Banking Central | Big Brother is watching! MFIs get a wake-up call as RBI flags a caution on rate frenzy

On July 19, while speaking at the at the Financial Express Modern BFSI Summit in Mumbai, Reserve Bank of India (RBI) Governor Shaktikanta Das clearly acknowledged the problem and issued a strong warning to the MFIs looking at only short term gains at the cost of healthy credit culture.

Critical issues relating to conduct sometimes get sidestepped in the pursuit of short-term gains, Das said.

Here's what the governor said in this context: “For instance, charging of very high interest rates by certain regulated entities for micro finance loans is not in order. I would like to reiterate what I said in my monetary policy statement on June 7, 2024: regulated entities should use their regulatory freedom responsibly to maintain fair and transparent pricing of small value loans. Unfair or usurious practices under micro-finance loans would compel us to have a re-look at the revised regulatory framework for microfinance loans issued in March 2022.”

This warning from the RBI governor couldn’t have come at a better time.

The Indian MFIs have learned their lesson in the hardest way in the last decade.

An entire industry was brought down to its knees when similar departures from healthy credit practices took hold in the industry leading to a harsh state-level regulation and subsequently pushing the RBI to come with a new set of rules for NBFC-MFIs alone.

A number of well-known microlenders had to shut shop and find new businesses models. This followed massive layoffs in the microlending space and loss of livelihoods for many more including those small borrowers who used to rely heavily on such firms.

Please, let’s not relive those days again!

Microlenders play a key role in filling the gap in financial inclusion in the far-flung areas of the country where big banks and NBFCs typically don’t go. But the model has to be based on strong fundamentals of corporate governance and discipline. Let the greed not take over the long-term goals.

As I wrote a month ago, for microlenders in India, it's time to take a pause, and revisit the meaning of this old saying, for good reasons.

Typically, the microfinance providers of MFIs charge high rates from their borrowers because their cost of borrowing is high. The MFIs do not have access to cheaper customer deposits that banks enjoy. Charging a margin of around 10-12 percent over the borrowing cost of 9-12 percent is normal, which makes the borrowing cost for their end-customers around 24 percent.

That is kind of an acceptable rate in the industry because microloans are known for their timely availability without a collateral and aren’t too sensitive to rates.

Also, it is perfectly legal to charge any rates they choose since there is no cap on the interest rates as the RBI had in March 2022 removed limits on the pricing of loans given by these entities.

But the flexibility stops there; there is a Lakshamn rekha that these firms can’t cross.

Tailpiece

Ahead of the Union Budget 2024-25, the finance ministry will release its economic survey today around noon which will give us a glimpse into the thinking of the department into various issues in the economy. It may offer some suggestions too to the government.

Those suggestions may or may not ultimately find place in the Budget document to be released tomorrow. Have a great week ahead.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers)