In the last 10 years, the financial sector has gone through the roof. FinTech’s size of the industry market was $584 billion in 2022 and is expected to reach $1.5 trillion by 2025. The skyrocketing growth is due to the important role played by the various financial institutions. Among these institutions, microfinance institutions (MFIs) and non-banking financial companies (NBFCs) are among the major components of growth. The primary objective of Micro Finance Institutions (MFIs) is to provide small loans to low-income people and, whereas Non-Banking Financial Companies (NBFCs) work on a broader spectrum aim at offering a huge and diverse range of financial services, including loans, asset financing and other means of investment to individuals as well as the businesses.
What are MFIs?
Micro Finance Institutions (MFIs) are financial institutions that aims at small loans, popularly known as micro-loans in a common parlance, to low-income groups. The main focus of the MFIs is to generate the income activities such as small businesses among economically disadvantaged groups. MFIs promotes the financial inclusion by extending credit to individuals and small businesses that lack access to traditional banking services.
According to the RBI, an NBFC-MFI is defined as a non-deposit-taking NBFC that holds at least 85% of its assets in the form of microfinance loans. These loans are restricted at a particular limit to make sure that it is accessible to low-income groups, examining whether they are rural or urban, as well as keeping the annual income of the borrower in mind.
Regulatory Framework of MFI
MFIs in India are primarily governed by the following:
- Reserve Bank of India (RBI): Although MFIs are not classified as banks, the RBI regulates them under specific guidelines, particularly if they fall under the category of Non-Banking Financial Companies – Micro-Finance Institutions (NBFC-MFIs). The RBI sets forth the rules for interest rate caps, borrower income limits, and the size of micro-loans, ensuring that MFIs remain focused on financial inclusion.
- RBI Master Directions for NBFC-MFIs (2011): Currently, MFIs classified as NBFC-MFIs follow the RBI’s Master Directions, which prescribe eligibility criteria, minimum capital requirements, and operational guidelines. These directions mandate that at least 85% of an NBFC-MFI’s assets should be in the form of qualifying microfinance loans.
- The Self-Regulatory Organizations (SROs): Apart from direct RBI, MFIs are also governed through self-regulatory bodies like the Sa-Dhan and MFIN (Microfinance Institutions Network). These SROs ensure ethical conduct, customer protection, and adherence to best practices across the industry.
What are NBFCs?
Non-banking financial Companies (NBFCs) are financial institutions that aim to provide a wide range of financial services like loans, asset financing, leasing, and investment products, but they do not hold a full banking license. It provides financial services not only to individuals but also to small businesses and large corporations, giving them a gateway to financial products that may not be readily available through traditional banking channels.
As per the Reserve Bank of India (RBI) Act, 1934, NBFCs are defined as financial institutions that engage in activities such as lending, investing, and asset financing without accepting demand deposits as banks do. NBFCs must maintain a minimum level of net-owned funds and are subject to regulatory oversight by the RBI. While NBFCs are not allowed to issue cheques or demand drafts like traditional banks in India, they play a significant role in bridging the credit gap between individuals and enterprises, especially in the areas and sectors that are underserved by traditional banks.
Regulatory Framework
NBFCs in India are primarily regulated under the following:
- Reserve Bank of India Act, 1934: The foundational regulatory framework for Non-Banking Financial Companies (NBFCs) comes from this act, which defines NBFCs and provides the legal basis for their supervision and regulation. NBFCs must register with the RBI and comply with its directives on capital adequacy, asset classification, and governance.
- Master Directions for NBFCs by RBI (2016): These guidelines issued by the RBI lay out the functional requirements for NBFCs that includes minimum capital, provisioning norms, and prudential regulations.
- The Companies Act, 2013:Â As NBFCs are the companies registered under the Companies Act, 1965/2013, the institutes are mandated by the parliament of India to adhere to the provisions of the Companies Act, 2013, which governs their formation, governance, and lays down reporting obligations.
- Credit Rating and Prudential Norms: Credit rating maintains the creditworthiness of a borrower that helps in maintaining the transparency and stability, NBFCs are required to undergo regular credit rating assessments and follow limits on credit concentration, liquidity management, and asset quality standards to keep an eye on the financial background and stability of the borrowers.
