Micro Finance in India (MFI) - Know Its Objectives & Structure (2024)

Micro Finance is a non-profit organization that provides financial assistance to low-income people. Microloans, micro-savings, and microinsurance are examples of these services. Micro Finance in India is financial institutions that make small loans to persons who do not have access to traditional banking services. The term “small loans” is defined differently in different nations. In India, it is defined as loans of less than one lakh rupees. Micro finance institutions in India has risen significantly in India over the last two decades, and it now serves roughly 102 million impoverished people’s accounts (including banks and small financing banks).

This article will discuss the key facts regarding microfinance institutions to aid UPSC IAS Exam candidates in their GS-III preparation.

In this article, we shall discuss in detail about history, objectives and regulations related to microfinance.

What is Micro Finance?

Microfinance is a vital financial service for small businesses and entrepreneurs lacking access to traditional banking. It includes "relationship-based banking" for individuals and "group-based models" where multiple entrepreneurs seek loans. Microfinance institutions charge interest on loans, typically at lower rates than traditional banks. Critics argue that microfinance profits from the financial vulnerability of low-income people. World Bank data shows over 500 million people have experienced economic improvement through microfinance.

Structure of Microfinance

The structure of Microfinance Institutions (MFIs) is designed to address the challenges faced by traditional financial services in meeting the credit needs of the low-income segment at a reasonable and sustainable cost. A Joint Liability Group (JLG) is an informal association of 4-10 people who collaborate to apply for bank loans individually or collectively, providing mutual guarantees. Self-Help Group (SHG) comprises microentrepreneurs with similar socioeconomic backgrounds who voluntarily save money together and contribute to a common fund, supporting each other during emergencies. SHG members rely on collective knowledge and peer pressure to ensure proper credit use and timely repayment.

History and Evolution of Microfinance in India

• Microfinance has its origins in the mid-nineteenth century.
• The concept of providing minor credits to entrepreneurs and farmers to alleviate poverty was proposed by Lysander Spooner in the 1800s.
• Friedrich Wilhelm Raiffeisen established the first cooperative lending bank to assist farmers in rural Germany.
• The term "microfinancing" emerged during the growth of Bangladesh's Grameen Bank in the 1970s, founded by microfinance pioneer Muhammad Yunus.
• Grameen Bank formalized microfinance practices after its establishment in 1976.
• Many people in developing nations still rely on subsistence farming or basic food trading for a living, and smallholder agriculture has received significant support.

Objectives of Microfinance

• Transform into a financial institution that supports the development of sustainable communities.
• Assist in the supply of resources that benefit the poorest members of society. In this aspect, women are given special attention because they have successfully established income-generating businesses.
• Examine the choices available to aid in the faster eradication of poverty.
• Encourage poor people to start their businesses.
• Empowering rural people by teaching them basic skills so that they can start their enterprises and earn money.

Role of Microfinance

Microfinance institutions have a specific focus: they aim to offer banking services to low-income individuals and groups, and they receive funding from established financial institutions to support the underprivileged. Consequently, these institutions have become powerful tools in the fight against poverty in India.

Microfinance services are provided through various sources, including:

• Formal institutions like rural banks and cooperatives.
• Semiformal organizations, often non-governmental entities.
• Informal sources, including small-scale lenders and shop owners.
• Institutional microfinance encompasses offerings from both formal and semiformal institutions, with some MFIs being well-managed and self-sufficient in their operations.

Different categories of institutions are involved in providing microfinance in India, such as:

• Commercial banks.
• Credit unions.
• NGOs (Non-Governmental Organizations)
• Sectors within government banks.
• Cooperatives.

These institutions not only offer microcredit but also supplementary financial services like insurance, savings, and remittances. Moreover, they provide non-financial services such as training, counseling, and support for borrowers in the most convenient manner possible. Borrowers have the flexibility to determine interest rates based on loan purpose and their own financial history, as well as their repayment schedules.

Major Features of Micro Finance in India

• Borrowers typically come from economically disadvantaged backgrounds.
• Microfinance loans, often referred to as microloans, are typically for small amounts.
• The repayment period for microfinance loans is usually short.
• Collateral is not a requirement for microfinance loans.
• Microfinance loans are commonly repaid more frequently.
• The primary objective of most microfinance loans is to generate income.

Current Status of Micro Finance in India

• As of March 31, 2022, the program covers 140 million families and 11.9 million SHG groups with cumulative savings of $472.4 billion.
• During FY 2021-22, 3.4 million SHGs were credit linked, and loans worth $997.2 billion were disbursed, with a credit outstanding of $1,510.5 billion for 6.74 million SHGs (an average of $0.24 million per SHG).
• The E-Shakti program digitized data of over 1.2 million SHGs to facilitate credit linkage with banks, aiming to improve the process.
• The figure below displays the state-wise credit linkage status of SHGs as of December 31, 2022, where 57% of SHGs with savings have loans outstanding with banks.
• Nine states have a credit linkage percentage higher than the all-India average, with Andhra Pradesh leading at 90% of its SHGs having outstanding loans, followed by Bihar (89%) and Karnataka (87%). Southern and Eastern states, along with Tripura, dominate the list.

