We appreciate the Malegam Committee’s recommendations to increase the supervisory capacity of the RBI , to make MFI regulation consistent at the national level, to promote good corporate governance, to increase bank lending to MFI’s, and to make available alternative sources of equity.
We are less enthusiastic that the Malegam Committee chose to focus their efforts narrowly on the product design of the JLG loan instead of understanding the way microfinance functions and proposing the proper role of market players in ensuring orderly growth of this sector.
Ensuring complete access to finance for every individual and every enterprise in India will require a flurry of innovations in financial products, delivery channels, and human resource management by a wide array of strong firms competing with each other to do business with the low- income household in a responsible manner.
Efforts to stifle this innovation by the Malegam Committee – no matter how well intentioned – must be reconsidered.
We believe that there is an important role for the regulator to play in making sure that innovation is encouraged among responsible players in a manner that benefits low income households, and we are hopeful that the RBI will agree with our view when it reviews the Malegam Committee’s report.
Although we appreciate the positive intention of the Malegam Committee, the report that it issued has numerous sections that will undoubtedly (1) hurt low-income households, (2) protect the largest incumbent MFIs, and that (3) perpetuate the convenient myth that low income households are more irrational than the rest of us.
The following is our perspective with respect to several sections of the report that we believe require additional consideration.
Recommendations that will hurt low income households
Recommendations that will protect the big incumbent MFIs
Many of the recommendations favour the largest existing MFIs, are likely to drive smaller MFIs out of businesses, and create entry barriers for any new players.
The larger MFIs benefit from economies of scale and will be more easily able to comply with the increased capital requirements. They will be more easily able to build the infrastructure recommended and move faster into the market place where they could corner the maximum market share thereby preventing the entry of smaller or newer MFIs in that market.
Recommendations that improperly assume that low income households are more irrational than the rest of us
14 Responses
Make no mistake. The days of MFI as the primary vehicle for promoting financial inclusion in the country is over. Though MFIs could have claimed the latter status till now; the scenario has changed. The sector’s strategic significance has been downgraded and the new policy framework would encourage other vehicles like direct bank lending. While Malegam report did not explicitly state as a recommendation, the implications implicitly is that it wants to contract the growth of the MF sector and thereby discourage PE investment in the country by creating a significantly lower growth environment for the sector.Sooner the MF reconcile to the emerging policy framework, the better they can adapt
Make no mistake. The days of MFI as the primary vehicle for promoting financial inclusion in the country is over. Though MFIs could have claimed the latter status till now; the scenario has changed. The sector’s strategic significance has been downgraded and the new policy framework would encourage other vehicles like direct bank lending. While Malegam report did not explicitly state as a recommendation, the implications implicitly is that it wants to contract the growth of the MF sector and thereby discourage PE investment in the country by creating a significantly lower growth environment for the sector.Sooner the MF reconcile to the emerging policy framework, the better they can adapt
I agree on the untenability of a cap on household income. Households with annual incomes higher than 50,000 may also need micro credit.
Similarly, prescribing a loan cap, the Committee seems to be prescribing a limit on the consumption needs of a low income household. Elsewhere in the report, it talks about the frequency of loan-repayment being decided by the borrower depending on his individual circumstances. In a similar vein, the quantum of loan too should be allowed to be decided by the borrower based on his individual circumstances.
The prescription of a minimum 75% of lending on income-generating purposes too seems unjustified. There are a number of items of expenditure which may not be directly or immediately linked to income-generation. Besides, the focus should be on the general and overall uplift of the well-being of the borrower rather than merely on his income-generating capabilities.
The margin cap, if I understand correctly, caps the chargeable rate of interest on an aggregate basis. This and the cap on interest rate on individual loans are supposed to help limit the risk of high interest costs currently being incurred by the borrowers, and are, hence, beneficial to them. Taken along with the prescription of a minimum networth, this could benefit larger MFIs more than the relatively smaller ones. This makes bringing in scale imperative and seems aimed at encouraging consolidation in the industry. Just how this consolidation would benefit the end borrower in terms of allowing efficient delivery of low cost credit across all regions of the country is a moot point, however.
