Microfinance Origin, Definitions, Advantages, Barriers

Microfinancing’ was introduced in India in the 1980s as a solution to poverty and to empower women. Despite its strong potential, the microfinance sector faces challenges related to accessibility in rural India.

Microfinance is a type of banking service provided to those who have difficulty in accessing formal financial services. It is targeted at the low-income and unemployed fraction of the population. The institutions supporting microfinance offer services such as lending, setting up bank accounts and providing micro-insurance products. In developing countries such as India, financial services through formal channels do not meet the demands of the rural poor, so microfinance can help small-scale businesses flourish by providing greater financial stability.

Microfinance, also called microcredit​, is a type of banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services.

While institutions participating in the area of microfinance most often provide lending microloans can range from as small as Rs 10,000 to as large as Rs 500,000 many banks offer additional services such as checking and savings accounts as well as micro-insurance products, and some even provide financial and business education. The goal of microfinance is to ultimately give impoverished people an opportunity to become self-sufficient.

Microfinance is a category of financial services targeting individuals and small businesses who lack access to conventional banking and related services. Microfinance includes microcredit, the provision of small loans to poor clients; savings and checking accounts; microinsurance; and payment systems, among other services. Microfinance services are designed to reach excluded customers, usually poorer population segments, possibly socially marginalized, or geographically more isolated, and to help them become self-sufficient.

Origin

In India, the first initiative to introduce microfinance was the Self-Employed Women’s Association (SEWA) in Gujarat, which established SEWA Bank in 1974. Since then, this bank has been providing financial services to individuals who wish to grow their own businesses in rural areas. One successful initiative is Kudumbashree, the Kerala state’s Poverty Eradication Mission that was launched in 1998.

This female-led community organisation of Neighbourhood Groups (NHGs) brings women from rural and urban areas together to fight for their rights and helps empower them. Through these NHGs, women work on a variety of issues like health, nutrition and agriculture. They can collect income and seek microcredit while working under this scheme. Such small-scale initiatives are promoting financial independence in underprivileged areas.

There is a need to provide microfinance facilities to cater to India’s large rural population. The main objectives of microfinance in India should be promoting socio-economic development at the grassroots level through a community-based approach, empowering women and increasing the household income. As with implementing any transformative initiative, running a microfinance programme in rural India comes with some challenges:

The International year of Microcredit consists of five goals:

• Assess and promote the contribution of microfinance to the MFIs
• Make microfinance more visible for public awareness und understanding as a very important part of the development situation
• The promotion should be inclusive the financial sector
• Make a supporting system for sustainable access to financial services
• Support strategic partnerships by encouraging new partnerships and innovation to build and expand the outreach and success of microfinance for all.

Microfinance Companies in India

Some of the microfinance companies that offer loans to the unbanked and under banked population in India as are follows:

• Arohan financial banks
• BSS microfinance pvt ltd.
• Cashpor microcredit
• Equitas microfinance pvt ltd
• Asirvad microfinance pvt ltd
• Bandhan financial services pvt ltd.
• Disha microfin pvt ltd
• Annapurna microfinance pvt ltd
• Esaf microfinance and investments pvt ltd
• Fusion microfinance pvt ltd

Advantages

• Borrowers are from the low-income group
• Loans are of small amount, micro loans
• Short duration loans
• Loans are offered without collaterals
• High frequency of repayment
• Loans are generally taken for income generation purpose

Barriers

Lack of Enough Awareness of Financial Services in the Economy

A developing country in the making, India has a low literacy rate, which is still more moderate in its rural areas. A large chunk of the Indian population fails to understand the basic financial concepts. There is a severe lack of awareness of financial services provided by the microfinance industry among the masses. This lack of adequate knowledge is a significant factor that keeps the rural population from accessing MFIs for easy credit to meet their financial needs.

Inadequate Investment Validation

Investment valuation is a crucial capability for the healthy functioning of an MFI. The developing nature of the markets in which MFIs operate, the market activity is often limited. That is why it becomes difficult for MFI to gain access to market data for valuation purposes.

Widespread Dependence on Indian Banking System

Because most microfinance institutions function as registered Non-Governmental Organizations (NGOs), they are dependent on financial institutions such as commercial banks for stabilized funding to carry out their own lending activities. Most of these commercial banks are private institutions charging a higher rate of interest. They also sanction loans for shorter periods. The massive dependence of Indian MFIs on banks makes them incompetent as a lending partner.

Higher Interest Rates

The financial success of MFIs is limited when compared to commercial banks in India. The centuries-old banking system has a strong foothold in Indian grounds and is slowly evolving to meet the needs of the times. Most Microfinance Institutions charge a very high rate of interest (12-30%) when compared to commercial banks (8-12%). The regulatory authority RBI issued guidelines to remove the upper limit of 26% interest on MFI loans.

Over-Indebtedness

The microfinance sector deals with marginalized sections of Indian society intending to improve their standard of living, and thus over-indebtedness poses a severe challenge to its growth. The growing trend of multiple borrowing by clients and inefficient risk management are the most significant factors that stress the microfinance industry in India. The microfinance sector gives loans without collateral, which increases the risk of bad debts. Fast-paced growth needs proper infrastructural planning, in which the Indian microfinance sector evidently lacks.

Regulatory Issues

The Reserve Bank of India (RBI) is the premier regulatory body for the microfinance industry in India. However, RBI more or less caters to commercial and traditional banks more than it helps MFIs. Even the needs and the structure of microfinance institutions are entirely different from those of other conventional lending institutions.