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The Indian Informal Credit Problem

Updated: Aug 7, 2023

The risks of informal credit pose a serious threat to those sections of Indian society that are already disadvantaged by virtue of their low incomes and lack of access to resources. The Indian state must prioritise initiating policy to solve this issue, to achieve proper and inclusive development. Are Mudra Loans a plausible option to achieve this aim?

India’s economic environment is characterised by active poverty, inequality and unemployment. In the midst of these lies an all-encompassing issue: a serious dearth of availability and access to formal credit sources. This is exacerbated in both regions that are generally under-resourced and communities that are underprivileged. This problem is also particularly emphasized in India because of the long-term nature of the impacts that it leaves.

Lack of access to credit affects individuals in the immediate short term by creating barriers to the pursuit of entrepreneurial ventures and business. It, however, leaves long-term impacts too – like when people pursue alternative avenues of financing. This is distinguishable in the informal credit sector in the country, and its many marked features. This sector entails institutions and individuals transacting in cash finance, without the involvement of formally registered banks or security markets. It is characterised by a severe lack of formal regulation and monitoring. The Business Standard reports that this cash-driven informal market in India creates an astounding $500 industry in the country.

How does this industry reinforce financial underdevelopment? How does it exacerbate inequalities and their impacts? Individuals from low-income backgrounds often face a lack of several resources required to pursue their professional aspirations, regardless of entrepreneurial or agricultural backgrounds. Circumstances often force them to rely on informal lenders, categorised by astoundingly high interest rates and associated risk. This gets them stuck and struggling in a vicious cycle of poverty, having to pay more than even the amount initially borrowed under pressure from the lenders. Additionally, these individuals miss multiple opportunities to expand or scale their business and to save efficiently. Hence, the lack of access to formalised credit routes, with fixed and reasonable interest rates and regulations only exacerbates financial inequalities and their impacts.

The most intuitive intervention in attempting to tackle the issue of limited formal credit sources is through microfinance institutions. Microfinance institutions provide loans of small amounts to individuals from low-income backgrounds. These typically come with low interest rates and terms of repayment that are flexible. Particularly, they are sympathetic to the conditions of low-income individuals, they do not require extensive reporting of credit history and large collateral amounts. While other alternatives include improving financial literacy and digital financing, microfinance is one of the most viable interventions.

The Indian government, in April 2015, introduced a microfinance-based financial support scheme called Mudra Loans. The Micro Units Development and Refinance Agency Limited (MUDRA) is classified as a refinancing institution which works with banks and other microfinance and lending institutions at different regional levels. Its aim is to develop the finance and lending sector, particularly providing financial assistance to low-income individuals running micro and small enterprises. The microloans largely focus on three sectors characterized by high growth: manufacturing, retail trading and services. The loans are collateral-free, and the terms of repayment are based on the specific subtypes of the loan availed. There are three types: Shishu, Kishor and Tarun, differing based on the amounts offered. This varies from Rs. 50,000 to Rs. 10 lakhs.

By the year 2016 alone, one year from its initiation, the Mudra loans scheme significantly surpassed its target numbers, disbursing Rs. 1.53 trillion worth of loans. These numbers have been replicated in subsequent years, and have particularly benefited women across the country. In fact, in Mudra loans availed in the year 2018, a significant 74% of beneficiaries were women.

Availing these microloans enables people to expand their businesses, and save money. It facilitates the entrepreneurial spirit, and, as the data shows, sustains women empowerment. The Mudra loans scheme does seem to be a viable solution to a confluence of finance and developmental goals that India needs to prioritise. The scheme also could have the potential to be both expanded to larger scales and replicated at multiple levels. It is worthwhile to follow closely the way it pans out in this financial year too.

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