- Since the 1980s microfinance has become an important component of development, poverty reduction and economic regeneration strategies around the world. By the early twenty-first century, tens of millions of people in more than 100 countries were accessing services from formal and semi-formal microfinance institutions
- Microfinance rests on the belief of mutual faith and reciprocity. Members in a genuine, self-selected and closely associated group are mutually responsible for the financial dealing of each member. When a request for a loan is received, members discuss the need and prospects of repayment. Once satisfied, the loan amount is approved. Group lending is preferred to individual lending as social collateral, peer pressure and good collection methods reduce defaults significantly. Microfinance loans are primarily unsecured and work on the principles of peer pressure to avoid defaults. Microfinance serves low-income households and encourages the spread of banking services. Financial inclusion is essentially providing banking services to the population derived from this facility. Microfinance is thus an enabler for promoting financial inclusion.
- Those institutions which have microfinance as their main operation are known as microfinance institutions. A number of organizations with varied size and legal forms offer microfinance service. These institutions lend through the concept of Joint Liability Group (JLG). A JLG is an informal group comprising of 5 to 10 individual members who come together for the purpose of availing bank loans either individually or through the group mechanism against a mutual guarantee. The reason for the existence of separate institutions i.e. MFIs for offering microfinance are as follows:
- High transaction cost – generally micro-credits fall below the break-even point of providing loans by banks
- Absence of collaterals – the poor usually are not in a state to offer collaterals to secure the credit
- Loans are generally taken for very short duration periods
- Higher frequency of repayment of instalments and the higher rate of Default.
Salient Features of Microfinance
- Borrowers are from the low-income group
- Loans are of small amount – microloans
- Short duration loans
- Loans are offered without collaterals
- High frequency of repayment
- Loans are generally taken for income generation purpose
Reasons why big bank are not lending money to lower income segment groups
- High transaction cost of processing
- Lack collateral or guarantors
- Repayment capacity
- Lack of access to financial infrastructure
The Malegam Committee
- The Reserve Bank of India (RBI) responded by appointing an RBI sub-committee known as the Malegam Committee. This committee aimed to address the primary customer complaints that led to the crisis, including coercive collection practices, usurious interest rates, and selling practices that resulted in over-indebtedness. The existing regulations did not address these issues, thus, who should respond to these issues, and how they should respond, was uncertain. This prolonged the general regulatory uncertainty and the resulting repayment and institutional liquidity issues. The Malegam Committee released their recommended regulations in January 2011. These recommendations were 'broadly accepted' by RBI in May 2011, though specific regulation was only released regarding which institutions qualify for priority sector lending at this time.
- Additionally, an updated version of the Micro Finance Institutions (Development and Regulations) Bill 2011 is in Parliament, which aims to provide a regulatory structure for microfinance institutions operating as societies, trusts, and cooperatives. Although this shows that regulators are taking steps to address the crisis issues and resolve regulatory uncertainty, banks have not resumed lending to microfinance institutions as of July 2011.
- While Microfinance may be scaling geographically and average lending per capita rising structural and cultural issues limit effectiveness. At times cross guarantee programs are rolled out to reduce credit risk and in turn foster community solidarity. When it works it works but when community buys it is difficult to achieve then lender risk rises and many at times individuals do not get approved for loans. To conclude, microfinance has made satisfactory progress during the last one and half decade. This progress was achieved purely at the public initiative. There is strong need to expand it to other backward areas. However, strong support, including policy and finance, from the government and other agencies would be necessary to extend it to all places.
Types of Micro FinanceDifferent types of microfinance institutions in India The microfinance models are developed in order to cope with the financial challenges in financially backward areas. There are various types of microfinance companies operating in India.
Joint Liability Group (JLG)Joint Liability Group can be explained as the informal group consists of 4-10 individuals who try to avail loans against mutual guarantee from banks for the purpose of agricultural and allied activities. This category generally consists of tenants, farmers and other rural workers. They work primarily for lending purposes, although they also offer the savings facility. In this type of institution, every individual of a borrowing group is equally liable for the credit (Singh, 2010). This kind of institution is simple in nature and requires little or no financial administration (UBI, no date).
However, one of the serious problems of this structure is personal preferences in lending credit which resulted in a partial failure of the system. Of late due to various promotional initiatives were taken by banks such as Indian bank, Karur Vysya Bank and Indian Overseas Bank, the credibility of Joint Liability Group model has received a boost (The Hindu, 2016). It still remains a landmark movement in the area of protection of farmer’s land ownership rights.
Self Help Group (SHG)Self Help Group is a type of formal or informal group consisting of small entrepreneurs with similar kind of socio-economic backgrounds. Such individuals temporarily come together and generate a common fund to meet the emergency needs of their business. These groups are generally non-profit organizations. The group assumes the responsibility for debt recovery. The advantage of this micro-lending system is that there is no need for collateral. Interest rates are also generally low and fixed especially for women (Chowdhury, 2013; Business Standard, 2017). In addition, various tie-ups of banks with SHGs have been implemented for the hope of better financial inclusion in rural areas (Jayadev and Rao, 2012).
One of the most important ones is NABARD SHG linkage program where many self-help groups can borrow credit from the bank once they successfully present a track record of regular repayments of their borrowers. It has been very successful especially in Andhra Pradesh, Tamil Nadu, Kerala and Karnataka and during the year of 2005-06. These states received approximately 60% of SGH linkage credit (Taruna and Yadav, 2016).
The Grameen Bank ModelGrameen Model was introduced by the Nobel laureate Prof. Muhammad Yunus in Bangladesh during the 1970s. It has been widely adopted in India in the form of Regional Rural Banks (RRB). The goal of this system has been the overall development of the rural economy which generally consists of financially backward classes. But this model has not been fully successful in India as rural credit and system of recovery are a real problem. A huge amount of non-performing assets also led to the failure of these regional banks (Shastri, 2009). Compared to this model Self Help Groups have been more successful as they are more suited to the population density of India and far more sustainable (Dash, 2013).
Rural CooperativesRural Cooperatives in India were set up during the time of independence by the government. They used the mechanism to pool the resources of people with relatively small means and provide financial services. Due to their complex monitoring structure, their success has been limited. In addition, this system only catered to the credit-worthy individuals of rural areas, not covering a large part of the country’s financially backward section (Rajendran, 2012).
Present scenario of India
- India falls under low-income class according to World Bank.
- It is second populated country in the world and around 70% of its population lives in rural area
- 60% of people depend on agriculture, as a result, there is chronic underemployment and per capita income is only $6490
- The result is abject poverty, low rate of education, low sex ratio, and exploitation.
- Low asset base- according to reserve bank of India, about 51% of people house possess only 10% of the total assets of India.
- Resulted in low production capacity both in agriculture (which contribute around 22-25% of GDP) and manufacturing sector
- Rural people have very low access to institutionalized credit (from commercial bank).
Need of Micro FinanceAbout half of the Indian population still doesn’t have a savings bank account and they are deprived of all banking services. Poor also need financial services to fulfil their needs like consumption, building of assets and protection against risk. Microfinance institutions serve as a supplement to banks and in some sense a better one too. These institutions not only offer microcredit but they also provide other financial services like savings, insurance, remittance and non-financial services like individual counselling, training and support to start own business and the most important in a convenient way. Some claim that the interest rates charged by some of these institutions are very high while others feel that considering the cost of capital and the cost incurred in giving the service, the high-interest rates are justified.
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