RBI tells states to stop regulating microfin rates

MUMBAI: The Reserve Bank of India (RBI) has told some state governments to refrain from regulating interest rates charged by microfinance institutions (MFIs).

The regulator feels that the various state-level money lending legislations, which put a cap on the interest rate an entity (other than a bank) can charge, should not be applicable to MFIs. The RBI move follows an incident in Andhra Pradesh where the state government had pulled up local microfinance institutions for competing with the state lending programme, Velagu.

The central bank is understood to be of the view that the provisions of the Moneylender Act should not apply to microfinance institutions operating in the form of non-banking financial companies and companies that do not declare dividend and are registered under Section 25 of the Companies Act. However, state legislations may continue to govern MFIs operating as trusts or NGOs.

Sources said RBI is also of the view that these state laws should be suitably amended to scrap the cap on rates. Instead, the norms should reflect market realities and could be notified by the state from time to time. This is part of an idea to enable money lenders obtain bank finance to onlend to farmers.

The regulator may well be of the view that interest rates are not under the purview of state governments. States also do not possess the wherewithal to handle these issues and, hence, RBI has indicated to local authorities that it is open to discuss and address their grievances and issues related to the microfinance industry. But RBI insists that interest rates cannot be capped by state authorities.

According to a senior official of an MFI operating in Hyderabad, the interference of the state has led to some MFIs, which had originally started operations in Andhra Pradesh, to lower their presence in the state. Even banks that were very active in the microfinance space in the state have revised their risk perceptions.

The official said an initiative such as the one by RBI will do away with the growing uncertainty among the MFIs operating in the state and prevent further exodus. The main issue in Andhra Pradesh is that the government is playing the role of a regulator as well as a competitor and, hence, is deploying its state machinery and legal power to stifle competition from private MFIs.

Said a senior banker, “Over a period of time, if the lender comes across an improvement in credit quality and size of the loan in case of a particular client, it may do well to lower rates. In such a situation, an individualistic self-service approach will be far more beneficial. Group lending is costlier, considering that the loan amounts are smaller and doorstep services are to be offered.”

He said that issuing biometric smart cards offering portable credit history is a pre-requisite. “In fact, Bank of Ghana has recently issued an advertisement calling for tenders to issue such cards for the whole country. Cross-subsidisation and pressurising MFIs to lower rates are not sustainable in the long run,” said the banker.

While money lenders charge an interest of up to 8% on a monthly basis, MFIs charge 1-2% for the same duration. MFI officials said that given the current structure of costs, loan sizes and default records, unless rates vary in the range of 24% to 28%, it is not possible to have an economically viable model.

However, going forward, rates as low as 14-16% can be achieved, provided there is an improvement in technology, cost of funds is lower and MFIs have a mix of rural-urban operations.

Globally, it has been observed that wherever rates have been capped, it led to the exclusion of the poor and even to the closure of MFI operations. In India, the government has expressed concern over the fact that the eventual interest cost borne by the borrower is in excess of 20%. the RBI circular states that rates below 30% are acceptable.