TEAM NAME: SUnSHine

MICROFINANCE IN INDIA – NEED FOR

2010
STRENGTHENING THE LEGAL FRAMEWORK

Aditya S Prakash | Dr. Surel N Shah

FTMBA Core, NMiMS, Mumbai
9833692253 | 9326440836
aditya.prakash@nmims.edu
surel.shah@nmims.edu

MICROFINANCE IN INDIA – NEED FOR
STRENGTHENING THE LEGAL FRAMEWORK
Co-Authors
Aditya S Prakash
MBA Core
II Year
NMiMS, Mumbai
aditya.prakash@nmims.edu
______________________________________________________________________________________
Abstract
Microfinance has gained a lot of
significance and momentum in the last
decade. India now occupies a significant
place and a niche in global
microfinance. Microfinance is defined as
provision of thrift, credit and other
financial services and products of very
small amount to the poor in rural, semi-
urban and urban areas for enabling
them to raise their income levels and
improve living standards. India has
supported social banking for a long
time. National Bank for Agriculture and
Rural Development (NABARD) has
played a key role in increasing the
enthusiasm of bankers and politicians to
bring about changes and sowing the
seeds of this national movement which
now encompasses 1.4 million such
groups (over 20 million members). The
Small Industries Development Bank of
Microfinance in India – Need for Strengthening the Legal Framework
2
Dr. Surel Shah
MBA Core
II Year
NMiMS, Mumbai
surel.shah@nmims.edu
India recognized the opportunity and
started implementation of an ambitious
national programme. The reform of the
interest rate regime has constituted an
integral part of the financial sector
reforms initiate in our country in 1991.
For the purpose of facilitating smoother
and more meaningful banking with the
poor, Government of India has
introduced a bill in the lower house of
the Parliament to regulate microfinance
institutions (MFIs) in the country, the
bill is called The Micro-financial Sector
(Development and Regulation) Bill,
2007. This bill is the result of the
demand from certain sections of the
growing microfinance sector for a
suitable regulatory framework.
 3

INTRODUCTION opportunity. This will give small

Microfinance is one of the few market entrepreneurs the ability to take more
based, saleable anti-poverty solutions risks with their business. This kind of
that is in place in India today and the funding is just being tested globally.
argument to scale it up to meet the over-
whelming need is compelling. By HISTORY OF SOCIAL BANKING
unleashing the entrepreneurial talent of India has supported social banking for a
the poor, we will slowly but surely long time. Policy directions to rapidly
transform India in ways we can only expand rural branches, mandate credit
begin to imagine today. Microfinance is allocations for priority sectors (including
defined as provision of thrift, credit and agriculture), deliver large subsidy
other financial services and products of oriented credit programmes to serve
very small amount to the poor in rural, marginal communities and poor
semi-urban and urban areas for enabling households and control interest rates
them to raise their incomes levels and have been tried for over 35 years. The
improve living standards. Micro-credit first breakthrough emerged from policy
Institutions (MCI) provide these support to enable informal self help
facilities. Microfinance has gained a lot groups (SHG) of 15-20 members
of significance and momentum in the (mainly women) to transact with
last decade. India now occupies a commercial banks. These SHGs build up
significant place and a niche in global and rotate savings amongst themselves,
microfinance through promotion of the open bank accounts and take
self-help groups (SHGs) and the home responsibility for lending and recovering
grown SHG-Bank Linkage (SBL) money financed by banks. With the
model. The Indian model offers greater missionary zeal of the National Bank for
potential to address poverty as it is Agriculture and Rural Development
focused on building social capital (NABARD), the increasing enthusiasm
through providing access to financial of bankers and politicians and emerging
services through linking with the success in repayment and social impact,
mainstream. Equity like funding at this this national movement now
level is a huge need and in turn, a huge encompasses 1.4 million such groups

Microfinance in India – Need for Strengthening the Legal Framework


(over 20 million members). The Small
Industries Development Bank of India
(SIDBI) recognized the opportunity and
started implementation of an ambitious
national programme. Providing loan and
capacity building support to MFIs and
capacity building and rating support for
sector development, this programme
already supports 70 MFIs and has
disbursed US$ 46 million. Microfinance
offers another big paradigm shift in
providing equal opportunity in building
business and a 'huge' market to boot.
Foreign investors have been completely
taken in by microfinance and are
investing in the space across the board.
In microfinance, short term loans are
empowering poor women by helping
them become economically self-reliant.
Emerging world of microfinance
sometimes gets damned for stories about
micro-sharks indulging in usury and
dishing out pricey short term loans.
DEVELOPMENT OF
MICROFINANCE IN INDIA
The reform of the interest rate regime
has constituted an integral part of the
financial sector reforms initiative in our
country in 1991. With a view to facilitate
smoother and more meaningful banking
Microfinance in India – Need for Strengthening the Legal Framework
4
with the poor, a pilot project for
purveying micro credit by linking SHGs
with banks was launched by NABARD
in 1992. Reserve Bank of India (RBI)
had then advised commercial banks to
actively participate in this linkage
programme. The scheme has since been
extended to RRBs and Co-operative
Banks. The number of SHGs linked to
banks aggregated 4,61,478 as on March
31, 2002. This translates into an
estimated 7.87 million very poor
families brought within the fold of
formal banking services as on March 31,
2002. More than 90 per cent of the
groups linked with banks are exclusive
women groups.
Cumulative disbursement of bank loans
to these SHGs stood at Rs. 1,026.34
Crores as on March 31, 2002 with an
average loan of Rs. 22,240/- per SHG
and Rs. 1,316/- per family. As regards
model-wise linkage, while Model I, i.e.
directly to SHGs without
intervention/facilitation of any Non-
Government Organisation (NGO) now
accounts for 16 per cent, Model II, i.e.
directly to SHGs with facilitation by
NGOs and other formal agencies
amounts to 75 per cent and Model III,
 5

