Banks See Sharpest Drop In MFI Portfolios In Q3 FY26 Amid Tightening Credit

Recently, banks reported a sharp contraction in their microfinance portfolios in the recent quarter. As per the reports, the MFI portfolio has fallen by 40% to ₹65,687 crore in Q3 FY26. The decline is the steepest across all lender categories, including dedicated non-banking financial companies–MFIs and small finance banks.

As banks scale back exposure to the segment while specialised microfinance institutions expand their footprint, the question emerges: why are banks pulling back from the microfinance sector more aggressively than other lenders?

How Much Did The Microfinance Portfolio Shrink In Q3FY26?

The overall industry reports indicate that the portfolio outstanding declined by 22% on a yearly basis and fell by 7% sequentially in December, 2025. Apart from major banks, small finance banks reduced their portfolios by 25%, not-for-profit MFIs by 22%, MFIs by 14%, and NBFCs by 4%.

On a year-on-year basis, the number of loans disbursed by banks fell from 42 lakh to 27 lakh in Q3 2026. On the other hand, NBFC reduced its loan portfolio from 15 lakh to 12 lakh.

Why Did The Banks Reduce Their Exposure In The Microfinance Sector?

Here are the two key reasons that reduced the banks' exposure in the microfinance sector:

• Tightening underwriting rules: Declining asset quality has forced the institution to adopt a tighter loan disbursement framework. For instance, the inclusion of guardrails aims to reduce the leverage at the borrower level.

• Liquidity crunch: Smaller lenders were facing liquidity constraints that reduced loan disbursement.

Which Lenders Are Gaining Market Share?

As per the reports, the NBFC-MFIs have expanded their presence in the sector and have risen to 44% from 37%. Further, it was noted that the NBFC-MFI has disbursed around 48 lakh loans in Q3 FY2026 as compared to 43 lakh loans during the same period in last year. Thus, indicating a rise of 5 lakh loans.

Also Read - IDBI Bank Stock Extends Fall On Disinvestment Worries

What Does It Mean For the Investors?

Banks pulling back their microfinance exposure by 40% and cutting loan disbursals clearly show they are getting cautious, mainly due to rising defaults and stricter lending rules. This could hurt earnings in the near term.

In contrast, NBFC-MFIs gaining market share (up to 44%) and increasing disbursements suggest a rotation of opportunity toward specialised lenders with stronger on-ground underwriting and borrower networks. However, this expansion comes with elevated credit risk, especially if borrower leverage remains high.

Investors may consider:

• Reducing overweight positions in banks with high MFI exposure in the short term

• Selectively tracking NBFC-MFIs with strong collection efficiency and capital buffers

• Monitoring GNPA trends, borrower leverage, and rural cash flows as leading indicators

Overall, the sector is entering a consolidation and risk-repricing phase, favouring disciplined and specialised players over aggressive lenders.

Sources

PTI

News18

CNBC