Introduction

Microfinance, also known as microcredit, refers to a broad range of financial services provided to individuals and small businesses who lack access to traditional banking. These services include micro-loans, savings accounts, insurance, remittances, and other financial products, catering primarily to the economically weaker sections of society. The key objective of microfinance is to promote financial inclusion, enabling marginalized communities to achieve economic independence and social empowerment.

Women are the primary beneficiaries of microfinance services, as financial inclusion has been linked to their increased participation in economic activities, improved decision-making power, and enhanced social status.

The microfinance sector in India has evolved over several decades, facing various regulatory changes, financial crises, and structural transformations. Today, microfinance institutions (MFIs) and self-help groups (SHGs) collectively serve 12–14 crore households, with an outstanding loan portfolio of ₹7 lakh crore. Of this, ₹4 lakh crore is accounted for by Joint Liability Group (JLG) lending.

Despite its significant contributions, the sector has encountered several challenges, including over-indebtedness, rising non-performing assets (NPAs), regulatory constraints, and operational inefficiencies. This article explores the historical evolution, current status, challenges, and potential solutions for ensuring the long-term sustainability of microfinance in India.

Evolution of Microfinance in India

The microfinance movement in India has developed through multiple phases, adapting to socio-economic needs and regulatory frameworks.

Early Foundations (1970s–1990s): Establishing the Model

• 1974: Self-Employed Women’s Association (SEWA) Bank, India’s first microfinance institution, was established in Gujarat. SEWA pioneered financial inclusion for self-employed women.
• 1992: National Bank for Agriculture and Rural Development (NABARD) introduced the Self-Help Group (SHG) pilot project, which encouraged SHGs to pool savings and access bank credit.

Regulatory Recognition (2000s–2010s): Scaling Microfinance

• 2004: The Reserve Bank of India (RBI) classified microfinance under priority sector lending (PSL), compelling banks to allocate a percentage of their lending to microfinance activities.
• The Andhra Pradesh crisis exposed the risks of aggressive lending, coercive loan recovery, and over-indebtedness, leading to severe restrictions on microfinance activities in the state.
• The Malegam Committee was formed in 2010 to introduce new regulatory norms and ensure responsible lending practices in the microfinance sector.
• 2015: Micro Units Development and Refinance Agency (MUDRA) Bank was launched, supporting small businesses with easier access to microcredit.

Post-2015 Developments: Expansion and Challenges

• 2016: Demonetization caused a liquidity crunch, impacting borrower repayments and the availability of funds for MFIs.
• 2017: The Goods and Services Tax (GST) implementation created operational hurdles for MFIs.
• 2018–2019: The IL&FS and DHFL financial crises restricted funding to NBFC-MFIs, hampering their lending capacity.
• 2020–2021: The COVID-19 pandemic caused large-scale economic disruptions, leading to high loan defaults and operational challenges for MFIs.

Despite these setbacks, the sector rebounded through technological advancements, improved risk assessment mechanisms, and digital financial services. The post-COVID recovery led to a nearly 50% increase in microfinance loan portfolios and accounts over the last two years.

Microfinance Business Models in India

India’s microfinance sector operates through diverse models that cater to different borrower segments.

1. Self-Help Groups (SHGs)

• SHGs are small groups of 10–20 members who save collectively and borrow from pooled savings.
• NABARD’s SHG-Bank Linkage Programme (SHG-BLP) is the world’s largest microfinance initiative, enabling SHGs to access bank credit.
• SHGs operate under a peer-monitoring model, ensuring loan repayments through mutual accountability.

2. Microfinance Institutions (MFIs)

MFIs provide credit to Joint Liability Groups (JLGs), where 4–10 members guarantee each other’s loans.

• Structured Repayments: MFIs follow strict repayment schedules, ensuring financial discipline.
• Regulatory Oversight: NBFC-MFIs dominate the sector and are regulated by the RBI.

3. Types of Microfinance Lenders

1.     NGO-MFIs: Operate as non-profit organizations under the Societies Registration Act, 1860, or the Indian Trusts Act, 1880.

2.     Co-operative Societies: Entities like Primary Agricultural Credit Societies (PACS) provide microfinance services in rural areas.

3.     Section 8 Companies: Non-profit companies under the Companies Act, 2013, focusing on financial inclusion.

4.     NBFC-MFIs: Account for 80% of microfinance lending and are heavily regulated by the RBI.

Current Status and Growth Trends

• The microfinance sector currently serves over 3 crore borrowers.
• Total loan outstanding: ₹7 lakh crore, with rapid expansion post-pandemic.
• Employment Generation: The sector has contributed to 130 lakh jobs and 2% of India’s Gross Value Added (GVA).

However, increasing delinquencies and NPAs are signs of financial stress.

• Rising NPAs:
• ESAF Small Finance Bank’s gross NPAs surged to ₹1,279.3 crore (6.9%) in September 2024, up from ₹399.1 crore (2.6%) a year earlier.
• CRISIL projects that SFB NPAs will rise from 2.3% in FY24 to 2.9% in FY25.
• Declining Collection Efficiency:
• Collection efficiency dropped from 98% in FY24 to 94% in Q2 FY25, reflecting stress in the sector.

Challenges Facing Microfinance in India

1. Operational and Structural Issues

• Over-leveraged Borrowers: Many individuals take multiple loans without adequate repayment capacity.
• Weak JLG Model: Declining accountability has led to rising defaults.
• Staff Attrition and Fraud: High employee turnover and fraudulent lending practices hinder recoveries.

2. Borrower Indebtedness and Credit Stress

• Rising credit card debt: Outstanding balances increased from ₹2.30 lakh crore in 2023 to ₹2.71 lakh crore in 2024.
• Regulatory Restrictions: The RBI has imposed restrictions on NBFC-MFIs due to predatory pricing and poor borrower evaluation.

3. External Challenges

• Election-Year Debt Waiver Promises: Political interventions disrupt repayment discipline.
• Natural Disasters: Floods and droughts severely impact borrower liquidity.

Strengthening Microfinance through Policy Measures

1.     Standardized Household Income Assessment: Sa-Dhan is working on a uniform income model to improve credit risk evaluation.

2.     Real-Time Credit Data Updates: The periodicity of borrower data uploads to credit bureaus should be reduced from fortnightly to weekly.

3.     Mandatory Aadhaar-Based KYC: Ensuring uniform borrower identification will prevent loan duplication and data mismatches.

4.     Stronger Regulatory Oversight: The RBI should introduce tighter monitoring mechanisms for NBFC-MFIs to curb predatory lending practices.

Conclusion

Microfinance has transformed India’s financial landscape by bridging the credit gap for millions of low-income households. However, the sector faces rising NPAs, borrower over-indebtedness, and regulatory hurdles that threaten its stability. Strengthening borrower assessment, increasing transparency, and enforcing responsible lending practices are crucial to ensuring the long-term sustainability of microfinance in India.

By leveraging technology, data-driven policies, and financial innovations, microfinance can continue to be a powerful tool for economic empowerment and poverty alleviation.

Source: thehindubusinessline