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Y. S. P. Thorat
Graham A. N. Wright

Linking self-help groups with banks is easily the largest and fastest growing microfinance programme in terms of its outreach and sustainability.

GLOBALLY, over a billion poor people are still without access to formal financial services and some 200 million of them live in India. Microfinance, the provision of a wide range of financial services to the poor on a sustainable basis, has proved to be immensely valuable. Access to financial services has allowed many families throughout the developing world (and, indeed, in poorer parts of the developed world) to make significant progress in their own efforts to escape poverty.

The microfinance industry has traditionally seen poor people's needs for financial services simply as "credit for enterprise". Recently, however, it has become clear that the poor need access to money to send their children to school, to buy medicines; they need "financial services to reduce their vulnerability". As a result, worldwide, microfinance institutions (MFIs) have started developing and delivering a range of financial products. This reflects the Millennium Development Goals (MDGs) that offer broadly accepted, measurable indicators of poverty reduction that are focussed on poverty, education, health and empowerment.

In recognition of the potential of microfinance to address the diverse aspects of poverty, the United Nations launched the International Year of Microcredit 2005. The Year, in the words of the UN Secretary General, Ms Kofi Annan, "underscores the importance of microfinance as an integral part of our collective effort to meet the Millennium Development Goals. The challenge before us is to address the constraints that exclude people from full participation in the financial sector... Together, we can and must build inclusive financial sectors that help people improve their lives."

How does microfinance contribute to the MDGs? The International Year of Microcredit 2005's Fact Sheet, Microfinance and the Millennium Development Goals, notes that a review of microfinance literature points to several specific conclusions about its impact on poverty reduction and several other MDGs.

Eradicate extreme poverty and hunger: There is extensive evidence that microfinance helps reduce poverty through increases in income, allowing the poor to build assets and reducing their vulnerability. For example, Shahidur R. Khandker's 1998 seminal study for the World Bank notes that: "In Bangladesh, 5 per cent of the Grameen Bank's clients graduated out of poverty every year by participating in microfinance programmes and, more importantly, households were able to sustain these gains over time."

Achieve universal education: Households that have access to microfinance spend more on education than non-client households. Improvement in school attendance and the provision of educational materials are widely reported in microfinance households. Participation in credit and savings programmes has enabled many families to send several children at a time to school, and has reduced drop-out rates in higher primary grades. For example, Save the Children's 1999 study in Honduras showed that microfinance clients increased earnings, which enabled them to send their children to school.

Promote gender equality and women's empowerment: Microfinance has been widely credited for empowering women by increasing their contribution to household income, the value of their assets, and control over decisions that affect their lives. For example, the Women's Empowerment Programme in Nepal found that 68 per cent of its members were making decisions on property, family planning and daughters' education, and also negotiating their children's marriages.

Reduce child mortality, improve maternal health, and combat disease: Microfinance contributes to improved nutrition, housing, and health, especially among women clients. Access to a range of financial services can have significant positive effects on a wide variety of the manifestations of poverty. The new vision driving the micro-finance industry is for a world in which all poor have permanent access to a wide range of financial services, delivered through a variety of convenient mechanisms by different types of institutions. Financial service for the poor is no longer only about microcredit, but recognises the importance of savings, money transfers, remittances and insurance. As is already clear in India, the providers are savings and credit cooperatives, commercial banks, community finance institutions, NGO-MFIs, consumer credit companies, insurance companies, and other types of institutions including the private sector companies.

Worldwide, the increasing competition among products and institutions is resulting in greater efficiency and a broader range of products, to the benefit of the clients. Advances in technology is leading to reduced transaction costs, thus overcoming the long-standing barriers to the expansion of services.

E-banking offers a huge opportunity to leapt-frog bankers' traditional concerns about "high volumes of low value transactions" and "investing bricks in bricks and mortar", and will increase volumes while driving down marginal costs.

New technologies can also improve information about clients, reduce risk and, thus, costs. These factors have resulted in a growing number of commercial financial institutions initiating efforts to serve the low-income market.

This financial systems approach focusses on microfinance — commercial financial intermediation among poor borrowers and savers; the emphasis is on institutional financial self-sufficiency. But sustainability is not the goal. It is the means to large-scale provision of financial services to low-income people.

So what does all this mean for India? India has the world's most extensive banking infrastructure. Today, there are about 60,000 retail credit outlets of the formal banking sector comprising 12,000 branches of district-level cooperative banks, over 14,000 branches of the Regional Rural Banks (RRBs) and over 30,000 rural and semi-urban branches of commercial banks; in addition to 112,000 cooperatives credit societies at the village level.

