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“Before any farmer can ask for a loan, he has to produce, one – land records, two – records of rights, three – no dues from the government, four – records of all land revenue paid, five – land valuation certificates, six – no dues from agricultural societies, seven – permission from court if applicant is a minor and eighth (and here is the best part!) – No Dues Certificates from all the other 9 banks in the area.”

The above quote is taken from Sir Mark Tully’s 2003 bestseller “India in Slow Motion,” which dealt with the challenges facing India, and the pace at which the country was addressing them. But in the years since it was published, India has adopted a fast-forward approach to many issues that make Sir Tully’s observations seem somewhat dated. Nowhere is this more evident than in the country’s efforts to advance financial inclusion.

For the last ten months or so, the pace of financial inclusion initiatives in India has been supersonic. Policy decisions at the top levels of government are implemented on the ground with minimal time lag, boosting India’s financial inclusion landscape through new institutions and programmes like Pradhan Mantri Jan-Dhan Yojana (PMJDY), Payment Banks, Small Finance Banks, and the microfinance refinance bank Pradhan Mantri Mudra Yojana. Since August of last year, banks in India have opened 147 million new bank accounts under PMJDY, with over 18 million new accounts opened in a single week in August – a Guinness World Record. According to the global FINDEX 2014 numbers, 53 percent of adults in India now have at least one bank account – growth that is largely attributed to PMJDY.

But while these developments are legitimately exciting, it’s important not to get caught up in the hype that can surround this type of long-awaited progress. And there are a number of unanswered questions about the real impact of these different initiatives, not least of which is the fact that around 72 percent of the new accounts opened under PMJDY show zero balances.

In that spirit, let’s examine the most recent of India’s financial inclusion developments, the USD $3.3 billion Micro Units Development and Regulatory Agency (MUDRA), which is linked to the broader PMJDY initiative. MUDRA’s goal is to meet the funding requirements for unfunded members of the Non Corporate Small Business Segment (NCSBS), which comprises millions of small and micro businesses. When it’s fully operational (likely in the coming months), MUDRA will seek to refinance and regulate all the country’s microfinance entities, including the non-bank financial company microfinance institutions (NBFC-MFIs) that are currently regulated by the RBI, and that make up the vast majority of India’s microfinance providers.* Before we touch upon the challenges for MUDRA in accomplishing this, let’s look at some interesting questions regarding its effects on microfinance in general:

1. Small business finance companies like NBFC-MFIs borrow funds at an average rate that ranges between 12-15 percent. Since MUDRA will act as a refinance agency for these MFIs and offer lower-cost funds at rates as low as 6 percent, will this lead to a downward movement of the overall cost of funds, ultimately lowering the interest rates paid by end customers?

2. Will MUDRA spur an intensity in MFIs’ “customer acquiring battle” at the ground level that’s similar to what we have seen in the case of retail banking for consumer finance products like cars, housing, personal loans or credit cards?

3. It is a general perception that MFIs and Business Correspondents that partner with commercial banks to seek finance for microfinance operations experience unequal partner relationships with these banks. This impacts their negotiation capability, with banks as the larger partner sometimes adopting an uncompromising attitude. Will the entry of MUDRA change this equation?

Existing NBFC-MFI Regulations and Hurdles For MUDRA

MUDRA intends to ride on the network efficiencies, customer proximity and market familiarity of MFIs. It will offer loan products of small, medium and larger sizes (called Shishu, Kishor and Tarun, respectively). These approaches are promising, but there exist some serious challenges that must be addressed before it’s too late.

For instance, in 2011, the RBI introduced a regulatory framework that prescribed that 85 percent of the total portfolio of an MFI had to comply with micro-regulations called Qualifying Asset Criteria. These regulations place the following restrictions on MFIs, which could pose a significant barrier to the delivery of MUDRA products:

1. Lending Amount Caps: There is currently an upper cap of USD $1000 for MFIs’ first cycle loan, with subsequent cycles capped around USD $1,700 in rural areas, and around USD $2,700 in semi-urban and urban areas. This means, under current regulations, MFIs cannot fully serve those clients who may be eligible for MUDRA products like Kishor (USD $834 – 8,334) and Tarun (USD $8,335 – 16,667) simply because the ticket sizes for these two MUDRA products are often more than the USD $2,700 limit.

