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The Scope of Microfinance in Indian

ContextA Project Report

Under the Guidance of

Ms. Harsh Bala

Submitted by

Student Name: Mukesh Kumar

Roll No. 521075942

In partial fulfillment of the requirment for the award of the degree of

MBA Finance

August-2011

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ACKNOWLEDGEMENT

One rarely gets the opportunity to thank people who have really helped

one in the development of one's work, helped one to grow in a newly emerging field

and motivated one towards the different dimensions of the same.

With limitless humility I would like to thank 'GOD' the Almighty, the

Merciful, the Compassionate, who bestowed me with health and courage enough to

complete the task.

I would require more and more acknowledgement to express the diverse

ways in which I am indebted to my parents who always to express stood by me

during my times of test and trails. Their heartfelt blessings; motivation, love and

sacrifices cannot be reciprocated in tangible and intangible means, wisdom or

emotions.

(Mukesh Kumar)

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Bonafide Certificate

Certified that this project report titled “The Scope of

Microfinance in Indian Context” is the bonafide work of

“ Mr. Mukesh Kumar, Registration No.521075942”

who carried out the project work under my supervision.

Signature Signature

Head of the Department Faculty Incharge

ICAII CAMPUS

2266, Phase - 7, Ph : 0172 - 2267883, M : 9915998811

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Abstract

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Microfinance is gathering momentum to become a major force in India. The self-

helpgroup (SHG) model with bank lending to groups of (often) poor women

withoutcollateral has become an accepted part of rural finance. The paper discusses

the state of SHG-based microfinance in India. With traditionally loss-making rural

banks shiftingtheir portfolio away from the rural poor in the post-reform period, SHG-

basedmicrofinance, nurtured and aided by NGOs, have become an important

alternative to traditional lending in terms of reaching the poor without incurring a

fortune in operating and monitoring costs. The government and NABARD have

recognized this and have emphasized the SHG approach and working along with

NGOs in its initiatives. Over half a million SHGs have been linked to banks over the

years but a handful of states, mostly in South India, account for over three-fourth of

this figure with Andhra Pradesh being an undisputed leader. In spite of the impressive

figures, microfinance in India is still

presently too small to create a massive impact in poverty alleviation, but if pursued

with skill and opportunity development of the poor, it holds the promise to alter the

socioeconomic face of the India’s poor.

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Table of ContentsChapter

No.Title Page No.

1.0 Introduction 1.

1.1Demand of Micro Finance Services in

India42.

1.2 Demand for Credit 43..

1.3Demand for Savings and Insurance

Services45.

1.4Demand of Microfinance forHousing in

India46.

1.5The Problems Associated with

Mainstream MFIs99.

1.6Self Help Groups (SHGs) as borrowing

units102.

1.7 The role of NGOs in Microfinance 104.

1.8Government support for SHG-based

financing107.

1.9The Road Ahead – Prospects and

Challenges113.

2.0 Conclusion 117.

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Introduction

8 Microfinance is defined as provision of thrift, credit and financial services and

products of very small amount to the poor in rural, semi-urban or urban areas for

enabling them to raise their income levels and improving their living standards (Small

amount is conceived upto Indian Rupees Rs.50,000/- for the present). Microfinance

per se has been century old phenomenon in India with emergence of cooperative

banking in the beginning of 20th century. There have been policy initiatives,

institutional thrust and efforts on the part of policy makers, development institutions

and implementing agencies for furtherance of microfinance services over the years in

the context of vast socially disadvantaged and financially excluded population. A

series of policy measures were taken by the Govt. of India in the financial sector,

which have facilitated intensification and deepening of microfinance. These included

nationalisation of commercial banking sector in 1969, setting-up of Regional Rural

Banks (RRBs) in 1975, reforms of financial sector (since 1991), implementation of

pro-poor schemes/programmes through credit delivery system, etc. Similarly, Reserve

Bank of India’s (RBI) (the Central Bank of the Country) initiatives in terms of focus

on expansion of rural branches of banks, priority sector norms, financial inclusion,

etc., had positive bearing on microfinance development. The priority sector norms

envisaged that 40% of Net Bank Credit should be directed towards the identified

sectors/activities of which 18% for agriculture, 10% for weaker sections, etc. With

over 6,00,000 villages and 74% of poor people living in rural areas, microfinance

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continued to be the major challenge for rural credit. Thus, the formal financial sector

which consists of about 36000 rural and semi-urban branches of Commercial banks,

14000 branches of RRBs, 13,000 branches of Cooperative Banks and over a hundred

thousands of rural Cooperative Societies have been engaged in rural credit and the

bulk of their loan accounts are small size loans within the purview of microfinance.

National Bank for Agriculture and Rural Development (NABARD) was set-up by an

Act of Parliament in 1982 for pursuing the mandate of ‘integrated rural development’

through triple major functions- financial, developmental and supervisory. It also

played catalytical role in the microfinance development.

1.2. Despite the phenomenal expansion of the organised banking system and

continued thrust on pro-poor policies and schemes till 80’s, a large segment of the

poor continued to remain excluded from the banking system. The traditional

misconception about the banking with poor that they cannot save, not credit-worthy

and cannot manage business enterprise, prevailed supreme during the period .

Moreover, there were serious aberrations affecting timely and adequate credit delivery

to the poor through conventional lending procedure, system and schemes. The impact

of poverty alleviation programmes was diluted because of poor targeting, mismatch

between borrowers’ capabilities and purpose of loans, lack of linkage with other

support system, leakages at various levels, lack of voluntary participation on account

of directed credit, inadequacy of loan and consequent substandard asset creation.

NABARD initiated search for alternative policy, systems, procedures, savings and

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loan products, other complementary services and new delivery mechanism that would

fulfill the requirements of the poor and disadvantaged.

1.3. The Self-Help Groups (SHGs) - Bank Linkage Programme (SHG-BLP) was

conceptualised and launched by NABARD in 1992 as a pilot with 500 SHGs

combining the mutual strength of formal credit institutions and informal agencies

(SHGs). The linkage concept involves forming small, cohesive and participative

groups of the poor, encouraging them to pool their savings regularly and using the

pooled savings to make small interest-bearing loans to members and in the process,

learning the nuances of financial discipline. The SHGs first get saving linked with

banks and with banks gaining confidence with the group dynamics and their internal

lending processes, provide credit in proportion to the savings. The success of

programme exploded all myths regarding the Banking with Poor. Recognising its

potential innovation for providing access to microfinance in a cost-effective, hassle-

free and timely manner to the poor, the programme was mainstreamed in 1996. The

programme was made part of priority sector and normal lending business of the banks.

With the policy support of Reserve Bank of India, continued multi-pronged

promotional efforts and leadership of NABARD, participation of all other

stakeholders - Self Help Promoting Institution (SHPI), financing banks, Govt. etc., the

SHG-BLP continues to flourish. The programme has become a national movement

with more than 6.12 million SHGs having been saving-linked with savings of

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Rs.54456.20 million and more than 4.24 million SHGs credit linked with loan

outstanding of Rs.226808.5 million as on 31 March 2009. It is the largest

microfinance programme in the world in terms of outreach covering nearly 86 million

households, largest financial inclusion programme in India. SHGs have become the

common vehicle of development process, converging all development and livelihood

programmes. The programme has transformed the rural financial institutions and their

approaches to microfinance delivery to the poor, led to emergence of large number of

SHPIs, Federations, Business Facilitators and above all, ushered socio-economic

empowerment of the poor, particularly women. The massive growth of the programme

has brought to the fore several new issues and challenges e.g., ensuring balanced

distribution of SHGs across the regions, micro-enterprise promotion for matured

SHGs/members, sustenance of quality of SHGs, etc.

1.4. On the other hand, MFIs of different legal forms have made rapid strides and

expanded their outreach through SHGs, Joint Liability Groups (JLGs) and individuals

by way of providing them doorstep financial services. Under SHG-Bank Linkage

Programme, apart from banks financing SHGs directly, they have financed MFIs for

on-lending to SHGs and other small borrowers. As on 31 March, 2009, 1915 MFIs

had loan outstanding of Rs.50091 million under this route. Besides, the MFIs have

pursued aggressive expansion mode. Notwithstanding their growth in business

portfolio, outreach and financial services, the issues and challenges of multiple

financing, over-indebtedness, weak governance/internal checks and control system,

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high interest rates, lack of transparency of operations, etc., have surfaced, in the MFI

front.

1.5. Notwithstanding the above growth story of SHG-Bank Linkage Programme and

MFIs, there is huge unmet demand of financial services for the poor. As per the World

Bank’s estimates on global poverty, India has 456 million poor people of which about

42% of total population, 1.15 billion living below the revised International Poverty

Line (IPL) of USD 1.25 (INR 50) per day. As per the National Sample Survey

Organisation (NSSO) Survey (59th Round) Report, 51.4% of farmers households are

financially excluded from the formal/informal sources. Of the total farmers

households, only 27% access to formal sources of credit and one-third of this group

also borrows from non-formal sources. In this context, the microfinance sector offers

tremendous scope for growth. There are expectations from the new generation of

customers, besides small farmers, marginal farmers, oral lessees, tribals, dryland

farmers, rural women, etc., for their unique needs for financial services.

Home to the largest population of poor in the world, India has been a natural

candidate for experimenting with microfinance as a tool for poverty alleviation. With

a nationalized formal banking sector that has emphasized rural and developmental

banking for several decades now, India’s involvement with small credit targeted

primarily at the rural poor is hardly new. However, recent years have generated

unprecedented interest in microcredit and microfinance in the form of group-lending

without collateral; thanks in part to the remarkable success of institutions like the

Grameen Bank in neighboring Bangladesh and BRI, BancoSol and others in more

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distant lands. The performance of organizations like SEWA in Western India and

SHARE and BASIX in Southern India have convinced many a sceptic that

microfinance can indeed make a difference in India as well. Over the past decade,

NABARD’s “SHG-Bank Linkage Program” aimed at connecting self-help groups of

poor people with banks, has, in fact, created the largest microfinance network in the

world. The self-help group approach has won enthusiastic supporters among

influential policymakers like the Andhra Pradesh CM, Chandrababu Naidu. Even the

central government has recognized the advantages of group lending and has adopted

the approach in its battle against poverty.

Microcredit, in the sense of small loans to the poor, is of ancient origins in India.

Traders and moneylenders have traditionally provided credit to the rural poor, usually

at exorbitant rates of interest leading to considerable hardship and impoverishment of

borrowers, including undesirable and illegal practices like bonded labor. What we

refer to as microfinance today does not include such exploitative practices, but rather

lending to the poor at reasonable but sustainable rates.

Within India the microfinance movement in Western and Southern India have

received most attention, both in the media as well as in academic research1. The

poster boys among the Indian microfinance NGOs – SHARE, BASIX, SEWA,

MYRADA and PRADAN, for instance – have deservingly received attention from

academicians, media-persons as well as the government. Andhra Pradesh, in

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particular, has witnessed a remarkable growth in microfinance activities and its

success stories have been widely reported as well.

However Self-Help Groups (SHGs), usually at the behest of certain developmental

non-government organizations (NGOs), have quietly mushroomed in most districts of

India over the last few years. Millions of poor, predominantly women, are now

members of thousands of SHGs. Given the lack of an easily accessible data source

covering the operation and performance of multiple MFIs and SHGs spread out over a

region, it is hardly surprising that much of the extant research on microfinance in

India, as in most other countries, has focused on developing case studies, often

covering the well-known success stories. In this paper, we seek to follow a slightly

different approach.

The paper is organized in the following manner. The next section provides a brief

background of lending to the rural poor by the rural banking sector in India. The

following section takes a look at the different aspects of Self-Help Groups as the

emerging entity in microfinance. The fourth section studies the performance of the

rural banking system in the microfinance area. The fifth and final section concludes

with a pointer towards the future.

‘Microfinance refers to small scale financial services for both credits and deposits-that

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are provided to people who farm or fish or herd; operate small or micro enterprise

where goods are produced, recycled, repaired, or traded; provide services; work for

wages or commissions; gain income from renting out small amounts of land, vehicles,

draft animals, or machinery and tools; and to other individuals and local groups in

developing countries in both rural and urban areas’- Marguerite S. Robinson.

The Indian state put stress on providing financial services to the poor and

underprivileged since independence. The commercial banks were nationalized in 1969

and were directed to lend 40% of their loan able funds, at a concessional rate, to the

priority sector. The priority sector included agriculture and other rural activities and

the weaker strata of society in general. The aim was to provide resources to help the

poor to attain self sufficiency. They had neither resources nor employment

opportunities to be financially independent, let alone meet the minimal consumption

needs.

To supplement these efforts, the credit scheme Integrated Rural Development

Programme (IRDP) was launched in 1980. But these supply side programs (ignoring

the demand side of the economy) aided by corruption and leakages, achieved little.

Further, ‘The share of the formal financial sector in total rural credit was 56.6%,

compared to informal finance at 39.6% and unspecified sources at 3.8%. [RBI 1992].

Not only had formal credit flow been less but also uneven. The collateral and

paperwork based system shied away from the poor. The vacuum continued to be filled

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by the village moneylender who charged interest rates of 2 to 30% per month (Rural

Credit and Self Help Groups-Microfinance needs and Concepts in India-

K.G.Karmakar 1999). 70% of landless/marginal farmers did not have a bank account

and 87% had no access to credit from a formal source.( World Bank NCAER, Rural

Financial Access Survey 2003)

It was in this cheerless background that the Microfinance Revolution occurred

worldwide. In India it began in the 1980s with the formation of pockets of informal

Self Help Groups (SHG) engaging in micro activities financed by Microfinance. But

India’s first Microfinance Institution ‘Shri Mahila SEWA Sahkari Bank was set up as

an urban co-operative bank, by the Self Employed Women’s Association (SEWA)

soon after the group (founder Ms. Ela Bhatt)was formed in 1974.

The first official effort materialized under the direction of NABARD.(National Bank

For Agriculture And Rural Development).The Mysore Resettlement and Development

Agency (MYRADA) sponsored project on “Savings and Credit Management of SHGs

was partially financed by NABARD during 1986-87.[‘Mainstreaming of Indian

Microfinance’- P.Satish, 2005]

2. MFIs - Various Legal Forms

In response to inadequacies of the banking system in terms of outreach to bottom of

pyramid on the one hand and the exploitative practices of village money lenders in

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relation to their customers, trapping them in an ever moving vicious circle of poverty,

paved the way for creation of people-based voluntary organisations which started to

focus on or diversify to microcredit.

2.1 NGO-MFIs

The NGOs are registered as Public or Private Trusts under the Indian Trust Act, 1882

or any State enactment governing trust for public religious or charitable purposes.

Many are also registered under the Societies Registration Act, 1860 or any other State

enactment governing such Societies. NGO-MFIs vary significantly in their size,

philosophy and approach and take-up financial intermediation to provide

microfinance.

2.2 Cooperative MFIs

The Cooperative Societies registered as cooperative society or mutual benefit society

or mutual aided society under any State enactment relating to such societies or any

multi-State cooperative Society registered under Multi-State Cooperative Societies

Act, 2002, do undertake microfinance activities.

2.3 Non-Banking Financial Companies (NBFC)

The profit-making NBFCs registered under the Companies Act, 1956 undertake

microfinance activities.

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Not for profit Section 25 Companies as also NGO-MFIs are not permitted to accept

public deposits. The ‘For Profit” NBFCs which take public deposits are regulated

prudentially by the RBI.

2.4 Thus, three categories of institutions emerged in microfinance sector. Firstly,

Apex Development Institutions like NABARD, Small Industries Development Bank

of India (SIDBI) and Rashtriya Mahila Kosh (RMK) provided funding and

promotional support to banks/MFIs. Secondly, the banks with their more than 150,000

outlets in rural India upscaled and deepened their microfinance

delivery mainly through SHG-BLP. Thirdly, MFIs of the above categories introduced

varieties of products and services.

Concrete and authentic data on number and nature of MFIs are not available in the

absence of full-fledged and comprehensive regulatory architecture.

As per RBI Annual Report, there were 12,739 NBFCs of which 336 NBFCs had been

permitted to accept public deposits. As per Sa-dhan Quick Report 2009 (umbrella

organisation of MFIs), 232 MFIs had loan outstanding of Rs.11374 crore supporting

2.26 crore households. For profit organisations shared 62% of client outreach and

75% of the total business portfolio. As per the Inventorisation Survey conducted by

GTZ in 13 States, 786 MFOs (3 Cooperatives, 445 MACS, 24 NBFCs, 9 Section 25

Companies, 199 Societies and 106 Trusts) had total loan outstanding of Rs.41420

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million as on 31 March 2008. However, only 4% of the agencies (companies)

accounted for 67% of total loan outstanding.

