After unsecured retail loans, why is microfinance the latest focus of RBI?
After unsecured retail loans, why is microfinance the latest focus of RBI?
The latest move to increase risk weights in MFI loans - a response to overheating?
A day ago, Moneycontrol broke out an exclusive story on a Reserve Bank of India (RBI) directive to a few large private banks to hike risk weights on microfinance loans.
According to its sources, the regulator in recent communications to at least five large private banks, has mandated the lenders to raise the risk weights on micro-loans from 75 percent to 125 percent, effective immediately. It is also anticipated that more banks may be required to follow suit.
Conflicting signals?
On one hand, the central bank pushes to increase priority sector loans (PSL), wherein microfinance is the key component. On the other hand, by raising risk weights on these loans, it’s discouraging banks from exposure to microfinance, which is essential to the PSL framework. What’s causing such dissonance? Before we delve deeper into this, let’s assess the state of the microfinance industry.
The state of affairs of microfinance in India
Let’s first look at the definition of microfinance. All collateral-free loans to individual/s belonging to low-income households, i.e., households having annual income up to ₹3,00,000 are treated as microfinance loans, irrespective of whether it was originated by a microfinance institution (MFI) or any other regulated entity.
The microfinance sector has shown robust growth, with a portfolio outstanding of ₹442.7K crore as of March 2024. This represents an 8.5% quarter-on-quarter
(Q-o-Q) and a substantial 26.8% year-on-year (Y-o-Y) increase.
Market Share Distribution
NBFC MFIs: Continue to lead the market with a 39.2% share.
Banks: Hold a 33.2% share.
Small Finance Banks (SFBs): Account for 16.9%.
Other NBFCs: Make up 10.2% of the market.
Growth Trends
NBFCs: Experienced a 13.9% Q-o-Q growth and a 45.8% Y-o-Y growth.
Banks: Showed a 7.7% Q-o-Q growth and a 25.9% Y-o-Y growth.
NBFC-MFIs: Reported a 9.3% Q-o-Q growth and a 23.5% Y-o-Y growth.
SFBs: Had a 5.5% Q-o-Q growth and a 27% Y-o-Y growth.
Portfolio Performance
Portfolio at Risk (PAR):
PAR 31-180 DPD: Increased from 2.0% in December 2023 to 2.1% in March 2024.
PAR 91-180 DPD: Remained stable
Loan Cycles
1st Loan Cycle: Constituted 42.7% of the value in Q4 FY24, down from 50.9% in Q4 FY23.
2nd Loan Cycle: Increased to 23.4%.
4+ Loan Cycles: Rose to 21.8%.
Top States by Gross Loan Portfolio (GLP)
West Bengal: Showed the highest Q-o-Q growth of 11.8%.
Bihar: Followed with 11.7%.
Uttar Pradesh: Noted an 11.1% growth.
Sector Dynamics
Average Balance per Borrower:
Tamil Nadu: ₹62.2K.
Bihar: ₹58.8K.
Uttar Pradesh: ₹50.1K.
So, what could have prompted the central bank’s risk weight adjustment in microfinance?
Increasing Delinquency Rates: PAR for 31-180 days past due (DPD) increased from 2.0% in December 2023 to 2.1% in March 2024. Even though the PAR 91-180 DPD remained stable, a rising trend in early-stage delinquencies can signal worsening credit quality, leading to higher risk weights
High Growth: The microfinance sector has seen substantial growth, with an 8.5% quarter-on-quarter (Q-o-Q) and 26.8% year-on-year (Y-o-Y) increase in the portfolio. Rapid growth often comes with increased risks as institutions may extend credit to less creditworthy borrowers
Segmented Market Risks: The growth in different segments of loans and an increasing proportion of higher-value loans may introduce additional risk, as larger loans can lead to more significant defaults if borrowers struggle to repay.
Concentration Risks: The top 10 states contribute to 83.5% of the Gross Loan Portfolio (GLP), indicating a high concentration of risk in specific regions. Any regional economic downturn could disproportionately affect the sector's overall health.
Increased Borrower Exposure: There is a notable percentage of borrowers with exposure to multiple lenders, which can increase delinquency rates as borrowers juggle repayments. This situation contributes to the overall credit risk in the sector.
To my mind, RBI's risk-weight adjustment is not a resounding alarm but rather a stress test. However, if this measure extends to Small Finance Banks (SFBs), it could raise challenges as microfinance loans constitute a majority of their loan portfolios, barring a few exceptions like AU and Equitas.
A bubble’s brewing in UP and Bihar!
Last month, the RBI advised MFIs to ease up on loan approvals in Uttar Pradesh and Bihar. The reason? The regulator is worried that MFIs in the region might fall into a trap of massive lending to subpar borrowers.
For context, microfinance in the two states has been growing rapidly; making up over a quarter of all microfinance loans in the country. Additionally, CRIF Highmark's quarterly reports on microlending in India for FY24 showed that, on average, nearly 10% of microfinance borrowers in UP and Bihar had loans from three or more lenders. It’s become a highly penetrated market with very few white spots.
Combine this with the problem of rampant usurious practices in the MFI space. Just last month, the RBI Governor once again called out MFIs for imposing excessive interest rates on their loans. And this comes two years after the regulator removed pricing caps from MFI loans, giving MFIs the freedom to have pricing policies that are internally approved by their boards, rather than imposed by RBI. Yet usury continues to plague the sector.
The bottom line
To my mind, there’s a need for regulatory clarity along with tightening in the microfinance space. Lending to new-to-credit, low-income borrowers need to operate as a ‘seller beware’ model, keeping in mind their level of financial literacy, which is acquired over a period through experience with financial products, peer-group discussions and regular lender interactions.
While the regulator drives efforts towards customer education and stronger governance, FinTechs can drive efforts towards product focus on suitability and affordable credit.
Additionally, the regulator must also clarify reporting norms. A monthly reporting system is not ideal in case of microfinance where an amount of even ₹50,000, not captured, could make the difference between responsible finance and over indebtedness. Hence, real-time reporting to credit bureaus must become mainstream to address the issue of over-indebtedness and multiple borrowing in a better way. This is best achievable through digital transformation, for it’s easy to build safeguards into the digital lending ecosystem to make it safer for consumers.
However, the way to go is to not entangle the digital-borrowing segment and their lenders to the microfinance model (credit assessment based on household income rather than individual income), but to modernise the microfinance model to leverage digital platforms, improve credit assessments, and enhance financial inclusion.