Page 11 - Banking Finance October 2020

RBI CORNER

"You can think of lower ERP as inves- these companies struggling with high cost of funds plus 12 percent for
tors assigning higher valuations, that is, cost of funds. smaller MFIs from their borrowers and
Price to Earnings (PE) multiples to MFIs are institutions that source funds cost of funds plus 10 percent for big-
stocks rather than their earnings going from banks and then lend to smaller ger MFIs. This was later changed to
up. Therein lies the risk. Stock prices base rate formula.
borrowers. While bigger MFIs get
are being driven by investor confi-
cheaper loans from banks, smaller ones Typically, the central bank on the last
dence rather than earnings," said Vikas
with a lower rating typically pay more working day of every quarter, sets the
Gupta, founder, Omniscience Capital,
at around 16-18 percent. rate for the next three months taking
a SEBI Registered Investment Advisory an average of the base rates of the
Presently, the RBI sets the base rate
firm. country's five largest commercial
that NBFC-MFIs can charge to their
"With an ERP of 4.7% and a risk free borrowers on a quarterly basis. Accord- banks.
rate of 5.9% (based on the current 10 ing to this, the interest rates charged For the quarter beginning October 1,
yr G-Sec yield), the long term return on
by an NBFC-MFI will be lower of the the RBI has set the average base rate
Indian equities is 10.6%. If you consider cost of funds plus margin or the aver- at 8.12 percent to be charged from
the effect of long term capital gains
age base rate of the five largest com- borrowers by NBFCs-MFIs. This means
tax, it falls further to around 9.5%,"
mercial banks by assets multiplied by they can charge only upto 22.33 per-
said Ravi Saraogi, founder, Samasthiti 2.75. Going by this, MFIs can only cent from borrowers. But, smaller
Advisors, a SEBI Registered Invest- charge upto 22-23 percent to their NBFC-MFIs get money at 16-18 per-
ment Advisor. borrowers, which constraints their cent from banks. And they can lend to
The paper also highlights the discon- margins. borrowers only staying within the in-
nect between stock prices and the real The RBI introduced the base rate sys- terest rate cap.
economy.
tem to bring in more transparency in According to Dayal, around 130 MFIs
"The regression results suggest that the interest-rate setting process. Base with loan book less than Rs 100 crore
while the increase in ERP assumes sig- rate is the minimum rate at which lend- rely on NBFCs for more than 75 per
nificance in explaining the dependent ing institutions can give loans. They cent of their funding at a higher rate
variables, that is, IIP and GDP, de- typically charge other components (16-18 percent) compared with bigger
crease in ERP is insignificant in line above the base rate to arrive at the MFIs which get money at 12-14 per-
with the economic theories. This is final lending rate. cent.
largely consistent with the divergence
MFIs want the RBI to either widen the As against this, larger MFIs borrow
between real economy and market
basket from five banks currently includ- from big commercial banks. Banks typi-
observed in 2019 wherein ERP stayed
ing small finance banks (SFBs) or bring cally do not lend to smaller, low-rated
low contributing to surge in equity back the old formula of cost of funds MFIs due to high risk aversion. This
markets to record-highs and GDP plus margins removing the interest makes average base rate of five large
growth stayed muted. Overall, while rate cap. banks irrelevant for smaller MFIs.
the ERP has stayed below 4 percent
levels since 2016, real GDP growth has "We have requested RBI to include "The smaller MFIs play a key role in
remained below 2016 level which was SFBs also while calculating the base promoting financial inclusion. The cur-
8.7 per cent," the paper adds. rate to make the base rate more re- rent high cost of funds make their busi-
flective of the cost of funds," said ness unsustainable. If these entities fail,
MFIs write to RBI seeking Somesh Dayal, Associate Director at borrowers will be pushed back to the
one of the microlenders' industry body, hands of moneylenders," said Dayal.
change in base rate calcu- Sa-Dhan, to Moneycontrol. By includ- Sa-Dhan has highlighted that how
lation ing the base rate of SFBs, the final av- these MFIs have to primarily rely on
erage base rate for MFIs will be more
Microlenders have asked the RBI to NBFCs for their lending, borrowing at
change the way base rate is calculated realistic, reflecting their cost of bor- rate of 16-18 per cent, the pricing cap
rowing, said Dayal.
for smaller microfinance institutions of 2.75 times the base rate of the five
(MFIs) to make business viable for Earlier, the RBI allowed MFIs to charge largest commercial banks severely

BANKING FINANCE | OCTOBER | 2020 | 11