UNIT 2 – Microfinance

Introduction

Microfinance is a way in which loans, credit, insurance, access to savings accounts, and money transfers are
provided to small business owners and entrepreneurs in the underdeveloped parts of India.

The beneficiaries of microfinance are those who do not have access to these traditional financial resources.
Interest rates on microloans are generally higher than that on traditional personal loans.

Types of Microfinances

Microloans:
Microfinance loans are significant as they are provided to borrowers with no collateral. The result of microloans
should be to have its recipient outgrow smaller loans and be ready for traditional bank loans.

The importance of Microloans is that it is provided with no collateral. The borrower is not bound to pledge
something as security for repayment of the loans. It offers a better overall loan repayment rate than traditional
banking products.it enhances the possibility of future investments as it is a sustainable process. Most
importantly it gives people a soothing and no stressful life.

Micro savings:
Micro savings accounts allow entrepreneurs to operate savings accounts with no minimum balance. These
accounts help users inculcate financial discipline and develop an interest in saving for the future.

The importance of micro-savings is that poor people and small businessman with low income can operate their
accounts with no minimum balance. These accounts do not bound people to maintain their accounts with a
certain amount of money in them.

Microinsurance:
Microinsurance is a type of coverage provided to borrowers of microloans. These insurance plans have lower
premiums than traditional insurance policies.
The importance of microinsurance is that it is the machinery to protect the poor people from all the mishaps
that might take place in the future, for example, Accidents, chronic disease, etc. It addresses all kinds of risks
that people of a low-income group or poor people face globally.

Features of Microfinance

• The borrowers are generally from low-income backgrounds

 • Loans availed under microfinance are usually of small amounts, i.e., microloans
• The loan tenure is short
• Microfinance loans do not require any collateral
• These loans are usually repaid at higher frequencies
• The purpose of most microfinance loans is income generation

Objectives

• Provide Access to Funds

• Encourage Entrepreneurship and Self-Sufficiency
• Manage Risk
• Empower Women
• Community-Wide Benefits

Advantages

Disadvantages

Harsh repayment criteria

In the absence of the legit working protocol and compliances, Microfinance Companies could adopt a harsh
repayment approach that someone would not prefer in the state of the financial crisis. Easy debt never comes
with relaxed conditions, and that is something true with microfinance companies as well. Since these companies
work under strict compliances, they could manipulate their customer for repayment unethically.

Small Loan amount

Unlike mainstream financial banks, Microfinance Companies offers a smaller loan amount. Since these banks
don’t ask for collateral against the credit, the disbursement of the large loan amount is practically impossible in
their case.

High-interest rate

Another problem with Microfinance Companies is that they were unable to render low-interest based loans.
This is because they don’t follow traditional banks’ footprint, where the accumulation of funds is easy. Plus, they
have to borrow money from these banks to execute appropriately and allocate some part of it for risk
management. Hence operating cost per transaction is quite high for them despite the high volume of
transactions per day.
Unlike banks, the microfinance institution accumulates funds through private equity to render financial services.
This primarily implies that these firms are under relentless pressure to create more profit for their investor,
consequently forcing them to crank up the interest rate.

Challenges

• High cost involved in small transactions.

• Lack of debt and equity funds for MFI’s to pass on to the poor.
• Difficulty in measuring the social performance of MFI’s.
• Increase in competition
• Improper regulation

Stakeholders in microfinance

Stakeholder theory posits that an organization is a social construction made of interaction of various
stakeholders. The organization is envisioned as the center of a network of stakeholders, a complex system of
exchanging services, information, influence and other resources

Microfinance organizations provide financial services to low-income people. These organizations have been
increasing dramatically worldwide. This increment calls attention for these organizations and their boards to
make strategic decisions that enable them to perform well and compete with each other. Based on the
literature, this paper identifies six types of microfinance stakeholders who sit on boards. These are clients,
employees, government, donors, creditors, and owners. This paper discusses the different roles of these
stakeholders when they sit on boards of microfinance organizations and these roles are further explained to
show how they contribute to the process of making strategic decisions.
Social Finance and Financial Inclusion

According to C. Rangarajan there are six approaches in the system of Financial Inclusion, which are, as
follows.

• First, credit to the farmer households is one of the important elements of financial inclusion among
them providing credit to the marginal and sub marginal farmers as well as other small borrowers is
crucial to the need of the hour.
• Second, rural branches must go beyond providing credit and extend a helping hand in terms of advice
on a wide variety of matters relating to agriculture.
• Third, in the district where the population per branch is much higher than the national average
commercial banks may be encouraged to open the branches.
• Fourth, there is a need for the simplification of the procedures in relation to granting of loans to small
borrowers.
• Fifth, the further strengthening the SHG-Bank Linkage Programme (BLP), as it has proved to be an
effective way of providing credit to very small borrowers.
• Sixth, the business facilitator and correspondent model needs to be effectively implemented
MUDRA

The central government had introduced the Micro Units Development Refinance Agency (MUDRA) where the
scheme aims to refinance collateral-free loans of up to Rs 10 lakh granted by lending entities to non-corporate
small borrowers, for revenue growth actions in the non-farm sector.

Currently, loans granted under this system have falls under three categories namely,

Shishu loans for up to Rs 50,000,

Kishor loans in a range between Rs 50,001 to Rs 5 lakhs and

Tarun loans ranging from Rs 5 lakhs to 10 lakhs.

As a way to make the MUDRA scheme popular, the government aims to set up a Rs 3000-crore Credit
Guarantee Fund to back these loans.

