INTRODUCTION :-

non-banking financial company (NBFC) is a company registered under

the Companies Act, 1956 and is engaged in the business of loans and
advances, acquisition of shares/stock/bonds/debentures/securities issued by
Indian government or local authority or other securities of like marketable
nature, leasing, hire-purchase, insurance business, chit business, but does
not include any institution whose principal business is that of agriculture
activity, industrial activity, sale/purchase/construction of immovable
property.

A non-banking institution which is a company and which has its principal

business of receiving deposits under any scheme or arrangement or any
other manner, or lending in any manner is also a NBFC (residuary non-
banking company i.e. RNBC).

MEANING OF NBFC

Section 45I of the Reserve Bank of India Act, 1934 defines non-banking
financial company as

a financial institution which is a company;

a non-banking institution which is a company and which has as its

principal business the receiving of deposits, under any scheme or
arrangement or in any other manner, or lending in any manner;

such other non-banking institution or class of such institutions, as the

Bank may, with the previous approval of the Central Government and by
notification in the Official Gazette, specify;
In short

NBFC may be defined as a company registered under the Companies Act,

1956.

Which provides banking services without meeting the legal definition of

bank such as holding a banking license?

NBFC are basically engaged in the business of loans and advances,

acquisition of shares/stocks/bonds/debentures/securities issued by
government or local authority or other securities of like marketable nature,
leasing, hire-purchase, insurance business, chit business.

But does not include any institution whose principle business is that of
agricultural activity or any industrial activity or sale, purchase or
construction of immovable property.

[Trading in shares & securities in capital market is also falls under the
definition of the NBFC, and as a results required prior registration as a NBFC]
TYPE OF NBFC

Asset Finance Company(AFC)

The main business of these companies is to finance the assets such as
machines, automobiles, generators, material equipments, industrial
machines etc.
Investment Company (IC)
The main business of these companies is to deal in securities.
Loan Companies (LC)
The main business of such companies is to make loans and advances (not
for assets but for other purposes such as working capital finance etc. )
Infrastructure Finance Company (IFC)
A company which has net owned funds of at least Rs. 300 Crore and has
deployed 75% of its total assets in Infrastructure loans is called IFC provided
it has credit rating of A or above and has a CRAR of 15%.
Systemically Important Core Investment Company (CIC-ND-SI)
A systematically important NBFC (assets Rs. 100 crore and above) which has
deployed at least 90% of its assets in the form of investment in shares or
debt instruments or loans in group companies is called CIC-ND-SI. Out of the
90%, 60% should be invested in equity shares or those instruments which
can be compulsorily converted into equity shares. Such companies do accept
public funds.
Infrastructure Debt Fund (IDF-NBFC)
A debt fund means an investment pool in which core holdings are fixed
income investments. The Infrastructure Debt Funds are meant to infuse
funds into the infrastructure sector. The importance of these funds lies in the
fact that the infrastructure funding is not only different but also difficult in
comparison to other types of funding because of its huge requirement, long
gestation period and long term requirements. In India, an IDF can be set up
either as a trust or as a company. If the IDF is set up as a trust, it would be a
mutual fund, regulated by SEBI. Such funds would be called IDF-MF. The
mutual fund would issue rupee-denominated units of five years maturity to
raise funds for the infrastructure projects. If the IDF is set up as a company,
it would be an NBFC; it will be regulated by the RBI. The IDF guidelines of the
RBI came in September 2011. According to these guidelines, such companies
would be called IDF-NBFC. An IDF-NBFC is a non-deposit taking NBFC that
has Net Owned Fund of Rs 300 crores or more and which invests only in
Public Private Partnerships (PPP) and post commencement operations date
(COD) infrastructure projects which have completed at least one year of
satisfactory commercial operation and becomes a party to a Tripartite
Agreement.
Non-Banking Financial Company Micro Finance Institution
(NBFC-MFI) NBFC-MFI
a non-deposit taking NBFC which has at least 85% of its assets in the form of
microfinance. Such microfinance should be in the form of loan given to those
who have annual income of Rs. 60,000 in rural areas and Rs. 120,000 in
urban areas. Such loans should not exceed Rs. 50000 and its tenure should
not be less than 24 months. Further, the loan has to be given without
collateral. Loan repayment is done on weekly, fortnightly or monthly
installments at the choice of the borrower.
Non-Banking Financial Company Factors (NBFC-Factors)
Factoring business refers to the acquisition of receivables by way of
assignment of such receivables or financing, there against either by way of
loans or advances or by creation of security interest over such receivables
but does not include normal lending by a bank against the security of
receivables etc. An NBFC-Factoring company should have a minimum Net
Owned Fund (NOF) of Rs. 5 Crore and its financial assets in the factoring
business should constitute at least 75 percent of its total assets and its
income derived from factoring business -companies-nfbc/
FUNCTIONS OF NBFC :-

Non-Banking Financial Companies are doing functions akin to that of banks,

however there are a few differences:

1. An NBFC cannot accept demand deposits (which are payable on

demand), like the savings and current accounts.

