India’s Microfinance Bill Answers Most Questions
The Government of India promised a new draft microfinance legislation, and it has delivered. The consultative process adopted, the work done by the Malegam Committee, and the regulations issued by the Reserve Bank of India (RBI) and the participation of the lenders, practitioners and others have made the draft comprehensive and well-rounded. The Andhra Pradesh statute, despite its debilitating impact on the sector, seems to have triggered this comprehensive response from the Union government. The need to regulate the microfinance sector in customers’ interest and also the need to avoid a multitude of microfinance legislation in different states has led to this bill which keeps registered microfinance institutions (MFIs) out of the ambit of money lending laws.
The chief features of the bill are that every institution in microfinance should register with the regulator, transform into a company when they attain a significant size, be subject to a variety of prudential and operational guidelines that are introduced by the regulator, provide periodic information to the regulator and face penal action for violation of law or any rules framed. The bill provides flexibility of RBI to apply different measures, vary the same and delegate the powers to regulate to NABARD.
The grievance redressal procedures, mandatory enrollment to credit bureaus and code of conduct enforcement through industry associations will improve customer protection. The creation of national and state councils should provide wider sector participation in policy making. The proposed microfinance fund that would not only provide grants but also bulk finance to MFIs is a very welcome proposition.
Requiring all institutions, regardless of form, to register as an MFI is a critical and necessary step toward effective regulation. The reason for excluding cooperative societies accepting deposits from members only from the definition of an MFI is not clear. There are MFIs which are cooperative in form that deal with members only. That does not make the members any better protected. If the cornerstone of the bill is customer protection, it should be extended to cooperative MFIs as well.
National versus state level supervision
While the proposal to set up a strong advisory council at the national level is welcome, the council should be vested with a role in regulation and supervision. It should be asked to consider periodic reports prepared by the regulator on the state of practice in the sector and compliance with regulation by the institutions. In addition to other functions described in the bill, the council could perform the functions that Board of Supervision¹ performs in respect of banks. The State councils are a good way of involving the state governments. But the councils should be linked to the national council and given a role with content rather than just creating them. Without a significant role and participation in some manner in the activities of the national council, the state councils will become either defunct or deviant. The proposal for appointment of an ombudsman is a welcome measure and will boost the industry’s own effort to handle grievances better.
The step of keeping MFIs outside the purview of money lending is a forward looking step that would improve availability of financial services in the hinterland. Officials in AP have taken exception to a particular provision in the draft bill that seeks to keep MFIs outside money lending law. This is nothing new, as banks regulated by the Banking Regulation Act are kept outside the purview of state jurisdiction. Only when the institutions are unregulated and the practice is exploitative and coercive that the States’ powers under money lending Act become enforceable. The bill introduces regulation relating to form, business, processes, products, pricing and provides a high degree of flexibility to RBI to adopt measures to enforce customer protection practices of a kind not seen in banking regulation.
The requirement of systemically important MFIs to become companies should be strengthened by taking away the option to transform in to a not for profit company under section 25 of companies Act. The existing regulatory framework of RBI is lenient towards section 25 companies; in fact there is no regulatory effort spent on such companies. When MFIs become systemically important they should be actively regulated.
Pricing and interest rates
Sections 23 and 24 of the proposed bill contain the substance of RBI’s regulatory powers. The powers of RBI to issue directions under section 24 are comprehensive and cover almost all aspects of functioning of the MFIs. For the first time the concept of APR is used in the industry to demystify the pricing of loans. While there seems to be a provision for recognition of Self-Regulatory Organization of MFIs, the process of recognition has not been spelt out. The industry associations have a critical role to play in assisting the regulators. In section 25, the bill has chosen to implement margin caps rather than interest rate caps. Absolute interest rate caps are anti-market and introduce rigidities. However RBI has been given the powers to impose an APR cap. The specific mention of margin cap under section 25 leads one to believe that the margin cap will be imposed across the sector and the APR cap will be used only in exigencies.
An interesting insertion is the possibility of RBI refinance to MFIs. The proposed Microfinance Development Fund is intended to provide loans, refinance, grants, capital and any other form of financial assistance. The size of the fund and the RBIs stance on financing microfinance sector will be eagerly awaited. The refinance facility (whether offered by RBI or arranged through financial institutions) would be a significant step forward for the resource starved sector.
The bill proposes penalties for MFIs of a maximum of Rs 5 lakhs (almost $11,000) which seem paltry in comparison with the size of MFIs and the damage potential of ill-advised actions. There is a need to raise the maximum penalty and relate the same with the nature of violation of law or regulatory advice, and possibly made proportional to the size of the MFI. Section 38(1) facilitates RBI to delegate powers under the Act to NABARD. The wording is carefully done to offer flexibility to RBI to delegate powers in respect of select class of MFIs. This will ensure that regulatory load can be distributed between RBI and NABARD. SIDBI could have been brought on board and offered space in regulation. Perhaps the high level of its financial support to MF sector has restrained the government from including SIDBI on account of the potential for conflict of interest.
