Policy Term Paper Anish Final

8/9/2019 Policy Term Paper Anish Final

1/26

A commentary on the microfinance legislations

in India

Anish Shankar Menon

January 20, 2014

Abstract

This paper provides a commentary of the microfinance legislations

in India namely the Andhra Pradhesh Micro Finance (Regulation and

Money Lending) Act, 2011 and the Microfinance Institutions (Devel-

opment and Regulation) Bill, 2012. It also analyses the legislations

and the benefits and costs that they hold for the various stakeholders.

1 Introduction

Microfinance was unregulated by any legislation for most part of its ex-

istence in India. Towards the end of the last decade, the Government of

Andhra Pradhesh (hereinfter the AP Government) passed the Andhra Prad-

hesh Micro Finance (Regulation and Money Lending) Ordinance, 2010 (here-

inafter the Ordinance) and correspondingly the Andhra Pradesh Micro Fi-

nance Institutions (Regulation of Money Lending) Rules 2010 (hereinafter the

Rules). The Ordinance, which later became the Andhra Pradhesh Micro

Finance (Regulation and Money Lending) Act, 2011 (hereinafter the Act)

1


2/26

was enacted as a response to what the AP Government felt was the growing

malpractice of the microfinance industry (MFI) in the State. In 2012, the

Central Government tabled the Microfinance Institutions (Development and

Regulation) Bill, 2012 (hereinafter the Bill) which dealt with the regulation

of the MFI in India. If passed, the Central Act would supersede the State

legislation in matters that are dealt in both legislations.

This paper tries to provide a clause by clause commentary of both the

Act and the Bill.1 It provides a comparative analysis wherein the provision

in the Act is analyzed first followed by the corresponding provision (if any)

of the Bill. The important sections exclusive to the Bill are then studied. In

the latter part, an analysis of the legislations is done and an attempt is made

to understand their impact on the various stakeholders.

2 The legislations at a glance

The Ordinance was promulgated on the fifteenth of October, 2010. The

Act was passed on the first of January, 2011 with retrospective effect from

the date of promulgation of the Ordinance. The Ordinance has twenty four

sections with forty one sub-sections while the Act has twenty five sections

with forty one sub-sections. Both the legislations have fourteen definitions.

The Ordinance and the Act are almost identical except for a minor difference

in one definition. In S 2(d) of the Ordinance, under the definition of MicroFinance Institution, the Ordinance uses the term low income population

while the Act uses the term below poverty line population in the same

definition which is also numbered S 2(d) in the Act.

1Note: Some clauses have b een omitted from discussion if they are simple definitionsor are self explanatory without a need for interpretation. In this matter, the author hasexercised his personal choice and discretion.

2


3/26

The Bill is divided into twelve chapters. It has fifty two clauses and eighty

seven sub-clauses. It has eighteen definitions in S 2.

In the following section, the paper critically comments on each provison

of the Act and the Bill. First the section in the Act is looked at and then

the corresponding clause in the Bill is examined.

3 Commentary

3.1 Preliminaries

Section 1 of both the Act and the Bill provides the short title, commence-

ment and extent of the legislations. It also elucidates the objective of the

legislations. The objective of the Act is to protect the women self help

groups (SHGs) from exploitation by the MFIs in the State of Andhra Prad-

hesh (AP). The Act clearly demonstrates that it was enacted as a reaction

to some event(s) that occurred in the State which expedited the need for,

according to the Government of AP, such a legislation. The title does not

seem to say that the Act is for regulating MFIs in the State. Instead it says

that it was enacted to protect women SHGs from explotation by MFIs. In a

way it assumes that MFIs areprima facieexploitative in nature which paints

such institutions in bad light.

The Bill on the other hand states as its objectives, the development

and regulation of MFIs. It is more broader in scope as it includes all rural

poor and people from certain disadvantaged sections. Another objective is

to promote financial inclusion. Though the Bill might too have been drafted

and floored in haste as a response to the Act, it is certainly more well thought

out.

The Act is applicable to the State of Andhra Pradhesh while the Bill

3


4/26

extends to the whole of India.

Another salient feature of the Bill is that it demonstrates the Central

Governments desire to bring MFIs under the regulation of the Reserve Bank

of India (RBI).

3.2 Definitions

Section 2 of both the Act and the Bill deal with definitions. This section

deals with important definitions in the Act and the Bill. The focus is on

definitions of common terms in the legislations.

Section 2(b) of the Act defines interest. Interest according to the Act

is only the return on the amount lent. However the Bill has a much wider

definition in clause 2(1)(a). It uses the term "annual percentage rate" and

which is an annualized rate of all amounts charged by the MFI including

interest, processing fees, service charges and similar fees. This means that

the MFIs according to the Act can charge higher rates as other fees and will

not be in violation of any provisions. A further reading of the Act shows

that only interest as defined by it is to be displayed. Hence the MFI can still

earn a high margin with fees other than interest in AP. (This is taken care of

by the Rules which defines effective rate of interest that includes insurance

and all other fees.)

