Unit 1- Introduction to Micro Finance

Understanding Financial System :M

 A financial system is a set of institutions, market and practices
(regulations) that facilitate and allow for the exchange of funds
between borrowers, lenders and investors.
 A sound financial system is a critical factor for the economic growth of
the nation.
 Generally, the financial system can be broadly classified into
i) Financial Market
ii) Financial Institution
iii) Financial instruments
 Nepalese Financial system has composed with central bank (NRB),
Securities Board of Nepal (SEBON), Insurance Board of Nepal
(Beema Samiti), and Department of Corporative as a regulatory
institutions.

List of banks and financial institutions in Nepal licensed by the Nepal

Rastra Bank.

 Class A: Commercial Banks

 Class B: Development Banks
 Class C: Finance Company
 Class D: Micro Finance Institutions
 Infrastructure Development Bank.

Concept of MicroFinance:

 Microfinance is a category of financial services targeting individuals and

small businesses who lack access to conventional banking and related
services.
 Microfinance refers to the financial services provided to low-income
individuals or groups who are typically excluded from traditional banking.
  Microfinance has composed of two words micro and finance which means
small credit, but the concept of microfinance goes beyond the provision of
small credit to the poor.

Objective of Micro-finance are:

 To help in the creation of income-producing activities

 Building assets
 Stabilizing consumption
 Protecting against risks
 Fighting against poverty
 maintain financial inclusion
 empower women or other disadvantaged population groups
 create employment opportunity
 assist socio-economic transformation
 no physical collateral requirement
 Lending by group formation

It principally achieves the above objective through

 Micro-credit
 Micro Savings
 Micro-Insurance, and
 Money Transfers for the poor
  Microfinance is not simply banking, but it is a development tool.
 Microfinance activities usually involves
i) small loans, typically for working capital
ii) informal appraisal of borrowers and investment
iii) Collateral substitutes, such as group guarantees or
compulsory savings.
iv) access to repeat and larger loans, based on repayment
performance
v) efficient loan disbursement and monitoring
vi) secure saving products
 Microfinance is an activity that involves innovative techniques ( group
lending, joint liabilities, and no need of physical collateral) to provide
financial services for a certain category of people (the poor who have
no access to formal financial services) with a certain purpose
(principally for investment in a business or productive sectors), and
aimed to achieve a certain objective(poverty reduction and financial
inclusion).

Characteristics of Microfinance:
 i) Both financial and Social intermediation
ii) No physical Collateral requirement.
iii) Group Based Lending system
iv) Focused on the marginalized and poor peoples
v) Micro-Enterprises or Business creation
vi) A tool of Financial Inclusion
vii) Facilitates for socio-Economic transformation

Evolution and Development of Microfinance

Microfinance has rapidly evolved and expanded from the relatively narrow field of micro
enterprise credit to the more comprehensive concept of microfinance. The ideas and
aspiration behind microfinance are not new. Small informal savings and credit groups
have operated worldwide, from Ghana to Mexico to India and beyond. In Europe, as
early as the fifteenth century, the Catholic Church founded pawn shops as an
alternative to usurious moneylenders. These pawn shops spread throughout the urban
areas in Europe throughout the fifteenth century. The poor's formal credit and savings
institutions have also been around for generations, offering financial services for
customers who commercial banks traditionally neglected.

Microfinance has developed steadily and rapidly over the last twenty years. Its
antecedents include cooperative and community endeavors in the nineteenth century in
Germany and elsewhere in Europe. Microfinance emerged in the 1970s as social
innovators began to offer financial services to the poor, those who were previously
considered 'unbankable because of their lack of collateral. Once given the opportunity,
not only did clients of microfinance institutions expand their businesses and increase
their incomes, but their high repayment rates demonstrated that the poor are capable of
transforming their own lives, given a chance. This model of lending disproved all
conventional thinking about banking.