2. Two Lender Limit: In order to prevent customer over-indebtedness after the microfinance crisis in Andhra Pradesh in 2010, the RBI imposed a two-lender limit, which prevented clients from seeking loans from more than two different MFIs. The intent was to discourage multiple lending and promote responsible finance practices, particularly in the absence of a credit bureau ecosystem for microfinance customers. However, these micro-regulations are already being diluted, as other lending institutions like commercial banks, credit cooperatives, Regional Rural Banks, Primary Agriculture Cooperative Societies, etc. do not fall under their purview, and therefore serve microfinance customers who need additional credit. And there may be scenarios where small business customers of MUDRA products might want to seek credit services from more than two MFIs based on their specialized product offerings, and might not be able to because of the two-lender regulation.

3. Lending Rate Caps: Currently MFIs have two ways to calculate their interest rates, as prescribed by the RBI: the cost-plus model and the 2.75X base-rate model, the lowest of which prevails. The cost-plus model means the highest interest rate charged by an MFI whose portfolio size is over USD $16 million (INR 100 crore) cannot be more than the cost of funds (say 12-15 percent) plus a 10 percent margin to cover operating expenses and profits. For all other MFIs whose portfolio size is less than USD $16 million, the calculation is the same, except the margin would be 12 percent.

The 2.75X model uses the average base rate of the five largest Indian commercial banks by assets, multiplied by a factor of 2.75. But the average base rate is advised by the RBI and can change every quarter, raising the question of how MFIs can revise their credit pricing so often, while also communicating it to existing customers – which may impact the number and/or amount of installments. Since MFIs generally serve clients with low or negligible literacy, communicating such changes is tedious and confusing at the customer level. Additionally, regulations say that while MFI lenders may charge interest rates above 26 percent, the difference between the interest rates of two individual loans cannot exceed 4 percent. But in practice, assuming that only a part of an MFI’s portfolio will be refinanced by MUDRA, the interest rates between these lower-cost products and commercial bank-refinanced products may be more than 4 percent.

4. Lending Tenor Restrictions: Existing regulations control the tenor of the loan amount. According to the RBI guidelines, any loan value exceeding USD $250 will have a repayment tenor of no less than 24 months, without any pre-closure charges. But generally, small enterprises have a short cash-flow cycle. This may enable a borrower to repay her micro/small loan well before 24 months and graduate to a higher loan amount.

5. MUDRA/PMJDY Linkage: MUDRA is intended to complement PMJDY bank accounts, but there are a number of limitations that could complicate their linkage. For instance, MUDRA intends to launch a MUDRA Card to meet customers’ unanticipated money requirements, and integrate it with the payments infrastructure, especially ATMs. But since accounts opened under the PMJDY scheme are categorized as small accounts with limited Know Your Customer requirements, these accounts have severe operative restrictions on the maximum amounts that can be deposited, withdrawn and transferred. Due to these restrictions, in many cases, it would be impossible for MUDRA customers to use their PMJDY accounts to transact, as the loan ticket-sizes would be higher than their small account limitations. Thus, the dovetailing of PMJDY and MUDRA may not take place at all.

There is no denying that these are interesting times for financial inclusion in India, and this once slow-moving country is determined to move fast through MUDRA and other financial inclusion schemes. However, there are equally strong challenges that need to be addressed for seamless integration of these multiple initiatives – so in some cases, faster may not always be better.

* Note: For the purposes of this post, the terms NBFC-MFI and MFI are used interchangeably, to refer to NBFC-MFIs as defined by the RBI.

Jatinder Handoo is Financial Inclusion Advocacy Manager at Microfinance Institutions Network (MFIN). All views expressed in this post are personal, and MFIN does not necessarily subscribe to them.