Microfinance Bill sets the terms, RBI sole regulator

It’s final. The Reserve Bank of India will be the overlord of microfinanciers.

Clearing the confusion over regulation of microfinance activity once for all, the Centre has reiterated that the apex bank will be the single-point regulator for the sector.

The RBI will also decide the margins they enjoy and penalise errant players.

While proposing an interest rate cap of 26% for MFIs, the Malegam Committee had called for a margin cap of 10% over the cost of funds for players with loan portfolios exceeding `100 crore and 12% over the cost of funds for smaller ones. RBI had broadly accepted the panel’s recommendations.

The margins enjoyed by most MFIs are in excess of the recommended levels.

SKS Microfinance, India’s largest microfinancier, had a net interest margin of 17.3% in 2009-10 and was expected to grow this to 19.15%, Manish Chowdhary and Aditya Narain of Citigroup said in a May 3 report.

With the RBI as the regulator, these players appear set for a margin squeeze.

The draft Microfinance Institutions (Regulation and Development) Bill 2011 also prescribes several penal provisions apart from stringent accounting and auditing norms.    

“If any provision of this Act is contravened or if any default is made in complying with any other requirement of this Act or of any rules, regulations or orders or directions given or notification issued or condition imposed thereunder, any person guilty of such contravention or default shall be punishable with fine which may extend to Rs5 lakh and where a contravention or default is a continuing one, with further fine, which may extend to Rs10,000 for everyday after the first, during which the contravention or default continues or with imprisonment for a term not exceeding two years or with both,” it says.

The microfinance sector has been facing severe headwinds since Andhra Pradesh served a ban on the players operating in the state and went on to put in place legislation to regulate it. The Act resulted in a significant drop in microfinance activity in the state, which accounted for over 25% of the portfolio for most of the MFIs. Predictably, the players had cried foul, saying it amounted to double regulation as most of them were already registered with the RBI as non-banking finance companies.

The Bill has mandated the central bank to be the one-point regulator and has also prescribed a procedure for grievance redressal through the setting up of an ombudsman system.

“The Central government may, by notification, constitute a council, to be known as the Micro Finance Development Council, to advise the Central government on formulation of policies, schemes and other measures required in the interest of orderly growth and development of the micro finance sector and micro finance institutions, to promote financial inclusion,” says the draft Bill. The central council would in turn depend on the state level advisory councils for seeking the grassroots level inputs.

“The central council and the advisory council set up at the state level is a very good move since it will be helpful in getting the real feedback from the market,” said Alok Prasad, CEO of Microfinance Institutions Network. Prasad was also a member of the drafting committee of the Bill.

The MFIs have also been under attack due to the usurious interest rates charged by them. A study conducted by the Andhra Pradesh government had found that the interest rates were as high as 40%, which imposed significant financial burden on the borrower and forced him to default on repayments in several cases.

The Bill does not talk specifically about the interest rates, but has mandated the RBI to fix the margins that can be derived by the MFIs.

“The Reserve Bank may specify margin for microfinance institutions generally or for a class of microfinance institutions or for any micro finance institution in particular, considering the size of their operations and other relevant parameters,” the draft Bill says. Additionally, the MFIs will also have to get the margins certified by the auditor to ensure that there is no excess margin being retained by the MFIs.

“We are happy that the RBI has been designated as the single-point regulator for the microfinance related activities. It is a well crafted document and the committee consisted of all the stakeholders. Considerable deliberations were made before drafting the Bill,” said Prasad.

The emphasis on financial inclusion may have led the government to entrust the regulation of the microfinance sector to the RBI.