Microfinance is a relatively new term in the world of finance and banking. While lending money has been prevalent for over a couple of thousand years, the concept of microfinance in a structured shape took birth about 50 years ago. Of course, one would have read about small amounts of money being loaned to the poor during 1700-1800 in Ireland. But there is no documentation to establish that formal business loans were disbursed till the 1970s.
Do You Know? Today even a person in the lowest rung of society can aspire to become an entrepreneur. Loans as little as Rs 20,000 are available as microfinance for a business loan.
What Is Microfinance?
Microfinance is a concept whose primary goal is to use loans as a tool to alleviate poverty in India. However, most microfinance firms go beyond that and help in other areas like education, insurance, and even guiding the needy on banking operations.
Microfinance has helped many to improve their lives through entrepreneurship. The focus has mainly been on Rural India, where normal banking systems are beyond the reach of the poor, somewhat uneducated population.
When Did Microfinance Originate?
The idea of microfinance was conceived by Prof. Muhammad Yunus, a highly acclaimed Bangladesh economist and social leader. In 1970, he started the Grameen Bank to revive the lives of the poor and oppressed. He believed that, with a little help, the poor could be transformed into entrepreneurs who added value to society. His untiring efforts were very well received in Bangladesh and the entire world. Grameen Bank set records in the disbursal of microfinance business loans.
In 2006, Yunus and his Grameen Bank were awarded the Nobel Peace Prize. Being the philanthropist that he was, he allocated the entire Nobel Prize Money for noble causes like developing low-cost, high-nutrition food for the poor, establishing the Yunus Science and Technology University, and building an eye hospital for the poor. More than 100 countries in the world have adopted the microfinance for business loan model of Muhammad Yunus.
One of the first microfinance firms in India was SEWA bank in Ahmedabad. SEWA stands for Self-Employed Women's Association. Subsequently, encouraged by the Government's progressive policies, many more followed.
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Why Is Microfinance Required?
In this world, economic disparity is always a significant challenge grappled with by governments. Rich business people can afford to invest in profitable ventures and get richer. The poor struggle to make ends meet and get poorer. For peace and stability in the world, such a crass imbalance must be curtailed. The only way it can be achieved is if we can find a way to improve the financial condition of the poor. We can expect their lives to get better slowly by lending very small amounts to the poor. Microfinance for a business loan is thus a simple way to create productive entrepreneurs out of the poor.
Types of Microfinance
In India, there are four types of microfinance for business loans.
1. JLG – Joint Liability Group
This is where a few people join together and seek a loan based on a joint guarantee. Quite a few banks have now come forward to support this scheme to provide microfinance for business loans. The liability is equally binding on every member of the Group. This certainly has the problem of too many minds operating together with the likelihood of differences of opinion. But, at a macro level, they are working well.
2. SHG – Self-Help Group
This is a very active and successful type of microfinance for business loans. In this category, a group of people come together (like a cooperative society), operate with a common purpose, and have similar activities. Farming groups, for example. To support this initiative, the Government of India created an apex body in 1982. It was named National Bank for Agriculture and Rural Development (NABARD). This turned out to be a major success and spread all over the country in no time. NABARD’s contribution was most significant in the Southern states of Tamil Nadu, Kerala, Karnataka and Andhra Pradesh.
3. Grameen Bank Model
We talked about Prof. Yunus of Bangladesh and the Grameen Bank he created. This experiment spread such huge waves worldwide that India could not just be a silent onlooker. India swiftly got into action and encouraged the formation and spread of RRBs (Regional Rural Banks). RRBs are created to serve rural areas with basic banking and financial services. However, RRBs also have urban branches. This model met with some success but was not as effective as some of the other models. Repayment failures and inadequate measures to control them were the primary reasons.
4. Rural Cooperatives
Rural Cooperatives are not a new concept. It existed right from the days of India’s Independence and has been mushrooming all over rural India. A group of people with limited resources would pool and use them to lend as business loans. This model also met with limited success as it was somewhat restrictive. Loans were given only to those with a stronger financial base to repay. The objective of poverty alleviation was not met.
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Features of Microfinance for Business Loan
How is microfinance for business loans different from the traditional banking system?
The fundamental difference is in their goals. The goal of a commercial bank is to generate a profit. The primary purpose of microfinance is poverty alleviation and improvement of the quality of life of the rural population.