2. It is not a part of the payment and settlement system and as such

cannot issue cheques to its company customers and

3. Deposit insurance facility is not available for NBFC depositors unlike in

case of banks (It means the public deposits with them are unsecured.
In case a NBFC defaults in repayment of deposit, the depositor can
approach Company Law Board or Consumer Forum or file a civil suit to
recover the deposits).

Under the RBI Act, 1934, any Non-Banking Financial Company (NBFC) have to
get registered with Reserve bank of India (RBI). However, to obviate
dual regulation, certain category of NBFCs which are regulated by other
regulators are exempted from the requirement of registration with RBI such
as:

1. Venture capital fund, merchant banking companies, stock broking

companies register with Sebi;
 2. Insurance company holding a valid certificate of registration issued by
IRDA;

3. Nidhi companies under the Companies Act, 1956;

4. Chit companies under the Chit Funds Act, 1982;

5. Housing finance companies regulated by National Housing Bank (of the

RBI).

A company incorporated under the Companies Act, 1956 and desirous of

commencing business of the NBFC should have a minimum net owned fund
(NOF) of Rs 25 lakh (raised to Rs 2 crore from April 21, 1999). NBFCs
registered with RBI have been reclassified (since 2006) as the Asset
Finance Company (AFC); Investment Company (IC) and the Loan Company
(LC). Provisions for accepting deposits are:

There is ceiling on acceptance of public deposits an NBFC maintaining

required NOF and CRAR and complying with the prudential norms can
accept public deposits maximum upto four times of NOF;

Can offer the maximum 11% rate of interest;

Minimum investment grade credit rating (MIGR) is essential (may get

itself rated by any of the four rating agencies namely, CRISIL, CARE,
ICRA and FITCH Ratings India Pvt. Ltd.);

Are allowed to accept/renew public deposits for a minimum period of

one year and maximum period of 5 years; and

Effective from April 2004, cannot accept deposits from NRIs except
deposits by debit to NRO account of NRIs provided such amount do not
represent inward remittance or transfer from NRE/FCNR (B) account,
 however, the existing NRI deposits can be renewed (Note: different
foreign currency accounts opened by the Indian banks have been given
as the

IMPORTANT GUIDELINES ON BANK FINANCE TO NBFC *

Bank Finance to NBFC registered with RBI

Banks are permitted to extend need based working capital facilities as well
as term loans to all NBFCs registered with RBI and engaged in
infrastructure financing, equipment leasing, hire purchase, loan,
factoring and investment activities. Banks are also permitted to extend
finance to NBFCs against second hand assets financed by them.

Banks may formulate suitable loan policy with the approval of their Boards
within the prudential guidelines and exposure norms prescribed by the RBI to
extend various kinds of credit facilities to NBFCs for permitted activities.
Bank Finance to NBFCs not requiring Registration
NBFCs not requiring registration include:-

a) Insurance Companies registered under Sec. 3 of the Insurance Act, 1938.

b) Nidhi Companies notified under Section 620A of the Companies Act, 1956.

c) Chit Fund Companies carrying on Chit Fund business as their

principal business.

d) Stock Broking Companies/Merchant Banking Companies registered

under Section 12 of the SEBI Act; and

e) Housing Finance Companies being regulated by the National

Housing Bank (NHB) which have been exempted from the requirement of
registration by RBI.

Banks may take their credit decisions on the basis of usual factors like the
purpose of credit, nature and quality of underlying assets, repayment
capacity of borrowers as also risk perception, etc.

Bank Finance to Residuary Non-banking companies Residuary Non-Banking

Companies (RNBCs) are the companies classified and registered with
Department of Non-Banking Supervision, RBI as such. Banks can finance to
the extent of their Net Owned Fund (NOF).

