Critical Analysis of the Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance, 2025.

S.Basavaraj, Senior Advocate, Bengaluru. 
1. The Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance, 2025, has been promulgated to regulate microfinance activities, prevent coercive loan recovery practices, and protect vulnerable borrowers. 
2. While the ordinance aims to address financial exploitation, several defects and criticisms arise concerning its legal clarity, retrospective operation, overreach, and impact on financial inclusion.
3. Vague and Overbroad Definitions. The ordinance lacks precise definitions for key terms, leading to potential misinterpretation:
"Lender" includes Micro Finance Institutions (MFIs), Money Lending Agencies, digital lending platforms, and individuals. This implies stringent regulatory oversight for informal lenders. There is a possibility of including even the hire-purchase and purchase through hypothecation process also. The definition has the potentiality of including every bonafide loan transaction for the lack of clarity. 
"Coercive Action" is broadly defined under Section 8, encompassing actions like "frequenting the borrower's house" and "persistently following the borrower." This can criminalize even legitimate debt collection efforts. For example, re-possessing vehicles under auto-loan scheme will be considered as coercive action even though the lending is backed by documents and verification. Moreover, The Hon'ble Supreme Court of India Charanjit Singh Chadha v. Sudhir Mehra, (2001) 7 SCC 417 had an occasion to consider the issue as whether the hire-purchase amounts to money lending and the profit generated from the contract amounts to interest.
"Vulnerable section of the society" – Section 2(g) this term as to mean and include farmers, women, self-help groups of women, agricultural laborers, workmen, footpath vendors, other vendors who move from one place to another, workers working in milk dairies, construction workers, migrant workers, and those groups of people who are disadvantaged as compared to others, mainly on account of reduced access to basic services and the underlying determinants of health, housing, sanitation, etc. and those who are economically backward, low on livelihood patterns with no regular source of income.
Problems with this Definition: It is subjective and broad categories: The definition does not provide clear income or occupational benchmarks to determine who qualifies as "vulnerable."
Terms like "economically backward," "low on livelihood patterns," and "no regular source of income" are vague and subjective, leading to arbitrary interpretations by authorities.
No Standardized Eligibility Criteria: Does every woman qualify as vulnerable, or only those in self-help groups (SHGs)?
How does a migrant worker prove vulnerability?
Is a construction worker employed by a reputed company also considered vulnerable?
No linkage to existing poverty classifications such as Below Poverty Line (BPL) status, income certificates, or social security schemes.
Discretionary Power to Authorities: Since vulnerability is loosely defined, authorities (Deputy Commissioners or Registering Authorities) get excessive discretion to determine eligibility.
This may lead to inconsistencies, bureaucratic delays, and potential misuse by politically or socially influential groups.
4. Confusion in Implementation of debt waivers. Section 14(a) retroactively discharges loans for the "vulnerable section of society" if the lender is unregistered or unlicensed. Since vulnerability is not well-defined, there will be disputes over eligibility for loan waivers. A borrower earning ?30,000 per month but working as a vendor may claim protection, while an agricultural worker earning ?10,000 may be excluded if not officially classified as vulnerable.
How will lenders verify a borrower's "vulnerable" status? Can borrowers fraudulently claim vulnerability to avoid repayment?
What happens if a borrower was "non-vulnerable" at the time of the loan but later became "vulnerable"?
Exclusion of Other Potentially Vulnerable Groups. The ordinance does not specify whether it covers other vulnerable groups such as:
Senior citizens with no income
Differently-abled individuals without financial support
Persons affected by natural disasters, pandemics, or financial crises
The inclusion criteria are arbitrary, and many deserving individuals may be left out due to bureaucratic oversight.
5. Risk of Misuse and Political Manipulation. Since "vulnerable section" lacks clear guidelines, political parties and influential groups may manipulate the system to extend debt waivers selectively. This could lead to financial instability for lenders and discourage genuine microfinance lending to weaker sections.
6. Exemption of NBFCs and Banks – Creating Regulatory Arbitrage
Section 1(3) explicitly excludes RBI-registered banks and NBFCs, creating an uneven regulatory field.
