India Considers New Law to Regulate Micro-lenders

July 11, 2011 Posted by India Briefing Reading Time: 2 minutes

By Vivian Ni

Jul. 11 – The Indian government recently proposed to establish a new law in order to better regulate the country’s microfinance industry that is faced with complaints of aggressive lending practices and high interest rates. Aiming to bring various microfinance institutions (MFIs) under the regulation of the Reserve Bank of India (RBI), the proposed law is expected to strongly impact smaller players who look for large profit through their lending businesses.

According to reports, the draft bill proposed that all entities involved in micro-finance activity should obtain a registration certificate from the country’s central bank: the RBI. Non-bank micro-lending companies that have provided a minimum of Rs.500,000 in net owned funds can get registered within three months when the law takes effect.

The new law may also require some systemically important MFIs to be converted into section-25 companies – one of three forms of non-profit organizations in India legalized under the country’s Companies Act in 1956.

As the common regulator, the RBI is empowered to restrict interest rates on loans, prescribe various rules, and conduct risk assessments. The bank is also proposed to be able to impose a ceiling on the amount of assistance individual clients can receive, and prescribe the tenure of assistance.

In addition, the processing fees, interest rates and the life insurance premiums that MFIs charge are likely to be prescribed by the RBI, in order to effectively avoid unreasonably high loan interest rates and control MFI profit margins.

A variety of other rules that ensure a more robust and transparent microfinance market are expected to follow the new law as well. The regulator can prescribe governance norms, recovery methods and operation methods for MFIs. It will also launch credit ratings, so that assistance can be delivered to the poor who need it for productive needs and micro-lenders can also constrain their bad loans.

The proposal for the new law comes after India’s microfinance industry was badly affected last year by restrictive state rules implemented in the southern state of Andhra Pradesh. Both loan and fund collections dropped sharply in the state – which was India’s largest microfinance market – as a result of the government crackdown.

The new bill for a more regulative market is hoped to give scale players more impetus. Stocks of SKS Microfinance – India’s largest and only listed micro-lender – rose by 20 percent on Thursday morning, following the release of the draft legislation. However, for smaller for-profit players, they will have to strive for an increase in their scale; otherwise they might have to exit the business due to profit shrinkage, according to Fitch Ratings.

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