LEGAL & REGULATORY FRAMEWORK FOR MICROFINANCE IN INDIA

LEGAL & REGULATORY FRAMEWORK FOR MICROFINANCE IN INDIA

Microfinance Institutions, as the name suggests, it plans to cater to the financial need of the smallest strata (low-income group) of the society. The smallest category of the society like rural women, peasants, workers and other such small people who have no capacity to visit the banks for loan application in connection with their occupations.The microfinance industry has achieved an unprecedented growth over the last two decades

Therefore Microfinance Services Regulation Bill has been introduced for the purpose of financial assistance to be provided to an eligible individual directly or by a group mechanism for certain purpose to be achieved by the borrowers(members).

There are various types of microfinance institutions/ organizations operating in India. Mainly they are like

Joint Liability Group (JLG), Self Help Group (SHG), the Grameen Bank Model and Rural Cooperatives etc.  Having main aim of financial inclusion of smallest person of the society.

However, it is not easy to operate smoothly by such MFIs as there are many challenges faced by Indian microfinance industry.

The main area of its operation is confined to the poorer section of the country, over-indebtedness is a common and serious challenge faced by the MFIs.The members have generally borrowed the funds from other available sources. There are some of the other challenges also and they are like

High rates of interest being charged to members.

Over-dependence on the banking system to procure the funds for MFI business.

Illiteracy and lack of awareness by the members (borrowers) as they are largely from a rural

The legal framework for MFIs in India with reference to its registration and other parameters can be broadly narrated as under:

For Societies – Registration for this is a very easy process with no minimum capital requirement. Further, they are not allowed for deposit mobilization/ collection from the public. It has to operate amongst its members only.

For Trust—Registration for this is very easy with no minimum capital requirement. It is not allowed for deposit mobilization/ collection from the public. It is sometimes problematic as the funds for further expansion may not be available. It has limited scope for expansion.

For Sec. 25 Companies—Registration is easy but not that easy as those of trusts and societies, especially for an existing company to convert into a Section 25 company. It is not allowed for deposit mobilization/ collection from the public. However, it contributes a lot to the process of financial inclusion.

For NBFC-MFI— Registration for this is to be taken up with RBI and it is difficult to obtain due to stringent provisions of the RBI. It requires minimum capital of Rs. 5 crores (Rs. 2 crores for North-East India region) to start MFI operations. It is not allowed for deposit mobilization/ collection from the public. It has a large scope and provides a good background for scaling up of the operations as it has investors’ confidence with it. It is observed that many MFIs in India, especially in South India and West Bengal, have grown and developed its activities/ operation remarkably.RBI is a strict regulator for MFIs and it monitors very closely from time to time.

For Cooperative Societies— Registration for this is very easy (except in the state of Maharashtra) with the minimum capital requirement. It has very minimal regulatory requirements to fulfill in this matter. It is allowed to collect the deposits from its members only. It is relatively easy to scale up/ expand its activities. It is observed that many cooperative societies in Maharashtra and South India have progressed very much in terms of size and activities undertaken.

There are many structural weaknesses of RRBs, cooperative societies, and urban cooperative banks, thus the microfinance movement has a remarkable presence in the Indian credit market.

However, the RBI has clearly specified the regulatory framework for MFI which guide them to function smoothly and it is summarized as below:

As per the RBI, NBFC – Microfinance Institutions means a non-deposit taking NBFC (other than a company formed and registered under section 25 of the Companies Act, 1956) that fulfils the necessary conditions pertaining to minimum net owned funds, net assets criteria, qualifying assets criteria and other incidental requirements related to the loan disbursement to the members. The regulatory guidelines of RBI help a lot to grow, expand and develop the MFIs in a systemic way.

The regulatory framework in a country can have a huge impact on the viability of microfinance. The forms of legal organisation an institution has exemptions available to them, registration requirements, interest rate caps, capitalisation etc. are all determined by the legal framework.

The aim of supportive regulatory framework is to build strong regulated and unregulated institutions of all types -

 to provide services on sustainable basis under uniform, common, shared performance standards.  to encourage the regulatory authority to develop appropriate prudential regulations and staff capacity that are tailored to the institutions operational and risk profile.

This objective requires defining different tiers of financial institutions with different degrees of regulatory requirements. The requirement could vary from

(i) Simply registering as legal entities.

(ii) To prepare and publish periodic reports on operations and financial results

(iii) Observing non-prudential rules of conduct in business operations.

(iv) Securing a proper being and being subject to prudential regulation by a regulatory authority, prudential supervision, or both by a central supervisory authority.

