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    1. MICROFINANCE - AN OVERVIEW 131.1 Microfinance - A Short Background 131.2 Global Developments in Microfinance 141.2.1 Penetration in South Asia 181.3 Micro-Finance in India 211.3.1 Models practiced in Indian Microfinance Industry 221.3.1.1 MFI Model 22

    1.3.1.2 Self Help Group Bank Linkage Model 221.3.2 MFI and SHG Bank Linkage Credit Supply 231.3.3 Role of Central Banks 261.3.4 Role of Women 291.3.5 Microfinance & Poverty Alleviation 301.4 Urban Microfinance 341.5 Rating of Microfinance Institutions

    ISSUES & CHALLENGES 82

    4.1 Literacy & Skill Levels of Clientele 824.2 High Transaction and Service Cost 834.3 Credit Risk 854.4 Skewed Regional Distribution of Microfinance 864.5 Diversion of Funds to Unproductive Activities 86

    4.6 Regulatory Issues 874.7 Irregular Flow of Income due to Seasonality 874.8 Uncertainty of Market Conditions 884.9 Lack of Tangible Proof for Assessment of Income 884.10 Need for Information Sharing & Better Technology

    LIST OF FIGURESSavings by Region1.2 Savings by Region 953 MFIs Reporting, July 2007 61 Million Savers1.3 MFI's by region, Based on a sample of 2,207 MFIs in 20071.4 Direct Financing Model1.5 SHG Bank linkage Model1.6 Growth in borrowers under MFI channel (2003-2007)1.7 Growth in outstanding loan portfolio under MFI channel (2003-2007)

    1.8 Estimated loan outstanding under SHG bank linkage channel ( 2003-2007)1.9 Share of bank linkage SHG and MFIs in microfinance disbursement (2003)1.10 Share of bank linkage SHG and MFIs in microfinance disbursement (2007)1.11 Growth in cumulative disbursements by SHGs and MFIs channels (2003-2007)1.12 Instituitional flow of microfinance2.1 Major market players in rural credit2.2 Growth in client outreach by MFIs2.3 Classification of activities Micro credit loan being takenLIST OF TABLES2.1 Growth of SHG Linked in 13 Priority sectors2.2 Growth of SHGs in Regions2.3 MFI Outreach State-wise2.4 Top 40 MFI Institutions and their Active Borrowers (2007)2.5 Top Microfinance Institution Performance in the year 2007

    2.6 Top 20 Districts by MFI Penetration (2007)

    Introduction

    Microfinance - A Short Background

    Achieving balanced and inclusive economic growth is a key challenge faced bypolicymakers in countries around the world. The gains of economic growth are accessibleto a greater extent by the relatively advantaged, who find it easier to participatein the growth process. Poorer people, who are separated by distance from the

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    urban areas where economic activity is concentrated, have to wait much longer toreap the benefits of economic growth. Engaging these sections of society in the economicmainstream is essential to achieve balanced growth, which is critical for thelong-term sustainability of social development and economic prosperity.Access to financial services is a key element of the process of socio-economicempowerment. Only by delivering financial services to people in rural areas andlower income strata can they be brought within the ambit of economic activity.

    Only then can the full potential of the countrys physical and human resources berealized. The rural economy represents a large latent demand for credit, savingsand risk mitigation products like insurance. Governments and regulators the worldover have articulated the expansion of financial service delivery to this segment ofthe population as a priority objective.

    Indian Economy and MicrofinanceHome to about 1.1 billion people as of 2007, India constitutes approximately one sixthof the worlds total population. It is the worlds largest democracy and a key emergingmarket alongside China and Brazil. The picture of growing GDP and rising foreigninvestments shows an environment where wealth is increasing for the nation.Due to its large size and population of around 1000 million, India's GDP ranks

    among the top 15 economies of the world. However, around 300 million people or about60 million households, are living below the poverty line. It is further estimated that ofthese households, only about 20 percent have access to credit from the formal sector.Additionally, the segment of the rural population above the poverty line but not richenough to be of interest to the formal financial institutions also does not have good accessto the formal financial intermediary services, including savings services.A group of micro-finance practitioners estimated the annualised credit usage of

    all poor families (rural and urban) at over Rs 45,000 crores, of which some 80 percent ismet by informal sources. This figure has been extrapolated using the numbers of ruraland urban poor households and their average annual credit usage (Rs 6000 and Rs 9000pa respectively) assessed through various micro studies.

