Micro Credit Financing – A Strategic Overview

By Ashish Ambwani & Dheeraj Mehta, IIM Lucknow


1.1 Definition of Micro Credit

Micro credit can be defined as the extension of small loans to population, too poor to qualify for traditional bank loans. These schemes are characterized by relatively small loans, a few hundred dollars at most. The repayment period is relatively short, about a year or so. Women are the major beneficiaries of these schemes, and the destination of the funds primarily includes agriculture, distribution and trading, small craft, processing industries and consumption credits too.

1.2 FAPILVI Approach towards the Development of Microcredit Systems

Any microcredit system for being in place needs to have the following structured approach. For this purpose alone a suggested model is the FAPILVI approach. This proposed structure is the first step towards making the microcredit institutions function effectively.

Familiarization: It indicates that a systems' development in rural area requires recognition of informal local socio-cultural/religious institutions and the establishment of roots of proposed system in them for sustainability.

Prioritization: The priority for the weaker segments unreached by the conventional banking e.g. women, handicaps etc. should be transparent.

Identification: Identification of the existing beneficial financing methods and establishing links with the semi- formal institutions concerned with micro finance activities.

Linking: For ensuring effective linkages and active people's participation either in the formal or informal institution, the establishment of an organic link between the institution and the clients.

Value addition: The policy environment should be targeted to replace ‘credit alone approach' by ‘credit plus approach' for effecting viability of the products/instruments in rural areas.

Integration: The micro financial planning system to be amalgamated with the formal planning system already existing in the rural areas to bring in the user-friendly approach for the targets.

Once the FAPILVI model is in place the microcredit institutions can be oriented towards effective functioning.

1.3 Functioning of Microcredit Institutions

We can classify the functioning of the microcredit institutions into the following categories:

First, in the formal institutions, the branch managers invariably discuss with local government/development agencies, as well as local people, the identification of various products for the preparation of the Service Area Credit Plans in the rural areas.

Second, some of the banks organize local informal groups like village level committees, farmers' clubs and village development councils and they act as links between the banks and the people and ensure that the products developed match the demand of local clients.

Third, in a few cases of formal financial institutions, a separate cadre of workers, like ‘Sevanirathas' in SKDRD, Rural Service Volunteers among the bank staff themselves in Canara Bank (like GPU of HNB in Sri Lanka) are created to form organic links between the banks and people, thereby taking care of the clients' demand.

Fourth, government programmes like IRDP/PMRY, RBI/NABARD, Government/RBI provide various products and detailed guidelines for implementation at micro level.

All these microfinancial activities with micro systems and institutions directly take care of the welfare of the rural poor, the rural women, the rural youth and the rural unemployed without much waiting for trickles from the top.

1.4 An example of successful MicroCredit - Grameen Bank, Bangladesh

The Grameen Bank is based on the voluntary formation of small groups of five people each to provide mutual, morally binding group guarantees in lieu of the collateral required by conventional banks. At first only two members of a group are allowed to apply for a loan. Depending on their performance in repayment the next two borrowers can then apply and, subsequently, the fifth member as well.

The assumption is that if individual borrowers are given access to credit, they will be able to identify and engage in viable income-generating activities - simple processing such as paddy husking, lime-making, manufacturing such as pottery, weaving, and garment sewing, storage and marketing and transport services.

The success of this approach shows that a number of objections to lending to the poor can be overcome if careful supervision and management are provided. For example, it had earlier been thought that the poor would not be able to find remunerative occupations. In fact, Grameen borrowers have successfully done so. It was thought that the poor would not be able to repay; in fact, repayment rates reached 97 percent. It was thought that poor rural women in particular were not bankable; in fact, they accounted for 94 percent of borrowers in early 1992. It was also thought that the poor couldn't save; in fact, group savings have proven as successful as group lending. It was thought that rural power structures would make sure that such a bank failed; but the Grameen Bank has been able to expand rapidly.

1.5 Conclusion

Thus microfinance as seen has the potential to revolutionize the existing structure of rural credit. It is imperative that policy makers, financial institutions as well as entrepreneurs attempt to create such schemes across the nation.

About the authors:

Ashish Ambwani

Education: BE (Electrical & Electronics), NIT Trichi, Majors: Marketing, Finance

Ashish is known for his capability of working hard and getting things done right, as well as for his dry, sarcastic sense of humor. Apart of being part of INDEX, the market research group of IIM Lucknow, Ashish also takes keen interest in quizzing and is passionate about reading and music and Calvin & Hobbes.

Dheeraj Mehta

Education: BE (Computers), NSIT, Delhi University , Majors: Finance, Strategy

A consistent performer, Dheeraj ranks amongst the top 10% at IIM Lucknow. Besides being a member of the Alumni Committee at IIM L, he is responsible for setting up & managing Credence Capital, the country's second student run equity fund at IIM Lucknow with over Rs. 1.5Lac AUM