Some of India’s smaller non-bank financiers have been getting a bit too creative lately. And that has led the Reserve Bank of India (RBI) to consider restricting the access to financing needed by self-employed professionals and small business owners.
Revolving credit—which allows people to borrow money up to a set limit, pay it back and borrow again—is a goalpost zealously guarded by banks. Allowing non-banks unfettered access could encourage borrowers to pay interest to one lender by dipping into their so-called flexi loan with another. Rinsed and repeated, this might lead to the evergreening of bad debt.
That happens at banks too, but there’s just about 100 of them to supervise. Even though they are also regulated, policing more than 9,000 non-bank financiers is nearly impossible. Hence, RBI wants loans allowing flexibility around repayments reserved for deposit-taking institutions and credit-card issuers. Other lenders will be banned.
RBI has invited public comments by 28 August on a proposal that shadow banks should only offer term loans with pre-determined repayment schedules. For overdraft limits, borrowers must go to banks.
It is a well-meaning directive that nonetheless ignores the precarious structure of employment in the world’s most-populous nation. Less than half of urban workers—and just 13% in rural areas—get a monthly salary.
For over 200 million self-employed people, banks are not a reliable source of financing to smooth unpredictable cash flows. They are reluctant to give working-capital limits to tiny enterprises that lack collateral, while freelancers have trouble getting credit cards because they are unable to submit evidence of steady income.
Smaller firms have it especially hard because buyers are notoriously slow to pay. Non-bank lenders stepped into this gap with a product approved once for a fixed maturity. It is not a limit that revolves endlessly. Borrowers withdraw funds as needed and repay surplus cash when available.
Borrowers who use about 70% of their withdrawable limit cut interest costs by 200 to 250 basis points while keeping a buffer for rainy days. Lenders enjoy a 30 to 50 basis point advantage over a simple term loan. It works for both sides.
Is there evergreening of bad debt in India? Sure. Smartphone-based loan apps have gone overboard with small-value ($200 or less) loans used to make ends meet. These carry usurious rates with no stacking limits. It is here that regulation is needed. Flexi loans, which have been offered by large non-banks for a decade or longer, serve a genuine need without posing much of a systemic risk.
Market leaders like Bajaj Finance and Aditya Birla Capital have erected guardrails. As they and other lenders explained to RBI in 2024, a properly structured flexi loan is not an open-ended credit facility.
When a bank gives a business an overdraft, it runs an annual health check on their sales and inventory. By the time stress is detected, a default has usually occurred. With flexi loans, the sanctioned limit remains capped, follows a rigid amortization schedule and reduces to zero in five to seven years. To avoid delinquency, borrowers must pay monthly instalments using outside funds—not unused balances.
Throwing the baby out with the bathwater is a failure of imagination. Instead, the regulator should make fuller use of its regulatory sandbox—a controlled environment designed to assess risks and weigh opportunities. All flexi loans could be battle-tested in real time, allowing RBI to gather granular data based on actual borrower behaviour.
Banning the product will not make it go away. One flexi contract will splinter into 20 term loans, adding to paperwork and overwhelming credit bureaus. Lenders scoring borrowers based on the number of loans will have to rewrite algorithms. Borrowers will pay more in processing fees. None of this will yield any systemic improvement.
The larger point here goes beyond credit. Basic financial activities like saving, borrowing and insuring against unforeseen events must not remain the preserve of the country’s salaried middle class.
India’s credit market can no longer afford to ignore its small business owners, gig workers and freelancers. Their numbers will only grow as artificial intelligence puts pressure on salaried jobs. Digitization has made the self-employed more visible and creditworthy, and they need access to the formal financial system without exposing it to unseen risks.
That calls for more competition, not less. Unless banks guarding their goalposts are challenged by imaginative non-bank rivals, why would they innovate to defend their turf? That is how RBI should see its role in the flexi-loan debate. ©Bloomberg
The author is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia.