RBI group against controlling rates on SME loans

The group is in favour of affordable and reasonable cost of credit. It, however, pointed out that efforts at controlling interest rate by imposing caps generally turns these limits into floor rate, according to the central bank.

In November 2007, RBI had set up an Internal Working Group (IWG) to study recommendations of the National Commission for Enterprises in the Unorganised Sector (NCEUS) to suggest an appropriate action plan.

The commission had sought rationalisation and reduction in interest rate on loans to small units in the unorganised sector. This, it sought to achieve by controlling the rate of interest, which needs to be governed by the overall cost and not the specific high cost of lending small loans alone.

The Internal Working Group, in its report, has also made recommendations, among other things, to address the issues of credit allocation, expanding the outreach of banking services and improving the access of credit to various segments of population in the unorganised sector.

Referring to the link between lending rates and the cost of funds, the RBI group said, "It needs to be appreciated that the bank advances would need to cover the cost of funds being incurred by them in addition to the operational costs."

The credit is normally priced (fixing interest rate and other conditions) according to the risk perception of the borrower, transaction cost and the funding cost, the group added.

The funding cost is neutral across borrowers. The operational costs could vary from bank to bank due to factors such as size, territory being covered and level of technology absorption. Hence, it would not be appropriate to control the interest rates to reduce the cost of funds.

The RBI group said the credit record bureaus and credit information companies should be quickly established so that such record is available to banks for pricing credit according to risk perception.

These bureaus along with improvement in risk assessment would help to reduce the transaction cost and pass on the benefit to small and micro enterprises in the form of reduced interest rate, the group said.