On borrowed time: Rural finance, new rules and old gaps

Alongside better regulation of moneylenders, the problems point to the need for improved access to credit.

Bengaluru: It has been more than six months since 15 families from three villages under the Rampur Gram Panchayat in Nanjangud taluk ‘disappeared’ to avoid paying the exorbitant interest on loans borrowed from various sources. “There is no news of them whatsoever,” says B M Srinivasa, vice president of the Rampur Gram Panchayat.

Tragedies, protests and public anger have moved the state government to come up with an ordinance to “rein in” financing entities that are not registered with the Reserve Bank of India. However, the ordinance does not address the structural problems dogging the rural credit market.

“It started with Covid. Once the lockdowns were lifted, people who had borrowed money in distress were under pressure. There was no other way but to borrow from a different source to pay the older loan. When the baggage of borrowings began tightening, they disappeared,” Srinivasa tells DH.

Microfinance institutions and moneylenders fill major gaps in financial services in villages. In a rural economy where self-employment (64.7 per cent) and casual labour (24.8 per cent) together contribute to nearly 90 per cent of all the employment (as per the Periodic Labour Force Survey 2023-24), uncertainty in the time of mounting debt has pushed households into crisis. 

Jayalakshmamma, who borrowed Rs 2.5 lakh to pay for her husband’s health expenses, was locked out of her house at Vijayapura near Devanahalli, Bengaluru Rural district, in August last year.

She managed to pay back Rs 2.3 lakh. As the prolonged illness kept her husband out of work, the lender demanded an additional Rs 3 lakh to close the loan. “He finally backed out after the media glare and allowed the closing of the loan after paying the right amount. However, my husband has still not recovered. I do not know what to do now,” she says.

This is not the first time microfinance firms and private lenders have come under the spotlight. Over the last two decades, they have been linked to a spate of farm suicides, apart from other distress situations in rural households. During this time, several analysts have cautioned that the absence of regulations and enforcement systems will lead to a crisis.

Over the years, microfinance has become a generic term for all moneylenders offering loans without collateral. In reality, those offering such loans are a mix of companies registered with the Reserve Bank of India (RBI), unregistered companies, housing finance companies, cooperative societies, trusts, associations, self-help groups and private moneylenders. All categories, however, have come under the scanner.

The RBI set up Sa-Dhan and MFIN as self-regulatory organisations (SROs) for the registered microfinance companies. However, the mechanism has not proven to be foolproof.

In October last year, the RBI barred Arohan Financial Services and other companies from lending due to “unfair” and “usurious” practices. The company’s top official, however, was elected chairperson of the MFIN a few months before the action. While the RBI has lifted the restrictions on Arohan in January 2025, observers have questioned the infallibility of the SROs.

T Yashavanth, general secretary of Karnataka Pranta Raitha Sangha, says that over the years, even big companies have been rushing to the rural credit market due to the high margins they offer.

“Many have realised that there is no sector in the world which allows making such profit. A forensic audit of the companies will show that there are some who are charging 150 per cent interest. For defaulters, it climbs higher. The lenders divide the premium and collect it every week. So, you see 50 to 100 lenders in every part of a town,” he says.

A source in the Association of Karnataka Microfinance Institutions (AKMI) blames private money lenders and non-registered companies for the problem. “Last year, the Dharwad district administration called for a meeting. I still remember that apart from the 28 registered participants, there were also 720 entities of different categories who are not governed by the standard RBI rules,” he says.

Prof M S Sriram, chairperson, Public Policy, Indian Institute of Management-Bangalore, says the state government’s ordinance overlooks the complexities of the rural credit system and the need for reforms. “The starting point for the state government is the simple fact that a whole lot of financial activities take place outside the purview of the RBI. Considering that even the self-regulatory mechanism instituted by the RBI for microfinance companies has limitations, the state government should set up a finance regulatory authority for all finance companies registered under the state laws,” he said.

In fact, the ordinance is seen as a knee-jerk reaction. Insiders acknowledge the flaws in the SROs looking into the registered microfinance companies. “There are companies resorting to indiscriminate lending without assessment of a borrower’s credit score. However, the audited data will show that only 8 per cent to 10 per cent of our total borrowers have more than four loans. There is a need to differentiate between companies doing legitimate business and others leaving a trail of over-leveraged families,” a man who has worked in the banking and microfinance sector for over 25 years tells DH.

Jiji Mammen, executive director and CEO, Sa-Dhan, says they have issued a code of conduct for “our members” on adhering to responsible lending. “We monitor the implementation closely. In addition to the code of conduct, we have also prescribed additional guardrails by the name of ‘Sankalps’ in June 2024 to ensure more rigour in curtailing any over-lending by members. Accordingly, no MFI can lend to a household with credit exposure higher than Rs 2 lakh. Similarly, the borrowers with some non-performing assets should not be considered for more lending,” he says.

Acknowledging the confusion over the registered and other entities, he says those operating under the RBI rules have been told to check the comprehensive credit bureau data for all borrowers before lending. “We have a local officer stationed in the state and he keeps a close watch and also organises training programmes for microfinance officials. We are also working closely with AKMI, the state-level association for MFIs,” he says.

A less talked about problem is the limited access to low-interest loans. AKMI sources say the total portfolio of the 31 registered companies in Karnataka is about Rs 70,000 crore. “However, hardly Rs 5,000 crore comes in the form of low-interest loans from NABARD. Many companies are borrowing at 14 per cent and charging 22 per cent annual interest, of which 6 per cent-7 per cent goes towards the operational cost. Of course, there are bad apples, but they are few,” an insider says.

R S Deshpande, former director of the Institute for Social and Economic Change, says that inflation in rural areas needs to be read into the recent government surveys revealing a rise in rural expenditure.

He was responding to a question on the rise in rural monthly per capita consumption expenditure (MPCE) from Rs 3,773 in 2022-23 to Rs 4,122 in 2023-24.

“Consumption increases due to inflation as well as demonstration effect, where low-income groups imitate the consumption patterns of higher-income groups. While we can infer such an effect in the rise in non-food and non-essential expenditure, more granular data is required to back it up with evidence,” he says.

Suresh K P, a rural development expert, says over the years, access to information has brought unbridled consumerism to the rural hinterlands. “No wonder the government report says rural spending is up. The villagers are borrowing money to finance a lifestyle that is not sustainable. The government allowed microfinance firms to finance the money. Now, it is telling people not to repay the loan. The ordinance and the proposed amendments to the laws do not offer any solution to the structural problems,” he says.

He adds there is a need for a regulated lending regime that does not provide loans based on one’s aspirations. “Laws need to be tweaked in a way that rural households can borrow with responsibility. The government can help cooperatives by enabling lending through joint liability groups,” he says.