Money & Banking

‘Microfinance lenders should not put profit above social objectives’

Our Bureau Mumbai | Updated on October 27, 2021

M Rajeshwar Rao, Deputy Governor, RBI   -  PTI

RBI Deputy Governor M Rajeshwar Rao cautions against undoing three decades’ progress in the microfinance sector

Lenders in the microfinance space should not mimic mainstream finance strategies as they need to balance social objectives with their lending operations, said M Rajeshwar Rao, Deputy Governor, Reserve Bank of India (RBI).

“The roots and origin of microfinance should not be forgotten and sacrificed at the altar of bottom-line growth. There is no denying the fact that self-sufficiency and financial sustainability are the objectives that the lenders need to pursue.

“However, prioritisation of profitability at the expense of social and welfare goals of microfinance may not be an optimal outcome,” Rao noted in his inaugural address at the Sa-Dhan National Conference.

He emphasised that lenders must remain cognisant of the fact that balance-sheet growth should not be built by compromising on prudent conduct.

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Referring to the negative consequences of over-indebtedness, harsh recovery practices and adverse outcomes from harassment of customers, the Deputy Governor cautioned these will adversely impact the microfinance ecosystem.

“From society’s perspective, there are economic and social implications. While chasing higher asset growth and returns, lenders should not throw caution to the winds.

“Any slip-up through adverse actions of the MFIs [microfinance institutions] may undo the tremendous progress achieved over the decades, and the sector can ill-afford to do that,” he said.

Three sets of criticisms

The Deputy Governor stated that there have mostly been three distinct sets of criticisms against microfinance lenders — they lead borrowers into debt-trap like situations; they charge usurious rates of interest, often disproportionate to their funding and operational costs; and they deploy harsh recovery methods, leading to distress among borrowers.

Lenders must introspect and address these issues to prevent the recurrence of crisis episodes, he said, adding that the consultative document on ‘regulation of microfinance’ tries to address some of these issues through the proposed framework.

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Over-indebtedness and multiple lending

Rao said the revised framework proposes to address over-indebtedness by prescribing a common definition of microfinance loans, which will be uniformly applicable to all lenders, and linking loan amount to household income.

It proposes that the payment of interest and repayment of principal for all outstanding loans of the household at any point of time should not exceed 50 per cent of its income.

Pricing of microfinance loans

The revised framework proposes to do away with the prescribed ceiling on lending rate and mandate all lenders to have a board-approved policy on an all-inclusive interest rate for microfinance borrowers.

The lenders would also have to provide borrowers a simplified factsheet on the pricing of microfinance loans along with the disclosure of minimum, maximum and average interest rates.

According to the Deputy Governor, the intention is to bring into play market mechanism to lower the lending rates for the entire microfinance sector and empower the customer through transparent disclosures.

Customer protection

A cap on the loan repayment obligation of a household as a percentage of the household income is expected to address the inability of microfinance borrowers to repay the loan.

It has been proposed to extend the collateral-free nature of microfinance loans, as applicable to NBFC-MFIs, to all lenders in the microfinance space.

Published on October 27, 2021

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