REGULATORY PRESCRIPTIONS - Microfinance: misunderstood, Malegamed

A generally beleaguered microfinance industry was eagerly waiting for Yezdi Malegam for deliverance. Any conversation about the microfinance business would end with the expectation that the Malegam committee would de- liver a healthy dose of oxygen to the choking microfinance industry. The report was expected to be the panacea for all that ails microfinance in India. The report, which came out on Monday, disappoints not only in its inability to meet these expectations, but also on fundamentals. While each one of the recommendations may have merit when seen in isolation, together they are a lethal combination. It is difficult to ac- cept that the collective wisdom of Malegam, Shashi Rajagopalan, an expert in cooperatives; Aditya Birla Group head Ku- mar Mangalam Birla; Reserve Bank of India (RBI) Deputy Governor K.C. Chakrabarty and former chief of India's space research organization U.R. Rao could have delivered this blow to the microfinance sector in the country. First, the good things in the recommendations: The committee suggests retaining priority sector status for the micro- credit business; keeping micro-finance institutions (MFIs) out of the Moneylenders Act; keeping the regulatory role with RBI instead of state governments; enhancing the role of RBI in supervision; and engaging with industry associations on an on- going basis. However, there are several problems with the report. Chakrabarty, during his brief tenure as the central banker in charge of rural credit, provided progressive measures for financial inclusion in the banking sector by suggesting two radical steps in the rather conservative atmosphere of RBI — the first was to remove licensing requirements for opening branches in towns with a population less than 50,000 people; the second was to remove the interest rate cap on all loans as the base rate regime kicked in. The only area where there were some controls on interest rates was in the case of politically sensitive agricultural loans. As a member of the Malegam committee, he has signed off on a report that puts a cap on micro- finance interest rates at 24%, without dissent. The question is not whether 24% is an appropriate cap; it is more about the principle. One of the concerns that led to the formation of the committee was that microfinance companies were profiteering from the poor and not treating them with dignity. As a central banker, a more non-invasive way of addressing the issue would have been in controlling the capital flow to these institutions both through the nature of equity investments and through the banking system, thereby giving the market an opportunity to experiment and provide diversity of services, improving transparency and enforcing a customer responsibility code. If the banking sector, the auto finance sector and the housing finance sector have plurality of institutions (and no loan size and interest rate caps and definitions of moratoriums) with the central bank stepping in whenever it seems to think a larger customer interest is involved (as it did in the case of teaser rates offered by housing finance companies), we see no reason why the same principles should not be applied to the poor. Dealing with poverty does not mean restricting choices and giving people what we think is good. Dealing with poverty means trying to give the poor as much dignity and diversity of choices that the non-poor enjoy. The report defies the plurality of institutions and choices. The Andhra Pradesh ordinance (as recommended by the sub-committee) can lapse because the panel has effectively completed the task that was started by the state government. For not having abdicated the responsibility to supervise and inspect MFIs that have shown poor governance and indifferent behaviour towards customers, this antidote by the RBI committee appears populist and misplaced in what should be controlled and what should not be.