India: Banks Should Charge Less than 10% while Lending to Microfinance Institutions

Jul 2010
New Delhi, India, July, 08 2010 - Vijay Mahajan, who in June took over as chairman of the Washington DC-based Consultative Group to Assist Poor (CGAP), wants banks in India to lend to microfinance institutions (MFIs) at sub-10% interest under the new base rate regime. Banks lend to MFIs at 11.5-14.5% interest, and these lenders charge rates as high as 30% for small loans to the poor.

Mahajan, founder-chairman of microfinance firm BASIX group, however, said in a recent interview he expects rates charged by MFIs to go down on higher volumes and anticipated lower cost of funding.Mahajan, the first Indian to head CGAP, is also president of the Micro Finance Institutions Network (MFIN), a self-regulatory body comprising 39 MFIs. These represent some 80% of India’s microfinance sector, estimated at Rs24,000 crore in terms of loans.

CGAP, a microfinance body and independent policy and research centre, was set up by the World Bank and 33 donor countries. Edited excerpts:

What are your priorities as the new chairman of CGAP?

CGAP’s overarching goal is to build financial systems which work for the poor. We are not only focusing on credit but also on financial systems, which means there have to be a full range of products including savings, money transfer, payments and insurance, etc. Secondly, the institutional framework comprising banks, NBFCs (non-banking financial companies), distribution agents, regulators, etc., should come in place. The other important thing is micro-insurance. The most important thing is savings, which is being given top priority. Traditionally, the emphasis of the microfinance field has been on micro-credit. We want to change it to micro-savings. We want to establish affordable and accessible savings products and channels.

How do you view the increased prudential restrictions on MFIs?

While we want to work with the regulators to ensure that the overall financial system remains healthy, we want to also ensure that they don’t inadvertently do something which becomes anti-inclusion. If they think microfinance is risky and, therefore, increase the capital adequacy ratio to 20-25%, then it automatically becomes burdensome. We want to tell them to look at the asset quality and long-term track record of the sector and make capital requirements in proportion to that.

Would tighter norms increase the cost of funds for MFIs?

Given the high portfolio quality of microfinance, and in the spirit of Basel II (global accounting) norms, and also keeping in view the new base rate regime, the banks should charge less than 10% while lending to MFIs. The banks are now charging 11.5% to 14.5%. If there is 100-200 basis points increase following Basel II norms, it will be (an) additional burden on MFIs, which are already finding it difficult to bring down the interest rates they charge to borrowers, which now averages at 26%. Given the track record of low risk on loans to MFIs, the banks should apply thin risk premium on loans to MFIs. (One basis point is one hundredth of a percentage point).

Do you see interest rates charged by MFIs going down significantly?

I think the interest rates will come down at least for three reasons. As the volumes go up, the average costs will come down, some of which can be passed on to the customers. Secondly, with alternative sources of finance, including base rate-based lending by banks, the cost of funds for MFIs should come down. Today, the average cost of funding is 12-13% and I expect it to come down to 10-11%. The third is technology. Automation of processes...will bring down the cost of operations.

There are fears of a bubble being formed in the Indian MFI sector because of over lending, lack of processes, and excessive geographical and product concentration.

Both CGAP and MFIN are aligned on the issue to treat these concerns as early warnings to take corrective actions. Accordingly, MFIN is initiating efforts towards creating (a) credit bureau and code of conduct for the member MFIs, where action will be initiated against the erring members.

Do you see the need for an exclusive regulator for the sector?

In my individual capacity, on the request of the Indian government, I have recommended (the) creation of a body on the lines of South Africa’s Micro Finance Regulatory Council. Below...Rs50,000 or Rs1 lakh, all types of financial transactions, whether savings, credit, insurance, remittances, pensions, should be regulated by the body.

Source :

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