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TEAMNAM

E:SUnSHine

2010

MICRO

FINANCEININDIA

N

EEDFOR

STRENGTHENINGTHELEGALFRAMEWORK

Aditya S Prakash | Dr. Surel N Shah

FTMBA Core, NMiMS, Mumbai

9833692253 | 9326440836

[email protected]

[email protected]


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Microfinance in IndiaNeed for Strengthening the Legal Framework

2

MICROFINANCE IN INDIA NEED FOR

STRENGTHENING THE LEGAL FRAMEWORK

Co-Authors

Aditya S Prakash Dr. Surel Shah MBA Core

II Year NMiMS, Mumbai NMiMS, [email protected] [email protected]______________________________________________________________________________________

Abstract

Microfinance has gained a lot of

significance and momentum in the last

decade. India now occupies a significant

place and a niche in global

microfinance. Microfinance is defined as

provision of thrift, credit and other

financial services and products of very

small amount to the poor in rural, semi-

urban and urban areas for enabling

them to raise their income levels and

improve living standards. India has

supported social banking for a long

time. National Bank for Agriculture and

Rural Development (NABARD) has

played a key role in increasing the

enthusiasm of bankers and politicians to

bring about changes and sowing the

seeds of this national movement which

now encompasses 1.4 million such

groups (over 20 million members). The

Small Industries Development Bank of

India recognized the opportunity and

started implementation of an ambitious

national programme. The reform of the

interest rate regime has constituted an

integral part of the financial sector

reforms initiate in our country in 1991.

For the purpose of facilitating smoother

and more meaningful banking with the

poor, Government of India has

introduced a bill in the lower house of

the Parliament to regulate microfinance

institutions (MFIs) in the country, the

bill is called The Micro-financial Sector

(Development and Regulation) Bill,

2007. This bill is the result of the

demand from certain sections of the

growing microfinance sector for a

suitable regulatory framework.
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INTRODUCTION

Microfinance is one of the few market

based, saleable anti-poverty solutions

that is in place in India today and the

argument to scale it up to meet the over-

whelming need is compelling. By

unleashing the entrepreneurial talent of

the poor, we will slowly but surely

transform India in ways we can only

begin to imagine today. Microfinance is

defined as provision of thrift, credit and

other financial services and products of

very small amount to the poor in rural,

semi-urban and urban areas for enabling

them to raise their incomes levels and

improve living standards. Micro-credit

Institutions (MCI) provide these

facilities. Microfinance has gained a lot

of significance and momentum in the

last decade. India now occupies a

significant place and a niche in global

microfinance through promotion of the

self-help groups (SHGs) and the home

grown SHG-Bank Linkage (SBL)

model. The Indian model offers greater

potential to address poverty as it is

focused on building social capital

through providing access to financial

services through linking with the

mainstream. Equity like funding at this

level is a huge need and in turn, a huge

opportunity. This will give small

entrepreneurs the ability to take more

risks with their business. This kind of

funding is just being tested globally.

HISTORY OF SOCIAL BANKING

India has supported social banking for a

long time. Policy directions to rapidly

expand rural branches, mandate credit

allocations for priority sectors (including

agriculture), deliver large subsidy

oriented credit programmes to serve

marginal communities and poor

households and control interest rates

have been tried for over 35 years. The

first breakthrough emerged from policy

support to enable informal self help

groups (SHG) of 15-20 members

(mainly women) to transact with

commercial banks. These SHGs build up

and rotate savings amongst themselves,

open bank accounts and take

responsibility for lending and recovering

money financed by banks. With the

missionary zeal of the National Bank for

Agriculture and Rural Development

(NABARD), the increasing enthusiasm

of bankers and politicians and emerging

success in repayment and social impact,

this national movement now

encompasses 1.4 million such groups


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(over 20 million members). The Small

Industries Development Bank of India

(SIDBI) recognized the opportunity and

started implementation of an ambitious

national programme. Providing loan and

capacity building support to MFIs and

capacity building and rating support for

sector development, this programme

already supports 70 MFIs and has

disbursed US$ 46 million. Microfinance

offers another big paradigm shift in

providing equal opportunity in building

business and a 'huge' market to boot.

