Importance of Microfinance

Nepal is one of the first countries in South Asia to start microfinance services. It traces back to 1956 when 13 cooperatives were formed in the Rapti Valley of Chitwan to give credit to the flood-stricken people. However, the first microfinance programme was started in the early 1990s by Nepal Bank Limited in collaboration with the German development agency GTZ. The World Bank defines microfinance as “the provision of financial services to low-income people, who traditionally lack access to formal banking services, such as credit, savings, insurance, and remittances.’ 

At the start of the 21st century, the sector saw significant growth due to the entry of non-governmental organisations (NGOs) and microfinance institutions (MFIs). This sector has played a vital role in poverty alleviation, financial inclusion and women's empowerment. From just 38 MFIs in 2001, now its number has crossed over 3,000, serving over 3.7 million clients. Giving access to credit to the unbanked rural population is one of the biggest achievements of the MFIs. Agriculture being the backbone of the Nepali economy, these institutions have reached out to rural farmers and given them access to formal credit and other financial services. Farmers are the main clients of microfinance compromising 56 per cent of the total clients. 

The growth of MFIs in rural Nepal has resulted in the growth of the per capita income of rural households. The per capita income of the rural population has risen from US$ 250 in 2001 to US$ 789 in 2019. The MFIs have provided loans to the rural women to set up their businesses such as food processing, dairy, poultry, tailoring, etc. These institutions also connected their clients to new markets for their products and services, thereby improving the social status and conditions of women.

MFIs have helped in alleviating poverty though their impact has been limited. There are multiple reasons for the limited success of MFIs. Firstly, the majority of the MFIs are concentrated in the plains and lowlands which has deprived the hilly people of access to the formal credit system. Secondly, the lack of skilled staff especially in rural areas restricts their ability to provide quality services across the length and breadth of the country. Thirdly, it is the high tax that is levied on MFIs, which has increased the cost of operations due to which the MFIs have not moved beyond the Terai region. Lastly, the lack of good infrastructure such as roads, electricity and telecommunications has hindered the expansion of the MFIs in the hilly region.

Nonetheless, the MFIs are helping create a sustainable and robust economy. The COVID-19 pandemic has proved that overdependence on some sectors can adversely impact the economy. Nepal needs to move beyond tourism and remittances as the progress of these two sectors is highly governed by the external factors. Agriculture is an important contributor to gross domestic product and engages more than 60 per cent of the population. It is necessary to transform subsistence farming into a food processing export industry. MFIs can lend funds to farmers at cheaper rates, facilitating them to procure modern seeds, fertilisers and machinery and also build effective irrigation techniques. 

Service sector contributes around 61 per cent to gross domestic product (GDP). But this sector’s growth has been slow due to lack of finance especially for small and medium-sized enterprises (SMEs) as traditional bank give them limited credits in the absence of collateral and credit history. MFIs can solve this by providing affordable loans to SMEs based on the current cash flows and future revenue projections. This will enable the SMEs to expand their operations and also implement new technologies.