An alternate financial system for rural India
Indian Institute of Management Bangalore
Indian Institute of Management Bangalore
Micro-finance is increasingly playing
an important role in meeting the financial needs of the poor
in developing nations. This form of financing has received a
lot of attention over the last few years around the world. India
, being a predominantly agricultural society, could benefit
tremendously in terms of poverty alleviation, improvement in
standards of living of the poor etc.
The rural population in India suffers
from a great deal of indebtedness and is subject to exploitation
in the credit market through high interest rates and lack of
convenient access to credit. Rural households need credit to
fund their working capital needs on a day-to-day basis, investment
in agriculture, insurance against minor spikes and troughs with
respect to income and expenditure. Since cash flows in rural
areas for the majority of households are small and savings are
small as well, rural households typically tend to rely on credit
for other consumption needs like education, food, housing, household
functions etc. To meet these credit needs rural households need
access to financial institutions that can provide them with
credit at lower rates and at reasonable terms than the traditional
money lender thereby helping the rural populace avoid debt-traps
that are common in rural India .
The main features of Micro-credit
include the following.
Group lending thereby
lowering transaction costs and improving repayment through the
concept of social collateral
Way of promoting market-led
growth/privatizing the economy
Targeting the poor below
the line of poverty
Limited size of loans
that varies from region to region
Delivery of the loans
through NGO and Micro Finance Institutions (MFI)
Self-Help Group (SHG)
is a small voluntary association of poor people, preferably
from the same socio-economic background. This group concept
is leveraged using NGOs for provision of micro-finance in India
. SHGs typically involve women, about 10-20 in number and the
group members pool in their savings every week, fortnight or
month in a bank. This pool of money can then be used as collateral
to provide loans for income-generating activities. NGOs play
an important role in promotion of Microfinance through SHGs.
For provision of these services, NGOs get some financial support
in the form of grant from Apex Financial Institutions like NABARD
and RMK (Rashtriya Mahila Kosh).
The RBI has been issuing directives
for a long time now regarding ‘social and development banking'.
Some of these are:
Imposing a cap on the
Sectoral allocation of
credit and expansion of rural branches.
In line with this it was made mandatory
for commercial banks to lend around 40% of their advances to
the ‘priority sector'. Also now there has been a change in the
definition of ‘priority sector'. Advances to newly created infrastructure
funds, to non banking finance companies for on-lending to small
units, to the food processing industry and even to multinationals
like Kelloggs, Pepsi, Hindustan lever etc. fall under priority
Also all of the formal sector institutions
involved in microfinance have depended on refinancing and recapitalization
by apex institutions like NABARD and SIDBI on a regular basis.
Impact of other Government policies:
High Fiscal deficit:
This results in the government appropriating all the financial
savings to repay its own debt instead of helping the rural sector.
The government also further
aggravates the banks problems by capping the PLR especially
to small sector industries and by flooring the deposit rates
thus increasing the banks borrowing costs.
The following are some of the limitations
that can be seen in the micro-finance lending scenario in the
In spite of the rapid
growth of micro-credit, the outreach is still modest in terms
of proportion of poor households served, covering less than
5% if India's rural poor.
The quality and sustainability
of independent micro-financing institutions and SHGs is a concern
as these suffer from weak governance and internal management
The current MFI movement
is highly biased towards women, when men form a bulk of the
clientele in the unorganized money-lending sector (approx Rs.
The current regulatory
environment needs to be upgraded in the form of clear policies
that will promote and sustain MFIs in India .
There is always a danger
that as MFIs grow, they could fall into the trap of catering
to the richer clientele among the rural masses thereby defeating
the basic purpose of micro-credit.
MFIs are largely concentrated
in the southern regions and a concerted effort is required to
disperse these institutions across the nation.
The following suggestions are in order
for the development and scaling up of micro-finance in the country.
Credit Scoring Models:
Scoring develops a scorecard that loan officers use by
inputting client data to create "scores" that predict
several types of client behavior . It helps evaluate credit
risk and thus automates loan application approval process. This
can be implemented for MFIs that are typically large and for
individual clients as opposed to group lending since group characteristics
are difficult to evaluate using these models.
Quality of SHGs :
Evaluation of the management and internal control structures
of SHGs should be promoted using formal credit ratings processes.
Such models are evolving in the industry and needs to be carefully
evaluated and promoted across the country. This will help in
improving loan recoveries and speeding up the process for loan
disbursals. An example of such a model is the GIRAFE methodology,
a comprehensive rating and evaluation tool designed to address
the unique characteristics of MFIs . Promotion of transparency
and effective supervision will also ensure the maintenance of
the quality of the SHGs.
Deregulation of Interest
Rates: This will help MFIs to adjust its interest rates in line
with its costs thereby enabling their sustainability in the
Development of Standardized
Loan Appraisal Forms will help in speedy disbursal of
loans thereby reducing transaction costs.
rates : MFIs need to develop mechanisms that take advantage
of the group lending process and reduce default rates. This
can be done by focusing on target groups and emphasizing on
the self-selection of its members that will ensure mutual responsibility
for loan repayment. The restriction of the group size and enforcement
of group liability by excluding groups that do not repay from
future loans can help increase repayment rates.
The government can initiate
policies, which promote c ompetition in this sector
thus generating high payoffs. This will also help in eliminating