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The Reserve Bank of India (RBI) recently released a consultative document on revised framework for the regulation of microfinance loans. The document released by the central bank proposes to protect microfinance from over-indebtedness, bringing down interest rates through competitive forces, and empower borrowers to make informed decisions. The document proposes to apply a common MFI framework for all its regulated entities and not just the NBFC-MFIs. The RBI has also proposed to ensure that a borrower’s burden of repayment is capped as a per cent of their household income and to remove interest rate caps for microfinance lenders amongst other proposals in the consultative document that seeks feedback from stakeholders.
The proposals put forth by the central bank have the interest of the borrowers at its heart and to ensure that the regulations meant for microfinance loans are made applicable to all regulated entities operating in the space, instead of just the NBFC-MFI. At present, the NBFC-MFI holds just 30% of India’s microfinance loan portfolio. While the proposal shall have a positive impact, there could also be few inadvertent consequences that must be taken into consideration.
The present MFI regulation (only applicable to NBFC-MFIs) caps the total indebtedness of microfinance borrowers at an absolute value of INR 1.25 lakh and this ceiling was applicable only to loans availed from NBFC-MFIs. However, this poses two major risks – a borrower could potentially source up to INR 1.25 lakh from NBFC-MFIs even with an insufficient household repayment capacity; or a borrower may source additional debt from entities other than NBFC-MFIs. These risks could drive microfinance borrowers to over-indebtedness.
The RBI’s proposed framework intends to ensure that the repayment burden on a microfinance borrower is not more than 50% of their household income and extends the purview of these regulations to all RBI-regulated entities (RE). With this, the regulator is ensuring that despite the burden of microfinance debt from any RE, a household shall be left with at least 50% of its income to meet its basic needs.
According to the proposed framework, borrowers shall not be left with any motivation to understate their household income levels as there is a higher emphasis on the repayment burden and it shall only limit their access to credit. Now with borrowers, who potentially could have been understating their household income to qualify for microfinance loans from NBFC-MFIs, shall move out of the definition of microfinance loans.
The impact of such a change needs to be understood from the perspectives of NBFC-MFIs and other regulated entities. Since the NBFC-MFI entities have a strict cap on the non-MFI loans that they are allowed to offer, they will find it difficult to retain customers whose household income is now reported. NBFC-MFI may eventually lose the customers as their household income increases along with their credit requirements. Customers whose household income is not rising beyond the set limits can continue to avail credit from NBFC-MFI entities but with restrictions on the total repayment burden being less than 50% of their household income (and hence the loan ticket size).
For other regulated entities, a large portion of their current loan portfolio which were large ticket microfinance loans shall not continue to qualify under the microfinance loan definition. Since these entities can offer alternate products under priority sector lending; they can continue to service these customers having household income over the limits defined in the proposed MFI framework. While this would lead to a significant shift in the classification of loans with a significant depletion expected on the assets tagged as microfinance loans.
In a market with multiple alternatives, there is a strong possibility of institutions moderating their interest rates to gain a competitive advantage, thus bringing down the interest rates for microfinance borrowers.
With the existing model of operations, microfinance lending/borrowing has a dependency on geographic coverage. Since access to microfinance credit is dependent on the geographic presence of lenders, borrowers in remote locations are left with limited options. With limited competition and the absence of a rate ceiling, there is a possibility of lenders increasing interest rates instead of reducing them in such areas.
Given that India has the second-largest unbanked population in the world (around 19 crore in 2018) and the geographic profile of microfinance borrowers in India today, a large share of these borrowers shall potentially be exploited.
As per the proposed framework, NBFC-MFIs can charge penal interest on late repayments after mentioning them in bold in the loan agreement. This shall help these entities, who are currently not allowed to charge any penalty on delayed payments, to ensure borrowers repay on time or else receive additional interest on such delayed payments.
With the added emphasis on disclosure of rates of interest and gradation of risks, terms and conditions including the disbursement schedule and all relevant charges in vernacular language, there shall be more transparency and clarity in the information conveyed to microfinance borrowers, thus helping them in making better-informed decisions.
