The RBI will now directly regulate microfinance sector

The Reserve Bank of India has now decided to bunch together the beleaguered microfinance sector as a niche segment within the category of non-banking financial companies (NBFC).

This means it will now be the direct regulator of this sector - in line with the recommendations of the Malegam Committee which made recommendations in this regard after the Andhra microfinance fiasco.

Under guidelines issued on Friday, the RBI has directed all existing microfinance institutions (MFIs) who can meet its new regulatory norms to register as NBFC-MFIs by April 2012. Those who do not meet the norms cannot, henceforth, lend more than 10 percent of their total assets to the sector.

The conditions set for NBFC-MFIs include the following:

[caption id=“attachment_147365” align=“alignleft” width=“380” caption=“Hemalatha (C) and other loan borrowers show pass books given to them by a micro finance company at Ibrahimpatnam. Reuters”]  [/caption]

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- They must have minimum net owned funds of Rs 5 crore (Rs 2 crore if they operate in the North-East).

- Their capital adequacy ratio (CAR) has to be 15 percent. This ratio is the measure of a bank’s capital weighed against its risk assets (loans). Since MFIs in Andhra are stuck upto their necks in bad debts, the RBI has given them a one-year concession in capital adequacy. MFIs with more than 25 percent exposure to Andhra Pradesh need to maintain only 12 percent CAR in the first year.

- MFIs cannot lend at more than 26 percent interest, and margins on borrowed funds cannot exceed 12 percent. This means if MFIs can borrow cheap - say at 10 percent - the interest rate cap on lending is 22 percent, and not 26 percent.

- As far as lending is concerned, not more than two MFIs can lend to the same borrower while one borrower cannot be a member of two groups simultaneously. The frequency of repayment instalments can be decided by the borrower.

- MFIs should have higher cutoffs for lending in urban and semi-urban areas.

- MFIs have to start provisioning for defaults, and loans that are not serviced for more than 90 days should be classified as non-performing.

The Reserve Bank has had to step in because states were beginning to impose their own regulations. This is what happened in Andhra Pradesh, where the state issued an ordinance last October when reports of borrower suicides and unfair debt collection methods were reported. The MFI boom collapsed immediately after the Andhra law was imposed.

In its recent report on “Trend and Progress of the Banking in India, 2011-12”, the RBI had expressed concern over states bringing in their own regulations. This was queering the pitch for big MFIs with business across several states since they would have to follow different laws in different states.

The collapse of MFIs in Andhra Pradesh also sent a clear warning signal that MFIs needed a single regulatory environment - especially since microfinancing is seen as one way of improving financial inclusion.

The National Bank for Agriculture and Rural Development (Nabard) was one of the choices for regulating MFIs, but since it has its own lending exposures to rural areas, the mantle finally fell on the RBI itself.

The MFI industry is likely to welcome the new norms, barring the one capping interest rates. In the current high interest rate scenario and high default rates, the 26 percent limit will squeeze their margins.