The mythical phoenix cyclically regenerates itself, combusting to be born again out of its ashes. Some legends say it dies in a show of flames, while others say it simply dies and decomposes before being born again.
What does the phoenix have to do with banking and finance? Well, there is some bit of similarity if we look at the history and evolution of India’s microfinance industry. Like the phoenix, it time and again faces challenges – sometimes, perhaps, even an existential crisis – but every time, it bounces back.
The latest blow has come from the Karnataka government, which is ready with the final draft of the Karnataka Micro Finance (Prevention of Coercive Actions) Ordinance, 2025 that can be promulgated anytime now.
This is not the first time that an Indian state is taking the industry head-on. On December 30, 2020, the Assam legislative assembly unanimously passed the Assam Micro Finance Institutions (Regulation of Money Lending) Bill, 2020 to protect economically vulnerable people, particularly women, from micro finance institutions (MFIs) and money lenders.
After the Bill was passed, the state’s finance minister, Himanta Biswa Sarma, had said, “This is the best legislation given to the women of our state who have long been exploited, and loan recovery agents of microfinance institutions have often taken undue advantage from them.”
Sarma also questioned the Reserve Bank of India’s (RBI’s) jurisdiction. “The RBI wrote a letter to me yesterday and asked to consult it before passing the Bill. It suggested some amendments also. How can the RBI come into the picture? This is a privilege of the House,” he had said.
Among other things, the Assam law made it mandatory for all MFIs to register themselves with the state with details of their areas of operation and interest rate charged. Coercive actions for the collection of dues were made punishable with imprisonment of six months and/or a penalty of Rs 10,000.
Later, in September 2023, the Assam government tabled a legislation to exclude the entities regulated by the RBI from it.
The provocation for the Bill was aggressive loan disbursement by some MFIs, leading to the borrowers being over-leveraged. As a result, many borrowers were unable to service their loans.
Ten years before the Assam episode, in December 2010, the Andhra Pradesh government had passed the Andhra Pradesh Micro Finance Institutions (Regulation of Moneylending Activities) Act, prohibiting MFIs from collecting repayments from borrowers’ homes or workplaces, and directed them to collect money at public places mentioned in the Act on a monthly basis instead of the prevalent weekly centre meetings.
The AP Act was a result of unethical practices adopted by some MFIs to recover loans, which had apparently led to suicides by some borrowers, besides allegations of multiple borrowing and of charging high interest rates.
In the five years between 2005 and 2010, India’s microfinance industry had emerged as one of the largest in the world, with Andhra Pradesh as its hub. The AP Act was a death warrant for it, and the operations of all MFIs in the southern state came to a grinding halt. Almost every state felt the ripples it created, with bad loans piling up as borrowers refused to pay back, and banks declining to give loans to the MFIs. Bank loans are a lifeline for the MFIs.
Karnataka is not the hub of microfinance at this point. Going by data from Equifax Credit Information Services Pvt Ltd, a credit bureau, in December 2024, Karnataka was the fourth largest state for the microfinance industry, which had a Rs 384,396 crore portfolio. Ahead of Karnataka are Bihar, Tamil Nadu and Uttar Pradesh in terms of the volume of business. West Bengal follows Karnataka.
As of November, there were at least 5.5 million borrowers in Karnataka, and the state’s microfinance portfolio was around Rs 37,500 crore, provided by banks (both universal as well small finance banks), non-banking financial companies (NBFCs) and MFIs.
What does the ordinance propose to do? Within 30 days of its commencement, all MFIs operating in Karnataka must apply for registration within the state, giving details of where they want to operate, the rate of interest charged and the method of recovery of loans, among other stipulations. The registering authority at any time can cancel the registration suo motu or on receiving complaints from borrowers.
The government can specify the norms for lending, collection and recovery practices. Any coercive action for loan recovery by an MFI or its agents will be punished. The punishment includes imprisonment between six months and ten years and a penalty of up to Rs 5 lakh. The state registration authority is also empowered to suspend or cancel the registration of an errand MFI.
Of course, the proposed ordinance clearly says that it will not be applicable to any bank or NBFC registered with the RBI. The question is: If the Bill is targeting the unregulated entities that have been mimicking MFIs on the field, shouldn’t the word “micro finance” be replaced with some other word? Indeed, microfinance is all about micro loans but since the MFIs primarily disburse such loans (banks of course do too), they get the blame and cannot escape the fallout as most of the borrowers don’t distinguish between regulated lenders and the unregulated ones.
(Incidentally, the Andhra Pradesh ordinance of 2010 was originally applicable to even the RBI-registered entities. A High Court and then the Supreme Court squashed that. The state later removed the RBI-registered entity through an amendment to the Act.)
Typically, local influential persons work as ring leaders for the unregulated micro lenders and take the community of borrowers for a ride. A “ring leader” is an intermediary or an agent, often a community leader, who acts as a point of contact between a lender and its borrowers, facilitating loan applications, collecting repayments, and managing groups of borrowers within a specific area.
They are responsible for conducting meetings in their premises and collecting weekly repayments from the borrowers. Sometimes they collect the money but don’t pay the dues, and instead pocket the funds. It’s a lose-lose game, both for the borrowers and the lenders. The borrowers turn defaulters and the lenders’ bad loans rise.
If Karnataka goes ahead with the ordinance in the current form, the regulated micro lenders will find the going tough in the state, and the impact will be felt across India. This is at a time when the MFI industry is grappling with a rising pile of bad loans and a declining loan book.
In the past one year, between December 2023 and 2024, the micro loan portfolio has shrunk 3.52 per cent. In the December quarter, Rs 63,959 crore was disbursed – 35 per cent less than in the year-ago quarter. The NBFC-MFIs have the largest share of the portfolio at 39.1 per cent, followed by private banks (32.5 per cent), small finance banks (16.15 per cent) and pure-play NBFCs (12.26 per cent).
How has the quality of assets been? Around 6.92 per cent of the loans have not been serviced for at least 30 days; delinquency for more than 90 days is 3.9 per cent, and for more than 180 days, it is 9.46 per cent. Year-on-year, there is a sharp rise in bad loans.
What is Karnataka’s share of bad loans? In the bracket of 30-179 days past due (DPD), it has risen from 0.76 per cent to 4.62 per cent in the past one year; for 90-179 DPD, the rise is from 0.34 per cent to 2.18 per cent. The proportion of bad loans in the 180+ DPD bracket has remained almost unchanged (4.88 per cent/4.85 per cent). Karnataka, in fact, is doing better than other states.
Among the top 10 states with micro finance exposure, Odisha has the maximum bad loans (11.31 per cent loans not serviced for more than 30 days), followed by Jharkhand (11.03 per cent), Uttar Pradesh (9.06 per cent), Rajasthan (8.17 per cent) and Madhya Pradesh (7.97 per cent). In percentage terms, the rise in bad loans has been five times or more for a few states.
Let’s hope that like phoenix, the MFI industry is able to rise from the current mess, which is not confined to Karnataka alone.
PS: The Karnataka governor wrote back to the state government on January 7, saying, “Instead of bringing the Ordinance in a hurry, I advise the State to deliberate this issue in detail and bring an effective enactment in the interest of the affected people and to protect their rights.”
According to him, “This Ordinance will benefit the borrower section of the society, in (sic) the same time, it will affect the lenders who are also part of the same society. Hence, this issue needs to be deliberated in detail in the state Legislature.”
This column first appeared in Business Standard
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