micro finance in india - eirc newsletter - 3rd jan, 2011

8/7/2019 Micro Finance in India - EIRC Newsletter - 3rd Jan, 2011

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Microfinance in India

Nidhi [email protected]

Vinod Kothari & Company

What started as a US$ 27 revolution by Prof. Muhammad Yunus who gave the world themicrofinance revolution Grameen Bank , where by lending mere US$ 27 to 42 people hechanged their life, today he was quoted saying Microfinance has been abused and distorted

Microfinance in India has been in the news for all wrong reasons. With the Andhra Pradeshgovernment passing an ordinance, there have been news waves doing rounds calling this bubblebursting that has been lingering unabated, bringing a jolting halt to the Rs. 20,000 crore industryin India and exposing the inherent problems in the sector.

Sometime in mid October, Andhra Pradesh government passed an ordinance, calling theborrowers to stop paying their loans, making it illegal for the micro lenders to ask for weeklyrepayments and also required them to get a no objection from the local authorities beforeproviding for a second loan to a borrower. The Andhra Pradesh government also asked RBI toban MFIs from accessing capital markets and a statutory cap to be imposed on the interest ratescharged by the MFIs.

Andhra Pradesh being the hub of microfinance activities in India, suffered a serious set-back,

with loan collections dropping to less than 20 percent from 98 percent previously, causing jittersthat it would have a contagion effect on the other states as well and throttle the industry. WhileMFIs battled their credibility, further damage was caused when banks starting recalling theirloans and curb their funding to the industry causing liquidity crisis, as microfinance institutionsare largely dependent on outside funding.

The pertinent question here is what led to such harsh measures being taken by the APgovernment?

MFIs were charging usurious interest rates and were using harsh recovery practices. MFIs

typically borrowed from banks at a rate of 13 percent, and charge interest rates that are 3 times of what the banks charge in the name of loan processing fee, operational expenses etc. There wereproblems of multiple lending and the incentive of bigger loans for repayment of smaller loans.The borrowers were caught in the vicious cycle of ballooning loans.

So the AP government demanded the MFIs were required to go through the local authoritiesbefore issuing second loan and barred debt collectors from visiting borrowers' homes and usingany coercive means for collection.


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Though the objective of the AP Ordinance was to protect the interest of the poor againstexploitative practices and bringing about more transparency levels, dealing with problems of high debt levels, multiple lending and pressure on repayment rates, The decision seemed moreabrupt and under political pressure. The government asking borrowers not to repay the loancannot be a solution to the several suicides caused due to microfinance debt.

The AP High Court also did not see the rational, did not grant a stay on the ordinance and therepercussions were liquidity crunch for MFIs, collections dropping and operations coming to ahalt. Post this ordinance, in line with the recommendation of the finance ministry, several MFIsconsented on bringing down the interest rates from 30% to 24% indicating the kind of margin theMFIs maintained.

What is Microfinance?

Microfinance is defined as rendering of financial services in the form of credit, savings, deposits

and insurance to low income group people and to individuals who fall below the poverty line forcreating social value. The rural money lenders or the mahajans extracting exorbitant amounts forthe loans extended to the poor and the needy had been prevalent in all parts of the country.Sometimes the interest rates are as high as 36% to 60% as these moneylenders enjoyedmonopoly. To provide relief from the exploitation of such money lenders and to also providefinance to those who did not have access to these money lenders concept of microfinanceemerged.

The low income population, specially the rural population does not have the access to the regularcommercial banking channels. Absence of formal employment and inability to provide any

collateral against the loans makes them non-bankable. Typically these individuals do not haveany collateral to offer against the loan demands. So, microfinance institutions have a role to playto bridge the gap between the financial institutions and the poor.

Microfinance in India

To cater to the needs of the poor and the impoverished and to provide a helping hand inalleviating their economic condition microfinance movement in India began.

The legal framework for establishing a co-operative movement came about in 1904; ReserveBank of India established an Agricultural Credit Department in 1934 and then came the Regional

Rural Banks in 1975, the Integrated Rural Development Program (IRDP) in 1978 and thepremier agency for rural credit NABARD was established in 1982. The history of micro credit/ micro financing goes way back in India.

The Anand Milk Union (more popularly known as Amul) was one such dairy co-operativemovement in India that was revolutionary and changed the face of rural India making manywomen in villages self-sufficient and independent.


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In 1991 1992 NABARD started the project of linking the SHGs with the Banks with a view toproviding meaningful banking facilities to the poor. RBI added to the initiative by advising thebanks to actively take part in the project. In 2000 the Govt. of India vide their notification datedAugust 29, 2000 has included Micro Credit/Rural Credit in the list of permitted non-bankingfinancial company (NBFC) activities for being considered for Foreign Direct Investment(FDI)/Overseas Corporate Bodies (OCB)/Non-Resident Indians (NRI) investment to encourageforeign participation in micro credit projects. This covers credit facility at micro level forproviding finance to small producers and small micro enterprises in rural and urban areas.

Micro finance institutions thereby are very pivotal in developing countries to help economicallymarginalized population to access capital to be micro entrepreneurs and become operationallyself-sufficient in all respects. Today NABARD, SIDBI, HDFC, RRBs and many co-operativesare engaged in extending micro finance to the poor. NABARD started the self-help group(SGHs) and bank linkage program as a pilot project in 1992 which went to become the mostpopular model of micro financing.

How does the model work?

Commonly, an MFI does a comprehensive survey of the villages and then based on certainparameters chooses a village and offer their mission, methodology and the services to thevillagers. Thereafter villagers are asked to gather in a group of five to serve as guarantors foreach other enforcing them to be loyal to each other. This is done so that in case a group memberis not able to repay the loan, the others can help him/ her in making payments. In case if anymember defaults in the loan the group is penalized and sometimes is also barred from taking afurther loan. On the other hand making timely payments also attract incentives. This peer

pressure always brings out the diligence in paying the loan and acts as collateral for the MFI.

After this set up the group training begins. From understanding of the business skills, helpingidentify the business generation activity to calculation of interest, credit discipline, signing of names and so on; the members of the group are trained thoroughly for five days. Thereafter avillage centre is created of all these groups which ensure that all the groups duly meet theirresponsibility of paying loans. This creates a dual liability system and finally the finances startflowing in. The loan repayment is in weekly installments. The group needs to put some amountof their income in a separate account as savings and there is another account maintainedseparately for fines. First one or two members of the group are given loans where if for the next

six weeks there is no default then the other members of the group are given loan. Surprisinglywomen are better in repaying their loans than men.

Another way of expanding operations is by linking the MFIs to the formal sector lenders aligningthe strengths of the two. By entering into a joint venture with the commercial financialinstitutions the MFIs can access the broader base of resources while retaining its accessibility tothe poor. This would mean that the financial institutions would provide huge funds and the MFIs


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will act as conduit in determining how the loans can be packeted in smaller proportions to be of use to low income households.

Today there are millions of families today are benefiting from this movement and the movementis fueling in them the spirit of entrepreneurship.

Microfinance is at crossroads today but has the ability to affect lives of a vast number of peopleand is the answer to the upliftment of the poor by helping more access loans. However theconcepts credibility has been tarnished by the profit making lenders money lenders of thenew age on one hand and the legislative intervention could result in moral hazard with someborrowers taking advantage of the current confusion to refuse making timely payments.

With the rapid growth that the industry has witnessed not just indicates the need for its existencebut also its usefulness. The current situation could force a lot of MFIs to turn to the urban poorbecause the average loan size is bigger in cities for the time being. However it would not be an

end to the industry for sure.

micro finance in india - eirc newsletter - 3rd jan, 2011

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