Micro Finance Introduction

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  • 8/6/2019 Micro Finance Introduction



  • 8/6/2019 Micro Finance Introduction



    Microfinance serves as an umbrella term that describes the provision of banking services by poverty-focused financial institutions (microfinance institutions MFIs) to poor parts of the population that arenot being served by mainstream financial services providers. According to the World Bank, around 1.1bn people live in extreme poverty of less than USD 1 a day and around 2.7 billion people equivalentto roughly 40% of the worlds population live on lessthan USD 2 per day.


    Extreme poverty shares in developing countries vary widely with regional figures ranging from 9% inEast Asia and the Pacific to 41% in Sub-Saharan Africa. The core service of microfinance is theprovision of microcredit.Typically, these are small loans to the working poor. These loans usually amount to a local currencyequivalent which starts at just below USD 100 and can, over time, reach several times this amountdepending on the geographic region. For instance, in Asia the average loan amounts to around USD150, while in Eastern Europe and Central Asia loans amount to approximately USD 1600 on average.4In addition, many MFIs are increasingly starting to offer micro-deposits and micro-insurance servicesto their clients. In terms of institutional and ownership structures, the MFI universe is composed of a

  • 8/6/2019 Micro Finance Introduction


    large variety of different forms which comprises NGOs, cooperatives, specialised financial institutionsand niche banks that in some cases are even regulated financial institutions.

    Understanding Microfinance

    Robinson (2001) defines microfinance as small-scale financial servicesprimarily credit and savingsprovided to people who farm, fish or herd and adds that it refers to all types of financial servicesprovided to low-income households and enterprises. In India, microfinance is generally understood butnot clearly defined. For instance, if an SHG gives a loan for an economic activity, it is seen asmicrofinance. But if a commercial bank gives a similar loan, it is unlikely that it would be treated asmicrofinance. In the Indian context there are some value attributes of microfinance: Microfinance is an activity undertaken by the alternate sector (NGOs). Therefore, a loan givenby a market intermediary to a small borrower is not seen as microfinance. However when an NGO givesa similar loan it is treated as microfinance. It is assumed that microfinance is given with a laudableintention and has institutional and non exploitative connotations. Therefore, we define microfinance not

    by form but by the intent of the lender.

    Second, microfinance is something done predominantly with the poor. Banks usually do notqualify to be MFOs because they do not predominantly cater to the poor. However, there is ambivalenceabout the regional rural banks (RRBs) and the new local area banks (LABs).

    Third, microfinance grows out of developmental roots. This can be termed the alternativecommercial sector. MFOs classified under this head are promoted by the alternative sector and targetthe poor. However these MFOs need not necessarily be developmental in incorporation.


    Microfinance is the provision of a broad range of financial services such as deposits, loans, payment

    services, money transfers, and insurance to poor and low-income households and, their

    microenterprises. Microfinance services are provided by three types of sources:

    Formal institutions, such as rural banks and cooperatives;

    Semiformal institutions, such as nongovernment organizations; and

    Informal sources such as money lenders and shopkeepers.

    Institutional microfinance is defined to include microfinance services provided by both formal and

    semiformal institutions. Microfinance institutions are defined as institutions whose major business is

    the provision of microfinance services.

  • 8/6/2019 Micro Finance Introduction



    The systems and procedures of banking institutions was emphasizing on complicated qualifying

    requirements, tangible collateral, margin, etc., that resulted in a large section of the rural poor shying

    away from the formal banking sector. The banks too experienced that the rapid expansion of branch

    network was not contributing to an increasing volume of business to meet high transaction costs and risk

    provisioning, which even threatened the viability of banking institutions and sustainability of their


    At the same time, it was not possible for them to allow a population of close to 300 million - even if

    poor - to remain outside the fold of its business. The search for an alternative mechanism for catering to

    the financial service needs of the poor was thus becoming imperative.

    Microfinance in the Asian and Pacific Region

    Over 900 million people in about 180 million households in the Region live in poverty. Most of the

    Regions poor (i.e., those who earn less than $1.00 a day) or more than 670 million people, live in rural

    areas (footnote 1), although urban poverty is also a growing problem in virtually all DMCs. Most rural

    poor people are engaged in agricultural or related activities as laborers or small scale farmers. Many are

    also involved in a variety of microenterprises. In many countries, women, who are a significant

    proportion of the poor and suffer disproportionately from poverty, operate many of these


    Most formal financial institutions do not serve the poor because of perceived high risks , high costs

    involved in small transactions ,perceived low relative profitability, and inability of the poor to provide

    the physical collateral usually required by such institutions. The business culture of these institutions

    is also not geared to serve poor and low-income households. Lacking access to institutional sources of

    finance, most poor and low-income households continue to rely on meager self-finance or informal

    sources of microfinance. However, these sources limit their ability to actively participate in and benefit

    from the development process (Appendix 2). Thus, a segment of the poor population that has viable

    investment opportunities persists in poverty for lack of access to credit at reasonable costs. The poor

    also lack access to institutional credit for consumption smoothening and to other services such as

    payments, money transfers, and insurance.10 Most of the poor households also find it difficult to

    accumulate financial savings without easy access to safe institutions that provide deposit services.

  • 8/6/2019 Micro Finance Introduction



    Microfinance in India started in the early 1980s with small efforts at forming informal self-help groups(SHG) to provide access to much-needed savings and credit services. From this small beginning, themicrofinance sector has grown significantly in the past decades. National bodies like the SmallIndustries Development Bank of India (SIDBI) and the National Bank for Agriculture and RuralDevelopment (NABARD) are devoting significant time and financial resources to microfinance. Thispoints to the growing importance of the sector. The strength of the microfinance organizations (MFOs)in India is in the diversity of approaches and forms that have evolved over time. In addition to the home-grown models of SHGs and mutually aided cooperative societies (MACS), the country has learned fromother microfinance experiments across the world, particularly those in Bangladesh, Indonesia, Thailand,and Bolivia, in terms of delivery of microfinancial services.

    Microfinance is an activity that includes the provision of financial services such as credit, savings, and

    insurance to low income individuals which fall just above the nationally defined poverty line, and poor

    individuals which fall below that poverty line, with the goal of creating social value. The creation of

    social value includes poverty alleviation and the broader impact of improving livelihood opportunities

    through the provision of capital for micro enterprise, and insurance and savings for risk mitigation and

    consumption smoothing. History of Microfinance in India In India, institutional credit agencies (banks)

    made an entry in rural areas initially to provide an alternative to the rural money lenders who provided

    credit support, but not without exploiting the rural poor. There are 3 main factors that count to the

    bringing up of Microfinance as a Policy in India

    1. The first of these pivotal events was Indira Gandhis bank nationalization drive launched in 1969

    which required commercial banks to open rural branches resulting in a 15.2% increase in rural bank

    branches in India between 1973 and 1985. Today, India has over 32,000 rural branches of commercial

    banks and regional rural banks, 14,000 cooperative bank branches.

    2. The second national policy that has had a significant impact on the evolution of Indias banking and

    financial system is the Integrated Rural Development Program (IRDP) introduced in 1978 and designed

    to be a direct instrument for attacking Indias rural poverty. This program is interesting to this study

    because it was a large program whose main thrust was to alleviate poverty through the provision of

    loans and it was considered a failure.

    3. The last major event which impacted the financial and banking system in India was the liberalization

    of Indias financia