Reports

407 kb
Date : 24 Jul 2007
Report of the Technical Group Set up to Review Legislations on Money Lending

Acknowledgements

Chapter
No.

Particulars

1.

Introduction

2.

The Context and the Focus

3.

Money Lending Legislation – The International Scenario

4.

The Current Legal Framework

5.

Linkages between Moneylenders and Formal Credit Channels

6.

Functioning of Moneylenders

7.

Model Legislation on Moneylenders and Accredited Loan Providers

8.

Summary of Recommendations

Annex

 

I

Moneylenders & Accredited Loan Providers’ Bill, 2007 (Model Legislation)

II

Enforcement Machinery under the Laws of  various Countries

III

List of Money Lending Laws In India

IV

Provisions requiring Registration/Licensing and Penalties

V

Applicability / Exemption To Companies

VI

Applicability of State Legislations to banks and to certain transactions



CHAPTER - 1

Introduction

1.1 The All-India Debt and Investment Survey as on June 30, 2002 (NSS Fifty-Ninth Round released in December 2005) had shown that the share of moneylenders in the total dues of rural households had increased from 17.5 per cent in 1991 to 29.6 per cent in 2002. Considering that high indebtedness to moneylenders can be an important reason for the distress amongst farmers, the Reserve Bank Governor announced in the Annual Policy Statement dated April 18, 2006 for the year 2006-07,  that a Technical Group would be set up to review the efficacy of the existing legislative framework that governs  money lending. The Group would also review the enforcement machinery in different States and make recommendations for its improvement.

Constitution of the Technical Group

1.2 Accordingly, in May 2006, the Reserve Bank constituted a Technical Group under the chairmanship of Shri. S.C.Gupta, Legal Adviser-in-Charge, Reserve Bank of India as detailed below. 

Chairman

Shri S.C.Gupta, Legal Adviser-in-Charge, Legal Department, 
Reserve Bank of India (since retired)  

Members

1. Shri Girish Shankar, I.A.S., Secretary, (Cabinet Secretariat), Government of Bihar   

2. Shri A.Giridhar, I.A.S., Secretary to Government (IF), Finance Department, Government of Andhra Pradesh 

3. Shri Ashok Jain, I.A.S., Finance Secretary (II), Finance Department, Government of  Rajasthan (later  replaced by Shri Sanjay Malhotra,I.A.S.)

4. Shri P. Vijaya Bhaskar, Chief General Manager, Department of Banking Operations and  Development , Reserve Bank of India 

5. Shri P. Krishnamurthy, Chief General Manager-in-Charge, Department of Non-Banking Supervision, Reserve Bank of India         

6. Shri K.U.B.Rao, Adviser, Department of Economic Analysis and Policy, Reserve Bank of India 

7. Dr. K.S.Ramachandra Rao, Principal Adviser, Department of Statistical Analysis  and Computer Services, Reserve Bank of India (since retired).

Member Secretary

Shri G.Srinivasan, Chief General Manager, Rural Planning and Credit
Department, Reserve Bank of India.

Invitees from the State Governments

1. Shri Ashok Barnwal, Secretary, Finance , Government of Madhya Pradesh

2. Shri K.S. Pannu, I.A.S. , District Magistrate, Amritsar,  Government of Punjab

3. Shri Anupam Kishore, Joint Secretary (DMU), Government of Goa

4. Shri Mara Pandiyan, Secretary, Taxes Department, Government of Kerala

5. Shri Murmu, Registrar of Co-operative Societies, Government of Gujarat

6. Shri Jayant Kawale, Secretary (Co-operation Marketing), Co-operation, Marketing  and Textile Department, Government of Maharashtra

7. Dr. S. Subramanya, Secretary to Government (Budget & Resources), Finance Department, Government of Karnataka

8. Shri D.S.Misra, Secretary, Finance Department, Government of Chattisgarh 

9. Shri P. Wangdi, Controller of Accounts, Finance, Revenue and Expenditure Department, Government of Sikkim.

10. Secretary, Co-operation Department, Government of Assam

11. Shri Lalmalsauma, I.A.S., Financial Commissioner, Government of Mizoram

Terms of Reference

1. To study the functioning of moneylenders in the light of recent developments in the financial sector;
2. To review international practices in regulating money lending activities and suggest best practices for adoption in India;
3. To study the features, legal framework and enforcement mechanisms for money lending and similar activities in the different States of India;
4. To examine the linkages, if any, between money lending activities and formal credit channels.
5. To make recommendations to State Governments, in the light of above review/study, for improving the legal and enforcement machinery for money lending and similar activities in the interest of rural households.
6. Any other relevant matter.

Approach of the Group

1.3 The Group adopted an extensive consultative approach for ascertaining the ground realities of money lending activities. Besides relying on the experience of State Government officials, the group also invited experts in the field to share their views on the subject.

1.4 Three sub-groups were constituted. While the Group had five formal meetings, the sub-groups visited different places viz., Bangalore, Hyderabad, Thiruvananthapuram, Patna and Kolkata and held meetings with the State governments, bankers and groups/associations of moneylenders. They also interacted with experts.  In addition, a survey was conducted using a structured questionnaire, through the Regional Offices of the Rural Planning and Credit Department of the Reserve Bank of India, covering  177 districts in 25 States through focus-group discussions with bankers, borrowers, moneylenders, MFI/NGOs and district administrations. A detailed questionnaire on money lending legislation was also forwarded to all the States, to which eight responded. 

Organisation of the Report

1.5 The Report is organised into eight chapters. Chapter One outlines the background, constitution, terms of reference, and the approach of the Group.  Chapter Two elaborates the contextual significance of the setting up of the Group with reference to the distribution and composition of indebtedness of rural households, particularly farmer households.  It also takes into account the efforts of the Government and the Reserve Bank to improve financial inclusion and to provide additional impetus to the flow of credit from the banking sector to rural areas. Chapter Three highlights the international experience with an overview of legislation in some countries. Chapter Four focuses on the existing legal framework that governs money lending in India. Chapter Five explores the possibility that moneylenders may have linkages with formal financial institutions.  Chapter Six discusses the findings/results of the visits of the sub-groups and the survey conducted by the Regional Offices of the Reserve Bank. Chapter Seven attempts Model legislation on money lending covering the legal framework, the enforcement machinery, conclusions and the recommendations of the Group. Chapter Eight contains the summary of the recommendations.


CHAPTER – 2
The Context and the Focus

“…We need more thinking on the credit front. While the financial system should do more for the credit needs of farmers, we need to raise some questions. What do farmers need – a lower rate of interest or reliable access to credit at reasonable rates? Is our existing institutional framework adequate for meeting the requirements of our farmers who are a perse lot? Do we need to create new institutional structures such as SHGs, micro finance institutions, etc, to provide improved and reliable access to credit? Or do we need to bring in Moneylenders under some form of regulation? It is necessary that we find answers to these questions in the near future.'

- Hon’ble Prime Minister of India, Dr. Manmohan Singh
(in his address at the 2nd Agricultural Summit, October 18, 2006)

Box-1
Report of the Study Group of the Banking Commission on the Indigenous Bankers

“…Today there is a network of financial institutions…. Would the commercial banks be in a position to supply funds to millions of small borrowers with comparable ease and informality, i.e., give loans on the basis of personal creditworthiness rather than tangible securities? Or would it be correct to say that indigenous bankers perform a gap-filling function in as much as they are catering to a class of borrowers whom the banks for various reasons cannot reach directly? And what follows as a corollary, is there need to forge a stronger link between the organised and the indigenous financial sectors? The broad conclusion of the Study Group’s enquiry was that in many ways the indigenous bankers constitute an indispensable link between the organised banking system and the class of small borrowers who may not be in a position to obtain funds at the right time and in the right quantum from the organised banking system…. For instance, the discounting shroffs (the multanis) etc., act as the intermediary between the commercial banks and the small borrowers about whose creditworthiness the bank would not usually have adequate information…… In the view of the Study Group, the hundi could have provided an appropriate basis for the development of a truly integrated bill market adapted to the needs of the local environment. The hardening of attitudes on both sides, however, rendered any direct link or integration with the organised sector difficult. The indigenous bankers were reluctant to segregate their banking and non-banking activities. Another major difficulty was that the authorities were sceptical regarding the hundi as emanating from a particular trade transaction and therefore as a genuine trade bill. In their opinion, the advances were more often in the nature of accommodation paper and in the absence of documentary evidence to back the paper, it was difficult to say that the credit was in all cases used to support a genuine productive activity. In any event, with the nationalisation of major commercial banks and the emphasis of policy on the expansion of  branches and direct financing of priority sectors like small-scale industry and agriculture, the urgency for a link between the two sectors appears to have receded into the background….. Although the Central Banking Enquiry Committee recommended that the indigenous bankers be linked directly with RBI and these bankers were also keen on such a link in the first half of this century, the Study Group is of the opinion that it is not now necessary or feasible to establish such a direct link….. The proper course would be for the Reserve Bank to exercise indirect influence over the business of indigenous bankers through the medium of commercial banks….. Because they remain outside the rigid cast-iron framework of rules and regulations and they are able to operate with a certain degree of flexibility which is what attracts the small borrower.”

2.2 The Study Group was of the opinion that given the framework and functioning of the organized banking system, and the attributes of small borrowers and their typical needs, there is bound to be a disconnect between the two. The indigenous bankers, the Group opined, are necessary to fill this gap. Thus, the thrust of the recommendations of the Study Group was that indigenous bankers had a niche role to play and it would be advantageous to harness the synergies between them and the organized banking system. To this end, the Group had suggested linkage between the two, and recommended that commercial banks could finance indigenous bankers and Reserve Bank could extend refinance to the banks. However, the Group’s recommendations, made mainly in the context of urban moneylenders, were not implemented. 

