FINANCE SECTOR
Dissertation submitted in part fulfilment for the requirement of the
Degree of
National Law University
I hereby declare that the dissertation entitled “THE ROLE OF
MICROFINANCE IN INDIAN FINANCE SECTOR” Submitted
at is outcome of my own work carried out under the supervision of PROF. Mr. Anil
Kumar Rai, National Law University, Delhi.
I further declare that the best of my knowledge the dissertation does not contain any part
of work, which has not been submitted for the award of any degree either in this
University or any other institutions without proper citations.
Riti Singh
CERTIFICATE OF SUPERVISOR
This is to certify that the work reported in the LL.M dissertation entitled “THE
ROLE OF MICROFINANCE IN INDIAN FINANCE
SECTOR” submitted by RITI SINGH at National Law University, Delhi is
a bona fide record of her original work carried out under my supervision.
Prof. Mr. Anil Kumar Rai
National Law University, Delhi
Place: New Delhi, India
Date:
IV
ACKNOWLEDGEMENT
I am immensely thankful and grateful to Prof. Mr. A.K.Rai, my dissertation supervisor
for helping, inspiring, motivating me all throughout this work. I am also thankful to him
for being so supportive throughout this journey.
Finally, I must express my very profound gratitude to my parents for providing me with
unfailing support and continuous encouragement throughout my years of study and
through the process of researching and writing this dissertation. This accomplishment
would not have been possible without them. I would like to thank my friends for their
supports while preparing this dissertation.
I would also like to give special thanks to all the academic as well as non-academic staff
members of National Law University, Delhi who have always been very supporting and
encouraging during the journey of my research work.
Riti Singh
58 LLM18
ACCION- American for Community In Other Nations.
ADB- Asian Development Bank.
AUM- Assets Under Management.
DFI- Development Finance Institutions
FID- Financial Inclusion Department
FIF- Financial Inclusion Fund
IAMI- International Association of Microfinance Investors
IMF- International Monetary Fund
MUDRA- Micro Units Development and Refinance Agency.
NABARD- National Bank for Agriculture and Rural Development.
NHFDC- National Handicapped Finance and Development Corporation
NBFC- Non- Banking Financial Companies.
NHB- National Housing Bank
RMK- Rashtriya Mahila Kosh
RRB- Regional Rural Banks.
SEWA- Self-Employed Women's Association.
SIDBI- Small Industries Development Bank of India.
SKS- Swaya Krishi Sangam
USAID- United States Agency for International Development
VII
SUPERVISOR’S CERTIFICATE III
TABLE OF CONTENTS VII-XI
INSTITUTION
7-13
VIII
2.1.1. DEFINITION OF MICROFINANCE
2.1.3. MICROFINANCE AND ITS EFFECT ON POVERTY
ELEVATION
2.2.1. MEANING
2.2.3. INDIAN FINANCIAL SECTOR
7
7
8
9
10
10
11
11
13
CHALLENGES FACED BY THEM IN RAISING FUNDS IN INDIA
15-27
3.2.3. EMPOWER WOMEN
3.2.4. COMMUNITY-WIDE BENEFITS
3.3.1. SAVINGS AND DEPOSITS
INVESTORS
3.3.4. INVESTMENT FUNDS
3.3.5. QUASI-EQUITY
3.3.10. ASSIGNMENT AND SECURITISATION
IN OBTAINING THE FUNDS
INEFFICIENT RISK MANAGEMENT
BANKS
3.4.5. REGULATORY ISSUES
22
23
24
25
26
26
26
27
27
INSTITUTIONS
29-35
4.1.1. SHG-BANK LINKAGE MODEL
4.1.2. MFI-BANK LINKAGE MODEL
4.2.1. NABARD
(SIDBI)
CORPORATION (NHFDC)
29
29
29
30
30
31
31
31
31
32
32
32
X
4.5. CHALLENGES FACED
5.2. ROLE OF COMMERCIAL BANKS IN MICROFINANCE
5.2.1. DIRECT LENDING
5.2.3. MICROFINANCE SUBSIDIARY
BANKS IN MICROFINANCE
HELPING MICROFINANCE
5.4.1. COMMITMENT
MEDIUM ENTERPRISES
6.2. NEED FOR MICRO FINANCE IN THE DEVELOPMENT OF
SMALL ENTERPRISE
GOAL OF DEVELOPMENT
41-45
41
41
44
44
XI
44
45
Chapter 1
1.1 Abstract: -
NABARD has defined microfinance as the provision of thrift, credit, and many other type
of financial services and products of very small amount basically for the poor people in
rural, semi urban or urban areas and this provision is for enabling these people to raise
their level of income and standard of living. 1
Microfinance is a range of financial services which provides assistance to small scale
entrepreneurs as access to banking and other related services for them is quite difficult.
Poverty eradication is the main objective of microfinance as it assists the poor and thus
helps in poverty eradication and by helping the poor it also helps is boosting the economy
and strengthening the financial sector. The main service provided by microfinance is
micro credit but it also provides other wide range of services which includes insurance,
savings, remittance and also non-financial services like training, counseling etc.
Microfinance sector helps in business development and thus it is regarded as one of the
important pillars of the economy in modern times. 2
Microfinance existed since the 18th century. Jonathan Swift introduced the Irish Loan
Fund system, which tried to improve the conditions for impoverished Irish citizens, can
be attributed as one of the first micro lending operations. 3 In its modern times, micro
financing became popular on a large scale in the 1970s. Grameen Bank, which was
started by Muhammad Yunus, in 1976, in Bangladesh was the first modern microfinance
institution which gained popularity. The Grameen Bank also suggested to its customers
“16 Decisions”, which was a list comprising of several ways by which the poor people
can improve their lives. This “16 Decisions” comprised of both socio- economic issues
like dowries, drinking water and sanitation. Mohd. Yunus and Grameen Bank were
awarded the Nobel Peace Prize in 2006 for their incredible efforts.
1 S.L. SHETTY , MICROFINANCE IN INDIA- ISSUES, PROBLEMS AND PROSPECTS: A CRITICAL REVIEW OF
LITERATURE.(2012). 2 TODD A. WATKINS , INTRODUCTION TO MICROFINANCE (WORLD SCIENTIFIC).
3 BRIGIT HELMS, ACCESS FOR ALL: BUILDING INCLUSIVE FINANCIAL SYSTEMS. (DAI) (2006).
2
Microfinance has emerged as a larger movement whose object is "a world in which as
everyone, especially the poor and socially marginalized people and households have
access to a wide range of affordable, high quality financial products and services,
including not just credit but also savings, insurance, payment services, and fund
transfers. 4 For instance, in Bangladesh only microfinance has benefitted around 15
million families by providing micro credits to them and also other facilities such as
micro-savings and micro-insurance and all this has also resulted in about 40% reduction
in the rural poverty.
SEWA Cooperative Bank which was initiated by Ela Bhatt in 1974 in Ahmedabad,
Gujarat, is regarded as one of the first modern day microfinance institution of its
kind. The concept of Micro-credit in Bangladesh was introduced by Muhammad Yunus,
who is a Nobel Prize winner. He introduced it in the form of the "Grameen Bank".
NABARD also with the aim to help the poor people who don’t have easy access to banks
and more specifically to help the Self-help Groups (SHGs) which is a model based on
microfinance only. This sector is growing and evolving at a very progressive rate as this
can be seen by analyzing the amount of energy and resources which has been devoted by
the national bodies like Small Industries Development Bank of India (SIDBI) and
National Bank for Agriculture and Rural Development (NABARD).
In the light of this background, this dissertation will majorly focus on microfinance and
its role in modern financial industry, the role of government in strengthening
microfinance and how microfinance is helping the MSMEs in India.
4 Robert Peck Christen, Richard Rosenberg & Veena Jayadeva, Financial institutions with a double-bottom
line: implications for the future of microfinance CGAP OCCASIONAL PAPER 2-3 (2004) .
3
1.2. LITERATURE REVIEW: -
Microfinance 5 is “the provision of financial services to low-income poor and very poor
self-employed people”. These financial services 6 generally include savings and credit but
can also include other financial services such as insurance and payment services.
Therefore, microfinance involves the provision of financial services such as savings,
loans and insurance to poor people living in both urban and rural settings who are unable
to obtain such services from the formal financial sector
The microfinance industry’s objective is to satisfy the unmet demand on a much larger
scale, and to play a role in reducing poverty. While much progress has been made in
developing a viable, commercial microfinance sector in the last few decades, several
issues remain that need to be addressed before the industry will be able to satisfy massive
worldwide demand 7 .
