Dvara Research BlogDvara Research Blog
Dvara Research Blog
Doorway to Financial Access
  • Home
  • Our Work
  • Themes
  • Subscribe
    • Email Subscription
    • Feed
  • Contact Us
Menu back  

Assam Crisis Brings to Fore Protracted Regulatory Issues in Tackling Borrower Debt Stress

February 3, 2021Leave a commentResearch Viewed : 286

By Amulya Neelam, Dvara Research

Over the past several months, there have been reports of growing debt stress among microfinance borrowers in Assam[1]. Reports of collection agents harassing the borrowers, especially women, for the non-repayment of dues, have led to protests and general social unrest in the area. The state of Assam has already been the subject of several shocks such as political protests, a natural calamity in the form of a flood, and not to mention, the ongoing pandemic[2]. The cascading of these multiple shocks, in turn, has led to an increase in delinquencies for both banks and microfinance institutions[3]. In response to these agitations, the state of Assam passed ‘The Assam Microfinance Institutions (Regulation of Money Lending) Bill, 2020’ with an intention to protect economically vulnerable people from microfinance institutions (MFI) and money lenders. This bill has provisions on, among others, the maximum limit of borrower indebtedness (significantly lower than the prescribed regulatory limit), the number of permissible MFIs lending to borrowers, and specifics on permissible recovery activities. These provisions directly challenge the authority of the Reserve Bank of India (RBI) which regulates banks and Non-Banking Financial Institutions (NBFCs) including NBFC-MFIs.

NBFC-MFIs are a separate category of NBFCs formed by the RBI based on recommendations of the Sub-Committee of the Central Board of Directors of RBI to Study Issues and Concerns in the MFI Sector (popularly known as the Malegam Committee)[4]. The creation of NBFC-MFIs was, in turn, a response to the financial crisis in Andhra Pradesh (AP) in 2010, where the State Government passed an Ordinance[5] to control the lending activities of banks and NBFCs in the state[6].  But the Malegam Committee wasn’t the first. There were attempts prior to this to regulate microfinance, albeit through a legislative route[7].

The immediate result of the AP crisis was a steep rise in delinquencies from pre-crisis PaR 30[8] figures of less than 4% to around 24% in 2011[9]. Further effects were that in the year after the ordinance, the Indian microfinance sector saw a decline of both overall loan portfolio and number of borrowers by around 20%[10], and a significant decline in the average household consumption in the AP region[11].

Such knee-jerk reactions to instances of harassment by microlenders of over-indebted households[12] deprive low-income households who have a legitimate demand for credit. It also begs the question of why citizens must shift to formal credit if basic protections cannot be provided to them in their interactions with lenders. As the events in Assam seem to be following a similar path as those in AP from a decade ago, it is incumbent upon the RBI to reflect on the issues plaguing the sector and to explore, beyond a cursory assessment of political risk, why such events that result in great costs to low-income borrowers and the providers of finance to them, keep recurring. We provide some analysis.

1. Unsuitable Indebtedness limits

At the heart of the recurring issues is a failure of the consumer protection mandate of the RBI to protect the interests of low-income household borrowers. NBFC-MFIs’ micro-lending is restricted by the RBI to households with up to Rs. 1.25 lakh income (rural) and Rs. 2 lakhs (remaining areas). The total borrower indebtedness is capped at Rs. 1.25 lakh, irrespective of whether the borrower belongs to a rural or non-rural household[13]. An estimation of the household debt-income ratio considering the average MFI interest rate and tenure shows us that these limits (which have been revised upwards multiple times since they were first introduced) are likely increasing the borrowers’ risk of over-indebtedness even if one were assuming stable monthly incomes and no expenses (see Table 1[14] on likely figures of household debt-to-income given the current lending criteria[15]).

NBFC-MFIs are permitted to lend up to an indebtedness limit of Rs.125,000 (this includes interest) to a single member of a non-rural household irrespective of the quantum of non-microfinance loans the borrower or her household already has. Assuming a conservative estimate that the borrower will take two years to repay the amount borrowed, and that this amount is in fact the upper limit allowed, then this implies that her annual indebtedness limit for microfinance loans is Rs.62,500 and that her debt-to-income ratio on an annual household income base of Rs.200,000 is 31.3%. If there are two microfinance borrowers in the household, which is quite common, the debt-to-income ratio will increase to 62.5%. For a rural household with a lower income base, the corresponding ratios are higher, at 50% and 100% respectively.

