Rate caps hinder banks’ penetration into microfinance sector: HNB chief

• Says rate caps have made growth in this vital customer segment extremely difficult
• Points out default risks in microfinance sector have increased significantly 
• Expects rise in general market rates on back of strong private sector credit demand

The interest rate caps hinder the formal banking sector’s penetration into the microfinance sector, as the default risks in the sector have increased substantially, while the banking sector braces for a rise in general market interest rates, on the back of strong demand for private sector credit. 

According to Hatton National Bank PLC (HNB) Chiarman Dinesh Weerakkody, there is a greater need for the formal banking sector to play a larger role in meeting the fund requirements in the fledgling micro enterprises, due to their high level of untapped opportunity and also to prevent these micro businesses from falling prey to the loan sharks. 

However, he said the interest rate caps in the sector remain a deterrent in achieving that. 

“Opportunities for growth in the microfinance sector remain high; however, the interest rate ‘caps’ have made growth in this vital customer segment extremely difficult, as default risks have increased significantly,” Weerakkody said in HNB’s latest annual report.

A new piece of legislation titled Microfinance and Credit Regulatory Authority Act, aimed at regulating the unregulated money lending activities, was scheduled to be put before the Cabinet of Ministers after it was given the green light by the Monetary Board. The draft act, if passed, would effectively replace the existing Microfinance Act, No.06 of 2016. 

HNB had a business segment titled ‘HNB Microfinance’, with a lending portfolio of Rs.25.9 billion by end-2020, up just 2.2 percent, compared to a 7 percent contraction in 2019, due to subdued economic performance that year. 
The bank meanwhile improved the quality of its micro-lending portfolio to 7.9 percent from 8.1 percent in 2019 and considers the sector as a key growth driver in 2021 
and beyond. 

“HNB Microfinance will be a key area of growth as the world moves into a new norm,” the bank said.

The bank also expects the demand for private sector credit to accelerate in 2021, with the projected recovery in the economy after the temporary setback caused by the pandemic in 2020. But it braces for an uptick in the interest rates as credit demand picks up. 

“This is likely to edge the interest rates upwards as private sector credit demand grows, supporting both opportunities for growth and profitability,” Weerakkody added. 

Slightly higher interest rates from where they are now could result in stretched margins for banks leading to higher profits, as a little uptick in rates is not damaging for the growth in loans as sentiments are improving on the economy. 

The banking sector as a whole navigated the pandemic-induced challenges reasonably well, demonstrating its resilience, supported by both the regulatory-driven assistance and banks’ own measures to mitigate risks.

But Weerakkody flagged one possible concern that the sector could confront in the post-moratoria period in the area of non-performing loans and credit costs, which depends on how the borrowers cope up the debt servicing with the payment holidays coming to an end.

However, a faster recovery in the economic activities will build more financial muscle for borrowers to service their loans while the Central Bank last week issued guidelines to extend payment relief to the passenger transport sector, which is still reeling from the pandemic. 

Those measures could effectively smoothen out any potential concerns have on the banking sector asset quality as predicted by some rating agencies. 

“Also, with the authorities hopeful of muting the growth in COVID-19 rates to more manageable levels and the expected economic growth, we are optimistic that most customers would progressively recover by the end of the first quarter and the loan recovery rates will be strong,” Weerakkody added.