Hi everyone,  

Welcome to the 132nd edition of The Pattern, a weekly where we dive into the latest from the world of economy, technology, and finance. Let’s get started. 

MFLs and Private banks walking on a tightrope  

The microfinance sector has long been heralded as a key driver of financial inclusion in India, bringing credit to underserved communities. Yet, recent developments have revealed cracks in this promising narrative. RBI is giving major red flags to the lending sector, which has raised concerns from private banks, and government directives cast shadows over microfinance's future in India.  

Today's story has two exhibits in the lending sector, leading to bottlenecks that are likely to cause deep troubles if not tackled promptly.  

Exhibit A  

The Finance Minister of India, in the Union Budget 2024, announced that the Mudra loan limit would be increased to ₹20 lakhs from the current ₹10 lakhs. This is for the borrowers who have successfully repaid their previous loans. This falls under a new category introduced by the government in Mudra loans, the Tarun Plus, allowing borrowers to access loans up to ₹20 lakhs.  

This is good news for small and micro businesses that receive help from the Mudra Yojana. This program has approved more than 40.82 crore  as of FY 2023, which supports job creation and entrepreneurship. It shows how effective last-mile credit delivery systems can be when they come with policy backing. However, private banks seem to be concerned about the larger ticket sizes.  

Private banks in India are seeking a reduction in their targets under this scheme due to several pressing concerns. But why? 

Since its inception in 2015, Prime Minister Mudra Yojana, or PMMY, has disbursed more than 487.8 million loans totaling Rs 29.79 trillion, and MFIs have been key players in this journey.  

However, the economic challenges following the COVID-19 pandemic have led to a decline in loan demand from small businesses. Loan approvals have dropped significantly because people are borrowing less during the COVID-19 pandemic.  

While the private banks say that the lending goals are unrealistic right now since the economy is struggling. They are worried about rising defaults and a decrease in demand from rural areas. Some banks have already had trouble meeting these targets and are concerned about the quality of the loans they are issuing. 

In other words, private banks are concerned about potential defaulters. 

Exhibit B  

MFIs have proved to be the fan favourite among small businesses as they are less stringent than the bigger banks. MFIs provide small, unsecured, collateral-free loans to low-income folks, typically those with annual household earnings of ₹3 lakhs or less. But that has not worked out for them well.  

States like Uttar Pradesh and Bihar are case studies in this burgeoning crisis. RBI data highlights that these regions are witnessing a disproportionate spike in microfinance credit, which, while initially promising, now raises red flags. Defaults are climbing, and so is borrower distress. 

As of June 2024, the percentage of microfinance loans in India overdue for more than 90 days has increased to 1.2% , up from 0.89% in June 2023. This means that more borrowers are having trouble paying back their loans on time, which concerns the microfinance sector.  

Looking into this data, Department of Financial Services (DFS) Secretary M. Nagaraju recently emphasized that reckless lending without adequate borrower financial literacy can only harm these groups in the long term. Over 7.7 million Self-help Groups have outstanding loans of around ₹2.6 trillion. Additionally, Joint Liability Groups have around ₹4.4 trillion in loans.   

Private banks and MFIs are under the radar for handing out loans to self-help groups (SHGs) without properly checking their ability to pay back. The reason? They’re trying to hit tough lending targets. But this often means they’re not considering whether the borrowers can repay their loans, leading to people getting in over their heads and more defaults. 

In other words, the regulatory body is concerned about potential defaulters. 

Conclusion?  

The Indian microfinance sector is at a crossroads.  

Private banks are pushing for a break on Mudra loan targets. Financial inclusion is a great initiative, but this scheme creates pressure on them to hit high disbursement goals, making it tough for them to properly evaluate borrowers' creditworthiness. On top of that, there’s the regulatory pressure. The RBI is really stepping up its focus on compliance and transparency, which means MFIs and NBFCs are under more scrutiny than ever.  

The finance sector is feeling the heat in this tug-of-war between the regulators and the government. It’s crucial to navigate this situation carefully for the millions of people who rely on these services. 

That’s all for this week. I will see you next week. As always, I’ll leave some reading recommendations below.  

Reading List:  

Private Banks seek reduction in Mudra target  

DFS Secretary warns MFIs on reckless lending to SHGs, cites risk to sector stability  

Why is RBI concerned over microfinance credit growth in UP and Bihar?  

Insolvency and Bankruptcy Board of India proposes several changes in latest paper  

Gold loans may soon come with monthly payment plans  

Thank you for reading. If you liked this edition, forward it to your friends, peers, and colleagues. You can also connect with me on Twitter  here  and follow  FinBox on LinkedIn  to always get all updates. 

Cheers, 

Mayank  

All opinions expressed are my own and do not necessarily reflect the views of FinBox or its promoters.