Microlenders under RBI lens for 'netting off' loans; all you need to know

Following its recent action to cap the high interest rates applied to microfinance loans, the Reserve Bank of India (RBI) is now turning its attention to a long-standing industry practise known as ‘netting off’ loans. The central bank now aims to uncover the true financial health of borrowers and address concerns over potential loan rollovers, according to a report in MoneyControl.

 

What is the 'netting off' process?

 

In the microfinance industry, lenders frequently renew or issue fresh loans before borrowers have fully repaid existing ones. Commonly referred to as 'netting off,' this process allows lenders to settle an outstanding loan by issuing a new credit facility, effectively resetting the borrower’s debt while covering any outstanding installments. This method is often used by banks and non-bank financial companies (NBFCs) in tandem with weekly, bi-weekly, or monthly repayment schedules to maintain borrower accounts in good standing.

 

This practise, however, has raised concerns with the RBI, particularly around transparency. Sources close to the regulator suggest that without proper visibility, it is difficult to determine whether borrowers are repaying on time or merely receiving fresh credit. This ambiguity challenges the assessment of default risk, especially with loans that are continually renewed before nearing the SMA-2 category, which indicates loans overdue by 61 to 90 days and is a common indicator of borrower stress.

 

Regulatory concerns

 

During its FY24 annual inspection of banks and NBFCs, the RBI flagged concerns regarding the widespread use of 'netting off' in microfinance loans. A senior executive from a small finance bank told MoneyControl that this practise has become increasingly common since the pandemic, with the regulator initially noticing it in FY22 and formally raising it as an issue in FY23. In FY24, the prevalence of loan rollovers led to heightened scrutiny, ultimately prompting the RBI to take a closer look.

 

The RBI is now directing banks and NBFCs involved in microfinance lending to ensure borrowers fully repay outstanding loans before availing of new ones. A CEO from an NBFC-MFI confirmed the new mandate, adding that the regulator seeks to prevent lenders from rolling over loans without first closing the existing credit.

 

Broader implications 

 

Some lenders argue that 'netting off' helps ease the repayment burden on borrowers by offering additional support, especially in challenging financial times. However, the RBI remains cautious, questioning whether this practise truly serves the borrower’s needs or simply allows lenders to maintain accounts as standard in their records. A senior executive at a private bank commented that, in many cases, distinguishing between genuine borrower assistance and the avoidance of loan classification as non-performing is difficult.

 

A report from CRIF Highmark, released earlier this year, revealed that around 10 per cent of microfinance borrowers in states like Uttar Pradesh and Bihar have loans with three or more lenders. According to the RBI, without clear differentiation, practises like 'netting off' are increasingly seen as a form of "ever-greening" – the extension of new loans to avoid declaring defaults.

 

Future outlook

 

The strain within microfinance loans became especially evident in Q2FY25 results, with several banks and NBFCs indicating that stress in the sector is likely to normalise by March 2025. Institutions have also hinted at a likely deceleration in loan growth in the microfinance segment as they adjust to the RBI’s new regulatory expectations. 

 

As of now, the RBI has not issued an official statement on these regulatory adjustments, but the industry is already seeing a shift as lenders align with the anticipated new standards.