A new era for microfinancing: RBI has done its part, onus now on industry to redeem policy trust

The new RBI guidelines move regulation from a micro-business-rules approach to a principles-based one and plug regulatory gaps by making the framework applicable to all regulated entities

Various guidelines like target household income limit, loan limits, indebtedness level, and pricing caps applied only to NBFC-MFIs.

By Alok Misra

Global development literature is replete with the empirical correlation between access to finance (A2F) and inclusive development. A2F for low-income clients powers economic and social upside and leads to building an inclusive society where the rising tide truly lifts all boats. India’s development policy has always been predicated on this premise and microfinance has been the pillar of policy framework since the early 90s. A recent study by NCAER, commissioned by MFIN, found that microfinance in India contributes 2.03% to the Gross Value Added (GVA) and creates/sustains 12.8 million jobs per year. This is a humongous contribution in local level job creation, economic growth and associated benefits like social mobility and checking urban migration.

Microfinance has undergone significant changes in the last decade. Bandhan became a bank from NBFC-MFI, eight other NBFC-MFIs became small finance and mainstream banks, and NBFC also went downstream to the microfinance market. While these changes increased competition, the regulatory framework crafted in 2011 focused on NBFC-MFIs-created arbitrage among different legal entities. Why so? It is because the 2011 policy was formulated when NBFC-MFIs were almost the sole purveyors of microfinance. With the ecosystem changed, the regulations covered only 35% of the microfinance market. Various guidelines like target household income limit, loan limits, indebtedness level, and pricing caps applied only to NBFC-MFIs. This created a piquant situation as the end client being same, issues of excess leverage, and field discipline came to the fore.

Realising the potential of collateral spillover, the industry came together and formulated a Code for Responsible Lending (CRL) in 2018, which brought some basic discipline across lenders. It is credit-worthy that different lenders like banks and NBFCs voluntarily accepted to comply with CRL norms. However, as voluntary compliance has limits, with some players remaining out, hot spots like Assam continued to emerge. Thus, while CRL was a novel initiative by the microfinance sector to deal with the changed ecosystem, a regulatory review was due.

It was music to the ears when the RBI Governor announced in January 2021 that RBI will come out with a discussion paper on harmonised regulation for microfinance. This fructified on March 14, 2022, with the issue of harmonised guidelines applicable to all regulated entities (REs).The new regulatory framework crystallises the vision of RBI— client centricity and a level playing field. It is being hailed as path-breaking and will usher in a new chapter for financial inclusion in the country. First, it plugs regulatory gaps by making applicable the framework on all REs. Regulatory unity across diverse legal forms, be it banks , NBFCs, or NBFC-MFIs, underscores the focus on clients and moves the sector towards “asset class”-based regulation over “legal form”-based regulation. This is a bold policy reform and will benefit low income clients. Second,  RBI has moved from micro-business rules to a principles-based approach in regulating the sector—a very prudent approach signifying the maturity of microfinance in India. 

Let us examine a few specific changes. Under the 2011 policy applicable only to NBFC-MFIs, the regulation prescribed an annual income limit of Rs160,000  and Rs 200,000 for rural and urban households respectively. RBI has revised this Rs 300,000 and done away with rural-urban distinction. This will enable microfinance players to cover the “middle” segment which gets lost between the microfinance market and the typical banking customer as well as sustain the focus on poverty. This is a positive step also because interlinkages and migration often make the rural-urban boundary anachronistic. RBI’s intent of ensuring that clients are served responsibly and are not indebted beyond their repayment capacity is explicit in the concept of Fixed Obligation to Income Ratio (FOIR). This moves the needle correctly from current approach of basing it on number of lenders and loan amount and ensures that a household’s repayment obligation does not exceed 50% of its income and this is an outer limit. Ignoring these tectonic changes, often, the discussion turns to the removal of pricing caps for NBFC-MFIs. Lending rate deregulation started in 1991 and the pricing cap formula only applied to 35% of the microfinance market. The new policy stipulates that all REs will need to have a board approved policy on pricing, which will be subject to regulatory scrutiny and clients have to be given a fact sheet disclosing an all encompassing APR.

The flexibility in pricing will spur innovation, incentivise REs to serve low density areas, and bring transparency in lending rates. At present, across REs, 55.7 million low-income clients are being provided small scale credit services across 632 districts with a Gross Loan Portfolio of Rs 2.56 trillion as of December 31, 2021. It is expected that with these policy changes, the client outreach will expand to 100 million in next 3-4 years, bringing a significant number of new-to-credit customers to formal finance. With RBI having done its part, it is on the industry now to redeem policy trust and build an inclusive India on its march to amrit kaal.

The author is CEO and director MFIN, the industry association for microfinance and RBI-recognised self-regulatory organisation.

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First published on: 24-03-2022 at 04:40 IST