Importance of Microfinance Institutions in India

Introduction:

Microfinance has grown as a need-based programme for women’s empowerment and poverty eradication in the development paradigm. Microfinance has emerged as one of the most effective strategies for impoverished people’s economic empowerment.

Microfinance got its start in the 1970s when social entrepreneurs began lending money to the working poor on a massive scale. Professor Muhammad Yunus, who won the Nobel Peace Prize in 2006 with Grameen Bank, is one person who has gained worldwide prominence for his work in microfinance. The purpose of microfinance was to help people get out of poverty.

Over the last two decades, policymakers, international development agencies, non-governmental groups, and others have produced a variety of development techniques targeted at reducing poverty in developing nations. Microfinance programmes, which provide financial services in the form of savings and credit opportunities to the working poor, are one of these initiatives that have grown in popularity since the early 1990s.

What is Microfinance?

Microfinance is a method of providing capital to small business owners and entrepreneurs. Small and individual enterprises frequently lack access to traditional financial resources provided by large institutions. This makes it more difficult for them to obtain loans, insurance, and investments that would help them expand their firm.

“The provision of thrift, saving, credit and financial services and products of very small amount to the poor in rural, semi-urban and urban areas for enabling them to raise their income level and improve their standard of living.”^[1]

The term “microfinance” refers to the variety of financial products offered by microfinance institutions (MFIs), such as microloans, microsavings, and microinsurance.

Microcredit is a subset of microfinance, which is a large range of services. Microcredit is the provision of credit to low-income people. Microcredit is a subset of microfinance, and the two are frequently mixed up. Microcredit may be attacked by critics who use the terms microcredit’ microfinance’ interchangeably. More than 500 million people are estimated to have profited from microfinance activities, according to the World Bank.

The microfinance market’s development and growth affects more than simply people who use or are considering using microfinance services. Microfinance in India runs through two channels:

1. NABARD’s Bank Linkage Program (SHG) (SBLP)
2. Microfinance Institutions or Organizations (MFIs)

Microfinance’s distinguishing traits include:

1. Borrowers come from low-income families.
2. Microloans are small-dollar loans.
3. Loans with a short repayment period
4. Loans are available without the need for collateral.
5. Repayments are made frequently.
6. Loans are typically taken out to supplement one’s income.^[2]

Microfinance Institutions

Microfinance institutions are those that specialise in microfinance as their primary business. Microfinance is provided through a variety of organisations of various sizes and legal structures. The Joint Liability Group concept is used by these entities to provide loans (JLG). A JLG is an informal group of 5 to 10 people who get together for the goal of obtaining bank loans, either individually or through a group method, in exchange for a mutual guarantee.

Traditional microfinance institutions (MFIs) contained exclusively Non-Governmental Organisations (NGO), specialised microfinance banks, and public sector banks for many years. The marketplace has been changing recently.

In India, microfinance establishments (MFIs) take the form of NGOs (documented as societies or trusts), Section 25 Companies, and Non-Banking Financial Companies (NBFCs). Commercial banks, regional rural banks (RRBs), cooperative societies, and other significant lenders have all assisted MFIs in obtaining refinancing. Self-Help Groups (SHGs) have also been used by banks to give direct loans to group borrowers. Microfinance has taken the centre spotlight as a promising means of widening financial services to unbanked populations.

Microfinance institutions are a good complement to banks, and in some ways, they are even better. These institutions not only provide microcredit, but also other financial services such as savings, insurance, and remittance, as well as non-financial services such as individual counselling, training, and support for starting a business, all in a convenient manner. All of these services are delivered to the borrower’s doorstep, and in most circumstances, with a repayment schedule that is convenient for the borrower.

Significance of Microfinance Institutions

Over the previous five years, the Indian microfinance sector has seen enormous expansion, with institutions facing little oversight. Prudential criteria applied to some microfinance firms, but no regulations addressed loan practises pricing or operations.

Many central and state government poverty reduction programmes are currently in place in India, however, microfinance is a significant contributor to financial inclusion. It has made a significant contribution to the eradication of poverty over the last few decades. According to reports, those who used microfinance were able to enhance their income and thus their standard of living.

Microfinance allows people to expand their current prospects. The presence of microfinance institutions that provide funds for little businesses has boosted the income proliferation of disadvantaged households. It makes credit more accessible, microfinance options help people get credit when they need it the most. Customers scarcely receive subtle loans from banks; MFIs that provide microloans replenish this void. It allows for future investments by increasing the amount of money available to the poor. As a result, in addition to supporting these families’ fundamental necessities, MFIs also offer them credit to build better houses, improve local healthcare facilities, and explore new business prospects. It helps the underserved in society, the women receive the majority of the microfinance loans given by MFIs. Microfinance also benefits jobless people and individuals with impairments. These funding remedies serve people in gaining strength in their lives by enriching their living predicaments.

