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Much like Karnataka’s Microfinance Institutions (MFI) ordinance, Tamil Nadu’s April 26 bill targeting coercive loan recovery may disrupt collection efforts of registered lenders, including MFIs, micro-LAP, and two-wheeler loan providers serving low-income groups, analysts have warned.

Analysts at IIFL Securities said that the legislation is modelled on Karnataka’s MFI ordinance, which similarly targeted predatory recovery methods but inadvertently strained the operations of registered lenders.

The Karnataka experience showed a drop in collection efficiency below 90 percent for regulated entities due to borrower confusion and misinterpretation of the law, which some borrowers exploited to avoid repayments despite having the capacity to pay.

Tamil Nadu, accounting for 13 percent of India’s microfinance assets, such as Muthoot MFI, ESAF Small Finance Bank, L&T Finance, CreditAccess Grameen, and Ujjivan Small Finance Bank, could face delays in asset quality normalisation, according to analysts.

The Tamil Nadu Bill

The Tamil Nadu Bill, much like Karnataka’s MFI ordinance, primarily focuses on unregistered lenders, aiming to shield economically vulnerable groups such as farmers, women, self-help groups, agricultural labourers, workmen, footpath vendors, dairy workers, construction workers, and migrant workers. These groups are often trapped in cycles of financial distress due to attractive loan offers from predatory lenders, including digital lending platforms, that lead to unsustainable debt.

The bill is part of a broader pattern of regulatory interventions to protect vulnerable borrowers, following the State’s historical efforts through laws like the Tamil Nadu Pawn Brokers Act, 1943, the Tamil Nadu Money-Lenders Act, 1957, and the Tamil Nadu Prohibition of Charging Exorbitant Interest Act, 2003.

These laws already regulate moneylenders and pawnbrokers to curb exploitative practices.

However, the state Deputy CM said the growing trend of vulnerable groups falling prey to predatory loan offers, necessitating stronger protections.

According to an analyst at a leading brokerage firm, the Tamil Nadu Bill’s vague definition of "coercive" recovery methods, potentially encompassing persistent follow-ups, late-night calls, or physical intimidation, could lead to inconsistent enforcement.

This ambiguity may allow unregistered lenders to exploit legal grey areas or cause borrowers to misinterpret legitimate recovery efforts as coercive, he said.

Many MFIs and banks rely on unregulated business correspondents (BCs) or field agents for loan disbursement and recovery. The Karnataka ordinance highlighted how such agents, not being regulated entities, were targeted under new laws, disrupting operations for compliant lenders.

"If the Tamil Nadu Bill does not clarify the role of BCs, it risks hampering legitimate collection efforts or creating legal risks for MFIs outsourcing recovery," he said.

The Tamil Nadu Bill could inadvertently favour unregulated lenders operating covertly, he said, as registered entities face stricter scrutiny.

By restricting recovery practices, it may also reduce credit availability for vulnerable groups if MFIs scale back lending in Tamil Nadu due to regulatory risks, as seen in Karnataka where some lenders cut disbursements post-ordinance, he said.

Karnataka ordinance

Karnataka’s ordinance, enacted on February 12, 2025, targets unregistered lenders with penalties of up to 10 years of imprisonment and Rs 5 lakh fines but exempts RBI-regulated entities, minimising disruption compared to other States.

However, borrower confusion led to repayment refusals, impacting regulated lenders.

In contrast, Andhra Pradesh’s 2010 ordinance covered both registered and unregistered entities, halting private microfinance operations and causing severe liquidity issues. Assam’s 2020-2021 relief measures, including loan waiver promises, eroded credit discipline, exacerbating delinquencies amid overleveraging and natural calamities.

Analysts at IIFL Securities have predicted elevated sector stress, with collections at risk due to borrower misinterpretation and challenges in distinguishing regulated from unregulated lenders.

Company representatives, according to sources, hesitate to oppose the Bill, framed as a civil rights issue, with one of them saying, “We cannot even propose modifications or oppose because it is a civil rights issue.”

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