Net Owned Fund (NOF)

Net Owned Fund means:-

a) Aggregate paid up equity capital and free reserve net of accumulated

loss, deferred revenue expenditure, and other intangible assets;

b) and further reduced by:-

i) Investment in shares of subsidiaries, companies in the same group, and

all other NBFCs; And

ii) the book value of debentures, bonds, outstanding loans and
advances (including hire purchase and lease finance) made to, and
deposits with subsidiaries of such company and companies in the same
group to the extent such amount exceeds ten percent of (a) above (Section
45-IA of Reserve Bank of India Act, 1934)

Activities not eligible for Bank credit

a) Bills discounted / rediscounted by NBFCs, except for rediscounting of bills

discounted by NBFCs arising from sale of commercial vehicles
(incl. light vehicles and two wheeler and three wheeler vehicles subject to:-
Bills should have been drawn by manufacturer on dealers only;

Banks satisfying the genuineness of the transaction and bona fides and
track record of NBFCs

b) Investments of NBFCs both of current and long term nature in any

company/entity by way of shares, debentures, etc. (Stock Broking companies
may be provided need based credit against shares and debentures held by
them as stock-in-trade.

c) Unsecured loans / inter-corporate deposits by NBFCs to / in any company

d) All types of loans and advances by NBFCs to their

subsidiaries, group companies / entities.

e) Finance to NBFCs for further lending to individuals for subscribing to

IPOs and for purchase of shares from secondary market.

Bank Finance to Factoring Companies

Banks can finance factoring business of Factoring Companies which comply

with certain criteria as under:-

a) Carry out all the components of standard factoring activity viz. financing of
receivables, sale-ledger management and collection of receivables.
b) At least 80 per cent of their income from factoring activity.

c) The receivables purchased / financed, irrespective of whether on 'with

recourse' or 'without recourse' basis, form at least 80 per cent
of the assets of the Factoring Company.

d) The assets / income referred to above would not include the

assets / income relating to any bill discounting facility extended
by the Factoring Company.

e) The financial assistance extended by the Factoring Companies is

secured by hypothecation or assignment of receivables in their favour.

Other restrictions/Prohibitions

a) Granting of bridge loans of any nature or interim finance against

capital/debenture issues and or in the form of loans of a bridging nature
pending raising of funds from

market or elsewhere.

b) Advances against collateral security of shares to NBFCs.

c) Issuance of guarantees for placement of funds with NBFCs.

Prudential ceiling on exposure to NBFCs

The exposure (both lending and investment, including off

balance sheet exposures) of a bank to a single NBFC / NBFC-AFC
(Asset Financing Companies) should not exceed 10% / 15% respectively of
the bank's capital funds as per its last audited balance sheet.

Banks can assume exposures on a single NBFC / NBFC-AFC up to 15% /

20% respectively of their capital funds provided the exposure in excess of
10% / 15% respectively, is on account of funds on-lent by the NBFC / NBFC-
AFC to the infrastructure sector.

Further, exposure of a bank to the NBFCs-IFCs (Infrastructure

Finance Companies) should not exceed 15 per cent of its capital funds as
per its last audited balance sheet, with a provision to increase it to 20 per
cent if the same is on account of funds on-lent by the IFCs to the
infrastructure sector.

Banks may also consider fixing internal limits for their aggregate exposure
to all NBFCs put together.

Other restrictions re. investments by banks in securities/instruments issued

by NBFCs

Banks should not invest in Zero Coupon Bonds (ZCBs) issued by NBFCs
without creating sinking fund by NBFCs for accrued interest and keeps it
invested in liquid investments/securities (Govt. Bonds).

Banks are permitted to invest in Non-Convertible Debentures (NCDs) with

original or initial maturity up to one year issued by NBFCs
subject to compliance of prudential guidelines in force.

After reclassification circular dated 06.12.2006, following categories of NBFCs

have emerged; Assets finance company Loan company; Investment
company;Investment Company has been further divided in two categories
Core Investment companies; Other company Further Classification of NBFCs
which is Non deposit taking (NBFC ND) based on the Size of its Asset:

Systematic Investment NBFC-ND with assets size of more than 500 Cr.
and; Non- Systematic Investment NBFC-ND with assets size of less than
500Cr
As per revised guidance, assets size of all the NBFCs in the group is to be
taken for the purpose of calculating assets size of NBFC, and if assets size of
all the NBFCs in a group exceeds 500 crore then guideline in respect of
Systematically important Non Banking financial (Non- Deposit accepting or
Holding) companies prudential norms ( Reserves Bank ) Direction, 2015 is to
be applicable.

