The microfinance and small loans sector in India has witnessed rapid growth, offering financial support to rural and low-income populations. However, the rising incidence of NPAs (Non-Performing Assets) in these small loans has become a concern for the Indian economy and stock markets. Despite the introduction of new regulations by the RBI for this sector, a decline in profitability and an increase in NPAs are being observed among banks and microfinance companies.
In states like Bihar, Odisha, and Uttar Pradesh, the growing demand for microfinance loans, coupled with increasing risks, indicates that the sector is now going through a challenging phase. This article explores the reasons behind the rising NPAs in small loans, their impact on investors, and the future outlook for this sector.
What’s Happening?
In recent years, the microfinance sector has seen significant growth, but profitability remains a challenge. Since FY17, microfinance loans have grown at an average annual rate of 23%, increasing from Rs 1 trillion to approximately Rs 4.3 trillion by June 2024. Despite this growth, two major players, Bandhan Bank and IndusInd Bank, are struggling with profitability in the microfinance segment.
Recently, IndusInd Bank’s stock dropped by as much as 20%, primarily due to increasing NPAs in its microfinance segment. Similarly, Ujjivan Small Finance Bank, which focuses on small loans, has seen its stock fall by more than 30% in 2024.
Current Scenario
Instability in the microfinance and small finance banks has created ripples in India’s financial system. Following the implementation of ‘harmonised’ regulations by the RBI in 2022 defaults on many small loans have increased. As a result, banks have had to raise their provisioning, impacting their profitability. IndusInd Bank’s stock recently declined by 20%, and shares of other small finance banks and NBFCs (Non-Banking Financial Companies) have also experienced a downturn.
As mentioned in Mint, according to a MicroLend Report by CRIF Highmark for June 2024, approximately 86 million individuals are currently availing of microfinance loans in India, with 5.5 million borrowers engaging with four or more lenders. The report highlights that over 67% of the outstanding debt in the PAR 31-180 category comes from borrowers who have four or more active lenders.
Key Challenges
In 2022, the RBI made several key changes, such as removing interest rate caps, expanding the definition of MFI loans, and eliminating the maximum limit of lenders per borrower. Following these changes, a significant increase in the number of lenders has been observed in states like Bihar and Odisha. In these states, the microfinance portfolio’s CAGR (Compound Annual Growth Rate) exceeds 30%, indicating additional risks in the sector.
In Bihar, MFI penetration is over 80%, and recent floods have affected nearly 1.5 million people across 17 districts, increasing the likelihood of stress in this sector.
What’s in It for Investors?
Due to rising defaults and NPAs, stock prices of several small finance banks and NBFC-MFIs have declined. Over the past two years, Bandhan Bank and IndusInd Bank have reported annual growth rates of just 13% and -3%, respectively, which is relatively low. Companies like CreditAccess Grameen and Arman Financial have also seen their stock prices return to March 2020 lows.
To address the heightened risk, the RBI has increased the risk weightage on microfinance loans from 75% to 125%, categorising them as high-risk unsecured loans. This move has posed a challenge for investors, as the market has reflected weakness in this sector, leading to lower stock valuations.
What’s Next?
While the microfinance sector is currently under pressure, there are signs that it could still present investment opportunities. Microfinance is a cyclical sector, and some institutions have shown resilience in managing the stress. According to the CRIF Highmark report, the asset quality of five leading MFIs is better than the industry average. As mentioned in Mint, according to Sadaf Sayeed, CEO of Muthoot Microfin, certain MFIs have a capital adequacy ratio of 25-30%, which could help them navigate through the crisis.
Thus, the future of India’s microfinance sector holds both challenges and opportunities. Investors will need to closely monitor how these institutions compete and stabilise themselves during times of stress.
That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!
*The companies mentioned in the article are for information purposes only. This is not an investment advice.
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