Microfinance: Challenges and Response

This note justifies the need for microfinance, and recommends ways that MFIs can reduce costs and improve operations.

The formal financial system in India does not meet even ten percent of the credit needs of the poor. Banks hesitate to deal with the poor because of high transaction costs and perceived risks. MFIs, thus, fill the gaps in credit delivery by commercial banks. High MFI interest rates are justified because they cater to the specific needs of a large clientele, make frequent visits to borrowers and support them in accessing livelihoods. MFIs, however, must bring down costs by:

• Accessing cheaper funds from domestic and foreign sources, and reducing transaction costs through the effective use of information technology;
• Considering cross-subsidization on the basis of nature, amount and purpose of loans;
• Providing only those services where they have a comparative advantage.

Finally, MFIs need personnel who are not only people-friendly, but also understand the banking business. Since it is difficult to find individuals with proficiency in both areas, MFIs need to provide training to their staff to strengthen their people and technical skills.