INTRODUCTION

Poor and low-income people all over the world have been connected with money lenders who
provide easy access to credit but at higher rate. The cost of interest generally ranges from 36
percent to as high as 120 percent. There are two main approaches to financing the poor viz., the
poverty lending approach that focuses on reducing poverty through credit that that are funded by
donors and patrons, government and other concessional dispensations. Many organizations using
the poverty lending approach do provide credit to poor borrowers at the low cost. But in the long
run, these very institutions are sustainable primarily because their interest rate on credits is just
too low for their full cost recovery. Except for mandatory savings required as a precondition for
receiving a loan, savings is not a significant part of the poverty lending approach. In contrast, the
financial system approach focuses on commercial financial intermediation for the economically
active poor and they offer easy access to credit at a reasonable and affordable cost. Their credit
portfolio is financed by savings, commercial debt and for profit investment in varying
proportions. Commercial financial intermediation is not advocated to poor people who are badly
malnourished, in poor health and without any skill or ability. Undernourished and starving
borrowers, if given credit, will use it to buy food for themselves and their dependents. Poor who
are starving and hungry need food, shelter, medicine, skill training and opportunity for
employment.
Jesus says,” man cannot live by bread alone”. Abraham says,” man lives by bread
alone when there is no bread.” If a person is starving only food occupies his mind. He needs the
bread. It may be not enough, he needs many more things, but that many more things come only
later on; first comes the bread. It is but natural that as soon as one need is satisfied, a second need
becomes apparent. The person forgets that he or she was starving and now starts to be concerned
about a need which was formerly of less significance. People are not completely satisfied on any
need level, but a reasonable amount of gratification of first priority need. However, it has to be
noted that the primary goal of both the poverty lending approach and the financial system
approach is providing financial services to the poor people.
Despite the vast expansion of formal credit system in India, the dependence of
the poor particularly in the rural sector on the money lenders continues in many areas especially
for meeting the emergent requirements of the family. Such dependence is more pronounced in
the case of marginal farmers, landless labourers, petty traders, and rural artisans belonging to the
socially and economically backward classes and tribes and also the dalits. For a variety of
reasons, credit flow to these marginalized sections of the Indian society has not come to be
institutionalized. Apart from the social exclusion, the most germane fat is that is the difficult in
dealing effectively and economically a large number of small borrowers who require credit
frequently and in small quantities.
The interest in microfinance has emerged during last two decades: multilateral
lending agencies, bilateral donor agencies, developing and developed country governments, and
NGOs all support the development of microfinance. A variety of private banking institutions has
also joined this group in the recent years. As a result, micro finance services has grown rapidly
during the last decade, although from an initial low level, and have come to forefront of
development discussions concerning poverty reduction. Despite this growth, as concluded in the
recently completed rural Asia study “rural financial markets in Asia are ill-prepared for the
twenty- first century”. About 95% of some 180 million poor households in the Asia and pacific
region still have little access to institutional financial services. Development practitioners, policy
maker, and multilateral and bilateral lenders, however, recognize that providing efficient
microfinance services for this segment of the population is important for a variety of reasons

(i) 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 smoothen their consumption, manage their risks better, build their assets gradually,
develop their micro enterprises, enhance their income earning capacity, and enjoy an improved
Quality of life. Microfinance services can also contribute to the improvement of resource
allocation, promotion of markets, and adoption of better technology; thus, microfinance helps to
promote economic growth and development.

(ii) Without permanent access to institutional microfinance, most poor households continue to
rely on meager self-finance or informal sources of microfinance, which limits their ability to
actively participate in and benefit from the development opportunities.

(iii) Microfinance can provide an effective way to assist and empower poor women, who make
up a significant proportion of the poor and suffer disproportionately from poverty.

(iv) Microfinance can contribute to the development of the overall financial system through
integration of financial markets.

Microfinance is the provision of financial services to low-income clients, including consumers

and the self-employed, who traditionally lack access to banking and related services. The term
micro credit should not be confused with micro finance. Micro credit is a narrow term it means
credit or loan to poor. Whereas micro financing includes providing financial assistance to the
poor, providing technical know how and in some places providing insurance also.

The microcredit summit 2007 defines microcredit as the extension of small loans to
entrepreneurs too poor to qualify for traditional bank loans. It has proven as an effective and
popular measure in the ongoing struggle against poverty, enabling those without access to
lending institutions to borrow at affordable interest rates and start small business. The key
implication of microcredit is in its name itself ‘micro’. A number of issue come to mind when
‘micro’ is considered: the small size of the loans, shorter repayment periods and amounts, the
micro level of activities, the community- based proximity of microcredit, etc. hence microcredit
is not the solution. But is a menu of options and enablement’s that has to be put together, based
on local conditions and needs. With the current explosion of the interest on microcredit issues,
several developmental objectives have come to be associated with it, besides that of only credit.
Of particular importance is saving as an end in itself, and as a guarantee for loans. Microcredit
has been used as an inducer in many communities organizing programme and as an ingredient in
large education/ training exercises.

The reserve bank of India has defined microfinance as provision of thrift, credit
and other 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 levels and improving living standards.
Microfinance institutions are those that provide these facilities. The virtual library on microcredit
takes microcredit beyond the confines of money and declares in its conceptual framework that
microcredit is as much about money as it is about information. Microcredit is one wayu of
reaching the poor and has demonstrated its effectiveness. A major concern of microfinance is to
increase penetrative outreach so that credit can be institutionalized and a large number of people
can benefit through improved access to credit for enabling them to raise their income level and
thereby their living standards.