Main point of Highlights in RBI Circular on New Regulatory Framework issued

10.11.2014

Limit of minimum Net Owned Fund raised to 2 Crores for all NBFCs by
2017.

a) Rs. 100 lakh by the end of March 2016,

b) Rs. 200 lakh by the end of March 2017.

Increase in limit for defining systemically important non-Deposit taking

NBFCs (NBFCs-ND-SI), that is asset size of Rs. 500 crore and above as per
the last audited balance sheet.

Assets size of NBFCs in case of multiple NBFCs: For the purpose of

determining the status of NBFCs (NBFC-ND-SI) total assets of all NBFCs in a
group will be aggregated.

NBFCs with assets of less than Rs. 500 crores are exempted from the
requirement of maintaining Capital To Risk Asset Ratio (CRAR) and complying
with credit concentration norms.
 Revised provisioning norms for Standard Assets: The provision for
standard assets for NBFCs-ND-SI and for all NBFCs-D, had been increased to
0.40% as follows

a) 0.30% by the end of March 2016.

b) 0.35% by the end of March 2017.

c) 0.40% by the end of March 2018.

Increase in Tier 1 Capital from existing 7.5% to 10% in phases Disclosures

in Financial Statement from 31.03.2015 Registration/ licence/ authorisation
obtained from other financial sector regulators; Ratings assigned by credit
rating agencie Penalties, if any, levied by any regulator.

Information about country of operation and joint venture partners with

regard to Joint Ventures and Overseas Subsidiaries.

Asset liability profile .

Returns to be file with RBI:- NBFCs-ND, with assets less than Rs. 500 crore,
including investment companies, shall henceforth be required to submit only
a simplified Annual Return the details of which shall be separately
communicated. Till such time, they are require to submit the existing
Returns.

On 27.03.2015 RBI has issued Circular no DNBR (PD) CC.No. 024/ 03.10.001/
2014-15 on Regulatory Framework for NBFCs :- RBI has issued the following
Notifications.

For Net Owned Fund requirements

 Non-Systemically Important Non-Banking financial (Non-Deposit Accepting
or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015.

Systemically Important Non-Banking financial (Non-Deposit Accepting or

Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015

Non-Banking Financial Companies Acceptance of Public Deposits (Reserve

Bank) Directions, 1998.

Non-Banking Financial (Deposit Accepting or Holding) Prudential Norms

(Reserve Bank) Directions, 2007.

Non-Banking Financial Company Factor (Reserve Bank) Directions, 2012.

Some of the important points/Highlights of Non-Systemically Important Non-

Banking financial (Non-Deposit Accepting or Holding) Companies Prudential
Norms (Reserve Bank) Directions, 2015.

Income recognition, Income from Investments, Accounting of investments,

Asset Classification

Accounting Standards and Guidance Notes issued by the Institute of

Chartered Accountants of India (referred to in these Directions as ICAI)
shall be followed in so far as they are not inconsistent with any of these
Directions.

Need to have Policy on Demand/Call Loans

Provision for Standard Assets, Every Non-Banking Financial Company shall

make provision for standard assets at 0.25 percent of the outstanding.
 Every non-banking financial company shall append to its balance sheet
prescribed under the Companies Act, 2013, the particulars in the schedule as
set out.

Requirement as to capital adequacy: only applicable to NBFC-MFI and

Infrastructure Finance Company (IFC).

Submission of a certificate from Statutory Auditor to the Bank: Every non-

banking financial company shall submit a Certificate from its Statutory
Auditor that it is engaged in the business of non-banking financial institution
requiring it to hold a Certificate of Registration under Section 45-IA of the RBI
Act and is eligible to hold it. A certificate from the Statutory Auditor, within
one month from the date of finalization of the balance sheet and in any case
not later than December 30th of that year.

The leverage ratio of every Non-Banking Financial Company shall not be

more than 7 at any point of time, with effect from March 31, 2015.

Loans against non-banking financial companys own shares prohibited.

Loans against security of single product gold jewellery:- All NBFCs shall
maintain a Loan-to-Value (LTV) Ratio not exceeding 75 per cent for loans
granted against the collateral of gold jewellery.

Loans against security of shares:- 1. All NBFCs with asset size of `.100
crore and above shall,

(i) maintain a Loan to Value (LTV) ratio of 50% for loans granted against the
collateral of shares, and
(ii) accept only Group 1 securities (specified in SMD/ Policy/ Cir-9/ 2003 dated
March 11, 2003 as amended from time to time, issued by SEBI) as collateral
for loans of value more than Rs. 5 lakh, subject to review by the Bank.

