Reforming Lending to Low-Income Households in India

India has developed a robust last-mile credit ecosystem, yet repeated shocks over the past 15 years—Andhra Pradesh crisis (2010), demonetisation (2016), Covid-19 (2020), and the slowdown since early 2024—have caused abrupt lending cuts and household distress.

The solution lies in moving from stop-start lending cycles to continuous, reliable access to formal credit for low-income households.

Key Recommendations

Harmonise Bank-NBFC Partnership and Strengthen PSL

• India’s credit ecosystem spans universal banks, small finance banks (SFBs), NBFCs, and fintechs, linked through direct assignments, co-lending, lending service providers, and business correspondent arrangements.
• Current anomalies:
  • SFBs cannot co-lend, unlike banks and NBFCs.
  • Income from DA assignments is recognised upfront, but not in other formats.
  • Default guarantees allowed in co-lending but not in direct origination.
• Recommendation:
  • Supervise overall bank exposure to non-banks, not just individual transactions.
  • Ensure originators/servicers commit adequate capital to align incentives.
  • Refine Priority Sector Lending (PSL) by increasing weightage for underserved segments and districts.

Reduce Funding Fragility

• Household credit relies heavily on bank funding, including NBFC balance sheets and off-balance-sheet instruments.
• This channel concentration makes the system vulnerable to sudden stops.
• Solution:
  • Deepen capital market access for NBFCs.
  • Provide market-making support for NBFC bonds and securitised instruments to ensure continuity in credit supply during stress.

Replace Crude Lender Caps with Credible Income Assessment

• Traditional caps (e.g., max three lenders per borrower) are too blunt, risking exclusion of entrepreneurial households.
• Recommendation:
  • Use income proxies, occupational archetypes, and soft information from frontline workers for assessing repayment capacity.
  • Establish RBI technical committee standards for minimum validation, governance, and calibration.
  • Leverage the forthcoming all-India household income survey by Ministry of Statistics and Programme Implementation for benchmarking.

Rationale

• Despite concerns about over-leverage, household debt is 42% of GDP, lower than many emerging markets.
• Informal borrowing persists and universal banks struggle to meet PSL targets consistently.
• Harmonised rules, diversified NBFC funding, and credible income assessment can smooth credit access, reduce boom-bust cycles, and minimise disruption to livelihoods.