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Microfinance
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Microfinance is a term for the practice of providing financial services, such as

microcredit, microsavings or microinsurance to poor people.[1] By helping them to
accumulate usably large sums of money, this expands their choices and reduces the risks
they face.[2] As suggested by the name, most transactions involve small amounts of
money, frequently less than US$100.[3]

[edit] History

The origin of microfinance is often dated as late as the 1970s. Only then, it is often
argued, did any programs pass two key tests:

• to show that poor people can be relied on to repay their loans, and
• to show that it's possible to provide financial services to poor people through
market-based enterprises without subsidy.

Recent evidence gathered by Timothy Guinnane, an economic historian at Yale, raises

questions about this view. Guinnane demonstrates that the success of Friedrich Wilhelm
Raiffeisen's village banking movement in Germany, which actually began in 1864 and
reached 2 million rural farmers by 1901, resulted in large part from its ability to pass both
these tests.

Guinnane shows how the village-based bonds of association of these early credit unions
gave them both the information and enforcement advantages needed to make loans to
people who were both too poor and too remote to access bank loans.[4] Raiffeisen was
moved to action by the poverty of the recently freed serfs, and by the degree of
exploitation they faced from local moneylenders.[5]

The caisse populaire movement founded by Alphonse Desjardins in Quebec, also met
these tests. Desjardins and his wife Dorimène had strong faith in these principles,
founding the first caisse in 1900 (which she managed), until 1906, when a law governing
them was passed in the Quebec assembly.[6].
Like Raiffeisen, Desjardins was concerned about poverty. But he was spurred to action
by his outrage over usury. In 1897 as parliamentary reporter, he learned of "one notable
[court] case in Montreal within the last few days, in which a man obtained a loan of $150,
and was sued for, and was compelled to pay in interest, the sum of $5,000".[7]

In the 1970s, a new wave of microfinance initiatives introduced many new innovations
into the sector. Solidarity lending emerged as a distinctive new methodology, made
famous by Dr. Muhammad Yunus, the founder of Grameen Bank, who was awarded,
together with Grameen Bank, the Nobel Peace Prize in 2006.

[edit] Types

Kasmonie: In Suriname, an informal financial savings and loan system exists. It is called
“kasmonie” or “cash-money”. In this system a self-selected group of trusted individuals
agrees “to save a fixed amount of money on a periodical basis and each of them in turn
receives the whole pool once. It is generally used by microentrepreneurs.

[edit] Microfinance and development

Today, microfinance plays a major role in the development of many African, Asian, and
Latin American nations. Its impact is substantial enough to have warranted
acknowledgment by the United Nations who declared 2005 "The international year of
microfinance", reminding people that millions worldwide benefit from microfinance
activities.[8]

[edit] Development of the sector in India

This section does not cite any references or sources.
Please improve this section by adding citations to reliable sources. Unverifiable material may be
challenged and removed. (October 2007)

In India, microfinance traces its roots to mid 1970s when some prominent Indian NGO
like Myrada & Pradan started using the Self Help Group (SHG) model. The SHG is used
as a platform for social mobilization and finance is one of the various services provided
to the grassroot community through this model. It was widely replicated across other
developmental NGOs.

It is a community driven and managed microfinance model where the NGO plays the role
of a facilitator, for instance providing capacity building services to the groups and
building relationships with banks.

During the late 90's , the Grameen model promoted by Muhammad Younus of Grameen
Bank and the ASA model promoted by the Association for Social Advancement, both
from Bangladesh, found rapid acceptance amongst the newer breed of microfinance
institutions in India. This was due to the models' capability for rapid scaling in terms of
client outreach. Also these models are less dependent on donor funds and passes the
actual service charge to the clients while retaining a margin for its own growth. These
models have proven to be robust revenue models.

Slowly a distinct trend of shifting from non profit, grant-supported organizations to for
profit institutions (non-banking financial corporations) became visible in Indian
microfinance sector.

[edit] Criticism

There is, however, criticism towards microfinance institutions. In 2001, a Wall Street
Journal article raised questions about the Grameen Bank,[9] including repayment rate,
collection methods and questionable accounting practices.

On a larger scale, some argue that if microfinance is a successful anti-poverty program,

then government welfare could be shrunk or eliminated as inefficient.[10]

Research on the actual effectiveness of microfinance as a tool for economic development

remains slim, in part owing to the difficulty in monitoring and measuring this impact.[11]
Questions have arisen regarding whether microfinance can ever be as important a tool for
poverty alleviation as its proponents and practitioners would submit.[12]

It is not widely known that interest rates charged to borrowers frequently range from
2.5% to a 4% a month (about 31% to 50% a year), depending on the country.[citation needed]
This is justified to pay staff salaries and technical assistance from rich countries.[citation
needed]
Microfinance institutions argue that rates are not really high compared with those
charged by local money lenders (often over 10% a month). They also point out that if
their interest rates were not fair, they would have fewer borrowers and more
delinquencies than in fact, they do. But it is quite controversial that they charge such high
interests to poor individuals, with money that is often donated.[citation needed] The type of
interest rate charged to the borrowers is rarely disclosed by the non-government
organizations which receive donations.

There are other critics in the section of critics to microcredit.

[edit] Key debates

One key debate within microfinance has been whether donors and practitioners should
focus on impact, i.e. improved living standards for the poor, or financial sustainability.
The former approach has been called 'poverty lending' or 'the welfarist approach',
whereas the latter is sometimes termed 'the institution-building' or 'financial system
approach'.[13] Whereas the welfarist approach often supplements financial services with
other services such as education and health, institution-builders focus solely on financial
service.

The arguments for this approach are that:

 1. if poor people are willing to pay to use the institution, it must be offering them
value
2. only by ensuring financial sustainability can the huge demand be met
3. donors are best to direct subsidies to other services like education and health
through separate non-profit organizations.

Examples of the welfarist approach are FINCA International, and Freedom From Hunger.
Examples of the institution-building approach are ACCION International, BRI Unit Desa,
and Women's World Banking.

Another key debate centers on the appropriate target group for microfinance services.
One view is that the most important form of microfinance is credit targeted to poor
people who are also talented entrepreneurs. If these people gain access to credit, they will
expand their businesses, stimulate local economic growth and hire their less
entrepreneurial neighbours, resulting in fast economic development. While this approach
has had significant results in the cities of the developing world, it has failed to reach the
majority of poor people, who are rural subsistence farmers with little, if any, non-farm
income. As urban-rural income inequities continue to rise in the developing world, this
result is increasingly viewed with dissatisfaction.

The World Bank estimates that of approximately 1.2 billion people who subsisted on less
than US$1 a day in 2003, 850 million lived in rural areas.[14] There is increasing
recognition that poor people can and do save informally at home -- but lose much of their
savings because home is a risky place to save.[15] There is also recognition that before
rural farmers will have the confidence to start businesses, they must be able to gain more
control over other household risks such as hunger, disease and natural disaster. This
requires access to safe, flexible small-balance savings accounts.

