After clamping down on high interest rates charged by lenders to microfinance borrowers, the Reserve Bank of India (RBI) has shifted its focus to one of the long-standing practices followed by the industry known as ‘netting-off’ of loans.
The intent behind clamping down on this industry practice, according to sources aware of the matter, is to ascertain how many borrowers remain standard should a loan not be rolled over by the lender. “At present, loans are rolled over by lenders when they are nearing the repayment tenure. It not very clear if loans are being rolled over due to a borrower’s incapacity to repay Without clarity on this aspect, it is tough to gauge the possible extent of ever-greening of loans,” said a highly placed source aware of the matter.
What is netting off?
With most lenders, whether banks or non-banks, following a weekly, bi-weekly, and monthly collection policy, most accounts do not dip into the special mention accounts categories. The SMA-2 category, which refers to loans overdue by 61–90 days, are often considered as the potential pool of defaulting borrowers. RBI’s contention is that the true picture of default is tough to ascertain because loans are being rolled over ahead of the repayment tenure.
It is a common practice in the microfinance industry for a lender to rollover or sanction new loan ahead of a borrower fully repaying the existing credit facility. Invariably, loans are rolled over when 1–3 installments are due by the borrower and the fresh loan is netted off against the existing dues of the borrowers. By doing so, the earlier loan is settled by the lender and replaced with a new credit facility.
This practice is commonly called as 'netting off' of loans.
How the issue surfaced?
It is gathered that during the annual inspection of banks and NBFCs for FY24 by the RBI, the true picture of MFI loans from a credit worthiness standpoint was tough to ascertain due to the widespread practice of ‘netting off’ of loans.
This is why the regulator may have decided to act on this front.
“The regulator is asking banks and NBFCs lending to MFI borrowers to ensure that the current outstanding is first closed or fully paid off by the borrower before they can avail a fresh loan from the lender,” said a CEO of an NBFC-MFI on conditions of anonymity.
While lenders have presented a case to RBI that the practice is being followed by them to ease the burden for borrowers, this justification hasn’t been taken well by the regulator. The RBI’s apprehension, according to a private bank’s senior executive, is whether such a practice is genuinely being followed for convenience of lending or to maintain an account as standard in its books. In most cases is difficult to ascertain the actual motivation.
“Without being able to differentiate between the two, the practice, according to RBI, is tantamount to ever-greening of loans,” said a CEO of a bank. According to industry sources, the issue of loan rollovers became very prevalent after the pandemic. "While the issue was first raised in FY22's annual inspection, it became very glaring in FY23 when observations were made on a few entities. In FY24, it became a thorny issue forcing RBI to go beyond just making observations," said a senior executive of a small finance bank.
To put things in perspective, while stress has been brewing in MFI loans since December last year, it was most felt in the September FY25 quarter results. Most banks and NBFCs, in their management commentary in Q2FY25, have guided for normalisation of stress in the MFI space by March 2025. They have also projected for softening of loan growth in the MFI segment. “All these are following RBI’s annual inspection for last fiscal,” said a person with direct knowledge of the matter.
Email sent to RBI seeking comments on this matter remained unanswered till the time of publishing this article.
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