India’s microfinance sector is showing signs of recovery after navigating one of its most challenging periods in recent years, with improving disbursements, stabilising asset quality and a return to sequential portfolio growth signalling a gradual turnaround, according to CareEdge Ratings.
Industry disbursements rose to nearly ₹77,500 crore in Q4FY26, the highest level in eight quarters, while industry assets under management (AUM) increased 3.3% sequentially after declining for seven consecutive quarters.
However, the recovery is expected to be more measured than in previous cycles, with larger, well-capitalised NBFC-MFIs likely to be better positioned to benefit from the improving operating environment.
CareEdge Ratings expects NBFC-MFI AUM to grow by around 15% in FY27, while return on total assets (RoTA) is projected to improve sharply to approximately 2.4% from 0.5% in FY26.
Asset quality improves
The sector’s lending discipline has strengthened following the introduction of industry guardrails and recent policy initiatives aimed at curbing borrower overleveraging.
The share of borrowers with more than three lender relationships declined to around 5% in FY26 from 13% in FY24, indicating a significant reduction in multiple borrowing.
The portfolio originated after the implementation of the guardrails is also showing healthier collection performance. Portfolio at risk (PAR) of 1–30 days declined to 0.5% in March 2026 from 1.4% a year earlier, while PAR of 31–90 days fell to 0.8% from 2.8% during the same period.
With much of the legacy stress having been addressed, credit costs are expected to moderate, supporting a gradual improvement in profitability.
CareEdge expects credit costs to decline to around 3.5% in FY27 from 5.4% in FY26.
Larger MFIs gain an edge
The recovery, however, is unlikely to be evenly distributed across the sector. Larger NBFC-MFIs, supported by stronger capitalisation and better access to funding, are expected to have an advantage in scaling their businesses.
Large MFIs are also increasingly diversifying beyond traditional microfinance products. Non-microfinance AUM accounted for approximately 19% of their total AUM in FY26, compared with 13% for medium-sized NBFC-MFIs and just 2% for smaller players.
While such diversification could moderate portfolio yields and margins, it could improve earnings stability and reduce concentration risk over the longer term.
Funding remains key differentiator
Access to funding is likely to remain the biggest differentiator in the sector’s recovery. While larger NBFC-MFIs continue to have relatively better access to funding, smaller institutions face tighter liquidity conditions, higher borrowing costs and more cautious lender appetite.
Small NBFC-MFIs raised borrowings equivalent to only around 14% of their opening AUM in FY26, compared with approximately 26% for medium-sized MFIs and 60% for large NBFC-MFIs.
The disparity in funding access could result in an uneven recovery and increase the likelihood of further consolidation in the sector.
The Credit Guarantee Scheme for MFIs 2.0 is aimed at bridging this funding gap, although its uptake remains modest, according to CareEdge Ratings’ survey of rated NBFC-MFIs.
Recovery faces external risks
Despite the improving fundamentals, the sector continues to face several risks. Funding conditions, weather-related disruptions, rural income volatility and localised political developments will remain key monitorables for NBFC-MFIs.
CareEdge expects the combination of improving asset quality, business growth and lower credit costs to drive a significant improvement in profitability in FY27.
The recovery is therefore taking shape, but the next growth cycle is likely to be characterised by greater lending discipline, stronger differentiation between institutions and a sharper advantage for well-capitalised players.