For lenders, it is a quest for wealth at the bottom of the pyramid; for borrowers, an aspiration for a better lifestyle. But the absence of adequate guardrails has resulted in losses for lenders and financial distress for borrowers.
In the financial heart of Mumbai, Reserve Bank of India (RBI) issued an unusually sharp rebuke to the microfinance industry.
DISMAL NUMBERS:
The latest numbers tell a dismal tale. As of March 31, the share of microfinance loans that are overdue by one to six months has jumped to 6.2%, up sharply from just 2% a year previously, indicating a significant rise in repayment delays. The size of the industry has also shrunk with 4.2 crore active MFI (microfinance institution) borrowers – a 9.2% drop from the previous year — while the sector’s AUM (assets under management) stood at Rs 1.47 lakh crore, down 11.9%, year-on-year.
Roughly, 37% of borrowers now juggle debts from multiple lenders, a worrying sign of over-indebtedness. Small finance banks have borne the brunt: their delinquency rate rose to 5.4% in the second quarter of fiscal year 2025.
HUMAN TOLL IN HINTERLANDS:
The sector’s human toll is most plainly seen in stories that trickle out of India’s hinterlands. Repayment “is taking a toll on family finances.”
Entangled in a web of microfinance loans that is becoming increasingly difficult to escape. “They charge exorbitant interest rates — between 21% and 30%.
BORROWERS, BEWARE:
Easy access to credit has also encouraged borrowing for consumption and non-productive expenditure, such as weddings and festivals, making household finances unsustainable. Many borrowers, having taken multiple loans for such purposes, now find themselves trapped in cycles of debt, without matching income streams.
The enduring grip of private lenders, or mahajans, even amid rising institutional credit. Local parlance distinguishes between “licence holders” (openly operating) and “unlicensed mahagans” (covert agents), the latter thriving in bazaars and driving up NPAs.
The consequences can be tragic.
HARASSMENT FROM AGENTS:
Across the industry, the squeeze is showing. NBFC-MFI defaults above 90 days have risen. Share prices of lenders with microfinance exposure — Bandhan, IndusInd, RBL — plunged to 52-week lows. Bihar, Tamil Nadu, Uttar Pradesh, Odisha, and Karnataka now account for 62% of all delinquencies — a concentration that evokes the 2010 Andhra Pradesh crisis.
The state government passed a law to regulate illegal money lending in 2023, but many borrowers misread it as a govt-backed debt-relief scheme. Several MFIs said this misconception triggered a wave of strategic defaults, with borrowers halting repayments, believing loans would be waived.
Borrowers have also begun speaking out about harassment by recovery agents. “People leave secretly at night, migrating to other states to escape the humiliation.” These companies have become the new usurers, exploiting poor villagers with predatory practices.
A VICIOUS CYCLE:
In a small way, the microfinance defaults are similar to the US sub-prime crisis.
How easy credit has been used as a palliative to paper over the growing inequality in income, how using credit to finance a better lifestyle has been leading to more indebtedness.
Credit contagion has begun to spread. Microfinance stress is spilling into auto and business loans, especially in Karnataka and Tamil Nadu. Bihar’s portfolio remains the largest — and, for now, relatively stable.
Regulators are tightening the screws. RBI has nudged the industry to cap unsecured loans at Rs 2 lakh and, in tandem with MFIN (Micro-Finance Institutions Network), limited lenders to four per borrower. New rules to formalize grievance redress, impose lending bans only for arrears above Rs 3,000 and mandate MFI registration have all been rolled out, The measures have slowed lending, but may improve long-term stability.
“The new norm will allow for more balanced portfolio construction and enable MFI’s to cater to clients in the ‘missing middle’, including those moving to MSMEs and micro-housing.”
SILVER OF HOPE:
Meanwhile, Bihar offers a rare glimmer of hope. The state’s Economic Survey for 2024-25 noted a rise in MFI lenders from 42 in 2022 to 64 in 2024. Loan disbursal jumped from Rs 4,503 crore to Rs 25,458 crore. NPAs for commercial banks declined from 7.5% to 5.9%, and for regional rural banks from 30.4% to 23.8%. Small finance banks posted the lowest NPA, 1.9%. The state credits “collaborative efforts of both banks and govt.”
For all the promise microfinance once held, its resurgence of late bears too much resemblance to its troubled past. The tension between financial inclusion and financial exploitation continues to define the industry’s uneasy tryst with the bottom of the pyramid.
