INTRODUCTION

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.
More broadly, it is a movement whose object 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." Those who promote microfinance
generally believe that such access will help poor people out of poverty.
Microfinance is a broad category of services, which includes microcredit.
Microcredit is provision of credit services to poor clients. Although microcredit is
one of the aspects of microfinance, conflation of the two terms is endemic in public
discourse. Critics often attack microcredit while referring to it indiscriminately as
either 'microcredit' or 'microfinance'. Due to the broad range of microfinance
services, it is difficult to assess impact, and very few studies have tried to assess its
full impact.
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 that 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 Muhammad Yunus, were starting and shaping the modern
industry of micro financing. Another pioneer in this sector is Akhtar Hameed Khan

URBAN POVERTY
1

As the world moves into the year 2012, there will be more number of people living
in urban areas than rural areas. In fact, the 20th century witnessed a rapid growth in
urban population. The next few decades will see unprecedented scale of urban
growth in the developing world including those in Asia and Africa continents. The
urban population in these two continents will double in a period of 30 years.
Asia has been witnessing the triple dynamics of growth, rapid urbanisation and
growing poverty. While many Asian countries witnessed higher economic growth,
the growth pattern brought about enormous disparities across and within nations.
India has shared the growth pattern and rapid urbanisation with some of the fastest
growing regions in Asia. The Country has witnessed around 8% growth in GDP in
the last couple of years and has planned to achieve a target of over 9% growth by
the end of 11th plan period.
Indias urban population is also increasing at a faster rate than its total population.
With over 575 million people, India will have 41% percent of its population living
in cities and towns by 2030 AD from the present level of 286 million and 28%.
Economic development and urbanisation are closely linked. In India, cities
contribute over 55 % to countrys GDP and urbanisation has been recognised as an
important component of economic growth.
With India becoming increasingly globalized and urban, there is also an increase in
the number of poor people living here. As per the latest NSSO survey reports there
are over 80 million poor people living in the cities and towns of India. The Slum
population is also increasing and as per TCPO estimates 2001, over 61.80 million
people were living in slums. It is interesting to note that the ratio of urban poverty
in some of the larger states is higher than that of rural poverty leading to the
2

phenomenon of Urbanisation of Poverty. Urban poverty poses the problems of

housing and shelter, water, sanitation, health, education, social security and
livelihoods along with special needs of vulnerable groups like women, children
and aged people.
The sustainability of urban development in India is seen in the context of shelter
and slums, Basic urban services, Financing urban development and Governance
and Planning. India has entered the Eleventh Plan period with an impressive record
of economic growth.
However, the incidence of decline of urban poverty has not accelerated with GDP
growth. In fact, urban poverty will become a major challenge for policymakers in
our country as the urban population in the country is growing, so is urban poverty.
Therefore, a need has arisen to develop new poverty reduction tools and
approaches to attack the multi-dimensional issues of urban Poverty. For this,
policymakers at the national and local levels should have a good understanding of
the nature of urban poverty as well as accurate data on various issues relating to it,
in order to develop programme/policies to manage urban poverty in a systematic
manner.

URBAN MICROFINANCE IN THE CONTEXT OF

URBAN POVERTY
3

The evolution of social banking concept in India is through the development of the
Self Help GroupBank Linkage Scheme. The genesis of the scheme was an
experiment piloted by the National Bank for Rural Development (NABARD) in
the late 1980s to link informal groups of low income individuals in rural areas with
banks The experiment was mainstreamed by the Reserve Bank of India as the
SHG-Bank Linkage Scheme in 1996 when linkage banking was included as an
activity of banks under priority sector lending. The institutional structure that
facilitates rural financial intermediation was strengthened by the setting up of
Regional Rural Banks in 1975 and the National Bank for Agriculture and Rural
Development in 1982 with the mandate of developing the cooperative credit
system. The debate on financial services to the poor and low income households in
India has revolved around the rural population since the time when banks were
nationalized for the first time in the country.
Unlike rural financial intermediation, flow of financial resources to urban
populations was never a matter of serious debate in India. The tendency among
microfinance intermediaries to move towards urban centers came only after it
found that the rural markets coming to a saturation point. Still now the SHG-Bank
Linkage model remains predominantly a rural phenomenon. Economic
Development Associates (2004) observed that about 80 per cent of the micro
finance clients are without any formal savings, and 91 per cent, without formal
credit. Nearly 77 per cent of the micro credit clients are in the rural sector. The first
targeted credit programme with focus on enterprise and self employment
opportunities in urban areas was launched in 1989 during the Seventh Five Year
Plan period (1985-90). Various urban poverty alleviation schemes with a credit
focus introduced in India since 1989 shows that they broadly followed a top-down
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approach. The Swarna Jayanti Shahari Rozgar Yojana (SJSRY) is the first such
urban scheme launched by Government of India where community based
organizations, especially poor urban women, were recognized as the critical points
of delivery of benefits Indian Bank has started Microstate branches that are
exclusive satellite branches for servicing micro loans (Business Line, 2007).
Later State Bank of India has promoted about 7000 SHGs in the city of Mumbai of
which nearly 2000 are bank linked. Credit flow from formal financial institutions
to the urban population groups steadily increased in India since the 1970s and this
has come to be concentrated in large cities and larger sized credit brackets. Though
the social banking efforts of the central bank and the government financial
intermediation in rural areas too have gone through a phase of expansion but the
low income asset holding segments of urban areas have largely been bypassed by
such overall expansion in financial intermediation. While the states poverty
alleviation approach has steadily expanded from mere provision of basic amenities
and services to facilitating creation of income earning opportunities, it has failed to
make any significant impact on the urban poor. The impact of microfinance
interventions will be severely limited both in urban and rural locations unless well
directed investments are made in physical and social infrastructure.

