In 2007, India’s Micro-Finance Industry had just ₹6,000 crore in assets under management. Today, that figure stands at ₹3.8 lakh crore—a staggering 70x jump in 17 years. This is a financial revolution that has brought 7.8 crore Indians into the formal credit system for the first time.
But here’s what makes this story particularly compelling: the very characteristics that fueled this explosive growth—small-ticket, unsecured loans to borrowers with no credit history—are now being tested in ways the industry hasn’t seen in years.
We’re witnessing something rare in Indian finance: a sector grappling with the tensions between financial inclusion and commercial sustainability. The outcome will shape not just microfinance, but the entire narrative around credit access in Bharat.
In today’s Create Wealth newsletter, let’s examine what’s really happening on the ground, how institutions are adapting, and what it signals for the next chapter of inclusive credit.
In this edition, we will cover –
- The rise and size of Indian microfinance industry
- The risk-return trade-off at the heart of microfinance
- Microfinance under strain: Decoding the inflection
- Guardrails going up: How lenders are responding on the ground
- What we look for in a lending business- The Dezerv framework
- What really drives long-term returns in lending businesses
Let’s dive in:
The rise and size of Indian microfinance
Microfinance is one of the most powerful tools of credit delivery in India. It operates in places where formal banking rarely reaches: small towns, rural belts, and informal settlements. Its borrowers are often daily wage earners, small entrepreneurs, or first-time credit users with no fixed income or assets to offer.
And yet, this segment has scaled across the country with surprising efficiency. That’s because it follows a very specific model, one that looks very different from traditional lending.
Loan sizes are small, typically ranging from ₹20,000 to ₹50,000, tailored to household-level working capital needs Loans are unsecured, extended without physical collateral Interest rates usually range between 24–36%, a function of higher credit cost, high-touch distribution, and frequent repayments. Tenures are short, typically 12–24 months, with weekly or monthly collection cycles. The lending model relies heavily on group liability and repayment discipline, not hard assets.
Ten years ago, microfinance barely registered on India’s credit map. In FY14, AUM stood at ₹27,800 crore. By FY24, it had surged to ₹4.3 lakh crore, compounding at over 30% for a decade.
In contrast, overall bank credit grew at around 10–11% CAGR, making microfinance one of the fastest-expanding segments in lending.
Today, microfinance makes up around 2% of total bank credit and nearly 8% of all retail loans. It reaches over 7.8 crore unique borrowers, spanning 36 states and union territories and 718 districts across the country.
The risk-return trade-off at the heart of microfinance
Most retail banks build their businesses around low-risk, high-quality lending. Their core books comprise secured products such as home loans, auto loans, gold loans, or unsecured credit such as personal loans or credit cards, typically to salaried professionals with stable income profiles.
The result:
- Net interest margins (NIMs) are low, as banks lend to high-quality borrowers at relatively low rates (NIM is the spread between the interest rate charged to borrowers and the interest rate paid to lenders.)
- Credit costs are minimal, typically in the 0.3% to 1% range (Credit Costs are provisions made for expected loan losses, expressed as a percentage of assets)
- Return on equity (RoE) is stable and predictable, driven by consistent asset quality and operating leverage
(Bear with me, we will delve into what these terms mean in the microfinance industry, in the next segment)
To understand why some lenders withstand cycles while others stumble, it helps to go back to first principles. The lending business, at its core, runs on a simple formula where small shifts in risk, cost, or leverage can dramatically alter outcomes.
Microfinance institutions operate on the other side of the credit spectrum, i.e., the riskier end of the market.
Their customers are informal and unbanked. Loans are small, unsecured, and cash flow visibility is limited. There’s no credit bureau trail to fall back on. Just trust, backed by discipline on the ground.
It’s a pure risk-reward equation.
Perhaps that’s why every successful MFI eventually aspires to become a small finance bank, and every small finance bank, over time, seeks a universal banking license.
Because scale demands stability.The ability to accept deposits, diversify across asset classes, and access lower-cost liabilities becomes essential as the loan book grows
Where traditional banks underwrite quality, MFIs underwrite uncertainty.
And in a cycle like this, the outcome hinges entirely on execution.
Microfinance under strain: decoding the inflection
Microfinance is a structurally cyclical business.
When things go well, the model delivers explosive growth and returns. RoEs touch as high as 25–30%, capital rotates quickly, and portfolio expansion, i.e, loan growth, looks effortless. The short-tenure, high-yield structure compounds rapidly, and lenders are often rewarded for simply growing faster than their peers.
Consider that these return profiles are far above what most Tier 1 banks deliver.
HDFC Bank, ICICI, Kotak, and Axis typically deliver RoEs between 13 to 18%, supported by secured assets, risk-weighted pricing, and diversified lending books that keep performance steady across cycles.
In microfinance, fast growth drives profits in good times, but also deepens the impact when stress hits.
The reason? It’s in the formula.
- System-wide disbursements have slowed down, leading to a 13% YoY fall in industry AUM.
- Credit costs for FY25 have spiked to 6.2%, up from ~2.8% in FY24. That alone wipes out a chunk of NIM.
- Sector-wide Gross NPAs have nearly doubled, rising to 16% from 8.8% just a year earlier as of FY25.
- Meanwhile, operating costs remain structurally high due to the field-heavy model.
- The result is an RoA squeeze, and with it, an RoE collapse, even for otherwise well-run lenders.
This year has been among the most challenging for the microfinance sector in recent memory. This stress can be attributed to a combination of external shocks and internal vulnerabilities, including rising borrower leverage, weakening of the joint liability model and softening credit discipline.
