> Posted by Anita Gardeva
There is little doubt that the Malegam Sub-Committee Recommendations will have serious implications for microfinance providers in India if they are passed. But what might the consequences be for clients?
In order for financial inclusion to have a positive impact on clients it needs to result in quality financial services. Financial services that lack quality will not be effective tools to help the poor manage their limited and volatile resources.
Quality financial inclusion means that financial services are convenient, affordable, suited to client needs, and flexible. It also means that products are delivered in a sustainable manner, with strong client protection practices operating, and with dignity for clients.
The recommendations proposed by the Malegam Sub-Committee are focused on preventing client over-indebtedness. They include a loan size cap (Rp. 25K), an interest rate cap (24 percent), a limit on the number of MFIs that can serve one client (two), and the number of self-help groups that a person can be a member of (one). If passed into law, the recommendations would also require that 75 percent of every microfinance loan be used for income-generating activities. Finally, the proposed rules would make it hard for NBFC-MFIs to provide individual loans or develop other financial services.
These rules look like strong medicine for preventing over-indebtedness and protecting clients, but they would have debilitating side effects. If passed, they would move the Indian microfinance industry backwards in other aspects of quality, such as product suitability and flexibility, and even affordability and convenience in the long term.
If the medicine that the RBI decides to prescribe to alleviate problems of over-indebtedness comes with a list of negative side effects, at which point are the side effects worth the cure?
For Indian clients, the recommendations, if passed, could lead to consequences such as:
- Less access to financial services for the poorest (as a result of recommended income limits and restrictive interest rate caps)
- Less flexibility around how to use a loan, which can result in an inability to use the loan to cope with unexpected vulnerabilities
- Less access to appropriately sized loans and to flexible loan terms
- Less access to other financial services beyond credit
- Less convenience: more time spent traveling to institutions to repay loans and in group meetings
- Fewer institutions to choose from and less diversity of product offerings
- Less innovation around new products and methodologies
- Less transparency in pricing (resulting from interest rate caps, despite separate recommendations for improving transparency)
These trade-offs are not small, especially when combined. An Indian microentrepreneur might be safer from becoming over-indebted but she also might not be able to grow her business into a viable enterprise because she’s not able to access enough capital. A family that borrows to cover children’s educational expenses might have to go to less reliable and more expensive lenders to avoid mandates on how the money is used.
Most disappointing might be the fact that India’s mono-product microfinance model would become entrenched in regulations, with few prospects for offering the products clients need as much or more than credit: savings, insurance, and payments.
We hope that the regulations the Reserve Bank of India ultimately installs do not undermine the central purpose of financial inclusion, but instead help to nurture an industry focused on promoting the client’s well-being and freedom to choose among a range of quality financial services.
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