All NBFCs with asset size of Rs.100 crore and above shall report on-line to
stock exchanges, information on the shares pledged in their favour, by
borrowers for availing loans. The infrastructure for on-line reporting to the
stock exchanges has been put in place. The exchanges may be approached
for creation of user IDs. The web links for the respective exchanges are
provided below:

Some restriction on Concentration of credit/investments: An NBFC which is

non-Operative Financial Holding Company ( NOFHC)

Opening Branches exceeding one thousand in number: Non-Banking

Financial Company shall obtain prior approval of the Reserve Bank to open
branches exceeding 1000.

Information with respect to change of address, directors, auditors, etc. to

be submitted:- NBFC need to intimate within one from occurrence of the
changes.

Submission of Branch Info Return:- all Non-deposit taking NBFCs having

total assets more than Rs.50 crore, shall submit a quarterly return on Branch
Information within ten days of the expiry of the relative quarter.

Other important matters/things to be remembered is as follows:-

Accounting for taxes on income Accounting Standard 22 Treatment of
deferred tax assets (DTA) and deferred tax liabilities (DTL) for computation of
capital.

As creation of DTA or DTL would give rise to certain issues impacting the
balance sheet of the company, it is clarified that the regulatory treatment to
be given to these issues are as under:

The balance in DTL account will not be eligible for inclusion in Tier I or Tier
II capital for capital adequacy purpose as it is not an eligible item of capital.

DTA will be treated as an intangible asset and should be deducted from

Tier I Capital.

NBFCs may keep the above clarifications in mind for all regulatory
requirements including computation of CRAR and ensure compliance with
effect from the accounting year ending March 31, 2009.

In this connection it is further clarified that DTL created by debit to

opening balance of Revenue Reserves or to Profit and Loss Account for the
current year should be included under others of Other Liabilities and
Provisions.

Requirement for obtaining prior approval of RBI in cases of

acquisition/ transfer of control of NBFCs. The prior written
permission of the Reserve Bank of India shall be required for

any takeover or acquisition of control of an NBFC, whether by acquisition of

shares or otherwise;
 any merger/amalgamation of an NBFC with another entity or any
merger/amalgamation of an entity with an NBFC that would give the acquirer
/ another entity control of the NBFC;

any merger/amalgamation of an NBFC with another entity or any

merger/amalgamation of an entity with an NBFC which would result in
acquisition/transfer of shareholding in excess of 10 percent of the paid up
capital of the NBFC.

Prior written approval of the Reserve Bank would also be required before
approaching the Court or Tribunal under Section 391-394 of the Companies
Act, 1956 or Section 230-233 of Companies Act, 2013 seeking order for
mergers or amalgamations with other companies or NBFCs.

Conclusions and Recommendations:

Previous studies had shown that the MFIs of Bangladesh have performed
better as compared to Indian MFIs until 2007. However, this study has found
that from last five years the Indian MFIs have performed better as compared
to the MFIs of Bangladesh in most of the financial indicators.
For ensuring prudential management, banks in India are expected by the RBI
to maintain Capital Adequacy Ratios (CAR - net worth as a proportion of risk-
weighted assets) of 9% and NBFCs of 15%. In case of the MFIs of
Bangladesh, the capital adequacy is higher than Indian MFIs; therefore, they
are much safer in economic downturn. However, the trend of this ratio is
upward in case of India and downward in case of Bangladesh. This trend is a
cause of concern for the MFIs of Bangladesh. One of the major reasons for
this trend is the legal form of MFIs. In order to serve the large population of
underserved poor, several Indian NGO

MFIs are converting themselves into NBFC MFIs. Therefore they are able to
raise their capital base. In case of Bangladesh, NBFC MFIs are not
operational; therefore, they have limited scope to increase their capital
base.

By 2007, the aggregate figures suggested that capital adequacy of Indian

MFIs was an issue as even the largest MFIs were only just at acceptable
levels and below the 12% norm being introduced then. The Debt/Equity
ratios emerging were far higher than the 5:1 norm in such lending by
commercial banks. However, from 2007 onwards, the private equity funds
joined

the microfinance focused social investment funds Bellwether, Lok Capital,

Unitus and others in making investments in the Indian microfinance sector
[51]. Even the International Finance Corporation (IFC) became involved. As a
result, the equity constraint eased considerably, particularly for start-up MFIs
established by professionals and weighted average for Indian MFIs is now in
excess of 15% well ahead of the banking sector.

