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Tuesday, October 9, 2012

MICROFINANCE AND ITS INDIAN SCENARIO

MICROFINANCE AND ITS INDIAN SCENARIO


Microfinance is usually understood as providing financial services to micro-entrepreneurs and small businesses, which lack or have very limited access to banking and related services due to the high transaction costs associated with serving these client categories. 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. Microfinance means providing the banking and finance facilities to the poor or the nearly-poor people. This term is often confused with ‘Microcredit’. Microcredit, however, stands for providing credit facilities like loans to the poor or the nearly-poor.

Traditionally, banks have not provided financial services, such as loans, to clients with little or no cash income. Banks incur substantial costs to manage a client account, regardless of how small the sums of money involved. There is a break-even point in providing loans or deposits below which banks lose money on each transaction they make. Poor people usually fall below that breakeven point. Hence there is a general unwillingness on the part of most of the financial institutions to provide credit to such people.


The Origin

Microfinance sector has grown rapidly over the past few decades. Nobel Laureate Muhammad Yunus is credited with laying the foundation of the modern MFIs with establishment of Grameen Bank, Bangladesh in 1976. Today it has evolved into a vibrant industry exhibiting a variety of business models. Close to 7 million people use the services to Grameen Bank to access the financial sector.


Microfinance in India

Microfinance in India can trace its origins back to the early 1970s when the Self Employed Women’s Association (“SEWA”) of the state of Gujarat formed an urban cooperative bank, called the Shri Mahila SEWA Sahakari Bank, with the objective of providing banking services to poor women employed in the unorganised sector in Ahmedabad City, Gujarat.  The microfinance sector went on to evolve in the 1980s around the concept of Self Help Groups (SHGs), informal bodies that would provide their clients with much-needed savings and credit services. From humble beginnings, the sector has grown significantly over the years to become a multi-billion dollar industry, with bodies such as the Small Industries Development Bank of India and the National Bank for Agriculture and Rural Development devoting significant financial resources to microfinance. Today, the top five private sector MFIs reach more than 20 million clients in nearly every state in India and many Indian MFIs have been recognized as global leaders in the industry.

Microfinance Institutions (MFIs) in India exist as NGOs (registered as societies or trusts), Section 25 companies and Non-Banking Financial Companies (NBFCs). Commercial Banks, Regional Rural Banks (RRBs), cooperative societies and other large lenders have played an important role in providing refinance facility to MFIs. Banks have also leveraged the Self-Help Group (SHGs) channel to provide direct credit to group borrowers.

According to the latest research done by the World Bank, India is home to almost one third of the world’s poor (surviving on an equivalent of one dollar a day). Though many central government and state government poverty alleviation programs are currently active in India, microfinance plays a major contributor to financial inclusion. In the past few decades it has helped out remarkably in eradicating poverty. Reports show that people who have taken microfinance have been able to increase their income and hence the standard of living. These institutions not only offer micro credit but they also provide other financial services like savings, insurance, remittance and non-financial services like individual counselling, training and support to start own business and the most importantly in a convenient way. The borrower receives all these services at her/his door step and in most cases with a repayment schedule of borrower’s convenience. But all this comes at a cost and the interest rates charged by these institutions are higher than commercial banks and vary widely from 10 to 30 percent. Globally the average interest rate charged on microfinance loan is 37%.

This high interest rate is seemingly the problem for most of the microfinance borrowers.


Channels of Micro Finance
In India microfinance operates through two channels:
1. SHG – Bank Linkage Programme (SBLP)
2. Micro Finance Institutions (MFIs)

SHG – Bank Linkage Programme
This is the bank-led microfinance channel which was initiated by NABARD in 1992. Under the SHG model the members, usually women in villages are encouraged to form groups of around 10-15. The members contribute their savings in the group periodically and from these savings small loans are provided to the members. In the later period these SHGs are provided with bank loans generally for income generation purpose. The group’s members meet periodically when the new savings come in, recovery of past loans are made from the members and also new loans are disbursed. This model has been very much successful in the past and with time it is becoming more popular. The SHGs are self-sustaining and once the group becomes stable it starts working on its own with some support from NGOs and institutions like NABARD and SIDBI



Sl. No.


