Small Finance Banks’ Gross NPAs Projected to Fall 120 Basis Points by March 2027: Crisil
India’s small finance banks are expected to see a significant improvement in asset quality during the current financial year, with gross non-performing assets projected to decline by around 120 basis points to 2.6–2.8% by March 2027, according to Crisil Ratings.
The expected improvement would take the sector’s GNPA ratio down from 3.8% in March 2026 and 4.4% in March 2025, extending the recovery from the recent credit-stress cycle.
Crisil expects the improvement to be driven primarily by a normalisation in the microfinance portfolio, where tighter underwriting standards and stronger borrower-selection practices are beginning to improve repayment performance.
At the same time, small finance banks have increasingly diversified towards non-microfinance lending, which now accounts for around 70% of total advances, compared with about 50% in fiscal 2022.
Asset quality in these non-microfinance portfolios has remained relatively stable, providing an additional buffer as banks reduce their dependence on unsecured microfinance lending.
The outlook nevertheless carries an important caveat: many of the newer portfolios in segments such as MSME lending, loans against property and vehicle finance have not yet been tested through a complete credit cycle.
SFB Gross NPAs Expected at 2.6–2.8% by March 2027
Crisil expects the small finance banking sector’s overall GNPA ratio to decline to:
2.6–2.8% by March 2027.
That compares with:
3.8% in March 2026
and:
4.4% in March 2025.
A decline of roughly 120 basis points in a single financial year would represent a substantial improvement in headline asset quality.
The forecast suggests that the credit stress that affected small finance banks over the previous two years is beginning to recede.
Microfinance Recovery Will Be Main Driver
The most important driver of the improvement is expected to be the recovery of:
microfinance lending.
Small finance banks have historically maintained significant exposure to borrowers at the lower end of the income spectrum, including unsecured microfinance customers.
This business supports the financial-inclusion role of SFBs but can also experience sharp deterioration when borrowers become overleveraged or household cash flows weaken.
That is what occurred during the recent stress cycle.
Microfinance Accounted for Disproportionate Delinquencies
Microfinance currently accounts for only around:
30% of SFB advances.
Despite that relatively modest share, the segment contributed disproportionately to delinquencies during the previous two financial years.
Crisil attributed much of the stress to:
borrower overleveraging.
Customers in some markets had accumulated loans from multiple lenders, increasing repayment burdens beyond sustainable levels.
When borrower leverage rises, even relatively small disruptions to income can cause repayment difficulties across several loans simultaneously.
Microfinance GNPA Could Drop to 3.8–4%
Crisil expects asset quality within the microfinance portfolio itself to improve sharply.
Microfinance GNPAs are projected to decline to approximately:
3.8–4.0% by March 2027.
That would compare with:
7.6% in fiscal 2026
and:
8.4% in fiscal 2025.
The improvement would therefore represent a substantial normalisation after two years of elevated credit stress.
Lower slippages and better recoveries are expected to support that decline.
Tighter Underwriting Is Improving Borrower Selection
One of the most important changes has been tighter underwriting.
Small finance banks have recalibrated growth and strengthened their assessment of:
borrower indebtedness,
existing loan obligations,
repayment history,
and overall debt-servicing capacity.
Crisil believes these changes are improving the quality of borrowers entering newer loan vintages.
As these newer loans become a larger part of the outstanding portfolio, the quality of the overall microfinance book should gradually improve.
Newer Loan Vintages Are Becoming More Important
The concept of a loan vintage is important in understanding the forecast.
Loans originated before underwriting rules were tightened may continue to produce stress for some time.
Newer loans, however, were originated under:
more conservative borrower-selection standards.
As older stressed loans are:
repaid,
recovered,
written off,
or otherwise leave the portfolio,
newer vintages gradually represent a greater proportion of total loans.
If those newer loans perform better, portfolio-wide asset quality improves.
Guardrails 2.0 Has Tightened Microfinance Lending
Small finance banks have also aligned their underwriting with the microfinance industry’s:
Guardrails 2.0 framework.
The measures were designed to reduce excessive borrower leverage and improve lending discipline.
Among the key safeguards are restrictions around:
total borrower indebtedness,
lending to materially delinquent borrowers,
and:
the number of microfinance lenders serving an individual borrower.
