A Detailed Study on Microfinance

A Project Submitted to

University of Mumbai for partial completion of the degree of

Bachelor in Commerce (Accounting and Finance)
Under the Faculty of Commerce

By

Pandya Dhavlangi Satyen

Vaishali

Under the Guidance of

Prof. Monica Bhoir

Malini Kishor Sanghvi College of Commerce and Economics

Nrimaladevi Arunkumar Ahuja Marg,

J.V.P.D. Scheme, Vile Parle (W)Mumbai -49

MARCH 2022

I
 INDEX

List of tables

List of graphs

List of Abbreviations

Chapter1
Introduction
1 1
Abstract

2 1
Overview of Microfinance
2.1 1
Definition of Microfinance
2.2 2
Historical development of Microfinance
2.3
3
Microfinance and its effects on poverty elevation
3
4
An Overview of Modern Financial Service Sector
3.1
Meaning
4
3.2
Aims of Finance industry
5
3.3
5-6
Indian financial sector
3.4
7
NBFC
4
9
Expectations of Microfinance Institutions and the

ChallengesFaced By Them in Raising Funds In In

5
Goals of Microfinance 10
6
Purpose of Microfinance Institutions
10-11
7
Financial resources of Microfinance Institutions 13-19

2
7.1 Savings and Deposits 13

7.2 Social investors 13-14

7.3 Soft loans and grants 14

7.4 Investment Funds 14

7.5 Microfinance investment funds 14-15

7.6 Quasi-Equity 15

7.7 Non –Convertible debentures 15

7.8 Bank loans 16

7.9 Private Equity 17

7.10 Equity from capital market sources 17-18

7.11 Assignment and Securitisation 18-19

8 Challenges faced by Microfinance institutions in

19-26
obtaining the funds
8.1 Over-indebtedness due to multiple borrowing and 21-22

insufficient risk management

8.2 High rates of interest as compared to mainstream 22

bank

8.3 Over-dependence on banking system of funding 22

8.4 Lack of awareness of financial services 22-23

8.5 Regulatory issues 23

8.6 Problem in indentification of appropriate model 23-25

3
 9 The role of Government in boosting Microfinance 27-28

institutions

9.1 Dominant models of Microfinance in India 28-29

9.2 Support in the formal sector 30-31
9.3 The Andra Pradesh Microfinance institution Act 31-32
of 2010

9.4 Role of Reserve bank of India 32-33

9.5 Challenges faced 33-34
10
Commercial bank and Microfinance institutions 35-40
10.1
Need of Commercial bank 35-36
10.2
Role of commercial bank in microfinance 36-37
10.3
Comparative advantage of commercial bank on 38-39
Microfinance

10.4
Obstacle for commercial in helping Microfinance 39-40
11
Microfinance institutions and micro, small ,and 41-46
medium enterprises

11.1
Definitions of micro , small , medium enterprises
41
11.2
Need of Microfinance in development of small
41-44
enterprises

11.3
Ways in which Microfinance helps in achieving
44-46
the goal of development

4
Chapter II Research Methodology 47-49
1 47
Methodology
2
Hypothesis 47-48
3
48
4 Scope of study

Limitation of study
48
5
Source of data 48-49
ChapterIII
Literature Review 50-51
Chapter IV
Data and Interpretation
52-62
Chapter V

Conclusion and Suggestion 63-66

5
 LIST OF TABLES

1. What is the age group of Respondent? 52

53
2. What is the gender of the respondents ?
54
3. What is the profession of the respondents ?
55
4. What is the annual income ?
56
5. Are you aware about Microfinance ?
57
6. From where did you learn about microfinance ?
58
7. Have you ever taken small amount loan from Self-Help group model or Joint Liability Group ?
59
8. Have ever taken small amount loan from bank ? lower than 2.5l?
60
9. Are you aware about the government policies regarding microfinance 61

10.Do you agree that government and bank with the help of microfinance have helped thelow 62
income group population in our country?

11. Is microfinance the best way to help the low income group? 63

6
 LIST OF GRAPHS

1. What is the age group of Respondent? 52

2. What is the gender of the respondents ? 53

54
3. What is the profession of the respondents ?
55
4. What is the annual income ?
56
5. Are you aware about Microfinance ?
57
6. From where did you learn about microfinance ?
58
7. Have you ever taken small amount loan from Self-Help group model or Joint Liability Group ?
59
8. Have ever taken small amount loan from bank ? lower than 2.5l?
60
9. Are you aware about the government policies regarding microfinance
61

10.Do you agree that government and bank with the help of microfinance have helped thelow 62
income group population in our country?

11. Is microfinance the best way to help the low income group? 63

7
List OF Abbreviations
ACCION- American for Community In Other

Nations.ADB- Asian Development Bank.

AUM- Assets Under Management.

CARE- Cooperative for Assistance and Relief

Everywhere.CGAP- Consultative Group to Assist the

Poor

DFI- Development Finance

InstitutionsFID- Financial Inclusion

Department FIF- Financial Inclusion

Fund

FITF- Financial Inclusion Technology Fund

IAMI- International Association of Microfinance

InvestorsIMF- International Monetary Fund

Mohd.- Mohhammad

MFI- Micro Finance Institution.

MFV- Microfinance investment

vehicles MSME- Micro Small and

Medium Enterprise.

MUDRA- Micro Units Development and Refinance Agency.

NABARD- National Bank for Agriculture and Rural Development.

NHFDC- National Handicapped Finance and Development

CorporationNBFC- Non- Banking Financial Companies.

NHB- National Housing Bank

NCD- Non-Convertible
IX
Debentures

NGO- Non- Governmental Organisation.

X
 Acknowledgement

To list who all have helped me is difficult because they are so numerous and the depth
is so enormous.

I would like to acknowledge the following as being idealistic channels and fresh
dimensions in the completion of this project.

I take this opportunity to thank the University of Mumbai for giving me a

chance to do thisproject.

I would like to thank my Principal, Dr. Keshav Ghorude for providing the necessary
facilitiesrequired for completion of this project.

I take this opportunity to thank our Coordinator Prof. Dimple, for hermoral support
and guidance.

I would also like to express my sincere gratitude towards my project guide Prof.
Monica Bhoir whose guidance and care made the project successful.

I would like to thank my College Library, for having provided various reference books
and magazines related to my project.

Lastly, I would like to thank each and every person who directly and indirectly helped
me in the completion of the project especially my Parents and Peers who supported
me throughout my project.

XI
 CHAPTER I
INTRODUCTION

2. AN OVERVIEW OF MICROFINANCE

2.1 DEFINITION OF MICROFINANCE:

“Microfinance refers to the provision of small scale financial services including

microcredit, savings, payment services, micro insurance and other services to the rural
and urban poor clients who don't have access to the banking services on sustainable
basis”1 The definition given by the Asian Development Bank (ADB) states that,
“microfinance is a provision which pertains to a broad range of financial services such
as deposit, loans, payment services, money transfers and insurance to the poor and low-
income households and their micro-enterprises”2.

The World Bank in its definition of microfinance has highlighted a link between
microfinance and development. Microfinance refers to the provision of financial
services to low-income clients, including the self-employed. Microfinance is not
simply banking, it is a development tool. Microfinance involves a wide range of
activities such as giving small loans, providing micro insurance and giving financial and
business education to the poor people and they also indulge in providing vocational
training to the poor people who can learn through these programs so that they can earn
their living and can subsequently become self- sufficient and can further help in the
development.3

1
2.2 HISTORICAL DEVELOPMENT OF MICROFINANCE

The history of microfinance can be traced back to the Starr-Bowkett Society. Further in
18th and the 19th century. Jonathan Swift inspired the Irish Loan Funds which was also a
type of microfinance.4 These Irish loans were interest free loans and also sometimes
inthe form of charities also. The Individualist anarchist, Lysander Spooner in the mid of
the19th century wrote about the advantages of the microfinance and the benefits derived
from small loans by the poor people.5 The first cooperative lending bank was opened in
Germany in the 19th Century to support the poor farmers. It was founded by Friedrich
Wilhelm Raiffeisen 6. In Latin America and Asia microfinance started as an experiment.
In 1950, Commila Model was used by Akhtar Hameed Khan in East of Pakistan,
according to this model loans were given through community based initiatives. 7 This
project was not a success because of the over involvement of the Government of
Pakistanand also because of the hierarchies which was made within the group.

Microfinance gained popularity in 1976, when on the outskirts of Chittagong University

campus in the village of Jobra, in Bangladesh, Muhammad Yunus started the Grameen
Bank.8 After seeing the success of the Grameen Bank in Bangladesh many other
microfinance institution have come up and have helped the low income group of the
society and they have also come up with many other strategies which includes providing
collateral free loans to poor people, especially in rural areas, at full-cost interest rates
and these loans are repayable in frequent installments and all the borrowers are arranged
into different groups. In 1983, this institution became a bank. In the year 2006, Nobel
Peace Prize was given to Mohd. Yunus and Grameen Bank for their efforts, loans
without financial security was an idea which was not thought upon and worked before
him but he transformed his dream into reality and helped people throughout the
world.9

2
2.3 MICROFINANCE AND ITS EFFECT ON POVERTY ELEVATION:

Microfinance is an effective tool for poverty eradication this was underlined by Mohd.
Yunus also, he also once remarked that, “Maybe our great-grandchildren will go to
museums to see what poverty was like”11. This remark shows his confidence in the
technique of microfinance in poverty elevation.