The framework identifies different categories and tiers institutional providers of microfinance and specifies the activities that trigger the need for progressively stronger type of regulation and supervision. There is a plurality in the regulatory mechanism - RBI, GOI and State Governments. It is a known fact that the Reserve Bank of India is a super regulator for the financial system. To reach large number of people, microfinance eventually moves through institutions that are licensed and supervised by country's financial authorities. Because microfinance is different from conventional banking, the banking laws and regulations of most countries are gradually being adjusted to accommodate licensed microfinance. Microfinance regulation refers to the set of legal rules that apply to microfinance. Areas of regulation that typically require adjustment include the relaxation of unsecured lending limits, tightening of capital adequacy ratio, strict rules for provisioning for loan losses and lower minimum capital requirements. Since MFIs are generally small institutions than banks or NBFCs.

Microfinance regulations refer to the set of legal rules that apply to micro finance. Supervision is in the process of enforcing compliance with those rules.

Financial services providers that take deposits need prudential regulation. Regulation helps in long-term sustainability, even though MFIs may safe under it in the initial years. Regulation and supervision ensure that MFIs are run prudently and cases of poor people losing their money due to fraud or incompetence are minimised. Various policies, guidelines, actions / initiatives and programmes of the government and Reserve Bank of India are the indicatives of the recognition and role of the microfinance in the socio-economic development of rural sector in India. Sound and unambiguous legislative framework is a prerequisite for an efficient regulatory system. At present, In India, there are about 60 Acts and multiple rules and regulations, many of which are archaic and the large number of amendments have made the laws ambiguous and complex. Government of India has constituted a financial sector legislative reforms commission (FSLRC) to rewrite and streamline the financial sector laws, rules and regulations to bring them in harmony with India's fast growing financial sector. This study has made an attempt to highlight the policies, guidelines and directives related to field undertaken for research work that is for effective regulation of microfinance activities in India.

Some of the fundamentals of regulation should be worthy of recall. They are -

 Do not regulate what cannot be supervised. Even carefully developed regulations will become irrelevant if effective supervision is not enforceable.  Safety, soundness and sustainability should serve as foundation for a good regulatory framework.  Micro-finance supervision requires cultural change.  There should be regulatory impact assessment as part of the act that should be presented to both houses of parliament on the first day of the Budget discussion session.  As a basic general principle, microfinance regulation should be uniform across all institutional forms so as to discourage regulatory arbitrage. This involves structuring operations in such a manner that organisation comes under the jurisdiction of a weaker regulator.

POLICY GUIDELINES ISSUED BY GOVERNMENT

Many important policy initiatives were taken by the Government of India, the most significant of which was the nationalisation of 14 commercial banks. These nationalised banks would be allowed to open urban bank branch provided it first opens four rural branches. Simultaneously, the concept of priority sector lending was developed and as a matter of policy it was formalised by RBI in 1972. Special programmes aimed at creating self-employment among the rural population started. This policy initiative had a significant impact and in just six years (by 1975), 10,882 rural and semi-urban branches of commercial banks had been opened1

.It was felt that the weaker sections in the rural areas can best be served by sepcialised institutions created for this purpose. These institutions need not be very large institutions in terms of capital, geographical coverage and staff, as they need to be "local" in character so that they and their staff can develop a bonding or a lasting relationship with the local population. Thus the Regional Rural Banks were born, with ownership of Central Government (50%) the State Government (15%) and a sponsoring commercial bank (35%). RRBs were started with a small capital base of only Rs. 25 lakh, generally operated in two or three districts, serving about 40 lakh people and were mandated, when created, to have only weaker sections of the population as their clients. Right from the day of its birth, every RRB was scheduled bank and fully regulated by the central bank of the country. Simply, RRBs were the first legal and fully regulated microfinance institutions (MFIs) set up anywhere in the world.

MAJOR GOVERNMENT POLICY GUIDE LINES

As per government policy, any financial institution that undertakes microfinance activities, but is not registered as a section 25 company, qualifies as a non-banking finance company and all related regulations apply. The regulation will include registration with the RBI, imposition of prudential norms and compulsory credit rating of deposit taking non-banking finance company.

 Micro-finance institutions registered as section 25 companies can engage in

1 Source - The Journal of Indian Institute of Banking & Finance July-September 2009. P. 23

microfinance activity without registering with the RBI or obtaining its permission, microfinance activity is limited to business loan up to Rs. 50,000. Section 25 companies are not allowed to accept deposits.

 With respect to the microfinance activities of a society, the registrar has no responsibility for prudential regulation, financial performance or solvency. The registrar can only intervene if there is a major dispute regarding the management of society, or if registrar suspects fraud against the society's creditors or other unlawful or unauthorised activities.

 Microfinance in India can take many forms and have numerous applicable regulations and responsible regulators. In case of societies and trusts, microfinance activities are largely unregulated and unsupervised.

 Non-banking finance companies and cooperatives are permitted to accept deposits. NBFCs must adhere to additional stringent regulations and cooperatives are only permitted to accept deposits from their members, not the general public.

 No microfinance institution registered as NBFCs accept deposits because regulation requires that institution must obtain an investment grade rating, which no microfinance institution has obtained.

