Micro-finance in Rural India: Challenges for the Future
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- Aishik Chakraborty
- Aritra Datta
- Shubham Chowdhury
- Snehashish Saha
Rural India is home to about two-thirds of the India's 125 crore population. This population is mostly engaged in agriculture that contributes 17.2 percent to India's GDP. However, this dependence on agriculture is gradually diminishing with small-scale cottage industries and self-help groups gaining prominence in rural economy. This is clearly reflected by the contribution of industry in rural economy which has grown to 30.2 percent in the recent years. However the self-help groups and cottage industries often have to depend on the local moneylenders for financing of its activities with most large scale banks yet to make a foray into rural markets. In such circumstances, micro-finance gains prominence in financing activities of such industries.
Micro-finance is a critical factor in uplifting rural economy. However this sector suffers from various challenges. It is imperative that the challenges are studied in order to ensure the Indian growth story to continue. This study will analyze the prevalent challenges and recommend strategies to overcome these bottlenecks.
Micro-finance refers to small scale financial services provided by financial institutions to the financially backward classes. These services include savings, credit, insurance, etc. The conditions for a financial service to be termed as micro-finance is that the transaction should be small and the customers should be financially weak. Jeffrey Sachs, the renowned economist once claimed that “The key to ending extreme poverty is to enable the poorest of the poor to get their foot on the ladder of development.”
The concept of micro-finance was introduced in India during the 1990s. The country is home to about a third of the world’s poor, most of who do not have access to commercial banking services. The key problem areas in rural financial markets included a lack of credit in rural areas, absence of modern technology in agriculture, low savings capacity in rural areas and prevalence of usurious moneylenders. In such circumstances, micro-finance provides financial inclusion to the under-privileged sections of the society. In absence of micro-finance, the poor in rural India would fall prey to the money-lenders who charge a very high rate of interest on credit and thereby rob the poor of their savings.
Micro-finance differs from conventional banking as unlike conventional banks, micro-financing lays more emphasis on the principles of co-operation, equality and mutual self-help. Micro-finance targets mostly the women of rural India, with more than 90% of its customers being women belonging to self-help groups. Micro-credit is mostly used for direct investments by self-help groups and facilitates access to credit by clients who need small amounts of credits but are less credit-worthy for larger loans.
However, MFIs in India are susceptible to a number of challenges including political interference. They compete with both politicians and government backed lending programs for the same target segment. The ability of the Indian MFI industry to mitigate this risk is a crucial factor in determining its success. An example of a crisis in the micro-finance sector was when Andhra Pradesh found itself at the center of a debacle thatwas triggered by a the highly successful MFI, SKS Microfinance, which tactfully covered up cases of suicides among MFI borrowers. While it has not been clearly established whether indebtedness or coercive MFI tactics triggered the suicides, the political backlash was intense. In order to counterbalance the political criticism, the state government hastily pushed through a legislation that effectively crippled the MFI industry in the state.
RBI established a committee, headed by Y.H. Malegam, to review the various issues and to recommend regulatory steps needed to prevent these incidents from recurring. Released in January 2011, we the recommendations will have wide ranging impacts on the industry.
Some of the key impacts include:
- Creation of entry and operational barriers through higher net worth, capital adequacy, loan portfolio allocation requirements with a possibility of some banks absorbing some of the MFIs.
- Implementation of industry specific corporate governance standards, greater oversight by the RBI, tailoring NPA definitions in accordance with industry standards will improve corporate governance and transparency .
- Establishment of a fully fledged credit bureau, limitations on the number of loans to each household, conditions on procedures for loan sanctioning and repayments will reduce the incidence of over-borrowing and multiple-lending .
The World Bank has also taken major steps in the sector of micro-finance. Formation of Consultative Group to Assist the Poor (CGAP) in 1995 as a consortium of 33 Public and private development agencies and establishment of Microfinance Management Institute(MAFMI) in 2003 are significant landmarks. Regional multilateral development banks like Asian Development Bank also champion the cause of commercial micro-finance. Nationalization of existing private commercial banks, massive expansion of branch network in rural areas, mandatory directed credit to priority sectors of the economy, subsidized rates of interest and creation of a new set of rural banks at district level and an Apex bank for Agriculture and Rural Development (NABARD20) at national level are some of the organizations working in micro-finance.
The initial micro-credit innovations in Bangladesh, Bolivia and Indonesia demonstrated the success of micro-lending. However the popularity of micro-finance in India stemmed from its ability to reach the poor without collateral and near full recovery rates. Micro-finance is contributing significantly to the financial activities of the poor. Various initiatives and programs have been launched to fortify the position of micro-finance in India. The speed of enforcement and the degree to which these recommendations are implemented will determine how much the industry will change and how likely it is to succeed.
Microfinance suffers from various challenges from its competitors and also from the issues stemming from the mismanagement of various micro-finance companies. The study will enable us to recommend the future strategies and build the way forward for MFIs in India by addressing the following issues.
- What is microfinance and how does it impact rural India?
- What are the challenges faces by MFIs in India?
- What are its implications on the various stakeholders (villagers, money-lenders, banks, Govt. and the MFI institutions)
- What are the possible solutions to these challenges?
- Action plan for the recommendations.
The research will be based on the following methodologies.
- Identification and interpretation
- Identify the major issues and challenges.
- Formulate relevant questions keeping in mind these issues.
- Gather information from primary and secondary sources.
- Interpret the solutions to the issues
- Support and supplement the findings from research data.
- Data Analysis
- Gather data from self help groups and find whether they are involved in Micro Finance, and how micro finance has contributed to their business and rural India in general.
- Challenges that they face while getting the requisite loan from the Micro Finance Institutions.