Foreign investors have been completely

taken in by microfinance and are

investing in the space across the board.

In microfinance, short term loans are

empowering poor women by helping

them become economically self-reliant.

Emerging world of microfinance

sometimes gets damned for stories about

micro-sharks indulging in usury and

dishing out pricey short term loans.

DEVELOPMENT OF

MICROFINANCE IN INDIA

The reform of the interest rate regime

has constituted an integral part of the

financial sector reforms initiative in our

country in 1991. With a view to facilitate

smoother and more meaningful banking

with the poor, a pilot project for

purveying micro credit by linking SHGs

with banks was launched by NABARD

in 1992. Reserve Bank of India (RBI)

had then advised commercial banks to

actively participate in this linkage

programme. The scheme has since been

extended to RRBs and Co-operative

Banks. The number of SHGs linked to

banks aggregated 4,61,478 as on March

31, 2002. This translates into an

estimated 7.87 million very poor

families brought within the fold of

formal banking services as on March 31,

2002. More than 90 per cent of the

groups linked with banks are exclusive

women groups.

Cumulative disbursement of bank loans

to these SHGs stood at Rs. 1,026.34

Crores as on March 31, 2002 with an

average loan of Rs. 22,240/- per SHG

and Rs. 1,316/- per family. As regards

model-wise linkage, while Model I, i.e.

directly to SHGs without

intervention/facilitation of any Non-

Government Organisation (NGO) now

accounts for 16 per cent, Model II, i.e.

directly to SHGs with facilitation by

NGOs and other formal agencies

amounts to 75 per cent and Model III,


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i.e. through NGOs and financing

agencies as facilitators represents 9 per

cent of the total linkage. While 488

districts in all the states/Union

Territories (UTs) have been covered

under this programme, 444 banks

including 44 commercial banks

(including 17 in the private sector), 191

RRBs and 209 co-operative banks along-

with 2,155 NGOs are now associated

with the SHG- bank linkage programme.

A Non Government Organisation (NGO)

is a voluntary organization established to

undertake social intermediation like

organizing SHGs of micro entrepreneurs

and entrusting them to banks for credit

linkage or financial intermediation like

borrowing bulk funds from banks for on-

lending to SHGs. A task force on

Microfinance recognized in 1999 that

microfinance is much more than micro

credit. Membership of SaDhan (a

leading association) has expanded from

43 to 96 Community Development

Finance Institutions during 2001-04.

During the same period, loans

outstanding of these member MFIs have

gone up from US$ 16 million to US$

101 million. The CARE CASHE

Programme took on the challenges of

working with small NGO-MFIs and

Community owned / managed

microfinance organizations. Outreach

has expanded from 39,000 to around

3,00,000 women members over 2001-05.

Many of the 26 CASHE partners and

another 136 community organizations

these NGO-MFIs work with, represent

the next level of emerging MFIs and

some of these are already dealing with

ICICI Bank and ABN Amro. In addition

to the dominant SHG methodology, the

portfolios of Grameen replicators have

also grown dramatically. The Outreach

of SHARE Microfin Limited, for

instance, grew from 1,875 to 86,905

members between 2000 and 2005 and its

loan portfolio has grown from US$ 0.47

million to US$ 40 million. The 2005

national budget has further strengthened

this policy perspective and the Finance

Minister of Indian Government Mr. P.

Chidambaram announced "Government

intends to promote MFIs in a big way.

The way forward, I believe, is to identify

MFIs, classify and rate such institutions,

and empower them to intermediate

between the lending banks and the

beneficiaries." The 2005 Budget opened

a small window in this area and central

bank annual policy recently confirmed


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discussions on this: As a follow-up to

the Budget proposals, modalities for

allowing banks to adopt the agency

model by using the infrastructure of civil

society organizations, rural kiosks and

village knowledge centers for providing

credit support to rural and farm sectors

and appointment of micro-finance

institutions (MFIs).

