Microfinance is taking baby steps to recovery but there is a long walk ahead

Bad loan ratios moderated and loan collections improved in the September quarter due to the return of borrower discipline, bankers said. However, profitability remains under pressure and growth still appears far. A key reason: Uneven recovery across states and lenders.

Bandhan Bank, which has a large microfinance book, said it is seeing steady improvement in this microfinance portfolio, particularly across its key eastern markets. Its 30-day-plus delinquency ratio now stands at 3.8%, well below the industry average of 5.1%, while 90-day-plus delinquencies have improved to 2.04% compared to 3% for the sector.

Still, Bandhan remains cautious in expanding microfinance, as it strives to reduce concentration risk and make more secured loans. Its emerging entrepreneurs business portfolio, which comprises microloans, small business and agri-loans, contracted 13% annually to ₹51,730 crore in the September quarter. This segment now accounts for around 37% of its total loan book of ₹1.4 trillion, down from over 45% a year earlier.

Secured focus

“Even if we grow in microfinance, our growth in non-microfinance will be at a much higher rate,” managing director and chief executive officer Partha Pratim Sengupta said, adding the share of secured loans in the overall mix is expected to rise further over the next six to seven quarters.

Currently, the secured loan book makes up about 55% of Bandhan’s total advances, and the bank expects this to increase to 57-58% over the next year and a half.

IDFC First Bank, which also has a microfinance portfolio, believes that stress should stabilize in the next six months. “Our own guess is that by the end of this year, it (stress in MFI loan portfolio) should stabilize; like, it should taper off on the low bottom side by end of this year and then grow from there,” said V. Vaidyanathan, managing director and chief executive officer. Gross slippages in the bank’s MFI book fell 9% sequentially in the September quarter.

The reduction in MFI business—down 42% annually to ₹7,306 crore—impacted IDFC First’s income during the quarter, but it is expected to stabilize in the second half of the year and grow from there on. Of the bank’s total loan book, the share of MFI loans also declined to 2.4% as of September end against 5.6% in the year ago period.

Write-offs define new normal

While asset quality improved at most lenders, it did come at a cost. CreditAccess Grameen, India’s largest NBFC-MFI, reported accelerated write-offs of ₹554 crore in the second quarter related to loans that were overdue for more than 180 days, citing the need to clean up the legacy stress. Its portfolio at risk (PAR) for borrowers with four lenders stood at 15.1%, higher than 14.3% as of June-end, suggesting delinquencies have largely stabilized, the management said in its earnings call. PAR is defined as an outstanding loan portfolio that is at default.

“Across the sector, most large players in this space have shrunk their books by 25-50% in the past two years. They call it cautious deleveraging, but in reality, much of the book reduction has come through write-offs,” said Jinay Gala, director at India Ratings and Research.

Experts also believe that the decline in the days-past-due (DPD) book at most lenders does not necessarily mean a path to profitability.

“Even if the NPAs (non-performing assets) have decreased, the credit cost will rise,” said an analyst on condition of anonymity. “The second half still doesn’t look quite bright from the profitability and growth perspective.”

Policy reforms

In April, self-regulator Microfinance Institutions Network (MFIN) capped the number of lenders per borrower at three, and restricted total indebtedness of a single borrower to ₹150,000.

“The guardrails have reduced over-leverage but also slowed fresh lending,” the analyst quoted above said, adding that until borrowers clear old loans and fall below the cap, growth will remain constrained.

The share of microfinance accounts with exposure to more than four lenders has fallen to 10% in June from 19% a year ago, and for those with over three lenders were down to 24.8% from 34.7%, according to a report by India Ratings and Research dated 30 October.

The rating agency expects collection efficiency to improve further as disbursements rise, but expects near-term pressure to persist due to erratic monsoon patterns.

“The 2025 monsoon’s highly uneven spatial distribution marked by floods in central and western states and droughts in the east and northeast created significant stress for rural borrowers,” the report said.

Flood-hit regions including Madhya Pradesh, Gujarat, Punjab and Rajastha, saw widespread crop damage, infrastructure disruptions and temporary displacements, reducing household cash flows. On the other hand, drought-affected states such as Bihar, Assam, and Odisha faced agricultural failure and water scarcity, further constraining income streams.

Election adds uncertainty, but impact limited

With upcoming state elections in Bihar, concerns have resurfaced over potential political interference and debt waivers, which has disrupted microfinance lenders in the past. Bihar is one of the key markets for microfinance by volume and value. It continues to be the top state, accounting for nearly 15% of the sector’s total portfolio, with top 25 districts accounting for 18% of the total portfolio, according to the credit information companies’ data for FY25 attributed in a Sa-Dhan report on 10 October. Total loan outstanding for the MFI sector stood at ₹3.81 trillion at the end of FY25.

However, Bandhan Bank does not see a repeat of past disruptions.

“Most political parties now realize that debt waivers are not a permanent solution and states do not have the fiscal capacity to fulfil such promises,” Sengupta said. “So far, we haven’t seen major noises from borrowers or any dip in collection efficiency.”

Lenders are also following guidance from MFIN, which has advised field officers to communicate clearly with borrowers during elections that talk of loan waivers is neither sustainable nor rightful.

Overall, analysts expect larger banks and MFIs to come out of the woods first, followed by smaller MFIs, which are unlisted or are smaller in size and scale, as for them funding and growth will be a major challenge. “We as a house feel that the stress is near the bottom, but things will not revive that fast. It will be a slow and gradual journey towards normalcy. FY26 also would be like a de-growth for the sector. FY27 also would be largely flattish or just coming to the neck may be marginally 2-5% kind of growth,” Gala said.