Microfinance PDF

Definition Microfinance primarily refers to micro- credit. A micro-credit is a small loan which is mainly granted to people with a low income. According to Reserve Bank of India : Microfinance is a form of financial service which provides small loans and other financial services to po...

Definition Microfinance primarily refers to micro- credit. A micro-credit is a small loan which is mainly granted to people with a low income. According to Reserve Bank of India : Microfinance is a form of financial service which provides small loans and other financial services to poor and low-income households. Meaning Microfinance refers to the provision of financial services to low-income clients, including consumers and the self-employed, who traditionally lack access to banking and related services. In its simple form, it involves providing small loans (microcredit) to poor people to help them engage in productive activities or grow small businesses. Discussion The clients of microfinance are landless labourers engaged in agriculture, mining and construction, small and marginal farmers, rural artisans and weavers, self-employed in urban informal sector, self-employed in non-farm activities and women. Non-government organizations (NGOs) are the key players in the microfinance sector. Discussion Microfinance represents the financial services provided to low-income individuals or groups who are typically excluded from traditional banking. Most microfinance institutions focus on offering credit in the form of small working capital loans, sometimes called microloans or microcredit. However, many also provide insurance and money transfers. Microfinance aims to improve financial services access for marginalized groups to promote economic self- sufficiency. Discussion It is an economic tool designed to promote financial inclusion which enables the poor and low-income households to come out of poverty, increase their income levels and improve overall living standards. It can facilitate achievement of national policies that target poverty reduction, women empowerment, assistance to vulnerable groups, and improvement in the standards of living.  Microfinance institutions (MFIs) are financial companies that provide small loans to people who do not have any access to banking facilities. The definition of “small loans” varies between countries. In India, all loans that are below Rs.1 lakh can be considered as microloans. Microfinance institutions have been gaining popularity in the recent years and are now considered as effective tools for alleviating poverty.  Transform into a financial institution that assists in the development of communities that are sustainable. Help in the provision of resources that offer support to the lower sections of the society. There is special focus on women in this regard, as they have emerged successful in setting up income generation enterprises. Evaluate the options available to help eradicate poverty at a faster rate. Mobilize self-employment opportunities for the underprivileged. Empowering rural people by training them in simple skills so that they are capable of setting up income generation businesses.  It provides easy access to credit – Microfinance companies provide credit to people when it is needed the most. Banks do not usually offer small loans to customers, MFIs provide microloans to bridge this gap. It enables people to expand their present opportunities – The income accumulation of poor households has improved due to the presence of microfinance institutions that offer funds for their businesses.  It serves the under-financed section of the society – Majority of the microfinance loans provided by MFIs are offered to women. Unemployed people and those with disabilities are also beneficiaries of microfinance. It inculcates the discipline of saving – When the basic needs of people are met, they are more inclined to start saving for the future. It is good for people living in backward areas to inculcate the habit of saving.  It results in better credit management practices – Microloans are mostly taken by women borrowers. Statistics prove that female borrowers are less likely to default on loans. Apart from providing empowerment, microloans also have better repayment rates as women pose lesser risk to borrowers. This improves the credit management practices of the community.  National Bank for Agriculture and Rural Development (NABARD) is the main regulatory body in the country’s rural banking system. It was established in 1982 by the Government of India. It aims to provide and regulate credit to the rural areas, which will be a first step towards enhancing the rural development in the country.  NABARD has been given many responsibilities related to the formulation of policies, planning, and operations in agriculture and financial development. NABARD works towards promoting and developing industries in the rural areas like the agriculture industry, cottage industries, other small scale industries, and rural crafts in an effort to create better infrastructure and better employment opportunities for the people living in these regions.  Self Help Group Bank Linkage program (SHG-BLP) is a landmark model initiated by the National Bank for Agriculture and Rural Development (NABARD) in 1992 to deliver affordable door-step banking services and has largely achieved the stated goals of financial inclusion. The SHG Bank linkage program started by NABARD had a modest beginning with 225 credit linked groups and a loan amount in of Rs. 29 lakhs in in 1992. Within 3 years, 4750 SHGs were credit linked with different banks by the end of 3 year phase with bank loan of Rs 6.06 crores.  As on 31st March 2019, loans amounting Rs 87000 crores have been made to 50.77 lakhs SHG. Under the scheme, SHGSs obtain loan from Commercial, Rural & Cooperative Banks. The banks lend to the SHG and are eligible for re-finance from NABARD at subsidized interest rates. The success of SHG-BLP also attracted the attention of State governments as a result many State governments undertook major programs to promote SHGs.  Government initiatives play a significant role in channelling the credit flow to underserved sectors through priority sector lending. Government has taken steps to empower women by providing them easy access to credit, assistance in starting their own business and financial literacy programs. Schemes like Pradhan Mantri Mahila Shakti Kendra are expected to create a conducive environment for women to realize their full potential.  The GOI started the SGSY (Swarna-Jayanti Gram Swarojgar Yojna). It was implemented with group mode of financing. For covering all BPL families. SGSY was restructured in 2011 to form National Rural Livelihood Mission (NRLM) which was re-christened as Deen Dayal Upadhaya Antyodaya Yojana to be implemented in mission mode across the country. The scheme envisages providing skills training to rural poor.  Multiple government schemes* have been promoted to provide and measure the access of financial services to needy individuals. In September 2018, the Ministry of Finance, Government of India, launched the Financial Inclusion Index to measure access to, usage and quality of financial services. Additionally, Jan Dhan Darshak, a mobile app, has been launched by the Department of Financial Services (DFS) to help people locate relevant financial services in their vicinity. Micro Finance Programme SIDBI offers micro credit facilities to MSMEs who are engaged in industrial activities. These credit facilities are offered through MFIs or NGOs. MFIs/NGOs source funds from SIDBI and make the funds available to MSMEs for their commercial needs. The features of the program are as follows: The Government would provide funds to SIDBI, which would then be used as security deposits for the loans issued to MFIs/NGOs. The funds paid by the Government to SIDBI under the Micro Finance Program would be called ‘Portfolio Risk Fund’. SIDBI can then use this fund for security deposit requirements of the loans issued to MFIs/NGOs. Micro Finance Programme MFIs/NGOs would have to pay only 2.5% of the loan amount as security deposit for the loan and the remaining 7.5% is funded from the Portfolio Risk Fund paid by the Government. Interest would be paid by SIDBI to the Government on the security deposit held. The rate of interest would be the same as that paid to MFIs/NGOs on their 2.5% deposit. SIDBI would be responsible for the recovery of the loan granted to MFIs/NGOs. When the loan is recovered fully, the Government’s contribution of 7.5% of the loan and the interest earned thereon would be rotated and used for future loans.  It was created after its announcement in the Union Budget of 2000-01 with an initial outlay of Rs 100 crores, which was later enhance to Rs 200 crores. The objective of the MFDF is to facilitate and support the orderly growth of the microfinance sector through various ways for enlarging the flow of financial services to the poor, particularly for women and vulnerable sections of the society. The fund is managed by a Board consisting of representatives of NABARD, commercial banks and professionals from the microfinance area. In 2005 Government of India decided to re-designate the Microfinance Development Fund (MFDF) as Microfinance Development and Equity Fund (MFDEF). High rates of interest as compared to mainstream banks MFIs charge a very high rate of interest (12-30%) as compared to commercial banks (8-12%). The borrowers generally have no options to access the fund. Issue of over-indebtedness caused by the charging of high interest rate may lead to default in payment by borrowers. 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 stabilized 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. Banks frequently lend to micro-lending companies to satisfy their priority sector loan goals. Over-indebtedness Microfinance institutions offer financial services to the weaker members of As a result, over- indebtedness is a huge problem. There are possibilities of multiple borrowings as this sector provides loans without collateral which raises the risk of bad debts. It is compounded by a lack of risk management framework. Lack of awareness of financial services. Literacy rate in India is 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 meet their financial needs but also makes them financially excluded. MFIs’ are faced with the task of educating the people and establish trust before selling their product. Regulatory Concerns The Reserve Bank of India (RBI) is currently the governing agency for India’s microfinance industry. However, it has generally catered to commercial and traditional banks rather than microfinance institutions. Furthermore, the microfinance industry’s needs and systems are different from banks. The industry has been subjected to regulatory changes. Some have improved the industry, but many issues remain unsolved, such as creating entry hurdles to keep unworthy players out. Therefore there is a need for a separate regulatory authority for this industry. 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 the situation and also the decision of selection is irreversible in nature. So, it affects the sustainability of the organization in the long-run. Regulatory Concerns The Reserve Bank of India (RBI) is currently the governing agency for India’s microfinance industry. However, it has generally catered to commercial and traditional banks rather than microfinance institutions. Furthermore, the microfinance industry’s needs and systems are different from banks. The industry has been subjected to regulatory changes. Some have improved the industry, but many issues remain unsolved, such as creating entry hurdles to keep unworthy players out. Therefore there is a need for a separate regulatory authority for this industry.  The Board of Directors of the Reserve Bank of India, at its meeting held on October 15, 2010, formed a Sub-Committee of the Board to study issues and concerns in the microfinance sector regarding the entities regulated by the Bank. The Composition of the Sub-Committee was as under: 1. Sh. Y.H. Malegam – Chairman 2. Sh. Kumar Mangalam Birla 3. Dr. K. C. Chakrabarty 4. Smt. Shashi Rajagopalan 5. Prof. U.R. Rao 6. Sh. V. K. Sharma (Executive Director) – Member Secretary The terms of reference of the Sub-Committee were as under: 1. To review the definition of ‘microfinance’ and ‘Micro Finance Institutions (MFIs)’ for the purpose of regulation of non-banking finance companies (NBFCs) undertaking microfinance by the Reserve Bank of India and make appropriate recommendations. 2. To examine the prevalent practices of MFIs in regard to interest rates, lending, and recovery practices to identify trends that impinge on borrowers’ interests. 3. To examine and make appropriate recommendations in regard to the applicability of money lending legislation of the States and other relevant laws to NBFCs/MFIs. The terms of reference of the Sub-Committee were as under: 4. To examine the role that associations and bodies of MFIs could play in enhancing transparency disclosure and best practices 5. To recommend a grievance redressal machinery that could be put in place for ensuring adherence to the regulations recommended at 3 above. 6. To examine the conditions under which loans to MFIs can be classified as priority sector lending and make appropriate recommendations.  RECOMMENDATION 1: NEW CATEGORY OF NBFCS CALLED NBFC MFIS It was recommend that a separate category be created for NBFCs operating in the Microfinance sector, such NBFCs being designated as NBFC-MFI. The Sub-Committee recommends that an NBFC-MFI may be defined as: “A company (other than a company licensed under Section 25 of the Companies Act, 1956) which provides financial services pre-dominantly to low-income borrowers with loans of small amounts, for short-terms, on an unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks and which further conforms to the regulations specified in that behalf”. RECOMMENDATION 2: NBFC TO SATISFY CERTAIN CONDITIONS TO BE CLASSIFIED AS NBFC MFI It was recommended that an NBFC classified as an NBFC-MFI should satisfy the following conditions: 1. Not less than 90% of its total assets (other than cash and bank balances and money market instruments) are in the nature of “qualifying assets.” A “qualifying asset” shall mean a loan which satisfies the following criteria: a. The loan is given to a borrower who is a member of a household whose annual income does not exceed Rs. 50,000; A “qualifying asset” shall mean a loan which satisfies the following criteria: b. The amount of the loan does not exceed Rs. 25,000 and the total outstanding indebtedness of the borrower including this loan also do not exceed Rs. 25,000. c. The tenure of the loan is not less than 12 months where the loan amount does not exceed Rs. 15,000 and 24 months in other cases with a right to the borrower of prepayment without penalty in all cases. d. The loan is without collateral. e. The aggregate amount of loans given for income generation purposes is not less than 75% of the total loans given by the MFIs. f. The loan is repayable by weekly, fortnightly, or monthly installments at the choice of the borrower. 2. The committee further recommended that an NBFC which does not qualify as a NBFC-MFI should not be permitted to give loans to the microfinance sector, which in the aggregate exceed 10% of its total assets. Areas of Concern In the Indian Context, specific areas of concern have been identified: These are: a) Unjustified high rates of interest. b) Lack of transparency in interest rates and other charges. c) Over-borrowing d) Ghost borrowers e) Coercive methods of recovery.