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Micro Finance - A step towards Financial Inclusion

Posted in Finance Articles, Total Reads: 1761 , Published on May 11, 2015

In a country where about half of the population is still untouched by banking facilities, financial inclusion of poor surely seems elusive. This however has been changing at a rapid rate, the gap being filled by micro finance institutions (MFI) .RBI and government have also taken necessary steps to facilitate it. Things however were not so bright a few years ago as many MFI took heavy blow during 2010 microfinance crisis in Andhra Pradesh.

In 2010, instigated by increasing number of borrower’s suicide, the government of Andhra Pradesh passed Andhra Pradesh Microfinance Institutions Act to regulate the lending and collection practices of MFI. Andhra Pradesh was hub of microcredit at the time and the regulation resulted in heavy loses with repayment rate falling from 99 percent to about 10 percent. Ultimately $1.2bn in debts had to be written off as unrecoverable, and several large Andhra Pradesh based players essentially collapsed. This however was also a result of lending to people with low credit worthiness, already in debts to other lenders. The sector was driven by short-sightedness of reaping instant profits and an eye on initial public offerings. The industry however has learned from its mistakes and has been making a stable growth owing to the RBI and changes it has adopted.

RBI has brought in multiple regulations needed to check micro lending and ensuring stable growth. It has fixed the margin between the cost of borrowing and lending. Interest rates were also regulated and loan norms of lending were defined. This has brought lending rates from as high as 30% in 2010 to around 23-24%. Over the past four years, the industry has seen other changes as well, including the creation of two credit bureaus which makes it possible to take appropriate credit decisions and avoid default. Other steps such as diversification of the product basket and adoption of new practices to focus on customers’ needs along with code of conduct, this ensures responsible lending.

Also granting of banking license to Bandhan Financial services by the RBI has given prospect to other MFI of being granted license in future. This will help not only to increase the investment in the sector but also will enable the MFI to offer other financial services such as deposits which only banks are allowed at present. As a result of these initiatives microloan portfolio in 2014 was at Rs209 billion, 48% above its pre-crisis level. The government has also been doing its part in increasing the penetration of microfinance. The Pradhan Mantri Jan Dhan Yojna (PMJDY), which has opened about 150 million bank accounts by January 2015 with an overdraft facility of Rs.5000 and debit cards and accident insurance cover of Rs.1 Lakh & Life Insurance cover of Rs.3000,are a landmark initiative in financial inclusion of poor. This will enable the financial facilities which cannot be met by micro lenders. The overdraft facility also enables the people to invest in money making assets at minimal rate. However the very size of population and scale of poverty left much to be desired. Micro finance is still in its native stage and has got a lot to cover volumes in terms of both capital as well as people.

With rapid growth in micro finance the sector is increasingly being driven by commercial concerns and there is risk of it distracting from the issue at the core of it i.e. facilitating financial inclusion of poor. Thus it is imperative to keep a check on the way this sector unfolds as to prevent exploitation of poor. A stable growth will go a long way in benefiting all the stake holders of the sector as it is still in its initial phase with immense growth opportunity.

This article has been authored by Abhinandan Singh from DoMS IIT Roorkee

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