How can Indian Microfinance Institutions Face these 3 Challenges?
India is one of the fastest-growing economies despite poverty being a major concern of the country. According to the sources, about a quarter of the country's population in rural areas is below the poverty line, that is, about 25.7 percent of India's rural population and 13.7 percent of the urban population falls below the poverty line. To help these set of people to improve their standard of living, the microfinance institutions came into existence, offering smaller credits for a shorter tenure. Besides, these loans do not need any collateral. Generally, the microfinance loans range from $100 to $25,000. Apart from lending, many banks also provide other services such as micro-insurance, education loans, and more.
The MFIs mainly focus on the unemployed and low-income group. Consequently, the MFIs have not gained the success on par with the other commercial banks; MFIs even lacks in terms of operations and financial processes. Here are a few significant challenges that restrain the Indian microfinance institutions from reaping its utility completely.
Higher Rate of Interest
In comparison with its competitors, MFIs have not gained notable success. The main reason for this is that the MFIs are just a few years old, while the banking systems have been around since decades. Thus, these micro finances tend to charge a higher rate of interest of about 12 to 30 percent. This rate of interest is dramatically high as compared to other commercial banks, which offer just eight to twelve percent. Furthermore, the RBI's announcement of removing the upper limit of the MFIs interest has benefitted the industry players but worsened the scenario for the customers. However, the MFI industry could improvise this situation, buy enhancing the regulations and market structure. This would eventually increase the economy, resulting in efficient output, through which the MFIs could cut down the rate of interest, and elevate business.
Inefficient Risk Management
The ultimate goal of these MFIs is to elevate the standard of living for the economically weaker section of the society. Thus, an excessive debt of such borrowers is one of the most serious problems faced by the microfinance, and such borrowers tend to borrow a huge sum. Also, the microfinance procedure does not require any security; hence, it is difficult to carry out the verification of the customers before lending the loan. The lack of recovery measures had landed the microfinance industry in crisis in 2008. Moreover, the MFI industry has not set up any plan or strategies to exempt such bad loans, and this has been observed in various states of India like Karnataka, and MP. Alongside, some banks began to monitor the credit risks which in-turn adds to the cost. To overcome this problem, the MFIs could merge with the workforce solution providers which would provide authentic information of the employees to its authorized clients.
Usually, the MFIs rely on commercial banks for their funding activities to carry out the business process. It is also noticed that about 80 percent of the business funding for the MFIs has been obtained from the commercial banks, and most of them are private banks, thus, charge a high rate of interest on the short term of loans to the MFIs. This over-dependency on the banks makes the microfinance less competent, which in turn affects the MFIs profit returns. As a solution for this issue, the MFIs could expand its funding sources and opt for the sources of those funds on lower interest. Thus, by reinforcing the regulation, the MFIs can reduce their rate of interest. Also, choosing feasible sources for funding would elevate the microfinance profit.