RBI proposes to remove pricing ceiling for microfinance loans

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The Reserve Bank of India, in an advisory document, proposed lifting the price caps on microcredit imposed after the 2010 microfinance crisis. The recommendation is part of a broader effort to ensure a level playing field for banks, non-banks and microfinance firms, each of which is engaged in microcredit, but has different rules.

The regulator proposes harmonization of regulations between NBFC and NBFC-MFI.

Each MFI’s board can create an interest rate model, taking into account the value of funds, margin and risk premium, and determine the interest rate charged on loans and advances. The advisory document states that it is necessary to establish “appropriate internal principles and procedures”, adding that this should be guided by the Code of Good Practice.

Freedom of pricing would be a departure from current regulations.

Currently, there is a 10% margin limit on top of the cost of funds for MFIs with outstanding loans of Rs 100 million or more. Otherwise, the margin limit is 12%. It is also possible to use a separate formula that uses the average base rate of the five largest public sector banks, but there is a limitation.

These price caps were introduced in 2014 by the regulator following recommendations from a committee led by YH Malegam. The committee found that high prices, questionable recovery practices, and over-lending to unworthy clients led to the 2010 microfinance crisis.

To protect vulnerable borrowers, the regulator is basically offering better disclosures.

“Interest rates and risk grading approach should also be available on company websites or published in appropriate newspapers (for borrowers),” RBI said in a statement.

Borrowers should be provided with clear information on the interest rate mechanism in loan agreements in their own language, and lenders should disclose any penalty interest charged for late repayment.

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