3. Supervision and Regulation of banks and MFIs in India

3.1 Banking Sector

The Banking Regulation (BR) Act, 1949 provides legal framework for regulation and

supervision of the formal banking institutions. The financial institutions includes 80

Commercial Banks (CBs), 86 Regional Rural Banks (RRBs), 1770 Urban Cooperative

Banks, 4 Development Finance Institutions (DFIs), 12739 NBFCs, 31 State

Cooperative Banks (SCBs), 370 District Central Cooperative Banks (DCCBs). In

terms of the B.R. Act, together with certain provisions of RBI, Act, 1934, the RBI

assumes powers to prescribe standards and liquidity, solvency and soundness of the

regulated institutions so as to ensure that interests of depositors are protected. The

Commercial Banks, Urban Cooperative Banks and For Profit NBFCs (registered with

RBI) will be subject to supervisory and regulatory jurisdiction of RBI, while RRBs

and SCBs/DCCBs will be under the supervisory jurisdiction of NABARD, without

dilution of the regulatory and supervisory powers of RBI. The supervisory and

regulatory policy and practices for these entities have been developed and matured

over the years. While the Board of Financial Supervision (BFS) in RBI provides

direction and guidance to exercise regulatory and supervisory powers, the Board of

Supervision (BOS) in NABARD extends policy guidance in supervision of

SCBs/DCCBs and RRBs. The Asset classification and provisioning norms,

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supervisory rating standards, liquidity, disclosure norms, Risk Management System,

audit and accounting principles, exposure limits, codes of standards and fair practices,

on-site inspection processes, Off-site Surveillance System (OSS), statutory reporting

and compliance through Prompt Corrective Action (PCA) trigger points, preventive

action through warning signals and punitive action through regulatory

directions/penalty/prohibitions/cancellation of license, Grievance Redressal

Mechanism, internal checks and control system, entry barriers, supervisory and

regulatory guidelines, fit and proper criteria for Board and Directors, Corporate

governance standards, Branch Licensing Norms, Financial Performance Standards,

etc., have been put in place, as a matter of regulatory and supervisory architecture.

CBs have been asked to comply with Basel II norms within the stipulated time-frame.

The banks which provide microfinance are required to undertake those safeguards and

obligations. Although, RRBs and cooperative banks have not been called upon to

comply with various principles of Basel Principles of I/II supervision, specifically

within any time-frame, they have been facilitated to implement/comply with various

principles of supervision as enshrined by Basle Committee. NABARD has adopted

CAMELSC approach (Capital, Asset Quality, Management, Earnings, Liquidity,

Systems and Compliance) with regard to inspection process and supervisory rating of

RRBs and Cooperative Banks. NABARD, apart from making suitable

recommendations to RBI for licensing and regulatory action and providing inputs

from time to time, has evolved and implemented suitable supervisory best practices

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pertaining to RRBs and Cooperative Banks. There has been steady progression in this

direction.

3.2 Regulation of MFIs

NBFCs have played significant role in the Indian Financial Sector in providing

outreach to the small clients. With the objective of integrating NBFCs with the

financial mainstream, the RBI brought them under its regulatory arm by way of

amendment of RBI Act, 1934 in 1996. This paved the way for mandatory registration

of companies undertaking financial services with the RBI, compulsory credit rating of

deposit taking NBFCs and their compliance to prudential norms. As per Section 45-IA

of the BR Act, no NBFC can commence or carry on the business without obtaining

certificate of registration from the RBI and having Net Owned Funds (NOF) (Share

holders’ equity + internally generated reserves) of Rs.20 million. All NBFCs have to

comply with the provisions of Companies Act relating to Board of Directors, Share

Capital, Management Structure, audit, maintenance and publication of books of

accounts and general conduct, etc., in addition to the requirements of RBI. Important

prudential norms to be complied include Capital Adequacy Ratio (CAR) based on the

risk weight of assets (15%), income recognition, accounting standards, asset

classification, provisioning for bad and doubtful debts, disclosures in balance sheet,

ceiling on concentration of credit/investment, etc. Not less than 15% of their deposits

should be invested in specified securities and approved securities (Govt.

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Securities and Bonds Guaranteed by Govt.) NBFC are required to notify RBI of their

intention to open branches. However, only the NBFCs taking public deposits have to

comply with prudential norms on CAR, ceiling on concentration of

credit/investment/quantum of deposits, etc. Thus, RBI is empowered to give rigorous

policy prescriptions and regulatory directions to NBFCs having requisite NOF and

accepting public deposits.

However, by loan volumes, 77% of the MFI Sector is under RBI’s direct regulation;

but 75% of the MFIs are functioning outside regulation. The prudentially unregulated

entities are MACS, Trusts, Registered Societies which are having a small client base

and limited volumes of business.

4. Regulatory Approaches and Initiative and in MFI Sector - International Experience

Learnings

4.1 Advantages of Regulation

Although the regulation of MFI Sector has been of recent origin, the regulation per se

of banking sector is established, well documented and evaluated over the years. The

following are accepted as attended advantages and benefits of regulation and

supervision of banks/MFIs:

i. Protects the interest of the depositors;

ii. Put in place prudential norms, standards and practices;

iii. Provides sufficient information about the true risks faced by the banks/MFIs;

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iv. Promoters systemic stability and thereby sustains public confidence in the

banks/MFIs;

v. Prevents a bank’s/MFI’s failure/potential dangers through timely interventions;

vi. Penalises the violations, misconducts, non-compliance to the norms of behaviour;

vii. Provides invaluable advisory inputs for problem-solving and overall improvement

of the banks/MFIs;

viii. Promoters safe, strong and sound banking/MF system and effective banking/MF

policy and

ix. Promotes and enhances orderly economic growth and development.

4.2 Genesis, Trends and Practices of Regulation - International Perspectives

During the 1990’s, many countries started to supervise and regulate the nascent

microfinance sector. The earliest initiatives to bring microfinance under formal

regulation and supervision were undertaken in Latin America. Around the world,

microfinance has been on the agenda of policy makers,

regulators and supervisors. Over 50 countries have implemented or are considering

specific arrangements for regulation and supervision of microfinance either as a

separate new law or as amendments to the existing legal and regulatory framework. In

certain countries, Central Bank has assumed the supervisory and regulatory role, while

in others separate authority (existing authorities or newly created authority/networks)

has been empowered and delegated powers of regulation/supervision. In some

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countries Self-Regulatory Organisations (SRO) have been tried, particularly for non-

prudential regulation. The principles define regulation as set of statutory rules that

apply to MFIs while supervision is the process of implementing and enforcing

compliance with these rules. A clear distinction between prudential and non-

prudential regulation is also established. Prudential regulation mandates capital

adequacy requirements, loan loss provisioning, financial solvency, etc., for protecting

the depositors. Non-prudential regulation covers enabling aspects like business

operation, performance monitoring, credit information services, transparent reporting

and disclosure, codes of fair practices and system, consumer protection, fraud

prevention, etc. There has been differences in the extent and application of regulations

- some have extended prudential to only deposit-taking MFIs. In recognition of

uniqueness of MFIs and small, mostly uncollatoralised loans, lower minimum capital,

higher capital adequacy, lower unsecured lending limits, more aggressive loan

loss provision, simpler loan documentation, lower physical security and branching

needs, lower frequency and content of reporting, lower reserve against deposits,

ownership suitablility and diversification requirements are suggested. Most of the

countries use a combination of quantitative and qualitative indicators to assess

soundness of MFIs. The regulatory rating indicator of ACCION CAMEL has been

suitably adopted to MFIs. The rating agencies like planet rating, M-CRIL, Micro

Finanza, Moody’s, Standard and Poor, etc., have also developed suitable rating norms

and could be useful tools for regulators/supervisors. There has been also attempts to

evolve social performance

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rating standards by integrating economic and social rating, by the Social Performance

Task Force (SPTF), CERISE, CGAP - Grameen Ford, FINCA’s FACT Tools, Planet,

M-CRIL, etc. Although, guiding principles on Regulation and Supervision of

Microfinance issued in 2003 by Consultative Group to Assist the Poor (CGAP)

indicates certain consensus, there has been divergence in trends and practices across

the world.

4.3 The following are certain broad experiences and lessons internationally, in

microfinance regulation.

(i) Microfinance has been conceived with a wider spectrum and perspectives

(ii) Microfinance has been driver to building inclusive sector.

(iii) Regulatory framework is tailored to the national circumstances.

(iv) Regulation is directed towards activities rather than institutions

(v) Regulation should be proportionate to the expected benefits

(vi) Elements for an enabling framework are to encourage microfinance activities and

increase the level of access to finance.

(vii) The regulation is to encourage linkage and partnership between banks,

Microfinance Organisations (MFOs) and other retail outlets.

(viii) Regulation is to ensure consumer protection - prohibition of deceptive and unfair

practices in lending and collection, to ensure disclosure of full costs, fees and terms of

products and services, supply clients with accurate, full, accessible, comparable and

transparent information.

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(ix) Microfinance regulatory framework should find ways to pressure the social

objectives of microfinance transactions.

(x) Regulation is to set performance standards portfolio management, MIS, internal

control system and governance.

(xi) Regulation ensures registration, reserves, compliance with prudential norms,

directions in reporting needs.

(xii) We need not regulate those which we cannot supervise.

The international experience of microfinance regulation clearly indicates that in

several countries in Asia and Africa that microfinance could be central to achieving

overall social objectives and that a conducive environment including a relevant legal

framework needs to be provided for the sector to grow in orderly and systematic

manner.

Proposed statutory framework for Micro Finances Services-

Position and Perspectives

5.1 Draft Microfinance (Development and Regulation) Bill 2007

The issue of evolving/implementing a suitable statutory and policy framework for

regulation and supervision of the growing microfinance sector had drawn the attention

of the Policy Makers amidst the debates of over the issue in the country A Task Force

was constituted in 1999 (under the Chairmanship of the then Managing Director of

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NABARD). to look into the related issues, which had recommended certain short term

and long term measures for the purpose. The GOI took the pro-active

initiative of drafting Micro Financial Sector (Development and Regulation) Bill, 2007

in consultation with RBI, NABARD, Indian Banking Association (IBA) and

microfinance sector, with a view to bringing about appropriate statutory framework,

institutional mechanism and policy environment. The objectives were as under:

(1) To bring about orderly, holistic and integrated development of microfinance

sector;

(2) To enlarge and facilitate financial inclusion to the poor and disadvantaged;

(3) To protect the interests of small depositors/thrifts;

(4) To eliminate the scope of exploitation to the vulnerable clientele of the sector and

(5) To facilitate universal and easy access to credit, thrift and other financial facilities

to women and disadvantaged.

The intentions of the GoI in this regard were spelt out in the consecutive Union budget

announcements - 2006 and 2007.

The draft bill was approved by the Union Cabinet and then introduced in the

Parliament on 20 March 2007. Then the bill was referred to the Standing Committee

of Parliament. All stakeholders had presented their views/suggestions to the then

Committee. The period of Lok Sabha expired and new Govt., at the Centre took over

after the general election. The GoI is contemplating to re-introduce the bill in the

Parliament. In the meanwhile, the Committee on Financial Inclusion (Dr. Rangarajan

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Committee) recommended that regulation of the entire MFI Sector including NBFCs

may be kept under the Bill.

5.2 Provision and features of the Draft Bill

The basic features of the draft bill are as under:

i. In recognition of NABARD’s track record in the relevant field, the bill envisages to

entrust to the National Bank the regulatory, supervisory, promotional and

developmental role for microfinance services through Microfinance Organisations

(MFOs)

ii. As NBFCs and Section 25 Companies are already regulated by RBI, it only seeks to

regulate and develop the Micro Finance Organisations (e.g. Societies registered under

Society Registration Act, 1860, Trusts created under the Indian Trust Act, 1982,

Public Trust under State enactment, Cooperative Societies under Multi-Purpose

Cooperative Societies Act, 2002,

Cooperative Society/Mutual Benefit Society) undertaking thrift and/or other micro

finance services for the poor and disadvantaged section.

iii. A Microfinance Development Council (MFDC) comprising of senior executives

from RBI, NABARD, SIDBI, NHB (National Housing Bank), GOI and eminent

experts to advise Regulator and give policy directions.

iv. Envisages policies and procedures for MFOs for registration and cancellation of

registration.

29

v. Defines the powers and functions of Regulator in various aspects in implementing

the provisions of the Act and obligations of the supervised MFOs.

vi. Envisages the functions and the jurisdiction of Auditors, Ombudsman (for

redressal of public grievances) and the GOI.

vii. The provision of penalties on account of violations of the Act

viii. Institution of Micro Finance Development and Equity Fund (MFDEF) for

promotion and development of microfinance services.

ix. The areas under which regulations to be made by the Regulator and the rules to be

framed by GOI.

5.3 Role Expectations from the Regulator

The following are the functions envisaged for the Regulator in the draft bill:

i. To promote and ensure orderly growth of MF services;

ii. Policy formulation for greater transparency, effective management, better

governance and efficient MF services;

iii. To evolve Sector-related benchmarks and performance standards – methods of

operations, governance, codes of conduct;

iv. Developing rating norms for mFOs – accessing bank credit, Business

Correspondent/ Facilitator;

v. Specifying Accounting/ audit standards, books of accounts;

vi. Developing information/ database for mFI sector;

30

vii. Promoting institutional development customers’ education, training and capacity

building;

viii. Supporting research, documentation and dissemination of information;

ix. Undertaking Registration – procedures, issuance, cancellation;

x. Conducting On-site inspection, off-site surveillance, issuance of directions;

xi. Exercising penal powers in case of violation/false information;

xii. Coordination with other agencies; and

xiii. Managing/ administering Ombudsman scheme, mFDEF, mFDC.

5.4 Broad Philosophy of the proposed Bill – Beyond conventional Banking

Regulation

i. Regulation of microfinance services – Directed to activities rather than institutions;

ii. Regulation to ensure protection of the consumers (Micro-clients ) – Public

Grievance Redressal;

iii. Regulation to concurrently trigger development processes considering the very

nascent and delicacy of microfinance services/MFOs;

iv. Regulation to cover thrift or any other financial services;

v. Rigours of registration/regulations for MFOs doing thrift services compared to

other financial services; and

vi. Regulation to strike a balance between development of none/less regulated entities

and tough financial discipline.

31

5.5 Expected Outcome for the proposed Bill

i. Development of order and discipline and sound system, fair practices, Governance

in MFOs;

ii. Encouraging disclosures and transparency on the functioning;

iii. Generating data-base and financial and information on MFOs – Common

Reporting;

iv. Development of Social Performance Management;

v. Providing protection to thrifts of the members;

vi. Ensuring Grievance Redressal of the customers;

vii. Triggering Developmental and corrective action, based on on-site inspection and

OSS;

viii. Facilitating Sound Accounting Practices, Audit, etc.;

ix. Ensuring Compliance to inspection and audit leading to improvement in

performance.

6. The Central Issues

Notwithstanding the merits of the Bill, there has been debates as to the rationale of

regulation, the institutional mechanism and the precise reason for combining

regulation and development aspects envisaged under the bill. These three issues are

analysed in depth hereunder:

32

6.1 Rationale of Regulation

6.1.1 Increasing level of Access to Finance

During the past decade and a half, the role of Micro Finance as a component of

poverty reduction strategies has come to be well recognised. As a result, increasing

numbers of NGOs, as well as government, bilateral and multilateral funded

development activities are including microfinance components in their programmes.

As NGOs-MFOs have been expanding their businesses, the limitations of grants and

donor funds are being experienced and the MFOs are looking more and more for

funds from the banking system, capital from private and public sources and are

seeking to raise deposits from their clients. It is estimated that the outreach of the

MFOs is close to 5 million clients on a cumulative basis. The smaller of the NGO

MFOs are providing financial services to the poor and this cannot be ignored anymore

as the banking system may not be in a position to replace these MFOs overnight.

Surveys show, however, that informal-sector lenders remain a strong presence in rural

India and are still able to deliver services that are not yet provided as well by the

formal and semiformal sectors.

