The Rising Stress in India's Microfinance Sector: A Deep Dive into the Latest Micrometer Report

Introduction

The microfinance sector in India has played a pivotal role in fostering financial inclusion by extending credit to underserved communities. By empowering small entrepreneurs, women, and rural populations, microfinance institutions (MFIs) have contributed significantly to economic growth and self-reliance. However, the latest Micrometer Q3 FY 2024-25 report paints a concerning picture, revealing a surge in non-performing assets (NPAs), declining loan disbursements, and deteriorating credit discipline. These trends indicate growing distress in the sector, raising questions about its future sustainability and regulatory responses.

This article provides an in-depth analysis of the current state of India's microfinance industry, the underlying causes of its challenges, and potential strategies for mitigating risks while ensuring inclusive growth.

Key Highlights from the Report

1. NPAs Soar to ?50,000 Crore, Raising Alarm Bells

• The gross NPA ratio has skyrocketed to 13% of the total loan book, indicating severe stress in loan repayments.
• Portfolio at Risk (PAR) 31-180 days has increased to 6.4%, a drastic jump from 2.0% a year ago.

2. Asset Quality Deteriorates Across Lenders

• Banks & Small Finance Banks (SFBs): PAR 31-180 increased to 6.8% and 7.2%, respectively, up from 2.3% and 2.8% in the previous year.
• NBFC-MFIs: PAR 31-180 surged to 6.7%, compared to 1.6% last year.
• NBFCs: PAR 31-180 climbed to 3.7%, up from 1.0% a year ago.

These figures reflect increasing defaults, particularly in high-risk borrower segments, despite regulatory efforts to ease capital allocation requirements.

3. Loan Disbursements and AUM Shrink

• Loan disbursements fell by 35.8% YoY, with ?22,091 crore disbursed in Q3 FY25 compared to ?34,422 crore in Q3 FY24.
• Assets Under Management (AUM) declined by 6.5% QoQ to ?1.42 lakh crore, indicating reduced lending activity.

4. Regional and State-Level Trends

• East & North-East India maintain the largest share of the microfinance portfolio (32%), followed by South (31%).
• The Top 3 states in terms of portfolio outstanding: Bihar, Tamil Nadu, and Uttar Pradesh. Tamil Nadu has the highest average loan outstanding per account (?30,952), followed by West Bengal (?29,290).

Regulatory Challenges and Market Impact

The microfinance sector has faced significant regulatory changes, particularly in Karnataka, where the Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance, 2025 has been introduced. This ordinance aims to curb coercive recovery practices but may impact collections and lender confidence.

Additionally, the Reserve Bank of India (RBI) has attempted to ease capital constraints by lowering risk weights on bank loans to NBFCs and MFIs. However, these measures have not fully mitigated concerns surrounding over-lending and weak credit discipline.

Underlying Causes of Rising NPAs and Stressed Assets

Several factors have contributed to the worsening financial health of microfinance institutions:

1. Over-Lending and High Leverage

• Many borrowers, especially in rural areas, have multiple loans from different lenders, leading to excessive debt burdens.
• The lack of a comprehensive credit assessment system allows borrowers to secure multiple loans beyond their repayment capacity.

2. Economic Slowdown and Inflationary Pressures

• The slowdown in rural economic activity and inflationary pressures have reduced borrowers’ repayment capabilities.
• Many micro-businesses, particularly in agriculture and small trading, have struggled with rising input costs.

3. Political and Policy Risks

• Frequent state-level loan waivers create a culture of repayment deferral, discouraging financial discipline among borrowers.
• Policies such as the Karnataka ordinance, though well-intended, can create unintended disruptions in loan collections.

4. Weak Credit Monitoring Mechanisms

• Despite improvements in credit bureau coverage, gaps remain in tracking borrower liabilities across multiple institutions.
• Many smaller MFIs lack sophisticated risk assessment models to detect early signs of distress.

Future Outlook: Can the Sector Recover?

While challenges persist, the microfinance sector can take several corrective steps to improve resilience and restore lender confidence.

1. Strengthening Credit Risk Management

• Adoption of AI-driven credit scoring models and alternative data analytics can improve borrower assessment.
• Stricter underwriting standards and cap limits on multiple borrowing should be implemented to control over-lending.

2. Enhancing Financial Literacy Among Borrowers

• MFIs must conduct extensive financial literacy programs to educate borrowers on responsible borrowing and credit discipline.
• Strengthening Self-Help Groups (SHGs) can also enhance collective accountability for repayments.

3. Diversification of Funding Sources

• The 39.6% drop in debt funding signals an urgent need for MFIs to explore alternative financing sources.
• Development finance institutions, impact investors, and blended finance structures could offer more stable funding options.

4. Strengthening Regulatory Framework

• The RBI and industry bodies should work towards a unified borrower database to prevent multiple loan exposures.
• Clearer guidelines on recovery practices will help mitigate risks of coercion while ensuring timely repayments.

Conclusion: The Road Ahead for Indian Microfinance

The microfinance sector stands at a crucial juncture—balancing financial inclusion with sustainability requires prudent risk management, regulatory oversight, and digital innovation. The coming quarters will be critical in determining how the industry adapts to these evolving challenges.

While NPAs have surged and loan disbursements have declined, the resilience of the sector depends on how quickly lenders, regulators, and stakeholders can work together to rebuild borrower confidence and create a more stable lending ecosystem.

The need of the hour is responsible lending, effective borrower education, and enhanced monitoring mechanisms to ensure that microfinance continues to empower India's underserved communities without falling into another debt crisis.

What are your thoughts on the growing stress in India's microfinance sector?

How can stakeholders mitigate risks while ensuring inclusive growth?

Let's start a conversation in the comments below!