Microfinance industry is better at monetary transmission??

This is an interesting piece of news. Banks have not lowered policy rates following rate cuts by Indian central bank. This has hindered further rate cuts leading to this evergreen friction between government, central bank, banks and companies.

However, one part of banking industry is transmitting rate cuts faster  – MFIs:

Lessons learned by the industry from the events about five years ago, leading to near collapse of the industry, are new being manifested by a flurry of volunteer interest rates cut. In October 2010, followed by a regime of unregulated interest rates and coercive recovery practices, the microfinance industry was subjected severe regulatory retribution. 

Now, following cuts by banks, the microfinance institution network (MFIN), the representative body of MFIs, has advised its members to reduce interest rates by at least 25 basis points by the end of September.  

In June this year, SKS had reduced interest rates by 155 basis points on account of better operational performance and lower cost of funds. The company reduced interest rates from 23.55 per cent to 22 per cent with effect from 1 July. Another mid-sized MFI, Arohan, announced reduction of interest rate by 55 basis points with effect from 20th July to 25.70 percent on its flagship product, Saral. Bangalore-based Ujjivan Financial Services, recently reduced its interest rates on group loans by 60 basis points to 23 per cent, effective August 10th, 2015.  This month, Equitas Microfinance, reduced its interest rates by 100 basis points to nearly 22 per cent. Earlier, in June Equitas had reduced its interest rates by 50 basis points.  

By September, we expect most of the MFIs to reduce interest rates. The rate cut has been due to twin factors of fall in cost of funds and operational efficiency. Also, as MFIs grow, they are getting more credit trustworthy and are being also upgraded by rating agencies. This apart, economies of scale has helped reduced the cost of operations, which has led to an overall reduction in interest rates,” said  Manoj Kumar Nambiar, president, MFIN.

“We made a series on interest rates cuts after started reducing repo rate. Also, the overall cost of funds have come down due to operational efficiency,” said Samit Ghosh, founder and Managing Director, Ujjivan.

The slew of interest rates cut come on the backdrop of last year’s RBI regulation, which linked lending rates to cost of funds. Last year, RBI had removed interest rate cap of 26 per cent on loans given by microfinance companies. Under the new rules, for large MFIs (with a portfolio of more than Rs 100 crore or more), the lending rate should be calculated on the basis of cost of funds, plus 10 per cent margin, while for other MFIs , the margin was kept at 12 per cent.

“In March we reduced interest rates to neatly 24.1 per cent. We will progressively keep reducing interest rates, as and when cost of funds comes down. There has been a reduction in interest rates from banks, but the process is little slow,” said V S Radhakrishnan, managing director and CEO of Janalakshmi Financial Services.

Hmm. Perhaps, the earlier clean up helped MFIs transmit rate cuts faster this time. But how come some MFIs cutting rates more than the magnitude of policy rates?

Banking transmission literature usually suggests that it is small banks/small financial players which are quicker compared to bigger players. As policy rates ease, large banks are able to adjust their asset side by just playing on the investment portfolio. So easier policy  which leads to cheaper and more infusion of funds in large banks first finds its way into investments. It is only gradually the impact is seen on credit/loan book and only when the easier policy is expected to last for sometime. If central bank just pauses after few eases, banks do not want to be caught easing too much.

Whereas small players do not have such choice. Their investment books are usually small/negligible. So the onus falls on the loan/credit book which takes the hit right away.  So in line with what economic literature has been saying.

Need to look at the details though.

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