2.3 The  AIl India Debt and Investment Survey (NSS Fifty-Ninth Round) has revealed that share of institutional agencies in the total cash dues of urban households had increased from 72 per cent in 1991 to 75.1 per cent in 2002 and that of moneylenders had also increased during the period from 10.2 per cent to 14.1 per cent. In the case of rural households, on the other hand, the share of institutional agencies had in fact declined from 64 per cent in 1991 to 57.1 per cent in 2002. And more significantly, the share of moneylenders had increased in the same period from 17.5 per cent to 29.6 per cent in the case of rural households.
An analysis of source-wise distribution of outstanding loans taken by farmer households in different States is given in Table 1 below:

Table 1

Per 1000 rupees distribution of outstanding loan taken by farmer households in different States

 

Sources of Loan

Govt.

Co-op.
society

Bank

Agri./ 
profess-ional
money
lender

Trader

Relatives &
friends

Doctor,
lawyer
etc.

Others

All

Andhra Pr.

 10

104

200

534

48

53

9

41

1000

Arunachal Pradesh

 61

    0

208

          0

    159

     507 

        0

65

1000

Assam

70

  27

278

155

    120

    247

        5

99

1000

Bihar

22

 25

370

328

11

128

12

106

1000

Chhattisgarh

13

206

505

130

42

63

7

     35

1000

Gujarat

 5

418

272

65

44

177

9

10

1000

Haryana

11

239

426

241

31

34

15

4

1000

Himachal Pr.

61

116

476

72

55

170

1

49

1000

Jammu & Kashmir

131

   2

543

11

155

155

0

2

1000

Jharkhand

 39

 45

557

190

17

136

4

12

1000

Karnataka

 19

169

501

200

19

68

4

21

1000

Kerala

 49

283

491

74

17

66

10

 9

1000

Madhya Pr.

 19

169

381

226

90

101

5

8

1000

Maharashtra

 12

485

341

68

8

59

3

24

1000

Manipur

 15

   0

167

329

40

401

0

49

1000

Meghalaya

 60

   0

   0

128

3

809

0

0

1000

Mizoram

243

 31

499

  0

33

193

0

0

1000

Nagaland

 75

 77

536

3

153

155

0

0

1000

Orissa

130

181

437

148

  8

84

1

10

1000

Punjab

  19

176

284

363

82

63

6

 7

1000

Rajasthan

  13

  59

270

365

192

69

       18

14

1000

Sikkim

348

    0

230

73

221

67

0

61

1000

Tamil Nadu

 20

233

281

397

  4

52

1

11

1000

Tripura

164

 28

605

20

39

119

0

25

1000

Uttar Pr.

 24

 67

512

191

29

138

19

20

1000

Uttaranchal

315

 48

398

59

17

149

0

14

1000

West Bengal

103

192

285

130

107

154

7

23

1000

Group of UT’s

307

147

136

103

61

245

0

1

1000

All India

 25

196

356

257

52

85

9

21

1000

Estimated Number (00)

14769

114785

117100

125000

53902

77602

7181

14605

434242

Sample Number

  992

   5844

  6296

6919

3018

4528

345

872

23935


The survey reveals that out of every Rs 1,000 outstanding of farmer households in the country, Rs 257 was sourced from moneylenders. The share of moneylenders in the indebtedness of farmer households in Bihar, Manipur, Punjab, Rajasthan, Tamil Nadu and Andhra Pradesh were well above the national average, with Andhra Pradesh at the top. The penetration of moneylenders is significant even in States that are regarded as being adequately banked (Andhra Pradesh and Tamil Nadu).

Initiatives in institutional credit in the rural sector

2.4 To provide an impetus to the flow of credit from the banking sector to rural areas, a host of measures have been initiated by the Government and the Reserve Bank. The progress in rural banking over the last several decades was described by Governor Y.V.Reddy in a recent speech, extracts of which are given in Box-2.

The first Smarajit Ray Memorial Lecture delivered by Dr. Y.V. Reddy, Governor , Reserve Bank of India,  organised  by  the  Andhra  Pradesh  Mahila  Abhivruddhi  Society,  Hyderabad  on  December  16,  2006 at the Centre for Economic and Social Studies, Ameerpet, Hyderabad.


Box-2

“…..Rural banking was traditionally a monopoly of the Moneylenders, till the colonial Government enacted Co-operative Societies Act in 1904 with a view to making the co-operatives as premier institutions for disbursement of credit. The process of a three-tier structure for co-operatives commenced in 1915. Government was also providing agricultural loans usually called Takkavi loans, which have since been discontinued. The RBI Act vested a unique responsibility of rural credit to the central bank. All India Rural Credit Survey (1951) of the RBI opined that the co-operatives were “utter failure” in providing rural credit, but added they had a vital role in agriculture credit. The Imperial Bank was nationalised as SBI, which was visualised as a vehicle for rural banking. … Many State Governments legislated the registration and regulation of Moneylenders but with little emphasis on implementation. Nationalisation of banks in 1969 gave a boost to expansion of banks and banking in rural areas. The Reserve Bank hived off a part of its role in agricultural credit to a separate national level institution, viz. Agriculture Refinance and Development Corporation (ARDC) in 1975. Soon thereafter, a legislation was enacted to create Regional Rural Banks, with participation from Central and State Governments and the nationalised banks, which have their network spread almost all over the country. Subsequently, the ARDC was converted into NABARD..… Simultaneously, the directed credit in the form of priority sector lending continued and the administered interest rate regime lasted. During the reform period, capital was infused into the RRBs and the NABARD. While the priority sector lending continued, the administered interest rate regime was dismantled.  To make up for the shortfall in the priority sector lending by the banks, the Rural Infrastructure Development Fund (RIDF) was initiated to ensure the envisaged flow of bank resources to agriculture through the intermediation of the NABARD and the State Governments. A system of Special Agricultural Credit Plan was also introduced. …..More recently, since 2004, vigorous efforts have been made to more than double the credit flow to agriculture. Emphasis has been laid on sound credit culture, effective credit delivery and appropriate credit pricing. Innovations in the area of rural credit have included introduction of Kisan Credit Cards and encouraging SHG-bank linkages. Further, new instruments for financial inclusion such as General Credit Cards and no-frills accounts were initiated. Micro finance programme was intensified and new guidelines for business-facilitator model were issued. Use of technology for rural banking is being encouraged. Special Area Plans for banking in several States such as Uttaranchal, North Eastern States, Chattisgarh and Bihar…. have been formulated to suit the local conditions. In terms of institutional development, consolidation of the RRBs, revamping of the urban co- operative banks as per the vision document, revival of rural co-operative credit structure as per the Vaidyananthan Committee recommendations, a plan for restructuring of long-term lending institutions for agriculture, and a revisit of the prescriptions relating to the priority sector lending are underway. …… A Working Group was constituted by the Bank to look into the relief measures for the distressed farmers.  Above all, as per the Government of India announcement in 2006, it has been decided to subsidise the commercial banks and NABARD to enable provision of short-term credit at 7% interest rate to the major segment of the farmers”. (This has been extended for 2007 also). “Thus, there have been vigorous and determined efforts towards expansion of rural credit, especially through rural banking…However, an assessment of the position at ground level indicates that accessing non-institutional credit still continues as far as rural areas and agriculture sector are concerned. The credit-deposit ratio continues to be low in the rural areas, despite the intermediation of banks. The all-in costs of credit from banks, after factoring in timeliness, transaction-costs, access, etc, appears high for agriculture relative to private corporate sector even after accounting for the risks as reflected by the level of actual non-performing assets. The performance of some of the public sector banks in rural and agricultural lending is inadequate, while that of most of the private and foreign banks is even lower, despite considerable expansion of the scope of priority sector lending…….While there has been notable progress in micro finance, it is mostly confined to the States with fairly well-developed banking system. Further, the cost of credit at around 20 to 30% also appears high……..Though there has been significant growth in rural credit in the recent years, its medium-term sustainability is contingent upon growth in agriculture and improvements in the institutional settings. In brief, the perceptions on the outcomes of vigorous and varied efforts to expand the reach of rural banking seem to be less than expected.”

2.5 The constraints faced by the formal financial system in reaching rural households in a flexible and hassle-free manner led, almost as a natural consequence, to emergence of various options like the SHG-bank linkage programmme and the microfinance institutions (MFIs). MFIs range from fair-sized NBFCs to much smaller societies and trusts. The use of MFIs and other intermediaries as business facilitators and business correspondents was also allowed by the Reserve Bank in January 2006. Some banks are experimenting with using post offices as agents. In Andhra Pradesh, Village Organisations (VOs), which are set up as co-operatives through federated SHGs are being gainfully utilised for upscaling bank linkages because it is easy for bankers to deal with seven or eight VOs instead of a large number of SHGs. A pilot project in using VO as a business correspondent has commenced in Andhra Pradesh using IT solutions for ensuring necessary safeguards.

2.6 The SHG-bank linkage model has been quite successful in as much as 25.84 lakh groups have been linked to banks covering about 33 million women. The total credit cumulatively disbursed is about Rs14,479 crore. The current outstanding credit is at around Rs 4,000 crore. There is no doubt that in some regions these institutional arrangements have addressed the problem of the poor. Their success in empowerment of women, especially poor women, is remarkable. The access to savings and credit facilities provided by the SHG-bank linkage model would not have been possible by branch banking alone. At the same time, it is important to note that the rates of interest paid by the borrower member of the SHG could be as high as 18 to 24 per cent i.e., much higher than that charged by banks on their direct loans. In case of MFIs also, the interest rates are around 20 to 24 per cent. It should also be noted that these initiatives have generally been extensive in areas that are already served by banks and that their activities in the backward and tribal areas are limited. In the recent period, there have been initiatives by NABARD in extending the SHG model to some under-served areas.

2.7 Notwithstanding concerted and multi-pronged efforts to extend institutional credit to all sections of society as also other initiatives for increasing the outreach of banks by using SHGs and MFIs as intermediaries, the dependence on moneylenders has not decreased in rural areas and has, in fact, increased in several regions. Against this background, there is a case for looking at possibility of leveraging the presence of moneylenders who continue to operate despite century-long efforts by policy makers to find substitutes for them. Concerns regarding usurious rates of interest and harsh recovery practices are a reality and ways should be found by which the law can be enforced. The focus of the Technical Group was therefore, on whether there could be a way of incentivising good conduct and practices by moneylenders while simultaneously providing for a more effective enforcement of penalties for violations of the law.


