PBoC to Abolish Interest Rate Caps and Expand Funding for Microfinance Institutions
In February 2010, Zhou Xuedong, Director-General of the Regulatory Department of the People’s Bank of China (PBoC, the central bank) announced in the local financial press that the PBoC is planning certain policies pertaining to microcredit companies (MCCs) that could make this model more profitable and sustainable. MCCs are specialized lending companies that piloted by the PBoC starting in 2005 to expand micro-credit access in China. As of 2009 year end, there were 1,334 registered MCCs. Under current guidelines, MCCs face a number of restrictions, including being limited to a single country or district. However, Director Zhou indicated that two current restrictions will soon be revised: interest rate caps will be removed and tight restrictions on debt financing will be eased.
The current restriction on interest rates stipulates that a loan’s annual interest rate cannot exceed four times the prevailing base lending rate on the day of the loan transaction. The regulation on rates has been of great concern to potential investors who recognize that if a MCC disburses lower-value loans, operations are bound to be more expensive, thus requiring a higher interest rate in order for the MCC to be sustainable. In addition, if a MCC receives funding from a more commercial source, then the current interest caps can barely cover the cost of the financing. At the time of print, the baseline annual rate was 5.94%, allowing for a maximum annual interest rate of 23.76%. In addition to the liberalization of interest rates, the central bank plans to allow a MCC to borrow up to twice its net registered capital from a maximum of two financial institutions and one non-financial institution. At present, a microcredit company can only take out debt financing equivalent to 50% of the total value of its registered capital. With the cost of equity traditionally much more expensive than the cost of debt, the current restriction greatly increases a MCC’s cost of borrowing.
By allowing interest rates to be determined by the market and lowering the cost of borrowing, MCCs can expand their operating scale and reach more clients. Increasing the profitability of MCCs will also attract additional investment interest to the sector, funneling even more needed capital to the loan recipients. Although the policy changes have yet to be implemented, the proposed changes demonstrate the PBoC’s drive to promote private sector development by helping MCCs to increase the profitability and sustainability of its model.
Source
- Ifeng Finance News http://finance.ifeng.com/news/20100226/1860532.shtml
- Xinhua News http://cs.xinhuanet.com/xwzx/03/201002/t20100226_2350073.htm