Relevance: GS-3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment. Inclusive growth and issues arising therefrom

Key Phrases: Regulated Entities, Microfinance Loan, Financial Services, Non-Banking Financial Companies, regulatory framework, Financial Inclusion, no pre-payment penalty, Microfinance Institutions, H. Malegam Committee, Qualifying Assets

Why in News?

• Microfinance companies are expecting greater growth in rural markets than urban, following the new guidelines issued by the Reserve Bank of India.
• MFIs believe these measures, along with the rising demand for loans in rural India, should drive growth for NBFC-MFIs.
• According to data from the Microfinance Institutions Network, the gross loan portfolio of the sector in India rose by 10% to ₹2.85 trillion as on 31 March 2022 from ₹2.59 trillion a year ago.

Introduction:

• Microfinance is a basis of financial services for entrepreneurs and small businesses deficient in contact with banking and associated services.
• The term “microfinancing” was first used in the 1970s during the development of Grameen Bank of Bangladesh, which was founded by Muhammad Yunus. In 1976, Yunus institutionalised the approaches of microfinance, along with the foundation of Grameen Bank in Bangladesh.

What is Microfinance?

• Microfinance is a form of financial service which provides small loans and other financial services to poor and low-income households.
• It is an economic tool designed to promote financial inclusion which enables the poor and low-income households to come out of poverty, increase their income levels and improve overall living standards.
• Financial services through formal channels do not meet the demands of the rural poor, so microfinance can help small-scale businesses flourish by providing greater financial stability.

What are Microfinance Institutions (MFI)?

• MFI is a financial organisation that offers financial services to low-income populations.
• These services include
  • microloans,
  • microsavings and
  • microinsurance.
• MFI gives small loans to the poor without collateral, flexible EMI.
• In 2010, on recommendations of H. Malegam Committee, RBI created a new NBFC category called Micro Finance Institution (MFI).
• In India, all loans that are below Rs.1 lakh can be considered as small loans or microloans.
• MFIs are regulated by
  • The Non-Banking Financial Company -Micro Finance Institutions Directions, 2011 of the RBI, and
  • The Ministry of Corporate Affairs.
• An NBFC-MFI has been defined as a non-deposit taking NBFC with minimum net owned fund of ₹5 crore (₹2 crore for NBFC-MFIs registered in the North Eastern Region) and having minimum 85 per cent of its net assets (assets other than cash, bank balances and money market instruments) in the nature of ‘qualifying assets’.

Why MFIs?

• To safeguard the interest of people outside the formal financial system.
• Failure of formal banking institutions in lending to the rural poor in the absence of proof of recognised employment or collateral that can be offered by them while applying for loans leaves the poor with no alternative but to borrow money from local moneylenders at high-interest rates. In order to safeguard the interest of such individuals MFIs are useful.

What is difference between bank and microfinance?

• A microfinance institution offer loans with little to no asset to the clients while in a bank one has to have collateral to receive a loan.

Key Provisions of RBI (Regulatory Framework for Microfinance loans) Directions, 2022:

1. Applicability to the following entities known as Regulated Entities (REs):
   • All Commercial Banks (including Small Finance Banks, Local Area Banks, and Regional Rural Banks) excluding Payments Banks;
   • All Primary (Urban) Co-operative Banks/ State Co-operative Banks/ District Central Co-operative Banks
   • All Non-Banking Financial Companies (including Microfinance Institutions and Housing Finance Companies).
2. Definition of Microfinance Loan:
   • A microfinance loan is defined as a collateral-free loan given to a household having annual household income up to ₹3,00,000.
   • The cap earlier was ₹1.25 lakh in rural areas and ₹2 lakh in other areas.
   • For this purpose, the household shall mean an individual family unit, i.e., husband, wife and their unmarried children.
   • For entities to qualify for an NBFC-MFI licence, they should have at least 75% of assets in microfinance and the cap on NBFCs was increased to 25% of assets as against 10% earlier.
   • Maximum possible indebtedness per borrower is increased to Rs 2,40,000 and the 10% spread cap that was applicable to NFBC-MFIs is removed.
3. Assessment of Household Income:
   • Each RE shall put in place a board-approved policy for assessment of household income.
   • Each RE shall mandatorily submit information regarding household income to the Credit Information Companies (CICs).
4. Limit on Loan Repayment Obligations of a Household:
   • Each RE shall have a board-approved policy regarding the limit on the outflows on account of repayment of monthly loan obligations of a household as a percentage of the monthly household income.
   • This shall be subject to a limit of maximum 50 per cent of the monthly household income.
   • The outflows capped at 50 per cent of the monthly household income shall include repayments (including both principal and interest component) towards all existing loans as well as the loan under consideration.
5. Pricing of Loans:
   • The RBI has now offered freedom in fixing the lending rates which will be approved by the board.
   • A ceiling on the interest rate and all other charges applicable to the microfinance loans.
   • There shall be no pre-payment penalty on microfinance loans.
   • Penalty, if any, for delayed payment shall be applied on the overdue amount and not on the entire loan amount.
   • Any change in interest rate or any other charge shall be informed to the borrower well in advance and these changes shall be effective only prospectively.

Relevance of these Guidelines:

• The guidelines are promising for NBFC-MFIs, since RBI has done away with the margin caps that were specifically applicable to non-banking finance company–microfinance institutions (NBFC-MFIs), to bring harmonisation of the regulatory framework.
• It levels the playing field for them (hitherto the 10% spread cap was applicable only to NBFC-MFIs) and it allows the board to create a policy that prices the credit risk adequately.
• The framework for microfinance loans announced by the RBI will further help deepen penetration of micro-credit in the country.
• This harmonised regulatory framework for different types of lenders, will encourage healthy competition and enabling customers to make an informed choice regarding their credit needs.
• The new framework will help scale the industry further, ensure better risk mitigation and financial inclusion.

Conclusion:

• The microfinance programme has witnessed phenomenal growth in India in the last decade. However, the focus of most of the microfinance service providers has remained on expanding the outreach of microfinance programme with little attention to the depth, quality and viability of the financial services.
• Thus, in addition to removing these problems, there needs to be a proper structure to let microfinance empower rural India.
• MFIs should ensure that the ‘stated purpose of the loan’ that is often asked from customers at the loan-application stage is verified at the end of the tenure of the loan.
• The concerns should lie on people’s accessibility to microfinance in rural and urban areas, the regulations that come with it and the provision of basic training for the rural and urban poor on how to use these loans for productive purposes.

Source: Live-Mint

Mains Question:

Q. Although microfinance in India has witnessed growth in recent decades but its penetration in rural India is not as effective. In the light of the statement suggest measures to increase its impact and effectiveness. (250 words).