 In the Finance Bill for the year 2005-06, the microfinance sector has been allowed access to ECB, provided they - (i) should have a satisfactory borrowing relationship for at least three years with a scheduled commercial bank authorized to deal in foreign exchange and (ii) would require a certificate of due diligence as 'fit and proper' status of the board / committee of management of the borrowing

entity from the designated AD.

 All the entities taking up microfinance are allowed to receive grants and subsidised loans from domestic sources. However, in order to obtain grants from foreign sources, institutions must be registered with the Ministry of Home Affairs under the foreign contribution (Regulation) Act 1976.

 Since, microfinance is largely recognised as a charitable activity, the entire grant meant to support the corpus fund of the society is exempted from taxation. Since private trusts taking up micro-finance activities are also subjected to the same provisions of Income Tax Act, their grant income may also be exempted from the taxation. This provision does not apply to cooperative societies, cooperative banks

and NBFCs.

 Non Banking Finance Company (NBFCs) can obtain foreign capital in the form of equity subject to approval by the Foreign Investment Promotion Board (FIPB).

 Cooperative Societies and Cooperative banks, with their distinctly for-profit constitution can, theoretically, obtain funds from capital market. NBFCs can also access capital markets subject to their adhering to prudential and reporting norms of RBI. Both types of institutions need to report their capital market transactions periodically to the central bank on prescribed formats.

 All the legal entities involved in the business of microfinance are subject to some forms of disclosure :

(i) Societies and trusts are subject to annual disclosure.

(ii) Cooperative societies report to the registrar of cooperatives on prescribed

formats.

(iii) Cooperative banks; like NBFCs also need to disclose on such areas as the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR), details of public deposits, Asset Liability Management, (ALM), Income recognition and asset classification to RBI.

(iv) NBFCs, especially those accepting public deposits must make periodic disclosures on parameters like SLR, public deposits and access to capital markets, ALM and asset classification and income.

 For consumer protection especially in the context of credit markets, existing mechanism are available in the domain of the micro-finance industry. These include - (a) existing consumer protection laws, (b) redressal mechanism (c) recovery and bankruptcy process and (d) education.

 In the budget speech of finance minister in 2005, "the government intends to promote MFIs in a big way. The way forward is to identity MFIs, classify and rate such institutions and empower than to intermediate between the lending banks and the beneficiaries. Commercial banks may appoint MFIs as "Banking Correspondents" to provide transaction services on their behalf. Since MFIs require infusion of new capital, I propose to redesign the existing Rs. 100 crore Microfinance Development Fund as "Micro-Finance Development and Equity Fund", and increase the corpus to Rs. 200 crore. The fund will be managed by a board consisting of representative of NABARD, Commercial banks and professional with domain knowledge.

REGULATION OF MICRO-FINANCE INSTITUTIONS

The rapid growth of micro-finance sector and varied number of microfinance providers influencing the lives of millions of clients have necessitated the need for regulating the sector. In India microfinance is provided by a variety of entities. These include banks (including commercial banks, RRBs and Cooperative Banks), primary agricultural credit societies, SHGs linked to banks and MFIs that include NBFCs section 25 companies, trusts and societies as also cooperatives (Under MACS). Currently, banks and NBFCs fall under the regulatory review of Reserve Bank. Other entities are covered in varying degrees of regulation under the respective state legislations. There is no single regulator for thus sector. In this context for the orderly growth and development of the sector, the Government of India has proposed a legislation and formulated a Micro-financial Sector (Development and Regulation) Bill, 2007. The Bill envisaged NABARD to be the regulator and provides that all micro-finance organisations desirous of offering thrift services may get registered with NABARD.

STATE LEVEL REGULATIONS

Various requirements have been enacted to restrict and control microfinance practices at the state level. Most prominent state level regulations are the money lending act and the Andhra Pradesh Micro-Finance Institution (regulation of money lending) ordinance, 2010. The money lending Act, though originally intended to restrict the interest rates charged by money lenders, has been applied to micro-finance institutions in some states. The Andhra Pradesh ordinance was enacted in 2010 during the repayment Crisis in Andhra Pradesh, greatly restricting microfinance institutions by including measures such as by district registration, required collection near local government premises, and forced monthly repayment schedules. The another land mark of the Andhra Pradesh Government is the legislation enacted in 2010-11 which has brought the customer protection issues to the central stage. The legislation stipulated mandatory registration of MFIs, disclosure of effective interest rate to the borrowers, ceilings on the interest rates and strict penalties for coercive recovery practices.

ELEVENTH PLAN DOCUMENT OF THE GOVERNMENT

In the eleventh plan document, Government recognised the importance of strengthening SHG initiatives, policies and schemes which will simultaneously increase women's awareness, bargaining power, literacy, health, vocational and entrepreneurial skills, which will determine how SHGs may better serve the interest of poor women and suggest changes required in overall SHG policy frameworks. The Eleventh Plan recognised the importance of this issue and proposed a HLC (High Level Committee) to conduct a review of SHG related policies and programmes.

