High-Interest Microfinance by NBFCs: A Challenge to Commercial Banks | S S Sangwan

Abstract

Keywords: microfinance, death insurance to protect loan, operating cost, financial cost, lending and borrowing rate

Microfinance in India is the buzzword nowadays in banking circles, and its outstanding funding has reached Rs.5.4 lakh crore as of March 2023 as per the latest Bharat Microfinance Report (BMFR) released on the 8th November by Sa-Dhan, a Self Regulatory Organisation of Non-Banking Finance Companies (NBFCs). This funding is about 10 % of total priority sector lending by banks and about 40 % of bank financing to weaker sections (Sa-Dhan, 2023). Microfinancing (MF) has mainly been through group approach that may be self-help groups (SHGs) of 10 members and Joint Liability Groups (JLGs) of 5 members. MF has passed through different phases in the last three decades. To start with, MF was started by the National Bank for Agriculture and Rural Development (NABARD) in the year 1992 wherein SHGs of the poor were directly financed by banks with NGOs as facilitators in forming the groups. This approach dominated for a decade and around 2005, the Microfinance Institutions (MFIs) came into operation and started financing the SHGs with their resources alongwith direct financing by the banks. The MFIs became the dominant mode for MF from 2005 to 2015 with regulatory support from RBI. Around 2015, many MFIs converted into Non-Banking Finance Companies (NBFCs) wherein profit motive was a driving force. The NBFC-MFIs register under the Companies Act with the Ministry of Corporate Affairs and the RBI. Hence, NBFCs are more formalised institutions than NGOs/MFIs. As of February 2023, about 213 active MFIs and 99 NBFCs are registered with the RBI. At present, NBFC outreach is in 718 districts compared to 720 districts by the banks and are giving tough challenges to banks. Some banks have also adopted smaller MFIs as their extended arms for MF. Growth in the MF credit through NBFCs during 2022-23 is 21 % compared to 15.9 % of banks for all purposes.

The average MF loan amount disbursed per client works out to be Rs43908 in NBFCs and Rs38859 in MFIs. As per the analysis of the BMFR 2023, the proportion of loan amount used for productive purposes was 95 per cent. The main income-generation activities are agriculture, animal husbandry, trading, transport, etc, whereas; non-income-generating activities are housing, education of children, health, and bill payments. In agriculture, the lowest category of farmers were able to purchase timely inputs with microloans. These bifurcations of mf utilisation are only estimates and not based on any survey. The author, in his study found that the use for productive purposes was about 50 % in Haryana and 40 % in Himachal Pradesh by the SHG members (Sangwan 2013). The non-productive purposes were house repair & construction, marriages, domestic consumption and education of children. In another study of the author, it was revealed in the survey by the author that the share of productive purposes increases in the subsequent loans (Sangwan, 2002).

It is reavealed that in recent years, the proportion of MF through JLGs mode has surpassed that of the SHGs. As per the BMFR 2023; in 2022-23, loans disbursed through JLG mode are 81 % compared to 19 % through SHG and other modes. It is to be noted that SHG loans are saving linked while the JLGs loans are almost given instantly after verification of addresses and other details of the members and mutual guarantee of group members without the condition of saving. It was verified by visiting and interacting with the MF wing of a private bank that it was giving Rs35,000 to each member of group in the first instant within a week and Rs45,000 in a second instant after payment the first loan.

The average interest charged is around 25 % per annum in JLGs compared to about 12 % in saving-linked SHGs by the banks. It is estimated in the BMFR that the average operating cost of NBFC-MFIs is about 7 % due to frequent monitoring in the field and the average financial cost is about 12 %, varying from 10 to 14 % for different categories of the MFIs. NBFCs are not allowed to accept demand deposits like banks; moreover, the rate of borrowing from banks is higher for smaller and unrated MFIs. In recent years, their average borrowing rate has slightly comedown as more NBFCs have graduated to better ratings. It is revealving that the commercial banks are also charging interest @ around 25 % from the members of JLGs. In addition, the JLG- loaners have to pay a death insurance premium for the loan protection. It is about 2 % of the loan amount. It also benefits the life insurance companies of the respective banks.

