Microfinance regulation has previously focused on non-banking financial companies – microfinance institutions (NBFC – MFI), and not on other entities engaged in microfinance such as banks and other NBFCs. The Reserve Bank of India (RBI) issued a consultation paper in 2021 proposing to bring all entities engaged in microfinance within the same regulatory framework and introducing other changes such as pricing. Having received feedback in March 2022, the RBI issued a new regulatory framework on microfinance (MFI directions) applying to all commercial banks apart from payment banks, co-operative banks and all non-banking financial companies, collectively called regulated entities (RE), from 1 April 2022.
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The MFI directions define a microfinance loan as a collateral-free loan to a low-income household, which is defined as a household with an annual household income not greater than INR300,000 (USD4,000). A household is a husband, wife and their unmarried children. To reduce reliance on informal financing channels, the end use of loans is no longer a factor in the classification of microfinance loans. Previously, NBFC – MFIs had to provide at least 50% of loans for income-generating purposes.
REs must have board-approved policies to assess household incomes. The MFI directions set out a specimen methodology for such policies and have provisions that enable associations and self-regulatory organisations of REs to develop common frameworks. REs are required to have board-approved policies on the maximum loan repayment obligations of a household. Previously, the maximum indebtedness of a microfinance borrower to an NBFC – MFI was capped at a certain monetary threshold. This cap has been removed, and REs can provide microfinance loans subject only to the requirement that the aggregate loan repayment obligations of a household for all outstanding loans, microfinance or otherwise, do not exceed 50% of the monthly household income of the borrower. This requirement applies prospectively.
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Previously, the pricing of MFI loans was based on a prescribed percentage above the average base rate of banks periodically published by the RBI. The MFI directions now require interest rates on microfinance loans to be based on board-approved policies of REs, which set out the interest rate model, components of the interest rate and their range, and a ceiling on interest rates and all other charges. The MFI directions forbid usurious interest rates.
REs will have to provide simplified pricing factsheets in a prescribed format setting out interest rates and all other charges payable to assist borrowers in making informed decisions. Any costs not disclosed in the factsheet cannot be charged. REs are not allowed to charge prepayment penalties on microfinance loans, and penalties on delayed payments can only be charged on the overdue amounts.
An NBFC – MFI had to maintain at least 85% of its net assets as qualifying assets, but is now required to maintain 75% of its total assets as microfinance loans. Other REs can now provide microfinance loans up to 25% of their total assets, instead of the earlier limit of 10%.
The MFI directions set out required conduct towards borrowers, the training of staff, outsourcing of activities, grievance redress, recovery of loans and the engagement of recovery agents. The use of harsh practices in recovery is expressly prohibited. REs must have in place a board-approved policy on fair practice codes to be followed.
Certain not-for-profit companies providing microfinance loans were previously exempted from registration as NBFC – MFIs. This exemption has now been removed and such companies will have to apply for registration as NBFC – MFIs within three months from the issue of the MFI directions.
The MFI directions consolidate and align the regulatory framework for microfinance across all REs, thereby minimising regulatory arbitrage and encouraging healthier participation in the microfinance sector. The simplification of the regulatory framework for microfinance and the broad-based move from prescriptive to principle-based regulation reflects the growing maturity of this sector and the RBI’s confidence in the existing participants in this sector.
Sawant Singh and Aditya Bhargava are partners at Phoenix Legal. Sristi Yadav, a senior associate, also contributed to the article.
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