Microfinance

MICRO FINANCE AND INCLUSIVE GROWTH

Microfinance refers to a broad range of financial services, primarily credit, made available to people who don’t have access to formal banking services. Normally, these services would be required in areas with small population.Therefore, Micro-financial institutions (MFIs) facilitate the reach of financial services at a more ‘micro’ level.

Why microfinance makes sense?

• Cost-effectiveness (Believe it or not!)

o Money lenders charge exorbitant rates (50-100% p.a.) and the lending too is normally secured by land/ property; So if crops fail, the farmer loses his income (crop proceeds) as well as his asset (land)

o Commercial Banks charge much lower officially viz. 6-8% p.a. but the overall cost to the borrower far exceeds this number

o Loans can be rarely availed without kickbacks to credit officers

o Borrower has to make multiples visits to the distantly located bank branches.

• Better monitoring of end-use of funds; Improved Credit Discipline

o MS Swaminathan Committee highlighted that defining end-use of funds was crucial to ensuring farmers’ prosperity.

When a farmer takes a loan to (allegedly) buy seeds/ fertilizers/ tractor, he can still use the credit to fund his daughter’s wedding/ dowry (debt fueling consumption).

• Vital tool for Financial Inclusion

o Financial Inclusion is key to inclusive growth and the role played by MFIs in the process leading to employment generation and sustenance cannot be over-emphasized

Are For-profit organizations bad?

• ‘High’ rate of interests

o Although there is a case for capping interest rates and regulating the MFIs (which is likely to happen soon), the high rate of interest is needed to cover

o cost of funds (remember, MFIs don’t have access to low cost CASA funds),

o cost of service (MFI agents visit the borrower for all his requirements and the borrower is required to visit the office only once), and

o higher level of risk (lending in not secured by borrowers’...