CHAPTER – 3
Money Lending Legislation – The International Scenario
Introduction

3.1 The name by which moneylenders are called may vary from country to country but they can be found performing similar activities all over the world. It is natural therefore that, with a view to having a level playing field, several governments should have attempted to regulate the activity. In this Chapter we analyse the main features of money lending legislation in the following countries. The sample includes developed as well as the developing countries.

1. Hong Kong                - Moneylenders’ Ordinance, 1997
2. Singapore                 - Moneylenders’ Act, 1959
3. Japan                       - Money Lending Business Control and Regulation Law, 1983
4. Lesotho                    - Moneylenders’ Order, 1989
5. United Kingdom         - Consumer Credit Act, 1974
6. West Pakistan          - The Punjab Moneylenders Ordinance, 1960
7. USA (S. Dakota)        - Title 54 of the South Dakota State Laws (Debtor and       Creditor)
8. South Africa              - The National Credit Act, 2005

The administrative authorities empowered under the money lending laws in the above countries  may be seen in Annex-II.

3.2 The nature of the money lending laws is regulatory, with emphasis being on protecting the interests of the borrowers by providing definite upper limits on rates of interest and curbing coercive recovery practices. The latter is sought to be done by penalizing such acts as also by denying the benefits of legal remedies to moneylenders to recover loans to the extent to which they are tainted with illegalities. Coercive recovery practices are also sought to be curbed by providing definite recovery procedures generally through Courts. Where there are violations, procedures are also prescribed to provide a remedy to the injured. The prescription of fair practices is generally restricted to imposing certain obligations usually in the nature of requiring moneylenders to provide documents evidencing loan transactions containing detailed description, inter alia, of the amount of loan, date of payment of the loan and rate of interest.

Definitions

3.3. The definition of the term ‘moneylender’ in legislation is generally all-inclusive, and means a person who is in the business of lending money (loans), whether as principal business or otherwise. However, nearly all legislations expressly exclude certain categories of persons from the definition. The excluded categories are either incorporated bodies or institutions in the business of banking, insurance, dealing in securities etc., which are otherwise regulated by formal regulatory bodies in those countries. There are certain other non-incorporated but registered bodies, such as, registered co-operative societies, which are also excluded from the definition of moneylenders. In addition to such individuals being expressly excluded, the laws abroad also exclude either a class of loans or loans provided by a class of persons from being regarded as “loans” for the purpose of the money lending legislation thereby taking them out of the purview of those laws. For example, under the Hong Kong Law, the following types of money lending are excluded from the applicability of the Ordinance:

a. A bona fide loan made by an employer to his employee

b. A loan made to a company secured by a mortgage

c. A loan made by a credit card company to a credit card holder for purchase or refinance of immovable property

d. A loan by a person whose ordinary or primary business does not include money lending

e. A loan made by a pawn broker (since the pawn brokers in Hong Kong are regulated by a separate legislation, loans made by them are not covered under the Moneylenders’ ordinance)

f. A loan made by a statutory corporation under the powers conferred upon it under the statute

g. Loans from provident fund, chit fund, from holding company to subsidiary company, or by one subsidiary company to another subsidiary company

h. Loans for transactions involving import into or export out of Hong Kong.

i. Loans made to a company having paid up capital of not less than Hong Kong dollars one million, or whose shares or debentures are listed on the recognised stock exchanges in Hong Kong.

3.4. It was also seen that when a loan or a body or person making that loan came under a formal regulatory jurisdiction, it (or he or she) was excluded from the purview of the money lending legislation. But there are exceptions. For example, in Lesotho, certain transactions are exempted although these transactions are not formally regulated. Similarly, in Pakistan trade loans are expressly excluded from the definition of “loan” and thereby from the purview of the legislation. In Hong Kong, Singapore, and Lesotho, the law enables authorities to grant exemptions. The Singapore legislation provides that other than the persons expressly excluded from the purview of the law, any person who lends a sum of money in consideration of a larger sum being repaid shall be presumed to be a moneylender, until the contrary is proved.

3.5 In all the countries being discussed here, registration or obtaining a licence is compulsory. Such licences are generally valid for 12 months and can be renewed. Procedures for obtaining licences are prescribed. The licence is for the business of money lending as a whole and restrictions generally tend to be geographical in nature, which means that the licence is valid only for a particular area. All these countries require a register of licensed moneylenders to be maintained. These registers also contain details of the licence, including whether the licence has been cancelled, suspended or revoked. In the United Kingdom, the Office of Fair Trading maintains a Consumer Credit Register wherein the details of everyone who holds a licence, has applied for one, or had one revoked, suspended or varied, is available and the same is made available to the public. Similarly, under the Singapore law, the list of licensed moneylenders is published in the Gazette by the Registrar from time to time.  The presence of the name of a person is evidence that he or she is a licensed moneylender and the absence therefrom is evidence that he or she is not licensed.

3.6   If money lending is conducted without a valid licence, the lender becomes liable for criminal action and the offence can entail a fine or imprisonment or both. In the South African law, a credit agreement is rendered unlawful and amounts paid thereunder non-recoverable if at the time when the agreement was made, the credit provider was not properly registered. Similarly, under the Singapore and Hong Kong laws, such person would not be entitled to recover the loan or loans, which has or have been provided without having a licence. Under the Pakistan law, such a licence should be in force or valid even at the time of filing a case before the Court except in cases where the licence has been suspended or cancelled. However, the moneylender can still file a suit before the Court for the recovery of the loan (even though he is not technically in possession of a licence) if he has a certificate issued by the Collector specifying the loans in respect of which a suit may be instituted or the decree in respect of which an application for execution may be presented by him.

3.7  In addition to the above, laws are sought to be enforced by restricting legal remedies available to the moneylender. In cases where a moneylender does not possess a valid licence, he or she loses the entitlement to recover the loans through the legal process. Under the Singapore Law, by having ‘residual’ clauses like deeming certain persons who lend money in consideration of receiving a higher money from the borrowers to be moneylenders, any person who seeks the help of the Court to enable him to recover such loan may have to either prove that he is not a moneylender or, if he is one, to produce a valid money lending licence. In cases where there are duties imposed under the law in the event of non-compliance with those duties moneylenders are barred from recovering such loans, either in part or full, to which the acts of non-compliance relate.

3.8 Overall, this comparison with international practice suggests that there is great deal of similarity with Indian laws. However, some features are peculiar to specific countries eg. the calculation of repayment amounts in the case of loans taken in kind, as in  Pakistan; the prevention of over indebtedness of the borrower by restricting the amount of loans that could be provided to a particular borrower as in Japan, South Africa, South Dakota; enabling persons to seek recourse to an alternate dispute resolution mechanism as in South Africa; requiring borrowers to obtain “credit insurance” in South Dakota and South Africa and provisions enabling the establishment of credit information agencies to obtain information about a borrower’s indebtedness as in Japan.

CHAPTER – 4
The Current Legal Framework
Introduction

4.1  The Constitution of India has conferred the power to legislate on matters relating to money lending and moneylenders to the States. Most of them have enacted the laws (Annex-III). Many of these are comprehensive legislations providing detailed and stringent provisions for regulation and supervision of the money lending business. These legislations contain provisions aimed at protecting the borrowers from malpractices of the moneylenders. In Andhra Pradesh, there are two laws governing moneylenders, applicable to different parts of the State. The Andhra Pradesh (Telangana Area) Moneylenders Act, 1349 F (Act No. V of 1349 F) is applicable to the whole of the Telangana area, whereas the Andhra Pradesh (Andhra Region Scheduled Areas) Moneylenders Regulation, 1960 (A. P. Regulation No.1 of 1960) is applicable to the Andhra region. Efforts are being made by the State government to come up with a single Act that covers the whole State. Orissa also has two laws, which are made applicable in different parts. The Orissa (Scheduled Areas) Moneylenders' Regulation, 1967 has been made applicable to the Scheduled areas of the State, whereas the Orissa Moneylenders' Act, 1939 is applicable to rest of the State.

4.2 Some States have enacted separate legislations governing the business of pawn-broking, while others have incorporated separate provisions for pawnbrokers within the money lending legislation itself. For the purposes of this report, we have focused on the legislations dealing with money lending, leaving aside the laws governing pawn broking.

4.3  The history and object of enacting the money lending legislations can be inferred from the observations made by some High Courts. Thus, in Sk. Abdul Sattar v. Sitaram Sah and Anr., the Bihar High Court observed as under :

'Before embarking upon this question, it is relevant to state at the outset that the Act was brought on the Statute book to consolidate and amend the law relating to regulation of money-lending transactions and to grant relief to the debtors in the State of Bihar.”

Similarly, in the case of J.D. Nichani and Anr., v. State of Madras, the Madras High Court, while dealing with the challenge to the constitutional validity of certain provisions of the Madras Moneylenders Act, 1957, made observations to the effect that the Madras legislation had been enacted in order to cure the defects that were noticed in enforcing the provisions of the Section 51A of the City Police Act, 1888 which, in turn, was introduced in order to put an end to the malpractices followed by a special class of moneylenders known as pawnbrokers, and for the purpose of framing a legislation to regulate and control the business of moneylenders in the then State of Madras.  In a case relating to the Bombay Money Lender's Act, 1946 the Bombay High Court held that the Act was a piece of social legislation. In yet another case in Bihar, it was held that the Act was a measure of beneficial legislation intended to liberate agricultural debtors from shackles of the ever-continuing indebtedness.

Salient features of the Money Lending Legislations

4.4. An examination of the money lending legislations of 22 States shows that the provisions are generally similar. The salient features are:

Requirement of registration/license for carrying on the business of money lending within a State/a portion of the State;
Duties of the moneylenders with respect to maintaining and providing statement of accounts to the debtors;
Penalties for carrying on business without licence and for intimidating the debtors or interfering with their day-to-day activities, including the cognizability of such offences;
Maximum rates of interest that can be charged;
Matters that the Courts are required/empowered to decide in suits filed by moneylenders;
Applicability to companies engaged in the money lending business. However, some States in exercise of their general exemption powers, have granted exemptions to companies from the applicability of the legislations.
Exemption to loans from a trader to another trader, loans by banks, co-operative societies, financial institutions, etc.

