Whalesbook
Focus on Quality Lending
February saw India's microfinance sector's gross loan portfolio grow to Rs 3.29 lakh crore, marking a 2.5% month-on-month increase. This cautious recovery highlights a significant strategic shift rather than a return to past expansion levels. Beneath this growth, lenders are increasingly prioritizing established borrowers with strong repayment histories and shifting towards higher-value loans. The average loan ticket size has reached a record ₹61,253 as of December 2025, a 16% year-on-year increase. This indicates a deliberate move away from the smaller, widespread loans common during earlier expansion phases. This focus on 'time-tested borrowers' and 'higher-value lending' shows a sector recalibrating its risk appetite after the recent over-lending crisis.
Portfolio Quality Improves Amidst Caution
Loan book quality has also improved sequentially. Dues unpaid for 30-179 days fell by 52 basis points to 2.8%, while loans overdue by more than 180 days decreased by 15 basis points to 16.8%. This improvement stems from tighter underwriting standards and a more selective approach to acquiring new customers. The sector now advocates for 'disciplined expansion' and 'calibrated consolidation,' prioritizing affordability and stronger credit filters. Technology is often leveraged to enhance risk assessment for a more targeted borrower base.
Deeper Dive: De-risking After the Crisis
The current focus on higher-value loans and established borrowers contrasts sharply with the aggressive expansion tactics that led to the microfinance crisis. Lenders are consciously reducing exposure to the 'bottom of the pyramid' segments, which proved most vulnerable to over-leverage and economic shocks. This risk-averse strategy is reflected in shrinking overall portfolio values for some segments. Total outstanding microfinance portfolios declined 22% year-on-year to over Rs 2.69 lakh crore by December 2025, despite sequential disbursement growth. This shows a consolidation towards larger, more secure loans rather than an expansion of the borrower base. Companies like Fusion Finance, which saw its loan book contract due to past rural over-leverage, are now recalibrating their models. They are focusing on quality growth and improved collection efficiencies to recover from past stress. Fusion Finance's MD & CEO, Sanjay Garyali, has emphasized tighter underwriting and using technology for better credit filters, signaling a clear move towards a more prudent operational model.
Investor sentiment reflects this shift. Major players like Bandhan Bank trade at a P/E ratio of approximately 23.78, suggesting investor confidence in its profitability. AU Small Finance Bank, with a P/E around 28.57, also shows a valuation that prices in stable earnings. These figures indicate the market values the stability and profitability derived from more controlled lending practices, even as the sector recovers. Satin Creditcare Network, at a P/E of roughly 8.41, appears more attractively valued, potentially indicating a higher risk premium or a more aggressive growth focus.
Concerns Remain: Impact on Financial Inclusion
While improved asset quality and a shift to higher-value loans benefit lender stability, this strategic recalibration raises concerns about the sector's broader impact on financial inclusion. Focusing on 'time-tested borrowers' and 'higher-value lending' may inadvertently sideline the very segments microfinance was designed to serve: those with limited credit history or smaller income-generating capacities. The 23% year-on-year contraction in active loans further supports this narrative of moderated borrower outreach. This suggests a bifurcated market is emerging: one serving more affluent, established micro-borrowers with larger loans, and another segment potentially facing reduced access to formal credit, pushing them back to informal lending channels.
Rating agencies echo these concerns. India Ratings and ICRA maintain 'deteriorating' and 'negative' outlooks respectively for FY2026, highlighting persistent structural weaknesses like ongoing asset quality stress and subdued profitability, especially for smaller lenders. The government's recent ₹20,000 crore credit guarantee scheme aims to bolster lending. However, its effectiveness depends on MFIs adjusting operations and banks' willingness to lend to weaker entities, a prospect many find unlikely without robust credit ratings.
Future Outlook: Balancing Stability and Inclusion
The microfinance sector's future trajectory hinges on balancing the need for prudent lending with its foundational role in financial inclusion. While analyst forecasts suggest moderate growth of around 4% for FY2026, a rebound is anticipated for FY2027 as portfolio quality continues to improve. Continued emphasis on leveraging technology for credit filtering and income recognition, along with disciplined expansion, is expected to foster more sustainable growth.
However, the sector must navigate challenges like rising funding costs and the need to enhance financial and digital literacy among borrowers. This will help prevent a recurrence of past stresses and ensure growth benefits the most vulnerable segments of society.