We missed that earlier: The Reserve Bank of India (RBI) issued an advisory document on June 14th that prescribes new regulatory frameworks for various lenders in the microfinance sector.
Why is that important? Microfinance is a form of financial service that provides small loans to low-income households. Microfinance through mobile apps has become popular in recent years. However, because this space is not well regulated, it raises several concerns (see below). The proposed guidelines will address some of these concerns.
The RBI invites banks, NBFCs including NBFC MFIs, industry associations and other stakeholders to comment and make suggestions on these proposed guidelines by July 31, 2021.
Who do the proposed guidelines apply to?
Extends from NBFC MFIs to all lenders: While the previous guidelines applied specifically to Non-Banking Financial Company – Micro Finance Institutions (NBFC-MFIs), the new guidelines are aimed at all regulated companies (REs) of the RBI. “The [current] A comprehensive regulatory framework only applies to NBFC MFIs, while other lenders, who make up around 70 percent of the microfinance portfolio, are not subject to any similar regulatory framework, ”said RBI, explaining the reasons for this change. This means that banks, all NBFCs and all other regulated companies that offer microfinance fall within the scope of the proposed guidelines.
Does this apply to lending apps? Credit apps are not explicitly mentioned in the consultation report. These apps work on multiple models. Some have their own NBFC licenses, while others work with banks or NBFCs to offer credit to customers. If they offer credit or work with a regulated company, the suggested guidelines apply to them. However, there are many unauthorized apps in app stores that are outside the scope of the proposed guidelines. The RBI has a separate Working group Develop a regulatory framework for digital lending, including lending through online platforms and mobile apps, but most guidelines on microfinance are likely to extend to these apps.
What concerns do the proposed guidelines seek to address?
Over-indebtedness: While more than two NBFC MFIs are not allowed to lend to the same borrower and there is a regulatory cap on the maximum amount that can be lent by an NBFC MFI, other lenders are not subject to these restrictions as the current regulatory framework only applies to NBFC MFIs. Consequently, small borrowers can obtain multiple loans from multiple lenders, increasing their over-indebtedness. This leads to forced collection practices, the consultation document says.
High lending rates: There is currently a regulatory cap on interest rates for NBFC MFIs. However, this has unintended consequences as other lenders who do not have this cap use it as a benchmark. As a result, banks and large NBFC MFIs, which have comparatively lower financing costs, also charge high interest rates. For this reason, “it is the borrowers who are deprived of the benefits of increased competition and economies of scale,” explained the RBI.
How do the proposed guidelines deal with over-indebtedness?
In order to avoid over-indebtedness of microfinance borrowers, the report suggests regulations that allegedly address the total indebtedness of these borrowers against their ability to repay, rather than just taking into account the indebtedness itself or just the indebtedness of NBFC MFIs. The following measures are accordingly:
Common definition of microfinance: The proposed guidelines define microfinance loans as “safety-free loans to households with an annual household income of 1.25,000 or 2,000,000,000 for rural and urban / semi-urban areas”. A household is further clarified as “a group of people who normally live together and get food from a common kitchen”. This definition now applies uniformly to all supervised companies of the RBI, so that the target borrowers can be identified with certainty regardless of the type of lender. As for the method of assessing household income, the RBI has left it up to companies to produce a board-approved guideline as it is difficult to come up with a common formula.
Limit for the maximum permissible debt: “The proposed regulation aims to ensure that the budget is not burdened. Accordingly, the payment of interest and principal on all outstanding loans of the household are limited to 50 percent of the household income at any point in time. However, individual REs may adopt a conservative threshold based on their own assessments and the policy approved by the Board, ”explained RBI. For example, if a household earns 1 00,000 00,000 per year, the monthly household income is 8333. Therefore, the monthly repayment outflow for any microfinance loan this family receives should be half that of 4,166 yen.
How do the proposed guidelines deal with high lending rates?
