India: Micro Loan Interest Rates Down on Lower Cost of Funds

Jul 2016
India, July, 21 2016 - With cost of funds for microfinance institutions coming down significantly due to successive rate cuts by the RBI, interest rates on small loans have come down by more than 100 basis points in the last one year. Moreover, in the next quarter there could be a further reduction in interest rates.

According to Manoj Kumar Nambiar, managing director of Arohan in the next quarter alone there was a possibility of further reduction in interest rate by 100 basis points, as not only have the cost of funds come down, but its credit rating has also improved. At present, Arohan on an average, charges around 23.9 per cent interest rate.

"With successive rate cuts, the cost of funds in the MFI industry has come down. As per the RBI guidelines, MFIs are required to reduce interest rates with the fall in cost of funds. Moreover, when one MFI reduces interest rates, other firms would also have to at the possibility of reducing interest rates," said Nambiar.

Recently, Bandhan Bank announced reduction in interest rates on micro loans by 60 basis points, which effectively reduced its interest rates on microfinance lending from 20.50 per cent to 19.90 per cent.

In the last one year, the cost of funds of MFIs has come down to around 14 per cent, from more than 15 per cent a year ago. In addition, on account of better ratings from credit agencies due to stability in the MFI sector, several small and mid-sized MFIs are negotiating for better rates from banks.

Micro loan interest rates down on lower cost of funds

According to the present RBI regulations, large MFIs (with a portfolio of more than Rs 100 crore or more), the lending rate should be calculated on the basis of cost of funds, plus 10 per cent margin. For other MFIs , the margin was kept at 12 per cent. Earlier, the RBI had removed interest rate cap of 26 per cent on loans given by microfinance companies.

"MFIs have been reducing interest rates from the last two to three quarters. While the interest rates are linked to cost of funds, other factors have also contributed to the reduction. For example, increasingly, MFIs are leveraging on technology to reduce operational cost. A number of them are going for cashless transaction," said Ratna Vishwanathan, chief executive officer of Microfinance Institutions Network (MFIN).

In the last financial year, Ujjivan reduced lending rates by around 160 basis points. At present, Ujjivan charges between 22-23 per cent for a majority of its loan products.

"As on March 31, 2016, 50 per cent of the total borrowings were floating and we were also able to take benefit of the reduced interest rates scenario in the economy. With increased capitalization levels and better credit ratings, Ujjivan negotiated lower rates for borrowings. The reduced borrowing cost was passed on to our customers we were able to reduce lending costs to customers by around 160 bps during the FY," according to the latest annual report of Ujjivan.

Last year, MFIN had advised its members to reduce interest rates by at least 25 basis points by the end of September 2015. At present, Bharat Financial Inclusion Ltd, earlier known as SKS Microfinance , has one of the lowest interest rates in the industry at 19.75 per cent. In November last year the company had reduced interest rates by one percentage point to 19.75 per cent.


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