating financial systems that work
for the poor & boost their contribution to economic growth.

One approach is to tap into developed capital market through microfinance investment
funds enable individual investors & portfolio managers to allocate a part of their equity
or fixed income investment to microfinance as an asset class.

The microfinance is changing the landscape of banking across the world. It has change
the ivies of people & revitalized communities in the world’s poorest as well as richest
countries. The microfinance is a better targeted financial help to a clientele that is poorer
& vulnerable than traditional bank clients. The broad classification of microfinance
includes rural credit through specialized banks traditional informal

Microfinance like loans from friends & relatives money lenders etc. BANK-NGO
partnership based on microfinance, non NGO, non collateralized microfinance, Garmin
bank type microfinance etc. anyone who can access to saving, credit, insurance other
financial services is more resilient & better able to deal with everyday demands.
Microfinance helps the poor & low income clients deal with such basic needs, like with
access to micro insurance which is a part of microfinance, poor people can cope with

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sudden expenses associated with serious illness or loss of assets. It also provides them
access to formal saving accounts & thus an incentives to save. Clients who join & stay
in microfinance programmed have better economic condition than no clients.

FURTHERSTIC STUDY OF MICRO FINANCING IN INDIA

The micro financial institutions are today, no doubt, acquiring the status of
moment in the banking sector. Its importance can be gauged from the fact that United
Nations has designated year 2005 as the international year of micro credit. Today
effective micro finance is seen as solution to many of the existing social and emotive
problems ranging from rural employment to empowerment. The various micro finance
institutions models are quite effective in dispensing the much needed credit to the
targeted clients. However, there exists certain weakness in existing micro finance
institution models. There is enough space of more efficiency and better results in credit
disbursement through micro finance institutions.

If we look back, it is found that Garmin Bank type micro finance institution model is
one of the most successful models in micro finance. The bank has successfully served
the rural people in Bangladesh with on physical collateral relying on group
responsibility to replace the collateral requirements. This model, like other model, has
also some weaknesses. It involves too much of external subsidy which is not replicable.
Garmin Bank has not oriented itself towards mobilizing people’s resources. The
repayment system of 50 weekly equal installments is not practical because poor do not
have a stable job and have to migrate to other places for job. The communities are

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agrarian during lean seasons it becomes responsible for them to repay the loan. Pressure
for high repayment drives members to money lenders.

Most of the existing micro finance institutions are facing problems regarding skilled
labor, which is not available for local level accounting. Drop out of the trained staff is
very high. Also most of the models do not lend for agriculture.

The four pillars of micro finance credit systems are

 Supply of credit
 Demand for finance
 Intermediation by individuals or authorities.
 Regulation by statutory bodies.
The end goal of any such basic model is accessibility of finance to poor.

The new model calls for exploiting the latent rural human resource by talent
spotting and training them as per their, for example, the graduates can be trained in
accounting or as Self Help Group leaders. The awareness campaign regarding various
rights, subsidies, and incentives given by various micro finance schemes may be
disseminated by involving local rural youth, which may very well connect to the local
based on similarity in dialect, living ways and culture.

It envisages the CENTRE as the hub of all activities. It is a place where all funding,
responsibility and accountability, is concentrated. This will ensure efficiency, better
control and reduced cost of interfacing between dispenser and taker of credit. The
CENTRE will also do a grading systems-A,B,C,D, Effect under which grading system
would be based on number of years client has been attached with any of the micro
finance institutions and its positive track in repaying the loans, including the condition
that at least one amount of the loan was greater than rupees 5000.

The criteria for grading are:

A>=12 years attached with any MFI, subject to the conditions above.

B>=10 years attached with any MFI, subject to the condition above.

C>=7 years attached with any MFI, subject to the condition above.

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 D>=5 years attached with any MFI, subject to the condition above.

E>=3 years attached with any MFI, subject to the condition above.

The client of A, B and Consumption can take loan directly from the CENTRE, other
conditions for eligibility being the same. These are persons who have successfully came
out of the vicious circle of poverty, cycle and are aspiring to grow big and still bigger,
comparatively.

Micro Finance (MF) Institutions

Introduction

A range of institutions in public sector as well as private sector offers the

microfinance services in India. They can be broadly categorized in to two categories
namely, formal institutions and informal institutions. The former category comprises of
Apex Development Financial Institutions, Commercial Banks, Regional Rural Banks,
and Cooperative Banks that provide micro finance services in addition to their general
banking activities and are referred to as micro finance service providers. On the other
hand, the informal institutions that undertake micro finance services as their main
activity are generally referred to as micro Finance Institutions (MFIs). While both
private and public ownership are found in the case of formal financial institutions
offering micro finance services, the MFIs are mainly in the private sector.

