RBI microfinance policy change proposals will hurt the poor
The proposed guidelines will favour profit-driven private credit institutions at the cost of public sector banks.
In June 2021, the Reserve Bank of India (RBI) mooted a new initiative naming it “Consultative Document on Regulation of Microfinance” The RBI’s purported objective is to bring in more and more of private sector lenders so that competition among them grows, and the borrowers get better service and loans at lesser rates of interest. When implemented, the new policy will attract more and more private players to the micro-finance sector. However, it is the lure of more profit that can entice private players to start micro finance bodies. Quite understandably, operational profits of the micro finance institution can rise if the borrowers are made to pay more interest. So, the RBI initiative looks counterproductive. The avowed objective of onboarding more and more of the rural poor in to the banking system will this be negatively hit.
The main planks of RBI’s new plan
The document circulated by the RBI recommends that 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. Instead, the Boards of Directors of the companies who run the micro finance entities will decide the rate they will charge on their loans. The idea is to pit one lender against the other that market forces come into play, and the borrower gets the best deal. However, there is a pitfall here that seems to have been ignored. The Non-Banking Finance Institutions cum Micro Finance Institutions (NBFCs-MFIs) will find themselves in a disadvantage vis-à-vis the other entities like commercial banks, small finance banks, and NBFCs.
RBIA’s new thinking buries its earlier goal to make available low-cost loans the people in the lowest rungs of society. Public sector banks will find themselves absolved of this responsibility. While they might relish the idea, the harm to the rural poor will be considerable. Rural women who traditionally take loans on their families’ behalf, will find themselves pushed further into the fringes. Women empowerment will take a back seat. With interest rates de-regulated, loans could be very difficult to service, and defaults might rise.
Rate of interest on loans – the crucial factor
According to present practice, the ‘maximum rate of interest rate charged by an NBFC-MFI shall be either
a. the cost of funds plus a margin of 10% for larger MFIs (a loan portfolio of over ₹100 crore) and 12% for others;
b. the average base rate of the five largest commercial banks multiplied by 2.75 —whichever is lower.
In June 2021, the average base rate announced by the RBI was 7.98%. Even with this apparently low rate, some Small Finance Banks (SFBs) and NBFC-MFIs officially charged anything between 22% to 26% on the loans they gave. This works out to roughly three times the base rate!
Small loans — a lifeline for rural households
Rural households are increasingly availing microfinance to meet their many needs. In a study was conducted by the Foundation of Agricultural Studies in two Tamil Nadu villages from southern Tamil Nadu, done by the Foundation for Agrarian Studies, it was found that the loans were given to villagers without any collaterals. Thus, the loans fell under ‘unsecured’ category. The lenders were private bodies like SFBs, NBFCs, NBFC-MFIs and some private banks.
The caste and socio-economic class of the borrowers determined their preferred lender and the purpose for which they took the loans. I n terms of source and purpose of borrowing. For the poorest households, the small loans were absolutely vital. Without these loans, the hardships they would face would be too unbearable. For the poor peasants and daily wage workers, and to people from the Scheduled Castes and Most Backward Classes category, the loans came as a true lifeline for survival. It was also seen that the loans were seldom utilized for any productive purpose. Second, the borrowed amounts were rarely used for productive purpose that could bring in some returns. The loans were used for renovating their humble dwellings, and buying items of food or items essential for daily living. The pattern of such spending points to the grinding poverty these people have to contend with and the way the bank loans help them keep their pots boiling.
These poor borrowers had to pay interest of about 22 to 26% per year on the loans they availed. It’s interesting to compare such high-interest loans with those availed through Primary Agricultural Societies (PACs). Curiously, Crop loans from Primary Agricultural Credit Societies (PACS) in Tamil Nadu had a nil or zero interest charge if repaid in eight months. The next cheaper source of loan was the Kisan Credit Cards which carried 4% interest per annum. Actually, the rate is 9%, but interest subvention of 5% brought it down to 4% for the borrower. To qualify for such subvention, the loan has to be repaid in 12 months. Failing this, the defaulter would be charged 11%. Other types of loans from scheduled commercial banks carried an interest rate of 9%-12% a year. As even the RBI concedes, the rate of 22-26% charged by small private entities is too much on the higher side and defeats the purpose of providing cheaper credit to the rural poor.
