Why do Micro-Finances Matter?

There are means to achieve the end result and often, there would be alternative routes as well to attain the same outcome without compromising the nature and quality of the outcome altogether. In fact, the human mind keeps innovating to identify alternative solutions for every circumstance and problem in our day-to- day lives. We have alternative religious faiths, alternative medicine, alternative lifestyle and the list continues.

When we say alternatives, they are in no way inferior to the existing solutions or means. For example, alternative medicines like Ayurveda and Homeopathy have proven to be as effective as the mainstream allopathic or conventional medicine. In a similar fashion, we have the microfinance, which is rising as an alternative source of financing the entrepreneurs and businesses who otherwise find it difficult to access sufficient capital from the traditional banking sector. According to the definition given by Investopedia,
“…Microfinance, also called microcredit, is a type of banking service that is provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services.” Traditional banking mechanism that we see today- in public sector banks like SBI, PNB or private sector banks like ICICI, Citi, HSBC etc. – all function within the realms of the principles of banking practices that have evolved over the course of time.

Medieval times were known to have institutions and guilds to facilitate the transformation that the then economy was experiencing- a shift from the century-long feudal practices to the cash economy. When the businesses expanded and the local feudal economy gave way to the monetary economy based on business and trade, there was a dire need for the cash in the economy. Cash was needed as capital, as an investment and as a means to expand the businesses. Since the feudal class controlled a majority of the wealth during that time, there was a dire need for the steady flow of capital into the businesses, which, however, was beyond the realms of the financing capabilities of the business and trading class. Thus, the individuals came together, pooling their financial resources, giving rise to the modern day banking intermediaries. Today, the basic structure followed by the banks are more or less similar to the way they used to operate in the medieval times.

While this conventional form of banking was very efficient and acted as the driving force behind the economic growth and development for a long period of time, it had its own structural issues. For example, traditional banking requires the individuals to hold a collateral to borrow money in the form of loans. Though this intended to reduce the risks associated with the credit, this essentially kept a large share of the population- mostly the poor and the marginalized- out of the credit market. Essentially, the conventional banking system became elitist over the course of time by concentrating its operations within the elitist and privileged classes of the society while keeping the marginalized and disadvantaged groups at bay. It is at this juncture that micro-financing institutions could ignite a revolution by bringing even the most disadvantaged, poorest sections of the society into mainstream financial activities and thus, uplift them from their stagnated living conditions.

Micro-finance institutions act more or less like how peer-sharing networks operate. It is largely decentralized and has the capability of reducing the credit risk by a substantial level without compromising the ability of the individuals. It divides the risk amongst all the borrowers and thus, uses the tool of moral persuasion and peer pressure to make the individuals pay. For instance, the Grameen Bank model follows the mechanism of lending to a group so that the chances of individual defaults will be reduced by the members of the group, leading to higher repayment rates and profitability for the bank. Similar is the case of the farmer’s cooperatives or the women self-help groups like ‘Kudumbasree Mission’ where female entrepreneurship is encouraged without compromising the creditworthiness of such loans.

Microfinance is, in fact, revolutionizing the way in which we see the financial institutions; it is bringing more and more people into the mainstream financial activities while not compromising the credentials of such institutions. Micro-financing institutions also ensure that even the most underprivileged of the society are taken into consideration, which is highly essential for the developing countries like India.

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