Impact of Microfinance on the Indian Economy

Impact of Microfinance on Indian Economy

What Do We Mean When We Say "Microfinance Impact"?

Understanding how financial services affect the lives of the poor is what impact is all about. Most impact analyses have so far concentrated on microcredit programs rather than a broader variety of financial services. Impact involves income growth, asset creation, and vulnerability reduction.

Impact indicators go beyond traditional business metrics (assets, jobs, and revenues) to incorporate a variety of other factors. Various aspects of poverty, such as overall household income, societal gains in health and education, as well as empowerment (in terms of increased self-esteem and control of household resources among women). 

Benefits of Microfinance 

Microfinance has a number of advantages, lets have a look at them - 

1.  Supplying instant cash

The microfinance system aids in fostering a higher degree of adaptable behavior throughout the economy. It facilitates effective and efficient household operation in general. Additionally, it aids in reducing poverty in these households. It enables businessmen to manage their firms while simultaneously growing them. It gives the company the chance to obtain instant resources for continuing its operations. Additionally, it promotes wealth accumulation, which increases one's availability of finances when needed. 

2.  Credit Availability

The larger banks do not participate in lending to the economically weaker parts since the credit amount is lower when they do so. Large banks also don't lend money to persons who have few or no assets. As they are founded on the idea that tiny credit amounts might be a start towards breaking the cycle of poverty, microfinancing comes to the rescue in this situation. Women typically lack sufficient identification credentials and titles to their homes or land, which makes it difficult for them to access conventional financial institutions.

3.  Better Loan Repayment Rates

Statistics show that women are less likely than men to miss a loan payment, hence microfinance organizations frequently focus on women as potential customers. In addition to giving women more authority, they are the safest investment option for lenders. While men only display these qualities to a 48 percent percentile, women do so to a 55 percent percentile. Since they target women as credit borrowers in recognition of this, microfinance institutions have an overall payback percentage of more than 98 percent, despite the fact that there are frequently many accounts that are past due.

4.  Cares for those who are Overlooked

The majority of people who get microfinance products from microfinance organizations are women, people with disabilities, the unemployed, and people who must provide for their basic needs. It has been found that businesses with a female board of directors outperform those with a male board by achieving up to 66 percent higher returns on invested capital and 42 percent higher returns on sales. Even in industrialized countries, women hold major business leadership positions and mentor others in entrepreneurship.

5.  A Chance to Education 

Since these households are typical of agricultural origin and require their children to work in order to make money and support the family financially, children from economically weaker homes are either not enrolled in school or skip their scheduled school days. By providing money to cover the family's financial needs, microfinance products can save these kids' lives and enable them to finish their education.

Let's say a young girl attends school for eight years. If so, there is a four-fold reduction in the likelihood of her getting married young, a four-fold reduction in the likelihood of teen pregnancies, and an increase in the likelihood that they will graduate from high school, increasing their chances of landing a decent job or pursuing further education.

6.  Future investments are more likely as a result.

The cycle of poverty never ends. Shortage of money leads to a loss of food and water, which causes unhygienic living conditions, hunger, and illness, which prevents people from working and, ultimately, ends in a lack of money.

7.  Expanding Financial Options 

By expanding financial options, microfinance seeks to end this vicious cycle. If money is available, then the most basic demands are satisfied. In order to increase productivity and prevent chronic illness, expenditures can be made on bettering sanitation, digging better wells, and providing better health care. Children can complete their schooling, and the average family size decreases as survival rates rise. Since the people can now meet their fundamental necessities, all of these increase the potential for future investments.

8.  Real Jobs are Created

When business owners obtain credit from microfinance organizations to launch their ventures, they open up employment chances for others. The local economy benefits from increased employment since more money is spent at nearby shops and services.

9.  Substantial Economic Gains

Access to better nutrition, higher consumption, and consumption smoothing are all benefits of participating in microfinance programs. Here, stability is the economic reward rather than money. The high payback rates are evidence of the satisfaction microcredits have brought. Therefore, microfinance almost always has a favorable overall impact. Microfinance, therefore, offers many benefits and is a crucial instrument in the fight to end the cycle of poverty.

Challenges of Microfinance 

1.  Over-Indebtedness

Over-indebtedness is a major barrier to the expansion of the microfinance business because it works with underprivileged groups in Indian society who want to raise their standard of living. The most important reasons that put pressure on the microfinance business in India are the rising tendency of multiple borrowing by clients and ineffective    risk management. Providing loans without security raises the risk of bad debts in the microfinance industry. The Indian microfinance industry clearly lacks the basic infrastructure planning required for rapid growth.

2.  Compared to mainstream banks, higher interest rates

When compared to Indian commercial banks, MFIs' financial success is modest. The long-standing banking system is well-established in India and is gradually changing to meet modern demands. When compared to commercial banks, the majority of microfinance institutions charge quite high-interest rates (12–30%). (8-12 percent ). Guidelines were published by the regulatory body RBI to abolish the 26 percent cap on interest rates for MFI loans.

The RBI guidelines amendment helped many MFI sector businesses, while it had the opposite effect on borrowers. The result of borrower indebtedness brought on by the increasing interest rates is a significant trend in farmer suicide in places like Andhra Pradesh and Maharashtra.

3.  Dependence on the Indian Banking System is widespread

As registered NGOs, the majority of microfinance institutions rely on financial institutions like commercial banks for stabilized funding to conduct their own lending activities. The majority of these commercial banks are privately owned organizations that charge higher interest rates. Additionally, they approve loans with shorter terms. Indian MFIs are incapable of being a reliable lending partners because of their extreme reliance on banks.

4.  Lack of Enough Awareness of Financial Services in the Economy

A developing country in the making, India has a low literacy rate, which is still more moderate in its rural sections. The majority of Indians lack a fundamental understanding of financial principles. The general public has very little knowledge of the financial services offered by the microfinance sector. The rural population's inability to utilize MFIs for a quick credit to meet their financial needs is significantly hampered by this lack of adequate understanding.

Additionally, it contributes to the nation's pervasive financial exclusion. MFIs also have the extra responsibility of educating the public and building trust before they begin loaning money. It is challenging for these institutions to survive in the highly competitive conditions found in developing countries because of the significant lack of knowledge about the policies and goods offered by MFIs.

5.  Regulation Concerns

In India, the microfinance sector is primarily regulated by the Reserve Bank of India (RBI). However, the RBI primarily supports conventional and commercial banks rather than MFIs. Microfinance organizations have substantially different requirements and organizational structures than other traditional lending organizations.

While certain laws appear to have benefited MFIs, others left many problems unresolved. The microfinance sector seems to have had trouble surviving despite intermittent and unheard-of legislative reforms. Although new legislation leads to structural and  operational changes, it can leave the standards of conduct unclear. Failure to produce innovative financial products and services and subpar performance are the outcomes.

6.  Selection of the Proper Model

The Joint Liability Group (JLG) or Self-Help Group (SHG) lending models are used by the majority of MFIs in India. They hardly ever choose the model using scientific justification. Regardless of the circumstance, the majority of MFIs select the models at random.

Additionally, the model choice is permanent and raises the danger of borrowing beyond what the weaker portion can handle. In the end, the model choice has an impact on the MFI organization's long-term viability.


Even though it has come a long way, the microfinance industry can benefit from technological advancement by providing loans to India's rural population. The use of alternative data facilitates lending to rural residents with poor credit histories and aids in lowering over-indebtedness. Additionally, the software tool can produce recommendations for borrowers' specific needs-based products. 

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