Microfinance Crisis: Unlicensed Firms to Face Consequences in Karnataka

Bengaluru, Feb 13 (NationPress) The recent enactment of the Karnataka Microloan and Small Loan (Prohibition of Coercive Measures) Ordinance, 2025, means that microfinance institutions (MFIs) operating without the necessary licenses will now face stringent penalties, including imprisonment for up to 10 years and fines reaching Rs 5 lakh.

The ordinance, effective from February 12, aims to curb the issues associated with MFIs that engage in coercive practices, leading to dire consequences such as suicides and abandonment of homes, as highlighted by the Chief Minister’s Office (CMO).

As stipulated in the legislation: “In cases where coercive recovery tactics are employed, those accountable will face severe legal consequences, including a maximum of 10 years in prison and fines of up to Rs 5 lakh. These violations are designated as cognizable and non-bailable, ensuring that police cannot decline to document these incidents.”

This ordinance specifically targets unregistered microfinance institutions that lack registration with the Reserve Bank of India (RBI) or relevant central and state government authorities.

Registered microfinance institutions are exempt from these regulations. It is estimated that about Rs 60,000 crore in loans have been disbursed to approximately 1.09 crore borrowers from registered entities, while unregistered institutions have lent around Rs 40,000 crore, although precise figures are not available, according to the CMO.

All microfinance institutions must register with district authorities to operate within each district, providing essential information such as interest rates, borrower data, and loan repayment status.

Additionally, these institutions are required to deliver quarterly and annual business reports to the respective district authorities. Noncompliance could lead to penalties of up to Rs 10,000 or six months of imprisonment, or both, according to the law.

Key aspects of the new law include its aim to alleviate the financial strain on borrowers caused by exorbitant interest rates levied by microfinance institutions and other lenders, while also preventing harassment stemming from coercive recovery tactics.

The ordinance is poised to particularly safeguard vulnerable groups, including women, farmers, and women’s self-help groups, from harassment during loan repayment.

Microfinance institutions are strictly prohibited from demanding any collateral from borrowers.

Furthermore, these institutions must clearly disclose their interest rates in writing to borrowers.

The government retains the authority to appoint ombudsmen through official notifications to address disputes involving microfinance institutions.

The ordinance explicitly outlines prohibited coercive recovery methods, allowing a police officer of the rank of Deputy Superintendent of Police (DySP) or higher to register cases on their own accord.

The government can issue periodic guidelines to ensure the effective enforcement of the ordinance. This legislation aims to improve financial discipline among unregistered microfinance institutions, safeguarding borrowers from harassment and coercive recovery practices.

Karnataka Governor Thaawarchand Gehlot recently approved this ordinance put forth by the Congress-led government to address the challenges posed by microfinance institutions.

Previously, the Governor had declined the ordinance, labeling the penalties of 10 years of imprisonment and Rs 5 lakh fines as “excessive.”

The Governor also suggested that law enforcement could have utilized existing regulations to manage the situation.

This ordinance may have adverse effects on the microfinance sector, which could subsequently impact the impoverished communities, the Governor cautioned.