INTRODUCTION

Microfinance is a source of financial services for entrepreneurs and small businesses lacking access to
banking and related services. The two main mechanisms for the delivery of financial services to such
clients are: (1) relationship-based banking for individual entrepreneurs and small businesses; and (2)
group-based models, where several entrepreneurs come together to apply for loans and other
services as a group.

In some regions microfinance is used to describe the supply of financial services to low-income
employees, which is closer to the retail finance model prevalent in mainstream banking.

For some, microfinance is a movement whose objective is "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." Many of those who
promote microfinance generally believe that such access will help poor people out of poverty,
including participants in the Microcredit Summit Campaign. For others, microfinance is a way to
promote economic deve10pment, employment and growth through the support of micro-
entrepreneurs and small businesses.

Microfmance is defined as any activity that includes the provision of financial services such as credit,
savings, and insurance to low income individuals which fall just above the nationally defined poverty
line, and poor individuals which fall below that poverty line, with the goal of creating social value.
The creation of social value includes poverty alleviation and the broader impact of improving
livelihood opportunities through the provision of capital for micro enterprise, and insurance and
savings for risk mitigation and consumption smoothing. The range of activities undertaken in
microfinance include group lending, individual lending, the provision of savings and insurance,
capacity building, and agricultural business development services.

Definition:

According to International Labour Organisation (IL0) Microfinance is an economic development

approach that involves providing financial services through institutions to low income clients.

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In India Microfinance has been defined by The National Microfinance Taskforce 1999 as the provision
of thrift, credit and other financial services and products of very small amount to the poor in rural,
semi-urban or urban areas for enabling them to raise their income levels and improve living
standards.

The dictionary meaning of ‘finance’ is management of money. The management of money denotes
acquiring & using money. Micro Finance is buzzing word, used when financing for micro
entrepreneurs. Concept of micro finance is emerged in need of meeting special goal to empower
under-privileged class of society, women, and poor, downtrodden by natural reasons or men made;
caste, creed, religion or otherwise. The principles of Micro Finance are founded on the philosophy of
cooperation and its central values of equality, equity and mutual self-help. At the heart of these
principles are the concept of human development and the brotherhood of man expressed through
people working together to achieve a better life for themselves and their children.

Traditionally micro finance was focused on providing a very standardized credit product. The poor,
just like anyone else need a diverse range of financial instruments to be able to build assets, stabilize
consumption and protect themselves against risks. Thus, we see a broadening of the concept of
micro finance--our current challenge is to find efficient and reliable ways of providing a richer menu
of micro finance products. Microfinance is not merely extending credit but extending credit to those
who require most for them and their family’s survival. It cannot be measured in term of quantity, but
due weight age to quality measurement. How credit availed is used to survive and grow with limited
means.

Principles of Microfinance:

The poor has the capability to repay the loans and generate services

An effective tool for poverty alleviation

To provide financial services to an increasing number of disadvantaged people

Greater reach and sustainable development

To raise their income level and improve their standard of living

Women, to start or expand very small, self sufficient businesses

The transparency of financial activities.

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History of Microfinance

The history of micro financing can be traced back as long to the middle of the 1800s when the
theorist Lysander Spooner was writing over the benefits from small credits to entrepreneurs and
farmers as a way getting the people out of poverty. But it was at the end of World War II with the
Marshall plan the concept had a big impact.

The today use of the expression micro financing has its roots in the 1970s when organizations, such
as Grameen Bank of Bangladesh with the microfinance pioneer Mohammad Yunus, where starting
and shaping the modern industry of micro financing. Another pioneer in this sector is Akhtar Hameed
Khan. At that time a new wave of microfinance initiatives introduced many new innovations into the
sector. Many pioneering enterprises began experimenting with loaning to the underserved people.
The main reason why microfinance is dated to the 1970s is that the programs could show that people
can be relied on to repay their loans and that it's possible to provide financial services to poor people
through market based enterprises without subsidy. Shore bank was the first microfinance and
community development bank founded 1974 in Chicago .

An economical historian at Yale named Timothy Guinnane has been doing some research on Friedrich
Wilhelm Raiffeisen's village bank movement in Germany which started in 1864 by the year 1901 the
bank had reached 2 million rural farmers. Timothy Guinnane means that already then it was proved
that microcredit could pass the two tests concerning people’s payback moral and the possibility to
provide the financial service to poor people.