No upper interest limit: Current regulations put a cap on the interest rate charged by an NBFC-MFI. This has kept interest rates generally at 24-26 percent. Because different types of lenders have significant differences between funding costs and operating costs, the RBI stated that setting a specific benchmark would have the same problems as the current guidelines, mainly building a benchmark that also includes lenders who use it Can afford to charge lower interest fees do not. As a result, NBFC MFIs are not required to have an interest rate cap and must comply with a guideline approved by the Board of Directors and the Code of Fair Practice, “which would ensure disclosure and transparency”. indicated the advisory document. “The market mechanism should make it possible to lower lending rates for the entire microfinance sector,” added the RBI.
Simplified leaflet on the pricing of microfinance loans, which is mandatory for all lenders: “A cross-country study conducted by the World Bank concluded that a simplified financial product pricing information sheet resulted in three times better decision-making among low-income borrowers compared to other financial literacy materials,” the consultation document stated. In order to enable microfinance borrowers to make an informed decision, the RBI will therefore prescribe a standardized and simplified one-sided disclosure format that only contains information on the pricing of microfinance loans. “This format is intended to enable borrowers to compare interest rates as well as other fees related to a microfinance loan in an easy-to-understand way,” said the RBI.
You should see minimum, maximum, and average interest rates: “The boards of all REs establish appropriate internal policies and procedures for setting interest rates and other fees on microfinance loans so that the flat rates charged to microfinance borrowers are not usurious,” the proposed guidelines state. In addition, all REs are obliged to display the minimum, maximum and average interest rates they have calculated for microfinance loans and to present them to the RBI.
What other customer protections are offered to microfinance borrowers?
No collateral requirement: Because low-income borrowers often “lack the lenders’ preferred type of collateral and what they have to pledge, but are of little value to lenders but highly valued by the borrower (e.g. household items, furniture, etc.) ), “All microfinance loans must be security-free, suggest the new guidelines. So far, this has only applied to loans offered by NBFC MFIs. It is important “to ensure that the borrowers do not lose possession of assets essential for their continued existence in the event of default”, according to the RBI.
No early repayment penalty: All microfinance borrowers will be able to prepay with no penalty, as is the case with NBFC MFIs, according to the report.
Greater flexibility in terms of repayment frequency: Microfinance borrowers from NBFC MFIs are allowed to repay weekly, fortnightly or monthly installments of their choice. The new guidelines suggest that all supervised entities must have a panel-approved policy in place to allow microfinance borrowers the flexibility of repayment frequency according to their requirements.
What changes are specific to NBFC MFIs?
No absolute ceiling on the loan amount: Previously, NBFC MFIs had a loan amount limit of 1.25,000 (75,000 first in the first cycle and excluding loans to cover educational and medical expenses from the loan limit); and a minimum term of 24 months for loans over 30,000. “With the proposed regulation of linking the loan amount to household income, an absolute upper limit for the loan amount would no longer be necessary,” said the RBI.
Half of the loans no longer have to be granted to generate income: The current rules requiring NBFC MFIs to lend at least 50 percent of loans for income generation purposes will be repealed. “Providing credit for other purposes such as repaying expensive loans to moneylenders, education, medical expenses, consumption smoothing, household property acquisition, housing, emergencies, etc. is also important in the Indian context,” stated RBI.
How do nonprofit guidelines apply?
A new definition applies: Since January 2000, RBI has granted certain exemptions to non-for-companies that engage in microfinance activities and do not accept public deposits. Microfinance activities were defined as loans of no more than 50,000 for a commercial enterprise and 1.25,000 for to pay the cost of a housing unit to a poor person. According to the proposed guidelines, the new definition of microfinance applies to non-profit enterprises.
Larger nonprofits may not get an exemption: The RBI is also considering whether all non-profit companies should be granted a blanket exemption. It is considering “bringing companies above a certain threshold in terms of balance sheet size (e.g. assets of $ 100 billion and more) into the regulatory framework of the Reserve Bank,” the consultation document reads. “According to the information in the Bharat Microfinance Report, 2020, around 90 percent of the companies under Section 8 that conduct microfinance activities will continue to be exempted from the registration requirement,” explained the RBI.