ICRA RESEARCH SERVICES

MFI sector back on growth track, but new challenges on the horizon
Credit quality trends in retail loans - Indian Microfinance Sector

INDIAN MICROFINANCE INDUSTRY

Industry Update

September 2018
Contacts:

Karthik Srinivasan Supreeta Nijjar Vibhor Mittal Abhijeet Ajinkya Swathi Hebbar
+91 22 6114 3444 +91 24 4545 324 +91-22-61143440 +91-22-61143434 +91 80 4332 6404
karthiks@icraindia.com supreetan@icraindia.com vibhorm@icraindia.com abhijeet.ajinkya@icraindia.com swathi.hebbar@icraindia.com
 Summary

Good growth potential

The Indian microfinance sector (including the SHG Bank Linkage Programme) grew 25% (annualised) in Q1 FY2019 to Rs. 2.25 lakh crore. The growth
was supported by good collection efficiency, continued investor support to microfinance institutions (MFIs), funding availability and demand for
microcredit.

ICRA expects the traction in disbursements to continue and the industry grow at 20-22% per annum over the medium term. While the segment
continues to offer good growth potential, most of the incremental growth opportunities lie in the relatively tougher states, which are less penetrated,
or in mature states that offer higher ticket sizes to borrowers. Foray into the relatively under-penetrated markets would also entail investments in
terms of creating a microfinance credit culture and training potential borrowers. However, these are crucial for instilling credit discipline, which, in
turn, is a critical factor for ensuring good asset quality in the long term. Further, in the mature states, the credit evaluation processes will have to be
upgraded as the MFIs move to higher ticket sizes.

Managing high client and employee attrition would be key for meeting growth plans
While growth prospects remain good, high client and employee attrition could lead to scalability challenges for the sector. Employee attrition
continues to be around 25-30% at the field level. This coupled with 25-30% expansion in the field staff every year to support branch expansion, would
imply that around 50% of the staff, at any point in time, would have a vintage of less than a year in a given entity. This implies continuous need for
staff training and development. Further, the training needs are likely to change as the lenders move towards higher automation of processes and
higher ticket sizes. Client attrition rates have also increased with an increase in competition. This also leads to pressure on the field staff to
continuously acquire clients and penetrate newer geographies for maintaining the client growth rates.

Including the SHG Bank Linkage Programme, banks were the most significant providers of microcredit (60%) as on June 30, 2018, followed by Non-
Banking Finance Companies-Microfinance Institutions(NBFC-MFIs) at 26% and Small Finance Banks at 14%. ICRA expects the share of banks to expand
with the expected merger of Bharat Financial Inclusion Limited and IndusInd Bank Limited, and the increased focus of banks on growing their business
correspondent (BC) portfolios. ICRA has also noticed the trend of banks/larger NBFCs taking partial/majority stakes in MFIs. In some cases, MFIs are
also working on increasing lending through the BC model and developing co-lending arrangements, which are likely to be more efficient from a credit
risk and capital management perspective.

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 Improving geographical mix and asset quality
The geographical mix of the industry has been improving at the state and district level. Karnataka and Tamil Nadu remained the top two states in
terms of portfolio share, as on June 30, 2018. However, with the increased focus of industry participants on expanding their reach in the
underpenetrated states of Bihar and Odisha, where the asset quality indicators remained benign even after demonetisation, the share of these two
states increased. While the share of Bihar increased to 10%, as on June 30, 2018, from 8% in September 2016, Odisha’s share increased to 8%, as on
June 30, 2018, from 5% in September 2016. Even at the district level, the share of the top 20 districts declined to around 18% of the portfolio
outstanding as on June 30, 2018 from 25% in September 2016.

Improving collection efficiencies of the loans disbursed post demonetisation led to an improvement in delinquency trends for the sector (MFIs and
SFBs). The overall 0+ dpd for the sector reduced to 8% in June 2018 from a peak of 23.6% in February 2017. Harder bucket delinquencies reduced
as well with the 90+ dpd declining to 7.3% in June 2018 from 12.2% in June 2017, supported by increased portfolio growth, write-offs and arrear
funding by some lenders. Uttar Pradesh, Maharashtra, Gujarat, and Uttarakhand, which had high delinquencies as of June 2017, showed a reduction
in delinquency levels across all buckets.
An analysis of the portfolio cuts of MFIs reveals that the ticket sizes and loan tenures are rising. While the opportunity to scale up and grow remains
intact, there is need for a more involved credit analysis and assessment of the actual debt repayment capacity of the borrower. Further, the risk
management policies of the lenders in the sector need to be aligned with responsible and sustainable growth, where the overall indebtedness of the
borrower from all formal sources is considered for leverage calculations rather than for compliance with regulatory norms. Given that the target
segment for microfinance-focussed lending by MFIs, SFB licensees and commercial banks is the same, both lenders and regulators need to critically
reassess the guidelines from a risk perspective and maintain the core objective of ensuring that the end borrower is not overleveraged.

The asset quality indicators should be supported, over the medium term, by structural factors such as group selection/elimination and the fact that
MFIs represent the lowest cost of funding for borrowers. Nevertheless, the segment remains vulnerable to income shocks and is politically sensitive.
Therefore, ICRA expects credit costs for the sector to remain volatile with mean credit costs at 1.5-2.5%, which could vary among players across cycles,
depending on their risk management practices.

Capital requirements remain high despite regular infusions in the past

While investors continued to support the industry with equity infusion of Rs. 4,061 crore in FY2018 (~Rs. 6,570 crore in FY2017), 87% of the capital
was infused in the top 10 lenders in terms of portfolio size. In ICRA’s opinion, the sector would need external capital of Rs. 6,000-9,000 crore for the
next three years to meet the growth plans. While raising capital is unlikely to be a major impediment for well-managed large MFIs/SFBs, the smaller
entities may continue to struggle to raise equity. This could result in an increase in the share of smaller MFIs originating more portfolio through the
BC model, as partners to larger lenders, to conserve capital. Alternatively, there could be further consolidation in the industry with the smaller MFIs
being acquired by larger NBFCs/banks.

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 Maintaining Adequate liquidity will be critical

In addition to the capital flow which aided the liquidity profile of MFIs in the past, their liquidity profile is also supported by the priority sector status
attached to the bank loans and off-balance sheet funding (largely assignments) of MFIs and relatively shorter tenures of their assets vis-a-vis liabilities.
However, incremental funding requirements for the MFIs are likely to remain high given the growth aspirations and the need to maintain
disbursement levels for servicing the existing client requirements as well. At the same time, the recent volatility in the wholesale market is likely to
keep the cost of funds elevated for these MFIs especially since these players are highly dependent on wholesale funding sources. Overall, availability
of fresh funding would be a key factor impacting MFIs’ liquidity profiles going forward.

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 Subscribe to the report for the following

▪ Trends in Market Size and Growth

▪ Trends in Geographical Mix
▪ ICRA’s experience from field visits
▪ Trends in Asset Quality
▪ Overall, State wise and District Wise
▪ Trends in micro loan pools
▪ Key trends in portfolio cuts analysed

▪ Key Credit Factors and Outlook

• Growth potential and scalability challenges

• Access to capital limited mostly to larger lenders
• Banks likely to emerge as largest lenders to the segment
• Competitive positioning of SFBs, MFIs, BC model
• What can be the next large source of risk to the sector?

▪ ICRAs coverage of the sector

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