The Master Circular on Micro Credit – Reserve Bank of India

At last, after much serious consideration, consultation, thought and discussion, the Oracle of India on matters financial, has spoken. On last day of January (31) 2011, the Master Circular on Micro Credit was issued by the Reserve Bank of India (India’s Central Bank), ‘consolidating and updating all the circulars issued by the Reserve Bank on the subject’.

The document hits India’s microfinance sector at a time of crisis. Farmer suicides in Andhra Pradesh by alleged MFI borrowers due to massive over-borrowing, resulting in Indian politicians attacking the concept and its operators, for-profit microfinance institutions making humongous profits and also high value Initial Public Offerings (IPO) on the world’s stock exchanges has drawn criticism.

Yunus under scrutiny

In neighbouring Bangladesh, the Nobel Peace Prize Laureate Prof. Yunus and his assertion of microfinance ‘sending poverty to the museum’ at an early date is coming under the scrutiny of a politically-motivated Presidential Commission of Inquiry.

The Government has appointed a new Chairman to Grameen Bank, who has said that Prof. Yunus is no longer recognised as the bank’s Managing Director. He says that Yunus is way over the age of retirement prescribed for financial institutions and that although in 2000 when Yunus reached 60, he was elected Managing Director ‘indefinitely,’ the regulator never ratified that decision.

The international development community has set up an organisation called ‘The Friends of Grameen’ to defend Yunus and Grameen as well as the concept of microfinance from what they consider an unfair attack, consisting of high profile international development personalities.

The latest reports from BBC and Al-Jazeera are that the Central Bank of Bangladesh has ‘fired’ Prof. Yunus from Grameen Bank! The matter is now with Prof. Yunus’ lawyers.

Further, the Massachusetts Institute of Technology published research which claimed to show that in Andhra there was no credible evidence that women borrowers had been able to enhance their socioeconomic status by investing in human development aspects by having access to microfinance. All these factors seemed to attack the credibility of microfinance as a development tool.

Defining microfinance

The Master Circular begins with a definition of Micro Credit: ‘The provision of thrift, credit and other financial services and products of very small amount to the poor in rural, semi urban and urban areas for enabling them to raise their income levels and improve their living standards. Micro credit institutions are those, which provide these facilities.’

Compare and contrast this with the definition in the new draft law on microfinance the authorities in Sri Lanka have publicised, where in Part II Section 10(2) defines a microfinance business as the ‘acceptance of deposits and providing financial accommodation in any form and other financial services mainly to low income persons and micro enterprises’.

The Master Circular goes on to pinpoint the economic problem. ‘Despite the vast expansion of the formal credit system in the country, the dependence of the rural poor on moneylenders continues in many areas, especially for meeting emergent requirements. Such dependence is pronounced in the case of marginal farmers, landless labourers, petty traders and rural artisans belonging to the socially and economically backward classes and tribes whose propensity to save is limited or too small to be mopped up by the banks.’

Potential of SHGs

The importance of the role played in India by informal groups promoted by Non Governmental Organisations (NGOs) is mentioned in the Master Circular as proving that ‘Self Help Savings and Credit Groups (SHG) have the potential to bring together the formal banking structure and the rural poor for mutual benefit and that their working has been encouraging’.

The Master Circular states that India’s National Bank for Agriculture and Rural Development (NABARD) has launched a pilot project for promoting this linkage between SHGs and commercial banks by way of refinance, technical support and guidance to the agencies participating n the initiative.

The Master Circular repeats NABARD’s criteria for selecting SHGs for the programme – existence for at least six months prior, actively promoted the savings habit, either formally registered or informal groups. Advances given by Banks to SHGs were considered to be advances to ‘weaker sections’ of the community, a specified priority sector.

Studies conducted by NABARD, the Master Circular states, have brought out ‘encouraging and positive features like increase in loan volume of the SHGs, definite shift in the loaning pattern of the members from non income generating activities to production activities, nearly 100% recovery performance, significant reduction in transaction costs for both the banks and borrowers, 85% of the SHG’s linked with the banks through this programme were formed exclusively by women, etc.’

The banks were advised that ‘they may consider lending to SHGs as part of their main stream credit operations both at the policy and the implementation level. In reporting requirements the banks should include lending to SHG as part of their lending to weaker sections. SHGs unregistered and registered which are engaged in promoting the savings habit among their members would be eligible to open savings bank accounts with banks’.

The Master Circular reiterates the importance of training of field level officials of banks and the sensitisation of controlling and other senior officials of the banks on the linkage programme between SHG and banks. The banks should closely monitor the progress of the linkage activities.

The Master Circular states that the Task Force on Supportive Policy and Regulatory Framework for Microfinance set up by NABARD in 1999 recommended that the policy and regulatory framework should give a fillip to SHGs and NGOs engaged in micro-financing activities.

