The microfinance sector is witnessing encouraging signs of recovery, with several lenders reporting increased business volumes and improved repayment patterns. This turnaround comes after a challenging period for the sector, with well-capitalized institutions leading the recovery while smaller players continue to face difficulties.

Small Finance Banks Lead Recovery

Several small finance banks have demonstrated strong performance in their microfinance portfolios during the third quarter. The following institutions have reported notable growth:

NBFC-MFIs including CreditAccess Grameen, Fusion Finance, Muthoot Microfin, and Satin Creditcare Network are expected to report sequentially higher disbursement numbers. Some of these institutions also anticipate quarter-on-quarter growth in their respective assets under management.

Market Dynamics and Challenges

The recovery pattern shows clear differentiation based on institutional strength. Lenders with strong capital backing are expected to recover faster, while smaller and mid-sized MFIs continue struggling with limited equity and reduced borrowing capacity. Industry executives note that increased loan disbursements may not necessarily translate into sectoral asset growth due to higher rundown rates of existing loans.

Bandhan Bank's Balance Sheet Restructuring

Bandhan Bank, the country's largest microfinance lender, adopted a different strategy during the third quarter, focusing on balance sheet cleansing activities:

These strategic moves are expected to further shrink the bank's microfinance portfolio as part of its balance sheet optimization efforts.

Sector Performance Metrics

The overall microfinance market has experienced significant contraction, according to CRIF High Mark data:

Equitas Small Finance Bank reported particularly strong quarterly performance, with microfinance and micro loan advances surging 52.00% quarter-on-quarter to ₹5,159.00 crore at December-end, compared to ₹3,395.00 crore at September-end. This growth was largely attributed to the purchase of agricultural loans worth ₹1,343.00 crore from other regulated entities.

Recovery Outlook

The microfinance sector's recovery appears to be gaining momentum, though it remains uneven across different types of institutions. Well-capitalized lenders are demonstrating resilience and growth capability, while the sector continues to work through the challenges that led to the significant market contraction from its March 2024 peak.

The Indian microfinance industry is facing significant challenges as bad loans rise and loan portfolios contract, despite measures to limit borrower exposure. Recent data reveals a concerning trend in the sector's financial health, with implications for both lenders and borrowers.

Rising Portfolio at Risk

The microfinance sector has seen a sharp increase in its Portfolio at Risk (PaR) for loans in the 31-180 day bucket. This crucial metric has more than doubled, reaching 5.40% from 2.50% in the previous year. This surge comes despite the implementation of voluntary caps limiting borrowers to three lenders, a measure intended to curb over-indebtedness.

Segment-wise Performance

Different segments within the microfinance sector have experienced varying degrees of stress:

• Banks: PaR increased from 2.50% to 5.40%
• NBFC-MFIs: PaR rose from 2.60% to 6.00%

Long-term Stress Intensifies

The sector is also grappling with mounting long-term stress. The PaR for loans overdue by more than 180 days has seen a significant jump:

• Previous period: 7.60%
• Current period: 13.60%

This nearly 80% increase in long-term delinquencies signals deepening financial distress among borrowers.

Contracting Loan Books

Alongside rising bad loans, the microfinance sector is experiencing a substantial contraction in its loan book:

The overall industry portfolio has shrunk by 7.50% to Rs 3.53 lakh crore. This contraction is also reflected in the number of loan accounts, which have decreased from 14.9 crore to 12.5 crore.

Funding Pressures

NBFC-MFIs are facing increased funding pressures:

• Debt raised: Rs 12,781 crore (down 19.90% year-on-year)
• Equity infusion: Rs 34,582 crore (down 6.20% year-on-year)

Market Share

Despite the challenges, NBFC-MFIs continue to hold the largest market share in the microfinance sector at 39.00%, followed by banks at 33.00%.

The microfinance sector's current struggles highlight the delicate balance between financial inclusion and sustainable lending practices. As the industry grapples with rising bad loans and shrinking portfolios, it may need to reassess its strategies to ensure long-term viability while continuing to serve its target demographic.