Micro Finance Company

Advantages and Disadvantages of Microfinance Companies

Microfinance companies have been established for the purpose of providing financial services to the micro-sector of the economy, which basically consists of a poor section, farmers, small traders, and retailers in rural and semi-urban areas.

These are the organizations established for the purpose of carrying on the business of extending micro-finance services and may also operate in the form of a society, a trust, or a co-operative society. In this article, we are concentrating on the advantages and disadvantages of Micro Finance Company in India.

Key Principles of Microfinance Companies

With the emergence of the financial sector bringing into existence a wide variety of financial products, there is an increased diversification in the customer base. On one hand, the banks and large financial institutions are concentration on big business; on the other hand, NBFCs have taken charge of the financial needs of the unorganized sector of the economy. Some of the principals guiding the working mechanism of micro-finance companies are as follows:

• A variety of other financial services will be needed by the poor and not just loans; therefore, it is a powerful tool to eradicate poverty;
• It concentrates on building a financial system for the poor and unemployed;
• It strives to build permanent local financial institutions that aim to attract domestic deposits, recycle them into loans, and provide other financial services;
• Enabling financial services is the government’s job, not providing them.

Objectives of Microfinance Companies

Various objectives of the micro-finance companies are as follows:

• Promoting socio-economic development at the community level;
• Developing and strengthening self-help groups and facilitating sustainable development through them;
• Providing vocational training to unskilled population;
• Empowerment of women;
• Conducting programs for the poor;
• Promoting sustainable agriculture and sound conservation of natural resources;
• Organizing and coordinating based on the grass-root level;
• Making efficient use of the available resources for the generation of livelihood.

Regulatory Structure of Microfinance in India

Micro-finance companies are operated in two regulatory setups:

1. Non-Banking Financial Companies (NBFC) under the Reserve Bank of India or
2. Companies Act, 2013^[1]

Many micro-finance companies are registered in our country as NBFCs, which are collecting, saving, and utilizing their funds for loans and other activities, e.g. BASIX, Asmitha, SKS, and Janasree Micro-finance. Kerala is registered as an NBFC.

Other categories of micro-finance companies are registered under the Companies Act. The main motive of these entities is earning profits. Even if they are the companies registered under the Act, the micro-finance companies shall obtain a license from the RBI before carrying out its operations.

On the basis of profit-making, micro-finance companies are categorized into non-profit institutions, mutual profit institutions, and for-profit institutions.

The objective of non-profit institutions is only the financial and social empowerment of the beneficiary class. Such schemes are processed in a different form; such as the society under the Societies Registration Act of 1860. Mutual benefit institutions work only for the benefit of their members. Those are listed under co-operatives, which can be just savings and credit co-operative or be further qualified as a co-operative bank, mutual benefit trust, Nidhi companies. A for-profit body may be registered as AOPs, investment trusts, and a company that is either an NBFC or bank.

Disadvantages of Microfinance Company

The disadvantages of MF Companies are as follows:

• Harsh Repayment method

Microfinance companies adopt a harsh repayment method in absence of legit protocol and compliances. As these companies work with strict compliances, they can manipulate their customers for repayment.

• Small loan amount

Microfinance companies offer small loan amount unlike other financial institutions who provide big loans.

• High interest rate

Another concern is that they were not able to render low interest based loans. Therefore the operating cost per transaction is too high for them despite high volume of transactions.

Advantages of Microfinance Company

The advantages of MF Companies are as follows:

• Collateral free loans

Majority of the MF Companies doesn’t seek any collateral for providing financial credit.

• Quick Disbursal of loan

With Microfinance Company one can get quick loan to meet their financial urgency. Financial crisis can be worrisome for anyone here MF companies can assist in getting quick loan.

• Extensive portfolio of loans

It is not just provides loans in urgent times but also disburses housing loans, and working capital loans with less formalities.

• Self sufficiency and entrepreneurship

It can provide funds to an individual to set up a healthy business that needs minimal investment and provides sustainable profit, thereby promoting self sufficiency and entrepreneurship.

History of the Microfinance Sector in India

Microfinance is a new model for development and poverty alleviation, which has attracted many foreign and Indian investors who joined hands with each other to build and fund these institutions as these became a safe haven for investments. The motivation was that poor people are good borrowers. Not only the return on capital was very high, but also it provided the highest level of safety as repayment of the loan was fully assured.

Some microfinance companies in India are also engaged in raising capital through share market at a very high premium rate, thus catering to the requirements of the richer class.

Due to the outburst of microfinance activities, in Andhra Pradesh, the sector reached a saturation point, registering a faster pace of development when compared to others in the other parts of the world. Multiple loans availed by individuals resulted in a felony, which resulted in many customers taking the extreme step of suicide. Those poor people were tempted into this debt trap and then overloaded with loans, without giving much importance to the repayment capabilities resulting in a huge amount of liability which was beyond their ability to repay. Most of the borrowers were ignorant about repayment terms. The borrowers were then forced to borrow more money from money lenders, which in turn only worsened their situation.

Conclusion

Therefore, there is a need for efficient microfinance management, which will work towards fulfilling the financial needs of the underserved section of society. At the same time, there should be proper control and regulations over the working of the micro-finance companies.

Read our article:Role of MFIs in Rural and Small-Scale Sector