A stable regulatory environment is needed for the revival of the performance of Indian microfinance institutions (MFIs) according to Fitch Ratings. The firm added that such a challenge is common to the microfinance sector globally, as the industry is evolving from being largely unregulated.
In a special report published today, Fitch has examined the implications of the proposed regulations in India. It observes that an uneven playing field could emerge if regulations are set by different bodies. "The experience of co-operative banks in India suggests that multiple regulators may not be as effective as a single strong regulator, and may also make it difficult for MFIs to comply with different sets of guidelines. Having a common and consistent set of regulations would add stability to MFIs' operations and enhance creditor comfort," says Ananda Bhoumik, senior director, financial institutions at Fitch.
The matter may need to be addressed quickly, as there may be a real possibility that rising delinquencies in Andhra Pradesh (AP) could spill over to its neighbouring states of Karnataka and Tamil Nadu. Delinquencies in AP shot up in October 2010 after state regulations imposed restrictions on collections, forcing some of the large MFIs to restructure their borrowings that are primarily from commercial banks, added the report.
"Fitch's early estimates of the impact of the Reserve Bank of India-appointed Malegam committee's recommendations, which are expected to set the tone of the central bank's guidelines, do not suggest a crushing blow to the performance of the larger MFIs", says Mark Young, managing director, Financial Institutions at Fitch. The interest rate and margin caps on lending, together with tighter loan-loss provisions and general provisioning norms, will however impact the smaller players, forcing commercially oriented MFIs to seek greater scale or to withdraw from the market. Consolidation may therefore be a feature of the sector as MFIs re-examine their business models in response to the regulations.
Both debt and equity funding may remain constrained compared to the past as investors reassess the risks in the sector as MFIs adjust to the new paradigm. "From a creditor's perspective, the lower pace of growth is good news, while lower margins would somewhat erode the defence against shocks to asset quality, the minimum core Tier 1 ratio of 15% provides comfort," added Bhoumik.
Fitch's outstanding National Ratings of MFIs are in the 'BBB (ind)' category (mapped from an international rating in the 'B' category), and while the low rating level captures the risks that these entities face, they are also premised on expectations of strong ongoing collection levels. Fitch does not rate any MFI with exposure to AP.
MFIs in India had seen breathless growth during the last five years, led by a large pool of underprivileged borrowers with no access to organised credit. The system follows the joint-liability group model, targeted mostly at women, with average loan size under $ 250 equivalent. Currently, the 10 largest MFIs account for over 75% of the total sector loans. The higher barriers to entry created by regulations may mean that commercially orientated MFIs will be less likely to target smaller, more geographically remote market segments - due to the capped margins and higher operating costs required to serve these segments.