The devil is in the details – Microfinance loans could be more usurious than seen in paper
The actual cost of microfinance loans is even higher under certain circumstances. Most loans from NBFC-MFIs have to be repaid in full in 24 monthly instalments. Let’s see this case. A loan of Rs.30,000 from an NBFC-MFI will carry a monthly repayment liability of Rs.1640. Out of this, Rs. 1250 is set aside for principal and Rs.390 for interest. After some simple calculation, we can see that the simple interest works out to 15.6% at the beginning. As the repayment progresses, the outstanding principal amount reduces, but the interest due remains same. Thus, in the last phase of repayment, the interest rate comes to a whopping 31%. The borrower does not understand this, nor does he have any recourse to other cheaper source of credit.
As if this is not enough, a processing fee of 1% is added and the insurance premium is deducted from the principal. Since the loans are insured against risks of death of the borrower, or any default, claiming that the higher rate of interest is justified to factor in the enhanced risks of lending to such customers does not stand reason.
Further, coercion as a means to force recovery is accepted as standard practice. Abusing the defaulter right in front of his family and neighbours undermines his standing in his community. The RBI has forbidden loan collection at the doorstep of the borrower, but this caution is not heeded.
If the borrower is unable to pay the instalment, other members of the group have to pitch in to service the loan with the group leader taking responsibility. However, this provision is frequently breached by the lenders who cite a group formed earlier for some other purpose to be the collective borrower. Clearly, this is illegal.
The change on the anvil
Microfinance lending entities have been in existence since 1990. Now, these entities have been formally brought under RBI’s regulatory control. RBI now actively promotes them too. Lending by small finance banks (SFBs) to NBFC-MFIs are now classified as priority sector advances. After COVID-19, the cost of funds given to NBFC-MFIs has been reduced. But, there is no provision to pass on the benefits to the poor borrowers.
In the 1990s, microcredit was given by scheduled commercial banks either directly or via non-governmental organisations to women’s self-help groups, but sensi8ng an opportunity to make more profits, many microfinance institutions have entered the fray. By the mid-2000s, the market became abuzz with stories if malpractices sand irregularities. This is when SKS and Bandhan came into limelight. Andhra plunged into a massive microfinance crisis pointing to the need for taking corrective action by RBI
The Malegam Committee recommended formation of a new regulatory framework for NBFC-MFIs. It came into being in December 2011. A few years later, the RBI permitted a new type of private lender, Small Finance Banks (SFBs), a view to taking banking activities to the “unserved and underserved” sections of the population.
As of today, 31% of microfinance is provided by NBFC-MFIs, and another 19% by SFBs and 9% by NBFCs. Over the last few years, this sector has recorded phenomenal growth, driven by high profits. Consequently, the share of public sector banks in microfinance (the SHG-bank linked microcredit), of 41%, is projected to fall.
The proposals in the RBI’s consultative document, if implemented, will lead to a further privatisation of rural credit. Cheap credit, so direly needed by the rural poor will become scarcer. The poor borrowers will thus suffer. In the post-pandemic times, when resurrecting the broken rural economy is the need of the hour, such a step of RBI will surely hurt the population. The All-India Democratic Women’s Association, has flagged the RBI initiative calling it cruel and anti-poor. The Association has demanded that the lending rate to the rural women borrowers must not exceed12% per annum. To ameliorate the sufferings off those languishing in the outer fringes of the society, RBI and the government need to be far more pro-active. Nationalized Banks have to come forward to provide this direly-needed service.