Microfinance portfolios of small finance banks and non-bank microfinance institutions (together referred to as MFIs) are showing a distinct improvement and stability in asset quality since June 2017, shrugging off the impact of demonetisation, which had cranked up delinquencies, affected borrower behaviour and worsened asset quality.

While some idiosyncratic risks remain, three data points underscore the change on the ground:

1. Asset quality has improved, as evidenced by reducing portfolio delinquencies
   
2. Cumulative collection efficiencies have risen to over 99% for disbursements since April 2017 and,
   
3. High degree of investor support reflected in the significant equity and debt raised post demonetisation.

Portfolio delinquencies, for a representative set of MFIs¹, measured in terms of 30 and 60 days past due (dpd), have improved to ~5.6% and 5.3%, respectively, as on December 2017, compared with 7.6% and 6.8%, respectively, as on June 2017.

“The reduction in delinquencies shows that borrowers are paying more than one instalment and there is recovery in the higher-delinquency buckets,” said Krishnan Sitaraman, Senior Director - CRISIL Ratings. “Collection efficiencies of over 99% for newer originations indicate improving market environment and better borrower discipline.”

To be sure, the weakening in asset quality was not pervasive. In terms of States, Tamil Nadu, Kerala, Odisha, West Bengal and Bihar remained largely resilient despite demonetisation and its aftermath. These States continue to exhibit strong collection performance with 30 dpd staying below 2%.

But the big takeaway is the improvement in asset quality performance in Uttar Pradesh, Maharashtra and Karnataka, which were in the front and centre of demonetisation impact. For instance, 30 dpd in Uttar Pradesh reduced to an estimated 14% as on December 2017 from 23% in June 2017.

Asset quality performance, though, remains weak in Vidarbha, some districts in central and southern Madhya Pradesh and select districts in Karnataka and Uttar Pradesh.

CRISIL estimates ultimate credit losses due to this demonetisation linked impact to be in the 5-7% range for the entities it rates. Healthy capital position to provide cushion against sudden increase in credit losses due to idiosyncratic risks and continued funding support remains critical in the MFI sector.

So far, strong investor appetite for both equity and debt capital market issuances has helped MFIs tide over the challenges. Since demonetisation, CRISIL estimates MFIs have raised around Rs 4,000 crore of equity and Rs 7,000 crore of debt. Additionally, banks and refinance institutions also continue to extend funding to MFIs. Priority sector eligibility for banks on direct lending to MFIs has also helped.

Says Ajit Velonie, Director - CRISIL Ratings, “Capitalisation will continue to be the key rating differentiator for MFIs given the inherently weak borrower segment, susceptibility to socio-political issues, and consequent volatility in asset quality and profitability performance.”

CRISIL-rated small finance banks and MFIs in ‘A’ category have either parent companies with strong credit profiles or adequate capitalisation with sizeable networth, and high networth coverage for net non-performing assets. Hence, their overall credit profiles are expected to remain resilient despite asset quality challenges.

¹ Representative set of MFIs and SFBs covering 50% of industry AUM (excludes one large SFB)