With increasing assistance from the World Bank and other donors, microfinance is
emerging as an instrument for reducing poverty and improving the poor's access to
financial services in low-income countries. Providing the poor with access to financial
services is one of many ways to help increase their incomes and productivity. In many
countries, however, traditional financial institutions have failed to provide this service.
Microcredit and cooperative programs fill this gap. They provide credit through social
mechanisms such as group-based lending to reach the poor and other clients, including
women, who lack access to formal financial institutions. Their purpose is to help the poor
become self-employed and thus escape poverty. This book examines the experiences of
the Grameen Bank, the Bangladesh Rural Advancement Committee, and the Bangladesh
Rural Development Board's Rural Development Project-12, in order to quantify the
5 MARIA OTERO, ELISABETH RHYNE, THE NEW WORLD OF MICROENTERPRISE FINANCE: BUILDING
HEALTHY FINANCIAL INSTITUTIONS FOR THE POOR (KUMARIAN PRESS LIBRARY OF MANAGEMENT FOR
DEVELOPMENT). 6 JOANNA LEDGERWOOD, MICROFINANCE HANDBOOK: AN INSTITUTIONAL AND FINANCIAL PERSPECTIVE.
7 Anita Campion, Challenges To Microfinance Commercialization, 42096 JOURNAL OF MICROFINANCE.
potential and limitations of microcredit programs as an instrument for reducing poverty
and delivering financial services to the poor. 8
According to S.L.Shetty, has talked about the factual profiles of prevalent microcredit
programs in India and goes far beyond the review of literature on the concept, country
models, and history of the movement. Have also given the up-to-date review of the
regulatory measures and their nuances, as well as a detailed review of evaluation and
impact studies. It also dwells on the limitations of the microfinance movement to satisfy
the credit needs of the vast informal-sector enterprises and discusses the new initiatives
that the authorities have taken under the broad theme of "financial inclusion." Keeping
the broader objective of distributional goals embedded in the microfinance
movement, this record attempts an assessment of the wider challenges faced by the
financial system by providing suggestions for reaching out to the small and informal
sectors on a more effective scale. 9 It is also of much relevant that the access of these
fundamental services provided by the microfinance institutions should reach to all people
in developing countries as it will help in acceleration of economic development of
countries. 10
1.3. RESEARCH QUESTION: -
In the light of problem, background leads to the following problem statement, which will
also be the overarching question/statement for this investigation:
What is the impact of Microfinance on the modern finance Industry specifically in India?
What is the role played by the Government in microfinance sector?
8 SHAHIDUR R. KHANDKER, FIGHTING POVERTY WITH MICROCREDIT: EXPERIENCE IN BANGLADESH, Oxford
University Press, (1998). 9 S.L. SHETTY , MICROFINANCE IN INDIA- ISSUES, PROBLEMS AND PROSPECTS: A CRITICAL REVIEW OF
LITERATURE. (2012). 10
Social Affairs, United Nations Capital Development Fund.
Why does microfinance institutions needs help of commercial banks and what difficulties
does commercial banks face in helping them?
What is the role of microfinance institutions in helping the Micro and Small Scale
Enterprises and how do they achieve the task of economic development through this?
1.4. RESEARCH OBJECTIVES: -
The objectives of this research are: -
1. Understanding the meaning of micro finance and the modern financial industry
especially in the context of India.
2. Study the expectations of Microfinance institutions and the challenges faced by them
in obtaining the funds.
3. Understanding the role of Government in boosting Micro finance institutions.
4. Study the relationship between Commercial banks and microfinance institutions
5. Determine the role of MFIs in the development of Micro Small and Medium Scale
Enterprises.
1.5. HYPOTHESIS: -
1. Microfinance institutions help MSMEs in providing finance and thus helps in
eradicating poverty and in turn help in boosting the economy.
2. Commercial banks have an advantage over microfinance institutions.
3. Promote economic development, employment and growth through the support of
micro-entrepreneurs and small businesses.
Researcher has applied doctrinal method of research while conducting this research. This
Research is based on the secondary data which includes books, journals, articles, internet
sources, etc.
1.7. Chapterisation
This dissertation is divided into seven chapters. The first chapters contains the abstract of
the study which gives a brief understanding about the work, it has also dealt with the
research question, objectives, hypothesis, methodology used in this research work and
the literature review. Chapter two gives a comprehensive understanding about
microfinance and the modern financial institutions. It also deals with the history and
evolution of the Indian financial sector. Chapter three deals with the expectations of the
microfinance institutions, sources from where they raise funds and the challenges faced
by them in doing so. Chapter four talks about role of government in facilitating the micro
finance institutions and the fifth chapter deals with the relationship between the
commercial banks and the microfinance institutions in detail, further the sixth chapter has
dealt with the role of microfinance institutions in developing the small, medium and
micro enterprises as this is one of the main activities in which the microfinance
institutions are involved. Conclusion is there in the seventh chapter which contains the
impact of microfinance institutions on msmes and the financial industry and the
suggestions.
7
Institution
2.1.1. DEFINITION OF MICROFINANCE:
“Microfinance refers to the provision of small scale financial services including
microcredit, savings, payment services, micro insurance and other services to the rural
and urban poor clients who don't have access to the banking services on sustainable
basis” 1 The definition given by the Asian Development Bank (ADB) states that,
“microfinance is a provision which pertains to a broad range of financial services such as
deposit, loans, payment services, money transfers and insurance to the poor and low-
income households and their micro-enterprises” 2 .
The World Bank in its definition of microfinance has highlighted a link between
microfinance and development. Microfinance refers to the provision of financial services
to low-income clients, including the self-employed. Microfinance is not simply banking,
it is a development tool. Microfinance involves a wide range of activities such as giving
small loans, providing micro insurance and giving financial and business education to the
poor people and they also indulge in providing vocational training to the poor people who
can learn through these programs so that they can earn their living and can subsequently
become self- sufficient and can further help in the development. 3
1 JOAN PARKER, CAN MICROFINANCE MEET THE POOR’S FINANCIAL NEEDS IN TIMES OF NATURAL
DISASTER? (2000). 2 ADB, (LEDGERWOOD J., 1998) 2000.
3 Id.
2.1.2. HISTORICAL DEVELOPMENT OF MICROFINANCE
The history of microfinance can be traced back to the Starr-Bowkett Society. Further in
18 th
and the 19 th
century. Jonathan Swift inspired the Irish Loan Funds which was also a
type of microfinance. 4 These Irish loans were interest free loans and also sometimes in
the form of charities also. The Individualist anarchist, Lysander Spooner in the mid of the
19 th
century wrote about the advantages of the microfinance and the benefits derived
from small loans by the poor people. 5 The first cooperative lending bank was opened in
Germany in the 19 th
Century to support the poor farmers. It was founded by Friedrich
Wilhelm Raiffeisen 6 . In Latin America and Asia microfinance started as an experiment.
In 1950, Commila Model was used by Akhtar Hameed Khan in East of Pakistan,
according to this model loans were given through community based initiatives. 7 This
project was not a success because of the over involvement of the Government of Pakistan
and also because of the hierarchies which was made within the group.
Microfinance gained popularity in 1976, when on the outskirts of Chittagong University
campus in the village of Jobra, in Bangladesh, Muhammad Yunus started the Grameen
Bank. 8 After seeing the success of the Grameen Bank in Bangladesh many other
microfinance institution have come up and have helped the low income group of the
society and they have also come up with many other strategies which includes providing
collateral free loans to poor people, especially in rural areas, at full-cost interest rates and
these loans are repayable in frequent installments and all the borrowers are arranged into
different groups. In 1983, this institution became a bank. In the year 2006, Nobel Peace
Prize was given to Mohd. Yunus and Grameen Bank for their efforts, loans without
financial security was an idea which was not thought upon and worked before him but he
transformed his dream into reality and helped people throughout the world. 9 Mohd.
4 AIDAN HOLLIS & ARTHUR SWEETMAN, COMPLEMENTARITY, COMPETITION AND INSTITUTIONAL
DEVELOPMENT: THE IRISH LOAN FUNDS THROUGH THREE CENTURIES (1997). 5 LYSANDER SPOONER, POVERTY: ITS ILLEGAL CAUSES AND LEGAL CURE (2012) (1846).
6 DEUTSCHER RAIFFEISENVERBAND, THE RAIFFEISEN ORGANIZATION: BEGINNINGS, TASKS, CURRENT
DEVELOPMENTS, (2011). 7 MILFORD BATEMAN, WHY DOESN'T MICROFINANCE WORK? (ZED BOOKS 2010).
8 BEATRIZ ARMENDARIZ , THE ECONOMICS OF MICROFINANCE (CAMBRIDGE, MASS: THE MIT PRESS)
(2005). 9 www.grameen-info.org/
9
Yunus once also said that, “Maybe our great-grandchildren will go to museums to see
what poverty was like” 10
.