THE ANDHRA PRADESH MICROFINANCE / INSTITUTIONS

(REGULATION OF MONEY LENDING) ACT, 2010

Large-sized MFIs are operating in the state of Andhra Pradesh. Adverse developments were reported in the form of high interest charged by certain MFIs, coercive methods of recovery, poaching of SHGs by MFIs, multiple financing by the MFIs leading to over indebtedness by the poor households etc. In their backdrop, Government of Andhra Pradesh, in October, 2010, issued Andhra Pradesh Micro Finance Institutions (Regulation of Money lending) ordinance, 2010 to "Curb the undesirable operations of MFIs" in the state. The Act is applicable to NBFCs doing microfinance business in the state.

The act purported to ‘protect women SHG from the exploitation’ by MFIs in the state. The Act rolls out the following:

i) All MFIs operating in Andhra Pradesh shall within 30 days apply for

registration before the registering authority.

ii) Members of one SHG shall not be the member of more than one SHG.

iii) All loans by MFIs have to be without collateral.

iv) Maximum amount of interest was stipulated, the aggregate interest not to exceed the principal amount.

v) MFIs must display the rates of interest in their premises.

vi) No MFI shall extend further loan to an SHG where the SHG has an

outstanding loan from a bank.

vii) MFI shall not deploy agents for recovery.

viii) Repayments have to be made at the office of the Gram Panchayat or at the designated public place.

ix) Loan recoveries have to be made only in monthly installments.

x) Carrying business without registration and including a coercive recovery method would attract penalty by way of imprisonment.

MICRO-FINANCE INDUSTRY BILL, 2010

The ministry of finance in 2010 in this bill defined both eligible clients as well as micro-finance services - Eligible clients are defined as members of a SHG or any other group engaged in micro-finance, and belonging to one or more of the following categories,

i) Small farmers not owning more than two hectares of agricultural land.

ii) Landless cultivators of agricultural land including oral lessees, tenants or share croppers.

iii) Landless and migrant labourers.

iv) Artisans, micro entrepreneurs and persons engaged in small and tiny economic

activities.

v) Women and

vi) Any other such category that may be prescribed

This definition helps to distinguish between borrowers of MFIs and borrowers of banks with loan amounts comparable to those of MFI borrowers. However, the bill appears to be focused on micro-credit rather than micro-finance.

The bill does extend micro-finance services to include as follows -

i) Credit not exceeding Rs. 50,000 per individual for the purpose of agriculture, small enterprise and allied activities.

ii) Financial services through any agent as permitted by RBI.

iii) Life insurance, general insurance and pension services that have been approved by the authorities regulating these services.

iv) Any other service specified by NABARD regulations.

In the light of the policy on general financial inclusion, it seems to be reasonable that regulation will cover any entity, regardless of its legal structure, its financial services activities, and its process design whether group-based or individual based. RBI’s DIRECTIVES & SUPPORT FOR EFFECTIVE

REGULATION OF MICRO-FINANCE PROGRAMMES IN INDIA

To have access to institutional credit by poor sections of the society, microfinance is one of the most sustainable and effective tool. Where microcredit refers to availability of loans in small quantities, microfinance has a broader meaning and it includes other financial services likes saving, insurance etc.

Realising the importance of credit in the socio-economic development process, the Reserve Bank of India has taken various steps in this regard and has encouraged banks to make timely and adequate finance available to poor for agriculture as well as allied activities making institutional credit and finance to the poor. Between 1950 and 1969 the emphasis was on the promoting of cooperatives. The nationalization of major commercial banks in 1969 marks a watershed. From this onwards, the focus shifted from the cooperatives as the sole providers of rural credit to the sole providers of rural credit to the multi agency approach. This also marks the beginning of the phenomenal expansion of the institutional structure in terms of commercial bank branch expansion in the rural and semi urban areas. For the next decade and half, the Indian banking scene was dominated by this expansion. Regional rural banks (RRBs) were setup in 1975 as low cost institutions mandated to reach the poorest in the credit deficient arrears of the country. RRBs are the only institutions in the Indian context which were created with a specific poverty alleviation microfinance mandate. During this period, Central Bank (RBI) intervened to enable the system to overcome the problems which were considered as discouraging the flow of credit to rural sector such as absence of collateral among the poor, high cost of servicing, geographically dispersed customers, lack of trained and motivated rural bankers etc. After this the concept of ‘Priority Sector’ gained importance in the late sixties to focus attention on the credit needs of neglected sectors and under privileged borrowers.

 In 1987-90, NABARD conducted several studies of the MYRADA Model such as the transaction cost study. Based on the feedback, NABARD and RBI took three policy decisions:-

a) Banks could lend to groups at low traction cost, which would account for priority sector lending.

b) In 1992 RBI agreed to give one loan to the group. Emphasis was on giving the group, the freedom to decide how best to distribute the loan amount.

c) Banks could lend to unregistered groups as long as they function as registered society.

