The microfinance business in India has been clamouring for regulation for a long time. Internationally, microfinance is rapidly shifting from being a niche product to a globally recognised form of finance. In India, microfinance institutions (MFIs), with a loan outstanding of Rs30,000 crore, may have been dwarfed by the banking industry but it still serves nearly 25 million poor people in the rural and urban areas whom banks have failed to reach.
The regulatory vacuum is not only bad for the MFIs and the banks that fund them but also for the poor. This fact has been amply demonstrated by the Andhra Pradesh Microfinance Institutions Ordinance 2010. Suddenly, the 6.25 million poor who have been getting loans to the tune of R9,000 crore from the MFIs have been left high and dry by this fiat. In AP, the Self Help Groups (SHGs) including the state government-led programmes reach 54% of the rural households, followed by moneylenders (37%) and MFIs (17%). Yet the MFIs, without any independent investigation, have been blamed for the suicides. Today, MFIs are fighting for survival and are defaulting on their payments to the banks.
The MFIs' work is not formally recognised and kept outside the purview of the state and district credit committees. But MFIs must be made part of such panels to help avoid an AP-like crisis. After two years of lobbying, the Association of Karnataka Microfinance Institutions (AKMI) is being inducted into the state-level bankers' committee.
The RBI regulates the non-banking finance companies-MFIs (NBFC-MFIs) who account for 80% of the non-SHG lending in India. The MFIs have been requesting that a separate category be created for NBFC-MFIs, only then could this pave the way for a special regulation for this segment.
For quite some time, the Reserve Bank of India (RBI) has been concerned with the quality of governance and excessive commercialisation of the larger MFIs and their reluctance to pass on the benefits of scale by reducing pricing. The RBI could have brought the NBFC-MFIs in line and the industry would not have had to suffer at the hands of the AP government, which has taken on the role of a 'regulator'.
However, let us not confuse the AP ordinance with regulation. It is extremely poorly drafted and the underlying objective is clear: target the NBFC-MFIs that compete with the state-sponsored microfinance programme. The Economist Intelligence Unit's annual rating of the microfinance business environment is based on three factors: regulatory framework, institutional development and investment climate. India ranked eighth in this. But in the regulatory framework it ranked 14, behind Philippines, Cambodia and Pakistan (all ranked No. 1). With the current developments in AP, our ranking will take a serious tumble.
The Microfinance Bill, meanwhile, which seeks to regulate the not-for-profit MFIs (that account for only 20% of the market), has been pending in Parliament since 2007. This Bill has many fundamental flaws and it will split the sector into two between the RBI and the National Bank for Agriculture and Rural Development. The dual regulator approach is not a recipe for success but a starting point. Ideally, one central regulatory body for the industry should be created. Time is of the essence as the regulatory vacuum, if it continues indefinitely, would be a major setback to the goal of financial inclusion.
We look forward to the recommendation by the Malegam Committee set up by the RBI. Let us hope that the committee, along with the ministry of finance, will expeditiously resolve the issue of regulating the microfinance sector early next year. If not, it will be a setback to the industry and the poor who are serviced by it.
The ongoing crisis will lead to a shakeout in the microfinance industry, especially those institutions that are poorly governed and straying from the mission of poverty alleviation. Regulation is required not only to protect the vulnerable poor from the unacceptable practices of some MFIs but also the industry from arbitrary ordinance/regulation.
Samit Ghosh is managing director, Ujjivan Financial Services, and a board member of Microfinance Institution Network. The views expressed by the author are personal.