Another organization, the caisse populaire movement grounded by Alphone and Doriméne
Desjardins in Quebec, was also concerned about the poverty, and passed those two tests. In between
1900 to 1906 when they founded the first caisse, they passed a law governing them in the Quebec
assembly; they risked their private assets and must have been very sure about the idea about
microcredit.

Today the World Bank estimates that more than 16 million people are served by some 7000
microfinance institutions all over the world. CGAP experts mean

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that about 500 million families benefits from these small loans making new business possible. In a
gathering at a Microcredit Summit in Washington DC the goal was reaching 100 million of the world's
poorest people by credits from the world leaders and major financial institutions.

The year 2005 was proclaimed as the International year of Microcredit by The Economic and Social
Council of the United Nations in a call for the financial and building sector to “fuel” the strong
entrepreneurial spirit of the poor people around the world.

The International year of Microcredit consists of five goals :

Assess and promote the contribution of microfinance to the MFIs

Make microfinance more Visible for public awareness and understanding as a very important part of
the development situation

The promotion should be inclusive the financial sector

Make a supporting system for sustainable access to financial services

Support strategic partnerships by encouraging new partnerships and innovation to build and expand
the outreach and success of microfinance for all

The economics professor Mohammad Yunus and the founder of Grameen Bank were awarded the
Nobel Prize 2006 for his efforts. The press release from nobelprize.org states:

“The Norwegian Nobel Committee has decided to award the Nobel Peace Prize for 2006, divided into
two equal parts, to Muhammad Yunus and Grameen Bank for their efforts to create economic and
social development from below. Lasting peace cannot be achieved unless large population groups
find ways in which to break out of poverty. Micro-credit is one such means. Development from below
also serves to advance democracy and human rights. Muhammad Yunus has shown himself to be a
leader who has managed to translate visions into practical action for the benefit of millions of
people, not only in Bangladesh, but also in many other countries. Loans to poor people without any
financial security had appeared to be an impossible idea. From modest beginnings three decades
ago, Yunus has, first and foremost through Grameen Bank, developed micro-credit into an ever more
important instrument in the struggle against poverty. Grameen Bank has been a source of ideas and
models

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for the many institutions in the field of micro-credit that have sprung up around the World.

Every single individual on earth has both the potential and the right to live a decent life. Across
cultures and civilizations, Yunus and Grameen Bank have shown that even the poorest of the poor
can work to bring about their own development.

Micro-credit has proved to be an important liberating force in societies where women in particular
have to struggle against repressive social and economic conditions. Economic growth and political
democracy cannot achieve their full

potential unless the female half of humanity participates on an equal footing with the male.

Yunus’s long-term vision is to eliminate poverty in the world. That vision cannot be realised by
means of micro-credit alone. But Muhammad Yunus and Grameen Bank have shown that, in the
continuing efforts to achieve it, microcredit must play a major part.”

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The Clients of Microfinance

The typical micro finance clients are low-income persons that do not have access to formal financial
institutions. Micro finance clients are typically selfemployed, often household-based entrepreneurs.
In rural areas, they are usually small farmers and others who are engaged in small income-generating
activities such as food processing and petty trade. In urban areas, micro finance activities are more
diverse and include shopkeepers, service providers, artisans, street vendors, etc. Micro finance
clients are poor and vulnerable non-poor who have a relatively unstable source of income.

Access to conventional formal financial institutions, for many reasons, is inversely related to income:
the poorer you are, the less likely that you have access. On the other hand, the chances are that, the
poorer you are, the more expensive or onerous informal financial arrangements. Moreover, informal
arrangements may not suitably meet certain financial service needs or may exclude you anyway.
Individuals in this excluded and under-served market segment are the clients of micro finance.

As we broaden the notion of the types of services micro finance encompasses, the potential market
of micro finance clients also expands. It depends on local conditions and political climate, activeness
of cooperatives, SHG & NGOS and support mechanism. For instance, micro credit might have a far
more limited market scope than say a more diversified range of financial services, which includes
various types of savings products, payment and remittance services, and various insurance products.
For example, many very poor farmers may not really wish to borrow, but rather, would like a safer
place to save the proceeds from their harvest as these are consumed over several months by the
requirements of daily living. Central government in India has established a strong & extensive link
between NABARD (National Bank for Agriculture & Rural Development), State Cooperative Bank,
District Cooperative Banks, Primary Agriculture & Marketing Societies at national, state, district and
village level.