CONCEPT OF FINANCIAL INCLUSION

5

Financial inclusion or inclusive financing is the delivery of financial services at

affordable costs to sections of disadvantaged and low-income segments of society
in contrast to financial exclusion where those services are not available or
affordable. An estimated 2.5 billion working-age adults globally have no access to
the types of formal financial services delivered by regulated financial institutions.
For example in Sub-Saharan Africa only 24% of adults have a bank account even
though Africa's formal financial sector has grown in recent years. It is argued that
as banking services are in the nature of public good; the availability of banking and
payment services to the entire population without discrimination is the prime
objective of financial inclusion public policy.
Financial Inclusion is delivery of banking services at an affordable cost to the vast
sections of disadvantaged and low income groups. The main focus of financial
inclusion is to promote sustainable development and generating employment in
rural areas for the rural population. Out of 19.9 crore households in India, only
6.82 crore households have access to banking services. As far as rural areas are
concerned, out of 13.83 crore rural households in India, only 4.16 crore rural
households have access to basic banking services. In respect of urban areas, only
49.52% of urban households have access to banking services. Over 41% of adult
population in India does not have bank account. There are many factors affecting
access to financial services in by weaker section of society in India. Several steps
have been taken by the Reserve Bank of India and the Government to bring the
financially excluded people to the fold of the formal banking services. The 100 per
cent financial inclusion drive is progressing all over the country.

FINANCIAL INCLUSION IN INDIA

There are several factors affecting access to formal banking system in any country.
They include culture, financial literacy, gender, income, assets, proof of identity,
and remoteness of residence and so on.
The aim of financial inclusion is to promote sustainable development and
generating employment for a vast majority of population especially in the rural
areas. In the first-ever index of Financial Inclusion to find out the reach of banking
services among 100 countries, India has been ranked 50. At present, only 34% of
the Indias population has access to banking services. The NSSO survey reports
that there are over 80 million poor people living in the cities and towns of India
and they lack access to the most basic banking services- such as savings accounts,
credit, payment services, advisory services etc. Low income groups do not have
access to the formal banking systems, as they usually do not have the documents
needed to open a bank account. As a result, they depend on the informal sector
for their savings and loan requirements.
There are number of factors affecting access to financial services by weaker
section of society in India. The lack of awareness, low incomes and assets, social
exclusion, illiteracy are the barriers from demand side. The distance from branch,
branch timings, cumbersome procedures, high instruction costs etc. are the barriers
from the supply side. Hence, there is a need for financial inclusion to build uniform
economic development, both spatially and temporally, and ushering in greater
economic and social equity.
The Eleventh Five Year Plan (2007-12) envisioned inclusive growth as a key
objective. The inclusive growth implies an equitable allocation of resources with
benefits accruing to every section of society. It is aimed at poverty reduction,
7

human development, health and provides opportunity to work and to be creative.

Achieving inclusive growth in India is the biggest challenge as it is very difficult to
bring 600 million people in rural India into the mainstream. One of the best ways
to achieve inclusive growth is through financial inclusion.
In recent years, Indian banking sector is grappling with the issue of financial
inclusion. But, it is not altogether a new exercise. Financial inclusion was
embedded in Indian credit policies in the earlier decades also, though in a
disguised form and without the same nomenclature. Banks have evolved specific
strategies to expand the outreach of their services in order to promote financial
inclusion. This can be achieved in a cost-effective manner through forging links
with micro finance institutions and local communities.
Access to financial services allows lower income groups to save money outside the
house safely, prevents concentration of economic power with a few individuals and
mitigates the risks that poor people face as a result of economic shocks. The
breadth of financial inclusion in a country is usually measured by the percentage of
people who have access to bank accounts.