2.1.3. MICROFINANCE AND ITS EFFECT ON POVERTY ELEVATION:
Microfinance is an effective tool for poverty eradication this was underlined by Mohd.
Yunus also, he also once remarked that, “Maybe our great-grandchildren will go to
museums to see what poverty was like” 11
. This remark shows his confidence in the
technique of microfinance in poverty elevation.
This technique is considered as very effective for poverty alleviation and is also effective
in imparting various information which relates to education, sanitation, health, legal
rights and other information which proves to be helpful in improving the standard of
living of the poor people. Many microfinance programs have also targeted the women
who live in house in the society as they are one of the most vulnerable section of the
society. These women are financially weak as they have no assets or any kind of financial
security of their own. Studies have proved that these techniques have improved the
condition of the women by giving them opportunity of self- employment which in turn
provides financial, social security and also helps women in gaining self- confidence and
helps in improving their status in the society.
Microfinance also saves people from the exploitation of the moneylenders who charge
exorbitant rate of interest while providing the loans to the poor people and this
exploitation and makes the poor more poorer and later this turns into a vicious cycle.
Hence majorly low income people of the society are benefitted from microfinance
schemes and these schemes helps them in engaging in micro and small enterprises. 12
Effective collateral substitute for short- term and working capital loans to micro-
entrepreneurs 13
10
COLIN KIRKPATRIK, RON CLARKE, CHARLES PORIDANO 173 HANDBOOK ON DEVELOPMENT POLICY AND
MANAGEMENT, (EDWARD ELGAR PUBLISHING) (2002). 11
Id. 12
Mark Schreiner, Aspects Of Outreach: A Framework For Discussion Of The Social Benefits Of
Microfinance, JOURNAL OF INTERNATIONAL DEVELOPMENT, (2002). 13
A. Hubka, R. Zaidi, Impact of Government Regulation on Microfinance, World Development Report:
Improving the Investment Climate for Growth and Poverty Reduction, 1, (2005).
10
2.2.1. Meaning
Capital markets, insurance sector and non- banking financial companies (NBFCs) makes
up the financial sector of a country. Institutions which are involved with money are
included in the financial service sector of financial industry. These institutions includes
business providing money management, insurance sector, issuance of securities, trading
services and lending and investing activities. 14
Banks, Credit card issuers, Insurance
companies, Investment bankers, Securities traders, Financial planners, Security
exchanges, pension funds, mutual funds and other smaller financial entities are some of
the institutions which are part of this sector.
In India, commercial banks constitutes the largest part of the financial sector as it covers
sixty- four percent of the total asset in the financial sector. The Government of India has
introduced several reforms to liberalise, regulate and enhance this industry. The
Government and Reserve Bank of India (RBI) have taken various measures to facilitate
easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These
measures include launching Credit Guarantee Fund Scheme for Micro and Small
Enterprises, issuing guideline to banks regarding collateral requirements and setting up a
Micro Units Development and Refinance Agency (MUDRA). With a combined push by
both government and private sector, India is undoubtedly one of the world's most vibrant
capital markets. In 2017, a new portal named 'Udyami Mitra' has been launched by the
Small Industries Development Bank of India (SIDBI) with the aim of improving credit
availability to Micro, Small and Medium Enterprises' (MSMEs) in the country. India has
scored a perfect 10 in protecting shareholders' rights on the back of reforms implemented
by Securities and Exchange Board of India (SEBI). 15
14
2.2.2. Aims of Finance Industry 16
1. The main aim of the finance sector is to provide financial stability both within and
outside the country this also leads to generation of employment and increase in
productivity. All this increases the confidence of people and encourages saving and
investment.
2. Another aim of this industry is to provide an easy access to finance s that people can
manage their needs and expand their opportunities and improve their living standards.
When finance is easily accessible then people can have better self- employment
opportunities, better housing and education facilities.
3. Another important aim is to finance the growing need of the infrastructure of the
country such as roads, power generation, hospitals, schools and other places of public
utilities. The finance sector also aims to help the Government in bearing risks while
undertaking such projects.
4. Sustainable Development is another goal of the modern finance sector. Sustainable
development of the economy requires huge financing and the financial sector through its
various services help in achieving this aim.
2.2.3. Indian Financial Sector
The Reserve Bank of India (RBI) was founded in 1935 under the Reserve Bank of India
Act “…to regulate the issue of Bank Notes and keeping the reserves with a view to
securing monetary stability in India and generally to operate the credit and currency
system of the country to its advantage.” Apart from being the central bank and monetary
policy authority, the RBI is the regulator of all banking activity, including non-banking
financial companies, manager of statutory reserves, debt manager of the government, and
banker to the government. At the time of independence in 1947, India had 97 scheduled 17
16
https://www.worldbank.org/en/topic/financialsector/overview. 17
4 The ‘scheduled’ banks were banks “which were included in the Second Schedule to the RBI Act and
those banks in British India that subsequently became eligible for inclusion in this Schedule by virtue of
private banks, 557 “nonscheduled” (small) private banks organized as joint stock
companies, and 395 cooperative banks. The decade of 1950s and 1960s was characterized
by limited access to finance of the productive sector and a large number of banking
failures. 18
Such dissatisfaction led the government of left-leaning Prime Minister (and the
then Finance Minister) Mrs. Indira Gandhi to nationalize fourteen private sector banks on
20 July 1969; and later six more commercial banks in 1980. Thus, by the early 1980's the
Indian banking sector was substantially nationalized, and exhibited classical symptoms of
financial repression, viz., high pre-emption of banks' investible resources (with associated
effects of crowding out of credit to the private sector), subject to an intricate cobweb of
administered interest rates, and accompanied by quantitative ceilings on sectoral credit,
as governed by the Reserve Bank of India. Besides the commercial banks, there were four
other types of financial institutions in the Indian financial sector: development finance
institutions (DFIs), co-operative banks, regional rural banks and post-offices.
NABARD, the NHB and SIDBI are continuing largely as refinance institutions with
support from the government. 19
As of 2015, there are 1,579 urban co-operative and
94,178 rural cooperative banks. A majority of these banks tend to operate in a single
state, and they are regulated and supervised by state-specific Registrars of Cooperative
Societies (RCS), along with overall oversight by the Reserve Bank of India. 20
Asset
management industry in India is one of the fastest growing industry in the world. Total
AUM of the industry increased 40 per cent year-on-year to hit a record Rs 23 lakh crore
(US$ 358.78 billion) at the end of November 2017. Corporate investors accounts for
around 46.26 per cent of total AUM in India. High Net Worth Individuals and retail
investors account for 28.01 per cent and 22.96 per cent, respectively.
their paid-up capital and reserves being more than Rs 500,000 in the aggregate…the power to include or
exclude banks in or from the Schedule was vested with the Governor General in Council” (RBI, 2008) 18
As against 566 commercial banks operating in 1951, only 89 survived by 1969, the rest went into
liquidation or amalgamation during 1951–1969; see RBI (2008) for details. 19
IDBI: Industrial Development Bank of India; ICICI: Industrial Credit and Investment Corporation of
India; IFCI: Industrial Finance Corporation if India; NABARD: National Bank fir Agriculture and Rural
Development; NHB: National Housing Bank; SIDBI: Small Industries Development Bank of India. 20
Rakesh Mohan & Partha Ray, Indian Financial Sector: Structure, Trends and Turns, 580, Stanford
Centre for Development, (2016).
13
Revenues of the brokerage industry in India are estimated to grow by 15-20 per cent to
reach Rs 18,000-19,000 crore in 2017-18. Insurance industry is another important
constituent of Indian financial services industry. The insurance industry has been
expanding at a fast pace. The total first year premium of life insurance companies grew
18.9 per cent year-on-year to reach US$ 18.44 billion during April-November 2017. 21
2.2.4. Non-Banking Finance Companies (NBFCs)
India has a number of non-banking financial companies (NBFCs). The NBFCs is far from
being a homogenous entity and include many diverse types of financial institutions from
a housing finance company to an equipment leasing company. 22
The diversity among the
entities of the NBFC sector is also reflected in attributes like sizes and the extent of
regulatory oversight. In the popular discourse the role of NBFCs are seen from two
distinct angles: (a) they have been very useful for sectors / activities that are generally
excluded from formal banking activities; and (b) at some regularity some of the deposit
raking NBFCs have been source of financial irregularity in some localized pockets and
raised the issue of consumer protection. Although NBFCs have existed for a long time in
India, these entities experienced sudden spurt in their activities between the late 1980s
and the mid-1990s. This sharp jump in NBFC deposits was mostly, “on account of the
high rates of interest offered on such deposits” (RBI, 2003). At the current juncture,
while a large chunk of deposit and non-deposit taking financial companies are regulated
by the RBI, housing finance companies are regulated by National Housing Bank, Chit
Funds are regulated by the State Governments, and Mutual Benefit companies are
21
http://blog.ficci.com/financial-sector-india/2776/. 22
These include: (i) Asset Finance Companies (AFCs); (ii) Loan Companies (LCs); (iii) Investment
Companies (ICs); (iv) Infrastructure Finance Companies (IFCs); (v) Core Investment Companies (CICs);
(vi) Infrastructure Debt Funds (IDF-NBFCs); (vii) NBFC-Microfinance Institutions (NBFC-MFIs); (viii)
Factoring companies (FCs); (ix) Mortgage Guarantee Companies (MGCs); (x) Residuary Non-Banking
Companies (RNBCs); (xi) Housing Finance Companies; (xii) Mutual Benefit Companies; and (xiii) Chit
Fund companies
regulated by Ministry of Corporate Affairs, Government of India. This multiplicity of
regulators has always become an issue in their functioning. 23
23
Rakesh Mohan & Partha Ray, Indian Financial Sector: Structure, Trends and Turns, 580, Stanford
Centre for Development, (2016).
