Role of microfinance sector in Indian Economy

Context:

• Microfinance institutions (MFIs) have played a leading role to bring inclusive finance into the development mainstream. 

More about the news: 

• Promoting Women Entrepreneurship: They have engineered an efficient business model that utilizes the prevailing social collateral to ignite women’s entrepreneurship spirit. 
  • Microfinance Institutions Network (MFIN) launched a TV commercial ‘Microfinance – har hausle ke saath’. Its aim is to spread awareness on how the microfinance sector helps the low income financially excluded women realise its earning potential by granting quick and simple access to credit with no collateral.
  • Satin Creditcare Network Limited (SCNL), a microfinance company, sanctioned loan to rural women and helped expand weaving business.
• Microfinance outreach: They have enabled microfinance outreach in nearly 85 per cent districts of India with more than two lakh frontline employees distributing credit and associated services.
• Role in digital transition: Regular interaction with customers by using robust technology platforms has given them presence in 729 districts and helped create a strong bridge between physical and digital India. 
• Strong regulation ecosystem: The sector is supported by a strong ecosystem of robust regulations, the JanDhanAadhaar-Mobile (JAM) trinity, well functioning credit bureaus, and support from banks under priority sector lending.
• Inclusivity: Audio-visual content in vernacular languages is widely utilised to continuously impart financial literacy.They have

What are Microfinance institutions (MFIs)?

• MFIs are financial companies that provide small loans to people who do not have any access to banking facilities. The interest rates provided by microfinance institutions are lower than those charged by normal banks. The services under it includes:
  • Microloans: It allows individuals to borrow small sums of money without providing any collateral In India, all loans that are below Rs.1 lakh can be considered as microloans
  • Microsavings: These savings accounts are available for entrepreneurs to operate with no minimum balance.
  • Microinsurance: They offer insurance coverage to borrowers of microloans for a comparatively low premium.

Regulatory Framework:

• MFIs are governed by the RBI’s Non Banking Financing Company–microfinance institutions (NBFC-MFIs)- Directions, 2011, and the Ministry of Corporate Affairs. 
• RBI recognised self-regulatory organisation(SRO): The RBI regulations for microfinance provide an effective framework for customer protection. This framework is supported by RBI recognised self-regulatory organisation (SRO). 
  • The SRO supports the MFIs in the implementation of the regulations, takes initiatives for capacity building, improves governance through regular guidance and surveillance and provides a platform for resolving sector level challenges.
• In March 2022, the Reserve Bank( RBI)introduced an updated and all-encompassing harmonised framework for microfinance loans Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022. It’s major provisions include:
  • Microloan Eligibility: Under the updated guidelines, households with annual incomes of up to ₹3 lakh are now considered eligible for microloans.. 
  • Loan Pricing cap: The cap on loan pricing has been eliminated, facilitating greater reach within current markets and enabling entry into previously untapped ones.
  • Limiting Prepayment penalties: Microfinance loans will no longer incur prepayment penalties.

Groups Organized by Microfinance Institutions in India:

1. Joint Liability Group (JLG): This is usually an informal group that consists of 4-10 individuals who seek loans against mutual guarantee. 
   • Beneficiaries: The loans are usually taken for agricultural purposes or associated activities. Farmers, rural workers, and tenants fall into this category of borrowers. 
   • Loan Liability:  Each individual in a JLG is equally responsible for the loan repayment in a timely manner. 
2. Self Help Group (SHG): A SHG is a group of individuals with similar socio-economic backgrounds who come together for a short duration and create a common fund for their business needs. There is no requirement of collateral in this kind of group lending. 
3. Grameen Model Bank: It has inspired the creation of Regional Rural Banks (RRBs) in India. 

• Its goal was to provide microcredit services for financially disadvantaged groups, women in particular, enabling them to break the poverty cycle by making investment first with small loans and then generating returns.

     4. Rural Cooperatives: The resources of poor people are pooled in and financial services are provided from             this fund. 

How are MFIs Funded:

• Member and customer deposits:This is applicable to MFIs that are organised as mutual funds, cooperatives, and microfinance banks offering savings products.
• Subsidies and grants: Grants are more prominent when the MFI is just being set up.
• Own capital: The microfinance institution’s own finance/capital accounts for a part of the funding extended to borrowers.
• Loans from partner banks: This is the primary source of funding for an MFI.
• Funding received from public investors: Bilateral or multilateral organisations offer funds to MFIs. This is a source of long-term funding for the MFI.
• Funding received from private investors: These funds are supplied directly to the MFI or through investment funds that specialise in microfinance. This is also a source of long-term funding for the MFI

Significance of MFIs:

