” SMEs not only help in industrialization of

                      ” Microfinance is the provision of savings accounts, loans, insurance, money transfers and other banking services to customers that lack access to traditional financial services, usually because of poverty. “AbstractWith just over 10 percent of the world’s population having access to traditional banking services, it becomes essential to bridge the gap between people and such services. An economy like India where income disparity-the magnanimous difference between the rich and poor- is so prevalent, there is a critical need for a mechanism that aims to help the poor and underprivileged. Microfinance promises to do exactly that; it aims to solve the problem of the poor, destitute as well as other low income groups by providing them, in addition to credit facilities, several other banking services like savings, deposits, insurance etc. People with no credit history, collateral, or steady income are provided with an access to basic financial services through MFIs. Most mainstream banks have considered the poor high-risk and hard to serve because they often live scattered across remote areas and because the small loans they need are costly to make and maintain. But microfinance, challenges those traditional assumptions. In the past three decades, microfinance has blossomed from Grameen nonprofit experiment in Bangladesh to a global industry. Today, microfinance players include governments, philanthropists, social investors, and commercial banks, such as Citigroup, that are attracted by the potential for profit and corporate social responsibility. Over the last five decades, Indian Small and Medium Enterprises (SME) sector has emerged as a highly dynamic and vibrant sector. SMEs not only help in industrialization of rural & backward areas but also play a key role in providing employment opportunities. Small enterprises in India suffer from a great deal of indebtedness and are subject to exploitation in the credit market due to high interest rates and lack of access to convenient credit facilities. They need credit to fund their working capital needs on a day-to-day basis as well as long term needs like emergencies or other income related activities. MFIs provide a solution to their credit needs as well. Despite being so popular in such a short amount of time, MFIs are faced with problems like sustainability, as it is challenging to achieve sustainability while reaching the remote rural poor, especially those at the bottom of the income ladder, because of the high costs and risks involved. Also microfinance institutions have to overcome problems of regional disparity, limited reach in poorer states, high interest rates as well as develop a proper framework for the functioning of such institutions. Through this paper, we aim to study the concept of microfinance-its inception, evolution and growth as well as the various hurdles that form part of the microfinance industry along with solutions and areas of growth for microfinance institutions. We will also talk about the role that micro finance banks and institutions play in the survival of small and medium enterprises as well as the extent to which the small businesses have benefited from the credit scheme of microfinance banks. To adequately support small enterprises, MFIs will need to better understand their unique needs and customize financial services and build appropriate infrastructure to meet their demand.Evolution of microfinanceThe history of microfinance can be traced back as far as the middle of 1800s, when theorist Lysander Spooner was writing about the benefits of small credit to entrepreneurs and farmers as a way of getting people out of poverty. However, the mechanism of micro-credit can be witnessed even in the 15th century when Italian monks founded the very first community oriented pawn shops which later started charging interests to cover their operating costs.During the 18th century, Irish Loan Fund System was established, which provided small loans to poor farmers who had no collateral. At its peak, the system has been able to cover 20% of all Irish households annually. In 1864, Friedrich Wilhelm Raiffeisen started ‘village bank movement’ in Germany which involved the concept of micro-credit. By 1901, it had reached 2 million rural farmers. In 1895, Indonesian People’s Credit Banks became the largest microfinance system in Indonesia with around 9000 branches. In 1970s, pioneers such as David Bussell and Al Whittaker founded ‘Opportunity International’ which recognized the fund requirements of local poor who had clever business ideas for the economy. It was in 1970s when Mohammed Yunus, who also received Nobel Prize in 2006 and Akhtar Hameed Khan started the very famous Grameen Bank of Bangladesh which now serves over 7 million poor Bangladeshi women. During the same time period, institutions like ACCION International in Latin America and Self – Employed Women’s Association (SEWA), India gained recognition for their experimental programs of extending tiny loans to groups of poor women to invest in microfinance. In 1974, Chicago got its first microfinance and community development bank, namely, Shorebank, Chicago.The system of microfinance has gained tremendous recognition in 21st century with 2005 being proclaimed as the ‘International Year of Microcredit’ by  Economic and Social Council of the United Nations. As per World Bank, there are over 7000 microfinance firms all over the world serving over 16 million people which means that over 500 million families are being benifitted every year.IntroductionA MFI is a financial institution that provides small loans to people who otherwise wouldn’t have access to credit. India defines microfinance as loans less than 1 lakh. Some well known examples of MFIs in India include Grameen financial services limited, Equitas microfinance Pvt. Ltd. etc. The