Microfinance in India : Evolution of the concept from past to present and the impact of digital revolution.
Microfinance is a category of financial services catering to low income but economically active individuals, nano and small businesses. It serves as one of the significant sources of credit for these customers since they don’t have access to credit from conventional banking resources and don’t have higher collateral demands by the major banking institutions.
“Community connectedness is not just about warm fuzzy tales of civic triumph. In measurable and well documented ways, social capital makes an enormous difference in our lives….Social capital makes us smarter, healthier, safer, richer and better able to govern a just and stable democracy”
- Robert D Putnam
Circle of Trust and Social Capital
The poor women organised in self-help groups leverage ‘social capital’ for each other, a resource derived from the close social ties and trust embedded in their social networks. This social capital enforces a ‘circle of trust’ around the SHG members making their behaviour more predictable and implementing certain norms of reciprocity in the group. It reinforces the groups’ collective bargaining power to seek credit and also increases their risk-taking ability. This phenomenon acts as a self-regulator for the group members to repay their loans on time and also attracts the MFIs to lend. The poor may be deprived of money, property, or any other collateral, but they can leverage this social capital to seek loans when organised in a group. This inclusiveness, this unique democratic accessibility of the poor to social capital, is the cornerstone on which the microfinance concept is based.
Trigger for promotion in India
Microfinance as a concept is centuries old, but in its modern form, the concept was pioneered by Prof Muhammad Yunus. In the 1970s, he started giving small loans in Bangladesh and eventually established the Grameen Bank in 1983. The concept became popular with the financial institutions in India as the top-down approach of government and the multitude of subsidised loan schemes were not generating the necessary impact. This very need led to the creation of NABARD in 1982. With the policy support from RBI, NABARD initiated the ‘Self Help Group’ lending model and started its flagship ‘Self Help Group Bank Linkage Programme (SHG-BLP)’. In this, NABARD urged NGOs to foster and train SHGs to deposit their savings with established banks and within the legal framework. The intent behind the programme was to move from paper-backed collateral to socially backed collateral from an organised group of people and develop the habit of savings in them.
Why Microfinance ?
Microfinance comprises access to small ticket loans for poor clients known as ‘microcredit’, current and savings account facilities, microinsurance and payment systems, among other services offered by Micro-finance Institutions (MFIs). It gives option for people to avoid the usury of non-institutional lenders and prevent falling into the perpetual debt trap. Therefore, governments promote this effective tool in furthering the financial inclusion of the under-banked and non-banked sections.
Existing Microfinance Lending Models in India
At present, there are three models prevalent in microfinance lending -
· Self Help Group (SHG) — model used by NBFC-MFIs and Small Finance Banks
· Joint Liability Group (JLG) — model used by NBFC-MFIs and Small Finance Banks
· SHG Bank Linkage — model used by scheduled commercial, corporate and regional rural banks
Digital Revolution in Microfinance
As per a World Bank Report (2016), increased connectivity and digital advances open the door to a slew of developmental benefits, dubbed “digital dividends,” that could help fuel growth, expand opportunities, and improve service delivery. As shown in the diagram below, digital technologies promote development through inclusion, efficiency and innovation. As technology grows, there is a reduction of information asymmetry, which furthers inclusion. This improved information flow among the parties facilitates a higher number of transactions with a reduced cost, effort and risk. There is optimum use of resources, and the existing processes become quicker and cheaper, thereby leading to an increase in efficiency.
Inclusion: Digital technologies made monitoring and sharing information more manageable, thereby promoting trust and transparency in the system. It led to adopting a broader view of financial inclusion and taking it beyond the mere provision of financial services to the unbanked.
Efficiency: Digital technologies can reduce transaction costs and increase the productivity of existing factors of production. In the face of increased competition from emerging players, many MFIs leverage digital technologies to improve their operational efficiency and gain that competitive edge.
Innovation: MFIs offer dynamic incentives, regular repayment schedules and collateral substitutes to help sustain standard repayment rates. To provide customized services to individuals, MFIs often face a dearth of user-specific information. To develop robust risk mitigation strategies and provide better services, the MFIs in the Indian market are using credit bureau data and contribute to it. This also helps the final consumers since it facilitates future engagements with the MFIs.
