TERM PAPER OF BANKING & INSURANCE

TOPIC: MICRO FINANCE DEVELOPMENT OVERVIEW

AND CHALLENGES

SUBMITTED TO: SUBMITTED BY

MR. SACHIN LAL KASHYAP AMANDEEP SINGH
BBAV RT1809 A01
CONTENTS
1.INTRODUCTION
 KEY PRINCIPLES
 PROFILE OF MICRO FINANCE IN INDIA
2.NEED FOR MICRO FINANCE
3.KEY PLAYERS IN MICRO FINANCE
4.MODEL OF MICRO FINANCE PRACTICES

 TABLE
5.GLOBAL ACCEPTANCE OF MICRO FINANCE
6.INDIAN MICRO FINANCE CONTEXT
7.CHALLENGES

 BOUNDARIES & PRINCIPLE

 INCLUSIVE FINANCIAL SYSTEM
 MICRO FINANCE & SOCIAL INTERVENTION
 OTHER CRITICSM
 ROAD AHEAD
8.CONCLUSION
Microfinance is the supply of loans, savings, andother basic financial services to the poor.
People livingin poverty, like everyone else, need a diverse range of financial instruments to run
their businesses, build assets, stabilize consumption, and shield themselves against risks.
Financial services needed by the poor include working capital loans, consumer credit, and
savings, pensions, insurance, and money transfer services .

Microcredit generally means:

1.Small size loans;

2.Shorter repayment periods;

3.Flexible and easy to understand regulations and

needs;

4.Small scale activities based on local conditions

and needs;

5.Clients are small entrepreneurs and low-income

households;

6.Loans used to generate income, develop enterprises

and used by the community for social services such
as health and education.

Key principle of microfinance:

1.The poor need variety of financial services, not just loans (but also savings, transfers, insurance
etc.).

2.Microfinance is a poverty instrument against poverty (access to sustainable financial services –

increase income, build assets, reduce vulnerability, better nutrition, health, education etc.).

3.Microfinance means building financial system that serves the poor (microfinance should
become an integral part of the financial sector).

4.Financial sustainability is necessary to reach a significant numbers of poor people

(sustainability is the ability of microfinance provider to cover all of its costs and the ongoing
provision of financial services to the poor).

5.Microfinance is about building permanent local financial institutions (building financial

systems for the poor means building sound domestic financial intermediaries that can provide
services to poor people on a permanent base).
Profile Of Micro Finance In India
The profile of micro finance in India at present can be traced out in terms of
poverty it is estimated that 350 million people live Below Poverty Line. The
following are some components of micro finance:

a) This translates to approximately 75 million households.

b) Annual credit demand by the poor in the country is estimated to be about

Rs 60,000 crores.

c) A cumulative disbursement under all micro finance programmes is only

about Rs. 5000 crores.

d) Total outstanding of all micro finance initiative in India estimated to be Rs.

1600 crores.

e) Only about 5% of rural poor have access to micro finance.

f) Though a cumulative of about 20 million families have accepted accessed.

g) While 10% lending to weaker sections is required for commercial banks,

they neither have the network for lending and supervision on a larger
scale or the confidence to offer term loan to big micro finance institutions.

h) The non poor comprise of 29% of the outreach.

Need For Micro Finance

Micro finance aims at assisting communities of the economically excluded to
achieve greater levels of asset creation and income security at the household
and community level. Access to financial services and the subsequent transfer of
financial resources to poor women enable them to become economic agents of
change. Women become economically self-reliant, contribute directly to the well
being of their families, play a more active role in decision making and are able to
confront systematic gender inequalities. Access to credit has long been
considered a major poverty alleviation strategy in India. Micro credit has given
women in India an opportunity to become agents of change. Poor women, who
are in the forefront micro credit movement in the country use small loans to jump
start a long chain of economic activity.
Micro finance is accessing financial services in an informally formal route, in a
flexible, responsive and sensitive manner which otherwise would not have been
possible for the formal system for proving such services because of factors like
high transaction cost emanating from the low scale of operation, high turnover of
clients, frequency of transaction etc. (Vijay Mahajan and G. Nagasri, 1999). Micro
finance and Self Help Group (SHG) must be evolved to see that SHGs do not
charge high rates of interest from their clients and improve access to those who
cannot sign by making their use through thumb impression.

