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Microfinance Lending Gains Autonomy: RBI’s Move to Lift Pricing Caps

Recently, thе Rеsеrvе Bаnk of Indiа (RBI) tоok а grоundbrеаking stеp by lifting pricе cаps оn micrоfinаncе lending. This decision can exert аn significant impact on non-banking financial company-microfinance institutions (NBFC-MFIs).

This stratеgic shift aims to harmonisе thе rеgulatory landscapе for all microfinancе lеndеrs, including banks, thеrеby crеating a morе lеvеl playing fiеld. Thе nеw guidеlinеs also mandatе that all microfinancе lеndеrs dеvеlop a board-approvеd policy for loan pricing, marking a pivotal shift towards a morе risk-basеd and flеxiblе lеnding approach.

However, it also brings some challenges and risks that must be carefully managed. This blog post еxplorеs thе implications of thе RBI’s movе on microfinancе lеnding in India.

Thе Prеvious Rеgimе: Pricing Caps and Its Limitations

Thе intеrеst cap rеstrictions undеr thе prеvious guidеlinеs mеant that microfinancе lеndеrs could not chargе morе than a spеcifiеd maximum ratе.

This capped the interest rate for any loan at either 10-12 percentage points above the institution’s cost of funds or 2.75 times the average base rate of the five largest commercial banks, whichever was lower. The purpose of these caps was to protect borrowers from being charged excessively high interest rates on their loans.

But on the other hand, thеy stоppеd NBFC-MFIs from bеing аblе to sеt thе pricеs of thеir loans basеd on how riskу a particular borrowеr was аnd what it cost thеm to givе that pеrson a loan.

As a result, microfinancе lending оften had the sаmе intеrеst chargеd to it irrespectivе of which customer group it was extended to.

This meant microfinance lenders had to use a one-size-fits-all approach that didn’t account for the diverse risks of lending to various borrower groups or allow institutions with higher funding costs to set competitive loan prices.

Thе Nеw Framеwork in Microfinance Lending: Risk-Basеd Pricing and Flеxibility

With the removal of pricing caps, NBFC-MFIs are now required to underwrite loans based on a risk-based analysis and charge a risk premium accordingly.

This change aligns microfinance lenders with traditional financial institutions like banks, allowing for more nuanced and individualised loan pricing.

The RBI’s directive for a board-approved policy on microfinancе lending pricing emphasises transparency and accountability. This policy must contain well-documented components, such as:

Interest Rate Model:

Cost of funds: Clearly defines how the cost of funds is calculated (e.g., borrowing rates, operating expenses).
Risk premium: Establishes a methodology to assess the borrower’s risk profile and determine the appropriate risk premium.
Margin: Specifies the lender’s profit margin, which covers administrative costs and ensures profitability.
Spread range: Defines acceptable ranges for each component to allow for flexibility while maintaining control.

Ceiling on Interest Rate: This sets a maximum allowable interest rate to protect borrowers from excessive charges.
Other Applicable Charges: Lenders also need to transparently disclose any additional fees or charges associated with the loan (e.g., processing fees, late payment fees).

Implications for Microfinance Lending Institutions

The removal of pricing caps has several implications for microfinance lending, such as:

1. Enhanced Freedom and Competitive Advantage

When it comes to portfolio management and profit maximisation, NBFC-MFIs have the independence of determining their loan interest rates based on the level of risk.

Consequently, institutions that can borrow at lower costs are now able to transmit these cost savings to the clients by charging them lower interest rates.

On the other hand, businesses sourcing funds at higher costs can adjust their pricing to maintain financial viability. This will better position them to compete in the industry, as it enables them to cater to a broad spectrum of customers with different risk appetites.

2. Enhancеd Markеt Rеach and Financial Inclusion

The RBI has also increased the maximum annual household income cap for microfinance loan eligibility in rural areas from the previous INR 1.25 lakh to INR 3 lakh and in urban areas from INR 2 lakh to INR 3 lakh. This widens the potential borrower base, enabling more low-income families to avail of microfinance services.

Supporting the objective of financial inclusion through expanding market reach, this moves makes it possible for more people to get credit facilities that are crucial for economic empowerment and poverty alleviation.

3. Incrеasеd Compеtition

Rеmoving pricing caps can also stimulatе competition among MFIs. Whеn institutions havе thе frееdom to sеt intеrеst ratеs, thеy must compеtе on factors such as sеrvicе quality, borrowеr еxpеriеncе, and innovativе product offеrings.

This compеtition can drivе improvеmеnts in thе ovеrall еfficiеncy and еffеctivеnеss of thе microfinancе lending sеctor, ultimatеly bеnеfiting borrowеrs through bеttеr sеrvicеs and morе compеtitivе pricing.

4. Encouragement of Innovation

Allowing institutions to determine their pricing can foster innovation in microfinance lending. By doing this, MFIs have an opportunity of trying out new microfinance lending systems, risk appraisal methods as well as product offerings so that they can best serve their customers.

