MICRO FINANCE

Introduction

5.1 Micro finance is the provision of thrift, credit and other financial services and products of very small amounts to the poor for enabling them to raise their income levels and improve their living standards. It has been recognised that micro finance helps the poor people meet their needs for small credit and other financial services. The informal and flexible services offered to low-income borrowers for meeting their modest consumption and livelihood needs have not only made micro finance movement grow at a rapid pace across the world, but in turn has also impacted the lives of millions of poor positively.

5.2 In the case of India, the banking sector witnessed large scale branch expansion after the nationalisation of banks in 1969, which facilitated a shift in focus of banking from class banking to mass banking. It was, however, realised that, notwithstanding the wide spread of formal financial institutions, these institutions were not able to cater completely to the small and frequent credit needs of most of the poor. This led to a search for alternative policies and reforms for reaching out to the poor to satisfy their credit needs.

5.3 The beginning of the micro finance movement in India could be traced to the self-help group (SHG) - bank linkage programme (SBLP) started as a pilot project in 1992 by National Bank for Agricultural and Rural Development (NABARD). This programme not only proved to be very successful, but has also emerged as the most popular model of micro finance in India. Other approaches like micro finance institutions (MFIs) also emerged subsequently in the country.

5.4 Recognising the potential of micro finance to positively influence the development of the poor, the Reserve Bank, NABARD and Small Industries Development Bank of India (SIDBI) have taken several initiatives over the years to give a further fillip to the micro finance movement in India.

5.5 The Chapter traces the evolution of micro finance movement in India, the supporting policies and current status in this regard. The Chapter is orgainsed into five Sections.  Section 2 discusses various micro finance delivery models in India. Section 3 discusses the various policy initiatives undertaken by Reserve Bank, NABARD and SIDBI in the context of micro finance movement in India. Section 4 evaluates the progress of micro finance in India and Section 5 discusses impact of micro finance movement in India.

2. Micro Finance Delivery Models in India

5.6 The non-availability of credit and banking facilities to the poor and underprivileged segments of the society has always been a major concern in India. Accordingly, both the Government and the Reserve Bank have taken several initiatives, from time to time, such as nationalisation of banks, prescription of priority sector lending norms and concessional interest rate for the weaker sections. It was, however, realised that further direct efforts were required to address the credit needs of poor. In response to this requirement, the micro finance movement started in India with the introduction of SHG-bank linkage programme (SBLP) in the early 1990s.  At present, there are two models of micro finance delivery in India: the SBLPmodel and the MFI model. The SBLP model has emerged as the dominant model in terms of number of borrowers and loans outstanding. In terms of coverage, this model is considered to be the largest micro finance programme in the world. The Reserve Bank, NABARD and SIDBI have also taken a range of initiatives to provide a momentum to the micro finance movement in India. The developments relating to evolution of various models of the micro finance movement are detailed in the present section.

SHG-Bank Linkage Programme

5.7 The micro finance sector started getting recognition in India after the launch of the

SBLP. Internationally however, a lot of groundwork and consultative efforts had been in progress since the 1980s, which set a backdrop for micro finance efforts in India. The field of micro finance is diverse and still evolving. There is no single approach or model that fits in all the circumstances. The concept of micro finance implies informal and flexible approach to the credit needs of the poor. As such, each model has to be tailored according to the circumstances and the local needs.  It is in this context that a study of different models of micro finance developed internationally becomes interesting. One of the oldest and most successful models internationally has been the Grameen Bank Model in Bangladesh (Box V.1).

