KOCHI: After years of building their businesses around unsecured lending to low-income borrowers, small finance banks are shifting towards gold loans and other secured credit. The microfinance crisis has forced a rethink—but can they retreat from the very customers they were created to serve?
Microloans were once the bread and butter of several small finance banks (SFBs). Today, the same business is forcing them to rethink their lending strategies, clean up stressed portfolios and seek growth in gold loans, mortgages and other secured lending.
The shift marks a significant change for institutions established to extend formal banking and credit to underserved sections of society. For some lenders, microfinance was not merely a product; it was the foundation of their business model.
ESAF Small Finance Bank is a case in point. Its managing director and chief executive, K Paul Thomas, said in a Business Standard interview in March 2023 that the bank’s portfolio was entirely unsecured when it started. The share had fallen to 78 per cent by the time of the interview, and ESAF wanted to bring it down further to 60 per cent over the following two to three years.
The figures referred to unsecured lending, not microfinance alone, but they illustrate the scale of ESAF’s original dependence on lending without collateral.
Other small finance banks had similarly concentrated portfolios. Micro-banking accounted for 97.5 per cent of Ujjivan Small Finance Bank’s loan book in March 2017, while Utkarsh Small Finance Bank’s joint-liability-group (JLG) exposure, including business correspondent-led JLG lending, was nearly 90 per cent of its gross loan book in March 2020.
The model helped these lenders reach borrowers who were often excluded from conventional banking. But concentrated exposure to unsecured lending also left them vulnerable when repayment discipline weakened and borrowers became overleveraged.
When high yields turned into liability
Microfinance offered lenders access to a large, underserved customer base and the prospect of attractive yields. Interest rates on some microfinance products exceeded 20 per cent, though rates varied across lenders and products.
But rapid expansion, multiple borrowing and weak assessments of repayment capacity eventually exposed the risks of the model. Borrowers who had taken loans from several institutions found themselves struggling to service their obligations. Collection difficulties and rising delinquencies then fed into lenders’ provisions, write-offs and losses.
The Reserve Bank of India’s warning was unmistakable. Deputy Governor M Rajeshwar Rao said in June 2025 that the sector continued to suffer from a:
“The [microfinance] sector continues to suffer from a vicious cycle of over-indebtedness, high interest rates and harsh recovery practices.”
Rao also urged lenders to look beyond the conventional “high-yielding business” label and approach microfinance with an empathetic and developmental perspective, recognising its socio-economic role.
The message went beyond the immediate problem of bad loans. Microfinance was intended to widen access to credit, not simply to generate high returns. When borrowers are repeatedly lent money without adequate assessment of their ability to repay, financial inclusion can turn into a debt trap.
The cost of cleaning up
The impact on lenders has been substantial. ESAF reported a net loss of Rs521 crore in FY25 amid elevated credit costs and provisions against stressed assets.
In June 2025, the bank approved the sale of around Rs735 crore of non-performing and technically written-off loans to asset reconstruction companies. Other lenders also moved to dispose of stressed microfinance portfolios.
Ujjivan Small Finance Bank, for instance, sold a microfinance non-performing portfolio with a face value of about Rs365.5 crore to an asset reconstruction company for Rs34.26 crore. The transaction illustrated how deeply impaired loan portfolios can lose value when sold.
Such sales and write-offs can help lenders reduce legacy stress and move forward with cleaner balance sheets. But they do not mean the underlying loans have been recovered. Nor does an improvement in reported asset quality necessarily mean that the structural problems which produced the bad loans have disappeared.
Gold loans offer a way out
The response has been a deliberate shift towards secured lending. Gold loans, in particular, offer lenders a tangible asset against which they can lend, while allowing borrowers to access credit without the documentation often required for other secured products.
ESAF’s transformation illustrates the change. Its microfinance portfolio fell from Rs13,764 crore in March 2024 to Rs9,705 crore in March 2025, reducing its share of the overall portfolio from 70 per cent to 49 per cent.
By September 2026, according to the bank’s latest quarterly results, secured advances had reached Rs15,377 crore, accounting for 64 per cent of gross advances. Its gold loan portfolio stood at Rs10,456 crore. These numbers underline the growing importance of secured lending to its business.
Yet the transition is not simply a matter of replacing every microloan with a gold loan. ESAF’s total unsecured advances were Rs8,557 crore in the September 2026 quarter, up 15 per cent year-on-year, even as they declined sequentially. The figures suggest that the bank is changing the composition of its lending rather than abandoning unsecured credit altogether.
The same distinction matters across the sector. Small finance banks are seeking to reduce their dependence on traditional group microfinance, diversify their portfolios and tighten underwriting standards. That is different from declaring microfinance a business they no longer want.
Retain the customer, change the product
Baskar Babu Ramachandran, managing director and chief executive of Suryoday Small Finance Bank, explained the commercial logic in a Business Standard interview in July 2025:
“Once you’ve acquired the customer through unsecured lending — which is easier to originate — the opportunity lies in retaining and upgrading them through secured offerings.”
The argument is that a lender need not abandon a customer simply because the customer’s borrowing needs evolve. It can retain that relationship by offering a wider range of products as the borrower’s income, financial profile and capacity to borrow change.
But the strategy has a limitation. Not every low-income borrower owns gold or property to pledge as collateral. If lenders increasingly favour secured loans, borrowers without assets could find formal credit harder to obtain precisely when they need it most.
That is the financial-inclusion dilemma at the heart of the SFB business model. Banks need to protect their balance sheets, but retreating too far from unsecured lending could leave a significant section of their original customer base underserved.
Is microfinance disappearing?
Not yet. The sector’s recent crisis has prompted lenders to recalibrate growth, tighten credit assessment and reduce concentrated exposure to unsecured lending. CRISIL Ratings said in September 2026 that SFB asset quality was expected to improve, supported by a recovery in microfinance performance and growth in non-microfinance portfolios.
There are also signs of renewed lending activity. Recent industry reporting points to improving asset quality and a revival in disbursements by some microfinance lenders and small finance banks. The evidence therefore suggests a restructuring of the business rather than its wholesale abandonment.
The more important question is whether the industry can rebuild a sustainable microfinance model. Better checks on multiple borrowing, realistic assessments of repayment capacity, responsible pricing and disciplined collection practices will be essential if lenders are to avoid repeating the recent cycle of rapid growth followed by severe stress.
Small finance banks were created to deepen financial inclusion. Microfinance was one of the principal routes through which they pursued that mandate. The challenge now is to make the model sustainable without shutting out the very borrowers it was designed to serve.
