Microfinance Sector Tightens Lending Norms Amid Asset Quality Stress

The microfinance sector in India, which has been grappling with severe asset quality challenges, is set to undergo a transformation. The Microfinance Institutions Network (MFIN), one of the two self-regulatory organizations for the sector, has introduced a stricter framework aimed at addressing over-indebtedness and restoring stability to the industry. These new measures, effective January 2025, are expected to safeguard the sector’s long-term sustainability while ensuring financial inclusion remains intact.

The Crisis in Microfinance
Over the past few quarters, the microfinance sector has witnessed a sharp deterioration in asset quality. Data for September reveals that the sector’s gross non-performing assets (NPAs) surged to 11.6%, an 18-month high. This distress stems from a combination of external and structural factors:

Adverse Weather Events: Heatwaves have disrupted the livelihoods of borrowers, primarily from the agrarian and informal sectors, hampering their repayment capacity.
Political Disruptions: The two-month-long general elections created uncertainties, delaying financial transactions and economic activities in rural and semi-urban regions.
Overleveraging of Borrowers: The ease of access to credit had led to borrowers taking multiple loans, often beyond their repayment capacity.
The Reserve Bank of India (RBI) has also flagged regulatory violations. Last month, it barred two Non-Banking Financial Company-Microfinance Institutions (NBFC-MFIs) from issuing fresh loans for charging excessive interest spreads and misjudging household income while assessing repayment obligations.

MFIN’s New Guardrails
To mitigate these challenges and bolster the sector’s resilience, MFIN has rolled out revised norms. These measures are expected to limit over-indebtedness while ensuring borrowers are not overwhelmed by repayment burdens.

Stricter Lending Criteria:
MFIN has requested its members to cease lending to delinquent customers with overdue loans exceeding 60 days and an outstanding amount greater than ₹3,000. Previously, the threshold was 90 days. Loans overdue for more than 90 days are classified as non-performing, so this change seeks to encourage earlier intervention.

Reduced Lender Cap:
The maximum number of lenders a borrower can approach has been reduced from four to three. This measure aims to address overleveraging, a critical issue that has exacerbated repayment stress among borrowers.

Loan Indebtedness Cap:
Total microfinance loans to a single borrower were capped at ₹2 lakh in July 2024. MFIN has now clarified that this cap includes unsecured retail loans, not just microfinance loans, further limiting the borrower’s exposure to debt.

Interest Rate Rationalization:
Members have been urged to review their interest rate structures to ensure efficiency gains are passed on to borrowers. Other than processing fees and credit life insurance, no additional charges can be deducted from sanctioned loan amounts.

Balancing Growth with Prudence
The revised norms are expected to curtail credit delivery, particularly for borrowers at the bottom of the income pyramid. While this may slow down the growth trajectory of microfinance institutions in the short term, it is a necessary step toward ensuring sustainable financial inclusion. By tightening lending norms, MFIN aims to address the root causes of the sector’s crisis—over-indebtedness and inefficient credit delivery.

MFIN Chief Executive Alok Misra emphasized, “The sector has been taking voluntary steps in line with emerging issues, going above and beyond RBI regulations. We are confident that these measures will make the sector more resilient.”

Broader Implications for the Sector
The implementation of these norms will have significant implications for both borrowers and microfinance institutions:

Reduced Over-Indebtedness:
By capping the number of lenders and tightening credit assessment criteria, MFIN aims to minimize the risk of borrowers defaulting due to excessive debt.

Improved Asset Quality:
Stricter norms for overdue accounts will encourage early intervention and better recovery rates, ultimately reducing NPAs.

Enhanced Borrower Protection:
The inclusion of unsecured retail loans in the ₹2 lakh cap ensures a holistic approach to assessing borrower indebtedness, preventing instances of financial distress.

Pressure on MFIs’ Profit Margins:
The sector may face margin pressure as institutions revise interest rates and align operations with the new norms. However, this trade-off is essential for long-term stability.

The Way Forward
MFIN’s proactive measures are a testament to the sector’s commitment to addressing its challenges head-on. However, this transformation will require collective effort from all stakeholders—regulators, institutions, and borrowers.

The Reserve Bank of India’s oversight will remain critical to ensuring compliance and safeguarding borrower interests. Simultaneously, microfinance institutions must focus on enhancing operational efficiencies and leveraging technology for better credit assessment and delivery.

While these changes may momentarily impact credit flow to the underserved segments, they are pivotal in laying the foundation for a resilient and sustainable microfinance ecosystem. By addressing over-indebtedness and prioritizing asset quality, the sector can continue to play its vital role in advancing financial inclusion and empowering underserved communities.

Conclusion
The Indian microfinance sector is at a crossroads. The challenges it faces are significant, but the steps being taken by MFIN reflect a deep understanding of the need for systemic change. By tightening lending norms, rationalizing interest rates, and capping indebtedness, the sector is positioning itself for sustainable growth.

As these measures come into effect in January 2025, their success will depend on how effectively microfinance institutions adapt to the new regulatory environment. Ultimately, these changes will not only stabilize the sector but also strengthen its ability to uplift millions of borrowers, driving financial inclusion and economic empowerment across the country.

The image added is for representation purposes only