Table 1: Revisions to MFI Lending Criteria to Rural Households

In reality, expenses form a substantial portion of allocations for incomes[16] of low-income households. The average annual expenses for an Indian rural household belonging to the bottom 3 income quintiles[17] stands at 90% of income and that for an urban household is at 86%. The allocations do not reduce much for households belonging to the third quintile alone (71% and 74% for rural and urban respectively). If one were to make a more realistic calculation of debt-to-Income in the form of debt-to-disposable surplus of the household, all these households will be in the red, indicating that these prescriptions are not just wrong for the purpose they are meant to serve, but they also inflict egregious harms on India’s low-income households.

Further, making the matter worse is the incomplete picture of borrower indebtedness that is reported to credit bureaus. A 2016 study in the Krishnagiri district by Dvara Research showed that less than half of a household’s institutional debt is captured in the reporting to credit bureaus[18]. The study found that this incomplete credit profile led to about 33% of households being misclassified as being eligible to receive loans when in fact their indebtedness levels were above the prescribed total indebtedness limits.

Moreover, only NBFC-MFIs are subject to these debt-to-income limits as well as the multiple lending limit of having not more than two NBFC-MFIs lend to a borrower. These entity-specific regulations mean that other entities such as banks, including small finance banks, most of whom were earlier NBFC-MFIs, can lend beyond these limits to the same borrower, adding to their indebtedness.

In short, the prescribed indebtedness limits are unsuitable, and the issue worsens due to the lack of a complete picture of borrower indebtedness being required by / made available to lenders.

A possible solution

There have been efforts by the Microfinance Institutions Network (MFIN) to bring all lenders of microloans to adhere to a set of common guidelines under their ‘Code for Responsible Lending’ which is applicable to an extent to banks as well[19]. Additionally, MFIN also plans to bring in a 360° credit bureau report which provides information on all the members of the borrower household and not just the borrower alone[20]. However, these efforts will only solve part of the problem.

The RBI must categorically require all lenders to undertake an assessment of the borrower’s repayment capacity before sanctioning loans[21]. Such an assessment must take into account the disposable income and all repayment obligations of the borrower, without which, the provider’s lending may push the borrower into over-indebtedness even if the provider continues to adhere to the prescribed regulatory limits[22]. It is important that such a requirement be placed on all lenders (banks and NBFCs) and for all retail credit products (such as farm loans and MSME loans) and not just on NBFC-MFIs or only for microloans. No borrower must be over-lent by an entity simply because such a rule does not apply to them.

Once such a requirement is in place and the RBI builds some muscle to supervise the ability of lenders to undertake such assessments with the full seriousness that such assessments deserve,  the stipulation of a maximum number of loans or loan limits will become redundant and can gradually be removed. Needless to say, this would also help in creating intensified price competition in microfinance.

2. Inadequate credit market monitoring abilities of the supervisor

With the current supervisory system of returns in place for banks and NBFCs, the RBI has visibility only on the outstanding amounts in a region or economic sector on a quarterly basis. This means that it does not collect information on fresh credit disbursed every quarter. Without this, the RBI will not be able to track a periodically changing picture of the extent of lending, and any subsequent overheating in the credit ecosystem on a granular basis, such as for the various districts of Assam. Moreover, while the lender has visibility over the debt serviceability of its borrowers and the Credit Information Companies record borrowers’ outstanding credit and repayment behaviour, this information is not visible to the RBI[23] in a manner that it can be tracked at a sufficient level of granularity.

A possible solution

We propose that the RBI build capabilities to monitor credit markets at a granular level and in doing so, build in-house capabilities to detect and prevent regional or customer-segment level pockets of borrower debt stress. We propose a framework for the same (in Figure 1) with indicators at three different levels – 1) Market 2) Provider and 3) Borrower-level. Building data collection and analysis capabilities along the lines of this framework will provide the RBI an increased level of visibility over the level of indebtedness in the economy, as well as oversight of the credit markets [24].

Figure 1: Framework for Credit Monitoring and Detection of Over-indebtedness

Among the component indicators of the framework, is the borrower level indicator of debt service capacity ratio (DSR)[25], which could serve as an early warning indicator of difficulties faced by the borrower households in meeting their repayment obligations. For information on DSR to become visible to and usable by the RBI, we propose that all providers must capture and report the distribution of borrower DSRs across income segments to the RBI. Given that real-time tracking of DSR may not be feasible, other indicators in conjunction with the DSR can be used to provide reasonable visibility into localised overheating. For instance, a high number of loans per borrower is often correlated with the incidence of over-indebtedness. Therefore, capturing the distribution of this indicator (i.e., distribution of number of loans per borrower across income categories) could help tremendously to produce early warning signals for the RBI. Further, these indicators, when analysed together with market level indicators such as the credit-district GDP ratio as in the case of districts in Assam, would alert the RBI to signs of regional over-heating, based on which the RBI could intervene to slow down credit growth.

