Stress in MFI sector largely due to customer overleveraging: Motilal Oswal

Situation to last for whole of FY25, with Q2 being the most challenging period, it says

The current stress in the microfinance (MFI) sector is largely driven by unchecked credit growth and the issuance of multiple loans to customers on fake voter ID cards among other documents, which resulted in significant overleveraging among borrowers, said Motilal Oswal in a report on Friday, adding that the industry's challenges are largely self-inflicted.

Additionally, the report has indicated that stress in the MFI sector in the current cycle will last for the whole of FY25, and the sector will begin to exhibit signs of normalisation only at the onset of FY26. “Our channel checks suggest that Q2FY25 will be the most challenging quarter of FY25 and credit costs in H2FY25 will likely remain elevated,” it said.

 

The MFI sector has been grappling with persistent challenges and obstacles over the past five-six months, resulting in a notable deterioration in asset quality.

According to Sa-dhan data, the asset quality of the microfinance portfolio deteriorated in the quarter ended June 2024 (Q1FY25). The loans with 90-plus days past dues (dpd) rose to 1.2 per cent in June 2024 from 0.9 per cent in June 2023. Loans with 30-plus dpd have risen to 2.70 per cent in June 2024, compared to 2.30 per cent in March 2024, and 2 per cent in June 2023.

Sa-dhan is a Self-Regulatory Organisation (SRO) for MFIs that collects and analyses data to understand the microfinance sector.

“In Q1FY25, several NBFC-MFIs (including small finance banks and a few banks) highlighted disruptions due to elections and heatwaves. While these factors may have led to operational challenges in convening centre meetings and delays in repaying EMIs, they could not have affected customers' willingness or ability to repay,” the report highlighted.

According to the report, the current state of the MFI sector can be attributed to several factors, including, but not limited to, customer overleveraging and inability to repay, resulting in low centre meeting attendance; lending to customers with multiple fake voter ID cards categorized as new-to-credit (NTC) customers; and defaults from “ring leaders” or “intermediaries” in some pockets of the country.

Additionally, high attrition at field officer and even branch manager levels, and heavy rainfall and/or floods in certain regions that adversely impacted customer earnings and even their repayments, played their part. Not all of these reasons are mutually exclusive, and there is a fair possibility that one could be the cause of the other, the report stated.

The built-up stress has prompted both the Reserve Bank of India (RBI) and the SRO to take action such that there is no further deterioration in asset quality. As a result, the MFI sector's assets under management (AUM) growth is expected to moderate while overall industry profitability will take a hit.

RBI governor Shaktikanta Das had recently pointed out that some non-banking financial companies (NBFCs), including MFIs, were following growth-at-any-cost approach and the regulator would not hesitate to take action against them, if necessary. On Thursday, RBI barred two NBFCs and as many MFIs — Asirvad Microfinance and Arohan Financial Services — from sanctioning and disbursing loans for charging exorbitant interest rates to borrowers.

“For a majority of the MFI sector participants, we expect a fresh equity raise within the next 6-12 months to give confidence to all their stakeholders, including lenders and credit rating agencies,” the report said.