This exclusion creates room for evasion, as many predatory lenders could operate under the garb of NBFCs to bypass regulations.
Instead of blanket exclusion, uniform consumer protection should have been ensured.
7. Overreach of Regulatory Powers. Section 4(1) grants the Registering Authority the power to cancel or suspend licenses based on mere complaints.
8. Section 9 allows inspections, entry, and seizure of records without specific procedural safeguards.
The ordinance empowers authorities to interfere excessively with microfinance operations, leading to bureaucratic inefficiencies and corruption risks.
9. Lack of a Clear Interest Rate Cap. The ordinance fails to prescribe a specific cap on interest rates but only requires disclosure of rates (Section 7).
This omission limits the effectiveness of borrower protection, as MFIs could continue charging exorbitant rates.
10. One-Year Licensing Requirement – Creating Market Uncertainty. Section 3 mandates annual registration renewal, causing uncertainty for MFIs, affecting long-term investments and loan structuring.
MFIs typically require longer operational stability to attract investments and plan loan disbursements.
11. Retrospective Operation. Nullification of Existing Loans (Section 14)
Section 14(a) retroactively discharges all loans given by unregistered/unlicensed lenders.
This violates contractual rights, leading to severe financial losses for MFIs and lenders who operated legally before the ordinance.
Retrospective nullification discourages future credit availability, harming financial inclusion efforts.
12. Civil Proceedings and Legal Uncertainty
Section 14(b) bars civil courts from entertaining any recovery suits for pre-existing loans from unlicensed lenders.
Section 14(c) abates all pending suits and appeals for loan recovery.
Legalizing loan default retrospectively sets a dangerous precedent, encouraging willful default.
13. Violates Article 19(1)(g) of the Constitution
The retrospective ban on loan recovery deprives lenders of their right to conduct business freely.
The ordinance should allow regulated recovery mechanisms instead of completely nullifying existing contractual obligations.
14. Penal Provisions – Draconian and Excessive Punishments
Section 12 imposes up to 10 years imprisonment and a ?5 lakh fine for coercive recovery actions.
The offense is made cognizable and non-bailable, treating it on par with severe crimes like financial fraud.
15. Lack of proportionality: Distinguishing between fair recovery methods and coercive actions is left to law enforcement discretion.
This could result in abuse of process and harassment of legitimate lenders.
16. Practical and Economic Impact
Negative Impact on Financial Inclusion
Many small MFIs and informal lenders fill the credit gap left by banks, serving low-income groups.
Excessive regulation could push lending underground, leading to more informal and unregulated lending.
17. Instead of restricting lending, the government should focus on interest rate standardization and borrower education.
18. Discourages Investment in Karnataka’s Microfinance Sector
Arbitrary registration requirements, excessive penalties, and retrospective application could scare away investors and lenders.
Investors prefer regulatory certainty, and annual licensing requirements create unpredictability.
19. Alternative Approaches for Better Regulation
Instead of harsh criminal penalties, the government should:
Cap interest rates using RBI guidelines.
Mandate grievance redressal mechanisms rather than outright banning debt collection.
Encourage credit bureau integration to ensure responsible lending.
In conclusion, the Ordinance is a flawed legislation with good intentions. While the ordinance attempts to protect borrowers, it suffers from regulatory overreach, excessive penalties, and retrospective application that undermines financial stability. Instead of outright bans, a balanced approach is needed, promoting responsible lending while ensuring borrower protection.
Recommendations for Improvement
Clearly define coercive actions to avoid criminalizing lawful recovery.
Remove retrospective nullification of loans to protect contractual rights.
Standardize interest rate caps rather than only mandating disclosure.
Streamline licensing to avoid market uncertainty and excessive bureaucratic control.
Strengthen borrower protections via transparency and grievance redressal instead of focusing on punitive measures.
S. Basavaraj
Senior Advocate,
Bengaluru. 
raj@dakshalegal.com
Note: The author has used ChatGPT for the initial analysation of the Ordinance.