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Micro Credit: Definition, How it Works & Importance

By Tata Capital
28 November 2025
9 mins read
3255

Micro credit loans are small loans. Micro credit, or microfinance scheme, was introduced to benefit people without a steady source of income, credit history, or traditional financial resources. The micro credit system has a major role in developing financial inclusion in India. Through this scheme, microcredit lenders offer easy to formal credit for borrowers across semi-urban and rural sectors of the country.

This article will define micro credit, discuss the key aspects of the micro credit system and its relevance in the lending ecosystem.

What is Micro Credit?

Microcredit is a small loan given to people who don’t have a regular income or access to banks. It is mainly meant for those living in rural or semi-urban areas who want to start a small business but don’t have the money to do so. These could be farmers, shopkeepers, tailors, artisans, or women running home-based businesses.

Many of these people cannot get loans from regular banks because they don’t have a steady job, a credit history, or assets to offer as security. That’s where microcredit comes in. It gives them a chance to borrow a small amount and use it to earn a living.

Microcredit is usually provided by microfinance institutions, NGOs, or community groups. In many cases, loans are given to a group of people who support each other in repaying the money.

The goal of microcredit is not just to give money but to help people stand on their own feet.

With these small loans, borrowers can buy tools, raw materials, or goods to sell and slowly build a stable source of income. Over time, it helps improve their quality of life and supports the growth of local businesses.

Also, read – What Are Microfinance Loans

History of Micro Credit

The origin of the micro credit concept can be traced to 1983 when economist Muhammad Yunus started the Grameen Bank in Bangladesh. He started the bank with the main intention of providing loans to people from lower socio-economic status to reduce the increasing wealth gap in Bangladesh.

In India, microcredit line of finance gained momentum during the 1990s and was officially introduced in 1994. Small Industries Development Bank of India (SIDBI) was one of the pioneer organisations that developed the microcredit scheme in India.

Also, read – A Guide on MSME Loan without Collateral

How Micro Credit Works

Microcredit is based on the idea that people from low-income backgrounds also want to become self-reliant and start small businesses. However, they often cannot get help from regular banks because they lack a stable income, credit history, or collateral. Microcredit fills this gap by offering small loans through microfinance institutions, NGOs, or local groups.

These loans are designed to be simple and accessible. In many cases, there is no need for a formal written contract. The borrower might be charged a small interest. Some schemes may also require the borrower to regularly deposit a small part of their income into a savings account. This amount acts as a form of security. Once the loan is fully repaid, the borrower can withdraw the full savings amount.

Additional Information on Micro Credit – What are Micro Credit-funded activities?

Microcredit is mainly used to support small, income-generating activities. These include setting up cottage industries, buying seeds or equipment for farming, carrying out artisan work like pottery or weaving, or starting a small shop or service business.

Through these loans, individuals can build a steady income, support their families, and gradually become financially independent.

Also, read – Know Everything About Micro Loan Against Property (LAP)

Features of Micro Credit

Microfinance loans offer various benefits to low-income individuals to make them financially secure and independent.

Here, let’s define microcredit key features:

Available for low-income groups and individuals in rural and semi-urban areas of India
Microfinance loans can be used for self-employment and entrepreneurship activities
Collateral-free loans with easy affordability
Low-amount loans
Low and economical rate of interest
Not governed by traditional lenders, so quick access to funds
Minimal requirement of paperwork
Faster loan processing owing to quick turnaround time
Flexible repayment options based on the nature and duration of employment activity
Repeat loans available based on the scheme, repayment capability, and necessity
Helps socially and economically backward people improve income and livelihood

What are the Benefits of Micro Credits?

Microcredit offers several benefits, especially for those without access to traditional financial services:

It provides financial access to individuals who are usually excluded from conventional banking systems.
It helps reduce poverty by enabling people to earn an income and improve their standard of living.
It empowers women by offering them financial support to become independent and contribute to their households.
It promotes entrepreneurship by helping individuals start or grow small businesses at the local level.
It supports community development by strengthening local economies and encouraging long-term progress.

Also, read – Eligibility Criteria for Mudra Loan

Types of Microcredit

Various types of microcredits offered in India are:

Micro Loans – These are small loans given without any collateral. They help borrowers understand the loan process and build a credit history. Over time, this prepares them to apply for larger loans from banks or other formal lenders.
Micro Savings – Micro savings accounts are designed for people with low income and do not require maintaining a minimum balance. These accounts encourage regular saving habits and help individuals earn interest on their deposits.
Micro Insurance – Micro insurance provides coverage to microloan borrowers at low premium rates. It protects individuals and families from financial risks due to accidents, illness, or other emergencies, offering security during uncertain times.

Eligibility Criteria for Micro Credit Schemes in India

All micro credit schemes have specific requirements and restrictions, which is why it’s essential to know micro credit eligibility before applying. Applicants must be Indian citizens who meet the age and scheme criteria.

For example, the National Handicapped Finance and Development Corporation (NHFDC) scheme requires at least 40% disability and applicants over 18 (14 in some cases). The Pradhan Mantri Mudra Yojana (PMMY) is for citizens aged 18–65 with business plans for income-generating activity.

Understanding who can get micro credit is helpful for a frictionless application process.

Also, read – How to Apply for a Bank Credit Facilitation Scheme?

What is Micro Credit Operation Channel in India?

In India, microfinance is operated mainly by two channels: SHG – Bank Linkage Programme (SBLP) and Microfinance Institutions (MFIs).

SHG – Bank Linkage Programme (SBLP)

The National Bank for Agriculture and Rural Development (NABARD) launched the SBLP initiative in 1992. The model focuses on supporting women from economically backward classes in self-help groups of 10-15 members to become financially independent. Women in self-help groups contribute their savings within the groups. Later, the investment is used to offer loans for funding activities that help generate income for the members.

