Micro Finance

Microfinance is a type of banking service that is provided to unemployed or low-income individuals or groups
who would otherwise have no other means of gaining financial services. Ultimately, the goal of microfinance is
to give low income people an opportunity to become self-sufficient by providing a means of saving money,
borrowing money and insurance.
FEATURES OF MICROFINANCE
It is an essential part of rural finance.
It deals in small loans.
It basically caters to the poor households.
It is one of the most effective and warranted Poverty Alleviation Strategies.
It supports women participation in electronic activity.
It provides an incentive to grab the self employment opportunities.
It is more service-oriented and less profit oriented.
It is meant to assist small entrepreneur and producers.
Poor borrowers are rarely defaulters in repayment of loans as they are simple and Godfearing.
India need to establish several Microfinance Institutions.
"Microfinance:Credit Lending Models" is an attempt to document the various models currently being used by
microfinance institutions throughout the world. A total of 14 models are described below. They include,
associations, bank guarantees, community banking, cooperatives, credit unions, grameen, group, individual,
intermediaries, NGOs, peer pressure, ROSCAs, small business, and village banking models. In reality, the
models are losely related with each other, and most good and sustainable microfinance instititions have features
of two or more models in their activities.

1. Association Model
This is where the target community forms an 'association' through which various microfinance (and other)
activities are intiated. Such activities may include savings. Associations or groups can be composed of youth,
women; can form around political/religious/cultural issues; can create support structures for microenterprises
and other work-based issues. In some countries, an 'association' can be a legal body that has certain advantages
such as collection of fees, insurance, tax breaks and other protective measures. Distinction is made between
associations, community groups, peoples organizations, etc. on one hand (which are mass, community based)
and NGOs, etc. which are essentially external organizations.

2. Bank Guarantees Model

As the name suggests, a bank guarantee is used to obtain a loan from a commercial bank. This guarantee may be
arranged externally (through a donor/donation, government agency etc.) or internally (using member savings).
Loans obtained may be given directly to an individual, or they may be given to a self-formed group. Bank
Guarantee is a form of capital guarantee scheme. Guaranteed funds may be used for various purposes, including
loan recovery and insurance claims. Several international and UN organizations have been creating international
guarantee funds that banks and NGOs can subscribe to, to onlend or start microcredit programmes.

3. Community Banking Model

Community Banking model essentially treats the whole community as one unit, and establishes semi-formal or
formal institutions through which microfinance is dispensed. Such institutions are usually formed by extensive
help from NGOs and other organizations, who also train the community members in various financial activities

of the community bank. These institutions may have savings components and other income-generating projects
included in their structure. In many cases, community banks are also part of larger community development
programmes which use finance as an inducement for action.

4. Cooperatives Model
A co-operative is an autonomous association of persons united voluntarily to meet their common economic,
social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise.
Some cooperatives include member-financing and savings activities in their mandate.

5. Credit Unions Model

A credit union is a unique member-driven, self-help financial institution. It is organized by and comprised of
members of a particular group or organization, who agree to save their money together and to make loans to
each other at reasonable rates of interest. The members are people of some common bond: working for the same
employer; belonging to the same church, labor union, social fraternity, etc.; or living/working in the same
community. A credit union's membership is open to all who belong to the group, regardless of race, religion,
color or creed. A credit union is a democratic, not-for-profit financial cooperative. Each is owned and governed
by its members, with members having a vote in the election of directors and committee representatives.

6. Group Model
The Group Model's basic philosophy lies in the fact that shortcomings and weaknesses at the individual level
are overcome by the collective responsibility and security afforded by the formation of a group of such
individuals. The collective coming together of individual members is used for a number of purposes: educating
and awareness building, collective bargaining power, peer pressure etc. The Group model is closely related to,
and has inspired, many other lending models. These include Grameen, community banking, village banking,
self-help, solidarity, peer pressure etc.