Government of India vide their

notification dated August 29, 2000 has

included 'Micro Credit/Rural Credit' in

the list of permitted non-banking

financial company (NBFC) activities for

being considered for Foreign Direct

Investment (FDI)/Overseas Corporate

Bodies (OCB)/Non-Resident Indians

(NRI) investment to encourage foreign

participation in micro credit projects.

This covers credit facility at micro level

for providing finance to small producers

and small micro enterprises in rural and

urban areas.

MICRO CREDIT PROVIDERS AND

PRESENT LEGAL ASPECT

Reserve Bank of India Act (RBI Act)

1934, Banking Regulation Act (BR Act)

1949,State Bank if India Act (SBI Act),

SBI subsidiaries Act and Acquisition &

Transfer of Undertaking Act 1970 &

1980 govern the Domestic Commercial

Bank such as public sector banks,

private sector banks & local areas banks.

Regional Rural Bank Act (RRB Act)

1976, RBI Act 1934 & BR Act 1949

govern Regional Rural Banks. Co-

operative Societies Act, BR Act 1949

(AACS) and RBI Act 1934 (for

scheduled Banks) govern the co-

operative Banks. State legislation like

MACS governs Co-operative societies.

RBI Act 1934 and Companies Act 1956

govern the Registered Non-Banking

Financial Companies (NBFCs). Sec 25

of Companies Act and RBI Amendment

Act 1997 govern the unregistered

NBFCs. Societies Registration Act 1960,

Indian Trusts Act, Chapter III c of RBI

Act 1934 and State Money lenders Act

govern other providers like Societies,

Trust etc.

SEPARATE MICROFINANCE BILL

IN PARLIAMENT

Government of India had introduced a

bill in the lower house of the Parliament

to regulate microfinance institutions

(MFIs) in the country. The bill called

The Micro-financial Sector

(Development and Regulation) Bill,

2007. This bill is the result of the


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demand from certain sections of the

growing microfinance sector for a

suitable regulatory framework.

NEED FOR A SEPARATE BILL /

ACT FOR MICROFINANCE

REGULATION IN INDIA

The concerns over the bill are arising

due the following reasons:

1. There is a concern for entrustingthe responsibility of regulation of

microfinance providers to the

NABARD as it has many

limitations as a regulator.

2. Critics say that self help groups(SHGs) may become sub-servant

to MFIs which could siphon off

their savings for their own

lending needs leading to

disempowerment.

3. Doubts have been raised over theability of NGOs to ensure safety

of the deposits of the poor.

4. There is the argument from thewomen's lobby that in spite of

women being the major

stakeholders of microfinance, the

bill has not made any attempt to

give adequate representation to

them.

5. The manner of drafting the billand the way it has been

introduced by the government

has also drawn serious flak.

So the entire process has left to be

desired in terms of transparency and

wider consultation. The All India Debt

and Investment Survey had revealed that

only about 13.4 per cent of the rural

households have access to institutional

credit. Financial inclusion of the poor

continues to be a major challenge. The

Rural Finance Access Survey (RFAs)

conducted by NCAER had also revealed

the acuteness of the financial exclusion

of the poor. The RFAs has found that

nearly 87 per cent of the poor

households were without access to any

formal credit and about 70.4 per cent of

the poor did not have any deposit

account. But there is no clear

explanation in the bill as to how the

absence of a legal framework is

constraining these MFIs and in what way

the provision of such framework would

help attain the goal of financial

inclusion.

NGOs in India have played a crucial role

in the spread of microfinance. The

success is also attracting many newer


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NGOs to enter the field. It is estimated

that in India as of 2006 there are about

800 NGOs involved in the delivery of

microfinance with an outreach of about

7.3 million households. Like credit, the

poor need savings services to meet

various contingencies they face in their

livelihood. However, the poor find it

difficult to save with the formal banks

for many reasons. In the absence of

formal savings mechanism, the bulk of

the poor adopt various unsafe and

inconvenient methods of savings.

