By N.Srinivasan,Author, State of the Sector – Microfinance India 2008,2009 and 2010.

Microfinance Focus, May 4, 2011: The much awaited RBI’s stance on regulation of MFIs was made public as part of the monetary policy statement issued on 3 May by the Governor.  A notification giving effect to the announcements in the policy document has also been issued (Link). The policy document had the following to say about regulation of microfinance.

• to accept the broad framework of regulations recommended by the Committee;

• that bank loans to all MFIs, including NBFCs working as MFIs on or after April 1, 2011, will be eligible for classification as priority sector loans under respective category of indirect finance only if the prescribed percentage of their total assets are in the nature of "qualifying assets" and they adhere to the "pricing of interest" guidelines to be issued in this regard;

• that a “qualifying asset’’ is required to satisfy the criteria of (i) loan disbursed by an MFI to a borrower with a rural household annual income not exceeding ` 60,000 or urban and semi-urban household income not exceeding ` 1,20,000; (ii) loan amount not to exceed ` 35,000 in the first cycle and ` 50,000 in subsequent cycles; (iii) total indebtedness of the borrower not to exceed ` 50,000; (iv) tenure of loan not to be less than 24 months for loan amount in excess of ` 15,000 without prepayment penalty; (iv) loan to be extended without collateral; (v) aggregate amount of loan, given for income generation, not to be less than 75 per cent of the total loans given by the MFIs; and (vi) loan to be repayable by weekly, fortnightly or monthly instalments at the choice of the borrower;

• that banks should ensure a margin cap of 12 per cent and an interest rate cap of 26 per cent for their lending to be eligible to be classified as priority sector loans;

• that loans by MFIs can also be extended to individuals outside the self-help group (SHG)/joint liability group (JLG) mechanism; and

• that bank loans to other NBFCs would not be reckoned as priority sector loans with effect from April 1, 2011.

The significant pronouncement relates to the acceptance of the broad framework that Microfinance is a separate category of financial services activity and has to have certain defining characteristics.  If NBFCs offer financial services that have the defining characteristics then they would be regulated differently from the other NBFCs.  The characteristics (‘qualifying asset’) that define microfinance according to the announced regulations are

a.The credit services should be offered to small income households (Rs 60000 – USD1350 per annum in Rural centres and Rs 120000 – USD 2700 in urban and semi-urban centres)

b.The loans amounts should be small (not exceeding Rs 35000 – USD 790 in the first cycle of loans and Rs 50000 – USD 1125 in the second and subsequent cycle of loans) and without collateral

c.MFIs should be concerned about excessive debt at the borrowers hands ( the absolute ceiling level of debt per borrower fixed at Rs 50000 – USD 1125)

d.Loan service should be reasonably within the capacity of the borrower (with large loans exceeding Rs 15000 having a minimum repayment period of 24 months)

e.Not less than 75% of the total amount of loans given should be for the purpose of income generation

f. Not less than 85% of total assets of the NBFC should be in the nature of qualifying assets and

g. The repayment intervals – weekly, fortnightly or monthly – would be at the choice of the borrower

The NBFC-MFIs have the following obligations to meet

1. The microfinance loans having the characteristics described above should not be less than a prescribed percentage – the percentage itself is not specified and is likely to be announced as part of the detailed guidelines to be issued

2. Ensure that the loans are not priced above 26% and the margin does not exceed 12%.

3. Determine that the indebtedness of the borrower does not exceed Rs 50000.

4. Get their books and operations audited for a certification that (i) 85% of total assets of the MFI are in the nature of “qualifying assets’’, (ii) the aggregate amount of loan, extended for income generation activity, is not less than 75% of the total loans given by the MFIs, and (iii) pricing guidelines are followed.

If NBFC-MFIs conform to these guidelines, then the loans given to them by banks would be reckoned as part of Priority Sector Lending.

While the broad framework of the Malegam Committee has been accepted, there have been several departures that had perhaps become necessary as a result of valid issues brought forward in several consultations.  The table provides a comparison of the recommendations of the Malegam Committee and the decisions taken thereon.

Implications

The changes would not significantly alter the client acquisition policies as the household income range is sufficiently large.  For the first time in about 15 years, RBI has come out with interest rate restrictions, which were gradually dismantled post –reforms of the financial sector. The interest cap in absolute terms is bound introduce rigidities; with the interest rates in the market for other financial instruments being free and changing in response to demand, supply and relative risks, MFIs would be unable to pass on increased finance costs to their borrowers.  RBI has specified in the detailed guidelines that the interest rate of cap of 26% is to be calculated on a reducing balance basis to ensure that the variability in installments do not increase the real rates. The margin cap on the other hand is dynamic, and the clarity on how it is to be calculated is useful. The ceiling of loans at Rs 50000 provides space for MFIs to operate and retain customers for a few years. The ceiling is also in line with the limits proposed in the previous version of Microfinance Bill.  The service charge will impede transparency in pricing and introduce a tendency on the part of MFIs to offer very short term loans of less than a year and improve revenues through multiple service charge collection within a year.

MFIs would be hard put to assess the indebtedness level as the same is not defined.  If loans from non-MFI sources is to be reckoned it is likely to be a herculean task, given the prevalence of high levels of informal debt.  NBFCs bulk-lending to MFIs will suffer as a result of the denial of priority sector benefits to banks for their loans to such NBFCs. Their cost of funds is likely to increase as a result.  With a ceiling of 26% on their loans, MFIs are unlikely to borrow at high costs from bulk lenders.

Conclusion

The enforcement and monitoring of compliance for the present is left to the Chartered Accountants, who would certify three key aspects as to the nature of loans provided by MFIs.  But the detailed guidelines to follow would possibly outline the regulatory practice. The modifications to Malegam recommendations reflect a large measure of pragmatism in dealing with the issues on the part of RBI.  The detailed guidelines will be eagerly awaited to examine whether those aspects on which there is no comment in the monetary policy, have been dealt with.  There could also be some apprehensions about the ‘devils in the detail’.    These regulations would still be irrelevant to those MFIs not in the company form.   As they would continue to be unregulated, banks may not be interested to provide them funds.  Even if the banks want to provide loans to such MFIs, the same might not be eligible for priority sector benefits.

The proposed guidelines mark for the first time customer protection is taken as a basis for regulation of credit-only institutions.  There is almost no prudential aspect of MFIs covered in the policy. The AP microfinance legislation helped in easing the process of acceptance of the responsibility for customer protection based regulation of microfinance by RBI.  To a significant extent these guidelines are likely to be adopted by the proposed central legislation.  The legitimacy now afforded to the sector will hopefully keep other state governments from introducing legislation to regulate MFIs.  The MFIs have to start performing socially and make full use of the opportunity given now.  The pity is that the acceptance of regulatory responsibility for borrowing customers comes from the graveyard of some MFIs that are unlikely to survive. The situation in AP has perhaps gone beyond redemption and this regulatory effort comes a bit late in the day for microfinance sector in AP.  With recoveries at around 10 to 15%, MFIs with significant exposures in AP are unlikely to survive.    Even the restructured debt of such institutions will only soften the blow on banks, which now will be in a position to write off the NPAs over a longer period.  With declining recovery rates from the SHGs and the resultant reluctance of banks to expand the exposure, the poor households of AP will take much longer to rediscover the easy access to credit that they enjoyed prior to October 2010.   The learning curve thus far has been steep.  The sector will continue to pay a price for both delayed appropriate regulation and precipitate inappropriate regulation.