RBI has removed the interest rate ceiling on non-collateral loans offered by NBFCs, including Small Finance Banks, non-profit companies and even the banks from first April, 2022 (RBI, 2022). RBI has even raised the annual family income ceiling to Rs 3 lakh to be eligible for collateral-free loans. It was previously Rs1.25 lakh in rural and 2 lakh in urban areas. Thus, more families become eligible for MF, hence, the lientele of NBFC-MFIs has increased many folds. It may be one of the reasons that the MF increased by 21% compared to the 15.9 % growth in the portfolio of the banks.

Owing to the high financial and operating-costs of the NBFCs ; presently, interest charged by them is about 24 % to 29 % per annum. As per the BMFR 2023, the effective yield of selected 82 MFIs was 20.65 % during 2022-23 compared to 16.50 % in the previous year. As per the BMFR 2023, the estimated income of 172 MFIsincreased to Rs 27811 crore with an increase of 43 % over the previous year’s income of Rs19447 crore. The Commercial Banks (CBs) are also charging interest of about 25 % on unsecured JLG loans despite their average financial cost of 6% on the deposits from the public. In the improved performance of CBs, the higher interest rate from MF laons may have contributed. Their good results allow us to say that microfinance has now become a good business under the cover of financial inclusion. Because of unprecedented higher growth in the unsecured loans, RBI has increased the risk provisioning on unsecured retail lending from 100 to 125 % for NBFCs and banks on 16 November 2023, though it will exclude the housing, education and vehicle loans (RBI 2023)

Challenges and concern

First, it is a matter of satisfaction that MF through NBFC-MFIs have penetrated credit to low-income people, especially women (98%) in remote areas who still do not have access to low-interest bank loans. But, MF penetration is highly skewed towards Southern (32%) and Eastern Regions (28%) compared to Northern (9%), Western (9%), and Northeast (3%) regions. It is a matter of concern. The second area of concern is the lack of comprehensive data on indebtedness from Credit Information Companies because the SHG lending of about Rs2 lakh crore is not being captured as it overlaps in some families which impacts the proper assessment of loan proposals. Third, MFIs especially the smaller ones have high borrowing costs and they may be justified in charging higher interest but the CB banks with about half the financial costs than MFIs, are also financing MFs at the same rate. It is suggested that the CBs may play the role in moderating the rate of interest on the MF. Good financial results of banks and NBFCs also indicate scope for reducing the interest rate wherein the banks should take a lead.

References

• RBI (2022): Master Directions- RBI (Regulatory Framework for Microfinance loans) Directions, 2022. RBI/DOPR/2021-22/89 dated 14 March.
• — (2023b): Regulatory Measures towards Consumer Credit and Bank Credit to NBFCs. RBI/2023-24/85 dated 16 November.
• Sa-Dhan (2023a): Agenda Notes of Sa-Dhan National conference on 8 & 9th November, The Asoka Hotel New Delhi; pp.
• —(2023 b): The Bharat microfinance Report 2023 supported by National Bank for Agriculture and Rural Development, November, pp. Xxiv +212
• Sangwan SS (2013): A Comparative Study on Implementation and Impact of microfinance through SHGs in Himachal Pradesh and Haryana, Study Series SBI Chair Chandigarh No-1, Centre for Research in Rural and Industrial Development, Chandigarh. August, pp. ix+105.
• —(2002): Self Help Groups in Karnal, Gurgaon and Bhiwani Districts of Haryana- An Ex-post Evaluation Study by NABARD, Regional Office, Chandigarh, September

(Author: Dr Sher Singh Sangwan, Former Professor SBI CRRID Chandigarh
and GM NABARD)