The question on how to regulate microfinance institutions (MFIs) continues to vex the Reserve Bank of India (RBI), Nabard and the finance ministry. They were not satisfied with the previous options before them, namely, regulating MFIs’ conduct through interest rate caps, priority sector lending norms, NBFC norms or the draft microfinance bill. Consequently, a new set of regulatory approaches, variously advanced by regulators and microfinance industry professionals, are doing the rounds now.
Convert MFIs into banking correspondents (BC): This would enable MFIs’ clients to access insured deposits, national payments system and remittance services even as the MFIs come under the supervision of the banks. However, the MFI segment is not too enthused at the prospect. Partly because the commission banks pay BCs is barely enough to meet the cost of delivering these products, and partly due to other stipulations which restrict BCs to rural India even though financial inclusion is abysmal in urban India as well, or insist that BCs confine their operations to a 15 km radius around the bank.
Even the regulators have their concerns. For instance, RBI deputy governor Usha Thorat flagged possible risks like conflicts of interest, co-mingling of MFI and bank funds, misrepresentation and other agency-related risks recently in her talk at a seminar co-hosted by the US Federal Reserve, IMF and the World Bank in early June.
Create a separate regulator for financial inclusion: The argument here is that India needs a new breed of small finance banks, perhaps 100 of them, each of which can open and serve 3-5 million account-holders. And that none of the existing regulators has the bandwidth to create and regulate 100 such entities. And, hence, the need for a new financial inclusion regulator. The proposal carries risks of regulatory confusion. For instance, who will regulate lending by banks to the poor — RBI or the financial inclusion regulator?
Also, financial inclusion is an integral part of the financial sector, and so, if the plan is to mainstream the poor, it is only right the regulation be done by the RBI, point out critics of the proposal to create a new regulator for financial inclusion. If need be, they say, supervision can be handled by Nabard or someone else. But ultimate authority has to vest with the RBI.
Regulate MFIs by encouraging greater competition in rural areas: The RBI cannot do field-level regulation, RBI deputy governor KC Chakrabarty told ET in an interview, and that competition — by pushing cooperatives, private and public banks into rural areas — is the best way to ensure the bad eggs in the industry behave.
However it can be argued that these institutions have been around for decades, and even during the days when they were not measured on financial performance but on the social results they delivered, they failed to reach out to the masses. Today, when they are as driven by numbers as private banks, and given that the rural customer is “too low-end and high cost”, these banks are not structured to handle such transactions.
Regulate by size: Small organisations working at a district level can be tracked by Nabard. Once their loan portfolio crosses a threshold – say Rs 100 crore — they should come under RBI’s purview. Agrees IIM professor MS Sriram: “Define microfinance as an amount equivalent to `small borrowal account’ (Rs 2 lakh at present) and say that any NBFC having 90% of its portfolio as small borrowal accounts will be categorised as NBFC MFI. Over a period of time, these outfits could be allowed to morph into small banks, and then into larger banks.” While the proposal for small finance banks finds acceptance with the industry, they emphasise the need for support and regulation.
And that the RBI doesn’t have the bandwidth. Ergo, again, the need for a new regulator. The bigger question here, of course, is whether MFIs should be allowed to become banks and accept deposits. Which boils down to whether closely held organisations should be allowed to collect deposits from a scattered public.
Today, some of India’s leading MFIs face charges of both corporate misgovernance and lending irregularities — like coercive repayment techniques and harsh repayment schedules that result in women taking fresh loans to settle existing debt.
Any regulatory framework chosen must check corporate misgovernance and ensure microfinance doesn’t degenerate into predatory lending. The first option (banking correspondents) is not viable for the MFIs. When it comes to monitoring lending practices, the second and fourth options will face the same problems as the RBI. The third option, while enabling borrowers to choose their financial services provider, hinges on whether banks, etc, want to lend in rural areas.
The alternative is to flank country-level regulation — which lays down principles to check more dubious practices by the industry — with state moneylending acts. If need be, interest caps defined in these acts can be tweaked to better accommodate the industry’s economics.
Convert MFIs into banking correspondents (BC): This would enable MFIs’ clients to access insured deposits, national payments system and remittance services even as the MFIs come under the supervision of the banks. However, the MFI segment is not too enthused at the prospect. Partly because the commission banks pay BCs is barely enough to meet the cost of delivering these products, and partly due to other stipulations which restrict BCs to rural India even though financial inclusion is abysmal in urban India as well, or insist that BCs confine their operations to a 15 km radius around the bank.
Even the regulators have their concerns. For instance, RBI deputy governor Usha Thorat flagged possible risks like conflicts of interest, co-mingling of MFI and bank funds, misrepresentation and other agency-related risks recently in her talk at a seminar co-hosted by the US Federal Reserve, IMF and the World Bank in early June.
Create a separate regulator for financial inclusion: The argument here is that India needs a new breed of small finance banks, perhaps 100 of them, each of which can open and serve 3-5 million account-holders. And that none of the existing regulators has the bandwidth to create and regulate 100 such entities. And, hence, the need for a new financial inclusion regulator. The proposal carries risks of regulatory confusion. For instance, who will regulate lending by banks to the poor — RBI or the financial inclusion regulator?
Also, financial inclusion is an integral part of the financial sector, and so, if the plan is to mainstream the poor, it is only right the regulation be done by the RBI, point out critics of the proposal to create a new regulator for financial inclusion. If need be, they say, supervision can be handled by Nabard or someone else. But ultimate authority has to vest with the RBI.
Regulate MFIs by encouraging greater competition in rural areas: The RBI cannot do field-level regulation, RBI deputy governor KC Chakrabarty told ET in an interview, and that competition — by pushing cooperatives, private and public banks into rural areas — is the best way to ensure the bad eggs in the industry behave.
However it can be argued that these institutions have been around for decades, and even during the days when they were not measured on financial performance but on the social results they delivered, they failed to reach out to the masses. Today, when they are as driven by numbers as private banks, and given that the rural customer is “too low-end and high cost”, these banks are not structured to handle such transactions.
Regulate by size: Small organisations working at a district level can be tracked by Nabard. Once their loan portfolio crosses a threshold – say Rs 100 crore — they should come under RBI’s purview. Agrees IIM professor MS Sriram: “Define microfinance as an amount equivalent to `small borrowal account’ (Rs 2 lakh at present) and say that any NBFC having 90% of its portfolio as small borrowal accounts will be categorised as NBFC MFI. Over a period of time, these outfits could be allowed to morph into small banks, and then into larger banks.” While the proposal for small finance banks finds acceptance with the industry, they emphasise the need for support and regulation.
And that the RBI doesn’t have the bandwidth. Ergo, again, the need for a new regulator. The bigger question here, of course, is whether MFIs should be allowed to become banks and accept deposits. Which boils down to whether closely held organisations should be allowed to collect deposits from a scattered public.
Today, some of India’s leading MFIs face charges of both corporate misgovernance and lending irregularities — like coercive repayment techniques and harsh repayment schedules that result in women taking fresh loans to settle existing debt.
Any regulatory framework chosen must check corporate misgovernance and ensure microfinance doesn’t degenerate into predatory lending. The first option (banking correspondents) is not viable for the MFIs. When it comes to monitoring lending practices, the second and fourth options will face the same problems as the RBI. The third option, while enabling borrowers to choose their financial services provider, hinges on whether banks, etc, want to lend in rural areas.
The alternative is to flank country-level regulation — which lays down principles to check more dubious practices by the industry — with state moneylending acts. If need be, interest caps defined in these acts can be tweaked to better accommodate the industry’s economics.
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