To conclude, we see that such regulatory and supervisory lapses affect both borrowers and providers in the credit market. Political parties in Assam are now calling for loan waivers of microloans. Such political decisions could further worsen delinquencies, the credit culture, and future credit prospects of borrowers. Therefore, it is imperative that these lapses be addressed by the RBI so that such crises do not occur as often as they do.


[1] Malik.S. (2020, February). Microfinance Lenders in Assam See the Biggest Jump in Stressed Assets in Q3. BloombergQuint. Retrieved from: https://www.bloombergquint.com/business/microfinance-lenders-in-assam-see-the-biggest-jump-in-stressed-assets-in-q3

[2] Nath.HK. (2020, December). Assam minister slams MFIs for harassing poor women over failed loan repayments. India Today. Retrieved from: https://www.indiatoday.in/india/story/assam-minister-slams-mfis-harassing-poor-women-over-failed-loan-repayments-1754685-2020-12-31;
Roy.S. (2020, October). Micro-credit collections in East, N-E lagging national average. Business Line. Retrieved from: https://www.thehindubusinessline.com/money-and-banking/impacted-by-covid-floods-mfi-collections-in-east-north-east-still-at-80/article32872563.ece

[3] Nahata.P. (2020, January). ICRA Flags Asset Quality Risks for Microfinance Lending in Assam. BloombergQuint. Retrieved from: https://www.bloombergquint.com/business/icra-flags-asset-quality-risks-for-microfinance-lending-in-assam

[4] See Report of the Sub-Committee of the Central Board of Directors of Reserve Bank of India to Study Issues and Concerns in the MFI Sector. Retrieved from: https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/YHMR190111.pdf

[5] See ‘Andhra Pradesh Micro Finance Institutions (regulation of money lending) Ordinance, 2010’. Retrieved from: https://indiamicrofinance.com/wp-content/uploads/2020/08/Andhra-MFI-Ordinance.pdf

[6] See commentary on the key aspects of the ordinance situation in 2010: Mor.N, Ananth.B. (2010, November). Andhra Pradesh Financial Crisis Threatens to Snowball into a National Crisis. Retrieved from: https://www.dvara.com/blog/2010/11/18/andhra-pradesh-financial-crisis-threatens-to-snowball-into-a-national-crisis/

[7] See ‘The Micro Financial Sector (Development & Regulations) Bill 2007’ which sought to designate NABARD as the regulator of the micro financial sector. Accessible from: https://www.prsindia.org/billtrack/the-micro-finance-institutions-development-and-regulation-bill-2012-2348

[8] Portfolio at Risk (PaR) 30 is the percentage of gross loan portfolio that is overdue by more than 30 days. 

[9] Mader.P. (2013, February). Rise and Fall of Microfinance in India: The Andhra Pradesh Crisis in Perspective. Strategic Change. Retrieved from: https://www.researchgate.net/publication/264487807_Rise_and_Fall_of_Microfinance_in_India_The_Andhra_Pradesh_Crisis_in_Perspective

[10] ibid

[11] Sane.R, Thomas.S. (2015, November). The real cost of credit constraints: Evidence from Micro-finance. The B.E. Journal of Economic Analysis & Policy, Volume 16, Issue 1, Pages 151–183, eISSN 1935-1682, ISSN 2194-6108, DOI: https://doi.org/10.1515/bejeap-2014-0154

[12] See commentary on the key aspects of the ordinance situation in 2010: Mor.N, Ananth.B. (2010, November). Andhra Pradesh Financial Crisis Threatens to Snowball into a National Crisis. Retrieved from: https://www.dvara.com/blog/2010/11/18/andhra-pradesh-financial-crisis-threatens-to-snowball-into-a-national-crisis/

[13] See ‘Qualifying Assets Criteria – Review of Limits’, RBI Notifications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT95A0F9E84CA85C4CE3A1ABA9B2E2459569.PDF

[14] Expanded from N.Kumar, D.George. (2019, October). Let’s stop kicking the can down the road: Highlighting the important and unaddressed gaps in microcredit regulations. Retrieved from: Dvara Research Blog | Let’s stop kicking the can down the road: Highlighting important and unaddressed gaps in microcredit regulations     

[15] See ‘Qualifying Assets Criteria – Review of Limits’, RBI Notifications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT95A0F9E84CA85C4CE3A1ABA9B2E2459569.PDF

[16] Unpublished work from Dvara Research’s Household Finance Research Initiative using data from the CPHS-CMIE survey. The averages have been taken for the period 2014 to 2019 to smooth out volatilities in individual years.

