Consultative Document on Regulation of Microfinance

Why in news?

RBI recently released Consultative Document on Regulation of Microfinance that aims to reassess the priorities of the sector

What is microfinance?

Microfinance is a form of financial service which provides small loans and other financial services to poor and low-income households.
In India, all loans that are below Rs. 1 lakh are considered as microloans.
Based on the recommendations of Malegam Committee, RBI introduced a comprehensive regulatory framework for NBFC-MFIs in 2011.

What are the key proposals?

Gives a common definition i.e Collateral-free lending to households with annual income of Rs 1.25 lakh in rural areas and Rs 2 lakh in urban areas should be considered as microfinance.
Caps loan repayment (principal and interest) for all outstanding loans of the household at 50% of household income.
All Regulated Entities to have a board-approved policy for household income assessment.
No pre-payment penalty.
Greater flexibility of repayment frequency for all microfinance loans.
Prescribed criteria for exemption of ‘not for profit’ microfinance companies.
Alignment of pricing guidelines for NBFC-MFIs with guidelines for NBFCs.
Introduction of a standard simplified fact sheet on pricing of microfinance loans for better transparency.
Display of minimum, maximum and average interest rates charged on microfinance loans on the websites of regulated entities.

What is the significance of the proposal?

The proposed framework is a great leap forward and reflects bold thinking
Avoids over-indebtedness and multiple lending
Addresses the concern of low-income borrowers who often lack the type of collateral often preferred by the lenders

What are the challenges?

Low-Income Households who typically form the customer base for often have seasonal and volatile incomes
It is difficult to separate the household’s personal expenses from that of their occupational pursuits

How can the challenges be addressed?

A structured survey-based approach could be used to assess a household’s expenses, debt position and income from various sources of occupation
A template-based approach where various templates for different categories of households (as per location, occupation type, family characteristics, etc.) could be used
Centralised database can be used to collect and maintain household income data for uniformity in data collection
Technology can be used to assess the cash flows and repayment capacity of micro-enterprises
An overarching set of principles to prevent mis-selling by retail lenders is needed

Source: The Hindu, Livemint