http://www.worldcat.

org/title/development-banking-in-india/oclc/26094599

1. INTRODUCTION OF MICRO FINANCE

Microfinance is the provision of financial services to low-income clients or solidarity lending

groups including consumers and the self-employed, who traditionally lack access to banking and
related services.

More broadly, it is a movement whose object is "a world in which as many poor and near-poor
households as possible have permanent access to an appropriate range of high quality financial
services, including not just credit but also savings, insurance, and fund transfers.. It is an
effective way to fight poverty. Microfinance has proven to be a very effective development tool
because it provides empowerment instead of charity. Typically, microfinance clients are self-
employed household entrepreneurs who lack the resources to invest in their business and their
future and thus cannot escape the grips of extreme poverty. Here is a typical microfinance
success story taken from the United Nations Capital Development Fund:

A UNCDF microfinance project in Bangladesh provided beneficiaries loans of about $30 US.
Most of the loans were spent on productive purposes such as rice production, cattle fattening,
and small-scale entrepreneurial initiatives. The activities that were financed were essentially
carried out by individuals, in their homes or on plots of land. To receive credit, however, a
small-scale or landless farmer had to be incorporated in to a group of his/her peers who would
agree to jointly accept responsibility for repayment. The project has proven to be highly
successful. " One small loan enabled me to improve the livelihood of my entire family" said
Anwar Begum, who borrowed enough money to purchase a small cow. In three years she
quadrupled her investment by selling both milk and calves from the original cow, and has built a
new house for herself.

1.1 DEFINITION

Microfinance” is often defined as financial services for poor and low-income clients. In practice,
the term is often used more narrowly to refer to loans and other services from providers that
identify themselves as “microfinance institutions” (MFIs). These institutions commonly tend to
use new methods developed over the last 30 years to deliver very small loans to unsalaried
borrowers, taking little or no collateral. These methods include group lending and liability, pre-
loan savings requirements, gradually increasing loan sizes, and an implicit guarantee of ready
access to future loans if present loans are repaid fully and promptly.

More broadly, microfinance refers to a movement that envisions a world in which low-income
households have permanent access to a range of high quality financial services to finance their

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income-producing activities, build assets, stabilize consumption, and protect against risks. These
services are not limited to credit, but include savings, insurance, and money transfers.

1.2 NEED FOR MICRO - FINANCING

Since independence, various governments in India have experimented with a large number of
grant and subsidy based poverty alleviation programmes. These programmes were based on
grant/subsidy and the credit linkage was through commercial banks only. As a result, these
programmes became unsustainable, perpetuated a dependant status on the beneficiaries and
depended ultimately on the govt. employees for delivery. This not only led to misuse of both
credit and subsidy but banks never looked at it as a profitable and commercial activity as well.

Hence was adopted the concept of micro-credit in India. Success stories in neighboring
countries, like Grameen Bank in Bangladesh, Bank Rakiat in Indonesia, Commercial &
Industrial Bank in Philippines etc, gave further boost to the concept in India in the 1980s. India
thus adopted the similar model of extending credit to the poorest sector and took a no. of steps to
promote micro-financing in the country.

1.3 BOUNDARIES AND PRINCIPLES

Poor people borrow from informal moneylenders and save with informal collectors. They receive
loans and grants from charities. They buy insurance from state-owned companies. They receive
funds transfers through formal or informal remittance networks. It is not easy to distinguish
microfinance from similar activities. It could be claimed that a government that orders state
banks to open deposit accounts for poor consumers, or a moneylender that engages in usury, or a
charity that runs a heifer pool are engaged in microfinance. Ensuring financial services to poor
people is best done by expanding the number of financial institutions available to them, as well
as by strengthening the capacity of those institutions. In recent years there has also been
increasing emphasis on expanding the diversity of institutions, since different institutions serve
different needs.

Some principles that summarize a century and a half of development practice were encapsulated
in 2004 by Consultative Group to Assist the Poor (CGAP) and endorsed by the Group of Eight
leaders at the G8 Summit on June 10, 2004:

1. Poor people need not just loans but also savings, insurance and money transfer services.
2. Microfinance must be useful to poor households: helping them raise income, build up
assets and/or cushion themselves against external shocks.
3. Microfinance can pay for itself. Subsidies from donors and government are scarce and
uncertain, and so to reach large numbers of poor people, microfinance must pay for itself.
4. Microfinance means building permanent local institutions.

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 5. Microfinance also means integrating the financial needs of poor people into a country's
mainstream financial system.
6. The job of government is to enable financial services, not to provide them.
7. Donor funds should complement private capital, not compete with it.
8. The key bottleneck is the shortage of strong institutions and managers. Donors should
focus on capacity building.
9. Interest rate ceilings hurt poor people by preventing microfinance institutions from
covering their costs, which chokes off the supply of credit.
10. Microfinance institutions should measure and disclose their performance – both
financially and socially.

