Summary of Regulation In India
- REGULATED ENTITIES
- Commercial Banks
- Non-Banking Financial Companies-MFIs (NBFCs-MFIs)
- All other NBFCs (if not registered with RBI, microfinance activities may not exceed 10% of total assets)
- TYPES OF REGULATION
- Prudential and non-prudential regulation for Banks, Deposit-taking NBFC-MFIs and Non-Deposit taking NBFCs
- Non-prudential regulation for other credit organizations
- LIST OF TRUTH IN LENDING ACT
- Reserve Bank of India Circular- NBFCs -MFIs -Directions-2014-02-07
- Reserve Bank of India Master Circular on Non-Banking Financial companies -MFIs -2013-07-01
- Reserve Bank of India Circular on Non-Banking Financial Companies –MFIs – Margin Cap-2013-05-31
- Reserve Bank of India Circular on Non-Banking Financial Companies -MFIs – 2012-08-03
Truth-in-lending Legislation in India
The Reserve Bank of India (“RBI”) introduced microfinance sector regulation in India following the microfinance crisis in the state of Andhra Pradesh in 2010. In response to the crisis, the RBI introduced a prudential and non-prudential regulatory framework with the objective of stabilizing and restoring public confidence towards the industry. For additional details on the prudential framework, please see Section 4(B) of the Circular issued by the RBI on July 1, 2013.
The truth-in-lending-provisions of the legislation particularly focus on capping the interest rate charged by Non-Banking Financial Companies – Micro Finance Institutions (“NBFC-MFIs”) and introduce statutory requirements for fair lending practices regarding interest rate transparency. The regulation also aims to prevent over-indebtedness and bad loan recovery practices among NBFC-MFIs.
The law requires NBFC-MFIs to provide the borrower a copy of a standard loan agreement form with the loan term and conditions, including the annualized interest rate and method of application. To assist the borrower in conducting a meaningful comparison of terms and conditions among different NBFC-MFIs, each loan application must include the information that affects the borrower.
Following the conclusion of the loan, each borrower must receive a summary loan card reflecting “the effective rate of interest charged,” all other terms and conditions attached to the loan, information which adequately identifies the borrower and acknowledgements by the NBFC-MFI of all repayments.
In addition, each NBFC-MFI must prominently display the effective interest rate it charges in all of its offices and official literature.
The RBI Circulars do not specifically address enforcement mechanisms in the case of violations of credit consumer rights. The Circulars do, however, state that non-compliance with the directions may subject the Lender to the penal provisions of the Reserve Bank of India Act of 1934. In addition, each NBFC-MFI must be a member of a Self-Regulatory Organization (SRO) recognized by the RBI and adopt a Code of Conduct prescribed by the SRO. The Circulars also mention a “monitoring” role to be played by NBFC-MFIs themselves and by the banks that lend to them.
For more detailed aspects of the truth-in-lending directives in the India, please download the Legal Summary Document referenced above.
National Truth-in-lending Formula
The RBI allows NBFC-MFIs to charge only three pricing components: the nominal interest rate, a processing charge, and an insurance premium, if any. NBFC-MFIs are also required to compute the effective interest rate in annualized terms and to use a declining balance methodology.
- Nominal Interest Rate Price Cap: the RBI Circulars set a price cap on the determination of the nominal interest rate. NBFC-MFIs cannot charge a nominal interest rate that exceeds the lower of: (i) the Lender’s cost of funds plus a specified margin or (ii) the average base rate of the five largest commercial banks by assets, as determined by the RBI, multiplied by 2.75. (Please see the legal summary for a more detailed explanation)
- Processing Charges and Insurance: Processing fees charged by NBFC-MFIs are excluded from the stipulated pricing cap. However, NBFC-MFIs may charge only one processing fee, and it cannot exceed 1% of the loan amount. NBFC-MFIs may separately collect insurance charges, including related administrative charges, limited to recovery of actual costs of the insurance provided.
The Circulars do not provide a standardized interest rate formula. NBFC-MFIs may employ any interest rate formula for the calculation and communication of the effective interest rate they charge.
Pricing Components in the National Formula
NBFC-MFIs are allowed to charge the pricing components listed below. However, the July 1, 2013 Circular banned NBFC-MFIs from collecting cash collateral, whether in the form of compulsory deposit or otherwise, and from charging penalties on late loan repayments.
Pricing Components Included
- Nominal interest rate
- Processing charge (Max 1%)
- Insurance charge
Pricing Component Excluded
- Compulsory deposit (Banned)
- Late penalty payment (Banned)