Context

In June 2021, the Reserve Bank of India (RBI) published a “Consultative Document on Regulation of Microfinance”. The likely impact of the recommendations is unfavourable to the poor.

Background of microfinance in India

• Microfinance lending has been in place since the 1990s.
• In the 1990s, microcredit was given by scheduled commercial banks either directly or via non-governmental organisations to women’s self-help groups.
• But given the lack of regulation and scope for high returns, several for-profit financial agencies such as NBFCs and MFIs emerged.
• The microfinance crisis of Andhra Pradesh led the RBI to review the matter, and based on the recommendations of the Malegam Committee, a new regulatory framework for NBFC-MFIs was introduced in December 2011.
• A few years later, the RBI permitted a new type of private lender, Small Finance Banks (SFBs), with the objective of taking banking activities to the “unserved and underserved” sections of the population.
• Today, as the RBI’s consultative document notes, 31% of microfinance is provided by NBFC-MFIs, and another 19% by SFBs and 9% by NBFCs.
• These private financial institutions have grown exponentially over the last few years.

What are the recommendations in the document?

• The consultative document recommends that the current ceiling on rate of interest charged by non-banking finance company-microfinance institutions (NBFC-MFIs) or regulated private microfinance companies needs to be done away with.
• The paper argues that the interest rate ceiling is biased against one lender (NBFC-MFIs) among the many: commercial banks, small finance banks, and NBFCs.
• It proposes that the rate of interest be determined by the governing board of each agency, and assumes that “competitive forces” will bring down interest rates.

Comparison of rate of interest

• According to current guidelines, the ‘maximum rate of the interest rate charged by an NBFC-MFI shall be the lower of the following: the cost of funds plus a margin of 10% for larger MFIs (a loan portfolio of over ₹100 crores) and 12% for others; or the average base rate of the five largest commercial banks multiplied by 2.75’.
• A quick look at the website of some Small Finance Banks (SFBs) and NBFC-MFIs showed that the “official” rate of interest on microfinance was between 22% and 26% — roughly three times the base rate.
• How does this compare with credit from public sector banks and cooperatives?
• Crop loans from Primary Agricultural Credit Societies (PACS) in Tamil Nadu had a nil or zero interest charge if repaid in eight months.
• Kisan credit card loans from banks were charged 4% per annum (9% with an interest subvention of 5%) if paid in 12 months (or a penalty rate of 11%).
• Other types of loans from scheduled commercial banks carried an interest rate of 9%-12% a year.
• As even the RBI now recognises, the rate of interest charged by private agencies on microfinance is the maximum permissible, a rate of interest that is a far cry from any notion of cheap credit.
• The actual cost of microfinance loans is even higher for several reasons.
•  An “official” flat rate of interest used to calculate equal monthly instalments actually implies a rising effective rate of interest over time.
• In addition, a processing fee of 1% is added and the insurance premium is deducted from the principal.

Violations of RBI guidelines

• In line with RBI regulations, all borrowers had a repayment card with the monthly repayment schedules.
• This does not mean that borrowers understood the charges.
• Further, contrary to the RBI guideline of “no recovery at the borrower’s residence”, the collection was at the doorstep.

Conclusion

The proposals in the RBI’s consultative document will lead to further privatisation of rural credit, reducing the share of direct and cheap credit from banks and leaving poor borrowers at the mercy of private financial agencies. This is beyond comprehension at a time of widespread post-pandemic distress among the working poor.

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