Reining in MFIs

The proposed Central legislation on microfinance seeks to create a regulatory framework where none existed and lay down some broad parameters of functioning for an important financial sector enterprise. Microfinance is both a social and business activity and is new to the country. Since it is  not governed by clear and enforceable laws its working was different from state to state and even from one company to another.

Last year’s crisis in the sector had its origins in these problems. It is necessary to have a set of uniform rules and have the companies working under the supervision of a single authority. The authority is the Reserve bank of India, as proposed in the bill. Regulatory efforts by other agencies like banks and the NABARD which finance MFIs have been ineffective.  But there are doubts whether the RBI can control the operations of a very large number of enterprises. The bill proposes that all MFIs with net owned funds worth over Rs 5 lakh should register with the RBI. There will be thousands of them and the RBI will need a separate machinery to motor their activities.

Last year’s crisis in the sector was mainly the result of usurious and unethical practices resorted to by some MFIs with respect to interest rates and methods of collection. The Andhra Pradesh government had to promulgate an ordinance to check these malpractices. Much of the Rs 25,000 crore microfinance industry was concentrated in the state. High interest rates and coercive practices had led to farmers’ suicides and the government had to step in. But this also led to a collapse of the industry with many firms, even those that employed fair practices, having been left with large unrepaid loans.

The bill empowers the RBI to fix a range for the MFIs’ rates which will cover interest and all other costs. This might make the operations transparent, as at present most MFIs do not even publicly announce their interest rates. However, there is a view that a ceiling on interest rates and margins may be difficult to enforce and that it may put smaller MFIs at a disadvantage vis- a-vis bigger ones.

Andhra Pradesh is not happy with some provisions of the bill and feels that the states should also have a role in the supervision of the working of the MFIs. But the bill is welcome in so far as it tries to regulate a vital industry.