Funding Microfinance in India

Syllabus: GS3/Economy

Context

• The microfinance sector in India has been in the news for reasons like issues of over-leverage, higher delinquency and unhealthy collection practices.

About the Microfinance Sector in India

• Microfinance offers crucial banking services to low-income individuals or groups who otherwise wouldn’t have access to financial services. 
• Microfinance institutions (MFIs) provide various services including microloans, savings accounts, and financial education, primarily in developing countries.
• MFIs including NBFCs, NBFC-MFIs, small finance banks (SFBs), and banks, serve nearly eight crore poor households by offering doorstep, collateral-free credit.

Trends Shaping Microfinance Funding

• Digital Transformation: Fintech partnerships are enabling MFIs to reduce operational costs and improve credit assessment, making them more attractive to investors.
• Blended Finance Models: Combining concessional funding with commercial capital is helping de-risk investments and attract private sector participation.
• Green Microfinance: Funding is increasingly directed toward environmentally sustainable projects, such as solar energy loans or climate-resilient agriculture.
• Gender-Lens Investing: Investors are prioritizing MFIs that empower women entrepreneurs, recognizing the multiplier effect of female financial inclusion.

Concerns & Challenges in the Microfinance Sector in India

• Overdependence on Debt Capital: Most MFIs rely heavily on debt from banks and financial institutions that makes them vulnerable to interest rate fluctuations and liquidity crunches, especially during economic downturns.
• Limited Equity Infusion: Investors are cautious due to concerns over asset quality, regulatory risks, and limited exit options.
  • It restricts the sector’s ability to scale and absorb shocks.
• Geographic Concentration of Lending: MFI operations remain concentrated in around 250 districts, leaving two-thirds of the country under-penetrated, especially in the Northeast and tribal belts, undermining the sector’s core mission of inclusion
  • States like Odisha, Kerala, Tamil Nadu, and Rajasthan have witnessed a material rise in overdue loans, while Uttar Pradesh shows deterioration in early-stage delinquencies.
• Overleveraging of Borrowers: Multiple loans from different institutions have led to unsustainable debt levels.
  • In several states, the average loan outstanding per borrower now exceeds per capita income, raising alarms about repayment capacity.
• Regulatory Tightening: The RBI’s push for stricter household income assessments and compliance norms has led to regulatory embargoes on major players like Asirvad Microfinance and Arohan Financial Services.
  • While necessary for borrower protection, these measures have slowed disbursals and increased operational complexity.
• Structural Challenges:
  • High Interest Rates: Many MFIs continue to charge high margins, raising concerns of borrower exploitation and financial distress, despite access to low-cost capital.
  • Shrinking Loan Portfolios: The gross loan portfolio fell by 13.5% to ₹3.75 lakh crore in FY25, reflecting cautious lending amid rising defaults and regulatory pressure.
  • Policy Backlash: Historical events, such as the Andhra Pradesh ordinance in 2010, still cast a shadow.
    • The Supreme Court overturned the restrictions in 2023, but the sector’s reputation and investor confidence remain fragile.

Government Efforts & Initiatives in the Microfinance Sector in India

• RBI’s Regulatory Framework for Microfinance Loans: The RBI introduced a unified regulatory framework effective from April 1, 2022, applicable to all Regulated Entities (REs) including NBFC-MFIs, banks, and housing finance companies. Key features include:
  • Uniform Definition: Microfinance loans are defined as collateral-free loans to households with annual income up to ₹3,00,000.
  • Repayment Flexibility: REs must offer borrower-friendly repayment schedules based on board-approved policies.
  • Income Assessment: REs are required to assess and report household income to Credit Information Companies (CICs).
  • Repayment Cap: Monthly loan repayments must not exceed 50% of household income, ensuring responsible lending.
• PM SVANidhi Scheme: It is a flagship initiative launched by MoHUA to provide working capital loans to street vendors. Recent developments include:
  • Extension till March 31, 2030 with a total outlay of ₹7,332 crore.
  • Enhanced Loan Limits: First tranche up to ₹15,000, second up to ₹25,000, and third up to ₹50,000.
  • Digital Empowerment: Introduction of UPI-linked RuPay Credit Cards and cashback incentives for digital transactions.
  • Expanded Coverage: Now includes census towns and peri-urban areas, beyond statutory towns.
  • Impact: Over 96 lakh loans disbursed totaling ₹13,797 crore; 47 lakh digitally active beneficiaries have conducted over 557 crore transactions.
• RBI’s Advisory Role in MSME Credit Flow: RBI’s Standing Advisory Committee (SAC) influences microfinance, while focused on MSMEs indirectly by promoting:
  • Unified Lending Interface (ULI) and Account Aggregator Framework for seamless credit access.
  • Digital Solutions for alternative credit assessment and faster disbursal.
  • Fair Lending Practices and proactive rehabilitation for distressed borrowers.

Path to Sustainable Growth

• Geographic Expansion: Expansion into newer geographies is crucial to reduce over-saturation and ensure balanced growth.
• Strengthening Credit Assessment: Robust evaluation of household income and existing liabilities is key for sound underwriting.
  • MFIs need to integrate better assessment frameworks to avoid over-indebtedness.
• Managing Non-Microfinance Portfolios: RBI’s recent relaxation on non-qualifying assets provides growth avenues, but institutions need expertise and caution to diversify without risking financial health.

Source: BL