Loans to the underprivileged are a lucrative and fast-growing business for India’s financiers. Citi Financial Services, for instance, has opened hundreds of new branches to grab this market. Its officials say they sanction loans of up to Rs 50,000 within 48 hours with minimal checks and documentation. The high growth rate of this market segment indicates booming demand, although there is little transparency on interest rates and other charges.
But the RBI is clearly worried. The latest credit policy statement says that banking ombudsmen have been “receiving several complaints about excessive interest rates and charges on certain loans and advances”. The RBI warns that “although interest rates have been deregulated, rates beyond a certain level may be seen to be usurious and can neither be sustainable nor in conformity with normal banking prudence”. It has asked the boards of banks to lay down internal guidelines, principles and procedures to ensure that usurious interest rates are not charged.
What exactly does it mean? The RBI is concerned that the effective interest rate on loans of upto Rs 50,000 is as high as 48-55% per annum. Those classified as high-risk or sub-prime borrowers are charged a flat rate of about 25%, which translates to an effective rate of around 33% on a diminishing basis. Banks then load on a variety of administrative and service charges to pump up their returns even higher.
Yet, this business is clearly booming, and bankers could well argue that although the rates seem usurious, they are providing funds at lower cost than the average moneylender, with less risk of being bashed up by moneylenders’ goons at the first sign of possible default. It is not that banks do not use strong-arm tactics, but there is a subtle difference in the kind of recovery personnel used. Bankers say that the RBI has been agitated about usurious rates for a while, and a couple of banks—HSBC and ICICI Bank—were even persuaded to reduce their lending rates to this segment.
Putting an end to usurious rates is not going to be as simple as asking banks to lay down internal guidelines, policies and procedures. The RBI has to ensure that its rules and policies apply uniformly across the financial sector. It can certainly persuade banks to lower interest rates and administrative charges, but there is little it can do about non-banking financial companies (NBFCs) like Citi Financial or India Bulls that have both the financial muscle and the operational freedom to grow even faster than banks.
Putting an end to usurious rates is not going to be as simple as asking banks to lay down internal guidelines, policies and procedures. The RBI has to ensure that its rules and policies apply uniformly
Logically, it may be argued that banks could indeed lower interest rates and make up their profits through larger borrowing volumes. But banks, in turn, could justify exorbitant rates by arguing that they cater to a riskier segment. Many borrowers are small-time vendors and traders, who are using bank services for the first time. They are being given an opportunity to generate a credit history for future borrowings if they are able to establish their financial discipline.
Interestingly, the high cost of financial services for the poor seems to be a global phenomenon. A study titled, The High Cost of Being Poor in the District of Columbia: Financial Products and Services, by the Center for Responsible Lending and the Urban Institute, came to the conclusion that low-income households in the District of Columbia pay higher prices than more affluent households for the same basic goods and services. Minority populations are among the worst-hit by these cost inequities, which are further exacerbated by disparities in the quality and range of goods and services available to the underprivileged. The ‘poverty premium’ is most striking in the financial services sector, where the absence of reasonably priced products forces poor households to rely on ‘alternative’ financial services on terms that may horrify the well-off.
The Washington DC Attorney General wants legislation to protect these consumers in the US. The RBI seems to be thinking along the same lines, but it needs to level the field between banks and NBFCs first.