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MICROFINANCE REGULATIONS

Why in news?

The Reserve Bank of India (RBI) has proposed a new regulatory regime for microfinance with uniform set of guidelines for all lenders.

About Microfinance

Microfinance is a form of financial service which provides small loans and other financial services to poor and low-income households to enable borrowers to work their way out of poverty by undertaking income generating activities.

Overview and background

  • Indian microfinance sector has witnessed phenomenal growth over past two decades in terms of increase in both the number of institutions providing microfinance and quantum of credit made available to the microfinance customers.
  • Microcredit is delivered through a variety of institutional channels viz., (i) scheduled commercial banks (SCBs) (including small finance banks (SFBs) and regional rural banks (RRBs)) lending both directly as well as through business correspondents (BCs) and self-help groups (SHGs), (ii) cooperative banks, (iii) non-banking financial companies (NBFCs), and (iv) microfinance institutions (MFIs) registered as NBFCs as well as in other forms. Currently it is serving around 102 million accounts of the poor population of India.
  • However, as the sector grew, certain inadequacies and failures became apparent culminating in the Andhra Pradesh microfinance crisis in 2010.

This crisis was attributed to the irrational exuberance of some MFIs who, in their  eagerness to grow business, had given a go by to the conventional wisdom and good practices such as due diligence in lending and ethical recovery practices.

  • In the wake of this crisis, RBI constituted Y H Malegam Committee to study issues and concerns in the MFI sector.

Based on the recommendations of the Malegam Committee, RBI introduced a comprehensive regulatory framework for NBFC-MFIs in 2011.

An NBFC-MFI has been defined as

  • a non-deposit taking NBFC,
  • with minimum net owned fund of ₹5 crore (₹2 crore for NBFC-MFIs registered in the North Eastern Region) and,
  • having minimum 85 per cent of its net assets (assets other than cash, bank balances and money market instruments) in the nature of ‘qualifying assets’.

This comprehensive regulatory framework is however, applicable only to NBFC-MFIs, whereas other lenders, which comprise of around 70 percent share in the microfinance portfolio, are not subjected to similar regulatory conditions.

Key Recommendations of Malegam Committee

Regulatory approach towards microfinance has been largely based on the recommendations of the Malegam Committee.

The key recommendations of the Malegam Committee were as follows:

·         Creation of a separate category of NBFC operating in the microfinance sector to be designated as NBFC-MFI

·         Criteria for defining ‘microfinance loans’ classified as ‘qualifying assets’

·         Prudential norms on capital adequacy and provisioning requirements

·         Prescriptions related to pricing of credit in terms of a margin cap and interest rate ceiling on individual loans

·         Transparency in interest charges as well as other terms and conditions of the loan

·         Measures to address multiple lending, over-borrowing and coercive methods of recovery

·         Establishment of a proper system of grievance redressal

The RBI is therefore now proposing a single uniform set of regulations for all Regulated entities (REs) of RBI operating in the microfinance sector.

Regulation of MFIs

Parameters

Existing Regulatory framework for NBFCMFIs

Proposed changes in regulatory framework

Definition of

Microfinance

borrower

A microfinance borrower is identified by annual household income not exceeding ₹1,25,000 for rural and ₹2,00,000 for urban and semi-urban areas.

• Same criteria shall be extended to all REs for the purpose of the common definition.

o All REs shall have a Board approved policy enumerating factors considered for assessment of household income

Limits on

household

indebtedness

Total indebtedness of the borrower does not exceed ₹1,25,000 (excluding loan for education and medical expenses);

• Link the loan amount to household income in terms of debt-income ratio.

o Accordingly, all lending institutions has to ensure that the EMI a household has to pay does not exceed 50 per cent of its income

Nature of loans

Collateral free loans without any

prepayment penalty

The collateral free nature of microfinance loans shall

be extended to all REs.

Limit on

number of

loans, loan

amount and

tenure

• Loan amount limit of ₹1,25,000

(₹75,000 in first cycle and exclusion of loans for meeting education and

medical expenses from loan limit);

• Minimum tenure of 24 months for

loans above ₹30,000

• No more than two NBFC-MFIs can lend to the same borrower.

• Minimum 50 per cent of loans to be

given for income generation activities

All limits shall be withdrawn

Repayment

periodicity

Microfinance borrowers of NBFC-MFIs are permitted to repay weekly, fortnightly or monthly instalments as per their choice.

