Public sector banks are not too keen to police microfinanciers, a task that the government wants them to do.

The finance ministry recently asked banks controlled by the government to ensure that microfinance institutions (MFIs) do not charge hefty interest rates to poor borrowers.

The bulk of the money that microfinanciers lend comes from banks, and the government insists that public sector lenders must force MFIs to cap their loan rates at around 22-24% as a precondition for access to bank finance.

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Banks charge 9-14% on loans given to MFIs, but some MFIs charge clients as much as 36%.

Several senior bankers said that the government request is impractical to implement.

“We need to see the operating cost of MFIs and whether it’s practical to cap the rates. If the government makes it mandatory, we may even have to stop lending to them," Bank of Maharashtra’s chairman and managing director Allen C.A. Pereira said.

“It’s very difficult to implement (the ministry directive). If you cap it at 24%, they (MFIs) may charge other things to make up for that," S.S. Ranjan, chief financial officer of State Bank of India, the nation’s largest lender, told Mint.

Union Bank of India’s general manager S. Govindan also said it won’t be possible for banks to dictate the lending rate to MFIs. “All that we can do is to ask them to bring down the rates, and if they do not comply, banks may not continue the support to such institutions," he said.

S.A. Panse, executive director of Vijaya Bank, said, “The regulator through licensing authority of MFIs may be in a better position to regulate the maximum rate of interest levied by the MFIs to their beneficiaries."

But the banking regulator has so far distanced itself from the issue. A senior Reserve Bank of India (RBI) official, who did not want to be named, said the central bank may not step into the picture when it comes to restriction of MFI loan rates.

“We are not going to price interest rates. It is up to the banks. More than interest rates, the timely availability of the credit to the poor is important," the official said.

The finance ministry, in a letter last week, asked state-run banks to ensure that their MFIs do not charge unreasonably high rates to their clients and banks must fix a ceiling of 22-24 % for the MFI loans. The ministry, in its communication, also made it clear that MFIs should not indulge in “evergreening" of loans.

“Evergreening" is a practice of taking a fresh loan to pay up an old loan.

“When banks lend at reasonable rates to MFIs, why do they (MFIs) lend at much higher rates to poor people? We have asked banks to ensure that these rates are not very high," a finance ministry official told Mint.

According to him, RBI should advise banks to put in a mechanism to ensure that MFIs do not charge abnormally high rates.

Under current norms, banks need to give loans to farmers and small-scale industries to the extent of 40% of their loan book, known as priority sector loans. When they fall short of the target, they can give loans to MFIs and such exposure is considered part of priority sector loans. The exact amount of bank credit to MFIs was not immediately available.

K. Ramakrishnan, chief executive of Indian Banks’ Association, the national bankers’ lobby, declined to comment.

Chandra Shekhar Ghosh, chief executive of India’s fourth largest MFI, Bandhan Financial Services Pvt. Ltd, said it is not possible to operate in a situation where the interest rates are capped. “If MFIs stop functioning, then the villagers will have to go back to the moneylenders," Ghosh said.

Bandhan has recently reduced its interest rates by 5 percentage points to 19%. Ghosh said reducing rates may not be possible for all players.

“If there is a cap on interest rate, small MFIs will be out of business," he said.

Gobinda Banerjee, a general manager with Punjab National Bank, said bigger MFIs are in a position to bring down interest rates, but for smaller MFIs it may not be possible immediately as their reach and scale is small, but operating cost is very high.

India has around 800 MFIs, according to the National Bank for Agriculture and Rural Development (Nabard). However, not more than 10 MFIs have an outreach of 100,000 microfinance clients, Nabard’s website said.

SKS Microfinance Ltd, the largest among them, disbursed loans of 14,300 crore till March to 6.8 million borrowers.

A study by Access Development Services, a research and consultancy firm in the microfinance space, said MFIs added 8.5 million consumers in fiscal 2009, taking their consumer base to 22.6 million, a 60% increase.

The growth in their loan book was around 97%, from 5,950 crore to 11,734 crore.

In terms of consumer acquisition, Spandana Sphoorty Financial Ltd recorded the highest growth rate—104%. Bandhan and SKS expanded their consumer base by 91% and 87%, respectively. SKS and Spandana expanded their loan books by 214% each.

A 2008 study on MFIs by rating agency Crisil Ltd said MFIs are dependent on banks and financial institutions for their funding needs, and are not dependent on the capital markets. The study also said that private banks are aggressive in lending to MFIs than the public sector banks.

Kotak Mahindra Bank Ltd’s group head (retail banking) K.V.S. Manian said interest rates should be left to the market as every institution fixes rates based on their style of operations and cost-structure.

According to Citibank’s chief financial officer Abhijit Sen, it will be difficult for banks to cap the loan rates of such firms in the absence of an appropriate regulatory framework.