The Micro Financial Sector (Development and Regulation) Bill, 2007 (henceforth the Bill) is the first step in regulating a sector which has grown primarily out of social entrepreneurship. An attempt to regulate this sector needs to aim at better corporate governance without stifling the existing dynamism.
An analysis of the Bill reveals both positive and negative features. On the positive side, the Bill attempts to introduce a certain amount of accountability to the sector by requiring mandatory registration of microfinance organisations (MFOs). It introduces the prospect of MFO inspection which could improve consumer protection in microfinance.
A second positive aspect is that it does not introduce interest rate caps, which could have been damaging for the sector. As interest rates are a function of risk, cost of funds and transaction costs, a cap can lead to the exclusion of customers whose risk profiles call for interest rates in excess of the cap. In the context of microfinance, a uniform interest rate would create incentives for MFOs to move away from difficult and new geographies where transaction costs are higher. Interest rate caps could also be detrimental in attracting capital to the sector.
A third positive is that the Bill permits MFOs complying with certain conditions to accept savings from customers. This addresses an important drawback of the microfinance sector in India, namely the lack of savings products due to regulatory hurdles.
There are also some provisions in the Bill which cause concern. The primary concern is on the choice of the National Bank for Agricultural and Rural Development (NABARD) as the regulator for the sector. Of the two main delivery channels for micro-credit in the sector, namely, the SHG (self-help group)-bank linkage channel and the MFI (microfinance institution) channel, NABARD has been actively associated with the former and has recently announced its entry into the latter. The regulatory role will strengthen its position relative to other participants in the sector. This situation may not be beneficial for other market participants and also for consumers, who stand to gain if there is healthy competition among service providers.
A second concern is regarding the prudential norms prescribed for deposit-taking MFOs. There is a single safeguard for savings which is that MFOs need to create a reserve fund by depositing 15 per cent of their net profit before dividend every year. An MFO not making profit need not form the reserve fund, leaving no safety net for the depositors.
A third negative is the lack of clarity on the scope of the Bill. The Bill defines an MFO as “including” societies, trusts and co-operatives, leading to varying interpretations on whether institutional structures such as non-banking financial companies (NBFCs) come under its ambit.
Considering the potential of the sector, a review of the Bill to rectify the above drawbacks is essential. A sound regulatory structure that encourages professionalism and growth in the sector could pay the country rich dividends by way of inclusive growth.