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Legal and Regulatory Framework for Microfinance Institutions

Narendra Kumar

| Updated: Jun 25, 2018 | Category: Micro Finance Company

Microfinance Institutions

What are Microfinance Institutions?

Microfinance Institutions, as the name suggests, it plans to cater to the financial need of the smallest strata (low-income group) of the society. The smallest category of the society like rural women, peasants, workers and other such small people who have no capacity to visit the banks for loan application in connection with their occupations.

The microfinance industry has achieved an unprecedented growth over the last two decades

Therefore Microfinance Services Regulation Bill has been introduced for the purpose of financial assistance to be provided to an eligible individual directly or by a group mechanism for certain purpose to be achieved by the borrowers(members).

There are various types of microfinance institutions/organizations operating in India. Mainly they are like

Joint Liability Group (JLG), Self Help Group (SHG), the Grameen Bank Model and Rural Cooperatives etc.  Having main aim of financial inclusion of smallest person of the society.

However, it is not easy to operate smoothly by such MFIs as there are many challenges faced by the Indian microfinance industry.

The main area of its operation is confined to the poorer section of the country, over-indebtedness is a common and serious challenge faced by the MFIs.The members have generally borrowed the funds from other available sources. There are some of the other challenges also and they are like

  • High rates of interest being charged to members.
  • Over-dependence on the banking system to procure the funds for MFI business.
  • Illiteracy and lack of awareness by the members (borrowers) as they are largely from a rural 

The legal framework for MFIs in India with reference to its registration and other parameters can be broadly narrated as under:

  1. For Societies – Registration for this is a very easy process with no minimum capital requirement. Further, they are not allowed for deposit mobilization/ collection from the public. It has to operate amongst its members only.
  2. For Trust—Registration for this is very easy with no minimum capital requirement. It is not allowed for deposit mobilization/ collection from the public. It is sometimes problematic as the funds for further expansion may not be available. It has limited scope for expansion.
  3. For Sec. 25 Companies—Registration is easy but not that easy as those of trusts and societies, especially for an existing company to convert into a Section 25 company. It is not allowed for deposit mobilization/ collection from the public. However, it contributes a lot to the process of financial inclusion.
  4. For NBFC-MFI— Registration for this is to be taken up with RBI and it is difficult to obtain due to stringent provisions of the RBI. It requires minimum capital of Rs. 5 crores (Rs. 2 crores for North-East India region) to start MFI operations. It is not allowed for deposit mobilization/ collection from the public. It has a large scope and provides a good background for scaling up of the operations as it has investors’ confidence with it. It is observed that many MFIs in India, especially in South India and West Bengal, have grown and developed its activities/ operation remarkably.RBI is a strict regulator for MFIs and it monitors very closely from time to time.
  5. For Cooperative Societies— Registration for this is very easy (except in the state of Maharashtra) with the minimum capital requirement. It has very minimal regulatory requirements to fulfill in this matter. It is allowed to collect the deposits from its members only. It is relatively easy to scale up/ expand its activities. It is observed that many cooperative societies in Maharashtra and South India have progressed very much in terms of size and activities undertaken.

There are many structural weaknesses of RRBs, cooperative societies, and urban cooperative banks, thus the microfinance movement has a remarkable presence in the Indian credit market.

However, the RBI has clearly specified the regulatory framework for MFI which guide them to function smoothly and it is summarized as below:

As per the RBI, NBFC – Microfinance Institutions means a non-deposit taking NBFC (other than a company formed and registered under section 25 of the Companies Act, 1956) that fulfills the necessary conditions pertaining to minimum net owned funds, net assets criteria, qualifying assets criteria and other incidental requirements related to the loan disbursement to the members. The regulatory guidelines of RBI help a lot to grow, expand and develop the MFIs in a systemic way.

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Narendra Kumar

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