Bringing MFIs under the regulation of the Reserve Bank of India is questionable as it is not equipped with any protection mechanism and also overlooks consumer protection, experts say

The decision to bring the microfinance sector under the regulation of the Reserve Bank of India (RBI) has raised concerns among industry experts, who feel that the draft microfinance bill ignores safeguard mechanisms and consumer protection.

According to the draft of the Microfinance Institutions (Development and Regulation) Bill 2011 adopted by the government on 6th June, the RBI will regulate the Indian microfinance sector. In the new bill, all the microfinance institutions (MFIs) including non-banking finance companies (NBFCs), before commencing their businesses have to register with the RBI.

Ramesh Arunachalam, who has authored a recently released compendium on the history and growth of the industry, told Moneylife, "The proposed draft micro-finance bill is very welcome as the RBI is the legitimate regulator of the larger financial sector. From that perspective I am very happy and have argued the same in my recently released book. However, I am concerned that the bill, which leaves regulation of several hundred MFIs to the RBI, does so without necessary safeguard mechanisms. A second concern in the bill is that it does not look at consumer protection and/or consumer redressal in any significant manner." Mr Arunachalam's book is title "The Journey of Indian Microfinance: Lessons for the Future".

Mr Arunachalam said, "The department of non-bank supervision (DNBS), at the RBI, was a mute spectator to what happened between April 2008 and March 2010 when top five Andhra Pradesh headquartered NBFCs, MFIs, filing papers with DNBS, added 9.59 million clients and increased their gross loan portfolio by $2 billion. This is equivalent to each of those five NBFCs and MFIs, adding a gross loan portfolio of Rs78.55 crore per month, which continued for two years. It is important to note that the department of non-bank supervision is supposed to supervise every NBFC that has a loan portfolio of over Rs100 crore closely and each of these five MFIs were adding almost 78% of that threshold value (of Rs100 crore portfolio) every month for the two years. This is a huge task by any standards. Clearly, these are the trends that should have grabbed the attention of anyone, let alone the regulators/supervisors but, for some reason, they did not."

Critics point to a few worrisome provisions in the Bill, like the overlap between NBFCs and MFIs, which continues in this Bill. "Regrettably, the overlap between NBFCs and MFIs remains under the Bill. It would be most illogical to have a company carrying out microfinance business being regulated both as an NBFC and as an MFI. However, clause 11 (3) and (4) clearly suggest that such overlap will continue-which is a regrettable waste of regulatory attention. In fact, the Bill mandates that an MFI that becomes systematically important (based on a number of borrowers-the number to be notified by the RBI) will have to convert itself into a company. Once it converts, it obviously becomes an NBFC also," writes Vinod Kothari, on the website microfinancefocus.com.

The Bill has also mentioned the concept of 'thrift' services, which is defined in clause 2 (p) as collection of time deposits. "This seems to suggest that the RBI is inclined to permit MFIs to accept deposits too-a long-felt need. There is a mention in the marginal notes below section 14 about thrift services, but it seems that the provision actually fell through, somewhere along the way, as there is no substantive provision in the law about thrift acceptance," Mr Kothari stated.

Mr Arunachalam added, "We certainly require a microfinance law to provide legitimacy to the microfinance sector. Rather than being a paper tiger, the Bill should have the teeth and a mechanism to ensure orderly growth of the sector and for this the most critical aspect is to look at the supervisory capacity of the RBI and evaluate it to see what needs to be done to ensure ground level implementation."