    .Microfinance DefinedFor the purposes of this study microfinance can be defined as any activity thatincludes the provision of financial services such as credit, savings, and insurance to low incomeindividuals which fall just above the nationally defined poverty line, and poorindividuals which fall below that poverty line, with the goal of creating social value. Thecreation of social value includes poverty alleviation and the broader impact of improvinglivelihood opportunities through the provision of capital for micro enterprise, andinsurance and savings for risk mitigation and consumption smoothing.History of Microfinance in India

    In India, institutional credit agencies (banks) made an entry in rural areas initially to

    provide an alternative to the rural money lenders who provided credit support, but notwithout exploiting the rural poor. There are 3 main factors that count to the bringing upofMicrofinance as a Policy in India1. The first of these pivotal events was Indira Gandhis bank nationalization drivelaunched in 1969 which required commercial banks to open rural branches resulting[3] ina 15.2% increase in rural bank branches in India between 1973 and 1985. Today, Indiahas over 32,000 rural branches of commercial banks and regional rural banks, 14,000cooperative bank branches.2. The second national policy that has had a significant impact on the evolution of

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    Indias banking and financial system is the Integrated Rural Development Program(IRDP) introduced in 1978 and designed to be a direct instrument for attacking Indiasrural poverty. This program is interesting to this study because it was a large programwhose main thrust was to alleviate poverty through the provision of loans and it wasconsidered a failure3. The last major event which impacted the financial and banking system inIndia was the liberalization of Indias financial system in the 1990s characterized by aseries of structural adjustments and financial policy reforms initiated by the ReserveBank of India (RBI).The systems and procedures of banking institutions was emphasizing oncomplicated qualifying requirements, tangible collateral, margin, etc., that resulted in alarge section of the rural poor shying away from the formal banking sector. The bankstoo experienced that the rapid expansion of branch network was not contributing to anincreasing volume of business to meet high transaction costs and risk provisioning, whicheven threatened the viability of banking institutions and sustainability of their operations.At the same time, it was not possible for them to allow a population of close to 300million - even if poor - to remain outside the fold of its business.

    The search for an alternative mechanism for catering to the financial service needs of thepoor was thus becoming imperative.

    Analysing the current Scene of Micro Finance Services

    We are seeing a new type of loan methodology being evolved that is somewhat of ahybrid in nature. It considers itself in the business of improving livelihoods, in whichlivelihood financial services is one piece. It places equal emphasis on the provision ofagricultural business development services and technical services in addition to theprovision of financial services, which includes credit but is not limited to it. Credit is notsufficient alone to guarantee an improvement in the livelihoods of the rural poor. It isbelieved that other financial and technical services are necessary and can be provided ona revenue model in order to be sustainable.

    Micro-Finance Institutional Structure in India

    Microfinance in India started in the early 1980s withsmall efforts at forming informal self-help groups(SHG) to provide access to much-needed savings andcredit services. From this small beginning, the microfinance sectorhas grown significantly in the past decades. National bodies like

    the Small Industries Development Bank of India (SIDBI) and theNational Bank for Agriculture and Rural Development(NABARD) are devoting significant time and financial resources to microfinance.This points to the growing importance of the sector.

    The strength of the microfinance organizations (MFOs) in India isin the diversity of approaches and forms that have evolved overtime. In addition to the home-grown models of SHGs and mutuallyaided cooperative societies (MACS), the country has learnedfrom other microfinance experiments across the world, particularly

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    those in Bangladesh, Indonesia, Thailand, and Bolivia, in terms ofdelivery of micro financial services. Indian organizations could alsolearn from the transformation experiences of these microfinanceinitiatives.

