The Reserve Bank of India (RBI) on Monday allowed microfinance lenders to fix interest rates on loans with a rider that those should not be usurious for the borrowers.

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A microfinance loan is defined as a collateral-free loan given to a household having an annual income of up to Rs 3 lakh.

Each regulated entity (RE) should put in place a board-approved policy regarding pricing of microfinance loans, said the 'Master Direction, Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022'.

In the past, the central bank used to announce the rates on quarterly basis.

"Interest rates and other charges/ fees on microfinance loans should not be usurious. These shall be subjected to supervisory scrutiny by the Reserve Bank," it said.

Also, each RE has to disclose pricing-related information to a prospective borrower in a standardised simplified factsheet.

"Any fees to be charged to the microfinance borrower by the RE and/ or its partner/agent shall be explicitly disclosed in the factsheet. The borrower shall not be charged any amount which is not explicitly mentioned in the factsheet," it added.

The directions will come into force from April 1.

Further, there should be no pre-payment penalty on microfinance loans.

"Penalty, if any, for delayed payment shall be applied on the overdue amount and not on the entire loan amount," the RBI said.

Regarding limit on loan repayment obligations of a household, it said each RE should have a board-approved policy regarding the limit on the outflows on account of repayment of monthly loan obligations of a household as a percentage of the monthly household income.

"This shall be subject to a limit of maximum 50 per cent of the monthly household income," it said.

There should also be a standard form of loan agreement for microfinance loans in a language understood by the borrower.

Under the earlier guidelines, an NBFC that does not qualify as a non-banking financial company - microfinance institution (NBFC-MFI), cannot extend microfinance loans exceeding 10 percent of its total assets.

The maximum limit on microfinance loans for such NBFCs (NBFCs other than NBFC-MFIs) now stands revised at 25 percent of the total assets.

In December 2021, RBI had fixed the applicable average base rate to be charged by NBFC-MFIs to their borrowers for the quarter beginning January 1, 2022 at 7.89 percent.

MFIN, the association for microfinance entities has welcomed the harmonised regulations for the sector announced by RBI.

Commenting on the regulation, Alok Misra, CEO and Director, MFIN said the harmonised regulations will usher in a new era/beginning for the microfinance sector where a common regulatory framework will be applicable to all REs of RBI.

"Besides creating a level playing field, the framework will address issues of over indebtedness and multiple lending which were of paramount concerns for the sector," Misra said.

Udaya Kumar Hebbar, MD and CEO at CreditAccess Grameen said the revision of the income cap to Rs 3 lakh will expand the market opportunity and interest rate cap removal will promote risk-based underwriting.

"This reflects the confidence shown by the central bank in the ability of MFIs to responsibly cater to the bottom of the pyramid," Hebbar said.