India – microfinance, Reserve Bank and low-income borrowers

India’s Reserve Bank has released a report to study the issues and concerns in the microfinance sector, which has gone through a major crisis in 2010. The Reserve Bank of India’s Report of the RBI Sub-Committee of its Central Board of Directors to study Issues and concerns in the micro finance institutions (MFI) Sector is summarised here [pdf].

The Sub-Committee has recommended the creation of a separate category of non-banking finance companies (NBFCs) operating in the microfinance sector to be designated as NBFC-MFIs. To qualify as a NBFC-MFI, the Sub-Committee has stated that the NBFC should be “a company which provides financial services pre-dominantly to low-income borrowers, with loans of small amounts, for short-terms, on unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks” and which further satisfies the regulations specified in that behalf.
The Sub-Committee has also recommended some additional qualifications for NBFC to be classified as NBFC-MFI. These are:
(a) The NBFC-MFI will hold not less than 90% of its total assets (other than cash and bank balances and money market instruments) in the form of qualifying assets.
(b) There are limits of an annual family income of Rs.50,000 and an individual ceiling on loans to a single borrower of Rs.25,000
(c) Not less than 75% of the loans given by the MFI should be for income-generating purposes.
(d) There is a restriction on the other services to be provided by the MFI which has to be in accordance with the type of service and the maximum percentage of total income as may be prescribed.
The statement is here [pdf].

The RBI said: “Credit Support to Micro Finance Institutions (MFIs). The Reserve Bank of India had held discussions with select banks on December 22, 2010 to get an assessment regarding the ground level situation in the microfinance sector in Andhra Pradesh and other States and the need for any interim measures. The banks informed that collections by MFIs in Andhra Pradesh had deteriorated considerably and there were some incipient signs of contagion spreading to other States. Subsequently, IBA based on the feedback received by them from banks had come up with a proposal that there is a need for extending certain relaxations in the restructuring guidelines of RBI for the MFI sector.”

“Considering the fact that the current problems afflicting the Micro Finance Institutions (MFIs) sector are not necessarily on account of any credit weakness per-se but are mainly due to environmental factors, it has been decided that the special regulatory asset classification benefit could be extended to restructured MFI accounts, which are standard at the time of restructuring, even if they are not fully secured. This relaxation is granted purely as a temporary measure and would be applicable to Standard MFI accounts restructured by banks up to March 31, 2011.”
RBI’s credit statement is here [pdf].

The financial press has reported the RBI’s intervention extensively.