The objective is to prevent the kind of multiple-lending behaviour that contributed to the recent stress cycle.
Lending to Delinquent Borrowers Has Been Restricted
Under the industry framework, lenders tightened restrictions on extending additional microfinance loans to customers who already have serious overdue obligations.
This is significant because continued lending to financially stressed borrowers can temporarily conceal repayment problems while increasing ultimate credit losses.
Stronger bureau checks and lender-level restrictions can reduce this risk.
For SFBs, better borrower screening should translate into:
lower future delinquencies
and:
better collection efficiency.
Number of Lenders Per Borrower Has Also Been Limited
Another important measure concerns:
multiple lending.
A borrower receiving relatively small loans from several institutions can accumulate a much larger overall debt burden than any one lender intended.
Industry guardrails therefore seek to limit the number of microfinance institutions simultaneously lending to one borrower.
This should make borrower leverage more visible and manageable.
The full benefit is expected to emerge gradually as loans originated under the revised rules mature.
SFBs Also Used Significant Write-Offs
Banks have not relied solely on stronger underwriting.
They have also cleaned up existing stressed portfolios.
Crisil estimates that SFBs wrote off advances equivalent to approximately:
7% of the outstanding portfolio as of March 2024.
The majority of these were microfinance loans.
The figure includes loans sold to asset reconstruction companies.
Write-offs helped remove deeply stressed assets from bank balance sheets and contributed to the reduction in headline GNPAs during fiscal 2026.
Write-Offs Do Not Mean Credit Problems Disappear
A write-off removes a loan from the bank’s reported gross loan portfolio for accounting purposes, but it does not necessarily mean recovery efforts stop.
Banks can continue attempting to recover written-off accounts.
Nevertheless, repeated high write-offs can affect profitability because lenders have already recognised the associated credit cost.
The more important long-term development is therefore not the write-off itself but the improvement in newer loan performance.
Sustainable asset-quality recovery requires:
fewer new defaults,
rather than only removal of old bad loans.
Lower Slippages Should Support Recovery
Crisil expects lower:
slippages
to contribute to the improvement.
A slippage occurs when a previously performing loan becomes non-performing.
If fewer borrowers move into the NPA category while banks simultaneously recover or write off older stressed accounts, the GNPA ratio can decline rapidly.
Improving microfinance collections therefore have a compounding effect.
They reduce new problem loans while strengthening cash recovery from existing exposures.
Recoveries Are Also Improving
Higher recoveries are another positive factor.
Collections weakened during the period of borrower over-indebtedness, but stronger repayment behaviour among newer borrowers is expected to improve overall portfolio performance.
Better recoveries directly reduce the outstanding amount classified as non-performing.
Combined with continued loan-book growth, this can bring the GNPA ratio down even faster.
The denominator expands while the stock of problematic assets declines.
Non-Microfinance Portfolio Now Accounts for Around 70%
The second major structural factor supporting SFB asset quality is diversification.
Non-microfinance lending now represents approximately:
70% of total small finance bank advances.
That compares with around:
50% in fiscal 2022.
This is a significant shift in business mix.
Small finance banks are becoming less dependent on one relatively volatile unsecured lending segment.
Instead, they are building increasingly diversified portfolios across multiple secured and semi-secured credit categories.
SFBs Have Expanded Into Secured Lending
Small finance banks have increased their presence in areas including:
MSME finance,
loans against property,
vehicle finance,
housing-related loans,
and other secured lending products.
Secured loans generally provide lenders with collateral that can help reduce losses if borrowers default.
That does not mean secured credit is risk-free.
But a diversified secured portfolio can behave differently from unsecured microfinance and reduce concentration risk across the bank.
Non-Microfinance GNPAs Have Remained Stable
Crisil estimates gross NPAs in SFBs’ non-microfinance portfolios at approximately:
2.2–2.4%
during both fiscal 2025 and fiscal 2026.
The rating agency expects the ratio to remain within the same range during the current financial year.
This stability is important because the non-microfinance portfolio now constitutes the majority of SFB advances.
If its asset quality remains steady while microfinance improves, overall GNPA levels can decline materially.