Hence, more effective financial solutions will be created to solve the special problems faced by people with little income. Some innovations include introducing digital lending platforms, developing different types of loans, and utilising alternative ways to score credit.

This can significantly elevate the client experience and expand the reach of microfinance services.

Addressing Main Risks and Ensuring Balance in Microfinance Lending

Ensuring balance in microfinance lending requires adopting a host of measures, including:

1. Prevent Potential for Exploitative Practices

While the ability to set interest rates may encourage innovation and competition, it also presents risks for exploitative practices. MFIs could charge borrowers excessively high interest rates if there are no limits on pricing.

This would burden them financially unjustly, leading to over-indebtedness among low-income people. Therefore, regulatory bodies must have strong supervisory systems in place so as to stop predatory lending and safeguard the welfare of those who borrow.

2. Balancing Financial Sustainability and Affordability

Achiеving a balancе bеtwееn thе financial sustainability of MFIs and thе affordability of crеdit for borrowеrs is a kеy challеngе. They must generate enough money for revenue to take care of their operational costs and manage risks while keeping interest rates affordable for targeted customers.

This balancing requires thoughtful consideration of factors like efficiency in operations, risk management, and social and economic conditions among borrowers. Regulators and MFIs should work together to develop guidelines that promote responsible lending while ensuring the sector’s long-term viability.

All parties involved should collaborate in setting up rules that will foster ethical lending practices without jeopardising their future existence.

3. Ensuring Effеctivе Ovеrsight and Rеgulation

Thе RBI’s dеcision to lift pricing caps nеcеssitatеs a robust rеgulatory framework to еnsurе еffеctivе ovеrsight and monitoring of thе microfinancе lending. This includеs еstablishing guidеlinеs for transparеnt pricing, fair lеnding practicеs, and adеquatе borrowеr protеction mеasurеs.

Rеgulatory authoritiеs must also еnhancе their capacity to monitor and address any еmеrging risks, such as prеdatory lеnding and ovеr-indеbtеdnеss. Strеngthеning rеgulatory ovеrsight is еssеntial to maintain thе intеgrity and stability of thе microfinancе sеctor whilе safеguarding thе intеrеsts of borrowеrs.

The Bottom Line

The RBI’s decision to rеmovе pricing caps on microfinancе lending marks a significant step towards a more flеxiblе and inclusivе financial systеm.

By еnabling NBFC-MFIs to pricе loans based on risk assеssmеnt, thе nеw guidеlinеs providе thеsе institutions with grеatеr autonomy to managе thеir portfolios and sеrvе a divеrsе rangе of borrowеrs.

Whilе thе incrеasеd flеxibility posеs challеngеs, such as thе risk of highеr intеrеst ratеs for cеrtain sеgmеnts, thе safеguards introducеd by thе RBI aim to protеct borrowеrs and prеvеnt ovеr-indеbtеdnеss.

Finеzza providеs an еxtеnsivе array of products, such as Bank Statеmеnt Analysis, crеdit burеau data analysis tool, loan origination systеms, and more. These are dеsignеd to help MFIs and financial institutions make impactful decisions.

Our loan management system supports diverse types of loans, flexible repayment frequencies and payment modules and provides bank payment reconciliation.

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6 Ways Tech in Finance is Transforming Microfinance Institutions

Embedded Finance

The microfinance sector has evolved rapidly since Muhammad Yunus pioneered the movement around three decades ago. India, one of the fastest-growing economies in the world, banks on microfinance for sustainable growth and economic development due to the significant rise in the number of micro, small, and medium (MSMEs) seeking swift, organised, and streamlined access to credit, loans, and financial services.

The average loan size dispersed to Indian MSMEs was 9.74 million Indian Rupees in the second quarter of 2023 – the highest-ever recorded, indicating the sector’s robust growth.

The growth can be attributed to a few factors, including the entry of tech in finance and a gradual shift away from field-officer or branch-led lending. Adopting fintech tools has paved the way for swift loan origination, improved customer experiences and service, accurate fraud detection, and opened the doors to data analytics for enhanced prediction and risk assessment.

This article explores the role of tech in finance, especially in revolutionising the operational capacity of microfinance institutions and what we can expect in the future.

Current State of the Indian Microfinance Sector

The Indian microfinance sector grew by 21% in the financial year 2022-2023, with a total of Rs 3,19,948 crore dispersed against Rs 2,53, 966 crore in the financial year 2021-2022.

Microfinance institutions (MFIs) and NBFCs dispersed the lion’s share, lending Rs 1,24, 063 crore, closely followed by traditional lenders, including banks. These figures indicate the sustained demand for microfinance services in India.

The Government of India has been instrumental in driving this demand and transforming the face of the Indian microfinance sector. For example, over 500 million bank accounts have been opened thus far under The Pradhan Mantri Jan-Dhan Yojana (PMJDY), which was rolled out in 2014.

