CRACKDOWN CHAOS

Microfinance falters following clampdown by Karnataka, yet a bounce back beckons

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India’s microfinance sector has been facing challenges in recent months. The state government of Karnataka has passed a law tightening its grip on unregistered microfinance and money-lending institutions following a series of suicides linked to exploitative lending and aggressive loan recovery tactics by some unregistered lenders. Although the intention of the state government is laudable - and the law applies only to the informal microfinance sector - the organized, formal sector is bearing the brunt of its effects.

Microfinance in India is undertaken by a host of entities, including scheduled commercial banks (SCBs), co-operative banks, non-banking financial companies (NBFCs), and microfinance institutions (MFIs) registered as NBFCs, all of which are regulated by the Reserve Bank of India (RBI).

How, then, is the new law impacting the formal sector? While the current crisis is limited to Karnataka, there is precedent in other regions, with many borrowers expecting some relief from the government. Many borrowers, despite their ability to repay, are delaying payments. Consequently, repayment and collection efficiency have already dipped nationwide, leading to a jump in bad loans for all microfinance lenders.

This scenario disrupts the sector’s fundamentals. On one hand, borrowers’ credit discipline deteriorates as they fail to repay, anticipating government relief; on the other, microfinance lenders become more cautious in their lending, thereby hampering overall growth.

To remind, the sector has witnessed significant growth over the past few decades.

According to one report, India’s microfinance industry has grown by more than 2000% in the past 12 years, with its business soaring from ₹17,264 crore in March '12 to ₹3.93 lakh crore as of November ‘24.