Recently, the Reserve Bank of India (RBI) has exercised its authority over Microfinance Institutions (MFIs), enhancing their freedom to fix their own interest rates for borrowers. However, the apex banking authority has wisely put a restriction in place, barring these institutions from charging exorbitant rates. The regulation will come into force starting April 1, 2022.
In 2021, the RBI had proposed the lifting of the interest rate cap on MFIs, resulting in the most recent development. This article seeks to delve into the highlights of these guidelines, what they mean for both lenders and borrowers, and the numerous entities that fall under their umbrella.
Redefining Microfinance Loan
A milestone change in the guidelines is the revised interpretation of a microfinance loan. Definitionally, it now refers to a collateral-free loan offered to a household that earns an annual revenue of up to Rs. 3 lakh. Previously, this income cap was set at Rs.1.2 lakh for rural and Rs.2 lakh for urban borrowers.
Setting New Standards for Regulated Entities
The new guidelines have significant implications for Regulated Entities (REs), calling for the need to put in place board-approved policies relating to pricing, interest rate caps and other charges associated with microfinance loans. REs are also obliged to regularly update borrowers about changes in pricing.
Terms of Penalty and Recovery
Under the new agreement, there will be no prepayment penalty on microfinance loans. For delayed payments, penalties will only be applied to the overdue amount. Any looming changes in interest or charges must be communicated to the borrower well ahead of time. On issues of recovery, REs must establish identification mechanisms for borrowers facing difficulties in repayment.
Who Does The Guidelines Apply To?
The guidelines will be applicable to all Commercial Banks, including Small Finance Banks, Local Area Banks, and Regional Rural Banks, excluding Payments Banks. All Primary (Urban) Co-operative Banks/ State Co-operative Banks/ District Central Co-operative Banks, and Non-Banking Financial Companies (including Microfinance Institutions and Housing Finance Companies) are also bound by these guidelines.
Benefits of the Revised Guidelines
There are numerous benefits attached to these new regulations. They offer a chance to scale up the industry, ensures better risk mitigation, and promotes financial inclusion. It paves way for healthy competition among various types of lenders and empowers customers to make more informed choices regarding their credit needs.
Understanding Microfinance Institutions
Microfinance Institutions (MFI) are entities that provide financial services to low-income groups. Their offerings range from small loans, savings schemes, to insurance policies. The mission behind MFIs is to enhance access to banking facilities for those who have been eluded by such services till date.
Over time, microfinance has grown exponentially and currently serves around 102 million accounts in India alone. A diverse pool of financial service providers for low-income groups, such as NGOs, cooperatives, community-based development institutions, commercial and state banks, insurance and credit card companies, have emerged, presenting new opportunities.
In India, NBFC-MFIs are regulated by the Non-Banking Financial Company -Micro Finance Institutions (Reserve Bank) Directions, 2011 of the Reserve Bank of India (RBI).