The proposal, if implemented, will end the existing regulatory cap on MFI interest rate.(MINT)
The proposal, if implemented, will end the existing regulatory cap on MFI interest rate.(MINT)

MFIs may get to set interest rates

  • The RBI had on February 5 signalled the need for a framework that is uniformly applicable to all regulated lenders in the microfinance space.
Livemint | By Shayan Ghosh, Mumbai
UPDATED ON JUN 15, 2021 03:22 AM IST

Microfinance institutions (MFIs) may get freedom to set interest rates guided by a board-approved policy, under a Reserve Bank of India (RBI) proposal to review the regulatory framework governing them. The proposal, if implemented, will end the existing regulatory cap on MFI interest rates.

“Non-banking financial company (NBFC)-MFIs, like any other NBFC, shall be guided by a board-approved policy and the fair practices code, whereby disclosure and transparency would be ensured. There would be no ceiling prescribed for the interest rate. However, while doing so, they should ensure usurious interest rates are not charged,” The RBI said in its Consultative Document on Regulation of Microfinance. The idea is to harmonize regulations across categories of microlenders.

The RBI had on February 5 signalled the need for a framework that is uniformly applicable to all regulated lenders in the microfinance space. While the microlending space has scheduled commercial banks, small finance banks and NBFCs, investment and credit companies, the regulatory focus has largely been on those registered as NBFC-MFIs.

The discussion paper intends to facilitate a review of the applicable regulatory framework for microfinance activities undertaken by all regulated entities, RBI said. This is expected to address concerns related to over-indebtedness of microfinance borrowers and to enable a market mechanism to bring down interest rates.

Microlenders at present have limited freedom to set interest rates. The maximum an MFI can charge is the lower rate between the cost of funds plus a margin of 10 percentage points for NBFC-MFIs with loan portfolio exceeding 100 crore and 12 percentage points for others and 2.75 times the average base rate of the five-largest commercial banks.

The RBI believes this rate ceiling also has had an unintended consequence of creating a regulatory prescribed benchmark for other microlenders. For instance, lending rates of banks also hover around this regulatory ceiling, despite the comparatively lower cost of funds. Ultimately, borrowers are deprived of the benefits of enhanced competition and economy of scale even under a falling interest rate regime, it said.

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