Banking Central | Microlenders, it's time to take a pause and think again, lest it hits you back

"Those who don’t learn history are doomed to repeat it."

For microlenders in India, it's time to take a pause, and revisit the meaning of this old saying, for good reasons. I’m afraid some of the crucial reasons that had brought down the entire Indian microlending industry after the 2010-2012 Andhra Pradesh crisis are showing up again.

A section of microlenders in states like Assam, West Bengal, Bihar and Odisha have gone back to the routine of charging excessively high interest rates, sometimes as high as 35-40 percent annually, as Moneycontrol reported.

Well, this isn’t a good sign for the industry. Typically, the microfinance providers of MFIs charge high rates from their borrowers because their cost of borrowing is high. The MFIs do not have access to cheaper customer deposits that banks enjoy. Charging a margin of around 10-12 percent over the borrowing cost of 9-12 percent is normal, which makes the borrowing cost for their end-customers around 24 percent. That is kind of an acceptable rate in the industry because microloans are known for their timely availability without a collateral and aren’t too sensitive to rates.

Technically, too, it is perfectly legal to charge any rates they choose since there is no cap on the interest rates as the RBI had in March, 2022 removed limits on the pricing of loans given by these entities.

It doesn't, however, give a free hand to the lenders to charge whimsically.  There is always a line that the industry must not cross for its own good. There is no rationale that can justify rates as high as 35-40 percent. This means a margin of 25-35 percent over their lending rates.

It is nothing but greed. While the lender widens the margin, the borrower

faces a heavier debt load, that will eventually lead to most certain defaults and set wrong recovery practices, setting the perfect recipe for an impending disaster.

Take this case, for example. I know someone whose driver, earning a monthly salary of Rs 20000, has a Rs 2-lakh loan from a microlender at a very high rate. Effectively, the person pays almost half of his income towards servicing the loan, leaving not much in hand to save after meeting the basic needs of family. Such borrowers are typically forced to borrow again to meet their consumption needs and thus sets off a vicious cycle of debt. A default becomes inevitable. And, when the money doesn't come back, it typically forces the lenders to resort to arm-twisting tactics.

The microloan industry must recall what happened during the 2010 Andhra crisis. A few rogue MFIs which resorted to unhealthy credit practices of charging high rates and arm-twisting recovery practices that eventually brought the whole industry to its knees as there have been instances of suicide linked to the MFI loan burden.

Everyone knows what happened after that. The erstwhile uinted state of Andhra Pradesh introduced a draconian law restricting the MFI operations of collections and fresh loan disbursals in a big way which brought the whole business to a grinding halt. The repercussions were felt across other states as well and the banking regulator had to step in and bring in tight regulations to reinstate discipline in the industry.

The latest instances of high interest rates are reminiscent of the events in 2010. If these practices continue, it can lead to a much bigger problem. Certainly, a decade and a half after the Andhra crisis, the Indian microfinance industry is learnt from its past mistakes. But ignoring early warnings of resurgence in unhealthy credit practices might prove costly.

Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers