Microfinance industry refashions itself amid opportunities and challenges

Central bank has taken a sympathetic view of institutions by easing some lending norms

“The microfinance sector continues to suffer from a vicious cycle of over-indebtedness, high interest rates and harsh recovery practices,” said M Rajeshwar Rao, deputy governor at the Reserve Bank of India (RBI), last week. These are tough words from the otherwise soft-spoken Rao, the senior-most in that position at the central bank. He also pointed out the prevalence of Shylock-like tendencies: “Lenders should look beyond the conventional ‘high-yielding business’ tag…and approach it with an empathic and developmental perspective, recognising the socioeconomic role that microfinance plays in empowering vulnerable communities.”

 

His observations came three days after the RBI’s move to give a breather to microfinance institutions (MFIs) — it lowered the qualifying assets threshold to a minimum of 60 per cent of total assets (net of intangible assets) from 75 per cent. What does this mean for the trade? The earlier ratio, set in March 2022, was on total assets of MFIs rather than on net assets. This included even the cash carried by an MFI and fixed assets while calculating the ratio — it led to a much smaller space for any diversification. The change provides additional headroom of 15 per cent for venturing into other products and borrower segments apart from the legacy qualifying microfinance loans.

 

And what kind of diversification is on the cards in terms of asset classes? 

 

“MFIs will in all probability stick to their segment of borrowers whom they know well. There’s scope to do secured loans (like home improvement, against property and gold), two-wheeler finance, etc,” says Manoj Nambiar, managing director of Arohan Financial Services (he is also the vice-chairman of MicroFinance Institutions Network or MFIN). It will help MFIs to strengthen their financials, offer better services “and may also lower the pricing for microfinance borrowers, as there will be scope for cross- subsidisation,” notes Jiji Mammen, executive director and chief executive officer of Sa-Dhan (which, like MFIN, is a self-regulatory organisation or SRO for the trade). 

 

It can be safely deduced that MFIs are on a cusp — they will have to relook at the way they have been going about their business. For MFIN and Sa-Dhan, it will also be a testing time given the premium placed by the central bank on the SRO architecture in general — to ring in best practices among regulated entities, in whichever segment they are located. 

 

Business overview

 

CRIF High Mark’s latest ‘MicroLend Report’ puts the gross loan portfolio for microfinance at ₹381.2 trillion in FY25, a fall of 2.6 per cent quarter-on-quarter and 13.9 per cent year-on-year. This reflects a deliberate shift by lenders to manage emerging stress, especially in light of regulatory developments and collection practices.

 

Take delinquency indicators — early-stage portfolio-at risk (PAR 1-30 days) improved to 1.4 per cent in FY25 since Q3 FY24 (1.8 per cent). “However, PAR 31-180 remains a concern, although it has eased slightly to 6.2 per cent by FY25 from 6.4 per cent in Q3 FY24,” says Ramkumar Gunasekaran, director and head-sales, CRIF High Mark. But a closer reading shows that delinquencies in both the PAR 1-30 and PAR 31-180 buckets are way above their FY24 positions — at 0.7 per cent and 2.1 per cent, respectively. That said, Gunasekaran is hopeful that as “institutions recalibrate and regulatory frameworks evolve, we are confident that the sector is laying the groundwork for stronger and more inclusive growth.” 

 

The number of active microfinance loans declined to 140 million in FY24 from 161 million a year ago; borrowers with five or more lender associations now constitute only 4.9 per cent of the total book, down from 9.7 per cent during this period. But the RBI’s Financial Stability Report of December 2024 (FSR, December 2024) noted that alongside rising delinquencies, borrower indebtedness has risen: the share of borrowers taking loans from four or more lenders has increased to 5.8 per cent in the last three years (September 2024 over September 2021) from 3.6 per cent. The quarterly average ticket size of microfinance loans disbursal has risen by 43 per cent over this period to ₹50,430 in Q2 FY25 from ₹35,299 in Q2 FY22.

 

The trend in MFI credit also mimics the plot in the unsecured segment. FSR, December 2024 said that 11 per cent of the borrowers originating a personal loan under ₹50,000  — be it from banks or nonbanking financial companies (NBFCs) — had an overdue personal loan; and over 60 per cent of them had availed of more than three loans up to Q3 FY24 (the data cut-off period for that edition of FSR). 

 

Variables at play

 

Prashant Mane, associate director at Crisil Ratings, says: “While the guardrail framework seeks to limit the risk from borrower over-leverage, it could potentially lead to lower credit flow to borrowers who already have availed of funds from more than three lenders.” Plus, the Karnataka government’s ordinance against unregistered lenders and coercive loan recovery methods could impact repayment behaviour among borrowers, leading to lower collections in the state, as is already being seen.

 

RBI-registered MFIs are exempt from the ordinance’s purview. Nevertheless, inappropriate interpretation of the ordinance could result in borrower collections slowing and growth being impacted in the state. As we enter a new state  elections cycle, this is a variable that has to be watched for.

 

The RBI has taken a different route to arrest the stress among MFIs. It has not hiked the risk weighting like it did for unsecured loans of banks and NBFCs, but has taken what most MFI bosses term as positive: lowering the qualifying assets threshold to a minimum of 60 per cent of total assets from 75 per cent. That is to create room to diversify. The bet is that “lenders should look beyond the conventional 'high-yielding business’ tag” — as Rao put it.

 

Over to MFIs for now.