RBI sounds alarm on microfinance: High interest, harsh recovery hurt vulnerable borrowers

The Reserve Bank of India (RBI) has once again highlighted serious concerns surrounding the microfinance sector in the country. At a recent event held in Mumbai, RBI Deputy Governor M. Rajeshwar Rao cautioned against the growing challenges faced by microfinance institutions (MFIs) and emphasized the need for a more sensitive and development-oriented approach towards this crucial sector.

“Microfinance has played a significant role in extending financial services to the weaker sections of society,” Deputy Governor Rao acknowledged. However, he warned that despite its positive impact, the sector continues to grapple with several serious issues that threaten its sustainability and social objectives.

One of the primary concerns outlined was the vicious cycle of over-indebtedness, high-interest rates, and aggressive recovery practices. Although some relief has been observed in interest rates recently, many regions still face prohibitively high costs of borrowing. Furthermore, Deputy Governor Rao pointed out that despite access to cheaper funds, several lenders continue to charge excessive margins. In certain cases, these margins have been deemed exorbitant and unjustified.

“There is a growing tendency among some microfinance entities to treat the sector merely as a profit-making business,” he remarked, urging stakeholders to view microfinance with a more sensitive and growth-oriented perspective. He emphasized that microfinance holds the potential to empower economically weaker sections of society but only if managed responsibly.

The Deputy Governor also drew attention to recent instances of irregularities within the sector, including an increase in loan defaults and unethical recovery methods. Such practices, he cautioned, have occasionally led to tragic outcomes. “It is imperative for all stakeholders to implement timely corrective measures,” he stressed.

To improve the sector’s health, Deputy Governor Rao called for better credit appraisal systems before disbursing loans, ensuring that lending decisions are more prudent and borrower-centric. He warned against forced or unethical recovery tactics and advocated for delivering financial services in a responsible and sustainable manner.

While acknowledging that the microfinance business model is fundamentally sound, he pointed out inherent flaws in the incentive structures that sometimes lead to customer exploitation. “These systemic shortcomings harm the customers and warrant a thorough re-examination of the model,” he concluded.

The RBI’s renewed focus on the microfinance sector underscores the delicate balance between financial inclusion and consumer protection, highlighting the importance of safeguarding vulnerable borrowers while fostering sustainable growth in this vital segment of India’s financial ecosystem.