Additionally, tech adoption in finance accelerated further with the Digital India program aimed toward converting India into a digital economy.

India’s push toward a digital financial model is aided by Aadhar, enabling financial technology (Fintech) to roll out electronic ‘Know Your Customer’ (eKYC) authentication services.

Tech’s Impact on Microfinance Institutions

The onset of tech in finance has opened up many opportunities for MFIs, allowing them to improve client outreach, operations, and decision-making. It will continue to transform how financial services are delivered.

Let’s explore how MFIs leverage technology to improve efficiency across the value chain.

1. Promote Awareness

The role of tech in finance is pivotal in boosting product awareness among Indian microfinance users by joining hands with incumbent MFIs. One way Fintech companies add value is by building chatbots to help customers determine whether they are eligible for a loan.

Many companies also leverage augmented reality (AR) to assist customers with low literacy in interpreting complex written material.

2. Efficient Customer Onboarding

Tech in finance is also revolutionizing customer onboarding, making it easier for lenders to verify customer information, evaluate creditworthiness, and streamline the application process.

The advent of new-age Fintech solutions has enabled Aadhar-linked KYC, e-documents verification via the DigiLocker application, and video identification. Furthermore, MFIs are also leveraging artificial intelligence (AI) and machine learning (ML) to automate customer onboarding, fraud detection, and customer authentication.

3. Judgemental Scoring Models to Underwrite Loans

Many MFIs collaborating with fintech firms rely on judgemental scoring models, wherein critical insights over the past year are converted and evaluated to facilitate real-time decision-making.

Additionally, tech in finance is also enabling the use of ML to assess unstructured data points covering social and behavioral attributes and financial data.

4. Loan Disbursement

Cashless disbursements through RTGS/NEFT/IMPS and Aadhar-enabled Payment Systems (AePS) are becoming increasingly popular as more and more MFIs are undertaking 100 per cent cashless disbursements. This microfinance technology offers host-to-host banking to enable real-time loan disbursements.

5. UPI and Aadhar Pay

Unified Payment Interface (UPI) and Aadhar Pay are becoming increasingly popular among MFIs as smartphone penetration is at a record high in India. Many buy-now-pay-later (BNPL) companies primarily catering to the GenZ and millennials allow their customers to repay loan amounts through UPI.

Alternatively, borrowers can also use Aadhar Pay to repay loans at kiosks equipped with the BHIM Aadhar App and biometric devices.

6. Leveraging AI for Fraud Detection

Around 58% of AI applications in the finance sector are used to curb fraudulent activities. The technology primarily leverages data analytics and advanced algorithms to spot anomalies, track patterns, and, most importantly, fraudulent activities.

ML algorithms allow AI systems to learn from past data, respond to evolving fraud techniques, and detect suspicious activity accurately.

Parting Notes

Tech in finance is crucial in transforming India’s microfinance sector. While the demand for microfinance services continues to march upward, the average loan size dispersed by MFIs is also rising, indicating its crucial role in aiding India’s economic growth.

Government initiatives coupled with the entry of a host of Fintech startups have laid a solid foundation for turning India’s aspirations of becoming a digital economy into reality. The increasing partnership between Fintech startups and MFIs will redefine how microfinance services are delivered.

Finezza offers a wide range of products, including bank statement analyser, credit bureau data analysis, and loan origination systems that enable MFIs and financial institutions to make informed decisions. Our document identification framework facilitates swift and automated document verification.

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Microfinance: What Lenders Should Consider While Approving a Microloan

Loan Origination System

Microfinance is generally associated with financial inclusion and poverty alleviation. It aims to help individuals and small businesses who have limited access to conventional banking services. In a broader sense, microfinancing refers to providing financial services like access to money transfers and savings accounts, credit facilities, and insurance to the economically weaker segments (EWS) of society. However, in the world of economics, it is often used as a substitute to refer to the loans and advances extended to the lower-income groups for productive or income-generating activities.

Looking back at the history of microfinancing, one can see that the concept’s origins were microloans or microcredits. The program initially started as an experiment, providing tiny loans to financially backward women and small businesses for sustainable development in place of financial aid. Today, millions of people across nations take advantage of microloans to generate livelihood.

Characteristics of Microcredit

Microloans are probably the most significant products in microfinance as they have a considerable impact on the economic progress of their beneficiaries. Microfinance institutions (MFIs) must balance the social objectives of the lending process with the due diligence of credit appraisals to achieve profitable credit portfolios.

Microcredit is different from conventional modes of loans and advances. Therefore, credit appraisals must weigh certain factors to assess the viability and success of such decisions. Before moving on to that discussion, it is necessary to briefly re-visit the features of microloans;

1. The Lacklustre Borrower Profile

The majority of microcredit beneficiaries are from low-income families. Due to demographic or geographic factors, they have very limited or no access to formal credit facilities, proven sources of income, and, consequently, insufficient credit history. Usually, the clientele includes women, entrepreneurs, and artisans from impoverished families.

