Syllabus
GS Paper III – Inclusive growth and issues arising from it.
Context
50 years of Indian Microfinance Sector
Indian Microfinance Sector
Introduction
In 1974, India’s first Microfinance Institution (MFI), Self Employed Women’s Association (SEWA) Bank, was registered as a cooperative bank, marking the beginning of the microfinance movement in India. Nobel Laureate Muhammad Yunus further revolutionized the sector with the establishment of Grameen Bank in Bangladesh in 1976, laying the foundation for modern MFIs. In India, the Reserve Bank of India (RBI) serves as the regulatory body for MFIs. The Malegam Committee, constituted by the RBI in 2010, recommended a holistic framework to regulate Non-Banking Financial Company-Microfinance Institutions (NBFC-MFIs), ensuring responsible lending and client protection.
Microfinance (Microcredit)
- Definition: Microfinance, also termed as microcredit, refers to banking services provided to low-income individuals or groups who lack access to traditional financial services.
- Interest and Repayment: Similar to conventional banks, MFIs charge interest on loans and establish specific repayment plans with regular instalments.
- Services Offered:
- Savings Accounts: Providing a safe place for individuals to save money.
- Checking Accounts: Allowing for easy access to funds and transactions.
- Fund Transfers: Facilitating the transfer of money between accounts.
- Micro Insurance: Offering insurance products tailored to the needs of low-income clients.
- Microcredit: Extending small loans to individuals or groups to support entrepreneurial activities.
Significance of Microfinance Sector
- Financial Inclusion: A powerful instrument for integrating the financially excluded into the formal economy, fostering socio-economic development.
- Women’s Empowerment: Enhances the status of women through Self Help Groups (SHGs), promoting financial independence and decision-making capabilities.
- Poverty Alleviation: Contributes to reducing poverty levels and advancing rural development by providing access to credit and financial services.
- Economic Stability: Supports the creation of sustainable livelihoods, leading to economic stability and resilience among low-income populations.
- Entrepreneurial Growth: Facilitates the growth of small businesses and entrepreneurial ventures, driving local economies.
- Social Capital: Strengthens social capital by fostering community bonds and collective action through group-based lending models.
- Access to Financial Services:
- Savings: Encourages saving habits among the poor.
- Insurance: Provides micro-insurance to protect against risks.
- Credit: Offers small loans for business and personal needs.
- Inclusive Growth: Promotes inclusive growth by ensuring that marginalized sections of society have access to financial resources.
Growth and Resilience of the Indian Microfinance Sector
- Rapid Growth: The gross loan portfolio of the Indian microfinance sector expanded approximately 16.5 times, from INR 17,000 crore to INR 2.85 lakh crore between 2012 and 2022.
- Market Share: Non-Banking Financial Companies (NBFCs) have strengthened their position in the microfinance market, holding a 39.1% share compared to the 33.5% share held by traditional banks as of FY23.
- Resilience Amid Challenges: Despite the COVID-19 pandemic, the sector has shown remarkable resilience. Portfolio delinquencies have returned to pre-pandemic levels, indicating improved portfolio health.
- Increase in Borrowers: The number of unique borrowers has significantly increased to 7.4 crore, with 14.6 crore loan accounts as of December 2023.
- Operational Efficiency: The sector’s growth is underpinned by efficient business operations and prudent lending practices.
- Profitability: Profitability has been on the rise due to higher yields and lower credit costs. The RBI’s revised regulations in 2022 have provided MFIs with greater flexibility in setting lending rates.
Initiatives taken by Government for Microfinance in India
- SHG-Bank Linkage Program: Aims to boost the loan volume for Self Help Groups (SHGs) and shift their lending focus from non-income generating activities to production-based ventures.
- Pradhan Mantri Mudra Yojana (PMMY): Offers loans up to ₹10 lakh to non-corporate, non-farm small/micro enterprises through commercial banks, NBFCs, etc.
- Loan Categories: Loans under MUDRA are classified into Shishu, Kishore, and Tarun.
- 2024 Union Budget: Increased the loan limit to ₹20 lakh for those who have previously availed and successfully repaid loans under the Tarun category.
- National Rural Livelihood Mission (NRLM): Focuses on promoting self-employment and organization of rural poor by providing them access to financial services.
- Stand-Up India Scheme: Facilitates bank loans between ₹10 lakh and ₹1 crore to at least one Scheduled Caste (SC) or Scheduled Tribe (ST) borrower and at least one woman borrower per bank branch for setting up a greenfield enterprise.
- Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGTMSE): Provides credit guarantee to financial institutions for loans extended to micro and small enterprises, ensuring collateral-free credit.
