An Introduction to Indian Microfinance

The term microfinance refers to the provision of financial intermediation services to clients having low incomes. These services include savings and credit; and in some cases, also insurance and money transfers. The task force set up by the National Bank for Agriculture and Rural Development (NABARD), under the chairmanship of Sh YC Nanda has suggested the following working definition of microfinance: “Provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban and or urban areas for enabling them to raise their income levels and improve living standards”. (Report of the Task Force on Microfinance, 1999)

Microfinance operations usually involve:
• Making small and flexible loans according to clients’ requirements, repayment capacities and cash-flows
• Providing secure deposit facilities to the poor, which allows them to save as and when they have surpluses
• Collateral substitutes such as group guarantees and compulsory savings
• Encouraging repeat and larger loans based on repayment performance
• Continuous monitoring and follow up to ensure timely repayments of loans
Microfinance has evolved as a development approach intended to benefit the economically underprivileged. Difficulty in accessing institutional finance by the poor, the government’s commitment to making credit accessible by the poor and the success of Grameen Bank in Bangladesh have all contributed to the ascent of microfinance in India.

Microfinance in India: Scope, Demand and Supply
There is a large demand for microfinancial services in India. India is estimated to have nearly 400 million people who are below or just above an austerely defined poverty line . The number of households, who need microfinancial services, would therefore range between 70 to 80 million. The current annual credit demand by the poor in India (fifty million households) is estimated to be between Rupees 15,000 to Rupees 45,000 crores (Mahajan and Ramola , 2003). These households also have a high demand for saving services, though, quantified estimates are not available. The fact that the poor turn to informal and often unreliable sources to save suggests that a large part of their savings demand is unmet. A large proportion of the annual credit demand of the poor also, is unmet. An optimistic estimate is that the number of small loan accounts from banks covered some 40 million households in the year 2000. The remaining households have to depend upon other sources to meet their credit needs (Fisher and Sriram, 2002). The total loan outstanding of all microfinance initiatives in India has been estimated to be around Rs1200crores for the financial year ending March, 2003 (Mahajan and Ramola, August 2003). Even if one were to assume a thirty percent increase for the year 2003-2004, the loan outstanding figure will come to Rs1600 crores which is tiny given the annual demand.

Savings in the microfinance sector
Mcril’s microfinance review based on a sample of 90 Indian MFIs estimated that these MFIs had raised some $32.9 million (or Rs145 crores) as client deposits. These deposits were accepted formally – and taken onto their balance sheets – by the sample MFIs from their members/clients. The review also noted that this was an underestimation of the amount of savings actually mobilised by MFIs since it did not include the amount that is retained by each self-help group for internal circulation. The review further estimated that the actual level of savings by members of MFIs – both with the MFI and the SHG – was around three times the figure recorded in the MFI’s accounts. This would increase the total savings of members of Indian MFIs in the sample to $80 million (Rs360 crores).


NABARD SHG Bank Linkage Programme
The SHG – Bank linkage program was launched by the National Bank for Agriculture and Rural Development (NABARD) in the year 1992 as a pilot project aimed at financing 500 Self Help Groups (SHGs) across the country. The programme was perceived as a success and banks continued to finance SHGs in the coming years. The Reserve Bank of India (RBI) included financing to SHGs as a mainstream activity of banks under the priority sector in 1996. As a result of this programme the banking system comprising of the public and private sector commercial banks, regional rural banks and cooperative banks has joined hands with several organizations in the formal and semi-formal sectors to facilitate the provision of financial services to a large number of poor.

The beneficiary group
The beneficiary of NABARD’s linkage program is the Self Help Group (SHG), which is trained in the skills of thrift and credit and given access to banking sector funds. An SHG is a group of about 20 people from a homogeneous class, who come together for addressing their common problems. They are encouraged to make voluntary savings on a regular basis. They use the pooled resources to make small interest bearing loans to their members. The process helps them imbibe the essentials of financial intermediation including prioritization of needs, setting terms and conditions, and accounts keeping. This gradually builds financial discipline in all of them and they gain experience in handling resources of a size that is much beyond individual capacities of any of them. Once the group shows financial maturity, banks are encouraged to make loans to the SHG in multiples of the accumulated savings of the SHG. The bank loans are given without any collateral and ideally at market interest rates. The group continues to decide the terms of loans to their own members. Since the group’s own accumulated savings are part of the aggregate loans made by the groups to their members, peer pressure ensures timely repayments.

Products and Services
The product package under this scheme comprises of primarily two activities: social intermediation followed by financial intermediation. Social intermediation results in skill up gradation among SHG members. The members get trained in managing money as well as basic accounting. It also helps them develop a sense of financial discipline.

