Tens of millions of Indian women take microfinance loans every year. Some of these loans are for consumption, but many help fuel small businesses. These unsecured loans are at relatively high interest rates of 18 to 24 per cent, and women usually form joint liability groups to take on these borrowings. All these women are insured, and their credit history is recorded. Partly as a result of these arrangements, 98 per cent of the loans are repaid despite the high rates of interest. There are now close to 60 million borrowers, and the average loan size is close to Rs.40,000.
It's fair to say that microfinance operations have worked well in many places, and this sector has helped India achieve financial inclusion in a big way. Microfinance is now a big business, and no longer hidden below the water line. Predictably, with this scale, new standards and regulations have also emerged. All microfinance lenders are registered with the Reserve Bank of India (RBI), and many of them are also members of one of the self-regulatory organisations: Sa-Dhan and the Microfinance Institutions Network (MFIN). These two have a code of conduct for microfinance operations, which they can enforce on their own members - up to the extent of fining them for breaches of this code.
Despite this narrative of steady improvements, problems do arise, and they increasingly have in the last few years. The problems are typically of two types: over-lending by multiple lenders to the same borrower increasing her total installments beyond what she can afford to pay, and harassment by other women in the group or by the staff of the lender in case she defaults on her payments. After natural calamities, these problems increase because these disasters often harm the small shops and other tiny businesses that these women run. After every cyclone or flood or drought, some or the other district in India will see microfinance problems bubbling over.
A clear regulatory framework is needed
Microfinance borrowers are also voters. So, if anything goes wrong with a borrower, it can and does escalate politically, with much attention from the local MLA or the local media. Women use WhatsApp to relay their troubles to others and matters can and do quickly spread across the district, or even the state. In times of distress, MLAs often ask District Collectors and other officials to intervene. The only way that they can do is by directing lenders to not collect one or two installments - effectively, a moratorium.
Since it is the RBI that regulates microfinance, no state government, far less a district official, has the power to suspend such commercial transactions between a private lender and a borrower. And yet, they do. After the floods in Kerala in 2018; after the cyclone in Odisha in 2019; after the drought in southern Maharashtra in 2018 and 2019, these problems kept cropping up.
In Assam in 2019, floods badly hit borrowers, many of whom had taken more loans than what the RBI permitted - lenders were to blame for this. The inability to repay was first felt by a few borrowers in a few districts, especially those who worked in tea estates. Their problems were worsened by a few instances of wrong behavior by lenders' staff. In two months, the distress in Assam worsened - some local groups began advising borrowers to default. Media coverage followed, the government intervened, and finally a law was passed in 2020, severely curtailing microfinance operations in Assam, and waiving the loans of many existing borrowers.
India's Constitution gives only the Union government the right to regulate finance, which is through the RBI. Yet, the Assam government bypassed the RBI to impose its own law, just as Andhra Pradesh (and then Telengana) did in 2011. This despite much lobbying by banks and other lenders in Assam and elsewhere.
The RBI is proposing new rules for microfinance. There will be no cap on the number of lenders from whom a person may borro (earlier, this was capped at two) or the interest rate that lenders can charge, so long as the total monthly installments of all loans is less than half the monthly income of the borrower. These long-asked-for rules will level the playing field, allowing microfinance institutions to compete better with banks, which have relatively fewer restrictions on their operations.
These new rules are good for the industry, but if they are not backed more effective regulation and self-regulation, this critically important sector will face more challenges. It is expected that interest rates charged to borrowers may rise as the RBI's ceiling on interest rates (set by a formula) is removed. It is also expected that there may be more lending to existing borrowers, and that most of them will soon be paying installments of half their income. Today, the loan sizes are relatively small, and their installments are not that high.
If more microfinance borrowers get into distress, this is bound to increase political and state government pressure to ensure more effective regulation that protects the interests of borrowers (who are all voters). Intervention by state and district authorities can resolve a few grievances, but it will make lenders wary of extending more unsecured loans, thus harming the financial inclusion of the relatively poor.
Self-regulation has a role to play
The RBI remains the regulator, but it will find it difficult to attend to so many grievances of so many small borrowers, as it failed to do in Assam, necessitating political intervention. To ensure effective protection of the interests of borrowers, there should be a single, empowered self-regulatory body, rather than two ineffective ones. This body should only regulate, leaving advocacy to the existing MFIN and Sa-Dhan (just like CII and FICCI today do only advocacy).
This body should be funded by lenders @ Rs. 10 for every loan that they give out (or Rs. 10 for every borrower, every year). That will raise Rs.60 crores a year, which is more than enough to have a body that is present not just in Delhi, but also with chapters every state. It will have enough staff to investigate all customer complaints. It will be empowered to issue penalties to members. Because microfinance is already a political and democratic issue, the state chapters of this SRO should have on their governing council, one representative of the state government (needed after the Assam law), and one representative from the RBI - the majority will continue to be lenders, to ensure it is a true self-regulatory organisation.
Better regulation (or self-regulation) is also needed for fintechs and other digital lenders. They may use artificial intelligence or social media and their algorithms may be better at deciding at who to lend to and how much, but they will still face problems if borrowers cannot or will not pay back. And if such borrowers do complain to the authorities, it will be difficult for the lenders to justify these loans that are after all given at higher interest rates than what a bank would normally give as a personal loan.
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Each borrower's existing loans and repayments are available in the four major credit bureaux, and it will be easy to not give a fresh loan to someone who's already paying back close to the ceiling. The credit history of more than sixty million microfinance borrowers (apart from other borrowers) is one of the big achievements that India has, and this should be used by the RBI in any regulation. The RBI should unify all forms of lending and set a single ceiling of the total installments paid across all types of loans - microfinance, digital lenders, NBFCs, and banks.
In China, which is the leading country for such types of fintech lending, there are already government regulations to better protect the borrowers. In India too, we need both more customer-friendly regulations, and perhaps self-regulation for digital lending, just as I’ve suggested for microfinance. Only then will the promise of financial inclusion, microfinance, and digital lending result in sustainable lending that benefits both the borrower and the lender.