STATUS OF FINANCIAL INCLUSION IN INDIA

The process of financial inclusion in India can be broadly classified into three
phases. During the first phase (1960-1990), the focus was on channeling of credit
to the neglected sectors of the economy. Special emphasis was also laid on weaker
sections of the society. Second Phase (1990-2005) focused mainly on strengthening
the financial institutions as part of financial sector reforms.
Financial inclusion in this phase was encouraged mainly by the introduction of
Self- Help Groups (SHGs) bank linkage programme in the early 1990s and
Kissan Credit Cards (KCC) for providing credit to farmers. The SHG- bank
Linkage programme was launched by NABARD in 1992 with policy support from
RBI, to facilitate collective decision making by the poor and provide door step
banking. During the Third Phase (2005 onwards), the financial Inclusion was
explicitly made as a policy and thrust was on providing safe facility of savings
deposits through no-frills accounts.
Several steps have been taken by the RBI and government to bring the financially
excluded people to the fold of formal banking services. They include:

Introduction of no-frills accounts

Relaxing Know-Your Customer (KYC) norms
General Purpose Credit Card Schemes (GCC)
Business Facilitator and Business Correspondent Models
Project Financial Literacy
National Rural Financial Inclusion Plan (NRFIP)
Financial Inclusion Fund (FFF)

MICROFINANCE AS AN ANTI POVERTY

VACCINE FOR RURAL 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% 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, and 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 assets of India .This has resulted low
production capacity both in agriculture (which contribute around 22-25% of GDP)
and Manufacturing sector. Rural people have very low access to institutionalized
credit (from commercial banks).
A Profile of Rural India

350 million Below Poverty Line

95 % have no access to microfinance.
56 % people still borrow from informal sources.
70 % don't have any deposit account.
87 % no access to credit from formal sources.
Annual credit demand is about Rs.70,000 crores.
95 % of the households are without any kind of insurance.
Informally Microfinance has been in practice for ages.

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Micro financing has become important since the possibility of a sub-Rs 1,000
mobile handset has been ruled out in the near future. Rural India can generally
afford handsets in the price range of Rs 1,500-2,000.
To succeed in India, agribusiness must empower the farmer by making agriculture
profitable, not by expropriating him foe this particular purpose the farmer should
be funded for their basic and small needs. Micro finance is expected to play a
significant role in poverty alleviation and development. The need, therefore, is to
share experiences and materials which will help not only in understanding
successes and failures but also provide knowledge and guidelines to strengthen and
expand micro finance programmes.

Success Factors of Micro-Finance in Rural India

A. For NGOs
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 micro enterprise loans can be profitable for borrowers
and for the lenders, making microfinance one of the most effective poverty
reducing strategies.
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 simple and
peoples acceptance is high all characteristics of microfinance.
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 Canvassing by various factors, including the National Bank for Agriculture

and Rural Development (NABARD), Small Industries Development Bank of
India (SIDBI), Friends of Womens World Banking (FWWB), Rashtriya
Mahila Kosh (RMK), Council for Advancement of Peoples 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 microfinance projects. One might call it the supply push.
B. For Financial Institutions and banks
Microfinance 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. This also seems to sound nice
to the government, which in the post liberalization 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
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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 favorable 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.

THE TRANSFORMATION OF MICROFINANCE IN

INDIA
From small efforts of starting informal self-help groups (SHG) to access the muchneeded savings and credit services in the early 1980s, the microfinance sector has
grown significantly today. The fact that national bodies like Small Industries
Development Bank of India (SIDBI) and National Bank for Agriculture and Rural
13

Development (NABARD) are devoting significant time, energy and financial

resources on microfinance is an indication of the reckoning of the sector.
The strength of the microfinance organisations (MFOs) in India is in the diversity
of approaches and forms that have evolved over a period of time. While India has
its home-grown model of SHGs, and Mutually Aided Co-operative Societies
(MACS) there is significant learning from other microfinance experiments across
the world, particularly Bangladesh, Indonesia, Thailand and Bolivia.

Value attributes of Microfinance

First, microfinance is something that is done by the alternative sector not the
government, and or the commercial sector.
Second, microfinance is something done exclusively or predominantly with the
poor. Again, the banks do not qualify to be MFOs because they do not exclusively
or predominantly cater to poor. However, to the extent that the banks have got into
the business of linking SHGs, they are considered as providers of finance to MFO
and in some cases promoters of microfinance, but not as players of microfinance.
Third, microfinance grows out of developmental roots. This is what can be termed
as alternative commercial sector. This encompasses the first two points the
organisations are promoted by the alternative sector, and targeting the poor.
However the new organizations growing out of these roots need not necessarily be
developmental in the form of incorporation. There are MFOs that have been
offshoots of NGOs run on commercial lines. There are also instances where new
MFOs are promoted on commercial lines.
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Lastly, the Reserve Bank of India (RBI) has defined microfinance by specifying
criteria for MFOs to seek exemption from registration under the Non-Banking
Finance Company (NBFC) guidelines.
This definition is limited to not-for-profit companies and as of date only two MFOs
in India Sanghamithra Rural Financial Services (SRFS), and Indian Association
of Savings and Credit (IASC) qualify to be classified as microfinance companies.