7. Individual Model
This is a straight forward credit lending model where micro loans are given directly to the borrower. It does not
include the formation of groups, or generating peer pressures to ensure repayment. The individual model is, in
many cases, a part of a larger 'credit plus' programme, where other socio-economic services such as skill
development, education, and other outreach services are provided.

8. Intermediaries Model
Intermediary model of credit lending positions a 'go-between' organization between the lenders and borrowers.
The intermediary plays a critical role of generating credit awareness and education among the borrowers
(including, in some cases, starting savings programmes. These activities are geared towards raising the 'credit
worthiness' of the borrowers to a level sufficient enough to make them attractive to the lenders. The links
developed by the intermediaries could cover funding, programme links, training and education, and research.
Such activities can take place at various levels from international and national to regional, local and individual
levels. Intermediaries could be individual lenders, NGOs, microenterprise/microcredit programmes, and
commercial banks (for government financed programmes). Lenders could be government agencies, commercial
banks, international donors, etc. Most models mentioned here invariably have some form of organizational or
operational intermediary - dealing directly with microcredit, or non-financial services. Also called the
'partnership' model.

9. NGO Model
NGOs have emerged as a key player in the field of microcredit. They have played the role of intermediary in
various dimensions. NGOs have been active in starting and participating in microcredit programmes. This
includes creating awareness of the importance of microcredit within the community, as well as various national
and international donor agencies. They have developed resources and tools for communities and microcredit
organizations to monitor progress and identify good practices. They have also created opportunities to learn
about the principles and practice of microcredit. This includes publications, workshops and seminars, and
training programmes.

10. Peer Pressure Model

Peer pressure uses moral and other linkages between borrowers and project participants to ensure participation
and repayment in microcredit programmes. Peers could be other members in a borrowers group (where, unless
the initial borrowers in a group repay, the other members do not receive loans. Hence pressure is put on the
initial members to repay); community leaders (usually idetified, nurchured and trained by external NGOs);
NGOs themselves and their field officers; banks etc. The 'pressure' applied can be in the form of frequent visits
to the defaulter, community meetings where they are identified and requested to comply etc.

11. ROSCA Model

Rotating Savings and Credit Associations or ROSCAs, are essentially a group of individuals who come together
and make regular cyclical contributions to a common fund, which is then given as a lump sum to one member in
each cycle. For example, a group of 12 persons may contribute Rs. 100 per month for 12 months. The Rs. 1,200
collected each month is given to one member. Thus, a member will 'lend' money to other members through his
regular monthly contributions. After having received the lump sum amount when it is his turn (i.e. 'borrow' from
the group), he then pays back the amount in regular/further monthly contributions. Deciding who receives the
lump sum is done by consensus, by lottery, by bidding or other agreed methods.

12. Village Banking Model

Village banks are community-based credit and savings associations. They typically consist of 25 to 50 lowincome individuals who are seeking to improve their lives through self-employment activities. Initial loan
capital for the village bank may come from an external source, but the members themselves run the bank: they
choose their members, elect their own officers, establish their own by-laws, distribute loans to individuals,
collect payments and savings. Their loans are backed, not by goods or property, but by moral collateral: the
promise that the group stands behind each individual loan. The Village Banking model is closely related to the
Community Banking and Group models.

Role of Micro Finance in poverty allevation

1. Self Employment :- Poverty reduction through self employment has long been a high priority for the
Government of India. Microfinance is an experimental tool in its overall strategies. Most of poor people manage
to optimize resources over a time to develop their enterprises. Financial services could enable the poor to
leverage their initiative, accelerating the process of generating incomes, assets and economic security. However,
conventional finance institutions seldom lend down-market to serve the needs of low-income families and
women-headed households. Therefore fundamental approach is to create the self employment by financing the

