Microfinance recovery may be delayed by a quarter as stress persists

The fall in new delinquencies in the microfinance industry has slowed, delaying recovery by a quarter, with meaningful earnings growth expected only from Q4 FY26 or FY27

The recovery in the microfinance industry is likely to be delayed by a quarter due to a slower reduction in new delinquencies. Although delinquencies are falling, the pace plateaued in July–August 2025 compared to the sharp drop seen before June 2025, according to a report by Motilal Oswal.

 

“Several lenders had forecast a complete recovery by the end of the second quarter (Q2 FY26), with a return to normalcy in the second half of the year. However, current sentiment suggests this recovery could be delayed by 30–45 days, or potentially by a full quarter,” the report said.

 

The MFI industry has undergone a sharp contraction over the past year, with the gross loan portfolio (GLP) moderating to Rs 3.5 trillion as of June 2025 from Rs 4.3 trillion in March 2024. This was caused by a broad-based reduction in assets under management (AUM) across players, driven by deliberate slowing of disbursements, forward flows, and accelerated write-offs, as companies addressed operational challenges and executed structural changes. However, with healthier balance sheets and improved underwriting standards, the industry is positioning itself for a more sustainable growth trajectory.

 

Analysts said: “While recovery is underway, AUM growth is likely to remain subdued in Q2 FY26 as most players focus on resolving residual stress and adapting to operational and strategic realignments implemented over the past year. A more pronounced acceleration in disbursements and AUM growth, along with a decline in credit costs, is expected in H2 FY26 across the sector.”

 

While over-leveraging was a key concern, additional challenges such as the Karnataka ordinance and the Tamil Nadu Bill delayed recovery and extended the normalisation timeline for companies. Although the sector is on a recovery path, the rebound remains uneven across players and states.

 

In Assam, some entities have been offering higher ticket-size loans, but customers lack the repayment capacity given their income levels. In Rajasthan, manpower availability and stability remain issues, hindering operational changes. High attrition has also slowed recovery. Further, states such as Punjab and Jharkhand are showing weakness due to recent floods, which are also likely to impact recovery.

 

Fresh slippages have moderated significantly, but legacy stress must still be provided for, which will keep credit costs slightly elevated in the near term. Analysts said this would weigh on near-term profitability for some companies. While most NBFC-MFIs are guiding for normalised credit costs from H2 FY26, supporting profitability improvement, a more meaningful earnings recovery is expected only from Q4 FY26 or in FY27.

 

This improvement will be driven by stronger AUM growth, minor expansion in net interest margins (NIMs) from a gradual decline in borrowing costs, a reduction in interest income reversals, a moderation in cost ratios as AUM growth accelerates, and lower credit costs. 

However, analysts believe the worst of this MFI credit cycle is over and the industry is set to recover gradually, operating with greater discipline and stronger risk management.