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Financial needs and financial services

In developing economies and particularly in the rural areas, many activities that would be classified in
the developed world as financial are not monetized: that is, money is not used to carry them out.
Almost by definition, poor peOple have very little money. But circumstances often arise in their lives
in which they need money or the things money can buy.

Poor people have several types of needs :

Lifecycle Needs: such as weddings, funerals, childbirth, education, homebuilding, widowhood, old
age.

Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death.

Disasters: such as fires, floods, cyclones and man-made events like war or bulldozing of dwellings.

Investment Opportunities : expanding a business, buying land or equipment, improving housing,

securing a job (which often requires paying a large bribe), etc.

Poor people find creative and often collaborative ways to meet these needs, primarily through
creating and exchanging different forms of non-cash value. Common substitutes for cash vary from
country to country but typically include livestock, grains, jewellery and precious metals.

Microfinance began to develop as an industry. In the 2000s, the microfinance industry’s objective is
to satisfy the unmet demand on a much larger scale, and to play a role in reducing poverty. While
much progress has been made in developing a viable, commercial microfinance sector in the last few
decades, several issues remain that need to be addressed before the industry will be able to satisfy
massive worldwide demand.

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Role of Microfmance

The micro credit of microfmance programme was first initiated in the year 1976 in Bangladesh with
promise of providing credit to the poor without collateral , alleviating poverty and unleashing human
creativity and endeavour of the poor people. Microfmance impact studies have demonstrated that:

Microfinance helps poor households meet basic needs and protects them against risks.

The use of financial services by low-income households leads to improvements in household

economic welfare and enterprise stability and growth.

By supporting women’s economic participation, microfinance empowers women, thereby promoting

gender-equity and improving household well being.

The level of impact relates to the length of time clients have had access to financial services.

How does microfmance work?

System of “microloans”, typically less than $100

Instead of using collateral to gain credit loans are secured against the honour of a peer group; if one
person fails to make their payment, others in the lending circle will be denied future credit

It has outperformed almost all other forms of development lending

It is said that microfinance has lifted 100 million people out of poverty over the last three decades.

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Activities in Microfinance

Micro Credit:

It is a small amount of money loaned to a client by a bank or other institution. Microcredit can be
offered, often without collateral, to an individual or through group lending.

Micro Savings :

These are deposit services that allow one to save small amounts of money for future use. Often
without minimum balance requirements, these savings accounts allow households to save in order to
meet unexpected expenses and plan for future expenses.

Micro Insurance:

It is a system by which people, businesses and other organizations make a payment to share risk.
Access to insurance enables entrepreneurs to concentrate more on developing their businesses while
mitigating other risks affecting property, health or the ability to work.

Remittances :

These are transfer of funds from people in one place to people in another, usually across borders to
family and friends. Compared with other sources of capital that can fluctuate depending on the
political or economic climate, remittances are a relatively steady source of funds.

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Major centres of Microfinance

Global Entrepreneurship

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Microfinance provided by banks and financial institution

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Difference between banks and financial institution

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Microfinance in India

At present lending to the economically active poor both rural and urban is pegged at around Rs 7000
crore in the Indian banks’ credit outstanding. As against this, according to even the most
conservative estimates, the total

demand for credit requirements for this part of Indian society is somewhere around Rs 2,00,000
crore.

Microfmance Changing India

Micro-Finance is emerging as a powerful instrument for poverty alleviation in the new economy. In
India, micro-Finance scene is dominated by Self Help Groups (SHGS) Banks linkage Programme,
aimed at providing a cost effective mechanism for providing financial services to the 'unreached
poor'. In the Indian context terms like "small and marginal farmers", " rural artisans" and
"economically weaker sections" have been used to broadly define micro-finance customers. Research
across the globe has shown that, over time, microfinance clients increase their income and assets,
increase the number of years of schooling their children receive, and improve the health and
nutrition of their families.

A more refined model of micro-credit delivery has evolved lately, which emphasizes the combined
delivery of financial services along with technical assistance, and agricultural business development
services. When compared to the wider SHG bank linkage movement in India, private MFIs have had
limited outreach. However, we have seen a recent trend of larger microftnance institutions
transforming into Non-Bank Financial Institutions (NBFCs). This

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changing face of microfinance in India appears to be positive in terms of the ability of microfmance
to attract more funds and therefore increase outreach.

