India pushes for national microfinance rules

India’s central bank experts have called for a nationwide regulatory regime for microfinance institutions – including a cap of 10 per cent to 12 per cent on microlenders’ interest margins – to facilitate the extension of credit to poor borrowers while preventing exploitation.

The proposals, which are likely to serve as the framework for new Reserve Bank of India rules for the sector, come as the microfinance industry struggles to survive an intense regulatory backlash prompted by mounting concern that overlending by aggressive, for-profit microlenders has created serious hardships for the very poor borrowers they claim to be trying to help.

The Reserve Bank of India’s special committee, set up last year to study the microfinance industry and its practices, recommended that microloans to the poor be capped at Rs25,000 ($550) per borrower and employ flexible repayment schedules, with borrowers given a choice as to whether to make weekly, fortnightly or monthly repayments.

Though the committee ruled out any fixed interest rate cap given the “volatile” cost of funds to the industry, it said interest rates on microloans should be capped at 10 per cent over the cost of funds for large microfinance companies and 12 per cent above the cost of funds for smaller counterparts.

Microfinance companies were previously categorised as non-banking finance companies, the regulation of which did not include interest margin caps.

Indian microlenders have, in recent years “made profits which are in excess of what can be considered as reasonable, given the vulnerable nature of the borrowers,” the committee said, adding that microloan recipients need special protection, given their low levels of financial literacy and precarious economic circumstances.

“Borrowers in the microfinance sector represent a particularly vulnerable section of society,” the report said, noting that many live in “an environment which is fragile and exposed to external shocks which they are ill-equipped to absorb”.

Indian microlenders, which had been growing at a blistering pace in the past few years, have been in a tailspin since October, when the southern state of Andhra Pradesh imposed draconian curbs on micro-lenders activities after a spate of suicides by over-indebted borrowers.

Collection rates in the state – a hotspot of microlending – suddenly plummeted from about 98 per cent to only 10 to 20 per cent. Meanwhile, India’s commercial banks, which had been lending aggressively to micro-finance institutions, suddenly froze their credit lines, creating a major credit squeeze on the companies.

But Alok Prasad, director of the Microfinance Institutions Network, which represents India’s 44 for-profit microfinance companies, said he believed the RBI proposals represented a “sound, constructive” basis for the industry to move forward.

“You’ve got clarity, which is crucial,” he said. “With clarity, more regulation and more controls. It’s a package; you’ve got to live with that package. In my view, the industry has to temper and moderate a lot of things it was doing earlier.”

On Wednesday, the RBI also said commercial banks could restructure loans to microlenders without classifying them as bad debts, effectively extending a crucial financial lifeline to struggling microlenders.

It also requested that the Andhra Pradesh state government withdraw its current restrictive law on microfinance institutions, saying the state government’s concerns had been dealt with by its proposals.