The microfinance sector in India has gone through turbulent times in the past couple of years. The southern state of Andhra Pradesh, the biggest market for the country’s microfinance institutions, was at the center of the storm, and populist moves by politicians led to mass default of loans of more than US$ 1.5 billion. Operations are almost at a halt there. The central government has now stepped in. The Microfinance Institutions (Development and Regulation) Bill, 2012 puts the Reserve Bank of India firmly in control of the sector. Vijay Mahajan, the president of the Microfinance Institutions Network of India and also the founder and chairman of the Basix social enterprise group talked to India Knowledge @Wharton about the implications of the new bill and the way ahead for the sector. The government has introduced The Microfinance Institutions (Development and Regulation) Bill, 2012. It allows the Reserve Bank of India (RBI) to fix the maximum interest rates microfinance institutions (MFIs) can charge. Given the cost structure for an MFI.

It is a pretty steep downward sloping curve. Assuming the borrowing rates are at around 13% to 14%, if you have a million customers, you could break even at 24%. If you have a half-million customers, you could probably break even at 26%. Anything less [than a half-million customers], you will not really break even at 26%. Earlier, the practice was that MFIs used to charge high interest rates in the initial years, build volumes, and then keep cutting the interest rates and eventually reach equilibrium. Now, like any other financial institution whether an insurance company or a bank, an MFI is also expected to finance its losses until break even through its equity. the RBI can do that, but as we have seen, the RBI has been very sensible. They have gone on a data-based decision. The Malegam Committee has recommended 24% and in a December 2011 circular, the RBI has mentioned a cap of 26%. This is a huge landmark [in the history of India’s microfinance sector] because this is the first time that the regulator has accepted that small loans can cost as much as 26%. This is a huge acceptance of the reality. And in all these eight months that the circular has been there in the public domain, there has not been a single criticism of it in the Parliament. While there have been many questions in the Parliament about the microfinance sector, there has not been a single question about interest rates.