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New RBI Regulations would Strengthen MFI Ecosystem

15
MAR 2022

By Amit Rane

India Ratings and Research (Ind-Ra) opines that the key changes in the final regulations for microfinance institutions
(MFIs) will bring in the entire industry under the regulatory coverage unlike one-third of the industry coverage earlier.
Moreover, the ability of small and mid-sized MFIs players to implement risk-based pricing would enable building both
scale and operating buffers, resulting in improved credit worthiness in the eyes of lenders. This is in line with the
agency’s FY23 Outlook: Microfinance where it had said that the viability of the small-medium MFIs could improve post
the implementation of the proposed harmonisation guidelines. The notification is also expected to improve the ability
of non-bank finance company (NBFC)-MFIs to penetrate into newer geographies, as pricing can now be
differentiated, and cover the higher operating costs for the same.
The Reserve Bank of India’s (RBI) announced ‘Master Direction
– Reserve Bank of India (Regulatory Framework for
Microfinance Loans)
Directions, 2022’, on 14 March 2022 (effective from 1 April 2022). The key changes
in the final
regulations include the widening of the definition of regulated
entities to include commercial banks, co-operative
banks, district/state
central co-operative banks, NBFC-MFIs, NBFC housing
finance companies (HFCs), as well  as the
removal of pricing caps. The RBI also expects the not-for-profit companies (with
assets under management more
than INR1 billion) involved in the microfinance activities
to apply for an NBFC-MFI licence. 

These guidelines withdraw the regulated pricing caps and

allow NBFC-MFIs to implement risk-based pricing based on
the customers’ risk
profile (more driven by the board’s policies on pricing), although the RBI does
keep the right to
qualify interest rates usurious in case it deems so. The new
guidelines expand the definition of microfinance
borrowers (in terms of
household income assessment) and reduce the qualifying assets criteria to 75% from
85% of
the total assets earlier. This could spur investments by NBFC-MFIs in
building capabilities in other loan products that
an MFI customer can graduate
to. 

Positive Implications for MFI Sector: The implementation of the new regulations would lead to a positive
effect
on NBFC-MFIs, especially for mid and small sized ones which were unable
to originate substantially and their viability
came under question once the
lending rate came down to 21.5% on account of the price caps. In addition, only
30% of the microfinance industry was constituted by NBFC-MFIs where the RBI
guidelines were mandatory while it
was voluntary for the rest (where banks,
small finance banks, NBFCs were larger players). There were differences in
the
way two-lender norms were followed by all regulated entities. Some considered
banks as among the two eligible
lenders while some were of the view that this was
applicable only to NBFC-MFIs. There was also diverse opinions on
whether the extant
norms include secured NBFCs (gold, two-wheeler etc).  This has been completely removed to
bring a
level playing field. From the borrowers’ point of view, this could result in
increased cost of credit;
nevertheless, this borrower segment’s demand and
performance are reasonably inelastic to pricing range as it exists
now
(19%-25%). 

The regulator by reducing the minimum requirement of

microfinance loans in the total loan assets of NBFC-MFIs to
75% from 85%
earlier wants to encourage portfolio diversification to improve the shock-absorbing
capacity in case of
an event risk, and hence is 
a long-term positive as companies can offer secured loans up to 25% of assets
under
management to  minimise the overall
credit risk. This could also provide adequate opportunities to NBFC-MFIs to
invest in capabilities related to non-micro loan products.  

Figure 1 shows a return on asset (RoA) tree for a small and a

large MFI under old regulations and new regulations.
This calculation does not
consider the scale impact that higher ticket sizes could bring in.

Figure 1

Typical RoA Tree and Expected Returns (Over

Medium Term)

  Before new regulations After new regulations

Large
NBFC- Small/Medium Large
NBFC-MFI Small/Medium
MFI NBFC-MFI MFI

Feasible pricing (% yield on advances) 19.5 21.5 21.0 24.0

Cost of
borrowing (%) 9.7 13.5 9.7 13.5

Effective
cost of funding (%) 7.8 10.8 7.8 10.8

Effective
spread (%) 11.7 10.7 13.2 13.2

Fees and
other income (%) 1.0 1.0 1.0 1.0

Total
income (%) 12.7 11.7 14.2 14.2

Operating
costs (%) 5.0 8.0 5.0 8.0
 Pre-provisioning
profit (%) 7.7 3.7 9.2 6.2

Provisioning
(%) 2.0 2.0 2.0 2.0

PBT (%) 5.7 1.7 7.2 4.2

Post tax
ROA (%) 4.3 1.3 5.4 3.2

Leverage
(x) 4.0 4.0 4.0 4.0

ROE (%) 17.1 5.1 21.6 12.6

Assumptions:
1) Pricing in current scenario assumed based on RBI stipulated margin caps.
2) Effective cost of
funding takes into account the 20% Tier-I Capital which
has nil interest cost. 3) Operating cost declines
substantially with scale;
assumptions for typical MFIs with assets under management greater than INR50
billion
under Large NBFC-MFI category & INR10 billion under small/medium
NBFC-MFI, 4) Pricing in post harmonisation
scenario is Ind-Ra estimate