The bill hopes that this problem can be

addressed by enabling NGOs to offer

savings services to the poor. The

inability to accept savings from their

clients is considered to be a major

hindrance in mobilizing cheaper funds

need for scaling up. This in turn is

supposed to have contributed to the

problem of high lending rates charged by

the NGO-MFIs.

With the rapid growth of their

microfinance activity, NGO-MFIs are

faced with the dilemma which emanates

from the nature of their organization

form. Increased outreach and loan

business has created skepticism about

the not-for-profit nature of the NGOs.

Microfinance being an activity required

to be pursued on a cost recovery basis,

the not-for-profit form is found to be

operationally constraining and inherently

contradictory by the NGOs.

The uncertainty over the tax status of the

surplus generated from microfinance

operations has created serious concern

among NGOs. Many of them are looking

for a suitable form of organization which

can help them take up microfinance in a

full-fledged way with low capital

requirement and without any dilemma

over profit.

CONCLUSION

A World Bank study assessing access to

financial institutions found that amongst

rural household in Andhra Pradesh and

Uttar Pradesh, 59 per cent lack access to

deposit account and 78 per cent lack

access to credit. Considering that

majority of the 360 million poor

households (Urban and rural) lack access

to formal financial services, the number

of customers to be reached, and the

variety and quantum of services to be

provided are really large. It is estimated

that 90 million farm holdings, 30 million


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non-agricultural enterprises and 50

million landless households in India

collectively need approx US$ 30 billion

credit annually. This is about 5 per cent

of India's GDP and does not seem to be

an unreasonable estimate. A tiny

segment of this US$ 30 billion potential

market has been reached so far and this

is unlikely to be addressed by MFIs and

NGOs alone.

Reaching this market requires serious

capital, technology and human

resources. However, 80 per cent of the

financial sector is still controlled by

public sector institutions. Competition,

consolidation and convergence are all

being discussed to improve efficiency

and outreach but significant opposition

remains, for example, the All India Bank

Employees Association has threatened to

strike if the Government proceeds with

its policy of reducing its capital in public

sector banks, merging public sector

banks or even enhancing Foreign Direct

Investments in Indian Private Banks.

The legal aspect for microfinance aims

of creating an enabling provision for the

NGOs to deliver microfinance in an

integrated way and seeks to achieve this

by prescribing relatively liberal

prudential norms.

Efforts are needed to ensure that the

poor and women are able to exercise

control and ownership over MFIs. The

government has to ensure that all the

stakeholders are duly consulted before

the bill passed so that interest of the poor

should be safeguarded properly.


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REFERENCES

1. Karthi Keyan, M (2006): PilotingDeficit Rain fall Insurance with

Small Rainfed Farmers: DHAN

Foundation, Madurai (Mimeo)

2. M P Vasimalai, K Narender(2007): Microfinance for Poverty

Reduction: The Kalanjiam way,

Economic & Political Weekly

March 31-April6, 2007 page

1190

3. Aloysius P Fernandez (2007): AMicrofinance Institution with a

Difference, Economic & Political

Weekly March 31, 2007 page

1183

4. Sukhevinder Singh Arora (2005):The Microfinance India

Conference and a look at an

Expanding, United Nations

Capital Development Fund

Microfinance Issue, 13 June

2005.

5. Shylendra H.S. (2007):Microfinance Bill- Lissing the

Forest for the Trees, Economic &

Political Weekly July 14-20,

2007, page 2910-14.

6. Business Today Jan 13, 2008page 156.

7. www.rbi.gov.in

8. www.epw.org.in
http://www.rbi.gov.in/http://www.rbi.gov.in/http://www.epw.org.in/http://www.epw.org.in/http://www.epw.org.in/http://www.rbi.gov.in/

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