Rising credit costs stemming from asset quality challenges that have begun to surface means profitability of microfinance institutions (MFIs1) could be suppressed this fiscal, reducing their return on managed assets (RoMA) to 2.0-2.5% from a high of ~4% last fiscal.
That said, risk-based pricing adopted by MFIs after the removal of interest margin cap and stronger balance sheets will limit the decline in profitability and support the credit profiles of most MFIs. A CRISIL Ratings analysis of MFIs accounting for ~85% of the industry assets under management (AUM), indicates as much.
Delinquencies in the early buckets – 0+ and 30+ dpd (days past due) – increased by around 110 basis points (bps) and ~55 bps, respectively, during the first quarter of fiscal 2025 as compared to preceding March quarter.
Malvika Bhotika, Director, CRISIL Ratings, said, “Four factors have impacted the portfolio quality of MFIs. One, lending to over-leveraged borrowers. Two, debt-waiver campaigns. Three, continued high attrition of field-staff. And last, ground-level operational challenges given elections and intense heat wave. The blended impact of these factors resulted in average monthly collection efficiency dropping to ~96% during the first quarter of this fiscal and further to ~94% so far in the second quarter, from an average of 98% last fiscal.”
While the delinquencies have increased across most states, the northern region has been the most affected. Punjab and Haryana (affected by debt waiver issues) had 0+ dpd of ~32% and ~8.5%, respectively. These states, however, accounted for only ~2.5% of the industry AUM as of June 2024.
Among the top five states in terms of AUM, Tamil Nadu has seen the sharpest increase with 0+ dpd spiking by almost 130 bps on-quarter, while Uttar Pradesh saw ~120 bps rise. Among the states outside the top five, Rajasthan, Odisha and Kerala witnessed an increase of ~190-250 bps.
To mitigate the asset quality challenges, the self-regulatory organisations, Microfinance Institutions Network (MFIN) and Sa-dhan, came up with two key guardrails in July 2024 — limiting the number of MFIs lending to any borrower to four and capping the loan limit to Rs 2 lakh per borrower to reduce over-leveraging. CRISIL Ratings estimates that loans over Rs 2 lakh comprised 7-8% of AUM as of June 2024.
The build-up of delinquencies will mean higher provisioning with MFIs creating management overlays and shoring up provisioning buffers. Resultantly, credit costs are expected to increase to ~3.5% in fiscal 2025 from ~2% earlier.
Prashant Mane, Associate Director, CRISIL Ratings, said, “After the removal of the interest margin cap, overall margins as well as operating profitability of MFIs had touched a 5-year high with PPoP2reaching 7.5- 8.0% in fiscal 2024. Consequently, despite the increase in credit costs and operating costs as collection efforts intensify, overall profitability, though lower, is expected to remain adequate at 2.0-2.5% for the sector.”
It must be noted that MFIs have navigated much bigger challenges in the past (including the pandemic) and the sector has emerged stronger and more resilient after every crisis. Even now, the balance sheets of MFIs remain strong, supporting their credit profiles. Leverage has been comfortable at 3.3-3.8 times in recent years. Healthy internal accruals and significant capital raises have kept leverage in check despite high growth in the past two fiscals.
All said, the ability of MFIs to control early bucket delinquencies and improve collection efficiency will bear watching.
1 MFIs refer to non-banking financial company MFIs or NBFC-MFIs
2 PPoP – Pre-provisioning operating profitability
