How to Start a Microfinance Business in India

Microfinance India Feb 22, 2021

Microfinance companies are the companies that fulfil the financial needs of individuals and businesses, on a smaller or lower level. They provide small denomination loans to individuals and companies.

Why Do We Need A Microfinance Company?

In India, we already have many institutions like banks that sanction loans to the finance business. Then why do we need Microfinance Companies?

The answer to this is simple; we need such companies to encourage women entrepreneurs.

  • To provide startups with financial support.
  • To provide a nominal amount of loans.
  • To establish financial equitability.

Formation of a Microfinance Company in India

Ideally, only NBFCs (Non-Banking finance companies) are allowed and authorized by the RBI to conduct financial business. However, there are some exemptions provided by RBI to particular companies to perform the financial activities up to a limited amount of fund size.

The first prerequisites to start an MFI are to abide by the country’s regulations and meet the funding needs.

Type 1 - Profit-making MFI: A profit-making Microfinance Institute (MFI) can either be registered as a Non-Banking Financial Company or a co-operative society.

The commercialization of the entity is a significant factor to attract market investors. RBI supervises the entity, and they need to improvise their performance to assure good investment for the investors.

Type 2 - Non-profit-making MFI: As a non-profit-making MFI, a company can also start as an NGO registered as a Society, trust, or company. An MFI under Non-Profit Organization is registered as Trusts, under the Indian Trust Act 1882 and Companies act 2013.

NGOs that are registered as companies are termed sector 8 companies under the companies act 2013.  Sector 8 companies have higher credibility amongst Government departments, Donors and other stakeholders.

Type 1 - Profit-making MFI: Register as an NBFC

The NBFC-MFI is allowed to offer the microloan to a specific type of clients and borrowers.

To start with it, you need to have the following documents and qualifications:

  • At least one of the directors or commonly must have financial services experience of at least ten years.
  • Small finance companies can use SHGs (self-help groups) to intermediate the financial transaction.
  • The license to operate an NBFC is to be applied only from RBI. NBFC-MFI has to have a paid-up capital of INR 5 crores at least.
  • The NBFC should be a member of the Credit information companies and be a member of at least one Self-Regulatory organization.
  • The company should have a CIBIL membership. The first borrowing should not exceed INR 50,000. The upper limit for all the next borrowings is INR 1 lakh.
  • At least 10% of the total assets of the small finance should be loans.

Documents required to register Microfinance NBFC:

  • List of directors
  • KYC
  • Income proof
  • Education/professional qualifications
  • Work experience proof in the field of financial services and
  • Net worth certificate
  • Credit report
  • Memorandum of Association (MOA) and Articles of Association (AOA) of the NBFC as proof
  • Incorporation certificate
  • Banker's analysis of the company,
  • No lien supporting the net owned fund of 5 crores
  • Details of the action plan of loan products
  • Decision-making plan about the approval or rejection of loan application
  • Organization structure plan
  • Board agreement for the NBFC formation

Steps involved:

Step 1: Register your Company

The first step involved getting your financial bank registered in a company’s name as a private or public limited company.

Step 2: Raise a  Capital (Minimum INR 5 Cr)

For NBFC Registration, the minimum paid-up capital of 5 crores is mandatory.

Step 3: Issue Certificate of No Lien

You can obtain a certificate of No Lien by creating a fixed deposit of 5 crores.

Step 4: Register with RBI

File an Online Application with RBI.  Once the application has been successfully submitted, Your Company gets a Company Application Reference Number (CAR number). This CAR number must be used in all further communications with the RBI.

Step 5: Finish the Filing with the RBI

First, you need to file an online application, once done with it, all necessary documents should be sent to India’s reserve bank’s regional office.

Type 2 - Non-profit-making MFI:

The registration process for sector 8 companies is more straightforward and cheaper than Type 1 of registration (NBFC).  The RBI approval is not mandatory; however, you have to abide by the guidelines regarding the interest rates and charges.

The Number of Compliances is much less than profit-making Microfinance institutions.

  • No minimum ceiling for fundraising
  • The average interest rate cannot exceed 26%
  • The processing charge cannot cross over 1% of the gross amount.
  • No public deposits accepted.

Documents required to start your Sector 8 companies are:

Copies of Pan Card, Aadhaar Card, or any other address proof of the shareholders. Address proof for the registered office of the company would include ownership proof, NOC, etc.

Steps to be followed

Step 1: Obtain their DSC and DIN.

Step 2: Choose a name for the company and get it approved by the ROC. The name you select must be unique to reflect your brand, a maximum of 6 choices could be filed at a time.

Step 3: Apply for a License of the company mentioning the social work you will do in India, from the Central Government.

Step 4: On License approval, apply for the incorporation.

Step 5: The application for incorporation should have all applications attached like MOA, AOA, and Declaration where your company name will be issued with the certificate of incorporation.

Step 6: Then get the pan and tan for your sector 8 company