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The proposed harmonisation guidelines are the need of the hour to address the diverse interpretations of regulations by the multiple forms of entities (mostly regulated) involved in microfinance, says India Ratings and Research (Ind-Ra).

The Reserve Bank of India’s (RBI) consultative document on the regulation of microfinance dated June 14, 2021 proposes to include a common definition of microfinance loans applicable to all regulated entities.

In addition, it tries to achieve a common process to arrive at the maximum permissible borrower indebtedness, by doing away with the cap on the number of lenders per borrower and pricing caps.

The proposals have the potential to create a level playing field for non-banking finance companies- microfinance institutions (NBFC-MFIs), while also providing mid and small sized MFIs with the ability to lend profitably.

The current lending caps make balance sheet lending challenging, as some of them have  borrowing costs in the  range from 13%-15% which leaves little space for operating costs and possible credit costs, says Ind-Ra.

Pricing– Positive Implications for NBFC-MFIs: These could have significant, substantially positive implications for NBFC-MFIs, especially for mid and small sized ones which were unable to originate substantially and their commercial competitiveness had significantly reduced once the lending rate came down to 21.5% on account of the price caps.

These price caps were on the basis of Malegam Committee recommendations, given the span and variation in pricing and disclosure mechanisms prevalent before. In addition, only 30% of the microfinance industry was constituted by NBFC-MFIs where the RBI guidelines were mandatory while it was voluntary for the rest.

Most non-NBFC MFIs are not following the RBI price caps for NBFC-MFIs; the proposed harmonisation guidelines could be a positive for NBFC-MFIs in this regard. From the borrowers’ point of view, this could result in increased cost of credit; nevertheless, this borrower segment’s demand and performance are reasonably inelastic to pricing range as it exists now (19%-25%).

Two-lender Norms – Interpretations Unwarranted under Proposed Norms: There were differences in the way two-lender norm was looked at by all regulated entities. Some considered banks as among the two eligible lenders while some were of the view that this was applicable only to NBFC-MFIs. There was also diverse opinions on whether the extant norms include secured NBFCs (gold, two-wheeler etc). The extant guidelines were issued when NBFC-MFIs were the dominant form of financiers in this segment. Many of them converted into or got acquired by banks subsequently. The proposed guidelines focus on assessing borrower income levels; eliminating the two-lender norm.

Income Assessment for Households: The adherence to borrower income levels and borrower indebtedness by non-NBFC-MFIs was not consistent and the proposed harmonisation guidelines could address the same. The aforementioned proposal states that the income assessment should be at the household level. While informally this was in practice with many MFIs, the process and inclusion / exclusion of incomes to be considered for assessment would now be driven a board policy.

However, this could also imply that the assessment of income could differ among various lenders and hence there may not be a standard assessment, leaving scope for loose lending standards in case the assessment process is not tight. Payment of interest and principal of all outstanding debt shall be capped at 50% of the household income; the regulator is of the view that this negates the need for specifying maximum permissible indebtedness and clears the confusion around which forms of financiers should be included in the calculations, says Ind-Ra.

Section 8 Companies: Section 8 companies (above balance sheet size of Rs 1,000 million) are dependent for their funding needs on public funds including borrowings from banks and other financial institutions. Due to their interconnectedness with other financial intermediaries, any risk arising out of their business can get transmitted to the financial sector. Hence, Section 8 companies shall be provided six months to register and have the minimum net-owned funds in line with NBFC-FIs which are also proposed to be increased.

Harmonisation Norms – Need of the hour: In last two years, it was observed that there was a wide variation in   disbursement ticket sizes per loan (loans per customer of 1.83 – all India average at end-September 2020), higher for banks by over 30% than those of small finance banks, NBFCs and NBFC-MFIs.

Ind-Ra, in its state-wise ticket size and macroeconomics analysis, has observed that the average outstanding per unique borrower is the highest in West Bengal and Assam, and this has been the case at least for the past three years. Also, Assam and West Bengal are among the top 10 states (by microfinance assets under management across forms of institutions) with per capita net state gross domestic product lower than the national average; this would translate to lower per capita incomes in these states as against the more developed states.

 

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