MICROFINANCE INDUSTRY, TREMENDOUSLY IMPROVING THE

LIVES OF PEOPLE IN RURAL AREAS

The responsibility of meeting the credit needs in the rural areas of India was
entrusted primarily with the cooperative banking sector until about the mid-1960s. As
the technological developments in the agricultural sector started gathering
momentum, it was expected that commercial banks would play an increasing role in
the rural credit market through branch expansion and direct lending. One of the
major objectives of the nationalisation of Indian commercial banks was the
improvement of the flow of formal institutional credit into rural households, especially
to the poor, thus relieving them of the burden of usurious debt.
The overriding objective of nationalization was the taking of banking to the masses.
The government envisaged that 40 percent of the total credit of the nationalised
banks/commercial banks should be channelized to priority sectors (of which 18
percent was for agriculture and ten percent for weaker sections), groups or regions
to support activities that were either considered to be socially beneficial or inherently
risky and borrower groups that were likely to be marginalised in the credit markets, at
lower rates of interest. This was an important step in the direction of asserting the
developmental role of banks.
These measures had a strong impact on rural economy. The vast branch expansion
of nationalised banks helped the people in remotest areas to have access to
financial services. The growth and extension of rural credit displaced village
moneylenders to a significant extent (Bell, 1990) and led to modest increases in
aggregate crop output, sharp increases in the use of fertilizers and in investments in
physical capital like tractors, pump sets and animal stocks. A substantial positive
effect is seen in non-farm employment and output also
(Binswanger and Khandker, 1992).
Although the banking system has experienced phenomenal growth in terms of
geographical spread, deposit mobilization and disbursal of credit in rural areas after
approach and negotiate with formal financial institutions. The drive of very poor
people to help themselves through self-employment is ignored by the formal financial
sector. Because the very poor have not traditionally been recognized as creditworthy
or able to save, they are not perceived by the conventional agencies as profitable
clientele for credit.
Further, the rural credit system entrapped by the twin problems of high transaction
cost and poor repayment performance reduces the profitability of rural branches of
nationalized banks. The incompetence of management of individual banks also
increased the non-viability of the rural credit delivery system (Analyst,
1993). the creditworthiness criteria adopted by institutional credit are alienating small
farmers from borrowing as lending is closely linked to the landholding status of the
borrower. The formal credit institutions neglected consumption needs of the poor and
emphasized only on production credit. The spread of the system has been uneven
across regions and wealth groups. The proportion of the poor obtaining credit from
the banking system has been lower than their share of the total population.
Moreover, there is widespread belief that the poor are unbankable. There are also
internal problems such as the absence of linkages of credit with marketing,
investment credit having no provision for working capital. Inadequate staff and
managerial deficiencies within the banking system have also been causing problems
(Rajasekhar, 1994).
Objectives

1. To examine the extent of financial exclusion in rural India

2. To enquire into the role of microfinance in helping the rural population in the
case of financial inclusion.
3. To study the extent of progress made by microfinance in rural India
4. To look into the challenges ahead for microfinance in India

Methodology

Secondary sources of data are used. Data published by various institutions such as
Government of India, World Bank, Consultative Group to Assist the Poor (CGAP),
Reserve Bank of India (RBI), National Bank for Agriculture and Rural Development
(NABARD, State Level Bankers Committee (SLBC), etc have been used.

Discussion of results

The process of financial inclusion is an attempt to bring within the ambit of the
organized financial system the weaker and vulnerable sections of society. Financial
inclusion can be defined as the delivery of credit and other financial service at an
affordable cost to the vast sections of the disadvantaged and low income groups.
The objective of financial inclusion is to extend the scope of activities of the
organized financial system to include, within its ambit, people with low incomes.
Through graduated credit, attempts must be made to lift the poor so that they come
out of poverty. Financial inclusion may, therefore, be defined as the process of
enabling access to timely and adequate credit and other financial service by
vulnerable groups, such as weaker sections and low income groups at affordable
cost. The target for National Rural Financial Inclusion Plan (NRFIP) is to provide
access to comprehensive financial services to atleast 50% (55.77 million) of the
excluded rural cultivator and noncultivator households, across different States by
2012 through rural/ semi urban branches of Commercial Banks and Regional Rural
Banks.

