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MUMBAI- The Reserve Bank of India has removed pricing caps on microfinance loans given by financial institutions, the central bank said in a circular issued on Monday setting out fresh guidelines for microfinancing.

Previously, there were limits set on the maximum interest rate that a microfinance lender could charge on loans which was set at a maximum of 10-12 percentage points above the institutions' cost of funds or 2.75 times the average base rate for top five commercial banks.

Any loan given without a collateral to a household having an annual income of up to 300,000 Indian rupees ($3,918) is considered to be a microfinance loan.

The RBI had put out a discussion paper on microfinance loans in June 2021 and released final guidelines after taking into account comments received from stakeholders.

In its consultation paper, the RBI said boards of microfinance institutions will have the freedom to determine the interest rates on loans, while adding that it wanted to create a level playing field for all lenders so that the market mechanism would lead to a reduction in lending rates across the entire sector.

"Interest rates and other charges/ fees on microfinance loans should not be usurious. These shall be subjected to supervisory scrutiny by the Reserve Bank," the release said.

RBI also said the lenders' should adopt flexible repayment policies to meet borrowers' needs.

The central bank has also laid down stricter guidelines concerning recovery of loans, agreements made with customers as training of staff.

The new guidelines will be effective April 1, 2022, the RBI said.

Microfinance firms in India typically cater to people without bank accounts and the industry has an outstanding portfolio of 2,260 billion rupees ($29.52 billion) as of September 2021, according to Equifax.

Bankers and analysts estimate that over 50% of the market still remains untapped which has resulted in a lot of interest from global private equity and venture capital firms.