This article is written by  Raksha Yadav pursuing a Diploma in Law Firm Practice: Research, Drafting, Briefing, and Client Management.  This article has been edited by Ruchika Mohapatra (Associate, Lawsikho). 

This article has been published by Sneha Mahawar.

Introduction

The term ‘Microfinance’ itself defines its meaning. It is a banking facility that is provided to unemployed persons and any individuals or groups who have inadequate income from their current earning sources to suffice for their day-to-day expenses.

Microfinance is a service that also includes microcredit which provides credit to its poorer clients. Though microcredit and microfinance are often used interchangeably, there are some differences. Under microcredit, financial assistance is given to the clients but in microfinance loans and other services such as insurance, saving accounts are provided to the borrowers. Therefore, microfinance has a broader meaning than microcredit.

Many entrepreneurs have innovative ideas and plans but they do not have sources of finances and taking loans from the market is full of risks and challenges and few people prefer to invest their capital into new startups whereas, microfinance provides a source to entrepreneurs who are willing to start their own business with low capital and allows small businessmen to take loans for their business safely or ethically. It helps the people to develop the sources of their livelihood or provide employment to the other person. To develop the nation and contribute to the economy of the country it is required to develop small businesses at the local level. It is in developing countries such as Uganda, Indonesia, Serbia, and Honduras that most of the micro-financing services seem to be occurring. And according to the World Bank, there are 500 million people who are getting benefits from microfinance services.[1] In India, there are several institutions for microfinance.

Types of microfinance

The different types of microfinance are the following:

  1. Joint liability group
  2. Self-help group
  3. The Grameen Bank Model
  4. Rural cooperatives

Joint liability group or JLG

JLG is a group of 5-10 persons who take loans for agriculture and their operations. Under this group, every person is liable for their credits. The group  can invest loans for various purposes under this.

A self-help group or SHG

It is a formal or informal group of 10 to 20 members. These members are small entrepreneurs who have the same background and work on similar activities. Under this type, the interest rate is low and for women, it is fixed.

The Grameen Bank Model

The Grameen model starts with two people but later the numbers will be increased when the loan will have been paid. Under this type of structure, the field manager or a unit manager communicates with the families living in the villages. This system aims to develop the rural area and financially independent the backward classes.

Rural cooperatives

The size of rural cooperatives is 70 to 80 members in every group and all the members approach financial institutions together. The main purpose of this is to lend the loans for agriculture purposes.

History of Microfinance

Microfinance is financial services like saving accounts, insurance funds, and credit that are provided to the poor and low-income people to raise their earnings and living standard in society. The concept of microfinancing has been traced to the middle of the 1800s after theorist Lysander Spooner had written about the benefits which entrepreneurs and farmers were getting from small credit thus, rising above the poverty line. Independently to Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to support farmers in rural Germany. A Nobel prize winner, Muhammad Yunus introduced the concept of microfinance in the form of the Grameen Bank of Bangladesh. Later on, the National Bank for Agriculture and Rural Development (NABARD)  adopted this concept in India. Muhammad Yunus is also known as ‘Father of Microfinance.

A few features of microfinance are mentioned below

  1. It provides loans to the people who live below the poverty line without security.
  2. The members of self-help groups can also enjoy microfinance.
  3. NGOs decide the terms and conditions for the poor people.
  4. The main purpose of microfinance is to generate income
  5. And the tenure for a loan is short.

Importance of microfinance

Assistance to poor people

The main purpose of microfinance is to provide financial support to poor people or low-income persons. It has a wide range of finance. Those people who can not avail of loans from the normal banking system can easily get them from microfinance as there is a less complex system compared to the banks. It allows them to get the loans at a cheaper rate.

Poverty

India is a developing country where there is a constant rise in the number of unemployed people and also in the number of startups being established each year. Most startups fail due to issues with regard to ideas or finance, and it is in these circumstances that microfinance provides loans to new entrepreneurs and small businesses. It aims to generate employment and contribute substantially to the economy of the country.

Women empowerment

Self-help groups are the best option for women to enable them to start their work easily. It also provides financial freedom to women. 50% of self-help groups are formed by women only. It helps make women socially and economically strong.

Personality development

When any person starts his own business, lots of skills have been developed such as leadership, cooperation, and facing challenges.

Contribution to society

Microfinance helps to begin a new business which creates an earning source for many persons and it also contributes to creating an employment opportunity.

