RBI’s new directions to MFIs pose risk of over-leveraging: Icra

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NEW DELHI – The Reserve Bank of India’s decision on Monday to do away with limits on the pricing of small loans disbursed by the non-banking finance companies and microfinance institutions poses a risk of over-leveraging, rating agency ICRA said.

The RBI’s master directions on the regulatory framework for microfinance are aimed at providing a level playing field to all entities involved in microfinance businesses and build upon a consultation paper issued in June 2021.

According to the norms, the process of underwriting loans will be carried out on an analysis of risk, and in line with the same, a risk premium would be charged from the borrower. The revised framework is applicable from April 1.

The regulated entities which fall under the purview of the RBI’s norms include NBFC-MFIs, scheduled commercial banks (SCBs), small finance banks (SFBs), NBFC–investment and credit companies (NBFC-ICCs) and others.

“The regulator has enhanced the annual household income threshold than what was proposed in consultation paper in June 2021 and this could increase the maximum permissible indebtedness limit of borrowers than current level,” Vice-President and Sector Head, Financial Sector, ICRA Sachin Sachdeva said.

“In addition, RBI has removed cap on the number of NBFC-MFIs who can provide loans to a microfinance borrower. Instead, it has focused on borrowers’ repayment capacity and accordingly capped the fixed obligation to income ratio (FOIR) at 50%.”

Even as the limit on the fixed obligation to income ratio would act as a safeguard against excessive leveraging, the increased permissible debt limit and divergences in household income assessment criteria across lender still pose risks, the rating agency said, adding that the maximum permissible debt limit stands to rise significantly from the current levels of Rs 1.25 lakh.

“Assuming tenure of 24 months and interest rate of 22% p.a., the maximum permissible household-level loan comes to around Rs. 2.40 lakh,” Sachdeva said.

Furthermore, the ceiling on interest rates had been essentially functioning as the interest rate in the industry for all players and the removal of this rate may lead to players engaging in competition when it comes to pricing of loans, benefiting borrowers in the long term, ICRA said.

The rating agency noted, however, that low elasticity of interest rates in the sector and a likely moderation in profitability emanating from hit to businesses from the COVID crisis could result in a rise in interest rates over the near term.

“Though NBFC-MFIs will enjoy more flexibility, they will have to put in place board-approved policies on household income assessment, loan pricing regulations and other related aspects,” Sachdeva said.

“In addition, increased data gathering, comprehensive credit bureau checks and enhanced disclosure requirements may slightly increase the operating costs.”

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