Evolution of Microfinance in India

The genesis of microcredit, and therefore microfinance is credited to Dr. Muhammad Yunus, who founded the Grameen Bank in 1983. In India, however, financial services especially for the rural poor also had a parallel evolution, starting from the earliest cooperative societies in 1890 to the burgeoning microfinance sector of today, dominated by Self Help Groups (SHGs), which have emerged as micro level financial intermediaries.

Prelude
The role prescribed for financial sector in India to achieve developmental goals dates to pre independence days. The agriculture credit department was set up in 1935 by the Reserve Bank of India to promote rural credit. In its early days, the government of India sought to promote rural credit by strengthening the cooperative institutions. The need to replace costly informal credit with institutional credit was strongly felt as the All India Rural Credit Survey report of 1954 found that informal sources accounted for 70% of rural credit usage, followed by cooperatives (6.4%) and commercial banks (0.9%).

The “Lead Bank Scheme” was introduced in 1969, thereby starting a process of district credit plans and coordination among the different financial intermediaries. The same year also saw the nationalization of fourteen commercial banks. As a result of these initiatives, the share of formal financial sector in total rural credit usage rose to 30% in 1971. The Regional Rural Banks (RRBs) were conceptualized in 1975 to augment the delivery of financial services in rural areas. This resulted in the creation of a network of banks which is one of the largest in the world even today. Not surprisingly, the All India Survey Debt and Investment Survey of 1981 found that the share of formal financial sector in total credit had risen to over sixty percent.

Preparing the Ground
The government initiated the Integrated Rural Development Programme (IRDP) in 1980-81. The objective of IRDP was to direct subsidized loans to poor self employed people through the banking sector. The National Bank for Agriculture and Rural Development (NABARD) was established in 1982. In the same year the government established Development of Women and Children in Rural Areas (DWARCA) scheme as a part of IRDP. It was around this time that the first Self Help Groups (SHGs) started emerging in the country mostly as a result of NGO activities. The NGO MYRADA was one of the pioneers of the concept of SHGs in India. It was in 1984-85, when MYRADA started linking SHGs to banks. These SHGs were large enough for the bank to have transactions. The SHGs in turn were also very responsive and flexible to the needs of their members. While MYRADA did not directly intervene in the credit market for the poor, it facilitated “banking with micro institutions established and controlled by the poor”. The SHGs were a step in that direction. Thus, seeds were sown for the modern microfinance sector in India to emerge.

IRDP is estimated to have reached over 55 million poor families until 1999, when it was transformed into Swarnajyanti Gram Swarozgar Yojna (SGSY). The IRDP, in spite of its immense outreach, experienced very low repayment rates and created 40 million defaulters, which coupled with the subsidy component ruled out long term sustainability of the programme.

The formal financial sector has been criticized to be supply driven during this phase (Sriram and Fisher, 2002) . The formal financial sector was characterized by:
• A large network of banks including cooperative banks and innovations such as RRBs,
• Focused approach on credit,
• Lending targeted at the “priority sector” such as agriculture and weaker sections of the population,
• Interest rates ceiling,
• Subsidies.

Financial services, were thus, viewed as a social obligation. Given the high rates of default, a formal loan waiver was announced by the government in the year 1989. This had a negative impact on credit discipline, and reinforced the view that lending to the poor was not a profitable business among the mainstream financial institutions.

Economic Reforms and a new Generation of Financial Institutions
In the year 1991, India faced a balance of payment crisis. India’s foreign reserve fell to a very low level and the country’s ability to meet foreign debt obligations was seriously impaired. This, however, propelled the government into introducing structural changes in the economy-commonly referred to as the Economic Reforms of 1991. This gradually resulted in greater autonomy to the financial sector. As a result, new generation private sector banks such as UTI Bank, ICICI Bank, IDBI Bank (all established in 1994) and HDFC Bank (early 1995), emerged. The Narsimhan Committee report of 1991 also recommended phasing out of interest rate concessions. At the same time the Brahm Prakash Committee recommended reducing state involvement in cooperative banks.

Microfinance is BornThe SHG – Bank linkage programme was formally launched by the NABARD in the year 1992, with it circulating guidelines to banks for financing Self Help Groups (SHGs) under a Pilot Project that aimed at financing 500 SHGs across the country through the banking system. While, the banks had financed about 600 SHGs by March 1993, they continued to finance more and more SHGs in the coming years. This encouraged the Reserve Bank of India (RBI) to include financing to SHGs as a mainstream activity of banks under their priority sector lending in 1996. The Government of India bestowed national priority to the programme through its recognition of microfinance and it found a mention in the Union Budget of 1999. The banking system comprising public and private sector commercial banks, regional rural banks and cooperative banks has joined hands with several organizations in the formal and non-formal sectors to use this delivery mechanism for providing financial services to a large number of poor.

Concurrently, in 1993, the Rashtriya Mahila Kosh (RMK) to accelerate the flow of self employed women in the unorganized sector. It is worth mentioning that the Sewa Cooperative Bank has been operating in Gujarat with similar objectives since 1974. The bank has been viable right from its inception and is an ideal example of community owned sustainable financial service delivery. Microfinance received greater recognition when the Small Industries Development Bank of India set up a Foundation for Microcredit with initial capital of Rs100 crores in 1998. The same year also saw the formation of Sa-dhan as an apex level association of Community Development Finance Institutions. The passing of Mutually Aided Cooperative Societies Act by Andhra Pradesh in 1995, followed by some other states has also acted as a stimulant as many new microfinance initiatives have come up under the MACS act. In addition to the success of the Nabard-SHG bank linkage programme, alternative microfinance initiative following Grameen and/or SHG methodology or at times individual lending model has also been successful.

Some Recent DevelopmentsThe year 2004 has seen some very important development in the microfinance sector in India. The banking sector led by ICICI bank has shown interest in microfinance as a viable commercial opportunity. The total disbursement of the banking sector to microfinance is put at around Rs1000 crores for the year 2003-04. ICICI Bank plans to build a microfinance portfolio in excess of Rs1000 crores. It has taken a lead in establishing innovative partnerships with microfinance institutions which will allow for risk sharing between the two. ICICI bank has also securitized the microfinance portfolio of Share and Basix, and has potentially opened the doors of capital markets for the microfinance sector. Microfinance sector in India is set to enter a new growth phase in its evolutionary course.