Pricing Under Political Pressure at an NBFC-MFI
Sahaj Microfinance, an NBFC-MFI with an AUM of ₹480 crore across 3.1 lakh borrowers in four districts of eastern Uttar Pradesh, charges an all-in effective rate of 23.5%. Its cost of funds is 10.5%, operating expense ratio 8.9% and credit cost 1.9%, producing an ROA of roughly 2.2% before tax. A local MLA has publicly called the company a 'new-age moneylender', and a regional rural bank has just launched an SHG-linked product at 14.5%, taking 800 of Sahaj's better clients in two blocks. On Friday the board will consider the business head's proposal to cap the customer rate at 18% 'to protect our reputation'. The finance head warns that the cut can only be funded by shrinking field staff or by raising the average ticket from ₹38,000 to ₹70,000. Sixty-one per cent of Sahaj's loans are below ₹50,000, every loan is collateral-free, board policy caps the total repayment obligation at 50% of household income, and each field officer already handles 420–450 clients.
1. Using the stated cost structure, assess whether an 18% cap is financially feasible, and identify what actually drives Sahaj's cost of delivery.
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Arithmetic first. Break-even yield = cost of funds + operating expense + credit cost = 10.5% + 8.9% + 1.9% = 21.3%. At the current 23.5% yield the pre-tax spread is 2.2%; at 18% the entity runs at roughly −3.3% of assets, which on an AUM of ₹480 crore is about ₹16 crore of annual loss. That is not a pricing decision, it is a capital-erosion decision: at that burn rate the net worth needed to support the portfolio is consumed within a couple of years, and the entity would have to stop disbursing, which hurts the same borrowers the cut is meant to protect.
Where the cost really sits. The 8.9% opex is not fat. It is the price of a ₹38,000 ticket collected in cash at the doorstep every fortnight in dispersed rural habitations; opex per borrower is roughly ₹3,300, and a bank with ₹2 lakh tickets and branch-based collection carries a fraction of that per rupee lent. The 1.9% credit cost is also a fair-weather number - in a hail or flood year it can go to 4–5% and erase the entire margin even at 23.5%.
Conclusion. 18% is viable only after opex falls to about 4%, which requires digital repayment, larger tickets and lower officer-to-client ratios - a multi-year programme, not a board resolution. A rate cut delivered before the cost base moves is a transfer of loss to the lender, not a benefit to the client.
2. The business head argues that raising the average ticket to ₹70,000 will fund the rate cut. Evaluate this against microfinance fundamentals and the 50% repayment-obligation cap.
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The proposal confuses revenue per loan with revenue per rupee of risk. Two things break.
1. The household cash-flow test. Sahaj's typical borrower household earns ₹1.3–1.5 lakh a year. A ₹70,000 loan at 24% over 18 months carries an EMI of roughly ₹4,670, or about ₹56,000 a year - already 37–43% of household income before counting the ₹30,000–45,000 the same household typically owes two other lenders. Add those EMIs and the 50% cap is breached. A ₹70,000 ticket is therefore only lendable to a household earning ₹2.5 lakh+, which is a different customer.
2. Mission drift and the portfolio test. Chasing larger, better-off borrowers to subsidise the rate is the classic drift path: the small, first-time, new-to-credit borrower who justified the MFI's existence gets priced out or served last. It also shifts the portfolio mix, and the entity must still satisfy the requirement that microfinance loans form at least half of its total loan portfolio - large collateral-free loans to households above the ₹3 lakh income threshold do not count, so growth of that book mechanically erodes the qualifying share.
A better answer to the RRB is not a bigger loan but a cheaper channel: reward borrowers who move to UPI repayment with a 1.5–2% rate reduction, funded by the ₹400–500 per client per year saved on cash handling.
3. Give two non-price responses that would defend the client base without breaching sustainability, and explain the mechanism by which each works.
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Response 1 - Cost-based segmentation. Offer 19.5% (not 18%) to clients with 24+ months of clean repayment who opt for digital repayment, and keep 23.5% for cash-at-doorstep clients. The mechanism is honest price discrimination by cost-to-serve: the digital cohort genuinely costs less, and the retained margin on the cash cohort funds it. The blended yield falls by perhaps 0.8%, not 5.5%, and no cohort is served below cost.
Response 2 - Compete on reliability and disclosure, not on rate. The RRB product is cheaper but requires weekly group meetings at a branch 9 km away - a real cost of 2–3 hours and ₹40–60 of transport for a daily-wage woman. Sahaj's counter is guaranteed doorstep collection at a fixed time, a 48-hour emergency top-up, bundled hospital-cash cover, and above all radical transparency: a loan card stating the all-in effective annual rate, the total repayment, the absence of any processing fee, prepayment penalty or security deposit, and a toll-free grievance number printed on it.
The mechanism matters: the 'moneylender' allegation is a credibility problem, not a price problem. Publishing the cost build-up in the local language, and getting the state-level self-regulatory body's client-protection audit report into the public domain, answers the allegation directly. A rate cut that makes the entity unviable answers it for one news cycle and then produces a collapse in service that is far worse for clients.