March 14, 2022, is a red letter day for the Indian microfinance industry. The new regulations for microfinance are a real shot in the arm for financial inclusion in the world’s sixth largest economy that’s fighting hard for poverty alleviation.

The new norms, to come into play from April, will create a level playing field for banks and other financial intermediaries on the microfinance turf; intensify competition by freeing interest rates; and help expand the coverage to include millions more who don’t have access to formal financial channels as yet.

Before we peer through a periscope to get a feel for the new microfinance landscape, here’s a snapshot of the industry: In December 2021, the outstanding micro loan portfolio was a little over Rs2.56 trillion. Of this, banks’ share was close to 1.04 trillion, followed by non-banking financial companies-micro finance institutions (NBFC-MFIs) at Rs87,444 crore and small finance banks (SFBs) at Rs42,847 crore. Pure play NBFCs and others made for the rest of the pie.

There were 257 million customers under NBFC-MFIs’ fold, followed by banks’ 227 million, SFBs’ 136 million, NBFCs’ 71 million and others’ 12 million. These add up to 703 million but there were 557 million “unique” customers, as many have taken loans from more than one lender.

The average size of a micro loan for banks was Rs37,449; for NBFC-MFIs, Rs34,000 and for SFBs, Rs31,511. For NBFCs and others, it was much less. The average size of a micro loan in the industry was Rs34,035.

Till now, the microfinance regulations – including interest rates, profile of borrowers and how many borrowers one can lend to — are applicable to the MFIs only, while banks are free from all shackles, leading to overleveraging and exploitation of customers in some cases. The activity-based (read: micro loans) regulations, as opposed to entity-based (read MFIs) ones, will address this anomaly.

What are the new regulations?

# Lenders are free to decide on interest rates but they need to follow a board-approved transparent policy. The Reserve Bank of India (RBI) will keep a close watch on this. Lenders of all hues will be able to charge differential interest rates, depending on the borrowers’ risk profile. Once the credit bureaus create the database, the group lending model may partially give way to individual lending. Even within a group, there will be competition among borrowers to raise their credit ratings as one can access cheaper loans with a better credit profile.

Currently, CRIF High Mark Credit Information Services Pvt Ltd and Equifax are exclusively focusing on micro lenders. Experian and TransUnion CIBIL Ltd also collect data from micro lenders. Incidentally, MFIs report the credit data of the borrowers daily to the agencies; banks do so monthly. Uniform reporting will help the lenders make better credit decisions.

## A family with an annual income of Rs3 lakh will be entitled to get micro loans to the extent it services them using half of the income. At Rs12,500 monthly instalment (that makes Rs1.5 lakh loan repayment), a family can get a loan of between Rs2.45 lakh and Rs3.45 lakh, assuming 18-20 per cent interest rate and two-three-year maturity of such loans.

## Lenders will now give loans for any purpose – education, health, wedding, et al. Till now, up to 50 per cent of loans are allowed for non-productive purposes but in reality 90 per cent are given for income-generation. This forces many borrowers to source money from loan sharks at exorbitant rates. At least partially, that practice will stop now.

## Till now, NBFC-MFIs must have 85 per cent unsecured loans in their portfolio. This is being brought down to 75 per cent to help them derisk their portfolio to some extent. But there is a catch. The current norm of 85 per cent is applicable to net assets, while the new norm of 75 per cent is in relation to overall assets, including cash, bank balance and investments. The real benefit will be much less than 10 percentage points.

On the other hand, NBFCs’ maximum exposure to micro loans is being raised from 10 per cent of total assets to 25 per cent. This will ensure more credit flow to this sector.

The challenge before the lenders will be assessment of household income and indebtedness, as authentic documentation is not available for these borrowers. Credit data such as self-help group (SHG) loans, crop loans, credit by cooperatives and not-for-profit entities is not shared with the credit bureau platforms fully. Unless the RBI ensures that the credit bureaus aggregate all industry data, household indebtedness will be subject to interpretation of different lenders.

There could also be a mad rush to capture the borrower before a household reaches the indebtedness threshold. Some impatient-to-grow lenders may rush to cash in on the loopholes from April 1 itself.

Treating all collateral-free loans as microfinance and non-insistence on a specific repayment period offers flexibility to MFIs to design new products and diversify the range in sync with the changing aspirations of their customers. This will ensure more credit flow to lifecycle needs like housing, water sanitation, renewable energy, education, etc.

There will be no penalty of prepayment of loans and recovery needs to be made at places mutually agreed upon by the borrowers and the lenders. Calling the borrowers before 9 am and after 6 pm is also banned.

All these will help deepen the market and discipline the errant lenders but the RBI must take a second look at a few issues of new regulations.

@ It has allowed the lenders to sell “non-credit” products with “full consent of the borrowers”. Some of the lenders have already been selling solar lights, pressure cookers, bicycles and such stuff and exploiting naïve customers. Now, they will go the whole hog as the RBI has legitimised it. Cross-sale of products barring credit insurance should be banned till a cooling off period of 90 days as borrowers have little choice but to buy them when these are sold along with the loans. This is exploitation of its worst kind.

@@ The interest rate calculation formula specified by the RBI will prevent lenders from enjoying huge margins and especially banks, which have low-cost deposits, will be discouraged from charging the same rate as the MFIs. But should insurance charges be included for pricing micro loans? Most of the customers in this segment are not insured and death rates are high. Inclusive of insurance charges, the interest rates will be high, which may not be politically palatable. The calculation of internal rate of return, or IRR, for a lender should exclude insurance though it should be mandatory to declare it.

@@@ India’s microfinance industry is at a crossroads now. The Covid pandemic has wreaked havoc and many of them have restructured between 10 and 30 per cent of loans; and gross bad loans could be in the range of 5-15 per cent. The micro, small and medium enterprises have got the benefit of the government’s Emergency Credit Line Guarantee Scheme but the MFI industry caters to very few of them. Reducing exposure to unsecured loans from 85 per cent to 75 per cent will be of little help. If the regulator wants to make the segment resilient, it should drop it to 60 per cent.

@@@ Finally, cash collections of micro loans run into thousands of crores a month. Shouldn’t the RBI look for a differential pricing for digital offerings? That will help speed up digitisation in this segment.

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