Source: Ind-Ra analysis

 
Systemic Risk Implications in Mid-Long Term Would Depend on
Implementation: There has to evolve a
common framework for evaluation and income assessment for target borrowers. The
regulator has capped the
monthly EMI to maximum half of the monthly household income.
In Ind-Ra opinion, if not implemented carefully from
the credit risk
perspective, the purpose of microfinance could be diluted and the group
structure may not be cut
out to withstand defaults on high indebtedness because
theoretically, the maximum ticket size is INR200,000.
Competition could result
in weak pricing standards and could have a systemic risk impact in the medium
to long term.
This would also entail NBFC-MFIs to bring about sophistication in
their operating and pricing models and risk and
supervisory structures and
could include substantial training to existing members of their staff.

Figure 2

Summary of Key
Changes

  Before the new regulations After new regulations

Definition of NBFC-MFIs only All commercial

banks (excluding only
regulated entities payment  banks),
co-operative banks,
district/state central co-operative banks,
NBFC MFI, NBFC
HFC
Definition of MFI To be classified
as a qualifying asset, a loan is Collateral-free
loans to households
loan (Qualifying required to satisfy the following criteria: having annual household income not
asset) (i) Loan which
is disbursed to a borrower with exceeding INE3,00,000.
Not separately
household annual income not exceeding defined for rural and urban areas.  All
INR1,25,000 and INR2,00,000 for rural and other criteria have been removed.
urban/semi-urban households,
respectively;  
(ii) Loan amount
does not exceed INR75,000 Application to
not for profit companies
in the first cycle and INR1,25,000 in engaged in Microfinance activities (which
subsequent
cycles; were
exempt earlier).
(iii) Total
indebtedness of the borrower does  
not exceed INR1,25,000 (excluding loan for Emphasis on
having board approved
education and medical expenses); policies on relevant aspects of credit
(iv) Minimum
tenure of 24 months for loan including income
assessment
amount exceeding INR30,000;
(v)
Collateral-free loans without any
prepayment penalty;
(vi) Minimum 50%
of the aggregate amount
of loans for income generation activities; and
(vii)
flexibility of repayment periodicity (weekly,
fortnightly or monthly) at
borrower’s choice.

Definition of Required to have

minimum 85% of its net Minimum
requirement of microfinance
NBFC-MFI assets as ‘qualifying assets’. loans for NBFC-MFIs also stands revised
to 75% of
the total assets.

For NBFCs (Other NBFC that does

not qualify as an NBFC-MFI, NBFC that does
not qualify as an NBFC-
than NBFC -MFI) cannot extend microfinance loans exceeding MFI, cannot extend microfinance loans
10% of
its total assets exceeding 25% of
its total assets

Limit on loan No such limit.

However, limit on no of lenders Monthly EMI
(including principal and
repayment and total indebtedness interest) < 50% of the monthly
obligations of a household income
household

Pricing of loans Interest rate charged should be lower of - Interest rate

charged will be decided by
a) cost of funds plus margin of 10% for NBFC- a board approved 
policy with clear
MFIs with loan
portfolio exceeding INR1,000 delineation of components such as cost
million and 12% for others; of funds,
risk premium and  margins.

b) 2.75x of the average base rate of the five Companies need

to define and display
largest
commercial banks the maximum, minimum and average
rate of interest that
can be charged.

Penalty on There shall be

no penalty charged on delayed Penalty, if any,
for delayed payment shall
overdue payment payment. be applied on the overdue amount and
not on the
entire loan amount.

Minimum net INR5 crore

(INR20 million in NE Region) INR70 million (INR50
million in northeast
worth region) – by 31 March 2025
INR100 million –
by 31 March 2027

Mandatorily Was mandatory

for NBFC-MFI only Each regulated
entity shall mandatorily
submission of submit information regarding household
information income to the
credit information
companies including information related
to assessed income

 Appointment of Not allowed

earlier Engagement of
recovery agents is
recovery agent permitted

Not for profit No regulations

applicable Not for profit
Companies with asset size
companies more than INR 1 billion are required to
be
registered as NBFC MFI.

Source: RBI, Ind-Ra

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Analyst Names

Amit Rane

Senior Analyst

India Ratings and Research Pvt Ltd Wockhardt Towers, 4th Floor, West Wing, Bandra Kurla
Complex, Bandra East,Mumbai - 400051

+91 22 40001700

Jindal Haria

Director
+91 22 40001750
Media Relation
Ankur Dahiya

Manager – Corporate Communication

+91 22 40356121