India’s Microfinance Bill Answers Most Questions

by N Srinivasan : Sunday, July 24, 2011

The Government of India promised a new draft microfinance legislation, and it has delivered.  The consultative process adopted, the work done by the Malegam Committee, and the regulations issued by the Reserve Bank of India (RBI) and the participation of the lenders, practitioners and others have made the draft comprehensive and well-rounded.  The Andhra Pradesh statute, despite its debilitating impact on the sector, seems to have triggered this comprehensive response from the Union government.  The need to regulate the microfinance sector in customers’ interest and also the need to avoid a multitude of microfinance legislation in different states has led to this bill which keeps registered microfinance institutions (MFIs) out of the ambit of money lending laws.

The chief features of the bill are that every institution in microfinance should register with the regulator, transform into a company when they attain a significant size, be subject to a variety of prudential and operational guidelines that are introduced by the regulator, provide periodic information to the regulator and face penal action for violation of law or any rules framed. The bill provides flexibility of RBI to apply different measures, vary the same and delegate the powers to regulate to NABARD.

The grievance redressal procedures, mandatory enrollment to credit bureaus and code of conduct enforcement through industry associations will improve customer protection. The creation of national and state councils should provide wider sector participation in policy making.  The proposed microfinance fund that would not only provide grants but also bulk finance to MFIs is a very welcome proposition.

Requiring all institutions, regardless of form, to register as an MFI is a critical and necessary step toward effective regulation.  The reason for excluding cooperative societies accepting deposits from members only from the definition of an MFI is not clear.  There are MFIs which are cooperative in form that deal with members only.  That does not make the members any better protected.  If the cornerstone of the bill is customer protection, it should be extended to cooperative MFIs as well.

National versus state level supervision
While the proposal to set up a strong advisory council at the national level is welcome, the council should be vested with a role in regulation and supervision.  It should be asked to consider periodic reports prepared by the regulator on the state of practice in the sector and compliance with regulation by the institutions.  In addition to other functions described in the bill, the council could perform the functions that Board of Supervision¹  performs in respect of banks.  The State councils are a good way of involving the state governments.  But the councils should be linked to the national council and given a role with content rather than just creating them.  Without a significant role and participation in some manner in the activities of the national council, the state councils will become either defunct or deviant.  The proposal for appointment of an ombudsman is a welcome measure and will boost the industry’s own effort to handle grievances better.

The step of keeping MFIs outside the purview of money lending is a forward looking step that would improve availability of financial services in the hinterland.  Officials in AP have taken exception to a particular provision in the draft bill that seeks to keep MFIs outside money lending law.  This is nothing new, as banks regulated by the Banking Regulation Act are kept outside the purview of state jurisdiction.  Only when the institutions are unregulated and the practice is exploitative and coercive that the States’ powers under money lending Act become enforceable.  The bill introduces regulation relating to form, business, processes, products, pricing and provides a high degree of flexibility to RBI to adopt measures to enforce customer protection practices of a kind not seen in banking regulation.

The requirement of systemically important MFIs to become companies should be strengthened by taking away the option to transform in to a not for profit company under section 25 of companies Act.  The existing regulatory framework of RBI is lenient towards section 25 companies; in fact there is no regulatory effort spent on such companies.  When MFIs become systemically important they should be actively regulated.

Pricing and interest rates
Sections 23 and 24 of the proposed bill contain the substance of RBI’s regulatory powers.  The powers of RBI to issue directions under section 24 are comprehensive and cover almost all aspects of functioning of the MFIs.  For the first time the concept of APR is used in the industry to demystify the pricing of loans. While there seems to be a provision for recognition of  Self-Regulatory Organization of MFIs, the process of recognition has not been spelt out.  The industry associations have a critical role to play in assisting the regulators.  In section 25, the bill has chosen to implement margin caps rather than interest rate caps.  Absolute interest rate caps are anti-market and introduce rigidities.  However RBI has been given the powers to impose an APR cap.  The specific mention of margin cap under section 25 leads one to believe that the margin cap will be imposed across the sector and the APR cap will be used only in exigencies.

An interesting insertion is the possibility of RBI refinance to MFIs.  The proposed Microfinance Development Fund is intended to provide loans, refinance, grants, capital and any other form of financial assistance.  The size of the fund and the RBIs stance on financing microfinance sector will be eagerly awaited.  The refinance facility (whether offered by RBI or arranged through financial institutions) would be a significant step forward for the resource starved sector.

