The Microfinance Industry in India

Paper Presentation

Abstract:

This industry report presents a detailed overview of the microfinance industry in India.
The advent of new millennium witnessed significant developments in the Indian
microfinance industry, which attracted the attention of several private sector and foreign
banks.

The report analyzes the potential of Indian microfinance industry and examines the recent
polices of Indian government to boost the growth of the industry. It describes various
microfinance models popular in India and includes a note on the leading players in the
Indian microfinance industry. Finally, the report examines the challenges facing the
industry in the near future.

Microfinance in India is approaching a historic 'tipping point' that could lead to a

massive poverty reduction in the next five to ten years." 1

- Grameen Foundation US in 2005.

"Microfinance is not a charity. It is a way to extend the same rights and services to low-
income households that are available to everyone else. It is recognition that poor people
are the solution, not the problem." 2

- Kofi Annan, Secretary General, United Nations in 2004

Introduction

India has one of most extensive banking infrastructures in the world. However, millions
of poor people in India do not have access to basic banking services like savings and
credit. In the mid-1990s, about 70% of India's population lives in rural areas which
account for only 30% of the bank deposits.

About 70% of the rural poor do not have bank accounts and 87% of them do not have
access to credit from banks.3 In the same period, the share of non-institutional agencies
including traders, money lenders, friends and relatives in the outstanding cash dues of
rural households was 36%.4

In the past, both public and private commercial banks in India perceived rural banking as
a high-risk, high-cost business i.e. a business with high transaction costs and high levels
of uncertainty. Rural borrowers, on their part, felt that banking procedures were
cumbersome and that banks were not very willing to give them credit.

Commenting on the problems faced by the microfinance industry in India, YSP Thorat,
managing director of National Bank for Agriculture and Rural Development (NABARD),
and Graham AN Wright, an international expert in microfinance, wrote, "Poor credit-
deposit ratios, unsustainable lending and high-levels of non-performing assets often
cripple much of this infrastructure."5

In 1954, All India Rural Credit Survey Committee recommended expansion of the
cooperative credit system to cater to the credit needs of the rural poor. The regional rural
banks (RRBs) were incorporated in 1976. By the mid-1970s, the banking sector was
operating as a three-tier system. The first tier consisted of commercial banks, RRBs
formed the second tier, and cooperative banks formed the third tier. About 49% of all
scheduled commercial banks operated from rural areas. In the early 1980s, the Indian
government realized the need for microfinance to provide the rural poor with savings and
microcredit services. Loans available through microcredit schemes were more accessible
to the poor people as compared to bank loans. It also compared favorably with non-
institutional money lenders in terms of cost.

Introduction Contd...
In the late 1990s, the microfinance business was boosted by the innovative initiatives take
up by microfinance institutions (MFIs), non-governmental institutions (NGOs) and
banks. They offered micro-credit i.e. credit provided to poor people for financial and
business services and for self employment in rural areas. It fulfilled their basic needs and
emergency requirements. The microfinance business had the ability to reach the most
deserving people and also increased the repayment rates for banks, which were, at the
time, burdened by mounting non-performing assets (NPAs) on the rural credit extended
by them.

Background Note

In the early 1980s, NABARD study found that though the network of rural bank branches
had been trying to create self employment opportunities by providing bank credit for over
two decades, many poor people remained outside the purview of the formal banking
system. The existing banking policies, procedures and systems including deposit and loan
products were not tailored to the requirements of the poor. They required better access to
services and products rather than subsidized credit. The study concluded that there was a
pressing need to improve access to microfinance. It therefore recommended that
alternative policies, systems and procedures be put in place in order to boost the growth
of microfinance in India.

The Reserve Bank of India (RBI)6 and NABARD were actively involved in spreading the
network of commercial banks in rural areas, especially after nationalization. RBI had
made it compulsory for all private sector banks to open at least 25% of their branches in
rural and semi-urban areas.

It had also stipulated that 40% of the net bank credit should be allotted to sectors
categorized as priority sectors, like housing, rural development and agriculture. With
these measures, commercial banks did move into rural areas but the advances given to the
poor remained very low. To improve the accessibility of the existing banking network to
the poor, the Self Help Group (SHG)7 - Bank Linkage Model was launched in 1992 with
a pilot project for promoting 500 SHGs. The objective of the microfinance initiatives was
to facilitate empowerment of the poor, while pursuing the macro economic objective of
overall economic growth. In 1995, the RBI set up a working group to study the
possibility of linkages between informal SHGs and banks...

Types of Microfinance Institutions

Microfinance institutions develop and deliver a range of financial products for the poor.
There are three categories of microfinance institutions. They are:

NON-PROFIT MFIS/NGO MFIS

These are Societies under the Societies Registration Act, 1860 or corresponding State
Acts.

Others in this category are Public Trusts under the Indian Trust Act 1882, and non-profit
companies under Section 25 of the Companies Act, 1956. There are several NGOs which
are registered as trust/society and have helped the SHGs form into federations.
Federations are formal institutions and carry out both non-financial and financial
activities including social and capacity building activities, SHG training, and promotion
of new groups, apart from financial intermediation.

These institutions cannot undertake financial intermediation activities on a large scale, as

they are prohibited from carrying out any commercial activities...

Microfinance - Major Players

The major players which were instrumental in the growth of microfinance industry in
India included NABARD, SIDBI, Rashtriya Mahila Kosh, FWWB and SHARE Microfin
Limited.

NABARD

NABARD was established in 1982 to provide credit to the rural sector. NABARD was a
pioneer in microfinance programs in India.
The bank's vision is "to facilitate sustained access to financial services for the unreached
poor in rural areas through various microfinance innovations in a cost effective and
sustainable manner."

By 2005, NABARD's SHG-Bank Linkage program had emerged as one of the largest
microfinance programs in the world. NABARD also collaborated with NGOs, MFIs,
banks and governmental agencies in order to use other models of rural credit like the
Grameen Model and the individual banking model.

Encouraged by the success of the SHG program, NABARD planned to link 1 million
SHGs by 2007 and reach 100 million rural poor...

The Future

Many private and foreign banks have unveiled their plans to enter the Indian
microfinance sector because of its very low NPAs and high repayment rate of more than
95% in spite of offering loans without any collateral security.

The main reason for high repayment rates was that the loans were managed at the
community level. Borrowers took loans to improve their standard of living and start a
small business. If the repayment was done in time, only then were more loans given.
According to Udaia Kumar, Chairman and Managing Director, SHARE Microfin
Limited, "In all cases there is no security taken. We don't have a legal system. We build a
relationship with the client. We motivate them, train them, and give them the confidence
that they have the capacity to handle. We ensure that the money is used for the purpose
that they have taken. We ensure that they make profits. Then definitely they will come
back with the repayment. Our repayment rates are 100%...

Exhibits

Exhibit I: State Wise Distribution of SHGs (as on March 2004)

Exhibit II: Number of SHGs Formed by Public Sector Banks - Credit Provided
Exhibit III: SHG-Bank Linkage Model Wise Cumulative Position (As On March 2004)
Exhibit IV: Sources of MFI Funding
Exhibit V: SHG-Bank Linkages Program (Operational Highlights 2003-04)
Exhibit VI: SHG Bank Linkage Program (Support to RRBs Functioning as SHPI)
Exhibit VII: SHG Bank Linkage Program (Grant Assistance Sanctioned to Banks Under
Cooperatives as SHPI)
Exhibit VIII: Role and Responsibilities of Farmers' Club Volunteers
Exhibit IX: Promotion of SHGs Through Farmers Clubs
Exhibit X: Identification of Mature Groups for Promotion of Micro Enterprises

Keywords:

Microfinance in India, Microfinance Models, Regional Rural Banks, NABARD, Self

Help Groups, SHG-Bank Linkage Program, SHARE Microfin Limited, SIDBI, Liquidity
Management Support Scheme, Friends of Women's World Banking and Microfinance
Rating