2. Loans Linked With a Livelihood Activity

The main objective of microfinance is to enable the borrower to generate income. Therefore, monies are advanced for undertaking subsistence activities. Microloans are rarely advanced for consumption purposes.

3. Small Loans for Short Durations

The ticket size of the microloan is very small, and the loan amount usually depends upon its purpose. They have short tenures and get amortised in small and more frequent instalments.

4. Unsecured Advances

Households seeking microloans, with less than INR 3 lakhs annual income, do not need collaterals to secure credit as per the Reserve Bank of India.

5. Capability for Effecting Transformations

Microlending activity can bring a positive transformation in the beneficiary community and economy. It also builds the entrepreneurs’ confidence in entrepreneurial ventures.

Making Microfinance Ethically Profitable

Uplifting the economically underprivileged segments of society is the foundation of microfinance. Traditional MFIs were non-profit, non-governmental organisations (NGOs) or small finance banks and NBFCs, dedicated solely to their social objective. But as financial markets began to evolve, large consumer finance companies and fintech lenders began to enter the micro-lending space. MFIs are now faced with the dilemma of achieving profitability without sacrificing welfare objectives. They can ethically combat the competition and become more resilient by doing the following:

1. Scaling up Their Activities

While microfinance has benefited customers, it has not made an impact on a larger scale. Achieving economies of scale in microlending will ultimately benefit the borrowers. A growing clientele base will increase the profit margins and reduce the cost of funds. MFIs can pass on a portion of these cost savings to their borrowers in the form of lower interest rates.

2. Leveraging Technologies

Fintech lenders are overtaking conventional MFIs and expanding their customer base with ease. Tech-enabled business models are more agile and scalable. They reduce the cost of operations, increase customer outreach, and promote innovation in product design, delivery, and service. MFIs can scale their operations by harnessing data and tech capabilities.

What Factors Should Be Considered When Approving a Microloan?

A microlending model sustains as long as it is viable to investors. The model will fail for the recipients if it does not work for those lending the capital. MFIs can adapt to market changes by focusing on their asset growth and returns. But such growth should not compromise their fundamental social goals.

Microfinance lenders must examine the following factors to proceed with the credit decision:

1. Identify the Target Beneficiary Group

Market segmentation focuses the resources on addressing the needs of those customers who can maximise the lender’s outreach, returns, and the social impact of the loan.

2. Determine the Amount of Loan

Lenders can bring down the cost of funds and reduce interest rates if loan ticket sizes are bigger. A study on Indian MFIs found that apart from the purpose of the loan, regional attributes, perceived income from the activity, borrower’s education, age, and loan experience and even the distance between the clients’ homes and MFIs’ offices could influence the loan amount.

3. Assess the Purpose

As microfinance lends to low-income individuals, lenders can determine if the activity will generate enough income to cover loan repayment. Moreover, lenders may be willing to advance credit for other reasons if they can relate to it on a compassionate basis, such as covering emergency medical expenses. By analysing the character of the borrower you will be able to make an informed decision.

4. Examine the Credit Score and Spending Habits

The credit score is useful in determining default risk. Microloan borrowers might have insufficient credit histories to get a credit score. Lenders can use borrowers’ bank statements to observe their spending patterns and loan repayment capacity and use it to make the final call.

5. Stay Socially Responsible

MFIs must finely manage lending to the underprivileged without compromising the due diligence of the credit process. Business growth should not dilute credit quality.

The Path Ahead

With the evolving fintech sector and faster technology adoption among the common people, the time has come for the microfinance models to upgrade their core competencies. Many digital payment systems have leveraged their capacities to offer digital microloans to their customers. MFIs must respond proactively to these changes to avoid becoming redundant.

Conventional lenders have the upper hand over digital challengers in the responsible credit delivery of microloans to the underprivileged. However, that advantage may soon vanish as digital lenders catch up. Adopting technologies and customising services according to the changing preferences of the target customers is the only step in the right direction.

Finezza presents cutting-edge products for credit evaluation and lending lifecycle management. Our agile loan management system supports various types of loans like salary advances, virtual credit cards, education loans, supply chain financing, etc. Contact us today to learn how Finezza’s tools can assist your lending business.

Top Four Reasons to Be Ethical to Solve Problems of Microfinance

Lending Lifecycle Management

In the industrial economy of the 80s, microfinance emerged as an option to eradicate poverty. But due to high volumes and profitability, it has become heavily commercialised. The higher interest rates and over-indebtedness have led to a high suicide rate among borrowers. Which raises the question, “is it fair to maximize profits from the poor”. In this article, we examine the need to be ethical while addressing the problems of microfinance.