Key Differences Between MFIs and NBFCs
| Micro Finance Institutions (MFIs) | Non-Banking Financial Companies (NBFCs) | |
| It provides micro-loans to low-income individuals and small businesses, mainly for income-generating activities. | It provides a wide range of financial services that includes loans (personal loans, vehicle loans, home loans, gold loans, credit card services, and insurance services), asset financing, and investments to the individuals and businesses. | |
| It primarily focuses on providing credit for micro-enterprises and self-employment opportunities. | It operates across various financial services like loans, leasing, hire purchase, and asset management. | |
| It targets underserved, low-income groups, particularly in rural areas. | It targets a broad spectrum of customers, including individuals, small businesses, and corporations. | |
| It gives small loans, mostly below ₹1 lakh. | It provides small to large-scale loans depending on the type of service. | |
| It is regulated by the Reserve Bank of India. | It is regulated by the RBI under the RBI Act, 1934. NBFCs must also comply with the Companies Act, 2013. | |
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It is governed by the RBI Act of 1934, RBI Master Directions for NBFCs, and the Companies Act of 2013. | |
| In MFIs, at least 85% of total assets must be in the form of microfinance loans. | There is no such restriction as imposed on MFIs, asset composition can vary widely based on the business model. | |
| It focuses on ethical lending and consumer protection through self-regulatory organizations (SROs) like MFIN and Sa-Dhan. | The focus is on creditworthiness, governance, and transparency but is less specific to consumer protection than MFIs. |
Common Misconceptions
1. Misconception: MFIs Charge Extremely High Interest Rates than Conventional Banks
Reality: While it’s true that MFIs often charge higher interest rates (usually 25.99% p.a.) than traditional banks, the reason is attributed to the expenditure on operational, risk management, and the nature of micro-lending.
Solution: To address concerns about high interest rates-
- RBI can enforce transparency in pricing and establish interest rate caps for MFIs.
- Educate the borrowers about the cost structure, the reason behind the higher interests and the value of services provided by these institutes that can also help them make informed decisions.
2. Misconception: NBFCs Are Just Like Ordinary Banks
Reality: No, NBFCs are not banks. It cannot accept demand deposits and does not have the same regulatory framework as traditional banks. Though they offer similar financial services like traditional banks, the nature of its services, operation, management, and its regulations is way different than banks. NBFCs focus on particular section of the society that provides loans without hard core requirements and procedures.
3. Misconception: MFIs and NBFCs Are Only for Low-Income Borrowers
Reality: It is true that the primary target of the MFIs is only low-income individuals and micro-entrepreneurs. NBFCs cover a vast customer base that includes individuals from middle-income to businesses.
Conclusion
Microfinance institutions (MFIs) and non-banking financial companies (NBFCs) play a significant role in India’s financial ecosystem. Each works with the aim of increasing financial activities by targeting different segments of the market. Though RBI regulates both institutes, NBFCs are the corporate entities registered under the Companies Act 2013, which has to follow the regulatory framework of the statutes enacted by the parliament of India. The size of NBFCs is much higher than that of MFIs.
If you are an NBFC, MFI, or an individual who is looking for financial services, feel free to reach out to us. Our professional team is ready to assist you and pave your way to navigate through the complexities of financial services.
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FAQs
1. What is the main aim of Micro Finance Institutions (MFIs)?
MFIs aim to provide small loans to underserved individuals and small businesses to promote financial inclusion.
2. How do Non-Banking Financial Companies (NBFCs) differ from banks?
NBFCs offer financial services like loans and asset financing but do not hold a banking license and cannot accept demand deposits.
3. Are interest rates on loans from MFIs regulated?
Yes, the interest rates of MFIs are regulated by RBI.
4. Can a common man approach an NBFC for a personal loan?
Absolutely, NBFCs offer a variety of personal loans, including vehicle loans, home loans and gold loans.
5. Do MFIs need any collateral/security to issue any loan?
Many MFIs provide collateral-free loans to individuals having annual income up to Rs. 3,00,000/-