5.8 As early as December 1984, the Fifth General Assembly of the Asia Pacific Regional Agricultural Credit Association (APRACA) held at Bangkok exhorted the agricultural and rural development finance institutions in the region to mobilise savings from the rural areas with the objective of providing loanable funds for agriculture and rural development. The experience in some of the countries where informal self help groups (SHGs) of rural people which promoted savings among members and used these resources for meeting their credit needs, were considered useful innovations. Further, the Third Consultation on the Scheme for Agricultural Credit Development (SACRED) held at Rome in 1985 called for active promotion of linkages between banking institutions and SHGs as a mean of improving the access of low income group to banking services. The Executive Committee Session of APRACA held at Seoul in October 1985 approved the holding of a South-East Asian sub-regional workshop to devise ways and means of improving such linkages. The APRACA Regional Workshop held at Nanjing, China in May 1986 recommended national level consultation and organisation of national surveys of SHGs in collaboration with APRACA and other agencies.

5.9 The Sixth General Assembly of APRACA held at Kathmandu, Nepal in December 1986 considered a project proposal on ‘promotion of linkages between banking institutions and SHGs in rural savings mobilisation and credit delivery to the rural poor’. It was decided that each member country would form a Task Force to conduct a survey of SHGs and thereafter, formulate suitable national level programmes. Consequent upon this, a Task Force was set up in India in the Ministry of Agriculture, to identify the existing SHGs, undertake a survey of the groups and draw a plan of action for channeling the flow of savings and credit between the rural poor and banks through SHGs and identify concrete projects for action research in this field. Accordingly, in February 1987, it was decided that a study team led by NABARD and comprising of representatives from various financial institutions, should be constituted to undertake the survey. The survey was undertaken in September 1987 and the report discussed at the 18th Executive Committee Session and 10th Foundation Anniversary of APRACA held at New Delhi in November 1987. This survey report laid the foundation of the SHG-bank linkage programme in India launched as a pilot project in 1992.

5.10 The pilot project was launched by NABARD after extensive consultations with Reserve Bank, commercial banks and nonGovernmental Organisations (NGOs) with the following objectives: (i) to evolve supplementary credit strategies for meeting the credit needs of the poor by combining the flexibility, sensitivity and responsiveness of the informal credit system with the strength of technical and administrative capabilities and financial resources of the formal credit institutions; (ii) to build mutual trust and confidence between the bankers and the rural poor; and (iii) to encourage banking activity, both on the thrift as well as on credit sides, in a segment of the population that the formal financial institutions usually find difficult to cover.

5.11 The SHGs were expected to facilitate collective decision making by the poor and provide ‘doorstep banking’, the banks as wholesalers of credit, were to provide the resources, while the NGOs were to act as agencies to organise the poor, build their capacities and facilitate the process of empowering them. It was expected that the pilot project would prove advantageous to both banks as well as the SHGs. The banks would gain by a way of reduction in their transaction costs due to reduction in work relating to appraisal, supervision and monitoring of loans. The SHGs would benefit by getting access to a larger quantum of resources, as compared to their meager corpus generated through thrift. The banks were expected to provide credit in bulk to the group and the group, in turn, would undertake on-lending to the members. The quantum of credit given to the group by the bank would be in proportion to the savings mobilised by the group and could vary from 1:1 to 1:4. It was prescribed that the purposes for which the group would lend to its members should be left to the common wisdom of the group. The rate of interest to be charged by the SHG to its members was also left to the group to decide. The pilot project envisaged linking of only 500 SHGs to banks. By the end of March 1993, 225 SHGs were actually linked. With the figure reaching 620 at the end of March 1994, the pilot project was a success.

5.12 The programme has since come a long way from the pilot project of financing 500 SHGs across the country. It has proved its efficacy as a mainstream programme for banking with the poor, who mainly comprise the marginal farmers, landless labourers, artisans and craftsmen and others engaged in small businesses such as hawking and vending in the rural areas. The main advantages of the programme are timely repayment of loans to banks, reduction in transaction costs both to the poor and the banks, doorstep “saving and credit” facility for the poor and exploitation of the untapped business potential of the rural areas. The programme, which started as an outreach programme has not only aimed at promoting thrift and credit, but also contributed immensely towards the empowerment of the rural women.

• Model I: SHGs promoted, guided and financed by banks.
  