Section 2(c) of the Act defines loan. The Bill does not have a definition of

loan but a similar definition for micro-credit facilities exist in clause 2(1)(h)

and clause 2(1)(j)(A) of the Bill. Both cases include advances in cash or

kind. However the definition in the Bill is much more comprehensive. In

fact the Bill defines microfinance activities in clause 2(1)(j) which includes

micro-credit facilities. The maximum loan amount in mentioned in the Bill

to be Rupees Five Hundred Thousand or such sum as may be mentioned by

4


5/26

the RBI. Such a limit is not mentioned in the Act. In a way this shows the

Cenral Governments desire to entrust the control of MFIs to the RBI. The

reason would be driven by the fact that a considerable number of MFIs are

registered as Non Banking Financial Companies (NBFCs) which are already

under the control of the RBI. The Malegam Committee Report that was

a precursor to the Bill was also commissioned by the RBI. A loan would

include guarantees in the case of the Bill. Though not explicit in the Act,

loan could also be construed to include guarantees since the Act includes

payment on account of or on request of another person. Another noticeable

difference between the Act and the Bill is that, in the case of the Act, only

loans given to SHGs are covered. Reading the definition in entirety, it has

to be construed that any person would be either a member or having any

relation to a member of the SHG and not a third party. Such a limitation

however is not placed in the case of the Bill. The impact of this lies in the

fact that the SHG model is one of the many models of micro-credit delivery.The Act affects only the SHG model of business. The other models do not

seem to be covered under it. This is sought to be remedied in the definition

in the Bill.

Section 2(d) of the Act defines a microfinance institution. The defini-

tion of the Act is not complete. It is open to questions of interpretation. For

example it includes a Society registered under the Andhra Pradhesh Cooper-

ative Societies Act, 1964, or the Andhra Pradhesh Societies Registration Act2001 and the like, in whichever manner formed and by whatever name called.

On reading this could be interpreted as being relevant only to societies. It

could further be argued that co-operative societies registered under different

legislations would also not be covered under the Act. It also means that

trusts do not fall within its ambit. All other microfinance activities such as

5


6/26

microinsurance, pension services and other similar functions generally car-

ried on by MFIs are excluded. Only MFIs that lend to the below poverty

line (BPL) population are included in the definition. The difference between

a person below the poverty line and just above it in most likelihood is neg-

ligible. It could be inferred that the BPL status is determined by whether a

person holds a BPL card or not. This means that if the MFI lends to persons

without the BPL card are excluded from the definition. The definition uses

includes person. This could be construed as having the same meaning as

S 2(31) of the Income Tax Act, 1961. This means that even individuals are

included under this definition. The implication of this is that unregistered

moneylenders are also included under the ambit of the Act if they lend to the

SHGs as defined under the Act. However if such a reading of the definition

of person is made then trusts are also included. The Bill has a much more

clearer definition under clause 2(1)(i) and enumerates the forms of organiza-

tions that can be considered to be MFIs. It explicitly excludes individualswho are registered moneylenders. It extends the breadth of the definition by

allowing the RBI to declare such institutions to be MFIs as it may deem fit.

Hence if the RBI so wishes, unregistered moneylenders too can be covered

under the definition in the Bill.

Section 2(g) of the Act defines registering authority. The project director

of District Rural Development Agency and of MEPMA is the registering

authority in case of rural and urban areas respectively. The district collectormay nominate a registering authority under his discretion also. In the Bill,

no such definition exists. However under clause 14 of the Bill, registration

must be done with the RBI as per regulations specified. In both cases MFIs

would be subject to multiple statutory requirements. For example a company

carrying on microfinance business would be governed by the Companies Act,

6


7/26

1956 and also the Bill. This would increase compliance and reporting costs

significantly.

Section 2(h) of the Act defines registration to mean registration of MFIs

under the Act. No corresponding section exists in the Bill but as mentioned

above S 13 of the Bill says that MFIs cannot conduct business without regis-

tration and clause 14 as mentioned above assigns the RBI as the registering

authority.

Section 2(i) of the Act defines defines a Self Help Group (SHG). Accord-

ing to the Act, an SHG has a few features. First, it should be formed by

women on principles of self help. It should also be registered aa SHG with

the Society for Elimination of Rural Poverty (SERP) in the rural areas and

the Mission for Elimination of Urban Poverty in Municipal Areas (MEPMA)

in urban areas. The Act targets a particular section of the people i.e., the

Government sponsored SHGs. What this means is that if the SHGs consist of

male members and/or is not registered under the aforementioned programsthen it is not covered under the Act. Though microfinance is predominantly

targeted at poor women, men too fall under its purview. The Bill therefore

does not define what a SHG is.

Section 2(j) of the Act defines SHG Bank Linkage. This is simply the

credit provided by banks to SHGs based on a micro credit plan prepared by

the SHGs for business activities. It thus does not include personal loans.