Penalties
The bill proposes penalties for MFIs of a maximum of Rs 5 lakhs (almost $11,000) which seem paltry in comparison with the size of  MFIs and the damage potential of ill-advised actions.  There is a need to raise the maximum penalty and relate the same with the nature of violation of law or regulatory advice, and possibly made proportional to the size of the MFI.  Section 38(1) facilitates RBI to delegate powers under the Act to NABARD.  The wording is carefully done to offer flexibility to RBI to delegate powers in respect of select class of MFIs.  This will ensure that regulatory load can be distributed between RBI and NABARD.  SIDBI could have been brought on board and offered space in regulation.  Perhaps the high level of its financial support to MF sector has restrained the government from including SIDBI on account of the potential for conflict of interest.

Post Andhra Pradesh
Section 42 should provide a sense of relief to the sector reeling from the aftermath of the State legislation on MFIs in Andhra Pradesh.  The registration with RBI effectively protects MFIs from State Government action under money lending laws.  This is a long overdue requirement for conduct of business in microfinance.  States with competing microfinance programs kept themselves above law and influenced the governments to take action against other MFIs.  The sector had been reduced to a state where microfinance became a hazardous business that had to be controlled to the point of extinction.  The proposed bill restores the freedom of enterprises to run a business in financing vulnerable people, subject to reasonable regulations.

MFIs and deposits
The bill, without overtly saying so, hints at the possibility that MFIs will be permitted to mobilize thrift (small illiquid savings).  If the regulations are introduced for this and MFIs permitted to mobilize thrift it would be an exciting development as it makes meaningful financial inclusion possible.  The tough task of ensuring depositor protection remains unexplained.  Whether the bill could have gone a step further and mandated coverage of MFI mobilized thrift under deposit insurance as is the case in some other countries?

The strong customer protection content reflects a significant change in stance on part of the government – that even borrowers are entitled to protection.  The actual measures indicated in the proposed legislation mostly take in to account potential abuses in pricing, competition, and irresponsibility on the part of lender.  The bill requires implementation and enforcement in some cases.  The regulatory capacity has to be ramped up and the small and medium MFIs capacity to comply with regulation would also need to be beefed up. The bill is an important first step; several more steps in translating the bill to action are required before we reach a stage that restores the vitality of the sector.

Right now the bill is just a draft and needs to be passed by the Indian Parliament.  More than a 100 million people are keeping their fingers firmly crossed.

–N.Srinivasan, Independent consultant and author of State of the Sector Microfinance India – 2008,2009, and 2010

Also check out the Financial Inclusion Regulation Center’s India profile page for more information.

¹Set up by RBI in respect of commercial banks and financial institutions and NABARD in respect of cooperative banks and RRBs.

India’s Ministry of Finance released the much awaited draft microfinance bill which is to be introduced in the country’s parliament shortly. This post is the next in a short series of commentary on the bill by a variety of experts from the region on what the bill means for India and the global microfinance industry.

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PART OF THE SERIES: India Microfinance Bill Series

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  1. July 25th, 2011 at 5:42 am, 7/25/2011 Blogs Update « AbolishPoverty ()

    [...] India's Microfinance Bill Answers Most Questions [...]

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  • July 27th, 2011 at 11:38 pm, SUBHASH WADHWA ()

    Srinivasan has given a very good objective comments on the Bill. Suggestions about bringing other form of MFIs like Coopoeratives (MACS),Section 25 Companies etc need to be brought under some sort of supervision and caps on interests may be looked into. Savings/thrift is an important financial inclusion service which can be and need be provided at the door step to the poor by MFIs,besides a cost reducing measure for MFIs. The Bill should address this problem looking to its importance and interest of poor as well as MFIs.

  • July 28th, 2011 at 9:37 am, Emily ()

    hi -
    Can you please clarify the legislative status of the bill? It is still draft and not passed, right? What is the likely timeline?
    Many thanks.

  • July 29th, 2011 at 1:52 pm, N.Srinivasan ()

    The bill still a draft, now placed for public comments. It will be moved in the parliament for being voted as law. This would take some more time.
    Srinivasan

  • July 31st, 2011 at 5:43 am, 7/31/2011 Blogs Update « AbolishPoverty ()

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  • August 1st, 2011 at 5:43 am, 8/1/2011 Blogs Update « AbolishPoverty ()

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  • August 2nd, 2011 at 7:54 am, Dr.V.Rengarajan ()

