Microfinance is providing financial services to that section of the population which is not served by the traditional financial institutions. Micro-credit refers to the granting of very small loans to impoverished borrowers, with the aim of enabling the borrowers to use that capital to become self-employed and strengthen their businesses.

Microfinance Institutions give loans in smaller ticket sizes ranging from Rs.20,000 to Rs. 1,25,000. Although Microfinance Institutions (MFIs) charge a higher rate of interest, it is still less than informal money lenders.

Traditional Banks have not being able to effectively service this section of the populations because:

  1. Higher cost: Because of the higher overheads of traditional banks they find it infeasible to service loans at lower ticket sizes.
  2. Lack of Collateral: The poor lack ability to provide collateral in order to secure loans.
  3. Lack of documentation: Poor lack the adequate documentation required to avail loans from traditional banks.
  4. Collection Mechanism: Microloans is all about low cost effective collection mechanisms which traditional banks lack.

A combination of above factors have resulted in making most microloans unfeasible and unattractive for banks.

Microfinance institutions have evolved a low cost model of assessing customers and ensuring timely collection. They usually lend only to ladies and that through Self help groups with joint liability. Loans are ideally given for small businesses. Moreover MFIs employ local people in collection work which visit these borrowers at the doorstep to collect payments and deliver credit as well.

Microloans are more about effective collection than credit appraisal (Credit appraisal is the process of determining whether the borrower will be able to pay)

As of June 2020, according to Microfinance Institution Networks (MFIN), the total loan portfolio stood at around Rs. 190,684 Cr with around 9.27 crore loan accounts..

Tomorrow we will see why the Microfinance model blew up in Andhra Pradesh in 2010.

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Published by Abhishek N Jain

One thought on “Explained: Micro-finance”

  1. Yep. Very subtly put. Collection is more imp than credit appraisal. However, initial capital is needed plus what about regulatory process. I don’t think it is smooth. Further, identifying the correct geography is also critical.

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