Laissez faire for MFIs

Through a circular last week, the Reserve Bank of India effected a much-needed overhaul of the restrictive norms governing the microfinance sector. The new rules broaden the definition of micro loans, impose uniform regulations on NBFCs and other entities extending microfinance, and do away with the rigid pricing and exposure caps that today deny many small borrowers access to credit.

The new regulations, effective April 1, make four significant changes. One, prescriptive norms on the kind of loans that can qualify as microfinance will be liberalised. Today, microfinance loans are defined as loans to borrowers with household income not exceeding ₹1.25 lakh in rural areas and ₹2 lakh in urban areas, with the loan amount not exceeding ₹1.25 lakh. More than two NBFCs cannot lend to a borrower. Now, these criteria will be replaced by the simple stipulation that any collateral-free loan given to households with annual income up to ₹3 lakh would qualify as a micro loan. These changes are likely to open up credit access to low-income households who were hitherto excluded from formal finance. Two, micro borrowers will be allowed greater leeway on loan size and end-use. Instead of stipulating loan size, lenders have been asked to ensure that borrowers’ total repayment obligations don’t exceed 50 per cent of income. Micro loans no longer need to be used in ‘income-generating’ activities. This appears practical, as micro-borrowers may want to legitimately use the money for education, medical emergencies or even repaying high-cost debt from moneylenders. Three, the rate cap that requires NBFCs to lend at spreads not more than 10-12 percentage points over their cost of funds will be removed. Given that banks are not subject to rate caps on micro-loans, this appears fair. But there’s a risk that this could lead to higher rates for borrowers, especially in a rising rate scenario. Overall, the new norms level the unequal playing field between NBFCs and other entities such as banks and small finance banks extending micro-loans. Though non-NBFC entities account for 70 per cent of micro lending, they were so far not subject to any of the rules applied to NBFC-MFIs. The RBI’s shift to regulating microfinance as an activity, instead of focussing on just one set of entities — NBFC-MFIs, can result in better consumer protection.

The liberalised rules are designed to spur growth in micro-credit. But it remains to be seen if relaxations such as the removal of rate caps work to the good of borrowers. While the RBI seems to expect that lending rates will decline, so far, even entities such as banks who weren’t subject to regulatory rate caps have pegged their lending rates to the NBFCs. A rush to acquire new borrowers may also result in asset quality compromises by players. One needs to see if competition works effectively to rein in borrowing rates, while keeping undue risk-taking by lenders in check.

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