Telangana HC order on MFI regulation a boon for sector, say experts

Representative image.

The Telangana High Court’s ruling of February 14, which says that states cannot control microfinance institutions regulated by the Reserve Bank of India, will enable more companies to start microlending, said experts.

The order, which placed the regulation of MFIs solely on the RBI, will also set a precedent for other states, they said.

A crisis triggered by a draconian law promulgated by the erstwhile Andhra Pradesh government in 2010 forced many MFIs to shut their business.

These firms may now return, experts said. This will have positive implications not just in the region but in other states as well, they said.

“The court order will result in existing MFIs boosting their business and players who were targeting to return to the sector will look for opportunities,” said Puli Kishor Kumar, former chief executive officer of Trident Microfinance, which shut down due to the crisis.

MFIs are companies that cater to low-income borrowers and source money from commercial banks to do business.

In 2010, the MicroFinance Institutions Network (MFIN) filed a case when the crisis broke out following the implementation of a controversial law that restricted MFI operations in then Andhra Pradesh. This resulted in the closure of several microlenders and alleged suicides by about 50 borrowers.

Regulatory clarity

The RBI then issued fresh regulations that excluded non-banking financial companies (NBFC)-MFIs registered with it from provisions of the impugned acts—the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act, 2011, and the Telangana Micro Finance Institutions (Regulation of Money Lending) Act, 2011.

The Telangana court ruling has brought regulatory clarity in the microfinance space and companies that have been out of business can work on revival plans while existing institutions can target wider markets, experts said.

“There was an issue of dual regulation of the microfinance sector. Now, there will be more clarity around the laws and this would allow MFIs to operate more freely than before. Other than this, this order can work as a reference for MFIs when state governments, if any, bring in regulatory laws for MFIs,” Puli said.

Other than the RBI Act and the Moneylenders Act, MFIs were regulated under state acts such as the Assam Micro Finance Institutions (Regulation of Money Lending) Act, 2020, and the Kerala Moneylenders Act, 1958.

In May 2022, the Supreme Court, in its judgement in the matter of Nedumpilli Finance Company versus State of Kerala and several other civil appeals, ruled that moneylending acts by governments in Kerala and Gujarat will not apply to NBFCs regulated by the RBI.

The CUTS Centre for Competition, Investment & Economic Regulation highlighted in a report that state laws and the absence of a single national regulation for MFIs had resulted in difficulties in their expansion.

It said state governments could intervene and enforce additional regulation on MFIs regarding permissible products, methods of collection, and code of conduct. The lack of a nationwide regulatory structure made expansion of MFIs to multiple states difficult to manage and much less transparent, it said.

With the apex court’s order of 2022 and the Telangana high court ruling, experts said the regulatory part would be with the apex bank and the job of executing them would be in the hands of state governments.

“Laws concerned with MFIs introduced by the RBI should be solely used to regulate the sector. State governments cannot use their laws to govern MFIs and create a dual regulatory environment,” said Rama Venugopal, a financial management expert.

According to Juhi Mehta, a partner at BTG Legal, state governments cannot rely on provisions in the Seventh Schedule of the Constitution to regulate certain aspects of NBFCs on the ground that such aspects are not provided for in the RBI Act.

“The powers available to the Reserve Bank of India to regulate NBFCs are from the ‘cradle to the grave,’” Mehta said.