Deregulation of rates for NBFC-MFIs may lead to expansion of market

The Reserve Bank of India’s (RBI’s) proposal to lift the interest cap on non-banking financial company-microfinance institutions (NBFC-MFIs) will ensure there is no arbitrage for certain market participants in the sector. The market mechanism will, eventually, crystallise the interest rate range within which all players will function, observed experts.
 
It will also lead to higher coverage because the deregulation of interest rates for NBFC-MFIs will allow them the flexibility to venture into areas where access to credit has so far been limited due to operational costs attached to it. With no cap on pricing, these lenders can afford to take the risk, which they earlier shied away from.
 
Eleven years after the Malegam Committee report, which was the basis for the microfinance regulation, the RBI has decided to bring in changes in the current regulations to address the over-indebtedness of microfinance borrowers and enable a scenario where interest rates can be brought down.
 
In the paper, the RBI has proposed a debt-income ratio cap wherein loans should be extended to microfinance borrowers in a way that payment of interest and repayment of principal for all outstanding loans of the household at any point in time do not cross 50 per cent of the household income.
 
Although the current cap on interest rate is for NBFC-MFIs, constituting 30 per cent of the market, it has been observed that banks with lower cost of funds - in comparison to microfinance lenders - have kept their rates around the ceiling meant for NBFC-MFIs. Moreover, the large NBFC-MFIs have not rationalised their lending rates, despite achieving economies of scale.

 
Hence, the RBI believes that NBFC-MFIs, like any other NBFC, should be guided by a board-approved policy and the fair practices code, whereby disclosure and transparency would be ensured. There will be no ceiling prescribed for the interest rate. However, while doing so they must ensure that usurious interest rates are not charged. 
 
“The intention is to enable the market mechanism to bring the lending rates downwards for the entire microfinance sector,” said the RBI.
 
Nitin Chugh, managing director (MD) and chief executive officer (CEO), Ujjivan Small Finance Bank, said, “The revised norms will give a lot more headroom to NBFC-MFIs that will benefit from the deregulation of interest rate cap. The market will expand, help to reach out to many more people, and result in a higher coverage.” Experts are of the view that rates may not change much on the overall level in the near term, but rates charged by banks may come down slightly.
 
That the RBI has asked market participants to prepare a fact sheet to be given to borrowers, a board-approved policy on pricing will be subject to RBI review, ensure institutions are kept under check, and there is greater transparency in the rates they are charging.
 
Chandra Shekhar Ghosh, MD & CEO, Bandhan Bank, said, “The proposal to move towards a market-driven interest rate, which will depend on the cost of funds (i.e., if the cost of fund increases, the rates can increase and vice versa), is a good move as it offers flexibility.” Interest-rate caps are not a good policy choice and various global studies have proven this, said Alok Misra, CEO, Microfinance Institutions Network.
 
Among NBFC-MFIs, the best ones lend at 19 per cent and banks go up to 24 per cent.
 
"So, when you get the flexibility on pricing, you can price the risk as well as cross-subsidise and move to areas where the need for financial inclusion is more. Also, the microfinance market has stabilised and is highly competitive. Hence, the interest rates will be range-bound,” said Misra.
 
Pillarisetti Satish, executive director, SaDhan, said the reduction in rates will be more from the side of banks and small finance banks and also from bigger NBFC-MFIs with access to funds at a relatively lower rate than small and medium NBFC-MFIs. 
 
 “...I think the rates will be similar to where they are today, even after removing the cap on what the NBFC-MFIs can charge,” said Manoj Kumar Nambiar, MD, Arohan Financial Services.
 
“But the guidelines put by the RBI on disclosure, the process to be followed for pricing, and the publicity it will give will not allow anybody to charge abnormal rates. There will be a crystallisation of a band within which institutions will work,” added Nambiar.
 
Under the new rules proposed by the RBI, microfinance loans would mean collateral-free loans to households with an annual household income of Rs 1.25 lakh and Rs 2 lakh for rural and urban or semi-urban areas, respectively.
 
But, the issue here is the assessment of annual income of the household. Hence, the RBI has said all regulated entities should have a board-approved policy in place enumerating the factors considered for the assessment of household income. 
 
“From a borrower’s perspective, the good thing is that the family income will be calculated, not individual income. Some of the calculation metrics for arriving at the household income will be prepared by the organisation and approved by the board. So, it’s good that the RBI has not prescribed a common structure, but asked each organisation to come up with its assessment,” said Ghosh.
 
Borrowers will also get more choices between institutions charging different interest rates, added Satish.