    The different organisations in this field can be classified as "Mainstream" and

    "Alternative" Micro Finance Institutions (MFI).Mainstream Micro Finance InstitutionsNABARD, Small Industries Development Bank of India (SIDBI), Housing DevelopmentFinance Corporation (HDFC), Commercial Banks, Regional Rural Banks (RRBs), thecredit co-operative societies etc are some of the mainstream financial institutionsinvolved in extending micro finance.Alternative Micro Finance InstitutionsThese are the institutions, which have come up to fill the gap between the demand andsupply for microfinance. MFIs were recently defined by the Task Force as "those whichprovide thrift, credit and other financial services and products of very small amounts,mainly to the poor, in rural, semi-urban or urban areas for enabling them to raise their

    income level and improve living standards."The MFIs can broadly be classified as:NGOs, which are mainly engaged in promoting self-help groups (SHGs) and theirfederations at a cluster level, and linking SHGs with banks, under the NABARDscheme.NGOs directly lending to borrowers, who are either organised into SHGs or intoGrameen Bank style groups and centres. These NGOs borrow bulk funds fromRMK, SIDBI, FWWB and various donors.MFIs which are specifically organised as cooperatives, such as the SEWA Bankand various Mutually Aided Cooperative Thrift and Credit Societies (MACTS) inAP.MFIs, which are organised as non-banking finance companies, such as BASIX,

    CFTS, Mirzapur and SHARE Microfin Ltd.

    Indian Microfinance ContextIndian public policy for rural finance from 1950s to till date mirrors the patternsobserved worldwide. Increasing access to credit for the poor has always remainedat the core of Indian planning in fight against poverty. The assumption behindexpanding outreach of financial services, mainly credit was that the welfare costs ofexclusion from the banking sector, especially for rural poor are very high. Startinglate 1960s, India was home to one of largest state intervention in rural creditmarket and has been euphemistically referred to as Social banking phase. It sawnationalisation of existing private commercial banks, massive expansion of branchnetwork in rural areas, mandatory directed credit to priority sectors of the economy,subsidised rates of interest and creation of a new set of rural banks at district leveland an Apex bank for Agriculture and Rural Development (NABARD20) at nationallevel. These measures resulted in impressive gains in rural outreach and volume ofcredit. As a result, between 1961 and 2000 the average population per bank branchfell tenfold from about 140 thousand to 14000 (Burgess & Pande, 2005) and theshare of institutional agencies in rural credit increased from 7.3% 1951 to 66% in1991.

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    These impressive gains were not without a cost. Government interventions throughdirected credit, state owned Rural Financial Institutions (RFI) and subsidised interestrates increased the tolerance for loan defaults, loan waivers and lax appraisal andmonitoring of loans. The problem at the start of 1990s

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    looked twofold, the institutional structure was neither profitable in rural lending norserving the needs of the poorest. In short, it had created a structure, quantitativelyimpressive but qualitatively weak.Microcredit emergence in India has to be seen in this backdrop for a betterappreciation of current paradigm. Successful microfinance interventions across theworld especially in Asia and in parts of India by NGOs provided further impetus. In

    this backdrop, NABARDs search for alternative models of reaching the rural poorbrought the existence of informal groups of poor to the fore. It was realized that thepoor tended to come together in a variety of informal ways for pooling their savingsand dispensing small and unsecured loans at varying costs to group members onthe basis of need. This concept of Self-help was discovered by social-developmentNGOs in 1980s. Realising that the only constraining factor in unleashing thepotential of these groups was meagerness of their financial resources, NABARDdesigned the concept of linking these groups with banks to overcome the financialconstraint. The programme has come a long way since 1992 passing through stagesof pilot (1992-1995), mainstreaming (1995-1998) and expansion phase (1998onwards) and emerged as the worlds biggest microfinance program in terms ofoutreach, covering 1.6 million groups as on March, 2005. It occupies a pre-eminent

    position in the sector accounting for nearly 80% market share in India.Under the programme, popularly known as SHG-Bank Linkage programme there arebroadly three models of credit linkage of SHGs with banks. However, the underlyingdesign feature in all remains the same i.e. identification, formation and nurturing ofgroups either by NGOs/other development agencies or banks, handholding andinitial period of inculcating habit of thrift followed by collateral free credit from bankin proportion to the groups savings. In accordance with the flexible approach, thedecision to borrow, internal lending and rate of interest are left at the discretion ofgroup members. Its design is built on combining the collective wisdom of the poor,the organizational capabilities of the social intermediary and the financial strengthof the Banks.

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