Micro finance: Empowering a Billion Dreams

1. The theme for this year 2021 is  ‘Revitalizing Financial Inclusion’ –
2. Covid -19- pandemic has worst affected the vulnerable and disadvantaged sections of the society.
3. Microfinance can transform social and economic structures and balance the welfare and profitability paradigm being one of most important financial tools to foster financial inclusion by enabling the poor and low-income households to increase their income levels, improve their overall standards of living and thereby come out of poverty. 
4. In India mostly two micro finance model are developed –
5. First - the bank led approach mainly through Self Help Group (SHG) – Bank Linkage Programme (SHG-BLP), that was started as a pilot project in 1992 by National Bank for Agricultural and Rural Development (NABARD) and
6. The second is specialised micro finance institutions led model includes credit and thrift products, micro insurance, micro pension, micro remittances, digital payments, amongst others. It serves the double objectives of social benefits with financial viability.
7. The need for regulating the MFIs was felt in early 2000s- based on the recommendation of the committee constituted under the Chairmanship of Shri Y. H. Malegam.
8. RBI introduced a comprehensive regulatory framework for NBFC-MFIs in December 2011.
9. The eligibility criteria for microfinance loans for lending to belonging to low-income groups without collateral, with flexible repayment schedules. Besides, the special emphasis on protection of borrowers and fair practices in lending such as transparency in charges, ceilings on margins and interest rates, non-coercive methods of recovery, measures to contain multiple lending and over-indebtedness.
10. Indian microfinance sector has witnessed phenomenal growth over past two decades. Micro credit is delivered through a variety of institutional channels viz., scheduled commercial banks (SCBs), regional rural banks (RRBs), cooperative banks, non-banking financial companies (NBFCs), Section 8 companies and microfinance institutions (MFIs) registered as NBFCs as well as in other forms.
11. The small finance banks (SFBs) are the latest in the structure. One universal bank in 2014 and eight entities granted approval for starting Small Finance Banks in 2016 were NBFC-MFIs.
12. Three most criticisms are imposed against micro finance lenders –
    1. that they lead their borrowers into debt-trap like situations;
    2. They charge usurious rates of interest often disproportionate to their funding and operational costs; and
    3. They deploy harsh recovery methods leading to distress amongst borrowers.

The above issues are needed to be introspected and addressed by the lenders.

Over-indebtedness and Multiple Lending

1. To save the borrower from over indebtedness, the NBFC-MFI regulations do not permit more than two NBFC-MFIs to lend to the same borrower with a regulatory ceiling on the maximum amount that can be lent by an NBFC-MFI, however observed that small borrowers are increasingly able to get multiple loans from several lenders well beyond their repayment capacity, contributing to over-indebtedness. The borrowers then end up defaulting on their repayment obligations. Then there are reports of coercive recovery practices by the entities looking to recover their dues. In this entire process, there is a compromise with the basic tenet of responsible lending with the small and marginal borrowers ending up becoming victims of over-indebtedness.
2. In the proposed framework, it has therefore been suggested that the regulations should focus on repayment capacity of the borrowers rather than considering only indebtedness or indebtedness from only NBFC-MFIs in isolation. The proposal is that the payment of interest and repayment of principal for all outstanding loans of the household at any point of time should not be more than 50 per cent of the household income.

Pricing of Micro finance Loans

1. The banks (including SFBs) have been advised to benchmark all new floating rate personal or retail loans to an external benchmark w.e.f. October 1, 2019, however benchmark-based pricing has not been introduced for NBFCs, including NBFC-MFIs, yet.
2. Under the revised framework, it is proposed to do away with the prescribed ceiling and mandate all lenders to have a board approved policy on all-inclusive interest rate charged to the micro finance borrowers. The lenders would also have to make available a simplified factsheet on pricing of micro finance loans to the borrowers along with the disclosure of minimum, maximum, and average interest rates charged by them. The intention is to enable the market mechanism to come into play with the expectation that it will bring the lending rates downwards for the entire microfinance sector and empower the customer through transparent disclosures.

Customer Protection Measures

1. The inability/ difficulty of a borrower to repay his loan may be caused by several reasons such as unforeseen/ unavoidable adverse circumstances, natural calamities, over-indebtedness, etc. A cap on the loan repayment obligation of a household as a percentage of the household income is expected to address the inability of the microfinance borrowers to repay the loan. The Reserve Bank is looking to strengthen this issue and proposed to extend the collateral free nature of microfinance loans, as applicable to NBFC-MFIs, to all lenders in the micro finance space.

Way forward

1. The negative consequences of over-indebtedness, harsh recovery practices and adverse outcomes arising from harassment of customers will adversely impact the MFI eco system.
2. Lenders need to remain cognizant of the fact that the balance sheet growth should not be built by compromising on the prudent conduct.
3. Micro finance should be focussed on understanding the needs of the customer first and offer them adequate levels of support through appropriate financial products. The customers of micro finance institutions often have lower level of financial awareness and literacy and are often too desperate to turn away any source of credit. Therefore, they need to be treated with care and empathy and should not be considered as a mere data points for investor presentations.
4. As microfinance industry serves lower strata of the society and micro and small businesses, it has its own set of operational challenges and costs. Technology should help the industry to overcome this challenge.

Concluding thoughts

1. For most of us, it is hard to imagine a life without financial services, but billions of people around the world do not have to imagine it but live through it every day. Unless we work to uplift this vast section of the society by bringing them into the formal financial fold, a billion aspirations may remain unfulfilled. Micro finance has come of age in India. It has developed into an important financial delivery mechanism. It has particularly helped women to become owners of assets, have an increased say in decision making and lead dignified lives. In current landscape, it is possible to expedite financial inclusion process by leveraging the flexibility provided by the multiple tech-led models for delivering a wide range of financial services. From the regulatory side, the growth of the sector guided by the ultimate objective of financial inclusion and customer protection should be looked into.