SCOPE OF MICROFINANCE AND

ITS IMPACT

AMITY UNIVERSITY
UTTAR PRADESH

SUBMITTED TO : SUBMITTED BY:

Mr. Kumar Saurabh Karishma Jain
BFIA – VI
A3110108022

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 ACKNOWLEDGEMENT

I wish to express my gratitude to my faculty guide Mr. Kumar Saurabh for his invaluable
guidance and cooperation during the course of my dissertation. He provided me with him
assistance and support whenever needed that has been instrumental in completion of this
project.

The learning during the project was immense & invaluable. My work basically includes
“Scope of microfinance and its impact.” The present report is an amalgamation of my
thoughts and efforts.

Signature
Karishma Jain

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 TABLE OF CONTENTS

CHAPTER NO. TOPIC PAGE NO.

1 Executive Summary 4
2 Research Methodology 5
A. Research Objective 5
B. Research design 5
C. Data collection 5
D. Limitation of the study 6
3 Review of literature 7-8
4 Industry Profile 9-19
5 What is microfinance? 20-24
Source of credit in India 25-26
What are MFIs? 27-31
Types of MFIs 32-38
Interest Rate 39-40
Micro Financial sector development 41-43
& regulation bill,2007
Various MFIs & NGOs 44-50
Impact of microfinance 51-55
Present Scenario 56-58
6 Recommendations 59
7 Bibliography 60

CHAPTER -1
EXECUTIVE SUMMARY

There is growing interest in microfinance as one of the avenues to enable low income
population to access financial services. India with a population of around 300 million poor
people has emerged as a large potential opportunity for the microfinance sector. With only
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48% of the population accessing financial services, expanding the microfinance sector is also
important from the perspective of financial inclusion(World Bank, 2008). Since 2004, the
Reserve Bank of India (RBI) has emphasized financial inclusion as an important goal.

While there have been various initiatives to promote microfinance in India since the 1970s,
the sector witnessed rapid growth only in the 1990s. The RBI has since the mid 1990s helped
in attracting funding for the sector by including microfinance in the “priority sector”, to which
banks are mandated to allocate a percentage of their lending. However, no specific regulation
was imposed on the sector as a whole primarily because it was felt that regulation may hamper
the sector’s key strengths of informality and flexibility.
With the growth of the sector both in terms of size, scope and number of participants, there is
however now a need for developing a more formal regulatory structure. First, regulation is
needed to enable a number of large microfinance institutions (MFIs) to offer savings services,
so as to address a major shortcoming of the sector. The largest MFIs in the country, which
cumulatively account for 80% of the sector in terms of portfolio outstanding are non-banking
finance companies (NBFCs), who are unable to accept savings deposits (Ghate, 2007). In
order to do so, NBFCs need to obtain investment grade rating from a credit rating institution,
which is difficult for the MFIs. As a result, most of the growth in microfinance in India has
been concentrated on provision of loans or “microcredit”.
Thus, this dissertation explores the development of microfinance in Indian and its impact om
the Indian economy.

CHAPTER -2
RESEARCH METHODOLOGY

A. RESEARCH OBJECTIVES

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The primary objective is to focus on the scope of microfinance and its impact on the Indian
economy.

The secondary objectives are:-

 Who is being served through micro finance?

 How microfinance help poor?
 Why do MFIs charge high interest rates to poor people?
 Who provide micro finance?
 What are the myths regarding MFIs?

B. RESEARCH DESIGN

The research design adopted is Exploratory Research Design to know about the origin of
microfinance and its impact. Exploratory research provides insights into and comprehension
of an issue or situation.

C. DATA COLLECTION
The data used in the study is secondary data. Secondary Data is the data which has been
already collected by someone else for different and general purpose. The data is collected
from reports and official publications, internet, online forums, journals and newspapers.

D. LIMITATIONS OF THE STUDY

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1. The concept of microfinance started in Bangladesh and my study is based on the Indian
microfinance industry, so there might be some discrepancies between the two and they may
not be clearly visible.

2. The information collected may not be highly credible since the banks in India do not have
established microfinancing departments.

CHAPTER – 3
REVIEW OF LITERATURE

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According to the 2000 Population and Housing Census, 80% of the working population is
found in the private informal sector. This group is characterized by lack of access to credit,
which constrains the development and growth of that sector of the economy. Clearly, access to
financial services is imperative for the development of the informal sector and also helps to
mop up excess liquidity through savings that can be made available as investment capital for
national development.

The former UN Secretary General Kofi Annan during the launch of the International Year of
Micro Credit (2005), “…Sustainable access to microfinance helps alleviate poverty by
generating income, creating jobs, allowing children to go to school, enabling families to
obtain health care, and empowering people to make the choices that best serve their needs.”
(Kofi Annan, December 2003).

Micro credit is thus one of the critical dimensions of the broad range of financial tools for the
poor, and its increasing role in development has emanated from a number of key factors that
include; The fact that the poor need access to productive resources, with financial services
being a key resource, if they are to be able to improve their conditions of life; The realization
that the poor have the capacity to use loans effectively for income-generation, to save and re-
pay loans.

According to Simanowitz and Brody (2004, p.1), micro-credit is a key strategy in reaching the
MDGs and in building global financial systems that meet the needs of the most poor people.”
Littlefield, Murduch and Hashemi (2003) state, “…micro-credit is a critical contextual factor
with strong impact on the achievements of the MDGs. Micro-credit is unique among
development interventions: it can deliver social benefits on an ongoing, permanent basis and
on a large scale”.
However, some schools of thought remain sceptical about the role of micro-credit in
development. For example, while acknowledging the role micro-credit can play in helping to
reduce poverty, Hulme and Mosley (1996) concluded from their research on micro-credit that
“…most contemporary schemes are less effective than they might be” (1996, p.134). The

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authors contended that micro-credit is not a panacea for poverty-alleviation and that in some
cases the poorest people have been made worse-off.
This notwithstanding, microfinance has emerged globally as a leading and effective strategy
for poverty reduction with the potential for far-reaching impact in transforming the lives of
poor people. It is argued that microfinance can facilitate the achievement of the Millennium
Development Goals (MDGs) as well as National Policies that target poverty reduction,
empowering women, assisting vulnerable groups, and improving standards of living as could
be infer from Kofi Annan’s speech above.
The researcher with the information from the above contentions and postulations of the
various researchers will explore the gaps in their submission as he investigates the correlation
between monetary depth and poverty and moreover find out the impact and the essence of
these MFIs vis-à-vis poverty alleviation in the country.

Commentators such as Littlefield, Murduch and Hashemi (2003), Simanowitz and Brody
(2004) and the IMF (2005) have commented on the critical role of microfinance in achieving
the Millennium Development Goals. Simanowitz and Brody (2004, p.1) state, “Microfinance
is a key strategy in reaching the MDGs and in building global financial systems that meet the
needs of the most poor people.” Littlefield, Murduch and Hashemi (2003) state “microfinance
is a critical contextual factor with strong impact on the achievements of the MDGs…
microfinance is unique among development interventions: it can deliver social benefits on an
ongoing, permanent basis and on a large scale”.
Referring to various case studies, they show how microfinance has played a role in eradicating
poverty, promoting education, improving health and empowering women (2003).

CHAPTER -4

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 INDUSTRY PROFILE

Growth of Micro-Finance Sector at Global Level

Let us look at the historical account of the emergence and growth of micro finance
sector at the global level. The Grameen Bank, Bangladesh, was started as an experiment in
1976 and accorded a special banking charter in 1983. In 1981 NDF (National Development
Foundation), Jamaica, was started with support of Pan American Development Foundation. In
1983 ADEMI (Association for Development of Micro Enterprises) was established in
Dominican Republic, Santo Domingo with support from ACCION, an International Agency.
In 1984 BRI (Bank Rakayat Indonesia) started micro-finance in Indonesia. In 1984, K-REP
(Kenya Rural Enterprise Programme) was set up by USAID (United States Agency for
International Development) to develop credit programmes for micro-enterprises through
NGOs intermediation. In 1986 ACEP (Agence de Credit Pour ‘L Enterprise Privee) was
established in Senegal with the support of USAID.

In 1986, PRODEM (Foundation for the Promotion and Development of Micro Enterprises)
which was established by USAID and ACCION International in Bolivia, started micro
finance. Later on it was converted into a bank called Bancosol (Banco Solidario) in 1992. In
1987 IDH (Instituto de Desarrollo Hondurando) was started in Honduras with the support of
Opportunity International. In 1992, BANPECO (Banco Nacional del Pequeno Comercio) that
is, National Bank for Small Traders was renamed as BNCI (Banco Nacional de Comercio
Interior), that is National Bank for Domestic Commerce and started micro-financing in urban
areas of Mexico. Micro-Credit Summit (2-4 February, 1997) held at Washington D.C. was
organized to launch a global movement to reach 100 million of the world’s poorest families,
especially the women of those families, with credit for self-employment, by the year 2005.

