Introduction:Microfinance is a financialservice wherein small amounts of money is lent to individuals who cannot affordfor it from banks and other services.
The amount may range from $100 to$25000(Source: Investopedia). Previously, microfinance wasquite a narrow concept as, it was only lending of money to very smallbusinesses who failed to get financial support from banks. The main feature ofthe microfinance is that the borrower need not set any collateral against it. Due to the efforts of Prof.
Muhammad Yunus whowas instrumental in providing support to the poor and underprivilegedespecially women by starting the Grameen Bank during the year 1970 inBangladesh, microfinance today, has expanded not to the areas of credit butalso savings, insurance and leasing. Since then, the industry has been thrivingand has attracted a considerable interest in the financial world. Since thereare no restrictions in order to get open access to capital, it has a greaterchance of harbouring economic growth. Microfinance with respect to Risk management:Although the industry is growingin leaps and bounds, the Micro Finance Institutions(MFI) are concerned aboutdeveloping new products and services.
I say this because, there are risks whichare associated with the dynamism of microfinance which are not fully understoodby 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, creditrisk, strategic risks, etc. In order to mitigate this risk, the MFIs generallyhave high repayment rates. Studies have revealed that a new technique which iscalled ‘group based/incentive based lending’ is generally used by these MFIs.Such type of lending makes each member of the group jointly liable for thecredit; if any of the member’s default, each and every member of the group istaken to task; it is mandatory for the prospective borrowers to form groupsthemselves.
Limitations:Microfinance or microcredit,though a modern phenomenon, has several drawbacks. Studies have revealed thatas an industry it has not yet had a huge impact, especially in India. Therehave been cases wherein the institutions have used coercive ways in order torecover the loan amount. Because of this and many other reasons, the gapbetween the rich and the poor is widening. A study on the effectiveness of theMFIs by the Vietnam Bank for Social Policies (VBSP) revealed that microfinancefails to reach to the poorest of the poor and that the MFIs are concentratingon people who would repay the loans than to the ones who really are in need ofit.
The MFIs are focusing on having a trade-off between financial over theirsocial goals. With respect to the borrowers, the loans are used for consumptionpurposes rather than using the money for starting an enterprise. There ispractically no guarantee of reduction of poverty because there is no legalsystem which ensures that this process goes on smoothly. This ultimately leadsto a cycle of borrowings and a vicious cycle of greater debt.
Case scenario in Indian Context:There have been instances inIndia where there were frauds committed in the form charging exorbitantinterest rates, aggressive loan practices by Share and Spandana, both which aretwo of the largest commercial MFIs. The inhabitants of Peddammagadda townsituated in Warrangal, a city in the south Indian state of Andhra Pradesh, havebeen trapped in the vicious cycle of debt for keeping their clothing businessalive. Conclusion:Though Microfinance has attracteda considerable interest in the financial world, it needs to be sustainable onan overall basis. There needs to be a system which actually regulates the functioningof these MFIs through which it can in an effective way, contribute to FinancialInclusion.