Borrowers benefit of MFI competition

Saturday, August 11, 2007

Finally, this is one news that will make the man on the street happy. In an era of rising interest rates, microfinance institutions have decided to absorb the higher cost of funds themselves, thanks to competition.

Some banks, particularly state-owned ones, who lend directly to the borrower, have not passed on the higher costs since they feel that these portfolios are too small to impact their balance sheets.

Microfinance institutions (MFIs) rely upon the private sector and multinational banks for their loans. Interest rates on loans from these banks to MFIs have risen from 9-10% to more than 13-14% in the past few months. A tight liquidity situation forced most to raise deposits at higher costs (two-digit interest rates), which has led to their net interest margins coming under severe pressure.

A senior official of a multinational bank said, ?The main reason why MFIs have not been able to pass on the rising costs is that most of them have disbursed loans based on fixed terms and conditions. There is a fixed tenure, in most cases, a year or so. Hence, when there are surprise rate hikes during the year, they are unable to pass on the cost immediately.?

?So, there is a probability that when these MFIs reset their terms next year, they would hike the lending rates for fresh borrowers, sparing the existing clientele,? he added.

The other reason being that a rise in interest rates on small-ticket loans would hike the equated instalments and impact their repayment schedules. MFIs argue that customers seldom understand these mechanics when rates are hiked and they are told to cough up an additional amount during repayment. Thus, MFIs are looking for other ways to reduce costs, such as increasing the number of borrowers under a single loan officer or slowing down their expansion plans.

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Source: The Economic Times, India (link opens in a new window)