Introduction

Microfinance, also known as microcredit, is a financial service that offers loans, savings and
insurance to entrepreneurs and small business owners who don't have access to traditional
sources of capital, like banks or investors. The goal of micro financing is to provide
individuals with money to invest in themselves or their business.it is also referred to as the
alternate commercial sector targeting the poor. Micro finance is holistic concept-it includes
not only micro credit but also support services such as savings, insurance, payments, and
technical assistance and capacity buildings.

Definition

The task on supportive policy and regulatory framework for the microfinance constituted by
NABARD (Nation Bank for Agriculture and Rural Development) defined microfinance as
“the provision of thrift, credit and financial services and product of very small amount to the
poor’s in rural, semi urban and urban areas for enabling them to raise their income level and
improve their standard of living”.(Sen,2008)

"Microfinance focuses on meeting the financial needs of populations that are financially
underserved," said Tarsava.

"These are individuals who usually lack the credit or resources to secure a loan and are
unlikely to get approval from traditional banks. Typically, these consumers are seeking small-
denomination loans to finance the purchase of specific equipment, or the capital to start a
small business."

Historical background of microfinance

The history of micro financing can be traced back as long to the middle of the 1800s when
the theorist Lysander Spooner (an American political philosopher, essayist, pamphlet writer)
was writing over the benefits from small credits to entrepreneurs and farmers as a way getting
the people out of poverty. But it was at the end of World War II with the Marshall plan the
concept had a big impact.

The today use of the expression micro financing has it roots in the 1970s when organizations,
such as Grameen Bank of Bangladesh with the microfinance pioneer Mohammad Yunus,
where starting and shaping the modern industry of micro financing. Members of Grameen
bank are the owners of bank. The group normally consists of five members and the liability to
the loan lies with the individuals. Loan is given on the basis of trust. The success of Grameen
bank proved that poor needed access to financial service. Micro finance in india involved to
fill the gaps created by formal banking institutions. Shri mahila SEWA (self-employed
women’s association) Sahakari bank in Ahmadabad and working women’s forum in Tamil
Nadu were the pioneers. Another pioneer in this sector is Akhtar Hameed Khan (Pakistani
development practitioner and social scientist). At that time a new wave of microfinance
initiatives introduced many new innovations into the sector. Many pioneering enterprises
began experimenting with loaning to the underserved people. The main reason why
microfinance is dated to the 1970s is that the programs could show that people can be relied
on to repay their loans and that it´s possible to provide financial services to poor people
through market based enterprises without subsidy. Shore bank was the first microfinance and
community development bank founded 1974 in Chicago.

The Norwegian Nobel Committee has decided to award the Nobel Peace Prize for 2006,
divided into two equal parts, to Muhammad Yunus and Grameen Bank for their efforts to
create economic and social development from below. 

NGOS AND SHGS (Self Help Groups)

NGOS are the significant player in the microfinance sector. It is an voluntary organization
established to social intermediation. MYRADA (Mysore Resettlement and Development
Agency) were the pioneers to promote SHGs. An SHG is registered or unregistered group
of 15-20 members who have a relatively and homogeneous social and economic
background and have voluntarily come together to save small amount to a common fund
and to meet their emergency needs on mutual help basis. Micro finance is used by SHGs to
meet the survival needs, diversify their source of income, meeting day to day requirement
of funds and setting up of micro enterprise.

SHG- Operational methodology

 Village meeting of women in villages by MFI.

 Group formation
 Group training for 5 – 7 days on procedures and development skills
 Group meeting:- once in week for mobilizing savings, disbursing and repaying
loans.
 MFI facilitates capacity building, group dynamics and monitor credit discipline
through staff.

Objectives of Micro Finance

A relatively new branch of financial services, microfinance aims to promote self-sufficiency
and economic development among people who don't have access to the traditional financial
sector. They do this primarily by extending small loans without the strict requirements of
traditional lenders. Recipients are usually the poor and "unbanked," but they also include
people who are not poor but who lack the credit standing to borrow money to start or grow a
business.

Access to Capital
When people can't tap into the mainstream financial services system for capital to start a
business, they're forced to turn to "informal" sources -- relatives, friends and even black-
market lenders, or "loan sharks." Such sources are often unreliable, and they can also be
expensive, charging potentially ruinous interest rates that can strangle a new business before
it can get established. By lending money to such people, microfinance institutions provide
access to capital.

