Indian Central Bank releases the board sub-committee report on microfinance regulation

It was much awaited. Everyone including Central Bank (Reserve Bank of India), finance ministry, banks, investors and other provincial governments have been buying time in the name of this report's arrival. As some of you may know RBI has constituted this sub-committee headed by an eminent chartered accountant Mr. Malegam in the aftermath of Andhra Pradesh government's promulgation of infamous microfinance ordinance that has practically brought the industry to standstill, contributed to soaring payment defaults in AP and led to liquidity crunch all over the country. The industry's future was being questioned and Malegam committee recommendations were touted as possible way ahead.

The report is finally out and here it is. I am pasting the summary below from another website microfinancefocus.com and my views are underneath:

The Sub-Committee has recommended creation of a separate category of NBFCs operating in the microfinance sector to be designated as NBFC-MFIs. To qualify as a NBFC-MFI, the Sub-Committee has stated that the NBFC should be “a company which provides financial services pre-dominantly to low-income borrowers, with loans of small amounts, for short-terms, on unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks” and which further satisfies the regulations specified in that behalf.

The Sub-Committee has also recommended some additional qualifications for NBFC to be classified as NBFC-MFI. These are:

a. The NBFC-MFI will hold not less than 90% of its total assets (other than cash and bank balances and money market instruments) in the form of qualifying assets.

b. There are limits of an annual family income of Rs.50,000 and an individual ceiling on loans to a  single borrower of Rs.25,000

c. Not less than 75% of the loans given by the MFI should be for income-generating purposes.

d. There is a restriction on the other services to be provided by the MFI which has to be in accordance with the type of service and the maximum percentage of total income as may be prescribed.

The Sub-Committee has recommended that bank lending to NBFCs which qualify as NBFC-MFIs will be entitled to “priority lending” status. With regard to the interest chargeable to the borrower, the Sub-Committee has recommended an average “margin cap” of 10 per cent for MFIs having a loan portfolio of Rs. 100 crore and of 12 per cent for smaller MFIs and a cap of 24% for interest on individual loans. It has also proposed that, in the interest of transparency, an MFI can levy only three charges, namely, (a) processing fee (b) interest and (c) insurance charge.

The Sub-committee has made a number of recommendations to mitigate the problems of multiple-lending, over borrowing, ghost borrowers and coercive methods of recovery. These include :

a. A borrower can be a member of only one Self-Help Group (SHG) or a  Joint Liability Group (JLG)

b. Not more than two MFIs can lend to a single borrower

c. There should be a minimum period of moratorium between the disbursement of loan and the commencement of recovery

d. The tenure of the loan must vary with its amount

e. A Credit Information Bureau has to be established

f. The primary responsibility for avoidance of coercive methods of recovery must lie with the MFI and its management

g. The Reserve Bank must prepare a draft Customer Protection Code to be adopted by all MFIs

h. There must be grievance redressal procedures and establishment of ombudsmen

i. All MFIs must observe a specified Code of Corporate Governance

For monitoring compliance with regulations, the Sub-Committee has proposed a four-pillar approach with the responsibility being shared by (a) MFI (b) industry associations (c) banks and (d) the Reserve Bank.

While reviewing the proposed Micro Finance (Development and Regulation) Bill 2010, the Sub- Committee has recommended that entities governed by the proposed Act should not be allowed to do business of providing thrift services. It has also suggested that NBFC-MFIs should be exempted from the State Money Lending Acts and also that if the recommendations of the Sub-Committee are accepted, the need for the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act will not survive.

The Sub-Committee has cautioned that while recognising the need to protect borrowers, it is also necessary to recognise that if the recovery culture is adversely affected and the free flow of funds in the system interrupted, the ultimate sufferers will be the borrowers themselves as the flow of fresh funds to the microfinance sector will inevitably be reduced.

We will have to wait for expert analysis of the report and its implications on the future of the indistry in India but a quick read does not reflect the work as pathbreaking to me. Most of the recommendations are not only impractical but also outright silly in my opinion.

Stipulating that loans should be given only in groups, no more than Rs. 25,000 ($500) should be given to each borrower, Rs. 50,000 ($1,000) annual family income limit, 75% portfolio in income generation activities and above all interest cap are some the recommendations that are key and I find them not only as infringement of individuals' right to borrow but also less business friendly.

The committee should know that not everyone can borrow in groups nor is it a good idea to do so beyond a limit. At the time when many MFIs are beginning to learn the art of individual lending to meet higher credit needs that cannot be fulfilled through group methodologies this recommendation is a shot in the foot and reflects gross lack of understanding of the business among the committee members.

It is very surprising to hear the highest financial authority of the country recommending that an individual cannot be given more than $500. It sounds to me that when it comes to poor again they are being subjected to government or regulator's dictat. When you and I do not have a limit to borrow, why should a poor fellow be restricted of this access? It would be rather more beneficial if the committee has stipulated some non-negotiables in assessing the payment capacity of the borrowers rather than prescribing the blanket loan amount to all.

Income limit of $1,000 is another big flaw. 70% of India's population lack access to any kind of financial service. Restricting microfinance to the lowest strata not only deprives the rest of the unreached population from financial access but also makes it unviable for the providers to carry on business. Most of the households that earn less than this amount are either laborers or tiny farmers. The former cannot borrow from MFIs because they don't have a business to invest in and the latter is too risky to lend to through exisiting microfinance methods unless s/he has alternative income sources. 

Limiting loan exposure to income generation activities ignores the fact that poor needs credit not only for running businesses but also for consumption smoothing, housing, education, health needs etc. One cannot define how much a poor should use for business or consumption as long as s/he exhibits the capacity to repay.

The committee recommends capping the operational spread of MFI and interest rates. This recommendation is a half-baked cookie. I don't understand why they fell short of capping the rates at which banks lend to MFIs. Without addressing the cost of funds issue it is unfair for MFIs to cap their lending rates.

Finally, there is no mention of other financial services such as savings, insurance, money transfers and loans for other needs.The committee has taken a very narrow view of microfinance which is regrettable.

One thing that I think is certainly positive for the industry is the recommendation to retain microlending under priority sector. This is important to keep the bank credit flow active and adequate. Other recommendations are not really great but good ones. Credit bureau, good governance, grievance redressal system and code of conduct are all good.

It would be interesting to watch which ones would the RBI accept, tweak or reject before releasing the regulatory framework for microfinance which would be first if its kind in the country.

Your views in the meantime are most welcome.