Certain common features found in majority of the legislations are outlined in the following paragraphs.

Object and Coverage

4.5  The object of legislation pertaining to money lending is to regulate and control the business of moneylenders.  The various Moneylenders Acts define a moneylender as a person whose main or subsidiary occupation is the business of advancing and realising loans. Banks and Co-operative Societies are excluded from the purview of the Acts of many States. Generally, the laws have been made applicable to individuals, firms, association of individuals and companies. However, Nagaland and Andhra Pradesh (as applicable to the Andhra Region Scheduled Areas) have excluded companies from the purview of their respective enactments.

Registration/Licensing

4.6  All the moneylending legislations provide that moneylenders are required to register and obtain a licence. All the State legislations, except those of Punjab and the National Capital Territory of Delhi, also provide for penalties if any person carries on business without registration/licence. The punishments range from a low fine of Rs.200 to imprisonment for a period of 3 years and maximum fine of Rs 50,000.  Kerala prescribes a minimum punishment of imprisonment for 6 months. Some States provide for enhanced punishments for second and subsequent offences.

4.7 Kerala and Karnataka provide for the payment of a security deposit by the moneylender at the time of applying for the licence, which is liable to be forfeited in the event of his contravening any of the provisions of the respective Acts/Rules, falsification of accounts, and commission of certain offences. Almost all laws, except of Kerala, Nagaland and Andhra Pradesh (Andhra Region Scheduled Areas) Moneylenders Regulation, 1960, also impose a bar on suits filed by unregistered moneylenders.

Loans in kind, goods and materials

4.8  Most State Acts include the advance of both money and kind within the definition of the term 'loan'. The AP (Andhra Region Scheduled Areas) Moneylenders Regulation, 1960 defines a “loan” (section 2(10)) as advance of money or articles, goods or materials for interest and includes any transaction, which the Court finds in substance to amount to such an advance.  In Uttar Pradesh, the sale of goods on credit and hire purchase are not covered. In Kerala and Bombay, a loan advanced in the regular course of business by a trader legitimately carrying on any business has been exempted from the definition of 'loan'. In Karnataka, loans from a landlord to a tenant for financing of crops or seasonal finance of not more than fifty rupees per acre of land held by the tenant have been exempted from the definition of the term 'loan'. Under the Orissa Moneylenders' Act, 1939, supply of goods (i) on khata carrying simple interest upto six and a quarter per cent per annum and (ii) on credit, are not treated as loans.

Keeping, Filing and Furnishing of Accounts

4.9 Almost all the States have provisions requiring moneylenders to keep statement of accounts in the form and manner prescribed in the Rules. Moneylenders are also required in Karnataka, Uttar Pradesh, Kerala, Maharashtra, Nagaland, Madhya Pradesh and Rajasthan to file statement of accounts with the registering/licensing authorities and generally they are required to do so annually. 

Another requirement is to furnish a statement of accounts to the borrowers as prescribed under the Rules. Delhi, Punjab and Haryana do not contain provisions for the keeping of accounts, filing statement of accounts/returns with registering authorities and furnishing of account details to the borrowers. Similarly, even though the Andhra Pradesh (Telangana Area) Moneylenders Act, 1349 F provides for keeping of accounts, it does not contain any provision requiring the lenders to file statements of accounts/returns to the registering authorities. In Bihar, the filing of accounts with registering authorities has been restricted to the accounts of scheduled castes and scheduled tribes only. Karnataka, Uttar Pradesh, Kerala, Maharashtra, Bengal, Orissa, Bihar, Andhra Pradesh, Rajasthan and Nagaland enable the State authorities to inspect the books of accounts and related documents. Some States even have powers of search and seizure of books of accounts and documents relating to money lending. Most of the States also prescribe penalties for the falsification of accounts/entry of wrong sums in accounts.

Interest Rates

4.10 Interest rates chargeable by moneylenders are either fixed by Statute or the Statutes empower the respective Governments to fix the interest rate by issue of notification from time to time. The same forms a bench-mark for the Courts to determine whether the interest rates charged are excessive in the given facts and circumstances of a case. The Courts are also empowered to examine whether or not interest rates charged on a loan transaction are excessive under a central legislation, namely, the Usurious Loans Act, 1918, wherein guidelines for determining what is ‘excessive’ have been provided in terms of Section 3(2) of the said Act. Some States have provisions empowering the Courts to limit the amount of interest to a sum less than the principal of the loan while passing a decree and also for reopening of transactions.

Molestation

4.11 Karnataka, Kerala, U.P., Tamil Nadu, Bombay and Bengal have provisions defining an offence of ‘molestation’ and prescribing penalty for the commission or abetment to commit the same. The term ‘molestation’ has been defined to include use of violence/intimidation against the debtor or family members/loitering near the house or work place/doing of any act calculated to annoy the debtor, etc.

Reopening of transactions by Court

4.12  With the exception of Kerala, Punjab, Delhi, Haryana and AP (Telangana Area) all other States examined by the Group permit the Courts to reopen the transactions pertaining to the loan, settle accounts between the parties and reduce the amount charged to the debtor in respect of any excessive interest.

Trade credit

4.13  Loans from one trader to another (trade credit) have been exempted, expressly or impliedly in Kerala, Andhra Pradesh (Telangana Area), Orissa, Karnataka, Rajasthan, Tamil Nadu, Maharashtra, Gujarat, Nagaland, Haryana, Punjab and Delhi. Even agricultural input credit appears to have been excluded from the purview of the legislations of the States of Karnataka, Maharashtra, Gujarat, Kerala and Madhya Pradesh.

Special features

4.14 Apart from the general provisions common to the legislations of all the States, there are certain special features unique to some of them, which are noteworthy.

Commercial lending

4.15  The Bengal Moneylenders Act, 1940 has a provision defining “commercial loan” (Section 2(4)) to mean a loan advanced to any person to be used by such person solely for the purposes of any business relating to trade, commerce, industry, mining, planting, insurance, transport, banking or entertainment, or to the occupation of wharfinger, warehouseman or contractor or any other venture of a mercantile nature, whether as proprietor or principal or agent or guarantor. Interest rate permitted is higher for such loans. The Andhra Pradesh (Telangana Area) Moneylenders Act, 1349 F has a provision (Section 2(9)) defining the meaning of “trader” and read with the provisions of Section 2(4)(g), providing for exemption to certain categories of loans, which include loan by a trader to another trader. The Kerala Act, while defining “loan”, has excluded an advance made by a trader bona fide carrying on business, other than money lending, if such loan is advanced in the regular course of such business.

Penalty for taking salami, batta, gadiana

4.16  The Bihar Moneylenders Act, 1974 contains a provision providing for penalty on moneylenders who takes from a debtor at the time of advancing loans or deducts out of the principal of such loan any salami, batta, gadiana or other extraction of a similar nature.

Composition of Offences

4.17 Certain legislations provide for compounding some of the offences made punishable under the Moneylenders legislations.

Exemptions

4.18   Generally all the legislations define a moneylender to be a person advancing loans. Exemptions from the applicability of the provisions of the money lending laws are of various types (i) exemption provided under the definition of moneylender(Rajasthan Moneylenders Act), (ii) exemption provided under the definition of loan (generally in many legislations); (iii) provisions expressly exempting persons / entities from the provisions of the legislations (Madhya Pradesh Moneylenders Act, 1934); (iv) Provisions empowering Government to exempt persons / entities from the provisions of the legislations; (iv) limited exemption is granted under certain legislations (Bombay Moneylenders Act, 1946 – applicable to Maharashtra and Gujarat) to banks, companies, unincorporated bodies etc.

Debt collectors

4.19 The AP (Andhra Region Scheduled Areas) Moneylenders Regulation, 1960 has a provision for employing debt collectors by moneylenders after obtaining authorisation from the authority in terms of section 11. The Nagaland Moneylenders Act, 2005 prohibits employment of persons by moneylenders for the purpose of demanding or recovering any loan due to him unless such person is in possession of a certificate (issued by the designated authority of the State) authorising him to act as a debt collector.

Money lending to be carried on as a “business”

4.20 The money lending laws of many States specifically cover those who carry on money lending as a business.

Definition of “bank” and exemption to advances made by banks

4.21 The term “bank” has been defined in certain laws to mean a company carrying on the business of banking and registered under the enactment relating to companies. As regards Public Sector Banks, the above mentioned Acts are silent.

Loans by Cheque

4.22 In UP there is a provision requiring that loans above Rs 1,000 are to be evidenced by a cheque.

Board for Resolution of Disputes

4.23  In Bihar Chapter IV deals with conciliation proceedings for resolving disputes pertaining to loans exceeding Rs 100 between the moneylender and the debtor, irrespective of the pendency of a suit for recovery of the loan before a court. In terms of these provisions, the State government can refer the dispute to a Board constituted by it consisting of three members – a chairman who has to be a person agreed upon by the parties or an officer not below the rank of a Sub-Deputy Collector, and one member each representing the parties to the dispute. The decision of the Board is final and cannot be called in question before any Court.

Security Deposits

4.24  Kerala and Karnataka require registered moneylenders to keep security deposits with the Government. The law provides a detailed table specifying the amount of money required to be deposited by a moneylender, and it is linked to the amount of money lent in a year.  The security deposits specified under the Kerala Moneylenders Act, 1958 range from a minimum of five thousand rupees to a maximum of two lakh rupees. The security deposits specified under the Karnataka Moneylenders Act, 1961 range from a minimum of five thousand rupees to a maximum of fifty thousand rupees.

Audit by Chartered Accountants

4.25 The Kerala Moneylenders Act, 1958, is the only Act, which provides that the accounts of every moneylender be audited at least once in every year by a person who is a chartered accountant and the audit report submitted to the specified authority.

