Inadequate coverage

It is to be welcomed that the government proposes to enact a law to regulate the rapidly growing microfinance sector, but the Bill that it has drafted for the purpose has some obvious lacunae that need to be addressed. Going by the available information, the new law will apply to only microfinance organisations that act basically as service providers through bodies like the self-help groups (SHGs) and non-government organisations (NGOs); it will not apply to the microfinance institutions that actually provide the bulk of the finance. In reality, the latter may need the regulations more than the former. Microfinance institutions are the ones which have attracted criticism for charging high interest rates, which partly defeats the purpose of providing affordable microfinance in a local setting. Matters are not helped when politicians (like the present chief minister of Andhra Pradesh) win votes by promising to making unsustainable promises of interest rate cuts""promises that fall into the same category as free power, because after a while there will be neither credit nor power.

It has been argued that the microfinance institutions, being a category within the non-banking financial sector, are governed by the Reserve Bank of India Act and, as such, have to be excluded from the purview of the proposed microfinance law. But the RBI has not formulated regulations aimed specifically at these institutions, as distinct from the other non-banking financial companies (NBFCs). Indeed, most microfinance institutions do not even qualify to be treated as NBFCs as they do not fulfil the entry-level capital requirement of Rs 2 crore. In other words, the RBI should bring out specific rules to cover this specific sub-category, or they should be taken out of the purview of the RBI Act and placed under the ambit of the new law for the microfinance sector. While there are differences in operating style, the governing norms for these institutions have to be in conformity with those applicable to microfinance organisations. This is easier to do by bringing them all under one umbrella law. It is also important that the full implications of allowing these organisations to take deposits from the public are taken into account. There has to be a proper marriage between the level of systemic risk to retail customers, and the intensity of regulation of the sector. It is not clear that the two have been matched at all hierarchies in the microfinance sector.

The microfinance development council, proposed to be created under the new law, would have to ensure that both microfinance organisations and the institutions meet popular aspirations. Also vitally needed are measures to reduce the present high transaction costs of these bodies, which force them to charge high interest rates ranging from 20 per cent upwards. The good thing about grassroots-level microfinance bodies is that they know their customers well and understand their needs and cash flow, so that they can chalk out loan repayment schedules accordingly. This is an important reason why, despite the high interest, the recovery rates in microfinance are as high as 90 per cent, against just 60 per cent in the case of the rural operations of commercial banks and even worse for the cooperative banking sector. Given this success record and the growth impulse in the sector, the government would do well to have wider consultations with the players in the microfinance sector before finalising the proposed Bill.