RBI microfinance proposals those are anti-poor

Syllabus: General Studies Paper 3

Context:

In June 2021, the Reserve Bank of India (RBI) published a “Consultative Document on Regulation of Microfinance”. 

• While the declared objective of this review is to promote the financial inclusion of the poor and competition among lenders, the likely impact of the recommendations is unfavourable to the poor. 
• Microfinance means providing small loans (microcredit) to very poor families to help them engage in productive activities or nurture their tiny businesses. 

Key recommendations of the RBI document

• The current ceiling on rate of interest charged by non-banking finance company-microfinance institutions (NBFC-MFIs) or regulated private microfinance companies needs to be removed, as it is 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. 
• The RBI did not mention any initiative to expand low-cost credit through public sector commercial banks to the rural poor, the bulk of whom are rural women (as most loans are given to members of women’s groups).
• It also proposes to de-regulate the rate of interest charged by private microfinance agencies.
• According to current guidelines, the ‘maximum rate of interest rate charged by an NBFC-MFI shall be the lower of the following: 
  • the cost of funds plus a margin of 10% for larger MFIs (a loan portfolio of over ₹100 crore) and 12% for others; or 
  • the average base rate of the five largest commercial banks multiplied by 2.75’. 
• In June 2021, the average base rate announced by the RBI was 7.98%. The “official” rate of interest on microfinance was between 22% and 26% — roughly three times the base rate.

Concerns

• Microfinance is becoming increasingly important in the loan portfolio of poorer rural households. 
  • A study of two villages from southern Tamil Nadu found that a little more than half of the total borrowing by households resident in these two villages was of unsecured or collateral-free loans from private financial agencies (SFBs, NBFCs, NBFC-MFIs and some private banks).
• Unsecured microfinance loans from private financial agencies were of disproportionate significance to the poorest households — to poor peasants and wage workers, to persons from the Scheduled Castes and Most Backward Classes.
• These microfinance loans were rarely for productive activity and almost never for any group-based enterprise, but mainly for house improvement and meeting basic consumption needs.
• High interest rates: Poor borrowers took microfinance loans, at reported rates of interest of 22% to 26% a year, to meet day-to-day expenses and costs of house repair.
  • Whereas crop loans from Primary Agricultural Credit Societies (PACS) in Tamil Nadu had a nil or zero interest charge if repaid in eight months. 
  • Kisan credit card loans from banks were charged 4% per annum (9% with an interest subvention of 5%) if paid in 12 months (or a penalty rate of 11%). 
  • Other types of loans from scheduled commercial banks carried an interest rate of 9%-12% a year. 
• The actual cost of microfinance loans is even higher: This is because every month the principal amount is reduced but the interest charge is the same. 
  • An “official” flat rate of interest used to calculate equal monthly instalments actually implies a rising effective rate of interest over time.
  • A processing fee of 1% is added and the insurance premium is deducted from the principal. As the principal is insured in case of death or default of the borrower or spouse.Aa high interest rate is in response to a high risk of default.
  • The borrowers do not understood the charges.
• Contrary to the RBI guideline of “no recovery at the borrower’s residence”, collection was at the doorstep. Note that a shift to digital transactions refers only to the sanction of a loan, as repayment is entirely in cash. 
  • If the borrower is unable to pay the instalment, other members of the self-help group have to contribute, with the group leader taking responsibility. 

Microfinance in India

• Microfinance, also called microcredit, is a type of banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services.
• In India, all loans that are below Rs.1 lakh can be considered as microloans.
• There are different types of financial services providers for poor people- non-government organizations (NGOs); cooperatives etc.
• Non-Banking Finance Company (NBFC)-MFIs in India are regulated by The Non-Banking Financial Company -Micro Finance Institutions (Reserve Bank) Directions, 2011.
• Priority Sector Lending

• All scheduled commercial banks and foreign banks (with a sizable presence in India) are mandated to set aside 40% of their Adjusted Net Bank Credit (ANDC) for lending to these sectors.
• Regional rural banks, co-operative banks and small finance banks have to allocate 75% of ANDC to PSL.
• Lending by small finance banks (SFBs) to NBFC-MFIs has been recently included in priority sector advances. 

Changing microfinance scenario in India

• Microfinance lending has been in place since the 1990s, but today the privately-owned for-profit financial agencies are “regulated entities” by the RBI. 
• In the 1990s, microcredit was given by scheduled commercial banks either directly or via non-governmental organisations to women’s self-help groups, but given the 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), and a crisis in some States such as Andhra Pradesh, arising out of a rapid and unregulated expansion of private for-profit micro-lending.
• The microfinance crisis of Andhra Pradesh led the RBI to review the matter, and based on the recommendations of the Malegam Committee, a new regulatory framework for NBFC-MFIs was introduced in 2011. 
  • The definition of microfinance itself is proposed to mean collateral-free loans to households with annual household incomes of up to ₹1,25,000 and ₹2,00,000 for rural and urban areas respectively. 

• 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.
• Today 31% of microfinance is provided by NBFC-MFIs, and another 19% by SFBs and 9% by NBFCs. 
• These private financial institutions have grown exponentially over the last few years, garnering high profits, and at this pace, the current share of public sector banks in microfinance (the SHG-bank linked microcredit), of 41%, is likely to fall sharply.

The proposals in the RBI’s consultative document will lead to a further privatisation of rural credit, reducing the share of direct and cheap credit from banks and leaving poor borrowers at the mercy of private financial agencies. To meet the credit needs of poorer households, we need a policy reversal: strengthening of public sector commercial banks and firm regulation of private entities.

The Hindu Link:

https://www.thehindu.com/opinion/lead/rbi-microfinance-proposals-that-are-anti-poor/article36848338.ece