Capping growth

The regulatory intervention by the RBI has not gone beyond providing a basic legal framework for the functioning of MFIs.

in New Delhi

IN an attempt to control the unethical characteristics of microfinance institutions (MFI) in India, including coercive recovery, exorbitant interest rates and lack of transparency in lending, the Reserve Bank of India (RBI) introduced a set of regulatory guidelines on December 2, 2011. Also, a Bill, the Micro Finance Institutions (Development and Regulation Bill), 2012, is to be tabled in the current session of Parliament.

The RBI's intervention is the first step in the ongoing process of creating a sound legal framework for monitoring MFIs. However, the guidelines on interest rates provide ample space for MFIs to function as a profit-making sector which provides micro-credit to the poor at high interest rates. The deregulation of micro-credit lending rates by banks has also ensured that they lend to MFIs at high interest rates of 15 to 17 per cent. As MFIs are allowed a margin cap of 12 per cent and an interest rate cap of 26 per cent under the present RBI guidelines, the burden of high interest rates is passed on to the poor.

The RBI's creation of a new category, NBFC (non-banking financial company)-MFIs, is also aimed at boosting MFIs for profit instead of making them a model measure for poverty alleviation.

MFIs across the country are already demanding a revision of the interest rate cap of 26 per cent so as to be able to maintain a bigger margin of profits. The existing low levels of financial inclusion across the country only about 20 per cent of the 74,000 branches of banks are in rural areas compel people to approach MFIs.

The high interest rates allowed to MFIs is a continuation of the post-liberalisation trend of banks shifting their focus from social and developmental goals to garnering profits. This was evident in the complete deregulation of interest rates on micro-credit by the RBI in its Monetary and Credit Policy of 1999-2000.

The RBI's present move, while attempting to regulate the interest charged by MFIs, does not put a cap on the micro-credit lending rates by banks. The regulatory framework imposes a maximum household income limit of Rs.60,000 a year in rural areas and Rs.1,20,000 a year in urban areas for availing micro-credit. At least 85 per cent of the loans disbursed by the banks will have to meet this criteria.

The Andhra Pradesh model

In the wake of reports of coercive recovery practices and interest rates as high as 60.5 per cent by MFIs, the Andhra Pradesh government got the Andhra Pradesh Microfinance (Regulation of Money-lending) Act passed in 2010. The Act prevented coercive recovery practices by MFIs in rural areas. The MFIs were asked to switch from weekly recovery to monthly recovery. The Act also mandated that MFIs be registered with the district authority to collect instalments at the panchayat office and fresh lending not be made without the approval of the authority.

A subcommittee of the Central Board of Directors of the RBI was constituted in 2010 under the chairmanship of Y.H. Malegam to study the concerns of the MFI sector. The RBI accepted the broad framework of the regulations submitted by the committee and came out with the December 2 directive for MFIs.

All NBFC-MFIs are required to maintain a margin cap of 12 per cent and an interest cap of 26 per cent. This means that MFIs cannot charge more than 12 per cent above the rate at which they borrow from the banks, subject to the cap of 26 per cent. All new NBFC-MFIs are required to maintain a capital adequacy ratio of not less than 15 per cent of their aggregate risk-weighted assets. Capital adequacy ratio determines the bank's capacity to meet credit and operational risks.

An NBFC-MFI is required to possess a minimum net-owned fund of Rs.5 crore. For NBFC-MFIs registered in the north-eastern region, the net-owned fund requirement is relaxed to Rs.2 crore.

At present, 36 NBFC-MFIs are registered with the RBI, as per information provided by the Ministry of Finance. The RBI guidelines extend only to NBFC-MFIs and not to MFIs registered as Section 25 companies.

Matthew Titus, executive director of Sadhan, an association of 250 non-governmental organisations (NGOs), MFIs and other community development finance institutions engaged in microfinance, welcomed the move to have a regulatory framework, but hoped that the RBI would reconsider the margin cap and interest rate cap as the lending rates of banks are not capped.

