Synopsis: Increased Default Risk, Indian banks anticipate a rise in microfinance loan defaults in the second half of the fiscal year due to recent regulatory changes by the RBI, which restrict loan renewals without full repayment of previous loans. Regulatory Crackdown, the Reserve Bank of India has highlighted unfair practices in microfinance, including high-interest rates and processing fees, prompting new informal guidelines.
Indian banks are preparing for increased stress in their microfinance loan portfolios as the Reserve Bank of India (RBI) tightens its regulatory stance on lending practices within the sector.
According to statements from four banking insiders, the RBI's recent informal directive prevents lenders from issuing new microfinance loans to borrowers until previous dues are fully cleared.
This change comes in response to growing default rates in collateral-free microfinance loans, which are extended to individuals earning up to ₹300,000 ($3,556) annually.
Microfinance loan portfolios of prominent banks, including IndusInd Bank, Kotak Mahindra Bank, RBL Bank, and Bandhan Bank, showed a noticeable rise in default rates in their July-September earnings reports, revealing the strain within the sector.
These loans, typically issued without collateral, serve low-income earners who often lack steady incomes, making timely repayment a recurring challenge.
The RBI has flagged various malpractices in the microfinance sector, including excessive interest rates and high processing fees, both of which have been publicly criticized by the regulatory authority.
Last month, in an informal move, the RBI communicated to banks that no new microfinance loans should be issued to borrowers with existing, unpaid loans.
While these guidelines have not been publicly disclosed, bankers believe that the restriction aims to curb "evergreening" practices—whereby banks issue new loans to repay existing debts, thereby masking the real level of non-performing assets (NPAs).
"Netting off" previous dues through new loans has been a common practice, especially given that many microfinance borrowers lack stable income streams, explained one banker.
With the recent guidelines, some borrowers may face difficulties in repaying their dues, potentially leading to cascading defaults in the absence of fresh credit.
This regulatory shift is likely to exacerbate sectoral stress in the coming months, according to experts.
"We are still not out of it," said Venkatesh M, Managing Director of IIFL Samasta Finance, adding that the microfinance segment may continue facing challenges into the next quarter.
Gaurav Dua, Senior Vice-President and Head of Capital Market Strategy at Sharekhan by BNP Paribas, projected that stress levels could remain elevated for the next 4-6 months due to the increasingly stringent regulations.
The microfinance market, where banks and non-bank financial companies (NBFCs) compete to offer loans, has experienced rapid growth, with the latest data from industry body MFIN showing an 18.3% increase in outstanding loans year-on-year as of June-end.
Despite this expansion, the RBI's move to prevent "netting off" is likely to impact loan performance negatively, as it aims to bring greater transparency to the actual level of NPAs.
In conclusion, the Indian microfinance sector is bracing for prolonged challenges, as regulatory shifts by the RBI address longstanding malpractices but simultaneously impact loan renewals.
With default risks rising and the potential for cascading defaults due to restricted access to fresh credit, banks are likely to experience continued stress in this portfolio over the next few quarters.
As regulatory scrutiny intensifies, the sector must adapt to maintain stability amid a new wave of stricter oversight.
Disclaimer: This article provides information for educational and informational purposes only and should not be considered as financial advice. Readers are encouraged to consult with a qualified financial advisor before making any investment decisions.