Faced By Them in Raising Funds In India
The eradication of poverty can be said to be the main idea behind microfinance.
Microfinance is majorly involved with the act of providing finance to the marginalized
section of the society who does not have an easy access to the commercial bank. 1 Mohd.
Yunus who founded Grameen Bank and was also a recipient of the Nobel Prize in 2006,
is often considered as a founding father of the microfinance. Being an economist at the
University of Chittagong in Bangladesh, he had an idea of providing loans and financial
support to the marginalized section of the society as the traditional banking system is not
easily accessible to them. His vision was that microfinance would be able to eradicate
poverty by providing finance to the poor people and making them self- sufficient. The
main features of microfinance are helping the lower strata of the society and also
involving women and providing finances and other assistance to them so that they can be
empowered. The vision which was proposed by him was new to many people and it was
accepted by a lot of people all over the world as it proposed one of the remedies to
eradicate poverty in an efficient manner as poverty is one of the major problems in the
development of the country. By providing finances to the marginalized section,
microfinance is also involved in bridging gap between the traditional financial institutes
and the marginalized section.
Credit unions, Non- Governmental Organizations, commercial banks, some government
institutions, cooperative banks and society, etc are some of the institutions which are
involved in microfinancing. In India various Non-Banking Financial Companies (NBFC)
are also involved in the activity of microfinance and thereby providing assistance to the
marginalized section of the society. 2
1 JOANNA LEDGERWOOD MICROFINANCE HANDBOOK: AN INSTITUTIONAL AND FINANCIAL PERSPECTIVE.
2 https://economictimes.indiatimes.com/money-banking/mfis-at-the-crossroads/articleshow.
https://economictimes.indiatimes.com/money-banking/mfis-at-the-crossroads/articleshow
16
3.1. Goals of Microfinance
The microfinance sector consistently focuses on understanding the needs of the poor and
on devising better ways of delivering services in line with their requirements, developing
the most efficient and effective mechanisms to deliver finance to the poor. Continuous
efforts towards automation of operations is steady improving in efficiency. The
automated systems have also helped accelerate the growth rate of the microfinance
sector.
The goal for MFIs should be:
• To improve the quality of life of the poor by providing access to financial and support
services;
• To be a viable financial institution developing sustainable communities;
• 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;
• Learn and evaluate what helps people to move out of poverty faster;
• To create opportunities for self- employment for the underprivileged;
• 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.
3.2. Purpose of Microfinance Institutions
Traditionally, when a person wants to start a business venture, they go to a bank for a
loan. But what should a budding entrepreneur do if he is too poor to obtain finance to
start a profitable business? The answer lies in a relatively new branch of financial
services called microfinance. Its purpose is to provide basic financial services such as
loans, savings and insurance to underprivileged people. A microfinance institution (MFI)
17
is simply one that offers such services to the poor; according to the Consultative Group to
Assist the Poor (CGAP), it can be a credit union, commercial bank, financial non-
governmental organization, or a credit cooperative.
3.2.1. Provide Access to Funds: - Typically, the poor acquire financial services like
loans through informal relationships. These loans, however, come at a high cost per
dollar loaned and can be unreliable. Furthermore, banks have not traditionally viewed
poor people as viable clients and often will reject them due to unstable credit or
employment history and lack of collateral. MFIs dismiss such requirements and provide
small loans at high interest rates, thus providing MFIs the funds they need to continue
operation.
3.2.2. Encourage Entrepreneurship and Self-Sufficiency:- Underprivileged people
may have potentially profitable business ideas, but they cannot put them into action
because they lack sufficient capital for start-up costs. Microcredit loans give clients just
enough money to get their idea off the ground so they can begin turning a profit. They
can then pay off their micro-loan and continue to gain income from their venture
indefinitely.
3.2.3. Empower Women: - Women make up a large proportion of microfinance
beneficiaries. Traditionally, women (especially those in underdeveloped countries) have
been unable to readily participate in economic activity. Microfinance provides women
with the financial backing they need to start business ventures and actively participate in
the economy. It gives them confidence, improves their status and makes them more
active in decision-making, thus encouraging gender equality. According to CGAP, long-
standing MFIs even report a decline in violence towards women since the inception of
microfinance.
3.2.4. Community-Wide Benefits: - Generally speaking, microfinance institutions seek
to reduce poverty worldwide. As they obtain funds and services from MFIs, recipients
gain enormous financial benefits which trickle down to others in their families and
communities. New business ventures can provide jobs, thereby increasing income among
18
community members and improving their overall well-being. Microfinance services gives
hope to people who previously had little or no opportunity to be self-sufficient.
3.3. Financial Resources of Micro Finance Institutions
3.3.1. Savings and deposits
Internationally micro saving products, also known as retail deposits, offered by MFIs
serve as a low cost source of funding and are a common practice in countries like the
Philippines, Uganda, Pakistan, Peru and Kenya. Most governments only allow
microfinance banks to offer micro saving products and prohibit other MFIs from raising
deposits. The potential pitfall of these deposit products is that MFIs may fail to provide
instantaneous liquidity. In India, the SHG model is primarily built up on mobilisation of
savings. SHG members borrow funds from banks against these deposits. 3
3.3.2. Individual philanthropic sources and social investors
Non-profit investors, such as individuals interested purely in the social impact of
microfinance, often lend their own money to MFIs through online platforms,
internationally the most famous of which are Kiva and Micro Place. Similarly, high net
worth individuals who are interested in philanthropy often give away great sums of
money to MFIs, in acts known as ‘venture philanthropy’.
Social investors are individuals or institutions (high net worth, foundations, endowments,
and retirement plans) which choose to apply non-financial characteristics to their
investment decision making. These non-financial characteristics are often related to the
investors’ value system or social mission, and may include concern for environmental
protection, social and economic development of the poor, education and health, as
priorities. For example, in India Rang De, an MFI raises money from social investors.
Commercial institutions also participate in such social investment. For example, Citibank
provides charitable contributions to three local MFIs in Haiti to help restore the country’s
3 SRINIVASAN, MICROFINANCE INDIA: STATE OF THE SECTOR REPORT, (2010).
19
microfinance industry which has suffered severe challenges in the aftermath of the 2010
earthquake. 4
3.3.3. Soft loans and grants
Concessionary or soft loans (low cost debt) or grants are another source of funds from
socially responsible investors, which include national and regional development banks,
international NGOs, non-profit corporations, charitable trusts, or funds held by donor and
development agencies, such as the Grameen Trust, Swedish International Development
Agency (SIDA), United States Agency for International Development(USAID), United
Nations Capital Development Fund (UNCDF), the Asian Development Bank (ADB), the
World Bank, the Bill and Melinda Gates Foundation, Ford Foundation, the International
Monetary Fund (IMF), ACCION and CARE. Some development agencies only interact
with governments, but their funds can be accessed either directly or indirectly by MFIs.
3.3.4. Investment funds
Internationally there are many investment funds that specialise in microfinance and this
proves to be a good source and are also deploying their structuring and fund-management
skills to offer investment products that appeal to a broad range of investor risk profiles
and social motivations. 5
3.3.5. Microfinance investment vehicles
Microfinance investment vehicles (MIVs) are private entities which act as intermediaries
between investors and microfinance institutions. MIVs may be self-managed, managed
by an investment management firm, or by trustees. They may receive investments
through the issuance of shares, units, bonds or other financial instruments. Depending on
the type of MIV, these investments may then be provided to MFIs as debt, equity, or
guarantees. MIVs make use of different currencies as well, since they are located all over
the world. While some MIVs are primarily profit seeking, others additionally combine
the objective of social impact. This diversity among MIVs makes it possible for many
4 24 IIMB MANAGEMENT REVIEW, 28-39 (2012).