    Dealing with some unanswered questions by Indian’s MF bill
    1. Customer’s protection
    It appears that the main focus of the draft MF Development and Regulation Bill .is to give ‘customer protection’. It is therefore an imperative need first for clarity on the needs of the ‘customer of MFI and an appreciation on the distinction between the poor customer of MFI in particular on one hand and typical customer of financial institution .in general on the other. MF focuses on exclusive inclusion of excluded poor where as bank finance aims inclusion of all excluded. While the MFI customer requires more of nonfinancial input access besides financial ones for a sustainable impact , the others type of customer needs confines mostly financial access. While the institutional issues pertaining to the delivery of the financial services and the recovery of it are common to the both types of customers, the demand of most disadvantaged and vulnerable poor customers of MFI goes beyond in terms of non financial support services for achieving the declared purpose of such MF services – reduction of poverty. Perhaps the Bill may ensure protection the poor customers by and large from institutional issues such coercive recovery , over indebtedness etc., but it indicates only partial protection relating to financial transactions only which is inadequate to these unique poor customers. In this context , how to protect these poor clients from other external vulnerabilities which could influence over all performances of these financial services? Unless this aspect is adequately addressed in MF platform, the Bill facilitates only formalization of one more financial institution in the multi agency led rural financial landscape ‘also to run ‘ for the cause of the disadvantaged section.
    2. ‘Income Recognition’ & ‘Income Generation’ .
    It is stated in the Bill (Chapt.5.24. 1 ) that in the public interest RBI may give directions to MFIs relating to Income Recognition(IR) and Asset classification, Provision for bad & doubtful assets etc., based on risk weight for assets. These accounting standard norms are all no doubt vital tools for assessing and maintenance of ‘health status of Asset of any financial institution for that matter including MF institution concerned . Here one should not fail to perceive in MF arena the inherent unique phenomenon of correlation between the ‘Income Recognition’ at institutional level and the ‘Income Generation ‘ (IG)at poor customer level.. To go deep into the functioning of these asset related concepts , the correlation ship indicates that unless the asset (micro credit) is productively used at poor customer’s level for ‘ Income generation’ , it is bound to influence the performance of asset at institutional level in terms of poor recovery and have chain effect on ultimately on ‘Income Recognition. It is therefore imperative to make ‘provisions’ in terms of adequate non financial services for ensuring the productivity of the micro asset at client level first so that it will lead to sustainable income generation leading to good repayment and eventually facilitating for income recognition of asset etc., at institutional level. If non financial ‘provisions’ are appropriately taken care of for the functioning of micro asset at filed level , then there is no need for financial ‘provisions for bad and doubtful debts at institutional level.. This correlation factor between IR and IG assumes importance in the context of mandatory maintenance of 75% of total asset portfolio under IG activity as stipulated for NBFC-MFI(Malegam Committee). Hence this factor relating to adequate non financial; provisions to IG activities of the poor customers of MFI also deserve to be covered in customer protection’ umbrella.
    3. Drop out customers of MFI-
    When we discuss on the matters relating to customers protection, it is not of context to emphasize the need for giving protection to the drop out customers from MFI-SHG system (India’s largest officially recognized MF delivery conduit) for their ‘second’ inclusion and rejuvenation.(42% of SHGs reported drop out phenomenon-Srinivasan’s MF status report).While inclusion of the poor takes place ceremoniously and vociferously at one end , exclusion of the included poor client also happens unceremoniously and silently at other end. . This is unfair! How does the MF Bill address this point from customer perspectives?
    4.Intergrated MF services –
    As per the Bill (Chapter 1.2.g) MF means one or more of following MF services viz., Micro credit, collection of thrift, remittance of fund, providing pension or insurance services and any other as may be specified. Only when all MF services are holistically provided to the poor clients by the financial institution , they only deserve to be called MFI. If it confines to micro credit service only (mostly ) it should be called Micro credit institution. Since all these services are required by the same cohort of customers for reaching ultimate social gaol, these MFIs need to be encouraged for extending integrated services covering all MF services singly or severally so long their targeted customers hail from different layers in the poverty pyramid. Integration of micro credit product with micro insurance should become mandatory as done in priority sector lending in formal banking sector.
    5. Grievance re-dressal Mechanism (Chapter 8.3.c )
    If the poor client brings grievances relating to access to non financial services like power, transport, marketing, farm inputs, required for their IG activities (financed by MFIs) , does this mechanism consider this grievances also?
    6.State Advisory councils –(Chapter 3. 8. 2.)
    For implementing and monitoring various policy initiatives, progress and development of MF sector activities with the best appreciation of micro level issues , it would be more ideal and useful to have a similar set up at district level taking advantage of exisiting coordination committees like DCC/BLBC already constituted ( by RBI under Lead Bank scheme) where all the participating financial players including insurance companies in MF activities along with the government development agencies. The agenda like ‘ Exchange of information on over due borrowers among the MF players’, ‘arrangement of non financial supporting services for various micro credit related activities’ by the government agencies ,Advocacy for integration of micro insurance services etc may facilitate for qualitative micro finance performance . It is a high time to focus more on MF activities in Lead Bank scheme, Service Area Approach and District Credit Plan to ensure an integrated approach all the players for development through credit and poverty reduction through Micro finance . On similar to the functioning of SLBC at state level, there should be a State level MF Committee (SLMFC) with a lead MFI for coordination
    7.MicroFiance Development Fund(Bill. Chapter VI)-
    As stated this fund is applied for provisioning loan, refinance, grant, seed capital etc., for MFIs, This fund would facilitate them for providing more financial activities only to their poor customers. In the context of recognition of non financial support services (as highlighted above in points 1, 2 and 5) , demanded for various IG activities of the poor , there is an imperative need to divert Rural Infrastructure Development Fund(RIDF) more exclusively for providing physical support services depending on the specific requirement of the service area of MFIs . This calls for formulation of Micro finance Plan (MFP)at district level taking cognizance of the potential for IG activities as indicated in Potential Linked Credit Plan (PLCP- prepared by NABARD) integration with District Credit Plan(DCP) of Banking system