Change in approach to banking

The focus on MFIs as profit-making ventures needs to be seen in the context of allowing the entry of private players into the credit sector instead of expanding the services of public financial institutions in rural areas. The government has also not adequately explored alternative models of credit such as direct lending by banks to self-help groups (SHGs), which considerably reduces the rate of interest.

Speaking to Frontline, R. Ramakumar, an associate professor with the Tata Institute of Social Sciences in Mumbai, explained: The government and the RBI have wilfully promoted a policy direction in the last 10-15 years whereby private players are allowed to engage in micro-credit. In 1999, the RBI, in its Monetary and Credit Policy, deregulated all interest rates on micro-credit. The absence of regulation and the freedom given to private players allowed MFIs to charge exorbitant rates of interest. The present RBI guidelines still allows an interest rate cap of 26 per cent, while you can get a home loan or a car loan at 9 per cent or 11 per cent.

Ramakumar explained how the present guidelines benefit banks instead of the poor: The lending rates of banks are not capped while lending to MFIs is classified as priority sector lending. As a result, the banks are lending to MFIs at high interest rates of 15-17 per cent while fulfilling their priority sector lending commitments on paper. There is no evidence to show that MFIs have led to any significant levels of poverty alleviation in India. Direct lending by banks to SHGs at lower interest rates would be a much better model of lending. The Kudumbashree scheme of the Kerala government is a case in point. The RBI guidelines are an extension of a policy-induced focus on profitability in the banking sector.

The Kudumbashree scheme follows the bank-SHG model of lending whereby banks lend to SHGs at 11-13 per cent and the SHGs lend to borrowers at a minimal interest rate of 6-7 per cent. The government introduces a viability gap funding or subsidy to fill this gap.

Speaking to Frontline, All India Democratic Women's Association (AIDWA) general secretary Sudha Sundararaman said that government policy favoured MFIs instead of strengthening the model of banks lending directly to SHGs.

The linkages between banks and SHGs need to be strengthened so that SHGs are able to avail themselves of loans directly from banks, and poor women customers can be given loans at interest rates as low as 4 per cent. We feel MFIs are taking advantage of this position, with the banks lending to them being identified as priority sector lending. The RBI guidelines continue to allow them a high interest rate of 26 per cent and these high rates are passed on to the women borrowers. In 2009-10, the amount of loans given to MFIs by public-sector banks has more than doubled to about Rs.862 crore. There has not been as much direct lending to the SHGs. Bank lending to NBFC-MFIs should not be categorised as priority sector lending. AIDWA had submitted a memorandum to the RBI in November last year demanding the strengthening of the links between banks and SHGs, and a uniform regulatory framework for all MFIs.

The actual beneficiaries of MFI credit should be the poor. If MFIs claim to represent the poor, they should not be complaining about an interest rate cap of 26 per cent, said Dr Amiya Sharma, an executive director with the Rashtriya Grameen Vikas Nidhi, a development support organisation working in eastern and north-eastern India.

Usurious rates

The major criticism against MFIs is the usurious interest rates they charge. Though the RBI has set the interest rates of NBFC-MFIs at 26 per cent, the rates at which banks have been lending to MFIs have not been regulated. In the past one year, the rates at which public-sector banks lend to MFIs have gone up from an average of about 10-11 per cent to 15-17 per cent at present.

The RBI's steps to rein in interest rates have come in only after they assumed exorbitant proportions as a result of the volatile market forces. Competition among private players, in this instance, did not bring down interest rates for credit available to the poor, as the demand was much larger than the supply, with limited formal financial products available to the poor in rural areas.

The interest rate cap was introduced by the RBI with a view to prevent MFIs from charging exorbitant interest rates. However, without a subsequent regulation of the lending rates by banks and proactive measures to improve financial inclusion, the RBI has only allowed banks to lend to MFIs at high interest rates.

Further, the present guidelines allow a margin cap of 12 per cent, which essentially means that a high interest rate of 26 per cent is passed on to the borrower. Even then, MFIs are not happy with the present interest rates and margin cap. They essentially look at the MFI model as a business model for profitability and think of the exercise of providing micro-credit in terms of their operating costs.