Credit discipline has come under pressure in key states. In Karnataka, regulatory changes have disrupted recovery momentum, while in Assam, past support schemes have left a lingering impact on repayment behaviour.
Guardrails going up: How lenders are responding on the ground
With portfolio stress building and delinquencies rising, most microfinance lenders are now in protection mode. The emphasis has shifted from rapid growth to asset quality, and across the board, institutions are tightening operational and credit filters. The actions may vary in intensity, but the direction is clear: caution, discipline, and selective lending.
Conference calls from leading MFIs this earnings season reveal a common thread:
- Tighter borrower-level screening: New disbursals are increasingly being directed toward low-risk households. Most lenders are strictly adhering to the microfinance industry norm of not lending to customers with more than three active loans. In many cases, that bar has been internally lowered to two.
- Pause on repeat lending in high-stress areas: Lenders have begun pausing or delaying repeat loans in regions showing early signs of stress. States like Karnataka, Bihar, and parts of the Northeast are seeing a moderation in activity, with lenders slowing disbursements to protect asset quality.
- Focus on vintage and repayment history: The lens has shifted to customer track record. Borrowers with a proven repayment history across multiple loan cycles are being prioritised for fresh loans. First-time and new-to-credit customers are being screened more cautiously.
- Stricter centre formation norms: Centre-level policies have also been tightened. Lenders are revising group composition rules to reduce behavioural contagion within borrower cohorts and are opening fewer new centres than before.
- Improved collection focus: With early bucket delinquencies rising, many lenders are actively reinforcing on-ground collections. In some markets, net collection efficiency is beginning to stabilize, indicating that early actions may be yielding results.
- Real-time portfolio surveillance: Internal risk teams are now closely tracking borrower-level data, flagging potential defaults earlier than before. The goal is to catch slippages before they scale into larger stress pools.
What we look for in a lending business- The Dezerv framework
On the surface, lending seems straightforward: raise capital, lend it out, earn the spread. But in reality, it is one of the most demanding businesses to run. Lending institutions are exposed to behavioural risk, regulatory shocks, execution challenges, and the unforgiving maths of leverage.
At Dezerv, we evaluate every lender through a structured framework called the PQRS framework —a four-pillar model that helps us assess credit business based on their credit rating but many other parameters. Here is what we assess in the PQRS framework –
P – Performance
Are they running an efficient lending engine? We examine loan growth, spreads (NIMs), operating expenses, and return on assets to evaluate core business efficiency.
Q – Quality
What’s beneath the hood? This pillar looks at governance standards, promoter integrity, board oversight, and how prudently the institution underwrites and risk provisions.
R – Rating
External credit ratings offer an independent signal. We assess current ratings, agency history, and any rating actions that reflect shifts in risk perception.
S – Solvency
Does the lender have the balance sheet strength to weather volatility? We analyse debt-to-equity levels, capital buffers, and interest coverage to understand how well they can absorb shocks.
Together, these four filters help us separate execution strength from cosmetic growth. Because in lending, resilience matters more than runway.
What really drives long-term returns in lending businesses
In banking, trust is everything. And trust, ultimately, is placed in the hands of the ones steering the institution. Leadership quality, therefore, is not a soft metric. It is the first and most enduring signal to track.
Even within MFIs, the market knows where it’s willing to pay up; some names trade at 3–4x price-to-book, a level reserved for franchises that consistently manage risk, return, and reputation. Because the truth is: pulling off loan growth is easy. In this sector, everyone can do it. What separates the few is how they behave when the tide turns.
For investors, MFIs are often seen as high-beta proxies for rural India, deeply exposed to the economic rhythms of the hinterland. They are volatile. They are operationally intense. But they are also one of the clearest windows into how formal capital flows through Bharat.
If recent earnings are any signal, rural India is showing early signs of a recovery, even as urban consumption remains soft. That, too, will shape how these institutions are valued in the next cycle.
These green shoots are now beginning to show up in the numbers:
- Lender consolidation is visible. The proportion of borrowers with three or more active lenders has dropped from 20% in March 2024 to 12% in March 2025, pointing to more disciplined credit deployment and better adherence to MFIN guardrails.
- The share of high-ticket borrowers is reducing. Borrowers with loan exposure above ₹2 lakh have declined from 8% to 3%, indicating a shift toward safer borrower profiles.
- Collection efficiency has improved from a low of 95.2% in Q2 FY25 to 97.8% in Q4, reflecting tighter on-ground execution.
- Many lenders have accelerated write-offs to clean up their books. Write-offs as a percentage of AUM rose from 1.5% to 4.8% in the last two quarters.
- Asset quality is beginning to recover. PAR 90+ has declined from 2.1% in September 2024 to 1.4% in March 2025
While it is too early to call it a full recovery, the directional trend is positive, and markets will be watching closely.
In summary
Here’s what I find most fascinating about this microfinance cycle: it’s not just about loan defaults or quarterly numbers. It’s a real-time stress test of India’s financial inclusion experiment.
Every credit cycle teaches us something about risk, discipline, and the true cost of growth. The microfinance sector has weathered the Andhra Pradesh crisis, demonetisation, and COVID. Each shock made the industry stronger, more regulated, and more disciplined.
What we’re witnessing now is similar: a necessary recalibration that will separate the institutions built for scale from those built to last.
Because here’s the reality, as one saying goes, “You cannot be bullish on India and bearish on banking”
Microfinance, for all its cyclical volatility, sits at the heart of this equation. It’s the bridge between Bharat and formal finance.
The institutions that emerge stronger from this cycle—those with disciplined underwriting, strong collection systems, and prudent risk management will define the next decade of financial inclusion.
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