The Future of Microfinance in India:

What is so exciting about Indian Microfinance?A Task Force on Microfinance recognised in 1999 that microfinance is much more than microcredit. It stated: "Provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and or urban areas for enabling them to raise their income levels and improve living standards". The Self Help Group promoters emphasise that mobilising savings is the first building block of financial services. For many years, the national budget and other policy documents have almost equated microfinance with promoting SHG links to the banks. The Central Bank notification that lending to MFIs would count towards meeting the priority sector lending targets for banks offered the first signs of policy flexibility towards MFIs. One could argue that MFIs are small and insignificant, so why bother. The larger point is about policy space for innovation and diversity of approaches to meet large unmet demand. The insurance sector was partially opened to private and foreign investments during 2000. Over 20 insurance companies are already active and experimenting with new products, delivery methodologies and strategic partnerships. Microfinance programmes have rapidly expanded in recent years.  Membership of Sa-Dhan (a leading association) has expanded from 43 to 96 Community Development Finance Institutions during 2001-04. During the same period, loans outstanding of these member MFIs have gone up from US$15 million to US$101 million. The CARE CASHE Programme took on the challenge of working with small NGO-MFIs and community owned-managed microfinance organisations. Outreach has expanded from 39,000 to around 300,000 women members over 2001-05. Many of the 26 CASHE partners and another 136 community organisations, these NGO-MFIs work with, represent the next level of emerging MFIs and some of these are already dealing with ICICI Bank and ABN Amro. In addition to the dominant SHG methodology, the portfolios of ‘Grameen’ replicators have also grown dramatically. The outreach of SHARE Microfin Limited, for instance, grew from 1,875 to 86,905 members between 2000 and 2005 and its loan portfolio has grown from US$0.47 million to US$40 million. Since banks face substantial priority sector targets and microfinance is beginning to be recognised as a profitable opportunity (high risk adjusted returns), a variety of partnership models between banks and MFIs have been tested. All varieties of banks - domestic and international, national and regional - have become involved, and ICICI Bank has been at the forefront of some of the following innovations:  Lending wholesale loan funds.

  Assessing and buying out microfinance debt (securitisation).  Testing and rolling out specific retail products such as the Kissan (Farmer) Credit Card.  Engaging microfinance institutions as agents, which are paid for loan origination and

recovery, with loans being held on the books of banks?  Equity investments into newly emerging MFIs. Banks and NGOs jointly promoting MFIs.

The 2005 national budget has further strengthened this policy perspective and the Finance Minister Mr P. Chidambaram announced "Government intends to promote MFIs in a big way. The way forward, I believe, is to identify MFIs, classify and rate such institutions, and empower them to intermediate between the lending banks and the beneficiaries."

Savings services are needed by many more customers and as frequently as access to phone services. Many poor households value access to savings services and find new providers and arrangements, despite hearing of unreliable savings collectors or even occasionally falling prey to such arrangements. Many customers are rich, literate and lucky to have banks working for them. But many others lack access to safe, secure and accessible savings services for the short, medium and long terms. In the past, many banks sent collectors to gather these savings but problems with monitoring, inability to tackle misappropriation and the rising aspiration of collectors to become permanent staff of public sector banks killed a useful service. The Central Bank has strictly forbidden commercial banks from using agents in collection of savings services. This is unfortunate as: Effective microfinance delivery is about managing transaction costs for providers and customers. A combination of agents and technology can play a powerful role in rightly aligning incentives for the collector and customers, while keeping transaction costs manageable for everyone. The banks can only open so many branches, and fixed and operating costs are high, apart from approvals still needed from the Central Bank to open new branches or close existing ones. The appointment of agents can keep costs manageable and offer greater flexibility to Banks. Banking service may not be able to defy the commercial logic pursued by most other sectors where a variety of retailers provide services to customers, while companies focus on customer needs, product design, quality control, branding, logistics and distribution. Fortunately, the 2005 Budget opened a small window in this area and the Central Bank annual policy recently confirmed discussions on this: "As a follow-up to the Budget proposals, modalities for allowing banks to adopt the agency model by using the infrastructure of civil society organisations, rural kiosks and village knowledge centres for providing credit support to rural and farm sectors and appointment of micro-finance institutions (MFIs) as banking correspondents are being worked out." But it may be noted that between the budget and the annual policy statement, "credit" has again crept in as the key perceived need. A World Bank study assessing access to financial institutions found that amongst rural households in Andhra Pradesh and Uttar Pradesh, 59% lack access to deposit account and 78% lack access to credit. Considering that the majority of the 360 million poor households (urban and rural) lack access to formal financial services, the numbers of customers to be reached, and the variety and quantum of services to be provided are really large. Vijay Mahajan, Managing Director of BASICS, estimated that 90 million farm holdings, 30 million non-agricultural enterprises and 50 million landless households in India collectively need approximately US$30 billion credit annually. This is about 5% of India's GDP and does not seem an unreasonable estimate. A tiny segment of this US$30 billion potential market has been reached so far and this is unlikely to be addressed by MFIs and NGOs alone. Reaching this market requires serious capital, technology and human resources. However, 80% of the financial sector is still controlled by public sector institutions. Competition, consolidation and convergence are all being discussed to improve efficiency and outreach but significant opposition remains; for example, the All India Bank Employees Association has threatened to strike if the Government proceeds with its policy of reducing its capital in public sector banks, merging public sector banks or even enhancing Foreign Direct Investments in Indian private banks. Many speakers at the Microfinance India Conference talked about the significant and growing gap between surging growth in South India, which contrasts with the stagnation in Eastern, Central and North Eastern India. Microfinance on its own is unlikely to be able to address

formidable challenges of underdevelopment, poor infrastructure and governance. The self help group movement is beginning to focus on issues of quality and there were some interesting discussions on embedding social performance monitoring as a part of the regular management information systems. At the time of the conference, a leading and responsible MFI was being investigated by the authorities for charging "high" rates of interest. Per unit transaction costs of small loans are high but many opinion leaders still persist with the notion that poor people cannot be charged rates that are higher than commercial bank rates. The reality of the high transaction costs of serving small customers, their continuing dependence on the informal sector, the fact that most bankers shy away from retailing to this market as a business opportunity, and the poor quality of services currently provided does not figure prominently in this discourse. While the Central Bank has deregulated most interest rates, including lending to and by MFIs, interest rates restrictions on commercial banks for retail loans below US$5,000 (all microfinance and beyond) remain and caps on deposit rates also discourage sharing transaction costs with customers. But most conference participants accepted the imperatives to build sustainable institutions. There is still lot of policy focus on what activities are and are not allowed and not enough operational freedom as yet for banks and financial institutions to design and deliver programmes, and be responsible for their actions. Prescriptions and detailed circulars often limit organisational innovation and market segmentation. As Nachiket Mor of ICICI Bank said at the conference that if the right indicators are monitored and operational freedom and incentives are clear, both public and private banks have the capacity to rapidly address the remaining challenges.  ‘Savings service is the neglected daughter of the family of financial services’. This metaphor is used because of the sustained discrimination against and frequent disregard for savings services, despite their productive and reproductive role in financial services. This is evident from different nomenclature used at both the international (UN International Year of Microcredit, Micro Credit summit) and national levels (Priority Sector Lending; Annual Credit Policy; Credit/ deposit ratio). Savings services can be a useful entry point for the unbanked to build up a history with the formal financial institutions before customers are entitled to other financial services. With the greater spotlight on knowing the customer and the fact that poor households do not have a salary slip, utility bills, clear land titles or unique identity papers, a regular savings record could be the first building block to membership of the formal financial sector. What is more, with savings services, poor customers need to trust the financial institution and not the other way round. Microfinance is not yet at the centre stage of the Indian financial sector. The knowledge, capital and technology to address these challenges however now exist in India, although they are not yet fully aligned. With a more enabling environment and surge in economic growth, the next few years promise to be exciting for the delivery of financial services to poor people in India.In this context, BISWA as an NGO- MFI is rapidly carving its identity. The BISWA module of convergence in micro finance and social development is being watched very keenly by all. In its convergence mode the five services, micro finance, micro insurance, micro enterprise, micro marketing and social development, are being delivered through a single window service system. This unique experiment in elevating poverty is coming through a successful module. 

The Future of Microfinance - Closing Session 2011 Sa Dhan Conference

The Future of Microfinance:

Ms. Jayshree Vyas:The whole movement is going through a very critical time. There is a liquidity crisis, uncertainty – we don’t what kind of regulation will come tomorrow – but we are part of a movement where we are use to struggle.

