Mumbai: Indian microfinance institutions (MFIs) may soon be allowed to collect small deposits, or thrifts, from borrowers once the new national regulation on the crisis-gripped sector comes into play.

Small deposits: A file photo of an MFI area manger at a meeting with borrowers in a village near Mysore. By Hemant Mishra/Mint

MFIs are institutions that provide tiny loans to the poor at 24-36%, nearly double the rate at which they borrow from banks, citing high operating costs.

The new legislation, the Micro Finance Institutions (Development and Regulation) Bill, will also give sole regulatory status to the Reserve Bank of India (RBI) to govern the sector and overrule all state-level legislation including the controversial Andhra Pradesh microfinance law, a finance ministry official said, requesting anonymity.

The ministry last week finalized the structure of the legislation, which will be moved to the cabinet in the next two weeks, after the law ministry takes a look at it, the official said.

“RBI will be the sole regulator for the sector, and MFIs will be allowed to collect thrifts from self-help groups (SHGs)," said the official, who was part of the committee that finalized the draft. “Also, it’s logical that the new legislation will overrule all state laws on the subject."

SHGs are typically groups of six-seven women who save and lend within the group. SHGs also borrow from banks and lend at a margin to its members.

The government has gone ahead with its decision to allow MFIs to collect thrifts from SHGs despite stiff RBI opposition. The Indian central bank cited concerns on the safety of the money deposited with microlenders.

The move to allow MFIs to access public money is significant as once they are allowed to collect money from the public, they can bring down cost of funds. Typically, MFIs source 60-80% of their funds from banks and the remaining from private investors.

Although allowing MFIs to collect deposits could help them bring down cost of funds and improve margins, they will face competition from commercial banks, analysts said.

“MFIs will face stiff competition from banks to get a share of public money. They have to beef up branch operations to mobilize such small deposits," said Hatim Broachwala, an analyst at Fortune Financials, a Mumbai-based brokerage. “But overall, it could bring down their cost of funds."

“This can really benefit MFIs as the cost of funds can be brought down and can thus sustain within the interest rate cap prescribed by RBI," said Kishore Kumar Puli, managing director and chief executive officer of Trident Microfin Pvt. Ltd and head of industry lobby Microfinance Institutions Network’s Andhra Pradesh chapter. “This will also encourage microlenders to actively involve in the financial inclusion."

Also, with the new law promising to overrule the controversial Andhra Pradesh law and other state legislation, it will be easier to do business for MFIs operating in multiple states, Puli said. “Operating in multiple states is extremely difficult for MFIs if all states start promulgating different laws."

Andhra Pradesh, which accounts for a quarter of India’s 20,000 crore microlending sector, promulgated a law in October 2010 to control MFIs after a series of suicides were reported in the state because of alleged coercive practices used by some lenders to recover money.

The law, which prohibited MFIs from collecting weekly instalments from borrowers, carrying out doorstep business, and giving a second loan to the same borrower without government approval, resulted in collection rates of MFIs dropping to 5-10% in the state and forced them to stop giving new loans.

The situation worsened when opposition political parties unleashed a statewide campaign asking people not to repay the loans. Due to the uncertainty, banks, too, stopped giving loans to MFIs.

The crisis had a telling impact on Andhra Pradesh-based MFIs, mainly India’s lone listed microlender, SKS Microfinance Ltd, which saw its loan book nearly halving to 2,635 crore in September this year. Ever since the firm got listed in August 2010, its shares have lost more than 80% of their value.

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