Microfinance in India

Syllabus: Economy

Source: BL

Context: The RBI Deputy Governor flagged a rising crisis in India’s microfinance sector, citing a sharp fall in the gross loan portfolio (13.9%) and surge in delinquencies and NPAs (₹55,000 crore).

About Microfinance in India:

• What is Microfinance in India? Microfinance refers to small-ticket financial services (loans, savings, insurance) extended to low-income households excluded from formal banking.

• Microfinance refers to small-ticket financial services (loans, savings, insurance) extended to low-income households excluded from formal banking.

• Objective: Promote financial inclusion, entrepreneurship, and poverty alleviation through credit access without collateral.

• History: 1974: India’s first MFI – SEWA Bank, Ahmedabad. 1976: Grameen Bank by Muhammad Yunus (Bangladesh) popularized global microcredit. 2010: Malegam Committee recommended regulatory norms for NBFC-MFIs.

• 1974: India’s first MFI – SEWA Bank, Ahmedabad.

• 1976: Grameen Bank by Muhammad Yunus (Bangladesh) popularized global microcredit.

• 2010: Malegam Committee recommended regulatory norms for NBFC-MFIs.

• Regulator: Reserve Bank of India (RBI)

Present Trends in the Microfinance Sector (FY25):

• Loan Portfolio Shrinkage: The gross loan portfolio (GLP) fell by 13.5% to ₹3.75 lakh crore, reflecting reduced disbursals and growing risk aversion by lenders.

• Rising Defaults: Non-performing assets surged to ₹55,000 crore, while loans overdue by 31–180 days (PAR) rose sharply from 2% to 6.2%, signalling deep credit stress.

• Disbursal Dip: Q4 FY25 witnessed a 34% drop in disbursals to ₹70,942 crore YoY, indicating cautious lending amid tightening regulatory scrutiny and defaults.

• Average Loan Size: Despite lower disbursals, average loan ticket size rose by 11.5% to ₹53,897, suggesting lenders are focusing on fewer but higher-value accounts.

• State Trends: Karnataka saw a 17% portfolio drop due to policy backlash, while Bihar, Tamil Nadu, and UP led in active microfinance engagement and outstanding credit.

Challenges to Microfinance:

• Over-indebtedness: Borrowers are taking multiple loans from different entities without proper assessments, resulting in repayment defaults and financial distress.

• High Interest Rates: Even institutions with access to low-cost capital are levying high margins, raising concerns of usury and borrower exploitation.

• Coercive Recovery Practices: Instances of aggressive recovery, borrower harassment, and even suicides have raised ethical and legal alarms in the sector.

• Credit Appraisal Gaps: Poor risk assessment and commission-based lending incentives are pushing loans to financially fragile clients, worsening asset quality.

• State Regulatory Uncertainty: Laws like Karnataka’s penal action on coercive recovery practices have disrupted operations of even compliant and formal microfinance players.

Way Ahead:

• Stronger Credit Risk Frameworks: MFIs must integrate better risk profiling tools and limit multiple borrowings to prevent borrower over-leverage and defaults.

• Regulation of Recovery Practices: RBI must enforce a uniform recovery code ensuring borrower dignity and outlawing intimidation and coercion during repayment collection.

• Rate Rationalisation: A ceiling on microloan interest rates and margin controls could curb profiteering and improve affordability for poor borrowers.

• Empathetic Lending: The focus must shift from profit-maximisation to developmental finance that uplifts communities and promotes social equity.

• Tech-Based Monitoring: Using AI, data analytics, and early warning systems can help MFIs predict defaults and monitor repayment health proactively.

Conclusion:

Microfinance remains a vital pillar of India’s inclusive development story. However, its potential is hindered by credit quality erosion, ethical breaches, and regulatory lapses. A calibrated approach combining financial prudence with social empathy is essential for sustainable impact.

• “In the villages itself no form of credit organisation will be suitable except the cooperative society.” – All Indian rural credit survey. Discuss this statement in the background of agriculture finance in India. What constrain and challenges do financial institutions face supplying agricultural finances? How can technology be used to better reach and serve rural clients? (2014)