IntroductionMicrofinance institutions (MFIs) perform a
crucial function of facilitating financial inclusiongoals in developing countries through the provisionof micro-finance services. Micro-finance servicesinclude: (a) micro-credit facilities to the extent ofM05lac [or M10lac if so specified by the Reserve Bankof India (RBI)]; (b) the collection of thrift; (c)pension; (d) insurance services; and (d) theremittance of funds to individuals within Indiasubject to prior approval by the RBI.
MFIs in India have grown tremendously in termsof size, outreach, and financial maturity since theiremergence in the 1980s. Recent RBI reports withregard to microfinance activities state that alongsideself-help group (SHG)-bank linkage programmes,MFIs, such as non-government organisations(NGOs) and non-banking finance companies(NBFCs) have emerged as important sources ofmicrofinance delivery in India. Consequently,incentives have been provided for penetration ofbanking into unbanked areas and encouraging MFIsas intermediaries. However, the growth of the MFIshas been geographically disproportionate. The
Malegam Committee report noted that distributionof microfinance penetration is more than half of thetotal MFI portfolio of India in the Southern regionwhile the Eastern region has over one fourth of thetotal MFI portfolio.
This briefing paper presents a picture of theregulatory instruments governing differentmicrofinance entities in the country. Specific featuresof regulation of NBFC-MFIs, and the current stateof the conflict between State Money Lendinginstitution actors and the RBI has been captured.Prudential and non-prudential norms of regulationand their consequent impact on competition havebeen dealt within this paper.
Legal Structure of MFIs:A microfinance institution under the Microfinance
Institutions (Development and Regulation) Bill,2012 includes the following entities: (a) a societyregistered under the Societies Registration Act, 1860;(b) a company registered under section 3 of the
Regulation of MicrofinanceInstitutions in India
Considering the importance of microfinance institutions in fulfilling the goals offinancial inclusion, it is essential to understand the body of laws, rules and regulationswhich govern this financial tool. Following the aftermath of the Andhra Pradeshmicrofinance issue and the subsequent rise of the microfinance industry nevertheless,various prudential and non-prudential norms were evolved by the regulatory bodiesin the country in order to effectively regulate microfinance institutions. However, anoverlap between the areas dealt with by various authorities governing microfinanceentities on critical issues like interest rate determination create uncertainty on the basicconditions of thriving in this sector for participant institutions. This briefing paperdeals with some of the problems in regulation of microfinance institutions and presentssolutions which should be taken into consideration.
in specified priority sectors at concessional rates ofinterest. Currently only MFIs registered as NBFC-MFIs are designated as a priority sector. The numberof priority sectors has recently been reduced, whichsuggests that banks will be relying more heavily onlending to MFIs to meet the priority sectorrequirements.
In order to register as a NBFC-MFI, an institutionmust meet requirements specified by RBI. RBIrequires that a minimum of 75 percent of a NBFC-MFIs loan portfolio must have originated forincome-generating activities. Additionally, an NBFC-MFI must have 85 percent of its total assets asqualifying assets (excluding cash, balances with banksand financial institutions, government securities andmoney market instruments). A qualifying asset is aloan which meets the following criteria:
1. Borrowers household annual income does notexceed M60,000 or M1,20,000 for rural andurban areas respectively.
2. Maximum loan size of M35,000 (first cycle)and M50,000 (subsequent cycles).
3. Maximum borrower total indebtedness ofM50,000.
4. Minimum tenure of 24 months when loanexceeds M15,000.
5. No prepayment penalties.6. No collateral.7. Repayable by weekly, fortnightly or monthly
instalments at the choice of the borrower.
Deposit Mobilisation: Regulation stipulates that onlyNBFCs and Cooperatives are permitted to acceptpublic deposits, though NBFCs must adhere toadditional stringent regulations,2 and Cooperativesare only permitted to accept deposits from itsmembers. There also exists what is called a depositslimited for NBFCs linked to the institutions Net
Owned Fund (NOF). No MFIregistered as an NBFC currently acceptsdeposits because regulation requiresthat institutions must obtain aninvestment grade rating, which no MFIhas obtained so far.
Access to Capital: MFIs in theory canraise capital through various methods,including borrowing from domestic andforeign debt markets, obtaining grantsand loans from subsidised lendingfunds, attracting foreign equityinvestment from capital markets,though legal structure of MFIs restrictcapital acquisition from some of thesesources.
