Macro challenges of micro lenders

The freedom to fix interest rates has encouraged a few MFIs to jack up rates on Day One. It will take a while for borrowers to get the benefit as products, processes and digitisation evolve

In 2011, when the Reserve Bank of India (RBI) freed the savings bank interest rates, a few private banks rushed to raise the rate to woo customers.

Over a decade later, when India’s banking regulator freed the lending rates for micro loans last month, some micro lenders did the same, rushing to raise their loan rates on Day One.

In the first instance, the consumers got the benefit while the banks, over a period of time, grabbed a bigger pie of the savings deposits. In the second case, the consumers are at the receiving end as they have to pay more to get micro loans. 

The lenders, particularly those seeing higher stressed assets since many Covid pandemic-affected borrowers have been defaulting in servicing loans, have raised rates to boost their interest income. They can justify the hike, citing higher risks for unsecured loans.

The higher income will enable them to set aside more money or make provision for bad loans. Quite a few micro lenders have seen their stressed assets — the combination of gross non-performing assets and restructured loans — crossing one-fifth of their loan books.

In mid-March, when the RBI announced new regulations for microfinance with effect from April, the sector experts were effusive in their praise for the regulator. 

In the new norms, they saw the “creation of a level-playing field” (between banks and microfinance institutions or MFIs), “mainstreaming micro loans” and “intensifying competition”. Words such as “disruption”, “freedom”, “transparency”, “uniformity” were flung at the audience at countless seminars organised by the MFI industry in March to dissect the regulations.

The new norms give freedom to the lenders to decide on interest rates but they need to follow a board-approved transparent policy. They can charge different interest rates to different borrowers, depending on their risk profile.

The norms also specify who a micro borrower is. A family with an annual income of Rs 3 lakh is entitled to get micro loans to the extent it services them using half of the income.

Till March, up to 50 per cent of loans were allowed for non-productive purposes but now the lenders can give loans for any purpose — education, health, building a roof overhead, wedding, et al.

Finally, the portion of unsecured loans for an NBFC-MFI has been pared to 75 per cent from 85 per cent of their loan portfolio to help them derisk their balance sheets to some extent.

Most were expecting the interest rates to move downwards. Banks, particularly, which have lower cost of funds, will pare their rates. Banks’ cost of funds is roughly half of the MFIs, which borrow from banks to lend to micro borrowers.

But banks can always justify higher interest rates as micro loans are unsecured. Don’t they charge 24-36 per cent to those who revolve their payments for credit card spend, which is not backed by any collateral? Besides, for most micro borrowers, access to credit is more important than cost of credit. And, despite charging higher interest rates, banks are definitely more charitable than the loan sharks. They will take time to cut down loan rates.

Meanwhile, it’s a reign of confusion for the micro borrowers. The websites of some of the MFIs display a wide range of interest rates — the difference between the floor and the ceiling is as much as 10 percentage points or more. It all depends on the cycle of loan. In other words, a first-time borrower (for the first cycle) may have to pay double the interest rate of what an existing borrower, who has completed four to six cycles, will pay.

Insurance charges being included for pricing micro loans is also adding to the confusion. Most micro credit exposures are insured. With insurance premium included, loan rates are going up but the banks do not earn the premium. While a lender must declare this transparently, including insurance premium to calculate interest rates distorts the rate architecture.

The scene is a bit chaotic at this point. A retired banker, who now works for an MFI, sums it up well when he says, the first time a coffee machine is installed at an office, everybody rushes to have free coffee. Those who drink coffee twice a day go for four cups and even those who don’t, try it out as they are getting it free. For weeks, at least, there will be a long queue near the coffee vending machine till the crowd disperses and a semblance of discipline returns to the office floor.

We may have to wait for a year or two to see the outcome of the new norms and the expansion of the micro loan turf beyond district headquarters and localities adjacent to the highways. As the scene unfolds, a few new challenges will emerge.

For instance, the decades-old joint liability group or JLG model of micro lending will collapse, gradually though. This is simply because the credit-worthiness of all group members is not the same. Hence, depending on their risk profiles, different members will have to pay different interest rates. There may be common collection points but the group model, the bedrock of micro loans, may not last for long.

The lenders are now expected to focus on the debt-equity ratio of a borrower as a family with an annual income of Rs 3 lakh is entitled to get micro loans, which it can pay off using half of the income. Following this formula, at Rs 12,500 monthly installment (that makes Rs 1.5 lakh loan repayment), a family can get a loan of between Rs 2.45 lakh and Rs 3.45 lakh, assuming 18-20 per cent interest rate and two- to three-year maturity of such loans.

This is simple arithmetic but its implementation is not that simple. For instance, a family that has already taken a farm loan under the Kisan Credit Card scheme to buy agriculture inputs such as seeds, fertilisers, pesticides, etc. does not service such loans every month. How will the monthly interest payment by such a family be counted?

Besides, how does one assess the income of a household? Child labour is rampant in semi-urban and rural India. Two teenage boys working at tea shops may earn Rs 100 a day each but can this income be officially treated as household income? Or, for that matter, after marriage, a woman school teacher’s salary may continue to be counted as a household income of her parents’ family as well as her husband’s family. How does one prevent double counting?

Over years, new products, processes and digitisation will evolve and interest rates will come down. There will be a churn in the industry with a few small MFIs being forced to close shop or merge with bigger others. As the turf expands and borrowers get the benefit of lower interest rates, we will also see many of them breaching the Rs 3-lakh threshold and becoming regular borrowers even as new borrowers get into the microfinance fold. 

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd

His latest book: Pandemonium: The Great Indian Banking Story

To read his previous columns, please log on to https://bankerstrust.in

Twitter: @TamalBandyo