Microfinance institutions aid in the creation of work chances by assisting in the creation of jobs in underprivileged communities. It instils the habit of saving, when people’s fundamental needs are addressed, they are more likely to begin saving for the future. It is beneficial to instil the habit of saving in those who live in underdeveloped areas. Poor people with limited income can now save and become bankable. The funds raised from savings and microcredit received from banks are used to give loans and advances to the organization’s members. As a result, microfinance aids in the mobilisation of savings. It provides considerable economic benefits, people who participate in microfinance activities are more likely to have higher levels of consumption and better nutrition. This eventually results in the community’s economic value increasing. Microloans are mostly taken out by women borrowers, which leads to improved credit management practices. Female borrowers are less likely to default on loans, according to statistics. Microloans have better repayment rates than traditional loans since women are at a lower risk for borrowers. This enhances the community’s credit management methods. It also leads to better education and has been observed that families who benefit from microloans are more inclined to provide their children with a better and continuing education. As family finances improve, children are less likely to be pulled out of school for financial reasons.

Microfinance also protects people from the exploitation of moneylenders who charge exorbitant interest rates when lending to the poor, and this exploitation further impoverishes the poor, leading to a vicious cycle. Microfinance has aided in the identification of potential rural entrepreneurs. SHGs urge their members to start enterprises together or separately. They receive leadership skills training from their supporting institutions.

The MFIs goal of financial stability and long-term viability, on the other hand, must not be disregarded. For such Micro Finance Institutions, managing both purposes is frequently a burdensome grindstone. The reason for this is that the unprivileged group to whom the loans are given lacks a steady source of income to serve as collateral for the loan amount. Many times, in order to achieve the goal of creating consistent cash flows in the institution, comprehensive credit risk analysis is completely overlooked. This is due to their continued vulnerability in terms of market position, as well as poor risk management techniques for credit risk, operational risk, and liquidity risk.

Microfinance institutions in India face a number of risk management issues. The most common issues include Increased competition, operational risk and managerial inability (due to broad geographical presence), a lack of awareness of risk management, a lack of board member participation, and a poor management response to internal fraud are all common issues^[3]. There are several elements that contribute to such issues, including government policies, economic and environmental considerations, and political dynamics.

Microfinance institutions in rural areas of the country have operating risks because they are frequently separated from their main branch. When there is no direct supervision, the organization’s employees are more prone to engage in fraudulent activities. Furthermore, there is less motivation to devote to client pleasure, resulting in inadequate repayment methods and increased debts for the MFI. Furthermore, being present in such isolated areas can lead to pressure from local political parties to take unfavourable acts, such as cancelling loans or penalties. Along with that, the Andhra Pradesh crisis in the Microfinance industry affected the whole system of Microfinance creating political upheaval in the state. If the absence of managerial skills, particularly in risk management, persists, microfinance institutions would suffer the brunt of such a crisis much more. There is a clear need to build a framework to reduce risks and capitalise on possibilities that may present themselves to these microfinance firms.

According to a survey by the World Bank, 1.4 billion people in developing nations live on less than $1.25 per day. As a result, one of the key millennium development goals announced by the United Nations in 2008 is to eliminate poverty by 2015.^[4]

Conclusion

Microfinance has the potential to significantly improve the poor’s level of living. The provision of financial services has a significant impact on any country’s economic progress. Microfinance refers to a wide range of financial services provided to the poor and low-income population, including deposits, loans, payment services, money transfers, insurance, savings, and microcredit. An economy’s investment potential is aided by a well-developed financial system. The Indian microfinance business model’s strength and long-term viability stem from the fact that it addresses a vast unmet need for financial inclusion. Because of the enormous number of Indians who are now unbanked and the country’s diverse geography, the microfinance sector has a lot of room to grow.

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References:

^[1] Taskforce on Supportive Policy and Regulatory Framework for Microfinance (NABARD).

^[2] Jacob & Vishal Vivek, Microfinance – Current status and growing concern in India AVANTGARDE (Oct. 28, 2021, 12:01 PM) http://www.iitk.ac.in/ime/MBA_IITK/avantgarde/?p=475.

^[3] Fernando, N. A. (2007) Managing Microfinance Risks: Some Observations and Suggestions, Asian Journal of Agriculture and Development, (Nov. 02, 2021, 10:25 AM) https://econpapers.repec.org/article/agsphajad/166009.htm. 

^[4] United Nations Millennium Development (Nov. 7, 2021, 16:17 PM) https://www.un.org/millenniumgoals/poverty.shtml.