Companies Act, 1956; (c) a trust established underany law for the time being in force; (d) a bodycorporate; or (e) any other organisation, which maybe specified by the RBI if the object of the institutionis the provision of microfinance services. It does notinclude a banking company, co-operative societiesengaged primarily in agricultural operations orindustrial activities or any individual who carrieson the activity of money-lending and is registeredas a moneylender under the provision of any Statelaw.
A MFI in India acquires permission to lendthrough registration (Table 1 provides details of theregistration requirements). MFIs are registered as oneof the following five types of entities1:
1. Non-Government Organisations engaged inmicrofinance (NGO MFIs), comprising ofSocieties and Trusts;
2. Cooperatives registered under theconventional state-level cooperative acts, thenational level Multi-State CooperativeSocieties Act (MSCA 2002), or under the newState-level Mutually Aided CooperativeSocieties Act (MACS Act);
3. Section 25 Companies (not-for profit);4. For-profit NBFCs; and5. NBFC-MFIs.
Table 1 tabulates the major regulationsapplicable to NBFCs as stipulated by the RBI. Majorregulatory aspects include priority sector lending,deposit mobilisation, access to capital, the MoneyLending Act, and state level regulations.
Priority Sector Lending: Priority sector lending is agovernment initiative which requires banks toallocate a percentage of their portfolios to investment
Table 1: MFIs by Type of RegistrationCategory Type of MFI RegistrationNot for NGO MFIs: Societies Registered under SocietiesProfit & Trusts (500) Registration Act, 1860
and / or Indian Trust Act 1882
Section 25 Section 25 of CompaniesCompanies (10) Act, 1956
Mutual Cooperatives (100) Registered under State CooperativeBenefit Societies Act or Mutually Aided
Cooperative Societies Act (MACS) orMulti-State Cooperative SocietiesAct, 2002
For-Profit NBFC (50) Companies Act, 1956 & registeredwith RBI
NBFC-MFI RBI Circular, May 2011
Source: M-CRIL Microfinance Review 2010, http://www.m-cril.com/Backend/ModulesFiles/NewsEvents/M-CRIL-Microfinance-Review-Nov2010.pdf
NBFCs can receive both equity and debtinvestments. They can raise foreign equityinvestment, though a minimum investment restrictionrequirement of US$500,000 applies, also with a capof no more than 51 percent stake in the institution.Grants and subsidised onward-lending funds fromdomestic and foreign sources are not restricted,provided that the foreign grants do not exceed theceiling of US$5mn per year.
Money Lending Act: The Indian Moneylenders Act1918 has been adapted by various state governmentsto restrict interest rates charged by moneylenders.Although the primary purpose of this act is to protectthe vulnerable section from usurious interest rates thatmoneylenders charge, some states have applied theact to Societies and Trusts also to restrict their lendingactivity. Other states have applied the MoneyLending Act to other forms of MFIs.
State Level Regulation: In late 2010, the AndhraPradesh government enacted the Andhra PradeshMicro Finance Institutions (regulation of moneylending) Ordinance, which was later enacted in toAct, to regulate the activities of MFIs. The Act stopsMFIs from collecting old loans and originating newloans until the institution registers with the districtauthorities where they operate. The Act alsomandates an interest rate cap such that the totalinterest charge cannot exceed the principal amountof the loan. The Act also entrusts a great deal ofdiscretionary power to the registering authorities andimposes restrictions on collection practices.
Regulation by the RBI and Money LendersLegislations
Microfinance entities have approached the courtsto resolve the issue of dual regulation3 by the RBIand under the State Level Money Lenders Legislations.These microfinance entities contend that an NBFCengaged in microfinance operations, if it has registereditself under RBI norms, should be exempt fromregistration under the state money-lending norms.This is because certain aspects pertaining to thefunctioning of the NBFCs such as procuring a licence,the regulation of levy of interest and rate of levy ofinterest would be subject to dual regulation ifexemption from state-money-lending legislations isdenied.
State-wise, there are two questions which have tobe answered to predict whether the issue of conflictbetween a State Money Lenders Act, and the RBInorms will be resolved in the same fashion: the issueof dual regulation, and specifically, whether RBI
norms (such as the Fair Practices Code) willencompass the regulation of interest by the RBI. Thesecond facet is critical in determining the profitabilityof operation because the interest rate prescribed byState Level Money Lending legislations is so low asto render the enterprise unviable.
