Context: In recent times, Microfinance institutions have been increasingly adopting technology to enhance operational efficiency, improve underwriting models and reduce expenses.
About Microfinance:
Microfinance is a banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services.
Microfinance allows people to take on reasonable small business loans safely, and in a manner that is consistent with ethical lending practices.
The term “microfinancing” was first used in the 1970s during the development of Grameen Bank of Bangladesh, which was founded by Muhammad Yunus.
Today, microfinance is available in nearly 85 per cent districts of India with more than two lakh frontline employees distributing credit and associated services.
Need for Microfinance:
To safeguard the interest of people outside the formal financial system.
Failure of formal banking institutions in lending to the rural poor in the absence of proof of recognised employment or collateral that can be offered by them while applying for loans leaves the poor with no alternative but to borrow money from local moneylenders at high-interest rates.
In order to provide credit facilities to such individuals, MFIs are useful.
Benefits of Microfinance:
Financial Inclusion: Microfinance has emerged as one of most important tools to foster financial inclusion.
It enables the poor and low-income households to come out of poverty, helps women to become owners of assets, has an increased say in decision making and leads dignified lives embodying the concept of a collective good.
Inclusive Growth: Microfinance plays a critical role in promoting inclusive growth by making credit available at the last mile and therefore, acts as a safety net for those at the bottom of the pyramid.
Microfinance loans provide financial access to the poorest that allows many of them to start new businesses, grow existing businesses, insure against shocks due to bad weather and illness, and smooth consumption.
Adopting Tech: MFIs (microfinance institutions) have been increasingly adopting technology to enhance operational efficiency, improve underwriting models and reduce expenses while continuing the focus on customer-centricity.
Audio-visual content in vernacular languages is widely utilised to continuously impart financial literacy.
Improve Underwriting Models: A separate credit bureau for microfinance was established about a decade back.
Intense efforts by MFIs and credit bureaus have led to the development of robust databases and a credit bureau report is an essential part of underwriting now.
Expanding Reach of Microfinance: In terms of reach, microfinance operations cover 28 states and 9 union territories (UTs).
In terms of regional distribution, eastern & north-eastern regions of the country have the largest share at 37 per cent followed by south at 27 percent and west at 15 per cent.
Thus, in impacting the lives and livelihoods, the role of microfinance continues to be important. While microfinance is present in almost all nooks and corners of the country, in terms of geographical distribution, 82 per cent of the loan portfolio is concentrated in ten states.
Strong Customer Protection: The RBI regulations for microfinance provide an effective framework for customer protection.
This framework is supported by the RBI recognised self-regulatory organisation (SRO).
The SRO supports the MFIs in the implementation of the regulations, takes initiatives for capacity building, improves governance through regular guidance and surveillance and provides a platform for resolving sector level challenges.
Digitalisation initiatives: Digitalisation initiatives have been aligned with the rapid diffusion of smartphones and growing comfort of borrowers with digital modes of transactions.
Today, nearly 100 per cent of loans are digitally disbursed directly into the bank account of the borrowers and an increasing number of repayments are also being done digitally.
Challenges of micro financial institutions:
Fragmented Data: While overall loan accounts have been increasing, the actual impact of these loans on the poverty-level of clients is not clear as data on the relative poverty-level improvement of MFI clients is fragmented.
Impact of Covid-19: It has impacted the MFI sector, with collections having taken an initial hit and disbursals yet to observe any meaningful thrust.
Social Objective Overlooked: In their quest for growth and profitability, the social objective of MFIs—to bring in improvement in the lives of the marginalized sections of the society—seems to have been gradually eroding.
Loans for Non-income Generating Purposes: The proportion of loans utilized for non-income generating purposes could be much higher than what is stipulated by the RBI which is 30% of the total loans of the MFI.
These loans are short-tenured and given the economic profile of the customers, it is likely that they soon find themselves in the vicious debt trap of having to take another loan to pay off the first.
Regulatory Framework for Microfinance in India:
The Reserve Bank came out with a comprehensive and revised regulatory framework for microfinance loans in March 2022.
Core Principles:
Intent in framing these guidelines was built around the idea of customer protection. To achieve, the framework has incorporated five core principles, namely –
Addressing regulatory arbitrage with the introduction of a lender agnostic and activity-based regulation so that all the regulated entities engaged in microfinance pursue the goal of customer protection within a well-calibrated and harmonized set-up.
Protection of microfinance borrowers from over-indebtedness caused by granting of loans beyond the repayment capacity of the borrowers which, then, can potentially get manifested into coercive recovery practices.
Enabling the competitive forces to bring down the interest rates by way of enhanced transparency measures.
Enhancement of customer protection measures by way of strengthening them and extending them to all regulated entities.
Facilitating flexibility to design products/ services to meet the needs of microfinance borrowers in a comprehensive manner.
Major Provisions:
The central bank has allowed households earning up to ₹3 lakh annually to be classified as eligible for microloans, expanding the market for microfinance institutions (MFIs)
It also removed the cap on pricing loans, aiding deeper penetration into existing markets and entry into new ones.
There shall be no pre-payment penalty on microfinance loans.
Significance
MFIs believe these measures, along with the rising demand for loans in rural India, should drive growth for NBFC-MFIs.
These regulations can improve credit culture. Credit assessment of households is very beneficial for long-term sustainability.
This harmonised regulatory framework for different types of lenders, will encourage healthy competition and enable customers to make an informed choice regarding their credit needs.
Way Forward:
The microfinance program has witnessed phenomenal growth in India in the last decade. However, the focus of most of the microfinance service providers has remained on expanding the outreach of microfinance programs with little attention to the depth, quality and viability of the financial services. The RBI should encourage all institutions to monitor their impact on society by means of a ‘social impact scorecard’.
