Why profitability of microfinance companies will revive this year

Microlenders have been facing a squeeze with poor sentiments and asset quality and repayments concerns over the last two years.

But things are likely to change this year as the enhanced flexibility to set lending rates being 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, according to rating and research agency CRISIL.

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

A number of NBFC-MFIs have increased their lending rates by 150-250 basis points recently providing a 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 due to natural calamities or socio-political issues.

Over the past two fiscals, the annual credit cost of NBFC-MFIs had shot up to around 4-5% because of pandemic-related provisioning, compared to around 1.5-2% prior to that.

With asset-quality pressures gradually easing and sizeable provision buffers already created, their credit cost is expected to decline to around 2.5-2.8% this financial year, estimates CRISIL.

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.

On the flip side, even as the asset-quality stress has started to ease, it is still higher than pre-pandemic levels. It would need to improve further to allay concerns.