A commentary on the microfinance legislations

in India
Anish Shankar Menon
January 20, 2014

Abstract
This paper provides a commentary of the microfinance legislations
in India namely the Andhra Pradhesh Micro Finance (Regulation and
Money Lending) Act, 2011 and the Microfinance Institutions (Development and Regulation) Bill, 2012. It also analyses the legislations
and the benefits and costs that they hold for the various stakeholders.

Introduction

Microfinance was unregulated by any legislation for most part of its existence in India. Towards the end of the last decade, the Government of
Andhra Pradhesh (hereinfter the AP Government) passed the Andhra Pradhesh Micro Finance (Regulation and Money Lending) Ordinance, 2010 (hereinafter the Ordinance) and correspondingly the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Rules 2010 (hereinafter the
Rules). The Ordinance, which later became the Andhra Pradhesh Micro
Finance (Regulation and Money Lending) Act, 2011 (hereinafter the Act)
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was enacted as a response to what the AP Government felt was the growing
malpractice of the microfinance industry (MFI) in the State. In 2012, the
Central Government tabled the Microfinance Institutions (Development and
Regulation) Bill, 2012 (hereinafter the Bill) which dealt with the regulation
of the MFI in India. If passed, the Central Act would supersede the State
legislation in matters that are dealt in both legislations.
This paper tries to provide a clause by clause commentary of both the
Act and the Bill.1 It provides a comparative analysis wherein the provision
in the Act is analyzed first followed by the corresponding provision (if any)
of the Bill. The important sections exclusive to the Bill are then studied. In
the latter part, an analysis of the legislations is done and an attempt is made
to understand their impact on the various stakeholders.

The legislations at a glance

The Ordinance was promulgated on the fifteenth of October, 2010. The

Act was passed on the first of January, 2011 with retrospective effect from
the date of promulgation of the Ordinance. The Ordinance has twenty four
sections with forty one sub-sections while the Act has twenty five sections
with forty one sub-sections. Both the legislations have fourteen definitions.
The Ordinance and the Act are almost identical except for a minor difference
in one definition. In S 2(d) of the Ordinance, under the definition of Micro
Finance Institution, the Ordinance uses the term low income population
while the Act uses the term below poverty line population in the same
definition which is also numbered S 2(d) in the Act.
1

Note: Some clauses have been omitted from discussion if they are simple definitions
or are self explanatory without a need for interpretation. In this matter, the author has
exercised his personal choice and discretion.

The Bill is divided into twelve chapters. It has fifty two clauses and eighty
seven sub-clauses. It has eighteen definitions in S 2.
In the following section, the paper critically comments on each provison
of the Act and the Bill. First the section in the Act is looked at and then
the corresponding clause in the Bill is examined.

Commentary

3.1

Preliminaries

Section 1 of both the Act and the Bill provides the short title, commencement and extent of the legislations. It also elucidates the objective of the
legislations. The objective of the Act is to protect the women self help
groups (SHGs) from exploitation by the MFIs in the State of Andhra Pradhesh (AP). The Act clearly demonstrates that it was enacted as a reaction
to some event(s) that occurred in the State which expedited the need for,
according to the Government of AP, such a legislation. The title does not
seem to say that the Act is for regulating MFIs in the State. Instead it says
that it was enacted to protect women SHGs from explotation by MFIs. In a
way it assumes that MFIs are prima facie exploitative in nature which paints
such institutions in bad light.
The Bill on the other hand states as its objectives, the development
and regulation of MFIs. It is more broader in scope as it includes all rural
poor and people from certain disadvantaged sections. Another objective is
to promote financial inclusion. Though the Bill might too have been drafted
and floored in haste as a response to the Act, it is certainly more well thought
out.
The Act is applicable to the State of Andhra Pradhesh while the Bill
3

extends to the whole of India.

Another salient feature of the Bill is that it demonstrates the Central
Governments desire to bring MFIs under the regulation of the Reserve Bank
of India (RBI).

