How microfinance loans work: Features, criteria and approval process

The Reserve Bank of India (RBI) defines these as collateral-free loans provided to individuals belonging to low-income households, that is, those with annual incomes of up to Rs. 3 lakh. One doesn’t need to keep any kind of deposit, margin, collateral, or security with the lender at any stage of the loan, and any loan backed by hypothecation of any security shall not be treated as a microfinance loan.

The various types of microfinance loans include education loans, consumer product loans, emergency loans, income generation loans, mid-term loans, agriculture loans, individual loans for business or personal use, among others.

Loan features

The typical size of such loans ranges from Rs. 10,000 to Rs. 1.25 lakh, and in some cases, higher. The repayment tenure for such loans ranges from one to three years, with the term of 12-24 months common for smaller loans. There is no prepayment penalty and the repayment frequency is flexible—weekly, fortnightly or monthly. Also, the repayment amount cannot be more than 50% of the household income.


While there is no ceiling on interest rates that can be charged on microfinance loans, these cannot be excessively high and have to be board-approved. This means it has to be based on a risk-based pricing policy by considering the cost of funds, risk premium and margin, and has to be approved by the lender’s governing body.

Who can disburse these loans?

Such loans can only be provided by regulated entities, including banks, small finance banks, regional rural banks, non-banking financial institutions (NBFC), NBFC-microfinance institutions (MFI), cooperatives and cooperative banks, selfhelp groups, non-governmental organisations (NGOs), commercial and payment banks.

Eligibility criteria

The applicant needs to meet the following conditions to be eligible for a microfinance loan.

• The applicant should be an Indian citizen.
• The annual household income has to be less than Rs.3 lakh.
• The age of the applicant is typically between 18 and 60 years.
• Total monthly repayment obligation should not exceed 50% of the household income.
• These loans are typically for people engaged in income generating activities, such as running a small business, for working capital requirement, or equipment purchase.
• The applicant should have a clean, existing credit record.