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Regulating microfinance

In 2005, then Reserve Bank of India governor Y.V. Reddy summed up the central bank’s approach to microfinance when he said regulating the industry would militate against its core spirit—informality and flexibility—that had served it so well. Five years later, as a microfinance Bill remains stalled, that regulatory gap still exists.

It is perhaps because of this lack of oversight that the Andhra Pradesh and Kerala governments have sought to bring some microfinance institutions (MFIs) in these states under local moneylending norms. As The Economic Times reported last week, the intent has been to control the rates of interest charged on microloans to the poor. Moneylending rules in Kerala, for example, specify interest rate ceilings that MFIs under its ambit would be obliged to follow.

The interest rate debate is important, and the high rates charged by some microlenders have had influential critics. Most recently, RBI deputy governor K.C. Chakrabarty cast doubts on the ability of microfinance to bring about the financial inclusion that it aims at, citing the industry’s high cost of lending. With such existential concerns, the debate over regulating MFIs gains greater importance.

To be sure, regulation is crucial in an industry that has come a long way both in terms of size and complexity since its humble beginnings in the 1970s. The upcoming public share sale of SKS Microfinance, India’s largest microlender, is a sign of the increasing commercialization of what continues to be seen in some circles as an exclusively social movement. Managing this new profit motive and its accompanying moral dilemma, and balancing it against the established ideas of inclusivity are the functions of regulation. Besides, effective oversight has positive externalities on risk perception, helping MFIs attract commercial investment and making them less dependent on donor funds.

At the same time, a regulatory stranglehold runs the risk of hobbling the industry. The commercial viability of microlenders is relevant not just to the investors who put their money in the sector, but also to the growth and outreach of MFIs that will finally determine their effectiveness in bringing inclusion to the excluded. Even in their search for inclusive practices, regulators will have to ensure that competition and market forces don’t get crowded out.

Source :
Livemint.com
 
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