Understanding the Challenges and Reforms in Microfinance

Challenges Facing the Microfinance Sector

The microfinance sector is currently grappling with several pressing issues that could undermine its stability and growth. Key challenges include:

• High Household Exposure: Many borrowers hold multiple loans across various lenders, often exceeding their repayment capacity.
• Informal Income: Accurately assessing household income is challenging due to informal or seasonal earnings.
• Over-indebtedness: Borrowers are increasingly unable to repay their loans due to multiple debts and rising Equated Monthly Installments (EMIs).
• Data Reporting Gaps: Cooperatives and informal lenders do not report their activities to credit bureaus, which weakens oversight.
• State-Level Legislation: Recent state bills, such as those in Karnataka and Tamil Nadu, have disrupted the uniform regulation of the sector.
• Declining Group Strength: Joint Liability Groups (JLGs) have shrunk in size, diminishing their collective ability to absorb defaults.

Solutions to Stabilise the Microfinance Sector

In response to these challenges, several solutions have been introduced to stabilise the microfinance sector:

• New Guardrails (July 2024):
  • Loan Cap: Total household loan exposure is capped at ₹2 lakh.
  • Credit Bureau Checks: Mandatory verification of borrowers before lending.
  • Loan Restrictions: No new loans if the borrower has more than ₹3,000 in defaults.
  • Top-up Conditions: New top-up loans are allowed only after 50% repayment or 12 months.
• Stricter NPA Norms:
  • Reducing the default threshold from 90 to 60 days, with plans to bring it to 30 days.
  • Limiting the average number of lenders per borrower to three.
  • Enhancing credit discipline through regular data updates and tighter enforcement.

Impact of State Laws on the Microfinance Sector

State laws have a significant impact on the microfinance sector:

• Karnataka Microfinance Bill: Initially included all lenders, causing disruption but later excluded regulated entities, which still raised concerns about increasing delinquencies.
• Tamil Nadu Bill: Similar in intent; ongoing engagement with the RBI and government to avoid unintended restrictions.
• Lack of Uniformity: Inconsistent regulatory environments arise when regulated NBFCs and MFIs are not exempted from these state laws.

Challenges with the JLG Model

The JLG model, once effective in ensuring mutual repayment, is now under strain due to:

• Smaller group sizes (now typically 4–5 members).
• Larger loan sizes (often exceeding ₹50,000 per member).
• Increased burden on other members if one individual defaults, weakening peer accountability and raising repayment pressure.

Current Stress Levels in the Microfinance Sector

Current data reveals concerning stress levels in the sector:

• Approximately 5% of assets are at risk, with loans overdue between 30–179 days.
• 60–70% of MFIs are experiencing some degree of stress.
• However, easing is anticipated from Q2 2025, provided no new disruptions occur.

Synopsis

The microfinance sector faces considerable pressure from rising defaults, poor income assessments, and inconsistent state legislation. New norms introduced in mid-2024 aim to enhance borrower discipline and improve institutional lending practices. While the Karnataka and Tamil Nadu Bills have temporarily disrupted the market, a turnaround is expected by mid-2025. Structural changes, including capping loan exposure, mandatory credit checks, and limiting group lending sizes, are essential for stabilising the sector.

Frequently Asked Questions (FAQs)

Q1. What are the primary issues affecting the microfinance sector?
Answer: The main issues include high household exposure, over-indebtedness, informal income assessment challenges, and inconsistent state-level legislation that disrupts uniform regulation.

Q2. What new regulations have been introduced for microfinance?
Answer: New regulations include a loan cap of ₹2 lakh, mandatory credit bureau checks, and restrictions on lending to borrowers with defaults exceeding ₹3,000.

Q3. How do state laws impact microfinance operations?
Answer: State laws create inconsistencies in regulation, affecting operational stability, as seen with the Karnataka and Tamil Nadu Bills which initially caused market disruptions.

Q4. Why is the JLG model under pressure?
Answer: The JLG model is strained due to smaller group sizes and larger loan amounts, making it harder for members to manage defaults without significant stress.