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Indian Interest Rate Caps and Transparency

Published on February 19, 2010

by Noah Simpson

According to a recent report by MicroCapital, a new bill introduced in the Indian parliament would remove the existing cap on microloan interest rates. This has important implications for transparency, and provides a unique opportunity to examine the effects of rate caps on microfinance.

Setting an interest rate cap has been advocated as a means of client protection, but often it can end up harming those it seeks to protect. Due to the higher interest rates that are traditionally associated with smaller loans, the poorest clients who seek these loans often are left without access to credit when interest rate caps are implemented. This is because the smallest microloans become less appealing to MFIs seeking financial sustainability. In other words, MFIs have trouble affording smaller loans when the cap on rates is set below the interest rate needed to make those loan products sustainable. Efficiency and market penetration have been shown to decrease in the presence of loan rate caps (see a presentation by CGAP’s Richard Rosenberg on this topic here), and the poorest people bare the brunt of this problem. In addition, pricing often becomes less transparent in the presence of these caps because MFIs often add-on additional fees and charges to attempt to achieve sustainable products. Thus, despite noble intentions interest rate caps contribute to unhealthy microfinance markets.

 

India’s movement to abolish its rate cap should be encouraged for these very reasons. However, issues regarding transparency extend beyond pricing caps, and accountability is extremely important in any market. According to MicroCapital’s report, the Indian regulatory body would still closely monitor interest rates and advise MFIs to keep rates low under the new law. In cases such as this, MFTransparency has a unique opportunity to work alongside governments such as India’s who recognize the importance of transparent pricing. MFTransparency presents a way to provide accountability for interest rates without imposing a cap. By focusing on transparency and improved education, the efficiency and market penetration that interest rate caps hinder can be maintained while simultaneously encouraging consumer protection. As the bill in India moves toward eventual approval, we hope that the Indian government will continue to nurture the microfinance industry in their country by encouraging transparent pricing and embracing healthy competition. We look forward to working closely with the government and all microfinance stakeholders as we launch our work in India.

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