Is RBI missing the wood for the trees? 

The microfinance sector has been on a roll since the RBI’s path-breaking guidelines of March 2022.

Both sectors currently in the cross hairs of the Reserve Bank of India, MFI-NBFCs and NBFCs, are into unsecured lending. In lending to the poor, the regulator’s concerns are about excessive interest rates charged while in retail unsecured credit, where lending rates are far lower, it worries about a bubble building up from unmanaged growth at a time when banks are in good health.

Its latest move of temporarily banning four NBFCs, on the charges of usurious loan pricing, has sent shock waves, not because high rates of interest were unheard of but because the punishment seemed excessive.

2022 regulatory flattening

The microfinance sector has been on a roll since the RBI’s path-breaking guidelines of March 2022 which sought to create a level playing field for all players in the microfinance domain. NBFC-MFIs which were trailing banks a few years back, have now raced to the top with a credit growth of 38 percent during FY23.

An important change was the replacement of a rule-based guidelines with a principle-based framework. In fact, two specific changes, the cap on repayment obligations of borrowers and a framework for determination of household income and repayment capacity, are significant as they were specifically designed to lower the cost of credit for borrowers- the repayment cap by nudging lenders to keep rates low so that repayment obligations stayed within limits, and the income limit by reducing indebtedness and thereby lowering risk premium for borrowers. But it was precisely these guidelines that the NBFC-MFIs seem to have violated.

Practical problems in gauging borrower income

The RBI had formulated broad guidelines for determining household income, but this is easier said than done. It is well known that over 75 percent of rural employment is either self-employed or casually employed and determining income of such a large informal segment can be a massive challenge for anyone, let alone NBFC-MFIs. One of the MFIs even highlighted this issue in its Annual Report.

As for the charge of usurious interest rates, the RBI’s guidelines themselves are not specific, only stating that the entity should have an approved pricing policy in place that would not be seen as excessive. The charge of non-adherence is therefore puzzling when there were no prescribed norms.

Ban can have unforeseen consequences

The ban could also turn out to be counterproductive if it accentuated distrust and apprehension, what the RBI was trying to prevent in the first place. As for excessive growth, a point to be noted is the nature of the business. On average, nearly 70 percent of loans have tenures of less than two years and as much as a quarter less than a year. Data show that unique borrowers (having more than one loan account but counted only once) have not grown as rapidly as loan portfolio did, which suggests that a large part of the growth may have come from refinancing the same borrowers.

The RBI’s guidelines are only two years old and NBFCs will need time to adapt to a principle based framework, considering the milieu in which they operate. Moreover, with NBFC-MFIs being heavily dependent on banks for funding (almost 70 percent of their borrowings) there are also natural checks on their growth.

Overblown anxiety in personal credit

As for unsecured retail personal credit, the RBI’s other bugbear, the worries are again about unfettered growth but being consumption loans, the fear is that bad underwriting and follow-up could lead to an asset bubble with systemic implications. It seems particularly worried about NBFCs with low capital buffers that were growing rapidly.

In the MPC policy statement the Governor even alluded to the possibility of growth being driven not by demand but by ROE-seeking strategies of their investors, including MFIs. While these fears may not be unfounded, the systemic risk concerns appear a tad overblown for several reasons.

For one, unsecured personal credit outstanding is spread across about 4.3 crore borrower accounts making it unlikely that defaults could ricochet through the financial system. Also, the weighted average lending rates of unsecured personal loans at 10.8 percent has not increased much over the past three years and is still moderate compared to MFI loans. Two, credit card debt though growing at a fast clip, is only a small percentage of total credit (1 percent of total bank credit and 5percent of personal loans) which again makes it highly improbable that it will be a systemic risk.

Interestingly, the credit card debt outstanding represents largely the free credit availed by holders, seen from the fact that while annual credit card transaction volumes are around Rs 17 lakh crore (RBI payments data) outstanding debt was only about Rs 2.6 crore (working out to about 45 days’ credit). This may also explain why some of RBI’s measures like increasing the cost of credit for credit card loans did not work.

RBI itself believes that retail lending by NBFCs has moderated and its share in total credit had fallen from 32% per cent to 23% (Report on Banking). Maybe its public concerns relate to specific segments, such as fintech NBFCs which have also witnessed rapid growth. These entities have been using technology to expand customer reach and as per a CARE report, their assets tripled from Rs.10,262 crore in FY20 to Rs.33,676 crore in FY24. The RBI has long been wary of digital lending as also outsourced underwriting.

Finally, the shift to retail credit itself was a flight to safety driven by risk aversion of banks and NBFCs, badly bruised by NPAs from industrial and corporate lending. With insufficient demand from other sectors, retail seemed a good bet then but if corporate demand were to pick up, retail could take a back seat. With RBI now keeping a close watch, it remains to be seen what their strategies are going to be.