    In fine Micro finance and MF customers are unique from its own perspectives and the approach for customer protection in MF arena also need to unique making subtle difference from customer of other financial institutions.
    Any policy initiatives for various activities of MF need to be looked into more from development perspectives for reaching the said goal rather than end up with regulatory aspects alone with mere institutional strengthening.
    Dr V.Rengarajan

  • August 3rd, 2011 at 2:17 pm, Rafe ()

    Srinivasan, can you clarify one point from your entry? You mention the bill calling for “mandatory enrollment to credit bureaus,” but the only language I found that would be relevant is on Pg. 18, which lists under the Reserve Bank powers to issue directives to MFIs the power to “Require MFIs to become member of Credit Information Bureaus that may be set up for the Micro Finance Sector.”

    This would seem to say that the RBI COULD require participation in credit bureaus that MAY exist, but does not outright require participation in bureaus just off of this bill. Can you clarify whether you in fact meant mandatory enrollment in practice, or just as an option the RBI would have the power to enact if it so chose?

  • August 5th, 2011 at 11:03 am, N.Srinivasan ()

    Dear Rafe,
    Section 24 of the bill deal with powers of RBI to issue directions to MFIs under which it can require MFIs to enroll as member of credit bureaus. When RBI issues the direction it becomes mandatory on MFIs and they do not have an option.
    In case of banks, the Credit Information Companies Act made it necessary for banks to be a member of at least one credit bureau. In case of MFIs, this is what would happen,but with a direction from RBI, given that there are credit bureaus for MFIs and one of them is already operational.
    Srinivasan

  • August 5th, 2011 at 11:08 am, N.Srinivasan ()

    Dear Mr Rangarajan,
    Thanks for your detailed response. I wanted to respond to one of your observations: The grievance redressal procedure refers to microfinance institution related issues only and not others and redressing authority does not have competence over other issues. What you suggest seems to be more in the line of consumer courts and tribunals.

  • August 8th, 2011 at 6:35 am, Dr.V.Rengarajan ()

    Thanks for your detailed response. I wanted to respond to one of your observations: The grievance re-dressal procedure refers to microfinance institution related issues only and not others and redressing authority does not have competence over other issues. What you suggest seems to be more in the line of consumer courts and tribunals.