Post Andhra Pradesh
Section 42 should provide a sense of relief to the sector reeling from the aftermath of the State legislation on MFIs in Andhra Pradesh. The registration with RBI effectively protects MFIs from State Government action under money lending laws. This is a long overdue requirement for conduct of business in microfinance. States with competing microfinance programs kept themselves above law and influenced the governments to take action against other MFIs. The sector had been reduced to a state where microfinance became a hazardous business that had to be controlled to the point of extinction. The proposed bill restores the freedom of enterprises to run a business in financing vulnerable people, subject to reasonable regulations.
MFIs and deposits
The bill, without overtly saying so, hints at the possibility that MFIs will be permitted to mobilize thrift (small illiquid savings). If the regulations are introduced for this and MFIs permitted to mobilize thrift it would be an exciting development as it makes meaningful financial inclusion possible. The tough task of ensuring depositor protection remains unexplained. Whether the bill could have gone a step further and mandated coverage of MFI mobilized thrift under deposit insurance as is the case in some other countries?
The strong customer protection content reflects a significant change in stance on part of the government – that even borrowers are entitled to protection. The actual measures indicated in the proposed legislation mostly take in to account potential abuses in pricing, competition, and irresponsibility on the part of lender. The bill requires implementation and enforcement in some cases. The regulatory capacity has to be ramped up and the small and medium MFIs capacity to comply with regulation would also need to be beefed up. The bill is an important first step; several more steps in translating the bill to action are required before we reach a stage that restores the vitality of the sector.
Right now the bill is just a draft and needs to be passed by the Indian Parliament. More than a 100 million people are keeping their fingers firmly crossed.
– 2008,2009, and 2010 Also check out the Financial Inclusion Regulation Center’s India profile page for more information.
¹Set up by RBI in respect of commercial banks and financial institutions and NABARD in respect of cooperative banks and RRBs.
India’s Ministry of Finance released the much awaited draft microfinance bill which is to be introduced in the country’s parliament shortly. This post is the next in a short series of commentary on the bill by a variety of experts from the region on what the bill means for India and the global microfinance industry.
Srinivasan has given a very good objective comments on the Bill. Suggestions about bringing other form of MFIs like Coopoeratives (MACS),Section 25 Companies etc need to be brought under some sort of supervision and caps on interests may be looked into. Savings/thrift is an important financial inclusion service which can be and need be provided at the door step to the poor by MFIs,besides a cost reducing measure for MFIs. The Bill should address this problem looking to its importance and interest of poor as well as MFIs.
The bill still a draft, now placed for public comments. It will be moved in the parliament for being voted as law. This would take some more time.
Dealing with some unanswered questions by Indian’s MF bill
1. Customer’s protection
It appears that the main focus of the draft MF Development and Regulation Bill .is to give ‘customer protection’. It is therefore an imperative need first for clarity on the needs of the ‘customer of MFI and an appreciation on the distinction between the poor customer of MFI in particular on one hand and typical customer of financial institution .in general on the other. MF focuses on exclusive inclusion of excluded poor where as bank finance aims inclusion of all excluded. While the MFI customer requires more of nonfinancial input access besides financial ones for a sustainable impact , the others type of customer needs confines mostly financial access. While the institutional issues pertaining to the delivery of the financial services and the recovery of it are common to the both types of customers, the demand of most disadvantaged and vulnerable poor customers of MFI goes beyond in terms of non financial support services for achieving the declared purpose of such MF services – reduction of poverty. Perhaps the Bill may ensure protection the poor customers by and large from institutional issues such coercive recovery , over indebtedness etc., but it indicates only partial protection relating to financial transactions only which is inadequate to these unique poor customers. In this context , how to protect these poor clients from other external vulnerabilities which could influence over all performances of these financial services? Unless this aspect is adequately addressed in MF platform, the Bill facilitates only formalization of one more financial institution in the multi agency led rural financial landscape ‘also to run ‘ for the cause of the disadvantaged section.
2. ‘Income Recognition’ & ‘Income Generation’ .