Entrepreneurship and Self-Sufficiency

Underprivileged people may have potentially profitable business ideas, but they cannot put
them into action because they lack sufficient capital for start-up costs. "Microcredit" loans
give clients just enough money to get their idea off the ground so they can begin turning a
profit. They can then pay off their micro loan and continue to gain income from their venture
indefinitely.

Improved Standards of Living

Microcredit ultimately aims to give impoverished people enough financial stability to move
from simply surviving to accruing savings. This gives them a certain amount of protection
from sudden financial problems. Savings also allow for educational investment, improved
nutrition, better living conditions and reduced illness. Micro insurance, another segment of
the microfinance sector, provides people the ability to pay for health care when needed, so
they can receive treatment for health conditions before they become grave and more costly to
treat.

Women's Economic Advancement

Women make up a large proportion of microfinance beneficiaries. Traditionally, women
(especially those in underdeveloped countries) have been unable to readily participate in
economic activity. Microfinance provides women with the financial backing they need to
start business ventures and actively participate in the economy. The aim is to improve their
status and make them more active in decision-making, thus encouraging gender equality.
According to the international Consultative Group to Assist the Poor, microfinance
institutions have even reported a decline in violence against women in areas targeted by
microfinance programs.

Trickle-Down Benefits
Microfinance lenders hope to improve not just the lives of their direct clients, but also the
health of their clients' communities. New business ventures can provide jobs, thereby
increasing income among community members and improving their overall well-being.

Funding to microfinance
These are the sources of funding to MFIs and how they are able to amass adequate funding in
order to serve their clientele.

1. Shareholder equity

2. Debt capital

3. Venture capital

4. Grants and donations

5. Bank loans

6. Crowd funding

7. Peer to peer P2P funding

8. Deposit based capital

• Shareholder equity:

Many financial institutions are owned by wealthy individuals and corporate institutions. They
put together the initial or seed capital of the business to kick-start the operation. This initial
capital is used to get the license, to acquire offices, hire key personnel and help to start the
operation of the business. On many occasions, just one individual could commence the
funding until others would join later on. These individuals are called Founders of the
organization.

• Debt capital:

This type of capital is infused into a business with the understanding that it must be paid back
at a predetermined date. In the meantime, the owner of the capital (typically a bank,
bondholders, or a wealthy individual), agree to accept interest in exchange for you using their
money. Think of interest expense as the cost of “renting” the capital to expand your business;
it is often known as the cost of capital.

Debt capital differs from equity or share capital because subscribers to debt capital do not

become part owners of the business, but are merely creditors, and the suppliers of debt capital
usually receive a contractually fixed annual percentage return on their loan, and this is known
as the coupon rate.

 As we already said that debt capital is a loan. This money (which was given to the company
as loan) is given to the debt holders first before giving it to preference holder and equity
holders. Equity holders (shareholders) have all rights in the business, but the debt holders
have no rights on the business.

• Venture Capital:
A venture capital is defined as a capital invested in a project in which there is a substantial
element of risk, typically a new or expanding business. In other words, a venture capital is
financing that investors provide to start-up companies and small businesses that are believed
to have long-term growth potential.

Venture capital generally comes from well-off investors, investment banks and any other
financial institutions that pool similar partnerships or investments.

• Grants and Donations:

The minority of the microfinance institutions get their funding from grants and donations.
These donations come from foundations, NGOs, charities and some social enterprise
organizations that will like to contribute to the development of micro financing in some
specific areas. Some private organizations/companies also do it through what is called
Corporate Social Responsibilities (CSR). These grants and donations are called Donated
Equity in the books of the recipient MFIs.

• Bank Loan:

With this, MFIs do borrow from the banks to expand their loan portfolios and also meet
critical fixed assets and operational needs. But the majority of these MFIs only borrow to
fund their loan portfolios. This is done after they have exhausted their shareholders’ capital or
need a bridging finance. A bridging finance is used when expected fund is delayed and a
quick fund is needed to cover the gap between the shortfall now and the time of receiving the
expected fund. With this, MFIs do borrow from the banks to expand their loan portfolios and
also meet critical fixed assets and operational needs. But the majority of these MFIs only
borrow to fund their loan portfolios. This is done after they have exhausted their
shareholders’ capital or need a bridging finance.

Bridging finance is used when expected fund is delayed and a quick fund is needed to cover
the gap between the shortfall now and the time of receiving the expected fund.

