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Protecting the poor, not MFIs
By suggesting a cap on interest rates on microloans and annual income of poor borrowers, a Reserve Bank of India (RBI) panel on microfinance led by noted chartered accountant Y.H. Malegam has ruffled many feathers. In an interview, Malegam defended the recommendations, saying the panel’s mandate was to protect poor borrowers and not microfinance institutions (MFIs). Look at the philosophy behind it and not the numbers, and the annual income limit can be different in rural and urban India, he said. Describing MFIs as “greedy”, he said they book enough profits and could use part of it to reduce rates, which he strongly emphasized should not exceed 24%. If RBI accepts the recommendations, there will be no need for the recent Andhra Pradesh law for regulating MFIs, he said.
Q&A
Limit on annual income can be changed……Y H Malegam
Mumbai: The Malegam panel’s recommendation that only those households which have up to Rs50,000 in annual income should be eligible for borrowing money from microfinance institutions (MFIs) have drawn flak from all quarters. Critics say by suggesting a cap on loan rate, the panel is also denying market forces in shaping the cost of loans.
But noted chartered accountant Y.H. Malegam, 77, who has been serving as director on Indian central bank’s board for 17 years, said one should look at the philosophy of the report and not the figures. The objective is to define what microfinance is and regulate them and the numbers can be revised.
He said in an interview that there could be a distinction between borrowers in rural, semi-urban and urban India. While Rs50,000 annual income criterion can be kept for rural India, it can be raised for semi-urban and urban pockets.
He, however, strongly defended the idea of capping the exposure limit for an individual borrower at Rs25,000 and the loan rate at 24%. He described MFIs as “greedy” and said the mandate of the panel was to protect borrowers and not lenders. MFIs have enough profits and they can use part of it to reduce interest rate, he said.
If indeed the Reserve Bank of India accepts the recommendations, there will be no need for the Andhra Pradesh law for regulating MFIs in the southern state, he said. Edited excerpts:
You seem to have focused on micro-microfinance, allowing households having only up to Rs50,000 annual income to access micro-credit.
I think we should not place too much of emphasis on these numbers. It makes much more sense if you look at the philosophy of the whole report. Whether it is Rs50,000 or Rs100,000, the number can easily be changed. In fact, Rs50,000 is the number which was often mentioned to the committee by some of the MFIs and banks. It’s not something which we picked up out of thin air.
Also, it was basically in the context of rural areas. Obviously, that Rs50,000 may not be appropriate for an urban area or a semi-urban area. When the regulations are made, this can be easily revised.
So, I think the concept that there should be a limit is more important, rather than the number.
So you are flexible.
Yes. As I said, this is only a recommendation. When the regulations are framed, depending on the response, this limit can be changed. I have a feeling that the logical thing will be to create a distinction between rural, urban and semi-urban areas. It can be higher for urban. But the final decision should come from RBI (Reserve Bank of India).
What about the limit of Rs25,000 on individual loans?
I don’t think that should be changed. If you look at the statistics today, 92% of MFI loans are below Rs15,000. Only 8% is outside of Rs15,000, which we are increasing to Rs25,000. The second thing is that 90% of the loans (of each MFI) should be qualifying loans, or loans that satisfy the criteria. The balance 10% need not satisfy this criterion. This can go beyond Rs25,000.
So your view is that Rs50,000 cap on annual income can be changed, but Rs25,000 will stay.
Yes. Let’s put it this way. Rs50,000 is a limit, which we know cannot be enforced. How do you find out what is the household income? It can only be based on the declaration given by individuals. But the concept that there should be a limit is more important. Because, if you do not have a limit, MFIs can give loan to anyone. Someone with a household income of Rs10 lakh can take a Rs15,000 loan. Does that make sense?
MFIs tend to give loans (to) people with higher income for safety. The objective of microfinance is to give finance to people who cannot otherwise get finance. Therefore, by putting a limit, you indicate your intension and give a signal that you would expect MFIs to give loans to poor people.
Are you also flexible on the loan rate cap at 24%?
If you look at the interest rate charged by MFIs, it has a component of the funds which they borrow. The cost of funds may be beyond their control if interest rates go up. But the other components—the staff cost, bank office cost, loan losses and the return on their capital—can be controlled. If the size of loans increases, the cost per loan will come down. Your loan losses are also within your control. If you improve your system, you should be able to bring down your cost.
What kind of return should an MFI look for?
If you have a capital adequacy of 15%, out of Rs100, Rs15 is your own funds and Rs85 is what you have borrowed. You should get a 15%, post tax return on that. This is reasonable, works out to as much as 22% pretax return. Since interest cost is beyond your control, we give you a margin in excess of the actual cost of interest. Within that margin, 10% for larger MFIs and 12% for smaller MFIs. If you want to pay higher salaries, your cost will be higher and your profits will be lower.
Today, the average cost for borrowing for MFI is less than 12%. Let’s take it as 12%. If you add 10% margin, then you can charge 22%. If you add 12%, then you charge 24%. The government has already announced that public sector banks should ensure that MFIs should not charge more than 24%.
Why are they charging so high?
When you are growing at a very fast pace, there is a lot of development cost which is incurred and that development cost is reflected in today’s cost. You are asking the current borrower to pay for that development. If you look at any other industry, no one can do that. There should be some ways through which you bear that cost and recover it when you reach a certain size.
The whole concept of microfinance is getting debased because of greed. If you say I am small and my costs are high and the customer should pay higher interest, then I will tell you to grow larger. Why should a borrower subsidize you?
While the borrowing cost is fixed across India, other costs vary in different regions.
If you look at any other industry, there is always a cross-subsidization. Take the banking industry—it lends to exports at a lower interest, but makes it up somewhere else.
You do not want MFIs to offer other services, but that’s the way they can make money and bring down loan cost.
There is a distinction between the financial services and other services. If you render services like remittance, that is a financial service. Now, if you sell mobile sets or supply products to kirana shops, those are not financial services. You are dealing with a vulnerable borrower whose banking power is limited. So there is big risk if an MFI goes to a borrower and says, if you want a loan, you buy a handset or insurance policy. We want to avoid this risk.
Smaller MFIs may not be able to survive. Do you see consolidation in the sector?
The concept of microfinance itself started as NGOs (non-governmental organizations) and they were all non-profit NGOs. The intention was to provide some facilities to (the) poor to work themselves out of poverty. Then they said if we remain non-profit companies, we are not able to get enough money and grow. If I want to protect the borrower, I must encourage you to grow large. That will help you bring down the cost and pass it on to the borrower.
How should MFIs raise money?
There are people who want to establish a social mutual fund for providing money to MFIs. They don’t want exorbitant profits and are happy with 10-12% return. These mutual funds will invest in only those MFIs which are willing o do social work. Grameen Foundation has made such an offer. They would like to allow us to have a social mutual fund which offers muted returns.
The Central government is preparing a Bill which envisages National Bank for Agriculture and Rural Development (Nabard) as the regulator for MFIs. But you want RBI to be the regulator.
There are three types of MFIs—the self-help group model where banks lend money to the groups; the MFI model where banks give money to MFIs to be given to individuals; and others. The first two constitute 92% of the industry, which is regulated by RBI. The remaining 8% consists of cooperative societies, trusts, etc.
The Bill says that Nabard should be the regulator. But it is also a participant in the business as it lends money. There is a conflict of interest when a lender becomes a regulator.
Nabard should either give up its role as a lender and remain a regulator or give up its role as a regulator and remain a lender.
Which one do you prefer?
I would prefer Nabard to give up its role as a lender.
Ultimately, we are concerned with this risk that someone takes advantage of regulatory arbitrage.
You have said that if the recommendations are accepted, the Andhra Pradesh law on MFIs will become redundant. How can a panel take on a sovereign Act?
We are saying that the Andhra Pradesh Act will not survive as far as NBFCs (non-banking financial companies) are concerned because RBI is going to regulate them. There are some provisions in the Act that create problems. For instance, it says that MFIs have to register themselves with the gram panchayat office. Now if you have to register with RBI also, then there can be a lot of duplication.
There are issues on repayments—how it can be done and the frequency. We are in favour of making a distinction between the recovery of loan and its disbursement. As far as the disbursement is concerned, it can be made at some central point because that happens only once. That central point can be anywhere, even under a tree.
The important thing is that if a borrower repays the amount in the presence of others who have jointly guaranteed his repayment, then there will be peer pressure on that person. Whether the repayment should be weekly, monthly or fortnightly, must depend on the nature of the loan and the cash flows it generate.
If RBI accepts your recommendations, will Andhra Pradesh repeal the law?
There is no harm in a state having its own law. But the difficulty is that if an MFI operates in five different states and each state has its own law, and in addition there is a regulation by RBI, then how will it manage its operations?
Have you spoken to Andhra Pradesh on this?
Their secretary made a representation to us. We told him that if you are satisfied that we are bringing in regulations that substantially cover the areas which you have identified, and if you accept that there is difficulty in having multiple regulations by different states, then why would you insist on having your own Act?
What was their response?
They said the state government would consider. But obviously, they don’t seem to agree to that. There is nothing we can do in that matter.
What about coercive recovery?
We have said quite candidly that a regulator cannot punish for coercive recovery. It’s a matter for the law and there are enough provisions in the law to take action against coercive recovery. In order to ensure coercive recovery is reduced, first you put the responsibility on the management not just on the individual himself. Banks earlier had this problem, but they solved it.
Then we have dealt with the question of compliance. It must be a responsibility taken up by more than one pillar. Let the MFI itself enforce compliance; then the banks, the industry associations and RBI. So even if compliance is weak in one area, it can be compensated by other.
You have given only a month to implement the recommendations.
We have not given any time frame. Only on one aspect —the rate of interest—we said it must be implemented by April. But we are not going to control interest rates for individual loans, but will look at the average rate for the whole year.
While it will be easier for large MFIs to bring down rates, smaller MFIs will find it very difficult.
I am not protecting MFIs. I’m protecting the borrower. I believe that a borrower should not be charged interest rate in excess of 24%.
In the last several years, MFIs have made larger profits. What is the harm in using a part of that profit to bring down the interest rate now?
In the long term, do you expect this to come down further?
It can come down. Their cost of funds should come down. If government feels that lending rates should come down from 22% to 20%, it must find some ways to make bank finance available for MFIs at cheaper rate.
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