India’s microfinance industry has grown 10 per cent to Rs2.54 trillion in the March quarter over December quarter. The year-on-year growth has been 8.4 per cent. This is good news. The better news is that the Reserve Bank of India (RBI) proposes to radically change the regulations for the industry.
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 micro loans, the NBFC-MFIs. This was done in December 2011, based on the recommendations of a committee headed by revered chartered accountant Y H Malegam. A decade later, the RBI is set to change the rules of the game.
The NBFC-MFIs no longer dominate the microfinance turf. Even though there are 86 NBFC-MFIs among 197 micro lenders, their share in the outstanding loan portfolio is less than 31 per cent in contrast to commercial banks, which have 41 per cent share. But when it comes to loans, the share of banks and NBFC-MFIs is almost equal at little over 35 per cent.
Clearly, 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 per cent of their loan portfolio must consist of such micro loans against which borrowers don’t need to offer any collateral. The household income of a rural borrower should not exceed Rs1.25 lakh and of urban borrower, Rs2 lakh. The loan amount is capped at Rs75,000 for the first cycle; it can be raised to Rs1,25,000 subsequently. But such rules are only meant for NBFC-MFIs; banks are free from such shackles.
Also, for the NBFC-MFIs, both the pricing of the loan and processing fees are regulated. The relatively large NBFC-MFIs can charge their borrowers either a 10 percentage points spread over their average cost of funds or 2.75 times the average of five banks’ base rate — whichever is lower. Banks, however, are free to set their loan rates.
Essentially, there is no level playing field. The RBI is planning to address this through a new set of regulations. What are they?
# The limit that not more than two NBFC-MFIs can lend to one borrower is being waived. It’s not the number of lenders but the amount one can borrow that’s important now. The focus is being shifted from who is lending and how much to the capacity of the borrower to repay the debt. All lenders will be clubbed together; the total indebtedness of a borrower will be linked to the capacity to pay.
# The deciding factor will be the debt-income ratio. The payment of interest and principal for all outstanding loans by a borrower is capped at 50 per cent of the household income, at any given point of time. The lenders will need to assess the household income with diligence and must have a board-approved policy on factors to be considered for assessing this income.
# With this, the limit on loan amount and minimum tenure of loans, currently applicable to only NBFC-MFI, will cease to exist. If a family is capable of servicing higher debt, an NBFC-MFI will be able to offer that.
# The collateral-free nature of the micro loans remains but this is being extended to banks as well; they cannot demand collateral for micro loans. All lenders should allow the borrowers to pre-pay loans without any penalty; they must have a board-approved policy to offer flexibility of repayment schedule for the convenience of the borrowers.
# The so-called Section 8 or not-for-profit companies, which have been in the business of micro lending and have a relatively large loan book (say, Rs100 crore and more), will be treated the same way as the NBFC-MFIs. They will require Rs5 crore capital. Around 80 per cent of Section 8 companies have less than Rs100-crore loan book.
# 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 (again, applicable to only NBFC-MFIs). The wall between income-generating and consumption loans is being pulled down. The lenders can give loans for education, medical expenses, household assets, consumption and even repayment of high-cost loans taken from money lenders.
# Finally, 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.
This has huge implications. Even though banks have access to cheap money in the form of deposits, they charge relatively high rates as the NBFC-MFI loan rates serve as the benchmark. For instance, if an NBFC-MFI charges 21 per cent from its borrowers, a bank can rush and grab the borrowers, offering 19 per cent. That’s cheaper than what an NBFC-MFI is charging but a bank’s cost of funds is far less than that of NBFC-MFIs.
Once it is left to the market, competition will decide the loan rates. Large NBFC-MFIs, with better liability-management capability, may bring down the loan rates. If that happens, banks will be forced to pare their rates. More importantly, the NBFC-MFIs will not be required to offer the same loan rate to all borrowers, irrespective of their business models and capacity to pay. Like the banks, they will be able to charge different rates to borrowers even in the same geography, based on the credit ratings of the customers.
What’s the net result of a uniform regulation of NBFC-MFIs and banks, and allowing the market to decide on interest rates? The micro loan industry will expand in new geographies and bring in new borrowers under its umbrella.
Over the past few years, a few banks have been fishing in the same pond, exploiting the regulatory loopholes. That’s lazy banking. The game of flooding the borrowers with more debt than what they can service will stop. All lenders will have to look for new pastures to grow. The new norms, when in place, will usher in a new era for microfinance.
This column first appeared in Business Standard.
The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd
His latest book: Pandemonium: The Great Indian Banking Story