need to have such an institution is that most commercial financial institutions, like banks, are not able to reach out to this low-income sector public. It breeds financial illiteracy by excluding such people from availing financial services. MFIs find themselves in a fix in terms of whether to focus on already existing entrepreneurs or on potential entrepreneurs seeking for funds to start up a business venture. Working capital is the main hindrance in the development of already existing SMEs and to meet these needs, they borrow finance mostly from informal sources which have high interest rates and conventional or traditional structures of extending loans.High rates of interest for poor people?The small size of the loans is directly related to the high interest rates that MFIs tend to charge. You might expect MFIs to charge low interest rates because they serve poorer segments of the population, but in fact the opposite is true. To serve the base of the pyramid, you need to provide small loan amounts, which are much more expensive to provide operationally than large loan amounts. For MFI to be self-sustainable, they need to charge a high enough interest rate to cover their costs. Moreover, MFIs don’t have a strong base of deposits from customers that can be extended as loans. The loans offered by them come from their dependence on banks and other financial institutions that hinders its ability to be self sufficient. Small and medium enterprisesSMEs in India can be classified into service and manufacturing SMEs.  Manufacturing enterprises can be categorised into two broad categories. Those enterprises where the investment lies between 25 lakhs and 5 crores are small enterprises while those with more than 5 crore investment but less than 10 crore investment are medium enterprises. Similarly, service enterprises with investment between 10 lakhs and 2 crores are small enterprises and between 2 and 5 crores are medium enterprises. Presently, there are close to 51 million SMEs operating in India. They are regarded as facilitators of economic growth. Its main benefit is its employment creation potential and low capital requirement. In the last five-year plan, this sector demonstrated an average growth of 12%, raising the share of the manufacturing sector in GDP to 16%. With the country moving towards a more inclusive growth agenda, a robust MSME sector can accelerate the growth rate, as they do not necessitate huge investments while simultaneously acting as supportive units to larger industries.In spite of their contribution, MSMEs in India face several challenges. They often need to keep pace with rapidly changing technologies and face the risk of becoming technologically obsolete. MSMEs also need to identify their key competitive strengths to maintain product standards and quality and the scarcity of skilled workers. Apart from all these problems one of the main problems SMEs are facing is the high costs of credit. According to the RBI, most MSEs {95%} fund their own activities. Enterprises are financed either by debt, equity or a combination of the two.  The two types of financing are derived from either the formal or informal financial sector. In the formal sector, commercial banks and development banks are the main sources, while the informal sector comprises of loans from friends, relatives and cooperative societies. A lot of commercial banks are not willing to finance small businesses because of the risks and uncertainties involved. .Research methodologyTo have a better understanding of the structure and relationship that exists between Microfinance institutions and SMEs, we conducted a survey of 10 SMEs. A structured questionnaire was designed to facilitate the acquisition of relevant data which was used for analysis. Descriptive statistics which involves simple percentage graphical charts and illustrations were used in data presentations and analysis. A majority of enterprises in the sample were at the start up stage while a few were in the survival stage.Our survey was divided into three main segments, namely:Business details including industry type, number of people employed and capital requirements.Business performance including revenues and profits.Sources of finance available in the market and the avenues chosen for financing.Significance of the studyTo justify the importance of the current study, it is important to mention this area of study is very important for the development of socio economic activities in developing countries like India and its contribution to the development of micro and small enterprises. The study of this  nature is essential to identify the role of MFIs products and services in small and microenterprises sector. This will enhance the identification of  MFIs as industry facilitators and their contribution to the rural population in accessing inexpensive financial services in their localities to boost their living standards in a sustainable manner.  The analysis of our study has given the following results:Most SMEs are a part of the manufacturing sectorThe number of people employed in SMEs grow tremendously each year 85% of the SMEs rely on internal/own funds, 11% rely on institutional sources such as banks, MFIs and 4% rely on non institutional services.Even those dependant upon institutional services don’t borrow much from MFIs. MFIs perform well in terms of revenues and profits and have growth potential. Problems in the microfinance sector A report by International Finance Corporation (IFC) analysed that the total financing gap in the SME space is Rs. 2.93 trillion. The problems resulting in this gap are:  Over-indebtedness due to multiple borrowings and inefficient risk managementMicrofinance institutions (MFI) provide financial services to the poorer section of the society due to which over-indebtedness is a major issue. Lack of risk management framework and multiple