Where Angels Prey

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Thursday, January 20, 2011

The RBI Sub-Committee Report: My Summary of Key Recommendations

Ramesh S Arunachalam
Rural Finance Practitioner

We have all being waiting for this report[i] and here is the summary of recommendations…taken from
the report…I will start providing an analysis of the same, bit by bit, hereafter…

“The Board of Directors of the Reserve Bank of India, at its meeting held on October 15, 2010 formed
a Sub-Committee of the Board to study issues and concerns in the microfinance sector in so far as
they related to the entities regulated by the Bank.

The composition of the Sub-Committee was as under:-
1.  Shri Y.H. Malegam – Chairman
2.  Shri Kumar Mangalam Birla
3.  Dr. K. C. Chakrabarty
4.  Smt. Shashi Rajagopalan
5.  Prof. U.R. Rao
6.  Shri V. K. Sharma (Executive Director) – Member Secretary

1.3 The terms of reference of the Sub-Committee were as under:-
1. To review the definition of ‘microfinance’ and ‘Micro Finance Institutions (MFIs)’ for the
purpose of regulation of non-banking finance companies (NBFCs) undertaking microfinance
by the Reserve Bank of India and make appropriate recommendations.

2. To examine the prevalent practices of MFIs in regard to interest rates, lending and
recovery practices to identify trends that impinge on borrowers’ interests.

3. To delineate the objectives and scope of regulation of NBFCs undertaking microfinance by
the Reserve Bank and the regulatory framework needed to achieve those objectives.

4. To examine and make appropriate recommendations in regard to applicability of money
lending legislation of the States and other relevant laws to NBFCs/MFIs.

5. To examine the role that associations and bodies of MFIs could play in enhancing
transparency disclosure and best practices

6. To recommend a grievance redressal machinery that could be put in place for ensuring
adherence to the regulations recommended at 3 above.

7. To examine the conditions under which loans to MFIs can be classified as priority sector
lending and make appropriate recommendations.

8. To consider any other item that is relevant to the terms of reference.


Recommendation # 1: New Category of NBFCs Called NBFC MFIs…

We would therefore recommend that a separate category be created for NBFCs
operating in the Microfinance sector, such NBFCs being designated as NBFC-MFI.

The Sub-Committee recommends that a NBFC-MFI may be defined as

“A company (other than a company licensed under Section 25 of the Companies Act, 1956) 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 conforms to the regulations specified in that behalf”. 

Recommendation # 2:  NBFC To Satisfy Certain Conditions (Non-Negotiables) To
Be Classified as NBFC MFI…

We would, therefore, recommend that a NBFC classified as a NBFC-MFI should
satisfy the following conditions:

a)      Not less than 90% of its total assets (other than cash and bank balances and money market instruments) are in the nature of “qualifying assets.”
b)      For the purpose of (a) above, a “qualifying asset” shall mean a loan which satisfies the following criteria:-
i.                 the loan is given to a borrower who is a member of a household whose annual income does not exceed Rs. 50,000;
ii.               the amount of the loan does not exceed Rs. 25,000 and the total outstanding indebtedness of the borrower including this loan also does not exceed Rs. 25,000;
iii.              the tenure of the loan is not less than 12 months where the loan amount does not exceed Rs. 15,000 and 24 months in other cases with a right to the borrower of prepayment without penalty in all cases;
iv.             the loan is without collateral;
v.               the aggregate amount of loans given for income generation purposes is not less than 75% of the total loans given by the MFIs;
vi.             the loan is repayable by weekly, fortnightly or monthly
  installments at the choice of the borrower.

c)      The income it derives from other services is in accordance with the
       regulation specified in that behalf.

We would also recommend that a NBFC which does not qualify as a NBFC-
MFI should not be permitted to give loans to the microfinance sector, which in
the aggregate exceed 10% of its total assets.

