India’s microfinance sector is facing a severe crisis, with at least half a dozen companies defaulting on bank loans due to asset quality stress and funding crunch. These companies, including VFS Capital, Navachetana Microfin Services, and Arth Finance, are struggling to survive due to a liquidity crunch and difficulties in operating without institutional funding support. The sector’s stress began building in April last year, after a brief revival from the pandemic, and has resulted in a significant increase in late-stage portfolios at risk, with a surge to 15.32% at the end of the September quarter.

The micro-loan market has contracted to ₹3.46 lakh crore, registering a 17% year-on-year drop, with a near 20% fall in the number of active loans to 132 million. Listed microfinance firms, such as Fusion Finance and Spandana Sphoorty Financial, have suffered net losses in the second quarter, extending the run of negative earnings they reported over the past several quarters. Mainstream lenders, including Bandhan Bank, IndusInd Bank, IDFC First Bank, and RBL Bank, have also encountered profitability hits due to the stress in their microfinance portfolios.

VFS Capital, which has a cumulative exposure of ₹143 crore toward five lenders, failed to meet its repayment commitments, with a total overdue amount of ₹82 crore. The company had applied for a small finance bank licence from the Reserve Bank of India (RBI) in January but withdrew it last month after its financial condition worsened. Other affected lenders, including Bank of Maharashtra and IDBI Bank, have told VFS to submit financial statements and a certified book debt statement for the quarters ended June and September.

The situation is similar for Navachetana Microfin Services, which has delayed debt servicing since April and submitted a debt restructuring plan to lenders with the proposal to repay the dues in the next seven years. Some of the company’s loans from banks have already turned into non-performing assets (NPAs) by legal definition. Lenders to these entities have suggested forensic audits to determine the cause of the default and to consider restructuring of bank accounts.

Sectoral leaders are calling for financial institutions to become more lenient while lending to smaller microfinance entities and are expecting the government to consider a proposal to provide a guarantee fund for the microfinance sector. Without institutional funding, several other small lenders are likely to be on the brink of default very soon. The government guarantee programme can facilitate lending to these entities and help them overcome the current liquidity crisis.