NOTES ON MICROFINANCE

UNIT 1 : INTRODUCTION TO MICROFINANCE

Microfinance is a form of financial services for entrepreneurs and small businesses lacking access to
banking and related services. The two main mechanisms for the delivery of financial services to such
clients are: (1) relationship-based banking for individual entrepreneurs and small businesses; and (2)
group-based models, where several entrepreneurs come together to apply for loans and other services
as a group.

For some, microfinance is a movement whose object is a world in which as many poor and near-poor
households as possible have permanent access to an appropriate range of high quality financial services,
including not just credit but also savings, insurance, and fund transfers. Many of those who promote
microfinance generally believe that such access will help poor people out of poverty. For others,
microfinance is a way to promote economic development, employment and growth through the support
of micro-entrepreneurs and small businesses.

Microfinance is a broad category of services, which includes microcredit. Microcredit is provision of

credit services to poor clients. Microcredit is one of the aspects of microfinance and the two are often
confused. Critics may attack microcredit while referring to it indiscriminately as either 'microcredit' or
'microfinance'. Due to the broad range of microfinance services, it is difficult to assess impact, and very
few studies have tried to assess its full impact. Proponents often claim that microfinance lifts people out
of poverty, but the evidence is mixed. What it does do, however, is to enhance financial inclusion.

HISTORY OF MICROFINANCE
Microfinance is not a new concept. Over the past centuries, practical visionaries, from the Franciscan
monks who founded the community- oriented pawnshops of the 15th century to the founders of the
European credit union movement in the 19th century (such as Friedrich Wilhelm Raiffeisen) and the
founders of the microcredit movement in the 1970s (such as Muhammad Yunus and Al Whittaker), have
tested practices and built institutions designed to bring the kinds of opportunities and risk- management
tools that financial services can provide to the doorsteps of poor people.

Small operations have existed since the 18th century. The first occurrence of micro-lending is attributed
to the Irish Loan Fund system, introduced by Jonathan Swift, which sought to improve conditions for
impoverished Irish citizens. In its modern form, micro-financing became popular on a large scale in
the 1970s.

The first organization to receive attention was the Grameen Bank, which was started in
1976 by Muhammad Yunus in Bangladesh. In addition to providing loans to its clients, the Grameen
Bank also suggests that its customers subscribe to its "16 Decisions," a basic list of ways that the poor
can improve their lives.
The "16 Decisions" touch upon a wide variety of subjects ranging from a request to stop the practice of
issuing dowries upon a couple's marriage, to keeping drinking water sanitary. In 2006, the Nobel Peace
Prize was awarded to both Yunus and the Grameen Bank for their efforts in developing the microfinance
system.

While the success of the Grameen Bank (which now serves over 7 million poor Bangladeshi women) has
inspired the world, it has proved difficult to replicate this success. In nations with lower population
densities, meeting the operating costs of a retail branch by serving nearby customers has proven
considerably more challenging. Hans Dieter Seibel, board member of the European Microfinance
Platform, is in favour of the group model. This particular model (used by many Microfinance institutions)
makes financial sense, he says, because it reduces transaction costs. Microfinance programmes also
need to be based on local funds.

There are other microfinance operations around the world. Some larger organizations work closely
with the World Bank, while other smaller groups operate in different nations. Some organizations
enable lenders to choose exactly who they want to support, categorizing borrowers with criteria such as
level of poverty, geographic region, and type of small business.

Others are very specifically targeted. There are organizations in Uganda, for example, that focus on
providing women with the capital to undertake projects like growing eggplants and opening small cafés.
Some groups focus their efforts only on businesses whose goal is to improve the overall community
through initiatives such as offering education, job training, and working toward a better environment.

1.1 HISTORY OF MICROFINANCE IN INDIA

The origin of microfinance in India predates its reported existence anywhere in the world by two to
three millenniums. It existed in the form of financial intermediation, comprising lending, deposit taking
and other financial services known as merchant banking during the first millennium B.C. and even
beyond it. One can find examples of merchant guilds dealing in goods and money in Vedic scripts dating
back beyond first millennium B. C.

First official interest in informal group lending in India was taken up by National Bank for Agriculture and
Rural Development (NABARD) in 1986-87, when it initiated certain research projects on Self Help Groups
(SHGs) as a channel for delivery of microfinance.

