MFIs and the process towards profit

New Delhi: A non-banking financial company (NBFC) involved in the gold loan business registered a net interest margin of close to 7 per cent in FY24. The company claims to provide instant, hassle-free digital gold loans at interest rates starting from 12 per cent. Its average cost of borrowing is around 9 per cent. Simply put, the net interest margin is the difference between lending and borrowing rates. So in this case the net interest margin should have been 3 per cent. Then, how does it become 7 per cent?

When prodded, a top official of the company explained the math behind these numbers on the condition of anonymity: Though the company advertises the starting interest rates on loans at 12 per cent, the average interest it earns is around 17-18 per cent. “The interest rate starts at 12-13 per cent,  but in the majority of cases, borrowers default. A miss of even a single EMI leads to an increase in interest rates,” the company official said.

The interest also rises when a borrower asks for a higher amount of money. Suppose you have gold jewellery valued at Rs 1 lakh. If you take a loan of Rs 50,000, you will be charged interest of about 12 per cent. But if you want to take a Rs 80,000 loan, you might be asked to pay 18 per cent interest.

The official claimed that this is not specific to his company, but is a general industry trend. NBFCs maximise profits by playing with the proportion of money lent with regard to the valuation of mortgaged assets and also with repayment terms and conditions.

As per the Reserve Bank of India's Regulatory Framework for Microfinance Loans, "all collateral-free loans to individuals belonging to low-income households, having annual income up to Rs 3,00,000 are treated as microfinance loans."

The main purpose of microfinance institutions is to extend financial services to economically disadvantaged people who might otherwise borrow from loan sharks.

In India, it was first introduced by the SEWA Bank, a division of the Self-Employed Women's Association (SEWA), which was founded in Ahmedabad in 1972 by lawyer and social activist Ela Bhatt. In May 1974, SEWA Bank was registered as a co-operative bank under the dual control of the RBI and the Gujarat state government. It provides credit to women in the informal sector, especially those who earn a living through their own small business or through their own labour.

Microfinance institutions have witnessed massive expansion in the past five decades. As per Microfinance Industry Network (MFIN) data, the size of the microfinance industry loan portfolio was over Rs 4 lakh crore as on September 30, 2024. There are 194 microfinance entities in the country with active loan accounts amounting to 14.6 crore. The total number of borrowers is over 8 crore.

Microfinance institutions can be classified into the following broad categories: small finance banks, non-banking financial company-micro finance institutions (NBFC-MFIs), banks, and non-profit MFIs.

All of these, with the exception of non-profit MFIs, are under RBI regulation. The non-profit MFIs are mostly registered as either trusts or societies and are regulated as per their corresponding Acts.

Microfinance institutions mostly borrow from banks and other financial institutions to lend money to their customers. In its latest financial stability report, released in December, the RBI flagged signs of stress in the microfinance sector. It also noted that the sector has been grappling with delinquencies across all types of lenders and ticket sizes.