Microfinance is considered as a tool for socio-economic development, and can be clearly

distinguished from charity. Families who are destitute, or so poor they are unlikely to be able to
generate the cash flow required to repay a loan, should be recipients of charity. Others are best
served by financial institutions.

1.4 WHO ARE MICROFINANCE CLIENTS?

Typical microfinance clients are poor and low-income people that do not have access to other
formal financial institutions. Microfinance clients are usually self-employed, household-based
entrepreneurs. Their diverse “microenterprises” include small retail shops, street vending,
artisanal manufacture, and service provision. In rural areas, micro entrepreneurs often have small
income-generating activities such as food processing and trade; some but far from all are
farmers.

Hard data on the poverty status of clients is limited, but tends to suggest that most microfinance
clients fall near the poverty line, both above and below. Households in the poorest 10% of the
population, including the destitute, are not traditional microcredit clients because they lack stable
cash flows to repay loans. Most clients below the poverty line are in the upper half of the poor. It
is clear, however, that some MFIs can serve clients at the higher end of the bottom half. Women
often comprise the majority of clients.

Over the past decade, a few MFIs have started developing a range of products to meet the needs
of other clients, including pensioners and salaried workers. Although little is known about the
universe of potential clients, the number of households without effective access to financial
services is enormous.

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1.5 TYPES OF ORGANIZATIONS AND COMPOSITION OF THE SECTOR

Microfinance providers in India can be classified under three broad categories: formal,
semiformal, and informal.

• Formal Sector

The formal sector comprises of the banks such as NABARD, SIDBI and other regional RURAL
BANKS. They primarily provide credit for assistance in agriculture and microenterprise
development and primarily target the poor. Their deposit at around Rs. 350 billion and of that,
around Rs 250 billion has been given as advances.

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 • Semi Formal Sector

The majority of institutional microfinance providers in India are semi-formal organizations

broadly referred to as MFIs. Registered under a variety of legal acts, these organizations greatly
differ in philosophy, size, and capacity. There are over 500 non-government organizations
(NGOs) registered as societies, public trusts, or non-profit companies.

• Informal Sector

In addition to friends and family, moneylenders, landlords, and traders constitute the informal
sector. While estimates of their importance vary significantly, it is undeniable that they continue
to play a significant role in the financial lives of the poor.

2. MODELS OF MICRO FINANCE

• Association

This is where the target community forms an 'association' through which various microfinance
(and other) activities are intiated. Such activities may include savings. Associations or groups
can be composed of youth, women; can form around political/religious/cultural issues; can create
support structures for microenterprises and other work-based issues.

In some countries, an 'association' can be a legal body that has certain advantages such as
collection of fees, insurance, tax breaks and other protective measures. Distinction is made
between associations, community groups, peoples organizations, etc. on one hand (which are
mass, community based) and NGOs, etc. which are essentially external organizations.

• Bank Guarantees
As the name suggests, a bank guarantee is used to obtain a loan from a commercial bank. This
guarantee may be arranged externally (through a donor/donation, government agency etc.) or
internally (using member savings). Loans obtained may be given directly to an individual, or
they may be given to a self-formed group.

Bank Guarantee is a form of capital guarantee scheme. Guaranteed funds may be used for
various purposes, including loan recovery and insurance claims. Several international and UN
organizations have been creating international guarantee funds that banks and NGOs can
subscribe to, to onlend or start microcredit programmes.

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 • Community Banking

Community Banking model essentially treats the whole community as one unit, and establishs
semi-formal or formal institutions through which microfinance is dispensed. Such institutions are
usually formed by extensive help from NGOs and other organizations, who also train the
community members in various financial activities of the community bank. These institutions
may have savings components and other income-generating projects included in their structure.
In many cases, community banks are also part of larger community development programmes
which use finance as an inducement for action.

• Cooperatives

A co-operative is an autonomous association of persons united voluntarily to meet their common

economic, social, and cultural needs and aspirations through a jointly-owned and democratically-
controlled enterprise. Some cooperatives include member-financing and savings activities in
their mandate.

• Credit Unions
A credit union is a unique member-driven, self-help financial institution. It is organized by and
comprised of members of a particular group or organization, who agree to save their money
together and to make loans to each other at reasonable rates of interest.

The members are people of some common bond: working for the same employer; belonging to
the same church, labor union, social fraternity, etc.; or living/working in the same community. A
credit union's membership is open to all who belong to the group, regardless of race, religion,
color or creed.

A credit union is a democratic, not-for-profit financial cooperative. Each is owned and governed
by its members, with members having a vote in the election of directors and committee
representatives.

