A quiet revolution is lifting the poor

Much has been said about over-lending and defaults. Here's how lending works for the bottom-of-the-pyramid

Going by the Reserve Bank of India’s (RBI’s) definition, a microfinance loan is a collateral-free amount lent to a household earning up to Rs 3 lakh a year. The household refers to an individual family unit – husband, wife and their unmarried children.

 

A typical microfinance borrower is a married woman, educated up to secondary school with a household size of four, having an annual income of Rs 3.1 lakh per annum. Primarily located in rural India (67.5 per cent), she actively contributes to her household’s income. She holds standard identity documents—such as a PAN card, Aadhaar, and Voter ID—required for Know Your Customer (KYC) compliance, and her household’s primary source of livelihood is petty trade or small business.

 

What does a typical microfinance loan look like? It carries an average principal of Rs 51,222, a tenure of 23 months, and an average interest rate of 23.9 per cent. Key charges include interest, credit life insurance, and processing fees, alongside optional add-ons like health insurance or third-party products. The average monthly instalment comes to Rs 2,993.

 

These insights are drawn from the latest National Council of Applied Economic Research (NCAER) study on the effectiveness of regulated small borrowing in India, commissioned by the Microfinance Industry Network (MFIN), an industry association and self-regulatory organisation. This study builds upon a baseline report conducted by NCAER and MFIN in 2011—the first large-scale empirical evaluation of India’s microfinance sector following the 2010 Andhra Pradesh crisis that crippled the microfinance industry.

 

The industry's total loan book shrank to about Rs19,500 crore in 2011 and the customer base fell sharply from around 31-32 million to 26.4 million unique borrowers as many lenders shut down operations or stopped disbursing new loans. In June 2026, the total outstanding portfolio stood at Rs3.33 trillion, with the industry serving about 60 million unique active borrowers holding roughly 106 million active loan accounts nationwide.

 

The latest NCAER survey covered 10,342 borrowers of 19 regulated entities across 50 districts and 300 pin codes in 10 major states.

 

Borrower households reported average monthly savings of Rs 3,200. This finding is consistent with the National Bank for Agriculture and Rural Development's (NABARD's) bi-monthly report on Rural Economic Conditions & Sentiment Survey (September 2025) which suggests that households save about 13.8 per cent of their income. All borrowers had a savings account and about 30 per cent had multiple accounts. Among traditional saving practices, 71.9 per cent kept money at home, about a quarter in Post Office accounts, and 19 per cent with self-help groups.

 

An analysis of household income allocation reveals that surveyed families spend an average of Rs 16,465 per month on regular living expenses, Rs 4,827 on loan instalments, Rs 1,209 on investments, and save Rs 3,200. In total, approximately 82.4 per cent of household income is absorbed by day-to-day expenses and existing debt obligations, leaving a narrow financial cushion.

 

RBI regulations allow a Fixed Obligation to Income Ratio (FOIR) of up to 50 per cent. Once basic living expenses and baseline savings are factored in, the effective surplus available to service additional loans is far tighter—roughly 10 to 12 per cent of income. This highlights the crucial need for lenders to perform detailed household-level expense assessments before extending new credit—a practice that not every lender follows. FOIR is a metric that lenders use to measure what percentage of one’s monthly income goes towards paying fixed regular expenses and existing debts.

 

Across different lenders such as microfinance institutions, non-banking financial companies, universal banks, and small finance banks, the weighted average annual interest rate was 27.3 per cent, ranging between 24.1 per cent and 30.3 per cent. The effective interest rate, computed for the client, had a minimum of 28 per cent and an average of 33 per cent.

 

While these figures may seem high at first glance, the alternative for low-income borrowers is far costlier -- ranging between 97 per cent and 178 per cent, charged by moneylenders. 

 

In the previous study undertaken by NCAER (in association with MFIN) in 2011, informal loans were found to constitute as much as 46 per cent of all reported loans and 47 per cent of the total amount borrowed by households. In the current study, only 1 per cent of individuals reported resorting to informal sources of borrowing alongside formal loans.

 

This drastic reduction in informal debt over the last 15 years demonstrates a major structural shift towards formal, regulated finance at the bottom of the pyramid. Furthermore, operational efficiency has improved significantly: The average turnaround time for loan disbursal was found to be just six days, and 98.8 per cent of borrowers acknowledged receiving timely credit during emergencies.

 

Microfinance also continues to drive productive economic activities. Of the 10,342 borrowers surveyed, 48.1 per cent utilised their loans to invest in existing enterprises, while 14.4 per cent funded new business ventures. Another 25.1 per cent applied the funds for farming or building a shop.

 

This means despite the RBI’s removal of end-use restriction on microfinance loans, the credit extended by the sector continues to target promotion of income-generating activities – borrowers’ earning capacity and creation of jobs. Another earlier NCAER study (Present and Potential Contribution of Microfinance to India’s Economy, 2021) estimated that 12.8 million jobs were created by the microfinance industry in 2018-19. The social impact of microfinance lending too is considerable as 78 per cent of surveyed borrowers (99 per cent of whom are women) say that they contribute to their household income.

 

Around 86.4 per cent of the borrowers had two loans and FOIR of the sample was 18.7 per cent, well within the RBI prescribed threshold of 50 per cent. However, to avoid over-indebtedness of the borrowers, the lenders should include a household expenses analysis in the process of estimating loan absorption capacity.  Since households spend about 82.4 per cent of the income on expenses and existing loan instalments, the residual income available for new loan instalments is just 8-10 per cent of the income.

 

Understanding the state of digital readiness of an average microfinance borrower was also a part of this study. The survey showed that 61.1 per cent of the respondents owned smartphones while another 26.3 per cent (mostly in rural India) operated feature phones. A small but substantial proportion of the borrowers (12.2 per cent) did not own any type of phone. And, the proportion of borrowers repaying digitally is just around 12 per cent.

 

This gap requires urgent attention from fintech innovators and lenders.

 

Overall, the findings underscore the critical role of microfinance in expanding access to formal credit for low-income households and reducing dependence on informal lending. It identifies positive trends in savings behaviour, financial awareness, and responsible borrowing and highlights the need for greater adoption of digital payments, financial literacy initiatives and careful assessment of household indebtedness to ensure borrowing is sustainable.

 

Microfinance is reducing the dependence on informal lending at the bottom of the pyramid but it is not a silver bullet. The outcome can vary significantly depending on the context, implementation, and borrower circumstances. Continuous evaluation of small borrowing practices is crucial to understanding their impact and refining approaches to better serve low-income households. This report is a significant step in that direction – a lesson for the industry. The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, log on to www.bankerstrust.in. X: @TamalBandyo