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,

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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.

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.

In the last two decades, the microfinance industry has faced three distinct waves of action.
The first was when people working in developmental sector discovered the methodology of
reaching micro-loans to the poor through a methodology mastered by Grameen Bank. The
wave 2 came in when the first generation organizations reached scale and sought methods to
morph into for-profit commercial organizations. The wave 3 is when mainstream commercial
institutions like L&T finance, Equities and the private equity players started looking at
microfinance as an interesting business.

The basic methodology being used in commercial microfinance in India was innovated by
Grameen Bank and later improvised by several players.

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.

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.

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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.

CHALLENGES

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For the first time people in the developmental sector were discovering a methodology where
they could keep in touch with a large number of poor clients, scale rapidly, and actually count
the direct impact of their work5. The counting could easily be done by number of clients
reached, the portfolio quality, amount loaned and the magic 100% recovery statistic. This was
a magic formula discovered and by the time the Microfinance Institutions [MFI] spent three to
four years in operations, they found that there were challenges in keeping pace with the
growth opportunities. From 2002 onwards we found these MFIs talking a new language – the
language of transformation.

Traditionally, banks have usually not provided financial services to clients with little or no
cash income. In addition, most poor people have few assets that can be secured by a bank as
collateral. This means that the bank will have little recourse against defaulting borrowers.
Because of these difficulties, when poor people borrow they often rely on relatives or a local
moneylender, whose interest rates can be very high. Moneylenders usually charge higher rates
to poorer borrowers than to less poor ones. While moneylenders are often demonized and
accused of usury, their services are convenient and fast, and they can be very flexible when
borrowers run into problems. Hopes of quickly putting them out of business have proven
unrealistic, even in places where micro finance institutions are very active.
While the success of Grameen Bank (which now serves over seven million poor Bangladeshi
women) has inspired the world, it has proved difficult to replicate this success in practice. In
nations with lower population densities, meeting the operating costs of a retail branch by
serving nearby customers has proven considerably more challenging.

NSSO data reveal that 45.9 million farmer households in the country (51.4%), out of a total of
89.3 million households do not access credit, either from institutional or non institutional
sources. Further, despite the vast network of bank branches, only 27% of total farm
households are indebted to formal sources(of which one-third also borrow from informal
sources). Farm households not accessing credit from formal sources as a proportion to total
farm households is especially high at 95.91%, 81.26% and 77.59% in the North Eastern,
Eastern and Central Regions respectively. Thus, apart from the fact that exclusion in general is

12
large, it also varies widely across regions, social groups and asset holdings. The poorer the
group, the greater is the exclusion.
While financial inclusion can be substantially enhanced by improving the supply side or the
delivery systems, it is also important to note that many regions, segments of the population
and sub-sectors of the economy have a limited or weak demand for financial services. In order
to improve their level of inclusion, demand side efforts need to be undertaken including
improving human and physical resource endowments, enhancing productivity, mitigating risk
and strengthening market linkages. However, the primary focus of the Committee has been on
improving the delivery systems, both conventional and innovative.

LESSONS FROM INTERNATIONAL EXPERIENCES

Though country wise experience may vary, the lessons provide a sound basis for
understanding the role and limitations of micro finance.

The poor’s are bankable:

The poor have always borrowed money for a multiplicity of purposes from informal sources
and repaid most of these loans. A participatory involvement and realization that repayment
enhances their long term borrowing capacity ensures the proper attitude towards repayment.
At the same time, MFIs should have effective methods for monitoring the loans and ensuring
repayment at convenient times.

Micro credit benefits the poor:

Borrowers often increase their incomes and improve their livelihood because of micro credit.
Employment impact is more limited. Micro finance leads to changes in the use of technology
only of the less poor as adoption of new technology is risky and the poorer borrowers are
more risk averse. Where wide gender disparities abound, micro finance catering to women
raises their sense of participation and increases their empowerment.

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Realistic interest rate is vital:

While in the long run the interest charged by the MFIs should cover the total cost, there
appears to be a good case for subsidizing cost of risk, as otherwise the interest cost could be
prohibitive. Since the enhancement of repayment of loans is closely related to knowledge of
borrowers, development of peer pressure and group responsibilities, these take time.
Therefore while sustainability can be achieved only with interest cost meeting the total cost of
lending, this can be achieved only after a gestation period. During this gestation period, MFIs
should charge the cost of financial funds plus a margin it deems sufficient to cover part of the
other costs. This rate of interest would be higher than the commercial banks lending rates but
much lower than interest rate of informal lenders.

Governance and financial systems require strengthening:

The issues of governance that require to be addressed include greater transparency in their
activities and finances, the determination of the lines of responsibility and accountability and
control of MFIs. The main issues revolve around the composition of the board of
management, accounting systems and regulatory conformity. Good accounting practices are
essential to insure accountability in continuous evaluation of performance.

Strong regulatory framework:

With an expansion in the number of MFIs and many of them accepting savings, it is generally
argued that MFIs should be subject to a regulatory framework in the interest of both the poor,
as also the long term viability and sustainability of MFIs. A cost effective or subsidized
regulatory mechanism may be necessary.

No single model of MFI:

The extent of participatory decision making has to be decided on the basis of whether
collective decision making is a realistic option. While participatory involvement is desired,
many other successful MFIs have adopted a 'top down' approach. Therefore, each MFI would

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require to be designed according to the context and environment it operates in and be willing
to respond to changes in the light of its own experience.

Most MFIs require outside funding:

Most MFIs require outside finances for commencement and the gestation period. Other
expenditure is likely to be so high in the beginning that a relatively high interest rate above the
average of the market rate but below the informal moneylender rates is not likely to cover
costs. Therefore substantial outside assistance would be needed to enlarge the number of
MFIs and their outreach.

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MAJOR MILESTONES IN INDIA

A Brief History of Microfinance in India

The post-nationalization period in the banking sector, circa 1969, witnessed a substantial
amount of resources being earmarked towards meeting the credit needs of the poor. There
were several objectives for the bank nationalization strategy including expanding the outreach
of financial services to neglected sectors (Singh, 2005). As a result of this strategy, the
banking network underwent an expansion phase without comparables in the world. Credit
came to be recognized as a remedy for many of the ills of the poverty. There spawned several
pro-poor financial services, support by both the State and Central governments, which
included credit packages and programs customized to the perceived needs of the poor.

While the objectives were laudable and substantial progress was achieved, credit flow to the
poor, and especially to poor women, remained low. This led to initiatives that were institution
driven that attempted to converge the existing strengths of rural banking infrastructure and

16
leverage this to better serve the poor. The pioneering efforts at this were made by National
Bank for Agriculture and Rural Development (NABARD), which was given the tasks of
framing appropriate policy for rural credit, provision of technical assistance backed liquidity
support to banks, supervision of rural credit institutions and other development initiatives.

In the early 1980s, the GoI launched the Integrated Rural Development Program (IRDP), a
large poverty alleviation credit program, which provided government subsidized credit
through banks to the poor. It was aimed that the poor would be able to use the inexpensive
credit to finance themselves over the poverty line.

Also during this time, NABARD conducted a series of research studies independently and in
association with MYRADA, a leading non-governmental organization (NGO) from Southern
India, which showed that despite having a wide network of rural bank branches servicing the
rural poor, a very large number of the poorest of the poor continued to remain outside the fold
of the formal banking system. These studies also showed that the existing banking policies,
systems and procedures, and deposit and loan products were perhaps not well suited to meet
the most immediate needs of the poor. It also appeared that what the poor really needed was
better access to these services and products, rather than cheap subsidized credit. Against this
background, a need was felt for alternative policies, systems and procedures, savings and loan
products, other complementary services, and new delivery mechanisms, which would fulfill
the requirements of the poorest, especially of the women members of such households. The
emphasis therefore was on improving the access of the poor to microfinance rather than just
micro-credit.

To answer the need for microfinance from the poor, the past 25 years has seen a variety of
microfinance programs promoted by the government and NGOs. Some of these programs
have failed and the learning experience from them have been used to develop more effective
ways of providing financial services. These programs vary from regional rural banks with a
social mandate to MFIs. In 1999, the GoI merged various credit programs together, refined
them and launched a new programme called Swaranjayanti Gram Swarazagar Yojana
(SGSY). The mandate of SGSY is to continue to provide subsidized credit to the poor through

17
the banking sector to generate self-employment through a self-help group approach and the
program has grown to an enormous size.