In terms of demand for micro-credit or micro-finance, there are three segments, which demand
funds. They are:

. At the very bottom in terms of income and assets, are those who are landless and engaged in
agricultural work on a seasonal basis, and manual labourers in forestry, mining, household industries,
construction and transport. This segment requires, first and foremost, consumption credit during
those months when they do not get labour work, and for contingencies such as illness. They also
need credit for acquiring small productive assets, such as livestock, using which they can generate
additional income.

. The next market segment is small and marginal farmers and rural artisans, weavers and those self-
employed in the urban informal sector as hawkers, vendors, and workers in household micro-
enterprises. This segment mainly needs credit for working capital, a small part of which also serves
consumption needs. This segment also needs term credit for acquiring additional productive assets,
such as irrigation pump sets, bOre wells and livestock in case of farmers, and equipment (looms,
machinery) and work sheds in case of non-farm workers.

. The third market segment is of small and medium farmers who have gone in for commercial crops
such as surplus paddy and wheat, cotton, groundnut, and others engaged in dairying, poultry, fishery,
etc. Among non-farm activities, this segment includes those in villages and slums, engaged in
processing or manufacturing activity, running provision stores, repair workshops, tea shops, and
various service enterprises. These

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persons are not always poor, though they live barely above the poverty line and also suffer from
inadequate access to formal credit.

These are the people who require money and with Microfmance it is possible. Right now the problem
is that, it is SHGs' which are doing this and efforts should be made so that the big financial
institutions also turn up and start supplying funds to these people. Today India is facing major
problem in reducing poverty. About 25 million people in India are under below poverty line. With low
per capita income, heavy population pressure, prevalence of massive unemployment and under
employment , low rate of capital formation , misdistribution of wealth and assets , prevalence of low
technology and poor economics organization and instability of output of agriculture production and
related sectors have made India one of the poor countries of the world.

Present scenario of India

India falls under low income class according to World Bank. It is second populated country in the
world and around 70 % of its population lives in rural area. 60° 0 of peOple depend on agriculture, as
a result there is chronic underemployment and per capita income is only $ 3262. This is not enough
to provide food to more than one individual. The obvious result is abject poverty, low rate of
education, low sex ratio, exploitation. The major factor account for high incidence of rural poverty is
the low asset base. According to Reserve Bank of India, about 51 % of people house possess only 10%
of the total asset of India. This has resulted low production capacity both in agriculture (which
contribute around 22-259 0 of GDP) and Manufacturing sector. Rural people have very low access to
institutionalized credit (from commercial bank).

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Poverty alleviation programmes and conceptualisation of microfinance

There have been continuous efforts of planners of India in addressing the

poverty. They have come up with development programmes like Integrated Rural DeveIOpment
programme (IRDP), National Rural Employment Programme (NREP), Rural Labour Employment
Guarantee Programme (RLEGP) etc. But these programmes have not been able to create massive
impact in poverty alleviation. The production oriented approach of planning without altering the
mode of production could not but result of the gains of development by owners of instrument of
production. The mode of production does remain same as the owners of the instrument have low
access to credit which is the major factor of production. Thus in Nineties National bank for
agriculture and rural development (NABARD) launches pilot projects of Microfmance to bridge the
gap between demand and supply of funds in the lower rungs of rural economy. Microfinance the
buzzing word of this decade was meant to cure the illness of rural economy. With this concept of Self
Reliance, Self Sufficiency and Self Help gained momentum. The Indian microfinance is dominated by
Self Help Groups (SHGs) and their linkage to Banks.

Deprived of the basic banking facilities, the rural and semi urban Indian masses are still relying on
informal financing intermediaries like money lenders, family members, friends etc.

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Distribution of lndebted Rural Household Agency wise

Source: Debt and Investment Survey, G0I

Seeing the figures from the above table, it is evident that the share of institutional credit is much
more now.

The above survey result shows that till 1991 , institutional credit accounted for around two-thirds of
the credit requirement of rural households. This shows a comparatively better penetration of the
banking and financial institutions in rural India.