3.2

Definitions

Section 2 of both the Act and the Bill deal with definitions. This section
deals with important definitions in the Act and the Bill. The focus is on
definitions of common terms in the legislations.
Section 2(b) of the Act defines interest. Interest according to the Act
is only the return on the amount lent. However the Bill has a much wider
definition in clause 2(1)(a). It uses the term "annual percentage rate" and
which is an annualized rate of all amounts charged by the MFI including
interest, processing fees, service charges and similar fees. This means that
the MFIs according to the Act can charge higher rates as other fees and will
not be in violation of any provisions. A further reading of the Act shows
that only interest as defined by it is to be displayed. Hence the MFI can still
earn a high margin with fees other than interest in AP. (This is taken care of
by the Rules which defines effective rate of interest that includes insurance
and all other fees.)
Section 2(c) of the Act defines loan. The Bill does not have a definition of
loan but a similar definition for micro-credit facilities exist in clause 2(1)(h)
and clause 2(1)(j)(A) of the Bill. Both cases include advances in cash or
kind. However the definition in the Bill is much more comprehensive. In
fact the Bill defines microfinance activities in clause 2(1)(j) which includes
micro-credit facilities. The maximum loan amount in mentioned in the Bill
to be Rupees Five Hundred Thousand or such sum as may be mentioned by
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the RBI. Such a limit is not mentioned in the Act. In a way this shows the
Cenral Governments desire to entrust the control of MFIs to the RBI. The
reason would be driven by the fact that a considerable number of MFIs are
registered as Non Banking Financial Companies (NBFCs) which are already
under the control of the RBI. The Malegam Committee Report that was
a precursor to the Bill was also commissioned by the RBI. A loan would
include guarantees in the case of the Bill. Though not explicit in the Act,
loan could also be construed to include guarantees since the Act includes
payment on account of or on request of another person. Another noticeable
difference between the Act and the Bill is that, in the case of the Act, only
loans given to SHGs are covered. Reading the definition in entirety, it has
to be construed that any person would be either a member or having any
relation to a member of the SHG and not a third party. Such a limitation
however is not placed in the case of the Bill. The impact of this lies in the
fact that the SHG model is one of the many models of micro-credit delivery.
The Act affects only the SHG model of business. The other models do not
seem to be covered under it. This is sought to be remedied in the definition
in the Bill.
Section 2(d) of the Act defines a microfinance institution. The definition of the Act is not complete. It is open to questions of interpretation. For
example it includes a Society registered under the Andhra Pradhesh Cooperative Societies Act, 1964, or the Andhra Pradhesh Societies Registration Act
2001 and the like, in whichever manner formed and by whatever name called.
On reading this could be interpreted as being relevant only to societies. It
could further be argued that co-operative societies registered under different
legislations would also not be covered under the Act. It also means that
trusts do not fall within its ambit. All other microfinance activities such as

microinsurance, pension services and other similar functions generally carried on by MFIs are excluded. Only MFIs that lend to the below poverty
line (BPL) population are included in the definition. The difference between
a person below the poverty line and just above it in most likelihood is negligible. It could be inferred that the BPL status is determined by whether a
person holds a BPL card or not. This means that if the MFI lends to persons
without the BPL card are excluded from the definition. The definition uses
includes person. This could be construed as having the same meaning as
S 2(31) of the Income Tax Act, 1961. This means that even individuals are
included under this definition. The implication of this is that unregistered
moneylenders are also included under the ambit of the Act if they lend to the
SHGs as defined under the Act. However if such a reading of the definition
of person is made then trusts are also included. The Bill has a much more
clearer definition under clause 2(1)(i) and enumerates the forms of organizations that can be considered to be MFIs. It explicitly excludes individuals
who are registered moneylenders. It extends the breadth of the definition by
allowing the RBI to declare such institutions to be MFIs as it may deem fit.
Hence if the RBI so wishes, unregistered moneylenders too can be covered
under the definition in the Bill.
Section 2(g) of the Act defines registering authority. The project director
of District Rural Development Agency and of MEPMA is the registering
authority in case of rural and urban areas respectively. The district collector
may nominate a registering authority under his discretion also. In the Bill,
no such definition exists. However under clause 14 of the Bill, registration
must be done with the RBI as per regulations specified. In both cases MFIs
would be subject to multiple statutory requirements. For example a company
carrying on microfinance business would be governed by the Companies Act,

1956 and also the Bill. This would increase compliance and reporting costs
significantly.
Section 2(h) of the Act defines registration to mean registration of MFIs
under the Act. No corresponding section exists in the Bill but as mentioned
above S 13 of the Bill says that MFIs cannot conduct business without registration and clause 14 as mentioned above assigns the RBI as the registering
authority.
Section 2(i) of the Act defines defines a Self Help Group (SHG). According to the Act, an SHG has a few features. First, it should be formed by
women on principles of self help. It should also be registered aa SHG with
the Society for Elimination of Rural Poverty (SERP) in the rural areas and
the Mission for Elimination of Urban Poverty in Municipal Areas (MEPMA)
in urban areas. The Act targets a particular section of the people i.e., the
Government sponsored SHGs. What this means is that if the SHGs consist of
male members and/or is not registered under the aforementioned programs
then it is not covered under the Act. Though microfinance is predominantly
targeted at poor women, men too fall under its purview. The Bill therefore
does not define what a SHG is.
Section 2(j) of the Act defines SHG Bank Linkage. This is simply the
credit provided by banks to SHGs based on a micro credit plan prepared by
the SHGs for business activities. It thus does not include personal loans.
This also in a way suggests that MFIs are facilitators who essentially act
as intermediaries between the bank and the SHG and nothing else since
the economic plan must be developed by the SHG. The definition has no
mention in the Act apart from being defined and seems superfluous. A similar
provision does not exist in the Bill.
Section 2(k) of the Act defines a SHG member. Read in conjunction with