• Grameen model
The Grameen model emerged from the poor-focussed grassroots institution, Grameen Bank,
started by Prof. Mohammed Yunus in Bangladesh. It essentially adopts the following
methodology:

A bank unit is set up with a Field Manager and a number of bank workers, covering an area of
about 15 to 22 villages. The manager and workers start by visiting villages to familiarise
themeselves with the local milieu in which they will be operating and identify prospective
clientele, as well as explain the purpose, functions, and mode of operation of the bank to the
local population. Groups of five prospective borrowers are formed; in the first stage, only two of

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them are eligible for, and receive, a loan. The group is observed for a month to see if the
members are conforming to rules of the bank. Only if the first two borrowers repay the principal
plus interest over a period of fifty weeks do other members of the group become eligible
themselves for a loan. Because of these restrictions, there is substantial group pressure to keep
individual records clear. In this sense , collective responsibility of the group serves as collateral
on the loan.

• Non-Governmental Organizations

NGOs have emerged as a key player in the field of microcredit. They have played the role of
intermediary in various dimensions. NGOs have been active in starting and participating in
microcredit programmes. This includes creating awareness of the importance of microcredit
within the community, as well as various national and international donor agencies. They have
developed resources and tools for comunities and microcredit organizations to monitor progress
and identify good practicecs. They have also created opportunities to learn about the principles
and practice of microcredit. This includes publications, workshops and seminars, and training
programes.

• ROSCAs

Rotating Savings and Credit Associations (ROSCAs) are essentially a group of individuals who
come together and make regular cyclical contributions to a common fund, which is then given as
a lump sum to one member in each cycle. For example, a group of 12 persons may contribute Rs.
100 (US$33) per month for 12 months. The Rs. 1,200 collected each month is given to one
member. Thus, a member will 'lend' money to other members through his regular monthly
contributions. After having received the lump sum amount when it is his turn (i.e. 'borrow' from
the group), he then pays back the amount in regular/further monthly contributions. Deciding who
receives the lump sum is done by consensus, by lottery, by bidding or other agreed methods.

• Village Banking

Village banks are community-based credit and savings associations. They typically consist of 25
to 50 low-income individuals who are seeking to improve their lives through self-employment
activities. Initial loan capital for the village bank may come from an external source, but the
members themselves run the bank: they choose their members, elect their own officers, establish
their own by-laws, distribute loans to individuals, collect payments and savings. Their loans are
backed, not by goods or property, but by moral collateral: the promise that the group stands
behind each individual loan.

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3. STEPS TAKEN BY INDIA TO PROMOTE MICRO-FINANCING

It set up development banks, such as SIDBI, NABARD which focused on rural credit and micro-
financing. NGOs and SHGs were encouraged to become the govts arm in extending micro-credit
to the poor. They were provided supplementary credit needed to fund the credit, paper work was
reduced between them and the banks. Also, the govt assisted in mobilizing funds from formal
financial institutions to meet the larger credit needs of these organizations.

4. FOCUS ON WOMEN FOR MICRO CREDIT

Micro-finance, as is being practiced by the National Credit Fund for Women or the Rashtriya
Mahila Kosh (RMK), could be defined as a set of services comprising the following activities :

a) Micro- Small loans; primarily for income generation activities, but also for
credit: consumption and contingency needs.

b) Micro- Thrift or small savings from borrowers’own resources.

savings:

The main features of the micro-finance services being provided by RMK are:

1. It is a tool for empowerment of the poorest; the higher the income and better the asset
position of the borrower, the lower the incremental benefit from further equal doses of
micro-credit is likely to be.
2. Delivery is normally through Self Help Groups (SHGs).
3. It is essentially for promoting self-employment; the opportunities of wage employment
are limited in developing countries - micro finance increases the productivity of self-
employment in the informal sector of the economy - generally used for (a) direct income
generation (b) rearrangement of assets and liabilities for the household to participate in
future opportunities and (c) consumption smoothing.
4. It is not just a financing system, but a tool for social change, specially for women - it does
not spring from market forces alone - it is potentially welfare enhancing - there is a public
interest in promoting the growth of micro finance - this is what makes it acceptable as a
valid goal for public policy.
5. Because micro credit is aimed at the poorest, micro-finance lending technology needs to
mimic the informal lenders rather than the formal sector lending. It has to: a) provide for
seasonality (b) allow repayment flexibility (c) eschew bureaucratic and legal formalities
(d) fix a ceiling on loan sizes.

Microfinance approach is based on certain proven truths which are not always recognised. These
are:

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 • That the poor are bankable; successful initiatives in micro finance demonstrate that there
need not be a trade off between reaching the poor and profitability - micro finance
constitutes a statement that the borrowers are not ‘weaker sections’ in need of charity, but
can be treated as responsible people on business terms for mutual profit -
• That almost all poor households need to save, have the inherent capacity to save small
amounts regularly and are willing to save provided they are motivated and facilitated to
do so -
• That easy access to credit is more important than cheap subsidised credit which involves
lengthy bureaucratic procedures - (some institutions in India are already lending to
groups or SHGs at higher rates - this may prevent the groups from enjoying a sufficient
margin and rapidly accumulating their own funds, but members continue to borrow at
these high rates, even those who can borrow individually from banks) -
• 'Peer pressure' in groups helps in improving recoveries

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