Shompa Karmakar learned about microfinance from a neighbour a decade ago. She joined a group of local women to secure small loans — worth a few thousand rupees at a time — and build up her cooking business.

Karmakar, 34, eventually opened a small fast-food restaurant in a busy suburb of Kolkata that served dosas, biryani and chow mein, together with her husband Amit and seven employees. She took her largest loan, worth Rs200,000 ($2,720), from India’s largest microlender Bandhan Bank in March 2020.

It went disastrously wrong from there. Her restaurant closed when the country entered a national lockdown weeks later, and her 40-year-old husband suffered a heart attack — she says from stress. An attempt to revive the business was cut short when India was hit with a second devastating coronavirus wave earlier this year. Amit, who recovered from his previous health scare, and their remaining employees caught Covid. 

The shop is now closed, its colourful signboard dusty and dented, and Karmakar is no longer able to repay her loan. “It’s out of my hands,” she says, speaking outside her home in the alleyway behind the shop. “On top of everything, my husband had a heart attack. How could it get worse?”

Shompa Karmakar in front of her shuttered restaurant in Kolkata, India
Shompa Karmakar in front of her closed restaurant in Kolkata, India © Benjamin Parkin/FT

Karmakar is one of millions of microfinance borrowers and small-business owners in India struggling to pay their debts, threatening what has been one of the country’s biggest economic success stories and a pillar of its financial system.

The expansion of credit in recent decades has allowed low-income Indians to take loans to pay for everything from dairy cows to new houses to job-creating small businesses. This microfinance model, which has been used across the developing world, has been hailed for helping to provide the financial security and inclusion needed to lift millions from poverty.

High rates of repayment rewarded the Indian lenders that extended credit to them, making it among the healthiest pockets of a financial sector otherwise plagued by one of the world’s highest bad loan ratios. It contrasted virtuously with large-scale corporate lending to “Bollygarch” tycoons, some of whom have made failed bets on sectors like power or airlines or have been accused of siphoning off the money.

The pandemic has reversed this dynamic. Larger corporations have been best placed to withstand the economic shock, tapping easy liquidity, gaining market share and cutting costs, including through lay-offs.

The lack of a safety net for low-income Indians and small businesses, meanwhile, has been brutally exposed as they have struggled to operate online, Covid health emergencies have pushed many into debt and banks have cut back on higher-risk, unsecured lending.

The Reserve Bank of India warned in its July financial stability report of signs of stress among small businesses and retail borrowers. Analysts fear this could leave scars on India’s economy and financial system, weighing on growth and exacerbating inequality for years to come.

“For larger players, they could revive faster . . . but for smaller regional lenders and microfinance players whose equity gets diluted, it could mean trouble,” says Siddharth Goel, an analyst at Fitch Ratings. “There could be a shift in market share — strong becoming stronger, weak becoming weaker.”

Bandhan Bank has seen its share of non-performing loans — in which payments are over 90 days late — rise to 8.2 per cent in the quarter that ended June 30 from below 2 per cent before Covid. Another fifth of its loans are overdue by less than 90 days, according to brokerage Motilal Oswal.

Chandra Shekhar Ghosh, managing director of Bandhan Bank, at his office in Salt Lake, Kolkata
Chandra Shekhar Ghosh, founder of Bandhan Bank, believes his customers need space to recover © Chhandak Pradhan/FT

Other microfinance and small business lenders have seen similar drops in collections.

Bandhan’s founder, Chandra Shekhar Ghosh, believes customers like Karmakar will once again start repaying — but need space to recover. He says the bank typically writes off less than 1 per cent of its accounts, but concedes it could rise to 5 per cent in an “extreme” case.

“These people will return back,” says Ghosh. “They are only asking for time. They are in business. Without business they cannot survive.”

“These types of customers do not understand the impact of 90 days. They only say, ‘Sir, give some time. I will come back.’” 

Life-changing investments

Mousumi Karmakar, no relation to Shompa, has been a model microfinance customer, rising from someone who never had a loan or even bank account to a business owner. From an original loan of Rs10,000 taken from her local Bandhan branch 10 years ago, her latest was Rs270,000.