MFI operations

Based on the recommendations of the Advisory Committee on Flow of Credit to Agriculture and Related Activities from the banking system (Vyas Committee), in view of the need to protect the interests of depositors, MFIs would not be permitted to accept public deposits unless they comply with the extant regulatory framework of the Reserve Bank.

On the critical issue of interest rates – the Master Circular states that ‘the interest rate applicable to loans given by banks to MFIs organisations or by the MFI to SHG member beneficiaries would be left to their discretion’.

Consider and compare the provision on this aspect provided in the draft law on microfinance in Sri Lanka. In Part IV, Sec. 23 empowers the proposed Microfinance Supervisory and Regulatory Authority (MRSA) to specify, among other things, the rate of interest for any financial accommodation provided to any borrower by any MFI.

Interest rates

Fixing the rate of interest is fundamental for MFI operations. MFI lend to borrowers whose credit history and profile is well known to them. They know the risks they are assuming, it will change from borrower to borrower. Since MFIs have a geographical focus, they know the viability of the particular enterprise they are financing in that region.

In Sri Lanka borrowers have choice – MFIs, Cooperative rural banks, Samurdhi banks, commercial banks, State banks, thrift and savings cooperatives, finance companies and leasing companies, etc., all compete to deliver MF products to borrowers.

In such an environment interest rates are necessarily competitive; there can be no monopoly on microfinance. The discretion of fixing the interest rate must be with the MFI lender. It is not a figure which a regulator can determine. The RBI’s Master Circular has upheld this principle, notwithstanding all the pressure from Indian politicians to place a cap on interest rates charged by MFIs.

Liberalisation

The Master Circular refers to the work of the Task Force on Supportive and Regulatory Framework for Microfinance set up by NABARD in 1999, whose recommendations resulted in the relaxation of many stringent rules which applied to the sector as a step in the direction of liberalisation of the regulatory environment.

In the year 2000 the Master Circular states that a Micro Credit Special Cell was set up by the RBI in the year 2000, which issued guidelines for mainstreaming micro credit and enhancing the outreach of micro credit providers. The banks were allowed to formulate their own models to choose any conduit or intermediary for extending micro credit.

No criteria for selection of micro credit organisations were prescribed, but scrutinising their governance norms was recommended. Banks could adopt their own lending norms depending on ground realities. While no targets were prescribed for micro credit disbursement, the branch, block and state credit plan should include micro credit. A simple system requiring minimum procedures was recommended.

‘Total Financial Inclusion’

The Reserve Bank in its Review of Monetary and Credit Policy 2003/04, advised banks that they should provide incentives to branches to finance SHGs. The group dynamic of SHGs need not concern the bank. The approach to micro-financing should be totally hassle free and may include consumption expenditures.

The banks were cautioned on operating in the same geographical area as other banks and creating an environment of multiple lending. MFIs should be encouraged to build the capacity of SHGs. Adherence to transparency and best practices by SHGs was to be encouraged by the banks.

The Master Circular draws attention to the Finance Minister of India’s 2008 /09 budget speech where the encouragement to the banks to embrace the concept of ‘Total Financial Inclusion’ was clearly stated.

Positive document

Overall the Master Circular of the Reserve Bank of India on Micro Credit is a positive document promoting the outreach by banks to MFIs, NGOs and SHGs. It is in this aspect totally different from the ‘control, regulate, dominate and limit’ approach of microfinance regimes in other jurisdictions.

The attitude to civil society organisations is a very positive one in the Master Circular and is completely in contrast with the view of politicians and regulators in other parts of South Asia; witness how the Bangladeshi politicians are gunning for Grameen and the negative attitude to civil society capacity in other South Asian states.

Clearly the RBI has not taken to the anti micro finance approach of the Indian and Bangladeshi political class, described earlier. The role of microfinance in reaching the exemplary goal of Total Financial Inclusion in India has been clearly established.

All countries, including Sri Lanka, looking at ways and means to regulate microfinance operations and to enhance the role of microfinance in reaching the goal of Total Financial Inclusion, should closely look at the current economic environment in India on microfinance and the RBI’s Master Circular.

Supportive regulatory environment

Total Financial Inclusion is the target for which financial planners should aim. Microfinance is the instrument which has the capacity to deliver this. But to achieve Total Financial Inclusion of the poor and marginalised, the regulatory environment has to be supportive.

The link between the formal banking system and the microfinance sector must be strengthened. This the Reserve Bank of India has come to realise and categorically pushed the formal banking system to work closely with the Self Help Groups (SHG) at the bottom of the economic pyramid. One could only wish for this sort of enlightened thinking in neighbouring countries!

The elimination of financial exclusion is the last frontier in the war on poverty being waged as an economic struggle for economic liberation of the poor and marginalised. The Master Circular shows that facilitating participation is the way forward, not by marginalising and excluding civil society. It’s an ‘all hands on deck’ battle, and there is no way it can be won by marginalising and isolating those at the bottom of the economic pyramid and their organisations.

(The writer is a lawyer, who has over 30 years experience as a CEO in both government and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)