MICROFINANCE IN INDIA

A perspective of how Covid-19 and involvement of fintech industries have impacted this sector

By Lavanya Thukral | 6 min read

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Business Advisory | Financial Services

Introduction

Microfinancing is the buzz word today. It started with the sole aim of weeding out poverty from the lower classes of society by focusing on microcredit lending designed to spur growth in developing economies. The concept of Microfinance is not a recent development in India, it has been followed from earlier times when there were money lenders who used to provide ready credit to farmers and other low-income people.

Muhammad Yunus a Nobel Prize winner, introduced the concept of Microfinance in Bangladesh in the form of the “Grameen 80 Bank” in 1976. NABARD (National Bank for Agriculture and Rural Development) took this idea and started concept of Micro Finance in India in the year 1998. Financial inclusion has emerged as a major policy objective in the country; Microfinance has become a medium of extending financial services to unbanked sections of population through the Jan Dhan Yojana.

Initially the term Microfinance had a limited definition: the provision of microloans to poor entrepreneurs and small businesses lacking access to credit.

The two main mechanisms for the delivery of financial services to such clients were:

(1) relationship-based banking for entrepreneurs / wannapreneurs / solopreneurs and small businesses; and

(2) group-based models, where several entrepreneurs come together to apply for loans and other services as a group.

Over time, microfinance has emerged as a larger movement whose object is: “a world in which everyone, especially the poor and socially marginalized people and households have access to a wide range of affordable, high quality financial products and services, including not just credit but also savings, insurance, payment services, and fund transfers.” Microfinance is targeted at the low-income and unemployed fraction of the population.

Clients of Microfinance:

  • Landless laborers engaged in Agricultural, mining & construction.        
  • Small & Marginal Farmers.
  • Rural Artisan and weavers.
  • Women
  • Self-employed in Urban Informal sector non-farm activities.
  • Small Business & Entrepreneurs.

All these micro & small enterprises play a significant role in the Indian Economy, the government also aims to increase the MSME sector’s share in the GDP to 40 per cent to benefit the rural poor. It won’t be wrong to refer them as the ‘Backbone of the country.’

What are MSMEs?

So, in very simple words the full form of the acronym itself says it’s meaning i.e., Micro, Small & Medium Enterprises, which are classified into two sectors Manufacturing Enterprises & Services Enterprises. For example, group of women dealing in tailoring work, or making Pickles, etc.

The basis for classifying MSME as micro, small and medium enterprises has been updated recently. Revised MSME classification effective from 1st July 2020 is:

As per the report published in Feb 2021, around 6.5 crore micro, small and medium enterprises (MSMEs) contribute 30 per cent to GDP. The government of India has taken various steps to boost up the growth of this sector. Also, everyone might have heard about various campaigns like AatmaNirbhar Bharat Abhiyan or Self-reliant India, Vocal for Local etc., by PM Narendra Modi, that are directly approaching MSMEs and all the new startups and small traders & domestic business on small scale etc.

In the Budget 2021, following measures were taken by the Gov. of India to promote MSMEs-

  • Review of more than 400 old Customs Duty Exemption this year.
  • Rationalizing exemption on import of duty-free items as an incentive to exporter of garments, leather & handicraft items. Most of these are manufactured by MSMEs.
  • To further reduce Compliance burden, limits increased for Tax Audit from Rs 5 Crore to Rs 10 Crore subject to certain conditions.

Channels of Microfinance

Microfinance in India operates primarily through two channels:

Microfinance in India operates primarily through two channels:

  • SHG-Bank Linkage Program (SBLP) – This channel was initiated by NABARD in the year 1992. This model encourages financially backward women to come together to form groups of 10-15 members. They contribute their individual savings to the group at regular intervals. Loans are provided to members of the group from these contributions. SHGs (Self Help Groups) are also offered bank loans at later stages, and these loans can be used for funding income generating activities.
  • Microfinance Institutions (MFIs) – These institutions have microfinance as their primary operation. These lend through the concept of Joint Liability Group (JLG), i.e., an informal group that consists of 5-10 members who seek loans either jointly or individually.

Types of Microfinances

  • MicroLoans – Microfinance loans are significant as these are provided to borrowers with no collateral. The end result of microloans should be to have its recipients outgrow smaller loans and be ready for traditional bank loans.
  • MicroSavings – Microsavings accounts allow entrepreneurs operate savings accounts with no minimum balance. These accounts help users inculcate financial discipline and develop an interest in saving for the future.
  • MicroInsurance – Microinsurance is a type of coverage provided to borrowers of microloans. These insurance plans have lower premiums than traditional insurance policies.

