Interest Rate Loans

BOX 2: Deregulation of Interest rate

Deregulation and Rationalization of interest rate was one of the major objectives of the financial sector reforms initiated in 1990s. In wake of this objective most of the interest rates have been gradually deregulated since mid-1990s. Currently RBI only regulates the Interest rate on Saving Deposits, NRI deposits, Small loans up to Rs. 2Lakh and Export Credit.

Deposit Rates:

Deposit Rate on Small Savings is administered by the RBI because most of these deposits are held by small households in semi urban and rural households. Deposit rate on Small Savings was reduced from 4% to 3.5% p.a in March 2003, since then it has not been changed.

Deposit Rate on NRI deposits: Currently 3 deposits schemes are operational for Non Resident Indians, viz., Foreign Currency Account (Banks) [FCNR(B)], Non-Resident (External) Rupee[ NRE], Non-Resident (ordinary) [NRO]. FCNR(B) scheme allows only for Term Deposits, whereas under NRE & NRO Scheme one can have saving, current, recurring, Fixed Deposits.

The interest on the FCNR(B) and NRE Deposits are subject to a ceiling prescribed by RBI from time to time. The Interest rate on the NRO Account is determined by the banks for fixed deposits and interest rate on the savings deposits is same as domestic saving Bank Deposits.

The ceiling on interest rates on FCNR(B) were linked to Libor/ Swap rates whereas that on NRE used to be at par with the domestic interest rate. In order to maintain consistency in the interest rates offered to NIRs a ceiling on the NRE deposits was prescribed linked to the LIBOR/Swap rate by RBI in 2003-04. Effective from 17 July 2003 a ceiling of LIBOR / Swap rates for the US dollar of corresponding maturity plus a spread of 250 basis point was prescribed by RBI. Since then the ceiling rate prescribed by RBI has been revised a number of times.

Lending Rates:

The lending rates of bank were gradually deregulated since October 1994 and Banks were required to announce a Prime Lending Rate (PLR), which was based on their Cost of Funds and transaction Costs, with approval from their Board of Directors. In April 1999, a system of Tenor linked PLR was adopted by RBI. This provided operational flexibility to the banks. Despite of falling Deposit rate and reduction in banks operational cost the PLR did not show a down trend. Also with existence of multiple PLR pricing of loans became very complex. So to protect bank's customers RBI advised the banks to provide the minimum and maximum interest rate charged alongside their PLRs, effective June 2002. This information was posted on RBI website on a quarterly basis.

In the year 2003-2004 RBI discontinued the policy of Tenor linked PLR and adopted the system of Benchmark PLR (BPLR). The BPLR is calculated taking into account

Actual Cost of Fund

Operating Expenses

A minimum margin to cover regulatory requirements of Provisioning/Capital Charge.

Profit Margin

All the other lending rates are to be determined with reference to BPLR, taking into account the term premia and or risk premia. After adoption of the BPLR system it was observed that the rates were lower in the range of 25-200 basis points from their earlier levels.

BOX 2: Priority sector lending:

One of the major objectives of nationalization of commercial banks was disseminating credit to the sectors like agriculture and small scale industries which lacked access to institutional credit. Thus the concept of priority sector lending came into existence to ensure credit from banking system flowed to vital sectors of the economy. Initially there was no target fixed in respect of priority sector. In 1974 the public sector banks were advised that their priority sector lending should reach a minimum level of one third of their outstanding Credit by 1979. The private sector banks were also advised in 1978 to lend minimum 33 1/3 % of their total outstanding credit to the priority sector by end of March 1980. Gradually the RBI increased the target to 40% of aggregate advances. In achieving this overall target, sub targets for lending to agriculture and weaker section have been prescribed by RBI. At present the banks are required to lend at least 18% of their (Net Bank Credit) NBC to agriculture sector and 10% of their NBC to Weaker sections.

As per RBIs guidelines the foreign sector banks also needed to increase their advances to the priority sector to reach a level of 15 per cent of their net bank credit (NBC) by end March 1992. In April 1993, this minimum requirement for priority sector lending was raised to 32 per cent of NBC to be achieved by March 1994. With increased target of 32 per cent, foreign banks were also required to attain two sub-targets of 10 per cent in respect of SSI and 12 per cent for exports.

with effect from April 30, 2007, the priority sector lending target/sub-targets have now been to adjusted net bank credit (ANBC) or credit equivalent amount of off-balance sheet exposures, whichever is higher.

Domestic schedule banks that have shortfalls in the priority sector or agriculture lending target are required to make a contribution to the Rural Infrastructure Fund Development fund (RIDF) established by National Bank for Agriculture and Rural Development (NABARD). However if the Foreign Banks fail to attain their prescribed targets and sub targets, they are required to deposit an equivalent amount with the Small Industries Development Bank of India (SIDBI) for a period of one year at the rates decided by RBI.

Box 3: Micro Finance in India

Social Banking has been supported in India since a very long time. Since independence the Government of India and RBI have been instrumental in providing the poor section of Indian society an access to the banking system. Nationalization of commercial banks in 1969 was one of the major steps taken in this direction. In post nationalization era banking sector experienced substantial flow of fund and phenomenal increase in its outreach.

