The microfinance industry was once seen as a solution to rural India’s credit gaps. The government’s ₹20,000 crore Credit Guarantee Scheme for Microfinance Institutions 2.0 (CGSMFI 2.0) acknowledges stress in the sector. It will have limited impact unless the industry addresses deeper weaknesses in its growth model. Microfinance expanded access to credit for households excluded from formal banking. The industry’s portfolio crossed ₹3.2 lakh crore, with more than 100 million loan accounts.
Rapid growth weakened lending discipline; multiple lending, weak borrower assessment, and aggressive expansion created recurring stress cycles. The current phase reflects another such correction.
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The weakening of the joint liability group (JLG) model has amplified this shift. Group-based lending—where small borrowers guarantee each other’s loans—was central to maintaining repayment discipline and lowering default risk. As borrowers increasingly access credit from multiple lenders, this mechanism has diluted. Peer monitoring is weaker, and repayment incentives are less effective.
CGSMFI 2.0 and uneven credit flows
CGSMFI 2.0 aims to ease funding constraints, especially for smaller and lower-rated MFIs. The sovereign guarantee is meant to encourage banks to lend.
Banks remain cautious. Lending is concentrated among large, well-rated MFIs. Smaller institutions continue to face funding constraints. Without a broader change in bank risk appetite, the scheme’s reach will remain uneven.
This caution also reflects regulatory tightening by the Reserve Bank of India. The 2022 harmonised framework shifted microfinance regulation from entity-based rules to activity-based norms, allowing lenders greater flexibility in pricing and underwriting.
In practice, this has led to risk-based pricing and sharper differentiation across borrowers, reinforcing banks’ preference for better-rated institutions and lower-risk segments.
Recovery that shifts the borrower mix
Credit bureau data shows a recovery in disbursals and loan sizes. Asset quality has improved.
This recovery is selective. MFIs appear to be focusing on relatively better-off borrowers within the low-income segment. That reduces risk for lenders but weakens the sector’s financial inclusion objective.
Disbursals also remain below pre-pandemic levels.
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Borrower stress and incomplete data
Aggregate indicators such as the fixed obligation to income ratio (FOIR) remain below 20%. These averages conceal stress at the borrower level.
Many borrowers hold multiple loans. Their repayment burden rises sharply, sometimes breaching regulatory thresholds. Overlapping lending remains a persistent problem.
Credit bureaus capture formal loans. Informal borrowings are not recorded. Lenders therefore lack a full view of borrower indebtedness. This limits effective risk assessment.
The risks are also uneven across regions. Microfinance stress tends to be concentrated in specific states and districts, often driven by local economic shocks or lending concentration. This concentration can quickly translate into system-wide stress.
External shocks and fragile repayment capacity
The scheme was designed before the West Asia crisis. External shocks increase income volatility for low-income households. Repayment capacity weakens quickly in such conditions.
This raises the risk of stress even as policy support is expanded.
Surveys by the National Bank for Agriculture and Rural Development indicate a decline in the share of rural households relying solely on formal credit.
This suggests a shift back to informal sources such as moneylenders. The shift reflects both tighter lending by MFIs and borrower over-indebtedness.
The cycle is familiar: borrower stress leads to tighter credit, which pushes households back to informal borrowing.
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Rising cost of credit
Microfinance lending rates are increasing. MFIs cite higher borrowing costs from banks. These costs are being passed on to borrowers. Higher interest rates further strain repayment capacity.
Small and mid-sized MFIs face capital constraints and rising non-performing assets. This is creating conditions for consolidation. Consolidation could improve scale and risk management. It may also reduce competition and weaken the role of smaller, community-based institutions.
The limits of a credit-led approach are now evident. Credit expansion alone does not ensure financial inclusion. Household resilience depends on savings, insurance, and stable incomes. MFIs, banks, and policymakers need to align around this broader framework. Without structural reform, the sector is likely to return to its cycle of rapid expansion followed by stress.