Banks' pricing of micro-finance loans may soon be linked to MCLR

85% qualifying asset rule for MFIs may be tweaked to assist diversification

Banks’ pricing of micro-finance loans may soon be linked to their marginal cost of funds-based lending rate (MCLR) and caps imposed on per customer exposure to arrest levels of indebtedness.
 
Microfinance institutions (MFIs) may also be allowed a leeway with a mark-up over the 10 per cent of their cost of borrowings when pricing loans. This takes into account the fact that they are not able to absorb the additional credit costs arising out of the pandemic for two consecutive financial years. The limited headroom within the margin of the existing 10 per cent over the cost of funds constrains in pricing based on credit risk as compared to banks. Additionally, the 85 per cent qualifying asset rule for MFIs may be tweaked so that they can diversify their asset class. This is important as some of them may be aspirants for the on-tap-SFB licences and a huge concentration to a specified asset class is a huge risk, considering that microfinance is already a sensitive sector.
 
The above may find mention in the Reserve Bank of India’s (RBI’s) consultative document for harmonising the regulatory frameworks applicable to the sector, which is expected to be released this fortnight, industry sources said. The total exposure of banks and microfinance institutions (MFIs) to the sector is Rs 2.3 trillion with the former having the lion’s share of nearly Rs 1.37 trillion — which includes small finance banks (SFBs) as well. The linkage to the MCLR for banks in the pricing of such loans will not only take care of their cost of funds, but factors in the negative carry of reserve requirements — cash reserve ratio and statutory liquidity ratio — and tenor premiums, and operating costs.
 
While universal banks have a lower MCLR compared to SFBs, overtime micro-finance lending rates of the latter will move southwards as they build out their current and savings accounts (CASA) portfolio. The imposition of caps per customer exposure for banks could mirror that imposed on MFIs at Rs 1.6 lakh for rural and Rs 2 lakh for urban households, with borrowers’ indebtedness capped at Rs 1.25 lakh.  It was pointed that given the increasing level of indebtedness in the sector; and poor collections ever since Covid-19, the change in the pricing mechanism and caps on indebtedness will protect borrowers, safeguard the health of the regulated entities even as it does not affect the business model adversely.

 
It is surmised that all hues of microcredit lenders could follow a standard template for reporting data to the credit bureaus with reporting on a daily frequency for a more accurate view on client indebtedness. RBI Governor Shaktikanta Das had in February this year said the banking regulator will come out with a consultative document for harmonising the regulatory frameworks applicable to various regulated lenders — banks, non-banking financial companies (or NBFCs which are dedicated MFIs; and those which are not), and SFBs. While the Assam government’s passage of the Micro-Finance Institutions (Regulation of Money Lending Bill, 2020) was seen as the trigger for the central bank’s move, the industry had been polarised on regulations for some time now.
 
These issues came to fore once again during talks between the Assam government and microfinance network of India (MFIN) over the past 10 days. Central to the debate is that banks had access to CASA, but were pricing their micro-finance loans much higher than dedicated shadow banks. This, even as the latter had to borrow from banks. MFIs are also hamstrung by the fact that when pricing their loans, there is a ceiling of 2.75 times the marginal cost of funds-based lending rate of the top-five banks in India (and this works out 21.45 per cent currently). And, they can’t price at more than 10 per cent over their cost of borrowings.
 
Pricing by NBFC-MFIs has come down 3-5 per cent over the years, whereas pricing by banks to MFI borrowers has not reduced despite reduction in secular interest rates. A few prominent banks charge MFI borrowers 24-26 per cent, whereas the maximum lending rate allowed for NBFC-MFIs is not more than 21.5 per cent due to the 10 per cent over the cost of funds regulation.