Speaking to Frontline, Sarat Chandra Das, an executive with Grameen Sahara, a microfinance company that has been in operation since 2007 primarily in Assam, said: With the capital adequacy norms and the margin cap of 12 per cent, the interest earned on lending rates has decreased while the interest on borrowing rates from banks has increased.

The level of financial penetration in the north-eastern region is already low, and these guidelines are further decreasing the availability of cheap credit to the poor from the MFIs. Though the minimum capital requirements have been relaxed in the north-eastern region, there is still a requirement for minimum net-owned funds worth Rs.2 crore for an MFI. The minimum requirements are pushing out smaller MFIs that operate in remote areas. At present, there are only four registered NBFC-MFIs in the north-eastern region North-Eastern Regions Financial Services Limited, Rashtriya Grameen Vikas Nidhi, Asomi Finance Limited and Unaco Finance Limited.

Amiya Sharma stressed the need for more proactive intervention by the state to drive down the interest rates and make cheap credit available. He said, The government can introduce viability gap funding to bridge the gap between the lending rates of banks and the borrowing rates of MFIs. This is a case of regulation without a comprehensive understanding of how the sector works and who all are dependent on the sector. The MFIs cannot expect to make profits comparable to commercial banks; for them to be able to cover operating costs and make a small margin, the government could have stepped in. The increasing growth of commercial banks after 1991 has led to the neglect of the social objective of banks. The regional rural banks (RRBs) have also not been very successful in attaining the goal of financial inclusion.

Ramakant Patel, a field executive with Bharatiya Samruddhi Finance Limited, a microfinance company with operations in Madhya Pradesh, Maharashtra and Andhra Pradesh, who has worked in Satna and Hoshangabad districts of Madhya Pradesh for three years, explained, While the growth of MFIs has been stalled by low profit margins, local moneylenders continue to lend at rates as high as 100-150 per cent interest per annum. Also, MFIs complain that the imposition of a uniform interest rate across the country does not take into account the region-wise differences in the operating costs of MFIs.

A senior executive with Sadhan noted, In the north-eastern region, Uttarakhand and the remote areas of Madhya Pradesh and Chhattisgarh, the operating costs of MFIs are much higher on account of accessibility issues. With a margin cap and an interest rate cap, the government is making it difficult for MFIs to start operations in regions where their services are most needed.

Income limit

The RBI norms regarding the maximum household income limit the possibilities of a sustainable improvement in the livelihoods of the poor. The potential of microfinance institutions to alleviate poverty through creation of sustainable livelihoods is defeated when a cap is placed on the maximum household income.

Ramakant Patel explained, The limit means that we can't give a loan if the income level of the customer improves marginally. This provision especially hurts entrepreneurs in rural areas. If a customer avails himself of a loan to start off a business and his income improves, he might want to take another loan to boost his business. This provision will only push people back to a state of poverty. Even for someone whose income is slightly above the cap, there are requirements for cheap credit for health, education, and so on.

He pointed out the bureaucratic hurdles in obtaining an income certificate. At the village level, you have to approach the block office or the zilla panchayat for an income certificate to prove your household income. This increases the hassles involved in obtaining a loan.

Ramakumar, though unconvinced about the utility of the MFI as a model for creating sustainable livelihoods, felt that the maximum household income limit imposed by the RBI was bizarre. How do you fix a maximum household income limit to determine who deserves credit? There is no rationale behind this.

Amiya Sharma stressed that setting a uniform income limit across the country was problematic. The social standing of someone earning Rs.1,20,000 per annum in Delhi might be very different from that of someone earning the same amount in Assam. How can there be a uniform yardstick across States for determining creditworthiness?

Enlightened' regulation

In addition to reining in private players providing basic financial services to the poor in rural India and preventing them from functioning merely as a lucrative business model, the state has to intervene proactively to evolve methods of reaching out to the poor in need of credit. But as of now, regulatory intervention by the RBI has not gone beyond providing a basic legal framework for the functioning of MFIs. It could explore alternative models that establish a more direct relationship between public-sector banks and the poor.