The Microfinance Industry in India

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.

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 highlevels of non-performing assets often cripple much of this infrastructure."

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. 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) 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) - 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.

Excerpts:
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 nonfinancial 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%. Issue:
Evaluate and analyze the trends and new developments in microfinance industry in India. Do you think Microfinance has a better future in India?