5 http://www.forbes.com/2007/12/20/elizabeth-littlefield-microfinance-biz-cz_el_1220littlefield.html.
http://www.forbes.com/2007/12/20/elizabeth-littlefield-microfinance-biz-cz_el_1220littlefield.html
20
different types of investors to get involved in the microfinance sector. These have the
capacity to conduct the specialised due diligence and monitoring required for sound
investing in this niche market, and fund investing confers the added benefit of
diversification across many MFIs, countries and currencies. The International
Association of Microfinance Investors (IAMFI) estimates that as of April 2009 there are
104 MIVs with a total of $6.1 billion in assets under management. 6
In the Indian context, such potential has not been captured so far. The RBI Report
(2011) suggests that to meet the funding requirements of the sector, a ‘domestic social
capital fund’ may be established. This fund will be targeted towards ‘social investors’
who are willing to accept ‘muted’ returns, say, 10%–12%. This fund could then invest in
MFIs which satisfy social performance norms laid down by the fund and are measured in
accordance with internationally recognised measurement tools.
3.3.5. Quasi-equity
The World Bank in collaboration with the Small Industries Development Bank of India
(SIDBI) has designed a project to offer MFIs a new kind of quasi-equity product aimed at
strengthening MFI balance sheets. Similarly NABARD is also supporting MFIs with the
Microfinance Development and Equity Fund.
3.3.6. Non-convertible debentures
In an attempt to create new avenues to raise funds, non-convertible debentures (NCDs)
were issued by MFIs. The country’s first ever NCD issue that was listed on the stock
exchange was by SKS Microfinance. It had raised Rs. 750 million at a coupon rate of
10% in May 2009, which was soon followed by another issue of SKS and Grameen
Koota. MFIs have increasingly tapped the NCD route to create a diversified lender base.
3.3.7. Bank loans
In the Indian context, commercial banks lend to MFIs and SHGs. Commercial banks in
India have to meet the mandatory requirement of lending 40% of their advances to the
priority sector. Thus banks are a major source of finance to MFIs and their interest rate is
12–14%. Both short-term loans and long-term debt can be acquired from commercial
banks.
The Small Industries Development Bank of India, an apex financial institution for
promotion, financing and development of small scale industries in India, has launched a
major project – the SIDBI Foundation for Micro Credit (SFMC) – to facilitate the
accelerated and orderly growth of the microfinance sector in India. SFMC is emerging as
the apex wholesaler for microfinance in India providing a complete range of financial and
non-financial services such as loan funds, grant support, equity and institution building
support to the MFIs. SIDBI also provides equity capital to eligible institutions to meet the
capital adequacy requirements and to raise debt funds. Keeping in tune with the sectoral
requirements, SIDBI has also introduced quasi-equity products viz, optionally convertible
preference share capital, optionally convertible debt and optionally convertible
subordinate debt for new generation MFIs which are generally in the pre break-even
stage requiring special dispensation for capital support by way of a mix of Tier I and Tier
II capital. The Transformation Loan (TL) product is envisaged as a quasi-equity type
support to partner MFIs that are in the process of transforming their existing structure
into a more formal and regulated set-up for exclusively handling microfinance operations
in a focused manner. Being quasi-equity in nature, the TL helps MFIs not only in
enhancing their equity base but also in leveraging loan funds and expanding their
microcredit operations on a sustainable basis. The product has the feature of conversion
into equity after a specified period of time, subject to the MFI attaining certain structural,
operational and financial benchmarks. This non-interest bearing support facilitates the
young but well performing MFIs in making long term institutional investments and acts
22
as a constant incentive to MFIs to transform themselves into formal and regulated
entities. 7
3.3.8. Private equity
The private equity market is an important source of funds for start-ups, private middle-
market companies and firms in financial distress. The huge demand for credit among the
poor has become an attractive investment avenue for private equity and venture capital
investors. These investors normally look for innovative and technology oriented ventures
where a conventional source of funding is difficult. Sequoia Capital India was the first
traditional venture capital (VC) firm to invest in the space with 11.5 million USD in SKS
Microfinance in 2007. The International Finance Corporation (IFC), the investment arm
of the World Bank, has invested 300,000 USD in Utkarsh Microfinance Private Limited,
a microfinance startup providing loans in northern India. The amounts raised through
private equity deals are showing an increasing trend indicating that microfinance is a high
return investment avenue. With India being a very attractive market in this field, many
private equity firms have started investing here.
3.3.9. Equity from capital market sources
MFIs have also started accessing resources through the capital market. Internationally a
few microfinance institutions such as Bank Rakyat at Indonesia (BRI), BRAC Bank in
Bangladesh, Banco Compartamos in Mexico and Equity Bank in Kenya have raised
equity capital through public issue. The four institutions are well known throughout the
microfinance industry for their exceptional growth, robust financial performance and
ability to expand their outreach to the working poor. They are now listed on national
stock exchanges and, in two cases, have sold internationally 8 . The initial public offerings
(IPOs) and listings have allowed the four institutions to tap into the mainstream investor
community and take advantage of myriad new opportunities. This has also signalled to
capital markets that the microfinance sector is a potential source of profitable investment.
7 http://www.sidbi.in/Micro/mfi.htm.
8 IRA W. LIEBERMAN, ANNE ANDERSON, ZACH GRAFE, BRUCE CAMPBELL & DANIEL KOPF, MICROFINANCE
AND CAPITAL MARKETS: THE INITIAL LISTING OR PUBLIC OFFERING OF FOUR LEADING INSTITUTIONS
(2007).
23
Raising capital through public issue has increased liquidity for investors by creating
opportunities for equity investors to exit, especially those who contribute as private
equity and seed capital. This has made microfinance an attractive investment avenue for
private investors.
In the Indian context, the SKS IPO is a milestone event. The Hyderabad based SKS
Microfinance floated its first public offering of equity and mobilised 358 million USD,
priced at 1.6 billion USD. The shares which were oversubscribed 13.7 times (primarily
by institutional investment interest) fixed the price per share at Rs 985 reflecting a
valuation of 98 times the face value of shares. Overall, the valuation accorded a book
value to market value ratio of six times. Microfinance has got the attention of the capital
market and around six other MFIs are aspiring to enter the equity market with their own
share floats.
3.3.10. Assignment and securitisation
The rapid growth in the microfinance sector, especially of NBFC-MFIs has led to the
search for innovative financial sources to meet the financial requirements of the sector.
The need for securitisation is common to all financial intermediaries, but when it comes
to microfinance, the growing asset size (which is the very essence of microfinance
economics) puts pressure on the balance sheet. Hence, off-balance sheet methods of
funding, or any devices other than plain balance sheet borrowing are needed to sustain
the growth rate. 9
Three forms of structured financial products have gained significance; these are: bilateral
loan assignments, securitisation and collateralised debt obligations (CDOs).
In the case of assignment, the loan pool receivables are directly assigned to the assignee
or the purchaser, usually a bank. These deals are also rated but no specific instrument like
pass-through certificate (PTC) is issued. Banks often prefer this route as the loans need
9 M.S. Sriram, Commercialization Of Microfinance In India: A Discussion Of The Emperor’s Apparel, 24
Economic and Political Weekly, 65, 74 (2010).
24
not be marked-to-market (as they are on the banking books), whereas the securities
against those loan pools (as in the case of securitisation), if issued by the same seller will
have to be marked-to-market (as they are securities and hence will be on the bank’s
trading books). Besides this, banks will be able to pick and choose the loans that qualify
for priority sector lending norms, and hence such transactions fit exactly into their
objective. So, banks usually go in for bilateral assignment during the fag-end of the
financial year, based on their requirement for such loan pools. Further, most banks also
offer competitive rates if they are keen to have such loans on their books. Securitisation
typically involves the conversion of assets which have predictable future cash flows (for
example, a pool of microloans) into standardised, tradable securities. The securitisation
process allows MFIs to pool the receivables from loans and sell the same to third parties
like banks, mutual funds and insurance companies. This is an opportunity for MFIs to
increase their funding sources.
The primary objective of securitisation is to obtain financing for a company’s ongoing
business needs. A properly structured financial asset securitisation also can permit a
company to obtain a lower cost of financing compared to secured or even unsecured debt.
Securitisation allows the originator to remove the asset and all corresponding risks
associated with it completely from its balance sheet. It also reduces the need to hold
capital against the asset. The broad structure of transactions (as in the case of
securitisation) – including bankruptcy remoteness, limited recourse to originator,
performance of servicing function by the originator, and permissible commingling of
pool collections with servicer’s own funds – are common to both assignment and
securitisation.