This technique is considered as very effective for poverty alleviation and is also
effective in imparting various information which relates to education, sanitation, health,
legalrights and other information which proves to be helpful in improving the standard
of living of the poor people. Many microfinance programs have also targeted the women
who live in house in the society as they are one of the most vulnerable section of the
society. These women are financially weak as they have no assets or any kind of
financialsecurity of their own. Studies have proved that these techniques have improved
the condition of the women by giving them opportunity of self- employment which in
turn provides financial, social security and also helps women in gaining self- confidence
and helps in improving their status in the society.

Microfinance also saves people from the exploitation of the moneylenders who charge
exorbitant rate of interest while providing the loans to the poor people and this
exploitation and makes the poor more poorer and later this turns into a vicious cycle.
Hence majorly low income people of the society are benefitted from microfinance
schemes and these schemes helps them in engaging in micro and small enterprises. 12
Effective collateral substitute for short- term and working capital loans to micro-
entrepreneurs13 is provided by micro finance institutions.

3
3 An Overview of Modern Financial Service Sector

3.1 Meaning

Capital markets, insurance sector and non- banking financial companies (NBFCs) makes
up the financial sector of a country. Institutions which are involved with money are
included in the financial service sector of financial industry. These institutions includes
business providing money management, insurance sector, issuance of securities, trading
services and lending and investing activities.14 Banks, Credit card issuers, Insurance
companies, Investment bankers, Securities traders, Financial planners, Security
exchanges, pension funds, mutual funds and other smaller financial entities are some of
the institutions which are part of this sector.

In India, commercial banks constitutes the largest part of the financial sector as it covers
sixty- four percent of the total asset in the financial sector. The Government of India has
introduced several reforms to liberalise, regulate and enhance this industry. The
Government and Reserve Bank of India (RBI) have taken various measures to facilitate
easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These
measures include launching Credit Guarantee Fund Scheme for Micro and Small
Enterprises, issuing guideline to banks regarding collateral requirements and setting up a
Micro Units Development and Refinance Agency (MUDRA). With a combined push by
both government and private sector, India is undoubtedly one of the world's most
vibrant capital markets. In 2017, a new portal named 'Udyami Mitra' has been launched
by the Small Industries Development Bank of India (SIDBI) with the aim of improving
credit availability to Micro, Small and Medium Enterprises' (MSMEs) in the country.
India has scored a perfect 10 in protecting shareholders' rights on the back of reforms
implemented by Securities and Exchange Board of India (SEBI).15

4
3.2 Aims of Finance Industry16

1. The main aim of the finance sector is to provide financial stability both within
and outside the country this also leads to generation of employment and increase in
productivity. All this increases the confidence of people and encourages saving and
investment.

2. Another aim of this industry is to provide an easy access to finance s that people
can manage their needs and expand their opportunities and improve their living
standards. When finance is easily accessible then people can have better self-
employment opportunities, better housing and education facilities.

3. Another important aim is to finance the growing need of the infrastructure of the
country such as roads, power generation, hospitals, schools and other places of public
utilities. The finance sector also aims to help the Government in bearing risks while
undertaking such projects.

4. Sustainable Development is another goal of the modern finance sector.

Sustainable development of the economy requires huge financing and the financial
sector through its various services help in achieving this aim.

3.3 Indian Financial Sector

The Reserve Bank of India (RBI) was founded in 1935 under the Reserve Bank of India
Act “…to regulate the issue of Bank Notes and keeping the reserves with a view to
securing monetary stability in India and generally to operate the credit and currency
system of the country to its advantage.” Apart from being the central bank and monetary
policy authority, the RBI is the regulator of all banking activity, including non-banking
financial companies, manager of statutory reserves, debt manager of the government,
and banker to the government. At the time of independence in 1947, India had 97
scheduled17

5
private banks, 557 “nonscheduled” (small) private banks organized as joint stock
companies, and 395 cooperative banks. The decade of 1950s and 1960s was
characterizedby limited access to finance of the productive sector and a large number of
banking failures.18 Such dissatisfaction led the government of left-leaning Prime
Minister (and the then Finance Minister) Mrs. Indira Gandhi to nationalize fourteen
private sector banks on 20 July 1969; and later six more commercial banks in 1980.
Thus, by the early 1980's the Indian banking sector was substantially nationalized, and
exhibited classical symptoms of financial repression, viz., high pre-emption of banks'
investible resources (with associated effects of crowding out of credit to the private
sector), subject to an intricate cobweb of administered interest rates, and accompanied
by quantitative ceilings on sectoral credit, as governed by the Reserve Bank of India.
Besides the commercial banks, there were fourother types of financial institutions in the
Indian financial sector: development finance institutions (DFIs), co-operative banks,
regional rural banks and post-offices.

NABARD, the NHB and SIDBI are continuing largely as refinance institutions with
support from the government.19 As of 2015, there are 1,579 urban co-operative and
94,178 rural cooperative banks. A majority of these banks tend to operate in a single
state, and they are regulated and supervised by state-specific Registrars of Cooperative
Societies (RCS), along with overall oversight by the Reserve Bank of India. 20 Asset
management industry in India is one of the fastest growing industry in the world. Total
AUM of the industry increased 40 per cent year-on-year to hit a record Rs 23 lakh crore
(US$ 358.78 billion) at the end of November 2017. Corporate investors accounts for
around 46.26 per cent of total AUM in India. High Net Worth Individuals and retail
investors account for 28.01 per cent and 22.96 per cent, respectively.

6
Revenues of the brokerage industry in India are estimated to grow by 15-20 per cent to
reach Rs 18,000-19,000 crore in 2017-18. Insurance industry is another important
constituent of Indian financial services industry. The insurance industry has been
expanding at a fast pace. The total first year premium of life insurance companies
grew
18.9 per cent year-on-year to reach US$ 18.44 billion during April-November 2017.21

3.4 Non-Banking Finance Companies (NBFCs)

India has a number of non-banking financial companies (NBFCs). The NBFCs is far
from being a homogenous entity and include many diverse types of financial
institutions froma housing finance company to an equipment leasing company. 22 The
diversity among the entities of the NBFC sector is also reflected in attributes like sizes
and the extent of regulatory oversight. In the popular discourse the role of NBFCs are
seen from two distinct angles: (a) they have been very useful for sectors / activities that
are generally excluded from formal banking activities; and (b) at some regularity some
of the deposit raking NBFCs have been source of financial irregularity in some localized
pockets and raised the issue of consumer protection. Although NBFCs have existed for a
long time in India, these entities experienced sudden spurt in their activities between
the late 1980sand the mid-1990s. This sharp jump in NBFC deposits was mostly, “on
account of the high rates of interest offered on such deposits” (RBI, 2003). At the
current juncture, while a large chunk of deposit and non-deposit taking financial
companies are regulated by the RBI, housing finance companies are regulated by
National Housing Bank, Chit Funds are regulated by the State Governments, and
Mutual Benefit companies are

regulated by Ministry of Corporate Affairs, Government of India. This multiplicity of

regulators has always become an issue in their functioning

7
8
4. Expectations of Microfinance Institutions and the Challenges Faced
By Them in Raising Funds In India
The eradication of poverty can be said to be the main idea behind microfinance.
Microfinance is majorly involved with the act of providing finance to the marginalized
section of the society who does not have an easy access to the commercial bank. 1 Mohd.
Yunus who founded Grameen Bank and was also a recipient of the Nobel Prize in
2006,is often considered as a founding father of the microfinance. Being an economist at
the University of Chittagong in Bangladesh, he had an idea of providing loans and
financial support to the marginalized section of the society as the traditional banking
system is not easily accessible to them. His vision was that microfinance would be able
to eradicate poverty by providing finance to the poor people and making them self-
sufficient. The main features of microfinance are helping the lower strata of the society
and also involving women and providing finances and other assistance to them so that
they can be empowered. The vision which was proposed by him was new to many
people and it was accepted by a lot of people all over the world as it proposed one of the
remedies to eradicate poverty in an efficient manner as poverty is one of the major
problems in the development of the country. By providing finances to the marginalized
section, microfinance is also involved in bridging gap between the traditional financial
institutes and the marginalized section.

Credit unions, Non- Governmental Organizations, commercial banks, some government

institutions, cooperative banks and society, etc are some of the institutions which are
involved in microfinancing. In India various Non-Banking Financial Companies
(NBFC) are also involved in the activity of microfinance and thereby providing
assistance to the marginalized section of the society.2

9
 5. Goals of Microfinance

The microfinance sector consistently focuses on understanding the needs of the poor and
on devising better ways of delivering services in line with their requirements,
developing the most efficient and effective mechanisms to deliver finance to the poor.
Continuous efforts towards automation of operations is steady improving in efficiency.
The automated systems have also helped accelerate the growth rate of the microfinance
sector.