[17] The average annual income of rural households belonging to the bottom three quintiles is Rs.113,532. This roughly matches to the annual income limit of Rs.125,000 prescribed for microlending to rural households.

[18] Prathap V., Khaitan R. (2016, December).  When is Microcredit Unsuitable? Dvara Research Working Paper Series No. 2016-02. Retrieved from:  https://www.dvara.com/research/wp-content/uploads/2017/01/When-is-Microcredit-Unsuitable-Guidelines-for-Lending.pdf

[19] Ray.A. (2019, Sep). Lenders of micro loans to follow a responsibility code. The Economic Times. Retrieved from: https://economictimes.indiatimes.com/industry/banking/finance/mfin-sa-dhan-release-code-for-responsible-lending-for-micro-credit-industry/articleshow/71150442.cms?from=mdr

[20] See CARE Ratings Webinar – Is microfinance sector on the path of recovery post moratorium (51:23). (2020, August). CARERatingsOnline. Retrieved from: https://www.youtube.com/watch?v=2fIhdh6cLW4

[21] One of the good practices as highlighted by FinCoNet in its report on responsible lending is ‘Reasonable assessment of the interests of a consumer’ which states that credit providers and credit intermediaries must facilitate the provision of credit only upon the reasonable assessment that it meets the interest of the consumer, including affordability. See FinCoNet report on responsible lending- Review of supervisory tools for suitable consumer lending practices. (2014, July). International Financial Consumer Protection Organisation. Retrieved from: http://www.finconet.org/FinCoNet-Responsible-Lending-2014.pdf

[22] For a comprehensive description of business processes that MFIs can incorporate into their operations to reduce instances of borrower over-indebtedness, refer: George.D. (2019, February). A Practical Note on Operationalising Suitability in Microcredit. Retrieved from: https://www.dvara.com/research/wp-content/uploads/2019/02/Operationalising-Suitability-in-Microcredit.pdf

[23] Bhattacharya.D., Neelam. A., George.D. (2021, January). Detecting Over-Indebtedness While Monitoring Credit Markets in India: An Approach. Retrieved from: https://www.dvara.com/blog/2021/01/28/detecting-over-indebtedness-while-monitoring-credit-markets-in-india-an-approach/

[24] ibid

[25] Debt Service Capacity Ratio = (Income of the Borrower – Expenditure of the Borrower)/ Repayment Obligation of the Borrower

Share Via :Tweet about this on Twitter
Twitter
Share on Facebook
Facebook
Share on LinkedIn
Linkedin
Email this to someone
email
AssamBorrower debt stressBorrower level indicatorsFinancial Systems DesignMarket IndicatorsmicrofinanceMicroloansover-indebtednessProvider level IndicatorsRBI
Leave Comment

Cancel reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

8 + 17 =

clear formSubmit

Related posts
Making Grievances Matter: Unpacking Exclusion, Grievance Redress, and the Role of Civil Society Organisations
March 2, 2021
Access, Redressal & Finance in Uttar Pradesh: The Farmers in Rural Uttar Pradesh
February 19, 2021
Consumer Grievance Redress in Financial Disputes in India
February 18, 2021
Managed Care: Linking Health Care with Health Insurance
February 16, 2021
Our Response to the Report by the Committee of Experts on Non-Personal Data Governance Framework, December 2020
February 13, 2021
State of Financial Inclusion in Rural Tamil Nadu: Notes from the Field
February 12, 2021
Search
Recent Comments
  • Srikara Prasad on Artificial Intelligence in Digital Credit in India: “Thank you for the feedback and for sharing these resources, Mr Rathi. They will definitely be helpful in our work.”
  • Harshit Rathi on Artificial Intelligence in Digital Credit in India: “Hi, Wonderful article on the use of AI/ML for digital credit in India. As rightly mentioned in the article, many…”
  • Srikara Prasad on Artificial Intelligence in Digital Credit in India: “Thank you, Bindu. Our upcoming posts on regulation of AI in finance will benefit from these pointers. It will be…”
Subscribe and Follow Us

Popular Post

Popular Post
  • Making Grievances Matter: Unpacking Exclusion, Grievance Redress, and the Role of Civil Society Organisations
    March 2, 2021
  • Access, Redressal & Finance in Uttar Pradesh: The Farmers in Rural Uttar Pradesh
    February 19, 2021
  • Consumer Grievance Redress in Financial Disputes in India
    February 18, 2021

