MUMBAI: Rising credit cost, stemming from asset quality challenges that began to surface several months ago, will crimp the profitability of microfinance institutions due to the higher credit cost which will halve their return on managed assets to 2-2.5 percent this fiscal from a high of 4 percent last fiscal.
Industry wide credit cost is expected to increase to 3.5 percent in fiscal 2025 from 2 percent earlier, according to Crisil.
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 their credit profiles, says the report based on an analysis of MFIs accounting for 85 percent of the industry assets under management.
Delinquencies in the early buckets - 0+ and 30+ dpd (days past due) - increased by around 110 bps and 55 bps, respectively, during the first quarter of fiscal 2025 from the March quarter.
According to Malvika Bhotika, a director with the agency, four factors have impacted the portfolio quality of MFIs: lending to over-leveraged borrowers; debt-waiver campaigns; continued high attrition of field-staff; and 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 percent during the first quarter and further to 94 percent so far in the second quarter, from an average of 98 percent last fiscal,” she said.
While 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 percent and 8.5 percent respectively. These states, however, accounted for only around 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 saw an increase of 190-250 bps.
To mitigate the asset quality challenges, the self-regulatory organisations, Microfinance Institutions Network (MFIN) and Sadhan, 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.
According to Crisil's analysis, loans over Rs 2 lakh comprised 7-8 percent of the industry AUM as of June 2024.
The build-up of delinquencies will mean higher provisioning with MFIs creating management overlays and shoring up provisioning buffers. As a result, credit costs are expected to increase to 3.5 percent in fiscal 2025 from 2 percent earlier.
According to Prashant Mane, an associate director with the agency, after the removal of the interest margin cap, overall margins and operating profitability of MFIs had touched a 5-year high of 7.5-8.0 percent in fiscal 2024. Consequently, despite the increase in credit costs and operating costs as collection efforts intensify, overall profitability is expected to remain adequate at 2.0-2.5 percent for the sector.