Commercial banks are beginning to recognize microfinance as a viable market and offer financial services like loans, deposits, and money transfers to low-income households and small businesses. While banks have advantages over non-bank microfinance institutions like established infrastructure and access to deposit funding, they also face challenges in adapting traditional banking practices to the needs of poor clients. The document discusses various approaches banks can take to engage in microfinance, such as direct lending, creating a microfinance subsidiary, or partnering with existing microfinance organizations.

1. ROLE OF BANKS IN MICRO-
FINANCING
Submitted By:- Jaspreet Singh
3035
B. Com (P) Part 1
Submitted To:- Prof. Mrs. Neena Sareen Ma’am

2. MEANING
Microfinance in its broadest terms can be defined as
provision of a range of financial services such as
deposits, loans, payment services, money transfers
and insurance to poor and low income households,
and their micro enterprises (Source: Asian
Development bank report on microfinance
development strategy). While a commercial bank is
a financial institution that offers a broad range of
deposit accounts, including checking, savings, and
time deposits, and extends loans to individuals and
businesses.

3. BACKGROUND: THE COMMERCIALIZATION OF
MICROFINANCE
Poverty is one of the few challenges that every single
country in the world has to deal with and the numbers
say it all. According to the World Bank, 2.7 billion people
lived on less than $2 a day in 2001. Despite the
difficulties involved in changing this situation, there are
solutions and microfinance is one of them. Starting with
the Grameen Bank founded by Mohammad Yunus in the
1970s, microfinance represented a method of lending
that was to be tailored specifically to the world’s poorest
populations. Throughout the years, microfinance has
proved to be a viable solution for the alleviation of
poverty. In fact, nowadays, the industry is facing a new
phase in its history: commercialization.

4. THE CHALLENGE OF MICRO-FINANCE FOR
COMMERCIAL BANKS
 Many commercial banks in developing countries are
beginning to examine the micro-finance market. During
the last five years, their exploration of this new market
has been facilitated by donor-funded loan guarantees,
central-bank rediscount lines, and specialised technical
assistance. Although the initial resources for loans
frequently came from donor-funded credit programs,
commercial banks in time began to draw on their own
deposit sources for a growing share of their total funds
for micro-loans.
 At the same time micro-enterprise lending NGOs with
heavy case loads have begun to transform themselves
into regulated banks or specialised financial institutions
offering micro-deposit facilities as well as micro-loans.

5. COMPARATIVE ADVANTAGES OF COMMERCIAL
BANKS IN MICRO-FINANCE
 The are regulated institutions fulfilling the conditions of
ownership, financial disclosure, and capital adequacy that
help ensure prudent management.
 Many have physical infrastructure, including a large network
of branches, from which to expand and reach out to a
substantial number of micro-finance clients.
 They have well-established internal controls and
administrative and accounting systems to keep track of a
large number of transactions.
 Their ownership structures of private capital tend to
encourage sound governance structures, cost-effectiveness,
and profitability, all of which lead to sustainability.
 Because they have their own sources of funds (deposits and
equity capital), they do not have to depend on scarce and
volatile donor resources (as do NGOs).
 They offer loans, deposits, and other financial products that
are, in principle, attractive to a micro-finance clientele.

6. THE POLICY ENVIRONMENT
 The policy arena is of strategic importance for
commercial banks. Non-bank micro-lending NGOs can
operate in a repressed financial market environment
because they are not subject to the regulatory interest
rate ceilings, high reserve requirements, and selective –
that is, targeted – credit policies characteristic of these
markets. Commercial banks, however, cannot escape
these regulations, which, in the end, reduce their profit
margins. Markets experiencing substantial financial
liberalisation offer a far more promising opportunity for
experiments in micro-finance to cover lending and default
costs and the opportunity cost of funds.
 Although important, a favourable policy environment is
not sufficient for a successful commercial bank
involvement in micro-finance.

7. FINANCIAL PRODUCTS AND METHODOLOGIES
 Short-term, working-capital loans.
 Lending based on character, rather than collateral.
 Sequential loans, starting small and increasing in size.
 Group loan mechanisms as a collateral substitute.
 Quick cash-flow analysis of businesses and households, especially
for individual loans.
 Prompt loan disbursement and simple loan procedures.
 Frequent repayment schedules to facilitate monitoring of
borrowers.
 Interest rates considerably higher than those for larger bank
customers to cover all costs of the micro-finance program.
 Prompt loan collection procedures.
 Simple lending facilities, close to clients.
 Staff drawn from local communities, with access to information
about potential clients.
 Computerising with special software to allow loan tracking for
larger programs.

8. DIRECT LENDING
 Firstly, banks can directly lend to micro entrepreneurs. Usually, a
participation of this sort is
 observed in banks founded with the aim of solely serving the
microfinance sector. The
 pioneer in this field is the Grameen Bank founded by Muhammad Yunus
in 1976, with the
 sole goal of helping the impoverished through the provision of small
loans to a group of
 borrowers. Group lending consists of the attribution of a loan to each
person in the group, but
 the loans are not renewed to anyone in the group if ever one borrower
defaults on the loan.
 Consequently, through social pressure, the group lending method gives
individuals incentives
 to be financially disciplined and to repay their loans. Another example is
the ProCredit group
 which provides loans to small and medium-sized enterprises through its
19 development
 oriented banks in Africa, Europe and Latin-American.

9. 2.2 A MICROFINANCE SUBSIDIARY
 Secondly, banks may choose to separate their microfinance operations through the creation
 of a new subsidiary. Primarily, such subdivisions can help banks mitigate the levels of risks
 associated with lending to the poor. Nevertheless, it can also be seen as a necessary step for
 banks providing both consumer finance and microfinance, as each sector requires a different
 approach to business and a distinct training of the employees. Furthermore, from the
 perspective of the borrower, separating the microfinance services from the consumer finances
 might generate more trust and acknowledgement of the bank’s commitment to the goal of
 10
 reducing poverty. In this respect, Sogesol is the microfinance subsidiary of the commercial
 bank Sogebank, the largest commercial bank in Haiti. The many years of experience of
 Sogebank, bring some important advantages to Sogesol. The loans that originate from the
 microfinance subsidiary can be repaid through the branches of Sogebank. Furthermore, the
 parent company also provides other types of support to Sogesol such as human resources,
 legal affairs, auditing and marketing.

10. PARTNERSHIP WITH A MICROFINANCE
INSTITUTION
 Partnership with a microfinance institution
 Thirdly, banks can build partnerships with microfinance
institutions. Banks can lend to
 microfinance institutions in the form of wholesale banking, and
in turn, MFIs can employ the
 capital to lend to the poor. In the partnership, the bank usually
provides the loan funds, the
 technology and evaluates the pricing and the levels of risk
involved with the loans. On the
 other hand, the MFIs undertake the origination, monitoring
and collection of the loan.
 Indeed, there are a lot of advantages for MFIs in engaging in
partnerships with banks. With
 the greater amount of capital comes the increase in loan
sizes, and the more branches a bank
 has, the greater the outreach achieved through geographical
expansion.

11. CONCLUSIONS