The Karnataka Micro Loan and Small Loan (Prevention of Coercive Action) ordinance 2025 effective 12 February 2025 could have short-term disruptions, impact customer discipline in the near term and lead to an increase in delinquencies in the fourth quarter (4QFY25) for non-banking finance companies-microfinance institutions (NBFC-MFIs), cautioned India Ratings and Research (Ind-Ra).
This is despite the ordinance excluding banks, NBFCs and NBFC-MFIs and being applicable to un-registered/ unlicensed microlenders.
The credit rating agency noted that Karnataka has the fourth-largest microfinance market in the country and some large NBFC- MFIs have a sizeable portion of their portfolio in the state.
Furthermore, the political events unfolding in Karnataka could have a spillover effect in the nearby regions and would be a key monitorable.
Ind-Ra has maintained a deteriorating sector outlook and a Stable rating Outlook for NBFC-MFIs for FY26.
“Recent developments in Karnataka could exacerbate the ongoing situation for the MFI sector and delay the recovery further as a temporary impact on credit discipline of borrowers is likely, given the geographical contribution of the state and the relative dip seen in the collection efficiency already”, says Karan Gupta, Head and Director Financial Institutions, Ind-Ra.
The agency observed that post new reports regarding several families in Karnataka being allegedly abused by microfinance companies over the past few months and company representatives harassing borrowers in the name of repayment, the issue became political including the arrest of some collection agents by local police authorities and the state government bringing in the Microfinance Ordinance.
It noted that the key points covered under the ordinance include mandatory registration of unregulated micro-lenders with designated district authorities within a specified time frame, prohibition of coercive recovery practices, transparency in loan pricing, establishment of an ombudsperson for mediation of disputes between borrowers and lenders and debt relief in case of loans disbursed prior to implementation of the ordinance.
Ind-Ra opined that the ordinance targets to address the key issue of coercive collection and recovery practices adopted by MFI executives and private moneylenders including fines of up to ₹5 lakh or a jail term of up to 10 years. This could lead to a more ethical lending environment in the state over the medium to long-term.
However, on the counter-side, this may also lead to near-term disruptions in the existing operational environment for NBFC-MFIs.
The agency assessed that with stricter regulations on recovery practices, registered players could face challenges in making collections, especially from the high-risk borrowers in deeper delinquency buckets.
This may also impact borrower discipline as they may feel less pressured to make repayments, leading to increased defaults and asset quality issues for the segment. Incremental disbursements may also be impacted, till the operations are streamlined in the state.
Ind-Ra said the ordinance also points towards relief on the loans extended by un-registered/ unlicensed MFIs, prior to the ordinance’s implementation.
It took note of the Self-Regulatory Organisations (SRO) guardrails which restrict the number of microfinance lenders to three per borrower and incremental exposure to delinquent borrowers (overdue for more than 60 days), which will help improve the borrower discipline but over the medium term. However, near-term impact on borrower repayment behaviour remains a monitorable.
The agency noted that Karnataka has the fourth-largest microfinance market after Bihar, Tamil Nadu and Uttar Pradesh. Moreover, the top five large NBFC-MFIs operate in the state, comprising nearly 35 per cent of the gross loan portfolio as of December 2024.
The share of Karnataka in the overall loan portfolio for such players ranges between 9 per cent – 33 per cent, indicating some level of geographical concentration risk. With the ongoing political issues in the state, the collection efficiency levels in the state dipped by 1 per cent – 4 per cent between December 2024 and January 2025, Ind-Ra said.
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