All REs shall have a Board approved policy to provide the flexibility of repayment periodicity to microfinance borrowers as per their requirement

Pricing of micro

loan

Maximum interest charged by an NBFC-MFI shall be the lower of –

• the cost of funds plus a margin cap of 10% for MFIs with loan portfolio of ₹100 crore or above and 12% for

others;

• The average base rate of the five largest commercial banks by assets multiplied

by 2.75.

No ceiling prescribed for the interest rate of NBFCMFIs.

• The Board of each NBFC-MFI shall adopt an interest rate model taking into account relevant factors such as cost of funds, margin and risk premium and determine the rate of interest to be

charged for loans and advances.

• NBFC-MFIs, like any other NBFC, shall be guided by fair practices code and would ensure disclosure and transparency of interest rates.

Exemptions to

not-for-profit companies

Exemption from registration requirements to those ‘not for profit’ microfinance companies (registered under Section 25 of

the Companies Act, 1956 (Section 8 of the Companies Act, 2013)) which are:

• engaged in providing credit not

exceeding ₹50,000 for a business

enterprise and ₹1,25,000 for meetingthe cost of a dwelling unit to any poor person and

• not accepting public deposits.

Exemption to those ‘not for profit’ microfinance companies which are-

• engaged in providing collateral-free loans to households with annual household income of ₹1,25,000 and ₹2,00,000 for rural and urban/semi

urban areas respectively,

• EMIs of loans does not exceed 50 per cent of the household income and

• having asset size of less than ₹100 crore.

Necessity for review of the current regulatory framework

The emerging dynamics in the microfinance sector as well as the concerns of customer protection call for a review of the regulations so that all the regulated entities (REs) engaged       

Need for review of the current regulatory framework

The emerging dynamics in the microfinance sector as well as the concerns of customer protection call for a review of the regulations so that all the regulated entities (REs) engaged in microfinance pursue the goal of customer protection within a well-calibrated and harmonized set-up.

  • Over-indebtedness of borrowers: Current regulations which do not permit more than two NBFC-MFIs to lend to the same borrower give space to other lenders. As a result, small borrowers are increasingly able to get multiple loans from several lenders, contributing to their over-indebtedness leading to difficulties in repayments and forced recoveries.

The recommendation of linking the loan amount to household income in terms of debt-income ratio is to ensure that the household is not strained.

  • Creating a level playing field: Prevailing regulations on interest rate ceiling has been keeping the interest rates at a higher level for NBFC-MFIs. As a result, lending rates of banks also hover around this ceiling rate, despite comparatively lower cost of funds. Ultimately the borrowers are getting deprived of the benefits from enhanced competition as well as economy of scale.

The proposed removal of capping on interest rate of NBFC-MFIs could enable the market mechanism to bring the interest rates downwards in the microfinance sector and empower the borrowers to make an informed decision by enhancing prevalent mechanisms on transparency of loan pricing.

  • Increasing accessibility of microloans by withdrawing the need for collateral: Low-income borrowers often lack the type of collateral often preferred by the lenders and what they have for pledging, instead is of little value for the lenders but is highly valued by the borrower (e.g. household items, furniture, etc.). Even if lenders take such collateral, it is for leverage to induce repayments rather than to recover losses.

Obviating the dependency on informal sources of credit: Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households’ had recommended that over-emphasis on income generating loans may drive the borrowers towards more expensive informal loans for fulfilling their entire financial needs.

Therefore, limits regarding minimum 50 per cent of loans for income generation purpose, which are presently applicable only to NBFC-MFIs, are proposed to be withdrawn.

  • To prevent trickling down of the risks: Section 8 companies are dependent for their funding needs on public funds including borrowings from banks and other financial institutions. Due to their interconnectedness with other financial intermediaries, any risk arising out of their business can get transmitted to the financial sector. Thus, companies having asset size more than 100 crores are not exempted from RBI regulations.

Questions expected in the examination:

Question 1. Explain the recent regulations proposed by Reserve Bank Of India for Microfinance Institutions.

Question 2. Give an account of Microfinance growth in India. Also mention the challenges in regulation of Microfinance Institutions.

Question 3. How can you say that Microfinance Institutions are facilitating lower income groups to improve their overall standard of living? Discuss in detail.

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