Microfinance institution

The institutions which provide microcredit or microfinance are a boon to the borrowers who do not avail of loans from the bank. It supports the lower section of society, especially women to come forward and start their businesses. The top microfinance companies of India are listed below-

Microfinance CompanyLoan amountInterest rate
Equitas Small FinanceUp to 25,000More than 25,00024% p.a23% p.a
ESAF Microfinance & Investments (P) LtdRs.1000- Rs.1 Lakhs22%-26% p.a
Fusion Microfinance Pvt. LtdRs.3000- Rs.60,00021%-21.5% p.a
Annapurna Microfinance Pvt LtdRs.1500- Rs.25 lakhs18% -26%p.a
Arohan Financial Services LtdRs.11000- Rs.50,00020.70%-21.25% p.a
BSS Microfinance LtdRs.8000-Rs.60,00025% p.a
Asirvad MF LtdRs. 2498-Rs.45,00021.70%

Regulation of microfinance

In 2010, in a tragic incident that took place in the state of Andhra Pradesh,  57 microcredit debtors committed suicide which create a huge crisis in the microfinance sector. In 2012 at the Lok Sabha, ‘The Micro Finance Institutions (Development and Regulation) Bill, 2012’ was introduced. It provides a framework for microfinance development and its regulations in the country. The Reserve Bank of India formed the Malegam Committee under the chairmanship of Y.H. Malegam introduced Andhra Pradesh Microfinance Ordinance 2010 which aims to restrict such incidents and low rates for repayment but it caused  a huge loss for the microfinance sector. A sub-committee of Malegam gave recommendations to the Reserve Bank of India which were accepted. Microfinance Institutions (Development &Regulation) Bill 2011 was introduced in May 2012 in Lok Sabha. The main highlights of the bill are the following:

  1. The Reserve Bank of India has the authority to regulate microfinance and set limits on the lending rates and provide guidelines for microfinance institutions.
  2. This Bill has also provided for the RBI to manage the MicroFinance   Development Fund which can be used for loans, refinance, and investment of microfinance institutions.
  3. To monitor the microfinance sector at the central level, state, and district level it is necessary to set up councils and committees.
  4. It is required to create a grievance redressal mechanism.
  5. The RBI has proposed to lift the interest cap from a microfinance institution and all the microloans should be issued on the common rules and regulations.

Almost 10 years after the Malegam Committee Report of 2011 that helped establish micro-finance as a legitimate asset class, the Reserve Bank of India (RBI) released its Consultative Document on Regulation of Microfinance in the year 2021. As per the RBI’s proposal, the Microfinance loans for households or an annual household income should mean collateral-free. The maximum limit for rural is Rs 1,25,000 and for urban or semi-urban areas the limit is Rs 2,00,000.

As a result, the RBI policy covering microfinance activities of MFIs covers only 30 percent of all the MFIs in India, so the remaining 70 percent are not restricted by policy measures such as loan caps and lender limit norms. Despite the fact that some NBFCs and MFIs have scaled up and have low expenses, the lending rate for microcredit remains high. This blog looks at the key issues in the consultation paper.

In its recent proposal, the RBI hopes to stop the restriction that borrowers can borrow only from two lenders. It has been argued that the current two-lender rule prevents over-indebtedness and makes loan tracking easier. The RBI proposes to do away with the interest rate cap on microfinance loans. Setting interest rates for NBFCs and MFIs has created an unintended benchmark for the industry, even if banks are able to achieve economies of scale by having lower costs of funds.

RBI has mooted capping the payment of interest and repayment of principal for all outstanding loan obligations of the household as a percentage of the household income, subject to a limit of a maximum of 50%. All the entities have to permit the borrowers to repay weekly, fortnightly, or monthly installments as per their choice and there can be no prepayment penalty.

Conclusion

Microfinance is a financial tool for individuals or groups of people who have low income or no income, who can approach microfinance institutions for a loan. This facility reduces the barriers for all the people who are willing to start their own business at their rules but either they do not have the proper source to raise capital from the market or the investors hesitate to invest in the startups. The banking system puts huge interest rates on loans sometimes which causes huge losses for the person. The Reserve Bank of India is the authority to regulate microfinance in India and it puts a lower interest rate on microfinance loans.

According to my findings in India, there are a large number of young people who are unemployed despite the fact that they have the option to obtain loans from microfinance institutions and begin working. It is preferable to be an employer rather than an employee.

References


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