• Model II: SHGs promoted by NGOs/ Government agencies and financed by banks.
  
• Model III: SHGs promoted by NGOs and financed by banks using NGOs/formal agencies as financial intermediaries.

24, 2008, in addition to entities already permitted earlier, subject to appropriate due diligence.

3. Policy Initiatives in India

5.19 Several initiatives have been taken by the Reserve Bank, NABARD and also SIDBI with a view to giving a further fillip to the micro finance movement in India. A summary of major initiatives is presented in the present section.

Policy Initiatives by the Reserve Bank

5.20 In January 1993, SHGs, registered or unregistered were allowed by the Reserve Bank to open savings bank account with banks. Further, to study the potential of the micro finance movement, the Reserve Bank constituted in 1994 a ‘Working Group on NGOs and SHGs’ (Chairman: Shri S.K. Kalia). Based on its recommendations, banks were advised, inter alia, that financing of SHGs should be included by them as part of their lending to the weaker sections and that SHG lending should be reviewed at the State level banker’s committee (SLBC) level and by the banks at regular intervals.

5.21 To further promote the SHG momentum in the country, banks were advised by the Reserve Bank in 1998 that SHGs which
were engaged in promoting the savings habits among their members would be eligible to open savings bank accounts and that such SHGs need not necessarily have availed of credit facilities from banks before opening savings bank accounts. Subsequent to the Monetary and Credit Policy announcement for the year 1999-2000, banks were also advised that interest rates applicable to loans given by banks to micro credit organisations or by the micro credit organisations to SHGs/ member beneficiaries, would be left to their discretion.

5.22 A Task Force on Supportive Policy and Regulatory Framework for micro finance was set up by NABARD in 1999 of which the Reserve Bank was a member. The Task Force looked into the entire gamut of issues related to micro finance, particularly regulatory issues. Recognising the growing importance of micro finance, the Reserve Bank constituted a micro credit special cell in the Bank in 1999 to suggest measures for mainstreaming micro credit and accelerating flow of credit to MFIs. The special cell has since been converted into a micro finance and financial inclusion division in the Reserve Bank.

5.23 Several non-banking finance companies (NBFCs) and residuary non-banking companies (RNBCs) also started entering the micro finance sector, gradually recognising the potential in the sector. In order to further facilitate the process, in January 2000, all NBFCs and RNBCs were advised by the Reserve Bank that those NBFCs which were engaged in micro financing activities, licensed under Section 25 of the Companies Act, 1956, and which were not accepting public deposits were exempted from the purview of Sections 45-IA (registration), 45-IB (maintenance of liquid assets) and 45-IC (transfer of  a portion of profits to Reserve Fund) of the Reserve Bank of India Act, 1934.

5.24 Based on the reports of the special cell constituted in the Reserve Bank and the Task Force on Supportive Policy and Regulatory Framework, the Reserve Bank issued comprehensive guidelines to banks in February 2000 for mainstreaming micro credit and enhancing the outreach of micro credit providers. These guidelines, inter alia, stipulated that micro credit extended by banks to individual borrowers directly, or through any intermediary, would from then onwards be reckoned as part of their priority sector lending. Banks were given freedom to formulate their own model/s or choose any conduit/intermediary for extending micro credit. Banks were also permitted to prescribe their own lending norms so as to provide maximum flexibility with regard to micro lending. Such credit was to cover not only consumption and production loans for various farm and non-farm activities of the poor, but also include their other credit needs. Banks were asked to delegate adequate sanctioning powers to branch managers and to keep the loan procedures and documents simple for providing prompt and hassle free micro credit.

5.25 The rapid development of the sector necessitated addressing the various issues associated with the sector. In October 2002, the Reserve Bank set up four informal groups to look into issues relating to: (i) structure and sustainability; (ii) funding; (iii) regulations; and (iv) capacity building of micro finance institutions. Taking into consideration the recommendations of the groups, banks were advised that they should provide adequate incentives to their branches for financing the SHGs and that the group dynamics of working of the SHGs should be left to them.

