In a village in rural Andhra Pradesh in the early 1990s, ten women pooled twenty rupees each into a common fund. They had no bank accounts, no collateral, no credit history. What they had was each other. When one member needed a loan, the group decided collectively whether to lend — and the social pressure to repay was stronger than any legal contract. NABARD noticed, and in 1992 launched a pilot to link these Self-Help Groups directly to commercial banks. That pilot became the largest microfinance programme the world has ever seen. But the journey from informal savings circles to a regulated lending category under RBI oversight would take three decades, one devastating crisis, and a complete rethinking of how India regulates credit to the poor.
Also in this series:
- SHG-Bank Linkage and Microfinance Regulation
- NBFC Regulation: The Complete Timeline
- Priority Sector Lending: The Complete Timeline
- Financial Inclusion vs KYC: The Regulatory Tension
Why did rural women need a group mechanism to access credit?
Individual rural women in 1990s India had none of the three things banks require: collateral, documented income, or a credit history. Moneylenders filled the gap at rates of 36% to 120% annually. The SHG model substituted social collateral for physical collateral — the group's collective reputation replaced the land title or gold pledge a bank would normally demand.
NABARD's pilot linked SHGs to commercial banks through a simple mechanism: groups of 10–20 women would save collectively for six months, demonstrate internal lending discipline, and become eligible for bank credit at a ratio of 1:1 to 1:4 against their savings. The RBI's Master Circular describes the rationale:
"Self-Help Savings and Credit Groups had the potential to bring together the formal banking structure and the rural poor for mutual benefit... NABARD launched a pilot project to cover Self-Help Groups promoted by Non-Governmental Organizations, banks and other agencies under the pilot project and supported it by way of refinance." — Master Circular on SHG-Bank Linkage Programme (July 2016)
By 2009, the programme had linked over 6.1 million SHGs to banks, covering roughly 80 million households. Banks got near-perfect repayment rates (above 95%), women got affordable credit, and NABARD absorbed the initial risk through refinance. The early Master Circulars on Micro Credit consolidated these guidelines year after year.
What went wrong in Andhra Pradesh?
The SHG model proved the demand for microfinance was enormous. That attracted commercial capital. Through the 2000s, Microfinance Institutions structured as NBFCs entered the market aggressively. SKS Microfinance went public in 2010 at a valuation that stunned the financial sector. Where SHGs had been about collective self-help, MFIs were about disbursement targets and investor returns.
In Andhra Pradesh — the highest concentration of both SHGs and MFIs in the country — the collision was devastating. Field agents pushed multiple loans on the same borrowers. A single household might owe money to three or four MFIs simultaneously, none aware of the others. Recovery turned coercive. When borrowers who could not repay began taking their own lives, the political crisis became unavoidable.
The AP government responded in October 2010 with the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Ordinance, 2010, effectively shutting down MFI operations in the state. The ordinance was blunt, but the underlying problem was real: an entire lending segment had grown to scale with no entity-specific regulation from the RBI.
Why did the Malegam Committee recommend a new regulatory category?
The AP crisis forced the RBI to act. In October 2010, it constituted a Sub-Committee of its Central Board, chaired by Y.H. Malegam. The committee's January 2011 report identified the core problem: MFIs operated as NBFCs, but generic NBFC regulation had no provisions for the specific risks of microfinance — over-indebtedness, coercive recovery, usurious pricing, multiple lending. The solution was a new regulatory category: the NBFC-MFI. The RBI's consultative document on regulation of microfinance, released in February 2021, traced its lineage directly to Malegam's work.
The key recommendations that became regulation:
Interest rate caps. NBFC-MFIs could charge a maximum margin of 12% over their cost of funds (10% for larger MFIs with loan portfolios above Rs 100 crore). Why this specific structure? Because a flat rate cap would have favoured large, well-funded MFIs and killed smaller ones. The margin cap meant every MFI's ceiling was tethered to its own borrowing cost.
The qualifying loan definition. A microfinance loan could only go to households with annual income up to Rs 1,25,000 (rural) or Rs 2,00,000 (urban). Loan size was capped at Rs 50,000 in the first cycle, Rs 1,00,000 in subsequent cycles. Why these thresholds? To ring-fence the category — if an NBFC wanted the regulatory benefits of the MFI designation, it had to actually serve the poor.
