MFI guarantee scheme offers relief, but sector faces key challenges

Centre's credit-guarantee scheme offers temporary relief to microfinance institutions, but sustainable recovery will depend on improved lending practices, risk management, and sector discipline

The Centre has moved to offer a Rs 20,000 crore credit-guarantee scheme for micro-finance institution (MFIs). The MFI credit-guarantee scheme - which had been in the works for nearly six months - will kick in on March 20 and remain active until June 30, or when cumulative-guarantee coverage reaches Rs 20,000 crore, whichever is earlier.

 

However, the success of the scheme is largely dependent on how the sector tweaks its own workings.

 

The interest rate on loans sanctioned by banks to MFIs has been capped at the external benchmark lending rate or the one-year marginal cost of lending rate plus two per cent per annum. MFIs are required to pass on these benefits to small borrowers. However, this pass through must be at least one per cent below their average lending rate over the past six months. Further, the lending limit is now linked to the MFI’s size: at 20 per cent of assets (capped at Rs 100 crore for small MFIs), Rs 200 crore for medium-sized MFIs, and Rs 300 crore for large players.

 

As the Reserve Bank of India's (RBI) Financial Stability Report (December 2025) noted, combined credit from NBFCs and NBFC-MFIs to the microfinance sector, which comprises 51.2 per cent of total credit outstanding to the sector, contracted by 8.5 per cent in H1FY26. In terms of asset quality, the ratio of stressed assets (31-180 days-past-due) has been declining for three successive quarters. The credit cost of NBFC-MFIs, however, rose sharply to 15.5 per cent in September 2025 from 4.4 per cent in September 2023 due to higher risk provisions and write-offs.

 

“A point which the lenders need to keep in mind is that now with a sovereign guarantee available, banks and lending institutions need to scale down their lending norms to MFIs so that the benefit of the scheme is fully utilised,” said Jiji Mammen, executive director and chief executive officer, Sa-Dhan, the self-regulatory organisation for the sector.

 

“As it is the window for the scheme is short. We hope to have better understanding on these and implement the scheme smoothly and ensure the credit Guarantee is fully utilised. If this happens, I am sure the sector will revive once again,” he added.

 

Credit bureau CRIF High Mark’s latest edition of its quarterly 'MicroLend: December 2025 (Q3 FY26)' puts the gross microfinance portfolio at Rs 3.21 lakh crore as of December 2025 and supporting 11.2 crore active loans marks a fall of 18 per cent and 23 per cent, respectively, on a year-on-year basis. This is even as there is a shift to loans to the Rs 50,000-plus ticket size, reflecting a shift to safety as well as an adjustment for inflation.

 

It also spotlights the issues highlighted by RBI Deputy Governor Swaminathan J in a speech on November 14, in which he asked MFIs to serve the household, not just the applicant. “Credit decisions work best when they read the full cash life cycle of the family. It is better to promote a savings habit, a basic insurance cover, and a short emergency line, as all these together can make credit quality predictable," he said at the time.

 

The other aspects he touched upon were tech-enabled underwriting with human judgment, making the shift from mono-product to micro-enterprise finance, building climate resilience at the base of the pyramid, and responsible use of data. “Taken together, the aim is to convert first access into regular use, regular use into stable income, and stable income into a clear route to formal credit. This is the quality of growth the sector should now aim for," he said.

 

The RBI, on its part, has allowed MFIs to diversify into relatively less vulnerable sectors. It revised the qualifying asset criteria to 60 per cent of total assets (netted off by intangible assets) from the earlier prescription of 75 per cent on June 6, 2025.

 

The MFI story as it stands

 

• The credit-guarantee scheme will take effect on March 20 and remain active until June 30 or when cumulative-guarantee coverage reaches Rs 20,000 crore, whichever is earlier
• The RBI’s Financial Stability Report (FSR: December 2025) said combined credit from NBFCs and NBFC-MFIs to the microfinance sector, which comprises 51.2 per cent of total credit outstanding to the sector, contracted by 8.5 per cent in H1FY26
• The FSR observed in terms of asset quality, the ratio of stressed assets (31-180 days-past-due) has been declining for three successive quarters. The credit cost of MFIs, however, rose sharply to 15.5 per cent in September 2025 from 4.4 per cent in September 2023 due to higher risk provisions and write-offs