Amongst these the Mysore Resettlement and Development Agency (MYRADA) sponsored “Action
Research Project on Savings and Credit Management of SHGs” was also partially sponsored by NABARD.
In 1988-89, in collaboration with some member institutions of the Asia Pacific Rural and Agricultural
credit Association (APRACA), NABARD undertook a survey of 43 NGOs in 11 states in India to study the
functioning of the MFI-SHGs and possibility of their collaboration with formal banking system.
Loans to poor people by banks have many limitations including lack of security and high operating cost
and so Microfinance was developed as an alternative to provide loans to poor people with the goal of
creating financial inclusion and equality. Muhammad Yunus, a Nobel Prize winner, introduced the
concept of Microfinance in Bangladesh in the form of the "Grameen Bank". NABARD took this idea and
started the concept of Micro Finance in India.

India's Bharat Financial Inclusion Limited (formerly known as SKS Microfinance Limited ie. Swayam
Krishi Sangham) also serves a large number of poor clients. Formed in 1998, it has grown to become one
of the biggest microfinance operations in the world. SKS works in a similar fashion to the Grameen Bank,
pooling all borrowers into groups of five members who work together to ensure that their loans are
repaid.

In conclusion, Microfinance sector in India has taken a big leap; however, in size and outreach it may not
be comparable to the neighboring Bangladesh. A suitable regulatory framework, innovative products,
self-regulation by MFIs, appropriate governance, technology to reduce transaction costs, training and
marketing facilities to the micro entrepreneurs are the key factors that can contribute to the growth and
deepening of this sunrise sector. In the present state the liquidity crunch faced by the MFIs, and the
banks – lifeline of the sector, shying away to lend to MFIs, can sound death knell of the sector. Imminent
steps by the government are required to sustain the growth of the microfinance sector

Micro Finance is defined as, financial services such as Saving A/c, Insurance Fund & credit provided to
poor & low income clients so as to help them to raise their income & there by improve their standard of
living.

From this definition it is clear that the main features of Micro Financing are:

1) Loans are given without security

2) Loans to those people who live in BPL (Below Poverty Line)

3) Even members of SHG enjoy Micro Finance

4) Maximum limit of loan under micro finance is Rs. 25,000/-

5) The terms and conditions given to poor people are decided by NGOs

6) Micro Finance is different from Micro Credit- under Micro Credit, small amount of loans are given to
the borrower but under Micro Finance, besides loans many other financial services are provided such as
Savings A/c, Insurance etc. Therefore Micro Finance has wider concept as compared to Micro Credit.
1.2 FUNDAMENTALS OF MICROFINANCE
ABSTRACT

Microfinance is a form of financial services for entrepreneurs and small businesses lacking
access to banking and related services. The two main mechanisms for the delivery of financial services to
such clients are: (1) relationship-based banking for individual entrepreneurs and small businesses; and
(2) group-based models, w here several entrepreneurs come together to apply for loans and other
services as a group. Microfinance is a broad category of services, which includes microcredit.
Microcredit is provision of credit services to poor clients. Microcredit is one of the aspects of
microfinance and the two are often confused.

A. Definition of Microfinance
Microfinance is the provision of a broad range of financial services such as – deposits, loans,
payment services, money transfers and insurance products – to the poor and low-income households,
for their microenterprises and small businesses, to enable them to raise their income levels and improve
their living standards.

B. Core Principles for Microfinance

➣ The poor needs access to appropriate financial services
➣ The poor has the capability to repay loans, pay the real cost of loans and generate savings
➣ Microfinance is an effective tool for poverty alleviation
➣ Microfinance institutions must aim to provide financial services to an increasing number of
disadvantaged people
➣ Microfinance can and should be undertaken on a sustainable basis
➣ Microfinance NGOs and programs must develop performance standards that will help define and
govern the microfinance industry toward greater reach and sustainability

