• The Financial Literacy Cell

RBI’s Proposals for Microfinance Institutions

"In view of the fresh challenges brought on by the pandemic and to address the emergent liquidity position of smaller Microfinance institutions (MFIs), lift of interest rate cap on microfinance institutions as well as a Reckon of fresh lending to smaller MFIs (with asset size of up to Rs500 crore) for on-lending to individual borrowers as priority sector lending," the RBI Governor Shaktikanta Das

Micro-finance institutions are in constant dilemma of following guidelines from different sectors. Therefore, to eliminate this dilemma, Reserve Bank of India (RBI) proposed to lift interest rate cap on Micro Finance Institutions (MFIs). A common set of guidelines will regulate micro loans, irrespective of which sector provide these guidelines. Poor and low-income households do not have access to banking facilities. So, Microfinance is a form of financial service which provides small loans and other financial services. The definition of small loans varies as we move across the border, however, in India all loans that are below Rs. 1 lakh can be considered as microloans. In the past two decades the magnitude of institutions providing microfinance as well as the quantum of credit provided by them to the customers has witnessed an exceptional growth. Institutes that are involved in providing Microcredit are as follows: • Scheduled commercial banks (SCBs) (including small finance banks (SFBs) • Regional rural banks (RRBs) • Cooperative banks • Non-banking financial companies (NBFCs) • Microfinance institutions (MFIs) registered as NBFCs

Non-banking financial company (NBFC)-MFIs are also known as non-deposit taking financial companies. There are certain conditions that need to be fulfilled to qualify as NBFC-MFIs, which are as follows: • Minimum Net Owned Funds (NOF) of Rs. 5 crores. • At least 85% of its Net Assets in the nature of Qualifying Assets. ( The assets that require a considerable period of time to be used or for resale are known as Qualifying Assets ) The Consultative Document on Regulation of Microfinance, presented by RBI provides that all the action of NBFC-MFIs are to be guided by board-approved policies that involve fair disclosure and transparency of practices code. In accordance to that, Cadging interest should not be charged by the such institutes. The significance of Microfinance Institutions has grown tremendously over the years. The government designed this economic mechanism to uplift the overall standard of living of poor and low-level income group of the nation. This will promote financial inclusion, that will enable the needy to come out of poverty and attain the loans from a legitimate institute rather than unfaithful ones. In previous decades, government has launched various policies that target reduction of poverty, women empowerment, vulnerable group assistance etc.

RBI’s proposal will push such other policies in a beneficial position. The central bank believes that the cap on interest rate on MFIs has created an inadvertent benchmark for all the micro-lenders, which further delays the functioning of the nation as a whole. The proposal redefined the ambit of microfinance loans, which must involve collateral-free loans to households with annual household income of Rs 1,25,000 and Rs 2,00,000 for rural and urban/semi urban areas, respectively. According to the new proposal, ‘household’ means a group of persons normally living together and taking food from a common kitchen. A new repayment mechanism was also introduced by RBI that involves mooting the cap on payment of outstanding obligations of interest and principal amount as a percentage of household income i.e., subjected to a limit of maximum 50%. Experts pointed out that the new rules will help to review the issue of over indebtedness of microfinance borrowers, and will help to unify the interest mechanism of the market. It will mirror the regulators' belief in the ability of microfinance lenders to transparently set interest rates. MFIs comprises 227 institutes, at present. They have limited amount of freedom, the minimum they can charge is the lower interest rate between the cost of funds adding a margin of 10% for NBFC-MFIs, that further involves a loan portfolio exceeding ₹100 crore and 12% points for others along with a 2.75 times average base rate of the five-biggest commercial banks. The major difference between the two institutions is that while other NBFCs can operate at a very high level, MFIs focuses on only the smaller level of social strata, with need of minimal amounts as loans. The new policy suggested by RBI is a common definition of microfinance loans analogously applicable to all entities to ensure target borrowers are focused with an element of certainty, irrespective of the type of moneylenders. However, the maximum acceptable level of indebtedness for microfinance borrowers shall be applicable to all regulated entities. Therefore, the present prerequisite that limits lending up to two NBFC-MFIs to the same borrower will be discarded, to form a uniformity level.

“Microfinance stands as one of the most promising and cost-effective tools in the fight against global poverty.”

Jonathan Morduch

By - Kramank Garg

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