Key Players In The Micro Finance System

i) National Bank for Agricultural and Rural Development (NABARD):

NABARD is an apex institution, accredited with all matters concerning policy,
planning and operations in the fields of credit for agriculture and other
economic activities in rural areas in India. NABARD was established in 1982
as a Development Bank, in terms of the Preamble of the Act, “for providing
and regulating credit and other facilities for the promotion and development of
agriculture, small scale industries, cottage and village industries, handicrafts
and other rural crafts and other allied economic activities in rural areas with a
view to promoting integrated rural development and securing prosperity of
rural areas and for matters connected therewith or incidental thereto”. The
corporate mission set by NABARD for making available microfinance services
to the very poor envisages coverage of one third of the rural poor through one
million SHGs by the year 2006-07. The propose targets are given in the
following table:

Table 1. Target of SHG and Bank

YEAR NUMBER OF CUMULATIVE BANK LOAN CUMULATIVE
SHGS TO BE NUMBER OF REQUIREMENT BANK CREDIT
LINKED DURING SHGS TO BE DURING THE INVOLVED AT
THIS YEAR LINKED DURING YEAR IN MILLION THE END OF
THIS YEAR YEAR IN MILLION
2002-2003 125000 585000 7909 18172

2003-2004 110000 695000 14172 32884

2004-2005 105000 800000 28184 61068

2005-2006 100000 900000 41256 102234

ii) Reserve Bank of India

The earliest reference to micro credit in a formal statement of monetary and
credit policy of RBI was in former RBI President Dr. Bimal Jalan’s Monetary and
Credit Policy Statement of April 1999. The policy attached importance to the work
of NABARD and public sector banks in the area of micro credit. The banks were
urged to make all out efforts for provision of micro credit, especially forging
linkages with SHGs, either at their own initiative or by enlisting support of Non-
Government Organisation (NGOs).

iii) Self Help Groups

The origin of SHGs is from the brainchild of Grameen Bank of Bangladesh, which
was founded by Mohammed Yunus SHG was started and formed in 1975. The
establishment of SHGs can be traced to the existence of one or more problem
areas around which the consciousness of rural poor is built and the process of
group formation initiated. SHG are considered a new lease of life for the women
in villages for their social and economic empowerment. SHG is a suitable means
for the empowerment of women. Since SHGs have been able to mobilize savings
from persons or groups who were not normally expected to have any ‘saving’ and
also to recycle effectively the pooled resources amongst the members, their
activities have attracted attention as a supportive mechanism for meeting the
credit needs of the poor (NABARD, 2004). The main characteristics of SHGs are
as follows:

a) The ideal size of an SHG is 10 to 20 members. (In a bigger group,

members cannot actively participate)

b) The group need not be registered.

c) From one family, only one member. (More families can join SHGs this
way)

d) The group consists of either only men or of only women. (Mixed groups
are generally not preferred)

e) Women’s groups are generally found to perform better.

f) Members have the same social and financial background. (Members

interact more freely this way)

g) Compulsory attendance. (Full attendance for larger participation)

Models of Micro Finance Practices:
The following are the variety of delivery models of micro finance in India:

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

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

Model II - SHGs formed by formal agencies other than banks (NGOs and other),
but directly financed by banks: - In this model, the NGOs and other agencies
have played the role of facilitator. Upto March 2005, 72% of SHG financed were
from this category. Model III- SHGs financed by banks using NGOs and other
agencies as financial intermediaries: - In this model, the NGOs and other
agencies play the role of financial intermediation. Upto March 2005, only 7% of
SHG financed were from this category.
Thus in 2006-07, the country witnesses a marked proliferation of SHGs to the
extent of 24,76,492. In no less discouraging terms the bank loans also amounted
to Rs 13, 511.86 crores as indicated in the following table:

