The basic principles of micro finance that distinguishes it from the general credit delivery is its small amounts of loan, lack of physical collateral but emphasis on social collateral or peer monitoring and focus on women borrowers offered for informal economic activities that thrives in local geography. It can potentially pull the poor out of poverty by empowering them to take up small economic activities (street vending, repair shops, petty door-to-door services, providing utilities and many more activities). Such micro activities should be able to generate income for day-to-day sustenance with ability to repay loans in small instalments and borrow again for larger activities. The cyclical economic activities should keep rotating to enhance their plight. Providing low ticket size loans for micro activities who have no means to offer collaterals or proven income levels.
Microfinance sector has witnessed phenomenal growth, more noticeably in the past two decades in terms of increase in both the number of institutions providing microfinance as also the quantum of credit made available to the microfinance borrowers. Microcredit is delivered through a variety of institutional channels viz., (i) scheduled commercial banks (SCBs) (including small finance banks (SFBs) and regional rural banks (RRBs)) lending both directly as well as through business correspondents (BCs) and self-help groups (SHGs), (ii) cooperative banks, (iii) non-banking financial companies (NBFCs), and (iv) microfinance institutions (MFIs) registered as NBFCs as well as in other forms. Due to spate of development and thrust on microfinance, the total loans outstanding under the sector as on September 2020 stands at Rs 2.27 lakh crore and is gaining prominence as a distinct line of business for lenders.
Role of microfinance
It was in 1990s that RBI recognised microfinance as a new paradigm of poverty alleviation. Since then, RBI has been developing the sector as a means to support those who do not have assets to offer as collaterals to borrow from formal financial institutions. Such people continue to remain hostage to landlords and mighty people. They have to pay usurious interest rates to local lenders to meet their small day to day needs. Later on, social groups started forming to work together in groups to undertake micro activities undertaken through Self-help groups (SHG)-Bank linkage programme, which began formalizing during 1990s that could bring microfinance into greater prominence.
In the background of its evolution and growing significance in the economy, RBI came up with guidelines to regulate microfinance to ensure the borrowers are not exploited. RBI move accelerated flow of affordable finance to provide relief to millions struggling at the bottom of the pyramid.
The present endeavour to revise the guidelines began with the introduction of Revised Regulatory Framework for NBFCs – A Scale Based Approach set to become effective from October 1, 2022.
Carrying forward the reforms, as mooted in its Monetary Policy Review of February 5, 2021, RBI reviewed the regulatory framework for Non-Banking Financial Company – Micro Finance Institutions (NBFC-MFIs) to bring about uniformity among all regulated entities in the micro finance space – Scheduled Commercial banks, small finance banks and NBFC-Investment and Credit Companies, rather than prescribing these guidelines for NBFC-MFIs alone.
Highlights of new guidelines:
- Effective from April 1, 2022, the collateral free loans can be given to household microfinance borrowers who have income of up to Rs. 3 lakhs. The annual income criteria were hitherto standing at Rs.1.25 lakh in rural and Rs.2 lakhs for urban and semiurban areas which is now clubbed together.
- All collateral-free loans, irrespective of end use and mode of application/processing/disbursal (either through physical or digital channels), provided to low-income households, i.e., households having annual income up to ₹3,00,000, shall be considered as microfinance loans. Now the base of microfinance loans outstanding will go up as all collateral free loans will be classified as microfinance loans.
- The amount of monthly loan instalment (principal and interest) towards repayment of microfinance loans should not exceed 50 of annual income, including repayment commitments of other loans availed collectively by the household. Each borrower household should be left with 50 percent of income for their own maintenance.
- Neither any collaterals can be obtained nor any lien on their deposits, if any can be marked by the lenders.
- Autonomy is now given to the microfinance lending institutions. Hence, income assessment criteria, basis of fixing interest rates should be on uniform model reflecting cost of funds, risk premium and its basis, servicing and processing charges and all associated pricing factors should be transparent and should be based upon a board approved policy. It will also be subject to regulatory scrutiny.
- Such laid down criteria should be uniformly applied with transparency by disclosing it on website and fact sheet circulated along with the publicity literature. The borrower should be able to understand why his interest rate is fixed at a particular level and what charges are levied and why.
- No penalty can be charged for prepayment of the microfinance loans. Overdue interest if any is to be levied only on the delayed amount and not on entire loan.
- Self-regulatory organisations can get together to evolve common framework based on the indicative methodology outlined in the RBI guidelines.
- A fair practice code must be adopted by the lenders to treat the microfinance borrowers fairly, transparently and uniformly. Loan agreement forms and documents should be based on terms of sanction accompanied by a loan card to be issued to the borrower showing all details.
- The training, the attitude of staff should be built into a supportive team in enforcing recovery of loans without using any bullying tactics. The microfinance portfolio is to be developed on professional lines providing services on fair terms.
Since micro finance is viewed globally as a means of credit-based poverty alleviation and financial inclusion program, the lenders should adopt a proactive approach in supporting lower strata of the society providing microfinance. The modified microfinance guidelines could be the stepping stone in accelerating flow of credit to microfinance sector, particularly coming at a time when the micro units are in the severe grip of crisis in the aftermath of the damage caused by ongoing Covid-19.
It can be a game changer for many ailing sectors of micro enterprises. Based on new guidance, lenders should have commitment to reach out to deserving sectors of the community. The kind of borrower orientation provided in the guidelines is a right balance between allowing regulated entities to do business while the borrowing community commands the attention of the lenders. The care with which the new set of guidelines are articulated, the sector will be greatly benefited and many low-income communities can emerge out of the poverty.
Views expressed above are the author’s own.
END OF ARTICLE