Stress in Microfinance Sector Due to Rise in Delinquencies 

Syllabus: GS3/ Economy

Context

• India’s microfinance sector is witnessing a rise in delinquencies, even as the overall banking sector records a 12-year low in non-performing assets (NPAs).

What is Microfinance?

• Microfinance refers to the provision of small loans and financial services to low-income groups who lack access to traditional banking channels. 
• Microfinance institutions (MFIs) play a pivotal role in financial inclusion by offering credit to underserved populations, primarily for entrepreneurial activities and income generation. Types of MFIs are;
  • Non-Banking Financial Companies – Microfinance Institutions (NBFC-MFIs).
  • Non-Governmental Organizations (NGOs): It operates as non-profit organizations.
  • Cooperatives: They are Member-owned institutions providing microfinance services.
  • Commercial Banks and Small Finance Banks (SFBs): Provide microfinance as part of their priority sector lending.

Current Scenerio

• Rising Delinquencies:
  • Microfinance loans to low-income groups have shown a sharp increase in Portfolio at Risk (PAR) (overdue loans of 31-180 days).
  • Geographic Impact: Bihar, Tamil Nadu, Uttar Pradesh, and Odisha account for 62% of new late payments.
  • Delinquencies are increasing across all loan categories, with Small Finance Banks (SFBs) being most affected.
• Market Share and Growth:
  • NBFCs and banks together hold 71.3% of the total microloan portfolio.
  • Despite a 7.6% year-on-year growth in the loan book and an 8.9% rise in the live customer base, there was a quarterly decline of 4.3% in the loan book and 1.1% in the customer base.

Reasons for Rising Delinquencies

• Borrower Overleveraging: Increased borrowing from both MFI and non-MFI sources has resulted in excessive debt burdens among borrowers.
• Instances of Frauds: Cases of misrepresentation and fraudulent practices have led to heightened operational risks.
• Economic Distress: External economic shocks and income uncertainties have impacted repayment capacities.
• Operational Challenges: High staff attrition and lack of proper borrower assessment mechanisms.

Impact of Rising Delinquencies

• Financial Strain on MFIs: Increased credit costs reduce profitability for MFIs, affecting their financial stability.
• Reduced Lending Capacity: Higher NPAs limit the ability to extend fresh credit to borrowers, hampering financial inclusion.
• Borrower Distress: Overleveraged borrowers face economic hardships and risk exclusion from financial systems.
• Sector-Wide Confidence Issues: Rising defaults can diminish investor and lender confidence in the microfinance ecosystem.

Way Ahead

• Strengthening Credit Assessment: Implementing better risk profiling and borrower assessment mechanisms.
• Financial Literacy Initiatives: Enhancing borrower awareness regarding credit management.
• Stricter Regulatory Oversight: Strengthening supervision to prevent fraud and malpractices.
• Operational Strengthening: Reducing staff attrition through better training and incentives.
• Debt Consolidation Measures: Offering structured repayment plans for overleveraged borrowers.

Concluding remarks

• To ensure the long-term health of the microfinance sector, a balanced approach involving stronger credit discipline, financial education, and regulatory vigilance is essential. 
• Addressing structural vulnerabilities and promoting responsible lending practices will be crucial for sustaining financial inclusion in India.

Sources: IE