In 1993, the RBI also allowed SHGs (registered or unregistered) to open saving accounts in banks. Facility of availing bank services from all nationalized banks was a major boost to the movement.

SUPPORTIVE POLICIES OF RBI FOR LINKAGE PROGRAMMES

With the view of developing supplementary credit delivery mechanism to reach the poor in cost-effective and sustainable manner, NABARD introduced in 1992 a pilot project for linking 500 SHGs. The self help group - bank linkage programme (SLBP) was further extended to Regional Rural Banks and cooperative banks in 1993 and is now permitted by the RBI as a component of priority sector lending. RBI extending and implementing the linkage programme. The supportive polices of RBI are :-

i. Interest rates of banks to the micro-credit institution or by the micro-credit institutions to SHG or their members deregulated.

ii. Complete freedom to banks to choose their models.

iii. Micro-credit reckoned as a part of micro-credit partner for bankers.

iv. Freedom in designing of lending and saving products.

v. Maximum flexibility provided in lending norms.

vi. Making micro-credit an integral part of bank corporate credit plan.

vii. Mobilisation of savings.

This activity of RBI paved the way for socio-economic empowerment of

women and build confidence in them.

RBI has been making efforts to give a fillip to micro-finance initiatives through creating and enabling environment. It is now looking into issues relating to - structure and sustainability and capacity building of micro-finance institutions.

RBI has said that as per current policy, Foreign investment in securitisation of micro-finance projects" activity did not fall under any of the specified 19 NBFC's activities which is planning to open up foreign investment. The Government will accordingly have to draft a fresh policy to allow FDI in microfinance securitisation. Securitising the loans given by domestic micro-finance institutions was expected to generate more liquidity for the market for small finance. Micro-finance initiatives have shown that banking with the poor is a viable proposition. Micro-credit has been hailed as the best method of creating. NABARD has been playing a catalytic role in terms of promotional support to NGO's and also in nurturing quality SHGs.

OTHER POLICY INITIATIVES BY RBI

Several policy initiatives have been taken by the Reserve Bank of India with a view to give a further fillip to the microfinance movement in India. A summary of major initiatives is being presented as follows:

1) The Self Help group (SHG) Bank Linkage Programme A working group, under the chairmanship of Shri S.K.Kalia (Managing Director, NABARD) was set up by the RBI in 1994. The group came up with wide range of recommendations on SHG and bank linkage as a potential innovation in the area of banking with the poor. According to it, “Micro credit has been defined as the provision of thrift, credit and other financial services and products of very small amount to the poor in rural, semi- urban and urban areas for enabling them to raise their income levels and improve their living standards”. Micro credit institutions are those, which provide these facilities. As a follow up of the recommendations of the working group, banks were advised in April 1996 as under.

a) SHG lending as Normal Lending Activity: Banks were advised to include SHG Linkage in their corporate strategy/ Plan, training, curriculum of their officers and staff and to implement it as a regular business activity and monitor and review it periodically.

b) Separate segment under Priority Sector: Banks should report their lending to SHG as a separate dept, via, “Advances to SHG” irrespective of the purpose for which the members of SHG’s have been disbursed loans. Lending to SHGs should be treated as part of the lending to weaker section.

c) Inclusion in Service Area Approach: Banks will identify branches having potential for linkage and provide support to them and include SHG lending within their Service Area Plan, But SHG Linkage is a credit innovation and not a targeted credit programme.

d) Margin and security Norms: According to the operational guidelines of NABARD, SHGs may be sanctioned saving linked loans by bank in the ratio of 1:4 (i.e. saving: loan) this ratio can be beyond the limit of 1:4 in case of matured SHGs.

e) Documentation: Keeping in view the nature of lending and status of borrowers, banks should strive to remove all operational irritants and make arrangements to expeditiously sanction and disburse credit by delegating adequate sanctioning powers to branch managers. The loan application forms procedures and documents should be made simple to provide prompt and hassle free credit.

f)Training: Considering the requirement and magnitude of training needs of bank officers / staff both at field level and controlling office level, banks may initiate suitable steps to internalize the SHG’s linkage project and organize short duration programmes for the field level functionaries.

g) Monitoring and Review of SHG Lending: Due to emerging potential of SHGs, it is decided to review their progress at the state level banker’s committee (SLBC) and by banks at regular intervals. A progress report may be sent to NABARD (Micro credit innovations department) Mumbai in prescribed format on a half yearly basis as on 30 September and 31st March each year.

h) Presence of defaulters in SHGs: The defaulters by a few members of SHG to the financing bank should not ordinarily come in the way of financing SHGs by banks.