Previously, microfinance was known as rural finance or informal finance. Rural finance
and informal finance have similar characteristics and practices as microfinance because
they involve small loans usually tailored to the poor. The term 'microfinance became
popular and widely used with the establishment of Grameen Bank by Professor
Muhammad Yunus in the 1970s. Rural finance was practiced in Ireland and Germany in
the sixteenth and seventeenth centuries. In Germany, Friendrich Wilhelm Raiffeisen
created a credit cooperative, one of the tools of microfinance providers, after the 'hunger
year' of 1846. The credit cooperative provided loans to poor farmers in rural areas, and
by 1910, it had successfully served 1.4 million farmers in Germany and been replicated
in Ireland and Northern Italy.
The rapid development of formal microfinance started in Bangladesh in the 1970s. It
was initiated by Professor Muhammad Yunus, an economist of Bangladesh who was
conscious of the hardship the poor faced, especially the women, in his country.
Professor Yunus began mero-lending by giving out collateral-free loans to low-income
people involved in income-serealing activities such as weaving bamboo stools and
making pots. Finally, it became the Grameen Bank, which now serves more than
millions of clients and is a model for many worldwide.

Muhammad Yunus believed that the capitalist banking system could not resolve the
poverty problems of his country. In 1976, after finally convincing the people of the
validity of his ideas, Yunus set up a bank called the Grameen Bank (Bank of the
Villages) in 1983. The Grameen Bank offers easy and small credit to poor women
without requiring collateral. However, Yunus successfully proved that the Grameen
Bank could succeed and be a realistic strategy in changing poor peoples' lives even
without collateral. The credit bank offers to improve not only the women's economic
status but also empowers their lives. With micro-credit, the women become an income
contributor to the family, increasing their self-worth. The women borrowers also become
more financially independent and have the confidence to participate in community
organizations. For his outstanding efforts in shaping the modern industry of micro-
financing, Muhammad Yunus and the Grameen Bank were awarded the Nobel Peace
Prize in 2006.

Microfinance became possible on a broad scale through a convergence of events. The

most important was the liberalization of financial markets in the 1980s and beyond.
Liberalization facilitated the emergence of new types of formal financial institutions
dedicated to the bottom end of the market. Finally, the participation of bilateral and
multilateral development cooperation and technical cooperation agencies helped spread
microfinance activities worldwide.

Successes in the early 1980s on the social front of microfinance in Bangladesh and on
the commercial front in Indonesia provided basic institutional models: the maximalist or
'Finance Plus' and the minimalist or 'Finance Only' approaches. The international year
of micro-credit in 2005 and the Nobel Prize for Professor Yunus and his Grameen Bank
of Bangladesh in 2006 highlighted the importance of microfinance over the world.
Today, several microfinance institutions and their offspring worldwide continue to
provide a substantial volume of credit and other financial services to households and
tiny businesses. Despite these achievements, there is still a long way to extend access
to all who need financial services. Specifically, three significant challenges define the
frontier of financial services for the poor (i) scaling up quality financial services to serve
large numbers of people, (ii) reaching increasingly more impoverished and more remote
people, and (iii) lowering costs to both clients and financial service providers. Today,
microfinance is one significant component of the broader financial inclusion system,
comprised of various players with the common objective of delivering high-quality
financial services to low-income people. New technologies continue to create
opportunities to broaden access and lower the cost of delivering financial services to
poor people. Financial services are now available in many markets to anyone with a
mobile phone, with innovation driving both improved product design and delivery.

History of Microfinance in Nepal

The modern banking system was introduced in Nepal after the establishment of Nepal
Bank Limited as the first commercial bank in 1994 BS. The microfinance formally
started in the year 2036/37 when the Agriculture Development Bank launched the Small
Farmers Development Project. Intensive banking program was started by Rastriya
Banijya Bank in 2038 BS under the direction of Nepal Rastra Bank. In the year 2039
BS, the Department of Women's Development (Government of Nepal) started credit
project for rural women.

