Microfinance credit quality in shape; drying up of liquidity forcing clients to informal sector

By PNI Admin On Sep 23, 2025

Bengaluru: As of end August, the microfinance sector credit quality measured in terms of Portfolio at Risk (PAR) between 1-90 days has improved to 3.4% from the peak of 4.6% in September, 24. This indicates improvement in the portfolio quality and higher collection efficiencies / repayments of the new loans disbursed which showcases a healthy trend for the sector.

The credit quality ratio would have been even better, given the above trend, but for severe drop in liquidity (funding from banks and AIFIs) which has been primary reason for the decline of 21% in loans outstanding from March, 24 to August, 25. The direct impact of drop in microfinance loans has impacted nearly 45 lakh borrowers[1] going out of microfinance fold and thereby facing issues in sustaining livelihoods. This presents a risk of large segment of borrowers slipping back into the fold of informal lending with dependence on moneylenders, reversing years of progress in financial inclusion.

NBFC-MFIs, which primarily rely on wholesale funding from banks, have witnessed a sharp slowdown in fund flows over the past few quarters. Overall, Y-o-Y debt funding declined by nearly 54%, from ₹30,018 crore in Q4 FY23-24 to ₹13,840 crore in Q4 FY24-25[2], underscoring the mounting liquidity challenges faced by the sector.

Amid this crunch, NBFC-MFIs are increasingly relying on their own equity to sustain operations. This is reflected in the year-on-year decline in the debt-equity ratio from 3.3 in Mar ‘24 to 2.9 in Mar ‘25[3], indicating that the sector is becoming underleveraged. With reduced borrowings and plateaued Debt-equity leverage, reliance on internal funds is set to constrain future growth of the sector.

To address the liquidity challenge, MFIN has been advocating for the revival of the Credit Guarantee Scheme for MFIs (CGSMFI), first launched by the Department of Financial Services, Ministry of Finance, in July 2021. The scheme was instrumental in enabling even smaller and lower-rated MFIs to access funds at lower costs during the COVID period. The scheme acted as a catalyst for starting the virtuous cycle of funding and growth and had no fiscal implications.

MFIN has been requesting the Government for a ₹20,000 Cr credit guarantee scheme to kickstart the wholesale funding from banks and arrest the decline in credit flow. MFIN has also proposed that to encourage banks to lend to Small and Medium MFIs, the scheme should provide higher guarantee coverage for these institutions.

Reviving CGSMFI as “CGSMFI 2.0” will be critical to restoring liquidity, expanding credit flows, easing banks’ risk perceptions, and ensuring wider participation of Small and Medium MFIs, thereby safeguarding financial inclusion gains and sustaining affordable credit access for millions of low-income households.

Speaking on August end figures, Dr. Alok Misra, CEO & Director of MFIN said “the sector has done its part in terms of guardrails, which are bearing results as seen in credit quality, however, decades of hard work in financial inclusion is at stake, due to severe drop in bank funding. At a time, when the RBI has infused extra liquidity in the system, the most needy sector is facing crunch. I sincerely hope the Government through Guarantee scheme will remedy the situation during the festive season”.