May 15, 2024

Introduction

Microfinance institutions have been helping India in improving the overall quality of life of the people, especially the poor. They are playing a key role in India’s development by promoting financial inclusion and supporting the economic development of the country. Traditional banks usually lack the flexibility, follow strict protocols, and evaluate the creditworthiness of the borrower solely by credit score, which is only available to people who have previously taken loans. Now, this restricts traditional banks from reaching people of lower income class. Unlike these conventional banks, microfinance institutions assess the creditworthiness of the borrowers using the 5Cs of credit. In this blog, let us understand the 5Cs of credit and how it plays a vital role in promoting overall financial inclusion in the country.

5Cs of Credit

The 5Cs of credit in microfinance are used by microfinance institutions as an eligibility criterion for assessing the creditworthiness of potential borrowers. This strategy allows microfinance institutions to serve people better, improve their lifestyles, and also reduce the risk of financial loss to the lender.

1. Character

The character of a borrower is evaluated based on his previous credit history, borrowing behavior, timely repayments, collection accounts, and bankruptcies. Microfinance institutions evaluate borrowers’ key attributes such as reputation, integrity, and readiness to repay the loan. These are evaluated by the reports generated by Cibil this will help the institutions predict the likelihood of repayment.

How does this aid in financial inclusion?
The character-based lending approach allows MFIs to target low-income individuals and help them improve their lifestyle.

2. Capacity

The capacity of the borrower is evaluated based on his/her current income source. This will evaluate the financial capacity of the borrower to repay the loan. This ratio is known as DTI(Debt-to-Income) and is calculated by adding the borrower’s monthly debt and dividing it by their monthly income. A good DTI ratio indicates the borrower’s ability to repay the loan responsibly.

How does this aid in financial inclusion?
This approach allows MFIs to evaluate the borrower’s capacity and tailor the loan terms to their income cycle, making repayment smoother and feasible. Even the private sector job holders are entitled to this, promoting financial inclusion.

3. Capital

The capital is basically the amount of money that the borrower has both in the form of cash and assets. This usually reflects the borrower’s financial status and also helps MFIs to serve the underserved. A large capital usually decreases the chances of getting a microloan, this is because the borrower is entitled to funds that can be used for their own development. This allows the lender to develop customized products and services that are catered especially to underserved people.

How does this aid in financial inclusion?
Capital demonstrates the commitment of the borrower, this reduces lenders’ risk. Capital-based lending supports micro businesses and organizations to encourage entrepreneurship among low-income individuals.

4. Collateral

Collateral refers to assets or properties owned by the borrower. Collateral is used by MFIs to secure the debt, people with secured collateral are more likely to get microloans from these institutions. MFIs go further to help low-income borrowers by accepting alternative collateral ie. Group or Social collateral. The groups are known as SHG(Self-Help Group) and (Joint Liability Group) JLG Microfinance.

How does this aid in financial inclusion?
Alternative collateral-based lending allows MFIs to provide micro-loans(meaning of microcredit is a loan of a small amount) to people with no traditional assets, aiding in their lifestyle development.

5. Conditions

Conditions are external factors that influence the loan repayment of the borrower. These are more general and future-proof conditions such as employment type, the current job, and the industry of the borrower. Conditions allow MFIs to customize the loan processes and offer more variety of loans depending on the borrower’s circumstances. These conditions by microfinance institutions allow them to serve underprivileged people better.

How does this aid in financial inclusion?
MFIs evaluate the economic, political, and social conditions of the borrower, this helps in tailoring the loan terms to the borrower’s circumstances. By considering borrowers’ environment this maximizes financial inclusion.

Conclusion

In summary, the 5C s are essential evaluation criteria for MFIs to provide loans to the right people at the right period of time. SLGs promote financial inclusion and accessibility to credit for low-income individuals. MFIs in India have extended credit to over 205 lakh borrowers (as of JAS’23), underlining their commitment to supporting income-generating activities and livelihoods. At Chaitanya, we provide non-collateral loans to help low-income people access loans without having to provide any collateral or security. This is our way of providing financial support without adding additional stress or burdens to the families.

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