The goal for MFIs should be:

• To improve the quality of life of the poor by providing access to financial and
support services;

• To be a viable financial institution developing sustainable communities;

• To mobilize resources in order to provide financial and support services to the

poor, particularly women, for viable productive income generation enterprises enabling
them toreduce their poverty;

• Learn and evaluate what helps people to move out of poverty faster;

• To create opportunities for self- employment for the underprivileged;

• To train rural poor in simple skills and enable them to utilize the available
resources andcontribute to employment and income generation in rural areas.

6. Purpose of Microfinance Institutions

Traditionally, when a person wants to start a business venture, they go to a bank for a
loan. But what should a budding entrepreneur do if he is too poor to obtain finance
to start a profitable business? The answer lies in a relatively new branch of financial
services called microfinance. Its purpose is to provide basic financial services such as
loans, savings and insurance to underprivileged people. A

10
microfinance institution (MFI)is simply one that offers such services to the poor;
according to the Consultative Group to Assist the Poor (CGAP), it can be a credit
union, commercial bank, financial non- governmental organization, or a credit
cooperative.

11
1. Provide Access to Funds: - Typically, the poor acquire financial services like loans
through informal relationships. These loans, however, come at a high cost per
dollar loaned and can be unreliable. Furthermore, banks have not traditionally viewed
poor people as viable clients and often will reject them due to unstable credit or
employment history and lack of collateral. MFIs dismiss such requirements and provide
small loans at high interest rates, thus providing MFIs the funds they need to continue
operation.

1. Encourage Entrepreneurship and Self-Sufficiency:- Underprivileged people may

have potentially profitable business ideas, but they cannot put them into action because
they lack sufficient capital for start-up costs. Microcredit loans give clients just enough
money to get their idea off the ground so they can begin turning a profit. Theycan
then pay off their micro-loan and continue to gain income from their venture
indefinitely.

2. Empower Women: - Women make up a large proportion of microfinance beneficiaries.

Traditionally, women (especially those in underdeveloped countries) have been unable
to readily participate in economic activity. Microfinance provides women with the
financial backing they need to start business ventures and actively participate in the
economy. It gives them confidence, improves their status and makes them more active
in decision-making, thus encouraging gender equality. According to CGAP, long-
standing MFIs even report a decline in violence towards women since the inception of
microfinance.

3. Community-Wide Benefits: - Generally speaking, microfinance institutions

seek to reduce poverty worldwide. As they obtain funds and services from MFIs,
recipients gain enormous financial benefits which trickle down to others in their
families andcommunities. New business ventures can provide jobs, thereby increasing
income among

12
 community members and improving their overall well-being. Microfinance services
giveshope to people who previously had little or no opportunity to be self-sufficient.

7. Financial Resources of Micro Finance Institutions

7.1 Savings and deposits

Internationally micro saving products, also known as retail deposits, offered by MFIs
serve as a low cost source of funding and are a common practice in countries like the
Philippines, Uganda, Pakistan, Peru and Kenya. Most governments only allow
microfinance banks to offer micro saving products and prohibit other MFIs from raising
deposits. The potential pitfall of these deposit products is that MFIs may fail to provide
instantaneous liquidity. In India, the SHG model is primarily built up on mobilisation of
savings. SHG members borrow funds from banks against these deposits.3

7.2 Individual philanthropic sources and social investors

Non-profit investors, such as individuals interested purely in the social impact of

microfinance, often lend their own money to MFIs through online platforms,
internationally the most famous of which are Kiva and Micro Place. Similarly, high net
worth individuals who are interested in philanthropy often give away great sums of
money to MFIs, in acts known as ‘venture philanthropy’.

Social investors are individuals or institutions (high net worth, foundations,

endowments, and retirement plans) which choose to apply non-financial characteristics
to their investment decision making. These non-financial characteristics are often
related to the investors’ value system or social mission, and may include concern for
environmental protection, social and economic development of the poor, education and
health, as priorities. For example, in India Rang De, an MFI raises money from social
investors. Commercial institutions also participate in such social investment. For
example, Citibankprovides charitable contributions to three local MFIs in Haiti to help
restore the country’s

13
 microfinance industry which has suffered severe challenges in the aftermath of the 2010
earthquake.4

7.3 Soft loans and grants

Concessionary or soft loans (low cost debt) or grants are another source of funds from
socially responsible investors, which include national and regional development banks,
international NGOs, non-profit corporations, charitable trusts, or funds held by donor
and development agencies, such as the Grameen Trust, Swedish International
Development Agency (SIDA), United States Agency for International
Development(USAID), United Nations Capital Development Fund (UNCDF), the Asian
Development Bank (ADB), the World Bank, the Bill and Melinda Gates Foundation,
Ford Foundation, the International Monetary Fund (IMF), ACCION and CARE. Some
development agencies only interact with governments, but their funds can be accessed
either directly or indirectly by MFIs.

7.4 Investment funds

Internationally there are many investment funds that specialise in microfinance and this
proves to be a good source and are also deploying their structuring and fund-
managementskills to offer investment products that appeal to a broad range of investor
risk profiles and social motivations.5

7.5 Microfinance investment vehicles

Microfinance investment vehicles (MIVs) are private entities which act as intermediaries
between investors and microfinance institutions. MIVs may be self- managed, managed
by an investment management firm, or by trustees. They may receive investments
through the issuance of shares, units, bonds or other financial instruments. Depending on
the type of MIV, these investments may then be provided to MFIs as debt, equity, or
guarantees. MIVs make use of different currencies as well, since they are located all
over the world. While some MIVs are primarily profit seeking, others additionally
combine the objective of social impact. This diversity among MIVs makes it possible
for many

14
different types of investors to get involved in the microfinance sector. These have the
capacity to conduct the specialised due diligence and monitoring required for sound
investing in this niche market, and fund investing confers the added benefit of
diversification across many MFIs, countries and currencies. The International
Association of Microfinance Investors (IAMFI) estimates that as of April 2009 there are
104 MIVs with a total of $6.1 billion in assets under management.6

In the Indian context, such potential has not been captured so far. The RBI Report
(2011) suggests that to meet the funding requirements of the sector, a ‘domestic social
capital fund’ may be established. This fund will be targeted towards ‘social investors’
who are willing to accept ‘muted’ returns, say, 10%–12%. This fund could then invest
in MFIs which satisfy social performance norms laid down by the fund and are
measured in accordance with internationally recognised measurement tools.

7.6 Quasi-equity

The World Bank in collaboration with the Small Industries Development Bank of India
(SIDBI) has designed a project to offer MFIs a new kind of quasi-equity product aimed
at strengthening MFI balance sheets. Similarly NABARD is also supporting MFIs with
the Microfinance Development and Equity Fund.

7.7 Non-convertible debentures

In an attempt to create new avenues to raise funds, non-convertible debentures (NCDs)

were issued by MFIs. The country’s first ever NCD issue that was listed on the stock
exchange was by SKS Microfinance. It had raised Rs. 750 million at a coupon rate
of10% in May 2009, which was soon followed by another issue of SKS and Grameen
Koota. MFIs have increasingly tapped the NCD route to create a diversified lender base.

15
 7.8 Bank loans

In the Indian context, commercial banks lend to MFIs and SHGs. Commercial banks in
India have to meet the mandatory requirement of lending 40% of their advances to the
priority sector. Thus banks are a major source of finance to MFIs and their interest rate
is 12–14%. Both short-term loans and long-term debt can be acquired from commercial
banks.

The Small Industries Development Bank of India, an apex financial institution for
promotion, financing and development of small scale industries in India, has launched a
major project – the SIDBI Foundation for Micro Credit (SFMC) – to facilitate the
accelerated and orderly growth of the microfinance sector in India. SFMC is emerging
as the apex wholesaler for microfinance in India providing a complete range of financial
and non-financial services such as loan funds, grant support, equity and institution
building support to the MFIs. SIDBI also provides equity capital to eligible institutions
to meet thecapital adequacy requirements and to raise debt funds. Keeping in tune with
the sectoral requirements, SIDBI has also introduced quasi-equity products viz,
optionally convertible preference share capital, optionally convertible debt and
optionally convertible subordinate debt for new generation MFIs which are
generally in the pre break-evenstage requiring special dispensation for capital support
by way of a mix of Tier I and Tier II capital. The Transformation Loan (TL) product is
envisaged as a quasi-equity type support to partner MFIs that are in the process of
transforming their existing structure into a more formal and regulated set-up for
exclusively handling microfinance operations in a focused manner. Being quasi-equity
in nature, the TL helps MFIs not only in enhancing their equity base but also in
leveraging loan funds and expanding their microcredit operations on a sustainable basis.
The product has the feature of conversion into equity after a specified period of time,
subject to the MFI attaining certain structural, operational and financial benchmarks.
This non-interest bearing support facilitates the young but well performing MFIs in
making long term institutional investments and acts

16
 as a constant incentive to MFIs to transform themselves into formal and regulated
entities.7

7.9 Private equity

The private equity market is an important source of funds for start-ups, private middle-
market companies and firms in financial distress. The huge demand for credit among the
poor has become an attractive investment avenue for private equity and venture capital
investors. These investors normally look for innovative and technology oriented
ventures where a conventional source of funding is difficult. Sequoia Capital India was
the first traditional venture capital (VC) firm to invest in the space with 11.5 million
USD in SKS Microfinance in 2007. The International Finance Corporation (IFC), the
investment arm of the World Bank, has invested 300,000 USD in Utkarsh
Microfinance Private Limited, a microfinance startup providing loans in northern India.
The amounts raised through private equity deals are showing an increasing trend
indicating that microfinance is a highreturn investment avenue. With India being a very
attractive market in this field, many private equity firms have started investing here.