    Thank you Mr Srinivasan for your response
    If the mechanism like consumer court or tribunals serve the purpose, it is welcome from the perspectives of the disadvantaged and the poor customers. But what I afraid that needed legal formalities to be followed here may not be a conducive one to these disadvantaged customers unless they are entitled a kind of ‘rights to access’ to these non financial services in the context of inclusive growth.
    However, what I contemplate in regard to the ‘re-dressal of grievances’ of the poor customer, is that while the mechanism suggested in the Bill takes care of the matter related institutional issues, the other development oriented issues related to supporting infrastructure required for micro enterprises of the poor customers may be brought and discussed for solution in the coordination forums like SLBC/DCC/BLBC already constituted by RBI under Lead Bank scheme ( An unique innovative scheme of RBI only in Indian Banking sector in the world for the cause of coordinated ‘Development through credit’.) The MF Bill is therefore to make it mandatory for participating NBFC-MFIs to become member in these forums and to represent their clients’ needs regarding supporting services( This action in a way helps protect the assets of the MFI and poor customer as well) . Since the members of these forums include financial institutions operating in the respective areas and the concerned district development officials, besides apex banks’ representatives (RBI/NABARD) also participate, a consultative decision making coupled with collective decision making for collective action through this coordination mechanism may go long way for assessing the specific infrastructural ( like chilling plants, formation of cooperative milk societies, collection centers, milk routs etc as in the case of Dairy animals scheme- a popular micro enterprise for the poor women ) needs and subsequent implementation. Such collective endeavor may facilitate redressal of grievances to a greater extent not only to the NBFC-MFI clients but also the customers of the banking community as a whole in the area concerned. At the same time provision of these supporting services facilitate smooth income generation and ensure productivity of the micro credit at poor customer level. Eventually it leads to good repayment and no need for coercive action for recovery by MFI also thereby reducing the burden of the redressal grievance mechanism conceived in MF-Bill
    The above argument is made in the context of three factors First, three forth of asset portfolio of NBFC-MFI is mandated for income generation. Second as emphasized in the committee report on Financial Inclusion(Dr.C.Rangarajan ) the financial inclusion will not work without adequate infrastructure support . Finally it is imperative that both regulatory and development measures need to go together sensibly without establishing any water tight compartment at least in our strategy for the ‘battle against poverty’.
    Hope the above views may be considered while finalizing the MF-Bill for the benefit of both the poor customer and NBFC-MFI as well
    Thanks for sharing my views
    Dr Rengarajan

  • September 1st, 2011 at 12:27 pm, Daniel ()

    Thank you Mr. Srinivasan. It is indeed a great Article on the MFID&R Act. The Bill suggests / commands all the Societies, Trusts and Section 25 Companies to be registered under the NBFS. Actually most of the charitable and religious Trusts / Societies are the ones that reaching the people BPL. If they had to be registered under the companies Act and perform like the corporates or as the professional Banks, how that is going to work?

    NGO’s that are involved in the development of the poor sector by providing Micro Finance, should be considered based on their performances as they have spared the co operative societies. After reading this Bill many MFIs would register under the co operative societies Act and continue to do what they are doing.

    I do need your comments on this please!

    Mr. Daniel

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  • September 24th, 2011 at 6:29 am, Srinivasan ()

    Dear Mr Daniel,
    The law does not require the trusts, societies, etc to become companies. The law will require all MFIs regardless of form to get a one time registration from the regulator to carry on microfinance business. If these MFIs in other forms become systemically important (by todays definition of NBFCs, if assets exceed Rs 1 billion, they are systemically important) then they are required to transform in to companies – either for profit or non-profit. I would tend to agree that large institutions offering financial services should be in a form where there is identified ownership and a concept of capital. But we can have the option of such institutions in other forms becoming a cooperative MFI, which is more suited to the several community based organisations such as federations.
    The exemption available to cooperatives is for member-only institutions. It would be difficult for existing MFIs that to become cooperatives, collect share capital from every customer, share profits with customers and run institutions along cooperative democracy principles.
    Srinivasan

  • December 23rd, 2011 at 5:36 pm, cyril ()

    Dear Mr Srinivasan,
    We are an NGO involved with community development and empowrement acyvities. One of our functions is to extend micro-credit to the poor and needy. We are not a micro-finance institution.

    Do you think we would still come under the perview of the proposed legislation?

  • December 28th, 2011 at 12:41 am, Srinivasan ()

    Dear Cyril
    Regardless of form, if your NGO carries out microfinance activities as defined under the bill, it would come under the proposed legislation. The definition of microfinance activity in the bill reads “Micro finance services” means one or more of
    the following financial services involving small amounts to individuals or groups:
    (i) providing micro credit; (ii) collection of thrift; (iii) remittance of funds;
    (iv) providing pension or insurance services; (v) any other services as may be specified.
    in such form and manner as may be prescribed.”
    The definition does not distinguish between mission, mandate and overall objectives of the organisation.
    Hence as the bill stands today, your NGO would under the proposed legislation.

  • January 5th, 2012 at 4:31 am, cyril ()

    Dear Mr Srinivasan,

    Many thanks for the clarification.

    Cyril

  • February 21st, 2012 at 8:05 am, Jacquiline ()

    When I was a student in India, such Bills were unheard of, but now am glad things have changed.

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