 
Shortcomings of Micro-Finance

 Industry is still Young

The microfinance industry has for a long time been an institution-focused industry that has
not paid much attention to the needs of clients. The industry has focused on offering non-
diversified products with limited flexibility in order to reduce the cost of services that are
already very resource intensive. While this approach promotes efficiency and allows for
better control, it has failed to meet the diverse and dynamic client needs that are becoming
more and more sophisticated. The result has been an increase in client desertion, delinquency
and limited or slow growth. With the growth of competition in the industry, these problems
can only intensify. Although the industry is still fairly young and has not yet encountered
fierce competition, there is need to prepare for this eventuality, as it is (in most markets)
inevitable.

• Dependent
However, among the 10,000 + MFIs around the world, very few are currently viable by some
estimates only one per cent. And many remain heavily donor-dependent. To meet the
enormous demand for services, MFIs can no longer rely solely on the limited pool of donor
funds. Instead they must become part of the financial landscape, attracting funding from more
abundant commercial sources. In short, microfinance must complete the metamorphosis from
mostly donor dependent collection of programs to a mature industry capable of growing
sustainably. But what are the constraints to building a microfinance industry? First and
foremost, to carry the industry moniker the microfinance community must develop and
adhere to sound financial standards to gain credibility from commercial investors. Second,
microfinance practitioners must offer a wider range of financial services beyond
microenterprise credit. MFIs have traditionally offered relatively rigid loans to cover working
capital requirements of microenterprises, principally among market vendors. But many MFIs
increasingly recognize that the poor are not a homogeneous group and they demand varied
loan products, safe savings, insurance, and other financial products. Developing client-
responsive, flexible financial services for the poor is a top priority. Third, the microfinance
industry needs to answer some basic questions: Who are microfinance clients? How poor are
they? And how do they use financial services? Answers to these questions will help ascertain
how to reach poorer clients than are currently being served and determine which flexible
financial products can fully meet the needs of the very poor.
• Microfinance loans are expensive
Interest rate charged by microfinance programs are often over 20%. They have to be, because
overhead is high for administering tiny loans. That mean it’s for borrowers to make enough
profit to really get ahead, after they pay loan costs.
• Depends on lenders
To some extent micro lending depends on an ever increasing number of lenders in order to be
successful.
• Inability to reach poorest of the poor
The inability to reach pores of the poor is a problem that plagues most poverty alleviation
programs. As Greshams law remind us, if the poorer and the non-poorer are combined within
a single program, the non-poorer will always derive out the poor. To be effective, the delivery
system must be designed and operated exclusively for the poor. Compounding the issue of
reach, the poorest often live in rural areas, far removed from populated centers and are often
not targeted by MFIs as a result
• Microfinance targets women
Microfinance helps women. Almost all micro borrowers are women, who develop home
businesses women are generally more responsible than men, as any development worker will
tell you. They use their profits to feed and educate their children, instead of blowing it on
booze and gambling. In many patriarchal societies men control all the resources, and waste
them. So microfinance programs targets women(due to higher repayment rates), which may
result in men requiring wife to get loans from them.
• Resources
MFIs have large base of borrowers availing very small loans. This large number of borrowers
overburdened the staff at MFIs and the productivity ratio of each staff decrease.
 Issue of environment:
The issue of environment is one that is not adequately addressed by microfinance programs.
In fact, entrepreneurs and microenterprises that borrow funds may use these for activities that
can have damaging impacts on the environment. For example, the use of chemical dyes in the
production of in textile or cloths, the disposal of wastewater from catering enterprises or the
heavy use of pesticides in agriculture are all negative impacts that can arise from the
activities of small microfinance dependent business.

The nature of microfinance: microfinance vs. microcredit

Micro-credit is defined as a credit (small amounts) provided to very poor, often unemployed
people without any collateral, to help them live better. Just small credits can help these
people to repay their previous loans and start their own new business. The amount of credit is
smaller and the credit cycle is shorter than standard loans of commercial institutions typically
from six to twelve months with weekly or fortnightly installments. The system of
installments; built on regular, fixed small installments starting very early after contract is
signed; is less encumbering for clients but is more exacting from administrative aspect.

What is microfinance? Microfinance refers to small-scale financial services –primarily credit

and savings – provided to people who farm or fish or herd; who operate small enterprises or
microenterprises where goods are produced, recycled, repaired, or sold; who provide
services; who work for wages or commissions; who gain income from renting out small
amounts of land, vehicles, draft animals, or machinery and tools; and to other individuals and
groups at the local levels of developing countries, both rural and urban.

