Regulating Microfinance Institutions in India : A complex task

The Indian microfinance industry comprises of numerous microfinance providers who are spread all across the country. The starting point of complexity in regulating the industry lies in the diverse nature of institutional forms they are registered as, viz. – NBFC-MFIs, cooperative societies, non-profit organization, trusts, all subject to different laws. The Draft Micro Financial Sector (Development and Regulation) Bill was tabled in the Parliament in 2007, but it failed to become an Act. Since then, there has been no clear consensus on whether MFIs should have their own legislation, or be subjected to the same norms as banks and NBFCs. The Finance Ministry and Nabard are again renewing efforts to put a clear regulatory structure in place. Recent reports about MFIs offering loans without adequate background checks on borrowers’ repaying ability, the amorphous ways of fixing the interest rates have raised questions about corporate governance in the industry, thereby alerting the regulators. Recently it was suggested that the RBI regulate the MFIs by capping the interest rates that are charged, or by applying NBFC norms. It is a complex task, since there is no clear way of knowing what the right interest rate to charge is, given the country’s large geographical expanse and the great diversity among borrowers’ credit profiles. Moreover, any attempt to regulate the MFIs has to tread a fine balance, since a large part of the rural populace is already a part of the system, and therefore has a direct bearing on rural economic activity. An appropriate way of bringing structure to the microfinance industry at this juncture might be to just lay down prudential norms for the industry for an interim period, and mandate all microfinance institutions regardless of their institutional forms to report to one single authority (RBI or Nabard). Greater information sharing might be the simple answer to improving corporate governance at MFIs.