NBFC-MFIs are increasingly becoming a significant force in India's financial landscape due to their targeted focus on providing collateral-free loans to underserved segments of the population, particularly low-income households. By offering microfinance loans for essential consumption needs without requiring collateral, NBFC-MFIs are bridging a critical gap in financial inclusion. The recent regulatory updates, including the layered approach for different asset sizes, have further enhanced the clarity and scope for NBFC-MFIs, ensuring that they can operate effectively while adhering to necessary prudential norms.
After reviewing monetary policy in November 2010, the Central Board of the Reserve Bank constituted a Committee to study issues and concerns of the microfinance sector. The committee submitted a report, in response to which a broad framework of regulations was recommended in the Monetary Policy Statement 2011-12. A separate category of Micro Finance Institutions ('MFI') within the Non-Banking Financial Company sector ('NBFC') was created.
Regulatory Framework for Microfinance loans
Microfinance loans are collateral-free loans given to households with annual incomes of up to 3 lakhs. Under the framework, the loan is not linked with a lien on the borrowers' deposit account to ensure collateral-free loans to individual family units. Loans for consumption, for example, for meeting ceremonial expenses, household expenses, etc., without collateral would be treated as microfinance loans.
The following are the Regulated Entities ('REs') for the framework of Microfinance loans –
- 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
- All Non-Banking Financial Companies (including Microfinance Institutions and Housing Finance Companies)
An NBFC-MFI is a non-deposit-taking NBFC, that satisfies the following-
- Minimum Net Owned Funds ('NOF') of Rs. 5 crore; for those registered in the North East, the minimum NOF shall be Rs. 2 crore.
- Minimum of 85% of its net assets are qualifying assets.
In the Master Directions –Regulatory Framework for Microfinance Loans 2022 ('Directions 2022'), net assets are total assets other than cash, bank balances, and money market instruments. Further, qualifying assets also have prescribed criteria. These specifications must be adhered to as they collectively make for the regulatory framework for NBFC MFI, defining entry point norms, prudential norms, and other regulations.
Recent Developments
The RBI recently updated its Master Direction for the Regulatory framework for microfinance loans in July 2022, which came into force in October 2023.
RBI has established a layered approach with an incremental increase in obligations for each layer, in terms of asset size, the scale of activities, and perceived risks. The Master Directions has divided different categories of NBFCs into sections as applicable; NBFC-Base Layer, NBFC-Middle Layer, NBFC-Upper Layer, etc.
The updated Master Directions bring necessary clarity regarding the regulatory requirements for different layers of NBFCs, specifically for NBFCs with an asset size of more than INR 500 crore, which fall in the Base Layer. The definition of NBFC-MFI was altered to include non-deposit-taking NBFCs with a minimum of 75% of their total assets deployed towards microfinance loans.
Pricing and Interest Rates of Loans
All REs ought to have a board-approved policy regarding loan pricing. This policy should include a comprehensive interest rate structure detailing the all-inclusive interest rate calculation regarding the cost of funds, risk premium, and margin, specifying each amount based on objective criteria. The policy should also set a ceiling on the interest rate and any other applicable charges for microfinance loans.
The RE and/or its partner/agent must include particulars of pricing and interest rates in a factsheet. A mechanism for identifying borrowers facing repayment-related difficulties shall be put in place by the REs to disseminate necessary guidance and available recourse. The customer must only pay the charges explicitly mentioned in the factsheet. Any training the lenders provide to help customers avail of a loan has to be free of cost.
The RBI has mandated that lenders display their minimum, maximum and average interest rates charged on microfinance loans in all offices, information booklets, pamphlets, and websites. Moreover, the RBI will scrutinize these rates. Any interest rate or other charge shall be informed well in advance and in writing, to the borrower. Any changes can only be effective prospectively.
Conclusion
The focus on interest rate transparency and borrower protection has bolstered trust in the sector, making it an attractive space for both investors and borrowers alike. With rising demand for accessible credit in rural and semi-urban areas, NBFC-MFIs are poised to play a key role in India's financial inclusion journey, contributing to economic empowerment at the grassroots level.
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