The Rule of “Damdupat”

4.26 Some of the State laws contain a provision providing for the maximum amount of interest recoverable on loans made by moneylenders, incorporating the rule of damdupat. The rule of damdupat is a branch of the Hindu law of debt. According to this rule, the amount of interest recoverable at any one time cannot exceed the principal. The rule was applied not only to unsecured loans, but to loans secured by a pledge of movable property and those secured by a mortgage of immovable property. The Rajasthan Moneylenders Act even has got a provision expressly stating that in cases where the moneylender has realised from the debtor an amount equal to or more than twice the amount of the principal, the debtor shall stand discharged and requiring the moneylender to efund the amount so realised in excess of twice the amount of the loan to the debtor. 

Usurious Loans Act, 1918

4.27 The Usurious Loans Act, 1918 is also currently applicable to transactions relating to money lending. The Usurious Loans Act, 1918 (ULA) was enacted with the object of preventing the Civil Courts being used for the purpose of enforcing harsh and unconscionable loans carrying interest at usurious rates. The provisions of ULA enable the Courts to reopen transactions by way of money or grain loans in cases where the Court is satisfied (a) that the interest or other return is excessive and (b) that the transaction is substantially unfair and after investigation of the circumstances, both attendant and antecedent, to revise the transaction between the parties and, if necessary, to reduce the amount payable to such sum as the Court, having regard to the risk and all circumstances of the case, may decide to be reasonable.  ULA has been made applicable to suits for (a) recovery of a loan, (b) enforcement of any security taken or any agreement, made in respect of any loan and (c) redemption of any security given in respect of any loan. The State Government has been empowered to exempt, by way of notification in Official Gazette, any area, class of transactions or class of persons from the applicability of ULA. ULA provides guidelines to the Court for examining whether a particular rate of interest can be considered to be excessive or not and also for considering whether a transaction is substantially unfair or not.  The ULA is applicable to all suits as mentioned above irrespective of the parties involved in the disputes. Therefore, the Act is also applicable to suits in which a moneylender is a party. In view of the provisions of section 21A of the Banking Regulation Act, 1949, the provisions of the ULA are not applicable to banks. Some States like Madhya Pradesh and Maharashtra have made amendments to ULA specifically providing that charging of compound interest in excess of a particular percentage shall be deemed to be excessive. The State of Tamil Nadu has made an amendment to the effect that if compound interest is charged in case of loans to agriculturists, then the Court shall presume that the interest is excessive. Even if there is no prohibition under ULA against charging of compound interest, the Courts have a duty of examining the transaction as a whole and ascertaining whether in a given case, the transaction is unfair or the rate of interest is usurious. The Bengal Moneylenders Act, 1940 has repealed the Usurious Loans Act, 1918 in respect of money lending transactions falling within the purview of the Bengal Moneylenders Act.

Interest Act, 1978

4.28   Though not a part of the overall body of laws relating to money lending, there is one more Act, viz, the Interest Act, 1978 which can also be applied by Courts while granting interest in suits. The Act is a Central Act and it was enacted with a view to consolidate and amend the law relating to allowing of interest in certain cases. Its provisions empower the Court to allow interest in any proceeding for the recovery of any debt or damages or in any proceedings in which a claim for interest is made in respect of any debt or damages already paid to the person entitled to the debt or damages at a rate not exceeding the 'current rate of interest' for the period specified in the provisions.

CHAPTER – 5

Linkages between Moneylenders and Formal Credit Channels

5.1  Various studies in India and abroad show that the informal sector is better at serving the sectors neglected by banks such as small businessmen, traders, poor transport operators, handloom weavers, small farmers, self-employed people and women. They are also better at recovering loans. They have better market knowledge and lower transaction costs. They are flexible and can customise the products to suit the needs of individual borrowers. They respect the borrowers’ privacy. On the other hand, the formal sector has strengths in terms of its access to low cost funds, providing safe avenues for savings and access to payments system. But their procedures and practices deter the poor.

Review of Literature

5.2 A review of the available literature suggests that moneylenders continue to provide financial intermediation in areas that are underserved by formal institutions.  The very small scale is the critical determining factor, as they are able to provide very tiny sums as loans. J. Howard M.Jones, Professor in University of Reading, U.K. who had  examined micro-finance  in a tribal village in Rajasthan found that moneylenders continued to cover both consumption and production needs which, given the small scale of finance required, are unlikely to be met by formal financial intermediaries or MFIs. The inherent flexibility in loan use, along with the speed with which the transaction is completed, has ensured continued demand.  In contrast to the attitudes of bank managers towards the rural poor, clients were treated with respect by the moneylender. Interestingly, although the interest rates charged by the moneylenders had not come down with the advent of bank credit in the village, additional charges levied by the moneylenders had. This was attributed to the greater financial awareness in the population. Jones concludes that once recognised and understood in all their diversity, the moneylender might have new and different roles to play in future implementations of policy to provide financial services to the rural poor.  Supporting Jones is the view that the informal sector serves as lender of last resort to those who are unable to obtain finance in the formal sector because the transaction costs of lending to this group are prohibitive, as the loans they demand are so small.

5.3 A.K. Garg, MD Agricultural Finance Corporation suggests that a comprehensive financial system based on bank-moneylender linkages is required.  He notes that if a comparison is made between the credit card interest rates and interest rates charged by moneylenders, the latter are clearly less exploitative. Prof. R. Vaidyanathan, IIM Bangalore, is of the opinion that it is important to recognise moneylenders as legitimate agents of economic activity, and that banks must treat them as channel partners and provide them with credit. It has been suggested by him that banks might consider adopting a policy of encouraging the informal sector with refinance wherever possible (for example, chit funds and nidhis).  In respect of nidhis, for instance, which extend loans only against tangible security, deposit insurance by the Deposit Insurance and Credit Guarantee Corporation of India could be extended.  With such refinance and liberal credit facilities to the deserving informal financial institutions, the banks will be helping the poor indirectly without undertaking a direct risk of default.

5.4  Citing the experience of Bangladesh,  P.B. Ghate mentions that, the 'recovery agents' help borrowers roll over bank loans for a fee, after which borrowers obtain a fresh bank loan. It was seen that even after paying the fee, they found the loans worthwhile (Ghate, 1992). Alternatively, K.G.Karmakar (1999) observes moneylenders in India also disburse loans to borrowers who have bank sanctioned loans but wait to receive them. These anecdotes imply that linkages provide an appealing option (Varghese, 2004). Using a micro data set from Indian villages, Varghese provides the evidence that those borrowers who borrow also from moneylenders repay banks with greater ease. Thus, borrowers can use moneylenders to smooth cash flows so as to meet bank obligations better. In another interpretation of this linkage, banks provide production loans and moneylenders provide bridge loans in order to ensure continuing access.

5.5  But there are concerns as well. K. Hoff and J. E. Stiglitz (1997) provide evidence that infusion of government subsidised formal credit have not improved the terms offered by the moneylenders. Subsidy induces new entry, which reduces the market of each moneylender and forces him to operate at a higher marginal transacting cost. Thus, interest rates charged by moneylenders rise. An increase in entry also adversely affects borrower’s incentive to repay, which increases the enforcement effort that each moneylender must expend per borrower to ensure repayment.

5.6 D.Hulme and P. Mosley argue that the Indonesian system, often quoted as the example of successful linkage, works because of a clear system of control which may not work in all places. Careful consideration must, therefore, be given to the credit market structure that determines the division of surplus among banks, borrowers, and moneylenders. In a monopolistic market, the moneylender can extract the maximum amount and keep borrowers at their lowest reservation utility. In those linkages, borrowers may collude with informal lenders.

5.7 One of the difficulties in the linkage model is the need for banks to ensure that the informal lender continues to lend in an informal manner. In the context of banks lending to Praja Naya Niyamakas (PNNs) of Sri Lanka, the warning is that since the PNNs bear the risk of lending they should be free to lend in any manner they wanted. Banks should only use moral suasion to achieve the objectives of the scheme, “otherwise this linking would be a kiss of death” (Sanderatne, 1992).

5.8 Also both theoretically and empirically, linkages are at an embryonic stage in many countries. Issues of mechanism, design, institutions, and incentives are relatively new areas to explore. Furthermore, historically, policymakers have viewed moneylenders as exploitative. This adds a moral and equity dimension that acquires political weight. Indeed, in certain cases, banks may not find it worthwhile since normally, one bank would not like to provide another with borrower training and management skills gratis. Though no study provides independent evaluation on the effectiveness of moneylenders with respect to non-moneylenders, if banks hire moneylenders, they need not expend resources on training since moneylenders are already experienced in this field. Therefore, both commercial banks and the informal institutions would need additional incentives for these linkages. (Verghese 2004).

5.9 In India, initiatives have been taken to bridge the gap in lending by banks. Guidelines have been issued to the effect that the services of Banking Correspondent (BC)/Banking Facilitator (BF) model may be utilised by banks for expanding their outreach in rural areas and in previously unbanked areas. However, only a few banks have adopted these innovations, and there have been reservations in widely expanding/implementing the models. One of the reasons for the scheme not taking off is reported to be the restriction on the BC/BF to recover charges directly from the ultimate borrower.