6.1.2 Transformation of MFOs

‘The NGO MFOs’ are transitory organisations and they reach out to the very poor

who are not at present being served by the banks. These clients could graduate to

become direct clients of the banks, as they require higher level of funds to finance

their enterprises. In rural financial system in India, these NGO MFOs serve an

33

important role and they have to slowly graduate into full-fledged formal financial

institutions either in the cooperative form or as companies or NBFCs. In order to help

the NGO MFOs evolve into formal regulated financial institutions, they need to

follow standards and practices befitting the entry into formal financial institutions.

The MFO Development and Regulation aims to provide this transition and help them

graduate into mainstream financial institutions.

6.1.3 Registrar’s limitations

The NGO MFOs are normally registered as Societies under the Societies Registration

Act or as Trusts under the Indian Trusts Act or their variants in many States of the

country. These legal forms are not designed to regulate financial intermediation.

These MFOs operate sometimes conceptually in a vacuum as far as their

responsibility in financial intermediation is concerned. The people who

sometimes suffer on account of the omissions and commissions of these MFOs are the

poor clients who have no protection whatsoever. These legal Acts under which the

MFOs presently operate, although the Registrar is perceived as a regulator, is not a

regulator of MFOs under these legal Acts in the strict sense of the term. The

Regulator’s boundaries are strictly in the administrative sphere and the financial

soundness of the MFOs is not his jurisdiction nor of his interest. For example, the

Registrar of the Societies in each State enforces the provisions of the principal Act or

the corresponding Acts enacted by the other states. The principal Act does not define

the term ‘Registrar’.

34

It is clear from the list of powers and duties of the Registrar, he does not have

overbearing powers in terms of handling of the affairs of a society. With respect to the

functioning of the Micro Finance operations of a society, the Registrar has no

responsibility for any form of prudential regulation or determination of its financial

performance or solvency. The Registrar can intervene only if a major dispute arises in

the management of the society or there is apprehension of an intention to defraud the

creditors of the society or to engage in other unlawful or unauthorized acts.

The provision of financial services means not only the handling of funds that belong

to public organizations but also the management of savings that belong to poor

people. The availability of resources combined with a liberal policy environment

could result in NGOs or others undertaking microfinance without having a full

understanding of the complexities and discipline of financial management. It is

possible that the entry of under-prepared or ill- motivated organizations may

assume financial intermediation as already happened to some extent. If the growth of

this important sector is to be managed without significant disaster stories, it is

important that not only the standards are introduced in the immediate future but also

that some form of regulation be considered.

6.1.4 Market-Based System

The regulation and supervision of MFIs has the larger aim of developing a niche

market-based financial system for all products — credit, savings, insurance, transfer

35

facilities and other services for the clients. A market-based financial system assumes

the existence of sufficient competition and incentives to provide the lowest-cost

services possible to clients, where cost includes all costs — interest rates, transaction,

and monitoring. The ultimate aim of MFIs and NGO facilitators involved in financial

services for the poor ought to be to ‘mainstream’ their client base, to avoid the

marginalization of the clients vis-à-vis financial services. The corollary aim is raising,

the standard of practice, making it sustainable and enabling it to contribute to the

development of the financial system.

6.1.5 Motivation for Regulation

The motivation for regulatory intervention is based on the assumption that an

asymmetry of information exists between the lender and the borrower. The borrower

knows more about what he is going to do with his funds and his ability to repay than

the lender. In deposit-taking, the financial institution knows more about how the

deposits are going to be used or its own solvency than the depositor. This asymmetry

of information results in problems of ‘adverse selection’ and ‘moral hazard’ in the

transaction. (Staschen 1999) Regulation to match the actions of the institution (agent)

and the client (principal) exists and is accomplished in three ways — control the

actions of the agent, restrict the decision-making power of the agent and set

appropriate incentives for the agent such that the interests of the agent and principal

are harmonized. The last option, while least costly in terms of monitoring, is the

hardest to design. The first two options involve a supervising agency with statutory

36

authority to control the agent and lead to inefficiencies in the market. In economic

theory (but not in development finance), the manager’s role is to maximize his

information advantage not only over his competition but also over the clients which

are curbed by regulation. In practice, all three methods are employed to regulate

financial institutions. In short, the reasons for regulation are (a) It is difficult for small

depositors to closely monitor the performance of the MFOs and (b) Even if the MFOs

do not take deposits, they largely handle public money in the form of debt raised from

the banks and they are liable to behave opportunistically and pursue personal gains at

the expense of the client and the tax payers funds.

Some regulatory framework is necessary if the ultimate aim is to expand, scale and

mainstream this segment of the financial system. Thus, regulation attempts to

accomplish limiting the danger of opportunistic behavior on the part of the institution

(consumer protection) and preventing unwarranted runs on the system, thereby

ensuring stability. If public deposits are not mobilized, then the regulation will be kept

at a minimum.

6.2 Why to combine Development and Regulation

It is accepted that protection of depositor is the basic objective of a conventional

regulation. However, under microfinance, it is supervision and regulation +. That is

why the Bill is titled as MF (Development and Regulation) Bill envisaging promotion,

supervision and regulation and prescribing multi-pronged developmental and

37

promotional role of the regulator, besides registration, inspection, issue of directions

and imposing penalty in case of non-compliance to its directions and regulations.

Internationally, Microfinance by definition includes micro savings, microcredit, micro

insurance, micro pensions and micro money transfers. Sometimes, these are

intertwined into each other and for example, micro insurance and micro savings are so

intertwined that there would be a thin line between them. Anyway, the Bill is not

about regulating these add on activities per se than about regulating micro financial

services. In the case of micro insurance and micro pensions, regulation would be only

in the area of client protection.

Moreover, the bill focuses on microfinance services rather than MFOs. In the recent

legislations in India e.g., Insurance Regulatory Development Authority (IRDA),

Provident Fund Regulation, etc., both developmental and regulatory aspects have been

incorporated.

6.3 Why NABARD should be the Regulator

The GOI’s choice in proposing NABARD as promoter, supervisor and regulator for

MFOs has received acceptance at various levels, probably due to certain practical

considerations as under:

38

(i) NABARD was conceived by the Committee to Review Arrangements for

Institutional credit for Agriculture and Rural Development (CRAFICARD). Their

thinking and vision was that in the context of complexities and diversities of rural

India, an organisation like NABARD could take a holistic view of rural development

and assume triple role of financing, development and supervision of Rural Finance

Institutions for integrated rural development.

(ii) Various Committees (e.g. Expert Committee, Narasimahan Committee, Vyas

Committee, etc.) had assessed the supervisory role of NABARD and appreciated its

professional approach and balancing role.

(iii) Internationally, regulatory and supervisory organisational structures in banking

and MFI Sector have displayed several varying models being effective in different

countries. IMF Survey in April 2007 covering 139 Financial Sector

Regulatory/Supervisory Agencies revealed existence of different organisational

structures in regulation and supervision e.g., stand-alone supervisory agency, authority

based in a Central Bank, Ministry of Finance or combined with other agencies.

(iv) NABARD’s supervisory services in the context of difficult and complex

organisational entities viz., RRBs and Cooperative Banks has been recognized during

the last 27 years. It has put in place several supervisory best practices developed over

the years. The professional Board of Supervision comprising the experts and

stakeholders, separate Department of Supervision with expert and experienced staff

ensure professional and independent approach. The officials who have exposures to

the field in various capacities take holistic view of rural credit, RFIs and MFIs.

39

(v) Its pioneering role in financing, promotion and development of MF, particularly,

its leadership role in SHG-Bank Linkage Programme and managing Microfinance

Development and Equity Fund (MFDEF) have been recognised widely.

(vi) The inspection findings in respect of RRBs and Cooperative Banks are

internalised and corrective remedial steps undertaken by the developmental and

financial services departments of NABARD. This way, supervisory and regulatory

inputs are expected to trigger developmental action by NABARD with respect to

MFOs.

(vii) The All India presence of NABARD through its Regional Offices in all States

and District Development Managers (DDMs) in districts would facilitate providing

market intelligence which are having bearing on supervisory and regulatory functions.

7. Preparations Prelude to Passage of the Bill The fate of the Bill will be dependent on

the will of the GOI and Parliament. Irrespective of what

would be the shape, structure and nature of supervisory and regulatory architecture,

NABARD has taken a series of steps to better understand the system and practices of

the MFOs through conduct of system studies in select MFOs, organising

training/exposure programmes on promotion, supervision and regulation of MFOs for

its officers and the officials of MFOs, evolving rating norms, development of MIS,

etc. Under the purview of Technical Collaboration - NABARD-GTZ Rural Finance

40

Programme, the component of promotion, supervision and promotion of MFOs has

been included envisaging various interventions as above. The GOI have been

provided with various critical inputs on the related aspects from time to time.

8. International Cooperation and Exchange

There has been global efforts in micro credit/microfinance development. The Micro

Credit Summit, Declaration of Millenium Development Goals (MDG) and role of

international donor agencies have been instrumental in furthering microfinance sector

over the years. Similar efforts in regulation and supervision by the majority of Central

Banks, Regulatory and Supervisory Authorities could facilitate exchange of mutual

experience and learnings. Developing a new regulatory regime for microfinance

takes a great deal of analysis, consultation and negotiation. If cost of regulation and

supervision is to be shared by the supervisory regulated entities, considerable study,

analysis and insight in the working of MFIs may be required before opening a

regulatory window. There could be mutual understanding and cooperation for

development of regulatory, supervisory and development architecture, tools and

methods, rating norms, disclosure standards, risk management system, Off-site

Surveillance System (OSS), Computerisation and MIS, etc. Designing training

modules for the supervisors and supervised on various aspects of systems and

standards in the MFIs through collective efforts would be rewarding. The Inspection

Manuals and Guidelines can be prepared by pooling together common experience.

41

Recent works (viz., Hirschland, Harper, Chao-Beroff - 2008) by a group of

microfinance experts on member-owned institutions (MOI) points in a similar

direction and recommends for international Task Force of experts, promoters and

practitioners to build consensus on good practices for MOIs operating in rural areas

and to identify norms, standards and related risks as a step towards appropriate

regulation and supervision. Others (Wevas and Fisher 2006) have proposed a Basle

Accord like process to develop international guidelines for MFIs’ regulation.

9. Perspectives

The regulatory and supervisory framework envisaged will eliminate restrictions on

orderly growth of the sector and lead to evolution of market-oriented financial and

credit policies. The technology adoption, voluntary codes of internal discipline, risk

management architecture, introduction of innovative MF products and models will

lead to organisational transformation and growth. The improved performance will

enhance the creditability and open up opportunities for garnering funds from banks.

The public will get their grievances addressed through Ombudsmen like mechanism.

Care needs to be taken to avoid over regulation and attempts to be made to facilitate

development of innovative MF products and models. In due course, the MFI will be

integrated with mainstream financial system.

It may be difficult to envision sustained financial efforts without mainstreaming such

institutions and equipping them with suitable business strategies. The MFIs will

42

require huge capacity building efforts before they can be subjected to effective

regulation and supervision.

The institutions already empowered with regulatory and supervisory powers in

microfinance sector could be the torch bearers for the rest of the countries where

regulatory and supervisory framework is yet to be set-up. They could guide, motivate,

support and enlighten all others in this direction, in the years ahead for creating a

better regulatory and supervisory environment in the MFI world. The Regulator and

supervision should ultimately benefit the people at the bottom of pyramid.

1.1: Demand of Micro Finance Services in India

Due to its large size and population of around 1000 million, India's GDP ranks among

the top 15 economies of the world. However, around 300 million people or about 60

million households, are living below the poverty line. It is further estimated that of

these households, only about 20 percent have access to credit from the formal sector.

Additionally, the segment of the rural population above the poverty line but not rich

enough to be of interest to the formal financial institutions, also does not have good

access to the formal financial intermediary services, including savings services.

A group of micro-finance practitioners estimated the annualised credit usage of all

poor families (rural and urban) at over Rs 45,000 crores, of which some 80 percent is

43

met by informal sources. This figure has been extrapolated using the numbers of rural

and urban poor households and their average annual credit usage (Rs 6000 and Rs

9000 pa respectively) assessed through various micro studies.

Credit on reasonable terms to the poor can bring about a significant reduction in

poverty. It is with this hypothesis, micro credit assumes significance in the Indian

context. With about 60 million households below or just above the austerely defined

poverty line and with more than 80 percent unable to access credit at reasonable rates,

it is obvious that there are certain issues and problems, which have prevented the

reach of micro finance to the needy. With globalisation and liberalisation of the

economy, opportunities for the unskilled and the illiterate are not increasing fast

enough, as compared to the rest of the economy. This is leading to a lopsided growth

in the economy thus increasing the gap between the haves and have-nots. It is in this

context, the institutions involved in micro finance have a significant role to play to

reduce this disparity and lead to more equitable growth.

1.2: Demand for Credit:

At the very bottom in terms of income and assets, and most numerous, are those who

are landless and are engaged in agricultural work on a seasonal basis, and manual

labourers in forestry, mining, household industries, construction and transport. This

44

segment requires, first and foremost, consumption credit during those months when

they do not get labour work, and for contingencies such as illness. They also need

credit for acquiring small productive assets, such as livestock, using which they can

generate additional income.

The next market segment is small and marginal farmers and rural artisans, weavers

and those self-employed in the urban informal sector as hawkers, vendors, and

workers in household micro-enterprises. This segment mainly needs credit for

working capital, a small part of which also serves consumption needs. In rural areas,

one of the main uses of working capital is for crop production. This segment also

needs term credit for acquiring additional productive assets, such as irrigation

pumpsets, borewells and livestock in case of farmers, and equipment (looms,

machinery) and worksheds in case of non-farm workers. This market segment also

largely comprises the poor but not the poorest.

The third market segment is of small and medium farmers who have gone in for

commercial crops such as surplus paddy and wheat, cotton, groundnut, and others

engaged in dairying, poultry, fishery, etc. Among non-farm activities, this segment

includes those in villages and slums, engaged in processing or manufacturing activity,

running provision stores, repair workshops, tea shops, and various service enterprises.

These persons are not always poor, though they live barely above the poverty line and

also suffer from inadequate access to formal credit.

45

1.3:Demand for Savings and Insurance Services:

The demand for savings services is ever higher than for credit. Studies of rural

households in various states in India show that the poor, particularly women, are

looking for a way to save small amounts whenever they can. The irregularity of

cashflows and the small amounts available for savings at one time, deter them from

using formal channels such as banks. In urban areas also this is true, in spite of better

banking facilities, as shown by the experience of the SEWA Bank, Ahmedabad. The

poor want to save for various reasons – as a cushion against contingencies like illness,

calamities, death in the family, etc; as a source of equity or margin to take loans; and

finally, as a liquid asset. The safety of savings is of higher concern than interest rates.

The demand for savings services is high in rural areas as well, as can be seen from a

recent study of women’s savings and credit movement in Andhra Pradesh. Almost all

women’s groups in their early years begin with regular savings and their savings

exceed the loans they give from their funds. Of course, part of this lower demand for

credit is the inadequate absorption capacity of women, which comes from long years

of exclusion from the economic sphere outside their homes.

The demand for insurance services, though not very well articulated, is also

substantial. This comes from the fact that not only incomes of microfinance customers

low, but are also highly variable. Insurance by the poor is needed for assets such as

livestock and pumpsets, for shelter. Crop insurance could be very useful to the rural

46

poor. Finally, insurance against illness, disability and death would also reduce the

shocks caused by such contingencies, which lead the poor into taking loans at such

times at high interest.

1.4 Demand of Microfinance for Housing in India

New Housing Policy Measures in India

The concept of affordable housing has drawn some attention of the policy makers in

recent years to address some of the housing issues of poor and low income groups. To

ensure ‘shelter for all’ the National Housing and Habitat Policy (NHHP) in 1998 and

subsequent housing policies have played crucial role in reforming the hosuning sector

by opening up housing sector to private setor and successfully rooted the government

out of direct construction activity and delineated a facilitation role for it in the housing

47

sector. It laid greater emphasis on the aspect of “Habitat” as a supplementary focus to

housing. The emphasis on “providing” housing continued with emphasis on both

quality and cost-effectiveness, long-term goal of eradicating houselessness, improving

the housing conditions of the inadequately housed, and providing a minimum level of

basic services and amenities to all. The NHHP was formulated to address the issues of

sustainable development, infrastructure development, and for strong PPPs for shelter

delivery with the objective of creating surpluses in housing stock and facilitating

construction of two million dwelling units each year.