A new microfinance paradigm is taking shape, with the goal of developing full-service
for-profit banks for all poor people. This approach is exemplified by the transformations
at Grameen Bank (referred to as 'Grameen II') since 2000 and has been championed by
practitioners such as Stuart Rutherford, Graham Wright, Madeleine Hirschland and
Marguerite Robinson. The Consultative Group to Assist the Poor (CGAP) has also
published extensively on the new microfinance. These banks will be able to support their
clients' efforts to control family risks as well as capitalize on business opportunities. They
will offer savings, insurance, remittance services, and personal and business loans, to
help clients grow their assets while increasing their incomes.

http://www.microfinancegateway.org/section/faq

Frequently Asked Questions

1. What is microfinance?
2. What is the difference between microfinance and microcredit?

3. Who are the clients of microfinance?

4. How does microfinance help the poor?

5. When is microfinance NOT an appropriate tool?

6. Why do MFIs charge such high interest rates to poor people?

7. Aren't the poor too poor to save?

8. What is a Microfinance Institution (MFI)?

9. Can microfinance be profitable?

10. Are commercial banks involved in microfinance?

11. What is the government’s role in supporting microfinance?

12. What is the role of the financial regulator in supporting the development of
microfinance?

13. Are there training courses that would enable me to get more in-depth exposure to
microfinance?

. What is microfinance?
To most, microfinance means providing very poor families with very small loans (microcredit) to help them
engage in productive activities or grow their tiny businesses. Over time, microfinance has come to include a
broader range of services (credit, savings, insurance, etc.) as we have come to realize that the poor and the
very poor who lack access to traditional formal financial institutions require a variety of financial products.

Microcredit came to prominence in the 1980s, although early experiments date back 30 years in
Bangladesh, Brazil and a few other countries. The important difference of microcredit was that it avoided the
pitfalls of an earlier generation of targeted development lending, by insisting on repayment, by charging
interest rates that could cover the costs of credit delivery, and by focusing on client groups whose alternative
source of credit was the informal sector. Emphasis shifted from rapid disbursement of subsidized loans to
prop up targeted sectors towards the building up of local, sustainable institutions to serve the poor.
Microcredit has largely been a private (non-profit) sector initiative that avoided becoming overtly political,
and as a consequence, has outperformed virtually all other forms of development lending.

Traditionally, microfinance was focused on providing a very standardized credit product. The poor, just like
anyone else, need a diverse range of financial instruments to be able to build assets, stabilize consumption
and protect themselves against risks. Thus, we see a broadening of the concept of microfinance--our current
challenge is to find efficient and reliable ways of providing a richer menu of microfinance products.

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2. What is the difference between microfinance and microcredit?

Microfinance refers to loans, savings, insurance, transfer services and other financial
products targeted at low-income clients. Microcredit refers to a small loan to a client
made by a bank or other institution. Microcredit can be offered, often without collateral,
to an individual or through group lending.

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3. Who are the clients of microfinance?

The typical microfinance clients are low-income persons that do not have access to
formal financial institutions. Microfinance clients are typically self-employed, often
household-based entrepreneurs. In rural areas, they are usually small farmers and others
who are engaged in small income-generating activities such as food processing and petty
trade. In urban areas, microfinance activities are more diverse and include shopkeepers,
service providers, artisans, street vendors, etc. Microfinance clients are poor and
vulnerable non-poor who have a relatively stable source of income.

Access to conventional formal financial institutions, for many reasons, is directly related
to income: the poorer you are, the less likely that you have access. On the other hand, the
chances are that, the poorer you are, the more expensive or onerous informal financial
arrangements. Moreover, informal arrangements may not suitably meet certain financial
service needs or may exclude you anyway. Individuals in this excluded and under-served
market segment are the clients of microfinance.

As we broaden the notion of the types of services microfinance encompasses, the

potential market of microfinance clients also expands. For instance, microcredit might
have a far more limited market scope than, say, a more diversified range of financial
services which includes various types of savings products, payment and remittance
services, and various insurance products. For example, many very poor farmers may not
really wish to borrow, but rather, would like a safer place to save the proceeds from their
harvest as these are consumed over several months by the requirements of daily living.

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4. How does microfinance help the poor?

Experience shows that microfinance can help the poor to increase income, build viable
businesses, and reduce their vulnerability to external shocks. It can also be a powerful
instrument for self-empowerment by enabling the poor, especially women, to become
economic agents of change.

Poverty is multi-dimensional. By providing access to financial services, microfinance

plays an important role in the fight against the many aspects of poverty. For instance,
income generation from a business helps not only the business activity expand but also
contributes to household income and its attendant benefits on food security, children's
education, etc. Moreover, for women, who, in many contexts, are secluded from public
space, transacting with formal institutions can also build confidence and empowerment.
Recent research has revealed the extent to which individuals around the poverty line are
vulnerable to shocks such as illness of a wage earner, weather, theft, or other such events.
These shocks produce a huge claim on the limited financial resources of the family unit,
and, absent effective financial services, can drive a family so much deeper into poverty
that it can take years to recover.

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5. When is microfinance NOT an appropiate tool?

Microfinance increasingly refers to a host of financial services—savings, loans,
insurance, remittances from abroad, and other products. It is hard to imagine that there
would be any family in the world today for which some type of formal financial service
couldn't be designed and made useful. But the fact of the matter is, that in most people's
mind, "microfinance" still refers to microcredit.

Microcredit is only useful in certain situations, and with certain types of clients. As we
are finding out, a great number of poor, and especially extremely poor, clients exclude
themselves from microcredit as it is currently designed. Extremely poor people who do
not have any stable income—such as the very destitute and the homeless—should not be
microfinance clients, as they will only be pushed further into debt and poverty by loans
that they cannot repay. As currently designed, microcredit requires sustained, regular, and
often significant payments from poor families. At some level, the very cause of poverty is
the lack of a sustained, regular, and significant income. Even though a family may have a
significant income for extended periods, it may also face months of no income, thereby
reducing its ability to enter into the type of commitment demanded today by most MFIs.
Some people are just too poor, or have incomes that are too undependable to enter into
today's loan products. These extremely poor people at the bottom percentiles of those
living below the poverty line need safety net programs that can help them with basic
needs; some of these are working to incorporate plans to help “graduate” recipients to
microfinance programs.

