A new lease of life for micro finance companies

At last, there is light at the end of the tunnel for the scores of micro finance institutions (MFI) in the country.

The government, last week, released the draft of a new bill: The Microfonance Institutions (Development and regulation) Bill 2011 (MFI Bill), to govern and develop the MFI industry in the pursuit of spreading financial inclusions.

The last one-and-half years was the darkest time for the 230 MFIs who together have lent around Rs 18,000 crore to the poor and needy people of the country.

Firstly, the management of the largest and only listed MFI, SKS Microfinance was embroiled in a series of controversies that created a negative image for the entire industry. Secondly, the Andhra Pradesh (AP) government stopped MFIs operating in the State from collecting loan repayments on the allegation that high interest rates charged by MFIs have forced many farmers to commit suicide.

As AP accounted for nearly 40 per cent of all MFI loans in the country, the ban on repayment led to non payment of close to Rs 9,000 crore to MFIs. Sensing the risk in MFI business, banks have virtually stopped lending to them choking the funds flow. As a result, many small MFIs became bankrupt.

The MFI industry is now expected to get a new lease of life after the draft bill becomes legislation. The industry players are naturally happy. “Over all this is a very positive development for the microfinance sector in terms of bringing it into the ambit of organised financial services,” said Ujjivan Financial services Managing Director Samit Ghosh.

“Earlier MFIs were loosely regulated and operated in the twilight zone, vulnerable to ordinances or legislations like those in Andhra Pradesh last year which suffocated the entire sector in the State.”

Extension of banks
Welcoming the MFI bill, Deccan Herald spoke to five players, who pointed out several positive implications it carried. The first and foremost is that finally, the MFI industry is getting recognised and being considered as an important agent of change in the country’s socio-economic milieu.

Said the draft MFI bill: “Micro finance institutions to work as extended arms of the banks and financial institutions and provide access to financial services for the rural and urban poor and certain disadvantaged sections of the people.”

In spite of the growth and spread of the banking system, according to the bill, many of the poor households still do not have access to basic financial services such as savings, credit and money transfer and the financial exclusion faced by such people results in discrimination and denial of equal opportunities to them.

“Since the MFI bill lays down the complete future regulatory roadmap for the industry, we welcome it on behalf of the sector,” said founder of Basix and Chairman of Microfinance Institutions Network, Vijay Mahajan.

Added Chandra Shekhar Ghosh, Managing Director Bandhan, an MFI with loan outstanding of Rs 2,514 crore, “The most important is RBI being the regulator, the Bill gives us the recognition and legitimacy to carry on our business.” Agreed chief of another MFI, “All these days we were made to look like blood sucking Shylocks. Now we will be an important of the country’s financial system.”

Freedom from clutches
The second most important implication is that MFIs, like banks, will be out of the purview of ‘Money Lending Act’ and other related legislations, enacted by state governments to prevent private money lenders exploiting poor people. This will save MFI from AP like situation where close to 9.2 million borrowers in the state did not repay loans worth Rs 9,000 crore by taking shelter under Money Lenders Act.

The bill, however, says that an Advisory Council will be set up at the central level and the RBI can also allow setting up of such council at the state level with representations from the government, the RBI and the industry.

According to the bill, the State Advisory Councils shall advise the Central Government the progress achieved in implementation of the policy initiatives in the state. It will also keep tabs and report on the following matters: whether lending activities undertaken by micro finance institutions are resulting in over-indebtedness and consequent large scale defaults; whether recovery practices adopted by micro finance institutions are fair and reasonable; whether the grievance redressal mechanism is working satisfactorily, etc.

Bigger role
In this respect, Grameen Financial Services (Grameen Kuta) Managing Director Suresh Krishna feels a bit uncomfortable. “I am a little worried that the State Councils may raise politically motivated objections if they decide to create problems for the industry in the name of protecting borrowers,” Krishna said. He also felt that the lower limit of net-owned funds at Rs 5 lakh is a bit too low and may lead to proliferation of many small micro lenders burdening the regulator with lots of work.

The MFI bill has also expanded the scope of the industry from being only the lender of small loans. It proposes to allow them to give micro credit to individuals or groups, collect deposits, remit funds, provide pension or insurance services and any other services as may be specified by the regulator.

“We are very happy that the scope has been extended. Earlier we were not allowed to take deposits as it was considered to be too risky and the fear was small investors will get cheated,” explained Ghosh of Bandhan.

In Bangladesh, where microfinance is big and popular among the people, nearly 40 of the fund is raised from small depositors. Ghosh thinks that raising deposits from people where the lending is also taking place will help create a greater bonding with customers.

The bill also gives a detailed guideline on the role of the regulator. It has laid down provisions that will allow the RBI to fix ceiling on the amount of credit to be given and the number of individual clients to whom such financial assistance may be provided by any micro finance institution. The RBI will also have the right to specify the ‘margin cap’ which will stipulate interest MFIs can charge in relation to their cost of fund.

It will have the power to decide the tenure of financial assistance, judge the purpose for which financial assistance can be given and periodocity of repayment schedules. To levy processing fees, interest, life insurance premium and other terms relating to financial assistance, MFIs will have to follow RBI guideline. All MFIs will have to create a reserve fund from surplus generated, if any, and such funds cannot be used to distribute as dividend to shareholders.

Moreover, every micro finance institution will have to prepare, in respect of all services transacted by it, a balance sheet, profit and loss account or an income and expenditure account for the financial year, in formats specified by the RBI.

Though such regulations are quite restrictive, more so as many MFIs till recently charged exorbitant interest rates (going up to 35-40 per cent), the industry is not complaining much.

“Strict regulation from a single regulator is very much needed in the formative stage, it will lead to orderly development,” said Ghosh of Bandhan. Mahajan also agreed by saying, “The regulation goes beyond the Malegam Committee recommendations and provides comforts to the industry.”

But Samit Ghosh of Ujjivan is of the view that the bill retained some of the negative recommendations of the Malegam Committee in terms of micromanagement, like specifying financial product specifications, margin and interest rate caps and so on.