There are several policy initiatives to encourage private sector participation in

fulfilling the wider housing gap in the lower segments. The scheme of Affordable

Housing aims at promoting various types of public-private partnerships – between

private sector, the cooperative sector, the financial services sector, the state govt. and

urban local bodies, etc. For realizing the objective to promote sustainable

development of habitat in the country with a view to ensuring equitable supply of

land, shelter and services at affordable prices to all sections of society the National

Urban Housing & Habitat Policy (NUHHP) 2007 was a notable policy measures. It

was designed towards the goal of affordable housing for all. National Urban Housing

and Habitat Policy 2007 (NUHHP), is a major policy effort on urban housing and

habitat of the Ministry of Housing and Urban Poverty Alleviation, Govt. of India. It

gives a detailed account of the status of urban housing in India, the problem of

housing shortage etc. NUHHP seeks to promote sustainable habitat in the country and

48

delineates specific areas of action and an action plan towards achieving ‘Housing for

All’ – its ultimate goal. Given the magnitude of the housing shortage and budgetary

constraints of both the Central and State Governments, it is amply clear that

government efforts will not suffice in fulfilling the housing demand. The new policy

focuses on multiple stake-holders and seeks to promote various types of public-private

partnerships for realizing the goal of 'Affordable Housing for All'.

NUHHP 2007 aims at to promote development of cost-effective, quality approved

building materials and technologies with a view to bringing down the cost of

EWS/LIG houses and it dwells upon the roles of various stakeholders and specific

action required pertaining to land, finance, legal and regulatory reforms as well as

technology support and transfer. This policy emphasizes on appropriate fiscal

concessions for housing and infrastructure seeks to develop innovative financial

instruments like development of Mortgage Backed Securitization Market (RMBS) and

Secondary Mortgage Market. It also also makes to attract Foreign Direct Investment

(FDI) in areas like integrated development of housing and new township

development. It

Similarly, Jawaharlal Nehru National Urban Renewal Mission (JNNURM), is a

programme with objective to provide stimulus to economic activities through

affordable housing programmes in partnership. Though its immediate objective is

employment generation to the urban poor and asset creation for income generating

49

activity, the JNNURM seeks to fill up the gaps in infrastructure and deficiencies in

housing and basic services through appropriate investments.

.

Other policies adopted by the Central Government, from time to time, were

accompanied by initiation of various programmes and schemes. The National Slum

Development Programme (NSDP) had provision for adequate and satisfactory water

supply, sanitation, housing, solid waste management, primary and non-formal

education. The scheme provided additional central assistance to States to supplement

the resources of the State Government for provision of basic infrastructure and

services in slum areas. The Swarna Jayanti Shahari Rozgar Yojana (SJSRY) was

designed to provide gainful employment to the urban poor by encouraging setting up

of self-employment ventures and provision of wage employment opportunities for

families below poverty line in urban areas. The Two Million Housing Programme

(TMHP) was launched with the objective of ‘housing for all’ with particular emphasis

on the needs of economically weaker sections and low income group categories. The

Valmiki Ambedkar Awas Yojana (VAMBAY) aimed at providing subsidies for

construction of housing and sanitation for urban slum dwellers living below poverty

line in different towns/cities all over the country. It appears that there some public

policy interventions also induce pro-poor housing demand directly or indirectly.

There were several other policies and programme implemented towards minimizing

housing deficit for the needy poor. But due to its limited spread and other limitations

50

such as constraints of fund allocation, location in far-flung places with poor

infrastructure, acute shortages of urban land, encroachments and absence of property

rights and poor selection and implementation process many pro-poor housing schemes

have not been successful (Sundaram & Tendulkar, 1995, Hirway 1987). Evaluation of

some earlier popular pro-poor housing programme such as IAY (Indira Awas Yojana)

and coverage of some new housing schemes, Rajiv Awas Yojana (RAY), Valmiki

Ambedkar Awas Yojana and the National Slum Development Programme

substantiates it. In case of IAY, the scheme mostly has not helped the expected

number of houseless and the intended beneficiaries (SCs, STs & BPL). There is a

great disproportionality between the funds provided and the targets achieved

(Planning Commission, undated)1. It might have induced growth of informal housing,

without appropriate plan and prospects to minimize the pressure of housing deficit. To

a large extend informal housing do not benefit from the outcome of public housing

programme, research and development in low cost housing technology such as

construction of quality housing using the most cost effective and environment friendly

building technologies, designs and materials.

Social Housing Schemes

S.No. Name of the Scheme Started in

1. Indira Awas Yojana 1990

2. EWS Housing Scheme for beedi workers and hamals 1991

1

51

3. National Slum Development Programme 1996

4. A two million Housing Programme for EWS/LIG 1998

5. PM Gramin Awas Yojana 2000

6. Valmiki Ambedkar Awas Yojana (VAMBAY) 2001

7. JNNURM (BSUP and IHSDP) 2005

Source: Ministry of Housing and Urban Poverty Alleviation (MoHUPA), GoI.

The mission to create a slum-free country through major housing schemes like IAY,

Rajiv Awas Yojana (RAY), special schemes for SC & ST etc. has not met the

expectations. The focus is still on providing heavily-subsidized home ownership to a

few, rather than shelter for all. However, Eleventh Plan (2007-12) targets construction

of 150 lakh houses under IAY for the poorest of the poor, houseless and unserviceable

kutcha house (Panning Commission, 2008). To eliminate backlog of houselessness in

rural areas IAY has been focusing on accurate targeting, adequacy of cost of unit,

provision of necessary infrastructure and ownership issues.

But there is no relief to the impasse of housing situation in the country both at national

and regional level showing much is required to perform at policy level. It is now

realized that subsidized housing scheme may not be the sufficient to tackle the

housing problems. To lure the private sector to make investment in housing sector, the

Government has offered some incentives in terms of fiscal and other concessions so

that the private sector can be motivated to take up the task for the housing for poor.

52

These concessions are proposed to be linked with housing for vulnerable sections. In

this connection the ninth five-year plan (1997 to 2002) has rightly stated "Housing has

been primarily a self help activity. In addition to IAY other strategies to tackle

housing shortage are encouraging prime lending institutions to enhance credit flow to

rural areas, flexible financial product for rural housing through commercial banks,

encouraging small and medium developers for rural housing and institutional

mechanism to address credit risk perception in housing rural sector. Policy efforts are

proposed to set up rural housing consortium comprising National Housing Bank

(NHB), NABARD and leading commercial banks and MFIs to provide equity and

debt for rural housing. Provision of special incentive to housing finance institutions to

increase their rural housing loan portfolios from current 10-20% of their total housing

loans is also under consideration (Planning Commission, 2008).

In fact, urban housing problem has been severe with rapid rural to urban migration. It

has put high pressure on urban land and housing sector. For instance, total urban land

stock in India is 2.3% of its geographical area and it houses 30% of the country's

population. The national housing policy recognizes that provision of shelter is

important in the following terms. It improves the quality of life of the poor creates

conditions for attainment of better health, hygiene, and education enhances

productivitystimulates economic activitycreates employment opportunities motivates

savingspromotes social justice Considering the severity of housing problem in the

country a high level task force was set up in 2008 by M/o Housing & Urban Poverty

Alleviation to look into the various aspects of providing ‘Affordable Housing for All’

53

under the Chairmanship of Sh. Deepak Parekh. The task force has strongly

recommended the need for ‘Affordable Housing’ and early effective policy action to

address the problem with focus on the housing finance.

Nature of Housing Need & Demand in India

In addition to huge shortage of housing in the country there is a mismatch between

demand and supply of housing units across rural and urban areas and different socio-

economic groups. About 99% of the housing shortage of 24.7 million for 67.4 million

households at the end of the 10th Plan pertains to the Economically Weaker Sections

(EWS) and Low Income Groups (LIG) sectors. During the 11th Plan, the Group

estimated that the total housing requirement (including backlog) will be to the tune of

26.53 million units for 75.01 million households (NUHHP, 2007). As 26.7% of the

total poor in the country live in urban areas and it constitutes about 80.7 million

persons or about one-forth of the country’s total urban population, the issue of

affordability assumes critical significance. The 61st Round of National Sample Survey

Organisation (NSSO) reports that the number of urban poor has risen by 4.4 million

persons, between 1993-94 to 2004-05 and it shows that shortage of housing for the

urban poor is alarming. But the situation in rural areas is also equally worse as three-

fourth of the poor live in rural areas and many of them lack minimum housing.

Many low income households get excluded from formal housing finance on the

ground that they are unable to meet the criteria and fail to afford it. Several public

54

housing assistance programmes such as slum upgrading, subsidized housing

programme, urban development and poverty eradication normally exclude many

needy people or they have to wait for years together to get their turn. Though, several

transparent methodologies have been introduced to make the selection process free

and fair, greater participation of people to minimize exclusion of needy and

underprivileged but desired outcome has not been achieved. One of shortcomings of

these housing programmes is ignorance of the local housing needs and conditions.

Uniform in nature, high incidence of exclusion of potential beneficiaries, high

administrative cost and other problems have made them unpopular. On the other hand,

inequality in housing conditions seems moved along with income inequality across

groups and regions. The poor have become progressively incapable of self help and

mutual help for solving their housing problems. While their dependence on public

housing support continues in the absence of alternate means to improve their housing

condition much hyped public pro-poor housing programme fails to meet it. Budgetary

constraint for public housing schemes and poor fund arrangement and access to

housing finance by the housing poor accentuate the problem of housing defict in both

urban and rural areas. The Working Group on Urban Housing pertaining to the 11th

Plan made different assumptions on unit cost of construction of houses in million plus

cities and other urban areas for estimating the investment required for overcoming the

housing shortage. The total estimated investment for meeting the housing requirement

upto 2012 was estimated to be of the order of Rs.3,61,318.10 crores consisting of

Rs.1,47,195 crores for mitigating housing shortage at the beginning of 11th Plan and

55

Rs.2,14,123.10 crores for new additions to be made during the 11th Plan period (this

includes construction of pucca houses & upgradation of semi-pucca and kutcha

housing units). Off late it was realized that access to formal housing finance by the

low-income groups is one of the key factors and policy areas for resolving the housing

problem in India. But much has not been progressed in this regard.

Supply of Housing Finance in India

Access to housing finance is one of the major constraints for low-income groups. It is

partly because of abysmally low exposure of many leading housing finance companies

(HFCs) to pro-poor housing finance and largely due to their inaccurately assess the

credit risk associated with low income borrowers. High transactions cost to lend low

income group, low profit margins, lack of clear land titles, uncertainty of repossession

etc. are the other major factors prohibit many housing financing institutions to step

into low segment housing finance business. On the other hand, there is hardly any

incentive for them doing this. However, low repaying capacity and low margin in case

of low segment housing credit market may not be true in all contexts. In the words of

the Prof Muhammad Yunus “Its not people that are not credit-worthy, it is banks that

are not people-worthy’’.

Considering the importance of housing, particularly in the period when level of

income is rising across social groups, the actual housing credit demand is

underestimated to avoid credit risks and high transaction costs in low segment housing

56

finance markets. In spite of notable contribution of housing sector in the economy2

low segment housing finance has not been given due importance in India. Housing,

besides being a very basic requirement, holds the key to accelerate the pace of

development. Investments in housing like any other industry have a multiplier effect

on income and employment. It is estimated that overall employment generation in the

economy on account of additional investment in the construction/housing sectors is

eight times the direct employment (IIM Ahmedabad : 2000).

Till the emergence of National Housing Bank in 1988, about 80 percent of housing

finance was supplied from informal sources (RBI, 2009). Due to stringent housing

loan terms and procedures followed by housing finance institutions only about 10% of

their consumer housing portfolio is directed towards the lower middle and low income

groups. Many HFCs rather follow a safe route by lending in bulk to organizations

(MFIs, Cooperatives, RRBs, NGOs) serving the housing finance of the poor and low

income groups. Banks insist on clear land title, irregular income of the borrowers and

their servicing capacity, quality of construction, repayment conditions and beneficiary

identification processes that hardly fulfill by poor and low income groups. This has

resulted in very low penetration of traditional mortgage finance market, particularly in

low income housing. In India, the mortgage to GDP ratio is estimated at 2% against

51% in USA and between 15-20% in South East Asian countries. So, supply of formal

2

57

housing finance to poor and low income groups is limited and selective that helped in

accentuating access to housing finance in lower segment.

Under this situation, housing problems of many poor and low income households

could be vicious and multidimensional in nature. As their demand for housing remains

high with limited or no financing options, they may likely to explore other available

financing options, which range from moneylenders to relatives. Many a times these

options may not work in favour of such borrowers but they cannot ignore expenditure

on housing. Under this condition, promotion and development of microfinance for

housing (MFH) could be an important alternative for poor and low-income groups for

financing their housing expenditure and investment.

Though pro-poor public housing policy has been reemphasized as part of development

policy and programme at national and sub-national level, it is still confined to supply

driven subsidized housing where possibility of exclusion is high. There is lack of

demand driven housing finance policy initiative for the target low income group. In

fact, low segment housing demand and housing finance remained a neglected issue in

development policy discussion and pro-poor financial sector development. Only

recently it became a portfolio of microfinance sector, but much is not know about it.

Microfinance for Housing (MFH): A Pro-Poor Housing Finance

Housing microfinance is one of the recent avenues for low-income households to

access loans for housing. MFH was first strongly entrenched in Latin and Central

58

America, but is now widespread in other regions of Asia and finally taking hold in

India. Unfortunately, microfinance for housing in India is not well discussed and

debated at policy level. Despite of the fact that microcredit sector in the country is

growing faster, the potential role of microfinance for housing has not been recognized.

There has not been much effort to study the potential size of low segment housing

finance markets in India. Interestingly, microfinance for housing already developed in

other countries, getting popularized in India. But much is not known about it. The

present study attempts to analyze current situation of microfinance for housing in

India with focus on select locations and functioning of different housing microfinance

programme.

Housing microfinance has emerged in recent years as a discrete area of practice that

intersects housing finance and microfinance. It is perceived as filling a large void due

to the limitations of traditional mortgage finance and building on the lessons of

microenterprise finance. However, it offers affordable finance for the poor in ways

that were not possible even a decade ago. It has brought together a variety of

stakeholders ─ government housing agencies, financial institutions, microfinance

institutions, credit cooperatives, NGOs, and even private developers. However,

despite the housing microfinance phenomenon of recent years, much still needs to be

done in order to respond to the massive demand for pro-poor housing around the

world due to rapid urbanization.

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However, there are other issues relating housing finance in rural areas for low-income

groups. In rural areas, housing for the poor and the low-income groups suffer from

fulfilling the usual conditions of mortgages. They lack access to sustainable materials

and linkages with existing infrastructure. Rural housing structures mostly composed

of mud, thatch, stones and other low-cost, readily available materials. The money and

time it takes to repair these structures often leads to debt or lost man days of

employment. The housing problem in rural villages is further exacerbated by the

unsteady income of the villagers, who are often wage labourer or marginal farmers.

Approaches of MFH

Basically there are two types of approach of housing microfinance programs exist in

developing countries. One is microcredit to housing finance (MCHF) programs and

other is shelter advocacy to housing finance (SAHF). Shelter advocacy to housing

finance (SAHF) programs is an approach defending the right of the poor to equitable

access to resources, particularly land and shelter, as well as adequate infrastructure

and services. Most of SAHF initiatives operate on a small scale within limited local

boundaries, although some have begun to scale up and have joined regional or

national federations of community-based organizations to gain political visibility in

lobbying government to redistribute services or effect policy changes (HUGSD,

2000).

The micro-credit to housing finance (MCHF) programs initially began as micro-credit

initiatives for small and micro-enterprises. Off late, microfinance institutions observed

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that their clients borrow for income generation purposes channel the funds into

housing improvements. It drew their attention to expand lending portfolio and to offer

housing finance products. The strong connection between the home as both shelter

and a place to house or support income-generating activities made this a logical

evolution and eased the transition to new financial products, structures, and loan terms

(HUGSD, 2000).