- What are the viable alternatives to Micro Finance.
- The strategic importance of Micro Finance Institutions to their organization.
- How Micro Finance has impacted their lives and whether the impact is positive or negative.
The study will consider all the dimensions of Micro Finance in Rural India and provide the following value additions to the field.
- Appreciate the importance of Micro Finance in rural India and explain their significance.
- Understand the perceptions of the rural population about Micro Finance in India.
- Remove the apprehensions about Micro Finance and communicate the benefits of Micro Finance to the rural population.
- Understand and comprehend the challenges that Micro Finance Institutions face in rural India.
- Elucidate how the challenges impact the MFI’s.
- Analyze and evaluate the challenges critically.
- Develop strategies for overcoming the current challenges and sustaining them.
- Analyze the competitors and their strategies.
- How can MFI’s handle the challenges and maintain their customer base.
- Design the future path of development for Micro Finance in India.
Existing micro-finance models in India
The following micro-financing models are prevalent in India. Each of these models have their own advantages and disadvantages.
- SHG-Bank Linkage Model: In this model the SHGs get credit directly from the co-operative banks, regional rural banks, NABARD, etc. This model provides credit to SHGs at lower rates of interest. However this model reduces the credit worthiness of the SHGs and increases the risk of default for the banks.
- Bank-MFI Linkage Model: In this model, the MFIs act as intermediaries and guarantors for the SHGs and receive financing from banks for further lending it to the SHGs. This model helps in improving the credit worthiness of the SHGs and reduces the risks for the banks. However the SHGs have to pay a higher rate of interest to MFIs in this model.
Challenges faced by the Micro-finance sector in India
Through extensive study and discussions with relevant stakeholders, the following have been identified as being the foremost challenges to the micro-finance sector in India.
- There is extreme skewness in distribution of micro-finance services in India. 52% clients of micro-financing come from southern India while 23% come from eastern India. The share of micro-finance beneficiaries from North, West, Central and North-East India stand at an abnormally low level of 9%, 12%, 3% and 3% respectively. This disparity clearly shows that micro-financing services are unevenly spread and is not available to many people who need it.
- Micro-finance is mostly concerned with micro-credit to SHGs. However other financial services such as insurance, savings schemes are not provided. Also it serves the SHGs, individual businesses don’t benefit through micro-finance.
- Micro-finance is considered as a social/charitable business rather than a profitable one. Consequently, almost 90% MFIs are dependent on subsidies and suffer from a high debt-equity ratio.
- The loan sizes are generally small and involves high transaction and processing costs. Consequently the interest rates are higher.
- There is high turnover of MFI employees. The reasons are poor salary, lack of incentives and working mostly in rural areas with limited opportunities. The employees also lack in financial and technical training.
- The MFIs lack control over how efficiently the money is used after lending. This often leads to bad investments by SHGs and results in default. MFIs are aware of this risk and keep the interest rates high in absence of a collateral.
- Micro-finance has reached only a small fraction of the people who need it.
- The micro-finance sector lags behind from technological perspective that would allow it to disburse loans more effectively.
- Absence of best practices norms in the industry often leads to coercive recovery of loans.
- The poor in urban areas cannot avail micro-finance services. Hence these services should be extended for the urban poor as well.
- Micro-finance institutions have a very low rate of customer retention. This is because clients are not properly educated about the services available from the MFIs.
Based on the findings, the following steps are recommended for reviving micro-finance sector in India and turning it into a tool for poverty alleviation and financial inclusion.
- Micro-finance reaches a very small fraction of the people who need it. Hence an overall scaling up of micro-finance sector is imperative. The initiative can be in form of public ventures, private banks or PPP model. The MFIs and NBFCs are to be brought under a regulatory authority to ensure standardization and enforce best practices.
- The micro-finance sector should diversify its portfolio from being a money-lending entity into an sector that provides holistic financial services such as insurance and savings to its clients. It should also try to widen its client base from SHGs in rural areas to the deserving urban poor who require financial inclusion.
- Greater use of technology and analytics can negate some issues that arise out of asymmetric information while sanctioning a loan and provide better risk analysis. This will allow MFIs to lower the risk of default while the poor will benefit from lower interest rates due to less chances of default.
- There employees should be provided with better incentives and given proper training to educate the rural people with the benefits of services provided by the MFIs. They should also be provided with technical and financial training to better assess the credit worthiness of the client.
- The perception of MFIs should change from being social or charitable organizations into being sustainable and profitable organizations. This would allow MFIs access into financial markets and investments and end their dependency on subsidies.
The following questions were asked to hostel and mess staff and security guards of IMI who were likely to have been exposed to the Micro-finance sector. The questionnaire and responses are as follows.
- Are there any SHGs operating your native village?
- Do you have any close relative associated to SHGs?
- Which part of the country your native village is situated at?
- Are you aware of the services that micro-finance institutions provide?
- Do you have access to micro-finance institutions in your village?
- What is the preferred source of credit in your village?
- Has micro-finance institutions uplifted the rural class?
- Microfinance in India: Empirical Evidence, Alternative Models and Policy Imperatives - Rajaram Dasgupta
- Access, Use and Contribution of Microfinance in India: Findings from a National Study - Frances Sinha
- Microfinance in India - K.G. Karmakar - ISBN: 978-0-7619-3626-8
- Microfinance in India: Mission or Misery? - Jaideep Singh Panwar
- The Microfinance Sector in India: Which Way Now? - Savita Shankar and Mukul G. Asher
- Issues and Challenges Relating to Microfinance in India - Dr. Sandeep Bansal
- Microfinance in India: Contemporary Issues and Challenges - Sibghatullah Nasir
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