International Experience of Linkage

5.10 Africa, Asia and Latin America show a rich variety of linkages between the formal and informal sectors. These financial linkage services include rural smallholders, enterprises, households, small traders and local organisations and associations, and any previously unbanked rural people, such as subsistence farmers and women. One of the schemes adopted by Agricultural Bank of Malaysia, involved using co-operatives, farmer’s organisations and private traders as local credit agents of the bank. The Praja Naya Niyamaka (PNN) scheme inaugurated by the two state banks in Sri Lanka has attempted to link informal credit sources to the institutional banking system. Here banks lend funds to persons of proven credit worthiness, often on the basis of collateral, at an interest rate of 18 per cent per annum and expect the PNNs to lend at an interest rate not exceeding 30 per cent per annum. The banks give the PNNs guidelines on how to lend but do not require them to provide documentation and other proof of their lending. The regional development banks in Indonesia have established village units, which disburse loans at weekly mobile bank offices.  In order to monitor these transactions, the village units actually hire ex-moneylenders as commission agents to monitor repayments. The lenders receive four per cent of collected loan instalments.  The whole system builds a web of incentives, with other participants such as the village headman, who provides some of the linkage advantage, screening borrowers and receiving one and a half percent of pre-tax profits.  Another Indonesian bank (BUPB) offers field officers minimum guarantees plus two percent of fully repaid loans and seven and a half percent of savings.  In eight other financial intermediaries in Indonesia, village agents screen and collect loans.  The agents’ wages depend on observable variable such as collected repayments, loan instalments and primarily adjusted profits.  This flexible system varies in its implementation across villages in that wages are village specific.  The Philippines Government has actively intervened to incorporate the informal sector into the overall strategy of agricultural development. When the Masagna-99 formal credit programmes expanded, repayments deteriorated, borrowers were excluded and they therefore shifted back to informal lenders. The same phenomenon occurred in rural Thailand when the Bank for Agriculture and Agricultural Cooperatives (BAAC) attempted to expand credit. A more proactive and inclusive attitude towards moneylenders has resulted in success for the new credit programmes. In recent years, there have been an increasing number of financial institutions in Ghana seeking to establish more formal, purposive linkages with informal financial agents. Evidence suggests a complex set of relationship between a wide range of players in the formal, semi formal and informal financial sectors.  Recent examples are (i) Accra based non-bank financial institution had linkage with susu collectors (ii) Accra based Commercial Bank had linkage with Rotating Savings and Credit Associations (ROSCAs), and (iii) another Rural Bank had established links with ROSCAs.  Linkage to susu groups and susu collectors offers the potential for reaching even more women clients. The outreach potential of linkage for the formal financial institutions is very apparent in Ghana. These links were all established in the last 5 years. The non-regulated Bolivian NGO FADES entered into strategic linkages with private and public sector organisations in an effort to increase its rural outreach.  Between 2000 and 2004, a very rapid expansion of its branch network caused FADES to experience a decline in the average number of rural clients per branch, which motivated them to find innovative solutions to sustain their extensive branch network.  FADES decided to opt for linkages with several non-financial institutions, and offered to facilitate electricity payments, pension transfers and to sell several utility cards on behalf of Government institutions.  This broader array of services led to an increase in the flow of people at the branch, it ensured a flow of funds at the branch level that reduced the need for transfers within the network, and the fees charged were sufficient to pay for several expenses at the branch. In Rwanda, as both the formal and informal financial sectors are relatively weak the potential for linkages is extremely low. However, more than 20,000 individuals living deep in the countryside of Rwanda now access credit and other financial services of the Peoples Bank on a regular basis.  Also training of SHGs on savings and credit operations, is taking place.

Survey findings relating to linkages

5.11  The results of the survey conducted in various districts across the country were mixed. While many saw advantage in forging formal links either as agent or for on-lending, their concerns were on the adequacy of the remuneration. Registered moneylenders/pawn brokers and unregistered moneylenders who were big farmers or had a huge volume of business, expressed their unwillingness to work as agents/correspondents of the banks. In urban areas, there had been a decrease in the business of moneylenders with the advent of Credit Cards and ATMs. Branch managers, while welcoming the suggestions from point of view of better outreach, credit appraisal, supervision and recovery in the context of their limited staff constraints, perceived the downside as essentially one of reputation risk.

5.12  The advantages of forging links with moneylenders for more efficient credit delivery according to the branch managers are:
(i) Better identification of prospective customers in view of better information with moneylenders;
(ii) Better coverage of remote and unbanked rural areas;
(iii) Facilitate better recovery;
(iv) Increase in the portfolio of banks;
(v) Availability of credit at lower rates compared to what is presently being paid by borrowers to moneylenders;
(vi) Help in avoiding multiple lending to same borrowers against same assets by both the banks as well as moneylenders;
(vii) Save the time and effort of banks in credit appraisal, making pre-sanction visits, documentation processes, credit supervision, and recovery, etc., thereby facilitating better credit flow especially in the context of staff shortages at rural branches;
(viii) Provision of services during the bank holidays as well as after banking hours, which would prove beneficial to people in need of funds in emergency situations.

5.13  The disadvantages are:
(i) The inability of the banks to enforce end-use of funds, reasonableness of interest rates and ensure fair recovery practices;
(ii) The likelihood of monopolistic practices if banks withdraw and lend only  through moneylenders;
(iii) Scope for increased political influence;
(iv) High interest rates, diversion of funds for furtherance of moneylenders’ own businesses leading to further malpractices as more funds are made available to them;
(v) Adverse affect on direct lending and possibility of deterioration of direct relationship between banks and customers and continuance of coercion in recovery, ultimately resulting in tarnishing the bank’s image.

5.14 Most moneylenders felt they needed commission of at least 6 per cent to cover their transaction cost as they were dealing with very small loans. They were also concerned about the non-availability of relief/concessions in the event of non-wilful defaults. They feared that banks might not allow the facility of automatic rescheduling of loan and they would be forced to repay on behalf of the farmer-borrowers as per the original repayment schedule, which might lead to recovery risk.  They also apprehended that formal linkages might attract adverse attention from income tax and police authorities, and feared harassment from the co-operative department if registration under money lending were made compulsory for accessing bank finance; instead some moneylenders preferred regulation/inspection by some outside agencies, such as NABARD.

Models for linkage

5.15 The literature reviewed suggests that financial linkages can be grouped into two broad categories: direct and facilitating. Direct financial linkages refer to linkages between financial institutions in which the main purpose of the linkage is to help informal institutions diversify their sources of funding, expand their loanable funds and balance liquidity shortages and excesses.  A typical example of this type of linkage is a bank or apex organization offering bulk loans to MFIs for on-lending to clients. Facilitating linkages, on the other hand, refer to linkages between institutions in which the formal institution hires the informal institutions to act on its behalf. This type of linkage facilitates the transactions, such as remittances, payment of utilities, and mobilisation of savings or even facilitates loan payouts.  Typically, one partner or financial institution will pay the other partner a fee to facilitate the transaction. 

5.16 The search for effective linkages forms part of a wider program in the microeconomics of development. Linkages can help bridge the persistent dualism in many developing countries like India by providing a step in the development process. The linkages suggest that banks should compensate moneylenders according to the moneylenders’ opportunity costs and information contribution. Learning from the cross-country experiences, there appears to be potential for linkages between informal and formal financial system in India, which has a strong formal financial sector, but a relatively weaker informal sector. Anecdotal evidence suggests that commercial banks have already been lending to the artisans in Punjab and Chandigarh in a small way, who in turn lend to the farmers and traders, which may be formalised. In the South also, an attempt at linkage has been made by the Indian Bank which has initiated a scheme of lending through rural credit franchisers (RCF) viz. pawn brokers to meet the working capital requirements against gold ornaments through RCF for agricultural purposes. 

5.17 Thus, linkages would exploit the advantages of each sector. For example, banks could issue large production loans and request moneylenders to monitor and enforce that loan. In monitoring the loan, moneylenders adopt their own flexible practices. In this manner, banks access borrowers to whom they would otherwise not lend and borrowers access loans that would otherwise be beyond their reach.

5.18 The essential lesson from the international and theoretical studies and the Group’s survey is that any attempt in the linkage model to put too many onerous oversight obligations on banks in terms of processes and procedures will be counterproductive as the moneylenders will not be happy. There is need for considerable flexibility, judging only by outcomes and whether objectives achieved compared to the pre-linkage position. It is equally important to recognise that any model can be successful only if more credit flows at lower cost and in timely fashion.


CHAPTER - 6

Functioning of Moneylenders

6.1 The Technical Group formed sub-groups to solicit the views of the State Governments, bank officials and moneylenders' associations on money lending legislation and the linkages between formal sector and informal credit markets in different parts of the country. The groups toured southern centres including Bangalore, Hyderabad and Thiruvananthapuram and the eastern centres of Patna and Kolkata.

Survey results

6.2  In addition to the visits of the sub-group, 16 Regional Offices (ROs) of RBI carried out  a survey on the role of informal credit providers (including moneylenders) in rural areas covering 177 districts in 25 States through their Lead District Officers. An important objective of the survey was to identify the downside as well as the upside of such linkages. 

The survey was done through focus group discussions, using a structured questionnaire, with cross section of borrowers, rural branch managers, officials from the district administration, different types of informal credit providers, MFIs/SHGs etc., during September-October 2006. The districts were selected taking into account geographical representation, the prevalence of money lending activity and the scale of agricultural operations.

The objective of the meetings of the sub-group and the survey was to understand why, despite the expansion of co-operatives and banks in the rural areas, the dependence of rural households on moneylenders was still so high and had, in fact, increased. The survey also wanted to get a feedback on/from the district administration and moneylenders on the enforcement of existing legislation, suggestions for improvements that would encourage registration and the kind of linkages that could be forged between the formal sector and the informal sector.

Findings

6.3 A profile of the prevailing practices of the various types of informal credit providers gleaned from the survey is given in Box-3. While there is considerable variety of practices in various regions, the common features have been depicted.

Box 3

 Profile of Informal Credit Providers

Various categories of informal credit providers are in existence in most of the States where the survey was conducted. The categories of informal credit providers in order of frequency are pawnbrokers followed by input suppliers, arthiya/commission agents, kirana shopkeepers, lender against land, etc. According to what was reported by the 11 Regional Offices of the RBI there were 12,601 registered moneylenders as on March 1995. This number has increased to 19,627 as on March 2006. Anecdotal evidence suggests that there is a corresponding increase in unregistered moneylenders. 

Their mode of operations, viz, maintaining inter-personal relationship with the borrowers, their informal approach, round-the-clock availability of finance, etc., have made them the most important lenders in the villages. Their policy of 'any time, anywhere, any amount', which is borrower-friendly, has strengthened their position in the villages, thus reducing the role of banks. They offer a variety of products tailor-made to the needs of the borrowers.

