Any economist worth his salt would attest that credit is the backbone of economic growth. Credit is the engine which keeps the economy going and this is as much true for Macroeconomy as it is at micro-level as well. For someone at just about the poverty level and looking to establish her business, credit is a must have factor because she lacks capital to fully establish her business. However, the poor find it disproportionately difficult to access formal credit from financial institutions. Multiple factors are responsible why a poor can’t access formal credit? To name a few she wouldn’t normally have collateral to mortgage and cogent business plans to impress upon savvy bankers. Against this backdrop the microfinance, particularly microlending concept emerged as a beacon of hope.
In the Indian context, where more than 40% of the population was below the poverty line in 2001, the microfinance got its messaging spot on. It had a social objective to achieve – to reduce poverty by helping the poor establish and run their businesses without worrying about the usurious rates charged by moneylenders. It was in fact among the first few industries to adopt double bottom lines – measuring social impact along with the financial performance. Social messaging of the microfinance was always that it was responsible in its ways; and it needed regulatory and financial support to achieve this important societal objective of providing dignified livelihoods to the poor.
Indian Microfinance has come a long way since early days and according to Sa-Dhan, an association of community development finance institutions, the combined micro credit portfolio of all lenders (including SHGs) as on 31st March, 2021 stands at ₹ 2,47,839 Cr. Even if we conservatively put a timeline of the mid 90’s for the current form of this movement to take root, it’s been over 25 years since. It is a long enough time period to put these objectives to test, namely – how has the Indian microfinance lived up to those initial objectives? And where does it go from here?
We cover the journey of Indian Microfinance in a series of three articles. These will deal with the following
- Evolution of Indian Microfinance
- Factors limiting Indian Microfinance
- Future roadmap of Indian Microfinance
Background
World over, formal financial institutions have been reluctant to lend to the poor on account of lack of collateral or irregular cash flows; and because of the operational challenges and higher cost of serving the low-income population, especially in the rural locations. . At the same time credit initiatives such as “Rotating Credit and Savings Association (ROSCA)”, where prospective borrowers pool in their funds, have been operational since ages. However, the latter were always constrained by lack of funds, management, and trust issues.
In India, some civil society organizations successfully experimented with more appropriate microfinance models for poor households. Prominent examples of this are SEWA Bank (Ahmadabad) and Working Women’s Forum (Chennai). The first Self Help Groups (SHGs) started emerging in the country in the 1980s as a result of NGO activities such as MYRADA.
“Self Help Groups (SHG)” mechanism, where prospective borrowers pool in their savings in a bank account, building a corpus, against which they could borrow funds, was a further evolution which took care of the paucity of funds issue. In 1984-85 MYRADA started linking SHGs to banks, when the SHGs’ credit needs increased and the groups grew large enough for the bank to have transactions with. SHGs idea was taken up on a large scale later by “National Bank of Agriculture and Rural Development (NABARD)”. With the success of this program the “Reserve Bank of India (RBI)” in 1996 took a policy decision to include financing to SHGs as a mainstream activity of banks under their “Priority Sector Lending (PSL)” portfolio. This was a big policy step to resolve the funding issue; however, it did not solve the management issues
The government put all its might behind this mechanism and directed banks to lend to these SHGs. Borrowings of the SHGs also grew at frenetic pace; however, it wasn’t a self-sustainable model. SHGs always required support and intervention of external entities in the form of an agency which would maintain the books for these SHGs and take care of other management functions. Soon, the field was ripe enough for NGOs to provide management services to community groups while linking those to banks for funds.
Almost at the same time, though independently, in Bangladesh a doughty professor started a movement called the “Grameen Model” of financing which replaced “social capital” as a collateral against which the financial institutions could lend to the poor. For almost two decades India paid scant attention to its success but created too loud a buzz to ignore. That’s when the “Joint Liability Group (JLG)” or so called “Grameen Bank Model” led microfinance movement started in India. It is difficult to put a finger on the actual date of its birth in India, but it will be safe to put it somewhere around the mid 90’s.
