There is also a need for constructive collaboration between the formal sector finance institutions and MFIs
In the current economic slowdown, it is relevant to talk about creating avenues for those who struggle for the basics. For a country such as India, with 850 million people living on less than $2 (Rs97) a day, this question may hold the key to greater insights. Foreseeing the need for structural change, Muhammad Yunus of Bangladesh popularized the concept of microfinance, and the world today beholds a Grameen Bank serving over 7.34 million people with a recovery rate of 98.35%.
MFIs’ overall reach in India is 15-20 mn clients with only 35% of the 60-70 mn poor families being served Microfinance refers to a movement that envisions a world in which low-income households have access to a wide range of financial services, including not just credit but also savings, insurance and fund transfer. The success of microfinance can be attributed to the principle of solidarity lending, which happens through solidarity groups. Solidarity lending lowers the cost to a financial institution related to assessing, managing and collecting loans.
The need for microfinance gains magnitude owing to the wide gap between its demand and supply. Despite the success of microfinance institutions (MFIs), their overall reach in India is 15-20 million clients with only 35% of the 60-70 million poor families being served. The absence of a lending product to serve the needs of the very low income group can be attributed primarily to the perceived risks of lending to this sector. A large number of small loans are needed to serve the poor, but lenders prefer dealing with large loans in small numbers to minimize transaction costs. Bankers also tend to consider low income households a bad risk, imposing exceedingly high information monitoring costs on operation.
So, MFIs start where the formal sector ends and substitute the informal source of financing. Also Read More on Budget 2009 A study that included data from 62 self-sufficient MFIs showed that the average return on assets was 5.5%, which compared favourably to commercial-bank returns. In India, 38% of the sample MFIs is turning a profit, though only 15% earn more than 3%.
There are grounds for hope that microfinance can become attractive to mainstream retail bankers. Microfinance calls for active, participating clients as well as skilled and efficient work force. Its main challenge remains recovering timely repayments, considering the unstable nature of the clients’ cash flows, making efficient risk management critical to the success of an MFI. There is also a need for constructive collaboration between the formal sector finance institutions and MFIs, in which the former provides funds and the latter extends savings and loan facilities to the urban poor. On the demand side, focus must be to organize and make clients more participative. They must be made accountable to the use of the credit given. Savings must be encouraged.
On the supply side, the concentration must be to transform MFIs into professionally managed, externally regulated entities. There must be uninterrupted supply of services to clients. The profitability and viability of the service must be given importance. All MFI credit models lack an appropriate legal and financial structure and so there must be a more formal environment to regulate and coordinate the activities of MFIs. Government should provide an enabling legal and regulatory framework which encourages the development of a range of institutions and allow them to operate as recognized financial intermediaries subject to simple supervisory and reporting requirements. The Indian MFI sector is among the fastest growing and most efficient in the world.
The sample institutions had an average of 326 staff members with a ratio of 231 borrowers being served per staff member. This is two-thirds more than other surveyed South Asian countries. The future of microfinance in India is bright and promising. Microfinance will continue to develop into an important delivery mechanism to reach out to the poor and achieving financial inclusion and empowerment of women. Its role in enhancing human capital is considerable. The objective of microfinance initiatives must be to evolve the bankable clients to creditworthy clients, thus making concerns about poverty irrelevant. Shanto Ghosh, Piyush Gupta, T. Shraddha Rao and Abhiram V. are with Deloitte Touche Tohmatsu India Pvt. Ltd.