As indebtedness rises, microfinance industry has amber lights switched on

MFIs are now the largest providers of micro-credit with loans outstanding of Rs 1,42,245 cr at end-May 2023

“I don’t want to sound alarmist, but it pays to be cautious,” says Manoj Kumar Nambiar, managing director (MD) of Arohan Financial Services, a micro-finance institution (MFI).

MFIs are now the largest providers of micro-credit with loans outstanding of Rs 1,42,245 crore at end-May 2023; their share being 40.6 per cent of industry portfolio of Rs 3,50,322 crore (this data is based on loans originated after February 2017; June 2023 data is not yet available). While banks were dominant during Covid-19, MFIs have since taken the lead.

The value of the Financial Inclusion Index (FI Index) for March 2023 at 60.1 compares to 56.4 in March 2022, with growth across all sub-indices. “Improvement in FI Index was mainly contributed by usage and quality dimensions, reflecting deepening of financial inclusion,” said the Reserve Bank of India (RBI) last week.

So, what explains Nambiar’s stance? “Indebtedness is on the rise. While delinquencies have not gone up, they are still not back to their pre-Covid levels”. More than 75 per cent of the microfinance portfolio is in rural areas. “The sector needs to take adequate caution while expanding its credit portfolio so that it doesn’t burden borrowers with extra repayments, especially at a time when the rural economy may suffer due to a rainfall deficit,” says Jiji Mammen, chief executive officer (CEO) and executive director of Sa-Dhan, a MFI self-regulatory organisation. Bihar is a case in point: The largest state in terms of microfinance loan outstanding is rainfall deficient.

Industry’s challenge

The average loan amount disbursed per account has moved up: During Q1 FY24, it was Rs 44,114, an increase of around 8.3 per cent in comparison to the same quarter of the last financial year, according to the Microfinance Institution Network. And a gradual shift to individual loans from the joint liability group model gives rise to overleveraging risks. 

“The concurrent challenge is managing growth alongside credit quality, which warrants meticulous observation,” notes CareEdge Ratings. This is despite there being a discernible reduction in the restructured loan portfolio, with the book contracting to 5.1 per cent as on September 30, 2022 from 9.5 per cent in FY22 and further to 1.6 per cent in FY23. Another variable: “Continuation of support from impact funds and private equity (PE) investors at the same pace will also be critical and needs to be closely monitored,” according to CareEdge.

And last week, Mint Road issued a key notification that went below the radar: 'Data quality index (DQI) for commercial and microfinance segments by credit information companies (CICs)'. CICs have been asked to provide DQI to credit institutions (CIs), latest by March 31, 2024; this information would also include numeric scores on a monthly basis. And CIs have been asked to undertake a half-yearly review of DQI for all segments to improve the quality of the data submitted to CICs. Simply put, the quality of microfinance loans is under close watch.

Here’s one more data point to take into account. Across all fast-moving consumer goods (FMCG) categories, the number of stores stocking products has gone down month-on-month. “With the August rain shortfall being at almost a 100-year low, we do see kiranas stocking very carefully. Even as we expect edible oil prices to hold during the festival season, they are currently down by over a third year-on-year and leading to a drop in sales,” says Akshay D'Souza, chief of growth and insights at Bizom, a retail intelligence platform. “As we look ahead, it does seem that the impact of rains in September will be critical to the sowing season and this could impact sentiment and sales and consumption of FMCG products, especially in rural areas”.

In the plot

A potential slowdown in credit to MFIs is to be read in along with what’s happening in the world of business correspondents (BCs), who have played a big role in financial inclusion, contributing hugely to the success of the Pradhan Mantri Jan Dhan Yojana (PMJDY). “Yet we continue to face challenges in accessing adequate VC (venture capital) funding. This could become a hurdle for financial inclusion going ahead,” says Seema Prem, co-founder and CO, FIA Global, a corporate BC.

The underserved have started to become more comfortable with adopting complex financial products; and the BC industry, with its extensive digital network and millions of trained banking agents is uniquely positioned to cater to this demand effectively (even as boots-on-ground continues to be critical). “Without funding, BCs will struggle to invest in the latest technology, enhance their service offerings and expand their reach”. A fact: No BC has received funding in the last decade for working on the PMJDY programme. What’s sought to be conveyed here is that by investing in BCs, the government will set the foundation for a robust financial ecosystem that fosters entrepreneurship, wealth creation, and employment opportunities. And, in turn, this will contribute significantly to propelling the march towards a $5 trillion economy.

“Customer affinity of the BC channel is strong and leveraging the extensive distribution network of these agents can improve the flow of credit to the underserved. The RBI should work towards broadening the current co-lending framework to allow banks to collaborate with tenured BCs,” says Dharanidhar Tripathy, MD and CEO of Business Correspondent Resource Council. His solution: Set up an India Business Correspondent Equity Fund – similar to the India Microfinance Equity Fund – as a consortium between government, banks and financial institutions. This will catalyse VC and PEs also to join in.

What is unfolding on the MFI plot on early signs of indebtedness mirrors what is mentioned in RBI’s September bulletin: Net financial savings were down at 5.1 per cent of gross domestic product (GDP) in FY23 from 7.2 per cent in the previous financial year. Financial liabilities of households were sharply up 5.8 per cent last fiscal compared with 3.8 per cent in FY22, suggesting a larger-than-usual recourse to debt-driven consumption.

And on top of all this, there’s the elephant in the room: We are heading towards a big electoral cycle. The temptation to announce loan write offs – will it raise its head?