- Interest Subvention Scheme for Women SHGs: Offers interest subvention on loans to women SHGs, making credit more affordable and encouraging entrepreneurship among women.
- Deendayal Antyodaya Yojana: Aims to uplift the urban poor by enhancing sustainable livelihood opportunities through skill development and access to credit.
Challenges and Concerns related to Microfinance Sector
- High Transaction Costs: Serving a large number of small borrowers incurs significant transaction costs, including travel and monitoring expenses, making operations unsustainable for formal financial institutions.
- Lack of Collateral: Many rural poor lack the necessary documentation and collateral, making it challenging to secure loans and ensure repayment.
- Dependence on Moneylenders: Despite the presence of MFIs, many borrowers still rely on traditional moneylenders due to their easier access and flexible terms.
- Regulatory Challenges: Issues such as policy inconsistency and the absence of a supportive legal framework hinder the effective functioning of MFIs.
- High Interest Rates: Interest rates charged by MFIs often surpass those of commercial banks, potentially overburdening poorer borrowers.
- Over-Indebtedness: Borrowers often take loans from multiple sources, leading to excessive debt.
- Operational Costs: Small loan portfolios and costly credit risk management systems increase operational expenses, making it difficult for MFIs to achieve financial sustainability.
- Financial Literacy: Low levels of financial and digital literacy among borrowers can lead to misuse of funds and repayment difficulties.
- Cost of Credit: MFIs often face challenges in accessing low-cost funding, limiting their ability to offer affordable credit.
Way Forward
- Enhancing Financial Literacy: Implement widespread financial literacy programs and partner with NGOs and educational institutions to conduct workshops and training sessions in rural and underserved areas.
- Improving Access to Affordable Funding: Develop partnerships with corporates, impact investors, and international financial institutions, and encourage the use of innovative financing mechanisms such as social impact bonds and blended finance to secure low-cost funding for MFIs.
- Strengthening Regulatory Framework: Ensure consistent and supportive regulatory policies, and establish a dedicated regulatory body for microfinance to streamline oversight and address sector-specific issues effectively.
- Leveraging Technology: Invest in digital platforms and fintech solutions to enhance operational efficiency, reduce transaction costs, and improve customer service, while utilizing data analytics and artificial intelligence to develop customer-centric products and mitigate risks associated with over-indebtedness and credit defaults.
Conclusion
The journey of Indian microfinance towards profitability has been arduous and challenging. The sector’s remarkable growth has been propelled by regulatory reforms, technological advancements, and proactive government initiatives, which have extended credit to millions of poor households previously excluded from traditional financial services. Despite this progress, the sector still grapples with significant challenges such as limited access to affordable funding, low financial and digital literacy among borrowers, and concerns over customer data security. Issues like over-indebtedness and the need for innovative, customer-centric solutions also persist. Nevertheless, the sector has shown resilience, with profitability increasing in recent years due to higher yields and reduced credit costs, demonstrating its ability to withstand adversities like demonetisation and the COVID-19 pandemic.
Reference: ORF
Related PYQ
What are the salient features of ‘inclusive growth’? Has India been experiencing such a growth process? Analyze and suggest measures for inclusive growth. [UPSC CSE – 2017 Mains]
Practice Question
“Fifty years of Indian microfinance: The long journey to profitability.” Discuss the evolution, challenges, and future prospects of the Indian microfinance sector. (250 words)
Guidelines to Answer the Question
Introduction
- Briefly introduce the concept of microfinance and its significance in India.
- Mention the timeline of 50 years to set the context.
Body
- Evolution of the Microfinance Sector:
- Highlight key milestones such as the establishment of SEWA Bank in 1974, the SHG-Bank Linkage Program, and the rise of NBFC-MFIs.
- Discuss the impact of regulatory reforms and technological advancements.
- Challenges Faced:
- Address high transaction costs, lack of collateral, and dependence on moneylenders.
- Mention regulatory hurdles, high interest rates, over-indebtedness, and operational costs.
- Discuss issues related to financial literacy and data security.
- Achievements and Resilience:
- Highlight the sector’s growth in terms of loan portfolios and borrower numbers.
- Discuss the sector’s resilience during crises like demonetisation and the COVID-19 pandemic.
- Mention the increase in profitability due to higher yields and reduced credit costs.
- Future Prospects:
- Suggest measures to overcome existing challenges, such as improving financial literacy and access to affordable funding.
- Discuss the potential for technological innovations and customer-centric solutions.
- Emphasize the role of government initiatives and regulatory support in sustaining growth.
Conclusion
- Summarize the sector’s journey and its importance in promoting financial inclusion and socio-economic development.
- End with a forward-looking statement on the potential of microfinance in India.