India needs guardrails for shadow-bank flexi loans, not blanket bans

The RBI's proposal to restrict flexible repayment loans by nonbanks could curb risks of bad-debt evergreening, but may also hurt self-employed workers and small businesses that rely on such credit

By Andy Mukherjee

 

Some of India’s smaller nonbank financiers have been getting a bit too creative lately. And that has led the Reserve Bank of India to consider restricting the access to financing needed by self-employed professionals and small business owners. 

 

Revolving credit — which allows people to borrow money up to a set limit, pay it back and borrow again — is a goalpost zealously guarded by banks. Allowing nonbanks unfettered access could encourage borrowers to pay interest to one lender by dipping into their so-called flexi loan with another. Rinsed and repeated, this might lead to the evergreening of bad debt.

 

 

That happens at banks too, but there’s just about 100 of them to supervise. Even though they are also regulated, policing more than 9,000 nonbank financiers is nearly impossible. Hence, the Reserve Bank of India wants loans allowing flexibility around repayments reserved for deposit-taking institutions and credit-card issuers. Other lenders will be banned.

 

The RBI has invited public comments by Aug. 28 on a proposal that shadow banks should only offer term loans with pre-determined repayment schedules. For overdraft limits, borrowers must go to banks.

 

It’s a well-meaning directive that nonetheless ignores the precarious structure of employment in the world’s most-populous nation. Less than half of urban workers — and just 13% in rural areas — get a monthly salary. For over 200 million self-employed people, banks aren’t a reliable source of financing to smooth unpredictable cash flows. They’re reluctant to give working-capital limits to tiny enterprises that lack collateral, while freelancers have trouble getting credit cards because they’re unable to submit evidence of steady income.

 

Smaller firms have it especially hard because buyers are notoriously slow to pay. Nonbank lenders stepped into this gap with a product approved once, for a fixed maturity. It’s not a limit that revolves endlessly. Borrowers withdraw funds as needed and repay surplus cash when available.

 

Borrowers who use about 70% of their withdrawable limit cut interest costs by 200 to 250 basis points while keeping a buffer for rainy days. Lenders enjoy a 30 to 50 basis point advantage over a simple term loan. It works for both sides.

 

Is there evergreening of bad debt in India? Sure. As I wrote recently, smartphone-based loan apps have gone overboard with small-value ($200 or less) loans used to make ends meet. These carry usurious rates with no stacking limits. It is here that regulation is needed. Flexi loans, which have been offered by large nonbanks for a decade or longer, serve a genuine need without posing much of a systemic risk.

 

Market leaders like Bajaj Finance Ltd. and Aditya Birla Capital Ltd. have erected guardrails. As they and other lenders explained to the RBI in 2024, a properly structured flexi loan is not an open-ended credit facility.

 

When a bank gives a business an overdraft, it runs an annual health check on their sales and inventory. By the time stress is detected, a full default has usually occurred. With flexi loans, the sanctioned limit remains capped, follows a rigid amortization schedule, and reduces to zero in five to seven years. To avoid delinquency, borrowers must pay monthly installments using outside funds — not unused balances.

 

Throwing the baby out with the bathwater is a failure of imagination. Instead, the regulator should make fuller use of its regulatory sandbox — a controlled environment designed to assess risks and weigh opportunities. All flexi loans could be battle-tested in real time, allowing the RBI to gather granular data based on actual borrower behavior.

 

Banning the product won’t make it go away. One flexi contract will splinter into 20 term loans, adding to paperwork and overwhelming credit bureaus. Lenders scoring borrowers based on number of loans will have to rewrite algorithms. Borrowers will pay more in processing fees. None of this will yield any systemic improvement.

 

The larger point here goes beyond credit. Basic financial activities like saving, borrowing, and insuring against unforeseen events must not remain the preserve of the salaried middle class. India can no longer afford to ignore its small business owners, gig workers, and freelancers. As artificial intelligence puts pressure on salaried jobs, their numbers will only grow. Digitization has made the self-employed more visible and creditworthy, and they need access to the formal financial system without exposing it to unseen risks.

 

That calls for more competition, not less. Unless banks guarding their goalposts are challenged by imaginative nonbank rivals, why would they innovate to defend their turf? That is how the RBI should see its role in the flexi-loan debate.  

Disclaimer: This is a Bloomberg Opinion piece, and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper