The MFI Industry in India — from Micro to Macro?

The operating style of many microfinance institutions (MFIs) in India has been criticised by several eminent policy makers. MFIs provide small loans to the poor who do not qualify for traditional banking credit, help lift them out of poverty and spur entrepreneurship. Rash and faulty practices both on part of the lenders and borrowers in the industry have now led to borrowers defaulting on payments and taking their lives and banks ceasing to lend to the cash-strapped micro-loan companies. Collections by MFIs in Andhra Pradesh had deteriorated considerably and there were some incipient signs of contagion spreading to other States. To deal with the problem, the RBI has temporarily relaxed provisioning norms to enable banks to continue lending to the cash-strapped MFIs. Banks can now restructure loans extended to MFIs even if they are not fully secured; bank loans to MFIs were mostly unsecured but to avail of the regulatory asset classification benefits under the present restructuring guidelines of the RBI, the accounts had to be fully secured. As a special case, banks need not for now classify such loans as non-performing assets (NPAs).

The RBI also constituted a committee, headed by Y H Malegam, to look into issues facing the microfinance sector in order to bring about long term and structural changes in the functioning of MFIs. According to the committee report the players in the Microfinance sector fall under three main groups: The (Self help Group) SHG-Bank linkage model (pioneered by NABARD) accounting for about 58% of the outstanding loan portfolio; Non-Banking Finance Companies (NBFCs) accounting for about 34% of the outstanding loan portfolio, which encourage villagers to form Joint Liability Groups (JLG) and give loans that are jointly and severally guaranteed by the other members of the group, and Others including trusts, societies, etc, accounting for the balance 8% of the outstanding loan portfolio. All NBFCs are currently regulated by RBI (under Chapters III-B, III-C and V of the Reserve Bank of India Act). There is, however, no separate category created for NBFCs operating in the Microfinance sector, which is required as the borrowers in the microfinance sector represent a particularly vulnerable section of society lacking individual bargaining power, financial literacy and the ability to absorb external shocks The need for regulation is also strengthened because over 75% of the finance obtained by NBFCs operating in this sector is provided by banks and financial institutions including SIDBI. As at 31st March 2010, the aggregate amount outstanding in respect of loans granted by banks and SIDBI to NBFCs operating in the Microfinance sector amounted to Rs.13,800 crores. In addition, banks were holding securitized paper issued by NBFCs for an amount of Rs.4200 crores. Banks and FIs (including SIDBI) also had made investments in the equity of such NBFCs.

Many NBFCs in this sector started off as non-profit entities providing micro-credit and other services to the poor however, as they found themselves unable to raise adequate resources for a rapid growth of the activity, they converted themselves into for-profit NBFCs. Others entered the field directly as for-profit NBFCs seeing this as a viable business proposition. Significant amounts of private equity funds have consequently been attracted to this sector. As there have been accusations of MFIs charging unreasonable fees and using loan sharks to collect outstanding payments, the Malegam panel has proposed a cap of 24% on the interest charged and an upper limit of 25,000 Rupees ($549; £344) on individual loans (as well as the aggregate value of all outstanding loans of an individual borrower). It 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 It also proposed a transparency in charges, with an MFI allowed to levy only three charges - processing fee, interest and insurance charge. Further, NBFCs operating in the Microfinance sector not only compete amongst themselves but also directly compete with the SHG-Bank Linkage Programme. The 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 borrower can be a member of only one self-help group or a joint liability group; not more than two MFIs can lend to a single borrower; there should be a minimum period of moratorium between the disbursement of loan and the commencement of recovery; the tenure of the loan must vary with its amount; a credit information bureau has to be established; the primary responsibility for avoidance of coercive methods of recovery must lie with the MFI and its management; and the RBI must prepare a draft customer protection code to be adopted by all MFIs. As there may be a need to give special facilities or dispensation to NBFCs operating in this sector, a separate category of NBFCs for microfinance institutions is suggested, defined as “A company (other than a company licensed under Section 25 of the Companies Act, 1956) 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 conforms to the regulations specified in that behalf”. The committee also recommends that bank advances to MFIs shall continue to enjoy “priority sector lending” status. However, advances to MFIs which do not comply with the regulation should be denied “priority sector lending” status. While the committee guidlines are overall well balanced in favour of both borrower and lender, certain recommendations raise additional challenges in terms of both compliance and operations and may phase-out smaller MFIs. For example, the ascertaining of family income and that a lender borrows from not more than two sources would be very difficult in reality. For the borrowers, a Rs.25,000 limit may not be enough in certain circumstances to pull a family out of poverty and make the borrower credit worthy in future. Insistence on loans being made primarily for income-generating activities may, again defy the very purpose of microfinance. Currently an MFI being a NBFC is required to have a minimum capital of Rs.2 crores, the suggestion that for a NBFC MFI this should be increased to a minimum Net Worth of Rs.15 crores, if adopted would raise entry-barriers to the industry.