MFIN nudges the RBI: Address overlaps between microfinance and digital lending

The Microfinance Institutions Network (MFIN) has requested the RBI to review and address the overlap between microfinance and digital lending. With an intention to strengthen consumer protection practices, MFIN wants fintech lenders to comply with microfinance lending guidelines.

What does it mean for the lenders?

1. As per the provisions of Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022 ("MFI Directions"), lenders are required to determine whether the personal loans being extended by them fall within the definition of microfinance loans. (Microfinance loans are defined under the? as - "a collateral-free loan given to a household having annual household income up to ?3,00,000."). Typically, lenders obtain a declaration from the borrowers on their annual household income and in most cases, based on these declarations, the loans end up falling out of the said definition.
2. As per MFIN, over 60% of digital lending is to low-income, new-to-credit (NTC) borrowers and over 50% of these loans should ideally qualify as microfinance loans. Seemingly, MFIN does not quite agree with the current approach being followed by the digital lenders. It will be interesting to see the RBI's take on this.
3. If it is so that majority of the fintech loans qualify as microfinance loans, the lenders will be faced with a new challenge of managing the "qualifying asset criteria". In simple words, NBFCs that have more than 75% of their net assets in the form of microfinance loans, ought to be registered as MFIs. Existing NBFC-ICCs, operating entirely in personal digital lending domain, will have to closely evaluate their qualifying criteria and take necessary steps to ensure compliance.
4. The limit of 50% on repayment obligations would require lenders to evaluate existing credit obligations of the borrower and accordingly structure the EMIs for the loan.
5. Typically, the pricing of microfinance loans is substantially lower than other personal loans. (Given the nature of personal loans such as BNPL, consumer lending, etc. lower IRRs may not be feasible for the lenders)
6. Lenders are not allowed to charge pre-payment penalty on microfinance loans.

What does it mean for the borrowers?

1. At credit evaluation level, additional checks for assessment of income may be introduced.
2. The aggregate amount of monthly repayment obligations (aggregate of all loan repayment obligations) will have to be limited to 50% of the monthly household income.
3. Impact on the interest rate and prepayment charges, as discussed above.

The convergence of microfinance and digital lending (aka digital microfinance loans) is growing faster than one could have expected. MFIN's concerns on the underwriting practices and the possibility of borrowers getting over indebted are well-reasoned. But, looking at the nature and end-used of such personal loans (which may be and many a times is clearly avoidable), will it be prudent to treat them at par with microfinance loans?