Overview

The Reserve Bank of India (RBI), exercising its authority under Section 45L(1)(b) of the RBI Act, 1934, issued a cease-and-desist order against four NBFCs—Asirvad Micro Finance Limited, Arohan Financial Services Limited, DMI Finance Private Limited, and Navi Finserv Limited, which were engaged in microfinance loans —effective October 21, 2024. These entities are barred from sanctioning and disbursing loans until further notice.

Reason for Action

Key Violations include:

• Unfair and usurious lending rates.
• Non-compliance with regulatory guidelines on household income assessments and repayment obligations for microfinance loans.
• Breaches in Income Recognition and Asset Classification (IR&AC) norms, leading to the evergreening of loans.
• Issues with disclosure requirements, management of gold loan portfolios, and improper outsourcing of core financial services.

Impact on the Companies

The NBFCs are restricted from issuing new loans but may continue servicing existing customers and handling collections per regulatory norms. These measures aim to protect borrowers from unfair practices and promote transparency in lending.

The restrictions will persist until the NBFCs address deficiencies and comply with RBI guidelines on pricing, risk management, and customer service.

This article further examines the RBI’s regulatory norms for microfinance institutions (MFIs), focusing on interest rates and the assessment of household income during the credit evaluation process

Need to Know the Rules of RBI Vis-à-Vis Practices Being Followed on Some Issues Where RBI Has Concerns Related to Consumers’ Protection

• Interest Model in Micro Loan Under Old Regime and New Regime

  The RBI’s new directions from March 14, 2022, deregulated microloan pricing to encourage fairness, transparency, and competition. Previously, interest rates were capped with margins of 10–12% based on NBFC asset size, and most of the NBFCs used to charge  a maximum rate of 23.13% depending upon the borrowers profile.

  Now, NBFCs, banks, and other financial institutions determine interest rates using their models. Data from an SRO indicates that some MFIs charge 28–30%, with reports suggesting a few MFIs charging as high as 40%, according to an RBI executive director.

• RBI Norms Connected to the Interest Rate

  Under revised RBI guidelines, while interest rates are deregulated, microlenders are cautioned against excessive rates, which remain subject to RBI scrutiny. As per the RBI Scale-Based Regulations, 2023, all NBFCs, including MFIs, must adopt an interest rate model factoring in costs, margins, and risk premiums. This model must be published on their website as part of their Fair Practices Code (FPC) or separately.

  MFIs must:

  1. Establish a policy for interest rate determination, considering all cost components.
  2. Define the spread range across borrower categories.
  3. Disclose the maximum interest rate ceiling and other charges.
  4. Display the maximum, minimum, and average interest rates at offices and online.
  5. Notify borrowers of rate changes in advance, ensuring changes are prospective only.

• Customer Complaints Increased Manifold

  RBI’s Annual Report on Banking Ombudsman Scheme (March 2024) reveals an increase in complaints against NBFCs.
  Complaints related to the FPC rose to 56.41% in 2023, indicating widespread issues in loan and advance practices, such as differential interest rates and penalty charges for delays.

• Assessment of Household Income

  Under the RBI’s revised MFI Directions, 2022, MFIs must adopt a policy to determine household income, as microloans are defined for households with an annual income of up to ₹3,00,000. A household includes the husband, wife, and unmarried children. Household income determination ensures loan repayment does not exceed 50% of monthly income, including the loan under consideration. Guidelines include profiling household members, categorizing income into primary/other sources, and expenditure into regular/irregular types.

  MFIs must report household income to Credit Information Companies (CICs) to help other lenders avoid breaching the 50% repayment cap. SROs, such as Sa-Dhan, provide detailed methodologies to determine household income which includes verification of income documents, analyzing cash flow, checking business records, assessing assets, conducting personal interviews, and leveraging technology for data collection and verification. Cross-verification involves random sampling, internal/external audits, and field reviews triggered by alerts.

  Periodic training for field officers is mandated to improve income assessment. However, some MFIs rely on practices such as

  • Verify income documents (salary/wage slips) of borrower and family.
  • Check bank statements to assess the inflow outflow of funds.
  • Analyze cash flow and income-expenditure patterns of the borrower and family.
  • For entrepreneurs, review sales records, inventory, and vendor bills (last 6 months).
  • Assess asset ownership (e.g., house, vehicles) for income indication.
  • Conduct friendly personal interviews with the borrower, family, and group members (for group lending).
  • Use technology for data collection, verification, and decision-making.
  • Cross-verify income assessments via Random sampling, On-desk manager review, Internal auditor and compliance team review, External auditor review On-field assessment based on alerts/triggers.

Concluding Remarks

The RBI’s action against four NBFCs highlights its commitment to protecting borrowers and ensuring ethical practices in the microfinance sector. By addressing non-compliance with fair pricing, lending norms, and household income assessments, the RBI aims to curb exploitative practices affecting vulnerable borrowers.

Regulatory reforms like interest rate deregulation and mandatory transparent interest rate models promote a competitive and equitable ecosystem. However, rising complaints about Fair Practices Code violations indicate challenges in adherence. The RBI’s focus on over-indebtedness through strict household income assessments underscores the need for disciplined implementation by MFIs.

As the RBI intensifies enforcement in the microfinance space, lenders must upgrade their systems to meet regulatory standards and safeguard low-income populations effectively.

[Note: RBI recently lifted the ban on Navi Finserv Limited]