The Microfinance Meltdown in India
Microfinance was once hailed as a revolutionary solution to poverty for the developing countries that struggle with incomplete markets where interest rates vary widely, and credit access remains limited. Because information gaps persist and collateral is difficult to secure, formal lenders frequently deem small businesses and households unviable, reinforcing financial exclusion among the poorer populations and slowing economic growth.
It is, therefore, no wonder that small business owners and families in rural India who face barriers to credit from formal lenders prefer, and even rely on, the system of microfinance. Originally popularized by Grameen Bank in Bangladesh (The Economist, 2025), microfinance provides loans to poorer areas in India, particularly to women in need of credit. Nearly 60 million Indians have borrowed $35 billion worth of such loans and have a repayment rate of around 95% (The Economist, 2025). This economic institution is supposed to counter credit constraints by replacing the security of collateral with alternatives manageable by small village populations. Either through progressive lending or group lending, poorer populations and especially women can access credit (Human Rights Watch, 2025).
All the same, microfinance is not a guaranteed path out of poverty. A randomized control trial from 2015 found that while it helped some entrepreneurs, it was not a universal solution for all, and it did not change consumer behaviour much. Specifically, researchers Banerjee et al. stated that microfinance had “no significant changes in health, education, or women's empowerment” (Banerjee et al., 2015). Today, however, even if the institution cannot substantially improve overall living standards, its use is widespread; nearly every second household takes out microfinance loans (FE Business, 2025). Yet the system is cracking under the pressure of economic downturns, political opportunism, and weak regulatory oversight.
The first crack comes from widespread borrower distress. Increasing rates of overdue payment signal growing financial stress among low-income borrowers. With rural wages dropping by 0.4% from 2019 to 2024, economic strain on the households increases borrowing, all while deprioritizing repayments. Over-indebted households fall into vicious cycles of defaults and delinquency doubles to 6% (The Economist, 2025).
Without a centralized credit registry to track household borrowing, households can easily take overlapping loans in order to repay present or previous debts, creating a micro-level credit bubble. The absence of a microfinance registry allows households to borrow small amounts from new lenders. Over 90% of repayments are made in person and in cash, leaving little to no repayment records (Breza & Kinnan, 2018; The Economist, 2025). In response, the Reserve Bank of India attempted to intervene with regulatory reforms in 2022 to curb the risk of over-indebtedness by capping total loan repayment to 50% of household income, but weak enforcement has rendered the reform largely symbolic (Ajmal IAS Academy, 2025).
The second crack is of a political nature. Politicians have made the practice of microfinance difficult. Alok Misra from the Microfinance Industry Network reported in The Economist that the state government of Bihar distributed loans of 10,000 rupees to 7.5 million women, only for political leaders to later signal that repayments might be paused until after the elections. When news got out that the collection of loans was to be put on pause until after the elections, borrowers, expecting the loans to be waived, stopped repaying (The Economist, 2025). Election-driven interventions like these create a moral hazard: if borrowers believe political actors will forgive loans, the incentive to repay diminishes and lowers repayment discipline, ultimately destabilizing the microfinance ecosystem.
In this economic predicament, the financial institutions that fund microfinance (i.e. banks, corporations, and investors) have begun to lose confidence. As a result, banks have slowed lending to non-bank microfinance institutions, which account for nearly 40% of all microloans. Because these non-bank lenders depend heavily on term loans and other long-term borrowing, the reduction in funding caused their credit growth to fall to 15% in the year to March 2024, down from 30% the previous year (The Economist, 2025).
Perhaps this news of a crumbling microfinance should bring about more concern about the nature of the system itself. The operational challenges, rising defaults, political interference, and weak regulation are not merely technical problems; they expose how easily a financial tool designed to empower the poor can be transformed into a mechanism that exploits them. After all, microfinance was created by Muhammad Yunus, who was initially optimistic about funding Bangladesh’s Grameen Bank. He predicted that by lending small sums of money, “microfinance might relegate poverty to museums” (Finch et al., 2022).
However, households that borrow money and struggle to repay their strict repayment schedules end up in dire situations. Many reduce their food consumption, some have to sell their houses and lands for loan repayment, and debt suicides occur (Human Rights Watch, 2025). Many women are forced to sell “whatever they could get their hands on”, selling even food meant for their children (Karim, 2011). In other instances, borrowers experience “house breaking”, a practice in which houses are dismantled, and the materials are sold to recover the defaulted sum (Karim, 2011).