According to empirical studies conducted by NABARD in 1980's it was observed that despite of having a wide network of bank branches a very large number of the poor continued to remain outside the reach of the formal banking system. It was also observed that the existing banking policies, systems and procedures, and deposit and loan products were perhaps not well suited to meet the needs of the poor. Thus The need for supplementary credit mechanism which could be cost effective and convenient for both the banks and poor section of the society came to fore. So the initiatives to develop Micro finance in India were encouraged. These initiatives were centered on two models viz. SHGs linkage programme and the Micro finance Institutions. (MFIs)

SHG- Bank Linkage Programme:

The SHG-Bank Linkage programme was initiated as an action research programme in 1989. On the basis of findings of these programme a pilot project, which linked 500 SHGs to banks, was launched by NABARD in 1992. Organisation of rural poor into SHGs enhanced their capabilities to manage their own finances and negotiate bank credit on commercial terms.

The main advantages of this programme are:

Timely repayment of loans.

Reduction in transaction cost of both poor and the banks.

Provision of Door step banking facilities to the poor

Exploitation of untapped business potential of the rural areas.

India has adopted a multi agency approach for developing its micro finance programme with involvement of Commercial banks, Co-operative banks, RRBs, and the NGOs.

Currently three SHG-Bank linkage models are operative in India:

Model I: Under this model banks themselves take up the work of forming and nurturing the groups, opening their savings accounts and providing them bank loans

Model II: Under this model SHGs are formed by the NGOs & formal agencies but directly financed by banks.

Model III: Under this model SHGs are financed by banks using NGOs and other agencies as intermediaries. A few more lines

The SHG-Bank linkage model is the predominant micro finance model in India. There has been a massive expansion of the programme since its inception. The cumulative number of SHGs credit linked to banks, which was 500 at the beginning of this programme in 1992, has tremendously increased to 2,924,973 by end march 2007. Banks loans disbursed to SHGs has also increased over the years. The bank loans disbursed to SHGs during 2006-2007 amounted to Rs. 6,643 crore, this was higher as compared to loans of Rs.4,499 crore disbursed during 2005-2006. The number of poor families benefiting through SHGs increased to 41 million during 2006-2007, as compared to 32.9 million 2005-2006, registering a growth of around 24% over 2005-2006 .

The SHG-Bank Linkage programme are commercially viable to the banks because of the low transaction cost, almost zero NPA levels in SHGs portfolio of banks and high coverage of rural clientele of bank's branches. In terms of relative shares of different agencies, commercial banks are leading with highest share both in terms of number of SHG credit linked and amount of loan disbursed, followed by the Regional Rural banks (RRBs) and co-operative banks. Though the RRBs are at second position, their share has been declining over the years. Till 2005-2006 the share of co-operative banks has been increasing both in terms of number of SHGs credit linked and loans disbursed. But in the previous year i.e. 2006-2007 the share of co-operative banks in terms of number of SHG credit linked has remained unchanged at 14% and their share in terms of loan disbursed has declined to 9% in 2006-2007 as compared to 10% in 2005-2006.

Out of the three SHG-Bank linkage models, Model II involving NGOs and Government agencies has been most successful. By end March 2007 80.7 % SHGs were financed by banks under this model.

Historically there has been concentration of SHGs in the southern states, basically due to the head start of the programme and also due to initiatives taken by the state government. But during last few years the programme had gained momentum in other states also. To spread the out reach of micro credit in other states NABARD has taken up intensification of SHGs linkage programme in 13 identified priority states, which account for 70% of the rural poor population. During 2006-2007, NABARD intensified the implementation of this programme and as a result the programme spread in these states indicating a marked shift from its initial localization in the southern region. The cumulative share of non-southern states rose from 29% at end March 2001 to 48 % at end March 2007.

One million of the approx 2.9 million SHGS are matured and have availed multiple loans from the banking system. The challenge now faced by the development planners is to facilitate the matured SHGs to take up as income generating micro enterprises. Hence during 2005-2006 NABARD initiated a focused and location specific Micro Enterprise Development Programme (MEDP) on skill up gradation and development for sustainable livelihood, for members of the matured SHGs. During 2006-2007, 297 MEDPs were conducted by NABARD covering about 7579 SHG members. The micro enterprise for which training was imparted covered a wide range of activities such as goatery, mushroom cultivation, papad, agarbatti making, and candle making ect..

MFIs-Bank Linkages:

Micro-Finance Institutions are working under various legal forms in the country. These can be broadly classified as

a society registered under the Societies Registration Act, 1860

a public Trust registered under the Indian Trust Act, 1882/ public Trust Act, 1920 or any state enactment governing religious or charitable public trusts

a co-operative society registered under the provisions of the State Cooperative Societies Act or under the Mutually Aided or Mutual Benefit Co-operative Societies Act or Multi-State Co-operative Societies Act, 2002 or under any other law relating to Co-operative Societies in force in India

a not-for-profit company registered under Section 25 of the Companies Act, 1956 and specifically exempted from registration by the Reserve Bank;

Non-banking financial companies (NBFCs) registered under the Companies Act, 1956 and regulated by the Reserve Bank.

Many efforts are being made to promote linkages of MFIs with the banks. During 2005-2006 NABARD had launched a Scheme to provide financial support to banks towards rating MFIs, with the objective of promoting flow of credit to the MFIs from banks. A scheme called ‘Capital/Equity support to MFIs from MFDEF' was launched to enable the MFIs to leverage capital/equity for accessing commercial and other funds from banks. Under this scheme Three MFIs were provided capital support to the tune of Rs.3 crore during 2006-2007.

Further, with a view to promoting the orderly growth of the micro finance sector, a Micro Financial Sector (Development and Regulation) Bill, 2007 was prepared by NABARD in consultation with the Ministry of Finance, Government of India. The Bill was introduced in the Lok Sabha on March 20, 2007. It has been referred to the ‘Standing Committee' of Parliament for further deliberations.

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