Microfinance woes not over yet as Karnataka sees fresh wave of bad loans, says InCred Equities

Analysts visiting key microfinance hubs in Karnataka observed that lenders are increasingly cautious

Karnataka, which accounts for about 10 percent of India's mainstream microfinance market, is experiencing a surge in bad loans, estimated at high-single to early-teen percentages in Q4FY25, wrote analysts at InCred Equities. The rise in defaults is being driven by overleveraging, sub-lending, and a recent state ordinance.

Analysts visiting key microfinance hubs in the state observed that lenders are increasingly cautious, given the changing dynamics. Karnataka had previously ranked among the top-performing states in terms of asset quality in Q3FY25, with only a modest increase in early delinquencies. However, Q4FY25 has brought a sharp deterioration, with a noticeable spike in early-stage defaults.

Adding to the stress, new customer additions in Karnataka have virtually stalled. The stricter lending restrictions—which limit borrowers to no more than three active loans and cap ticket sizes at Rs 2 lakh—have also led to a decline in loan renewals.

ALSO READ: Microfinance sector’s portfolio at risk 31-180 days rises sharply to 6.4%

"The higher focus on collections and new regulatory guardrails has restricted disbursements to only existing borrowers, with the renewal rate now at just 30-40 percent," analysts noted.

Analysts expect it will take another two quarters for the market to stabilise before disbursements can resume with renewed momentum. While the stress is widespread, seasoned players such as CreditAccess Grameen and Ujjivan Small Finance Bank are in a relatively better position, thanks to their experienced underwriting and disciplined collection processes.

Among covered stocks, InCred Equities maintains a "hold" rating on Spandana Sphoorty Financial, with a target price of Rs 360, valuing the stock at 0.8x FY26F BV.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.