Context: India’s microfinance sector is witnessing a rise in delinquencies, even as the overall banking sector records a 12-year low in non-performing assets (NPAs).

What is Microfinance?

• Microfinance refers to the provision of small loans and financial services to low-income groups who lack access to traditional banking channels. 

• Microfinance institutions (MFIs) play a pivotal role in financial inclusion by offering credit to underserved populations, primarily for entrepreneurial activities and income generation. Types of MFIs are;

• Non-Banking Financial Companies – Microfinance Institutions (NBFC-MFIs).

• Non-Governmental Organizations (NGOs): It operates as non-profit organizations.

• Cooperatives: They are Member-owned institutions providing microfinance services.

• Commercial Banks and Small Finance Banks (SFBs): Provide microfinance as part of their priority sector lending.

Current Scenerio

• Rising Delinquencies:

• Microfinance loans to low-income groups have shown a sharp increase in Portfolio at Risk (PAR) (overdue loans of 31-180 days).

• Geographic Impact: Bihar, Tamil Nadu, Uttar Pradesh, and Odisha account for 62% of new late payments.

• Delinquencies are increasing across all loan categories, with Small Finance Banks (SFBs) being most affected.

• Market Share and Growth:

• NBFCs and banks together hold 71.3% of the total microloan portfolio.

• Despite a 7.6% year-on-year growth in the loan book and an 8.9% rise in the live customer base, there was a quarterly decline of 4.3% in the loan book and 1.1% in the customer base.

Stress-in-Microfinance-Sector-Due-to-Rise-in-Delinquencies

• Reasons for Rising Delinquencies

• Borrower Overleveraging: Increased borrowing from both MFI and non-MFI sources has resulted in excessive debt burdens among borrowers.

• Instances of Frauds: Cases of misrepresentation and fraudulent practices have led to heightened operational risks.

• Economic Distress: External economic shocks and income uncertainties have impacted repayment capacities.

• Operational Challenges: High staff attrition and lack of proper borrower assessment mechanisms.

Impact of Rising Delinquencies

• Financial Strain on MFIs: Increased credit costs reduce profitability for MFIs, affecting their financial stability.

• Reduced Lending Capacity: Higher NPAs limit the ability to extend fresh credit to borrowers, hampering financial inclusion.

• Borrower Distress: Overleveraged borrowers face economic hardships and risk exclusion from financial systems.

• Sector-Wide Confidence Issues: Rising defaults can diminish investor and lender confidence in the microfinance ecosystem.

Factors Driving Stress in the Microfinance Sector

• Operational and structural issues:

• Over-leveraged borrowers: Aggressive lending practices have led to sanctioning loans without adequate repayment capacity.

• Weak JLG model: Declining attendance and accountability among borrowers exacerbate defaults.

• High staff attrition and fraud: Operational disruptions caused by staff turnover and fraudulent practices hinder recovery efforts.

• External challenges

• Socio-political risks, such as debt-waiver campaigns and general elections, along with natural disasters, further strain borrower repayment capabilities.

• Economic stress in rural and semi-urban areas continues to limit the repayment capacity of small borrowers.

Regulatory and Institutional Responses to Deal with the Stress in the Microfinance Sector:

• Regulatory actions:

• The RBI has issued a "cease and desist order" to some NBFC-MFIs to address issues such as loan netting and lending to ineligible borrowers.

• It has also tightened lending norms for unsecured loans and urged institutions to adopt sustainable risk management frameworks.

• Institutional adjustments:

• Banks and NBFCs are re-evaluating their underwriting standards and focusing on risk mitigation.

• The sector is witnessing a slowdown in growth, with MFIs’ assets under management (AUM) expected to drop to 17–19% in FY25 from 29% in FY24.

Sector Resilience Amid Challenges and Future Outlook:

• Strengths of the microfinance sector:

• Despite vulnerabilities, the sector has historically shown resilience, overcoming shocks like demonetisation and the pandemic.

• Investor confidence remains strong, underscoring the sector's critical role in financial inclusion.

Future outlook:

• Analysts predict continued stress in FY25, with delinquencies rising across unsecured and microfinance loans.

• A cautious approach in fresh sanctions and stronger recovery efforts are essential for stabilising the sector.

• Regulatory oversight and institutional adaptability will be key to navigating these challenges.

Road Ahead

• Strengthening Credit Assessment: Implementing better risk profiling and borrower assessment mechanisms.

• Financial Literacy Initiatives: Enhancing borrower awareness regarding credit management.

• Stricter Regulatory Oversight: Strengthening supervision to prevent fraud and malpractices.

• Operational Strengthening: Reducing staff attrition through better training and incentives.

• Debt Consolidation Measures: Offering structured repayment plans for overleveraged borrowers.

Conclusion

• To ensure the long-term health of the microfinance sector, a balanced approach involving stronger credit discipline, financial education, and regulatory vigilance is essential. 

• Addressing structural vulnerabilities and promoting responsible lending practices will be crucial for sustaining financial inclusion in India