Keya Sarkar: A Bill that leaves a lot to be desired

OUT OF FOCUS

While the government has long been talking about the need to create a regulatory framework for the microfinance sector, it is only now that a draft microfinance Bill is ready and is slated to be tabled in the Budget session of Parliament.

The sector, which had been growing at a modest pace for over a decade, has seen a huge surge in interest from the commercial banks, thanks to lending to this sector qualifying as priority sector lending by commercial banks. In addition, there has been increasing interest from foreign venture funds and trust funds to invest in start-up microfinance companies. And then the fact that India's achievements have not equalled those of Bangladesh, which was in global focus thanks to Mohammad Yunus winning the Nobel this year, have all contributed to the government finally recognising the existence of microfinance as a service and the need to regulate it.

In order to appreciate what the government is seeking to do and how effective that may be, it would be worthwhile to understand the structure of the microfinance industry as it exists today. There are typically three types of microfinance organisations: NGO MFIs, cooperative MFIs and company MFIs, which may be either non-profit (Sec 25 companies) or for profit (in which case they would be regulated by the RBI and be categorised either as an NBFC or a bank).

In terms of size there would be over a 1,000 NGO MFIs, over 3,000 cooperative MFIs and only around 20-odd company MFIs. However, the company MFIs account for almost 80 per cent of the industry's (estimated at Rs 3,000 crore currently) loan outstanding. Strangely, the microfinance draft Bill completely ignores their existence and is applicable only to NGOs, societies and trusts which have formed self-help groups.

The apparent reason for the exclusion of company MFIs, which have so far been primarily responsible for the financial inclusion of many of the country's poor, is that they are already regulated by the RBI and therefore do not require fresh directives. But the truth is that while the RBI recognises nine different NBFC categories, the MFI category is not one of them. And there is no greater obstacle to the growth of an organisation or industry than not knowing which authority it is governed by.

Besides confusion over regulation, NBFC MFIs currently have to live with the fact that:

Under the RBI Act, NBFC guidelines specify an entry level capital requirement of Rs 2 crore, which is rather high for the purpose of starting an MFI. Eventually, as an MFI grows and develops a portfolio of, say, Rs 15 crore, it can have a capital of Rs 2 crore and maintain capital adequacy of 12 per cent, as required, but having Rs 2 crore at the outset is a problem.

RBI External Commercial Borrowings (2004) guidelines do not allow NBFC MFIs to take ECBs.

RBI's Business Correspondent guidelines (2006) do not permit NBFCs to become so;

FIPB guidelines (2001) for foreign equity in NBFCs engaged in microfinance require a minimum foreign capital of $500,000;

State Level Moneylenders' Acts apply in some states, with a cap on interest rates;

IRDA guidelines (2005) do not permit NBFCs to engage in micro-insurance;

SEBI guidelines for Venture Capital Funds do not allow investing the equity of NBFCs;

The proposed MF Act (2007) does not cover NBFCs, and so thrift services are being allowed only to NGOs under the new Act.

Instead of correcting the existing anomalies, if the new Bill becomes an Act and addresses only NGO MFIs and cooperative MFIs, to be regulated by Nabard, as the draft Bill suggests, it would be ignoring not only the largest players in the microfinance sector but negating the huge strides that these companies have made in efficiency in general and governance in particular.

I am reminded in this connection of what Deep Joshi, executive director, Pradan, one of India's most respected NGOs, had said about the rapid growth of NGO MFIs at a round table discussion on microfinance: "the image of the NGO is led by the exceptional few that are mission focused and strategic. The majority tends to take on current ideas and funding for current ideas often spawns new NGOs. Microfinance in that is the current flavour".

Like the NBFC proliferation of the 1980s, which finally led to the great scams of Harshad Mehta and C R Bhansali, if the government encourages the expansion of more NGO MFIs the next scam would be waiting to happen. And despite the best efforts of Nabard, for whom supervision would be a new role, microfinance bodies like NBFCs in the past would get a bad name. At stake of course are only a couple of million poor.