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 rates under its new regulatory framework for microfinanciers, says a research note.
In the report, CRISIL Ratings says, "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 the 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, it added.
According to Krishnan Sitaraman, senior director and deputy chief ratings officer of CRISIL Ratings, many NBFC-MFIs have increased their lending rates by 150-250 basis points (bps) 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 a material impact on profitability," he says.
Over the past two fiscals, the annual credit cost of NBFC-MFIs had shot up to around 4%-5% because of pandemic-related provisioning, versus about 1.5%-2.0% prior to that. With asset-quality pressures gradually easing and sizeable provision buffers created, the rating agency expects their credit cost to decline to about 2.5-2.8% this fiscal (see chart below).
In this context, the new RBI framework augurs well for the next phase of growth for NBFC-MFIs, it says, adding, "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."
Poonam Upadhyay, director of CRISIL Ratings says, "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.
According to CRISIL, even asset-quality stress, which has started to ease, is still higher than pre-pandemic levels. As of March 2022, over 30 portfolio at risk (PAR) for NBFC-MFIs stood at about 10% versus around 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," the rating agency concludes.