The controversy into which the microfinance sector has recently been plunged has reportedly prompted the Union government to speed up its proposed legislation for the sector so that disparate action by individual states does not stymie its growth. This is just as well because it will be a tragedy if, in seeking to rein in the culpable, regulation ends up throwing the baby out with the bathwater. Microfinance is one of the best things that has happened to poor people and every effort must be made to nurture it as it stands at the threshold of self-sustaining growth. To evolve regulation, which is both correct and judicious (over-regulation will stifle), it is necessary to know who is doing what in the sector. It has come to be dominated by the big boys, those which are for-profit and constituted as non-banking financial companies (NBFCs). They account for 90 per cent of the entire loan portfolio of the sector, according to the latest study by Sa-Dhan, the umbrella organisation representing all microfinance institutions (MFIs). As it happens, these NBFC-MFIs are already under the regulatory supervision of the Reserve Bank of India (RBI). The top financial regulator is the best equipped to supervise large financial institutions and that is the way it should remain. RBI has, in fact, in the recent period stepped up its supervision of “systemically important” NBFC-MFIs with loan portfolios over Rs 100 crore.
What a Bill can do is bring the rest of the sector — MFIs constituted as societies, trusts and self-help groups — under a common regulator. But more importantly, the Bill should lay down a code of conduct which will apply to all — big and small — and be more important for the health of the sector than the health of individual balance sheets. The first norm must be to ban multiple lending (the large MFIs engage in it extensively) and lay down a road map to slowly draw down and eliminate the current multiple-lending overhang. The present troubles of the sector began with the attempt by large MFIs in Andhra Pradesh to target the members of self-help groups, which are part of a micro-credit initiative of the state government and which together have borrowed substantially from public sector banks. The Bill can also make it obligatory for all MFIs to state upfront what their lending rate is after taking into account various methods used like insisting on security deposits, which raise the effective rate of interest above what is claimed. Once this information is available, discussion can begin on what is an acceptable range of lending rates for the sector. Finally, the practice of obtaining and enforcing group guarantees should be ended. Peer pressure lies at the root of the coercive recovery methods, which have reportedly led to suicides. It is ironic that the crisis in microfinance lies in its success. The aggressive and successful NBFC-MFIs which were able to attract global private equity (PE) now have the latter breathing down their necks, making it imperative for them to post good performance and achieve high valuations so that the PE players can exit at a profit.