RBI panel had warned of MFI issues

Two months before the microfinance sector crisis in October, an internal committee of the Reserve Bank of India (RBI) had warned of possible problems in the sector.

The report, finalised in July-August, had recommended that RBI withdraw priority sector status to microfinance institutions (MFIs) for bank loans if they fail to bring down interest rates. But before the regulator could act on the report, the sector was mired in crisis.

All MFIs do not come under RBI’s purview. It regulates only those registered as non-banking finance companies. Although they form only a small number of MFIs, they account for 80 per cent of the microfinance business.

The committee, which was constituted under RBI Executive Director V K Sharma, had also recommended that banks extend 40 per cent of their total lending to the priority sector.

MFIs raise 75-80 per cent of their borrowings from banks, 15 per cent from equity and another 10 per cent from other sources like cash securities. Interest rates charged by MFIs can be as high as 32 per cent, though most have started cutting rates after the recent controversy.

The panel report, which has not been made public by RBI, questioned the business model of MFIs and highlighted the need for a complete revamp. It was pointed out that unsecured loans for unproductive purposes could lead to larger problems.
 

EARLY SIGNAL

* Panel was constituted under Exec Director V K Sharma 

* Suggested no priority sector status if interest rates not cut 

* Questioned business model, highlighted need for revamp

RBI has since set up a committee to examine the issue of high interest rates, coercive recovery tactics and multiple lending practices by MFIs. The committee, headed by Y H Malegam, a senior member on RBI’s board of directors, will submit its report in three months.

The Malegam committee was set up after the Andhra Pradesh government promulgated the Micro Finance Institutions (Regulation of Money Lending) Ordinance, 2010, on October 15. The ordinance directed the compulsory registration of MFIs and barred weekly collection of dues. Following the move, banks became hesitant to lend to MFIs.