The draft Bill on microfinance regulation put out by the government has the virtue of being unambiguous. It seeks to put the Reserve Bank of India (RBI) unequivocally in charge of this sector and end the regulatory ambiguity that was exposed when the crisis in the sector blew up last year. This gap and crisis, which centred around Andhra Pradesh, prompted the state government to come up with its own regulation for the sector to contain the political fallout of suicides induced by coercive recovery practices. Those regulations were draconian and, if left to define the future regulation of the sector, would have seriously impaired its growth. Plus, there would have been total confusion if other states had followed suit and drafted their own regulatory frameworks. That would have been calamitous since microfinance is one of the key weapons, though not the only one, to fight poverty and every effort is needed to make it sustainable and self-financing. Recoveries by microfinance institutions (MFIs) in Andhra are down to 10 per cent and MFIs stand to lose Rs 7,000 crore or more. The Andhra model will mean the end of private finance and leave the sector to be funded only by the state government and banks via self-help groups.
Predictably, the Andhra government does not like the draft Bill and has highlighted the anomaly that while it seeks to keep the states from regulating the sector, they will nevertheless be left holding the baby when malpractices create crises like suicides. Also, the draft Bill seeks to limit the margins that MFIs will be able to earn when high costs and low margins can coexist with high interest rates. What is needed is a cap on interest rates, something that affect the borrower. The proposed law leaves most of the specifics to be spelt out by the RBI through its regulations. The regulations resulting from the Malegam committee’s recommendations reveal the RBI’s mind and these stipulate an interest rate ceiling. The problem with a cap is that it will push out of business small MFIs that don’t have scale to bring down costs. A few large players without fresh blood coming in can create unhealthy market conditions to the detriment of small borrowers.
Microfinance became exciting when it was realised that its business model had stabilised and could offer a return to private equity. But things went off the rails when private equity-funded MFIs, mostly concentrated in Andhra Pradesh, expanded their loan books too rapidly and chased recovery over-zealously, creating social distress. It is now clear that microfinance is neither wholly commerce nor wholly philanthropy. Social entrepreneurship should guide it, producing enough returns to attract social capital but not freely floating global capital. A cushion is needed to take care of the vulnerability of the poor (occasionally they will face distress and default). Those providing it can look for steady moderate returns over a long period and scope for additional returns from offering a range of financial services to the poor. The draft Bill includes remittance, pension and insurances services among microfinance activities. MFIs need to be driven along the right channels so that at some point the best and most stable among them can accept deposits, like Grameen Bank. The draft signals this by including thrift under the MFI menu.
