After growing at an annual rate of over 18 per cent in the five years from FY19 to FY24, microfinance lending has suffered a sharp setback in the last two years. The microfinance portfolio of banks and NBFCs (Non-Banking Finance Companies) shrank by 18 per cent in the nine months to December 2025, on top of a 14 per cent contraction in FY25.
Banks have halved their lending to microfinance institutions on asset quality and regulatory worries. However, with the microfinance loan book at barely ₹3.5 lakh crore today, there is an urgent need for credit flow to this sector to restart. The Credit Guarantee Scheme for Microfinance Institutions announced by the Centre, seems to be an attempt to nudge banks into lending to NBFCs and microfinance firms by shielding them from default risks. However, it sets one too many conditions to avail of the cover. Under it, the National Credit Guarantee Trustee Company (NCGTC) will provide credit guarantees worth ₹20,000 crore to banks or financial institutions against loans to NBFCs or microfinance firms that cater to micro borrowers, until June 30, 2026. NCGTC will guarantee against 70 per cent of defaults from loans to large NBFCs, 75 per cent to medium ones and 80 per cent to small firms for a maximum period of three years. While the guarantees offered are attractive, other terms and conditions attached to these loans seem restrictive.
To avail of the cover, banks/lending institutions need to ensure that the interest rates at which NBFCs or microfinance firms on-lend to their borrowers is capped at their EBLR (external benchmark linked lending rate) or MCLR (Marginal Cost of Funds-based Lending Rate) plus 2 per cent. They are also required to price loans 1 per cent below the rates they charged for the last six months. As microfinance loans are usually priced much higher in the market to factor in credit risks, it is unclear how NBFCs will demarcate loans under this scheme from their normal micro-loans, especially as this is a limited-period scheme. Even if this is possible, pricing a section of microfinance loans at a discount could distort borrower expectations. It needs to be noted that Reserve Bank of India (RBI) has since 2022, encouraged lenders to move to market-based pricing of their microfinance loans by doing away with earlier rate caps.
If they avail of the scheme, banks need to ensure that at least 5 per cent of their loans are disbursed to small NBFCs and 10 per cent to medium ones. As banks may like to take these calls based on prudent underwriting, this can be a deal-breaker. Banks are also expected to monitor microfinance lenders to ensure that they use the credit only to create fresh loans (and not rollover existing loans) and monitor adherence to the rate caps. Overall, banks may prefer giving up the credit guarantee, rather than adhere to these conditions. To step up credit flow, policymakers may need to look beyond banks to bond markets, where investors have the risk appetite to bankroll riskier lending.
Published on March 25, 2026