Self Help Groups: An Alternative Credit System for Small Business

For a vegetable vendor who shifts cities with the seasons, or a tailor working out of a one-room shop, walking into a bank for a loan often ends in disappointment. The bank wants proof of residence, a credit history, and collateral. The vendor has none of these. This mismatch between how formal banking works and how millions of small earners actually live has created a vast credit gap. Self Help Groups (SHGs) emerged as a practical answer, building a bridge between the informal economy and the formal banking system. They have grown into one of the most successful alternative credit delivery mechanisms anywhere in the world.

Why formal credit stays out of reach 🔗

Before understanding the solution, it helps to see the problem clearly. A bank loan looks simple on paper, but the paperwork itself is the barrier for many people who need credit the most.

When someone applies for a loan, a bank typically asks for proof of age, proof of identity, proof of residence, a record of past dealings, a business plan, and some form of guarantee or collateral. Each of these is a reasonable safeguard from the bank’s point of view. Together, however, they form a wall that many people simply cannot climb.

The migrant and the deprived 🔗

Consider people who move constantly for work, or street children, or families living in urban slums. A migrant worker cannot easily prove a stable residence because their address keeps changing. Without a fixed address, opening and maintaining a bank relationship becomes difficult. Without an ongoing banking relationship, there is no record of past dealings to show. And almost none of these earners own property or assets to pledge as collateral.

This is not a small group. India’s microfinance and financial inclusion story has been driven precisely by the scale of this exclusion. The unorganized sector employs a huge share of the workforce, and for years these workers were left with only one option for credit: the local moneylender, who charged interest rates that could trap a borrower for life. The challenge, then, was to design a credit system that did not depend on collateral, fixed addresses, or thick paper files.

What a Self Help Group actually is 🔗

A Self Help Group is a small, informal group of people who come together voluntarily to solve their credit problem on their own terms. There is nothing complicated about the basic idea. A group of willing people, usually between ten and twenty members from similar economic backgrounds, decide to pool their money through regular saving.

This regular saving is called thrift. Each member contributes a small, fixed amount every month, however modest. The amounts are kept in a common bank account in the group’s name. Over time, these tiny individual savings add up into a meaningful pool of money that belongs to the group collectively.

Lending from the pool 🔗

Once the pool exists, the group puts it to work. When a member needs money, perhaps to buy stock for a small business, pay a medical bill, or cover a family expense, the group lends from the pooled fund. The crucial point is that the terms of each loan, including the interest rate and the repayment schedule, are decided by the members themselves through consensus.

This internal lending solves several problems at once. There is no collateral demanded because the members know each other and the social bond acts as the guarantee. Decisions are quick because there is no distant office to approve them. And the interest earned on internal loans flows back into the group’s own fund, growing the pool further rather than enriching an outside lender.

The National Bank for Agriculture and Rural Development (NABARD) describes a healthy group as one that follows five disciplines, often called the Panchsutras: holding regular meetings, saving regularly, lending internally based on member demand, repaying loans on time, and keeping proper books of account. These five habits turn a casual gathering into a functioning financial unit.

Building the bank’s confidence 🔗

Saving and lending internally is only the first stage. The real power of the SHG model comes from connecting the group to a formal bank, so the group can borrow a much larger sum than its own savings would allow. This connection has to be earned, and it is earned through visible discipline.

A well-run group operates almost like a tiny bank. It maintains careful records of every meeting and every transaction. It keeps minutes, records who attended, notes how much each member saved, and tracks every internal loan and repayment. These records are not just for the group’s own use; they are evidence of reliability.

The six-month test 🔗

The group also stays in regular touch with the bank where it holds its savings account. Members often invite bank officials to attend their meetings and witness the activities first hand. This transparency lets the banker see that the group meets regularly, saves consistently, and recovers its internal loans.

After roughly six months of this disciplined activity, the group typically becomes eligible to receive a loan from the bank. This is the heart of the SHG-Bank Linkage Programme, which NABARD launched as a pilot in 1992 to connect a few hundred groups with formal banks. The bank lends to the group as a whole, against the group’s collective guarantee rather than individual collateral. The group then re-lends this money to its members for their needs.

