Microfinance – UPSC Economy Notes

Definition: Microfinance involves providing credit and other financial services, such as insurance, in very small amounts to individuals in rural, semi-urban, and urban areas. The aim is to empower the poor, enabling them to increase their income levels and improve living standards. Microfinance Institutions (MFIs) are entities that offer these financial services.

Scope of Microfinance:

1. Credit Needs:
   • Covers consumption and production loans for various farm and non-farm activities of the poor.
   • Includes credit for housing and shelter improvements.
2. Dominant Model in India:
   • SHG-Bank Linkage Programme:
     • Self-Help Group (SHG): A group of micro-entrepreneurs with a similar social and economic background.
     • Objectives:
       • Regularly save small amounts.
       • Contribute to a common fund.
       • Address emergency needs on a mutual help basis.
     • Emerged as the dominant microfinance dispensation model in India.
3. Other Microfinance Models:
   • Various models have evolved, contributing significantly to microfinance channels.
4. Foreign Participation:
   • Government allows ‘Micro Credit/Rural Credit’ activities for FDI/Overseas Corporate Bodies (OCB)/NRI investment to encourage foreign participation in microcredit projects.

Types of Micro Credit Providers in India:

• Domestic Commercial Banks: Public Sector Banks, Private Sector Banks, and Local Area Banks.
• Regional Rural Banks.
• Co-operative Banks.
• Co-operative Societies.
• Rent providers like Societies, Trusts, etc.

Concerns in Indian Microfinance:

1. High Interest Rates:
   • Unjustifiably high rates of interest.
2. Lack of Transparency:
   • Lack of transparency in interest rates and other charges.
3. Multiple Lending:
   • Borrowers obtaining loans from multiple sources.
4. Upfront Security Deposits:
   • Upfront collection of security deposits.
5. Over-Borrowing:
   • Borrowers taking loans beyond their capacity.
6. Ghost Borrowers:
   • Instances of fictitious or ghost borrowers.
7. Coercive Recovery Methods:
   • Unethical and coercive methods of loan recovery.

Addressing these concerns is crucial for ensuring the ethical and sustainable functioning of microfinance initiatives in India.

Malegam Committee Recommendations:

The Malegam Committee, appointed by the Reserve Bank of India (RBI), proposed several recommendations for the regulation of Micro Finance Institutions (MFIs). Here are the key suggestions:

1. Interest Rates:
   • MFIs should be allowed to charge a maximum interest of 24% on small loans.
   • Small loans should not exceed ₹25,000.
2. NBFC-MFI Category:
   • The creation of a separate category of Non-Banking Financial Companies (NBFC-MFI) for the microfinance sector.
3. Loan Eligibility:
   • Small loans of up to ₹25,000 could be given to families with an annual income of up to ₹50,000.
4. Purpose of Loans:
   • 75% of loans extended by MFIs should be for income generation purposes.
5. Borrowing Limits:
   • A borrower cannot take loans from more than two MFIs.
6. Regulatory Oversight:
   • Regulation of MFIs should be done by the National Bank for Agriculture and Rural Development (NABARD) in close coordination with the RBI.
7. Priority Lending Status:
   • Bank lending to NBFCs qualifying as NBFC-MFIs should be entitled to ‘priority lending’ status.
8. Group Memberships:
   • A borrower can be a member of only one self-help group or a joint liability group (JILG). In JILG, money is lent to a member, but the entire group is responsible for repayment.

These recommendations aimed to provide a regulatory framework for the microfinance sector, ensuring fair practices, reasonable interest rates, and the promotion of responsible lending for income-generating activities among the target population.

FAQs

1. What is microfinance?

Microfinance refers to financial services, such as loans, savings, and insurance, provided to low-income individuals or groups who lack access to traditional banking services. These services are typically offered by microfinance institutions (MFIs) and aim to empower entrepreneurs and small businesses to alleviate poverty and foster economic development.

2. How does microfinance work?

Microfinance works by providing small loans, often without collateral, to individuals or groups who would not qualify for traditional bank loans. These loans are used to start or expand small businesses, purchase essential goods, or invest in education and healthcare. Microfinance institutions also offer savings and insurance products tailored to the needs of low-income clients.

3. What are the benefits of microfinance?

Microfinance has several benefits, including poverty alleviation, women’s empowerment, and economic growth. By providing access to financial services, microfinance enables low-income individuals to generate income, build assets, and improve their standard of living. Microfinance also promotes financial inclusion by bringing marginalized populations into the formal financial system.

4. Are there any challenges associated with microfinance?

While microfinance has proven effective in many cases, it also faces challenges such as high interest rates, over-indebtedness, and limited scalability. Additionally, ensuring the sustainability and social impact of microfinance programs requires effective regulation, risk management, and client protection measures.

5. What is the future of microfinance?

The future of microfinance lies in innovation, technology, and partnerships. Advancements in digital finance and mobile banking have the potential to reach more underserved populations and lower the costs of delivering financial services. Collaboration between MFIs, governments, and other stakeholders is also crucial for scaling up microfinance initiatives and maximizing their impact on poverty reduction and inclusive growth.