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Banks sign contracts with MFIs to rein in rates

Commercial banks are now inking upfront contracts with micro-finance institutions to ensure MFIs do not charge interest rates beyond a certain ceiling from clients, most of whom are farmers, poor rural women and daily wage earners. Mahua Venkatesh reports. Small money matters

india Updated: Dec 13, 2010 08:14 IST
Mahua Venkatesh

Commercial banks are now inking upfront contracts with micro-finance institutions (MFIs) to ensure MFIs do not charge interest rates beyond a certain ceiling from clients, most of whom are farmers, poor rural women and daily wage earners.

The move comes amid hectic confabulations between the government, MFIs and the Reserve Bank of India (RBI) about constructing appropriate framework for regulating micro-lenders, which experts feel are critical for pushing the objectives of financial inclusion.

Unlike commercial banks, MFIs do not get access to the RBI's refinance options such as the repo window. Banks borrow from the RBI at the repo rate, currently pegged at 6.25%.

The average cost of raising money for most MFIs is much higher. They typically borrow from banks at rates varying between 9% and18% depending on the tenure and value of loan.

This, MFIs insist, pushes up lending rates to final borrowers, which in some cases are much more than 30%.

"There is no bar in lending to MFIs but we have decided to sign a contact before lending to them, ensuring that they cannot charge interest above 30%," T.M. Bhasin, CMD, Indian Bank, told Hindustan Times.

Banks are also carefully examining financials and past records of each MFI before lending.

MFIs have come under criticism for their strong arm tactics, high interest rates and coercive methods of loan recovery, especially in Andhra Pradesh, which accounts for 30% of the country's micro-finance portfolio.

"Although we have not reduced our exposure to MFIs, we are considering the proposals on the basis of merit," M.D Mallya, CMD, Bank of Baroda said.

The Andhra Pradesh government last week tabled a Bill that seeks to replace an Ordinance that it had promulgated after a spate of suicides by MFI borrowers charging these institutions with adopting coercion.

The RBI has set up the Malegam Panel to recommend measures for regulating micro lenders.