Enhanced flexibility to set lending rates will be one of the drivers supporting a revival in the profitability of non-banking financial company-microfinance institutions (NBFC-MFIs) this fiscal. This emanates from the Reserve Bank of India’s (RBI) removal of the interest margin cap on lending rate under its new regulatory framework for microfinanciers.

The other factors that will support the improvement in profitability include a reduction in credit cost and an increase in permissible household income limit according to the new framework. These, in turn, will help enlarge the market in terms of target borrowers and geographies, especially in hinterland.

Additionally, the current rising interest rate environment is not expected to impair the profitability of NBFC-MFIs as higher borrowing costs would be offset by steeper lending rates, cushioning net interest margins.

Says Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, CRISIL Ratings, “A number of NBFC-MFIs have increased their lending rates by 150-250 basis points in recent months. This provides reasonable headroom to absorb higher borrowing costs. Lenders can also dip into their contingency provision buffer created over the past two fiscals to manage asset-quality challenges, if any, in specific states due to natural calamities or socio-political issues — without material impact on profitability.”

Over the past two fiscals, the annual credit cost of NBFC-MFIs had shot up to ~4-5% because of pandemic-related provisioning, versus ~1.5-2.0% prior to that. With asset-quality pressures gradually easing and sizeable provision buffers created, their credit cost is expected to decline to ~2.5-2.8% this fiscal (see chart 1 in annexure).

In this context, the new RBI framework augurs well for the next phase of growth for NBFC-MFIs. The higher income eligibility threshold and enhanced flexibility to price loans will spur deeper penetration into existing markets and entry into new geographies. That, together with rising demand for loans in rural India should drive NBFC-MFIs’ credit growth, which is expected at 25-30% this year.

Says Poonam Upadhyay, Director, CRISIL Ratings, “One issue that this segment has been facing for some time now is potential over-indebtedness of borrowers. The introduction of a cap on total monthly repayment obligations of borrowers will persuade lenders to tighten their processes to assess borrower indebtedness. That will induce sustainable growth over the long run.”

The new regulatory guidelines also focus on the assessment of household income of the borrower besides credit assessment. The robustness of the income assessment framework and related policies that NBFC-MFIs will implement in the revised dispensation will remain a monitorable.

Even asset-quality stress, which has started to ease, is still higher than pre-pandemic levels. As of March 2022, 30+ portfolio at risk (PAR) for NBFC-MFIs stood at ~10% (versus ~16% as of June 2021). For full normalisation of asset quality, this improvement in PAR has to sustain and there should be no material slippages from the restructured portfolio.

Most of the larger NBFC-MFIs have navigated the pandemic by focusing on sustenance of adequate liquidity, provisioning and capitalisation buffers, which supported their credit profiles. Support from strong parents has also helped a number of lenders.

The impact of future waves of the pandemic and a sharper-than-expected increase in interest rates will bear watching.