S 2(i) this would be a woman who is registered with the SHG and intends
to borrow though it. This clause causes some confusion as the SHG has to
be registered as per S 2(h) with the concerned authority. The registration of
the member would then be a second level of registrations where the member
registers with the SHG. The process of registration and documents for proof
of registration have not been mentioned in the Act. The Bill has a similar
definition of client under clause 2(1)(b). The definition includes members of
SHGs, MFIs or any other groups thus making it broader than the definition
in the Act. The client has to be a member of the institution only amd
registration is not compulsory. Also, in contrast to the Act, both men and
women can be clients.

3.3

Registration

Section 3 of the Act deals with registration of MFIs. Section 3(1) of the Act
requires that the MFIs in existence apply for registration within thirty days
of the commencement of the Act with the registering authority. They have
to furnish information of among other things of the interest rate that they
would charge. This interest rate cannot be called the effective interest rates
according to the Act since it only includes a return on the amount lent as per
the definition of the Act and does not include any fees or ancilliary charges.
However this lacunae has been solved by the Rules that defines effective rate
of interest to include all other charges. The MFI also has to provide details
of how it would conduct due diligence, recovery of balances and other similar
information. It also has to provide a list of people involved in collecting and
recovery of the loan amounts. This part of the provision is unclear since if
one were to interpret this provision broadly then everyone in the MFI would
be in the activity of lending and recovery of funds. If this was interpreted in
8

a narrow perspective then this would mean the people involved in the lower
levels where the loans are actually disbursed and recovery made. In either
case the exercise is futile since a reasonably high level of employee turnover
may be expected in a MFI and the Act does not indicate that any change in
employees should be notified to the registereing authority. Hence both the
rationale and efficacy of this part of the provision is questionable. Chapter V
of the Bill in entirety deals with the registration of the MFIs. As mentioned
earlier the registration authority is the RBI. Clause 14 of the Bill deals with
registration. An important point to note is that the section furthers the confusion created in clause 2(1)(j) of the Bill. Clause 2(1)(j) defines microfinance
services wherein it not only includes micro credit facilities but also pension
and insurance services among other services. Pension is regulated by the
Pension Fund Regulatory Development Authority (PFRDA) while insurance
is regulated by the Insurance Regulatory Development Authority (IRDA).
Service providers would therefore need multiple registrations.
Section 3(3) of the Act essentially means that the registration granted is
for a period of one year and has to be renewed after the end of the period.
A similar renewal is not envisaged in the Bill. The renewal would add to the
complexity and cost of operations of the MFI.
Section 3(4) of the Act deals with the grant of renewal of registration of
the MFIs. The provision says that the decision to renew or not will be takena
after assessing the performance of the MFI and after hearing objections if
any from the general public regarding the renewal. This provision could be
subject to a lot of misuse since according to it virtually anyone could object
the renewal of registration of the MFI. No corresponding provision exists in
the Bill.
Section 4 of the Act deals with the registering authoritys maintenance

of registers of all the MFIs under its jurisdiction. On reading the Rules, the
register (every jurisdiction will have only one register) contains a list of all
MFIs in that jurisdiction along with some relevant information like registered
address, area of operation etc. This register is open to the general public for
inspection. This provision is quite welcome since it provides all the important
information as regards MFIs at a single place. No corresponding provision
exists in the Bill.
Section 5 deals with the registering authoritys power to suspend or cancel
registration. Such suspension can be enforced for violation of any of the
provisions of the Act. This too is a provision that can be misused. The
registering authority can, suo moto or upon complaints of the SHG or its
members or on the complaints of the general public, suspend or cancel the
registration of the MFI after providing sufficient reasons and allowing the
MFI to be heard. This means that the registering authority can entertain
complaints made by anyone and initiate action against the MFI. Another
provision that is a cause of worry is S 5(2) of the Act which empowers the
regisration authority to suspend registration pending enquiry. Rule 11 of
the Rules that deal with the suspension seems unclear. According to it, the
suspension will be effected after giving the MFI the reason for suspension.
The suspension will then be followed by a notice and the enquiry will be
finished within fifteen days of providing the reason(s) for suspension. The
notice shall be issues as per Rule 10(2) which gives fifteen days for the MFI
to show cause. This means that there are two distinct documents that the
registering authority will send to the MFI. The first being the statement
of reasons and the second being the notice. Neither the Act nor the Rules
lay down as to within how many days would the notice be sent after the
statement of reasons is send. The term immediately seems vague. It would

10

be better if a time for sending the notice after the statement of reasons is
fixed. Section 16 of the Bill deals with cancellation of registration and is
much more well drafted. No suo moto action by the registering authority is
prima facie envisaged and clear conditions are laid out as to why cancellation
of registration may take place. Another point of difference is that in the Bill,
an aggrieved MFI has a clear method by which it could appeal against the
suspension or cancellation of its registration. Such a provision does not exist
in the Act. The Act however proposes the setting up of fast track courts for
the disposal of microfinance related cases in clause 15.