Study Government Schemes in detail!

Microfinance Institutions in India

Microfinance institutions in India organize a variety of groups to provide credit, insurance, and financial instruction to the rural population

Challenges Faced by MFIs in India

• Impact of COVID-19: It has impacted the MFI industry, with collections initially losing money and leads.
• The quality of SHGs (Self-Help Groups) has been questioned due to the rapid expansion of the SHG-Bank Linkage Program.
• Geographic Constraints – Around 60% of MFIs think that geographic factors make it difficult to engage with clients in remote places, posing a problem for the organization’s growth and expansion.
• Scalability Issues – Smaller microfinance systems sometimes struggle to maintain profitability and performance in these markets due to strong growth rates seen by Financial Institutions as a result of getting service delivery correctly.
• Diverse business models – Supporting many features and loan activities is complex and expensive.
• High Transaction Costs – Microfinance institutions have a significant transaction cost burden.
• Safety and KYC issues: Customers served by Microfinance instructions frequently need more official identification or the ability to provide actual security, making it extremely difficult for institutions to offer banking services.
• Budget constraints — Most MFIs are unable to make big upfront investments.
• Funding: Banks often feature various products and an assured deposit structure.
• Overborrowing: The largest danger confronting the microfinance industry today is borrowers’ proclivity to overborrow.
• Unfavourable policies: While microfinance institutions have been lucrative in India, they have faced laws and populist politics that have been detrimental.
• Missing of Targets: MFIs frequently overlook the urban poor in favour of concentrating their efforts on the rural poor.
• Loan Default: Risk management remains ineffective.
• Lenders charge high-interest rates: MFIs charge a high rate of interest on loans ranging from 12 to 30 per cent of the principal amount.

Benefits of Microfinance

• People can use microfinance as a source of capital. It also empowers women, potentially leading to greater family economic stability.
• In addition, the International Finance Corporation (IFC) projected that over 130 million people benefited directly from microfinance activities as of 2014.
• However, only about 20% of the world’s poor, or three billion individuals, may benefit from these microfinance enterprises.
• In addition, the IFC assisted in establishing or improving credit reporting bureaus in 30 developing countries.
• According to World Bank data, more than 500 million people have benefited from microfinance-related organizations.

MUDRA

• The central government established the Micro Units Development Refinance Agency (MUDRA) to refinance collateral-free loans of up to Rs 10 lakh issued by lending organizations to non-corporate small borrowers for revenue generation activities in the non-farm sector.
• Loans given under this method currently fall into three categories: Shishu loans up to Rs 50,000, Kishor loans between Rs 50,001 and Rs 5 lakhs, and Tarun loans between Rs 5 lakhs and Rs 10 lakhs.
• The government plans to create a Rs 3000-crore Credit Guarantee Fund to support these loans to popularize the MUDRA initiative.

Check out the article on MUDRA in detail!

Regulations for MFI

• The majority of MFI restrictions are based on their legal standing.
• Like ordinary banks, microfinance banks will be expected to follow all banking regulations.
• Cooperatives and non-governmental organizations will not be subject to the same regulations. Similar monitoring authorities may, however, regulate them.

Provisions of Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022

• The income eligibility for collateral-free loans from MFIs has been increased to Rs 3 lakh annually from the previous Rs 1 lakh.
• Each regulated enterprise (RE) is required to have a board-approved policy for microfinance loan pricing.
• The central bank will now announce rates on microfinance loans on a quarterly basis.
• Interest rates and other charges/fees on microfinance loans should be reasonable, and the Reserve Bank will conduct supervisory examinations to ensure compliance.
• Prospective borrowers must receive standardized pricing-related information from each RE in the form of a simple factsheet.
• All costs charged by the RE and/or its partner/agent to the microfinance borrower must be specified in the booklet.

Way Forward

• MFIs should ensure that the stated purpose of the loan, frequently requested from consumers throughout the loan application process, is checked at the conclusion of the loan’s term.
• The RBI should urge all institutions to use social impact assessment to track their influence on society.
• MFIs must focus on developing a viable microfinance strategy with a clear economic and social objective.
• Transparency: MFIs must adhere to an actual interest rate on items and amounts that customers must disclose.

Download the test series for UPSC IAS Exam here.

We hope all your doubts regarding Microfinance are addressed after going through this article. Testbook provides comprehensive notes for different competitive examinations. It has always assured the quality of its product like content pages, live tests, Gk and current affairs, mocks, and so on.Ace your UPSC preparation with the Testbook App!