Definition of Microfinance for Housing (MFH)

Microfinance for housing (MFH) is a subset of microfinance, designed to meet the

housing needs of the poor, especially those without access to the banking sector or

formal mortgage loans. MFH is designed for low-income households who wish to

expand or improve their dwellings, or to build a home in incremental steps, relying on

sequential small loans. It is basically a non-subsidized, sustainable approach tailored

to the needs of the low-income market. Such products are developed over the years to

finance for the housing needs of micro and small entrepreneurs. Housing microfinance

is believed to progressively upgrade poor families' homes – which include improving

existing rooms, adding a room, or installing water or electricity. However, MFH

differs from formal mortgage lending in four basic ways:

MFH loans are smaller and shorter term than conventional mortgage loans,

Because of its smaller size, MFH loans are not used to purchase a house or bigger

expenditure on housing. It is mostly meant for house improvements, incremental

building, or development of a starter dwelling in sites and services initiatives;

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MFH loans are usually not collateralized by the property, which is, of course, a

defining characteristic of formal mortgage loans; and Mostly banks and HFCs are the

primary source of mortgage lending, MFH is offered by banks, MFIs, NGOs, co-

operatives and NBFIs.

In general housing and micro enterprise loans may sometimes be indistinguishable:

first, many micro businesses are conducted in whole or in part from the home, and

secondly, many micro lenders have learned that some portion of their enterprise loans

are being used for housing.

Who Offers MFH

MFH is offered by variety of institutions including MFIs, banks, NBFIs, cooperatives,

credit unions, and NGOs. A major distinction can be made between financial

institutions offering micro enterprise loans (MFIs, banks and NBFIs), and institutions

whose main purpose is improving the shelter situation of the poor, which may or may

not be financial institutions. In this regard, past experience, advantage of like fund

availability, customer information and policy incentives etc. matter for housing

microfinance programme. In the present study we have considered two different

supply channels of MFH – commercial banks and MFIs who deal in microfinance for

housing. While commercial banks have an advantage of using their own fund and

experience in housing finance, selecting customers, executing MFH and recovery of

loan are positive. For instance, based on its experience some banks like HDFC Bank

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in India have promoted organization involved in microfinance for housing3. Similarly,

Grameen Bank in Bangladesh, recognized customer demand for MFH some years ago,

and began offering housing loans as “rewards” for successful completion of micro

enterprise loans. However, some MFIs may be unwilling to provide MFH at the

expense of their traditional micro-enterprise lending.

Microfinance for Housing & MFIs

As microfinance sector is becoming competitive with faster growth and wider

outreach the requirement of its clients is also becoming diverse and specific. Under

this situation some MFIs may respond to their clients demand and expand product

offerings beyond enterprise lending, particularly, in housing sector. It may be in the

interest of the MFIs to diversify their portfolios and remain competitive. On the other

hand, diversification of portfolio of MFIs into new areas such as MFH may help them

to achieve better, sustained financial performance.

MFH is often treated as invisible part of micro enterprise finance as use of micro

enterprise loans for housing purposes hardly recognized. Though MFH is different

from micro-enterprise loan, previous success with micro-enterprise loans commonly

used to underwrite MFH loans. As all MFH borrowers may not be entrepreneurs, and

all MFH loans are not offered by micro lenders (MFIs), underwriting generally

includes a variety of approaches to reducing credit risk. Lenders may rely on

3

63

mandatory savings over a specified period, membership in savings groups, and/or co-

signers. For MFH loans collateral may include property and other assets and land title.

MFH may expand or improve the households dwelling for the purpose of conducting

its business, or selling or storing the goods being produced. It indicates role of MFIs

could be instrumental in achieving better outreach and efficacy of microfinance for

housing than other credit lending institutions dealing with only housing microfinance.

The present study would like to discuss on the potential role of MFIs and other local

institutions in expanding MFH and its likely impact in select study areas. The study

would attempt to analyze possibility of MFIs and other local institutions to diversify

their portfolio into housing finanace. This may be important, especially for MFIs, as

in many cases they have grown “horizontally,” by offering the same inflexible

products to new customers.

As regard to demand for MFH, household as a decision making unit, demand for

credit to invest in housing basically on following grounds and seek finance for it, in

spite of the fact that investment on housing assets do not generate direct income

Provision of living space for the family members and livestock Improving safety,

health and sanitary conditions such as bathrooms, toilet, strengthening wall, roof and

entrance Investing on housing as valuable assets Equating or upgrading social and

economic identity or statusInvestment for home based income generation activities.

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However, the household decision for MFH and housing activity would depend on a

variety of factors, including occupation and income, current housing condition, land

title, and access to credit sources, saving etc. Given some supply-side constraints such

as lack of appropriate loan products, inadequate legal framework and high transaction

cost etc. many poor households may unable to realize their housing goals. In some

cases, poor households do not have choice but to build their own housing and to

finance it from own savings, informal borrowings, remittances which are not only

slow process but sometimes tend to be expensive. With this background, the present

study would analyze how MFH, as a way out of pro-poor housing problem

particularly those who are excluded from formal housing finance.

On supply side there may be some challenges to MFH programme. Credit lending

institutions dealing with MFH often face difficulty in fund raising, inexperienced

staff, credit risk associated with low income borrowers, lower profit margins, lack of

land titles etc. Some of the important issues and challenges for the housing

microfinance market discussed in the literature are

complexity of the low segment housing market versus the conservative (risk averse)

approach of financial institutions,differences between MFH and the traditional

microfinance, organizational and operational structure for launch, and scale of MFH

products prominence of progressive housing among low income groups competition

from other credit lending institutionsReview of LiteratureMicrofinance institutions

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have long observed that clients use part of micro-enterprise loan for improvement of

their living conditions (Bruce Ferguson & Heider, E. 2000). Their clients borrow for

income generation purposes, yet channel the funds, partially or fully, into housing

improvements. Micro-enterprise loan offers much better repayment terms than

informal sources of money lending, and such a loan can serve as a supplement or

alternative to saving towards housing improvements. Drawing on their experience that

microfinance has potential beyond income-generating uses (enterprise) and can apply

to personal asset building activities such as investments in housing. Believing that

economically active poor people can finance their habitat needs in a manner that is

incremental and affordable, some MFIs have broadened their lending portfolio to offer

housing finance product for new housing construction and other house improvement

activities. Recent studies show that the scale of demand for housing improvement is

substantial (Herbert & Pickering, 1997; Harvard Joint Center, 2000) across world.

Contrary to general belief, low income households are willing to spend a high

percentage of their incomes to improve and expand their houses (World Bank &

Capital Advisors, 1998).

In 1997, the World Bank and Capital Advisors conducted a study on the willingness

and ability of low income households to pay for housing improvement loans in three

cities located at the border with the United States (Ciudad Juarez, Tijuana, and

Matamoros). The study concluded that out of total low income households who were

in need of housing credit for their home improvements and willing to take out loans

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only 14% qualified for it. It implies that there is huge market potential for housing

improvement loans but many households may not not qualify for such loans under

given conditions.

However, conventional mortgage markets do not cater to the low income groups

because larger part of their income they spend on immediate consumption. Mortgages

require regular payments on longer period of time. Low -income households are often

self-employed and their incomes vary greatly and they occasionally face crises - such

as sickness and injury - that absorb all their available resources. Mortgages typically

require that households hold full legal title to their property. Low and moderate

income households often acquire lots in informal subdivisions and then construct

temporary dwellings to vouchsafe the properties (Ferguson & Heider, 2000).

Major characteristics of micro-finance for housing are small loan size for incremental

upgrading of an existing dwelling or new house, short repayment period, small or no

subsidy, creative underwriting adapted to the conditions and prospects faced by

low/moderate-income, technical assistance in documentation and building, and -

sometimes - alternate forms of title as collateral. House construction can take longer

time, in some cases decades, depending on the arrangement of fund, availability of

housing material and others factors. It can have adverse impact at household level as

well as macro level developmental stimulus that housing sector usually provides.

Earlier studies show that typically, low –income households construct their own units

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over longer period of five to 15 years (Turner, John and R. Fichter, 1972). They

usually, start with the acquisition of land, build a small and temporary dwelling to

live. Gradually add space and increasing quality. When the lot is small, households

usually try outward expansion, complete flooring and finishing, adding space for

sanitation and other uses, getting legal connections to electricity and water supply. In

this context, micro-finance for housing programme may suit to the incremental

upgrading housing process. Loans are small, incremental and, hence, affordable to

low-income households.

As complete house is built step by step over time, progressive build is the way most

poor and self-employed people acquire homes, largely because it makes the process

affordable. So MFH is believed to motivate many poor and low income groups to

build their house over time, particularly when housing finance is inadequate or it is

difficult to arrange at one time.

As regard to type of housing activities, MFH caters to low-income people for variety

of activities including new constructions; repairs, improvements or upgradation of

existing structures; purchase of land; and investment in infrastructure. In the absence

of adequate formal housing finance available to the poor, most of their housing

activity long been a progressive endeavor. Poor households have to confront with

several problems like arranging for land, fund building material and other loan

68

servicing which often force them to construct their homes incrementally, over a period

of years or even decades (Martin Carlos, 2008).

Regarding rural urban housing requirement its nature may vary from region to region

and group to group depending on land and building materials costs, structure of house

distance from workplace etc. So MFH can have different impact on rural and urban

clientele. Rural housing is qualitatively different from urban housing in the sense that

the housing activity is not very much based on the cash economy but depends to a

considerable extent on land rights and access to resources.

But in urban areas the complex land and housing market dynamics, particularly the

political and legal ramifications of land tenure, render the task of MFH more

complicated. This could be the reason why many MFH programs operating on a

relatively small scale in and operated in rural areas. However, in India SEWA’s

Parivartan slum upgrading scheme strives to build on their institutional status to

address the land, housing, and infrastructure problems affecting their client base.

Quantum and tenure of housing loan is important for low-income groups and

households having irregular income who develop a tendency to build house over time

referred as ‘progressive housing’ or ‘progressive build,’. It implies that poor

households build gradually and incrementally, a few rooms at a time (Ferguson,

2003). MFH of small loans of a shorter tenor will suit to the housing credit need of the

target groups. Similarly, performance of MFI in lending housing finance depends in

69

its fund arrangement ability, which remains an important constraint as it required huge

amount of fund for longer period (Young, 2007; Krishnan, Ramji & Taishi, 2007).

Though several credit lending institutions are participating in housing microfinance

market commercial banks have shown little interest. The hesitancy of commercial

banks towards developing MFH offerings calls for understanding why they do so.

They usually have little interest in lending to low-income households, particularly for

small loans which are less profitable. It is plausible that commercial banks are wary of

MFH because of the overall complexity of housing issues and the subsequent

perception of risks at lower segment of the market. They may prefer to extend

“conventional” well-tested micro-enterprise loans rather developing MFH products. It

would be interesting to find about commercial bank's participation in MFH market in

our study.

One of the most widely debated topics regarding pro-poor housing is its subsidy

component. Housing subsidies not only prompt distortions in the market but can have

detrimental effects in terms of relocation, displacement, increased cost of living of the

beneficiaries, thereby defeating the original intent of those subsidies (Martin Carlos

2008). A serious problem with national housing subsidies in some countries is the

presence of administrative barriers or difficult requirements that prevent low-income

households from accessing the funds. For instance, the South African program

requires low-income households to build the house in order to receive the housing

subsidy; disbursement of the subsidy takes place upon certifying occupancy of the

70

dwelling. Needless to say, the majority of poor households lack sufficient funds to

build the house. In Chile, a down payment that is beyond the means of most low-

income households is required in order to participate in the national housing program.

In Indian context, pro-poor housing subsidy has been a complex matter like other

subsidies such as input subsidies in agriculture where exclusion of target groups

continues. Housing subsidy extended through different schemes constitute only a part

of the total unit cost demanded by the beneficiary and it often makes the housing

scheme financially unviable. Nair (1999) has pointed out that the unfortunate part of

Indian housing scenario is the financial imprudence of the political leaderships in the

country. She argues that the real gainers of the budgetary sops offered by the

government are the urban middle class, middle-income housing projects and housing

finance institutions; not the poor who really need housing finance.

While comparing between rural versus urban programmes the research of Buckley et

al. (2005) shows that rural subsidies are six times higher than urban subsidies, even

though the ratio between rural and urban poor is three to one. Thus, on per capita

basis, the rural poor get twice as much funding as the urban poor which often difficult

to find on ground.

Based on above discussion and available literature we have listed out some important

issues relating to microfinance for housing and existing research gap.

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Major Issues of Microfinance for Housing & Research Gap There is huge gap

between housing units and housing finance for lower segment. It predominates over

other key issues relating to pro-poor housing such as availability, access and supply of

housing finance, nature & pattern of demand for housing and other issues Low cost

and affordable housing often prescribed to address problems of housing without much

focus on the ground reality such as needs of the occupants (space for livestock, store

and activities), house building and designing (economical - within the reach of the

beneficiary), durable & safe (recurring expenses on repair and replacement of low

cost house), adjustable to technology (solar energy etc).

There is need for alternative housing finance models like microfinance for housing as

because of failure of formal housing finance system to meet the needs of poor and low

income group. Identification of institutions and housing loan products to meet local

needs is missing in the policy debates on pro-poor housing.

Investment in housing could be effective way out of the poverty for many poor and

low income households. Leakages and exclusion from public support and programmes

may be reduced if the beneficiary has a durable permanent house.

Many poor could not afford to build durable house and hence go for temporary non-

durable housing arrangements which may put more burden on the poor in terms of

expensive maintenance of houses (regular replacement of thatched roof, repairing of

walls etc.).

Product design of MFH may be a gray area as borrowers invariably desire long-term

and high value loans irrespective of their capacity to repay.

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There is a link between housing and income generating activity of the poor and low

income households.

Objectives of Study:

The objective of this study is to illustrate the nature and pattern of microfinance for

housing in India and the challenges and potential of low segment housing finance

market. The findings of the study are likely to benefit financial institutions and

organization those who are already in the industry or those who are interested in

diversifying into the housing microfinance field. The study focuses on the Indian

context, where the demand for housing improvement loans is believed to be very large

and government housing programs have proven inadequate and ineffective.

There are few studies available on the topic in India context . Realizing the visible gap

in research and understanding on microfinance for housing in India, the present study

is an attempt in the regard. The specific objectives of the study are as follows.

To understand and discus the overall demand and priority of housing and current

housing finance arrangement among low-income groups.

To assess different practices of housing microfinance and the potential market for

MFH.

To examine the non-MFH credit borrowing pattern and its utilization pattern among

low-income households vis-à-vis their nature and type of housing activities.

To analyze performance of different MFH programme, it impacts, challenges and

designing of MFH products. To explore possible institutional partnership between

73

MFI and other institutions and how up-scaling of housing microfinance will benefit all

stakeholders. Hypothesis:

Based on above analysis we formulate following hypothesis to verify from primary

household level data in select study areas.

There is huge unmet demand for housing credit at lower segment

MFH and MFE (microfinance for enterprise) inter-linkages could be a solid base for

MFH expansion. Microenterprise loan impacts borrower’s income where as

microcredit for housing impacts borrower’s assets base and may impact income.

Rate of repayment is low in case of microfinance for housing loan than general

microcredit. Repayment capacity of the borrowers is based on generation of future

income in case of microenterprise loan but incase of housing loan it is borrower’s

existing surplus and future cash flow that determine repayment of housing loan.

Progressive housing or incremental housing over time is common among low income

groups due to lack of access to adequate housing credit.

There is lack of innovative product design in housing microfinance programme. There

is lack of awareness and adoption of low cost housing technology.

Methodology

The study follows following methodologies to arrive at proposed objectives and

findings.

Analysis of secondary data and information: Available secondary data on

microfinance for housing from published reports, documents and other literatures

were collected and analyzed in in Indian context.

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Pilot visit and consultation with different housing finance institutions (HFC, Banks,

MFI, NBFC, NGO), apex housing organization (HUDCO, NHB), low cost housing

consultancy agency (Micro Home Solution) and local experts and other key

informants. Primary field survey: With help of structured questionnaire, specially

designed for the study, household surveys were conducted in different sample villages

in two districts each in Kerala and Karnataka (mainly to cover MFH clients)

Interviews with senior executives and other staffs of selected housing microfinance

lending institutions and their supporting institutions.

Focus group discussion in some sample villages and collection of information from

some key informants in study areas.

Major Variables and Contexts:

Out of few known housing microfinance programmes in India, we selected two

different models based on its evolution, operation, product design and other aspects

that match to the spirit of the study. Out of these two, one programme was initiated by

the state govt. with support from commercial banks and the other was MFI supplied.

However, selection of the study areas was made after a series of discussion with the

stakeholders and local experts and performance of the MFH programme. Selection of

districts and Taluks was based on the intensity of the programme as most of the

districts were having similar pattern of MFH activities. Selection of sample

households was made on representative random sampling to capture different aspect

of the MFH programme in different contexts.

