Earlier this week, the RBI came out with a consultative document on the regulation of microfinance.

The proposals of the document include a common definition of microfinance loans applicable to all regulated entities, alignment of pricing guidelines for NBFC-MFIs with guidelines for NBFCs, introduction of a standard fact sheet on pricing of microfinance loans, and a board-approved policy for household income assessment, among others.

"The proposals have the potential to create a level-playing field for non-banking finance companies-microfinance institutions (NBFC-MFIs), while also providing mid- and small-sized MFIs with the ability to lend profitably," India Ratings and Research said in a report.

The current lending caps make balance sheet lending challenging, as some of them have borrowing costs in the range from 13-15 percent which leaves little space for operating costs and possible credit costs, it said.

According to ICRA Ratings, the proposal to remove the cap on interest rate is expected to provide more flexibility to NBFC-MFIs and create a level-playing field for all the regulated entities.

"The interest rate ceiling had been working as a de facto interest rate in the industry for all the players, and the removal of the same is expected to make the players compete on loan pricing, thus benefiting the borrowers in the long term," ICRA said in a report.

However, given the low interest rate elasticity in the sector and given the moderation in the profitability because of the COVID-19-induced stress, transmission of any rate benefits may be delayed, the agency said.

ICRA Vice-President and Sector Head (Financial Sector Ratings) Sachin Sachdeva said the RBI has proposed to remove cap on the lending amount and the number of NBFC-MFIs who can provide loans to a microfinance borrower.

Instead, it has proposed to focus on borrowers' repayment capacity and accordingly, proposed to cap the fixed obligation to income ratio (FOIR) at 50 per cent, he said.

The proposed set of rules would be applicable for all lenders and, with the focus on borrowers' repayment obligations in relation to the total household income, are expected to help mitigate the issue of over-leveraging at the borrower level, if implemented properly, Sachdeva said.

India Ratings said the adherence to borrower income levels and borrower indebtedness by non-NBFC-MFIs was not consistent and the proposed harmonisation guidelines could address the same.

It said that while informally, this was in practice with many MFIs, the process and inclusion/ exclusion of incomes to be considered for assessment would now be driven by a board policy.

"However, this could also imply that the assessment of income could differ among various lenders. Hence, there may not be a standard assessment, leaving scope for loose lending standards in case the assessment process is not tight," India Ratings said.