In order to serve the large poor population of India, Indian MFIs have to
further increase their capital base. The conversion from NGO to NBFC will
also enhance the capital adequacy for the sector.
In terms of outreach, India and Bangladesh are at the same level. However,
the growth rate of Indian MFIs is much higher (60% CAGR in the last five
years) as compared to Bangladesh

(stagnant). Though the market penetration is quite low in India particularly in

UP, MP, Bihar, Orissa, Chhattisgarh, which shows that there exists huge
business opportunities for Indian

NBFC MFIs. However, at the same time the Indian MFIs will have to explore
the cost effective means to reach to the least densely populated area.

No significant differences found between the means of Indian MFIs and the
MFIs of Bangladesh on Operational Self Sufficiency, Yield to Gross Loan
Portfolio and Return on Asset indicators. Both countries (India and
Bangladesh) have above 90% client as women borrowers, which justify the
social commitment of MFIs of their respective countries.

It can also be concluded that the equity holders will be more interested in
investing into Indian MFIs than the MFIs of Bangladesh because; they will
earn higher return on their investment. The operating efficiency of Indian
MFIs is better and increasing because of higher growth in outreach and
better utilization of work force (the main operating expense of MFIs). Despite

the improvement in operating efficiency, the yield of Indian MFIs is rising

fast. This means that Indian microcredit borrowers are now paying a
relatively high cost for their microcredit.

Moreover, at the same time, there has been a substantial widening in the
margin available to the average MFIs for covering financial expenses, loan
loss provisions and surplus.

Portfolio quality of Indian MFIs (PAR>30 days = 2.4%) is far better than the
MFIs of Bangladesh (12.1%) and global median (3.1%). This may be because
of ever-greening resulting in under-reporting by branches to the head office.
Following the Andhra Pradesh crisis of 2006, there has been a significant
delinquency crisis in southern Karnataka since 2009 and growing issues with
portfolio quality even in states like U.P. with relatively recent microfinance
activity. Concerns about consumer protection have led to the state
governmentof Andhra Pradesh stepping in with a heavy-handed ordinance
that threatens to bring all microfinance activity to a halt. While this crisis
may blow over, greater introspection on issues of multiple lending, the
quality of internal control systems, malpractices in loan collection and how
to improve portfolio management are certainly called.

It is also concluded that the MFIs, which are converting themselves into
NBFC, are financially more viable and their outreach is high. The Young MFIs
of India are more profitable, creating better quality asset, and increasing
their outreach at a higher rate as compared to the Mature and old MFIs, while
Mature and Old MFIs are utilising administrative and personnel expenses in
a much better manner.

Through the analysis of the second objective, it is found that the outreach
and capital adequacy are the prominent factors, which are affecting the
financial sustainability of Indian

MFIs. Nevertheless, the capital structure does not affect the sustainability. In
case of Bangladesh, the asset quality and capital adequacy are the main
factors, which are affecting the sustainability of MFIs. Again, the capital
structure does not affect the sustainability of MFIs.

The third objective has suggested a new, comprehensive, and simplified

model for financial sustainability of MFIs. With the help of this model, MFIs
can quantify the level of financial sustainability. This model will also be used
to create a sustainability index for various

countries and help the regulator identifying the strong and weak areas of the
sector. In addition, the existence of the new model is also expected to
facilitate MFIs to access to capital markets. Having access to sustainability
information may reduce some of the transaction uncertainty.

While microfinance remains a small proportion of the overall financial system

in terms of portfolio size, it is growing much faster; bank credit grew by
17.5% during 2008-09 while microfinance portfolios grew by around 100%.
As a result, in terms of portfolio size as well as number of clients served it is
becoming an increasingly significant part of the financial system.

Deposit services remain a distant dream. Thrift deposits are accepted

formally by MFIs from their members and are recorded as part of their
balance sheets wherever these are legally permitted. The magnitude of MFIs
deposit services in India is limited by the fact that not all MFIs are allowed by
the regulator to offer such services.

Given recent actions by the Government of Andhra Pradesh, the expected

deterioration in portfolio quality as a result, it is quite likely that there will be
an increase in costs incurred by Indian MFIs to maintain lending standards
while ensuring portfolio quality. At the same time,

it is likely that the portfolio yield will decline in response to the political and
media pressure on interest rates to end-clients. The implications of such
drastic interventions by the government for the long-term sustainability of
MFIs are difficult to predict. At best it will result in a decline in capital
available for microfinance, thereby slowing down the financial inclusion
effect of MFIs operations; at worst it could destroy microfinance altogether,
resulting in throwing low income families back into the not-so-benevolent
arms of moneylenders.