Diversification Is Reducing Microfinance Concentration
The change in loan mix represents an important evolution in the small finance bank business model.
Many SFBs developed from institutions with strong microfinance origins.
As they matured into banks, they gained the ability to broaden lending across:
retail,
small businesses,
secured credit,
and other customer segments.
Diversification makes the balance sheet less vulnerable to a sudden shock in one borrower category.
The current GNPA forecast demonstrates the potential benefit of that transition.
Secured Lending Creates Different Risk Profile
A secured loan is backed by an underlying asset.
Examples include:
property,
vehicles,
or business assets.
When borrowers default, lenders may have greater recovery options than with unsecured lending.
Microfinance loans, by contrast, typically have little or no collateral.
Credit performance therefore depends much more directly on borrower cash flow and repayment discipline.
Moving toward secured lending can consequently improve resilience, although underwriting quality remains critical.
Newer Secured Portfolios Have Limited Seasoning
Crisil nevertheless cautioned against assuming that current performance will continue automatically.
Several non-microfinance portfolios are:
relatively young.
In banking, a portfolio needs time to season.
A newly originated loan book can initially show low delinquencies simply because borrowers have not yet passed through enough repayment cycles.
Asset quality often becomes clearer only after loans have been outstanding for several years and have encountered different economic conditions.
Full Credit-Cycle Performance Remains Untested
This is particularly important for fast-growing SFB portfolios.
Some lending categories expanded during relatively favourable economic conditions.
They have not necessarily experienced:
a prolonged slowdown,
significant income shock,
weak rural demand,
high financing costs,
or other adverse conditions.
Their performance through a full credit cycle therefore remains untested.
That is one of the biggest medium-term variables for the sector.
MSME Lending Will Require Close Monitoring
Crisil specifically identified:
MSME lending
as an area requiring monitoring as portfolios mature.
Small businesses can be more economically sensitive than larger companies.
Their cash flows may be affected by:
input-cost inflation,
slower demand,
working-capital pressure,
commodity prices,
and regional economic conditions.
MSME borrowers often have less financial flexibility than large corporations.
That can make asset quality more sensitive to sudden economic disruptions.
Loans Against Property Carry Property and Cash-Flow Risks
Loans against property are another growing area for small finance banks.
These loans are collateralised by residential or commercial property.
However, the existence of collateral does not eliminate credit risk.
Repayment still depends primarily on the borrower’s income or business cash flow.
If economic conditions deteriorate sharply, defaults can rise even if lenders ultimately possess recoverable collateral.
Property values and the speed of enforcement can also affect final recovery outcomes.
Vehicle Finance Is Sensitive to Operating Economics
Vehicle-finance performance can be particularly sensitive to:
fuel prices,
freight demand,
rural incomes,
and commercial activity.
A commercial vehicle borrower, for example, depends on transport earnings to service monthly instalments.
If fuel prices rise sharply while freight rates remain weak, borrower profitability can deteriorate.
Similarly, rural vehicle demand can be influenced by agricultural incomes and monsoon conditions.
This explains why Crisil identified vehicle finance as a portfolio requiring continued monitoring.
Fuel Prices Are an Important Macro Variable
Fuel costs have implications beyond transportation.
Higher energy prices can increase:
logistics costs,
business operating expenses,
and inflation.
For small businesses and self-employed borrowers, these increases can directly affect repayment capacity.
SFBs increasingly serving these customer groups therefore need to incorporate such risks into their credit models.
At present, Crisil does not expect these factors to create material asset-quality stress.
But the exposure needs to be watched as the loan mix changes.
Rural Income Trends Matter for SFBs
Small finance banks have relatively significant exposure to:
rural
and:
semi-urban India.
That makes rural household income an important asset-quality driver.
Agricultural output,
farm prices,
employment,
and government spending
can all affect borrowers’ ability to meet loan obligations.
A healthy rural economy supports repayment performance across:
microfinance,
vehicle loans,
small-business credit,
and housing-related products.
Weak rural income can have the opposite effect.
Monsoon Outcomes Remain Relevant
The monsoon continues to affect rural credit conditions.
Adequate and well-distributed rainfall supports agricultural output and household income in many regions.