Table 2. Progress of SHg Bank Linkage in India

YEAR NEW SHGS TO BANK
BE FINANCED GROWTH% CUMULATIVE LOAN IN GROWTH%
NO CRS CUMULATIVE
DURING THE DURING AMOUNT
YEAR NO THE
YEAR
1992-1999 32995 - 32995 57 - 57
1999-2000 81780 148 114775 136 138 193
2000-2001 149050 82 263825 288 112 481
2001-2002 197653 33 461478 545 89 1026
2002-2003 255882 29 717630 1022.34 87 2048
2003-2004 361731 41 1079091 1855 81 3904
2004-2005 539365 41 1618456 2994 62 6898
2005-2006 620109 15 2238565 4499 50 11397

Growth of linked SHGs in 13 priority states

STATE 2003 2004 2005 2006 2007 PERCENT

GROWTH
ASSAM 3,477 10,706 31,234 56,449 81,454 44

BIHAR 8,161 16,246 28,015 46,221 72,339 57

CHATTISGARH 6,763 9,796 18,569 31,291 41,703 33

GUJARAT 13,875 15,974 24,712 34,160 43,572 28

HIMACHAL 8,875 13,228 17,798 22,920 27,799 21

PRADESH
JHARKHAND 7,765 12,647 21,531 30,819 37,317 21

MAHARASTRA 28,065 38,535 71,146 131,470 225,856 72

MADHYA 15,271 27,095 45,105 57,125 70,912 24

PRADESH
ORISSA 42,272 77,588 123,256 180,896 234,451 30

RAJASTHAN 22,742 33,846 60,006 98,171 137,837 40

UTTAR 53,696 79,210 119,648 161,911 198,587 23

PRADESH
UTTRANCHAL 5,853 10,908 14,043 17,588 21,527 22

WEST BENGAL

32,647 51,685 92,698 136,251 181,563 33

TOTAL 249,462 397,464 667,761 1,005,272 1,374,917 37

PERCENT 59 68 51
INCREASE
Global Acceptance of Microfinance
It is claimed that this new paradigm of unsecured small scale financial service provision helps
poor people take advantage of economic opportunities, expand their income, smoothen their
consumption requirement, reduce vulnerability and also empowers them .

Former World Bank President James Wolfensohn said “Microfinance fits squarely into the
Bank's overall strategy. As you know, the Bank's mission is to reduce poverty and improve living
standards by promoting sustainable growth and investment in people through loans, technical
assistance, and policy guidance. Microfinance contributes directly to this objective”. The
emphasis on microfinance is reflected in microfinance being a key feature in Poverty Reduction
Strategy Papers

Realising the importance of microfinance, World Bank has also taken major steps in developing
the sector. Formation of Consultative Group to Assist the Poor (CGAP) in 1995 as a consortium
of 33 Public and private development agencies and establishment of Microfinance Management
Institute (MAFMI) in 2003 are significant landmarks. CGAP acts as a “resource center for the
entire microfinance industry, where it incubates and supports new ideas, innovative products,
cutting-edge technology, novel mechanisms for delivering financial services, and concrete
solutions to the challenges of expanding microfinance” MAFMI was established with support of
CGAP and Open Society Institute for meeting the technical and managerial skills required for
microfinance sector.