Under NABARD’s guidelines, banks extend loans in proportion to a group’s savings, often several times the amount the group has deposited. A bank can offer a savings-linked loan in a ratio that multiplies the group’s own pool, and well-established groups can access even larger amounts. Crucially, the bank deals with one group account instead of twenty separate tiny accounts, which sharply reduces its transaction costs and makes lending to poor households commercially workable.

The NGO as an intermediary 🔗

Direct linkage between a group and a bank is one route, but it is not the only one. Many groups, especially newly formed ones, need handholding before they are ready to deal with a bank directly. This is where non-governmental organisations (NGOs) play a vital role as intermediaries.

An NGO with a proven track record can borrow funds from larger financial sources and then on-lend that money to several SHGs. In this model the NGO acts as a wholesaler of credit: it takes on the relationship with the big lender, and it passes the credit down to the groups it works with, often providing training and supervision along the way.

Where the NGO gets its funds 🔗

Several apex institutions in India exist specifically to channel credit through NGOs to groups at the grassroots. The Small Industries Development Bank of India (SIDBI) supports micro and small enterprise finance, including lending routed through intermediaries to reach small borrowers.

The Rashtriya Mahila Kosh (RMK), or National Credit Fund for Women, was set up in 1993 under the Ministry of Women and Child Development. It works as a facilitating agency: rather than lending directly to individual women, RMK provides loans to NGO-run intermediary organisations, which then on-lend to women’s SHGs in a collateral-free, hassle-free manner. The structure is deliberately tiered, with RMK lending to the NGO at a low rate, the NGO passing it to the group, and the group reaching the individual member.

Similarly, the National Minorities Development and Finance Corporation (NMDFC), under the Ministry of Minority Affairs, runs a micro-finance scheme that extends credit to SHG members from minority communities, particularly women in remote villages and urban slums who cannot access formal banking. NMDFC channels this credit through its state agencies and through NGOs that organise borrowers into groups.

Together with commercial banks, these institutions form a layered supply of credit. Money flows from large national bodies, through trusted NGOs, into small groups, and finally to the individual earner who needs a few thousand rupees to keep a business going. Each layer adds reach and supervision without demanding the collateral that excluded these borrowers in the first place.

The road ahead for Self Help Groups 🔗

The Self Help Group movement has moved well beyond its early pilot stage. What began with a few hundred groups in the early 1990s has become the largest microfinance programme in the world by client base, with the savings-led model covering tens of millions of households.

The impact has been studied closely. An independent evaluation of the rural livelihoods mission built on this model found a meaningful rise in household income and a sharp increase in household savings compared with the baseline, across nine states. Research on the programme has repeatedly found that it improves outreach, raises incomes, and empowers members both economically and socially, with all-women groups tending to perform especially well.

Spreading where exclusion runs deepest 🔗

The model also keeps evolving in its geography. In its early years, SHG activity was concentrated in southern states such as Andhra Pradesh, Tamil Nadu, Kerala, and Karnataka. More recently it has spread into the eastern and north-eastern regions, where financial exclusion has historically been greatest. This expansion matters because it brings credit to exactly the areas the formal banking system reached last.

For small businesses run by people the formal system once turned away, the Self Help Group is more than a source of cheap credit. It is a way to build a financial track record, a habit of saving, and a collective voice. As long as a large share of the population remains outside conventional banking, the SHG is expected to keep growing as a strong and dependable alternative channel for delivering credit to those who need it most.

What do you think? If you were advising a group of street vendors with no fixed address and no collateral, would you encourage them to form their own Self Help Group first, or to seek out an established NGO that could link them to credit faster? And which matters more for a group’s long-term success, the discipline of regular saving or the size of the bank loan it can eventually access?

References

1. https://rmk.nic.in/welcome-rashtriya-mahila-kosh
2. https://www.nabard.org/contentsearch.aspx?AID=225&Key=shg+bank+linkage+programme
3. https://www.indiafilings.com/learn/self-help-group-bank-linkage-programme
4. https://en.wikipedia.org/wiki/Self-help_group_(finance)
5. https://www.sidbi.in/
6. https://rmk.nic.in/
7. https://nmdfc.org/nmdfcschemes
8. https://www.tandfonline.com/doi/abs/10.1080/09584935.2012.737306