What Is Microfinance? How Does it Work

Microfinance meaning, in simple words, indicates providing banking facilities to those who do not have access to traditional financial services. Financial services are an efficient way to help meet your personal goals. But how do these solutions impact the economy on a larger scale? Obviously by facilitating cash flow and liquidity in the market. 

That said, what happens when most of the population cannot access these services? As a result, growth gets stunted. One reason for the financial exclusion is the stringent eligibility requirements set by institutions. Due to these, individuals belonging to the low-income group are often left out. However, microfinance serves as a viable solution, promoting financial inclusion.

Read on to learn all about microfinance, its importance, benefits and more.

What is Microfinance?

Microfinance in India refers to the financial services made accessible to those who cannot access them through traditional institutions. Microfinance was traditionally made available through microfinance institutions (MFIs).

Microfinance companies in India operate similarly to banks, NBFCs and other financial institutions that offer services on a larger scale. The difference, however, lies in the fact that MFIs offer services catered to meet the requirements and financial capability of the low-income group.

A key eligibility requirement to avail of microfinance services is the income limit, which is set at ₹3 lakhs by the RBI. This is important because companies and institutions offering services to a larger group often have high-income requirements, thus making them inaccessible to the low-income group. 

People are increasingly borrowing from microfinance institutions due to the benefits it offers to individuals and the country. Banks and NBFCs have also started offering basic financial services to their customers after realising the needs that microfinance companies cater to. 

Types of Microfinance

A microfinance company is often differentiated based on the service it offers. Listed below are the basic financial services offered through microfinance:

• Microloans 

A collateral-free credit option that enables entrepreneurs to set up or expand a small business. When they repay on time, it also gives them a chance to avail of larger services from traditional institutions that require a good credit history.

• Microinsurance

Through this, individuals or small businesses ca access insurance coverage that protects them against unexpected expenses at a lower premium.

• Microsavings

By eliminating the minimum balance requirement, such services encourage them to invest at their convenience and earn returns, ultimately inculcating financial discipline.

Benefits of Microfinance

Here are some of the top benefits of microfinance that the underserved sections of population get to enjoy:

• Provides access to funding that often isn’t available through traditional institutions
• Offers opportunities for employment by allowing small business owners to grow
• Gives the group a chance to become self-sufficient and meet their goals
• Reduces financial stress and makes better opportunities accessible
• Access to flexible loan terms at affordable interest rates
• Loans available without providing any collateral as security

How Microfinancing Works in India?

Microfinancing in India works through the following channels:

SHG-Bank Linkage Programme (SBLP)

Launched by NABARD IN 1992, the SHG-Bank Linkage Programme encourages women belonging to the economically weaker sections to form groups of 10-15 members and contribute their savings regularly to the group. From these pooled savings, members of the group can avail of loans when needed. 

Microfinance Institutions (MFIs)

Microfinance Institutions (MFIs) are organisations that provide microfinance services like:

• Loans
• Bank accounts
• Insurance
• Remittances

These institutions get financial resources from lending institutions, which they use to provide affordable loans to the economically weaker sections. They work like Joint Liability Groups (JLGs), which are informal groups of 4-10 members. These JLGs can apply for loans as group members or individually. 

What are Microfinance Institutions?

Check out the various types of microfinance institutions:

Joint Liability Groups

Joint Liability Groups (JLGs) are informal groups with 4-10 members that seek loans based on mutual guarantee. Farmers, tenants and rural labourers are the main borrowers and loans associated with agriculture and similar businesses are the most common. 

Self-help Groups

Self-help Groups (SHGs) are groups with people belonging to similar economic groups seeking to financially support each other. The group members pool funds for a specific period to meet their business needs. 

NABARD’s SHG linkage program also allows various self-help organisations to borrow money from banks. To get the funds from banks, they need to provide a record of making payments regularly.

Grameen Bank Model

The Grameen Bank model was introduced by the Nobel Laureate, Prof. Muhammad Yunus, in the 1970s in Bangladesh. The main aim of this model is to boost and stabilise the rural economy. This model has also helped in the introduction of Regional Rural Banks (RRBs) in India to offer financial support to the economically weaker sections.

Rural Cooperatives

Rural cooperatives were started in India during the independence era. It included collecting assets from the financially weaker individuals and providing banking services to them. This system did not work as planned since it was more beneficial to creditworthy borrowers in rural India.

Microfinance in India is growing rapidly due to the emerging MFIs and financial institutions, which now offer financial services inclusively. Among the many banks, NBFCs and financial institutions promoting financially inclusive growth is Fibe. 

Through Fibe, you can get an Instant Personal Loan of up to ₹5 lakhs affordably. With easy-to-meet eligibility criteria and an alternate credit scoring model, Fibe aims to make loans accessible even to those who are new to credit. Download the Fibe Instant Loan App or log in to our website to apply digitally and get quick access to funds.

FAQs on Microfinance

How to apply for microfinance in India?

You need to visit the microfinance institution (MFI) of your choice to get microfinance. Then, connect with a representative to discuss your needs, fill out the necessary form and submit the required documents. Checking the process and requirements before applying is important since they differ across various financial institutions. 

What documents do I need to submit to avail of a microfinance loan?

The document requirements for a microfinance loan depend on the institution. Generally, you need to submit your ID, address and income proof with a filled application form. If you are getting a loan for your business, you will need to provide your business and financial documents as well.

How do I know if I am eligible for a microfinance loan?

Income is an important eligibility criterion for microfinance loans and the RBI has set the threshold at ₹3 lakhs. Microfinance institutions may also have other eligibility criteria. Therefore, checking the eligibility criteria of the particular institution is important to understand your eligibility for the loan.

What are the benefits of microfinance?

Some top benefits of microfinance include:

• Immediate access to funds
• Financing solutions for those excluded from traditional institutions
• Better financial growth on a personal and market level

What is the difference between a bank and a microfinance institution?

A key difference between a bank and a microfinance company in India is that a microfinance company provides services to people in the low-income group. On the contrary, a bank offers services to people belonging to all income groups.