This refers to Somasekhar Sundaresan’s article “Centre’s moves on micro credit is a mistake” (September 27). On the issue of interest rate caps, most microfinance institutions (MFIs) operate at a net yield ranging between 28 and 33 per cent. The commercial basis for this is that MFI operating costs are very high. SKS Microfinance has reported operating costs of around 12 per cent in its IPO prospectus. Add to this the cost of funds, which is around 11-12 per cent for the top MFIs and 1-2 per cent higher for smaller ones. Add a loan loss provision of 2 per cent and you get 26-27 per cent as the break-even rate. A yield of 30 per cent will give them a profit of around 3 per cent. A directive requiring MFIs to operate at a cap of 24 per cent will create panic among MFIs with systems, processes and infrastructure that make it difficult to immediately shift to dramatically lower rates.
Moreover, the withdrawal of priority sector status may have an upward impact on the rate banks charge to MFIs. More importantly, this may squeeze the volume of bank credit available to the MFI industry, working as a double whammy.
The poor need access to credit on a consistent basis. Most MFI loans have a tenure of one year with instalments collected on a weekly basis. An interest rate drop from 28 per cent to 24 per cent on a loan of '10,000 means total savings of '300 in the hands of the borrower for a one-year loan. This will reduce their weekly instalment by around '6. My interaction with MFI borrowers suggests that their top priority is to get bigger loans and better service.
MFI rates will be forced downwards over the next few years on account of competition. Some of the leading MFIs have already announced a drop in rates and more of this will be seen in the years to come.
We must remember that banks were charging 45-50 per cent a couple of years ago when they made small-ticket personal loans available to lower middle-class customers. The only reason this business has halted today is that heavy losses and frauds have resulted in many banks withdrawing this product. Even today, banks charge credit card rates and personal loan rates that are comparable to, if not higher than, MFI lending rates.
Moves to cap MFI interest rates and remove priority sector status will go against the government’s stated policy of financial inclusion. This will squeeze bank credit to the poor and may drive many MFIs out of business. Instead of focusing on improving MFIs’ lending practices, the priority is to make them more transparent and see that they reduce multiple lending to segments such as agricultural labourers.
Arunkumar, on email