In June 2021, the Reserve Bank of India (RBI) published a “Consultative Document on Regulation of Microfinance”.
While the declared objective of this review is to promote the financial inclusion of the poor and competition among lenders, the likely impact of the recommendations is unfavourable to the poor.
If implemented, they will result in an expansion of microfinance lending by private financial institutions, in the provision of credit at high rates of interest to the poor, and in huge profits for private lenders.
While microfinance lending has been in place since the 1990s, what is different about the recent phase of growth of financial services is that the privately-owned for-profit financial agencies are “regulated entities”.
Microfinance: Crucial for rural households: with Tamil Nadu Case study:
Microfinance is becoming increasingly important in the loan portfolio of poorer rural households.
- In a study of two villages from southern Tamil Nadu, done by the Foundation for Agrarian Studies, we found that a little more than half of the total borrowing by households’ resident in these two villages was of unsecured or collateral-free loans from private financial agencies (SFBs, NBFCs, NBFC-MFIs and some private banks).
- There was a clear differentiation by caste and socio-economic class in terms of source and purpose of borrowing.
- First, unsecured microfinance loans from private financial agencies were of disproportionate significance to the poorest households to poor peasants and wage workers, to persons from the Scheduled Castes and Most Backward Classes.
- Second, these microfinance loans were rarely for productive activity and almost never for any group-based enterprise, but mainly for house improvement and meeting basic consumption needs.
- Our data showed that poor borrowers took microfinance loans, at reported rates of interest of 22% to 26% a year, to meet day-to-day expenses and costs of house repair. How does this compare with credit from public sector banks and cooperatives?
- Crop loans from Primary Agricultural Credit Societies (PACS) in Tamil Nadu had a nil or zero interest charge if repaid in eight months.
- Kisan credit card loans from banks were charged 4% per annum (9% with an interest subvention of 5%) if paid in 12 months (or a penalty rate of 11%).
- Other types of loans from scheduled commercial banks carried an interest rate of 9%-12% a year.
- As even the RBI now recognises, the rate of interest charged by private agencies on microfinance is the maximum permissible, a rate of interest that is a far cry from any notion of cheap credit.
The recommendations given in consultative document:
The consultative document recommends that:
- The current ceiling on rate of interest charged by non-banking finance company-microfinance institutions (NBFC-MFIs) or regulated private microfinance companies needs to be done away with, as it is biased against one lender (NBFC-MFIs) among the many (commercial banks, small finance banks, and NBFCs).
- It proposes that the rate of interest be determined by the governing board of each agency, and assumes that “competitive forces” will bring down interest rates.
- Not only has the RBI abandoned any initiative to expand low-cost credit through public sector commercial banks to the rural poor, the bulk of whom are rural women (as most loans are given to members of women’s groups).
- In addition, it also proposes to de-regulate the rate of interest charged by private microfinance agencies.
- According to current guidelines, the ‘maximum rate of interest rate charged by an NBFC-MFI shall be the lower of the following:
- The cost of funds plus a margin of 10% for larger MFIs (a loan portfolio of over ₹100 crore) and 12% for others; or
- The average base rate of the five largest commercial banks multiplied by 2.75’.
- In June 2021, the average base rate announced by the RBI was 7.98%. A quick look at the website of some Small Finance Banks (SFBs) and NBFC-MFIs showed that the “official” rate of interest on microfinance was between 22% and 26% — roughly three times the base rate.
How private financial institutions have grown exponentially?
- In the 1990s, microcredit was given by scheduled commercial banks either directly or via non-governmental organisations to women’s self-help groups, but given the lack of regulation and scope for high returns, several for-profit financial agencies such as NBFCs and MFIs emerged.
- By the mid-2000s, there were widespread accounts of the malpractices of MFIs and a crisis in some States such as Andhra Pradesh, arising out of a rapid and unregulated expansion of private for-profit micro-lending.
- The microfinance crisis of Andhra Pradesh led the RBI to review the matter, and based on the recommendations of the Malegam Committee, a new regulatory framework for NBFC-MFIs was introduced in December 2011.
- A few years later, the RBI permitted a new type of private lender, SFBs, with the objective of taking banking activities to the “unserved and underserved” sections of the population.
- Today, as the RBI’s consultative document notes, 31% of microfinance is provided by NBFC-MFIs, and another 19% by SFBs and 9% by NBFCs.
- These private financial institutions have grown exponentially over the last few years, garnering high profits, and at this pace, the current share of public sector banks in microfinance (the SHG-bank linked microcredit), of 41%, is likely to fall sharply.
- The proposals in the RBI’s consultative document will lead to a further privatisation of rural credit, reducing the share of direct and cheap credit from banks and leaving poor borrowers at the mercy of private financial agencies.
Maximum instances of NBFC-MFI’s not following RBI guidelines:
Contrary to the RBI guideline of “no recovery at the borrower’s residence”, collection was at the doorstep.
Note that a shift to digital transactions refers only to the sanction of a loan, as repayment is entirely in cash.
Many borrowers said the debt collector used bad language in a loud voice, shaming them in front of their neighbours.
If the borrower is unable to pay the instalment, other members of the group have to contribute, with the group leader taking responsibility.
In our survey, there was no organic connection of microfinance to any group activity or enterprise.
As an agent of a NBFC-MFI told us, “We have used the groups formed earlier for other activities solely to show that we lend to a group”.
RBI should encourage all institutions to monitor their impact on society by means of a ‘social impact scorecard’.
MFIs need to focus on creating a sustainable and scalable microfinance model with a mandate that is unequivocal about both economic and social good.
MFIs should ensure that the ‘stated purpose of the loan’ that is often asked from customers at the loan-application stage is verified at the end of the tenure of the loan.
The proposals of RBI’s consultative document is beyond comprehension at a time of widespread post-pandemic distress among the working poor.
The All-India Democratic Women’s Association, in its response to this document, has raised concerns about the implications for women borrowers and demanded that the rate of interest on microfinance not exceed 12% per annum.
To meet the credit needs of poorer households, we need a policy reversal: strengthening of public sector commercial banks and firm regulation of private entities.