14 November 2024
India's microfinance sector is facing significant challenges, including rising borrower indebtedness, regulatory interventions, and operational inefficiencies, which are negatively impacting asset quality and growth. According to a report by CareEdge Ratings, high levels of borrower debt, increased delinquency rates, and a weakened Joint Liability Group (JLG) model are contributing to a difficult operating environment. As a result, the sector’s growth is expected to slow to around 4% for FY25, down from the double-digit growth seen in previous years.
In the first half of FY25, the microfinance segment experienced a notable increase in delinquencies, which CareEdge Ratings projects will continue. This uptick is linked to growing borrower indebtedness due to multiple loans and larger loan amounts, which have increased by 27% over the past three years. Major states such as Bihar, Uttar Pradesh, Rajasthan, and Madhya Pradesh have seen sharp rises in accounts overdue by 30 days or more, with further increases anticipated in the second half of FY25.
The JLG model, which relies on peer pressure to ensure repayments, is also weakening due to declining center attendance and reduced collective accountability among borrowers. This deterioration, combined with rising borrower defaults, puts pressure on asset quality and affects the profitability of non-bank financial company microfinance institutions (NBFC-MFIs).
Regulatory scrutiny has intensified, with the Reserve Bank of India (RBI) issuing 'desist' orders to some NBFC-MFIs, preventing them from issuing new loans due to predatory pricing, inadequate transparency, and flawed assessments of borrower income. The report also highlighted concerns about some borrowers holding multiple fake voter IDs, frequently classified as new-to-credit (NTC), further undermining the integrity of lending in the sector. Additionally, the RBI has cautioned against 'loan netting,' a practice where MFIs reschedule loans to avoid recognizing delinquencies, potentially obscuring the true extent of non-performing assets.
Amid these regulatory and operational pressures, profitability metrics for NBFC-MFIs are expected to decline sharply in FY25. CareEdge Ratings projects a decrease in the return on total assets (ROTA) to approximately 0.4% from 4.3% in FY24, driven by increased credit costs—which are forecasted to rise to 6%—and compressed net interest margins (NIMs) due to reduced yields. Higher operating expenses are also expected to climb to 5.9% this year, adding to the financial strain that institutions are experiencing, as they navigate slower growth and a smaller revenue base.
Despite these challenges, banks remain a critical funding source for MFIs, with over 60% of the segment's on-book funding sourced from the banking sector. However, rising delinquencies and increased regulatory scrutiny have prompted banks to adopt a more cautious approach toward lending to smaller MFIs, which could impact the latter's funding stability. A decline in bank lending or investment support could significantly hinder growth in a sector that relies heavily on external capital.
India's microfinance sector is facing significant challenges, including rising borrower indebtedness, regulatory interventions, and operational inefficiencies, which are negatively impacting asset quality and growth. According to a report by CareEdge Ratings, high levels of borrower debt, increased delinquency rates, and a weakened Joint Liability Group (JLG) model are contributing to a difficult operating environment. As a result, the sector’s growth is expected to slow to around 4% for FY25, down from the double-digit growth seen in previous years.
In the first half of FY25, the microfinance segment experienced a notable increase in delinquencies, which CareEdge Ratings projects will continue. This uptick is linked to growing borrower indebtedness due to multiple loans and larger loan amounts, which have increased by 27% over the past three years. Major states such as Bihar, Uttar Pradesh, Rajasthan, and Madhya Pradesh have seen sharp rises in accounts overdue by 30 days or more, with further increases anticipated in the second half of FY25.
The JLG model, which relies on peer pressure to ensure repayments, is also weakening due to declining center attendance and reduced collective accountability among borrowers. This deterioration, combined with rising borrower defaults, puts pressure on asset quality and affects the profitability of non-bank financial company microfinance institutions (NBFC-MFIs).
Regulatory scrutiny has intensified, with the Reserve Bank of India (RBI) issuing 'desist' orders to some NBFC-MFIs, preventing them from issuing new loans due to predatory pricing, inadequate transparency, and flawed assessments of borrower income. The report also highlighted concerns about some borrowers holding multiple fake voter IDs, frequently classified as new-to-credit (NTC), further undermining the integrity of lending in the sector. Additionally, the RBI has cautioned against 'loan netting,' a practice where MFIs reschedule loans to avoid recognizing delinquencies, potentially obscuring the true extent of non-performing assets.
Amid these regulatory and operational pressures, profitability metrics for NBFC-MFIs are expected to decline sharply in FY25. CareEdge Ratings projects a decrease in the return on total assets (ROTA) to approximately 0.4% from 4.3% in FY24, driven by increased credit costs—which are forecasted to rise to 6%—and compressed net interest margins (NIMs) due to reduced yields. Higher operating expenses are also expected to climb to 5.9% this year, adding to the financial strain that institutions are experiencing, as they navigate slower growth and a smaller revenue base.
Despite these challenges, banks remain a critical funding source for MFIs, with over 60% of the segment's on-book funding sourced from the banking sector. However, rising delinquencies and increased regulatory scrutiny have prompted banks to adopt a more cautious approach toward lending to smaller MFIs, which could impact the latter's funding stability. A decline in bank lending or investment support could significantly hinder growth in a sector that relies heavily on external capital.
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