The Reserve Bank of India must be commended for the speed with which its board of directors' appointed sub-committee, headed by Y.H. Malegam, has set forth not just the problems besetting the microfinance space but also the recommendations for the regulation of Non-Banking Financial Companies (NBFCs) that have been operating in micro-credit lending. As the panel notes at the outset, the RBI regulates NBFCs under the RBI Act but has no special regulations for NBFCs engaged in micro-lending.

The first question the reader of the report is likely to ask is: why not? After all, microfinance has long been considered a crucial vehicle for financial inclusion and since 1992 Nabard has had a Self-Help Group-Bank Linkage programme for collateral-free loans.

For the past few years private sector NBFCs have entered the field and SKS Microfinance's resounding initial public offer last year would have revealed how collateral-free lending to the poor had become as a business (viz. profit-oriented) proposition.

In its annual reports Nabard noted the progress of both the SHG-Bank model and NBFCs in the distribution of micro-credit. Now the panel informs us that the NBFCs had begun not just competing amongst themselves but also with the SHGs, on whose members they “poached” to form their own Joint Liability Groups (JLGs), lending indiscriminately for other than “income-generation” activities. Data provided by the panel show both SHGs and JLGs disbursing just a quarter of their loans for ‘income generation' with JLGs lending more generously for activities such as ‘home improvement.'

The sector was witnessing competition between the state-inspired SHG route and the NBFCs keen to expand their lending portfolio and earn profits to cover their cost of funds; in the SKS Microfinance case, to earn shareholders increasing value.

The Malegam panel bravely confronts what appears to be an intractable problem in the sector: satisfying the needs of collateral-free borrowers and, on the other hand, not just covering the cost of funds but also earning profits.

It sets conditions for “qualifying assets” of NBFC-MFIs: among others, interest and margin ceilings, (the latter the difference between cost of funds and loan pricing), an insistence on 75 per cent loans for income-generation activity, a schedule of repayment based on borrowers' capacity and a cap on loans of Rs 25,000 for an individual.

The panel's regulations appear justified after the events that earned NBFC-MFIs a disreputable tag but they may prove to be impractical; consumption loans are an important part of the borrowers' debt portfolio, interest caps can always be skirted around. Impractical regulation could drive out the private sector, leaving the micro-credit ‘infant' on the laps of publicly-owned entities.

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