Whalesbook
Microfinance Sector Shows Strong Comeback
India's microfinance sector has turned a corner. After eleven quarters of shrinking loan books and major write-offs, the sector's gross loan portfolio grew by 5.3% from January to March. This marks a significant recovery for an industry whose total market size had shrunk to a three-year low by December 2025. The loan book reached ₹3.39 lakh crore by the end of March, up from ₹3.22 lakh crore the previous quarter. This rebound follows a long period of decline from a peak of ₹4.43 lakh crore on March 31, 2024.
Asset Quality Improves
Data from Equifax India shows a significant improvement in asset quality. The 30-day-plus delinquency rate fell across lenders, reaching 2.3% for January-March, the lowest in five quarters. This drop suggests borrowers are repaying loans better, leading to a healthier asset profile. This contrasts sharply with stressed periods where the 30+ days overdue rate peaked at 6.2% in FY2025.
Banks Drive Growth While SFBs Pull Back
The recovery is mainly led by Non-Banking Financial Company-Microfinance Institutions (NBFC-MFIs) and private banks, which boosted their microfinance loans. NBFC-MFIs grew their business by 7.7% quarterly to ₹1.42 lakh crore, gaining a 42% market share. Private banks grew even faster, up 8.8% to ₹89,548 crore, capturing 26% of the market. In contrast, Small Finance Banks (SFBs) reduced their microfinance exposure, with their total business falling to ₹50,725 crore from ₹54,234 crore last quarter. SFBs are shifting focus to secured loans to manage credit risk, indicating divergent lending strategies in the microfinance sector. Other NBFCs, like L&T Finance, also saw modest portfolio growth.
Past Strains and Regulatory Backstop
This recovery follows a period of significant strain, marked by shrinking loan books and large write-offs. The sector's gross loan portfolio had previously contracted by about 18% year-on-year by December 2025 and fell 13.9% in FY2025. This difficult time saw credit costs surge to 15.5% by September 2025, up from 4.4% two years earlier. The Reserve Bank of India (RBI) supported stabilization, including lowering the minimum asset requirement for NBFC-MFIs from 75% to 60%. Regulatory rules, like the Master Directions from July 2022 and January 2025, set interest rate policies, income limits (₹3 lakh annual), and require repayment not to exceed 50% of monthly household income, all aimed at protecting borrowers.
Fintech's Role and Competition
Fintech advancements have boosted client reach and efficiency in Indian microfinance. Digital lending platforms and payment gateways complement traditional MFI services, with greater microfinance outreach linked to POS device use. However, digital changes pose challenges, especially for smaller MFIs that may struggle against larger players and face digital literacy gaps. The rise of many lending apps and fintechs means micro-lending firms must carefully manage operations to prevent over-lending.
Market Shifts and Divergent Strategies
The microfinance sector's path has seen cycles of growth and stress. After the 2010 Andhra Pradesh crisis, reforms created the NBFC-MFI category and stricter interest rate caps. Today, while NBFC-MFIs and private banks are expanding, the retreat by SFBs signals a reassessment of the microfinance segment's profitability and risk. SFBs are focusing more on secured lending to manage credit risk, moving away from their past role in broader financial inclusion. This split suggests a realignment in the microfinance ecosystem, with some firms favoring stability and risk reduction over rapid growth.
Risks Remain Despite Recovery
A key risk is the clear strategic divergence, especially Small Finance Banks deliberately reducing their microfinance exposure. This signals a reassessment of risk and return, as SFBs favor higher-yield secured loans to manage credit risk. This could mean a less attractive long-term outlook for unsecured micro-loans for these banks.
Over-Indebtedness and Fintech Threats
Despite falling delinquency rates, the risk of borrowers being over-indebted remains a concern. Reports show a large part of the microfinance loan book belongs to borrowers managing multiple loans, causing repayment stress and higher defaults. Fiercer competition from fintechs and lending apps increases this risk, as they may not follow the same strict rules as traditional MFIs, potentially worsening over-lending.
Regulatory and Funding Challenges
While RBI support has been vital, regulations can change. New regional bills, like the Bihar Micro Finance Institutions Bill, 2026, highlight possible local regulatory hurdles, even if they exempt RBI-regulated firms. Also, the RBI's shift in the minimum asset requirement for NBFC-MFIs to 60% could, over time, pull them away from serving the poorest if not managed well. Smaller and mid-sized MFIs still face funding limits as banks become pickier lenders, potentially restricting cash flow and growth.
Credit Costs and Portfolio Concentration
Credit costs remain a major challenge. By September 2025, costs hit 15.5%, a big jump from 4.4% two years ago, due to higher provisions and loan write-offs. Also, loan books concentrated in top states like Bihar, Uttar Pradesh, and Tamil Nadu create significant concentration risk.
Outlook for FY2026
Analysts expect moderate growth of about 4% for the microfinance sector in FY2026, with a stronger rebound possible in FY2027 as loan quality improves. Most institutions are likely to focus on balance sheet stability and careful risk management over rapid expansion. While the sector shows strength, the strategy changes by SFBs and ongoing competition point to a dynamic and split market ahead.