7 May, 2011:
RBI Guideline no RBI/2010-11/505 dated May 3 2011 possibly write a new chapter in the history of Indian microfinance. Most significantly, it is a kind of a reassurance that banks will continue to lend to microfinance institutions (MFIs), and subject to conditions, such lending will qualify as priority sector lending.
However, as in case of most RBI guidelines, these guidelines too leave lot of scope for ambiguity, uncertainty and debate.
The guidelines set rules about MFIs, loans to whom would qualify for priority sector treatment. Note that these guidelines are not by itself mandatory for the MFIs. MFIs may choose not to comply with the same, and banks may still lend to such MFIs – the implication is that lending by such banks will not qualify as priority sector lending. This may obviously have implications on the rates of interest that banks charge from the borrowing MFIs. One has to wait and see the legislation or regulation that will follow the Malegam Committee regulations.
Business composition rules:
The composition of the business of an MFI will have to be as follows:
At least 85% of total assets of the MFI are "qualifying assets". In computing "total assets", cash and bank balances, investments in government securities and money market instruments will not be counted. This stipulation leaves lots of unanswered questions:
a. Is the limit of 85% applicable to new business done post 1st April 2011, or applicable to all existing business too? The language of the RBI circular is quite clear – that the limits are to be tested with reference to the total assets of the MFI, and the total "qualifying assets". However, including existing portfolio of MFIs would be lead to most impractical results, as it will apply the lending criteria retroactively. For example, one cannot go back in the past and ensure that the margin cap of 12% is observed, and so on. Therefore, it is almost imperative that a clarification to this effect has to come-that the criteria will apply to portfolio created on or after 1st April 2011. But that, also, would be impractical to apply since the balances of "qualifying assets" are to be compared to total assets.
b. Assuming that the RBI does not come with any clarification, what are the options MFIs have? It would take quite some times for them bring down the volume of "non-qualifying assets" in regular course, more so, if they are unable to get new loans from banks. It may make sense for MFIs to create new vehicles-say a subsidiary company, back it up with the guarantee of the parent, and park new, qualifying business in the new vehicle.
c. A very important question is, at what stage does the bank seek compliance of the new guidelines? The circular says that the bank will seek, at the end of each quarter, a certificate from a chartered accountant regarding the compliance with the conditions. This would certainly mean that the compliance with the new requirement is post-facto, and not a prior compliance. That is to say, a bank may give a sanction on the condition that the conditions will be complied with and the certificate as expected therein will be given – if the conditions are not satisfied, the bank may retrospectively revise the interest rate, and/or withdraw the loan. As regards the quarterly certification, it is notable that there is no time limit within which the certificate would be given, but one would expect at least 60 days time to be allowed, as MFIs will need to be able to produce quarterly accounts to get the certificate from a chartered accountant.
d. Lots of questions of detail arise about meaning of "total assets". Though the RBI itself excludes cash and bank balances, government securities and money market instruments, would items like deferred tax assets, advance tax, TDS, etc be counted as assets? The idea of fixing the 85% "qualifying asset" criteria is that not more than 15% of the portfolio is of assets that do not qualify. An investment in fixed assets is not a part of the portfolio of the MFI. Office furniture, or computers, are not assets in the sense of being a part of the portfolio. So, properly speaking, the 85% limit should only be applied with reference to "assets", rather than adjustable accounting entries such as deferred tax assets, advance tax, TDS, etc. On extension, even investments in assets which are not part of business of the MFI-such as office assets, should also be excluded. Investments in subsidiaries or other NBFCs is deducted from the net owned funds of the MFIs for consideration of capital adequacy – on ground of parity, this investment should also be excluded while counting the 85% limit. In short, there may be lot of gray areas in computing "total assets" to apply the 85% rule.
- There is almost an overlapping, unclear rule that says: "aggregate amount of loan, extended for income generating activity, is not less than 75% of the total loans." First of all, one must note the bad English – as it should be "aggregate amount of loans". But then, it is difficult to understand the need for this addition, almost overlapping requirement. Perhaps the only meaning of this criteria can be – the loans that the MFI extends should be primarily for income-earning activities, and should not be intended for promoting consumption – for example, for buying a TV or funding a marriage, etc. It is a different story that it is impossible to monitor the utilization of the loan.
