India's microfinance sector continues to grapple with high interest rates, rising borrower over-indebtedness, and coercive recovery practices, highlighting the need for urgent lender reforms, a deputy governor of the central bank said. "The (microfinance) sector continues to suffer from vicious cycle of over-indebtedness, high interest rates and harsh recovery practices," M. Rajeshwar Rao said at an event in Mumbai on June 5.

The speech was uploaded on the central bank's website on Monday.

Indian banks have reported stress in the microfinance segment since the beginning of the current financial year, largely due to high borrower indebtedness, declining rural incomes, and election-related disruptions

Even lenders with access to low-cost funds have been found to be charging significantly higher margins than the industry norm, which in several instances appear excessive, Rao said.

While some moderation in interest rates on microfinance loans has been observed in recent quarters, pockets of high interest rates and elevated margins continue to persist, Rao said in the speech.

Rao urged lenders to look beyond the conventional "high-yielding business" tag for the microfinance sector, adding that there is a need to strengthen credit assessments to prevent borrower over-leverage and strictly avoid coercive recovery practices.

Despite sound business models, he pointed out that organizational structures and incentive schemes might be flawed, resulting in "perverse" outcomes for customers.

"This calls for an introspection around the models," he added.