Banks tighten underwriting, go slow on MFI loans as asset quality stress weighs

Mumbai: Most banks have tightened underwriting for microfinance loans as lenders across the board reported elevated slippages and increasing stress in their unsecured advances in the second quarter ended September.

The microfinance segment has seen a rise in delinquencies, overleveraging in some customer segments, and a fall in collections. That has started to weigh on banks’ asset quality, pushing them to slow down growth in the segment, build up provision buffers and take measures to boost collections.

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Since the liberalization of microfinance institution (MFI) norms two years ago when microloans were linked to household income levels, there has been a rush towards MFI financing, Suresh Ganapathy, managing director, head - financial services research at Macquarie Capital, said in a recent note. "Our channel checks reveal many have inflated their assessment of household income levels to give larger ticket size MFI loans and ticket size in MFI space has gone up.”

Near-term back burner

RBL Bank has put microfinance lending on a “near-term back burner” because of on-ground issues such as borrower leverage and customers taking loans from multiple lenders, chief executive officer R Subramaniakumar said in the Q2 earnings call. This overleveraging has resulted in a near-term impact on asset quality, and the bank’s focus is now on improving collections and renewals of existing borrowers, while limiting exposure to one loan per borrower, he said, adding that normalcy is expected January-March onwards.

The bank also remodelled the collection platform with digital tools, advanced analytics and separation of the recovery teams to improve collections, besides adding dedicated teams for early-stage delinquencies that are 30 and 60 days past due (dpd).

RBL Bank posted a 59% on-year and 35% sequential rise in provisions to ₹618 crore, owing to higher slippages in the credit cards and microfinance portfolios.

Its mid-sized peer IndusInd Bank posted a drop in its net profit due to higher stress in the microfinance segment—the lender provides collateral-free loans to individuals with annual incomes of up to ₹3 lakh.

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Headline gross NPA ratio for the bank rose 10 basis points (bps) over the previous quarter to 2.1%, with the rise in the microfinance segment at 138 bps to 6.54%. The microfinance portfolio comprised 9% of the total loan book as of September 2024. Gross microfinance slippages for the quarter stood at ₹398 crore.

“The microfinance 30-90 dpd book increased by 2.1 percentage points during the quarter given the sectoral stress,” IndusInd Bank MD and CEO Sumant Kathpalia said, adding that he expects disbursements to improve this quarter but remain below the “distribution potential” as the bank remains watchful of lending to the sector.

For Bandhan Bank, of the ₹1,115 crore slippages during the quarter, ₹752 crore came from the microfinance segment, which accounts for around 45% of total loans.

Boosting contingency provisions

The deterioration in asset quality led lenders such as IDFC First Bank and Axis Bank to boost contingency provisions during the quarter. IDFC First Bank made contingency provisions of ₹315 crore specifically against the microfinance business, equivalent of 99% of the loans under the special mention account (SMA-1 and SMA-2) books and 2.5% of the entire microfinance portfolio as of September 2024. On the other hand, Axis Bank—which reported retail slippages of ₹4,073 crore—said the provisions were made on a “prudent basis”.

SMA-1 and SMA-2 accounts comprise loans due for 31 to 90 days, after which they are classified as non-performing assets (NPAs).

Ujjivan Small Finance Bank’s credit cost rose to 1.72% from 1.47% in Q1 FY25, with the lender hiking its overall credit cost estimate for FY25 to 2.3-2.5% from 1.7% to account for the impact of the recent MFI-linked slippages on asset quality.

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The hit on provisioning and credit costs also prompted some lenders to consciously slow down advances in the unsecured segment, given that in addition to microfinance, the asset quality of this category has also worsened due to rising stress in personal loans and credit cards.

“The slightly muted sequential growth in retail was due to us consciously reducing the growth in microfinance given the current industry conditions and the focus on collections,” said Jaideep Iyer, head – strategy, RBL Bank. “As soon as we see collections come to pre-stress levels, we should be able to then push the pedal on growth, which we expect should take anywhere between 3 to 6 months,” he said, adding that he expects credit costs for the segment to remain elevated for some time.

Microfinance loan book contracts

IndusInd Bank’s microfinance loan book contracted 12% sequentially, with the average loan outstanding per borrower at around ₹40,000. For IDFC First Bank, the share of microfinance to total loans fell to 5.6% from 6.3% a quarter ago.

While signs of stress had started emerging in January-March and April-June this year, lenders previously largely attributed this to transitory seasonal factors, delays in agriculture-related payments and disruptions in collections due to the general elections and heat waves. But a sustained stress in the MFI sector, and repeated warnings and actions by the Reserve Bank of India prompted banks to acknowledge the stress in their portfolios. Even banks such as Kotak Mahindra Bank and AU Small Finance, which earlier were confident of their asset quality, reported higher slippages in their unsecured loans in the quarter ended September.

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The stress in the current cycle could last for the entire of FY25, and the sector is expected to exhibit of signs of normalization only in the beginning of the next financial year, Motilal Oswal Securities said in a report. “Our channel checks suggest that Q2FY25 will be the most challenging quarter of FY25 and credit costs in H2FY25 will likely remain elevated.”

The sectoral stress is largely “self-inflicted”, the report said, driven by unchecked credit growth and issuance of multiple loans to customers on fake voter ID cards and other documents, which resulted in significant overleveraging.