Poor rainfall or localised weather shocks can weaken farm cash flows.
For banks with concentrated exposure to particular districts or states, regional weather outcomes can therefore affect delinquency performance.
Portfolio diversification across geography and borrower segments helps reduce this vulnerability.
Early Stress Indicators Have Improved
Crisil's confidence in the recovery is supported by improvements in:
special mention accounts.
SMA accounts represent loans showing early signs of repayment stress before they become full NPAs.
The combined share of SMA-I and SMA-II accounts declined to:
2.4% of gross advances as of March 2026.
That compares with approximately:
3.4% one year earlier.
This provides an important forward-looking signal for asset quality.
Why SMA Accounts Matter
Gross NPAs tell investors what has already gone wrong.
SMA data can indicate:
what may go wrong next.
Loans move through delinquency stages before crossing the threshold into non-performing status.
A lower share of early-stage stressed accounts therefore suggests fewer loans may become NPAs in subsequent periods.
The reduction from 3.4% to 2.4% indicates better collection performance and a smaller pipeline of potentially problematic loans.
Collection Efficiency Is Strengthening
Improving collection efficiency is one reason early stress indicators have declined.
In microfinance, collection discipline is particularly important because repayments typically occur frequently and loan balances are unsecured.
A deterioration in collections can become visible quickly.
Conversely, improving collections provide an early indication that borrower cash flows and credit discipline are stabilising.
This supports Crisil’s expectation of lower GNPA levels by March 2027.
Sector Appears to Be Moving Beyond Recent Stress Cycle
Taken together, the data suggest SFBs are moving beyond the recent period of elevated microfinance stress.
The sequence has broadly involved:
borrower overleveraging,
rising delinquencies,
tighter underwriting,
reduced growth in stressed categories,
portfolio write-offs,
and gradual improvement in newer loan vintages.
The sector is now entering the recovery phase.
The next challenge will be preserving asset quality while returning to sustainable credit growth.
Growth Discipline Will Be Important
Improving asset quality can tempt lenders to accelerate loan growth again.
That creates a familiar banking risk.
If institutions loosen underwriting too quickly in pursuit of market share, the next cycle of credit stress can begin before the previous one has fully ended.
SFBs will therefore need to balance:
growth
with:
credit discipline.
The recent microfinance experience demonstrates the cost of allowing borrower leverage to rise too rapidly.
Better Asset Quality Can Support Profitability
Lower NPAs can improve profitability through several channels.
Banks may need to make fewer provisions for bad loans.
Recoveries can improve.
Management attention can shift from collection and restructuring toward growth.
Lower credit costs also allow more operating income to flow through to profit.
For SFBs, this could strengthen the earnings environment if the GNPA forecast materialises.
Lower Credit Costs Can Improve Return Ratios
Banks measure profitability partly through metrics such as:
return on assets
and:
return on equity.
Elevated credit costs can depress both.
If microfinance losses normalise and provision requirements decline, SFB profitability can recover even without a dramatic increase in loan yields.
That can also improve internal capital generation, supporting future balance-sheet expansion.
Capital Strength Remains Important
Small finance banks must maintain sufficient capital to absorb credit losses and support lending growth.
An improving asset-quality cycle can preserve capital because fewer loans require large loss provisions.
However, rapid expansion into new businesses can also consume capital.
Banks therefore need to manage:
growth,
profitability,
and capital adequacy
together.
The strongest institutions will be those able to expand without sacrificing balance-sheet resilience.
Deposit Franchise Is Another Strategic Factor
As SFBs diversify their loan books, the liability side of the balance sheet remains equally important.
Small finance banks compete with:
large private banks,
public-sector banks,
and other financial institutions
for deposits.
Historically, some SFBs have offered higher deposit rates to attract customers.
A stronger asset-quality profile can improve confidence among:
depositors,
investors,
and counterparties.
Over time, that can help institutions build more stable funding franchises.
Diversification Is Changing SFB Identity
The move from roughly 50% non-microfinance exposure in fiscal 2022 to around 70% now highlights how quickly the sector is evolving.
Small finance banks are increasingly becoming:
diversified retail and small-business banks
rather than:
institutions dominated by microfinance.
