Scaling-Up Microfinance For India's Rural Poor

Abstract

This paper reviews the current level and pattern of access to finance for India's rural poor and examines some of the key microfinance approaches in India, taking a close look at the most dominant among these, the Self Help Group (SHG) Bank Linkage initiative. It empirically analyzes the success with which SHG Bank Linkage has been able to reach the poor, examines the reasons behind this, and the lessons learned. The analysis in the paper draws heavily on a recent rural access to finance survey of 6,000 households in India, undertaken by the authors. The main findings and implications of the paper are as follows: India's rural poor currently have very little access to finance from formal sources. Microfinance approaches have tried to fill the gap. Among these, the growth of SHG Bank Linkage has been particularly remarkable, but outreach remains modest in terms of the proportion of poor households served. The paper recommends that, if SHG Bank Linkage is to be scaled-up to offer mass access to finance for the rural poor, then much more attention will need to be paid towards: the promotion of high quality SHGs that are sustainable, clear targeting of clients, and ensuring that banks linked to SHGs price loans at cost-covering levels. At the same time, the paper argues that, in an economy as vast and varied as India's, there is scope for diverse microfinance approaches to coexist. Private sector microfinanciers need to acquire greater professionalism, and the government, too, can help by creating a flexible architecture for microfinance innovations, including through a more enabling policy, legal and regulatory framework. Finally, the paper argues that, while microfinance can, at minimum, serve as a quick way to deliver finance to the poor, the medium-term strategy to scale-up access to finance for the poor should be to 'graduate' microfinance clients to formal financial institutions. The paper offers some suggestions on what it would take to reform these institutions with an eye to improving access for the poor.

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“…Moreover, Table 3 shows that more than 50 percent of individuals in emerging markets lack access to formal finance. Basu et al (2005) have documented that 80 percent of individuals in India's agricultural sector have no access to formal finance.…”

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“…After more than a decade of financial reforms and deregulation, India's financial sector has changed, in some respects, beyond recognition (see Basu 2005). Beginning in the early 1990s, interest rates were largely liberalized, and the burdens of priority sector requirements eased.…”

“…The ratio of private credit (from deposit money banks and other financial institutions) to GDP in India remains low at under 40 percent, compared with over 100 percent for countries such as China, Korea, and Malaysia. Financial sector risks and reform issues have been covered elsewhere, including in Basu (2005) and also in the previous Development Policy Review (World Bank 2003).…”

“…Recent data from a World Bank-NCAER Rural Finance Access Survey (World Bank 2003d) indicate that access to formal finance is a problem across rural India and is a particularly severe problem in some of the lagging states, such as Uttar Pradesh, where 80 percent of all rural households have no access to formal credit, and 87 percent of poor rural households have no access to credit from a formal source (Basu and Srivastava 2005). According to the Rural Finance Access Survey 2003, for those rural households that do have access to formal finance, commercial banks are by far the most dominant source.…”

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“…The share of these small farms accounts for 50% of the total cultivated area, that of marginal farmers (less than one hectare) 39%. Marginal farmers in India have profited comparatively little from the economic boom and poverty reduction of the last two decades (Basu & Srivastava, 2005). This is mainly due to their reliance on rain, which is uncertain and occurs with great variance.…”