B. Characteristics and Features of Microfinance

Characteristics Distinguishing Features

Type of client  Low Income
 Employment in informal sector; low wage bracket
 Lack of physical collateral
 Closely interlinked household/business activities
Lending Technology  Prompt approval and disbursement of micro loans
 Lack of extensive loan records
 Collateral substitutes; group-based guarantees
 Conditional access to further micro-credits
 Information-intensive character-based lending linked to cash
flow analysis and group-based borrower selection
Loan Portfolio  Highly volatile
  Risk heavily dependent on portfolio management skills
Organizational Ideology  Remote from/non-dependent on government
 Cost recovery objective vs. profit maximizing

Institutional Structure  Decentralized

 Insufficient external control and regulation
 Capital base is quasi-equity (grants, soft loans)

C. Definition of Microfinance loans

Microfinancing loans are small loans granted to the basic sectors, on the basis of the borrower’s
cash flow and other loans granted to the poor and low-income households for their microenterprises
and small businesses to enable them to raise their income levels and improve their living standards.
These loans are typically unsecured but may also be secured in some cases.

D. Collateralization of Microfinance Loan

A microfinance borrower is not likely to be able to borrow from a large commercial, thrift or
rural bank but from an NGO microfinance institution or perhaps from a small rural or cooperative bank.
Thus, microfinance loans are typically unsecured, for relatively short periods of time (180 days) with
monthly (or more frequent) amortizations of interest and principal, and often featuring a joint and
several guarantee of one or more persons and, certainly, seldom with tangible collateral. But in some
cases, they can also be secured, depending on the capacity of the borrower to offer collaterals
acceptable to the lending institution.

F. Interest on Microfinance Loans

Old Approach
The old (and by now highly discredited as ineffective) approach to loans for low-income
borrowers emphasized subsidized interest rates. It did not recognize that subsidized below-market
interest rates do not necessarily result in opening up access to financial services for low-income
households and microenterprises.
New Approach
The new approach which has been demonstrated by global experience is characterized by a
market-based interest rate regime which permits the institution providing microfinance services to
cover administrative costs, provisions for loan losses and intermediation/funding costs. This basis is
consistent with financially sustainable rural finance and microfinance. Invariably, the global experience
continues to validate the proposition that what matters most to the poor and undeserved segments is
access to financial services rather than their interest-rate cost – most especially because
microenterprise and small business borrowers will take a microfinance loan whose repayment periods
match the additional cash flows they hope to generate.
Therefore, interest on such microfinancing loans shall be reasonable but shall not be lower than
the prevailing market rates. This is to enable the lending institution not only to recover the financial and
operational costs incidental to this type of microfinance lending but also to realize some bottom line
gains.

G. Segments of Demand for Micro-credit

(1) The landless who are engaged in agricultural work on a seasonal basis and manual laborers in
forestry, mining, household industries, construction and transport; requires credit for consumption
needs and also for acquiring small productive assets, such as livestock.
(2) Small and marginal farmers, rural artisans, weavers and those self-employed in the urban informal
sector as hawkers, vendors and workers in household micro-enterprises: requires credit for working
capital, including a small part for consumption needs. This segment largely comprises the poor but not
the poorest.
(3) Medium farmers/small entrepreneurs who have gone in for commercial crops and others engaged in
dairy, poultry . . . . Among non-farm activities, this segment includes those in villages and slums engaged
in processing or manufacturing activity. These persons live barely above the poverty line and also suffer
from inadequate access to formal credit.

H. How are MFIs Funded?

Microfinance Institutions get funding from several sources, such as:
 Member and customer deposits – This is applicable to MFIs that are organised as mutual funds,
cooperatives, and microfinance banks offering savings products.
 Subsidies and grants – Grants are more prominent when the MFI is just being set up.
 Own capital – The microfinance institution’s own finance/capital accounts for a part of the
funding extended to borrowers.
 Loans from partner banks – This is the primary source of funding for an MFI.
 Funding received from public investors – Bilateral or multilateral organisations offer funds to
MFIs. This is a source of long-term funding for the MFI.
 Funding received from private investors – These funds are supplied directly to the MFI or
through investment funds that specialise in microfinance. This is also a source of long-term
funding for the MFI.