Huge market

Microfinance (MF) has come a long way since its inception in the 1980s as a social instrument to help the poor. It is now a fledgling market with more players like NBFCs, small business banks, and self-help groups. Currently, the global microfinance market is over $178.84 billion and is expected to grow by 10.8% to $496.90 billion by 2030. (Microfinance Market Size, Share and Industry Forecast – 2030 (alliedmarketresearch.com)

Only 6% of the poor have access to formal credit, the high volumes have attracted more players. That’s why in 2021 the Reserve Bank of India (RBI) saw 94 registered Microfinance Institutions (MFI) in India.

Problems of ethics in MF:

MF intends to provide capital to the poor and uplift society. But due to heavy commercialisation, it has been misused in the past three decades. To chase profitability, the MFIs charge interest rates as high as 30% to 100%. Moreover, studies suggest that in their bid to lure investors, MFIs chase high net-worth individuals and neglect the poor. Thus, the funds are made available to the rich at cheaper rates.(Ethics in Microfinance | OpenMind (bbvaopenmind.com)

Why is it important to be ethical to solve problems of Microfinance

MF has a noble aim to serve the unserved sections of society and alleviate poverty. It is due to their efforts that over 4.5 million people were brought under the threshold of Rs 100/day globally between 1990-2010. (An analysis of the current state of ethics in microfinance. sevenpillarsinstitute.org). However, it has become a profitable business for many institutions. Here are four reasons to be ethical to solve problems of microfinance.

1) Reduces poverty –

While our constitution promises equal opportunities for everyone, the reality is different. Equality in financial services does not exist for the poor who are at the mercy of loan sharks. MF makes funds available to the lower strata of society to lead a life of dignity. As per statistics, 90% of MF business loans are used for non-business purposes. People buy objects and services with this money which better their lives.

2) Leads to women empowerment –

Microfinance is particularly targeted at women as they are better at repaying loans than men. As per studies, 4 out of 5 MF clients are women. In India, women get micro-credit through self-help groups (SHGs) which they use to have sustainable livelihood. Their financial contribution to the family raises their self-esteem, earns them respect, and gives them decision-making power. They get a say in their children’s education, family health, investments, etc. (Role-of-Microfinance-in-Empowering-Women.pdf (ijemr.in). And thus, leads to women’s empowerment.

3) Helps in business growth –

MF is said to be based on a simple hypothesis that every person has an entrepreneurial spirit in them. By providing them a collateral-free loan, an MF helps a micro-enterprise expand itself to become a small business. According to a study by Crepon et al, in rural Morocco, easy loans by MFs has led to the expansion of existing businesses in the agricultural sector.

4) It’s possible to be ethical & profitable –

This is amply demonstrated by Pro-Credit Holding -AG (PCH) of Germany. It follows a commercial approach and is profitable without biting into the flesh of borrowers. The group has 22 small business banks in 22 countries and was about to bring out an IPO. But it had to step back due to the 2007 global financial crisis. Even then it has been able to maintain steady growth in consumer loans of over 7%. And in 2021 registered 68% in profit after tax.

With technology, MFIs can be ethical

MFIs argue that they charge higher interest rates to cover their operational costs. But with increased digital penetration and technology, it is now possible for them to tide over this issue. Today many banks, NBFCs, and Fintechs operate online without investing in costly operations. MFIs can adopt this model and serve society without burning a hole in their pockets.

Finezza’s lending management software is a preferred choice of many MFIs and NBFCs (non-banking financial institutions). If you are an MFI or NBFC in need to integrate your software to offer world-class banking services to your clients, then do get in touch with Finezza. Contact us today to integrate your services with Finezza.

Challenges and Opportunities Facing India’s Digital Microfinance

Loan Origination System

The Internet revolution and increased mobile penetration across rural markets have fuelled the emergence of digital technologies in India’s microfinance sector over the last decade.

MFIs have now begun to adapt to new technology trends for faster loan origination, efficient customer service and delivering flexible lending requirements using alternate channels.

The proliferation of low-cost mobile devices has accelerated the expansion of digitally-literate populations, allowing traditional microfinance institution (MFI) borrowers to evolve into more tech-savvy, social media-friendly, and experience-driven clients.

Therefore, increased knowledge and usage of digital platforms and a broader digital payment acceptance network will help minimise reliance on cash-based transactions and pave the way for MFI customers to adopt digital repayment methods.

Digitisation Journey of India’s Microfinance Sector: Important Breakthroughs

Since the early 2000s, technology adoption has been an essential component of the Indian microfinance sector.

In 2008, the Rangarajan committee report recommended that technology-based solutions be increased for financial inclusion in India. The report served as the foundation for establishing the Financial Inclusion Technology Fund (FITF), which invests in information and communication technology.

Furthermore, the government’s Digital India programme helped accelerate the transition to a digital economy. For example, Aadhaar facilitated the transition from traditional banking to a digital model by providing a supportive ecosystem for technology providers to launch electronic “know your customer” (KYC) and authentication services.