The minimum networth requirement for NBFC-MFIs of Rs. 15 crore and the proposed loan cap on NBFCs which are not MFIs lending to this sector (10% of their loans) seem like entry barriers and discouraging competition.
I think the objective of reforms of the MFI sector should be on efficient delivery of low cost credit that can be easily serviced by the low-income borrowers across all regions of the country. Of course, some of the measures prescribed by the Committee, such as interest rate cap, margin cap, setting up of a credit information bureau, client protection, corporate governance, etc., are highly relevant and seem to support this objective. But whether this objective is served by big MFIs or small ones, NBFCs or NBFC-MFIs, income-generating loans or those aimed at other, equally important purposes may not be relevant.
I agree on the untenability of a cap on household income. Households with annual incomes higher than 50,000 may also need micro credit.
Similarly, prescribing a loan cap, the Committee seems to be prescribing a limit on the consumption needs of a low income household. Elsewhere in the report, it talks about the frequency of loan-repayment being decided by the borrower depending on his individual circumstances. In a similar vein, the quantum of loan too should be allowed to be decided by the borrower based on his individual circumstances.
The prescription of a minimum 75% of lending on income-generating purposes too seems unjustified. There are a number of items of expenditure which may not be directly or immediately linked to income-generation. Besides, the focus should be on the general and overall uplift of the well-being of the borrower rather than merely on his income-generating capabilities.
The margin cap, if I understand correctly, caps the chargeable rate of interest on an aggregate basis. This and the cap on interest rate on individual loans are supposed to help limit the risk of high interest costs currently being incurred by the borrowers, and are, hence, beneficial to them. Taken along with the prescription of a minimum networth, this could benefit larger MFIs more than the relatively smaller ones. This makes bringing in scale imperative and seems aimed at encouraging consolidation in the industry. Just how this consolidation would benefit the end borrower in terms of allowing efficient delivery of low cost credit across all regions of the country is a moot point, however.
The minimum networth requirement for NBFC-MFIs of Rs. 15 crore and the proposed loan cap on NBFCs which are not MFIs lending to this sector (10% of their loans) seem like entry barriers and discouraging competition.
I think the objective of reforms of the MFI sector should be on efficient delivery of low cost credit that can be easily serviced by the low-income borrowers across all regions of the country. Of course, some of the measures prescribed by the Committee, such as interest rate cap, margin cap, setting up of a credit information bureau, client protection, corporate governance, etc., are highly relevant and seem to support this objective. But whether this objective is served by big MFIs or small ones, NBFCs or NBFC-MFIs, income-generating loans or those aimed at other, equally important purposes may not be relevant.
I would like to compliment the Malegam Committee on the background research that they were able to access in preparing the report and for several of their recommendations. Given the very short time at their disposal this is indeed very creditable. I hope that the publication of their report will give the banking system reassurance that they can go ahead and continue to lend to the microfinance sector and allow the movement to try its best to get back on track. However, I share the concerns expressed in this post and feel that on several fronts even the research reported by the Committee points to a conclusion very different from the ones that they eventually arrived at.
I am particularly anxious that some of the recommendations, if accepted, would prevent the transformation of microfinance into full service finance for rural customers. The whole point of becoming an NBFC is that the entity is then able move beyond traditional JLG lending (which is also permitted to deemed NBFCs constituted under the Section 25 of the Companies Act) and gradually start to offer larger loans, individual loans, enterprise loans, crop loans, equipment loans, etc. while continuing to offer the original JLG product. This allows the entity to meet in-full the requirements of those borrowers that need larger amounts as well as use the wider product-scope to spread its cost structures over a much larger pool of assets and bring its lending rates down, eventually well below even the caps specified by the Committee for the traditional JLG product. The 90/10 recommendations (Clause Numbers 5.9 and 5.10), if accepted, would essentially freeze the sector to permanently stay in its current form since nobody else would even be allowed to address the needs of this sector and no other business models would evolve. And for this reason, as well as several others listed in the above post, there would also then be no impetus for interest rates to come down further blow the caps specified by the Committee. It is my belief that costs of operations, using new technologies and economies of scope and scale can be brought down to as low as 5 to 6% relatively quickly and over time an even lower rate structure is conceivable. The committee has also not offered any rationale for the Rs. 15 crore minimum capital requirements even for pure non-deposit taking NBFCs despite recommending very conservative loan limits and being aware of the very low default rates that have been observed for this sector in India for over a decade. There is no particular rationale offered by the Committee for its Rs. 25,000 maximum loan stipulation as well. I feel that these requirements would make entry of new participants much more difficult; create monopolies and make it harder for the sector to reduce interest rates. In my view creating a separate category of NBFC-MFIs; requiring a minimum capital value of Rs. 15 crore and stipulating Rs. 25,000 as a maximum loan limit would not be advisable moves and would eventually end up exacerbating several of the current challenges that the sector currently faces.