Together with her husband Arup, a broad-shouldered school badminton champion, the 29-year-old runs a hole-in-the-wall sporting goods and repair shop in an alleyway, selling cricket bats or mending torn football boots. If she is able to repay her current loan and get a new one, she wants to hire someone to run a second outlet. “If I get financial support, I will keep increasing,” she says.

Mousumi and Arup Karmaker at their hole-in-the-wall sporting goods shop
Mousumi and Arup Karmakar at their hole-in-the-wall sporting goods shop © Benjamin Parkin/FT

The rise of lenders like Bandhan has been a success story of Indian finance. Ghosh, the son of a sweetshop owner, studied in Bangladesh where he saw the microfinance model pioneered by Muhammad Yunus, the Nobel Prize-winning founder of Grameen Bank.

Lenders typically give out unsecured loans as low as a few dollars to poor borrowers, usually women, who otherwise depended on informal moneylenders with triple-digit interest rates that trap them in cycles of debt.

That money could be used for potentially life-changing investments in something as simple as a sewing machine with which to start a modest garment trade. Borrowers are often given loans in groups that meet regularly, and are sometimes even jointly liable for each others’ debts, creating a level of accountability towards each other that helps keep repayment high.

Bandhan, which was founded in Kolkata in 2001 and has 12m customers, is one of only a handful of lenders since 2014 to have received an RBI licence to transform into a fully fledged bank.

Unlike many microfinance lenders or non-bank financial companies, who often struggle for funding, it can access cheap money through depositors and has diversified into segments like mortgages. Its loan book grew above Rs800bn, though around two-thirds of its business remains in microfinance.

A man walks along a near-deserted street during a lockdown in April this year in Mumbai
A man walks along a near-deserted street during a lockdown in April this year in Mumbai © Fariha Farooqui/Getty Images

Microfinance has however been hit by scandals after unscrupulous lenders used harassment and sometimes violence to force repayment. Andhra Pradesh in 2010 halted all collections on microloans after 30 suicides in the state were blamed on pressure to repay, sparking a multiyear industry crisis.

The strain on the sector increased before Covid. An economic slowdown that started in 2018 piled pressure on borrowers. And the high-profile failures of well-known non-bank financial companies accused of wrongdoing sparked a credit crunch, as the banks that had funded microfinance or small-business lenders became wary of the sector.

Covid has proved a much-deeper shock, sending India into a historic contraction.

After the country entered lockdown in March 2020, the RBI unveiled a six-month moratorium on loan repayments and a restructuring programme designed to prevent an immediate wave of defaults. A study by industry association Sa-Dhan found that around 90 per cent of microfinance lenders extended the moratorium to customers.

Column chart showing how bad debt will hang over Indian banks by comparing real GDP, credit growth, credit cost and return on average assets with non-performing plus restructured loans for 2021, 2022 and 2023

This helped the banking sector avoid the worst of an expected surge in bad loans, but those relief measures had mostly run their course by the time India’s second Covid wave erupted in March. At its peak, India was recording more than 400,000 infections and 4,000 deaths a day, hospitals were overwhelmed and local authorities reintroduced lockdown restrictions.

Small borrowers, already weakened by the first wave, were ill-prepared.

“Our small businesses [have] really seen their revenue streams constrict again, significantly,” says Hardika Shah, the founder of Bangalore-based Kinara Capital, a lender that provides small business loans. “Customers really didn’t want to default. They were just in a bad situation. The bad situation was amplified by illness and a level of agony.”

“You might have some reserves and some bullets in the chamber, but you’ve kind of used them all to survive,” she adds. “The emotional wear and tear was noticeable and significant, far more than it was the first time.”

Shikha Das at her tea stall in Kolkata, India
Shikha Das, who runs a tea stall with her husband, is worried about another wave of coronavirus © Benjamin Parkin/FT

Prolonged pain

Shikha Das runs a tea stall with her husband and a small garment business, selling children’s clothing or shirts to local market vendors on credit.

