MICROFINANCE IN INDIA

Author: Deepak Tiwari Author: Ravichandra.GStudent, 2nd Semester, MBA Student, 2nd Semester, MBASir M. Visvesvaraya Institute of Technology Sir M. Visvesvaraya Institute of Technology Bangalore BangaloreCell number: 9379298455 Cell number: 9886747490 Email ID: tiwarideepakihmgoa@gmail.com Email ID:ravi.chandra1985@ymail.com

Abstract:

In the Indian subcontinent terms like "small and marginal farmers", " rural artisans" and

"economically weaker sections" have been used to broadly define micro-finance customers.

The recent Task Force on Micro Finance has defined it as "provision of thrift, credit and other

financial services and products of very small amounts to the poor in rural, semi urban or urban

areas, for enabling them to raise their income levels and improve living standards". Women

constitute a vast majority of users of micro-credit and savings services.

India's GDP ranks among the top 15 economies of the world. However, around 300 million

people or about 60 million households, are living below the poverty line. It is further estimated

that of these households, only about 20 percent have access to credit from the formal sector.

A group of micro-finance practitioners estimated the annualized credit usage of all poor families

Sat over Rs 45,000 crores, of which some 80 percent is met by informal sources. This figure has

been extrapolated using the numbers of rural and urban poor households and their average annual

credit usage assessed through various micro studies.

Credit on reasonable terms to the poor can bring about a significant reduction in poverty. It is

with this hypothesis; micro credit assumes significance in the Indian context. There are about 60

million households below or just above the austerely defined poverty line and with more than 80

percent unable to access credit at reasonable rate. With globalization and liberalization of the

economy, opportunities for the unskilled and the illiterate are not increasing fast enough, as

compared to the rest of the economy. This is leading to a lopsided growth in the economy thus

increasing the gap between the haves and have-nots. It is in this context, the institutions involved

in micro finance have a significant role to play to reduce this disparity and lead to more equitable

growth.

Introduction

Microfinance sector has covered a long journey from micro savings to micro credit and then to

micro enterprises and now entered the field of micro insurance, micro remittance, micro pension

and micro livelihood. This gradual and evolutionary growth process has given a great boost to

the rural poor in India to reach reasonable economic, social and cultural empowerment, leading

to better life of participating households. Microfinance has registered an impressive expansion at

the grass root level.

The year 2008-09 is the third year that the data on progress in Microfinance sector have been

presented on the basis of returns furnished directly to NABARD by Commercial Banks (CBs),

Regional Rural Banks (RRBs) and Cooperative Banks operating in the country. The data

includes the information related to savings of Self Help Groups (SHGs) with banks as on 31

March 2009, loans disbursed by banks to SHGs during the year 2008-09 and outstanding loans of

SHGs with the banking system and the details of Non-Performing Assets (NPAs) and recovery

percentage in respect of bank loans provided to SHGs as on 31 March 2009.

The banks operating, presently, in the formal financial system comprises of Public Sector

Commercial Banks (27), Private Sector Commercial Banks (28), Regional Rural Banks (86),

State Cooperative Banks (31) and District Central Cooperative Banks (371).

NABARD has also been instrumental in facilitating various activities under Microfinance sector,

involving all possible partners in the arena.

Demand of Micro Finance Services in India

Due to its large size and population of around 1000 million, India's GDP ranks among the top 15

economies of the world. However, around 300 million people or about 60 million households,

are living below the poverty line. Only about 20 percent have access to credit from the formal

sector.

A group of micro-finance practitioners estimated the annualized credit usage of all poor families

(rural and urban) at over Rs 45,000 crores, of which some 80 percent is met by informal sources.

This figure has been extrapolated using the numbers of rural and urban poor households and their

average annual credit usage (Rs 6000 and Rs 9000 pa respectively) assessed through various

micro studies.

Credit on reasonable terms to the poor can bring about a significant reduction in poverty. It is

with this hypothesis; micro credit assumes significance in the Indian context. With about 60

million households below or just above the austerely defined poverty line and with more than 80

percent unable to access credit at reasonable rates, it is obvious that there are certain issues and

problems, which have prevented the reach of micro finance to the needy.

