The Reserve Bank of India’s new framework for the microfinance sector, in which it replaced rule-based guidelines on pricing of loans with a principle-based framework, is aimed at making the borrower aware of the total cost being paid by him for the loan, while ensuring comparability amongst lenders by standardising the calculation of all-inclusive cost. These measures, along with a cap on repayment obligations and steps to check over-indebtedness introduced by the regulator, will eventually bring down interest rates for the borrowers, said M Rajeshwar Rao, Deputy Governor, RBI.
Speaking at the launch of MFIN’s India Microfinance review, Rao said, “…the intent of regulation is to make the borrower aware of the total cost being paid by him for the loan and at the same time ensure comparability amongst the lenders by standardising the calculation of all-inclusive cost.”
“It is expected that availability of such information will help borrowers make an informed choice while assessing the available options. In addition to specific pricing related regulations, this framework needs to be seen in a holistic manner, wherein certain indirect but equally important measures have been introduced to bring down the interest rate,” he said.
In March 2022, the RBI brought out a comprehensive and revised regulatory framework for microfinance loans, centred around the idea of customer protection. The core principles of these regulations are: addressing the regulatory arbitrage with the introduction of a lender agnostic and activity-based regulation; protecting microfinance borrowers from over-indebtedness caused by granting of loans beyond the repayment capacity; enabling competitive forces to bring down the interest rates; enhancing customer protection measures; and facilitating flexibility to design products/services.
Commenting on the “pricing and transparency” part of the regulations, Rao said the introduction of a simplified fact sheet spells out the methodology for calculation of all-inclusive effective interest rate. This ensures comparability of interest rate across different lenders.
“There have been some demands that insurance charges should not be included in the calculation of effective interest rate. There does not seem to be any logic for excluding some components from the calculation of all-inclusive cost of the borrower which she/ he is actually paying,” said Rao.
He also elaborated that the introduction of a cap on repayment obligations is expected to nudge lenders to keep interest rates low so that repayment instalments do not exceed the maximum prescribed limit. Also, the measures to check over-indebtedness will help improve the credit worthiness of borrowers, bringing down the credit risk premium, which should translate into lower interest rates.
Rao also outlined that one important aspect of the new guidelines is that outsourcing of any activity by the regulated entity does not diminish its obligations and they will be accountable for inappropriate behaviour by its employees or employees of the outsourced agency and have to provide timely grievance redressal for both.
“With increasing competition and level playing field for all regulated entities in the sector, one of the differentiating factors going forward will be the customers’ experience with the lenders’ services,” Rao said.
“The new framework has put in place a few ground rules to address concerns around misconduct towards microfinance borrowers. Conduct towards customers being integral to ethical business practices, it becomes the responsibility of everyone involved in the process to ensure that the guidelines on conduct are followed in both letter and spirit and the customer is treated fairly and respectfully at all times,” he said.
“While we acknowledge the rights of the lenders to recover overdue loans, I would like to make it clear in no uncertain terms that the Reserve Bank has zero tolerance for misconduct towards the borrowers”, Rao emphasised.
Over the last decade, the landscape of the microfinance sector has undergone significant changes, so much so that microfinance institutions (MFIs), which once commanded a dominant position in the industry, have been replaced by banks, including small finance banks, as the bastions of the industry.
According to the latest data (up to June 30), the total microfinance loan portfolio stands at Rs 2.93 trillion, in which banks hold the largest share of 38 per cent followed closely by NBFC-MFIs at 35 per cent. SFBs, other NBFCs and other entities have a combined share of 27 per cent.