rural poor through financial institutions. Microfinance, thus, creates the hope and increases the self-esteem of
the poor by giving the opportunities to be employed.
2. Women Empowerment:- In rural areas women living below the poverty line are unable to realize their
potential. Microfinance programmes are currently being promoted as a key strategy for simultaneously
addressing both poverty alleviation and womens empowerment. The self help groups (SHGs) of women as
sources of microfinance have helped them to take part in development activities. The participation of women in
SHGs made a significant impact on their empowerment both in social and economic aspects. Vast sections of
the rural poor are even now deprived of the basic amenities, opportunities and oppressed by social customs and
practices. Several programmes were implemented by various governments and nongovernmental organizations
to uplift them both economically and socially. It has been an accepted premise that women were not given
enough opportunities to involve themselves in the decision making process of the family as well as in the
society. Hence, women were the main target groups under SHG programme. Microfinance can provide an
effective way to assist and empower poor women, who make up a significant Proportion of the poor and suffer
from poverty.
3. Poverty Reduction Tool:- Microfinance can be a critical element of an effective poverty reduction strategy.
Improved access and efficient provision of savings, credit, and insurance facilities in particular can enable the
poor to smooth their consumption, manage their risks better, build their assets gradually, and develop their
micro enterprises. Microfinance is only a means and not an end. The ultimate goal is to reduce poverty.
Government, NGOs and other financial institutions have introduced various welfare schemes and activities to
reduce poverty. Microfinance, by providing small loans and savings facilities to those who are excluded from
commercial financial services has been developed as a key strategy for reducing poverty throughout the world.
4. Inability to Generate Sufficient Fund:- Inability of MFIs to raise sufficient fund remains one of the
important concern in the microfinance sector. Though NBFCs are able to raise funds through private equity
investments because of the for-profit motive, such MFIs are restricted from taking public deposits. Not-forprofit companies which constitute a major chunk of the MFI sector have to primarily rely on donations and
grants from Government and apex institutions like NABARD and SIDBI. In absence of adequate funding from
the equity market, the major source of funds for MFIs are the bank loans, which is the reason for high Debt to
Equity ratio of most MFIs.. After the Andhra crisis, it is reported that banks have stopped issuing fresh loans
and even though currently few banks have resumed, they want MFIs to increase their equity to get fresh loans.
So the only mode for the MFIs to increase their portfolio size is to increase their equity. The problem of
inadequate funds is even bigger for small and nascent MFIs as they find it very difficult to get bank loans
because of their small portfolio size and so they have to look for other costlier sources of fund.
Microfinance has proven to be an effective and powerful tool for rural development and poverty
reduction. Like many other development tools, it has sufficiently penetrated the poorer strata of society. The
poorest form the vast majority of those without access to primary health care and basic education; similarly,
they are the majority of those without access to microfinance. Micro-finance is one of the ways of building the
capacities of the poor and developing them to self-employment activities by providing financial services like
credit, savings and insurance. To provide micro-finance and other support services, MFIs should be able to
sustain themselves for a long period. There are so many schemes for the development of poor In India. Creating
self employment opportunities through micro finance is one way of attacking poverty and solving the problems
of unemployment. In India, the micro finance movement has almost assumed the shape of an industry,
embracing thousands of NGOs/MFIs. During the last decade, the sector has witnessed a sharp growth with the
emergence of a number of Micro Finance Institutions (MFIs) providing financial and non-financial supports to
the poor in an effort to lift them out of poverty. There are over 1,000 Indian MFIs. These institutions assume the
responsibility of making available much needed micro credit to the poor section of the society for generating the
self employment The MFI channel of credit delivery, coupled with the national level programme of SHG-Bank
Linkage, today, reaches out to millions of poor across the country.

4. Economic Growth :-Finance plays a key role in stimulating sustainable economic growth. Due to
microfinance, production of goods and services increases which increases GDP and contributes to economic
growth of the country.
5. Mobilisation Of Savings :- Microfinance develops saving habits among people. Now poor people with
meagre income can also save and are bankable. The financial resources generated through savings and micro
credit obtained from banks are utilised to provide loans and advances to its members. Thus microfinance helps
in mobilisation of savings.
6. Development Of Skills:- Micro financing has been a boon to potential rural entrepreneurs. SHGs encourage
its members to set up business units jointly or individually. They receive training from supporting institutions
and learn leadership qualities. Thus micro finance is indirectly responsible for development of skills.
7. Mutual Help And Cooperation:- Microfinance promotes mutual help and co.operation among members. The
collective efforts of group promotes economic interest and helps in achieving socio-economic transition.
8. Social Welfare:- With employment generation the level of income of people increases. They may go for
better education, health, family welfare etc. Thus micro finance leads to social welfare or betterment of society.

