Newspapers have reported that the Government of India’s (GOI) finance ministry has sought to direct public sector banks to impose and monitor a cap of about 24 per cent on the rates at which micro-finance institutions (MFIs) may extend their loans to the ultimate micro-credit borrowers.
MFIs are an emotive sub-ject. Proponents laud the concept – images of the ru-ral poor getting first-time access to institutionalised credit can indeed be heart-warming. Detractors assail MFIs as usurious money-lenders wearing ironed clothes – their argument is that the MFI credit is extremely expensive, making the social impact questionable. The truth, as in most cases, would lie somewhere in between.
Even before going into the merits of the issue, it is important to note that the GOI’s move raises two fundamental issues. First, interest rate policy is the domain of the Reserve Bank of India (RBI), and not an arena that the GOI should intrude into. Bank loans of less than Rs 2 lakhs was the last segment to be freed from a fixed rate pricing – the RBI capped these loans at the prime lending rate of the bank. As the designated regulator, if the RBI were desirous of regulating the rate at which credit delivery should take place, the RBI could intervene using its powers to regulate non-banking financial companies to directly regulate the MFIs.
Second, is an issue of corporate governance – every public sector bank is a dis-tinct institution, answer-able to shareholders, who comprise, in several cases, persons other than the GOI. It is the prerogative and the duty of the boards of directors of these banks to run the banks in compliance with law, compete with others in the market as well as they can in the best intere-sts of their shareholders and stakeholders. By issuing a fiat to public sector banks the GOI is undermining the authority of the boards of directors and the interests of fellow shareholders, making a mockery of corporate governance for these banks.
Issuing such directives to the public sector banks, outside the regulatory and legal framework, could lead to three potential outcomes. The banks may stop lending to MFIs for fear of displeasing the GOI with their inability to implement an impractical measure. MFIs may move away from public sector banks and seek lines of credit from elsewhere. Both these outcomes would only hurt the supply of credit to small-loan borrowers.
The third possibility – that of public sector banks attempting to implement the GOI directive could result in MFIs adopting means other than interest rates to price credit delivery, taking the game out of the public sector banks’ hands. Worse, such innovation could be assailed as an “MFI Scam” in future, setting the industry back by a few decades. All of this can only hurt the policy of working towards improved financial inclusion.
Coming to the question of whether credit delivery by MFIs ought to be regulated in any manner whatsoever, one can’t forget that when any economic activity expands conspicuously, regulatory and political attention would follow. Just as every other man on the street once wanted to set up a power plant, each one now wants to set up an MFI.
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Regulatory attention would do well to study and learn the business well, and see how best to nudge the system into delivering on financial inclusion. Indeed, there is no denying that borrowers in India per se have little regulatory protection as compared with developed credit jurisdictions – the average credit card user in Mumbai can be as clueless about the terms of credit as a borrower of micro credit in Raipur. The RBI would do well to examine whether it needs to lay down disclosure norms, but after conducting a clear empirical study of the ground realities.
It is important to scientifically study the social impact of micro-credit and develop models to measure impact. It is now time to graduate from purely anecdotal sunshine stories. Whether a micro-credit borrower is able to grow his business thanks to credit access and graduate into a bigger businessman, or whet-her the cost of credit is so back-breaking that his business has no hope of scaling up in a lifetime, is worth a scientific study. Therefore, one would have to study whether the micro credit borrowing is being serviced based on cash flows from the business operation, should be measured and documented.
Finally, micro credit is a high-credit-risk business, and credit enforcement and administration can be more expensive than normal – interest rates would therefore naturally be higher normal. Equally, MFIs and their promoters cannot lose sight of how a conspicuous flow of benefits only to the equity contributor, thanks to a business where the counterparties are unable to grow, would present a political landmine and cry out for regulatory intervention.
Micro-credit is described by some as “subsistence borrowing” as opposed to nor-mal credit for funding busin-ess, and that it is flawed to measure impact on the borrowers. More the reason, regulators would be unable to suppress the urge to intervene — particularly for a nation that has followed a dictum: “Show me a symptom, and I will write you a regulation.”
(Disclosure: The author has personal and professional interests in MFIs.) (The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)
Email: somasekhar@jsalaw.com