Often times governments and aid agencies wish to use microfinance as a tool to
compensate for some other social problem such as flooding, relocation of refugees from
civil strife, recent graduates from vocational training, and redundant workers who have
been laid off. Since microcredit has been sold as a poverty reduction tool, it is often
expected to respond to these situations where whole classes of individuals have been
“made poor”. Microcredit programs directed at these types of situations rarely work.
Credit requires a 98% “hit” rate to be successful. This means that 98% of recent
vocational school graduates or returning refugees would need to be successful in
establishing a microenterprise for repayment rates to be high enough to allow for a
program's overall sustainability. This is simply unrealistic. Running a program with
substantial default rates undermines the very notion of credit and destroys credit
discipline among those who could repay promptly but who look foolish given that many
do not.
Microcredit serves best those who have identified an economic opportunity and who are
in a position to capitalize on that opportunity if they are provided with a small amount of
ready cash. Thus, those poor who work in stable or growing economies, who have
demonstrated an ability to undertake the proposed activities in an entrepreneurial manner,
and who have demonstrated a commitment to repay their debts (instead of feeling that the
credit represents some form of social re-vindication), are the best candidates for
microcredit. The universe of potential clients expands exponentially however, once we
take into account the broader concept of “microfinance”.

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6. Why do MFIs charge such high interest rates to poor people?

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 make small loans. A $100 dollar loan, for example, requires the same personnel and
resources as a $2,000 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, follow through with
visits to reinforce the repayment culture. It can easily cost US$25 to make a microloan.
While that might not seem unreasonable in absolute terms, it might represent 25% of the
value of the loan amount, and force the institution to charge a “high” rate of interest to
cover its cost of loan administration.

The microfinance institution could subsidize the loans to make the credit more
"affordable" to the poor. Many do. However, the institution then depends on permanent
subsidy. Subsidy-dependent programs are always fighting to maintain their levels of
activity against budget cuts, and seldom grow significantly. They simply aren't
sustainable, especially if other microcredit operations have shown that they can provide
credit and grow on the basis of “high” rates of interest—and along the way serve far
greater numbers of clients.

Evidence shows that clients willingly 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 finance 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 higher returns, or to take advantage of economic
opportunities. The return received on such investments may well be many times greater
than the interest rate charged.

Moreover, the interest rate is only a small part of their overall transaction cost of credit,
and if microfinance institutions offer credit on a more accessible basis, substantial costs
in terms of time, travel, paperwork, etc. can be reduced, thus benefiting the poor. A long
series of studies has shown that many programs that charge subsidized interest rates end
up using rationing mechanisms to distribute credit in response to excess demand. These
mechanisms cause the borrower to have to “jump through hoops”, increasing the time and
money s/he must put out to get the loan. In fact, these transactions costs are frequently
higher than the interest costs, which takes away the advantage to the borrower of the
interest rate subsidy. However, while increased access to credit for the poor on a long
term and sustainable basis can bring significant benefits, MFIs must continue to work to
improve efficiency levels, and to increase scale. This will bring down the cost of
providing loans, and the benefits transferred to the poor in terms improving loan
products, better access to loans, and lower borrowing costs.

7. Aren't the poor too poor to save?

The poor already save in ways that we may not consider as "normal" savings--- investing
in assets, for example, that can be easily exchanged to cash in the future (gold jewelry,
domestic animals, building materials, etc.). After all, they face the same series of sudden
demands for cash we all face: illness, school fees, need to expand the dwelling, burial,
weddings.

These informal ways that people save are not without their problems. It is hard to cut off
one leg of a goat that represents a family's savings mechanism when the sudden need for
a small amount of cash arises. Or, if a poor woman has loaned her "saved" funds to a
family member in order to keep them safe from theft (since the alternative would be to
keep the funds stored under her mattress), these may not be readily available when the
woman needs them. The poor need savings that are both safe and liquid. They care less
about the interest rates that they can earn on the savings, since they are not used to saving
in financial instruments and they place such a high premium on having savings readily
available to meet emergency needs and accumulate assets.

These savings services must be adapted to meet the poor’s particular demand and their
cash flow cycle. Most often, the poor not only have low income, but also irregular
income flows. Thus, to maximize the savings propensity of the poor, institutions must
provide flexible opportunities--- both in terms of amounts deposited and the frequency of
pay ins and pay outs. This represents an important challenge for the microfinance
industry that has not yet made a concerted attempt to profitably capture tiny deposits.

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8. What is a Microfinance Institution (MFI)?

Quite simply, a microfinance institution is an organization that offers financial services to
low income populations. Almost all of these offer microcredit and only take back small
amounts of savings from their own borrowers, not from the general public. Within the
microfinance industry, the term microfinance institution has come to refer to a wide range
of organizations dedicated to providing these services: NGOs, credit unions,
cooperatives, private commercial banks and non-bank financial institutions (some that
have transformed from NGOs into regulated institutions) and parts of state-owned banks,
for example.
The image most of us have when we refer to MFIs is of a “financial NGO”, an NGO that
is fully and virtually exclusively dedicated to offering financial services; in most cases
microcredit NGOs are not allowed to capture savings deposits from the general public.
This group of a few hundred NGOs have led the development of microcredit, and
subsequently microfinance, the world over. Most of these constitute a group that is
commonly referred to as "best practice" organizations, ones that employ the newest
lending techniques to generate efficient outreach that permit them to reach down far into
poor sectors of the economy on a sustainable basis.
A great many NGOs that offer microcredit, perhaps even a majority, do many other non-
financial development activities and would bristle at the suggestion that they are
essentially financial institutions. Yet, from an industry perspective, since they are
engaged in supplying financial services to the poor, we call them MFIs. The same sort of
situation exists with a small number of commercial banks that offer microfinance
services. For our purposes, we refer to them as MFIs, even though only a small portion of
their assets may actually be tied up in financial services for the poor. In both cases, when
people in the industry refer to MFIs, they are referring only to that part of the institution
that offers microfinance.

There are other institutions, however, that consider themselves to be in the business of
microfinance and that will certainly play a role in a reshaped and deepened financial
sector. These are community-based financial intermediaries. Some are membership based
such as credit unions and cooperative housing societies. Others are owned and managed
by local entrepreneurs or municipalities. These institutions tend to have a broader client
base than the financial NGOs and already consider themselves to be part of the formal
financial sector. It varies from country to country, but many poor people do have some
access to these types of institutions, although they tend not to reach down market as far as
the financial NGOs.

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9. Can microfinance be profitable?

Yes it can. Data from the MicroBanking Bulletin reports that 63 of the world's top MFIs
had an average rate of return, after adjusting for inflation and after taking out subsidies
programs might have received, of about 2.5% of total assets. This compares favorably
with returns in the commercial banking sector and gives credence to the hope of many
that microfinance can be sufficiently attractive to mainstream into the retail banking
sector. Many feel that once microfinance becomes mainstreamed, massive growth in the
numbers of clients can be achieved.
Others worry that an excessive concern about profit in microfinance will lead MFIs up-
market, to serve better off clients who can absorb larger loan amounts. This is the
“crowding out” effect. This may happen; after all, there are a great number of very poor,
poor, and vulnerable non-poor who are not reached by the banking sector.

