Under a proposal by the Reserve Bank of India (RBI) to review the regulatory framework governing microfinance institutions (MFIs), they may be given the freedom to set interest rates guided by a board-approved policy. If adopted, the proposal would eliminate the existing regulatory cap on MFI interest rates.
“Like any other NBFC, non-bank financial company (NBFC)-MFIs shall be governed by a board-approved policy and a fair practises code that ensures disclosure and transparency. There would be no cap on the interest rate. They should, however, take care to avoid charging usurious interest rates in the process “The RBI stated in its Consultative Document on Microfinance Regulation. The goal is to harmonise regulations across microlender categories.
On 5 February, the RBI stated the importance of establishing a framework that is uniformly applicable to all regulated lenders in the microfinance sector. While commercial banks, small finance banks, and NBFCs, investment and credit companies are all regulated in the microlending space, the regulatory focus has largely been on those registered as NBFC-MFIs.
RBI stated that the discussion paper aims to facilitate a review of the applicable regulatory framework for all regulated entities’ microfinance activities. This is expected to address concerns about microfinance borrowers being over-indebted and to enable a market mechanism to bring interest rates down.
According to industry experts, this proposal demonstrates the regulator’s confidence in microfinance lenders’ ability to set interest rates transparently.
“With this move, the RBI demonstrated its confidence in the microfinance sector’s maturity. This is a progressive step in which the institution is responsible for setting a reasonable interest rate on transparent terms “P. Satish, executive director of Sa-Dhan, an industry association representing 227 MFIs, stated.
At the moment, microlenders have limited discretion over interest rates. The maximum rate that an MFI may charge is the lower of the cost of funds plus a margin of ten percentage points for NBFC-MFIs with loan portfolios exceeding 100 crore and twelve percentage points for others, or 2.75 times the average base rate of the five largest commercial banks.
The RBI believes that this rate ceiling also unintentionally created a prescribed benchmark for other microlenders. For example, despite the lower cost of funds, banks’ lending rates also hover near this regulatory ceiling. Borrowers ultimately lose out on the benefits of increased competition and economies of scale, even in a falling interest rate environment, the report stated.
The new framework proposes a uniform definition of microfinance loans that would apply to all regulated entities, ensuring that target borrowers can be identified with certainty regardless of the type of lender. Second, the maximum level of debt that microfinance borrowers may incur shall apply to all regulated entities. Third, the current restriction on lending to the same borrower by no more than two NBFC-MFIs will be eliminated.
Additionally, each regulated entity would be required to have a board-approved policy for assessing household income, periodicity of repayments according to borrower requirements, and all-inclusive interest rates charged to borrowers. Apart from that, there should be no penalty for early payment.
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