A steep drop in microloan repayment in India does not threaten the health of the nation's banking system, analysts and regulators say.

Many small borrowers in Andhra Pradesh state, which accounts for about a third of India's microlending, stopped repaying their loans after a government crackdown on unscrupulous lending practices that allegedly contributed to dozens of suicides.

Now the crackdown on microlending — small loans typically no more than a few hundred dollars — seems to be spreading. Orissa state is also examining microfinance lending practices and wants to cap interest rates charged to borrowers, state finance minister Prafulla Ghadai told reporters Friday. The Reserve Bank of India is conducting its own review of microlending practices as well.

India's commercial banks are the main source of financing for microfinance institutions, prompting fears that loan defaults could reverberate through the banking system, causing instability — a concern regulators and analysts say is unfounded.

"There is no implication for the stability of the financial system," Reserve Bank of India governor D. Subbarao said at the bank's last policy review, in response to a question about microfinance institutions, or MFIs. "On a systemic level, the MFI issue is not likely to have any implications."

Indian banks in the fiscal year ending March 2010 had up to 101.5 billion rupees ($2.2 billion) in loans outstanding to microfinance institutions, about twice as much as the prior year, according to the National Bank for Agriculture and Rural Development.

While banks are an important source of capital for microfinance institutions, microfinance institutions account for less than 1 percent of the banking industry's outstanding loan book today, analysts say. That means even if the entire sector defaulted — an unlikely scenario — banks could absorb the losses.

"The banking sector is well protected," said Angel Broking analyst Vaibhav Agrawal. "It's not that big a deal."

Banks have become the primary source of capital for microfinance lenders because of so-called "priority sector" lending requirements, which mandate that a bank give 43 percent of its loan book to underserved sectors like agriculture, small business and microfinance.

Lending to microfinance institutions has been seen as an efficient way to meet this requirement and commercial banks now provide about 80 percent of capital at most microfinance companies, according to the Microfinance Institutions Network, a group of 44 of India's largest microfinance companies.

Microfinance Institutions Network estimates that total microfinance loans in India today are about $6.5 billion. If banks lend 80 percent of that, their exposure would be $5.2 billion.

That's only 0.7 percent of banks' 32 trillion rupees ($707 billion) total outstanding loans today, Agrawal said.

He said ICICI Bank, India's largest private sector bank, has one of the largest proportionate exposures in the industry, with 23 billion rupees ($508.8 million) in microfinance loans, or 1.2 percent of its 1.9 trillion rupee ($43.0 billion) loan book.

He said public sector banks, like India's largest lender, the State Bank of India, would likely have lower exposures because they have extensive rural branch networks that lend to local self-help groups directly rather than going through microfinance institutions.

SKS Microfinance, India's largest microlender, said loan collections in Andhra Pradesh, which have been essentially frozen for a month, have begun to improve. The state accounts for about 27 percent of the company's outstanding loans.

After the Andhra Pradesh government's crackdown, SKS was blocked from collecting repayments at over half its village collection sites and 66 employees were arrested or detained by police, SKS spokesman Atul Takle said Friday.

All employees have been released, he said. Since the company restarted collections on November 15, it has been able to access 97 percent of collection sites.

Executives still worry that switching from a weekly to a monthly repayment schedule, per the government's order, may reduce collections.

"We prefer the weekly model. That's the way people can repay smaller sums of money. In a monthly set up they don't have any place to save that money," Takle said.

SKS warned stock exchanges Thursday that reduced collections in Andhra Pradesh could hurt the company's revenue and profitability. It said repayment rates in other states remain 99 percent.