🌸 RBI Firms Up Norms for SPV Lending to Microfinance Institutions (MFIs)

Empowering Structured Lending with Stronger Regulation – August 2025 Edition

🌱 Introduction: The Growing Roots of Financial Inclusion

India’s financial inclusion journey is deeply rooted in the role of Microfinance Institutions (MFIs). These entities provide small, collateral-free loans to low-income households—fueling entrepreneurship, consumption, education, and resilience against shocks. However, as the sector grows, so does the complexity of funding it. One such evolving model involves Special Purpose Vehicles (SPVs), created to pool, finance, or securitize MFI loans.

Recognizing the expanding use of SPVs in this space, the Reserve Bank of India (RBI) has stepped in during 2025 with updated regulatory clarity and supervisory norms. This move strengthens transparency, reduces systemic risk, and aligns structured finance practices with India’s inclusive credit goals.

🧩 Understanding SPVs and Their Role in Microfinance

A Special Purpose Vehicle (SPV) is a separate legal entity—often a trust or a company—created to isolate financial risk. In microfinance, SPVs are commonly used to pool microloans originated by MFIs and raise funds by issuing securities or borrowing from institutional investors like banks.

This structure offers two primary benefits:

• Risk Mitigation: By transferring microloan assets to an SPV, the originating MFI reduces its balance-sheet exposure.

• Liquidity and Capital Access: Banks and financial institutions gain indirect exposure to microloans without engaging in retail disbursement.

While effective, this structure requires robust oversight to prevent excessive risk layering, off-balance-sheet manipulations, or non-transparent lending practices. RBI’s new framework aims to fill this regulatory gap.

🎯 The Need for RBI’s Intervention

The exponential growth of the microfinance sector has been accompanied by increasing reliance on alternative lending structures, especially SPVs. However, the absence of dedicated, comprehensive norms had left room for inconsistency in:

• Risk classification of SPV exposures

• Capital adequacy treatment for lenders investing in SPV-issued securities

• Qualifying asset verification for MFIs

• Clarity on borrower documentation and fair practice standards

Given the essential nature of microfinance and its exposure to low-income, often vulnerable borrowers, it became necessary for the RBI to step in with a cohesive regulatory structure for SPV-related transactions. The result: a new set of integrated norms aligned with existing master directions, capital regulations, and the evolving credit environment.

🏦 RBI’s Revised Regulatory Framework: A Closer Look

The changes introduced in 2025 aren’t a standalone SPV-specific circular but a combination of amendments under multiple directions and regulations. Here’s a breakdown of the main areas affected:

🔹 1. Risk-Weight Rationalization

Previously, microfinance loans attracted higher risk weights under Basel III norms, especially when treated as unsecured consumer credit. In a significant relief:

• Loans defined as microfinance, but meeting Retail Portfolio Qualifying Criteria, now carry a reduced risk weight of 75%.

• If not meeting those criteria, such loans continue to attract 100% risk weight.

• SPV exposures that pool compliant microfinance loans can help banks reduce capital allocation, provided documentation and classification are accurate.

This reform encourages more institutional investment into microfinance via SPVs while maintaining prudential safeguards.

🔹 2. Revised Qualifying Asset Criteria for NBFC-MFIs

Under the updated norms, Non-Banking Financial Company – Microfinance Institutions (NBFC-MFIs) must ensure that at least 60% of their net assets remain in the form of qualifying microfinance loans.

SPV-participated loans will count toward this 60% only if they:

• Fully comply with the RBI’s definition of microfinance

• Follow proper borrower income assessment (household income ≤ ₹3 lakh per annum)

• Remain collateral-free and priced within board-approved limits

• Adhere to fair practices and standardized disclosures

If this qualifying asset ratio falls below 60% for four consecutive quarters, the MFI is required to submit a remediation plan to RBI—signaling heightened scrutiny and regulatory intervention.

🔹 3. Adjustments in Priority Sector Lending (PSL) Norms

To bring in more flexibility, the RBI has revised PSL obligations for Small Finance Banks (SFBs). Effective April 2026, SFBs are required to maintain only 60% of their adjusted net bank credit in the Priority Sector, down from the earlier 75%.

This change allows SFBs greater headroom to participate in SPV funding models without overstepping PSL mandates. It may also lead to better capital deployment across secured lending verticals while still supporting financial inclusion.