7.8 Equity from capital market sources

MFIs have also started accessing resources through the capital market. Internationally a
few microfinance institutions such as Bank Rakyat at Indonesia (BRI), BRAC Bank in
Bangladesh, Banco Compartamos in Mexico and Equity Bank in Kenya have raised
equity capital through public issue. The four institutions are well known throughout the
microfinance industry for their exceptional growth, robust financial performance and
ability to expand their outreach to the working poor. They are now listed on
nationalstock exchanges and, in two cases, have sold internationally 8. The initial public
offerings (IPOs) and listings have allowed the four institutions to tap into the
mainstream investor community and take advantage of myriad new opportunities. This
has also signalled to capital markets that the microfinance sector is a potential source of
profitable investment.

17
 Raising capital through public issue has increased liquidity for investors by creating
opportunities for equity investors to exit, especially those who contribute as private
equity and seed capital. This has made microfinance an attractive investment avenue for
private investors.

In the Indian context, the SKS IPO is a milestone event. The Hyderabad based SKS
Microfinance floated its first public offering of equity and mobilised 358 million USD,
priced at 1.6 billion USD. The shares which were oversubscribed 13.7 times
(primarily by institutional investment interest) fixed the price per share at Rs 985
reflecting a valuation of 98 times the face value of shares. Overall, the valuation
accorded a book value to market value ratio of six times. Microfinance has got the
attention of the capital market and around six other MFIs are aspiring to enter the equity
market with their own share floats.

7.9 Assignment and securitisation

The rapid growth in the microfinance sector, especially of NBFC-MFIs has led to the
search for innovative financial sources to meet the financial requirements of the sector.
The need for securitisation is common to all financial intermediaries, but when it comes
to microfinance, the growing asset size (which is the very essence of microfinance
economics) puts pressure on the balance sheet. Hence, off-balance sheet methods of
funding, or any devices other than plain balance sheet borrowing are needed to sustain
the growth rate.9

Three forms of structured financial products have gained significance; these are:
bilateral loan assignments, securitisation and collateralised debt obligations (CDOs).

In the case of assignment, the loan pool receivables are directly assigned to the assignee
or the purchaser, usually a bank. These deals are also rated but no specific instrument
likepass-through certificate (PTC) is issued. Banks often prefer this route as the loans
need

18
 not be marked-to-market (as they are on the banking books), whereas the securities
against those loan pools (as in the case of securitisation), if issued by the same seller will
have to be marked-to-market (as they are securities and hence will be on the bank’s
trading books). Besides this, banks will be able to pick and choose the loans that qualify
for priority sector lending norms, and hence such transactions fit exactly into their
objective. So, banks usually go in for bilateral assignment during the fag-end of the
financial year, based on their requirement for such loan pools. Further, most banks also
offer competitive rates if they are keen to have such loans on their books. Securitisation
typically involves the conversion of assets which have predictable future cash flows (for
example, a pool of microloans) into standardised, tradable securities. The securitisation
process allows MFIs to pool the receivables from loans and sell the same to third parties
like banks, mutual funds and insurance companies. This is an opportunity for MFIs to
increase their funding sources.

The primary objective of securitisation is to obtain financing for a company’s ongoing

business needs. A properly structured financial asset securitisation also can permit a
company to obtain a lower cost of financing compared to secured or even unsecured
debt.Securitisation allows the originator to remove the asset and all corresponding risks
associated with it completely from its balance sheet. It also reduces the need to hold
capital against the asset. The broad structure of transactions (as in the case of
securitisation) – including bankruptcy remoteness, limited recourse to originator,
performance of servicing function by the originator, and permissible commingling of
pool collections with servicer’s own funds – are common to both assignment and
securitisation.

8 Challenges faced by the Microfinance Institutions in Obtaining the

Funds
One of the main economic issue which exist in every developing country is poverty.
One of the main reasons behind the problem poverty is income distribution. In India also
income distribution is very uneven which leads to increase in poverty with every passing
day. Despite of significant progress made by the service and manufacturing sector,

19
the agricultural sector still plays a very important role in the Indian economy. 50% of
the Indian population depend on agriculture and allied activities and approximately 69%
of India’s population is in rural areas. 10 Microfinance majorly focuses on financial
inclusion of this sector of the Indian society as people falling under this sector are
comparatively more backward and poorer. The initiative of NABARD in linking the
traditional banking system with the Self- Help Groups has helped micro finance
institutions in achieving its goals. But still there are many challenges faced by these
institutions. They face challenges with regard to structural, operational and financial
processes.

20
Major challenges faced by Indian microfinance industry

The people who take help of these institutions generally belong to the marginalized
section of the society hence over-indebtedness, high interest rates, and excessive
dependence on the banking system, illiteracy and lack of awareness about the products.

8.1 Over-indebtedness due to multiple borrowings and inefficient risk management

Microfinance institutions (MFI) provide financial services to the poorer section of the
society in order to improve their standard of living. Therefore over-indebtedness is
major issue. Lack of risk management framework and multiple borrowings by most
clients led to micro-finance crisis in India in 2008. In some cases, it has been seen that
there is no apex control over the MFIs’ is also a reason. This sector gives loans without
collateral which increases securiy the risk of bad debts. Moreover the fast paced growth
of the sector has not been met with proper infrastructure planning. This kind of problems
has been reported in states like Andhra Pradesh, Karnataka, and Madhya Pradesh. Over
indebtedness is a cause of concern for MFIs’ as it negatively affects their portfolio. It
also makes them vulnerable to credit risk and increases the cost of monitoring11.

21
 8.2 High rates of interest as compared to mainstream banks

MFIs’ when compared to commercial banks do not enjoy the same rate of financial
success. One of the reason is that while banking system is centuries old, micro finance is
only a few decades old in India12. MFIs’ charge a very high rate of interest (12-30%) as
compared to commercial banks (8-12%). Recently, the RBI (India’s regulatory bank)
announced the removal of upper limit of 26% interest on MFI loans (ET, 2014). This
has benefited the industry’s players but left the customers in a worse situation than
before. Due to the issues of over-indebtedness caused by the charging of high interest
rate, rateof suicide of farmers increased in states like Andhra Pradesh and Maharashtra.

8.3 Over-dependence on banking system for funding

Majority of the MFIs’ in India are registered as Non- Governmental Organizations

(NGOs). They are dependent on financial institutions such as commercial banks for
stabilised funding for their own lending activities. Around 80% of their funds come
from banks. Most of these are private banks which charge a high rate of interest and also
the term of loans is of shorter period. Most of the times, banks lend to micro lending
firms in order to meet their so-called priority sector loan targets. The over dependence
of Indian microfinance industry on banks make them incompetent and less reactive
towards dealingwith default and delinquencies.

8.4 Lack of awareness of financial services

Like all other developing and underdeveloped countries, the literacy rate in India is very
low and the rate is much lower in the rural areas. Nearly 76% of India’s adult population
does not understand basic financial concepts. Lack of awareness of financial services
provided by the Indian microfinance industry is a challenge for both, customer
and MFIs’. This factor not only causes hindrance for villagers to join hands with MFIs’
to

22
meet their financial needs but also makes them financially excluded. MFIs’ are
facedwith the task of educating the people and establish trust before selling their
product. Micro finance institutions struggle to make their business more financially
viable due to this lack of awareness.

8.5 Regulatory issues

Presently the Reserve Bank of India (RBI) is the regulatory body for the microfinance
industry in India. However it has traditionally catered to commercial and traditional
banks rather than MFIs’. Moreover the needs and the anatomy of micro finance
industryis supremely different from that of banks. In the past the industry has undergone
sporadic and unprecedented regulatory changes. Some of these have benefited the
industry greatly, but a lot of issues were unaddressed, like creating barriers for entry to
restrict unworthy players. Not only has it led to constant structural and operational
changes but also createdambiguity in norms of conduct. Therefore there is a need for a
separate regulatoryauthority for this industry. Regulatory issues have led to sub-optimal
performance and failure in the development of new financial products and services
through which the poorer section can be benefitted.

8.6 Problem in identification of appropriate model

In India, most of the MFIs’ follow Self-Help Group model (SHG model) or Joint
Liability Group model (JLG model). The problem is that most of the time, selection of
model are not scientific in nature. The models are selected randomly, not according to
thesituation and also the decision of selection is irreversible in nature. So, it affects the
sustainability of the organisation in the long-run and also increases the risk of
borrowings for the poorer section beyond they can bear. This is also one of the main
reasons of crisis of microlending in the state of Andhra Pradesh. It has been repeatedly
stressed that the industry needs to undergo business process reengineering to effectively
reach out to the under-financed.13
5.4.6 .Problems faced because of covid 19

The pandemic and its multi-pronged effects are no more a secret topic for any country
around the globe. This article focuses on COVID-19 effect on microfinance sector in
23
India.

24
Medical experts brought in an effective solution to contain this pandemic; that is voluntary
Social Distancing further leading to complete Lock Down where situation is beyond self-
discipline. Microfinance sector also got hit by this pandemic and is facing another big crisis
after 2010 AP amendment bill and 2016’s demonetisation. Small and micro loans serve
large segment of population running small and micro enterprises mostly in unorganised
livelihood domains. These financial institutions play a key role between commercial
lending institutions ready to take moderate risk for better returns and clients who are in
need of non- collateralised loans to finance their livelihood activity.

Latest report published by MFIN, shows that as on the sector caters 3.22 crore clients with
gross loan portfolio of Rs. 74,371 crore. This converts to average loan amount of Rs 22,000
plus for all active accounts, which shows 6% YoY increase. The sector holds a strong
position, when it comes to return on investment in monetary and social returns. The amount
of money deployed in this industry reaches out huge number of customers, with sustainable
and traceable livelihood options and making it more impactful for social scientists and for
financial investors. The reports also mention that the industry received Rs. 42,140 crore as
debt and Rs. 16,140 crore as equity which is 33% higher (respectively under both
categories) than previous year, showing increase in demand of loans and increase in trust
from lenders. Microfinance industry works on a crude principle of ‘Close Contact, Trust
and Financing Sustainable Livelihoods’. On one hand it fuels micro and small enterprises;
while on other hand generates employment opportunities in unorganized and organized
sector. It is estimated that even during pandemic this sector employs more than 2 lakh
individuals working at field level, organizing virtual meeting with clients and resolving their
queries related to business sustainability, finances, convergence of government support and
even personal health management related to COVID-19. Other than internal employment,
the sector gives employment and entrepreneurial opportunity to almost all those who take
loan
i.e. 3.22 crore individuals. In other words each income generating loan given is for changing
the life of all family members, an average of five.

Complete lockdown brought halt to almost every business, but worst affected were those

25
with small or no reserves and operate in high liquid model. Most micro and small
businesses

26
are impacted except the ones engaged in activities coming under essential goods and
services as announced by government from time to time.

Diminishing earning capacity of MFI clients is now becoming threat to MFI existence,
although government is trying to smooth out its operations through rescheduling of loans.
MFIs have their own debt obligations and liquidity needs; post pandemic scenario is
certainly going to put pressure on sector with surge in demand for more income generating
loans and more gestation period. The scenario is building for new mergers and acquisition
in the sector with lots of financial restructuring.

Affected cash flows of business enterprises in turn affected their microfinance service
providers and hence the commercial banks at higher level. Unemployment in unorganised
sector surpassed all levels till date, affecting migrants in big cities, enterprise owners in
cities and towns, rural entrepreneurs and semi/skilled labour all across the MSME
ecosystem. Microfinance providers are expected to face serious liquidity crunch during
COVID-19, gap between revenue and operational expenditures are increasing with
depleting reserves. This shrinking liquidity may not create problem for large MFIs or those
with strong stable backup, but is sufficient to haunt small and mid size MFIs. MFIs with
stable financing, well-established technology platforms and strong hold on communities
have higher probability to survive during and after this pandemic. Criticality of
microfinance operations is not limited to this sector only; slowly it will start effecting large
financiers of these MFIs including commercial banks (private and public), donors and
investors.

Reserve Bank of India, being a regulator of financial sector announced various steps to limit
macro effect of pandemic on overall financial system of country, including increase of
moratorium period for loans, part rebate of interest rate, special package etc; but most of
these announcements from RBI are focussed on commercial banks and remained vague for
MFIs and its customers in particular.

27
9 The Role of Government in Boosting Micro Finance Institutions
After 1990, India economy has become an open economy and thereby it has attracted
many foreign investors and global corporations to invest in India. All this have made
India as a hub of investment and have put Indian economy at the forefront of world trade
and industry. But even after such transformation in the economy, many people are still
unaffected because of these changes and are still living in poverty. Thus, the idea behind
Microfinance is to provide financial services to the low-income proletariat who
traditionally lack access to banking and other monetary services.

During the last two decades, substantial work has been done in developing and
experimenting with different concepts and approaches to reach financial services to the
poor, by the Government, Non-Governmental Organisations (NGOs) and banking
institutions in various parts of the country.

Microfinance refers to small scale financial services, both credit & savings, that are
extended to the poor in both rural and urban areas. It refers to economic services which
mitigate vulnerability to economic shocks, promotes savings and supports self-
empowerment. Microfinance encompasses a variety of financial instruments. The only
common factor amongst the available services is the low amount of capital
involved. Most Microfinance programs provide multiple services like lending, savings,
life insurance, crop insurance etc.

Such financial services are important for the uplift of the economically weak sections of
the society who are not able to avail financial services from the traditional sector.
Thelack of access to credit for the poor can be attributed to practical difficulties arising
from the discrepancy between the mode of operation followed by financial institutions
and the economic characteristics and financing needs of low-income households.
Microfinance based credit delivery mechanism ensures viable financial services to
address issues like actualizing equitable gains from development activities on a
sustained basis, and plays a vital role in fighting

28
 NABARD has taken the lead in promoting microfinance in India. Its Self Help Group-
External website that opens in a new window (SHG) model has created opportunities for
commercial banks to lend to the poor. It has been encouraging voluntary agencies,
bankers, socially spirited individuals, other formal and informal entities and also
government functionaries to promote and nurture SHGs & Microfinance Institutions
(MFIs)).

Due to the Government's active promotion & special schemes, Commercial banks have
actively started lending capital to SHGs & MFIs, which then further lend to their
members overcoming the information asymmetries that the bank would normally have
faced. Thus engaging a dormant source of financing for the needy, as in lending to the
poor, banks face high risks and transaction costs, while the lack of borrower information
and of collateral make it unattractive for the formal financial sector to lend to the very
poor.

9.1 Dominant Models of Microfinance in India

1. SHG-Bank Linkage Model: This model involves Self Help Groups (SHGs) which
are financed directly by the Commercial Banks (Public Sector and Private Sector),
Regional Rural Banks (RRBs) or Co-operative Banks.

Microfinance programmes focus on organisation at the grassroots level through a

process of social mobilisation that enables the poor to build Self Help Groups (SHGs)
amongst themselves, consisting of 10-20 persons. They participate fully and directly and
take decisions independently in such organisations.

These groups are formed, developed and strengthened to evolve into self-managed
people's organisations which provide internal loans to its members from the group
corpus. The group corpus is supplemented with Revolving Fund sanctioned as cash
creditlimit by the banks.

2. MFI-Bank Linkage Model: This model covers financing of Micro finance

Institutions (MFIs) by banking agencies for on-lending to SHGs and other small
borrowers covered under microfinance sector.
29
MFIs combine flexibility, sensitivity and responsiveness of the informal credit system
with technical & administrative capabilities and financial resources of the formal
financial sector which rely heavily on collective strength and closeness of social groups
for effective social mobilisation to enable financial empowerment.

MFIs have adapted themselves to circle around the shortcomings of traditional financial
organisations, by forming a partnership between socially focussed NGOs, which invest
in human and social capital at the grass roots, and economically sensitive banking
institutions, experienced in mobilising funds for graduating and enabling rural
communities.

MFIs enable commercial banks to overcome the formal requirements of paper-work to

support transaction costs, information asymmetries and risk, making lending to the poor
a commercially attractive proposition. The role of the MFIs therefore is to act as the
guarantor to the bank, to support the credit worthiness of the poor.

3. Grameen Model- Grameen Model was pioneered by DR Mohammed Yunus of

Grameen Bank of Bangladesh. It is perhaps the most well-known and widely practiced
model in the world. In Grameen Model the groups are formed voluntarily consisting of
five borrowers each. The lending is made first to two, then to the next two and then to
the fifth. These groups of five meet together weekly, with seven other groups, so that
bank staff meets with forty clients at a time. While the loans are made to the individuals,
all in the group are held responsible for loan repayment. According to the rules, if one
member ever defaults, all in the group are denied subsequent loans.