MFIs have also become popular throughout India as one form of financial intermediary to the
poor. MFIs exist in many forms including co-operatives, Grameen-like initiatives and private
sector MFIs. Thrift co-operatives have formed organically and have also been promoted by
regional state organizations like the Cooperative Development Foundation (CDF) in Andhra
Pradesh. The Grameen-like initiatives following a business model like the Grameen Bank.
Private sector MFIs include NGOs that act as financial services providers for the poor and
include other support services but are not technically a bank as they do not take deposits.

Recently, microfinance has garnered significant worldwide attention as being a successful tool
in poverty reduction. In 2005, the GoI introduced significant measures in the annual budget
affecting MFIs. Specifically, it mentioned that MFIs would be eligible for external
commercial borrowings which would allow MFIs and private banks to do business thereby
increasing the capacity of MFIs. Also, the budget talked about plans to introduce a
microfinance act that would provide some regulations on the sector.

It is clear from the previous that the objectives of the bank sector nationalization strategy have
resulted into several offshoots, some of which have succeeded and some have failed. Today,
Self-Help Groups and MFIs are the two dominant form of microfinance in India.

Growth of microfinance in India

The growth of microfinance is visible in many aspects. There are more than 2000 NGOs
involved in the NABARD SHG-Bank linkage program. Out of these, approximately 800
NGOs are involved in some form of financial intermediation. Further, there are 350 new
generation co-operatives providing thrift and credit services. According to our estimate, the
present total outstanding, including Sa-Dhan members and bank linkages is approximately
Rs.700 crores (Rs. 150 crores of Sa-Dhan members and another Rs. 550 crores from the
Banking system). The total client base is estimated at 6-8 million as opposed to the
Government of India (GOI) intention to reach 25 million clients. The growth of community
institutions has taken place with the role to take social and financial intermediation. A
18
numbers of community banks have come into existence at village and block levels call '
Federation of Self Help Groups'.

The inadequacies of the formal financial system to cater to the needs of the poor and the
realization of the fact that the key to success lies in the evolution and participation of
community based organizations at the grassroots level led to the emergence of new generation
of MFIs.

One kind of MFI is an NGO engaged in promoting Self Help Groups (SHGs) and their
federations at a cluster level and linking SHGs with Banks under the Scheme. Examples are
Myrada in Karnataka, which has promoted Sanghmitra, a company of its village saving and
credit sanghas, PRADAN which has established a large number of SHGs and federated them
under Damodar in Bihar, Sakhi Samiti in Rajasthan.

Another kind is NGO-MFI directly lending to the poor borrowers, who are either organized
into SHGs or into Grameen Bank type of groups after borrowing bulk funds from SIDBI,
RMK and FWWB. Examples in this category are Rashtriya Gramin Vikas Nidhi (RGVN)
which runs credit and savings programme in Assam and Orissa on the lines of Grameen Bank,
Bangladesh. Also we have SHARE in AP, ASA in Tamil Nadu under this category.

There are MFIs which are specifically organized as cooperatives, such as over 500 Mutually
Aided Cooperative Thrift and Credit Socities (MACTS) in AP, promoted among others by
Cooperative Development Foundation (CDF) and the SEWA Bank in Gujarat which also runs
federations of SHGs in nine districts.

Then we have MFIs, which are organize as Non-Banking Finance Companies (NBFC) such as
BASIX, CFTS Mirzapur, SHARE Microfin. Ltd and Sarvodaya Nanofinance Ltd.

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 CHAPTER-5

What is microfinance?

The proposed Microfinance Services Regulation Bill defines microfinance services as

“providing financial assistance to an individual or an eligible client, either directly or through
a group mechanism for:

I. an amount, not exceeding rupees fifty thousand in aggregate per individual, for small and
tiny enterprise, agriculture, allied activities (including for consumption purposes of such
individual) or
II. An amount not exceeding rupees one lakh fifty thousand in aggregate per individual for
housing purposes, or
III. Such other amounts, for any of the purposes mentioned at items (i) and (ii) above or other
purposes, as may be prescribed.”

“Microfinance” is often defined as financial services for poor and low-income clients. In
practice, the term is often used more narrowly to refer to loans and other services from
providers that identify themselves as “microfinance institutions” (MFIs). These institutions
commonly tend to use new methods developed over the last 30 years to deliver very small
loans to unsalaried borrowers, taking little or no collateral. These methods include group
lending and liability, pre-loan savings requirements, gradually increasing loan sizes, and an
implicit guarantee of ready access to future loans if present loans are repaid fully and
promptly.

More broadly, microfinance refers to a movement that envisions a world in which low-income
households have permanent access to a range of high quality financial services to finance their
income-producing activities, build assets, stabilize consumption, and protect against risks.
These services are not limited to credit, but include savings, insurance, and money transfers.

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Microfinance in India operates through two channels –

1. Microfinance Institutions (MFIs)

2. NABARD’s SHGsbank linkage programme (SBLP)- a partenership model between
SHGs, banks and NGOs.

State Intervention In Rural Credit In India

In India, credit demands in the rural sector were largely met by cooperative societies till the
mid 1960s. Though commercial banks in rural India largely supported agri-business and
marketing, the credit flow to the rural sector was never sufficient to complete the demands.
One of the objectives of the bank nationalization was to increase the flow of credit to the rural
population. The largest micro credit programme in the world was Integrated Rural
Development Programme (IRDP).

Government Sponsored Programmes

The lack of any market based incentives for better performance of credit and deposit
mobilization channels and the continued use of lending methodology which has systematically
eroded credit discipline and has made the practice of micro finance more difficult in India
than in many other developing countries are the two perspectives that need to be taken into
consideration. In the sixth five year plan several anti poverty measures like IRDP, training of
rural youth for self employment(TRYSEM), development of women and children in rural
areas(DWRCA), national rural employment programme(NREP) and rural landless
employment guarantee programme(RLEGP) were launched.

Integrated Rural Development Programme (IRDP)

IRDP was launched in 1979 in 2300 select community development blocks and from October
2, 1980 it was extended to the entire country.

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IRDP had two major components:

 Subsidy made available by the government

 The bank credit that was given alongside the subsidy to enable the beneficiary the
access to farm and non-farm assets to generate income.

It recognized that poor may not have the required funds to meet with the margin requirements
of the banks and aimed at promoting self employment through the provision of productive
assets by providing them soft bank loans with a capital subsidy of up to 50%. Despite massive
outreach the impact in terms of upliftment of households above the poverty line was dismal at
16-18%. The repayment rate in the IRDP programme has been low: 25-33%. The subsidy like
loan waiver which was disagreed with all over the world was institutionalized in this scheme.
The massive failure of the IRDP and its allied programmes forced the government to
restructure them. Swanajayanti Gram Swarozgar Yojana(SGSY) was launched April 1,1999.
it is conceived as a holistic programme of micro enterprise development in rural areas with the
emphasis on organizing the rural poor into SHGs, capacity building, planning of activity
clusters, infrastructure support etc. The programme has inbuilt safeguards for the weaker
sections and is credit driven. A network of agencies at rural level such as district rural
development agencies, NGOs, etc. implement this programme.

Regional Rural Banks (RRBs)

Financial services in the rural sector are provided mainly by 33000 branches of the
commercial banks, the branches of 91 RRBs and rural cooperatives. These came into
existence because the banking commission had felt the need for a specialised network of bank
branches to cater to the rural sector. Subsequently RRBs were instituted in 1975. Over the
years this branch network has gone up. However the performance has not been good. In view
of the importance of the RRBs it is likely that we are going to continue with the programme of
strengthening the RRBs.

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NABARD and SHG- Bank Linkage Programmes
In 1992, NABARD issued policy guidelines for bank linkages with SHGs. Bank managers
were initially reluctant to use the new lending technology. The SHG group guarantees the
loan. Under the 1992 guideline, the SHG functions as a joint liability group, replacing the
other collateral for the loans.
The formation of SHGs is a costly task and requires intensive efforts in recognizing groups of
people with common interests. The SHG bank linkage programme has its origins in a GTZ-
sponsored project in Indonesia. The collateral free loans increase progressively to up to 4
times the level of the groups savings deposits. SHGs thus 'linked' became micro banks able to
access funds from the formal banking system. The linkage permitted the reduction of
transaction costs of the banks through the externalization of costs of servicing individual loans
and through ensuring their repayment through peer pressure.

The outreach of the SHG bank linkage may seem to be impressive but in the context of the
magnitude of poverty in India and the flow of funds of poverty alleviation it represents a very
small intervention, accounting for less than 5% of the banking system's disbursements for
agriculture and allied activities. Thus SHG has not made a significant addition to the credit
flow to the rural areas.