Issues that trigger transformation

Size

The most significant issue that triggers a transformation is growth. Both promoters
and providers of microfinance encounter this though at different stages of
growth. Invariably the promoters of microfinance find that the existing institutions
are unwilling to provide finance at the same pace at which the providers expect
them to provide finance. Working with the attitudes of these organisations is not an
easy task. For instance, MYRADA in India was working hard on linking SHGs to
the local banks and often found that the mainstream organisations have their
limitations. In several cases the initiative was individual driven and depended on
the manager. In such a situation impatience creeps in and the NGO would get into
action to either start lending on their own (they need not necessarily transform, but
open a division for microfinance), or set up a MFO.
Financial Sustainability

15

This issue is closely linked to the growth. Beyond a level of operations, the MFOs
will have to seek external funds. Donor money can only start up microfinance
activity. Donors cannot be a sustainable source of funding. Then, the only
alternatives left for the MFO would be to either seek investments or loans. When
MFOs seek investments or loans from the mainstream organisations, questions will
be asked on the ownership structure and capital adequacy. For a MFO to survive in
the long run, it has to transform itself into a financial institution that is accountable.
Taxation
In the Indian context, significant issues pertaining to taxation are raised in some
forums. The argument is simple. If a NGO- that usually is a tax-exempt entity,
carries out commercial activities on a large scale, then it would attract the attention
of the taxation authorities. It is possible that in the process of building up a micro
finance NGO, we might jeopardize the tax status of the other activities, making
even grants taxable. This is one of the concerns of NGO- MFOs. This triggers a
search for an alternative where microfinance could be kept isolated.

SCALING UP MICROFINANCE FOR INDIAS

RURAL POOR
Since the early national plans, successive governments in independent India have
emphasized the link between improving access to finance and reducing poverty, a
stance that has had influence globally.
The need to improve financial access for Indias poor, the overwhelming majority
of whom are concentrated in rural areas, 3 motivated the establishment of a vast
network of rural cooperative credit banks in the 1950s, followed by a drive to
16

nationalize commercial banks, launched in 1969. This led to thousands of new

bank branches in rural areas across the country. The strategy during the 1970s and
1980s gave the lead role to the nationalized (state-owned) commercial banks, who
were charged with loosening the grip of traditional informal sector moneylenders
through the use of targeted low-priced loans. The 1990s saw the partial
deregulation of interest rates, increased competition in the banking sector, and new
microfinance approaches, most notably, a nationwide attempt, pioneered by nongovernmental organizations (NGOs) and now supported by the state, to create links
between commercial banks, NGOs, and informal local groups (self-help groups,
or SHGs). Better known as SHG Bank Linkage, this approach has grown
dramatically over the past decade, and while its outreach is still modest in terms of
the proportion of poor households served, many believe it is destined to become
the countrys dominant system of mass-outreach banking for the poor.

Scaling up Microfinance
With significant achievements in recent years, SHG-Bank Linkage needs to be
actively supported since, among alternatives in the microfinance sector, this is
where there appears to be maximum potential for scaling-up, while leveraging on
Indias vast network of rural banks. At the same time, in an economy as large and
varied as Indias, there is much scope for diversity and new approaches.

17

Government has an important role to play in creating space for innovation and a
flexible architecture for new, independent microfinance institutions.
Enabling policy, legal and regulatory framework
An enabling policy, legal and regulatory framework is critical to scaling-up. Such a
framework is already in place for SHG Bank Linkage, and scaling-up the model
would require the government to simply ensure that the existing framework is
maintained. This would require ensuring that the model continues to have a
champion with a clear leadership role a task which NABARD has assumed with
exemplary diligence by introducing policies and measures to encourage banks to
lend to SHGs. And it would require the authorities to maintain a hands-off
regulatory policy. Government could play an important role in establishing an
enabling policy, legal and regulatory framework for MFIs. While the success of
individual MFIs is largely attributable to their visionary leaders, this is clearly not
enough to mainstream the cause of MFIs.

Attention to quality, and the importance of financial sustainability

Scaling-up SHG Bank Linkage requires attention to the quality and sustainability
of groups, their promoters and lenders (banks).But in recent years, growing
concerns have emerged about group quality as well as the ability of partner banks
to properly assess, monitor and manage risk on their SHG portfolios. Going
forward, if SHG Bank Linkage is to be scaled-up, NABARD and its partners face
several challenges, 24 key among which include ensuring that high quality groups
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are created and maintained, and that concerns over numeric targets of group
creation and linkage do not override attention to group quality and resilience. In
particular, the success and sustainability of SHG Bank Linkage depends crucially
upon greater clarity about who is to play the key role of maintaining quality, and
how the costs of doing so are to be met. A clear strategy is required on how new
groups will be promoted, and who will fund this. If NGOs remain involved as
promoters and minders of the groups, they will need to be paid to do so, yet in the
long run, with their social-development perspective, NGOs are not ideal candidates
for this role, and nor is it clear who are to be their long-term paymasters.
Clear targeting of clients
Equally important is the need to ensure proper targeting of clients. The dual pursuit
of social ends and financial profits is an ongoing tension for all in microfinance.
While our analysis of SHG Bank Linkage indicates that the model has so far
successfully targeted the poorer segments, mission drift is a common fear as
pressures mount to serve richer clients with larger loans. Keeping focused on its
target population is thus critical to the success of microfinance in India, as
elsewhere.
Inclusiveness and competition in the microfinance sector can
generate high payoffs