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Percentage distribution of debt among indebted Rural LabourHouseholds by source of debt :

Source: Rural labor enquiry report on indebtedness among rural labor households

The table above reveals that most of the rural labour households prefer to raise loan from the non-
institutional sources. About 64 % of the total debt requirement of these households was met by the
non-institutional sources during 1999-2000. Money lenders alone provided debt (Rs.1918) to the
tune of 32% of the total debt of these households as against 28 % during 1993-94. Relatives and
friends and shopkeepers have been two other sources which together accounted for about 22% of
the total debt at all-India level.

The institutional sources could meet only 36%of the total credit requirement of the rural labour
households during 1999-2000 with only one percent increase over the previous survey in 1993-94.
Among the institutional sources of debt, the banks continued to be the single largest source of debt
meeting about 17 percent of the total debt requirement of these households. In

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comparison to the previous enquiry, the dependence on co-operative societies has increased
considerably in 1999-2000. During 1999-2000 as much as 13% of the debt was raised from this
source as against 8% in 1993-94. However, in the case of the banks and the government agencies it
decreased marginally from 18.88% and 8.27% to 17.19% and 5.37% respectively during 1999-2000
survey.

Table shows the increasing influence of moneylenders in the last decade. The share of moneylenders
in the total non institutional credit was declining till 1981, started picking up from the 1990s and
reached 27 per cent in 2001. At the same time the share of commercial banks in institutional credit
has come down by almost the same percentage points during this period. Though, the share of
cooperative societies is increasing continuously, the growth has flattened during the last three
decades.

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The households with a lower asset size were unable to find financing Options from formal credit
disbursement sources. This was due to the requirement of physical collateral by banking and
financial institutions for disbursing credit. For households with less than Rs 20,000 worth of physical
assets, the most convenient source of credit was non institutional agencies like landlords,
moneylenders, relatives, friends, etc. Looking at the findings of the study commissioned by Asia
technical Department of the World Bank (1995), the purpose or the reason behind taking credit by
the rural poor was consumption credit, savings, production credit and insurance. Consumption credit
constituted two-thirds of the credit usage within which almost threefourths of the demand was for
short periods to meeting emergent needs such as illness and household expenses during the lean
season. Almost entire demand for the consumption credit was met by informal sources at high to
exploitive interest rates that varied from 30 to 90 per cent per annum.

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Almost 75 per cent of the production credit (which accounted for about onethird of the total credit
availed of by the rural masses) was met by the formal sector, mainly banks and cooperatives.

Banking Expansions

Starting in the late 1960s, India was the home to one of the largest state interventions in the rural
credit market. This phase is known as the “Social Banking” phase. It witnessed the nationalization of
existing private commercial banks, massive expansion of branch network in rural areas, mandatory
directed

credit to priority sectors of the economy, subsidized rates of interest and creation of a new set of
regional rural banks (RRBs) at the district level and a specialized apex bank for agriculture and rural
development (NABARD) at the national level.

The Net State Domestic Product (NSDP) is a measure of the economic activity in the state and
comparing it with the utilization of bank credit or bank deposits indicates how much economic
activity is being financed by the banks and whether there exists untapped potential for increasing
deposits in that state.

E.g. In the year 2003-2004 the percentage of bank deposits to NSDP is pretty high at around 75%-
80% in Bihar and Jharkhand or these states are not as under banked as thought to be.

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Microfinance Models

Microfinance Institutions

MFIs are an extremely heterogeneous 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. Since 2000, commercial banks including Regional Rural Banks have been
providing funds to MFIs for on lending to poor Clients. Though initially, only a handful of NGOs were
“into” financial intermediation using a variety of delivery methods, their numbers have increased
considerably today. While there is no published data on private MFls operating in the country, the
number of MFIs is estimated to be around 800.

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Bank Partnership Model

This model is an innovative way of financing MFIs. The bank is the lender and the MFI acts as an
agent for handling items of work relating to credit monitoring, supervision and recovery. In other
words, the MFI acts as an agent and takes care of all relationships with the client, from first contact
to final repayment. The model has the potential to significantly increase the amount of funding that
MFIs can leverage on a relatively small equity base. A sub variation of this model is where the MFI, as
an NBFC, holds the individual loans on its books for a while before securitizing them and selling them
to the bank. Such refinancing through securitization enables the MFI enlarged funding access. If the
MFI fulfils the “true sale” criteria, the exposure of the bank is treated as being to the individual
borrower and the prudential exposure norms do not then inhibit such funding of MFIs by commercial
banks through the securitization structure.