2) NBFCs engaged in Micro Financing Activities

As NBFCs have played significant role in the Indian Financial sector in providing outreach to the small clients. With the objective of integrity, RBI brought them under its regulatory aim by way of amendment of RBI Act, 1934 in 1996. This required mandatory registration of co’s undertaking financial services with the RBI, compulsory credit rating of deposit taking NBFCs and their compliance to prudential norms. As per section (45-Ia) of the Banking Regulation Act, no NBFC can commence or carry on the business without obtaining certification of registration form the RBI and having net owned funds (NOF) (Share holders equity + internally generated reserves) of Rs. 20 million. In addition to the requirements of RBI, All NBFC’s have to comply with the provisions of Companies Act relating to Board of Directors, share capital mgmt structure, audit, maintenance and publication of books of accounts and general conduct etc. Important prudential norms to be complied include Capital Adequacy Ratio (CAR) based on the risk weight of assets (15%), accounting standard, asset classification, provision for bad and doubtful debts, disclosure in balance sheet ceiling on concentrate of credit / investment, etc. Not less than 15% of their deposits should be invested in specified securities and approved Govt. securities. NBFCs are required to notify RBI of their intention to open branches. Thus RBI is empowered to give rigorous policy prescriptions and regulatory directions to NBFCs having requisite (NOF) and accepting public deposits.

3) Opening of Saving Bank Accounts

To further promote the SHG momentum in the country, RBI advised the banks in 1998 that SHGs which were engaged in promoting saving habits among their members would be eligible to open savings bank accounts and that such SHGs need not necessarily have availed of credit facilities from banks before opening savings bank accounts.

4) Interest Rates

Subsequent to the monetary and credit policy announcement for the year 1999-2000 banks were also advised that interest rates applicable to loans given by banks to micro credit organisations or by the micro credit organisations to SHGs / member beneficiaries would be left to their discretion.

RBI’s 2004 Master Circular on Micro Credit states that interest rates on loans from banks to MFIs or from MFIs to SHGs and individuals are left to the discretion of the loaning agency.

Table 3.1: Comparison of Rates of Various Sources

Various Sources Quoted interest Rate Effective interest rate incl. transaction costs Details

Bank loans to SHGs 12% - 13.5% 21% - 24% Number of visits to banks, compulsory savings and costs incurred for payments to animators/staff/local leaders MFI loans to micro borrowers 15% - 24% 15% - 24% No transaction costs except time spent in meetings

Moneylenders, landlords, trader 36% - 120% 48% - 150%

Source: RBI, 2004.

5) Mainstreaming and enhancing outreach

In April 1999, the word microcredit was used for the first time in the credit policy. The statement said, “Micro-credit Institutions are important vehicles for delivery of credit to self employed persons, particularly women in rural and semi- urban areas.”And further: “A special cell was set up in RBI in order to liaise with NABARD and microcredit institutions for augmenting the flow of credit to this sector. The time frame for the cell was one year and its proposals were given the highest attention.” The credit policy drew a distinction between small loans given by banks and the loans given to MFIs for on-lending.

The banks did not have a level playing field, but were possibly happy to outsource small credit to MFIs. This opened bank finance to the MFIs, who were largely dependent on donor money. The recommendations made by the Task Force were being ‘processed’ by NABARD in consultation with RBI and Government as appropriate. The mid-term review reiterated the importance of MFIs and asked banks to include microcredit in their corporate strategy to be reviewed on a quarterly basis. Banks were advised to follow the under noted guidelines in Feb, 2000 issued by RBI.

i) The banks may formulate their own model(s) or choose any intermediary for extending micro credit. They may choose suitable branches/pockets/ arrears where micro credit programmes can be implemented. Micro credit extended by banks to individual borrower directly or through any intermediary would be reckoned as part of their priority sector lending.

ii) Banks can deal with micro credit organizations having proper credentials, track record, system of maintaining accounts and records with regular audits in place and manpower for closer supervision and follow up.

iii) Banks may prescribe their own lending norms for loan and savings products and the related terms and conditions including the size of the loan, unit cost, unit size, maturity period, grace period, margins etc. to provide maximum flexibility in regard to micro lending. Such credit should, therefore cover not only consumption and production loans for various farm and non-farm activities of the poor but also include their other credit needs such as housing and shelter improvements.

iv) Micro credit should be included in branch credit plan, block credit plan and state credit plan of each bank. Micro credit should also form an integral part of the bank’s corporate credit plan and should be reviewed at the highest level on a quarterly basis.

v) A simple system requiring minimum procedures and documentation is a precondition for augmenting flow of micro credit. Hence, banks should make arrangements for expeditiously sanction and disburse micro credit by delegating adequate sanctioning powers to branch managers.