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Keeping in mind the limited housing microfinance products/schemes we selected the

study areas and the clients of some known organizations dealing with MFH for

sometime, for detail study. However, effort was made to explore other housing

microfinance programme such as Gujarat Mahila Housing SEWA Trust and Indian

Association of Savings and Credit (IASC) but not considered for detail study due to

its features and scope and other factors related to the present study. Detail household

information about demographic feature, house type and characteristics, house use

pattern, pre-MFH housing priorities/plans, current expenditure on housing, housing

loan terms and conditions, post-MFH changes in housing expenditure, non-MFH

borrowing pattern and condition, status of housing activities, housing credit use,

constraints, participation in group microcredit programme and other social-economic

households features were collected with help of uniform interview schedule. In

Bhavansree programme in Kerala sample households were selected from client of

three banks i.e. SBI, SBT and ICICI Bank. In Karnataka most of our sample

households were microcredit clients of different SHG groups formed by MYRADA,

and now being served by SFRS (Sanghmithra Rural Financial Servises).

Random selection of households was done at village (Karnataka) and CDS (Kerala)

level based on type of households and type of housing activity. However, prior

information about the group and housing activity was collected from the concern bank

branch mangers or credit officers and analyzed it prior to visit to the sample

villages/CDSs

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Microfinance – ‘the new Mantra in Rural Finance’

The rural finance policy pursued in most developing countries beginning from 1950s

was based on providing subsidized credit through state controlled or directed

institutions to rural segments of population. Expansion of credit coverage through

state interventions was based on various theoretical assumptions. Seibel & Parhusip

(1990)2 mention that this approach was based on the premise that rural micro-

entrepreneurs are unable to organize themselves, they need subsidized credit for

increasing their income and are too poor to save. Yaron, Benjamin & Piprek (1997)3

have traced this traditional approach in rural finance leaning heavily towards direct

interventions to Keynesian influence. Under this approach, in addition to the

assumptions listed above, the key problem areas visualized in rural financial markets

included a lack of credit in rural areas, absence of modern technology in agriculture,

low savings capacity in rural areas and prevalence of usurious moneylenders.

These distortions and imperfections in rural credit markets were sought to be

addressed through Government interventions. With difference of range and degree,

most developing countries from 1950s to the 1980s were home to interventions

ranging from establishing state owned financial institutions, interest rate ceiling on

deposits and credit, credit subsidy, directing credit to particular sectors and

nationalization of private banks.

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This ‘supply led’ approach in rural finance caused various qualitative issues such as

concerns about financial viability of institutions on account of high rate of loan

delinquency, cornering of subsidy by well off people in what has been described as

‘rent seeking’ behaviour, continued presence of moneylenders, inability to reach the

core poor and led to a reorientation in thinking around 1980s. United State’s Agency

for International Development’s (USAID) spring review of Small Farmer Credit in

1972/73, covering 60 reports on specific farm credit programmes in developing

countries followed by a World Conference on Credit for Farmers in Developing

Countries in 1975 organised by FAO were the first landmark events pointing the

deficiencies of directed and subsidized credit approach. These thoughts got

crystallised during the ‘Colloquium on Rural Finance in Low Income Countries’ by

USAID and World Bank in 1981 and shaped the emergence of new thinking in rural

finance. Hulme & Mosley (1996)4 credit the counter revolution against Development

Financial Institutions (DFIs) which were a prime symbol of Government intervention

in rural credit markets to ‘Ohio school’ as the economists5 at Ohio State University

provided the theoretical underpinnings to the critique of past approach and contributed

to transfer of these ideas into operational policies of World Bank.

Emergence of micro credit7 in late 1970s and early 1980s in the backdrop of growing

world attention on deficiencies of earlier approach in rural finance explains much of

its dominant theoretical underpinnings. The initial micro credit innovations in

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disparate settings of Bangladesh, Bolivia and Indonesia8 demonstrated the success of

micro lending to poor without collateral requirements. Rhyne (2001)9 observes that

these interventions demonstrated techniques for lending to the poor with better

outreach and cost recovery. Despite the contextual differences, the unifying thread of

these early innovations lay in their certain common principles like reliance on

character or peer pressure rather than collateral as loan security, leveraging social

capital, positive incentives for repayment and interest rates that approached or covered

cost. These innovations acted as catalysts for replication across the globe and their

underlying principles continue to form the bedrock of microfinance interventions till

date.

The universal appeal of microfinance stemmed from its ability to reach the poor

without social collateral and generation of near full recovery rates through what has

been described as a Win-Win proposition. The mainstreaming of microfinance

worldwide and its global acceptance in development community is based on this Win-

Win proposition. This concept of provision of sustainable financial services at market

rates has been termed as ‘Financial System’ approach or ‘Commercial microfinance’.

The progress report submitted by Micro credit summit campaign10 indicates that as of

Dec.31, 2004, 3,164 microcredit institutions have reached 92.27 million clients

translating into microcredit interventions having reached 333 million poor families

worldwide. The obsession with microfinance in development sector is succinctly

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captured by Remenyi (2000, p30)11, “every bilateral donor and NGO seems to

believe that it too must be involved in microfinance if it is to retain credibility as a

development agency with an option for the poor”.

Global Acceptance of Microfinance

It is claimed that this new paradigm of unsecured small scale financial service

provision helps poor people take advantage of economic opportunities, expand their

income, smoothen their consumption requirement, reduce vulnerability and also

empowers them.

Former World Bank President James Wolfensohn said “Microfinance fits squarely

into the Bank's overall strategy. As you know, the Bank's mission is to reduce poverty

and improve living standards by promoting sustainable growth and investment in

people through loans, technical assistance, and policy guidance. Microfinance

contributes directly to this objective”14. The emphasis on microfinance is reflected in

microfinance being a key feature in Poverty Reduction Strategy Paper.

Realising the importance of microfinance, World Bank has also taken major steps in

developing the sector. Formation of Consultative Group to Assist the Poor (CGAP) in

1995 as a consortium of 33 Public and private development agencies and

establishment of Microfinance Management Institute (MAFMI) in 2003 are

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significant landmarks. CGAP acts as a “resource center for the entire microfinance

industry, where it incubates and supports new ideas, innovative products, cutting-edge

technology, novel mechanisms for delivering financial services, and concrete

solutions to the challenges of expanding microfinance”.

MAFMI was established with support of CGAP and Open Society Institute for

meeting the technical and managerial skills required for microfinance sector.

CGAP has been instrumental in shaping the dominant theoretical orientation of

microfinance. The guiding philosophy behind diverse sphere of CGAP activities by

way of dissemination of microfinance best practice, grant-making to Micro Finance

Institutions, and fostering national-level policy on microfinance has been

‘Commercial microfinance’. The CGAP dossier on ‘Best Practices’ and brochure on

‘Key principles of microfinance’ succinctly capture the philosophy of insistence on

full cost recovery through market based interest rates and higher recovery rate of

micro loans. The influence of CGAP philosophy has also shaped World Bank’s

thinking on microfinance. Current World Bank President in his message to CGAP

annual meeting in 2005 acknowledged this by saying “CGAP has helped build

consensus around the fundamentals of an inclusive financial system. The CGAP Key

Principles of Microfinance, endorsed last year by the G8, have this year been

championed by Worldwide, as a result of the CGAP system, good practice is

increasingly becoming standard practice”.

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Other Regional multilateral development banks like Asian Development Bank also

champion the cause of commercial microfinance. ADB 17outlining its policy for

microfinance lends support to the logic by saying “to the poor, access to service is

more important than the cost of services” and “the key to sustainable results seems to

be the adoption of a financial-system development approach”.

The underlying logic offered in support of this is universally based on twin arguments

i.e., a) subsidized funds are limited and cannot meet the vast unmet demand, hence

private capital must flow to the sector and b) the ability of the poor to afford market

rates. Though, various scholars like Morduch have brought out the flaws of this Win-

Win proposition like belief in congruence between commercial microfinance and

poverty outreach, this paper will limit itself to analyzing as to how the focus on

commercialization has relegated impact assessment to backstage.

Microfinance & MDG

The current literature on microfinance is also dominated by the positive linkages

between microfinance and achievement of Millennium Development Goals (MDGs).

Microcredit Summit Campaign’s 2005 report argues that the campaign offers much

needed hope for achieving the Millennium Development Goals, especially relating to

poverty reduction. CGAP (ibid) lends support to this by saying that the growing body

of evidence suggests microfinance to be a critical contextual factor in achievement of

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MDGs. ADB (ibid) in its theme chapter on microfinance also cites access to financial

services as critical for eliminating poverty and reaching MDGs. IFAD along with

Food and Agriculture Organisation (FAO) and the World Food Programme (WFP)

declared that it will be possible to achieve the eight Millennium Development Goals

(MDGs) by the established deadline of 2015 “if the developing and industrialised

countries take action immediately” by implementing plans and projects, in which

microcredit could play a major role.

Indian Microfinance Context

Indian public policy for rural finance from 1950s to till date mirrors the patterns

observed worldwide. Increasing access to credit for the poor has always remained at

the core of Indian planning in fight against poverty. The assumption behind expanding

outreach of financial services, mainly credit was that the welfare costs of exclusion

from the banking sector, especially for rural poor are very high. Starting late 1960s,

India was home to one of largest state intervention in rural credit market and has been

euphemistically referred to as ‘Social banking’ phase. It saw nationalisation of

existing private commercial banks, massive expansion of branch network in rural

areas, mandatory directed credit to priority sectors of the economy, subsidised rates of

interest and creation of a new set of rural banks at district level and an Apex bank for

Agriculture and Rural Development (NABARD20) at national level. These measures

resulted in impressive gains in rural outreach and volume of credit. As a result,

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between 1961 and 2000 the average population per bank branch fell tenfold from

about 140 thousand to 14000 (Burgess & Pande, 200521) and the share of institutional

agencies in rural credit increased from 7.3% 1951 to 66% in 1991.

These impressive gains were not without a cost. Government interventions through

directed credit, state owned Rural Financial Institutions (RFI) and subsidised interest

rates increased the tolerance for loan defaults, loan waivers and lax appraisal and

monitoring of loans. The problem at the start of 1990s looked twofold, the

institutional structure was neither profitable in rural lending nor serving the needs of

the poorest. In short, it had created a structure, ‘quantitatively impressive but

qualitatively weak’.

Microcredit emergence in India has to be seen in this backdrop for a better

appreciation of current paradigm. Successful microfinance interventions across the

world especially in Asia and in parts of India by NGOs provided further impetus. In

this backdrop, NABARD’s search for alternative models of reaching the rural poor

brought the existence of informal groups of poor to the fore. It was realised that the

poor tended to come together in a variety of informal ways for pooling their savings

and dispensing small and unsecured loans at varying costs to group members on the

basis of need. This concept of Self-help was discovered by social-development

NGOs23 in 1980s. Realising that the only constraining factor in unleashing the

potential of these groups was meagreness of their financial resources, NABARD

designed the concept of linking these groups with banks to overcome the financial

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constraint. The programme has come a long way since 1992 passing through stages of

pilot (1992-1995), mainstreaming (1995-1998) and expansion phase (1998 onwards)

and emerged as the world’s biggest microfinance programme in terms of outreach,

covering 1.6 million groups as on March, 200524. It occupies a pre-eminent position

in the sector accounting for nearly 80% market share in India.

Under the programme, popularly known as SHG-Bank Linkage programme there are

broadly three models of credit linkage of SHGs with banks. However, the underlying

design feature in all remains the same i.e. identification, formation and nurturing of

groups either by NGOs/other development agencies or banks, handholding and initial

period of inculcating habit of thrift followed by collateral free credit from bank in

proportion to the group’s savings. In accordance with the flexible approach, the

decision to borrow, internal lending and rate of interest are left at the discretion of

group members. Its design is built on combining the “collective wisdom of the poor,

the organizational capabilities of the social intermediary and the financial strength of

the Banks”.

The success factors of the programme lie in it being beneficial for both banks and

clients – another example of Win-Win proposition. The programme is an attractive

proposition for banks due to high recovery rates and lowering of transaction costs by

outsourcing costs associated with monitoring and appraisal of loans. Records show a

recovery rate as high as 95% for loans extended by banks to SHGs and a study

sponsored by FDC26, Australia, it was observed that the reduction in costs for the

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bankers is around 40 % as compared to earlier loans under Integrated Rural

Development Programme (IRDP). Similar findings in respect of commercial benefit

of SHG lending to banks were reported by Siebel & Dave (2002)27. The programme’s

exclusive focus on reaching those sections of population, who were hitherto out of

reach of financial system has increased the coverage of poor. Non reliance on physical

collateral and total flexibility in loan purpose and amount has also resulted in

increased coverage of the poor and the marginalised.

The programme has received strong public policy support from both Government of

India and Reserve Bank of India. The importance attached to it by Government is

exemplified by mention of yearly targets by Finance Minister in his annual budget

speech as well as introduction of similar group based lending approach in

government’s poverty alleviation programme. The success of the programme in

reaching financial services to the poor has won international admiration. World Bank

policy paper28 hails the programme and states that it is particularly suited to India

because the model capitalises on country’s vast network of rural bank branches that

are otherwise unable to reach the rural poor.

“Financial System’ approach – Shifting of ‘Goalpost’ & its impact

The growth of microfinance in India has also to be seen in the light of financial sector

reforms in India starting from 1991 and the global emphasis on commercialization of

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the sector. The financial sector reforms in India have focused on fostering a market

based financial system by increasing competition and improving the quality of

financial services. The new approach has been deeply influenced by the reorientation

among international rural financial policy makers centering around concepts such as

self-help, self sustained growth and institutional viability. Under the new approach ,

institutional viability is of prime concern and instruments of directed credit and

interest rate directives have been totally diluted or been done away with. As a

consequence, banks are increasingly shying away from rural lending as well as

rationalizing their branch network in rural areas. Burgess & Pande (ibid) have brought

out this fact in their study by stating that while between 1977 and 1990 (pre reform

period) more bank branches were opened in financially less developed states, the

pattern was reversed in post reform period. Thus while, the access of the rural poor to

credit through traditional bank lending has reduced in post reform period, the policy

recommendation is to fill this gap through microfinance.

Flowing out of negative experiences of the earlier state intervention, institutional

viability has become the focal point for evaluation of success of credit interventions.

The philosophy and design of SHG-Bank linkage programme reflects this new

concern vividly by emphasising on full cost recovery in order to become an attractive

proposition for banks. Siebel & Dave in their study on commercial aspects of SHG

programme succinctly state the new paradigm with focus on institutional

sustainability by saying that as against the long standing tradition of government

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owned banks undermining rural finance with cheap credit “NABARD belongs to the

new world of rural finance: it is profit making; and it actively promotes the viability of

rural banks under its supervision”. The design features of the programme emphasise

that it does not envisage any subsidy upport from the government in the matter of

credit and charges market related interest rates based on the premise that sub-market

interest rates could spell doom; distort the use and direction of credit (Kropp & Suran,

200229). High recovery rates under the programme are used to justify the dictum that

‘poor need timely and adequate credit rather than cheap credit’.

With this shift to parameters of institutional success, the issue of impact assessment

has been relegated to the background. Impact assessment is either left for inference

through proxy measures like volume of credit, repayment rates and outreach or one-

off sample impact assessment exercises. The field research was undertaken to

understand the clients perspective and analyse the factors behind repayment rates as

well as impact of credit on socio economic well being of clients. The research covered

93 client households from 5 Self Help Groups from three different locations in

Western and Central part of India. While statistically the number may look

insignificant considering the size of the programme, use of participatory methods of

research add to its depth and value. Only groups which have been in the programme

for at least two years were studied as groups of less than 2 years of formation may not

be best suited to capture impact.

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As the size limitations of paper constrain a detailed enumeration of field research

findings, only the key findings of the field research30 having a bearing on the central

aspect of the paper are listed –

-All clients were saving regular amounts of money at monthly/bimonthly

interval building up the group savings - Internal loaning of group funds was very high

resulting in significant waiting time for members interested in borrowing - Social

awareness index of group members as measured on Likert Scale showed a definite

positive trend after joining the group - Reliance on moneylenders for credit eliminated

or decreased in case of approx 2/3rd of clients - No specific benchmarks for group

membership leading to inadequate poverty targeting - Only 6% clients had taken up

any economic activity post group formation - Marginal increase in real term income

level after joining the group - Bank credit to group often a result of banker’s zeal to

achieve targets rather than based on group demand - Bank credit as well as loans used

overwhelmingly for consumption purpose - Group members not willing to borrow to

take up economic activity on account of credit risk and absence of skills - Prompt

Repayment a factor of group pressure and sourced out of reduced consumption, extra

work and borrowing from other sources - High rates of interest in internal lending

among group members (2-3%) was seen by members as prescribed by the group

forming agency and accepted as being better than even higher rates of informal sector.

