Evolving Asset Quality Risks To Impact Growth, Microfinance's Profitability: Icra

Rating agency Icra has highlighted the increasing delinquencies in the microfinance sector, which is likely to push up the NBFC-MFI credit costs to 320 to 340 bps in FY2025 from 220 bps in FY2024. The evolving asset quality risks will dampen sectoral growth and earnings in the current fiscal.

The rating agency Icra expects NBFC-MFIs’ asset under management (AUM) growth to dip to 17 to 19 per cent in FY2025 from 29% in FY2024. The robust growth in the last two years has accentuated concerns about the potential overleveraging of borrowers in certain regions.

Further, farmers’ protests and the Karz Mukti Abhiyan in certain regions, especially Punjab and Haryana, have impacted collections and asset quality. This, along with climatic conditions and operational challenges, including employee attrition, would keep the asset quality under pressure in the near term. As per Icra's estimates, non-performing assets (NPAs) have increased by 30 bps in Q1 FY2025.

Prateek Mittal, Assistant Vice President and Sector Head– Financial Sector Ratings, Icra said, “Microfinance exposure in Bihar and Uttar Pradesh has grown at a compounded annual growth rate (CAGR) of 36 per cent and 46 per cent, respectively in FY2021-FY2024 compared to the overall industry growth of 19 per cent during the period." In addition, the average loan outstanding per borrower has been increasing and was relatively higher about per capita income of these states, Mittal added. 

One of the industry’s self-regulatory organisations, Microfinance Industry Network, recently introduced guardrails for responsible lending, to strengthen lending practices and address concerns regarding the overleveraging of borrowers. The salient features include capping the overall microfinance indebtedness of a borrower to Rs. 2 lakh while restricting the number of microfinance lenders to a maximum of four. 

In Icra's opinion, while these norms are expected to address the risk to some extent, adherence to the same remains monitorable. Icra expects some impact on the business volumes in the near term with some borrowers becoming ineligible for microfinance loans under the lending guardrails.

The NBFC-MFIs reported a marginal decline in assets under management (AUM) in Q1 FY2025. While demand remains robust, Icra expects the NBFC-MFIs’ AUM growth to significantly moderate to 17 to 19 per cent in FY2025 from 29 per cent in FY2024, given the rising concerns on asset quality and operational challenges. 

On the earnings front, Icra expects them to report a lower but healthy return on managed assets (RoMA) of 2.5 to 2.7 per cent in FY2025 compared to a record high of 3.6 per cent in FY2024. The increasing cost of funds and downward revisions in lending rates are likely to compress the interest margins of the NBFC-MFIs in FY2025. This, along with asset quality pressure, is expected to moderate their earnings in FY2025.

“Rising borrower leverage levels and increase in multiple lending in the areas of operations have led to concerns on near-term asset quality. Microfinance is at an important juncture wherein prudent lending practices grounded in a deep understanding of the borrower’s repayment capacity need to be the focus area for sustainable growth. Longterm prospects for the industry, however, remain healthy,” Mittal added.

The rating agency maintains a stable outlook on the sector on the back of adequate capitalisation and liquidity even as earnings and asset quality are likely to witness near-term headwinds.