On 14^th March Reserve Bank of India (RBI) announced Regulatory Framework on microfinance loans.

Removal of margin caps

• The Reserve Bank of India (RBI) has done away with the margin caps on the pricing of small loans given by non-banking financial company-microfinance institutions (NBFC-MFIs).
• Earlier, there was a limit on the interest rate charged by microfinance lenders. The maximum interest rate was 10-12% above the cost of funds incurred by the institution or 2.75 times the average base rate of the five-largest commercial banks, whichever is lower.
• Now, the removal of margin caps brings NBFC-MFIs to the same level as other lenders such as banks. This will pave the way for the underwriting of loans based on risk analysis. Also, depending on the borrower, a risk premium can be charged by the lenders.

New policy

• According to the new directions, all microfinance lenders must bring out a board-approved policy regarding the pricing of loans.
• A detailed interest rate model should be prescribed in the policy document, which includes various components of interest rate, such as cost of funds, risk premium, margin, etc. The policy document should also mention a ceiling on the interest rate and all other charges applicable to microfinance loans.
• The new directions provide flexibility to lenders. For example, a lender can charge a low-interest rate on loans, if there is access to low-cost funds. On the other hand, if there is no access to low-cost funds, a higher interest rate can be charged on loans.

Income limit

Annual household income, to be eligible to avail microfinance level has been raised to ?3 lakh. Thus, the market size of microfinance lending will be increased. Earlier, the annual household income limit to avail microfinance loans was ?.25 lakh in rural areas and ?2 lakh in other areas.

Other highlights

To curtail over-lending to customers, RBI has put a cap on repayment value to 50% of the monthly household income. The Central bank has also said that there will not be any prepayment penalties on microfinance loans.