Bank Partnership Model

This model is an innovative way of financing MFIs. The bank is the lender and the MFI acts as an
agent for handling items of work relating to credit monitoring, supervision and recovery. In other
words, the MFI acts as an agent and takes care of all relationships with the client, from first contact
to final repayment. The model has the potential to significantly increase the amount of funding that
NIFIS can leverage on a relatively small equity base. A sub variation of this model is where the MFI, as
an NBFC, holds the individual loans on its books for a while before securitizing them and selling them
to the bank. Such refinancing through securitization enables the MFI enlarged funding access. If the
MFI fulfils the “true sale” criteria, the exposure of the bank is treated as being to the individual
borrower and the prudential exposure norms do not then inhibit such funding of MFIs by commercial
banks through the securitization structure.

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Service Company Model

Under this model, the bank forms its own MFI, perhaps as an NBFC, and then works hand in hand
with that MFI to extend loans and other services. On paper, the model is similar to the partnership
model: the MFI originates the loans and the bank books them. But in fact, this model has two very
different and interesting operational features:

(a) The MFI uses the branch network of the bank as its outlets to reach clients. This allows the client
to be reached at lower cost than in the case of a stand-alone MFI. In case of banks which have large
branch networks, it also allows rapid scale up. In the partnership model, MFIs may contract with
many banks in an arm’s length relationship. In the service company model, the MFI works specifically
for the bank and develops an intensive operational cooperation between them to their mutual
advantage.

(b) The Partnership model uses both the financial and infrastructure strength of the bank to create
lower cost and faster growth. The Service Company Model has the potential to take the burden of
overseeing microfmance operations off the management of the bank and put it in the hands of MFI
managers who are focused on microfmance to introduce additional products, such as individual loans
for SHG graduates, remittances and so on without disrupting bank operations and provide a more
advantageous cost structure for microfinance.

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Legal Regulations

Banks in India are regulated and supervised by the Reserve Bank of India (RBI) under the RBI Act of
1934, Banking Regulation Act, Regional Rural Banks Act, and the Cooperative Societies Acts of the
respective state governments for cooperative banks.

NBFCs are registered under the Companies Act, 1956 and are governed under the RBI Act. There is no
specific law catering to NGOs although they can be registered under the Societies Registration Act,
1860, the Indian Trust Act, 1882, or the relevant state acts. There has been a strong reliance on
selfregulation for NGO lVIFIs and as this applies to NGO MFIs mobilizing deposits from clients Who
also borrow. This tendency is a concern due to enforcement problems that tend to arise with self-
regulatory organizations. In January 2000, the RBI essentially created a new legal form for providing
microfmance services for NBFCs registered under the Companies Act so that they are not subject to
any capital or liquidity requirements if they do not go into the deposit taking business. Absence of
liquidity requirements is concern to the safety of the sector.

Review of Legal Text and Framework for Various Institutional Forms

1) Societies Registration Act, 1860 - NGOs are mostly registered under the Societies Registration Act,
1860. Since these entities were established as voluntary, not-for-proflt development organisations,
their microfinance activities were also established under the same legal umbrella. This sub-section
examines the provisions of the Societies Act from the perspective of the practice of microfmance in
India

2) Indian Trusts Act, 1882 - Some MFIs are registered under the Indian Trust Act, 1882 either as
public charitable trusts or as private, determinable trusts with specified beneficiaries/members.

3) Not-for-profit Companies Registration under Section 25 of the Companies Act, 1956 - An

organisation given a license under Section 25 of the Companies Act 1956, is allowed to be registered
as a company with limited liability without the addition of the words ‘Limited’ or ‘Private Limited’ to
its name. It is also

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eligible for exemption from some of the provisions of the Companies Act, 1956. For companies that
are already registered under the Companies Act, 1956, if the central government is satisfied that the
objects of that company are restricted to the promotion of commerce, science, art, religion, charity
or any other useful purpose; and the constitution of such company provides for the application of
funds or other income in promoting these objects and prohibits payment of any dividend to its
members, then it may allow such a company to register under Section 25 of the Companies Act.

