The Indian central bank's proposal to establish a common regulatory framework for the smallest loans in the country will help harmonize the sector and level the playing field among different types of lenders, analysts said.
The Reserve Bank of India, or RBI, on June 14 invited public feedback on proposed new rules for microfinance lending operations by commercial banks, nonbank financial companies, or NBFCs, and specialty lenders that provide credit to the smallest borrowers by household income. The current regulation for the sector applies only to NBFC microfinance institutions and leaves lenders of about 70% of the small loans portfolio to follow different sets of rules.
The central bank is proposing to remove interest rate caps on microfinance and link the loan amounts to the repayment ability of households.
"The proposed regulatory regime will create a level-playing field for all incumbents and risk-based pricing approach is likely to enable the players to absorb cyclical lumpy credit cost more effectively than earlier," ICICI Securities research analysts wrote in a note for clients.
Microfinance is an economic tool designed to promote financial inclusion and helps low-income households out of poverty, the RBI said. Such lending has seen "phenomenal growth" in India based on both the number of institutions providing such loans and the quantum of credit made available to customers, it said.
Banks currently make up 41% of the 2.279 trillion rupees worth of microfinance credit outstanding. NBFC microfinance institutions account for about 31% of such loans, while other NBFCs make up 8.7%, according to the central bank.
New rules
The RBI is proposing to remove the current cap of 125,000 rupees of loans and funding from a maximum of two lenders to be classified as microfinance. Instead, the loan amount will be linked to household income. It would limit the repayment and principal for all outstanding loans of the household to 50% of the household income, so that at least half of earnings are available to meet other expenses. The central bank plans to remove caps on pricing of loans that are currently applicable only on nonbank microfinance institutions, allowing all lenders to price their loans based on risk.
The current rules have left gaps that allow borrowers to obtain multiple loans from several lenders, ending in over-indebtedness. That can potentially result in coercive recovery practices and compromises the protection of small borrowers, the RBI said.
The new rules, if approved, will benefit NBFCs and microfinance lenders the most with a better pricing mechanism and relaxation on ticket sizes of the loans, ICICI Securities said, adding that the impact on banks is likely to be "neutral-to-positive."
The central bank's proposals aim to deregulate NBFCs and microfinance lenders, rather than tighten the rules for banks to bring parity between different institutions, Jefferies said. "This is a forward looking approach," it said.
The definition of microfinance — loans to borrowers with a household income of under 125,000 rupees for rural areas and 200,000 rupees for urban ones — will remain unchanged, the central bank said.
Comments and suggestions on the proposals can be submitted to the central bank by July 31.
As of June 14, US$1 was equivalent to 73.18 Indian rupees.