Non-banking Financial Companies (NBFC) and Microfinance Institutions (MFI) are often the only source of banking services in rural India. In October 2010, the sector took a hard hit after the Andhra Pradesh (AP) government passed an ordinance to check MFIs owing to multiple farmer suicides over coercive collection tactics. As AP was, and still remains, a big market for MFIs, those with high exposure in the state suffered losses amounting to ₹7,800 crore.
Since then, MFIs like SKS Microfinance have rebuilt their net worth and resumed operations in AP with the court’s consent; on the condition that they adhere to rules pertaining to loan interest rates and collection practices.
Post the AP incident, the RBI became the sole regulator of the microfinance function in India. A central bill was also tabled for Parliament approval to override state Acts on MFI regulation. The goal is to protect borrowers’ interests and clarify rules mandating the operations of MFIs and NBFCs across the country. According to RBI norms, all NBFC-MFIs must:
- register as an NBFC-MFI with RBI
- become the member of at least one Self-Regulatory Organization (SRO) recognized by the RBI
- make 100% provisions for their entire exposure to AP
- maintain 15% capital adequacy ratio (ratio of capital to risk-weighted assets)
- maintain a cap on margins though the 26% cap on interest rates has been removed
- not exceed 4% difference in minimum and maximum rates for individual loans
- maintain 85% or more of net assets as qualifying assets
- allocate 70% of loans to income generating activities and 30% to purposes such as housing repairs, education, medical and other emergencies
New NBFC MFI formations must have minimum net owned funds of ₹3 crore by March 2013 and ₹5 crore by March 2014.
While NBFC-MFIs appreciate the clear guidelines, they have reservations on the cap on margins. MFIs that have suffered heavy losses in AP could get wiped out if they cannot maintain the capital adequacy ratio expected. They are already struggling with high operational costs and hefty provisions.
In February, the RBI invited NBFCs to apply for bank licenses by July 1, 2013. Applying entities must have a minimum track record of 10 years as well as clearance from sector regulators, enforcement, and investigative agencies such as IT Department, CBI and ED. Companies must have ₹500 crore as minimum paid-up capital to set up a bank with not more than 49% foreign investment. They must also open least 25 per cent of branches in unbanked rural areas.
While the increased competition is expected to benefit borrowers in terms of interest rates and loan terms, the entry of corporate in NBFC could be disruptive. Established companies like Aditya Birla Money Ltd. will gain from launching a bank but the business volume and profitability of existing MFIs and independent NBFCs will be affected, at least till the time they can match their deposit franchise with existing borrowings. Furthermore, corporate business models could conflict with the social objective of MFI leading to its dilution.