RBI's microfinance move: Tightening the reins while easing the credit squeeze

RBI's decision on Wednesday to relax risk weights in banks' microfinance lending should be seen as an assertion of its confidence that earlier curbs are delivering results. The stress showing up in this segment - NPAs in the sector have surged to an all-time high of ₹50,000 cr, according to data from Crif High Mark - is the outcome of credit contraction that would, left to itself, have tamed delinquency. Lenders pulled back after RBI last year capped credit and interest rates to overleveraged borrowers. Evergreening of loans has been curtailed, with the new rules setting limits on the number of loans to individual borrowers and prohibit fresh lending to any debtor in default. But this is strong medicine, administered to check the spike in unsecured credit resulting from a previous round of relaxation of microfinance lending rules.

The need has now shifted to a more nuanced approach that relies on a combination of recognition and the revival of rural incomes to reduce stress in microlending. RBI's latest move would suggest that improvements in lending discipline will eventually lead to a plateauing of bad loans and bring the segment into the regulatory comfort zone. An extended credit squeeze in microcredit has a bearing on rural consumption, which RBI will have to keep in mind as it resets its monetary stance to prioritise growth revival over last-mile disinflation. Besides, this segment of borrowers is more vulnerable to adverse climate-driven events whose frequency is increasing.

Lenders will need more time to set their microfinance books in order. But the segment will also benefit from the fresh infusion of credit administered responsibly. Activity-based regulatory interventions have established their robustness to deal with larger volumes. This is the balance RBI would be seeking in its role as monetary authority and banking regulator. The idea is to lower delinquency without shrinking the microfinance loan book. A cleaner delivery mechanism and enhanced credit supply are prerequisites for this outcome.