The proposed guidelines will favor private credit institutions to the detriment of public sector banks
In June 2021, the Reserve Bank of India (RBI) published a âMicrofinance Regulation Advisory Documentâ (https://bit.ly/3ixTIH3). While the stated objective of this review is to promote the financial inclusion of the poor and competition among lenders, the likely impact of the recommendations is against the poor. If implemented, they will translate into an expansion of microfinance lending by private financial institutions, high interest credit provision to the poor, and huge profits for private lenders.
The advisory document recommends that the current cap on the interest rate applied by non-bank finance institutions-microfinance institutions (NBFC-MFIs) or regulated private microfinance firms be removed, as it is biased against a single lender (NBFC -IMF) among the many (commercial banks, small financial banks and NBFC). He proposes that the interest rate be determined by the board of directors of each agency and assumes that âcompetitive forcesâ will drive interest rates down. Not only has the RBI abandoned any initiative to extend low-cost credit through public sector commercial banks to the rural poor, most of whom are rural women (as most loans go to members of women’s groups). ), but, in addition, it also proposes to deregulate the interest rate applied by private microfinance agencies.
According to current guidelines, the âmaximum interest rate charged by an NBFC-MFI is the lower of: cost of funds plus a 10% margin for larger MFIs (a loan portfolio of more than 100 crore) and 12% for the others; or the average base rate of the five largest commercial banks multiplied by 2.75 ‘. In June 2021, the average base rate announced by the RBI was 7.98%. A quick glance at the websites of some small financial banks (SFBs) and NBFC-IMFs showed that the “official” interest rate on microfinance was between 22% and 26%, or about three times the rate. basic rate.
Crucial for rural households
Microfinance is gaining more and more importance in the loan portfolio of the poorest rural households. In a study of two villages in southern Tamil Nadu, carried out by the Foundation for Agrarian Studies, we found that just over half of the total borrowing from households residing in these two villages was unsecured or non-secured loans. guarantee with private financial agencies. (SFB, NBFC, NBFC-IMF and some private banks).
There was a clear differentiation by caste and socio-economic class in terms of the source and purpose of the loan. First, unsecured microfinance loans from private financial agencies were disproportionately important to the poorest households – to poor peasants and wage workers, to people from the main castes and backward classes. Second, these microfinance loans were rarely intended for productive activity and almost never for group enterprise, but primarily for home improvement and meeting basic consumer needs.
Our data showed that poor borrowers took out microfinance loans, at reported interest rates of 22% to 26% per year, to cover daily expenses and house repair costs. How does this compare with the credit of banks and public sector co-operatives? Primary Agricultural Credit Societies (PACS) crop loans in Tamil Nadu had zero or zero interest charges if repaid within eight months. Kisan bank credit card loans were charged 4% per annum (9% with a 5% interest subsidy) if paid in 12 months (or a penalty rate of 11%). Other types of loans from regular commercial banks carried an interest rate of 9% to 12% per annum. As even the RBI now recognizes, the interest rate charged by private microfinance agencies is the maximum allowed, an interest rate that is far from any notion of cheap credit.
A loan break, violations
The real cost of microfinance loans is even higher for several reasons. First, because of the repayment method: a loan of, say, 30,000 from an NBFC-MFI must be repaid in 24 equal monthly installments of 1,640. Each month, a capital of 1,250 and interest of 390 are repaid. The first month the simple interest on this loan is 15.6% per annum but at the end of the first year the interest rate is 31%. This is because each month the principal is reduced (by 1,250) but the interest charges are the same. In short, an “official” flat rate interest rate used to calculate equal monthly payments actually implies an effective interest rate that increases over time.
In addition, a 1% processing fee is added and the insurance premium is deducted from the capital. As the principal is insured in the event of death or default of the borrower or spouse, it cannot be argued that a high interest rate corresponds to a high risk of default.
Does the borrower understand this mechanism? In accordance with RBI regulations, we found that all borrowers have a repayment card with monthly repayment schedules. During their regular visit, the loan collector checked off the payment paid. This does not mean that the borrowers understood the charges.
In addition, unlike the RBI directive of âno collection at the borrower’s homeâ, collection was at the door. Note that a switch to digital transactions only refers to the sanction of a loan, the repayment being made entirely in cash. Many borrowers said the debt collector used foul language out loud, shaming them in front of their neighbors.
If the borrower is unable to pay the down payment, the other members of the group must contribute, with the group leader taking responsibility. In our survey, there was no organic link between microfinance and a group activity or a business. As one NBFC-MFI agent told us, “we used the groups formed previously for other activities only to show that we are lending to a group.”
While microfinance loans have been in place since the 1990s, what is different in the recent phase of financial services growth is that private for-profit financial agencies are âregulated entitiesâ. In fact, they were promoted by the RBI. Small finance bank (SFB) loans to NBFC-MFIs have recently been included in priority sector advances. And, after COVID-19, the cost of funds provided to NBFC-MFIs was lowered, but without additional restrictions on the interest rate or other parameters affecting the end borrower.
In the 1990s, microcredit was provided by regular commercial banks, either directly or through non-governmental organizations, to women’s self-help groups, but given the lack of regulation and opportunities for high yields, several for-profit financial agencies such as NBFCs and MFIs have emerged. . In the mid-2000s, there were numerous reports of poor practices by MFIs (such as SKS and Bandhan) and a crisis in some states such as Andhra Pradesh, resulting from a rapid and unregulated expansion of private microcredit. for profit. .
The microfinance crisis in Andhra Pradesh led the RBI to look into the issue, and based on the recommendations of the Malegam Committee, a new regulatory framework for NBFC-MFIs was put in place in December 2011. A few years later Later, the RBI allowed a new type of private lender, the SFBs, with the aim of expanding banking activities to âunserved and underservedâ segments of the population.
Today, as the RBI consultative document notes, 31% of microfinance is provided by NBFC-MFIs, and 19% by SFBs and 9% by NBFCs. These private financial institutions have grown exponentially in recent years, garnering high profits, and at this rate, the current share of public sector banks in microfinance (microcredit linked to SHG-banks), of 41%, is likely to drop sharply.
The proposals in the RBI consultative document will lead to further privatization of rural credit, reducing banks’ share of direct and cheap credit and leaving poor borrowers at the mercy of private financial agencies. This is beyond comprehension at a time of widespread post-pandemic distress among the working poor. The All India Democratic Women’s Association, in its response to this document, expressed concerns about the implications for female borrowers and demanded that the interest rate for microfinance not exceed 12% per annum. To meet the credit needs of the poorest households, we need a policy reversal: strengthening of public sector commercial banks and strong regulation of private entities.
Madhura Swaminathan is Professor, Indian Statistical Institute, Bengaluru