Banking Central | Why Telangana HC verdict on MFI regulation is important

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On February 14, in a historic judgment, the Telangana High Court ordered that non-banking finance companies (NBFCs) operating as microfinance institutions (MFIs) that are regulated by the Reserve Bank of India (RBI) will not come under the control of state laws. Only the central bank has power to regulate these entities, it said.

In May last year, in an equally important judgment, the Supreme Court had ruled that state moneylending acts will not apply to NBFCs that are under the regulation of the RBI. This is the second time in last one year, judiciary has drawn a line between the RBI and the state governments in the regulation of NBFCs.

For the NBFC industry, these rulings have immense importance. For years, NBFCs and NBFC-MFIs have faced the problems of dual regulations. In fact, the very route of the 2010 Andhra Pradesh microfinance crisis was a state law.

The Andhra Pradesh Microfinance Act 2010 severely restricted the operations of microlenders in the state, impacting all aspects of the work of MFIs, including field-level collections and fresh lending. What followed was a  mayhem. The industry plunged into an overnight crisis, forcing many of these companies shut business. The crisis had a devastating impact on several microfinance companies, ended livelihoods for hundreds of employees and denied credit access to thousands of poor borrowers.

The court order may not compensate the affected parties but it is never too late for a corrective action. The verdict will give confidence to new entrepreneurs who wants to operate in microfinance. Clarity of regulations may even prompt some of the former MFIs which had shut shops to return to business. That will be good news for thousands of low-income borrowers in India’s microlending market.

Over decades, MFIs have played  a crucial role in extending credit to the last mile. These companies have acted as a bridge between large formal financial institutions and small borrowers. The business isn’t easy. It requires significant local knowledge, strong field expertise that big banks typically do not have and deep understanding of the local markets.

Unfortunately, like in many other industries, a few bad apples spoiled the entire lot in 2010. These villainous parties engaged in arm-twisting recovery practices, introduced usurious charges and pushed the vulnerable into the death-pit of over indebtedness. This attracted the state's attention.

But, the AP Act killed even the ethically operated companies and broke the back of the industry while targeting the wrongdoers. The war on microfinance lasted till the RBI stepped in with new regulations in December 2011. Even after that states continued to intervene in NBFCs’ operations in some way.

With clarity finally emerging on regulation, one could hope that there won’t be further another Andhra Pradesh-like crisis.