• Financial Inclusion: MFIs bridge the gap between the unbanked population and the formal financial system and promote financial inclusion fostering economic empowerment and stability for underserved communities.
• Women Empowerment: By providing women with the means to start or expand their businesses, microfinance contributes to closing the gender gap and creating more equitable opportunities for women.
• Rural economic development: It provides agricultural loans to farmers, enabling them to invest in agricultural resources leading to higher farmer income and overall rural development.
• Social and economic development: By granting individuals and communities access to financial services, it creates opportunities for job creation, higher living standards, and reduced inequality. 
• Financial literacy programs: By enhancing financial literacy, with the help of financial literacy programs and training for their clients, microfinance fosters responsible financial behaviour and empowers individuals to maximise the benefits of their financial resources

Status in India:

• Microfinance customers: According to the Microfinance Institutions Network’s estimations, the industry serves 66 million customers at the end of the same period, resulting in a penetration of 32 per cent. 
• Sector growth: The industry continues to witness a healthy customer addition, with 14 per cent growth in FY23 coupled with normalised on-demand collection efficiency largely above 98 per cent. 
• Market penetration: A portion of customers has surpassed the traditional microfinance limit of an annual household income of Rs 3 lakh. 
  • Strong historical performance and improved business results have prompted these customers to shift into personal lending areas that involve larger loan amounts. 
• Limit of non-microfinance loans: Under the current rules, the limit for non-microfinance loans has been raised to 25% of net assets. This aims to accompany customers throughout their financial journey, identify opportunities and create suitable financial solutions.
• Reaching last mile: System of disbursing small loans, credit, insurance, access to savings accounts, and money transfers to MSMEs and underbanked entrepreneurs or individuals is gradually penetrating the unserved segments of society.
• Digitalisation Initiatives: They have been aligned to the rapid diffusion of smartphones and growing comfort of borrowers with digital modes of transactions.
  • Today, nearly 100 per cent of loans are digitally disbursed directly into the bank account of the borrowers and an increasing number of repayments are also being done digitally.
• MFI Model evolution: In terms of non-credit offerings, notable innovations are emerging in the realm of payment, savings, and micro-insurance products. These developments highlight the MFI model’s evolution beyond traditional credit distribution methods. 
• Technology Adoption: MFIs are progressively integrating technology to boost operational efficiency, enhance underwriting models, and minimize costs, employ audio-visual content in regional languages to consistently promote financial literacy.

Challenges Faced by MFIs in India:

• High interest rates: Some microfinance institutions in rural India charge relatively high interest rates to cover operational costs, which can place a burden on borrowers with limited financial resources. 
• Narrowing down on the appropriate lending model: SHG or JLG models of lending are chosen by MFIs at random. Such an unscientific model choice increases the risks of borrowings for the weaker sections beyond what they can bear and repay.
• Reliance on commercial banks: Most NGO-MFIs in India rely on commercial banks to ensure stable funding having higher interest rates and shorter lending terms. MFIs also finding it difficult to grow independently without any support from anchor investors.
• Lack of infrastructure: Limited access to transportation, communication networks, and banking facilities can hamper the efficient delivery of financial services and hinder the growth of microenterprises.
• Skewed Distribution: In terms of regional distribution, eastern & north-eastern regions of the country have the largest share at 37 per cent followed by south at 27 percent and west at 15 per cent and 82 per cent of the loan portfolio is concentrated in ten states.
• Social and cultural barriers: Traditional gender roles, social norms, and caste-based hierarchies restricts the participation of certain segments of the population, particularly women, in microfinance programs.
• Dependency for funding: Funding Micro lending institutions are highly dependent on the market for funding. This means that at the smallest of events affecting business, MFIs find it difficult to procure financing.
• Transition to traditional banking: Several microfinance institutions have converted into small finance banks and thus, they can lend at higher interest rates besides,  accessing low cost deposits.
• Disadvantage for small entities: The top 10 MFIs  find it easy to get bank loans or equities; the smaller entities are usually at a disadvantage while accessing loan.

Way Forward: 

• Lower interest rates: It is crucial to ensure affordable and transparent interest rates to prevent over-indebtedness and protect the welfare of borrowers.
• Addressing infrastructure gaps: Maintaining robust infrastructure is essential to enhance the effectiveness of microfinance programs in rural areas.
• Bridging social and cultural barriers: Sensitizing communities, empowering women through targeted interventions, and fostering an inclusive environment are crucial to overcome these barriers and ensure equal access to microfinance opportunities.
• Supportive Regulatory Environment: Simplifying MFI licensing and removing growth-hindering regulations are necessary steps. 
• Serving unserved regions: Tax incentives in underserved areas like aspirational districts or hilly tracts can foster MFI expansion and financial inclusion. 
• Financial literacy programs: Promoting responsible borrowing requires financial literacy programs for borrowers, aided by initiatives like NABARD’s capacity-building efforts. 
• Banks stepping into microfinance: By leveraging their cost-effective deposit capabilities, banks could extend microloans directly to the rural population.

News Source:Business Standard