Microfinance Institutions

Published on 30 Jan 2025

Microfinance institutions are specialized financial institutions that offer a range of financial services to low-income individuals who have limited access to formal banking services. These services include microloans (loans below one lakh taken without collateral), micro savings and micro insurance. As per a report by Microfinance Institutions Network, the microfinance industry grew 16 times in the last decade with a loan portfolio of Rs. 2.85 lakh crores.

Types of Microfinance lending in India

• Joint Liability Groups: These are informal groups of farmers, rural labourers etc that seek mutually assured loans. Here, all the members of the group are equally responsible for loan repayment.

• Self Help Groups: SHGs can borrow from banks at a cheaper rate without collateral if they can show that the borrowers have made regular payments within the SHG.

• Regional Rural Bank Model: To serve rural areas with basic banking and financial services to boost the rural economy.

• Cooperatives: A model where the resources of the poor are pooled and financial services are made available. 

Role of Microfinance Institutions (MFI) in development

• Financial inclusion: Microfinance caters to the needs of certain sections which hitherto enjoyed less access to financial services, hence they help in deepening the penetration of financial services in India.

• Example: As per Microfinance Institutions Network’s estimates, the microfinance industry serves 66 million customers with a penetration of 32%.

• Target low-income people: The collateral free nature of the microfinance instruments makes them more appealing to the low-income people, thus increasing the credit access to the poor people.

• Example: In India, the household income limit should be within 3 lakhs to be qualified as microfinance. This ensures that the beneficiaries are of low income / low-middle class groups.

• Promote entrepreneurship: The finance offered by MFIs enables individuals to invest in income generating operations or scale-up existing operations, thus offering a new source of income or augmenting an existing income.

• Example:  According to Association of Karnataka Microfinance Institutions, close to 90% of MFI borrowers of the state utilised the loan for income generating activities.

• Women empowerment: Women are the main beneficiaries of the SHG based microfinance lending. These services are vital for them to start a new venture and to be self-sufficient.

• Example: According to NABARD, the Bank Linkage programme covers over 14.2 crore families through 119 lakh SHGs, of which 87% are women.

• Rural development: The MFIs mostly target the underserved rural areas of India. Growth of more rural entrepreneurs can increase rural wealth and facilitate rural development.

• Rehabilitation: By providing access to finance in vulnerable areas, like naxal areas, disaster-struck areas, tribal areas, etc., they help in the development and rehabilitation of the people in those areas.

Issues related to Microfinance Institutions

• Reliance on commercial banks: Most MFIs in India rely on commercial banks to ensure stable funding as they fail to grow independently without support from anchor investors.

• Skewed regional distribution: The penetration of MFIs have not been uniform across India, with certain states enjoying better access to microfinance services.

• Example: According to RBI, 82% of microfinance loans are concentrated in ten states, mainly to eastern and southern India.

• High interest rates: Often, MFIs charge higher interest rate on the borrowers to covers their operational cost, which cannot be afforded by the poor.

• Example: In 2022, RBI expressed displeasure towards MFI lending rate increasing to a 5 year high of 24.75% since May 2022, which was 200 bps increase in pricing on a year-on-year basis.

• Narrowing down on the lending model: The SHG or Joint Liability group model of lending are chosen unscientifically by the MFIs at random, which increases the borrowing risks for the weaker sections.

• Social and cultural barriers: Social stereotypes still discriminate against certain sections from the financial market, with women and lower castes finding it more difficult to access loans.

• Example: As per RAS study, Indian women entrepreneurs receive only a 27% credit equivalent of their bank deposits, which is a huge contrast to 52% for men.

• Lack of financial literacy: India has a poor record with respect to financial literacy, in both urban and rural India.

• Example: As per Asian Development Bank, only 27% Indians and 24% of women in India are financially literate.

Way Forward

• Diversify the fund sources: This is required for MFIs to reduce their dependence on commercial banks and to facilitate better penetration of services.

• Transparent fixing of interest rate: This could reduce the present higher interest rate and ensures better transmission of interest rates.

• Improve microfinance infrastructure: The facilities at rural MFIs need to be improved with better incorporation of technology to improve the effectiveness of their functioning.

• Financial literacy programmes: Campaigns at the community level to make people more aware of saving and managing their finance to reap maximum benefit.

Microfinance instruments must be made accessible to the poor at an affordable rate, which could aid the development of marginalised communities, facilitate rural development, and make the financial sector more inclusive and hence is the need of the hour.

Tags:
Social Justice

Keywords:
Microfinance Institutions MFI Types of Microfinance lending in India Joint Liability Groups SHG Role of Microfinance Institutions in development entrepreneurship financial inclusion Women empowerment Issues related to Microfinance Institutions

Syllabus:
General Studies Paper 2

Topics:
Social Justice