The microfinance landscape in Karnataka presents a complex scenario. It offers borrowers quick access to credit without requiring collateral or a credit history, while also exposing them to aggressive collection practices. In response to this duality, the Karnataka government has introduced the Micro Loan and Small Loan (Prevention of Coercive Actions) Bill, 2025. This proposed legislation aims to free borrowers from the debt obligations, including interest, associated with loans acquired from unregistered microfinance institutions (MFIs).
The bill stipulates that any collateral taken by these unauthorized lenders must be returned to the borrowers, thereby exempting them from further repayment obligations.
Despite ongoing discussions to amend existing regulations, experts underscore that these issues expose significant flaws within the microfinance sector and highlight systemic failures. They argue for comprehensive reform, improved governance, and a more sophisticated approach to address these challenges.
Government Action in Light of Harassment Cases
The need for governmental oversight has grown in light of numerous reported cases of harassment by microfinance companies, including a tragic incident in Haveri that brought predatory lending practices into the spotlight.
Recent reports indicate that rural areas in Karnataka have increasingly witnessed such tragedies. For instance, in January, two individuals—Krishnamurthy (35) from Malkundi village and Jayasheela (53) from Ambale village—took their own lives after struggling to repay microfinance loans amounting to ₹4 lakh and ₹5 lakh, respectively.
Complexities of Microfinance
Karnataka’s microfinance sector supports over 10 million individuals, with approximately 6.3 million unique borrowers relying on microcredit. The total gross loan portfolio for MFIs in the state surged from ₹16,946 crore in March 2019 to ₹42,265 crore by March 2024. However, this rapid growth has introduced significant challenges, particularly in terms of repayment difficulties and aggressive debt recovery practices.
Ravindra Babu S, a professor at CHRIST University, describes the issue of microfinance-related harassment as multifaceted. Many borrowers lack financial history or bank accounts, placing them at risk of exploitation by unregulated lenders who operate outside the bounds of oversight. In the regulated sector, the reliance on third-party collection agents often leads to the use of coercive tactics in debt recovery.
Krishnan Iyer, Co-founder and CEO of Finezza Information Technologies, points out that unregulated microfinance operators frequently borrow capital to lend at exorbitant interest rates. He attributes the problem of harassment in microfinance to broader systemic failures within the country.
Babu also mentions the liquidity challenges faced by lenders, noting that aggressive recovery methods sometimes arise from the necessity to sustain liquidity. “For lenders, having available cash is essential—as loans must be repaid to reissue them. In times of liquidity crises, some may resort to desperate measures to reclaim funds,” he explains.
Challenges in Loan Monitoring
The type of loan significantly impacts repayment capacity. For farmers, loan repayment hinges on crop yields, which can be highly unpredictable, leading to seasonal income variations. Conversely, housing loans are generally secured, allowing lenders to recover funds through the sale of the property if necessary. However, unsecured microfinance loans often lack monitoring of their intended use, complicating repayment efforts. Iyer notes, “If a borrower utilizes a loan for a wedding or vehicle instead of for income-generating purposes, repaying it becomes problematic. Where is the accountability in monitoring how these loans are spent?”
The Call for a Comprehensive Strategy
Anand Mishra, a professor of accounting and finance at BITS Law School in Mumbai, emphasizes that while collateral-free loans are crucial for financial inclusion, they must remain financially sustainable. He cites countries like Cambodia, Jordan, and Mexico, which have encountered similar issues related to over-borrowing and predatory collection methods.
Mishra argues for a more nuanced policy response that includes stronger mechanisms for assessing household income and debt. He suggests implementing differentiated pricing based on the purpose of loans—distinguishing between loans intended for income generation and those meant for consumption—adding that typical policy changes may not suffice.
In conclusion, as Karnataka works to reconcile the benefits and pitfalls of microfinance, it becomes increasingly evident that a comprehensive and well-regulated approach is essential to protect vulnerable borrowers.