Type of MFI


Number


Legal Registration
          Not-for Profit MFIs
1
NGOs
400-500
Society Registration Act, 1860
Indian Trust Act, 1882
2
Non-Profit companies
20
Section-25 of Indian Companies Act, 1956
          Mutual Benefit MFIs
3
Mutual benefit MFIs – Mutually Aided Cooperative Societies (MACS)
200-250
Mutually Aided Co-operative societies, Act enacted by State Governments
         
         For Profit MFIs
4
Non-Banking Financial Companies (NBFCs)
45
Indian companies Act, 1956
Reserve Bank of India Act, 1934



Micro Finance Insitutions 

Those institutions which have microfinance as their main operation are known as micro finance institutions. A number of organizations with varied size and legal forms offer microfinance service. These institutions lend through the concept of Joint Liability Group (JLG). A JLG is an informal group comprising of 5 to 10 individual members who come together for the purpose of availing bank loans either individually or through the group mechanism against a mutual guarantee. The reason for existence of separate institutions i.e. MFIs for offering microfinance are as follows:
· High transaction cost – generally micro credits fall below the break-even point of providing loans by banks
· Absence of collaterals – the poor usually are not in a state to offer collaterals to secure the credit
· Loans are generally taken for very short duration periods
· Higher frequency of repayment of installments and higher rate of Default

Non-Banking Financial Companies (NBFCs), Co-operative societies, Section-25 companies, Societies and Trusts, all such institutions operating in microfinance sector constitute MFIs and together they account for about 42 percent of the microfinance sector in terms of loan portfolio. The MFI channel is dominated by NBFCs which cover more than 80 percent of the total loan portfolio through the MFI channel.

Women and groups comprise almost 95% of the microfinance credit in India.


Microfinance crisis in India:

Andhra Pradesh witnessed a huge problem in terms of Microfinance. Some people committed suicides and other protested against MFI and Govt. policies through rallies, at times violent.

Andhra Pradesh accounted for almost 70% of Indian Microcredit. However, due to huge interest rates most of the people were not able to repay the loans with interest.
This was followed by coercive practices to collect the funds from the borrowers.  The most shocking part here is that the same MFIs used their polished sales people to lure the poor to avail loan which was normally beyond the poor person’s capacity and then the same organization coerced the people to pay.

The problem may have arisen because of several reasons:

Lack of proper monitoring: Most of the organizations did not monitor as to where the funds were used after being given as a loan. The poor often used to spend it on personal work rather than using it generate income as it was originally envisaged for.

Multiple credits: The poor often used to take another microcredit to repay the previous one and the chain used to continue. At times loans were taken on names of the different members of the same family and the problem of repayment only increased with that.

High interest rates: Critics argue that at times interest rates from private MFIs were as high as 30-35%. Very high considering the clients to whom it was charged.


The Current Scenario:

To regulate the Microfinance industry in a better manner and to ensure that incidences like that of Andhra Pradesh are not repeated, the Government proposed a regulatory body to control the Microfinance sector of India and accordingly The Reserve Bank of India is to be entrusted with the task.

The Cabinet has approved a bill aimed to bring microlenders under the Reserve Bank of India’s purview. The Microfinance Institutions (Development and Regulation) Bill needs Parliament’s approval to become a law.
India’s once-thriving microfinance sector was devastated by a crackdown more than a year ago by the government of Andhra Pradesh, which was the industry hub and largest market. The state rules resulted in a drop-off in loan collections and a drying up of funding for microlenders.
However, the much-needed amendments suggested by industry experts and states like Andhra Pradesh seem to have gone unheard.
The Andhra Pradesh government, for instance, had objected to the description of the MFIs as extended arms of the banks, considering the pure-play money lending activities of the MFIs.
Though the MFIs have been welcoming the bill since it is expected to allow them to expand their business, the Andhra Pradesh government had also raised an objection to the free hand given to the MFIs to collect thrift from the MFI customers.
Though it was largely agreed that a central legislation, unlike the one promulgated by the AP government, would bring the much required discipline in the microlending sector, official sources are sceptical about the actual implementation of the legislation since it is the RBI that has responsibility of the regulation.
However, the bill also empowers the RBI to penalise the erring MFIs with a penalty extending up to Rs5 lakh. The bill has gone soft on the issue of interest rates charged by the MFIs though the MFI sceptics were expecting the capping of the rates.

To conclude, we can say that after the intervention of the Government and subsequent control of the Microfinance sector by the RBI we can expect that the Indian Microfinance will change for sure, and it will change the good, much for the actual upliftment of the poor.


(This article is meant for academic purpose only. With inputs from NABARD report on MFI, Wall Street Journal, Times of India, The Hindu, IIM K Journal and the web)

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