Microfinance in India: Key regulations, issues and implications

Abstract

Microfinance is the provision of financial services to low-income clients, including consumers and the self-employed, who traditionally lack access to banking and related services.1 In broader terms, it deals with financial inclusion2 which involves provision of permanent access to a range of high quality financial services, including credit, savings, insurance, and fund transfers to a large number of poor households. Microfinance services are provided by three types of sources3 : * Formal institutions, such as rural banks and cooperatives; * Semiformal institutions, such as nongovernment organizations; and * Informal sources such as money lenders and shopkeepers. Institutional microfinance includes microfinance services provided by both formal and semiformal institutions. Microfinance institutions are defined as institutions whose major business is the provision of microfinance services. Development practitioners, policy makers, multilateral and bilateral lenders, recognize that providing efficient microfinance services to the people belonging to the bottom of the pyramid is important for a variety of reasons as elucidated below: i. Microfinance can be a critical element of an effective poverty reduction programme. Improved access and efficient provision of savings, credit, and insurance facilities in particular can enable the poor to enjoy an improved quality of life as they will be able to smoothen their consumption, manage their risks better, build their assets, develop their microenterprises, and enhance their income earning capacity. Microfinance services can also contribute to the improvement of resource allocation, promotion of markets, and adoption of better technology thereby helping in promotion of economic growth and development. ii. Without permanent access to institutional microfinance, most poor households continue to rely on meager self-finance or informal sources of microfinance, which limits their ability to actively participate in and benefit from the development opportunities. iii. Microfinance can provide an effective way to assist and empower poor women, who make up a significant proportion of the poor and suffer disproportionately from poverty. iv. Microfinance can contribute to the development of the overall financial system through integration of financial markets. The extent to which people are banked depends primarily on how wealthy they are. Even in the poorest countries, rich urban customers get access to good banking. Although there are a range of financial services used by the poorest, these are usually provided outside the formal banking system4 . Microenterprise activity has had a profound effect on a country's economic growth since the turn of the century. However, until recently, policy makers' belief in trickle-down strategies for development has greatly underplayed the importance of microenterprise. The promotion of microenterprises in developing countries is justified in their abilities to foster economic growth, alleviate poverty and generate employment (Livingstone, 1991).