Hence, the key features of microfinance are as follows:
- Loans target rural, low-income persons who strongly urge to start a profitable activity.
- The loan amounts are small. Hence, they are often called microloans. They usually range between ₹20,000 to ₹50,000, rarely higher.
- The term of these loans and closure of the loans are generally short.
- No collateral is expected or demanded in microfinance business loans.
- The repayment instalments are more frequent and short-spaced than commercial banks' loans.
- Microfinance business loans are primarily meant for income generation.
- Microfinance firms often provide additional services like education, insurance, business training, counselling, banking, etc.
Who Provides Microfinance?
Several organizations provide microfinance for business loans. Generally speaking, the following are the most common categories:
- Cooperative banks and Societies
- Credit Unions
- NGOs who focus on rural livelihoods
- Regular Commercial banks
- Formal and Informal groups are formed by interested persons to meet a common purpose
Eligibility and Documentation
There is not necessarily a standard format for documentation for microfinance for business loans. Every institution designs and implements its processes.
The most common ingredients are listed below:
- An application form to be duly filled in
- Proof of Identity
- Proof of address
- Photographs of all applicants
- If it is a Firm, copies of Company/Partnership registration documents
- If loans have been taken before, the history of repayment
- Audited financials of the previous years
- Income Tax Assessment Order or ITR application of the borrowers
- Recent Bank statements for at least 6 months
- If it is for the purchase of any equipment, quotation and the proforma invoice of such equipment
- Those with professional education must submit their certificates.
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Brief List of Microfinance Organisations
The most active organisations engaged in offering microfinance for business loans are:
- Arohan Financial Services Pvt Ltd
- BSS Microfinance Pvt Ltd
- Cashpoor Micro Credit
- Equitas Microfinance Pvt Ltd
- Asirvad Microfinance Pvt Ltd
- Bandhan Financial Services Pvt Ltd
- Disha Microfin Pvt Ltd
- Annapurna Microfinance Pvt Ltd
- ESAF Microfinance and Investments Pvt Ltd
- Fusion Microfinance Pvt Ltd
Microfinance for a business loan is one of the fastest-growing sectors in the Indian economy. NABARD alone has advanced over ₹6 lakh crores of loans so far. With India's large rural base, the scope of this sector seems limitless.
The World Bank reports that in 2021 alone, more than 500 million people have availed of microfinance facilities.
Track Record of Repayment of Business Loans
Lending always carries the risk of default by borrowers. Lenders cannot escape this fact. However cautious lenders are, there will always be circumstances beyond the borrower’s control. This leads to the failure of the borrower to make repayments on time.
Commercial banks are protected to a great extent as their loans are covered through collateral. But, in the case of microfinance for business loans, loans are provided without collateral. Thus it is open to risk.
When a borrower fails to repay either the principal instalment or the interest beyond 90 days from the due date, the loan is declared a Non-Performing Asset (NPA). In the organized banking sector, this is expected to be fairly low. RBI’s latest reports indicate that NPAs are falling at about 5.9%. RBI predicts that this could drop further to 5.5%.
In FY21, public sector banks reported a gross NPA of ₹6,00,000 Crores, a mind-boggling figure. Compared to this, the 12% repayment failure rate amounting to ₹330 crores in the microfinance segment looks insignificant. Regarding amounts lost or written off, NPA in microfinance is below 6% of what commercial banks will lose. We can thus safely state that, given the higher purpose of establishing microfinance for business loans, the objectives have been well met.
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Regulations Governing Microfinance for Business Loan
With the rapid, uncontrolled spread of microfinance for business loans, the Government of India realized that some unscrupulous elements could take advantage of the less educated and ignorant rural borrowers. Hence, to ensure that the segment is monitored and protected, the Government of India enacted the Microfinance Institutions (Development and Regulation) Bill in 2012.
The Bill facilitated the creation of a Microfinance Development Council. The Council drew members from several Ministries, RBI, SIDBI, NABARD and others. States were also asked to create Regional Councils. As the sole regulator of NBFC microfinance, the RBI will ensure that the interest of all present and future stakeholders are protected.
Any activity impacting a large segment of society is bound to receive both applause and criticism. However, we should view the activity based on the results it has achieved in an overall manner. Judging from this, microfinance for business loans has greatly contributed to millions of people who could never have dreamt of a better life. It is for those in authority and power to use this facility for the common good of all.
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