borrowings by most clients makes them vulnerable to credit risk and increases the cost of monitoring. This sector gives loans without collateral which increases the risk of bad debts. Moreover the fast paced growth of the sector has not been met with proper infrastructure planning. High rates of interest as compared to mainstream banksMFIs’ when compared to commercial banks charge a very high rate of interest (12-30%) as compared to commercial banks (8-12%). Recently, the RBI (India’s regulatory bank) announced the removal of upper limit of 26% interest on MFI loans. Due to the issues of over-indebtedness caused by the charging of high interest rate, rate of suicide of farmers increased in states like Andhra Pradesh and MaharashtraOver-dependence on banking system for fundingMajority of the MFIs’ in India are dependent on financial institutions such as commercial banks for stabilised funding for their own lending activities. Around 80% of their funds come from banks. Most of these are private banks which charge a high rate of interest and also the term of loans is of shorter period. The overdependence of Indian microfinance industry on banks make them incompetent and less reactive towards dealing with default.Lack of awareness of financial servicesLike all other developing and underdeveloped countries, the financial literacy rate in India is very low Lack of awareness of financial services provided by the Indian microfinance industry is a challenge for both, customer and MFIs’. This makes customers financially excluded. MFIs’ are faced with the task of educating the people and establish trust before selling their product.Regulatory issuesPresently the Reserve Bank of India (RBI) is the regulatory body for the microfinance industry in India. However it has traditionally catered to commercial and traditional banks rather than MFIs’. Need and the anatomy of MFIs is supremely different from that of banks . Regulatory issues have led to sub-optimal performance and failure in the development of new financial products and services. Impact of Demonetization on the Microfinance IndustryThere has been a negative impact of demonetization on the microfinance industry. A decrease in outreach, loan amounts disbursed and average loan amount disbursed were the outcome of demonetization. The loan amounts disbursed by 16% from a year earlier. The average loan amount disbursed  per account during the quarter stood at Rs. 20,981, lower than that of the preceding quarter of Rs. 21,469. In financial year 2016-17 the average loan amount disbursed per account also reduced to Rs.17,779 from Rs.17812 in the previous year. These trends clearly suggest that MFIs registered a decline in number of clients, total loans disbursed and average loan disbursed per account in the post demonetization period. This is a clear indication of reduction in outreach of microfinance as well as a potential decline in availability of credit to low-income households at a time when the prospects of the sector’s growth were high. Demonetization has also affected the repayment rates drastically. If MFIs, particularly the smaller MFIs, continue to experience worsening repayment rates and defaults, their sustainability is questionable. Bearing in mind the importance of microfinance in the inclusion of around 40 million people in the financial sector, demonetization has dealt a severe blow to the microfinance sector in more than one way.  SolutionsRisk management strategyA risk management strategy is needed due to the following reasons:Institutions are growing bigger in size and reach and to keep pace they need to upgrade their internal management systems and risk management which helps in managing credit and liquidity risks, market risks, operational risks, etc. Only proper analysis of credit risk can help bank to avoid facing failures of financial losses.Making calculated decisions: Assessment assists MFIs in making educated decisions about the risks that cannot be tolerated. Cost-effectiveness and profitability:Risk management methods can ensure that their capital and cash are managed better.Obtaining more funds: The microfinance institutions are funded either by the way of debt or with the savings that are deposited by the clients in their institutions.To obtain more funds by the way of debt, strong financial performance becomes a due necessity. Application of credit risk mitigation strategies are important to retain strong financial position in the economy.Essentials of Risk management strategyDecentralisation-Involves developing a culture which encourages controls with delegated authority that allows the loan officers to be responsive to client needs.Effective support system-Requires an effective support system of information technology and sound MIS such that MIS should be consistent with MFIs operations.Culture of training- Entails a need for providing regular training to build a competent and loyal employee base. This will result in improved efficiency and reduced costs.Client centered services- such products and services should be provided as are demanded by customers.Role of Information technology in financial inclusionA lack of suitable financial infrastructure provides the main bottleneck which can be successfully tackled with innovative implementation of information technology.For example, introduction of mobile banks, where the growing telecommunication connectivity provides not only convenience but also reduction in cost of providing financial services,. This makes it possible for different banking entities to provide special services keeping the target market in mind.Government should play a major roleSmooth functioning of Indian microfinance industry can be enabled through setting up of a separate regulatory authority to discourage malpractice and political influence. Strengthening the credit check and debt collection processes and educating the villagers about products and consequences is important. Specific representatives of the legal system should be appointed who will visit the villages on a regular basis. The government is trying to aid this sector by helping the linkage between the self-help group and banks to grow through NABARD.     