Non Banking Finance Companies (NBFCs) - As per the Section 45-I of the RBI Act, an NBF C is a
company which carries on any of the following activities as its business or part of its business:

Lending;

Receiving deposits (as the principal business);

Acquisition of shares, stocks or other securities;

Hire-purchase or leasing;

Insurance;

Chit funds; and

Lotteries

As per this definition, if a company undertakes microfinance, it automatically becomes an NBFC and
all related regulations apply

Nidhi Companies - Section 620 of the Companies Act allows for the formation of a special type of
company called ‘Nidhi’ company also known as ‘Mutual Benefit Society’. Certain provisions of the
Companies Act have been modified under this section. Accordingly, provisions on the service of
documents, issue of additional capital, annual returns, dividends, loans and remuneration to
directors and winding up processes have been modified for companies recognised as Nidhi or Mutual
Benefit Society.

Banking Regulation Act as Applicable to Co-operatives - Under the Banking Regulation Act only the
State Cooperative Banks, District Central Cooperative Banks and Primary Cooperative Banks (Urban
Cooperative Banks - UCBs) are recognised as cooperative banks. The State Cooperative Banks and
Central

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Cooperative Banks form part of the three-tier rural cooperative credit structure promoted by the
state governments and NABARD. The relevant categories of Co-operative banks suitable for MFIS are
Primary Cooperative Banks (UCBs).

State Acts on Mutually Aided Cooperative Societies - Many states have brought amendments in their
cooperative societies acts thereby making the functioning of cooperatives more autonomous and
free from government interference. This act was first passed in the Andhra Pradesh and has
functioned as a model for many states which have brought fresh legislations to effect changes in
their state cooperative society acts. Some of the states have gone a step timber and brought in
reforms that have far reaching implications for the functioning of MFIs. Noted among these states
are Orissa, Bihar, Madhya Pradesh and Kamataka. The Orissa act allows the SHGs to become
members of cooperative societies while the other state acts do not have this provision.

Producer Companies Act - Amendments in the Companies Act 1956 have provided for a new type of
company to be owned by the primary producers.

The Act defines the primary producer as any person engaged in any activity connected with or
relatable to any primary produce. As per the proposed amendment, primary produce means:

a). produce of farmers, arising from agriculture (including animal husbandry, horticulture,
floriculture, viticulture, forestry, forest products, revegetation, beeraising and farming Plantation
products), or from any other primary activity or service which promotes the interest of the farmers
or consumers; or

b). produce of persons engaged in handloom, handicraft and other cottage industries;

c). any product resulting from any of the above activities, including by-products of such products;

d). any product resulting from an ancillary activity that would assist or promote any of the aforesaid
activities or ‘anything ancillary’ thereto; and

e). any activity which is intended to increase the production of anything referred to in sub-clauses ‘a’
to‘d’ or improve the quality thereof.

Success Factors of Microfinance in India

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Over the last ten years, successful experiences in providing finance to small entrepreneur and
producers demonstrate that poor people, when given access to responsive and timely financial
services at market rates, repay their loans and use the proceeds to increase their income and assets.
This is not surprising since the only realistic alternative for them is to borrow from informal market at
an interest much higher than market rates. Community banks, NGOs and grass root savings and
credit groups around the world have shown that these microenterprise loans can be profitable for
borrowers and for the lenders, making microfinance one of the most effective poverty reducing
strategies.

For NGOs

1) The field of development itself expands and shifts emphasis with the pull of ideas, and NGOs
perhaps more readily adopt new ideas, especially if the resources required are small, entry and exit
are easy, tasks are (perceived to be) siniple and people’s acceptance is high -all characteristics (real
or presumed) of microfinance.

2)Canvassing by various factors, including the National Bank for Agriculture and Rural Development
(NABARD), Small Industries Development Bank of India (SIDBI), Friends of Women’s World Banking (F
WWB), Rashtriya Mahila Kosh (RMK), Council for Advancement of People’s Action and Rural
Technologies (CAPART), Rashtriya Gramin Vikas Nidhi (RGVN), various donor funded programmes
especially by the International Fund for Agricultural

Development (IFAD), United Nations Development Programme (UNDP), World Bank and Department
for International Development, UK (DFID)], and lately commercial banks, has greatly added to the
idea pull. Induced by the worldwide focus on microfinance, donor NGOs too have been funding
microfmance projects. One might call it the supply push.

