“Microfinance is an idea whose time has come.” – Kofi Annan, former Secretary-General of the UN

Since independence in 1947, India has prioritised the issues of poverty, rural livelihoods, and women’s economic and social empowerment. Whilst the percentage of Indians who live rurally has been declining since 1951  , this figure still stands at a staggering ≈64% . Poverty in India is also concentrated in rural areas. In addition to not reaping the benefits of economic development, rural communities lack adequate access to the formal banking system. India’s early national plans and successive governments have placed recognised the critical role that access to finance plays in ensuring and promoting equitable growth. Hence, the introduction and prevalence of microfinance in India, which is defined as the “provision of financial services that’s available to low-income people  ,” most commonly in the form of microcredit: small loans provided to poor clients. Microfinance, however, is not limited to lending; many microfinance institutions offer micro-insurance products, checking and savings accounts, and more. Against this backdrop, this essay examines the role and contribution of microfinance in India. It assesses benefits, identifies existing challenges, and explores possible ways of strengthening the impact of microfinance, especially in light of the effects of the COVID-19 pandemic on the lives of millions of workers in India’s informal sector. 

Microfinance was first pioneered in 1976 by Nobel Peace Prize-winning economist Muhammad Yunus, founder of Bangladesh’s Grameen Bank. His idea of providing microcredit without requiring collateral has since been replicated and implemented throughout the developing world. India today has nearly 3,000  microfinance institutions (MFI) and NGOs, which provide a plethora of benefits to India’s rural poor. The microfinance sector has undergone extensive growth over the past decade: there has been an almost-fourteenfold increase in GLP

By not requiring collateral on loans, MFI’s have managed to reach and aid millions of India’s poor. Between 2014 and 2022, the number of verified microcredit recipients increased from 18 million to 64 million. Despite not having a credit history, collateral, or steady incomes, India’s rural poor are offered access to basic financial services. Reasons for borrowing range from cattle fattening to opening a restaurant to buying and driving a rickshaw. Women, many of whom are traditionally disadvantaged in rural areas, constitute the majority of microcredit recipients and have been offered opportunities for empowerment through the promotion of entrepreneurship and financial autonomy. 

Microfinance has proven to be beneficial to lenders, too. According to Pierre Omidyar, the founder of eBay, “Microfinance has already shown that enabling the poor to empower themselves economically can be good business.” Before the pandemic, microfinance loans had a 98% repayment rate, despite relatively high-interest rates. For MFI’s, therefore, lending remains a worthwhile and sustainable practice. Furthermore, microfinance inadvertently benefits workers in urban areas. When there is a large influx of workers into cities, the large increase in labour supply pushes down its price; wages are depressed. Microfinance, by offering opportunity and financial stability to rural workers, reduces the need for rural-urban migration, simultaneously combating this wage depression.

Despite its benefits, microfinance continues to be criticised for not reaching the deserving poor in both rural and urban areas. The reach of microfinance has not been consistent. Benefits have not reached some states, those living in difficult geographies (far-flung areas without proper forms of communication and infrastructure), and the urban poor. However, encouraging MFIs to open new branches in areas of low microfinance penetration, either through donations or government subsidies, can help combat this issue.

Furthermore, the fact that microcredit does not require collateral tempts borrowers into accepting offers that they do not fully understand. These offers often come with high-interest rates, leading to people falling into debt traps. This problem has been exacerbated by COVID-19. As of 2022, roughly 5% of all Indians are in debt to a microlender, and this sum totals $31.6 billion USD. The pandemic has left thousands of small businesses and millions of individuals struggling to pay debts, threatening the economic success story of microfinance. However, the Reserve Bank of India continues to keep a watchful eye over the sector given its high levels of risk, thereby protecting borrowers and lenders alike. Full transparency on interest rates and the MFI’s services can ensure that the beneficiary of microcredit is provided with the freedom and ability to compare different financial products and understand the financial service they’re using.

A contemporary analysis of microfinance would be incomplete without commenting on the role it played during COVID-19. The response of Indian microfinance institutions to the pandemic illustrates the profound resilience of the sector. Despite the vast array of challenges faced by MFI’s as a result of the pandemic, many opened up to new products and services, focusing primarily on loans dedicated to agriculture and new digital products and services . Their adaptability and optimism were showcased, with over 85% of Indian MFI’s changing loan offerings and procedures, offering supportive measures for clients (such as the provision of hygiene equipment), and attempting to intensify communication with rural and urban clients. The microfinance sector’s response to the pandemic is strongly indicative of its capacity to evolve and improve in the future, as well as to combat the challenges it faces.

When it was first introduced in the 1980s, microfinance was a humble approach to improving the outreach of the banking system, deepening rural credit, and thereby offering financial stability and autonomy to India’s rural poor. Since then, it has transcended into a holistic initiative for building financial, social, economic, and technological capital.

Improving access to finance for the rural poor presents a daunting challenge in a country as vast as India, but microfinance has taken remarkable strides towards this goal. It can only be expected that over the coming years as India recovers from the onslaught of the COVID-19 pandemic, microfinance will play an even greater role in promoting sustainable livelihoods, empowering women, and eradicating poverty.