6) Exemption for NBFCs

Several non-banking finance companies (NBFCs) and residuary non-banking companies (RNBCs) also started entering the micro finance sector, gradually recognizing the potential in the sector. In January 2000, all NBFCs and RNBCs were advised by the Reserve Bank that those NBFC’s which were engaged in micro financing activities, Licensed under section 25 of the companies Act, 1956 and which were not accepting public deposits were exempted from the purview of Sections 45- IA (registration), 45-IB (Maintenance of liquid assets) and 45-IC (transfer of a portion of profits to Reserve Fund) of the Reserve Bank of India Act, 1934.

7) Delivery Issues

The Reserve Bank constituted four informal groups in October 2002 to examine various issues concerning micro finance delivery. On the basis of the recommendations of the groups and as announced in Paragraph 55 of the Governor’s Statement on mid-term Review of the Monetary and Credit Policy for the year 2003- 2004, banks have been advised as under:-

i) Banks should provide adequate incentives to their branches in financing the Self Help Groups (SHGs) and establish linkages with them, making the procedures totally flexible to suit local conditions.

ii) The group dynamics of working of the SHGs may be left to themselves and should neither be regulated nor formal structures imposed or insisted upon.

8) ECBs under Automatic Route

Based on the recommendations of the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the Banking System (Chairman: Prof. V. S. Vyas), which submitted its final report in June 2004, it was announced in the Annual Policy Statement for the year 2004-05 that in view of the need to protect the interest of depositors, MFIs would not be permitted to accept public deposits unless they complied with the extant regulatory framework of the Reserve Bank. However, as an additional channel for resource mobilisation, the Reserve Bank in April 2005 enabled NGOs engaged in micro finance activities to access the external commercial borrowings (ECBs) up to US$ 5 million during a financial year for permitted end use, under the automatic route.

9) Services of Intermediaries through BF/BC Models

In order to examine issues relating to rural credit and micro finance, an internal group (Chairman: Sh. H.R. Khan) was set up in 2005. Based on the recommendations of the group and with the objective of ensuring greater financial inclusion and increasing the outreach of the banking sector, banks were permitted in January, 2006 to use the services of NGOs/SHGs, MFIs (other than NBFCs) and other civil society organisations as intermediaries in providing financial and banking services through business facilitator and business correspondent models.

10) Constitution of Coordinated forum

All Regional Directors of the Reserve Bank were advised in April 2006 that whenever issues relating to micro finance were noticed in the areas under their jurisdiction, they may offer to constitute a coordination forum comprising representatives of SLBC convener banks, NABARD, SIDBI, State Government officials, and representatives of MFIs (including NBFCs) and NGOs/SHGs to facilitate discussion on the issues affecting the operations in the sector and find local solutions to the local problems.

11) Banking Correspondents

In January 2006, the Reserve Bank permitted banks to utilize the services of NGOs, MFIs (other than NBFCs) and other Civil Society organization as intermediaries in providing financial and banking services through the use of business facilitator and business correspondent (BC) models. The BC model allows banks to do ‘cash in cash out’ transactions at a location much closer to the poor while relying on the financial strength of the bank to safe guard the deposits. Union Finance Minister in the Union Budget 2008-2009, made the announcement that Banks were permitted to engage retired bank employees, ex-servicemen and retired government employees as business correspondents (BCs) with effect from April 24, 2008.

12) Financing of MFIs by banks

In May, 2006, A Joint fact finding study on microfinance conducted by Reserve Bank and a few major banks made the following observations:

i) Some of the microfinance institutions (MFIs) appear to be focusing on relatively better banked areas, Competing MFIs were operating in the same area, resulting in multiple lending and overburdening of rural households.

ii) The MFIs were disbursing loans to the newly formed groups within 10-15 days of their formation, in contrast to the practice obtaining in the SHG-Bank Linkage programme which takes about 6-7 months for group formation / nurturing / handholding. As a result, cohesiveness and a sense of purpose were not being built up in the groups formed by these MFIs.

iii) Banks, as principal financiers of MFIs do not appear to be engaging to ensure better transparency and adherence to best practices. In many cases, no review of MFI operations was undertaken after sanctioning the credit facility. In Nov, 2006, these findings were brought to the notice of the banks to enable them to take necessary corrective action where required.

13) Total Financial Inclusion and Credit Requirement of SHGs

Attention was invited to Paragraph 93 of the Union Budget announcement made by the Honourable Finance Minister for the year 2008-2009 wherein it has been stated as under:-

It was required by Honourable Finance Minister in budget of year 2008-2009 that Banks will be encouraged to embrace the concept of Total Financial Inclusion.

Government will request all scheduled commercial banks to follow the example set by some public sector banks and meet the entire credit requirements of SHG members, namely, (a) Income generation activities, (b) social needs like housing, education, marriage, etc. and (c) debt swapping, in April 2008.

