Chapter 1.3The Policy Response: How the Funding Channel Was Kept Open
The channels examined so far operate on the borrower’s income. The channel examined here operates on the lender’s funding, and during the period under review it came closer than any other to closing altogether. On 20 March 2026, the Government of India notified the Credit Guarantee Scheme for Microfinance Institutions 2.0.
Indian Microfinance: Resilience, Responsibility & Inclusion Ramesh Srivatsava Arunachalam
1.3 The Policy Response: How the Funding Channel Was Kept Open
The channels examined so far operate on the borrower’s income. The channel examined here operates on the lender’s funding, and during the period under review it came closer than any other to closing altogether. The contraction in microfinance portfolio between mid-2024 and the end of 2025 had two distinguishable causes, and distinguishing them mattered for the choice of remedy. The first was demand-side and deliberate: underwriting standards tightened, first under the household-level assessment and repayment-obligation limits introduced in 2022, then under the industry guardrails adopted from April 2025. Fewer households qualified, and that was the intended effect of a correct policy. The second was supply-side and unintended: bank lending to microfinance institutions became more cautious as asset quality deteriorated — the gross non-performing asset ratio of the microfinance segment of non-banking financial companies approximately doubled to 4.1 per cent — and the caution fell hardest on the smallest institutions, which have the least diversified funding.24 Since small institutions serve disproportionately the geographies that larger institutions have not entered, a funding constraint concentrated among them translates directly into a withdrawal of credit access from the least-served districts.
On 20 March 2026, the Government of India notified the Credit Guarantee Scheme for Microfinance Institutions 2.0. Its design repays close reading, because almost every parameter addresses a specific feature of the diagnosis rather than the problem in general. The scheme provides guarantee cover through the National Credit Guarantee Trustee Company, a subsidiary of the Small Industries Development Bank of India (SIDBI), to banks lending to microfinance institutions for on-lending within the Reserve Bank’s regulatory definition, with a corpus of ₹200 billion.25 Coverage is tiered inversely to institution size — 80 per cent of the amount in default for small institutions, 75 for medium and 70 for large, replacing a flat 75 per cent — which concentrates support where the funding constraint was tightest rather than distributing it in proportion to existing scale.26 Pricing is capped at both ends: bank lending to institutions at the benchmark rate plus 2 per cent, and institutions must on-lend at least one percentage point below their own average lending rate of the preceding six months, with a guarantee fee of 0.5 per cent per annum.27 The second cap is the analytically interesting one, because it ensures the benefit reaches the household rather than being retained in the intermediation margin. Funds are ring-fenced to incremental lending, and the scheme operates through automatic approval rather than case-by-case sanction, which matters because a guarantee that takes two quarters to obtain does not address a liquidity constraint arriving now.
In June 2026 the Government extended the scheme to 31 August 2026 and raised the maximum loan amount for large institutions from ₹3 billion to ₹10 billion, with approximately ₹85 billion sanctioned 42 per cent of the corpus.28,29 That utilisation figure deserves to be stated alongside the design, because the two together carry the actual lesson. An instrument whose parameters are this closely matched to the diagnosis had, some twelve weeks after notification, drawn down under a twenty-fifth of the capital committed to it. Three explanations are available and they call for different responses: that the original cap suppressed demand from the entities able to use the facility quickly, which the June revision implicitly accepted; that lending banks rather than microfinance institutions were the binding constraint, since a guarantee reduces loss given default but does not restore appetite; or that the on-lending rate condition, analytically the scheme’s best feature, is commercially unattractive to institutions still rebuilding margin. Establishing which applies, from the sanction data the trustee company holds, is the single most useful piece of policy evaluation available to this sector, and it is available at negligible cost. Two features of the episode deserve emphasis. The instrument is time-bound by construction: a guarantee scheme that becomes permanent alters the risk assessment of every subsequent lending decision and eventually substitutes for the underwriting it was meant to protect, while one that expires restores the ordinary discipline of the funding market. And the design works through pricing, not merely availability — most credit guarantee schemes address whether credit flows; this one also addresses at what price it reaches the ultimate borrower, converting a liquidity instrument into a transmission instrument. Table 1.3 sets out the structure.
Table 1.3: Credit Guarantee Scheme for Microfinance Institutions 2.0 — design and rationale
| Parameter | Provision | What it addresses |
|---|---|---|
| Corpus | ₹200 billion, guarantees through National Credit Guarantee Trustee Company (NCGTC) | Scale sufficient to shift bank risk perception |
| Guarantee coverage | 80% small, 75% medium, 70% large institutions | Concentrates support where the funding constraint bound hardest |
| Rate cap on wholesale lending | External Benchmark Lending Rate (EBLR) or Marginal Cost of Funds-Based Lending Rate (MCLR) plus 2 per cent | Prevents the guarantee being priced away by the lender |
| Rate condition on on-lending | At least 1 percentage point below the institution’s own prior six-month average | Ensures the benefit reaches the household, not the margin |
| Guarantee fee | 0.5 per cent per annum | Keeps the instrument close to cost |
| Tenure | Three years, including a one-year moratorium | Matches the recovery horizon rather than the quarter |
| End use | Incremental lending only, disbursed within three months | Prevents substitution for existing exposure |
| Approval | Automatic at the trustee company | Speed, since a delayed guarantee does not relieve a present constraint |
| Validity | To 31 August 2026 or ₹200 billion of guarantees | Deliberately time-bound rather than permanent |
Union Budget and its utilization
The Budget acts on several fronts at once. The Union Budget for 2026-27 sets the fiscal frame for the coming year. Total expenditure is estimated at ₹53.47 trillion, 7.7 per cent above the revised estimate, with capital expenditure rising 11.5 per cent and the fiscal deficit targeted at 4.3 per cent of GDP against a revised 4.4 per cent.30 Three allocation decisions bear directly on the transmission channels: the rural employment guarantee received an allocation approximately 42.8 per cent above the revised estimate; the National Rural Livelihoods Mission received ₹172.80 billion, an increase of approximately 20 per cent; and the women-specific (Part A) component of the gender budget was raised to approximately ₹1.07 trillion.31,32 The most consequential announcement, however, was not an allocation. Building on the Lakhpati Didi programme, the Budget proposed Self-Help Entrepreneur Marts — community-owned retail outlets within cluster-level federations of self-help groups, with the explicit intent of helping women move from credit-linked livelihoods to ownership of enterprises. The framing matters as much as the instrument, because it locates the next phase of policy at the point of market access, which is where credit-to-income conversion is either achieved or lost.