This is giving us hope that we are going to survive & grow – not because we want to grow but so that poor people can come out of poverty, this is the spirit. Let us be together, think to the future and be optimistic.

Questions from the audience facilitated by Mr. Matthew Titus:

Question 1

-Political risk: What is it that we need to learn from NABARDs experience in dealing with changing politics and coming from the context of agriculture finance.

Mr. Rao Response

-Excerpt: During the first 20 years in this industry it was a partnership, NGO/GOVT/Bankers were working together. However that partnership eventually broke up for differing reasons. Pushing credit beyond the capacity of the poor to utilize it is not the way forward. The crisis with the MFI has introduced the question of whether we should protect the viability of the institutions serving the poor, or the viability of the poor.

Questions 2

-National & State government laws: Going forward what is it that we as MFI practitioners should push forward for the federal and regulatory laws.

Mr. Umarji Response

-One of the major things that needs to be done by MFIs is to ensure that each MFI observes certain norms in recovery practices as well as the Code of Conduct which has been provided by Sa-Dhan. Coercive recovery methods have always existed – (he then cites ICICI Supreme Court case). It would be necessary that the state authorities are taken into confidence and kept informed of the MFIs activities. Lending activities should be informed to the state government as well as recovery practices, etc. This is very important.

Question 3

-What kind of dialogue do we need to consider in this process of getting this newly introduced legislation drafted?

Ms. Sukriti Likhi Answer

-It’s going to be a very open and transparent process and the first meeting is on the 24th of htis month, for which you are invited. You concerns, especially as members of the board, will be heard and considered.

Question 4What do you expect the industry to do in terms of working with the state in working on the regulatory draft and building the industry.

Mr. Thiru

The process of drafting legislation has already started however we can’t stop the activities which are already taking place. It will take a while for the legislation to become a law, maybe 1 of 2 years. However Sa Dhan has provided a Code of Conduct and this will need to be adhered even more strictly so that we have no further problems with MFI operations. In the absence of legislation at the central level the state government will have to govern MFI operations and there will be a lot of pressure on state government to watch MFI operations. In the absence of this central legislation MFIs should use self-discipline in their operations.

Question 5

What is your one wish for the industry?

Jayshree Vyas

Throughout the sessions I have heard one phrase continuously mentioned – Financial Literacy – there is a need for providing financial literacy. To change behaviour on a day to day basis, helping people to understand the importance of saving, protecting lifecycle needs. These kinds of financial literacy programs we had already designed – but now the question of transparency is being raised and that can be addressed by educating the poor.

What we are planning in the school of Micro Finance next year is a full ‘Financial Literacy’ year. We are already working with NABARD, we’re planning on going to the Ministry of Finance and we’re looking for further partnerships with all of our MF organizations. We’re feeling that this is the time to spread the financial literacy movement all over the country.

Matt: What is the role or the message that the government would like to send so that liquidity can open up for Non-Profit Micro Finance institutions?

Likhi: You have to build trust until the regulatory framework comes into force. Once you’re able to generate that trust I don’t believe that the liquidity will be a problem. Given the fact that banks get an advantage by lending to you (MFIs) under priority sector lending – why would they not lend to you? There is no policy not to give you money, no one is banning the banks from giving you money, i think it’s more of a problem with reputation/trust in the institution.

Vyas: Actually when you’re talking about making trust there was not a single MF organization that had defaulted. However after this crisis the issues arose. This is definitely a problem which was created once the act came in; the MFs have created and maintained this trust.

Lihki: Yes, however the legislation will take time. You have to go out and prove your good intentions. Once your proven yourself and re-created the trust the banks will continue to loan.

Matt: Is it possible that NABARD, theoretically, could re-open a re-financing possibility for MFIs?

Rao: Yes, that’s a good point. If the finance is not available to the poor then actions need to be taken. We are not worried about the institution whether its cooperatives or commercial banks – the worry is about reaching the poor.

Matt: Thank you Sir - that would be very welcomed to the industry. However what can the industry do to facilitate this?

Rao: MFIs need low cost funds however the regulatory framework should be in place. Without the regulatory framework there is not much that can be done.

Likhi: The fund would be with SIDBI and it would be available for equity support. For smaller non-profit MFIs who could not raise the required equity the government would be able to provide support.