It is interesting to note that while the programs that reach out to the poorest clients
perform less well as a group than those who reach out to a somewhat better-off client
segment, their performance is improving rapidly and at the same pace as the programs
serving a broad-based client group did some years ago. More and more MFI managers
have come to understand that sustainability is a precursor to reaching exponentially
greater numbers of clients. Given this, managers of leading MFIs are seeking ways to
dramatically increase operational efficiency. In short, we have every reason to expect that
programs that reach out to the very poorest microclients can be sustainable once they
have matured, and if they commit to that path. The evidence supports this position.

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10. Are commercial banks involved in microfinance?

Yes. Increasingly, formal financial institutions are recognizing the benefits of serving
poorer clients. For more information, see the following documents in the Microfinance
Gateway Library:

11. What is the government’s role in supporting microfinance?

Governments have a complicated role when it comes to microfinance. Until recently,
governments generally felt that it was their responsibility to generate development
finance', including credit programs for the disadvantaged. Twenty years of insightful
critique of rural credit programs revealed that governments do a very bad job of lending
to the poor. Short term political gain is just too tempting for politically controlled lending
organizations; they disburse too quickly (and thoughtlessly) and they collect too
sporadically (unwillingness to be tough on defaulters). In urban areas, governments never
really got into the act, and subsidized microenterprise credit is still relatively rare when
compared to its rural counterpart.
Now that microfinance has become quite popular, governments are tempted to use
savings banks, development banks, postal savings banks, and agricultural banks to move
microcredit. This is not generally a good idea, unless the government has a clear
acceptance of the need to avoid the pitfalls of the past and a clear means to do so. Many
governments have set up apex facilities that channel funds from multilateral agencies to
MFIs. Apex facilities can be quite complicated and there are few successful examples in
microfinance. Successful apex organizations in microfinance tend to be built on the backs
of successful MFIs, not the other way around. Finally, governments can also get involved
in microfinance by concerning themselves with the regulatory framework that impinges
on the ability of a wide range of financial actors to offer financial services to the very
poor. This topic is treated below.

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12. What is the role of the financial regulator in supporting the development of
microfinance?
Many feel that the most important role of a financial regulator in supporting the
development of microfinance is to create an alternative institutional type that allows
sound financial NGOs, credit unions, and other community-based intermediaries to
obtain a license to offer deposit services to the general public and obtain funds through
apex organizations. In a few countries, this may be an appropriate strategy. In most
countries, however, the general level of development of the microfinance industry does
not yet warrant the licensing of a separate class of financial institutions to serve the poor.
And, in most countries, budgetary restrictions faced by bank regulators make it very
unlikely that they will be able to supervise a whole host of small institutions; these
institutions' total assets may make up a tiny percent of the total financial system, but the
cost of adequate supervision could eat up between 25 and 50 % of the total budget of the
agency.

Rather, regulators can work with the nascent microfinance industries of most countries on
issues such as modifying usury limits as stated in the commercial code to allow
appropriate levels of interest, generating credit information clearinghouses to share
information on defaulting borrowers to limit their ability to go from one MFI to another,
working with civil authorities to ensure that private loan contracts can be recognized by
courts in those transition economies that lack even basic legislative infrastructure, and
reporting requirements that will prepare MFIs to eventually become regulated.

Regulators can also examine the laws, executive decrees, and internal regulations that
limit the ability of traditional banking institutions to do microfinance. These regulations
include limits on the percent of a loan portfolio that can be lent on an unsecured basis,
limits on group guarantee mechanisms, reporting requirements, limits on branch office
operations (scheduling and security), and requirements for the contents of loan files. Not
least, banking regulators may need to look at the way in which they would evaluate
microloan portfolios within large banks.

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13. Are there training courses that would enable me to get more in-depth exposure
to microfinance?
Yes. A number of institutions provide workshops and trainings on microfinance topics
from product costing to accounting to MFI management to reaching the poor, and much
more. Trainings vary in length, location, and cost…please consider the institutions listed
below as a starting point in learning more about microfinance training. See also the
Events page of the Gateway for specific announcements of upcoming workshops.

http://economictimes.indiatimes.com/articleshow/1648287.cms

Scaling up microfinance in India

The impressive recent growth of certain sectors of the Indian economy is a necessary but
insufficient condition for the elimination of extreme poverty.
In order to ensure that the poorest benefit from this growth, and also contribute to it, the
expansion and improvement of the microfinance sector should be a national priority.

Researchers tell us that in Bangladesh, where 15 million families now benefit from small
loans and other financial products such as micro-savings and micro-insurance, 40% of the
overall reduction of rural poverty in recent years has been due to microfinance.

Two other studies suggest that the impact of microfinance on the poorest is greater than
on the poor, and yet another that non-participating members of communities where
microfinance operates experience socio-economic gains — suggesting strong spillover
effects. Moreover, well-managed microfinance institutions (MFIs) have shown a capacity
to wean themselves off of subsidies and become sustainable within a few years.

Microfinance is powerful, but it is clearly no panacea. Our experience in the business

world has taught us that solutions marketed as cure-alls to complex societal problems
rarely if ever pan out as promised.

Microfinance does not directly address some structural problems facing Indian society
and the economy, and it is not yet as efficient as it will be when economies of scale are
realised and a more supportive policy environment is created.

Loan products are still too inflexible, and savings and insurance services that the poor
also need are not widely available due to regulatory barriers. Insufficient data exists on
client-level impact, though new tools such as the Poverty Progress Index of Grameen
Foundation and the work of Sa-Dhan (the association of Indian MFIs) on measuring
client satisfaction are addressing this gap.

Still, microfinance is one of the few market-based, scaleable anti-poverty solutions that is
in place in India today, and the argument to scale it up to meet the overwhelming need is
compelling.

The impressive accomplishments of MFIs and their clients in one state — Andhra
Pradesh — provides a glimpse as to what is possible country-wide. In 2000 three leading
MFIs — SHARE, SKS and Spandana — reached far fewer than 100,000 families.

With support from Sidbi, ICICI Bank, HDFC, Citigroup, Grameen Foundation (and its
new joint venture, Grameen Capital India), Friends of Women’s World Banking, Unitus,
and others, these three organisations now serve more than 1.5 million families, most of
them very poor when they started accessing micro-financial services.

SHARE, led by the extraordinary microfinance pioneer Udaia Kumar, alone reaches
900,000. SKS has emerged as the fastest growing microfinance institution in the world
and its founder, Vikram Akula, was recently honoured as one of the top 100 people “who
shape our world” by Time magazine.

Economies of scale and imaginative uses of technology have brought costs and interest
rates down in Andhra Pradesh, as one would expect.

The rest of India is catching on and catching up. According to Sa-Dhan, the overall
outreach is 6.5 million families and the sector-wide loan portfolio is Rs 2,500 crore.

However, this is meeting only 10% of the estimated demand. Importantly, new initiatives
are expanding this success story to the some of the country’s poorest regions, such as
eastern and central Uttar Pradesh.

A new institutional capacity-building collaboration between American Express

Foundation and Grameen Foundation will be critical in ensuring that progress is
nationwide and sustainable.

Professionally-run, full-service MFIs can and do complement the self-help group

movement, which has its own impressive track record. Indian MFIs, through Sa-Dhan,
are raising standards, most recently by proposing an industry-wide consumer protection
code that most MFIs have already agreed to in principle.

The local and national governments have an important role to play in ensuring the growth
and improvement of microfinance. First and foremost, the market should be left to set
interest rates, not the state. Ensuring transparency and full disclosure of rates including
fees is something the government should ensure, and something that new technologies as
well as reporting and data standards are already enabling.
Furthermore, government regulators should set clear criteria for allowing MFIs to
mobilise savings for on-lending to the poor; this would allow for a large measure of
financial independence amongst well-managed MFIs — as the Grameen Bank of
Bangladesh has achieved in recent years through an aggressive and highly successful
savings initiative.

Each Indian state could consider forming a multi-party working group to meet with
microfinance leaders and have a dialogue with them about how the policy environment
could be made more supportive and to clear up misperceptions.

There is an opportunity to make a real dent in hard-core poverty through microfinance. A

new paper, “Measuring the Impact of Microfinance: Taking Stock of What We Know
“(which can be downloaded for free from website, shows that in most countries where
quality microfinance programmes have been scaled up, poverty has been reduced,
sometimes dramatically.

With one state leading the way, we need to build on a successful model. By unleashing
the entrepreneurial talent of the poor, we will slowly but surely transform India in ways
we can only begin to imagine today.

(Khosla, the co-founder of Sun Microsystems, is a partner at Khosla Ventures, and a

member of the Investment Committee of Grameen Foundation. Gandhi is a managing
director and head of the Global Financial Institutions Group of Credit Suisse Group,
and the vice-chair of the India Advisory Council of Grameen Foundation.)

http://www.cgap.org/keyprinciples.html

The Consultative Group to Assist the Poor

Key Principles of Microfinance

1. Poor people need a variety of financial services, not just loans. Like everyone else, the poor
need a range of financial services that are convenient, flexible, and affordable. Depending on
circumstances, they want not only loans, but also savings, insurance, and cash transfer services.

2. Microfinance is a powerful tool to fight poverty. When poor people have access to financial
services, they can earn more, build their assets, and cushion themselves against external shocks.
Poor households use microfinance to move from everyday survival to planning for the future: they
invest in better nutrition, housing, health, and education.

3. Microfinance means building financial systems that serve the poor. In most developing
countries, poor people are the majority of the population, yet they are the least likely to be served
by banks. Microfinance is often seen as a marginal sector—a “development” activity that donors,
governments, or social investors might care about, but not as part of the country’s mainstream
financial system. However, microfinance will reach the maximum number of poor clients only when
it is integrated into the financial sector.

4. Microfinance can pay for itself, and must do so if it is to reach very large numbers of poor
people. Most poor people cannot get good financial services that meet their needs because there
are not enough strong institutions that provide such services. Strong institutions need to charge
enough to cover their costs. Cost recovery is not an end in itself. Rather, it is the only way to reach
scale and impact beyond the limited levels that donors can fund. A financially sustainable institution
can continue and expand its services over the long term. Achieving sustainability means lowering
transaction costs, offering services that are more useful to the clients, and finding new ways to
reach more of the unbanked poor.

5. Microfinance is about building permanent local financial institutions. Finance for the poor
requires sound domestic financial institutions that provide services on a permanent basis. These
institutions need to attract domestic savings, recycle those savings into loans, and provide other
services. As local institutions and capital markets mature, there will be less dependence on funding
from donors and governments, including government development banks.

6. Microcredit is not always the answer. Microcredit is not the best tool for everyone or every
situation. Destitute and hungry people with no income or means of repayment need other kinds of
support before they can make good use of loans. In many cases, other tools will alleviate poverty
better—for instance, small grants, employment and training programs, or infrastructure
improvements. Where possible, such services should be coupled with building savings.

7. Interest rate ceilings hurt poor people by making it harder for them to get credit. It costs
much more to make many small loans than a few large loans. Unless microlenders can charge
interest rates that are well above average bank loan rates, they cannot cover their costs. Their
growth will be limited by the scarce and uncertain supply soft money from donors or governments.
When governments regulate interest rates, they usually set them at levels so low that microcredit
cannot cover its costs, so such regulation should be avoided. At the same time, a microlender
should not use high interest rates to make borrowers cover the cost of its own inefficiency.
 8. The role of government is to enable financial services, not to provide them directly. National
governments should set policies that stimulate financial services for poor people at the same time
as protecting deposits. Governments need to maintain macroeconomic stability, avoid interest rate
caps, and refrain from distorting markets with subsidized, high-default loan programs that cannot
be sustained. They should also clamp down on corruption and improve the environment for micro-
businesses, including access to markets and infrastructure. In special cases where other funds are
unavailable, government funding may be warranted for sound and independent microfinance
institutions.

9. Donor funds should complement private capital, not compete with it. Donors provide grants,
loans, and equity for microfinance. Such support should be temporary. It should be used to build
the capacity of microfinance providers; to develop supporting infrastructure like rating agencies,
credit bureaus, and audit capacity; and to support experimentation. In some cases, serving sparse
or difficult-to-reach populations can require longer-term donor support. Donors should try to
integrate microfinance with the rest of the financial system. They should use experts with a track
record of success when designing and implementing projects. They should set clear performance
targets that must be met before funding is continued. Every project should have a realistic plan for
reaching a point where the donor’s support is no longer needed.

10. The key bottleneck is the shortage of strong institutions and managers. Microfinance is a
specialized field that combines banking with social goals. Skills and systems need to be built at all
levels: managers and information systems of microfinance institutions, central banks that regulate
microfinance, other government agencies, and donors. Public and private investments in
microfinance should focus on building this capacity, not just moving money.

11. Microfinance works best when it measures—and discloses—its performance. Accurate,

standardized performance information is imperative, both financial information (e.g., interest rates,
loan repayment, and cost recovery) and social information (e.g., number of clients reached and
their poverty level). Donors, investors, banking supervisors, and customers need this information to
judge their cost, risk, and return.

http://www.grameenfoundation.org/what_we_do/microfinance_in_action/

Microfinance
Microfinance success stories

Odette, Haiti
 Yuli, Indonesia

Andrea, Mexico

Chaibia, Morocco

Spread the word:

Send an e-card
with the story of
Odette, Yuli, Andrea, or Chaibia

An effective poverty reduction strategy

Microfinance is often considered one of the most effective and flexible strategies in
the fight against global poverty. It is sustainable and can be implemented on the
massive scale necessary to respond to the urgent needs of those living on less than
$1 a day, the World’s poorest.