This also in a way suggests that MFIs are facilitators who essentially actas intermediaries between the bank and the SHG and nothing else since

the economic plan must be developed by the SHG. The definition has no

mention in the Act apart from being defined and seems superfluous. A similar

provision does not exist in the Bill.

Section 2(k) of the Act defines a SHG member. Read in conjunction with

7


8/26

S 2(i) this would be a woman who is registered with the SHG and intends

to borrow though it. This clause causes some confusion as the SHG has to

be registered as per S 2(h) with the concerned authority. The registration of

the member would then be a second level of registrations where the member

registers with the SHG. The process of registration and documents for proof

of registration have not been mentioned in the Act. The Bill has a similar

definition of client under clause 2(1)(b). The definition includes members of

SHGs, MFIs or any other groups thus making it broader than the definition

in the Act. The client has to be a member of the institution only amd

registration is not compulsory. Also, in contrast to the Act, both men and

women can be clients.

3.3 Registration

Section 3 of the Act deals with registration of MFIs. Section 3(1) of the Act

requires that the MFIs in existence apply for registration within thirty days

of the commencement of the Act with the registering authority. They have

to furnish information of among other things of the interest rate that they

would charge. This interest rate cannot be called the effective interest rates

according to the Act since it only includes a return on the amount lent as per

the definition of the Act and does not include any fees or ancilliary charges.

However this lacunae has been solved by the Rules that defines effective rate

of interest to include all other charges. The MFI also has to provide details

of how it would conduct due diligence, recovery of balances and other similar

information. It also has to provide a list of people involved in collecting and

recovery of the loan amounts. This part of the provision is unclear since if

one were to interpret this provision broadly then everyone in the MFI would

be in the activity of lending and recovery of funds. If this was interpreted in

8


9/26

a narrow perspective then this would mean the people involved in the lower

levels where the loans are actually disbursed and recovery made. In either

case the exercise is futile since a reasonably high level of employee turnover

may be expected in a MFI and the Act does not indicate that any change in

employees should be notified to the registereing authority. Hence both the

rationale and efficacy of this part of the provision is questionable. Chapter V

of the Bill in entirety deals with the registration of the MFIs. As mentioned

earlier the registration authority is the RBI. Clause 14 of the Bill deals with

registration. An important point to note is that the section furthers the con-

fusion created in clause 2(1)(j) of the Bill. Clause 2(1)(j) defines microfinance

services wherein it not only includes micro credit facilities but also pension

and insurance services among other services. Pension is regulated by the

Pension Fund Regulatory Development Authority (PFRDA) while insurance

is regulated by the Insurance Regulatory Development Authority (IRDA).

Service providers would therefore need multiple registrations.Section 3(3) of the Act essentially means that the registration granted is

for a period of one year and has to be renewed after the end of the period.

A similar renewal is not envisaged in the Bill. The renewal would add to the

complexity and cost of operations of the MFI.

Section 3(4) of the Act deals with the grant of renewal of registration of

the MFIs. The provision says that the decision to renew or not will be takena

after assessing the performance of the MFI and after hearing objections ifany from the general public regarding the renewal. This provision could be

subject to a lot of misuse since according to it virtually anyone could object

the renewal of registration of the MFI. No corresponding provision exists in

the Bill.

Section 4 of the Act deals with the registering authoritys maintenance

9


10/26

of registers of all the MFIs under its jurisdiction. On reading the Rules, the

register (every jurisdiction will have only one register) contains a list of all

MFIs in that jurisdiction along with some relevant information like registered

address, area of operation etc. This register is open to the general public for

inspection. This provision is quite welcome since it provides all the important

information as regards MFIs at a single place. No corresponding provision

exists in the Bill.

Section 5 deals with the registering authoritys power to suspend or cancel

registration. Such suspension can be enforced for violation of any of the

provisions of the Act. This too is a provision that can be misused. The

registering authority can, suo moto or upon complaints of the SHG or its

members or on the complaints of the general public, suspend or cancel the

registration of the MFI after providing sufficient reasons and allowing the

MFI to be heard. This means that the registering authority can entertain

complaints made by anyone and initiate action against the MFI. Anotherprovision that is a cause of worry is S 5(2) of the Act which empowers the

regisration authority to suspend registration pending enquiry. Rule 11 of

the Rules that deal with the suspension seems unclear. According to it, the

suspension will be effected after giving the MFI the reason for suspension.

The suspension will then be followed by a notice and the enquiry will be

finished within fifteen days of providing the reason(s) for suspension. The

notice shall be issues as per Rule 10(2) which gives fifteen days for the MFIto show cause. This means that there are two distinct documents that the

registering authority will send to the MFI. The first being the statement

of reasons and the second being the notice. Neither the Act nor the Rules

lay down as to within how many days would the notice be sent after the

statement of reasons is send. The term immediately seems vague. It would

10


11/26

be better if a time for sending the notice after the statement of reasons is

fixed. Section 16 of the Bill deals with cancellation of registration and is

much more well drafted. No suo moto action by the registering authority is

prima facieenvisaged and clear conditions are laid out as to why cancellation

of registration may take place. Another point of difference is that in the Bill,

an aggrieved MFI has a clear method by which it could appeal against the

suspension or cancellation of its registration. Such a provision does not exist

in the Act. The Act however proposes the setting up of fast track courts for

the disposal of microfinance related cases in clause 15.

