The infirmities in the proposed microfinance regulation and it’s implications

Emmanuel Murray
Microfinance Jobs
Article Jul 21, 2021 0

“Why should boys have all the fun?” – Popular TVS Scooty Ad signature

The updated version “Why should banks eat all the cake?” NBFC-MFIs

On the 14th of June 2021, RBI released a Consultative Document on Regulation of Microfinance. The need for a re-look at the Regulations has been quite well articulated in the Document, and as per my understanding stemmed from three points:

  1. The looming overhang of over-indebtedness of Microfinance clients
  2. The interest rate to Microfinance clients having remained largely static, and
  3. Most importantly, NBFC-MFIs feeling that banks that are ‘having all the fun’. In my assessment, Microfinance loans have the highest yield among all asset classes in the Priority Sector, and is the main reason for banks scrambling to acquire MFIs, not their love for serving the poor or weaker sections.

The solution being proffered, which is encapsulated in the Discussion Paper is to link Microfinance loans to household income , and limit lending to a level of payout not exceeding 50% of the household income. On the face of it, this seems an appropriate solution, but in my view is fraught with immense infirmities which make the practical implementation of such an idea difficult.

First, the repayment will need to be arrived at against future income. As all players in this space agree, a major part of the income comes from agriculture, as farm labor or as crop production. these are variable and are a function of production and prices. While weather and other vagaries influence production, price is influenced by several factors including market sentiment. The variations across years is significant.

Second, there are things like milk that are produced for home consumption. The complexity in this is that the inputs (feed, AI, vaccines, medicines) are monetary, but the output is not monetized. So do we treat the milk produced and consumed by the household as income or not?

Third, the unit for assessment of income is taken as the household. as per some generally accepted definition. The challenge today is that all the income of the household does not flow into the family pool. Today, a large number of children live with their parents but prefer to save their earnings for their own future. Similarly, wife and children are left behind in the village, while the man is in the city working (example as a driver on Uber). He also has variable earnings, living costs and remits funds at his own discretion.

These and other factors (like seasonality in cash flows) make it almost impossible to get a fix on the household income. Further, the job of arriving at this seems to have been left to the household, and thus adds to the complexity. In reality, what will happen is that a MF lender will appear on the scene, make some back of the envelope calculations and fill it up. The way it will be done is by deciding a loan amount and working backwards with filling-in the blanks. Anytime later, another lender may appear on the scene, ‘help’ the person with some new numbers and give another loan. This will iterate till the Income converges towards Rs1.25 lakh, the income ceiling.

Regulation complied, everyone happy.

In fact, to implement the idea of household income is great as an idea, but practically un-doable. Period. It will at the lender level require customising the loan for each household and is in sharp contrast to the one size fits all factory model of lending presently in vogue in Microfinance.

If done in right earnest, this model will effectively shrink the microfinance market rather than grow it. Are banks and MFIs ready for that? I have serious doubt.

On the interest rates issue, I will write another piece, if I feel like. Having been in the policy making space for a while, I was privy to the thinking that went into policy at one point in time (upto 2001-02), and how everyone has followed the letter, leaving the spirit of the policy far behind, to make it a profitable industry for all players except microfinance borrowers. That situation is unlikely to change soon.

Author: Emmanuel Murray (Senior Advisor at Caspian Impact Investment Adviser FPO and Agri Startup Evangelist. Mentor and Coach. Believer in exploring, experimenting and sharing knowledge)

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