Multiple loans leading to debt trap? Amid rising microfinance defaults, what to do if you're struggling to repay your loan

Loan defaults continue to rise among small borrowers as is evident from the sharp jump in non-performing assets (NPAs) in the sector, reveals recent data by credit bureau CRIF High Mark. According to the study, the gross NPA ratio in the microfinance sector soared to 11.6% by September 2024, an 18-month high. 

At the heart of the issue is overlapping credit exposure. The data revealed that around 5 million microfinance borrowers, who constitute around 6% of the total borrower base as of November 2024, have taken loans from four or more lenders. Data from the Reserve Bank of India (RBI) also showed that the share of borrowers with loans from four or more lenders increased to 5.8% in September 2024, compared to 3.6% in September 2021.

The pattern of multiple borrowings is increasingly pushing borrowers into a debt trap and adding pressure on the financial system. Borrowers find it difficult to manage the repayments, especially amid economic uncertainties and personal financial emergencies.

"The overlapping credit exposure has significantly contributed to a rise in non-performing assets (NPAs) across the microfinance sector, leading to stress among small borrowers and raising concern across lending institutions," says Mayank Khera, co-founder and COO at Credgenics.

He adds that early intervention and structured support from lenders are crucial to help borrowers recover from financial distress.

What should do you

For borrowers who miss repayment deadlines or default on microfinance loans, the most important first step is to communicate with their lender.

Most microfinance institutions (MFIs) understand that borrowers may go through temporary financial hardship. Many are open to offering loan restructuring or repayment rescheduling to the borrower if he is proactive and transparent about his situation.

Borrowers should avoid taking new loans to repay old ones, as this only worsens their financial burden. Instead, they should review credit reports regularly to monitor outstanding dues. "Seek credit counselling to understand repayment options and avoid aggressive collection pressures. Engage with financial literacy programmes to build long-term money management skills," says Khera.

From a preventive perspective, borrowers need to adopt smarter repayment strategies. "This includes budgeting for repayments, avoiding multiple concurrent loans, prioritising high-cost debt, and building a basic emergency fund. MFIs and financial institutions are also increasingly investing in borrower education to improve repayment behaviour and long-term financial resilience," he adds.

MFIs are also stepping up their efforts to educate borrowers. Financial literacy and borrower awareness campaigns are being run to promote healthy repayment behaviour and financial discipline.

To further support borrowers, Online Dispute Resolution (ODR) platforms are being promoted as an efficient way to handle grievances and resolve financial disputes. These platforms offer a cost-effective and quick alternative to traditional legal channels and help maintain transparency and trust in borrower-lender relationships.

With the RBI encouraging digital financial services and the proposed Arbitration and Conciliation Amendment Bill 2024, the use of ODR is expected to expand rapidly. Khera said, "This will play a vital role in protecting vulnerable borrowers while strengthening the credibility of the microfinance ecosystem."

As defaults increase and financial stress mounts, borrowers and lenders must act swiftly and wisely. By staying informed, seeking early help, and making smart financial decisions, microfinance borrowers can not only avoid default but also build a stronger foundation for future financial stability.