The microfinance sector in Karnataka has long been a double-edged sword, offering quick credit without the hassle of collateral or credit score requirements, while also exposing borrowers to coercive collection practices. The Karnataka government recently tabled the Micro Loan and Small Loan (Prevention of Coercive Actions) Bill, 2025, which proposes to fully discharge borrowers from repaying loans, including interest, taken from unlicensed and unregistered microfinance institutions (MFIs).
The bill also mandates that any securities collected by such unregistered lenders be released, effectively discharging from any repayment obligations, including interest.
While amendments to existing regulations are being discussed, analysts point out that the issue highlights loopholes in microfinancing and systemic failures, calling for broader intervention, stronger governance, and a more nuanced approach.
Government intervention follows multiple cases
The government’s intervention follows multiple cases of harassment by microfinance companies, including a suicide in Haveri that brought attention to predatory lending practices.
Reports suggest that Karnataka’s rural communities frequently witness such tragedies. In January, Krishnamurthy (35) from Malkundi village and Jayasheela (53) from Ambale village died by suicide after failing to repay microfinance loans of ₹4 lakh and ₹5 lakh, respectively.
Micro-finance- a multi-layered conundrum?
Microfinance institutions support over 1 crore individuals in Karnataka with 63 lakh unique borrowers relying on microcredit loans. The total gross loan portfolio of MFIs in the state has grown sharply, from ₹16,946 crore in March 2019 to ₹42,265 crore in March 2024. However, this rapid expansion has also brought challenges, including repayment struggles and debt collection abuses.
Ravindra Babu S, Professor at CHRIST University calls the microfinance harassment issue layered and complex. He explains that many microfinance borrowers lack financial credibility or even a bank account, making them vulnerable to unorganised, unregistered lenders operating outside regulatory oversight. Even in the regulated sector, third-party collection agents rather than the lenders themselves often handle debt recovery, leading to coercive collection tactics.
Krishnan Iyer, Co-founder & CEO of Finezza Information Technologies, highlights another dimension of the problem, stating unregulated microfinanciers often borrow money and lend it forward at exorbitant interest rates. “The issuer of microfinance harassment arises from systemic failures in the country,” he observes.
Babu further explains the liquidity crunch faced by lenders, which drives aggressive recovery tactics. “For lenders, maintaining liquidity is critical—loans must be repaid so they can be reissued. When a liquidity crisis occurs, some resort to extreme measures to recover funds,” he adds.
Lack of end-use monitoring
The nature of the loan also plays a crucial role in repayment ability. A farmer’s loan repayment is determined by his crop output, which is unpredictable, and causes seasonal fluctuations. In contrast, a housing loan is secured, meaning lenders can recover their money by auctioning the asset if needed. However, unsecured microfinance loans lack end-use monitoring, making it difficult to ensure that borrowed money is used productively, said Iyer.
“If someone takes a loan and spends it on a wedding or a vehicle, rather than on income-generating activities, repayment becomes a challenge,” he added. “Where is the oversight on how these loans are being used?”
The need for nuanced approach
Anand Mishra, Professor of Accounting & Finance at BITS Law School, Mumbai, argues that providing collateral-free loans is an important financial inclusion tool, but it should be financially viable. “Countries like Cambodia, Jordan, and Mexico have faced similar issues of over-borrowing, loan sharking, and predatory collection practices,” he notes.
While policy changes would typically involve imprisonment for harassment and capping interest rates, Mishra believes a more nuanced approach is needed. We need better mechanisms to assess household income and debt levels, and pricing differentiation between loans for income generation and pure consumption,” he suggests.