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.As defined by the Asian Development Bank (ADB), it is - A provision of a
broad range of financial services such as deposits, loans, payment services, money transfers, and
insurance to poor and low-income households and their micro-enterprises. In the late 90s,
numerous agencies involved in micro-financing operations in India started adding other financial
services, including micro-insurance to its micro-finance operations. The situation of micro-
financing in India has thereby improved with certain steps taken by the government and now, the
private players, banks etc as well. As we know that in India large number of population is living
in remote areas they generally don’t have access to banking services instead of having low
income there is a need to provide banking and financial services to people living in these areas.
Large number of ngo’s and government are participating in it to improve the standard of living of
poor people and to remove poverty.

Since independence, various governments in India have experimented with a large

number of grant and subsidy based poverty alleviation programmes. These programmes were
based on grant/subsidy and the credit linkage was through commercial banks only. As a result,
these programmes became unsustainable, perpetuated a dependant status on the beneficiaries and
depended ultimately on the govt. employees for delivery. This not only led to misuse of both
credit and subsidy but banks never looked at it as a profitable and commercial activity as well.

Hence was adopted the concept of micro-credit in India. Success stories in neighboring
countries, like Grameen Bank in Bangladesh, Bank Rakiat in Indonesia, Commercial &
Industrial Bank in Philippines etc, gave further boost to the concept in India in the 1980s. India
thus adopted the similar model of extending credit to the poorest sector and took a no. of steps to
promote micro-financing in the country.

A significant feature of the micro-finance movement in

India is that it has relied heavily on the existing banking infrastructure, in the process obviating
the need for a new institutional set-up. Most of the leading practitioners of microfinance
activities follow the Grameen model. Banks lend micro credit through SHGs and MFIs that have
contacts in small villages. India’s bank- SHGs link programme is now the biggest in the world.
According to the RBI annual report 2005-06, the cumulative number of SHGs linked to bank
stood at 2.2 million with total bank credit to these SHGs at Rs 113,980 million. Of late some of
the leading commercial banks, such as ICICI bank, HDFC bank, UTI bank and state bank of
India, have begun focusing on this sector rather aggressively. Even some of the multinational
banks operating in India, such as ABN amro, standard chartered, HSBC and Citibank, have
moved into the sector. Not to be outdone, the old generation banks located in south India,
particularly, Kerala based, the dhanalakshmi bank has taken a great stride in meeting the
aspirations of the poor and has carried the mantle of microfinance across the state of Kerala.
Today is there is a growing realization among the commercial banks that microfinance is a
bankable proposition. The award of peace Nobel to Prof Yunus and grameen bank is expected to
provide boost to microfinance activities in India. ICICI bank, which emerged as an active and
innovative player in the microfinance segment, has now joined hands with Grameen foundation
US.
HISTORY OF MICROFINANCE

The concept of microfinance mainly started after the initiated by Nobel winner for peace Prof
Yunus In 1974, famine struck Bangladesh. At the time, Dr. Muhammad Yunus was a professor
of economics at the University of Chittagong. Disillusioned by the elegant theories of economics
that could not explain the thousands of poor people dying of starvation on the streets; he was
determined to find a practical way to help the poor. During a visit to the nearby village of Jorba,
he was astounded to find that a sum of $27 could radically change the lives of 42 people in the
village. This was the sum of money they collectively needed to buy bamboo to make the stools
they sold to make a living. He took $27 from his pocket and made 42 loans to the stool makers in
this tiny village. They were able to pay him back with interest and take a step towards lifting
themselves out of poverty.

This simple idea that the poor could use credit to lift themselves out of poverty, led Dr. Yunus to
create The Grameen Rural Bank in 1983. Since its inception, it has made over $8.96 billion in
loans to over eight million borrowers. its methodologies have become the cornerstone of the
microfinance industry. In 2006, The Grameen Bank and Dr. Yunus were awarded the Nobel
Peace Prize.

.Meanwhile, starting in the 1970s, experimental programs in Bangladesh, Brazil, and a few other
countries extended tiny loans to groups of poor women to invest in micro-businesses. This type
of micro enterprise credit was based on solidarity group lending in which every member of a
group guaranteed the repayment of all members. These "micro enterprise lending" programs had
an almost exclusive focus on credit for income generating activities (in some cases accompanied
by forced savings schemes) targeting very poor (often women) borrowers.

• ACCION International, an early pioneer, was founded by a law student, Joseph Blatchford, to
address poverty in Latin America's cities. Begun as a student-run volunteer effort in the
shantytowns of Caracas with $90,000 raised from private companies, ACCION today is one of
the premier microfinance organizations in the world, with a network of lending partners that
spans Latin America, the United States and Africa.

• SEWA Bank. In 1972 the Self Employed Women's Association (SEWA) was registered as a
trade union in Gujarat (India), with the main objective of "strengthening its members' bargaining
power to improve income, employment and access to social security." In 1973, to address their
lack of access to financial services, the members of SEWA decided to found "a bank of their
own". Four thousand women contributed share capital to establish the Mahila SEWA Co-
operative Bank. Since then it has been providing banking services to poor, illiterate, self-
employed women and has become a viable financial venture with today around 30,000 active
clients.

• Grameen Bank. In Bangladesh, Professor Muhammad Yunus addressed the banking problem
faced by the poor through a programme of action-research. With his graduate students in
Chittagong University in 1976, he designed an experimental credit programme to serve them. It
spread rapidly to hundreds of villages. Through a special relationship with rural banks, he
disbursed and recovered thousands of loans, but the bankers refused to take over the project at
the end of the pilot phase. They feared it was too expensive and risky in spite of his success.
Eventually, through the support of donors, the Grameen Bank was founded in 1983 and now
serves more than 4 million borrowers. The initial success of Grameen Bank also stimulated the
establishment of several other giant microfinance institutions like BRAC, ASA, Proshika, etc.

Through the 1980s, the policy of targeted, subsidized rural credit came under a slow but
increasing attack as evidence mounted of the disappointing performance of directed credit
programs, especially poor loan recovery, high administrative costs, agricultural development
bank insolvency, and accrual of a disproportionate share of the benefits of subsidized credit to
larger farmers. The basic tenets underlying the traditional directed credit approach were
debunked and supplanted by a new school of thought called the "financial systems approach",
which viewed credit not as a productive input necessary for agricultural development but as just
one type of financial service that should be freely priced to guarantee its permanent supply and
eliminate rationing. The financial systems school held that the emphasis on interest rate ceilings
and credit subsidies retarded the development of financial intermediaries, discouraged
intermediation between savers and investors, and benefited larger scale producers more than
small scale, low-income producers.

Meanwhile, micro credit programs throughout the world improved upon the original
methodologies and defied conventional wisdom about financing the poor. First, they showed that
poor people, especially women, had excellent repayment rates among the better programs, rates
that were better than the formal financial sectors of most developing countries. Second, the poor
were willing and able to pay interest rates that allowed microfinance institutions (MFIs) to cover
their costs.

1990s These two features - high repayment and cost-recovery interest rates - permitted some
MFIs to achieve long-term sustainability and reach large numbers of clients.

Another flagship of the microfinance movement is the village banking unit system of the Bank
Rakyat Indonesia (BRI), the largest microfinance institution in developing countries. This state-
owned bank serves about 22 million micro savers with autonomously managed micro banks. The
micro banks of BRI are the product of a successful transformation by the state of a state-owned
agricultural bank during mid-1980s.

The 1990s saw growing enthusiasm for promoting microfinance as a strategy for poverty
alleviation. The microfinance sector blossomed in many countries, leading to multiple financial
services firms serving the needs of micro entrepreneurs and poor households. These gains,
however, tended to concentrate in urban and densely populated rural areas.

It was not until the mid-1990s that the term "micro credit" began to be replaced by a new term
that included not only credit, but also savings and other financial services. "Microfinance"
emerged as the term of choice to refer to a range of financial services to the poor, that included
not only credit, but also savings and other services such as insurance and money transfers.

ACCION helped found Banc Sol in 1992, the first commercial bank in the world dedicated
solely to microfinance. Today, Banc Sol offers its more than 70,000 clients an impressive range
of financial services including savings accounts, credit cards and housing loans - products that
just five years ago were only accessible to Bolivia's upper classes. Banc Sol is no longer unique:
more than 15 ACCION-affiliated organizations are now regulated financial institutions.

Today, practitioners and donors are increasingly focusing on expanded financial services to the
poor in frontier markets and on the integration of microfinance in financial systems development.
The recent introduction by some donors of the financial systems approach in microfinance -
which emphasizes favorable policy environment and institution-building - has improved the
overall effectiveness of microfinance interventions. But numerous challenges remain, especially
in rural and agricultural finance and other frontier markets. Today, the microfinance industry and
the greater development community share the view that permanent poverty reduction requires
addressing the multiple dimensions of poverty. For the international community, this means
reaching specific Millennium Development Goals (MDGs) in education, women's
empowerment, and health, among others. For microfinance, this means viewing microfinance as
an essential element in any country's financial system.
NEED FOR MICROFINANCE

Since independence, various governments in India have experimented with a large number of
grant and subsidy based poverty alleviation programmes. These programmes were based on
grant/subsidy and the credit linkage was through commercial banks only. As a result, these
programmes became unsustainable, perpetuated a dependant status on the beneficiaries and
depended ultimately on the govt. employees for delivery. This not only led to misuse of both
credit and subsidy but banks never looked at it as a profitable and commercial activity as well.

Hence was adopted the concept of micro-credit in India. Success stories in neighboring
countries, like Grameen Bank in Bangladesh, Bank Rakiat in Indonesia, Commercial &
Industrial Bank in Philippines etc, gave further boost to the concept in India in the 1980s. India
thus adopted the similar model of extending credit to the poorest sector and took a no. of steps to
promote micro-financing in the country.

India has one of the largest networks of bank branches in the world, but the hundreds of millions
of poor in the country are largely out of it. Banks were nationalized three and half decade ago
with the hope and promise that their products and services would reach the poor. But that goal is
not even close to being met today. With 52000 commercial bank branches, 12522 branches of
regional rural banks and 100000 cooperative bank branches, the country is teeming with
institutions that should be able to meet the credit needs of the people. But if you are poor, you
are also probably out of luck with banks; it is tough persuading them to even let you open a bank
account. The consequences have been devastating. Consider these numbers: 75 million
households in India depend on money lenders to meet financial needs; almost 90 percent of the
people in the rural India have no access to insurance; 50 million households are landless and
need small credit to start some economic activity. And even families earning Rs 4000-5000 a
month in urban areas spends huge portions of their earning to service their ever continuous debt.

But out of necessity and enterprise, those locked out of the banking world have found a way out.
It is called microfinance- the extension of small loans to individuals who are poor to qualify for
traditional bank loans, as they have no assets to be offered as guarantee. In India, microfinance
has worked largely through SHGs. Predominated by women, these are formed by simple rules-
save, accumulate and give loans to each other. Globally, it is slowly proving one of the most
effective strategies to neutralize poverty. According to Christina barrineau, chief technical
advisor for micro credit 2005, a United Nations initiative to expand micro credit opportunities,
the figure for worldwide micro credit vary widely, from 70 million to 750 million outstanding.
After almost three decades, the microfinance movement has created a global network of tens of
million of women entrepreneurs and growing sub- classes of sophisticated businesswomen who
are helping to reduce poverty.

