The new realities, predicated on RBI’s acceptance of the Malegam framework, are yet to hit microfinanciers. By accepting the spirit of the Malegam panel report, the Reserve Bank of India (RBI) has taken a step away from its regulatory approach towards the financial sector and from its approach towards microfinance. This step, of controlling interest rates and margins, has been introduced at a time when RBI governor D. Subbarao has indicated his “bias” for deregulation of interest rates on savings accounts (Mint, 4 May). For once, RBI has put the brakes on microfinance institutions (MFIs), after having allowed them to grow at an uncomfortable pace. While the central bank has removed the sting from the Malegam recommendations by moving the interest cap to 26% and the margin cap to 12%, the step is myopic. These controls are applicable to organizations that want to avail resources from the priority sector lending window. For others, it could be business as usual. In accepting this framework, RBI has only partially addressed the issue of client protection that led to the Andhra Pradesh crisis. The central bank’s notification gives choice to the borrowers on repayment periodicity; it remains silent on coercive recovery practices. It protects clients by putting Rs. 50,000 as an upper ceiling for credit—a measure that freezes the poor households’ enterprise at one buffalo and a fraction of the price of a good hybrid cow. Given that there are no mezzanine institutions that can fill in the gap after this limit, RBI is in effect punishing poor households emerging out of poverty under the guise of protection. It would have been desirable to peg the limit at Rs. 2 lakh, which is RBI’s definition of small borrowal accounts. This would have given MFIs the scope to innovate and cross-subsidize between their large and small borrowers. MFIs which are on the treadmill of small finance, quick turnaround, efficient operations and scale, will benefit from the move. The regulation is loaded against small MFIs that cannot negotiate cheap finance and maintain costs in the 12% band. If this regulatory framework continues, we will see substantial consolidation in the industry. One recommendation—that MFIs should have a minimum capital of Rs. 15 crore—does not appear in RBI’s notification. The central bank is known for its bias for large organizations, so that regulation becomes viable. We will see action on this front after the Usha Thorat committee submits a report on the comprehensive review of the legal and regulatory framework of non-banking financial companies. With the interest and margin caps, there are implications. The margin cap would push MFIs towards automation, efficiency and cost cutting. The first to face the brunt will be the credit officers whose alternatives at this time are limited. They would see a drop in their incentives. Also, with so much of chatter around profiteering from the poor, MFIs may limit the shareholder returns to benchmark with the banking industry. The benefits of the efficiency gains will disproportionately move to the top management, as current compensation rather than equity options. The exuberance of the investors will be moderated. Microfinance is no longer a hot destination for private equity/venture capital/hedge funds. The possibility of diversified income is limited by the other conditions, and we can expect private sector investments in MFIs to slow. With an income condition for the client (upper ceiling of annual income of Rs. 60,000 in rural areas and Rs. 1.2 lakh elsewhere), MFIs that fall within the priority sector ambit will move away from rural locations. While this difference appears to recognize the difference in the purchasing power and income opportunities in urban locations, it is negated by the common upper limit amounts and the tenor of loans. While openly welcoming the new regulation, several actors may not have internalized the implications in the way the details are tucked in:
i) The loan amount cannot exceed Rs. 35,000 in the first cycle and Rs. 50,000 in subsequent cycles;
ii) Loans exceeding Rs. 15,000 should have a tenor of more than 24 months;
iii) 75% of the loans are to be given only for income-generation purposes.
The exposures of MFIs usually carry a one-year tenor, effectively putting an individual loan-size cap of Rs. 15,000. The chief beneficiaries of this policy are the auditors who would certify that:
i) The income of the borrowers representing the “qualifying asset” is less than specified limits;
ii) At least 75% of the borrowers’ indebtedness is on a productive loan;
iii) That 85% of the assets are “qualifying assets”.
RBI might not have had the time to see how much the auditors would charge to give these certificates, and whether these verification costs (over and above high delivery costs) can be covered within the ceiling of the 12% margin limit between borrowing and lending rates that the central bank has fixed. The benefits of the priority sector loans may not be commensurate with the costs of complying with the conditions. Even if the average cost of borrowing is around 14%, and an MFI gets an yield of 26-30%, it may not want loans under the priority sector. However, the question is whether the banks will lend to these institutions if they shed the microfinance tag. Even if they do, will the pricing be attractive? We have to wait for the bullishness of MFIs to wane and the reality to hit them. That is a while away.
MS Sriram is an independent researcher and consultant, and former professor at the Indian Institute of Management, Ahmedabad.