Further summarizing the findings at the cost of over simplification, it can be said that

while the programme had definite impact on building of social capital, it had marginal

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impact on income levels. At this point it is useful to clarify that positive contribution

on social sphere is by itself a significant achievement, however the problem lies with

extension of positive impact to economic activities. The findings sit uneasily with

earlier evaluations of the programme in respect of economic impact, while being in

consonance with social impact. Puhazhendhi & Satyasai (2000)31 in their study

commissioned by NABARD covered 223 SHGs spread over 11 states across India.

The study found that 58.6% of sample households registered an increase in assets

from pre to post SHG situation, an additional 200 economic activities taken up by

sample households and decrease in the percentage of sample households with annual

income levels of Rs.22500 from 73.9% to 57%. Another study32 commissioned by

NABARD in 2002 with financial assistance from SDC33, GTZ34 and IFAD

35covered 60 SHGs in Eastern India. The findings of this study also corroborate the

findings of earlier evaluation with 23% rise in annual income and 30% increase in

asset ownership among 52% of sample households. World Bank policy research paper

(ibid) 2005 details the findings of Rural Finance Access Survey (RFAS) done by

World Bank in association with NCAER36. The RFAS covered 736 SHGs in the

states of Andhra Pradesh and Uttar Pradesh and also points to positive economic

impact. The findings indicate 72% average increase in real terms in household assets,

shift in borrowing pattern from consumption loans to productive activities and 33%

increase in income levels.

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The divergence of field research findings demands a situational analysis of the field

study findings. The study sites exhibited certain common features, which can be said

to be true of most of Indian rural landscape. The major occupation of group members

was agriculture supplemented by other activities such as farm labour, factory labour

and poultry. Being rain fed areaa, lack of irrigation facilities, declining terms of trade

in agriculture and fragmentation of land have accentuated their vulnerabilities over a

period of time. The group members lacked any specific handicraft skills and had not

received any skills training for undertaking any other non farm activity. In this

scenario, post SHG, the group members have been content with using the group

savings and bank loan as replacement/reduction of costly borrowings from informal

sources. The high rate of internal lending reflected in bank and group records was

used by them for meeting their consumption and emergency requirements. Detailed

interaction revealed that group members do not have the confidence to use credit for

productive purposes in view of lack of opportunities and partly also ingrained through

their past borrowing experience. Irrigation and depressed commodity prices act as

deterrent in farm sector investments, while lack of skills and invasion of rural markets

by big consumer goods companies reduce the scope for rural micro enterprises. It is

striking that while globalization is exerting pressure on national level companies, their

penetration into rural markets is reducing the market sphere for rural enterprises.

In this scenario, it seems rather naïve to visualize flourishing of microenterprises

through provision of microcredit. Dichter (2006)37 in his paper drawing on African

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experience rightly draws attention to both these aspects by pointing to the “infertile

context” of rural settings and says “if the large majority of us in the advanced

economies are not entrepreneurs, and have had in our past little sophisticated contact

with financial services, and if most of us use credit, when we do, for consumption,

why do we make the assumption that in the developing countries, the poor are

budding entrepreneurs….”.

Besides acknowledging the positive social outcomes, the field study findings also

point to smoothing of consumption needs and marked reduction in dependence of

exploitative informal sources of credit. These aspects are in itself a significant welfare

gain, however the paper questions the extension of this to economic development

which is altogether a different domain from short term crisis management.

In the absence of any significant economic development, the findings logically point

to an unmistakable trend of repayments being made out of reduced consumption,

increased working time as farm labour and borrowing from relatives, other groups in

vicinity or moneylenders in extreme cases. In such a scenario, while loan volume,

outreach and repayment may outwardly justify the intervention and make it attractive

for bankers, its impact on economic gains for clients gets missed out. The common

underlying assumption behind reliance on such parameters is belief in the linear cycle

of credit, starting from credit offtake followed by economic activities, rise in

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income/assets and repayment out of additional income. The figure below illustrates

this :

Reliance on credit off take and recovery as a proxy for positive economic

development ignores the critical issue of ‘impact assessment’ at client level. This

aspect of microfinance has received increasing attention. Dichter (ibid) feels that the

use of proxies like repayment rate to justify impact is not tenable as it does not

MF Service Client Repayment

Monitoring

Favorable indicator of both ends of credit cycle imply +ve impact

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examine the source of repayment. Money being fungible, repayment needs to be

traced to income from business activity to justify it as criteria. Deubel (2006)38 citing

(Buckley, 199739) states that loan repayment rate as an indicator may show

participant’s ability to repay but does not take into account the impact of loan on

enterprise. Weiss & Montgomery (2004)40 observe that high recovery rates may be

due to intense group pressure and do not reflect capacity to repay.

The focus on financial sustainability has meant that much of the evaluation criteria for

microfinance interventions is based on institutional performance. Weber (2006)41

says that while the virtuous impact of microfinance is used to justify its expansion,

much of this assessment is based on institutional success and avoidance of engaging

with impacts. Very significantly he points out this focus by observing “Thus, as long

as institutional sustainability obtains, it has been fairly common practice among the

policy makers-and their commissioned researchers-to interpret financial viability as

indicative of the social, political and economic success of microfinance programmes”

(ibid, p 53). He also argues that such an approach constitutes the ideology and practice

of neoliberalism as it is based on the ontological premise that competitive financial

institutions provide the foundation for entrepreneurial success and are best suited to

reduce poverty.

Simanowitz & Walter (2002, p3)42 correctly observe that “Microfinance is a

compromise between social and financial objectives. To date most emphasis has been

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on financial and institutional performance”. In order to bring the social aspect back

into microfinance, Imp-Act43 based on three years of action research covering 30

organisations in 20 countries has been advocating mainstreaming of Social

Performance Management (SPM) to improve the effectiveness of microfinance in

reducing financial exclusion and poverty.

While microfinance may be a winning proposition for banks, the winning evidence on

client’s side seems doubtful. The institutional approach flowing out of past negative

experiences has shifted the goalpost to financial solvency but in the process missed

the vital link of credit usage.

In this scenario, it can be said with certainty that potential of microfinance to

contribute to achievement of MDGs in India, especially reduction of poverty remains

suspect. Greeley (2005)44 rightly notes that in absence of specific poverty targeting

and mainstreaming of impact assessment, the claims about the impact of microfinance

on the achievement of MDG lacks credibility.

Road Ahead

Indian rural finance sector is at crossroads today. Following the financial sector

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reforms with its emphasis on profitability as the key performance benchmark,

banks are increasingly shying away from rural lending as well as rationalizing

their branch network in rural areas. Burgess & Pande (ibid) have brought out

this fact in their study by stating that while between 1977 and 1990 (pre reform

period) more bank branches were opened in financially less developed areas,

the pattern was reversed in post reform period. Thus while, access of credit to

the rural poor has reduced in post reform period, the policy recommendation is

to fill this gap through micro credit. The SHG-Bank linkage programme has

witnessed phenomenal growth and the current strategy is to focus on 13

underdeveloped states as also graduate the existing SHGs to the next stage of

micro enterprises.

At this stage, the paper argues that if SHG-Bank linkage programme has to

contribute to poverty reduction, there is an imperative need for integrating

impact assessment as a necessary design feature of the programme. The

significance of bringing the focus back to ‘people’ from ‘institutions’ and

adoption of localized people centric approach can hardly be overemphasized. In

line with the tenets of commercial microfinance, it is critical that scarce public

resources are used judiciously and with better targeting.

Adequate emphasis on impact assessment is an integral part of the triangle45 of

factors necessary for judging microfinance intervention.

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Impact

Financial sustainability Outreach to the poor

Critical Triangle

Institutional innovations

97

Mainstreaming of impact assessment in the SHG-Bank linkage programme will

call for extra efforts and resources as also create conflict with the present focus

on numerical growth. Realisation of a substantial trade off between sustainable

economic impact and exponential growth, calls for courageous public policy

decisions. World Bank policy research working paper (ibid) also points that

ensuring preoccupation with achievement of numeric targets does not override

attention to group quality will be a key future concern for SHG-Bank linkage

programme.

Though, the paper is focused on pointing the missing link of impact in the current

paradigm of rural finance focusing mainly on institutional viability, other critical

issues having a bearing on impact also merit attention. The SHG-Bank linkage

programme at present has no explicit social or economic benchmarks for inclusion of

members into groups to be credit linked in line with the flexible approach of the

programme. However, as seen above the extension of credit in infertile local context

has negligible chances of leading to productive investment. Similarly inclusion of core

poor in the programme, who had little experience of economic activities, also limits

productive use of capital. Segmentation of credit demand based on economic and

social status is key to optimum utilization of scarce resources. Robinson (2001)46 is

probably right in observing that commercial microfinance is not meant for core poor

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or destitutes but is rather aimed at economically active poor. She opines that providing

credit to people who are too poor to use it effectively helps neither the borrower nor

the lender and would only lead to increasing of debt burden and erosion of self

confidence and suggests that this segment should not be the target market for financial

sector but of state poverty and welfare programmes. In addition to this, irrespective of

socio economic status, credit can be put to little productive use in resource deficient

and isolated areas. In such areas, credit flow has to follow public investments in

infrastructure and provision of forward and backward linkages for economic activities.

Homogenization of service delivery without fully taking into account situational

context and client needs will continue to have limited impact.

Supply of Micro-Finance Services

RBI data shows that informal sources provide a significant part of the total credit

needs of the rural population. The magnitude of the dependence of the rural poor on

informal sources of credit can be observed from the findings of the All India Debt and

Investment Survey, 1992, which shows that the share of the non-institutional agencies

(informal sector) in the outstanding cash dues of the rural households was 36 percent.

However, the dependence of rural households on such informal sources had reduced

of their total outstanding dues steadily from 83.7 percent in 1961 to 36 percent in

1991.

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1.5 The Problems Associated with Mainstream MFIs

To enable the reach of micro finance services to the needy, the problems associated

with the legal, regulatory, organisational systems and the attitudes should be

addressed to and the desired changes brought in these, to make them more effective.

The mainstream financial institutions are flush with funds and have access to

enormous amounts of low cost savings deposits. Indeed, the poorer the region, the

lower the credit deposit ratio – most of the eastern UP, Bihar, Orissa and the North-

East have Credit Deposit ratios of 20-30 percent. Thus while banks are physically

present in rural areas and offer concessional interest rates, rural producers are not able

to access, with the result that the rest of the deposits are finding their way into the

financial sector.

The Banking Sector and lending to the rural poor – A Background

With directed priority-sector lending an explicit feature of the formal banking sector,

India has built up a network of rural banks that is rare if not unparalleled in the world.

In 1999, 196 RRBs had over 14,000 branches in 375 districts nation-wide, covering,

on an average, about three villages per branch. The rural banking system, in its

entirety, has an even more impressive coverage. Together, the RRBs, the nationalized

commercial banks and the credit cooperatives — comprising of Primary Agricultural

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Credit Societies (PACS) and Primary/State Land Development Banks (P/SLDS) —

have one branch for every 4,000 rural residents (Bhatt and Thorat, 2001).

In spite of such an impressive coverage, the formal banking sector has had a limited

impact on microfinance or lending to the poor. The RRBs were set up in the mid-70’s

with a clear mandate for lending to the poor as it was felt that the cooperative banks

were being dominated by the rural wealthy an that the commercial banks had an urban

bias. 1 See, for instance, Fisher and Sriram (2002) .

For the first two decades of their existence, political pressure and focus on outreach at

the expense of prudent lending practices led to very high default rates with

accumulated losses exceeding Rs. 3,000 crores in 1999. The reforms in the mid-90’s,

following the recommendations of the Narsimhan Committee Report, removed some

of the constraints on the functioning of RRBs, easing their interest ceiling and

allowing them to invest in the money market. The financial situation of the RRBs has

improved since then with declining losses and over 80% of the RRBs are now

profitable. However, much of this turnaround has resulted from a shift to investment

in government bonds (that have gained with falling interest rates) and loans to the

non-poor in rural areas.

The focus on financial sustainability has cost outreach dearly. Recent years have

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witnessed – perhaps predictably – a sharp decline in the share of rural and small loans

in the portfolio of the banks. The locational distribution of bank branches has also

undergone a considerable shift away from the rural areas

Over its entire lifetime, the formal rural banking system in India has struggled to

balance the dual objectives of outreach and financial performance. A post-reform shift

in focus has benefited the latter only at the expense of the former.

The lending portfolio of scheduled commercial banks also reflects this shift away

from rural areas. At the end of 2001-2002, the share of agriculture in the outstanding

credit of scheduled commercial banks was less than 10% which is even less than the

share of personal loans (housing loans and loans for consumer durables).

Small loans have also declined in importance in recent years. Since over 98% of rural

loans are below Rs 2 lakhs, this implies a concomitant shift out of rural areas. The

logic of this shift is easy to appreciate. In 2002, 45% of the borrowers of scheduled

commercial banks were from rural areas, but they accounted for only 13.4% of their

outstanding loans. For metros, the corresponding numbers were 15% and 54%

respectively. With their focus shifted to financial performance, the banks are naturally

shifting their portfolio to the low cost segment.

Microfinance provides an important way to balance the outreach among the rural poor

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while keep the cost of lending low. To the extent that the costs of credit risk

assessment and monitoring can be reduced with the help of NGOs, banks can actually

reach out to a large number of truly poor households without incurring heavy

transactional expenses.

1.6 Self Help Groups (SHGs) as borrowing units

Self Help Groups (SHGs) form the basic constituent unit of the

microfinancemovement in India. An SHG is a group of a few individuals – usually

poor and often women – who pool their savings into a fund from which they can

borrow as and when necessary. Such a group is linked with a bank – a rural, co-

operative or commercial bank– where they maintain a group account. Over time the

bank begins to lend to the group as a unit, without collateral, relying on self-

monitoring and peer pressure within the group for repayment of these loans.

An SHG consists of five to twenty persons, usually all from different families. Often

a group like this is given a name. Each such group has a leader and a deputy leader,

elected by the group members. The members decide among themselves the amount of

deposit they have to make individually to the group account. The starting monthly

individual deposit level is usually low – Rs. 10 or Rs. 20 (about 20-40 US cents). For

a group of size 10, this translates to Rs. 100 to 200 (about $2 to $ 4) of group savings

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per month. On the basis of the resolutions adopted and signed by all members of the

group, the manager of a local rural or commercial bank opens a savings bank account.

The savings are collected by a certain date (often the 10th of the month) from

individual members and deposited in the bank account.

Joining an existing SHG is often a costly affair for an aspiring villager. In order to

maintain parity among the members a new member has to join by depositing the total

accumulated individual savings and interest of the group. Besides the new member

has to be accepted by every member of the existing group. Thus it is often easier for a

person not affiliated with an SHG to start a new SHG than joining a pre-existing one.

Loans are then given out to individual members from out of these funds upon

application and unanimous resolution drawn at a group meeting. The bank permits

withdrawal from the group account on the basis of such resolutions. Such loans, fully

funded out of the savings generated by the group members themselves, are called

“interloans”.

The repayment periods of loans are usually short, 3-6 months. After regular loan

issuance and repayment for six months, the bank considers making a bank loan to the

SHG. The maximum loan amount is a multiple (usually 4:1) of the total funds in the

group account. This limit is also reached gradually starting from a lower (2:1 or 1:1)

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figure. Thus a 10 member SHG with individual monthly deposit level of Rs. 20,

completing a six-month successful “inter-loaning”, accumulates total savings of

Rs.1200/- (part of which may be lent out to individual members) and is eligible for a

maximum bank loan of Rs. 4800/-.

1.7 The role of NGOs in Microfinance

Self Help Groups are almost always formed with outside assistance. Developmental

NGOs, often with considerable history of working in a particular area for projects like

literacy, sanitation etc., take to organizing SHGs, bringing together people, explaining

the concept to them, attending and helping coordinate a few of the initial group

meetings, helping them maintain accounts and linking them with the banks. Of late,

some of the rural banks themselves are being designated as Self Help Promoting

Institutions (SHPIs) and they help in the formation and ‘nursing’ of SHGs. Figure 2

gives the country-level breakdown of SHGs according to their promoting institution.