The inclusiveness of SHG Bank Linkage, which has involved a partnership

between government, NGOs, and a range of rural banks (commercial banks, RRBs,
co-operative banks) has already generated a strong payoff. Further gains in terms
of outreach and financial sustainability may be reaped through involving private
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sector banks and MFIs in SHG Banking. Encouraged by early results, the new
private sector banks, most notably ICICI Bank, but also UTI Bank and HDFC
Bank, are actively seeking exposure in the microfinance sector. While their current
exposure to microfinance is too small to make a difference to their overall
portfolio, these newer banks are pursuing innovative approaches to microfinance
as a potential business and not merely as a social or priority sector lending
obligation. Key innovations include a pilot scheme by ICICI bank that uses NGOs
or MFIs26, traders, or local brokers, as intermediaries/ service providers for loans
to groups of small and marginal farmers. The tasks of loan appraisal, processing,
management, collection, etc. are delegated to the NGO/MFI/intermediary but the
loans are always on the books of the bank (ICICI funds the borrower directly and
the loan does not pass through the NGO/MFIs).

MICROFINANCE IN INDIA- A TOOL FOR

POVERTY REDUCTION
According to recent RBI estimates, there are over 450 million unbanked people
in India, most of who live in rural areas. The term unbanked refers to people who
have no access to formal financial services, but rather must rely on either family or
informal providers of finance, such as the village moneylender. It is undisputed
that access to finance is critical for enabling individuals and communities to climb
20

out of poverty. It is also generally agreed that relying on the limited resources of
village moneylenders exposes the poor to coercive lending practices, personal risks
and high interest rates, which can be a much as 150%.
Therefore the Indian Government and the RBI have a policy of financial
inclusion. As part of this policy, the government requires Indian banks to lend to
priority sectors, one of which is the rural poor. Until recently, banks were happy
to lend money to MFIs who would then on-lend funds, primarily to poor women
across rural India. The banks have welcomed this policy because historically they
tended to charge MFIs average interest rates of 12-13% and benefited from 100%
repayment rates.
Microfinance in India is currently being provided by three sectors: the government,
the private sector and charities. These three sectors, as large as they are, have only
a small fraction of the capital and geographic scale required to meet the
overwhelming need for finance amongst Indias rural poor.
The top 10 private sector microfinance providers in India together serve less than
5% of the unbanked population of India approximately 20 million clients. For
example, SHARE Microfin Limited (SHARE) and Asmitha Microfin Limited
(Asmitha), two of the five largest MFIs in India, have almost Rs 4,000 crore
($900MM) loaned to over 5 million poor women in 18 Indian states (prior to the
crisis, the combined outstanding loan portfolio had been as high as Rs 6,750 crore
($1.525BN)). Yet, despite the size of MFIs like SHARE and Asmitha, only a
fraction of the overwhelming need is being met.
Private sector MFIs have an essential role to play if the goal of financial inclusion
is to be realized, as neither the government nor charities have the capital nor
21

business model required to meet the insatiable demand for finance in rural India.
As the public listing of SKS Microfinance underscored, private sector institutions
are able to attract increasingly large amounts of private capital, in order to
accelerate the growth of the industry, which is essential to expanding financial
inclusion as far and as fast as practicable.

Road Ahead

Indian rural finance sector is at crossroads today. Following the financial sector
reforms with its emphasis on profitability as the key performance benchmark,
banks are increasingly shying away from rural lending as well as rationalizing their
branch network in rural areas. Burgess and Pande (ibid) have brought out this fact
in their study by stating that while between 1977 and 1990 (pre reform period)
more bank branches were opened in financially less developed areas, the pattern
was reversed in post reform period. Thus while, access of credit to the rural poor
has reduced in post reform period, the policy recommendation is to fill this gap
through micro credit. The SHG-Bank linkage programme has witnessed
phenomenal growth and the current strategy is to focus on 13 underdeveloped
states as also graduate the existing SHGs to the next stage of micro enterprises.
The paper argues that if SHG-Bank linkage programme has to contribute to
poverty reduction, there is an imperative need for integrating impact assessment as
a necessary design feature of the programme. The significance of bringing the
focus back to people from institutions and adoption of localized people centric
approach can hardly be overemphasized. In line with the tenets of commercial
microfinance, it is critical that scarce public resources are used judiciously and
with better targeting. Adequate emphasis on impact assessment is an integral part
22

of the triangle of factors necessary for judging microfinance intervention . Though,

the paper is focused on pointing the missing link of impact in the current paradigm
of rural finance focusing mainly on institutional viability, other critical issues
having a bearing on impact also merit attention. The SHG Bank linkage
programme at present has no explicit social or economic benchmarks for inclusion
of members into groups to be credit linked in line with the flexible approach of the
programme. However, as seen above the extension of credit in infertile local
context has negligible chances of leading to productive investment.
Similarly inclusion of core poor in the programme, who had little experience of
economic activities, also limits productive use of capital. Segmentation of credit
demand based on economic and social status is key to optimum utilization of
scarce resources.