The current microfinance loan program launched in Nepal is modeled after the program
of Rural Bank Bangladesh started by Professor Mohammad Yunus. The credit for
starting microfinance in Nepal goes to Dr Harihardev Pant. He was then the Deputy
Governor of Nepal Rastra Bank. NRB started a microcredit program which was later
called microfinance. The microfinance program was started by Grameen Bank from the
government level and NGOs from the private sector. This was later transformed into the
concept of Microfinance Development Bank. At that time, microfinance banks were
established under the then Development Banks Act. But now microfinance are
operating under the Banks and Financial Institutions Act. As it is being operated as a
bank under the Banking and Financial Institutions Act, it has to be called a microfinance
financial institution instead of a bank under the same act.

From 2047 BS, Nepal Rastra Bank introduced the provision of investing 3 percent of the
total loan to the poor. Non-governmental organizations and private sector started the
microfinance program in the year 2048 BS. Similarly in 2049 BS, Nepal Rastra Bank
along with the investment of the Government of Nepal established Eastern Rural
Development Bank ('Purwanchal Grameen Bikas Bank') and Far Western Rural
Development Bank (Sudur Paschimanchal Grameen Bikas Bank'). The establishments
of these rural banks were based on the financial system of Rural Bank Bangladesh.
Immediately after that, in the year 2050 BS, non-governmental organizations like
Nirdhan, CSD, Chimek and other organizations started operating microfinance
programs. In the past, NRB implemented various poverty oriented loan programs such
as small sector loan program, priority sector loan program, intensive banking loan
program, small and home industry loan program, productive loan program for rural
women through banks and financial institutions. However, these programs failed to
achieve the intended objectives. Thus, the concept of microfinance programs emerged
in Nepal.

Table: Highlights of microfinance development in Nepal

AD Key Activities
1956 The government established 13 cooperatives in Chitwan district

1963 Establishment of Cooperative Bank

1968 Establishment of Agriculture Development Bank
1974 NRB directed two national-level commercial banks to invest 5 percent of
their total deposits in small industries
1975 Agriculture Development Bank launched Small Farmer Development
Programme (SFDP) as a pilot project in two districts
1981 Intensive Banking Program (IBP) tries to involve commercial banks in micro-
credit
1982 Gender-based micro-credit program started in the name of Production
Credit for Rural Women (PCRW) that provided a new direction
1992 Establishment of Credit Information Bureau (CIB) to minimize the case of
multiple borrowing The government set up two Grameen Bikash Banks
(GBBs) in Far Western Development Region (FWDR) and Eastern
Development Region (EDR). Three more GBBs were established after that
1992 Cooperative act enacted
1993 Converted Small Farmer Development Programme (SFDP) into Small
Farmers Cooperative Limited (SCL)
1994 Gender program refined and another woman-focused project, MCPW (Micro
Credit Project for Women) initiated by Asian Development Bank.
In the late Several financial intermediary NGOs (FINGOs) and private microfinance
1990's banks started microfinance programs in the country. The wholesale lending
organization was established for financing microfinance institutions.
1998 Rural Microfinance Development Centre (RMDC was established with the
view of wholesale lending and capacity building to the MFIs
2000 Establishment of Centre for Microfinance Nepal (CMF) to promote and
strengthen microfinance services through capacity building, training,
knowledge management, research policy, and networking
2005 Government of Nepal enacted promulgation of National Microfinance Policy
in Nepal.
2014 Merged five regional rural development banks established by the
government. Now, Nepal Rural Development Bank Limited.
2017 Conversion of Financial Intermediary Non-Government Organizations
(FINGOs) into D Class Microfinance Institutions.
2019 The government focused on the merger policy of microfinance institutions
onwards for sustainability. Monetary policy has made necessary provisions for the
merger and acquisition of microfinance institutions. The government has
prioritized financial inclusion to expand the financial services by using
financial technology (Fintech) or the digitalization process.
Distinction between Minimalist and Maximalist approaches of Microfinance

