While incentives to commercial banks to venture into

While each phase represents distinct features
of its own, there are some overlaps and crosscutting themes among them. An
overriding feature of Indian Microfinance throughout its evolution is its focus
on poverty alleviation in rural areas. This focus has broadly determined the
approach and operations of microfinance in India. In addition to this Indian
microfinance is characterized by existence of both State and Civil Society
Organization in delivery of microfinance services while private players joining
the wagon during phase IV. In context of Indian Microfinance, it is important
to note that each phase was influenced not only by learning from earlier phase
but also from development discourse, government policies and international trends
in microscope eco-space among other things. The remaining section describes
each phase in detail.



Phase I: Early 1900s – 1969

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Credit Cooperatives

The earliest phase of Indian Microfinance can
be described from early 20th century until 1969, when credit cooperatives
largely dominated as an institution in provision of microfinance services. This
phase began with passing of Cooperative Societies Act 1904, to extend credit in
Indian villages under government sponsorship. This step was provoked by
agrarian riots in the Deccan in the late 19th century that brought forth the
issue of farmer indebtness to moneylender to British Government. The agrarian
riots prompted the British Government to give thrust to the system of Taccavi
loans to farmers, regulate money lending and promote rural credit cooperatives
as an alternative to money lenders. The rural credit cooperatives in India
became a means of pooling the few resources of the poor and providing them with
access to different financial services. However, not much was achieved until
independence when credit cooperatives were chosen by the government as an
institutional mechanism for delivering credit to the farm sector. Choice of
credit cooperatives was inevitable in immediate context of post-independence.
On one hand commercial banks had very low presence in the rural areas and on
the other all commercial banks were in the private sector and political imperative
of the time did now allow government to provide an appropriate set of
incentives to commercial banks to venture into the rural areas. In such a
situation, cooperatives were the only option given their spatial spread and
penetration in remote areas. In terms of finance policy the approach was supply
driven with provision of subsidized credit through state controlled or directed
institutions to rural population.


rural cooperatives were riddled with plethora of problems. The 1945 Cooperative
Planning Committee found that a large number of cooperatives were “saddled with
the problem of frozen assets because of heavy over dues in repayment.” All
India Rural Credit Survey in 1947 brought out that only 3% of the total
borrowing of the cultivators was being met through the cooperatives. It also
revealed that the share of Institutional agencies, comprising the government,
the cooperatives and the commercial banks, in financing the borrowings of rural
household was only 7.3 per cent in 1951-52 corresponding to the share of
private money lenders which was as high as 68.6 per cent. With large scale
failure of credit cooperatives the stage was set for some fundamental changes
in microfinance institutional delivery.



5.      Phase II: 1969 – 1991

Driven Rural Finance through National Banks and Emergence of NGOs in


nationalization of Banks in 1969 along with a strong political emphasis towards
poverty eradication led to a new rural finance policy that was directed at
reducing the lending imbalances in particular sectors. This new policy resulted
in among other things to establishment of Regional Rural Banks (RRBs) and
adoption of priority sector lending by Banks under direct specifications of the
Reserve Bank of India (RBI). A decade later rural financial delivery got
further boast in 1980-81 with the government sponsored Integrated Rural
Development Programme (IRDP), under which loans of less than Rs 15,000 were
given to poor. In 20 years since its implementation the financial assistance of
approximately Rs 250 billion ($5.6 billion) was provided to roughly 55 million
families. However, under such aggregated figures, at the ground level IRDP led
to large scale misuse of credit. This created a negative perception about the
credibility of the micro borrowers among bankers further hindering access to
banking services for the low-income people. In addition to this State led large
scale program, some civil society organizations successfully experimented with
microfinance models that were more appropriate for the needs of poor
households. Some prominent examples of this are SEWA Bank (Ahmedabad),
Annapurna Mahila Mandal (Mumbai), and Working Women’s Forum (Chennai). The
first Self Help Groups (SHGs) started emerging in the country in 1980s as a
result of NGO activities such as MYRADA. In 1984-85 MYRADA started linking SHGs
to banks, when the SHGs’ credit needs increased and the groups grew large
enough for the bank to have transactions with SHGs idea was taken up on a large
scale later by NABARD scaling up Indian Microfinance to new heights.