Areas of Concern

In particular, in the Indian context, specific areas of concern have been identified: These are:
a) unjustified high rates of interest
b) lack of transparency in interest rates and other charges.
c) multiple lending
d) upfront collection of security deposits 
e) over-borrowing
f) ghost borrowers
g) coercive methods of recovery

The following recommendations are made with regard to these areas of concern…

Recommendation # 3: Measures (Including Margin Caps) Related To Pricing

We would, therefore, recommend that there should be a “margin cap” of 10% in respect
of MFIs which have an outstanding loan portfolio at the beginning of the year of Rs. 100
crores and a “margin cap” of 12% in respect of MFIs which have an outstanding loan
portfolio at the beginning of the year of an amount not exceeding Rs. 100 crores.  There
should also be a cap of 24% on individual loans.  

Recommendation # 4: Ensuring Transparency in Interest Charges…

We would, therefore, recommend that:-
a)      There should be only three components in the pricing of the loan, namely (i) a processing fee, not exceeding 1% of the gross loan amount (ii) the interest charge and (iii) the insurance premium.
b)      Only the actual cost of insurance should be recovered and no administrative charges should be levied.
c)      Every MFI should provide to the borrower a loan card which (i) shows the effective rate of interest (ii) the other terms and conditions attached to the loan (iii) information which adequately identifies the borrower and (iv) acknowledgements by the MFI of payments of installments received and the final discharge. The Card should show this information in the local language understood by the borrower.
d)      The effective rate of interest charged by the MFI should be prominently displayed in all its offices and in the literature issued by it and on its website.
e)      There should be adequate regulations regarding the manner in which insurance premium is computed and collected and policy proceeds disposed off.
f)        There should not be any recovery of security deposit. Security deposits already collected should be returned.
g)      There should be a standard form of loan agreement.

Recommendation # 5: Dealing With Multiple-lending, Over-borrowing and Ghost-borrowers

We would, therefore, recommend that:-
a)      MFIs should lend to an individual borrower only as a member of a JLG and should have the responsibility of ensuring that the borrower is not a member of another JLG.
b)     a borrower cannot be a member of more than one SHG/JLG.
c)      not more than two MFIs should lend to the same borrower.
d)     there must be a minimum period of moratorium between the grant of the loan and the commencement of its repayment.
e)     recovery of loan given in violation of the regulations should be deferred till all prior existing loans are fully repaid.

We would, therefore, recommend that all sanctioning and disbursement of loans should be done only at a central location and more than one individual should be involved in this function. In addition, there should be close supervision of the disbursement function.

Recommendation # 6: Establishing Credit information Bureaus and Populating Data…

We would therefore recommend that 
a)      One or more Credit Information Bureaus be established and be operational as soon as possible and all MFIs be required to become members of such bureau.
b)     In the meantime, the responsibility to obtain information from potential borrowers regarding existing borrowings should be on the MFI.

Recommendation # 7: Measures Against Coercive Methods of Recovery

We would, therefore, recommend that:-
a)      The responsibility to ensure that coercive methods of recovery are not used should rest with the MFIs and they and their managements should be subject to severe penalties if such methods are used.
b)     The regulator should monitor whether MFIs have a proper Code of Conduct and proper systems for recruitment, training and supervision of field staff to ensure the prevention of coercive methods of recovery.
c)      Field staff should not be allowed to make recovery at the place of residence or work of the borrower and all recoveries should only be made at the Group level at a central place to be designated.
d)     MFIs should consider the experience of banks that faced similar problems in relation to retail loans in the past and profit by that experience.
e)     Each MFI must establish a proper Grievance Redressal Procedure.
f)       The institution of independent Ombudsmen should be examined and based on such examination, an appropriate mechanism may be recommended by RBI to lead banks.

