For microlenders in India, it’s time to pause and reflect. There are troubling signs that the issues which nearly collapsed the industry during the 2010-2012 Andhra Pradesh crisis are re-emerging. In states like Assam, West Bengal, Bihar, and Odisha, some microlenders are charging excessively high interest rates, sometimes as high as 35-40 percent annually. This is alarming for the industry. Microfinance institutions (MFIs) typically charge high rates because their cost of borrowing is high; they lack access to cheaper customer deposits that banks enjoy. Charging a margin of 10-12 percent over a borrowing cost of 9-12 percent results in a total borrowing cost of around 24 percent for their customers. This rate is generally acceptable because microloans are timely, don’t require collateral, and aren’t too sensitive to interest rates.
Technically, it is legal for MFIs to charge any interest rates they choose, as the Reserve Bank of India (RBI) removed limits on loan pricing for these entities in November 2022. However, this does not mean MFIs have free rein to set exorbitant rates. The industry must maintain ethical standards and avoid crossing certain lines. Charging 35-40 percent interest, which implies a margin of 25-35 percent over their borrowing rates, is driven by greed and is unsustainable. This burdens borrowers with heavier debt loads, leading to inevitable defaults and unethical recovery practices, creating a recipe for disaster.
Consider this example: A driver earning a monthly salary of Rs 20,000 has taken a Rs 2-lakh loan from a microlender at a very high rate. He ends up paying almost half his income to service the loan, leaving little for basic family needs. Such borrowers often need to borrow more to cover living expenses, creating a vicious cycle of debt and making default inevitable. When repayments falter, lenders typically resort to harsh recovery tactics.
The microloan industry must remember the 2010 Andhra crisis. A few rogue MFIs engaged in unhealthy credit practices, including high-interest rates and aggressive recovery tactics, which led to borrower suicides and brought the industry to its knees. The state government responded with strict laws that severely restricted MFI operations, halting collections and new loan disbursements. This had nationwide repercussions, forcing the banking regulator to impose tight regulations to restore discipline in the industry.
The current instances of high-interest rates are reminiscent of 2010. If these practices continue, they could lead to a much larger crisis. Although the Indian microfinance industry has learned from past mistakes, ignoring early signs of unhealthy credit practices could be costly. The industry must act now to avert another crisis and ensure sustainable, ethical lending practices.