Microfinance consists of making small loans, usually less than $200, to

individuals, usually women, to establish or expand a small, self-sustaining
business. For example, a woman may borrow $50 to buy chickens so she can sell
eggs. As the chickens multiply, she will have more eggs to sell. Soon she can sell the
chicks. Each expansion pulls her further from the devastation of poverty.

Microfinance, the Grameen way, includes several support systems that

contribute greatly to its success. Microfinance institutions offer business advice
and counseling, while clients provide peer support for each other through solidarity
circles. For example, if a client falls ill, her circle helps with her business until she is
well. If a client gets discouraged, the support group pulls her through. This
contributes substantially to the extremely high repayment rate of loans made to
microfinance entrepreneurs.

An equally important part of microfinance is the recycling of funds. As loans

are repaid, usually in six months to a year, they are re-loaned. This continual
reinvestment multiplies the impact of each dollar loaned.

Microfinance has a positive impact far beyond the individual client. The vast
majority of the loans go to women because studies have shown that women are more
likely to reinvest their earnings in the business and in their families. As families cross
the poverty line and micro-businesses expand, their communities benefit. Jobs are
created, knowledge is shared, civic participation increases, and women are
recognized as valuable members of their families and communities.

http://www.grameenfoundation.org/what_we_do/microfinance_support/

Microfinance Program Support

Building strong institutionsRanging in size from just a few hundred clients to
hundreds of thousands, our partner microfinance institutions are the bedrock of our
outreach to the poor. Our success is intricately tied to their impact and performance.
As the demand for microfinance increases, these front-line institutions must be able
to adapt to the changing needs of the communities they serve. To help them operate
more efficiently and be more effective, we provide each partner with financial
products and services that are tailored to meet their needs.

Drawing on the skills and expertise of our in-house professionals and a pool of
consultants, we work with individual MFIs to develop a comprehensive technical
assistance package, including:

• financing strategies that foster smart growth

• training and capacity-building programs that help to expand and strengthen
day-to-day operations
• outreach initiatives that increase their visibility both in local and international
communities

To be more effective, MFIs must also know how their products and services are
helping their clients to escape poverty. Grameen Foundation is helping them
measure their social performance with its Progress Out of Poverty Index. It allows
the MFIs to better determine their clients’ needs, which programs work best, how
quickly clients leave poverty, and what helps them to move out of poverty faster. It
builds on previous efforts within the industry to measure and manage social
performance and is available to Grameen Foundation partner MFIs, as well as those
outside the network.

centre of microfinance.
The Centre for microFinance (CmF) has been set up in Jaipur (Rajasthan) to widen, deepen and
upscale the microFinance movement in Rajasthan.

The Centre is an autonomous institution; it employs high quality professionals to provide a wide
range of technical and other support services to mF players. Given its mandate the centre places
value on networking and collaborations with stakeholders. It undertakes direct action only in gaps
where players neither exist nor can be catalyzed

About Us

The Centre for microFinance (CmF) has been set up in Jaipur (Rajasthan) to strengthen the
microFinance sector. The objective of the Centre is to provide services to mF players and various
stakeholders in the microfinance sector. Sir Ratan Tata Trust along with banks, state
government and partner NGOs thought about a ‘knowledge and support centre’ for micro finance
sector in Rajasthan. Prof V S Vyas, Chaiman IDS, Jaipur undertook Feasibility Study and
suggested for setting up the Centre for Micro Finance to help in widening, deepening and up
scaling the micro finance sector. The Steering Committee headed by Mr. N S Sisodia, IAS, ex
Secretary Banking Government of India, met for the first time on June 9th, 2005 at IIHMR, Jaipur.

The primary role of the centre is to help in coordinating and channeling actions and programmes
of various stakeholders- government departments, banks, and civil society institutions to
strengthen microFinance movement in Rajasthan. The Centre for microFinance is the nodal
agency for all the projects under Sakh se Vikas-The Rajasthan Microfinance Initiative of The Sir
Ratan Tata Trust, particularly of the implementation projects within it. Centre is an autonomous,
self-governing institution. It employs high quality professionals to provide domain expertise. Given
its mandate the centre places value on networking and collaborations with other stakeholders. It
undertakes direct action only in gap areas where players neither exist nor can be catalyzed.

The centre for microFinance is housed in Indian Institute of Health Management Research
(IIHMR) Jaipur.

Core Values of CmF

Integrity and Sensitivity towards Poor and Marginalized

Innovative

Proactive and Responsive

 Collaboration and Leverage

Autonomous, Self-Governing

http://www.uncdf.org/english/microfinance/pubs/newsletter/pages/2005_06/
news_india.php
The Future of Microfinance in India:

The Microfinance India Conference and a Look at an Expanding Market

By Sukhwinder Singh Arora, Financial Sector Team, Policy Division, DFID*

I recently participated in the Microfinance India conference (New Delhi, April 12-
14, 2005), organised by CARE India, PlaNet Finance India, the United Nations
Development Programme, the Small Industries Development Bank of India,
SADHAN, CGAP, ICICI Bank, Ford Foundation and Friends for Women's World
Banking to mark the International Year of Microcredit. The key themes of this
conference were "Inclusion, Impact, and Innovation in the Microfinance Industry".

This was the second annual event of what is now becoming a large annual
gathering to celebrate successes, discuss perspectives and research, and build
networks around the microfinance sector in India. Reconnecting after a few
years, I was pleased to see all the buzz about microfinance and the number and
diversity of stakeholders who collaborated on the conference. The number and
diversity of delegates, the level of participation from senior policy makers and
bankers and the quality of debates and media attention confirms that
microfinance is no longer at the periphery of the financial sector in India. This
short note is a personal reflection on what has changed, what may take a long
time to change and what India and the rest of the World may learn from each
other.

A Long History of Social Banking

India has supported social banking for a long time. Policy directions to rapidly
expand rural branches, mandate credit allocations for priority sectors (including
agriculture), deliver large subsidy oriented credit programmes to serve marginal
communities and poor households and control interest rates have been tried for
over 35 years.

The new generation microfinance was slow in coming to India. Low levels of
grants to microfinance institutions, an unfavourable policy environment,
substantial traditional banking infrastructure and a search for context specific
solutions has constrained rapid scale up. The first breakthrough emerged from
policy support to enable informal self help groups of 15-20 members (mainly
women) to transact with commercial banks. These groups build up and rotate
savings amongst themselves, open bank accounts and take responsibility for
lending and recovering money financed by banks. With the missionary zeal of the
National Bank for Agriculture and Rural Development (NABARD), insights gained
by NGOs, the increasing enthusiasm of bankers and politicians and emerging
successes in repayment and social impacts, this national movement now
encompasses 1.4 million such groups (over 20 million members).

