The Sub-Committee of RBI Board headed by Shri Y.H. Malegam has submitted its report to the RBI within the stipulated time. The Committee was appointed in October 2010 in the wake of the crisis-like situation that emanated from Andhra Pradesh(AP) following controversy over the alleged abusive practices adopted by the MFIs involving high-interest rates, coercive recovery methods, and multiple-loans. The Committee, among other issues, was expected to examine the prevalent practices of MFIs with regard to interest rate and lending and recovery practices, and explore the scope for regulating these MFIs by RBI and the regulatory framework needed.
Some major recommendations of the Committee are:
1) Creation of a separate category of NBFCs in the MF sector designated as NBFC-MFIs. A definition of such NBFC-MFIs is also given which will be regulated by the RBI. These MFIs will have not less than 90 percent of their total assets as qualifying assets which are basically loans of the size not exceeding Rs. 25,000 given to a low-income household.
2) A ceiling on the rate of interest charged by these MFIs by a `margin cap’ and an absolute cap to be imposed to prevent exploitation of individual borrowers.
3) Transparency to be enhanced by MFIs about interest rate charges by specifying charges permissible, and provision of a loan card with details of effective rate. These MFIs have to lend only to a group member and avoid giving multiple loans besides conducting loan transactions in a central location.
4) A credit information bureau to be set up for mutual sharing of information by MFIs about their borrowers. MFIs will adopt a customer protection code.
5) MFIs will put in place a good corporate governance system including adherence to prudential norms like capital adequacy ratio (15%) and loan-loss provision (1%). The NBFC-MFI shall have a minimum capital of Rs. 15 crores.
6) Industrial associations and banks beside RBI will play a key role in monitoring compliance of regulatory norms and codes by MFIs. The NBFC-MFIs are to be exempted from the provisions of moneylending, and also from the new AP MF regulation Act.
The NBFC-MFIs have generally welcomed the recommendations of the Committee. They are bound to take such a stand as they feel vindicated about their `grievances’ vis-à-vis states. But the Committee’s approach and the suggestions are ridden with several limitations and paradoxes. Let me high light some of them based on the first reading of the report. The Committee though aware of the major concerns including the failure of RBI to ensure orderly growth of the MF sector comes up with measures aimed at addressing symptoms than the root causes.
First of all, it is a narrowly focused report looking at only a particular set of institutions i.e. NBFC-MFIs. In that sense, the broader sectoral needs and challenges are not adequately addressed making RBI take a fragmented view. There are many paradoxes in the Committee’s approach and recommendations gave the prevailing economic scenario.
The first paradox is the use of excessive regulation in a liberalizing scenario. The new NBFC-MFIs created have been prescribed with very strict and high prudential and other norms. Not only these norms preclude the easy entry of interested players, especially from civil society background but have the potential to drive the MFIs to become more commercial. A major paradox here, given the argument that credit-only MFIs need not be regulated, RBI would be very meticulously regulating these credit-only NBFC-MFIs. If savings are not going to be included, what is the whole rationale for such excessive regulation of this new category of MFIs created?
The Committee seems to be using regulatory norms to address the abusive practices being adopted by MFIs including charging high-interest rates. If the concern is mainly one of reducing such practices and not ensuring savings services by these NBFC-MFIs, the solution should have been to go into the causes of those practices per se than to recommend such excessive regulatory norms for institutions which are supposed to serve the poor. In other words, the Committee has recommended full-fledged regulated measures for fragmented services by the designated MFIs. It is not sure how far these regulatory norms will help to overcome the key concerns, given several challenges being faced by these MFIs.
No doubt the interest rates of MFIs are a matter of concern. MFIs should be enabled to offer affordable services. The solution of the Committee is here is the cap or ceiling on the interest rate, which is a paradox again. When RBI says that it is following a liberalized interest rate regime, such a prescription goes against the declared policy unless the MFIs are given adequate concessions or cheaper fund facilities to overcome the cost constraint. How far the RBI will be able to ensure this ceiling in true letter and spirit is a major question.
Coming specifically to the cap, the Committee says it has worked out a normative cost basis to arrive at such a cap. In this framework, return on equity is also a normative component as per the Committee which is actually a mechanism to drive these MFIs into the hands of commercial players who are also to be blamed for the existing problems.
Moreover, the basis of cost worked on an average level ignores the difficulties that could emerge due to wide variations across MFIs. The prescription of the double cap (margin and absolute) is likely to create more hassles in the implementation. The MFIs on the lower side of cap can continue to charge higher permissible level. Further, who will monitor and authenticate the actual costs of MFIs? Is that the role expected of any regulator? Again, in a declared market-driven economy, the regulator meticulously monitoring the cost of a financial firm including penalizing them for any price violation is an incongruity. The Committee here comes out too naïve in terms of its understanding of the underlying causes and its remedies. A major cause of the higher interest rate charged by MFIs is due to their inability to tap cheaper funds like banks. Having fully denied savings services by these MFIs, no attempt is made by the Committee to address this structural issue.
There should have been clear recommendations to provide relatively cheaper refinance to these MFIs by NABARD and other public agencies as they are trying to address a crucial developmental challenge of financial inclusion. This would have helped MFIs to access cheaper funds from public sources instead of commercial sources. The absence of such a mechanism is the main reason why MFIs look towards costly and commercial sources to augment funds. The Committee has only tried to fix the rate of interest and not fix this basic problem.
There is a suggestion of the creation of the social capital funds, to augment MFI funds. In a commercialized world when MFIs are trying to offer IPO, one can imagine the scope for any such social funds to flow in a significant way. The Committee hence has given a kind of green signal for MFIs to go more commercial and market-oriented.
For compliance with regulator norms and code of conduct, the Committee is emphasizing on the role of industry associations which have to come up in a competitive way to be assigned the role. How far self-regulation, in a market-driven environment would work is nay body’s guess. At the same time, an RBI committee in the way is admitting the inability of RBI as a state institution to ensure the orderly and sound working of the MFIs.
For a more fundamental cure, the Committee could have recommended creation a full-fledged MFIs- a kind of micro-banks with the ability to mobilize savings and overcome structural constraints. With the RRBs having been converted as regular banks, literally there is a greater vacuum in the public sphere for the poor. Instead of such a fundamental solution, the Committee has gone in for those which are unrealistic besides being contradictory. The Committee has recommended that NBFC-MFIs be exempted from money lending acts as RBI is going to regulate them. What if the regulation fails to ensure desirable changes? This was the reason which had compelled states like AP to explore their own regulatory measures for MFIs. The state including RBI has failed to play the expected role in ensuring orderly growth of the MF sector through its vacillation and lack of a proactive regulatory framework for the MF sector. Now through excessive regulation of a particular set of MFIs, the Committee hopes RBI would help overcome its past failure.
Hence, the Malegam Committee report is a disappointment for the real cause of financial inclusion. Nothing more could have been expected from a group of Central Bank governors under the current economic environment.