3.4. Challenges faced by the Microfinance Institutions in Obtaining the
Funds
One of the main economic issue which exist in every developing country is poverty. One
of the main reasons behind the problem poverty is income distribution. In India also
income distribution is very uneven which leads to increase in poverty with every passing
day. Despite of significant progress made by the service and manufacturing sector, the
25
agricultural sector still plays a very important role in the Indian economy. 50% of the
Indian population depend on agriculture and allied activities and approximately 69% of
India’s population is in rural areas. 10
Microfinance majorly focuses on financial inclusion
of this sector of the Indian society as people falling under this sector are comparatively
more backward and poorer. The initiative of NABARD in linking the traditional banking
system with the Self- Help Groups has helped micro finance institutions in achieving its
goals. But still there are many challenges faced by these institutions. They face
challenges with regard to structural, operational and financial processes.
Major challenges faced by Indian microfinance industry
The people who take help of these institutions generally belong to the marginalized
section of the society hence over-indebtedness, high interest rates, and excessive
dependence on the banking system, illiteracy and lack of awareness about the products.
3.4.1. Over-indebtedness due to multiple borrowings and inefficient risk
management
Microfinance institutions (MFI) provide financial services to the poorer section of the
society in order to improve their standard of living. Therefore over-indebtedness is major
issue. Lack of risk management framework and multiple borrowings by most clients led
to micro-finance crisis in India in 2008. In some cases, it has been seen that there is no
apex control over the MFIs’ is also a reason. This sector gives loans without collateral
which increases securiy the risk of bad debts. Moreover the fast paced growth of the
sector has not been met with proper infrastructure planning. This kind of problems has
been reported in states like Andhra Pradesh, Karnataka, and Madhya Pradesh. Over
.
N. SRINIVASAN , MICROFINANCE INDIA STATE OF THE SECTOR REPORT, (2010).
3.4.2. High rates of interest as compared to mainstream banks
MFIs’ when compared to commercial banks do not enjoy the same rate of financial
success. One of the reason is that while banking system is centuries old, micro finance is
only a few decades old in India 12
. MFIs’ charge a very high rate of interest (12-30%) as
compared to commercial banks (8-12%). Recently, the RBI (India’s regulatory bank)
announced the removal of upper limit of 26% interest on MFI loans (ET, 2014). This has
benefited the industry’s players but left the customers in a worse situation than before.
Due to the issues of over-indebtedness caused by the charging of high interest rate, rate
of suicide of farmers increased in states like Andhra Pradesh and Maharashtra.
3.4.3. Over-dependence on banking system for funding
Majority of the MFIs’ in India are registered as Non- Governmental Organizations
(NGOs). They are dependent on financial institutions such as commercial banks for
stabilised funding for their own lending activities. Around 80% of their funds come from
banks. Most of these are private banks which charge a high rate of interest and also the
term of loans is of shorter period. Most of the times, banks lend to micro lending firms in
order to meet their so-called priority sector loan targets. The over dependence of Indian
microfinance industry on banks make them incompetent and less reactive towards dealing
with default and delinquencies.
3.4.4. Lack of awareness of financial services
Like all other developing and underdeveloped countries, the literacy rate in India is very
low and the rate is much lower in the rural areas. Nearly 76% of India’s adult population
does not understand basic financial concepts. Lack of awareness of financial services
provided by the Indian microfinance industry is a challenge for both, customer
and MFIs’. This factor not only causes hindrance for villagers to join hands with MFIs’ to
12
K. Pal Narwal, S. Pathneja & M. Kumar Yadav, Performance Analysis of Banks and Microfinance
Institutions in India (2015).
meet their financial needs but also makes them financially excluded. MFIs’ are faced
with the task of educating the people and establish trust before selling their product.
Micro finance institutions struggle to make their business more financially viable due to
this lack of awareness.
3.4.5. Regulatory issues
Presently the Reserve Bank of India (RBI) is the regulatory body for the microfinance
industry in India. However it has traditionally catered to commercial and traditional
banks rather than MFIs’. Moreover the needs and the anatomy of micro finance industry
is supremely different from that of banks. In the past the industry has undergone sporadic
and unprecedented regulatory changes. Some of these have benefited the industry greatly,
but a lot of issues were unaddressed, like creating barriers for entry to restrict unworthy
players. Not only has it led to constant structural and operational changes but also created
ambiguity in norms of conduct. Therefore there is a need for a separate regulatory
authority for this industry. Regulatory issues have led to sub-optimal performance and
failure in the development of new financial products and services through which the
poorer section can be benefitted.
3.4.6. Problem in identification of appropriate model
In India, most of the MFIs’ follow Self-Help Group model (SHG model) or Joint
Liability Group model (JLG model). The problem is that most of the time, selection of
model are not scientific in nature. The models are selected randomly, not according to the
situation and also the decision of selection is irreversible in nature. So, it affects the
sustainability of the organisation in the long-run and also increases the risk of borrowings
for the poorer section beyond they can bear. This is also one of the main reasons of crisis
of microlending in the state of Andhra Pradesh. It has been repeatedly stressed that the
industry needs to undergo business process reengineering to effectively reach out to the
under-financed. 13
The Role of Government in Boosting Micro Finance Institutions
After 1990, India economy has become an open economy and thereby it has attracted
many foreign investors and global corporations to invest in India. All this have made
India as a hub of investment and have put Indian economy at the forefront of world trade
and industry. But even after such transformation in the economy, many people are still
unaffected because of these changes and are still living in poverty. Thus, the idea behind
Microfinance is to provide financial services to the low-income proletariat who
traditionally lack access to banking and other monetary services.
During the last two decades, substantial work has been done in developing and
experimenting with different concepts and approaches to reach financial services to the
poor, by the Government, Non-Governmental Organisations (NGOs) and banking
institutions in various parts of the country.
Microfinance refers to small scale financial services, both credit & savings, that are
extended to the poor in both rural and urban areas. It refers to economic services which
mitigate vulnerability to economic shocks, promotes savings and supports self-
empowerment. Microfinance encompasses a variety of financial instruments. The only
common factor amongst the available services is the low amount of capital involved.
Most Microfinance programs provide multiple services like lending, savings, life
insurance, crop insurance etc.
Such financial services are important for the uplift of the economically weak sections of
the society who are not able to avail financial services from the traditional sector. The
lack of access to credit for the poor can be attributed to practical difficulties arising from
the discrepancy between the mode of operation followed by financial institutions and the
economic characteristics and financing needs of low-income households. Microfinance
based credit delivery mechanism ensures viable financial services to address issues like
actualizing equitable gains from development activities on a sustained basis, and plays a
vital role in fighting poverty
29
NABARD has taken the lead in promoting microfinance in India. Its Self Help Group-
External website that opens in a new window (SHG) model has created opportunities for
commercial banks to lend to the poor. It has been encouraging voluntary agencies,
bankers, socially spirited individuals, other formal and informal entities and also
government functionaries to promote and nurture SHGs & Microfinance Institutions
(MFIs)).
Due to the Government's active promotion & special schemes, Commercial banks have
actively started lending capital to SHGs & MFIs, which then further lend to their
members overcoming the information asymmetries that the bank would normally have
faced. Thus engaging a dormant source of financing for the needy, as in lending to the
poor, banks face high risks and transaction costs, while the lack of borrower information
and of collateral make it unattractive for the formal financial sector to lend to the very
poor.
4.1. Dominant Models of Microfinance in India
4.1.1. SHG-Bank Linkage Model: This model involves Self Help Groups (SHGs) which
are financed directly by the Commercial Banks (Public Sector and Private Sector),
Regional Rural Banks (RRBs) or Co-operative Banks.
Microfinance programmes focus on organisation at the grassroots level through a process
of social mobilisation that enables the poor to build Self Help Groups (SHGs) amongst
themselves, consisting of 10-20 persons. They participate fully and directly and take
decisions independently in such organisations.
These groups are formed, developed and strengthened to evolve into self-managed
people's organisations which provide internal loans to its members from the group
corpus. The group corpus is supplemented with Revolving Fund sanctioned as cash credit
limit by the banks.
4.1.2. MFI-Bank Linkage Model: This model covers financing of Micro finance
Institutions (MFIs) by banking agencies for on-lending to SHGs and other small
borrowers covered under microfinance sector.
financial sector which rely heavily on collective strength and closeness of social groups
for effective social mobilisation to enable financial empowerment.
MFIs have adapted themselves to circle around the shortcomings of traditional financial
organisations, by forming a partnership between socially focussed NGOs, which invest in
human and social capital at the grass roots, and economically sensitive banking
institutions, experienced in mobilising funds for graduating and enabling rural
communities.
