Context: In this episode of The Big Picture based on Regulatory Framework For Microfinance. RBI has recently released its Consultative Document on Regulation of Microfinance sector aimed at protecting and empowering borrowers. As per the framework the household income will be as per Board approved policy. There will be no pre payment penalty and collateral for all microfinance loans and a simplified fact sheet on pricing of loans will be introduced. In this episode we will discuss and analyse all aspects of this issue.
Key Points
To regulate the functioning of microfinance institutions (MFIs), the Reserve Bank of India (RBI) has suggested a new regulatory framework for these bodies, under which it has recommended that 

• there should be no pre-payment penalty, 
• no requirement of collateral and 
• greater flexibility of repayment frequency for all microfinance loans.

The central bank also aims to give a common definition of microfinance loans for all regulated entities.

• These suggestions have been sent to all financial institutions by RBI in the form of a consultative document, on which their comments have been sought by July 31, 2021.
• The RBI has also proposed to cap the outflow on account of repayment of loan obligations of a household to a percentage of the household income.

In addition to this, it has directed all such institutions to display minimum, maximum and average interest rates charged on microfinance loans, on the websites of regulated entities.

• Also the RBI has proposed that a Board approved policy for household income assessment should be in place.
• Another suggestion is that there should be an alignment of pricing guidelines for non banking finance companies (NBFCs) and MFIs with the guidelines for NBFCs.

Comments

• In order to ensure transparency, the RBI has suggested that MFIs should introduce a standard simplified fact sheet on pricing of microfinance loans.

Role played by MFIs

The two key systems for the release of financial services to such customers include ‘relationship-based banking’ for individual entrepreneurs and small businesses along with ‘group-based models’ where several entrepreneurs come together to apply for loans and other services as a group

• Be a viable financial institution developing sustainable communities.
• Mobilize resources to provide financial and support services to the poor, particularly women, for viable productive income generation enterprises enabling them to reduce their poverty.
• Learn and evaluate what helps people to move out of poverty faster.
• Create opportunities for self-employment for the underprivileged.
• Train rural poor in simple skills and enable them to utilize the available resources and contribute to employment and income generation in rural areas.

Benefits from MFIs

• It allows people to provide for their families. Through microfinance, more households are able to expand their current opportunities so that more income accumulation may occur.
• It gives people access to credit. “By extending microfinance opportunities, people have access to small amounts of credit, which can then stop poverty at a rapid pace,”
• It serves those who are often overlooked in society. About 95 percent of some loan products extended by microfinance institutions are given to women, as well as those with disabilities, those who are unemployed, and even those who simply beg to meet their basic needs.
• It creates the possibility of future investments. Microfinance disrupts the cycle of poverty by making more money available.
• It can create jobs. Microfinance is also able to let entrepreneurs in impoverished communities and developing countries create new employment opportunities for others.
• It encourages people to save. “When people have their basic needs met, the natural inclination is for them to save the leftover earnings for a future emergency,”

However, off-late the main goals of MFIs are deviated:

• MFIs have strayed away from their original purpose of poverty alleviation and social empowerment to short-term profit-making.
• Many have begun to replicate the behaviour of mainstream financial institutions, setting financial targets which loan officers are under tremendous pressure to deliver.
• MFIs are harassing their clients who are usually too desperate to turn away from the credit being offered. This is true even when credit comes with the catch of high repayment rates.
• Several large MFIs that transformed into small finance banks (SFBs) are looking to diversify into inclusion adjacencies such as micro, small and medium enterprise loans and affordable housing loans.
• The demand potential in these segments also remains buoyant over the medium term given the untapped potential.

Suggestion

• There is a need for MFIs to consider adopting more flexible operating models, providing skills training and offering services such as portability of accounts to provide greater access for a longer duration of time.
• A diversified menu of micro loan products linked to sustainable income generation activities via micro enterprises or a creation of community-based pooled enterprise could possibly make it more attractive and compatible with the requirements of women.
• In addition, linking such developmental initiatives to an institution to nurture, monitor and handhold those activities in the formative stages is crucial for sustainability.

Road Ahead

• As per the World Bank estimates, more than 500 million people have improved their economic conditions via microfinance-related entities. Strengthening the credit check and debt collection processes and educating the villagers about products and consequences is important. A model to retain and recycle within the target population could possibly lead to a sustained route for poverty alleviation.