5.26 Based on the recommendations of the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the Banking System (Chairman: Prof. V S Vyas), which submitted its final report in June 2004, it was announced in the Annual Policy Statement for the year 2004-05 that in view of the need to protect the interest of depositors, MFIs would not be permitted to accept public deposits unless they complied with the extant regulatory framework of the Reserve Bank. However, as an additional channel for resource mobilisation, the Reserve Bank in April 2005 enabled NGOs engaged in micro finance activities to access the external commercial borrowings (ECBs) up to US$ 5 million during a financial year for permitted end use, under the automatic route.

5.27 In order to examine issues relating to rural credit and micro finance, an internal group (Chairman: Shri H.R. Khan) was set up in 2005. Based on the recommendations of the group and with the objective of ensuring greater financial inclusion and increasing the outreach of the banking sector, banks were permitted in January 2006 to use the services of NGOs/SHGs, MFIs (other than NBFCs) and other civil society organisations as intermediaries in providing financial and banking services through business facilitator and business correspondent models.

5.28 All Regional Directors of the Reserve Bank were advised in April 2006 that whenever issues relating to micro finance were noticed in the areas under their jurisdiction, they may offer to constitute a coordination forum comprising representatives of SLBC convenor banks, NABARD, SIDBI, State Government officials, and representatives of MFIs (including NBFCs) and NGOs/SHGs to facilitate discussion on the issues affecting the operations in the sector and find local solutions to the local problems.

5.29 In May 2006, a joint fact-finding study was conducted by Reserve Bank and a few major banks. It was observed during the study that some of the MFIs financed by banks or acting as their intermediaries/partners were focussing on relatively better banked areas and trying to reach out to the same set of poor, resulting in multiple lending and overburdening of rural households. Further, many MFIs supported by banks were not engaging themselves in capacity building and empowerment of the groups to the desired extent and banks did not appear to be engaging them with regard to their systems, practices and lending policies with a view to ensuring better transparency and adherence to best practices. Guidelines  were, therefore, issued to banks in November 2006, advising them to take appropriate corrective action.

5.30 The Union Budget for the year 2008-09 announced that banks would be encouraged to embrace the concept of total financial inclusion. The Government would request all scheduled commercial banks to follow the example set by some public sector banks and meet the entire credit requirements of SHG members, namely: (a) income generation activities; (b) social needs like housing, education, marriage: and (c) debt swapping. Consequent upon this, in April 2008, banks were advised by the Reserve Bank to meet the entire credit requirements of SHG members, as envisaged in the Union Budget.

Recent Initiatives by NABARD

5.31 NABARD has been playing a crucial developmental role for the micro finance sector in India. NABARD has been organising/ sponsoring training programmes and exposure visits for the benefit of bank officials, NGOs, SHGs and Government agencies to enhance their effectiveness in the field of micro finance. The best practices and innovations with respect to the sector are widely circulated among Government agencies, banks and NGOs. NABARD also provides support for capacity building, exposure and awareness building of the SHGs and NGOs.

5.32 NABARD launched the ‘Micro-Enterprise Development Programme’ (MEDP) for skill development in March 2006. The basic objective was to enhance the capacities of matured SHGs to take up micro enterprises through appropriate skill upgradation. The programme envisaged development of enterprise management skills in existing or new livelihood activities, both in farm and non-farm sectors. The duration of training can vary between 3 to 13 days depending upon the objective and the nature of training. During the year 2007-08, 394 MEDPs were conducted covering 9,182 SHG members on activities like bee-keeping, mushroom cultivation, horticulture and floriculture, vermi-compost/ organic manure preparation and dairy. As on March 31, 2008, 674 MEDPs had been conducted covering 16,761 participants.

