Microfinance is one of the most interesting financial innovations of the modern era. It was born from a simple but urgent question: why can’t the low-income people access loans from regular banks? For decades, the answer was clear—small loans to people without collateral were seen as too risky, too costly, and unprofitable for traditional banks. Microfinance emerged to close this gap, and its history in India can be traced through four major phases.
The Era of State-Led Credit (Pre-1990s)
After Independence, rural lending in India was dominated by moneylenders, who controlled about 70% of credit, while banks contributed less than 1%. To change this, the government nationalised major banks in 1969, promoted cooperatives, and established Regional Rural Banks (RRBs) in 1975. By 1981, formal institutions accounted for over 60% of rural credit—a remarkable turnaround.
However, this model relied heavily on subsidised loans, such as the Integrated Rural Development Programme (IRDP) launched in 1980. With very low interest rates and weak repayment discipline, millions of defaults occurred, and many borrowers began to see loans as government grants. A loan waiver in 1989 further undermined credit culture, leaving banks convinced that lending to low-income households was unsustainable. This marked the end of the subsidy-driven approach and set the stage for new models in the 1990s.
Rise of Self-Help Groups (1990s)
The 1990s brought economic reforms and a new approach: sustainability over subsidy. This shift gave rise to the Self-Help Group (SHG) model. Small groups, often 10–20 women, pooled their savings and lent to each other. Over time, they built financial discipline and trust, which allowed banks to lend larger sums to the group as a whole.
This solved two of banks’ biggest concerns—lack of collateral and unreliable repayment—through “social collateral.” The SHG-Bank Linkage Programme launched in 1992 with National Bank for Agriculture and Rural Development (NABARD)’s support and delivered excellent repayment rates. By the late 1990s, SHGs had become a recognised part of India’s financial system, with government programmes and NGOs scaling the model nationwide.
At the same time, Microfinance Institutions (MFIs) began to emerge. These were dedicated organisations lending directly to the low-income households, often as non-profits. They proved that efficient, disciplined lending to low-income households was possible, breaking the myth that they were “unbankable.”
The Boom and the Crisis (2000–2011)
The 2000s were a period of explosive growth. Commercial banks, impressed by repayment rates, began channeling funds to MFIs. Many MFIs converted into for-profit Non-Banking Finance Companies (NBFCs), attracting private equity and global attention. The UN declared 2005 the “Year of Microcredit,” Muhammad Yunus received the Nobel Peace Prize in 2006, and SKS Microfinance went public in 2010.
But rapid growth had consequences. Mission drift set in as institutions prioritised scale over client relationships. Households became over-indebted as multiple MFIs lent to the same borrowers, and reports of coercive recovery practices emerged. The flashpoint came in Andhra Pradesh in 2010, when the state government imposed severe restrictions on MFIs. Repayment rates plummeted, and the industry collapsed in its largest market.
This crisis forced regulators to act. In 2011, the Reserve Bank of India (RBI) created a new regulatory category, the NBFC-MFI, capping interest rates while setting clearer rules for the sector.
The New Normal (2012–Present)
In the aftermath of the crisis, repayment culture was damaged, and many MFIs struggled. A national Microfinance Institutions Bill was introduced in 2012 but lapsed without passing. Still, RBI regulations provided stability, and the sector gradually rebuilt itself.
The SHG model also evolved. NABARD launched “SHG-2” in 2012, introducing flexible credit products and pathways for successful entrepreneurs to graduate into larger Joint Liability Groups.
The most significant milestone came in 2014, when the RBI allowed MFIs to act as Business Correspondents for commercial banks. This expanded their role beyond lending: MFIs could now offer savings accounts, remittances, insurance, and pensions on behalf of banks, effectively becoming a last-mile link that the big banks could not build on their own.
Today, microfinance in India is no longer just about small loans. It has matured into a crucial pillar of financial inclusion, connecting millions of low-income households to the broader financial system.
What’s next
The journey of microfinance in India has been anything but linear. From heavy-handed state-led programmes, to grassroots Self-Help Groups, to a commercial boom followed by crisis, and finally to today’s more regulated and integrated system, the sector has constantly evolved.
The mission, however, has remained the same: to provide financial tools that empower low-income people to build better lives. As technology advances and new models emerge, the story of microfinance is far from over.