I. Groups Organised by Microfinance Institutions in India

There are several types of groups organised by microfinance institutions for offering credit, insurance,
and financial training to the rural population in India:
1. Joint Liability Group (JLG)
This is usually an informal group that consists of 4-10 individuals who seek loans against mutual
guarantee. The loans are usually taken for agricultural purposes or associated activities. Farmers, rural
workers, and tenants fall into this category of borrowers. Each individual in a JLG is equally responsible
for the loan repayment in a timely manner. This institution does not need any financial administration,
as it is simple in nature.
2. Self Help Group (SHG)
A Self Help Group is a group of individuals with similar socio-economic backgrounds. These small
entrepreneurs come together for a short duration and create a common fund for their business needs.
These groups are classified as non-profit organisations. The group takes care of the debt recovery. There
is no requirement of a collateral in this kind of group lending. The interest rates are generally low as
well. Several banks have had tie-ups with SHGs with a vision to improve financial inclusion in the rural
parts of the country.
The NABARD SHG linkage programme is noteworthy in this regard, as several Self Help Groups are able
to borrow money from banks if they are able to present a track record of diligent repayments.
3. Grameen Model Bank
The Grameen Model was the brainchild of Nobel Laureate Prof. Muhammad Yunus in Bangladesh in the
1970s. It has inspired the creation of Regional Rural Banks (RRBs) in India. The primary motive of this
system is the end-to-end development of the rural economy. However, in India, SHGs have been more
successful as MFIs when compared to Grameen Banks.
4. Rural Cooperatives
Rural Cooperatives were established in India at the time of Indian independence. The resources of poor
people were pooled in and financial services were provided from this fund. However, these systems had
complex monitoring structures and were beneficial only to the creditworthy borrowers in rural India.
Hence, this system did not find the success that it sought initially.

J. Top 10 Microfinance Companies in India

1. Equitas Small Finance
The lender offers small loans between Rs.2,000 and Rs.35,000 to the Economically Weaker Section
(EWS) and Low Income Group categories in the country.
2. ESAF Microfinance and Investments (P) Ltd
ESAF Microfinance is a leading MFI in India that has empowered more than 4 lakh members through its
150 branches. It offers an extensive range of business development and financial services to the
economically and socially challenged members of the society. The institution offers a bouquet of loan
products to suit the varied needs of customers.
3. Fusion Microfinance Pvt Ltd
Fusion Microfinance is an RBI registered NBFC-MFI that works on a JLG lending model of Grameen. The
institution offers loans to women in the rural and semi-urban regions. Apart from offering financial
support and insurance protection, the company also imparts financial literacy to its customers.
4. Annapurna Microfinance Pvt Ltd
The purpose of Annapurna Microfinance is to provide loans to the financially underserved population.
Technical and financial education is also imparted to beneficiaries to strengthen their entrepreneurial
skills. It is one of the top ten NBFC-MFIs in India today.
5. Arohan Financial Services Limited
Eastern India’s largest NBFC MFI, Arohan Financial Services Limited offers financial inclusion products to
1.9 million customers throughout India. The local partners of the company help in improving its reach to
remote locations. Non-financial products are also offered by the company at affordable costs. Arohan
also has an MSME lending business in its portfolio.
6. BSS Microfinance Limited
The company offers microloans to poor women so that they can be part of income generating activities
that bring them out of poverty. The institution offers loans in the states of Maharashtra, Karnataka,
Tamil Nadu, and Madhya Pradesh.
7. Asirvad Microfinance Limited
This microfinance institution has an extensive network of branches throughout 22 states in India. It
offers microloans to women entrepreneurs from low-income households for income generation
activities. Currently, three types of loans are offered to borrowers, i.e., Product Loan, Income
Generation Program (IGP) Loan, and Small and Medium Enterprise (SME) Loan.
8. Cashpor Micro Credit
Cashpor is a microfinance institution that works towards bringing the economically backward sections of
the society out of poverty. The products offered by the company include credit facilities, savings
services, insurance coverage, and pension services.
9. Bandhan Financial Services Limited
The motive of the institution is to reduce socio-economic poverty by generating employment
opportunities for low-income households. Cost-effective financial and non-financial products are
provided in this regard.

10. Fincare Business Services Limited –

The Fincare group consists of two NBFC-MFIs, i.e., Disha Microfin Ltd. (now referred to as Fincare Small
Finance Bank) and Future Financial Services Pvt. Ltd. (FFSPL). The company caters to the semi-urban and
rural households of the country, offering Microenterprise Loans (MEL) and loan against gold with quick
disbursals.