35 % interest rate cap on Lanka’s microfinance industry

The Central Bank ( CB) has introduced a maximum rate of interest for microfinance loans with the aim of protecting customers from being charged exorbitant interest rates on microfinance loans granted by Licensed Finance Companies (LFCs).

LFCs are barred from charging a rate exceeding 35 per cent per annum inclusive of all other charges on micro- finance loans, a directive issued by the CB under the Finance Business Act revealed recently.

Microfinance and finance companies have agreed to cap annual interest rates at 35 per cent for all new loans, a senior Central Bank official told the Business Times.

However several CEOs of LFCs noted that this directive will increase operational cost of companies adding that their human resources will need to be cut down, negatively affecting all the families dependent on them.

Capping the interest rate will also affect the cash flow of LFCs from small loans, which comprise a large percentage of their loan portfolio, they added.

There is an estimated Rs. 140 billion of loans below Rs. 100,000 from finance companies to small borrowers in all districts not counting unregulated micro-lenders, according to Finance Ministry’s latest statistics.

This latest cap on interest will compel many finance companies to stop offering small loans; rural areas will miss out billions of rupees in money circulation a year, and the rural poor will be forced to turn to moneylenders who charge far more than micro finance institutions, they claimed.

At least a rate of 40 per cent interest is required, they said pointing out that LFCs pay massive amounts of taxes to the government and when income levels fall, payable tax amount will also decrease and affect the government’s tax revenue, they warned.

LFCs collect money from customers in the form of Savings/ FDs and this money is invested in the form of loans, a CEO of a leading finance company explained.

On the other hand, he noted that the LFCs take in customer savings at a much higher rate than banks and hence it’s almost impossible to manage their cost of funds at the current rate imposed by the Central Bank.

The interest cap is expected to lead to a reduction in the number of loans provided by microfinance institutions to low- income earners; he said adding that, higher rates are essential to offset the risks of lending to the poorest of the poor.