MF interest rates: PMEAC talks tough

Criticises strong-arm collection tactics

After the Reserve Bank of India (RBI) tightened the noose on India’s micro-finance institutions (MFIs), it is now the turn of the Prime Minister’s Economic Advisory Council (PMEAC), which on Wednesday said that MFIs must work within a stringent regulatory mechanism.

“There should be a limit on interest charged on borrowers and a format for providing loans,” PMEAC Chairman C Rangarajan said.

MFI growth in India has been remarkable in the past five years in the wake of most formal financial institutions showing reluctance to serve the poor and micro-enterprises due to the prevalence of repayment risks.

In 2009, there were about 27.5 million borrowers and 84 MFIs, with an estimated portfolio of $4 billion, according of official data, which says, the annual growth over the last five years has been 62 per cent in terms of clients and 88 per cent in terms of MFI portfolios.

While, the RBI has acknowledged that the role of MFIs is important as they facilitate financial inclusion, there is a raging controversy over their anti-poor activities, with the charges against them involving usurious interest rates and strong-arm collection tactics employed by some MFIs.

Concerned over the problems of multiple lending, Rangarajan also said that MFIs should discourage multiple loans to same borrowers. Two or more loans by the same household from a single source is referred to as multiple borrowing.

Multiple borrowing has emerged as a major cause for concern as it is usually taken by the small borrower to pay off the existing debt, which in fact creates a vicious cycle of debt for the borrower.

“Strong-arm tactics adopted in recovering loan repayments have evoked much resentment. Equally, the business models adopted by many large MFIs were wrong.

Multiple loans to borrowers for non-productive activities are a self-defeating exercise,” the PMEAC chief said.

According to him, the overall cost to borrowers must be maintained at a level consistent with the repaying capacity of borrowers.

Following the Malegam Committee recommendations in the aftermath of the Andhra microfinance fiasco, the RBI had bunched together the microfinance sector as a niche segment within the category of non-banking financial companies and brought them under its direct regulation.

It had also set strict lending norms for the sector and asked them to start provisioning for defaults. Under the new rules, MFIs are not allowed to lend at more than 26 per cent interest, and margins on borrowed funds cannot exceed 12 per cent.

Also, not more than two MFIs should lend to the same borrower, while one borrower should not be a member of two groups simultaneously.

The frequency of repayment instalments should be decided by the borrower.