Microfinance Institutions (MFIs)

Microfinance refers to the provision of financial services (primarily small loans, and sometimes savings, insurance, etc.) to low-income individuals or groups who lack access to traditional banking. In the Indian context, microfinance mainly means micro-credit – small, collateral-free loans given to the poor, with the goal of entrepreneurship, income generation, or meeting urgent needs. The concept gained prominence as a tool for poverty alleviation and women’s empowerment (e.g., Grameen Bank model in Bangladesh, Self-Help Group movement in India).

Microfinance Institutions (MFIs) are organizations that specialize in delivering these services. They can have various forms – NGOs, cooperatives, Section-8 (non-profit) companies, and notably NBFC-MFIs which are for-profit companies registered with RBI to do micro-lending.

NBFC-MFIs

Within the NBFC universe, NBFC-MFI is a distinct category created by RBI in 2011 (post the Andhra Pradesh microfinance crisis) to bring large MFIs under uniform regulation. An NBFC-MFI must dedicate the majority of its loan portfolio to micro-loans that meet RBI’s qualifying criteria. It operates much like a lending company but with additional microfinance-specific regulations focusing on borrower protection and loan parameters.

Key Features of Microfinance Loans

Collateral-Free

Micro-loans are given without any collateral. Borrowers are typically too poor to offer security; instead, MFIs use group liability or community peer pressure as a form of soft guarantee. Group lending (through Joint Liability Groups or Self-Help Groups) is common – small groups of borrowers mutually guarantee each other’s loans.

Small Ticket Size & Short Tenure

Loan amounts are usually small (could be ₹10,000 up to ₹50,000 or a bit more for successive cycles). Initially, borrowers get a very small loan; upon successful repayment, they become eligible for slightly larger loans in subsequent cycles. Loan tenures range from a few months to 1-2 years, often with weekly or fortnightly installment repayments, aligning with the cash flows of the borrower (who might be a vegetable vendor, artisan, etc. earning daily/weekly).

Higher Interest Rates (compared to banks)

Since MFIs lend without collateral and incur high operating costs (servicing many tiny loans and door-step collection), they charge higher interest (could be 20%+ annually).

However, these rates are still usually far lower than what informal moneylenders charge the poor. RBI had earlier imposed an interest rate cap or margin cap on NBFC-MFIs (for example, interest could not exceed cost of funds + 10% or an absolute cap around 26%).

Recent changes (2022) have removed the strict cap, allowing risk-based pricing, but MFIs must disclose interest rates transparently and not have usurious rates. Competition and guidelines ensure rates remain reasonable.

Target Segment

MFIs target low-income households. Originally, RBI defined eligible borrowers by household income: e.g., rural households with annual income up to ₹1 lakh and urban/semi-urban up to ₹1.6 lakh (these were earlier limits).

• In March 2022, RBI simplified this to a uniform ₹3,00,000 annual household income ceiling for microfinance loans (irrespective of rural or urban).

This broadened the scope of microfinance to slightly higher-income but still economically vulnerable groups. MFIs also heavily focus on women borrowers – a majority of micro-loans are given to women, believing they are more likely to use the funds productively for family welfare and repay reliably.

End-Use

Loans are often for income-generating activities (small business, buying tools or livestock, stocking inventory for a tiny store, etc.), but some portion can also go toward consumption needs, medical emergencies, education, or home repairs. To qualify as a microfinance loan under NBFC-MFI norms, at least 50% of the loans by number must be for income generation (this requirement ensures microfinance retains a development orientation).

Regulatory Guidelines and Recent Changes

RBI’s regulatory framework for NBFC-MFIs (which now largely extends to all microfinance lending by any regulated entity) includes:

Qualifying Asset Criteria

Earlier, an NBFC-MFI had to maintain at least 85% of its net assets as qualifying microfinance loans. This was relaxed to 75% in 2022 and further to 60% in 2023. This means NBFC-MFIs can now use up to 40% of their portfolio for other lending (which could be slightly larger loans or other products), giving them flexibility to diversify their business and reduce risk concentration. However, they still remain primarily micro-lenders.

Indebtedness Cap

To prevent over-borrowing, guidelines limit how much a microfinance borrower can be indebted. The total loans of a single borrower (from all sources) was earlier capped (e.g., ₹1 lakh total debt limit). The new regulation takes a different approach:

• it requires that a borrower’s monthly loan repayments should not exceed 50% of the household’s monthly income.
• Lenders must assess income (self-declared or via verification) and ensure the borrower isn’t over-leveraged beyond this 50% repayment-to-income ratio.

This is a critical check against borrowers taking multiple loans from different MFIs unbeknownst to each.