3.4 Matters relating to functioning of the MFI

Section 6 of the Act prohibits membership in more than one SHG. This

would limit obligations to multiple parties. In case of existing multiple mem-

berships, the member can choose the SHG she wants to be a member of

and can send a notice(s) to the SHG(s) whose membership she wants to

terminate. The member must then settle the amount(s) outstanding to the

SHG(s) whose membership she has terminated within three months from the

commencement of this Act. This provision could cause a lot of hardship for

the member. Suppose a member has loans of |15,000 each from four SHGs

which she took a day before commencement of this Act. This provision would

essentiall mean that she would have to repay |45,000 within three months

which otherwise might have had a longer tenure. No similar provision exists

in the Bill.

Section 7 of the Act states that the MFIs must not obtain any security

from the member. Any security already obtained will stand released forth-

with. An objective of microfinance was to provide loans to people who did

not have security. Hence this provision is in the spirit of microfinance lending

11


12/26

as envisaged by its founders. According to clause 2(h) of the Bill, a micro

credit facility is defined as a loan, advance, grant or guarantee without secu-

rity. Hence this provision of the Act is welcome. No similar provision exists

in the Bill.

Section 8 deals with the public display of the interest rates by the MFIs.

Read in conjunction with Rule 14 of the Rules, the interest rate means the

effective interest rate. This is a welcome provision since the members would

be able to choose the MFI based on interest rates. A similar provision exists

in clause 26(3) of the Bill where the MFI has to clearly convey the annual

percentage rate to the borrower and this should be clearly mentioned in the

loan document or sanction letter as the case may be.

Section 9 of the Act is essentially the restatement of the rule ofDamdupat

as stated in the Hindu law. This means that the MFI cannot recover interest

more than the principle amount. The maximum ceiling amount of the total

repayment of principle and interest is capped at twice the amount of theprinciple. Any excess amount so recovered has to be refunded to the bor-

rower and such borrower will stand discharged of the loan. No corresponding

provision exists in the Bill.

Section 10 of the Act prohibits further lending to an SHG or its members

without prior permission from the registering authority. It is true that this

provision will prevent further indebtedness of members. However this would

also delay loans to members who have a good track record and who requirefunds urgently. Coupled with the fact that the members are prohibited from

joining multiple SHGs, this provision could cause distress in genuine borrow-

ers. The procedure laid down in the Act for the top-up loan is long-winded

and would cause distress to the members who would in most cases require the

loan urgently. The MFI would be better equipped to assess the creditwor-

12


13/26

thiness of its members and should be given freedom in topping up existing

loans without permission subject to a cap. No similar provision exists in the

Bill.

Section 11 of the Act deals with the form of contracts between the mem-

bers and the MFIs and the books to be maintained by the MFIs. The provi-

sion read along with Rule 20 of the Rules states that the terms would include

the repament of the loans in instalments whose periodicity is not less than

one month. Therefore the usual weekly repayments are prohibited. The in-

terest too is calculated on a diminishing balance basis. Many MFIs used to

calculate interest on the total amount, add the same to the principle and

divide it into weekly instalments. The method envisaged by the Act would

therefore reduce the interest received by such MFIs. The MFI has to main-

tain a cash book and a ledger recording its transactions. A similar provision

exists in clauses 18 and 19 of the Bill. A formal set of books of accounts are

to be maintained by the MFI that would be subject to audit by a CharteredAccountant or any other qualified person as determined by the RBI. The

RBI too has powers to inspect the books of accounts.

Under Section 11 of the Act, the MFI must also provide a statement to

the borrower that clearly shows all terms of the loan within seven days of the

loan being made. It must also provide receipts for repayments that are duly

acknowledged by the borrower. Any document relating to the loan must be

provided to the borrower if she makes an application in writing free of cost(Rule (22)). Collection of repayments must be made at a public place. It

also prevents the deployment of recovery agents to recover the loans. Only

those employees mentioned in Form 1 are allowed to recover loans under

the provisions of the Act.2 A similar provision in the Bill is clause 25(2)(n)

2Rule 24. Form 1 refers to the form in which the list of persons responsible for theconduct of the business is to be provided to the registering agency and the problems

13


14/26

where the RBI can direct the MFI to disclose its acting as an agent for loan

collection. However there is no provision that asks the MFI to provide a list

of employees who are engaged in the activities of lending and recovery.

Section 12 of the Act makes it mandatory for the MFIs to submit a

monthly statement with information regarding borrowers, the amount lent

and the interest charged. A similar provision exists in clause 23 of the Bill.