Micro Finance Service Providers

The micro finance service providers include apex institutions like National
Bank for Agriculture and Rural Development (NABARD), Small Industries
Development Bank of India (SIDBI), and, Rashtriya Mahila Kosh (RMK). At the retail
level, Commercial Banks, Regional Rural Banks, and, Cooperative banks provide
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micro finance services. Today, there are about 60,000 retail credit outlets of the formal
banking sector in the rural areas comprising 12,000 branches of district level
cooperative banks, over 14,000 branches of the Regional Rural Banks (RRBs) and over
30,000 rural and semi-urban branches of commercial banks besides almost 90,000
cooperatives credit societies at the village level. On an average, there is at least one
retail credit outlet for about 5,000 rural people. This physical reaching out to the far-
flung areas of the country to provide savings, credit and other banking services to the
rural society is an unparalleled achievement of the Indian banking systems.

MFIs: There are a large number of NGOs that have undertaken the task of financial
intermediation. Majority of these NGOs are registered as Trust or Society. Many NGOs
have also helped SHGs to organize themselves into federations and these federations
are registered as Trusts or Societies. Many of these federations are performing non-
financial and financial functions like social and capacity building activities, facilitate
training of SHGs, undertake internal audit, promote new groups, and some of these
federations are engaged in financial intermediation. The NGO MFIs vary significantly
in their size, philosophy and approach. Therefore these NGOs are structurally not the
right type of institutions for undertaking financial intermediation activities, as the
byelaws of these institutions are generally restrictive in allowing any commercial
operations. These organizations by their charter are non-profit organizations and as a
result face several problems in borrowing funds from higher financial institutions. The
NGO MFIs, which are large in number, are still outside the purview of any financial
regulation. These are the institutions for which policy and regulatory framework would
need to be established.

Non-Profit Companies as MFIs: Many NGOs felt that combining financial

intermediation with their core competency activity of social intermediation is not the
right path. It was felt that a financial institution including a company set up for this
purpose better does banking function. Further, if MFIs are to demonstrate that banking
with the poor is indeed profitable and sustainable, it has to function as a distinct
institution so that cross subsidization can be avoided. On account of these factors, NGO
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MFIs are of late setting up a separate Non-Profit Companies for their micro finance
operations. The mFI is prohibited from paying any dividend to its members. In terms
of Reserve Bank of India’s Notification dated 13 January 2011, relevant provisions of
RBI Act, 1934 as applicable to NBFCs will not apply for NBFCs (i) licensed under
Section 25 of Companies Act, 1956, (ii) providing credit not exceeding Rs. 50,000
($1112) for a business enterprise and Rs. 1, 25,000 ($2778) for meeting the cost of a
dwelling unit to any poor person, and, (iii) not accepting public deposits.

Mutual Benefit MFIs: The State Cooperative Acts did not provide for an enabling
framework for emergence of business enterprises owned, managed and controlled by
the members for their own development. Several State Governments therefore enacted
the Mutually Aided Co-operative Societies (MACS) Act for enabling promotion of
self-reliant and vibrant co-operative Societies based on thrift and self-help. MACS
enjoy the advantages of operational freedom and virtually no interference from
government because of the provision in the Act that societies under the Act cannot
accept share capital or loan from the State Government. Many of the SHG federations,
promoted by NGOs and development agencies of the State Government, have been
registered as MACS. Reserve Bank of India, even though they may be providing
financial service to its members, does not regulate MACS.

For-Profit MFIs: Non Banking Financial Companies (NBFC) are companies

registered under Companies Act, 1956 and regulated by Reserve Bank of India. Earlier,
NBFCs were not regulated by RBI but in 1997 it was made obligatory for NBFCs to
apply to RBI for a certificate of registration and for this certificate NBFCs were to have
minimum Net Owned funds of Rs 25 lakhs and this amount has been gradually
increased. RBI introduced a new regulatory framework for those NBFCs who want to
accept public deposits. All the NBFCs accepting public deposits are subjected to capital
adequacy requirements and prudential norms. There are only a few MFIs in the country
that are registered as NBFCs. Many MFIs view NBFCs more preferred legal form and
are aspiring to be NBFCs but they are finding it difficult to meet the requirements
stipulated by RBI. The number of NBFCs having exclusive focus on mF is negligible.

How does microfinance help the poor?

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 Experience shows that microfinance can help the poor to increase income,
build viable businesses, and reduce their vulnerability to external shocks. It can also
be a powerful instrument for self-empowerment by enabling the poor, especially
women, to become economic agents of change.
Poverty is multi-dimensional. By providing access to financial services, microfinance
plays an important role in the fight against the many aspects of poverty. For instance,
income generation from a business helps not only the business activity expand but
also contributes to household income and its attendant benefits on food security,
children's education, etc. Moreover, for women, who, in many contexts, are secluded
from public space, transacting with formal institutions can also build confidence and
empowerment.

CONCLUSION

The legitimacy of microfinance is beyond doubt. In a context of growing

financialisation, the poor more than anybody else need microfinance services. In the
same vein, in a context where democracy remains mainly formal and inaccessible to
the poorest, the collective approach (which is at the core of Indian microfinance through
the Self-help-group concept) undeniably represents a tool for democratic practices and
therefore for grass roots development, especially for women.

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