Microfinance Institutions (MFIs)

MFIs aim for joint liability for seeking loans. Under an MFI microfinance scheme, an informal group of 4-15 individuals can avail of a loan either individually or jointly.

Apart from these two channels, there are certain banks and social organisations like non-profit ones, that offer microloans to borrowers.

Who Provides Micro Credit? (Microfinance Institutions & Banks)

In India, microcredit is offered by various microfinance providers, institutions, banks, and even NGOs. The objective is to support low-income individuals and small businesses.

Some specialized microfinance institutions include Non-Banking Financial Companies (NBFC-MFIs) and NGOs like the Chaitanya India and FINCA International.

Banks can also play a role in providing microcredit. There are commercial banks and small finance banks that provide microcredits through different schemes and through their partnerships with MFIs.

Government institutions support other microcredit providers. They work with MFIs and banks. This increases the number of verified and trusted microfinance providers. Individuals and businesses are able to benefit from this network of microcredit lenders India.

Challenges and Criticisms of Micro Credit

Despite their benefits, it is important to be aware that microcredit comes with several micro credit challenges.

Sometimes, borrowers use loans for daily expenses rather than starting or growing a business, which can lead to excessive debt.
Some MFIs offer higher interest rates, which can make repayment harder.
The governance of microcredit can be tricky. A lack of awareness in the general public and newer technological challenges in microcredit adoption are examples.

These disadvantages of micro credit show why borrowers need to plan carefully and choose trustworthy microcredit lending institutions.

List of Schemes of Micro Credits

India has several microcredit schemes that support individuals in starting or expanding small businesses. Some of the key initiatives include:

National Urban Livelihoods Mission (NULM)
Mahila Samridhi Yojana
Stand-Up India Scheme
National Handicapped Finance and Development Corporation (NHFDC)
Micro Units Development and Refinance Agency Ltd. (MUDRA)
Small Industries Development Bank of India (SIDBI)
National Bank for Agriculture and Rural Development (NABARD)
National Scheduled Tribes Finance and Development Corporation (NSTFDC)
Pradhan Mantri Mudra Yojana (PMMY)

These schemes aim to improve financial access, especially for marginalized and underprivileged communities.

Conclusion

Micro credit is a key factor in the success of financial inclusion in India. The small loan scheme has helped eradicate poverty in India over the last few decades by helping lower-income and socially backward classes improve their income and standard of living.

The vast Indian population largely exists in rural areas, where there is a lack of access to traditional banking services. However, people from low-income groups need financial services to meet their basic needs. Micro credit has helped bridge this gap. Through microfinance, even people from lower strata of society can access financial services to enhance income and self-sufficiency.

Tata Capital offers easy and attractive microfinance loan interest rates. Borrowers can avail of a quick loan up to Rs. 2 lakh with minimal documentation, flexible tenure, and EMI repayments. Tata Capital microfinance loans are customised to suit borrowers’ varying loan needs. For more details, visit Tata Capital.

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FAQs

What are microcredit-funded activities?

Microcredit usually supports small-scale work like farming, handicrafts, cottage industries, and local businesses. It helps people start or grow income-generating activities at a grassroots level.

What is an example of a microcredit?

Grameen Bank in Bangladesh is a well-known example. It gives small loans to low-income individuals, especially women, to help them start or grow small businesses.

What is the limit of a micro loan?

Micro loans are offered to people with an annual household income of up to Rs 3 lakh. These loans are small and do not need any collateral.

Who is eligible for microcredit?

Microcredit is meant for low-income individuals like small business owners, farmers, and women entrepreneurs who cannot access regular bank loans or financial services.

Is microcredit always successful?

Not always. While it helps many, some borrowers face issues like high interest rates, debt pressure, or limited impact due to social or financial challenges.

What is micro credit?

Micro credit meaning is small loans that are designed for low-income individuals, businesses, or groups that do not have proper access to traditional banking. Micro credit helps groups start or expand their businesses, support income-generating activities, especially for people in rural areas.

How does micro credit differ from a traditional bank loan?

Micro credit offers smaller loan amounts. These are often provided without collateral through MFIs, banks, and NGOs and are aimed at helping underserved communities. Traditional bank loans offer much larger amounts, tend to require collateral, and have stringent eligibility criteria.

What are the main features of micro credit?

Micro credit usually involves small amounts, short repayment periods, and minimal paperwork and collateral requirements. Some programs also offer guidance on using the loan responsibly. These loans mainly help people earn income, start businesses, or cover essential needs, especially for financially vulnerable groups of people.

What are the different types of microcredit available?

Microcredit is offered in different forms. For example, individual loans go to a single person, group loans support a group of people starting a business, agricultural loans can fund farming or livestock, and microenterprise loans help small businesses grow. Some micro credit loans cover personal or household needs.

Who is micro credit designed for in India?

In India, microcredit is designed for low-income individuals, small business owners, and rural communities. In such schemes, women and marginalized groups are often prioritized. These schemes usually help people who are unable to take the traditional bank loan route for their needs.

What is the average loan amount under micro credit?

In India, microcredit loans are usually up to ₹3 lakh. The exact amount is variable. That depends on the borrower, their income, and the purpose of the loan. These loans are designed to help start or grow businesses, support agriculture, or cover essential personal needs.

What role does micro credit play in financial inclusion?

Microcredit helps people who don’t have access to regular banking. It gives them a chance to earn income, start businesses, and improve their quality of living. Micro credit also helps build credit history, especially for women and low-income communities, giving them more opportunities in the future.

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