RBI’s Master Direction on Regulatory Framework for Microfinance Loans

Prabhat Nigam

13 Sep, 2022

Recently, the Reserve Bank of India (RBI) has released Master Directions on Regulatory Framework for Microfinance Loans, 2022 wherein RBI has directed that microfinance lenders cannot charge usurious rate of interest from borrowers and asked them to put in place a ceiling limit on pricing of loans and related fees.     

What is a microfinance loan?

A microfinance loan can be defined as a loan where collateral is not asked for. It is a loan given to a household whose annual income is not having more than Rupees 3 lakh. The term household shall comprise of an individual family unit i.e. husband, wife and unmarried children.

It must be noted all the collateral-free loans irrespective of their end use, processing, disbursal, mode of application provided to low-income households having an annual household income less than Rupees 3 shall be considered or deemed as microfinance loans. 

Applicability of RBI’s Master Direction

• All Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks) excluding Payments Banks.
• All Primary (Urban) Co-operative Banks/ State Co-operative Banks/ District Central Co-operative Banks^[1]
• All Non-Banking Financial Companies (including Microfinance Institutions and Housing Finance Companies)

What are the directions in Regulatory Framework for Microfinance Loans?

Guidelines on assessment of Household income

Each RE has to put in place a board approved policy for the assessment of household income.

Guidelines on Loan Repayment Obligations and Pricing of Loans

The directions provided that all the regulated entities (RE) have to put in place a board-approved policy regarding microfinance loans covering a ceiling on the interest rate and all other charges which are applicable to microfinance loans.

It is directed that the interest rates and other fees/ charges on microfinance loans cannot be usurious and that these shall be subjected to supervisory scrutiny by the RBI itself.

The Directions also provide that it is the duty of every RE to disclose pricing-related information to a prospective buyer in a factsheet which is standardised and simplified.

Disclosures related to any fees to be charged to the microfinance borrower by the RE and / or its partner/ agent shall be done in explicitly in the factsheet itself. Any amount which has not been explicitly mentioned in the factsheet shall not be charged on the borrower’s account. Further, there cannot be pre-payment penalty on microfinance loans.

If any penalty is imposed on delayed payment of loan, then the penalty shall be applied only on the overdue amount and not on the entire loan.

With regards to the limit on loan repayment obligations of a household, the Directions provide that each RE must have a board approved policy with respect to the limit on the outflow on account of repayment of monthly loan obligations of a household as a percentage of the monthly household income.      

The Directions have kept a maximum limit of 50 percent of the monthly household income.

According to the previous guidelines, an NBFC which does not qualify as a Non-Banking Financial Company- Microfinance Institution (NBFC-MFI) cannot provide microfinance loans which exceed 10 percent of its total assets. According to the new Directions released by the RBI, the previous maximum limit pegged at 10 percent of total assets of NBFCs other than NBFC-MFI has been revised to the maximum limit of 25 percent of NBFCs total assets. 

Guidelines on conduct towards the borrower

There should be a standard form of loan agreement for microfinance loans which is drafted in a language which can be easily understood by the borrower which shall incorporate the information which adequately identifies the owner, simplified factsheet on pricing, all other T&Cs attached to the loan, details of grievance redressal system etc.

Guidelines related to Recovery of Loans

Each RE has to put in place mechanism for identification of borrowers who are facing problems in repayment of loans, engagement with such borrowers and providing them with necessary guidance on the recourse available.

Recovery of the amount shall be done at a designated/ central place decided mutually between the borrower and the RE. However, field staff shall be allowed to make recovery at the place of residence or work of the borrower of the borrower fails to appear at the designated place on two or more successive occasions.

RE or its agents are not supposed engage in any harsh methods towards recovery such as threatening or using abusive language, persistently calling the borrower and or calling the borrower before 9 am and after 6 pm, harassing relatives, friends etc.

There should be dedicated mechanism for redressal of recovery related grievances, the details of which should be known to the borrower at the time of loan disbursal.

Engagement of Recovery Agents

The REs who engage in the process of hiring recovery agents need to do due diligence of the recovery agents which will include the individual involved in the recovery process. Due diligence shall include verification of the antecedents of their employees which will include police verification. It will be duty of the RE to provide the details of recovery agents to the borrower before initiating the process of recovery.  

Conclusion  

The Directions have been well devised taking into consideration the demands of both the stakeholders i.e. the borrowers and the registered entities. For the borrower, the directions do not prescribe any penalty on the prepayment of loan, protection of harsh methods of loan recovery agents etc. and for the REs such as increasing the upper limit of loan disbursal equivalent to 25 percent of the total assets of the business, standardised formats etc. All in all, these directions have addressed the needs and concerns of both the stakeholders.