According to Alex counts, president of Grameen foundation USA, a microfinance organization

in Washington, microfinance is now reaching 80 million families, 90 percent of borrowers being
women and that’s just the tip of the iceberg in terms of demand. Alex counts say further that to
ensure growth, larger, more sophisticated business must emerge.
 Can a mere 500 rupees change a life? This sounds unbelievable, as price spirals by the day.
But in numerous villages in India, this miracle is quite real; million of poor women are today
using small loans to rewrite their present and future. Many of them have not even seen the
corridors of a primary school, but are using common sense to propel their entrepreneurship and
group business activities. Dr .C. Rangarajan, chairman, economics advisory council of the
government of India, points out, “microfinance can be aid employment and sustain households
giving them opportunities they never had before”. It is called micro credit with good reasons.
The size of the loan is typically small. The borrower is usually battling against poverty. The
repayment schedule is simple and short. And, the activity for which the loan is taken is often of a
small nature. But poor women, who are in the forefront of the microfinance movement, use small
loans to jump start a long chain o economic activity from this small beginning. As they have
enormous pride in their integrity, they repay the loans quickly and reliably, not wanting to be
noticed as defaulters. Then, they begin again, this time with a bigger loan-and keep expanding
their profit base until they do not need the loans any longer. Microfinance has given women in
India an opportunity to become agents of change. The movement has made them more confident
than ever helping them to explore new horizons and new dreams. The most active states in India
in the context of paradigm shift in the microfinance are the three southern sates viz., Kerala,
Andhra Pradesh and Tamilnadu. Other states where such self-help groups are making a dramatic
difference are Karnataka, Himachal Pradesh and Uttaranchal. Sheila dixit chief minister of Delhi
says: “microfinance will be the future mantra for alleviation of poverty. I have met women who
say that 500 to 800 rupees makes all the difference as it dramatically changes their standard of
living.

This is the positive side of the story. The negative one is that India’s demand for micro
finance is rs.500 billion, and only rs.28 billion of this amount has been generated so far; there is
still a long way to go. Nearly 7.5 million poor households in India desperately want access to
financial services to meet immediate needs. Almost 36 percent of the country’s rural households
have to look for credit outside the formal sector. A World Bank study of over 6000 families in
Andhra Pradesh and Uttar Pradesh, two of India’s largest states, shows that 87 percent of them
have no access to credit, 85 percent have no access to insurance and 56 percent borrow from
money lenders. The poor need banking services more than credit, as they need to safely secure
their little savings coming from their men folk who have migrated in search of work. the chief
culprits are the banks, who continue to see the poor women- rural as well as urban- as unworthy
of credit, and are only slowly awakening to the possibilities. Points out jayshree vyas, managing
director of sewa bank at Ahmadabad which mainly has self employed street vendors as account
holders: “we started a bank as the women demanded it. They wanted a place to put their savings.
The banking sector earlier never respected self-employed women”. Today, the sewa bank in
Ahmadabad is a model for others to replicate. It has deposits of over Rs. 100 crores got from
nearly 250,000 women. It is the biggest poor women’s bank in the world.

With a view to facilitating smoother and more meaningful banking with the poor, a pilot
project for purveying micro credit by linking the SHGs with banks was launched by NABARAD
in 1991-1992. RBI then advised commercial banks to actively participate in this linkage
programme. The scheme was next extended to RRBs and cooperative banks. The number of
SHGs linked to banks aggregated 461,478 as on March 31, 2002. as regards model wise linkage,
while model I, viz., directly to SHGs without intervention of any NGO now accounts for 16
percent, model II, viz., directly to SHGs with facilitation by NGOs and other formal agencies
amount to 75% and model III, viz through NGO facilitator and financing agency represents 9
percent of the total linkage.

Since the mid-1980 many developing countries have improved their macro-economic
management. On the one hand, the successive failures of state sponsored public sector
enterprises had forced the governments to tighten their spending and on the other hand , the
demand for low cost goods and services produced by the informal sector increased as the
agricultural technologies and policies changed and the rural income substantially improved. In
the context, policy makers in some countries re- examined their approach to informal enterprises
viewing them not as a problem for the economy but rather as an important tool to mitigate
current problems that are caused by poverty and multiplied by massive rural–urban migration.
According to World Bank report 1999/2000, in 1998, about 1.2 billion people, i.e., 24 percent of
the total population in developing and transition economies lived on less than $ 1 day. The full
magnitude of the demand for microfinance has begun to be understood only recently. During the
second half of 20th century, credit for agriculture has generally been accorded very high priority.
However, the huge demand for credit from self-employed micro- entrepreneurs has been ignored
by financial sector. Until the 1980s, the presence of informal micro-enterprises like the street and
pavement sellers, home units, petty shops and tiny business, and small transport operators were
generally perceived by policymakers and the economists to be result of the economic
dysfunction and aberration. Given this perspective, the response of the government was to focus
on improving the management o the formal economy, thereby increasing its absorbing capacity.
This approach it was thought would enable low income and unemployed people to become
integrated into the formal sector in many countries remained essential invisible in the
government plans and budgets, in economists’ model, in banks, portfolios and in national
policies. Yet these micro-enterprises provide a regular income stream for the poor people. They
create employment; provide cheap food, clothing, transportation and a means for an honorable
and decent living.

Many banks in India are now recognize the potential in rural banking lack the
capability to serve this market. Lending by commercial banks without any collateral to the
poorest of poor is very difficult as banks don’t have the expertise in these areas. That is why
micro finance institutions should step in. if microfinance institutions are strong, banks will
readily lend to them. That there are significant opportunities for banks in microfinance is
unquestioned. Banks like ICICI are exploring how it could reap the benefits from microfinance
revolution.

