Dual regulation is bad

MFI issues won't be solved by state regulation

One of the promises made by both major political parties in the recently concluded Assam legislative assembly elections was the waiver, in part or full, of the outstanding loans or remaining interest due to microfinance institutions (MFIs). The new cabinet of Chief Minister Himanta Biswa Sarma has moved swiftly to fulfil this promise, setting up a committee that is to report in a month on how to deal with the MFIs in the state. The previous government had already passed a Bill to regulate MFIs within Assam this January. In a meeting with stakeholders convened by the new government recently, representatives from the Reserve Bank of India (RBI) made their objections to the Bill known. The RBI’s objections are on solid grounds theoretically. It is not a good idea for state governments to get into the financial regulation game. Cooperative banks, also overseen by state-level regulators, had become the location for a great deal of mis-lending and fraud. The Banking Regulation Act was amended last July to strengthen regulation by the RBI as a consequence. MFIs should not be turned into new co-operatives. It is worth noting that the past mishandling of MFIs by state governments, particularly in undivided Andhra Pradesh, was the reason for the RBI’s guidelines on microfinance in the first place.

The Assam MFI legislation — the Assam Microfinance Institution (Regulation of Money Lending) Act — itself is more stringent than the RBI’s in several respects, ending for example the practice of doorstep collection and requiring collection to take place at public offices such as gram panchayat buildings. It places a cap on the total loan outstanding and the loan interest payable, and requires MFIs to register locally. The impact on the state’s credit culture is already being felt. Industry representatives have said that repayment rates in Assam have fallen to 50 per cent or so, down from the national average of over 90 per cent. Given the importance of microfinance to small entrepreneurs and distressed households, the likely outcome of this destruction of the credit culture — a denial of credit to large swathes of the state — would certainly be disastrous.

There is a right way and a wrong way to address the problems of MFIs in Assam. The state government should have raised the issues being faced by the borrowing public in the state with the regulator, and asked for appropriate regulatory changes. The onus would then have been upon the RBI to explain what it was doing to remedy the situation. Certainly, there are some serious complaints — for example, that the requirement that no MFI lend to someone with more than one existing loan is being widely breached. MFI over-selling needs to be curbed by the regulator. Had the Assam government made these points to the RBI, it would have been hard pressed to explain what it is doing to enforce its regulations. But creating a parallel regulatory structure is hardly the right solution, as it will either lead to regulatory arbitrage or reduce the outlay of MFI loans in the state. Nor should people be encouraged to default on their payments on the assumption that the government has their backing. The Assam government should reconsider its legislation, and the RBI must meet it halfway by explaining how it intends to take the problems raised by the public on board.