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Relevance Of Microfinance In India

Posted in Finance Articles, Total Reads: 2863 , Published on October 23, 2012

Are Microfinance Institutes (MFIs) relevant in a country like ours? Before delving into answering this question, let’s try and understand completely the nuances of the question.

Microfinance Institute is basically a type of a bank service which provides various financial options like loans, savings, deposits, payment services, insurance and the like for the people who have low levels of income. As the name suggests, Microfinance, deals with small chunks of money. Small amounts of money are lent out at a rate of interest which is kept lower than that asked by private money lenders. The idea being, to provide an opportunity for the low income earning people to meet their ends and thereby helping them to become financially stable-cause and effect relationship.

Now, let’s discuss about the present economic scenario prevailing in India. We have over the past few years have witnessed a lot of unfavorable things happening. Few of them being, high suicide rate of Farmers in Andhra Pradesh, continuous rise in inflation rates especially on food products and oil, increasing interest rates and slower economic growth. The world is getting smaller, and incidents in US and Greece have culminated in the economic downturn India is facing today. After all, the theory of rational expectations does have a major role to play.

Let us put things into perspective now, MFIs in India. Ideally speaking, for a country like India, where nearly 26% of the population lives below the poverty line, the concept of MFI should work very successfully. Also adding further incentive to this is the fact that the primary occupation in India is Agriculture and most Indians are farmers. The problem of private money lenders(loansharks)has been existing for a very long time and MFIs should therefore be a fine solution. Establishment of MFIs all across India, looks a very fruitful decision to make. Also considering the fact that in the 300 year history of MFI, it has been found that the level of default rate has been found least in case of MFI (less than 10% have defaulted)

This begs the question “How can MFIs be not relevant in India?”

And so, we had MFIs established in India. SKS MFI which recently went public in 2010, was one of the oldest MFIs set up in India in 1998. Many MFIs have been established since then and laws and regulations have been passed regarding how the functioning of these institutions will take place. We presently have 146 MFIs in India, with loans operating in the range of 5.2 billion US dollars. MFIs are actually helping in better utilization of money and thereby act as a key factor in driving the economy forward. Many poor people now have access to this financial service and hence an opportunity to grow and develop. All these only seem to paint a rosy picture but things somewhere did go wrong.

The financial sector of Indian MFIs was hit by a crisis; crisis of such big a magnitude that the question of its very survival in India has come out strongly. As per the data given in livemint, more than 90 % of the total exposure faced by Andhra Pradesh MFIs has been carried on their books as bad assets and this value is close to INR 6500 crores (About 9.2 million borrowers in Andhra Pradesh defaulted in repaying money borrowed from MFI). Writing off such a high value at the end of the financial year would leave their accounts in the negative. Also, most banks which provide the financial assistance to these MFIs have increased the rate of interests at which they lend because of 2 reasons, firstly the policies of RBI which have resulted in increase of Basis points and secondly MFIs have now started carrying a tag of highly risky investment as they are not sure of the returns owing to an MFI crisis. I guess this is what is called the spiraling down effect.

But how did this all happen?

The origin of this crisis was in October 2010 when Andhra Pradesh announced a law to control micro-lenders after a spate of reported suicides following alleged coercive recovery practices adopted by some.The law, which restricted MFIs from collecting money from borrowers on a weekly basis, made government approval mandatory for borrowers taking more than one loan. Subsequently, placement of a limit by the RBI on the loan rate by MFIs, the MFIs ended up making losses. Let’s understand the problems that existed in the Microfinance Industry practices.

1. Mis-selling of micro-credit products.

2. Very high Interest rates

3. Coercive debt collection practices.

So, if the question is asked now “Are MFIs relevant to India?” my answer would be still a yes.

Let me explain the reasons.

The death of the MFI industry will push the poor into the grip of moneylenders and deal a blow to the government’s financial inclusion drive. The government and RBI must come up with an MFI survival strategy before it’s too late.

MFIs are probably the only source of a Financial Service to the poor of India. And a regulated way of lending loans to the poor will not only help them, but will also help people move above the poverty line with the financial assistance provided. MFIs have a lot of scope in India because it can cater to the need of close to 300 million people who live below the poverty line.

Let us get into the aspect of how MFIs can survive in India? I believe there is a three pronged approach which can help the present scenario reach an improved state than the one presently existing. For any financial institution, there are always 3 prominent things involved, the Customer, the Institution and the regulations which define the relation between the two.

So, the first step is preserving the needs of the micro-borrower and ensure a sense of Financial Protection into the system.

Secondly, the Institution needs to diversify its services so that the level of risks can be significantly reduced. Consider the example of Janalakshmi Financial Services. They have diversified into the field of distributing products like pension, insurance and also sells mortgages and enterprise loans all across India. And it has been able to float safe in these gusty winds.

And finally, the relation between the consumer and producer managed by the regulations. A system should be created wherein the Institutions can communicate to its potential consumers in a better way. Also, another step to improve the connect would be to make all other financial institutes to also have a small division of Micro finance lending.

This 3-step mechanism could just be the silver bullet required to help boost the growth of MFI industry in India.

This article has bee authored by Madhavan Dakshinamurthy from IIFT.

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