In India, millions of small business owners and self-employed individuals dream of starting or expanding their businesses, but often face a significant challenge: access to funds. Traditional banks usually have lengthy procedures, require collateral, and demand strong credit histories. For people in low-income households or informal sectors, meeting these requirements is tough. This is where microfinance loans have become an essential tool for financial inclusion.

Microfinance in India empowers small borrowers by offering small-scale loans and financial services to low-income households who are excluded from conventional banking. These loans help individuals manage their finances, start small ventures, and improve their livelihoods.  Let’s explore how microfinance works today, its benefits, and its evolving role in empowering India’s low-income entrepreneurs.

What Is Microfinance?

Microfinance refers to small, low-value loans and related financial services provided to low-income households, typically under the regulatory framework defined by the RBI in March 2022. It includes microfinance loans, micro-savings, and micro-insurance. The goal is to provide people with the tools to manage money, grow income, and achieve financial independence.

Microfinance institutions (MFIs) and NBFC-MFIs are the key players in this system. These organizations provide micro loans typically below ₹1.25 lakh to low-income borrowers, often through group-lending models such as Joint Liability Groups (JLGs). Some models use social collateral or peer accountability, meaning that while physical collateral is not required, borrowers are collectively responsible for repaying the loan.

RBI data also shows that MFIs now serve a growing proportion of urban and semi-urban borrowers (over 45% of their portfolio), reflecting the shift in demand beyond rural areas.

How Microfinance Loans Work in India?

Microfinance operates primarily through two models: the Self-Help Group (SHG) Bank Linkage Programme and NBFC-MFI/JLG models.

  • SHG Bank Linkage Programme

In this model, a group of individuals, often women from similar backgrounds, forms a Self-Help Group (SHG). Members pool their savings and deposit them into a linked bank account. The bank provides credit to the group, which then lends it to its members. This model promotes community-based lending and mutual trust.

  • NBFC-MFI / JLG Model

NBFC-MFIs provide microloans directly to low-income borrowers, usually in the form of small, short-term loans of up to ₹1.25 lakh, focusing on financial inclusion rather than broader MSME lending. The repayment obligations of borrowers are capped at 50% of household income under the RBI's 2022 framework, ensuring responsible lending.

The application process for microfinance loans is usually simple. Borrowers submit basic identification documents, income details, and the purpose of the loan. Loan officers often visit borrowers to assess repayment capacity before disbursing funds.

Types of Microfinance Services

Microfinance includes more than loans; it offers various financial products for low-income households:

  • Micro Loans

Small-value loans (typically under ₹1.25 lakh) for low-income households to support income-generating activities or essential needs. These are also called mini loans, making them suitable for small vendors, home-based businesses, and first-time entrepreneurs who need quick access to funds.

  • Micro Savings

Savings programs with minimal or zero balance requirements help households build financial resilience and a safety net.

  • Micro Insurance

Protects borrowers from unforeseen events such as health emergencies, crop failures, or natural disasters, ensuring financial stability.

Together, these offerings help people manage risk, plan, and stay financially secure.

Benefits of Microfinance Loans for Entrepreneurs

Microfinance improves financial inclusion and supports livelihood generation for low-income households:

  1. Access to Credit: Provides small loans to households typically excluded from formal banking. Group guarantees or social collateral often serve as substitutes for traditional collateral.
  2. Promotes Self-Employment: Encourages low-income individuals to start small businesses, such as tailoring, handicrafts, or small retail units.
  3. Builds Financial Discipline: Regular repayments and savings improve borrowers’ credit behavior.
  4. Supports Women's Empowerment: A large share of microloans is extended to women, promoting financial independence, and community development.
  5. Encourages Rural and Semi-Urban Development: Microloans enable small businesses to grow and generate local employment, though the economic impact is modest relative to MSMEs or formal banking.
  6. Responsible Lending: RBI’s framework caps repayment obligations to prevent over-indebtedness and ensures borrowers are not overburdened.

Government and Institutional Support

True microfinance operates under the RBI's regulatory framework and is supported by NBFC-MFIs, banks, and NGOs. These entities ensure that financial services reach low-income households, especially women and informal-sector workers, thereby promoting inclusion and entrepreneurship.

Beyond dedicated MFIs, several mainstream financial institutions, such as Tata Capital, also play a role in advancing financial inclusion. While not a microfinance institution, Tata Capital provides small business and livelihood loans to emerging entrepreneurs, bridging the gap between traditional banking and grassroots credit needs.

Challenges in Microfinance

Despite its benefits, microfinance faces systemic challenges:

  • Borrowers may become over-indebted when taking multiple loans.
  • Coercive recovery practices have been reported in some regions.
  • Interest rates can be higher than traditional bank loans due to operational costs.
  • Regional concentration in states like Tamil Nadu and Bihar can create localized vulnerabilities.
  • Lack of financial literacy can lead to mismanagement of funds.

Digital innovations, better regulation, and financial literacy programs are helping address these issues.

Conclusion

Microfinance plays a vital role in improving financial inclusion and supporting low-income households in India. By providing small, manageable loans, microfinance institutions help borrowers start businesses, generate income, and improve livelihoods. While it is not a foundation for macroeconomic growth, it has a tangible impact on financial empowerment at the household and community level.

Microfinance continues to evolve, helping women and low-income entrepreneurs in rural, semi-urban, and urban areas gain access to finance and achieve financial stability.