At a time when many questioned the need for specialised microfinance

institutions (MFIs) in India, the Small Industries Development Bank of India
recognised the opportunity and started implementation of an ambitious national
programme. Providing loan and capacity building support to MFIs and capacity
building and rating support for sector development, this programme already
supports 70 MFIs and has disbursed US$46 million.

What is Exciting about Indian Microfinance?

A Task Force on Microfinance recognised in 1999 that microfinance is much

more than microcredit, stating: "Provision of thrift, credit and other financial
services and products of very small amounts to the poor in rural, semi-urban and
or urban areas for enabling them to raise their income levels and improve living
standards". The Self Help Group promoters emphasise that mobilising savings is
the first building block of financial services.
For many years, the national budget and other policy documents have almost
equated microfinance with promoting SHG links to the banks. The central bank
notification that lending to MFIs would count towards meeting the priority sector
lending targets for Banks offered the first signs of policy flexibility towards MFIs.
One could argue that MFIs are small and insignificant, so why bother. The larger
point is about policy space for innovation and diversity of approaches to meet
large unmet demand. The insurance sector was partially opened to private and
foreign investments during 2000. Over 20 insurance companies are already
active and experimenting with new products, delivery methodologies and
strategic partnerships.

Microfinance programmes have rapidly expanded in recent years. Some

examples are:

• Membership of Sa-Dhan (a leading association) has expanded from 43 to 96 Community

Development Finance Institutions during 2001-04. During the same period, loans outstanding of
these member MFIs have gone up from US$15 million to US$101 million.
• The CARE CASHE Programme took on the challenge of working with small NGO-MFIs and
community owned-managed microfinance organisations. Outreach has expanded from 39,000 to
around 300,000 women members over 2001-05, Many of the 26 CASHE partners and another 136
community organisations these NGO-MFIs work with, represent the next level of emerging MFIs
and some of these are already dealing with ICICI Bank and ABN Amro.
• In addition to the dominant SHG methodology, the portfolios of Grameen replicators have also
grown dramatically. The outreach of SHARE Microfin Limited, for instance, grew from 1,875 to
86,905 members between 2000 and 2005 and its loan portfolio has grown from US$0.47 million to
US$40 million.

Since banks face substantial priority sector targets and microfinance is beginning
to be recognised as a profitable opportunity (high risk adjusted returns),[1] a
variety of partnership models between banks and MFIs have been tested. All
varieties of banks - domestic and international, national and regional - have
become involved, and ICICI Bank has been at the forefront of some of the
following innovations:

• Lending wholesale loan funds.

• Assessing and buying out microfinance debt (securitisation).
• Testing and rolling out specific retail products such as the Kissan (Farmer) Credit Card.
• Engaging microfinance institutions as agents, which are paid for loan origination and recovery, with
loans being held on the books of banks.
• Equity investments into newly emerging MFIs.
• Banks and NGOs jointly promoting MFIs.

The 2005 national budget has further strengthened this policy perspective and
the Finance Minister Mr P. Chidambram announced "Government intends to
promote MFIs in a big way. The way forward, I believe, is to identify MFIs,
classify and rate such institutions, and empower them to intermediate between
the lending banks and the beneficiaries."
What is beginning to happen in microfinance can be seen from the perspective of
what has happened to phones in India. With the right enabling environment, and
intense competition amongst private sector players, mobile phones in India
expanded by 160% during just one year 2003-04 (from 13 to 33 million). Mobile
tariffs fell by 74% during the same period. While this is heady progress, there is a
less heralded but even more powerful nationwide success on access. In the late
eighties, the phone infrastructure was the monopoly of public sector institutions.
Phones were difficult to get and even more difficult to use for those lacking
ownership. Realisation that users need not own a phone to access one led to
privatisation of the last mile - where a phone user could interface with a private
sector provider using the public sector telecom infrastructure. Even with this
policy change, today there are 2.5 million entrepreneurs selling local, national
and international phone services through the length and breadth of India. Many
of these are now graduating to sell internet services and could potentially be
banking agents - that is the evolving story.

Savings services are needed by many more customers and as frequently as

access to phone services. Many poor households value access to savings
services and find new providers and arrangements, despite hearing of unreliable
savings collectors or even occasionally falling prey to such arrangements. Many
customers are rich, literate and lucky to have banks working for them. But many
others lack access to safe, secure and accessible savings services for the short,
medium and long terms.[2] In the past, many banks sent collectors to gather
these savings but problems with monitoring, inability to tackle misappropriation
and the rising aspiration of collectors to become permanent staff of public sector
banks killed a useful service. The central bank has strictly forbidden commercial
banks from using agents in collection of savings services. This is unfortunate as:

• Effective microfinance delivery is about managing transaction costs for providers and customers.
• A combination of agents and technology can play a powerful role in rightly aligning incentives for
the collector and customers, while keeping transaction costs manageable for everyone.
• The banks can only open so many branches, and fixed and operating costs are high, apart from
approvals still needed from the central bank to open new branches or close existing ones. The
appointment of agents can keep costs manageable and offer greater flexibility[3] to Banks.
• Banking service may not be able to defy the commercial logic pursued by most other sectors where
a variety of retailers provide services to customers, while companies focus on customer needs,
product design, quality control, branding, logistics and distribution.

Fortunately, the 2005 Budget opened a small window in this area and the central
bank annual policy recently confirmed discussions on this: "As a follow-up to the
Budget proposals, modalities for allowing banks to adopt the agency model by
using the infrastructure of civil society organisations, rural kiosks and village
knowledge centres for providing credit support to rural and farm sectors and
appointment of micro-finance institutions (MFIs) as banking correspondents are
being worked out." But readers may note that between the budget and the annual
policy statement, "credit" has again crept in as the key perceived need.
Challenges Remain

A World Bank study assessing access to financial institutions found that amongst
rural households in Andhra Pradesh and Uttar Pradesh, 59% lack access to
deposit account and 78% lack access to credit. Considering that the majority of
the 360 million poor households (urban and rural) lack access to formal financial
services, the numbers of customers to be reached, and the variety and quantum
of services to be provided are really large. Vijay Mahajan, Managing Director of
BASICS, estimated that 90 million farm holdings, 30 million non-agricultural
enterprises and 50 million landless households in India collectively need approx
US$30 billion credit annually.[4] This is about 5% of India's GDP and does not
seem an unreasonable estimate.

A tiny segment of this US$30 billion potential market has been reached so far
and this is unlikely to be addressed by MFIs and NGOs alone. Reaching this
market requires serious capital, technology and human resources. However,
80% of the financial sector is still controlled by public sector institutions.
Competition, consolidation and convergence are all being discussed to improve
efficiency and outreach but significant opposition remains; for example, the All
India Bank Employees Association has threatened to strike if the Government
proceeds with its policy of reducing its capital in public sector banks, merging
public sector banks or even enhancing Foreign Direct Investments in Indian
private banks.

