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35 percent interest rate cap on Sri Lanka’s microfinance industry

Central Bank has introduced a maximum rate of interest for microfinance loans with the aim of protecting customers being charged exorbitant interest rates on microfinance loans granted by Licensed Finance Companies (LFCs).

LFCs should not charge a rate exceeding 35 percent per annum, inclusive of all other charges on micro finance loans, a directive issued by the country’s monetary authority under the Finance Business Act revealed recently.

Former Minister of Finance and Media Mangala Samaraweera allocated approximately LKR 1 billion to write-off microfinance loans up to LKR100,000 taken by 75,000 women in drought-affected 12 districts. 

According to Samaraweera, 70-90 percent of rural population in the North, East, North West and North Central rely on micro credit, given the limited access to credit from banks, at an exorbitant interest between 40-220 percent. 

"We have information that certain young women are being forced to pay debt with sexual favours. It’s a very sad, tragic and desperate situation in which the government felt it had an inherent moral duty to intervene. So, that’s why we took a historic step of writing-off debt of nearly 75,000 women at the first phase,” Samaraweera said in August.

As such, microfinance and finance companies have agreed to cap annual interest rates at 35 percent for all new loans, a senior Central Bank official said. But several CEOs of licensed finance companies noted that this directive will increase operational cost of companies due to the cut down of interest rates adding that their human resources will also need to be cut down which will negatively affect all their employees.
Capping the interest rate at 35 percent will further affect the cash flow of finance companies from small loans, which comprise a large percentage of their loan portfolio, they added.

There is an estimated LKR 140 billion of loans below LKR 100,000 from finance companies to small borrowers in all districts, not counting unregulated micro-lenders, according to finance ministry’s latest statistics.

This latest 35 percent cap on interest will compel many finance companies to stop offering small loans; rural areas will miss out billions of rupees in money circulation a year, and rural poor will be forced to turn to moneylenders who charge far more than micro finance institutions, they claimed.

They stressed that finance companies contribute a massive amount to government coffers by way of taxes and a reduction in the interest cap would also affect the tax income earned. Therefore, they said that the Central Bank should look at least capping the interest rate at 40 percent.

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