Recommendation # 8: Regulator To Publish A Customer Protection Code

We would, therefore, recommend that the regulator should publish a Client Protection Code for MFIs and mandate its acceptance and observance by MFIs. This Code should incorporate the relevant provisions of the Fair Practices Guidelines prescribed by the Reserve Bank for NBFCs. Similar provision should also be made applicable to banks and financial institutions which provide credit to the microfinance sector.

Recommendation # 9: Measures To Be Undertaken To Improve Efficiencies

We would, therefore, recommend that MFIs review their back office operations and
make the necessary investments in Information Technology and systems to achieve
better control, simplify procedures and reduce costs.

Recommendation # 10: Actions To Build Capacity of SHGs/JLGs

We would, therefore, recommend that under both the SBLP model and the MFI
model greater resources be devoted to professional inputs both in the formation
of SHGs and JLGs as also in the imparting of skill development and training and generally in handholding after the group is formed. This would be in addition to and complementary to the efforts of the State Governments in this regard. The architecture suggested by the Ministry of Rural Development should also be explored.

Recommendation # 11: Corporate Size for NBFC MFIs

We would, therefore, recommend that all NBFC-MFIs should have a minimum Net
Worth of Rs.15 crores.

Recommendation # 12: Strengthening Corporate Governance Framework Aspects

MFIs have twin objectives, namely to act as the vehicle through which the poor can work their way out of poverty and to provide reasonable profits to their investors. These twin objectives can conflict unless a fair balance is maintained between both objectives. This makes it essential that MFIs have good systems of Corporate Governance.

Some of the areas in which good corporate governance can be mandated would be:-
a)      the composition of the board with provision for independent directors
b)     the responsibility of the board to put in place and monitor organisation level
policies for:-
i.         the growth of the loan portfolio including its dispersal in different
ii.       regions
iii.      the identification and formation of joint liability groups
iv.     borrower training and education programmes
v.       credit and assessment procedures
vi.     recovery methods
vii.    employee code of conduct
viii.  employee quality enhancement programmes
ix.     compensation system for employees including limits on variable
            pay and the limit therein on  weightage for business
development and collection efficiency 
x.       customer grievance procedures
xi.     internal audit and inspection
xii.    whistle blowing
xiii.  sharing of information with industry bodies

c) disclosures to be made in the financial statements including:
(i)             the geographic distribution of the loan portfolio, both in terms of number of borrowers and outstanding loans 
(ii)           analysis of overdues
(iii)         the average effective rate of interest, the average cost of funds and the average margin earned
(iv)         analysis of the outstanding loans by nature of purpose for which loans were granted
(v)           composition of shareholding including percentage shareholding held by private equity

We would, therefore, recommend that every MFI be required to have a system of
Corporate Governance in accordance with rules to be specified by the Regulator.

Recommendation # 13: Measures To Maintenance of Solvency

We would, therefore, recommend that provisioning for loans should not be maintained for individual loans but an MFI should be required to maintain at all times an aggregate provision for loan losses which shall be the higher of:
i.                 1% of the outstanding loan portfolio or
ii.               50% of the aggregate loan installments which are overdue for more than 90 days and less than 180 days and 100% of the aggregate loan installments which are overdue for 180 days or more.

We would, therefore, recommend that NBFC-MFIs be required to maintain Capital
Adequacy Ratio of 15% and subject to our comment in para. 21.3 in main report,
all of the Net Owned Funds should be in the form of Tier I Capital.

Recommendation # 14: Measures to Increase Competition

We would therefore recommend that bank lending to the Microfinance sector both
through the SHG-Bank Linkage programme and directly should be significantly
increased and this should result in a reduction in the lending interest rates.

Recommendation # 15: Eligibility for Priority Sector Lending Status

We would, therefore, recommend that bank advances to MFIs should continue to
enjoy “priority sector lending” status. However, advances to MFIs which do not
comply with the regulation should be denied “priority sector lending” status. It
may also be necessary for the Reserve Bank to revisit its existing guidelines for
lending to the priority sector. 

