The ghost of the Andhra microfinance crisis of 2010 seems to be back, driving the industry to the edge, with some smaller players charging as high as 35-40 percent on their loans in certain parts of the country.
Microfinance institutions (MFI) lend to low-income groups living in unbanked and underbanked areas typically at an interest rate of 21-25 percent. There is no cap on the interest rates as the Reserve Bank of India (RBI) had in November 2022 removed limits on the pricing of loans given by these entities. Earlier guidelines prescribed a maximum interest rate that an MFI could charge on loans to be around 10-12 percentage points above the institution’s cost of funds, or in other words, 2.75 times the average rate of the five-largest commercial banks.
These MFIs, industry officials said, are spread across the country with a majority of them functional in rural Bengal and Assam. During the 2010 MFI crisis, many microlenders across the country had to shut shop as funding dried up and bad loans piled up. The RBI brought in regulations later to bring in discipline in the sector.
Also read: Some MFIs, shadow banks charging high rates on small value loans, says RBI governor
“The RBI’s concern on high interest rates of some NBFCs and MFIs are majorly around very small industry players. These are those MFIs which do go unnoticed as they are very small in size and most of them operate in eastern states like West Bengal and Assam,” said a senior industry executive who didn’t want to be named. He also refused to divulge details as the "information is sensitive".
The MFI industry had run into issues recently with Assam Chief Minister Himanta Biswa Sarma appealing to people in October 2023 to avoid taking loans from MFIs as they were charging very high interest rates. Another senior executive, who did not wish to be named, said that some small industry players are charging 35 to 40 percent.
An email sent to the RBI seeking comments for the story remained unanswered till the time of publishing the story.
Also read: Overall banking, NBFC, MFI sector stable, RBI watchful of risks, says Governor
In the post-deregulation scenario, said Gaurav Dixit, BFSI director at CareEdge, that MFIs charge rates in accordance with the individual borrower's risks. “After the removal of cap by the RBI, the MFIs have the freedom to charge rates according to the risk of the borrowers and their operations,” he pointed out.
MFIs saw a significant rise in cost of funds after the Covid pandemic which drove them to raise their lending rates, Dixit said. After the imposition of stricter measures across states during the second wave of Covid-19, ratings agency India Ratings said the overall MFI sector's collections could drop by a cumulative 10-15 percent in May 2021, compared to March 2021 and their credit cost estimate range for FY22 could jump to 5-10 percent from 3-6 percent.
Caution from RBI
The central bank started cautioning NBFCs and MFIs over charging high interest rates on some loans.
During the June 7 monetary policy presser, RBI Governor Shaktikanta Das said that the regulator had come across instances of microlenders and non-bank financiers charging "high, usurious interest rates" on small-value loans, reminding them to judiciously use their pricing power. The regulator reiterated that customer protection is one of its top priorities.
“There are some outliers that are charging usurious interest rates with whom RBI’s supervisory department is engaged,” Das said. Out of 9,500 NBFCs, supervisory action has been taken on three, he added.
Also read: Assam MFI Bill, socio-political factors hit local microlenders, says report
“It has been observed in some MFIs and NBFCs that the interest rates on small value loans are high and appear to be usurious,” Das said. “The regulatory freedom enjoyed by the regulated entities in respect of interest rates and charges should be used judiciously to ensure fair and transparent pricing of products and services.”
Additionally, Moneycontrol learnt that the apex bank, in the past few days, has been reaching out to some MFI lenders to gather details on the penalties charged and action taken against defaulters. “Some MFIs have received an email from the central bank asking for the penalty amount charged by them to defaulting borrowers. They are also asking for details on the penalty actions taken against the defaulting borrowers,” an executive from an MFI said.
Another executive of an MFI explained that the RBI has found issues around the model of some MFIs. “I think that the RBI has found some absurdity in the model of some MFIs. And that is why the RBI is insistent to understand things from them,” the executive said.
What do industry bodies say?
Mahesh Thakkar, director-general of the Finance Industry Development Council (FIDC), an industrial body of NBFCs, said that entities under the FIDC are not charging high interests and that the body is constantly monitoring risks. "We constantly monitor the industry and the industry players,” he said.
Jiji Mammen, executive director and CEO of Sa-dhan, an association of Microfinance and Impact Finance Institutions and a MFI industrial body, said: "The average lending rate is around 24 percent with some charging as low as 18 percent and a few charging more than this. But we have not seen any MFIs charging very high rates. We have also seen that the final pricing is linked with their cost of funds and whoever is able to raise funds at the lower cost is able to charge a lesser rate of interest."
Microfinance Industrial Network (MFIN), another industrial body for MFIs, declined to respond to Moneycontrol’s queries.
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