Regulators of Microfinance in India

  • Usually, the banking framework is reasonably standard in most countries. However, this is not the case for the microfinance industry and countries in Asia have different frameworks. This is primarily due to the regulatory environment. Examples of different kinds of institutions are:

    • Deposit taking Non-Banking Financial Companies (NBFC- D)
    • Non-deposit taking NBFCs (Non-Banking Financial Companies)
    • Banks
    • Co-operatives
    • Digital finance companies and
    • Non-Governmental Organizations (NGO)

    The reason for this wide variety in the types of institutions providing microfinance is that it is recognized as an attractive business opportunity as well as a tool for social good.

    Reserve Bank of India Self-Regulating Bodies- MFIN (Microfinance Institutions Network), Sa-Dhan are the Regulatory bodies of the institutions like NBFC-MFIs, Banks, NGOs in India.

Financial Technologies

Digital technologies are rapidly making inroads into all realms of human life and the microfinance sector is one such area. Ongoing innovations in digital technology contribute to reshape its operational models, governance structures, its risk profile, industry networks and dominant practices.

Microfinance players are using and exploring new technologies and solutions for improved client outreach, decision-making and operations. Technology is revolutionizing the way financial services are delivered and the same disruptions are affecting the technology landscape of the microfinance sector.

Fintech companies have become significant within the microfinance institution (MFI) ecosystem with different technology stacks enabling the microfinance sector to carry out more than their basic operations through collaboration and development.

A large Indian small finance bank has implemented a technology solution in partnership with a fintech company through which they have enabled Aadhaar-linked know your customer (KYC), video ID verification, verification of e-documents via Digi Locker and uses artificial intelligence and machine learning technologies for preventing fraud, customer authentication and automating the customer onboarding process.

There are certain new technologies & innovations with the deployment of which Microfinance sector can work more effectively and efficiently.

Impact of Covid-19

Microfinance sector also got hit by this pandemic and is facing another big crisis after 2010 AP amendment bill and 2016’s demonetization. Small and micro loans serve large segment of population running small and micro enterprises mostly in unorganized livelihood domains. These financial institutions play a key role between commercial lending institutions ready to take moderate risk for better returns and clients who are in need of non-collateralized loans to finance their livelihood activity.

The microfinance sector in India has been undergoing a transformation. COVID-19 presents new challenges and significant financial risks. It also presents an opportunity to build long term resilience.

Covid-19 Challenges:

  • A huge loss can be seen in the Labor market, specifically for the low-skilled workers who don’t have the option of working from home.
  • It has also been observed that the income losses are uneven. Income losses among the genders as the women among lower-income groups bearing a larger brunt of the impact.
  • Small traders, hawkers and daily wage laborer’s who constitute a large chunk of microfinance borrowers were the worst hit by the lockdown beginning from April 2020.
  • This category of employment accounted for about 32% of the total employment but it suffered 75% of the hit in April 2020.
  • However, with gradual lifting of lockdowns the employment situation improved in the succeeding months, with overall unemployment rate recovering from 26.19% on April 19, 2020 to 8.13% on August 30, 2020.

Path from Crises to Recovery

While the challenges are real, in general microfinance clients indicate that they are willing to continue their business activities and are willing to take the risk of restarting their operations.

Following are some of the actions and policies that may help clients of microfinance to restart their businesses and/or repay their outstanding loans:

  • General support packages to restart or re-profile a business after the COVID-19 crisis, including loan guarantees, salary support, government purchase or subcontracting, etc.
  • Targeted support incentives that may increase demand for products and services offered by microfinance clients, for example tourist vouchers to provide incentives to travel and use tourist infrastructure which will provide demand for the microfinance clients.
  • Conditional full or partial loan forgiveness for entrepreneurs who will restart their businesses or create new jobs within the next 12-18 months, with forgiven loans to be remitted to the MFIs that originated such loans.

Several initiatives undertaken by SHGs in various villages, Districts and States for combating COVID-19 & adapting to changing environment:

  • Mask Making & Distribution: Hundreds of SHGs were involved in making & supplying lakhs of masks within a very short span of time.
  • Distribution of Food Kits: Food kits containing essential items like rice, dal, potato, onion etc. were distributed to the needy people.
  • Community Kitchen: Community kitchen were setup for hundreds of hungry people. Society for Rural & Youth Educational Advancement (SRYEA) with 15 volunteer members from 3 SHGs were involved in “Food on Wheels” providing food to hungry & impecunious people. Likewise, Ambe Mission Mangalam, Krish Sakhi Mandal, Jai Goga Sakhi Mandal SHGs were working in it.

At the end, it would be simple to conclude that there are many impactful changes that enhanced the importance of microfinance in India. Micro finance plays a major role to lessen the impact of poverty from the society. Many initiatives have also been taken by the government to ease compliances and to promote such institutions.

Also, these institutions work towards the empowerment of women, which is a great move towards the development of the country.

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