New RBI rules may change customer focus of microfinance lenders, say experts

On March 14, the Reserve Bank of India (RBI) introduced a new set of regulations governing microfinance lending.

The RBI has defined microfinance as a collateral-free loan to a household having an annual income up to Rs 3 lakh, among other changes. This new definition makes it possible for microfinance institutions (MFIs) to expand their scope when it comes to borrowers.

But there is an emerging debate on how this new rule will impact the sector. While one section argues that this will help expand the industry, there are others who think the higher income limit could dilute the very definition of microfinance which is essentially giving loans to small borrowers.

A section of industry experts say these new regulations are likely to shift the customer base and bring more borrowers from urban locations and also from several other micros, small and medium enterprises (MSMEs).

Shift from group borrowing to individuals

In a recent interview with Moneycontrol, Muthoot Microfin CEO Sadaf Sayeed said these regulations may bring more individual borrowers to the fold of microfinance. However, women entrepreneurs from rural areas will continue to be the core of the microfinance lending sector, he said.

Traditionally, microfinance lending has primarily focused on women belonging to joint liability groups (JLGs) and self-help groups from rural areas and the idea was to extend loans to those without access to formal financial institutions like banks. But the customer base will gradually broaden and shift with these new regulations.

“The model has evolved and can graduate to individual loans. But at present MFIs want to retain group guarantee as a collateral substitute,” said P Satish, executive director, Sa-Dhan, a self-regulatory organisation for the microfinance sector.

Focus on urban customers 

According to recent data from industry body Microfinance Institutions Network, the sector has nearly 78 percent rural portfolio, while urban portfolios constitute around 22 percent. But experts said that the new framework may bridge that gap and make microfinance more accessible to people from urban locations as well.

“Many MFIs also have an urban focus, especially when they work with customers from the slums of the big cities and from other poor sections,” said Satish.

“The credit needs and the level of deprivation need to be considered and that is often more in big cities as they have a large number of the migrant population who don’t even have a proper residential address,” said Satish.

Experts pointed out that the level of financial deprivation is more among the urban poor, so it is likely that some of the MFIs may gradually shift their focus to them.

“The shift in terms of the customer base will happen to urban locations under different models too. Any unsecured loans of smaller amounts like Rs 5,000 disbursed by fintech companies will also fall under the microfinance loans, as per the new regulations,” said Kishore Kumar Puli, managing director of Pradakshana Fintech.

At the same time, he pointed out that there are certain loopholes that need to be addressed when several other loans are coming under the umbrella of microfinance loans.

According to Puli, earlier it was the low-income community that was defined as the segment that didn’t have access to formal financial institutions. “As per new guidelines, the segment of borrowers is not clear. Now if a loan is given to any individual from class IV employees with less than Rs 25,000 of monthly income, it will be considered a microfinance loan, but ideally, it was not supposed to be. It can be sold to banks to get priority sector benefits,” said Puli.

Will MSMEs get a piece of small loans?

At the same time, a higher income limit has opened the door for various MSMEs to benefit from microfinance, experts said.

“Bigger MFIs may like to go for bigger ticket sizes. Since the qualifying asset has decreased from 85 percent to 75 percent, these institutions can go for larger ticket sizes through that way,” said Saibal Paul, associate director, Sa-Dhan.

Paul said the microfinance sector is looking to participate in larger loan deals for MSME clients with the threshold now going up.

“MSME loans up to Rs 2 lakh are unsecured loans and now any small shopkeeper opting for MSME loan for his small-scale business will also get considered as microfinance loans,” added Paul.

According to Paul, bigger MFIs may like to go for bigger ticket sizes for graduated clients, making space for mid-sized and smaller MFIs for lower ticket sizes.

“Smaller MFIs with the high cost of funds will get a breather as sustainable margin can be calculated. MFIs working in the difficult geographies, e.g. the northeast region, with the high cost of operations, will be able to cater to the unreached population with a bit more addition of cost of operation,” Paul said.

As qualifying assets have been reduced, there is every possibility the MFIs will be able to cater to the requirements of MSME clients. It is a welcome move from the regulator, Paul added.