Published on January 2, 2017
1. Study of Higher Lending Interest Rates Charged by Microfinance Institutes.
2. Financial Equilibrium Income from loans ≥ Cost of funds + Loan loss expense + Operating Expense + Margin (Profit) • Different interest rate for different customer, region, product • Following equation is considered to determine interest rate
3. Cost of Funds Borrow money to Lend money Institution Rate of Interest (on declining balance) 1 NABARD 8-9 2 SIDBI 8-9 3 RMK 8 4 Commercial Banks a. Public Sector 12 b. Private Sector 14 (Source: Report on microfinance by DEVELOPMENT POLICY DIVISION PLANNING COMMISSION)
4. Operating Expense Reach to customer Maintain human capital Age (years) OER Yield <3 46.0% 19.0% 3-5 19.0% 17.0% 5-7 14.0% 20% >7 15.0% 19.0% M-CRIL 18.5% 19.1% Top 10 (as per Loan amount outstanding) 12.3% 24.8% (Source: Report on microfinance by DEVELOPMENT POLICY DIVISION PLANNING COMMISSION)
5. Overall Item of cost Basis of cost Percentage Cost of Funds Average borrowing rate (table 1) 10% Operating expense Salary and Money transfer charges by government post office/ bamks or other FIs 10-14% Cost of provisioning for bad debts As per RBI norms, based on extent of bad debts 1-3% Profit margins Minimum required to maintain capital adequacy as per RBI norms 1-2% Total 22- 29%
6. What actually customer pays Annual Percentage Rate (APR) Repayment daily, weakly, monthly APR (Interest + Fee): Interest and processing charges APR (Interest + Fee + Insurance): Interest, processing charges, credit insurance APR (Interest + Fee + Insurance + Deposit): Interest, processing charges, credit insurance, security deposit APR (Interest + Fee + Deposit): Interest, processing charges, security deposit
7. Findings Higher interest rates charged by Microfinance institutes are mainly for two reasons ◦ High cost of capital (avg. 10%) ◦ High operating expense (avg. 12.3%) Provision for loan loss and profit margin are smaller component of interest rate. Interest will be much higher even without them. Average interest rate that can be charged by MFI comes as 22 - 29% form theoretical calculation. Average interest rate actually charged by MFIs is 28.19 - 29.61%
8. Suggestions Government should provide low cost funds to MFIs which is beneficial to MFIs and ultimately to poor borrowers. This is already implemented in African countries where bank charges only operating expense and some minimal interest while funding to MFI. NABARD has scheme to reimburse interest payment of SHG loan but this is only for PSU banks. MFIs should also be considered for such scheme.