- This criteria, along with the limits on the amount of loans, have the effect of making housing microfinance loans as non-qualifying. Housing microfinance is an extremely important extension of the idea of microfinance, and there is no reason why the RBI should have frowned upon these loans.
There are 2 significant norms for the borrower – the borrower's household income, and the borrower's indebtedness. The entire microfinance industry is confused as to how the second criteria will be satisfied – how does a lender know what is the indebtedness of the borrower is, and what controls does the lender anyway have on whether the borrower takes a further loan after borrowing from one lender, or simply does not disclose the loans he already has. In fact, both the criteria about income and indebtedness are purely perfunctory guidelines, and are simply a lipservice to concern that microfinance is promoting a debt trap. There is no way the lender can test the annual income of the household, nor is there anyway, at least in the current scenario, whereby the lender may verify the indebtedness of the borrower. Hence, both will have to depend on self-declaration given by the borrower at the time of taking the loan. Obvious enough, there is no question of monitoring the indebtedness of the borrower having given the loan. Also, the income criteria is applicable at the time of giving the loan: if microfinance has any usefulness, the loan itself may step up the income of the borrower.
Loan terms criteria:
The criteria about the terms of the loan are several – (a) loan size; (b) loan tenure; (c) loan security, and (d) mode of repayment.
- The loan size shall not exceed Rs 35000 in first cycle and Rs 50000 in subsequent cycles. Though most MFIs consistently lend to one (mostly female) member in the family, an optimist may like to circumvent the loan size requirement by giving a loan to two members of the same family, though that is clearly not the intent.
- The loan tenure shall be at least 24 months. In addition, the borrower has the right to prepay, and prepay without penalty. Many MFIs would argue and say that they do not charge a penalty on prepayment – they rather give a rebate. That is, they charge less than the nominal value of future instalments, and therefore, there is no question of a prepayment penalty. However, the implication of not charging a prepayment penalty are that on prepayment, the MFI will exactly charge the-then outstanding principal, or, alternatively, charge the discounted value of future receivables, discounting the same at the effective interest rate. Most MFIs at their branch level may not even have the system to compute the outstanding principal. Most MFIs and MFI borrowers understand flat interest rates – for them, 15% interest is 15%, not 28%. Declining balances interest is difficult to explain to this segment, as the segment works on simple addition of interest and division of interest + principal by the number of instalments. This is not to favour the flat interest rate, which is surely illusory, but the question is one of understandability at borrower level.
- The third condition says, the loan shall not have any collateral. Once again, this rules out housing microfinance loans.
- The 4th condition rather unclearly talks of payment mode – weekly, fortnightly or monthly at the preference of the borrower, leaving it unclear whether the choice is open choice, or made once at the time of the agreement. However, it should be obvious that this is the choice made by the lender and the borrower at the time of the agreement – it is, therefore, not unilateral choice. Besides, a lender may also insist that a choice once made will not be changed.
Perhaps the most daunting move on the part of the RBI is the pricing guidelines. Once again, as things stand, the RBI circular does not amount to a rate regulation. A lender may not comply with the pricing guidelines at all, the only consequence of which that the lender will not qualify to receive bank loans at priority sector rates. Two, even if a lender wishes to so qualify for priority sector loans, upto 15% of the total assets may still be in non-qualifying loans.
While the margin cap and cap on rates of interest have been widely talked about, the important prescription is that MFIs will not charge any penal rate for delayed payment. The correct implication of this must be understood – it is not that for a delayed payment, there will be no implication for the borrower at all. The borrower may be charged interest for delayed payments – but only upto the interest rate fixed for the original loan. For instance, if the IRR of a loan is 26%, the borrower may be charged the same interest rate for delayed payments too. The idea of not charging a penal rate is that the borrower must not have to pay a higher rate for defaulted payments, than for payments made in time.
Yet another prescription is that there not be any security deposit or margin. The word "margin" here means cash margin only – it cannot mean borrower participation in the asset or capital expenditure that the borrower incurs. For example, if the borrower wants to buy a sewing machine of Rs 50000, nothing stops the MFI from insisting on the borrower putting up a cash contribution of Rs 10000, so that the loan size is limited to Rs 40000. The idea of "no margin/ no security deposit" is that the IRR of the MFI should not stand to increase due to margin or security deposit.
Currently, this is a fluid state of regulation for MFIs, as reportedly, more regulations are due to come. Until that happens, MFIs will have to quickly readjust to the new bank lending norms.
[By: Vinod Kothari]