MFI industry's new challenge: Funds needed to survive, banks must act

The sector is ready to make amends, but it needs money to remain in business. If banks don't loosen the purse strings, things will worsen

Until recently, India’s microfinance industry faced the challenge of rising bad loans. By the time it has got a grip on the situation, another challenge, an equally daunting one, has cropped up.

 

A few smaller microfinance lenders are facing difficulties servicing bank loans; some may have even defaulted.

 

Since the industry hasn’t been in the best of health, some banks, their primary lenders, have closed the money tap.

 

When money is in short supply, it’s difficult for those non-banking financial companies (NBFCs) that operate in the microfinance segment – NBFC-MFIs – to expand their loan book since they first need to clear the debt to their lenders. Else, they cannot get fresh loans. In the process, recoveries may be affected further.

 

In such a situation, they depend on repayment by existing borrowers to extend fresh loans. When borrowers falter, the lenders’ kitty dries up and they stare at defaults.

 

While NBFC-MFIs can have up to 40 per cent non-microloans on their books, NBFCs can give 25 per cent of their loans to micro-borrowers. Both sets of financial intermediaries have banks as their primary lenders.

 

Industry estimate indicates that in the financial year 2024-25 (FY25), NBFC-MFIs received a little over ₹57,000 crore from banks and other financial institutions for on-lending to customers. This was around 38 per cent less than FY24. For large MFIs, 82 per cent of debt funding was by the banks; medium and small MFIs received 54 per cent and 28 per cent of their funds from banks, respectively.

 

As of December 2024, 9,291 different kinds of NBFCs were registered with the Reserve Bank of India (RBI). Of these, 95 are MFI-NBFCs – 26 classified as middle-layer intermediaries and 69, lower level. A middle-layer entity has an asset size of at least ₹1,000 crore.

 

Over the last one year, the MFI loan portfolio – microloans disbursed by all sorts of financial intermediaries, including banks – has shrunk. It’s a flight to safety for lenders. Typically, small loans are not backed by collateral securities. While universal banks and small finance banks are shifting their exposure to secured loans, MFI-NBFCs are shrinking their loan books.

 

Credit bureau CRIF High Mark Credit Information Services Ltd’s data shows that in March 2024, the outstanding microloan portfolio was ₹4,42,700 crore. It has since been shrinking with every quarter. In March 2025, it was ₹3,81,225 crore. By the June 2025 quarter, it was down to ₹3,59,169 crore.

 

NBFC-MFIs’ share is the highest (₹1,39,308 crore), followed by universal banks (₹1,17,810 crore), small finance banks (₹56,199 crore), NBFCs (₹43,451 crore) and others (₹2,401 crore).

 

The good news is that delinquencies have been slipping.

 

For instance, PAR (portfolio at risk) 1-30 had peaked at 2.1 per cent in September 2024. It has fallen to 1.6 per cent in June 2025. PAR 1-30 is an indicator to measure the percentage of loans not being repaid for 1 to 30 days, and run the risk of turning bad.

 

Similarly, PAR 31-60 has fallen from its peak of 1.5 per cent in December 2024 to 1.1 per cent in June 2025, and PAR 61-90, from 1.6 per cent to 1.3 per cent during this period.

 

Meanwhile, PAR 180+ – loans that have not been serviced for more than six months – hit an all-time high of 14.9 per cent in June 2025. But no reason to panic here since these are old bad loans, created during the Covid pandemic or even before that. The entire pile of bad loans in this bracket has probably been provided for. Most lenders have written them off, but not removed them from the credit bureau database.

 

A July report of Avendus Capital Pvt Ltd shows that leading players in the microfinance industry are redesigning their operating models for resilience and scale. The portfolio exposure with more than three lenders has dropped from 20 per cent in March 2024 to 12 per cent in March 2025. During this period, borrowers with credit exposure of at least ₹2 lakh have declined from 8 per cent to 3 per cent. Lenders are showing efficiency in collecting loan repayments, and cleaning their balance sheets by writing off bad loans; the quality of assets, too, is improving.

 

In June 2024, of 86.5 million active customers, around 2.5 million had taken more than five loans. A year down the line, the number has fallen to 1 million of 79.8 million active customers. Similarly, around 3.2 million customers had exposures to four loans last year; this has come down to 2.1 million.

 

Two self-regulatory associations of the industry have been keeping a close watch on the evolving situation. They have put up guardrails such as capping loans per borrower to ₹2 lakh, the number of loans per borrower to three, and barring fresh loans from being disbursed to delinquent customers.

 

Between FY17 and FY24, the microfinance loan book grew from ₹1.07 trillion to ₹4.34 trillion, at a compound annual growth rate (CAGR) of around 22.1 per cent (all figures are rounded off). Over the same period, the number of unique borrowers rose by just 6.9 per cent, while the loan per borrower CAGR increased by 14.3 per cent. That’s history now.

 

Unlike in the past, when natural calamities and politics played spoilsport, this time round, the industry itself has created the situation for itself.

 

Before the Covid lockdown, demonetisation and the implementation of the goods and services tax helped clean the landscape up. Shortly after, the RBI’s new microfinance norms came into play from April 2022. There is no longer a cap on loan rates; lenders are free to set interest rates, but they must follow a board-approved, transparent policy.

 

The new norms also created a level playing field. Earlier, banks had an unfair advantage over microlenders. Now, the rules apply to microloans rather than microlenders. Microloans have also been redefined, allowing lenders to provide loans for any purpose, such as education, health, or weddings, as long as debt repayment does not exceed 50 per cent of the household income.

 

All this has changed the lenders’ approach. Until the latest round of crisis, they wanted to lend more and more. Almost all of them raised their loan rates to recover the losses of the Covid-19 period. Have they reduced rates after recovering those losses?

 

Growth in the sector was driven more by the lenders’ obsession to disburse loans rather than borrowers’ demand. To complicate matters, borrowers were being pursued by various types of lenders: universal banks, small finance banks, NBFC-MFIs, NBFCs and fintechs.

 

When one has easy access to a variety of loans, there is the temptation to borrow more. Borrowers are taking on more debt at higher costs as the cost of intermediation is rising with banks giving loans to large NBFCs. Large NBFCs, in turn, are giving loans to small NBFCs, and so on. This weakens borrowers’ ability to repay.

 

The industry is ready to make amends, but it needs money to remain in business. If banks do not loosen the purse strings, things will worsen.

 

Until recently, the banking industry viewed collaboration with non-banks as the key to reaching the hinterland – giving loans to those at the bottom of the pyramid. It should not junk that plan. MFI-NBFCs can take care of last-mile connectivity. They can combine tech and touch with their unique business model.

 

Indeed, giving microloans is a business, not a social service. But, the MFI-NBFCs need to remember that they are agents of financial inclusion, not financial exploitation, which is the root cause of the latest round of crisis.

 

MFIs need to change their approach to business and banks need to open the tap for liquidity. That will be a win-win for both.  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