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BW Businessworld

Giving Away Turf

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The National Bank for Agriculture and Rural Development would seem to be just the institution to keep an eye on microfinance institutions. After all, it claims presence in every one of the country's 28 states and 391 districts; if its claim is correct, it has a far more comprehensive reach than the Reserve Bank of India. And normally, no government institution would forgo a chance of lording it over other institutions. We have seen enough turf battles; the sight of a government regulator running away from the battle is exceptional. The last chairman of Nabard, U.C. Sarangi, had the right institutional outlook: he was all ready to take over the regulation of all MFIs. Prakash Bakshi, who replaced him at the beginning of June, has, however, eschewed such ambition, and asked the Reserve Bank of India to regulate all MFIs.

The reason he gave was that Nabard lacked some things required to operate at the field level. If so, it is also in the best position to acquire them. The reason he left unexpressed was that the Reserve Bank is the regulator of the bigger MFIs which account for 90 per cent of lending; it might as well regulate the remaining 10 per cent. But the argument could be turned on its head; one could well argue that Nabard was set up as a specialised institution to promote rural lending and is the right institution to regulate all MFIs; it is time for the Reserve Bank to get out of something it has made a perfect mess of.

However, the reason for Bakshi's self-abnegation can be guessed from the context. If he were to take over regulation of MFIs, he would have to confront the strongmen of Andhra Pradesh government, who last December gave their district collectors the power to decide who should get loans from MFIs, who should repay, and when. Since the state government has taken charge, borrowers see no reason why they should repay MFIs, so repayments have shrunk to 10-15 per cent of the dues. Henceforth, microfinance will be a side business of Andhra politics. Nabard lacks the muscle to confront the Andhra musclemen.

Where Nabard fears to tread, the Reserve Bank has already waded into the morass. It appointed a committee; on its recommendations, the Reserve Bank laid down conditions that loans to MFIs had to fulfil if they were to be included in "priority sector lending" (indigenous banks are forced to give at least 40 per cent of their credit to the sector so called) and called "qualified assets". They could be only unsecured loans given to villagers with income under Rs 5,000 and semi-urban borrowers with income under Rs 10,000 a month at interest below 26 per cent; the first loan had to be less than Rs 35,000, and total loans less than Rs 50,000,  and if a loan exceeded Rs 15,000, it should not be repayable in less than two years. If the lender had borrowed the money, his lending rate should not be more than 12 per cent above his borrowing rate.

Thus the Reserve Bank imposed on the lender the impossible condition of finding out how much a borrower had borrowed from which lenders in how many loans. And irrespective of the creditworthiness of borrowers, it forced lenders to give out lots of small loans. In other words, it forced high costs on MFIs. It is doubtful whether these conditions can support a viable but honest business, and they are so complicated that it would be impossible for any regulator to verify whether these conditions had been met. That is why Bakshi did not want to take on the job of having to verify them. Let the Reserve Bank manage the mess it has created; that was his implicit message.

It is easy for Nabard to disengage itself from the Reserve Bank, but the villagers cannot. Reserve Bank will never mention it, but the principal source of funds for villagers is not its daughter banks, but moneylenders; what it is trying to regulate is the institutions that compete with moneylenders.

It is this objective that accounts for price control and margin control on interest rates, the minimum term and the insistence on absence of security against the loans. But these conditions it has laid down also define the borrower — one with a very limited capacity to repay. MFIs which try to serve him will be saddled with heavy administrative costs and subjected to considerable risk. So the Reserve Bank has confronted MFIs with a choice. Either they may enter the business of serving poor villagers and face severe regulatory constraints, or they may keep away from the poor and do business without having the Reserve Bank in their hair. It is obvious what those who want to do honest business will choose: keep away from the villager.

(This story was published in Businessworld Issue Dated 27-06-2011)