3.4

Matters relating to functioning of the MFI

Section 6 of the Act prohibits membership in more than one SHG. This
would limit obligations to multiple parties. In case of existing multiple memberships, the member can choose the SHG she wants to be a member of
and can send a notice(s) to the SHG(s) whose membership she wants to
terminate. The member must then settle the amount(s) outstanding to the
SHG(s) whose membership she has terminated within three months from the
commencement of this Act. This provision could cause a lot of hardship for
the member. Suppose a member has loans of |15,000 each from four SHGs
which she took a day before commencement of this Act. This provision would
essentiall mean that she would have to repay |45,000 within three months
which otherwise might have had a longer tenure. No similar provision exists
in the Bill.
Section 7 of the Act states that the MFIs must not obtain any security
from the member. Any security already obtained will stand released forthwith. An objective of microfinance was to provide loans to people who did
not have security. Hence this provision is in the spirit of microfinance lending
11

as envisaged by its founders. According to clause 2(h) of the Bill, a micro

credit facility is defined as a loan, advance, grant or guarantee without security. Hence this provision of the Act is welcome. No similar provision exists
in the Bill.
Section 8 deals with the public display of the interest rates by the MFIs.
Read in conjunction with Rule 14 of the Rules, the interest rate means the
effective interest rate. This is a welcome provision since the members would
be able to choose the MFI based on interest rates. A similar provision exists
in clause 26(3) of the Bill where the MFI has to clearly convey the annual
percentage rate to the borrower and this should be clearly mentioned in the
loan document or sanction letter as the case may be.
Section 9 of the Act is essentially the restatement of the rule of Damdupat
as stated in the Hindu law. This means that the MFI cannot recover interest
more than the principle amount. The maximum ceiling amount of the total
repayment of principle and interest is capped at twice the amount of the
principle. Any excess amount so recovered has to be refunded to the borrower and such borrower will stand discharged of the loan. No corresponding
provision exists in the Bill.
Section 10 of the Act prohibits further lending to an SHG or its members
without prior permission from the registering authority. It is true that this
provision will prevent further indebtedness of members. However this would
also delay loans to members who have a good track record and who require
funds urgently. Coupled with the fact that the members are prohibited from
joining multiple SHGs, this provision could cause distress in genuine borrowers. The procedure laid down in the Act for the top-up loan is long-winded
and would cause distress to the members who would in most cases require the
loan urgently. The MFI would be better equipped to assess the creditwor-

12

thiness of its members and should be given freedom in topping up existing

loans without permission subject to a cap. No similar provision exists in the
Bill.
Section 11 of the Act deals with the form of contracts between the members and the MFIs and the books to be maintained by the MFIs. The provision read along with Rule 20 of the Rules states that the terms would include
the repament of the loans in instalments whose periodicity is not less than
one month. Therefore the usual weekly repayments are prohibited. The interest too is calculated on a diminishing balance basis. Many MFIs used to
calculate interest on the total amount, add the same to the principle and
divide it into weekly instalments. The method envisaged by the Act would
therefore reduce the interest received by such MFIs. The MFI has to maintain a cash book and a ledger recording its transactions. A similar provision
exists in clauses 18 and 19 of the Bill. A formal set of books of accounts are
to be maintained by the MFI that would be subject to audit by a Chartered
Accountant or any other qualified person as determined by the RBI. The
RBI too has powers to inspect the books of accounts.
Under Section 11 of the Act, the MFI must also provide a statement to
the borrower that clearly shows all terms of the loan within seven days of the
loan being made. It must also provide receipts for repayments that are duly
acknowledged by the borrower. Any document relating to the loan must be
provided to the borrower if she makes an application in writing free of cost
(Rule (22)). Collection of repayments must be made at a public place. It
also prevents the deployment of recovery agents to recover the loans. Only
those employees mentioned in Form 1 are allowed to recover loans under
the provisions of the Act.2 A similar provision in the Bill is clause 25(2)(n)
2

Rule 24. Form 1 refers to the form in which the list of persons responsible for the
conduct of the business is to be provided to the registering agency and the problems

13

where the RBI can direct the MFI to disclose its acting as an agent for loan
collection. However there is no provision that asks the MFI to provide a list
of employees who are engaged in the activities of lending and recovery.
Section 12 of the Act makes it mandatory for the MFIs to submit a
monthly statement with information regarding borrowers, the amount lent
and the interest charged. A similar provision exists in clause 23 of the Bill.
However the periodicity of the returns and its contents are not specified.

