Karnataka Micro Loan, and Small Loan Ordinance, 2025 

An attempt to regulate the unorganised microfinance market 

– Team Finserv –  Aditya Iyer | Manager  (finserv@vinodkothari.com) 

Background 

As has been evident from numerous reports, the microfinance sector in India is facing mounting pressure. Rising borrower distress and overindebtedness have led to criticism of microlenders for their aggressive loan sanctions without adequate checks on the borrower’s ability to pay and harsh recovery practices.   Concerns broadly pertain to: Vulnerability of borrowers, cross-selling and opacity of terms, unjustified/usurious rates of interest, multiple loan facilities and coercive methods of recovery etc.

While RBI registered entities are subjected to various regulations such as sector-specific RBI directions on microfinance, MFIN guardrails, NBFC Directions etc. there is not much to regulate the unorganised sector. In an attempt to address these concerns, and curb the challenges faced by local borrowers, the Karnataka Government promulgated ‘The Karnataka Micro Loan And Small Loan (Prevention Of Coercive Actions) Ordinance, 2025’, hereafter referred to as “Ordinance”.  Other states too have attempted to regulate microfinance lending in the past. For instance, the aftermath of the 2010 Andhra Pradesh microfinance crisis, resulted in the Andhra Pradesh Microfinance Institutions (Regulations of Money Lending) Act (2011). Similarly, Assam has also promulgated the Assam Microfinance Institutions (Regulations of Money Lending) Act (2021). The Karnataka ordinance emerges particularly in light of the spate of reported borrower suicides in the region, and reports of usurious recovery practices by lenders. 

The salient features of the ordinance, are as captured below: 

Applicability

1. Applicability upon Banks and NBFCs:  The Ordinance shall not be applicable to any banking or Non-Banking Financial Company, registered with the RBI (Section 1(3)). Therefore, NBFC-MFIs, banks and NBFCs engaged in microfinance will not be governed by the same.
2. Class of lenders being regulated: “Lender” has been defined to include microfinance institutions, moneylending organisations, partnership firm, persons/group of persons, or digital lending platforms whose principal or incidental activity is to lend money, or offer financial support of whatsoever nature, in cash or kind to earn profit by charging interest on daily, weekly, monthly or yearly basis.
   This definition, by virtue of Section 1(3), excludes RBI regulated entities and only applies to persons/entities engaged in unregulated lending activities. Kindly note that businesses with not only principal but also incidental money-lending activities have been covered.
3. Geography: The applicability is upon lenders (as defined above), operating in the State of Karnataka. Other lenders will be regulated by the money-lending Acts and/or microfinance specific Acts in their respective jurisdictions.
4. Does it include LSPs of REs operating in Karnataka?: At the outset, this Ordinance is applicable on “Lenders” which besides excluding RBI regulated entities, refers to entities whose principal business or incidental activity is to lend money, or offer financial support of whatsoever nature. LSPs that are themselves regulated entities would be automatically excluded from this ambit. Non-regulated LSPs, servicing loans in Karnataka, would also not be covered under the same as they would not be lending money (principally or incidentally), and they function as agents of the regulated entities, who are themselves excluded from the ambit of the Ordinance. However, Lenders may indirectly apply the same to their agents  as well.
5. Type of loans or credit facilities covered: The Ordinance governs microfinance loans, however, what is a “microfinance” loan has not been defined in the same. It is presumed that the threshold for what lending constitutes microfinance lending, is as has been captured under the Microfinance Directions for regulated entities. From a literal reading of the text, it may be noted that the definition of a Lender is an inclusive definition under the Ordinance, and is not limited only to persons/entities engaged in microfinance lending. Further, the definition of a borrower refers to JLGs, SHGs and borrowers from vulnerable sections of the society and where the borrower has taken a loan from such Lenders for any purpose. While the Ordinance signals its applicability to borrowers from the agricultural sector and economically vulnerable sections of society, the exact ambit of the Ordinance either on the type of lenders, borrowers or loans is not fully precise.

Key requirements emerging from the Ordinance: 

Conclusion 

While the concerned Ordinance does not cover Banks and NBFCs engaged in microfinance lending, the reports of rising asset quality stress in microfinance, coupled with the scrutiny MFI lenders have received in recent news from state governments, signals the need to adjust lending practices, and governance norms. 

As regards the Ordinance itself, since it would not applicable upon RBI regulated entities, it would include in its ambit individuals engaged in the business of lending, partnerships, and companies engaged in business of microfinance lending without breaching the PBC (thus not requiring NBFC registration). This would be in addition to the , ‘The Karnataka Money-Lenders Act, 1961, which defines “money-lender” includes individuals, HUFs, companies, and unincorporated body of individuals, engaged in the business of money-lending in the state of Karnataka, or has its principal place of money lending business in Karnataka, and does not include banks and certain financial institutions. While the existing Money Lending Act itself would have been amended, the Ordinance raises a pertinent question of giving legal recognition to the unregulated MFI lending sector. 

Finally, certain sections of the Ordinance may have warranted more deliberation. For instance the absence of quantitative thresholds for what qualifies as microfinance lending, introduces ambiguity to the Ordinance. Similarly, the requirement that loan documents and information be in Kannada, does not fully address other linguistic communities that may be beneficiaries of microfinance lending in Karnataka (e.g. migrants from other states).