Microfinance and Financial Inclusion

Since formal credit institutions rarely lend to the poor, special institutional
arrangements become necessary to extend credit to those who have no collateral to
offer. Microfinance, by providing small loans and savings facilities to those who have
been excluded from commercial financial services, has been promoted as a key
strategy for reducing poverty in all its forms by agencies all over the world.
Microcredit has been defined as programmes that provide credit for self-
employment and other financial and business services (including
savings and technical assistance) to very poor persons (Micro Credit Summit,
1997). Nowadays, microfinance represents something more than microcredit - it also
refers to savings, insurance, pawns and remittances, in sum to a much wider range
of financial services (Tankha, 1999). In most cases, microcredit programmes offer a
combination of services and resources to their clients in addition to usual credit for
self-employment. Also, this is an effort to provide a bridge between formal financial
markets and the informal groups in the formal microfinance initiatives.
The basic idea of microfinance is that poor people are ready and are willing to pull
themselves out of poverty if given access to economic inputs. The need for
informality in credit delivery and easy access is demonstrated by the fact that Self
Help Groups (SHGs) and Microfinance Institutions (MFIs) constitute the fastest
growing segment in recent years in reaching out to small borrowers. Micro-finance is
a new development in which Indian institutions have acquired considerable expertise
and where up-scaling holds great promise both to expand the nature of financial
services offered to micro enterprises and to make these the springboard for
entrepreneurial development. (Planning Commission, 2006)
The SHG movement is bringing about a profound transformation in rural areas of
India. MFIs play a significant role in facilitating inclusion, as they are uniquely
positioned in reaching out to the rural poor. Many of them operate in a limited
geographical area, have a greater understanding of the issues specific to the rural
poor, enjoy greater acceptability amongst the rural poor and have flexibility in
operations providing a level of comfort to their clientele. It is roughly estimated that
there are about 1,000 NGO-MFIs and more than 20
Company facilitating the activities in all over India. There are today over 22 lakh such
groups linked with banks. The objective of the country is to enrol at least 50% of all
rural women in India as members of SHGs over the next five years and link these
SHGs to banks.

Progress of Microfinance in India

The institutions which engage in microfinance services in India follow three types of
approaches namely
1. The Grameen Bank approach
2. The Cooperative Societies (which are members of a cooperative bank)
approach
3. The SHG Programme approach.
In the four years between 2003 and 2007, small borrower bank accounts (credit) i.e.
upto Rs 25,000 increased marginally from 36.9 million to 38.6 million, while SHGs
borrowing members grew from 10 million to 40.5 million and MFIs borrowers grew
from 1.1 million to 8 million. In 2007-08, MFIs have added 6 million clients increasing
their outreach to 14 million as per data brought out by Sa Daan.
An innovative scheme in rural delivery system launched by NABARD is the linking of
SHGs of the poor with banks and bulk lending through NGOs. NABARD considers
SHGs a pre-microenterprise stage for a majority of the rural population. The linkage
project envisages active involvement of NGOs who play a crucial role in formation,
nurturing, stabilising and guiding the SHGs into cohesive and dynamic groups
inculcating the habits of thrifts and credit management and ultimately establishing
linkage with the banks. Under the SHG-bank linkage programme, three linkage
models have broadly emerged. Under the first model, banks directly link
SHGs without the intervention of the NGOs. In the second model, banks provide
credit to SHGs and NGOs act as Self Help Promoting Institutions (SHPIs). Under the
third model, NGOs act both as SHPIs and financial intermediaries for channelising
credit from banks to SHGs.
Challenges Ahead for Microfinance in India

An evaluation of SHGs carried out by the regional offices (ROs) of the Reserve Bank
revealed that there was scope for improvement in the area of maintenance of books
of accounts. It also brought out that rotation of group leaders was generally not
followed by SHGs. However, other best practices like strict adherence to attendance
of group meetings, recording minutes of the meetings and prompt repayment of bank
loans were being followed. The momentum of growth in the micro-finance sector has
brought into focus the importance of regulating the sector to function in an efficient
and orderly manner. There would be need for greater transparency in their
functioning and for facilitating their reach to un-banked population of the country
Interest rates in the microfinance sector have to be significantly higher than in the
banking sector reflecting the much higher cost of doing business. This attracts
criticism but it is important to remember that most microfinance institutions charge
rates which are much lower than rates charged by money lenders. Borrowers stand
to benefit from the experience of micro-finance institutions as these provide
competition to money lenders.
(Planning Commission, 2006)
Over the past two decades, institutions that make microloans to low-income
borrowers in developing and transition economies have focused increasingly on
making their operations financially sustainable by charging interest rates that are
high enough to cover all their costs. They argue that doing so will best ensure the
permanence and expansion of the services they provide. Sustainable (i.e., profitable)
microfinance providers can continue to serve their clients without needing ongoing
infusions of subsidies, and can fund exponential growth of services for new clients by
tapping commercial sources, including deposits from the public. MFIs on average
have higher returns on assets than commercial banks do, but MFIs produce lower
returns on equity for their owners. The median return on MFI owners equity in 2006
was moderate12.3 percent, roughly 4 percent lower than the return for banks.
(Rosenberg, et al.)
There have been incidents of state governments imposing restrictions on micro-
finance institutions in a manner which does not reflect an appreciation of the realities
on the ground. Excessive regulation and control of this sector may be particularly
dangerous as it can prevent the development of a healthy and competitive
microfinance sector which could compete with usurious money lenders. (Planning
Commission, 2006)