S. Bhanu, 48, who runs a tiny textile business in Godavarikhani village in the Karimnagar district of Andhra Pradesh, doesn’t know much about the crisis that has gripped India’s `20,000 crore micro-lending industry, reported The Mint. But Bhanu can tell you about how much more she owes the local moneylender in the past two months.
She started borrowing from him ever since the microfinance institutions, or MFIs, shut their doors to clients in October. She recently took a loan of `15,000 from a local moneylender at a contracted rate of 15% per month, that works out to an annual rate of 150%, around six times higher than what the MFIs used to charge.
A new state law has made it mandatory for MFIs to seek government approval to issue fresh loans. This, coupled with a political campaign against the institutions and the reluctance of banks to lend to the sector, has put a halt to their activity. Interest rates charged by informal lenders have more than doubled to 12-15% per month in Andhra Pradesh over the last two months, or 120-150% annually. Poor borrowers are left with no option but to seek such money to meet their daily funding requirements.
“It is very difficult to arrange money to purchase cloth from town. I sell these in neighbouring villages and repay the loan amount. For a Rs 15,000 loan, now I have to repay over Rs 4,000 per month, which is beyond my repayment capacity,” Bhanu told Mint over the phone. She previously used to borrow funds from SKS Microfinance Ltd, Spandana Sphoorty Financial Ltd and Trident Microfin Pvt. Ltd, at a little over 24%. Borrowers are now staring at a debt trap on account of the exorbitant rates charged by informal lending sources.
Traditionally, while MFIs give tiny loans to borrowers at 24-32% either directly or through self-help groups (SHGs) without taking any collateral, moneylenders charge more than 60% against land documents or gold ornaments. Such transactions typically do not involve agreements or receipts for the borrower. “This was the situation in the state before MFIs expanded operations here some 10 years back,” said Kishore Puli, managing director and chief executive officer, Hyderabad-based Trident Microfin Pvt. Ltd.
According to a recent study by the Institute for Financial Management and Research (IFMR), a private organization that works on financial inclusion, over 80% of borrowers in rural Andhra Pradesh currently rely on informal sources for timely credit. Andhra Pradesh accounts for more than a quarter of loans given by MFIs in the country, and has nearly 10 million small borrowers, according to various estimates.
MFIs saw collection rates falling to 10-20% in the southern state following the legislation, which was preceded by an ordinance, and are currently fighting the Bill in the Andhra Pradesh high court. “Rates charged by informal sources, primarily moneylenders, have doubled in the last two months,” said Vijay Mahajan, president of the Microfinance Institutions Network (MFIN). “Lending rates charged by moneylenders on loans against gold and silver have also shot up over the last two months.”
Typically, non-banking financial companies (NBFCs) engaged in lending against gold ornaments charge 18-24%, which translates into around 2% monthly. Informal lenders, active in states such as Andhra Pradesh and Tamil Nadu, charge more. According to Mahajan, rates charged on gold and silver loans have surged to 48-60%.
“We normally lend at 18-24% (on) gold loans and the idea is to ensure timely availability of credit to the customer. When funding from organized sources stops, customers will have to go back to moneylenders, who charge much more,” said the head of a south India-based gold loan NBFC, which has significant operations in Andhra Pradesh. He did not want to be named.
The Reserve Bank of India (RBI) committee headed by board member Y.H. Malegam to chalk out new regulations to govern the sector is expected to submit its report soon. The panel is set to recommend an upper ceiling for interest rates chargeable to poor borrowers, and is in favour of bringing all for-profit microlenders under RBI regulations, Mint reported on 13 January.

India’s central bank Wednesday allowed a special relaxation to banks in restructuring loans to microlenders, a move that will give lenders temporary flexibility in providing credit support to the cash-strapped institutions, reported the Wall Street Journal. The country’s microfinance institutions, mostly operating in the southern state of Andhra Pradesh, are facing severe repayment problems after the provincial government took steps to regulate lending practices following allegations that MFIs charged small borrowers high interest rates and, in some cases, were overly aggressive in collections.
The Reserve Bank of India terms the repayment problem as one due to environmental factors and not because of credit weakness. “It has been decided that the special regulatory asset classification benefit could be extended to restructured MFI accounts, which are standard at the time of restructuring, even if they are not fully secured,” the central bank notification said.
Banks can restructure unsecured loans of MFIs without classifying them as sub-standard or bad, according to the notification. Under RBI rules, banks have to keep aside a larger portion of cash against bad loans. Banks can restructure the microlender loans up to March 31 and all banks that are financing MFIs should come together and decide the next course of action, the RBI said.
“It is a very positive move, which will enable MFIs to carry out work unabated, at least outside Andhra Pradesh,” Vijay Mahajan, president of representative body, Microfinance Institutions Network, told Dow Jones Newswires. A deadlock between MFIs and the Andhra Pradesh government continues without any improvement, he said. He expects about 50 billion rupees to 80 billion rupees worth of microfinance loans to come up for restructuring.
MFIs borrow from banks and offer small loans of about $100 each to borrowers without collateral. Repayments are usually on a weekly basis. Mr. Mahajan said the sector should be back on track in two to three months. The RBI said the relaxation extended to banks is intended to be an interim measure until the committee–set up by the central bank in late 2010 to study microlending–submits its report. The committee, headed by Y.H. Malegam, is to suggest long term and structural changes in the functioning of MFIs in India.

