KOLKOTA: Microfinance institutions (MFIs) and small finance banks operate in a challenging ecosystem where their cost of funds is significantly higher than that of regular banks.
Coupled with elevated operational expenses, this translates to higher lending rates, typically between 21 per cent and 24 per cent annually. Ironically, these high rates are also blamed for the growing delinquencies in the sector, putting MFIs in a potential Catch-22 – a predicament with no easy escape.
At the Eastern India Microfinance Summit in Kolkata on Friday, industry leaders highlighted these issues while urging reforms to break the cycle. They called for dedicated mechanisms like a credit guarantee scheme, refinance facilities, or interest subvention to enable access to cheaper funds.
The cost conundrum
“Given the cost structure, it would be difficult for NBFC-MFIs to reduce rates below 20 per cent,” said Sadaf Sayeed, CEO of Muthoot Microfinance. He advocated for a refinance facility akin to what the National Housing Bank (NHB) offers to the housing finance sector, which provides cheaper funding options.
Partha Pratim Sengupta, managing director of Bandhan Bank, suggested revamping the Credit Guarantee Fund Trust for Micro and Small Enterprises scheme to make it more suitable for the microfinance sector. He also proposed introducing an interest subvention scheme similar to that available for agricultural loans.
Manoj Nambiar, managing director of Arohan Financial Services and chairman of the Microfinance Institutions Network (MFIN), argued that interest rates in microfinance are often misunderstood.
“Many wonder how borrowers manage a 24 per cent interest rate, but they fail to recognise that this rate is calculated on a reducing balance, equating to about 13.5 per cent on a flat-rate basis,” Nambiar explained. He also emphasised that access to credit, not just the rate, is crucial for small borrowers.
Regulatory scrutiny
The microfinance sector, valued at around Rs4 lakh crore (approximately 3 per cent of GDP), serves 85 million borrower families, indirectly benefiting 300 million people. Despite its scale, the sector faces rising defaults, driven by over-lending, over-leveraging, and inadequate household income assessments.
Reserve Bank of India (RBI) deputy general manager Dharmendra R Bagada stressed the importance of responsible lending practices. “This sector deals with the most vulnerable lower-income segments. Sensible lending is non-negotiable,” he said.
Bandhan’s Sengupta urged the industry’s self-regulatory bodies – MFIN and Sa-Dhan – to take ownership of systemic gaps. “Acknowledging the problem is the first step towards resolving it. Deflecting criticism won’t help,” he noted.
The way forward
With the sector under heightened regulatory scrutiny, the need for structural reforms has never been more urgent. Whether it’s through innovative funding mechanisms or improved governance, breaking free from this Catch-22 demands a concerted effort from policymakers, regulators, and industry leaders alike.