I am also very deeply disturbed at the view the Committee eventually takes on the manner in which poor women conduct their financial lives and their maturity and sagacity. Microfinance plays multiple roles in the lives of low income households including seasonal cash management (so that school fees can be paid even during the seasonal troughs); asset transformation from small savings to larger valued assets (such as higher quality roofs and beds); refinance of high cost loans from money lenders; and as a substitute for good commitment-savings products. This is also acknowledged by the Committee but while making its recommendations it surprisingly reaches an opposite conclusion without citing any research or offering any rationale for overlooking its own earlier observations or suggesting any alternative solutions. I feel that these recommendations of the Committee along with those restricting the amounts she can borrow and severely limiting the choice of providers that she can access, constitute an infringement of the rights of the low income household, particularly women, to conduct their own financial affairs as they think best fit. Similar stipulations, if imposed on middle and upper income households would be resisted very strongly, but have been recommended for imposition on poor women without any evidence that they are in any way less rational than high and middle income customers and good evidence that the opposite is actually the case.
I hope that when the report is reviewed by the Reserve Bank of India and guidelines eventually framed these concerns are kept in mind. The issue of the Andhra Pradesh Act I feel has a fairly straightforward legal resolution and there are good legal precedents that the Courts I am sure will eventually use to strike it down. The recommendations of the Committee however have a much wider application and I fear that they could seriously derail the progress towards universal high quality financial inclusion in the entire country if they are accepted in their entirety.
I would like to compliment the Malegam Committee on the background research that they were able to access in preparing the report and for several of their recommendations. Given the very short time at their disposal this is indeed very creditable. I hope that the publication of their report will give the banking system reassurance that they can go ahead and continue to lend to the microfinance sector and allow the movement to try its best to get back on track. However, I share the concerns expressed in this post and feel that on several fronts even the research reported by the Committee points to a conclusion very different from the ones that they eventually arrived at.
I am particularly anxious that some of the recommendations, if accepted, would prevent the transformation of microfinance into full service finance for rural customers. The whole point of becoming an NBFC is that the entity is then able move beyond traditional JLG lending (which is also permitted to deemed NBFCs constituted under the Section 25 of the Companies Act) and gradually start to offer larger loans, individual loans, enterprise loans, crop loans, equipment loans, etc. while continuing to offer the original JLG product. This allows the entity to meet in-full the requirements of those borrowers that need larger amounts as well as use the wider product-scope to spread its cost structures over a much larger pool of assets and bring its lending rates down, eventually well below even the caps specified by the Committee for the traditional JLG product. The 90/10 recommendations (Clause Numbers 5.9 and 5.10), if accepted, would essentially freeze the sector to permanently stay in its current form since nobody else would even be allowed to address the needs of this sector and no other business models would evolve. And for this reason, as well as several others listed in the above post, there would also then be no impetus for interest rates to come down further blow the caps specified by the Committee. It is my belief that costs of operations, using new technologies and economies of scope and scale can be brought down to as low as 5 to 6% relatively quickly and over time an even lower rate structure is conceivable. The committee has also not offered any rationale for the Rs. 15 crore minimum capital requirements even for pure non-deposit taking NBFCs despite recommending very conservative loan limits and being aware of the very low default rates that have been observed for this sector in India for over a decade. There is no particular rationale offered by the Committee for its Rs. 25,000 maximum loan stipulation as well. I feel that these requirements would make entry of new participants much more difficult; create monopolies and make it harder for the sector to reduce interest rates. In my view creating a separate category of NBFC-MFIs; requiring a minimum capital value of Rs. 15 crore and stipulating Rs. 25,000 as a maximum loan limit would not be advisable moves and would eventually end up exacerbating several of the current challenges that the sector currently faces.
