Microfinance Fundamentals: Definition, Client Segment and Evolution
What the domain covers
This domain tests the definition and boundary of microfinance, its core client segment, and the principles that distinguish it from mainstream banking and from charity. Expect questions on the RBI definition, the evolution from group lending to the 2022 framework, and the double bottom line.
Definition and boundary
Microfinance is the supply of financial services (credit, savings, insurance, remittances and pensions) to low-income households and micro-enterprises that mainstream banks find costly to serve. Microcredit is only the loan component. Under RBI's Master Direction on the Regulatory Framework for Microfinance Loans (2022), a microfinance loan is a collateral-free loan to a household with annual household income up to ₹3,00,000. The definition is household-based, not borrower-based, and applies to all RBI-regulated entities.
Core features
- Small ticket, short tenure and frequent instalments.
- No collateral; character, cash flow and group guarantee substitute for security.
- High transaction cost per rupee lent, so doorstep collection and low-cost processes matter.
- Target segment: low-income households, women, micro-entrepreneurs and informal workers.
- Double bottom line: financial inclusion and institutional sustainability.
Evolution
Grameen Bank's solidarity-group model (Bangladesh, 1983) showed poor borrowers could repay. India's SHG-Bank Linkage Programme scaled bank credit through women's groups. The 2010 Andhra Pradesh crisis exposed multiple lending and coercive recovery, leading to RBI's 2022 harmonised framework and stronger conduct rules.
Worked example
A household earns ₹18,000 a month. A proposed EMI is ₹8,000, or 44% of income, so it passes the 50% repayment test. But the household already pays ₹3,000 to another lender. Total obligation is ₹11,000, or 61%, so the new loan must be cut until total EMI is ₹9,000 or less. Also, if annual household income is ₹3.2 lakh, the loan is not a microfinance loan under the RBI definition.
Traps
Do not treat microfinance as only credit, confuse microcredit with microfinance, use the old ₹1 lakh/₹1.6 lakh thresholds, or assume MFIs receive interest subsidies or loan waivers.