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 Table 1 Outreach of SHG-Bank linkage

31.03.2000 31.03.2004 31.03.2007

1)Number of groups(000) 1147 1079 1143

2)Cumulative coverage(no. of families in 1.9 16.7 41

millions)

3) Women’s group to total(%) 85 90 90

4)Cumulative bank loan(Rs.crores) 192.98 3904 18041

5)Repayment Rate(from SHG- 95 95 >90

Bank/NGO)(%)

6)Average loan per SHG(Rs) 16814 36179 61678

7)Average loan per family(Rs) 1016 2338 n.a.

24
 SOURCE OF CREDIT IN INDIA

Non-Institutional or Informal Sources of Micro-Credit in India

In nutshell, one can say that RFIs do not fulfill the credit needs of the farmers, rural
producers and the rural poor in general, resulting in non-institutional sources of credit. The
indirect reason responsible for the growth of non-institutional sources of credit was also the
economic weakness of the Jajmani System*. The non-institutional sources of credit would
include big farmers, big farmer-cum-money-lenders, commission agents, friends/ relatives,
moneylenders, traders, village shopkeepers and others. The All India Rural Credit Survey
Committee, appointed by the RBI in 1951 under the Chairmanship of Gorwala, undertook a
comprehensive survey of rural credit and submitted its report in August 1954. The survey
revealed that shares of institutional and non-institutional sources of rural credit were 7.3 per
cent and 92.7 per cent respectively.

At present about two-third of the credit need in rural areas is met out by informal
sources. But the moneylenders have yet to disappear, though they charge very high rate of
interest, varying between 36 to 30 % per annum. The is also need to sensitize the issue of
informal rural banks that they provide timely and adequate credit to the rural poor without
much paperwork and for any purpose, especially for meeting consumption and other social
needs. But physical, economic and social exploitation of the poor people is attached with this
system.

The Formal Sector Institutions:

Traditionally, the formal sector Banking Institutions in India have been serving only the needs
of the commercial sector and providing loans for middle and upper income groups. Similarly,
for housing the HFIs have generally not evolved a lending product to serve the needs of the
Very LIG primarily because of the perceived risks of lending to this sector. Following risks
are generally perceived by the formal sector financial institutions:
 Credit Risk
 High transaction and service cost
 Absence of land tenure for financing housing

25
  Irregular flow of income due to seasonality
 Lack of tangible proof for assessment of income
 Unacceptable collaterals such as crops, utensils and jewellery

As far as the formal financial institutions are concerned, there are Commercial Banks,
Housing Finance Institutions (HFIs), NABARD, Rural Development Banks (RDBs), Land
Development Banks Land Development Banks and Co-operative Banks (CBs).
As regards the Co-operative Structures, the Urban Co.op Banks (UCB) or Urban Credit Co.op
Societies (UCCS) are the two primary co-operative financial institutions operating in the
urban areas. There are about 1400 UCBs with over 3400 branches in India having 14 million
members, their total lending outstanding in 1990-91 has been reported at over Rs 80 billion
with deposits worth Rs 101 billion.
Similarly there exist about 32000 credit co.op societies with over 15 million members with
their total outstanding lending in 1990-91 being Rs 20 billion with deposits of Rs 12 billion.

The Government has taken several initiatives to strengthen the institutional rural credit
system. The rural branch network of commercial banks have been expanded and certain policy
prescriptions imposed in order to ensure greater flow of credit to agriculture and other
preferred sectors. The commercial banks are required to ensure that 40% of total credit is
provided to the priority sectors out of which 18% in the form of direct finance to agriculture
and 25% to priority sector in favour of weaker sections besides maintaining a credit deposit
ratio of 60% in rural and semi-urban branches. Further the IRDP introduced in 1979 ensures
supply of credit and subsidies to weaker section beneficiaries. Although these measures have
helped in widening the access of rural households to institutional credit, vast majority of the
rural poor have still not been covered. Also, such lending done under the poverty alleviation
schemes suffered high repayment defaults and left little sustainable impact on the economic
condition of the beneficiaries.

26
WHAT ARE MFIs?

The proposed Microfinance Regulation Service Bill defines an MFI as “an organization or
association of individuals including the following if it is established for the purpose of
carrying on the business of extending microfinance services:

I. A society registered under the Societies Registration Act, 1860,

II. A trust created under the Indian Trust Act,1880 or public trust registered under any State
enactment governing trust or public, religious or charitable purposes,

III. A cooperative society / mutual benefit society / mutually aided society registered under
any State enactment relating to such societies or any multistate cooperative society registered
under the Multi State Cooperative Societies Act, 2002 but not including:

􀂙 a cooperative bank as defined in clause (cci) of section 5 of the Banking Regulation Act,
1949 or
􀂙 a cooperative society engaged in agricultural operations or industrial activity or purchase or
sale of any goods and services.”

MFI objectives

Academics as well as practitioners disagree amongst themselves on which are the optimal
objectives and methods of MFIs. Different groups emphasize social welfare and financial
efficiency respectively. These objectives are somewhat mutually exclusive since there is a
trade-off between outreach, impact and sustainability in microfinance lending.
Outreach is defined as the effort of MFIs to extend loans to a wider audience (breadth of
outreach), and especially to poor people (depth of outreach). Impact, on the other hand, refers
to whether microfinance really helps the borrowers, i.e. raises the incomes and welfare of the
poor. The third term, sustainability, implies full cost recovery at worst and profitability

27
 considering the cost of capital at best. A sustainable MFI is not dependent on subsidies from
governments or donors.

The goal for MFIs should be:

I. To improve the quality of life of the poor by providing access to financial and support
services;
II. To be a viable financial institution developing sustainable communities;
III. To mobilize resources in order to provide financial and support services to the poor,
particularly women, for viable productive income generation enterprises enabling them to
reduce their poverty;
IV. Learn and evaluate what helps people to move out of poverty faster;
V. To create opportunities for self-employment for the underprivileged;
VI. To train rural poor in simple skills and enable them to utilize the available resources and
contribute to employment and income generation in rural areas.

Constraints

To increase the outreach of micro finance services to the needy the issues or problems
associated with the legal, regulatory, organisational systems should be addressed. Some of the
main constraints are:

 Borrower-unfriendly products and procedures: Most bank products are standardised.

The branches do not have the right to modify the projects. Hence the products do not reach
the rural poor.
 Inflexibility and delay: Banks follow rigid procedures which result in a lot of delay.
Borrowers are de-motivated from taking further loans. Thus the amount of loans and their
terms are prefixed for a given set of client
 High transaction costs: The interest rate offered to the borrowers is regulated and so the
transaction costs are high. The borrowers have to make a large number of trips to provide
the documents. This makes loans less attractive for borrowers

28
 Legal and regulatory framework: The policymakers feel that farmers and poor people
need low interests and subsidised credit. They believe that the poor cannot save, they are
unwilling to repay the loans and the administrative costs are high for servicing them. The
RRBs act does not permit private shareholding in any RRBs, and the cooperative acts of all
states do not permit district level cooperative banks to be setup except by the state
government. The result of these two acts is that rural credit has been a monopoly of the state
owned institutions.
 Legal constraints: A majority of MFIs function as NGOs to accept funds. The major
sources of funds for NGOs are grants that are very limited. NGOs do not have appropriate
financial structure for carrying out micro finance activities. NGOs being registered as
societies or trusts do not have equity capital and can never have adequate capital. The other
alternative for the MFIs is to become a cooperative or a company. As in the long run the
primary source of lending funds for MFIs is deposits, till that stage, the MFI has to rely on
borrowings and to get it; it has to have equity capital.
 Lack of commercial orientation: Most of the MFI in the initial period are highly
successful in making credit to customers available at low cost on account of subsidies and
grants that the MFIs are able to attract. However the fail to maintain the same record in the
long run because of the lack of commercial orientation.
 Lack of proper governance and accountability: Governance and accountability are
limited in the case of not for profit organisations. This needs to be improved. The lender
should be more stringent.

29
Microfinance Institutions:

The following are the some of leading microfinance institutions in India working in the sector
.
 Association for Sarva Seva Farms (ASSEFA)

 Mitrabharati - The Indian microfinance Information Hub Mysore Resettlement and

Development Agency (MYRADA)

 SADHAN - The Association of Community Development Finance Institutions

 SEWA: Self-help Women's Association

 SKS India - Swayam Krishi Sangam

 Streedhan - Banking with Rural Women

 Working Women's Forum, Madras, India

• ACCION International, it is a Latin America’s one of the prime microfinance institution

working with the poor. In an early pioneer, ACCION 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.

30
• 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.

