micro Finance Service Providers

The micro finance initiative in private sector can be traced to the initiative undertaken by Ms.Ela Bhat for providing banking services to the poor women employed in the unorganised sector in Ahmedabad City of Gujarat State. Shri Mahila SEWA (Self Employed Women’s Association) Sahakari Bank was set up in 1974 by registering it as a Urban Cooperative Bank. Since then, the bank is providing banking services to the poor self-employed women working as hawkers, vendors, domestic servant etc. As on March 2003, the mFI had a membership of 30,000, seventy per cent of whom are from urban area. The deposit and loan portfolio stood at Rs 623.9 million ($ 13.86 million) and Rs133.6 million ($2.97 million) respectively. Though the mFI is making profit, yet the SEWA bank model of mFI has not been replicated elsewhere in the country.

In the midst of the apparent inadequacies of the formal financial system to cater to the financial needs of the rural poor, NABARD sponsored an action research project in 1987 through an NGO called MYRADA. For this purpose a grant of Rs. 1 million ($22,222) was provided to MYRADA for an R&D programme related to credit groups. Encouraged by the results of field level experiments in group based approach for lending to the poor, NABARD launched a Pilot Project in 1991-92 in partnership with Non-governmental Organisations (NGOs) for promoting and grooming self help groups (SHGs) of homogeneous members and making savings from existing banks and within the existing legal framework. Steady progress of the pilot project led to the mainstreaming of the SHG-Bank Linkage Programme in 1996 as a normal banking activity of the banks with widespread acceptance. The RBI set the right policy environment by allowing savings bank accounts of informal groups to be opened by the formal banking system. Launched at a time when regulated interest rates were in vogue, the banks were expected to lend to SHGs at the prescribed rates, but the RBI advised the banks not to interfere with the management of affairs of SHGs, particularly on the terms and conditions on which the SHGs disbursed loans to their members.

The uniqueness of the micro finance through SHG is that it is a partnership based approach and encouraged NGOs to undertake not only social engineering but also financial intermediation especially in areas where banking network was not satisfactory. The rapid progress achieved in SHG formation, which has now turned into an empowerment movement among women across the country, laid the foundation for emergence of mFIs in India.

NGO mFIs: There are a large number of NGOs that have undertaken the task of financial intermediation. Majority of these NGOs are registered as Trust or Society. Many NGOs have also helped SHGs to organise themselves into federations and these federations are registered as Trusts or Societies. Many of these federations are performing non-financial and financial functions like social and capacity building activities, facilitate training of SHGs, undertake internal audit, promote new groups, and some of these federations are engaged in financial intermediation. The NGO mFIs vary significantly in their size, philosophy and approach. Therefore these NGOs are structurally not the right type of institutions for undertaking financial intermediation activities, as the byelaws of these institutions are generally restrictive in allowing any commercial operations. These organisations by their charter are non-profit organisations and as a result face several problems in borrowing funds from higher financial institutions. The NGO mFIs, which are large in number, are still outside the purview of any financial regulation. These are the institutions for which policy and regulatory framework would need to be established.

Non-Profit Companies as mFIs: Many NGOs felt that combining financial intermediation with their core competency activity of social intermediation is not the right path. It was felt that a financial institution including a company set up for this purpose better does banking function. Further, if mFIs are to demonstrate that banking with the poor is indeed profitable and sustainable, it has to function as a distinct institution so that cross subsidisation can be avoided. On account of these factors, NGO mFIs are of late setting up a separate Non-Profit Companies for their micro finance operations. The mFI is prohibited from paying any dividend to its members. In terms of Reserve Bank of India’s Notification dated 13 January 2000, relevant provisions of RBI Act, 1934 as applicable to NBFCs will not apply for NBFCs (i) licensed under Section 25 of Companies Act, 1956, (ii) providing credit not exceeding Rs. 50,000 ($1112) for a business enterprise and Rs. 1,25,000 ($2778) for meeting the cost of a dwelling unit to any poor person, and, (iii) not accepting public deposits.

Mutual Benefit mFIs: The State Cooperative Acts did not provide for an enabling framework for emergence of business enterprises owned, managed and controlled by the members for their own development. Several State Governments therefore enacted the Mutually Aided Co-operative Societies  (MACS) Act for enabling promotion of self-reliant and vibrant co-operative Societies based on thrift and self-help. MACS enjoy the advantages of operational freedom and virtually no interference from government because of the provision in the Act that societies under the Act cannot accept share capital or loan from the State Government. Many of the SHG federations, promoted by NGOs and development agencies of the State Government, have been registered as MACS. Reserve Bank of India, even though they may be providing financial service to its members, does not regulate MACS.