Indian Microfinance Context

Indian public policy for rural finance from 1950s to till date mirrors the patterns observed
worldwide. Increasing access to credit for the poor has always remained at the core of Indian
planning in fight against poverty. The assumption behind expanding outreach of financial
services, mainly credit was that the welfare costs of exclusion from the banking sector, especially
for rural poor are very high. Starting late 1960s, India was home to one of largest state
intervention in rural credit market and has been euphemistically referred to as ‘Social banking’
phase. It saw nationalisation of existing private commercial banks, massive expansion of branch
network in rural areas, mandatory directed credit to priority sectors of the economy, subsidised
rates of interest and creation of a new set of rural banks at district level and an Apex bank for
Agriculture and Rural Development (NABARD) at national level. These measures resulted in
impressive gains in rural outreach and volume of credit. As a result, between 1961 and 2000 the
average population per bank branch fell tenfold from about 140 thousand to 14000 and the share
of institutional agencies in rural credit increased from 7.3% 1951 to 66% in 1991.
These impressive gains were not without a cost. Government interventions through directed
credit, state owned Rural Financial Institutions (RFI) and subsidised interest rates increased the
tolerance for loan defaults, loan waivers and lax appraisal and monitoring of loans. The problem
at the start of 1990 Looked twofold, the institutional structure was neither profitable in rural
lending nor serving the needs of the poorest. In short, it had created a structure, ‘quantitatively
impressive but qualitatively weak’
.
Microcredit emergence in India has to be seen in this backdrop for a better appreciation of
current paradigm. Successful microfinance interventions across the world especially in Asia and
in parts of India by NGOs provided further impetus. In this backdrop, NABARD’s search for
alternative models of reaching the rural poor brought the existence of informal groups of poor to
the fore. It was realised that the poor tended to come together in a variety of informal ways for
pooling their savings and dispensing small and unsecured loans at varying costs to group
members on the basis of need. This concept of Self-help was discovered by social-development
NGOs in 1980s. Realising that the only constraining factor in unleashing the potential of these
groups was meagreness of their financial resources, NABARD designed the concept of linking
these groups with banks to overcome the financial constraint. The programme has come a long
way since 1992 passing through stages of pilot (1992-1995), mainstreaming (1995-1998) and
expansion phase (1998 onwards) and emerged as the world’s biggest microfinance programme in
terms of outreach, covering 1.6 million groups as on March, 2005 . It occupies a pre-eminent
position in the sector accounting for nearly 80% market share in India.

Under the programme, popularly known as SHG-Bank Linkage programme there are broadly
three models of credit linkage of SHGs with banks. However, the underlying design feature in all
remains the same i.e. identification, formation and nurturing of groups either by NGOs/other
development agencies or banks, handholding and initial period of inculcating habit of thrift
followed by collateral free credit from bank in proportion to the group’s savings. In accordance
with the flexible approach, the decision to borrow, internal lending and rate of interest are left at
the discretion of group members. Its design is built on combining the “collective wisdom of the
poor, the organizational capabilities of the social intermediary and the financial strength of the
Banks”
CHALLENGES .
Traditionally, banks have not provided financial services, such as loans, to clients with little or no
cash income. Banks incur substantial costs to manage a client account, regardless of how small
the sums of money involved

In addition, most poor people have few assets that can be secured by a bank as collateral. As
documented extensively by Hernando de Soto and others, even if they happen to own land in the
developing world, they may not have effective title to it. This means that the bank will have little
recourse against defaulting borrowers.

Because of these difficulties, when poor people borrow they often rely on relatives or a local
moneylender, whose interest rates can be very high. An analysis of 28 studies of informal
moneylending rates in 14 countries in Asia, Latin America and Africa concluded that 76% of
moneylender rates exceed 10% per month, including 22% that exceeded 100% per month.
Moneylenders usually charge higher rates to poorer borrowers than to less poor ones. While
moneylenders are often demonized and accused of usury, their services are convenient and fast,
and they can be very flexible when borrowers run into problems. Hopes of quickly putting them
out of business have proven unrealistic, even in places where microfinance institutions are active

Boundaries and principles

Poor people borrow from informal moneylenders and save with informal collectors. They receive
loans and grants from charities. They buy insurance from state-owned companies. They receive
funds transfers through formal or informal remittance networks. It is not easy to distinguish
microfinance from similar activities. It could be claimed that a government that orders state
banks to open deposit accounts for poor consumers, or a moneylender that engages in usury, or a
charity that runs a heifer pool are engaged in microfinance. Ensuring financial services to poor
people is best done by expanding the number of financial institutions available to them, as well
as by strengthening the capacity of those institutions. In recent years there has also been
increasing emphasis on expanding the diversity of institutions, since different institutions serve
different needs.

