Time for Banks To Drive Micro-Credit Push : Daily Current Affairs

Relevance: GS-2: Government policies and interventions for development in various sectors

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

Key Phrases: Reserve Bank of India, Banking Regulation Act, rural India, Microcredit, MFIs, micro-loan norms, Malegam Committee, Deendayal Antyodaya Yojana, Non-productive.

Why in News?

  • The economic potential of micro-finance is immense, provided beneficiaries are correctly identified. Banks, with their low cost of funds, can lend viably and cheaply.

Context:

  • The Reserve Bank of India announced a major reform in the microfinance segment last week. Its Master Direction under the Banking Regulation Act, which harmonises its lending norms for bank and non-bank players, has the potential to widen the coverage of the formal micro-loan delivery system, enhance access to loans for a large aspirational segment of our population and reduce the cost of credit for the poor.
  • The next big push to inclusion and growth of a resilient rural India can come if only commercial banks, with their low-cost deposit advantage, would enter this space to lend micro loans directly with an appropriate low-cost, high-touch collection machinery in place.
  • The RBI’s move to almost treble/double the family income limit for rural and urban households for their loans to be classified as priority sector micro-credit and make loans purpose-neutral is the most important aspect of this announcement. Earlier, the classification as PSL was subject to lower income and lower loan limit norms. Also, banks have not been lending micro loans directly except under the umbrella of the Livelihood Mission group loans or through on-lending by MFIs because the ticket-sizes were too small.

  • Microcredit is a common form of microfinance that involves an extremely small loan given to an individual to help them become self-employed or grow a small business. These borrowers tend to be low-income individuals, especially from less developed countries (LDCs). Microcredit is also known as "microlending" or "microloan."

What RBI did?

Simplifying the Norms

  • The latest announcement is essentially aimed at making micro-loan norms simple and straightforward. It has also stipulated that the repayment load of a household should not exceed 50 per cent of the income, which is a deterrent to over-indebtedness. This approach is also a reflection of the maturity of a market which has long outgrown the misadventures of State Government intervention in the erstwhile Andhra Pradesh. That led to tightening of the leash and laying down of norms on the basis of the Malegam Committee recommendations.

Malegam Committee recommendations to RBI regulation for Micro Finance industries are:

  • Micro lenders can put in place a board-approved policy to arrive at all-inclusive interest rates charged to the borrower.
  • An interest rate model can be adopted by the NBFC – MFIs taking into account factors such as the cost of funds, margin and risk premium so as to determine the rate of interest to be charged for loans and advances.
  • The rate of interest, the rationale for charging different rates of interest from different categories of borrowers and the approach towards degrees of risk need to be disclosed to the borrower in the loan application form and communicated explicitly in the letter sanctioning the loan.
  • MFIs can lend to borrowers based on the household income limit and the rule that more than two MFIs cannot lend to the same borrower is proposed to be scrapped.
  • The payment of interest and repayment of principal on all outstanding loans of the households at any point of time shall be capped at 50% of household income.
  • While the committee’s norms adopted in 2011 were relevant in the wake of the developments that rocked the system then (when a number of MFIs folded up), the new steps are proof of the central bank’s recognition of both the potential of the micro-credit market. At present, it is reckoned to have an outstanding of ₹2.5-lakh crore covering not less than six crore borrowers. It is estimated, as per a recent KPMG study, that the microfinance sector has grown at a compounded annual growth rate of 30 per cent since 2014 and the Jan Dhan Yojana/Aadhaar duality has provided a fillip.
  • The access to credit has also been pushed by the Government’s own Deendayal Antyodaya Yojana (DAY) under which ₹1.4-lakh crore (included in the overall ₹2.5-lakh crore) is the outstanding loans to 37 lakh self-help groups. The total number of SHGs are about 75 lakh, which means that 50 per cent are yet to be credit-linked.
  • These are people at the bottom of the pyramid who require very small amounts of money for surplus-value creating activities. They are bankable and largely creditworthy. The default rate in the micro-credit scheme under DAY is also low (around 2-3 per cent) and banks earn a decent return unlike in some of the other government-sponsored schemes where the credit costs are high.
  • While small loans do support people build livelihoods if they run micro/small/village-level enterprises, there is no conclusive evidence yet that micro credit by itself can lead to poverty reduction. The selection of beneficiaries is of utmost relevance. Creation of incremental income either directly or indirectly and incremental debt-servicing capacity should be the yardstick while extending credit.

Non-Productive Purposes

  • Micro loans can also go for conventional “non-productive” purposes as even they have positive economic consequences. For instance, indirect surplus-value generation out of micro loans can happen when the loan is used, say for buying kitchen equipment like a mixer, gas-stove and the resultant time saved is used by the beneficiary for additional income generation through wages/other activities.

Way forward:

  • Indeed, one of the early attempts to evaluate the effect of micro credit by the Nobel-prize winning economists Abhijit Banerjee and Esther Dufflo states that “Our results show that short-term access to credit allows a significantly higher proportion of talented entrepreneurs to scale up their businesses. In sum, it appears that there are indeed sizeable benefits from microfinance for some people, but it takes time for these benefits to accumulate. And it is important to look for the impacts in the right place. The disappointing effect of microfinance overall may be related to lenders’ lack or willingness (or ability) to identify the right beneficiaries”.
  • The major makeover should come from banks. The banks’ cost of funds being low, they will be in a position to earn decent margins even while balancing commercial considerations with the larger socio-economic impact. Their interest rates could be much lower than that of non-banks.
  • A micro-credit push will be another step towards ‘Antyodaya’ — welfare for those at the bottom of the pyramid.

Source: The Hindu BL

Mains Question:

Q. Discuss the economic potential of micro-finance in rural area of India. What are the challenges faced by Microfinance in India and suggest measures to tackle these challenges.