Context:
The microfinance sector in India faces growing challenges due to uncontrolled credit growth and over-leveraging among borrowers. These factors have created a ripple effect, contributing to stress in loan portfolios and placing pressure on banks and non-banking financial companies (NBFCs) to offload their non-performing microfinance assets.
Key Issues in Microfinance Stress
- Unbridled Credit Growth:
- Aggressive lending practices have led to excessive credit exposure for borrowers, making it difficult for them to meet repayment obligations.
- High Delinquency Rates:
- Over-leveraging has increased default rates, especially among small borrowers, significantly impacting portfolio quality.
- Recovery Challenges:
- Loan recovery remains resource-intensive and costly, compounded by the cash-driven nature of microfinance operations and limited infrastructure.
- NPA Disposal to ARCs:
- Banks and NBFCs, including prominent players like IndusInd Bank, are selling non-performing microfinance loans to Asset Reconstruction Companies (ARCs).
- Example: IndusInd Bank sold loans worth ₹1,573 crore at a recovery rate of 5.04%, underscoring the deep discounting required.
Challenges for Asset Reconstruction Companies (ARCs)
- Pricing Limitations:
- ARCs find microfinance portfolios viable only when priced below 10% of the outstanding loan value, reflecting the high risk and cost of recovery.
- Preference for Secured Portfolios:
- ARCs prioritize retail NPAs with secured backing over unsecured microfinance loans, which offer limited recovery potential.
- Cash-to-Security Receipts (SRs) Model:
- ARCs prefer acquiring portfolios through a cash-to-SRs basis, which reduces upfront costs and balances risk-sharing between lenders and buyers.
- Competition with NARCL:
- The National Asset Reconstruction Company Ltd (NARCL), a state-owned entity, has shifted focus to corporate NPAs, leaving private ARCs to explore retail segments. However, the microfinance segment remains less attractive due to its complexity and low margins.
Way Forward
- Better Pricing Mechanisms:
- Banks and NBFCs need to adjust expectations on pricing non-performing microfinance loans, aligning them with market realities to attract ARC interest.
- Improved Risk Assessment:
- Stronger credit assessment mechanisms can mitigate over-leveraging risks, reducing future stress.
- Policy Support:
- Regulatory and infrastructure support, including streamlined recovery frameworks, can enhance the viability of the microfinance sector and asset recovery.
- Focus on Secured Lending:
- Diversifying into secured microfinance products may help balance risks and offer better recovery outcomes for lenders.