Microfinance is considered as a tool for socio-economic development,and can be clearly

distinguished from charity. Families who are destitute, or so poor they are unlikely to be able to
generate the cash flow required to repay a loan, should be recipients of charity. Others are best
served by financial institutions
Inclusive financial systems
The microcredit era that began in the 1970s has lost its momentum, to be replaced by a 'financial
systems' approach. While microcredit achieved a great deal, especially in urban and near-urban
areas and with entrepreneurial families, its progress in delivering financial services in less
densely populated rural areas has been slow.

The new financial systems approach pragmatically acknowledges the richness of centuries of
microfinance history and the immense diversity of institutions serving poor people in developing
world today. It is also rooted in an increasing awareness of diversity of the financial service
needs of the world’s poorest people, and the diverse settings in which they live and work.

Microfinance and Social Interventions

There are currently a few social interventions that have been combined with micro financing to
increase awareness of HIV/AIDS. Such interventions like the "Intervention with Microfinance
for AIDS and Gender Equity" (IMAGE) which incorporates microfinancing with "The Sisters-
for-Life" program a participatory program that educates on different gender roles, gender-based
violence, and HIV/AIDS infections to strengthen the communication skills and leadership of
women "The Sisters-for-Life" program has two phases where phase one consists of ten one-hour
training programs with a facilitator with phase two consisting of identifying a leader amongst the
group, train them further, and allow them to implement an Action Plan to their respective
centres.

Microfinance has also been combined with business education and with other packages of health
interventions. A project undertaken in Peru by Innovations for Poverty Action found that those
borrowers randomly selected to receive financial training as part of their borrowing group
meetings had higher profits, although there was not a reduction in "the proportion who reported
having problems in their business"

Other criticisms
There has also been much criticism of the high interest rates charged to borrowers. The real
average portfolio yield cited by the a sample of 704 microfinance institutions that voluntarily
submitted reports to the MicroBanking Bulletin in 2006 was 22.3% annually. However, annual
rates charged to clients are higher, as they also include local inflation and the bad debt expenses
of the microfinance institution
There has also been criticism of microlenders for not taking more responsibility for the working
conditions of poor households, particularly when borrowers become quasi-wage labourers,
selling crafts or agricultural produce through an organization controlled by the MFI

Road Ahead
Indian rural finance sector is at crossroads today. Following the financial sector reforms with its
emphasis on profitability as the key performance benchmark, banks are increasingly shying away
from rural lending as well as rationalizing their branch network in rural areas. Burgess & Pande
(ibid) have brought out this fact in their study by stating that while between 1977 and 1990 (pre
reform period) more bank branches were opened in financially less developed areas, the pattern
was reversed in post reform period. Thus while, access of credit to the rural poor has reduced in
post reform period, the policy recommendation is to fill this gap through micro credit. The SHG-
Bank linkage programme has witnessed phenomenal growth and the current strategy is to focus
on 13 underdeveloped states as also graduate the existing SHGs to the next stage of micro
enterprises.

Conclusion
The Indian economy at present is at a crucial juncture, on one hand, the optimists are talking of
India being among the top 5 economies of the world by 2050 and on the other is the presence of
260 million poor forming 26 % of the total population. The enormity of the task can be gauged
from the above numbers and if India is to stand among the comity of developed nations, there is
no denying the fact that poverty alleviation & reduction of income inequalities has to be the top
most priority. India’s achievement of the MDG of halving the population of poor by 2015 as well
as achieving a broad based economic growth also hinges on a successful poverty alleviation
strategy.
In this backdrop, the impressive gains made by SHG-Bank linkage programme in coverage of
rural population with financial services offers a ray of hope.