Recommendation 16: Dealing With Assignment and Securitisation

We would, therefore, recommend that:-
a)      Disclosure is made in the financial statements of MFIs of the outstanding loan portfolio which has been assigned or securitised and the MFI continues as an agent for collection. The amounts assigned and securitised must be shown separately.
b)     Where assignment or securitisation is with recourse, the full value of the outstanding loan portfolio assigned or securitised should be considered as risk-based assets for calculation of Capital Adequacy.
c)      Where the assignment or securitisation   is without recourse but credit enhancement has been given, the value of the credit enhancement should be deducted from the Net Owned Funds for the purpose of calculation of Capital Adequacy.
d)     Before acquiring assigned or securitised loans, banks should ensure that the loans have been made in accordance with the terms of the specified regulations.

Recommendation # 17: Alternative Methods in Funding of MFIs

We would, therefore, recommend that:
a)      The creation of one or more "Domestic Social Capital Funds" may be examined in consultation with SEBI.
b)      MFIs should be encouraged to issue preference capital with a ceiling on the coupon rate and this can be treated as part of Tier II capital subject to capital adequacy norms.

Recommendation # 18: Methods And Measures of Monitoring Compliance

We would, therefore, recommend that:-
a)      The primary responsibility for ensuring compliance with the regulations should rest with the MFI itself and it and its management must be penalized in the event of non-compliance
b)      Industry associations must ensure compliance through the implementation of the Code of Conduct with penalties for non-compliance.
c)      Banks also must play a part in compliance by surveillance of MFIs through their branches.
d)      The Reserve Bank should have the responsibility for off-site and on-site supervision of MFIs but the on-site supervision may be confined to the larger MFIs and be restricted to the functioning of the organisational arrangements and systems with some supervision of branches. It should also include supervision of the industry associations in so far as their compliance mechanism is concerned. Reserve Bank should also explore the use of outside agencies for inspection.
e)      The Reserve Bank should have the power to remove from office the CEO and / or a director in the event of persistent violation of the regulations quite apart from the power to deregister an MFI and prevent it from operating in the microfinance sector.
f)        The Reserve Bank should considerably enhance its existing supervisory organisation dealing with NBFC-MFIs.

Recommendation # 19: Dealing With State Level Moneylending Acts

We, therefore, recommend that NBFC-MFIs should be exempted from the provisions of
the Money-Lending Acts, especially as we are recommending interest margin caps and
increased regulation.

We would, therefore, recommend that if our recommendations are accepted, the
need for a separate Andhra Pradesh Micro Finance Institutions (Regulation of
Money Lending) Act will not survive.

Recommendation 19: Transitory Provisions for Implementing report

We would therefore recommend that:
a)      1st April 2011 may be considered as a cut- off date by which time our recommendations, if accepted, must be implemented.  In particular, the recommendations as to the rate of interest must, in any case, be made effective to all loans given by an MFI after 31st March 2011.
b)     As regards the other arrangements, Reserve Bank may grant such extension of time as it considers appropriate in the circumstances.  In particular, this extension may become necessary for entities which currently have activities other than microfinance lending and which may need to form separate entities confined to microfinance activities. “ [ii]


  1. thanks Ramesh for a very useful summary!

  2. Hi Ramesh

    First impressions

    Make no mistake. The days of MFI as the primary vehicle for promoting financial inclusion in the country is over.

    Though MFIs could have claimed the latter status till now; the scenario has changed. The sector's strategic significance has been downgraded and the new policy framework would encourage other vehicles like direct bank lending.

    While Malegam report did not explicitly state as a recommendation, the implications implicitly is that it wants to contract the growth of the MF sector and thereby discourage PE investment in the country by creating a significantly lower growth environment for the sector.

    Sooner the MF reconcile to the emerging policy framework, the better they can adapt

    Read More:
    India's Central Bank finally give a loud unambiguous policy signal: MFIs will not die, only need to be castrated. Part 1