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‘Growth of the economy’, ‘GDP rate’ and ‘Employment rate’ are some of the most common terms that one may come across on a daily basis. And these figures and numerical estimates that come up are all based on the level of investment and consumption in the country. It is a well-established fact that the growth of any economy requires a high level of business activities complemented with high demand among consumers. However, in a country like India having a population of over 1 billion with around 400 million people below the poverty line and a set of 44 million people unemployed; a two square meal seems a distant dream for many.


There isn’t sufficient support to a common person to be self-employed and our economy has moved towards the service sector job culture and is largely becoming dependent on other entrepreneurs. There is also a lack of financial inclusion and financial literacy in our country and thus, the financial institutions are more inclined towards the metropolitan cities and larger towns. In such a situation micro-finance institutions provide the right platform and resources to the rural population.


So what do you exactly understand by the term ‘micro-financing’? In simple words, it means financing at the micro level. It involves meeting the financial requirements of the people at the bottom of the pyramid who cannot access the formal banking channels and it tries to speed up the process of development by improving household income, providing adequate support for economic activities, and sharing the responsibilities of the government and of the mainstream financial sector. Some notable features of micro-financing are:


1. Loans to lower income groups.

2. Lending lower amounts.

3. Short term lending.

4. Purpose of loans – income generation.

5. Loans without collateral.


Growth of Micro Finance in India

India, as a matter of fact, has a huge proportion of its population living in rural areas. The people residing in these regions are oblivious to the growth opportunities that banks and other financial institutions offer. The MFIs have grown at a rapid pace in the country and are expected to grow at an even faster rate in the coming few years.


There is an expectation of growth that is attached with MFIs because the technological advancements and the reach of media are growing at a rampant pace and there is hardly an individual without a cell phone. This provides micro-finance institutions with an opportunity to reach out to the masses at large.


The literacy rate in the country is on the rise and this also adds to the list of advantages that MFIs have. But in order to grow at a rapid pace MFIs have to take up the initiative of providing financial literacy and facilitating financial inclusion of the rural population. MFIs have to take up this initiative since the formal education of our country does not provide direct financial knowledge.


MFIs are also bound to grow as institutions by virtue of transforming into small finance banks. Undoubtedly, this shall prove to be a great boost to the economy and the people at large.


Micro Finance Creating Employment and Entrepreneurs

Majority of the economic activities in our country take place in the MSME sector and this sector provides employment to a large number of people. MFIs play a huge role in developing and in the prosperity of these enterprises. These enterprises aren’t in a position to procure funds easily from commercial banks and it is at this point of time that MFIs come to their rescue by providing finance.


MFIs have spread the reach of credit in rural areas. A major portion of the benefits of MFIs isderived by the women of the society. Women have gone on to become entrepreneurs with the financial assistance provided by MFIs. This has led to a great boost to the rural population with an additional source of livelihood being available and has helped in improving their living conditions and social upliftment in society.


In India, micro-finance is at a nascent stage with a vast potential for growth. While the sector has begun to grow, there are quite a few challenges that have to be addressed to make it growth effective:


1. It is alleged that while MFIs are capable of preventing people from further slipping into poverty, they cannot reduce poverty. This is due to the following reasons:


• Most women, who are often the targets for micro-finance, use it for consumption purposes.

• Repayment rates are high because women, very smartly use membership of multiple micro-finance facilities to keep the debt revolving. They are smart enough to know that if they default, the agency will turn off the tap.

• This increases money circulation but does precious little to lift people out of the poverty trap since very little money is put in entrepreneurial activities anyway.


2. Unnecessary loan waivers by politicians tend to harm the poor people in the long run. This is because every time there is a loan waiver, banks may not be willing to lend in that area. There should be an independent financial commission comprising financial, judicial and public policy experts that should decide who gets the loan waiver and by how much.


There are quite a few other options that the MFIs can exercise to cater to their growth potential. A few of them are listed below:


1. Unlock savings potential: The rural Indian population has a slice of its income that is left with them after their consumption expenses. MFIs should look at it as an opportunity and should tap such resources. The people have to be made aware of such an opportunity and should be convinced that their money is bound to grow with the banks. This way MFIs can have a reduction in their cost as the rate of interest provided on deposits is less than 12% (rate of financing through commercial banks). This reduction in cost can be further passed on to the borrowers.


2. Expanding product range:

MFIs can provide more products to their clients to increase their revenue sources and to attract a large number of customers. They can provide services such as insurance and other financial instruments. But the only thing that might hinder this process is the fact there is minimal financial literacy in the rural areas of the country and so MFIs will first have to educate the population about such opportunities.


3. Mudra loans and its micro-financing connect:

‘Mudra loans’ is an initiative taken by the Government of India to help micro-entrepreneurs procure financial assistance. This initiative has proven quite beneficial for micro-finance institutions as they are able to procure finances at cheaper rates hence bringing down their interest rates and increasing customer base.


Latest Trend

Micro-finance institutions of the country that have gained quite a bit of popularity and have a large capital base are on the verge of transforming themselves into banks. About 10 MFIs have received a banking licence in the last 3 years. These institutions are now treated as small finance banks. The most prominent of them being Bandhan Bank.


The banking system and institutions in India are more inclined towards providing loans and services to the huge corporate world and the non-banking institution tag in India is perceived to be a negative notion. And with many MFIs converting into small finance banks they will be able to gain better customer confidence and will be in a position to provide additional services apart from the short term loans. RBI is working in this regard and there are policy frameworks that might come up in some time regarding the functioning of such micro-finance institutions. Once the policy frameworks are established, it will make the transformation of MFIs into small banks quite simpler and easier and will lead to financial inclusion of such organisations.


The conversion of MFIs into small banks brings about more cheer for the customers. MFIs on usual get loans from commercial banks at the rate of about 12-14% and they are allowed to charge a spread of 10% on their loans, so an average customer ends up paying about 22-24% on their loans. But if these institutions are transformed into small banks then the cost of funding comes down to about 10%.


These institutions are now in a better position to cater to the needs of the public with a reduction in the cost of financing and are even able to prosper as a company. Conversion into small finance banks widens their coverage area and growth prospects. These banks have even listed themselves and are looking for expansion options to establish their presence around the country.


Our Take

Micro-financing institutions in the current scenario of our country are quite essential as they act as catalysts in connecting the rural population with the financial environment and instruments. Micro-financing institutions must be encouraged and provided with a better platform to function upon. The growth of these institutions looks promising but there are a few hurdles on the way that the Government must look at eventually overcoming. One very important aspect is that the micro-finance institutions are overcrowded in a few areas and their reach is still limited. The second point is that the RBI must take steps to regulate such institutions and provide a better framework for their functioning as this shall help them know the range within which they have to operate.


Micro-financing in correlation to the term looks great on a micro level but when we think about the micros and try connecting it to the overall economic growth than we don’t think it is something that can bring about a large boost to the economy. Micro-financing is something that will provide a base for financial inclusion of the population but there are larger steps required for the advancement of our country. Micro-financing is still in the initial stages in our country and it is something that has to be nurtured very well.


By Nikunj Sarda and Akash Agarwal

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