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The proposed interest rate cap of 24 per cent on individual loans could deter microfinance institutions (MFIs) from reaching out to the poorer segments of the population that require smaller loan sizes, Fitch Ratings said in a report.
Analysing the adverse effects of the interest rate cap, which was one among the many proposals mooted by the Reserve Bank of India's YH Malegam sub-committee to rejuvenate the MFI sector, the credit rating agency said smaller loans are expensive to administer.
MFIs may also avoid setting up or expanding operations in remote areas, which are typically more expensive to operate.
Excessive competition
“Caps may also create excessive competition amongst MFIs that service particular segments of the poor in regions that are relatively easy or less expensive to service, leading to the risk of multiple loans being made to these segments,” said the report.
Repayment model
If MFIs are forced to shift to a monthly repayment model, the rating agency said they may then have to reach out to traders, large farmers, and non-farm entrepreneurs whose cash flow cycles are longer, and thus it will be easy to shift to the monthly repayment schedule.
“On the one hand, this will bring down the transaction cost and help MFIs lower their interest rates.
“On the other hand, however, it means that MFIs will probably reduce lending to that segment of the population that needs microloans the most,” said Fitch.
Monthly repayment schedules, according to the agency, are often not in sync with the cash flows of the borrowers, as low-income households typically receive their wages on either a daily or weekly basis.
Directed funding
Funding is likely to remain constrained for MFIs as commercial investors reassess the risks in the sector in view of the emerging paradigm.
It is likely that directed or more socially-orientated funding — or even grant funding — will be needed to supplement existing funding to support lending growth in the near-term or to keep less viable institutions afloat.
Loan growth levels are likely to drop, which may have an impact on valuations and the flow of common equity to the sector.
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