Beyond Financial Inclusion: The Future of Microfinance in India

Background

Indian government’s recent financial budget for the fiscal year 2023-24 had numerous implications for various sectors, including microfinance. Microfinance has been a significant contributor to India’s economic growth, especially in rural areas, and has helped reduce poverty by providing financial assistance to small businesses and low-income households. Consequently, the dominance of NBFC-MFIs in the market continued, with a portfolio share of 40.4%, followed by banks at 32.5% and small finance banks at 17.2% (MFIN, 2023).

Figure 1. Average Ticket Size of Loans Disbursed under Microfinance (Source: Microfinance Pulse Report, 2023)

However, an analysis of the ticket size reveals a strategic move toward higher ticket-size loans, which are deemed more operationally viable and profitable. The average microfinance ticket size increased by 6.3% year-on-year to ₹41,391 in FY23. The Compound Annual Growth Rate (CAGR) for average ticket size from FY19 to FY23 was 6.3%, with the over ₹60,000 loan bucket exhibiting the highest CAGR of 6.9% (MFIN, 2023). Concurrently, the share of loans below ₹30,000 fell from 45% to 31% in terms of loan volume, hinting at a shift in microfinance clientele beyond those in need of financial inclusion (MFIN, 2023). Concurrently, the government has introduced various policies to support microfinance institutions (MFIs) and small businesses in the country. This blog post will discuss some of these policies in detail.

Increase in the Microfinance Fund

The government had increased the Microfinance Fund by INR 1,500 crore (USD 200 million) to benefit micro and small enterprises as well as MFIs (GoI, 2023). The increase in the fund will provide more financial support to the microfinance industry, which will help in the growth of small businesses in rural and urban areas, creating more job opportunities. This initiative will also help in reducing poverty in rural areas and increase financial inclusion, which is a crucial step towards achieving the goal of inclusive and sustainable economic growth.

Microfinance institutions in India face various challenges, such as lack of funding, high cost of borrowing, and stringent compliance regulations. The increase in the Microfinance Fund will help in addressing some of these challenges by providing more financial support to these institutions. This will enable MFIs to offer their clients better financial products and services and expand their outreach to more remote and underdeveloped areas.

Digital Payment Systems

The Indian government has been promoting digital payment systems for a while now, and it has been successful in reducing the use of cash in the country. In the recent budget, the government has announced various initiatives to promote digital payments further. The government has proposed to waive Merchant Discount Rate (MDR) charges on digital transactions for small businesses with a turnover of up to INR 50 crore (USD 6.7 million) (GoI, 2023). This initiative will encourage more small businesses to adopt digital payment systems, which will lead to less cash usage and promote financial inclusion.

The COVID-19 pandemic has highlighted the importance of digital payment systems in ensuring the continuity of economic activities during times of crisis. The promotion of digital payment systems will not only reduce the health risks due to proximal transmission but also help improve the efficiency and transparency of the financial system. This will also enable micro and small businesses to access a wider range of financial products and services, such as loans, insurance, and savings accounts previously inaccessible to them.

Credit Guarantee Scheme for Small Businesses

The government has also introduced a Credit Guarantee Scheme for small businesses in the budget for FY 2023-24 (GoI, 2023). Under this scheme, the government will provide a partial credit guarantee to banks and other lending institutions for loans given to small businesses. This initiative will help reduce the risk for lending institutions and encourage them to provide more loans to micro and small enterprises. This will lead to more financial support for small businesses, which will help them grow and create more job opportunities.

Small businesses in India have been facing various challenges, such as a lack of access to credit, high interest rates, and collateral requirements. The Credit Guarantee Scheme will help address some of these challenges by reducing the risk for lending institutions and making it easier for small businesses to access credit. This will enable them to invest in their businesses, expand their operations, and create more employment opportunities, which is crucial for the economic growth of the country.

Performance of the Microfinance Sector

In the fiscal year 2023, the microfinance sector exhibited substantial growth and resilience, overcoming challenges posed by the pandemic. Key financial indicators, such as the Portfolio at Risk (PAR) for NBFC-MFIs, demonstrated a positive trajectory, declining from 22.44% in June 2021 to 10.5% in March 2023 (SIDBI, 2023). The Microfinance Industry Network (MFIN)’s India Microfinance Review for FY23 revealed a commendable reduction in gross Non-Performing Assets (NPAs) as well. In FY23, the gross NPAs of MFIs decreased to 2.7%, reflecting a significant improvement from 5.6% in FY22 and 5.2% in FY21 (SIDBI, 2023). This financial rebound can be attributed to a combination of resumed business operations post-COVID and regulatory changes that played a pivotal role in restoring sustainability and profitability.

