MFIs went on a lending frenzy. The moment of reckoning has arrived

“Disbursements from banks have slowed down and they’re not giving fresh loans to MFIs (microfinance institutions),” said Jinay Gala, director, India Ratings and Research Ltd. “This funding tightness could play out for MFIs wherein banks could incrementally roll over their existing debt but giving them new credit lines would be a challenge.”

A lot of the microlenders could see their book shrinking because lending has slowed and incremental collections are being used to build on-balance sheet liquidity to manage immediate debt repayments or issues pertaining to asset quality and higher provisioning, Gala said.

Last Monday, Icra Ltd and Care Ratings Ltd downgraded Spandana Sphoorthy Financial Ltd after the company announced dismal results owing to rising stress in the MFI portfolio. The rating agencies said the company had breached certain financial covenants in respect of ₹640 crore of borrowings and received requests for early redemption of about ₹200 crore of non-convertible debentures till December.

“SFL’s performance in terms of profitability and asset quality has been impacted during 9M FY2025, on account of various issues including over-indebtedness of borrowers, dilution of credit discipline, elevation at field level attrition etc,” said Care Edge, which expects both profitability and asset quality to remain under pressure.

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Spandana reported net loss of ₹601 crore and write-off of ₹700 crore during the period. Consolidated assets under management shrunk to ₹8,936 crore as on 31 December from ₹11,973 crore in March last year, whereas gross stage 3 assets (overdue for more than 90 days) increased to 5.25% from 1.68%. The share of bank borrowing in funding fell to 49.4% from 55.7% over this period.

However, rating agencies are not terribly worried as the company has a capital adequacy ratio or buffer of 36% of risk weighted assets and strong liquidity position to meet any exigencies. The minimum capital adequacy ratio for NBFCs is 15%.

“The credit costs estimate for FY25 for the sector have increased over the period and are now estimated to be north of 8.5%. This will impact the profitability adversely,” said Sanjay Aggarwal, senior director at Care Ratings. “Collateral information being received now indicates improvement from January 26 onwards. However, we need more trends to arrive at any such analysis.”

Aggarwal expects “credit costs are likely to be spread over till Q2FY26 (July-September 2025), before stabilising thereafter. The profitability in the sector would remain moderated, going forward”.

Among the listed microlenders, Fusion Microfinance Ltd was the first to get downgraded in November last year after it reported higher-than-expected deterioration in asset quality and profitability.

The company’s gross stage 3 assets increased to 9.4% as of September from 2.9% as of March. The company reported a net loss of ₹341 crore in the first half of the fiscal year compared to net profit of ₹505 crore in the previous year. Its auditor had also raised questions regarding the company’s ability to continue as a going concern.

India’s largest MFI CreditAccess Grameen also reported a net loss of ₹99.5 crore in the quarter ended December compared with a profit of ₹186 crore in the previous three months and a profit of ₹353.3 crore a year earlier.

CreditAccess Grameen’s rating, however, continues to remain stable at AA-.

More downgrades feared

Lenders expect some more microfinance companies to see downgrades as funding slows down in the fourth quarter and stress continues to remain elevated.

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To be sure, microfinance companies were expecting funding to pick up in the fourth quarter as many banks have to meet their priority-sector lending requirement of 40%. But lenders remain cautious and expect funding to pick up only by June this year.

‘We were expecting an uptick in collection by December and January. But we have not seen that happen. Collection efficiency has not improved across geographies as these MFIs continue to face large scale attrition and poor funding,” said a senior official with a private sector bank. “Fourth quarter will see the delinquencies from the MFI lending done from April onwards.”

V. Vaidyanathan, managing director and chief executive officer of IDFC First Bank, said in the third-quarter earnings call that the lender is “slowing down the (MFI) book”. “It’s a bit of a double whammy, I should say, because suddenly now we also have credit cost coming or no income coming from that line because book is coming down.”

India Ratings has categorised the sector outlook as “deteriorating”, citing that the “funding avenues have become tighter”. “…but the rating outlook is ‘stable’ because most of these entities still have good on-balance sheet liquidity to service debt for the next 3-6 months,” India Ratings’ Gala said.

Still, according to him, the sector is not “at the peak of the cycle”, which could be seen in Q4 FY25 or even Q1 FY26 and March numbers could be worse as funding at the borrower level is also getting squeezed due to slower lending.

Lending frenzy

The microfinance industry’s loan portfolio surged in the last fiscal, according to the Micrometer report by Microfinance Industry Network or MFIN, the self-regulator for the sector.

Non-bank lenders saw a 37.5% increase in outstanding MFI loans to ₹40,469 crore at the end of March 2024, followed by NBFC MFIs at 23.6%, and small finance banks at 28.4%. The fourth quarter of the previous fiscal saw the highest quarterly disbursements at ₹48,322 crore.

Also read | MFI stress to weigh on small finance banks’ loan growth, asset quality

Bankers blame this aggressive lending for much of the stress that the industry is facing now.

“Funding is a continuing challenge for MFIs, especially the small- and mid-sized ones. MFIs need debt and equity funds. Both are a challenge. The major source of funds for MFIs are banks and DFIs,” said Jiji Mammen, chief executive officer, Sa-Dhan, the second self-regulatory organization of the MFI sector. “Owing to recent developments in the industry, the flow of funds to the MFIs are further impacted.”

Many microlenders have slowed down business since August last year and are bracing for future uncertainties.

Karnataka ordinance

The first concern is on account of any potential impact from the implementation of Karnataka government’s ordinance on curbing coercive recovery tactics by MFIs and unlicensed moneylenders. While the industry is hopeful that regulated entities may be kept out of the ordinance, they are not ruling out an impact on collections.

According to media reports, the ordinance has proposed stringent measures, including full loan waivers for borrowers who took loans from unlicensed lenders, restrictions on interest rates, and legal immunity from repayment demands.

Come April this year, MFIs are also expected to cap the number of lenders to three per borrower from four earlier. This is part of the guardrails MFIN had introduced in November last year. The cap, which was to come into effect from January, was postponed till April after the fourth quarter, typically a busy credit season.

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“The stress in the microfinance portfolio of lenders remains elevated, though the forward flow rates to delinquent buckets have seen a moderation from previous high, reflecting slight improvement in their incremental stress formation,” said said Anil Gupta, vice president at Icra.

However, capping the number of lenders to three for a single borrower “may squeeze the liquidity of [the] borrower, and hence the sustainability of the improved forward flow rates to delinquent buckets remains a monitorable”, Gupta said.

Hopes alive

Aditi Singh, chief strategy officer at Satin Creditcare, is optimistic.

“Financial institutions and lenders are still being cautious and may delay some amount of funding to look at another quarter of results,” she said. Even so, she said, some large multinational banks and foreign development finance institutions (DFIs) continue to lend to the sector, albeit selectively, drawing comfort from the parentage of portfolio quality.

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“The smaller players are also managing by direct assignment or through pool sales between the smaller MFIs and larger MFIs or banks etc. so that banks are able to meet their PSL (priority sector lending) targets and these impacted MFIs can have liquidity,” she said.

“There could be some consolidation that may happen, which is why most rating agencies’ sectoral view/outlook have been changed to ‘neutral’ or ‘negative’,” said Singh. “Therefore, capital market investors or those who are entering the market might want to delay their investment but seasoned lenders/investors who have experienced multiple cycles continue to lend.”