Analysing the Impact of the new Microfinance Lending Regulatory Framework

Ashish M. Shaji

24 Mar, 2022

The Reserve Bank of India had notified about the regulatory framework governing microfinance loans on March 14, 2022. This notification released by the Reserve Bank provided for policy level changes, including amendment in the definition of the microfinance loans. As per the amended definition as specified in the master circular of RBI, “A microfinance loan refers to a collateral-free loan which is given to a household having annual household income up to 300,000 rupees.” This regulatory framework is applicable to all financial entities that deal with microfinance loans which includes all commercial banks, co-operative banks, NBFCs, NBFC-MFI and HFCs. Moreover, this can have a significant impact on both lenders and borrowers. This article seeks to inform its readers about how the new microfinance lending regulatory framework announced by the RBI shall impact lenders and borrowers.

What is a Micro Finance Institution?

It refers to an organization that caters to low income populations, providing them with financial services. These financial services include microloans, micro insurance etc. These institutions play a pivotal role in financial inclusion as it provides loans to those people who may not have access to banking facilities.

The Microfinance sector has grown at a rapid pace over the past few years and presently, it is serving around 100+ million accounts (including banks and small finance banks) of the poor population cohort of India.

Analysis of the New Microfinance Lending Regulatory Framework

The new regulations shall help in the following manner:

• The amendment in the income cap to 3 lakh rupees per annum will expand the market opportunities, and the removal of the interest rate cap will promote risk based underwriting;
• The amendment shall help in harmonising the regulatory framework for various lenders and encourage a healthy competition. It will also help customers to make an informed decision about their credit needs;
• The new regulatory framework will also scale the industry further and enable better risk mitigation and drive financial inclusion;
• The new regulation levels the playing field for lenders in the microfinance segment and is expected to help people get cheaper access to credit;
• It is also expected to protect the borrowers’ interests and assist the sector in catering to the borrowers in need.

Analysing the impact in detail

Regulated entities designated as a commercial bank or a cooperative bank or housing finance companies, or NBFC-MFIs except for payment banks, shall extend comprehensive loan card document to their borrowers. This comprehensive loan card document shall be in a language that can be easily understood by borrowers.

The comprehensive loan card document shall comprise of various details, including terms and conditions of the loan, acknowledgements about repayment of the loan, if any, information on instalments obtained, final loan discharge, if applicable etc. This loan card will also have the details of the grievance redressal system, which includes the name and the contact information of the nodal officer put in place by the regulated entity.

This move will promote transparency in this sector and growth in the microfinance lending sector.

The RBI has also provided for some guidelines on training of staff employed by the registered entity. The guidelines provide that the conduct of the staff towards customers will determine their salary package, which means in case where a staff misleads or doesn’t help the borrower be aware of the loan terms or provide any relevant information connected to it, shall get a lower compensation.

RBI further stated that the training program for the staff shall include training them to inculcate appropriate behaviour towards customers and the conduct of the employees with its customers will be appropriately incorporated in the compensation matrix of the employee. This step from the RBI will result in staff or employees to deal in a better way with its customers.

There have been amendments introduced to make the loan recovery process smooth and seamless for both lenders and borrowers. The guidelines released from the RBI^[1] provide that the registered entities shall provide information on the grievance redressal mechanism for loan recovery at the time of borrowing. This move will enable borrowers to avail of the redressal facility in case a need arises in the future.

The RBI master circular also provides that in case the work has been outsourced to a third party company, the responsibility of code of conduct towards borrowers shall lie with the registered entity. This means that in case the employees of such third party company deals inappropriately with the borrower, the registered entity which appointed such third party shall be held liable. The circular provides that outsourcing any activity by the registered entity shall not diminish the obligations of such registered entity and the onus of compliance with these guidelines shall rest with the registered entity.

Conclusion

Microfinance institutions as well as MFI-turned lenders hailed the new microfinance lending regulatory framework by stating that these guidelines will further deepen the penetration of micro-credit in the nation. With the enhancement in the household income threshold, MFIs is expected to reach many more households and with a level playing field and increased competition, the end customer is set to benefit. According to the India Ratings and Research (Ind-Ra), the changes in the regulations for microfinance institutions (MFIs) will shift the entire industry under the regulatory umbrella, unlike one-third of the industry coverage earlier.

Read our Article:RBI’s Master Direction on Regulatory Framework for Microfinance Loans