Ind-Ra-Mumbai-7January 2025: India Ratings and Research (Ind-Ra) has revised the outlook on the microfinance (MFI) sector to deteriorating from neutral, while maintaining a Stable rating Outlook for FY26.
The agency opines that there are multiple headwinds for the sector such as borrower overleveraging for both MFI loans and non-MFI loans, reduced centre attendance, high attrition at branch levels and instances of frauds, all leading to a higher operating and credit cost for the sector in the medium term.
“Ind-Ra has revised the sector outlook on MFIs to deteriorating from neutral, while maintaining a Stable rating Outlook for FY26. Near-term challenges are likely to continue to play out with a recovery expected in 2HFY26. The Stable rating Outlook factors in adequate capitalisation and liquidity buffers and sufficient PPoP margins which will help absorb the current asset quality downturn”, says Karan Gupta, Head and Director Financial Institutions, Ind-Ra.
The asset quality stress cycle of non-bank finance companies (NBFC)-MFIs could continue in the near term, as tight funding from lenders could add to the challenges of the sector. Moreover, normalisation of delinquencies are expected only by 2HFY26 as the efforts being taken by industry participants start reflecting in the performance. Moreover, loan growth will take a backseat unless a consistent improvement in the collection efficiencies is seen. NBFC-MFIs’ profitability would recover only moderately in FY26, post a stressed FY25. The agency has maintained a Stable rating Outlook for NBFC-MFIs for FY26, given their adequate capitalisation, liquidity and pre-provision operating profit (PPoP) margins will help absorb the current asset quality downturn.
The agency notes that SRO has deferred the guardrail related to the maximum number of MFI lenders per borrower (to three from earlier four) to 1 April 2025 from 1 January 2025 which could help MFIs to manage delinquencies in 4QFY25; however, medium-term asset quality pressure is expected to continue.
De-leveraging Under-way; Slippages to Normalise in 2HFY26: Ind-Ra has been highlighting rising overleveraging across MFI borrowers and not limited to MFI loans, but other loans as well such as Kisan Credit Card loans, gold loans, state government loans and fintech loans. This is adding to the overall distress of borrowers. Ind-Ra notes early signs of increase in wage growths in recent months, however with the rise in the rural inflation, as seen from food inflation numbers, the agency believes borrower cashflows would be under pressure impacting their repayment ability and would be a key monitorable. The regulator has also rightly raised concerns on the sector post deregulation on pricing, where MFI lenders have seen an increase of 300-350bp in yields and now agreeing to moderate pricing. This could also moderate the expanded PoPP margins, thereby impacting the buffers to absorb asset quality shocks.
After facing significant stress in 1HFY25 as overleveraging risks played out in the sector and deleveraging measures taken by self-regulatory organisations accelerated the slippages, Ind-Ra expects collection efficiencies to stabilise in 4QFY25 and could show some improvement in 1HFY26. However, a roll-forward from the early delinquency buckets would keep the overall slippages high in FY25. We expect a moderate recovery in FY26, with PAR0+ stabilising at around 5% mainly in 2H, after some volatility in 1H due to seasonal weakness.
Deleveraging of borrowers could accelerate in 2HFY25 post the implementation of guardrails and control on disbursements. The average outstanding per borrower which was outpacing rural wage growth over the past few years could reverse in FY25 and FY26 as the industry turns cautious.