The concept of microfinance has evolved as a great tool of financial inclusion. Over the decade, this sector has managed to reach out to the poorest of the population and help them in setting up their commercial activities.
However, the idea does not come without its own share of risks. Over the years, it has created a vicious debt cycle for the bottom of the pyramid segment that the participants are finding difficult to break.
The microfinance industry was placed precariously even in the pre-pandemic scenario with rising debt levels per borrowers. Pandemic has made the situation worse, with borrowers finding it difficult to repay their EMIs due to the job losses and restrictions on commercial activities.
It has created a twin issue of poverty and indebtedness for the borrowers of microfinance institutions. Recently, the RBI has found the need to stop this problem from aggravating further and avoid a debt trap for the people at the bottom of the pyramid.
How Does the RBI Want To Tackle It?
Identifying the need to stop indebtedness from spreading further among the poor Indian citizens, the RBI has placed a consultative paper that aims to bring structural changes to the rules in the microfinance sector.
With a focus on controlling over-indebtedness, the RBI has recommended removing prepayment penalty and greater flexibility of repayment frequency for all microfinance loans.
The RBI has pitched for collateral-free MFI lending to households with an annual income of Rs 1.25 lakh in rural areas and Rs 2 lakh at urban and semi-urban centres. The RBI has also recommended introducing capping on EMIs to the percentage of the household income. Household income assessment would be made based on the internal policy approved by the board.
Impact on Lenders
With the proposed changes in the paper, the RBI intends to target three areas of concern. They are:
1) Target over-indebtedness,
2) Improving pricing gaps for different income groups, and
3) Bringing parity in microfinance rules among financial institutions.
RBI's consultation paper is for academic purposes and remains in the realm of discussions and suggestions. But, if the proposed changes are implemented in their current avatar, they are likely to face a few on-ground challenges.
For instance, assessing individual household income and introducing a cap on the EMI-income ratio would require microfinance lenders to allocate significant human and financial resources. It could end up increasing the cost of lending, which would eventually be passed on to the customers. Implementing consistent norms across entities would also be a challenging task for the RBI.
As for banks, the imposition of upper caps on household income could be negative for them. The limits of Rs 1.25 lakh for rural and Rs 2 lakh for urban households could limit the average ticket size growth.Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.