There is at least one retail credit outlet on an average for about 5,000 rural people or every 1,000 households. This is a remarkable and extensive network capable of meeting the financial needs of the entire rural population.

However, poor credit-deposit ratios (except in the case of the Primary Agriculture Credit Societies), unsustainable lending and high-levels of non-performing assets, often cripple much of this infrastructure.

Notwithstanding the phenomenal expansion of the outreach of the formal banking structure and the pro-poor directed policies and programmes, the All India Debt and Investment Survey, 1992, gave indications that the share of non-institutional agencies (informal sector) in the outstanding cash dues of the rural households was quite high at 36 per cent — and there are strong suggestions that this may well be an under-estimate. Recent studies commissioned for the World Bank and others suggest that this pattern has remained largely the same. Informal sources of finance are popular with poor households.

The main players in this sector are traders/money lenders, friends and relatives, revolving savings and credit associations and other neighbourhood self-help groups.

According to the Task Force on Revival of Cooperative Credit Institutions (2004), within the rural finance system, the commercial banks provide about 57 per cent of the total institutional credit for agriculture, followed by cooperatives (34 per cent) and Regional Rural Banks (9 per cent). In 2004, 16.7 million poor households were accessing credit through 35,000 branches of 560 commercial and cooperative banks under the SHG-bank linkage programme.

This activity is the result of Nabard's work in the microfinance sector, which started in 1992 through a pilot project for promoting 500 Self-help Groups (SHGs). As the idea gained acceptance from the banking system and the results were promising, the Reserve Bank of India (RBI) encouraged this positive initiative by issuing instructions to banks in 1996 to cover SHG financing as a mainstream activity under their priority sector-lending portfolio.

The Government of India (GoI) made linking SHGs with banks a national priority from 1999 onwards through its periodic policy and Budget announcements. Nabard continues to nurture the expansion of the outreach of the programme by providing umbrella support to the stakeholders.

Today, the programme is growing at a pace of about 2.5 million households annually. It is easily the largest and fastest growing microfinance programme in the world in terms of its outreach and sustainability.

There are few empirical studies to prove the commercial viability and the comparative product strength of SHGs in banks' credit portfolios. Until rigorous and extensive studies are completed, the jury remains out on the sustainability of both the SHGs and of the SHG bank linkage model for the banks delivering it.

In addition to the SHG-bank linkage approach spearheaded by Nabard, there were other experiments carried out by banks and microfinance institutions (MFIs) — usually using some form of the Grarneen Bank model imported from Bangladesh. These alternative routes to serving the poor community through appropriate financial delivery institutions such as MFIs also have an institutional space where the banking infrastructure is weak and/or unresponsive.

There are around 1,000 private MFIs operating in the country; however, not more than 10 of these have an outreach of 100,000 microfinance clients.

An overwhelming majority of MFIs have 500-1,500 clients. It is estimated that the MFIs' share of the total institution-based microcredit portfolio is about 8 per cent. NGO-MFIs are unable to offer a range of financial services and focus primarily on credit.

However, growing numbers of NGO-MFIs are transforming into non-banking financial corporations (NBFCs) to offer savings services and others are forging agency agreements with insurance companies to offer this important risk management service too.

Recently, the comparatively higher interest rate (12-36 per cent per annum) charged by the MFIs has again become a contentious issue. The high interest rate collected by the MFIs from their poor clients is still perceived as exploitative in some quarters. It is argued that raising interest rates too high could undermine the social and economic impact on poor clients. Since most MFIs deliver their services to the villages (rather than requiring the clients to come to the bank's branches) and have lower business volumes, their transaction costs are far higher than that of the formal banking channels.

It is notable that the MFIs still experience significant demand for their products and services and that their growth is constrained by the capacity of their staff and the availability of capital funds rather than by market forces. Internationally, the microfinance industry has had remarkable success in extending financial services to the poor; and has demonstrated a significant capacity to contribute to the Millennium Development Goals.

But the industry has a long way to go — and millions of low-income people remain unable to access formal financial services. In India, a very conservative estimate suggests that, at most, just 20 per cent of all the eligible low-income people have access to financial services from formal financial institutions, MFIs and other such stakeholders.

The Indian microfinance sector reflects many of the key successes and remaining challenges common round the globe.

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