The other precursor of technological breakthroughs in MFIs was the Government of India promoting the growth of financial technology via the Jan Dhan- Aadhaar-Mobile (JAM) trinity and IndiaStack.

The presence-less, paperless, cashless, and consent layers of IndiaStack enable lenders to unbundle their services and layer them in partnership with fintech companies to build products and value for a plethora of different customer demands.

Current Status of Digitisation in the Microfinance Sector

According to KPMG’s study on microfinance institutions, the current status of MFI digitisation is as follows:

Various technology stacks allow fintech within the microfinance sector to do more than just carry out basic operations via collaboration and development.
MFIs are managing everyday operations with the help of Fintech companies that offer core systems (loan origination and management systems). In contrast, advanced systems harness data from many sources and handle complicated analytics to facilitate effective sales and collection.
Identification technologies enable better KYC procedures, alternate credit scoring allows deeper customer insights, and cashless loan disbursements are expanding thanks to mobile-banking technologies.
Now, tech is aiding early warnings for MFI loan portfolios and creating customised financial products based on customer data.
Only 50% of MFIs have a core banking system (CBS) and a customer relationship management (CRM) system in place. Around 12% of MFIs have deployed either CBS or CRM.
For their customer on-boarding operations, one out of every four MFIs uses robotic process automation. However, only half of MFIs use emerging technologies like AI and ML to assess credit.
Only over 40% of MFIs use emerging technology for customer onboarding. Almost all MFIs use cashless channels to disburse loans. NEFT/RTGS/IMPS are the most widely used cashless channels, followed by AePS.

Challenges in Technology Implementation and Adoption in Microfinance

While the advantages of technological integration for MFIs are clear, some concerns and problems are to be addressed.

1. Digital adoption

MFIs have specific problems; they usually deal with personnel and business correspondent partners with weak financial literacy and inadequate formal education. The limited adoption of cashless transactions in the ecosystem is due to a lack of awareness of the banking infrastructure and digital services available.

Also read: How Account Aggregators can Lead to Safe Lending Decisions

Customers receiving loans disbursed straight into their bank accounts end up withdrawing these funds to spend in cash since the ecosystem continues to be cash-based. Because customers perceive no benefit in keeping their money digital, loan repayments are also cash. Repayment through cash can lead to delay in repaying loans by customers, affecting MFIs efficiency in loan recovery.

2. The human touch

The microfinance industry has always been known for its high-touch approach to customer service. However, with technology making inroads into the industry, opinions on how customer service dynamics are evolving are split.

The ‘on-the-ground’ field agents are crucial for understanding the financial possibilities available to the target segment that MFIs serve. As a result, any technology installation must keep customers connected while maximising company resources.

There’s also the issue of repayment. Big data and machine learning algorithms based on many data sources do not take into account certain softer evaluation characteristics that human field agents are adept at.

Hence, algorithm-based lending has a higher chance of default. While Joint Lending Group (JLG) or Self-Help Group (SHG) formats ensure group guarantees are in place, giving peer pressure to repay the loan, and centre meetings reinforce the repayment habit; nonetheless, MFIs must take a multipronged approach to solve this problem.

3. Digital talent gap

Even though digital adoption rates and Internet connectivity have been continuously expanding across India, there is a scarcity of expertise capable of adapting to the latest digital interventions in the Microfinance value chain.

Also read: How Collaborative Lending Can Extend Credit to the Underbanked

This is partly due to NBFC-MFIs’ geographic focus on rural and semi-urban areas, where staffing needs are directly satisfied by recruiting from the locally available pool in areas where significant digital skill gaps exist. For example, according to research, only 24% of the rural population between 15 and 29 can operate a computer, compared to 56% in metropolitan areas.

4. Technology partnership

Many sections of the country continue to be neglected in terms of infrastructure. According to a World Bank assessment, around 33% of villages lack access to all-weather roads and are cut off during the rainy season; India’s northern and northeastern regions are the least well-connected, with problems with electricity, payment infrastructure, and the Internet.

According to a survey, only 1417 of the 18452 communities have 100% household connectivity. Therefore, it will be challenging to make significant investments reliant on agreement among multiple industry players/factors in the ecosystem.

5. Regulations

Many people are concerned about the lack of clear IT regulations for MFIs, such as data protection, business continuity, security, cybersecurity, etc., leading to security breaches and customers’ lack of trust in sharing personal data with lenders.

If passed, the Personal Data Protection Bill, 2019, introduced in the Lok Sabha in December 2019, will address some of the above problems; MFIs will be compelled to comply and modernise their IT infrastructure correspondingly.

Also read: What are Payment Service Providers and how do they Work?

The challenges of providing a consent-based framework for protecting personal information, such as the “right to be forgotten,” and maintaining a safe and encrypted database that stores personal data and the consent format, would necessitate extensive design and execution work.

Future Roadmap: Opportunities for Microfinance

Fintech collaborations are transforming the microfinance sector, which will witness significant investments in digital capabilities in the next few years.

