Hyderabad: The Rs 30,000-crore microfinance industry grappling with allegations of charging usurious rates, saw their fortune dwindling in 2011 with the Reserve Bank capping the interest rates for small loans.

The story of SKS Microfinance's bombastic market debut in 2010 was overshadowed in 2011 as reported management tussle in the company hogged the limelight through the year. This was followed by the exit of Founder and Executive Chairman Vikram Akula.

SKS, which brought the MFI sector into limelight in 2010 with a Rs 1,650 crore (around USD 350 million) IPO, had raised hopes of other players to tap the capital market.

But the series of low moments faced by the sector, including concerns of corporate governance and strong-arm tactics for loan recovery, pushed it into the dark.

Microfinance -- the business of doling out small loans at high interest rates to poor people unable to access conventional lending instruments -- has come under intense regulatory scrutiny following farmers suicide in Andhra Pradesh in late 2010.

The spillover effect of the 2010 crisis was seen in 2011 when the Reserve Bank came out with regulations capping interest rates charged by microfinance institutions (MFIs) from small borrowers at 26 percent.

In order to help sector, RBI brought the cash-starved MFIs within the priority sector lending category. The decision allowed them to access credit from commercial banks. It also created a separate category of NBFC-MFI.

Now, the loan by banks to MFIs for on-lending to small borrowers fall under 'priority sector' category and fixed the loan amount for an individual borrower at Rs 35,000 from an MFI.

The central bank said the loans could be disbursed to rural families with an annual income of Rs 60,000 or urban and semi-urban households with income up to Rs 1.20 lakh.

The RBI, however, left it to the borrowers to decide on the repayment period either weekly, fortnightly or monthly.

It has also asked the MFIs to ensure that 75 percent of the loan extended is utilised by the borrowers for income generation purpose.

The sector had come under criticism for multiple lending, inscrutable business models and high interest rates of over 30 percent reaching a peak and coercive recovery tactics used by
the lenders.

Most microcredit firms lend money through Self help groups (SHG) or women's groups and reach out to borrowers. Interest rates charged by these MFIs usually run up to 36 percent, mostly due to the cost of administering millions of such loans in remote areas.

Against this backdrop, the Andhra Pradesh government had promulgated an Act that sought to control the interest rates charged by MFIs, as well as check their alleged use of coercive recovery tactics.

This dried up source of bank funding for the MFIs as many banks either stopped lending or trimmed their exposure to the sector. With time, banks resumed lending only to those MFIs which did not have presence in Andhra Pradesh.

Faced with funding problems, the MFIs had to resort to other fund raising measures like institutional placement. The Reserve Bank further went ahead and opened the External
Commercial Borrowing (ECB) window for them to tap the markets.

Country's only listed MFI SKS has already announced it would raise about Rs 500 crore through the sale of shares to institutional investors.

The RBI allowed MFIs to raise ECBs up to USD 10 million (about Rs 53 crore) during a financial year, higher than the earlier limit of USD 5 million, and the funds would have to be
utilised for lending to small borrowers.

Analysts however feel that the move would help large MFIs but not the medium to small size MFIs. With 2011 turning out to be a mixed bag for microfinance sector, players are likely to keep fingers crossed in the news year as they await a new set of regulations.

The problem started for the sector started after the Andhra Pradesh government issued an Ordinance to regulate the MFIs in the state.

The total loan of all MFIs to borrowers in Andhra Pradesh, which account for 25 percent of the total industry, fell to Rs 6381 crore, from Rs 10,386 crore extended before the Act.

Fresh disbursals in the State have come to a standstill.

While all MFIs put together had proposed 73,592 new loans to borrowers, the Government had rejected as many as 71,309 applications citing non-compliance of MFI Act.

As many as 24 MFIs of the total 44 recognized by the RBI are operating in AP.