RBI’s Regulatory Framework for Microfinance Loans

The Reserve Bank of India has directed regulated entities (REs) lending to the microfinance sector to ensure that loans are unsecured and not secured by a lien on the borrower’s deposit account, that repayments are capped, that interest rates are not usurious, and that there is no penalty for payment in advance. The central bank’s harmonized regulatory framework for regulated lenders, which includes scheduled commercial banks, small finance banks, NBFCs-MFIs, and NBFCs-investment and credit companies, includes these clauses. Let us know about the regulatory framework for Microfinance Loans.

What is Microfinance Loan?

A microfinance loan is defined as an unsecured or collateral-free loan given to a household with an annual household income of up to Rs. 3, 00,000 while earlier this limit was fixed at Rs. 2 lacs and Rs. 1.6 Lacs for urban households and rural households respectively. For this purpose, household means a separate family unit, i.e. husband, wife, and their unmarried children.

The microfinance lending framework announced by the RBI will further help deepen microcredit penetration in the country. The Reserve Bank of India (RBI) has allowed microfinance lenders to fix interest rates on collateralized loans that should not be usurious for borrowers.

Scope of RBI Master Directions 2022 for Microfinance Loans

The provisions of these guidelines apply to the following regulated entities (REs):

• All commercial banks, including small finance banks (SFBs), local banks (LABs), and regional rural banks (RRBs), but excluding payments banks;
• All Primary (Urban) Cooperative Banks/State Cooperative Banks/District Central Cooperative Banks; and
• All Non-Banking Financial Companies (NBFCs) including Micro Finance Institutions (MFIs) and Housing Finance Companies (HFCs).

Importance of this move

• Single Regulatory Platform: Changes are made to bring all microfinance lenders, including banks, small finance banks, NBFCs, and non-profit companies, on a single regulatory platform.
• Pressure Reduction: The 50% fixed debt-to-income ratio rule, which will be applied uniformly to all categories of borrowers, will reduce pressure, reduce defaults and reduce credit costs for the industry.
• Risk-based pricing: Removing the interest rate cap would allow these lenders to move to risk-based pricing.
• Increasing reach: Increasing the household income threshold will help MFIs reach many more households. With a level playing field and increased competition, end customers will benefit.
• Credit history: From now on, the loan rate may be slightly higher for new lenders with no credit history, while lenders with robust repayment histories may have lower rates.
• Over-indebtedness: Harmonized regulations will address the over-indebtedness concerns of microfinance borrowers.

Changes made by RBI

• The margin cap on loan interest rates was introduced a decade ago to prevent NBFC-MFIs from charging usurious rates.

The RBI has now offered freedom to set interest rates approved by the board but warned that they should not be usurious and that the rates would be subject to its supervision.

• Revised definition: RBI raised annual household income to Rs 3 lakh to classify an unsecured loan as a microfinance loan.

Until now, such loans given to households with an annual income of Rs 1.25 lakh in rural India and Rs 2 lakh in urban and semi-urban areas were classified as microfinance loans.

RBI has revised the minimum microfinance loan requirement for NBFC-MFIs to 75 percent of assets from 85 percent earlier.

• Unsecured loans: several other non-bank financial companies will now also be considered microloans.

All such loans, regardless of end use, will fall into this classification.

• It limited the borrowers’ monthly loan repayment, which should not exceed half of the household’s monthly income. This step is aimed at protecting borrowers from falling into a debt trap.
• No Penalty: No loan can be attached to a lien on the borrower’s deposit account. There will be no early repayment penalty for microfinance loans.
• The RBI has removed certain exemptions applicable to non-profit entities with an amount of Rs 100 crore and directed them to register as NBFC-MFIs within three months to bring them under its framework.
• The RBI has asked lenders to prominently display the minimum, maximum and average interest rates charged on loans at all their offices.
• Increased ceiling: RBI has revised the criteria for NBFCs that do not qualify as NBFC-MFIs to provide microfinance loans up to 25 percent of their total assets from 10 percent earlier.

Loan Repayment Limitations

• The rules set a limit on the household’s obligation to repay the loan. Repayments (including the principal and interest component) for all existing loans and loans under consideration are included in the outflow, which is limited to 50% of the household’s monthly income.
• Existing loans, the outflow of which exceeds 50% of the monthly household income due to repayment of monthly loan obligations, will be allowed to mature.

However, in such cases, no further loans will be provided to such households until the prescribed maximum of 50% is met.

Outsourced activities

The Central Bank stated that the outsourcing of any activity by RE does not absolve RE of its obligations and that RE bears full responsibility for compliance with these instructions.

The loan agreement, as well as the Code of Fair Practices (FPC), displayed at the office/branch/website, must state that the RE will be held accountable for unethical behavior by its employees or outsourced agency workers and provide prompt resolution of complaints.

Card of Credit 

• Each RE must provide the borrower with a credit card that contains information that properly identifies the borrower, a simplified pricing information sheet, and all other loan terms and conditions.
• The card should also contain the RE’s acknowledgment of all installments, including the installments received and the final bill, as well as information about the RE’s grievance redressal mechanism, including the RE’s nodal person’s name and phone number.
• Non-credit products can only be issued with the full consent of the borrower and the fee structure for such goods must be clearly explained to the borrowers in the credit card itself.

Assessment of household income

• Each RE shall implement a policy approved by the Household Income Assessment Board.
• Self-regulatory organizations (SROs) and other associations/agencies can also create a common framework based on an indicative methodology. REs may adopt/modify this framework as appropriate as per their requirements with the approval of their Boards of Directors.
• Every RE is required to submit household income information to the Credit Information Companies (CIC).

Loan recovery

• As per RBI, recovery will be done at a recognized/centrally designated location. The borrower and RE will agree on a meeting place.
• If the borrower fails to appear at the specified/designated location on two or more consecutive occasions, field staff will be entitled to recovery at the borrower’s place of residence or work.
• The Central Bank stressed that RE or its representative will not use any punitive enforcement tactics.
• At the initiation of the collection process, the RE will provide the debtor with the names and contact information of the collection agents to ensure proper notification and authorization.

The agent must carry a copy of the notification and RE authorization letter, as well as an RE or agency ID.

Final words

Hope this article has given a quick and detailed insight into the regulatory framework for Microfinance Loans. Recently, the Reserve Bank of India (RBI) has allowed microfinance institutions (MFIs) the freedom to set the interest rates they charge borrowers, with a caveat that the rates should not be usurious. These guidelines will take effect on April 1, 2022. In early 2021, the RBI proposed to lift the cap on interest rates for MFIs.