Nearly 75% of the surveyed MFIs have formed partnerships with Fintech companies, with the remaining MFIs planning to do so as part of their IT roadmap.
MFIs will need a customer-centric approach that strikes the right blend of technology and human touch.
MFIs should have a broader vision of where they want to be in three, five, or 10 years, from how they work with their clients to the efficiency of their operations, including their people and culture.
Fintech firms must take advantage of these opportunities and meet specific client needs.
MFIs have the opportunity to use fintech advances throughout the transaction cycle. Machine Learning and alternative data capabilities are projected to disrupt the microfinance industry by providing critical differentiators in asset sourcing and asset quality improvement.
Digital will shape the microfinance environment in the future. Microfinance operations will require a connected business infrastructure to be efficient and scalable.
MFIs will reduce expenses and establish more reliable credit profiles by integrating with Account Aggregator (AA) platforms to allow effective risk management solutions.
Training and equipping the MFI personnel with the skills needed to become digitally proficient should be prioritised.
Increased adoption of digital solutions across the value chain will assist MFIs in increasing overall productivity and efficiency. MFIs invest a significant amount of money in the workforce.
MFIs will boost their workforce productivity across customer sourcing, the credit assessment, customer servicing, and collection by implementing digital technologies. As a result, MFIs may be able to “do more with less” as a result of higher productivity.
Regulators in the financial services industry must make the required efforts to harmonise digital operations within the MFI space such that operational processes are consistent across all institutions.

Takeaways

Customers’ exposure and, as a result, their expectations from microfinance institutions will vary as literacy and mobile phone usage among the poor and rural regions rise.

Microfinance customers would expect personalised solutions based on automated analytics, machine learning, and artificial intelligence (AI) related to their life or business events.

Also read: 6 Reasons Why You Must Choose a Trusted LOS Partner

Customer service, on the other hand, will remain crucial, and the winners will be those who can supply low-cost, high-quality solutions via intuitive, user-friendly platforms.

Furthermore, as new technologies lower the cost of serving customers, more new entrants will increase competition in the microfinance business.

Finezza lending management software is a well-integrated solution for microfinance institutions and non-bank financial companies (NBFCs). The software solution enables MFIs to gain world-class banking capabilities, allowing them to compete effectively with mainstream commercial banks.

The 360-degree suite not only gives lenders a complete picture of the borrower, allowing them to make more balanced decisions, but the utilisation of AI and ML technologies also makes the process more risk-free.

Problems of Microfinance in India and the Way Ahead

Updates

Poverty is a significant economic problem in the majority of the developing world. In most rural areas of India, agriculture is the principal source of revenue. Agriculture employed 42.6% of India’s workforce in 2019. However, the rural community has been largely cut off from official financial institutions, resulting in poor performance

Microfinance raises household income and lowers poverty levels, particularly among the poorest. Nevertheless, there are several problems of microfinance in India.

Microfinance’s financial viability is one of the primary concerns, despite an 8.1% median return on equity in 2016. In addition, due to costly credit risk management systems and small loan portfolios, operational expenditures are relatively high.

So, what is the way ahead for microfinance in India? Keep reading to find out.

What are Microfinance Institutions?

Micro Finance Institutions (MFIs) are a type of NBFC that focuses on the financial requirements of the poorest people in the country, primarily in rural areas.

The Reserve Bank of India is the institution’s sole regulator. The primary goal of establishing the Indian microfinance business was to provide financial inclusion to the poorest and more backward sections of society.

Since microfinance primarily serves the weaker sections of society, overindebtedness by such borrowers is a common and one of the significant problems of microfinance in India. Borrowers are always in need of money, therefore they borrow from all available sources.

Significant Problems of Microfinance in India

Microfinance institutions that serve retail consumers have a unique set of problems that commercial banking solutions cannot handle. The following are some of the issues:

1. High-interest rates

Compared to commercial banks, MFIs do not have the same financial success rate. One reason is that, whereas the banking system in India dates back centuries, microfinance is only a few decades old. Moreover, compared to commercial banks (8-12%), MFIs charge a significantly high-interest rate (12-30%).

The Reserve Bank of India (RBI) recently announced the removal of the 26% interest cap for MFI loans. This has enriched the industry’s players while worsening the situation for customers.

Microfinance institutions have a limited transaction volume, yet the cost of those transactions is fixed and substantial, posing a considerable problem for all of them.

2. Over-indebtedness

Microfinance institutions offer financial services to the weaker members of society to help them improve their living standards. As a result, over-indebtedness is a huge problem. The microfinance crisis in India in 2008 was caused by a lack of risk management framework and repeated borrowings by most clients.

In some instances, there is no apex control over microfinance institutions. This sector provides loans without collateral which raises the risk of bad debts.

Furthermore, adequate infrastructure planning has not matched the sector’s rapid growth. Microfinance institutions are concerned about excessive debt since it has a detrimental impact on their portfolio, puts them in danger of credit, and increases the cost of monitoring.

