Microfinance sector needs to introspect, avoid harsh coercive recovery practices: Rajeshwar Rao

New Delhi, June 25 The Reserve Bank of India (RBI) on Wednesday said that while the microfinance sector has played an important role in financial inclusion, there are some issues which need urgent attention.

The sector continues to suffer from a vicious cycle of over-indebtedness, high interest rates and harsh recovery practices, RBI Deputy Governor M. Rajeshwar Rao said in an article in the RBI's June bulletin.

Microfinance has placed itself as a promising avenue for providing formal financial services to the excluded sections of the population.

"While some moderation in interest rates charged on microfinance loans has been observed in recent quarters, pockets of high interest rates and elevated margins continue to persist," Rao wrote.

"Even lenders having access to low-cost funds have been found to be charging margins significantly higher than the rest of the industry, and which, in several instances, appear to be excessive," he emphasised.

The lenders should look beyond the conventional "high-yielding business" tag for the sector and approach it with an empathic and developmental perspective, recognising the socioeconomic role that microfinance plays in empowering vulnerable communities, Rao added.

The frequency of disruptions in the microfinance sector has increased of late. Incidents of high borrower indebtedness, coupled with coercive recovery practices, sometimes lead to tragic consequences.

Rao suggested that it is in the collective interest of all stakeholders that such disruptions are pre-emptively addressed and avoided. In this regard, REs must also enhance their credit appraisal frameworks to prevent over-leveraging of borrowers.

Additionally, they must eschew any coercive or unethical recovery practices, ensuring that financial services are delivered in a manner that is both responsible and sustainable, he highlighted.

While the business model may be sound, the organisational structure and the incentive schemes framed to deliver the services may be flawed, resulting in perverse outcomes for customers.

"This calls for an introspection around the models," said Rao, adding that we need to be clear about the path that we must take to ensure greater financial inclusion.

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