Initial torchbearers of this model were NGOs who had realized limitations of the SHG-bank linkage model. Having learnt from the Grameen experience, NGOs approached banks to lend to them and they in turn lent to the JLGs. This was a more scalable model for the NGOs and easier for the banks to monitor. RBI also helped in growth of this with time-to-time updating of PSL guidelines which brought lending to these NGOs for the purpose of on lending to unbanked, under the ambit of PSL. This propelled growth of the JLG model to a higher orbit compared to slower growth and dependence on government initiatives of the SHG model. However, this growth also hit a ceiling in the form of a low capital base of the NGOs. Banks needed collateral from the organizations along with social capital of the JLGs to be able to lend to them. NGOs, given their terms of association, couldn’t provide any returns to their donors, thus limiting their access to capital. Breakthrough came in the form of “Non-Banking Finance Company (NBFC)” licenses for Microfinance institutions and that got the ball rolling. By 2004, when the minimum Net Worth requirement for owning an NBFC was₹2 Crore, there were hardly four NBFCs having microfinance as their core business. By 2012, when NOF had been increased to INR 5 Crore, the number of NBFC-MFIs had increased to about 50. Currently, when the NOF requirement is INR 20 Crore, the number of NBFC-MFIs is over 100 along with a few which have converted into “Small Finance Banks” and one which has converted into a Scheduled Bank.
A look at the following graphs is enough to leave someone spellbound with the kind of growth Indian Microfinance has seen. What also needs to be kept in mind is that figures for 2020 are
excluding that of the “Small Finance Banks (SFB)” and that of Bharat Financial Services Ltd. which were the largest block of Indian Microfinance industry.
To have a clear context, the table below shows growth of Indian MFIs against that of SHGs. You may notice that whereas in 2008, SHG movement was far ahead of MFIs but now its growth pales in comparison. Mind you, all this has been backed by private capital unlike SHGs which have required all might of Government apparatus behind it.
After about 25 years of eventful journey and having scaled previously inconceivable heights, it is opportune time to put initial promises to test. We take the three most contentious issues to assess the impact of microfinance.
Did it really make access to finance available to those who didn’t have access to banking networks?
The figure below makes it very clear that Microfinance in India never lost its focus on the unbanked clients (mostly rural, SC/ST, minorities). Point to be noted is that these numbers should be compared to the percentage of these sections in the overall population. However, it can be argued that the proportion of these sections is more among the unbanked. Consequently, they should have had a larger proportion in microfinance clientele. However, it could be considered a minor blip rather than being a point against microfinance drifting away from its intended segment.
Did it just reach out to a few who may already be availing credit and thus reached to a subset of the intended target segment rather than to the entire segment?
Now this is a serious question mark over the social objective of microfinance. Data seems to suggest that Indian Microfinance still is not down that street but seems to be slipping down.
As we see the number of loans per customer going up steadily and accelerating with every passing year. If we put this in context of over 100 districts not having any microfinance institutions makes this even grimmer. It leads to the conclusion that an increasing number of MFIs (it could be argued the new ones) tend to lend to someone who is already a microfinance customer. This is contrary to the original hypothesis.
Did MFIs pass on the economies of scale savings to the customers, in terms of interest rates coming down over a period of time?
MFIs always had interest rates higher than that of banks charge. Given, that these loans largely go to poorer section of society, this has been an oft repeated criticism. This makes MFIs prone to political interference. How much of this criticism was justified? It is quite clear that the rates that MFIs charge, 20% – 24% per annum, are towards the higher end of interest rate spectrum among the formal financial players. However, it needs to be put into context of these being unsecured loans. These interest rates need to be compared to credit card interest rates, though issued to generally salaried class with credit history, that ranges from 3% – 4% per month. Following chart makes it very clear that the interest rate charged by MFIs goes down as the size of the organization increases.
This becomes even more stark when we plot yield against the cost of capital, which forms the largest proportion of cost for MFIs. Yields have been consistently coming down irrespective of Financial Cost going up.
Having examined on the major criticism points, it is safe to conclude that Indian Microfinance has made huge strides and passed many tribulations by fire. It will be no hyperbole to say that it has seen three to four near death experiences. Even then it has largely been true to its initial promise of reaching out to unbanked population. There have surely been a few missteps, in terms of local level over-lending as well as unawareness to political economy of lending to poor. However, “Self-Regulatory Organizations (SROs)”, have rendered yeoman’s service in bringing clear strategies and ensuring compliance to an industry wide “Code of Conduct” and data sharing with Credit Bureaus as well as representations with political leaderships as well as with the regulators. All these steps, on part of SROs, helped Indian microfinance being recognized as a mainstream industry and now it has a even more important role to play in nation building.
As any industry needs certain factors going for it in order to fulfill its potential, so does the microfinance industry. In the second part of this series, we will look at the factors that limit the Indian microfinance industry.