Section 13 of the Act provides powers to the registering authority or any

officer authorized by him to call for records, enter the premises of the MFI,
search and seize any record and document. These are standard provisions
usually found in land revenue and tax laws and give wide powers to the
authority authorized to exercise it. Sections 100 and 102 of the Code of
Criminal Procedure, 1973 apply to the search and seizure. According to
Rule 26 of the Rules, witnesses can be summoned in accordance with the
relevant provisions of the Code of Criminal Procedure, 1973 and Chapter
X of the Land Revenue Act as the case may be. Two issues are of note in
this section. First is an example of careless draftsmanship. It should have
been record or document and not record and document. Second, the Act
should have provided for the number of days the seized documents could
be kept with the registering authority. Similar provisions exist in clause 27
(4)and (5) of the Bill. However powers of search and seizure are not provided
under the Bill. This might be incorporated at a later date or mentioned in
the rules that might be framed after the Bill has received assent.
Section 14 of the Act empowers the SHG, its members and any member
of the general public can register a complaint regarding any violation of the
associated with this has already been discussed while analyzing S 3 of the Act.
3
However the first return according to clause 23 of the Bill has to be filed within 90
days of the commencement of the Act (the Bill when passed).

14

provisions of the Act by an MFI with the registering authority. According

to Rule 28 of the Rules, this complaint has to be made in writing or over
the toll free phone specially provided for this purpose and an enquiry will be
made within seven days of registering the complaint. As mentioned earlier
in another instance, allowing the general public to register a complaint can
lead to a misuse of the provision. Grievance redressal is given under Chapter
IX of the Bill and the grievance redressal mechanism is yet to be formulated.
A marked difference between the Act and the Bill is that while in the Act,
proceedings may be initiated by the registering authority suo moto or on a
complaint by a member of the general public, in the Bill, no court will take
cognizance of an offence only on a complaint by an officer or any other person
authorized by the RBI. This would prevent a lot of vexatious litigation to
which the Act would be prone.4
Section 15 of the Act deals with the establishment of Fast Track Courts
to settle disputes between SHGs and its member, or the SHG and the MFI or
the members of the SHG and the MFI with regard to loans granted under the
Act. These courts are to be established in every district and its jurisdiction
determined. The cases have to be disposed off by the fast track courts within
a period of three months. The Act however does not mention as to where
the appeal from a fast track court lies. Hence assuming that the appeal lies
to the district court, then an additional three months is added to the legal
process. A similar provision does not exist in the Bill.
Section 16 of the Act deals with penalties for coercive measures. On
reading it seems that only those who actually have been party to coercive
practices shall be prosecuted. Coercive practices against the SHGs, members
or their family members are liable to be punished. The term family mem4
However in order to protect the interest of the clients, the Bill also classifies offences
related to the acceptance of thrift (defined later in the paper) and repayment as cognizable

15

bers is not defined and could lead to confusion. The term coercive action
is defined in this section. It includes among other things three clauses that
are loosely defined. One is doing any act calculated to annoy or intimidate
the second is frequenting the house or other place where such person resides
or works while the last is moving or acting in a manner which causes or is
calculated to cause alarm or danger. These clauses should be read in the
light of the fact that even a member of the general public can file a complaint.
This makes the clauses quite dangerous since misuse could be rampant. The
provision has a saving clause that exempts visits for collection or communication from the purview of this definition. However the onus of proving that
the visit was for the abover purpose would rest on the employee of the MFI
and would be quite difficult to establish in a court of law. The quantum of
punishment is a fine upto |1,00,000 and/or prison upto three years. Section
17 provides the same quantum of punishment for conducting the business
without registration or giving loans in contravention of the Act. However in
S 17, all persons responsible for the day to day affairs are liable for prosecution. Normally a saving clause exempting those acting without knowledge
and in good faith is provided after such a provision but there is none in the
Act. Section 18 deals with a general penal provision for contravention of any
other provision of the Act. The quantum of punishment in a fine of |10,000
and/or imprisonment upto six months. Rule 29 of the Rules further allows
the officer in charge of the local police station to take action for contravention of S 16 and/or S 17 either on complaint or suo moto. Chapter X of
the Bill deals with offences and penalties. The fines in the Bill are much
larger than those in the Act but the period of imprisonment is slightly less.
Coercive action is not defined in the Bill. Penalty for wilful misstatement,
furnishing wrong information and similar actions are similar to those in other

16

legislations. It is only when the rules for the legislation as enacted by the
Parliament are framed that the full list of offences will be clear.
Sections 20 to 23 of the Act are standard and protect officers who act
in good faith from prosecution, allow the Government to make and modify
rules etc. Section 24 of the Act requires that the Government prepare an
annual report on the administration of the Act which shall be tabled in the
Parliament. This would provide some accountability for the actions of the
Government especially in a law such as this which gives it sweeping powers.
There is no requirement in the Bill to prepare a report and present it in
Parliament. A reason for this could be that since the RBI is envisaged as
the authority responsible for the implementation of this legislation, it would
exercise adequate control over the operations of the MFIs. Similarily Chapter
XII of the Bill that deals with the miscellaneous affairs have provisions similar
to that of the Act in regard of the powers of the Central Government which
are quite standard.