🔹 4. Strengthened Governance, Transparency, and Fair Practices

To ensure SPVs do not become tools for bypassing consumer protection laws, the RBI has reiterated key compliance expectations:

• Board-Approved Lending and SPV Policies: Every regulated entity (RE) must have policies governing participation in SPVs.

• Household Income Verification: MFIs must develop board-approved methods for verifying borrower income, ensuring adherence to the ₹3 lakh income cap.

• Standardized Borrower Factsheets: Every microfinance loan, including those routed through SPVs, must disclose principal, interest rate, tenure, EMI, fees, and recovery processes in simple, local language.

• Fair Collection Practices: SPV-funded loans must follow the same ethical recovery norms applicable to directly disbursed microfinance loans.

These safeguards aim to protect end borrowers and maintain regulatory parity between SPV-based and traditional microfinance lending.

🌈 Practical Implications for Stakeholders

🏛️ For Banks and SFBs

• Strategic investments in SPV securities can now carry lower capital costs if the underlying loan pool qualifies as retail microfinance.

• PSL flexibility provides more lending freedom while maintaining exposure to inclusive finance sectors.

• However, misclassification of SPV assets or inadequate documentation may result in capital penalties and regulatory action.

🏢 For NBFC-MFIs

• SPVs continue to be a critical tool for liquidity and capital mobilization.

• Ensuring all SPV-funded loans meet RBI definitions is essential to maintain the qualifying asset ratio.

• Non-compliance may impact credit rating, funding cost, and RBI monitoring intensity.

🧾 For SPV Entities

• Legal structuring must align with RBI norms, ensuring the SPV is bankruptcy-remote and isolated from the originator’s balance sheet.

• Loan documentation, risk-sharing agreements, and repayment structures must be transparently disclosed to both investors and regulators.

• Fair practice codes must be embedded even when the SPV contracts loan servicing to MFIs.

💡 A Model Illustration of SPV Lending to MFIs

Let’s simplify the structure with a visualized example:

🔸 A well-established NBFC-MFI originates 50,000 microloans to women entrepreneurs in rural Maharashtra.

🔸 The MFI transfers these loans into a newly created SPV Trust, set up under SEBI-compliant norms.

🔸 A large commercial bank subscribes to bonds issued by the SPV, gaining indirect exposure to the microloan portfolio.

🔸 The MFI continues to service the loans, ensuring EMI collections, grievance redressal, and compliance with RBI’s borrower engagement standards.

🔸 If the loans are properly documented and qualify under Basel III’s retail portfolio category, the bank treats this exposure at 75% risk weight, making it a capital-efficient investment.

This model demonstrates the elegance and utility of the SPV structure when governed by strong regulations.

🌺 Why This Move is Significant for the Sector

The RBI’s regulatory refinement brings three major benefits to the Indian microfinance and structured lending landscape:

1. Strengthening Credit Discipline
   By enforcing borrower-level due diligence and fair practices in SPV-funded loans, RBI ensures no compromise on consumer protection.

2. Boosting Liquidity in the Sector
   With lower risk weights and more PSL flexibility, institutions are now more incentivized to fund MFIs through SPVs—bringing more capital into the ecosystem.

3. Mitigating Systemic Risk
   By placing SPVs within the regulatory perimeter, RBI curbs the risk of hidden exposures or lax underwriting practices—thereby protecting the broader financial system.

🛡️ Compliance is Key: The Legal & Governance Lens

While the regulatory tone is enabling, RBI emphasizes strict compliance. Institutions participating in SPV transactions must:

• Maintain loan-level audit trails to prove qualifying asset status

• Submit periodic disclosures regarding SPV exposures

• Avoid routing loans that may violate borrower affordability norms or increase indebtedness

• Implement Internal Control Systems (ICS) and Risk Management Frameworks (RMFs) around SPV operations

Additionally, RBI may seek information from SPVs, MFIs, and investing institutions to assess systemic exposure trends.

🌟 Conclusion: A Bold Step Towards Balanced Innovation

With its latest reforms, the Reserve Bank of India has achieved a delicate but necessary balance—enabling financial innovation through structured lending, while preserving the integrity of microfinance principles.

SPVs, when used responsibly, are a powerful tool to attract diversified capital into India’s inclusive credit markets. But with power comes responsibility. RBI’s updated norms ensure that this responsibility is shared—among lenders.