Liberalising of pricing cap will encourage financial inclusion, earlier in difficult territories where cost of operation is high or risk is high, MFIs were reluctant to operate due to their inability to price loans as per their risks and costs. Now with new proposed pricing regime, a risk-based pricing can be followed, which will allow MFIs to explore some new territories and provide much needed credit to unserved and underserved.
On 14th of June 2021, Reserve Bank of India released a consultative document on Regulations of Microfinance; these draft regulations are nothing less than a major reform for the Microfinance Industry. This is a very pragmatic and visionary document which liberalizes the regulations governing microfinance lending. The documents aim to harmonise regulation among all players in the microfinance industry and foster competition which will ultimately benefit the end borrowers.
One of the biggest reforms among many in the draft document is liberalising the pricing regime for NBFC-MFI. Till Now NBFC-MFIs were required to maintain their lending rate as lower of the two formulae shown below:
Cost of funds plus a margin cap of 12 per cent, if its loan portfolio does not exceed ₹100 crore; or 10 per cent otherwise; or
2.75 times of the average base rate of the five largest commercial banks.
Meanwhile the operating costs of MFIs have marginally increased or remained same, but credit cost has increased significantly. Due to collection related challenges due to the pandemic, there is also greater strain on operational costs; high digital adoption by customers is still quite far away. This is in-turn creating a severe pressure on margins of NBFC-MFIs, especially the smaller ones who are not able to borrow money at cheaper rates.
These regulations served the purpose in those times when there was lot of ambiguity and speculation about MFI interest rates, because there was lack of availability of data. But since the turn of the decade Microfinance industry has matured a lot,8 MFIs have become SFBs, one has become a full commercial bank, several of them are now listed on stock exchanges. Hence there is ample amount of information and case-studies available about MFIs in public domain. There are full-fledged MFI credit bureau systems in place. There are very well-respected Industry-SROs namely MFIN and Sa-dhan which are actively monitoring this space. This gives RBI enough confidence to consider liberalizing the pricing regime for microfinance sector.
Besides, pricing cap was prohibitive and discriminatory considering the regulatory arbitrage that currently exists between NBFC-MFIs as compared to Banks, SFBs, and Section-8 companies. While NBFC-MFIs which represent 30% of the market were subjected to this margin cap, institutions such as Banks, SFBs, Section-8 companies, and other NBFCs were free to charge interest rates as per their own pricing policies. By liberalizing this pricing cap, RBI would create a level playing field for all the operators in Microfinance space. This will lead to a healthy competition and customers will definitely get benefit out of this.
Liberalising of pricing cap will also encourage financial inclusion, earlier in difficult territories where cost of operation is high or risk is high, MFIs were reluctant to operate due to their inability to price loans as per their risks and costs. Now with new proposed pricing regime, a risk-based pricing can be followed, which will allow MFIs to explore some new territories and provide much needed credit to unserved and underserved. A universal risk-based pricing would also be good for financial health of the MFI industry as a whole.
To summarize, this liberalised pricing cap policy as proposed by RBI is very bold, pragmatic, and a sensible move. It should be supported whole heartedly by the industry.
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