RBI’s Regulatory Scaffolds for Microfinance Loans

Micro Finance was introduced during 1980’s in India to cater the needs of low income households and played as a tool of economic development to assist the poor to work their way out of poverty.

• Foremost dynamism to instigate Microfinance was the Self-Employed Women’s Association (SEWA) in Gujarat, which established SEWA Bank in 1974. Since then, this bank has bring forth financial services to individuals who wish to grow their own businesses in rural areas.
• Also, the Malegam Report in 2011 provided the regulatory framework for the Microfinance sector including regulations on loans. Based on the suggestions of the Report, a new category of ‘Non-Banking Financial Company’ – Microfinance Institutions by RBI. However, over the time this category of NBFC had market share of 30% and the rest of the sector was unregulated.

Applicability

The structure covering the loans have been compiled under the Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022 (hereinafter referred as “Master Direction) which was released on March 14, 2022 and will be effective from April 1, 2022.

The Master Direction caters to the unique requirements of the Microfinance space in India. It is applicable to all the institutions called as “regulated entities” consisting of following:

• 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; and
• All Non-Banking Financial Companies (including Microfinance Institutions and Housing Finance Companies).

Key Highlights:

1. Definition of Microfinance Loans- Clause 3 of the Master Direction definition of the term:-
   • The Microfinance Loan has been defined under the Master Direction as collateral free loan given to a household having annual income of Rs. 3 Lakhs. The term household has been defined as individual unit comprising of husband, wife and their unmarried children.
   • Also, the definition of Microfinance Loan has been given a wider scope and it is provided that any collateral free loan given to house hold unit having annual income up to Rs. 3 Lakhs irrespective of end use and mode of application/ processing/ disbursal will be considered as Micro Finance loan. Earlier annual income was demarcated separately for Rural and Urban household.
     In order to ensure that the loans stay collateral-free, RBI has suggested non-linkage of lien on deposit account of the borrowers with loans under this Master Direction.
2. Assessment of Household Income- Clause 4 of the Master Direction lays down for assessment of household income by Board of Directors of Microfinance Institution.
   • The Board of Directors of NBFC to approve policy on Assessment of Household Income. A sample assessment methodology has been provided under the Annexure- I which cover areas like composition of household, source of incomes etc. The methodology specifies following parameters to be taken into consideration while construing Income of Household:
     • Household profile- includes information about members, amenities, assets of household
     • Household income- Primary and other sources of Income
     • Household expenses- Regular and irregular expenses (over the year)
     Also, all the entities engaged in micro finance mandatorily have to submit the household income information to the “Credit Information Companies”.
3. Limit on Loan Repayment Obligations of a Household- The direction also provides for board approved policy in regard to the repayment of the loan under Clause 5.
   • Computation of loan repayment obligations shall include taking into account all outstanding loans (collateral-free microfinance loans as well as any other type of collateralized loans) of the household.
   • The outflows capped at 50% of the monthly household income shall include repayments (including both principal as well as interest component) towards all existing loans as well as the loan under consideration.
4. Pricing of Loans- Clause 6 of the Master Direction proposes on pricing of microfinance loans to cover the following particulars:
   • A well-documented interest rate model/ approach for arriving at the all-inclusive interest rate
   • Delineation of the components of the interest rate such as cost of funds, risk premium and margin, etc. in terms of the quantum of each component based on objective parameters;
   • The range of spread of each component for a given category of borrowers; and
   • A ceiling on the interest rate and all other charges applicable to the microfinance loans.
   Regulated Entities (RE) are required to disclose pricing related information to a prospective borrower in a standardised and simplified factsheet, as illustrated in Annexure II.
   All type of fees and charges applicable for microfinance borrower, payable to RE and/ or its partner/ agent, are required to be clearly mentioned in the said factsheet, i.e. the borrower shall not be charged any amount which is not explicitly mentioned.
5. Guidelines related to the recovery of Loans- The Master Direction’s Clause 7.4 has provided for the accommodative approach to be adopted by the regulated entities while doing recovery of Loans. The Master direction states that regulated entities should provide assistance and guidance if some difficulties are faced by borrower as part of Fair Practice Code. It also prohibits certain types of tactics which are considered to be of harsh nature. It also mandatorily provides for mechanism of grievance redressal related to loan recovery.
6. Not For Profit Companies to register as NBFC-MFI- Not For Profit Companies registered under Section 8 of Companies Act, 2013 which deals in Micro Finance Loans are brought under the purview of the provisions of this Master Direction where the monthly loan obligations of a household does not exceed 50% of the monthly household income. Not For Profit Companies with asset size of less than Rs. 100 Crore are now required to register as NBFC-MFI within 3 months of notification of this Master Direction, as mentioned in Clause 9.
7. Maximum Limit of Microfinance Loans by NBFC- The Reserve Bank has revised the maximum limit up to which a Non-Banking Financial Institution other then NBFC-MFI can issue Micro Finance Loans to 25% of Total Asset earlier it was 10%.
8. Net Owned Fund Requirement- The Bank requires a NBFC- Microfinance Institution is also required to attain Net Owned Fund as per Scale Based Regulation issued by RBI for NBFCs at Rs.10 crore. Reserve Bank provides glidepath to NBFCs to attain Net Owned Fund requirement by March 31, 2027.

Conclusion

In the last decade, this sector has evidenced phenomenal growth which has brought all Microfinance Institutions under one umbrella and has established steadiness. Banks have also made very specific provisions for borrowers/consumers of Money Market which seems to be similar under every other Regulation/Master Direction issued, such as provisions for conduct of recovery agent, reporting to Credit Information Companies, Fair Practice Code etc.

Next stride to execute Microfinance in Rural India is by expanding the number of loans taken, the duration of the loan, quality and availability of these financial services & ors., so that proper framework of this sector empowers the Rural India.

Disclaimer

The information provided in this article is intended for general informational purposes only and should not be construed as legal advice. The content of this article is not intended to create and receipt of it does not constitute any relationship. Readers should not act upon this information without seeking professional legal counsel.