How microfinance institutions work?


How microfinance institutions work?


One of the major issues faced by developing countries is that of poverty. These countries have yet not fully developed or industrialized and they have low HDI (Human Development Index). Hence, they usually struggle with the problems of growing divide between the rich and poor, economic and gender inequality, illiteracy, higher crime rate and other evils of the society.


The key to solve many of the issues of such a society lies in providing equal opportunity to all and making each and every segment of the society equally involved in the gains and losses of the whole country. A small step towards this is a “Microfinance Institution” or MFI.


A microfinance institution is basically an organization which provides financial services to the poor and disadvantaged households mainly in the rural areas. Its main goal is to make these services available even to the most remote or poor region of a country, hence they have a wide and highly branched distribution network.


The need to have such an institution is that most commercial financial institutions that we have today, like banks, are not able to reach out to this low-income sector public. They usually get left out and even simple basic financial services like a savings account or formal loaning is not available to this population resulting in bad practices like hoarding money in the house, informal money borrowing and lending and other fraudulent practices. It also breeds financial illiteracy. It is the right of each and every citizen to have access to financial services. With this in mind, the micro finance institutions came into existence.


Various types of institutions like – NGOs, commercial banks, credit unions, sectors of government banks and other cooperatives offer microfinance services. Nowadays, “for-profit” microfinance institutions are also growing. Such institutions in India are called Non-Banking Financial companies (NBFC).

The structure of microfinance institutions consists of the following hierarchy:


(Head office of the MFI –> Regional officer –> Divisional officer –> Branch officer –> Field officer –> Batches –> Group –> Individual)


Before selecting a village for setting up a MFI, a thorough evaluation of the village is carried out, and valuable statistics like the population, demographics, etc. are gathered.

Once the village is decided, an introductory seminar is carried out in the village and information is given out about the institution, the services it provides, and the mechanism of its operations.

After this interested women are gathered in groups. A group usually consists of 5 individuals headed by a leader from the group. When any credit is given to an individual, the remaining members of the group act as his guarantors, thus, the individuals are careful while forming a group. If a person defaults from repaying the loan then the entire group is penalized and it is this peer pressure which enforces loyalty among the individuals, and ensures that the full amount of the loan is repaid in time.

After this, group training programs start and a village center is created where all the payments will be collected. A field officer presides over the meetings of the village batches in the village center. These meetings are regularly conducted wherein repayments are collected and discussions on loans and other topics are carried out. However, it must be noted that any borrowing of loan is done only through the branch officer.
Owing to the high risk of default, borrowing is done only after thorough checks are conducted. There are specific rules which are followed by all the MFIs before they sanction a loan. The feature which makes an MFI unique and especially suited to the needs of the low income sector is that collaterals or securities are not necessarily required for taking a loan. Necessary evaluation and documentation is done and all care is taken to check the viability of the business and the individual’s group for repayment of the loans. Beating the high risk of default, the unique structure of such institutions and their way of functioning, as depicted above, have ensured a minimum default rate and over 95% of the loans are repaid. This is tremendous success and calls for even more growth.


Some of the well performing MFIs in the world are: The Grameen bank in Bangladesh, Microcredit organization Sunrise in Bosnia, BESA Fund in Albania, AgroInvest in Serbia,, etc. According to a rating provided by CRISIL, the top microfinance institutions in India is Annapurna Microfinance Ltd. Other well-known examples of MFIs in India include Grameen Financial Services Ltd., Equitas Microfinance Pvt. Ltd., Cashpor Micro Credit, SKS Microfinance Ltd, Ujjvan Financial Services Pvt. Ltd., etc.


Due to their performance, microfinance institutions are funded by donors, private equity funds or even other financial institutions. The method can be improved by inculcating technology in carrying out the transactions and using it in the best possible way. Point of sales terminals like bank cards swiping machines or even smartphones go a long way and are preferred over building brick and mortar stores. Effective use of technology will not only help the institutions in greater penetration, but it will also transform the processes into simpler, faster and cleaner steps. These institutions are not only creating value for themselves, they are creating value for the entire country by elevating the poor and offering them the services that they were earlier deprived of, thus rendering equal opportunities of success to all.


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