Microfinance framework overhaul a welcome move

By Sawant Singh, Aditya Bhargava and Sristi Yadav, Phoenix Legal

The Reserve Bank of India’s (RBI) comprehensive regulatory framework for microfinance prescribes requirements such as the nature of borrowers, maximum disbursement amounts and ceilings on interest rates and other charges. However, this framework applies only to non-banking financial companies – microfinance institutions (NBFC-MFIs), which reportedly provide only about 30% of microfinance loans in India. The disparity in the regulatory framework between NBFC-MFIs and banks has led to disgruntlement among NBFC-MFIs, as a leading view is that they are in the vanguard of microfinance lending, and often do the heavy lifting in developing new markets.

Sawant Singh
Phoenix Legal

In June 2021, the RBI issued a consultation paper, inviting feedback on a new framework uniformly applicable to all regulated entities (REs) active in microfinance, including scheduled commercial banks, small finance banks, NBFCs and NBFC-MFIs. Refreshingly, the paper mentions that the revised framework will be introduced in a non-disruptive manner and that all REs will have sufficient time to comply.

The paper proposes a uniform definition of microfinance for all REs on the basis of the household income of microfinance borrowers being up to INR125,000 (USD1,700) for rural areas and INR200,000 for urban and semi-urban areas. The paper notes that, in addition to REs, “not for profit” companies also provide microfinance loans, and are exempted from registration as NBFCs with RBI. The RBI proposes to limit this exemption to “not for profit” companies with the asset size of less than INR1 billion. Currently, the maximum indebtedness of a microfinance borrower from NBFC-MFIs, excluding loans for education and medical expenses, cannot exceed INR125,000, and more than two NBFC-MFIs cannot lend to a borrower. Instead of this limit-based approach, the paper proposes to tie the maximum indebtedness to the debt-to-income ratio of a household, and cap the aggregate indebtedness from all REs at 50% of household income. In a borrower-friendly move, the paper recommends that all REs provide simplified pricing fact sheets to microfinance borrowers to enable them to compare the pricing of microfinance loans and make informed decisions.

The current framework’s provisions on microfinance loans are collateral-free, and restrictions on charging prepayment penalties to microfinance borrowers are proposed to be extended to all REs. Microfinance borrowers will be able to repay loans in weekly, fortnightly or monthly instalments, and all REs are required to have board-approved policies on repayment.

Aditya Bhargava,Phoenix Legal
Aditya Bhargava
Phoenix Legal

Changes that apply only to NBFC-MFIs are also proposed. An NBFC-MFI is currently required to maintain at least 85% of net assets as “qualifying assets”. RBI proposes to simplify the qualifying assets criteria by aligning it with the definition of microfinance.

In this spirit of streamlining, the paper proposes removing minimum tenure restrictions and the requirement for NBFC-MFIs to provide at least 50% of loans for income-generating purposes. The detailed mechanism for calculating interest rates and interest ceilings is also proposed to be removed. Interest rates must now be based on the board-approved policies of NBFC-MFIs and the RBI’s fair practice code. Revisions to net-owned fund requirements for NBFC-MFIs will also be considered while finalising the new framework.

The theme of the consultation paper is to provide a standard set of rules for all REs and to remove any regulatory arbitrage between NBFC-MFIs and other microfinance lenders. End-use restrictions will be relaxed to enable borrowers to obtain loans through formal channels, eventually eliminating informal channels such as moneylenders. The proposed framework is a move in the right direction. Standardised regulations across all REs will encourage healthier competition and more competitive pricing of microfinance loans. A key difference between NBFC-MFIs and other REs is the high cost of funds for NBFC-MFIs, which is passed on to microfinance borrowers. To level the playing field between NBFC-MFIs and other REs, RBI should also consider introducing cheaper fundraising options for NBFC-MFIs, such as special liquidity windows.

Sawant Singh and Aditya Bhargava are partners at Phoenix Legal. Sristi Yadav, a senior associate, also contributed to this article.

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