For Profit mFIs: Non Banking Financial Companies (NBFC) are companies registered under Companies Act, 1956 and regulated by Reserve Bank of India. Earlier, NBFCs were not regulated by RBI but in 1997 it was made obligatory for NBFCs to apply to RBI for a certificate of registration and for this certificate NBFCs were to have minimum Net Owned funds of Rs 25 lakhs and this amount has been gradually increased. RBI introduced a new regulatory framework for those NBFCs who want to accept public deposits. All the NBFCs accepting public deposits are subjected to capital adequacy requirements and prudential norms. There are only a few mFIs in the country that are registered as NBFCs. Many mFIs view NBFCs more preferred legal form and are aspiring to be NBFCs but they are finding it difficult to meet the requirements stipulated by RBI. The number of NBFCs having exclusive focus on mF is negligible.

NGO-mFIs, non-profit companies mFIs, and mutual benefit mFIs are regulated by the specific act in which they are registered and not by the Reserve Bank of India. These are therefore not subjected to minimum capital requirements, prudential norms etc. NGO mFIs to become NBFCs are required to have a minimum entry capital requirement of Rs. 20 million ($ 0.5 million). As regards prudential norms, NBFCs are required to achieve capital adequacy of 12% and to maintain liquid assets of 15% on public deposits.

Not for profit mFIs are barred, by the Reserve Bank of India, from mobilising any type of savings. Mutual benefit mFIs can accept savings from their members. Only rated NBFC mFIs rated by approved credit rating agencies are permitted to accept deposits. The quantum of deposits that could be raised is linked to their net owned funds.

Initially, bulk of the funds required by mFIs for onlending to their clients were met by apex institutions like National Bank for Agriculture and Rural Development, Small Industries Development Bank Of India, and, Rashtiya Mahila Kosh. In order to widen the range of lending institutions to mFIs, the Reserve Bank of India has roped in Commercial Banks and Regional Rural Banks to extend credit facilities to mFIs since February 2000. Both public and private banks in the commercial sector have extended sizeable loans to mFIs at interest rate ranging from 8 to 11 per cent per annum. Banks have been given operational freedom to prescribe their own lending norms keeping in view the ground realities. The intention is to augment flow of micro credit through the conduit of mFIs. In regard to external commercial borrowings (ECB) by mFIs, not-for-profit mFIs are not permitted to raise ECB. The current policy effective from 31 January 2004, allows only corporates registered under the Companies Act to access ECB for permitted end use in order to enable them to become globally competitive players.

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Interest Rates

The interest rates are deregulated not only for private mFIs but also for formal baking sector. In the context of softening of interest rates in the formal banking sector, the comparatively higher interest rate (12 to 24 per cent per annum) charged by the mFIs has become a contentious issue. The high interest rate collected by the mFIs from their poor clients is perceived as exploitative. It is argued that raising interest rates too high could undermine the social and economic impact on poor clients. Since most mFIs have lower business volumes, their transaction costs are far higher than that of the formal banking channels. The high cost structure of mFIs would affect their sustainability in the long run.

Collateral requirements

 All the legal forms of mFIs have the freedom to waive physical collateral requirements from their clients. The credit policy guidelines of the RBI allow even the formal banks not to insist on any type of collateral and margin requirement for loans upto Rs 50,000 ($1100). 

Regulation & Supervision

India has a large number of mFIs varying significantly in size, outreach and credit delivery methodologies. Presently, there is no regulatory mechanism in place for mFIs except for those that are registered as NBFCs. As a result, mFIs are not required to follow standard rule and it has allowed many mFIs to be innovative in its approach particularly in designing new products and processes. But the flip side is that the management and governance of mFIs generally remains weak, as there is no compulsion to adopt widely accepted systems, procedures and standards. Because the sector is unregulated, not much is known about their internal health. Following Committees have examined the road map for regulation and supervision of mFIs

To address the issue of need for a differential regulatory framework, the latest committee sought answers to the following questions and concerns facing private mFIs in the Country:

(i)  Is non-existence of a separate differential regulatory framework a critical bottleneck hindering the growth of the sector?

(ii) Will MFIs be sustainable in medium term? If so, will they continue to focus on the poor?

(iii) Is access to public / member deposit the key issue for their sustainability?

(iv) Can MFIs finance loans for income generation at interest rates, which are sustainable by the rural poor?

(v) Is it possible to evolve commonly agreed standards for MFI sector covering performance, accounting and governance issues,
     which can open up possibilities of self-regulation?

(vi) Has the sector reached a critical mass where regulation becomes important?