31
 TYPES OF MICROFINANCE INSTITUTIONS

Microfinance institutions develop and deliver a range of financial products for the poor. There
are three categories of microfinance institutions. They are:

Micro finance institutions

Non - profit Mutual Benefit For profit

1. Non profit MFIs/NGO MFIs – It consist of-

a) Public Trust
b) Societies
c) Section 25 Companies

These are Societies under the Societies Registration Act, 1860 or corresponding State Acts.
Others in this category are Public Trusts under the Indian Trust Act 1882, and non-profit
companies under Section 25 of the Companies Act, 1956. There are several NGOs which are
registered as trust/society and have helped the SHGs form into federations. Federations are
formal institutions and carry out both non-financial and financial activities including social
and capacity building activities, SHG training, and promotion of new groups, apart from
financial intermediation. 
32
These institutions cannot undertake financial intermediation activities on a large scale, as they
are prohibited from carrying out any commercial activities.

The Role of NGOs

Non-Government Organizations (NGOs) have emerged as an integral part of the institutional
structure for addressing poverty as well as rural development, gender equality, environmental
conservation, disaster management, human rights and other social issues.

The NGOs, in order to support social and economic empowerment of the poor, have vastly
widened their activities to include group formation, micro credit, formal and non-formal
education, training, health and nutrition, family planning and welfare, agriculture and related
activities, water supply and sanitation, human rights and advocacy, legal aid and other areas.

These organizations mostly follow the target-group strategy under which the poor with
similar socioeconomic interests are organized into groups to achieve their objectives.

2. Mutual benefit - It consist of-

a) Self- help groups and Federation
b) Co- operative Societies

Since the reconstitution of the Commission in January 2000, the Commission started projects
with the aim of making women economically empowered.  One of the major initiatives taken
by the Delhi Commission for Women in the year 2000-2001 was to set up pilot projects in
collaboration with partner NGOs for empowering women economically and thus helping
prevent crimes against women.  The Commission tied up with various NGOs working in
various parts of Delhi for formation of Self-Help Groups.

What is SHGs
Self help support groups provide a setting in which people who share similar experiences
come together to offer practical and emotional support in a reciprocal and mutually beneficial
manner. People go to self help support groups for many different reasons.

33
Self – Help Group (SHG) is a small voluntary association of poor people, preferably from the
same socioeconomic background. They come together for the purpose of solving their
common problems through self-help and mutual help. The SHG promotes small savings
among its members. The savings are kept with a bank. This common fund is in the name of
the SHG. Usually, the number of members in one SHG does not exceed twenty.

The concept of SHG is based on the following principles:

• Self-help supplemented with mutual help can be a powerful vehicle for the poor in
their socioeconomic development;
• Participative financial services management is more responsive and efficient;
• Poor need not only credit support, but also savings and other services;
• Poor can save and are bankable and SHGs as clients, result in wider out reach, lower
transaction cost and much lower risk costs for the banks;
• Creation of a common fund by contributing small savings on a regular basis;
• Flexible democratic system of working;
• Loaning is done mainly on trust with a bare documentation and without any security;
• Amounts loaned are small, frequent and for short duration;
• Defaults are rare mainly due to group pressure; and
• Periodic meetings non-traditional savings.

Essential Features of SHGs:

The following are the major essential features to be kept in mind for successful
functioning of SHG’s.

• Group members come together voluntarily.

• Basis of coming together is mutual help.
• Homogenous group.
• Regular interaction among group members
• Group independently takes decision and manages its activities.
• Basis of people coming together is affinity.

34
 • All group members' participation is the process.
• Cooperation and discussion are the cornerstone of its functioning group maintains
its own accounts

SHG is a group formed by the community women, which has specific number of members
like 15 or 20. In such a group the poorest women would come together for emergency,
disaster, social reasons, economic support to each other  have ease of conversation, social
interaction and economic interactions.

Objectives

 To sensitize women of target area for the need of SHG and its relevance in their
empowerment process.
 To create group feeling among women.
 To enhance the confidence and capabilities of women.
 To develop collective decision making among women.
 To encourage habit of saving among women and facilitate the accumulation of their
own capital resource base.
 To motivate women taking up social responsibilities particularly related to women
development.

3. For profit - It consist of NBFCs.

It is an heterogeneous group of institutions (other than commercial and co-operative banks)

performing financial intermediation in a variety of ways, like accepting deposits, making
loans and advances, leasing, hire purchase, etc. They raise funds from the public, directly or
indirectly, and lend them to ultimate spenders. They advance loans to the various wholesale
and retail traders, small-scale industries and self-employed persons. Thus, they have
broadened and diversified the range of products and services offered by a financial sector.
Gradually, they are being recognised as complementary to the banking sector due to their
customer-oriented services; simplified procedures; attractive rates of return on deposits;
flexibility and timeliness in meeting the credit needs of specified sectors; etc.
35
The working and operations of NBFCs are regulated by the Reserve Bank of India
(RBI)within the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and the
directions issued by it under the Act. As per the RBI Act, a 'non-banking financial company'
is defined as:- (i) a financial institution which is a company; (ii) a non banking institution
which is a company and which has as its principal business the receiving of deposits, under
any scheme or arrangement or in any other manner, or lending in any manner; (iii) such other
non-banking institution or class of such institutions, as the bank may, with the previous
approval of the Central Government and by notification in the Official Gazette, specify.

PRODUCT AND SERVICES

Micro-finance could be defined as a set of services comprising the following activities:

Micro lending –
Over the years, NGOs in microfinance have developed innovative lending methodologies to
reach poor clients with microloans. They have borrowed many of their practices from
informal finance. Absence of these methodologies explains, in part, why formal lending
institutions such as banks have traditionally had difficulty reaching micro clients. Some of the
principal characteristics of micro lending are:

• Short-term, working-capital loans;

• Lending based on character, rather than collateral;
• Sequential loans, starting small and increasing in size;
• Group loan mechanisms as a collateral substitute;
• Quick cash-flow analysis of businesses and households, especially for individual loans;
• Prompt loan disbursement and simple loan procedures;
• Frequent repayment schedules to facilitate monitoring of borrowers;
• Interest rates considerably higher than those for larger bank customers to cover all costs of
the microfinance program;
• Prompt loan collection procedures;
• Simple lending facilities, close to clients;

36
• Staff drawn from local communities with access to information about potential clients; and
Computerization with special software to allow loan tracking for larger programs.

Micro deposits –
The new microfinance bankers knew relatively little about deposit mobilization
methodologies that reach the low-income and/or microenterprise client. There were some
notable exceptions, however, such as the Bank Rakyat Indonesia and the Bank Dagang Bali.
Perhaps best known is the Bank Rakyat Indonesia Unit Desa savings program, which has the
following characteristics:

Features attractive to the micro client:

• Liquid passbook savings accounts and low minimum balances;
• Depositories conveniently located;
• Secure deposits; and
• Real, positive interest rates on deposits.

Operational features of the program:

• Savings accounts with very low minimum balances;
• Lower levels of interest, compared with commercial banks, because of higher
administrative costs;
• Simple, hospitable buildings and mobile units with low overhead;
• Simple administrative forms and procedures;
• Courteous and friendly staff; and
• Incentives for savings, such as lotteries.

Human Resources
Until recently, microfinance methodologies have been labor-intensive, and all the bankers
interviewed evinced special concern for recruitment, training, and motivation of staff.

Micro insurance – Gives the entrepreneurs the chance to focus more on their core business
which drastically reduces the risk affecting their property, health or working possibilities. The
is different types of insurance services like life insurance, property insurance, health insurance
37
and disability insurance. The spectrum of services in this sphere is constantly expanded, as
schemes and terms of providing insurance services are determined by each company
individually;

Micro leasing – For entrepreneurs or small businesses who can´t afford buy at full cost they
can instead lease equipment, agricultural machinery or vehicles. Often no limitations of
minimum cost of the leased object;

Money transfer – A service for transferring money, mainly overseas to family or friends.
Money transfers without opening current accounts are performed by a number of commercial
banks through international money transfer systems such as Western Union , Money Gram,
and Anelik. On the surface they may seem like small money transfers, but when one considers
that such transactions take place millions of times around the world each week, the numbers
start to become impressive. According to the World Bank, the annual global market for
remittances – money transferred home from migrant workers – is around 167 billion US
dollars. The estimated total is closer to 230 billion dollars if one counts unregulated
transactions. Remittances are also an important source of income for many developing
countries including India, China and Mexico, all of which receive over 20 billion dollars each
year in remittances from abroad.

38
 INTEREST RATE CHARGED BY MFIs

Interest charged on loans is the main source of income for MFIs.  Thus they must be high
enough to cover operational costs.  Since micro-lending remains a high-cost operation,
interest rates remain high.  MFIs in the Asia-Pacific region charge rates ranging from 30 to
70% a year. However, it is important to remember that comparisons with rates charged by
commercial banks are inappropriate.  In that case, larger loans mean lower transaction costs
and result in lower interest rates. 

