Microscopic lens on Secured Micro-Lending

Secured micro-lending, a cornerstone of inclusive finance, refers to loans extended to underserved segments against collateral, typically ranging from microfinance loans, MSME loans, and housing loans. This space caters to ticket sizes up to half a million rupees, offering opportunities to individuals and businesses otherwise excluded from formal credit systems. But, has this sector reached a critical inflexion point in India?

In recent years, India has started witnessing challenges in secured micro-lending, with over-leveraged borrowers / households emerging as a key concern. Many middle- and lower-income families, seeking to unlock capital for livelihood or emergency needs, have found themselves trapped under increasing debt burdens. In addition, higher consumerism and hence increasing aspiration especially from younger generation in this segment has also driven higher credit offtake in the unsecured segment driving higher leverage for the household. This rising household indebtedness not only threatens borrowers' financial stability but also raises alarm bells for lenders, policymakers, and the broader financial ecosystem.

The Over-Leverage Paradox

One striking characteristic of this space is its contradictory pricing dynamic. Smaller loans, despite being secured and lower LTV, command far higher interest rates compared to larger secured loans with a higher LTV. Take, for instance, a property worth ₹10 million, which might qualify for a loan-to-value (LTV) ratio of 90% and interest rates between 8.3% to 9%. Contrast this with a property valued at ₹1 million, where eligibility could drop to just 40% and with interest rate ranging anywhere between 11% and 15(+)%, largely due to insufficient credit history. In all likelihood the borrowers tend to go for unorganized lenders / unsecured loans for bridging the funding gap. These factors aggravate the financial burden on households with limited borrowing power, further compounding indebtedness.

Historically, this segment boasted lower default rates compared to unsecured personal loans. However, recent trends indicate rising defaults as over-leveraging reaches unsustainable levels. Whether for micro-entrepreneurs or middle-class families pledging their homes, the inability to manage repayment cycles jeopardizes financial health and risks systemic instability.

Operational and Collateral Challenges

One major roadblock lies in the operational costs of lending. Sourcing and serving customers with smaller loans strain resources, while underwriting collateral presents its own challenges. Technology has been hailed as the savior, with AI-driven underwriting promising efficiencies. However, in this informal segment, where data is sparse and customer profiles are nuanced, technology’s limitations often result in mispriced risk. Aggressive adoption may lead to shortcuts that undermine portfolio quality.

Moreover, collateral in this market segment—often homes or rural properties—tends to have low marketability or is located in remote areas. This limits its utility in mitigating risks, reducing it to more of a symbolic asset than a genuinely actionable one during recovery.

End-use Tracking

Tracking end-use is crucial for lenders to determine the underwriting objective is met and funds are not misused. At present, data availability is limited for lenders to track the end-use and more so to ensure if the funds are not used for speculation or non-intended consumption thereby leading to higher defaults.

The Way Forward

The secured micro-lending market is grappling with two core issues: rising household indebtedness and unsustainable operational models. To address these, the sector must embrace a patient, sustainable approach. A laser focus on long-term gains rather than short-term growth is imperative.

Policymakers and lenders alike must champion responsible credit practices, ensuring that additional lending—such as top-ups and refinancing—does not deepen borrowers’ vulnerabilities. For middle-class families whose homes serve as collateral, unchecked leveraging can be disastrous. It is vital to strike a balance between expanding access to credit and protecting borrowers from financial distress.

Secured lending has always thrived as a business rooted in prudence. As the sector evolves, it is essential to prioritize sustainable growth over rapid expansion. Patience, moderation, and a commitment to ethical practices will be the guiding principles for navigating this critical juncture.