Freeing Microfinance: Recent RBI Advisory Document Releases MFIs From Barriers Imposed By 2011 Regulation
The world of microfinance had developed, to a large extent, as a result of benevolent neglect on the part of central banks. Regulations were only introduced when the industry attracted a significant number of customers. India is no different. The RBI first authorized informal self-help groups to open savings accounts in banks and provide bank loans to these groups in 1991-92. In 2000, it enabled all types of institutions to offer microcredits, and bank loans granted to these institutions for on-lending were treated as priority sector loans. Beyond these, RBI was unwilling to introduce regulations on the grounds that as long as they are not depository institutions, there is no need to regulate them. This was also the position of various committees appointed by the RBI, including the 2004 Vyas Committee.
RBI has become increasingly interested in the sector since the crisis in the Krishna district of Andhra Pradesh in 2006, and the events that led to the AP Microfinance Ordinance in 2010, which resulted in the constitution of the Malegam Committee. On its recommendations, RBI issued detailed guidelines for microfinance institutions (not the microfinance sector) in 2011. These guidelines introduced a new category of NBFC, namely NBFC-MFIs, and established standards for them. income criteria for MFI clients, repayment period, borrower loan limits, interest rate standards and caps, limits on the number of lenders to a borrower, and a host of other standards and criteria. The microfinance industry welcomed these guidelines because they put a minimum of order in the sector and prescribed a framework within which institutions could operate.
These happy moments continued until 2015-16. At that time, a few private sector banks began to increase their exposure to microfinance through separate verticals and a large MFI became a universal bank. This was followed by the entry of small finance banks (eight of which were MFIs) into the microfinance space. MFIs found to their dismay that if they were to adhere to a set of regulations, this was a general rule for non-MFIs (banks, SFBs and NBFCs). The microfinance industry has started asking the central bank for the lack of a level playing field for MFIs compared to non-MFIs. The main problem was that non-MFIs were not required to meet the standard of number of lenders (two in the case of NBFC-MFIs) and loan limits per borrower. This prompted non-MFIs to target borrowers identified and supported by MFIs with higher loan amounts, which led to high levels of borrower indebtedness. MFIs were left dry with their hands tied, while others were given unfettered freedom of operation. In addition, the interest rate cap (2.75 times the base rate declared quarterly by the RBI) squeezed the margins of small and medium MFIs, as none of them obtained loans from the largest banks. .
RBI’s recent advisory document literally frees MFIs from the shackles imposed by 2011 regulations and gives them a level playing field, hitherto reserved for non-MFIs. Central to this document is the need for lenders to adhere to lending standards based on household borrowing indebtedness. This would imply that credit institutions invest more time and energy in assessing the finances of borrowing households. While technology would be of great help, MFIs would be better placed to do so because their clients’ connections are closer and deeper.
Another important feature for MFIs is that by removing the 50% income-generating loan criteria and repayment period standards, the RBI facilitates the flow of credit in life cycle needs such as housing, drinking water, education, health, keeping them as important as income generation.
On the interest rate front, initially, a certain upward correction could be made by small and medium-sized MFIs depending on their borrowing rates. But in the long run, the rates of the largest institutions – banks as well as MFIs – would drop if they adhere to the transparent pricing standards outlined in the document.
The document strengthens the role of the regulator because the adoption of policies approved by the Council to determine household debt standards and set a transparent interest rate by each institution and their implementation requires rigorous prudential supervision. In addition, self-regulatory organizations (SROs) will have to reframe the existing code of conduct in accordance with the new directives and ensure compliance with these standards.
The author is Executive Director, Sa-Dhan, SRO of the microfinance industry. Views are personal