As the government seeks to reform the microfinance sector, which has long been plagued by irregularities and high interest rates, a crucial question has emerged: should lending rates of microfinance banks be capped? The newly promulgated Microfinance Bank Ordinance proposes transforming eligible microfinance institutions into specialised banks operating under a social business model. Under this framework, dividends for investors would be capped at the level of their total investment, while profits beyond capital recovery would be reinvested for social purposes. The ordinance states that the banks' primary objective would be to create new entrepreneurs by providing loans with or without collateral, and thereby to support job creation and poverty reduction. A critical issue, however, remains conspicuously absent from the ordinance: the interest rates these microfinance banks will be allowed to charge.
On this point, the Financial Institutions Division (FID) under the Ministry of Finance is in favour of capping lending rates of microfinance banks in line with commercial banks. Some economists, however, propose that interest rates should be left to market competition, arguing that borrowers' freedom to choose lenders will compel banks to offer loan at competitive rates. However, if past experience of microcredit operation in Bangladesh is anything to go by, giving a free rein to micro lenders can be tricky. Microfinance Institutions (MFIs) once used to charge borrowers 30-40 per cent interest. Then in the face of widespread backlash and international criticism, the Microcredit Regulatory Authority (MRA) was formed in 2006. The MRA capped microcredit interest rate at 27 per cent in 2010. Later in 2019, the MRA further lowered it to 24 per cent, which is effective till to date. Critics argue that the existing interest rate is still excessively high, particularly because the effective interest rate often rises well beyond the stated cap due to compound interest, where borrowers end up paying interest on accrued interest. Considering this, the FID's move to cap interest rates of microfinance banks and push for the introduction of a simple interest system in place of compound interest is welcome.
The current rate of interest rate on microcredit is disturbing for several reasons. First, there is a clear issue of disparity. Whereas the wealthier sections of society can borrow from commercial banks at interest rates of around 12 per cent, it is unacceptable that the poor microcredit borrowers are required to pay more than twice that rate. Then, the repayment on loans starts from the very first week, which gives borrowers almost no time to establish an income-earning enterprise. To cover the instalments of first few weeks, borrowers often have to resort to taking out a further loan from a different NGO. Thus, much of the repayment of the loan is in fact a fresh loan in disguise, contracted from other agencies to pay off the old debt and save the borrower from default. Thus in many cases the recipients far from getting enriched find themselves stuck in a vicious cycle. To free themselves from this trap, many of them end up selling their cows, farmlands and homesteads. In worst case scenarios, many even commit suicide.
Ideally, the primary objective of microcredit is poverty eradication. In practice, however, it has become a lucrative business for some NGOs, trading on poverty and exploiting the poor. Only time will tell whether the government's move to establish microfinance banks can turn the tide and stop the exploitation of the poor.