Still, there is much to be gained through lower microcredit interest rates.  The current high
costs mean microcredit efforts are not reaching as many people as they could be.   Interest
rates charged for lending are a function of a number of factors, of those, transaction costs and
risk figure prominently into the derivation of micro-lending interest rates. Micro-lenders are
subject to significantly higher transaction costs than banks in the developed world, both in
absolute and relative terms. 

Three types of costs  are associated with the lending process:

1. The cost of funds for on-lending,

2. The cost of risk (loan loss), and
3. Administrative costs (identifying and screening clients, processing loan applications,
disbursing payments, collecting repayments, and following up on non-repayment).

With regard to loan administration, Microcredit is an industry that is heavily dependent on

personal contact for its execution . This is very time-consuming and resource intensive, and
allows each loan officer to reach only a limited audience of potential borrowers. By contrast,
much of the administrative process for commercial banks leverages technology for
computerized credit scoring, communication with clients and payment processing. Not only is
the administrative process less efficient for a micro-lender for each loan, but the problem
is compounded further by the fact that while a developed commercial institution may lend a
large sum of money to one borrower, a micro-lender will lend very small sums to many

39
borrowers, thereby multiplying the total administrative costs by X number of borrowers.
Providing financial services to poor people is quite expensive, especially in relation to the size
of the transactions involved. This is one of the most important reasons why banks don't
usually provide small loans.
Lets take an example: A US$100 loan, for example, requires the same personnel and re-
sources as a $1,000 one thus increasing per unit transaction costs. Loan officers must visit the
client's home or place of work, evaluate creditworthiness on the basis of interviews with the
client's family and references, and in many cases, visit their clients to reinforce the repayment
culture. It can easily cost $25 to make a icroloan. In absolute terms this is asily understandable
but in relative erms it might represent 25% of the alue of the loan, and force the nstitution to
charge a seemingly high rate of interest to cover the cost of its oan administration.

Why clients are willing and able to pay these rates

Practical evidence shows that clients are willing to pay the higher interest rates necessary to
assure long term access to credit. They recognize that their alternatives—even higher
interest rates in the informal sector(moneylenders, etc.) or simply no access to credit—are
much less attractive for them.

Interest rates in the informal sector can be as high as 20 percent per day among some urban
market vendors. Many of the economic activities in which the poor engage are relatively low
return on labor, and access to liquidity and capital can enable the poor to obtain significantly
higher returns, or to take advantage of economic opportunities. The return received on such
investments is often many times greater than the interest rate charged. In economic terms we
could say that poor people previously without access to capital operate in a very steep part of
the utility curve. This fact actually makes microfinance economically viable and is one of the
core drivers of what we expect will be a rapid expansion of private-sector led microfinance
initiatives in the next year.

40
 Micro financial sector development and regulation bill, 2007

The Micro Financial Sector (Development and Regulation) Bill, 2007 seeks to promote the
sector and regulate micro financial organizations (MFO). The Bill was introduced in the Lok
Sabha on March 20, 2007. It has been referred to the Standing Committee on Finance
(Chairperson: Shri Ananth Kumar) on April 27, 2007.

HIGHLIGHTS OF THE BILL

 The Micro Financial Sector (Development and Regulation) Bill, 2007 seeks to
promote the sector and regulate micro financial organisations (MFO).
 National Bank for Agriculture and Rural Development (NABARD) shall regulate the
micro financial sector.
 Every MFO that accepts deposits needs to be registered with NABARD. Conditions
for registration include (a) net owned funds of at least Rs 5 lakh; and (b) at least three
years in existence as an MFO. All MFOs, whether registered or not, shall submit
annual financial statements to NABARD.
 Every MFO that accepts deposits has to create a reserve fund by transferring a
minimum of 15% of its net profit realised out of its thrift and micro finance services
every year.
 The central government may establish a Micro Finance Development Council to
advise NABARD on formulation of policies related to the micro financial sector.
 NABARD shall constitute a Micro Finance Development and Equity Fund to be
utilized for the development of the sector.

41
 DEFINATIONS IN THE BILL

MICROFINANCE-Micro finance is defined as the provision of thrift (savings), credit and

other financial services and products of very small amounts to the poor for enabling them to
raise their income levels and improve living standards.

MFO- the Bill defines an MFO as any organization that provides micro finance services and
includes societies, trusts, and co-operative societies (except co-operative banks, agricultural
co-operative societies, and co-operative societies engaged in industrial activity or sale of any
goods and services). The definition of MFO excludes SHGs and groups of SHGs.

MICRO FINANCIAL SERVICES -“micro financial services” to include insurance and

pension services without specifying to whom such services are to be provided.  This implies
that every insurance and pension company would be regulated by NABARD. 

An MFO may provide micro financial services to an 'eligible client'. Such services may be in
the form of financial assistance which cannot exceed (a) Rs 50,000 in aggregate per individual
for small and tiny enterprise, agriculture, and allied activities or (b) Rs 1.5 lakh in aggregate
per individual for housing purposes. These services also include insurance and pension
services, and such other services as may be specified by NABARD.
In India, micro finance is provided by apex development financial institutions (such as
National Bank for Agriculture and Rural Development - NABARD, Small Industries
Development Bank of India, and Rashtriya Mahila Kosh), commercial banks, regional rural
banks, co-operative banks, non banking financial companies (NBFCs) and various not-for-
profit entities.

There are different mechanisms through which the delivery of micro credit loans takes place.
Banks may lend directly to customers. Second, NABARD sponsors the Self Help Group-Bank
Lending Programme (SBLP). Under SBLP, self help groups (SHGs) need to save regularly for
a minimum of six months and maintain prescribed records and accounts in order to become
eligible to be linked to local banks. This programme provides credit to 22.38 lakh SHGs.

42
 Third, commercial banks or apex institutions lend to micro finance organizations (MFOs) for
further lending to groups or individuals (see chart below).

 
Chart: Institutional flow of micro finance

Key Concerns  

1.  It leaves non-banking financial companies and section 25 companies out of the purview of
its regulatory framework.

2. Does not regulate or put a ceiling on the interest rate charged to the clients in
SHGs.                                                                                                                             

3. It gives license to Micro Finance Organisations to make profit out of the thrift of the poor
women.                                                                                                                     

4. It weakens financial and social responsibility of banks, which will have a bad impact on the
poorest of the poor. 

5. It leaves non-banking financial companies and section 25 companies out of the purview of its
regulatory framework.

6. It does not regulate or put a ceiling on the interest rate charged to the clients in
SHGs.                                                                                                                                     

7. It gives license to Micro Finance Organisations to make profit out of the thrift of the poor
women.

8. It weakens financial and social responsibility of banks, which will have a bad impact on the
poorest of the poor.

9. It ignores the empowerment aspect of micro finance which should be an integral part of all
women’s self help groups. 

43
 Various micro finance institutions and NGOs

Bandhan

Bandhan was born as a capacity building institution (CBI) in the year 2000 with the objective
of addressing two grave issues:

 Poverty alleviation
 women empowerment

The sole solution to it lay in increasing the family income through women. This in turn called
for promotion, generation and development of income generating activities through the easy
accessibility of credit. Its initial objective as a capacity building institution was to build weak
MFIs into strong and effective source for the development of the poor and to ensure maximum
outreach from these organizations. In this regard, Bandhan felt the need of a laboratory where
the trainee MFIs after their training can have the first hand knowledge of microfinance and
it’s various facets. Thus the konnagar branch was opened up in the year 2001.However during
it's tenure as a CBI Bandhan came across various experiences that were responsible for its
pivotal shift to microfinance.

A visit to Bangladesh finalized Bandhan's decision to shift to credit delivery systems. It

decided starting work back in Bangladesh.

44
Financial products

1 Micro Loan Product

Bandhan offers Micro loan (1 year) to the borrowers. Bandhan follows a group formation,
individual lending approach. A group of 10-25 is formed and regular meetings are called.
After the members have attended the group meetings for two successive weeks, they are
entitled to loans. The loans are disbursed individually and directly to the borrowers through
the group.

2 Micro Enterprise programme (MEP)

Bandhan has realized that certain members have graduated in their capacities to take and
manage higher loans. These members demand a much higher loan cycle which is not at
present covered by the micro loan product of Bandhan. Thus to cater to these needs it
introduced the micro enterprise programme, a result of a few modifications in the micro loan
product.

3 Micro Health Loan

Over the years, Bandhan has been forwarding loans for income generation purposes however
the members are equally susceptible to health hazards and end up spending the loans on the
health concerns. Taking this into account Micro Health Loan was launched that would address
health emergency needs of the client and their family members i.e. husband's and children's
only.