Critics like Lamia Karim argue that the euphoric narrative surrounding microfinance obscures the negative social consequences and structural exploitation experienced by poor women borrowers. Microfinance institutions such as Grameen Bank, BRAC, Proshika, and ASA rely on coercive and predatory social mechanisms to ensure high recovery rates. They exploit existing rural social hierarchies and cultural codes of honour and shame. Women, being the bearers of family honour, are subjected to public shaming and humiliation if unable to repay a loan (Karim, 2011). Moreover, when microcredits are exclusively granted to women, such as in the Grameen model, the credit is frequently used by male relatives while the women retain the responsibility for the repayment. Therefore, many women are compelled to take loans from which they receive little or no benefit, yet they bear severe consequences if they are unable to repay (Cervantes-Zepeda & Montoya, 2014).
At the same time, despite rising defaults and political interference, billions continue to flow into the system, signalling that the industry remains highly profitable and likely to endure in some form. The World Bank’s International Finance Corp, for example, has invested a massive $5.3 billion in India and other countries in Asia (Finch et al., 2022). And they are not the only ones; development banks, non-governmental organizations, and socially-minded impact investment firms have all committed funds (Finch et al., 2022). Their confidence is not misplaced: microfinance institutions in India charge interest rates ranging from 21% to 26% (MFIN, 2025). For these institutions, abundant capital combined with weak consumer protection has created a business model capable of generating steady profits precisely because it relies on the financial vulnerability of borrowers. Therefore, despite its ethical and operational failures, the microfinance system is unlikely to collapse outright, but it raises the pressing question of whether its survival will continue to benefit lenders more than the borrowers it was meant to serve.
Therefore, while this current economic crisis may appear temporary, it should not be treated as such. This meltdown only reveals the contradictions at the heart of the industry. What the institution has become is a disheartening, highly financialized system vulnerable to political manipulation, investor pressures, and borrower distress.
Sources:
The Economist, (2025, October 16). Indian microfinance is in trouble. The Economist. https://www.economist.com/finance-and-economics/2025/10/16/indian-microfinance-is-in-trouble
Banerjee, Abhijit, Esther Duflo, Rachel Glennerster & Cynthia Kinnan. (2015). The Miracle of Microfinance? Evidence from a Randomized Evaluation. American Economic Journal: Applied Economics 7 (1): 22–53. DOI: 10.1257/app.20130533 https://pubs.aeaweb.org/doi/pdfplus/10.1257/app.20130533
FE Business. (2025, February 11). How has microfinance grown in India in the past 5 years? Financial Express. https://www.financialexpress.com/business/sme-how-has-microfinance-grown-in-india-in-the-past-5-years-3746213/
Finch, G., Kocieniewski, D., Rangarajan, S., & Cannon, C. (2022). How microfinance banks profit off the developing world. Bloomberg. https://www.bloomberg.com/graphics/2022-microfinance-banks-profit-off-developing-world/
Reserve Bank of India. (2022). Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022 (DoR.FIN.REC. 95/03.10.038/2021-22). https://fidcindia.org.in/wp-content/uploads/2022/03/RBI-MFI-MASTER-DIRECTIONS-14-03-22.pdf
Breza, E., & Kinnan, C. (2018). Measuring the equilibrium impacts of credit: Evidence from the Indian microfinance crisis (NBER Working Paper No. 24329). National Bureau of Economic Research. https://www.nber.org/system/files/working_papers/w24329/revisions/w24329.rev0.pdf
Human Rights Watch. (2025, September 24). Debt traps: Predatory Microfinance Loans and the Exploitation of Cambodia’s Indigenous peoples. https://www.hrw.org/report/2025/09/24/debt-traps/predatory-microfinance-loans-and-exploitation-of-cambodias-indigenous
Karim, L. (2011). Microfinance and Its Discontents: Women in Debt in Bangladesh (NED-New edition). University of Minnesota Press. http://www.jstor.org/stable/10.5749/j.ctttsh21
Microfinance Institutions Network. (2024). Interest rates by MFIN member regulated entities [PDF]. https://mfinindia.org/assets/upload_image/pdf/interest__rates_July.pdf
Cervantes-Zepeda, M, & Montoya, M. A. (2014).The Bright and Dark Sides of Microfinance. SSRN. https://ssrn.com/abstract=2392491 or http://dx.doi.org/10.2139/ssrn.2392491