The microfinance bill, which is under consideration of the parliamentary standing committee on finance, needs to be amended in several important respects. One of these relates to savings.
By allowing microfinance NGOs registered as societies, trusts and cooperatives to accept the savings of their members, the microfinance bill takes an important step forward. Unfortunately, the bill limits permissible savings to what it calls "thrift", or small, compulsory savings of uniform size made by members organised in groups.
While many savers welcome the discipline of compulsory savings, they tend to belong to the better-off among the poor, or to the "near-poor" above the poverty line. Many of the poorer members of self-help groups (and most of the self-excluded non-members), who have highly uncertain and variable incomes, prefer on the other hand to save small variable amounts, with variable frequency. Several surveys have found that the main reason for why only half of the roughly 40 million SHG members are below the poverty line is the inability of BPL persons to commit themselves to the required mandatory savings amounts and frequencies. Uniform mandatory savings are also the most frequent reason cited by drop-outs for leaving SHGs.
A concomitant of mandatory savings products is their illiquidity. While illiquid savings protect the savings of the poor from daily demands, and are suited to accumulating lump-sums for expected purposes such as life-cycle events, or school fees, or adding a new room to the hut, they are unsuited to coping with unexpected emergencies to which the poorest of the poor are most prone, such as sickness and disease, or the need to smoothen consumption in the lean season, or to repair a leaky straw roof in the middle of the monsoons.
Indeed, recognising the liquidity preference of the poor for many (although not all savings) purposes, MFIs in Bangladesh and all over the world that have the requisite accounting systems are moving to a system of voluntary savings in which the saver has some choice over the timing and amount of savings and withdrawals.
Thus the bill should make provision for the day when a larger number of NGO-MFIs have developed the capacity to offer voluntary savings. Further, the regulator should have the option under the bill to approve individual voluntary savings products in appropriate cases after due diligence on a case-by-case basis.
One of the major omissions in the bill is that it excludes MFIs registered as NBFCs and Section 25 companies, which account for nearly all the large MFIs, and the larger part of total microcredit in the country. Their number is steadily increasing, as more and more NGO-MFIs transform themselves into companies to attract equity investments on the basis of which they can borrow from the banks.
By virtue of being excluded from the bill, NBFC-MFIs will not be able to accept the savings of their own borrower-members, who will have to continue to rely on less convenient, riskier lower yielding, and often socially less productive savings instruments (such as ornaments). As is the case with NGO-MFIs, the vast majority of MFI members are net borrowers of the MFI at any one time. They borrow to finance their larger investment requirements, but simultaneously save small amounts to finance their liquidity requirements, provide for emergencies, and aggregate them into lump sums large enough to make useful investments. Since they are net borrowers, prudential concerns are much less pressing.
In excluding NBFCs and Section 25 companies, the bill also deprives more than half the borrowers from the protection of the ombudsman envisaged under the bill, and the sector as a whole from the benefits of universal performance standards in respect of microfinance activities, and a much-needed data base.
The bill implicitly confers a modicum of legitimacy on NGO-MFIs, but is careful not to step on the toes of the states by avoiding to assert that the principle of cost-recovering interest rates should take precedence over caps on interest rates under state Moneylender Acts.
The bill violates the spirit and intent of the new liberal, alternative cooperative Acts enacted in ten states which reduce the role of government in cooperation. It is true that the registrars under the new acts are not performing supervisory, data gathering and consumer protection functions any better than the old ones, but will the new regulator be able to do a better job for thousands of thrift cooperatives all over the country? In any case, cooperative is a state subject, and the states will have to sign on.
Even if they do, the bill is likely to be challenged on the grounds that cooperatives as mutual institutions are already allowed to mobilise their members' deposits, and the bill cannot take away this right.
The bill does not provide the sector with a form of registration uniquely suited to microfinance. It leaves NGO-MFIs with no alternative between remaining NGOs and having to raise enough capital to become NBFCs. Societies and trusts were not designed as vehicles for financial operations, and although NGO-MFIs are not for profit, they have a hard time convincing the local income tax authorities that their surpluses are intended for expansion and leverage of borrowed funds. Special-window MFIs with lower entry capital but higher capital adequacy requirements, as a unique legal form under the Act, would have constituted a valuable intermediate stage of incorporation between remaining an NGO and becoming a full-fledged NBFC.
Finally, the Microfinance Development Council, that is proposed to be set up, will be a government dominated body with a purely advisory role. Given the fact that the microfinance sector — like the IT sector — has grown so rapidly and in many ways creatively because it was outside the government, one would have thought that sector representation on the council would be higher, and that it would be given much greater autonomy. For all these reasons the bill, as it presently stands, is missing an important opportunity to provide Indian microfinance with an appropriate legal framework.