Micro Financing Business vs Ceiling on Interest Rates
1. NBFC-MFI
As per the Reserve Bank of India’s definition, an NBFC-MFI is a non-deposit taking NBFC (other than a company licensed under Section 25 of the Indian Companies Act, 1956) that fulfills the following conditions:
- Minimum Net Owned Funds of Rs.5 crore. (For MFIs that have undergone NBFC incorporation in the North Eastern Region of the country, the minimum NOF requirement shall stand at Rs. 2 crores).
- Not less than 85% of its net assets are in the nature of “qualifying assets”.
All companies, thus, seeking NBFC registration as NBFC-MFIs must not have less than 85% of its net assets as “qualifying assets”.
Ceiling on Interest Rates of NBFC-MFIs
Prior to April 1, 2014, there was an interest rate cap of 26% on loans given by MFIs that have successfully undergone the NBFC incorporation procedure. This capping was removed by the Reserve Bank of India which regulates microfinance companies and linked the interest rate to the cost of funds, providing a greater leeway to the lenders from April 1, 2014.
A notification on February 7, 2014, by the RBI, addressed as ‘Non-Banking Financial Company-Micro Finance Institutions’ (NBFC-MFIs) – Directions – Modifications in “Pricing of Credit” was published.
This notification stated that:-
On a review, it has been decided that the interest rates charged by an NBFC-MFI to its borrowers will be the lower of the following:
(a) The average base rate of five largest commercial banks multiplied by 2.75 per annum.
(b) Cost of funds plus margin cap of 10% for MFIs having loan portfolio above 100 crores and 12% for those with loan portfolio less than 100 crores.
RBI further clarified that the Reserve Bank shall declare the average of the base rates of the five largest commercial banks on the last working day of the previous quarter, which shall determine interest rates for the ensuing quarter.
2. Nidhi Company
A Nidhi company is an NBFC registered under Section 406 of Companies Act, 2013.
“Nidhi” means a company which has successfully undergone the NBFC incorporation procedure with the objective of cultivating the habit of thrift and savings amongst its members, receiving deposits from, and lending to, its members only, for their mutual benefit.
The deposits, thus, gathered are then used for its members or shareholders and the company provides loans or advances, and acquires government-issued stocks, bonds, debentures, securities, etc.
All Nidhi companies after NBFC registration are regulated by the Ministry of Corporate Affairs and all its financial dealings are monitored by the RBI.
Ceiling on Interest Rates of Nidhi Company
Rate of Interest on Deposits
Nidhi companies accept three types of Deposits and the rate of interest on all of them varies and are mentioned below:
1) Fixed Deposit
For fixed deposits the rate of interest being offered by a Nidhi company shall not exceed the maximum rate of interest prescribed by the Reserve Bank of India which the NBFCs can pay on their public deposits. The maximum rate of interest prescribed by RBI for an NBFC is 12.5% and going by this norm, the interest rate that can be offered by Nidhi Companies on fixed deposits cannot exceed 12.5%.
2) Recurring Deposit
When it comes to recurring deposit or monthly income scheme offered by the Nidhi companies, the rate of interest offered shall not exceed the maximum rate of interest prescribed by the Reserve Bank of India.
The RBI mandates that such companies can pay a maximum of 12.5% as the rate of interest and not beyond.
3) Saving Deposit
In case of savings deposits, a Nidhi company shall not offer a rate of interest exceeding 2% above the rate payable by nationalized banks on savings accounts. All NBFC registered Nidhi companies are bound to comply by this capping. For example if the current rate of interest offered by all nationalized banks ranges somewhere between 3-4% then accordingly, the Nidhi Company can offer an interest rate up to 6% and not beyond that.
Rate of Interest on Loans
A Nidhi company has to follow the RBI norm regarding interest rates to be charged on loans and accordingly it is specified that the rate of interest to be charged on any loan given shall not exceed 7.5% above the highest rate of interest offered on deposits. Thus, in case a Nidhi Company is offering 7% rate of interest on fixed deposit and recurring deposit and also 5% on savings, then the maximum interest that the said Company can charge shall be up to 14.5% on loans given by it.
Other Important Points:
The rate of interest on loans given by Nidhi companies shall be charged on reducing balance method only.
A Nidhi company shall make no discrimination and charge the same rate of interest in respect of the same class of loans.
A Nidhi company shall prominently display on its notice board at the registered office and each of its branch office (if any), the rates of interest of all classes of loans.
All Nidhi companies shall disclose the rate of interest being offered by them in the application form of the deposit.
A depositor who puts up a request to a Nidhi company to repay any deposit after a period of three months then he/she shall not be entitled to any interest up to six months from the date of deposit.
In case at the request of the depositor if a Nidhi company re-pays the deposit amount before the expiry of the period for which it has been accepted, then in that case the rate of interest shall be reduced by 2% from which the Nidhi would have been ordinarily paid.
However, in an instance of the death of a depositor, the amount deposited shall be paid to the legal heir, nominee or surviving joint deposit holder along with the rate of interest without any deduction in the interest amount.
3. NBFC-ND
Non Banking Financial Companies require NBFC registration and beyond that are categorized as either deposit taking or non-deposit taking. If an NBFC falls in the category of non-deposit taking, then ND is suffixed to their name (NBFC-ND). Further, the NBFCs which have asset size of Rs.100 Crore or more are called as Systemically Important NBFCs. These have been classified so because they can have bearing on financial stability of the country. Again the Non-deposit taking NBFCs under this category are denoted as NBFC-NDSI.
All NBFC-ND companies are mandatorily required to undergo NBFC registration before starting any related functions.
Ceiling on Interest Rates of NBFC-ND
The RBI has deregulated interest rates that the NBFCs can charge, other than NBFC– Micro Finance Institutions and therefore, such companies are free to set their own rates.
The rate of interest to be charged by the company is governed by the terms and conditions of the loan agreement entered into between the borrower and the NBFCs.
The interest rate charged to the borrowers is calculated based on varied parameters like:
- Prevailing Interest rate trends in the money market
- Risk profile of the borrower
- Cost of borrowing funds – Internal as well as external
- Tenure of the Loan
- Credit and default risk in the related business segment
4. Micro Finance Company-Section 8 Company
A Section 8 Company is so called because they get recognition under Section 8 of the Companies Act, 2013. Section 8 companies do not have the objective of making profits by carrying out trade and commerce but rather primarily have charitable and non-profit intentions. Thus, these companies which have undergone NBFC incorporation procedure, dedicate all their income and profit towards the furtherance of these objectives.
The Companies Act defines a Section 8 company as a non-profit organization which works with the objective to promote any of these- education, arts, sports, commerce, science, research, charity, social welfare, religion, environment protection or other similar objectives. Thus, these companies after successful NBFC incorporation utilize their profits towards the betterment of their cause and do not pay any dividend to their members.
Ceiling on Interest Rates of Section 8 Company
Section 8 Companies can carry out microfinance activities, subject to compliance of applicable RBI Act, guidelines and directions, and also that the microfinance activities should be for the promotion of activities as stated in section 8(1) (a) of the Companies Act, 2013.
The interest rate that a Section 8 company can charge must be the lower of the following:
(a) The average base rate of five largest commercial banks multiplied by 2.75 per annum.
(b) Cost of funds plus margin cap of 10% for MFIs having loan portfolio above 100 crore and 12% for those with loan portfolio less than 100 crore.
Registration Through Section 8
Compared to NBFC-MFI, the requirements for registration of a section 8 Company and applying for a central government license is quite simple.
Requirements for Registration Under Section 8
Maximum INR 50,000 can be given for the business purpose and INR 125,000 for the residential dwelling.
- No minimum net owned fund requirement.
- No RBI approval is required since RBI has exempted such companies from registration.
5. Multistate Co-operative Societies
An NBFC registration of a Cooperative Society is done as that of an autonomous association of people united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly owned and democratically controlled business. Thus, cooperatives cannot accept deposits from the general public but are only permitted to do so through their members.
When cooperatives and microfinance go hand in hand and are managed well, as registered under microfinance company registration, then they render help and power to the neediest and help improve their lives.
Cooperatives seeking micro finance company registration are to be done under the conventional state-level cooperative acts, the national level Multi-State Cooperative Societies Act (MSCA 2002), or under the new State-level Mutually Aided Cooperative Societies Act (MACS Act).
Ceiling on Interest Rates of Co-operative Societies
Such Co-operative Societies are not bound by the RBI’s regulations regarding the interest rates and thus, they are free to set their own rates. The rates are therefore, decided and approved by the Board of Directors of the Co-operative Societies.
Importance of MFIs in Modern India
Microfinance, which is also called microcredit, is a branch of financial services that helps to provide capital access to small business owners, entrepreneurs and individuals. These small and individual businesses generally lack access to traditional financial resources like banks and other major institutions, and thus, all related services. This made it difficult for them to access loans, insurance, and investments- things that are needed to grow their business.
In short, microfinance business means dealing with providing small business owners, entrepreneurs and individuals varied financial services like loans, credit, and access to savings accounts, insurance policies and money transfers.
All entities that are desirous of starting any microfinance business are mandatorily required to undergo the process of NBFC registration.
Salient Features Of Micro-Finance Business
Following are the key features of Micro-finance Businesses:
- The borrowers mostly belong to low income backgrounds.
- Loans availed under microfinance are usually micro loans, i.e., small amounts.
- The tenure of a loan is short.
- Microfinance loans are given without any collateral.
- These loans are to be repaid more frequently.
The entities providing microfinance facilities in India must have NBFC registration and also registered with appropriate agencies and obtain necessary licenses and permits.
Micro Finance Business Benefits
The unique 360-degree lending management solution allows microfinance lenders to access the huge untapped sector of the Indian economy without any need for manual intervention, excessive paper load and massive wait times.
The Government of India and the Reserve Bank of India has created a conducive policy framework for Microfinance Institutions (MFIs) to provide necessary legitimacy and impetus to the sector.
There are numerous advantages of Micro Finance Business but some of the prominent benefits are:
- Provides access to funding.
- Encourages self-sufficiency and entrepreneurship.
- It offers a better overall loan repayment rate than traditional banking products.
- Strengthens financial condition for some days till the situation gets better.
- Helps in meeting credit needs of economically weak people.
- Services range from emergency loans, consumption loans, business loan, working capital loan, housing loan, etc.
It was rightly said by Ralph Waldo Emerson– “Every Wall is a Door”
Thus, take a step forward to open the door for the new FDI norms.
Shweta Gupta from MUDS MANAGEMENT is recognized among the most-respected, knowledgeable and yes, pocket-friendly as well. Why not give them a call right now at +91 9599653306 and start a conversation immediately.