Figure 2. Status of Microfinance Sector in India (Source: Microfinance Pulse Report 2023)

Moreover, the report highlighted the outperformance of the new portfolio created in FY23, setting an optimistic tone for the sector’s future. The estimated potential demand for FY24 stands at ₹13 lakh crore, with a credit gap of approximately 70%. The microfinance loan portfolio demonstrated robust growth, expanding by 22% year-on-year to ₹3.48 lakh crore as of March 2023. This growth was supported by 80 lakh new clients added during FY23, bringing the total number of active loans to 12.96 crore, serving 6.64 crore borrowers across 729 districts, including 112 aspirational districts (MFIN, 2023).

An interesting shift in repayment dynamics was observed, with 46% of microfinance lenders opting for repayment tenures of 18-24 months (MFIN, 2023). However, 30% of industry-level loans extended beyond 24 months, signalling a shift in loan structures (MFIN, 2023). Notably, there is a trend toward monthly repayment frequencies, contributing to operational efficiency. Some institutions have even adopted weekly collections, reducing the cash handled and emphasizing the potential benefits of digitalization in repayment processes, as mentioned earlier.

Conclusion

The financial budget for FY 2023-24 has introduced various policies to support the microfinance industry and small businesses in India. The increase in the Microfinance Fund, promotion of digital payment systems, and Credit Guarantee Scheme for small businesses are some of the initiatives that will help reduce poverty, increase financial inclusion, and create more job opportunities. These policies are crucial for achieving inclusive and sustainable economic growth, which is essential for the nation’s overall development.

Despite the overall positive growth, certain challenges surfaced. The share of East and Northeast states in the microfinance sector declined to 34.9% from 37.7% year-on-year (SIDBI, 2023). However, Bihar emerged as the top state in terms of portfolio outstanding, contributing to the sector’s 24.3% year-on-year growth to ₹3.5 lakh crore as of June 2023 (SIDBI, 2023). Notably, the RBI expressed concern about the lending rates in the microfinance space, urging a graded pricing mechanism to address the diverse borrower categories. Despite this concern, the sector’s performance remained strong, with the top 10 states contributing 83.1% of the total gross loan portfolio.

In conclusion, the microfinance sector demonstrated resilience and adaptability in the past fiscal year, overcoming pandemic challenges and embracing regulatory changes. The positive trends in PAR reduction, NPA improvement, and portfolio growth indicate a sector poised for sustained development, although the RBI’s call for a nuanced pricing mechanism underscores the need for continued vigilance in maintaining sectoral stability.

It is essential to monitor the implementation of these policies and ensure that they are reaching the intended beneficiaries. The government should also work towards addressing other challenges faced by the microfinance industry and small businesses, such as regulatory compliance, infrastructure development, and skill development. By addressing these challenges, the government can create an enabling environment for the growth of the microfinance industry and small businesses, which will help in achieving the goal of inclusive and sustainable economic growth.

References

MFIN (2023), Micro Matters: Macro View, India Microfinance Review FY 2022-23, Microfinance Industry Network. https://mfinindia.org/assets/upload_image/publications/Studies/Micro Matters Macro View FY 2022 23 17 November.pdf

GoI (2023), Key Features of Budget 2023-24, Department of Economic Affairs, Ministry of Finance, Government of India, New Delhi. https://www.indiabudget.gov.in/budget2023-24/index.php#budget

RBI (2022), Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions,Reserve Bank of India. https://www.rbi.org.in/Scripts/NotificationUser.aspx/NotificationUser.aspx?Id=12256

SIDBI (2023), Microfinance Pulse Report, Equifax and Small Industries Development Bank of India. https://www.sidbi.in/en/microfinance-pulse

(Views expressed in the blog are personal and not of any organization/institution)

By Mr. Anirban Pal & Dr. P. K. Singh; ARF group members

(Write to us at arflab.web@gmail.com for this blog-related views and suggestions)