6.      Phase III: 1992 – 2000

SHGs bank Linkage program and Growth of NGO-

By 1990s the problems with both State
promoted institutional forms viz. credit cooperative and RRBs in delivery of
rural credit were quite evident. The credit cooperatives were crippled with
poor governance, management and the poor financial health due to intrusive
state patronage and politicization. RRBs financial position deteriorated due to
the burden of directed credit and priority sector lending and a restrictive
interest rate regime. The share of rural credit in the total credit
disbursement by commercial banks, which grew from 3.5 to 15 percent from 1971
to 1991, has now declined again to 11 percent in 1998 (Sa-Dhan, 2004). For the
first two decades of their existence, political pressure and focus on outreach
at the expense of prudent lending practices led to very high default rates with
accumulated losses exceeding Rs. 3,000 crores in 1999 (Rajesh, 2004). In this
background various qualitative issues such as concerns about financial
viability of institutions on account of high rate of loan delinquency,
cornering of subsidy by well off people, continued presence of moneylenders,
inability to reach the core poor came out in forefront and resulted in
reorientation in thinking around the1990s. In addition to inherent problems
with existing institution, the external factors also influenced Indian
Microfinance. The macroeconomic crisis in early 1990s that led to introduction
of Economic Reforms of 1991 resulted in greater autonomy to the financial
sector. This also led to emergence of new generation private sector banks viz.
UTI Bank, ICICI Bank, IDBI Bank and HDFC Bank that would become important
players in microfinance sector a decade later. An important development in this
phase was SHG Bank linkage program by NABARD which greatly increased banking
system outreach to otherwise unreached people and initiated a change in the
bank’s outlook towards low-income families from beneficiaries to customers.


The pioneering initiatives of MYRADA
mentioned earlier, the SHG–Bank linkage program was scaled-up on a large scale
by the NABARD in the year 1992 by giving guidelines to banks for financing SHGs
through the banking system. With the success of this program RBI in 1996 took
the policy decision to include financing to SHGs as a mainstream activity of
banks under their priority sector lending. Since then the banking system
comprising public and private sector commercial banks, regional rural banks and
cooperative banks has joined hands with several organizations in the formal and
non-formal sectors to use this delivery mechanism for providing financial
services to a large number of poor.


Following such attempts the face of the
Indian financial sector changed and the focus changed from excessive
subsidization of bank credit to lending at market rates. This period also
witnessed the entry of another set of stakeholders Microfinance Institutions
(MFIs), largely of non-profit origins, with existing development programs. MFIs
consist of Refinance Institutions, Banks, Non-Government Organizations (NGOs)
and Self Help Groups dealing with small loans and deposits in rural, semi urban
or urban areas enabling people to raise savings, productive investments and
thereby their standard of living (Nadarajan and Ponmurugan, 2006). (Jayasheela
et at, 2007). International success of Microfinance in Bangladesh, Indonesia
and in Latin America also influenced the thinking in Indian Microfinance
towards commercialization. Another remarkable achievement during this phase was
the creation of a new generation of cooperatives viz. “Mutually Aided
Cooperative Societies” (MACS), which lie outside the state control. This was
done mainly in an attempt to reform the cooperative system.


Phase IV: 2000 – today

Commercialization of Microfinance

Since 2000, the microfinance sector saw some
radical changes in many aspects. While the prime objective remains poverty
alleviation with new terms of inclusive growth or financial inclusion, sector
moved from sole social return approach to double bottom line approach of social
and financial returns. This change in approach led to many changes in the
functioning of microfinance. The emphasis on ‘bottom of the pyramid’ and good
financial returns of some of leading MFIs, brought many main stream commercial
entities taking interest in the sector not only as part of their corporate
responsibility but as new business line. One among prominent example in Indian
context is ICICI Bank that adopted innovative ways in partnering with NGOMFIs
and other rural organizations to extend their reach into rural markets. UN
declaration of Microfinance year in 2005 gave further impetus towards
recognition of microfinance as a poverty alleviation tool and was able to
attract a lot interest from large commercial entities such as foreign banks,
investors, pension funds etc. This resulted in their participation in the
sector for social and commercial return.


The MFIs side experienced similar appetite
for increasing commercialization to scale up its operations and profit. This
translated into a number of changes. Increasingly NGO-MFIs began transforming
into regulated legal formats such as Non-Banking Finance Companies (NBFCs) or
section 25 companies to attract commercial investment and become eligible for
deposit taking entity which could be an easy source of fund for lending but
remains untapped. Today’s MFIs, particularly those which were founded after
2000, look and think differently from those of the 1990s. Many of these “second
generation” MFIs are promoted by entrepreneurs with mainstream corporate
experience. Today, MFIs relate better to the market and see themselves as
businesses in the financial services space, catering to an untapped market
segment while creating value for their shareholders. This overriding shift in
orientation from development to social entrepreneurship has brought about
changes in institutions’ legal forms, capital structures, sources of funds,
growth strategies, and strategic alliances. Many first generation MFIs have
subsequently transformed into regulated, for profit business models and legal
structures. With increasing out reach and focus on profit, increasingly MFIs
emerged as strategic partners to banks, consumers finance, retailers interested
in reaching out to India’s low income client segments. A parallel trend is the
increased activity in the meso-level segment, which largely extends consumer
credit. Lead by pioneers such as Citi Financial and GE Money, today this space
has players such as HSBC’s Pragati Finance, Standard Chartered’s Prime
Financials, Fullerton India, and DBS Cholamandalam. At the policy level,
government has recognized the microfinance as important player towards
achieving Financial Inclusion. In 2006, government has also table a
Microfinance Regulation and Development Bill which seek to promote and regulate
the microfinance organizations. While the bill itself has come under severe
criticism on account of some critical loopholes, this is a landmark step
towards recognition of civil society organization in microfinance space.3