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Approach:

  1. Intro – briefly state about India’s microfinance sector.
  2. Mention the challenges to microfinance industry arising from erstwhile regulatory framework.
  3. Mention RBI’s steps to remedy this.
  4. Highlighting the key difference b/w microfinance & digital lending, elaborate on the associated challenges in digital-microfinance sector.
  5. Conclusion with way forward.

The Indian microfinance industry has been shaped around unsecured, micro sized, medium tenured, group liability, livelihood related lending to women & their households who are entrenched in the informal cash-based economy in rural/semi-urban areas. Strong policy & regulatory support along with tested business-model have made micro-finance a socio-economic tool, reaching over 15 crore households over the last decade.

Challenges: However, over time, the regulations on microfinance framed around this model has faced two challenges – (a) regulations including customer leverage and pricing caps applied to just one class of entities, i.e., NBFC-MFIs, leaving out 2/3rd of lending by other regulated entities like banks, SFBS, etc.; (b) The microfinance lending model factored in borrowers’ household income in deciding lending amount/debt serviceability, it only considered individual indebtness and not household indebtness.

RBI action: The recent RBI regulatory update on microfinance addresses these gaps – it applies to all regulated lenders and unsecured lending to low-income (Rs. 3 lakhs/year) households. Also, it mandates lenders to factor both income and indebtness of the household with clear definition to avoid any arbitrage/misinterpretation in the market. Removal of cap on interest rates allows a risk-based premium pricing. The new regulation is a watershed moment in microfinance, shaping the market by entrusting the lenders with household income assessment, pricing, repayment thresholds within an overarching customer-protection framework.

In the past few years, the government’s pioneering stewardship of digital economy and direction for financial inclusion through progressive regulatory & policy framework and public infrastructure like a thriving data-ecosystem, have created a perfect mix for digital-lending with a socio-economic impact. While digital lending is still nascent, it is trying to assess & address the current emerging consumer needs.

Microfinance vs digital lending: Unlike microfinance, where lenders physically check household’s annual/monthly income to assess risk or repayment capacity, digital lending looks at individuals differently, verifying credentials digitally and lending-collecting digitally.

 Associated difficulties: However, there remains anxiety over the regulatory definition of microfinance loans extending to unsecured digital loans to an individual from low-income household. This necessitates the digital lenders to physically check an individual’s household income to assure if a loan is a ‘microfinance loan’. This is a litmus test, as verifying an individual’s household is an anti-thesis to its fundamental business existence. Also it raises questions on individual’s choice, consent and constraints in accessing credit involving family members. For pure digital lenders, this could be a double-whammy of process & paperwork for which their model is not built.

Thus entangling the digital-borrowing segment to the microfinance model can slow down and even, possibly undermine the potential of digital lending for financial inclusion.

To ensure responsible borrowing, FinTechs can build a credit-assessment framework for low-income consumers’ indebtness and borrowing capability that the microfinance sector can emulate. At the same time, further safeguards should be built into the digital lending ecosystem to make it safer for consumers, along with customer education & strong governance. The construct of the microfinance industry and that of digital lending is for-profit with positive social impact. The regulatory framework should drive the industry to deliver this purpose. True financial inclusion gives choices to consumers, including the right to say no to all.

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