Growth and credit cost concerns mar microfinance sector prospects

There are increasing concerns about stresses in the MFI (microfinance) segment. Agencies such as Icra and Ind Ra have highlighted increasing delinquencies, which will push up NBFC-MFI credit costs to 320-340 bps in FY25 from around 220 bps in FY24. The asset quality risks will also dampen sectorial growth and earnings in FY25. Icra expects NBFC-MFIs’ AUM growth to dip to 17-19 per cent in FY25 from 29 per cent in FY24. AUM growth in Q1FY25 was down 24 per cent Y-o-Y on the back of a 30 per cent Y-o-Y decline in Q4FY24.

The rapid growth in AUM in the last two years may have led to potential over-leverage by borrowers. Ind-Ra claims that MFI borrowers may have hit very high levels of household leverage, given improved availability of MFI loans, government loans, Kisan Credit Card loans, mudra loans, gold loans and other fintech loans. Moreover, the farmers’ protests and the Karz Mukti Abhiyan in Punjab and Haryana have impacted collections and asset quality. Given adverse climatic conditions and operational challenges, including employee attrition, have led to non-performing assets (NPAs) increasing by 30 bps in Q1FY25, according to Icra estimates.

There are elevated PAR (Profit-At-Risk) portfolios across players (PAR being defined as loans overdue by 30 days or more). CreditAccess Grameen PAR escalated to 2.5 per cent by Mar’24, from 1.20 per cent in Mar’23; Ujjivan SFB’s up to 3.9 per cent in Q1FY25, from 2.6 per cent in Q1FY24. PAR for Spandana rose to 3 per cent in Q1FY25, from 0.8 per cent in Q1FY24; PAR for Utkarsh climbed to 5.4 per cent by Q1FY25, from 4.5 per cent in Q1FY24.

MFIs continue to show growth in disbursement with a rising first cycle ticket size. This needs to be curtailed with increasing signs of delinquencies in softer buckets. Also, MFIs need to avoid offering incremental top up loan given to the existing borrower by the same lender. It is estimated that more than four lenders or four active loans per borrower leads to higher delinquencies and the industry requires adequate risk controls built to contain borrower overleveraging.

Bihar and Uttar Pradesh grew at a CAGR of 30.5 per cent and 35.7 per cent over FY22-FY24, respectively, compared to the overall MFI CAGR of 18.1 per cent in the same period. Bihar is the largest state now in terms of outstanding AUM in MFI.

The self-regulatory organisation, Microfinance Industry Network, has recently introduced guardrails for responsible lending, to address concerns. The salient features include capping the overall microfinance indebtedness of a borrower to Rs 2 lakh while restricting the number of microfinance lenders per borrower to a maximum of four. There will be some impact on the business volumes in the near term as some borrowers become ineligible for MFI loans under the new guardrails.

Increasing cost of funds and downward revisions in lending rates are likely to compress interest margins in FY25. This will, along with asset quality pressure, moderate in FY25. But Icra expects lower but still healthy return on managed assets of 2.5-2.7 per cent in FY25 compared to a record return of 3.6 per cent in FY24.

Given MFI players had spikes in PAR and credit costs during Q1FY25, the over-leverage could take a couple of quarters to clear even after guardrails were imposed Q2FY25. Hence, growth and credit cost will be under pressure in the near-term. Analysts are cutting earnings estimates across the sector.