What is microfinance?

Since the 1980s microfinance has become an important component of development, poverty reduction and economic regeneration strategies around the world. By the early twenty-first century, tens of millions of people in more than 100 countries were accessing services from formal and semi-formal microfinance institutions
Microfinance rests on the belief of mutual faith and reciprocity. Members in a genuine, self-selected and closely associated group are mutually responsible for the financial dealing of each member. When a request for a loan is received, members discuss the need and prospects of repayment. Once satisfied, the loan amount is approved. Group lending is preferred to individual lending as social collateral, peer pressure and good collection methods reduce defaults significantly. Microfinance loans are primarily unsecured and work on the principles of peer pressure to avoid defaults. Microfinance serves low-income households and encourages the spread of banking services. Financial inclusion is essentially providing banking services to the population derived from this facility. Microfinance is thus an enabler for promoting financial inclusion.

The Reserve Bank of India (RBI) responded by appointing an RBI sub-committee known as the Malegam Committee. This committee aimed to address the primary customer complaints that led to the crisis, including coercive collection practices, usurious interest rates, and selling practices that resulted in over-indebtedness. The existing regulations did not address these issues, thus, who should respond to these issues, and how they should respond, was uncertain. This prolonged the general regulatory uncertainty and the resulting repayment and institutional liquidity issues. The Malegam Committee released their recommended regulations in January 2011. These recommendations were 'broadly accepted' by RBI in May 2011, though specific regulation was only released regarding which institutions qualify for priority sector lending at this time.
Additionally, an updated version of the Micro Finance Institutions (Development and Regulations) Bill 2011 is in Parliament, which aims to provide a regulatory structure for microfinance institutions operating as societies, trusts, and cooperatives. Although this shows that regulators are taking steps to address the crisis issues and resolve regulatory uncertainty, banks have not resumed lending to microfinance institutions as of July 2011.

While Microfinance may be scaling geographically and average lending per capita rising structural and cultural issues limit effectiveness. At times cross guarantee programs are rolled out to reduce credit risk and in turn foster community solidarity. When it works it works but when community buys it is difficult to achieve then lender risk rises and many at times individuals do not get approved for loans. To conclude, microfinance has made satisfactory progress during the last one and half decade. This progress was achieved purely at the public initiative. There is strong need to expand it to other backward areas. However, strong support, including policy and finance, from the government and other agencies would be necessary to extend it to all places.

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