SWOT ANALYSIS OF MICROFINANCE

Strengths
Helped in reducing the poverty: The main aim of Micro Finance is to provide
the loan to the individuals who are below the poverty line and cannot able to access
from the commercial banks. As we know that Indian, more than 350 million people
in India are below the poverty and for them the Micro Finance is more than the
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life. By providing small loans to this people Micro finance helps in reducing the
poverty.
Huge networking available: For MFIs and for borrower, both the huge network
is there. In India there are many more than 350 million who are below the poverty
line, so for MFIs there is a huge demand and network of people. And for borrower
there are many small and medium size MFIs are available in even remote areas.

Weaknesses
Not properly regulated: In India the Rules and Regulation of Micro Finance
Institutions are not regulated properly. In the absent of the rules and regulation
there would be high case of credit risk and defaults. In the shed of the proper rules
and regulation the Micro finance can function properly and efficiently.
High number of people access to informal sources: According to the World
Bank report 80% of the Indian poor cant access to formal source and therefore
they depend on the informal sources for their borrowing and that informal charges
40 to 120% p.a.
Huge demand and supply gap: There is a huge demand and supply gap among
the borrowers and issuers. In India around 350 million of the people are poor and
only few MFIs there to serving them. There is huge opportunity for the MFIs to
serve the poor people and increase their living standard. The annual demand of
Micro loans is nearly 60,000 crore rupees and only 5456 crore are disbursed to the
borrower.

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 Huge Untapped Market: Indias total population is more than 1000 million and
out of 350 million is living below poverty line. So there is a huge opportunity for
the MFIs to meet the demand of that unserved customers and Micro Finance
should not leave any stones unturned to grab the untapped market.

Threats
High Competition: This is a serious threat for the Micro Finance industry,
because as the more players will come in the market, their competition will rise,
and we know that the MFIs has the high transaction cost and after entrant of the
new players there transaction cost will rise further, players will come in the market,
their competition will rise.
Neophyte Industry: Basically Micro Finance is not a new concept in India, but
that was all by informal sources. But the formal source of finance through Micro
Finance is novice, and the rules are also not properly placed for it.
Over involvement of Govt.: This is the biggest that threat that many MFIs are
facing. Because the excess of anything is injurious, so in the same way the excess
involvement of Govt. is a serious threat for the MFIs. Excess involvement
definition is like waive of loans, make new rules for their personal benefit etc.

Opportunities
Huge demand and supply gap: There is a huge demand and supply gap among
the Borrowers and issuers. In India around 350 million of the people are poor and
only few MFIs there to serving them there is huge opportunity for the MFIs to
serve the poor people and increase their living standard. The annual demand of
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Micro loans is nearly Rs 60,000 crore and only 5456 crore are disbursed to the
borrower. (April 09)
Employment Opportunity: Micro Finance helps the poor people by not only
providing them with loan but also helps them in their business, educate them and
their children etc. So in this way, micro finance helps in increasing the employment
opportunity for them and for the society.
Huge Untapped Market: Indias total population is more than 1000 million and
350 million people are living below poverty line. So there is a huge opportunity for
the MFIs to meet the demand of the customers and Micro Finance Institutions
should not leave any stones unturned to grab the untapped market.

DELIVERY MODELS OF MICROFINANCE

THE GRAMEEN SOLIDARITY GROUP MODEL:
This model is based on group peer pressure whereby loans are made to individuals
in groups of four to seven . Group members collectively guarantee loan repayment,
and access to subsequent loans is dependent on successful repayment by all group
members. Payments are usually made weekly. Solidarity groups have proved
effective in deterring defaults as evidenced by loan repayment rates attained by
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organizations such as the Grameen Bank, who use this type of microfinance
model .
VILLAGE BANKING MODEL
Village banks are community-managed credit and savings associations established
by NGOs to provide access to financial services, build community self-help
groups, and help members accumulate savings . They have been in existence since
the mid-1980s. They usually have 25 to 50 members who are low-income
individuals seeking to improve their lives through self-employment activities.
These members run the bank, elect their own officers, establish their own by-laws,
distribute loans to individuals and collect payments and services. The loans are
backed by moral collateral; the promise that the group stands behind each loan.

NON GOVERNMENT ORGANISATION (NGO) MODEL:

This is the model practiced in the initial phase for social objective. This emerged as
the alternative when local money lenders were charging usurious rate of interest
without considering the problems of the individual borrowers and chit funds ran
with the risk of collapsing if there were defaults. In this model the utility of the
borrower is of prime concern and small groups were formed. The lending was
usually based on economic activities rather for consumption. The interest rates
were low which caused problem to self-sustainability of the NGOs. This model
was very similar to Self Help Group model (proposed by Mahatma Gandhi). The
model primarily focuses on the social causes rather than economic sustainability.
The equilibrium between effort and reward is violated. The effort of poverty

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alleviation is one sided (from NGO) which leads irresponsible borrowing, large
area coverage problem and threat to the self-sustainability of the NGOs.
SELF HELP GROUP MODEL (SHG) MODEL:
This model is highly influenced by the success of Grameen Bank in Bangladesh.
This model is commonly practiced with PSU banks and SHG linkage. PSU banks
had Rs. 1000 crore exposure to SHG based loans, lent another 60 crore to MFIs.
The SHG concept involves forming groups of 15-20 women, who meets regularly,
understand each others problems and bond for a while. They are expected to save
a small amount, keep the money in bank and earn interest. A member could borrow
if she falls ill and couldnt go for work. She would return the money with 18-24
per cent interest to the group. The recovery is almost certain due to the pressure
and bonding with the group. Such groups formation and bonding takes a minimum
of six to none months.