However the periodicity of the returns and its contents are not specified. 3

Section 13 of the Act provides powers to the registering authority or any

officer authorized by him to call for records, enter the premises of the MFI,

search and seize any record and document. These are standard provisions

usually found in land revenue and tax laws and give wide powers to the

authority authorized to exercise it. Sections 100 and 102 of the Code of

Criminal Procedure, 1973 apply to the search and seizure. According to

Rule 26 of the Rules, witnesses can be summoned in accordance with the

relevant provisions of the Code of Criminal Procedure, 1973 and ChapterX of the Land Revenue Act as the case may be. Two issues are of note in

this section. First is an example of careless draftsmanship. It should have

been record ordocument and not record anddocument. Second, the Act

should have provided for the number of days the seized documents could

be kept with the registering authority. Similar provisions exist in clause 27

(4)and (5) of the Bill. However powers of search and seizure are not provided

under the Bill. This might be incorporated at a later date or mentioned inthe rules that might be framed after the Bill has received assent.

Section 14 of the Act empowers the SHG, its members and any member

of the general public can register a complaint regarding any violation of the

associated with this has already been discussed while analyzing S 3 of the Act.3However the first return according to clause 23 of the Bill has to be filed within 90

days of the commencement of the Act (the Bill when passed).

14


15/26

provisions of the Act by an MFI with the registering authority. According

to Rule 28 of the Rules, this complaint has to be made in writing or over

the toll free phone specially provided for this purpose and an enquiry will be

made within seven days of registering the complaint. As mentioned earlier

in another instance, allowing the general public to register a complaint can

lead to a misuse of the provision. Grievance redressal is given under Chapter

IX of the Bill and the grievance redressal mechanism is yet to be formulated.

A marked difference between the Act and the Bill is that while in the Act,

proceedings may be initiated by the registering authority suo moto or on a

complaint by a member of the general public, in the Bill, no court will take

cognizance of an offence only on a complaint by an officer or any other person

authorized by the RBI. This would prevent a lot of vexatious litigation to

which the Act would be prone.4

Section 15 of the Act deals with the establishment of Fast Track Courts

to settle disputes between SHGs and its member, or the SHG and the MFI orthe members of the SHG and the MFI with regard to loans granted under the

Act. These courts are to be established in every district and its jurisdiction

determined. The cases have to be disposed off by the fast track courts within

a period of three months. The Act however does not mention as to where

the appeal from a fast track court lies. Hence assuming that the appeal lies

to the district court, then an additional three months is added to the legal

process. A similar provision does not exist in the Bill.Section 16 of the Act deals with penalties for coercive measures. On

reading it seems that only those who actually have been party to coercive

practices shall be prosecuted. Coercive practices against the SHGs, members

or their family members are liable to be punished. The term family mem-

4However in order to protect the interest of the clients, the Bill also classifies offencesrelated to the acceptance of thrift (defined later in the paper) and repayment as cognizable

15


16/26

bers is not defined and could lead to confusion. The term coercive action

is defined in this section. It includes among other things three clauses that

are loosely defined. One is doing any act calculated to annoy or intimidate

the second is frequenting the house or other place where such person resides

or works while the last is moving or acting in a manner which causes or is

calculated to cause alarm or danger. These clauses should be read in the

light of the fact that even a member of the general public can file a complaint.

This makes the clauses quite dangerous since misuse could be rampant. The

provision has a saving clause that exempts visits for collection or communi-

cation from the purview of this definition. However the onus of proving that

the visit was for the abover purpose would rest on the employee of the MFI

and would be quite difficult to establish in a court of law. The quantum of

punishment is a fine upto |1,00,000 and/or prison upto three years. Section

17 provides the same quantum of punishment for conducting the business

without registration or giving loans in contravention of the Act. However inS 17, all persons responsible for the day to day affairs are liable for prose-

cution. Normally a saving clause exempting those acting without knowledge

and in good faith is provided after such a provision but there is none in the

Act. Section 18 deals with a general penal provision for contravention of any

other provision of the Act. The quantum of punishment in a fine of|10,000

and/or imprisonment upto six months. Rule 29 of the Rules further allows

the officer in charge of the local police station to take action for contraven-tion of S 16 and/or S 17 either on complaint or suo moto. Chapter X of

the Bill deals with offences and penalties. The fines in the Bill are much

larger than those in the Act but the period of imprisonment is slightly less.

Coercive action is not defined in the Bill. Penalty for wilful misstatement,

furnishing wrong information and similar actions are similar to those in other

16


17/26

legislations. It is only when the rules for the legislation as enacted by the

Parliament are framed that the full list of offences will be clear.

Sections 20 to 23 of the Act are standard and protect officers who act

in good faith from prosecution, allow the Government to make and modify

rules etc. Section 24 of the Act requires that the Government prepare an

annual report on the administration of the Act which shall be tabled in the

Parliament. This would provide some accountability for the actions of the

Government especially in a law such as this which gives it sweeping powers.

There is no requirement in the Bill to prepare a report and present it in

Parliament. A reason for this could be that since the RBI is envisaged as

the authority responsible for the implementation of this legislation, it would

exercise adequate control over the operations of the MFIs. Similarily Chapter

XII of the Bill that deals with the miscellaneous affairs have provisions similar

to that of the Act in regard of the powers of the Central Government which

are quite standard.