Important provisions of the Microfinance

Bill in detail

The Bill follows a standard template in many ways. For example chapters II,
III and IV that deal with the institutional framework of microfinance administration follows a three tier approach similar to co-operative banks. Chapter
II deals with the establishment of the Micro Finance Development Council
(MFDC). The chairman is to be nominated by the Central Government while
the requirements for the other members are also laid down. The State Micro
Finance Council (SMFC) and the District Micro Finance Council (DMFC)
as provided for in Chapters III and IV also have similar structures suitably
17

scaled to their respective levels of functioning. The MFDC however has a

more advisory role while the other two have some implementation, supervisory and reporting obligations. A noteworthy point in the case of the DMFC
is as per clause 10 of the Bill, a representative of the lead bank is to attend
the meetings of the DMFC. A lead bank is defined in that clause to mean
a lead bank as assigned in the Lead Bank Scheme of the RBI. This again
shows the intent of the Government to link MFIs with the formal banking
system at a very fundamental level.
Chapter VI deals with provisions regarding reserves, accounts, audits
and returns. The audit provisions are standard. However the RBI has been
authorized to specify a percentage of net profits earned by the MFIs from
micro finance services to be transferred to a reserve. This accumulation would
in the future protect the clients of the MFIs. Since it is a reserve under the
RBI, MFIs would not fail to transfer the amount into the same.
Chapter VII provide detailed and sweeping powers to the RBI. These
include setting a cap on the margin and annual percentage rate.5 Further if
the RBI feels that the MFI is conducting business detrimental to the interests
of the clients then the RBI can virtually dictate all the business activities
of the MFI inclduing ceiling on number of clients, amount of micro credit
facilities, deployment of funds, locations and so on. Every aspect of the
business is included. In effect the RBI can run the MFI business in totality if
it feels that the business is run prejudicial to the interests of its clients. Such
powers can be justified in case of emergencies. However allowing the RBI to
fix a cap on the margin (effectively the profit) of the MFI seems unjustified.
All amalgamation and restructuring of the business would be done only if
the scheme is approved by the RBI. The Bill also talks about the conditions
5
Annual Percentage Rate has been defined above. Margin will be defined later in the
paper.

18

under which a MFI has to wind up its business.

Chapter VIII gives the details of the Micro Finance Development Fund
to be administered by the RBI and used for the development of microfinance
activities. The Central Government could encourage donations to this fund
by providing tax incentives for the donations.
Chapter IX deals with the dispute redressal mechanism. It is still not
comprehensive and only states that the ombudsman established under any
scheme of the RBI will be given the authority to deal with the disputes
related to microfinance.
Chapter X deals with offences and penalties. The maximum imprisonment is two years. However the fines are very large as in clause 34 where the
fine could extend to |5,00,000 and extend to |10,000 for every day the offence
continues. In addition, the RBI too can impose a fine that may extend to
|5,00,000.
Chapter XII deals with miscellaneous provisions. A particular provision
of note is clause 43 that specifies that member or clients of the MFI have
first charge over the assets of the MFI and shall be second in line to recover
their dues after the workmen of the MFI in case of any default.
A few definitions are of particular interest.
Clause 2(1)(h)defines margin. Margin is the difference between the cost
of funds and the annual percentage rate charged. The RBI has, through
powers conferred upon it, a right to set a limit on the margin. This essentially
is setting a limit on the profitability of the MFI. This would reduce interest
in MFIs as an interesting business opportunity. It has to be noted that as
per the Bill, the MFIs will operate in a highly regulated regime and would
spend a considerable amount on time and resources on compliance. The
Government must reconsider this as limiting profitability does not seem a

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reasonable step by the Government.

Clause 2(1)(j) defines microfinance services. It fixes the maximum limit
on a single individual borrower at |5,00,000 in normal cases and |10,00,000 in
exceptional cases. It also includes activities pension and insurance, domestic
remittances and thrift. Thrift is again defined in clause 2(1)(r) as any money
collected by MFIs from its members other than current account and deman
deposits. The definition is not quite clear but broadly referes to some sort
of savings that are made by its members. Hence in a subtle manner the Bill
also includes collection of deposits by MFIs in its definition of microfinance
services. However the RBI strictly regulates collection of deposits by Non
Banking Financial Services. The RBI may therefore propose a new structure
to govern the MFIs.

