Crackdown on four NBFCs: 14% spread on loans prompted RBI action

The regulator took such stern action amid a risk of rural distress due to unfair practices

The four non-banking finance companies (NBFCs), including two microfinance institutions (MFIs), that faced regulatory wrath last week were mainly charging exorbitant rates to microloan borrowers from the most vulnerable sections, in order to maintain spreads of 14 per cent, sources familiar with the development said.

On October 17, the Reserve Bank of India barred four NBFCs — Asirvad Micro Finance, Arohan Financial Services, DMI Finance, and Navi Finserv — from sanctioning and disbursing loans, citing usurious interest rates charged by them for their microfinance borrowers. 
 

In March 2022, the RBI removed the pricing cap for microfinance loans, which was 12 per centage points over the entity’s cost of funds. According to sources, an onsite regulatory inspection for FY23 and FY24 showed that most microfinance players were maintaining a spread — the difference between cost of funds and lending rates — of over 12 per cent, with a few around 13 per cent. 

Some entities had promised over 30% return to investors

The entities that faced action were found to have a spread of 14 per cent.
 

“The regulator gave the MFI industry flexibility as the pricing cap was removed. It was expected that they would be fair, transparent, and non-discriminatory while dealing with borrowers. Clearly, that has not happened,” a source said.
 

A spread of 14 per cent invariably led to an interest rate of 26-28 per cent for the borrowers. The regulator also reviewed the funding agreements of some players and found that some entities had promised over a 30 per cent return to their investors; many of these investors are private equity players. While announcing the monetary policy review earlier this month, RBI Governor Shaktikanta Das had said that NBFCs, sometimes under pressure from their investors, are “chasing excessive returns on their equity”.
 

After collecting data on spreads and cost of funds for the previous two financial years, the regulator interacted with microfinance players and the industry body during the first quarter of this financial year to express its views. However, corrective measures were not taken.
 

The source also said the exploitation of borrowers who are at the bottom of the pyramid was a key regulatory concern. For example, borrowers were charged Rs 500-1,000 for a few days of delay in monthly instalment payments, even for a loan of Rs 40,000-50,000. There is no norm on this issue, but the industry practice is to give the borrower a six-day leeway before imposing a fine.
 

Looming rural distress due to such unfair practices prompted the regulator to take such stern action, the source said, adding that this would also send a signal to other industry players to fall in line. The total size of the microfinance sector, in which some banks are also key players — like Bandhan Bank, IndusInd, and RBL Bank — is around Rs 3 trillion.
 

“The data from the microfinance industry body shows there are at least three active loans per borrower. In addition to that, if borrowers are charged such a high rate, there could be serious rural indebtedness in the coming days,” the source said.

That some entities are pushing loans was a concern expressed by the RBI governor in his monetary policy speech.
 

“These practices (chasing high returns) are sometimes further accentuated by what appears to be a ‘push effect’, as business targets drive retail credit growth rather than actual demand,” Das had said.
 

The regulator expects its recent action will sensitise the industry, and the entities will be subject to rigorous monitoring at regular intervals.
 

While the regulator had imposed business restrictions on several entities, including banks in the past, mainly due to non-compliance, this is the first time such action has been taken on the issue of loan pricing.