Micro finance-Bridging the development divide

With a modest beginning in the 1980s microfinance today has emerged as one of the most potent tool for poverty elimination, economic empowerment, gender inequality and financial inclusion of large number of poor and marginalised section of the society. Started with small efforts at forming informal Self-Help Groups of poor to provide much needed access to credit and saving facilities the microfinance sector has grown significantly in the past two decades both in terms of number of people covered and nature of services offered to the rural poor. Microfinance today is considered to be uniquely placed to take over the challenge of poverty elimination across the world due to better understanding of problems facing the rural people, greater acceptability among the poor and flexibility in operations.

 What is microfinance

Microfinance can be termed as small scale provision of financial services like credit, savings, insurance, money transfer and counselling to people who are unable to obtain these services from the formal financial institutions. They are generally left out of the formal commercial credit system for the reason that they have no formal employment and collateral securities to offer against the loans obtained from the banking system and banks have to incur large transaction and monitoring costs in serving small credit needs of these poor buyers. Absence of any formal credit source often leads these borrowers to depend on various informal sources of credit at usurious rates of interest often putting them into a debt trap. The economic theory offered in favour of Microfinance argues that when these small borrowers are given access to responsive and timely financial services for productive ventures, they over time not only increase their income and assets but become eligible for being adopted in the formal credit system over time. Practical experiences across the world have shown that the aforesaid objective is best served when poor are themselves organized into Self Help Groups pooling their small savings into a common fund to be lent by the group to the members. The financial resources at the disposal of the group are often supplemented by the loans from banks and other financial institutions to be utilised for income generating activities. Over time various kinds of microfinance institutions have emerged across the world depending upon local conditions and necessities but their essential characteristics remain the same i.e. targeted beneficiaries are generally low income households, loans extended are of small amounts generally without collateral for short duration with high frequency of repayments. Providing financial resources for income generating activities, the MFIs intervene to break the vicious circle of low capital, low productivity low income and low savings to which poor in the world find themselves.

Microfinance in India

Improving access to finance for the poor has always been considered an important policy tool for eradication of poverty in the country. Post Independence a large network of cooperative banks mostly in rural areas was created in the country to improve access of financial services to the rural poor. Financial inclusion received a major boost with the nationalisation of the State Bank of India in 1955 and fourteen other major commercial banks in 1969.The post nationalisation phase witnessed a rapid branch expansion in rural areas. The banks were also policy directed to lend 40 percent of their loanable funds at concessional rates of interest to the priority sectors like rural farmers, artisans, entrepreneurs etc.Various Regional Rural Banks were also set up in 1976 as low cost institutions to meet credit needs of the rural poor in credit deficient regions of the country.  A rural development programme aimed at providing income generating assets and self employment opportunities through the provision of financial resources to the rural poor under the name Integrated Rural Development Programme was initiated in the country in 1978.However, these supply side measures aimed at providing access to financial resources to rural poor failed to produce the required thrust needed to make a dent on mass poverty and deprivation prevalent in India. Flow of formal credit to the rural poor continued to be meagre and uneven with moneylenders and other informal sources ruling the roost in the village side. The collateral requirements and large paperwork’s needed to obtain loans aided by corruption and red tape continued to be effective impediments for large sections of poor illiterate Indians. The formal banking system treated lending to the poor as a social obligation under authoritative directions and never as a viable commercial activity. Meanwhile following trends in other parts of the world some informal efforts were made by various non-governmental organisations to organise people especially women into self help groups to meet their saving and credit needs. A series of research conducted by the National Bank for Rural and Agricultural Development (NABARD) revealed that the existing banking policies and operating procedures were not suited to meet the financial needs of the rural poor.  Formal banking system failed to meet the credit needs of rural poor. What matter the most for the rural poor was not just the credit at subsidized rate but the better access to financial products and services. There emerged a pressing need to develop alternative policies, institutions, financial instruments and delivery mechanisms to fulfil the credit needs of poor and deprived sections of the society.

Microfinance-post reform

Financial reforms carried in the country post 1991 aimed at improving the efficiency and financial productive of all the financial institutions in the country including those engaged in the provision of rural credit. Policy makers got engaged in searching for products and strategies that could deliver financial services to the poor in a sustainable manner. Empirical observations revealed that poor tended to and could be induced to come together in a variety of informal ways for pooling their savings and making loans to group members according to their needs.NABARD initiated the Self Help Group bank linkage model of providing financial services to the rural poor in 1992 on a pilot basis designed on the partnership between the SHGs,NGOs and banks. Financial resources pooled into the Self Help Groups were to be supplemented now by loans provided to the group for income generating activities and other livelihood promotion activities.NABARD also started providing grants, training and capacity building assistance to Self Help Promoting institutions which started acting as intermediaries and facilitators in the formation of credit linkage of the SHGs.Besides, the SHGs a number of microfinance institutions comprising of heterogeneous groups of Non Banking Financial Companies, Charitable trusts, societies and cooperatives have also been operating in the country. Financial supports are provided to them by the external donor agencies, SIDBI, NABARD etc.Since 2000 commercial and regional rural banks also have been providing loans to these institutions for lending to the poor.

