While the microfinance sector has grown significantly in the last five years, it is now facing a crisis for a number of reasons. Microfinance institutions (MFIs) are under scrutiny due to their alleged usage of coercive methods of recovery, multiple lending, over-borrowing, ghost borrowers and high interest rates.
Yet the undeniable fact is that the microfinance sector is providing financial help to borrowers who are in dire need of credit. Furthermore, their loans are at rates lower than those of the ubiquitous local money lender, many of whom could put Shylock to shame and are politically well connected. Along with providing financial help, the sector has also created a broad client platform which in the near future may be helpful in providing other services such as insurance.
Reeling under public outrage and media sensationalism and to curb alleged malpractices in the microfinance sector, the Andhra Pradesh State Government passed an ordinance which was later enacted in December 2010 as the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act.
The nature of the Act makes one wonder whether it is in fact intended to benefit local money lenders. In a recent judgment, the Supreme Court fined another State Government because the then chief minister had prevailed upon the police not to file a complaint against a local money lender turned politician. The Act also seems retrograde and restrictive in nature.
With the aim of providing a national regulatory framework for MFIs, the Reserve Bank of India formed a sub-committee (the Malegam Committee) to study issues and concerns in the microfinance sector. The Committee submitted its report in January 2011.
It recommended that MFIs having 90% or more of its total assets in the nature of loans qualified thereunder shall be classified as a non-banking financial company-micro finance institution (or NBFC-MFI) and be made to register with the Reserve Bank of India; and that all MFIs be made to cap their interest rates.
Other recommendations include:
(i) limiting the amount of lending to Rs25,000 ($550) for each borrower;
(ii) limiting the number of loans that a borrower may take from all MFIs to two; and
(iii) that a NBFC-MFI must disburse at least 75% of the total loans for income generation purposes only.
Socialism through the back door?
The positive points of the report include that lending to MFIs by banks should continue to enjoy priority sector lending status. The report emphasises having a minimum net worth and minimum capital risk adequacy ratio to improve MFIs' efficiency. Realising that securitisation is one of the MFIs' important tools for raising of capital, the committee has recommended disclosure requirements for securitisation and assignment (both with and without recourse).
Capping the interest rate without any control on the lending rate may not be helpful for the development of MFIs, as the interest rate charged by MFIs is directly linked to lending rates. The recommendation to have a minimum net worth may also severely hurt the prospects of small MFIs and those operating in difficult circumstances.
The report and the Act have attempted to regulate every business aspect of MFIs. The concern is that excessive regulation may result in impeding the survival of a sector that is still at a nascent stage.