A few weeks ago M-CRIL, an Indian microfinance ratings firm, published a white paper on India's evolving microfinance regulations. The overall message is that while the proposed regulatory framework is improving, it still needs work. One particular point caught my eye:
"The prevailing pricing regime – average cost of funds plus a margin cap – penalizes those MFIs that incur a high cost due to their commitment to responsible finance as well as those who are innovative in raising funds at low cost. Those that do both suffer a double 'whammy'."
While there is widespread agreement around the world that people should be protected from usurious interest rates on loans, there is little consensus on how to determine, and enforce, a cap on interest rates charged to the poor. The debate is as hot in the US (where it's fought over credit card and payday lending rates) as it is in India, Nicaragua and Bangladesh.
M-CRIL points out that one of the obvious ways of setting a cap on interest rates--a margin above the cost of capital--can be both hard to determine and have unexpected adverse effects. Specifically the cap proposed will force large MFIs to hold their operating costs below 8.5 percent. When you take into account that operating costs includes things like loan officer training, borrower qualification, and any coaching of or capacity building for clients, margin caps may have the unintended effect of pushing institutions committed to high-touch, supportive relationships with borrowers out of the market. There is no relief from concessional capital from social investors either. The lower cost of capital gets passed along to borrowers with no oppotunity for the MFI to invest more directly in their operations or borrowers.
This isn't just idle speculation from M-CRIL. In a study of the effects of regulation, FAI's Jonathan Morduch looks at how increasing regulatory costs affects MFIs' behavior. In summary, higher costs push for-profit MFIs to compensate by pursuing higher profit and less poor clients; non-profit MFIs maintain their outreach to the poorer households but have to scale back outreach.
But it's not just a one-way street. In another recent paper, Jonathan takes a look at how an MFIs ability to raise and cost of capital is affected by who they choose to serve and how they are structured. Non-profit MFIs who choose to serve poorer clients pay much higher costs in terms of debt-to-equity ratio than for-profit MFIs who have moved up the income ladder. Here's a quick summary from the paper:
The net effect is a recursive feedback loop from regulation to borrowers and back that can quickly amplify adverse effects. These are tricky trade-offs which are not easy to make. Hopefully the Reserve Bank of India will continue to consider the effects of particular regulations and tweak them over time to manage these tradeoffs.