Triple Jump news - Tuesday, January 25, 2011

India: Small-scale MFIs Affected

January 2011 - "The recommendations from the Malegam Committee in India will negatively affect small-scale microfinance institutions(MFIs) with rural outreach" says Michael van den Berg, regional manager for Europe, Caucasus and Asia at Triple Jump, in his first reaction to the recommendations published earlier this month.

Indian microfinance has lately come under increased scrutiny due to the wave of suicides in the state of Andra Pradesh, which were allegedly linked to irresponsible lending practices by MFIs. One of the core issues is overlending by MFIs to customers (who at times have as many as 10 loans with different MFIs) as a result of a focus on quantity rather than on quality. The recent events in the Indian microfinance sector have urged all stakeholders, from MFIs to financial regulators and investors to review how the poor can best be served with responsible financial services.

Lawmakers in Andhra Pradesh (the Indian state which is also home to the largest MFIs in the country) have adopted an ordinance which seeks to protect clients by limiting MFIs in where and how to provide loans and at what conditions. The ordinance has some good intentions, but many undesirable effects too.

The pan-Indian regulator for the financial sector, the Reserve Bank of India (RBI) has taken more time to come up with an approach. The RBI has asked a committee, chaired by Mr. Malegam, to come up with advice on how to allow for-profit Non-Banking Financial Company (NBFC) MFIs to provide access to finance for India’s poor while at the same time ensuring that this vulnerable target group is dealt with accroding to the highest possible ethical standards. The recommendations from the Malegam committee were made public on 18 January  2011.

From a first reading of the recommendations, we see that the committee has come up with a wide range of measures: a Code of Conduct, an Ombudsman for the sector, Client Protection and transparency proposals; but also with measures that prohibit MFIs from servicing clients with larger loan sizes (capped at EUR 400), prohibiting individual lending, setting minimum capital requirements (EUR 2.4Mn) and allowing for a maximum interest rate of 24%.

It is too soon to predict fully how these recommendations will affect NBFC MFIs in the long term. However, what can be concluded now is that the situation is difficult for small-scale MFIs with rural outreach, due to their higher operational cost structure. A better assessment of the consequences for the sector can be made within the next 12 months.