While Figure 2 shows that over half of the SHGs are formed by government agencies,

it should be remembered that about 60% of government-formed SHGs come from a

single state, Andhra Pradesh, where the state government has played a very pro-active

role in SHG financing. Over the last quarter century, a few organizations, outside the

purview of the public sector, have succeeded in effective poverty alleviation through

micro-credit. Self Employed Women’s Association (SEWA) in the Western Indian

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state of Gujarat and Working Women’s Forum in the Southern state of Tamilnadu

were among the pioneers in this effort.

The sector received a major boost in the 1990s with the entry of several non-

government organizations (NGOs). Many of these NGOs have been previously

functioning in different developmental roles among the poor, and now added

microcredit to the list of services they provided. A few others, impressed by the

success of microfinance elsewhere, started off as MFIs. Self-Help Groups (SHGs)

among the poor, mostly women, have rapidly become a common rural phenomenon in

many Indian states. NGOs provide the leadership and management necessary in

forming and running such groups in most cases. They also act as the crucial link

between these groups and the formal banking system. Presently well over 500 NGO-

MFIs are actively engaged in microfinance intermediation across the country.

There are several major legal, regulatory and financial challenges for NGOs involved

in microfinance activities. Legally, they are usually registered as societies and trusts

with no equity capital and consequently can never be “capital adequate” in leveraging

debt.

Also, these NGOs do not come under any specific control by any regulatory body and

their only responsibility is to submit annual accounts to the registrar of societies. This

lack of specific regulatory provisions has acted as a mixed blessing in the area – it has

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allowed for organic growth and spread of NGO MFIs and at the same time has led to

lack of financial sustainability for most of these organizations, sometimes with

disastrous effects on the goodwill of microfinance at large.

Linking SHGs to the formal rural banking sector

The main advantage of Self-Help Groups lies in their joint liability and consequent

“peer monitoring” of member borrowers. In association with sponsoring NGOs, they

serve to reduce the transaction and monitoring costs of small lending for the banks as

well as reach credit to the absolute poor. It is therefore hardly a surprise that they have

attracted considerable attention in the rural banking sector as well as from the

government in recent years.

Several alternative models of SHG-NGO-bank relationship have emerged in recent

years. One such model is where the bank lends directly to the SHG and the latter

further lends it to individual members. As a variant of this model, an NGO may

provide training and guidance to the SHG still dealing directly with the bank. This has

been the most popular model in the Indian context. Alternatively, the NGO itself may

act as an intermediary between the bank and the SHG, borrowing from the bank and

lending it to (usually multiple) SHGs. Yet another model involves the bank lending

directly to the individual borrower with the NGO and the SHG acquiring an advisory

role. Here the NGO assists the bank in loan monitoring and recovery. Figure 3 gives

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the approximate nationwide distribution of SHGs among the different bank financing

models.

1.8 Government support for SHG-based financing

While most of the SHG formation/nursing process has initially been in non-

government hands, the developmental potential of the SHG-based microfinance

process has not gone unnoticed by the government. In recent years, government

developmental programs have also sought to target the poor through the SHGs.

Starting with the Rashtriya Mahila Kosh and the Indira Mahila Yojana, the

government has used the SHG approach in many of its anti-poverty projects. The most

important of the government programs using the SHG approach is the Swarnajayanti

Gram Swarojgar Yojana (SGSY) launched in 1999. With increasing acceptance of the

SHG based developmental approach there is pressure set on village and block level

administrators to achieve targets of forming a certain number of SHGs by a specified

date. Thus Panchayats are also promoting SHGs in many areas.

Non-banking Financial Corporations (NBFCs) and other non-government

organizations (NGOs) typically connect these SHGs to local banks or to the funds

provided by wholesale credit suppliers like NABARD or SIDBI (Small Industries

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Development Bank of India). The SHGs develop a habit of saving among its members

for a period of time and then begin making loans to applying members from the

collective savings of the group. After a few rounds of successfully repaid loans, an

SHG begins borrowing from an outside source (i.e. a bank). Banks usually consider

SHGs “bankable” after six months of their existence.

Government involvement in microfinance has, however, not been an unmixed

blessing. Politicizing of the subsidy allotment among SHGs has become a big

problem. Qualification for government subsidy is easily influenced by Panchayat

members. Thus, Panchayats are now competing with NGOs and rural banks in

forming SHGs. While the Panchayat-formed SHGs have the lure of government

grants they are often open to political pressure and misuse of funds by the

recommending Panchayats and/or political parties. Besides, the NGO-formed SHGs

have the benefit of honest and expert counseling from the nursing NGOs. Thus the

quality of NGO-formed groups are usually superior to those formed by the local

government (Panchayats) and villagers are often keen to join the former. These age-

old problems of government initiatives in poverty reduction, unless stemmed quickly,

can actually harm the movement by eroding the fundamental precepts of self-help and

empowerment of the poor.

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The Swarnjayanti Gram Swarojgar Yojana

Swarnjayanti Gram Swarojgar Yojana (SGSY) has emerged as a main anti-poverty

programme instituted by the government in recent years. Started in April, 1999, it

seeks to lift the rural poor out of poverty in three years by generating significant

sustainable income. Organizing the poor into self- help groups (SHGs) lies at the heart

of this approach. The goal of the programme is to enable the poor attain income

generating assets. According to the SGSY Guidelines, “The SHG approach helps the

poor to build their self-confidence through community action. Interactions in group

meetings and collective decision making enable them in identification and

prioritization of their needs and resources. This process would ultimately lead to the

strengthening and socioeconomic empowerment of the rural poor as well as improve

their collective bargaining power.”

The SGSY strategy includes identifying a cluster of activities at the block level and

funding SHGs to perform these activities. The programme is implemented

countrywide through a hierarchy of SGSY committees, at the central, state, district

and block levels. The actual implementation requires close interaction between the

government officials at various levels, particularly the DRDAs (District Rural

Development Agencies), managers from the participating banks, NABARD, as well as

NGOs. The actual disbursement of government funds would be through the DRDAs

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who would distribute the subsidy to banks. The programme recognizes the important

role that NGOs play in the formation and nurturing of Self-Help Groups and seeks to

include them in the exercise.

From the point of view of SHGs, SGSY is an excellent source of subsidized credit. If

a group survives for 6 months it becomes eligible for a revolving fund of Rs. 25,000

from a participating bank. Out of this loan, Rs. 10,000 is in the form of government

subsidy and banks may charge interest only the amount exceeding this Rs.10,000. The

Rs. 25,000 fund injection becomes part of the group corpus. With some exceptions,

six months after the receipt of the revolving fund the groups would be tested for their

preparedness to take up economic activities. If they pass the test, they would be

eligible for loan-and-subsidy for economic activity up to a maximum of Rs. 10,000

per group member or Rs. 1.25 lakhs per group, whichever is less. There are also

incentives, payable in several stages, to NGOs or “animators” incubating and

nurturing SHGs.

Though financing is a very important part of SGSY, it is not the only element.

Identification of activity clusters, recognizing training needs of swarozgaris, imparting

proper training and building capacity of the groups and group members in the selected

activities are all essential elements of the programme. Also, SGSY is not the first or

only government programme to try the SHG approach. DWCRA (Development of

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Women and Children in Rural Areas), for instance, is also based on the same

approach.

Banking Sector and Microfinance

The formal banking sector has played an important role in microfinance in India.

Much of the microfinance initiative in India has involved Self-Help Groups (SHGs),

predominantly of poor women. NABARD’s Bank Linkage Program, pilot-tested in

1991-92 and launched in full vigor in 1996, has been a major effort to connect

thousands of such SHGs across the country with the formal banking system. By late

2002, it connected about half a million SHGs to the banking system with total loan

disbursement of about Rs. 1026 crores. Efforts of other organizations supplement that

of NABARD. By March 2001, SIDBI, for instance, had disbursed over Rs 30 crore to

SHGs through 142 MFI-NGOs.

The emphasis on linking the self-help groups of rural poor to the formal banking

system was made in the mid-80s in the Asia and Pacific Regional Agricultural Credit

Association and the SHG-Bank Linkage emerged as a result of that. RBI included the

program in its “priority sector lending” and in 1999, the Government of India

recognized in its Budget. A few studies commissioned by NABARD on the tenth

anniversary of the launching of the program in 2002 attempted an assessment of the

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program. The findings indicate that the program has emerged as the largest

microfinance network in the world with some impressive statistics.

As of March 2002 the program covered 461,478 SHGs with total cumulative lending

of Rs 1,026 cores (US $ 218.27 million). The accumulated savings in SHGs exceeds

Rs 875 crores (US $ 186.31 million) by unofficial estimates. 90% of SHGs financed

were exclusive women groups. 444 Banks (121 RRBs, 209 cooperatives banks, all 27

public sector banks and 17 private banks) with a total of 17,085 branches participated

in the program providing credit to about 7.8 million poor households in 488 districts.

Average loan sizes are Rs 22,240 (US $ 463) per SHG and 1,300 (US $27) per

member. Today, the program is estimated to cover well over 500,000 SHGs with

cumulative loans exceeding Rs. 1200 crore reaching over 8 million households.

(Kropp and Suran (2002) and Seibel and Dave (2002)).

The state-wise distribution of SHGs linked with banks shows considerable variation

in the share of total SHGs (see Figure 3). Andhra Pradesh has a disproportionately

large share of over 42% of all linked SHGs. Tamil Nadu and Uttar Pradesh (including

Uttaranchal) follow with about 12% and 11% share respectively. Karnataka come next

with about 9%. The rest of country thus accounts for about a quarter of the total SHGs

combined. From an all-India perspective therefore, the SHG-bank linkage experience

has been very strongly biased towards the South and has not provided a balanced

access to credit for the poor in India.

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In spite of the impressive rise of microfinance institutions, the scope of further

microfinance efforts in India is almost unlimited. Indeed poverty alleviation in India is

a Herculean task. India has roughly about 60 million poor households, accounting for

over 350 million people, about 35% of the entire population. Even NABARD aims at

reaching only 100 million of the poor (less than a third) by 2008. Clearly, a quantum

leap in microfinance activities is necessary if it is expected to make a serious impact

on the poverty situation in India. There are, of course, other issues connected with

microfinance and poverty alleviation. As elsewhere in the world, it is contended that

in India too microfinance often eludes the “poorest of the poor” and it is people above

poverty line – barely or comfortably – who can benefit from such micro-financial

services.

1.9 The Road Ahead – Prospects and Challenges

In this paper we have sought to provide a bird’s-eye view of the microfinance

sector in India. There have definitely been significant advances in recent years and the

concept and practice of SHG-based microfinance has now developed deep roots in

many parts of the country. Impact assessment being rather limited so far, it is hard to

measure and quantify the effect that this Indian microcredit experience so far has had

on the poverty situation in India. Doubtlessly, a lot needs to be accomplished in terms

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of outreach to make a serious dent on poverty. However, the logic and rationale of

SHG-based microfinance have been established firmly enough that microcredit has

effectively graduated from an “experiment” to a widely-accepted paradigm of rural

and developmental financing in India. This is no mean achievement. In fact to the

extent that people’s mindsets are the biggest roadblock in the success of an

innovation, it may well be one of the most important steps in the saga of microfinance.

The path ahead is obviously strewn with challenges. Scaling up of projects and

bringing millions of people within the fold of microfinance is no mean task. The most

convincing feature of this form of financing, that justifies its admittedly higher costs,

is the near-perfect repayment rates. The expansionary zeal of microcredit practitioners

should be balanced with the quality of loans – indeed a momentous challenge.

Government involvement in SHG-based microfinance is a welcome development but

it is not free from its ills. Government aid almost always brings in its wake political

favoritism and corruption. It is important to ensure that the government microfinance

initiatives do not go the way of their several well-intentioned predecessors.

The biggest challenge in development, however, is the simultaneous development

of investment potential and improvement of skill levels of the borrowers. A glut of

low-skilled services is an unwelcome substitute for scarcity of credit. As microcredit

alleviates the credit availability problem, the need for micro-consulting, business

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planning and services like marketing, are being felt with greater acuteness.

Microcredit cannot be expected to be a panacea to rural developmental problems. In

some sense, its role is similar to that of credit in the general economy. It is a string

that can hold back progress, but it is almost impossible to push on a string. There is a

very real need of investments that yield higher returns than the sustainable microcredit

interest rates for the microcredit initiative to be truly successful.

However, so far the evidence – largely anecdotal – points to the several beneficial

side-effects of microcredit. In particular, empowerment of women and the inculcation

of financial training and discipline amongst the poor will undoubtedly have long-term

socioeconomic benefits. The principles of self-help and microcredit thus hold the key

to economic and socio-cultural freedom for India’s millions of poor, opening the gates

of a hitherto untapped reservoir of human enterprise

Moving Forward

Most of the issues stated above are being tackled at various levels and the initiatives if

successful, could substantially remove these hurdles. Over the last few years, the

Government of India has been encouraging micro-finance as an alternative to IRDP

type of poverty alleviation programs because of the sustainability of micro-finance

activities. In the last two Budget Speeches, the Finance Ministers have talked about

the need to enhance the reach of the MFIs. The RBI also made a special mention of

micro-finance in its credit policy announced in April 1999. The RBI has established a

micro-credit cell; NABARD has set up a Micro-credit Innovations Department, while

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HUDCO is also formulating a similar plan. The issue of inappropriate legal form for

MFIs is being addressed by a Task Force setup by the Reserve Bank of India, which

among other things is looking into the regulatory and legal issues concerning

microfinance in India.

An increasing number of MFIs have begun to address the issue of financial

sustainability of their programs and have started taking effective steps towards

achieving sustainability. Many of them have increased their interest rates, at least to

cover their costs. Some of them have taken steps to convert themselves into for-profit

corporations and have sought commercial investors to invest in them. These will not

only make microfinance more commercially oriented but will also increase the quality

of governance.

Another welcome development in the Indian micro-finance sector in recent years has

been the establishment of networks of micro finance practitioners. These networks not

only help in creating awareness but also help in formation, experience sharing etc.

These could also develop into a Self Regulatory Organisation of microfinance

institutions.

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2.0 Conclusion

The Indian economy at present is at a crucial juncture, on one hand, the optimists are

talking of India being among the top 5 economies of the world by 205047 and on the

other is the presence of 260 million poor forming 26 % of the total population. The

enormity of the task can be gauged from the above numbers and if India is to stand

among the comity of developed nations, there is no denying the fact that poverty

alleviation & reduction of income inequalities has to be the top most priority. India’s

achievement of the MDG of halving the population of poor by 2015 as well as

achieving a broad based economic growth also hinges on a successful poverty

alleviation strategy.

In this backdrop, the impressive gains made by SHG-Bank linkage programme in

coverage of rural population with financial services offers a ray of hope. The paper

argues for mainstreaming of impact assessment and incorporation of local factors in

service delivery to maximize impact of SHG –Bank linkage programme on

achievement of MDGs and not letting go this opportunity.After the pioneering efforts

of the last ten years, the microfinance scene in India has reached a takeoff point. With

some effort substantial progress can be made in taking MFIs to the next orbit of

significance and sustainability. This needs innovative and forward-looking policies,

based on the ground realities of successful MFIs. This, combined with a commercial

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approach from the MFIs in making microfinance financially sustainable, will make

this sector vibrant and help achieve its single-minded mission of providing financial

services to the poor.

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Refernces/Bibliography

R. Srinivasan and M S Sriram – Microfinance in India: Discussion (2003)

M S Sriram- Microfinance and the State: Exploring Areas and Structures of

Collaboration (2005)

M.S.Sriram and Rajesh S Upadhyayula-The Transformation of the Microfinance

Sector in India: Experiences, Options and Future (2002)

Mahendra Varman P-Impact of Self- Help Groups on Formal Banking Habits (2005)

Frances Sinha-Access, Use and Contribution of Microfinance in India: Findings from

a National Study (2005)

Malcolm Harper, Andreas Berkhof, R V Ramakrishna-SHG-bank Linkage: A Tool for

Reforms in Cooperatives (2005)

Rajaram Dasgupta-Microfinance in India: Empirical Evidence, Alternative Models

and Policy Imperatives (2005)

Tara S Nair-Institutionalising Microfinance in India: An Overview of Strategic Issues

(2001) Vijay Mahajan and G Nagasri, BASIX-Building Sustainable Microfinance

Institutions in India (1999)