Your Guide to Microfinance in India
A majority of lenders consider microfinance to be an important part of their business. Over the decades, microfinance has been growing in importance in India as the lending industry increases its market penetration.
Microfinance can be seen as both an opportunity and a challenge. It provides lenders with a way to expand into new markets, however, it comes with a higher risk burden as well.
Let’s dive into a short guide to microfinance in India that lenders may find helpful.
What is Microfinance in India?
Microfinance is different from traditional finance in one key aspect. Microfinance focuses on providing financial services to low-income individuals who are usually outside the scope of traditional financial services. microfinance in IndiaMicrofinance is different from traditional finance in one key aspect. Microfinance focuses on providing financial services to low-income individuals who are usually outside the scope of traditional financial services.
Mainstream financial service providers have strict criteria about who they do business with so that they can reduce the risk burden of their financial activities. In contrast, financial institutions who are involved in microfinance offer financial services to high-risk individuals who need financial services at a smaller scale.
For example, a feature of microfinance companies is that they may be willing to offer a small loan to a farmer in the midst of a drought. Traditional finance would not offer this service since it has a high-risk burden and low potential reward.
Microfinance companies can sustain themselves and grow over time by doing business at a large scale and by offsetting the risk burden of their loans and other services.
Importance of Microfinance
There are several ways in which microfinance can supercharge an economy, especially a developing economy such as India. The vast majority of the Indian population are currently outside the scope of traditional finance.
A farmer in Bengal may not be able to get a loan from a traditional finance company. However, they may be able to receive a loan from a microfinance company. Hence, the farmer may be able to invest the required amount on his farm which can then deliver the proper yield allowing the farmer to continue his livelihood.
In essence, microfinance helps with poverty alleviation, financial inclusion, economic empowerment, job creation, as well as social development. Microfinance also presents a huge opportunity for lenders. The majority of the Indian population is currently underserved or completely unserved by the financial industry. Microfinance presents a way for financial companies to offer their services to low-income individuals and increase their market share.
Overall, it’s a very powerful tool that can have far-reaching positive consequences for a developing economy.
Challenges in Microfinance
While microfinance can be the solution to numerous problems, it is not without its share of challenges. A few of these issues are systemic and require wide-scale change. Other issues can be tackled by an individual microfinance lender.
One of the largest issues in microfinance is that lenders need to charge very high interest rates. The interest rates need to be very high in order to justify the significant risk burden that the company is holding when lending to the highest-risk segment of the population.
However, while the lenders may be able to justify the high interest rate, the issue is that many borrowers who are already financially vulnerable may not be able to repay their loans at such high rates.
Another large challenge within the microfinance space is overindebtedness. It is a common occurrence that borrowers who are unable to repay their current loan take another loan in order to repay an existing loan. Over time, this can prove to be a substantial burden on the borrower who now has to repay multiple loans at very high interest rates.
Some of the other important challenges are operational risks, regulatory compliance risks, and social and political risks that microfinance lenders have to face.
Future of Microfinance
The current state of microfinance in India is quite promising. The future of microfinance depends on the confluence of several factors.
The most promising factor is digital innovation.
Thanks to new technology such as smartphones, mobile apps, and 5G internet connectivity, it is now possible for financial services companies to reach previously unreachable swaths of the Indian population. As internet penetration rises, financial inclusivity and market penetration can rise alongside it.
Another factor affecting the future of microfinance is government initiatives. Government support programs such as Digital India can play a large role in helping microfinance lenders reach underserved communities and offer their services.
Further, the rise in impact investing (which is investing in companies and programs that have a social benefit) can allow lenders to gain the necessary capital to sustain their operations.
Microfinance companies are also diversifying their product range and are becoming more well-known which can have a positive impact on the future of microfinance as a whole.
Regulatory Framework
The question of who regulates microfinance in India often arises. There are several regulatory frameworks that any microfinance lender will be a part of. The Reserve Bank of India is ultimately in charge of and the principal regulator that oversees the operation of microfinance lenders in the country.
The RBI notifies new regulations and updates old regulations from time to time so that the microfinance industry can flourish while also protecting the rest of the economy.
Also, microfinance lenders are part of the Microfinance Institutions Network (MFIN) which plays a significant role in coordinating between all the various microfinance lenders and ensuring that there is consensus in how they operate.
Many regulations that apply to traditional finance will also apply to microfinance lenders and need to be complied with.
How Can Legodesk Help?
Legodesk is proud to offer a software tool that can help both traditional and microfinance lenders streamline their operations. Our software tool has been specially designed keeping the needs of lenders in mind.
Our software platform has several innovative features such as case management, contact management, the Feet-on-Street app, legal notice automation, and so on. Such a platform can help improve the efficiency of the debt collection operations of a lender.
We are trusted by banks, NBFCs, as well as enterprises.
Wrapping Up
Microfinance is an important tool for the Indian economy and can serve a crucial role in helping underserved sections of the Indian population gain access to financial services. While there are some challenges, the overall opportunity it can present to the lending sector cannot be denied.