Microfinance and Economic Development of India

Topics: EconomyIndia

Introduction

Microfinance is one of the important components of Economic development of India. As it concentrates on those Poor people who are far away from urban areas where economic activity is concentrated that’s why these people have to wait much longer to get the benefits of economic development, because of the non- development of infrastructure, Roadways, technological development and other components of Economic development. Microfinance reaches to these essential developing sections of the society to make the economic development balanced which is critical for the long-term sustainability of social development and economic prosperity.

Access to financial services is an important element of the process of socio-economic empowerment. Only by providing financial services to people in rural areas and lower income strata can they be brought within the ambit of economic activity. Only then can the full potential of the country’s physical and human resources be realized. The rural economy represents a large hidden demand for credit, savings and risk mitigation products like insurance.

Governments and regulators the world over have connected the expansion of financial service delivery to this segment of the population as a priority objective.

The Importance of Financial Services:

  • Below are the key points explaining the importance of Financial Services
  • Economic Development
  • Benefits of Government.
  • Economic Growth.
  • Ensures Greater income.
  • Maximizes Returns.
  • Minimization of Risks.
  • Promotes Savings.
  • Promotes Investments.
  • Balanced Regional Development.
  • Promotion of Domestic & Foreign Trade.

The delivery of financial services to lower income households in rural areas, however, presents a unique set of challenges.

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This customer segment has a high volume of low value transactions and requires doorstep services, flexibility in timing as well as simple procedures and documentation. These require a set of skills completely different from those deployed by mainstream financial intermediaries. Because of their high costs of traditional modes of outreach, like physical branch networks, prove to be inappropriate. Microfinance is a model which seeks to provide financial services to the rural people in a viable and in sustainable way.

Microfinance

Microfinance holds within the provision of a broad range of services such as loans, deposits, payment services, money transfers and insurance products to poor and low income households and microenterprises. Microfinance allows exchange of high cost debt from informal sources, thereby increasing disposable income. It inculcates financial discipline, resulting in ownership of assets, and increases the ability to withstand shocks due to access to savings products, credit and insurance. In lower income countries with inadequate institutional infrastructure, microfinance is an important development tool and has helped expand the depth of financial services.

The Indian Context

With a population of over 100 crores and estimates of the number of poor people ranging from 30 to 40 crores, India is one of the largest markets for micro financial services. It is determined that a large part of the demand for credit in this stratum is currently met by informal sources. The 20th century saw large scale efforts to improve the quality of life in rural India. Different approaches were adopted by government agencies and non-government organizations to improve the condition of the rural people. These included land redistribution, building economic and political awareness, technology transfer and delivery of a variety of services. Credit in the rural sector was highly supplied by co-operative societies till the mid of 1960s with the commercial banks’ rural operations centered on agri-businesses and marketing. One of the main objectives of bank nationalizations in 1969 and 1980 was to increase the flow of rural credit. However, merely expanding physical presence in rural areas did not achieve the expected results, given the need to overlay mainstream financial service delivery models with the social mobilization skills that were essential to meet developmental objectives. The self help group bank linkage programme was the initial microfinance initiative launched by the National Bank for NABARD in 1992. While this model of partnership between the banking sector and voluntary organizations achieved reasonable success, it continued to depend on the creation of an extensive banking network. Challenges in scaling up this model led to the introduction of financial intermediation by microfinance institutions that provide microfinance services to the poor, especially in rural areas.

Microfinance Institutions

MFIs borrow from commercial sources and on-lend to clients (groups/individuals). Most MFIs in India started with grants and concessional loans and gradually made the transition to commercial funding. While much of the development in the initial years was financed by concessional loans from funding agencies, this was followed from 2001 onwards by raising equity from domestic as well as international agencies and by borrowings from the banking sector. MFIs have been observed to administer risks better than the traditional banking sector.

There may be two explanations for this:

  • MFIs have developed specialized systems of evaluation, supervision, administration and recovery of credits attuned to their clientele, and
  • The clients have developed an appropriate financial culture.
  • Since 2003, several banks have entered the microfinance sector with innovative scaling-up strategies. In addition to term loans, some of the innovative structures offered by banks in India to create access to financial services in the rural areas are:
  • Partnership: Several MFIs have an excellent base and infrastructure in their specific markets. However, they lack access to product knowledge, funding and technology platforms. In the partnership model, the bank provides mezzanine equity and technology to the NGO/MFI and lends directly to clients with risk-sharing by the NGO/MFI. The bank also provides loan funds for the MFI’s own investment requirements. The MFI undertakes loan origination, monitoring and collection. The advantage of this structure is that it separates the risk of the MFI from the risk of the portfolio. Here the intermediary or the MFI assumes a fraction of the credit risk (to the extent of risk sharing), leading to a reduction in capital required. It combines the core competence of NGOs/MFIs with that of banks – social mobilization skills with finance.
  • Securitization: In this model the commercial bank identifies a portfolio based on fulfillment of minimum criteria and past portfolio performance. Though the MFI continues to collect receivables from the borrowers, its leverage is reduced which enables it to originate further assets. This product gives the bank the advantage of differentiating between the financial and operational risk of the MFI while credit enhancement improves the rating of the portfolio and enables competitive pricing. The product has highlighted the potential for creating a large secondary market in India for microfinance receivables. Bonds may also be issued against securitized microfinance assets, creating linkages between MFIs and capital markets.
  • On-Tap Securitization: In this product the bank provides the MFI advance funding with which the MFI can build assets. Once created, assets are assigned to the bank. The MFI can continue to build assets and assign them to the bank on a regular basis.

Microfinance provides a credit delivery channel to rural households. The main impacts of microfinance are increased access to credit for those at the ‘Bottom of the Pyramid’ with easy and door-step delivery of institutional credit, and, where available, the provision of risk covers for financial losses through a range of insurance products.

Scaling up the MFI model would involve the following ways:

  • Delivery of services at appropriate costs: Reduction in the cost of intermediation would have a direct impact on the profitability of MFIs. This could be achieved through increased efficiency in operations and through greater outreach.
  • Serving a wider set of clients: In addition to financing poor households, MFIs could extend their services to individuals with larger loan capacity to set up enterprises, purchasing farm equipment and housing. This would involve a shift from acting as an MFI to acting as an LFI (local financial institution).
  • Increasing profitability through cross-selling: MFI branches in unbanked areas provide significant opportunities to bundle services like insurance and collection of savings. Income from cross-selling would lead to an increase in the profits of MFIs.

Conclusion

In each and every country, development takes place over time, but its level and tempo may not be adequate to maintain a satisfactory standard of living for the less advantaged. In such situations, arbitration is in order to speed up the natural tempo of development. Microfinance is an arbitration which tries to speed up this process in a two pronged manner improving household income by providing timely and adequate support for economic activities, and sharing the responsibilities of the government and of the mainstream financial sector. In India, microfinance is at an ascent stage with a vast potential for development. While the sector has begun to develop, challenges must be addressed to make this development both effective and sustainable. Microfinance needs to become more accessible, more customized and more inclusive. To scale up activity in this area, we must build financial skills in microfinance institutions and establish conjunction to the debt and equity capital markets. Microfinance can then truly contribute to transforming rural India into an engine of economic development.

References

  • Microfinance in india by S.L. Shetty
  • Microfinance- Principles and Approaches by Dr.V. Rangrajan
  • Understanding Microfinance by Debadutta K.Panda
  • Woman and Microfinance :Prospectus and challenges by Amit kumar

Cite this page

Microfinance and Economic Development of India. (2022, Jun 02). Retrieved from https://paperap.com/microfinance-and-economic-development-of-india/

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