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Synopsis: Proposals of RBI’s consultative document will reduce the availability of cheap loans to the rural poor.
Background
In June 2021, the Reserve Bank of India (RBI) published a “Consultative Document on Regulation of Microfinance”. The paper was to promote the financial inclusion of the poor and competition among lenders. However, if the recommendations of the document are implemented, it will result in credit at high rates of interest to the poor, due to the expansion of microfinance lending by private financial institutions.
What are the recommendations?
Current ceiling on the rate of interest charged by non-banking finance company-microfinance institutions (NBFC-MFIs) or regulated private microfinance companies needs to be done away with. It is because the ceilings are biased against one lender (NBFC-MFIs) among the many (commercial banks, small finance banks, and NBFCs.
It proposes that the rate of interest be determined by the governing board of each agency, and assumes that “competitive forces” will bring down interest rates.
RBI abandoned any initiative to expand low-cost credit through public sector commercial banks to the rural poor. The bulk of these beneficiaries were rural women.
it also proposes to de-regulate the rate of interest charged by private microfinance agencies.
Read more – RBI’s proposal for regulation of the Microfinance sector- Explained, pointwise
Trends in Microfinance Loans to the poor section
Microfinance is important in the loan portfolio of poorer rural households. The source and purpose of borrowing differ as per caste and socio-economic class.
Firstly, unsecured microfinance loans from private financial agencies (SFBs, NBFCs, NBFC-MFIs, and some private banks) are important for Poor peasants and wage workers, persons from the Scheduled Castes, and Most Backward Classes.
Secondly, these microfinance loans are used mainly for house improvement and meeting basic consumption needs, instead of any productive activity.
Third, the reported rates of interest of these loans were 22% to 26% a year.
Whereas, the public sector banks and cooperatives are providing loans at much lower interest rates. For example, Kisan credit card loans from banks were charged 4% per annum after interest subvention of 5%.
Furthermore, the effective cost of these microfinance loans is much higher. an “official” flat rate of interest used to calculate equal monthly instalments. It means in the first month, the simple interest on this loan is 15.6% per annum but by the end of the first year, the interest rate is 31%.
In addition, a processing fee of 1% is added, and the insurance premium is deducted from the principal.
Further, contrary to the RBI guideline of “no recovery at the borrower’s residence”, collection was at the doorstep.
How microfinance system has been commercialized?
In the 1990s, scheduled commercial banks used to provide microcredit to women’s self-help groups. But due to lack of regulation and scope for high returns, several for-profit financial agencies such as NBFCs and MFIs emerged.
By the mid-2000s, there were widespread accounts of the malpractices of MFIs (such as SKS and Bandhan). It also led to the crisis in some states such as Andhra Pradesh.
RBI took note of the crisis and, based on the recommendations of the Malegam Committee, a new regulatory framework for NBFC-MFIs was introduced in December 2011.
A few years later, the RBI permitted a new type of private lender, SFBs, with the objective of taking banking activities to the “unserved and underserved” sections of the population.
Now the NBFC-MFIs account for 31% of microfinance, SFBs account for 19% and NBFCs for 9%.
What are the Implications of RBI’s proposal?
As per the present trends, the current share of public sector banks in microfinance (the SHG-bank linked microcredit), of 41%, is likely to fall sharply.
RBI’s consultative document recommendations will lead to further privatization of rural credit. It will reduce the share of direct and cheap credit from banks to the poorer sections.
Source: This post is based on the article “RBI microfinance proposals that are anti-poor” published in The Hindu on 6th October 2021.