Women need to guard their savings even in a bank fighting of pressure from their family.
Women don’t want to receive any letter from SEWA bank as they don’t want their husbands to
know that they had money, as then they would be pressurized to withdraw it. So there is a great
need of microfinance services to expand as poor people are starving for such kind of services
especially women.
Key Players in the Micro Finance System

i) National Bank for Agricultural and Rural Development (NABARD): NABARD is an apex
institution, accredited with all matters concerning policy, planning and operations in the fields of
credit for agriculture and other economic activities in rural areas in India. NABARD was
established in 1982 as a Development Bank, in terms of the Preamble of the Act, “for providing
and regulating credit and other facilities for the promotion and development of agriculture, small
scale industries, cottage and village industries, handicrafts and other rural crafts and other allied
economic activities in rural areas with a view to promoting integrated rural development and
securing prosperity of rural areas and for matters connected therewith or incidental thereto”. The
corporate mission set by NABARD for making available microfinance services to the very poor
envisages coverage of two third of the rural poor through more than one million SHGs by the
year 2011.

In November 1998 a high-powered Task Force on Supportive Policy and Regulatory Framework
for Micro finance (henceforth referred to as the Task Force) was set up by NABARD at the
instance of RBI. The objective of the Task Force were among others, to come up with
suggestions for a regulatory framework that brings the operations of the Microfinance
Institutions into the mainstream, to access the possible role of self-regulatory organizations and
to explore the need for a separate legal framework for micro finance.

ii) Reserve Bank of India

The earliest reference to micro credit in a formal statement of monetary and credit policy of RBI
was in former RBI President Dr. Bimal Jalan’s Monetary and Credit Policy Statement of April
1999. The policy attached importance to the work of NABARD and public sector banks in the
area of micro credit. The banks were urged to make all out efforts for provision of micro credit,
especially forging linkages with SHGs, either at their own initiative or by enlisting support of
Non-Government Organization. The micro credit extended by the banks is reckoned as part of
their priority sector lending, and they are free to device appropriation loan and saving products in
this regard. Considerable work had been done by RBI in this sector since 1991. In 1991-92 a
pilot project for linking up SHGs with banks was launched by NABARD in consultation with the
RBI. In 1994, the RBI constituted a working group on SHGs. On the recommendation of the
SHGs would be reckoned as part of their lending to weaker sections and such lending should be
reviewed by banks and also at the State Level Bankers’ Committee level, at regular interval.
Banks were also advised that SHGs, registered or unregistered, which engaged in promoting the
saving among their members, would be eligible to open savings bank accounts with banks
irrespective of their availment of credit facilities from banks.

iii) Self Help Groups

The origin of SHGs is from the brainchild of Grameen Bank of Bangladesh, which was founded
by Mohammed Yunus SHG was started and formed in 1975. The establishment of SHGs can be
traced to the existence of one or more problem areas around which the consciousness of rural
poor is built and the process of group formation initiated. SHG are considered a new lease of life
for the women in villages for their social and economic empowerment. SHG is a suitable means
for the empowerment of women. Since SHGs have been able to mobilize savings from persons
or groups who were not normally expected to have any ‘saving’ and also to recycle effectively
the pooled resources amongst the members, their activities have attracted attention as a
supportive mechanism for meeting the credit needs of the poor. The main characteristics of
SHGs are as follows:

a) The ideal size of an SHG is 10 to 20 members.

b) The group need not be registered.
c) From one family, only one member. (More families can join SHGs this way)
d) The group consists of either only men or of only women. (Mixed groups are generally not
preferred)
e) Women’s groups are generally found to perform better.
f) Members have the same social and financial background. (Members interact more freely this
way)
g) Compulsory attendance. (Full attendance for larger participation)

Function of SHGs

The following are the main functions of SHGs:

1) The amount may be small, but savings have to be a regular and continuous habit with all the
members. ‘Savings first – Credit later’ should be the motto of every group member.

2) The savings to be used as loans to members. The purpose, amount, rate of interest, etc. to be
decided by the group itself. Enabling SHG members to attain loans from banks, and repaying the
same.

3) Every meeting, the group will discuss and try to find solutions to the problem faced by the
members of the group.

iv) Micro Finance Institutions (MFIs)

A range of institutions in public sector as well as private sector offers the micro finance services
in India. Based on asset sizes, MFIs can be divided into three categories:

1) 5-6 institutions which have attracted commercial capital and scaled up dramatically when last
five years. The MFIs which include SKS, SHARE and Grameen Style program but after 2000,
converted into for-profit, regulated entities mostly Non-Banking Finance Companies (NBFCs).

2) Around 10-15 institutions with high growth rate, including both News and recently form for-
profit MFIs. Some of MFIs are Grameen Koota, Bandhan and ESAF.

3) The bulk of India’s 1000 MFIs are NGOs struggling to achieve significant growth. Most
continues to offer multiple developmental activities in addition to microfinance and have
difficulty accessing growth trends. Private MFIs in India, barring a few exceptions, are still
fledging efforts and are therefore unregulated. They secure micro finance clients with varying
quality and using different operating models. Regulatory framework should be considered only
after the sustainability of MFIs Model as a banking enterprise for the poor is clearly established.

v) Non Government Organizations (NGOs)

The Non Government Organizations involved in promoting SHGs and linking them with the
Formal Financial Agencies (FFAs) perform the following functions:

1. Organizing the poor people into groups

2. Training and helping them in the organizational, managerial and financial matters
3. Helping them access more credit and linkage with formal financial agencies
4. Channelizing the group effort for various development activities helping them in
availing opportunities,
5. Widening the options available for economic development
6. Helping them in sustaining the group effort
independently even after withdrawal of the NGO.
Models of Micro Finance Practices:

The following are the variety of delivery models of micro finance in India:

a) The SHG-Bank Linkage Model – The predominant model in the Indian Micro finance
context continues to be the SHG-Bank Linkage Model that accounts for nearly 20 million clients.
It started as an Action Research Project in 1989. Under this model, Self Help Promoting
Institution usually a NGO helps groups of 15-20 individuals through an incubation period after
which time they are linked to banks. The SHG had proved their efficacy over time but they suffer
from a meager resource base which handicapped their capacity to expand the economic activities
of their members. The factors received by the SHG members were the lack of information, time
consuming and expensive procedures for obtaining bank loans, rigid lending policies of banks in
respect of unit costs, unit sizes and group guarantee for loans. There are three linking model in
the country:

Model I -SHG formed and financed by banks: - In this model, the banks play the dual role of
promotion of SHGs and also provider of credit to SHGs. Upto March 2005, 21% of SHGs
financed were from this category.

