By Jagriti Bhattacharyya

Microfinance has been the darling of international development and viewed as a tool for poverty alleviation for long. Pioneered by Nobel-Prize-winning Bangladeshi economist Muhammad Yunus in 1976, microfinance began with lending small sums of money to women to develop their own businesses, who then repaid the amount in full. From its humble beginning in the 1970s in Bangladesh, microfinance — considered the most effective way of reaching those at the bottom of society — has today expanded its reach to countries worldwide. Yet, despite its burgeoning portfolio, a growing volume of academic research suggests that microfinance has produced little evidence, if at all, of any sustained impact in improving the lives of the poor.

The spate of harassment and tragic suicide cases reported widely in the media from different parts of the country is bringing the limelight back on the fundamental purpose of microfinance. The latest financial stability report of the Reserve Bank of India (RBI) pegged the sector’s share of overdue loans (between 31 and 180 days) as of September 2024 at 4.3%, which shows an increase from the 2.5% recorded at the end of March 2024.

Amidst this growing stress in the industry, the Microfinance Industry Network (MFIN) has taken cognisance of the growing indebtedness among the borrowers and proposed remedial measures. The MFIN, a self-regulatory organisation governing microfinance institutions (MFIs), has also brought in a new regulation that caps the maximum number of collateral-free loans per borrower to three instead of four earlier, and the total indebtedness considering all unsecured loans to be capped at Rs 2 lakh. This appears to have hit the right chord because when multiple lenders push loans to vulnerable borrowers, it leads them into a vortex of never-ending high interest-bearing loans. MFIs then deny those borrowers any further loans, but with a piling load of repayments the borrowers once again fall prey to loan sharks, the very ones from whom they intended to escape in the first place.

Structural reforms: Need of the hour

To tide over the ongoing crisis, the new regulations are welcome. However, long-term structural reforms are paramount to ensure microfinance serves as a tool for poverty alleviation and financial inclusion.

Despite the remarkable revolution of the digital payment landscape in urban India, cash continues to be dominant in rural households. Take the example of Siddhama, a household help in an apartment complex in Indiranagar, Bangalore. She earns roughly Rs 20,000 per month, but despite having a bank account in her husband’s name she insists on cash payments alone for her salary credits. Every month, she goes back to her native village in rural Karnataka, where her four children and parents reside, to hand them the money. Her husband, employed as a security guard in a neighboring household complex, earns a similar amount. She is the typical example of a microfinance customer. In households such as Siddhama’s, estimating incomes to ensure that customers fall under the ambit of microfinance continues to be an onerous task for non-banking financial company-MFIs and banks. But Siddhama reveals that she has taken loans on several occasion from MFIs as well as local moneylenders, most recently in order to meet the marriage expenses of her eldest daughter. While she and her husband continue to be employed in the informal daily-wage sector with no additional avenue for generating income, it becomes evident that most of the loans accessed by them were for consumption alone.

Impact of microfinance

The penetration of Aadhaar and e-Know Your Customer provides a sliver of hope. With more than 93% of India’s population registered for Aadhaar, the RBI should make it imperative for all lending institutions to not just share the details of their microfinance customers with credit bureaus for checking credit-worthiness but also report details of all such customers to research/academic institutions mandated with the task of analysing improvement in household incomes after taking MFI loans. The primary purpose of microfinance is not to drive consumption, but alleviate poverty. Analysing the impact of microfinance on poverty alleviation is only possible when adequate data at the grassroots is collected over time.

Utilising AI and data science models

In recent years, data science and artificial intelligence (AI) tools have transformed how lending institutions assess customers, disburse loans, and make collections, rendering the process convenient for customers as well as financial institutions (FIs). However, technology should not be restricted to uphold and protect the interests of FIs. Rather, AI should be utilised to analyse the impact of MFI loans on households’ ability to generate additional income, and subsequently the number of households who are able to overcome poverty and come into the fold of formal banking. For microfinance to be truly impactful, organisations must strive to serve all those who are at the bottom of the financial pyramid. AI and data science have contributed immensely to transform digital lending in India. Done right, they hold the key to revolutionise India’s microfinance story.

The writer is assistant professor, TAPMI, and senior research fellow, IISc Bangalore.

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