Microfinance in vicious cycle of debt, high rates, warns RBI deputy guv

RBI Deputy Governor M Rajeshwar Rao warns of high interest rates, borrower over-indebtedness, and coercive recovery in India's microfinance sector, calls for urgent lender reforms

India’s microfinance sector is facing a "vicious cycle" of borrower over-indebtedness, high interest rates, and coercive recovery practices, Reserve Bank of India (RBI) Deputy Governor M Rajeshwar Rao has warned. Speaking at an event in Mumbai on 5 June, Rao underscored the urgent need for structural reforms in lending practices to ensure responsible and sustainable credit models.

 

“The [microfinance] sector continues to suffer from a vicious cycle of over-indebtedness, high interest rates and harsh recovery practices,” said Rao, according to the full speech published on the RBI’s website on Monday.

 

He noted that even lenders with access to low-cost funds are charging “significantly higher margins than the industry norm,” which in many cases “appear excessive.”

 

Although interest rates on microfinance loans have moderated slightly in recent quarters, “pockets of high interest rates and elevated margins continue to persist,” Rao said, adding that these practices have intensified stress in the sector, particularly in the current financial year.

Concerns over mounting stress

Commercial banks have already flagged concerns about growing distress in the microfinance ecosystem, driven by borrower indebtedness, falling rural incomes, and election-related disruptions.

 

Rao called for a shift in mindset among lenders, urging them to stop treating microfinance as a “high-yielding business” and instead prioritise credit discipline and borrower welfare. “There is a critical need to curb over-leverage and strictly avoid coercive recovery practices,” he said.

 

He added that while many institutions have sound business models, flaws in organisational structures and incentive mechanisms can lead to “perverse outcomes” for borrowers. “This calls for an introspection around the models,” he said.

Financial inclusion and historical milestones

Rao’s remarks were part of a broader speech on financial inclusion, where he highlighted the vital role of access to financial services in reducing poverty, fostering social equity, and promoting economic development.

 

Reflecting on India’s progress in this area, he cited key milestones including bank nationalisation in 1969, the introduction of Priority Sector Lending, and the launch of the Pradhan Mantri Jan Dhan Yojana (PMJDY). As of 21 May 2025, over 550 million Jan Dhan accounts have been opened, with 56 per cent belonging to women, and cumulative deposits crossing ₹2.5 trillion.

Responsible lending and borrower awareness

Rao emphasised that increasing access to credit must go hand in hand with responsible lending and financial education. Without adequate awareness, financial inclusion could instead result in poor decision-making, mis-selling, and further debt accumulation.

 

“To facilitate informed decision-making by the customers and enhance transparency by the lenders, the RBI has mandated that all REs provide a standardised disclosure of key terms and conditions in the form of Key Fact Statement (KFS) to all retail and MSME borrowers,” he noted.

 

Rao’s candid comments reflect the central bank’s deepening concern over unhealthy practices in India’s microfinance space. As the country advances its financial inclusion agenda, the RBI is pushing for a parallel focus on ethical, transparent, and sustainable lending — especially for economically vulnerable populations.