3. Over-reliance on commercial banks

In India, most microfinance institutions are registered as Non-Governmental Organizations (NGOs). Their lending activities rely on financial institutions like commercial banks for stable funding.

Banks account for over 80% of their funds. The majority of these are private banks that charge high-interest rates and have shorter lending terms.

Banks frequently lend to micro-lending companies to satisfy their priority sector loan goals. However, the Indian microfinance industry’s excessive reliance on banks renders it inept and slow to respond to defaults and delinquencies.

4. Lack of financial services awareness

India, like all other developing and impoverished countries, has a very low literacy rate, which is even lower in rural areas. As a result, almost 76% of India’s adult population is unaware of basic financial principles.

The lack of understanding of the Indian microfinance industry’s financial services is difficult for both customers and MFIs.

This aspect makes it difficult for villagers to work with MFIs to address their financial needs, but it also makes them financially excluded. In addition, MFIs have the difficult challenge of educating the public and gaining their trust before selling their products.

Due to a lack of information, microfinance institutions struggle to make their businesses more financially sustainable.

5. Regulatory concerns

The Reserve Bank of India (RBI) is currently the governing agency for India’s microfinance industry. However, it has generally catered to commercial and traditional banks rather than microfinance institutions. Furthermore, the microfinance industry’s needs and anatomy are vastly different from banks’.

The industry has previously seen intermittent and unprecedented regulatory changes. Some have substantially improved the industry, but many issues remain unsolved, such as erecting entry hurdles to keep unworthy players out.

It has resulted in continual structural and operational changes, but it has also resulted in ambiguity in conduct norms. As a result, separate regulating authority for this business is required.

Regulatory concerns have resulted in suboptimal performance and the failure to produce new financial goods and services to help the poorest sections.

6. Self-help groups are expanding (SHGs)

Many MFIs use the SHG or Joint Liability Group (JLG) model. Unfortunately, these models are chosen at random irrespective of the situation, increasing the possibility of the weaker sections taking on more debt than they can handle, which is irreversible.

The government’s engagement in supporting self-help groups has witnessed rapid expansion, putting microfinance institutions under strain. This has long-term negative consequences for the MFIs’ viability.

7. Cost of outreach and missing targets

Microfinance institutions serve small-ticket loans to the urban poor and underbanked in distant hinterlands due to the model. However, there are logistical and field force costs associated with the outreach. As a result, margins are eroding, necessitating digitisation and process automation.

Moreover, MFIs frequently mistake ignoring the urban poor in favour of focusing on the rural poor. Only 800 MFIs have been identified in India that focus on the urban poor.

Problems of Microfinance in India: The Way Ahead

Microfinance has shown to be a significant tool in enhancing the welfare levels of the poor by increasing disposable household income during the last few decades.

However, broader benefits on social welfare, such as health, nutrition, education, and female empowerment, have yet to be widely recognised. Nonetheless, microfinance is widely regarded as a valuable instrument for reducing poverty in low-income countries.

The following are the solutions to overcoming the problems of microfinance in India and reaching more people:

1. Interest rate transparency

MFIs should adhere to an actual interest rate on products and amounts disclosed to clients.

2. Proper regulation

When microfinance was in its infancy and individual businesses were free to experiment with new business models, a restrictive environment requirement wasn’t a major problem.

However, the organisation now requires constraints to preserve stakeholders’ interests while promoting growth.

3. Rural poor focus

Instead of lowering the initial cost in places where MFIs exist, these institutions should begin focusing on the rural poor and open additional branches throughout the areas.

4. Range of products

MFIs should provide a comprehensive range of products, including credit, savings, remittance, financial advice, and so on, to help consumers transition away from commercial banks.

5. Use of technology

MFIs should use new technologies, IT tools, and applications to reduce operational costs.

Microfinance institutions should be encouraged to reduce their operating expenses by using cost-cutting methods.

6. Different fund sources

In the absence of sufficient finances, MFIs’ expansion and reach are limited, and to mitigate this disadvantage, MFIs may look for additional funding sources for their loan portfolio.

7. Field supervision

In addition to proper regulation of the microfinance sector, field visits can be used to monitor conditions on the ground and, if necessary, take corrective action.

This can be used to monitor MFI ground staff’s performance and loan recovery operations.

Microfinance institutions have undoubtedly proliferated and played an essential role in the cause of financial inclusion, but there is still much to be done.

The Indian microfinance sector is complicated, as evidenced by the foregoing research. And it requires prompt attention from the RBI in the form of a comprehensive regulatory framework designed to protect the help provided to the poor and financially marginalised.

Finezza lending management software is a well-integrated solution for microfinance institutions and non-bank financial companies (NBFCs).

The software solution enables MFIs to gain world-class banking capabilities, allowing them to compete effectively with mainstream commercial banks.

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