Microfinance is a form of financial inclusion that aims to provide access to credit and other financial services to the poor and low-income segments of society. Microfinance has been recognized as a tool for poverty alleviation, empowerment of women, and promotion of entrepreneurship in India. However, the microfinance sector in India also faces several challenges that hamper its growth and impact. Some of these challenges are:
Debt Overhang
This refers to the situation where borrowers take multiple loans from different sources and are unable to repay them on time. Over-indebtedness can lead to stress, harassment, default, and even suicide among borrowers. It can also affect the repayment capacity and creditworthiness of the microfinance institutions (MFIs) that lend to them. According to a report by PwC⁵, over-indebtedness is one of the major risks faced by the microfinance sector in India, especially in states like Tamil Nadu, Karnataka, Telangana, and West Bengal, where the average loan size and loan per borrower are high.
High-Interest Rates
The interest rates charged by MFIs are generally higher than those of mainstream banks, as they have to cover the high operational costs, credit risks, and regulatory compliance involved in lending to the poor. However, high interest rates can also deter potential borrowers from availing of microfinance services, or force them to resort to informal sources of credit such as moneylenders, who may charge even higher rates or exploit them in other ways. High interest rates can also reduce the net income and savings of the borrowers, and affect their ability to invest in productive activities.
Over-dependence on the Banking System
The microfinance sector in India relies heavily on the banking system for its funding needs, as MFIs borrow from banks and other financial institutions to lend to their clients. However, this also exposes the sector to the liquidity and solvency risks of the banking system, as well as the fluctuations in interest rates and credit availability. For instance, the failure of Infrastructure Leasing & Financial Services (IL&FS) in 2018 triggered a liquidity crunch in the non-banking financial sector, which affected the funding profile and cost of funds of NBFC-MFIs⁴. Similarly, the COVID-19 pandemic has caused disruptions in banking operations and loan collections, which have impacted the cash flows and liquidity of MFIs.
Lack of Awareness and Financial Literacy
Many potential and existing borrowers of microfinance lack awareness and financial literacy about the products and services offered by MFIs, their terms and conditions, their rights and responsibilities, and the grievance redressal mechanisms available to them. This can lead to mis-selling, over-borrowing, inappropriate use of loans, or inability to repay them. Lack of awareness and financial literacy can also limit the demand and uptake of other financial services such as micro-insurance, micro-savings, and digital payments, which can enhance the financial inclusion and well-being of the poor.
Regulatory Issues
The microfinance sector in India is regulated by different authorities such as the Reserve Bank of India (RBI), the National Bank for Agriculture and Rural Development (NABARD), the Securities and Exchange Board of India (SEBI), and various state governments. This creates a complex and heterogeneous regulatory environment for MFIs, which have to comply with different norms and standards depending on their legal form, size, scope, and location. For instance, NBFC-MFIs have to follow the RBI's guidelines on loan size, loan tenure, interest rate cap, margin cap, borrower eligibility, etc., while non-profit MFIs are regulated by NABARD under different criteria. Moreover, some state governments have enacted their own laws or regulations for MFIs, such as imposing interest rate ceilings, loan waivers, moratoriums, etc., which can create conflicts or inconsistencies with the central regulations.
The Problem in the Identification of the Appropriate Model
The microfinance sector in India comprises various types of MFIs such as NBFC-MFIs, non-profit MFIs (such as trusts, societies, and cooperatives), self-help groups (SHG) bank linkage programs (SBLP), joint liability groups (JLGs), etc., each with its own advantages and disadvantages. However, there is no clear consensus on which model is more suitable or sustainable for delivering microfinance services to the poor. For instance, some studies have suggested that SHGs are more effective than JLGs in empowering women and reducing poverty¹, while others have argued that JLGs are more efficient and scalable than SHGs². Similarly, some studies have found that NBFC-MFIs have better outreach and performance than non-profit MFIs³, while others have highlighted the social impact and innovation potential of non-profit MFIs⁵.
Recommendations
These are some of the major challenges faced by the Indian microfinance industry that need to be addressed through collective efforts by all stakeholders such as MFIs, regulators, policymakers, investors, donors, researchers, etc. Some possible solutions or recommendations are:
- Strengthening the credit information system and credit bureaus to prevent multiple lending and over-indebtedness, and to improve the credit assessment and risk management of MFIs.
- Promoting competition and innovation in the microfinance sector to reduce interest rates and operational costs, and to offer more diverse and customised products and services to the borrowers.
- Diversifying the sources and instruments of funding for MFIs, such as equity, debt, securitisation, bonds, etc., to reduce their dependence on the banking system and to enhance their liquidity and solvency.
- Enhancing the awareness and financial literacy of the borrowers through financial education campaigns, counseling, training, etc., to enable them to make informed and responsible financial decisions.
- Harmonising and simplifying the regulatory framework for MFIs, by adopting a uniform and proportionate approach based on the principles of consumer protection, financial stability, and financial inclusion.
- Encouraging collaboration and coordination among different types of MFIs, such as through partnerships, mergers, networks, etc., to leverage their respective strengths and synergies, and to achieve greater scale and impact.
Sources:
(1) Vision of microfinance in India - PwC. https://www.pwc.in/assets/pdfs/consulting/financial-services/vision-of-microfinance-in-india.pdf.
(2) Reserve Bank of India - RBI Bulletin. https://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=19775.
(3) Challenges faced by the Indian microfinance industry - Project Guru. https://www.projectguru.in/challenges-indian-microfinance-industry/.
(4) . https://bing.com/search?q=micro+finance+challenges+india.
(5) Microfinance: Status, Benefits, Challenges and Solutions - ForumIAS. https://blog.forumias.com/microfinance-status-benefits-challenges-and-solutions-explained-pointwise/.
(6)https://mfinindia.org/assets/upload_image/publications/Studies/MFIN%20India%20Microfinance%20Review%20FY%2020-21.pdf.
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