CASE STUDY: Shri Kshetra Dharmasthala Rural Development Project (SKDRDP)- Evolving interest ratesSKDRDP executive director L.H Manjunath is driving the digital movement among semi-literate men and women, some 3.8 billion people who save and borrow money from in small quantities from nine banks to make livelihood. SKDRDP which was a not-for-profit lender till 2008, is a business correspondent (BC) and business facilitator (BF) – a RBI approved intermediary between the banks and these people. SKDRDP has been functioning since 1982.SKDRDP will play the role of an aggregator and run an escrow account for receiving all the money.What differentiates SKDRDP from all other micro lenders is the interest it charges the small borrowers- the lowest in the industry. It is charging 16% interest rate on small loans against 19-20% or even 24-25% charged by some of the microfinance institution.It has been able to do so by giving up its role as micro-lender and becoming a BC-BF. Simply put, it doesn’t give loans to any member directly. Instead, it generates loans for banks and take care  of the loan repayment as business facilitator. As BC-BF, SDPDR doesn’t have any exposure to loans but manages the loan assets. For generating the loans and managing recovery it earns a fee of 5% on the outstanding amount even as it earns 0.5% for handling the cash of SHG member.At this point the cost of bank loan is 8.5-11% add 5% SKDRDP charges for  managing the portfolio and that’s how the figure of 16% comes, the maximum charged by the NGO. Till now there has been no case of default. Manjunath is confident the business will remain robust unaffected by any defaults. The key to success of this model is continuous innovations . For instance, under the norms of the NABARD, which nourishes the SHG movement in India, the group members need to start saving money first and only after six months they become eligible for loans that go upto 10 times their savings. SKDRDP has convinced NABARD to bring down the limit from six months to three months and push the threshold limit for the loan to Rs. 50,000 per group. Another important break with tradition is that instead of term loans, the SHGs are given cash credit facilities. The SHG members borrow money and repay in instalments to their CC account, which is readily available for any needy member within the SHG to make fresh borrowings. SKDRDP shows that small loans can be given at much cheaper rate than the MFIs charges. ANDHRA CRISISIn 2010, the AP-based SKS Microfinance became the world’s largest microfinance institution and went public by listing on the Mumbai stock market. It became the one stop solution for financing activities of the poor. The success however didn’t last long. The product they offered was good but it failed to become sustainable and reliable. What was previously a clear, practicable solution to alleviate poverty by offering micro-credit to the poorest sections of the society to build sustainable livelihoods suddenly became taboo. In Andhra Pradesh, the problems were checks on credit-worthiness before lending was rare nor were the borrowers trained on how to utilize the funds. In the heady euphoria of initial success, the focus shifted from the original vision of social inclusion to the bottom line. The Banks were also hit by crisis as 80% of loans MFIs borrowed were from the banks. Crisis has made borrowing expensive. Cost efficiency of MFIs in India has deteriorated, as even for non AP- MFIs cost per borrower has increased by 60% (MCRIL, 2012).In the wake of incidents like MFIs using unethical practices to recover the loans which apparently lead to suicides by the borrowers, allegation of multiple borrowing and charging high interest rates forced Andhra Pradesh (AP) Government to step in. Microfinance Market Outlook (2013) gave some hope of recovery for the Indian microfinance industry, as they expected it to expand by around 20% in 2013. Role of Credit bureaus is applauded for bringing positive outlook of microfinance in Andhra Pradesh as they helped in keeping a check on multiple borrowing which was one of the major responsible reasons behind the eruption of the crisis. But many informal sources of finance are yet out of the purview of Credit bureaus. Enactment of Micro Finance Institutions (Development and Regulation) Bill, 2012, which is still pending with the Standing Committee on finance, has potential to lead the microfinance sector under the wise regulation of RBI.Conclusion Indian Microfinance today is a dynamic space with multitude of players offering various products and services to low income clients with different approaches. However, the penetration of microfinance remains low. Microfinance calls for greater transparency and public awareness. To adequately support small enterprises, MFIs will need to better understand their unique needs to tailor financial services and build appropriate infrastructure to meet them. Successfully serving small enterprises is a process, not a one-time event. This will require a commitment from top management to create a client centric approach, hire dedicated and knowledgeable staff, and investment in appropriate technologies.REFERENCES1.http://www.ey.com/Publication/vwLUAssets/ey-evolving-landscape-of-microfinance-institutions-in-india/$FILE/ey-evolving-landscape-of-microfinance-institutions-in-india.pdf2.https://www.rbi.org.in/SCRIPTS/PublicationReportDetails.aspx?UrlPage=&ID=6083.http://www.banknetindia.com/banking/101021.htm4.https://www.jstor.org/stable/258308265.http://economicstudents.com/2014/04/the-problems-and-promise-of-microfinance/