Proposed microfinance rules might dampen growth in the sector
PremiumIn its consultation paper, the RBI has recommended putting all lenders under uniform rules
As the pandemic puts at risk the incomes of the most vulnerable households in the country, the Reserve Bank of India (RBI) wants to avoid a debt trap for Indians. Unfettered lending to the poor only kicks the can down the road for both borrowers and lenders. In this light, the RBI’s consultation paper on microfinance has hit the right notes.
The paper recommends that all lenders be brought under uniform rules, as against the current regime where only microfinance institutions (MFIs) were subject to certain limits on pricing and quantum of loans. But perhaps the most important detail is RBI’s approach to keeping household income as the base for regulation rather than number of lenders.
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The central bank has recommended a limit to how much a household can borrow by prescribing that the total repayment towards all loans cannot exceed 50% of income. To be sure, overleverage is the key problem to address amid a pandemic to avoid a surge in bad loans.
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Recall that the microfinance crisis of Andhra Pradesh in 2010 was triggered due to overleverage, as ambitious microfinance lenders hungry for growth offered multiple loans. Indeed, all the troubles of the microfinance industry, big or small, can be traced to overleverage of the borrower. In the immediate term, this puts pressure on the growth plans of banks and even small finance banks seeking growth.
HDFC Securities Ltd in a note said that Bandhan Bank and Ujjivan Small Finance Bank would be the hardest hit, given the high ticket size of their loans. Unlike in the past when no more than two MFIs could lend to the same borrower, this limit will now apply to all lenders.
What this approach does is shift the onus of assessment of household income onto lenders as they will need to have a board-approved plan for the same. “Open questions remain, such as validity of assessment of household income and consistency across entities; assessment of overall debt for household, given lack of cross-referenced database; and will these changes end up increasing the cost to customers?" analysts at Edelweiss Securities Ltd wrote in a note.
Then there are other problems that the removal of limits on pricing can bring about. RBI has suggested removing the cap on the spread that MFIs added to their cost of funds while charging borrowers. Obviously, this benefits MFIs immensely as their margins won’t be under pressure. Removing the pricing cap essentially puts the onus of appropriate and fair pricing on MFIs. A look at the microfinance industry before the cap was put shows that lenders have had a tough time resisting a boost to their margin by charging high lending rates. The paper prescribes a fact sheet where borrowers can compare interest rates of microfinance loans, but it remains to be seen if this alone will ensure loans do not become costly for borrowers. After all, the segment of borrowers serviced is the most vulnerable with low bargaining power.
In a nutshell, the recommendations bring in the much needed level playing field by putting all lenders under uniform rules. The household income approach shows that ultimately borrowers must benefit. RBI’s change in approach perhaps shows its confidence that lenders would be able to assess and price loans fairly. The jury is out on whether lenders would be able to match the expectations.
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