Draft Bill Gives Indian Microfinance Industry a Shot at Reincarnation

The central government of India has released a draft microfinance regulation bill for comment. For an industry still reeling from the blow of last October's Andhra Pradesh Ordinance, the draft bill looks like very good news. The market sees it that way: shares of SKS popped up 20%.The purpose of the bill is not to regulate microfinance but to build a legal framework for doing so. So by and large it avoids specifics of the sort in the Malegam Report (which would be overly restrictive, in my view). One exception: the minimum capital required for doing business would be only 500,000 rupees ($11,250) instead of Malegam's more exclusive 150 million ($3.375 million). (Of course, other rules would probably require MFIs with bigger portfolios to have more capital.)Here's what I see as significant in the draft:

• It respects the microfinance industry's right to exist. Fundamentally, the Andhra Pradesh government, through legal and sub-legal actions (sending word to the villages that people should not repay), has worked to destroy the industry within its borders. And it has been succeeding: collection rates have plunged from 99% to 10% or so and several microfinance institutions (MFIs) are teetering toward bankruptcy. The draft bill legitimizes microfinance and microfinance institutions by defining both of those terms broadly and delegating primary regulatory authority over them to the Reserve Bank of India (RBI), the country's central bank.

  It shall be the duty of the Reserve Bank to promote and ensure orderly growth of the micro finance Sector in accordance with such measures as it deems fit, for the purpose of promoting financial inclusion.

• In so doing, the draft bill holds out hope that regulations will be adopted that will dispel the uncertainty that now plagues the industry.
• The draft emphatically asserts precedence over state laws, seeking in effect to render the Andhra Pradesh Ordinance null and void. It does this in two ways. First, it explicitly gives the RBI power to monitor and regulate most aspects of MFI behavior mentioned in the AP law, including disclosure of interest rates and loan collection practices. Second, it says so, point blank:

  The provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law. Explanation: For removal of doubts it is declared that micro finance services extended by any micro finance institution registered with the Reserve Bank shall not be treated as money-lender for the purpose of any State enactments relating to money-lenders and usurious loans. [emphasis in original]

  The reference to moneylending is key. Item 30 of the State List of the Seventh Schedule of India's constitution (page 323(!) of this rendering) gives states jurisdiction over "money-lending and money-lenders; relief of agricultural indebtedness." The drafters of the AP law consulted lawyers too, and anchored their edicts in this line of the constitution. Microcredit, in their view, is moneylending. The central government says it isn't. If Andhra Pradesh fights the center on this, then I guess the question will go to the Supreme Court. Perhaps it will not come to that since the Congress Party controls both the center and Andhra Pradesh at the moment. Or perhaps I've just revealed my ignorance of Indian politics.
• The draft bill mentions "thrift"---savings taking---as well as remittances and insurance as legitimate activities of microfinance institutions. I wonder if this will open the door to diversification beyond credit. As Beth Rhyne and Felix Salmon argued last fall, the legal confinement to credit made the industry brittle.

Should this bill lead to law, I foresee unforeseen consequences. The bill gives the government comprehensive powers to define microfinance, to monitor and audit microfinance institutions, to shut them down, and even to own parts of them. Historically, the Indian microfinance industry has wanted as little as possible to do with the government, and not without good reason. Now, chased by a state government, it has leaped into the arms of the central one. Therein may lie its salvation---or perhaps I should say reincarnation, into a different life, one that be easier in some ways and tougher in others.More coverage: Wall Street Journal, LiveMint, Economic Times.