 Problems affecting MFIs

Although there have been various successful stories about microfinance institutions
helping the poor, they face many problems. The problems can be solved on many
occasions but sometimes cannot be avoided. We discuss the problems MFIs face
under the following broad categories.
 Managerial Reasons
One of the major problems which the MFIs can resolve is managerial problems. They
tend to be fairly straightforward and the solutions to them are also pretty
straightforward. Managerial problems are a major factor and they have more effects
 than any other problems discussed. These problems include mainly: lack of
management training, poor record keeping and obviously lack of management
capacity.
 Legal Reasons
Microfinance institutions can be viewed as a social organization helping the poor and
a profit organization too. In many countries, profit organizations are registered under
different set of acts and non-profit organizations come under different legislations. On
the first view, it could seem unsubstantial, but these legalities sometimes create
complications.
 “Unfortunate” Reasons
Sometimes microfinance institutions have to face problems which cannot be
resolved. These problems arise in cases when something “unfortunate” happens to a
person or a community (e.g. a flood or famine can kill the hopes of farmers to pay
their loans).
 Other Reasons
There are various other factors for the failure of MFI. Firstly: a) lack of vision is a
factor which pushes new MFIs in to extinctions. Formation of an MFI requires
considerable research and should have a clear cut vision of why they are operating
and the clients they will be serving. Sadly, due to lack of research MFIs set up by
NGOs fail to scale up. b) MFIs need trained staff to operate. In several cases, drop out
of trained staff is very high which reduces the reach of an MFI. Furthermore, the
“dropping out” rate is more than the “coming in” rate. c) MFIs serve society but they
are also a profit-making institution. In many cases, MFIs achieve a lot of success in
their programs in initial period, but they fail to maintain the same record in the long
run because of lack of proper commercial orientation, thus making them
unsustainable.

List of Microfinance institution in Pakistan

 BRAC
BRAC was initiated in 1972 by Sir Fazle Hasan Abed in the district of Sunamganj as a
small-scale relief and rehabilitation. It spans all districts of Bangladesh. It provides-free loans
to mostly poor, landless, rural women, enabling them to generate income and improve their
standards of living. Brac launched its operations in Pakistan to assist the government of
Pakistan to alleviate poverty and increase access to education and health.

Countries where BRAC operates:

Asia: Bangladesh, Afghanistan, Sri Lanka, Pakistan, Nepal,

Africa: Uganda, Liberia

BRAC has affiliate organizations in the United Kingdom and United States)

 CSC(Community Support Concern):

 Established in 1989, Community Support Concern (CSC) has been actively involved in
identifying and resolving key social and economic issues (lack of education, cultural and
religious discrimination, overpopulation, unemployment and corruption) faced by the most
marginalized groups in society, especially women and youth.

CSC has made development in Punjab’s underprivileged areas through projects that focus on
improving Health, Education, Disaster Management with an underlying focus on Women
Empowerment in each segment.

 Farmers Friend Organization (FFO):

Farmers Friend Organization (FFO) established in 2003 by a group of young committed
people.

Mission:

Its initiation was a response to the increasing poverty and injustice prevailing in the society.
FFO believes that by providing the poor with economic opportunities such as credit, they can
reach their full potential and overcome the barriers of poverty.

Criteria:

PRODUCT PURPOSE AMOUNTRANGE LOAN TERM

Principal Loan (PL) Productive 10,000-40,000 12 Months

Small Business Loan(SBL) Productive 10,000-100,000 12-18Months

 Islamic Relief Pakistan:

Islamic Relief Pakistan is an independent non-governmental organization (NGO) founded in
the UK in 1984 by a group of postgraduate students (Hany El-Banna Mohammed El-Alfy
,Ihsan Shabib and Essam El-Haddad). Islamic Relief started working in Pakistan in 1992
through a child welfare and protection programmes.

What does Islamic Relief do?

Islamic Relief Worldwide (IRW) provides development programs and respond to disasters,
emergencies, helping people in crisis and humanitarian relief regardless of race, political
affiliation, gender or belief.

 Kashf:
Kashf Easy Loan (KEL) is a relatively new loan product introduced to meet the urgent needs
of clients who require small loan amounts
for any purpose. It is an easily accessible loan of PKR 15,000.It aids those clients who wish
to fulfill their financial needs on an urgent basis. This loan can be availed on easy conditions
and less time.

Features and Specifications:

Term One year

Installments 12 (monthly installments)

Amount PKR 15,000

Client-testimonial

“As a first time borrower of microfinance, I am very happy with the Kashf Easy Loan which I
have used for home improvement by constructing a new washroom with indoor plumbing. I
will definitely look towards getting a higher loan for a small business inside my home in the
future”– Hina Kausar, Sheikhupura

 Soon Valley Development Program:

It was established in 1996 & was registered in 2001 as a non-government organization.
Found by Dr. Akhtar Hameed Khan.

