Micro finance in India: legal and regulatory framework

1. Microfinance in India: Legal &
Regulatory Framework

2.  Clarity of ownership
 Initial capital requirement and capital adequacy
 Ability to mobilise deposits
 Ability to raise equity
 Ability to raise grants
 Ability to raise funds from banks
 Regulatory authority
 Tax implications

3. Type of MFI Legal Form
Not for Profit Entities Society, Trust and Section 25
Companies
For Profit Entities NBFC, Local Area Bank,RRBs
Mutual Benefit Entities Cooperatives,Cooperative Banks

4. • Societies can be registered under the Societies Registration
Act, 1860 or under respective state acts
• A society can be registered by any seven persons
associated for any literary, scientific or charitable purposes
by subscribing their names to a memorandum of
association and filing with the registrar
• Cannot accept public deposit
• Exemption from Income Tax
• Need registration under FCRA to be able to accept foreign
grants

5. • Public Trusts can be established under the respective state
regulations. Private trusts can be established under Indian
Trusts Act 1882.
• Cannot accept public deposits
• Exempt from Income Tax if registered under Section 12A of
the Income Tax Act.
• Need registration under FCRA to be able to accept foreign
grants
TRUSTS

6.  Section 25 Companies are promoted for the purpose of
promotion of commerce, arts, religion, charity or any other
useful purpose with the intention to apply its profits, if any,
or other income in promoting only its objects
 They are prohibited from payment of dividends to
shareholders
 RBI has exempted NBFCs licensed under section-25 of the
Indian Companies Act from registration, maintenance of
liquid assets and transfer of profit to Reserve Funds, provided
they are engaged in micro-financing activities (Rs50,000 for
small businesses and Rs125,000 for housing)

7.  Registered under central/state/multi-state co-operative acts.
⇒ Regulated by Registrar of Co-operatives for registration,
management and audit
⇒ Regulated under the Banking Regulation Act, 1949 for licensing,
area of operations and interest rates
 Origins in cooperative credit societies which were organised to
provide credit to meet consumption needs of their members, and
relied on principles of thrift and self
 Urban cooperative banks were traditionally mandated to lend only
for non-agricultural purposes and were located in urban and peri-
urban areas

8.  Established by the Central Government through a notification in the official
gazette notification
 Minimum capital requirement is Rs 25 lakhs
 The share capital of the RRBs is required to be held by the Central
Government, State Government and Sponsor Bank in the ratio 50:15:35
 From the financial year 2006-07 RRBs have been brought under Income Tax
net
 RBI has also stipulated that RRBs need to maintain disclose Capital
Adequacy Ratio (CAR) starting March 2008

9.  RBI allowed the establishment of Local Area Bank in 1996 with a
view to providing institutional mechanisms for promoting rural
savings as well as for the provision of credit for viable economic
activities in the local areas
 LABs to observe priority sector lending targets at 40% of net
bank credit
 Lending primarily to agriculture and allied activities, SSI, agro-
industrial activities, trading activities and the non-farm sector
with a view to ensuring the provision of timely and adequate
credit to the local clientele in the area of operation
 LABs are registered as public limited companies under the Indian
Companies Act 1956
 Are allowed to operate in a maximum of three geographically
contiguous districts

10. • Minimum capital requirement for a LAB is Rs 5 crores
• Promoters of the bank may comprise individuals, corporate
entities, trusts and societies => Can mobilise deposits from
public
• Prudential norms related to banks are applicable
• At present only four LABs are functioning and no new
licenses are being issued

11.  Companies registered under Indian Companies Act 1956 can apply to RBI to carry on
the business of an NBFC (except Section 25 companies)
 NBFCs are for-profit entities and are taxable
 NBFCs are required to have net owned funds of Rs20 millions
⇒ Ownership can be defined precisely and they can raise equity, FDI
⇒ Mobilisation of public deposits allowed but under strict guidelines by RBI
 NBFCs are subject to prudential regulations regarding income recognition, asset
classification and provisioning, prudential exposure limits and accounting/disclosure
requirements provided they are mobilising public deposits
 Banks are comfortable lending to NBFCs which are well-capitalized and well-
performing