The Reserve Bank of India (RBI) has removed margin caps on the pricing of interest rates on small loans from Non-Banking Financial Corporations-Microfinance Institutions (NBFC-MFIs). In a March 14 circular, he said the loan interest rate should be calculated after considering various factors such as risk premium, cost of funds, margin and others. This means greater transparency as borrowers can see how their interest rate is calculated.
This decision also puts the lending rate mechanism of NBFC-MFIs at the same level as that of other lenders. Consumers will have more choices among lenders and will also understand the factors that influenced the loan. For example, including the risk premium in the calculation of interest rates for microfinance loans means that for a new borrower the interest rate will be higher, but for a good regular borrower (who has repaid loans on time), the interest rate will be lower.
NBFC-MFIs are non-banking companies that offer unsecured loans. According to the definition given in the latest RBI Principal Circular, “A microfinance loan is defined as an unsecured loan given to a household whose annual household income is up to Rs 300,000.”
The circular subjects all commercial banks, excluding payment banks, to the same regulatory rules. “This brings uniformity in the regulation of microfinance loans and will therefore promote the growth of the sector. There will be more access to low cost loans. Now it does not matter where a client goes for a loan because all banks, small financial banks, housing finance companies, cooperative banks and NBFC MFIs are subject to the same regulations,” said Dr N. Jeyaseelan, CEO of Virutcham. Academy for Social Changemakers LLP.
“Microfinance institutions primarily cater to the NTC (new creditor) segments and local borrowers, where data on financial history is limited. This move allows MFIs to take more calculated lending risks in the unsecured lending space and price them accordingly,” says Amit Das, co-founder and CEO of Think360.ai, a comprehensive data science company .
What is the Margin Cap?
Previously, various NBFC-MFIs collected funds from the market or from banks/financial institutions at one set of interest rates and then lend to clients at another interest rate. This interest rate difference was capped at 10-12% of funds raised or 2.75 times the average base rate of the five largest commercial banks, whichever was lower. This is called the margin cap because there is a cap on the maximum interest rate that can be charged.
The margin cap system no longer applies, but that doesn’t mean lenders can charge as much interest as they want. RBI also said that no lender can charge abnormally high interest rates. “Interest rates and other charges/fees on microfinance loans should not be usurious. These will be subject to supervisory control by the Reserve Bank,” the circular read.
“Removing the old margin cap is a step in the right direction. It promotes transparency. The RBI also asked to give three breakdowns (cost of funds, risk premium and margin) to show how the rate of interest has been secured. This will prevent lenders from charging exorbitant interest rates as they have to justify their loan rates,” added Jeyaseelan.
What is the new system?
Various policy changes are announced in the main RBI Circular. These are all lined up to make microcredit regulations the same for all lenders.
- Eligible assets: “Lowering the eligible asset threshold to 75% of net assets for an NBFC acting as a microfinance institution will potentially help bring more institutions under the NBFC-MFI umbrella. The more loan facilitators in the microfinance space designated to serve low-income households, the greater the number of clients served who are looking for low-cost unsecured loans,” says Raj Khosla, Founder and managing director of MyMoneyMatra. , a loan aggregator.
- Loan pricing: Each microfinance lending company must formulate a policy approved by the board of directors regarding the pricing of its loans. This policy should include a complete and well-documented interest rate model and the factors that influenced that interest rate. Factors such as cost of funds, risk premium, margin and other necessary details should be taken into consideration. Apart from this, any other additional charges applicable to the microfinance loan should also be specified in easy to read language. “These RBI guidelines will unlock credit for the low-income segment, while also boosting the level of credit risk stimulation for NBFCs and MFIs. However, this does not take away from the need for responsible credit risk management. As all microfinance lenders will put in place board-approved policies for loan pricing, we need to be careful of abusive pricing models that can lead to debt traps,” Das added.
- Loan repayment: The circular limits the maximum loan repayment amount to 50% of the borrower’s monthly household income. This means that no lender can sanction loans (principal amount and interest) to people beyond 50% of their monthly household income. Thus, if the monthly income of the borrower is Rs 25,000, the loan limit is Rs 12,500 per month. There will be no prepayment penalty. These conditions discourage excessive borrowing, which will lead to timely loan repayments. “Tying repayment capacity to household income is a welcome measure. The aggregate borrowing limit is calculated regardless of the number of lenders the loan is taken from,” Jeyaseelan added.
- Categories of borrowers: NBFC-MFIs can now grant 25% of their total loan portfolio to borrowers outside the microfinance category. This limit was 15 percent earlier. NBFCs, which by definition are not microfinance lenders, can now give up to 25% of their total loan portfolio to microfinance borrowers. This limit was previously 10 percent.