4. Co-operative model: A co-operative is an organization owned by the members who

use its services. This model works on the principle that every community has enough
human and financial resources to manage their own financial institutions. The members
who own it are the members who use its services and can comefrom different sections of
same community like agriculture, retail etc. Example is Sahavikasa or Co- operative
Development Foundation (CDF). It helps in assisting rural women and men

30
in the areas of operation in forming and developing self-sustainable

31
 co-operatives. It also provides education and training to the co-operators from its work
area.

9.2 SUPPORT IN THE FORMAL SECTOR

Microfinance institutions are a big stake holders in the Indian economy hence they are
need to be encouraged by the Government. Further the microfinance institutions
provides loans on fair terms and without collateral hence it is preferred by the people
belonging to the low income group as it frees them from the vicious cycle of debt in
which they get trapped because of the informal lending (especially moneylenders),
microfinance also need support and encouragement from the Government as it requires
less documentation Than the commercial banks and are also easily asseccible.1

1. NABARD- NABARD is a development bank which facilitates credit flow for

promotion and development of agriculture, small-scale industries, cottage and village
industries, handicrafts and other rural crafts. Its Financial Inclusion Department (FID) is
the nodal agency which oversees the Financial Inclusion Fund (FIF) and Financial
Inclusion Technology Fund (FITF) which promote microfinance initiatives.

2. Rashtriya Mahila Kosh- The National Credit Fund for Women or the Rashtriya
Mahila Kosh (RMK) has a large number of grant and subsidy based poverty alleviation
programs comprising micro-credit & micro-savings schemes with a focus on poor
womenacross the country. RMK takes active initiatives in channelising funds, market
development social advocacy.

3. Small Industries Development Bank of India (SIDBI) - SIDBI's Foundation for

Micro Credit is the apex wholesaler for micro finance in India. It provides a range of
financial and non-financial services such as loan funds, grant support, equity and
institution building support to the retailing Micro Finance Institutions (MFIs) including
two-tier MFIs so as to facilitate their development into financially sustainable entities,
besides developing a network of service providers for the sector.

32
6.2.3 Tamil Nadu Womens' Development Corporation- The Tamil Nadu Corporation
for Development of Women, in partnership with Non- Governmental Organizations
(NGOs) and Community based organizations, supports 'Mahalir Thittam' or Self Help
Groups (SHGs) which inculcate sound habits of thrift, savings and banking amongst the
volunteer members of the scheme.

4. National Handicapped Finance and Development Corporation (NHFDC) 2 – It

has been set up to promote economic and development activities undertaken by Persons
with Disabilities. The Corporation assists them by providing loans for self-employment
and other economic ventures. The majority of disabled population is constantly in need
of small loans for sustaining their existing employment, for generation of further
employment as also for meeting varied personal and social needs. The poorest among
the poor need loans of very small amount but their requirement is quick delivery of loan
at their doorsteps. Traditionally, private money lenders have been playing this role but
their intention has been to exploit the poor instead of helping them and this rather
worsened plight of the poor. Over a period of time, the significance of provision of
credit as an instrument of socio-economic change and development is being realised and
many international and national organisations including the nationalised banks have
come up to provide soft loans to the poor in order to free them from the clutches of
private money lenders. However, the task is gigantic and a wide gap persists in meeting
the credit needs of the poor.

9.3 The Andhra Pradesh Microfinance Institutions (Regulation of Money lending) Act,
2010.

The Andhra Pradesh legislative assembly cleared the bill to regulate microfinance
institutions (MFIs) in the state. The bill replaces an ordinance issued in October
following 54 suicide deaths allegedly due to coercive methods of loan recovery by
MFIs.3

The bill mandates MFIs to be registered with the district authority to collect installments
at the panchayat office and restricts fresh lending without prior approval of the
authority.
33
The bill does not cap the interest rate charged by MFIs as demanded by civil society
groups and politicians. MFI representatives had lobbied against any attempt to put a
ceiling on the interest rate. “This is a respite for MFIs,” said Vijay Mahajan, president of
Microfinance Institutions Network, a self-appointed regulatory body.

The respite might be short-lived. A few days before the bill was passed, the state
government recommended the Reserve Bank of India’s (RBI) Y H Malegam Committee
—set up to look into regulations for MFIs—to cap the interest rate. In its report, the
government suggested 8 per cent interest rate for all MFIs while giving the state
government power to supervise its implementation. This is about onethird of the current
interest rate charged by MFIs.

It also asked the RBI to debar MFIs from accessing capital market. This would block
two major MFIs that have proposed entry into capital market with an objective of
mobilising
`2,000 crore in six months. MFIs allege the state government is pushing the regulations
to gain a foothold in microfinace business. Since the state lends microfinance through
self- help groups, the bill aims to keep the groups out of MFI’s influence.

9.4 Role of Reserve Bank India

The central bank has to perform a wide range of promotional functions to support
national objectives and industries. One of the promotional function is microfinance.
Microfinance is touted as the big thing that can alleviate rural poverty.

The Reserve Bank of India (RBI) and National Bank for Agriculture and Rural
Development (NABARD) define micro-finance as Provision of thrift, credit and other
financial services and products of very small amounts to the poor in rural, semi-urban or
urban areas for enabling them to raise their income levels and in improving living
standards.4
Inclusive growth always received special emphasis in the Indian policy making.
Government of India and the Reserve Bank of India have taken several initiatives to
expand access to financial systems to the poor. Some of the salient measures are
nationalization of banks, prescription of priority sector lending, differential interest rate
schemes for the weaker sections, development of credit institutions such as Regional
Rural Banks, etc.

RBI norms for self-regulatory organisations of NBFCs engaged in micro-finance aids

the process of improved governance and grievance redressal within a well-defined
framework. The guidelines lead to creation of a layered regulatory framework which
would make for a good balance between core regulatory drivers and developmental
needs of the industry. The guidelines would substantially aid the process of improved
governance and grievance redressal, within a well-defined framework5.

9.5 CHALLENGES FACED

Microfinance was first introduced in India in the 1970s. Forty years on, the phenomenal
growth rate of the microfinance sector in the country has brought in funds from socially
motivated donors and investors, both foreign and domestic.

But cost of capital has been considerable, prompting lenders to charge high interest rates
as the average number of loans with borrowers of very small capital has increased across
the country. Large numbers of very small loans demand high rates, and artificially
lowering rates can desensitize MFIs from expanding their reach to the very poor.

The high growth of the industry has meant MFIs have, at times, ignored due
diligenceand have not taken measures to limit multiple lending. The rapid growth in the
for-profit MFI industry, which is still at a nascent stage, has raised several questions on
both corporate governance issues as well as the viability of the business model.
The fact that the client base of MFIs is the most vulnerable sections of society makes
them a target of political activism and regulatory intervention as well, especially
because the high profit growth of these firms is often seen to be at the expense of the
poor.

Although many of the Indian Non-profit organizations (NGOs) which have extended
themselves and set up their own in-house microfinance units, find themselves flailing,
financially. Some of those can be attributed to lack of expertise in the sector, but the
primary reason is suspected to be NGOs' alignment towards public service commitment
which makes it difficult for them to transition into profit based microfinance sector. The
ability to re-gain borrowed capital is necessary for sustainability of the organisations.

The Government has initiated a number of Innovative Pilot projects to address these new
challenges and improve the outreach and sustainability of the MFIs. It has also been
promoting the need for self-regulation by MFIs & NGOs, as over-regulation at a time
when the entire sector is at a budding stage of growth, could throttle the growth
potentialsof the SHGs.
10 Commercial Banks and Microfinance Institutions

10.1 The need for commercial banks:

Commercial banks provide a wide range of service which majorly includes accepting
deposits and giving loans to individuals and businesses. Commercial banks also help
microfinance institutions in in several ways, ranging from indirect involvement while
raising the capital to direct interaction with borrowers. Commercial banks have
realized the growth potential, which can be achieved through microfinance, apart
from the social needs and they are well suited to play a role in microfinance for the
following reasons.1 First of all, they are regulated and supervised. Indeed, the sources of
capital that are obtained reside in an entity independent from the MFI. This is a very
important factor that guarantees the flow of funds to microfinance as it installs trust in
donors. Indeed, one of the problems encountered by microfinance institutions is the lack
of a systematic control of these organizations. There are very few credit-rating agencies
supervising these institutions leading, to difficulties in the procurement of capital. (This
problem will be discussed further in part III, which deals with the barriers to
microfinance).

The second reason why commercial banks are more suited to provide microfinance
concerns the nature of their ownership. In this respect, under a private status, the owner
would want to make profit and therefore systematically seek success in their projects.
The financial institutions would therefore be strongly committed to the achievement of
certaingoals, such as financial viability.

Thirdly, banks can offer a wider range of financial services to the poor, a trend that can
already be observed in the goal of MFIs today. Another reason concerns the volume of
capital they are able to attain. Commercial banks have a wide network for getting funds
 and can consequently increase the loan numbers offered or the size. Furthermore,
through their branches, they can facilitate the access to their services through more
efficient transactions and thus allow a better supervision of loans and projects. From the
perspective of the bank, microfinance appears as an advantage primarily as a means to
diversify their capital. However, the most important reward for the bank is the creation
of mainstream bank customers in a few generations: banks can increase profits by
catering to a larger number of clients around the world. Finally, another advantage for a
bank involved in microfinance is the reinforcement of its public image: engaging in the
alleviation of poverty will build more trust for the bank in the formal financial sector.

10.2 ROLE OF COMMERCIAL BANKS IN MICROFINANCE

Commercial banks can engage in microfinance in many different ways, ranging from
direct relations with borrowers to a more indirect participation through the raising of
capital. Commercial banks play vital role in microfinance through following ways2-

1. Direct Lending: Commercial banks can lend to entrepreneurs directly. This sort of
participation of commercial banks are entirely targeted to serve the microfinance
sector. The pioneer in this field is the Grameen Bank founded by Muhammad Yunus in
1976, with the sole goal of helping the impoverished through the provision of small
loans to a group of borrowers. Group lending includes providing a loan to every
borrower of the group. However, new loans are not approved to borrowers if any
borrower defaults his existing loan. The process of group lending entails an
accountability on borrowers to repay their loan in more discipline way.

2. Partnership with Microfinance Institution: Commercial banks create partnershipwith

microfinance institutions. Banks lend to MIs in the form of retail and wholesale
banking. However, MFIs are involved in collection, monitoring and origination of loan.
MFIs enjoy lots of benefits by doing tie up with banks. As the higher amount of capital
can increase the size of the loan, banks have greater reach through their geographical
expansion. Furthermore, the bank’s personnel can also provide mentoring to MFIs in terms of
improving the operational efficiencies of the organization and making it aware of standardized
international practices in the world of finances if the bank has reached such a standard. One
such example is the case of ICICI Bank in India which is working in partnership with
microfinance institutions.
3. Microfinance Subsidiary: Banks can also choose their microfinance operations through
the creation of a new subsidiaries. Such kind of branches assist banks in mitigating the
risk levels involved while lending to the poor. From the borrower’s perspective,
specialized microfinance services provided by banks may create higher trust among
borrowers and shows the commitment of bank in poverty reduction.

4. Securitization: Last but not the least, commercial banks play vital
role in microfinance by raising funds in international as well as domestic market for
the several lending operations of MFIs.

10.3 COMPARATIVE ADVANTAGES OF COMMERCIAL BANKS IN

MICROFINANCE

At first glance, banks appear well positioned to offer financial services to ever-
increasing numbers of microfinance clients and to earn a profit. Banks have
several advantages over nonbank, microfinance institutions:

• They are regulated institutions fulfilling the conditions of ownership, financial

disclosure, and capital adequacy that help ensure prudent management.

• Many have physical infrastructure, including a large network of branches, from

which to expand and reach out to a substantial number of microfinance clients.

• They have well-established internal controls and administrative and accounting

systems to keep track of a large number of transactions.
• Their ownership structures of private capital tend to encourage sound
governance structures, cost-effectiveness, and profitability, all of which lead to
sustainability.

• Because they have their own sources of funds (deposits and equity capital), they do not
have to depend on scarce and volatile donor resources sd microfinance institutions
do.

• They offer loans, deposits, and other financial products that are, in principle,
attractive to a microfinance clientele. All of these advantages could give banks a
special edge over microfinance institution in providing microfinance services.

10.4 OBSTACLES FOR COMMERCIAL BANKS IN HELPING

MICROFINANCE

Banks lack, however, some key ingredients -most of all, the financial methodologies
to reach a low-income population. They also face many internal constraints that must
be overcome before they can produce a large, successful microfinance program. Our
study of banks in microfinance identified at least six key related issues banks need
to resolve to enter the microfinance market successfully3:

1. Commitment: the commitment of commercial banks (particularly

the larger banks) to microenterprise lending is often fragile, and generally
dependent on one or two visionary board members rather than based solidly in its
institutional mission.

2. Organizational structure: Microfinance programs need to be inserted into

the larger bank structure in such a way that they have relative independence and,
at the same time, have the scale to handle thousands of small transactions
efficiently.
3. Financial methodology: Banks need to acquire an appropriate financial methodology
to service the microenterprise sector —financial innovations that permit a cost-
effective analysis of creditworthiness, the monitoring of a large number of relatively
poor clients, and the adoption of effective collateral substitutes.

4. Human resources: Given that microfinance programs differ so radically

from traditional banking, banks must recruit and retain specialized staff to
manage these programs. Issues of recruitment, training, and performance-related
incentives require special consideration.

5. Cost-effectiveness: Microfinance programs are costly because of the small

size of their loans and because banks cannot operate them with their traditional
mechanisms and overhead structures. Strategies must be found to minimize processing
costs, increase staff productivity, and rapidly expand the scale of their
microenterprise portfolios —that is, increase the number of loans. Banks must
cover the costs of microfinance operations and specialized training through scale
economies.

6. Regulation and supervision: Banks must communicate with banking authorities

to ensure that reporting and regulatory requirements take into account the specialized
nature of microfinance programs.
 11 Micro Finance Institutions and Micro, Small and Medium
Enterprises
11.1 Definitions of Micro, Small & Medium Enterprises

In accordance with the provision of Micro, Small & Medium Enterprises Development
(MSMED) Act, 2006 the Micro, Small and Medium Enterprises (MSME) are classified
in two Classes: (a) Manufacturing Enterprises – The enterprises engaged in the
manufacture or production of goods pertaining to any industry specified in the first
schedule to the industries (Development and regulation) Act, 1951 or employing plant
and machinery in the process of value addition to the final product having a distinct
name or character or use. The Manufacturing Enterprises are defined in terms of
investment in Plant & Machinery. (b) Service Enterprises – The enterprises engaged in
providing or renderingof services and are defined in terms of investment in equipment.1

11.2 Need for Micro Finance in the Development of Small Enterprise

The major barrier to the development of Micro and Small Enterprises is access to credit.
The micro and small enterprises need to be financed differently and the financing is
determined by whether the firm is in the start-up phase or existing one and also whether
itis stable, unstable, or growing. Stable survivors are those who benefit in having access
to the financial services provided by MFIs to meet up with their production and
consumption needs. Unstable survivors are groups that are considered not credit worthy
for financial services to be provided in a sustainable way and growth enterprises are
Micro and Small Enterprises with high possibility to grow. In identifying the market,
MFIs consider whether to focus on already existing entrepreneurs or on potential
entrepreneurs seeking for funds to start up a business venture. Working capital is the
main hindrance in the development of already existing SMEs and to meet up this
problem they borrow finance mostly from informal financial services which have
high interest
rates and services offered by the formal sector or not offered by these informal financial
services.

Small and medium enterprises (SMEs) plays a major role in economic development
through creating employment, eradicating poverty and generating income. On the other
hand, Microfinance is an important tool that promotes the business development and
acts as a source of business growth through improving working capital. One of the
primary reason for the expansion of small business into medium and further to large is
due to microfinance. Microfinance is a financial resource for low-income individuals
and small medium enterprises for supplying loans, savings and other financial services
to poor. In India microfinance operates through two channels:

a) Self-help group bank linkage program: where a small group of 10-20 women or
men make small savings through contribution periodically and begin lending. They even
get linked to banks, banks lend to self-help group after checking their creditworthiness.

b) Microfinance institutions: which is an organization that provides microfinance

servicesfrom small non-profit organization to larger banks.

Access to finance is the major problem faced by micro-enterprises, to whom

commercial banks have traditionally concentrated their lending mainly to large formal
enterprises which have the expertise of doing business and possess collateral. They miss
out small enterprises as they lack expertise and riskier investment. Thus it is observed
that lack of proper access to finance as one of the factors hindering the SMEs growth.
So to facilitate financing the policies of microfinance institutions have been framed.

Microfinance institution emerged as a noble substitute for informal credit and an

effective instrument for providing funds, financial help for the growth of SME’s. Easy
accessibility of services offered by microfinance institutions has a direct impact on
the sales, profitand physical assets development of SME’s.
The key issue in agriculture and rural development during the 1960s and 1970s was
agricultural production2. Later on agricultural credit became an important input along
with improved seeds, fertilizers, pesticides, tools and machines and with the growing
population increasing numbers of rural people could not live on agriculture alone. To
survive they had to engage in numerous activities: on-farm, off-farm and non-farm.
Rural households and rural economies got increasingly diversified. Access to finance
was the limiting factor. Agricultural credit had been exclusive to farmers only.
Therefore many micro-entrepreneurs, traders and household business units were
unsatisfied so the need ofmicrofinance increased3.

