The Reserve Bank of India's (RBI) comprehensive regulatory framework for microfinance prescribes requirements such as the nature of borrowers, maximum disbursement amounts and ceilings on interest rates and other charges. However, this framework applies only to non-banking financial companies – microfinance institutions (NBFC-MFIs), which reportedly provide only about 30% of microfinance loans in India. The disparity in the regulatory framework between NBFC-MFIs and banks has led to disgruntlement among NBFC-MFIs, as a leading view is that NBFC-MFIs are in the vanguard of microfinance lending and often do the heavy lifting in developing new markets.
In June 2021, the RBI issued a consultation paper, inviting feedback on a new framework uniformly applicable to all regulated entities (REs) active in microfinance, including scheduled commercial banks, small finance banks, NBFCs and NBFC-MFIs. Refreshingly, the paper mentions that the revised framework will be introduced in a non-disruptive manner and that all REs will have sufficient time to comply.
The paper proposes a uniform definition of microfinance for all REs based on the household income of microfinance borrowers being up to 125,000 Indian rupees (approximately $1,700) for rural areas and 200,000 rupees for urban and semi-urban areas. The paper notes that, in addition to REs, not-for-profit companies also provide microfinance loans and are exempt from registration as NBFCs with the RBI. The RBI proposes to limit this exemption to not-for-profit companies with an asset size of less than 1 billion rupees. Currently, the maximum indebtedness of a microfinance borrower from NBFC-MFIs, excluding loans for education and medical expenses, cannot exceed 125,000 rupees, and more than two NBFC-MFIs cannot lend to a borrower. Instead of this limit-based approach, the paper proposes to tie the maximum indebtedness to the debt-to-income ratio of a household and cap the aggregate indebtedness from all REs at 50% of the household income. In a borrower-friendly move, the paper recommends that all REs provide simplified pricing fact sheets to microfinance borrowers to enable them to compare the pricing of microfinance loans and make informed decisions.
Restrictions on charging prepayment penalties to microfinance borrowers are proposed to be extended to all REs. Microfinance borrowers will be able to repay loans in weekly, fortnightly or monthly instalments, and all REs will be required to have board-approved policies on repayment.
Changes that apply only to NBFC-MFIs are also proposed. An NBFC-MFI is currently required to have at least 85% of net assets that count as "qualifying assets". The RBI proposes to simplify the qualifying assets criteria by aligning it with the definition of microfinance.
In this spirit of streamlining, the paper proposes removing minimum tenure restrictions and the requirement for NBFC-MFIs to provide at least 50% of loans for income-generating purposes. The paper also proposes the removal of the detailed mechanism for calculating interest rates and interest ceilings. Interest rates must now be based on the board-approved policies of NBFC-MFIs and the RBI's fair practice code. Revisions to net-owned fund requirements for NBFC-MFIs will also be considered while finalising the new framework.
The theme of the consultation paper is to provide a standard set of rules for all REs and to remove any regulatory arbitrage between NBFC-MFIs and other microfinance lenders. End-use restrictions will be relaxed to enable borrowers to obtain loans through formal channels, eventually eliminating informal channels, such as moneylenders. The proposed framework is a move in the right direction. Standardised regulations across all REs will encourage healthier competition and more competitive pricing of microfinance loans. A key difference between NBFC-MFIs and other REs is the high cost of funds for NBFC-MFIs, which is passed on to microfinance borrowers. To level the playing field between NBFC-MFIs and other REs, RBI should also consider introducing cheaper fundraising options for NBFC-MFIs, such as special liquidity windows.
For further information on this topic please contact Aditya Bhargava or Sristi Yadav at Phoenix Legal by telephone (+91 22 4340 8500) or email ([email protected] or [email protected]). The Phoenix Legal website can be accessed at www.phoenixlegal.in.