The Committee observed that while a few of the MFIs have reached significant scales of outreach, the MFI sector as a whole is still in evolving phase as is reflected in wide debates ranging around (i) desirability of NGOs taking up financial intermediation, (ii) unproven financial and organizational sustainability of the model, (iii) high transaction costs leading to higher rates of interest being charged to the poor clients, (iv) absence of commonly agreed performance, accounting and governance standards, (v) heavy expectations of low cost funds, including equity and the start up costs, etc.

The current debate on development of a regulatory system for the MFIs focuses on three stages. Stage one - to make the MFIs appreciate the need for certain common performance standards, stage two - making it mandatory for the MFIs to get registered with identified or designated institutions and stage three - to encourage development of network of MFIs which could function as quasi Self-Regulatory Organisations (SROs) at a later date or identifying a suitable organisation to handle the regulatory arrangements. The Committee recommended that while the MFIs may continue to work as wholesalers of microCredit by entering into tie-ups with banks and apex development institutions, more experimentation have to be done to satisfy about the sustainability of the MFI model. Such experimentation needs to be encouraged in areas where banks are still not meeting adequate credit demand of the rural poor. 

In regard to offering thrift products, the Committee felt that, while the NGO-MFIs can continue to extend micro credit services to their clients, they could play an important role in facilitating access of their clients to savings services from the regulated banks. As regards allowing NGO-MFIs to access deposits from public / clients, the Committee considers that in view of the need to protect the interests of depositors, they may not be permitted to accept public deposits unless they comply with the extant regulatory framework of the Reserve Bank of India. As no depositors' interest is involved where they do not accept public deposits, the Reserve Bank of India need not regulate MFIs.

As regards the high interest rates being charged by the MFIs, the Committee felt that the lenders to MFIs may ensure that these institutions adopt a ‘cost-plus- reasonable-margin’ approach in determining the rates of interest on loans to clients.

Conclusions

Private mFIs in India, barring a few exceptions, are still fledgling efforts and are therefore unregulated. Their outreach is uneven in terms of geographical spread. They serve micro finance clients with varying quality and using different operating models. Regulatory framework should be considered only after the sustainability of mFI model as a banking enterprise for the poor is clearly established. Experimentation of mFI model needs to be encouraged especially in areas where formal banks are still not meeting adequate credit demand of the rural poor.

Realizing the importance of mFIs in the delivery of financial services to the poor and their potential for expansion of services in remote and lesser-banked areas, NABARD has been extending technical and fund support to this sector.  Some of the concerns that necessitated NABARD to commence this support in 1993 were: 1) the need to provide timely credit to the poor in under banked regions and ii) to further improve the outreach of rural credit delivery system through alternate credit delivery mechanisms.

NABARD's support is being provided to various forms of microFinance institutions covering mFIs, second tier mF lending institutions, Grameen bank replicators, NGO-mFIs, SHG Federations etc. NABARD provides loan funds in the form of Revolving Fund Assistance (RFA) to NGO-mFIs on a very selective basis. The RFA is generally provided for a period of 5 to 6 years and is necessarily to be used for on lending to mF clients (SHGs or individuals). In addition, the agencies are also sanctioned, on a case-to-case basis, grant assistance for partly meeting the salary of field level staff, infrastructure development and operational deficits during the initial years. 

Cumulatively, as at the end of June 2004, Rs 26.98 crore (Rs 269.80 million) has been sanctioned as RFA to 31 NGO-mFIs and Rs. 0.58 crore (Rs 5.8 million) has been sanctioned as grant to various NGOs.  The amount excludes Rs 3.4 million sanctioned under SHG Post Office linkage programme in Tamilnadu. .
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During the year 2003-04, loan support of Rs. 84 million was sanctioned to two agencies viz. 1) Friends of World Women Banking, India  (Rs. 74 million) for on-lending to small NGOs & 2) Kalanjiam Development Financial Services-a section 25 company promoted by DHAN Foundation  (Rs 10 million) for on lending to SHGs.     

NABARD also provides technical support in the form of capacity building of staff of mFIs and also bankers in appraisal of mFIs for providing wholesale resource support. Since 2002, training programmes on  "Appraisal of mFIs" are being conducted through Bankers Institute of Rural Development (BIRD), Lucknow. These training programmes are intended to equip the stakeholders to appreciate the nuances in financing NGO-mFIs and also enhance the flow of loanable funds from mainstream financial Institutions like banks. Specially designed capacity building programmes are also being organised for Chief Executives & other staff of NGOs on promotion as well as managing of self help groups on a regular basis through our regional offices, in association with reputed resource NGOs & training establishments.