Categories

Categories
  • Channels(88)
  • Consumer Protection(33)
  • Events(30)
  • Featured(31)
  • Field Reports(6)
  • From the field(9)
  • General(22)
  • Guest(29)
  • Household Research(75)
  • Long Term Debt Markets(9)
  • News(45)
  • Origination(30)
  • Products(42)
  • Regulation(112)
  • Research(176)
  • Risk Aggregation(26)
  • Risk transmission(63)
  • Small Cities(21)
  • Technology(25)
  • Uncategorized(105)
  • Unemployment Support(5)

Archives

Archives
  • March 2021 (1)
  • February 2021 (8)
  • January 2021 (4)
  • December 2020 (7)
  • November 2020 (7)
  • October 2020 (11)
  • September 2020 (10)
  • August 2020 (12)
  • July 2020 (3)
  • June 2020 (5)
  • May 2020 (8)
  • April 2020 (4)
  • March 2020 (8)
  • February 2020 (3)
  • January 2020 (9)
  • December 2019 (4)
  • November 2019 (3)
  • October 2019 (7)
  • September 2019 (3)
  • August 2019 (2)
  • July 2019 (4)
  • June 2019 (4)
  • May 2019 (4)
  • April 2019 (7)
  • March 2019 (2)
  • February 2019 (3)
  • January 2019 (3)
  • December 2018 (5)
  • November 2018 (2)
  • October 2018 (5)
  • September 2018 (2)
  • August 2018 (2)
  • July 2018 (2)
  • June 2018 (2)
  • May 2018 (1)
  • April 2018 (1)
  • March 2018 (5)
  • February 2018 (2)
  • January 2018 (2)
  • December 2017 (5)
  • November 2017 (4)
  • October 2017 (3)
  • September 2017 (1)
  • August 2017 (3)
  • July 2017 (1)
  • June 2017 (3)
  • May 2017 (4)
  • April 2017 (3)
  • March 2017 (4)
  • February 2017 (3)
  • January 2017 (6)
  • December 2016 (5)
  • November 2016 (2)
  • October 2016 (3)
  • September 2016 (5)
  • August 2016 (4)
  • July 2016 (4)
  • June 2016 (8)
  • May 2016 (4)
  • April 2016 (5)
  • March 2016 (4)
  • February 2016 (3)
  • January 2016 (3)
  • December 2015 (3)
  • November 2015 (1)
  • October 2015 (2)
  • September 2015 (3)
  • August 2015 (5)
  • July 2015 (3)
  • June 2015 (3)
  • May 2015 (3)
  • April 2015 (2)
  • March 2015 (3)
  • February 2015 (1)
  • January 2015 (1)
  • December 2014 (5)
  • November 2014 (4)
  • October 2014 (3)
  • September 2014 (4)
  • August 2014 (4)
  • July 2014 (4)
  • June 2014 (8)
  • May 2014 (1)
  • April 2014 (4)
  • March 2014 (5)
  • February 2014 (6)
  • January 2014 (8)
  • December 2013 (7)
  • November 2013 (8)
  • October 2013 (7)
  • September 2013 (7)
  • August 2013 (5)
  • July 2013 (6)
  • June 2013 (7)
  • May 2013 (6)
  • April 2013 (8)
  • March 2013 (9)
  • February 2013 (6)
  • January 2013 (9)
  • December 2012 (8)
  • November 2012 (7)
  • October 2012 (5)
  • September 2012 (5)
  • August 2012 (5)
  • July 2012 (7)
  • June 2012 (4)
  • May 2012 (6)
  • April 2012 (4)
  • March 2012 (7)
  • February 2012 (6)
  • January 2012 (8)
  • December 2011 (8)
  • November 2011 (7)
  • October 2011 (8)
  • September 2011 (7)
  • August 2011 (3)
  • July 2011 (6)
  • June 2011 (11)
  • May 2011 (8)
  • April 2011 (9)
  • March 2011 (13)
  • February 2011 (10)
  • January 2011 (8)
  • December 2010 (10)
  • November 2010 (10)
  • October 2010 (10)
  • September 2010 (7)
  • August 2010 (13)
  • July 2010 (10)
  • June 2010 (6)
  • May 2010 (13)
  • April 2010 (7)
  • March 2010 (10)
  • February 2010 (5)
  • January 2010 (4)
  • December 2009 (3)
  • November 2009 (1)
  • October 2009 (6)
  • August 2009 (1)
  • July 2009 (2)
  • June 2009 (1)
  • May 2009 (1)
  • April 2009 (1)
  • March 2009 (1)

Share Via :Tweet about this on Twitter

Twitter

Share on Facebook

Facebook

Share on LinkedIn

Linkedin

Email this to someone

email

Site Map

www.dvara.com