Introduction
New provisions introduced by MFI directions
Comment
Microfinance regulation traditionally focused on non-banking financial companies – microfinance institutions (NBFC-MFIs), and such regulations had not been extended to other entities (such as banks and other NBFCs) engaged in microfinance.
In June 2021, the Reserve Bank of India (RBI) issued a consultation paper, which proposed bringing all entities engaged in microfinance under the same regulatory framework, and certain other changes such as on pricing. Based on the feedback received on the consultation paper, the RBI issued a new regulatory framework on microfinance (MFI directions) in March 2022 applicable to commercial banks (excluding payment banks), cooperative banks and all NBFCs (collectively, regulated entities (REs)), with effect from 1 April 2022.
New provisions introduced by MFI directions
Definitions of "microfinance loan" and "household"
The MFI directions now define a "microfinance loan" as a collateral-free loan given to a low-income household – that is, a household which has an annual household income of up to 300,000 Indian rupees (approximately $3,942). The MFI directions also defines a "household" as comprising a husband, wife and their unmarried children. In line with the proposal in the consultation paper, to reduce reliance on informal financing channels, the end-use of loans is no longer required to be considered for the classification of a microfinance loan. Previously, NBFC-MFIs were required to provide at least 50% of loans for income-generating purposes.
Assessing household income and loan repayments
To assess the household income, all REs must put in place a board-approved policy. The MFI directions prescribe an indicative methodology for this policy, and also prescribe provisions that enable associations/self-regulatory organisations of REs to develop a common framework for REs.
All REs are also required to have a board-approved policy on the maximum loan repayment obligations of a household. Previously, the maximum indebtedness of a microfinance borrower from an NBFC-MFI was capped at a prescribed monetary threshold. This cap has now been removed, and REs can provide microfinance loans subject to the requirement that the aggregate loan repayment obligations of a household for all outstanding loans (microfinance or otherwise) do not exceed 50% of the monthly household income of the borrower. This requirement is applicable prospectively.
Pricing of MFI loans
Previously, the pricing of MFI loans was based on a prescribed percentage above the average base rate of banks disseminated by the RBI on a periodic basis. The MFI directions now require the interest rate charged on microfinance loans to be based on board-approved policies of REs, which set out the interest rate model, the components of the interest rate and their range, and a ceiling on the interest rate and all other charges. Additionally, the MFI directions prescribe that interest rates should not be usurious.
REs would need to provide a simplified pricing factsheet to borrowers, in a prescribed format, setting out the interest rate and all other charges payable, to assist them in making an informed decision. Any costs not disclosed in the factsheet cannot be charged. Further, REs may not charge a prepayment penalty on microfinance loans, and any penalty on delayed payments can only be charged on the overdue amounts.
Qualifying assets
An NBFC-MFI was previously required to maintain at least 85% of its net assets as "qualifying assets". An NBFC-MFI is now required to maintain 75% its of total assets as microfinance loans. Other REs can now provide microfinance loans of up to 25% of their total assets (instead of the earlier cap of 10%).
Fair practices
The MFI directions have introduced certain directions on:
- conduct towards borrowers;
- the training of staff;
- the outsourcing of activities;
- grievance redressal;
- the recovery of loans; and
- the engagement of recovery agents.
The use of "harsh practices" for purposes of recovery is expressly prohibited. REs are also required to put in place a board-approved policy on a fair practices code to be followed.
Not-for-profit companies
Certain not-for-profit companies providing microfinance loans were previously exempted from registration as NBFC-MFIs. This exemption has now been removed, and such not-for-profit companies are now required to apply for registration as an NBFC-MFI within three months from the issue of the MFI directions.
The MFI directions consolidate and align the regulatory framework for microfinance across REs, thereby minimising regulatory arbitrage and encouraging healthier participation in the microfinance sector. The simplification of the regulatory framework for microfinance and the broad-based move from prescriptive to principle-based regulation also reflects the growing maturity of this sector and the RBI's confidence in the existing participants in this sector.
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