i.e. through NGOs and financing working with small NGO-MFIs and
agencies as facilitators represents 9 per Community owned / managed
cent of the total linkage. While 488 microfinance organizations. Outreach
districts in all the states/Union has expanded from 39,000 to around
Territories (UTs) have been covered 3,00,000 women members over 2001-05.
under this programme, 444 banks Many of the 26 CASHE partners and
including 44 commercial banks another 136 community organizations
(including 17 in the private sector), 191 these NGO-MFIs work with, represent
RRBs and 209 co-operative banks along- the next level of emerging MFIs and
with 2,155 NGOs are now associated some of these are already dealing with
with the SHG- bank linkage programme. ICICI Bank and ABN Amro. In addition
to the dominant SHG methodology, the
A Non Government Organisation (NGO) portfolios of Grameen replicators have
is a voluntary organization established to also grown dramatically. The Outreach
undertake social intermediation like of SHARE Microfin Limited, for
organizing SHGs of micro entrepreneurs instance, grew from 1,875 to 86,905
and entrusting them to banks for credit members between 2000 and 2005 and its
linkage or financial intermediation like loan portfolio has grown from US$ 0.47
borrowing bulk funds from banks for on- million to US$ 40 million. The 2005
lending to SHGs. A task force on national budget has further strengthened
Microfinance recognized in 1999 that this policy perspective and the Finance
microfinance is much more than micro Minister of Indian Government Mr. P.
credit. Membership of SaDhan (a Chidambaram announced "Government
leading association) has expanded from intends to promote MFIs in a big way.
43 to 96 Community Development The way forward, I believe, is to identify
Finance Institutions during 2001-04. MFIs, classify and rate such institutions,
During the same period, loans and empower them to intermediate
outstanding of these member MFIs have between the lending banks and the
gone up from US$ 16 million to US$ beneficiaries." The 2005 Budget opened
101 million. The CARE CASHE a small window in this area and central
Programme took on the challenges of bank annual policy recently confirmed

Microfinance in India – Need for Strengthening the Legal Framework


discussions on this: As a follow-up to
the Budget proposals, modalities for
allowing banks to adopt the agency
model by using the infrastructure of civil
society organizations, rural kiosks and
village knowledge centers for providing
credit support to rural and farm sectors
and appointment of micro-finance
institutions (MFIs).
Government of India vide their
notification dated August 29, 2000 has
included 'Micro Credit/Rural Credit' in
the list of permitted non-banking
financial company (NBFC) activities for
being considered for Foreign Direct
Investment (FDI)/Overseas Corporate
Bodies (OCB)/Non-Resident Indians
(NRI) investment to encourage foreign
participation in micro credit projects.
This covers credit facility at micro level
for providing finance to small producers
and small micro enterprises in rural and
urban areas.
MICRO CREDIT PROVIDERS AND
PRESENT LEGAL ASPECT
Reserve Bank of India Act (RBI Act)
1934, Banking Regulation Act (BR Act)
1949,State Bank if India Act (SBI Act),
SBI subsidiaries Act and Acquisition &
Transfer of Undertaking Act 1970 &
Microfinance in India – Need for Strengthening the Legal Framework
6
1980 govern the Domestic Commercial
Bank such as public sector banks,
private sector banks & local areas banks.
Regional Rural Bank Act (RRB Act)
1976, RBI Act 1934 & BR Act 1949
govern Regional Rural Banks. Co-
operative Societies Act, BR Act 1949
(AACS) and RBI Act 1934 (for
scheduled Banks) govern the co-
operative Banks. State legislation like
MACS governs Co-operative societies.
RBI Act 1934 and Companies Act 1956
govern the Registered Non-Banking
Financial Companies (NBFCs). Sec 25
of Companies Act and RBI Amendment
Act 1997 govern the unregistered
NBFCs. Societies Registration Act 1960,
Indian Trusts Act, Chapter III c of RBI
Act 1934 and State Money lenders Act
govern other providers like Societies,
Trust etc.
SEPARATE MICROFINANCE BILL
IN PARLIAMENT
Government of India had introduced a
bill in the lower house of the Parliament
to regulate microfinance institutions
(MFIs) in the country. The bill called
The Micro-financial Sector
(Development and Regulation) Bill,
2007. This bill is the result of the
 7

