A framework for microfinance regulation that would suit India

Source: Live Mint

Synopsis:  The proposed framework for microfinance regulation by RBI is a great leap forward and reflects bold thinking. Yet, expanding it to cover other elements can usher in responsible retail lending that includes but transcends microfinance.

Background

• The Malegam Committee Report of 2011 helped establish micro- finance as a legitimate asset class,
• After 10 years then, the Reserve Bank of India (RBI) had released its Consultative Document on Regulation of Microfinance in June 2021. This has several bold and fresh elements.
• Public policy would take a huge leap forward if other policy institutions adopt a similar approach on archaic laws and rules.

Evaluation of RBI’s major proposals?

• First, RBI is considering to remove the following
  • Limits on loan amounts, tenures
  • Limits on the number of non-bank finance company-microfinance institutions (NBFC-MFIs) lending to a borrower,
  • Its minimum 50% income-generation requirement,
  • its pricing cap for NBFC-MFI loans.
• These are welcome, given the maturing nature of the sector.
• Second, RBI is considering a common definition for ‘microfinance’ to mean ‘collateral-free’ loans to households with annual household incomes of ₹125,000 and ₹200,000 for rural and other areas, respectively.
  • The feature of equal monthly repayments seems to have been left out.
  • However, it’s not clear whether all other loans to these households, such as agriculture, Agri-equipment and gold loans, housing and two-wheeler loans, will fall outside this definition.
• Third, the idea of assessing household income and formal debt and not lending beyond a debt-to-income cut-off needs more deliberation.
  • According to Dvara Research study of Indian household income, Expenditure as a proportion of income is quite high for the bottom three quintiles.
  • So, providing consumption credit may be unsuitable for a household with, say, 30% debt as a proportion of income.
  • Additionally, factors such as high informal debt, or a high likelihood of health or weather shocks, can render debt unsustainable for households that lack insurance, liquidity buffers, etc.
  • In such a scenario, the 50% cut-off might be too low and push such borrowers towards expensive informal debt.
  • One idea is to define a ‘debt-to-disposable income’ cut-off, lending beyond which will need to be substantiated by lenders.
  • Determining income ranges for various customer segments with the support of industry bodies and using combined bureau reports for loan pricing can lend momentum to sector-wide solutions by the private sector.
• Finally, an overarching set of principles to prevent mis-selling by retail lenders is missing in our regulatory lexicon.
  • The European Banking Authority’s Guidelines on Loan Origination and Monitoring, 2020, have clear lender obligations for consumer credit and prohibitions on unsuitable outcomes. These are worth considering for India.