The role and significance of the Non-Banking Financial Company – Micro Finance Institutions (NBFC-MFIs) has been increasing over time. As of the end of September 2020, the microfinance industry served 5.71 crore borrowers, through 10.50 crore loan accounts amounting to a total loan portfolio of Rs 2,31,778 crores. Of this, NBFC-MFIs was the second-largest provider of micro-credit, accounting for 30.17% of the total industry portfolio. Banks topped the list with the largest share of the microfinance portfolio of 40.71% while Small finance banks (18.61%), NBFCs (9.52%), and other MFIs (0.99%) accounted for the balance. Yet until now, there has been a dual regulatory system, which stipulates different norms for banks and NBFCs which lend within the microfinance sector.
Where NBFC-MFIs are concerned, there is a cap for microfinance borrowers of Rs 1.25 lakh for rural and Rs 2.0 lakh for urban borrowers and the total household indebtedness of these borrowers has capped at Rs 1.25 lakh. Further, microfinance borrowers cannot borrow from more than two NBFC-MFIs. While these rules are applicable to MFIs, these rules do not apply to banks that lend to the microfinance sector, giving them a clear advantage.
Banks enjoy an edge over MFIs where the cost of borrowing is concerned too. A listed MFIs would have a borrowing cost of around 9-10% while banks have an average borrowing cost of 6-7%, even if they are largely in the business of microfinance. At the same time, there is no flexibility in the lending rates for MFIs and this puts immense pressure on MFI margins. NBFCs that are not MFIs also lend at rates that are much higher.
The RBI has acknowledged the need for a more uniform regulatory framework for various segments of the financial sector that cater to micro-entrepreneurs. Such a framework could go a long way towards creating a more sustainable ecosystem and supporting broader developmental activity within the country.
Towards this end, the regulator released a discussion paper – ‘Revised Regulatory Framework for NBFCs – A Scale Based Approach’ on 21 Jan 2021. The paper proposed a more stringent regulatory framework to bring in uniformly between all regulated lenders in the microfinance space, including scheduled commercial banks, small finance banks, and NBFC-Investment and Credit Companies. In a bid to also prevent the recurrence of systemic risks to the country’s financial system, it has proposed a scale-based approach. Effectively, it has proposed a supervisory framework of NBFCs based on a four-layered structure. The objective is complete uniformity of various norms for all the different types of entities that are catering to the Microfinance segment. Once implemented, this will ensure the structured and orderly development of the sector and the reduction of risk in lending.
The base of this framework would comprise those institutions which need the least regulatory intervention, like NBFCs currently classified as non-systemically important NBFCs (NBFC-ND), NBFCP2P lending platforms, NBFCAA, NOFHC, and Type I NBFCs. The middle layer, which will be subject to a stricter regulatory regime than the base institutions, may comprise NBFCs currently classified as systemically important NBFCs (NBFC-ND-SI), deposit-taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, SPDs, and CICs. According to the RBI, adverse regulatory arbitrage vis-à-vis banks can be addressed for NBFCs falling in this layer in order to reduce systemic risk spill-overs, where required. The upper layer could consist of NBFCs identified as ‘systemically significant’ and comprise NBFCs that have the ability to impact financial stability through systemic spill-over of their risks. The topmost layer will be the most stringently regulated and the paper clarified that the revisions applicable to the lower layers of NBFCs will automatically be applicable to NBFCs in the higher layers unless there is a conflict or otherwise stated.
All in all, the RBI’s step to harmonise the regulatory framework for the microfinance industry will augur well for the sector as it will encourage common lending norms for all lenders. It will also deter any state government regulation of microfinance players. Most importantly, it will enhance client protection, enabling micro-enterprises to enjoy steady financial support from the formal financial sector.