Risks face by FI
There are five generic risks to these financial institutions: systematic, credit, counterparty, operational, and
legal.
Systematic risk is the risk of asset value change associated with systemic factors. As such, it can be hedged but
cannot be completely diversified. In fact, systematic risk can be seen as undiversifiable risk. Financial
institutions assume this risk whenever assets owned or claims issued can change in value as a result of broader
economic conditions. Systematic risk comes in many forms. For example, as interest rates change, different
assets have somewhat different, unpredictable values. Energy prices affect transportation firms stock prices and
real estate values differently. Large-scale weather effects can strongly influence both real and financial asset
values for better or worse.
Some financial institutions minutely decompose systematic risk. Institutions whose balance sheets react
substantially to specific systemic changes may try to estimate the impact of the particular systematic risks on
performance, attempt to manage them, and thus limit their sensitivity to variations in these undiversifiable
factors. Accordingly, many institutions heavily involved in the fixed-income market attempt to track interest
rate risk more closely and rigorously than those that have little rate risk in their portfolios.8 They measure and
manage the firms vulnerability to interest rate variation, even though they cannot do so perfectly. Likewise,
international investors are aware of foreign exchange risk and try to measure and restrict their exposure to it.9
Similarly, investors with high concentrations in one commodity need to be concerned with commodity price risk
and perhaps overall price inflation, while investors with high single-industry investments monitor both specific
industry concentration risk and the forces that affect the fortunes of the industry involved.
Credit risk arises from a debtors nonperformance. It results from either an inability or an unwillingness to
perform in the precommitted, contracted manner. It can affect the lender who underwrote the contract, other
lenders to the creditor, and the debtors own shareholders. Credit risk is diversifiable but difficult to hedge
perfectly, because most of the default risk may result from systematic risk. The idiosyncratic nature of some
portion of these losses, however, remains a problem for creditors despite the beneficial effect of diversification
on total uncertainty. This is particularly true for creditors that lend in local markets and take on highly illiquid
assets.10

Counterparty risk comes from a trading partners nonperformance. This may arise from a counterpartys refusal
to perform due to an adverse price caused by systematic factors or from some other political or legal constraint
that the principals did not anticipate. Diversification is the major way to control nonsystematic counterparty
risk, which is like credit risk but is generally considered a transient risk associated with trading, rather than a
standard creditor-default risk associated with an investment portfolio. A counterpartys failure to settle a trade
can arise from factors other than credit problems.11
Operational risk is associated with the problems of accurately processing, settling, and taking or making
delivery on trades in exchange for cash. It also arises in record keeping, computing correct payment amounts,
processing system failures, and complying with various regulations. Individual operating problems seldom
occur in well-run organizations but can expose a firm to costly outcomes.
Legal risks, endemic in financial contracting, are separate from the legal ramifications of credit, counterparty,
and operational risks. New statutes, court opinions, and regulations can put formerly well-established
transactions into contention even when all parties have previously performed adequately and are fully able to do
so in the future. For example, the bankruptcy law enacted in 1979 created new risks for corporate bondholders.
Environmental regulations have radically affected real estate values for older properties. A second type of legal
risk arises from the activities of an institutions management or employees; fraud, violations of securities laws,
and so on can lead to catastrophic loss.
To some extent, all financial institutions face these risks. Nonprincipals or agents primarily face operational
risk. Since institutions in this case do not own the underlying assets in which they trade, systematic, credit, and
counterparty risks accrue directly to the asset holder. If the asset holder experiences a financial loss, however, it
often attempts legal recourse against the agent. Therefore, institutions engaged in only agency transactions bear
some legal risk, if only indirectly.