The Reserve Bank of India (RBI) has asked banks to go easy on microfinance institutions (MFIs) by relaxing certain norms regarding loan restructuring. Banks can now restructure loans extended to MFIs even if they are not fully secured. Business Standard reported that as a special case, banks need not classify such loans as non-performing assets (NPAs). “This relaxation was given considering the fact the problems afflicting MFIs were not necessarily on account of any credit weakness per se but mainly due to environmental factors,” RBI said in a note.
A top official of the Indian Banks’ Association said total lending by banks and financial institutions to MFIs was over Rs 20,000 crore. Over 85 per cent of the exposure was to six-seven large players. “Banks will subject larger MFIs to greater scrutiny for books, pricing and recovery practices,” said the official. The ad hoc measures required the various banks financing an MFI to come together to restructure the package. The common approach would improve information sharing and discipline in MFIs as borrowers, the official added.
The restructuring will involve giving more time for repayment, a cut in interest rates, making some sacrifice on the amount due, asking MFI promoters to bring additional capital and commitment to restructure clients’ loans. These measures are applicable only to standard accounts. When banks restructure unsecured credit, the account is treated as an NPA for one year and requires higher provisioning. As a special case, when restructured, the unsecured loans to MFIs would be treated as standard assets. This would save banks from making provisioning for NPAs.
RBI has advised banks to recycle the collections of MFIs. This translates into MFIs using the repayment amount for further lending and operational purposes. These temporary measures are applicable to MFI loans restructured till March 31, 2011. RBI said this would help ease the liquidity crunch until action was taken on the recommendations submitted by the Malegam committee.
The committee was set up under Y H Malegam to study the issues specific to the MFI sector. The sector was hit hard, especially in Andhra Pradesh, after new norms regarding lending rates and collection practices were implemented. This led to shortage of funds with MFIs, in turn, affecting their borrowings from banks.

India’s central bank has temporarily relaxed asset classification rules for bank loans to the microfinance sector, a move that it said will allow them to continue lending to the industry. The Economic Times reported that under the new rules, restructured loans to the microfinance sector, can be classified by banks as standard assets, even though such loans are typically unsecured, the Reserve Bank of India said in a notification on Wednesday.
Indian banks have to adhere to strict guidelines while classifying their loan book and set aside funds as provisions, which vary depending on the health of the asset. While unsecured loans attract higher provisions, the current change in rules means banks can treat restructured microfinance loans as standard assets, which attract minimum provisioning. “The fact that the RBI is making an exception on behalf of MFIs and taking special steps to support the industry is a good sign from a direction point of view,” Anurag Agarwal, senior vice president at Intellecap, a Hyderabad based consulting firm in the microfinance segment, told Reuters.
The sector has been hit hard ever since a state in southern India, which was the largest market for microfinance in India, implemented strict regulations in response to complaints over high interest rates, aggressive loan recovery practices and overextended borrowers. The law has effectively shut down microfinance operations in Andhra Pradesh as lenders stopped making fresh loans altogether, constrained by the drying out of funds, and repayments have slowed down to a trickle.
Commercial banks and other financiers are looking for guidance from a central bank subcommittee, headed by Y.H. Malegam, before extending more credit to microlenders. The report’s recommendations are expected toward the end of January. “This measure initiated by the Reserve Bank is expected to impart some liquidity support by banks to MFIs and facilitate a ‘holding on’ operation for some time till the Malegam Committee submits its report,” the RBI release said.
The new rules would apply to bank loans given to microfinance companies that have been restructured up to March 31, the statement said. The RBI also said that banks can form consortiums to decide on how to resume lending to microfinance companies. Some of the microfinance companies with large exposures to Andhra Pradesh, such as SHARE Microfin Ltd, Spandana Sphoorty Financial Limited and Asmitha Microfin Limited, may be forced to shut down if liquidity was not forthcoming, according to a source close to the matter.

