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Karnataka MFI ordinance isn’t that bad. But the industry is still worried
- Ordinance against coercive practices excludes RBI-regulated non-bank microfinance companies, but experts warn that collections could get impacted in the next two quarters.
Mumbai: The new ordinance notified by the Karnataka government to regulate microfinance loan recoveries may have come as a relief to non-bank microfinance companies regulated by the Reserve Bank of India (RBI), but experts warn that collections could get impacted in the next two quarters.
The Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance 2025 has made it clear that all regulated banks and microfinance institutions (MFIs) will be kept outside the provisions of the ordinance.
The ordinance, approved by the Karnataka governor, looks to penalize only unregulated MFIs and lenders for their coercive loan recovery practices by imposing a jail term of up to 10 years and a fine of up to ₹5 lakh for violations.
While this has come as a relief to the regulated MFI lenders, industry players caution there could be a short-term impact.
While the preamble of the ordinance clarifies that regulated MFI lenders will be excluded, the entire text refers to microfinance companies, which industry experts caution could be misinterpreted by local governments to include even the regulated entities.
“An Ordinance to protect and relieve the economically vulnerable groups and individuals, especially farmers, women and women’s self-help groups from the undue hardship of usurious interest rates and coercive means of recovery by Micro Finance Institutions or Money Lending Agencies or Organizations operating in the state of Karnataka and for matters connected therewith and incidental thereto,” it said.
According to Alok Prasad, former chief executive officer of self-regulator Microfinance Institutions Network (MFIN), in the short term, borrower sentiment and discipline could get adversely impacted, even as the Karnataka ordinance has specifically excluded regulated entities.
“The industry had desired the removal of the term MFIs from the text of the ordinance. It would have been fine if the Ordinance had generically referred to micro-loans, instead,” said Prasad. “It’s a real and understandable fear that the local state government officials and police may use this as an opportunity to interfere with the legitimate activities of regulated entities.”
Collections may also get impacted if local governments seek registration from business correspondents (BCs) and field agents, which work on behalf of the regulated MFI lenders for disbursement and collection of loans.
“Strictly speaking, the BCs are not the lenders. But, given their role in acquiring customers and even collections, this could become a contentious issue. More particularly, the collections aspect of their operations may lead to pressures for registration,” Prasad said.
Industry players, however, say they will work with the field staff to educate MFI borrowers and local state governments, and clear the confusion around the ordinance.
“Our field staff will use the exemption clause and certificate of registration to prove to the borrowers that we are RBI-registered, legitimate lenders,” said Manoj Nambiar, managing director, Arohan Financial Services, and chairman, MFIN. “There could be some confusion in the field in the short term. But one should understand that this is not a loan waiver or deferral, but a protection mechanism against coercive collection and recovery actions. Genuine borrowers know that maintaining their good credit record is their sole responsibility as we report on daily basis to the credit bureau.”
The ordinance came into force following a spate of suicides and complaints against harassment from microfinance company staff and agents, who resorted to aggressive recovery methods.
That said, the Karnataka MFI ordinance is considered to be less damaging as it steers clears of stepping on the RBI’s territory. However, that was not the case with the Andhra Pradesh ordinance, which covered even regulated entities, halting the operations of private microfinance organizations in the state and adversely impacting their recovery and liquidity. The Assam government, on the other hand, promised financial relief to borrowers in the state hit hard by covid-19, which also resulted in the deterioration of credit discipline.
The stress in the MFI portfolio of many banks and MFIs has been rising over the last few quarters owing to overleveraging and a slowdown in rural household income.
According to IIFL, the stress in the sector will remain elevated in the coming months with the implementation of the Karnataka ordinance and the new cap on lenders.
“Collections are likely to be impacted as it becomes difficult to explain the distinction to borrowers and local authorities. There is also risk of other states enacting similar laws, if it becomes popular amongst the electorate,” said IIFL in its report on Thursday. “With MFIN cap on 3 lenders also likely from April-25, we anticipate some stress to also emanate from 10-20% of MFI loans where customers have borrowed from 3 lenders in addition to the 8-30% exposure to customers having more than 4 lender associations.”
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Business NewsIndustryKarnataka MFI ordinance isn’t that bad. But the industry is still worried
First Published:13 Feb 2025, 07:47 PM IST
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