Over the past year, companies in the Microfinance (MFI) sector—or those with any exposure to it—have seen their stock prices take quite a beating on the bourses.
So, what was fueling the MFI sector’s rise to begin with? Where did things go off track? And what challenges are dragging it down now? Most importantly, is there light at the end of the tunnel—and just how long might that tunnel be?
Don’t worry, we’ll break it all down in the least boring way possible!
The Surge of MFI
After the downturn faced by MFIs due to COVID, the sector saw a strong rebound as the rural economy improved.
Pent-up demand, reverse labour migration towards rural areas, and newly expanded credit access for millions of small borrowers, classified as new-to-credit (NTC) customers, drove this recovery, resulting in impressive AUM growth of 20-30% across the board.
Additionally, given the higher risk associated with lending to borrowers without a credit history, MFIs were able to charge high interest rates, resulting in net interest margins (NIMs) of around 10-12%—significantly higher than the 4-6% NIMs typical for banks.
With high-margin lending and rapid AUM growth, MFIs were reporting multi-fold increase in their profits. But, as we know, there’s no such thing as a free lunch in the market—and soon, the tide began to turn.
The Downturn
The overwhelming AUM growth led MFIs to loosen credit standards, causing borrowers to become overleveraged.
This was worsened by a shift to voter IDs as the primary KYC document—a choice that made fraud easier, as fake voter IDs proliferated.
Unlike Aadhar cards, voter IDs are easier to duplicate, making it difficult for MFIs to track borrowers who took out multiple loans with multiple IDs, increasing defaults.
But that's not all. The industry also faced several other challenges:
Defaults from 'ring leaders' or intermediaries in certain regions, who exploit the system for personal gain;
High attrition rates among field officers and branch managers, creating operational disruptions;
Heavy rains and floods in some areas, which have impacted customer earnings and repayment abilities.
In short, “when it rains, it pours” seems to be the MFI sector’s reality!
The Struggles Persist
The stress faced by MFIs in recent quarters has led the industry’s self-regulatory organization (SRO) to take preventive actions.
These include (a) setting a cap of Rs. 2 lakh on total microfinance debt per borrower, and (b) limiting the number of lenders per borrower to four. While these are welcome steps, they may be “too little, too late.”
The damage to MFIs is becoming evident through rising provisions, increased credit costs that hurt profitability, lower return ratios, declining collection efficiency, and now, with the new SRO restrictions, AUM growth is expected to slow in the coming quarters.
Is There a Silver Lining?
So, after all this, you must be tempted to ask, is there any silver lining? The short answer? Not yet. As pointed out earlier, the stress on MFIs is likely to continue through 2Q and 3Q of FY25, with some relief expected by late FY25 or early FY26.
However, there are a few hopeful signs: (i) a potential RBI rate cut in late 2024 or early 2025 could ease borrowers' burdens as lower rates are passed on, and (ii) a strong upcoming harvest season could boost rural incomes and improve repayment capacity.
Company | Fall From Peak | FY26 P/B ratio |
CreditAccess Gramin | 47% | 1.8x |
Spandana Sphoorthy | 70% | 0.8x |
Fusion Micro Finance | 71% | 0.6x |
Satin Creditcare | 44% | 0.6x |
For those with a taste for adventure, the sharp drop in MFI stock prices might hint at potential value opportunities, given their low valuations. However, this isn’t a call to dive in—waiting for the dust to fully settle is essential.
Even when the sector stabilises, selecting the right company will remain a challenge, with several key factors requiring careful analysis. While the MFI sector might not be a “buy” right now, keeping it on the watchlist—with a strong dose of caution—is wise. After all, capital protection comes first.
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