With globalization and liberalization of the economy, opportunities for the unskilled and the

illiterate are not increasing fast enough, as compared to the rest of the economy. This is leading

to a lopsided growth in the economy thus increasing the gap between the haves and have-nots. It

is in this context, the institutions involved in micro finance have a significant role to play to

reduce this disparity and lead to more equitable growth and the status of microfinance in India is

as shown in the table below:

SOURCE: NABARD

Demand for Credit

In terms of demand for micro-credit, there are three segments and at the very bottom in terms of

income and assets, and most numerous, are those who are landless and are engaged in

agricultural work on a seasonal basis, and manual laborers in forestry, mining, household

industries, construction and transport.

The next market segment is small and marginal farmers and rural artisans, weavers and those

self-employed in the urban informal sector as hawkers, vendors, and workers in household

micro-enterprises. This segment mainly needs credit for working capital.

The third market segment is of small and medium farmers who have gone in for commercial

crops such as surplus paddy and wheat, cotton, groundnut, and others engaged in dairying,

poultry, fishery, etc.

Self Help Groups

Microfinance has evolved over the past quarter century across India into various operating forms

and to a varying degree of success. One such form of microfinance has been the development of

the self-help movement. Based on the concept of “self-help,” small groups of women have

formed into groups of ten to twenty and operate a savings-first business model whereby the

member’s savings are used to fund loans. The results from these self-help groups (SHGs) are

promising as it is proving to be an effective method of poverty reduction.

SOURCE: NABARD

The SHG Model and Structure

A SHG is a group of about 10 to 20 people, usually women, from a similar class and region, who

come together to form savings and credit organization. They pooled financial resources to make

small interest bearing loans to their members.

SHG Federation

SHGs have also federated into larger organizations. In Figure 1, a graphic illustration is shown

of a SHG Federation. Depending on geography, several clusters or VOs come together to form

an apex body or an SHG Federation. In Andhra Pradesh, the Village Organizations, SHG

Clusters and SHG Federations are registered under the Mutually Aided Co-operative Society

(MACS) Act 1995.

SHG Federations resulted in several key benefits including:

• Stronger political and advocacy capabilities

• Sharing of knowledge and experiences

• Economies of scale

• Access to greater capital

The State of SHGs in India

Before evaluating their impact and determine support solutions, it is important to examine the

current state of SHGs in India today. And, it is certainly a mixed picture.

SHGs – Micro Finance Institutions (MFI)-Bank Linkage

Micro Finance Institutions (MFIs) are playing an important role of financial intermediaries in

microfinance sector. The MFIs operate under various legal forms viz.,

NGO MFIs – Registered under Societies Registration Act, 1860 and / or Indian Trust Act,

1880

Cooperative MFIs – Registered under State Cooperative Societies Act or Mutually Aided

Cooperative Societies Act (MACS) or Multi- State Coop. Societies Act, 2002

NBFC MFIs under Section 25 of Companies Act, 1956 (Not for profit)

NBFC MFIs incorporated under Companies Act, 1956 & registered with RBI

The progress under SHG-MFI-bank Linkage program for the years 2007-08 and 2008-09 is

given below:

SOURCE: NABARD

Financial Support and Promotional Efforts by NABARD

1. NABARD Refinance Support to Banks

NABARD provides refinance support to banks to the extent of 100% of the bank loans disbursed

to SHGs. The total refinance disbursed to banks against banks’ loans to SHGs during the year

2008-09 was Rs. 2620.03 crore as against Rs. 1615.50 crore during the year 2007-08 registering

a growth rate of 62.2 %. Further, the cumulative refinance disbursed under SHGs bank linkage

Program by NABARD to Banks up to 31 March 2009 stood at Rs.9688.09 crore.

2. Promotional Support - SHG-Bank Linkage

(i) Micro Finance Development and Equity Fund (MFDEF)

During the financial year 2000-01, there was a creation of a Micro Finance Development Fund

(MFDF) with initial contribution of Rs.100 crore, to be funded by Reserve Bank of India and

NABARD (Rs.40 crore each) and the balance Rs.20 crore to be contributed by commercial

banks. The objective of MFDEF is to facilitate and support the orderly growth of the

microfinance sector through diverse modalities for enlarging the flow of financial services to the

poor, particularly for women and vulnerable sections of society consistent with sustainability.

