Small MFIs Struggle for Funding Despite Government Backing

Pearl Doshi - Gujarat Bureau Jun 29, 2026 1,500 Views

Smaller microfinance institutions (MFIs) in India are struggling to secure commercial funding, despite the government extending the Credit Guarantee Scheme for Microfinance Institutions (CGSMFI-2.0) until August 31, 2026.

NEW DELHI — Despite the Government of India’s extension of the Credit Guarantee Scheme for Microfinance Institutions (CGSMFI-2.0) until August 31, 2026, smaller microfinance institutions (MFIs) are finding it increasingly difficult to secure necessary funding. Industry bodies and representatives from smaller lenders have approached the Ministry of Finance to address a critical disconnect between the scheme’s intent and its practical implementation.

The CGSMFI-2.0, launched in March 2026, was designed to provide an 80% guarantee against defaults for small MFIs to encourage banks to extend credit. However, data as of June 10, 2026, shows that only ₹770 crore has been sanctioned under the scheme—a fraction of its ₹20,000 crore capacity.

Banks Remain Risk-Averse

The primary hurdle for smaller players is the risk-based lending approach adopted by commercial banks. According to industry executives, most banks continue to prioritize internal credit rating policies, often restricting lending to institutions with investment-grade ratings of BBB+ or higher.

Vivekanand Salimath, chairman of Bengaluru-based IDF Financial Services, noted that the current environment is significantly more restrictive than the post-pandemic era. "Under the Emergency Credit Line Guarantee Scheme (ECLGS), banks were encouraged to lend even to entities rated BB," Salimath said. "This time, no such direction has been given," leaving smaller, non-investment-grade MFIs effectively locked out of formal credit markets despite the government's guarantee support.

Sector-Wide Pressure and Asset Quality

The microfinance sector has faced a challenging period marked by borrower over-leveraging and state-level regulatory restrictions on recovery practices. These factors have led to asset quality deterioration and subsequent rating downgrades for many smaller MFIs. While the sector’s gross loan portfolio (GLP) grew by 3% sequentially to ₹3.25 lakh crore in the fourth quarter of FY26, the recovery remains uneven, favoring larger, established players.

In response to the funding bottleneck, industry leaders have held discussions with the Finance Ministry, with Joint Secretaries seeking feedback to bridge the implementation gap. K. Paul Thomas, the newly appointed chairman of Sa-Dhan, indicated that improving funding access for smaller institutions is a top priority. Sa-Dhan is currently working with 21 smaller MFIs through an acceleration program designed to bolster governance and operational capacity.

Why It Matters

For smaller MFIs, the lack of funding threatens their ability to serve rural and underserved borrowers, potentially impacting financial inclusion efforts. For the broader economy, the struggle of these institutions highlights the limits of government guarantee schemes when they are not paired with directives to banks regarding risk appetite. As the industry shifts toward higher-ticket loans for existing customers, the smallest "last-mile" lenders risk being left behind.

Key Facts at a Glance

Guarantee Scheme Extension: The CGSMFI-2.0 is now valid until August 31, 2026.
Underutilization: As of June 10, only ₹770 crore of the ₹20,000 crore capacity had been sanctioned.
Credit Rating Barrier: Banks primarily lend to MFIs rated BBB+ and above, sidelining smaller entities with lower ratings.
Industry Stress: The sector has experienced two years of portfolio consolidation before seeing signs of growth recovery in early 2026.

FAQ

What is the Credit Guarantee Scheme for MFIs (CGSMFI-2.0)?

It is a government initiative that provides a guarantee cover of 70%–80% against defaults on loans extended by banks to MFIs, intended to facilitate credit flow to small borrowers.

Why are banks reluctant to lend to smaller MFIs?

Banks cite concerns over the creditworthiness and lower credit ratings of smaller institutions, preferring to lend to those with established, investment-grade financial histories.

What are the consequences for the microfinance sector?

Smaller MFIs are struggling to expand their loan books, which may lead to a consolidation of the market where only larger, higher-rated players survive.

Big Relief for MFI Sector!

This video provides additional context on the government's extension of the credit guarantee scheme and its intended impact on boosting credit flow to the microfinance sector