That evolution could broaden their long-term growth opportunity.
But it also means management teams need expertise across many more types of credit risk.
A microfinance lender and an MSME or property lender require different underwriting capabilities.
Risk Models Need to Evolve With Loan Mix
As portfolios become more diverse, SFBs need increasingly sophisticated:
credit scoring,
early-warning systems,
collections,
portfolio analytics,
and risk pricing.
The data used to evaluate a microfinance borrower may differ substantially from the data required for:
an MSME,
a vehicle owner,
or a property-backed borrower.
Diversification therefore reduces concentration risk but increases operational complexity.
Banks that build strong risk-management infrastructure are likely to benefit most.
Stable Non-Microfinance GNPA Is Encouraging but Not Conclusive
The current 2.2–2.4% GNPA level in non-microfinance lending is encouraging.
But it covers portfolios that are still evolving.
That makes the next several years important.
If these books maintain stable asset quality as they mature, the SFB sector's structural risk profile could improve significantly.
If stress rises as newer portfolios season, some of the benefit from declining microfinance NPAs could be offset.
This is why Crisil continues to emphasise monitoring.
Overall SFB GNPA Remains Above Wider Banking Sector
Even after the projected decline to 2.6–2.8%, small finance banks would still have somewhat higher gross NPAs than the broader Indian banking system's recent lows.
That difference reflects the customer segments SFBs serve.
Small businesses, microfinance borrowers and lower-income households can carry higher credit risk than highly rated corporations or secured prime retail customers.
Higher risk is not inherently problematic if it is:
properly priced,
diversified,
and adequately provisioned.
Financial Inclusion Comes With Credit Complexity
Small finance banks were created partly to deepen access to formal banking and credit.
Their customer base includes many borrowers who historically had limited access to mainstream financial institutions.
Serving these segments has social and economic value.
But it also requires specialised risk management.
Income can be:
volatile,
informal,
seasonal,
or difficult to document.
Banks need underwriting systems capable of understanding these realities without either taking excessive risk or excluding creditworthy borrowers.
Stronger Underwriting Supports Sustainable Inclusion
The recent microfinance cycle illustrates why financial inclusion and underwriting discipline need to operate together.
Expanding credit quickly can increase access in the short term.
But if borrowers become overleveraged, defaults rise and lenders subsequently reduce credit sharply.
That can damage both institutions and customers.
More conservative borrower-level debt limits can make financial inclusion more sustainable by reducing the probability of repeated boom-and-bust lending cycles.
March 2027 Will Be Important Checkpoint
Crisil's forecast makes the end of fiscal 2027 an important checkpoint for the SFB industry.
By then, the market should have greater visibility into whether:
microfinance stress has genuinely normalised,
newer underwriting standards are working,
and:
non-microfinance portfolios remain stable as they mature.
A GNPA ratio within the projected 2.6–2.8% range would strengthen evidence that the sector has successfully moved beyond the recent stress period.
Conclusion
Small finance banks are expected to record a meaningful improvement in asset quality during fiscal 2027, with Crisil Ratings projecting gross NPAs to fall by around 120 basis points to 2.6–2.8% by March 2027.
The expected improvement is being driven primarily by the normalisation of microfinance portfolios after two years of stress caused by borrower overleveraging.
Microfinance GNPAs are projected to decline to 3.8–4.0% by March 2027, compared with 7.6% in fiscal 2026 and 8.4% in fiscal 2025, as tighter underwriting, improved borrower selection and newer loan vintages strengthen repayment performance.
At the same time, SFBs have diversified significantly. Non-microfinance lending now represents around 70% of advances, up from about 50% in fiscal 2022, while GNPAs in these portfolios have remained stable at approximately 2.2–2.4%.
Early warning indicators are also improving, with SMA-I and SMA-II accounts declining to 2.4% of gross advances in March 2026 from around 3.4% a year earlier.
The outlook is therefore increasingly positive, but the next phase presents a different risk.
As newer portfolios in MSME lending, loans against property and vehicle finance mature, their performance through a full credit cycle will need close monitoring.
For small finance banks, the key challenge is now shifting from managing past microfinance stress to ensuring that diversification and renewed growth do not create the next source of asset-quality pressure.
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