4 Microfinance

MICROFINANCE

By: Vandita Tiwari (Great Lakes Institute of Management, Gurgaon)

Microfinance, in truth, is a service which provides finance to low-income individuals or group of individuals who lack access to traditional or non-traditional financial services. The concept of microfinance has dual objectives of combating poverty and at the same time to help in the development of financial system of the country. It is a method of creating “economic and social development from below” by providing small loans to poor households who don’t have ability to provide collateral to banks and financial institutions for loans in the normal course. Micro finance or microcredit includes both formal and informal money lenders such as commercial banks, loan sharks, credit cooperatives etc. Though microfinance or microcredit are often used interchangeably, there is a distinction between the two. Microcredit is the act of providing small loans whereas microfinance encompasses other financial services such as banking facilities, insurance etc. Microfinance institutions sometimes provide social services such as educational facilities, clinical care and more.

Source: Journal of Global Health Reports

According to a GlobalNewswire report, global market for microfinance is predicted to reach US$ 313 billion by 2025. Driven by the widening gap in the distribution of wealth in the economy, microfinance initiatives are used to provide finance to those stricken by extreme poverty. It opens new opportunities for people to pull themselves out of the vicious cycle of poverty by providing access to business or education. It also aids the poor in managing their finances and can be used to leverage economic opportunities which brings about stability for their families.

Over time microcredit and microfinance have assisted in supporting small and medium enterprises (SME’s) and overall sustainable development through inclusive financial innovation. The MFI institutions have made extreme headway in helping poor to get out of their poverty, especially in the countries along “the Silk Road Economic Belt” and “Maritime Silk Road”. “Self-sufficiency” is the main indicator used internationally to measure sustainable development of MFI’s. This indicator has further two levels- (1) Operating selfsufficiency (OSS) and (2) Financial self-sufficiency (FSS).

The OSS rate determines the ability of an institution to earn sufficient revenue to cover its total costs in a given period of time. The FSS rate, on the other hand, reflects the ability of the institutions to provide sustainable services without accepting additional donations.

In the fast-growing markets of the world, in the recent past, have been facing repayment crises that the industry has faced are indicative of the splits that are appearing in the fabric of microfinance. The most common causes for these crises are violation of lending disciplines, too many MFI’s operating in the same area, borrowers taking more loans than they can reasonably repay etc. The debt induced distress caused has led to debates on the relationship between microfinance and over-indebtedness. In 2008, all the 12 largest MFI’s experienced increase in Portfolio-at-Risk reaching approximately 7% but at the time microfinance participation was not considered as a possible driver of the crises.

The United Nations (UN) recognised the success of MFI’s by declaring the year 2005 as the “International Year of Microcredit”. In the Indian market, there is a high concentration of microfinance industries and low competition, though it is one the leading markets in the world. The sector has undergone major changes in the structure of ownership, control and management of MFI’s and expanded immensely in the past two decades. The three most popular forms of organisations in the Indian microfinance sector are Non-Banking Finance Companies (NBFC’s), Banks and Co-operatives.

Source: Microfinance in South India (https://repository.upenn.edu/)

Microfinance is highly cultural and context specific and India, a country with a significant poor population, is an extremely profitable region for MFI’s. The UN has declared two main approaches for MFI’s: the “formal financial institutions approach” and the “community-based institutions approach”. The first approach builds on stable and strong financial institutions wanting to broadening their horizons to aiding the underserved. The second focuses on developing informal community financial institutions and connecting them to the financial sector directly or indirectly via creation of federations. Example- Self-help group (SHG) model that links to banks. In India, the SHG model is dominant in the microfinance industry. In 2010, this industry went through a severe crisis when approximately 100 suicides in Andhra Pradesh were linked directly to aggressive microcredit salesman and loan collectors from private sector MFIs of the state. The state politicians responded by requesting the borrowers to not repay their debts causing repayment rates to plummet from 98 to 5 percent. The RBI stepped in to regulate the sector and passed margin caps to prevent overcharging over 10 to 12 percent off the operating margin of the loans. But, in the first half of FY 2011, MFIs in Andhra Pradesh issued Rs.5000 crore to borrowers while in the second half of the same financial year they could only disburse Rs. 8.5 crore reducing the number of clients being served by microfinance globally by over 10 million. This sparked debates on the ethicality of profiteering off the poor. When MFI’s focus more on commercial interests, they deviate from the objective of serving the poor. It is imperative that regulators take necessary steps to maintain a stern vigil on this industry as the enormous socio-economic and financial benefits from

it can turn into the worst kind of exploitation. Still, microfinance programs provide aid to millions of households across the world and continues to drive toward a poverty free world.

REFERENCES

 Sunil Puliyakot (2020). “Does Microfinance Participation Lead to Over-Indebtedness? Evidence from India”, The Journal of Accounting Research and Audit Practices, Vol 19, No.3, pp 22-48.  Bhaskar, Arjun. (2015). Microfinance in South India: A Case Study. Retrieved May 2021, from http://repository.upenn.edu/  Yaning Li, Yi Yang, Gaoshuai Li & Xing Zhao (2020). “Study on Sustainable Development of Microfinance Institutions from the Perspective of Inclusive Finance—Based on MFI Data in Countries along the Belt and Road”, Emerging Markets Finance and Trade, 56:13, 3205-3216, DOI: 10.1080/1540496X.2019.1684893  Navin, Nitin & Sinha, Pankaj. (2019). “Market Structure and Competition in the Indian Microfinance Sector”. Vikalpa: The Journal for Decision Makers. 44. 167-181. 10.1177/0256090919896641.  Sengupta, Rajdeep & Aubuchon, Craig. (2008). “The Microfinance Revolution: An Overview”. Review. 90. 9-30. 10.20955/r.90.9-30.