In the present phase of microfinance processes, sustainability of Micro-Enterprises has

become very important. But there are many problems faced by Micro-Enterprises
like low profit margin, repayment of loan, infrastructure problems etc. The SHG bank
linkage4, in spite of the optimism generated by the expansion of SHG credit and the high
recovery rate there is a gap between actual per capita credit provided to the poor and the
demand. By 2008 there were 54 million microfinance customers in India, of these; 39.9
million customers were served by the SHG model while 14.1 million were served by the
MFI model. While the SHG model accounted for 77% of the total outreach, its growth
rate of 15% in 20007-08, was lower than that of the MFI model which grew by 40%. By
March 2009 it is estimated that the total outreach of the sector had grown to 86.2 million
with total loans outstanding of Rs.351 billion 5. This amounts to only around 6% of the
total credit outstanding of commercial banks in rural and semi-urban areas in
2008.Thusit can be suggested that there is still a lot of scope for the sector to grow.

Lack of access to finance can be identified as one of the major constraints hindering the
development of small businesses not just in India but in other developing countries also.
Commercial banks have traditionally concentrated their lending mainly to large formal
enterprises which have expertise of doing business and possess collateral and not
on
 small enterprises as they lack expertise and are riskier investment. Despite the
potentialof SMEs to facilitate economic growth, many studies have highlighted lack of
access to finance as a major problem which hinders the growth of SMEs.

11.3 Ways in which Microfinance helps in Achieving the goal of development

Rural economy forms the backbone of most developing countries. Lack of infrastructure
is one of the problems which this sector faces along with shortage of finances.
Microfinance institutions often provides help with regard to finance and
infrastructureand thereby helps in poverty eradication and also helps in the growth of the
economy.

Small and medium enterprises (SMEs) have long been one of the more chief sources of
employment and livelihood for the citizens in most developing countries, including
India. On the other hand, microfinance is crucial, when it comes to escalation of
business growth by way of generating steady working capital. So much so, that
microfinance has been solely instrumental in catapulting many small businesses to the
next league of augmented productivity and increased turnover. Listed below are some
ways in which microfinance institutions can help fund SMEs based out of developing
nations:

1. By providing easier access to credit facilities: - Microfinance institutions

serve as primary credit and lending facilities for both low-income individuals and small
and medium enterprises that fall shy of accessing easy loans from the organized
financial sectors.

Moreover, most of these institutions provide micro loans and other financial services
that attach affordable rates of interest and entail simpler procedures and minimal
documentation. Here, the financial performance of SMEs, among other factors, depends
on the ease with which they can avail loans from institutions of microfinance, essentially
indicative of a symbiosis.

2. By implementing inclusive policies: - SMEs often hire unskilled and semi-

skilled labourers - many of whom belong to the economically deprived and
marginalized categories - to carry out their routine operations. Microfinance lenders
collectively target aspirations of these sections of people, thereby developing business models
aimed at allaying poverty and improving their standard of living.
3. By aiding business expansion: - Probably the most significant function of
microfinancers is offering SMEs a blueprint for business expansion and assistance to
expand their operational footprint beyond the traditional strongholds. This primarily
happens by way of aid to SMEs to increase the number of outlets, access more
uncharted business areas and eventually become formidable contenders in the market.

Moreover, a group of people, sharing common aspirations and interests, can avail credit
facilities from microfinancing houses. What happens here is that should one of the
participants default at the time of repayment, there is usually a chance that the share
would be distributed and shouldered by the other members of the group.

This way, microfinancers usually find it relatively easier to recover their loans;
something that leads them to lend further, thereby allowing SMEs to utilize the funds, up
their productivity and increase profits in the process.

Microfinance institutes tend to enjoy better credibility: - You might attribute it to the
cooperative attitude of microfinancers, but SMEs have a tendency to trust microfinance
houses more. Another reason behind this might be customized financial products that
are in tune with the exact demands of SMEs and the nature of their businesses.

Developing nations have, beyond much doubt, embraced the concept of microfinance
loans and microfinance institutions, and it is no surprise that these micro lending houses
have come to be the lifeline of SMEs based out of these countries. It is with the
help of micro loans, that many deprived sections of the society have been able to
integrate with the mainstream.6
 CHAPTER II
REASEARCH METHODOLGY

1. Methodology

Research Methodology deals with the procedure adopted to carry out the study. “A
research design is the specification of methods and procedures acquiring the
information needed. It is an overall operational pattern or framework of the project that
stipulates which information should be collected from which sources by what
procedures.” For conducting the project, both primary and secondary methods of data
collection have been adopted.

Researcher has applied doctrinal method of research while conducting this research.
This Research is based on the secondary data which includes books, journals, articles,
internet sources, etc.

The objectives of this research are: -

1. Understanding the meaning of micro finance and the modern financial industry
especially in the context of India.

2. Study the expectations of Microfinance institutions and the challenges faced by

them in obtaining the funds.

3. Understanding the role of Government in boosting Micro finance institutions.

4. Study the relationship between Commercial banks and microfinance institutions

5. Determine the role of MFIs in the development of Micro Small and Medium
Scale Enterprises.

2. HYPOTHESIS: -

H0 Microfinance institutions help MSMEs in providing finance and thus helps in

eradicating poverty and in turn help in boosting the economy.

H1 Commercial banks have an advantage over microfinance institutions.

 H2 Promote economic development, employment and growth through the support of
micro-entrepreneurs and small business

3. Scope of Study
In the light of problem, background leads to the following problem statement, which will
also be the overarching question/statement for this investigation:

What is the impact of Microfinance on the modern finance Industry specifically in India?

What is the role played by the Government in microfinance sector?

Why does microfinance institutions needs help of commercial banks and what difficulties
does commercial banks face in helping them?

What is the role of microfinance institutions in helping the Micro and Small Scale
Enterprises and how do they achieve the task of economic development through this?

4. Limitations of the Study:-

1. The sample size of the present study was relatively small to generalize the result in
India context.

2. Data collected through Questionnaire may be biased.

3. The area of study is limited to a particular region, thus results may differ from place
to place.

4. Respondents may have to be contacted repeatedly or alternate respondents

may have to beidentified.

5. Time and Money are the major constraint in the study.

6. It was difficult to collect all the information due to the respondents' confidential nature.

5. Source of Data:-

1. The study is based on both primary and secondary data.

2. The primary data was gathered by employing a questionnaire method.

 1. Self - administered questionnaires were distributed to be answered by the public
in large as per requirement of the questions included in the questionnaire.

2. The goal of the study was to provide information primarily out of raw data. After
data gathering was completed it has been edited to detect errors or omissions and cross
checked to verify consistency with other respondents. Then the data was grouped based
on their similarity for easy handling.

3. Raw data was transformed into a format that is easy to understand and interpret.
Calculations of average and percentage were made for the purpose of summarising
data.

4. Finally the task of interpretation and a report describing the result has been done.

5. The secondary data was used for establishing research backgrounds and collected
from books, magazines, journal articles and the web.

Books regarding Information Technology and Artificial Intelligence in the banking sector
were collected from the library in order to get basic details and for more conceptual
concepts
 CHAPTER III
LITERATURE REVIEW: -

Microfinance5 is “the provision of financial services to low-income poor and very poor
self-employed people”. These financial services 6generally include savings and credit
but can also include other financial services such as insurance and payment services.
Therefore, microfinance involves the provision of financial services such as savings,
loans and insurance to poor people living in both urban and rural settings who are unable
to obtain such services from the formal financial sector

The microfinance industry’s objective is to satisfy the unmet demand on a much larger
scale, and to play a role in reducing poverty. While much progress has been made in
developing a viable, commercial microfinance sector in the last few decades, several
issues remain that need to be addressed before the industry will be able to satisfy
massiveworldwide demand7.

With increasing assistance from the World Bank and other donors, microfinance is
emerging as an instrument for reducing poverty and improving the poor's access to
financial services in low-income countries. Providing the poor with access to financial
services is one of many ways to help increase their incomes and productivity. In many
countries, however, traditional financial institutions have failed to provide this service.
Microcredit and cooperative programs fill this gap. They provide credit through social
mechanisms such as group-based lending to reach the poor and other clients, including
women, who lack access to formal financial institutions. Their purpose is to help the
poor become self-employed and thus escape poverty. This book examines the
experiences of the Grameen Bank, the Bangladesh Rural Advancement Committee, and
the Bangladesh Rural Development Board's Rural Development Project-12, in order to
quantify the
potential and limitations of microcredit programs as an instrument for reducing poverty
and delivering financial services to the poor.8

According to S.L.Shetty, has talked about the factual profiles of prevalent microcredit
programs in India and goes far beyond the review of literature on the concept, country
models, and history of the movement. Have also given the up-to-date review of the
regulatory measures and their nuances, as well as a detailed review of evaluation and
impact studies. It also dwells on the limitations of the microfinance movement to satisfy
the credit needs of the vast informal-sector enterprises and discusses the new initiatives
that the authorities have taken under the broad theme of "financial inclusion." Keeping
the broader objective of distributional goals embedded in the microfinance movement,
this record attempts an assessment of the wider challenges faced by the financial system
by providing suggestions for reaching out to the small and informal sectors on a more
effective scale.9 It is also of much relevant that the access of these fundamental services
provided by the microfinance institutions should reach to all people in developing
countries as it will help in acceleration of economic development ofcountries.