4 Important provisions of the Microfinance

Bill in detail

The Bill follows a standard template in many ways. For example chapters II,

III and IV that deal with the institutional framework of microfinance admin-

istration follows a three tier approach similar to co-operative banks. Chapter

II deals with the establishment of the Micro Finance Development Council

(MFDC). The chairman is to be nominated by the Central Government while

the requirements for the other members are also laid down. The State Micro

Finance Council (SMFC) and the District Micro Finance Council (DMFC)

as provided for in Chapters III and IV also have similar structures suitably

17


18/26

scaled to their respective levels of functioning. The MFDC however has a

more advisory role while the other two have some implementation, supervi-

sory and reporting obligations. A noteworthy point in the case of the DMFC

is as per clause 10 of the Bill, a representative of the lead bank is to attend

the meetings of the DMFC. A lead bank is defined in that clause to mean

a lead bank as assigned in the Lead Bank Scheme of the RBI. This again

shows the intent of the Government to link MFIs with the formal banking

system at a very fundamental level.

Chapter VI deals with provisions regarding reserves, accounts, audits

and returns. The audit provisions are standard. However the RBI has been

authorized to specify a percentage of net profits earned by the MFIs from

micro finance services to be transferred to a reserve. This accumulation would

in the future protect the clients of the MFIs. Since it is a reserve under the

RBI, MFIs would not fail to transfer the amount into the same.

Chapter VII provide detailed and sweeping powers to the RBI. Theseinclude setting a cap on the margin and annual percentage rate.5 Further if

the RBI feels that the MFI is conducting business detrimental to the interests

of the clients then the RBI can virtually dictate all the business activities

of the MFI inclduing ceiling on number of clients, amount of micro credit

facilities, deployment of funds, locations and so on. Every aspect of the

business is included. In effect the RBI can run the MFI business in totality if

it feels that the business is run prejudicial to the interests of its clients. Suchpowers can be justified in case of emergencies. However allowing the RBI to

fix a cap on the margin (effectively the profit) of the MFI seems unjustified.

All amalgamation and restructuring of the business would be done only if

the scheme is approved by the RBI. The Bill also talks about the conditions

5Annual Percentage Rate has been defined above. Margin will be defined later in thepaper.

18


19/26

under which a MFI has to wind up its business.

Chapter VIII gives the details of the Micro Finance Development Fund

to be administered by the RBI and used for the development of microfinance

activities. The Central Government could encourage donations to this fund

by providing tax incentives for the donations.

Chapter IX deals with the dispute redressal mechanism. It is still not

comprehensive and only states that the ombudsman established under any

scheme of the RBI will be given the authority to deal with the disputes

related to microfinance.

Chapter X deals with offences and penalties. The maximum imprison-

ment is two years. However the fines are very large as in clause 34 where the

fine could extend to |5,00,000 and extend to |10,000 for every day the offence

continues. In addition, the RBI too can impose a fine that may extend to

|5,00,000.

Chapter XII deals with miscellaneous provisions. A particular provisionof note is clause 43 that specifies that member or clients of the MFI have

first charge over the assets of the MFI and shall be second in line to recover

their dues after the workmen of the MFI in case of any default.

A few definitions are of particular interest.

Clause 2(1)(h)defines margin. Margin is the difference between the cost

of funds and the annual percentage rate charged. The RBI has, through

powers conferred upon it, a right to set a limit on the margin. This essentiallyis setting a limit on the profitability of the MFI. This would reduce interest

in MFIs as an interesting business opportunity. It has to be noted that as

per the Bill, the MFIs will operate in a highly regulated regime and would

spend a considerable amount on time and resources on compliance. The

Government must reconsider this as limiting profitability does not seem a

19


20/26

reasonable step by the Government.

Clause 2(1)(j) defines microfinance services. It fixes the maximum limit

on a single individual borrower at |5,00,000 in normal cases and |10,00,000 in

exceptional cases. It also includes activities pension and insurance, domestic

remittances and thrift. Thrift is again defined in clause 2(1)(r) as any money

collected by MFIs from its members other than current account and deman

deposits. The definition is not quite clear but broadly referes to some sort

of savings that are made by its members. Hence in a subtle manner the Bill

also includes collection of deposits by MFIs in its definition of microfinance

services. However the RBI strictly regulates collection of deposits by Non

Banking Financial Services. The RBI may therefore propose a new structure

to govern the MFIs.

5 An analysis of the legislations

Microfinance is a medium for financial inclusion. The neccesity of legal pro-

tection is mainly due to the nature of the consumers of microfinance services.

A vast majority are not highly educated, have few or no assets and are ex-

tremely vulnerable to exploitation. The business model of microfinance is

built on mutual trust and supervision and hence the borrowers under soci-

etal pressure will repay the loans.