JOINT LIABILITY GROUP MODEL (JLG MODEL):

In this model, agents of MFIs persuade 4-5 women to form a group and each
guaranteed the others loans. Most of the members could not develop the bonding
like SHG. The MFIs charge 12-18 percent in JLG, compared with that of 18-24
percent charged by SHG primarily run by PSU banks. MFI interest rates are nontransparent and effective rates are over 27 percent, considering loan processing
fees, penalties and hidden charges.

This model primarily focuses on the

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profitability of MFIs. The repayment rate is also low due to weak bonding among
the group members. The credit generation is more than actual production. Though,
most of the MFIs claim they have lent for income generating activities, in reality,
most lending has been for consumption purposes. Thus indiscriminate lending and
irresponsible borrowing is encouraged, leading debt trap and Micro finance
crisis.

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INTEREST RATES OF MICROFINANCE

INSTITUTIONS
Usurious interest rates have been one of the most important factors and most
controversial factors in microfinance. Though the rates may seem unduly high,
around 26% in India due to the cap and ranging from 26-35 % in most other
regions of operation, the rates are in fact justified. Cost of capital, Operating
expense and bad debt are the three most significant contributors of bad debt in
microfinance.
Though most of the factors contributing to the interest rates are unavoidable, i.e.
the operating costs will be high due to the large workforce needed to manage the
small loans and collection efforts, some others can be reduced through
optimization, i.e. Use of efficient algorithms to reduce work hours needed in
collection efforts etc.

The determinants of interest rates in microfinance

Cost of capital:
Cost of capital is one of the primary causes of the interest rates. Since MFIs arent
allowed to borrow from the people directly they have to rely on commercial banks
for loans. Due to this reason the cost of the funds borrowed is the market interest
rates. Since most micro loans given are without collateral, the risk is considerable
and hence the rates charged by the commercial banks are considerably high. The
rate of interest charged by these banks is around 12 to 15 percent, significantly

31

higher than the interest rates charged to other borrowers. The cost of capital
however is pretty much fixed and not much can be done to reduce this expense.
Operating Expense:
Microfinance is a human resource intensive service delivery model and transaction
costs tend to be higher than other financial service providers since average loan
sizes are small and services are usually delivered at doorstep. Transaction costs or
operating costs in MFIs are typically driven by the lending model
(Grameen/SHG/individual), average loan sizes, the processes of client acquisition
and servicing practices of the institution.
Operating expense is the single largest contributor to the interest rates in
microfinance, contributing as much as 62 percent. The good news is that through
various optimization techniques, that many of the MFIs have started adopting,
these operating expenses can be reduced significantly. Administrative expense and
personnel expenses are the two major contributors of operating expense.
Administrative expense is the charge due to office space, utilities needed etc. This
is more or less a fixed expense. The other aspect is personnel expense that includes
salary for the on field as well as off field agents, travel expenditure needed in the
collection effort. Based on my talks with a few people currently working in Indian
MFIs it can be said that personnel expense is the one with most scope of
improvement and all efforts at cost reduction are currently focused on that feature.

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 Bad Debt/Contingency Reserve:

Sometimes the people who borrow arent able to payback and thus the MFI loses
some money. This situation is known as bad debt. The MFI therefore has to charge
a bit higher interest rate to compensate its losses and thereby stay profitable.
However the bad debts are closely related to interest rates, i.e. if the interest rates
are raised too high then the people wont be able to repay thereby causing the MFIs
to charge higher to compensate the losses.
This sort of vicious circle is very harmful to any credit industry and can lead to
catastrophic consequences as were observed in Ghana. Bad debt constitutes around
6% of the interest rates charged.
Tax Expense:
Tax expense accounts for around 2 % of the interest rates in microfinance and is a
significantly small factor. This is purely determined by the tax laws of the country
of operation and not much can be done to reduce this factor.

TRENDS OF MICROFINANCE

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CONTRIBUTION OF VARIOUS MFIS IN INDIA

RATE OF DEFAULT IN MFIs IN 4 STATES

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 REACH OF MFIs

A STUDY ON RECENT TRENDS AND PROBLEMS IN

USING MICRO FINANCE SERVICES IN INDIA
It was well debated that in developing countries both formal and informal financial
sectors have failed to serve the poor at required level. While looking on the formal
sector, large loans and bureaucratic and long procedures for getting loans keep
away the poor from the financial institutions. On the other hand, informal sector
also failed to serve the poor community. Local moneylenders and indigenous
bankers are the major part in informal sector and charge very high interest. Lack of
provision of financial service and infrastructure in formal and informal services,
particularly credit has evolved the micro-credit planning and programs. Micro
finance programs can be an effective way to provide low-cost financial services to
poor individuals and families. It has been shown to help in the development and
growth of the local economy as individuals and families are able to move past
subsistence living and increase disposable income. Negative impacts of
microfinance and microcredit programs are that; microfinance programs benefit the

