Microfinance Institutions and Traditional Banks: 5 Main Differences

MFIs vs Banks
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Article Feb 14, 2022 0

Today, let’s take a closer look at something that we might or might not already know. We do know that Microfinance Institutions successfully reach the poor, and we also know that traditional banks, despite everything, have failed to do so. Why?

A better insight into their 5 main differences can help uncover all our questions.

Let’s begin.

First, let’s categorize the differences into 5 broad points.

The Framework of Regulation:

Who looks over the banks? If we choose to trust a bank, who makes sure its operations, and hence the promises made to us, are fulfilled? Who decides what rules and regulations a bank must abide to? Well for commercial banks, it’s a body we’re sure you must be familiar with. The Reserve Bank of India is the Indian regulatory authority that keeps a close eye on the activities of these banks, overseeing the development and management of the country’s economic system.

But what about Microfinance Institutions (MFIs)? For them, there’s National Bank for Agriculture and Rural Development (NABARD): the regulatory body for overall regulation of regional rural banks and apex cooperative banks in India. This body lays down the rules and regulations for all kinds of financial activities that’re related to MFIs. What else? NABARD also reaches out to allied economies and supports and promotes integrated development. With respect to institutions such as MFIs which are working in the field of rural upliftment, it provides training facilities.

So the head of the regulatory framework of MFIs and Commercial Banks are not exactly the same. As their operations are different, the rules that are set according to their functioning are also different.

Training Programmes:

Following the last part of our previous point, there’s a discreet but important difference that lies between MFIs and Banks.

What is it? It’s the component that talks about building relationships.

Training programmes that focus on this aspect are more prevalent in MFIs than, say, commercial banks. The bond between beneficiaries of microfinance loans and MFIs has to be created on the grounds of trust and consideration. That doesn’t happen overnight. So MFIs take the first step towards building that relationship between them and their beneficiaries; and take it upon themselves to primarily educate the people on the budgeting of their projects— for which they’re seeking loans in the first place.

As MFIs provide a strong support system to their borrowers and aim to help them successfully build their projects and their future, they invest in training programmes that can help them achieve this feat.

Credit Schemes:

The ability to repay most definitely plays the most important role in the credit operations of any bank. Commercial banks, more so. It’s difficult to ascertain the results and the entire process of lending depends on that single factor, making it harder for banks to simplify giving out loans and helping the poor. That is, until, MFIs made an appearance. When we talk about the repaying power of the borrowers, the credit facilities that MFIs have are carefully designed as per the capabilities of the borrower. This also makes their repayment schedule flexible. Weekly and bi-weekly payments might not be something that traditional banks choose to adopt. But MFIs have microlending products that are better suited to adapt to the borrower’s financial situations.

Having said that, it’s important to note that there are better mechanisms for credit appraisal in commercial banks that can greatly help the borrowers. The forces for risk management are also stronger. Of course, risk is involved in either of the two, but it’s seen to be better managed by traditional banks given their large-scale experience and investments.

Technological Infrastructure:

Going forward with the point of larger investments made in the previous difference, we see a greater gap between the technological aspects of traditional banks and MFIs. Not only their basic infrastructure, but the tech savviness of commercial banks is better. Customized products and services are now digitally available at commercial banks, decreasing the need of manpower and improving the customer experience.

On the other side, there’s a lack of rural infrastructure where the MFIs are situated, and without sustenance of resources such as transportation, communication and electric wiring, the road to development and growth seems bleak. With increase in operation costs as well, technological advancement has been left behind.

This is a major difference between traditional banks and MFIs that needs to be resolved for better progress of the entire country.

Collateral:

“But isn’t collateral necessary?” Sure, the need for collateral as a security has defined the way commercial banks work for ages. But this need starts to dissolve the closer you get to MFIs. In commercial banks, the process of getting your loan sanctioned is a tedious one; with long queues of financial inspection, borrower’s goodwill and pledge of loan collateral. This is not the case in MFIs. Here, the loans are for a variety of people. The people’s past is not brought into the spotlight, rather the promising light is shone on their futures. But when MFIs face a failure of payment, the chances to recover the loan amount become less and that of losses become high.

One of the biggest differences between traditional banks and MFIs is probably this difference in the treatment of “collateral”.

We, at MicrofinanceJobs.net, hope we could shed some better light on this subject. What did you think? Do you think traditional banks and MFIs can both progress together and bring equity to our economy? Let us know!

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Blog insights taken from:

  1. Chetty, Priya (2017, Jul 30). “Difference between microfinance institutions and commercial banks in India”. Knowledge Tank; Project Guru. (https://www.projectguru.in/microfinance-commercial-banks/)
  2. Microfinance Institutions; BankBazaar.
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