Based on Minimalist Maximalist

Approach Commercial front of The social front of microfinance applied in

microfinance applied in Bangladesh.
Indonesia.
Focus on More focus on financial Both financial and social intermediation
intermediation with some including a wide range of development-
degree of social oriented services to the poor to attack the
intermediation but avoid structural causes of poverty
the costs of additional
development-oriented
services or policies
Operating The operating costs The operating costs incurred in this
Cost incurred in this approach approach are relatively higher than the
are much lower than those minimalist approach.
of integrated micro-credit
programmes.
Assumptions This approach will This approach will acknowledge that the
acknowledge that the poor poor may need other development and
may need other social services. Still, microfinance
development and social institutions should provide or coordinate
services. Still, they have to to manage such services through
assume that other government and non-government
agencies will provide these organizations.
because such services are
not their corporate
business.
View This school of thought is This school of thought is based on holistic
not based on holistic and and integrated thinking.
integrated thinking.
Key Principles of Microfinance:
 Microfinance services must fit the need and preferences of clients
 Poor households and communities need access to a variety of financial services,
not just loan
 Microfinance is a powerful instrument against poverty
 Microfinance means building financial system that serve poor
 Financial sustainability is necessary to reach significant numbers of poor people
 Interest rate ceiling can damage poor people's access to financial services.
 Credit is not always appropriate
 The role of governments is as an enabler, not as a direct provider of financial
services
 Donor subsidies should complement, not compete with a private sector capital
 The lack of institutional and human capacity is the critical constraint to expansion
of microfinance
 The importance of financial and outreach transparency

Distinction between Microfinance and Banks

Based On Microfinance Banks(Tradational
Financing)
Loan Size It provides a tiny size of credit to the It provides medium and
clients. large credit to the clients

Duration of loans The duration of loans is short-term in It provides medium- and

nature. long-term loans.
Collateral There is no physical collateral Physical collateral is
requirement while taking loans. The required while taking loans.
collateral is the group members.
Loan Procedures At first, groups are formed, and loans The formal procedure, no
are provided to the person after group formation, and loans
recommendation by group members. are provided on an
individual basis.
Repayment The loans are repaid weekly or bi- Collateral and legal
monthly, or monthly repayment pressure are used to repay
through regular group meetings. The the loans if clients are not
peer pressure forces them to repay paying the loans on time.
the loans on time.
Motives Social business motive Profit motive

Target People Poor, marginalized, and Upper and medium classes

disadvantaged people people
Focus Area Rural and semi-urban areas where Urban and city areas
 there is no access to formal banking
institutions
Services It provides both financial and non- It offers only financial
financial services services
Specific Product Micro-credit, micro-savings, micro- Accepting deposits,
or services insurance, micro-pension, and micro- providing loans and other
remittance banking services
Repayment Rate High due to periodical follow-up. Average due to less follow-
up as compared to
microfinance institutions.
Monitoring and Better monitoring system. The Average and not periodical
follow-up meeting is conducted regularly supervision like
microfinance institutions.

Differences between Microfinance Institutions and cooperatives

Based On Microfinance Institutions Cooperatives
Types of “D Class” financial institutions Owner-managed
Institutions licensed under Nepal Rastra bank institutions.

Target Group Poor and marginalized people who The members of

are unbanked cooperative organization
are the target group who
has a similar economic
background.
Nature of Loans Initially, the size of the loans is small The size of the loan is both
and increases based on repayment. small and medium. The
Generally, loans are short term in size of the loan is relatively
nature. larger than MFIs
Lending The loan is provided based on the It requires collateral, and
procedure recommendation of a group without the loan committee
collateral. approves the loan.
Funding The saving collection by MFIs and The saving collection by
wholesale lending MFIs are the major cooperatives is the source
source of funding. of funding
Interest Rate Relatively higher as compared to Relatively lower as
other financial institutions. compared to microfinance
institutions.

Regulatory Nepal Rastra Bank (NRB) is The Department of

Authority responsible for licensing, regulating, cooperative is responsible
promoting microfinance institutions in for the registration,
Nepal. regulation, and promotion
of cooperatives in Nepal.