The current status of the sector

According to the Malegam committee estimates SHG bank linkage model account for about 58% of the outstanding loan portfolios in the microfinance sector and another 34 percent is contributed by the microfinance institutions. Other institutions like trusts, societies, etc hold the remaining 8 percent of the loan portfolio. According to the latest report by the NABARD on the status of microfinance in India around 69.5 lakh savings linked SHGs have been operating in the country covering a population of 9.7 crore.A amount of Rs.6198 crore was held by the commercial banks as savings of the SHGs while they distributed a total loan of the amount Rs. 14,400 crores during the financial year 2009-10 to the SHGs.Average loan amount outstanding per Self Help group in 2009-10 has been Rs.57, 795 while average loan extended per member amounted to Rs.4,128.Woman related SHGs account for more than the three-fourths of the benefits rendered under the SHG-bank linkage model. Following the policy directions issued in 2000 by the Reserve Bank of India a total number of 1659 microfinance institutions availed credit facilities to the tune of Rs.13, 955.74 crore from the commercial banks, RRBs, SIDBI etc.In 2010 MFIs serviced 26.7 million loan accounts with total outstanding loans of Rs. 18,344 crores. NABARD,made responsible for providing 100 percent refinance to financial institutions making loan to the SHGs disbursed a total amount of Rs.12,031 crore during the financial year 2009-10.

     

Problems faced by the microfinance sector

Working of microfinance institutions in the country has dispelled the notion that poor are non bankable. However despite, almost 40 years of existence in the country microfinance still falls way behind to its potential in contributing to economic development and eradicating poverty. The cost of the capital has been very high to the MFIs and despite growth in the availability of funds they often face the paucity in satisfying all the credit needs placed on them. Given the fact that most of the clients of MFIs are poor and small borrowers with no collateral to offer and needing small amounts of funds at frequent intervals often force MFIs to charge high interest rate. With the introduction of SHG-Bank linkage there has been a rapid growth in the number of SHGs.This has made the issue of sustainability of SHGs a matter of serious concern. Serving poor and mostly illiterate population in rural areas make Administrative and transaction costs high for microfinance institutions adding further to interest charged. Overconcentration of MFIs in the country in certain regions with growing competition among them and lack of adequate data base about borrowers has encouraged the phenomena of multiple lending and ghost borrowers. There are also greater issues of gradual nurturing of SHGs into self sustainable enterprise capable of satisfying livelihood and empowerment needs of their clientele and linking them to main stream capital markets and production process in the economy.

Criticisms of Microfinance

Microfinance institutions off late have been in the eye of the storm after a spate of borrowers suicide in Andhra Pradesh over coercive collection of dues. The government has issued an ordinance making prior official approval necessary for MFIs before making a loan to borrowers, ban on weekly collection of dues, and stopping lenders from collecting installment from a borrower's house. Microfinance institutions have been blamed for piggy-ridding on most vulnerable sections of the society. They are accused of charging usurious rate of interest determined in opaque manners guided by pure profit considerations. They are also accused of having a limited impact on poverty reduction and of little help in graduating borrowers to have financial inclusion in the formal credit system. A further anomaly observed in the functioning of MFIs have been to offer multiple loans to existing members of other SHGs without doing hard work in searching for hitherto neglected borrowers. This leads to less credit flows to people not in the SHG fold and multiple borrowing of heavy amount by existing SHG members often raising the problem of debt repayment.They are also blamed to have converted themselves into huge corporate organisations providing high dividends and salaries to their promoters and employees.

Malegam Committee recommendations

Following the rapid growth in the number of institutions operating in the microfinance sector, large amount of funds rooted through them and allegations about corporate misgovernance, overcharging and coercive practices used by the MFIs resulting in a spate of farmers suicide, the Reserve Bank of India set up a four member panel headed by Reserve Bank's Central Board Director Y.H. Malegam to look into the issues facing the microfinance institutions. The committee, while commending MFIs for the important role played by them in promoting financial inclusion and economic growth made some far-reaching recommendations for these institutions. It called for clubbing all MFIs into separate category of Non-banking financial companies for the Microfinance Sector having a net worth of at least Rs 15 crore with National Bank for Agriculture and Rural Development playing the role of the regulator in close coordination with the RBI.It also called for fixing an interest rate ceiling of 24 percent on small loans given by the MFIs and the loan amount shall not exceed Rs.25,000.It further noted that at least 75% of loans extended by MFIs should be for income generation purposes and there should be a limit on borrowers taking loan from more than two MFIs.The committee called for the continuation of bank loans to MFIs as priority sector lending but with a higher capital adequacy ratio of 15 percent. Based on committee’s recommendations RBI recently issued guidelines for the microfinance sector calling for a limit of 26 percent on interest charged,loan amount ceiling at Rs.35,000.

The way ahead

Despite the adverse criticisms received off late, microfinance in India has proved to be a powerful tool for financial inclusion, poverty elimination and economic empowerment. Despite rapid growth in the number of MFIs in the country the sector covers less than 10 percent of country’s poor with a highly skewed regional distribution. Their lies urgent need to increase the area of operations by the microfinance by the MFIs and the outreach to the poor. They need to continuously innovate the nature of services offered by them and the delivery mechanisms to ensure that benefits reach the intended.  They need to reduce their interest costs through the use of modern technology and taking advantage of economies of scale. The ultimate goal of microfinance institutions lies in promoting inclusive growth, i.e. in graduating its clients to be adopted in formal credit system. At the same time it needs to be remembered that microfinance has helped in providing social and economic empowerment but it cannot eradicate poverty by itself. Good governance, security, health, education and financial inclusion all work hand-in-hand towards poverty alleviation