Amount lent by moneylenders: District officials from only five States could furnish the data on the amount of loan advanced by the moneylenders in their jurisdiction as under:       

                                                                            Amt. in Rs. Crore

 

Name of State

As on March 1995 

As on March 2006

Gujarat

38.34

139.65

Maharashtra

29.90

82.28

Kerala

25.00

138.00

Karnataka

19.22

87.70

Uttar Pradesh

34.22

181.92

                                                                         

b) Size of the loan: The average size of the loan varied widely from Rs 1,000 to 30,000. In some cases, it could be as low as Rs 10 and as high as Rs 5 lakh.

c)  Purpose: The loans provided by the informal credit providers were generally short-term in nature and mainly for the purpose of meeting social obligations associated with weddings, birth or death ceremonies. Loans for farming and livelihood were also common.

d) Security obtained: Mostly all the loans were granted against the security of gold jewellery, land documents, cultivation rights, promissory notes and even against utensils. Many of the informal credit providers lent money/inputs-consumption and production credit to farmers/small businessmen without any security/documents and with only a signature in their cashbook register for having taken the loan.

 

e) Savings products offered by moneylenders: Though most moneylenders do not offer any savings products, some operate 'Chit Funds' and Bishis.

f) Innovative Products: Some moneylenders in Karnataka and Rajasthan had introduced a new product viz. 100 days loan. Under the scheme, the principal amount of Rs.1,000 is lent after deducting an interest amount of Rs120 (upfront) and a sum of Rs10 is collected on a daily basis for the next 100 days. The interest collected works out to 44 per cent per annum. Similarly, a sum of Rs 20,000 is lent deducting an amount of Rs 2,400 as interest (upfront) towards the purchase of vehicles etc., and Rs.200 is collected on a daily basis for the next 100 days.  In Karnataka in the Gangavati taluk of Koppal district, it was observed that informal credit providers (who were also rice mill owners and commission agents) have formed co-operative society (the Tungabhadra Co-operative Society) under the Karnataka Souharda Co-operative Societies Act. They accept deposits and lend to farmers with an informal agreement that the farmers will sell the produce only to the directors of the cooperative societies for liquidating the loan.  These societies collect pigmy deposits and also disburse loans with daily/weekly repayment schedules. Under the Souharda Co-operative Societies Act, the supervision and control of the Co-operation Department of Government of Karnataka is minimal and the accounts of the society are audited by a chartered accountant firm.

 

g)  Rates of interest: The rates of interest charged by the creditors ranged from 12 per cent to 150 per cent per annum although the average rate of interest ranged from 18 per cent to 36 per cent per annum. In some cases, it was observed that the input suppliers did not charge any interest explicitly though such interest was subsumed in the cost of the input itself. Also all moneylenders invariably deducted interest upfront from the principal amount and the balance amount was given to the borrower.

h) Collection of Interest: There was no fixed or specific period for the collection of interest by the lenders. They adopted their own practices which were binding on the borrowers. The interest was collected either upfront or on redemption of the loan as per the terms and conditions or after harvest or daily/monthly/half-yearly. In some of the districts of West Bengal it was observed that the interest was collected by the lenders by way of taking the cultivation rights of the mortgaged land which is known as 'Sudha-varna System' till the loan amount was repaid. This practice was also prevalent in Punjab. The lenders were not charging any additional interest except in few cases where penalties were imposed on borrowers for delayed repayment of the loan.

6.4 Reasons for continued dependence on moneylenders

Limited outreach of formal credit institutions: One of the important reasons for continued dependence on moneylenders is that despite its penetration, the formal credit delivery structure has not percolated down to the villages. The villagers, especially the poor, have to necessarily depend on moneylenders for their survival. It would seem from this that any attempts to stop money lending will affect the poor people in the villages by cutting off all access to credit. The main problem seems to be that the credit institutions that were created to replace the moneylenders have become very formal with cumbersome procedures. Equally importantly, the formal credit delivery channels also lack the personal bonds that moneylenders enjoy with the borrowers.
Banks do not like to deal with marginal farmers:  More than 50 per cent of the farmers belong to this category, with cultivable areas of less than one hectare. They did not get loans from the banks and were therefore, compelled to approach moneylenders for their needs.
Moneylenders do business at “doorstep” and respect privacy: Moneylenders provide 24/7 service and maintain confidentiality. They even visit households and give money and collect interest and also principal periodically, maintaining one-to-one business relationships.
They lend for consumption purposes without hesitation: Apart from agricultural operations, farmers are dependent on moneylenders for their requirements like weddings, illnesses in the family, education of children, etc. As consumption needs are not met by the formal sector, people approach moneylenders, even at centers where branches of commercial and co-operative banks are present. The rate of indebtedness is more in Kerala particularly among non-asset owning classes, because people tend to borrow more for consumption (sometimes of the conspicuous variety)  and not for farming activities  alone.
Inadequate and delayed credit: Under-financing coupled with the delay in sanctioning of loans by banks often forced the borrowers to approach moneylenders even though they charged much higher rates of interest.  In Karnataka, even farmers owning 10-15 acres of land were indebted to moneylenders for their emergency requirements. Owing to the high rate of interest charged, and the coercive methods used by them, clearing debts to moneylenders is given higher priority by the borrowers compared to bank loans. The result is that bank loans become overdue and sometimes turn into Non- Performing Assets (NPAs). 

Enforcement of the money lending legislation

6.5 Overall, it is very difficult to enforce legislation. The reasons are given below. In most areas, very few moneylenders have a valid licence and no new licence has been issued for a number of years. The common observation heard was that moneylenders operated covertly. In West Bengal, applications for licences were pending for consideration with SDOs/Collectors for over 3 to 5 years.  In Jharkhand, an official from one of the districts said that there were no registered moneylenders in his district because the activity was completely informal. The landless labourers get loans from moneylenders through middlemen, who act as a sort of guarantor.

Very few complaints against moneylenders were received by the district administration. But those complaints that were received were mainly about unlicensed money lending, charging of high rates of interest, land grabbing, taking blank pro-notes, etc. (The last pertains to the district of Bhatinda, Punjab, where the administration reported that they had received  one complaint each on land grabbing and taking blank pro-notes).  Action taken by the authorities varied from the imposition of a penalty, warning to cancel the licence and filing the cases with police.

One of the Divisional Commissioners in Bihar stated that till the 1980s regular reports about money lending were being sent to the State Government. But that has been discontinued over a period of time and as such no data is available on the moneylenders. Even the registered moneylenders do not submit the returns. 

In Kerala, where indebtedness to moneylenders  is very high, the role of the police in administering the Kerala Moneylenders Act, 1958 was very limited because none of the sections of the Act were effective mainly because the punishment imposed was not severe enough. The concern of the police was that suicides had been taking place because of the pressure tactics adopted by moneylenders.  It was proposed that the offences under the Act should be made cognizable and stringent punishment should be awarded to offenders.  

When queried about the ineffective implementation of the Act, some of the important reasons given were the lack of adequate administrative infrastructure, lack of awareness about provisions of the Act, absence of complaints, inadequate guidelines, interference of political leaders in local areas, and the fear of registering complaints. Disputes relating to money lending were settled locally by a group of people in the village without having to approach the authorities.  As a result, the Kerala administration did not receive any complaint against any moneylender. In Bihar, there was no reported case of illegal money lending as there were no complaints from the public. In West Bengal also the authorities said there were no complaints.

Why moneylenders do not register themselves

6.6   Moneylenders do not register for many reasons. District Officials felt that most of the moneylenders did not register because of:
(i) the ceiling on the interest rate on lending
(ii) the cumbersome process of registration
(iii) The high registration and renewal fee
(iv) the fear of disclosure of unaccounted money, and audit
(v) the fear of penalties and
(vi) the need to compulsorily submit statements/returns at periodic intervals etc.

Advantages of registration

6.7  The advantages of registration as perceived by moneylenders were:
(i) Registration would help them carry on business lawfully and have legal recourse against defaulters
(ii) Registration would enable them to exhibit their names over shops, which would enhance their status in society and also bring new customers and help in warding off undue harassment by police authorities

Possible incentives for registration.

6.8 Moneylenders suggested the following incentives to encourage more moneylenders to register:

(i) Simplification of procedures
(ii) Exemption from submission of certain types of returns
(iii) Allowing registered moneylenders to file suits for recovery
(iv) Government assistance in recovery of their dues
(v) Access to loan facilities of the banking system with the provision of adequate spread
(vi) Putting in place a proper mechanism of arbitration to resolve disputes and the implementation of Execution Petitions by government departments for effective recovery
(vii) Removal of restrictive clauses regarding rate of interest charged by the moneylenders
(viii) Creation of awareness among moneylenders about the legal framework by publicity/notification
(ix) Extension of the area of operation to the entire district
(x) Giving financial incentives
(xi) Providing legal backing and protection
(xii) Spreading the word that money lending is not an illegal business provided a licence is obtained

6.9 Moneylenders suggested the following changes in regulations to incentivise registration:

(i) The removal of restrictions regarding the area of operation in order to increase their customer base
(ii) Increase in the validity period of the licence
(iii) Dispensing with cumbersome procedures of submitting details of each and every transaction to the Registrar of Money Lending. Instead, half-yearly or yearly statements of all transactions should suffice.
(iv) Offering interest on the security deposits kept with the State governments
(v) Establishing a separate court for the speedy disposal of disputes
(vi) Extension of some of the facilities such as seizure of mortgaged property etc., as provided to co-operative societies
(vii) Amending the Act to permit moneylenders to function as agents of banks
(viii) Popularising money lending legislation and making it hassle-free so that moneylenders can operate like formal financial institutions

6.10 District officials from Karnataka said that security deposits kept with the State government under the Karnataka Moneylenders’ Act, 1961 was in the form of investment. Despite a court ruling in favour of the depositors, the payment of interest on such deposits which was in vogue earlier was discontinued in 1998. This may need to be restored. Further, they wanted the recovery mechanism facilities available to co-operative societies under Co-operative Societies Act to be extended to registered moneylenders. Some officials from Madhya Pradesh said not imposing the penalty for non-registration in the past could encourage registration.

