Wanted: A new model for microfinance as MFIs explore secured products

Some MFIs are turning into business correspondents. They are also looking for more secured loans, one of the products being loan against gold

The Union Budget 2026-27 has proposed a Rs 10,000 crore SME Growth Fund to provide equity support to small businesses and create champion SMEs. This is music to the ears of small and medium enterprises. A section of the lenders to such enterprises (particularly small enterprises) – the microfinance institutions, or MFIs – was looking for a credit-guarantee fund for themselves in the Budget. That has not happened. 

 

In July 2021, the government had launched a credit guarantee fund for the MFIs to provide up to 75 per cent coverage to lenders such as banks and non-banking financial companies (NBFCs) for loans given to smaller MFIs and NBFC-MFIs. Managed by the National Credit Guarantee Trustee Company Ltd (NCGTC), this fund was created to restore liquidity and boost credit flow to micro-borrowers reeling under the impact of the Covid pandemic.

 

The industry was expecting support from the government in the form of another credit guarantee fund since it is going through a rough patch.

 

Let’s see through numbers how bad the situation is.

 

At its peak, in the June quarter of financial year 2024-25, the microfinance portfolio stood at Rs 4,26,619 crore. Six quarters down, in December 2025, there was a 25 per cent erosion in micro loans – Rs 3,21,570 crore, according to Equifax Credit Information Services Pvt Ltd.

 

During this period, the number of active loan accounts dropped 31 per cent – from 156 million to 107.4 million. And, the number of borrowers (including the defaulters) fell from 87 million to 69 million.

 

Among the five states that lead in the number of micro-loan borrowers, Bihar has seen the number fall from 11.340 million to 9.15 million; Uttar Pradesh, from 8.992 million to 8.012 million; West Bengal, from 6.916 million to 6.151 million, and Karnataka, from 6.28 million to 5.468 million. Only Tamil Nadu was relatively less impacted. Here, the number decreased from 8.111 million to 7.922 million during this period.

 

In the March quarter of 2024, the industry had disbursed Rs 1,13,354 crore as loans. This dropped 44 per cent in the December 2025 quarter to Rs 63,348 crore.

 

The quarter-on-quarter (q-o-q) portfolio shrinkage in December 2025 over the September quarter was 6.02 per cent. Year-on-year (y-o-y),  December 2024 to December 2025, it was 16.34 per cent. The number of active accounts in December 2025, meanwhile, shrank 8.52 per cent q-o-q and 22.89 per cent y-o-y.

 

When it comes to quality of loan assets, MFI-NBFCs are worse off than NBFCs. For instance, NBFCs had 2.6 per cent of loans in the 30-day-plus delinquency bucket in December 2025 (borrowers who have not been able to service loans for more than 30 days) versus 3.5 per cent for MFI-NBFCs. Similarly, in the 90-day-plus delinquency bucket, NBFCs had 1.6 per cent such loans versus 2.1 per cent for MFI-NBFCs. In the 180-day-plus bucket, NBFCs reported 4.8 per cent such loans versus 10.7 per cent for MFI-NBFCs.

 

That said, data suggests the worst could be behind for the industry. For instance, the y-o-y loan disbursement in December was down 5.82 per cent, but q-o-q, it was up 7.76 per cent. Similarly, the percentage of loans not serviced for more than 30 days was 3.9 per cent in December, 136 basis points (bps) lower q-o-q and 302 bps lower y-o-y. For loans not serviced for more than 90 days, the December figure was 2.4 per cent, 84 bps lower q-o-q and 147 bps lower y-o-y. One bps is a hundredth of a percentage point. Clearly, the rate of delinquency is declining.

 

Still, the ground reality is grim. It’s true that while only a few small MFIs have closed shops, several are facing difficulties servicing bank loans. Some have even defaulted.

 

Sensing trouble, the banking industry has turned off the money tap for most micro lenders. When money is in short supply, MFIs cannot expand their loan book since they first need to clear the debt to their lenders. This has a chain reaction. When fresh loans are not disbursed, existing borrowers dither on servicing the loans. And, as the loan book shrinks, in percentage term, bad loans rise.

 

This is not the first time the MFI industry is facing trouble. An ordinance by the Andhra Pradesh government in October 2010 to tackle coercive loan recovery practices triggered a severe crisis for the sector. There were widespread loan defaults and a sharp contraction in the microfinance industry. Just before the Covid pandemic, a large section of borrowers in Assam refused to repay the loans, saying that MFIs were forcing them to over-borrow at usurious interest rates.

 

Even before the Andhra Pradesh and Assam episodes, the industry faced disruptions in various geographies, but those were all driven by external events – natural calamities, politics, and so on. For the current crisis, the industry itself is being blamed.

 

In April 2022, following the Assam crisis, the Reserve Bank of India (RBI) removed the interest rate cap for MFIs. The idea was to foster competition, allowing the market to drive the pricing. Grabbing this opportunity with both hands, almost every micro lender raised interest rates. They wanted to make good of the losses they had suffered during the Covid pandemic. For most entities, there was no looking back, despite the regulator’s repeated reminders.

 

Many of them have also been aggressive in disbursing loans, often without evaluating a borrower’s ability to replay. To complicate matters, many loan apps have entered the scene. Credit information bureaus aren’t always able to capture the record of the loans disbursed through these apps.

 

The RBI stepped in, and allowed MFIs to give non-micro loans up to 40 per cent of the total loans (against 25 per cent earlier) to diversify the loan portfolio. Two self-regulatory bodies have also framed rules to check over-indebtedness, capping a client’s borrowings to a maximum of three MFIs, and limiting the total household debt to Rs 2 lakh, but the damage has already been done. 

 

Today, at least one universal bank and some small finance banks are rejigging their balance sheets, and going for more secured loans. Pure-play NBFCs are also shifting their focus to secured loans, and limiting their exposure to small loans without collaterals.

 

Some MFIs are turning into business correspondents. Instead of keeping the loans in their own books, they are working on behalf of banks, disbursing and collecting loans for a commission. They are also looking for more secured loans – one of the products being loan against gold.

 

India’s microfinance sector is at a crossroads. It is exploring a new model. That’s the only way to survive the current crisis, which is largely self-created.

 

Meanwhile, the industry has not given up hope for government support. Going by media reports, the Expenditure Finance Committee has already approved a Rs 8,000 crore credit guarantee scheme to support MFIs. This is being done outside of the Union Budget. This will encourage banks to reopen the money tap for the smaller MFIs. Like in the past, it will be done through the NCGTC, the reports suggest. Even if this happens, it will probably be too little, too late.   

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