Agriculture Loans

Loans ranging from Rs. 10,000 to Rs. 200,000 for each individual for the purpose of
agriculture production as well as development and the repayments are based on the cash
inflows of the borrower .

Livestock Loans

Loan ranging from Rs. 10,000 to Rs. 200,000 for each individual. Repayment is based on
cash inflows of the individual/family. Loans are for Sacrificial (Eid Ul Azha) animal rearing
purposes

 Akhuwat Islamic microfinance (AIM):

Company set up under “Section 42 of the Companies Ordinance 1984” providing interest-free
microfinance according to Islamic finance doctrine of Qarz-e-Hasan (interest-free loans) to
the impoverished and underprivileged members of the society so as to enhance their
standards of living and enable them to improve their livelihoods.

Loan Process:
The loan process starts with the submission of applications by persons interested in getting
financial assistance. The Unit Manager (Loan Officer) then evaluates that whether the
applicant deserves the loan or not i.e. lives below the poverty line and capital is not involved
in any illegal business.
Preparation of Business Plans
Through the preparation of business plans the business idea of the intended loan is evaluated
to see if it is viable and whether it can generate income beyond the household expenses of the
individual so that the loan could be repaid easily. The applicant’s family is also interviewed
to make sure that they know about the loan and support the business idea.

Credit Appraisal

After initial appraisal by the Unit Manager, the application is forwarded to Branch Manager
who appraises the credit section of the appraisal process. Then the case is referred to Loan
Approval Committee.

The committee comprising of Unit, Branch and Area Mangers which reviews the credit case.
If the committee approves the case loan disbursement is done. The whole process takes
almost 3 weeks.

Guarantors of Loans

Every borrower also provides two individual guarantors who accept the responsibility of
monitoring the borrower and give assurance to persuade the borrower for timely payment of
loan.

One of the two guarantors may be from the same family.

Akhuwat’s fee structure

Interest: zero

Profit: zero

Loan Processing Fee: zero

SBP initiatives for the Promotion of Microfinance
Following are the SBP initiatives for the promotion of microfinance:-

1) Sustainable cost-covering operating/business model;

2) Mobilize private domestic capital;

3) Build human resource systems

4) Financial Inclusion Program

• Aimed at eliminating market failures.

• A £50 million program funded by the UK
• For financial services for poor, marginalized groups and for small enterprise
5) SBP encouraged partnerships between the post office (PO) network and MFI

• Post Offices, manages 4 million savings accounts

• Small accounts below Rs 10,000, through more than 12,000 branches.
• There is scope for the Post Office and MF providers to join forces
• With the MFI acting as intermediaries for funds raised by POs

SBP actions for microfinance

Following are the actions SBP takes for microfinance

 The Microfinance Credit Guarantee Facility

 The Institutional Strengthening Fund; and
 The Improving Access to Finance Services Fun

The microfinance credit guarantee facility

 Expected to increase the flow of credit to microfinance sector

 Commercial banks are allowed options to undertake microfinance business directly
and in partnership with MFIS by providing wholesale funds to them
 Standalone mf branches, establishment of independent subsidiary MFB &linkage with
NGO
 Build links between micro borrowers and formal financial institutions.
 Provide partial guarantee to minimize the perceived risk premium by covering part of
the losses incurred on funds made available to MFIS
The institutional strengthening fund

 Build capacity of the microfinance sector

 Improving human resource quality, service delivery and increasing service availability
to potential microfinance clients.
 Fund is established at the state bank under the UK government’s financial inclusion
program
 Generate on-lending resources through commercial sources, equity investments or
deposit mobilization strategy
 Provide grants for employing cost reduction mechanisms
The improving access to finance services fun

 Promote financial literacy

 Capacity building and training of government and regulatory authorities
 Training of financial services providers to promote expansion into rural areas;
product and service innovation
RECOMMENDATIONS

 The government should increase their efforts in encouraging microfinance banks

and institutions to support the small businesses.
 Microfinance banks should expand the repayment of their costumers asset loans
make use of collective group based loan disbursement strategy, as this will
minimize the rate the rate at which clients default in payment and the level of
portfolio at risk.
 Microfinance banks should support their clients by offering trainings on credit
maximization.
 Microfinance bank should try to find long term capital from pension and insurance
companies