6.11 According to the Registrar of Moneylenders (RML) in West Bengal, money lending legislation did not get proper attention from the SDOs/Collectors because they had other pressing matters to attend to.  He said that informal interest rates charged by the moneylenders were probably very high and many a times the value of the goods (such as ornaments) pawned by the borrowers, which could not eventually be redeemed. Representatives of the West Bengal Swarnakar Development Association stated that 1.5 per cent per month was their official rate of interest. They said that new customers bargained for even lower rates stating that the banks were offering lower rates. According to the Association, the applications for renewal of licences tended to remain pending with the authorities for long periods. As a result, their business suffered. Their view is the opposite of the State government’s view which thought moneylenders fleece the people. On the contrary, they were doing a service to the people and demanded that the government should exempt them from professional tax. They all claimed to be licence holders with Income Tax Permanent Account Numbers, trade licences, VAT and sale tax registration numbers,etc. They demanded that the system should provide for issue of one-time licence and simplified so that they could conduct their business freely. 

6.12  One common suggestion was that the licence fee should be made uniform in all the States. Spurious gold also was a problem.  It was felt that unregistered entities should be curbed, because they impaired the image of registered moneylenders.   In the South, the moneylenders were prepared to give collateral in case bank finance was extended, and to abide by the rules and regulations.  However, most of them were not willing to extend unsecured loans to their borrowers as banks do up to some limit and for certain purposes.  

Suggestions for improvement

6.13 Officials from Karnataka felt that the existing Act was effective and powerful but needed to include certain penal provisions if it was to be more effective. Pro-active measures by the State government viz., establishing special squads to check the menace of unregistered moneylenders, of charging very high rates of interest, and curbing unlawful and oppressive methods for recovery of dues, would go a long way in effective enforcement of Money Lending Act provisions.

6.14 The registration officials from Uttar Pradesh said that the Act was not effectively enforced because of the lack of adequate manpower and infrastructural support at the district level. To ensure its effectiveness, more teeth should be added to the Act so as to make it a deterrent for moneylenders to violate the cap on interest rates.

6.15 While some of the district authorities from West Bengal were in favour of repealing the Bengal Money Lending Act, 1940, other officials felt that it was not possible to curb the money lending due to the lack of adequate administrative infrastructure.  According to some others, the legislation was irrelevant because of the penetration by banks which had a large branch network across the length and breadth of the State.  

6.16 The Registrar from Gujarat reported that the amendments carried out in Maharashtra  to the Bombay Money Lending Act, 1946 have not been implemented in Gujarat. An increase in penalties, delegation of search and seizure powers, and adequate infrastructure could ensure the effective enforcement of the Act.

6.17 In Nagaland, the district administration, proposed that the activities of the Village Development Board could be included in money lending legislation. They also suggested that the registered moneylender may be allowed to file suits for recovery. The Act in Nagaland is yet to be put in practice.

6.18 District Administration officials from Tinsukia, Assam said that the Act was very old. 

6.19 In general, most officials were of the view that the following suggestions would help in the effective enforcement of the Act:
(i) Increase in penal provisions
(ii) Specific definition of ‘traders’ in the Act
(iii) Involvement of Gram Panchayats/Gram Sabhas in enforcing registration through its collective pressure. 
(iv) Incorporation of quasi judicial powers in the existing Act
(v) Amendment  of the Complaint Redressal Authority Act
(vi) Creation of awareness among the people and district administration about the Act.

6.20  All the moneylenders interviewed stated that the present interest rate cap under the Money Lending Act was not practical and viable as it did not offset adequately the cost of funds. It is interesting to note that some of the moneylenders from Orissa stated that the Act should be scrapped or removed.

6.21 In general, officials who were interviewed did not wish to include any other activity under Money Lending legislation. They said that the lack of administrative infrastructure, changes in the perception about the evils involved in the transactions in money lending and changes in the State policies were some of the reasons for laxity.

Are MFIs an alternative?

6.22 The crucial finding here is that in the districts surveyed, and where the presence of MFI-SHGs was significant, the incidence of money lending by traditional moneylenders has come down. However, this has not prompted moneylenders to reduce their interest rates. This could be because MFIs do not have a sufficiently large network.

6.23 In general, rural borrowers prefer to approach moneylenders for their credit needs because of the “anytime” availability of loans, that too with minimum formalities. They will turn to the banks only if timely and adequate credit is made available to them with simplified/hassle-free procedures/documentation, and a minimum gap between sanction and disbursement. In other words, the service aspect is crucial.

6.24 The majority of MFIs stated that their presence would replace the activities of moneylenders, while a few of them said that total replacement was not possible but that dependency on moneylenders could be reduced substantially.

6.25 Some MFIs were offering various types of flexible and need-based loan products. Illustratively, an MFI in Deogarh district in Jharkhand provided health insurance to the members of SHG on payment of premium of Rs. 346 and medical insurance up to Rs.20,000 could be availed of, provided the treatment was in the MFI empanelled hospitals.

6.26 One MFI in Davangere district of Karnataka said that they could replace the informal/unorganised moneylenders by providing finance to individuals if adequate finance was made available/extended to them by banks.

6.27 The following suggestions were made by the branch managers for increasing the outreach of MFIs:

(i) Introduction of a rating system for MFIs to facilitate the disbursement of loans without security/charge

(ii) Promotion of SHGs - especially women SHGs - to ensure cheaper credit to rural poor and farmers

(iii) Need to be more tolerant towards defaults

(iv) Increase the loan period from 11 months to 2-3 years

(v) Training field staff to be courteous and sensitive to borrowers 

(vi) Giving wider publicity, as most of the persons were not aware of the existence of such entities in their district

(vii) Encouraging venture capital funding in the initial stages of operation as some of the MFIs are confident of equity funding say after three years

(viii) Provision of soft loans, say at 5-6 percent per annum, so that they have reasonably higher margins to cover cost;

(ix) Clear guidelines for MFI including service charges collected by them

(x) The need for the expertise and guidance from banks and others for introduction of Information Technology

(xi) Encouraging NGOs with adequate remuneration to form and develop quality SHGs instead of proliferation of SHGs

(xii) Removal of MFIs  from the purview of the State Act on money lending

6.28 MFIs reported that they have taken the following steps to ensure transparency/fairness in interest plus charges, fair collection/recovery practices and code of conduct:

  • Conducting monthly meetings and regularly visiting the targeted groups 
  • Providing proper literature, application forms for loans, passbooks/statements of accounts periodically, repayment schedule to borrowers
  • Subjecting the books of accounts to audit and inspection
  • Clarity in by-laws and interest rates
  • Charging interest on loans on flat basis and on reducing balances
  • No hidden charges
  • Sensitising and training the field level staff to be courteous with regard to recovery of loans
  • Recovery at door step and collection against money receipts
  • Rules, regulations and procedures to be followed for assessment, meeting the clientele, recovery procedure, etc., are well documented in a Manual
  • 6.29 In Andhra Pradesh, the MFIs are reported to have voluntarily agreed to adhere to the code of conduct evolved by Sa-Dhan (An association of community development financial institutions).

    6.30 A majority of MFIs that were interviewed stated that they did not come under the purview of Money Lending Act. In Karnataka, the MFIs were either registered under Section 25 of the Companies Act or as a trust or as a NBFC. Registration under money lending legislation of the state was not considered necessary or obligatory. However, one MFI in Gulbarga District was registered under Money Lending Act in the State. 

    6.31 An alternate suggestion received from Karnataka was that PACS can provide an alternative conduit if they can partner with RRBs and banks.  As per existing instructions, these societies can only operate with DCCBs. If these societies are ceded to Rural/Semi-urban branches of the RRBs/banks, they can play an effective role in delivering credit to petty businessmen, farmers and other people.


    CHAPTER- 7
    Model Legislation on Money Lenders and Accredited Loan Providers
    Need for money lending legislation

    7.1 The majority of legislations relating to money lending were passed by the various States of India several decades ago. It is, therefore, pertinent to examine whether the legislations are still relevant in the modern context with the spread of banking,  changes in the financial sector and the increase in awareness among the rural households in the country. The recent NSSO survey has brought out the significant role played by the moneylenders in the credit delivery system of the country especially in the rural areas. The survey conducted by the Reserve Bank also brought out that the number of moneylenders and quantum lent by them has increased manifold between 1995 and 2006. In spite of there being a legislation, a large number of moneylenders continue to operate without licence and even the registered moneylenders charge interest rates much higher than permitted by the legislation apart from not complying with other provisions of the legislation. Signs of effective enforcement of the legislation are absent.  Absence of interest to get registered together with ineffective enforcement implies that the legislation does not reflect the ground realities.   There are no incentives for registration or conviction on the part of the State to implement the legislation. Officials of several State Governments, who are administering the legislations at the ground level, admitted that if the legislations are strictly enforced, moneylenders would go out of business and this would adversely affect the interests of the rural borrowers who would have no other source to meet their immediate personal needs. Considering the significance of moneylenders especially in the rural credit delivery system, there is a need for a suitable and effective legislation. While having enabling provisions in the legislation so that there are incentives for registration and mainstreaming the activity of money lending, there is a need for disincentives to those that escape the law in the form of more stringent action against unregistered lenders.

    Changes in existing legislation

    7.2 The legislations concerning money lending presently in force in the States vary from each other in respect of details such as entities covered under the legislation, inclusion/exclusion of trade credit, method of fixing maximum rates of interest that can be charged by moneylenders, powers available to the licensing/registering authorities for production of documents, search and seizure, the consequences of carrying on business without licence, etc. The Technical Group has tried to include the best features of legislation internationally and domestically. It recommends a model legislation for the consideration and adoption by those States that do not presently have a comprehensive legislation in place (Annex-I). The Technical Group also recommends some modifications in the existing legislations like a quick, informal and easy dispute resolution mechanism for better enforcement and mandatory provision for registration to undertake money lending activity in States that have no such provisions.

    Registration

    7.3 Internationally, informal non-institutional credit providers like moneylenders, loan providers, credit providers, etc. are required to be licensed or registered with a