The High Court of Kerala opined that the RBIAct and the State Money Lenders legislation dealtwith two different spheres and no exemption couldbe granted to entities which were registered undereither legislation. On the contrary, an attempt tobalance the conflict between state legislationsprescribing conditions of levy of interest, and theRBI norms was made by the Gujarat High CourtJudgment. Though money-lending may be regulatedby a State Act, but an NBFC, as an entity, itsoperation is dealt with by the RBI. It is only ajudgment by the Supreme Court which will dispelprominent doubts over this issue.
The RBI had addressed the issue of interestregulation through the Fair Practices Code andcorresponded with the respective state governmentsto assert that it should be given a clear reign overNBFCs, and to advocate that NBFCs dealing withmicrofinance operations should be exempt fromregistration under the State Money Lenders Act.However, certain state governments refused to regardRBI submissions that NBFCs should not be subjectto dual regulation by both the Centre, and the StateMoney Lending legislations. Certain stategovernments feel that this decision was a matter ofState policy.
Policy InitiativesUnder the Microfinance Institutions
(Development and Regulation) Bill, 2012, theCentral Government may, by notification, constitutea Council which is known as the MicrofinanceDevelopment Council to discharge the certainfunctions under the Act. Apart from this State levelMicrofinance Councils and District MicrofinanceCommittees are also formed.
In a perception survey, the majority ofstakeholders (68 percent) were of the opinion thatMFI sector in India needs to be regulated. To controlthe on-going problem of over-borrowing andunsustainable debt of MFIs, majority of therespondents (63.7 percent) suggested that thecreditor should conduct an ability to pay test (knowyour customer exercise) before extending multipleloans.
Regulation of NBFC MFIsNBFC MFIs are subject to the following
conditions: (i) Minimum NOF of M5 crore (if theNBFC is registered in the North Eastern Region ofthe country, the minimum NOF requirement isRs2crore) and (ii) not less than 85 percent of its netassets4 are in the nature of qualifying assets5.Theloan is required to be extended without collateral;the aggregate amount of loans which are given forincome generation are not less than 75 percent ofthe total loans given by the MFIs. The income derivedby the NBFC-MFI with the remaining 15 percent ofits assets are to be in accordance with the regulationsspecified in that behalf.6 An NBFC which is not anNBFC-MFI shall not be permitted to extend loansto the micro-finance sector which exceeds 10 percentof its total assets.7
Capital AdequacyCapital adequacy requirements are used by nearly
all countries to reduce the leverage and thus risk ofMFIs that are subject to prudential regulation. InIndia, NBFC-MFIs shall maintain a capital adequacyratio consisting of Tier I and Tier II Capital whichshall not be less than 15 percent of its aggregate riskweighted assets. The total of Tier II Capital at anypoint of time shall not exceed 100 percent of Tier ICapital.
Pricing of Products All NBFC-MFIs are required to maintain an
aggregate margin cap of not more than 12percent.
The interest on individual loans is not toexceed 26 percent per annum and is to becalculated on a reducing balance basis.
The processing charges must be less than 1percent of the gross loan amount. Theprocessing charges are not required to beincluded in the margin cap or the interest cap.
When NBFC-MFIs are engaged in the provisionof insurance services, the NBFC-MFIs can onlyrecover the actual cost of insurance for thegroup, livestock, health, for both the borrower,and the spouse. The administrative charges areto be recovered per the IRDA guidelines.
Fair Practices in Lending The three components which are taken into
consideration in the pricing of the loan are (i)interest charge, (ii) processing charge and (iii)insurance premium. NBFC-MFIs areprohibited from collecting a security deposit/margin from the borrower.
The effective rate of interest which is chargedby the NBFC-MFI will be displayed in all itsoffices, its website, and the literature issuedby the entity.
NBFC-MFIs are not permitted to collect apenalty on a delayed payment.
Other practices A standard form of a loan agreement is required
to be used. NBFC-MFIs are required to ensure that the
modes of recovery are non-coercive. They arerequired to ensure that a Code of Conduct isimplemented which incorporates the principleson Fair Practices as issued for NBFCs videcircular CC No. 80 dated September 28, 2006.
Multiple Lending, Over-Borrowing and GhostBorrowers.
NBFC-MFIs can lend to borrowers who arenot members of more than one Self Help Groupor Joint Liability Group.
Not more than two NBFC-MFIs should lendto the same borrower.
A minimum period of moratorium which isnot less than the frequency of repaymentshould operate between the grant of the loanand the due date of the repayment.