The microfinance sector is among the worst-hit sectors due to the ongoing COVID-19 pandemic. Small traders and daily wagers have been unable to meet their daily needs, let alone pay their debts. On the other hand, lenders for the microfinance sector have been struggling with defaulting borrowers and have led to curtailed lending in this space.
The sector has been facing issues relating to the inconsistency of regulatory framework for various lenders — the non-banking financial companies-micro finance institutions (NBFC-MFIs) being regulated for the microfinance sector are governed by stringent laws. However, all other lenders, which constitute almost 70 percent of the microcredit segment, including scheduled commercial banks, co-operative banks, NBFCs and non-profit institutions, are not regulated under the same lens crafted specifically for the microfinance sector.
The Reserve Bank of India has taken cognisance of all these issues and has recently issued a Consultative Document on Regulation Of Microfinance. The document aims at harmonising the regulatory set-up, ensuring financial inclusion of low-income borrowers, and promoting healthy competition among the lenders. However, there are certain roadblocks and issues which need to be detailed out.
The RBI document recommends capping the indebtedness of micro households such that the outstanding loan (including the principal and the interest amount) is not more than 50 percent of the household income. It should be noted that the assessment of income is at the household level rather than the individual level with an intent to ensure that the households are not strained. This assessment of household income in a fragmented society like ours would require a detailed process for KYC and thorough information about each individual’s (in the household) scheduled repayments across all other loans. The accuracy of such an assessment will definitely be a daunting task.
Another focus of the consultative document is to have a uniform framework applicable to all the lenders engaged in microfinance activities that are regulated by the RBI, under the umbrella of ‘regulated entities’. This is certainly a long-awaited move that will help in creating a level playing field for all the lenders. Though, in the process, the RBI has suggested withdrawing certain regulations which apply only to the NBFC-MFIs such as limit of lending to a borrower by not more than two NBFC-MFIs and the ceiling prescribed for the interest rate.
There may be merit in reconsidering the withdrawal limit on the number of lenders for a particular borrower. Instead, it may be more appropriate to increase the maximum number of lenders (maybe to three or four) to a particular household and apply such limitation uniformly to all ‘regulated entities’. This may help in restricting over-indebtedness in a particular household, curb defaults and help achieve the desired result of the proposed framework.
Further, the RBI has proposed to remove the ceiling on the interest rate which is applicable to NBFC-MFIs and which appears to have inadvertently acted as a benchmark for all other lenders as well. While the intent behind this is to encourage the lenders to take advantage of economies of scale, lower cost of funds and enable a market mechanism to bring the interest rates downwards, this may not work as desired and the lenders may end up charging higher rates of interest, thus defeating the intent of the consultative document.
Overall the proposed framework is a welcome step in the microfinance sector. It prescribes certain significant changes to ensure regulatory uniformity and financial inclusion — for example, the proposal for a common definition of ‘microfinance loans’ applicable to all REs, relaxing the more stringent laws for NBFC-MFIs, suggesting a flexibility of periodicity of repayments and prepayment without attracting a penalty, the exemption of ‘not for profit’ microfinance institutions from certain legal provisions, and, standardising a one-page disclosure format on the pricing of microfinance loans for easy comparison of interest rates provided by different lenders.
We look forward to the final document with a more detailed revised framework for the microfinance sector.