From a macroeconomic perspective, this can further be validated from Cobb-Douglas Production Function : Y = A x k^(α) x L^(β)
Where, ‘Y’ is the output, ‘k’ is the capital input, ‘L’ is the labour input. ‘α’ & ‘β’ are the share of contribution of ‘k’ and ‘L’ respectively. Here, ‘A’ is the total factor productivity which is dependent on the innovation change happening in the MFI technology at the moment. Also, if α + β > 1, then the MFI experiences increasing returns to scale. Thus, this condition holds when any digital technology adoption by MFI drives the ‘A’ which ultimately improves the allocation of ‘k’ and ‘L’. A digital technology change will result in increased productivity for MFI only if it yields increasing returns to scale.
Digital Technology Adoption for Microfinance Lending in India
Digital technology adoption has been a constant policy agenda for MFIs since the 2000s. The major agenda behind this trend was to improve operational efficiency and develop distinct capabilities to survive in the market. These efforts by MFIs promoted customer outreach and the sustainability of their value chain. Hence, widespread adoption of Management Information System (MIS), Automated Teller Machines (ATM), Interactive Voice Response (IVR) systems, etc. happened in the past decade.
The Rangarajan Committee Report (2008) on financial inclusion emphasized the need for technology-based solutions to reduce the transaction costs in the microfinance sector. The suggestions made in the report led to the setting up of a Financial Inclusion Technology Fund (FITF) to further investment in Information and Communication Technology (ICT).
The Banking Correspondent Revolution: One of the most significant fillips for technology adoption in MFIs came from Banking Correspondents (BC) partnerships with the commercial banks. Owing to their vast rural network, MFIs emerged as suitable partners for commercial banks to promote their financial services. It led to the emergence of ‘partnership models’ that got replicated in every state and incorporated the local element specific to that state. With the emergence of these new NBFC-MFIs, this partnership model got reinvigorated, and MFIs were given higher responsibilities in the partnerships. As banks moved ahead with technology adoptions, the trend also trickled into the MFIs as the BC model provided that motivation for change, incentives and promised profitable returns. Currently, the BC portfolio constitutes 23% of the total portfolio for MFIs
(Sa-Dhan, Q3 2020–21 Report).
Telecom Revolution: Another major shift in the adoption among MFIs was due to the large-scale penetration of mobile-based technology at various levels of the operation. The usage of mobile, internet and mobile aided banking promoted financial inclusion. The trend is still growing as the number of active internet users in India has reached 743 Mn in 2020.
Push by Government: The Government has been an essential catalyst in pushing digital transformation through programs like Digital India, Digidhan Mission, Jan Dhan Yojana and JAM Trinity, among many others. More recently, it established IndiaStack, a set of APIs that allows government bodies, businesses, startups and developers to utilise a unique digital Infrastructure to solve India’s complex problems towards presence-less, paperless, and cashless service delivery. It helps lenders and FinTech companies to create innovative products and value catering to different customer needs. The development of a neutral and open payment system has benefitted the MFI sector. The increased usage of Aadhaar, e-KYC, e-Signatures, DigiLocker, Unified Payment Interface (UPI), Immediate Payment Services (IMPS) and National Unified USSD Platform (NUUP), among others, have enabled MFIs to provide multiple products and services. The E-Shakti programme of NABARD attempts to promote digitization and remove information asymmetry faced by the SHGs by addressing quality of book-keeping, multiple memberships and the credit history of SHG members, among others (NABARD Report,2018).
The figure below signifies the impact of evolving disruptive technologies on microfinance at different maturity levels -
Going forward
The government has been shifting from its top-down governance approach to a bottom-up approach for addressing the poverty question, where MFIs rightly fit in place. The growing competition in the sector and addressing the customers’ evolving needs have opened the floodgates for disruptive digital technologies to enter and permanently overhaul the sector. The necessary human touch in operations and the resource of ‘social capital’ may face a threat if profit becomes the only motive behind evolving microfinance products. However, in this huge flood of technology and the tempest of competition, can microfinance sail through? Can it protect its unique nature of furthering financial inclusion? It needs to be seen!
References
1. https://en.wikipedia.org/wiki/Grameen_Bank
2. KPMG, ‘Microfinance Report (2018)’
Microfinance — Embracing Digital while — KPMG India (home.kpmg)
3. World Bank Group, World Development Report — ‘Digital Dividends (2016)’,
URL — World Development Report 2016: Digital Dividends (worldbank.org)
4. Ray, Saon; Paul, Sandeep and Miglani, Smita, ‘Innovation, efficiency and inclusion: Integration of digital technologies in the Indian microfinance sector’, Working Paper, №366, October 2018.
5. Cobb–Douglas production function — Wikipedia
6. Sa-Dhan, Q3 2020–21, Quarterly Microfinance Report
7. Bharat Microfinance Report 2020,
Bharat Microfinance Report (BMR) — Sa-Dhan
