RBI's Loan Caps Threaten Vital Access to Credit for India's Smallest Borrowers

Mumbai, Dec 3 (KNN) In October, the Reserve Bank of India (RBI) barred four small lenders from issuing fresh loans, citing concerns over their usurious interest rates. 

While the RBI's actions were aimed at curbing exploitative lending practices, they fail to address the underlying issue—access to credit for India’s most vulnerable borrowers. 

For millions of small borrowers, particularly pushcart vendors who rely on short-term loans for their daily business, the cost of capital is secondary to the ability to access funds in the first place.

The RBI’s concern is not without merit; in 2022, it removed caps on interest rates for small loans, a move intended to foster a more flexible lending environment. 

However, this change inadvertently opened the door for higher rates, which some lenders have used to exploit low-income borrowers. 

Take the example of a pushcart vendor who borrows Rs 5,000 in the morning, repays it in the evening, and is charged a 30-40 per cent annual interest rate. 

On paper, the interest appears manageable, but when calculated daily, the real cost is astronomical. A loan of Rs 4,500 with Rs 500 interest works out to a daily rate of 11.11 per cent—or an annual rate of over 4,000 per cent. 

For borrowers in dire need of funds, these rates, though steep, may seem like the only option compared to the predatory moneylenders they would otherwise turn to.

Instead of tightening access to credit, the RBI should focus on improving regulation to ensure that borrowers are not trapped in a cycle of debt. One of the key challenges with small loans is the risk of "evergreening," where borrowers take out new loans to pay off old ones. 

This creates a dangerous snowball effect, particularly when lenders fail to track multiple borrowings across institutions. The solution lies not in banning certain lenders but in enhancing regulatory oversight.

One promising tool to combat evergreening is the use of India’s account aggregator framework, which allows borrowers to provide consent for their financial data to be accessed by multiple lenders. 

By using this system, microlenders and NBFCs (non-banking financial companies) could share and verify borrower histories, preventing the cycle of multiple loans based on false or incomplete credit information.

Furthermore, the RBI could take a more proactive approach by promoting transparency in its regulations. Instead of individual meetings with errant lenders, the RBI should issue public guidelines and sanctions, helping other lenders avoid the same pitfalls. 

This would foster a more robust lending environment and reduce the likelihood of predatory practices.

Finally, the RBI could take a bold step toward long-term reform by advocating for a unified financial regulator. In many countries, one entity oversees all aspects of financial regulation, from insurance to bonds to banking. 

By doing so, the RBI can help the millions of small borrowers who rely on credit to survive and thrive in India's rapidly evolving economy.

(KNN Bureau)