MICROFINANCE AS A SOURCE OF FUND

"Microfinance" is often defined as financial services for poor and low-income clients. In
practice, the term is often used more narrowly to refer to loans and other services from
providers that identify themselves as "microfinance institutions" (MFIs). These
institutions commonly tend to use new Business Models developed over the last 30 years
to deliver very small loans to unsalaried borrowers, taking little or no collateral. These
methods include group lending and liability, pre-loan savings requirements, gradually
increasing loan sizes, and an implicit guarantee of ready access to future loans if present
loans are repaid fully and promptly.

MFI came into existence when the lack of access to credit for the poor is attributable to
practical difficulties arising from the discrepancy between the mode of operation
followed by financial institutions and the economic characteristics and financing needs of
low-income households. For example, commercial lending institutions require that
borrowers have a stable source of income out of which principal and interest can be paid
back according to the agreed terms. However, the income of many self employed
households is not stable, regardless of its size. A large number of small loans are needed
to serve the poor, but lenders prefer dealing with large loans in small numbers to
minimize administration costs. They also look for collateral with a clear title - which
many low-income households do not have. In addition bankers tend to consider low
income households a bad risk imposing exceedingly high information monitoring costs
on operation.

MicroCredit which is an integral part of Microfinance is the extension of very small loans
(microloans) to those in poverty designed to spur entrepreneurship. These individuals
lack collateral, steady employment and a verifiable credit history and therefore cannot
meet even the most minimal qualifications to gain access to traditional credit.

Over the last ten years, however, successful experiences in providing finance to small
entrepreneur and producers demonstrate that poor people, when given access to
responsive and timely financial services at market rates, repay their loans and use the
proceeds to increase their income and assets. This is not surprising since the only realistic
alternative for them is to borrow from informal market at an interest much higher than
market rates. Community banks, NGOs and grass root savings and credit groups around
the world have shown that these micro enterprise loans can be profitable for borrowers
and for the lenders, making microfinance one of the most effective poverty reducing
strategies.

To the extent that microfinance institutions become financially viable, self sustaining,
and integral to the communities in which they operate, they have the potential to attract
more resources and expand services to clients. Despite the success of microfinance
institutions, only about 2% of world's roughly 500 million small entrepreneurs are
estimated to have access to financial services.
The Grameen Bank which is a synonym for MicroFinance, makes small loans to the
impoverished without requiring collateral. Established in 1976, the Grameen Bank (GB)
has over 1000 branches (a branch covers 25-30 villages, around 240 groups and 1200
borrowers) in every province of Bangladesh, borrowing groups in 28,000 villages, 12
lakh borrowers with over 90% being women. It has an annual growth rate of 20% in
terms of its borrowers. The most important feature is the recovery rate of loans, which is
as high as 98%. A still more interesting feature is the ingenious manner of advancing
credit without any "collateral security". The Grameen Bank lending system is simple but
effective. The system of this bank is based on the idea that the poor have skills that are
under-utilized. A group-based credit approach is applied which utilizes the peer-pressure
within the group to ensure the borrowers follow through and use caution in conducting
their financial affairs with strict discipline, ensuring repayment eventually and allowing
the borrowers to develop good credit standing.

The Business Model on which most of the Microfinance works is solidarity lending.
Solidarity lending is a lending practice where small groups borrow collectively and group
members encourage one another to repay. It is an important building block of
microfinance. Solidarity lending lowers the costs to a financial institution related to
assessing, managing and collecting loans, and can eliminate the need for collateral.

Another kind of MFI in India is indigenously developed system known as Chit funds;
they are the closest thing to a bank in many parts of India. They mobilize huge amounts
of small savings and offer the same as some sort of microfinance. Properly used chit
funds are an effective tool to meet unplanned, unforeseen and unexpected expenses,
especially for the middle class and small businessmen. Chit fund is a dual-purpose
instrument for both borrowing and saving. It has no financial intermediation. Each chit
group is in a way a self-help group. Members invest a fixed amount every month. This
collection is available for borrowing. Auctions are conducted every month. The members
who bid for the highest discount win. The dividend at every auction is distributed to the
subscribers out of the discount (the difference between the chit amount and the amount
bid), after deducting the group foreman's commission. Shriram Chits has more than 22
lakh subscribers.

If we consider the fact that MFIs role is to lend loan to impoverished sector of the society
so that they raise their living standards and can provide a stable lifestyle to their families,
which can be possible only when a group of member can come up with an business idea.
But how successful the entity is going to be after its formation and will result in timely
repayment of the loan cannot be guaranteed. I personally feel, instead of letting the
inexperienced group to decide upon the venture all the time, MFIs or NGO's should set
up ventures which can be either be an subsidiary of existing stable company or something
which can traded outside the community, guaranteeing the flow of funds. This will bring
a stable or regular source of income for many households without the worries of loan.
The reason behind this though is the criticism behind the Microcredit institutions. Some
experts argue that most microcredit institutions are overly dependent on external capital.
A study of microcredit institutions in Bolivia in 2003, for example, found that they were
very slow to deliver quality microsavings services because of easy access to cheaper
forms of external capital. Global data tables from The Microbanking Bulletin show that
savings represent a small source of funds for microcredit institutions in most developing
nations.

Because field officers are in a position of power locally and are judged on repayment
rates as the primary metric of their success, they sometimes use coercive and even violent
tactics to collect installments on the microcredit loans. Some loan recipients sink into a
cycle of debt, using a microcredit loan from one organization to meet interest obligations
from another.

Recent move by Indian government to repay the loan taken by the farmers of certain
segment is the result of delinquency. To avoid such incidences again, its better to invest
in upbringing of this segment by bringing an regular source of income to the households.

Technology in Microfinance will not only help in retrieving the data for deserving
borrowers but can also help in tracking the flow of funds. Theoretically, microfinance
may encompass any efforts to increase access to, or improve the quality of, financial
services poor people currently use or could benefit from using. For example, poor people
borrow from informal moneylenders and save with informal collectors. They receive
loans and grants from charities. They buy insurance from state-owned companies. They
receive funds transfers through remittance networks (like Hawala). Technology can help
monitoring and improving the accessibility of funds to the deserving section of the
society and at the same time can help Microfinance institutions to measure and disclose
their performance both financially and socially to the government.

On the lines of core banking solutions, all MFIs in a country can be interlinked to each
other through network which will ultimately help govt. organization to follow the flow of
source of funds. This in other way can help in AML.

Proper Consulting can help MFI's or NGO's to decide upon the right industry which can
be established to a particular location. Taking a place like vidarbha into account, which
lacks in proper irrigation facilities, can be best judged to be the right place for a power
sector company to establish an solar power system. This will be financially many viable
then lending loans to struggling families of farmers who end-up in repaying their existing
loans.

Some valuable lessons can be drawn from the experience of Microfinance operation. First
of all, the poor repay their loans and are willing to pay for higher interest rates than
commercial banks provided that the venture they decide to start from the loan executes
successfully. Technology should be used for proper streamlining the flow of funds and at
the same time creating a transparent business model for the MFIs. Consultancies should
be used to decide if establishing a large scale industry is better for providing stability to
target segment.