Loans to the other half
What is microfinance?

Microfinance is about providing financial services to the very poor. While microcredit refers to lending, microfinance refers to other services such as savings, life insurance, crop insurance etc that may be provided to poor farmers.

Why donít the poor get credit from the formal financial sector?

In lending to the poor, banks face high risks and transaction costs. The lack of information and of collateral make it unattractive for the formal financial sector to lend to the very poor.

Government talks about encouraging bank lending to farmers. Why donít farmers borrow from banks?

It is often costly, time consuming and difficult for the poor to open bank accounts. The time taken for loans to be sanctioned tends to be long. Banks are unwilling to lend as they have to adhere to regulations about interest rates for small sized loans. Low rates make the loans unattractive. Money lenders are usually based locally and know the borrower. They are willing to lend at high rates of interest that take into account the higher risk of lending to the poor. Interest rates are often very high but they offer flexibility that formal sector lending is unable to.

What is the Grameen model?

In Yunusís Grameen model the bankís staff form groups of five persons. A loan given to a member of the group is guaranteed by the others. Even if the borrower has no collateral to offer to the bank, the social pressure exerted by others is often enough to ensure repayment. Yunusís idea was that there are often opportunities in the informal sector that can be exploited by the poor if they had access to finance. In this framework there are weekly meetings, forced savings and fixed schedules for repayment enforced by the bank staff.

Whatís the status of Indiaís microfinance institutions?

While the Grameen model exists in some parts of India, we also have our own version of microfinance enshrined in Self Help Groups (SHGs). These are groups of individuals who save and give loans primarily out of their own deposits. Unlike Grameen groups, the members of the SHG do voluntary savings, manage accounts, collect and give interest within the unit. The SHG model is more flexible in terms of repayments. Its more democratic framework is found by some to be more suitable to Indian conditions in contrast to the more regimented Grameen model. Micro finance institutions (MFIs) normally work with SHGs at the local level. Some are based on the Grameen model. Others arenít, but the principle of lending based on the social pressure to prevent default of the loan is the same.

What is the role of the government?

NABARD (National Bank of Agriculture and Rural Development) has taken the lead in SHG-bank lending. The SHG model has created opportunities for commercial banks to lend to the poor. The bank lends to an SHG that lends to its members overcoming the information asymmetries that the bank would normally have faced. Since the year 2000 priority sector lending to agriculture can be done through MFIs. This means that for what they lend, banks get refinance from NABARD at 6.5 per cent interest.

Why should commercial banks be interested in lending to the poor?

Consider a commercial bank like ICICI. It would typically charge an MFI 12 per cent. The MFI would then incur a service charge and lend to the SHG at about 16-18 per cent. The borrower would get the loan, for example, at 20 per cent. This is cheap for her compared to the moneylender and that is why she would like to continue the credit relationship with ICICI and not default on the loan. If she defaults, the whole group gets cut off, so the group either puts pressure on her to repay, or helps her repay the loan. If ICICI had lent to industry it might have received 8 or 10 per cent. Therefore, once the bank has dealt with the questions of transaction costs and information asymmetries and risk by lending to the poor through MFIs, the poor are a commercially attractive proposition.

How is microfinance doing in India?

Itís been growing fast in the last six years. Recovery rates are at about 98 per cent. Interest rates are higher than the formal sector (18 to 24 per cent) but lower than moneylenders (40 to 50 per cent). However, its reach is reported to be around 2 million, far less than the reach of Grameen in Bangladesh. The scope of expansion is limited by the lack of a proper regulatory framework.

Source: Ila Patnaik, 1 November 2006