It is stated in the Bill (Chapt.5.24. 1 ) that in the public interest RBI may give directions to MFIs relating to Income Recognition(IR) and Asset classification, Provision for bad & doubtful assets etc., based on risk weight for assets. These accounting standard norms are all no doubt vital tools for assessing and maintenance of ‘health status of Asset of any financial institution for that matter including MF institution concerned . Here one should not fail to perceive in MF arena the inherent unique phenomenon of correlation between the ‘Income Recognition’ at institutional level and the ‘Income Generation ‘ (IG)at poor customer level.. To go deep into the functioning of these asset related concepts , the correlation ship indicates that unless the asset (micro credit) is productively used at poor customer’s level for ‘ Income generation’ , it is bound to influence the performance of asset at institutional level in terms of poor recovery and have chain effect on ultimately on ‘Income Recognition. It is therefore imperative to make ‘provisions’ in terms of adequate non financial services for ensuring the productivity of the micro asset at client level first so that it will lead to sustainable income generation leading to good repayment and eventually facilitating for income recognition of asset etc., at institutional level. If non financial ‘provisions’ are appropriately taken care of for the functioning of micro asset at filed level , then there is no need for financial ‘provisions for bad and doubtful debts at institutional level.. This correlation factor between IR and IG assumes importance in the context of mandatory maintenance of 75% of total asset portfolio under IG activity as stipulated for NBFC-MFI(Malegam Committee). Hence this factor relating to adequate non financial; provisions to IG activities of the poor customers of MFI also deserve to be covered in customer protection’ umbrella.
3. Drop out customers of MFI-
When we discuss on the matters relating to customers protection, it is not of context to emphasize the need for giving protection to the drop out customers from MFI-SHG system (India’s largest officially recognized MF delivery conduit) for their ‘second’ inclusion and rejuvenation.(42% of SHGs reported drop out phenomenon-Srinivasan’s MF status report).While inclusion of the poor takes place ceremoniously and vociferously at one end , exclusion of the included poor client also happens unceremoniously and silently at other end. . This is unfair! How does the MF Bill address this point from customer perspectives?
4.Intergrated MF services –
As per the Bill (Chapter 1.2.g) MF means one or more of following MF services viz., Micro credit, collection of thrift, remittance of fund, providing pension or insurance services and any other as may be specified. Only when all MF services are holistically provided to the poor clients by the financial institution , they only deserve to be called MFI. If it confines to micro credit service only (mostly ) it should be called Micro credit institution. Since all these services are required by the same cohort of customers for reaching ultimate social gaol, these MFIs need to be encouraged for extending integrated services covering all MF services singly or severally so long their targeted customers hail from different layers in the poverty pyramid. Integration of micro credit product with micro insurance should become mandatory as done in priority sector lending in formal banking sector.
5. Grievance re-dressal Mechanism (Chapter 8.3.c )
If the poor client brings grievances relating to access to non financial services like power, transport, marketing, farm inputs, required for their IG activities (financed by MFIs) , does this mechanism consider this grievances also?
6.State Advisory councils –(Chapter 3. 8. 2.)
For implementing and monitoring various policy initiatives, progress and development of MF sector activities with the best appreciation of micro level issues , it would be more ideal and useful to have a similar set up at district level taking advantage of exisiting coordination committees like DCC/BLBC already constituted ( by RBI under Lead Bank scheme) where all the participating financial players including insurance companies in MF activities along with the government development agencies. The agenda like ‘ Exchange of information on over due borrowers among the MF players’, ‘arrangement of non financial supporting services for various micro credit related activities’ by the government agencies ,Advocacy for integration of micro insurance services etc may facilitate for qualitative micro finance performance . It is a high time to focus more on MF activities in Lead Bank scheme, Service Area Approach and District Credit Plan to ensure an integrated approach all the players for development through credit and poverty reduction through Micro finance . On similar to the functioning of SLBC at state level, there should be a State level MF Committee (SLMFC) with a lead MFI for coordination
7.MicroFiance Development Fund(Bill. Chapter VI)-
As stated this fund is applied for provisioning loan, refinance, grant, seed capital etc., for MFIs, This fund would facilitate them for providing more financial activities only to their poor customers. In the context of recognition of non financial support services (as highlighted above in points 1, 2 and 5) , demanded for various IG activities of the poor , there is an imperative need to divert Rural Infrastructure Development Fund(RIDF) more exclusively for providing physical support services depending on the specific requirement of the service area of MFIs . This calls for formulation of Micro finance Plan (MFP)at district level taking cognizance of the potential for IG activities as indicated in Potential Linked Credit Plan (PLCP- prepared by NABARD) integration with District Credit Plan(DCP) of Banking system
In fine Micro finance and MF customers are unique from its own perspectives and the approach for customer protection in MF arena also need to unique making subtle difference from customer of other financial institutions.
Any policy initiatives for various activities of MF need to be looked into more from development perspectives for reaching the said goal rather than end up with regulatory aspects alone with mere institutional strengthening.