Microfinance gets a boost from recent credit policy

Micro Finance | 16 October 2019

It came as no surprise that the Reserve Bank of India announced a 25-basis-point repo rate cut for the fifth time in a row during its October 2019 Monetary Policy Committee (MPC) meeting.Since the beginning of this calendar year,the central bank has cut the repo rate by a cumulative 135 basis points, bringing it to an eight-year low of 5.15%.

Repo rate cuts since February 2019



This rate reduction was expected for many reasons. To begin with, global economic activity, which was already weak during the August MPC meet of August 2019, has deteriorated further and uncertainty on the international economic landscape has heightened.This led the US Federal Reserve and Central banks in Europe and Japan to consider reducing rates, signalling a dovish global monetary scenario.

At the same time, domestic GDP growth has slumped to 5% in the first quarter of FY2019-20, ended June and indicators of economic activity for the second quarter look rather bleak too.A reduction in interest rates is the most basic prescription for sluggish growth. Fortunately, inflation continued to be within the RBI’s target band, giving the RBI enough leg room to reduce rates yet again.

A concern during the previous MPC meeting was that the transmission of policy rate changes to the lending rate of banks under the current MCLR framework was not satisfactory. This means that although policy rates are falling, those of banks and lenders down the line are not adjusting downwards concomitantly. Accordingly, the RBI made it mandatory for banks to link all their fresh retail loans to an external benchmark, effective October 1, 2019. However, when reviewed during the October 2019 meeting, it was found that monetary transmission continued to remain low. As against the cumulative policy repo rate reduction of 110 bps during February-August 2019, the weighted average lending rate (WALR) on fresh rupee loans of commercial banks declined by only 29 bps.

Ironically, overall liquidity in the system remained in surplus in August and September 2019. This was reflected by the weighted average call rate (WACR) trading below the policy repo rate in August and September 2019.

Perhaps this, and the fact that micro finance institutions (MFIs) play an important role in delivering credit to those in the bottom of the economic pyramid, prompted the RBI to announce a major policy change in that space. Accordingly, the central bank increased the household income limit for borrowers of Non-Banking Financial Company-Micro Finance Institution (NBFC-MFIs) from the current level of ₹ 1.00 lakh for rural areas and ₹ 1.60 lakh for urban/semi urban areas to ₹ 1.25 lakh and ₹ 2.00 lakh, respectively. Furthermore, the lending limit per eligible borrower was raised from ₹ 1 lakh to ₹ 1.25 lakh. These measures are expected to boost MFI lending to the bottom of the economic pyramid.

According to data collated by Equifax, as of June 2019, there were 84 entities in the NBFC-MFI segment with an outstanding loan book of around Rs 57,000 crore. The augmented household income limitfor borrowers will enable a much wider spread of credit through MFIs and could generate fresh economic activity at the base of the economic pyramid, creating a ripple effect on income and consumption too, helped along a little by the impact of a robust monsoon. Hopefully, this will be the shot in the arm that the country requires to bring it back on the high growth track.

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