Her father and mother were hospitalised with Covid during the second wave but recovered. Lockdown restrictions forced the stall to operate at reduced hours, meaning earnings were only about 25 per cent of pre-Covid levels.

Her garment customers were themselves unable to pay, and collectively owe her around Rs45,000. Her earnings are picking up, however, and she is trying to restart weekly repayments on her Rs150,000 loan from Bandhan.

“Markets are opening up slowly,” she says. “I have to start paying back Bandhan to be able to get more loans from them for my business . . . We will somehow get by.”

India is approaching its annual festive season, when a series of Hindu ceremonies such as Diwali and Durga Puja — particularly important in Kolkata and eastern India — boost commercial activity and gift buying. It is the most important time of the year for many businesses.

Das is fearful, however, that the festivities could be scuppered by another Covid wave, which some public-health experts warn could arrive in the coming months.

People shop at a wholesale vegetable market in Kolkata
Manufacturing and services activity has picked up, and S&P expects India’s economy to rebound 9.5 per cent in the year ending March © Mainak Bagchi/AFP/Getty Images

Ghosh, Bandhan’s founder, is hopeful that better preparedness and vaccination coverage will help avoid the disruption of earlier waves. More than a third of India’s 1.4bn population has received at least one Covid vaccine dose, while local authorities and hospitals have vowed to boost medical oxygen production and other health infrastructure.

“Every year, the Puja is the starting point for business,” he says. “One month before business will start. Buyers will come back.”

Manufacturing and services activity has already picked up, and S&P expects India’s economy to rebound 9.5 per cent in the year ending March — though off a low base following last year’s contraction. But the rating agency expects the financial sector to experience prolonged pain, with the share of weak bank loans remaining as high as 12 per cent for another year at least.

Double-scale chart showing how Bandhan's bad loans have surged by showing provisions in billions of rupees against gross non-performing assets as a percentage

The government has introduced relief measures, including a Rs75bn credit guarantee scheme for microfinance borrowers, though analysts say banks remain reluctant to fund vulnerable demographics.

“The main lifeline of credit to these smaller businesses are non-bank financial companies and microfinance institutions,” says Ravi Venkatesan, a former chair of the state-owned Bank of Baroda who works to promote small businesses. “Those people are no longer able to borrow from banks because those banks have become risk averse, so that whole channel is very dry.”

Years of gains in financial inclusion and poverty alleviation are at risk. A study during the first Covid wave last year in the southern state of Tamil Nadu found a third of small and medium-sized businesses were ready to return to informal moneylenders due to difficulty securing lending from formal institutions and the urgent need for cash.

Health workers inject an elderly man at his village outside Kolkata with the Covishield vaccine
Health workers inject an elderly man at his village outside Kolkata with the Covishield vaccine © Dibyangshu Sarkar/AFP/Getty Images

And the Pew Research Center found the ranks of India’s poor, defined as those earning less than $2 a day, swelled by 75m in 2020, before the most recent wave. Millions of newly middle-class Indians have lost the comfort and security they were beginning to enjoy. Their consumption was expected to be India’s growth driver for many years to come.

“It has had a long-term impact. A lot of people have slipped below the poverty line,” says Sanjay Sharma, who runs Delhi-based small-business lender Aye Finance. “They’ve lost jobs. There is a pressure [from] using up their savings. Once that happens, their wellbeing takes a hit. They had a medical emergency and had to spend large amounts.” 

It could dampen future prospects for the lenders that serve them. Analysts at Jefferies have lowered their net profit estimates for Bandhan Bank until 2024.

Ghosh believes it will take until at least 2024 for businesses to return to pre-Covid levels, but is optimistic about Bandhan’s plans to diversify and offer its customers a growing range of financial products from mortgages to car loans.

He says microfinance group meetings, which recently restarted after several months, are yielding positive results.

“There is a challenge. But when group meetings are happening and the customers are coming, then it’s also a little bit better,” he says. “Aspiration comes to group borrowers from others. They are saying, ‘How are you [paying]? What are you doing? My business is at a loss.’ They learn from other group members.”

Additional reporting by Jyotsna Singh in New Delhi

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