Banking Central | Microlenders, grow slow, grow steady!

The RBI had been urging the industry to discipline itself and avoid over aggression in lending practices.

The best option for an industry to stay the course is to correct itself before a regulator cracks the whip.

That's precisely what the Microfinance Institutions Network (MFIN) has done by issuing a slew of regulations to end some bad lending practices that were flourishing in the sector. Such a step in the right direction comes at a cost, but it brings with it the assurance of a brighter future.

An industry association like MFIN has a huge role to play to predict and pre-empt risks by putting in place an effective prevention mechanism. MFIN has taken the right step in the right direction to ward off a sharper backlash from the Big Brother of banking in India as well as to keep the booming sector on track.

What are the new rules?

To put a leash on rampant lending, the MFIN has asked its members to reduce the number of microfinance lenders per borrower to three from four. This is expected to calm down the aggressive business strategy the

lenders had embarked on. The industry association has also capped the outstanding loan amount of a borrower at Rs 2 lakh, including microfinance loans and unsecured retail loans, to avoid heavy disbursements and inevitable defaults.

The MFIN has ruled that its members must not lend to clients with payments lying overdue for more than 60 days, instead of the current practice of 90 days, or the outstanding amount exceeding Rs 3,000.

Further, the body asked regulated entities to ensure that efficiency gains from the interest rate movement to be passed to borrowers. Apart from processing fees and credit card insurance, no other charges can be deducted from the sanctioned loan amount, it said.

A step in the right direction

These regulations were much needed in the wake of reports of loose lending practices that have emerged from the sector. The RBI had been urging the industry to discipline itself and avoid over aggression in lending practices.

The new MFIN regulations became more significant as the sector saw a spurt in delinquencies and the RBI clamped down on some microlenders.

Brokerage firm UBS, however, anticipates elevated slippage levels microfinance companies even in the second half of the current financial year. In a note released on November 29, UBS said that the microfinance overdues continued to rise at an accelerated pace in October.

The brokerage said that PAR 0+, or Portfolio At Risk for zero days, has gone up by 130 basis points on a month-on-month basis in October to 17.5 percent, after having seen a jump of 380 basis points between March and September 2024. The PAR for 90+ days also increased by 60 basis points from September to 12.2 percent in October.

"While floods might have affected the collection efficiency in a few districts and partially explained the steep rise in the 1-90 DPD (Days Past Due), in our view, the pace of rise in delinquency suggests that over-leverage has not yet resolved itself and commentary by some managements around stress peaking out in the third quarter might prove to be too optimistic," UBS wrote in its note.

According to Crisil, the credit costs of microfinance companies are expected to rise to 3-3.5 percent in FY25 from around 2 percent last fiscal.

The ill-practices in the microfinance space revived the spectre of the 2010 Andhra Pradesh crisis, which was precipitated by wrong lending practices of some lenders and snowballed into a widespread crisis. Unlike today, the sector was out of bounds for the RBI too then, neither was there a strong self-regulation system. The scenario is different now. This time, the RBI has been cautioning MFIs about the governance issues and lending practices.

Good governance holds the key

The new regulations announced by MFIN for members may slow down the growth of these companies. As microlenders turn more cautious on fresh lending, loan growth will come down. But that isn’t a surprise. MFIs have to learn to live with the new reality. Greed of a few players cannot become the reason for the downfall of an entire industry.

The challenges on the recovery front may continue for a while till the on-ground economic momentum picks up. Rating agency India Ratings and Research recently said it has observed the recovery of non-performing micro-finance loans (MF NPLs) acquired by asset reconstruction companies (ARCs) as of June 2024 was broadly in line with its estimates formed at the time of the initial rating. The portfolio, comprising loans acquired in 3QFY23 and 4QFY23, experienced a faster recovery rate in the first six months post-acquisition.

However, the recovery momentum decelerated over the following 12 months, from June 2023 to June 2024, the agency said. "This trend indicates the early signs of a slowdown in the recovery of these loans," India Ratings said, adding high food inflation coupled with limited growth in rural wages and risk of over-indebtedness in the segment can delay the recovery process.

The microfinance industry is likely to face a tough phase in terms of growth and recoveries in 2025 but that should be construed as self-correction to thwart a return of the 2010 crisis. The lenders should focus on quality of loans, instead of quantity.

Banking Central is a weekly column that keeps a close watch on and connects the dots regarding the sector's most important events for readers.