Introduction: not to the areas of credit but

Introduction:

Microfinance is a financial
service wherein small amounts of money is lent to individuals who cannot afford
for it from banks and other services. The amount may range from $100 to
$25000(Source: Investopedia).

Previously, microfinance was
quite a narrow concept as, it was only lending of money to very small
businesses who failed to get financial support from banks. The main feature of
the microfinance is that the borrower need not set any collateral against it.  Due to the efforts of Prof. Muhammad Yunus who
was instrumental in providing support to the poor and underprivileged
especially women by starting the Grameen Bank during the year 1970 in
Bangladesh, microfinance today, has expanded not to the areas of credit but
also savings, insurance and leasing. Since then, the industry has been thriving
and has attracted a considerable interest in the financial world. Since there
are no restrictions in order to get open access to capital, it has a greater
chance of harbouring economic growth.

Microfinance with respect to Risk management:

Although the industry is growing
in leaps and bounds, the Micro Finance Institutions(MFI) are concerned about
developing new products and services. I say this because, there are risks which
are associated with the dynamism of microfinance which are not fully understood
by the institutions. Microcredit, which was the first microfinance revolution,
involves its own set of risks with respect to lenders.  The MFIs face various types of risk namely:
liquidity risks, market risks, operational risks, transaction risks, credit
risk, strategic risks, etc. In order to mitigate this risk, the MFIs generally
have high repayment rates. Studies have revealed that a new technique which is
called ‘group based/incentive based lending’ is generally used by these MFIs.
Such type of lending makes each member of the group jointly liable for the
credit; if any of the member’s default, each and every member of the group is
taken to task; it is mandatory for the prospective borrowers to form groups
themselves.

Limitations:

Microfinance or microcredit,
though a modern phenomenon, has several drawbacks. Studies have revealed that
as an industry it has not yet had a huge impact, especially in India. There
have been cases wherein the institutions have used coercive ways in order to
recover the loan amount. Because of this and many other reasons, the gap
between the rich and the poor is widening. A study on the effectiveness of the
MFIs by the Vietnam Bank for Social Policies (VBSP) revealed that microfinance
fails to reach to the poorest of the poor and that the MFIs are concentrating
on people who would repay the loans than to the ones who really are in need of
it. The MFIs are focusing on having a trade-off between financial over their
social goals. With respect to the borrowers, the loans are used for consumption
purposes rather than using the money for starting an enterprise. There is
practically no guarantee of reduction of poverty because there is no legal
system which ensures that this process goes on smoothly. This ultimately leads
to a cycle of borrowings and a vicious cycle of greater debt.

Case scenario in Indian Context:

There have been instances in
India where there were frauds committed in the form charging exorbitant
interest rates, aggressive loan practices by Share and Spandana, both which are
two of the largest commercial MFIs. The inhabitants of Peddammagadda town
situated in Warrangal, a city in the south Indian state of Andhra Pradesh, have
been trapped in the vicious cycle of debt for keeping their clothing business
alive.

 

 

Conclusion:

Though Microfinance has attracted
a considerable interest in the financial world, it needs to be sustainable on
an overall basis. There needs to be a system which actually regulates the functioning
of these MFIs through which it can in an effective way, contribute to Financial
Inclusion.