Model II -SHGs formed by formal agencies other than banks (NGOs and other), but directly
financed by banks: - In this model, the NGOs and other agencies have played the role of
facilitator. Upto March 2005, 72% of SHG financed were from this category.

Model III-SHGs financed by banks using NGOs and other agencies as financial intermediaries:
-In this model, the NGOs and other agencies play the role of financial intermediation. Upto
March 2005, only 7% of SHG financed were from this category. Thus in 2006-07, the country
witnesses a marked proliferation of SHGs to the extent of 24, 76,492. In no less discouraging
terms the bank loans also amounted to Rs 13, 511.86 crores

b) Grameen Model – Potential clients are asked by the MFO to organize themselves into
‘groups’ of five members which are in turn organized into ‘centres’ of around five to seven such
groups. The loans for productive purposes are provided by the MFO directly to the members of
small groups directly on the strength of group assurance. Grameen Model is being followed in
India by Association for Sarva Seva Farms (ASSEFA), Activists for Social Alternatives (ASA)
and Other Financial and Technical Services Ltd.

c) Cooperative Model – This has been initiated by Cooperative Development Forum (CDF),
Hyderabad which has relied upon a “Credit Union” involving the Saving First Strategy. It has
built up a network of Women Thrift Groups (WTGs) and Men Thrift Groups (MTGs). They are
registered under Mutually Aided Cooperative Society Act (MACs) and mobilize savings
resources from the members and access outside/ supplementary resources from the institutional
systems.
 d) Partnership Model – The partnership model pioneered by ICICI Bank attempted to address
the following key gaps:

To separate the risk of the MFI from the risk inherent in the Micro Finance portfolio.

To provide a mechanism for banks to incentivize partner MFIs continuously, especially in a

scenario when the borrower entered into a contact directly with the bank and role of the MFI was
closer to that of an agent.

To deal with the inability of MFIs to provide risk capital in large amounts, this limits the
advances from banks, despite a greater ability of the latter to provide implicit capital. In this
model, the MFI collects a ‘service charge’ from the borrowers to cover its transaction costs and
margins. The lower the defaults, the better the earnings of the MFI as it will not incur any
penalty charges vis-à-vis the guarantee it provides.
Micro-finance and Poverty Alleviation

The key to alleviating poverty is how effectively the tools of food, shelter, basic education,
opportunities for employment, health and medical services, financial services, infrastructure,
markets and communication are deployed either singularly or severally to the poor.Poverty is a
pervasive problem in our society. Spanning across the world, poverty exists in different levels
and various forms. At the current threshold of $1.25 a day, the World Bank estimates that around
25% of the population in developing regions lives below the poverty line. This figure translates
to 1.3 billion people living in poverty, or about 20% of the global population.

As the World Bank broadly defines it, poverty is a “pronounced deprivation in well-being,” The
poor are deprived of basic necessities in life, such as food, shelter, clothing, and clean drinking
water. They also lack access to health care, quality education, and employment opportunities that
are important in improving their human capital and facilitating social mobility. Due to the
profound impact that poverty has on the poor’s well-being, efforts have been made by various
multilateral organizations, such as the United Nations, to address these problems and combat
poverty. Through the years, different poverty reduction strategies and instruments have been
developed in order to improve the poor’s standard of living and help the people break the vicious
cycle of poverty.

One such poverty alleviation tool is microfinance, which has gained worldwide recognition since
the 1990s and has been proven to have positive effects on poverty levels in developing countries.
Microfinance is the provision of financial services to the poor, aiming to empower low-income
populations by providing them with access to credit and other financial services. Through
microfinance institutions (MFI), the poor can obtain collateral-free loans at relatively low
interest rates and use the money for creating micro enterprises (small businesses owned by poor
people), funding children’s education, and improving homes, among others. Aside from micro
credit, MFIs have also developed numerous financial products, such as micro-insurance and
micro-mortgage that are designed to accommodate the poor’s financial needs. Most of these
institutions have also required their clients to open up savings accounts, which could be used for
emergency and investment purposes. Indeed, microfinance has so much to offer to the poor that
it has now become a global phenomenon.

Despite the success of microfinance in including the poor people in the financial sector, critics
claim that this antipoverty tool lacks hard data to prove its positive impact on reducing poverty
levels. Some researchers also question the real impact of microfinance institutions (MFI) in
women empowerment, and argue that assistance from the public and private sectors must be
made available to effectively improve the lives of the poor. Others are also concerned at how
these institutions would be able to fulfill their social goals while trying to achieve long-term
sustainability.

