RBI slams microfinance institutions for charging higher rates to borrowers

Reserve Bank of India (RBI) Deputy Governor M. Rajeshwar Rao came down heavily on microfinance institutions (MFIs) for charging higher rates to borrowers, thus cautioning against irresponsible practices.

He expressed concern over some MFIs disproportionately increasing their margins under the new regime, warning that misuse of regulatory freedom would prompt regulatory action.

“It has been observed that while the lenders were quick to pass on the increased costs to borrowers, they have been reluctant to pass on the benefits envisaged under the new framework. Some MFIs have increased their margins disproportionately under the new regime. We are not oblivious to the misuse of the freedom provided to the microfinance sector and irresponsible practices would compel us to act,” he said.

In 2021, the RBI had given full freedom to entities on interest rates to be charged for microloans by lifting the interest rate cap of 24 per cent put earlier.

Further, Rao addressed the atypical nature of non-banking finance companies (NBFCs) advocating for bank-like status, stating that NBFCs serve distinct economic functions and should not seek to emulate banks.

He said, “The NBFCs have evolved as niche companies serving specific economic functions and it is uncharacteristic for them to demand becoming like a bank.”

He also highlighted issues with peer-to-peer (P2P) lending among NBFCs, citing instances where practices deviated from regulatory guidelines.

Rao emphasised the importance of educating lenders about credit risks and denounced any breaches of licensing conditions or regulatory standards.

Rao said, “Of late, some of the business practices of NBFC-P2Ps do not appear to be in line with the regulatory guidelines. A large proportion of lenders on NBFC-P2Ps are individuals and they are not expected to be well-equipped to understand the risks involved in providing credit. Instead of educating the lenders about the inherent risks in the lending activity, NBFC-P2Ps have been observed to underplay the risks through various means such as promising high/ assured returns, structuring the transactions and providing anytime fund recall facilities. Let me make it clear that any breach of licensing conditions and regulatory guidelines is not acceptable.”

Rao said the NBFC sector witnessed a growth of over 33 per cent in the personal loan segment over the last four years, contrasting with a modest 15 per cent growth in overall assets under management. This was one of the factors which prompted the central bank to raise the risk weights on unsecured loans towards the end of last year.

“The financial stability report (FSR) also notes that during the last four years, the compound annual growth rate (CAGR) for personal loans (nearly 33 per cent) has far exceeded that for overall credit growth (nearly 15 per cent) of the NBFC sector. Our recent increase in risk weights of select retail loan categories may have to be seen in this context,” he said.

In November 2023, RBI increased the risk weight on banks’ credit exposure to NBFCs, in addition to the risk weight already linked to the rating of these non-bank lenders. This adjustment applies only when the current risk weight based on the NBFC rating is below 100 per cent.