The second aspect of this scheme is provision of credit to these groups. Once the members have gained a fair experience in rotating SHG’s internal funds, they are allowed to access credit from banks. This takes care of their higher capitalization needs and provides them an opportunity to raise their incomes. For the bank, good groups making timely repayments represent an excellent business opportunity.

Business Linkages – Strategy
Over time the following three models of institutional linkages have evolved:
Model I: SHGs formed and financed by banks. In this model, banks themselves take up the work of forming and nurturing the groups, opening their savings accounts and providing them bank loans. Up to March 2002, 16% of the total number of SHGs financed was from this category.

Model II: SHGs formed by NGOs and formal agencies, but directly financed by banks. This model continues to have the major share, with 75% of the total number of SHGs financed up to March 02 falling under this category. Here, NGOs and formal agencies in the field of microfinance act only as facilitators. They facilitate organizing, forming and nurturing of groups, and train them in thrift and credit management. Banks give loans directly to these SHGs.

Model III: SHGs financed by banks using NGOs and other agencies as financial intermediaries. This is the model wherein the NGOs take on the additional role of financial intermediation. In areas where the formal banking system faces constraints, the NGOs are encouraged to approach a suitable bank for bulk loan assistance. This, in turn, is used by the NGO for on-lending to the SHGs. In areas where a very large number of SHGs have been financed by bank branches, intermediate agencies like federations of SHGs are coming up as links between bank branch and member SHGs. These federations are financed by banks, which, in turn, finance their member SHGs. The share of cumulative number of SHGs linked under this model up to March 02 continued to be relatively small at 9%, but in years to come, this is expected to become a major delivery mode.

SHG – Bank linkages: Outreach and Potential

With 7.8 million poor households accessing credit through 17,085 branches of the formal banking system under this program as on March 2002, it is the world’s largest microfinance program in terms of outreach. The corporate mission set by NABARD for reaching microfinance services to the very poor envisages coverage of one third of the rural poor of the country, i.e., a population of about 100 million rural poor through one million SHGs by the year 2007-08. Having already reached 0.942 million SHGs, along with nearly 14 million poor households in March, 2004, NABARD is on the course of exceeding its outreach target .

The Parallel Channel
In addition to NABARD’s microfinance programme, there are a number of other microfinance initiatives in India. Most of them are a result of NGO activities and have received grants from donor agencies. These microfinance programmes have also been aided by soft loans from the SIDBI Foundation for Micro Credit (SFMC), the Rashtriya Mahila Kosh (RMK) and Friends of Women’s World Bank (FWWB). These programmes represent diverse organizational forms such as Charitable Trusts and Societies, Cooperatives, Section 25 Companies, Non Banking Financial Companies (NBFCs), and Banks. A sample analysis of ninety MFIs in India by M-Cril reveals that there is a continued dominance of not-for-profit institutions (nearly 80%) in the provision of microfinance services through this channel.

The parallel channel is also characterized by different operating models – Self Help Group models, the Grameen model, the Individual Banking model or a Mixed model. The dominant model of microfinance delivery through this channel is again the SHG model. The operations of SHGs are based on the principle of revolving members’ own savings, which are augmented by funds borrowed by banks (SHG-Linkage Programme) or MFIs (the alternate channel). The primary features of this model have been presented in detail earlier. The following paragraphs discuss the other models.

Grameen model: This model was initially promoted by the Grameen Bank of Bangladesh. Grameen MFIs undertake individual lending but all borrowers are required to form into five member joint liability groups (JLGs). The JLGs, in turn, get together with 6-9 other neighbouring groups to form a centre. Peer pressure among the members is the key factor in ensuring repayment. Each borrower’s credit-worthiness is determined by the overall credit-worthiness of the group. Savings are a compulsory component of the loan repayment schedule but do not determine the magnitude or timing of the loan. The important MFIs following this model are Share Microfinance Limited (registered as NBFC) in Andhra Pradesh and Cashpor (Section 25) in Uttar Pradesh.

Mixed model: Some of the MFIs started with the Grameen model but later on went on to adopt some aspects of the SHG model. A prominent MFI that follows a hybrid model with features of both Grameen and SHG is Spandana, which operates in the Guntur region of Andhra Pradesh.

There are others MFIs that have chosen to adopt either the Grameen or the SHG model to cater to individual market segments while a few organisations also individual banking type products and methodologies, in addition to group based methods to provide financial services. An important example is Basix that uses diverse methodologies each suited to a particular market segment. Others such as the Indian Association of Savings and Credit (ISAC), a section 25 company promoted by the Housing Development Financial Corporation (HDFC) gives individual as well as group loans.

Individual Banking model: This is the provision of financial services by MFIs to individual clients – though they may sometimes be organised into joint liability groups, cooperatives or even SHGs. MFIs organized as Cooperative banks such as Pushtikar Samiti-a cooperative bank operating in Jodhpur, Rajasthan

Microfinance has emerged as a rapidly growing poverty focused development activity in India.