An analysis of the legislations

Microfinance is a medium for financial inclusion. The neccesity of legal protection is mainly due to the nature of the consumers of microfinance services.
A vast majority are not highly educated, have few or no assets and are extremely vulnerable to exploitation. The business model of microfinance is
built on mutual trust and supervision and hence the borrowers under societal pressure will repay the loans.
On the other hand the lenders (MFIs) too face huge risks in the conventional sense. Almost all the clients are those that are at the fringes or beyond
of the conventional banking system. They do not have collateral and hence
any loan made is not guaranteed. Promissory notes are in most cases insisted
upon but their utility is more symbolic and less practical. The MFI has no
further recourse in most cases if a client does not pay.

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Hence any legislation must include the interests of both these stakeholders.
The first question would be is regulation necessary? Though most will
be of the opinion that such an industry as microfinance has to be regulated,
there might be some who think otherwise. According to Cull, DemirgKunt and Morduch (2009) 6 , regulation moves microfinance institutions into
being banks. This means that the loan sizes on average increase and women,
who were the primary beneficiaries of microfinance, receive lesser loans. The
Government therefore has to see that microfinance institutions continue to
serve their target consumers.
There are many aspects to the analysis. Firstly, who will be the regulator of the MFIs? The Act has instituted the Registering Authority for
monitoring and implementation of the legislation. The Bill puts this onus on
the RBI. A seperate body focussed exclusively on the implementation of the
Act is beneficial to the clients. However in the case of the Bill, it is difficult
to hold RBI responsible for the functioning of the MFIs. The problem is
twin-pronged. First, the RBI is the super regulator of the financial system
especially banks and hence should not be burdened with micro-management
of institutions. A seperate body may be set up for the same. Second, with
the RBI oversight, MFIs are accorded the nature of pseudo-banks, which
they are not. It must not appear that MFIs are bank-like institutions. In
the criticism of the Bill, the Government of Andhra Pradhesh notes that the
Bill describes MFIs as extended arms of banks. MFIs are for profit instititions and must therefore not be confused with banks just because they are
6

Robert Cull, Asli Demirg-Kunt and Jonathan Morduch (2009), Does Regulatory
Supervision Curtail Microfinance Profitability and Outreach?, Policy Research Working
Paper 4748, The World Bank Development Research Group Finance and Private Sector
Team

21

associated with them.7

An important requirement of a financial institution is capital adequacy.
The Act is silent on it. This means that any person can start a MFI and
operate in Andhra Pradhesh (AP) without having adequate capital to cover
its loans. NBFCs have a minimum capital prescribed by the RBI. However
other forms of organizations do not. It might be true that the Act is quite
strict towards MFIs and prescribes severe punishments for transgressions, it
however does not have a mechanism by which capital adequecy is assured.
Due to this investors might not be willing to provide capital to MFIs. The
Bill on the other hand takes care of this problem by mandating the RBI to
prescribe the capital adequacy requirements for the MFIs.
Asset quality is another important factor in the case of financial institutions. Non-Banking Finance Companies (NBFCs) have asset quality requirements that are overseen by the RBI. However other forms of organizations
have no such requirement mandated upon by them by the respective legislations that govern them. Unifying the structure of organization will bring
uniformity to this matter. This would also benefit the MFIs since those banks
and investors who provide them with funds and capital will be reassured of
the strength of their financials.
With regard to conduct of business, the Act is silent in the sense that
it only specifies what is not to be done. In no way does it provide for any
support to the MFIs in the conduct of the business. This stems from the fact
that the AP Government believes that the MFIs act against the interest of
the poor as is evidenced in their comments on the Bill. However this model
is unsustainable. If MFIs do not receive adequate support then it will not
be possible for them to conduct business. The contract between a borrower
7
?The Micro Finance Institutions (Development and Regulation) Bill 2011: Comments
of Government of Andhra Pradesh

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and a lender is a private contract. Undue influence from external forces will
disrupt the delicate foundation on which it is built. If a borrower defaults
on purpose and the law does not protect the lenders interests then there
is a veritable mockery of the principles of equity and justice. On the other
hand the Bill recognizes the fact that there has to be a balance of interests
and hence has provided for the development of the microfinance business as
a whole.
Another contention limited to the conflict between the Central and State
legislation is the Constitutional validity of the Bill. The State argues that
according to List II (item 30), moneylending is a State subject. Though this
argument has some merit, microfinance encompasses credit provising and
includes many other activities in its domain. Hence the argument can be
countered. Another argument is that the Bill expressly excludes MFIs from
the ambit of moneylenders hence impinging upon the States jurisdiction.
This argument is not strong since according to Becker (2013) microfinance
was traditionally kept out of the definition of moneylenders due to which
state governments found it difficult to control.8 Besides most institutions
are not run as sole proprietary firms and are covered under the ambit of one
legislation or the other. The bigger question that the lawmakers need to
think about is how are the poor protected. This can be done by providing
for provisions specifically for the same in the Act and Bill themselves. As a
matter of fact there are many provisions in both the Act and the Bill that
protect the consumers right from usurious rates of interest to harrasment
from MFIs on issues of collection of instalments.
On the question of interest rates, both the Act and the Bill have different
8