5.33 In 2005-06, a pilot project for ‘promotion of micro-enterprises’ was launched among members of matured SHGs. This is being implemented by 14 NGOs acting as ‘micro-enterprise promotion agency’ (MEPA) in nine districts, viz., Ajmer (Rajasthan), Chandrapur (Maharashtra), Kangra (Himachal Pradesh), Madurai (Tamil Nadu), Mysore (Karnataka), Panchmahal (Gujarat), 24 north Pargana (West Bengal), Puri (Orissa) and Rae Bareli (Uttar Pradesh). The project is being implemented by each NGO in two blocks in each of the selected district. As on March 31, 2008, 2,759 micro-enterprises were established under the project involving bank credit of Rs.238 lakh.

5.34 NABARD also provides marketing support to the SHGs for exhibiting their products. During the year 2007-08, NABARD supported three exhibitions of products prepared by various SHGs at Bhopal, Chennai and Navi Mumbai involving grant of Rs.3.8 lakh. In addition, NABARD also provides promotional grant support to NGOs, RRBs, DCCBs, farmer’s clubs and individual volunteers and assists in developing capacity building of various partner agencies. NABARD has been making efforts to increase the number of partner institutions as self-help promoting institutions (SHPIs).

5.35 NABARD launched a pilot project in December 2003 to link post-offices with the SHGs with the objective of examining the feasibility of utilising the vast network of post offices in rural areas for disbursement of credit to rural poor on an agency basis (Box V.2).

5.36 The SHG Federations are emerging as important players in nurturing SHG, increasing the bargaining power of group members and livelihood promotion. The features and functions of SHG federation models promoted in the country vary, depending on the promoting agencies. Recognising the growing role of the SHG Federations and their value addition to SHG functioning, NABARD, during the year 2007-08 decided to support the Federations on a model neutral basis. Support is extended to the Federation by way of grant assistance for training, capacity building and exposure visits of SHG members. NABARD has also formulated the broad norms for deciding the grant of financial assistance to SHG Federations. During the year 2007-08, grant assistance amounting to Rs 10 lakhs was sanctioned to two federations.

5.37 Recognising the role played by MFIs, in extending micro finance services in the unbanked areas, NABARD extends support to these institutions through grant and loan based assistance. NABARD has been selectively supporting MFIs for experimenting with various micro finance models such as replication of Grameen Model, NGO networking (bigger NGOs supporting smaller NGOs), credit unions and SHGs federations, among others, to meet credit requirements of the unreached poor.  NABARD provides loan funds in the form of revolving fund assistance (RFA) on a selective basis to MFIs to be used by them for on-lending to SHGs or individuals. This loan has to be repaid along with service charge, within a period of 5 to 6 years.  During the year 2007-08, RFA amounting to Rs.8 crore was sanctioned to six agencies taking the cumulative credit sanctioned to Rs.36 crore covering 35 agencies.

5.38 In order to identify, classify and rate MFIs, NABARD introduced a scheme for commercial banks and RRBs to enable them to avail the services of accredited rating agencies for rating of MFIs. Banks can avail the services of credit rating agencies like CRISIL, M-CRIL, ICRA, CARE and Planet Finance for rating of MFIs and avail financial assistance by way of grant to the extent of 100 per cent of the total professional fees of the credit rating agency, subject to a maximum of Rs. one lakh. The assistance is available for the first rating of MFIs with a minimum loan outstanding of Rs.50 lakh and maximum loan outstanding of Rs.500 lakh. During the year 2007-08, rating support amounting to Rs 3 lakh to four agencies was provided.

5.39 Recognising the need for upscaling the micro finance intervention in the country, the Union Finance Minister, in the budget for the year 2000-01, announced creation of a Micro Finance Development Fund (MFDF). The objective of the MFDF is to facilitate and support the orderly growth of the micro finance sector through diverse modalities for enlarging the flow of financial services to the poor, particularly for women and vulnerable sections of society, consistent with sustainability. Consequently MFDF with a corpus of Rs.100 crore was established in NABARD. The Reserve Bank and NABARD contributed Rs.40 crore each to the fund, while the balance was contributed by eleven select public sector banks.

