PE and VC are overheating India's microfinance sector, Economic Survey warns

When private equity and venture capital entered India's microfinance sector, they brought capital, technology, and an insatiable appetite for growth. But this aggressive expansion that prioritises portfolio size over borrower capacity has fuelled a cycle of irresponsible lending that left the sector overheated and vulnerable, warns the Economic Survey.

In the fiscal year ending March 2025, the sector contracted by 14% as defaults surged. The problem, according to India's latest economic survey, is that microfinance has strayed from its original purpose.

What began as a social mission to help the poor build assets and weather shocks has become a vehicle for chasing returns. Private equity and venture capital investors, drawn by the promise of high yields, have pushed lenders to grow fast. The result is over-lending, over-indebtedness and stress.

The survey warns that "financialisation" of the sector has created a mismatch between what investors want and what borrowers need. Commercial capital has brought benefits—better technology, wider reach and professionalisation. But the incentive structures of PE and VC firms prioritise growth, profitability and exits.

Social impact is "stated as an objective," the survey notes, "but its achievement is not always tied to investment outcomes in a systematic or verifiable manner."

Online lenders, the fastest-growing segment, raised $735m across 60 rounds in 2024, according to Tracxn, a data firm. They were also the most funded fintech business model in 2024, when overall funding levels were lower.

Non-bank finance companies focused on microfinance (NBFC-MFIs) now hold 39% of the market by outstanding loans, followed by banks at 32% and small finance banks at 16%. These lenders operate across 685 districts in 28 states and five union territories, with the east and south accounting for 62% of the portfolio. Branch networks have tripled over the past decade to 37,380.

However, the survey argues that some key metrics, such as the number of people reached, the size of portfolios, the share of women borrowers and geographic spread that these MFI institutions chase, look impressive on paper but reveal little about borrower welfare. Scale-based metrics reward intensive lending, frequent top-ups and deeper credit penetration even when households cannot repay it said.

The survey cites evidence of over-indebtedness in regions with high lender concentration and multiple borrowing.

The problem is compounded by weak credit assessment. Lenders lack a standardised way to measure household income. In the absence of reliable cash flow data, they use in-house estimates that may not be accurate. They also have little visibility over other debts, such as gold loans, agricultural credit or borrowing from cooperative societies. This makes it hard to calculate total repayment obligations.

When households cannot repay, borrowers may exit the formal credit system altogether, weakening the long-term goal of financial inclusion. Easy access to repeated borrowing can displace precautionary savings and increase dependence on debt for routine expenses.

The policy response has begun. After stress surged in FY25, India's central bank reduced the minimum qualifying assets required for NBFC-MFIs from 75% to 60% of total assets, allowing them to diversify portfolios. Self-regulatory organisations imposed caps on loan sizes and overall borrower indebtedness. By the second quarter of FY26, risky assets had declined, and loan disbursements were recovering.

But the survey argues that bigger changes are needed. Investor exits and valuations should depend, at least partly, on meeting social goals, not just hitting financial targets. Before investors can cash out, they should prove that borrowers are actually better off—through higher assets, stable incomes or lower debt burdens. Third-party auditors would verify these claims over several years, making it harder to juice short-term growth at borrowers' expense.

This would change behaviour, the survey says. If investors cannot exit without showing real welfare gains, they have reason to slow down when credit demand is high. They would focus on loan quality, whether borrowers can truly repay, and products like savings accounts or insurance that build resilience rather than just debt.