MFIs enable commercial banks to overcome the formal requirements of paper-work to
support transaction costs, information asymmetries and risk, making lending to the poor a
commercially attractive proposition. The role of the MFIs therefore is to act as the
guarantor to the bank, to support the credit worthiness of the poor.
4.1.3. Grameen Model- Grameen Model was pioneered by DR Mohammed Yunus of
Grameen Bank of Bangladesh. It is perhaps the most well-known and widely practiced
model in the world. In Grameen Model the groups are formed voluntarily consisting of
five borrowers each. The lending is made first to two, then to the next two and then to the
fifth. These groups of five meet together weekly, with seven other groups, so that bank
staff meets with forty clients at a time. While the loans are made to the individuals, all in
the group are held responsible for loan repayment. According to the rules, if one member
ever defaults, all in the group are denied subsequent loans.
4.1.4. Co-operative model: A co-operative is an organization owned by the
members who use its services. This model works on the principle that every
community has enough human and financial resources to manage their own financial
institutions. The members who own it are the members who use its services and can come
from different sections of same community like agriculture, retail etc. Example is
Sahavikasa or Co-operative Development Foundation (CDF). It helps in assisting rural
women and men in the areas of operation in forming and developing self-sustainable
31
co-operatives. It also provides education and training to the co-operators from its work
area.
4.2. SUPPORT IN THE FORMAL SECTOR
Microfinance institutions are a big stake holders in the Indian economy hence they are
need to be encouraged by the Government. Further the microfinance institutions provides
loans on fair terms and without collateral hence it is preferred by the people belonging to
the low income group as it frees them from the vicious cycle of debt in which they get
trapped because of the informal lending (especially moneylenders), microfinance also
need support and encouragement from the Government as it requires less documentation
Than the commercial banks and are also easily asseccible. 1
4.2.1. NABARD- NABARD is a development bank which facilitates credit flow for
promotion and development of agriculture, small-scale industries, cottage and village
industries, handicrafts and other rural crafts. Its Financial Inclusion Department (FID) is
the nodal agency which oversees the Financial Inclusion Fund (FIF) and Financial
Inclusion Technology Fund (FITF) which promote microfinance initiatives.
4.2.2. Rashtriya Mahila Kosh- The National Credit Fund for Women or the Rashtriya
Mahila Kosh (RMK) has a large number of grant and subsidy based poverty alleviation
programs comprising micro-credit & micro-savings schemes with a focus on poor women
across the country. RMK takes active initiatives in channelising funds, market
development social advocacy.
4.2.3. Small Industries Development Bank of India (SIDBI) - SIDBI's Foundation for
Micro Credit is the apex wholesaler for micro finance in India. It provides a range of
financial and non-financial services such as loan funds, grant support, equity and
institution building support to the retailing Micro Finance Institutions (MFIs) including
two-tier MFIs so as to facilitate their development into financially sustainable entities,
besides developing a network of service providers for the sector.
1 India.gov.in.
4.2.4. Tamil Nadu Womens' Development Corporation- The Tamil Nadu Corporation
for Development of Women, in partnership with Non- Governmental Organizations
(NGOs) and Community based organizations, supports 'Mahalir Thittam' or Self Help
Groups (SHGs) which inculcate sound habits of thrift, savings and banking amongst the
volunteer members of the scheme.
4.2.5. National Handicapped Finance and Development Corporation (NHFDC) 2 – It
has been set up to promote economic and development activities undertaken by Persons
with Disabilities. The Corporation assists them by providing loans for self-employment
and other economic ventures. The majority of disabled population is constantly in need of
small loans for sustaining their existing employment, for generation of further
employment as also for meeting varied personal and social needs. The poorest among the
poor need loans of very small amount but their requirement is quick delivery of loan at
their doorsteps. Traditionally, private money lenders have been playing this role but their
intention has been to exploit the poor instead of helping them and this rather worsened
plight of the poor. Over a period of time, the significance of provision of credit as an
instrument of socio-economic change and development is being realised and many
international and national organisations including the nationalised banks have come up to
provide soft loans to the poor in order to free them from the clutches of private money
lenders. However, the task is gigantic and a wide gap persists in meeting the credit needs
of the poor.
4.3. The Andhra Pradesh Microfinance Institutions (Regulation of Money lending)
Act, 2010.
The Andhra Pradesh legislative assembly cleared the bill to regulate microfinance
institutions (MFIs) in the state. The bill replaces an ordinance issued in October
following 54 suicide deaths allegedly due to coercive methods of loan recovery by MFIs. 3
The bill mandates MFIs to be registered with the district authority to collect installments
at the panchayat office and restricts fresh lending without prior approval of the authority.
2 http://nhfdc.nic.in/schemes/micro-financing-scheme.
3 Centre for Microfinance and MicroSave [ANDHRA PRADESH MFI CRISIS AND ITS IMPACT ON
CLIENTS]- Ghiyazuddin M.A, MicroSave.
The bill does not cap the interest rate charged by MFIs as demanded by civil society
groups and politicians. MFI representatives had lobbied against any attempt to put a
ceiling on the interest rate. “This is a respite for MFIs,” said Vijay Mahajan, president of
Microfinance Institutions Network, a self-appointed regulatory body.
The respite might be short-lived. A few days before the bill was passed, the state
government recommended the Reserve Bank of India’s (RBI) Y H Malegam
Committee—set up to look into regulations for MFIs—to cap the interest rate. In its
report, the government suggested 8 per cent interest rate for all MFIs while giving the
state government power to supervise its implementation. This is about onethird of the
current interest rate charged by MFIs.
It also asked the RBI to debar MFIs from accessing capital market. This would block two
major MFIs that have proposed entry into capital market with an objective of mobilising
`2,000 crore in six months. MFIs allege the state government is pushing the regulations to
gain a foothold in microfinace business. Since the state lends microfinance through self-
help groups, the bill aims to keep the groups out of MFI’s influence.
4.4. Role of Reserve Bank India
The central bank has to perform a wide range of promotional functions to support
national objectives and industries. One of the promotional function is microfinance.
Microfinance is touted as the big thing that can alleviate rural poverty.
The Reserve Bank of India (RBI) and National Bank for Agriculture and Rural
Development (NABARD) define micro-finance as Provision of thrift, credit and other
financial services and products of very small amounts to the poor in rural, semi-urban or
urban areas for enabling them to raise their income levels and in improving living
standards. 4
4 S.L. Shetty , Microfinance In India- Issues, Problems And Prospects: A Critical Review Of Literature,
(2012).
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Inclusive growth always received special emphasis in the Indian policy making.
Government of India and the Reserve Bank of India have taken several initiatives to
expand access to financial systems to the poor. Some of the salient measures are
nationalization of banks, prescription of priority sector lending, differential interest rate
schemes for the weaker sections, development of credit institutions such as Regional
Rural Banks, etc.
RBI norms for self-regulatory organisations of NBFCs engaged in micro-finance aids the
process of improved governance and grievance redressal within a well-defined
framework. The guidelines lead to creation of a layered regulatory framework which
would make for a good balance between core regulatory drivers and developmental needs
of the industry. The guidelines would substantially aid the process of improved
governance and grievance redressal, within a well-defined framework 5 .
4.5. CHALLENGES FACED
Microfinance was first introduced in India in the 1970s. Forty years on, the phenomenal
growth rate of the microfinance sector in the country has brought in funds from socially
motivated donors and investors, both foreign and domestic.
But cost of capital has been considerable, prompting lenders to charge high interest rates
as the average number of loans with borrowers of very small capital has increased across
the country. Large numbers of very small loans demand high rates, and artificially
lowering rates can desensitize MFIs from expanding their reach to the very poor.
The high growth of the industry has meant MFIs have, at times, ignored due diligence
and have not taken measures to limit multiple lending. The rapid growth in the for-profit
MFI industry, which is still at a nascent stage, has raised several questions on both
corporate governance issues as well as the viability of the business model.
5 https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9823#Bi.
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The fact that the client base of MFIs is the most vulnerable sections of society makes
them a target of political activism and regulatory intervention as well, especially because
the high profit growth of these firms is often seen to be at the expense of the poor.
Although many of the Indian Non-profit organizations (NGOs) which have extended
themselves and set up their own in-house microfinance units, find themselves flailing,
financially. Some of those can be attributed to lack of expertise in the sector, but the
primary reason is suspected to be NGOs' alignment towards public service commitment
which makes it difficult for them to transition into profit based microfinance sector. The
ability to re-gain borrowed capital is necessary for sustainability of the organisations.
The Government has initiated a number of Innovative Pilot projects to address these new
challenges and improve the outreach and sustainability of the MFIs. It has also been
promoting the need for self-regulation by MFIs & NGOs, as over-regulation at a time
when the entire sector is at a budding stage of growth, could throttle the growth potentials
of the SHGs.
5.1. The need for commercial banks:
Commercial banks provide a wide range of service which majorly includes accepting
deposits and giving loans to individuals and businesses. Commercial banks also help
microfinance institutions in in several ways, ranging from indirect involvement while
raising the capital to direct interaction with borrowers. Commercial banks have
realized the growth potential, which can be achieved through microfinance, apart
from the social needs and they are well suited to play a role in microfinance for the
following reasons. 1 First of all, they are regulated and supervised. Indeed, the sources of
capital that are obtained reside in an entity independent from the MFI. This is a very
important factor that guarantees the flow of funds to microfinance as it installs trust in
donors. Indeed, one of the problems encountered by microfinance institutions is the lack
of a systematic control of these organizations. There are very few credit-rating agencies
supervising these institutions leading, to difficulties in the procurement of capital. (This
problem will be discussed further in part III, which deals with the barriers to
microfinance).
The second reason why commercial banks are more suited to provide microfinance
concerns the nature of their ownership. In this respect, under a private status, the owner
would want to make profit and therefore systematically seek success in their projects. The
financial institutions would therefore be strongly committed to the achievement of certain
goals, such as financial viability.
Thirdly, banks can offer a wider range of financial services to the poor, a trend that can
already be observed in the goal of MFIs today. Another reason concerns the volume of
capital they are able to attain. Commercial banks have a wide network for getting funds
1 www.countrystudies.us.
and can consequently increase the loan numbers offered or the size. Furthermore, through
their branches, they can facilitate the access to their services through more efficient
transactions and thus allow a better supervision of loans and projects. From the
perspective of the bank, microfinance appears as an advantage primarily as a means to
diversify their capital. However, the most important reward for the bank is the creation of
mainstream bank customers in a few generations: banks can increase profits by catering
to a larger number of clients around the world. Finally, another advantage for a bank
involved in microfinance is the reinforcement of its public image: engaging in the
alleviation of poverty will build more trust for the bank in the formal financial sector.
5.2. ROLE OF COMMERCIAL BANKS IN MICROFINANCE
Commercial banks can engage in microfinance in many different ways, ranging from
direct relations with borrowers to a more indirect participation through the raising of
capital. Commercial banks play vital role in microfinance through following ways 2 -
5.2.1. Direct Lending: Commercial banks can lend to entrepreneurs directly. This
sort of participation of commercial banks are entirely targeted to serve the
microfinance sector. The pioneer in this field is the Grameen Bank founded by
Muhammad Yunus in 1976, with the sole goal of helping the impoverished through the
provision of small loans to a group of borrowers. Group lending includes providing a
loan to every borrower of the group. However, new loans are not approved to
borrowers if any borrower defaults his existing loan. The process of group
lending entails an accountability on borrowers to repay their loan in more discipline
way.
5.2.2. Partnership with Microfinance Institution: Commercial banks create partnership
with microfinance institutions. Banks lend to MIs in the form of retail and
wholesale banking. However, MFIs are involved in collection, monitoring
2 Ruth Goodwin Groen, The Role of Commercial Banks in Microfinance: Asia-Pacific Region: A Report for
the Foundation for Development Cooperation, Foundation for Development Cooperation, 1998.
38
and origination of loan. MFIs enjoy lots of benefits by doing tie up with banks.
As the higher amount of capital can increase the size of the loan, banks have greater
reach through their geographical expansion. Furthermore, the bank’s personnel can also
provide mentoring to MFIs in terms of improving the operational efficiencies of the
organization and making it aware of standardized international practices in the world of
finances if the bank has reached such a standard. One such example is the case of ICICI
Bank in India which is working in partnership with microfinance institutions.
5.2.3. Microfinance Subsidiary: Banks can also choose their microfinance
operations through the creation of a new subsidiaries. Such kind of branches assist
banks in mitigating the risk levels involved while lending to the poor. From the
borrower’s perspective, specialized microfinance services provided by banks may
create higher trust among borrowers and shows the commitment of bank in poverty
reduction.
5.2.4. Securitization: Last but not the least, commercial banks play vital
role in microfinance by raising funds in international as well as domestic market
for the several lending operations of MFIs.
5.3. COMPARATIVE ADVANTAGES OF COMMERCIAL BANKS IN
MICROFINANCE
At first glance, banks appear well positioned to offer financial services to ever-
increasing numbers of microfinance clients and to earn a profit. Banks have
several advantages over nonbank, microfinance institutions:
•They are regulated institutions fulfilling the conditions of ownership, financial
disclosure, and capital adequacy that help ensure prudent management.
•Many have physical infrastructure, including a large network of branches, from
which to expand and reach out to a substantial number of microfinance clients.
•They have well-established internal controls and administrative and accounting
systems to keep track of a large number of transactions.
39
•Their ownership structures of private capital tend to encourage sound
governance structures, cost-effectiveness, and profitability, all of which lead to
sustainability.
•Because they have their own sources of funds (deposits and equity capital), they do not
have to depend on scarce and volatile donor resources sd microfinance institutions
do.
•They offer loans, deposits, and other financial products that are, in principle,
attractive to a microfinance clientele. All of these advantages could give banks a
special edge over microfinance institution in providing microfinance services.
5.4. OBSTACLES FOR COMMERCIAL BANKS IN HELPING
MICROFINANCE
Banks lack, however, some key ingredients -most of all, the financial methodologies
to reach a low-income population. They also face many internal constraints that must
be overcome before they can produce a large, successful microfinance program. Our
study of banks in microfinance identified at least six key related issues banks need
to resolve to enter the microfinance market successfully 3 :
5.4.1. Commitment: the commitment of commercial banks (particularly the
larger banks) to microenterprise lending is often fragile, and generally dependent
on one or two visionary board members rather than based solidly in its institutional
mission.
5.4.2. Organizational structure: Microfinance programs need to be inserted into the
larger bank structure in such a way that they have relative independence and, at
the same time, have the scale to handle thousands of small transactions efficiently.
3 S.L. SHETTY , MICROFINANCE IN INDIA- ISSUES, PROBLEMS AND PROSPECTS: A CRITICAL REVIEW OF
LITERATURE, (2012).
5.4.3. Financial methodology: Banks need to acquire an appropriate financial
methodology to service the microenterprise sector —financial innovations that
permit a cost-effective analysis of creditworthiness, the monitoring of a large
number of relatively poor clients, and the adoption of effective collateral substitutes.
5.4.4. Human resources: Given that microfinance programs differ so radically from
traditional banking, banks must recruit and retain specialized staff to manage
these programs. Issues of recruitment, training, and performance-related incentives
require special consideration.
5.4.5. Cost-effectiveness: Microfinance programs are costly because of the small
size of their loans and because banks cannot operate them with their traditional
mechanisms and overhead structures. Strategies must be found to minimize processing
costs, increase staff productivity, and rapidly expand the scale of their
microenterprise portfolios —that is, increase the number of loans. Banks must
cover the costs of microfinance operations and specialized training through scale
economies.
authorities to ensure that reporting and regulatory requirements take into account the
specialized nature of microfinance programs.
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Enterprises
6.1. Definitions of Micro, Small & Medium Enterprises
In accordance with the provision of Micro, Small & Medium Enterprises Development
(MSMED) Act, 2006 the Micro, Small and Medium Enterprises (MSME) are classified in
two Classes: (a) Manufacturing Enterprises – The enterprises engaged in the manufacture
or production of goods pertaining to any industry specified in the first schedule to the
industries (Development and regulation) Act, 1951 or employing plant and machinery in
the process of value addition to the final product having a distinct name or character or
use. The Manufacturing Enterprises are defined in terms of investment in Plant &
Machinery. (b) Service Enterprises – The enterprises engaged in providing or rendering
of services and are defined in terms of investment in equipment. 1
6.2. Need for Micro Finance in the Development of Small Enterprise
The major barrier to the development of Micro and Small Enterprises is access to credit.
The micro and small enterprises need to be financed differently and the financing is
determined by whether the firm is in the start-up phase or existing one and also whether it
is stable, unstable, or growing. Stable survivors are those who benefit in having access to
the financial services provided by MFIs to meet up with their production and
consumption needs. Unstable survivors are groups that are considered not credit worthy
for financial services to be provided in a sustainable way and growth enterprises are
Micro and Small Enterprises with high possibility to grow. In identifying the market,
MFIs consider whether to focus on already existing entrepreneurs or on potential
entrepreneurs seeking for funds to start up a business venture. Working capital is the
main hindrance in the d