The Hindu reported that to revive the crisis- ridden micro finance sector, a Reserve Bank of India Committee on Wednesday suggested that micro finance institutions (MFIs) be allowed to charge a maximum interest of 24 per cent on small loans which cannot exceed Rs.25,000. The committee, headed by Reserve Bank’s Central Board Director Y. H. Malegam, also pitched for creation of a separate category of non-banking financial companies (NBFC-MFI) for the micro finance sector.
The panel also said small loans of up to Rs.25,000 could be given to families having an income up to Rs.50,000 per annum. On repayment, it said, the borrowers should be given the option of weekly or fortnightly or monthly return of the loan. It further said at least 75 per cent of loans extended by MFIs should be for income generation purposes. It further recommended that a borrower cannot take loans from more than two MFIs.
These recommendations, the committee said, should be implemented from April 1, 2011. Industry body Microfinance Institution Network (MFIN) termed the recommendations as balanced. MFIN CEO Alok Prasad said, “It gives clarity to the industry requirements. The recommendations have been long demand of the industry.” On interest rate ceiling, he said, the micro finance industry was already moving in that direction, so it was nothing new.
The RBI constituted the committee in October last in the wake of allegations of overcharging and using coercive recovery practices by MFIs that led to a spate of suicides in Andhra Pradesh. The decisions taken by the State government to regulate MFIs slowed down the loan recovery process hitting the financial health of the sector. It was further aggravated by the reluctance of banks to support MFIs. To deal with the problem, the RBI earlier in the day relaxed provisioning norms to enable banks to continue lending to the cash-strapped MFIs.
About the regulations of MFIs, the Malegam Committee, suggested that it should be done by the National Bank for Agriculture and Rural Development (NABARD) in close coordination with the RBI. If the recommendations are accepted, the committee said, a separate law enacted by the Andhra Pradesh government would not be needed. With regard to NBFC-MFIs, the committee suggested that they should have a minimum net worth of Rs.15 crore. The other members of the panel include industrialist Kumar Mangalam Birla, RBI Central Board member U. R. Rao and RBI Deputy Governor K. C. Chakrabarty.
The sub-committee has recommended that bank lending to NBFCs, which qualify as NBFC-MFIs, will be entitled to the ‘priority lending’ status. With regard to the interest chargeable to the borrower, the sub-committee has recommended an average ‘margin cap’ of 10 per cent for MFIs having a loan portfolio of Rs.100 crore and of 12 per cent for smaller MFIs and a cap of 24 per cent for interest on individual loans.
The sub-committee has made a number of recommendations to mitigate the problems of multiple-lending, over borrowing, ghost borrowers and coercive methods of recovery. These include: a borrower can be a member of only one self-help group or a joint liability group; not more than two MFIs can lend to a single borrower; there should be a minimum period of moratorium between the disbursement of loan and the commencement of recovery; the tenure of the loan must vary with its amount; a credit information bureau has to be established; the primary responsibility for avoidance of coercive methods of recovery must lie with the MFI and its management; and the RBI must prepare a draft customer protection code to be adopted by all MFIs.

A year ago, in his study ‘Microfinance India: State of the Sector Report 2009’ (published by Sage Publications India, 2009), N Srinivasan of Access Development Services, wrote:

“Micro finance sector seems to grow and with no fullstop in sight. The sector performed creditably in a year that experienced a widespread liquidity crunch. The Self Help Group (SHG)–bank linkage programme made remarkable progress during the year; provisional data2 indicates that credit to more than 1.716 million SHGs would have been made available during the year. The outstanding SHG loan accounts were 4.14 million representing an estimated membership of 54 million. The MFIs too have recorded an impressive increase of about 8.5 million clients during the year registering a growth of 60 per cent over the previous year. The data collected from 230 MFIs by Sa-Dhan reveals that despite liquidity constraints faced by some MFIs, expansion in client outreach and loan portfolio was vigorous. The MFIs reported a total client base of 22.6 million as at the end of March 2009. The overall coverage of the sector as narrowly defined (outstanding accounts of members of SHGs and clients of MFIs) is estimated to have reached 76.6 million against 59 million last year.”
“After adjusting for overlaps the net client base of the micro finance sector is estimated at 70 million. The adjusted growth in outreach is estimated to be 14 million clients which is about 50 per cent more than the 9.9 million new clients added during the previous year. This growth story has several positive and some not so positive elements. In terms of sheer numbers, more than 50 percent of low income households of about 130 million are covered by one or the other form of micro finance. Outstanding loans of MFIs increased from Rs 59.50 billion to Rs 117.34 billion in 2008–09. In the case of loans outstanding loans in the books of banks against SHGs, the provisional information is that it has reached Rs.241.96 billion by March 2009 compared to Rs.170 billion in the previous year. The total outstanding microfinance loans amounted to Rs 359.39 billion posting a growth rate of 30% over the last year’s level of Rs 229.54 billion.”

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