Ashley Becker (2013), "Micro-Management": Constitutional and Policy Concerns

Arising from Indias Microfinance Institutions (Development and Regulation) Bill Northwestern Journal of International Law & Business Vol. 33 Iss. 3

23

points of view. The Act does not have a very comprehensive definition of
interest (a matter settled by the Rules). It also does not speak of interest
rate ceiling. The Bill however provides for interest rate ceiling. According
to the Key Principles of Microfinance enunciated by CGAP 9 , interest rate
ceilings are detrimental to the interests of the poor since the interest rates set
by the Government are usually low and the MFIs are not able to cover their
costs. This is a problem where the solution lies in balancing interests and
can only be fulfilled in practical operation. The regulator could give broad
guidelines for interest rate determination but need not fix a ceiling rate. If
this is constantly monitored then a reasonable solution can be arrived at.
On the question of multiple lending both the Act and the Bill have quite
clear provisions. These provisions are necessary since in many cases, microcredit is less of a need and more of a liability thrust upon the poor. Multiple
lending institutions provide loans to the same person thus magnifying her
indebtedness. This could be avoided if a central database was constituted
with the names of every borrower and other basic details. This exercise
could be done in collaboration with a central data collection and processing
agency. This would not only prevent cross-lending but also provide a detailed database for the authorities who can use it to formulate better policies
of financial inclusion.
Both the Act and the Bill explicitly prohibit MFIs from asking for collateral. Microfinance essentially began with the idea of providing loans to
people who could not avail conventional credit for various reasons, one of
them being their lack of pledgeable collateral. Hence the practice of taking
collateral goes against the basic tenets of microfinance and has been done
away with by the respective legislations. However both the Act and the
9

See http://www.cgap.org/sites/default/files/CGAP-Consensus-Guidelines-Key-Principles-of-Mic

pdf

24

Bill though providing for recourse against the lender for coercive practice
does not provide any rules in case the borrower defaults. This could lead to
willful default on the part of the borrower. The law should be fair to both
parties and hence there must be some provision that lays down the rules for
collection and subsequent procedure in case of default.
With reference to various offences including those that deal with usurious
rates of interest and coercive practices of loan collection, the Act is much
clearer than the Bill. It provides detailed descriptions of acts that could
be construed as a violation of its provisions and the penalty for the same.
The Bill however does not provide for the same. It would not be correct in
commenting on the inadequacy of the Bill in this matter since the rules for
the same are yet to be formulated.
The redressal mechanisms of the legislations need a mention. According
to Sane and Thomas (2012)

10

the Bill does not provide recourse to the

aggrieved under the Bill to appeal to the civil and criminal courts without
the express permission of the RBI. This point though valid can be argued
against since the aggrieved have their fundamental rights enshrined in the
Constitution to apply under writ to the High Court and Supreme Court.
The Act envisions special fast track courts that would be ancilliary to the
existing judicial system.
The Act and the Bill both represent microfinance legislations enacted (or
to be enacted) to regulate microfinance in India. However there arises a
constitutional issue with AP claiming that the centre has impinged on its
powers of lawmaking. According to Becker (2013), the differences in the two
legislations will not sort out once the Bill is enacted. The Bill is necessary
10

Renuka Sane and Susan Thomas, What should regulation do in the field of microfinance?, IGIDR Working Paper, 2012, http://www.igidr.ac.in/pdf/publication/
WP-2012-012.pdf

25

for the microfinance industry in India to flourish, the reason being that it is
an industry with great promise and potential but little governance and regulation. Considering the nature of business and the customers involved, the
Government must draft a legislation that finely balances consumer protection
and business advancement.

Conclusion

Andhra Pradhesh Micro Finance (Regulation and Money Lending) Act, 2011
was in response to the perceived microfinance crisis in AP. The Microfinance
Institutions (Development and Regulation) Bill, 2012 was in response to this
Act. The legislations were knee jerk reactions and hence do not seem to be
quite comprehensive and well drafted. The Bill still needs to be revised and
many changes need to be made. Microfinance is a large business in India
with immense growth opportunities. A well drafted legislation would go a
long way in achieving this potential.

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