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 Figure 1 Caste wise coverage in 2007-08 (micro health loan)

4 Insurance

Bandhan has tied up with Life Insurance Corporation to provide insurance coverage for the
entire loan amount availed in case of death of the beneficiary. Hundred percent of their
beneficiaries are covered under the programme.
The programme is currently running in the districts of Murshidabad, Malda and South- 24
parganas. Assets worth Rs.1531,663 have been distributed to 397 beneficiaries. Assets are
cow rearing, sheep rearing etc. The programme is also piloted in 4 urban branches of Kolkata.
Assets worth Rs.42,016 have been distributed to 23 beneficiaries. Most of the beneficiaries
have graduated to local micro finance programs.

5 Micro finance and Health protection (MAHP) initiative

Bandhan was extending micro finance services but realized that emergency health concerns
caused income leakage. Keeping this in mind Bandhan introduced it's Health programme with
assistance of freedom from hunger (FFH), a California based organization. The goal of the
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programme is to reduce the health expenditure of the poor families, in a way to sustain the
micro finance programme of Bandhan.

KASHF

Inspired by the success of the Grameen Bank, Kashf Foundation (meaning miracle or
revelation i.e. a process of self-discovery) began in 1996 as an action research program
focusing, for the first two years, on determining and understanding key factors having
an impact on the demand for micro finance services by poor women.
Kashf Foundation began with many firsts: it was the first specialized Micro finance institution
in Pakistan, it was the first Micro finance institution targeting only women from low income
communities and it was also the first Micro finance institution to charge a sustainable price for
its services. Since its inception, Kashf Foundation has continued to trail-blaze – in 1999 it
introduced the first pro-women consumption loan in the sector, in 2001 it was the first Micro
finance institution to offer micro-insurance services by collaborating with one of Pakistan’s
oldest insurance companies, in 2003 it was the first Micro finance institution to become
financially sustainable, in 2004 it was the first Micro finance institution to obtain an
investable credit rating and in 2007 it has been able to close over $36 million in commercial
deals with key local and international banks.

KASHF offers the following products to it's clients:

1 General loan (GL):

The GL is based on group collateral where a group of 25 women jointly insure each other
against default. In light of KASHF's strong commitment to customer care, center members
have to wait only 7 days after their registration to get the first loan, while repeat clients can
obtain a loan within 24 hours.  The loans are advanced to female members of the household
and it is the mutual decision of the household to decide on the economic activity that they will
invest in.

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2 Emergency loans (EL):

The Emergency loan has been designed to provide credit to clients during financially volatile
periods. Clients use EL to pay their children's school fees, utility bills and all other unplanned
petty expenditures. The EL loan is very easy and quick to access. Timely access to money
gives women a sense of relief and comfort since they are able to meet the needs of their
families and do not have to borrow at exorbitant rates from traditional money lenders or
request it from relatives and friends. The product is seen as a client friendly and women
friendly product due to its ease of availability. The EL serves as a complementary loan to the
GL and loans are disbursed through the same center methodology.

3 Home Improvement Loan (HIL):

Kashf introduced the HIL in 2006, since home improvement and renovation was identified as
a key priority by clients. The loan aims to increase the asset value of clients’ homes and
improve their living standards. Although seen as a non-productive loan some clients have
used it to make a room for the purpose of rental, while others have used it to provide a shed
for their cattle. Also, some of Kashf’s rental clients have been able to use it to construct basic
structures on plots of land they previously owned and which they hope to improve
incrementally.
The HIL works on the same group liability model where three to ten clients from the existing
center form an HIL group and the responsibility of approval and repayment lies with the
center. Since its inception in July 2006, a total of 215 loans have been disbursed resulting in a
total disbursement of Rs 4,680,000.

4 Business Surmaya Loan (BSL):

Clients requiring loans below Rs 500,000 cannot obtain access to formal financial sources,
since such amounts are still too small for commercial banks. Kashf targets fast moving small
entrepreneurs through the BSL, the entire methodology of which is based on a credit scoring
model. The BSL is advanced to clients with a minimum of 2 years running experience of their
businesses and has no collateral requirements. Generally the loan has a minimum processing
time of less than 5 days.

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5 Insurance
Credit for life insurance has been a popular product amongst Kashf’s clients, since economic
upheavals are a regular part of their lives. Kashf was one of the pioneer organizations to
introduce life insurance for poor clients in order to deal with emergency periods. This service
is provided to the client and her spouse at a minimal premium. The insurance covers all
outstanding loan balances plus a small burial payout at the time of the death of either party.
This means that the family is able to cope with the consequences of such an event and faces
no liabilities at that time. This saves them from the exploitative lending practices of the
traditional money lender, where the burden of repayment of the loan is transferred to the
remaining family members.

What is the difference between microfinance and microcredit?

Microfinance is defined as the practice of providing financial services – such as loans as low
as $100, savings and insurance – to very poor families, to help them grow tiny businesses or
engage in other productive economic activities. This process enables the working poor to
become more self-sufficient and in turn, improve the lives of family members, communities
and whole societies.

Microfinance used to be known only as “microcredit,” or just the part of financial

services that refers to loans. Microcredit came to prominence in the 1980s, though early
experiments date back 30 years ago in Brazil, Bangladesh and a few other countries. This
innovation empowered the poor in a new way by providing them with access to financial
services that were formal and secure. Microcredit also solved the problems of earlier kinds of
development lending – by insisting on repayment, by charging interest rates that could cover
the costs of delivering credit, and by focusing on clients whose alternative source of credit
was informal and insecure.

Microcredit is loaned to a micro-entrepreneur by a bank or other institution and can be

offered, often without collateral, to a group or an individual.

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  Group lending, also known as solidarity group lending or village banking, is a
mechanism that allows a number of individuals to gain access to microcredit by
providing collateral or guaranteeing a loan through a group repayment pledge. The
incentive to repay is based upon peer pressure; if one person in the group defaults, the
other group members make up the payment amount. 
 Individual lending focuses on providing microcredit to one client and does not
require other people to provide collateral or guarantee a loan.

One type of microcredit is a working capital loan which is most often used by a client to
purchase additional inventory for their business, such as bags of grain for a grain seller or soft
drinks for a beverage vendor.

Over time, the microfinance industry recognized that the poor who lack access to traditional
formal financial services required a variety of financial products to meet their needs, not just
microcredit. So microcredit evolved into microfinance. Microfinance includes a broader
range of services, such as loans, savings, insurance and transfer services (remittances)
targeted at low-income clients. A variety of institutions can provide these services, including
NGOs, credit unions, cooperatives, private commercial banks, non-bank financial institutions
(some that have transformed from NGOs into regulated institutions) and parts of state-owned
banks.

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 The Impact of Microcredit

1. Microcredit and the Millennium Development Goals

In 1996 Ismail Serageldin, the then chair of the Consultative Group to Assist the Poorest
(CGAP) claimed that “[m]icrofinance is a proven instrument to assist the very poor.”
This view is also shared by the World Watch Institute5 and underlines what has been stated
above, namely, that microfinance can be used as a strong anti-poverty tool. But does
microfinance actually meet these expectations and keep this promise?

The impact that microcredit has on the lives of poor people will be demonstrated by showing
how it contributes to each of the eight Millennium Development Goals (MDGs), which are
related to the reduction of poverty in all its forms. These goals were resolved in September
2000 by the General Assembly of the UN in their Millennium Declaration.

2. The Eradication of extreme Poverty and Hunger

The aim of the first MDG is to halve the proportion of people who live on less than $1 a day
between 1990 and 2015. According to current population projections of the World Bank, this
would equal 849 million people in 2015.

Today almost 1.1 billion people live on less than $1 and more than 2.7 Billion live on less
than $2 per day. The mean income for those living under $1 a day is $0.77 and it is $1.25 for
those living under $2 a day. While the number of people living on less than $1 per day is
slowly decreasing and is expected to be 913 million in 2015, the number of people living on
less than $2 a day is actually increasing. One of the outcomes from this degree of poverty is
that more than 27,000 children die every day from mostly preventable diseases, many of them
related to hunger.

Microcredit enables poor people to start new businesses, or to diversify existing ones, which
help them to increase their income. In addition to large amounts of anecdotal evidence, several
studies have documented the positive economic impact microcredit has on its clients. Cloud
and Panjaitan-Drioadisuryo have found that the average income of a sample of BRI borrowers
has increased by 112 percent and that 90 percent of their families have crossed the poverty
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line.60 Only 12 out of the 121 respondents of that study reported that their income had not
increased.61 According to the Grameen Bank website, 51.09 percent of their clients have
crossed the poverty line since they took their first loan.

