Budget 2025: 3 steps that can help empower microfinance industry

While the microfinance industry’s AUM accounts for just 4 percent of total bank credit, its impact is immense. According to an NCAER study, microfinance contributes 3 percent to the GVA of the economy.

It fosters entrepreneurship and supports livelihood activities, especially in rural India. The sector has also been instrumental in bridging the digital divide and promoting digital inclusion in rural areas. If India is to achieve its "Viksit Bharat" goals by 2047, digitalisation of the economy and increasing women's workforce participation will be crucial. Microfinance, through its formalisation of the rural economy, will play a significant role in this growth journey.

To nurture microfinance and support rural initiatives further, the government should focus on the following areas in the upcoming Union Budget:

1. Provide affordable credit/refinance facilities

Most microfinance entities rely on banks for loans to lend to end borrowers. Recently, the transmission of policy rate revisions from banks to NBFCs has not been proportionate. Despite being classified as priority sector lending, the rates at which MFIs secure funding for onward lending range between 10.5 percent and 16 percent, depending on the size of the entity.

To ensure affordable credit for rural entrepreneurs, there is an urgent need for a dedicated refinancing vehicle that can provide funds to MFIs at reduced rates, similar to the NHB refinance mechanism available to HFCs.

2. Enhance credit guarantee schemes

To encourage fund flow to remote regions and fulfill the financial inclusion agenda, the government can effectively leverage credit guarantee schemes to create a multiplier effect.

MFIs face significant risks when operating in rural areas, serving untested and underserved customers. An effective risk-sharing mechanism is essential for MFIs to continue their mission of inclusion and promote entrepreneurship among rural women.

While the government has a CGMFU guarantee scheme, the existing FLDG structure makes it unattractive for MFIs due to high costs (3 percent FLDG + 1.5-2 percent guarantee fee). Eliminating the First Loss Default Guarantee (FLDG) structure would make these programs more appealing.

3. Address financial vandalism

In addition to credit risks, MFIs face operational disruptions due to local interference by activists and leaders who promise loan waivers and encourage borrowers to default on repayments. This adversely impacts lenders' portfolios, including those of banks, SFBs, NBFCs and government schemes like MUDRA.

It also disrupts borrowers' credit discipline, leading to long-term harm. Defaulting borrowers are often pushed out of the formal lending system, leaving them vulnerable to exploitative moneylenders. The government should enact regulations to penalise misleading promises and provocations to default.

Considering the profound impact of microfinance on millions of lives, the sector can act as a catalyst for India’s economic revolution, paving the way for Bharat to achieve its "Viksit Bharat" vision well before 2047.

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