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Role Of Micro-Loan In Modern Financing Industry

Even though today the procedure and conditions of loan advancements from banks or other financial institutions have been made flexible, there are still major sections of the society who do not have resources securing a normal loan. Traditionally loan is approved when the borrower submit a collateral security so that in case if the borrower is unable to repay the loan with interest the collateral security submitted by the borrower can be seized by the bank and used as a means to recover the money given as loan.[1]

But he question is, what about the people who do not have anything to put as collateral in order to advance a loan from the bank? What about the people who are too poor to put anything as collateral for a loan? And this is how the concept of micro-loan was introduced which allows people advance loans from the banks without any collateral security.

What is Micro-loan?

As opposed to traditional loans in which loan is only provided on the condition that the borrower puts something for collateral and a normal amount of interest decided by RBI, micro-loan does not require any collateral security to be put in exchange for the loan but on slightly higher interest rates than that of normal bank loans. The definition of micro-loan is “a small loan typically for financing entrepreneurial projects by impoverished individuals and groups especially in poor or developing regions”.[2]

Micro-loan is a part of micro finance industry which also includes micro-savings and micro-insurance. Micro-finance is a way in which loans, credit, insurance, access to savings account, and money transfers are provided to small business owners and entrepreneurs in the underdeveloped parts of the world. The beneficiaries of micro-finance are those who do not generally have access to traditional financial resources like normal people but as compared to normal loans the interest rates on micro-loan are slightly higher than that of normal loans.

The loan that is not issued by banks, credit unions or any other financial institution is known as micro-loan.[3] Micro-loan are usually given in third world countries or developing countries for their under developed population so that this population can start a small business and start earning a living. Because the credit of these borrowers is quite low and there is a good chance of loan default, micro-loan allows higher interest rates than that of a normal loan making them enticing for some investors.[4]

Origin of Modern Micro-Loan

It is said that modern micro-finance was first originated from the Grameen Bank in Bangladesh in 1983.[5] It was founded by Muhammad Yunus in 1983, he started this project in the small town of Juba in Bangladesh. He would use his own money to deliver small loans at low interest rates for the poor people.

The Grameen Bank first started was a non-profit government organization which depended on government subsidies, it later became a corporate entity and was renamed Grameen II in 2002. Yunus was awarded the Nobel Peace Prize in 2006 for his work providing micro-credit services to the poor.[6]

Role of Micro-Loan in Modern Financing Industry

Even to this day almost half the population of our country does not have a basic savings account. This is the same group of people who are considered financially backward class and cannot even apply for a traditional loan at a traditional bank. Micro-finance provides access to services like micro-loan, micro-savings, micro-insurance to people who are financially underserved.

If micro-finance institutions were not serving these people they would resort to advancing of loans from unofficial channel who charge comparatively much higher interest than any other financial body, and there is a good chance if they didn’t pay back the borrowed money in given time these unofficial moneylenders would even resort to take over the properties of the borrower or may even threaten their lives.

Usually, in India micro-loans in the range between Rs.20,000-30,000 is availed. But in recent years the country has seen a rise in micro-loans in the range of Rs.30,000-40,000 by 56%. The micro-finance industry has seen a registered growth of 44% as of 31st March, 2019.[7]

Micro-loans are given to low-income individuals and groups. These loans are different from the traditional loans given by traditional banks. Micro-loan doesn’t require any collateral in return, although they are given at a certainly higher interest rate compared to traditional loan. The concept of micro-loan has proven to be one of the most effective tools in reducing poverty in India.

Micro-loan in India is provided to people in need mostly through two channels:

  1. SHG-Bank linkage Programme (SBLP):

    It was initiated by NABARD in 1992. This programme allows a group of 10-15 backward women to contribute their individual saving to the group at regular intervals. Loan is provided to members of the group from these contributions.

    This model has received a lot of praise in the past for contributing to the empowerment of women in our country.
  2. Micro-finance Institutions (MFIs):

    Micro-finance services are offered by various different sources: (a) Formal institutions which include corporations and rural banks, (b) Semi-formal institutions that include non-government organizations, (c) Informal sources such as shopkeepers and small scale lenders.

Micro-loan has become one of the greatest assets of India to fight poverty; the idea that was first developed in Bangladesh by Yunus has now become a very big part of our country. Micro-loan has been proven to be very useful over the past few years in not only fighting poverty but also help empowering people of backward classes and it has specially helped in empowering women considered of backward class.

Even though the concept of micro-loan has been praised by many because of its effectiveness of fighting poverty there are still some who believe that micro-loan and micro-finance actually makes poverty worse. The fact that many borrowers use these loans to pay-off their existing debts only adds to the cycle of money borrowing and increasing their debt trap. Some people also believe that micro-loan has not had a positive impact on gender relationships, does not decrease poverty and promotes “privatization of welfare”.[8]

When the first evaluation of micro-loan was conducted by Abhijit Banerjee and others the results were of mixed nature, they found out that there was no effect on household expenditure, education, health or gender equality.[9]

Micro-loan is a part of micro-finance which also includes micro-insurance and micro-savings. Over the years micro-loan has proved to be very much useful in fighting poverty not just in India but all the developing nations. It was Mohammad Yunus who came up with the idea of micro-loan in 1983, so that he could help the people living in his village Juba.

The idea was to give out loans to poor people in need of money without any collateral but with slightly higher interest rate then the traditional loan. This idea of his was highly praised and accepted by many developing and developed nations. In 2006 Yunus was awarded with the Noble Peace Prize.

To this day many countries use micro-loan to fight poverty including India. Micro-loan not only help fights poverty but also reduces unemployment and helps empower some of the backward class of people. Micro-Loan is a loan which is given to financially and socially backward people of the society without any collateral but higher interest rate then traditional bank loan. The main objective of micro-loan is to help the financially and socially backward class people so that there living standards can be increased leading to a happy and fulfilling life.

There are still many people who think that micro-loan is privatization of welfare and nothing more and that it doesn’t help with reducing poverty or increase the living standards of financially backward people. And that is why more and more people need to be educated about micro-loan so that negative myths related to micro-loan can be removed from people’s heads and so that more and more people who are financially backward can increase their standards of living.

  1. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
  3. Kiva. "The Journey of a Kiva Loan.",, Accessed- August 31, 2020.
  4. Kiva. "What's up with microfinance interest rates?",, Accessed- August 31, 2020.
  5. Bateman, Milford (2010). Why Doesn't Microfinance Work?. Zed Books.
  6. Nobel Nobel Peace Prize 2006:Muhammad Yunus, Grameen Bank, Accessed- 2 September , 2020
  7. CRIF High Mark Report
  8. Arp, Frithjof. "The 34 billion dollar question: Is microfinance the answer to poverty?". Global Agenda. World Economic Forum. Accessed- September 3, 2020
  9. Banerjee, Abhijit; Esther Duflo; Rachel Glennester; Cynthia Kinnan. "The miracle of microfinance? Evidence from a randomized evaluation". Accessed- 3 September 2020
Written By- Prakhar Chandel

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