Microfinance in India: The Big Picture

-Shivika

In a small village in Assam, a 30-year-old woman struggling to provide for her family, gets financial support from an institution that grants her a loan of INR 35,000, using which she starts a small grocery store of her own. Another woman, in a small district in Rajasthan, manages to get a loan of INR 25,000, which makes her far-fetched dream of farming on her small farm, due to lack of capital, possible. A third woman in Punjab, determined to help her husband financially, is able to start her own cosmetics business with a small loan of INR 30,000 she receives from a similar institution. These three women are among millions of such women who’re ensuring a better life for themselves and their families by becoming financially independent. And the institutions that are making this possible are the microfinance institutions.

So what is microfinance?

Microfinance refers to the basic financial services (essentially loans in most cases) provided to low-income individuals or groups who are typically excluded from traditional banking. Microfinance aims to improve financial services access for marginalized groups, especially women and the rural poor, and help them lift themselves out of poverty.

Even though the roots of microlending can be traced back to as far as the 18th century, it was Muhammad Yunus of Bangladesh who popularised this idea of fusing captilasim with social responsibilty, through the Grameen Bank that he founded in 1983, which provided small amounts of collateral free loans to the impoverished.

As per the Microfinance Barometer Report 2019, the global microfinance industry (as of 2019) was worth over INR 8.90 trillion, with the loan disbursed amount growing at an average annual rate of 11.5% over the last five years. The industry has impacted the lives of over 139.9 million borrowers worldwide, about 80% of whom are women and 65% from a rural background.

Microfinance Sector in India

Data from the SIDBI & Equifax Microfinance Pulse report (June 2019) estimates that in FY19, the total loan portfolio of the Indian microfinance industry grew at a rate of 40% YoY, with an outstanding loan portfolio worth INR 1.785 trillion (accounting for about 5% of the total credit market in India) and 64.1 million unique live borrowers.

Among the different players in India providing microcredit, microfinance institutions have the highest share (about 38%). Over the years, these institutions have attempted to penetrate the smallest of villages in the country to reach their target customer base. Their sheer presence in the most rural parts of India is one of the reasons why microcredit borrowers seem to be more inclined towards taking loans from them.

How do MFIs operate?

In India, MFIs essentially operate through two models – Self Help Group, or SHG, that focus more on savings generation, and Joint Liability Group, or JLG, which essentially focus on credit generation. JLG is the more common model adopted by MFIs due to its greater scalability and lower NPAs than SHG. The source of funds for MFIs are either large banks (primary source of funding for MFIs in India) or equity capital or both. The average ticket size disbursed by MFIs is INR 25,850 (MSME Pulse Report 2019). The interest rates they charge their customers range, on an average, from about 22%-28%; the reason for such high interests is attributed to the high operational costs for MFIs, which are primarily the result of strenuous collection processes. In a typical collection process – an MFI agent visits the borrower in her village to collect the repayment in cash. However, the agent is usually not able to receive the payment due for that month or week in a single visit and thus has to make multiple visits to the same borrower. This inefficiency in the process is thus compensated by a higher interest rate charged to the borrowers.

Challenges faced by the sector

The biggest problem faced by the microfinance sector is sustaining the high-interest rates it charges, owing to its high servicing costs arising due to operations in rural geographies and involving lower-income borrowers and collateral-free credit. The high interest rates in the sector result in unaffordability for the very segment of borrowers its operations are meant for. This problem manifests itself in the form of NPAs and over-indebtedness of the borrowers.

MFIs have also been slow in adopting technology to make their operations more cost-efficient, as there remains negligible to low awareness (and, resources) among its customer base.

Moreover,the sector has been reeling under the impact of the second wave of the pandemic with loan disbursements of NBFC-MFIs declining by 96% to INR 570 crore in the first quarter of the current financial year, according to a report by Microfinance Institutions Network (MFIN). Collection efficiencies have been hard hit, with loans in arrears for over 30 days, or 30+ portfolio at risk (PAR) as it is commonly known as, estimated to reach 14%-16%, surpassing the 11.6% reached in the aftermath of demonetisation in 2016-17.

Potent of Microfinance

Despite its challenges, the microfinance sector has shown resilience through each setback in the past – whether it was the Andhra Crisis of 2010 or the demonetisation of 2016 that left the borrowers cash-strapped, and has immense potential to be a game-changer with the correct push. This push could be achieved through a two-fold change:

Reducing excessive reliance on banks: Tapping into newer investment sources for a cheaper funding to MFIs will bring down the cost of borrowing for the end customer. Currently, MFIs are heavily dependent on banks, which serve as their primary source of funding. This not only raises the cost of capital for MFIs but is especially detrimental to the smaller MFIs that are still in their early stages and are yet to break even.
Embracing technology: In order to sustain itself in the long run, it is imperative for the microfinance sector to adapt to changing technological needs. MFIs should look at adopting digital means for fund transfers to borrowers. Furthermore, both MFIs and government policies should aim at making rural customers aware about digital payment methods. The government will have to play a big role in making these marginalised sections financially and digitally literate. Payments made through digital platforms will help bring down the high customer acquisition and service costs, thus improving collection efficiencies.

Microfinance has immense potential in making credit accessible to the most underserved of the population – not just helping them gain financial independence, but also leading to job creation. It has already been instrumental in offering formal credit to low-income households and micro, small and medium enterprises (MSMEs) alike, thereby increasing the contribution of these segments to India’s overall GDP. And with just the right policies, it can be a changemaker for the Indian economy.

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