(ii) Training and Capacity building

NABARD continued to organize training programs to enhance their effectiveness in the field of

microfinance. Training supplements and materials were supplied to banks and other agencies.

Best practices and innovations of partner agencies were widely circulated among government

agencies, banks and NGOs. During the year 2008-09, fund support of Rs. 6.10 crore was

provided for capacity building, exposure and awareness-building as against Rs. 6.24 crore during

2007-08. The cumulative fund support for the purpose as on 31 March 2009 stood at Rs. 35.09

crore. During the year, 6,278 training/ capacity building programs were conducted covering

2,83,998 participants.

(iii) Micro Enterprise Development Program (MEDP) for skill Development

It is tailor-made and focused on skill building training program. The duration of training

program ranged between 3 to 13 days. A training budget of Rs.30,000/- per program is

earmarked for imparting training to 30 participants up to 13 days. During 2008-09, a total 879

Micro Enterprise Development Programs (MEDPs), both under Farm and Non – farm activities,

were conducted across the country.

(iv) Grant Support to Partner Agencies for Promotion and Nurturing of SHGs

NABARD has been instrumental in the formation and nurturing of quality SHGs by means of

promotional grant support to NGOs, RRBs, DCCBs, Farmers’ Clubs and Individual Rural

Volunteers and by facilitating capacity building of various partners, which has brought excellent

results in the promotion and credit linkage of SHGs. Further, the number of partner institutions

functioning as Self-Help Promoting Institutions (SHPIs) over the years has increased to 2592.

Further, the grant to various partners under the SHG-BANK linkage program is as given below:

SOURCE: NABARD

(v) Pilot Project on SHG-Post Office Linkage Program

The Pilot Project for SHG-Post Office Linkage program was initially launched in 5 select

districts of Tamil Nadu, with the objective of examining the feasibility of utilizing the vast

network of Post Offices in rural areas in disbursement of credit to rural poor, through SHGs. The

progress under the project has been encouraging. As on 31 March 2009, 2,835 SHGs have

opened zero interest savings accounts with select Post Offices in Tamil Nadu and 889 SHGs

have been credit linked with loan amounting to Rs 213.11 lakh.

(vi) Support to Activity-Based Groups (ABG) and SHG Federation.

NABARD introduced a scheme for supporting small-scale activity-based groups where in

capacity building, production and investment credit and market-related support would be

extended. The scheme focuses on forming and nurturing groups engaged in similar economic

activities, such as farmers, handloom weavers, craftsmen, fishermen, etc., to improve efficiency

of their production and realize better terms from the market through economies of aggregation

and scale and the Progress of savings of SHG with banks is as given below in the following table

SOURCE: NABARD

The Problems Associated with Mainstream MFIs

The mainstream financial institutions are flush with funds and have access to enormous amounts

of low cost savings deposits. While banks are physically present in rural areas and offer

concessional interest rates, rural producers are not able to access, with the result that the rest of

the deposits are finding their way into the financial sector. Some of the main reasons for the

above are:

1. Borrower Unfriendly Products and Procedures

2. Inflexibility and Delay

3. High Transaction Costs, both Legitimate and Illegal

4. Social Obligation and not a Business Opportunity

5. Financing to Alternative MFIs

NABARD Act does not permit them to refinance any private sector FI and do any direct

financing (NABARD's direct lending to micro-finance NGOs so far has been out of donor

funds), similarly SIDBI Act restricts it from extending loans to the agricultural and allied sectors,

whereas many of members of the self help groups are engaged in such activities.

6. Complexity in Legal and Regulatory Framework

1. The policymakers feel that poor cannot save, they are unwilling to repay the loans, and the

administrative costs of servicing them are high.

2. The Regional Rural Banks Act does not permit any private share holding in any RRBs, and the

Cooperative Act of all states do not permit district level co-operative banks to be set up except

by the state government.

Problems for Alternative Micro-Finance Institutions

The alternative finance institutions have not been fully successful in reaching the needy. There

are many reasons for this:

1. Financial problems leading to setting up of inappropriate legal structures

2. Lack of commercial orientation

3. Lack of proper governance and accountability

4. Isolated and scattered

(i). Inappropriate Legal Forms

If an MFI opts to become an NGO, it has the following problems:

1.The major source of funds of NGOs are grants, which are very limited.

