Karnataka ordinance causes exactly what microlenders feared: a spike in stress

Mumbai: Parts of rural Karnataka have started showing initial signs of distress for microlenders, following the notification of the new ordinance that aims to protect borrowers from harassment by microfinance institutions (MFIs).

According to field reports, the collection efficiency of microfinance-focused non-bank financial companies (NBFC-MFIs) has fallen below 90% in northern districts of Karnataka, said two bankers on the condition of anonymity.

“There is confusion and chaos at the ground level. In some districts, borrowers are misbehaving or are being told not to repay,” said the first banker cited earlier. “Districts like Gulbarga and Belgaum are worst affected.”

Banks and NBFC-MFIs like CreditAccess Grameen, IIFL Samasta, Ujjivan Small Finance Bank are some of the largest players in Karnataka. According to the bankers cited earlier, centre managers and collection agents of MFIs are being told to go slow and not to push the borrowers too much into repaying.

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“Collection agents of most MFIs are playing it safe as they are now being told not to chase borrowers and put pressure on them. They are also being asked not to go for recoveries after 6pm,” said a banker cited earlier.

Collections were expected to be impacted after the notification of the Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance 2025. While it clarified that all regulated banks and MFIs will be kept outside the provisions of the ordinance, industry experts believe these rules could create confusion at the ground level. The ordinance 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.

“Many borrowers have the repayment capacity, but they are trying to be opportunistic. We are telling them that if they do’t pay their credit scores will be impacted,” said the chief executive officer of an NBFC-MFI.

The ordinance seeks 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.

Karnataka is among the top five states in the overall microfinance industry portfolio. The other four are Bihar, Tamil Nadu, Uttar Pradesh and West Bengal.

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According to India Ratings, the top five large NBFC-MFIs operate in the state, comprising nearly 35% of the gross loan portfolio as of December. The share of Karnataka in the overall loan portfolio for such players ranges between 9% and 33%.

Assets under management (AUM) of MFIs in the state stood at ₹60,000 crore at the end of March 2024, according to the Association of Karnataka Microfinance Institutions (AKMI) annual report for FY24.

“Even before the ordinance, Karnataka had seen a 200-basis-point dip in its collection efficiency due to the ongoing stress in the sector. I’m not surprised that the efficiency has fallen even below,” said Jinay Gala, director, India Ratings & Research Ltd. A basis point is one-hundredth of a percentage point.

However, NBFC-MFIs believe that Karnataka was one of the better performing states before the news about ordinance came out.

Stress in the Microfinance sector

“The stress in Karnataka emerged in the run-up to the ordinance. The biggest impact was seen in February. We expect things to normalize by March-end,” said Venkatesh N, founder and managing director, IIFL Samasta Finance.

Overall, stress in the microfinance sector has been building up over the last few months. The Reserve Bank of India’s (RBI) Financial Stability Report showed that stress in the microfinance (MFI) sector doubled in the first half of the fiscal, with loans due more than 31 to 180 days rising to 4.30% at the end of September from 2.15% at the end of March 2024. Borrower indebtedness also rose sharply, with the share of borrowers availing loans from four or more lenders increasing to 5.8% at the end of September 2024 from 3.6% in September 2021.

Also read | Banks go slow on microloans as asset quality stress weighs

The asset quality pain in the MFI sector worsened in the third quarter ended December, with banks and NBFC-MFIs seeing elevated non-performing assets (NPAs) and increased provisions. As per the MicroFinance Institutions Network’s (MFIN) Micrometer report for the third quarter released on Tuesday, the loan amount disbursed reduced by 20.02% and the number of new loans disbursed fell 29.02%. Portfolio quality as measured by PAR (portfolio at risk) 31-180 days overdue was 6.4% as compared to 2.0% at the end of Q3 FY24.

“We believe that the sector has not seen a peak in terms of asset quality pain. More players could take write-offs in the fourth quarter,” said Gala. “Also, the three-lender norm by MFIN, monsoon and heatwave could also have some impact on the collections. We don’t see headwinds moderating for the sector.”