In villages and urban slums across India, crores of women with no collateral, no credit history and no bank account access formal credit for the first time through microfinance: tiny loans – 20,000 to 60,000 rupees – given to groups of women who guarantee each other. The model, pioneered globally by Bangladesh’s Grameen Bank, has grown into a multi-lakh-crore Indian industry of microfinance institutions (MFIs), small finance banks and self-help group linkages. It is celebrated as financial inclusion’s greatest success and criticised for interest rates that can exceed 20 per cent. Both views contain truth. Here is how microfinance actually works.

The joint liability group: collateral without assets

The core innovation is social collateral. Borrowers organise into joint liability groups (JLGs) of 5 to 10 women; each member’s loan is guaranteed by the group – if one defaults, the others must cover it, and the whole group loses future access to credit. This elegantly solves the lender’s information problem: group members know each other’s character and cash flows far better than any bank officer could, so they screen out bad risks and enforce repayment through peer pressure. Loans are disbursed for income-generating purposes – livestock, sewing machines, small shops – though money is fungible and some flows to consumption. Repayment is in weekly or fortnightly instalments collected at centre meetings, creating a rhythm of discipline. The model achieves repayment rates above 95 per cent in normal times – better than most commercial lending – which is precisely why the industry can lend without collateral.

The MFI business model: high cost, high rate

MFIs borrow from banks and capital markets at 9 to 12 per cent, add operating costs – loan officers travelling to villages weekly, cash handling, group formation – of 8 to 12 per cent of the portfolio, plus credit costs and a margin, arriving at lending rates of 20 to 26 per cent. The rate shocks outsiders, but the unit economics are unforgiving: servicing a 30,000-rupee loan costs nearly as much in staff time as servicing a 3-lakh loan, so small tickets inherently carry high percentage costs. Scale, technology and competition have gradually compressed rates from the 30-per-cent-plus era of the 2000s. The RBI’s 2022 microfinance framework brought order: all regulated lenders follow common rules, interest rates must have a documented policy with no hidden charges, and a borrower’s total microfinance debt is capped relative to household income to prevent over-lending – the industry’s original sin.

The interest debate: inclusion versus exploitation

• Defenders argue the alternative is the moneylender at 60 to 120 per cent – microfinance at 24 per cent is liberation by comparison, and borrowers vote with their feet.
• Critics argue that lending to the poorest at the highest rates in the financial system is inherently extractive, pointing to over-indebtedness crises – Andhra Pradesh in 2010, Assam more recently – where aggressive lending ended in defaults and political backlash.
• The evidence suggests both: microfinance genuinely expands opportunity for disciplined borrowers while harming those pushed into debt traps by multiple lenders.
• The regulatory answer has been guardrails, not rate caps: income-based borrowing limits, credit bureau reporting for microloans, and transparency requirements.

The industry’s maturation – from NGO idealism to commercial scale to regulated mainstream – mirrors financial inclusion’s own journey: messy, imperfect, but transformative for the crores of women who built businesses on a 30,000-rupee loan.

The ecosystem beyond MFIs

Microfinance in India is broader than NBFC-MFIs. The self-help group-bank linkage programme – women’s savings groups linked to bank credit – reaches over 10 crore households and remains the largest microfinance channel by membership. Small finance banks, many converted from MFIs, combine micro-lending with deposits and broader services. And technology is reshaping distribution: digital collections, credit scoring using alternative data, and co-lending partnerships with banks are lowering costs steadily. The direction is toward cheaper, more transparent credit – the interest debate will not end, but the trend favours borrowers.

FAQs

Why are microfinance interest rates so high?

Small loan sizes mean high per-loan servicing costs – weekly village visits by loan officers. The rate reflects operating cost, not just profit; the alternative moneylender charges far more.

What happens if a group member defaults?

The joint liability means the group covers the shortfall, and continued default blocks the entire group’s future loans – the peer pressure that keeps repayment rates above 95 per cent.

Can men get microfinance loans?

The classic JLG model targets women, who show better repayment behaviour. Men access micro-credit through other channels – individual micro-enterprise loans, SHG-linked lending and small finance banks.

Compiled by the Khabar 24h Editorial Desk from publicly available sources.