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moderately poor more than the destitute, and thus impact can vary by income
group.
There is a strong tendency to move to the top of the clientele group, and to give
little attention to the needs of the poorest, with the end result that their proportion
diminishes over time.
The concept and practice of microfinance sector is increasingly adopting a
financial systems approach, either by operating on commercial lines or by
systematically reducing reliance on interest rate subsidies and aid agency financial
support surveyed nearly 73 micro finance institutions in the US and developing
countries on their impact evaluation. This study revealed that the sample
institutions regularly evaluated their programs, monitored project performance and
used findings to implement project changes and sought formal feedback from the
clients.

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SCOPE OF FURTHER STUDY

The existing policy and regulatory environment is favourable for the growth of a
vibrant microfinance sector in our country. Recognition of the role of microfinance
in poverty reduction and the need for closer ties between mainstream financial
institutions and the MFIs is encouraging. If we are serious about reaching out to
the poor households with appropriate financial services that will enhance their
income level and reduce their vulnerability, we need to develop strategies to
establish and strengthen partnership among all the stakeholders.
To bridge the existing demand and supply gap and to reach out to under-served
states where concentration of poverty is high, it is important to invest in the
capacity of the existing social intermediaries/ NGOs in organising the poor. Such a
strategy will help in building the local capacity to initiate area-specific
interventions. India, with its geographic, economic, social and cultural diversity
will require variety in delivery mechanisms of financial services. This should be
encouraged and recognized by the mainstream financial institutions.
Micro-loans alone will not reduce poverty, though they are helpful in arresting the
poor from further fall in times of crisis. There should be a clear strategy to help
them to move up through diversified loan products, bigger loan for productive
activities and measures to provide safety nets (insurance, savings) to reduce their
vulnerability.
Promoting livelihood opportunities and developing skills to undertake microenterprises will help in increasing the household income. The mainstream
institutions should allocate funds for building the capacity of members and
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promoters of collectives, since it is an investment they make for building the

demand base for their services. NABARD should take the lead in nurturing new
initiatives and strengthening the existing microfinance institutions and promoters
of community-based financial institutions.

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CONCLUSION
Microfinance expansion over the next decade can be expected to be an extension of
what has been achieved so far while overcoming the hurdles that have been posing
difficulty in effective microfinance operation and its expansion .Existing
microfinance institutions can expand their operations to areas where there are huge
numbers of Microfinance programs. More NGOs can incorporate microfinance as
one of their programs. In places where there are micro finance institutions, the
government channels at the grassroots level may be used to serve the poor with
microfinance. Postal savings banks may participate more not only in mobilizing
deposits but also in providing loans to the poor and on lending funds to the MFIs.
More commercial banks may participate both in microfinance wholesale and
retailing. They many have separate staff and windows to serve the poor without
collateral.
80% of the financial sector is still controlled by public sector institutions.
Competition, consolidation and convergence are all being discussed to improve
efficiency and outreach but significant opposition remains. Many private and
foreign banks have unveiled their plans to enter the Indian microfinance sector
because of its very low NPAs and high repayment rate of more than 95% in spite of
offering loans without any collateral security.
Microfinance is not yet at the centre stage of the Indian financial sector. The
knowledge, capital and technology to address these challenges however now exist
in India, although they are not yet fully aligned. With a more enabling environment
and surge in economic growth, the next few years promise to be exciting for the
delivery of financial services to poor people in India. Development of Small-Scale
Enterprises through microfinance will not only increase the outreach but will also
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help the generation of more employment and income for the poor. It is expected
that in the following years there will be considerable deepening of microfinance in
this direction along with simultaneous drives to reach and serve the poorest of the
poor.
The concept of Micro Finance is still new in India. Not many people are aware the
Micro Finance Industry. So apart from Government programmers, we the people
should stand and create the awareness about the Micro Finance.
The purpose of this study was to understand micro finance in India Micro Finance
Industry has the huge potential to grow in future, if this industry grows then one
day we will all see the new face of India, both in term of high living standard and
happiness.

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BIBLIOGRAPHY

Sriram MS (2002): Information Asymmetry and Trust: A Framework

for Studying Micro-finance in India. WP No. 2002-09-02.
Ahmedabad: Indian Institute of Management.
Planning Commission, Approach Paper to the Tenth Five Year Plan
(2002-07), New Delhi, 2001.
www.google.com
www.rbi.gov.in
www.microfinanceinsight.com
www.ifmr.ac.in
www.wikipedia.com
www.nationmaster.com
www.investopedia.com
International Journal of Management Research and Development
(IJMRD) ISSN 2248-938X , ISSN 2248-9398 (Online) Volume 3,
Number 1, Jan-March (2013)
International Journal of Management Research and Development
(IJMRD) ISSN 2248-938X ISSN 2248-9398 (Online) Volume 3,
Number 1, Jan-March (2013)

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