Keya Sarkar: Microfinance set for a big leap

OUT OF FOCUS

Ever since commercial banks have been facing stiff competition in financing cars and houses, they have been increasingly getting interested in the microfinance sector.

Thanks to this column I get banks, and now even non-banks, that want to know how to start.

There is an annual Rs 50,000 crore micro credit demand from the 75 million poor households in our country, against a supply of just Rs 1,800 crore, last fiscal.

Given this backdrop, recent enquiries from banks are good news. Except that there is no comprehensive "how to" manual for the microfinance sector in the absence of a comprehensive policy framework.

If any bank or non-bank wishes to lend to the microfinance sector, it will first have to understand and appreciate the diverse laws that govern this sector and the diverse regulatory bodies that are responsible for its supervision.

What any entrant to this sector has to do is to interpret existing rules made for the mainstream financial sector in the context of microfinance.

Which is not only difficult (because very often these rules are inconsistent with the needs of the microfinance sector) but also clumsy. Consequently, many banks tend to postpone their decisions or just drag their feet, which is a great pity, given the huge demand-supply gap.

It is probably this that pushed Sa-Dhan, an association of community development finance institutions, to focus on the "Regulation of Microfinance in India" in their annual conference on January 19 and 20. The fact that the conference was co-sponsored by SIDBI underscores the fact that even apex institutions are feeling the need for such regulation.

The finance minister, who made the inaugural address at the conference, ruled out tax sops and a new regulator for the sector. But he is keen to look into the problems of the sector and has asked Sa-Dhan to submit reform proposals.

There has been no dearth of lobbying by the microfinance sector for a framework, but till now governments have made empty promises. Now with the push from the large commercial banks eager to find a new asset class, hopefully the lobbying will carry more weight.

While anyone remotely interested in microfinance is aware of the great strides that Bangladesh has taken, thanks to the leadership of Mohammed Yunus, very few are aware that even Pakistan has already created a comprehensive policy framework (Ordinance no LV of 2001) to regulate the establishment, business and operations of microfinance institutions.

This ordinance covers the definition of microfinance and all its derivatives, lays down establishment and winding up rules, licensing authorities and procedures, regulation and supervision, statutory liquidity norms, etc.

In India there is no distinct legislation governing microfinance specifically. According to a paper by a legal organisation which has collated all rules governing this sector, a number of laws have an effect on the provisions of microfinance services in India.

While the constitution/establishment of microfinance is governed by laws like the Societies Registration Act, 1860; Companies Act, 1956; Cooperative Societies Act, 1912, etc., depending on the type of microfinance institution, the regulation of provisions of microfinance is primarily governed by (again depending on the type of MFI) by the Reserve Bank of India Act, 1934; the Banking Regulation Act, 1949; the NABARD Act, 1981; the SIDBI Act, 1989; and the Regional Rural Banks Act, 1976, in addition to the Income Tax Act.

The problems that each type of MFIs faces as a result of the multiplicity of regulation are:

NGOs, thanks to the RBI Act, which says "no unincorporated bodies are allowed to accept deposits from the public", always face the problem of limited sources of funds.

Borrowings could be another source of funds, except that NGOs have no real owners, i.e. the promoters usually do not have their own money at stake and the banks therefore have to rely on the NGOs' loan portfolios as an indicator of repayment capacity.

MFIs, which are companies registered under Section 25 of the Companies Act, have to deal with the fact that there is no clarity on whether microfinance falls under the objectives like promoting commerce, art, science, religion, charity, etc. for which Section 25 companies may be set up.

As is the case with NGOs, in the absence of clear provisions in the Income Tax Act indicating that microfinance services are charitable services, registration under Section 12A of the Income Tax Act is not easy for Section 25 companies.

NBFCs have a minimum capital requirement of Rs 2 crore, which is too high for those involved in financing self-help groups.

The present requirements as prescribed by the RBI for accepting deposits under NBFC Public Deposits Directions (such as obtaining a minimum investment grade or other specified credit rating for fixed deposits from any credit rating agency at least once a year) are stringent and discourage NBFCs from gathering deposits.

The minimum paid-up capital for a new bank in terms of guidelines on entry of new banks in the private sector as of January 2003, has made it impossible for an MFI to be set up as a bank.

While substantive changes to almost all legislation affecting MFIs will be required for making it possible for the microfinance sector to develop further, an alternative in the form of an enabling independent legislation as in the case of Pakistan may prove easier.

Speed is of essence.