India: Regulators calling for microfinance self-governance are part of the problem
Going round in lethal circles
News that India’s central bank has called on microfinance lenders to exercise restraint shows that regulators who expect the industry to police itself are part of the problem.
The deputy governor of the Reserve Bank of India, Rajeshwar Rao, is reported as having warned in February that the misuse of regulatory freedoms by microfinance lenders will prompt regulatory action. The central bank in 2022 removed caps on the margins earned on microfinance loans, and essentially allowed lenders to charge whatever they like.
RBI slams microfinance institutions for charging higher rates to borrowers (business-standard.com)
In many areas of regulatory activity, using a light touch and allowing new industries to grow before intervening only as and when necessary is no doubt a wise approach. Microfinance is a special case as the aim of the industry is to lend money at high interest rates to people too poor to borrow elsewhere. The industry makes the unevidenced claim that poverty reduction can be achieved as justification.
Microfinance has long since become a purely commercial industry. As such, there is no reason at all to expect the industry to go beyond the requirements which regulators lay down. Just like any other kind of commercial bank, the rational default of action for microfinance lenders is to do what regulators require of them, and no more.
The history of microfinance shows clearly that the poorest borrowers are those who suffer when regulators wait and see if abuses are going to arise. Of all places, this should be clear in India, where a spate of suicides in 2010 was connected with inability to repay microfinance loans.
The restrictions on microfinance lenders which the central bank unwound in 2022 were imposed after the suicides in Andhra Pradesh in 2010. The central bank had argued that this liberalised regime was needed to ensure a level playing bank between microfinance lenders and commercial banks - as if lending to the poor is the same as lending to affluent households and businesses.
Now, it seems, the central bank is starting to realise that if microfinance lenders are left to their own devices, there is no reason to expect a different outcome this time. The job of regulators is to regulate – borrowers of the future who have no other avenue of securing short-term liquidity have few other possible lines of defence.