India’s microfinance sector

India’s microfinance sector is going through a critical reset phase. As of end-November, the industry’s outstanding loan book declined to approximately ₹3.40 lakh crore, the lowest level in nearly four years. This contraction is not a reflection of weakened credit demand but rather a deliberate shift by lenders toward balance sheet protection amid visible asset quality stress.

Unsecured microfinance portfolios have been the epi-centre of this slowdown. Rising delinquencies, localized borrower stress, and higher operational risks have pushed lenders to adopt more conservative underwriting standards. Small non-banking financial companies and microfinance institutions are facing the sharpest pressure, primarily due to tighter funding access and higher risk premiums. While a few large players reported marginal portfolio growth in the December quarter, the broader sector remains cautious.

Data from small finance banks highlights the depth of the issue. Nearly one-fifth of unsecured microfinance assets across several SFBs have shown signs of stress, with sector-wide net NPAs approaching mid-teen levels even after write-offs. This has triggered a meaningful recalibration of lending strategies. Institutions are reducing unsecured exposure and increasing allocation to secured products such as gold loans, vehicle finance, affordable housing, and MSME-backed credit.

Another notable structural shift is the growing role of credit guarantees. Schemes such as the Credit Guarantee Fund for Micro Units are increasingly being used to protect incremental disbursements. This allows lenders to continue serving micro-entrepreneurs while containing downside risk. At the same time, regulatory flexibility has improved. The reduction in priority sector lending requirements for small finance banks from 75 percent to 60 percent provides room to diversify loan books beyond traditional microfinance.

From an industry cycle perspective, this phase resembles a normalization rather than a prolonged downturn. Experts expect recovery momentum to build gradually through FY26, with a more visible rebound in FY27 as asset quality stabilizes, funding conditions improve, and individual lending models mature. Growth is likely to be slower than previous upcycles, but structurally stronger, supported by better risk pricing, enhanced credit assessment, and improved portfolio granularity.

For investors and capital allocators, this transition phase is revealing. Institutions that demonstrate disciplined risk management, diversified funding sources, and measured growth strategies are better positioned to emerge stronger. The microfinance sector continues to play a vital role in financial inclusion, but its next phase will be shaped by prudence rather than pace.