5.40 As per the Union Budget announcement for the year 2005-06, the MFDF was re-designated as ‘Micro Finance Development and Equity Fund’ (MFDEF) with an increased corpus of Rs.200 crore. The fund is being managed by a board consisting of representatives of NABARD, commercial banks and professionals with domain knowledge. The Reserve Bank is a member of the Advisory Committee of the MFDEF.

5.41 The MFDEF maintained by NABARD is used for promotion of micro finance through scaling-up of the SHG-bank linkage programme, extending RFA and capital support to MFIs and undertake various promotional initiatives. During 2007-08, Rs.27 crore was utilised from the fund towards micro finance related activities (Box V.3).

5.42 The North-Eastern Council (NEC), Shillong parked a fund of Rs.50 lakh with NABARD during the year 2007-08 for facilitating miscellaneous training programmes involving Government/bank officials, NGOs, SHGs from States in the NER and Sikkim. During the year 2007-08, 73 programmes were sanctioned out of the fund involving a total grant assistance of Rs.45 lakh.

Micro Finance Initiatives by SIDBI

5.43 SIDBI launched its micro finance programme in February 1994 on a pilot basis. The programme provided small doses of credit funds to the NGOs all across the country. NGOs acted as financial intermediaries and on-lent funds to their clients. Limited amount of capacity building grant was also provided to the NGOs.

5.44 With a view to reducing the procedural bottlenecks, expanding the outreach, meeting the huge unmet demand of the sector and striving towards its formalisation, SIDBI reoriented its policy and approach to create a sustainable micro finance model that would significantly increase the flow of credit to the sector. To take the agenda forward, the SIDBI Foundation for Micro Credit (SFMC) was created in January 1999. SFMC’s mission is “to create a national network of strong, viable and sustainable Micro Finance Institutions from the informal and formal financial sector to provide micro finance services to the poor, especially women’’.

5.45 SIDBI was one of the first institutions that identified and recognised NGO/MFI route as an effective delivery channel for reaching financial services to those segments of the population not reached by the formal banking network. As a result of bulk lending funds provided, coupled with intensive capacity building support to the entire micro finance sector, it has come to occupy a significant position in the Indian micro finance sector. Today, SIDBI is one of the largest providers of micro finance through the MFIs.

5.46 SIDBI’s pilot programme of 1994 brought out one of the major shortcomings in micro finance lending programme. It showed that collateral-based lending does not work insofar as micro finance is concerned. NGOs/ MFIs acting as financial intermediaries do not have tangible collateral to offer as security for the loans. Doing away with collateral-based lending in MF necessitated that a mechanism be developed which would minimise the risks associated with lending. With a view to catering to this objective, SIDBI pioneered the concept of capacity assessment rating (CAR) for the MFIs. As part of its developmental agenda, SIDBI encouraged a private sector development consulting firm to develop a rating tool for the MFIs which was rolled out in 1999. Today, rating is a widely accepted tool in this sector. SIDBI has also succeeded in developing a market for rating services. Two mainstream rating agencies, viz., CRISIL and CARE have also started undertaking micro finance ratings, besides M-CRIL. SIDBI has also adopted the institutional capacity assessment tool (I-CAT) of access development services (ADS), a private sector consulting organisation, for rating of start-up/small and mid-sized MFIs.

5.47 SIDBI introduced a product called ‘transformation loan’ in 2003 to enable the MFIs to transform themselves from an informal set up to more formal entities. This loan is a quasi-equity product with longer repayment period and features for conversion into equity at a later date, when the MFI decides to convert itself into a corporate entity. Consequently, a number of MFIs went ahead with the transformation and some of them have now grown significantly and are serving millions of clients across several states. Recognising the need to offer the MFIs