Matt: Is it possible that state governments could help to provide finance for MFIs operating in their state?

Thiru: The kind of money that’s provided by the World Bank etc. Is not meant for re-financing, it’s made for infrastructure development. That money cannot be used for re-financing. However there is the BRI fund which could be given by banks in order to support BPL families. But banks would have to be convinced that the money was going to BPL families.

Matt: One comment from each of the panellist – what is it in terms of the clients that the industry needs to focus on:

Umarji: I would say continue to work for women’s empowerment

Sukriti: My request is to you who are all very influential in the field. Please help us in the financial literacy part. The poor must understand the products, liabilities and benefits they are getting. We must also put the infrastructure in place to make remittances available. The demand right now – the supply that you’re giving – once they understand what you’re giving the supply is only going to rise.

Jayshree: Go and talk with women. If you are in crisis go and talk with women and ask them for solutions. It shouldn’t be a relationship of just going and giving credit. We need to be empowered from them, but they will also get empowered because they are being informed with what’s going on in the world, why they aren’t getting a loan.

Rao: I think we should work on product differentiation. I think one mistake in the industry in providing only one product to the poor. Empowerment also needs to be documented.

Thiru: As part of the empowerment process financial literacy is a must. A lot of the MFIs in Tamil Nadu have already done this, providing booklets, but that only educates those that can read. Ultimately if the poor women are to be empowered there has to be information. She should be educated on the terms of the loan and what the possibilities are; implications of excessive borrowing would not be as much if we could tell her what the consequences are. Empowerment cannot be complete without literacy on the various terms and conditions of the loans being offered by MFIs.

SKS Microfinance's Vikram Akula: 'Mobile Banking Could Be the Future of Microfinance'Vikram Akula, founder and CEO of SKS Microfinance, launched the company in 1998 to offer small loans to very poor borrowers. Some 10 years later, SKS has become India's fastest growing microfinance institution (MFI), with more than two million borrowers. In the next two years, Akula would like SKS Microfinance, whose backers include venture capitalists such as Sequoia Capital, to grow to eight million borrowers -- which would make it the world's largest microfinance lender, surpassing Bangladesh's Grameen Bank. In an interview with India Knowledge@Wharton at the recent Wharton India Economic Forum, Akula spoke about emerging trends in microfinance.

Knowledge@Wharton:  Let's start by talking about how you got into microfinance. Could you tell us a little bit about how and why?

Akula:  Sure. I was born in India, but grew up in the United States. I'll go back to my childhood here; I used to go back to India quite a bit during school holidays, and I would see the extreme poverty we have in India, and then come back to a suburb of America. It was that juxtaposition of extreme poverty, on the one hand, and extreme wealth that made me say, "Okay, I want to do something to try and eradicate this kind of poverty." So upon graduating from college, I went and worked with an NGO, basically as a field agent, as a loan officer doing microfinance. I saw the tremendous impact that microfinance has on the lives of the poor, but I also thought that you

could do it in a more scalable manner. That's when I left that NGO to set up SKS, the entity that I now run.

Knowledge@Wharton:  I know you've spoken in the past about some of the constraints that face the world of microfinance. For example, lack of capital is always a problem. Lack of capacity is another major issue. And, of course, microfinance also has high transaction costs. What innovations has SKS has been able to bring about to tackle these issues?

Akula:  This is what I call the three "C's" -- the lack of capital, the lack of capacity, and the high cost of doing microfinance. In my analysis, these three constraints have prevented microfinance from scaling up rapidly.

We've done three things to deal with these problems that we think can overcome these constraints. The first is to use a for-profit model to overcome the constraints of capital. The second is to use best practices from the business world to overcome the constraints of capacity. And the third is to use technology to overcome the cost constraints.

Let me say a quick word about each. We believe that even though most microfinance institutions are non-profits -- and even though Professor Yunus [Nobel laureate and founder of Grameen Bank], who's a mentor of mine, talks about microfinance as a social business, meaning not paying dividends -- we believe that in fact, you have to structure things in a for-profit way. You have to pay investors high dividends, because otherwise there's no way you're going to access the kind of capital that poor people need. As a result, we've structured SKS as a for-profit, and that's enabled us to tap into commercial capital and provide unlimited amounts of finance to the poor.