2. If the NGOs earn a substantial part of their income from lending activity, they violate section

11(4) of the Income Tax Act and can lose their charitable status under Section-12.

3. NGOs do not have the appropriate financial structure for carrying out micro finance

Activities.

4. The minimum entry-level capital requirements is Rs 2 Crores, as started from April 1999.

5. It is difficult to mobilise any borrowings from Indian Financial Institutions due to the negative

image of NBFCs in general.

6. RBI’s requirement of at least two credit ratings in the context of loan takers from foreign

institutions.

(ii). Lack of Commercial Orientation

Since credit is available at low cost with subsidies and grants, most of the alternate MFIs

achieve a lot of success in their programs in the initial period, but they fail to maintain

consistency because of lack of commercial orientation thus making it unsustainable.

(iii). Lack of Proper Governance and Accountability

(iv). Isolated and Scattered

Conclusion

After the pioneering efforts of the last ten years, the microfinance scene in India has reached a

takeoff point. With some effort substantial progress can be made in taking MFIs to the next orbit

of significance and sustainability. This needs innovative and forward-looking policies, based on

the ground realities of successful MFIs. This, combined with a commercial approach from the

MFIs in making microfinance financially sustainable, will make this sector vibrant and help

achieve its singleminded mission of providing financial services to the poor.

Recommendations

The Committee examined the structure and nature of operations of MFIs and took into account

the proposed provisions of the MFI legislation which is under consideration of the GoI. Keeping

in view the above aspects, the Committee makes the following recommendations :

1.Greater legitimacy, accountability and transparency in MFIs.

2. There is a need to recognize a separate category of Microfinance – Non Banking Finance

Companies (MF–NBFCs), without any relaxation on start-up capital and subject to the regulatory

prescriptions applicable for NBFCs.

3. It should be specified that at least 80% of the assets of MF-NBFCs should be in the form of

microcredit of upto Rs. 50,000 for agriculture, allied and non farm activities and in case of

housing, loans upto Rs. 1,50,000, per individual borrower.

Other Recommendations:

1.MF-NBFCs as Business Correpondents (BCs) for a local feel.

2. Relaxation in FIPB guidelines

Current guidelines used by FIPB (Foreign Investment Promotion Board) require a minimum of

US$ 500,000 equity investment from a foreign entity. The Committee is of the view that the

minimum amount of foreign equity for MF-NBFCs may be reduced to a level of US$ 100,000.

To facilitate raising Indian equity, NABARD may extend equity support out of its MFDEF to

such MF-NBFCs based on objective rating / criteria.

To further facilitate raising India equity, the SEBI Venture Capital Guidelines may permit

Venture Capital Funds to invest in MF-NBFCs.

3.Tax Concessions

MF-NBFCs may be allowed, like Housing Finance Companies and Infrastructure Companies,

tax concessions to the extent of 40% of their profits, as a proportion to their business portfolio in

excluded districts as identified by NABARD without attracting tax.

4.MF-NBFCs as microinsurance agents

To enable MF-NBFCs to offer risk mitigation services to the poor, the Committee recommends

that the IRDA Microinsurance Guidelines, 2005 may permit MF-NBFCs to offer microinsurance

services as agents of regulated life and non-life insurance companies.

5.Code of conduct

A voluntary mutual code of conduct has been prepared by some MFIs covering aspects including

mission, governance, transparency, interest rates, handling of customer grievances, staff conduct,

recovery practices, etc.

6.Accounting and Disclosure Norms

The Institute of Chartered Accountants of India (ICAI) may be involved in formulating

appropriate accounting and disclosure norms for MFIs, so that they can generate confidence.

The cost of funds for MFIs, their operating costs, risk premium, etc., have to be studied for a

better understanding of viable and economic rates of interest that can be charged by them.

7.Unifying regulatory oversight

At present, all the regulatory aspects of microfinance are not centralized. The Committee feels

that RBI may consider bringing all regulatory aspects of microfinance under a single mechanism.

Further, supervision of MF-NBFCs could be delegated to NABARD by RBI.

References:

www.basixindia.com

www.nabard.org

www.rbi.org.in

www. microcapitalmonitor.com

www.microfinanceinfo.com