Date: 09/12/2022

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment. Inclusive growth and issues arising therefrom; Financial Inclusion and Microfinance.

Key Phrases: Regulated Entities, Microfinance Loan, Financial Services, Non-Banking Financial Companies, Regulatory Framework, Financial Inclusion, Prepayment Penalty, Microfinance Institutions, Self-regulatory Organisation (SRO), Customer Protection.

Context:

• In recent times, Microfinance institutions have been increasingly adopting technology to enhance operational efficiency, improve underwriting models and reduce expenses.

Key Highlights:

• Microfinance is a basis of financial services for entrepreneurs and small businesses deficient in contact with banking and associated services.
• The term “microfinancing” was first used in the 1970s during the development of Grameen Bank of Bangladesh, which was founded by Muhammad Yunus.
• Today, microfinance is available in nearly 85 per cent districts of India with more than two lakh frontline employees distributing credit and associated services.

Need for Microfinance:

• To safeguard the interest of people outside the formal financial system.
• Failure of formal banking institutions in lending to the rural poor in the absence of proof of recognised employment or collateral that can be offered by them while applying for loans leaves the poor with no alternative but to borrow money from local moneylenders at high-interest rates.
  • In order to provide credit facilities to such individuals, MFIs are useful.

Positive Note of Microfinance:

• Financial Inclusion
  • Microfinance has emerged as one of most important tools to foster financial inclusion.
  • It enables the poor and low-income households to come out of poverty, helps women to become owners of assets, has an increased say in decision making and leads dignified lives embodying the concept of a collective good.
• Inclusive Growth
  • Microfinance plays a critical role in promoting inclusive growth by making credit available at the last mile and therefore, acts as a safety net for those at the bottom of the pyramid.
  • Microfinance loans provide financial access to the poorest that allows many of them to start new businesses, grow existing businesses, insure against shocks due to bad weather and illness, and smooth consumption.
• Adopting Tech
  • MFIs (microfinance institutions) have been increasingly adopting technology to enhance operational efficiency, improve underwriting models and reduce expenses while continuing the focus on customer-centricity.
  • Audio-visual content in vernacular languages is widely utilised to continuously impart financial literacy.
• Improve Underwriting Models
  • A separate credit bureau for microfinance was established about a decade back.
  • Intense efforts by MFIs and credit bureaus have led to the development of robust databases and a credit bureau report is an essential part of underwriting now.
• Expanding Reach of Microfinance
  • In terms of reach, microfinance operations cover 28 states and 9 union territories (UTs).
  • In terms of regional distribution, eastern & north-eastern regions of the country have the largest share at 37 per cent followed by south at 27 percent and west at 15 per cent.
  • Thus, in impacting the lives and livelihoods, the role of microfinance continues to be important.
  • While microfinance is present in almost all nooks and corners of the country, in terms of geographical distribution, 82 per cent of the loan portfolio is concentrated in ten states.
• Strong Customer Protection
  • The RBI regulations for microfinance provide an effective framework for customer protection.
    • This framework is supported by the RBI recognised self-regulatory organisation (SRO).
    • The SRO supports the MFIs in the implementation of the regulations, takes initiatives for capacity building, improves governance through regular guidance and surveillance and provides a platform for resolving sector level challenges.
• Digitalisation initiatives
  • Digitalisation initiatives have been aligned with the rapid diffusion of smartphones and growing comfort of borrowers with digital modes of transactions.
  • Today, nearly 100 per cent of loans are digitally disbursed directly into the bank account of the borrowers and an increasing number of repayments are also being done digitally.

Way Forward:

• MFIs should ensure that the ‘stated purpose of the loan’ that is often asked from customers at the loan-application stage is verified at the end of the tenure of the loan.
• The concerns should lie in people’s accessibility to microfinance in rural and urban areas, the regulations that come with it and the provision of basic training for the rural and urban poor on how to use these loans for productive purposes.

Conclusion:

• The microfinance program has witnessed phenomenal growth in India in the last decade. However, the focus of most of the microfinance service providers has remained on expanding the outreach of microfinance programs with little attention to the depth, quality and viability of the financial services.

Source: Business Line

Mains Question:

Q. Although microfinance in India has witnessed growth in recent decades, it lacks adequate depth, quality and viability of financial services. In light of the statement suggest measures to address such issues. (250 Words).