Difference between traditional financing and microfinancing

Financing Models of Microfinance

1. Associations Model

The target community forms an 'association' through which various microfinance (and other) activities are
initiated. Such activities may include savings. These associations or groups can form of a youth, women. It is also
formed around political/religious/cultural issues. It can create support for microenterprises and other work-
based issues.

According to NABARD, SHG-BLP is the world’s largest microfinance program in the world.

2. Bank Guarantees Model

A Bank guarantee is used to obtain a loan from a commercial bank. This guarantee may be arranged externally (
through donor/donation, government agency, etc. ) or internally (using member savings). The loans obtained
may be given to an individual or they may be given to the self-formed group. It is a form of capital guarantee
scheme. Guaranteed funds may be used for various purposes, including loan recovery and insurance claims. The
guaranteed funds can be used for various purposes such as loan recovery or insurance claims.

Bellwether Microfinance Funds (India) is one such example.

3. Community Banking Model

In India, community banking looks very different. Self Help Groups (SHG) are often instituted in which members
of the local community join together and pool capital resources for lending to members. They value
transparency in their practices and utilizing their savings for their purposes of lending.

A successful example is the Royal Bank of Scotland (RBS) Foundation India, which has various microfinancing
programs to help the poorest communities across India.

4. Cooperatives Model

A co-operative is an autonomous association of persons united voluntarily to meet their common economic,
social, and cultural needs and aspirations through a jointly-owned and democratically-owned enterprise. The
members are the shareholders and have their share in equity capital. They also share the profit.

Co-operative Development Forum Hyderabad is a successful example of this model. It has built a network of
women's thrift groups and men's thrift groups.

5. Credit Unions Model

This model is based on a member-driven credit union, a self-help financial institution. A union of members is
formed. These members form the common community. They agree to save together and give loans to each
other at a nominal rate of interest. A credit union's membership is open to all who belong to the group,
regardless of race, religion, color, or creed.
The members are people of some common bond:

• Working for the same employer

• Belonging to the same church
• Labor union
• Social fraternity
• Living/working in the same community
6. Grameen Banking Model

It promotes credit as a human right and is based on the premise that the skills of the poor are underutilized.
The Grameen Bank (GB) is based on the voluntary formation of slight groups of five people to provide mutual,
morally necessary group guarantees instead of the collateral required by conventional banks.

The whole center is jointly responsible for the repayment. Grameen model is being followed by Sarv Seva
Abhiyan (ASSEFA), Activities for Social Alternatives.

7. Intermediary Model

This model positions a third party between the lending institutions and the borrowers. The intermediary plays a
critical role in generating credit awareness and education among the borrowers. Intermediaries could be
individual lenders, NGOs, microenterprise/microcredit programs, and commercial banks (for government-
financed programs). The intermediaries are incentivized in monetary and non-monetary forms.

8. Individual Banking Model

This is a straight forward credit lending model where microloans are given directly to the borrower. The
individual banking model is a shift from the group-based model. The MFI gives loans to an individual based on
his or her creditworthiness. It also assists in skill development and outreach programs. Co-operative banks,
Commercial banks, and Regional Rural Banks mostly adopt this model to give loans to the farming and non-
farming unorganized sector.

Self-employment women’s association in India s one such example to have adopted this model. The members
own and govern the group.

9. NGO Model

NGOs are one of the key players in the field of micro-financing. They help the cause of micro-financing by
playing the intermediary in multiple dimensions. Non-governmental Organizations (NGOs) played a vital role in
rural reconstruction, agricultural development, and rural development even during a pre-independent era in
our country. NGOs became a supplementary agency for the developmental activities of the government and in
some cases, they become alternatives to the government.

Non-governmental Organizations are committed to the upliftment of poor, marginalized, underprivileged,

impoverished, and downtrodden and they are close and accessible to their target groups.

Various NGOs are helping the cause of micro-financing. For example, MYRADA in Karnataka, SHARE in Andhra
Pradesh, RDO (Rural Development Organization) in Manipur, RUDSOVAT (Rural Development Society for
Vocational Training) in Rajasthan, and ADITHI in Bihar.

10. ROSCA Model Or Chit Funds

Rotating Savings and Credit Associations or ROSCAs, are essentially a group of individuals who come together
and make regular cyclical contributions to a common fund, which is then given as a lump sum to one member in
each cycle. At the end of a cycle, the total fund collected goes to any one member. Rotating Savings and Credit
Associations are a means to save and borrow simultaneously. There are lakhs of ROSCA functioning in India
today.

11. Village Based Model

It is closely related to the community banking and the Group model, this is the community-based saving and
credit model. A group of 25-50 people gets together to enhance their income through self-employment
activities. They get their first loan from the implementing agency, which helps them form the community credit
enterprise.

12. Small Business Model

This model places a big responsibility on small and medium enterprises. This has been changing, as more and
more importance is placed on small and medium enterprises (SMEs) - for generating employment, for increasing
income, and providing services that are lacking.

Future of Microfinance in India

• Affordable borrowing for one and all: Easy access to microcredit

• Reaching the doorstep of every unbanked customer
• The road ahead for a digital microfinance
• Leveraging women empowerment and mobilizing the entrepreneurial landscape

India aims to become a USD 5 trillion economy by 2025 and the microfinance industry will play a leading role in
uplifting the lives of millions of low-income households and enabling them to contribute to the country’s
economic growth.

Supply Demand of Microfinance

Impact of Microfinance

https://www.adb.org/news/features/how-microfinance-helping-poor-households-and-businesses-survive-and-
thrive-6-things