In this article, I focus on the key features of microfinance and outline its positive effects on
poverty levels, women empowerment, and psychological benefits. I also examine the main
criticisms and issues raised by other researchers with regards to microfinance’s real capability of
effectively facilitating social mobility, and briefly discuss the challenges faced by microfinance
institutions in industrialized countries.
Most poor people manage to mobilize resources to develop their enterprises and their dwellings
slowly over time. Financial services could enable the poor to leverage their initiative,
accelerating the process of building 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. They are very often denied access to credit for any
purpose, making the discussion of the level of interest rate and other terms of finance irrelevant.
Therefore the fundamental problem is not so much of unaffordable terms of loan as the lack of
access to credit itself. The lack of access to credit for the poor is attributable to practical
difficulties arising from the discrepancy between the mode of operation followed by financial
institutions and the economic characteristics and financing needs of low-income households. For
example, commercial lending institutions require that borrowers have a stable source of income
out of which principal and interest can be paid back according to the agreed terms. However, the
income of many self employed households is not stable, regardless of its size. A large number of
small loans are needed to serve the poor, but lenders prefer dealing with large loans in small
numbers to minimize administration costs. They also look for collateral with a clear title - which
many low-income households do not have. In addition bankers tend to consider low income
households a bad risk imposing exceedingly high information monitoring costs on operation.
Over the last ten years, however, 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 grassroots 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. To the extent that microfinance institutions
become financially viable, self sustaining, and integral to the communities in which they operate,
they have the potential to attract more resources and expand services to clients. Despite the
success of microfinance institutions, only about 2% of world's roughly 500 million small
entrepreneurs is estimated to have access to financial services. Although there is demand for
credit by poor and women at market interest rates, the volume of financial transaction of
microfinance institution must reach a certain level before their financial operation becomes self
sustaining. In other words, although microfinance offers a promising institutional structure to
provide access to credit to the poor, the scale problem needs to be resolved so that it can reach
the vast majority of potential customers who demand access to credit at market rates. The
question then is how micro enterprise lending geared to providing short term capital to small
businesses in the informal sector can be sustained as an integral part of the financial sector and
how their financial services can be further expanded using the principles, standards and
modalities that have proven to be effective. To be successful, financial intermediaries that
provide services and generate domestic resources must have the capacity to meet high
performance standards. They must achieve excellent repayments and provide access to clients.
And they must build toward operating and financial self-sufficiency and expanding client reach.
In order to do so, microfinance institutions need to find ways to cut down on their administrative
costs and also to broaden their resource base. Cost reductions can be achieved through simplified
and decentralized loan application, approval and collection processes, for instance, through
group loans which give borrowers responsibilities for much of the loan application process,
allow the loan officers to handle many more clients and hence reduce costs.

Microfinance institutions can broaden their resource base by mobilizing savings, accessing
capital markets, loan funds and effective institutional development support. A logical way to tap
capital market is securitization through a corporation that purchases loans made by micro
enterprise institutions with the funds raised through the bonds issuance on the capital market.
There is at least one pilot attempt to securitize microfinance portfolio along these lines in
Ecuador. As an alternative, BancoSol of Bolivia issued a certificate of deposit which is traded in
Bolivian stock exchange. In 1994, it also issued certificates of deposit in the U.S. The
Foundation for Cooperation and Development of Paraguay issued bonds to raise capital for
micro enterprise lending.

Savings facilities make large scale lending operations possible. On the other hand, studies also
show that the poor operating in the informal sector do save, although not in financial assets, and
hence value access to client-friendly savings service at least as much access to credit. Savings
mobilization also makes financial institutions accountable to local shareholders. Therefore,
adequate savings facilities both serve the demand for financial services by the customers and
fulfill an important requirement of financial sustainability to the lenders. Microfinance
institutions can either provide savings services directly through deposit taking or make
arrangements with other financial institutions to provide savings facilities to tap small savings in
a flexible manner.

Convenience of location, positive real rate of return, liquidity, and security of savings are
essential ingredients of successful savings mobilization. Once microfinance institutions are
engaged in deposit taking in order to mobilize household savings, they become financial
intermediaries. Consequently, prudential financial regulations become necessary to ensure the
solvency and financial soundness of the institution and to protect the depositors. However,
excessive regulations that do not consider the nature of microfinance institution and their
operation can hamper their viability. In view of small loan size, microfinance institutions should
be subjected to a minimum capital requirement which is lower than that applicable to
commercial banks. On the other hand, a more stringent capital adequacy rate (the ratio between
capital and risk assets) should be maintained because microfinance institutions provide
uncollateralized loans. Governments should provide an enabling legal and regulatory framework
which encourages the development of a range of institutions and allows them to operate as
recognized financial intermediaries subject to simple supervisory and reporting requirements.
Usury laws should be repelled or relaxed and microfinance institutions should be given freedom
of setting interest rates and fees in order to cover operating and finance costs from interest
revenues within a reasonable amount of time. Government could also facilitate the process of
transition to a sustainable level of operation by providing support to the lending institutions in
their early stage of development through credit enhancement mechanisms or subsidies.

One way of expanding the successful operation of microfinance institutions in the informal
sector is through strengthened linkages with their formal sector counterparts. A mutually
beneficial partnership should be based on comparative strengths of each sector. Informal sector
microfinance institutions have comparative advantage in terms of small transaction costs
achieved through adaptability and flexibility of operations. They are better equipped to deal with
credit assessment of the urban poor and hence to absorb the transaction costs associated with
loan processing. On the other hand, formal sector institutions have access to broader resource-
base and high leverage through deposit mobilization.

Therefore, formal sector finance institutions could form a joint venture with informal sector
institutions in which the former provide funds in the form of equity and the later extends savings
and loan facilities to the urban poor. Another form of partnership can involve the formal sector
institutions refinancing loans made by the informal sector lenders. Under these settings, the
informal sector institutions are able to tap additional resources as well as having an incentive to
exercise greater financial discipline in their management.

Aside from obtaining access to credit and other financial services, and creating micro enterprises
that provide employment, the poor also gain additional benefits that contribute to their overall
economic improvement and social mobility. In most third-world countries in which MFIs
operate, women empowerment is one of the most important effects that microfinance generates
in rural communities. By acquiring access to financial capital and starting their own family
business, women increase their decision-making power in the household and are able to possess
skills in entrepreneurship and financial management. They gain more knowledge in terms of
running their own source of livelihood and do not remain as ordinary housewives solely tied to
the responsibility of taking care of their families. They start to play important roles in their
communities and receive respect from other people for proving their great capacity to effectively
manage resources and organize micro enterprises. The benefits that women obtain from
microfinance are not only financial but also encompass gender empowerment and self-
actualization. In rural areas and villages, which are traditionally patriarchal, women are given the
opportunity to uplift their status in the society and prove their worth as capable members of their
community.

