Hi everyone,  

Welcome to the 149th edition of The Pattern, a weekly where we dive into the latest from the world of economy, technology and finance. Let’s get started. 

For many Indian citizens, a bit of downswing is all it takes for a seemingly helpful credit product to turn into a debt trap.  

This isn’t just stressful for the borrowers but it’s nerve wracking for the lenders too. Especially in microfinance. For borrowers, it's overleveraging. The burden of ongoing loans just to keep the household or business afloat. 

For lenders, especially NBFCs and MFIs, non-performing assets are piling up along with declining repayment rates and the difficulty of figuring out the borrower's creditworthiness. 

Over the years, due to the absence of strict rules, this became a vicious cycle. 

The fix  

From April 1 , Microfinance Institutions Network (MFIN) came up with a new guideline. Moving forward, microfinance borrowers will only be able to access a maximum of three lenders for credit. It's a straightforward idea with big implications. 

What was happening before?  

Here's what's been happening on the ground. A microfinance borrower takes a small loan from Lender A. Then another from Lender B. And maybe two more from Lenders C and D. Why? Earlier, the formal systems couldn't track these cross-lender borrowings in real time due to a lack of effective ways. And lenders, eager to meet targets, relied more on declarations than data. 

This lack of visibility has been one of the root causes of today's credit stress in the MFI sector. As of December, last year,  5.3% of India's 84 million microfinance borrowers had loans from more than three lenders. That's over 4.5 million people drowning in financial stress. As a real-time example, Bandhan Bank and IndusInd Bank have  8% and 14% of their portfolio overlapping with three or more other lenders, respectively.  

The problem  

The result? By December, NPAs in the sector had crossed ₹50,000 crore , which is around 13.2% of the gross loan portfolio, according to Sa-Dhan. 

Alok Biswas, MD of Janakalyan Financial Services, said that borrowers are already facing tight liquidity when running their businesses. The credit restriction might invariably lead to a rise in portfolio risk as the capital from these loans is often a lifeline - working capital for their business. But is this short-term pain for long term gain?  

The solution  

The three-lender cap rule is aimed at cutting this spiral off at the root. The idea had already been tested. Last year, MFIN imposed a four-lender cap after noticing a sharp rise in defaults linked to high indebtedness. Now, the more stringent three-lender rule takes a step further and is enforceable starting April 1, 2025. 

"The three-lender cap rule will bring discipline among lenders and also borrowers," said Manoj Kumar Nambiar, chairman of MFIN. 

And yet, the rule isn't pain-free. 

The short-term bane  

"There may be a bit of short-term impact, but this will be good in the medium to long term," added Nambiar. 

In the short term, restricting borrower access will reduce cash flow for those juggling repayments. Some borrowers will default, not because they won't repay, but because they can't find another lender to roll over the loan. 

That's a major concern for lenders. This can lead to new defaults, which means the rise of risky portfolios and poor loan recovery. Also, this will increase operational costs as they will need to upgrade the system to comply with the new rule. There's also the revenue hit—fewer eligible borrowers mean fewer disbursals, making it hard for the FIs to reach their targets. Due to these factors, we can't negate the risk of aggressive lending practices. As microfinance plays a crucial role in supporting small businesses and rural consumption, a lack of access to credit can loosely translate to a slower-moving economy. 

Still, we can't ignore one major risk. Informal lending. If the borrowers are unable to get access to formal credit, what will they do? In that case, they might turn to informal or predatory lending sources. This completely undermines the whole vision of this rule, as these informal lenders will eventually prey on the borrower's vulnerability. 

The long-term boon  

Despite the initial hiccups, this was long overdue. In India's informal economy, where most payments are in cash and there's little paperwork, MFIs have long operated in the dark. Creditworthiness was based on field surveys, word-of-mouth, or outdated data.  

A central database for real-time borrowers didn't exist. The result? The borrowers often slip through the cracks and take loans from multiple MFIs without anyone noticing. 

But now?  

The three-lender cap rule will be enforced using a central database, which MFIs are now mandated to use more rigorously. 

This rule encourages lenders to collaborate, share data, adopt better underwriting practices, and rethink how they assess borrower risk. It nudges borrowers toward credit discipline by default. Over time, it may create an ecosystem where borrowers are safer, and lenders are smarter. 

Reading List:  

1. Lenders urge RBI to return to daily overnight borrowing window to improve liquidity   

2. Around 50% of Mudra accounts belong to SC, ST and OBCs; boosting financial independence: SBI Report  

3. MFI loans down 41 per cent in December quarter, NPAs zoom  

4. Credit card spends drop to 8-month low of Rs 1.67 lakh cr in February   

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

Cheers, 

Mayank