Many speakers at the Microfinance India conference talked about the significant
and growing gap between surging growth in South India, which contrasts with the
stagnation in Eastern, Central and North Eastern India. Microfinance on its own
is unlikely to be able to address formidable challenges of underdevelopment,
poor infrastructure and governance.

The Self Help Group movement is beginning to focus on issues of quality and
there were some interesting discussions on embedding social performance
monitoring as a part of the regular management information systems.

At the time of the conference, a leading and responsible MFI was being
investigated by the authorities for charging "high" rates of interest. Per unit
transaction costs of small loans are high but many opinion leaders still persist
with the notion poor people cannot be charged rates that are higher than
commercial bank rates. The reality of the high transaction costs of serving small
customers, their continuing dependence on the informal sector, the fact that most
bankers shy away from retailing to this market as a business opportunity, and the
poor quality of services currently provided does not figure prominently in this
discourse. While the central bank has deregulated most interest rates, including
lending to and by MFIs, interest rates restrictions on commercial bank for retail
loans below US$5,000 (all microfinance and beyond) remain and caps on deposit
rates also discourage sharing transaction costs with customers.But most
conference participants accepted the imperatives to build sustainable institutions.

There is still lot of policy focus on what activities are and are not allowed and not
enough operational freedom as yet for banks and financial institutions to design
and deliver programmes, and be responsible for their actions. Prescriptions and
detailed circulars often limit organisational innovation and market segmentation.
As Nachiket Mor of ICICI Bank said at the conference, if the right indicators are
monitored and operational freedom and incentives are clear, both public and
private banks have the capacity to rapidly address the remaining challenges.

Closing Remarks

In my view, savings service is the neglected daughter of the family of financial

services. I use this metaphor because of the sustained discrimination against and
frequent disregard for savings services, despite their productive and reproductive
role in financial services[5]. This is evident from different nomenclature used at
both the international (UN International Year of Microcredit, MicroCredit summit)
and national levels (Priority Sector Lending; Annual Credit Policy; Credit/ deposit
ratio). Savings services can be a useful entry point for the unbanked to build up a
history with the formal financial institutions before customers are entitled to other
financial services. With the greater spotlight on knowing the customer and the
fact that poor households do not have a salary slip, utility bills, clear land titles or
unique identity papers, a regular savings record could be the first building block
to membership of the formal financial sector. What is more, with savings
services, poor customers need to trust the financial institution and not the other
way round.

Microfinance is not yet at the centre stage of the Indian financial sector. The
knowledge, capital and technology to address these challenges however now
exist in India, although they are not yet fully aligned. With a more enabling
environment and surge in economic growth, the next few years promise to be
exciting for the delivery of financial services to poor people in India.

I would like to congratulate CARE, as the lead organisers, for successfully

hosting this global cross learning event. Unusually, the event ended with a
statement of some objectively verifiable indicators (such as expansion of urban
microfinance, increased conference participation by public sector banks and
redressal of North South divide) on which the sector should track progress in a
years' time.

Is microfinance a success in India?

November 08, 2007 14:55 IST
Microfinance has no doubt improved the lives of the poor in India but sometimes it leads people to borrow
too much, to the extent that over indebtness can lead to suicides in extreme cases, says a new book.

"The controversy in Andhra Pradesh shows that the impact of microfinance needs to be more rigorously
documented in order to convince policy makers and regulators that the movement should be supported,"
writes Prabhu Ghate in 'Indian Microfinance: The Challenges of Rapid Growth'.

In March 2006, the Andhra Pradesh government raided and temporarily closed down nearly all branches of
microfinance institutions functioning in Krishna district.

The step led to widespread criticism in the media and did much to reverse the slowly growing awareness
and appreciation of the good work being done by microfinance institutions.

One short term impact of the crisis was a heightened perception of political risk among banks, which both
increased the interest rates as well as reduced new lending to microfinance institutions in Andhra Pradesh.

Another impact has been a sharp diminution in the rate of growth of microfinance institution model in Andhra
Pradesh. The writer says though the rate of growth of microfinance in India has accelerated to a great extent
in the past few years, making it the largest in the world, the sector continues to face persisting challenges

The main challenge facing the sector is identified as the need to enhance borrower, public and regulatory
support and understanding, by increasing transparency in dealings with borrowers and by educating the
poor.

In his book, Ghate attempts to put together a one-stop document that will help readers catch up on the latest
developments, issues and achievements of the microfinance sector in India.

"The sector is growing rapidly, both in the scale and in the diversity of actors, and is sitting on the cusp of
regulation. It is, therefore, in the midst of rapid flux," he says.

"For some time now, there has been a growing demand by practitioners, financial institutions, policy makers,
regulators, the research community, the media and the development community generally for a periodic,
comprehensive and up-to-date account of the sector.

"Players in various parts of the sector want to know much more about the parts of the sector they would like
to engage with more," says Ghate, who is an independent researcher and consultant and had worked as a
senior economist at the Asian Development Bank [Get Quote], Manila.

He goes on to cite a few examples, saying bankers and social venture capitalists are vitally dependent on
the success of the efforts of the training and capacity-building service providers in easing human resource
constraints facing the sector, and would like to know more about their activities.

According to Ghate, insurance companies are interested in opportunities offered by self help group (SHG)
bank linkage programme, just as bankers are curious about the opportunities that might lie in money
transfers.

"Additionally, not enough is known about the unfolding priorities of the donors. Everyone is affected by what
the regulators in turn need to know more about the sector they are charged with regulating," he writes.

This book furthers the goal of microfinance in India to bring the sector together to look at critical issues,
propose solutions and vision the harmonious growth of the sector as a whole.

Indian microfinance has continued growing rapidly towards the main objective of financial inclusion,
extending outreach to a growing share of poor households and to the approximately 80 per cent of the
population, which has yet to be reached directly by the banks.
The larger of the two main models - the self help group bank linkage programme - covered about 14 million
poor households in March 2006 and provided indirect access to the banking system to another 14 million,
including the borderline poor.

Although firm estimates are lacking, the other, the microfinance institution (MFI) model, served 7.3 million
households, of which 3.2 million were poor.

Even allowing for a degree of overlap of borrowers from both models, the total number of poor households
being reached was roughly a fifth of all poor households, as well as a smaller share of the larger number of
non-poor households who have yet to be reached by the formal financial sector.

Apart from providing financial services to both these segments of the population, there is widespread
evidence that the much stronger competition provided to the informal sector has significantly improved the
terms of credit provided to both segments by this sector, which is losing its share to both the formal and the
(semi-formal) MFI sector.