Pricing Freedom with Transparency

The March 2022 RBI “Regulatory Framework for Microfinance Loans” removed the prior interest rate caps for NBFC-MFIs, effectively bringing all lenders (including banks, small finance banks, etc.) onto a level playing field for micro-loans.

Now, each institution can set its own interest rates for microloans but must follow a Board-approved policy for pricing, ensure no usurious rates, and disclose the minimum, maximum, and average interest rates charged.

Also, no penalty for early repayment of microloans can be charged, and any penalty for delayed payment can only be on the overdue amount (not on entire principal).

Avoiding Coercive Collection

Regulations emphasize customer protection – MFIs must follow a Fair Practices Code. This includes not using harsh recovery practices, giving borrowers information in the local language, capping the number of loans to a borrower (earlier, max 2 MFIs could lend to one borrower; now that specific rule may have been relaxed but the 50% income rule indirectly controls multiple borrowing).

There are industry credit bureaus for MFIs that track borrower loan records to help enforce these norms.

Minimum Security of Tenure

Loans above a certain amount (e.g., >₹15,000) must have a minimum tenure (like 24 months) with the option of prepayment without penalty, ensuring borrowers are not forced into unrealistic short repayment periods for larger loans.

Institutions and Conversions

Many microfinance institutions that started as NBFC-MFIs have matured and even transformed:

• In 2015, RBI granted Small Finance Bank (SFB) licenses to ten entities, of which majority were NBFC-MFIs (e.g., Ujjivan, Jana, Equitas, Spandana – although Spandana didn’t become a bank, others did; Bandhan, a microfinance giant, got a full bank license in 2015).
• These conversions mean some of the largest MFIs are now banks, but they continue serving the microfinance customer base as bankers.
• There remain numerous NBFC-MFIs across India (large ones include CreditAccess Grameen, Satin Creditcare, Arohan, ASA India, etc.), as well as non-profit MFIs and cooperative ventures.
• They often form self-regulatory bodies (like Sa-Dhan or MFIN) that coordinate with regulators to ensure healthy practices.

Government Initiatives Supporting Microfinance

MUDRA

Micro Units Development and Refinance Agency Ltd (MUDRA), set up in 2015, provides refinancing to banks and NBFC-MFIs for lending to micro-entrepreneurs. Under the Pradhan Mantri MUDRA Yojana, MFIs channel credit to microbusinesses under categories Shishu (loans up to ₹50,000), Kishore (₹50k to ₹5 lakh), and Tarun (₹5–10 lakh). MUDRA refinance helps MFIs get funds at lower cost which they can pass on to borrowers.

NABARD’s SHG-Bank Linkage Programme

Parallel to MFI model, India has a massive self-help group (SHG) movement where banks lend to groups of women organized into SHGs. While not NBFCs, it’s part of microfinance ecosystem. Over 1 crore women have benefited from SHG bank linkage, often facilitated by NGOs and Microfinance Institutions acting as business correspondents or promoting entities. This is often mentioned in exams as another pillar of microfinance in India.

Importance and Impact

Microfinance has had a significant impact on poverty reduction and social upliftment at the grassroots. Studies show that micro-loans have enabled many households to start small businesses (like rearing livestock, running a tailoring shop, street vending, etc.), smooth consumption during difficult times, and reduce dependency on exploitative moneylenders.

It has especially empowered women – since loans are frequently given to women’s groups, it improves their decision-making power in the household and community. Repayment rates in microfinance historically have been very high (often 95%+), although the sector has seen periodic crises (due to natural disasters, local political issues, or over-indebtedness waves).

Challenges

Despite successes, MFIs face challenges:

Over-Indebtedness Risk

If multiple MFIs lend in the same area without coordination, borrowers might take on more debt than they can handle. This occurred in Andhra Pradesh in 2010 leading to a crisis. The new regulations aim to prevent this through credit bureaus and income-based limits.

High Interest Rates Perception

Even though MFI rates are lower than informal sector, interest around 22-26% can be seen as high and has drawn criticism. The balance between sustainability of MFIs and affordability for borrowers is delicate. Removing caps allows competition to drive rates, but RBI expects MFIs to be responsible.

Operational Risks

Microfinance is high-touch – loan officers often travel weekly to villages to collect installments. This model was stress-tested during events like COVID-19 pandemic, where movement restrictions and economic distress caused higher delinquencies. MFIs had to navigate moratoria and restructuring for the first time at large scale.

Transition to Banks

As some MFIs become banks or SFBs, the remaining NBFC-MFIs have to fill the gaps and also face competition from those new banks (which can take deposits). However, even SFBs often continue micro-loans as core business, so the mission continues albeit under a different license.