3. Achievement of universal primary Education

The aim of the second MDG is to ensure that all children will be able to complete primary
school by 2015. Currently more than 100 million children, most of them girls, are not in
school.Besides school fees, poor households often can not afford to send their children to
school because they need them to help in the family business. Microcredit programs mainly
contribute to the second MDG by increasing family’s income and therefore enabling parents
to send their children to school. Barnes, Gaile and Kibombo found that clients of an MFI in
Uganda spent significantly more on children’s education than non-clients, and in Zambia
Barnes showed that ongoing participation in the Zambuko Trust’s program had a positive
impact on the member’s children staying in school. In Bangladesh, the probability of girls
enrolling in school increased by 1.9 percent for every 1 percent increase in Grameen Bank
loans to female clients. For boys this number was even higher with the mean being 2.4
percent.

4. Promote gender Equality and empower Women

The aim of the third MDG is to eliminate the disparity in the ratios of girls to boys in primary,
secondary and tertiary education, in the ratio of literate females to males and to increase the
share of women in the labor market and in parliament.

At present the literacy rate for women is lower than for man all over the world. According to
the Human Development Report 2004, the average female literacy rate as a percentage of
male literacy rate is 75.9 in developing countries and is as low as 37 in Niger. But women are
not only discriminated against in education but also in access to medical services and
therefore have a higher mortality rate than man. The worldwide tendency for women to be
underrepresented in the labor market and in the parliaments is even more severe in developing
countries.

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5. Reduce Child Mortality and improve Maternal Health
The aim of the fourth MDG is to reduce the under-five mortality rate by two-thirds between
1990 and 2015 and the fifth MDG strives for a three quarter reduction in the maternal
mortality ratio by the same date.

MFIs are mainly contributing to these MDGs by increasing families income and therefore
enabling the households to afford better nutrition and medical services. Furthermore, they are
often linked with micro insurance or health education programs. Although no study has been
conducted so far on the direct impact of microcredit on maternal health, it can be assumed that
an overall improvement of access to medical services reduces maternal mortality as well. A
study of the Morgan State University, for example, suggests that microcredit has a positive
effect on the prevalence of contraceptives which leads to a decrease of unwanted pregnancies
and therefore reduces maternal death.

6. Develop a global Partnership for Development

The eight MDG is about the means to achieve the other seven MDGs. It calls for all players
involved in the endeavor of development and poverty eradication to work as partners in a
global context.

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 Limitation of Government Schemes/Rural Banks

In India, numerous government schemes have tried to provide various subsidized services to
the poor households. However, various studies have exposed the limitation of these programs,
showing the lack of access of mainstream financial services for these poor households and
their over-dependence on the local moneylenders in meeting their consumption and micro-
enterprise demands. According to an estimate, only 16% credit usage was met by the formal
sources, while the remaining 84% was met by the informal services. Despite having a wide
network or rural bank branches in the country and implementation of many credit linked
poverty alleviation programmes, a large number of the very poor continue to remain outside
the fold of the formal banking system. Various studies also suggested that the policies,
systems and procedures and the saving and loan products often did not meet the needs of the
very poor. NABARD refinances the microfinance sector loans by banks, but doesn’t
undertake direct financing. Thus, its ability to promote innovations or establish any “missing
link” units is very limited. Small Industries Development Bank of India (SIDBI) mainly uses
the network of State Financial Corporations (SFCs) and commercial banks to extend
microfinance sector loans in rural small towns. It also faces the same constraint. State
Financial Corporations (SFCs) largely concentrate on the upper end of SSIs and that too in
urban areas. However, through their district branches, a small proportion of lending is done to
the microfinance sector. hey Their lengthy and stringent procedures inhibit the poor.
Regional Rural Banks (RRBs) are located in rural areas, have low CD ratio but are suffering
immensely from lack of skills, incentives and infrastructure support. As can be seen from
above, while there is no dearth of institutions and branch network in urban and rural areas,
this physical outreach does not translate into access to credit by microfinance sector
producers.

However, wherever mainstream finance institutions are engaged in financing small borrowers,
their experience is characterized by a number of factors. Their institutional design and
mandate, which determines their procedures, do not suit the poor. The poor find their
procedures cumbersome, complicated and unsuitable for the local environment.. They have
also failed to provide a mix of credit for both consumption and productive loans. Therefore
poor feel alienated in dealing with them. They feel scared to go to them. Repeat loans, except
54
for crop production are rare, even for the borrowers who have repaid fully. Further, even
though the many of the loans extended to the poor by the public sector financial institutions
are subsidized, their ultimate cost to the borrowers is high which includes payments to the
middle men, wage and business loss due to time spent in getting the loans approved.

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 PRESENT SCENARIO

Most MFIs in India since the beginning of 1990 have been adopting the Joint Liability Model.
In the Indian context, microfinance is more inclined towards providing micro-credit to the
financially excluded population. Micro-credit has been largely directed by the non-profit
sector, but the emergence of for-profit Non-Banking Financial Companies (NBFCs) provided
the much needed impetus to the industry. NBFCs are regulated by the Reserve Bank of India;
regulations currently do not allow most MFI NBFCs to accept savings deposits.

In India microfinance is delivered by two primary channels called the Self-Help-Groups

(SHGs) and MFIs. As f March 2008, the total credit disbursement has been Rs 22,000 crore
(~USD 4.4 bn) through two primary channels – the SHG-Bank Linkage channel (75%) and
the MFI channel (25%). This represents less than10% of the total demand of Rs 250,000
crores. The Reserve Bank of India estimates that about 50% of the Indian population is still
unbanked.
There is no centralized database on the number of MFIs that operate in India. Estimates have
put it anywhere between 800 and 1,200. New institutions are being set up at a rapid pace.
These institutions look to exploit the market opportunities available for providing loans to
small clients. However, the success of these institutions depends a lot on managerial
commitment, critical mass, balanced approach, etc., to achieve the double bottom line of
financial sustainability and socially relevant engagement.

Top 5 MFIs by outreach and loan portfolio

By clients No. (million) By loan O/S Rs. (million)
SKS 1.88 SKS 7818
Share microfin 1.29 Spandana 7285
Spandana 1.19 Share microfin 5953
Bandhan 0.76 SKDRDP 3370
Asmita 0.7 Asmita 3360

Market share of different form of MFIs

Legal form No. Share(loan portfolio) %

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 NBFC 25 59.7%
Sec 25 company 22 11.6%
Society 104 18.8%
Trust 21 6.8%
Others 34 3.1%

Most of the large MFIs were typically NBFCs, the smaller MFIs were either socities or trusts.
The growth ratehas been the highest in the case of medium-sized MFIs with a portfolio of Rs
5 crore to 50 crore.

Investment Climate

Equity investments in microfinance have been growing quickly in recent years and there are
now 24specialized microfinance equity funds globally.

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Despite the global economic slowdown many funds and private equity players have expressed
interest and in fact invested in the microfinance sector. The reasons for the trend are many. A
large clientele of MFIs in the country is now being seen as that section of the society which is
largely insulated from the ripples of economic slowdown.

CHAPTER -6
RECOMMENDATIONS

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1. Greater legitimacy, accountability and transparency will not only enable MFIs to source
adequate debt and equity funds, but could eventually enable MFIs to take and use savings as a
low cost source for on-lending.

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. Such MF-NBFCs could be defined as
companies that provide thrift, credit, micro-insurance, remittances and other financial services
up to a specified amount to the poor in rural, semi-urban and urban areas.

3. To ensure that this provision is used by NBFCs which are focused on providing
microfinance to the poor, 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, whether
given through a group mechanism or directly.

4. The absence of Prudential Norms for this sector despite them performing similar functions
as the Banking sector of the country. Such norms are highly essential to regulate this sector, to
give it a formal recognition.

5. In addition, given the potential of this sector private sector participation should be
encouraged which can further organize and cushion it through financial assistance.

6. The MFIs and NGOs engaged in providing these services must be permitted to accept
deposits so that they can become self sufficient and mobilize these deposits into loans. This
will reduce their dependence and make them more efficient, this in turn can enable them to
charge lower interest rates as well.

CHAPTER – 7
BIBLIOGRAPHY

 www.google.com
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 www.microfinancegateway.com
 www.indiamicrofinance.com
 www.accion.org
 www.grameen-info.org
 www.rbi.org
 Sa-dhan (2009) Bharat Microfinance Report Viewed on 18 October 2009
(http://www.indiamicrofinance.com/microfinance/microfinance-india/the-
bharat-microfinancereport- quick-data-2009.html)
 www.nabard.org
 www.microfinanceregulationcentre.org
 www.bandhanmf.com
 Articles from, The Times of India and Hindustan Times.

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