Multiple triggers in MFI space may be offset by near-term headwinds

Improving asset quality and disbursement trends support outlook, but risks from Bihar legislation, geopolitics, and climate factors may weigh on growth

Recent reports on microfinance institutions (MFIs) indicate signs of recovery. But concerns include state elections, the negative impact of proposed Bihar legislation and possible impact of geopolitics and El Nino on agriculture.

 

Consolidation was visible in bank MFI exposures in the third quarter of financial year 2026 (Q3FY26), while non-banking financial companies (NBFCs) and Small Finance Banks (SFBs) may have gained market share in the MFI space. Disbursement was better, with bigger tickets and higher loan volumes. Asset quality improvements were also visible.

 

NBFCs and NBFC-MFIs have lower portfolios at risk with loans outstanding for over 30 days (PAR 30+) at 0.7 per cent, and 1.4 per cent for 7-9 MOB (Months on Board). But there have been elevated write-offs in some ticket segments.

 

The MFI segment may be moving into a phase of normalisation. Growth is being driven by higher-tickets. Lenders need to establish credit cost control and ideally, to diversify portfolios. Growth in AUM shouldn’t come at the cost of poor asset quality.

 

Industry wide, gross loan portfolios declined 7 per cent quarter-on-quarter (Q-o-Q) in Q3FY26, indicating borrower consolidation and derisking. Banks reduced exposure. Early indicators indicated peak delinquency may be over, with asset quality improving sequentially.

 

Improvement is visible across geographies. There could be sharp earnings growth (maybe triple digit) and strong gains in return on assets (RoA) from a low base of around 1 per cent. AUM may grow at 20 per cent over the next two fiscals if rural demand stays strong.  

 

The year-on-year (Y-o-Y) disbursement growth turned positive in Q3 after five quarters. Industry-wide disbursement growth was 9.2 per cent Q-o-Q and 5.2 per cent Y-o-Y from positive 8.7 per cent growth Q-o-Q and minus 18 per cent Y-o-Y in Q2FY26.

 

Growth was supported by higher tickets and loan volume growth (single digit percentage growth in average ticket sizes, and in loan volumes). NBFC-MFIs led the growth with 10 per cent Q-o-Q (27 per cent Y-o-Y), with market share gains. Banks had sequential uptick in disbursements of 13 per cent Q-o-Q (down 25 per cent Y-o-Y). Disbursements above ₹50,000 are the most popular with ₹50,000-80,000 bucket market share up to 42.8 per cent (41.9 per cent in Q2FY26), and the ₹80,000-10,0000 share going up to 17.9 per cent  (15.2 per cent  in Q2FY26).

 

Disbursements rose but AUM declined, with gross loan portfolio (GLP) down 7 per cent Q-o-Q and 18 per cent Y-o-Y, with consolidation in client bases and active loans. Banks’ MFI portfolio outstanding dropped 21 per cent Q-o-Q (8 per cent decline in Q2FY26). The NBFC-MFIs’ portfolio outstanding saw 0.5 per cent Q-o-Q decline, while SFBs and NBFCs saw contractions of 1.4 per cent and 1.2 per cent Q-o-Q, respectively. NBFC-MFIs gained market share in Q3FY26, up 280 basis points to 42 per cent, from 39 per cent in Q2FY26. SFBs saw 110 basis points Q-o-Q gain in market share.

 

By geography, portfolio contraction was pronounced in West Bengal (down 19 per cent Q-o-Q), Karnataka (down 8 per cent  Q-o-Q), Maharashtra (down 8 per cent  Q-o-Q) and Bihar (down 6 per cent Q-o-Q). UP saw a decline of 3 per cent Q-o-Q. Active loans in Tamil Nadu, Karnataka, West Bengal, Bihar and Odisha all reported Q-o-Q declines in active loans. Among all states, Tamil Nadu and Kerala have highest exposure per loan at about ₹33,000, with Bihar and Karnataka at ₹30,000-₹31,000.

 

Asset quality is better with PAR 1-30 down to 1 per cent, from 1.4 per cent in Q2, and also down in PAR 31-90 and PAR 91-180. Beyond PAR180, write offs have helped clean up balance sheets. Banks have written off over 27 per cent of PAR 180+ loans. NBFC-MFIs reported the highest improvement.

 

NBFC-MFIs may be the best positioned, given asset quality improvement and market share gains. The MFI guardrails appear to have worked. However, overleveraging may still be a problem and strict monitoring of MFI assets is necessary.

 

The concern is that the Iran conflict may affect fertiliser production, which could dampen rural sentiments. El Nino could also have a negative effect. The proposed Bihar Bill could affect 14 per cent of industry exposure as it proposes borrower protection measures like total interest capped at 100 per cent of principal, limits on borrower exposure to a maximum of two MFIs and restrictions on recovery practices. Analysts have CreditAccess Grameen, Muthoot Microfin, Satin, Fusion and Spandana among top bets.