Microfinance in Reset Mode: Sector Tightens the Screws After a Short, Sharp Shock

A Short, Sharp Shock for Microfinance

India’s microfinance sector is emerging from a turbulent phase. After a period of rapid growth driven by the RBI’s liberalised 2022 framework, the industry now finds itself navigating a compressed credit and regulatory cycle. The triggers? Borrower overleveraging, sharp regulatory pivots, and rising asset stress, particularly in Karnataka and Tamil Nadu.

Borrower stress began surfacing in rural and semi-urban areas, followed by a regulatory crackdown. In early 2025, the Karnataka government passed the Micro Loan and Small Loan (Prevention of Coercive Actions) Act, designed to curb illegal moneylenders. However, its ambiguous implementation disrupted even formal MFIs, denting collections and increasing delinquencies.

Simultaneously, the Microfinance Institutions Network (MFIN) introduced Guardrails 2.0, a self-regulatory framework (effective January 2025), which capped borrower exposure and tightened underwriting norms. These well-intentioned reforms, combined with borrower fatigue, triggered a sharp contraction across industry metrics.

Key Industry Metrics: March 2025

• Gross Loan Portfolio (GLP): ₹3.8 lakh crore (–14% YoY)
  
• Disbursements: ₹66,700 crore (–38% YoY)
  
• Average Borrower Exposure: ₹46,000
  
• Unique Active Borrowers: 8.3 crore
  

Despite the downturn, there are early signs this may be a short, intense reset, not a prolonged downturn. Asset quality is beginning to improve in some of the most affected states.

Company Highlights

CreditAccess Grameen: Taking the Pain Upfront

For CreditAccess Grameen, Q4FY25 was about prioritising long-term stability over short-term optics. While disbursement activity recovered sequentially, the lender focused on aggressively cleaning up its balance sheet.

• ₹480 crore in proactive write-offs
  
• Total provisions: ₹583 crore for the quarter
  
• Gross NPA: 4.8%
  
• Net NPA: 1.8%
  
• Collection efficiency: 92.2%
  

Karnataka continued to weigh heavily on collections, but management expects credit costs to remain elevated only through H1FY26. The approach? Absorb the shock early, and enter the next cycle with a stronger foundation.

Five Star Business Finance: Playing Offence, Selectively

Five Star Business Finance delivered a steady performance by moving up the credit curve. Rather than chase market share, the lender shifted focus toward mid-ticket, better-rated loans in the ₹3–10 lakh range.

• Collections: 97.7%
  
• Gross Stage 3 Assets: 1.8%
  
• Provisions: ₹25.4 crore
  
• Digital repayment share: Increasing steadily
  

By avoiding the riskier sub-₹3 lakh segment and improving operational efficiency, Five Star is positioning itself as a premium lender. The company is guiding for 25% AUM growth in FY26, with controlled credit costs in the range of 75–100 bps.

A Sector in Strategic Reset

Both companies reflect the broader shift underway in microfinance:

• CreditAccess is cleaning up legacy stress
  
• Five Star is selectively scaling up in more stable credit segments
  

Meanwhile, reforms like MFIN’s Guardrails 2.0 and Karnataka’s state law are pushing the industry to rewire its risk and distribution models. The once high-growth, loosely regulated sector is now moving toward quality-first lending with tighter underwriting, higher-ticket products, and more robust collection systems.

Looking Ahead: What Could FY26 Hold?

Although Karnataka and Tamil Nadu remain areas of concern, asset quality is already stabilising in states like Bihar, UP, and Odisha. With:

• Lower disbursement velocity
  
• Higher digital repayments
  
• Improved borrower screening
  

…the groundwork for a more resilient microfinance industry is being laid. If this trajectory holds, the sector could show early signs of normalisation by H2FY26. But the approach will look very different from the past: more selective, more cautious, and far more data-driven.

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