On the other hand the lenders (MFIs) too face huge risks in the conven-tional sense. Almost all the clients are those that are at the fringes or beyond

of the conventional banking system. They do not have collateral and hence

any loan made is not guaranteed. Promissory notes are in most cases insisted

upon but their utility is more symbolic and less practical. The MFI has no

further recourse in most cases if a client does not pay.

20


21/26

Hence any legislation must include the interests of both these stakehold-

ers.

The first question would be is regulation necessary? Though most will

be of the opinion that such an industry as microfinance has to be regulated,

there might be some who think otherwise. According to Cull, Demirg-

Kunt and Morduch (2009) 6, regulation moves microfinance institutions into

being banks. This means that the loan sizes on average increase and women,

who were the primary beneficiaries of microfinance, receive lesser loans. The

Government therefore has to see that microfinance institutions continue to

serve their target consumers.

There are many aspects to the analysis. Firstly, who will be the regu-

lator of the MFIs? The Act has instituted the Registering Authority for

monitoring and implementation of the legislation. The Bill puts this onus on

the RBI. A seperate body focussed exclusively on the implementation of the

Act is beneficial to the clients. However in the case of the Bill, it is difficultto hold RBI responsible for the functioning of the MFIs. The problem is

twin-pronged. First, the RBI is the super regulator of the financial system

especially banks and hence should not be burdened with micro-management

of institutions. A seperate body may be set up for the same. Second, with

the RBI oversight, MFIs are accorded the nature of pseudo-banks, which

they are not. It must not appear that MFIs are bank-like institutions. In

the criticism of the Bill, the Government of Andhra Pradhesh notes that theBill describes MFIs as extended arms of banks. MFIs are for profit insti-

titions and must therefore not be confused with banks just because they are

6Robert Cull, Asli Demirg-Kunt and Jonathan Morduch (2009), Does RegulatorySupervision Curtail Microfinance Profitability and Outreach?, Policy Research WorkingPaper 4748, The World Bank Development Research Group Finance and Private SectorTeam

21


22/26

associated with them.7

An important requirement of a financial institution is capital adequacy.

The Act is silent on it. This means that any person can start a MFI and

operate in Andhra Pradhesh (AP) without having adequate capital to cover

its loans. NBFCs have a minimum capital prescribed by the RBI. However

other forms of organizations do not. It might be true that the Act is quite

strict towards MFIs and prescribes severe punishments for transgressions, it

however does not have a mechanism by which capital adequecy is assured.

Due to this investors might not be willing to provide capital to MFIs. The

Bill on the other hand takes care of this problem by mandating the RBI to

prescribe the capital adequacy requirements for the MFIs.

Asset quality is another important factor in the case of financial institu-

tions. Non-Banking Finance Companies (NBFCs) have asset quality require-

ments that are overseen by the RBI. However other forms of organizations

have no such requirement mandated upon by them by the respective legis-lations that govern them. Unifying the structure of organization will bring

uniformity to this matter. This would also benefit the MFIs since those banks

and investors who provide them with funds and capital will be reassured of

the strength of their financials.

With regard to conduct of business, the Act is silent in the sense that

it only specifies what is not to be done. In no way does it provide for any

support to the MFIs in the conduct of the business. This stems from the factthat the AP Government believes that the MFIs act against the interest of

the poor as is evidenced in their comments on the Bill. However this model

is unsustainable. If MFIs do not receive adequate support then it will not

be possible for them to conduct business. The contract between a borrower

7?The Micro Finance Institutions (Development and Regulation) Bill 2011: Commentsof Government of Andhra Pradesh

22


23/26

and a lender is a private contract. Undue influence from external forces will

disrupt the delicate foundation on which it is built. If a borrower defaults

on purpose and the law does not protect the lenders interests then there

is a veritable mockery of the principles of equity and justice. On the other

hand the Bill recognizes the fact that there has to be a balance of interests

and hence has provided for the development of the microfinance business as

a whole.

Another contention limited to the conflict between the Central and State

legislation is the Constitutional validity of the Bill. The State argues that

according to List II (item 30), moneylending is a State subject. Though this

argument has some merit, microfinance encompasses credit provising and

includes many other activities in its domain. Hence the argument can be

countered. Another argument is that the Bill expressly excludes MFIs from

the ambit of moneylenders hence impinging upon the States jurisdiction.

This argument is not strong since according to Becker (2013) microfinancewas traditionally kept out of the definition of moneylenders due to which

state governments found it difficult to control.8 Besides most institutions

are not run as sole proprietary firms and are covered under the ambit of one

legislation or the other. The bigger question that the lawmakers need to

think about is how are the poor protected. This can be done by providing

for provisions specifically for the same in the Act and Bill themselves. As a

matter of fact there are many provisions in both the Act and the Bill thatprotect the consumers right from usurious rates of interest to harrasment

from MFIs on issues of collection of instalments.

