Regulation of Microfinance

30th October, 2021 Polity

Figure 1: No Copyright Infringement Intended

Context

Reserve Bank of India (RBI) published a “Consultative Document on Regulation of Microfinance”

To promote the financial inclusion of the poor and competition among lenders, the likely impact of the recommendations is unfavourable to the poor.
If implemented, they will result in an expansion of microfinance lending by private financial institutions, in the provision of credit at high rates of interest to the poor, and in huge profits for private lenders.

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, as it 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.
Not only has the RBI abandoned any initiative to expand low-cost credit through public sector commercial banks to the rural poor, the bulk of whom are rural women (as most loans are given to members of women’s groups), but, in addition, it also proposes to de-regulate the rate of interest charged by private microfinance agencies.
The ‘maximum rate of 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 MFls (a loan portfolio of over 7100 crore) and 12% for others; or the average base rate of the five largest commercial banks multiplied by 2.75’.
In June 2021, the average base rate announced by the RBI was 7.98%. 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.

Microfinance is becoming increasingly important in the loan portfolio of poorer rural households.
In a study of two villages from southern Tamil Nadu, done by the Foundation for Agrarian Studies, we found that a little more than half of the total borrowing by households resident in these two villages was of unsecured or collateral-free loans from private financial agencies (SFBs, NBFCs, NBFC-MFls and some private banks).
There was a Clear differentiation by caste and socio-economic class in terms of source and purpose of borrowing. First, unsecured microfinance loans from private financial agencies were of disproportionate significance to the poorest households — to poor peasants and wage workers, to persons from the Scheduled Castes and Most Backward Classes.
Second, these microfinance loans were rarely for productive activity and almost never for any group-based enterprise, but mainly for house improvement and meeting basic consumption needs.