On the second dimension of capacity, if you look at most microfinance institutions, they're structured as NGOs. They're small, they think about a thousand clients, or maybe 10,000 clients. In contrast, a business, whether it's Starbucks or Coke or McDonald's, thinks about millions or tens of millions of customers. We've looked at those types of companies and adopted the techniques that they've used within microfinance. That has given us an extremely fast growth rate.

Finally, when it comes to technology, we've developed an automated management information system because at the end of the day you're doing millions of very tiny transactions. There's a high cost to doing that. Unless you use technology, you'll never be able to bring down the transaction cost and to scale rapidly.

Knowledge@Wharton:  To tackle that last point first, I've heard you use mobile phones to manage transactions. Is that right?

Akula:  We are doing a pilot project right now with mobile phones. Clearly, we think, mobile banking is the future; it doesn't make sense to try and build a retail brick-and-mortar infrastructure in rural India. From a cost perspective, it makes no sense at all. Mobile technology today is robust enough that you can actually very easily do banking. We actually have a very successful pilot that we've done.

The problem is the regulatory environment. The central bank in India has not understood mobile banking and its full potential, and therefore their regulations get prohibitive for us. If those regulations get changed, then clearly this is the investment that we'd make. Mobile banking could be the future of microfinance.

Knowledge@Wharton:  Let's go back now, if you don't mind, to your first point about getting funds from private sources. I understand that SKS has raised funds from venture capitalists. When they invest in SKS microfinance, does that change their expectation of returns? Are they more "gentle" with you because you are lending to poor women, compared to if they were to lend to, say, a technology entrepreneur.

Akula:  We certainly have social investors, who come at it with a double-bottom line approach of making a social impact as well as a for-profit impact. But we also have investors who have a pure commercial interest. Take, for example, Sequoia Capital, the investors in Yahoo, Google, and so on. They're not interested in the social purpose. They're in there because their investors need to earn a high return, so they come in at a pure commercial angle.

Many people think there's a dichotomy between the social purpose and the commercial purpose, but we actually don't think there's a dichotomy. If you do what's right by the borrowers, if you charge reasonable interest rates, provide good service, not only is that intrinsically the right thing to do, but that's the way to build a good business, especially when you are working with the base of the pyramid, because the base of the pyramid customer is extremely loyal. If they feel they are being exploited or taken advantage of, they will turn on you in a second. But if you treat them well, they will stay with you. That becomes how to build a long-term healthy business. That's what our commercial investors want.

Knowledge@Wharton:  Typically, what are the interest rates for microfinance loans?

Vikram:  We charge an average interest rate of 24%. That seems extraordinarily high, but let me put this in context. Informally the village money lender, the loan sharks, will charge anywhere from 50% to as high as 1,000% interest. So, we are charging much less than what they charge.

I also submit that our interest rate is actually the lowest cost financing available to the poor. Even though a retail bank might charge, let's say, 12%, or a subsidized government loan might cost 7%, if you actually talk with borrowers and ask them how many trips they are making to a bank branch, what are the lost wages, the bus fares, the brokers fees, and sometimes bribes are paid to access that 7% loan, they actually end up paying much higher than 30%.

So, at 24%, we are asking the lowest cost financing available to the poor. The poor are earning such high returns on their micro enterprises that they have no problem paying 24% if their returns are averaging 100% or so.

Knowledge@Wharton:  It sounds like the rates you charge seem to be lower than those that credit card companies charge people here [in the U.S.].

Akula:  That's true.

Knowledge@Wharton: Knowledge@Wharton had interviewed Muhammad Yunus sometime ago. He brought up an interesting point -- perhaps because of the situation you are describing, he argued that some microfinance companies might need to be regulated because of the exorbitant interest rates they charge. Do you agree with that perspective?

Akula:  I think the best way to tackle interest rates is competition. Certainly in some areas you've got microfinance institutions (MFIs) that are trying to extract and charge high interest rates. Over time, you will see competition pulling that down. When we compete in different areas, the first thing we see is the local incumbent MFI will immediately drop its interest rates. We think that's the best way to do it. We wouldn't be in favor of regulation that caps interest rates. We are afraid that will prevent other competitors from coming in and prevent the more robust way of lowering interest rates. Still, there is a scope for regulation when it comes to ethical practices, such as truth in advertising, and transparency with your borrowers. Those are the types of things that will make a big difference to making sure that the sector remains healthy and prevents the bad apples from coming in.