14) Bank Loans to MFI for on Lending

Hinging on the recommendations of Malegam committee, RBI on May 3, 2011 released its circular on regulation after deciding to consider micro finance sector as a separate category. Banks were advised to meet the entire credit requirements of SHG members, as envisaged therein.

i) Most significant was the Cap on interest rate, MFIs were not allowed to charge interest rate beyond 26% on reducing balance basis with a peak up of not more than 12%.

ii) Bank credit to MFIs extended on or after April 2011 for on Lending to individuals and members of SHGs/JLG was covered under priority sector. Advance provided not less than 85% of total assets of MFI (other than cash balances with banks and financial institutions, government securities and money market instruments) are in the form of “qualifying assets”. In addition aggregate amount of loan, extended for income generating activity should not be less than 75% of the total loans of MFIs.

iii) A Qualifying Asset” shall mean a loan given by MFI, which satisfies following criteria:-

a) The loan is sanctioned to the borrower whose household annual income in rural areas is less than 60,000/- and in non-rural area it is less than 120,000/- b) Loan does not exceed 35,000/- in first cycle and 50,000/- in the subsequent cycles.

c) Total liability of the borrower is not more than 50,000/- d) Loan exceeding 15,000 will have minimum tenure of 2 yrs with the option of prepayment on delayed payment without penalty.

e) Loan is without collateral, repayable by weekly fortnightly or monthly installments with borrower’s choice.

iv) The Loan is without collateral and is routed preferably through SHG / JLG so that social and peer pressure for repayment replaces arm-twisting tactics.

v) Only three components are to be included in pricing of loans namely, 1% of  the gross loan amount as processing fee, the interest charge and actual insurance premium. Administrative charges for insurance should adhere to IRDA guidelines.

vi) The banks should obtain from MFI, at the end of each quarter, a chartered Accountants certificate which will certify that all the above mentioned conditions are followed.

15) REVISED REGULATORY NORMS FOR MF-NBFCs, 2012

RBI decided to make certain modifications in the directions issued on Dec. 02, 2011. These revised regulatory framework was issued on Aug 42012 by RBI. These modifications were as under:-

i) The Central Bank has done away with the 26% Cap on lending rates due to the dynamic nature of the cost of funds for microfinance but has said that margins will be capped. The maximum variance between the minimum and maximum interest rate cannot exceed 4%. RBI also cut the minimum amount of money to be lent to income generating assets to 70% from 75%.

ii) New entities going to start NBFC-MFI need a minimum fund of Rs. 5 Crore, while existing ones should have net owned funds of Rs. 3 Crore by March 31, 2013 and Rs. 5 Crore by March 31, 2014. In case of failure to comply with these norms, loans to the microfinance sector will be restricted to 10% of total assets.

NBFCs in the North Eastern region will have to maintain net owned funds of Rs. 1 Crore by March 31, 2013 and Rs. 2 Crore by March 31, 2014.

iii) Income generation activities should constitute at least 70% of the total loans of the MFI so that the remaining 30% can be allocated for other purpose such as housing repairs, education, medical and other emergencies.

16) REVISED ECB POLICY UNDER AUTOMATIC ROUTE (DEC, 2011)

Considering the specific needs of the micro finance sector, the existing ECB policy has been reviewed in consultation with the Government of India and it has been decided that hence forth MFIs may be permitted to raise ECB up to USD 10 million or equivalent during a financial year for permitted end-uses, under the Automatic Route. Detailed guidelines on ECB for MFIs with necessary safeguards are set out below. The following MFIs engaged in micro finance activities shall be considered as eligible borrowers to avail of ECBs:-

i) MFIs registered under the Societies Registration Act, 1860;

ii) MFIs registered under Indian Trust Act, 1882;

iii) MFIs registered either under the conventional state-level cooperative acts, the national level multi-state cooperative legislation or under the new state-level mutually aided cooperative acts (MACS Act) and not being a co-operative bank;

iv) Non-Banking Financial Companies (NBFCs) categorized as ‘Non Banking Financial Company-Micro Finance Institutions’ (NBFC-MFIs) and complying with the norms prescribed as per circular DNBS.CC.PD.No. 250/03.10.01/2011- 12 dated December 02, 2011; and

v) Companies registered under Section 25 of the Companies Act, 1956 and involved in micro finance activity. MFIs registered as societies, trusts and co-operatives and engaged in micro finance should have a satisfactory borrowing relationship for at least 3 years with a scheduled commercial bank authorized to deal in foreign exchange; and would require a certificate of due diligence on `fit and proper’ status of the Board/Committee of Management of the borrowing entity from the designated Authorized Dealer (AD) bank. ECB funds should be routed through normal banking channels. NBFC-MFIs will be permitted to avail of ECBs from multilateral institutions, such as IFC, ADB etc. / regional financial institutions/international banks / foreign equity holders and overseas organizations. Companies registered under Section 25 of the Companies Act and engaged in micro finance will be permitted to avail ECBs from international banks, multilateral financial institutions, export credit agencies, foreign equity holders, overseas organizations and individuals. Other MFIs will be permitted to avail ECBs from international banks, multilateral financial institutions, export credit agencies, overseas organizations and individuals.