Why the Microfinance Bill is a good move

The new draft microfinance Bill, on the finance ministry’s website, has a number of positive features which augur well for a geographically more balanced and healthier development of the sector.

First, despite having 71 million borrowers and accounting for abour Rs45,000 crore in loans outstanding, the microfinance sector does not have a regulatory structure that encompasses all the participants. The microfinance Bill will address this limitation by including all the participants, except the cooperatives, on a nation-wide basis.

Second, by specifically providing regulation of the microfinance institutions (MFIs), the Bill recognises that further development and geographical spread of the microfinance sector requires operations of the MFIs are not equated with money lending. The microfinance Bill will thus constrain states, such as Andhra Pradesh, using outdated money lending Acts, to regulate the MFIs.

Third, the Bill could help broaden the scope of services provided by microfinance sector as it defines microfinance to include microcredit, savings products, remittances, pensions, insurance and others. It recognises use of group and individual models.

The conditions under which savings products may be offered have not been delineated. Currently, only MFIs that are incorporated as cooperatives or local area banks can offer such products. It is, hence, important that operational guidelines for savings products be provided, with sufficient safeguards.

Fourth, the Bill calls for registration of all MFIs with the Reserve Bank of India (RBI) within a period of three months of it becoming Act. It mandates a minimum net worth of Rs 5 lakh for the MFIs, whether this limit is appropriate for deposit taking functions merits a re-think. NBFCs already registered with the RBI are also required to register themselves specifically as MFIs.

Registration can be expected to bring greater accountability to sector participants and will help build a more comprehensive database concerning various aspects. For databases to be useful, data mining capabilities, and analytically rigorous policy-oriented research will need to be encouraged. In particular, costs and benefits of administering and complying with the provisions of the microfinance Bill and of delivering microfinance services need to be analysed and results incorporated in regulatory and operational practices.

Fifth, the Bill requires MFIs, having an asset size higher than a specified value, to convert themselves into companies. Though most of the large MFIs are registered as NBFCs, the regulatory requirement to do so may help ensure greater transparency as disclosure requirements for firms are more stringent.

Sixth, the Bill mandates the creation of a reserve fund and annual audit of MFI accounts. Other than the minimum net worth of MFIs, the Bill avoids definitions of numerical limits, which is prudent as these would need periodic revision.

There are additional areas which merit further examination as the Bill progresses through the parliamentary process. Given the low net worth threshold prescribed for registration of MFIs, the process of registration and regulation of MFIs may stretch the regulatory capacity of RBI. Establishing a special division for microfinance regulation, with requisite expertise, merits consideration.

Though the Bill provides for delegation of powers by the RBI to Nabard, such a delegation of responsibilities is not desirable, as Nabard an active participant in the sector, should not be a part of regulatory process.

The Bill proposes Microfinance Development Councils (MDCs) at the Central level and at State levels with advisory roles. At the Central level, representation from government, Nabard, Sidbi and NHB and from the microfinance sector is envisaged. Care should, however, be taken to include representatives from different microfinance models.

Representatives of members of self help groups (SHGs) and MFIs and researchers should also be included. It may also be desirable to ensure representation from microfinance organisations operating in rural, urban and semi-urban areas, taking due cognizance of the rapid urbanisation.

At the state level, representation should cover government and private microfinance programmes and the councils should have chairperson with relevant expertise and independence. The Bill proposes that MDCs could advice on policies and measures relating to use of technology, establishing of credit bureaus and working of grievance redressal mechanisms.

It may be useful to specifically include improvement of financial literacy and financial education of microfinance members as a priority area for MDCs to address. The costs of setting up and operating the MCDs should be carefully analysed, and this should be made public. Transparency and accountability guidelines for the operations of the MCDs should be so structured asto facilitate such an analysis.

The Bill gives powers to the RBI to provide directives on various matters relating to the sector, including effective interest rates on loans and caps on profit margins. These have also been enumerated earlier in the RBI’s circular on priority sector eligibility for microfinance activities.

A number of sector participants have pointed out the practical difficulties in measurement and maintenance of profit margins as these tend to fluctuate over time with changes in cost of funds and changes in the number and maturity of MFI branches.

Other important powers given to the RBI are powers to direct MFIs to become members of credit bureaus, to observe codes of conduct formulated by recognised self regulatory organisations and to follow specific norms for corporate governance and client protection have important implications.

These requirements could be useful in building sector wide credit bureaus, giving more teeth to voluntary codes of conduct developed by the sector and improving governance practices in the sector.

Refinements and expeditious passage of the microfinance Bill could help enhance confidence in the sector, which has seen considerable erosion recently.

This could have positive implications for access to greater and long term funding from commercial and social enterprise oriented sources. Such access could enable MFIs to invest in technology and increase the scale of operations, helping to reduce transaction costs, and to expand geographical coverage. It could also facilitate options of micro-finance members to access other financial institutions.

The success of the microfinance Bill will be ultimately judged by its contribution to the national objective of financial inclusion in the country, and in terms of quantity and quality of services provided by the sector at affordable economic costs.

Mukul Asher (sppasher@nus.edu.sg) is a professor of public policy and Savita Shankar (savita.shankar@nus.edu.sg) is a research scholar at the Lee Kuan Yew School of
Public Policy, National
University of Singapore. Views are personal