“Should we get an MFI license?”

We often get clients asking us the question, do we need an MFI licence or is it enough to get an NBFC Loan Company licence? After all, the client reasons, being an MFI is simply to be under a tigher regulatory and compliance regime. This article seeks to outline the key pros and cons of both.

A Microfinance Institution is a special type of NBFC which is allowed to operate in the microfinance sector in India. The microfinance sector is formally defined by the RBI to be constituted of ‘qualifying assets’ which are defined as follows:

An asset is said to be a “qualifying asset” if it satisfies all seven of the below criteria:

  • loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding Rs. 1,00,000 or urban and semi-urban household income not exceeding Rs. 1,60,000 ;
  • loan amount does not exceed Rs. 60,000 in the first cycle and Rs. 1,00,000 in subsequent cycles;
  • total indebtedness of the borrower does not exceed Rs.1,00,000 Provided that loan, if any availed towards meeting education and medical expenses shall be excluded while arriving at the total indebtedness of a borrower;]
  • 3tenure of the loan not to be less than 24 months for loan amount in excess of Rs. 30,000 with prepayment without penalty;
  • loan to be extended without collateral;
  • 4aggregate amount of loans, given for income generation, is not less than 50 per cent of the total loans given by the MFIs
  • loan is repayable on weekly, fortnightly or monthly instalments at the choice of the borrower

An MFI is required to have 85% of its total assets as qualifying assets. A non-MFI NBFC may not have more than 10% of its total assets as qualifying assets.

According to data available from MFIN, the microfinance sector is dominated by NBFC-MFIs which account for 42% of all microfinance lending, followed by banks accounting for 38% and small finance banks(SFBs) accounting for 14%[1].  It is worth noting that the majority of SFBs also originated as MFIs- 8 out of the 10 the current SFBs in operation originated in this manner[2].

Application to setup an MFI must be made to the RBI- there are some differences in the constitutional and operational requirements of MFIs from other types of NBFCs.

NBFCs MFIs
NOF: minimum of 2 crores NOF: minimum of 5 crores (For NBFC-MFIs registered in the North Eastern Region of the country, the minimum NOF requirement shall stand at ` 2 crore)
Not more than 10% of total assets can be in microfinance sector i.e. classified as qualifying assets Atleast 85% assets must be qualifying assets
Other than IFCs, all other NBFCs must maintain a leverage of less than 7. Margin cap: 10% for MFIs with  portfolio exceeding 100 crores and 12% for other MFIs

 

Pricing of Credit: The cost of credit must be the lower of the two:

–          cost of funds +margin cap

–          average of lending rates of top 5 commercial banks times 2.75

 

LENDING PRACTICES:
-No use of coercive measures for recovery.

– Maximum indebtedness of borrower is 1 lakh at any point of time, and Rs.60,000 in first disbursement cycle.

-No more than 2 MFIs can lend to same borrower.

– There can no penalty charged for delayed payment.

– minimum period of moratorium between the grant of the loan and the due date of the repayment of the first instalment

-Several other qualitative and quantitative restrictions

-no security deposit can be charged from borrower

– Processing charges shall not be more than 1% of gross loan amount

– The average interest rate on loans sanctioned during a quarter does not exceed the average borrowing cost during the preceding quarter plus the margin, within the prescribed cap

– The maximum variance permitted for individual loans between the minimum and maximum interest rate cannot exceed 4 per cent

 

The asset classification norms:

 

Standard- no default in repayment of principal or payment of interest

Sub-standard- classified NPA for less than 18 months

Doubtful- remains a sub-standard asset for a period exceeding 18 months

Loss- adversely affected by a potential threat of non-recoverability

NPA- an asset, in respect of which, interest has remained overdue for a period of six months or more

 

 

Standard asset means the asset in respect of which, no default in repayment of principal or payment of interest is perceived and which does not disclose any problem nor carry more than normal risk attached to the business;

 

NPA means an asset for which, interest/principal payment has remained overdue for a period of 90 days or more

Provisioning requirements

– make provision against sub-standard assets, doubtful assets and loss assets as provided

Provisioning Norms:

 

The aggregate loan provision to be maintained by NBFC-MFIs at any point of time shall not be less than the higher of a) 1% of the outstanding loan portfolio or b) 50% of the aggregate loan instalments which are overdue for more than 90 days and less than 180 days and 100% of the aggregate loan instalments which are overdue for 180 days or more.

Capital Adequacy:

The minimum CRAR requirement for NBFCs is 15%.

 

NBFC-MFIs shall maintain a capital adequacy ratio consisting of Tier I and Tier II Capital which shall not be less than 15 percent of its aggregate risk weighted assets on-balance sheet and of risk adjusted value of off-balance sheet items. The total of Tier II Capital at any point of time, shall not exceed 100 percent of Tier I Capital.
No such requirement NBFC-MFIs shall become member of at least one Self-Regulatory Organization (SRO) which is recognized by the Bank and shall also comply with the Code of Conduct prescribed by the SRO

 

The answer lies in the access to the sheer volume of the microfinance space. Non-MFI NBFCs cannot tap very deeply into this space- not beyond 10% of their total assets. MFIs must content with a lower limit of 85% and there is no upper limit.
The table makes it clear that MFIs have several restrictions on their operation, require more money to form, have interest rate margins regulated and so on. Why then would one apply to become an MFI, and not become a simple NBFC Loan Company?

It is also noteworthy that MFIs have greater access to bank finance- though not necessarily any cheaper. Domestic Scheduled Commercial Banks and foreign banks with more than 20 branches have to meet the Priority Sector Lending Targets. The RBI has notified 8 such priority sector categories- ranging from agriculture to MSMEs to renewable energy.  There are sector-wise targets as well as overall targets for the total lending to all priority sectors put together.Bank loans provided to MFIs for on-lending will qualify and count towards banks meeting their priority sector lending targets under their respective categories- agriculture, MSMEs and ‘others’. There is no such provision for NBFCs. Hence MFIs are likelier to have easier and cheaper access to credit.

The Government has also set up the MUDRA Bank which provides refinance support to MFIs and Banks. Again, there is greater access to credit.

What thus becomes clear is that for a non-banking company to tap into the microfinance space is to enter a very restrictive space with several regulatory checks and balances. However this is the only route to take if one wants to penetrate deeply into this promising and voluminous sector.


REFERENCES and ACKNOWLEDGEMENTS:

By:

Vishes Kothari (vishes@vinodkothari.com)

Anita Baid (anita@vinodkothari.com)

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