Microfinance in India: A Changing Landscape

Introduction

Microfinance in India has long been a beacon of hope, extending small, collateral-free loans primarily to low-income households—especially women—who lack access to traditional banking. This model, underpinned by collective guarantees, has historically been successful, delivering high repayment rates and profitable loan portfolios. Moreover, it has empowered millions who would otherwise be forced to borrow from exploitative moneylenders.

However, the industry has endured several turbulent periods, from state interventions and election disruptions to the COVID-19 pandemic. As of 2024–25, microfinance faces a fresh challenge—one largely self-inflicted by rapid expansion and eased regulatory constraints.

A Quick History: From Early Success to Major Shocks

• Early 1990s: Microfinance in India emerges, driven by NGOs providing small loans to women in Joint Liability Groups (JLGs).
• High Repayment Rates: Because group members effectively cover each other's defaults, the model proves both profitable and socially impactful, motivating financial companies to invest in microfinance.
• Andhra Pradesh Crisis (2010): Allegations of unethical collection practices lead the state government to impose strict regulations, forcing many MFIs to suspend operations. The RBI eventually intervened, introducing the NBFC-MFI category to bring large microfinance players under its regulatory purview.
• Demonetization (2016): Because most microfinance transactions were cash-based, MFIs struggled during the sudden ban on high-value rupee notes. This phase eventually pushed the industry to adopt more digital processes.
• COVID-19 (starting 2020): Multiple waves of the pandemic, lockdowns, and borrowers’ lost incomes triggered a spike in non-performing assets (NPAs), leading to an increase in credit costs and hence losses.

By late 2022 and early 2023, as COVID-related pressures eased, microfinance bounced back strongly - only to find itself on the cusp of another internal crisis.

The Regulatory Easing and Fast Growth

In March 2022, the RBI issued revised guidelines for microfinance lenders. Key changes included:

1. Expanded Eligibility: Household income cutoff for microfinance loans increased from ₹1.25 lakh to ₹3 lakh per year.
2. Higher Borrowing Limit: Individuals could now borrow up to ₹2.4 lakh (previously ₹1.2 lakh).
3. Removal of Spread Caps: NBFC-MFIs were no longer constrained by a 10% limit on interest spread.
4. Shift from “Number of Lenders” Cap to FOIR: Rather than limiting how many lenders a borrower can have (previously four), regulations set a Fixed Obligations to Income Ratio (FOIR) at 50%.

These moves were welcomed by MFIs eager to recover from pandemic losses. Between Q3FY23 and Q4FY24, the overall microfinance loan book (AUM) shot up by around 44%.

The Overleveraging Problem

Unfortunately, the same deregulation that fueled growth led to overleveraging among borrowers. Easier access to credit from MFIs and fintech lenders meant it became common to see customers juggling multiple concurrent loans—sometimes up to 10 at once.

Meanwhile, wage growth in many parts of rural India remained stubbornly low. According to the Labour Bureau’s Wage Rates in Rural India (WRRI), the real wage growth for most occupations has stayed under 1% per year (and is lower for women than for men). This puts repayment capacity at odds with the rapidly growing loan obligations.

By March 2024, average borrower indebtedness had already climbed by around 41% compared to March 2020—yet incomes had barely risen in real terms. When combined with the pressure to grow at any cost, some lenders stretched the truth around borrowers’ incomes to meet FOIR requirements. That set the stage for rising delinquencies.

Signs of Stress

As borrowers found themselves overextended, late 2023 and early 2024 saw:

• Missed Group Meetings: More borrowers skipped JLG center meetings, forcing loan officers to go door-to-door.
• Geographic Clusters: States such as Odisha, Uttar Pradesh, Punjab, and Gujarat reported significant pockets of non-payment.
• Prioritization of Secured Debt: When borrowers have multiple loans—some secured, some unsecured—repayments typically go first to the secured lender, leaving microfinance loans at higher risk.

By FY25, well-known MFIs such as Fusion Finance, Spandana Sphoorty, and CreditAccess Grameen saw as much as 12–24% of their portfolios at risk due to borrowers also indebted to multiple other lenders.

Industry Guardrails

Recognizing the danger, microfinance’s self-regulatory organization, MFIN, introduced new guardrails in July 2024:

1. Restricting the number of microfinance lenders per borrower to four.
2. Capping total microfinance borrowing at ₹2 lakh per borrower.
3. Urging members to reduce interest rates to ease repayment burdens.

These steps target new disbursements rather than existing loans, so they do little to fix outstanding accounts. More critically, it cuts off incremental credit to leveraged borrowers with multiple loans – for the highly indebted, it is like cutting off oxygen since they can no longer borrow from Peter to pay Paul.

Reports also suggest the RBI has informally advised MFIs not to lend to borrowers in default until they clear overdue balances. This further reduces the supply of credit, in some unfortunate cases when the borrower is facing legitimate and temporary stress.

And so, while these measures are good in the long run, they have driven another wave of NPAs with Q2 and Q3FY25 seeing most pureplay MFI companies running losses.

Future Outlook

Unlike previous crises triggered by external shocks, this one stems from the sector’s own high-growth aggression. As delinquencies mount, most lenders have cut back on disbursements and are prioritizing collections. The days of double-digit quarterly growth appear over for now.

Going forward, annual industry growth could settle at between 10 to 15%, far lower than the high-growth periods of the past. And lenders are likely to focus more on adding new customers rather than hiking ticket sizes - given the high penetration of microfinance in key geographies, this will be a slower growth lever than the past. At the same time, employees will be more focused on recoveries than disbursements, productivity is likely to take a hit and be a drag on profits.

And since there is never a dull day in this space, there is potential trouble brewing in the state of Karnataka - nothing along the lines of the AP crisis, but still enough to cause operational on-ground issues to microfinance lenders.

Does the Joint Liability Model Still Work?

The traditional JLG concept, where the group shoulders each individual’s obligations, is under scrutiny. With borrowers having multiple lending relationships, the sense of collective accountability can fray. Industry participants also speak of a mindset shift, where borrowers no longer want to devote the time to a group meeting – when money can be disbursed and repaid with a press of a button thanks to UPI, why bother with meetings? On the other hand, many strong borrowers have already “graduated” to individual loan products with higher ticket sizes or even secured loans.

Some lenders believe this shift will eventually render the classic JLG model less relevant. Others think the model should endure, so long as it evolves to meet new realities. Our own view is that given the credit gap among this customer segment, microfinance is very much here to stay, but the industry is likely to grow slower and also consolidate.

Who’s Likely to Succeed?

Small Finance Banks (SFBs) with MFI exposure could emerge stronger from the crisis. They tend to have:

• Diverse product mixes: Both unsecured microfinance loans and secured loans to graduate borrowers.
• Better underwriting: Stronger data and processes to assess a customer’s real repayment ability.
• Established risk controls: A track record of balancing growth with quality.

Among pure-play microfinance companies, industry leaders are likely to drive share consolidation as the longer tail of lenders struggle to remain viable under the more stringent guidelines.

Conclusion

Microfinance in India stands at a crossroads—one shaped by the industry’s own rapid expansion and evolving borrower behavior. While the sector has proven its resilience through multiple crises in the past, this time the shock doesn’t come from a sudden policy shift or a pandemic; it’s self-inflicted, on the back of rapid growth and overleveraging.

While the industry is going through a shakeout, we see an opportunity among the stronger and better placed lenders. As a product, microfinance has had a real impact on countless lives in India, and with prudent policies and better self-regulation, it should continue to do so. Whether through joint liability or individual lending, the goal should remain the same: creating a sustainable pathway out of poverty for those who need it most.