On the question of interest rates, both the Act and the Bill have different

8Ashley Becker (2013), "Micro-Management": Constitutional and Policy ConcernsArising from Indias Microfinance Institutions (Development and Regulation) Bill North-western Journal of International Law & Business Vol. 33 Iss. 3

23


24/26

points of view. The Act does not have a very comprehensive definition of

interest (a matter settled by the Rules). It also does not speak of interest

rate ceiling. The Bill however provides for interest rate ceiling. According

to the Key Principles of Microfinance enunciated by CGAP 9,interest rate

ceilings are detrimental to the interests of the poor since the interest rates set

by the Government are usually low and the MFIs are not able to cover their

costs. This is a problem where the solution lies in balancing interests and

can only be fulfilled in practical operation. The regulator could give broad

guidelines for interest rate determination but need not fix a ceiling rate. If

this is constantly monitored then a reasonable solution can be arrived at.

On the question of multiple lending both the Act and the Bill have quite

clear provisions. These provisions are necessary since in many cases, micro-

credit is less of a need and more of a liability thrust upon the poor. Multiple

lending institutions provide loans to the same person thus magnifying her

indebtedness. This could be avoided if a central database was constitutedwith the names of every borrower and other basic details. This exercise

could be done in collaboration with a central data collection and processing

agency. This would not only prevent cross-lending but also provide a de-

tailed database for the authorities who can use it to formulate better policies

of financial inclusion.

Both the Act and the Bill explicitly prohibit MFIs from asking for col-

lateral. Microfinance essentially began with the idea of providing loans topeople who could not avail conventional credit for various reasons, one of

them being their lack of pledgeable collateral. Hence the practice of taking

collateral goes against the basic tenets of microfinance and has been done

away with by the respective legislations. However both the Act and the

9Seehttp://www.cgap.org/sites/default/files/CGAP-Consensus-Guidelines-Key-Principles-of-Micpdf

24
http://www.cgap.org/sites/default/files/CGAP-Consensus-Guidelines-Key-Principles-of-Microfinance-Jan-2004.pdfhttp://www.cgap.org/sites/default/files/CGAP-Consensus-Guidelines-Key-Principles-of-Microfinance-Jan-2004.pdfhttp://www.cgap.org/sites/default/files/CGAP-Consensus-Guidelines-Key-Principles-of-Microfinance-Jan-2004.pdfhttp://www.cgap.org/sites/default/files/CGAP-Consensus-Guidelines-Key-Principles-of-Microfinance-Jan-2004.pdf


25/26

Bill though providing for recourse against the lender for coercive practice

does not provide any rules in case the borrower defaults. This could lead to

willful default on the part of the borrower. The law should be fair to both

parties and hence there must be some provision that lays down the rules for

collection and subsequent procedure in case of default.

With reference to various offences including those that deal with usurious

rates of interest and coercive practices of loan collection, the Act is much

clearer than the Bill. It provides detailed descriptions of acts that could

be construed as a violation of its provisions and the penalty for the same.

The Bill however does not provide for the same. It would not be correct in

commenting on the inadequacy of the Bill in this matter since the rules for

the same are yet to be formulated.

The redressal mechanisms of the legislations need a mention. According

to Sane and Thomas (2012) 10 the Bill does not provide recourse to the

aggrieved under the Bill to appeal to the civil and criminal courts withoutthe express permission of the RBI. This point though valid can be argued

against since the aggrieved have their fundamental rights enshrined in the

Constitution to apply under writ to the High Court and Supreme Court.

The Act envisions special fast track courts that would be ancilliary to the

existing judicial system.

The Act and the Bill both represent microfinance legislations enacted (or

to be enacted) to regulate microfinance in India. However there arises aconstitutional issue with AP claiming that the centre has impinged on its

powers of lawmaking. According to Becker (2013), the differences in the two

legislations will not sort out once the Bill is enacted. The Bill is necessary

10Renuka Sane and Susan Thomas, What should regulation do in the field of micro-finance?, IGIDR Working Paper, 2012, http://www.igidr.ac.in/pdf/publication/WP-2012-012.pdf

25
http://www.igidr.ac.in/pdf/publication/WP-2012-012.pdfhttp://www.igidr.ac.in/pdf/publication/WP-2012-012.pdfhttp://www.igidr.ac.in/pdf/publication/WP-2012-012.pdfhttp://www.igidr.ac.in/pdf/publication/WP-2012-012.pdf


26/26

for the microfinance industry in India to flourish, the reason being that it is

an industry with great promise and potential but little governance and reg-

ulation. Considering the nature of business and the customers involved, the

Government must draft a legislation that finely balances consumer protection

and business advancement.

6 Conclusion

Andhra Pradhesh Micro Finance (Regulation and Money Lending) Act, 2011

was in response to the perceived microfinance crisis in AP. The Microfinance

Institutions (Development and Regulation) Bill, 2012 was in response to this

Act. The legislations were knee jerk reactions and hence do not seem to be

quite comprehensive and well drafted. The Bill still needs to be revised and

many changes need to be made. Microfinance is a large business in India

with immense growth opportunities. A well drafted legislation would go a

long way in achieving this potential.

26

Documents

Policy Term Paper Anish Final