Knowledge@Wharton:  As you've gone about building SKS Microfinance, what has been your single biggest challenge so far and how have you overcome it?

Akula:  The biggest challenge so far, and clearly the challenge going forward, is the political environment. The fact is that microfinance is still very much misunderstood by politicians and bureaucrats. People hear the interest rates, and they don't understand the context, and they feel something exploitative is going on.

We spend a lot of time trying to educate politicians and bureaucrats so they understand the power that microfinance has and understand how it works to actually help the poor. The poor certainly understand this, our customers do. They come back to us year after year. It's the political elite that doesn't understand it and sometimes misuses microfinance for political ends. That's been the biggest challenge.

Knowledge@Wharton:  How many customers do you have, and who is your typical borrower?

Akula:  Currently we have two million customers spread across 25,000 villages in 15 states of India. The typical borrower, typical first loan is about 8,000 rupees or about $200. A woman might take a loan to buy a cow, and then sell the milk, and then repay the loan on a weekly basis. She might do a small village grocery; she might do vegetable vending or another type of trading activity. What we see is there's a very high return on investment, and each year she's eligible to take a larger loan. So even though $200 might seem relatively small, eventually we'd like to see borrowers moving into $1,000 loans. Then you begin to see huge impacts in terms of poverty eradication.

Knowledge@Wharton:  Where do you see SKS being five years from now?

Akula:  I'll give you our two-year goal. We have close to two million clients now. We hope to scale to eight million clients in the next two years. Today we are largest MFI in India. If we hit that number of eight million, we will become the largest MFI in the world. In terms of scale,

that's one thing we would like to do.

We also have a vision to use microfinance, the channel we've created, to distribute the full range of finance services. Now we do primarily credit, and some insurance, but we know poor people need savings, they need remittances, and the other products as well. We want to introduce a range of different products.

We also think there are opportunities to leverage this channel to introduce non-financial products as well. So, currently, we're in discussions with groups about doing education loans and talking with education providers to provide low-cost schools. We have a health insurance product that we are teaming up with local hospitals. We are giving loans to buy cell phones, to buy consumer package goods. We think there is a whole range of non-finance products that poor people need that we could deliver through our channel.

Understanding Microfinance

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 programmes 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. The lack 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 in India

Microfinance based credit delivery mechanism ensures viable financial services to address issues like actualising equitable gains from development activities on a sustained basis, and plays a vital role in fighting poverty.

National Bank of Agriculture and Rural Development - External website that opens in a new window (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.

Dominant Models of Microfinance in India

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 credit limit by the banks.

MFI-Bank Linkage Model: This model covers financing of Microfinance Institutions (MFIs) by banking agencies for on-lending to SHGs and other small borrowers covered under microfinance sector.

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.

Support in the Formal Sector

National Bank for Agriculture and Rural Development - External website that opens in a new window (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.

Rashtriya Mahila Kosh - External website that opens in a new window

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

Small Industries Development Bank of India (SIDBI) - External website that opens in a new window

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.

Tamil Nadu Womens' Development Corporation - External website that opens in a new window

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

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 de-sensitize MFIs from expanding their reach to the very poor.

The high growth of the industry has meant MFIs have, at times, ignored due diligence and 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 - External website that opens in a new window 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 potentials of the SHGs.

Impact & Future of Microfinance in India

Microfinance has been a major success & is growing fast across the country. It has proved to be a powerful tool in initiating a cyclical process of growth and development. The general recovery rates for all services have been very high for all MFIs. Although interest rates are higher than the formal sector due to the perceived risk involved, MFIs still undercut the local moneylenders by a large margin.

Although microfinance has helped in providing social and economic empowerment, it cannot eradicate poverty by itself. Good governance, security, health, education and financial inclusion all work hand-in-hand at poverty alleviation.

Availability of credit may be a trigger for growth but the credit amount, by design, is too low to eradicate poverty. The Government thus has adopted a multi-pronged strategy to provide credit to the economically backward, with microfinance positioned strategically as a livelihood generator.

With the steady growth in reach of microfinance, the SHGs and their federations provide the social space and the political power that the poor need to overcome these hurdles. The scope for expansion in the sector remains the major draw for socially inclined profit-motive organisations & non-profits, both.