I am also very deeply disturbed at the view the Committee eventually takes on the manner in which poor women conduct their financial lives and their maturity and sagacity. Microfinance plays multiple roles in the lives of low income households including seasonal cash management (so that school fees can be paid even during the seasonal troughs); asset transformation from small savings to larger valued assets (such as higher quality roofs and beds); refinance of high cost loans from money lenders; and as a substitute for good commitment-savings products. This is also acknowledged by the Committee but while making its recommendations it surprisingly reaches an opposite conclusion without citing any research or offering any rationale for overlooking its own earlier observations or suggesting any alternative solutions. I feel that these recommendations of the Committee along with those restricting the amounts she can borrow and severely limiting the choice of providers that she can access, constitute an infringement of the rights of the low income household, particularly women, to conduct their own financial affairs as they think best fit. Similar stipulations, if imposed on middle and upper income households would be resisted very strongly, but have been recommended for imposition on poor women without any evidence that they are in any way less rational than high and middle income customers and good evidence that the opposite is actually the case.
I hope that when the report is reviewed by the Reserve Bank of India and guidelines eventually framed these concerns are kept in mind. The issue of the Andhra Pradesh Act I feel has a fairly straightforward legal resolution and there are good legal precedents that the Courts I am sure will eventually use to strike it down. The recommendations of the Committee however have a much wider application and I fear that they could seriously derail the progress towards universal high quality financial inclusion in the entire country if they are accepted in their entirety.
Also, the stipulation on the difference between borrowing and lending rates not to exceed 10 % kind of restricts entrepreneurial activity in the sector.
Also, the stipulation on the difference between borrowing and lending rates not to exceed 10 % kind of restricts entrepreneurial activity in the sector.
MF organisations big and small have been operating in India for a while now. The report comes as probably the first significant report towards better regulation of this market. So this is just a beginning in this direction and one cannot expect the report to provide a completely evolved rule book for this market out of this report. However, the 15 crore working capital requirement will drastically reduce the number of MF players to a few big ones who can never serve the vast population that need MicroFinance.
We are still in search of answers for how enable healthy competition under an environment better regulated, post this report.
MF organisations big and small have been operating in India for a while now. The report comes as probably the first significant report towards better regulation of this market. So this is just a beginning in this direction and one cannot expect the report to provide a completely evolved rule book for this market out of this report. However, the 15 crore working capital requirement will drastically reduce the number of MF players to a few big ones who can never serve the vast population that need MicroFinance.
We are still in search of answers for how enable healthy competition under an environment better regulated, post this report.
I don’t think that the Committee has done any research on their own considering that much of the data pulled out has been from others who I think are better experts of the industry (IFMR). Better recommendations could have been gathered had some of the Committee members simply visited long-time borrowers in villages in and around AP. Instead of thinking of ways of how to create formal systems of employment for borrowers of microfinance and better usage of credit, the focus on restrictions on the supply side will only restrict opportunities for risk taking and enterprise on the borrower’s side. This report seems to only serve the purpose of academic research- maybe we need another Committee that can recommend how to execute the recommendations.
I don’t think that the Committee has done any research on their own considering that much of the data pulled out has been from others who I think are better experts of the industry (IFMR). Better recommendations could have been gathered had some of the Committee members simply visited long-time borrowers in villages in and around AP. Instead of thinking of ways of how to create formal systems of employment for borrowers of microfinance and better usage of credit, the focus on restrictions on the supply side will only restrict opportunities for risk taking and enterprise on the borrower’s side. This report seems to only serve the purpose of academic research- maybe we need another Committee that can recommend how to execute the recommendations.