A New Era For Microfinance

Context: Over the past few years, some banks have been fishing in the same pond, exploiting the regulatory loopholes. That’s lazy banking. Now, all lenders will look for new pastures

An overview of the Microfinance industry in India

• India’s microfinance industry has grown 10% to Rs 2.54 trillion in the March quarter over December quarter.
• Following the Andhra Pradesh law in October 2010, which was put in place to curb the alleged excesses by the industry, the RBI set the stage for the entry of a new genre of financial intermediaries — the non-banking financial companies in the business of giving microloans, the NBFC-MFIs.
• This was done in December 2011, based on the recommendations of a committee headed by revered chartered accountant Y H Malegam.

Issues with the NBFC-MFI: NBFC-MFI’s are intimated by the presence of the banks

• No longer dominates the market: Even though there are 86 NBFC-MFIs among 197 micro-lenders, their share in the outstanding loan portfolio is less than 31%, in contrast to commercial banks, which have 41% share.
• Heightened regulations: For the NBFC-MFIs, both the pricing of the loan and processing fees are regulated.
  • Banks are more liberal in giving money to micro borrowers than the NBFC-MFIs. It’s a free market for banks, but the NBFC-MFIs are constrained by regulations.
  • Currently, no more than two NBFC-MFIs can lend to the same borrower, and at least 85% of their loan portfolio must consist of such microloans without any collaterals.

New regulations by the RBI: In order to create a level playing field between NBFC-MFIs and Banks.

• The limit that not more than two NBFC-MFIs can lend to one borrower is being waived.
• The deciding factor for indebtedness will be the debt-income ratio. The payment of interest and principal for all outstanding loans by a borrower is capped at 50% of the household income at any given point in time.
• The collateral-free nature of the microloans remains, but this is being extended to banks as well; they cannot demand collateral for microloans.
• The Section 8 or not-for-profit companies, which have been in the business of microlending and have a relatively large loan book (Rs 100 crore and more), will be treated the same way as the NBFC-MFIs.
• The RBI proposal is also in favour of doing away with the prevalent norm that 50 per cent of the loans must be for income generation, opening up avenues for education and other kinds of loans.
• The RBI wants to do away with the cap in loan rates. That will be left to the market. The NBFC-MFIs, like banks, will be allowed to fix the loan rates.

Implications of the above measures:

• Lowering of the interest rates: Since banks rates are often anchored upon the rates of the NBFC (despite them having low costs of funds), once the rates are left to the markets, competition will decide them.
• Financial inclusion: The microloan industry will expand in new geographies and bring in new borrowers under its umbrella.