demand from certain sections of the 5. The manner of drafting the bill
growing microfinance sector for a and the way it has been
suitable regulatory framework. introduced by the government
has also drawn serious flak.
NEED FOR A SEPARATE BILL / So the entire process has left to be
ACT FOR MICROFINANCE desired in terms of transparency and
REGULATION IN INDIA wider consultation. The All India Debt
The concerns over the bill are arising and Investment Survey had revealed that
due the following reasons: only about 13.4 per cent of the rural
1. There is a concern for entrusting households have access to institutional
the responsibility of regulation of credit. Financial inclusion of the poor
microfinance providers to the continues to be a major challenge. The
NABARD as it has many Rural Finance Access Survey (RFAs)
limitations as a regulator. conducted by NCAER had also revealed
2. Critics say that self help groups the acuteness of the financial exclusion
(SHGs) may become sub-servant of the poor. The RFAs has found that
to MFIs which could siphon off nearly 87 per cent of the poor
their savings for their own households were without access to any
lending needs leading to formal credit and about 70.4 per cent of
disempowerment. the poor did not have any deposit
3. Doubts have been raised over the account. But there is no clear
ability of NGOs to ensure safety explanation in the bill as to how the
of the deposits of the poor. absence of a legal framework is
4. There is the argument from the constraining these MFIs and in what way
women's lobby that in spite of the provision of such framework would
women being the major help attain the goal of financial
stakeholders of microfinance, the inclusion.
bill has not made any attempt to
give adequate representation to NGOs in India have played a crucial role
them. in the spread of microfinance. The
success is also attracting many newer

Microfinance in India – Need for Strengthening the Legal Framework


NGOs to enter the field. It is estimated
that in India as of 2006 there are about
800 NGOs involved in the delivery of
microfinance with an outreach of about
7.3 million households. Like credit, the
poor need savings services to meet
various contingencies they face in their
livelihood. However, the poor find it
difficult to save with the formal banks
for many reasons. In the absence of
formal savings mechanism, the bulk of
the poor adopt various unsafe and
inconvenient methods of savings.
The bill hopes that this problem can be
addressed by enabling NGOs to offer
savings services to the poor. The
inability to accept savings from their
clients is considered to be a major
hindrance in mobilizing cheaper funds
need for scaling up. This in turn is
supposed to have contributed to the
problem of high lending rates charged by
the NGO-MFIs.
With the rapid growth of
microfinance activity, NGO-MFIs are
faced with the dilemma which emanates
from the nature of their organization
form. Increased outreach and loan
business has created skepticism about
Microfinance in India – Need for Strengthening the Legal Framework
8
the not-for-profit nature of the NGOs.
Microfinance being an activity required
to be pursued on a cost recovery basis,
the not-for-profit form is found to be
operationally constraining and inherently
contradictory by the NGOs.
The uncertainty over the tax status of the
surplus generated from microfinance
operations has created serious concern
among NGOs. Many of them are looking
for a suitable form of organization which
can help them take up microfinance in a
full-fledged way with low capital
requirement and without any dilemma
over profit.
CONCLUSION
A World Bank study assessing access to
financial institutions found that amongst
rural household in Andhra Pradesh and
Uttar Pradesh, 59 per cent lack access to
deposit account and 78 per cent lack
access to credit. Considering that
majority of the 360 million poor
their households (Urban and rural) lack access
to formal financial services, the number
of customers to be reached, and the
variety and quantum of services to be
provided are really large. It is estimated
that 90 million farm holdings, 30 million
 9

non-agricultural enterprises and 50 by prescribing relatively liberal

million landless households in India
collectively need approx US$ 30 billion
credit annually. This is about 5 per cent
of India's GDP and does not seem to be
an unreasonable estimate. A tiny
segment of this US$ 30 billion potential
market has been reached so far and this
is unlikely to be addressed by MFIs and
NGOs alone.
prudential norms.
Efforts are needed to ensure that the
poor and women are able to exercise
control and ownership over MFIs. The
government has to ensure that all the
stakeholders are duly consulted before
the bill passed so that interest of the poor
should be safeguarded properly.

Reaching this market requires serious

capital, technology and human
resources. However, 80 per cent of the
financial sector is still controlled by
public sector institutions. Competition,
consolidation and convergence are all
being discussed to improve efficiency
and outreach but significant opposition
remains, for example, the All India Bank
Employees Association has threatened to
strike if the Government proceeds with
its policy of reducing its capital in public
sector banks, merging public sector
banks or even enhancing Foreign Direct
Investments in Indian Private Banks.

The legal aspect for microfinance aims

of creating an enabling provision for the
NGOs to deliver microfinance in an
integrated way and seeks to achieve this

Microfinance in India – Need for Strengthening the Legal Framework

 10

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Microfinance Bill- Lissing the
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Microfinance in India – Need for Strengthening the Legal Framework