Home / Industry / Banking /  RBI eases lending norms for microfinance institutions

Mumbai: The Reserve Bank of India (RBI) on Friday announced rules giving more flexibility to microfinance institutions (MFIs) to calculate the interest rate at which they can lend to borrowers, linked to their cost of funds.

This will, in effect, give more leeway to medium-sized micro lenders to price their loans based on their cost borrowings from commercial banks.

MFIs are companies that lend small loans to low-income borrowers. They typically lend at 26-34% and mainly source their funds from commercial banks for lending to borrower. MFIs operate in the form of non-banking financial companies (NBFCs) control majority of the market in terms of assets.

In a notification, the RBI said that MFIs can charge interest rates based the cost of funds plus margin (currently capped at 10%) or the average base rate of the five largest commercial banks by assets multiplied by 2.75, whichever is lower.

Going by the first formula, MFIs above 100 crore loan portfolio with higher cost of borrowings can charge about 27% as the average base rate currently is about 10%. Going by the second formula as well, rates would be in the 26-27% range as the prevailing cost of funds for most NBFC-MFIs is about 16-17%, while margin is capped at 10%. For a handful of large MFIs with strong credit ratings, borrowing costs are lower at around 14%, while the margin is capped at the same level.

The average of the base rates of the five largest commercial banks will be advised by the apex bank on the last working day of the previous quarter to determine interest rates for the ensuing quarter, RBI said. The new rules will come into effect from the quarter beginning 1 April 2014.

Presently, even though there is no cap on interest rate, medium-sized MFIs were forced to limit their interest rate at 26%, because if they charge above that banks wouldn’t give loans to them under the so-called priority sector lending under directions from RBI, Samit Ghosh, founder and chief executive officer of Ujjivan Financial Services Pvt. Ltd. According to Ghosh, smaller MFIs will now be able to avail funds under priority sector lending category even if their lending rates are more than 26%.

Under the priority sector lending, banks are required to lend 40% of their loans to agriculture, exports and other economically weaker sections. Banks typically lend to only those MFIs, which qualify for priority sector.

“For medium-sized MFIs, the rules will give flexibility to price loans depending upon their cost of funds, while for larger MFIs may have to bring down rates to 24%," Ghosh said. Presently, larger MFIs lend at an interest rate of about 25%.

In December, 2011, the RBI had capped the interest rate that can be charged by MFIs at 26%, based on the recommendations of an expert-panel under Y.H. Malegam. Later, the interest rate cap was removed but a margin cap of 10% was set for larger MFIs and 12% for those with loan book less than 100 crore.

The microlending industry had plunged to a crisis in October 2010 when Andhra Pradesh government promulgated a controversial law to control MFIs. The law restricted MFIs in the state from collecting money from borrowers on a daily basis and made it mandatory for them to seek government approval for every second loan issued to the same borrower.

Following this, MFIs in the southern state, the largest market for MFIs till then, plunged to a crisis with the repayment rate from their borrowers falling to less than 10%. The situation improved after the RBI announced regulations governing the sector towards the end of 2011.

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