Back on the rails

The new microfinance rules should end the crisis

The Reserve Bank of India’s (RBI’s) regulations for microfinance institutions (MFIs) registered with it as non-banking finance companies – these make up most of the MFI space – have been largely welcomed by the sector. There are several reasons for this. One, there are now at least some rules to go by, good or bad — one of the main problems earlier was the absence of such rules. Two, the sector finds the regulations to be a considerable improvement on the Malegam committee’s original proposal. This indicates that the regulator is willing to listen to the practitioners, thereby adding meaning to the interactions that took place after the committee’s report was released. It also implies that the issues on which the sector continues to have doubts are likely to be addressed once the guidelines are put in place and the consequences become apparent. The industry has been plagued by enormous uncertainty ever since it imploded in Andhra Pradesh, so any kind of return to business as practicable, if not as usual, will give satisfaction. This is a matter of vital national concern since income capabilities of millions of poor people now depend on a well-functioning microfinance system.

The regulations have sought to address several key concerns: MFIs charge exorbitantly high interest rates; their ways of calculating interest rates and practices like taking security deposits result in a higher rate of interest than officially declared; and multiple lending leads to diversion of funds from income generation to consumption, paving the way for greater future indebtedness. By fixing an interest rate ceiling of 26 per cent, defining how the interest should be calculated, putting a 12 per cent ceiling on margin requirement and abolishing the practice of taking security deposits, the regulations have sought to address some of the concerns. While industry players do not have much to complain about the above, they are negative about the RBI allowing a repayment period of two years. An individual MFI loan cycle does not exceed a year and giving a longer repayment period creates the risk of the repayment amount being used for consumption. MFIs also need to discuss how the margin amount should be calculated.

In the light of these regulations, the Andhra Pradesh government needs to relook its regulations to determine whether they are onerous. There can be justification, in fact a necessity, for strict rules in the face of improper practices adopted by lenders but once lessons have been learnt, it is necessary to go by regulations that do not choke off lending entirely. At present, recoveries in the state are in the range of 10 to 15 per cent. If this persists, MFIs with large exposure in the state are unlikely to survive. Rescheduling loans from banks to MFIs in trouble can help but there is no light at the end of the tunnel if borrowers think they need not repay. If that happens, they will be the ultimate losers.