The two-lender norm. No borrower should have loans from more than two MFIs. Total indebtedness could not exceed Rs 1,00,000. This was the direct response to the AP problem of multiple overlapping loans.
How did the NBFC-MFI category actually work?
The RBI issued the NBFC-MFI Directions (since withdrawn) on December 2, 2011. ⚠️ These directions have since been withdrawn and superseded by the 2022 harmonised framework. An NBFC could register as an NBFC-MFI only if at least 85% of its net assets consisted of "qualifying assets" — microfinance loans meeting the income and size thresholds. The architecture evolved through a chain of amendments:
"The limit of the loan amount, for which the tenure of the loan shall not be less than 24 months, has been raised to Rs 30,000 from the present limit of Rs 15,000." — NBFC-MFI Directions Modification (October 2015)
The qualifying asset thresholds were revised upward in November 2019 — household income limits raised to Rs 1,25,000 (rural) and Rs 2,00,000 (urban), indebtedness cap to Rs 1,25,000. The Priority Sector Lending classification for MFI on-lending was updated in parallel. And SHG member-level credit reporting, mandated from January 2016, closed the information gap that had made multiple lending possible.
Why did the RBI abandon the interest rate cap in 2022?
By the late 2010s, the interest rate cap was showing its contradictions. Well-run MFIs earned the same margin as poorly-run ones — the cap removed the reward for efficiency. Banks and SFBs entering the microfinance segment faced no cap at all, creating regulatory arbitrage. The quarterly applicable average base rate for NBFC-MFIs had become a mechanical exercise that did not actually protect borrowers.
The consultative document on regulation of microfinance proposed a radical shift: replace the cap with a conduct-based framework, and apply the same rules to all entities in the microfinance segment.
The Master Direction on Regulatory Framework for Microfinance Loans (March 2022) (since withdrawn) implemented this vision. ⚠️ This direction has been updated through July 2025 and subsequently withdrawn as part of the November 2025 regulatory consolidation. The key changes:
Unified definition. A microfinance loan is any collateral-free loan to a household with annual income up to Rs 3,00,000 — no rural/urban distinction. Why raise the threshold so far above the old NBFC-MFI limits? Because the 2011 thresholds had been overtaken by inflation and no longer captured the actual target population.
No interest rate cap. Instead, each RE must have a board-approved pricing policy with a documented interest rate model and self-imposed ceiling. The RBI reserved the right to intervene if rates were "usurious" — supervision rather than a mechanical rule.
Indebtedness assessment. Total repayment outflows cannot exceed 50% of household monthly income. This replaced the two-lender norm with a more sophisticated affordability test.
What role does industry self-regulation play?
The Microfinance Institutions Network (MFIN) was recognised by the RBI as a Self-Regulatory Organisation for the microfinance sector — part of the RBI's broader strategy of layered regulation where the regulator sets the framework and the SRO monitors day-to-day compliance.
Why does this matter? Because with over 100 million microfinance accounts across thousands of branches in rural India, the RBI needs an intermediary that understands ground-level lending practices. MFIN maintains the industry code of conduct, operates a common borrower database, and acts as the first line of regulatory discipline.
But self-regulation has limits. In October 2024, the RBI took supervisory action against select NBFCs including NBFC-MFIs for pricing practices that violated the spirit of the 2022 framework. In February 2025, a monetary penalty was imposed on Asirvad Micro Finance Limited. The message was clear: the conduct-based framework does not mean the RBI has stopped watching.
Where does this leave microfinance regulation today?
The SHG-Bank Linkage Programme, now governed by the Master Circular on SHG-Bank Linkage (April 2021), continues as one channel. The harmonised microfinance lending framework is the other. And the November 2025 consolidation has folded microfinance provisions into the broader NBFC credit facilities framework and the updated Priority Sector Lending Directions (January 2026).
The fundamental question has not changed since those ten women pooled their twenty rupees: how do you extend formal credit to people who have nothing a bank would normally accept as security? India's answer evolved from social collateral to regulated institutions to conduct-based supervision. Whether the 2022 framework proves durable depends on whether the RBI's supervisory capacity can match the scale of the sector it now oversees.
Last updated: April 2026