The poor in general experience social mobility through microfinance. As they acquire access to
credit and become included in the financial sector, they are able to improve their economic status
and increase their participation in the domestic market. Indicates in her research that there is a
growing number of literatures that can support the positive relationship between financial sector
development and poverty alleviation. She notes that because financial sector development
contributes to economic growth, it indirectly aids in alleviating poverty. Also, by providing
access to finance, the financial sector has direct effects on the economic condition of the poor.

Additionally, microfinance provides psychological benefits to its poor clients by promoting a

sense of “self-respect and dignity, much more than handouts and grants. Success, self-respect
and dignity are basic ingredients in overcoming the conviction that they and their children are
born losers, born to fail”. Knowing that they are able to take out a loan, start their own business,
and repay the borrowed capital through their own efforts and hard work, the poor can convince
themselves that they are capable of doing something that could certainly change their lives for
the better. They do not merely depend on loan sharks or moneylenders, who charge them for
exorbitant interest rates, to finance their daily needs. Moreover, they also do not have to
constantly rely on welfare programs for financial support, as becoming self-employed through
their own businesses allows them to have a more stable source of income. If effectively
managed, these businesses could potentially grow, resulting to a higher amount of earnings for
the poor’s household. And so, utilizing micro loans to advance entrepreneurial endeavors makes
the poor better off than simply relying on welfare and high-interest loans from moneylenders. As
the old adage goes, “Give a man a fish and you feed him for a day. Teach a man how to fish and
you feed him for a lifetime.” Providing the poor with the right financial tools and knowledge to
start a micro enterprise will help them long-term and allow them to become self-sustaining in the
process.

Microfinance institutions could also serve as intermediaries between borrowers and the formal
financial sector and on-lend funds backed by a public sector guarantee. Business-like NGOs can
offer commercial banks ways of funding micro entrepreneurs at low cost and risk, for example,
through leveraged bank-NGO-client credit lines. Under this arrangement, banks make one bulk
loan to NGOs and the NGOs packages it into large number of small loans at market rates and
recover them. As part of the poverty alleviation measures, the Government of India (GOI)
launched the Swarnjayanti Gram Swarozgar Yojana (SGSY) in 1999 where the major emphasis
is on self-help group (SHG) formation, social mobilization and economic activation through
micro-credit finance.
Up to March 2003, 13.38 lakh groups were constituted in 33 States and Union Territories, of
which 33,436 SHGs only could take up economic activities for their economic sustenance.
Simultaneously, the Government supports the National Bank for Agriculture and Rural
Development (Nabard) to take up activities such as group formation, micro-finance and
economic activation.
Besides this, the Rashtriya Mahila Kosh (RMK that is, National Credit Fund for Women) and the
Department of Women and Child Development have their own programmes under which micro
credit is being provided for economic empowerment of the rural poor.

The year 2001-02 marked a decade of self-help group-bank linkage programme in India. With
the growing importance of the micro-credit through SHG-bank linkage in India, the Reserve
Bank of India (RBI) in 1996 included financing to SHGs as a mainstream activity of banks under
their priority sector lending. The Government bestowed national priority to the programme
through its recognition in the 1999 Budget. It has been estimated that India has the world's
largest micro-finance programme in terms of out-reach, with 7.8 million households accessing
credit through 17,085 branches of the formal banking system under the micro-credit finance
programme.

It has been recognized by the World Bank and other multilateral organizations as an effective
method of alleviating global poverty. A number of case studies conducted in Bangladesh,
Indonesia, Africa, Latin America and other countries have already proven the positive impact of
microfinance on the economic status of the poor, while recognizing its ability in empowering
women, aiding social mobility, providing new knowledge through training, and contributing
psychological benefits to these people.

Despite the positive benefits incurred by the poor, microfinance has its own issues and criticisms.
Microfinance’s real impact on alleviating poverty at the global level is not supported by rigorous
research, as critics claim. Stories of success are also not enough to accurately measure the extent
to which microfinance has impacted the poor. MFIs are also criticized for charging high interest
rates in the pursuit of becoming self-sustainable organizations because this decision ultimately
affects their impoverished clients and borrowers. Meanwhile, MFIs in developed countries face
challenges in effectively helping the people, as microfinance has not yet become the main tool in
fighting poverty in these places. Because of more complicated economic structures, MFIs must
adapt new approaches to be able to effectively serve and address the needs of their customers.

When understanding the capability of microfinance as an anti-poverty tool, it is important to

remember that microfinance is not the only solution to global poverty. One cannot expect
microfinance to single-handedly eradicate poverty in the world as there are other variables aside
from economic factors that contribute to the prevalence of poverty in our society. Just like any
other anti-poverty program, microfinance has its own limitations and weaknesses, but this does
not mean that efforts in promoting this financial tool must be completely abandoned. So far, it
has improved the lives of thousands of families in various countries. That in itself is a great feat
that is just as crucial as any other effort directed towards poverty alleviation. By empowering the
poor and instilling in them a sense of self-respect, motivation, and drive to move out of poverty
and achieve success, microfinance is definitely an effective poverty alleviation tool that has
important implications in the future of the world’s low-income populations.
BIBLIOGRAPHY:

http://en.wikipedia.org/wiki/Microfinance
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http://www.accion.org/Page.aspx?pid=1648
http://www.globalenvision.org/library/4/1051/
https://www.microplace.com/learn_more/microfinancehistory

http://prativad.com/articles/Micro-finance-Models.htm

http://www.thehindubusinessline.com/2003/11/01/stories/2003110100020900.htm

http://stjliblog.wordpress.com/2010/04/19/microfinance-the-path-to-poverty-alleviation-by-
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Book-Somanath, V S (2009), microfinance-redefining the future, publisher-excel books, New

Delhi