3) All kinds of things from khadi spinning to Nadep compost to balwadis do not produce such
concrete results and sustained interest among beneficiaries as

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microfmance. Most NGO-led microfmance is with poor women, for whom access to small loans to
meet dire emergencies is a valued outcome. Thus, quick and high ‘customer satisfaction’ is the USP
that has attracted NGOs to this trade.

4) The idea appears simple to implement. The most common route followed by NGOs is promotion of
SHGs. It is implicitly assumed that no ‘technical skill’ is involved. Besides, external resources are not
needed as SHGS begin with their own savings. Those NGOs that have access to revolving funds from
donors do not have to worry about financial performance any way. The chickens will eventually come
home to roost but in the first flush, it seems all so easy.

5) For many NGOs the idea of ‘organising’ forming a samuha -has inherent appeal. Groups connote
empowerment and organising women is a double bonus.

6) Finally, to many NGOs, microfinance is a way to financial sustainability. Especially for the medium-
to-large NGOs that are able to access bulk funds for on-lending, for example from SIDBI, the interest
rate spread could be an attractive source of revenue than an uncertain, highly competitive and
increasingly difficult-to-raise donor funding.

For Financial Institutions and banks

Microtinance has been attractive to the lending agencies because of demonstrated sustainability and
of low costs of operation. Institutions like SIDBI and NABARD are hardnosed bankers and would not
work with the idea if they did not see a long term engagement which only comes out of sustainability
(that is economic attractiveness).

On the supply side, it is also true that it has all the trappings of a business

enterprise, its output is tangible and it is easily understood by the mainstream.

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This also seems to sound nice to the government, which in the post liberalisation era is trying to
explain the logic of every rupee spent. That is the reason why microfinance has attracted mainstream
institutions like no other developmental project.

Perhaps the most important factor that got banks involved is what one might call the policy push.
Given that most of our banks are in the public sector, public policy does have some influence on what
they will or will not do. In this case, policy was followed by diligent, if meandering, promotional work
by NABARD. The policy change about a decade ago by RBI to allow banks to lend to SHGs was initially
followed by a seven-page memo by NABARD to all bank chairmen, and later by sensitisation and
training programmes for bank staff across the country. Several hundred such programmes were
conducted by NGOs alone, each involving 15 to 20 bank staff, all paid for by NABARD. The policy push
was sweetened by the NABARD refinance scheme that offers much more favourable terms (100%
refinance, wider spread) than for other rural lending by banks. NABARD also did some system setting
work and banks

lately have been given targets. The canvassing, training, refinance and close follow up by NABARD
has resulted in widespread bank involvement.

Moreover, for banks the operating cost of microfmance is perhaps much less than for pure MFIs. The
banks already have a vast network of branches. To the extent that an NGO has already promoted
SHGs and the SHG portfolio is performing better than the rest of the rural (if not the entire) portfolio,
microfmance via SHGs in the worst case would represent marginal addition to cost and would often
reduce marginal cost through better capacity utilisation. In the process the bank also earns brownie
points with policy makers and meets its priority sector targets.

It does not take much analysis to figure out that the market for financial services for the 50-60
million poor households of India, coupled with about the same number who are technically above
the poverty line but are severely underserved by the financial sector, is a very large one. Moreover,
as in any emerging market, though the perceived risks are higher, the spreads are much greater. The
traditional commercial markets of corporate, business, trade, and now even

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housing and consumer finance are being sought by all the banks, leading to price competition and
wafer thin spreads.

Further, bank-groups are motivated by a number of cross-selling opportunities in the market, for
deposits, insurance, remittances and eventually mutual funds. Since the larger banks are offering all
these services now through their group companies, it becomes imperative for them to expand their
distribution channels as far and deep as possible, in the hope of capturing the entire financial
services business of a household.

Finally, both agri-input and processing companies such as EID Parry, fastmoving consumer goods
(FMCG) companies such as Hindustan Levers, and consumer durable companies such as Philips have
realised the potential of this big market and are actively using SHGs as entry points. Some amount of
freeriding is taking place here by companies, for they are using channels which were built at a
significant cost to NGOs, funding agencies and/or the government.

On the whole, the economic attractiveness of microfmance as a business is getting established and
this is a sure step towards mainstreaming. We know that mainstreaming is a mixed blessing, and one
tends to exchange scale at the cost of objectives. So it needs to be watched carefully.

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