Micro-mismatch

The draft Micro Finance Institutions (Development and Regulation) Bill, meant to provide a legal framework to an otherwise unregulated sector in the Indian financial system, is an attempt to over-regulate and micro-manage the microfinance sector. The draft can at best be termed a mimic of legislation on usurious practices and moneylenders that is in place in several states of the country. Buzzwords such as "systemically important" replace "exploitation", "expropriation" provides the modern setting to justify pervasive regulation. The draft bill adds a retrograde touch to the stalled process of financial sector reforms. The bill, if made law, will reduce competition in this industry as it hopes to regulate net margins. It will limit new entry into the industry. From the point of view of the customer, such regulation can push customers back to moneylenders who will now be outside these regulatory requirements.

The present draft represents the microfinance industry as "extended arms" of banks, allowing for bank-like regulatory architecture for microfinance firms. This could potentially stall any progress in the microfinance industry. Capital adequacy requirements work for banks and not for non-deposit-taking financial institutions. In allowing a regulator to set "capital adequacy based on risk weights for assets and deployment of funds", the draft bill fails to recognise that not all microfinance companies are deposit-taking, and even if so, the extent of deposit-taking, by virtue of the business model itself, is limited to and well below the maturity mismatch possible in its balance sheet. Prudential norms for banks lending to microfinance companies are already in place. Financial regulation is required to contain systemic risk and protect consumers. Systemically important microfinance institutions cannot be defined in terms of the number of clients they cover, but whether the failure of the institution could bring down the financial system altogether and, consequently, impact the underlying real economy. This is not an issue the microfinance industry poses today. The real issue is that of customer protection. An issue of consumer protection does not require micro-management of the business enterprise, but an effective arrangement to ensure that contracting parties are doing so knowing fully the consequences of non-adherence. The government may do well by looking into consumer protection more carefully than stifling microfinancial innovation.

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