The microfinance sector in India has recently shown signs of recovery after a period of stress marked by over-leverage and rising delinquencies. Data from credit bureaus reveal that after peaking in December 2024, delinquencies have started to decline. This improvement is attributed to stricter regulatory guardrails and better adherence to codes of conduct by microfinance institutions (MFIs). However, challenges remain in funding, geographic expansion, and credit assessment, requiring continued vigilance and innovation.
Recent Performance and Recovery
The microfinance sector experienced a peak in loan defaults at the end of 2024. Since then, collections have improved steadily over two quarters. This recovery is encouraging for a sector that supports nearly eight crore poor households. The sector includes Non-Banking Financial Companies (NBFCs), NBFC-MFIs, Small Finance Banks (SFBs), and other MFIs. The ease of doorstep lending without collateral has made microfinance popular but has also led to clients borrowing beyond their capacity.
Regulatory Measures and Guardrails
To curb over-borrowing, Sa-Dhan, the Self-Regulatory Organisation (SRO), introduced additional limits beyond the Reserve Bank of India (RBI) norms. These include a maximum household borrowing limit of ₹2 lakh and a lender cap of three per borrower. These guardrails have helped reduce exposure and the number of lenders per household. The sector’s future stability depends on strict adherence to these rules and ethical collection practices.
Geographic Expansion and Credit Assessment
Currently, microfinance operations are concentrated in about 250 districts. Two-thirds of Indian districts remain underpenetrated. Expanding into these areas could increase outreach, but the existing business model may not fit all regions. A more accurate assessment of household income and liabilities is crucial for responsible lending. This will help avoid over-indebtedness and improve credit underwriting.
Funding Challenges and Sector Resilience
Microfinance institutions primarily rely on debt funding as they cannot mobilise savings like cooperatives in other countries. Recently, bank funding to the sector has nearly halved, mainly benefiting large MFIs. Tightened lending norms and negative perceptions have made funding scarce. Credit rating agencies have also become more cautious, impacting capital access. Despite these hurdles, the sector has shown resilience during past crises such as the Andhra Pradesh microfinance crisis, demonetisation, and the Covid-19 pandemic. Innovation and improved practices remain key to overcoming current challenges.
Future Outlook and Strategic Focus
To sustain growth, MFIs must focus on expanding their operations into new geographies. They should also improve credit risk assessment and manage non-microfinance loan portfolios prudently. Regaining lender confidence is vital for funding stability. The sector’s ability to innovate and maintain ethical standards will determine its long-term success and impact on financial inclusion.
Questions for UPSC:
- Critically analyse the role of microfinance in financial inclusion and its impact on rural poverty alleviation in India.
- What are the challenges faced by Non-Banking Financial Companies (NBFCs) in India? How do regulatory measures affect their operations and growth?
- Explain the importance of credit assessment in microfinance lending. With suitable examples, underline the risks of over-indebtedness in vulnerable populations.
- Comment on the role of Self-Regulatory Organisations (SROs) like Sa-Dhan in the Indian financial sector. How do they complement the Reserve Bank of India’s regulatory framework?
