Microfinance Story of India

Gauging household income key for microfinance clients

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Definition of microfinance

Mains level : Paper 3- Making household income critical variable for loan assessment

Context

The Reserve Bank of India’s (RBI) recently released a Consultative Document on Regulation of Microfinance in June 2021.

Consultative document makes household income a critical variable

  • Following the Malegam Committee Report, which is a decade old now, the current document looks to reassess and realign the priorities of the sector.
  • Some of the key regulatory changes proposed in the document take household income as a critical variable for loan assessment
  • Definition of microfinance: The definition of microfinance itself is proposed to mean collateral-free loans to households with annual household incomes of up to ₹1,25,000 and ₹2,00,000 for rural and urban areas respectively.
  • Household income assessment: The document requires all Regulated Entities to have a board-approved policy for household income assessment.
  • Cap on repayment: It caps loan repayment (principal and interest) for all outstanding loans of the household at 50% of household income.
  • Therefore, measuring household income accurately becomes critical for the effective implementation of these norms.

Challenges in measuring the income of Low-Income-Household (LIH)

  • Seasonal and volatile: Low-Income Households (LIHs), who typically form the customer base for Microfinance Institutions (MFIs), often also have seasonal and volatile income flows. 
  • Measuring expenditure doesn’t reflect their income: Since income for LIHs is seasonal and volatile, there have been attempts to understand their inflows by measuring their expenditure.
  • But, given the rotational debts they avail to fund a consumption expenditure here and a loan repayment obligation there, expenditure also does not truly reflect the household’s income.
  • Not separate personal expenditure: Moreover, for most LIHs, their expenditure on income-related activity is not separate from their personal expenses.
  • Therefore, it is difficult to separate the household’s personal expenses from that of their occupational pursuits.
  • Given these complexities, we need to understand and accept that for the bulk of LIHs, household finance is not just personal family finance, but their business finance as well.

3 ways to measure household income for microfinance client

  • Structured survey approach: A structured survey-based approach could be used by Financial Service Providers (FSPs) to assess a household’s expenses, debt position and income from various sources of occupation and seasonality of income.
  • Template-based approach: A template-based approach could be used wherein FSPs could create various templates for different categories of households (as per location, occupation type, family characteristics, etc.).
  • These templates could then be used to gauge the household income of a client matching a particular template.
  • Centralised database: FSPs could also form a consortium to collect and maintain household income data through a centralised database.
  • This would allow for uniformity in data collection across all FSPs and, over time, can be used to validate the credibility of any new client’s reported income.
  • Such a database would also enable FSPs to track the changes in household income over time.

Way forward

  • Use technology: Finding cost-effective yet accurate ways of capturing this information becomes crucial.
  • Creating new technology to document and analyze cash flows of LIHs would not only facilitate credit underwriting but also innovation in the standard microcredit contracts through customized repayment schedules and risk-based pricing, depending on a household’s cash flows.

Conclusion

Eventually, an accurate assessment of household-level incomes would avoid instances of over-indebtedness and ensure the long-term stability of the ecosystem.

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