Micro Finance - Micro Finance in India (UPSC Notes)

Microfinance is a basis of financial services for entrepreneurs and small businesses deficient in contact with banking and associated services. The two key systems for the release of financial services to such customers include ‘relationship-based banking’ for individual entrepreneurs and small businesses along with ‘group-based models’  where several entrepreneurs come together to apply for loans and other services as a group. Similar to banking operation traditions, microfinance entities are supposed to charge their lender’s interests on loans. In most cases the so-called interest rates are lower than those charged by normal banks, certain rivals of this concept accuse microfinance entities of creating gain by manipulating the poor people’s money.


As per the World Bank estimates, more than 500 million people have improved their economic conditions via microfinance-related entities. Microfinance is an important topic for the IAS Exam and is included under the GS-II section of the UPSC Syllabus. 

History of Microfinance

The history of microfinance can be traced back to the middle of the 1800s. During the 1800s, the benefits of small credits to entrepreneurs and farmers was written by Lysander Spooner, the theorist, as a way to get people out of poverty.  Later, the first cooperative lending bank was founded independently by Friedrich Wilhelm Raiffeisen to support the farmers in rural Germany.

The term “microfinancing” was first used in the 1970s during the development of Grameen Bank of Bangladesh, which was founded by the microfinance pioneer, Muhammad Yunus. In 1976, Yunus institutionalized the approaches of microfinance, along with the foundation of Grameen Bank in Bangladesh. Since, in the developing countries, a large number of people still depends largely on subsistence farming or basic food trade for their livelihood, therefore, smallholder agriculture in these developing countries has been supported by the significant resources.

The information on Micro Finance is imperative for candidates preparing for the Civil Services Exam.

Aspirants can cover the topics mentioned in the UPSC Syllabus by following the below-mentioned links:

Microfinance in India

Lack of security and high operating costs are some of the major limitations faced by the banks while providing loans to poor people. These limitations led to the development of microfinance in India as an alternative to provide loans to the poor with an aim to create financial inclusion and equality.

SEWA Cooperative Bank was initiated in 1974 in Ahmedabad, Gujarat, by Ela Bhatt which is now one of the first modern-day microfinance institutions of the country. The National Bank for Agriculture and Rural Development (NABARD) offered financial services to the unbanked people, especially women and later decided to experiment with a very different model, which is now popularly known as Self-help Groups (SHGs). The SHG-Bank linkage programme in India has savings accounts with 7.9 million SHGs and involves the participation of regional rural banks (RRBs), commercial banks and cooperative banks in its operations. The origin of SHGs in India can be traced back to the establishment of the Self-Employed Women’s Association (SEWA) in 1972.

To know more about Self-help Groups (SHGs), refer to the linked page.

In 2013, a loan of $144 million was provided by Grameen Capital India to the microfinance groups. Apart from the Grameen Bank, another microfinance organization named Equitas was developed in Tamil Nadu. The Southern and Western states of India are the ones attracting the greatest number of microfinance loans.

What is MUDRA?

The central government had introduced the Micro Units Development Refinance Agency (MUDRA) where the scheme aims to refinance collateral-free personal loan of up to Rs 10 lakh granted by lending entities to non-corporate small borrowers, for revenue growth actions in the non-farm sector.  Currently, loans granted under this system have falls under three categories namely, Shishu loans for up to Rs 50,000, Kishor loans in a range between Rs 50,001 to Rs 5 lakhs and Tarun loans ranging from Rs 5 lakhs to 10 lakhs. As a way to make the MUDRA scheme popular, the government aims to set up a Rs 3000-crore Credit Guarantee Fund to back these loans.

Aspirants can go through the relevant links provided below for comprehensive preparation –

PMMY – Pradhan Mantri Mudra Yojana Types of Non Banking Financial Institutions India RBI Grants Licensing for Small Finance Banks
What is a Development Financial Institution Economic Contagion/Financial Contagion Capital Markets – Importance, Features, and Structure
Financial Inclusion – National Strategy for Financial Inclusion SIDBI – Small Industries Development Bank of India FSDC – Financial Stability and Development Council
RBI – Reserve Bank of India Micro-Irrigation Fund Finance Commission of India 
15th Finance Commission  Finance Bill – Article 110, 117 (Indian Constitution) Panchayat Finance

Micro Finance Associated Challenges 

  • Inadequate Data: While overall loan accounts have been increasing the actual impact of these loans on the poverty-level of clients is sketchy as data on the relative poverty-level improvement of MFI clients is fragmented.
  • Impact of COVID-19: It has impacted the MFI sector, with collections having taken an initial hit and disbursals yet to observe any meaningful thrust.
  • Social Objective Overlooked: In their quest for growth and profitability, the social objective of MFIs—to bring in improvement in the lives of the marginalized sections of the society—seems to have been gradually eroding.
  • Loans for Conspicuous Consumption: The proportion of loans utilized for non-income generating purposes could be much higher than what is stipulated by RBI. These loans are short-tenured and given the economic profile of the customers, it is likely that they soon find themselves in the vicious debt trap of having to take another loan to pay off the first.

Benefits of Microfinance

  • As per the World Bank estimates, more than 500 million people have improved their economic conditions via microfinance-related entities.
  • Also, the International Finance Corporation (IFC) estimated that, as of 2014, over 130 million people were directly benefited from the microfinance-related operations.
  • But, approximately only 20% of the three billion people who fall under the category of the world’s poor can avail these microfinance operations.
  • IFC also helped in establishing or improving the credit reporting bureaus in 30 developing nations.
  • Microfinance is also a source of capital for the people. It also empowers women in particular, which may lead to more stability and prosperity for families.

Way Forward with Microfinance

  • RBI should encourage all institutions to monitor their impact on society by means of a ‘social impact scorecard’
  • MFIs should ensure that the ‘stated purpose of the loan’ that is often asked from customers at the loan-application stage is verified at the end of the tenure of the loan.
  • The customer data in a scorecard that is verified and captured digitally can be used to evaluate the impact of each loan in the lives of the clients, subsequent improvement in their earning capacity over the years, other direct/indirect benefits rendered from loan utilization and finally how soon MFI customers are able to transition out of the MFI fold.

Microfinance is an important topic in the General Studies Paper-II of the UPSC exam. Questions can be asked from this topic in both the IAS prelims as well as the IAS mains exams.

Frequently Asked Questions about Micro Finance


What are the benefits of micro finance?

The benefits of microfinance include: Small loans enable entrepreneurs to start or expand micro, small and medium enterprises. Savings help families build assets to finance school fees, improve homes (e.g., install power or running water) and achieve goals. Insurance products can offset the cost of medical care.

What is difference between bank and microfinance?

A microfinance institution offer loans with little to no asset to the clients while in a bank one has to have collateral to receive a loan.

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